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The European Commission has proposed that independent aggregators should not be required anymore to pay compensation to suppliers, as is the case in many EU member states today. According to Philip Baker of the Regulatory Assistance Project (RAP) this proposal should be supported, as it will improve the flexibility of the market and lead to lower prices for consumers. However, it may not be appropriate in the long term: once it has achieved its goals, the issue of compensation should be revisited. (Editor’s note: this article is part of a two-part debate on supplier compensation in the EU power market. See for a different view this article from Kristian Ruby, Secretary-General of Eurelectric.)
Explicit demand response is a process in which third-party aggregators pay domestic and smaller commercial customers to flex their demand. It provides these consumers with a low-risk, automated path to market participation. It also helps to ease the integration of intermittent wind and solar generation, and reduce or delay the need for network investment associated with electrifying the heat and transport sectors.
In addition to smoothing the transition to a low-carbon future, explicit demand response can deliver an immediate and beneficial impact on customer’s electricity bills. By reducing demand during periods when capacity is scarce and wholesale prices are high, demand response reduces overall market costs thereby benefiting all consumers in the form of lower electricity bills, not just those who participate. Analysis suggests that even a modest application of demand response could generate savings of up to €1.6 billion annually across the German/Austrian, Nordic, and French electricity markets alone, with greater savings expected across Europe as a whole.
However, despite these benefits and the need to encourage customers to be more flexible, significant barriers to the successful development of aggregated demand response exist. In many Member States, aggregators are required to obtain permission from the customer’s supplier to operate on a customer’s load and to compensate the supplier for lost income. These requirements undermine the already fragile economics of explicit demand response, particularly in the domestic sector, and should be removed.
The Commission’s pragmatic proposals
The European Commission has proposed, in Article 17 of the Clean Energy Package Electricity Directive, which it presented on 30 November 2016, that aggregators should no longer be required seek permission from a customer’s supplier and that they should not be required to pay compensation to suppliers. This proposal is very much to be welcomed. While aggregators do not need to recover fuel costs, they do face significant capital costs in setting up explicit demand response programs, operating costs, and also need to pay participating customers. Given present market conditions, where highly restrictive price caps are often applied, forcing aggregators to compensate suppliers directly would undermine the economics of aggregation and significantly constrain its development.
The Commission’s proposal is a pragmatic response to this situation. It promotes the development of aggregation to ensure that all consumers have the opportunity to share in the associated benefits, while recognising that suppliers have the option of “self-compensating,” i.e., retaining some of reduction in wholesale prices before passing the remaining benefits on to consumers in the form of lower retail rates.
Anticipating the impact of wholesale market reform
The response to the Commission’s proposal has been mixed. The proposals are clearly helpful to the aggregator community, however suppliers are understandably concerned about not being able to recover the cost of energy that they may have bought up-front, but which they cannot bill to consumers who have opted not to consume that energy.
These concerns are not without justification. While the proposal that aggregators should not be required to compensate suppliers is appropriate in the prevailing circumstances, this may not be the case going forward. The Commission’s welcome proposals for wholesale market reform set out in the Clean package will, once implemented, substantially raise or remove price caps and ensure that wholesale energy prices more closely reflect the value that customers place on uninterrupted supply. Aggregated demand response will clearly benefit from periods of higher and more volatile energy prices, and market reform should significantly improve its profitability.
Therefore, once market reform has been introduced and aggregators, acting on behalf of customers, can access wholesale prices that reflect the true value of the demand response services they provide, it will become appropriate to revisit the issue of compensation. At that point, the question will become what level of compensation is appropriate?
Compensation set too low could over-stimulate demand response, at some point resulting in costs to non-participating consumers that exceed the benefits; compensation set too high could reward uneconomic behaviour by suppliers and suppress cost-effective demand-side resources. Given that the timing and extent of market reform will vary across jurisdictions, determining when to revisit the issue of compensation and what compensation should apply, are decisions best left to individual Member States.
A suggested amendment to the Commission’s proposal
Therefore, in order ensure that the Commission’s proposals for supplier compensation are consistent with the other market reforms called for by the Clean Energy Package, we suggest that a sunset clause should be applied to the current wording of Article 17 paragraph 3d of the Electricity Directive, which says that aggregators shall not be required to pay compensation to suppliers or generators. This would allow Member States to revisit the issue of compensation once market reform had been fully implemented or, alternatively, when it was considered that aggregated demand response was sufficiently developed or its economics sufficiently robust.
Once either of these two criteria has been satisfied, the goal of maximizing economic efficiency seems best achieved by linking compensation to the average year-ahead or seasonal wholesale energy price. This should both approximate the purchasing costs incurred by competent suppliers while rewarding aggregators and their customers roughly in line with the net benefits that price-responsive demand would realize. This approach has the added benefit of striking a fair balance between suppliers’ legitimate interest in being compensated and the intractable question of determining exactly what costs were incurred in any given case.
An additional safeguard to ensure the appropriate but not excessive deployment of aggregated demand response might be to include a net benefits test. This would compare the benefits of aggregated demand response seen by customers in the form of reduced wholesale energy prices with the market revenues seen by aggregators. If the latter exceeded the former, this would suggest that the introduction of direct aggregator to supplier compensation was justified. This would to some extent mirror the arrangements introduced by FERC (Federal Energy Regulatory Commission) in the United States, where explicit demand response is also subject to a cost benefit test.
In conclusion, we believe that Commission’s stance that aggregators should not be required to compensate suppliers directly is appropriate, given prevailing market conditions. But once the wholesale market has been reformed in line with the Commission’s proposals set out in the Clean Energy Package, demand response will become a far more profitable enterprise, so compensation should be allowed again.
Philip Baker responds to the article by Kristian Ruby of Eurelectric, “Stimulating demand response by forbidding supplier compensation is neither fair nor efficient“:
Eurelectric suggest that the Commission’s proposal would allow aggregators to re-sell energy without paying for it. In fact, aggregators don’t sell energy as such, they offer a reduction in energy to the market. If accepted, these offers reduce the amount of energy consumed and, as no more energy can be generated than is consumed, reduce the amount of energy that needs to be generated.
Eurelectric also suggest that the benefits of demand response accrue exclusively to the aggregator. Again, this is not accurate as demand response will reduce wholesale market clearing prices, therefore benefiting all suppliers who buy energy in the market and, ultimately, consumers – assuming that suppliers pass on these price reductions via retail tariffs. Demand response therefore benefits all consumers, not just those who reduce demand.
Finally, Eurelectric suggest that the Commission’s proposal could lead to the risk of demand response being “over-used” to the detriment of consumers. However, this risk is easily addressed by applying a “net benefit” test as suggested by RAP, similar to that applied in the United States.
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.
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Boys and girls, in case you haven’t seen a good example of regulatory capture before, look no further than the fact that that independent aggregators were ever required to pay compensation to suppliers.
This is getting ridiculous!
Now we have two completely opposite opinions on the same solutions to a certain idea, called demand response. Doesn’t that show, that there’s something fundamentally wrong with the idea itself?
€1.6 bn savings? Really, just like that…to whom and compering to what…what about the costumer…there’s still no free lunch in the universe. And we already have a discussion who will have to compensate who. What I am missing here is a discussion if demand response is even worthwhile trying and if there are not better solution. Energy efficiency measures in combination with co-generation would far outperform current deficient intermittent renewables. And no demand-response can change that. As (correctly) stated in this article, it’s inherently fragile system…and can be easily shattered…that’s why demand response can function reliably only in combination with predictable (base load) supply and predictable demand…everything else is a pipe dream and basically return to a pre-industrial economy dependent on weather…
If a tobacco firm sells less cigarettes because a health insurance company gives a discount to non-smokers, does the tobacco firm have a right to compensation from the health insurance company?
You have a point here, Hans…and really, where does it end…the irony is, with that kind of regulation, there will soon be no market left to regulate…and I rather not think what will happen to economy in that case…
And “If a tobacco firm sells less cigarettes because a health insurance company gives a discount to non-smokers, does the health insurance company have a right to
ask the tobacco firm for free cigarettes (as many cigarettes as the number of cigarettes which have not been smoked thanks to the discount), so the health insurance company can make profit by selling these cigarettes to other consumers ?”
This is precisely what several aggregators (not all) demand: they claim they have the right to sell kwhs on the electricity markets without paying for them or generate them beforehand – the amount of free kwh being equal to the amount of kwh not consumed or consumed later ; ofc these kwhs have to be generated – since they are sold and then consumed by someone else; who pays the generator then ? in France, it is RTE (the TSO) and the bill is passed away to consumers via the network tariff, and similar schemes are already in place in many countries. And (almost) everyone applaud and denounce the bad, bad suppliers (yet suppliers just want to be paid for any kwh that they previously owned and that is given away to aggregators – no “compensation” whatsoever here – just a payment in exchance for the change of ownership of kwhs).
These guys might be the cockiest, most efficient lobbyists we will ever see, seing how so many EU politicians support their amazingly preposterous claims.
The whole debate is so weird. I just can’t believe what i read. All these comparisons are so wrong. Ofc aggregators sell kwhs (how do you think they earn their revenue ?). WHy there is a deabte ?
Because they want to have the right to sell these kwh without buying them from the previous owner (which is often a supplier who does not want to cede its own kwhs for free), which is so dumb if you formulate it correctly. It is that simple. The word “compensation” is not appropriate at all here, once again this is a payment for acquiring kwhs. Orwell was such a visionary …. twisted words can twist our minds so easily.
@Hans, in your story ofc the tobacco firm has no right to any compensation at all; but this is not a good comparison. Let me give you a proper one: “If a tobacco firm sells less cigarettes because a health insurance company gives a discount to non-smokers, does the health insurance company have a right to
ask the tobacco firm for free cigarettes (as many cigarettes as the number of cigarettes which have not been smoked thanks to the discount), so the health insurance company can make profit by selling these cigarettes to other consumers ?”
Guys, there have dozens of billions at stake here, you should have a real look into the issue instead of taking position without understanding that you are being manipulated.
Do you know that the largest european aggregator is owned by the richest French family, and that they spend fortunes in lobbying too? These guys are bandits, they manipulate politicians with outright lies and fallacy so they can earn billions on the back of the small consumers who ofc will end up paying the bill.
Have you heard a single supplyer complaining about energy efficiency ? No you havent, they wouldn’t dare asking REAL compensation payments, e.g. to the guy whose job is to insulate your home. The word “compensation” should be banned from this debate, so freaking misleading ….
Aggregrators do not sell kWhs, they sell “anti-kWhs” to grid operators to help balance the grid. They also do not not get these for free, they pay the small power consumer to reduce their power consumption when asked.
Of course the power retailer will be irritated by this. They made a prediction of demand and bought power to cover that demand. The demand side management screws up the prediction. However, unless you are a very large power consumer, you did not sign a contract to consume power in a predictable way.
Ok you should dig the issue, because you do not understand how their business model works, and how balancing markets work. The irritation of suppliers has nothing to do with the fact that demand side screws up their prediction, it has do to with the fact that they could have to buy kWh and then cede them for free to aggregators.
1. as to balancing markets
They work almost as normal markets : you sell or buy kwhs on these markets, with a small bonus for the flexibility (some claim that only flexibility is sold and paid for, which is so not true). On this market, when a TSO pay ~10 €/MWh to a producer to increase the production, or to a consumer (or aggregator) to decrease the consumption, ~9,5 €/MWh is paid for the MWhs and ~0,5 €/MWh for the flexibility (in other words the producer can’t sell the extra production elsewhere as the TSO bought the MWhs, and the consumer has to be the owner of the MWh before selling it to the TSO). Aggregators lie to non-specialists by claiming they are only paid for the flexibility, but is is not true as they demand the ~10 €/MWh and not only the ~0.5 €/MWh.
2. as to the business model of aggregators
In France many aggregators have been working for years with very large consumers, all of them pay suppliers and find it perfectly normal. When the contractual price is lower than the market price, they “buy” the electricity to the supplier instead of the firm (who in the same time lowers its consumption), and they sell these kwhs on the market with a profit. Most stkeholders have validated this model, even though it remains a bit shaky. Such operations take place on several markets, not only for balancing purposes.
And now some aggregators disagree and want to be able to sell the electricity on the markets but without buying it (well, French aggregators have been granted this abnormal right, but only for aggregators working with small consumers and only on the balancing market, and now some want to remove these limits so they can earn billions on the back of small consumers who will end up paying the bill).
Clearly a case of incumbents protecting their market share and business model. Instead of protecting an out-of-date business model, a supplier that wants to remain relevant in future should join the aggregators and integrate demand side management in its business model.
Interesting debate about Demand (Side) response but fails to provide solution. The demand side should be separated to SMEs without prediction of their consumption and Industrial and Commercial users with firm prediction on the consumption. In the latter group the supplier is compensated because charges for the scheduled delivery irrespective on the consumption the aggregator and the consumer shares the added value of the flexibility. In the former group as the consumer signed up for a supply of their consumption which is predicted by the supplier only. For these SMEs and their supplier the best solution is to become the aggregator as well, build out the infrastructure and enjoy the benefits.
I would like to repeat my previous comment here, because I think it is still relevant and more context is needed for the debate:
An element that is forgotten in this discussion is the impact on the balance responsible party, the electricity grid must always be balanced (production = consumption). It is the job of the balance responsible party (often the supplier) to guarantee this for all the grid users in his portfolio, balance is maintained by forecasting, buying and selling electricity, in/decreasing production of own production unit, importing/exporting electricity etc. If the BRP is not in balance, he pays an imbalance tariff (sort of fine) to the TSO, who is responsible for the balance in the control area (mostly a whole country or region).
Therefore if there is unexpected change in consumption of a lot of grid users because of an external signal by a party who is not the BRP (for example explicit DR by an independent aggregator), there is an influence on the imbalance (and on the fine that the BRP must pay) on which he has no influence. A compensation is therefore necessary to maintain fairness in competing.
A very good source on this issue and an overview of several market models on how the problem can be solved, is this paper by ENTSO-E:https://www.entsoe.eu/Documents/Publications/Position%20papers%20and%20reports/entsoe_pp_dsr_web.pdf
The market design in the US is completely different (no separation between DSO/TSO and the suppliers, no unbundling etc.), so solutions and decisions of US regulators cannot be compared. The European context is far more complex and can differ from country to country. The best solution is therefore a market design specifically adapted to circumstances in each country, but that adheres to principles that are the same for everybody (position of CEER & ACER, organization of European regulators): http://www.ceer.eu/portal/page/portal/EER_HOME/EER_PUBLICATIONS/CEER_PAPERS/White%20Papers/Positions/EuropeanEnergyRegulators_WhitePaper-3-Facilitating%20Flexibility_2017-05-22_PUBLIC_.pdf.