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.
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.
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.
The Regulatory Assistance Project (RAP) is a globally operating independent and nonpartisan team of experts. Philip Baker (firstname.lastname@example.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.