Consumers big and small stand to gain as the full market power of energy demand response is unleashed, writes Alan Rai of the AEMC.

On March 12 the Australian Energy Market Commission (AEMC) published its second draft determination and rule to implement a wholesale demand response mechanism for large customers in the National Electricity Market (NEM). Considering a demand response mechanism (DRM) was first proposed by the AEMC in its magnus opus Power of Choice review in 2012, the AEMC’s draft rule is very pleasing. Since the NEM commenced, the demand side has rarely participated in central dispatch. The draft rule is therefore an important reform, introducing a low-cost mechanism for transparently engaging the demand side in central dispatch.

The focus of the DRM, and most of the proponents of demand response (DR), is on demand reduction (so-called “negawatts”) at peak-demand times, thereby lowering energy costs and emissions (where the saved peaking generation emits CO₂-e) and grid costs. This focus is laudable, though must be seen in a broader role for DR: the ability of DR to contribute to resolving Australia’s energy trilemma: emissions reduction, affordable electricity prices and a reliable and secure power system.

Viewed in this broader context, increased DR is about how to make demand more flexible, enabling demand to increase at certain times above where it would otherwise be and decrease at other times below its counterfactual level (the latter typically being the focus of most DR strategies).

The need for demand flexibility

Why do we need demand to be more flexible? In short, to enable a power system with an increasing penetration of variable renewable energy (VRE) like wind and solar PV to maintain reliability and security at lowest possible cost. As noted in a recent journal article with AEMC colleagues, increased VRE penetration across the NEM, especially in South Australia, has fundamentally changed the nature of electricity demand: intra- and inter-day demand today is much more variable and volatile than historically, and is projected to become more variable and volatile given projected future VRE penetration rates. The chart below illustrates this for demand in South Australia May 9 of various years, this date chosen to represent an innocuous time of year for the power system in the state.

Profile of daily operational and residual demand in South Australia, 9 May by year

Could this more variable demand be met by more flexible generation? Yes, it can and it is – and it is expected to continue doing so. As noted in another recent journal article, the value of being “dispatchable” has more than doubled in South Australia since 2014. Dispatchable capacity can be provided by supply-side and, where more cost-effective, demand-side resources. Hence the need to consider ways to unlock the potential flexibility in demand.

From before the start of the NEM, demand has faced signals to be more flexible. Large customers (that is, C&I and other non-residential customers) have faced signals from both: the wholesale market, by being exposed to the spot price for some or all of their demand, and; networks via demand charges (being charged on a $/kVA basis).

Residential customers have also faced signals from the distribution network to make their demand more flexible. Network businesses have provided controlled-load tariffs on specific loads (like hot water systems, pool pumps and air-conditioners). In contrast, wholesale demand response by residential customers is largely non-existent, as most customers remain on time-invariant, fixed-volumetric rate electricity offers, though this is changing (as noted in a recent AEMC paper).

The value of demand flexibility

South Australian Power Networks (SAPN) is currently trialling a “solar-sponge” tariff for residential and small business customers. This time-of-use (TOU) tariff incentivises electricity consumption during the middle of the day, periods when electricity is typically cheap in South Australia due to the high output from rooftop solar PV (and increasingly also from utility-scale solar PV). The chart below compares SAPN’s solar sponge residential tariff with average wholesale spot prices in the state, by time of the day.

SAPN’s “solar sponge” network tariff and average spot prices in SA

As noted above, the solar sponge tariff provides opportunities for demand flexibility, by consuming less in the morning (6am-9.30am) and afternoon/evening (3pm-12.30am), and more in the early hours (1am-5.30am) and middle of the day (10.30am-2.30pm). However, during the summer, the wholesale spot market provides greater benefits for demand flexibility than the network tariff. For example, over summer 2018-19 the peak to off-peak spot price ratio was around 4.82:1, whereas the corresponding price ratio for the solar sponge was 3.97:1. That is, the wholesale spot price over summer provided a 20% sharper signal for demand flexibility than the network tariff.

Whither (not wither) demand response?

While the AEMC’s draft rule will facilitate more DR, DR – more broadly, demand flexibility – will be increasingly needed in a NEM that is becoming more digitalised, decarbonised, distributed and decentralised.

Given these current and future trends, demand is better able than ever before to directly participate in wholesale markets, thereby enabling a true and active two-sided wholesale market for electricity. Such markets exist for many other commodities and services, but a lack of appropriate technology has prevented this for the NEM until now.

The need to enable an active two-sided wholesale market is a strategic priority for the Energy Security Board (ESB). The ESB is working closely with the AEMC, the Australian Energy Regulator and the Australian Energy Market Operator on options for market design beyond 2025. A two-sided wholesale market is one of the potential options for a post-2025 market design in the context of an increasingly digitally-connected system.

Ways to enable a two-sided wholesale market, and the associated regulatory implications, are discussed in detail in the AEMC’s consultation paper. Enabling a two-sided wholesale market involves, inter alia, the following considerations:

• greater transparency and information to AEMO about the location and operation of demand-side resources at the time of, and prior to, dispatch
• active involvement by demand-side resources in the central dispatch process, and
• maintaining appropriate consumer protections given the new business models and new technologies needed to enable a 2SM.

In summary, the future looks bright for DR. Best of all, not all consumers and loads need to participate in DR, yet all consumers stand to share in the benefits. Hooray for flexibility!

Alan Rai is a senior economist at the Australian Energy Market Commission. He has led various projects including the integration of renewables into the grid, emissions reduction policy design and wholesale and retail electricity market design. He is also a senior fellow in the Macquarie Business School and an industry fellow in the University of Technology Sydney Business School. Alan has worked at CSIRO, Macquarie University as assistant professor of finance and at the Reserve Bank of Australia. He holds a PhD in Economics from the University of NSW.