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Balancing risks and opportunities in efficiency investments.

Balancing risks and opportunities in efficiency investments.

Fortnightly Magazine - January 2010

In June 2008, the New York Public Service Commission (PSC) established the electric energy-efficiency portfolio standards for New York’s investor-owned utilities. 1 In its order, the PSC directed utilities to file three-year energy-efficiency plans which, once implemented, would generate cumulative savings of nearly 2.1 GWh from 2009 to 2011 at a total cost of about $518 million. Later that year, the PSC issued a supplemental order approving shareholder incentives for utilities successfully implementing their portfolios. 2 If all goes according to plan, the six affected IOUs stand to earn about $27 million annually in performance incentives over three years (see Figure 1) .

The structure of the incentive mechanism approved by the PSC presents risk factors that might affect utilities’ ability to realize the full earning potentials the mechanism offers.

The Case for Incentives

The PSC order was issued in August 2008, 21 years after the July 1989 resolution of the National Association of Regulatory Commissioners’ (NARUC), which recognized the earnings implications of conservation and least-cost planning for utilities. 3 The NARUC resolution recognized the need for removing obstacles standing between the idea of least-cost planning and the practical realities of traditional ratemaking, which created a strong economic disincentive to the utilities’ implementation of it. The resolution urged NARUC member state commissioners to: consider the loss of earnings potential associated with conservation and demand-side management; adopt appropriate ratemaking mechanisms to encourage utilities to help their customers improve end use efficiency cost-effectively; and ensure the successful implementation of a utility’s least-cost plan as its most profitable course of action. 4

The resolution proved popular and effective. Within four years, by the end of 1993, shareholder incentives had been approved for over 50 utilities in 20 states, including Con Edison and NYSEG. 5 The hallmarks of these early incentive structures were assured recovery of prudent energy-efficiency investments, and financial incentives to offset the loss of revenues resulting from reduced sales.

However, as utilities in many regions dealt with regulatory reform and restructuring of the electric utility industry in the mid 1990s to early 2000s, these schemes were abandoned in most jurisdictions. Uncertainties related to restructuring in general and the potential risks of stranded investment resulting from open access (in particular) led many utilities to cut back, or in many cases, to altogether halt their energy-efficiency investments. The low activity levels and dwindling new investments in energy efficiency lessened the importance and, to some extent, relevance of shareholder incentive mechanisms.

The past few years have seen a significant resurgence in energy efficiency for a number of reasons, mainly due to a renewed interest in integrated resource planning and the adoption of energy-efficiency portfolio standards (EEPS) in many states given concerns over climate change or energy security. These developments have prompted many regulatory commissions to reconsider energy-efficiency incentives. Based on recent data compiled by the Edison Electric Institute, incentive formulas have been approved in 18 states