Demand Response Parity in Wholesale Markets Hinges on FERC 745 Outcome

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1 RESEARCH North America Power and Utilities Energy Efficiency Demand Response Parity in Wholesale Markets Hinges on FERC 745 Outcome Supreme Court Review of Order 745 Key to Demand Response s Future in Regional Electricity Markets December 22, 2014 Policy Brief Author Erin Carson Senior Policy Analyst Eric Davis Research Manager Contact (212) info@enerknol.com Key Takeaways: Demand response (DR) participation in wholesale power markets has increased over the past six years, in part as a result of multiple FERC Orders Removal of DR from organized electricity markets would favor generators through increased sales; this could lead to higher associated emissions and peak power prices FERC Order 745 vacatur could lead to further litigation over demand response participation in all organized electricity markets Related Research Wholesale Demand Response Market Threatened by Order 745 Decision PJM Aims for Improved Reliability with Proposed Capacity Market Reforms Entities Mentioned: California ISO Constellation Energy EnerNOC FirstEnergy Midcontinent ISO New England ISO New England Power Generators Association New York ISO PJM Interconnection This report is for industry information only and we make no investment recommendations whatsoever with respect to any of the companies cited, mentioned, or discussed herein. Please refer to the end of this report for analyst certification(s) and other important disclosures.

2 Regional Generators Challenge FERC DR Order Under Section 205 of the Federal Power Act (FPA), the Federal Energy Regulatory Commission (FERC) holds jurisdiction over the rates and all rules and regulations affecting those rates for wholesale electric energy transmission in interstate commerce. Demand response (DR) participation in wholesale power markets has increased over the past six years, in part as a result of multiple FERC Orders (Figure 1). Demand response is broadly defined as load curtailment commitments in response to high prices, peak system demand, or other load management actions. FERC Orders key to DR growth in wholesale electricity markets Figure 1 FERC Orders Pertaining to Demand Response October 17, 2008 FERC issued Order 719 requiring RTOs and ISOs to compensate DR comparable to other (generating) resources, and accept wholesale market bids from aggregated retail customer demand response providers. March 15, 2011 FERC issued Order No. 745 (the Order), requiring RTOs and ISOs to compensate DR in wholesale energy markets at the full locational marginal price (LMP). May 23, 2014 Court of Appeals for the DC Circuit (Appeals Court) ruled in Electric Power Supply Association (EPSA) v. FERC, deeming DR a retail market product under state jurisdiction, invalidating FERC s jurisdiction over DR compensation in wholesale (energy) markets. September 17, 2014 The Appeals Court denied petitions for rehearing. October 20, 2014 The Appeals Court granted FERC a stay on its ruling, giving the Solicitor General (on behalf of FERC) until December 16 to file a petition for writ of certiorari for the Supreme Court to review the case. December 8, 2014 The Solicitor General applied -- and was granted -- for an extension to January 15 to file petition for a writ of certiorari to review the EPSA v. FERC Order 745 decision. Source: EnerKnol data In addition to the Electric Power Supply Association (EPSA) challenge of Order 745 in May 2014, complaints against DR participation in capacity markets have surfaced particularly in the PJM Interconnection (PJM) and New England ISO (ISO-NE) regions. Generators and generator groups say the Order 745 decision extends to capacity markets, and that by law, DR should not be permitted to participate. On September 22, 2014 FirstEnergy a mid-western investor-owned utility with a generation fleet of nearly 18 gigawatts (GW) submitted a complaint to FERC against PJM seeking removal of DR as a capacity resource in its tariff provisions and recalculation of its May 2014 Reliability Pricing Model (RPM) Base Residual Auction (BRA) a three-year forward capacity auction for the delivery year. PJM issued a response on October 22 urging FERC to deny the complaint, stating that further litigation of Order 745 to the capacity markets could cause extended operational and financial disruptions to PJM s RPM capacity market EnerKnol, Inc. All rights reserved. 2

3 In an additional challenge to DR participation in capacity markets, on November 14 the New England Power Generators Association (NEPGA) filed a complaint to FERC requesting ISO-NE disqualify DR from its February (ninth) Forward Capacity Auction (FCA) for the delivery year, and revise its tariff to exclude DR from all future FCAs. In a December 4 response, ISO-NE requested FERC reject the complaint primarily for not wholly demonstrating that the current tariff is not just and reasonable per section 206 of the FPA. Impacts of Vacating Order 745 Would Vary for Wholesale Markets The vacatur of Order 745 would impact the power sector by eliminating the existing wholesale market DR compensation program, despite relatively low DR participation when compared to the capacity and retail markets. California Wholesale DR Markets Lack Participation Despite ISO Efforts California currently lacks large-scale DR participation in its wholesale markets. This is despite allowing participation since 2010 through its Proxy Demand Resource product; implementing its Reliability Demand Response Resource since May 2014; and listing DR at the top of its energy resource loading order. California ISO s Supply Resource Demand Response Integration Working Group is currently exploring how to better incorporate DR into all markets, regardless of the FERC Order 745 uncertainty. MISO-Region DR Limited by High Threshold and State Regulations The Midcontinent ISO (MISO) covers all or portions of 16 states, the majority of which are regulated, as opposed to PJM and NY-ISO deregulated states. The majority of the approximately 10 GW of MISO-region DR resources are emergency Load Modifying Resources under regulated utility control and do not set MISO market prices when dispatched. To participate in MISO wholesale and ancillary markets, DR resources must be at least 5 MW. The combination of this high threshold with the fact that most MISO states do not allow DR resource aggregation have limited non-emergency DR proliferation in the region. Any FERC Order 745 decision would have limited impacts to the MISO region, as DR is already subject to state jurisdiction. 5 MW threshold and state regulations restrict DR participation in MISO markets DR Participation Primarily at Retail Level in NYISO Region The New York ISO offers wholesale market DR participation through its Day- Ahead Demand Response Program (DADRP). Despite this offering, the majority of the state s DR participation is through retail and reliability programs. Due to this factor, the FERC Order 745 case would likely have a limited impact on the state s DR programs. PJM Real-Time DR Performance Improved After Order 745 Without FERC oversight of DR compensation in wholesale markets, state and state public utility commissions (PUCs) may take a more active role in formulating their own state-specific DR programs. The implication of a stateled approach is that programs may varyingly compensate DR in the wholesale markets, if allowing DR participation at all. This could add market barriers to 2014 EnerKnol, Inc. All rights reserved. 3

4 DR expansion, depending on program compensation levels. Since Order 745 implementation, DR participation and performance actual megawatt-hour (MWh) DR divided by committed DR MWh in the PJM day-ahead and realtime energy markets has significantly improved (Figure 2). Figure 2 Wholesale Market DR Performance Pre and Post Order 745 Source: EnerKnol analysis of PJM data PJM outlines in an October 6, 2014 wholesale DR whitepaper that, depending on Order 745 outcomes, DR may not receive direct wholesale market compensation in the future. Instead, PJM proposed its Price-Responsive Demand (PRD) program in which load-serving entities (LSEs) and other entities would react to nodal, not zonal (LMP) prices, and would simply pay for less load at energy market clearing prices, as opposed to being directly compensated for energy use reductions. PJM already permits PRD in its dayahead energy market, in which LSEs stipulate a price at which they would curtail energy use. In the real-time market, a LSE can provide forecast PRD which PJM will enter into its regional dispatch models. Despite the proposed PRD programs, PJM wholesale DR market participation is currently through the Economic Load Response and Day-Ahead Scheduling Reserve Market programs. PJM s Proposed Capacity Market Reforms Pose Challenge for DR In the most recent PJM BRA, DR resources cleared nearly 11 GW, 6.6 percent of total cleared capacity (Figure 3). However, due to the events of the 2013/2014 winter, PJM determined that the compensation and nonperformance penalty levels for committed BRA capacity resources are not sufficient to ensure future system reliability. In response, PJM released an updated Capacity Performance Proposal on October 7 that establishes two main products Base Capacity and Capacity Performance. The proposal aims to transition DR from the supply- to demand-side resource via bids for capacity demand reductions from LSEs, starting in the May 2015 BRA for the 2018/2019 deliver year EnerKnol, Inc. All rights reserved. 4

5 Cleared DR (MW) Total Cleared (MW) RESEARCH POWER & UTILITIES DECEMBER 22, 2014 Figure 3 PJM BRA Auction Results - DR and Total Cleared Capacity 16,000 14,000 12,000 10,000 Total Cleared Capacity Demand Response 9,282 14,118 14,833 12,408 10, , , ,000 8,000 7, ,000 6,000 4,000 2, , , , ,000 Delivery Year Source: EnerKnol analysis of PJM data In the near-term, PJM may keep DR as a supply-side BRA product for its May 2015 BRA, pending Order 745 decisions and final FERC approval of the Capacity Performance Proposal. DR is also eligible to bid as a Base Capacity resource in the next two BRAs pending proposal approval if the resource can commit to an unlimited number of interruptions during the summer period of June through September and must be capable of maintaining each such interruption for at least a 10-hour duration between the hours of 10:00 a.m. to 10:00 p.m. EPT. A transition to a 100 percent CP for the 2020/2021 delivery year May 2017 BRA exposes DR resources to more stringent eligibility requirements and higher non-performance penalties under Capacity Performance product requirements, which could effectively eliminate the majority of DR in the PJM RPM. PJM DR capacity performance requirements pose significant challenge Despite Smaller Size, ISO-New England DR Market is Well-Established With interruptible load operations since 1987, and a formal program more than a decade old, the day-ahead (DA) and real-time (RT) ISO-NE DR markets are well-established. The ISO initially relied on DR for reliability purposes, but also offered a price-responsive program. The majority of ISO-NE wholesale DR is cleared in the DA market, however additional assets may be committed in the RT market in response to system load and pricing events. The introduction of the ISO-NE FCA shifted many DR assets away from the DA and RT markets, which significantly reduced wholesale DR market participation, despite the introduction of FERC Order 745 (Figure 4) EnerKnol, Inc. All rights reserved. 5

6 Cleared DR (MW Total Cleared (MW) RESEARCH POWER & UTILITIES DECEMBER 22, 2014 Figure 4 ISO-NE Real-Time Demand Resources: Cleared MWh and Payments Source: EnerKnol analysis of ISO-NE data Cleared DR capacity grew in five out of the first six ISO-NE FCAs, however this changed significantly in FCA-7 when EnerNOC and Constellation Energy withdrew their DR resources (Figure 5), likely due to sustained low auction clearing prices. Demand response participation dropped by 45 MW in FCA-8, however more than 300 MW of new energy efficiency resources were cleared. Figure 5 ISO-NE FCA Results - DR and Total Cleared Capacity 1,600 1,500 1,400 1,300 1,200 1,100 1, Total Cleared Capacity Demand Response 1,195 1, ,363 1,382 1, ,000 39,000 38,000 37,000 36,000 35,000 34,000 33,000 32,000 Source: EnerKnol analysis of ISO-NE data Auction Number and Delivery Year Similar to PJM, ISO-NE has proposed to more closely link resource payments with performance, with an aim to increase resource reliability. The pay-forperformance proposal will only consider DR for performance payment during scarcity conditions in peak reporting hours (generally 2-5p.m. during summer weekdays; 6-7p.m. for winter weekdays) or seasonal peak hours (load greater 2014 EnerKnol, Inc. All rights reserved. 6

7 than or equal to 90 percent the forecast peak load to occur once every two years). The aforementioned NEPGA complaint aims to disqualify DR from its February 2015 FCA, on the basis of the FERC Order 745 vacatur. Due to the pending status of the Order 745 case, it is unlikely any action will be taken to impact DR participation in the February ISO-NE FCA. DR Future Hinges on Potential Supreme Court Case DR compensation and participation in wholesale energy and potentially capacity markets is uncertain, and depends on if the Solicitor General petitions the Supreme Court to review the FERC Order 745 vacatur, and if the review is granted. A Supreme Court review of the Order 745 case could conclude in a redefinition of FERC jurisdiction over DR, and more extensively, a refinement of DR language in the Federal Power Act. If Order 745 is ultimately vacated, DR resources could be disincentivized from participating in wholesale electricity markets if the LMP is no longer the mandated compensation rate, if being allowed to participate at all. In the absence of an economic benefit for wholesale DR, incentive for load reduction will diminish, and power generation and associated emissions will rise. Also, an Order 745 vacatur could support further DR litigation arguments by FirstEnergy and NEPGA, despite the far-reaching implications of the complaints. However, as stated by EnerNOC in a 3Q conference call, there is significant opposition to FirstEnergy s complaint, including ten states and various other heavyweights. Without wholesale DR market participants to reduce peak demand, the most expensive peaker power plants will return to the grid, raising power prices in spot markets. Efficiency and generation reduction goals will also suffer from the decision to exclude DR from wholesale energy. Rather than markets reducing total electric generation or replacing traditional peak electric generation with renewables the least cost-effective, traditional generation sources will produce greater emissions EnerKnol, Inc. All rights reserved. 7

8 Disclosures Section RESEARCH RISKS Regulatory and Legislative agendas are subject to change. AUTHOR CERTIFICATION By issuing this research report, Erin Carson as author of this research report, certifies that the recommendations and opinions expressed accurately reflect her personal views discussed herein and no part of the author s compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. IMPORTANT DISCLOSURES This report is for industry information only and we make no investment recommendations whatsoever with respect to any of the companies cited, mentioned, or discussed herein. EnerKnol, Inc. is not a broker-dealer or registered investment advisor. Information contained herein has been derived from sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be a complete analysis of the company, industry or security involved in this report. This report is not to be construed as an offer to sell or a solicitation of an offer to buy any security or to engage in or refrain from engaging in any transaction. Opinions expressed are subject to change without notice. The information herein is for persons residing in the United States only and is not intended for any person in any other jurisdiction. This report has been prepared for the general use of the wholesale clients of the EnerKnol, Inc. and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient you must not use or disclose the information in this report in any way. If you received it in error, please tell us immediately by return to info@enerknol.com and delete the document. We do not guarantee the integrity of any s or attached files and are not responsible for any changes made to them by any other person. In preparing this report, we did not take into account your investment objectives, financial situation or particular needs. Before making an investment decision on the basis of this (or any) report, you need to consider, with or without the assistance of an adviser, whether the advice is appropriate in light of your particular investment needs, objectives and financial circumstances. We accept no obligation to correct or update the information or opinions in it. No member of EnerKnol Inc. accepts any liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this report and/or further communication in relation to this report. For additional information, please visit enerknol.com or contact management at (212) Copyright 2014 EnerKnol, Inc. All rights reserved. No part of this report may be redistributed or copied in any form without the prior written consent of EnerKnol, Inc EnerKnol, Inc. All rights reserved. 8