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Demand response - a solution to market turns?

Upheavals in electricity production force the operators in the field to consider new rules for the electricity market. Local Power’s Executive Director Toivo Hurme summarises the main points of what has been accomplished by the Smart Grid Working Group mapping the needs for change of the electricity market over the last two years.

The Smart Grid Working Group directed by the Ministry of Economic Affairs and Employment has discussed the needs for change of the electricity market and has processed related policies for almost two years. The group includes the authorities in charge of electricity market regulation, Finnish Energy and Local Power, representatives of electricity sellers and distribution companies, the transmission system operator FINGRID, Finnish Competition and Consumer Authority (FCCA), Finnish Clean Energy Association, Tampere University, Lappeenranta-Lahti University of Technology LUT and representatives of electricity users (Finnish Home Owners’ Association, Finnish Real Estate Federation (FREF) and Association of Energy Users in Finland). The working group has commissioned a pile of reports, heard dozens of experts and established several sub-working groups to process the more technical issues.

Above all, the group has discussed what kind of changes are needed in the electricity market rules with the changed physical production structure of electricity and the changes that are yet to come. Varying, weather-dependent production will increase, and new technologies will enable a more precise electricity consumption control at the users’ end. Many countries that have experienced a rapid change in electricity production, making the production more varied and reducing the base load production due to the diminishing of fossil and nuclear fuel (e.g. Australia, Germany and the US in part), have also experienced increasing difficulties in trading on the electricity market and great challenges in balancing the grid at times. Hydroelectric power offers us in the Nordic countries an exceptionally good load-following reserve, but it will not be sufficient in the long run and its use will probably become even more expensive.

Demand response as a key concept

The Smart Grid Working Group has, in particular, considered the means for promoting demand response. Demand response has been a part of everyday business for large electricity users, such as the industry, for a long time. In the future, however, the locations of small users are also needed to take part in balancing the electricity market.

If demand response is implemented well, it can be beneficial to all. The system will remain in balance with reduced costs, emission-free wind and solar power can be increased and the customer’s electricity invoice will become smaller. If the demand response is implemented poorly, it will generate unnecessary costs and trouble for customers. The customer will invest in equipment with a long repayment period in view of the gained energy savings, and electricity sellers or others aggregating demand response loads will not receive incentives for their business. Therefore, how can we develop the market so that demand response would be an easy and profitable business?

The Smart Grid Working Group has come to the conclusion that the current direct-load control method, which is still practised by some distribution companies, will be given up by spring 2021 at the latest. From that point on, customers will themselves be in charge of, for example, the pre-timed control of electric heating or the hot water storage tank or they will need to acquire a control service from the market. The goal is to ensure a more dynamic load control method than the current pre-timed control, as the use of wind power will increase, and the production peaks will become more random at different times of the day in the future. Customers cannot, however, be left to their own devices and, therefore, it will be outlined that customers may continue to use the existing controls also beyond spring of 2021, if they agree on the matter with their electricity seller. In any case, this change will require extensive customer communications when the management of the distribution company’s control calendar is transferred to become the responsibility of the sellers or even the customers themselves.

It needs to be noted that giving up the controls of the distribution company does not mean giving up the time-bound transmission tariffs. The distribution company will maintain its pricing freedom, if it chooses to apply it after giving up the direct load-control method.

Towards power-based pricing? 

It is believed and hoped that the distribution companies will be increasingly shifting to power-based pricing, which would be fairer amongst customers and would better match the costs of network operations. The power tariff would also make it easier to balance the grid, once the power limits in each grid section are known.

From the perspective of demand response, the power tariff may, however, weaken its profitability. The customer would not have any interest in being flexible, as long as consumption remains under the power limit. In this regard, the aim should be in reaching an overall optimum solution for the system. The power tariff should guide the customer to sensible use of the grid and the demand response service should steer to market price-based energy consumption. In an ideal situation, a service provider (hopefully an energy company!) would combine these two products in a package matching the customer’s wishes.

More grid flexibility

In addition, the Smart Grid Working Group has considered the properties of the next generation meters (AMR 2.0). Many are of the opinion that the electricity meter will not play a role in load control in the future; instead, it will be implemented directly by means of electric equipment with the help of different IOT and smart home solutions. That said, the working group is about to recommend that the load-control functionality is also to be required of the next generation meters. The price of the load-control relay is small, and it enables the implementation of rough demand response in situations where the more advanced solutions have not been successful. Load control via a meter would be market-based operation, so the AMR 2.0 interfaces shall be standardised and open to different operators.

In any case, grid operations of the future will include different flexible solutions that support the control of the system. The regulation of the distribution business should be developed in a direction where the acquisition of services making use of recent technology and, for example, the use of battery storage facilities could be seen as part of the distribution company’s regulated business.

With regard to batteries, a step in the right direction was the stand taken by the European Parliament on the Electricity Market Directive, according to which a distribution company may operate battery storage facilities forming a fixed part of the grip with a favourable decision by the national authorities. In Finland, a good reform is the tax change being prepared that will make the electricity, which is taken from storage and put to use, free from the electricity tax.

Equal treatment of customers is a must

With regard to taxation, the Smart Grid Working Group has considered a proportionally changing electricity tax linked to the electricity price. Such a dynamic electricity tax would encourage the use of electricity at times when the price is down and cut back when the price is up. Even though the dynamic electricity tax would have an increasing impact on demand response, according to reports, it will not go forward due to several reasons. The tax would complicate the electricity acquisition of customers and link demand response to the day-ahead market. In addition, the representatives of electricity users oppose the dynamic electricity tax because it would put consumers in different positions based on their ability to be flexible.

As part of market development, the Smart Grid Working Group has also discussed an invoicing model of the retail market. Discussion on the one-invoice model, which has been a source of disagreement in the field for a long time, is about to end in a compromise satisfactory to all parties, wherein the customer is guaranteed the right to receive one invoice for both electric energy and its transmission if so requested by the customer. However, it would be voluntary for sellers to offer the one-invoice option. The distribution companies will be obliged to offer all interested sellers the possibility of third-party invoicing on fair terms which include the distribution company’s right to securities for its receivables. The Smart Grid Working Group will also outline that the customer will still need a separate distribution agreement and the customer’s contact with the distribution company shall be maintained. Finnish Energy has launched a project to establish what kind of regulations changes would be required in practice by the implementation of voluntary collective invoicing.

Is demand response good business?

A good question on the profitability of demand response lingers in the background of promoting demand response. It is evident that the market price of electricity shall have to be sufficiently high to make the savings of a small customer meaningful.

Demand response also cannibalises itself. When prices go up and demand is flexible, prices will start to go down and the profitability of another demand response is reduced. Balancing price spikes is, of course, the purpose of demand response but gaining commercial benefit from it requires correct timing and large loads because the flexibility’s marginal benefit weakens quickly.

The final report of the Smart Grid Working Group will be published in October 2018. After that, there will be regulation changes, out of which many will probably coincide with the commissioning of the datahub. The changes will have to observe the interdependence of the factors. In any case, the turn of the decade will be extremely busy in the electricity market.