- Email: [email protected]
The great demand-side bidding debate rages on
T If E G
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E ;\ T D I: M , \ N [) - S I [) 1: B I lJ DIN C D E /l ;\ T I: R 1\ (; I; SON
Editor's note: The following lively critiques were recently sent by Amon) Lovins and Eric Hirst, respectively, to Clzarl/?$ Cicchetti and Bill Hogan at Harvard's Energy & Environmental Policy Center. Cicchetti and Hogan are authors ofa novel and widely /10 ted paper suggesting a new approac11 to dmtand-side bidding. T/leir proposal is, ill essence, tlrat when a uti/ill) pays a custOnlN" all illcentive to save electricity, that CIlstomer should have to repay to the utility the revenue the utility loses as II result of the salling. Lovins and Hirst argue, each quite independently of the otller, tlrat this is a bad idea and, far from preventing possible overirn>estment in end-use efficiency, will perpetuate present underirwestment. At our request, Lovins and Hirst have slightly revised tlleir letters to expand documentation, clarify afew shorthand passages. and define certain ternlS for readers not immersed in tire dcmalldside-bidding debate--an importallt and continuing dialogue in which these commelltaries usefully focus some key concepts at issue.
Professors Charles Cicchetti. and Bill Hogan t::nergy & ~nvironmental Policy Center John F. Kennedy School of Government 79 John F. Kennedy Street. Cambridge MA 02138
27.1.89
Dear Charlie and 'Bill: Your provocative August 1988 paper "Including Unbundled Demand Side Options in Electric Utility Bidding Programs'" (E-88-07)1 reached me in late september at the start of nearly three m'onths' almost constant travelling. I'm therefore sorry not to have an opportunity earlier to congratulate you on its ingenuity and to explain why I think it's misguided and mischievous. It introduces. I believe. a new and untimely level of confusion into the bidding debate just when many regulators were starting to understand it. This confusion arises. I hasten to add, not because your prose isn't admirably clear. bUl r:lther because many readers don't seem to be reading it with enough care and sophistication to understand its mort: perverse implications. In practical effect, your proposal is little marc than the discredited "no-losers test" ("hardly-any-winners test") in new garb. To emphasize first what 1 suspect are among our many important points of agreement: • saving electricity is important for many reasons and should be strongly encouraged up to its long-run-marginal-cost-effective-including-externalitieS2 limits; • fixed rebates for efficiency have two disadvantages -- paying more than necessary for some sayings. and not fostering competition between providers and between technologies (just as PURPA'S fixing of full avoided costs tended to inflate the prices of cheap supply up to that level. and gave providers little incentive to compete with each other); • ratepayers will be better off if producers do not capture all the rent. as occurred under stricl-avoided-cost PURPA buybacks of private supply;
I pale relerencel here are to your arillnal Harvard typelcript edition. J'I1\ srateful to Ralph Cavanarh, Eric Hint, Imd John PlunkeU fo)r helpful conunentl, but am 101el)' rupon.ible for theae viewi. 'Wouldn't that make .. IT..t Gennan compound .djedi"..? I ' ,l ~
34
,~ NOW MAS S
C R ! ! It R 0 AD. S NOW MAS S • COL 0 R ADO {303J 927·3851. 927.312'
5 I 6 S4 • 9 I9 ~
The Elcctric.ey Journal
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THE GREAT DEMAND-SlDE BIDDING DEBATE RAGES ON
2
• debates about how much electricity can be saved, at what cost, should be settled not by abstract debate but empirically, in a competitive energy-service market. These considerations lead naturally to demand-side, or, as I'd prefer, all-options bidding. 1 think that's a good idea·, and may indeed, around 1983 and earlier, have invented it. As to your proposed way of doing the bidding: stripped to essentials, your paper seems to me to suggest that revenue loss (reduced customer contribution to utility margins) exists, is a serious problem, and should be eliminated by charging the participant lor all of it. The customer who saves electricity with a utility's financial help would, to put it baldly, pay the utility the same bill as be/ore, even though she is using less electricitY. (It's interesting to imagine what the bizarre analogy on the supply side would look like!) Let's ignore the most obviously fatal objection to your scheme: that it abjectly and risibly fails what Dave Moskovitz and others currently exposed to journalistic scrutiny often call the Front-Page Test. ("UTILITY PENALIZES CUSTOMERS FOR SAVING ELECTRICITY. 'I bought a more efficient refrigerator to try to cut my electric bill,' squawked Mrs. O'Leary, 'and you know what those bastards did? They say I'm costing them so much money that they're going to keep my bill from going down, even though I'm now using less. Who's the idiot that dreamed this up?'", etc.) I can't imagine a politicany accountable regulator risking such headlines. Drawing a curtain of charity over this possibility, though, lel's go to the merits.
Critical assumptions To start with, you're probably aware of my frequently espoused view" that ;n practical programs (as opposed to theoretical microexamples), revenue loss is usually erased by some combination of service-demand growth, depreciation, opportunity to pay fixed costs with saved operating costs (when the end-use efficiency is achieved at a cost below the utility's short-run marginal cost, as it usually can be with modern technologies), opportunity to reduce present-valued interest accrual by prepaying debt, and increased revenue from new export opportunities presented by the newly freed-up capacity. Let us, however, ignore all that and assume for present purposes that revenue loss exists, is common, and is a real problem. The specific problem your paper then seeks to address is that economically inefficient purchases of negawatts may be made, thereby increasing present-valued costs of electrical service. This is, I agree~ a theoretical possibility;f • negawatts are very costly, • the utility pays essentially all the costs of obtaining tbem while the customer pays essentially none, • the customer's information/transaction costs are negligible, and • utility and customer invest under the same discount rate. In reality, however, virtually the opposite conditions obtain:
3S~ric:.\IY apeuinl,!lll revenue lou, i.e., ·dem&nd reduc:.&ion lit (rel&il t&rift - yuiable cod ± fuel-&djultmen&-c1aule errect), &djulted for the prolum COlt or achieYing the layinl"' and for tax ereeetl or other diatortionl. "See
~ my S-p&ge memo 'SaYine Electricity Doeln't Have to M.&n Railing Ratel"
RMI *U88·16. U po"tpaid.
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3 • properly chosen negawatts are actually very cheap5, • most programs leave the customer to pay much (or, in the commercial and industri~ al sectors, most -- commonly -70-90%) of the cost, • information/transaction costs to most customers are prohibitively high (unless reduced by e.g. utility intervention, which tends to cost much less than it saves), and • implicit discount rates for energy-saving investments are typically an order 0/ magnitude higher for utilities than for their customers, of any class. These discrepancies underpin my view that overbuying negawatts is not a real problem. It's a problem I'd love for us to have but doubt we ever will (and if we do, we should deal with it then, not now). It's the kind of problem that reinforces some uncharitable people's view of economists as people who lie awake nights worrying about whether what works in practice can possibly work in theory6. Your analysis appears to assume, inconsistently, that the market for energy-saving activities and equipment is imperfect enough to need utility intervention, yet at the same time so nearly perfect that customers will do and act upon ineffably precise reckonings leading them to buy lots of efficiency at costs very slightly above marginal supply costs (plus their unknowable externality premium if any). I've never met such a customer. You seem to agree that the big incentive of avoiding the retail tariff isn't currently enough to get most customers to bUy efficiency. That's the "payback gap" that justifies utility intervention in the first place, and indeed requires it for societal investment efficiency1. But you then propose to take away that big incentive and leave behind only the [often small] incentive of the utility rebate, thus leaving the customer less likely to act than beforel That's hardly helpful to what you say you're trying to achieve.
The" payback gap" Under what our Soviet friends might call "actually existing market conditions," an avoided 8¢/kW-h average-cost tariff only motivates the customer to buy savings costing on the order of O.8¢/kW-h. That's a severe underinvestment in negawatts. Why does it occur? Because for energy-saving investments, the customer's implicit real discount rate is of order 60-IOO+%/year real (corresponding to a -1-2' year payback horizon for 10ng6To mention a few practical example., Southern California Edl.on Co. In tha mid-l~O. w.. routinely buylnK bree .Iactrical .avlnp at proS"am c:oll. on the order of O.lf/kW-h for commercial and indutlrial aedonl or O.3¢/kW-h for all .ectonl combined. The .ocletal coat w.. 'everalCold hiaher, but 'till
all
two of the beet economiet. In the
1 phil Sharp'. and the NWPPC'. excellent Aucult 1988 Electricity Journal plecel Ihow that they concur.
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TI,e Electricity ]ol/ntal
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THE GREAT DEMAND-SIDE BIDDING DEBATE RAGES ON
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lived measures), compared to the utility's -5-6%/year real • Thus the customer buys savings costing only up to about a tenth as much as the avoided tariff. That is the real world in which customers, utilities, and regulators now operate. It is a major reason for utilities' offering efficiency incentives in the first place. The underinvestment in efficiency becomes less severe if part of the benefit which the customer sees is a high-certainty, up-front utility payment, such as the 12¢/kW-h bidderived utility incentive you describe9 (bringing the customer's total potential benefit in the previous example to 20¢/kW-h). If the incentive is very easy to get, it will probably motivate the customer to buy savings costing somewhat more than 2¢/kW-h (a tenth of the total benefit) -- an expression of why the incentive is worthwhile. (An incentive paid over time like the avoided tariff, however, is not so attractive and may not be worth more than an equivalent avoided tariff.) But even with the incentive, the customer will probably still buy savings only up to a cost far below the tariff or the utility's marginal cost -- i.e., will continue to underinvest in efficiency from the societal perspective -- because the incentive does not overcome all the reasons for the customer's relatively high discount rate lO • In fact, I object to your whole characterization, l la Larry Ruff and Paul Joskow, of ·paying the participant twice for the same. saving: l l The utility is not compensating the participant; it is instead obtaining the cheapest resource for its system by using the cheapest inducement it can devise to influence the customer's purchase so as to minimize total societal cost. Your rhetoric here is akin to Ken Costello's pejorative references to utility rebates as "subsidizing" efficiency. They're not a subsidy but an investment, made because they're cheaper than any alternative investment to meet the obligation to serve. Similarly, your discussion of the "no-losers· test on p. 7 may, I fear, reinforce Ruff's deliberately fostered confusion, in the minds even of some regulators, between this distributional-equity test and your correct criterion of [societal] economic efficiency 12.
8R .Jph Cav""alh, ,,",onl( othen, hu exhaudively documented thi. obeen-ed -lOx payback sap. I'm not eayinc \l laclte a rationlll buie -- only that it leade to horrendoue eocietal mi. allocation. if not correded. You, however, wrilale around the point at p. 6, n. 16, by tacitly ","umlna that the cuetomer'. diecount rate il a aood approximation 10 acceptable eocietal and utility di.count rat... .....uminl thi. doee nol make It .0, you .imply ienore the abundant empirical evidence of an order-oC-m~enitudedirrerence in the.. diecount ratu. 9In a practical program, lhi. would be con.idered an extremely hiah incentive, even if the 12C/kW-h payment were levelbed like the tariff rather than paid in a lump .um up front. The hhl'he.t actual offer of which I am aware, in a limited eubcla.. oC cue. in the Hood River County relrofit experiment, wae an up-front one-time payment of Sl.1S per fial-year kW-h uved. That corre.pond. for a 30-y meuure (at a 5'!t,hear ru.1 diecount rate) to 7.5¢/IcW-h. Moet actuallncentivee are at leut an order of maanitude lower than that. lOTheee include -- all relalive to the utility -- hllh Information coet, limited credibility of information and warrantabilily of vendon and Inltallen, whu.le factorW of implementalion, lack of encin.erine ekill., brifr uncertaintiee introduced by power-marketinll' procrame. undivenified riek portfolio, uncertain future cuhnow, and illiquidity of the money euNt in efficiency caine. 11Many reaulatory juri.diction. (~, NYPSC, II June 1988 Opinion & Order in Caee 29409, at pp. 36-37) and the Northweel Power Planninc Council have a1eo explicitly rejected lhie wdouble-payment" model.
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12At p. 8, n. 20, you quote my 19a. NARUC epcech to the effect that ·a kilowatt-hour .aved b juet like a kilowatt-hour lenerated.•.•o they ehould be treated alike: and you de.crib. thie eymmetry principle u ".uperficially plau.ible but nawed.w Your conclueion lhatlt'. nawed I., ... I araue here, nawed.
March 1989
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• T 11 E G R Ell T D 1: M II N n - SID 1: BID n 1 N G D F. B II T E R II G E SON 5
Other problems
Furthermore, your examples assume that marginal cost exceeds average price. Where the opposite obtains (as the nuclear advocates hope it will someday, and as it indeed may with advances like steam-injected gas turbines)13, your scheme offers customers no reason to treat with the utility at all, because it can offer them no incentive 1• - - only the avoided retail tariff, which the payback gap renders a manifestly inadequate incentive right now. In fact, in this case your scheme appears to me to become a simple no-losers test -- a well-known guarantee of economically inefficient societal investment Ui • Another strong objection to your proposal, which I understand Eric Hirst has advanced, is that it puts all risk on the customer and largely removes the utility's incentive fOT achieving (a) actual savings, and (b) cheap savings. (In fact, absent some mechanism like ER.AM16• no utility outside California reliably has such an incentive today; on the contrary, its most profitable strategy is generally to maximize its spending on efficiency measures but ensure they don't actually save any energy.) Unless the utility shares costs and risks -- and shares rewards for success, not effort -- with the participating customers. we'll be back to the worst results of solar tax credits: goldplating, lousy equipment, unaccountable performance, charlatans, you name it. At a time when diehard advocates of more central stations are continuing to claim that efficiency can't be relied upon to work, we hardly need regulatory schemes that are virtually certain to produce that result. I also agree with Ralph Cavanagh's observation that the participant's repayment of lost revenue to the utility further distorts the tariff structure: being in effect a fixed service charge, it makes a flat tariff look more like a declining-block one, thus reducing the customer's deeremental return to efficiency investments and the incentive to make them. It would be useful for you to point out, in discussing the concept of the energy-service
business (e.g. at p. 10), that a utility can sell efficiency without necessarily metering and 13And u you contemplate at p. 6, n. 15; but your text impliu there, wronely, that inveltine in enerlY -avin,.. will then be economically inefficient. Th"-t il not, I think, cornet 10 lonl aa the locietal COlt of the ..yinlt I. Ie.. than the utility'. Ihort-run mar~nal colt: .uch inv,"tmenta are ahny. worthwhile, reltardle.. of how much capacity the utility hu and regardlea. of the relationlhip between electricity price and marcinal coat. So lonl u it il cheaper on the marcin to eave electricity than to make it (even in exi.Unlt plante), one Ihould alwayl do 10, becaule capacity, includinC overcapacity, il a lunk COlt, but the efficiency inveltment .tilleavel mar~nal variable COlte. l(Except perhapI, in principle, the gruter certainty of the price the utility can offer, compared with the volatility of normal retail rat... I luppale that, on the PURPA analolY, one micht alia Ipeculate about the utilitY'1 ability to front!olld the payment Itream. But if we pureue thil analogy very far in licht ofCalitomia'a experience, there ie reuon for concern that utilitiea could later try to abroeate or complicate good-faith contrl'cU which lucceed beyond their wildelt dreama. 16My mOlt detl'i1ed critique of thl't line of arcument ie not your p. 7, n. 17 three-eentence quotation, but rather March 11186 reaponae to COltello (..p. pp. 1-11): RMI Publicatio~ *U86-'1, 13 pacee, $5 pOltpaid.
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16The California PUC'a Electric Revenue Adjultment Mechanilm, currently under attack but .till in force for all rate clu.u, decouplee utiliti..' profite from their lal.. by uling a balaneine account to make them whol.. Cor revenue ahortfall. if they ..II Ie.. than projected or to recapture exce..ive profit. if they aell more than projected. Thil limple mechani.m alia protecta utilitiea from f1uctuationa in weather, bu"in,," conditiona, etc., on which there'l no public-policy reuon to make their profile dependent. It correctl the inadvertent, perve"e incentive to aell more. ari.ing from the circumatance that when reculators eet an allowed rate of return, the way they actually enforce it il to let an electricity price bued on projected IIlel, yieldinr more profit to utilitiee that .ell more. The NARUC Conlervation Committee on 26 July 1988 "unanimoul1y aereed that adju.tmenta mUlt be ml'de to the ratemaldnr Connula to overcome /theJ...inherent dilincentive" that "reduced Ialel Ilead ,toJ...reduced profit•."
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The Electricity JOllnUlI
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selling an energy service such as comfort or torque. It can instead sell (a) electricity, plus (b) any needed and profitable combination of information, design, project management, equipment, installation, finance (usually the key element), operation, maintenance, monitoring, and updating ·that will result in an improvement of the customer's efficiency in using the electricity still sold. Such information/financial services are easy to "meter."
An innovation we don't need Finally, I don't see what your conceptually complex scheme offers that ERAM doesn't. seems very successful in removing the gaming of demand forecasts and in removing utilities' incentive (disincentive) to sell more (less) than ·projected. Its net rate effect. over its six years' operation, has averaged -- among much wider swings -- one fourth of one percent 17 , which is so far down in the noise that it shouldn't worry even an economist. let alone a customer. The two extra elements needed seem to me to be:
ERAM
• exemplary rewards (such as Moskovitzian incentive regulation 18, or letting utilities keep as extra profit part of what they save their customers); and • making saved electricity into a commodity subject to the same mechanisms that make other commodity markets work -- trading and fungibility in time and space, secondary markets, derivative instruments such as futures and options, arbitrage, etc. Most of these techniques, which I've been proposing for years, have just started to be seriously proposed or successfully used in the past half-year. These are both consistent with our shared goal of efficient market function. Or am I missing something obvious? please let me know how.
If you think I've misinterpreted your proposal,
With best wishes for an efficient and creative New Year, Cordially, ,4~·\":\-o.1
Amory B. Lovins Director of Research cc: Bradford, Cavanagh, Counihan, Hirat. Mo,kovib. Nicholson, Steh:er, Totten, Wiel
101"
i7 Even thia pretax, and included weather and economic Ouduationa .. well .. the effeda of efficiency programa. The evaluation ia in California PUC Diviaion of Ratepayer Advocatea, "Report on the 3R.'1 Proceeding (1.86-10-001),· October 1988. at Table 17.
l~David MOlkovit. of the Maine PUC haa propoaed adjuating utilities' rate of return, up or down within a twopercentage-point range, according to how well they control averaee cuatomer billl compared to corre.ponding bill. of an -ind..x group" of p ....r utilities aubject to aimilar weather, macroeconomic conditiona. and collective fuel mix. That ia. regulaton. lUI Cavanagh pula it, would adjuat "each utility'. profita depending on ita ability to outperform limilarly .Huated uliliti...• ("Commenta of the Natural RelOun:u Defen'e Council on New Directiona for the Commi..ion'. ·SR.·.· Proceeding.· 12 January 1989 filing with California PUC proceeding #1.86-10-001.)
Marc1l1989
39
T 11 E G lo? I: A T D I: M ;\ N [) - SID I: H 1 lJ
,
¢/kW·h (1986 $Ievelized at a 5%/y real discount rale)
1 N G nEB A T J: nAG E SON
Space Heating Residential Process Hea\ \ -
3-
2-
Water Heating (Passive Solar)
Electrolysis Industrial Process Heat
1-
J)
\
""'\ Cooling Electronics _""'....;_ _..;..... Drivepowe~ " '"Lighting HVAC\
Total U.S. electricity consumption in 1986 = 2,306 lW-h \
D+------...;..~=------_,_-----r_----_.---...:...--1SOD 2000 IlJoo SOD
Lighting
nv·h
-1-
A Preliminary Estimate of the Full Practical Potential for Retrofit Savings of U.S. Electricity at Average Cost -0.6 ¢IkW-h
Prellmlaary estimate of the supply curve for U.S. electrical end-use efficiency impronmeats at aa anraae cost -O.6C/kW-b. Please note that: . • For simplicity. measures applicable to each end-use have been lumped into a single . package rather than listed in individual sequence of marginal cost. • The curve shows. at this cost level, a potential to save -75% of U.S. electricity at an average cost of -O.6¢/kW-h and a marginal cost of -3¢/kW-h. or to save -50+% at a net average cost of zero. (This is because the cost of lighting retrofits -- which is on average negative, because maintenance costs avoided by the customer more than pay for the retrofit -- can be used to offset the small positive costs of many nonlighting measures. The combined average cost does not exceed zero until savings are well in excess of 50%.) • The list of efficiency measures considered is not complete; higher-cost options were excluded in each end-use, and including them would increase total savings. • No load management, lifestyle change. or further technological progress is included. The end-use services provided are unchanged or (often) qualitatively improved. • TOlal practical retrofit potential is shown. taking account of eligibility factors of the building and equipment stock. How much of that potential is aClually cap-· tured is a policy variable. The potential in new installations would be slightly larger and significantly cheaper -- in commercial buildings, often of negative net cost because of capital-cost savings from downsizing mechanical systems. • The cosl and performance data used are empirical, based only on technologies commercially available in 1988. Exhaustive technical documentation is available from Rocky Mountain Institute's COMPETITEK quarterly update service. • Analytic refinement of these calculations is continuing, and will undoubtedly change many delails of the curve, though not its general shape. The estimated uncertainty in the curve shown (as of November 1988) tOlals about ±IO percentage points in total quantity and a factor of two in average cost. but the average cost is believed to be almost certai~ly
40
The Electricity ]OllnUlI
I~
E ;\ T D I: M , \ N [) - S I [) 1: B I lJ DIN C D E /l ;\ T I: R 1\ (; I; SON
Editor's note: The following lively critiques were recently sent by Amon) Lovins and Eric Hirst, respectively, to Clzarl/?$ Cicchetti and Bill Hogan at Harvard's Energy & Environmental Policy Center. Cicchetti and Hogan are authors ofa novel and widely /10 ted paper suggesting a new approac11 to dmtand-side bidding. T/leir proposal is, ill essence, tlrat when a uti/ill) pays a custOnlN" all illcentive to save electricity, that CIlstomer should have to repay to the utility the revenue the utility loses as II result of the salling. Lovins and Hirst argue, each quite independently of the otller, tlrat this is a bad idea and, far from preventing possible overirn>estment in end-use efficiency, will perpetuate present underirwestment. At our request, Lovins and Hirst have slightly revised tlleir letters to expand documentation, clarify afew shorthand passages. and define certain ternlS for readers not immersed in tire dcmalldside-bidding debate--an importallt and continuing dialogue in which these commelltaries usefully focus some key concepts at issue.
Professors Charles Cicchetti. and Bill Hogan t::nergy & ~nvironmental Policy Center John F. Kennedy School of Government 79 John F. Kennedy Street. Cambridge MA 02138
27.1.89
Dear Charlie and 'Bill: Your provocative August 1988 paper "Including Unbundled Demand Side Options in Electric Utility Bidding Programs'" (E-88-07)1 reached me in late september at the start of nearly three m'onths' almost constant travelling. I'm therefore sorry not to have an opportunity earlier to congratulate you on its ingenuity and to explain why I think it's misguided and mischievous. It introduces. I believe. a new and untimely level of confusion into the bidding debate just when many regulators were starting to understand it. This confusion arises. I hasten to add, not because your prose isn't admirably clear. bUl r:lther because many readers don't seem to be reading it with enough care and sophistication to understand its mort: perverse implications. In practical effect, your proposal is little marc than the discredited "no-losers test" ("hardly-any-winners test") in new garb. To emphasize first what 1 suspect are among our many important points of agreement: • saving electricity is important for many reasons and should be strongly encouraged up to its long-run-marginal-cost-effective-including-externalitieS2 limits; • fixed rebates for efficiency have two disadvantages -- paying more than necessary for some sayings. and not fostering competition between providers and between technologies (just as PURPA'S fixing of full avoided costs tended to inflate the prices of cheap supply up to that level. and gave providers little incentive to compete with each other); • ratepayers will be better off if producers do not capture all the rent. as occurred under stricl-avoided-cost PURPA buybacks of private supply;
I pale relerencel here are to your arillnal Harvard typelcript edition. J'I1\ srateful to Ralph Cavanarh, Eric Hint, Imd John PlunkeU fo)r helpful conunentl, but am 101el)' rupon.ible for theae viewi. 'Wouldn't that make .. IT..t Gennan compound .djedi"..? I ' ,l ~
34
,~ NOW MAS S
C R ! ! It R 0 AD. S NOW MAS S • COL 0 R ADO {303J 927·3851. 927.312'
5 I 6 S4 • 9 I9 ~
The Elcctric.ey Journal
.
.
THE GREAT DEMAND-SlDE BIDDING DEBATE RAGES ON
2
• debates about how much electricity can be saved, at what cost, should be settled not by abstract debate but empirically, in a competitive energy-service market. These considerations lead naturally to demand-side, or, as I'd prefer, all-options bidding. 1 think that's a good idea·, and may indeed, around 1983 and earlier, have invented it. As to your proposed way of doing the bidding: stripped to essentials, your paper seems to me to suggest that revenue loss (reduced customer contribution to utility margins) exists, is a serious problem, and should be eliminated by charging the participant lor all of it. The customer who saves electricity with a utility's financial help would, to put it baldly, pay the utility the same bill as be/ore, even though she is using less electricitY. (It's interesting to imagine what the bizarre analogy on the supply side would look like!) Let's ignore the most obviously fatal objection to your scheme: that it abjectly and risibly fails what Dave Moskovitz and others currently exposed to journalistic scrutiny often call the Front-Page Test. ("UTILITY PENALIZES CUSTOMERS FOR SAVING ELECTRICITY. 'I bought a more efficient refrigerator to try to cut my electric bill,' squawked Mrs. O'Leary, 'and you know what those bastards did? They say I'm costing them so much money that they're going to keep my bill from going down, even though I'm now using less. Who's the idiot that dreamed this up?'", etc.) I can't imagine a politicany accountable regulator risking such headlines. Drawing a curtain of charity over this possibility, though, lel's go to the merits.
Critical assumptions To start with, you're probably aware of my frequently espoused view" that ;n practical programs (as opposed to theoretical microexamples), revenue loss is usually erased by some combination of service-demand growth, depreciation, opportunity to pay fixed costs with saved operating costs (when the end-use efficiency is achieved at a cost below the utility's short-run marginal cost, as it usually can be with modern technologies), opportunity to reduce present-valued interest accrual by prepaying debt, and increased revenue from new export opportunities presented by the newly freed-up capacity. Let us, however, ignore all that and assume for present purposes that revenue loss exists, is common, and is a real problem. The specific problem your paper then seeks to address is that economically inefficient purchases of negawatts may be made, thereby increasing present-valued costs of electrical service. This is, I agree~ a theoretical possibility;f • negawatts are very costly, • the utility pays essentially all the costs of obtaining tbem while the customer pays essentially none, • the customer's information/transaction costs are negligible, and • utility and customer invest under the same discount rate. In reality, however, virtually the opposite conditions obtain:
3S~ric:.\IY apeuinl,!lll revenue lou, i.e., ·dem&nd reduc:.&ion lit (rel&il t&rift - yuiable cod ± fuel-&djultmen&-c1aule errect), &djulted for the prolum COlt or achieYing the layinl"' and for tax ereeetl or other diatortionl. "See
~ my S-p&ge memo 'SaYine Electricity Doeln't Have to M.&n Railing Ratel"
RMI *U88·16. U po"tpaid.
J
~--------March 1989 35
3 • properly chosen negawatts are actually very cheap5, • most programs leave the customer to pay much (or, in the commercial and industri~ al sectors, most -- commonly -70-90%) of the cost, • information/transaction costs to most customers are prohibitively high (unless reduced by e.g. utility intervention, which tends to cost much less than it saves), and • implicit discount rates for energy-saving investments are typically an order 0/ magnitude higher for utilities than for their customers, of any class. These discrepancies underpin my view that overbuying negawatts is not a real problem. It's a problem I'd love for us to have but doubt we ever will (and if we do, we should deal with it then, not now). It's the kind of problem that reinforces some uncharitable people's view of economists as people who lie awake nights worrying about whether what works in practice can possibly work in theory6. Your analysis appears to assume, inconsistently, that the market for energy-saving activities and equipment is imperfect enough to need utility intervention, yet at the same time so nearly perfect that customers will do and act upon ineffably precise reckonings leading them to buy lots of efficiency at costs very slightly above marginal supply costs (plus their unknowable externality premium if any). I've never met such a customer. You seem to agree that the big incentive of avoiding the retail tariff isn't currently enough to get most customers to bUy efficiency. That's the "payback gap" that justifies utility intervention in the first place, and indeed requires it for societal investment efficiency1. But you then propose to take away that big incentive and leave behind only the [often small] incentive of the utility rebate, thus leaving the customer less likely to act than beforel That's hardly helpful to what you say you're trying to achieve.
The" payback gap" Under what our Soviet friends might call "actually existing market conditions," an avoided 8¢/kW-h average-cost tariff only motivates the customer to buy savings costing on the order of O.8¢/kW-h. That's a severe underinvestment in negawatts. Why does it occur? Because for energy-saving investments, the customer's implicit real discount rate is of order 60-IOO+%/year real (corresponding to a -1-2' year payback horizon for 10ng6To mention a few practical example., Southern California Edl.on Co. In tha mid-l~O. w.. routinely buylnK bree .Iactrical .avlnp at proS"am c:oll. on the order of O.lf/kW-h for commercial and indutlrial aedonl or O.3¢/kW-h for all .ectonl combined. The .ocletal coat w.. 'everalCold hiaher, but 'till
all
two of the beet economiet. In the
1 phil Sharp'. and the NWPPC'. excellent Aucult 1988 Electricity Journal plecel Ihow that they concur.
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TI,e Electricity ]ol/ntal
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THE GREAT DEMAND-SIDE BIDDING DEBATE RAGES ON
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lived measures), compared to the utility's -5-6%/year real • Thus the customer buys savings costing only up to about a tenth as much as the avoided tariff. That is the real world in which customers, utilities, and regulators now operate. It is a major reason for utilities' offering efficiency incentives in the first place. The underinvestment in efficiency becomes less severe if part of the benefit which the customer sees is a high-certainty, up-front utility payment, such as the 12¢/kW-h bidderived utility incentive you describe9 (bringing the customer's total potential benefit in the previous example to 20¢/kW-h). If the incentive is very easy to get, it will probably motivate the customer to buy savings costing somewhat more than 2¢/kW-h (a tenth of the total benefit) -- an expression of why the incentive is worthwhile. (An incentive paid over time like the avoided tariff, however, is not so attractive and may not be worth more than an equivalent avoided tariff.) But even with the incentive, the customer will probably still buy savings only up to a cost far below the tariff or the utility's marginal cost -- i.e., will continue to underinvest in efficiency from the societal perspective -- because the incentive does not overcome all the reasons for the customer's relatively high discount rate lO • In fact, I object to your whole characterization, l la Larry Ruff and Paul Joskow, of ·paying the participant twice for the same. saving: l l The utility is not compensating the participant; it is instead obtaining the cheapest resource for its system by using the cheapest inducement it can devise to influence the customer's purchase so as to minimize total societal cost. Your rhetoric here is akin to Ken Costello's pejorative references to utility rebates as "subsidizing" efficiency. They're not a subsidy but an investment, made because they're cheaper than any alternative investment to meet the obligation to serve. Similarly, your discussion of the "no-losers· test on p. 7 may, I fear, reinforce Ruff's deliberately fostered confusion, in the minds even of some regulators, between this distributional-equity test and your correct criterion of [societal] economic efficiency 12.
8R .Jph Cav""alh, ,,",onl( othen, hu exhaudively documented thi. obeen-ed -lOx payback sap. I'm not eayinc \l laclte a rationlll buie -- only that it leade to horrendoue eocietal mi. allocation. if not correded. You, however, wrilale around the point at p. 6, n. 16, by tacitly ","umlna that the cuetomer'. diecount rate il a aood approximation 10 acceptable eocietal and utility di.count rat... .....uminl thi. doee nol make It .0, you .imply ienore the abundant empirical evidence of an order-oC-m~enitudedirrerence in the.. diecount ratu. 9In a practical program, lhi. would be con.idered an extremely hiah incentive, even if the 12C/kW-h payment were levelbed like the tariff rather than paid in a lump .um up front. The hhl'he.t actual offer of which I am aware, in a limited eubcla.. oC cue. in the Hood River County relrofit experiment, wae an up-front one-time payment of Sl.1S per fial-year kW-h uved. That corre.pond. for a 30-y meuure (at a 5'!t,hear ru.1 diecount rate) to 7.5¢/IcW-h. Moet actuallncentivee are at leut an order of maanitude lower than that. lOTheee include -- all relalive to the utility -- hllh Information coet, limited credibility of information and warrantabilily of vendon and Inltallen, whu.le factorW of implementalion, lack of encin.erine ekill., brifr uncertaintiee introduced by power-marketinll' procrame. undivenified riek portfolio, uncertain future cuhnow, and illiquidity of the money euNt in efficiency caine. 11Many reaulatory juri.diction. (~, NYPSC, II June 1988 Opinion & Order in Caee 29409, at pp. 36-37) and the Northweel Power Planninc Council have a1eo explicitly rejected lhie wdouble-payment" model.
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12At p. 8, n. 20, you quote my 19a. NARUC epcech to the effect that ·a kilowatt-hour .aved b juet like a kilowatt-hour lenerated.•.•o they ehould be treated alike: and you de.crib. thie eymmetry principle u ".uperficially plau.ible but nawed.w Your conclueion lhatlt'. nawed I., ... I araue here, nawed.
March 1989
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• T 11 E G R Ell T D 1: M II N n - SID 1: BID n 1 N G D F. B II T E R II G E SON 5
Other problems
Furthermore, your examples assume that marginal cost exceeds average price. Where the opposite obtains (as the nuclear advocates hope it will someday, and as it indeed may with advances like steam-injected gas turbines)13, your scheme offers customers no reason to treat with the utility at all, because it can offer them no incentive 1• - - only the avoided retail tariff, which the payback gap renders a manifestly inadequate incentive right now. In fact, in this case your scheme appears to me to become a simple no-losers test -- a well-known guarantee of economically inefficient societal investment Ui • Another strong objection to your proposal, which I understand Eric Hirst has advanced, is that it puts all risk on the customer and largely removes the utility's incentive fOT achieving (a) actual savings, and (b) cheap savings. (In fact, absent some mechanism like ER.AM16• no utility outside California reliably has such an incentive today; on the contrary, its most profitable strategy is generally to maximize its spending on efficiency measures but ensure they don't actually save any energy.) Unless the utility shares costs and risks -- and shares rewards for success, not effort -- with the participating customers. we'll be back to the worst results of solar tax credits: goldplating, lousy equipment, unaccountable performance, charlatans, you name it. At a time when diehard advocates of more central stations are continuing to claim that efficiency can't be relied upon to work, we hardly need regulatory schemes that are virtually certain to produce that result. I also agree with Ralph Cavanagh's observation that the participant's repayment of lost revenue to the utility further distorts the tariff structure: being in effect a fixed service charge, it makes a flat tariff look more like a declining-block one, thus reducing the customer's deeremental return to efficiency investments and the incentive to make them. It would be useful for you to point out, in discussing the concept of the energy-service
business (e.g. at p. 10), that a utility can sell efficiency without necessarily metering and 13And u you contemplate at p. 6, n. 15; but your text impliu there, wronely, that inveltine in enerlY -avin,.. will then be economically inefficient. Th"-t il not, I think, cornet 10 lonl aa the locietal COlt of the ..yinlt I. Ie.. than the utility'. Ihort-run mar~nal colt: .uch inv,"tmenta are ahny. worthwhile, reltardle.. of how much capacity the utility hu and regardlea. of the relationlhip between electricity price and marcinal coat. So lonl u it il cheaper on the marcin to eave electricity than to make it (even in exi.Unlt plante), one Ihould alwayl do 10, becaule capacity, includinC overcapacity, il a lunk COlt, but the efficiency inveltment .tilleavel mar~nal variable COlte. l(Except perhapI, in principle, the gruter certainty of the price the utility can offer, compared with the volatility of normal retail rat... I luppale that, on the PURPA analolY, one micht alia Ipeculate about the utilitY'1 ability to front!olld the payment Itream. But if we pureue thil analogy very far in licht ofCalitomia'a experience, there ie reuon for concern that utilitiea could later try to abroeate or complicate good-faith contrl'cU which lucceed beyond their wildelt dreama. 16My mOlt detl'i1ed critique of thl't line of arcument ie not your p. 7, n. 17 three-eentence quotation, but rather March 11186 reaponae to COltello (..p. pp. 1-11): RMI Publicatio~ *U86-'1, 13 pacee, $5 pOltpaid.
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16The California PUC'a Electric Revenue Adjultment Mechanilm, currently under attack but .till in force for all rate clu.u, decouplee utiliti..' profite from their lal.. by uling a balaneine account to make them whol.. Cor revenue ahortfall. if they ..II Ie.. than projected or to recapture exce..ive profit. if they aell more than projected. Thil limple mechani.m alia protecta utilitiea from f1uctuationa in weather, bu"in,," conditiona, etc., on which there'l no public-policy reuon to make their profile dependent. It correctl the inadvertent, perve"e incentive to aell more. ari.ing from the circumatance that when reculators eet an allowed rate of return, the way they actually enforce it il to let an electricity price bued on projected IIlel, yieldinr more profit to utilitiee that .ell more. The NARUC Conlervation Committee on 26 July 1988 "unanimoul1y aereed that adju.tmenta mUlt be ml'de to the ratemaldnr Connula to overcome /theJ...inherent dilincentive" that "reduced Ialel Ilead ,toJ...reduced profit•."
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The Electricity JOllnUlI
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13 1 D DIN G DEB A T £ RAG E SON
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selling an energy service such as comfort or torque. It can instead sell (a) electricity, plus (b) any needed and profitable combination of information, design, project management, equipment, installation, finance (usually the key element), operation, maintenance, monitoring, and updating ·that will result in an improvement of the customer's efficiency in using the electricity still sold. Such information/financial services are easy to "meter."
An innovation we don't need Finally, I don't see what your conceptually complex scheme offers that ERAM doesn't. seems very successful in removing the gaming of demand forecasts and in removing utilities' incentive (disincentive) to sell more (less) than ·projected. Its net rate effect. over its six years' operation, has averaged -- among much wider swings -- one fourth of one percent 17 , which is so far down in the noise that it shouldn't worry even an economist. let alone a customer. The two extra elements needed seem to me to be:
ERAM
• exemplary rewards (such as Moskovitzian incentive regulation 18, or letting utilities keep as extra profit part of what they save their customers); and • making saved electricity into a commodity subject to the same mechanisms that make other commodity markets work -- trading and fungibility in time and space, secondary markets, derivative instruments such as futures and options, arbitrage, etc. Most of these techniques, which I've been proposing for years, have just started to be seriously proposed or successfully used in the past half-year. These are both consistent with our shared goal of efficient market function. Or am I missing something obvious? please let me know how.
If you think I've misinterpreted your proposal,
With best wishes for an efficient and creative New Year, Cordially, ,4~·\":\-o.1
Amory B. Lovins Director of Research cc: Bradford, Cavanagh, Counihan, Hirat. Mo,kovib. Nicholson, Steh:er, Totten, Wiel
101"
i7 Even thia pretax, and included weather and economic Ouduationa .. well .. the effeda of efficiency programa. The evaluation ia in California PUC Diviaion of Ratepayer Advocatea, "Report on the 3R.'1 Proceeding (1.86-10-001),· October 1988. at Table 17.
l~David MOlkovit. of the Maine PUC haa propoaed adjuating utilities' rate of return, up or down within a twopercentage-point range, according to how well they control averaee cuatomer billl compared to corre.ponding bill. of an -ind..x group" of p ....r utilities aubject to aimilar weather, macroeconomic conditiona. and collective fuel mix. That ia. regulaton. lUI Cavanagh pula it, would adjuat "each utility'. profita depending on ita ability to outperform limilarly .Huated uliliti...• ("Commenta of the Natural RelOun:u Defen'e Council on New Directiona for the Commi..ion'. ·SR.·.· Proceeding.· 12 January 1989 filing with California PUC proceeding #1.86-10-001.)
Marc1l1989
39
T 11 E G lo? I: A T D I: M ;\ N [) - SID I: H 1 lJ
,
¢/kW·h (1986 $Ievelized at a 5%/y real discount rale)
1 N G nEB A T J: nAG E SON
Space Heating Residential Process Hea\ \ -
3-
2-
Water Heating (Passive Solar)
Electrolysis Industrial Process Heat
1-
J)
\
""'\ Cooling Electronics _""'....;_ _..;..... Drivepowe~ " '"Lighting HVAC\
Total U.S. electricity consumption in 1986 = 2,306 lW-h \
D+------...;..~=------_,_-----r_----_.---...:...--1SOD 2000 IlJoo SOD
Lighting
nv·h
-1-
A Preliminary Estimate of the Full Practical Potential for Retrofit Savings of U.S. Electricity at Average Cost -0.6 ¢IkW-h
Prellmlaary estimate of the supply curve for U.S. electrical end-use efficiency impronmeats at aa anraae cost -O.6C/kW-b. Please note that: . • For simplicity. measures applicable to each end-use have been lumped into a single . package rather than listed in individual sequence of marginal cost. • The curve shows. at this cost level, a potential to save -75% of U.S. electricity at an average cost of -O.6¢/kW-h and a marginal cost of -3¢/kW-h. or to save -50+% at a net average cost of zero. (This is because the cost of lighting retrofits -- which is on average negative, because maintenance costs avoided by the customer more than pay for the retrofit -- can be used to offset the small positive costs of many nonlighting measures. The combined average cost does not exceed zero until savings are well in excess of 50%.) • The list of efficiency measures considered is not complete; higher-cost options were excluded in each end-use, and including them would increase total savings. • No load management, lifestyle change. or further technological progress is included. The end-use services provided are unchanged or (often) qualitatively improved. • TOlal practical retrofit potential is shown. taking account of eligibility factors of the building and equipment stock. How much of that potential is aClually cap-· tured is a policy variable. The potential in new installations would be slightly larger and significantly cheaper -- in commercial buildings, often of negative net cost because of capital-cost savings from downsizing mechanical systems. • The cosl and performance data used are empirical, based only on technologies commercially available in 1988. Exhaustive technical documentation is available from Rocky Mountain Institute's COMPETITEK quarterly update service. • Analytic refinement of these calculations is continuing, and will undoubtedly change many delails of the curve, though not its general shape. The estimated uncertainty in the curve shown (as of November 1988) tOlals about ±IO percentage points in total quantity and a factor of two in average cost. but the average cost is believed to be almost certai~ly
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The Electricity ]OllnUlI