by Diane Munns
Growing demand, rising costs and increasing concerns about the environment-each, by itself, justifies expanding energy efficiency’s role as a resource for the electric power industry. Taken together, they create the urgent need to make energy efficiency a sustainable business within every electric company.
The industry recognizes that efficiency must be integrated with its planning and operations. Electric companies also realize that because of their unique role as energy providers, they are the logical candidates to promote efficiency to their customers. Electric companies also have the scope and scale to make a difference in promoting efficient technologies, and they can do so at a favorable cost of capital.
Edison Electric Institute and its member companies are now engaged with federal agencies, state regulators, industry allies, and other stakeholders to transform the role of energy efficiency within the electric power industry. To assist this effort, we recently formed the Institute for Electric Efficiency (IEE). The IEE will act as a forum to promote best energy efficiency practices among electric utilities, to develop a resource base of regulatory models, and to convene conferences and seminars to promote the sharing of information on energy efficiency in the power sector.
Addressing costs
Capturing cost-effective energy efficiency brings with it its own costs, such as the cost to educate customers and the business costs to provide efficiency programs, such as energy audits and rebates for efficient windows, insulation and light bulbs. At the same time, if the company is successful in assisting customers to use electricity more efficiently, it can lead to a loss of sales. The electric company, like every company, needs these sales to pay its fixed costs. Lower sales also make it harder for the company to earn an adequate return on its investment.
The business models now being developed to promote energy efficiency in a sustainable manner have three components: timely recovery of the efficiency program costs, compensation for lost sales, and a profit margin on the energy efficiency investments. Electric companies in both traditional and restructured markets have begun exploring business models that include these components, such as the following.
Shared Savings. In this model, the regulator and utility agree on savings that can be achieved. A percentage of the savings achieved through efficiency programs administered by the utility is paid to the electric company, and the remaining savings flow through to customers. Ideally, this model also includes the prompt recovery of efficiency program costs. Without timely recovery, efficiency spending can hurt the company’s bottom line, causing a disincentive for aggressive program development.
In California, the Shared Savings model is combined with compensation for the loss of “throughput”-or sales-due to the efficiency activities. This is done by adjusting electric rates each year to balance out revenue gains or losses. The utility is also assured of recovery of its fixed costs, regardless of sales. This arrangement closely aligns the company’s incentives with those of the regulator and customer. The electric company is also motivated to find the most cost-effective investments in energy efficiency, since that will both generate the greatest net benefits and provide assurances of cost recovery.
Energy Efficiency Capitalization with Bonus Return on Equity. This model lets electric companies capitalize energy efficiency investments and earn a return on them, just as they would on a power plant or transmission line. In Nevada, the rate of return on equity includes a premium over the company’s normal return.
As with the shared savings model, the capitalization approach can be paired with a cost-recovery mechanism for expenses and a way to address the throughput issue. This model appeals to electric companies and regulators that are generally more comfortable with traditional rate-of-return regulation. The model also has fewer administrative complexities.
Virtual Power Plant. Based on Duke Energy’s Save-A-Watt proposal in North Carolina, the company is compensated for efficiency gains at a level comparable to what it would have been paid if it had built a power plant. The model puts the investment on par with supply-side investment and incents the company to find the most cost-effective efficiency. The company is only compensated for savings achieved and assumes the risk of program costs and lost sales.
Electric companies can choose among effective business models customized to their needs and by adopting a mixture of these strategies, the different regulatory environments, customer needs, and resource options found in each state can be accommodated. For regulators and electric companies, it will mean changing paradigms from a supply orientation to considering both supply and demand.
Energy efficiency can achieve its true potential: A powerful tool for increasing productivity, meeting future energy demand, managing and mitigating energy costs, and protecting the environment.
Author
Diane Munns is the executive director, retail energy services, at the Edison Electric Institute.
