FERC paid customers the generator's price for the power they did not use at peak

the problem

Meeting the grid's few extreme demand peaks meant running the costliest plants, or building new ones used hours a year

background

what everyone would do

The two obvious fixes both attacked the wrong side of the ledger: build enough generation to cover the once-a-year peak (an asset idle 363 days a year), or forbid/ration consumption at the worst hours (punishing the very users whose demand underpins the grid's economics). Neither makes the peak cost anything like what a genuine price for scarcity would.

what they saw

FERC saw demand at extreme hours as priced, whose mirror — consuming less exactly when energy is scarcest — is a service worth a plant's payment. Book the absence as supply and settle it at the same LMP.

the move

FERC Order 745 (2011) required organized wholesale markets to pay demand-response — customers who cut consumption at peak — the same Locational Marginal Price paid to generators, so long as a net-benefits test showed the payment bought cheaper overall prices. Demand reduction, an absence, was rebooked in the settlement as if it were an increase in supply.

why it works

Pricing demand reduction at the same LMP as generation changes what every participant rationally optimizes: a customer who otherwise leaves load running now faces a payment for shifting it, so the market's own price signal recruits millions of small, flexible consumers as an unbuilt peaker fleet. Because the payment is gated by a net-benefits test — demand response is paid only when the cost of paying it is less than the savings it creates in the wholesale price — the rule self-selects only the reductions that actually lower overall cost, which is exactly why the market-wide benefit survives the generators' objection that a customer 'only' refrains. The dispute over who regulates what (FERC vs. the states) was settled by the Supreme Court because the adjustment is a settlement practice of the wholesale market, not a change to the retail rate consumers pay.

the payoff

Supreme Court upheld it Jan 25, 2016 (FERC v. EPSA): demand response lowers prices and raises reliability — now entrenched in U.S. markets.

where it breaks

It needs a wholesale market that actually prices scarcity in the first place — where peak LMP genuinely reflects the cost of the marginal plant, there is a real spread for demand response to arbitrage. Where retail customers face flat regulated rates and cannot see or act on the wholesale signal, or the net-benefits test is omitted and demand response is paid at full LMP regardless of gain, the mechanism degrades: it can overpay reductions, shrink the margin generators need to stay in business, and discourage the construction the market still relies on. It also assumes customers have real load to shift; a use that cannot be deferred gains nothing from being paid to be idle.

what came after

The ruling formalized that 'reduction' and 'generation' are interchangeable resources in a market design, and the compensating principle — a demand-side absence pays at the scarcity price, subject to a net-benefit check — has spread to capacity markets and demand-response programs worldwide, becoming a standard tool for deferring new peaking plant.

references

1. [1]FERC v. EPSA (Stanford Law Review, Online)Stanford Law Review, 2016stanfordlawreview.org
2. [2]Case Update: The Supreme Court Upholds FERC Order 745Guarini Center, NYU School of Law, 2016guarinicenter.org

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