Conciliating energy companies economic interest with Demand-Side Management - A review of funding...

Conciliating energy companies economic interest with Demand-SideManagement - A review of funding mechanisms in a changing market

Carlos LopesCentro para a Conservação de Energia, Praceta 1, Estrada de Alfragide, 2720 Alfragide Portugal

Ecole des Mines de Paris - 60 Bd Saint Michel, 75272 Paris Cedex 06, [email protected]

Stefan ThomasWuppertal Institut für Klima Umwelt EnergieDöppersberg 19, 42103 Wuppertal, Germany

[email protected]

Lorenzo Pagliano, Pierluigi AlariPolitecnico di Milano

Piazza Leonardo 32, 20133 Milano, [email protected]

Abstract

This paper describes the possibility of designing funding mechanisms that conciliate the interest of electriccompanies with the social objective of delivering end-use energy efficiency. End-use energy efficiency carried out byenergy companies, here called Demand-Side Management (DSM), is being questioned in a number of countries. Thispaper starts by giving evidence that reconciliation mechanisms are needed to align the economic interest of electriccompanies in realising DSM. For this purpose, a quantitative cost-benefit analysis is used to illustrate the economicperspective of electric companies in an unbundled industry. Results show that there is a need for carefully examiningthe rules introduced through restructuring in order to avoid putting DSM activities at a disadvantage.

The reconciliation schemes that are investigated in this paper involve public benefit charges and ratemakingmechanisms that remove losses due to DSM activities. A detailed description of the various characteristics of schemesthat involve Public Benefit Charges is given, and a review of the situation in selected European Union countries as wellas in some USA Sates is presented.

The need to combine funding mechanisms with other mechanisms, like standards of performance, andmonitoring and reporting, is mentioned. These combinations are illustrated with case studies involving public benefitcharge and ratemaking mechanisms.

1. Introduction

It is generally well accepted that a large potential of untapped cost-effective end-use energy efficiency exists.This potential is sometimes called a "free lunch" that "you" could even "be paid to eat". Others argue that this potentialis just the result of engineering calculations and that we should, at the most, speak about a "no-regret" option. A numberof studies and pilot actions show that this potential, or "free lunch", exist, and that the biggest question is rather "how topick it up?" without making some actors loose. In this paper we discuss one of the ways to "pick up this lunch" which isend-use energy efficiency involving energy companies, here called Demand-Side Management (DSM). Therefore, DSMis defined here as "any customer-oriented activity carried out by energy companies or organisations related to themwhich comprises energy savings, load-management and fuel switching". In this paper, we will focus on the DSMactivities that are directed to obtain energy savings.

DSM is being strongly questioned in a number of countries. One of the arguments is that it would not becompatible with the increasing competition companies are facing. However, electric companies still have, in somecases, a number of advantages over other actors in delivering end-use energy efficiency, or at least in participating theseactivities. Moreover, they are often interested in improving their relationship with their customers and in adding theenergy services provision to the traditional functions of the electricity sector as a means to expand their activities. And,last but not least, competition will only be present on the generation and partially on the supply business and will bringadditional barriers to the delivery of energy efficiency to customers. Hence, there is a need to involve energy companiesin energy efficiency and remove barriers hampering from doing so.

In a competitive environment, energy companies might be affected by DSM activities. In fact, in Europe verylittle DSM have been carried out, at least when compared to the "regulatory mandated DSM" in jeopardise with the de-

regulation process. However, the trend in a number of European Union countries (e.g. The United Kingdom, Italy,Portugal, France) is rather to establish an explicitly regulated system replacing de facto self regulated monopoly due to,in some cases, the capture of the state-regulator. This new regulatory environment gives therefore new perspectives forDSM.

This paper looks at how electricity companies are affected by DSM and discusses mechanisms that reconciliatethe interests of energy companies and the realisation of energy efficiency. The two mechanisms that we analyse areschemes that involve Public Benefit Charges (PBC) and ratemaking mechanisms that allow the recovery of DSM coststhrough tariffs.

The results presented are based upon the outcomes of a study entitled "Completing the market for Least-CostEnergy Services, Strengthening Energy efficiency in the Changing European Electricity and Gas Markets" (WuppertalInstitut et al. 2000), had two main objectives: (1) to investigate the possibilities of doing IRP and DSM on therestructured Internal European Electricity and Gas Market; (2) to develop recommendations to stimulate IRP and DSMin the liberalised electricity and gas markets, both at European and National level.

The study was partly based on empirical national questionnaires. One survey was dedicated to describing themarket characteristics and a second survey dealt with DSM mechanisms, programs and services, as well as experienceswith Integrated Resource Planning. A spreadsheet was also developed to carry out a quantitative analysis of the effectsof DSM programmes, services and mechanisms on energy companies. The interim results and recommendations forpolicy were discussed with practitioners in National workshops held in the eight countries participating in the study.The situation in other countries has been analysed, when they presented a special interest regarding DSM. It is the caseof The Netherlands and the United States that are often mentioned in this paper.

2. The need for conciliating mechanisms

The rationale for any energy policy action to promote the rational use of energy is that there are a number ofmarket imperfections, barriers, or obstacles for the uptake of cost effective-energy efficiency technologies by the endusers. With the introduction of retail competition some barriers have increased and new ones have appeared. It is thecase of customer instability for example, that induces a strong short-term. However, there are a number of arguments,which support the view that energy companies should play a decisive role in the implementation of energy efficiency,and thus should receive incentives to do so:

• energy companies are becoming providers of energy services and there is a potential to integrate end-useefficiency into these services. Energy efficiency and other eco-efficient services can at least partlycounterbalance the reduced turnover and profits of energy companies in a liberalised market;

• it is easier to promote energy efficiency in co-operation with energy companies, if they have incentives to do so,than against pure energy suppliers who can only increase their profits through increased sales;

• energy company DSM is an instrument to internalise the abatement costs for avoiding negative externalities intothe costs of the sector which would otherwise cause the externalities (‘Polluter pays’ principle);

• energy companies present advantages over other actors, e.g. the information on and the contact with thecustomers, infrastructure (e.g., customer information centres) and, in some cases, a valuable experience that risksto be let broken down during the price competition phase.During the present phase of pure price competition, the disincentives are high for energy companies to develop

energy efficiency services and programmes. Therefore, energy companies must, under certain conditions that will bediscussed later, receive positive incentives for the necessary cultural change and the development of energy efficiencyservices and programmes.

Economic incentives and disincentives for DSM. Privatisation and consequent commercialisation of energycompanies has led to a focus on increased profits. However, under some types of tariff regulation or on the absence ofthe same, this increase is reached - or believed to be reached - through an increase on kWh sales. This focus onincreasing kWh sales can also result from the necessity that some energy companies feel to maintain revenues as ameans of compensating the price reduction, see (Adnot et al, 2000). We consider here that the increase in profits is themost important driver for an energy company. In order to analyse how profits are affected by DSM, a quantitative cost-benefit analysis is used to illustrate the perspectives of the various combinations of production, transmission,distribution and supply functions that electric companies can assume in an unbundled industry. For this analysis, thefollowing equation is used.

Net Effect = (Avoided Cost + Additional Revenues + Price increase) - (DSM Cost + Lost Revenues) (1)

Where:Benefits- Avoided Cost the benefit of avoided costs for energy supply;

- Additional revenues for example from: payments for energy efficiency services from existing or newcustomers; revenues from energy sales to customers who were retained or won as newcustomers due to the offer of energy services (in competitive markets); payments forDSM programme implementation from a dedicated fund.

- Price Increase the effect of a price increase due to incentive regulation;

Costs

- DSM Cost the costs of realising the DSM activity;- Lost Revenues lost revenues due to reduced kWh sales (only from DSM for the own customers).

A spreadsheet has been developed to simulate the impact of hypothetical DSM programmes and services on thedifferent energy companies. This exercise has been made for the eight participating countries in study (Belgium,Denmark, France, Germany, Italy, Portugal, United Kingdom and Sweden). A "reference" or "average" case has beendetermined. In order to simplify the interpretation of the results, we only present the results from this "reference" case,for the simplest hypothetical programme. This programme costs 2 cEUR/kWh, and allows a long-term avoided cost forsociety of 4,7 cEUR/kWh. The energy company carries 1 cEUR/kWh of the cost, but takes only the avoided short-termmarginal costs into account due to the present overcapacity in most of the EU countries. Figure 1 presents the result ofthe net effect resulting from this DSM programme on different energy companies (combinations of traditionalfunctions). The type of price/revenue regulation considered here is a price cap or cost of service/rate of return. Withother types of regulation which we have grouped under the name of "Multiple Driver Target", regulation losses due toreduced sales are reduced or even eliminated.

Fig. 1 - Economic effect of a hypothetical DSM programme in the domestic sector for different types of energycompanies.

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-7,2 -7,2

-4,5

2,2

3,8

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0,2

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-5

-3,5

-0,1

-4,4

-8

-6

-4

-2

0

2

4

6

8

Vertically integrated Distributor/Supplier Pure Supplier Pure Distributor

cEU

r/kW

h

�� DSM Cost and Lost Marginal revenues��

Avoided costs (Short run)Net effectCost of DSM

Net Effect

Cost of DSM1 cEur/kWh

Based on (Wuppertal Institute et al. 2000).

Except for the pure distribution company, even in the short-run perspective, the short-run avoided cost is higherthan cost of the DSM programme. However, under the assumed price cap or rate of return regulation, considering lostmarginal revenues, all companies experience losses unless a special situation, like the following ones, occurs:

- there is a higher avoided cost e.g. the delay of network upgrade;- an additional revenue is given, e.g. customers are won through the improved image created by the DSM

programme;- a policy mechanism is provided. This can be (i) a co-funding from a public benefit charge distribution, which

is investigated in chapter 3, and/or (2) a ratemaking mechanism that removes losses connected to reducedsales, which is the object of chapter 4;

- even if another actor or authority takes action to increase energy efficiency, all companies except the puresuppliers will still loose money, and thus may oppose to such policy for implementing energy efficiency.

It should be noted that the assumptions made are simplistic and that some important effects are not taken intoaccount in the estimation of costs and revenues of the energy companies, e.g. the effect of the timing of the kWh saved.For more details on assumptions, input data and results per country and per type of programme and services seeWuppertal Institute et al. 2000. Furthermore, the cost-effectiveness of the EE&DSM potential is unevenly distributed.This distribution depends on the technology, density, time, climate, service demand and also on the particular policy, aswell as the regulatory and industrial context. These factors are not taken into account in this "average" and aggregated

quantitative evaluation. On the other hand, this uneven distribution is a reason to involve electric companies since theyhave the possibility to identify a number of these situations. Thus, although the analysis presented is inevitablysimplistic, it demonstrates the need for conciliating mechanisms that provide the means to involve energy companiesand ESCOs in the search for capturing the existing potentials.

3. Public Benefit Charges to finance EE&DSM programmes

This chapter deals with schemes that involve Public Benefit Charges (PBC) to finance energy efficiency andDSM programmes, carried out by electric companies, ESCOs or other actors. This mechanism is aimed at conciliatingthe interests of energy companies with a DSM activity as a means to incite the companies to take part in the same. Inthe equation (1), this corresponds to the introduction of an "additional revenue". This "additional revenue" comes froma dedicated fund raised through a public benefit charge applied on all or certain actors of the electricity system.Schemes with PBCs have been experimented in a number of countries with different features. A synthesis of thefunctions and the possible options to assure them is presented in table 1 and 2. The type and amount of EE-DSMservices and programmes to be funded, and, as a consequence, the amount of the fund, will depend on the specific goalstargeted, as part of the accomplishment of a stated energy efficiency policy.

Table 1. Elements for the design of a fund from a public benefit chargeFunctions Possible Actors, Pros and ConsCreation anddesign

• Legislative authorities.• Regulatory authorities.• Energy companies, regulatory and legislative authorities as a result of a negotiated agreement.

Collection of thefund

• if it is levied on the supply price to customers, the supply company is the „natural actor“ since it has the billing contact withthe customer.

• if it is a „wire charge“, the transmission or distribution companies are the best actors.In addition, or as an alternative, the fund can be created through general taxation or a targeted tax (e.g. carbon tax).

Administrationof the funds

• Energy companies with regulatory oversight (Transmission, distribution, supply companies or their association). To adoptthis solution depends heavily on the tradition and the past performance of the energy companies. Accompanyingmeasures are needed, like correct price regulation and standards of performance with regulatory oversight.

Pros: It would reduce administrative costs. It is the solution suggested by Eurelectric. No need for new agency.Cons. If regulation of transmission and distribution or supply to non-eligible customers is wrongly designed, i.e. giving“artificial incentives” to increase sales, energy companies will receive conflicting signals. Retail suppliers in aliberalised market might see the delivery of energy efficiency to customers as being in conflic with their commercialobjectives. Some have no tradition and experience in energy efficiency.

• The Government/state through a State Agency that already exists.Pros. No incompatibilities with public interest objectives.Cons. Possible reluctance to add new specific objectives or activities to an existing agency. Difficulties in rapidly hiringor developing experience. Energy companies might not co-operate if losses as a consequence of programmes run bythe agency are not avoided through correct price regulation.

• The Regulatory Authority is naturally more concerned about the supervision the of sector’s compliance with public serviceobligation and competition issues. However, the environmental concerns are commonly also a stated objective for theregulator’s action.

• The Independent Transmission System Operator (ISO).• Non-profit organisation created for the purpose (e.g. UK with the Energy Saving Trust and Denmark with the Electricity

Saving Trust).Pros. Clarity of objectives and possibility of establishing adequate means.Cons. High start-up and administrative costs. Only feasible if there is a guarantee that the dedicated fund will last.

Design andimplementation

• Existing government/state agency. Will be better for "multiplier oriented" EE programmes, like market transformation ofefficient products, training etc. Pros & Cons: same as for administration of the funds.

of programmes • Energy companies with regulatory oversight (Transmission, distribution, supply companies or their association).Pros. Energy companies have direct contact with customers, (e.g. privileged means of communication through thebilling systems), and information on consumers' energy use patterns, and therefore will better address customer-oriented DSM programmes and energy efficiency services. In some cases (more frequent in the US than in the EU)energy companies have already a considerable experience in delivering EE-DSM to their customers.Cons. Strict rules are needed due to conflicts with commercial objectives if regulation has not been set right. If theyhave poor past performance, their right in using funds should be limited and/or allowed with stricter rules.

• An entrepreneurial organisation that designs and implements DSM programmes created for the purpose like in the UK withthe Energy Saving Trust and Denmark with the Electricity Saving Trust.

Pros. Will be able to address both multiplier- and customer-oriented DSM programmes.Same as for administration of the funds• Energy Service Companies. Strict rules are needed to monitor and verify the actual energy efficiency content of services.• Energy efficiency agencies (local or regional).• Customers' associations.

Table 2 - Characteristics and options for the creation of a fund from a public benefit chargeObjective • Regarding the activity: EE&DSM activities.

• Market transformation towards a self sustaining market for DSM services.• Quantified objectives vs not quantified.

Distribution • Tendering procedure (i.e., the body administrating the funds calls for tenders for implementation of pre-designed standardprogrammes, or for proposals and implementation of large retrofit projects, e.g. in industry).

• Application procedure (i.e., energy companies or other actors can put forward their programme designs and ask for funding).• Direct use, when the fund is administered by energy companies or by an independent body, and used for their own

programmes.Type ofcollection

• Volume based (on kWh) surcharge.Pros. Consistent with the efforts to internalise external costs which are mainly dependent on the amount of energy used.

• Fixed charge per user.Cons. Introduces an important price distortion and would heavily penalise small consumers. Keeps the marginal price ofthe kWh lower.

• From general taxation.Cons: it removes proportionality to energy consumed, it does not give a signal coherent with the 'polluter pays' principle.The level of the funds dedicated to EE may vary over time and is more endangered from changes in the political majority.

Level ofcollection

• Whole sale pool.• Transmission network.• Distribution network.• Final consumers: selected or all consumers.• General taxation.

Experiences with Public Benefit Charges. Schemes with public benefit charges have been experimented in anumber of countries. The different possibilities of designing this mechanism shown in tables 1 and 2 are evident in table3, which summarises the schemes in place in selected countries in the European Union (the 8 participating countries andThe Netherlands). The situation concerning the amount collected and also the overall design of the mechanism hasevolved rapidly, obliging numerous assumptions and averages to make data comparable. Most data used refer to 1998and 1999.

The amounts dedicated to EE&DSM in the selected countries can be compared in a homogeneous way like infigure 2. The levy is expressed in cEUR/kWh and corresponds to the total fund raised divided by the overall electricityconsumption in a given country. It also shows the percentage of this levy over the electricity price calculated for adomestic consumer, before taxes (type Dc, source Eurostat, 1998). The disparity between the countries is evident and itis worth to mention that Denmark, despite the comparatively high amount dedicated to EE&DSM, has one of the lowestelectricity prices in the EU.

In the United States, PBCs are globally higher than in the EU. In some States, PBCs assigned only to energyefficiency reach 3% (Massachusetts, Connecticut). The PBCs for EE&DSM in the states of California andMassachusetts amount to 380 MEuro (Kushler - ACEEE, 2000), which is higher than the amount reported within theEuropean Union (except Spain, Luxembourg, Greece and Ireland) which is 260 MEuro (Wuppertal Institute, 2000). Thesituation regarding energy efficiency in the US is different from the European Union. In the US utilities havetraditionally been given responsibility for energy efficiency by the regulatory commissions. According to (Eto et al.,1998), to give an active role to energy companies (like the administration of funds) should depend on the past andcurrent performance of energy companies. Despite their great experience in DSM, the role of energy companies inadministrating funds and implementing DSM programmes when designing public benefit charges is being reconsidered.In the 18 states with public benefit charges for energy efficiency reported by Kushler, 2000, only 9 are administered byutilities, and this number is expected to decrease.

This trend is evident in California where the Public Utility Commission (CPUC) proposed a different scheme forthe programme funding which “would have transferred public purpose surcharge funding for these programs to the statetreasury from the utilities”. This proposal was vetoed (AB 2461) and the utilities will continue to administer theprogrammes with regulatory oversight. However, the CPUC already announced that it was “opposed to continue withutility administration of energy efficiency programs and will actively pursue the creation of an organisational alternativefor the administration of these programs”. It would further favour the establishment of a legislatively mandated non-profit organisation.

It can be concluded that the design of such mechanisms in the European Union should be analysed carefully andthat there is no general recipe. The situation is certainly very different from country to country and the design,especially the role given to energy companies, should take into consideration the specific situation of the country, and inparticular the past performance of the energy company in end-use efficiency.

Table 3 - Mechanisms involving public benefit charges in European selected countriesCountries Creation and

typeTotal

MeuroCollection of fund Administration Implementation Control Objectives and

achievements.Belgium Levy from

voluntaryagreementVolume based

19 Collection: 40% byproduction; 60% byDis/SupCo.On all consumers.

Energycompanies

Energy companies Energy companies,agreement onreporting withVIREG

Target: save 8 TWh by2005 vs BAUResults: n.a.

Denmark Levy fromagreement.Volume based

30 Collected by DisCosOn all consumers

Discos Discos Not available

Levy fromagreementVolume based

12 Collected by DisCosOn domestic andpublic consumers

Electricity SavingsTrust

Tendering process Disco and DEA Not available

France LevyVolume based

2 On final consumers:- urban 2%;- rural - 0,5%.

FACE committee.Includes centraland localgovernment, EDFand ADEME

Local communities(grid owners),regional authorities,state agencies

Ex-post control isunder consideration

No

Germany Does not exist - - - - - -Italy Does not exist - - - - -Portugal Does not exist for DSM (only for RES and CHP)Sweden Does not exist - - - - -England &Wales.

Obligation(standards) andallowanceFixed percustomer

89 SupCos Sup companieswith regulatoryoversight

Sup companies Ofgem with EST Target:SOP 1: 6103 GWhSOP 2: 2 713 GWhResult:SOP1 - 6675 GWh

TheNetherlands

Allowance fromnegotiatedagreement

120 DisCo/SupCo Sup companies Sup companies Ministry/Utilitiesassociation

Target: n.a..Results: 7,4 TWh in1996, 2,5 Mton CO2

DisCo: Distribution Company; SupCo: Supply Company.

Fig. 2. Funds dedicated to EE&DSM coming from public benefit charges in European selected countries

0,00

0,02

0,04

0,06

0,08

0,10

0,12

0,14

Belgium

Denmark

France

German

yIta

ly

Portugal

Sweden

England & W

ales

The Neth

erlan

ds

cEur

o/kW

h

0,0%

0,2%

0,4%

0,6%

0,8%

1,0%

1,2%

1,4%

1,6%

1,8%

2,0%%

kW

h pr

ice

- Dom

estic

sec

tor (

Dc)cEuro/kWh

% of kWh price - Domestic sector Dc - Taxes exc.

4. Mechanisms to remove the artificial disincentives to DSM and to recover EE-DSM costsand lost revenues

Our description of different ways of funding energy efficiency DSM programmes is based on the assumption thatthe basic regulation scheme is free of “artificial incentives to increase sales” which make the penetration of energyefficiency technologies highly unattractive to energy companies even if this would benefit consumers. If thisprecondition is not met, the effectiveness of any DSM funding mechanism would be seriously affected; energycompanies would receive conflicting signals which would push them towards non participation or low formalengagement.

With restructuring, the monopoly sements, and hence, price regulation, is reduced to the transmission anddistribution networks and, at least for some time, to the supply to non-eligible (captive) customers. In order to fostereconomic efficiency and to avoid artificial incentives to increase kWh sales, price regulation for these market segmentsshould aim to align the evolution of revenues and profits with the evolution of cost drivers. For the price regulation ofthe monopoly activity of the electricity sector, the earliest schemes of Performance Based Regulation are the so-called

Price Cap and Revenue Target. They pose a limit on either one of two fundamental variables in regulation: the(average) price of energy or the total revenues of the energy company.

Pure Price Caps have been identified as a powerful incentive to Energy Companies to increase sales. Under thiskind of regulation larger profits than allowed by the regulator can be obtained when energy sales rise beyond theforecasted level which was used to set prices, since in this case the increase of revenues and profits would be higherthan the increase of costs. This effect holds true even when sales are non-economic, i.e. in the case where it is cheaperfor the customer and for society to save a unit of energy through the use of better end-use technologies, than to generateand distribute one. On the other hand, pure Revenue Targets, while avoiding artificial incentives to increase sales, canlead to price fluctuations when sales levels vary under events which are out of control of the energy company. One mainreason for these drawbacks is the fact that the formulas and the ways they are revised annually are too simple in eithercases. Simplicity is on the one hand advantageous but limits on the other hand the extent to which price or revenueevolution can reflect unit or total cost evolution over time.

Many studies and statistical analysis realised in the last years (OFFER 1999; Politecnico et al. 2000) haveinvestigated network companies evolution of costs over time. These studies identified the correlation of these costs witha number of variables (typically energy sales, number of served customers, grid length) beyond the pure volume of salesused in pure price cap regulation.

A number of regulatory entities have introduced new regulation schemes, which are based on the use of theselarger set of variables to determine the evolution of a revenue target over time. These new regulation schemes havebeen introduced in the United Kingdom in 1994, and in more recent years in Portugal, Norway, New South Wales(Australia) and Italy (for non-domestic captive customers).

We will here follow the nomenclature "Multiple Driver Target" (MDT) schemes introduced under a SAVE study(Politecnico et al. 2000), where these schemes have been analysed, their common features identified, and theirrelationship to pure price and revenue caps shown. A crucial element of implementing MDT regulation is the procedurereconciling actual revenues with allowed revenues calculated on the basis of the development of the actual cost drivers,by correcting any over or underpayments by the customers during the following regulation year.

Single programmes cost-recovery allowance.

When performing an EE-DSM programme, an energy company faces both direct programme costs and a net lossof revenues due to reduced energy sales as a result of DSM, which under many regulatory regimes cannot be recoveredand hence create extremely strong disincentives to this type of activities. These costs and losses can be recoveredthrough the use of a Public Benefit charge as described in chapter 3. The funds generated are then (at least partly,depending on the choices made) transferred to energy companies to pay for approved DSM programmes. Another wayto reach the same result is through the use of tariff mechanisms that allow energy companies to recover EE-DSM costsand not only generation and grid side investments. It should be noted that these two mechanisms are not mutuallyexclusive. These tariff making mechanisms can be divided in three groups.

1. Recovery of direct costs of an EE-DSM programme within tariffs. Direct costs of a DSM programmeinclude planning, implementation, monitoring and evaluation plus the part of the cost of the EE devices whichis borne by the energy company. In the case of Cost-Plus/Rate-of-return regulation, there is a need to explicitlyinclude the energy efficiency programme cost, in the acceptable costs to be recovered through tariffs. In thecase of Performance Based Regulation (e.g., the MDT regulation described above), one should make sure thatDSM costs can be covered outside the cap or target (by an additional term often called “Z term”), so that thiscomponent is not loaded with the same pressure to reduce costs of those components under the cap;

2. Recovery of net lost revenues within tariffs. With a Net Lost Revenue Adjustment (NLRA) mechanism, theenergy company is allowed to recover within tariffs net revenues lost due to a specific DSM programme. Theresult of this mechanism is the insensitiveness of energy company profits to the realisation of DSMprogrammes, due to a rise in the kWh unit price;

3. Giving a positive incentive to perform EE-DSM within tariffs. Recovery of direct DSM costs and net lostrevenues will only achieve that the regulated energy company does not make an economic loss. However, tomake DSM more attractive for the energy company than expanding capacities and sales, a positive incentivecan be envisaged.

One necessary condition for a DSM programme to be eligible to any of those mechanisms is that its costs arelower than the net benefit for society and for the customers. Several rate mechanisms have been developed to allow theenergy companies an adequate return on investments on energy efficiency programmes that is comparable to the returnof alternative investments.

5. The need to combine mechanisms - Experiences from the UK and Denmark

The funding mechanisms analysed in the two previous chapters are just components of an energy efficiencystrategy. To be effective and to avoid undesired effects, they need to be combined with a set of accompanyingmechanisms. These include quantitative objectives for energy savings, a tariff regulation that is free of artificialincentives to increase sales (when applicable), stantardised methods for monitoring, evaluation, reporting, certification

and verification procedures. The empirical analysis carried out by Wuppertal et al. 2000 confirmed that thiscombination of mechanisms is necessary to make DSM effective. In this chapter, two examples are presented wheresuch a combination has been implemented, with the particularity that both included the creation of an independententrepreneurial organisation.

England & Wales. A combination of an obligation, a funding mechanism and an independententrepreneurial organisation. The Energy Efficiency Standards of Performance (SOP) were created in 1994 by theelectricity regulator and requires Public Electricity Suppliers (PESs) to realise a predetermined amount of energysavings. The investment programmes are funded from an allowance of a maximum of £1 per franchise customer peryear (£1,2 for each gas and electricity consumer in the period the SOP3 that runs from 2000 to 2002), included withinthe PESs overall price control. The principal achievements of the two first periods of the Standards of Performance(1994-2000), have been 9,5 TWh of saved energy at a cost of 2,25 cEuro/kWh. The National Audit Office assessed itsbenefits for the nation as a whole to £390M, with total benefits exceeding total costs in the ratio of 2.9:1. Energyefficiency Standards of Performance are actually a mix of mechanisms, giving energy companies both “the duty and theability” to deliver energy efficiency to customers. The duty consists of an obligation to perform EE-DSM programmes,measured in terms of cumulative energy saved by measures during their lifetime. The ability consists in (1) a multipletarget driver ratemaking formula to remove artificial incentives to sales and disincentives to DSM, and (2) an allowanceto recover direct costs. The obligation was transferred to unbundled suppliers with the EESoP 1999-2000.

Fig. 3 - England & Wales. A combination of an obligation, a funding mechanism and an entrepreneurial organisation

Public Suppliers

Offer/Ofgem

Energy Savings Trust

Consumers

Government /State

DSM

CreatesFunds

Co-operation

EvaluationBefore+After

Obligation: Standards of Performance

Informationper project

Maximum Allowance£1 (1,2) /smallcustomer

Financial flow Information flowActor-Actor link Actor-Action link

The Danish Electricity Saving Trust and its funding system. The Electricity Savings Trust was created by theMinistry of Environment and Energy with the objective of reducing CO2 emissions, by 3 Mton by 2008. Thiscorresponds to 8% of today's emissions. The trust's activities comprise conversion from electric heating to CHP ornatural gas, and market transformation activities. It is a private independent entity with a board of 8 members named bythe ministry of environment and energy representing NGOs, municipalities, industry, energy companies and energyconservation expertise. The EST started in 1997, and in 1998 it started to be funded through a volume-based levy of0,08 cEUR /kWh, collected by distribution companies on households and public sector consumers. The total amountcollected is around 12 MEuro per year. Private companies or electricity companies are invited to tender to design andimplement projects. The projects with the highest expected reduction of CO2 emissions at the lowest cost are selected.

Fig. 4 - Danish Electricity Saving Trust and its funding system

DistributionCompanies

Electricity Savings Trust

Consumers

MinistryCreates

EvaluationBefore+After


Levy0,08cEUR/ kWhPublic anddomestic

Financial flow Information flowActor-Actor link Actor-Action link

Tenderingprocedure

Other marketactors

DSM+fuelswitching

MarketTransformation


6. Conclusions and Recommendations

The restructuring process of the electricity sector did not eliminate the necessity for electricity companies tocarry out energy efficiency. Electric companies still have a number of advantages over other actors e.g. the localimplantation, the direct contact with and information on consumers, and, in theory, the integrated view of the least costmix to supply energy services. With restructuring, some possibilities of realising DSM have appeared with theimplementation of re-regulation processes in some countries, and electric companies are trying to become energyservice providers, which could offer DSM services.

However, DSM, even when cost effective to customers and society as a whole, is, in many cases, not profitableto energy companies. This situation occurs on competitive segments, and under some existing tariff regulation schemes(e.g. price cap). DSM is also not interesting for companies that search increased revenues through increased kWh sales.Hence, if public authorities are willing to develop DSM activities, they need to put in place mechanisms to conciliatethe economic interest of energy companies with the realisation of DSM activities. Two "families" of such mechanismshave been analysed: (1) schemes involving a fund raised by a public benefit charge and (2) rate-making strategies thatallow the recovery of DSM costs, including loss of revenues.

The main advantage of a mechanism that involves Public Benefit Charges (PBC) to finance EE&DSMprogrammes is that it is applicable to all market types. It can easily be adapted, for example the distribution process ofthe funds can be easily changed should the performance of electricity companies not be satisfactory. There is also anumber of drawbacks associated with this mechanism: it does not contribute significantly to transform energycompanies into providers of energy efficiency services; its implementation might imply high transaction costs, forexample for tendering and application procedures; it usually requires the establishment of new institutions or newfunctions in existing institutions. Regarding the design of such a mechanism, the main conclusion is that there is nogeneral recipe that can be applied to all countries. It rather depends on the particular situation of the country. Tocontribute to the design of this mechanism, the different options are described and the conditions under which they aremore appropriate are discussed.

The tariff mechanisms to recover DSM costs and loss of revenues can be implemented and controlled by theexisting body in charge of tariff regulation and hence present the advantage of not requiring the creation of a new entity.Recovery of costs through tariffs allows for a great flexibility in the volume of DSM activities since in general theyearly amount to be spent is not limited, given that it is spent for cost effective EE-DSM. This means, however, that nominimum level of DSM investment is set. That it can only be implemented in monopoly segments is the largestlimitation of this mechanism.

The mechanisms analysed in this paper are components of an energy efficiency policy that needs to be combinedwith other measures. This need of combination is confirmed when analysing the situations in the United Kingdom,Denmark or The Netherlands. In addition to the funding mechanisms, other accompanying measures are needed. Theseinclude: a tariff regulation in monopoly segments that does not create artificial incentives to increase sales; quantifiedobjectives for energy savings; and stantardised methods for monitoring, evaluation, reporting, certification andverification procedures.

The study entitled "Completing the market for Least-Cost Energy Services, Strengthening Energy efficiency inthe Changing European Electricity and Gas Markets" (Wuppertal Institute, 2000) has recommended a Europeandirective composed of a comprehensive set of mechanisms. The proposed directive would leave up to the MemberStates to choose the way to achieve the objectives stated and we hope that the analysis provided in this paper willcontribute to the design of the conciliating mechanisms that will certainly be part of the national strategies.

7. References

Wuppertal Institute et al., Completing the market for Least-Cost Energy Services, Strengthening Energyefficiency in the Changing European Electricity and Gas Markets, Wuppertal, Germany: Wuppertal Institute, 2000.

Lopes, C, Nilsson, L., Thomas, S., Verbruggen, A., Linking Reforms and Energy Efficiency to Explore thePossibilities for IRP and DSM in the Liberalized Internal European Electricity Market, Proceedings of the ACEEE 2000Summer Study, Washington, D.C.: American Council for an Energy-Efficient Economy, 2000.

Adnot, J., Lopes. C., Cauret, L., Expanding the electricity supply chain: The provision of active energy servicesin the peculiar French electricity system, in Proceedings of UIE 2000 - Electricity for a sustainable urban development,UIE, Lisbon, 2000.

CEC (Commission of the European Communities)/Eurelectric (eds.), From Electricity Supply to EnergyServices: Prospects for Active Energy Services in the EU, Brussels: CEC/Eurelectric, 2000.

Baggs et al, Compatibility of energy efficiency and competition, Energy Efficiency and Market PlanningWorking Group, Unipede and Eurelectric, 1999.

Eto, J., Goldman, C., Nadel, S, Ratepayer-funded energy-efficiency programmes in a restructured industry :issues and options for legislators, Lawrence Berkeley National Laboratory and American Council for an Energy-Efficient Economy for the US-DoE , LBNL-41479, May 1998.

OFFEM-The Office of Gas and Electricity, Energy Efficiency – A Consultation Paper, July 1999.Koshler, Martin, Summary tables of Public Benefit Programs and Electric utility restructuring, ACEEE,

www.aceee.org, May, 2000.Hamrin, J., Vine, E., Eyre, N., Public Policy Implications of Mechanisms for Promoting Energy-Efficiency an

DSM in Changing Electricity Businesses, Research report n°2, Task VI of the International Energy Agency Demand-Side Management Programme, Center for Resources Solutions, San Francisco, USA, 1998.

http://www.cpuc.ca.gov/Wirl, F., Lessons from Utility Conservation Programmes, in The Energy Journal, Volume 1, N° 1, 2000;

The authors thank the participants of the study "IRP in a changing market" for their contributions, and the EUSAVE programme for funding. The first author thanks the Fundação para Ciência e Tecnologia - Praxis XXI,Subprograma Ciência e Tecnologia, 2nd Quadro Comunitário de Apoio, for the grant given.

http://www.aceee.org/

http://www.cpuc.ca.gov/

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