Creating Regulatory Structures for Robust Demand Response 

Participation in Organized Wholesale Electric Markets 

Hon. Jon Wellinghoff, David L. Morenoff, James Pederson, Mary Elizabeth Tighe, 

Federal Energy Regulatory Commission 

ABSTRACT 

Organized wholesale electric markets serve two-thirds of electricity consumers in the 

United States. Independent entities known as regional transmission organizations (RTOs) or 

independent system operators (ISOs), most of which are regulated by the Federal Energy 

Regulatory Commission (FERC), operate these markets. The RTOs and ISOs administer trading 

of electricity services in real time (current day) and, in some instances, day-ahead markets for 

sales of electricity at wholesale, including sales to load-serving entities (LSEs) that then provide 

service to retail consumers. Recent studies and experience indicate that important benefits, 

including dramatic reductions in wholesale prices, can stem from planned reductions in 

consumer usage, or demand response. 

A challenge to achieving these savings and benefits, however, has been enabling a robust 

industry to aggregate consumer demand and consistently and reliably deliver demand response to 

the organized markets. FERC is addressing that challenge by seeking to establish a federal 

regulatory framework that ensures that demand response has appropriate opportunities to 

participate in the organized markets and provides a stable base for the nascent demand response 

industry. This paper examines recent initiatives that FERC has undertaken in this area, as well as 

signs of progress that have coincided with FERC’s increased interest in demand response. This 

paper also discusses possible further steps toward regulatory structures that reflect these goals. 

The Organized Wholesale Electric Markets 

Independent entities known as regional transmission organizations (RTOs) or 

independent system operators (ISOs) operate organized wholesale electric markets that serve 

two-thirds of electricity consumers in the United States (IRC 2007, 4). These RTOs and ISOs 

are depicted below in Figure 1. 
 

Figure 1. Regional Transmission Organizations and Independent System Operators 

Source: FERC Website 

The Federal Energy Regulatory Commission (FERC) regulates six of the RTOs and ISOs 

reflected in Figure 1: ISO New-England, Inc. (ISO-NE); New York Independent System 

Operator, Inc. (NYISO); PJM Interconnection, L.L.C. (PJM); Midwest Independent 

Transmission System Operator, Inc. (Midwest ISO or MISO); Southwest Power Pool, Inc. (SPP); 

and California Independent System Operator Corp. (CAISO). These RTOs and ISOs administer 

trading of electricity services in real time (current day) and, in some instances, day-ahead 

markets for sales of electricity at wholesale, including sales to load-serving entities (LSEs) that 

then provide service to retail consumers. Among other responsibilities, the Congress has tasked 

FERC with ensuring that wholesale electricity rates, including rates in these organized markets, 

are just and reasonable and are not unduly discriminatory or preferential. 

Demand Response and its Benefits 

There is much evidence to indicate that dramatic reductions in wholesale electricity 

prices, as well as other important benefits, can stem from planned reductions in consumer usage. 

Planned reductions of consumer usage in the short term are known as demand response, which 

FERC and the U.S. Department of Energy have defined more specifically as follows: 

Changes in electric usage by end-use customers from their normal 

consumption patterns in response to changes in the price of electricity over 

time, or to incentive payments designed to induce lower electricity use at 
 

times of high wholesale market prices or when system reliability is 

jeopardized (FERC Staff 2006, viii; DOE 2006, ix). 

Modification of consumer demand in a longer timeframe would include implementation of 

energy efficiency measures, such as the installation of more energy efficient appliances and 

technologies. As FERC Staff has noted, national and state legislative and regulatory bodies, as 

well as utilities, have increasingly relied on energy efficiency as a tool to reduce system peak 

demand and meet capacity requirements (FERC Staff 2007, 3). Implementing both demand 

response and energy efficiency measures, each of which is an example of a demand resource, 

offers the greatest promise of achieving optimal efficiency, minimizing lost opportunities, and 

thus securing a wide range of benefits for consumers. 

 FERC has recognized a number of benefits associated with participation by demand 

response in the organized markets. Addressing one important benefit, FERC has stated that 

demand response helps to reduce prices in competitive wholesale markets in at least three ways. 

First, when demand response is bid directly into a wholesale market, the lower demand means a 

lower wholesale price. Second, demand response tends to flatten an area’s load profile, thereby 

reducing the need to use more costly resources during periods of high demand and lowering the 

overall average cost to produce energy. Third, demand response reduces generator market 

power. The more demand response that is available during peak periods, the more downward 

pressure it places on generator bidding strategies by increasing the risk to a power supplier that it 

will not be dispatched if it submits too high a bid (FERC 2008a, P 29-31). 

 The benefits stemming from demand response, however, go beyond reductions in 

wholesale prices. For example, FERC has stated that demand response enhances reliability and 

supports the use of renewable energy resources (FERC 2008a, P 27). These benefits are well 

illustrated by the response of the Electric Reliability Council of Texas (ERCOT) to a sudden 

drop in the system frequency in February 2008. Preliminary reports indicate that the frequency 

decline was caused by a combination of events, including a drop in wind energy production at 

the same time that evening electricity load was increasing, accompanied by multiple power 

suppliers falling below their scheduled energy production. Activating a demand response 

program through which primarily large industrial and commercial loads are paid to curtail their 

electricity use as needed for reliable grid operation, ERCOT obtained approximately 1,100 MW 

of resources within a 10-minute period and saw no other consumers lose power due to the 

frequency decline (ERCOT 2008). Thus, the rapid deployment of demand response provided 

vital system flexibility, which supported the use of wind generation, and made an essential 

contribution to protecting the reliability of the system. 

This example is striking, but far from unique. FERC Staff concluded in a recent study 

that in the summer of 2006 – a period of sustained, severe heat waves and record demand levels 

– demand resources were necessary to the reliable operation of electric markets (FERC Staff 

2007, 4). Moreover, protecting system reliability translates into both consumer cost savings and 

reductions in emissions. This is due to the fact that restarting a system after a blackout is not 

only expensive, but also can result in increased emissions through the inefficiencies inherent in 

restarting and ramping-up generation. 

 FERC has also stated that demand response provides for more efficient operation of 

markets and encourages new technologies that support the use of distributed generation and 

advanced metering (FERC 2008a, P 27). In addition, consideration of demand response 
 

promotes resource adequacy at least cost, and its development may defer or eliminate the need 

for more costly investments in generation or transmission facilities. 

 A common theme uniting all of these benefits stemming from increased deployment of 

demand response is the potential to save money for the consumers who benefit from and pay for 

electricity services. One recent study sponsored by PJM and the Mid-Atlantic Distributed 

Resources Initiative estimates that a 3 percent load reduction (which amounts to less than 1 

percent of PJM’s peak load) in the 100 highest priced hours would reduce locational marginal 

prices by 6 to 12 percent. This price reduction corresponds to approximately $330 million in 

savings per year, of which $20 million is estimated to be saved by the demand-reducing 

customers. Two to three times that amount would be saved by other customers in the MidAtlantic States due to lower market prices, and $8-12 million would be saved by customers 

outside the region (Felder and Newell 2007). 

Taking a broader geographic view, another recent study projects that if U.S. peak demand 

were to be reduced by 5 percent, the long-term benefits to consumers over a twenty-year horizon 

would have a net present value of $35 billion (Faruqui, et al., 2007). 

 

FERC Initiatives Involving Demand Response 

A significant challenge to achieving these savings and benefits has been enabling a robust 

industry to aggregate consumer demand and consistently and reliably deliver demand response to 

the organized markets. To address that challenge, FERC recently has undertaken several 

initiatives to ensure that demand response has appropriate opportunities to participate in the 

organized markets and to otherwise contribute to protecting system reliability. It would be 

premature at present to judge the ultimate success of these initiatives, though some signs of 

progress that have coincided with FERC’s increased interest in demand response are discussed in 

the next section of this paper. Nonetheless, these initiatives mark important steps toward 

establishing a federal regulatory framework that will provide a stable base for the nascent 

demand response industry. 

Order No. 890: Preventing Undue Discrimination in Transmission Service 

In February 2007, FERC issued Order No. 890, a final rule that reformed FERC’s pro 

forma Open Access Transmission Tariff (OATT). In Order No. 890, FERC stated that the 

OATT had fostered greater competition in wholesale power markets in the ten years since its 

adoption by reducing barriers to entry in the provision of transmission service. FERC also 

stated, however, that experience had revealed flaws in the OATT that undermined realizing its 

core objective of remedying undue discrimination. Among other flaws, FERC found that it was 

no longer sufficient to rely on voluntary efforts by the industry to develop consistent methods of 

calculating the amount of additional capability available in the transmission network to 

accommodate requests for transmission service. FERC also identified other practices that 

discourage efficient use of the existing transmission grid, as well as deficiencies in the 

transmission planning process (FERC 2007a, PP 1-4). 

The reforms that FERC adopted in Order No. 890 to correct such flaws included notable 

changes that involve demand resources. For the first time, FERC put demand response and other 

demand resources on an equal footing with other resources in directly contributing to the 
 

reliability and efficient operation and expansion of the electric transmission system. For 

example, FERC had previously identified a number of ancillary services that are needed to 

accomplish transmission service while maintaining reliability. Among others, these ancillary 

services include Reactive Supply and Voltage Control, Regulation and Frequency Response, 

Spinning Reserves, and Supplemental Reserves Services (FERC 1996, 31,705). In Order No. 

890, FERC found that where demand resources are capable of providing ancillary services, sales 

of those services by “load resources ... should be permitted where appropriate on a comparable 

basis to service provided by generation resources” (FERC 2007a, P 888). In support of that 

finding, the Commission stated that “comparable treatment of load resources” is consistent with 

the Energy Policy Act of 2005 (EPAct 2005), which established a national policy to eliminate 

“unnecessary barriers to demand response participation in energy, capacity, and ancillary service 

markets ...” (FERC 2007a, P 888; Wellinghoff and Morenoff 2007, 409-10). 

FERC also put demand resources on an equal footing with other resources in another 

respect. Order No. 890 sought to promote efficient utilization of transmission by requiring an 

open, transparent, and coordinated transmission planning process (FERC 2007a, P 3). That 

process will provide a forum for stakeholders to come forward with demand resource project 

proposals that they wish to have considered in development of a transmission plan (FERC 2007a, 

P 487). Such proposals could include not only demand response, but also energy efficiency 

measures. FERC stated that customer demand resources should be considered on a comparable 

basis to the service provided by comparable generation resources where appropriate (FERC 

2007a, P 494). 

Order No. 693: Mandatory Reliability Standards 

By enacting EPAct 2005, the Congress increased FERC’s responsibilities with regard to 

protecting the reliability of the interstate electric transmission system. Among other changes, 

EPAct 2005 required a FERC-certified Electric Reliability Organization (ERO) to develop 

mandatory Reliability Standards subject to FERC’s review and approval. Once approved, the 

Reliability Standards may be enforced by the ERO, subject to FERC oversight, or FERC may 

independently enforce the Reliability Standards. 

Implementing these provisions of EPAct 2005, FERC has recognized the importance of 

providing adequate opportunities for demand response and other demand resources to contribute 

to protecting reliability. In March 2007, FERC issued Order No. 693 and approved 83 of 107 

proposed Reliability Standards. FERC also directed the ERO to make modifications to several 

Reliability Standards to reflect capabilities of demand response and other demand resources. For 

example, FERC approved the ERO’s proposal to define demand-side management as “all 

activities or programs undertaken by a Load-Serving Entity or its customers to influence the 

amount or timing of electricity they use,” but also required a modification of that definition. 

FERC stated that load aggregators and industrial customers who do not take service through an 

LSE may play a role in meeting the Reliability Standards and, therefore, directed the ERO to 

modify its definition of demand-side management to cover not only activities undertaken by 

LSEs or their customers to influence the amount or timing of their electricity use, but also 

comparable activities undertaken by “any other entities.” FERC also directed the ERO to make 

modifications such that demand response and other demand resources that meet certain criteria 

will be allowed to be used to comply with Reliability Standards governing contingency reserves, 
 

reactive power, emergencies, and planning the reliable bulk power system (FERC 2007b, PP 

330-333, 405, 573, 1232, 1879; Wellinghoff and Morenoff 2007, 410-12). 

Rulemaking on Competition in Organized Markets 

In February 2008, FERC issued a Notice of Proposed Rulemaking (NOPR) that proposed 

reforms to improve the operation of the organized markets. Several of the proposed reforms are 

geared toward ensuring that demand response has appropriate opportunities to participate in 

those markets. Building on its actions in Order No. 890, FERC proposed to require RTOs and 

ISOs to accept bids from demand response resources, on a basis comparable to any other 

resources, for ancillary services that are acquired in a competitive bidding process. FERC stated 

that this policy would increase the competitiveness of ancillary services markets, help reduce the 

price of ancillary services, and improve the reliability of the electric transmission system (FERC 

2008a, P 56-57). In addition, FERC proposed to require RTOs and ISOs to amend their market 

rules as necessary to permit an aggregator of retail customers (ARC) to bid demand response on 

behalf of retail customers directly into the RTO’s or ISO’s organized markets, unless the laws or 

regulations of the relevant electric retail regulatory authority do not permit such participation by 

a retail customer. FERC stated that this proposal would reduce a barrier to demand response by 

permitting an ARC to act as an intermediary for many small retail loads that cannot individually 

participate in an organized market. FERC also stated that aggregating small retail customers into 

larger pools of resources increases the potential market and reliability benefits realized from 

demand response in wholesale markets (FERC 2008a, PP 86-93). 

In addition, FERC stated in the NOPR that price is an important factor in encouraging 

demand response in that market prices can elicit demand response from certain customers who 

are equipped to respond (FERC 2008a, P 109). FERC proposed to require the RTOs and ISOs to 

propose any necessary reforms to ensure that the market price for energy accurately reflects the 

value of such energy during periods of operating reserve shortage (FERC 2008a, P 117). FERC 

further proposed that a primary criterion for approving such pricing proposals would be an 

adequate record demonstrating that provisions exist for mitigating market power and deterring 

gaming behavior, including, but not limited to, use of demand resources to discipline bidding 

behavior to competitive levels during periods of operating reserve shortage (FERC 2008a, PP 

109, 118-19). 

Finally, FERC recognized in the NOPR that the need for, and the focus on, demand 

response will continue to increase. Therefore, while proposing specific reforms like those noted 

above to eliminate barriers to demand response, FERC also observed that other reforms may be 

necessary in the future. Consistent with that observation, FERC took two additional actions. 

First, FERC stated its intent to direct its staff to convene a technical conference to consider at 

least the following issues concerning demand response participation in the organized markets: 

(1) if there are barriers to comparable treatment of demand response that have not previously 

been identified and, if so, what they are; (2) potential solutions to eliminate any potential barriers 

to comparable treatment of demand response; (3) appropriate compensation for demand 

response; and (4) the need for the ability to standardize terms, practices, rules, and procedures 

associated with demand response (FERC 2008a, PP 94-95). FERC staff subsequently scheduled 

this technical conference for May 21, 2008. Second, to build on that technical conference, FERC 

proposed to require RTOs and ISOs to submit a study on remaining barriers to comparable 
 

treatment of demand response resources, including a timeline for implementation of proposed 

solutions (FERC 2008a, P 95). 

Some of the issues identified for the above-noted staff technical conference may prove 

particularly important to establishing a federal regulatory framework that ensures that demand 

response has appropriate opportunities to participate in the organized markets and provides a 

stable base for the nascent demand response industry. For example, FERC will likely need to 

clarify its view of what constitutes “comparable” treatment of demand resources. FERC could 

usefully reiterate that comparable treatment of demand response must recognize the distinctive 

technical and operating characteristics of demand response resources. FERC previously made a 

similar point in its order on rehearing of Order No. 890, stating: 

We disagree with TDU Systems that comparability requires that generation 

resources and demand resources be subject to the same operational 

parameters in every circumstance. Treating similarly-situated resources on 

a comparable basis does not necessarily mean that the resources are treated 

the same. As part of its Attachment K planning process, each transmission 

provider is required to identify how it will treat resources on a comparable 

basis and, therefore, should identify how it will determine comparability for 

purposes of transmission planning (FERC 2007c, P 216). 

Similarly, FERC will likely need to elaborate on what constitutes “appropriate” compensation 

for demand response. At and following the technical conference, it will be important to examine 

whether the full contributions made by demand response are being recognized in compensation 

or whether there are areas in which demand response remains undervalued. 

Although not specifically identified as an issue for the technical conference, it will also 

be important for FERC to consider carefully proposals for measurement and verification of 

demand response participation in the organized markets. FERC proposed in the NOPR that the 

RTOs and ISOs must adopt reasonable standards necessary for system operators to call on 

demand response resources, and mechanisms to measure, verify, and ensure compliance with 

such standards (FERC 2008a, P 26). Such measurement and verification is critical, and the form 

of measurement and verification should reflect the function of the service being provided. 

Progress toward Capturing Benefits of Demand Response 

It would be premature to judge the ultimate success of the FERC initiatives discussed 

above. Nonetheless, coincident with FERC’s increasing interest in demand response, there are 

signs of progress toward capturing the savings and benefits of demand response. 

A FERC staff survey of utilities and LSEs in the United States found that as of the end of 

2005, the annual resource contribution of demand resources was about 37,500 MW nationwide, 

including 29,655 MW of potential peak load reduction, or 4 percent of total projected demand 

for summer 2006. Approximately one-third of this potential peak load reduction was actually 

deployed in 2005 (FERC Staff 2006). In 2007, the North American Electric Reliability 

Corporation (NERC), which FERC has certified as the ERO, found that the nationwide 

application of demand resources had increased by almost 6 percent from the previous summer 

(NERC 2007a). NERC subsequently reported an even greater increase in demand resources 
 

available for winter, up 12 percent from 2006 (NERC 2007b). In May 2008, NERC stated that 

demand response is increasing as a resource to meet electricity demands, and that a significant 

amount of demand response is being used as a resource to increase operational flexibility (NERC 

2008). 

The organized markets provide opportunities for demand resources. For example, 

demand resources are eligible to participate to varying degrees in the energy and ancillary 

services markets of the ISO/RTOs. In addition, demand resources have begun to play an 

important role in maintaining the adequacy of resources for long-term electricity service. PJM 

conducts auctions in its forward capacity market, called the Reliability Pricing Model (RPM), for 

resources that will be delivered in future planning years. Demand resources have participated in 

these auctions and have been accepted, beginning with almost 600 MW for the 2007/2008 

planning year (Ott 2008). Following its May 2008 RPM auction for the 2011/2012 planning 

year, PJM announced that its total RPM results include 2,035 MW of demand response (PJM 

2008). In ISO-NE’s first Forward Capacity Market (FCM) auction, conducted in February 2008, 

2,554 MW of Demand Resources cleared for delivery in the 2010 to 2011 timeframe. This 

included 1,188 MW of New Demand Resources, exceeding the amount of New Supply 

Resources (626 MW) that cleared. New Demand Resources are also showing a strong interest in 

participating in ISO-NE’s second auction scheduled for December 2008 (Yoshimura 2008). 

Amid these developments and FERC’s above-noted actions in generic rulemaking 

proceedings, there are signs of an emerging demand resources industry. Distinct from demand 

response programs traditionally offered by vertically integrated utilities, there is a growing 

number of companies whose primary business plan is to assist and aggregate customers in 

provision of demand response. 

Next Steps for FERC on Demand Response 

Implementation of Order No. 890 is an ongoing process, to which FERC is devoting 

substantial attention. For example, in May 2008, FERC issued its first orders addressing 

proposals that respond to the transmission planning requirements of Order No. 890. FERC stated 

that the filing utilities had proposed tariff language providing that, as a general matter, demand 

response resources would be treated comparably. However, FERC directed each such utility to 

make a further compliance filing to address the requirement of Order No. 890-A to identify how 

it would treat resources on a comparable basis and how it would determine comparability for 

purposes of transmission planning (FERC 2008b, P 14, n.6). 

The rulemaking proceeding on competition in the organized markets is another important 

forum for further FERC action with regard to demand response. Any final rule that FERC issues 

in that proceeding is likely to incorporate into FERC’s regulations additional requirements 

intended to ensure that demand response has appropriate opportunities to participate in the 

organized markets. After FERC issues such a final rule, that action is likely to give rise to 

compliance proceedings in which each RTO or ISO proposes approaches to implementing the 

new requirements. Moreover, the FERC staff technical conference on demand response and the 

proposal for RTOs and ISOs to submit a study on remaining barriers to comparable treatment of 

demand response resources highlight FERC’s commitment to continue to explore these issues. 

As a corollary to these initiatives, FERC is actively participating in the National 

Association of Regulatory Utility Commissions (NARUC)-FERC Collaborative on Demand 
 

Response. Established in the fall of 2006, the Collaborative reflects the joint recognition among 

state utility regulators and FERC of the need to coordinate federal and state efforts to eliminate 

barriers to demand response. The Collaborative is now undertaking a significant study of ways 

to overcome barriers to customer demand response participation through coordinated retail and 

wholesale regulatory policies. 

All of these efforts are likely to intersect as the Commission fulfills its new 

responsibilities pursuant to the Energy Independence and Security Act of 2007 (EISA). In 

section 529 of EISA, the Congress directed FERC to conduct a National Assessment of Demand 

Response both to estimate the potential for demand response and to determine how to overcome 

the barriers to achieving that potential. The Congress also directed FERC to prepare a 

subsequent National Action Plan on Demand Response that will, among other objectives, 

develop analytical tools, information, model regulatory provisions, model contracts, and other 

support materials for use by customers, states, utilities, and demand response providers. 

These next steps indicate a number of areas in which FERC can build on its recent 

initiatives with regard to demand response. These efforts have significant potential to establish 

the regulatory framework needed for a robust industry to realize for electricity consumers the full 

potential saving and benefits associated with demand response. 

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and Recommendations for Achieving Them: A Report to the United States Congress 

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