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New York Negawatts

Balancing risks and opportunities in efficiency investments.

Fortnightly Magazine - January 2010

Comparing the savings distribution (see Figure 4) and incentives (see Figure 5) illustrates the inherent bias in the incentive mechanism’s structure. Figure 4 shows median total incremental savings are 93 percent of targeted savings, and the distribution of savings is fairly symmetric around the median. However, the distribution of incentive payments is skewed to the left and concentrated at incentive levels significantly less than the possible maximum. The median incentive is only 65 percent of the maximum. This suggests the utilities probably will come close to achieving the cumulative savings goal, but will earn incentives significantly less than the maximum. A fairer system would reward utilities on the basis of their cumulative savings performance.

The cap on incentive payments potentially could discourage investment in energy efficiency as expected savings approach the target. The mechanism’s maximum incentive and penalty cap are intended to simultaneously reduce risks to regulators of unexpected over-performance and to limit the liability of utilities for under-performance. In structuring the incentive mechanism, the PSC intended to create a “reasonable mix of risk and opportunity.” However, while balancing risks, the cap discourages additional investment in energy efficiency as expected savings approach the target. Because of the random nature of energy savings, the savings amount may exceed the target in a year. Excess energy savings would cause further erosion of revenues, without an opportunity for additional earnings to offset them. The cap limits what utilities can earn to compensate them for investing in energy efficiency, and creates investment disincentives as expected savings approach the target. Finally, the dead band between 70 percent and 80 percent of savings discourages energy-efficiency investments.

The mechanism’s intended balance and the fairness it implies have merits. Clearly, an unreasonably high penalty cap could impose some risk on the regulator that the utility will discontinue all investments in energy efficiency once it falls within the penalty region. This analysis shows a very low probability ( i.e., less than 2 percent) that three-year savings will fall below 50 percent of three-year targets. In the small number of cases where they do, they average a relatively high level of 45 percent. The cap on incentives, on the other hand, limits the earnings potential for performance significantly above expectations. The analysis results show, assuming typical performance for the six IOUs, a significantly higher probability ( e.g., 25 percent) that utilities will exceed their targets, but will receive no reward for their superior performance.

 

Endnotes:

1. New York Public Service Commission Case 07-M-0548, Energy Efficiency Portfolio Standards, and Order Approving Programs , issued June 23, 2008. In May 2009, the Commission issued a similar order that established targets and standards for natural gas efficiency programs.

2. New York Public Service Commission Case 07-M-0548, Proceeding on Motion of the Commission Regarding an Energy Efficiency Portfolio Standard, Order Concerning Utility Financial Incentives , Aug. 22, 2008.

3. Resolution in Support of Incentives for Electric Utility Least-Cost Planning ; issued by the NARUC Conservation Subcommittee and passed by the Executive Committee during the Summer Committee Meeting on July 27, 1989 in San Francisco.