The European Commission has proposed a general framework for independent aggregators in its new draft Electricity Directive to incentivise the development of Demand Response in Europe. According to the Commission, aggregators should not be required to compensate suppliers for the electricity sourced and only exceptionally for the imbalances induced. But a new study carried out by independent experts from consultancy DNV GL for Eurelectric shows that this is neither fair nor efficient, writes Kristian Ruby, Secretary-General of Eurelectric. (Editor’s note: This article is part of a two-part debate on supplier compensation. For a different view, see this article, A pragmatic proposal for supplier compensation, by Philip Baker of the Regulatory Assistance Project/RAP.)
Demand Response will be one of the building blocks of future wholesale and retail markets. Demand side flexibility helps to integrate the increasing amounts of intermittent renewable energy into the system and benefits consumers by giving them more control over their electricity consumption. Therefore utilities across the EU are keen to develop demand response on a commercial basis.
But a level playing field and fair rules for supplier compensation will be paramount to bringing this techhnology to scale.
The new Directive proposed by the European Commission on 30 November last year as part of the Clean Energy Package aims to encourage the adoption of demand response. One way in which it does this is by defining a framework for a new player in the electricity value chain: the aggregator, who combines customer loads and generated electricity for trading on the energy market.
The DNV GL study commissioned by EURELECTRIC analyses the Directive’s proposed model for independent aggregators. Regarding aggregators, the provisions in the Draft Electricity Directive say, among other things, that “Aggregators shall not be required to pay compensation to suppliers or generators” (article 17.3.d). An exception is made in some (but not all) cases where the aggregator causes imbalance in the system (article 17.4).
Article 17.3d is linked to the general market principle that energy procured also needs to be purchased. In the study this is termed “the bulk energy issue”. The proposal implies that the independent aggregator can re-sell energy – which it derives from load shedding among its customers – on the market without paying for it.
With demand response activation, the independent aggregator takes control of energy that was procured by the supplier for his consumer(s). The aggregator re-sells the electricity sourced by the supplier by re-routing it back to the power market. Without paying for it.
If implemented as suggested, this would correspond to a form of electricity short-selling without the supplier’s consent, providing liquidity and flexibility to the intraday and balancing market. The aggregator generates revenues at the cost of the supplier. According to DNV GL, this conflicts with the general market principle that energy sold needs to be bought or compensated for.
Regardless of the Demand Response’s benefits to the market, there is no reason why any market participant should not pay for the sourcing of energy and the energy taken from another market participant, in this case the supplier, without the latter’s consent.
Under the current proposal, then, the independent aggregator becomes a free rider, causing external costs to the supplier and ultimately to the whole system. The benefits of Demand Response activation accrue exclusively to the aggregator, while the costs are borne by the supplier.
This is likely to distort the market for power supply as it will affect especially smaller suppliers and new entrants. Indeed, if a small supplier has a number of customers who are active with aggregators, this will hit them harder.
Moreover, under the proposed framework, Demand Response activated by an independent aggregator, is likely to lead to economic inefficiency from an overall system perspective. When the actual costs of Demand Response, i.e. the loss in revenues to the supplier due to the bulk energy issue, are higher than the revenues generated by the aggregator, Demand Response activation is inefficient from a system perspective.
This is so because the aggregator will sell the associated energy even when the market price (e.g. intraday or balancing) is below the supplier’s procurement cost. See Figure 1.
Figure 1: Illustration of the Economic Efficiency and Inefficiency of DR depending on the price at which DR is activated and energy is procured by supplier (Source: DNV GL) The figure illustrates two situations for DR activations by the aggregator that may turn out to be efficient (left) and inefficient (right) from the power system’s perspective. DR activation will be inefficient when the price at which DR is activated and energy re-routed to the market, e.g. for balancing energy provision or for energy trades on the intraday wholesale (ID) market, is lower than the supplier’s decline in revenues from bulk energy sales, which roughly corresponds to the price at which the supplier procured the energy. If the aggregator is freed from any compensation for the bulk energy issue, inefficient activation of DR is a considerable risk.
The report by DNV GL also discusses Article 17.4 of the Draft Directive. If enacted, this would give rise to an additional inefficiency which the authors call the ‘imbalance issue’. This is the difference between the scheduled and the actual consumption in the supplier’s supply portfolio due to Demand Response activation by an independent aggregator. This imbalance is subject to central imbalance settlement (usually with the TSO).
The EU proposal does not allow for not compensating such imbalances induced by Demand Response activation, except in exceptional cases. While the supplier has no influence on the activation of Demand Response by the aggregator, he would have to take the financial responsibility for the imbalance.
Overall, the DNV GL’s study shows that the current EU proposal is likely to lead to market inefficiencies. Sound market design including Demand Response aggregation requires solutions that address the bulk energy and the imbalance issue.
In line with DNV GL’s recommendations, the power sector is calling on European decision-makers to to resolve the bulk energy issue by allowing full compensation of the supplier. Member States should be allowed to set the appropriate rules at national level.
When it comes to imbalances induced on other market participants, such as the supplier or a Balancing Responsible Party (BRP), mechanisms should be introduced to neutralize this effect. This is already the case in some Member States. Alternatively, the aggregator should be made financially responsible for the imbalance it induces on other market participants.
Supplier compensation could be implemented in various ways, building upon models already available in Member State regulation, to accommodate different market set ups and ensure regulatory continuity where a functioning framework is already in place.
The power industry supports the EU in encouraging the establishment of independent aggregators to enable more people to benefit from demand response. But the framework must ensure that demand response is deployed in a cost-efficient way in order to avoid spillover effects on other consumers’ bills and reduces the overall attractiveness of these services.
Setting up a temporary framework that gives specific advantages to specific market players, a solution proposed by the Regulatory Assistance Project (RAP), may not be the right way to proceed. It would indeed create regulatory uncertainty for aggregators and business models will then be established on this basis which will be difficult to adjust later on.
Kristian Ruby is Secretary-General of Eurelectric.
Note that the first two paragraphs of the article were edited slightly some hours after the original publication.
 In terms of economics: whenever the external cost of DR activation caused by the aggregator exceeds the actual value of his sales, a free-rider inefficiency is caused.