Culminating a contentious, yearlong rulemaking, a divided FERC (4-to-1) in Order No. 475 selected locational marginal pricing (LMP) for compensating a demand-response (DR) resource that participates in organized wholesale energy markets that regional transmission organizations or independent system operators (RTO/ISO) administer. To qualify for LMP compensation, the DR resource must clear in security-constrained dispatch and be able to (1) displace generation in a manner that helps the RTO/ISO balance supply and demand for electricity and (2) satisfy a net benefits test demonstrating that the DR resource is cost-effective.

The first of these two pre-conditions is operational and will depend on where the DR resource is located and how quickly it can respond to a dispatch instruction. The second pre-condition is more complex because of what is called the “billing unit effect.” That effect recognizes that, under an LMP compensation scheme, dispatch of a DR resource in certain instances might reduce load more than the LMP of energy, resulting in either no change or an increase in LMPs and a loss in consumer welfare. (Initially, this net benefit determination will be derived from historical supply curves, updated monthly, with the possibility that it ultimately will be programmed into the RTO/ISO’s dispatch algorithm for dynamic operation.) FERC’s compensation rule will not pay the DR resource LMP when there is no net benefit.

FERC explained that it sought to achieve parity between supply and demand resources, and instructed RTO/ISOs to strive for “comparability between demand response and generation in terms of market rules.” Importantly, in this order, FERC rejected proposals that would allow retail rates set by state regulators to determine the wholesale rates paid to either DR or generation resources. So long as the two pre-conditions are met, all DR resources in wholesale markets are to be paid the LMP, just as dispatched generation is.

To ensure that the RTO/ISO recovers its cost of purchasing DR resources at LMP, FERC also prescribed in Order No. 475 a rule for allocating those costs among wholesale customers. Specifically, an RTO/ISO is to allocate the cost of procuring DR resources proportionally to all energy market purchasers in the area(s) that experience net benefits – a reduced LMP – due to the DR resource.

Commissioner Philip Moeller dissented (dissent begins on pg. 106 of document) . He objected to the payment of LMP, arguing that LMP, not reduced by the DR resource’s savings from foregoing consumption, results in a “double payment.” He further argues that the net benefit pre-condition on eligibility for the LMP payment is unduly discriminatory and contrary to the stated goal of “comparability” since generation resources are not similarly tested to see if the produce a net benefit and excluded if they are determined not to. Generally, Commissioner Moeller would have preferred to have each RTO/ISO develop its own approach to compensating DR resources.