In a divided opinion, FERC recently issued its long-awaited order on demand response compensation in organized markets. The order allows demand response resources in wholesale energy markets administered by RTOs/ISOs to be compensated based on locational marginal pricing (LMP) in certain situations.

Specifically, demand response resources can qualify for LMP-based compensation if they clear security-constrained dispatch and satisfy a net-benefits test. The rule requires RTOs/ISOs to pay demand response resources the LMP as long as the dispatch of the demand response resources results in overall cost savings.

That is, demand response resources are generally compensated like generation, but only when the demand response resources are economical to dispatch. FERC found that this distinction from generation was necessary because of the “billing unit effect.” The billing unit effect occurs when the dispatch of a demand response resource reduces load more than the LMP of energy; the net effect is that the reduced consumer load could result in higher costs overall if the load drops faster than the price. In short, under FERC's rule, demand response resources would not be paid the LMP when utilizing demand response resources would not provide a net benefit to the market.

Market participants heavily debated the new rule during the past year, with generators expressing concern over losing revenue (and thus incentive to develop additional generation). Demand response providers generally support the new rule, but believe that the net-benefits requirement should not have been imposed because it does not treat demand response comparably to generation.

FERC Commissioner Moeller dissented from FERC's opinion. He argued two major points: first, that certain customers could receive a “double payment.” This would occur when a customer could reduce energy use and (i) save money by not paying for the unused energy, and (ii ) receive the full LMP for its energy by acting as a demand response resource. Second, Commissioner Moeller pointed out that FERC's original goal was to treat demand response resources comparably to generation, yet generation did not have to undergo a net-benefits test before receiving compensation.

Each RTO/ISO must make a compliance filing by July 2011 to demonstrate how it will implement the new rule, including the methodology it will use to calculate the net benefits of dispatching demand response resources. Demand response aggregators will be watching the rules for this new market opportunity closely.