4. Cost-Effectiveness

AB 1470 states the Legislature's intent that the SWH incentives created by the act "should be a cost-effective investment by gas customers" and states that "gas customers will recoup the cost of their investment through lower prices as a result of avoiding purchases of natural gas, and benefit from additional system stability and pollution reduction benefits." (Section 2862(l).) The statute added Section 2863, which states in pertinent part that:

The commission shall evaluate the data available from the Solar Water Heating Pilot Project conducted by [CCSE]. If, after a public hearing, the commission determines that a solar water heating program is cost effective for ratepayers and in the public interest, the commission shall ... design and implement a program applicable to the service territories of a gas corporation, to achieve the goal of the Legislature to promote the installation of 200,000 solar water heating systems in homes and businesses throughout the state by 2017.

In the Staff Proposal, staff noted both the AB 1470 requirements and the Commission's prior concerns about the need for SWH incentives. In D.06-01-024, the Commission questioned the need for SWH incentives if SWH systems are already cost-effective for system owners without incentives. Thus, a threshold issue this decision must address is whether a program to provide SWH incentives is cost-effective for either gas or electric-displacing SWH.

In order to provide a recommendation on cost-effectiveness of an SWH incentive program, staff separately considered the cost-effectiveness of gas-displacing and electric-displacing SWH. For gas-displacing SWH, staff relied on the SWH Pilot Program Interim Evaluation Report (January 2009) (Interim Evaluation) prepared by Itron, Inc. for CCSE, and the Addendum (April 2009) to the Interim Evaluation, also prepared by Itron.4 The Interim Evaluation and Addendum used a methodology based on a modified version of the California Standard Practice Manual (SPM), which was originally developed for evaluating cost-effectiveness of the Commission's energy efficiency programs. Itron's analysis examined cost-effectiveness from three perspectives - the participating ratepayer (Participant Test), the non-participating ratepayer (Non-Participant or Ratepayer Test), and society as a whole (Societal Test). The Itron analysis also examined four scenarios, each with varying assumptions regarding market characteristics. The scenarios were: Present Day/2008, Business as Usual/2017 (BAU), Moderate Changes/2017 (MOD) and Greenhouse Gas Driven/2017 (GHG). Itron then performed sensitivity analyses involving different allocations of incentive dollars across single-family residential, multifamily, and commercial customer classes.

The Staff Proposal focused on Itron's Societal Test results, concluding the Societal Test is appropriate for determining whether a statewide SWH incentive program is cost-effective for ratepayers and in the public interest, as required by Section 2863. As support for this view, the Staff Proposal notes the Commission's use of the Total Resource Cost (TRC) Test (similar to the Societal Test) when evaluating the Commission's energy efficiency programs, and that the Societal Test captures benefits that accrue to ratepayers and society more generally, such as avoided pollution, that are not included in either the Participant or Ratepayer Test.

According to the Staff Proposal, Itron's analysis shows that an SWH incentive program would be cost-effective under the MOD and GHG scenarios, which predict higher gas prices than the BAU scenario. For that reason, staff focused on the BAU scenario as the "worst-case," or most conservative scenario from the perspective of SWH cost-effectiveness. Itron performed a sensitivity analysis using the BAU scenario, which identified SWH system cost reductions as a potential driver of cost-effectiveness. Specifically, a 16% reduction in SWH system costs by 2017 increased the BAU benefit-cost ratio to 1.0 for the Societal Test. In addition, Itron found that, under the Societal Test, offering incentives to a mix of single-family, multifamily, and commercial SWH systems is slightly more cost-effective than offering incentives to only single-family residential customers in the GHG scenario, though slightly less cost effective in the BAU and MOD scenarios. The different customer types face different economics because of the structure of applicable gas and electric tariffs.

The Addendum concluded that the BAU scenario could result in a cost-effective SWH incentive program if the scenario incorporates an assumption of 16% cost reductions. In the Staff Proposal, Energy Division states its view that a 16% cost reduction is a reasonable expectation because it can be achieved through either a significant cost decline in a single cost category or small declines in several categories. To support this view, Energy Division notes that the Interim Evaluation identified potential cost reduction opportunities in equipment costs, labor costs, marketing, and permitting, as well as citing SWH system cost declines of 30% between 1980 and 1990. Given these observations, the Staff Proposal concludes that it is reasonable to expect a decline of at least half that magnitude over the next decade as the SWH market grows.

The Staff Proposal recommends the Commission adopt Itron's cost-effectiveness analysis, as described in the Interim Evaluation and Addendum, to move forward with an SWH incentive program as set forth in AB 1470.

For electric-displacing SWH, the Staff Proposal analyzes whether solar water heating is cost-effective, without incentives, to replace electric water heating technologies. The Staff Proposal finds that without incentives, SWH is not cost-effective on single-family homes, although it is currently cost-effective in multifamily applications.5 Next, the Staff Proposal describes the results of the same Itron analysis applied to an electric-displacing SWH program. The Itron analysis shows an eight-year incentive program is cost-effective when analyzed using the Societal Test and the BAU, MOD, and GHG scenarios. Therefore, the Staff Proposal recommends the Commission adopt a program to offer SWH incentives to technologies that displace electric water heating, funded through the CSI $100.8 million set aside for solar thermal technologies. Staff recommends the program pay incentives to single-family residential, multifamily, and commercial customers because all of these customers pay into CSI through assessments on their electric distribution rates.


Environment California, CALSEIA, and CCSE agree with the Staff Proposal's conclusions regarding cost-effectiveness of an SWH incentive program. These parties agree with the use of the Societal Test in the Itron Interim Evaluation.

In contrast, several parties raise issues with the cost-effectiveness analysis that the Staff Proposal relies on. TURN and DRA maintain the Commission should not rely on the analysis in the Staff Proposal because the cost-effectiveness analysis does not use a Commission adopted and publicly vetted methodology. Instead, the Interim Evaluation and Addendum use long-term estimates of costs, policies and market changes that are too uncertain. Moreover, TURN and DRA contend the analysis contains no evidence that prices will decline by the 16% necessary to make the BAU scenario cost-effective, and the MOD and GHG scenarios are unlikely. DRA requests that development of a statewide SWH program be suspended until a publicly vetted cost-effectiveness analysis can be performed. TURN opposes the idea of an SWH incentive program, alleging it represents a wealth transfer program funded by residential and small commercial gas ratepayers and benefitting health clubs, hotels, and restaurants.

The utilities, namely SCE, PG&E, and SDG&E/SoCal, all comment that the Itron analysis in the Staff Proposal is inconsistent with the cost-effectiveness tests used to evaluate energy efficiency programs and with the methodology recently adopted in D.09-08-026 for analysis of distributed generation (DG) programs. Specifically, the utilities criticize the Itron analysis for including benefits not recognized in other tests such as avoided health costs and job creation, and assigning much higher values to carbon credits than used in other proceedings. PG&E claims the Commission should use the Ratepayer Impact Measure (RIM) Test rather than the Societal Test because the RIM test, by definition, is the appropriate way to measure whether a program meets the requirement in AB 1470 that a program is "cost-effective for ratepayers."

AB 1470 states the Legislature's intent to reduce natural gas dependence because this dependence puts a strain on energy supplies and threatens California's growing population and economy. The legislation notes the pollution and greenhouse gas reduction benefits of SWH, as well as the fact that growing demand for SWH systems can create job growth in California. The Itron report demonstrates the large amounts of gas utilized to heat water in California: 1,862 million therms per year for single-family residential water heating, 778 million therms per year for multi-family water heating, and 279 million therms per year for major sectors of the commercial market. Alternatives to gas and electric water heating can play an important role in achieving California's aggressive goals to reduce natural gas usage and carbon emissions. Thus, it is clear that the proposed program to promote these alternatives, in order to make them mainstream and transform the market, meets the statutory requirement of being in the public interest.

Turning to cost-effectiveness, TURN, DRA, and the utilities are correct that the methodology used by Itron to examine the cost-effectiveness of an SWH incentive program is not entirely consistent with how we examine cost-effectiveness of our energy efficiency programs or our recently adopted methodology for DG programs. (See D.09-08-026.) Itron has included items as

benefits that have not previously been included when we run TRC or Societal

Tests, and certain inputs, such as carbon price and Market Price Referent (MPR)6 assumptions, differ from those used in other programs.

At the same time, AB 1470 charges the Commission with a unique obligation, to evaluate data from the CCSE SWH pilot and determine the cost-effectiveness of a statewide SWH program prior to its implementation. We did not make prior findings of cost-effectiveness for our Self-Generation Incentive Program (SGIP) or general market CSI programs. Further, there is no requirement that the Commission apply a specific methodology to meet the cost-effectiveness requirement in the statute.

In addition, it was necessary for Itron to perform its analysis and consider these potential program benefits prior to the issuance of a final decision on a cost-benefit methodology for DG in order for the Commission to consider development of a statewide SWH program in a timely manner and without undue delay. DRA asks us to gather further cost-benefit information, allow further proceedings on the appropriate methodology, and then re-do the cost-benefit analysis of the SWH pilot and a statewide program. This would delay our consideration of a statewide program by six months to one year. Such a delay in implementing a statewide program is, in our view, untenable. AB 1470 envisioned a 10-year SWH program when enacted in 2007, and at this point, only eight years remain for any program to run. We will not delay consideration of this program any longer.

Given the variety of scenarios under which Itron's analysis found the program to be cost-effective, and additional factors that could also significantly improve the cost-effectiveness of the program (such as availability of low cost loans, and likely reductions in the costs of SWH systems), we find the analysis performed by Itron allows us to meet the obligations of AB 1470. The Itron analysis supports the conclusion that a program of SWH incentives will provide societal benefits over the life of the systems installed.

Although Itron uses the Societal Test as opposed to the TRC or RIM Test supported by other parties, we will focus on the Societal Test results because the Societal Test includes pollution and greenhouse gas reduction benefits and considers the other items, such as job growth and market transformation, that are enumerated as benefits in AB 1470.

PG&E states we should rely solely on the RIM Test because the legislation requires a finding of ratepayer benefits and the RIM Test is the appropriate measure of ratepayer impacts. We do not agree with PG&E's narrow interpretation of AB 1470. The bill asks us to determine whether an SWH program is "cost effective for ratepayers and in the public interest" and it finds that "gas customers will...benefit from additional system stability and pollution reduction benefits." (Section 2862(l), emphasis added.) Thus, we do not find it appropriate to limit our analysis of cost-effectiveness to the RIM Test. Instead, we will use a test that considers broader societal impacts of a statewide program. As AB 1470 points out, ratepayers will derive benefits from pollution reduction, system stability, job growth, and SWH market transformation. Thus, we find it appropriate to use a test that considers ratepayer impacts as well as broader societal benefits.

Next, we find staff's analysis of the cost-effectiveness of incentives for electric-displacing SWH is reasonable and we will adopt it as well. Few parties commented on this portion of the Staff Proposal. We agree with the Staff Proposal that it is not cost-effective for SWH to replace electric water heating for residential customers without incentives. We also agree that it is reasonable to offer the program to all customer types because all customers pay into CSI through their distribution rates, in order to fund incentives to electric-displacing SWH systems. We agree with staff's assessment that it is unlikely many businesses in California use electric water heating. Thus, we expect commercial participation in the program to be minimal.

4 The Itron reports are Exhibits 1 and 2 on the record of this proceeding. Both Itron reports can also be found at the following website: http://energycenter.org/index.php/incentive-programs/solar-water-heating-pilot-program/swhpp-documents/cat_view/55-rebate-programs/172-swhpp/321-cpuc-documents.

5 The Staff Proposal does not discuss the cost-effectiveness of replacing electric water heating in commercial applications, presumably because so few commercial customers use electric water heating.

6 As required by Section 399.15(c), the Commission adopted a MPR methodology to estimate the long-term market price of electricity for use in evaluating the reasonableness of prices of long-term power purchase agreements for Renewable Portfolio Standard (RPS)-eligible generation. (See D.08-10-026, where the Commission refined the MPR methodology.)

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