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Rewarding What Matters in Energy Efficiency

Shifting Utility Performance to Focus on Climate

Customers spend roughly $7 billion a year across the United States on utility energy efficiency programs. Despite the importance of energy efficiency, electrification, and demand flexibility in meeting state climate goals, few of these funds are dedicated to programs explicitly designed to deliver on greenhouse gas (GHG) emissions reductions.

But a few intrepid states are beginning to experiment with mechanisms that incentivize utilities to reduce carbon pollution via energy efficiency (EE), electrification, and demand flexibility. Although a broad set of states are setting policies that reward utilities for saving energy, electrifying, and shifting demand in keeping with GHG reduction targets, they do this without expressly measuring the GHG reductions achieved. New York, Vermont, and Washington, D.C., are leading the charge with performance incentives for utilities and program administrators that encourage accelerated GHG reductions.

Utility programs touch millions of customers. Shifting their business model to measure success based on GHG reductions is one important tool to unlock the potential of these resources in meeting state carbon reduction targets. States and regulators seeking to align these programs with their overarching climate mandates can learn from states on the cutting edge of implementing performance incentive mechanisms for climate-forward efficiency.

Climate-Forward Efficiency Is Not Your Mother’s EE

EE, electrification, and demand flexibility are critical resources to achieve carbon neutrality by 2050, which is necessary to keep global average temperatures below 1.5°C. However, only a few utilities are designing their programs with GHG emissions reductions in mind, let alone measuring the carbon that is avoided by these programs.

Climate-forward efficiency represents a new approach to deploying energy efficiency, which drives down emissions by prioritizing energy efficiency investments across fuels (e.g., electrification), and across time, space, and geography (e.g., through time- and locationally targeted energy efficiency and demand flexibility). This renaissance in EE is a top strategy to address the major challenges of our time: decarbonization, energy affordability, public health, and more.

Although climate-forward efficiency should be at the top of states’ wish list, we don’t see utilities dedicating the needed time or effort to pursue it. Most utilities are discouraged from meaningfully investing in programs that will reduce their sales because capital investment (building big things like power plants and substations) and sales growth (increased customer demand) drive shareholder returns. These underlying incentives effectively put the brakes on utility efforts to manage demand to reduce overall greenhouse gas emissions and costs.

A Tool to Shift the Story: PIMs

Performance incentive mechanisms (PIMs) are one tool (alongside revenue decoupling and carbon pricing) to shift utilities’ incentives and get them stoked about climate-forward efficiency. PIMs have been in place for decades in many states across the country, making EE more financially attractive when compared with other investments utilities could make.

PIMs are in place for energy efficiency in 32 states, but they’re typically based on direct energy savings (kWh or therms), missing the time and locational value of GHG reductions. Not all energy efficiency is created equal — savings during times of high solar and wind output are much less valuable than those that occur at peak times or locations, avoiding the need to use peaker plants. Moreover, they miss the opportunity to encourage the fuel switching needed to meet those goals.

New research from RMI and ACEEE identified and categorized a new and evolving cross-cutting set of PIMs: climate-forward efficiency PIMs are mechanisms that explicitly or implicitly reward a utility for reducing or avoiding greenhouse gases through energy efficiency, demand flexibility, and building and vehicle electrification.

Early Experimentation: Climate-Forward Efficiency Mechanisms around the United States

RMI and ACEEE identified two broad categories of climate-forward efficiency PIMs. The first group, “explicit GHG” PIMs, expressly reward utilities for GHG reductions from climate-forward efficiency. The second group, “policy intent” PIMs, evolve beyond annual kWh or therms savings to implicitly reward GHG reductions, either by encouraging fuel switching or savings at times that deliver the most greenhouse gas reductions or value for the grid, or by valuing GHG in net benefits calculations.

To date, explicit GHG PIMs are rare due to the challenges in measuring these savings and because states rarely revisit their energy efficiency policies. However, we’re seeing a number of states adopt metrics and scorecards to track GHG emissions avoided by EE, demand-side management (DSM), and electrification, which may be a sign of more PIMs to come.

Policy intent PIMs, which are clearly linked to state emissions reduction policies in the legislative or regulatory decision that enacted them but do not explicitly measure avoided GHG emissions, are much more common. We found that they come in four varieties: fuel-neutral savings, time-based savings, program-specific PIMs, and net benefits PIMs that include avoided GHG benefits.

Explicit GHG PIMs in Practice

So what does this look like in practice? So far, only New York has had explicit GHG PIMs in place long enough to see results.

New York’s electric utilities each have explicit GHG PIMs for climate-forward efficiency focused on beneficial electrification, shifting vehicles and buildings to use electricity instead of directly burning fossil fuels. Each PIM rewards the utility for total lifetime CO2 or CO2e emissions reductions, measured on a marginal emissions basis, associated with annual incremental adoption of beneficial electrification technologies. Though these PIMs have only been in place for three years, half of New York’s six utilities have earned the maximum reward for their PIMs in the most recent two years. The other three utilities in the state have just one or two years of experience with these PIMs and have not yet met minimum targets.

An example of climate-forward efficiency PIMs with GHG “policy intent” comes from Efficiency Vermont, the electric “energy efficiency utility” in most of the state. In addition to an explicit GHG PIM, Efficiency Vermont has a complementary portfolio of PIMs designed to achieved GHG reductions from particular types of resources, including fuel-neutral savings PIMs that have been in place since 2015 and newly adopted winter and summer peak demand reduction PIMs. Efficiency Vermont’s fuel-neutral savings PIM measures MMBTU savings from “thermal-energy-and-process-fuels” use, including both natural gas and unregulated fuels like propane, fuel oil, and woody biomass. Fuel-neutral targets help to incentivize electrification and encourage utilities toward whole-building, systemic approaches that can deliver more emissions reductions. Efficiency Vermont exceeded its target for this PIM in each of the most recent three-year program funding cycles since the PIM has been in place.

For states that are not yet ready to implement a climate-forward efficiency PIM, tracking metrics and scorecards are a no-regrets starting place. Requiring the utility to track several metrics, or calculating one metric in a variety of ways, will give regulators the information they need to decide whether and how to craft a PIM down the road given quickly evolving programs, technologies, and methods for calculating the GHG avoided by EE, electrification, and DSM. In Hawaii, the PUC recently approved scorecards for electrification of transportation. They adopted a suite of program-specific scorecards (e.g., EV registrations by island), as well as time-based savings scorecards (e.g., measured EV load delivered to EV charging stations [kWh] occurring in peak and off-peak hours), setting the stage for later development of a PIM. However, the Commission did not institute a scorecard that measures GHG emissions avoided by transportation electrification, suggesting that future efforts to develop a PIM in this area might start with Policy Intent rather than being explicitly GHG focused.

Early Trends in Climate-Forward Efficiency PIMS

While energy efficiency PIMs have existed for some time, PIMs that incentivize GHG reductions through climate-forward efficiency — including demand response and flexibility and electrification — are just getting started, even in states that are on the vanguard of PBR implementation. Most have been adopted in just the past few years, but we see some early trends in how policymakers are using these tools.

First, most explicit GHG or policy intent PIMs for climate-forward efficiency are reward-only, as opposed to symmetrical (including both rewards and penalties) PIMs. The “Reduce GHG Emissions Benchmark” for the D.C. Sustainable Energy Utility is the only such symmetrical PIM currently in place, with the option for a reward of $1 million if it meets its targets, and an equal penalty if it fails to do so. Penalties are rare in energy efficiency PIMs, and it appears that regulators remain hesitant to set penalties in climate-forward efficiency PIMs design. This may be based on a perceived need to learn more about performance in order to set performance baselines, or because of a recognition that technologies and methodologies for calculating the metric are evolving. For this reason, penalties are more typically put in place for areas that are considered basic service obligations or other traditional outcomes. Such an approach — setting an upside-only PIM for the near-term — can allow time to gain experience with the mechanism or be a starting point upon which to explore the addition of penalties for sub-standard performance.

Beyond PIMs, policymakers and regulators are beginning to make GHG emissions reduction an explicit goal and objective for efficiency programming or PUC decision-making more broadly. In Massachusetts, the 2021 Climate Act reoriented program goals around GHG reduction and requires the state’s EE administrators to prioritize efficiency measures with longer effective useful lives and persistent GHG reductions, such as envelope improvements and efficient electrification. Such legislation sets a clear signal to utilities in the state that EE, DSM, and electrification should be treated as a meaningful pillar of every utility’s GHG reduction planning and investment strategies. Given increased attention to equity, environmental justice, and vulnerable communities in state policy, it wouldn’t surprise us if regulators begin to use PIMs to solve for disproportionate impacts of GHG emissions on these communities.

We expect additional states to implement climate-forward efficiency PIMs in the near future, as several states are currently engaged in PBR proceedings. For example, Connecticut, Illinois, North Carolina, and Washington all passed laws in 2020 and 2021 authorizing PBR. In each of those recent legislative efforts, reducing greenhouse gases was a primary motivation of the legislation, suggesting that climate-forward efficiency PIMs may be developed as a part of those processes. The early examples of explicit GHG PIMs from New York, D.C., and Vermont may serve as inspiration for their efforts to set utilities on a climate-aligned path.