Coordinating Energy Efficiency and Incentive-based Demand Response

Problem definition: Energy efficiency programs and demand response programs, two popular approaches to energy demand management, are traditionally designed and evaluated independently. Breaking with tradition, we study the interactions between energy efficiency upgrades and participation in incentive-based demand response programs. We re-examine the energy efficiency gap in light of demand response participation. We also illustrate how to coordinate the programs to maximize their combined benefits.Academic/practical relevance: Billions of dollars are spent annually in the U.S. on both energy efficiency incentives and demand response payments. Without coordination, the incentives from one program could undercut the effectiveness of another program. We examine ways to coordinate the incentives.Methodology: We use a sequential optimization model which accounts for the difference in time scale between long-term energy efficiency investments and daily demand response participation and minimizes discounted costs to an industrial firm as well as to society. Results: A larger demand response incentive leads to a reduced investment in energy efficiency. Even if the energy efficiency gap is closed by taxes or subsidies, the firm's impact on societal costs is not minimized unless the demand response incentive is properly set. Both energy efficiency and demand response programs contribute significantly to the reduction of societal costs.Managerial implications: Policies aiming to close or reduce the energy efficiency gap, such as investment subsidies and carbon taxes, may fail to achieve their desired outcomes when firms also participate in demand response. We provide theoretical support for jointly determining energy efficiency and demand response incentives, in both unconstrained and constrained policy situations, to maximize the combined benefits of both demand management programs