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Assessing long-term effects of demand response policies in wholesale electricity markets

April 2013

4th Latin American Meeting of Energy Economics

Co-author: Mauricio Cepeda

This paper deals with the practical problems related to long-term issues in wholesale electricity markets in the presence of demand response development. Different programs and policies have been implemented around the world aiming to develop demand response potential, including wholesale market participation, capacity mechanisms, technology-oriented programs and promotion subsidies prioritizing demand response.

Externalities, in particular the CO2 externality, have been one of the key elements in the debate on the effectiveness of different policies regarding demand response development. Policy makers have several options to deal with this externality.

The most direct one is to correct the externality by setting a CO2 price at a level that corresponds to the cost to society of the corresponding CO2 emissions. One alternative solution could be to subsidize carbon-free technologies as demand response. In this paper we examine potential long-term impacts of these two policies.

We rely on a long-term market simulation model that characterizes expansion decisions in a competitive regime and incorporates demand response development in the presence of either technology-oriented subsidies or market-driven development policies. We test for each policy two different scenarios regarding the possibility of internalization of the CO2 externality.

The results show that differences in development policies affect both investments and social costs in the wholesale electricity market. They also confirm previous findings that a market-driven development of demand response with the internalization of the CO2 externality is the most efficient approach to develop DR resources.

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