In an age of costly electricity and cheap efficiency, smart utilities will sell less electricity and more efficiency.
Amory B. Lovins is vice president, treasurer, and director of research at Rocky Mountain Institute, which he cofounded in 1982. By profession he is an experimental physicist. He attained prominence in the world of energy matters with the publication of his essay, “Energy Strategy: the Road Not Taken?” in Foreign Affairs, October 1976. His clients have included intergovernmental organizations, national and local governments, and private firms. Mr. Lovins was [educated at] Harvard University and holds an MA degree from Oxford University and four honorary doctorates.
Editor’s Note: This article originally was published in the March 21, 1985 issue of Public Utilities Fortnightly. It is reproduced here in slightly edited form — with a few corrections and with errata notes written by Lucien Smartt, then-editor, which were published in a subsequent issue. The original article was excerpted from the author’s presentation at the 96th annual convention of the National Association of Regulatory Utility Commissioners in Los Angeles, November 1984.
Original Foreword and Errata: The thesis of the following article is that in an age of costly electricity and cheap efficiency, as now, smart utilities will sell less electricity and more efficiency. They will market “negawatts” (saved electricity) and use new ways to finance their customers’ savings. Existing and future efficiency gains, if not properly managed, can quietly take away most of the present market for electricity, but they also offer alert utilities an unprecedented opportunity to control risk, improve cash flow, secure market share, save operating costs, and become once more a declining-cost industry.
Errata: Since the appearance of Amory B. Lovins’ article, “Saving Gigabucks with Negawatts,” in the March 21, 1985, issue of the Fortnightly, we have received numerous letters challenging the statement in the biographical paragraph written by the editors to accompany the article, that “Mr. Lovins was graduated from Harvard University and holds an MA degree from Oxford University and four honorary doctorates.” For the record, it should be stated that the list of credentials submitted by Mr. Lovins with his article made no claim of graduation or receipt of a degree from Harvard. It said simply, “Educated at Harvard and Oxford, he holds an Oxford MA and four honorary doctorates.” From this, the editors made an unjustifiable leap to an unwarranted conclusion that there had been a graduation from Harvard. One of our letter writers complained “that your magazine allows itself to be conned into perpetuating that myth” (i.e., of considerable attainments in the world of academic higher education). To this charge, our plea is nolo contendere.
For his part, Mr. Lovins has asked us to print a correction or clarification of a statement in the article (page 20) that, “In the best new office buildings from Reno to Stockholm, no space conditioning is needed.” He explains that “space conditioning” here means active space heating or refrigerative air conditioning, not evaporative cooling and other essentially passive techniques. This correction was proffered by the author too late for incorporation into the article as it appeared in the March 21 edition of this magazine, but we willingly publish it here.–Lucien Smartt, Editor (1985)
An economic and institutional revolution is sweeping electric utilities. Behind it is a quieter technological revolution: an astonishingly powerful, diverse, and rapidly emerging array of devices to wring more work from a kilowatt-hour. This article will outline the dimensions of these changes; how they are transforming utilities’ strategic planning imperatives; and how they can make the utility regulatory task more productive, consensual, and pleasant. It will by necessity be general and omit many details. But it will explain the consequences which flow from one premise: that people want, seek, and will eventually find the amount, type, and source of energy that will deliver each desired energy service (such as comfort, light, shaft power, and electrolysis) in the cheapest possible way consistent with reliability and convenience. Such a neo-classical competitive marketplace for energy services, in which electricity will be bought only where it is the best buy — the option with lowest private internal cost — is of course a theoretical construct. The actual market is a highly imperfect fuel bazaar, satisfying no condition of the ideal free market. Yet, as I shall show, it is beginning to behave remarkably like a free market, profoundly altering the prospects for electrical demand. Let me start with the bottom line:
- Full use of the best electricity saving measures now on the market could quadruple the efficiency of using electricity in the United States – using measures whose average cost is less than about two cents (1984 dollars) per kilowatt-hour saved.
- Since such savings cost less than just operating existing fossil-fueled or nuclear plants, such plants — even if just completed — cost less to write off (and displace with efficiency) than to run.
- Of all power now generated, at least 80 percent at today’s average price, and nearer 90 percent at marginal price — that is, the output of every thermal plant in the country — cannot compete with efficiency improvements now newly on the market.
- As that “overhang” of efficiency is purchased over the next few decades, making the plants’ uncompetitiveness manifest, some $100 to $200 billion worth of unamortized thermal power stations may have to be written off.
- By grossly underestimating the power of “technical fixes” to use electricity more productively, a $300,000 million industry is continuing to liquidate itself to build hundreds of plants it cannot afford, will not need, and will not be able to pay for — playing “You Bet Your Company” that its customers will take half a century to discover better buys.
- Future demand — that is, how long it will actually take the customers to discover least-cost options — is not a fate to be prophesied by examining the entrails of forecasters; it depends on customers’ access to information, capital, and freedom of choice. It is a variable to be influenced according to policy goals. Utility experience now shows that implementation of efficiency is or can be made faster and more reliable than building plants.
Modern Technology: Cases In Point
The savings available today are twice as big, and cost only a third as much, as those identified five years ago. (For example, Roger Sant’s pioneering 1979 least-cost analysis showed that with 1978 technologies and prices, about 43 per cent of the power sold cost more than efficiency.) Most of today’s very best electricity saving technologies were not available even a year ago. What are some of them?
- A Norelco SL-18 light bulb uses 18 watts of electricity, but produces the same amount of light as a 75-watt incandescent bulb and lasts over 13 times as long. It also gives light of better quality. Special fluorescent phosphors give nearly perfect color rendition, and a high-frequency solid-state ballast eliminates flicker and hum. If you screw one of these quadrupled-efficiency lightbulbs into a socket, replacing 75 watts with 18, you are effectively installing on the grid a 57-watt power plant, dispatching 57 “negawatts,” or unused watts, back to the utility to sell to somebody else. The SL-18 repays its high retail cost ($25 each in lots of six) two to three times over by saving $40 worth of electricity at 7 cents per kilowatt-hour, plus a dozen replacement bulbs (about $10 worth), plus the labor cost of installing them. When universally used (which should take 10 to 15 years) SL bulbs and their cousins will displace some 30 gigawatts-electric (GWe) of installed U. S. capacity at about 1 to 2 cents per kilowatt-hour. The gross value of the electricity saved will exceed $8 billion per year.
- High-frequency electronic ballasts improve the quality of fluorescent light and can save about 40 percent of their electricity, paying back in about a year. Automatic dimming by a daylight sensing photocell can increase the direct saving to 70 to 90 percent. Such ballasts, costing about 0.5 cents per kilowatt-hour, can displace 25+ GWe directly, plus 15+ GWe more by reducing air-conditioning loads.
- Daylighting retrofits, better lights, and improved mechanical systems can shift the balance point of typical deep-plan office buildings by at least 40 degrees Fahrenheit with a payback time of a year or two. (Thus a building which currently needs air conditioning at outside temperatures above, say, 20 degrees could now do without it up to 60 degrees.) Recirculation of ventilation air through floor-slab channels can also shift any residual air conditioning to the middle of the night. Even rudimentary retrofits of U.S. commercial buildings have cut electric demand by an average of 29 percent with a payback of about eight months. In the best new office buildings from Reno to Stockholm, no space conditioning is needed, yet capital cost is reduced by savings on mechanical systems. Similarly, a new office building in Jamaica’s tropical climate cuts electric use by about 90 percent at no extra capital cost. New retrofit techniques can cut most houses’ space-conditioning loads by 90 to 100 percent with paybacks generally around five to 10 years at present oil prices — less with all-electric homes.
- Straightforward design improvements can more than quadruple the efficiency of household appliances. For example, among the biggest users (refrigerators), the best mass-produced model, by Toshiba, uses a third as much electricity as an average U.S. model the same size: Toshiba has made its refrigerators 5.5 times more efficient in 10 years and is still improving them at the same rate. The best refrigerator in pilot production is about eight times as efficient as the U.S. average. The best prototype is 100 times as efficient — a 99 percent saving. Its payback is about five to six years at handmade prices, and should be about zero when it is eventually mass-produced. Such refrigerators can ultimately displace 25 GWe of installed U.S. capacity; other efficient appliances can save about 33 GWe.
- The photocopier in our office uses about a tenth the usual amount of electricity, because it sets the toner with a cold compression roller instead of a heated drum. New computers use 80 to 90 percent less power than mid-1970s models.
- New methods of properly sizing, coupling, and controlling electric motors typically double the practical drive efficiency at under 1 cent per kilowatt-hour. This one saving would displace over 70 GWe, or every nuclear plant in the country.
- A $100,000 microcomputer control for a giant compressor can save $1 million on its annual energy bill while greatly reducing its downtime.
- The best aluminum smelters save about 40 percent, and if Mitsui’s experimental coal-fired aluminum-smelting blast furnace works commercially, it will smelt aluminum using no electricity. Furthermore, many structural uses of aluminum and steel will probably be displaced by composites within this decade.
- Advanced Swedish pulp- and papermaking processes could save about 67 percent of the fuel and 42 percent of the electricity used by Swedish plants in 1975 (which were more efficient than most U.S. plants are today), cost effectively at under 2.3 cents per kilowatt-hour. Many chemical processes show even larger savings.
- At the same price, all of Swedish industry — the world’s most energy-efficient, and more biased than U.S. industry towards energy-intensive products — can double its electrical efficiency, using advanced technologies which are now starting to enter the market.
- Technological progress is rapid even in the most mundane areas. The best commercially available windows (R-5.4 argon-filled Heat Mirror) insulate twice as well as triple glazing, cost less, and typically gain more winter heat than they lose, even facing due north. R-11 to R-19 windows and half-inch thick R-30 insulation using evacuated glass beads are now experimental.
The effectiveness of many of these newly available electricity saving measures is illustrated by a 4,000-square-foot house-indoor farm-research center which my wife and colleague Hunter and I recently built at 7,100 feet in the Rockies — an 8,700-degree-day climate with temperatures down to –40 degrees. The building needs no heat: It passively captures a third more than it needs, and we vent the excess. It provides uniform comfort year-round with zero backup. It also uses only about 0.12 watts of electricity per square foot — less than a tenth the usual amount — and a third the normal of water. Our total energy bill for all purposes (two-thirds of it for office equipment) is under $320 per year, or 8 cents per square-foot-year — about 5 percent that of a normal office building. The net marginal cost of our energy saving measures, 1 percent of construction cost, pays back in one year. The building produces more than $19 per day worth of saved energy — economically equivalent to a 0.7-barrel-per-day stripper well. That saving should pay off the entire building in about 40 years. Our 2,500 visitors have also remarked on how the building combines efficiency with beauty and a very high quality of life.
Even if technological development were instantly arrested at its present stage — rather than continuing to evolve so quickly that takes a looseleaf mind to keep up with it — the technical and economic potential for saving electricity is already immense. It will greatly widen the two-to-one margin by which present U.S. generating capacity saturates the premium, nonthermal markets — the uses which can give us our money’s worth from a form of energy as costly as electricity. The new electricity saving technologies of which I have given a few examples are relatively so cheap, and collectively so large, that:
- The long-run supply curve for electricity is so flat and slopes so gently that the market-clearing price will never be high enough to justify building more central thermal power stations. The era of big plants is over.
- The long-run own-price elasticity of demand for electricity is extremely large; so large that higher prices will probably reduce utility revenues. A utility which raises its rates will probably lose more on the number of kilowatt-hours it sells than it makes up by charging more per kilowatt-hour. If so, new construction will require more revenue but yield less — a recipe for bankruptcy. Long-run revenue can be increased only by lower price, not by higher price.
- Higher prices — in other words — will make electricity even more uncompetitive with efficiency by pricing it further out of the market: Rate hikes make electricity even less able to compete with weatherstripping. Electricity is already priced, in general, above a monopolist’s profit maximizing level, and must be sold at lower prices if it is to recapture market share. (Higher subsidies do not help either: They must encourage and enable utilities to build more plants than can be amortized from their revenues.)
- There will be fierce competition for shares of a shrinking fuels and power market — yet whether the real price of electricity is more stable than that of fuels is irrelevant because neither can compete with efficiency.
- A rising electric share of end-use energy does not mean rising electrical demand: Many international analyses foresee a rising electric share of a dwindling end-use market (just what has happened in the U.S. lately).
These long-run conclusions are not just theoretical: They are what the market is doing. Since 1979, the United States has gotten more than 100 times as much new energy from savings as from all net expansions of energy supply combined. The energy content of a dollar of gross national product (GNP) has fallen by a fourth in the past decade — not through the sophisticated means I described, but mostly through such simple measures as caulk guns and duct tape. Even though the energy-GNP ratio continues in free fall by several percent per year, we have barely scratched the surface of how much efficiency is available and worth buying.
Of course, the electricity-GNP ratio has so far been more durable than the primary energy-GNP ratio — though that durability is often exaggerated: for example,
- Electric demand grew slower or fell faster than GNP in six of the past 10 and in seven of the past eight annual intervals;
- Electric demand has lately risen only about 80 to 90 percent as fast as GNP, and this elasticity is trending downwards;
- The electricity-GNP ratio has fallen since 1977 — steadily since 1979;
- At least 15 percent of U.S. economic activity, and the fastest growing part, is in the “gray economy” not reflected in the electricity-GNP ratio;
- In any event, correlation is no evidence of causality — as we discovered in the past decade, when the supposedly sacred and immutable causality inferred from the “ironclad” energy-GNP correlation suddenly crumbled.
This last point deserves special emphasis. No amount of econometric analysis of past behavior can predict the SL light bulb. In fact, there are at least seven good reasons why the electricity-GNP correlation has persisted a decade longer than the energy-GNP correlation, but should not long continue to do so:
- Compositional change: an average service-sector worker, for example, uses a quarter as much electricity as an average manufacturing worker, and many of our most electricity-intensive industries are shrinking or moving offshore;
- Most electricity saving technologies, unlike most direct-fuel saving technologies, are too new to be widely familiar or available;
- Most electricity using devices are specified by mechanical engineers, speculative builders, landlords, and others who care about capital but not running costs, whereas most fuel using devices are bought by end-users concerned with both;
- Electricity is more heavily subsidized than direct fuels (marginal nuclear electricity, for example, is least 70 percent subsidized);
- Power plant lead times are so long that it takes decades for marginal costs to work through fully into average prices (much slower than for fuels);
- Higher fuel prices hit direct-fuel users with full force, but are diluted by fixed charges when reflected in electric bills; and
- Many utilities have, or until lately had, promotional tariffs and programs.
As the lags arising from these artifacts gradually dissolve, I expect electric demand to trend downwards, just as total energy demand has been doing for years. The rate shock soon to hit a third of American households will speed that trend. Rapid economic growth — or, in particular areas, rapid in-migration — will also accelerate gains in electric efficiency, because old, inefficient buildings and equipment will be fixed up, retired, or diluted faster. And the writing is already on the wall: Electric demand per house, per commercial customer, and per unit of industrial output has been approximately flat or falling for years.
That is why it is perilous to ignore the engineering evidence of rising electrical productivity in favor of the evangelical theology of the electricity-GNP ratio — as if these two quantities must spiral ever upwards in a frenetic embrace. Of course, there will be new uses for electricity: there will be robots — which, if used throughout the economy, would consume at most hundreds of megawatts — new industrial electric processes, new home video games and computers, perhaps even Woody Allen’s “orgasmatrons” (shorthand for the not-yet-thought-of uses prominent in many demand forecasts). But I have seen no quantitative proof — only handwaving assertions — that new uses will make more than a minor dent in the immense savings that are clearly cost effective in every sector.
Competition from Entrepreneurs
Nor is efficiency the only formidable competitor with today’s power plants. In the past few years, for example, California utilities have offered to buy privately generated and financed electricity, generally at below full avoided cost. By the end of 1984 they had been seriously offered 18 GWe of alternative generation, of which 1.7 GWe was on line, 9.2 GWe was under contract and construction, and most was renewable. These figures exclude utility-owned capacity and joint ventures; including both would raise California’s offered and on-line renewable and other independent-producer capacity to about three-quarters of the current peak load. And new offers are coming in from entrepreneurs at the rate of about nine GWe per year! Of course, many small-power ventures are driven by tax preferences; but so are conventional power plants, whose subsidies, broadly speaking, tend to be comparable or larger.
Few people realize the scope of the renewable energy revolution — in part because the Department of Energy refuses to keep statistics on it. Since 1979, United States energy supply has been increased more by sun, wind, water, and wood than by oil, gas coal, and uranium (or any of them). More new generating capacity, too, has been ordered from small hydro and wind power than from coal or nuclear plants or both, excluding cancellations. Renewables now provide 9 percent of total U.S. primary energy, and the fastest growing part — outpaced only by savings.
By October 1, 1984, Federal Energy Regulatory Commission permits had been sought for over 14 GWe of dispersed generation — 4 GWe of it in the past year — and at least that much appears to be in advanced stages of planning. (In contrast, only 1.2 GWe of central thermal station capacity has been ordered since late 1981.) During 1984 alone, cogeneration is rising from 5 to 7 percent of national generating capacity. Renewable sources account for about a sixth of the cogeneration permit applications and for a far larger fraction of all new energy supplies: For example, counting both electric and useful thermal outputs, the nation now gets twice as much delivered energy from wood as from nuclear power. Windfarms are competing on the grid in at least six states; 2 to 3 GWe of wind capacity will be on line by 1986; and some of the latest wind machines look profitable even without tax credits (which can hardly be said for thermal power plants). Some 7 to 10 percent of all 1984 housing starts use passive solar design. About a million solar buildings have been put up in the past five years, most of them passive and many built by people with extremely low incomes.
Among technologies coming fast over the horizon, photovoltaic costs in particular continue to drop and worldwide technological breakthroughs are frequent, although federal funding cuts have greatly reduced U.S. market dominance. Pacific Gas and Electric Company’s director of photovoltaics thinks it will be fairly common by 1990 for houses in her service area to be net exporters of electricity from solar cells on the roof. One vendor already offers turnkey photovoltaic installations for $2,500 per kilowatt peak – about 10 to 15 cents per kilowatt-hour — if anyone will buy 100 MW peak, and is selling 2-MW-peak arrays which appear to be a fine industrial investment. Third-party financing is now available for wind, small hydro, solar water and process heat, cogeneration (from Roger Sant’s firm, among others) some photovoltaic systems, and many efficiency improvements; it is the fastest growing financial vehicle in the energy industry.
So rapid, in short, is the progress in not just developing but actually installing practical, cost-effective renewable sources that it now appears that far from there being too few such sources to run an advanced industrial economy, there will probably be too many. That is, there will probably be attractive renewable sources which will not ultimately find a big market niche, simply because there will not be enough demand to support them all: Efficiency will beat all forms of supply. Despite many rearguard attempts to frustrate its intent, the Public Utility Regulatory Policies Act, where given a chance, has succeeded beyond its proponents’ dreams — so far, indeed, that the avoided cost has nowhere to go but down.
As efficiency cuts electrical demand, renewables’ share of supply will become dominant. Quadrupled efficiency, other things being equal, would make the old, cheap hydro capacity already on-line supply not an eighth (as now) but half of all electricity used. The remainder could easily be filled, indeed will probably be overfilled, by a combination of small hydro, cogeneration, wind, and photovoltaics. The power they provide will be firmer than that which we get now from big thermal plants, which will have become uneconomic and unnecessary. Utilities in the 2030s will probably not be manufacturers of a bulk commodity, but rather dispatching and bookkeeping operations mediating between many dispersed sources and many dispersed users. The giant plants which dominate the grid today, by the time they retire, will have become mere historical curiosities.
Responding to Uncertainty
What does this imply for utility strategy? Because of competition from efficiency and alternative supply, and because of exogenous economic uncertainties, it is common ground that long-term demand for grid electricity is uncertain. The greater the scope for saving electricity, the greater the uncertainty: For example, a 5,000-sector least-cost analysis for Britain, based on 1980 technologies and prices, has shown that by 2025 the difference between the official estimate and the least-cost requirement for United Kingdom generating capacity is a factor of nine. If I am even party right about the even larger savings available from newer technologies, demand uncertainty is far larger than any utility appreciates.
Is the solution to uncertainty, then, to build more thermal power plants so as to ensure adequate electrical supply? Emphatically not, for three reasons:
- The financial risk of misforecasting is too great. For example, the August 1983 report of DOE’s $3 million electricity policy project (though effectively disavowed by the Deputy Secretary of Energy) called for building a big power plant per week starting now, based on forecast demand growth averaging 3 percent per year plus or minus one percentage point. But by 2000, that plus or minus one percent is equivalent to a quarter of today’s entire national generating capacity, with a capital cost of a third of a trillion 1983 dollars. Nobody can afford an “insurance policy” with such a huge premium.
- Construction at high marginal costs heightens the risk that higher prices may reduce the revenues needed to pay for that construction (and, in the shorter run, will exacerbate utilities’ inherent instability of cash flow, risking a “spiral of impossibility”). Ironically, a main cause of today’s uncertainty in demand is the rate volatility caused by construction — which was undertaken in a vain effort to hedge against uncertain demand!
- The plethora of decentralized sources, many already competitive and others fast becoming so, will make new big plants obsolete before they are finished.
Escaping from this maze requires rewriting the conventional tenets of utility management. If demand is uncertain, and building plants in self-protection is unaffordably risky, the answer is not to bet still more on becoming able to forecast better; it is rather to reduce uncertainty and risk to an affordable level. That is, rather than trying to project demand and build to meet it, the best-managed utilities are seeking to become indifferent to demand — flexible enough to meet it ad hoc. Rather than staking survival on any one of many conflicting forecasts, not all of which can be right, successful utility managers seek to become able to accommodate any of them in case it turns out to have been right. Such “management by open field running” requires that utilities:
- reduce the level of demand;
- reduce the uncertainty of demand; and
- reduce the unit cost of hedging against residual uncertainty of demand.
Reducing the level of demand saves two critical resources: money and time. It saves money in three ways: It saves operating costs in the short term (efficiency costs less than fuel plus operation and maintenance plus grid losses); it saves construction costs in the medium term; and it saves replacement costs in the long term. All three savings decrease the present value of revenue requirements. Reducing demand also stretches operating reserves and operating lifetimes, postponing capacity decisions as long as possible so that more information will be available.
Reducing the uncertainty of demand is equally vital. Consider the electricity needed to run, say, refrigerators in 2000. The number of refrigerators is only slightly less certain than population, since the market is highly saturated. But a utility which does not know whether its customers will buy 1,500- or 25-kWh-per-year refrigerators (both are now available) must assume the worst and buy extra, very costly capacity as “insurance.” Programs like appliance efficiency rebates, or (at no cost to the utility) federal or state appliance standards, at least knock the worst refrigerators out of the market and at best actively encourage customers to buy very efficient models. The more they do so — and utility experience now makes their behavior under such incentives fairly predictable — the more potential demand is eliminated and the less hedge must be bought against it.
Reducing the cost of hedging against remaining uncertainty requires utilities to acquire options which are small, modular, and incremental, and which have short lead times, relatively low capital intensity, and high velocity of cash flow. These keys to planning flexibility — buying options which are small, fast, and cheap — are now endorsed by every successful utility manager. Improved end-use efficiency meets these criteria best; central stations, worst; cogeneration and most dispersed renewable, in between (and better than combustion turbines).
There are many ways in which a utility can encourage and enable its customers to invest in efficiency on their side of the meter: information, example, targeted education of key groups, purging of institutional barriers, truthful prices, economic incentives, direct financing, and mechanisms for making a market in saved electricity. The appropriate blend and details of each of these instruments will be unique to each utility. I shall discuss here only the last three of them — the financial and market measures a utility can use — because as long as it is cheaper to save electricity than to make it, both utilities and ratepayers can benefit from properly structured utility financial participation in efficiency. After all, a kilowatt-hour saved is just like a kilowatt-hour generated, only cheaper, and can be resold to someone else, so they should be treated alike: Utilities should dispatch negative loads, and aggressively market negawatts, because they are thereby acquiring the cheapest resources for their system and helping their customers get the cheapest energy services.
Many smart utility managers are now using innovative financing concepts. Loans for saving electricity are now commonplace: Since I suggested them in 1976-’77, utilities with over half of national generating capacity have begun making them. Few such loans are well structured: Most are restricted to a list of approved measures (a list which is incomplete and usually becomes obsolete before the ink is dry), have a fixed and generally short repayment period, and bear low or zero interest requiring cross-subsidy. Nonetheless, the better loan programs, even though they also tend to promote obsolete technologies, have saved large amounts of electricity at about 1 to 2 cents per kWh. An even better system — full financing (gifts rather than loans) is preferred by some utilities, especially in the Northwest and for low-income customers who abhor additional debt on any terms. Participation rates for such consumer-pays-nothing programs have ranged up to 95 percent.
Some utilities also buy back saved electricity — in effect, as if it had been generated under PURPA. At least 25 utilities now offer rebates for buying efficient appliances, and thereby save electricity at a cost of 1 to 2 cents per kilowatt-hour. Pacific Gas and Electric and Southern California Edison Company pay respectively $280 per kW peak and $300 per kW peak for peak savings achieved by any method. Some Southern California Edison incentive programs amount to prepurchasing saved kilowatt-hours at a flat rate of 2 to 4 cents each (far below avoided cost).
In two striking prepurchase initiatives of the Bonneville Power Administration, Snohomish Public Utility District pays 29.2 cents per kWh and Pacific Power and Light Company in a Hood River county, Oregon, experiment pays $1.15 per per kWh, for first-year savings from any durable device. These up-front payments — less than the present value of a 10- to 20-year stream of avoided cost — enable the customer to buy the device that will produce the savings. For example, if I lived in Hood River county and wanted to buy my 23-kWh-per-year refrigerator, Pacific Power and Light would send me a check for more than $1,700. I could use it to buy the refrigerator, throw a party with the balance, and watch my annual bill drop by the value of about 1,500 kWh per year. Pacific Power and Light’s advance purchase of my savings amounts to installing in my house a small, cheap hydro dam which will reliably churn out its negawatts for decades to come. Similarly, “negative hookup fees” to reward contractors for efficient buildings could increase the contractors’ profits and their houses’ marketability, give the buyers better mortgage terms and higher resale value, and save the utility 10 to 20 times the value of the rebate.
The most elegant concept for marketing negawatts and demarketing costlier megawatts is for a utility to run a public auction. It would announce its willingness to enter, say, 10-year contracts to pay 1 cent per kWh for electricity made, displaced, or saved by any means. It would accept all bids at that price and place them under contract. It would then raise the offer to 2 cents per kilowatt-hour and sign up all bidders at that price; then offer 3 cents per kWh, and so on. Somewhere around 3 to 4 cents per kWh in my opinion, 4 to 5 cents per kWh in that of some my more pessimistic colleagues — in any event, at about half of present prices — the utility would have achieved a market-clearing price representing the least-cost balance between all supply options and all efficiency options. New auctions would be held as old contracts rolled over, or service demand increased, ensuring that all needs would be met while enabling improved technologies to lower embedded costs. Several utilities are now considering this method; one even hopes to become the nation’s first “negawatt broker,” making both spot and futures markets in saved electricity.
Third-party shared savings financing can give cheap power to industry without cross-subsidy: factories can finance savings by other customers, then buy back the saved kilowatt-hour at an arbitrated intermediate price (as is being tried in New Jersey). Shared savings financing is also simply a profitable venture, at which more than 11,000 energy service companies are currently succeeding in Europe. Under another exciting concept, a customer could sell the utility, as part of its resource plan, a covenant promising that his or her premises will never use more than x MWe. Such a covenant could even be resold, just as certificates of decrement of air pollution are now marketed and brokered under the Environmental Protection Agency’s “bubble concept.”
I assume here, conservatively, that utilities will follow a short-run avoided-cost criterion of buying all efficiency cheaper than operating the costliest marginal plant in service. This is simply the principle of economic dispatch: whenever efficiency beats thermal plants in the merit order, it should be dispatched first. Efficiency backs out the costliest plants first, reducing all customers’ bills just as a cheaper fuel contract would. The same fixed costs must be paid whether sales go up or down; if fixed costs are spread over smaller sales, electric rates may rise, but energy service bills will fall. Moreover, major savings are not achieved instantaneously, but over a period ordinarily comparable to the depreciation lifetime of power plants. If sales fall at the same rate at which net plant in-service depreciates, fixed charges per kWh sold will not change. In a practical case, doubled end-use efficiency could typically cut both electric bills and energy service bills in half while increasing the utility’s net for common (in absolute terms) by several-fold via halved operating costs. A utility should not fear reduced revenues, provided costs drop at least as fast; if they drop faster, absolute earnings will thereby increase.
If that basic criterion is followed — if utilities’ mission becomes, not selling more kilowatt-hours, but supplying, financing, or facilitating customers’ access to least-cost means of obtaining energy services — then utilities can once more become a declining cost industry, as they were before about 1970 — the good old days when regulators’ task was to allocate savings, not costs. As old, cheap hydropower comes to dominate supply of greatly reduced national demand, there will be enormous savings — ultimately over $50 billion per year — to allocate. Regulators can and should give a substantial portion of them to investors. Utility managers are far more likely to pursue least-cost investment strategies with vigor and imagination if they believe such behavior will gain a higher return. Regulators should therefore create and fulfill an expectation that sound, successful, entrepreneurial management which cuts effective operating costs will be amply rewarded.
Whatever direct financial incentives a utility offers should be:
- across-the-board (not tied to any list of approved measures);
- flexible (to elicit types of savings not anticipated);
- open-ended (so that the more people save, the more they earn);
- designed to reward people for saving electricity, not for spending money;
- adaptive (to take immediate account of new technologies and methods); and
- consistent (since nobody will believe a utility which says to save electricity this year, use more next year, and save the year after that).
Utility programs — and corresponding regulation — to encourage efficiency should not get stuck on a small number of programs, but try dozens at once in parallel: eliciting and rewarding innovation, taking risks, celebrating failures, and letting a thousand technological and institutional flowers bloom.
We live in age of costly electricity and cheap efficiency. Utilities which learn how to sell more efficiency and less electricity will prosper. Utilities which try to keep selling more electricity and less efficiency will disappear. The efficiency revolution can be a threat to utilities — quietly destroying their sales and pricing them ever further out of the market — or it can be an unprecedented opportunity for them to reduce risks, improve cash flow and coverage, multiply earnings by several-fold, secure a long-term market share, and enhance their popularity.
Given the increasing availability of cheap ways to save electricity, dramatic efficiency improvements will happen with or without the utilities’ blessing and comprehension. Their choice is between participation and obsolescence. Utilities which anticipate, and whole-heartedly participate in, the efficiency revolution will not only enjoy better foresight in and control of electrical markets; they will also become able to lower their prices and enjoy handsome returns, making money by slashing their operating costs and perhaps also as bankers marketing a financial product which earns them a spread.
Accordingly, to help ratepayers get reliable service at least cost while utilities make more money at less risk, the regulators’ challenge is to help remove utilities’ barriers to market exit from what is no longer a commercially viable enterprise — generating and selling electricity from large thermal power stations — and help instead to speed their entry as effective, efficient competitors in the emerging energy service marketplace.