Issuance of New Rules

On March 15, 2011, the Federal Energy Regulatory Commission (“FERC”) issued an order implementing new regulations relating to compensation for demand response in wholesale energy markets administered by regional transmission organizations (“RTOs”) and independent system operators (“ISOs”). As defined by FERC, demand response is a reduction in the consumption of electric energy by customers from their expected consumption in response to an increase in the price of electric energy or to incentive payments designed to induce lower consumption of electric energy.

Under the new regulations, RTOs and ISOs must revise their market rules to provide that a demand response resource will receive the locational marginal price (“LMP”) when its dispatch is cost-effective under a “net benefits test.” Recognizing that the dispatch of demand response resources will decrease the amount of load paying for energy, and could potentially also increase the cost to remaining load, FERC's net benefits test looks at whether the LMP decrease resulting from the dispatch of demand response resources exceeds the cost of dispatching and paying LMP to those resources. The net benefits test will be implemented using a monthly threshold price, to be updated each month by each RTO/ISO, which will determine the theoretical point at which the dispatch of demand response resources is deemed cost-effective. As discussed below, FERC further directed RTOs and ISOs to determine whether they can incorporate the net benefits test on a dynamic basis in their dispatch algorithms in the future. The cost of compensating demand response resources is to be allocated to customers benefiting from the lower LMP resulting from the dispatch of such resources.

Industry Reaction

While strongly supported by many demand response providers, FERC's approach was generally opposed, in both comments on a notice of proposed rulemaking and requests for rehearing of the March 15 rule, by other industry sectors, state regulators, and even some demand response resources. Among other things, various parties challenged FERC's jurisdiction to prescribe compensation for demand response based on its jurisdiction to regulate rates for wholesale sales of energy in interstate commerce.

Other parties, as well as dissenting Commissioner Moeller, argued that, despite FERC's stated goal to provide “comparable” compensation to demand response, the new rule gives demand response resources preferential treatment because such resources not only will receive the LMP but will also obtain savings from not consuming, and having to pay the retail rate for, energy. Commissioner Moeller and various parties further argued that providing full LMP compensation to demand response will distort price signals and lead to inefficient consumption and production decisions, and that demand response resources should be compensated at the LMP minus the applicable retail rate, rather than receiving the full LMP.

Other objections included, but were not limited to, arguments that FERC should have allowed each RTO/ISO to determine an appropriate compensation methodology for its respective region; that demand response and generation provide different services and should not be treated as interchangeable for compensation purposes; and that FERC has not shown that its compensation approach is necessary for or will result in greater demand response participation.

Next Steps

FERC's order setting forth the new demand response compensation rules was the subject of numerous requests for rehearing, which currently remain pending before FERC. Once FERC acts on rehearing, it appears highly likely that FERC's orders will be appealed to a federal court of appeals.

Absent a stay (and requesting rehearing of a FERC order does not stay the order's effectiveness), RTOs and ISOs will need to file tariff revisions by July 22, 2011 to comply with the new regulations or make filings explaining why their tariffs already comply with those rules, including revisions to implement the net benefits test, to measure and verify the provision of demand response, and to implement a cost allocation mechanism. Those tariff revisions will only become effective when accepted by FERC.

In addition, FERC acknowledged that current system limitations prohibit RTOs and ISOs from implementing the net benefits test on a dynamic basis. As a result, and as discussed above, the current rules require each RTO and ISO to establish a monthly threshold price to determine when the dispatch of demand response resources will be cost-effective, even though FERC acknowledged that this approach “may result in instances both when demand response is not paid the LMP but would be cost-effective and when demand response is paid the LMP but is not cost-effective.” Believing that a dynamic approach would be preferable to the monthly threshold price, FERC also directed each RTO and ISO to undertake a study to examine the possibility of integrating the impact of dispatching demand response into their dispatch algorithms, and to file the results of such studies by September 21, 2012.