Aligning Utility Incentives with Energy Efficiency Investment

1. Aligning Utility Incentives with Energy Efficiency Investment Val Jensen ICF International

2. Context - National Action Plan for Energy Efficiency • July 2006 report included a recommendation to “modify policies to align utility incentives with the delivery of cost-effective energy efficiency and modify ratemaking practices to promote energy efficiency investments.” • A key objective for Year 2 of the NAPEE effort is to, “undertake efforts to support key recommendations of the Action Plan.” • ICF retained by EPA on behalf of the NAPEE to develop a White Paper extending the work underlying this recommendation and provide additional information on cost recovery and incentive mechanisms • Original NAPEE and recommendations were focused on policy – current work is designed to support implementation activities – provide a resource.

3. 3 types of costs/financial implications that must be considered Program cost recovery Avoidance or recovery of lost margins Utility performance incentives Each of these affect utility earnings/net operating margins It is the direction and magnitude of this effect that ultimately determines whether a utility’s financial interest is aligned with a policy interest in promoting utility investment in EE. Our Objectives Properly portray these implications from the perspectives of both utilities and policy makers. Examine alternative approaches to addressing the implications. Provide concrete examples/case studies. Search for new approaches The Hierarchy of Financial Implication (a.k.a the 3-legged stool)

4. Mechanisms Examined Lost Revenue Recovery Mechanism (LRAM) Expense Rate Case Rider Lost Margin Recovery Program Cost Recovery Earnings/Net Operating Margin Capitalize Rate Case Deferral Decoupling Shared Savings Performance Incentives Performance Payment ROR Adder

5. Current Landscape

6. Preliminary Observations • Significant levels of investment (e.g., CT, VT, CA) will require: • All three levels of financial implication be addressed • 3rd party administration may substitute to some degree • But, what matters ultimately is the impact on earnings • Can get there in a variety of ways. • Policies don’t operate in isolation – influenced by: • General ratemaking policy • Utility resource acquisition policy • Climate policy • Market structure policy • Important differences exist between • Investor-owned and publics/coops; • Electric and gas

7. More Preliminary Observations • Policies need to address not only tangible costs, but also utilities’ perceptions of regulatory risk – policy stability is important. • Consistent policy with net positive impacts on earnings can play a major role in changing utility resource acquisition culture. • Policies that leave a utility financially neutral (no reduction in earnings) will produce indifference to EE. • Aligning IOU interests with a policy goal of aggressive investment in EE may require an ability to earn performance incentives. • Climate legislation will likely change the utility benefit-cost calculus for EE

8. Challenging Issues • Recovery of margins • Are margins guaranteed? • Do customers benefit? • What is the proper utility business model? • Performance Incentives • Should utilities be doing this anyway? • Could someone else do the job less expensively?

9. Process and Timeline • Detailed outline - April • Draft to Advisory Group - June • Draft to Leadership Group for review and input - late July • Final Draft – September • Distributed – October

10. Utilities Duke Energy Tampa Electric Co., PNM Questar Gas Co PG&E Southern Company Austin Energy Southern California Edison Tri-State Utility Commissions Idaho PUC, Kansas Corporation Commission District of Columbia PSC New York PSC Others NRDC Environmental Defense CT Office of Consumer Counsel Advisory Group