Addressing Incentives and Disincentives for Utility CDM

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Addressing Incentives and Disincentives for
Utility CDM

• Presented atOntario Energy Association
• Conservation-Demand Management Forum
• Doubletree International Plaza,
• Toronto Airport
• June 8, 2006
• Daniel M. Violette, Ph.D.
• Summit Blue Consulting
• Boulder, Colorado 80302
• e-mail dviolette_at_summitblue.com

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Point of View

• An incentive from one persons point of view, may
  be the removal of a disincentive from another
  persons point of view.
• Is removing a disincentive to cost-effective
  investment in CDM the same as increasing
  incentives?
• From this point of view, incentives can be
• Reducing operational and performance risks
  associated with CDM investments
• Reducing regulatory uncertainty around CDM
  investments
• Reducing organizational and structural barriers
  to CDM investments
• AND, reducing financial disincentives to CDM
  investments.

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CDM Complexity -- A Few Quotes

• Sports Analogies related to CDM Program
  Implementation
• In theory there is no difference between theory
  and practice. In practice there is. Yogi Berra
  (Manager, New York Yankees)
• You got to be careful if you don't know where
  you're going, because you might not get there.
  Yogi Berra
• We made too many wrong mistakes. Yogi Berra
• Some political wisdom related to CDM Assessment
• I didnt lie, I just said some things that later
  on seemed to be untrue. Richard M. Nixon (former
  U.S. President)
• I believe we are on an irreversible trend toward
  more freedom and democracy - but that could
  change. Dan Quayle (former Vice President)
• We are ready for any unforeseen event that may
  or may not occur. Dan Quayle (former Vice
  President).

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CDM Goal

• Goal -- A substantive shift in resource
  investment to conservation, energy efficiency,
  and load management.
• Lowers overall costs of meeting customer energy
  needs.
• Reduces system cost risks and enhances
  reliability
• Allows for more lead time for investment
  decisions by lowering the rate of growth in
  demand.
• Portfolio effect reduces risks associated with
  fuel price increases and increases resource
  diversity.
• Lowers risks associated with environmental
  compliance costs.
• Traditional industry approaches towards planning,
  operations management, staffing, and customer
  relationships are likely to be challenged by this
  goal.
• Another point of view Are utilities being asked
  to develop a new line of business, i.e., delivery
  of CDM services?

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CDM Programs

• Delivery of CDM programs are challenging and they
  take time.
• Program concepts
• Value propositions and customer assessments
• Marketing
• Make the Sales
• Delivery Channels appropriate industry
  infrastructure
• Fulfillment (get the service or technology to the
  customer)
• Quality control
• Financial accounting
• Designing a new CDM program is similar to the
  development of a new product or service with the
  same set of challenges.
• Not all programs will be successful, and many
  will need a shake-out period before they become
  successful.

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Where have we been?

• Investment in DSM has been uneven due to a number
  of factors
• Uncertainty related to restructuring and the role
  of utilities.
• A period of low gas prices leading to stable
  electric rates in the late 1990s

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Regulatory Developments (2003/2004)

• NARUC resolution State commissions should review
  and reconsider the level of support and
  incentives for existing gas and electric utility
  energy efficiency programs. (July 2003, Summer
  Meetings)
• NARUC resolution on gas and electric energy
  efficiency Remove regulatory and rate structure
  disincentives to the efficient use of natural gas
  and electricity. (July 2004, Summer Meetings)
• Resolved by the Board of Directors of the
  National Association of Regulatory Utility
  Commissioners (NARUC) to support the
  expansion of natural gas and electric energy
  efficiency programs and to address regulatory
  incentives to address the inefficient use of gas
  and electricity. (Adopted by NARUC Board of
  Directors July 14, 2004)

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Regulatory Developments (cont.)

• NARUC resolution recognizing the joint statement
  between the
• Natural Resources Defense Counsel (NRDC),
• American Council for an Energy-Efficient Economy
  (ACEEE),
• American Gas Association (AGA)
• which urged commissions to align the interests
  of consumers, utility shareholders, and society
  as a whole by encouraging conservation. (July
  2004, NARUC Summer Meetings)
• The 2003 and 2004 NARUC resolutions indicate an
  increased interest in providing utilities with
  appropriate incentives to aggressively pursue
  investments in energy efficiency.
• What factors were behind this recent interest and
  restatement of objectives by regulators?
• An awareness that standard practice likely will
  not achieve the desired goals.

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Tracing Some Roots (1988/1989)

• U.S. Congress make conservation investments
  at least as profitable, including income loss due
  to reduced sales, as investments in generation,
  transmission and distribution facilities. (U.S.
  Public Law 102-486, H.R. 776, I.C. 1912 modifying
  PURPA).
• RESOLVED Executive Committee of the National
  Association of Regulatory Utility Commissioners
  (NARUC) urges its member state commissions to
• 1) Consider the loss of earnings potential
  connected with the use of demand-side resources
• 2) Adopt appropriate ratemaking mechanisms to
  encourage utilities to help their customers
  improve end-use efficiency cost effectively and
• 3) Otherwise ensure that the successful
  implementation of a utility's least cost plan is
  its most profitable course of action.1
• Resolution sponsored by the NARUC Committee on
  Energy Conservation, July 1989.

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Convergence of Views (1988/1989)

• The National Association of State Utility
  Consumer Advocates (NASUCA) Least Cost Planning
  Manual states that regulatory treatment should
• Give the utility adequate incentives to treat
  demand-side and supply-side programs on a
  comparable basis,
• Encourage the utility to make demand-side
  investments which maximize economic efficiency,
  and
• Provide adequate ratepayer safeguards consistent
  with the least-cost utility planning process.2
• (NASUCA, "Least Cost Utility Planning Consumer
  Participation Manual, 1989, p. 56.)
• TODAY -- The rationale behind these policy
  statements remains unchanged, if not strengthen,
  by todays energy markets.
• AND, the risk mitigation aspects of CDM are even
  more apparent.

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Financial Perspective A Business View

• Two elements
• 1) Lost Revenues -- Implementing CDM programs
  that reduce sales also reduce utility margins.
• Often viewed as the most significant disincentive
  to CDM.
• Impacts both private utilities and public or
  consumer owned firms.
• 2) Return on Resources Positive incentives or
  margins for CDM services rendered using utility
  resources that meet a customer need.
• Rather than being a standard business practice,
  it is often argued that any margin on CDM
  activities should be provided only to promote DSM
  excellence, i.e., only earned once performance
  targets that demonstrate excellence are exceeded.
• There may be no return on many transactions that
  benefit all parties.
• This can ignore opportunity costs associated with
  scarce management time, and human resources and
  risks associated with regulatory, industry and
  program performance.

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Financial Approaches

• Lost revenues can be addressed via different
  types of recovery mechanisms
• Regulators have worked with the gas utilities in
  Ontario to successfully implement lost revenue
  adjustment mechanisms.
• Positive incentives also have been implemented in
  different ways
• Shared incentives based in net benefits (TRC
  measured).
• A fixed payment for each kWh or therm saved.
• Adjustments to rate of return.
• Capitalization of DSM expenditures.
• Bounties or milestone payments for DSM
  accomplishments.
• but, they are often tied to exceeding
  performance targets.

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Are Financial Incentives Important?

• One view is that utilities should provide
  energy-efficiency services at increment program
  cost (i.e., no margins).
• To serve the public interest.
• Provide what its customers/owners want.
• Promote good public and regulatory relations.
• These factors can be effective until the amount
  of money at stake becomes significant -- but
  isnt that what we want?
• Incentive measures which are genuinely
  attractive to utilities provide the necessary
  means to develop the real potential, whatever it
  may be. Such incentive measures are equally
  necessary to obtain public credibility for
  least-cost planning.
• Forward by John Rowe, then CEO New England
  Electric System, to "Profits and Progress through
  Least-Cost Planning" National Association of
  Regulatory Commissioners, November 1989.

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Stretching the Model A Business Enterprise
Approach

• An enterprise model approach would recognize that
  the utility is being asked to develop a new
  service offering, i.e., energy efficiency
  services, based on a different business model.
• The traditional utility is a capital-intensive
  enterprise with margins earned on capital
  invested.
• An energy-efficiency enterprise approach would
  emphasize a services-based business model.

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CDM as a Customer Service

• There are many examples of service firms
  business services firms, engineering services
  firms, accounting services firms, management and
  public relations services firms, and others.
• But, no service firm provides its service for a
  zero or even a negative return.
• At the extreme, consider a situation where the
  utility could meet all future energy needs
  without any additional capital investment, i.e.,
  all new demand growth is met through CDM.
• In this case, a utility would not earn any
  margins at all while still meeting customers
  energy services needs.
• Based on a services company model, a return could
  be earned that is similar to the return earned by
  other service firms.

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Returns in Services Industries

• Rates of return over the past year for four
  business services categories are shown in the
  table below
• Figures are derived from data provided by
  Standard and Poors Compustat data service.
  Rates of return are defined as pre-tax profits
  (before depreciation, interest expense, and
  non-operating income) as a percentage of costs.

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Practical Aspects of Incentives

• Non-financial organizational and industry
  barriers are real, and they present obstacles to
  be overcome.
• These might best be addressed by a business
  approach to CDM.
• Delivery of best practice CDM requires leadership
  within the organization, great staff, creative
  thinking and problem solving.
• Best practice programs cant easily be replicated
  because the processes are so human resource
  intensive.
• Regardless of program delivery (utility or 3rd
  party), resource planning and resource assessment
  approaches will need to change to appropriately
  incorporate the demand-side options.
• The transformation that some hope for, i.e., the
  transition to a conservation culture, will
  require substantive change throughout the
  industry.

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Setting the Game Plan

• Few really oppose the concept of achieving as
  much cost-effective conservation, energy
  efficiency and load management as possible.
• BUT, proponents and advocates of CDM still are on
  opposite sides of many issues
• Incentives (structure and how much)
• Regulatory oversight and potential penalties
• Delivery approach which organizations have
  responsibility
• Equity across program offers for customer
  segments
• Short-term versus long-term views of programs
• Evaluation requirements
• FOCUS NEEDED Put quality programs into the
  field.

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Quality Programs -- Lessons

• Quality in program delivery and implementation is
  not easily attained.
• Build quality controls into program delivery to
  provide real-time feedback.
• Monitoring (activity based),
• Verification (in-field assessment to ensure
  savings) and
• Evaluation (customer and end-use targeting to
  enhance efficiency, e.g., reduce free ridership)
• Appropriate financial incentives are needed to
  get leadership involved across utilities and
  industry partners do good and make it a
  business, self-sacrifice will only go so far.
• Build up the value in CDM and appropriate
  incentives will not pose a problem.
• Lets get the industry actors on the same side
  set up real incentives for the services provided
  and accountability for program quality.

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Given the clarity of the CDM debate, some
commentary that seems to fit

• "If crime went down 100, it would still be fifty
  times higher than it should be." Councilman John
  Bowman
• "I suppose you think that, on our board, half the
  directors do all the work and the other half do
  nothing. As a matter of fact, the reverse is
  true. Energy Trading Company CEO.
• "I think if you know what you believe, it makes
  it a lot easier to answer questions. I can't
  answer your question." George W. Bush.
• "There is a mandate to impose a voluntary return
  to traditional values." Ronald Reagan
• On a different note
• The world hates change, yet it is the only thing
  that has brought progress. Charles Kettering

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• DISCUSSION
• Contact
• Dan VioletteSummit Blue ConsultingBoulder,
  Colorado
• Phone [phone]
• E-Mail dviolette_at_summitblue.com