In the wake of Storm Uri, small customers served by retail electricity provider Griddy received huge bills for electricity priced at the ERCOT wholesale market price. Most defaulted, bankrupting Giddy and leaving ERCOT with a $3 billion revenue shortfall. Texas legislators responded by passing HB16, which prohibits anyone from offering a wholesale price-indexed product to a residential or small commercial customer. 

Ill-conceived and passed in haste, HB16 precludes the development of an entire class of innovative retail products but it does not close the door on small customer price-responsive demand (PRD). HB16 does not ban contracts that allow a small customers from selling its load reductions to its retail electricity supplier at a price indexed to the ERCOT wholesale market. Before describing this product in further detail, let’s consider the benefits that small customer PRD would bring to the ERCOT electricity market.

Benefits of small customer price-responsive demand

PRD effectively provides the bulk power system with an additional cushion of reserve, which reduces the need for involuntary load curtailments. Within the ERCOT footprint, residential and small commercial customers loads account for about 70% of the summer peak demand, primarily because of their air conditioning loads. An aggressively marketed PRD program could produce up to 5 GW of peak load reduction when the wholesale market price approaches the market price cap of $9,000 per MWh.

PRD also reduces wholesale market price volatility, thereby providing a more stable revenue stream for generators to recover their fixed costs. It does this by slowing movement up the Operating Reserve Demand Curve that determines the scarcity surcharge appended to the energy price determined by the marginal generator offer price.

Lastly, PRD reduces generator market power by forcing them to compete, not just among themselves, but also with retail customers.

How customers can sell their load reductions

When a small customer sells a load reduction to its retail electricity supplier what it actually sells is its entitlement to consume energy. This entitlement is a call option. The value of this call option is the wholesale market price less the fixed energy price in the customer’s contract with the retail electricity supplier and the energy price in its delivery tariff. Call options have been sold in other electricity markets for many years so there is a significant body of operational experience.

Selling PRD call options is not as efficient as PRD products that require the customer to pay prices indexed to the wholesale spot market prices (like the Griddy product), primarily because the former requires use of a consumption baseline to estimate how much energy the customer would have used if the wholesale price had not increased beyond the normal level. Typically baselines are developed from the customer’s historical usage during times of normal energy prices and they may be adjusted for ambient temperature to account for the customer’s temperature-sensitive loads.

Consumption baselines have several disadvantages. Firstly, they are necessarily created from the customer’s historical consumption so they cannot immediately capture the effects of non-price causal factors that change over time. Thus, a customer may be over- or under-compensated for his response to price signals. For example, this can happen if the customer’s family unit changes in size, affecting energy usage, or if the customer goes on an extended trip away from home. 

Secondly, a clever customer may be able to manipulate its baseline in order to obtain payment for nonextant load reductions. This is done by artificially increasing usage when prices are low to inflate the credits received when prices are high. Most of the manipulation that has been identified has occurred among large commercial and industrial customers that can afford to dedicate resources to "gaming the system." For most residential and small commercial customers, the transaction costs required typically exceed the gain.

There are ways to detect and minimize baseline manipulation. Still, there will always be instances where a customer is credited for load reductions that would have occurred in the absence of the payment incentive, or is not credited for legitimate load reductions.

The mechanics of implementation

Implementing load reduction sellbacks involves four activities:

·  Developing consumption baselines for participating customers

·  Assessing each customer’s load reductions

·  Settling each customer’s account

·  Crediting the customers and billing their retail electricity supplier.

The logical entities to perform these functions are the transmission and distribution (T&D) service providers because their customers are captive so they are assured of recovering the costs of developing and implementing the consumption baselines. In contrast, retail electricity suppliers do not have this assurance because of customer migration. Furthermore, the T&D service providers have access to all of their respective customers’ historical smart meter data; retail electricity suppliers do not. Lastly, there will be a need for conducting pilot programs to assess the efficacy of various baseline methodologies and of the best ways to market the PRD products before launching full-scale programs. Retail electricity suppliers lack the vehicles to recover the cost of such developmental efforts. 

When a retail electricity supplier pays for a load reduction it merely transfers revenues that it would have paid out (or would have gained if it were fully hedged) for the energy that its customer curtailed; consequently, the retail electricity supplier should be indifferent to participating in these PRD programs. However, to encourage participation it would be useful to credit the customer at prices slightly less than the full wholesale market prices and rebate the difference to the retail electricity supplier. Although this would reduce the economic efficiency of the program, the loss is unlikely to be very large because small customer demand will become very inelastic at market prices well below the $9,000 cap. 

PRD benefits all customers, not just those that participate in these programs, by reducing wholesale market prices and the need for involuntary load curtailments. In light of these public good benefits, all retail customers should bear the costs of the PRD program by allowing the T&D service providers full cost recovery through their delivery tariffs.

The Public Utility Commission of Texas has sole authority over the T&D service providers; it can make small customer PRD a reality.