Reinventing the energy conservation industry

R o l l y R o u s e is president of Conservation Conversions, Inc., a

Massachusetts-based consulting firm that designs and develops

market-oriented energy efficiency strategies for utility companies and

private property owners. From 1983 to 1991, Mr. Rouse ran Citizens

Conservation Corporation, Citizens Energy Corp.'s non-profit energy

conservation services subsidiary. He holds degrees in architecture and in

engineering and applied science from Yale University.

Reinventing the Energy Conservation Industry With a gradual transition from today's programs to a conservation market based on competition, customer choice, and private capital, utility investments in energy conservation can live up to their fult potential: lower electric rates and a more valuable array of services for all customers.

Rolly Rouse

T his article describes a new kind of financial instrument

- - the "demand-side manage-

ment performance annuity" and describes why it is needed. DSM performance annuities would cre-

ate a competitive market for energy savings. They would also al-

low utility companies to test the

viability of energy efficiency as a

"least cost" option. DSM performance annuities could revive the energy efficiency industry and establish it on a market-based platform that serves both electricity customers and policy makers better than the current DSM model.

Current demand-side manage-

ment programs are in deep

trouble. They attempt to define through top-down program plan-

ning, and through conscription of customer capital, what can better be created using a market-based approach. This seems increas-

ingly inappropriate to an industry that is already being transformed

to take advantage of the efficien- cies markets can produce.

DSM performance annuities would reconfigure demand-side

management as a market-driven resource procurement function. Under a DSM performance annuit~ a utility company might offer to pay investors for energy and capacity savings achieved over a pe-

riod of time - - sa~ five to 30

56 The Electricity Journal

years. To collect this stream of payments, DSM performance annuity holders must install or spon- sor energy efficiency improvements in ratepayer-owned properties.

The utility would pay DSM performance annuity investors based on performance. Performance standards would be established in advance by the utility company and its regulators. Investors would be responsible for deliver- ing documented savings each year. Payments would be made by the utility annually and in ar- rears. To reduce risks to ratepayers and utility company shareholders, payments could be indexed to match fluctuating market prices for fuel and power.

D SM performance annuities would be sold at auction

to the highest bidders. If the utility-offered annual payments for energy and capacity were too rich, investors would bid up the price at auction. Competition would squeeze out unnecessary profits, even as profits would at- tract new conservation industry competitors.

Because investors would pay the winning bid amount to the utility up front, the likelihood that they will deliver the savings is high. If they don't deliver, the utility keeps their money and pays them nothing. To enhance liquidity and market efficiency, DSM performance annuities would be tradable: Once issued, they could be bought or sold by anyone at any time.

DSM performance annuities offer utility companies a new way

to prosper and profit by serving the interests of customers, ratepayers, and shareholders. They turn demand-side management into a market-driven purchasing function. On the unregulated side of the business; utility companies can become active energy conservation service competitors.

I. What's Wrong With Today's DSM Programs

DSM performance annuities are designed to address three funda- mental problems with traditional demand-side management pro-

Conservation companies that focus primarily on real customer needs m not alphabet-soup demand- side management offerings reface rough sledding.

grams: the lack of market competition, artificial limits on customer choice, and the use of ratepayers rather than private investors as the primary source of capital.

A. Too Little Competition

Good intentions notwithstand- ing, today's demand-side management programs tend to stifle competition. Utility companies, not customers, typically decide who will be the winners and losers.

Conservation service providers must organize their activities around each program's terms, conditions, and timetables or be cut out of the action.

Conservation companies that focus primarily on real customer needs - - not alphabet-soup demand-side management offerings - - face rough sledding. They must cut through the confusion, misinformation, and hesitation to act created by an often bewilder- ing array of demand-side management promotions. Furthermore, they must convince their clients to forgo what on the surface often appears to be a free lunch offered by the utili~.

l 'n a truly competitive market, .a company's expenditures

and levels of output are based on prices and profitability - on its ability to add value in excess of risk-adjusted, project-specific capital costs. Outlays are adjusted constantly in response to changes in the market.

By contrast, under today's programs, utility demand-side management expenditures are based on rigid annual conservation program budgets that are pre-ap- proved by regulators. In many cases, it's not possible to know if immediate increases in program outlays would result in greater ratepayer benefits, let alone to act on that knowledge.

With a market-based approach to demand-side management, in- formation would be open, prices would be clear, and barriers to en- try would be low. Competition would be stimulated, not stifled.

November1994 57

B. Too Little Customer Choice

Under most demand-side management programs, customer choice is greatl~ if not completely, circumscribed. Participants are rarely allowed to act rationally (an ostensible demand-side management objective) and to select those improvements that create the greatest value under their unique circumstances. Instead they must accept square pegs for round holes.

Customers face a frustrating di- lemma. If they participate, they must choose among a set of predefined gifts (the prescribed DSM improvements), none of which may really suit their needs. If they don't, they get no gift at all. Worse, they are forced to subsi- dize improvements to their neigh- bors' or competitors' properties.

Most property owners are willing to consider substantial long- term investments in energy-saving capital improvements, if - - and only if - - the following conditions hold true:

• The project is designed to sat- isfy complex, property-specific needs;

• The work dovetails with other short- and long-term capital improvement plans and with the owner's business priorities;

• The improvements make good economic sense and do not create unacceptable business risks;

• Private capital - - usually in the form of debt m is available to finance the improvements;

• Owners have effective control over the process. Although assis- tance is needed and usually wel-

come, owners must be allowed to decide what to do and when, which professionals and contrac- tors to hire, the specific products to be used, and how the work will be paid for.

Under utility-sponsored programs, these basic requirements are rarely satisfied. It should not be surprising that property owners are often reluctant to participate, or that, once involved, they resist contributing more than modestly toward project costs. In fact, when customers demon- strate a limited willingness to share the cost of utility-sponsored energy improvements, this may well amount to a resounding, market-driven vote of "no confidence."

The real potential to add value for customers by installing capital- intensive energy improvement projects is quite large. However, as with all markets, the amount of

time it takes to penetrate them m to get everyone to a c t - - is usually considerable. (See sidebar below.)

The irony is that the cash benefits to participating customers from value-enhancing energy improvements are typically at least twice those to ratepayers in general. Moreover, if my experience is rep- resentative, the energy savings associated with projects with no u ~ -

ity funding is often greater than the savings under ratepayer-subsi- dized demand-side management programs.

There is, however, an even more important reason that customer choice is essential and that property owners must be allowed to make their own choices. Most efficiency improvements have criti- cal characteristics and cash im- pacts beyond energy savings. They increase or decrease mainte- nance needs and equipment replacement costs. They damage or

Misguided Attempts at Rapid Market Penetration

Many demand-side management programs are designed to achieve rapid market penetration. If all customers participate, then customer savings and ratepayer benefits can, in theory, be one and the same.

Unfortunately, attempts at rapid market penetration are usually self-defeating. They tend to institutionalize "cream-skimming" and "lost opportunities." They lead to "cookie cutter" solutions that make utility-sponsored conservation offerings less than satisfactory to many property owners. They greatly limit customers' willingness to share costs.

The notion of rapid or complete demand-side management market penetration is also at odds with consumer expenence. The hottest selling consumer product ever --VCRs - - achieved a U.S. penetration rate of less than 25% in the first 10 years. Televisions penetrated less than 20% of the market during the first decade after they were introduced; automobiles captured less than 5% (The Economist, May 30, 1992, at 19).

To believe that complex utility-sponsored conservation programs can saturate their markets in 5 or 10 years requires a leap of faith that defies reason. A time horizon of 20 or even 30 years seems more appropriate. By then, new technologies will have largely redefined the range of opportunities.


improve aesthetics, occupant com- fort, and employee productivity. They hurt or enhance marketabil- ity, occupancy rates, and rents. Such non-energy costs and benefits are usually more important to customers than energy savings.

Tradeoffs regarding employee satisfaction, product suitability and durabili~, and long-term capital replacement alternatives are complex and project-specific. Individual property owners and managers must be free to make such choices without major con- straints from their utility) If choices are forced into the cookie cutter mold of a DSM offering - - if customers are not allowed to make these complex value judgments for themselves - - sensible long-term decision-making, from the customer's point of view, is impossible. 2

C. Too Little Private Sector Capital

Toda}~ ratepayers usually bank- roll their utility company's demand-side management programs. Rather than use capital markets to provide liquidity and judge risks, 3 utility companies and regulators have forced ratepayers to serve as investors and to wait patiently for the promised payback.

Ratepayers provide more than just the equity needed to finance demand-side management investments and associated utility overhead. If results turn out to be worse than the utility company's initial engineering forecasts, or cost more than projected, ratepay-

Should Utility Companies Provide Conservation Financing?

One major reason regulators and advocates pushed utility companies into the energy conservation business in the first place was that they seemed to be the only ones with deep enough pockets to pay for it. Most utility companies have been unwilling to provide long-term financing, however. They prefer to expense their conservation investments and to quickly pass the costs on to ratepayers in the form of rate increases.

That utility companies have not jumped into financing energy conservation may not be such a bad thing. Popular notions to the contrary, utility companies are not the most logical or the most efficient source of capital for the energy conservation market.

Although utility companies are skilled at financing large construction projects, the structure of debt and equity, the profile of risk and reward, and level of complexity and fragmentation for energy conservation projects is completely different. With utility financing, the problems that plague today's programs might have been magnified. In short, electric utilities should not be expected to serve as banks for energy conservation projects.

ers shoulder virtually all the downside risk. 4

In competitive markets based on customer choice, comprehensive building improvements are almost always funded by tapping private capital markets, rather than out of current cash flows. Fi- nancings are typically structured using an appropriate combination of equity and debt. By borrowing funds, owners spread out cash costs to better match cash benefits, radically shortening their cash-on-cash payback.

Property owners put off major capital improvements until they are really needed. By waiting until they can lump together multiple improvements, owners cut transaction costs, achieve econo- mies of scale, and reduce the pro- portionate level of hassle and dis- ruption. Doing so makes it possible to secure long-term financing, thereby significantly reducing their project-specific cost of capital. In short, property owners apply an entirely different cal-

culus to comprehensive projects than they do to small, inconven- ient, a la carte improvements, s

Yet, in many states, utility companies continue to expense the costs of their demand-side management programs rather than placing them in rate base. 6 If individual customers don't choose to pay for their own long-term projects with cash, why should they be required - - as ratepayers - - to pay through increased rates for accelerated utility demand-side management programs and projects?

F ailure to address the issue of long-term financing is in-

dicative of deeper problems with the timing and comprehensive- ness of present conservation pro-

grams. Today's accelerated demand-side management offerings are too inflexible. They take little or no account of sensible long- term capital planning by the customer. They ensure that customers apply a high effective discount rate to demand-side management

November 1994 59

projects, greatly reducing their willingness to share costs.

With a market-based approach to demand-side management, utility companies would neither expense nor finance efficiency projects. Instead, they would tap the enormous, diverse, competitive private capital markets. They would leave judgments about project-specific capital costs to private investors, thereby sheltering ratepayers from the significant risks associated with capital-intensive demand-side management investments.

II. D S M Performance Annuit ies

DSM performance annuities help utility companies and regulators solve these three major problems. With DSM performance annuities, competition between service providers is fierce and un- impeded. Customers are free to choose among available products and services. 7 Capital is fur- nished primarily by capitalists and capital markets, not by utility customers.

A. Focus on Results

As the organizational theorist Stephen Covey points out, to secure the best results, one needs to "begin with the end in mind."8 DSM performance annuities allow government, industr3~ and consumers to come together by defining common objectives and desired results. By using the power and flexibility of competitive markets in place of top-down "programs," DSM performance annuities ensure that ratepayers

will pay as little as is consistent with the greatest possible mix of energy and environmental benefits. 9

B. Investors Buy the Right to Collect Payments for Documented DSM Performance

DSM performance annuities give holders the right to collect payment for future energ:~ capacity or transmission and distribu-

tion savings they achieve. Utility payments to the holder would be based either on predetermined price schedules, or - - if investors found this palatable - - on fluctuating (indexed) market prices for energy and capacity.

Utilities would sell the annuities to investors at auction. Auction proceeds would be used to reduce electric rates, and a portion would go to utility shareholders as an incentive. Rather than shoulder

rate increases and endure years of waiting for cash returns that ex- ceed their investment, ratepayers would receive immediate cash benefits.

C. Tap Private Capital Markets

DSM performance annuities permit regulators and utility companies to use private capital markets - - instead of utility balance sheets or customer rates - - as the source of debt and equity for energy conservation projects. Pri- vate investors 1° buy the right to collect a stream of future payments in exchange for documented performance. In order to collect, they must make long-term capital investments in improved energy efficienc}5 or must engage others to do so on their behalf. Property owners may choose between competing annuity holders or purchase annuities directly for their own use.

D. Let Everyone Compete

DSM performance annuities would be sold at auction to the highest pre-qualified bidders, with winners selected exclusively on price.

The annuities would be sold at a deep discount, to reflect investors' present value cost to market, install, and monitor energy-saving capital improvements.

Compared to today's programs, soliciting bids for DSM performance annuities would be inexpen- sive, timel:~ and efficient, n Sales would be spread out through quarterly offerings, with the terms and conditions published well in advance.


E. Pay Only for Documented Savings

With DSM performance annuities, utility companies pay only for documented energy and capacity savings. Payments must be based on monitored results backed up by independent financial audits. Utilities would main- tain control and ensure accuracy by performing independent performance checks on a statistical sample of projects. 12

F. Let Private Investors Absorb the Risks

With DSM performance annuities, private investors and lenders could absorb the performance and interest rate risks associated with financing energy-saving projects. Little of the risk is borne by utility companies or by ratepayers in general.

A portion of the risk might be

borne by participating customers.

This is appropriate, as they would be the primary beneficiaries.

Private-sector responsibility for underwriting and repaying conservation project financing would ensure that the cost of capital will accurately reflect project-specific risks. This is essential. Risks and risk-adjusted rates for debt and equity vary tremendously from one DSM project to another and one customer to the next. 13

The Heart of the Matter:

With or without our new paradigm, performance is at the heart of the matter for demand-side management. However, without a competitive market for energy savings, it is not possible to accurately establish what the savings are worth or to ensure that payments vary in direct proportion to documented performance. DSM performance annuities make monitoring a manageable problem.

At present, the framework under which performance is judged is pretty muddled. There are many different cost/benefit tests, the results of which are largely contradictory. Customer and ratepayer benefits are often co-mingled. Utilities have no unified model under which they can seek to maximize the net dollar benefits to their ratepayers. Gaming is rampant, as service providers and program participants seek to secure the biggest possible lunch, preferably for free.

Utilities generally receive full program cost recovery even if performance is poor. If actual savings are half the projections, the payment may be essentially twice what it should be. The worst penalty is usually a reduced incentive payment. As a percentage of total costs, this amount may be modest, but it does create a perverse incentive for utilities to conclude that their programs are fully cost effective, even when they aren't.

At present, DSM performance rules are constantly changing. One year's model for a cost-effective project is next year's turkey. Worst of all, although most of the energy and non-energy benefits flow to program participants and are property specific, the utility cost-benefit calculation is generally conducted as it the specific property owner doesn't even exist.

Given the importance of monitoring, it should not be surprLsing that - - even with our new paradigm - - performance remains at the heart of it all. With DSM performance annuities, utility DSM staffs and regulators will need to establish the terms and conditions of "performance." They will need to do this fairly and consistently. They will need to do this such

Monitoring Performance

that investors have full confidence that performance will lead to payment. Multiple annuity offerings will allow performance rules targeted to different types of energy-savings problems and to different classes of building.

In contrast to today's DSM environment, with DSM performance annuities the tools needed to establish real economic values to property owners will be in place. Utilities and regulators may (for fixed payment annuities) establish the maximum amount the savings are worlh, but markets will establish how much utilities pay. Gaming will coma to a screeching halt. The performance evaluation process will be depoliti- cized.

Accurate monitoring of savings remains a difficult, sometimes vexing problem. This is often raised as an obstacle to performance-based DSM, as if inaccuracy is OK only if the DSM program waste remains in-house.

When put in perspective, the potential inaccuracy of measured savings seems less daunting. Other aspects of the utility business are relatively imprecise as well, after all. For example, it is difficult to create rate structures that don't have major internal discontinuities (e.g., if a customer uses one more kWh or kW, he jumps to a lower rate and - - rather than rising - - the bill drops dramatically). The value of off-peak electric use has often slumped and soared as special peak-shaving rates were created and then eliminated.

As with rates, DSM performance monitoring will be precise only compared to a somewhat arbitrary base case or point of reference. This is OK. The best should not be allowed to become the enemy of the good. The precision with which DSM investors monitor savings should not need to be any greater than the precision with which utilities establish rates or forecast demand. From this perspective, monitoring savings is a difficult but not insurmountable problem.

November 1994 61

G. Let Investors and Customers Choose

DSM performance annuities would support the widest possible range of competitors and di- versity of approaches. Some individuals or organizations will choose to finance a broad range of projects. Others will specialize in narrow market niches. Some companies will offer bundled services and "one-stop shopping." Others will provide specialized engineering, financial construction management, and performance monitoring services separatel~ on an a la carte basis.

Individual customers could de- sign and time the installation of their own improvements. They

would be free to choose between a wide variety of strategies and service alternatives, and would not be forced to fit into the cookie cutter mold of a particular utility program or demand-side management bid offering.

Customers could weigh for themselves the complex non-energy considerations associated with most energy-saving capital improvements. They would be free to determine on a project-specific basis the amount, nature, and timing of their own cost contribu- tions.

H. Create a Liquid, Efficient Market

To ensure that the energy conservation market is as liquid as

The Paradigm Shift

Current DSM Model DSM Performance Annuities

Centralized

Budget-driven

"Programs"

Utility-centered

Fixed cost of capital

Ratepayer-financed

Focused on measures

Energy-only perspective

Regulators have no alternative but to micromanage the details

Bureaucratic

Regulatory model: Welfare office

no Little or, penalty for non-penormance

Judged based on value- neutral ratios

Leads to rate shock

Decentralized

Performance-driven

"Markets"

Customer-centered

Risk-based capital costs

Investor-financed

Focused on value added

Everything customers value

Regulators help create and oversee the orderly operation of competitive markets

Entrepreneurial

Regulatory moder.' ecurities and Exchange Commission

No performance, no payment

Judged based on net dollar benefits to ratepayers

Leads to rate cuts

possible, holders of DSM performance annuities would be free to sell them to others at any time. The annuities would be freely tradable. They could be bought or sold even before the first year of monitored savings and all the way out to the redemption date for the final year of savings.

Given rapid and continuing changes in the conservation market, in the value of savings, in energy-saving technology; and in the ownership of properties, such liquidity is essential. It would ensure that the DSM performance annuities will gravitate through arbitrage to their highest and best u s e .

By increasing competition and liquidity, and by capturing the highest possible cost contribu- tions from individual property owners, DSM performance annuities could create an efficient market that keeps ratepayers from paying too much for DSM savings. Correspondingly, by auc- tioning off the right to future payments, utilities would ensure that investor profits are squeezed as low as is consistent with maximum ratepayer benefits.

I. Eliminate DSM Rate Shock

With DSM performance annuities, payments for DSM savings could be structured and timed to match actual ratepayer benefits, with no front-loading. If holders fail to perform, no utility payments are issued. DSM rate shock would be eliminated.

Furthermore, DSM performance annuity auction proceeds produce a front-loaded stream of


cash from energy conservation. Competition drives up the price paid by investors for the annuities, front-loading some of the long-term demand-side management benefits. With DSM performance annuities, instead of raising rates, utility companies can lower them.

J. Make Integrated Resource Planning Manageable

DSM performance annuities create a level playing field for the widest possible range of potential demand-side management competitors. Sales at auction help eliminate conflict, litigation, and regulatory second-guessing. Successful integrated resources planning becomes a practical pos- sibilit34 without the need for si- multaneous supply and demand- side solicitations.

K. Offer Utility Companies a New Way to Grow Profits

Finall~ DSM performance annuities would offer utility companies an exciting new way to increase profits while helping the environment. Utility companies would earn predefined percentage returns on auction proceeds and annual DSM performance annuity payments. The level of incentive should be designed to offer utility companies that serve their ratepayers through least-cost purchases the opportunity to earn greater profits than would be possible with traditional supply-side alternatives. With DSM performance annuities, utility shareholders face a healthier, more profit- able future.

III. Reinventing the Energy Conservation Industry

It's time to reinvent the energy conservation industry - - to move from micro-management to markets. DSM performance annuities would force utility companies and regulators to focus on the most important questions:

• What do we really want? • How much are we willing to

pay?

• How will payments vary over time and under what specific terms will they be offered?

• How will we require conservation service providers to moni-

tor and document their perform-

ance? Such questions will continue to

be relevant even in the context of a radical restructuring of the en- tire electric utility industry (e.g., even with retail wheeling for all electric customers). Moreover, without a new, market-oriented approach, energy conservation may ultimately end up with little or no role to play in the restruc- tured industr}4

A. Utility Companies Must Play a Central Role

Some critics may oppose any utility funding for demand-side

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With DSM redesigned, attractive profits await.

November 1994 63

management. They may argue

that existing price signals should

be sufficient to ensure optimal re-

source allocation. They may

claim that utility companies

should get out of the energy conservation market completely. This

would just supplant one set of

problems with another, however.

Eliminating payments for con-

servation would simply ensure

that ratepayers cannot receive "least-cost" service. 14 It wou ld

force them to purchase supply-

side energy and capacity even

when demand-side alternatives

might be less costly, unnecessarily

driving up rates) s It wou ld be far

better to allow a newly created de-

mand-side marketplace to sort

things out based on prices and

performance.

B. Don't Throw Out the Baby With the Bath Water

If today's conservation pro-

grams are defunded or shut down

entirely; it will be a t remendous

waste. While the programs may

be flawed, they have created an in-

frastructure of people and busi-

nesses, of talent and experience

that should not be squandered.

The effectiveness of utility conser-

vation programs is impaired; the

energ~ commitment , and ability of utility conservation staffs is not.

Like the solar industry before it, current utility-sponsored energy

conservation programs have created both good and bad results.

The good results are an improved knowledge base and expanded

number of people and companies

working to save energ~ The bad

results are cited above, but boil

down to a regulatory framework

and demand-side management or-

ganizational model that substi-

tutes " top-down" (centralized)

programs for "bottom-up" (decen-

tralized) markets.

Rather than throw out the cur-

rent programs, we hope to see

them transformed. By using DSM

performance annuities, utility

companies can gradually move

their value-adding demand-side management operations into unregulated subsidiaries. 16 We pre-

- - - - 4

fer to think of the past few years

not as a failure but as a valuable

experiment that can serve as a

foundation for something even

better. Regulators, utility companies,

advocates, and conservation service providers should take pride in

what they have accomplished.

The energy conservation industry

has gone through a tremendous,

intensely focused period of learn- ing-by-doing.

Now it's time to apply the hard-

won lessons and to build a value-

based regulatory model that will

serve us into the next centur3a By

embracing a new, performance-

based energy conservation para-

digm, regulators and utility

companies, advocates and envi-

ronmentalists can balance energ~

environmental, and economic con-

ceres while creating new jobs,

new wealth, and an expanded tax

base for our nation.

With a gradual transition from today's programs to a conserva-

tion market based on competition,

customer choice, and private capi-

tal, utility investments in energy

conservation can live up to their

full potential: lower electric rates and a more valuable array of serv-

ices for all customers. •

Endnotes:

1. However, it would be best if their decision and their financing incorpo- rated the competitive market value of energy and demand savings to ratepayers in general.

2. As the eminent business thinker Peter Drucker points out, there is nothing worse than improving the efficiency of a process or function that ought to be eliminated. The primary focus should be on effectiveness, on addressing the right problems and opportunities. Improved efficiency, while important, is only a secondary consideration.

For example, today's offices have been transformed by personal computers. Yet many utility demand-side management programs focus on improving the efficiency of yesterday's all-ambi- ent lighting systems, rather than on addressing the real lighting needs of the 1990s. Comprehensive solutions require a reduction in glare from win- dows and overhead lights and a greater emphasis on task lighting at each workstation.


3. In competitive markets, these risks serve as the basis on which real, project-specific capital costs and discount rates are determined.

4. This investment risk is a major con- cern, as it is not unusual for actual monitored savings under demand- side management programs to be less than half the original engineering esti- mates.

5. Much attention has been given to the high implicit discount rates customers apply to low-cost energy-saving improvements. Little has been said, however, of the propensity of owners to install major home improvements - - family rooms, fireplaces, greenhouses, and replacement win- dows - - despite considerable evidence that their impact on resale value is but a fraction of their cost (typically 50 to 90 percent). This pattern of behavior suggests that the implicit discount rate for things that building owners ac- tually want is negative. Thus, letting customers choose their own building improvements is likely to have a significant beneficial impact on applica- ble discount rates and on customers' willingness to share costs.

6. Anecdotal evidence suggests that utility resistance to long-term conservation project financing is based largely on perceived regulatory risk. Utility company executives - - often with good reason - - fear that today's cost recovery promises may be broken by future public utility commission- ers.

7. Without forgoing utility funding of a portion of their costs if their efforts create measurable value added for ratepayers under competitive market conditions.

8. STEPHEN R. COVEY, PRINCIPLE-CEN-

TERED LEADERSHIP (Fireside, 1992).

9. DSM performance annuities are one example of a new class of financial instrument developed by CCI: instruments which are designed to bring market forces to those areas of economic activity traditionally addressed only through government outlays or through prescriptive regulation of pri-

vate sector activities. CCI's result-oriented financial instruments put competition in service of social goods.

10. Potential buyers include wealthy individuals, investment partnerships, Wall Street investment banks, unregulated utility subsidiaries, energy conservation companies, and equipment manufacturers.

11. Current approaches to bidding for conservation services are costly and time-consuming. Bidders must assem- ble large proposals listing their qualifi- cations, experience, and why they should be selected. Utility companies must review reams of documents.

They must attempt to make fair, objective choices when the process is un- avoidably subjective. This invites lawsuits by disgruntled competitors and second-guessing by regulators. It creates tremendous built-in conflicts.

12. Many utility companies may elect to hire independent firms that specialize in documentation, payment, and audits to perform these services on their behalf.

13. The market cost of capital is often very high for short-lived improvements with no non-energy benefits. It may be very low - - even lower than utility capital costs - - for comprehensive, long-lived energy improvement

projects that produce substantial non- energy benefits.

14. The author believes that traditional economic analyses of demand- side management opportunities largely miss the point. We view utility payments for demand-side management savings as a comparatively sim- ple purchasing function. The cash flow benefits to ratepayers equal avoided energy, capacity, and transmission costs minus lost revenues. In this context, the cost of lost sales (the spread between customer rates and marginal utility costs) reduces demand-side management benefits only for a relatively short period of time. As soon as the unit of energy or capacity produced through conservation is sold to another customer, the lost sale disappears. Given utility companies' use of accrued interest financing during construction for power plants, why not accrue the cost of lost sales and then amortize them out of long- term cash flows from demand-side management savings? Furthermore, before this is done, the market for utility and independent power must be made similarly efficient. If demand- side management improvements are to be charged for lost sales, utility- sponsored and independent power projects should be charged for costs in- curred during those periods in which, due to perennially incorrect demand forecasts, ratepayers foot the bill for unneeded capacity. At present, the cash burden on ratepayers from this supply-side problem dwarfs any plau- sible cost of lost sales from demand- side management. To create a level playing field, payments for utility or independent power production should be reduced to account for costs associated with excess capacity.

15. High electric rates will also damage electricity's competitive position and dampen load growth.

16. Alternatively, some utility companies may choose to transform their demand-side management programs into - - or sell them to - - independent conservation services companies.

November 1994 65

Documents

Reinventing the energy conservation industry