Getting paid to do less
Making money in the new energy system
Programming note: This week is a guest post from friend of the show, Mitch O’Neill. Mitch has worked on retailing, distributed energy resources, networks, community batteries and just about everything in between. Plus he knows how to make a mean chart!
Please enjoy a deep dive into the economics and mechanisms behind demand response and distributed energy resources in the national electricity market.
Last week Alex talked about all the weird and wonderful ways that electricity systems users can provide demand response. This week we’re going to take a peek at some of the finer details and economics around demand response on the east coast of Australia.
First though, some framing. The objective of the electricity system is to get people safe, reliable and cost effective access to electricity. This means when it's hot and you want to turn on your air conditioner it should work almost all of the time. Almost all of the time is even defined in various ways such as through the reliability standard and the Australian Energy Regulator’s (AER’s) regulation of electricity networks.
To make this access to electricity reliable you need lots of things. Generators to make the energy, and big enough poles and wires to get that energy from the generator to homes and businesses. But then, what if a big generator trips and causes a blackout? To deal with that contingency we need other generators on standby ready to pick up the slack. And we’ll need generators to flex their output up and down to compensate for the imbalance that loads can sometimes cause from switching on and off. We’ll also need generators for the potential couple of hours a year that everyone wants to turn the air conditioner on, and ensure our electricity pipes are big enough to shoot that power down to where it’s needed.
This and more is what’s required for that air conditioner to reliably work (and keep working) on a hot day, and we all pay for these various services to have reliable access to the system.
What if you didn’t want such reliable access though. What if when a big generator tripped you put your hand up to no longer have access to energy services until the grid was back in balance? Or during those high temperature peak periods you agreed to not use any grid energy, and maybe would even export some back.
For an energy user this is quite an annoying state of things, it’s like the ad supported version of Netflix – inconvenient, constraining, but… also cheap. And this, when you boil it down, is really what demand response is: accepting financial benefit for having lower access to uninterrupted electricity services (as well as sometimes having to provide those electricity services yourself).
With the increase in technology and digitisation, as well as the dynamic nature of the energy transition, providing demand response is becoming more lucrative and less inconvenient.
So who’s accepting this unreliable access to electricity services, in what way is it unreliable, and what do they get for it?
#1 Adjusting your energy usage when big things randomly switch off
If a large enough generator or load switches off1 the grid has just seconds to replace that lost generation or load or else a cascading series of events (which are fascinatingly unique to each scenario) will occur ending with many people experiencing… unserved energy, which is a fancy way of saying a blackout.2
To protect against this risk we have the contingency frequency control ancillary services (FCAS) markets, where generators are paid to be on standby in case one of these contingency events happen. It’s generators paying generators to backup generators.
Until mid-2017 that is, when distributed resources like industrial loads and household batteries (sometimes collectively referred to as distributed energy resources or DER) were allowed to start offering those contingency services themselves. Generators paying consumers to backup generators, which is now about 20% of the contingency FCAS market.
In the last 12-months providers of contingency FCAS from distributed energy resources have earned around $32M from the service. The majority has gone to Enel X, an aggregator of commercial and industrial sites and Energy Locals who are the aggregator of the Tesla South Australian Virtual Power Plant. There are other interesting providers of this backup service too such as:
SA Water Corp with a number of 1-2MW batteries at their desalination and wastewater treatment plants.
The Ikea Microgrid with its 3MW batteries which can simultaneously provide grid services and cook Swedish meatballs with onsite renewable energy.
Firmus who can vary the energy output from their Tasmanian data centre. Last year Firmus were big on bitcoin mining, this year it’s a pivot to the next hot thing: artificial intelligence.
If you add up all this revenue, it comes out to about $70,000/MW of capacity in the last 12-months. This translates into a couple hundred dollars for a residential battery, or $25,000+ for a 500kW machine.
We’re also seeing new contingency FCAS markets requiring faster and more sophisticated responses. Demand response is keeping step and participating in these new markets from day one, lowering the cost of these services.
#2 Reducing your energy usage when there’s not enough to go around, or its expensive
Last year I went to America for the first time and it seemed like 45-minutes before every flight there’d be an announcement. The announcement stated that the flight had been overbooked and were looking for volunteers to not take this flight, and that these volunteers would be well compensated. I never saw anyone volunteer, so about 15-minutes later they just start kicking people off the flight and giving them their $600 flight voucher.
In East Coast energy land we have this exact system and it’s called the Reliability and Emergency Reserve Trader (RERT). When it looks like there might not be enough generation to serve all the energy users, the market operator asks if anyone would like to voluntarily reduce their energy use and in return they will be well compensated. There have been around $200M of payments for these voluntary load reductions from 2018, and while occurring quite infrequently, mean large windfalls for the providers of this service when it occurs.
Below are some examples of what you could earn in RERT if you were paid $20,000/MWh for a two hour response i.e., reducing the electricity you use for two hours. Here you can see the wide range of assets and business models that participate in RERT, from residential batteries all the way up to huge smelters, even networks are starting to get a piece of the pie (in my opinion, too much of the pie) by lowering voltage on the network to temporarily reduce energy demand.
RERT is quite a niche way to provide demand response during generation shortfalls. The majority of demand response simply responds to the wholesale price when it goes high. It’s hard to know how much economic demand response is in the NEM3 or how it's operating, but if you had 1MW of demand response that responded with half its capacity on average whenever the wholesale price went above $1,000/MWh, below is how much you’d make in the various states. For reference, the dotted light blue line indicates how much a retailer would pay out to customers on a $20/month virtual power plant offer (assuming 200 customers per MW of capacity).
The amounts earned doing this kind of economic demand response vary wildly year to year. Last year you would have made a ton of money, this year not so much. So it’s up to demand response retailers to smooth out this volatility for consumers through various hedging contracts, or designing products where consumers bear the risk of this volatility, but are rewarded with lower long run energy costs.
#3 Reducing your energy usage when there’s not enough network capacity
We’ve talked about demand response when the system is unbalanced or there is a lack of generation, but what happens when there’s not enough capacity on the network to send that energy where it needs to go?
Well, networks can either build more network, or provide incentives during peak usage of the network for electricity users to use the network less.
One way these incentives can be created is for networks to define “critical peak periods” where network charges during those periods are extremely expensive, creating the incentive to reduce usage. Ausnet runs a version of this, with 5 “critical peak days” nominated by the network over summer where your usage on those days makes up a large component of your annual bill.
There’s also “non-network solutions” where rather than building more poles and wires on constrained parts of the network, you can just pay loads to reduce output (or batteries to discharge) during that time. Whether you build the poles and wires or pay the load depends on what’s cheapest. Determining “what is the cheapest”4 is done through a byzantine process called the regulatory investment test. Due to the complexity of running these tests, only large constraints are run through the non-network solution process, and therefore only large loads and batteries tend to be suitable for these solutions.
With the rise of rooftop solar and impending electrification of the household, business and transport, more of these constraints may occur on the network, so some networks are looking at how they can target smaller constraints and therefore include smaller users.
Is all this demand response a good thing?
Demand response tends to put downward pressure on electricity prices which creates a net benefit for energy users. It does this in the short run by requiring us to dispatch less of the expensive generation, and in the long run by having us build less stuff. When you hear headlines like “ARENA study suggests up to $8B in cost savings from load flexibility”, the benefits are mostly caused by these effects.
Different types of demand response have different levels of effectiveness though. If you do demand response but the market operator dispatches the high priced generator anyways, perhaps because the market operator didn’t know you were going to do the demand response, then there’s less impact to overall energy prices.
Additionally, if generation and network investors and the market operator are unsure whether demand response will grow in the next few years, they might just build all that extra generation and network anyway, reducing the “build less stuff” benefits of demand response.
Therefore it’s up to policymakers to figure out how demand response can be more transparent and dependable both in the short and long term, in order to really maximise the benefits for all energy users.
One other slightly awkward topic, particularly for the residential side, is often the people that can participate in demand response and have less reliable energy services are those who are pretty well off. For instance if you want to drop $100-$200 on a couple of sensibo controllers and have a reliable internet connection then you can shift some of your air conditioner usage outside the peak demand periods and be rewarded for that. If instead you have lower income, live in a poorly insulated house and turn your air conditioner off every time it’s hot to save a little more money, then that’s a bad outcome.
And so while it’s super cool (and probably beneficial to everyone) that Bob just goes off grid with his $15,000 home battery every time there’s peak energy demand, we can’t forget those who can’t or won’t do these things and still need reliable but low cost access to the electricity system. This group includes renters, lower income, and frankly just people who don’t want to get involved in all these complex demand response schemes and technologies. No shade on that.
Energy efficiency and demand shifting are much less complex and often very effective ways to reduce energy bills and the reliance on the energy system. Support for these solutions, particularly targeted at those groups above who disproportionately rely on access to the grid, continue to be essential and should not be diminished in the face of rising access to demand response programs.
Summing it up
Demand response is rewarding electricity consumers for having less reliable access to the electricity system and its services.
Demand response reduces total electricity system costs by dispatching less of the expensive generation during peak periods, and building less network and utility scale generation.
Revenue from providing demand response is often volatile year to year and it’s up to demand response retailers to either hedge against that volatility, smoothing out payments to consumers, or passing on that risk to informed consumers.
It’s important we not lose focus on those who can’t do demand response and require a high level of reliability and services from the electricity grid.
Did you like some of the graphs in this post? Well there’s plenty more graphs and analysis around demand response economics in the 2023 Grids Energy DER in Markets Report, a free report examining how DER is interacting with energy markets on the east coast of Australia.
Things happen
AGL fined for contingency FCAS breaches as the AER continues its run of doling out fines in close to real time.
SECV officially incorporated as a company a year after it was announced. The strategy has been made public, including a focus on residential electrification. We’ve written in the past about the historical programs the SEC engaged in to encourage households to embrace electricity over gas.
Copper String 2.0 still going ahead apparently, despite Glencore indicating they’ll exit Mt Isa in the next 2 years.
Western Power has stung a bunch of people with notices to replace defective power poles at cost on private property.
If you’re invited to the Australian Energy Regulator’s Halloween party just wrap some unpowered fairy lights around you and say you’re unserved energy to be the spookiest thing in the room.
Analysis of the AEMO demand side portal suggests there could be up to 4GW, but no one really knows for certain.
It’s probably more accurate to call it “what is the biggest net value?” but that’s less pithy.
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