Stimulating DSM Investment as a Product within Utility Portfolios

Brooks Albery | Sep 11, 2009

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The primary question being addressed through this conference is how internal operations and regulatory policies of utilities and the regulatory agencies will be impacted in a carbon-constrained future. Setting aside for the moment the question of whether constraining carbon is the right policy direction, the question becomes "how" the carbon constraining policies can be most economically implemented. Two primary directions for the industry under a carbon constrained future are: 1) utilize technology advancements to reduce the carbon intensity of how new power supply is provided to consumers; and, 2) utilize advancements in energy efficiency ("EE") to allow consumers to generate the same level of energy 'utility' out of a reduced amount of energy consumption.1 This paper provides thoughts from the electric utility's perspective in terms of operating Demand Side Management ("DSM") programs as a product line within their portfolio with an overall goal of maximizing shareholder returns. As a key player in any push to grow EE as a method for reducing carbon, the actions of the utilities will play a central role.

EE has a long track record of playing a significant role in the energy market but the impact of utility-based Demand Side Management programs is less clear. The ACEEE brings forth data indicating that advances in energy productivity and EE have in fact played the dominant role in our energy markets since 1970. Using the relationship between energy production and total economic output as a measure of energy intensity, the ACEEE paper shows that the US economy has reduced the energy input requirement (in BTUs) per dollar of gross domestic product by roughly 50%.

"[E]nergy efficiency has contributed more value to the economy in recent decades than any conventional energy resource, meeting three-fourths of all new demand for energy services since 1970" (Laitner 2008). [E]stimates for 2008 indicate that by the end of this year U.S. energy consumption per dollar of economic output will have declined by more than 50% since 1970, from 18,000 Btus to about 8,900 in 2008. As such, current levels of energy consumption in the U.S. are only half of what they would have been if levels of energy services, the structure of the economy, and overall energy productivity had remained unchanged."2

While a portion of this savings in energy intensity comes from structural changes like the movement away from manufacturing to more of a service-based economy, much of the energy savings likely also resulted from growth in organic EE.3 The next question is what role the electric utilities have played in the overall growth of EE and what can be done to further their contribution going forward.



Data from the EIA suggest that utility-based DSM programs and investments have had modest impacts on peak demand relative to total industry demand. Since 1996, utility-based DSM programs have been generating peak demand reductions at a fairly steady rate of around 3% of total generating capacity.4 While the utility-based programs may have significantly impacted the acceptance and growth of EE programs by acting effectively as a sales channel promoting efficiency to the customer base, the overall financial roll of the utilities has remained small.

Differences in growth between total net summer capacity and DSM peak impacts are also significant. Net summer peak capacity has increased by 28.7% over the period 1996 to 2007 while DSM peak impacts have remained largely flat with a total growth of only 1.3% over the same period. These numbers also support a conclusion that the utility-based programs, have played a relatively minor role in the overall EE market.

The topic of how best to provide regulatory incentives for DSM growth has been well covered through research projects like Aligning Utility Incentives with Investment in Energy Efficiency published by the EPA in 2007. The goal for this paper over the remaining pages is to discuss how viewing DSM as a product within the utility portfolio impacts decision making and to provide a current example from Florida on how DSM programs impact utility profits under traditional ROR regulation.

DSM as a Product within Utility Product Portfolios

As noted above, DSM EE programs allow customers to receive the benefits of energy consumption at a lower level of usage. The challenge lies in getting customers to make the upfront decision to invest in EE technology in order to enjoy the benefits of lower bills in the future. It is logical to view these DSM programs as providing customers the same level of benefit from energy consumption using a different product. In this respect, DSM is a product alternative within the overall energy market that competes against a decision to simply buy more KW hours provided through fleet or purchased power generation.

Looking at DSM programs as products provides a useful paradigm for understanding incentives and behavior. Like all products, the primary decision point comes from the end user: whether it is an industrial plant or a residential customer. In the case of DSM, end users are making decisions on trading off investments in energy savings through technology in exchange for reductions in bills going forward.5 Because investor owned utilities are in business to earn profits for shareholders (among other goals), it is necessary to understand the impact of this product substitution on overall utility profits in order to help interpret the position of utility-based DSM programs relative to the larger EE industry.

A slight twist in the analysis of DSM as a product in the utility's portfolio is that utilities are really only facilitating purchases of products rather than actually providing the end product itself. A standard DSM program that provides a monetary incentive for the purchase of newer technology is really only allowing the utility and regulatory agencies (through policy) to participate in the true product transaction which is the purchase of new or substitute technology. A simple example is the case of an incentive to replace old air conditioners where the actual product transaction involves the purchase of an air conditioner.

In spite of the rather tangential involvement of the utility in the transaction, the roles the utility plays in managing DSM like a product in its portfolio are critical for success. Basic product management and product marketing roles including marketing to educate customers on the program, vetting and training contractors that do install work, managing the customer experience from end to end, and regulatory and financial reporting all require sufficient attention from the utility to ensure success. The underlying challenge is that companies in a market economy are going to weigh their choices on how to spend limited resources based upon their returns on investment and DSM as a product will remain underfunded relative to its potential so long as its returns lag providing more kWh to customers.

In looking at utilities as 'total energy' companies in business to provide customers energy benefits either through both kWh or EE, utilities need to determine how much attention to focus on each product in their portfolio. While the paradigm for earning shareholder returns from selling kWh are well defined, the shareholder impacts from providing more EE through DSM programs are more elusive.

DSM Programs Drive Down Earnings Under Traditional ROR Regulation

A classical theory in the economics literature of firm behavior when under ROR regulation states that firms will maximize the capital assets in their rate base in order to maximize earnings.6 In a simplified view, overall revenues and the total volume of profits for the traditional ROR regulated utility are a function of the quantity of debt and equity along with the rates of return allowed for each asset class. As the quantity of assets that are declared used and useful and admitted into the rate base increase, so does the total volume of revenues and allowed profits.7

With DSM functioning as a substitute for additional energy consumption, DSM reduces the level of peak demand and thereby reduces the level of utility investments in generating capacity. The end result is a lower rate base, reduced revenues, and a smaller total quantity of returns on assets. The concept of 'uncoupling' revenues from units of KW energy sales does not necessarily resolve this challenge as future growth in revenues associated with additional investments in fleet generation are still impacted by DSM programs.

A simple current example of a utility proposing a DSM program that provides an addition 750MW of summer peak capacity over a 10-year planning horizon can help demonstrate this point. Assuming that the utility would build a 750MW plant in year 5 absent the DSM program and would utilize existing margins and purchased power to meet power needs until the plant is built, and assuming an overall ROR of 10% for simplicity. Under this scenario, the company will experience a reduction in net income of approximately ($140M) over the 10 year period due to the avoided rate base increase.8 While there is likely a fair degree of variance around this number, the direction of the impact on earnings and the order of magnitude should be reasonable. As such, the impact on utility incentives in terms of pushing DSM programs aggressively should also be clear.

Regulatory Policy Must Level the Financial Playing Field for DSM as a Product

Assuming the case has been made that utilities should be incented to participate in the energy market as providers of both energy and energy efficiency, the question becomes how to level the financial playing field. There are many methods currently in place for controlling how utilities participate in the DSM market. Some programs provide cost neutrality for DSM expenditures while other programs allow utilities to share in the net benefits associated with the DSM program or allow utilities to earn a premium above the authorized ROR on the current rate base. While a survey of existing DSM incentive policies is has been well covered and is beyond the scope of this paper, some examples of benefits and concerns is useful.

Regulatory approaches that track total DSM program costs and recover the overall DSM expenditures on a one-for-one basis through a general rate adder that is periodically adjusted or trued-up should be avoided as these policies provide a disincentive for DSM. In this case, there is a negative financial impact on the utility. In some cases, avoiding a penalty for missing DSM goals remains the only true financial incentive. DSM programs handled in this fashion will reduce the magnitude of overall earnings over the long run while providing profit neutrality over the short run period in which the DSM outlays are recovered. This result effectively provides a negative incentive for utilities to grow DSM programs as a product in their overall energy portfolio. The utility's view of the optimized level of DSM under this approach is zero from a long run earnings perspective.

A different approach allows utilities to earn higher ROR based upon success of their DSM products in the market. There are differing levels of complexity and likelihood for stimulating DSM demand depending on how these regulatory programs are designed. An example of one form of ROR adder program to stimulate DSM implementation was built into the Florida statutes in 2008.9 Under the Florida statute, utilities will benefit from an additional 50 basis point adder on their authorized ROR if the utilities are able to show that 20% of overall demand growth in their base is covered by 'energy efficiency and conservation measures'.10

There are two important aspects of the Florida incentive to consider: 1) impacts of the Florida incentive will vary depending on the timing of the avoided generation investment; and, 2) the 50 basis point adder will put the utilities into a negative position once the avoided CAPX exceeds around 5% of the total rate base (assuming a 10% ROR). The first impact is easily shown graphically in Figure 2.11 In the case depicted here, the utility benefits from the 50 basis point adder during all 10 years and suffers the reduction in the rate base (relative to a baseline that would have included a new plant) in years 5-10. Because the size of the avoided plant addition in this hypothetical would create an avoided CAPX impact of just under 5% of existing rate base, the impacts of the DSM program under this 10-year planning view never turn negative.12 The cumulative impact is heavily affected by the assumption on which year the avoided plant would have been completed and admitted into the rate base.



This second impact creates an interesting tension between short run and long run financial goals for the utility. A 50 basis point ROR adder dependent upon success in growing DSM programs going forward (the Florida plan) creates a short run incentive for additional returns while the longer term impacts of high DSM penetration exceeding 5% of the asset base creates a disincentive.13 Figure 3 attempts to show this dynamic with a new view of the 10-year planning horizon only now including 1800MW of existing DSM.14 As can be seen in this example, the utility continues to benefit over the first 5 years from the adder, but at a reduced rate now reflecting the rate base reductions associated with the existing DSM. When the additional 750MW of avoided fleet generation investment are added in year 5, the financial impact turns negative and quickly leads to a cummulative net negative impact. Given this dynamic, a more holistic review that considers total DSM in place as a percentage of the rate base is needed to determine whether the incentive effectively levels the playing field for the totality of DSM in the utility's base. The challenge created here is that the holistic and dynamic approach which includes analysis of the timing of past DSM implementation, the amount of avoided CAPX, assumed depreciation levels, will likely be more difficult and contentious to implement.



Go For Simplicity

Allowing utilities to classify DSM investments as regulatory assets that are included in the rate base presents a simpler approach to addressing the impacts of DSM programs on utility shareholders while incenting utilities to participate effectively in the EE market. Allowing a premium return on DSM expenditures will incent utilities to view DSM as a more profitable product and allow the industry to recognize the current cost advantages of EE. The Duke Power "Save-A-Watt" proposal is an example of this approach where the avoided CAPX in energy and capacity is amortized over the lifetime of the EE measures with the utility able to charge ratepayers a return on the un-depreciated avoided "investment". Categorizing direct investments in DSM programs and in supporting technology like AMI as regulatory assets will allow utilities and regulators the relative comfort of using the regulatory monitoring and compliance structures that have been in place for many decades.15 This level of familiarity with the rules and procedures will inherently make this regulatory approach simpler to implement.

There will, however, continue to be challenges under this approach with the biggest challenge being the assessment of whether investments are appropriate for inclusion in the rate base. Investments in DSM programs that have been thoroughly vetted and pass the standard tests for cost effectiveness and consumer impacts (e.g., RIM and TRC) should have little difficulty in entering the rate base as regulatory assets. Newer technologies like Smart Grid and AMI, which will be required to fully exploit DSM going forward, but are aimed at supporting DSM as opposed to providing the DSM 'product' itself, will have a more difficult time passing cost/benefit analysis necessary to enter the rate base. EISA 2007 begins to address uncertainty around investments in smart grid and AMI by directing states to "consider" requiring utilities to assess a wider variety of cost/benefit impacts associated with these investments.16

The case for providing higher returns on EE investments

Regulatory assets created through investments in DSM and supporting technologies like Smart Grid and AMI should enjoy a premium above existing ROR on rate base. First, if the policy goal is to move the energy market, both suppliers and customers, to DSM more quickly than status quo, then incentives should be provided to both consumers and utilities. The topic of providing incentives to customers to foster additional 'sales' of DSM is well covered. The impacts of providing incentives to utilities to generate additional DSM 'sales' and to grow DSM infrastructure is more open. While a rate adder designed to make a utility neutral on the impact of DSM on overall returns is a step in the right direction, the incentives are reduced to regulatory compliance and good will within the community and customer base.

Secondly, if it is correct that EE is the least cost form of energy in today's market, even prior to enforced carbon constraints, then the economic value to consumers and society as a whole is optimized by aggressively pursuing more EE. Under these conditions, as much new energy demand as possible should be provided by EE over new fleet generation, subject to the traditional benefit tests to ensure benefits accrue to the customer base. Programs that allow utilities to treat DSM investments as regulatory assets easily allow the benefits of the lower EE costs to be recognized in the energy market. States have begun to provide incentives to utilities over and above traditional returns through programs that share benefits between ratepayers and shareholders.17

Conclusions

Utility participation in the EE industry through DSM programs has lagged behind the growth in the EE industry in general and growth in total industry peak capacity over the last decade. It is instructive in understanding historical DSM trends and utility behavior by looking at DSM through the utility's perspective as one product in the portfolio of products that can be used to meet customers' energy needs. The topic of how to best provide incentives to utilities for DSM is well covered and there are many different approaches being utilized by regulatory agencies today. Programs that allow for cost recovery only and programs with pre-set rate adders must be viewed carefully to understand the differences between short run and long run impacts on utility shareholders. The best market-based approach to stimulate utility participation in DSM will allow utilities to seek profit maximization through DSM as a product. Combining customer safeguards through standard program benefit tests with programs that recognize EE's cost advantage in the market will help allow the industry to move toward an optimum level of EE as a choice in that way energy utility is provided to the customer base. And lastly, DSM incentive programs that utilize existing regulatory structures and rules have the best opportunity to achieve new DSM policy goals quickly. The next piece of research to be tackled is the level of incentive above current ROR that optimally reflects cost advantages that DSM currently enjoys in the market.

Next Steps for Research

Areas for continuing research in order to understand the scope of the role that utilities can play in the larger EE market include:

  • Calculating the optimal incentive level (above ROR) for utility DSM programs;
  • Calculating the total economic benefits associated with optimizing EE level; and,
  • Impacts on the larger EE market from fostering more aggressive participation by utilities.
  • References
    1. Energy 'utility' refers to the overall value consumers get from energy consumption. EE as referred to here does not imply a reduction in demand for energy as an industrial input or a consumer good; that would be conservation. EE refers to a more efficient utilization of energy. Consumers get the same benefit at a lower utilization level.
    2. The Size of the U.S. Energy Efficiency Market: Generating a More Complete Picture. Karen Ehrhardt-Martinez and John A. "Skip" Laitner, May 2008) Report Number E083
    3. Organic EE in this context refers to efficiency gains from industry evolution around technology-based product improvements like CFLs, improved insulation, and Energy Star product lines.
    4. % DSM is calculated by comparing DSM actual peak load reductions against total net summer capacity. Electric Net Summer Capacity numbers from EIA Table 8.11a. Utility DSM actual peak load reductions from EIA table 9.1.
    5. Some load management and shedding programs are different in nature and more closely resemble conservation as these programs will result in direct reductions in energy usage, typically in response to approaching peak capacity constraints.
    6. Averch & Johnson, Behavior of the Firm Under Regulatory Constraint, 53 Am. Econ. Rev. 1053 (1962); Wellisz, Regulation of Natural Gas Pipeline Companies: An Economic Analysis, 55 J. Pol. Econ. 30 (1963). A relatively accessible review of this theory as applied to telecommunications can be found in Albery & Sievers, The Averch-Johnson-Wellisz Model and the Telecommunications Industry, Fed. Comm. Law Jour. Vol. 40 Number 2 (1988).
    7. Note that the rate of profitability or the percent returns are fixed. Only the quantity of profitability is affected as the constant percentages are applied against a larger base.
    8. This estimate utilizes an estimate of $850 per KW for future construction costs in 2014, uses a 5% discount rate and applies an additional cost factor to better align impacts on earnings from changes in the rate base. The factor is derived from a current utility, is based upon actual 2008 results, and is designed to maintain the ratio between net income and a 10% ROR on total equity and debt.
    9. 2008 Florida Statutes, Title XXVII, chapter 366, section 366.82, paragraph 9.
    10. This DSM incentive was added to the Florida statutes in 2008 and will require regulatory review for each utility prior to implementation. Given the newness of the policy, no utilities in Florida have put the adder into place to date.
    11. This example uses similar assumptions including $850 per KW of construction costs in 2014, a 10% ROR, and uses FPL's 2008 asset base drawn from its SEC 10-K filing.
    12. The level of ROR adder to make DSM programs neutral under this simplified analysis is given by the following calculation ROR Adder = ((Avoided CAPXDSM /Rate Base) * ROR).
    13. Could this be a clever way for the legislature to take advantage of the notoriously short-term focus of Corporate America?
    14. This example is again based off of FPL and assumes rate base assets of $250 per KW reflecting lower construction costs in the past along with depreciation. This example is purely hypothetical and for exposition only.
    15. I realize that some may chafe at my characterization of traditional ROR regulation as 'comfortable'. In terms of the old expression "The devil we know", both regulators and utilities may be able to more easily make progress using adjustments to existing rules rather than creating a new set of regulatory rules to follow.
    16. Energy Independence and Securities Act of 2007, Pub. L. No. 110-140, -1305, 121 Stat. 1787 (2007).
    17. The cost capitalization approach used in Nevada offers a 500 basis point premium for DSM investments over supply investments. For the presentation Overview of Utility Incentives, Wayne Shirley, The Regulatory Assistance Project, August 26, 2008.

    Related Topics

    Comments

    The conventional definition of DSM is the management of customer demand by the utility company, not management by the customer. In spite of emerging smart grid and AMI being viewed as supporting increased levels of utility DSM programs, the majority of customers in general will not embrace it unless there is a fundamental change in how DSM programs get implemented.

    Most customers will oppose having more intrusive technology connected to smart grid or AMI implemented on their premises that their utility company "manages" for the purpose of reducing demand, because this literally means their utility company controls it. It essence it will be viewed as energy rationing at a minimum, or worse some customers may view it as a means for utility companies to manipulate energy bills to increase their incomes.

    Without changes the whole concept of new technology forced on customers for greater DSM will sooner or later be seen by customers to be the society in the fiction novel 1984 by George Orwell where the public becomes monitored and their lives more heavily controlled by government. Having an outside entity like one's utility company control a customer's environment or lifestyle through the use of new technology reeks of privacy invasion which most average citizens will vigorously oppose.

    For future smart grid- or AMI-supported utility DSM programs to be successful, they must be designed to incent customers to practice more demand management themselves.

    EE has grown historically without the use of utility DSM programs in the last few decades largely because customers have made all the controlling decisions on what to purchase to increase their EE and when to purchase it. Too, governments offering incentives for the public to adopt more EE have been steadily growing completely outside of the utility industry, with instruments like sales tax exemptions or rebates and subsidies given directly to consumers and industry to purchase EE products and services. The utility industry regulators and policymakers should learn from this.

    Smart grid and AMI together with other new consumer technologies can be used to simply empower customers to increasingly manage their own demand. Utilities can foster it by providing greater information to customers real time information about their energy uses, energy costs, the grid’s energy costs, and most critically offer creative rate incentives to customers who successfully implement timely demand responses or total energy consumption reductions.

    For example, Plug-In Hybrid Electric Vehicles are expected to emerge in huge numbers soon and could present onerous new demands on the grid at peak times without effective DSM. But rather than using new technology to FORCE consumers to recharge them at specific times of the day when utilities determine excess capacity is available i.e. forced rationing, it would be far more palatable with consumers and likely more effective overall if consumers were given incentives through individualized rates to decide for themselves when to recharge. Customers who have practices greater demand reductions in recent past for example could be offered greater rate discounts than others at specific desirable times of the day for recharging. This however flies in the face of uniform rate regulation where every customer must pay the same rate at any given time of the day. IN ESSENCE REGULATORY REFORM IS BADLY NEEDED TO MAKE FUTURE DSM PROGRAMS EFFECTIVE WITH CUSTOMERS.

    Thanks for the comments Bob. I especially agree with your last sentence that regulatory reform is needed if DSM is to fulfill its promise in the market. Having followed DSM dockets in state jurisdictions where the debate rages over how much DSM is technically and economically achievable, I have noticed an under-representation of the basic concern around incentives for the utility. With utilities in a great position to participate in this market as a primary sales channel for DSM, the opportunity is there for a much greater amount of DSM sales by utilities than has occurred to date. If it is true that EE cost roughly 50% of new fleet generation, then a form of sharing (Net Benefits) where in the utility is allowed to earn a higher return on DSM than fleet generation makes sense to me. This would allow the utility to follow basic business incentives that will increase earnings and customer utility around energy consumption.

    Lastly, by way of clarification, the DSM I am referring to in this paper is focused on investment programs like replacing air conditioners, roofs, insulation, etc. and not on utility control of real-time energy consumption through Smart Grid which is more demand response oriented.

    Thanks again for the comments.

    Brooks

    Brooks,

    Your last comment is absolutely correct. Governments who are promoting the subsidies and tax incentives for private industry and consumers to purchase EE should wake up and get the regulatory framework revised to allow utility companies to participate in the marketing of EE.

    Think about it, utility companies are a direct market pipeline to every customer on the grid, plus they have intimate knowledge of every customer's energy use habits on file. Utilities are in the best possible position logistically to strategically use that information and use their own marketing leverage.

    Here in Ontario my local distribution utility company, Horizon Utilities, has public speeches made by its CEO Max Cananzi posted on their website. His latest includes a direct appeal to the government of Ontario to effect regulatory change that would allow them to participate much more in EE commercialization in partnership with government incentive programs being doled out. Utilities are definitely interested since aside from realizing more DSM, it could potentially be a means to grow their incomes and businesses over and above rate base increases.

    The most important sentence in the article says, “A standard DSM program that provides a monetary incentive for the purchase of newer technology is really only allowing the utility and regulatory agencies (through policy) to participate in the true product transaction which is the purchase of new or substitute technology.” This can mean returns earned by the utility for DSM are an additional cost that would not be incurred in a normal transaction. If the utility supplies value through its marketing its cost may be justified. It is doing more than allowing the transaction; it is providing marketing for the supplier of the DSM. There remains a question about whether the utility is providing that marketing at a competitive price or is exacting a higher price through its monopoly power.

    However, the article also states that, “Data from the EIA suggest that utility-based DSM programs and investments have had modest impacts on peak demand relative to total industry demand.” This is the case in spite a major reductions in the energy intensity of our economy according to the article. Apparently the major achievements have occurred outside of utility DSM efforts. It appears that utilities have not been very effective marketers. Monopolists rarely develop effective marketing; they have no reason to do so. But it is disheartening that utilities have not been more effective in marketing DSM because they do bring something the article does not mention. Utilities provide incentives for DSM that are paid for by other customers. That is, cross subsidies. Utilities have a lot of experience with providing cross subsidies. They should be able to be more effective than the author finds them to have been.

    The real import of the article appears to be that it provides material to raise the question of whether utilities should be involved in DSM. Perhaps utilities really understand the long-term vs. short-term issues described here, and have figured out how to have it both ways. Collect incentives for DSM in the short-term without much impact on long-term energy demand. This implies that DSM will be more effective if incentives are provided without involving utilities. While Bob is right that utilities have a lot of data, the evidence referenced here suggests they employ it for a purpose other than making DSM effective.

    Dick,

    Emerging smart metering will give utility companies even more data to process, particularly hourly consumption and perhaps even peak demand readings for every customer. For the most part they will only use the data for TOU billing, but many including all of Ontario's utilities will be posting every customer's hourly consumption from the day before on secure account web pages for the customer's use if anyone wants to view it.

    My experience with some utility people is that most utility companies offer DSM programs mostly to their large industrial customers where they get a bigger bang for their dollar in load shedding. Residential DSM is only being offered when governments subsidize utilities directly for it, such as the communicating thermostats here in Ontario, and only to those customers willing to sign up for it. And yes there are many in the utility business who routinely question whether utility companies should even be involved at all in DSM because they don't have much financial incentive to be involved.

    My interpretation of this article is that utility companies could put much more investment in DSM, meaning investment in EE marketing and perhaps even EE product development and its commercialization, if only they could make a decent return on their investment. Having all this detailed customer consumption data on file, and having a marketing pipeline to every customer on the grid would only give them a strategic advantage over private businesses competing with them.

    For example, say a refrigerator manufacturer wants to sell their latest model proclaiming the best energy efficiency on the market. Traditionally they must advertise their fridge through conventional consumer media, and distribute their products through Home Depot type of retailers who mark the price up to make a healthy profit. Their claim of best efficiency on the market can only be supported by third-party agencies like Energy Star who would designate it with a "typical" energy consumption level. But as you know, energy consumption for any consumer product depends both on the product's efficiency level combined with a consumer’s behaviors on how they use them.

    Now picture instead your local utility company being allowed through regulatory reforms to participate in marketing these same refrigerators to consumers. They could advertise it to every customer with mailers stuffed in monthly bills or with ads posted on their website. They would say get a percentage of sales profits for each unit sold to their customers, becoming a source of income outside of their rate base income. Finally, armed with all that consumption data from customers, utilities are also theoretically in a great position to be players in the residential energy auditing business and consulting for home energy efficiency upgrades, now occupied mostly by private businesses. They would be poised to actually show customers the savings achieved from EE upgrades through their collected and analyzed meter data.

    I agree, Bob, that in an ideal world utilities would use their information for the good of man kind. But why should they?

    Utility capital costs in the US are driven 80% + by the infrastructure required to provide air conditioning. Yet utility programs do not address peak reduction in an effective way. Efficient pricing would recover the incremental cost of utility facilities during summer afternoons (standard economics), driving efficiencies and load shifting on a scale unimagined in our system of average cost pricing that subsidizes peak use. Sadly, we have been told by regulators from Ontario to California that real time pricing is coming, BUT the differences from period to period will be small. This means we will incur the cost while forgoing the benefits of real time pricing unless or until something allows real cost differences to emerge. That probably requires serious deregulation. And that would put detailed knowledge of energy consumption in the hands of consumers and competitive energy suppliers, instead of the owners of wires. But it would allow the cut throat competition that is so effective in driving efficiency elsewhere in our economy.

    Utilities love the current scheme. They get to build and earn on a large rate base as long as it continues to be used inefficiently. Having dealt with the lawyers and others who direct major utility decisions while working for one of the largest, I can assure you they are well aware of this. They use a different vocabulary, of course, to obfuscate what they understand. But they know where their money comes from and they will protect it. They can be bribed with incentives so large they are an affront to society to do some DSM as long as the major inefficiencies are preserved. But they cannot be made enthusiastic even then because the bribes, er incentives, can be withdrawn by future regulators, but they believe return on rate base is sacrosanct. That is the real world we need to deal with.

    I am currently assisting a client in collecting energy efficiency and solar rebates that will cost other rate payers a large sum. The rebates in this case are just gravy. They would have made the investments anyway. They are an exception. We have trained customers to wait to include energy efficiency until they get the bribe. But these bribes, er rebates or incentives, come and go and require a lot of effort. Now think about the advertising we would see for compact fluorescent lights if utilities were not involved. It would be along the lines of, “Stop paying the big bad utility all that money! Keep it for yourself!” Much more effective than what we see today.

    Consider how millions of US farmers learned modern farming techniques early in the 20th century. The US Ag Extension Service put people in the field who educated farmers about the advantages of improved practices. Those practices were adapted almost uniformly without resorting to rebates, etc. A program of education combined with efficient pricing for electricity would much more effective than a patch work of programs of the sort we see in the energy field. In the meantime the bribes we pay utilities to participate in DSM and energy efficiency programs are largely just an extra cost.

    Dick hits a nail with "There remains a question about whether the utility is providing that marketing at a competitive price or is exacting a higher price through its monopoly power. ", and also in his concern about where present utility incentives lie. It is next to impossible (and probably illegal) to force a private company to act against the interests of its shareholders. That needs to be addressed first, by re-structuring the utilities into separate pipes-and-wires distribution regulated monopolies not involved in sale of electricity, and multiple competitive generation companies who actually sell electricity to customers. In that environment, competitive advantage would accrue to the generation entity which could serve the mot customers with the least investment in generating stations, eg. the best demand management system for its customers.

    Len makes a great point, it should be the generators doing the selling of electricity, not the distribution-only local utility companies. His IMEUC proposals on this website are based exactly on this sort of reform.

    Dick, I understand completely your points about utility companies knowing exactly where their costs and incomes come from, and that they will protect the latter vigorously. My whole point is why not give them other sources of income through regulatory reforms, which does not mean all out energy price de-regulation. The extra sources of income might give them not only a mechanism to grow their businesses, but also some incentive to pursue DSM much more, even if it meant simply helping to educate customers on how to better practice their own demand management.

    Bob, the problem in motivating utilities with incentive payments for DSM is that those incentives are somewhat ephemeral. It is easy for them to be terminated after some years if they do not outright expire. Return on rate base is sacrosanct, so utilities can count on it for 30+ years. The level of current incentives required to overcome the legitimate concern over coming up short over the long-run by relying on DSM incentives would be unseemly. So utilities take what they are offered for doing DSM, but shape the flow they are going with to minimize the reduction in rate base. Even from inside the utility it is difficult to calculate the cost of these subtle twists and of course managements do what they can to keep it that way. From outside the utility we can only know there are large inefficiencies that cannot be addressed. There is no way to estimate them in any way that would be convincing.

    If regulators understood the alternatives to today's inefficient use of capital, and what it takes to get there, then utilities could not get return on excessive capital. But regulators are no where near that clever. Insistence on only small differentials in prices during the day is but one example of their limited understanding.

    Len is right that restructuring is necessary to achieve efficiency. I am going further and suggesting that energy efficiency would blossom once we worked through how companies can make profits in a deregulated world. Enthusiastic competitors would lap the reluctant utility. In economic terms, I am doubting whether cost of service regulation can achieve second best results that economists generally give it credit for achieving. It is such an extreme form of regulation that I think it achieves something that might be better considered to be third best results for both costs and energy efficiency.

    One only needs to look once at the typically abysmally poor load curves of utilities in "extremely energy consious" California to know that trying to get anything done by forcing businesses to act against their own shareholder's interests is a waste of time and money.

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