Building Sustainable Efficiency Businesses

1. Building Sustainable Efficiency Businesses Eric Ackerman Senior Manager, Regulatory Policy Edison Electric Institute NARUC Staff Subcommittee on Accounting and Finance October 8, 2007

2. Agenda • Context – The Need for Efficiency • Criteria For A Sustainable EE Business • Alternative Business Models • Conclusions

3. Demand for Electricity Is Increasing 6,000 5,000 4,000 Billion kiloWatthours 3,000 2,000 1,000 0 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 Historical Projected Sources: U.S. Department of Energy, Energy Information Administration, Annual Energy Review 2005 and Annual Energy Outlook 2007 Early Release

4. Causes for Rising Demand • Increasing population 11.18% in 10 years • Increased economic growth 50.1% in 8 years • Increased number of homes with central A/C 49% in 9 years • Plasma TVs up 50% 1st Qtr 05 from 1st Qtr 04 • MP3 players up >17 million in one year • Average US household owns 26 consumer electronics products

5. Increasing Energy Means Increasing CO2 Source: International Energy Agency, World Energy Outlook 2006

6. U.S. Green House Gas Emissions By Sector U.S. Territories 1% Agriculture 7% Electricity Residential Generation 6% 32% Commercial 7% Industry 19% Transportation 28%

8. Electricity Supply Margins Projected to Fall Below Minimum Target Levels in Some Areas of North America RFC (MISO)* 2008/2008 MRO 2009/2009 (US) RFC (PJM) 2012/2014 New York 2011/2016+ Rocky Mtn 2008/2011 New England 2009/2009 California 2009/2012 AZ/NM/SNV 2009/2011 SPP 2015/2016+ *Excludes MISO resources outside the RFC boundary TRE (ERCOT) 2009/2016+ 8

9. CEO Perspective Can We Meet Tomorrow’s Demand? Source: GF Energy 2007 Electricity Outlook Entering the Climate Zone June 18, 2007

10. Electric Infrastructure Investments For Regulated Utilities • Current net regulated electric utility property in service • ~ $ 400 Billion • Generation ~$ 53 Billion 2007-2016 • US DOE – Energy Information Administration projects ~$412 Billion 2005 – 2030 for all generation sources • Transmission ~$ 85 Billion 2007-2016 • Distribution ~$ 145 Billion 2007-2016 • Environmental ~$ 30-60 Billion 2007-2016 • Excludes potential cost of climate legislation • Other cost factors • Critical infrastructure protection, RTOs, pension funds, health care, disaster recovery, end of rate freezes, RPS, fuel

11. EE Can Mitigate Investment Risk • The last time: • We built new capacity to keep up with 6-7%/yr growth • Prices rose due to oil shocks • Growth slowed, reserve margins increased • Large disallowances were experienced • Wall Street remembers! • Aggressive efficiency increase can mitigate risk • Slow demand growth • Add new capacity at a slower rate • Mitigate rate shocks

12. The Role of Utilities • Regulated utilities are uniquely position to move the market: • They have scope & scale • They maintain key supporting infrastructures (rates, metering, billing) • They have reasonable costs of capital (most) • They have earned consumers’ trust • Utilities must be able to make real businesses out of efficiency • To pursue efficiency for the long-term • To apply the best talent and resources

13. Criteria for Sustainable EE Businesses • Timely recovery of DSM costs • Keeping whole for fixed costs • Make a margin on efficiency products & services

14. The Shared Savings Model One of the oldest, based on net benefits realized Net benefits (avoided cost savings – EE/DSM costs) measured immediately after a program year is completed and installations are validated. Utility retains a pre-determined “share” of savings Can include a risk-reward structure The incentive can be collected in a succeeding year, or spread over a longer collection period to allow measurement and verification. Incentive tied directly to net benefits Frequently linked with expensing efficiency program costs

15. The EE Capitalization / Bonus RoE Model Efficiency expenditures are capitalized as a Regulatory Asset and earn the allowed RoE as part of the cost of capital. The Reg Asset is amortized just like a power plant, but over a shorter period set by the Regulator. This spreads the recovery of costs over time. When an RoE “adder” of X 100s of basis points is included on the Equity portion, the shareholders are clearly rewarded.

16. The Virtual Power Plant Model This is the newest approach to shareholder incentives Utility receives a tariff-based revenue stream that is lower than the cost of a new power plant which is avoided. Guarantees a level of savings for customers The Percentage of Avoided Cost and the benefits and costs of the efficiency program are key variables. The Utility has full control over efficiency program design May wave rate mechanisms to collect efficiency program costs, fixed costs This Model spreads the rate impacts over the efficiency measure lives. No jurisdiction has yet ruled on this approach.

17. Considerations in Selecting a Business Model Are you starting from scratch or expanding existing programs? What levels of savings can you expect to achieve in the near term? Does your jurisdiction allow DSM cost trackers, ensure fixed cost recovery? Rate impacts over time. Tying incentives to savings vs spending.

18. Generic Modeling Results Energy efficiency can slow load growth and slow the increase in revenue requirements Monetization of carbon costs will increase this Impacts of increasing rates on non-participants may be an issue Shareholder incentives can make a modest contribution to net income and EPS growth. By reducing revenue growth, efficiency slows earnings growth How will Wall St. react? Need to balance efficiency with earnings growth Existing and new shareholders may have different but complementary views.

19. Conclusions Efficiency is a strategic priority. Utilities are uniquely positioned. Efficiency needs to be approached as a business. The ability to make a margin is fundamental. We need to get moving.

20. Appendix

21. Proto-typical Utility and EE Program “Perfect 10” Prototype Utility 1,000,000 customers Base rate, before growth is $ 0.10 per kWh in Year 0 Each customer uses 10,000 kWh per year, and pays $1000 Total sales are 10 million MWh and total revenues $ 1 billion Allowed RoE = 11.0 %

22. Avoided Costs and the Growth of Rates Basic Assumption: Avoided costs >> Average costs and base rates Growth induces rate increases (and earnings increase) In specific application, Utility would start from its System Base Case growth and cost plan. Power plants (and purchases) will be scheduled to meet future needs. Change to Slower Growth / Higher EE Case would determine Avoided Costs.

23. The Base Case EE Model The 5 Year EE program costs $40 million Per Year $25 mil to IOU (2.5%) and $15 mil to Participants (15%) EE cost = $ 0.054 per lifetime kWh saved Collected Ratepayers benefits: A Year’s Program creates 10 years of savings at $13 mil/Yr Total PV of $ 430 million Net benefits = $250 million Participants benefit: $420 million of Rebates and Bill Savings with10% lower usage. EE measure installation cost of $150 mil $270 million net benefit Non Participants cost: $20 million, the Difference!

24. EE Program Simulation – Revenue Requirements EE significantly reduces Rev Reqs. – about 4% Part of this story is lower growth in total earnings

25. EE Program Simulation - Participants and TRC Participants take “lion’s share” because they reduce their usage. In a sustained EE program, all can participate

26. EE Simulation – General Rate Impacts Five-year model shows initial rate increases as EE programs are expensed. Avoided energy benefits, net of any lost fixed costs, reduce those increases and then continue to reduce rates for lifetime.

27. Comparison of the Shareholder Incentives (Modeled with Given Parameters)