Optimal Electricity Demand Response Contracting With Responsiveness Incentives

36 Pages Posted: 26 Nov 2018 Last revised: 9 Jun 2019

See all articles by René Aïd

René Aïd

Université Paris-Dauphine

Dylan Possamaï

Columbia University

Nizar Touzi

Ecole Polytechnique, Paris

Date Written: November 1, 2018


Despite the success of demand response programs in retail electricity markets in reducing average consumption, the random responsiveness of consumers to price event makes their efficiency questionable to achieve the flexibility needed for electric systems with a large share of renewable energy. The variance of consumers' responses depreciates the value of these mechanisms and makes them weakly reliable. This paper aims at designing demand response contracts which allow to act on both the average consumption and its variance.

The interaction between a risk--averse producer and a risk--averse consumer is modelled as a Principal-Agent problem, thus accounting for the moral hazard underlying demand response contracts. The producer, facing the limited flexibility of production, pays an appropriate incentive compensation to encourage the consumer to reduce his average consumption and to enhance his responsiveness. We provide closed--form solution for the optimal contract in the case of constant marginal costs of energy and volatility for the producer and constant marginal value of energy for the consumer. We show that the optimal contract has a rebate form where the initial condition of the consumption serves as a baseline. Further, the consumer cannot manipulate the baseline at his own advantage. The first--best price for energy is a convex combination of the marginal cost and the marginal value of energy where the weights are given by the risk--aversion ratios, and the first--best price for volatility is the risk--aversion ratio times the marginal cost of volatility. The second--best price for energy and volatility are non--constant and non--increasing in time. The price for energy is lower (resp. higher) than the marginal cost of energy during peak--load (resp. off--peak) periods.

We illustrate the potential benefit issued from the implementation of an incentive mechanism on the responsiveness of the consumer by calibrating our model with publicly available data. We predict a significant increase of responsiveness under our optimal contract and a significant increase of the producer satisfaction.

Keywords: responsiveness incentive, optimal contract, demand response

JEL Classification: C72, D86

Suggested Citation

Aid, Rene and Possamaï, Dylan and Touzi, Nizar, Optimal Electricity Demand Response Contracting With Responsiveness Incentives (November 1, 2018). Available at SSRN: https://ssrn.com/abstract=3276585 or http://dx.doi.org/10.2139/ssrn.3276585

Rene Aid (Contact Author)

Université Paris-Dauphine ( email )

Place du Maréchal de Lattre de Tassigny
Paris, 75016

Dylan Possamaï

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

Nizar Touzi

Ecole Polytechnique, Paris ( email )

1 rue Descartes
Paris, 75005

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