What should be the involvement and mandate of the energy regulator in connection with promotion of Energy Efficiency and what are the main challenges associated from a regulatory perspective?

Level of Involvement for a Regulator: Policy-makers will set the targets and (often) procedures for Energy Efficiency (EE) initiatives. RE represents a supply-side intervention, and EE represents demand-side management. In general, the regulator will have a less direct role in EE than in RE initiatives, since the latter primarily involve adjustments by customers. However, EE basically promotes energy conservation—which means that programs impact utility costs (directly through program costs and changes in production patterns) and revenues. The context outlined in the FAQ on the involvement of the energy regulator with reference to the renewable energy is the same as for this question. Thus, we will not go into setting policy vs. implementing that policy and the other principles identified in the discussion of RE mandates and challenges. As in the case of RE, regulators might have wide discretion in the implementation and/or monitoring EE initiatives. The most likely roles involve giving technical advice to the agency developing EE initiatives, since changes in demand patterns will have implications for the operations and investment plans of utilities (and for costs, security of supply and quality of service) . As in the case of RE, energy efficiency is likely to be of concern to a number of governmental organizations. Formal memorandums of understanding should be developed with entities promoting EE, such as the Energy Ministry and environmental agencies. Such MOUs need to specify the responsibilities of the different entities so as to avoid duplication of effort (reducing delays) and to limit the likelihood that some problems will not be addressed.

Illustrative EE Programs: Many developing countries experience rationing of electricity, so improvements in energy efficiency by on group make more electricity available for other customers. EE programs can be incentivized by regulators or by other government agencies. The Bjork et. al. NARUC Handbook (2011)and The International Confederation of Utility Regulators (ICER) volume from 2010 identify a number of EE programs (which will be discussed in a later FAQ):

Utility EE Actions Incentivized by Regulators

1. Promoting utility-based EE/conservation programs
2. Incentivizing reduced Line Losses
3. Promoting improvements in Load Patterns and Power Factors (though time of use pricing and demand side management)
4. Incentivizing improvements in System Reliability (reducing self-generation by larger customers)
5. Regulating meters, billing, and other consumption information provided to consumers
6. Encouraging utility energy audits
7. Incentivizing smart grids

EE Activities Promoted by Other Agencies

1. Building Codes and Industry Standards for Products using Electricity: Minimal Role for the Sector Regulator.
2. Government (taxpayer) Provision of Financial Support
3. Tradable Certificates/saving obligations on energy utilities
4. Tenders for EE initiatives
5. Voluntary agreements between industry and government
6. Energy end-use efficiency in the public (Government) sector (for example, schools and hospitals)

Main Challenges Associated with Regulatory Functions Affecting Energy Efficiency: As was noted in the FAQ about the role of the energy regulator in connection with the promotion of renewable energy, public policy will determine broad approaches to energy efficiency. However, initiatives undertaken by the utility must generally be approved and certainly be monitored by the regulator, since these initiatives have implications for cost and demand patterns (and therefore, the price level and average price). In countries where there are energy shortages (and rationing), EE increases system reliability—improving the quality of service experienced by customers. Thus, the role of regulators primarily involves providing technical input into the development of EE policies initiated by other agencies or via legislated tax programs. However, EE and conservation programs incentivized by the utility must be approved and monitored by the regulator to ensure that the programs are well-designed and that they meet the objectives of the enabling legislation.

The key challenges are the same as the FAQ outlining the regulator’s role in renewable energy promotion (1) legal mandate of the regulator, (2) clarity in roles and responsibilities of different agencies (including identifying who has ultimate decision-authority), (3) coherence of programs (consistency across EE initiatives), (4) resources of the agency (technical expertise for evaluating and monitoring utility initiatives and for assisting external agencies), (5) transparent processes (so special interests cannot dominate the decision-process or have an inside track on utility contracts), and (6) stable and predictable funding for EE programs. In addition, the Regulator must determine (unless specified in law) which benefit-cost test is appropriate for evaluating utility-based EE programs.

Benefit Cost Tests for Utility-Based EE Programs

A contentious issue is the standard to be used for evaluating EE programs. There are at least five alternative tests: all five tests taken together provide a comprehensive picture of a program’s impact. However taken individually, they will provide different rankings of alternative programs. Ultimately, the primary test adopted for evaluating alternative programs will drive the net present value calculations (assuming there is agreement on the appropriate discount rates to be used in the analysis). Determining the appropriate metrics depends on the objectives of the program. Standard tools of finance provide key techniques for evaluating proposed programs as well as their impacts. Net Present Value is the best indicator, since it captures monetary inflows and outflows over time. However, part of the justification of EE programs is from the environmental benefits which are difficult to quantify. Nevertheless, some attempt must be made so that programs can be compared and evaluated. Reviewing the impacts of previous programs is crucial if decision-makers are to benefit from the lessons of the past. When unintended consequences of actions begin to be noted, the policies should come under immediate review.

There are several different tests that regulators employ to attempt to quantify the relative impact of EE/conservation programs. The particular measure employed will depend on the scope and priorities of the EE policy established by political actors, but it is likely that one measure alone will not provide a definitive answer for regulators. The best approach might be to use the methods that best address the focus of the policy and compare the results of the analysis. Ultimately, the regulatory ruling requires an analysis of the “no initiative” scenario (without the EE program) so the analysis considers differences from the baseline. In addition to the internal consistency of the programs, regulators must be aware of the effects of interactions between these programs, as these interactions may change the impacts of individual programs or produce unintended consequences. Five measures are outlined in Table 1, with a summary of the approach used by each standard, and the question it attempts to address.

Table 1: The Five Principal Cost-Effectiveness Tests Used in Energy Efficiency

Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects.

Furthermore, the discount rate used will differ among the tests:  the California Standard Practice Manual recommends participant’s discount rate for PCT, the utility’s WACC for RIM, PACT, and TRC, and the social discount rate for SCT.  So the regulator faces additional choices when evaluating utility-sponsored EE programs.  Another way of comparing the approaches is to look at different aspects of programs:

Table 2: Summary of Costs and Benefits Included in Each Test

The Standard Practice Manual goes into detail regarding the formulas for the various tests.  Whether particular impacts are “counted” or not affects whether a program will be viewed as cost-effective: the choice of a particular test (or combination of tests) by the regulator significantly affects the types of EE programs that can be implemented by the utility.  Another issue is whether individual programs for particular customer groups (such as those using emerging technologies or those directed at the poor) need to pass the test, or whether a portfolio of projects should pass the test. Other indicators include the ratio of benefits to costs, internal rate of return, levelized cost of conserved energy, and the payback period. However, Net Present Value provides the most comprehensive measure for benefits and costs.

Regulatory Functions Affecting Energy Efficiency: Energy regulators have authority to carry out functions that have implications for the financial feasibility of utility-based EE programs. Functions that are often assigned regulatory commissions were listed in the FAQ outlining the energy regulator’s role in promoting renewable energy, but are repeated here in abbreviated format, with specific applications to EE:

Issuing licenses related to regulatory functions: This function is less important for EE than for RE since the former do not involve siting issues.

Setting performance standards: If any performance targets are established for EE (for reducing energy consumption), these would be determined by broad public policy, leaving the sector regulator to implement incentives that contributed to the achievement of these targets. Significant regulatory attention would be devoted to the cost-effectiveness of programs under the control of utilities.

Monitoring the performance of regulated firms: As with RE, evaluating EE programs requires data collection and analysis. An important task for regulators would be to ensure that contracts with external service providers were designed and bid properly.

Establishing the price level and the structure of tariffs: When a customer makes energy efficiency investment, quantity demanded is reduced—lowering the utility bill and improving reliability. If the utility subsidizes the investment, regulators will need to analyze, evaluate, and approve utility-based programs using tests described earlier. In addition, EE can be promoted by particular rate designs, including time of use rates and industrial customer penalties for low power factors.

Establishing a Uniform Accounting System: Evaluating the cost-effectiveness of EE initiatives requires that operators provide data and reports and that regulators have the capacity to review those studies. The regulator must determine which benefit-cost test should be applied to utility programs.

Arbitrating disputes among stakeholders: Regulators can help resolve issues that are technical in nature; for example, which benefit-cost test to use for evaluating EE programs. Different customer classes will object to cross subsidization caused by utility programs. The regulatory commission is in a position to organize workshops and promote dispute resolution.

Performing (usually via independent consultancy) management audits on regulated firms: The regulator should review the organizational elements of EE programs on a regular basis to ensure cost effectiveness: are the goals of EE programs being met in a cost-effective manner?

Developing human resources for the regulatory commission: The implementation of EE policies depends on the quality of the professionals who are conducting regulatory analyses.

Reporting sector and commission activities to appropriate government authorities: Given the expertise assembled at a commission, the agency can provide information and advice to appropriate government departments that are concerned with EE.

Thus, regulators will make decisions that affect the funding of EE investments. Specific regulatory instruments for promoting EE are discussed in greater detail in another FAQ.

References

Encouraging Renewable Energy Development: A Handbook for International Energy Regulators
Prepared by Pierce Atwood LLP for NARUC, with USAID funding. January 2011, pp. vii-138.
Bjork, Isabel and Catherine Connors, Thomas Welch, Deborah Shaw, William Hewitt

Energy Efficiency Governance Handbook
International Energy Agency, 2011, 1-52.

Energy Efficient Cities Initiative: Good Practices in City Energy Efficiency
Cape Town-Kuyasa Settlement, South Africa. January 2012. pp. 1-14.
ESMAP

California Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects
2001

A Description of Current Regulatory Practices for the Promotion of Energy Efficiency
June 21, 2010, pp. 1-176.
International Confederation of Energy Regulators, ICER

Electrification and Regulation: Principles and a Model Law
Energy and Mining Sector Board Discussion Paper No. 18, World Bank, July 2006, 1-44.
Kilian Reiche, Bernard Tenenbaum, and Clemencia Torres de Mästle

An Analytical Compendium of Institutional Frameworks for Energy Efficiency Implementation
Energy Sector Management Assistance Program (ESMAP) Formal Report 331/08, October 2008.
Limaye, D. R., Heffner, and Sarkar

Financing Energy Efficiency in Developing Countries—Lessons Learned and Remaining Challenges
Energy Policy, 2010.
Sarkar, A. and J. Singh

World Bank GEF Energy Efficiency Portfolio Review and Practitioners’ Handbook
Thematic Discussion Paper January 21, 2004.
World Bank Environment Department

Additional References:

Beyond Bonn: World Bank Group Progress on Renewable Energy and Energy Efficiency in Fiscal 2005–2009.
World Bank Group Energy and Mining Sector Board. xvii-73.

Industrial Energy Efficiency for Sustainable Wealth Creation: Capturing Environmental, Economic, and Social Dividends
Industrial Development Report from UNIDO (United Nations Industrial Development Organization), 2011. xviii-239.

Energy Efficiency Governance– an emerging priority
ECEEE 2009 Summer Study.
Jollands, N. and Ellis Mark

Implementation of the 25 energy efficiency policy recommendations in IEA member countries: recent developments
Energy Efficiency Series IEA, March 2011.
Pasquier, Sara Bryan

Primer on Demand Side Management
Prepared by Charles River Associates for the World Bank, February 2005.

Financing Energy Efficiency: Lessons from Brazil, China, India and Beyond
The World Bank, 2008.
Taylor, Robert P., Chandrasekar Govindarajalu, Jeremy Levin, Anke S. Meyer, and William A. Ward