Allocating the Cost of Demand Response Compensation in Wholesale Energy Markets

Currently, demand response resources can sell load reductions in wholesale energy markets. However, paying for load reductions ultimately results in an unbalanced market, where the amount of resources sold (megawatts) is less than the amount of resources bought (megawatts and “negawatts”). To resolve this imbalance, the ISO must allocate the cost of compensating demand response to those buyers who benefit from reduced LMPs. Current cost allocation methods are quite broad and based on each energy buyer´s share of the total load. In an uncongested network, this results in a “fair” allocation of costs, i.e., an allocation proportional to the benefits that each party accrues. However, in a congested network, this is no longer the case, as price separation occurs between nodes. In this paper, we therefore propose a cost allocation method based on LMP sensitivity that accounts for the effect of congestion on the distribution of benefits between nodes with different LMPs. Since this sensitivity-based method only takes into account the cost allocation per node, we also propose a means of allocating costs between individual load serving entities (LSEs) at a single node. Due to this refinement, LSEs are rewarded according to their individual contribution to demand response. Finally, we define a fairness index to evaluate the performance of the proposed method as compared to a load-based allocation. We find that when load reductions are small (1%-3% total load), the fairness index of the proposed method is very close to zero, indicating almost identical benefit to cost ratios for all market participants. Although the fairness index increases with increasing load reductions, results show that even for larger load reductions, the fairness index is still lower for the proposed method than for the load-based allocation method.