Demand response as a trading asset: turning load into flexibility

What does demand response mean

Demand-side flexibility enables balancing the grid by using consumers' load. For the grid to be fully stable, demand and power supply must be completely balanced. This can be achieved by shedding, which temporarily reduces energy consumption when demand is highest and by shifting, which completely reschedules high-energy tasks away from peak times. Unneeded energy stored by consumers can also be returned to the grid.

Adjusting demand based on price signals

Consumer incentivisation is key to successful demand response. There are two key mechanisms: the first is price-based demand response, in which consumers shift their energy consumption in response to dynamic tariffs. Taking advantage of lower prices during low-demand periods and reducing consumption when prices are high during high-demand periods decreases energy bills for consumers and alleviates pressure on the grid. Incentive-based demand response involves a direct financial incentive for participants who reduce load during peak demand or an emergency.

Value creation mechanisms

Residential and industrial consumers alike can avoid peak prices by changing how and when they consume energy. We can learn more about how dynamic tariffs operate by examining how they benefit consumers financially. Also known as Time-of-Use (ToU) tariffs, consumers can purchase energy when prices are extremely low, sometimes even moving into negative pricing territory.

Avoiding peak prices

One way to avoid price spikes, particularly in an industrial environment, is peak shaving, which automates the switching off of non-essential services when prices are high, thereby avoiding capacity charges.

Providing balancing services

Thanks to balancing services, we can transform consumer energy behaviour into a tradable asset. By utilising decarbonisation tools such as heat pumps or EV charging, reducing energy consumption also gives consumers control over their energy bills.

Market participation

Two key players facilitate demand response: independent aggregators or energy suppliers. To participate in the market and meet minimum capacity requirements, aggregators must combine multiple smaller assets.

Wholesale markets 

We can use demand response to hedge against price volatility in the wholesale market. Consumers can monitor what's happening in the day-ahead market and adjust energy consumption accordingly. For example, when consumers recieve signals via platforms such as EPEX Spot that prices are increasing, they can shift operations to lower-priced periods.

Ancillary services

Ancillary services differ from the wholesale. market in the sense that they concentrate much more on balancing the grid. Frequency response is one ancillary service that temporarily pauses flexible loads when the grid frequency drops. Other services might include voltage control or grid security.

Constraints and risks 

Operational limitations 

Demand response can pose challenges due to operational limitations of commercial participants. This can occur due to core business disruption; for example, curtailing energy can disrupt HVAC systems, delay manufacturing lines, or cause a plant to breach safety regulations. These negative effects can persist long after the demand response period ends: large power spikes can occur immediately afterwards, as business operations continue as usual. This applies only to industrial processes that can respond to demand response periods; for example, large pumps cannot adjust quickly enough to meet them.

There are limited windows in which flexible assets can be traded: production cycles limit these trading windows, which should be taken into account.

Uncertain response    

We can treat consumer energy consumption the same way we treat other tradable assets. But this can cause response uncertainty through financial liabilities, facility restrictions and predictions that fall short: it can be hard to predict exactly how much load will be shed.

This is due in part to aggregation, in which many assets are combined into a single, more flexible asset. This can cause statistical variants, leading to underperformance from the combined asset. We can also see inaccuracies in calculations due to the baseline, which is an estimate, so when actual calculations are made, traders can be exposed to these inaccuracies. When consumers are overexposed to disruption from demand response, it can lead to what's known as participant fatigue, prompting them to opt out.

Portfolio implications

Trading in the context of demand response can be challenging due to the unpredictability of market participants and penalties for delivery shortfalls.

One positive to trading in relation to demand response is the use of demand as a hedge. Decreasing demand when the highest market rates apply is known as price cap hedging.

New flexibility opportunities

When we monetise electrical load flexibility, we can offset energy overheads, reducing costs. It also helps strengthen the grid's overall stability. For example, fleets of electric vehicles can charge up when renewable energy is plentiful and at its lowest cost, but then dispatch energy when energy is at its highest. We can also take advantage of automated smart buildings, which utilise the Internet of Things (IoT) to cool or heat buildings in line with price fluctuations.