Understanding Cost-Effectiveness Of Energy Effi Ciency .

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Understanding Cost-Effectivenessof Energy Efficiency Programs:Best Practices, Technical Methods, and EmergingIssues for Policy-MakersA RESOURCE OF THE NATIONAL ACTION PLANFOR ENERGY EFFICIENCYNOVEMBER 2008

About This DocumentThis paper, Understanding Cost-Effectiveness of Energy Efficiency Pro grams, is provided to assist utility regulators, gas and electric utilities,and others in meeting the 10 implementation goals of the NationalAction Plan for Energy Efficiency’s Vision to achieve all cost-effectiveenergy efficiency by 2025.This paper reviews the issues and approaches involved in consideringand adopting cost-effectiveness tests for energy efficiency, includingdiscussing each perspective represented by the five standard costeffectiveness tests and clarifying key terms.The intended audience for the paper is any stakeholder interested inlearning more about how to evaluate energy efficiency through the useof cost-effectiveness tests. All stakeholders, including public utility com missions, city councils, and utilities, can use this paper to understandthe key issues and terminology, as well as the various perspectives eachcost-effectiveness test provides, and how the cost-effectiveness testscan be implemented to capture additional energy efficiency.

Understanding Cost-Effectivenessof Energy Efficiency Programs:Best Practices, Technical Methods, andEmerging Issues for Policy-MakersA RESOURCE OF THE NATIONAL ACTION PLAN FORENERGY EFFICIENCYNOVEMBER 2008

The Leadership Group of the National Action Plan for Energy Efficiency is committed to takingaction to increase investment in cost-effective energy efficiency. Understanding CostEffectiveness of Energy Efficiency Programs: Best Practices, Technical Methods, and EmergingIssues for Policy-Makers was developed under the guidance of and with input from theLeadership Group. The document does not necessarily represent a consensus view and doesnot represent an endorsement by the organizations of Leadership Group members.Understanding Cost-Effectiveness of Energy Efficiency Programs: Best Practices, TechnicalMethods, and Emerging Issues for Policy-Makers is a product of the National Action Plan forEnergy Efficiency and does not reflect the views, policies, or otherwise of the federalgovernment. The role of the U.S. Department of Energy and U.S. Environmental ProtectionAgency is limited to facilitation of the Action Plan.If this document is referenced, it should be cited as:National Action Plan for Energy Efficiency (2008). Understanding Cost-Effectiveness of EnergyEfficiency Programs: Best Practices, Technical Methods, and Emerging Issues for PolicyMakers. Energy and Environmental Economics, Inc. and Regulatory Assistance Project. www.epa.gov/eeactionplan For More InformationRegarding Understanding Cost-Effectiveness of Energy Efficiency Programs: Best Practices, Technical Methods, andEmerging Issues for Policy-Makers, please contact:Katrina PielliU.S. Environmental Protection AgencyOffice of Air and RadiationClimate Protection Partnerships DivisionTel: (202) 343-9610E-mail: pielli.katrina@epa.govRegarding the National Action Plan for Energy Efficiency, please contact:Stacy AngelU.S. Environmental Protection AgencyOffice of Air and RadiationClimate Protection Partnerships DivisionTel: (202) 343-9606E-mail: angel.stacy@epa.govLarry MansuetiU.S. Department of EnergyOffice of Electricity Delivery and Energy ReliabilityTel: (202) 586-2588E-mail: lawrence.mansueti@hq.doe.govor visit www.epa.gov/eeactionplan

Table of ContentsList of Figures .iiiList of Tables.iiiList of Abbreviations and Acronyms. vAcknowledgements. viExecutive Summary . ES-11:2:3:4:Introduction . 1-11.1Background on Cost-effectiveness Tests.1-11.2About the Paper .1-21.3Structure of the Paper .1-31.4Development of the Paper.1-41.5Notes .1-4Getting Started: Overview of the Cost-Effectiveness Tests . 2-12.1Structure of the Cost-Effectiveness Tests .2-12.2The Five Cost-Effectiveness Tests and Their Origins .2-22.3Cost-Effectiveness Test Results in Best Practice Programs.2-22.4Notes .2-3Cost-Effectiveness Test Review—Interpreting the Results. 3-13.1Example: Southern California Edison Residential Energy Efficiency Program .3-13.2Considerations When Using Cost-Effectiveness Tests .3-93.3Notes .3-12Key Drivers in the Cost-Effectiveness Calculation . 4-14.1Framework for Cost-Effectiveness Evaluation .4-14.2Choosing Which Benefits to Include.4-24.3Level of Complexity When Forecasting Avoided Costs.4-34.4Forecasts of Avoided Costs .4-34.5Area- and Time-Specific Marginal Costs.4-64.6Net Present Value and Discount Rates.4-74.7Establishing the Net-to-Gross Ratio .4-94.8Codes and Standards .4-104.9Non-Energy Benefits and Costs .4-104.10Incentive Mechanisms.4-11National Action Plan for Energy Efficiencyi

5:6:4.11Greenhouse Gas Emissions.4-124.12Renewable Portfolio Standards.4-134.13Defining Incremental Cost .4-144.14Notes .4-16Guidelines for Policy-Makers . 5-15.1Emphasizing Cost-Effectiveness Tests .5-15.2Picking Appropriate Costs, Benefits, and Methodology .5-5Detailed Cost-Effectiveness Test Comparison—How Is Each CostEffectiveness Test Used?. 6-16.1Participant Cost Test .6-16.2Program Administrator Cost Test .6-26.3Ratepayer Impact Measure .6-46.4Total Resource Cost Test.6-56.5Societal Cost Test .6-76.6Notes .6-9Appendix A: National Action Plan for Energy Efficiency Leadership Group. A-1Appendix B: Glossary. B-1Appendix C: Cost-Effectiveness Tables of Best Practice Programs . C-1Southern California Edison Residential Incentive Program . C-1Avista Regular Income Programs . C-5Puget Sound Energy Commercial/Industrial Retrofit Program. C-8National Grid MassSAVE Program . C-12Appendix D: References. D-1iiUnderstanding Cost-Effectiveness of Energy Efficiency Programs

List of FiguresFigure 1-1. Ten Implementation Goals of the National Action Plan for Energy EfficiencyVision for 2025: A Framework for Change .1-3Figure 3-1. Hypothetical Cost-Effectiveness at Measure, Program, and Portfolio Levels.3-9Figure 3-2. Timeline of Distributional Impacts When PCT 1 and RIM 1 .3-11Figure 4-1. Implication of Time-of-Use on Avoided Costs .4-7Figure 4-2. Comparison of Marginal CO2 Emission Rates for a Summer Day in Californiaand Wisconsin .4-13Figure 4-3. Natural Gas, Energy Efficiency, and Renewable Supply Curves for California .4-14List of TablesTable 1-1. Cost-Effectiveness Tests in Use by Different States as Primary or SecondaryConsideration .1-2Table 2-1. Basic Approach for Calculating and Representing Cost-Effectiveness Tests.2-1Table 2-2. The Five Principal Cost-Effectiveness Tests Used in Energy Efficiency .2-2Table 2-3. Summary of Cost-effectiveness Test Results for Four Energy EfficiencyPrograms.2-3Table 3-1. Summary of Benefits and Costs Included in Each Cost-Effectiveness Test.3-2Table 3-2. Summary of Benefits and Costs Included in Each Cost-Effectiveness Test.3-3Table 3-3. SCE Residential Energy Efficiency Incentive Program Benefits.3-4Table 3-4. SCE Residential Energy Efficiency Incentive Program Costs.3-4Table 3-5. Summary of Cost-Effectiveness Test Results ( Million) .3-5Table 3-6. Participant Cost Test for SCE Residential Energy Efficiency Program .3-5Table 3-7. Program Administrator Cost Test for SCE Residential Efficiency Program .3-6Table 3-8. Ratepayer Impact Measure for SCE Residential Energy Efficiency Program.3-7Table 3-9. Total Resource Cost Test for SCE Residential Energy Efficiency Program .3-8Table 3-10. Societal Cost Test for SCE Residential Energy Efficiency Program.3-8Table 4-1. Universe of Energy and Capacity Benefits for Electricity and Natural Gas .4-2Table 4-2. Approaches to Valuing Avoided Energy and Capacity Costs by Utility Type.4-4Table 4-3. The Use of Discount Rates in Cost-Effectiveness Tests .4-8Table 4-4. Defining Customer Decision Types Targeted by Energy Efficiency Measures.4-15Table 4-5. Defining Costs and Impacts of Energy Efficiency Measures .4-16Table 5-1. Primary Cost-Effectiveness Test Used by Different States .5-1National Action Plan for Energy Efficiencyiii

Table 5-2. Cost-Effectiveness Tests in Use by Different States as Primary or SecondaryConsideration .5-2Table 5-3. Use of Cost-Effectiveness Tests by States.5-4Table 6-1. Benefits and Costs Included in the Participant Cost Test.6-1Table 6-2. Benefits and Costs Included in the Program Administrator Test .6-3Table 6-3. Benefits and Costs Included in the Rate Impact Measure Test.6-4Table 6-4. Benefits and Costs Included in the Total Resource Cost Test .6-6Table 6-5. Benefits and Costs Included in the Societal Cost Test .6-7Table C-1. SCE Program Costs. C-2Table C-2. SCE Program Benefits . C-3Table C-3. SCE Program Cost-Effectiveness Test Results . C-4Table C-4. Avista Program Costs . C-5Table C-5. Avista Program Benefits. C-6Table C-6. Avista Program Cost-Effectiveness Test Results. C-7Table C-7. PSE Program Costs . C-9Table C-8. PSE Program Benefits . C-10Table C-9. PSE Program Cost-Effectiveness Test Results . C-11Table C-10. National Grid Program Costs . C-13Table C-11. National Grid Program Benefits . C-14Table C-12. National Grid Program Cost-Effectiveness Test Results. C-15ivUnderstanding Cost-Effectiveness of Energy Efficiency Programs

List of Abbreviations and TWhUCAPUCTVOCWACCAnnual Energy OutlookBritish thermal unitcombined cycle gas turbineconservation and demand managementCalifornia Energy Commissioncompact fluorescent light bulbcarbon dioxidedebt-coverage ratioU.S. Department of Energydemand responsedemand-side managementU.S. Environmental Protection Agencygreenhouse gashorsepowerheating, ventilation, and air conditioninginstalled capacityinvestor-owned utilityintegrated resource planningkilowattkilowatt-hourliquefied natural gasload serving entitymillion Btumegawattmegawatt-hournon-energy benefitsnitrogen oxidesnet present valuenet-to-gross ratioNorthwest Power and Conservation CouncilNew York State Energy Research and Development Authorityprogram administrator cost test (same as UCT)participant cost testPuget Sound Energyratepayer impact measure testreturn on equityrenewable portfolio standardSouthern California Edisonsocietal cost testSeasonal Energy Efficiency Ratiosulfur oxidestransmission and distributiontime of usetotal resource cost testterawatt-hourunforced capacityutility cost test (same as PACT)volatile organic compoundweighted average cost of capitalNational Action Plan for Energy Efficiencyv

AcknowledgementsThis technical issue paper, Understanding Cost-Effectiveness of Energy Efficiency Programs, isa key product of the Year Three Work Plan for the National Action Plan for Energy Efficiency.This work plan was developed based on Action Plan Leadership Group discussions andfeedback expressed during and in response to the January 7, 2008, Leadership Group Meetingand the February 2008 Initial Draft Work Plan. A full list of Leadership Group members isprovided in Appendix A.With direction and comment by the Action Plan Leadership Group, the paper’s developmentwas led by Snuller Price, Energy and Environmental Economics, Inc., under contract to the U.S.Environmental Protection Agency (EPA). Additional preparation was performed by Eric Cutterand Rebecca Ghanadan of Energy and Environmental Economics, Inc.Rich Sedano and Brenda Hausauer of the Regulatory Assistance Project supplied informationon the use of cost-effectiveness tests by states and provided their expertise during the reviewand editing of the paper. Alison Silverstein also provided expertise during the review and editingof the paper.EPA and the U.S. Department of Energy (DOE) facilitate the National Action Plan for EnergyEfficiency. Key staff include Larry Mansueti (DOE Office of Electricity Delivery and EnergyReliability), Dan Beckley (DOE Office of Energy Efficiency and Renewable Energy), andKathleen Hogan, Katrina Pielli, and Stacy Angel (EPA Climate Protection Partnership Division).Eastern Research Group, Inc., provided copyediting, graphics, and production services.viUnderstanding Cost-Effectiveness of Energy Efficiency Programs

Executive SummaryThis paper, Understanding Cost-Effectiveness of Energy Efficiency Programs, reviewsthe issues and approaches involved in considering and adopting cost-effectiveness testsfor energy efficiency, including discussing each perspective represented by the fivestandard cost-effectiveness tests and clarifying key terms. This paper is provided toassist organizations in meeting the 10 implementation goals of the National Action Planfor Energy Efficiency’s Vision to achieve all cost-effective energy efficiency by 2025.Improving energy efficiency in our homes, businesses, schools, governments, and industries—which consume more than 70 percent of the natural gas and electricity used in the country—isone of the most constructive, cost-effective ways to address the challenges of high energyprices, energy security and independence, air pollution, and global climate change. Despitethese benefits and the success of energy efficiency programs in some regions of the country,energy efficiency remains critically underutilized in the nation’s energy portfolio. It is time to takeadvantage of more than two decades of experience with successful energy efficiency programs,broaden and expand these efforts, and capture the savings that energy efficiency offers.Understanding energy efficiency cost-effectiveness tests and the various stakeholderperspectives each test represents is key to establishing the policy framework to capture thesebenefits.This paper has been developed to help parties pursue the key policy recommendations andimplementation goals of the National Action

This paper, Understanding Cost-Effectiveness of Energy Effi ciency Pro grams, is provided to assist utility regulators, gas and electric utilities, and others in meeting the 10 implementation goals of the National Action Plan for Energy Effi ciency’s Vision to achieve all cost-effective energy effi ciency by 2025.

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