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Energy Efficiency Unmasked

Regulatory formulas for rewarding efficiency investments.

Fortnightly Magazine - February 2014
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efficient level will never be fully successful as long as utility commissions continue to set rates at average embedded cost ( i.e., below current marginal cost). Much like Sisyphus continuing to push a rock up a hill, utilities must struggle to reach the economically efficient level of investment, but continually find it out of reach due to the price-induced elevated level of consumption.

The analyses here highlight how to evaluate earnings equivalency from a percent of shared savings, program costs, or avoided costs for investments in EE. This ignores the question of the appropriate level of earnings that a utility should be allowed an opportunity to earn for implementing energy efficiency. Should it be set at a level equivalent to that on an asset, or at a different level? This presumes there’s also equivalency in the risk of investment in EE versus the risk of investment in new assets. Is there a difference in the level of risk associated with the implementation of energy efficiency? Should there be an adjustment (either up or down) applied to any of the EE recovery mechanism percentages to account for those differences if they exist? These questions are an area of research for future investigation.

Energy efficiency hasn’t been universally embraced despite recognition that it can reduce consumption to a more economically efficient level. Furthermore, EE has been implemented to varying degrees, using a wide range of regulatory approaches, including mandated levels of EE achievement. Regardless of the state or regulatory recovery mechanism, one of the primary impediments to EE adoption has focused on determining what (if any) incentives should be paid to utilities. 

As long as utilities are required to meet projected customer demand with adequate supply, new assets will need to be built. If a utility continues to experience positive load growth after implementing EE programs, a decision to build such an asset could be delayed, rather than eliminated. Alternatively, reductions from EE might necessitate the construction of a different asset altogether. Regardless of the outcome, utilities will need to build assets to a level that’s above the economically efficient level – as long as only cost-effective programs are implemented and rates are set on embedded costs. With appropriate regulatory treatment, utilities will pursue cost-effective EE in order to reduce demand toward the economically efficient quantity. 

Regulatory policies that create efficiency resource standards could raise concerns about implementation of EE that isn’t cost-effective. Arbitrary energy efficiency resource standards or mandates introduce new market inefficiencies that ultimately harm consumers and leave the energy market once again with an artificial level of demand and investment.

Endnotes:

1. Energy Information Administration, Table 8.10: Average Retail Prices of Electricity, 1960-2011.

2. See Kahn, Alfred E. The Economics of Regulation: Principles and Institutions, Volume 1, John Wiley & Sons, Inc., 1970, p. 110 where he states in reference to marginal costs: “…under original cost valuation the buyers pay not these, but some lower average as the cost of new, increasingly expensive plant is blended in with that of the old, the result is excessively large purchases of the public

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