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New Business Model Motivates Utilities to Help Reduce Energy Consumption

Changes in fossil fuel markets and updates to environmental regulations are making it more difficult for utilities to provide power at reasonable rates. In response to this challenge, a new business model is quietly emerging that allows utilities to sustainably grow and profit from helping their customers save energy and money. A new paper by the American Council for an Energy-Efficient Economy (ACEEE), The Old Model Isn't Working: Creating the Energy Utility for the 21st Century, describes the new business model and its potential to lead the nation into an energy paradigm shift.
 
"At the heart of the issue is the way that utilities currently make money by selling energy and building new power plants and transmission lines, instead of selling an energy service. This means that a utility is discouraged from investing in technologies and programs that reduce customer energy use through improved energy efficiency," said Dan York, ACEEE utility program director and lead author of the white paper.
 
"What we need to do is flip the century-old model on its head and change the financial motivations for utilities from selling energy and building power plants to helping customers use energy more efficiently," said Marty Kushler, ACEEE fellow and paper co-author.
 
Driving the urgency for action are updates to EPA environmental regulations that will require utilities to make significant investments in retrofitting or replacing power plants. These investments have the potential to raise electricity rates more than 20 percent for customers in some markets in the next few years. A recent ACEEE white paper shows how investments in energy efficiency can meet energy demand at a fraction of the cost of upgrading old coal-fired power plants or building new ones.
 
However, in order to prioritize investments in energy efficiency over new power generation, utility regulators need to adopt a new business model. The model encourages utilities to save energy through a "three-legged stool" approach that supports the financial interests of utilities and provides their customers with cheaper, cleaner energy through improvements in energy efficiency. The three "legs" of the new utility business model include:

Allowing utilities to earn a return on investments that save energy for customers: Traditionally, regulated utilities are allowed to earn a return on investments made in new supply resources. By allowing a return on investments in energy efficiency as they do on building new power plants, regulators can level the playing field and remove barriers to utility investment in customer energy efficiency programs. ACEEE's report, “Carrots for Utilities: Providing Financial Returns for Utility Investments in Energy Efficiency,” provides a review of state experiences with this approach.

Ensuring that energy savings don't reduce utilities' authorized revenues: Under the traditional regulatory model, reductions in energy sales result in reduced revenues for utilities. The new utility business model ensures that utilities don't lose out when customers save energy. Through "decoupling," utility profits are separated from energy sales, and rates are adjusted as necessary to ensure that utilities collect their authorized revenues. Utilities are not harmed financially if they reduce energy sales by improving customer energy efficiency.                                                                                                                                            

A less comprehensive approach for addressing these "lost revenues" is through a lost revenue adjustment mechanism (LRAM) that allows utilities to recover profits that are "lost" due to energy savings programs that reduce sales. A new ACEEE report, “Balancing Interests: A Review of Lost Revenue Adjustment Mechanisms,” reviews recent state experiences and discusses the pros and cons of that approach.

Permitting utilities to recover the costs of energy efficiency programs for customers: Cost recovery [http://aceee.org/sector/state-policy/toolkit/utility-programs/program-cost-recovery] of legitimate expenses incurred from efficiency measures is essential to make investments in energy efficiency a prudent choice for utilities.

In October, ACEEE's 2011 State Energy Efficiency Scorecard will provide an updated ranking of each state's progress in implementing the elements of the new utility business model.
 
"Our research shows that these approaches are working. They motivate utilities to reduce utility bills and save their customers money," said Sara Hayes, lead author of the ACEEE reports on shareholder incentives and lost revenues, and contributor to the forthcoming Scorecard.

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