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Korea Electric Power CompanyDemand Side Management

Fall 2007

Regulatory Treatment of Demand Side Management in the U.S.

Richard SedanoRegulatory Assistance Projecte-mail: [email protected]

phone: 802-223-8199

Introduction

Regulatory Assistance ProjectRAP is a non-profit organization, formed in 1992, that

provides workshops and education assistance to state government officials on electric utility regulation. RAP is funded by the Energy Foundation, US EPA & US DOE.

Richard Sedano was Commissioner of the Vermont Department of Public Service, 1991-2001

Wayne Shirley was Chair of the New Mexico Public Utilities Commission 1995-1998

The Regulatory Assistance

ProjectRAP Mission:RAP is committed to fostering regulatory policies for the electric industry that encourage economic efficiency, protect environmental quality, assure system reliability, and allocate system benefits fairly to all customers.

Demand Side Management - Fall 2007

Regulatory Environment -- HistoryEnergy efficiency emerges with 1970s oil shortagesGenerally seen as peripheralTreated as a social program implemented by utilities – an awkward fitProne attack due to political dogma and focus on short term rates


Regulatory Environment -- HistoryTwo things happened in 1990s to undercut energy efficiency

Industry restructuring and consideration of retail electric competitionNatural gas generation busbar prices low and stable

Customer generation was encouraged with cheap natural gas


Regulatory Environment -- TodayEnergy Efficiency expanding

Experience shows EE is cheap to acquireHard to build supply resources

Generation options costlyEnvironment

SecurityClimate change


VT v. NE & US Consumption

Economic growth does not mean needing more electricity if efficiency increases.


Regulatory Environment -- TodayDemand Response is expanding

Peak Power is the most expensive, often the most polluting and drives new constructionMarkets need an active demand sideEven storage-heavy areas are reaching their limits of peak support and need demand response

Enabling metering technology a key


Regulatory Environment -- TodayDistributed Generation expanding

But is more centered in niche applicationsCHP, where process energy is neededClean Energy (wind, solar), aided by subsidy

Policy issues remain to be resolvedInterconnectionBack up rates


Regulatory Environment -- TodayRegulatory Commissions are upgrading their capabilities

Those with experience have been coasting and are reconsidering programs and incentive issuesThose without experience are learning basics and coping with staff knowledge deficiencies


Legislative EnvironmentAs climate change and other energy issues get more attention from the public...Elected officials in Washington and in the states take more of an interest in clean energy policyResulting in a huge increase in the number of new laws in recent years


Federal – State jurisdictional line very important, and very clear

State authority over retail electric matters, including distribution companies paying for energy efficiency through customer bills

There can be federal appliance and equipment efficiency standardsFederal authority over wholesale markets


Energy Policy Act of 2005Collected State and Regional policies promoting utility energy efficiency – for “consideration”Energy Efficiency Report available at http://www.oe.energy.gov/DocumentsandMedia/DOE_EPAct_Sec._139_Rpt_to_CongressFINAL_PUBLIC_RELEASE_VERSION.pdfConsistent with National Action Plan


EPACT of 2005Directs states to “consider” advanced meter deployment and dynamic ratesInventory of demand response and advanced meters

Report at http://ferc.gov/legal/staff-reports/demand-response.pdf


National Action Plan for Energy Efficiency

An effort to gain consensus and direction on good ideas to promote energy efficiency in utility sectorA “leadership” group directs the projecthttp://www.epa.gov/cleanenergy/actionplan/eeactionplan.htm

Goal

To create a sustainable, aggressive

national commitment to energy efficiency

through gas and electric utilities,

utility regulators, and partner organizations



National Action Plan for Energy Efficiency -- Recommendations

1. Recognize energy efficiency as a high-priority energy resource.2. Make a strong, long-term commitment to implement cost-effective

energy efficiency as a resource.3. Broadly communicate the benefits of and opportunities for energy

efficiency.4. Provide sufficient, timely and stable program funding to deliver

energy efficiency where cost-effective.5. Modify policies to align utility incentives with the delivery of cost-

effective energy efficiency and modify ratemaking practices to promote energy efficiency investments


National Action Plan for Energy Efficiency – New Products

Examination of Utility Rate Revenue Stability Mechanisms and Incentives (Fall 07)Guidebook on Energy Resource Planning and Procurement Processes (integrating energy efficiency) (Spring 07)Guidebook for Conducting Potential Studies for Cost-Effective Energy Efficiency (Spring 07)Guidebook on Energy Efficiency Measurement and Verification Protocols (Fall 07)Building Codes and Energy Efficiency Fact Sheet (Spring 07)Educational Briefings, sample docket material, and resource lists (Spring 07)



Sector Collaboratives: A new way to engage customers

HotelsOffice buildingsSupermarketsCities


Keys to TransitionRecognition that supply bias has problemsLeadershipIdentification of beneficial policy changesSustained commitment to change

Including attention to sustaining business models that promote demand side resources


Action in the StatesThe DOE study and the Action Plan only reflect new developments in the states that have been already under way


California: Experience, Pride, FearLeadership in elevating energy efficiency to a high priority and treating it as a power system resourceLeadership in working to align incentives to promote energy efficiency

Decoupling and shared savingsLeadership in dynamic pricing and advanced meter study and deploymentGreat deal of potential still unrealized


http://epa.gov/cleanenergy/pdf/calif_cleanenergy.pdf


California’s Strategy is ClearEnergy Action Plan I and II

Loading, with demand resources firsthttp://www.energy.ca.gov/energy_action_plan/index.html

Coordinate EE programs with building energy codes and appliance efficiency standardsMeet half of expected load growth with programsLeading to CO2 and savings in the state’s cost of electricity


Vermont: Commitment, InnovationLeadership in committing to all cost-effective energy efficiencyLeadership in centralized administrationConsidering expansion to include end uses of unregulated fuelshttp://www.state.vt.us/psb/EEU/EEU.htm

See August 2, 2006 order and Act 61 links


Texas: Strategic DevelopmentEnergy efficiency performance standard

10% of forecasted growth, which is significantly below potentialStandard increased in 2007 ACEEE Report 073 March 2007


Northwest Power and Conservation Council

Four northwest states managing electric energy and rivers in concertLeadership in planning giving full value to energy efficiency

They use Monte Carlo techniques to create a probabilistic value for energy efficiency and demand response

WA, OR and ID have strong EE programs


Iowa and MinnesotaSteady energy efficiency programs in both states for a long timeMinnesota has a new law that significantly increases expectation for energy efficiency

Savings of 1.5% of retail sales each year from programsEffectively eliminates load growth$$ incentives for hitting savings targetshttp://www.epa.gov/cleanenergy/pdf/midwest_21Jun07/sundin.pdf


Massachusetts, New York and Connecticut

Long time commitment to energy efficiency maintained with retail competitionClimate change a new strong motivatorRenewed interest leading to examination of decoupling and incentives

http://www.mass.gov/Eoca/docs/dte/electric/07-50/62207order.pdfGovernors suggesting “all cost-effective energy efficiency” goal


ISO-New England adds Energy Efficiency to Capacity Market

New England has a new capacity marketBids are for 4 years

Energy efficiency qualifies as a resourceStates very supportive, overcame resistance

Rules require M&VRules require year round capacity, so seasonal EE packaged with other resourceshttp://www.iso-ne.com/genrtion_resrcs/dr/broch_tools/intro_to_dr_in_fcm_training_21607.ppt


Colorado, New Mexico, Arizona, Utah, Nevada

Sporadic commitment to energy efficiencyClimate change a new strong motivatorRenewed interest leading to new energy efficiency efforts and new supporting policies

Governors providing leadership


Arkansas: Collaborative Start-upLeadership from regulator

Motivated by concern for natural gas and coal siting and pricesCreated a sense of inevitability that promoted cooperation from utilities

Collaborative quickly led to rules, followed by programsOklahoma and Kansas looking carefully


Illinois, Maryland, Delaware: Rebound from retail competition

Poor implementation of retail competition led to big price increases in 2007Recognition that energy efficiency is important becomes politicalNew laws set very high standards to energy efficiency savings

Very little infrastructure in place at the start


A Choice of ObjectivesSave what you can within a budget (MA)All cost effective energy efficiency (VT)Save a certain percentage of forecasted growth (TX)Save a certain percentage of annual retail sales (IL)Figure it out as you go (IA)


White Tags – Trading Energy Efficiency

Some states are considering creating an energy efficiency performance standard, and then allowing trading so that those that can produce more savings that they need to meet their standard and sell the rights to claim the savings to others.Some states are considering folding this into a renewable portfolio standard.


Program Trends: It’s about the customerWhole BuildingsSpecialized ServicesMore strategic use of incentivesTargeted for system benefitUsing the InternetExpanded budgets will mean more attention to retrofit programs


Some Elements of Cost-EffectivenessLife-cycle – all costs and savings: requires assessment of average measure lifeFree riders – minimize, can’t eliminate, appropriate discountFree drivers – appear roughly equal to free ridersPersistence – characterize by program for evaluation, appropriate discountCapacity value – avoiding most expensive sales


Cost-Effectiveness TestsChoice communicates priorities

RIM Test is concerned for the individual and ratesTotal Resource Test considers the system benefits and long term costs, but ignores external benefitsSocietal Test considers everything with long term view

Using TRC or societal test could produce cost-effective programs equivalent to more than 5% of total utility revenues. Regulator gets to decide what consumers and the state economy can afford, and what cost-effective programs to sacrifice, and to recognize the capital consequences.


Cost – EffectivenessCalifornia Standard Practice Manual: Economic Analysis of Demand Side Programs and Projects

http://drrc.lbl.gov/pubs/CA-SPManual-7-02.pdf


Valuing ExternalitiesWhen you know the value is not zeroControl costsDamage costsAn adder or factor when control or damage costs are hard to calculate or too controversial to settle on (most typical response)Risk of value being internalized in future


Special IssuesLow income consumers need a different value proposition to say yes to EE

This means that the Benefit/Cost will be lower since these programs will cost moreMost states explicitly permit this

The US has a national weatherization program, and many states merge the two efforts


Special IssuesSplit Decision-Making

Many instances where builder or building owner have different interests than the building occupantPrograms need to attract builders and building owners to invest in efficiency even though it adds cost

Use financial, recognition, or other incentives


Monitoring and VerificationAn essential element of EE programs

Cost recoveryPerformance standard scoringShared saving scoringWhite tags appear to need a higher level of assuranceUse for capacity also needs high level of assurance


Monitoring and VerificationCosts between 3 and 5 per cent of program budgetsDeemed savings are increasingly used for high volume measures and reduces cost

Need to pay attention to climate zones for temperature sensitive measures.

Sufficient separation between program administrator and deemed savings staffIPMVP: commonly used basis


Energy Efficiency and Demand Response

Highly related and complementaryHelps to sell to customers at the same time for comprehensive effect for minimized program cost

Combined Commercial Cooling and Lighting LoadshapeBaseline, Load Management (STDR), and Energy Efficiency

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Energy Efficiency and Dynamic PricesPricing does convey a message to consumers

Charging the same all the time suggests that production costs are the same all the time. This is falsePrices that track in a rough way production costs reinforce messages on efficiency

Consumption itself is fairly inelastic, so programs are key to savings


Demand Response IssuesThird Party (Curtailment Service) Providers

Experts in demand response technology and salesAble to aggregate many customers into a well-managed portfolio response

Capacity Value, Market Rules, Planninghttp://www.energetics.com/madri/pdfs/PolicyStatement.pdf


Advanced Metering InfrastructureData storage with communications

Opens a door to capabilities that are beyond imagination

Costs must be justified today based on known valuesKnown operational values may not justify deployment yet in many utilitiesCalifornia is leading


Wholesale Markets and Demand Resources

An active demand side is thought to be essential to a functioning wholesale market that serves the public interest

Mitigate market power of suppliersMitigate reliability risks, maximize utilization of existing grid assetsMitigate price volatilityLeast cost provision of service


FERC Role Critical, yet DelicateFERC is responsible for overseeing wholesale markets

FERC doing a good job looking for opportunities to promote more demand resources

Demand resources are inherently retail, so states must do their part to enable them and FERC looks for ways to encourage


Utility Financial Interests in EECost RecoveryThe Throughput IncentivePerformance Incentives


1989 NARUC Resolution“Reform regulation so that successful implementation of a utility’s least-cost plan is its most profitable course of action”

How are we doing in achieving this objective?


Policy Trends: Aligning IncentivesUtilities have gone along with programs

As long as they don’t lose too many salesCustomers like it

They like it if some lost revenues are restoredTraditional cost of service provides $$ upside between rate cases as sales grow – the throughput incentive

Energy efficiency has not been in utilities financial interest


Aligning Incentives: SolutionsCost Recovery

Tariff Riders becoming more prevalentA certain amount is included in ratesDeviations in spending are reconciled periodically

Utilities looking for certainty of recovery and speed to account for changesSome public process to assure changes are in the public interest helps to enable


Aligning Incentives: SolutionsThroughput Incentive

Independent AdministrationLost Revenue Calculation and RecoveryDecoupling


Aligning Incentives: SolutionsFinancial Incentives

Shared Savings (California)Bonus return on equity (Nevada)Performance rewards (several states)Compensation keyed to avoided cost (Duke)


Overview

Goals: Create a much more energy-efficient economy Create a profitable EE business model for utility companies

Problem statement:Utility profitability is linked directly to sales volumes between rate cases (= all the time)

Recommendation: Decouple fixed cost recovery from sales volumes (one way is Revenue-Per-Customer true-ups to recover utility base revenues). Also needed: Performance incentives and shared savings for superior utility performance and added customer value


Traditional Regulation Provides Strong Disincentives for Customer-Sited Resources

Utility revenues and profits are linked to unit sales (kW, kWh, therms, etc.)

But, in the short run, a utility’s marginal costs are only vaguely related to electricity demand (more on this in a moment)

Loss of sales due to successful expansion of energy efficiency and DG/CHP will lower utility profitabilityEffect remains even with well-designed EE policies:

The incentive remains to boost sales even where utilities receive “net lost revenue recovery” for utility-sponsored EE

The effect can be quite powerful. . .


A Sample Distribution Utility

$9,900,000Allowed Return on Equity

$180,950,769Total

$15,230,769Equity

$5,720,000Debt

$160,000,000Operating Expenses

Revenue Requirement

10.48%100.00%Total

$15,230,769$9,900,0007.62%4.95%11.00%45.00%Equity

$5,720,000$8,800,0002.86%4.40%8.00%55.00%Debt

Pre-TaxAfter-TaxPre-TaxAfter-TaxCost Rate% of TotalCost of Capital

Dollar AmountWeighted Cost Rate

35.00%Tax Rate

$200,000,000Rate Base

$160,000,000Operating Expenses

Assumptions


Sales Affect Earnings

12.31%11.88%$11,076,180$1,176,180$1,809,5081.00%13.61%23.76%$12,252,360$2,352,360$3,619,0152.00%14.92%35.64%$13,428,540$3,528,540$5,428,5233.00%16.23%47.52%$14,604,720$4,704,720$7,238,0314.00%17.53%59.40%$15,780,900$5,880,900$9,047,5385.00%

11.00%0.00%$9,900,000$0$00.00%

4.47%-59.40%$4,019,100-$5,880,900-$9,047,538-5.00%5.77%-47.52%$5,195,280-$4,704,720-$7,238,031-4.00%7.08%-35.64%$6,371,460-$3,528,540-$5,428,523-3.00%8.39%-23.76%$7,547,640-$2,352,360-$3,619,015-2.00%9.69%-11.88%$8,723,820-$1,176,180-$1,809,508-1.00%

Actual ROE% ChangeNet EarningsAfter-taxPre-tax% Change in Sales

Impact on EarningsRevenue Change


Least-Cost Service Should be the Most Profitable

The “throughput” incentive is at odds with public policy to supply electric power services at the lowest total cost:

inhibits a company from supporting investment in and use of least-cost energy resources, when they are most efficient, encourages the company to promote incremental sales, even when they are wasteful

Ratemaking policy should align utilities’ profit motives with public policy goals: acquiring all cost-effective resources, whether supply or demandThe utilities’ throughput incentive promotes inefficient outcomes, even where:

there is no programmatic energy efficiency; andeven with third-party administration of energy efficiency programs.

We need a different business model for utility profitability


Solution: Decouple base revenues from sales volume

Breaks the mathematical link between sales volumes and base revenues* (and, ultimately, profits)

Makes revenue levels immune to changes in sales volumesEnables recovery of the utility’s prudently incurred fixed costs, including return on investment, in a way that doesn’t undermine customer savings and an efficient economy

Two objectives: To protect the utility from the financial harm associated with least-cost actions andTo remove the utility’s incentive to increase profits by increasing sales in other ways (e.g., electric heat promotions, reluctance to support appliance standards)

* Remember: “base revenues” are those covering costs that are essentially fixed in the short run, like capacity, wires, and meters. Variable costs, like fuel, can flow through a FAC or kwh rate.


Revenue Decoupling:The Essential Concept

Basic Sales-Revenue DecouplingUtility “base” revenue requirement determined with traditional rate caseEach future period has a calculable “allowed”revenue requirementDifferences between the allowed revenues and actual revenues are tracked

No magic time period for tracking differences, or for true-ups to bring in the desired revenue (monthly, quarterly, annually)

The difference (positive or negative) is flowed back to customers in a small adjustment to unit rates


Calculating allowed revenuesRegulation should link utility cost recovery to the costs the utility facesFirst thought: True-up recovery to cover a single dollar amount of total fixed costs Second thought: Use average revenue-per-customer

In the long-run total demand is the main cost driver But in the short-run (the rate-case horizon)

Utility costs vary more directly with numbers of customers than with salesParticularly true of distribution, where the marginal costs of delivery are, on average, very low or nil, but for which the costs of acquiring and serving customers are significant and recurring

So total revenue can growth as customer base grows


Revenue-Per-Customer DecouplingHolds class average revenues-per-customer (RPC) constant

Or may have a periodic increase or decrease in average revenues-per-customerIndustrial customers may be treated separately

Based on prior rate case valuesMonthly (or other periodic) true-up mechanism allows up or down adjustments in the RPC tracker similar to traditional fuel and purchase power adjustments


What incentives remain for utilities and customers?

Utility perspective: Decoupling revenues, rather than earnings directly, preserves the utility’s incentive to improve its operational and managerial efficiency

Customer perspective: This is a revenue issue, not a pricing or rate design issue: it is not intended to decouple customers bills from consumption

Traditional unit-based consumption prices (per kw and per kwh) remainCustomers should continue to see the cost consequences of their consumption decisionsUnit-based consumption pricing reflects the relationship between demand and cost causation in the long-run

Including the costs of wires, generation, and external costs


Maryland example:BG&E DecouplingAllowed Base Revenues = Test Year Average Use per Customer * Delivery Price * No. of CustomersAdjustment to Delivery Price = (Allowed Revenues -Actual Revenues) ÷ Estimated SalesAny difference between actual and estimated sales is reconciled in a future monthCalculated separately for each class Calculations of the billing adjustments are filed monthly with the Public Service CommissionIf needed, different factors can be used to capture the cost and revenue differences between existing and new customers


Decoupling Examples: Maryland – BGE, PEPCO North Carolina – Gas UtilitiesCalifornia – 3 IOUs Electric & Gas UtilitiesOregon – Northwest Natural GasNew Jersey (NJNG)Utah (Questar)Indiana & Ohio (Vectren)Vermont (GMP)


Applying RPC decoupling on a multi-year basis

RPC value can be periodically adjusted for inflation, productivity increases, or other factorsCan be combined with performance goals and incentives: Decoupling + PBR is a good packageAdjustments can be bounded (SDG&E, SoCalGas) and/or “shared” with customers (PG&E, Northwest Natural Gas)California has the most comprehensive decoupling and PBR mechanisms


Questions for discussionDecoupling as a building block in a shared savings/value proposition

Is decoupling essential? Is it enough?Why not just go to high fixed customer charges?Decoupling and utility risks –

How are weather risk, sales, and profits affected?Does decoupling shift risks to customers?

True-ups and rate volatilityComparing FAC and RPC “trackers”How often should we true up the RPC? Should true-ups be capped?

What formulas are best? Total revenue approachRevenue per customer – different customer classes?Adjust for inflation? For productivity?

How does decoupling mesh with PBR and shared savings? Isn’t decoupling part of a shared savings business model?


ResourcesWebsite: www.raponline.orgE-mail: [email protected] Model Revenue Stability Rider

http://www.energetics.com/MADRI/pdfs/Model_Revenue_Stability_RateRider_2006-05-16.pdf

RAP Efficiency Policy Toolkit:http://www.raponline.org/Pubs/General/EfficiencyPolicyToolkit.pdf