An earnings-equivalence model helps utilities and regulators calculate appropriate returns for conservation investments.
Michael Schmidt is a regulatory strategy manager with San Diego Gas & Electric, and has written several books for Public Utilities Reports Inc., including Performance Based Ratemaking: Theory and Practice. E-mail him at MSchmidt@semprautilities.com. The author would like to acknowledge the work of Michael A. Calabrese in developing the debt equivalence calculations shown in Table 4.
Traditionally, utility shareholders and their utilities have a bias toward supply-side resources as opposed to demand-side reduction programs. The reason for this bias is obvious—supply-side resources, such as new production facilities, add to the utility’s rate base, generating additional earnings.
Conversely, decreased sales (from energy efficiency) reduce the need for supply-side assets, thereby diminishing the utility’s earnings opportunities and possibly leading to under-earnings between rate cases. Furthermore, reductions in demand may result in excess supply-side resources that are likely to be excluded from rate base because they do not meet the “used and useful” standard.
Consequently, energy utilities place a great deal of emphasis on sales or throughput. In short, increased sales increase the need for supply-side assets and more earnings.
However, there is a solution: Allow energy utilities to benefit from earnings rewards for demand-side reduction. From an earnings perspective, such a solution would place demand-side alternatives on par with supply-side projects.
The DOE recently recommended this solution in a March 2007 report.1 However, the department did not offer a methodology for calculating a supply-side earnings equivalent for a demand-side energy efficiency program. Such a methodology will help utilities develop effective conservation incentive programs.