IABILITY
T
HE
C
RITICAL
R
OLE OF
D
EMAND
-S
IDE
R
ESOURCES
IN
P
OWER
S
YSTEMS AND
M
ARKETS
Prepared by
The Regulatory Assistance Project
for
The National Association of Regulatory Utility Commissioners
June, 2001
Richard H. Cowart
with assistance from:
Cheryl Harrington
David Moskovitz
Richard Sedano
Wayne Shirley
Frederick Weston
Funded by a grant from
The Energy Foundation
The Regulatory Assistance Project
16 State Street Montpelier, VT 05602
802-223-8199
RAPCowart@aol.com EFFICIENT RELIABILITY
PAGE i
A
CKNOWLEDGMENTS
This paper could not have been written without the creative insights, and the corrections and suggestions
provided by many talented and helpful people. Many of the ideas in this work have emerged from
collaborative discussions and workshops involving all of my colleagues at RAP. Eric Hirst and Brendan
Kirby provided excellent assistance on engineering and system management aspects of reliability.
Many others in the electric utility, regulatory, and advocacy communities have provided much of the
detailed information in the paper, and have helped to develop and critique the key ideas it presents.
Those involved in the Lighten the Load project, including Lea Aeschliman, Jon Coifman, John White,
Ralph Cavanagh, and Steve Nadel provided essential information and useful guidance on the context of
reliability challenges around the country. Others, including Riley Allen, Ned Raynolds, Chuck Goldman,
John Plunkett, and Marty Kushler, provided information and critical comments that have improved the
text in many places.
We are indebted to the Energy Foundation for supporting this research, and to NARUCs Energy
Resources and Environment Committee for sponsoring the work, and providing invaluable guidance on
the ideas contained in the paper. Many useful suggestions, both substantive and editorial, were provided
by Committee members and staff, including Nancy Brockway, Denis Bergeron, Alison Silverstein, and
Ann Thompson. Despite all of this useful assistance, the views and opinions expressed herein, and all
remaining errors, are solely those of the author.
In a more basic sense, this examination of public policy issues would not have been possible without the
dedication, commitment, and public-spirited focus of the Commissioners and Commission Staff of the
NARUC who have sought to advance the public good through research, education and policy
development. This paper is really part of a series, stretching back many years, through which
Commissioners and Staff have examined tough problems and their solutions. I owe a great debt to
many in the regulatory community who have, over the course of two decades, provided the foundations
for this work. EFFICIENT RELIABILITY
PAGE ii
T
ABLE OF
C
ONTENTS
A
CKNOWLEDGMENTS
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i
E
XECUTIVE
S
UMMARY
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iv
I.

I
NTRODUCTION
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
II.

T
HE
U
NWELCOME
T
RIO IN
T
ODAY S
P
OWER
M
ARKETS
:

R
ELIABILITY
C
HALLENGES
,

P
RICE
S
PIKES
,
AND
G
ENERATOR
M
ARKET
P
OWER
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
A. Reliability Challenges Expose the Value of Demand-Side Resources . . . . . . . . . . 3
B. Compounding the Problems of Thin Margins: Price Spikes and Market Power . . 7
1. Price Spikes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2. Market Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
C. Sources of Todays Reliability Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
1. Capacity Crunches are Directly Related to Load Growth . . . . . . . . . . . . . 10
2. Successful Energy Efficiency Programs Have Been Cut Back . . . . . . . . . 12
3. The Efficiency Yo-Yo: Demand-Side Cuts and the Rush to Restore Programs
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
III.

S
UPPLY
-S
IDE AND
D
EMAND
-S
IDE
R
ELIABILITY
:

T
HE
P
RACTICAL
R
EALITIES OF
E
XISTING
P
OLICY
16
A. Wires and Turbines Reliability Some Practical Considerations . . . . . . . . . . . 16
1. The Cost of New Generation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
2. Increasing Demands on Transmission Networks . . . . . . . . . . . . . . . . . . . . . 17
3. The Costs and Consequences of Overloaded Distribution Networks . . . . 18
4. Fuel Supply: Costs and Conflicts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
5. Environmental Costs of Wires and Turbines Reliability . . . . . . . . . . . . . 20
B. The Untapped Potential of Efficiency and Load Management How Large is the Reservoir?
22
1. Utility DSM Experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
2. Non-Utility Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
3. Potential for Price-Responsive Peak Reductions by Customers . . . . . . . 25
4. How Large Does the Customer Response Need to Be? . . . . . . . . . . . . . . . 26
IV.

W
HY
D
ON T
E
LECTRICITY
M
ARKETS
S
UPPORT
E
FFICIENCY AND
L
OAD
M
ANAGEMENT
?

M
ARKET
F
LAWS AND
M
ARKET
B
ARRIERS IN
T
ODAY S
P
OWER
M
ARKETS
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
A. Historic Barriers to Energy Efficiency Remain . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
B. The New Efficiency Vacuum: How Efficiency Harms Utility Profits . . . . . . . . . 28
1. Competitive Generation Incentives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
2. Wires Company Revenues and the Problem of Lost Profits Math . . . . . . 29
C. Barriers to Efficiency in Wholesale Power Markets . . . . . . . . . . . . . . . . . . . . . . 31 EFFICIENT RELIABILITY
PAGE iii
1. Six Reasons the Demand-Side Lags in Wholesale Market Reforms . . . . . 32
V.

T
APPING THE
D
EMAND
-S
IDE
R
ESERVOIR
:

A

S
OLUTION
M
ENU FOR
D
ECISION
-M
AKERS
. . . . . . . 34
A. Demand-Side Resources in Regional Power Pools and New Electricity Markets 36
1. Demand-Side Bidding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
a. Reforming Load Profiles: An Essential Step for Demand-Side Bidding
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
2. Multi-Settlement Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
3. Opening Ancillary Services Markets to Demand-Side Resources . . . . . . 44
4. Efficient Reliability Standard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
B. Rates and Rules for Wires Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
1. Transmission-Level Congestion Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
2. Enhancing Reliability Through Retail Rate Design . . . . . . . . . . . . . . . . . . . 55
a. Reforming Traditional Rate Caps and Default Service Rates . . . . 56
b. Revenue Caps, Not Price Caps or Fixed Charges, for Wires Companies
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
C. Promoting End-Use Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
1. Energy Efficiencys Multiple Reliability Benefits . . . . . . . . . . . . . . . . . . 61
2. Capturing Efficiency Resources: Mechanisms for Todays Markets . . . . 63
a. System Benefit Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
b. The Energy Efficiency Utility: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
c. System Benefit or Uplift Charges at the Regional Level . . . . . . . . 65
d. Complementary Policies for Efficiency . . . . . . . . . . . . . . . . . . . . . 67
VI.

C
ONCLUSION
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
A
PPENDIX
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 EFFICIENT RELIABILITY
PAGE iv
E
XECUTIVE
S
UMMARY
The reliability of electric supply, long taken for granted by most citizens and governmental officials, is
now a matter of increasing national concern. Economic growth, heat waves and cold snaps are driving
the demand for power to new peaks and taxing an already-constrained electric grid. Policymakers are
considering what steps can be taken to assure system reliability during the transition to competitive
markets, where traditional utility rules of price restraint and mutual aid are under siege. The California
power crisis of 2000-2001 commands national attention, but reliability problems in various forms are
arising in almost every region of the country.
As the recently-released National Energy Policy states, A fundamental imbalance between supply
and demand defines our nations energy crisis. New investments in generation and transmission
are obvious reactions to reliability challenges, but we must also consider the very real reliability benefits
that can be captured from energy resources held by customer