The Reliability and Welfare Impacts of Market-Based Demand Response Against Extreme Weather

Market-based demand response (DR) has emerged as an important emergency mechanism to cope with extreme weather shocks as well as the growing penetration of variable renewable energy (VRE). However, the value of DR remains unclear, which undermines efforts to design effective flexibility markets and ensure system reliability. To support China’s resilient power system decarbonization, this study quantifies the welfare impacts of DR under extreme weather, and explores how pricing and VRE penetration influence its optimal deployment. Key findings are summarized as follows: (1) Although extreme weather threatens power supply-demand balance, DR reduces average power shortages from 6.16% to 5.20% under different weather scenarios. (2) An optimal DR mechanism yields positive net welfare gains. On average, each province experiences a welfare increase of approximately 40.49 billion yuan, equivalent to 0.10% of provincial GDP. (3) Compensation prices in current pilots are approximately twice the theoretical optimum. Such pricing distortions result in GDP losses of 0.51% to 4.91% across different pilots. (4) The benefits of DR rise modestly with power system decarbonization. On average, total welfare increases by approximately 0.01%, that is, 12.58 billion yuan, for each 1% increase in VRE penetration.

JEL Classification: Q41, Energy: Demand and Supply; Prices; Q40, Energy: General