The Demanding Side of Utility Conservation

by David Lapp

 IN APRIL 1994, Washington, D.C. regulators denied the local electric utility's request to raise rates to cover millions of dollars in costs the company attributed to its conservation programs. Environmentalists rose in opposition to the decision, fearing the denial would dampen the company's commitment to energy conservation. Refusing to have ratepayers foot the bill for some of the Potomac Electric Power Company's (PEPCO) conservation costs seemed "unduly harsh" and would likely "have a withering effect on any future efficiency investment," a group of national environmental groups wrote in a letter to the D.C. Public Service Commission.

 Meanwhile, consumer advocates applauded the Commission's oversight of PEPCO's conservation program expenditures and praised the decision to deny $54 million of the utility's proposed rate hike. The Commission, which had ordered PEPCO to undertake conservation initiatives about six years earlier, prevented the utility from recovering conservation costs after determining that PEPCO failed to show that its programs actually led to energy savings, spent more on the programs than projected without justifying why, and encouraged customers to switch to electricity from natural gas.

The D.C. Commission's order - and the environmentalists' response - is the latest scuffle in an emerging conflict throughout the United States between environmentalists and ratepayer advocates, particularly those representing low-income consumers. Although advocates for low-income ratepayers support energy conservation programs, many are raising questions about who benefits from the programs, how much they cost, and how those costs are distributed.

Ed Meyers, one of three members of the Commission, has serious reservations about how utilities are administering conservation programs, commonly known as demand-side management (DSM). "There is a lot of what we call gold plating," he says. "A lot of money is spent for consultants, administrative matters and on programs that don't tangibly conserve energy. Those ineffective efforts have the effect of raising bills for hard-pressed urban consumers while not helping the cause of conservation."

Since low-income people spend three times the percentage of their total income on electricity than does the average U.S. citizen, they are especially vulnerable to excess costs attributable to utility conservation programs. "Some of the costs and incentives given to utilities have real impacts on electricity prices, despite conservation's potential to lower bills for all consumers," says George Sterzinger, a former Vermont utility commissioner. As a regulator from 1989 to 1991 in Vermont, Sterzinger helped create some of the state's first conservation programs, but he has become increasingly skeptical of the way many programs are now being implemented. He predicts a public "backlash" against high rates caused by utility-run conservation programs. "It's really only a question of how long before people figure out what's going on."

Energy conservation vs. profit maximization

 Environmentalists began promoting DSM programs in the late 1970s as concerns over acid rain and U.S. reliance on foreign oil mounted. Physicist Amory Lovins coined the term "negawatt" for a kilowatt of electricity saved, and environmentalists emphasized that while DSM costs might raise electricity rates in the short term, they would eliminate the need for building costly power plants in the future.

After an initial period of slow growth, utility expenditures on conservation programs began to rise rapidly - from less than $1 billion in 1990 to approximately $2.3 billion in 1992. Utility expenditures on conservation programs vary tremendously from state to state and utility to utility. California and New York have spent far more than most other states, and 13 utilities (of more than 3,000) account for nearly 50 percent of the total national investment in utility DSM.

In addition to curbing the environmental effects of generating electricity, improving energy efficiency can yield enormous economic savings by reducing energy bills. Although the up-front costs of many efficiency investments are higher than their conventional alternatives, over time the energy savings make the investment cost-effective. For example, while a compact fluorescent light bulb costs 10 to 15 times more than an incandescent bulb, it lasts more than a decade and consumes one-quarter the energy of an incandescent and will pay for itself many times over its useful life.

On the theoretical grounds of the technical potential for energy and economic savings, the benefits of conservation programs run by utilities would seem indisputable. But the electric industry is profit-driven, and utilities' profits are almost always based on electricity sales. As a result, utilities actually have a strong disincentive to reduce electricity consumption. Commissioner Meyers compares relying on electric utilities to implement conservation to "asking the tobacco industry to educate people about the dangers of smoking."

Eugene Coyle, an economist with the California consumer and low-income advocacy group Toward Utility Rate Normalization (TURN), explains, "In general, the more successful a DSM program is in reducing sales, the slower the rate of growth in earnings the utility will experience, and the lower the value of the stock."

To overcome the barriers to utility-run DSM, regulators - usually at the behest of environmentalists - permit a number of complex mechanisms intended to make conservation profitable for utilities. Although the mechanisms vary dramatically in different states (which set the terms for the utility's recovery of costs from ratepayers), the three key ways utilities recover DSM costs are: reimbursement for program implementation and administration costs, recovery of revenues allegedly lost because of lower electricity sales due to DSM, and "shareholder incentives" that allow utilities to earn equal or greater returns on conservation investments as on investments in generating capacity.

 "If I were a utility executive, I wouldn't put my finger on DSM without some way of making it profitable," says Bruce Driver of the Land and Water Fund of the Rockies (LAW Fund), an environmental group that promotes utility DSM in many western states. "They have to get [back] lost revenues or they simply won't do it." David Nemtzow, executive vice president of the Washington, D.C.-based Alliance to Save Energy (ASE), recounts a popular adage coined by an electric industry executive: "The rat has to smell the cheese." Ensuring utility profit-maximization "is an important element in demand-side management."

But critics of lost revenues and shareholder incentives argue that they are in fundamental conflict with the utilities' obligation under state and federal laws to operate efficiently and in the public interest - an explicit obligation in exchange for the utilities' exclusive franchise over retail electric service granted by government. Due to this mandate, many consumer advocates argue against any extra incentives for doing a job the utility should be doing anyway. "If you have a regulated utility that's getting a fair rate of return, that should be enough incentive for the utility to do what the regulator wants," says Arny. "Anything beyond that is really a bribe.

Right signals, wrong people

 The enthusiasm of many environmentalists notwithstanding, the efficacy of incentives in removing a utility's desire to sell more power remains largely unproven and controversial. "The bottom line is that the utilities would rather sell more electricity because that's how their business is measured - even if you have [recovery of] lost revenues that are supposed to keep the dollars the same," says Michael Arny, an expert in utility resource planning at the University of Wisconsin.

Complicating the problems of overcoming utilities' disincentive to effectively conserve energy is the difficulty of monitoring and verifying DSM-related energy savings. A highly inexact science, DSM program evaluation is considered "pretty good" if estimates of energy savings are within 30 percent of the amount actually saved, a range worth millions of dollars to utilities, says Commissioner Meyers.

This fuzziness gives utilities an opportunity to manipulate the system to their double benefit, Meyers says. "The best thing a utility can do to earn money is to operate a program which ostensibly conserves energy but may not be all that effective. That way they get [program] cost recovery, lost revenues and incentives without hurting sales all that much."

An analysis by the Electricity Consumers Resource Council (ELCON), a trade association of large industrial users of electricity, concluded that New York's DSM program is wasteful and inefficient at promoting energy conservation. ELCON estimated that only 28 percent of the more than $750 million spent on DSM in New York went to direct implementation of energy efficiency. Further analysis revealed that after discounting "phantom" savings - savings from the technical potential of conservation strategies that do not take into account the actual savings - and "free riders" - people who would have invested in energy efficiency without the program - only 2 percent went to direct implementation.

 Jim Gallagher, chief of energy efficiency planning at the New York Public Service Commission, says that more recent figures show that a higher figure - in the range of 40 to 42 percent - goes toward direct implementation.

The inherent contradictions in DSM - rooted in the effort to make electricity sellers into electricity savers - are evident in the everyday operations of utilities. Despite the spread of DSM programs, electric utilities still cling to their age-old practice of aggressively promoting consumption.

In some cases, utilities even attempt to increase overall sales by marketing electricity through DSM programs themselves. For example, DSM programs that promote high-efficiency electric heat pumps can wind up boosting a utility's overall sales growth by diverting consumers from lower-cost, more energy-efficient alternatives such as natural gas heating.

Jean Ann Fox, president of the Virginia Citizens Consumers Council, says that the design of some of Virginia Electric Power Company's (VEPCO) DSM programs "look to us like thinly veiled promotional devices." For example, VEPCO recently proposed an "Energy Saver Home" program. The utility offers purchasers of brand new, all-electric homes that meet high-efficiency standards a $10 rebate on monthly electric bills for 10 years. The problem is that electric heat is much less efficient than other alternatives. "You ought to clean up the incentives that promote electricity before you start paying people not to use so much," Fox says.

 Outside of DSM programs, utilities have many opportunities and methods of expanding their business of selling electricity. VEPCO, for example, recently proposed to charge new residences a $1,300 power line hook-up fee - but to waive the fee for homes equipped with all-electric appliances, a decidedly environment-unfriendly and economically inefficient approach.

Rick Tempchin, manager of energy efficiency policy and programs at the industry association Edison Electric Institute (EEI), says there is no contradiction between DSM programs and encouraging consumers to use electricity over more efficient competitors. "The bottom line is you always have to remember that electric utilities are competing with other fuels," he says. "Maintaining and increasing market share is a reality, so I don't see any real conflict [with DSM]."

Poor subsidize the rich

Outside of the complexities of how well DSM works lies another area of growing concern - how DSM benefits are distributed. While large electricity consumers are troubled by the costs of many utilities' programs, low-income people are even less likely to benefit.

Even when directed to residential customers, utility DSM programs commonly wind up benefiting middle and upper classes. Although low-income people often live in energy inefficient housing (where the greatest energy conservation savings can be reaped), they are the least likely to participate in utility conservation programs. "The burden of the cost and benefits of these programs are very unequal across income classes," says Ronald Sutherland, an economist with Argonne National Laboratory, a federal research center. "The residential households who participate and who receive these subsidies come to a large extent from high-income households. ...The rich people benefit and the poor people don't."

In a February 1994 study, Sutherland found that most participants in residential utility DSM programs are those who would likely make efficiency investments on their own and occupy homes that are newer and more energy efficient. His analysis also finds that utility DSM programs are not necessarily directly associated with energy savings, but that energy savings occur because those not participating in the programs reduce consumption as a result of higher prices. In other words, low-income people who are unable or unwilling to participate in DSM programs - but who feel the effects of higher electricity rates - wind up having to use less electricity or risk electric bills they can no longer afford.

The Boston-based National Consumer Law Center, a low-income advocacy group, found a number of reasons why effective conservation programs must target low-income people, including the fact that low-income people are more likely to rent homes, the historical mistrust of utilities by low-income people, the ineffectiveness of rebates for efficiency investments (since rebates do not address the problem of lack of access to credit and financing for the up front customer costs of DSM programs), and the lack of education and information needed to evaluate conservation program benefits.

The resulting disparities in costs and benefits for the rich and poor are often stark. In New York, for example, low-income residents paid $4.2 million in overall DSM surcharges but received only $62,000 in rebates under a set of programs adopted by the Niagara Mohawk Power Company, according to calculations by the consumer group Public Utility Law Project (PULP). PULP also found that low-income participation in the non-rebate DSM programs was significantly lower than participation of wealthier residents.

Niagara Mohawk's large industrial customers complained that the same programs were too costly and eventually won the ability to "opt out" of some program costs as part of a three-year experiment. Testifying on behalf of a group of low-income customers at the New York Public Service Commission, Sterzinger, the former Vermont regulator, said: "The same problems that affect these industrial customers, in particular paying for something which one doesn't receive, affects other classes as well. ... The [New York] Commission should be very concerned about over-assigning costs to low-income residential customers who have not participated in demand-side management programs and who can ill afford to pay program costs for which they receive no benefits."

As a result of PULP's protests, New York regulators required Niagara Mohawk to target some of its conservation efforts to low-income customers. According to PULP attorney Gerald Norlander, the resulting program was similar to the low-income programs run by other New York utilities - a small efficiency component with high administrative costs. "By and large, the utilities have loaded low-income programs with overhead and other costs rather than provide measures that really save energy," says Norlander. "We would rather see them put six inches of insulation in the wall."

Transferring costs to those who cannot or will not participate occurs as a matter of policy under the DSM cost-recovery mechanisms in New York, says Gallagher of the New York Commission. Utility "revenues stay the same as they did before the DSM program; they are just shifted from [DSM program] participants to non-participants."

Driver, of the pro-DSM LAW Fund, agrees that special attention must be paid to ensuring DSM programs do not have the "perverse" effect of transferring wealth from the poor to the rich. "Rates go up because of the lost revenue recovery. ...The problems that [Argonne economist Sutherland] raises in theory can happen. And he may have found some emperical evidence that it is happening. It just means that DSM advocates have to make sure that a wide variety of DSM programs are offered, particularly within the residential class. Or else you have an equity issue."

Driver had partial success in urging one Colorado utility to implement a low-income DSM program in 1992 that was paid for in part by federal weatherization program funds. Still, he acknowledges that the impact of DSM on low-income people is "something that we need to pay more attention to than we have so far."

Undermining conservation

Even if equity problems were solved, it is now clear that DSM will not be a cure-all for the inadequate use of existing cost-effective energy-efficient technologies. While utility-run DSM programs have undoubtedly saved energy, few environmentalists are satisfied that current investment levels will come close to achieving all the potential cost-effective savings or reduce carbon dioxide emissions sufficiently to meet international obligations. Skip Laitner, an analyst with the American Council for an Energy-Efficient Economy, says that "national projections for DSM expenditures may not be sufficient to capture the full potential for lowering overall costs of providing electric service." U.S. utilities annually spend only slightly over 1 percent of total revenues on energy efficiency and, in recent years, have cut total sales by about the same percentage. By maintaining current levels of investment, in the year 2000, energy consumption will drop by 4 percent - significantly short of the technical potential of 24 to 44 percent estimated by the electric industry's research arm, the Electric Power Research Institute.

Even the prospects for maintaining current levels of utility expenditures on conservation measures are dimmed by the changing structure of the electric industry. The Energy Policy Act of 1992 (EPAct) removed barriers to competition within the generation sector of the industry and ensured that competitors are able to move their power across the transmission lines of monopoly utilities. (Power- producing competitors of electric utilities generally offer cheaper power.) Most industry analysts expect competition to bring electricity prices down. In addition, many utilities are saddled with large debts incurred for high-cost power plants - a result of overly optimistic projections for electricity growth and unwise investments in large power plants, mainly nuclear and large coal facilities.

As competition grows, the traditional utility - which will still have substantial opportunity to use its monopoly power to generate profits - has even less incentive to undertake effective conservation initiatives, since they can erode the utility's ratebase and raise rates. Already, utilities positioning themselves for operating in a more competitive marketplace are cutting costs, including expenditures on social programs, which in the eyes of many utility executives include energy conservation programs. Although as recently as one year ago, analysts predicted DSM spending to continue rising, in some states expenditures have already reached a plateau or are starting to fall as a result of utility concerns over competition, according to Eric Hirst, an expert on DSM at Oak Ridge National Laboratory.

Finding new ways to conserve

With greater competition and new technologies becoming available, many proponents of energy efficiency are exploring new policies and programs to achieve their environmental and economic objectives.

While EPAct's electricity provisions focused primarily on competition in the generation sector of the industry, the law also seeks to assure that utilities "receive no unfair competitive advantage over small businesses in implementing demand side management programs." Many options exist for using competition to keep DSM costs down. One possibility is to allow the growing number of energy service companies to compete directly with utilities to manage the programs, particularly since many are hired to implement utility programs anyway. If the utility is genuinely better positioned to do the work, as some environmentalists argue, then its bid should be lower than any competitor's.

Once the need for new energy supplies is known, competition for DSM services could be overseen by the utility and its regulators or by the local or state government. TURN's Coyle proposes a tax on electricity sales to fund government-administered energy-efficiency programs. With different companies competing, there would be no need to provide utilities with shareholder incentives and recovery of lost revenues. "At least that way you would know that they are really committed to doing energy conservation," says Coyle, since the competitors would not have a simultaneous interest in promoting electricity use. Moreover, it would be easier to ensure that low-income people benefit from the programs, since they could be targeted specifically. (In one such example, Vermont runs a Weatherization Assistance Trust Fund for low-income people paid for with an excise tax on fuel.) Even under a more competitive system, however, special care must be taken to ensure low-income people benefit from any conservation measures they help pay for, says NCLC's Brockway.

American Council for an Energy Efficient Economy's Laitner says that, in many states, community action agencies, which often implement federal energy assistance and weatherization programs, are well positioned to implement low-income conservation measures. Many of these agencies could provide more effective conservation services at a lower cost than utilities, he says. Still, Laitner points out, programs must be coordinated with the planning process in which it is decided whether a new power plant is needed or not. Otherwise, people could end up paying twice - once for energy conservation and again for a new power plant that is not needed.

A variety of other mechanisms exist to help overcome the barriers to customer investment in energy efficiency. In many ways, electricity prices fail to reflect true costs. Producing a kilowatt hour of electricity at noon in the summer is far more expensive than at midnight, for example. And utilities now use a variety of pricing strategies to promote greater electricity consumption; conversely, strategies can be used to discourage wasteful consumption and promote conservation. For example, instead of offering discounts to large electricity customers for greater consumption, rates could fall as less electricity is used.

D.C. Commissioner Meyers advocates a rate structure based on efficiency itself. "I like a market- driven approach where, if you insure that your house or office is energy efficient, you qualify for lower rates than if you're in an inefficient house or building," he says. "With the money you don't spend on DSM, you can establish loan programs with no-interest or low-interest loans for low-income persons."

Perhaps the most effective method of advancing energy efficiency - though politically it may be the most difficult - is by simply adopting efficiency standards. Many standards are already in place - for appliances like refrigerators and furnaces, for example. Under EPAct, Congress passed new efficiency provisions for everything from lighting and heating and cooling equipment to electrical motors, showerheads and urinals.

EPAct also requires states to adopt efficiency standards for commercial buildings and establishes voluntary guidelines and programs to help encourage energy efficiency for industry. But many of the standards remain voluntary or fall short of current technological capabilities. By incorporating even stronger energy-efficiency standards into law, more of the financial burden of transforming wasteful energy consumption will fall to the manufacturers of household appliances, the builders of homes, computer manufacturers and the makers of thousands of other consumer and building products.