United States
            , Environmental Protection Air and Radiation  EPA/400/1 -91/006.B
            Agency  •    -,  (ANR^445)     April 1991
SrEPA    Acid Rain Advisory
            Committee Meeting:
            January 28-29,1991
            Energy Conservation
            and Renewables
            Issue Papers
                    , D.C. 20460



                      •. .  .  '       - -          .    -  -        C2


        ,..."   .     ACID RAIN ADVISORY COMMITTEE
                       January 28-29, 1991            •'•''..
     Background;  One of the requirements for receiving
allowances-from the. Conservation and Renewable Energy Reserve  is
that the applicant utility must have in place a "least cost plan"
for meeting future electric; needs.  "The genesis of this provision
is a movement initiated during the  1980s to formalize the
resource planning process undertaken by electric utilities and
ensure commissions and consumers that the full range of options -
-demand-side as.well asvsupply-side — were being considered  to
meet the power needs ofratepayers.  The products of this
movement have become;known as "Least Cost Plans", VLeast Cost
Utility Plans?1, "integrated, Resource Plans" and the like.  There
are as many definitions of these ..plans as states that have   ;
adopted'them.   While the precise-definitions and provisions
vary, the common.threads seem to be:;

     6    The utility must outline  a plan for meeting future
          demand at lowest system cost.

     o    In so doing, the utility  must explicitly consider both
      ' •'.  supply-side and demand-side resources.

     o;..:... The plan must be submitted to the utility's regulatory
          commission (or ratemaking authority) for review and
          public comment.
       A survey conducted in 1988 by the Electric Power Research
Institute concluded that least cost plans are under consideration
or'have been adopted in at least 43 states, a survey commissioned
by the National Association of State Utility Consumer Advocates %
(NASUCA) in 1989 determined that 14 states had adopted or were
considering least, cost plans*  The discrepancy is based on
definitions of least cost, plans and survey techniques'.  See
Cynthia Mitchell,. "Lagging in Least-Cost Planning--  Not As Far
Along As We Thought," Electricity Journal. December 1989, p. 24-
31.  For- results of the individual surveys see Electric Power
Research Institute, "Status of Least-Cost Planning in the United
States," (Pub. EM-6133, Project 2982-2, prepared for EPRI by
Barakat, Howard and Chamber1in) 1988; and C. Mitchell and J.
Wellinghoff,. LCUP Consumer Participation Manual. 1989 (copies
available, through NASUCA, Washington, DC).


     Legislative Languaget  (Title IV, Sec 404(f)(2)(B)(iii))

               "(I)  Such electric utility has adopted and is
          implementing a least cost energy conservation and
          electric power plan which evaluates a range of
          resources, including new power supplies,  energy
          conservation, and renewable energy resources, in order
          to meet expected future demand at the lowest system
               i* (IX)  The qualified energy conservation measures
          or qualified renewable energy, or both, are consistent
          with that plan.
               "(Ill)  Electric utilities subject to the
          jurisdiction of a State regulatory authority must have
          such plan approved by such authority.  For,electric
        .  utilities not subject to the jurisdiction of a State
          regulatory authority such plan shall be approved by the
          entity with ratemaking authority for such utility."
                                 """                *
     General Principles;  As stated in the legislation, the least
cost plan must be designed to meet electricity demand at lowest
system cost; a range of resources, including conservation and
renewable energy, must be evaluated in determining what least
cost is; and the process should undergo regulatory scrutiny by
the appropriate ratemaking body.

     The "lowest system cost11 criteria implies that utilities
applying the "no losers test", which focuses on comparisons of
rate impacts of different resource options, rather than overall
system cost impacts, will not qualify for allowances from the
C/RE Reserve.                .

     Issues for Discussion:

o    Should EPA explicitly require that public hearings before
     the ratemaking authority take place?  Does this happen
     everywhere anyway?

o  ,/iHow many utilities currently apply the "no losers test"?  To
   .  what extent can EPA (in cooperation with NARUC, DOE and
     others) assist in regulatory reform proceedings to ensure
     that these utilities modify their least cost planning
    , criteria and meet the qualifications necessary for
     application for allowances from the reserve?

o    Should EPA be specific about the breadth and depth required
     in utility evaluation of conservation and renewable energy

o    Should EPA mandate or encourage that environmental costs be
     incorporated into least cost plans?  Sec. 808 of Title VIII

      commissions  a  study to. be completed by May .1992 .on the
    • .environmental  costs of electric generation resource types:.,

                "(b)   RATE INCENTIVES STUDY; — Within 18 months
          after enactment,  the Federal Energy Regulatory,
          .Commission,  in.consultation, with the.Environmental
          Protection Agency,  shall complete.a study which      ,
          calculates the net environmental benefits; of renewable. \
          energy, compared.to nonrenewable energy,  and assigns; .
          numerical values to them.   The study, shall include -t  but
          notKbe  limited to,  environmental .impacts  on air,, water,,
          land  use,  water use,  human health,  and  waste disposal.
                *{C)   MODEL REGULATIONS.— In conjunction with
  ,'        the study in subsection (b),' the Commission shall
          '.propose one or more models for incorporating the net
          environmental benefits into the regulatory treatment of
       -.  renewable energy in order to provide-economic
          'compensation for those benefits.     ;  ? .     '-.   • .,  ?
                "(d)   REPORT.  — The Commission shall transmit the
          study and the model regulations to Congress, along with
:•     '    any recommendations oh the- best ways to reward
          renewable energy technologies'for their environmental
          ; benefits,  in a report no later .than, 24  months after  ,.
  ~-,      enactment."    •                   .
         -". 4* '   *      ' -  ' '     '  •           ' '       '   • .       i '•
 When completed, this study is likely to provide more .widespread
 quantitative support for initiatives underway in  some states
 already,  although the timing may not lend'itself  to EPA mandates
 at  this stage of  the -Conservation and Renewable Energy Reserve
 rulemaking.       .  .'•••"-* .                       ,

    .Charge of  the  Subcommittee!  It is the responsibility of the
 Subcommittee to draft criteria, and potentially language, to be
 used in the Conservation and Renewable Energy rule  for defining
 least cost plan.  . These criteria (and/or this language) will be
 presented to the  full ARAC on January 29 for review, discussion,
 and agreement.



                         ACID RAIN ADVISORY COMMITTEE     •
                              January 28-29,  1991          .  -
            Background:   One of the requirements for application for
       conservation allowances' from the Conservation and Renewable
       Energy Reserve, is that utilities have rates which guarantee that
       they make as much money on energy saved as energy sold. ;
       Historically a disincentive has been in place for pursuit-of
       demand side energy efficiency improvements by utilities.-
       Efficiency.improvements reduce sales, and thus decrease profits.
       John Rowe,  President and CEO of New England Electric System
       (NEES), summarizes the traditional utility disincentives for  .,
       conservation:          -           '           .    ,•       "     :

            1.   Slow and uncertain recovery - of costs;       . .   .  .  '- ,
            2.   Lost base revenues;  .         .   '•'•'-..-   '•-*/
            3.   Lack of direct profit opportunity;      •'".'*•'..
            4.  .Conservation expenditures beyond the "no losers", test
                'increase electricity, rates;     ,   .  -.. - .     '•-'
            5.   Few businesses or bureaucracies wish to shrink their
                 opportunities.  ..     '     .      •_ • -    *        • ;.  . '..
            6.   It is difficult to explain [conservation and load    :
                 management];to customers and employees if it is not
                                     .  '•  • h; '"•     -.••.-. v •     •.-..,''-.
       NEES and the New- England commissions to which it is accountable
       (as well as a number .of other utilities and commissions) have
       created a regulatory system which eliminates these disincentives,
       and in fact allows the, utility to profit from: conservation. The
       net income neutrality (NIN)  provision was included as a    .  "' /.-
       prerequisite for application for the reserve;in the same spirit:
       that is, to ensure that utilities are not harmed financially, by
       conservation investments. ,The authors of the-provision,,.-.1? "  ' ,
       Representative Edward Markey of Massachusetts and. Representative
       Carlos Moorhead of.California stated, "We believe that utilities
       must be allowed to profit- from conservation so that they will -
       aggressively pursue all cost-effective means of improving their
       customers'  energy efficiency."    .
            Legislative Language: (Title IV, Sec 404(f)(2)(B)(iv))
            "In the case of qualified energy conservation measures
            1 John W. Rowe, "Making Conservation pay: The NEES
       Experience',"  The Electricity:-Journal. December 1990, p.20,
           .,'--.'     •  f.'•'**. -•"   •'•••'    .* "•'       .   :
           •? House Report 101-490, Part 1,  at 675  (1990).'

     undertaken by a State regulated electric utility, the
     Secretary of Energy certifies that the State regulatory
     authority with jurisdiction over the electric rates of such
     electric utility has established rates and charges which
     ensure that the net income of such electric utility after
     implementation of specific cost effective energy
     conservation measure is at least as high as such net income,
     would have been if the energy conservation measures had not
     been implemented.  Upon the date of any such certification
     by the Secretary of Energy; all allowances which, but for
     this paragraph, would have been allocated under subparagraph
     (A) before such date, shall be allocated to the electric
     utility.  This clause is not a requirement for qualified
     renewable energy."         .

             *                           • '                   .
     General Principles;  A couple of general principles govern
the concept of net income neutrality and implementation of
utility conservation programs:

     (1)  eliminate the disincentives
     (2)  create the incentive.

     First is the decoupling of utility profits from sales.
Under standard practices, the more electricity a utility sells,
the more money it makes.  This poses a major disincentive for any
action which would reduce sales, i.e. conservation programs.
Unless this decoupling takes place, or unless explicit mechanisms
are included for full cost recovery of conservation expenditures,
a disincentive for conservation will exist.  If full cost
recovery is astutely adopted this disincentive can be effectively

     Second is the creation of an incentive to pursue demand side
programs ~ this in the form of explicitly linking profits .to
conservation.  Such profit-enhancing programs currently exist in
six .states (California, Massachusetts, Nevada, New Hampshire, New
York, and Rhode Island) with a number of others expected to
follow in the near future.  These mechanisms may be constructed
in a variety of ways.  In fact, flexibility has been the
watchword of most of the utility commissions that have incentive
programs so far.

     Recent Experience;  As stated above,  a number of utilities
and commissions have instituted provisions guaranteeing net
income neutrality.  The New England Electric System provides an
illustrative example of how one utility has put these provisions
into practice.  The key elements of their program are:

          o    Value guaranteed to the customers:-  ratepayers do
               not bear costs for conservation efforts which
               exceed the value of achieved .electricity savings.

                Shared savings for the company:  the amount of
                money the company earns  is a share of the value
                created --,• profits only  increase if customer
                belief its  increase. (see figure 1).
                Payment only for performance:   the company, earns
                only to the extent that real installations are
                achieved.  .••...
                  *  *   f, '•'    ~* -
                        •     **"    "               ,
                Agreement" on the technical parameters for one
                year:  the value calculations are open  for review,
                are  agreed upon for one  year and are then updated
                based on real experience.          •
                           RGURE1: C&LM Incentive
                  Distribution Costs
                   Una Losses,
                 Generating Costs
                Total Value of
                Avoided Costs
Program Cost
Net Value
               The NEES incentive structure is based on the difference between the value of
             conservation and its cost. The incentive allocates over 80% of net value to customers.
           (Source:  John Rove, "Making  Conservation Pay,.11
                     Electricity Journal.  December 1990,  p.  22.)
     The commissions  in Rhode Island,''Massachusetts,  and New
Hampshire established rules governing the NEES program in
slightly different.ways,  although the basic premises  remain
consistent.  The success of the program is demonstrated, though>
by the increasing contributions to NEES1s bottom line as the
program matures, and  perhaps most noteworthy, NEES's'projections
       John Rowe,  "Making Conservation Pay,"  p.  21.

that demand will fall by nearly 2% between 1990 and 1991 as a
result of Increased conservation efforts.

     The NEES program is simply one example of how net income
neutrality provisions seem to be benefiting ratepayers and
shareholders.  There are certainly many ways of structuring
programs to achieve similar success.  The discretion over
specific mechanisms is best left for utility/commission
negotiations;     .                    '

     Issues for Discussion;

o    How can the provision be structured to encourage maximum
     state participation, while safeguarding the spirit in which
     it was written?  Given that the legislative intent of the
     conservation and renewable energy .reserve seems to be to
     make conservation profitable so that utilities more
     aggressively pursue demand side options, what
     mechanisms/language will encourage this versus what
     mechanisms/language will not?  What elements are absolutely
     essential to guaranteeing net income neutrality?

o    Do the states seem ready and willing to move forward on the
     regulatory reforms necessary to guarantee Net Income
     Neutrality?  What activities by EPA (perhaps in cooperation
     with NARUC, DOE or others) will facilitate this movement?
     Would workshops and seminars be helpful?  Would the leaders
     in the northeast and west be interested in contributing to
     workshops targeting other regions?

o    How does the rigor of this provision relate to EPA's
     oversight role in the application and verification
     procedures that follow?  In general, the ARAC has expressed
     that, where possible, EPA should leave specific program
     discretion, evaluation and oversight to the states.  A clear
     net income neutrality provision may facilitate this.  If an
     unambiguous net income neutrality provision were in place ~
      one in which increased utility profits and subsequent
     ratepayer impacts were on the line — it is likely that the
     state-level scrutiny over specific conservation programs
     would be fairly stringent.  If state-level scrutiny were
     stringent then less federal oversight on details of specific
     programs would be necessary, ensuring greater flexibility in
     conservation program implementation and evaluation.

     If, on the other hand, the net income neutrality provision
     is fairly "loose", there may be less state-level oversight
     and may be greater opportunites for utility cream-skimming.
     In order to ensure that allowances in the reserve are

     *  Ibid.                 .

             allocated appropriately, EPA may need to be more
          "   prescriptive about conservation ..measures, particularly with
             regard.to quantification of savings during application and
             verification phases.  This tradeoff warrants Subcommittee

        Charge of the Subcommittee!  it is the responsibility of the
        Subcommittee, members to draft criteria, and potentially language,
        to be used in the conservation and Renewable Energy rule in .
        defining net income neutrality.  These criteria (and/or this
        language) will be-presented to the full ARAC on January 29 for
        review,<•discussion, and .agreement.


     -':"' :•;..- .               . -       •        •        --      ••••-  - C4 .  .
        *'           -                       -          'L -*•.*'•.." -u
   v                 ISSUES FOR FUTURE DISCUSSION    .  1     -   '   >

                        January 28-29,  1991

     : The following issues pertinent to the Conservation - and   v ,;
 Renewable Energy Reserve rule need to  be discussed in  detail by;
 the .Subcommittee during the next  several months: '  ' ' *

      (1)  Allowance Application and.Award Procedures  ""

      (2)  Verification Procedures           -               •

      (3)  Guidance on Conservation Measures  "•
                 .•-."""                '    '
      (4)  Renewable.Energy Technology  Guidelines

      (5)  Miscellaneous -       .

      If-time allows during the January meeting, discussions on
'some of these issues can be initiated.  Issue papers will be
, prepared and distributed prior to upcoming ARAC meetings, ''"'
 according to a schedule agreed'upon by the Subcommittee members.
 To ensure that the issue papers fully  explore each subject,  it
 .would, be helpful for members to read through .the  items noted and
..identify omissions.  Please, bring these omissions to, the
 attention .of Cathy Zoi so they.can be  added to the items  to be
 discussed. v   „-   .     '''-,    •-."'.         '

 '(1)   Allowance Application and Award Procedures

      o   'First-come, first-served provisions  '
      o    One-time, up-front application^(for the, duration  of the
           program or reserve) vs. annual application
      o    One-time, up-front distribution of allowances vs.
 •   . :     annual (year-end) distribution of allowances
 ;   ,  o    Application for measures that become active  some  time
           in the ,future (accounting for lead times)
      o    Over-application for the 300,000 allowances:
- .  • -•-'.. ••'' *  - ''lottery?     .'    '    '      -.     ' •   . • .,,.' •
           -   . pro-rata reduction in allowances'awarded?
     .. ;   -    EPA evaluation of  applications?
   •>".  ;  ••-!-.• .  'need'-based distribution?                '
      o    Guidance/specifications for  estimates of -energy to be
           saved or generated in forward-looking-year(s) (if
       '  •  applicable)               ,.
    -  o   , Forms and paperwork: integration of above issues  with
           permits and compliance  plans
      o    [additional items welcome]           . .

(2)  -Verification Procedures                             •

  •  o    Reliance on and coordination with state authorities
     o    Timing of verification submissions:  annually? within a
          certain time period of calendar-year end?
     o    Relationship to allowance awards - resolution of
     o .   Guidance/specifications for estimates of energy saved
          or generated; acceptable methodologies     /
     o    Forms and paperwork: integration of above issues with
          permits and compliance plans
     o    [additional items welcome]           	

(3)   Guidance on ConservationMeasures

     o    Applicability or non-applicability of supply-side
          efficiency improvements       .
     o    Applicability or non-applicability of fuel switching
     o    Guidance/specifications to be provided by EPA on other
          demand side measures and programs
     o    [additional items welcome]

(4.)   Renewable Energy Technology Guidelines         •     •     •  -

     o    Generation from hybrids                          .'...'-:.
               solar/natural gas                             ;
          -    coal/biomass co-firing-
     o . -  [additional items welcome]                ....

(5)   Miscellaneous

     o    Criteria which constitute "owns or operates" (in the
          context that a reserve applicant "must own or operate"
          ,a fossil steam plant >25 MW)

     o    [additional items welcome]                .

          ABAC Conservation and Renewables Subcommittee:
             Issues Discussed at December 14 Meeting.
Qualifying Technologies

o    Several,  participants supported  broad outlines  rather than
     prescriptive requirements in the provisions of; the regulations
     that specify qualified technologies. . The,consensus was that
     there is a need to; be flexible while  still maintaining an
     accountable system.                  /       .  ,.-v* ' '      ;-,
o    In general, there  is a need to work with State  PUCs to see
     what is acceptable.             '               .-..•-

o    The statute seems to give...EPA- discretion' to  define the types
     of DSM and renewable technologies that qualify (the law says
     "as defined.by Administrator").

Supply-Side vs.^ Demand-side Energy Efficiency          '

6    Participants discussed whether allowances should  be allocated
     to utilities for supply side energy efficiency technologies
     (e.g., heat rate  improvements, .transmission improvements),
     rather  than solely for .demand-side -measures.   A  related
     question  was whether interfuel substitution (e.g.,  gas for
     electric  heating),   should  be /considered  a  supply-side
     efficiency measure?  .•            '".''•'        "  ;

          In support of this approach,  some participants felt that
       *•  overall plant efficiency improvements might "provide more
        •.benefits than demand-side measures.  These participants
         . felt that a PUC should have the discretion to allow these
          types of measures to be included in a least*cost plan.

     -    On the other hand, if you include supply-side measures,
          do  you make  it too  easy to  get allowances?   Aren't
          general efficiency improvements already encouraged by the.
          emissions  cap  and   general  incentives ...to  conserve'
          allowances?       :             .         . ;  .'

          Several meeting  participants  argued  that  the  energy
          conservation  allowance  provisions  were  specifically
          included as an incentive for demand-side programs, which
          •have traditionally  faced  regulatory  barriers.    For
       .   example, one participant noted that the requirement for
          "no  impact on net income"  was included as an incentive
          for  PUCs  to  change  their  treatment, of  DSM programs.
          (However,   another participant countered that  in some
          cases,, utilities also have disincentives for supply-side
          efficiency improvements.)  '             .

          David Nemtzow, a member of Rep.. Markey's staff noted that
  • ••-*     .the  statute permits system-wide improvements (including

          supply-side).  However, the real question is what is the
          most appropriate use of the provisions?  He noted that  it
          is on the demand-side where the greatest intervention  is

o    Participants suggested that EPA investigate whether the Agency
     has the flexibility to encourage DSM as a preference,  but  to
     secondarily  allow utilities to petition  for. allowances for
     supply-side efficiency measures.        .
      1                                 •'
Definition of "Least Cost Planning11 and "no impacts on net income"

o    How should the regulations define Least Cost Planning and "no
     impacts on net income?"

          Only  a few  States  currently  treat  DSM  programs in a
          manner that  causes no  impacts  on net income.  Does  this
          mean  that  only a few states may reap  the benefits  of
          bonus allowances for renewable energy and DSM programs?
          Should a major goal be to encourage PUCs to alter their
          regulatory and accounting treatment of DSM programs?  If
          so, should we say this explicitly?

          The statute  says least cost plans must be approved  by
          State  authorities,  but  only  14 or  15 have what  some
          subcommittee members  suggested were  "real" least  cost
          plans  (an EPRI study was  also  referenced that says  that
          least  cost  planning  mechanisms  are in  place  in  -44

          Utilities  will have  different  criteria for  DSM  cost
          effectiveness.    in California,  the  PUC  allows  each
          utility to use a different methodology for  treatment  of
          DSM programs.   This  approach recognizes the need for
          flexibility, since  what works  for one  utility may not
          work for another.

          How flexible should we be  in defining "no impact  on net
          income"?   For  example, one participant  noted that his
          utility  gets income benefits  from  conservation  simply
          through fuel cost savings, because the marginal savings
          from reduced fuel costs are sometimes  higher than the
          marginal revenue from  electricity sales!

o    .Cross-subsidies is  an issue  that  must be addressed in any
     requirements for  "no net impact on  income."
Timing Issues

                                   Should utilities  be

From  the  utility perspective,  if  allowances  aren't
When  should allowances  be  awarded?
allowed to qualify up-front?

 .         .          .        ..                  •         . .
"'         : awarded up-front,  it  may be difficult to plan because
   .        they won't  know*.the  future  effects on  cash  flow or
.           whether they will  even be awarded  allowances from the
           reserve., .-'•••.'.    •    •'             '     .•"''"'"''•'

      -    On the other hand, there are .relatively few.allowances
           available in  the,  special reserve.   If  utilities" are
       .    allowed to qualify up-front,  most of the allowances may
           go to utilities  in the relatively few States where the
           regulatory climate already encourages DSM.programs.  Is
       :  --this consistent with the  goals  of  the program?  Does.EPA
           have the,-:-flexibility to spread allowances over a.number
           of programs, rather-than award them on a strict ".first
           come, first served" basis?              ,  .

 o    According-to:the statute,  allowances may not be awarded for
      DSM measures or renewable energy that was  "operational" before
      January  1,  1992. .. Suppose a  renewable  energy  project was
  .    largely completed before 1992  but was not.operational?   If it
      then comes on line after 1992,  does  it qualify for allowances?
    "v                .                * •         .       t _       ,  t

 o    Should.allowances.awarded for.a DSM program cover the entire
      8 year period, or does ah additional  increment of .electricity
      have to be saved each year to earn allowances for.that year?
      (Consensus  on' the  intent  of the  statute  was  .that  since
      emissions/would be avoided over 8 years, the allowances should
    •  be  awarded over 8/years).

 Verification/Quantification  of  Electricity Saved  and Emissions
 Avoided.  '•.'•-        '  '      \,  '   ;   /  ''      : .     .   -..,'\,"'

 o    Where utilities have been awarded allowances for DSM programs,
      how/'dp. you verify, and  quantify   the  energy savings  .and
      emissions avoided?  .
 o  .   How do you ensure accountability if there is a front-end award
      of allowances?  ;              -. '        r       :   .

 o     How should  verification and quantification  be tied  to the
      overall  permiting and compliance provisions of the Acid Rain
   ;   law?    '   ,  '   ...     •'-  " .  .   ..'...  ' '   • '-

 o     Should energy conservation be evaluated on a gross  basis?  Net
      basis?,. What about naturallyvoccurring  conservation?  Load
      management activities? ;  :':. . ."'...

 Issue to Be Addressed in Future Meetings

 o     How^should the regulations treat electric.power committments
    ,( from   Independent   Pbw.er5  Producers  that  are  qualifying
    .  facilities.under PURPA?                         .