How to make the utility of the future an energy-efficient one: New ACEEE report series charts the course for aligning utility business models and energy efficiency

Blog | June 09, 2015 - 2:37 pm
By Maggie Molina, Senior Director of Policy

Utilities have traditionally earned profits by simply selling more energy and building more power plants and infrastructure, which put their financial motivations squarely at odds with the goal of greater energy efficiency. Luckily, that business model has started to change, which is good news for the nation’s economy, environment, and for consumers who want more options for saving energy in their homes and businesses. With the proper regulatory tools in place, utilities’ financial motivations can be aligned with energy efficiency outcomes. As regulators, utilities, and other stakeholders begin to consider utility business models for the 21st century, they can look to recent state experience for insight into how to effectively incorporate energy efficiency as a utility system resource.

ACEEE has been researching this issue for years, and today we are releasing a series of three new reports on a range of topics related to utility business models and energy efficiency. We examined practices state by state across the United States, interviewed stakeholders for case studies of several state examples, and documented lessons learned. Here is a snapshot of our key findings:

First in the series is a paper that Marty Kushler and I wrote, titled Policies Matter: Creating a Foundation for an Energy-Efficient Utility of the Future. The paper does two things. First, it describes the comprehensive foundation of tools necessary for energy efficiency to thrive as a resource for a utility of the future. Second, it analyzes actual energy savings performance compared to the set of policies in place. In our 2011 report series on the same topics, we described the “three-legged stool” necessary to align utility business models and energy efficiency with three types of tools: program direct-cost recovery, decoupling or related mechanisms that allow recovery of lost contributions to fixed costs, and earnings opportunities for efficiency investments through performance incentives.

Our new analysis shows that while these three regulatory tools play a crucial role in elevating the interest in efficiency within utility companies, these alone have not been as successful at saving energy as states’ specific, long-term energy efficiency targets. For example, we have found that only states with an energy efficiency resource standard (EERS) have achieved annual savings of at least 1% of electricity sales. Our new analysis quantitatively shows that a comprehensive strategy—getting the business model right and setting specific efficiency targets—is most closely associated with achieving high savings. Such a strategy is essential to sustaining long-term utility interest in capturing cost-effective energy efficiency resources.

The next two reports take a deeper look at two legs of the stool. The second paper, Beyond Carrots for Utilities: A National Review of Performance Incentives for Energy Efficiency updates our analysis from 2011 on utility shareholder performance incentives for energy efficiency. In 2011, we identified and examined 18 states with this type of policy in place. This time our research team, led by Seth Nowak, found that 25 states have energy efficiency performance incentives for utilities or statewide program implementers, and two more states have the policy framework but have not yet implemented incentives. While the type and structure of the incentives varies significantly from state to state, in general, we identified a few noteworthy trends. We found that incentives are increasingly awarded based on specific energy savings-based targets. They’re also becoming more comprehensive, often requiring utilities to meet performance goals for multiple types of metrics to earn an incentive.

We also found that today incentives are more likely to be based on longer-term performance criteria. Overall, we found that performance incentives are working well to elevate the interest within utilities to invest in energy efficiency and to encourage utilities to meet or exceed their energy savings targets. Check out the twelve case studies included in the report for more background, policy details, and performance results on state experience with performance incentives.

Third, Annie Gilleo led the research for the second report coming out today, Valuing Efficiency: A Review of Lost Revenue Adjustment Mechanisms. LRAM is a rate adjustment mechanism that allows a utility to recover revenues that are reduced specifically as a result of energy efficiency programs. Though LRAM is meant to address the utility’s throughput incentive, i.e., the traditional link between more sales and profits, it does not completely remove that link. That’s because LRAM is typically not symmetrical, in that while a utility can recover lost revenues from efficiency programs, regulators do not typically make downward rate adjustments if the utility sells more energy than predicted. Full revenue decoupling does a better job of removing that link. LRAM also differs from decoupling in that it requires a utility to specifically estimate energy savings over a given time period.

In recent years, many states adopted the LRAM approach. Our research identified 17 states that have LRAMs in place for at least one major utility. While the number of states with this policy has increased in recent years, we also found that several states that had LRAM policies in the past have moved toward decoupling. This is not surprising, given that we found that states face numerous challenges and complexities with implementing LRAM. In particular, states with LRAM often struggle with the increased focus on evaluation, measurement, and verification of savings. Timing is also a critical issue because LRAM intertwines issues commonly dealt with in rate cases and efficiency proceedings, making it important to line up timing of these two processes. More frequent rate cases are also necessary to prevent lost revenue from stacking up over time. More importantly, an LRAM doesn’t fully address the throughput incentive. Utilities may be willing to do efficiency, but they still have an incentive to sell more energy. Because so many states struggle with these issues, we find that LRAM can be an acceptable temporary solution on the way to decoupling, but for several reasons is a less than optimal approach. Where possible, we recommend true symmetrical decoupling.

Energy efficiency has an important and large potential role to play in the utility of the future, but that outcome is highly dependent on a mix of policies that align utility business models with energy efficiency. As states look to the future, we hope they build on lessons already learned to create a comprehensive policy approach that gets the business model right for efficiency and sets specific, long-term efficiency targets. Check out our new report series for more information, and stay tuned for an ACEEE webinar on these reports coming in July!