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

Thought Experiment: What if global warming and resource limitations didn't exist? A way to move the energy policy debate forward.

Today I was listening to a podcast about US energy policy and what should be driving it. Climate change? Energy independence? Resource scarcity? National security? Job creation? This is something I've thought about at length before, and it inspired me to organize my thoughts and write it down. The question I framed to myself: How might the majority of Americans be able to unite behind a common cause that would build a solid foundation for reforming and progressing our nation's energy culture? The following is a basic stroll through my thought process.

I first thought about the polarizing arguments in the debate. Let's face it - the majority of climate scientists tell us the data shows global warming exists and that humans are at least partly to blame. Yet there is a very loud minority of people who believe climate science is wrong - either that humans are not to blame for global warming, or that global warming doesn't even exist. This is definitely a polarizing argument in the debate. So let's remove it. Let's assume that those who challenge global warming science are right. Let's assume we are in an alternate dimension where no one has ever heard of global warming, or if they have, it's not caused by humans so there's nothing we can do about it.

What else can we remove? Resource Scarcity. While I'm not sure of the exact numbers, it appears that the majority of fossil fuel resource analysts are predicting that peak oil has already occurred, is imminent, or will soon occur within this decade. Further, other fossil fuel resources will also inevitably reach a peak within the next generation or two. On the other side of the debate, there are those who believe resources will not run out as soon as projected, or that we'll continually be able to make new resource discoveries to carry us into the future. So let's remove this argument, too. In our alternate dimension, peak oil is a non-issue, at least another 100 years away.

So now we are in this alternate dimension where global warming and resource scarcity do not exist. How would our society's attitudes and policies toward energy use be different? How would it affect the energy policy debate?

In this dimension, there are still problems with the current energy culture. We still consume and import too much oil, which still supports an unhealthy trade deficit and makes us reliant on some countries with whom we might not otherwise be so friendly. This vulnerability is still a hot button issue in national security circles where energy independence is identified as a mitigation strategy to reduce the impact of risks similar to the 1970s oil embargo. And the oil is still combusted, contributing to smog and air pollution (and a lot of greenhouse gases, not that it matters in this dimension). Also, dirty coal still supplies 45% of our nation's electricity. This also still greatly contributes to air pollution and affects the health of every citizen downwind from a coal power plant. And coal is still stripped from mountain tops, creating huge amounts of water pollution and habitat destruction, and also negatively affects the health of every citizen downstream. Oh, and energy prices still widely fluctuate depending on supply & demand, wars, natural disasters, and speculators. Overall, this dimension has a familiar set of energy problems that need to be overcome, and are no less urgent than the ones we really face today.

What are the best ways to overcome these problems? How can this dimension achieve energy independence, reduce air and water pollution, and stop the destruction of common lands? A nice thing about these problems is that there is little debate that these problems exist - regardless of dimension! So people can move foward and decide what strategies to implement to resolve these problems.

So here is the first answer in my thought experiment. Perhaps the best way to move our nation's energy policy debate forward may be to drop the primary arguments for change. If we stop proclaiming that urgent change is needed because of climate change and resource scarcity, we can still proclaim that urgent change is needed to achieve energy independence and reduce air and water pollution - and the latter arguments are ones that a majority of people can unite behind.

Next I wanted to think about the effects on policy in the this dimension without global warming and imminent resource constraints. What are ways to achieve energy independence and significantly reduce air and water pollution?

First we have to quantitatively define success. The higher our degree of energy independence, the lower our risk to national security and foreign influence. A reasonable measurement of energy independence would be to determine how much of our energy supply is sourced domestically - any imported energy (oil, gas, electricity, biofuel, etc.) is not sourced domestically. Should we have a goal of 100% domestic energy sourcing? 95%? 90%? That's something our countrymen and countrywomen in this alternate dimension have to decide. As a baseline, it's interesting to note that the US is actually about 70% self-reliant on energy today [1].

Most imported energy is in the form of oil. And most oil is used in transportation. So the vast majority of heavy lifting to bring our energy independence score closer to 100% is to focus on transportation. We can affect the demand curve by reducing the number of miles we drive, increase energy efficiency, use alternative energy sources (i.e. batteries, domestic biofuels), or a combination thereof. We can affect the supply curve by increased domestic and offshore drilling - and note that just because this alternate dimension has no peak oil in sight doesn't mean that there can be an oil spigot in everyone's back yard. The US still has only have 3% of the world's oil reserves, in the same locations they are now.

In this alternate dimension, then, there would likely be a debate about whether to encourage more drilling, increase conservation, increase efficiency, or research and develop non-fossil fuel technologies. With a reasonably sized budget, we will likely end up funding them all. Of course, the fossil fuel industry has a cost advantage of being relatively inexpensive and mature technology, so subsidies for drilling aren't necessarily  needed to maintain profitability and relatively low gas pump prices. Thus, I think it's reasonable to assume that increased extraction efforts can proceed without government subsidies. Also, converting all of our foreign oil to domestic would not change the pollution problems that are still an issue. (And not just air pollution - think Deepwater Horizon, or fracking). Therefore, it seems reasonable that the focus of our collective tax money should be used to invest in efficiency and alternative energy technologies that are more environmentally sustainable over the long run. We can also brainstorm some creative conservation incentives that can be applied to commercial and personal transportation (e.g. encourage telecommuting, compressed work weeks, laddered gas prices that increase with increased consumption).

How can this alternative dimension measure and decrease energy-related air pollution? Criteria air pollutants are defined by the EPA as: particulate matter, ozone, carbon monoxide, sulfur oxides, nitrogen oxides, and lead. Hydrocarbons are also measured in automotive emissions.

Today's average auto emissions have vastly improved since regulations began in 1966. An average unregulated vehicle in 1966 had a combined emissions of nitrogen oxides, hydrocarbons, and carbon monoxide of 102.1 grams per mile [2]. Today's LEV II standard in California mandates a combined emissions of less than 4.36 grams per mile, or about 96% less emissions. That's a pretty good improvement. Of course, our city's smog and pollution problems are not gone, so more can be done. To further decrease pollution from vehicles, we might choose to enforce even more stringent restrictions on a grams per mile basis, or maybe place a tax on these pollutants. The tax could be paid by the manufacturer for the life of the car, or by the consumer based on the smog rating of the car and the number of actual miles driven in a year. This would encourage consumers to purchase more energy efficient and cleaner cars, and encourage manufacturers to produce these cleaner cars.

In 2009, America got 44.9% of its electricity from coal, 23.4% from natural gas, and 1% from oil, or 69.3% from fossil fuels [3]. Similar approaches as above could reduce pollution from electricity production, and since it's much easier to measure pollutants from these stationary sources, more opportunities for creative policies exist. Strict restrictions, taxes, or cumulative caps on specific pollutants emitted per MWh of electricity can be considered, although it may have to be technology-specific. It would also be unfair for some geographies to be overly burdened just because they lack abundant renewable resources. Decreased pollutants can be achieved by catalytic scrubbers and filters, increasing energy efficiency, or by developing non-fossil fuel sources. A related thought: Our states place large taxes on cigarettes because they emit pollutants that cause severe health problems to exposed persons - couldn't we reasonably tax coal for the same reason?

To reduce water pollution from fossil fuel extraction, our we can consider targeted restrictions on mountain-top coal mining, offshore drilling, and fracking operations.

The demand size of the equation can also be influenced to reduce pollution. To discourage ever-expanding electricity consumption, utility revenues can be decoupled from the amount of electricity consumed. Energy efficiency can be increased. Various NPV-positive efficiency projects have been identified. Further increases in efficiency can be achieved by subsidizing efficiency projects that are less profitable or have a longer payback. For example, the energy required for space heating in this country could be drastically reduced by the widespread adoption of geothermal heat pumps for both residential and commercial buildings. Since these systems have large up-front costs and potentially longer paybacks, a policy could be implemented to subsidize installations on a regional basis such that they have an average payback of less than 5 years. Research grants for developing reduced-cost drilling/excavating operations for pipe placement could also be considered.

In this alternate dimension without global warming or peak fossil fuels, the nation would still need government policies to focus on

• further restricting emissions from internal combustion engines
• encouraging more efficient or alternative energy transportation technologies
• increasing energy efficiency in buildings and industry
• cleaning emissions from fossil fuel-based electricity generation
• encouraging electricity generation from non-fossil fuel sources 
• enforcing cleaner methods for extracting fossil fuels  
• incentivizing energy conservation behavior 

Coming back to reality now, this list appears very similar to those strategies adopted to combat climate change and resource scarcity. But a comprehensive national energy policy can't seem to get traction because people are too busy fighting over the reasons why need to make changes. It doesn't seem very far-fetched that we could get a majority of Americans (and their representatives in congress) to agree that we need to achieve true energy indepedence and reduce air and water pollution from energy extraction and use. If we can agree on that and implement strategies that move us toward achieving those goals, we will still make great progress toward decreasing greenhouse gas emissions and reducing our appetite for dwindling resources. And if the climate scientists and resource analysts just happen to be right, then our efforts will provide benefits to overcome those challenges, too.


[1] Yergin D, The Fundamentals of Energy Security, Testimony to the House of Representatives, 22 March 2007, http://foreignaffairs.house.gov/110/yer032207.htm
[2] Chen et al, 2004, http://pubs.its.ucdavis.edu/publication_detail.php?id=200
[3] EIA, http://www.eia.doe.gov/cneaf/electricity/epm/table1_1.html

Dutch vs. Danish wind energy manufacturing and deployment - a case for strong and stable supportive policies

In response to the oil crises of the 1970s, large increases in wind energy research and development efforts were seen in Denmark, the Netherlands, Germany, and the US.  Not surprisingly, many of the world's largest turbine manufacturers are located in these countries.  What is more interesting is a comparison of resulting wind energy deployment and domestic wind manufacturing in Denmark and the Netherlands.

These countries have similar wind resources, and both enjoyed active government support for wind R & D.  Each country developed national laboratories dedicated to wind energy research.  By the year 2000, Denmark had installed 2340 MW of capacity. The Netherlands, on the other hand, had only installed 442 MW despite a goal of 2000 MW (Kamp, 2002).  A similar disparity existed in domestic wind manufacturing - Denmark had (and continues to have) a flourishing domestic wind turbine manufacturing industry, while the Netherlands had only one relatively small manufacturer.  The success of Denmark's wind energy efforts came despite the fact that the Netherlands spent more money on wind research and development than Denmark (Karnøe, 1995).  But why?

This subject has been studied by several scientists with varying focus.  The short answer is that learning environments and market stability were better in Denmark.  The initial wind turbine users in Denmark were mainly farmers and small companies.  This user base was well-organized and formed trusting relationships with wind manufacturers and research institutions.  This fostered a hands-on "learn by doing" approach to learning (Kamp, 2002).  

The user base in the Netherlands was not organized and did not form the same trusting relationships.  Perhaps most important was an early feed-in tariff in Denmark, which fostered a large and stable market (Ragwitz, 2010).  The feed-in tariff was able to provide a low-risk investment environment, which encouraged the market to grow. A study on wind energy incentives from Lawrence Berkley Laboratories states that "a sizable local market appears to be a pre-requisite to achieving successful localization [of a wind energy market]" and that "a stable feed-in tariff has clearly proven to be one of the most successful mechanisms to date for promoting large-scale wind energy markets that offer the stability necessary to attract local manufacturing" (Lewis & Wiser, 2005).

From this, it is clear that government support is essential for significant capacity growth and domestic manufacturing success.  The cost of wind energy has come down substantially in recent years, but it still needs some kind of support in order to experience continued growth.  And of course, countries have different economic and political characteristics and cultures, so a specific mechanism (like a feed-in tariff) is not suitable everywhere.
 

There are other ways a country like the US could do more to foster a domestic wind energy market and manufacturing base - local content requirements, tax incentives, mandatory renewable targets, government tenders, and others.  Whichever mechanism is used, it should create a stable and large market for wind energy investments.


Works Cited

Kamp, L. M. (2002). Learning in wind turbine development : a comparison between the Netherlands and Denmark. Retrieved September 24, 2010, from Universiteit Utrecht: http://igitur-archive.library.uu.nl/dissertations/2002-1128-170921/inhoud.htm

Karnøe, P. (1995). Institutional interpretations and explanations of differences in American and Danish approaches to innovation. In W. Scott, & S. Christensen (Eds.), The institutional construction of organizations. Thousand Oaks: Sage Publications.

Lewis, J., & Wiser, R. (2005). Fostering a Renewable Energy Technology Industry: An International Comparison of Wind Industry Policy Support Mechanisms. Berkley: Lawrence Berkley Laboratories. Available at http://eetd.lbl.gov/ea/emp/reports/59116.pdf

Ragwitz, M. (2010, September 20). Promotion Instruments for Renewable Energy Sources in the Electricity Sector. Akureyri, Iceland.