climate change policy partnership

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1 climate change policy partnership Transforming Utility and Ratepayer Support for November 2008 David Hoppock Jonas Monast Eric Williams Nicholas School of the Environment at Duke University Nicholas Institute for Environmental Policy Solutions Center on Global Change CCPP 08-tp1 TOWARD A LOW-CARBON ELECTRICITY SECTOR CCPP Technology Policy Brief Series

2 Transforming Utility and Ratepayer Support for Electrical Energy Efficiency Nationwide POLICY BRIEF David Hoppock Climate Change Policy Partnership Duke University October 2008

3 Series Overview: Toward a Low Carbon Electricity Sector This paper is one in a series by the CCPP at Duke University to explore the barriers facing large scale, low carbon electricity generation and increased efficiency in the near term primarily the next ten to fifteen years. Policy drivers may be necessary to provide the right price signal to develop low carbon emission technologies, but a price signal alone may not be enough to enable broad scale deployment. 1 Significant technical, legal, infrastructural, and social barriers prevent the implementation of the necessary technologies and efficiency improvements. The series provides an overview of the barriers and outlines general policy options for lawmakers who wish to speed the development and/or wide scale deployment of lowcarbon energy technologies. It will include papers focusing on specific energy generation technologies, including renewable energy and energy storage, and energy efficiency, a cost near term option for displacing carbon intensive energy effective generation. 1 Policy drivers are under consideration include a nationwide cap and trade system for greenhouse gas (GHG) emissions, regulation of GHGs emissions under the Clean Air Act, expanded action on the state and regional levels, or some combination thereof.

4 Table of Contents I. Executive Summary... 3 II. Introduction... 4 III. Benefits of Increasing Energy Efficiency... 4 IV. Energy Efficiency Investment in the U.S V. Market and Regulatory Barriers to Utility Investment in Energy Efficiency... 7 A. Utility market structure Traditional utility regulation Wholesale and restructured electricity markets Municipal and cooperatively owned utilities... 9 VI. Policy Options to Address Barriers to Investments in Energy Efficiency... 9 A. Innovative state policies to increase energy efficiency investment Decoupling Energy efficiency resource standards Ratepayer funded energy efficiency programs Declare energy efficiency as a priority resource B. Federal policy options to encourage large scale nationwide investment in energy efficiency Provide incentives to states that adopt utility decoupling Provide incentives to states that adopt policies that encourage or require investment in energy efficiency Provide incentives to states that reduce per capita electricity use by 0.5% (or more) per year National energy efficiency resource standard Federal ratepayer charge to pay for national energy efficiency programs VII. Conclusion VIII. References Climate Change Policy Partnership 2

5 I. Executive Summary As concerns about climate change, energy security and rising energy costs mount, greater investment in energy efficiency represents the most cost effective, near term solution for increasing energy security and significantly reducing U.S. greenhouse gas (GHG) emissions. Neither renewable energy sources, new nuclear plants, nor coal fired power plants with carbon capture and storage are positioned to provide significant power in the next 10 to 15 years. Fortunately, energy efficiency presents a proven, low cost method to significantly reduce electricity demand and GHG emissions in the near term. Massive energy efficiency opportunities exist nationwide and generally represent the lowest cost energy resource in the U.S. Energy efficiency investments generally cost less than half as much as comparable fossil fuel generation capacity and, on a per kwh basis, are less than half average retail electricity rates. The Environmental Protection Agency (EPA) estimates cost effective energy efficiency could reduce national electricity demand by more than 20% by 2025 and reduce cumulative carbon dioxide emissions by more than 200 million tons. There are numerous, well documented barriers to increased investment in energy efficiency. Traditional utility regulation discourages investment in energy efficiency and encourages utilities to increase sales as much as possible within their existing capacity, an effect known as the throughput incentive. Under traditional regulation, if a utility sells less electricity than is projected in the rate case, the utility may not have sufficient revenues to covers its costs, providing a strong disincentive to invest in energy efficiency. Generators in restructured markets and wholesale electricity providers place no value on energy efficiency because they can only earn revenues from the electricity they sell. Despite this, multiple states have successfully implemented policies to overcome these barriers to investment in energy efficiency. This policy brief discusses these barriers in detail and outlines numerous federal policy options to increase nationwide investment in energy efficiency, including: Provide incentives to states that adopt decoupling. Decoupling removes the disincentives to utility investment in energy efficiency inherent in traditional utility regulation. Provide incentives to states that require utility or ratepayer investment in energy efficiency. This would encourage investment in energy efficiency without the federal government endorsing a specific policy tool. Provide incentives to states that reduce per capita electricity use by 0.5% per year. Reducing per capita electricity use directly addresses the policy goals of increasing efficiency and reducing GHG emissions. Create a national energy efficiency resource standard. Energy efficiency resource standards use market based mechanism to find the lowest cost efficiency opportunities. Establish a federal electricity surcharge to fund national energy efficiency programs. Climate Change Policy Partnership 3

6 II. Introduction Concerns about climate change, energy security, and rising energy costs are increasing focus on lowcarbon electricity generation. Greater investment in energy efficiency represents the most costeffective, near term solution for increasing energy security and significantly reducing U.S. greenhouse gas (GHG) emissions. Wind and other non hydro renewable energy sources currently provide approximately 1% of electricity in the United States (Energy Information Administration 2008). While electricity generation from renewable energy sources continues to grow, Energy Information Administration (EIA) projections suggest that they are unlikely to provide large amounts (greater than 10% 20% 1 ) of power in the next 10 to 15 years. Many renewable energy sources are also not viable in all regions of the U.S. and some, such as wind and solar, are intermittent. A new generation of nuclear power and coal fired power plants with carbon capture and storage present long term options for low GHG emitting baseload supplies but will likely not be available on a large scale in the near term. Electric utilities, anticipating national climate change legislation, are responding by building natural gas generation capacity to meet growing electricity demand and to replace retired generation capacity. 2 Increased energy efficiency is a bridge to a low carbon future, but it faces numerous market and policy barriers. III. Benefits of Increasing Energy Efficiency Fortunately, energy efficiency presents a proven, low cost method to significantly reduce electricity demand and GHG emissions in the near term. Massive energy efficiency opportunities exist nationwide, including states that have already realized significant efficiency savings, and energy efficiency is the lowest cost generation source in the U.S. 3 On an equivalent energy services basis, energy efficiency generally costs less than half as much as new fossil fuel power plants. Energy efficiency generally costs around 3 cents per kwh, 4 as opposed to more than 6 cents per kwh 5 for electricity produced at a pulverized coal power plant (see Figure 1). The Environmental Protection Agency (EPA) estimates that cost effective energy efficiency could reduce national electricity demand by more than 20% by 2025, 1 EIA s Annual Energy Outlook 2008, which includes no cap on GHG emissions, projects that renewable electricity sources will provide 6% of electricity supply in 2020 and 2025, excluding conventional hydropower. The EIA s analysis of the Lieberman Warner Climate Security Act of 2007 projects that renewable electricity sources will provide 14% of electricity supply in 2020 and 15% in 2025, excluding conventional hydropower. 2 The Annual Energy Outlook 2008 projects utilities will add 22.7 GW of natural gas generation capacity between 2007 and 2010 while adding only 7.7 GW of new coal capacity. Utilities are also having difficulty permitting new coal generation capacity. An April 23, 2008, New York Times article reported that over one third of proposals to build new coal power plants have been blocked or abandoned. 3 Although not traditionally thought of as an energy source, energy efficiency effectively increases the capacity of existing electricity generation sources. Consumers purchase electricity for the energy service (utility) it provides, for example lighting, and are indifferent to how that energy service is produced. Energy efficiency increases the energy service of each unit of electricity produced, increasing the energy service capacity of an existing electricity distribution and generation system. 4 Three cents per kwh is the lifetime cost of avoided electricity purchases (measured as kwh purchases avoided). The 3 cents per kwh number is from two sources, EPA s National Action Plan for Energy Efficiency and the Resources for the Future paper Retrospective Examination of Demand Side Energy Efficiency Policies. 3 cents per kwh is an average some energy efficiency investments will cost more, some less, and some will generate net savings year levelized cost of electricity from a pulverized coal power plant. This includes capital and fuel costs. Climate Change Policy Partnership 4

7 reduce cumulative carbon dioxide emissions by more than 200 million tons and save customers almost $20 billion annually on their energy bills (Environmental Protection Agency 2006). Energy efficiency delivers multiple benefits beyond lower electricity costs and GHG emissions reduction. Increased investment in energy efficiency will reduce emissions of conventional air pollutants like mercury, sulfur dioxide, and particulate matter from power plants. Increased efficiency also reduces the need for resource extraction such as coal mining and natural gas drilling. Mining and other resource extraction activities often severely degrade land and water resources. Lower electricity demand reduces peak loads, lowering stress on the national grid and reducing the chance of blackouts. Increasing efficiency will lower total U.S. GHG emissions, making it easier for the economy to reduce GHG emissions and lower the market price for carbon credits under cap and trade legislation. In addition, lower electricity demand acts as a hedge against fossil fuel price volatility, increasing energy security and reducing the economy s vulnerability to external shocks. 6 6 A few economists contend that increasing energy efficiency actually increases energy consumption because as a product or service becomes cheaper, consumers use more of it. This is referred to as the take back or rebound effect. Many other economists strongly dispute this claim and empirical studies show that the take back effect is around 20 30% (please note that this includes all forms of energy consumption). It should be noted that the take back effect is largely due to increased consumer wealth, a positive policy outcome. The rebound effect is negated if energy prices rise as consumers increase efficiency. Climate Change Policy Partnership 5

8 Figure 1. Electricity Supply Cost Comparison Figure 2. Utility and Ratepayer Funded Per Capita Energy Efficiency Spending 2004 cents/ kwh Energy Efficiency Pulverized Coal Natural Gas Combined Cycle Wind* 2006 Average 2006 Average Retail Price Residential Price *Wind cost without federal production tax credit. Sources: DOE Cost and Performance Baseline for Fossil Fuel Energy Plants, EIA Electric Power Annual 2006, DOE Annual Report on U.S. Wind Power Installation, Costs and Performance Trends: 2007 $25.00 $20.00 $15.00 $10.00 $5.00 $0.00 Vermont Massachusetts California US Median Virginia Ratepayer funded spending includes utility and Public Benefits funded spending. Source: ACEEE The State Energy Efficiency Scorecard for 2006 IV. Energy Efficiency Investment in the U.S. Despite the large potential for cost effective energy efficiency nationwide, utility and ratepayer investment 7 in energy efficiency varies significantly across the nation. California, Massachusetts, and Vermont are all national leaders in utility and ratepayer energy efficiency investment. Investor owned utilities (IOUs) in California, 8 for example, will spend over $2 billion on energy efficiency (85% on electrical energy efficiency, the remainder on natural gas efficiency) between 2006 and 2008 with expected annual savings of 7.5 TWh (1 TWh = 10 9 kwh) (California Energy Commission 2005). As of July 2008, California IOUs had exceeded this goal and achieved annual savings of 7.7 TWh (California Public Utilities Commission, 2008). For comparison, California consumed 269 TWh of electricity in 2006 (Energy Information Administration 2007). 9 Massachusetts ratepayers invested $371 million in energy efficiency between 2003 and 2005, saving almost 3 TWh (Sandra Levine 2008). On a per capita basis, Vermont led the nation in combined ratepayer and utility funded energy efficiency investments in 2004, investing $22.54 dollars per person (see Figure 2). At the other end of the spectrum are states with minimal utility and ratepayer investment in energy efficiency. For example, Kansas utilities spent $4.2 million on energy efficiency in 2006 ($1.52 per person) while Arkansas utilities spent only $1.7 million ($0.60 per person). 10 The Edison Electric Institute estimates that shareholder owned electric utilities will spend 7 Ratepayer investments are funded through public benefits charges on consumers bills. 8 There are four investor owned utilities in California: Pacific Gas and Electric, Southern California Edison, San Diego Gas and Electric, and Southern California Gas Company. They serve about three quarters of California residents. 9 This figure covers retail sales only. On site electricity generation is not included. 10 Kansas and Arkansas data from the Energy Information Administration s Electric Power Annual All energy efficiency expenditure data in the Electric Power Annual report is from surveys sent to utilities and may not reflect all utility efforts on Climate Change Policy Partnership 6

9 approximately $30 billion on new generation capacity in 2008 (Edison Electric Institute) while the EIA reports that all U.S. utilities invested less than $1.5 billion in energy efficiency in 2006, the last year national utility efficiency investment data is available. 11 The greatest potential efficiency savings are in states with the lowest energy efficiency spending and policies that do not support energy efficiency investment. Texas, for example, is a national leader in renewable energy but lags behind in utility energy efficiency investment. Investor owned utilities in Texas spent only 0.4% of their revenue on energy efficiency in Texas electricity demand is forecast to increase by 1.9% per year through the year A comprehensive state effort to improve energy efficiency could eliminate over 80% of projected demand growth, reduce cumulative CO 2 emissions by 57 million tons in 2021, and save customers tens of billions of dollars (Optimal Energy 2007). If lawmakers determine that large scale implementation of energy efficiency is a national priority, the policies that facilitate utility and ratepayer investment in energy efficiency must be in place. There are numerous, well documented barriers to increased investment in energy efficiency. This policy brief examines policy and market barriers to large scale utility and ratepayer investment in demand side energy efficiency. Utilities and ratepayer investments in demand side energy efficiency are defined as any utility or ratepayer financed expenditure to decrease consumers energy consumption. This can include rebate and subsidy programs to lower the cost of energy efficient products such as compact fluorescent light bulbs, energy efficiency awareness campaigns, free energy audits for industrial customers, building renovations, or any other action that helps to reduce consumers net energy demand. This policy brief does not address policies to increase utilities generation and transmission efficiency. Other market barriers and topics related to increased energy efficiency include building codes, appliance standards, industrial efficiency, split incentives, transaction costs, and unpriced externalities. These subjects will be addressed in other CCPP policy briefs and reports. V. Market and Regulatory Barriers to Utility Investment in Energy Efficiency Utilities are well suited to make large scale investments in energy efficiency. They are structured to make major, long term investments in electricity markets and have direct relationships with their electricity customers. Utilities also engage in the kind of long term planning that is critical for successful implementation of large scale energy efficiency programs and have the best information about consumers electricity consumption. energy efficiency. 11 Shareholder owned electric utilities represent about 70% of the U.S. electric power industry. Total utility energy efficiency spending data from Electric Power Annual Utility investments do not include ratepayer funded investments in energy efficiency. Climate Change Policy Partnership 7

10 Energy efficiency is a proven, low cost method for consumers to save money and reduce their energy use, but without the proper policies and utility support, society cannot realize the full potential of energy efficiency as a low cost energy resource for electricity markets. To achieve large scale investment in energy efficiency, utilities and state utility regulators must view energy efficiency as equivalent to supply resources and invest in energy efficiency at levels similar to other generation sources. Utility regulations can be structured to allow investor owned utilities to profit from increased efficiency, not just cover the costs of regulator mandated efficiency programs. In order to maximize energy efficiency, utilities need to earn a higher rate of return on energy efficiency investments than on traditional generation capacity. Despite the benefits of energy efficiency large potential energy savings and the associated economic and environmental benefits traditional electricity regulation acts as a barrier to energy efficiency investments. A. Utility market structure There are three primary models for regional and state electricity markets: traditional regulated utilities, restructured markets, and municipally/cooperatively owned utilities. In restructured markets, customers can choose an energy provider but transmission and distribution is conducted by a separate, regulated utility. Traditional regulated utilities are investor owned, vertically integrated, regulator sanctioned monopoly electricity providers. Municipal and cooperatively owned utilities are controlled by local governments or local populations and regulate themselves. States generally play a minimal role in regulating municipal and cooperative utilities. Many states have a combination of one or more of the listed utility structures within their borders. States and public utility commissions conduct most utility regulation and electricity market oversight. Regulations and regulator goals vary considerably between states. The Federal Energy Regulatory Commission regulates interstate electricity transmission and transactions and has rules to ensure interstate transmission reliability. 1. Traditional utility regulation In a traditional utility regulation system, the utility presents a rate case, with a proposed retail electricity rate, to the regulator. The utility forecasts all costs, including all operational costs, debt servicing, approved planned investments, and a reasonable rate of return on the utility s investments. The utility also forecasts the amount of electricity it expects to sell to retail customers. Electricity rates are found by dividing expected costs by expected kwh sales. This rate is the price of electricity that the utility needs to charge so that it can recover all of its expected costs, assuming it sells exactly the number of kwh in its forecast. Once the electricity rate is approved by the state regulator, the rate is generally fixed until the next rate case. During this time between rate cases, a utility has a strong incentive to sell more electricity than forecasted because every additional kwh sold results in additional Climate Change Policy Partnership 8

11 profit above and beyond the allowable rate of return. This regulatory structure encourages the throughput incentive for utilities to increase sales as much as possible up to the point at which they need new capacity investments that would trigger a new rate case. Conversely, if the utility sells less electricity than is projected in the rate case, the utility may not have sufficient revenues to cover its expenses, providing a strong disincentive to invest in energy efficiency. Traditional utility regulatory systems do not provide a guaranteed rate of return on energy efficiency investments and generally ignore energy efficiency as a resource. This means that a utility cannot profit from increased efficiency or recover costs if electricity sales are less than projected because retail rates are fixed. Traditional utility regulation creates no incentives for utilities to invest in energy efficiency and in effect encourages utilities to increase sales as much as possible within their given generation and distribution capacity, thereby increasing GHG emissions. 2. Wholesale and restructured electricity markets Wholesale electricity markets place no value on energy efficiency. Wholesale generators can only collect revenues from electricity they sell, not from electricity they do not sell. In restructured markets, transmission and distribution utilities are regulated much the same way traditional regulated utilities are while generators compete to sell electricity to customers. 12 In restructured electricity markets, transmission and distribution utilities generally earn revenue through a wires charge on each kwh of electricity sold, discouraging transmission and distribution utilities from making investments in energy efficiency. Nevertheless, energy efficiency can help transmission and distribution utilities avoid costly capital improvements through reduced demand growth that eases the burden on congested transmission and distribution systems. 3. Municipal and cooperatively owned utilities Local governments directly manage and own municipal utilities. Many municipal utilities are also a source of revenue for local governments. Cooperative utilities are owned and managed by their customers. State public utility commissions generally have no jurisdiction over municipal or cooperative utilities. State governments can create regulations and requirements for municipal and cooperative utilities but are typically reluctant to do so. VI. Policy Options to Address Barriers to Investments in Energy Efficiency A. Innovative state policies to increase energy efficiency investment Multiple states have successfully adopted innovative policies to encourage large scale energy efficiency investment. All of these policies to increase efficiency investment can be used in combination and many states and utilities have successfully implemented two or more of the following policies. 12 Generators in restructured markets still face some regulation. These regulations vary from state to state. Climate Change Policy Partnership 9

12 1. Decoupling Decoupling removes the connection between electricity sales and utility profits, eliminating the throughput incentive. Decoupling also allows utilities to recover costs if total sales are less than projected. Under decoupling, regulators set efficiency and performance goals that utilities must meet in order to earn a profit. Utilities typically place revenues in a regulator controlled account. The account pays for the utility s operating costs and pays the utility a profit if it meets its efficiency and performance goals. Regulators periodically adjust electricity rates to ensure the account has sufficient funds to cover operating costs and utility profits. 13 Decoupling rate adjustments are typically very minor (0 to less than 3%) and many states cap decoupling rate adjustments at 2% or 3% per year. Decoupling is normally associated with traditional regulated utilities but can also be applied to the distribution and transmission utilities in restructured markets. 14 Critics of decoupling note that it transfers the risk of changing consumer demand from the utility to customers. With decoupling, utilities can avoid losses if electricity demand falls because of a recession or if a major employer leaves a utility s service area because the remaining consumers electricity rates increase to cover the lost revenue. Regulators can further encourage efficiency investment by structuring decoupling so that utilities are guaranteed a return on energy efficiency investment or guaranteed a higher rate of return on energy efficiency investments than on traditional generation and distribution investments. Regulators can also create annual lump sum rewards for utilities that reduce total or per capita electricity demand by a specified amount. The best known decoupling example is California s decoupling of sales from profits for investor owned utilities. California originally adopted decoupling for regulated, investor owned utilities in In 1996, California restructured its electricity market and introduced competition in electricity generation, ending decoupling. The 2001 California energy crisis convinced the California government to abandon restructuring and reintroduce electricity generation regulation and decoupling. During the 2001 crisis, the California government directed a massive, statewide energy efficiency initiative that helped to end the crisis by reducing peak summer demand over 8% in one year (Devra Bachrach 2003). Since reintroducing decoupling in 2001 and re emphasizing energy efficiency, investment in energy efficiency has increased significantly (see Figure 3 below). Many other states, including Maryland, Oregon, New Jersey, Idaho, New York, Minnesota, Massachusetts, and Vermont, have also adopted some form of decoupling. 13 Many regulated utilities and municipally owned utilities, especially utilities that use natural gas, have fuel charges that automatically adjust to account for fuel price volatility. Retail rate adjustments with decoupling are conducted to ensure there are sufficient revenues to cover utility operating costs and profits. 14 In restructured markets, decoupling only applies to transmission and distribution utilities. Transmission and distribution utilities profits are decoupled from electricity sales. Decoupling may present a new investment opportunity to transmission and distribution utilities who are not allowed to invest in generation by allowing them to partially compete in supplying customers electricity. Climate Change Policy Partnership 10

13 Figure 3: California Investment in Energy Efficiency Note: Includes utility, ratepayer, and state government investment in efficiency; does not include private investment. Source: Promoting Energy Efficiency in California, State EE/RE Technical Forum Energy efficiency resource standards Energy efficiency resource standards use market based mechanisms to encourage cost effective energy savings, similar to the federal sulfur dioxide cap and trade program and state based renewable portfolio standards (RPS). Under an energy efficiency resource standard, utilities receive energy savings targets for their service areas. Utilities document their energy savings using predetermined certification methods and receive energy efficiency certificates (see footnote for example). 15 Each utility must have enough certificates at the end of the year to meet its energy savings target. Utilities can buy and sell energy efficiency certificates to meet their requirements, allowing the market to find the lowest cost energy efficiency opportunities. Many states with energy efficiency resource standards allow utilities to buy efficiency certificates from the state at some predetermined rate, typically half the cost of retail electricity rates, to create a cap on certificate prices. The proceeds from these sales fund statesponsored energy efficiency programs. Some states, such as Hawaii for example, allow utilities to meet a portion of their RPS obligation through energy efficiency, in effect combining an RPS and an energy efficiency resource standard. Seventeen states now have energy efficiency resource standards or renewable portfolio standards that include energy efficiency. Vermont and Texas, states with two of the older programs, have exceeded their total savings goals. In Nevada and Hawaii, states with combined energy efficiency and renewable portfolio standards, utilities are maximizing their energy efficiency savings allotments to meet the 15 Utility A offers rebates on high efficiency dishwashers, which use 30% less electricity than conventional dishwashers. 1,000 customers utilize the rebates and purchase high efficiency dishwashers. The state regulator then awards Utility A energy efficiency certificates for these energy savings. Climate Change Policy Partnership 11

14 overall standards. Since March 2006, ten states have adopted energy efficiency resource standards and as of May, 2008 New Jersey and Michigan 16 had pending energy efficiency resource standards. Although it is too early to judge the success of many of these programs, clearly many states are convinced that energy efficiency resource standards are an effective policy tool for increasing efficiency. Energy efficiency resource standards programs have also proven effective internationally. The United Kingdom and the Flemish Region of Belgium have exceeded their program goals with the UK spending less than 1.5 cents per kwh of energy saved on the program. Italy and France also recently adopted national energy efficiency resource standards. Numerous advocacy groups, including the American Council for an Energy Efficient Economy (ACEEE), have called for a national energy efficiency resource standard (ACEEE 2008). In 2003 and 2005, Senator Jeffords (Vermont) proposed a national energy efficiency resource standard as part of broader energy legislation. Both times the bill was introduced and referred to the Committee on Energy and Natural Resources but was never debated or voted on (GovTrack, 2008). 3. Ratepayer funded energy efficiency programs Ratepayer funded energy efficiency programs use charges paid by utility customers to pay for state energy efficiency programs. Many states adopted efficiency charges in the 1990s to ensure a source of funding for state energy efficiency programs in restructured markets. As of September 2007, twentyseven states had ratepayer funded energy efficiency programs. Two of the more successful and wellknown programs include Efficiency Vermont and the Energy Trust of Oregon. Efficiency Vermont is a statewide energy efficiency utility that offers technical and financial assistance to individuals and businesses and is funded by statewide energy efficiency charges (Efficiency Vermont, 2008). The Energy Trust of Oregon uses a three percent public purpose charge to pay for residential and commercial efficiency programs as well as other renewable energy and research programs (Energy Trust of Oregon, 2008). 4. Declare energy efficiency as a priority resource Multiple states have created rules or passed laws requiring utilities and utility regulators to make energy efficiency the priority supply in resource planning. California s Energy Action Plan II, released in 2005, placed energy efficiency as the first resource in the utility loading order, meaning California investorowned utilities must invest in cost effective energy efficiency before investing in additional renewable or fossil fuel energy sources. Another example is the recent law passed by New Mexico requiring the New Mexico Regulatory Commission, which regulates the utility industry in the state, to remove all disincentives to energy efficiency investment. Through this law, the New Mexico Regulatory Commission has the authority and is required to create regulatory incentives for utilities to invest in energy efficiency and achieve the state s goal of developing all cost effective energy efficiency opportunities in the state. 16 The Michigan Legislature passed an energy efficiency resource standard and an RPS in September For more details see SB Climate Change Policy Partnership 12

15 B. Federal policy options to encourage large scale nationwide investment in energy efficiency The federal government currently plays a minimal role in electricity markets and does not regulate retail electricity sales. Federal policymakers considering legislation to improve efficiency should note that energy efficiency programs also take time to plan and implement, especially programs that encourage changes in customer behavior. Additionally, when considering any electricity policy, policymakers should focus on how much customers pay for electricity (i.e., their total electricity bill), not just electricity rates. Many efficiency programs raise rates slightly in the short term but create significant, long term benefits for customers on their future energy bills. The following policy options would require little or no action from states that already have significant energy efficiency programs and are designed to encourage all states to make a minimum investment in energy efficiency. 1. Provide incentives to states that adopt utility decoupling This policy would create federal incentives for states that adopt decoupling mechanisms for investorowned regulated utilities and distribution and transmission utilities in restructured markets. If the goal of the policy is to maximize energy efficiency investment, the incentive should require that states provide utilities with an additional rate of return on investments in energy efficiency (compared to other capital investments). Potential incentives include offering states a percentage of revenues from GHG emissions cap and trade auctions, as proposed in Lieberman Warner (S. 2191), increasing funding for mass transit, and increasing Federal Transportation Administration New Starts funding for transit capital investments such as light rail and bus rapid transit systems. The federal government could also offer disincentives for states that do not adopt decoupling. One potential disincentive is a federal surcharge on retail electricity sales for states that fail to adopt decoupling. These incentives would encourage states to remove the barriers to energy efficiency investment inherent in traditional utility regulation. Under decoupling, utilities can invest in energy efficiency as if it were an energy resource, like any other type of electricity generation. Nationwide, utilities are already spending billions of dollars per year on capital investment. With this policy, a portion of this capital investment could be invested in improving energy efficiency. Some states, such as Oregon for example, achieve significant efficiency savings without decoupling. Any federal decoupling incentive should reward states that are already achieving substantial energy efficiency savings without decoupling through an exemption or in combination with other federal efficiency incentives. 2. Provide incentives to states that adopt policies that encourage or require investment in energy efficiency Traditional utility regulation discourages investment in energy efficiency. This policy would provide incentives to states that create financial incentives for utility investment in energy efficiency or require utility or ratepayer funded investment in energy efficiency. States would have multiple ways to qualify Climate Change Policy Partnership 13

16 for this incentive. For example, states could require utilities to invest a percentage of their revenues on energy efficiency or create a third party or government entity that spends a percentage of ratepayer revenues on energy efficiency. Alternatively, states could adopt utility regulations that create higher rates of return on energy efficiency investments than traditional generation capacity investments. This policy need not apply to municipal or cooperative utilities or their customers. Potential federal incentives and disincentives for states are the same as listed in option 1. Any federal incentives should be contingent on performance goals to ensure that states spend money designated for energy efficiency investment on energy efficiency. This policy would give states greater flexibility for achieving the goal of increasing investment in energy efficiency than option 1. States employing third party entities to administer investments in energy efficiency, such as Vermont and Oregon, would be rewarded under this option. Unlike policy option 1, this option would not necessarily remove the throughput incentive for utilities. 3. Provide incentives to states that reduce per capita electricity use by 0.5% (or more) per year In 2001, the state of Connecticut achieved a 1% decrease in net annual electricity demand and Vermont reduced net annual electricity demand by 1.3% in A recent ACEEE report reviewed eleven state, regional, and national energy efficiency potential studies and found that the median achievable electricity demand reduction is 1.2% per year (Steven Nadel 2004). 17 Based on this evidence and other studies, all states should be able to reduce per capita electricity consumption by 0.5% per year for a number of years. Reducing per capita electricity consumption directly addresses the policy goals of increasing efficiency and reducing electricity use while allowing states to meet the savings goal however they see fit. To further encourage efficiency savings, the policy could include multiple savings goals, for example 0.5% per year and 1% per year, with larger incentives for states that achieve higher savings. Potential federal incentives and disincentives for states are the same as listed in option 1. Any annual electricity consumption comparison would need to account for year to year weather variations. The Federal government could use a variety of metrics to measure states per capita electricity use. These include: Percentage reduction in per capita residential electricity use. Residential electricity consumption is primarily dependent on residential building codes, appliance efficiency, and variations in weather. States can reduce residential electricity consumption using relatively simple policies such as stricter building codes, rebates for purchasing high efficiency appliances, and existing home weatherization programs. This metric would not penalize states that increase energy intensive industry or reward states with negative economic 17 Achievable energy efficiency is defined as cost effective energy efficiency that individuals and consumers can reasonably be expected to adopt given the correct information and incentives. Climate Change Policy Partnership 14

17 growth. Because of its narrow scope, this metric would not encourage improving commercial or industrial efficiency. Percentage reduction in per capita residential electricity use and percentage reduction in commercial electricity use per square foot of occupied office space, specifically excluding manufacturing and industrial building space. This metric would include most commercial building electricity use with a mechanism, square feet of occupied commercial building space, to adjust for changes in a state s economy. This metric would not encourage improving industrial efficiency. Percentage reduction in per capita electricity use for all sectors of the economy. This metric would encourage efficiency improvements in all sectors of the economy but may reward states that have negative economic growth or change from energy intensive industrial economies to low energy economies like services. 4. National energy efficiency resource standard A national energy efficiency resource standard would require all utilities to meet an annual energy savings targets based upon each utility s annual sales, or buy energy efficiency certificates from other utilities that surpass their savings target. To implement this policy the federal government would need to adopt national efficiency certification standards for utilities to use and a process for buying and selling certificates. 18 Utilities would be able to trade energy efficiency certificates with other utilities to find the lowest cost energy efficiency opportunities. The policy could include the option to buy credits from the federal government at a predetermined price to create a price ceiling for certificates. A national energy efficiency resource standard would force all utilities to take action on energy efficiency, and trading would facilitate finding the lowest cost efficiency options. Utilities in states without efficiency programs and standards generally offer the lowest cost efficiency opportunities. This program could be run in collaboration with states or directly by the federal government. The policy would create a national market for energy efficiency, encouraging entrepreneurs to enter the efficiency market. 5. Federal ratepayer charge to pay for national energy efficiency programs A federal electricity charge on customers electricity bills would create significant funding for energy efficiency programs nationwide. Revenues from the charge could pay for national energy efficiency programs and energy efficiency research or could be given to state and local governments for local efficiency programs. The charge would effectively be a minor tax on electricity consumption. Local governments and utilities would likely argue that they are best suited to implement energy efficiency programs. Proposed legislation by Representative Boucher (Virginia) (H.R. 6258) includes a charge on electric power from fossil fuel generation sources to pay for carbon capture and storage demonstration projects. Charges range from $ per kwh of coal generated electricity to $ per kwh of 18 The federal government has successfully implemented similar cap and trade markets for sulfur dioxide and nitrogen oxide emissions. An energy efficiency resource standard certificate trading market should be similar but with a larger trading volume. Climate Change Policy Partnership 15

18 natural gas generated electricity with expected annual revenues of approximately $1 billion. States, especially large states that would provide most of the revenue under this policy, would want revenues from their state spent on customers in their state or guarantees that the spending would fund programs that benefit all states, like energy efficiency research. States that are already spending a significant amount of ratepayer or utility revenues on efficiency could be exempted from all or part of this federal charge. This policy would ensure that all states are investing a minimum amount on energy efficiency. Any national ratepayer charge should include performance measures to determine if the program is an effective use of ratepayer funds. VII. Conclusion The best near term solution for reducing GHG emissions from the electricity sector is increasing energy efficiency. Large, cost effective efficiency opportunities are available nationwide and increasing efficiency will save consumers money by avoiding the large capital costs associated with new capacity. Despite the obvious benefits of increased efficiency, utility regulation often discourages investment that would otherwise be profitable and desirable from an environmental perspective. Policymakers seeking to reduce GHG emissions should consider policy options that remove existing barriers and encourage investment in energy efficiency. VIII. References American Council for an Energy Efficient Economy State energy efficiency resource standard (EERS). May Washington, D.C.: American Council for an Energy Efficient Economy. California Energy Commission Options for energy efficiency in existing buildings. Sacramento: California Energy Commission. California Public Utilities Commission Energy efficiency groupware application. Retrieved September 22, 2008, from Energy Efficiency: Department of Energy Annual report on U.S. wind power installation, costs and performance trends: Washington, D.C.: Department of Energy. Department of Energy, National Energy Technology Laboratory Cost and performance baseline for fossil fuel energy plants. Washington, D.C.: Department of Energy. Devra Bachrach, M.A Energy efficiency leadership in california preventing the next crisis. New York: Natural Resources Defense Council. Edison Electric Institute. n.d. Electric utility industry financial data and trend analysis. Retrieved October 14, 2008, from Edison Electric Institute. and_accounting/finance/research_and_analysis/quarterly_financial_updates/index.htm# quarterly. Efficiency Vermont About Us. Retrieved September 2, 2008, from Efficiency Vermont. Energy Information Administration Annual energy outlook Washington, D.C.: Energy Information Administration. Climate Change Policy Partnership 16

19 Energy Information Administration Electric power annual Washington, D.C.: Energy Information Administration. Energy Information Administration Energy market and economic impact of S. 2191, the Lieberman Warner Climate Security Act of Washington, D.C.: Energy Information Administration. Energy Trust of Oregon Who we are. Retrieved September 4, 2008, from Energy Trust of Oregon. Environmental Protection Agency National action plan for energy efficiency. Washington, D.C.: Environmental Protection Agency. Federal Energy Regulatory Commission. n.d. About FERC. Retrieved August 26, 2008, from Federal Energy Regulatory Commission. does.asp. Gotten, F. (2001). Report RS20981: Energy efficiency and the rebound effect: Does increasing efficiency decrease demand? Washington, D.C.: Congressional Research Service. GovTrack S [108th]: Electric Reliability Security Act of Retrieved August 27, 2008, from GovTrack Kenneth Gillingham, R.N Retrospective examination of demand side energy efficiency policies. Washington, D.C.: Resources for the Future. Laitner, J Energy efficiency: Rebounding to a sound analytical perspective. Energy Policy, Maggie Eldridge, B.P The state energy efficiency scorecard for Washington, D.C.: American Council for an Energy Efficient Economy. Martin Kushler, D.Y Aligning utility interests with energy efficiency objectives: A review of recent efforts at decoupling and performance initiatives. Washington, D.C.: American Council for an Energy Efficient Economy. Nadal, S Energy efficiency resource standards: Experience and recommendations. Washington, D.C.: American Council for an Energy Efficient Economy. Optimal Energy Power to save an alternative path to meet electric needs in Texas. Washington, D.C.: Natural Resources Defense Council and Ceres. Prusnek, B Promoting energy efficiency in california, state EE/RE technical forum call #8 Decoupling energy sales from revenues and other approaches to encourage utility investment in efficiency. Sacramento: California Energy Commission. Rosenthal, E. 2008, April 23. Europe turns back to coal, raising climate fears. New York Times, 3. Sandra Levine, D.H. 2008, June. Prime time for efficiency. Public Utilities Fortnightly, Sorrell, S The rebound effect: An assessment of the evidence for economy wide energy savings from improved energy efficiency. London: UK Energy Research Center. Steven Nadel, A.S The technical, economic and achievable potential for energy efficiency in the U.S. A meta analysis of recent studies. Washington, D.C.: American Council for an Energy Efficient Economy. Climate Change Policy Partnership 17

20 the Climate Change Policy Partnership The Climate Change Policy Partnership (CCPP) researches carbonmitigating technology, infrastructure, institutions and overall systems in order to inform lawmakers and business leaders as they lay the foundation of a low-carbon economy. Duke University s CCPP is an interdisciplinary research program of the Nicholas Institute for Environmental Policy Solutions, the Nicholas School of the Environment, and the Center on Global Change. Our corporate partners make our research possible and help us bridge the gap between academic research, business expertise, and effective climate change policy application. for additional copies of this report see: for more information please contact: Climate Change Policy Partnership Duke University Box Durham, NC fax ccpp@nicholas.duke.edu copyright 2008 Climate Change Policy Partnership, Duke University