Utility Financial Imperatives Become Efficiency's Achilles' Heel
Posted on Sunday, August 13 @ 19:24:09 PDT by Laura
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The attached article illustrates how California utilities pursuit of additions to their infrastructure ratebase might be undercutting their committment to energy efficiency. The researchers quoted suggest changes to the CPUC's infrastructure ratebasing policies.
Since the CPUC decoupled energy sales from Investor Owned Utility (IOU) shareholder earnings, the primary way a utility can increase its profits is to either build or purchase new IOU owned infrastructure projects like powerplants or transmission lines.
The existing CPUC infrastructure ratebasing policies appear to provide utilities like SDG&E a strong financial incentive to pursue new utility-owned infrastructure projects like the proposed Sunrise Powerlink, instead of purchasing power from plants built by other entities like the proposed repowering of the existing Encina and South Bay powerplants here in San Diego.
California Energy Circuit
JUICE: Utility Financial Imperatives Become Efficiency's Achilles' Heel
June 23, 2006
Utilities' drive to maximize shareholder returns may be undercutting the state's $2 billion investment in energy efficiency. To justify capital expenditures for new transmission lines and power plants to regulators, critics say utilities must see rising - not falling - demand for electricity.
Under current utility financial and regulatory structures, benefits from supply-side investments still outweigh energy efficiency for utility shareholders, according to Kevin Monte de Ramos, KMDR Research principal researcher. Consequently, he said, supply-side infrastructure investment remains utilities' key priority.
Utilities counter that their expanded energy-efficiency programs will be highly cost-effective and innovative, while being revenue-neutral. Utilities note that this is especially true if carried out in conjunction with smart metering and new tariffs that will dramatically alter the price of electricity by time of day.
Yet despite utilities' seeming embrace of energy efficiency and demand-side management, some economists still see a clear preference for the more expensive option of putting "new steel in the ground."
The conundrum that in a cost-cutting world, utilities would prefer high-cost to low-cost programs to meet customer needs is the subject of an upcoming article for the American Council for an Energy-Efficient Economy by Bill Marcus, JBS Energy economist, and Cynthia Mitchell, Energy Economics economist.
"No regulatory mechanisms can eliminate the reality that investor-owned utility energy efficiency administration creates tremendous opportunities for investor-owned utilities to game the system because the underlying business model of increasing sales to support ongoing capital investments remains intact," the economists write in an advance copy obtained by Circuit. "Investor-owned utilities' energy efficiency administration will not influence the underlying corporate business model; rather, the business model will influence investor-owned utility administration."
The economists - who work for consumer advocate group The Utility Reform Network - argue that revenue true-up mechanisms that descended from the Electric Revenue Adjustment Mechanism, known as ERAM, prevent excessive profits from increased electricity sales in the short run. This true-up attempts to decrease the financial disparity between investing in infrastructure and efficiency measures by removing the incentive to sell more power to increase revenues.
However, true-up mechanisms fail in the long run as rate cases are updated because new infrastructure is added to the utilities' rate base.
"A stable or increasing sales base is paramount to the investor-owned utilities' corporate business model because it is the critical driver for recurring capital intensive investments," note Marcus and Mitchell. In California, it is rising peak demand from air conditioning use that drives the need for more transmission and generating facilities, the economists observe.
Utilities counter that they have put numerous programs in place to diminish use of air conditioning on hot summer days when electricity demand hits peak levels.
"Often they are not aware of what we're doing," said Anne Silva, San Diego Gas &Electric spokesperson, of utility critics. "It behooves us to have our customers conserve because overuse can cause statewide power outages. That doesn't help any of our utilities."
SDG&E, for instance, enrolled customers in a program in which the utility remotely controls air conditioning units, shutting them down during periods of peak demand. In exchange, enrollees receive a price break on their bills.
The utility also sponsors a "cool zone" program, urging residents to gather in 90 community facilities - from senior centers to libraries - on the hottest days of summer rather than running their individual air conditioners at home.
Yet SDG&E and other utilities continue to plan and build new infrastructure to meet increasing loads, including what the California Energy Commission has observed in the past and forecasts for the future to be rising peak loads.
Constructing these facilities is one of the key reasons the price of electricity is so high in California, say economists. Severin Borenstein, University of California Energy Institute director, for instance, has estimated that under highly volatile market conditions, the wholesale price of the last megawatt-hour of power produced to serve peak demand in California could be as much as $16,146 under a real-time pricing scenario (Circuit, Sept. 16, 2005).
The average cost midday on a hot June 22 in Southern California ran $67.23 per megawatt-hour, according to the California Independent System Operator.
Irrespective of the price, however, California utilities profit by serving this peak, particularly to the extent that their allowable return on equity exceeds the cost of capital needed to build new facilities, Marcus and Mitchell write. Ergo, the more capital invested, the higher the earnings for company shareholders.
To create a balance between energy efficiency and supply-side investments, the economists advocate reducing the allowable rates of return in California from their current double-digit levels to single-digit ones. The current rates of return, they write, are 11.3 percent for Pacific Gas &Electric, 11.6 percent for Southern California Edison, and 10.7 percent for San Diego Gas &Electric. Reducing those rates would close the spread between the lower cost of capital and the allowable rate of return, making steel-in-the-ground projects less profitable and thereby leveling the playing field for energy efficiency, the two argue.
Utilities admit that they are making major investments in new transmission facilities and power plants.
"We have invested substantially in upgrading our facilities and transmission lines, and that's benefiting our customers in terms of capacity and reliability," said Jeff Smith, PG&E spokesperson. "But we can't comment on the paper until it is published."
In response to similar problems and conflicts, the Oregon Legislature in 2002 assigned administration of the state's public-goods charge-funded energy-efficiency program to a nonprofit corporation known as the Energy Trust of Oregon. With no representation on the organization's board, utilities have no control over how the money is spent, unlike in California, where utilities design energy-efficiency programs. At the end of 2005, the trust had reached 32 percent of its 10-year efficiency goal for the year 2012.
Oregon lawmakers called for third-party administration of the money after finding that there was a basic conflict between utilities that profit by selling energy and the goal of efficiency, which seeks to save energy, said Jan Schaeffer, trust spokesperson.
The program has been so successful that the Oregon Public Utility Commission is backing legislation to renew the trust's administration of state energy-efficiency programs beyond 2012, a commission spokesperson said.
In California, Mitchell and Marcus advocate limiting return on equity to spur more energy efficiency. However, between the lines of their paper they also hint that it might be less expensive for the state to achieve efficiency goals by moving administration of the program away from utilities, which have an inherent conflict of interest. Sempra Global also has suggested shifting statewide administration of public-goods money - which partially funds efficiency programs - to a third party to streamline the process and minimize litigation (Circuit, May 19, 2006).
William J. Kelly
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