Christopher Swope was GOVERNING's executive editor.E-mail: email@example.com
Can utilities make money on energy efficiency?
Saving electricity has never been a big priority in North Carolina. Power is cheap and plentiful, as it is across much of the South. These days, however, rising demand - what they call "load" in the electricity business - is catching up with supply. For the first time in two decades, the state needs a massive new workhorse of a power plant, what's known as a baseload plant. Actually, according to Duke Energy, the state's largest utility, North Carolina needs two of them.
For an investor-owned utility such as Duke, planning a pair of huge power plants is just another turn in a familiar cycle: grow demand, build supply, sell more power, generate more profit. It's a cycle geared for growing load, not shrinking it. It's a cycle that rewards Duke when consumers use more power. It's a cycle that encourages burning dirty coal, as Duke proposed with its two plants, since coal is so cheap. And it's a cycle that regulators in North Carolina, as in most states, acquiesced to for most of the past century.
Not anymore. When Duke's plan for the two coal plants went before the North Carolina Utilities Commission early this year, the regulators pushed back. Go ahead and build one coal plant, commissioners told Duke. As for the rest of the demand, Duke could make it up through energy efficiency. That wasn't all. Duke would have to spend 1 percent of its annual revenues - about $35 million - on helping its customers save electricity by buying energy-efficient appliances and lights and through other measures. For a state that had taken its energy abundance for granted, this was a staggering mandate.
What happened next was even more unusual. Duke went back to state regulators with an entirely new pitch. The problem with energy-saving programs, Duke said, is that utilities don't make money on them. In fact, utilities lose money because they don't sell as much of their product. Duke proposed to turn that equation around through a radical new regulatory approach it calls "save-a-watt." The idea is pretty simple: Let the utility earn profits by helping customers conserve power, just as it does by selling them more power. In fact, as Duke proposes it, energy efficiency might even become one of the company's most profitable lines of business. Duke CEO Jim Rogers says he'll propose a version of the same idea in Indiana, Kentucky, Ohio and South Carolina, the other states where Duke does business.
As North Carolina regulators mull Duke's plan this summer, they'll have a lot to consider. Critics accuse Duke of trying to greenwash its way to windfall profits. But many environmentalists, including some who are still fighting Duke's right to build any coal plants at all, find the premise behind save-a-watt encouraging. The nation can't get serious about conserving energy and fighting global warming, they say, until utilities see dollar signs in it. Utilities have always run modest efficiency programs, "but they don't usually put their heart into them," says Michael Shore, the Southeast air quality manager for Environmental Defense. "If efficiency is too successful, it goes against their business model. We need to develop models so that the utilities can make money through promoting energy efficiency."
Whether or not North Carolina regulators accept the save-a-watt approach, it's clear that states and utilities alike are fast changing their views toward energy efficiency. Not since the energy crisis in the 1970s have states pushed utilities to save electricity with so much zeal. Big new initiatives are underway in California, Minnesota and New York - perennial leaders when it comes to efficiency. Now, however, states that enjoy cheap power, including Arkansas, Idaho and North Carolina, are pinching as well. For all the headlines about the nuisances of coal and the distant hope of wind, solar and biofuels, what states are coming to see is that the easiest solution to their problems with energy is simply to use less of it.
"If you actively engage in energy efficiency, you can push out the date when you'll need new generating resources," says Marsha Smith, a utilities regulator in Idaho. Smith's state enjoys the nation's cheapest power, but is nevertheless asking utilities to ramp up their efficiency efforts. "Whether you're a low-cost state or a high-cost state, the further you can push that out, the better off you'll be."
That's always been the case, of course. But efficiency is back on the agenda only because several forces collided at roughly the same time. For one, high fuel costs are driving up the price of electricity. According to the Energy Information Administration, average rates across the country have increased by 19 percent over the past three years. Rate pain is especially acute in states that deregulated their power markets. When price caps came off last year, rates in Maryland increased 70 percent and rates in Delaware increased 60 percent. The flip side of these high power prices is that investing in efficiency now seems cheap by comparison.
Another factor is the huge and growing expense of building power plants. In North Carolina, Duke believed as recently as two years ago that it could build the two coal plants it wanted for $1 billion each. Now, thanks to the rising cost of building materials, Duke expects the bill for just the one plant it got approved to come in around $1.8 billion. That cost would translate directly into higher rates for customers. With eye-popping figures such as this on the table, states are beginning to see that the least expensive power plant is the one that never has to be built at all.
Finally, concern over climate change is also fueling the efficiency push. Across the country, utilities have proposed building 150 coal-burning power plants. Coal plants are cleaner and more efficient than they used to be, but coal nevertheless remains a leading source of carbon dioxide. It's hard to see today's coal boom as a moment of truth when the plant proposals come up one by one before the 50 state utility commissions. But a moment of truth is exactly what this is. If states allow all of these coal plants now, they'll be stuck with them and their greenhouse gases for two generations. On the other hand, if they can reduce demand for electricity, they just might prevent many of those coal plants from needing to be built in the first place.
The good news is that there's a lot of low-hanging fruit, as far as policies for reducing energy demand go. States can adopt efficiency standards for appliances, electronics and boilers that go beyond the federal government's minimum standards. They can upgrade their building codes and provide tax breaks or expedited permitting for green buildings. They can use tax breaks to help customers make smarter appliance purchases, trade in clunky old freezers or weatherize their homes. And they can lead by example, by improving energy performance within government buildings. At this micro-level, there are literally hundreds of ways to power down, and many have been shown to work when there is sustained effort put into it.
The problem with demand-side efficiency programs, however, is that states typically ask the electric companies to run them. There's a certain logic to that - utilities already maintain ties to customers. But utilities also have a built-in conflict with the job they're being asked to do. Quite simply, they're in the business of selling electricity. Economists have a name for this natural urge to sell more power and make more profit. They call it the "throughput incentive." Harris B. McDowell III, a state senator from Delaware, describes it this way. "Ask yourself: how hard would General Motors work to convince people they don't need a car? How hard does RJ Reynolds try to get people to stop smoking? It's the same problem when efficiency programs operate under the utility. They'll give lip service, but they won't pour their hearts out."
As McDowell sees it, utilities can't be entrusted with responsibility for energy efficiency. Instead, he prefers circumventing them altogether. McDowell's efficiency plan, which the Delaware legislature passed in June, sets up a competing "sustainable energy utility" whose sole task is to help customers save energy. The utility will subsidize purchases of energy-efficient appliances, and also aid customers who want to generate their own energy on site using solar, wind or geothermal technologies. Delaware will bankroll the new nonprofit with revenues from a $30 million bond sale. The hope is that after 10 years, the utility can sustain positive cash flow by taking a cut of the savings customers see on their energy bills.
Delaware's sustainable utility is a twist on a similar program that has been showing positive results in Vermont. McDowell thinks it's the best way to break the electric system of its gluttonous habits. "That structure knows only one thing, and that is to increase supply," McDowell says. "It's what's comfortable. The utilities know exactly how many consultants to hire to tell you to do that. But building more supply is a self-fulfilling prophecy. If you build it, they'll use it."
There are other ways to neutralize the throughput incentive. And electric utilities, which seem resigned to a future with some kind of carbon regulation, are increasingly open to talking about them. The Edison Electric Institute, the national voice of investor-owned utilities, recently hired Diane Munns to direct its energy-efficiency operations. Munns was a utility regulator in Iowa and co-chaired a panel that produced the National Action Plan for Energy Efficiency - a solid synopsis of barriers to efficiency and methods for overcoming them. Asked if any particular method works better than others, Munns said, "I'm not going to say there is a best way to do it. I think whatever gets you going is good. We need to get moving on efficiency." She continued, "It's whatever gets it done for you - whatever you can put together that you think can promote efficiency and keep your shareholders whole."
California thinks it has a method that works. The Golden State is the established leader in energy efficiency, and has been for some time. The proof is in what energy experts there simply call "the graph." What "the graph" (on page 27) shows is electricity use per capita, for both California and the rest of the United States. The line for the other 49 states trends steadily upward from the 1950s through today - a proxy for Americans' ever-growing appetite for electronics and big houses. The California line, however, goes flat in the late '70s, when the state adopted the nation's first efficiency standards for appliances and buildings. California hasn't eliminated the need for new power plants - its load continues to grow along with the population. But the average Californian today consumes about the same amount of power as he did a generation ago.
What's more, California began tackling the throughput incentive in the early 1980s. The tool it devised was called "decoupling." To understand what that means, it helps to know how rate regulation works. Typically, states allow utilities to recover their fixed costs, such as debt on power plants, and in addition earn a reasonable rate of return. These calculations are penciled out every so often in rate cases before public utility commissions. In the meantime, if utilities sell more power than they anticipated, they earn windfall profits. If demand is lower than expected, their profits suffer. What decoupling does is sever the link between a utility's sales and its profits. From time to time, regulators tweak rates in a way that smooths out ups and downs in revenue. The utility still makes its profit. But it also becomes agnostic on the question of whether it's better to sell more electricity or less of it.
California's decoupling experiment worked so well that a few other states also began tinkering with it. Then deregulation fever set in, and all the states pushed decoupling aside for what seemed like a much sexier idea: competitive power markets. Deregulation, as everyone knows, failed. Shortly after its blackout crisis of 2001, California went back to decoupling. This was one way California renewed its vows to energy efficiency. (Another key policy was called the "loading order," which put efficiency above renewable and fossil fuels in the list of utilities' options for meeting electric demand.)
California's second run with decoupling seems to be working. The state's three investor-owned utilities are in the midst of one of the nation's most aggressive efficiency campaigns ever. Between 2006 and 2008, they're investing $2 billion toward the goal of helping reduce customer demand for their product. Peter Darbee, CEO of Pacific Gas & Electric, attributes his company's newfound enthusiasm for efficiency to decoupling. Testifying before Congress, he said decoupling "means our financial health doesn't depend on selling more energy." Dian Grueneich, a public utility commissioner in Sacramento, agrees. "We believe strongly that decoupling is an essential part of doing a good job on energy efficiency," she says. "You can't just expect a business to want to do something where they lose money."
Now other states are looking at decoupling. Idaho just began a three-year pilot with Idaho Power in June. Minnesota, New York and Wisconsin are studying decoupling for electric utilities. Eleven states have adopted decoupling for their natural gas utilities.
Decoupling has its critics, especially among consumer advocates. Because of how the mechanism works, customers end up paying higher rates when they use less power - and it doesn't matter whether that's because efficiency programs are working or because of mild weather or a slow economy. Neutering the utilities' profit motive may make them lazy about controlling costs. Utilities might also forfeit their traditional role of helping government promote industry and economic development, a job that utilities always did in order to grow their load. And California's Grueneich admits that all decoupling does is level the playing field for efficiency programs. It eliminates a disincentive, but it doesn't make efficiency financially appealing for utilities, either.
California expects to correct that last problem soon. Later this month, the state utilities commission is due to introduce a package of financial incentives for utilities that would allow them to earn profits on efficiency programs. Other states have tinkered with such incentives, but Grueneich says the plan California is working on will be characteristically groundbreaking in its comprehensiveness. "Decoupling is a major first step," Grueneich says. "But the second step is that utilities make an approximately similar amount of money as they would if they took the same money and put it on the generation side."
If this way of thinking is nothing new in California, it's almost unheard of in North Carolina. Some credit for the new mindset goes to Jim Rogers, the CEO of Duke Energy. Rogers has been an outspoken advocate of a national cap-and-trade system for carbon emissions. He also served as Munns' co-chair on the National Action Plan for Energy Efficiency.
Rogers recently told the Charlotte Observer that he had an epiphany. It happened in February, he said, during a dinner with 14 environmentalists. They told him Duke should support renewables and take a more aggressive approach on energy efficiency. Rogers says now that he's following their advice. Surely, the epiphany was helped along by North Carolina's decision to limit Duke to one coal plant rather than two. Rogers began calling energy efficiency the "fifth fuel," right behind nuclear power, coal, natural gas and renewables. And he began laying the groundwork for save-a-watt. "We need a new regulatory compact," he wrote in an op-ed in March, "that puts investments in energy efficiency on an equal footing with new generation investments."
On the surface, save-a-watt sounds similar to what California is doing. But Duke's plan actually is quite different. It has nothing to do with decoupling, for example. Rather, what Duke is proposing is to make efficiency programs extremely lucrative - so much so that the utility won't just want to run them but run them with gusto. Richard Sedano, a director at the Regulatory Assistance Project, a Vermont think tank, describes it this way: "Save-a-watt attempts to overwhelm the throughput incentive with financial counter-incentives."
Here's what Duke proposed: In exchange for helping its customers save electricity, Duke wants to charge them for 90 percent of the cost of the power plant it no longer has to build. Duke says customers would save money compared with business-as-usual. And Duke would collect only if independent auditors verify that the load reductions are for real. "It's a fundamental shift," says Duke spokesman Tom Williams. "Efficiency is a business line for the utility now."
Some of the efficiency programs Duke would invest in are old standbys. For example, Duke would pay for energy audits of customers' homes and businesses, offering energy-saving suggestions, and it would subsidize purchases of compact fluorescent light bulbs and high-efficiency heating and cooling systems. Duke also would test new energy-saving technologies, such as advanced metering, as well as ways of remotely shutting off customers' air conditioners, freezers and hot water heaters for brief periods of time. The idea is to save energy without inconveniencing people. These steps would reduce demand by 1,700 megawatts by 2012. To sweeten the deal, Duke would retire 800 megawatts of its oldest, dirtiest coal plants as the energy savings come online.
Nobody in North Carolina disputes that Duke's save-a-watt plan is an innovative approach. The question now is whether North Carolina regulators will go along with it. The hang-up may be deciding whether Duke is trying to make efficiency too profitable. "The incentives are larger than what you'd normally see," Sedano says. "What a commission tries to decide about any cost it asks consumers to pay is, is it worth it?" James McLawhorn, director of the electric division of the North Carolina commission's public advocacy arm echoes the concern. "We recognize there needs to be some incentive," McLawhorn says. "But how much is enough and how much is too much?"