Promoting Energy Efficiency via Utilities

In order to reduce greenhouse gas (GHG) emissions and promote a more sustainable energy culture, increasing energy efficiency should be among the primary goals for federal and state energy policy. According a to 2009 McKinsey study, implementing energy efficiency measures not only have huge potential to reduce GHG emissions, but can often do so profitably [1]. Figure 1 shows a GHG abatement curve from the study. The dark bars represent net present value (NPV)-positive efficiency strategies for stationary uses (i.e. does not include transportation energy).

Figure 1 - Greenhouse gas abatement curve published in a 2009 McKinsey report [1].

One way to implement energy efficiency measures are through utilities. Not only can they increase the efficiency of their own generation plants, but they can encourage customers to increase their own household, commercial, and industrial energy usage. However, there is a problem with this: why would the shareholders of a utility - whose returns increase as energy use increases - want to decrease the amount of energy their customers use? This is a fundamental conflict of interest that regulators and operators have been trying to overcome, and are partially succeeding through decoupling measures.

Decoupling separates a utility's revenue from the amount of energy sold, effectively removing a utility's incentive to sell more energy and disincentive to promote energy efficiency. However, decoupling does not necessarily incent a utility to invest in energy efficiency. A 2007 report from the National Action Plan for Energy Efficiency Leadership Group does a great job of outlining this issue and providing solid program examples (a few of which I mention in this post) [2]. What follows is a presentation of decoupling strategies that are being used today - these experiences should be learned from, adapted, and expanded.

Expensing Energy Efficiency Investments

This policy allows a utility to invest in energy efficiency (EE) and recoup the invested amount in the same year via rate increases or fixed charges for rate-paying customers.

Pros: This is a low-risk, revenue-neutral mechanism for EE investment

Cons: There is no profit from the EE investments, so no incentive for the utility. Also, varying annual investments could introduce rate volatility to consumers. Further, EE investments could delay or decrease the need for investments in new generation capacity, which erodes the rate base of the utility.

Example: In Iowa, EE expenses are recovered over a 12-month period and rates are adjusted annually based on over/under recovery [2].

Performance Incentives

Similar to expensing, except the utility also receives a lump sum award based on the level of EE investments against set targets.

Pros: This is a low-risk, revenue-neutral mechanism for EE investment. This also creates an incentive to invest in EE, and provides cash flow to offset rate base erosion.

Cons: There is still risk of rate volatility. Also, there may not be link between the incentive and actual energy savings.

Example: In Massachusetts (NSTAR Electric), an annual incentive is based on savings, value, and performance. If targets are met, NSTAR receives 5% of net energy savings, and a bonus payment for "exemplary performance". The incentive is approximately $2.4 Million if all goals are met [2].

Shared Savings

This mechanism is also similar to expensing, except the utility is allowed to recover a percentage of the energy savings from EE investments.

Pros: This is a low-risk, revenue-neutral mechanism for EE investment. This also creates an incentive to invest in EE, and provides cash flow to offset rate base erosion. Further, this mechanism links the incentive payment with actual energy savings.

Cons: There is still risk of rate volatility to consumers if program controls are not in place.

Example: In addition to expensing the EE investment expenses, PG&E in California receives 15% of actual energy savings. They received $33.4 Million from efficiency incentives in 2009 [3].

Capitalizing EE Investments

This policy allows a utility to invest in energy efficiency (EE) and recoup the invested amount over time plus a rate of return. The revenue is still generated via rate increases or fixed charges for rate-paying customers.

Pros: This is a low-risk, revenue-neutral mechanism for EE investment. This also creates an incentive to invest in EE, and provides cash flow to offset rate base erosion. It also decreases rate volatility since expenses are recovered over a longer period.

Cons: This mechanism does not link the incentive with actual energy savings. It can also create shareholder concerns regarding the control of rate base assets (i.e. there is perceived risk if the energy efficiency investment is not under the control of the utility) [4].

Example: Nevada Energy receives a bonus ROE for EE investments. Their programs include free refrigerator replacement and rebates on lighting, AC, heat, water pumps, insulation, and others [2]. The program has achieved an estimated savings of over 250 GWh in 2007, with a further estimated $135 Million invested between 2008-2010 [5].

Virtual Power Plant

This is similar to capitalizing, except the utility plans for specific performance requirements from the virtual power plant similar to a real power plant, and targeted efficiency applications are identified to fulfill the performance requirements. This can be accomplished at much lower cost than developing new generation capacity.

Pros: Similar to capitalizing. Since the energy savings are more thoroughly planned, the investment is also more directly linked to savings.

Cons: There might still be shareholder concerns regarding the control of rate base assets.

Example: In Jiangsu, China, a 301 MW virtual power plant was designed with an estimated investment of $134 Million ($445/kW installed). The "virtual" levelized cost of electricity is about 1 cent per kWh [6].


Conclusion

This list of policy mechanisms is not comprehensive, but are specific examples that are being (or have been) used in various markets. So, which incentive structure is best? It depends. Different markets have different needs. How much efficiency is needed or is possible? What is the current regulatory structure? How much risk is the utility shareholders or ratepayers willing to accept? More than one solution (or a hybrid solution) may be appropriate. In each case, careful analysis of each situation is warranted. The important takeaway from this is that there are effective policies in place which are significantly reducing energy demand. The lessons learned from these policies should be used to refine and adapt programs to individual markets, with continuously improving results. These policies should be widely expanded to produce even greater reductions.


References

[1] McKinsey. Unlocking Energy Efficiency in the US Economy. 2009. http://www.mckinsey.com/clientservice/electricpowernaturalgas/downloads/US_energy_efficiency_full_report.pdf
[2] National Action Plan for Energy Efficiency. Aligning Utility Incentives with Investment in Energy Efficiency. 2007. http://www.epa.gov/cleanenergy/documents/suca/incentives.pdf
[3] PG&E. PG&E Corporation Financial Reports. May 12, 2010. http://www.pgecorp.com/investors/financial_reports/annual_report_proxy_statement/ar_html/2009/index.html
[4] Lazar J. Alternatives to Decoupling. 2008. http://docs.google.com/viewer?a=v&q=cache:UinqXRbJVXAJ:www.puc.state.mn.us/portal/groups/public/documents/pdf_files/000937~1.pdf+alternatives+to+decoupling&hl=en&pid=bl&srcid=ADGEESgGVPwOZLg5L0FWk1TVUwShxFkEbtvV0hRlP62hFJjVBh-Qo2-esJfb4
[5] NV Energy. A Balanced Approach - Sierra Pacific Resources 2007 Annual Report. 2008. http://media.corporate-ir.net/media_files/irol/11/117698/SRP_AR_2007and10K.pdf
[6] Asian Development Bank. A Rapid, Low Cost Path for Energy-Saving Investments in Jiangsu. 2005. http://www.google.com/url?sa=t&source=web&cd=3&ved=0CCoQFjAC&url=http%3A%2F%2Fwww.imt.org%2FPapers%2FChina%2FEPPProspectus.doc&ei=IGJ5TI_kEti4jAff5PTDBg&usg=AFQjCNHzKt86DspbhoPaItdSHaoaSan00Q