Return to Environment PageDemand Side Management in A Community Electricity Franchise
Testimony of Cape and Islands Self-Reliance
before the Massachusetts Department of Public Utilities
on the Economic Feasibility of Energy Efficiency Investment (July, 1996)

by Matt Patrick


These comments are part of the larger study on Community Electricity Franchises being conducted under grant to the Urban Consortium, by Barnstable County, The National Consumer Law Center and The Cape and Islands Self-Reliance Corporation. The study will explore how demand side management will work in the context of deregulation and the community electricity franchise (CEF). It will analyze the benefits of operating DSM from the community's perspective as opposed to the investor owned utility's perspective. It will give a side by side look at cost benefit analyses that compare demand side management (DSM) programs operated by CEF to DSM operated by an investor owned utility (IOU). The results are very favorable to DSM programs designed and implemented by the CEF. Finally, it will argue that any DSM makes the most sense when it is designed by and for the demand side - that is the communities where the DSM takes place.

What happens to the dynamics of the marketplace once a community decides to provide electricity for its citizens and employers? Should a CEF depend on its distribution company (old IOU) to meet the community's needs for DSM programs (and renewable energy programs)? Should the CEF decide what DSM it wants and then issue a separate request for proposals for DSM without involving the distribution company? How does a CEF pay for DSM? These are important questions that should be resolved by CEFs before negotiating contracts with power suppliers and the distribution companies in the deregulated marketplace.

Demand Side Management

In the context of a deregulated electricity market that supplies markets through "direct access," the role of the investor owned utility in demand side management (DSM) will become more tenuous. Currently, IOU's have little inherent incentive to institute DSM, especially when there is excess electricity capacity. They can generate more electricity (as they have evolved to do) to meet demand growth or they can implement DSM. The contradiction between the IOU and DSM will not be resolved by more artificial market compensations designed by regulatory authorities.

The Massachusetts Department of Public Utilities is hoping that DSM will be driven by the market after a five years transition period. Given the current price of electricity and the hope that deregulation is going to lower it further, it is difficult to understand how the market for DSM will develop especially when one considers that consumers will have no way to finance projects in their homes. To those who say the market will provide the financing, the markets provide the financing now but where is the market. Where are the DSM companies that will educate the public, provide the financing, market the program and implement the measures? The oil sector is a good case in point. Oil heated homes represents more than 50% of the housing market in Massachusetts yet there are no independent DSM programs that have targeted that market.

Operating in a deregulated marketplace, IOU's will have even less incentive to implement DSM and independent power producers will have no incentive. Quite clearly, any program that minimizes markets for the sale of more electricity will be discouraged by those that seek expanding markets for electricity sales.

Who will still have the incentive to implement DSM programs in a deregulated market place? The answer is simple, the people who pay for the electricity. However, individually they need capital and organization to make it happen. As a community they can accomplish much more than they can as individuals. Communities will have the incentive to implement DSM for economic and environmental reasons and a community in charge of its energy resources will have the unique opportunity to design and implement DSM to maximize the benefit to its citizens. A CEF, buying co-operatively, will provide the vehicle needed to deliver the benefits of DSM where it is needed and where it will be appreciated most. For the first time in the history of utilities, markets can be corrected to give the tools to design and implement demand side management to the demand side. Regulatory agencies should look at this as an opportunity to build market stability for the long term. As such, the CEF is a good model, one with very common - well established roots.

Once a CEF is paying for the electricity its citizens use, the basic premises of DSM economic analyses change dramatically. Normally, investor-owned utilities use the California "standard practice methodology" test to determine if a DSM program is going to be cost effective. The first of five questions in that test asks, "Is the utility's cost of the program less than the avoided supply cost?" Once a CEF is formed, the IOU is no longer the supplier of electricity. In Massachusetts, the DPU will require that the IOUs remain the distribution company and operate DSM programs. However, if the CEF is paying for the electricity, it will replace the IOU/distribution company with itself in the California test.

The CEF will choose the alternative in which they design their programs based on a different formula to determine cost effectiveness. As a non-profit entity the franchise will only be interested in covering its cost of capital which will be lower than an IOU's cost of capital. The pressure will be on IOUs to pay attractive dividends to their shareholders. In addition the CEF will not be interested in recovering "lost base revenues" (LBR).

Let's take a look at the comparative analysis of the IOU delivered DSM and the CEF delivered DSM. In the American Public Power Association's (APPA) Energy Services That Work, (Chapter 3, "The Economics of Energy Services"), the California standard practice methodology is explained. There are five questions that must be answered in the positive for the DSM program to be deemed worthy.

To explain a simple analysis of these factors the APPA examines a refrigerator rebate DSM program (see appendix A). Under "Demand Reduction" they find a capacity savings of $35.10/ year. That is the, "amount of supply in kW a utility needs at any given moment to supply a load. "In the case of a non-generating utility, it is capacity that does not have to be purchased from another entity; and for generating utilities, it is capacity that can be used for reserve, or sold to others." It therefore goes in the plus column for determining the cost effectiveness of the refrigerator rebate program. Other items are judged similarly.

Economic Analysis of a refrigerator efficiency rebate program for an IOU and CEF. Direct Costs Only
*IOU's recover LBR equivalent to their lost sales due to efficiency measures. CEF's will not recover LBR's so the lost sales due to efficiency is a plus in their column.

The above model shows a $30/year avoided cost supply based on a supply cost of $0.06 x 500kWh savings minus $10/year in lost distribution sales based on $0.02/kWh. Both add up to the retail cost to the customer in this model of $0.08/kWh.

Under the CEF, the modeling reveals direct savings to the community of $40/year based upon $0.08/kWh retail rate times 500 kWh saved. The community will save on the $0.02/kWh distribution rate as well as the supply cost.

In Massachusetts and other states, IOUs are entitled to LBR or sales lost equal to the amount of electricity saved by the implementation of DSM programs. The IOU's rate payers will pay for the cost of the DSM program and also the LBR. In Massachusetts the LBR exists past the measure's lifetime, adding more inefficiency to the system. In effect, ratepayers in Massachusetts pay twice for DSM - once for the program itself and for lost sales each succeeding year after the DSM measure is installed.

However, a CEF wouldn't recover money from its ratepayers for lost sales or distribution costs because the CEF is non-profit and is working to off set the growth of the system or reduce the load as specified in their contract with their wholesale supplier and distribution company. In other words, the CEF is trying to levelize its growth or reduce its load through DSM.

The electricity supplier's contract should stipulate that the franchise will be developing these programs to meet future growth (or a percentage of growth) projected over the (five to ten year) life of the contract or reduce the load. Therefore, the contract will require that the supplier need only plan on serving the base load minus future growth.

The above analysis points out that the refrigerator rebate program (or any other DSM program) operated by the CEF has a very favorable simple payback of program costs when compared to an IOU-operated DSM program. The CEF's payback is 2.1 years versus the IOU's payback of 3.63 years). The ten year simple savings are equally attractive for the CEF at $751 compared to the IOU at $357.

To illustrate how things change if the CEF designs its own DSM program, consider the following scenario. The utility marketplace has been deregulated and a group of towns has successfully formed a CEF. They decide to design their own DSM programs after considering the alternatives left to them by the Department of Public Utilities. In the DPU's default case the franchise would rely on the IOU (now the distribution company) to design the DSM programs based on the old economic modeling that determines if the IOU's program costs are less than the avoided supply cost.

Under that scenario, the funding for the programs operated in the community would be limited to avoided supply costs which the IOU puts at $0.015 per kWh [Commonwealth Electric actual avoided cost 1995]. Yet the retail cost of electricity to the CF is $0.08 in this example [actual retail cost for Commonwealth Electric customers is $0.143/kWh in 1996]. As in the first example, the utility will be able to capture Lost Base Revenues, the reward for investing in energy conservation equal to the amount of lost sales. Lets look at the analysis for this scenario.


Direct Costs Only
Demand-Reduction-(kW) 0.90.9

As you can see the IOU-designed DSM now has a payback of more than 6 years versus the CF's 2 years. This makes it even more difficult to economically justify any IOU-sponsored DSM program and makes CEF sponsored programs even more attractive. If the CEF decided to do only the DSM programs that have a five year payback or less, they would not do the refrigerator rebate program designed and implemented by the IOU/DISCO. However, if they designed the refrigerator rebate program themselves, it would be a very cost effective program with a two year payback. Yet we have not accounted for the "community-avoided cost" which could include the retail cost of electricity plus jobs, pollution and the community benefit of the multiplier effect of money saved from the retail cost of electricity.

"For energy efficiency expenditures the economic multiplier is $2.32. Economists for the State of Nebraska estimate that 80% of every dollar spent on energy leaves the state's economy." Massachusetts spent $11 million or 8% of its state national product on energy. It imports nearly 97% of its energy and, "the majority of these dollars flowed out of the state." Saving energy is one of the best economic programs we can institute and it comes with the added benefit of cleaner air and healthier lives.

In the final analysis, if the CF stays with the IOU designed DSM, it will not only lose the ability to design DSM programs to meet its own needs, it will find that many traditional utility DSM programs they had hoped to implement are not cost effective. Many more programs can be economically justified using community avoided cost that accounts for indirect benefits and costs realized by a community.

One outstanding example of the distortion of DSM occurs in Massachusetts (and other states) with large pools of electrically heated homes. Most IOUs will not consider the value of removing electric resistance heat as a DSM measure even though electric resistance heat is perhaps the most wasteful method of heating buildings. The Mass DPU does not require the utility to implement removal of electric heat and the replacement with some other form of heat. As a DSM measure, removal of electric heat and the replacement with conventional heating systems is one of the most cost-effective DSM measures, yet in a recent decision using the utility's avoided cost to justify a pilot program for conversion from electric heat to gas, the program was found to be not cost-effective [see above spreadsheet with IOU's $0.015/kWh avoided cost]. In contrast, the Burlington Electric Department (Vermont) found in 1990 that they could remove electric resistance heat to cost-effectively provide more capacity.

The reasons for not relying on the supplier for operation of DSM also have an historical basis as well. Where existing franchises, such as Chicago, have entered into contracts with IOUs for supply and DSM programs, the IOUs have made it a practice to stonewall, contesting the terms of contracts requiring DSM. The effect of this acrimony has included greatly postponed implementation or cancellation of DSM programs. Similarly, the IOU's approach to the verification of milestones or the interpretation of milestones, has postponed completion of DSM programs.

Most IOUs were forced to comply with DSM by order of their respective regulatory agency. Many programs were operated poorly by IOUs for the monopoly customers and franchise customers. Often environmental and consumer organizations questioned if the IOU's poor attitude had anything to do with the poor design and operation of DSM programs. Many still argue that it is not in the utility's interest to operate DSM programs that reduce utility sales.

As mentioned above, utilities are allowed to recover lost base revenues or LBR to give them more incentive for operating effective energy conservation programs. However, - and this is the critical irony of the current system for determining a DSM program's cost effectiveness - this "incentive" goes in the negative column when determining a DSM program's cost-effectiveness when you account for the fact that the customer will ultimately pay for that LBR as well as the program. This is an example of an artificial market device that back fires to cost the ratepayer more money.

Expensive monitoring and verification of DSM measures became a requirement during the late 1980's, the heavy implementation period by IOUs in Massachusetts. The monitoring and verification ensured that work was done correctly and that the numbers projected in the IOU's DSM plan were actually attained. The DPU mandated the requirement after questions were raised about the effectiveness of the programs.

CEFs should avoid the problems created by middlemen, which is what an IOU-designed DSM program would be in a deregulated marketplace. Additionally, in practice, IOU's don't implement DSM in the field. They hire a DSM company to implement programs and it can be argued that the DSM companies were largely responsible for the successfully operated IOU DSM programs. The fact that IOUs will continue to design DSM based on their avoided costs and then tack on lost base revenues, makes IOU design of a CEF's DSM programs untenable. In a deregulated marketplace there is no need to have another party involved. A franchise should work directly with a DSM provider to avoid contract interpretation problems and program design problems.

In contrast, municipal utilities from around the country have designed and implemented many favorably received DSM programs, mainly because the affected communities were involved in designing them. The Burlington Electric Department's electric heat removal program is a good case in point. They could have implemented many cost effective programs but decided to help citizens of the town remove electric heat because that is what their constituents wanted. Municipal utilities, like CEFs, have publicly accountable and democratically controlled methods of governance. Communities are inherently more capable of designing DSM programs for themselves than IOU companies that are primarily motivated by their need to satisfy shareholders. The IOU/DISCO will have even less of an incentive to implement DSM in a deregulated marketplace. They may just be a pass through of supply. The community will be the only party in the deregulated marketplace that has any interest or real incentive for implementing DSM.


Where does the DPU's authority begin and the community's leave off. It is clear that the DPU's strong suit is in rate design. They will determine if the rates proposed by the community are fair and equitable. Can they decide that program's charges are excessive or unreasonable? They probably could so the community must ensure that it creates an energy management plan that involves all stake holders in a democratic process and backs all DSM programs with a benefit cost ratios that are reasonable .

For communities that choose to define and implement their own social and environmental programs the towns can choose from California Standard Practice Tests or can devise a different standard but if they do so it must clearly define benefits and costs to minimize arguments.

To address the concerns about effects on rates caused by the reduction in demand, Communities could define cost effectiveness tests using retail costs and externalities as long as they are removing projected load growth from the system. After the load growth is removed than a wholesale cost should be used to eliminate or minimize cross subsidization among rate payer classes. Another precautionary measure to avoid cross subsidization is to keep the DSM fees for different classes of rate payers separate. A community energy plan that democratically involves all stakeholders in the process would serve as a blue print for DSM measures.

Does the DPU have the ability to approve a volumetric charge for the CEF's DSM? If the DPU can approve the DSM charges for the DISCO's DSM without legislation, could it also approve a DSM charge for a CEF? It is clear that a CEF could contract with its distribution company to pass through the DSM charge to the CEF's fund. This actually would be in the interest of the distribution company because it would then be able to bid on the provision of DSM.

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