Demand response in wholesale electricity markets: the choice of customer baseline

Given a hybrid electricity market structure, demand response (DR) in wholesale electricity markets depends critically on the choice of customer baseline. This paper reviews alternative customer baseline designs, focusing on administrative and contractual approaches. Administrative customer baselines have been developed over many years to provide estimates of the counterfactual consumption levels that would have prevailed without demand-response programs. However, experience suggests that this approach is vulnerable to opportunities for gaming and could result in illusory demand reductions. With full locational marginal price (LMP) payment, this approach imputes double-payment incentives that could induce excessive demand reduction undermining the efficiency of DR programs. Alternatively, a contractual customer baseline approach provides transparent rights and obligations for a robust framework that restores efficient DR under full LMP payment. As a retail rate design that provides two-sided contractual customer baselines, demand subscription service and DR programs form a much needed connection between the wholesale and retail markets in ways that promote price-responsive demand in a smart grid future.