Empirical Analysis of the Spot Market Implications of Price-Responsive Demand

Abstract

Regardless of the form of restructuring, deregulated electricity industries share one common feature: the absence of any significant, rapid demand-side response to the wholesale (or, spot market) price. For a variety of reasons, most electricity consumers still pay an average cost based regulated retail tariff held over from the era of vertical integration, even as the retailers themselves are often forced to purchase electricity at volatile wholesale prices set in open markets. This results in considerable price risk for retailers, who are sometimes additionally forbidden by regulators from signing hedging contracts. More importantly, because end-users do not perceive real-time (or even hourly or daily) fluctuations in the wholesale price of electricity, they have no incentive to adjust their consumption accordingly. Consequently, demand for electricity is highly inelastic, which together with the non storability of electricity that requires market clearing over very short time steps spawn many other problems associated with electricity markets, such as exercise of market power and price volatility. Indeed, electricity generation resources can be stretched to the point where system adequacy is threatened. Economic theory suggests that even modest price responsiveness can relieve the stress on generation resources and decrease spot prices. To quantify this effect, actual generator bid data from the New York control area is used to construct supply stacks and intersect them with demand curves of various slopes to approximate the effect of different levels of demand response. The potential impact of real-time pricing (RTP) on the equilibrium spot price and quantity is then estimated. These results indicate the immediate benefits that could be derived from a more price-responsive demand providing policymakers with a measure of how prices can be potentially reduced and consumption maintained within the capability of generation assets.

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