Changes in regulatory requirements, market structures, and operational technologies have introduced complexities that traditional ratemaking approaches can’t address. Poorly designed rates lead to...
The Trouble with Freeriders
The debate about freeridership in energy efficiency isn’t wrong, but it is wrongheaded.
the additionality requirement, which is the defining characteristic of the CO 2 offset concept established by the clean development mechanism (CDM) of the Kyoto Protocol. The mechanism, which is now the world’s largest greenhouse gas emissions offset scheme, is intended to validate and measure impacts from projects to ensure that they produce authentic benefits and are genuinely additional activities that wouldn’t otherwise have been undertaken.
In energy efficiency, freeridership factors into the calculation of a program’s impacts as the ratio of savings attributable to the program (net savings) and the savings expected to be achieved according to planning assumptions (gross savings). The result is the net-to-gross (NTG) ratio. 8
For utilities administering ratepayer-funded programs, the implications of NTG calculations can be large and wide-ranging. The calculations affect nearly all essential criteria that define and determine performance, particularly saving claims and cost-effectiveness. Uncertainty arises because the NTG ratio usually isn’t known until well after a program has been implemented. Utilities become exposed to financial risks, particularly in jurisdictions where performance standards include penalties for under-performance ( e.g., Pennsylvania, New York, and Washington), provisions for lost-revenue recovery ( e.g., Nevada and North Carolina), or shareholder incentive ( e.g., California and New York).
For these reasons, the concept of freeridership has been a uniquely charged topic, eliciting frustration and disagreement among energy-efficiency policy makers, program administrators, and evaluation experts. Despite years of research, no commonly held or precise understanding has been established of what NTG means, what it includes, how best to measure it, and what to do with the results once the measurement is done. In fact, its very definition isn’t firmly settled (see “From Gross to Net.”)
Freeridership, and the broader concept of NTG, remain, in the words of William Saxonis, a regulator in New York, a “regulatory dilemma.” 9
Freeridership remains the most common criticism of ratepayer-funded energy efficiency among the skeptics, 10 along with the so-called rebound effect (the notion that greater efficiency leads to increased consumption due to an income price effect) and persistence of savings. The debate over these topics dates back to the mid-1980s, when energy efficiency consisted of what were, by today’s standards, small-scale conservation programs focusing mostly on residential weatherization. Citing freeridership as an argument against public intervention in energy-efficiency markets, the critics of ratepayer-funded conservation argued that the presence of freeridership overstates the energy-savings potential of conservation programs and understates their actual cost, distorting resource choices.
Skeptics have criticized ratepayer-funded conservation on the grounds of distributional concerns arising from the potentially adverse rate impacts. 11 Because freeridership is correlated with the level of financial incentives available to the participant, the reasoning goes, if incentives are too high and the participant isn’t expected to commit his or her own money to the effort, freeridership will go up, reducing the effectiveness of the program and leading to higher average rates for consumers, particularly those who don’t benefit from the program. 12
This argument sounds right, but is wrong. Free riders in energy efficiency programs tend to be those willing to adopt a measure with