(TRC) test has become the dominant method of comparing the costs and benefits of demand-side management (DSM) programs. Yet the TRC test fails to recognize the negative rate impacts from reduced kilowatt-hour consumption. DSM advocates argue that more extensive DSM programs will compensate for this flaw. If all customers have an opportunity to participate in a DSM program, they claim, customers' total bills will fall in spite of rising rates that pay for the DSM investments. This argument rings hollow in an electric industry increasingly governed by market forces. The price increases needed to pay for large-scale DSM programs will undermine a utility's competitive position in that market.
Some jurisdictions are attempting to address this issue by requiring a Ratepayer Impact Measure (RIM) test that eliminates programs with any meaningful impact on sales. Several proposals have sought a middle ground between TRC and RIM, but these proposals tend to be short on tangible techniques to assist regulators in screening programs. They typically require the quantification of unquantifiable theoretical variables, adding an additional layer of uncertainty to an already uncertain analysis.
The true value of DSM remains its potential to defer a utility's need to add capacity, and thus save the cost of additional resources. All else equal, deferring capacity will lower revenue requirements and result in lower long-term rates. The standard for cost-effective DSM programs should ask whether the value of the capacity deferral is greater or less than the cost of the DSM program. A DSM investment should only be undertaken if the direct costs are less than the costs of the alternative supply-side resource. By contrast, the TRC includes the stream of energy cost savings over the life of the DSM technology as an additional benefit. Certain programs can pass a TRC test analysis because of their avoided energy costs, even though they have minimal impact on deferral of capacity. If cost-effectiveness is measured by TRC, even utilities with excess capacity will be required to make substantial investments in conservation programs. These programs benefit participating customers but lead to unnecessary rate increases to the detriment of all others. The illogic of this outcome is even clearer when viewed in the context of a more competitive electric industry where the negative consequences of rate increases will be further magnified. The TRC test also does not recognize that in that competitive marketplace, the kilowatt-hours saved through DSM will likely be resold.
A More Accurate Test
I propose that regulators exclude from the analysis any costs or benefits that do not directly affect long-term revenue requirements or provide some other direct benefits to nonparticipating customers. Let's call this test the Revised Utility Cost (RUC) test.
Figure 1 breaks out the costs and benefits of the various tests currently used in DSM program evaluation, as well as the RUC. These tests recognize four types of DSM program costs: the utility's program costs (administrative and promotional), utility incentive payments, net participant costs, and the revenue loss from reduced kilowatt-hour consumption. Note carefully the disaggregation of incremental DSM technology costs between the rebate paid by the utility and the participant's net out-of-pocket costs. The TRC test does not distinguish between costs paid by the utility and costs paid by the participant, even though the participant's out-of-pocket costs have no impact on the utility's cost of providing service.
Note also that the RIM test includes the lost revenue from the DSM program. The overall level of sales over which future revenue requirements will be spread obviously has an impact on rates. However, since there is no lost revenue counterpart on the supply side (although supply addition also has an impact on sales), including lost sales skews the analysis in favor of the supply-side option. More important, since lost revenues are a function of current and projected rates, including them introduces the utility's embedded costs into what is otherwise a marginal analysis. A RIM test standard would thus reject programs for any utility with high rates, regardless of that utility's capacity needs. Including revenues lost over the life of a DSM program as a direct cost inappropriately distorts the comparison between alternative supply- and demand-side investments. The RUC test includes only those costs that directly impact the utility's long-term revenue requirements. On the cost side, this makes it equivalent to the Utility Cost (UC) test.
A fundamental premise of the proposed RUC test is that fuel-cost savings are not a valid benefit of a DSM program. The RUC test includes only those items that can provide a quantifiable systemwide benefit to all ratepayers in the form of either reduced nonfuel revenue requirements or lower system-average fuel costs. In Ohio, as in most jurisdictions, fuel costs are passed through a fuel adjustment clause instead of base rates. A utility's reduced fuel consumption has no impact on nonfuel revenue requirements and thus provides little or no systemwide benefits. As such, it is generally inappropriate to include fuel savings in a cost comparison of supply- versus demand-side investments. An exception would be reduced fuel requirements that enable a utility to purchase a less costly mix of fuels. Since this exception would lower the average fuel costs faced by all customers, the incremental fuel cost savings would be included in the analysis on a kilowatt-hour basis. Other exceptions are certain to be identified as well. The legitimacy of any avoided energy-related benefits will depend on whether they provide benefits to both participants and nonparticipants. The RUC test provides a more appropriate comparison of the true systemwide costs and benefits of a DSM program.
How the RUC Differs
The RUC test differs from the UC test only in its exclusion of fuel-related avoided energy costs. The benefits of a DSM program as measured by the UC test will always be greater than (or equal to, in the case of certain load-shifting programs) the benefits measured by the RUC test. Since these two tests are identical on the cost side, the RUC test benefit/cost ratio will never exceed the comparable UC test ratio.
The TRC and RUC tests differ on both the cost and benefit side, but those differences are partially offsetting. All else being equal, the RUC's exclusion of customer costs will increase the benefit/cost ratio, while its exclusion of fuel-cost savings on the benefit side will reduce that ratio. Because the RUC test reduces the benefits over the life of the technology, in most cases, the reduction in benefits should be greater than the reduction in costs achieved by excluding the net customer costs. Thus, in general, the RUC ratios should be lower than the TRC ratios as well.
The main difference between the RIM and RUC tests is that the RIM includes avoided fuel costs on the benefit side and revenue loss on the cost side. The relationship between these tests will depend on the magnitude of the kilowatt-hour impacts (which are the basis of both avoided fuel costs and the lost revenues) relative to the kilowatt impact, and on the relationship between average and marginal costs. The actual relationship among the TRC, RUC, and RIM tests can only be determined on a case-by-case basis.
How the RUC Compares
Since the RUC test largely measures avoided capacity, its impact on a DSM portfolio will reflect the timing of the utility's capacity expansion plans. At a utility with little need for additional capacity, the test may not show DSM programs to be cost-effective, but will likely show the opposite for the same programs at a utility with more immediate needs. For a utility with high avoided capacity costs, the RUC test will also select programs according to onpeak impacts. This will result in greater emphasis on load- shifting and other programs with significant onpeak kilowatt impacts relative to kilowatt-hour impacts. This method will select fewer programs that cause adverse rate impacts.
Table 1 compares TRC, RUC, and RIM test benefit/cost ratios using actual data for an Ohio utility with low avoided capacity costs.
Utility With Low Avoided Capacity Cost
TRC RIM RUC
Water Heating Measures4.300.300.50
Compact Fluorescent Bulbs220.127.116.11
High-Efficiency Heat Pumps1.000.400.20
Audit/Direct Install Program0.900.200.05
Compact Fluorescent Bulbs1.300.300.50
2 bulb T-8, New Construction3.400.400.70
2 bulb T-8 system, Retrofit0.700.400.60
4 bulb T-8 system, Retrofit1.100.400.60
The results demonstrate the advantage of the RUC test over the TRC. A TRC test standard for the low avoided capacity cost utility would conclude that DSM is appropriate even though no significant capacity is being avoided. This result is clearly wrong and demonstrates why the TRC test should not be used as a stand-alone evaluation tool. The RUC test reaches the more reasonable conclusion that DSM is not appropriate for a utility with no foreseeable need to add capacity. It is counterproductive for a utility in this position to make an investment that will increase rates while providing minimal systemwide benefits.
Table 2 compares the same programs/measures using actual data for an Ohio utility with a much more immediate need for capacity additions.
Utility With High Avoided Capacity Cost
TRC RIM RUC
Water Heating Measures1.800.500.70
Compact Fluorescent Bulbs1.400.501.10
High-Efficiency Heat Pumps1.100.601.20
Audit/Direct Install Program3.700.702.20
Compact Fluorescent Bulbs 1.300.902.00
2 bulb T-8, New Construction 1.700.801.40
2 bulb T-8 system, Retrofit 1.000.801.50
4 bulb T-8 system, Retrofit 2.700.902.80
In this case, all but two of the programs/measures that pass the TRC also pass the RUC. All programs/
measures fail the RIM test for both utilities.
Obviously a RUC test standard gives more reasonable results. The TRC test inappropriately rewards energy savings and results in expenditures that are not justified on the basis of lowering long-term system-supply costs. The RIM test, on the other hand, inappropriately penalizes programs with significant energy savings by including the associated lost revenue as a direct cost. As a result, programs are eliminated in spite of their potential to avoid more costly capacity.
Unlike the TRC, the RUC test will screen out programs that lack significant capacity savings. Unlike the RIM, it will not screen out conservation programs as long as those programs also have significant capacity savings. Since the RUC test includes only costs and benefits that impact a utility's nonfuel revenue requirements or otherwise benefit all
ratepayers, it is a more valid comparison of a demand-versus supply-side investment.
The RUC test is also much more consistent with a competitive generation services market. A competitive supplier of generation services will underwrite DSM activities among its customers if the DSM cost plus the variable production cost is less than the market price at which the DSM-derived energy can be resold to other customers. The RUC test closely mimics this economic result when the variable production costs of the kilowatt-hour being generated for resale is included. If those variable production costs were included in a TRC test, on the other hand, they would be exactly offset by the avoided energy on the benefit side. The TRC test would only compare the DSM costs to the sale price, causing a financial loss on each transaction for which the DSM cost exceeds the sales price less variable costs. If the TRC is manifestly deficient in a profit-driven environment, it should also be rejected in a regulated environment, especially one that is likely to undergo massive changes in the not-too-distant future.
The movement toward a competitive electric industry puts the long-term value of DSM in question. Nonetheless, most jurisdictions will retain their DSM requirements while waiting for the fog of uncertainty regarding competition to clear. During this interim period, regulators should require only those DSM programs that clearly provide meaningful systemwide benefits. The test proposed here is a more valid approach to evaluating whether that standard is being met. It involves simple adjustments to the existing tests, and no new evaluation tools or additional research techniques. The RUC test can serve as a transitional test while we debate the
need for DSM in the upcoming competitive environment. t
Steve Puican is an economist in the Utilities Department of the Public Utilities Commission of Ohio. The opinions expressed here are those of the author and do not represent those of the Ohio PUC.
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