Presentation

1. Presentation Informational Workshop on DSM Issues: Utility Incentives, Market Transformationand Net-to-Gross Ratios (NTG) Colorado Public Utilities Commission Denver, Colorado March 18, 2010 By: Daniel Violette, Ph.D.; Frank Stern, M.S. Eng.; and Stuart Schare, M.S. Contact: stuart.schare@navigantconsulting.com

2. Introduction -- DSM Context and Perspective • This discussion addresses some select issues in DSM planning, evaluation and delivery. • Core questions include: • Can DSM be counted on as a resource? • How much uncertainty is there in DSM? • What is the role of DSM in planning? • Can we evaluate and assess DSM ? • How can utilities be motivated to do provide quality, cost-effective DSM? • These general questions have direct links to the items in this discussion – incentives, evaluation and net-to-gross (NTG), and market transformation

3. Context • DSM and Supply-Side investments from a planning perspective: • Develop plan that will produce the lowest revenue requirements for ratepayers 10 years from now. • DSM and Supply-Side investments both face considerable uncertainty. • Which is greater? It might be hard to tell. There is generally greater discussion about DSM uncertainties, but there are uncertainties on the supply side as well.

4. Context • DSM has its own uncertainties as well and they are discussed in subsequent sections; but, • If you have an ongoing DSM program, it can be held steady in times of less need and ramp up in times of great need. This flexibility has value. • It can bridge the gap between unplanned changes in the lead time required for new units. • It brings the demand-side into play in working towards an efficient supply-demand resource solution. • It can be used to hedge against uncertainties on the supply side in a truly integrated resource plan. • All decisions face uncertainty and all face a counter factual, i.e., you will never really know what revenue requirements might have been if you had built a gas plant instead of a coal plant.

5. The Challenge of DSM • Delivery of DSM programs are challenging and take time to roll out. • 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 DSM 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.

6. DSM Incentives Presented byFrank Stern

7. DSM Incentives: Agenda • Principles behind DSM incentives and related public policy issues • Alternative incentives frameworks and pros/cons • Examples of incentive mechanisms used by state Commissions • Latest trends in DSM incentives

8. Principles behind DSM incentives and related public policy issues “DSM, as a business venture, runs counter to Public Service’s current business practices.” Decision No. C08-0560. Public Utilities Commission of the State of Colorado Utilities earn a return on and off capital invested in power plants Without appropriate regulatory mechanisms, utilities have a strong disincentive to actively pursue DSM Under traditional regulation, utilities typically lose revenues and profits with most forms of energy efficiency Regulatory mechanisms address this problem

9. Why do utilities need incentives? “The rat must smell the cheese.” John Rowe, 1989 and 2009 CEO, New England Electric System and Exelon

10. Loss of Sales Can Substantially Lower Profitability • “A 5% decrease in sales can lead to a 25% decrease in net profit for an integrated utility.” • Harrington, C., C. Murray, and L. Baldwin (2007). “Energy Efficiency Policy Toolkit.” Regulatory Assistance Project

11. Alternative incentives frameworks and pros/cons Source: US DOE and EPA. “Aligning Utility Incentives in Energy Efficiency.” (2007). http://www.epa.gov/cleanenergy/energy-programs/napee/resources/guides.html.

12. Alternative incentives frameworks and pros/cons • Program cost recovery • Simple expense rate case rider is common. • Less common is capitalization • Lost margin recovery • Lost revenue adjustment mechanism allows a utility to recover margins attributable to decreased energy sales due to energy efficiency programs. • Decoupling severs the link between revenue recovery and sales. May not be sufficient to make up for loss rate base growth.

13. Alternative incentives frameworks and pros/cons • Performance incentive mechanisms: • Performance Target • Incentives are not paid unless a utility achieves some minimum fraction of proposed savings, and incentives are capped at some level above projected savings. • Shared savings (shared net benefits) • Award the utility a percentage of the present value of net benefits achieved by the efficiency programs. • Enhanced ROR • Utilities allowed an increased return on investment for energy efficiency investments or offered a bonus return on total equity investment for superior performance.

14. Examples of incentive mechanisms used by state commissions • Colorado • HB 07-1037 (C.R.S. §40-3.2-104) states that the Commission shall allow electric DSM investments an opportunity to be more profitable to the utility than any other utility investment that is not already subject to an incentive • Decision No. C07-0568 specifies a Partial Revenue Decoupling Adjustment. Rate rider in a given year will be designed to collect the associated revenues lost in excess of the 1.3 % threshold

15. Examples of incentive mechanisms used by state commissions • Colorado: Decision C08-560 • For each one percent of DSM goal attainment beyond 80 percent, Public Service shall earn an additional 0.2 percent of net economic benefits, up to a level of 10 percent of benefits at 130 percent of goal attainment. • For each one percent of DSM goal attainment beyond 130 percent, Public Service shall earn an additional 0.1 percent of net economic benefits, up to earning 12 percent of benefits at 150 percent of goal attainment. • This performance incentive, together with the “signing bonus” will be limited by an overall cap on the incentive. • Total incentives received by Public Service (“disincentive offset” plus performance incentive) shall not exceed twenty percent of Public Service’s total annual expenditures on DSM for the year.

16. Examples of incentive mechanisms used by state commissions California shared savings program Source: US DOE and EPA. “Aligning Utility Incentives in Energy Efficiency.” (2007). http://www.epa.gov/cleanenergy/energy-programs/napee/resources/guides.html.

17. Examples of incentive mechanisms used by state commissions • Massachusetts • Utilities can earn about 5% of program costs for energy efficiency programs that meet established program goals. • Generally utilizes a three-tiered structure. • First level is defined as performance that a Program Administrator expects to achieve in implementing its energy efficiency programs. • Second level is 75% of the design level. • Third level is 125% of the design level. • Incentives are awarded only if a program achieves the threshold level or above.

18. Examples of incentive mechanisms used by state commissions • Minnesota • Shared savings • Utilities earn performance incentives when achievements exceed 90% of kWh or MCF goals. • Companies awarded percentage of net benefits. • Incentives capped at 30% of approved spending levels.

19. Examples of incentive mechanisms used by state commissions • North Carolina: Duke Save-A-Watt • If energy efficiency is to be viewed from the utility’s perspective as equivalent to a supply resource, the utility should be compensated for its investment in energy efficiency by an amount roughly equal to what it would otherwise spend to build the new capacity that is to be avoided. • Utility capitalizes 90% of the PV of avoided cost of energy and capacity over the lifetime of the installed measures at the utility’s after-tax equity-weighted ROE • Program costs are not explicitly recovered. • Combines program cost recovery, recovery of lost margins, and shareholder incentives into one mechanism.

20. Examples of incentive mechanisms used by state commissions • South Carolina: Duke Save-a Watt • Lost revenue recovery component • Similar to shared savings mechanisms • Earnings are dependent on avoided costs savings • 55% of costs avoided by energy efficiency and 75% of costs avoided by demand response constitute potential earnings • Capped by a return on investment schedule based on performance • Not a standard performance target mechanism: • Similar to performance target mechanisms in that the maximum after-tax percent of return it can earn on program costs is based on actual performance as a percentage of targeted performance. • Unlike traditional performance target mechanisms in that the unit for measuring performance is avoided cost savings, not energy and peak demand savings.

21. Examples of incentive mechanisms used by state commissions • Nevada • Law gives utility authorized return on equity plus 5 percent for prudent and reasonable conservation and demand management investments. • Statute also allows utility to request a bonus ROE for “critical facilities” such as reliability investments in the same manner.

22. Examples of incentive mechanisms used by state commissions • Texas • State code specifies that a utility may be awarded a share of the net benefits for exceeding established demand reduction goals that do not exceed specified cost limits. • Net benefits are total avoided cost of the eligible programs administered by the utility minus program costs. • If a utility exceeds 100% of its demand reduction goal, bonus is equal to 1% of the net benefits for every 2% that the demand reduction goal has been exceeded, up to a maximum of 20% of the utility’s program costs. • Utility that meets at least 120% of its demand reduction goal with at least 10% of its savings achieved through “Hard-to-Reach” programs receives an additional bonus of 10% of the bonus calculated.

23. Latest trends in DSM incentives Source: Edison Foundation, Institute for Energy Efficiency. 2010. “State Efficiency Regulatory Frameworks.”

24. Latest trends in DSM incentives Source: Edison Foundation, Institute for Energy Efficiency. 2010. “State Efficiency Regulatory Frameworks.”

25. Closing M&V takes on new importance when financial incentives or penalties depend on it.

26. Effect of Decoupling or ShareholderIncentives on Utility ROE and Earnings Source: Financial Analysis of Incentive Mechanisms to Promote Energy Efficiency: Case Study of a Prototypical Southwest Utility. Cappers, Goldman, Chait, Edgar, Schlegel, Shirley. Lawrence Berkeley National Laboratory - Report Summary – March 2009

27. Effect of Decoupling AND ShareholderIncentives on Utility ROE and Earnings Source: Financial Analysis of Incentive Mechanisms to Promote Energy Efficiency: Case Study of a Prototypical Southwest Utility. Cappers, Goldman, Chait, Edgar, Schlegel, Shirley. Lawrence Berkeley National Laboratory - Report Summary – March 2009

28. Why should utilities earn a higher return on DSM than supply side investments? Source: Kihm, S. “When Revenue Decoupling Will Work . . . And When It Won’t. The Electricity Journal. October 2009. • Averch-Johnson effect: The firm has an incentive to acquire additional capital of allowable rate of return exceeds the cost of capital. • This effects holds for a large number of utilities. • A-J effect provides utilities with powerful incentive to invest in new generation rather than efficiency, in spite of decoupling. This implies that smaller scale investments need to produce a substantially higher ROI to be attractive to shareholder interests.

29. Market Transformation:Beyond DSM Rebates Presented by Stuart Schare

30. Context • Situation • Jurisdictions outside of Colorado are moving from “rebate-based” DSM strategies to include broader efforts to transform the market for energy efficiency • “Market transformation” (MT) may be more economical and allow greater penetration & savings • Complication • Quantifying energy savings and cost-effectiveness is difficult and uncertain • The Challenge • Bring MT strategies more centrally into DSM portfolios Source: DORA PUC, Energy Efficiency and Colorado Utilities, 2009

31. Definitions of Market Transformation • California PUC • “Long-lasting sustainable [market] changes by reducing barriers to the adoption of energy efficiency measures…” • “…to the point where continuation of the same publicly funded intervention is no longer appropriate” • Northwest Energy Efficiency Alliance (NEEA): • “The strategic process of intervening in a market to create lasting change in market behavior…to accelerate the adoption of all cost-effective energy efficiency as a matter of standard practice”

32. What is Market Transformation (MT)? • Long-term change in the structure and function of the energy efficiency (EE) marketplace • Build market infrastructure • Reduce barriers to adoption of cost-effective EE resources • Induce behavior change • Generate broad market effects • Many current EE program portfolios contain a mix of rebate and MT components • Continued evolution of program design • Desire to achieve broader and deeper program impacts

33. Phases of Market Transformation Acceptance(contractors) Acceptance(consumers) Affordability Awareness Availability Page 33

34. Traditional DSM Programs “Resource acquisition” or rebate programs

35. Savings Adjustments to DSM Programs:“Spillover” • Market effects due to the program • Increased awareness of technologies • Greater availability of energy efficient products • Lower prices for EE alternatives • Increased savings beyond what is recorded in program records • Participant spillover • Non-participant spillover • Market transformation

36. Relationships Between Program Savings, Spillover, and Market Transformation Source: California Energy Efficiency Evaluation Protocols, 2006

37. Savings Adjustments to DSM Programs:“Free Ridership” • Program-recorded savings that would have occurred even without the program • Customer would have purchased high-efficiency anyway • Partial free ridership • Fewer or less efficient measures • Uncertainty over whether efficient equipment would have been purchased • Program-induced market effects can increase free ridership over time • Reduces net program savings and cost-effectiveness over time • Rebate programs not designed to reach deep into the market • New program paradigm needed = Market Transformation

38. ??? Savings Adjustments DSM Programs:Free Ridership

39. Types of Market Transformation Programs ManufacturerSpecs End-userRebates UpstreamRebates Education/Awareness ContractorTraining Codes &Standards Fully Embedded in the Market Targeted at Individual Continuum of Market Transformation Texas Residential Duct Sealing ENERGY STAR Home Appliances Progress Energy “Save the Watts” NYSERDA Premium-Efficiency Motors

40. Representative NEEA Market Transformation Initiatives Technology Development and Dissemination Application of EE Technology ENERGY STAR Windows and Home Products Evaporator Fan VFDs Drive Power (NEMA Premium™ Motors) • BacGen • MagnaDrive • Verdiem • ASiMi • Scientific Irrigation Sys. Application of EE Practices • Building Commissioning • Building Operator Certification • Drive Power(Efficient motor rewinds)

41. Logic Models • Causal links between program activities, short-term responses, and long-term market effects • Purposes: Planning • Ensure that key market actor/end user groups are addressed • Identify overlap between different programs operating in the same market sectors Evaluation • Facilitate negotiation between program sponsors and evaluators/regulators regarding quantitative goals • Identify market indicators that track baseline and market activity

42. MT Program Evaluation Source: KEMA, CIEE 2009

43. Estimating MT Impacts • Approaches • Bottom-up accounting (early stages) • Top-down market view (long-term) • Defining the market • Product, service, geography, customer type • Identify and quantify: • Market activity (penetration rates, sales) • Baseline activity • Savings per “unit” of market activity

44. Energy Savings Impact

45. Case Study: Building Commissioning • Two initiatives • Commissioning (Cx) in Public Buildings • Fostering Cx in non-public buildings • Defining the market • New building commissioning (Cx) • Existing building retrocommissioning (RCx) • Within the Northwest WA, OR, ID, MT • What qualifies as Cx or RCx?

46. Case Study: Estimating Market Activity Three approaches: • Survey of Cx providers and building owners • Bottom-up analysis of Cx activity • Interviews with state officials/Cx providers • Secondary research • Top-down analysis from NEEA market assessment reports

47. Case Study: Findings of Cx Market Activity • Bottom-up estimates far lower than others • Assumed lower of results from Cx survey and top-down reports

48. Case Study: Findings for Baseline Activity • 10% baseline assumed from 2006 LTM&T • New indications of both NEEA and external influences on Cx activity • Cx requirements/standard practice for state buildings • LEED certification, environmental/“green” concerns • Baseline increased to 30% • Cannot be based on specific market data • Represents 3-fold increase reflecting growing impact of external market forces

49. Case Study: Findings for “Per-Unit” Energy Savings • Values from LBNL meta-analysis • Additional research on RCx savings • SDG&E and LBNL/SMUD • Range of savings bracketed existing NEEA LTM&T assumptions • Per-unit savings assumptions unchanged • Cx: 0.55 kWh/ft2 per year • RCx: 1.7 kWh/ft2 per year

50. Keys to Successful Tracking of Market Transformation • Precise definition of the market • Established methods for estimation of program impacts • Use of multiple methods/data sources • Application of best judgment and use of conservative assumptions