To control costs and fight climate change, US states are coming up with innovative ways to flexibly manage demand for energy use. New research from ACEEE and Energy Innovation finds that at least 13 states have created performance incentive mechanisms (PIM) to encourage utilities to deliver energy savings at specific times to optimize the nation’s power grid. This approach reduces emissions and allows utilities to incorporate more renewable power into the grid.
Demand reduction: key to lowering costs and emissions
Energy efficiency and demand response are essential tools to drive down the cost and greenhouse gas (GHG) emissions of electricity systems affordably and rapidly. These services can reduce demand at specific times to optimize the power grid, which we call “strategic demand reduction” (SDR). SDR reduces the cost to serve electricity customers by displacing the need for services traditionally provided by supply options, including substations, wires, and power plants.
Despite clear evidence of SDR’s value, utilities are just beginning to integrate it into their grid planning, investments, and operations (potential studies for demand flexibility and energy efficiency show vast untapped potential). One reason is that utility business models do not encourage SDR, because they depend on increasing capital investment to drive shareholder returns. Because SDR is often less expensive than traditional supply-side alternatives, it can forestall investment in resources that shareholders depend on for continued growth. Another challenge is the reduced electricity sales that result from energy efficiency, one option for delivering SDR.
An emerging solution: performance-based regulation
One emerging solution is performance-based regulation (PBR), a revenue model that rewards utility performance in meeting policy priorities, such as cost containment and GHG reductions. PBR is on the rise, with policy efforts in more than 19 states and the District of Columbia, including recently launched efforts in Minnesota and Colorado. PBR has several policy tools, including performance incentive mechanisms that reward utilities for energy efficiency investments that meet specific, measurable goals.
ACEEE has shown that PIMs can be an effective tool for motivating utilities to invest in energy efficiency. This new research takes a broader look at how this tool can drive SDR at critical times for the grid.
Strategic demand reduction PIMs on the rise
Our research found that 13 states (shown in map below) currently have PIMs for electric utilities. Some focus on long-term adaptation of customer demand in response to prices and efficiency measures (called “shape” in the seminal California demand response potential study) and others focus on traditional utility and wholesale market demand response programs (called “shed” in that study).
Strategic Demand Reduction PIMs by Type
We profiled seven of these states and found diverse approaches to rewarding utilities for their SDR. Some states used traditional utility procurement approaches to peak demand reduction, such as in Hawaii and Texas; in contrast, Massachusetts and New York used newer methods of encouraging SDR by compensating utilities for a mix of actions and outcomes.
Massachusetts recently demonstrated an evolution in metrics, adding winter and summer peak demand reduction goals. The utilities can meet these goals with energy efficiency as well as “active demand management,” which can include storage and demand response. New York’s outcome-based peak demand reduction and load factor PIMs (which it calls Earnings Adjustment Mechanisms) give utilities flexibility in meeting goals. Its approach enables a wide range of efforts, including demand response, energy efficiency measures with demand impacts, and rate design. Massachusetts and New York also differed in their award structure, with a shared savings incentive tied to different kinds of demand reduction in Massachusetts and a rate of return incentive tied to outcomes in New York.
Long-term, iterative PIMs largely successful in driving SDR
We found that PIMs are an effective tool for unlocking SDR. Of the five cases we studied with available results, four program administrators — in Massachusetts, New York, Texas, and Vermont — met or exceeded their targets. The others were too new or did not have results available.
A common feature was a process for iterative updates. With the advantage of several program review cycles, utilities could count on the regulatory certainty and stability needed to develop sophisticated programs, while still enabling regulators to update incentives to protect ratepayer interests and motivate continuous improvement.
Most demand reduction PIMs currently focus on long-term adaptation of customer demand in response to prices and efficiency measures (“shape services”) and traditional utility and wholesale market demand response programs (“shed services”). However states show increasing interest in moving demand from one time of day to another and in grid-balancing measures that target times when renewables create steep ramps in available supply (“shift services”). These approaches can better support distributed resources and renewables integration.
PIMs are one policy tool among many needed to accelerate SDR
PIMs are not enough to deliver the strong and varied SDR needed to reduce costs, shrink emissions, and accelerate grid integration of renewables. We need strong state and regional policies, including Energy Efficiency Resource Standards (EERS) and other clean energy targets, business model reforms including decoupling and energy efficiency PIMs, and independent evaluation, measurement, and verification (EM&V). Properly valuing SDR will also be vital for prices and participation models in wholesale markets, rate design, and distribution and integrated resource planning.
Looking ahead to a new decade of renewable energy advances and state policy goals to address climate and economic issues, the importance of SDR will continue to grow. States throughout the country, from New Hampshire to Michigan are assessing their PIMs for SDR, and other states including Minnesota and Hawaii may consider these metrics in PBR efforts that identify related policy outcomes. Recent legislation in Washington calls for demand response targets and establishes authority for PBR, opening the door for demand reduction PIMs.
Read our full report to learn more about PIMs for SDR that are delivering targeted energy savings to integrate renewables and deliver more cost-effective, reliable electricity systems.