Financial incentives and a regulatory framework that values demand-side flexibility assets are essential to limiting investments in the grid and backup generation
USE THE FLEX
Wholesale power prices rise and fall during the day but end users do not have similarly flexible tariffs so cannot take advantage of the lower prices
BREAK THE HABIT
Demand flexibility can reduce the need for grid investments but utilities have long been supported in making capital expenditures
KEY QUOTE
The market rules and regulations are still very much oriented to central power generation and consumers being passive bill takers
When the UK’s National Grid Electricity System Operator (National Grid ESO) rolled out its new Demand Flexibility Service in the winter of 2022, over one million British households signed up with their electricity suppliers to change the time they used appliances like dishwashers and tumble dryers and to recharge their electric vehicles (EVs) to off-peak periods. The new service allows the UK electricity system operator to access additional flexibility resources when national demand for electricity peaks during the winter. Participating consumers, sometimes referred to as “flexers” in the British press, are informed the day ahead and receive financial incentives like rebates or energy credits to encourage them to use electricity off-peak. This in turn reduces the need for the system operator to resort to traditional flexibility assets like gas peakers to prevent the risk of blackouts. Demand-side flexibility can be used to shave the peaks off electricity demand, while also helping to shift load to times when the power supply is overabundant and prices on wholesale markets are cheap. This typically coincides with moments when renewable energy supply is high, so it may also come with the benefit of lower curtailment of wind and solar plants resulting in fewer greenhouse gas emissions. Flexing demand will become increasingly important with the growing electrification of the heating and transport sectors, notes Alex Schoch of Octopus Energy, a UK-based utility. “We are moving from a world in which net energy load is decreasing because of energy efficiency into one in which it is increasing. Most of this transformation is happening in the consumer space,” he says.
COST SAVINGS
Heat pumps in houses and electric vehicle charging will add to electricity loads but can also be used flexibly. Homes can be pre-heated in off-peak hours, provided they are well-insulated, and EV charging can be programmed for times when electricity prices are low and power is green. Behind-the-meter rooftop solar and battery storage can also contribute to system flexibility, as can energy communities generating, storing and consuming power locally. Between €11.1 billion and €29.1 billion could be saved each year between 2023 and 2030 in distribution grid investments in the European Union with full exploitation of demand-side flexibility, according to a 2022 study carried out by DNV, an independent assurance and risk management provider, and Smart Energy Europe (smartEn), an association promoting digital, decentralised and decarbonised energy solutions. On top of that, the report estimates €71 billion in annual direct savings to consumers, €2.7 billion in annual cost savings from avoided peak generation capacity, a decline in renewable curtailment of some 15 terawatt hours (TWh) and 37.5 million tonnes less in annual greenhouse gas emissions. 
NO SENSE OF URGENCY
For the potential of flexibility on the demand side to be maximised, however, the regulatory framework and market design are key. Sabine Erlinghagen of Siemens Smart Infrastructure notes that the need for flexibility is becoming more pressing as the growth of distributed energy resources (DER) accelerates, “But there is not yet enough sense of urgency from a regulatory or a market design perspective,” she says. The energy transition will go faster and, “[Be] much more economically viable if you take advantage of flexibility both to avoid overinvesting to put copper in the ground as well as to lower the buffer you need to operate the grid,” she adds. Combined with software, flexibility allows the system operator to run the grid closer to its physical limits, Erlinghagen explains. There are already “a lot of good enabling frameworks at a European level” for demand flexibility, starting with the 2019 EU Electricity Directive, but implementation in national legislation is lagging, states Michael Villa of smartEn. Villa notes that there are still few electricity suppliers that offer dynamic price contracts to their customers while system operators “are not using the flexibility of market operators but are thinking in terms of investments to bolster the grid,” he says. “The biggest challenge is to flip the entire energy system on its head,” says Octopus Energy’s Schoch. “The market rules and regulations are still very much oriented to central power generation and consumers being passive bill takers.”
PRICE CUES
While power prices on the wholesale market rise and fall during the day, many end users do not have tariffs that are tied to these fluctuations, giving them little incentive to use electricity when the cost of providing it is lower. Travis Kavulla of NRG Energy, an integrated power company in the United States, highlighted in a recent paper the missing incentives in regulatory policy for active demand-side involvement in the electricity sector, not only for consumers but also for their suppliers. Kavulla notes that the rate-making process in the US has generally eliminated the financial advantage to utilities of reducing the power consumption of consumers when it is most expensive to serve them, given that these utilities simply recover the cost of service in electricity bills.
VISIBLE INCENTIVE
At the same time, competitive retailers may also see their ability and incentive to activate demand limited, Kavulla adds. While these retailers are exposed to marginal price signals for energy, this is not always the case for transmission, distribution and generation costs. “The lack of retailer exposure to providing a retail customer with electricity service will diminish the retailer’s incentive and ability to activate demand— even if the incentives for energy supply itself are well aligned,” he says. When it comes to consumers, Kavulla points out that time-varying rates have not worked when people have been required to opt-in, as take-up has been scant. “[Customers] should either take service under a time-varying rate as a default option or should be supplied by a provider that does have the financial incentive and ability to activate the customer’s demand in relation to the dynamic wholesale market on the customer’s behalf. Someone, somewhere, must face clear incentives to actively manage demand in order for it to happen,” he argues. The state of California has been a leader in moving towards time-varying rates. A new load management standard from the California Energy Commission (CEC) in effect starting April 1st, 2023, requires the state’s largest power utilities to develop retail electricity rates that change at least hourly. The utilities are also required to educate customers about time-dependent rates and automation technologies to facilitate their use. Ease of use is essential to activate demand flexibility, alongside proper remuneration for consumers, says Villa of smartEn. 
LOCAL PRICING
In a 2022 white paper, PJM Interconnection, the system operator for much of the eastern US, found that time-varying retail rates reduced the overall capacity procured and tripled the capacity contribution of solar in a scenario in which demand grows due to electrification. The value of the time-of-use element of the price signal is that it creates new market opportunities for demand response, explains Sophie Yule-Bennett of the Regulatory Assistance Project (RAP), an energy transition think tank. “If you are an aggregator, you can go to a household or a factory and offer to manage loads that are flexible to avoid consuming during peaks and paying peak prices,” she notes. The cost of supplying electricity is not only a function of time, however, but also of location and grid conditions. With locational pricing, local grid congestion is reflected in wholesale prices and provides a strong signal for demand flexibility, says Yule-Bennett. “Locational price signals incentivise the co-location of flexible demand with renewable generation, so flexible customers can benefit from responding to local signals while easing network congestion,” she adds. “We see movement towards the right price signals but there’s still a long way to go,” says Schoch of Octopus Energy. He notes that there are a growing number of flexibility services that retailers and third parties can access in Europe. “The value this unlocks can be packaged for customers and shared,” he adds. One example of how Octopus has been able to share the value of flexibility with its customers involves the creation of a virtual power plant (VPP) for EV charging managing over 100 megawatts (MW) of car batteries and offering a smart, affordable overnight charging tariff. A bespoke charging schedule was created for each customer and the service is automated. Schoch says one priority for sharpening price signals is the introduction of system charges—the costs that are paid for use of the electricity wires that transmit electricity—that are “truly dynamic and provide capacity signals much closer to real-time” at both the transmission and distribution grid levels. In the UK, there is currently a pricing mechanism that requires users to pay more at peak time but is divided into just three bands. Generally speaking, electricity bills with a large portion of fixed costs make it more difficult to give the right price signals for demand flexibility.
FLEXIBILITY FOR ALL
As power prices in Europe shot up after Russia’s invasion of Ukraine in February 2022, governments across the continent stepped in to help households and companies pay their power bills, damping price signals that can encourage demand flexibility. As the dust settles a bit, some lawmakers acknowledge that consumers cannot be completely sheltered from price signals. At the same time, equity is an essential element of flexibility and safeguards must be in place to protect consumers. “If the evolution of the energy market depends on making people’s lives harder and pushing them into poverty then it won’t work,” says Yule-Bennett. “Ultimately we want people to be able to benefit from price signals through accessible smart technology, energy efficient homes and user-friendly offers and services,” she says. 
PUT ON A SHOW
Hawaiian authorities switched to a performance-based rate system to encourage the use of demand flexibility
LEVEL-PLAYING FIELD
The lack of adequate price signals is not the only hurdle facing demand flexibility. SmartEn’s Villa points out that electricity markets remain largely closed to demand-side assets. Limitations to independent aggregators are still a barrier in several European Union (EU) member states. “There are also issues like bid size and product design, which are much more generation focused,” he says. For instance, some flexibility markets may require participants to deactivate demand for three hours, points out Villa. “It might be fine for a generator but if you want households to participate you cannot require three hours of curtailment,” he says. While capacity markets blunt price signals on wholesale markets to activate demand flexibility, a number of countries have nonetheless put them in place as a sort of insurance policy. Where they exist, capacity markets should also be inclusive of demand-side assets, stresses Yule-Bennett. Instead, capacity auctions have tended to be biased against demand flexibility, for example, with larger bid size thresholds that are easy for generators to meet but which create additional cost and risk for aggregators. Long lead times before contracts go into effect also make it difficult for aggregators to sell participation in a capacity mechanism to businesses and households.
OVERRIDING THE MARKET
From a regulatory point of view, Erlinghagen of Siemens stresses the importance of establishing the conditions under which a distribution system operator (DSO) would be able to override the functioning of the market in order to ensure grid stability. “The use of a heat pump or the charging of an EV can be made dependent on the price level, but it’s also important to know when a DSO would interfere with this,” says Erlinghagen. With the establishment of clear conditions, she notes that consumers would also benefit because system operators would be able to allow more electric vehicle charging stations, rooftop solar and other DER to connect to the grid.
ALIGNING INCENTIVES
Although demand flexibility can reduce the need for grid investments, utilities have long been incentivised to make capital expenditures, passing on costs and an agreed rate of return to end users in their electricity bills. Regulators are looking at how to change this. Incentives for investments in non-wires alternatives like demand flexibility are “already in EU legislation but have not been implemented”, says Villa. Article 32 of the EU’s Electricity Directive states that DSOs should be “adequately remunerated” for the procurement of flexibility services. The National Association of Regulatory Utility Commissioners (NARUC) in the US has examined how performance-based rate-making can be used to enable greater use of demand flexibility to better align a utility’s business decisions with policy goals. Performance-based rate-making approaches “can include moving financial motivations away from investing in capital expenditures to exploring demand- side opportunities that reduce or shift electricity consumption,” says NARUC. It points out that this can be achieved through financial incentives for achieving various demand flexibility-related goals with rewards tied to metrics other than the utility’s volumetric electricity sales. As Hawaii aims for 100% renewables by 2045, the state’s Public Utilities Commission moved from a cost-of-service mechanism to adopt a performance-based rate system in June 2021. “The performance mechanisms… include various metrics related to the advancement of demand flexibility, including grid investment, transportation electrification, asset effectiveness, customer engagement and interconnection experience,” said Leo Asuncion of the Hawaiian commission. “By collecting a robust data set and establishing transparent and well-defined metrics, our regulatory framework creates clear expectations for the utility,” he added. •
TEXT Heather O’Brian PHOTOS So Akomoto, George Burba