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FFICIENT
E
FFICIENT
R
ELIABILITY
T
HE
C
RITICAL
R
OLE OF
D
EMAND
-S
IDE
R
ESOURCES
IN
P
OWER
S
YSTEMS AND
M
ARKETS


Prepared for
The National Association of Regulatory Utility Commissioners
Richard C owart
Regulatory Assistance Project
June, 2001
E
FFICIENT
R
ELIABILITY
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 T
ABLE OF
C
ONTENTS
A
CKNOWLEDGMENTS
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i
E
XECUTIVE
S
UMMA RY
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 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
RACTICA L
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
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 . . . . . . . . . . 45
4. Efficient Reliability Standard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
B. Rates and Rules for Wires Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
1. Transmission-Level Congestion Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
2. Enhancing Reliability Through Retail Rate Design . . . . . . . . . . . . . . . . . . . . . 56
a. Reforming Traditional Rate Caps and Default Service Rates . . . . . . . 57
b. Revenue Caps, Not Price Caps or Fixed Charges, for Wires Companies
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
C. Promoting End-Use Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
1. Energy Efficiencys Multiple Reliability Benefits . . . . . . . . . . . . . . . . . . . . . 62
2. Capturing Efficiency Resources: Mechanisms for Todays Markets . . . . . . . . 65
a. System Benefit Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
b. The Energy Efficiency Utility: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
c. System Benefit or Uplift Charges at the Regional Level . . . . . . . . . . . 67
d. Complementary Policies for Efficiency . . . . . . . . . . . . . . . . . . . . . . . . 69
VI.

C
ONCLUSION
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
A
PPENDIX
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 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 customers: efficiency
and load management, customer-owned generation, and customer responses to market prices.
The nations utility regulators have also recognized the importance of demand-side resources for
reliability. They have by resolution urged state regulators, power pools, and Congress to
encourage and support programs for cost-effective energy efficiency and load management
investments as both a short-term and long-term strategy for enhancing the reliability of the
nations electric system..

This report explores the role that those resources can play in restoring
the demand-supply balance in electricity. It concludes that as much as 40% to 50% of expected
load growth over the next 20 years can be met through end-use efficiency and load management,
cost-effectively and reliably. It sets out a menu of regulatory and policy solutions to achieve that
potential.
The Benefits of Demand-Side Resources
A narrow focus on fixing todays weakest links in supply and delivery alone will ultimately be
less resilient and more expensive than a strategy that also targets reliability-enhancing demand-
side investments. Utility managers and regulators are often called on to identify the immediate
causes of each reliability event of public concern. It is usually possible to identify the weak link in
the chain that links generation, systems operation, transmission, and distribution to customer load.
And, certainly, inadequate generation capacity, aging distribution infrastructure, and overloaded
transmission links must be addressed to ensure reliable, high-quality servi