Seeking Consistency in Performance Incentives for Utility Energy Efficiency Programs

Regulators and legislators in many jurisdictions are requiring or investigating a variety of shareholder incentive mechanisms to overcome the inherent disincentives to utility investment in energy efficiency and demand side management as compared to supply-side investments. Performance incentive mechanisms are one of many tools available. The authors briefly examine the need and justification for performance incentives, the historical utility financial structures with regard to energy efficiency and challenges to this model created by policy initiatives, propose a set of metrics for shareholder incentives and set of criteria for comparability, present a sample of approved shareholder incentive mechanisms in tabular format, and suggest additional research efforts. The Need for Shareholder Incentives for Energy Efficiency Programs Utility regulators have approved a large number of shareholder incentive mechanisms to promote utility energy efficiency programs with the ultimate goal of achieving a variety of public purposes, such as emissions reductions, energy security, and cost-control. However, in contrast to the standard methodology and benchmarks available to regulators for determining the allowed return on equity (ROE) on utility investments in supply-side resources, utility regulators have employed a wide variety of practices and standards when approving shareholder incentives for energy efficiency programs. This report explores initial practices for shareholder incentives. Although it is less common today than it once was, utility compensation for energy efficiency programs is sometimes limited to simple recovery of its actual program expenditures, excluding any type of return. Yet as increasing amounts are spent on energy efficiency, the increasing emphasis on evaluation, monitoring and verification (EMV) provides a basic link to the energy reductions actually achieved, i.e., a demonstration of the actual results or performance. More frequently, regulators are also making an explicit link between the level of actual energy efficiency reductions and the utility’s revenue requirement, and providing a performance-based ratemaking structure that includes a financial incentive that benefits utility shareholders. Shareholder incentives may be necessary because utility activities that lead to reductions in energy use or increased self-generation will typically reduce electricity sales, thereby reducing earnings on existing investments in supply-side resources and reducing opportunities to earn on investments in new supply-side resources. For investor-owned utilities, these activities tend to reduce profitability, except perhaps for utilities operating under full revenue decoupling (RAP 2008). For public utilities, the lack of shareholder equity requirements mitigates the economic problem, but utility managers may be concerned about budget uncertainty and bond debt requirements (APPA 2009). Resolving the problem of reduced profitability for investor-owned