Demand response can drastically lower energy bills – if suppliers don’t get “compensated”

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photo Tom Taker

photo Tom Taker

New research commissioned by the Regulatory Assistance Project (RAP) finds that demand flexibility can save many billions of euros in electricity costs. As the European Commission is pondering the design of a new and interconnected energy market for Europe, it needs to make sure these benefits are realised, writes Phil Baker, Senior Advisor at RAP. Brussels should resist calls to “compensate” energy suppliers for perceived losses as a result of demand response arrangements.

By managing electricity consumption in response to price signals, customers can, either directly or through a third party (a demand aggregator), participate in the market and benefit from lower power costs. 

In order to more fully understand the potential benefits of customers managing their electricity consumption, RAP commissioned an analysis – Benefiting customers while compensating suppliers: getting supplier compensation right – of the impact of demand response on the French, German-Austrian, and Nordic day-ahead markets. The analysis demonstrates that all power customers benefit from increased consumer market participation and that, while varying from year to year, the potential benefits are considerable.

Philip Baker figure 1

This is illustrated in figure 1 which shows the predicted reduction in the French, German-Austrian, and Nordic day-ahead market costs due to the application of demand response. Depending on the level of demand response assumed (how much and for how many hours), the cost to suppliers in sourcing energy for their customers could be reduced by as much as €1600 million across the three markets. Assuming sufficiently competitive retail markets and/or adequate regulatory oversight, these savings should be passed through to customers in the form of lower retail prices.

The issue of supplier compensation

However, for the benefits to be reaped by customers an appropriate market design is needed. Some argue that suppliers should receive compensation from consumers or from the demand aggregators acting on behalf of consumers. (Demand aggregators “bundle up” the demand flexibility of many smaller customers.) In France this is already current practice: there suppliers are compensated for the loss of revenue resulting from demand response by a nationally administered arrangement.

The rather tenuous reasoning behind this claim is that suppliers have purchased energy from generators in anticipation of customers’ needs. When they find that customers don’t use the energy, they appear to face a loss. By contrast the customers make money from their “demand response” behaviour: they lower their consumption and can sell this “negative consumption” on in the market or as balancing service to the System Operator.

Suppliers could also gain by making use of demand response, if they chose to do so

However, this “supplier compensation”, which can take place either by a mandated negotiated agreement between supplier and demand aggregator or by an administered arrangement, appears both unjustified and counterproductive.

The justification for supplier compensation is flawed since, as demonstrated by RAP’s analysis, suppliers gain significantly from demand response in the form of lower energy sourcing costs. Suppliers could also gain by making use of demand response, if they chose to do so.

It is also counterproductive, since it would destroy the benefits that can be gained from demand response arrangements. In France, since 2014, some 80 to 87 percent of all demand response has been taken up by compensation payments. The revenue remaining for consumers or demand aggregators averaged some €7/MWh, insufficient to meet operational let alone capital costs.

A simple alternative

If suppliers need to be compensated, an alternative way needs to be found. An obvious solution would be that suppliers retain some of savings associated with reduced day-ahead wholesale market prices rather than passing all of those savings through to customers in the form of lower retail prices.

It is likely that potential savings will increase steadily over time with the continued deployment of intermittent generation and increasing energy price volatility

This solution becomes even more obvious when one considers that the costs incurred by suppliers are only a tiny fraction of their overall savings. In fact, in the scenarios investigated by RAP, the savings seen by suppliers in the form of reduced wholesale market costs exceed the likely reduction in revenues by a factor of at least 10 and as high as 70, providing more than enough headroom for suppliers to recover any lost income by this means.

Conclusions

Customer participation in the electricity market though managing consumption can deliver real benefits for all consumers. For the scenarios assumed in the analysis reported here, annual savings in consumers’ energy costs across the French, German-Austrian, and Nordic markets could amount to €1.6 billion—clearly, the savings to be achieved across the whole of Europe would be even more significant. It is also likely that potential savings will increase steadily over time with the continued deployment of intermittent generation and increasing energy price volatility.

However, these potential savings could be lost if customers, or aggregators operating on their behalf, are required to compensate suppliers directly for energy bought up-front but sold-on and not billed. Given the importance of demand flexibility to the cost-effective delivery of Europe’s energy policy goals, we urge the Commission and other EU entities to support its deployment by adopting a balanced approach to supplier compensation as they develop new proposals on power market design.

Editor’s Note

The Regulatory Assistance Project (RAP) is a globally operating independent and nonpartisan team of experts. Philip Baker (pbaker@raponline.org) is an energy consultant working with RAP and other clients on power system technical and commercial issues, integrating renewable energy sources, and European electricity market integration. This article is based on a blog post on the RAP website. For the full report see here.

Comments

  1. Mike Parr says

    “If suppliers need to be compensated” At no point in this article was a coherent reason given why this should be apart from “suppliers have purchased energy from generators in anticipation of customers’ needs”. That would be fine if it, for example, EdF (generation) and EdF (retail) were companies separately listed on the Paris bourse. The reality is that there is a synthetic separation.

    Continuing downwards. If I owned a CCGT in France, I’d have a gas contract for a certain volume. If I was stupid I’d let the contract have penalties for the use of more or less gas. But the reality is that France has a 3 month storage capacity for gas. Using more or less of this capacity has minimal financial impact. Generating more or less elec to meet more or less demand should be normal operation. Ditto for the nukes.

    Why should any demand aggregators need to compensate generators? What is happening is that the demand aggs’ are disintermediating the retailers. Well, that’s markets – it is a market development – if you “believe” in the efficacy of markets then that’s what happens when gaps start to open in a “market” for new developments. However, what we have here is the usual suspects (yes we are talking about you EdF, RWE, EON etc) wanting to take the “a little bit pregnant” approach towards markets. You are either in a market (where good & bad things happen vis-a-vis your competitive position) or you ain’t – you are either pregnant – or you ain’t. There is NO half way house. That said, the reality is that there is no “energy market” & the usual suspects want to keep it that way – hence the special pleading with respect to compensation when they see their “competitive” positions being eroded.

    I buy 5 loaves of bread from my local bakers each week. When on holiday I buy none – should I “compensate” them for their loss of business when I am on holiday? That’s the logic used by the usual suspects.

  2. Hans says

    Demand side response is usually used when supply threatens to be less than demand. This can be caused by a higher than anticipated demand, or by a lower than expected supply, for example when a power plant trips. In the first case the retailer sells at least at much as without the demand side response and thus needs no compensation. In the second case it seems more fair that the owner of the failing power plants pays compensation to the retailer than that the consumers would do that. Furthermore most demand side management does not remove the demand, but only shifts it in time, so overall turnover of the retailer* remains the same. Which makes it even more bewildering that retailers would need compensation. So it is difficult to understand why the compensation is there in the first place.

    Is there something I am overlooking?

    *I use “retailers” because “suppliers” is sometimes also used to describe power producers.

  3. Paul Giesbertz says

    Consumers are free. If a consumer wants to act on the market (e.g. by selling demand flexibility as operating reserve) and at the same time wants to be supplied by a supplier for its residual demand, then of course this supplier should also be free to adapt its price. Please note that flexibility and electricity are not separate commodities that are traded or valued on separate markets. Instead flexibility is a characteristic of capacity (of the consumer but also of a generator). The more flexible capacity is, the more revenues can be obtained on the power market.

  4. Pavla says

    Higher competition in any market will lower prices in that market, indeed. But should that imply a right of a subsidy for entering competitors, i.e. putting the different market actors on an uneven playing field? For example, if a new gas peaking plant starts bidding into the market, it can bring down the prices. But it still needs to pay for the fuel and stay in balance. Why should that not be the case for aggregators on the demand side? The article seems to be missing the point that the electricity whose consumption is to be shifted (not saved – that is why the “5 loaves of bread” example does not work) still needs to be generated, and therefore, needs to be sourced and paid for by someone.

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