[BETA] Fortnightly

As competition in the electric industry increases, so does utility concern about the effect of demand-side management (DSM) programs on electricity prices. Because DSM programs often raise prices, several utilities have recently reduced the scope of their DSM programs or focused these programs more on customer service and less on improving energy efficiency (see sidebar). Whether all utilities should follow suit is, however, open to question. We contend that DSM programs do not always exert upward pressure on prices (em just sometimes. The actual effect will depend on many factors: the intensity of DSM programs, the underlying utility cost structure and retail tariffs, avoided costs, and regulatory treatment of DSM-program costs.

We used the Oak Ridge Financial Model (ORFIN) to examine the two factors that contribute to DSM's upward pressure on prices: 1) the cost of the programs themselves, and 2) the loss of revenue associated with fixed-cost recovery. (The second factor reflects the reduction in revenues caused by DSM-induced energy and demand savings that exceed the reduction in utility costs.) Our analysis examined DSM price impacts as functions of the factors shown in Table 1. (For details, please consult the Oak Ridge National Laboratory report, Price Impacts of Electric-Utility DSM Programs.)

Using data from the Energy Information Administration on the 180 largest investor-owned utilities, we created a "typical" U.S. utility: Avoided costs are very low until 1999, reflecting a regional market that has considerable excess capacity and low-cost energy. Beginning in 2000, avoided costs increase rapidly to their steady-state values in 2002. These higher values reflect the need to construct new facilities to meet increasing demands. Total avoided costs are based on the assumption that the DSM programs avoid 50 percent of the system-average demand-related transmission and distribution (T&D) costs.

We then constructed a reference DSM program that operates in 1995, 1996, and 1997 to yield a

1-percent reduction in peak demand as of January 1, 1998. The program's conservation load factor (CLF) of 40 percent means that electricity consumption is cut 0.67 percent in 1998, given a system load factor of 60 percent. (CLF is the ratio of the reduction in average demand versus peak demand, as induced by a DSM program.)

The initial cost of the program is $1192 per kilowatt (Kw) (3.6 cents per kilowatt-hour (›/Kwh)), of which the utility pays half. The measures are assumed to last 15 years on average; the utility costs are added to rate base and capitalized over a 10-year book life. The program's costs and effects are split 33/67 percent between the residential and

commercial/industrial (C/I) sectors, consistent with the sectors' shares of total sales. The program defers 50 percent of the demand-related T&D avoided cost. The initial cost is set to yield a TRC benefit-to-cost ratio of 1.5. So that the effects of DSM fall entirely on customers, not on utility shareholders, our analysis included annual rate cases based on a future test year.

Over the 15-year lifetime of the DSM investment, the program cuts total costs by 0.13 percent, and raises average electricity prices by 0.25 percent. In the initial