Removing Disincentives: Efforts to Promote Electric Utility Efficiency By: Kenneth J. Gish, Jr. Smart grid technology refers to the integration of digital information technology with the electric grid. The development and implementation of smart grid technologies will lead to increased energy efficiency and distribution system reliability and, therefore, decrease the need for construction of new transmission and generation infrastructure. Consumers will see benefits from the smart grid through reduced electricity costs and increased reliability. Unfortunately, under traditional rate-making systems, there is little incentive for investor-owned utilities to invest in deploying energy efficient technologies. If a utility s revenues are calculated solely by multiplying its sales by an approved rate, there exists a disincentive to the utility for investment in energy efficiency measures such as a smart grid. Thus, for smart grid deployment to be a success, regulatory agencies must remove the disincentives to investment and develop a system that rewards utilities for implementing cost-effective energy efficiency and reliability measures. This paper explores programs in several states that include incentives for the utility to develop and implement energy efficiency measures. It focuses primarily on the demand-side management ( DSM ) program operated by Narragansett Electric Company ( Narragansett ) in Rhode Island. Other examples of programs are found in Massachusetts, New Hampshire, and Kentucky. While this list does not include all states with performance based incentives, the programs selected provide examples of what is currently used to enhance efficiency. An important theme running throughout these programs is that the utility s shareholders receive financial incentives tied to the effective implementation of their company s energy efficiency programs. These programs are examples of measures that could be implemented in the Pacific Northwest to support the development and deployment of the smart grid. 1 RHODE ISLAND Rhode Island requires public utilities to charge their customers 2.0 mills per kilowatt-hour to fund demand-side management programs. R.I. Gen. Laws 39-2-1.2(b). The design and implementation of the programs that these funds support are reviewed and approved by the Rhode Island Public Utilities Commission ( RIPUC ). Narragansett operates a DSM program which incorporates performance incentives for the Company s shareholders for meeting its energy efficiency goals. Narragansett s 2004 DSM program was approved on December 23, 2003. RIPUC Docket No. 3463, Report and Order In Re: The Narragansett Electric Company, Demand-Side Management Programs for 2004, July 28, 2004 ( 2004 Order ). Narragansett s program focuses on using the money it receives from the statutory DSM charge to provide incentives, primarily through the use of rebates and no- 1 The programs described in this paper apply only to investor-owned utilities whose rates are subject to state utility commission approval. 1
interest loans, for consumers to increase energy efficiency. 2 Narragansett s program also provides incentives to the company s shareholders to achieve increases in efficiency. The Narragansett program targets three sectors of the company s consumers. First, it targets residential customers by providing rebates to individuals who install approved energy efficient appliances in their homes. Similarly, it targets small commercial and industrial customers by providing financial assistance, through rebates and no-interest loans, to small businesses for the installation of energy efficient equipment. The small business program focuses on increasing the comprehensive nature of a customer s energy efficiency program. Finally, Narragansett provides technical consulting and financial incentives to its larger commercial and industrial customers (greater than 100 kw in demand). These incentives are designed to help a company offset the incremental costs of installing more efficient equipment. Critical to the success of Narragansett s DSM program is the availability of shareholder incentives for meeting certain efficiency goals. These incentives are necessary because as Narragansett implements its DSM programs, the kwh savings that result cause a reduction in revenues. See RIPUC Docket No. 3463, Report and Order In Re: The Narragansett Electric Company, Demand-Side Management Programs for 2003, p. 14, July 21, 2003 ( 2003 Order ). Narragansett has described its goals for the shareholder incentives as follows: 1. to reward Narragansett for effective program implementation; 2. to encourage Narragansett to prudently spend the entire DSM budget; 3. to encourage program innovation; 4. to encourage Narragansett to make services available to all customer constituencies; and 5. to eliminate adverse financial effects on Narragansett related to aggressive program implementation. 2003 Order p. 9. Without these incentives, it would be difficult for Narragansett to justify to its shareholders why it was intentionally lowering revenue from power sales. In years prior to 2004, Narragansett s shareholder incentive was tied exclusively to the amount of customer kwh savings. In 2003, Narragansett s shareholder incentive equaled the amount of kwh savings above the threshold savings amount (45% of the savings goal) multiplied by the incentive rate. RIPUC Docket No. 3463, Amended Settlement of the Parties, December 12, 2002, Attachment 5. The incentive rate varied with the customer group the savings came from, with higher rates for savings from small businesses and residential customers as those customer groups required more focus. For example, in 2003 Narragansett set a kwh savings goal of 12,452,223 kwh from its residential program. The threshold kwh savings (45% of the total savings goal) was 5,603,500 kwh, leaving 6,848,723 kwh of savings available for calculating the company s incentive. Narragansett s 2003 DSM budget for residential programs was $6,142,561. The incentive rate for residential efficiency savings was agreed to be 5%, so the incentive cap for residential savings was $307,128. Therefore, 2 See http://www.nationalgridus.com/narragansett/home/energyeff/energyeff.asp for a discussion of energy efficiency rebates available to Narragansett s residential customers. See http://www.nationalgridus.com/narragansett/business/energyeff/energyeff.asp for a discussion of energy efficiency incentives for commercial and industrial customers. 2
Narragansett s incentive rate, the amount of money available for incentives divided by the kwh savings above the threshold, was $0.0448/kWh. In 2004, Narragansett s DSM program was altered to include two types of shareholder incentives. Incentives based on meeting kwh savings targets per sector remained. The program, however, also added incentives to meet certain performance metrics. For each performance metric that is met, the Company will receive a $15,000 shareholder incentive. 2004 Order p. 17-18. The five performance metrics that Narragansett must meet to obtain the incentives are: 1. Achieve an ENERGY STAR qualified clothes washer market share for 2004 in Rhode Island that is 7 percentage points above the national average. 2. Conduct plans analyses and home ratings and sign ENERGY STAR builders agreements with 15% of the new homes built in Rhode Island in 2004. 3. Enroll in 2004 an additional 25 Rhode Island facility building engineers, technicians and contractors, or operators in the NEEP-Level 1-O&M training and certification course. 4. Contract with three new school projects through Design 2000plus to provide full incremental cost for high performance design and construction practices with a special focus on high quality energy efficient lighting. 5. Achieve a 14% comprehensiveness in Small Business Services in 2004. This metric is designed to ensure that the Company looks at all energy efficiency options for each small business customer. RIPUC Docket 3463 2004 DSM Program Settlement of the Parties, Performance Metrics Revised Attachment 7, November 7, 2003 (Revised Attachment 7). These metrics were chosen because they represented current market conditions in energy efficient technologies and would force the Company to stretch to achieve the desired results. Revised Attachment 7, p. 1. By crafting a shareholder incentive program that rewards the company if it meets its ambitious energy efficiency goals, Narragansett and RIPUC have eliminated the disincentive for implementing efficiency programs and have developed a system that actively promotes investment in energy savings. OTHER NEW ENGLAND STATES Along with Rhode Island, other New England States have developed programs where utilities receive financial incentives tied to their performance in achieving energy efficiency. In Massachusetts, utilities are required to charge consumers 2.5 mills per kwh to fund energy efficiency programs including demand-side management. Mass. Gen. Laws ch. 25, 19. These programs contain financial incentives for a utility s shareholders that eliminate the reduced revenue from throughput that energy efficiency can bring. Under Massachusetts guidelines for energy efficiency programs, a utility may receive a shareholder incentive equal to the product of the average yield of the three month United States Treasury T-Bill and costs of program implementation. Massachusetts Department of Telecommunications and Energy ( DTE ) Docket 98-100, Guidelines for Energy Efficiency Programs ( DTE Guidelines ), Section 5.2. To qualify for the incentive, the utility must achieve 75% of its design performance level. Once it achieves 75% performance, it will receive an incentive that varies with its actual performance level, up to 125% of design performance. The utility may propose any measure of its performance, subject to approval by 3
DTE. MA DTE Docket No. 04-30, Joint Petition of Massachusetts Electric Company and Nantucket Electric Company, pursuant to G.L. c. 25, 19 and G.L. c. 25A, 11G, for approval by the Department of Telecommunications and Energy of its 2004 Energy Efficiency Plan, September 13, 2004. 3 New Hampshire utilities also operate energy efficiency programs. All of the utilities in the state cooperate in the Core energy efficiency program. The Core energy program is funded by a systems benefit charge designated for the operation of energy efficiency programs. N. H. Rev. Stat. 374- F:3(VI). Like the other programs, the Core program provides financial assistance to residential and commercial electric customers to install energy efficient appliances and lighting, design efficient buildings and provide energy efficiency measures (such as weatherization) to low-income customers. New Hampshire Public Utilities Commission ( NHPUC ) Order No. 24,248, December 15, 2003, p. 5. The New Hampshire Core programs also provide for shareholder incentives of up to 12% of a utility s efficiency program budget provided certain cost-effectiveness and energy savings goals are met. NHPUC Order 23,982, May 31, 2002, fn 2, p. 6. KENTUCKY Energy efficiency programs allowing for shareholder incentives are not limited to New England states. Kentucky law authorizes public utilities to: recover in rates the full costs of demand-side management programs, any net revenues lost due to reduced sales resulting from demand-side management programs, and incentives designed to provide positive financial rewards to a utility to encourage implementation of costeffective demand-side management programs. Ky. Rev. Stat. 278.285(1)(c). The public utilities in Kentucky have all implemented demand-side management programs funded through the imposition of DSM surcharges on all customers. The Kentucky Public Service Commission ( KPSC ) recently approved Kentucky Power s request to increase its residential DSM surcharge from 0.282 mills per kwh to 0.375 mills per kwh and lowered its commercial rate from 0.049 to 0.048 mills. KPSC, Case No.2004-00316, Order In the Matter of The Semi-Annual Demand Side Management Program and Cost Recovery Filing of American Electric Power d/b/a Kentucky Power, September 24, 2004. The funds received from these surcharges will be used to offset any revenue losses that efficiency programs cause and provide incentives to the utility to make energy savings. CONCLUSION There are many examples of successful performance-based incentive programs that promote the implementation of energy efficiency programs. The programs in the states mentioned above are prime examples of these. In each state, the funding for the programs comes from the customers themselves. DSM surcharges or system benefits charges provide a pool of resources that allow the utilities to implement energy efficiency programs. Rates are designed to allow utilities to recover the revenue they lose from the loss of power sales that a more efficient system brings and to provide an incentive for utilities to meet their energy savings goals. 3 In its 2004 plan, Massachusetts Electric submitted incentive payment plans based on a flat 5% instead of the T-Bill rate. This was approved because the T-Bill rate had fallen to a point where the incentives were ineffective to motivate performance. 4
The smart grid will greatly enhance the efficiency and reliability of the electric distribution system. As with any other program that increases efficiency, it will likely do so at the expense of utility power sales. To promote the necessary utility investment in smart grid technologies, regulators must create a system that both removes the disincentive of lost sales and provides added incentives for meeting aggressive energy efficiency and system reliability goals. Implementing programs, similar to the ones discussed in this paper, that would provide incentives for utilities to invest in smart grid technologies might not be the easiest task. Each of the programs discussed here arose from legislative action and are based on statutory mandates. The statutes that allow for the incentives also allow utilities to include a DSM surcharge in the rates they charge customers, which can be a politically complicated situation. Finally, the programs discussed in this memo focus directly on energy efficiency which is a known concept and, therefore, may be easier to legislate for than the implementation of smart grid technologies. While roadblocks to incentive programs for smart grid deployment could exist, the development of conceptually similar programs for energy efficiency show that such incentive programs are not only possible, but can be successful. 5