Optimal electricity demand response contracting with responsiveness incentives

TL;DR

This paper develops an optimal demand response contract model that incentivizes consumers to respond to electricity prices while controlling response variability, improving system flexibility with renewable energy integration.

Contribution

It introduces a closed-form solution for demand response contracts considering both average consumption and response variance, accounting for risk aversion and moral hazard.

Findings

Optimal contract has a rebate form with a consumption baseline.

Consumer cannot manipulate the baseline for advantage.

Implementation increases responsiveness and producer satisfaction.

Abstract

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 through a Principal--Agent problem, thus accounting for the moral hazard underlying demand response contracts. 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 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.