Electric utilities nationwide are attempting to retreat from commitments to energy efficiency (em a retreat that will benefit few customers, while damaging many. This retreat is driven by fear of retail wheeling (em that consumers will be able to shop for the lowest prices among competing entities. In turn, the threat of retail wheeling has spurred utilities to a frantic scramble to cut costs and trim rates. Among the costs to fall under the knife are programs associated with resource planning, including demand-side management (DSM).Some utilities have attempted to discontinue DSM entirely. Others have proposed to continue DSM only where it has no rate impact on nonparticipants. But these cost-cutting efforts occur even though DSM programs can actually reduce the utility's total revenue requirement if they satisfy the Total Resource Cost test (TRC), the most commonly used cost/benefit test. Participants in DSM programs that qualify under TRC actually see their electricity use fall and their bills drop.
Regulators, facing skittish electric utilities, are caught in the middle. Despite the current rush toward competition, regulators should not abandon cost-effective DSM simply for fear of the short-run rate impacts.
Cost Cutting:
The Downside
Streamlining utility operating activities is good business practice if quality of service remains the same. But that's not what is happening.
DSM program costs are added to rates. That increment includes that portion of fixed costs no longer recovered when DSM pares down energy sales and utility revenues fall as a result. These fixed costs elevate the per-unit cost of furnishing electricity, which boosts rates and drives up bills of customers that do not participate in DSM programs. These adverse rate effects are typically captured by the Rate Impact Measure test (RIM).
But because the RIM test counts lost revenues from decreased utility sales as a cost, DSM that produces high-energy savings can have an unfavorable RIM score. The RIM test thus eliminates proven energy-saving measures from consideration.
RIM test reliance marks a large step backward in the planning evolution of the utility industry. By ignoring DSM's long-term potential to defer or displace future capacity needs at costs well below those of new construction, utilities will bear higher costs in the long run when additional capacity is needed, leading to higher rates. This "business as usual" planning approach has no nonparticipants; all customers will bear the future costs of new supply-side additions.
Dr. Peter Fox Penner, principal deputy assistant secretary for energy efficiency and renewable energy at the Department of Education, forcefully made this point in recent testimony before the Florida Commission:
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"The Department [of Energy] encourages utilities and state regulators to acquire DSM resources that will be cost-effective in minimizing the energy bills of utility consumers in the long run. The RIM test, which measures the impact of DSM programs on utility rates, can be useful in addressing DSM program design and cost-
allocation matters. However, the Department believes that the RIM test generally should not be used as a cost-effectiveness test for DSM programs, because it can rule out many DSM options that would be cost-effective in minimizing most customers' energy bills."1
This policy preference for the TRC test is rooted in mutual benefits to customers, the utility, the environment, and the economy. Because DSM initiatives are designed by utilities to reduce total revenue requirements, they therefore minimize rate-base needs,
reducing total utility costs recovered from ratepayers.
DSM costs and benefits are best evaluated with the TRC screening test. The TRC compares the total costs of the program (participant costs and program operating costs) against its total benefits (reduced participant bills, utility operating costs, fuel costs, new generation needs, and other reduced costs). Under established industry and regulatory practice, if a DSM program passes the TRC test (a "TRC program"), it saves more than it costs and should be implemented.
Resource Efficiency:
The Upside
Participants. Participants in a TRC program receive direct and indirect benefits. Many such programs reduce electricity use by promoting energy-efficient or
energy-conserving technologies. Reduced use means participant bills will go down, producing direct financial benefits. Even if short-term rates increase, the total cost of electricity (rate x usage) will be minimized. Many TRC programs can also improve overall comfort levels (through higher lighting levels or improved temperature comfort), yielding extra benefits usually not quantified in normal cost/benefit analyses of program selection.
Utilities. The utility that pursues TRC programs will also benefit. Utility costs normally reflected in the rate base will be reduced. For example, by implementing
energy-efficiency programs that reduce and manage consumption, the utility will cut costs associated with electricity generation, fuel purchases, transmission and distribution, line losses, and building new plants to meet growing demand. DSM can also help manage load profiles by shifting electricity use from peak periods to offpeak times when the per-unit cost of electricity is lower. In the long run, utility rates would be lower than if no DSM were pursued.
Utilities that fully pursue TRC programs may minimize future uncertainty by better managing system growth. They also minimize regulatory risk associated with stricter local, state, federal, or international environmental regulations. For example, they may reduce future costs for associated toxic or greenhouse gas emissions, or for acid rain control or spent nuclear fuel disposal. Perhaps most important, the increasingly difficult, costly, and contentious approval process for siting and construction of new generating capacity can be minimized or eliminated. By taking low-cost
actions now, utilities and their shareholders may effectively hedge against high compliance costs in the future.
The Environment. DSM programs that reduce consumption yield proven environmental benefits by avoiding generation and cutting plant emissions. For example, electric generation from fossil fuel produces significant greenhouse gases. These gases are thought to contribute to global climate change due to their heat-trapping ability. To attack this potential problem, the United States has formally committed to reduce national greenhouse emissions to 1990 levels by 2000. One of the cornerstones of the Clinton Administration's policy to meet this goal is to reduce carbon dioxide emissions through increased energy efficiency.
Generating plants fired by fossil fuels also emit sulfur dioxide and nitrogen oxide (NOx) (em gases that form acid rain as well as tropospheric ozone (smog). These environmental effects can significantly affect utility operations by imposing high costs for compliance with the requirements of Title I and Title IV of the Clean Air Act Amendments of 1990 (CAAA). One study found that PSI Energy of Indiana could use aggressive DSM programs to reduce its acid-rain compliance costs under the CAAA by $96 to $131 million.2 Elsewhere, the 13 states in the Northeast Ozone Transport Region have agreed to reduce NOx emissions from utility and large industrial boilers 75 percent by 2003. These reductions represent costs far in excess of the Act's better-known acid rain provisions.
Reduced overall fuel use also mitigates pollution effects associated with extraction of coal, oil, natural gas, and uranium; fuel processing; and fuel transportation. Moreover, DSM-induced fuel savings can offset U.S. dependence on foreign oil.
The Economy. DSM produces both micro- and macro-economic benefits. At the micro level, participating businesses can improve their profits and competitive position, both nationally and internationally, because their total electricity prices fall relative to a "no-DSM" situation. At the macro level, DSM reduces the amount of income wholesale and retail consumers are forced to spend on electricity bills. That frees up money that can be spent or saved, increasing national consumption and total Gross National Product.
Moreover, numerous studies on the employment impacts of full-scale DSM programs have shown that overall employment effects are unchanged or show slight overall increases, making the jobs versus environment debate a non-issue in this context. One recent study concluded:
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"The environmental and welfare benefits of DSM are unambiguous (em reduced use of electricity means lower emission levels and the reduction in the overall costs of electric energy leads to higher levels of consumption of other goods and services. These environmental and welfare gains are obtained with no loss in overall employment and no long-term increase in price levels."3
Utility-sponsored DSM programs can also influence consumer behavior by jump-starting the market for energy-efficient products, both directly and by raising consumer awareness. A good example of this phenomenon is the "free driver," an indirect result of a utility-sponsored DSM program. For instance, participants in a DSM program to install energy-saving compact fluorescent light bulbs may be so satisfied with the product that they install additional bulbs at their own expense. Such indirect benefits are not quantified in standard cost/benefit analyses, but can be significant.
Finally, DSM programs can transform markets, increasing consumer demand for energy efficiency. Increased demand spurs suppliers to improve production techniques; resulting economies of scale help lower costs; energy-efficiency companies can more rapidly develop and deliver services. All these developments help lower the costs of energy efficiency, ultimately benefiting all consumers.
Given these benefits, it would appear foolish for utilities (em and certainly their regulators (em to abandon TRC programs unless the impact on nonparticipants is enormous. Yet recent studies indicate that the rate impact of DSM programs is minimal.
A review of 10 evaluations of DSM rate impacts found a 1.7-percent median increase in electric rates from DSM. Moreover, 90 percent of study samples encountered rate impacts of 5.1 percent or less.4 According to the 1991 Annual Survey of Manufacturing (Bureau of the Census), average electricity cost represented only 1.2 percent of the value of shipped goods. Thus a 5-percent electric rate increase would produce a profit impact of only .06 percent of wholesale value for an average nonparticipating industrial customer who receives no bill reductions from DSM.5 That hardly seems large enough to stampede large users into the eager hands of low-cost power producers, especially when compared to the larger average rate impacts of
supply-side additions.
There are no nonparticipants when it is time to include the costs of building a new power plant in the rate base. When Baltimore Gas & Electric added a 600-Mw steam plant to its system, average rates increased 3.3 percent. Even more dramatically, during the mid-1980s, New Orleans Public Service Co. (NOPSI) attempted to increase rates either by a one-year hike of 65 percent or a 100-percent increase spread over 10 years, to recover costs associated with construction of the Grand Gulf nuclear plant. The NOPSI rate filings led ultimately to a 43-percent
increase in residential rates, a 90-percent increase in commercial rates, and a 36-percent industrial rate hike spread over six years.
Regulators:
Not Without Options
If nonparticipant rate effects remain a concern for regulators, the most equitable solution would ensure that utilities offer DSM programs to all customer classes, maximizing participation and penetration rates so all ratepayers can capture the benefits of reduced bills.
In addition, the costs (rate impacts) of DSM can be reduced (em and benefits increased (em through careful program design. For example, regulators can minimize "free ridership" by offering straight rebates only for the high end of the spectrum of product-efficiency ratings. Regulators may also use market "sticks" to encourage DSM while reducing rate impacts. By requiring the utility to offer incentives to manufacturers and wholesalers, DSM programs can nudge efficiency along the learning curve, bringing down upfront costs, while boosting demand for energy-efficient products.
If customer class equity is an issue, regulators can allocate costs solely to the customer class that benefits, shielding rate-sensitive customers. They can require the utility to capitalize or amortize DSM costs over the lifetimes of
efficiency measures, rather than over the short term. This technique (em natural for supply-side
additions (em spreads the costs of DSM programs over time.
At its 106th Annual Convention, the National Association of Regulatory Utility Commissioners (NARUC) passed a resolution stating that "a fundamental responsibility of state and federal electric utility regulators in this transition period is to assure that vital public interests and established public benefits will be preserved in any restructuring of the electric utility industry."6
NARUC defined these public benefits to include:
s system reliability
s responsible management of environmental impacts of electric generation
s promotion of systematic investments in energy efficiency (thus improving the nation's energy security and lowering energy costs)
s innovative rate designs
s support for research and development
s investments that speed the development of renewable energy technologies.
Regulators should adhere to the NARUC resolution and preserve DSM programs, absent verification that short-term DSM rate impacts will threaten competitive
position. t
Jeremy Levin was project coordinator with the Alliance for Affordable Energy, a nonprofit consumer advocacy group in Louisiana. He is currently a master's candidate in M.I.T.'s Technology and Policy Program.
Carrot and StickDSM can help retain customers that might otherwise stray to find a cheaper energy source.
Rochester Gas & Electric Co. recently convinced the University of Rochester not to install a 1-Mw cogeneration system by offering a $2-million incentive payment for an $8-million energy-efficiency program, in return for an agreement by the University to stay on RG&E's system for at least seven more years. Hirst, "Electric Utility DSM Programs in a Competitive Market," Oak Ridge National Laboratory, April 1994, at page 21.Stranded ExpectationsLouisiana Power & Light recently abandoned its first filed least-cost integrated resource plan because of "fundamental changes ... in the Company's expectations about the future environment."* LP&L withdrew its plan without demonstrating any proof of an actual new environmental--just a change in the Company's expectations. LP&L's withdrawal has cost the ratepayers of Louisiana $255 million in lost savings,# a significant abandoned benefit. *Motion to Withdrawn Application for Approval of Least-Cost Integrated Resource Plan and For Approval of Experimental Time-Of-Use Rate, filed July 18, 1994, p. 2.
#LP&L Least Cost Integrated Resource Plan, Executive Summary, LA PSC Dkt. U-20178, Dec. 1, 1992, p. 47.1 Florida PSC Docket Nos. 93548-EG, 93549-EG, 93550-EG, April 28, 1994, Direct testimony, p. 21.
2 Nadel, Jordan, Holmes & Neal: Using DSM to Help Meet Clean Air Act Targets: A Case Study of PSI Energy, ACEEE, October 1994.
3 E.g., Moscovitch, "DSM in the Broader Economy: the Economic Impacts of Utility Efficiency Programs," The Electricity Journal, May 1994.
4 Pye & Nadel, "Rate Impacts of DSM Programs: Looking Past the Rhetoric," ACEEE, April 1994.
5 Pye & Nadel, p. 17.
6 Resolution on Competition, the Public Interest, and Potentially Stranded Benefits, sponsored by the Committee on Energy Conservation, NARUC, Nov. 14, 1994.
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