3. Updated Energy Efficiency Policy Manual
for Post-2005 Programs

As noted in the December 17, 2005 Assigned Commissioner's Ruling, the current Energy Efficiency Policy Manual is clearly outdated. It was created in 2001 under an interim administrative structure with the Commission responsible for program selection and portfolio management. In particular, much of the current document is structured to provide guidance to IOU and non-IOU program implementers submitting proposals to Energy Division for staff review. Our recent decision on administrative structure (D.05-01-055) returns the IOUs to the program administrator role, and places quality control, advisory and primary EM&V responsibilities with our Commission staff. For energy efficiency activities beginning in 2006, the IOUs will take lead responsibility for selecting and managing a portfolio of energy efficiency programs that meet or exceed our annual and cumulative energy savings goals, with input from advisory groups and the public, and subject to our review and approval. The Energy Efficiency Policy Manual needs to be updated to reflect this new administrative structure.

More importantly, the policies and funding criteria contained in the current Energy Efficiency Policy Manual were established prior to the development of the Energy Action Plan, which places energy efficiency back at the forefront of resource procurement activities in California. In particular, the plan establishes a loading order of energy resources that requires California to first optimize "all strategies for increasing conservation and energy efficiency to minimize increases in electricity and natural gas demand" before turning to supply-side resources."⁹ By D.04-09-060, we translated this policy into specific, numerical goals for electricity and natural gas savings, underscoring that California's "one high-level, overriding goal guiding its energy efficiency efforts [is] to pursue all cost-effective energy efficiency opportunities." The Energy Efficiency Policy Manual, and the Rules contained therein, have also been updated to reflect this overriding goal in guiding program development and program evaluation.

The ALJ's initial draft of proposed rules (Draft Rules), followed by the pre-workshop comments and workshop discussion provided valuable input into this updating process. We summarize our determinations regarding the major issues raised by parties, and present the updated Energy Efficiency Policy Manual in Attachment 3. In Sections II-XI of that document, we present the policy rules governing energy efficiency activities (Rules), commencing in 2006.

3.1. Energy Efficiency Policy Objectives and
Program Funding Guidelines (Rules II.1-II.10)

This section of the Rules articulates the overriding goal of energy efficiency as the pursuit of "all cost-effective energy efficiency opportunities over both the short- and long-term." (Rule II.2) Workshop participants expressed varying levels of concern that the pursuit of this goal could create lost opportunities in the process if the IOUs focused narrowly on exploiting the most cost-effective measures first. We have adopted language that discusses the potential for lost opportunities, but also recognizes that this potential is considerably reduced now that the IOUs are required to meet or exceed aggressive annual and cumulative savings goals. We also direct the IOUs to develop strategies to minimize lost opportunities in the design and implementation of programs, and to describe those strategies in their program plan applications. In addition, in response to workshop comments, we have broadened the definition of "lost opportunities" to recognize that they can occur if energy efficiency options that offer long-lived, cost-effective savings are not exploited in tandem with other load-reduction technologies and distributed generation technologies being installed at the site (e.g., solar water heating or photovoltaics).¹⁰

The Rules also echo our observations in D.05-01-055 that capturing the most cost effective energy efficiency resources as possible over both the short- and long-term "is the most equitable way to distribute program benefit."¹¹ (See Rule II.3.) To this end, we direct the IOUs to manage the portfolio of programs to meet or exceed the Commission-adopted short-term and long-term savings goals by pursuing the most cost-effective energy efficiency programs first, while minimizing lost opportunities. (Rule II.5.) Following these guidelines will, in our view, dictate the appropriate balance for portfolio funding of resource programs among market sectors (e.g., residential, industrial and commercial). We also direct the IOUs to include in their portfolio a selection of statewide marketing and outreach programs, upstream market transformation programs, information and education programs, support for codes and standards and other activities in their proposed portfolios that support our short-term and long-term goals. In particular, IOUs are to allocate a sufficient portion of portfolio funding to statewide marketing and outreach to continue and build upon the success of the existing program. (Rule II.6.)

In their comments on the draft decision, TURN and Proctor Engineering contend that the policy rules require more explicit requirements to strategically impact critical peak procurement. In particular, these parties argue that the program plans that are being presented by the IOUs at advisory group meetings overemphasize lighting measures and insufficiently recognize the value of efficient air conditioners. In their view, this results from two factors: (1) the differential between peak and non-peak avoided costs adopted by the Commission in the avoided cost proceeding and (2) the relatively high "load factor" reflected in the Commission's adopted savings goals.¹²

With respect to avoided costs, we note that the Commission's interim avoided costs for energy efficiency, as adopted in D.05-04-024, establish a differential between peak and non-peak avoided costs on the order of 4 to 1. Proctor Engineering argues that a much higher differential should be established to reflect critical peak pricing periods, and that efficient air conditioners would be more cost-effective than efficient lighting measures using this higher differential. We note that the Commission is in the process of evaluating critical peak pricing in the context of avoided costs (R.04-04-025) and demand response programs (A.05-01-016 et al.). However, it is premature to anticipate the results of that evaluation in terms of what critical peak avoided costs might be adopted. Moreover, it is far from clear how critical peak avoided costs would be used in the context of energy efficiency measures that are not fully dispatchable. Nonetheless, we do recognize the need to continue to refine and improve upon our interim methodology for avoided costs over time, to ensure that the valuation of energy efficiency savings is as accurate as possible. As discussed in

D.05-04-024 and Assigned Commissioner rulings in R.04-04-025, we fully intend to do so.

Similarly, we recognize today, as we did in D.04-09-060, that the conversion factors used to calculate MW peak energy efficiency savings goals may need to be updated in the future. In that decision, we multiplied our adopted GWh savings goals by a 20% conversion factor to establish the corresponding peak MW reduction goals. We adopted a 20% conversion factor because (1) it represented a reasonable average of the conversion factors observed for the projected 2004/2005 program year measure savings and (2) doing so resulted in peak savings that would not exceed the total maximum achievable peak savings potential projected over the 10-year period. TURN and Proctor Engineering contend that this relatively low conversion factor means that lighting programs alone will meet the MW goals, and therefore provides the IOUs' with an incentive to overemphasize this measure relative to others with low load factor/critical peak savings. TURN therefore recommends that we consider increasing the conversion factor used to develop the savings goals, among other options to steer the portfolio design towards low load factor/critical peak savings measures.

In response, we note that we lack a sufficient record for modifying the conversion factors (and by definition, MW goals) in D.04-09-060, or for addressing the issue of what conversion factor we should use for future updates to those goals. However, we certainly did not intend for adopted conversion factors to dictate the load factors of future programs-in fact, we anticipated that the opposite would be true: "[A]s we look to develop energy efficiency programs for 2006 and beyond that more aggressively reduce peak loads, we may need to adjust the conversion factor upwards."¹³

In sum, we are not persuaded by the arguments of TURN and Proctor Engineering that the specific modifications to conversion factors or avoided costs they suggest in their comments should be adopted at this time, or in this procedural forum. However, we do believe that the Rules should be modified to reflect the need to ensure reliability in the near term, by encouraging aggressive programs that target measures with most of their energy savings during peak time periods. We modify Rule II.5 accordingly.

Several parties propose language that would add additional goals for program funding or guidelines for program design. For example, CSBN proposes that the Rules establish a priority for energy efficiency investments for underserved or hard-to-reach markets. NRDC proposes language directing the IOUs to seek a balance among programs targeted to residential and non-residential, retrofit and new construction, and statewide and local applications. NRDC also proposes language that would require the IOUs to make marketing and outreach materials available in multiple languages, to a reasonable extent, in order to ensure that programs reach language minority customers. Efficiency Partnership recommends that we establish a minimum funding level (7%) for statewide marketing and outreach activities, and require in the Rules that this funding be coordinated by and through a single statewide campaign. CCSF recommends that the IOUs be required to identify all savings opportunities at a customer site and develop a plan to achieve these savings within a given timeframe.

We agree with the observation of one workshop participant that, "if everything is a high priority, then nothing is a high priority."¹⁴ In particular, we believe that the appropriate mix of programs across market sectors and geography as well as appropriate program designs will reveal themselves as the IOUs focus on meeting or exceeding our short- and long-term goals pursuant to Rule II.5. Nonetheless, the Rules recognize that non-resource programs are also needed to support the savings goals, such as statewide outreach and marketing and support for codes and standards. However, rather than establishing specific funding levels or program design parameters in our Rules, we adopt general language suggested by workshop participants that recognizes the importance of such programs, and leave to the program planning process the development of specific program designs and funding proposals. (See Rule II.6.) In response to earlier written comments in this proceeding, we also include language that directs the IOUs to explore ways in which marketing and outreach activities can support the Climate Change Action Registry.¹⁵ (Rule II.7.)

This section of the Rules also recognizes the need to increase the current level of funding for emerging technologies in the program plans for PY2006 and beyond. In the ALJ Draft Rules, the language specified a funding level based on a recent white paper on emerging technologies issued by the CEC. During the workshop process, the IOUs worked with CEC staff to develop alternative language for this section of the Rules, together with a proposal for increased funding that the IOUs will propose to the advisory groups for inclusion in the PY2006 program plans, subject to our approval. The attached Rules now reflect the alternate language on emerging technologies developed during the workshop process. (Rules II.8 and II.9.)

3.2. Cost-Effectiveness (Rules IV.1-IV.11)

This section of the Rules describes the cost-effectiveness tests to be used in evaluating the program portfolios, and how they are to be computed. We describe these tests in greater detail in Section 4 below, when we address the performance basis for resource programs. A prospective showing of cost-effectiveness for the entire portfolio of ratepayer-funded energy efficiency activities and programs is a threshold condition for eligibility for ratepayer funds. (Rule IV.6.)

WEM recommends that each program should also be required to pass the required tests of cost-effectiveness in order to be eligible for funding. We disagree. As we discuss in Section 4 below, a portfolio level approach to evaluating cost-effectiveness and performance basis is necessary to encourage innovation and allow for some risk taking on pilot programs and/or new measures in the portfolio.¹⁶ Nonetheless, the Rules require that the results of the cost-effectiveness tests be considered when evaluating specific resource program proposals. (Rule IV.4.)

In response to comments on the draft decision, we also clarify that EM&V costs are included in calculations of cost-effectiveness and the performance basis, but should be allocated at the total portfolio level, rather than program by program.¹⁷ As we have stated in the past, EM&V expenditures represent a true cost of acquiring energy efficiency resources. Therefore, these costs should not be ignored when evaluating the cost-effectiveness of energy efficiency on either a prospective basis, or after the programs have been implemented.¹⁸ However, as we have also reasoned, these costs should be considered on a portfolio-level basis, rather than program-by-program for both practical and policy reasons. ¹⁹ Moreover, as PG&E points out, allocating EM&V costs at a total portfolio level (as in the past) will allow for economies of scale when designing EM&V by allowing for aggregation of studies.

Workshop participants also debated the issue of what discount rate should be used to translate future year benefits and costs into current year ("present value") terms in calculating the cost-effectiveness of energy efficiency programs. NRDC proposed using a 5% nominal discount rate. NRDC argues that this relatively low discount rate is appropriate because energy efficiency investments reduce societal risk and provide cost savings and environmental benefits that remain valuable well into the future. ORA proposes the use of an 8.15% nominal discount rate, which is the standard default discount rate that has been used in energy efficiency cost-effectiveness tests for the past several years.²⁰

For the reasons discussed in 4.2.1 below, we reject NRDC's proposal to use a lower "societal" discount rate to present value the cost and benefit streams associated with energy efficiency programs. Moreover, we note that the risk factors and environmental benefits that NRDC refers to in justifying a lower discount rate are already reflected in the avoided cost adders that we use to value the savings benefits of energy efficiency programs. Instead, since energy efficiency resource programs focus on avoiding or deferring more costly supply-side investments, we believe that the most appropriate discount rate to use is the IOUs' current weighted cost of capital.

Therefore, the Rules specify that the cost-effectiveness tests should utilize the most recent Commission-adopted values for the weighted cost of capital. Instead of using different values for each IOU, Energy Division should post a reasonable "average" of the Commission-adopted values to be utilized in discounting the costs and benefits of energy efficiency programs across all of the IOU service territories.²¹ Energy Division should post this average value on the Commission website with the most recent version of the Standard Practice Manual and provide the location of that posting in the references section of the Energy Efficiency Policy Manual, which will also be posted on the Commission website.

During the workshop discussion, a representative from PG&E requested clarification as to whether the costs used to calculate cost-effectiveness tests should include the IOUs' overhead and other costs associated with energy efficiency activities that are recovered through base rates. Apparently, only the IOU costs recovered through specific energy efficiency funding sources (public goods charge (PGC) or procurement rates) are currently reported for PY2004-PY2005 programs, although the IOUs have been required to report costs collected in base rates for prior program years. We affirm the ALJ's direction that all of the program administrators' costs related to energy efficiency programs, irrespective of their funding source, be once again included in the calculation of the Total Resource Cost (TRC) and Program Administrator Cost (PAC) tests of cost-effectiveness. To do otherwise would shield those costs from review during program planning and implementation. Without delay, Energy Division should clarify its reporting requirements to ensure that all such costs are counted, not only in compiling data on current programs per D.05-01-055 (Ordering Paragraph 5), but also in the reporting of estimated costs for future program proposals, the calculation of cost-effectiveness , and the evaluation of the performance basis after program implementation.

In addition, workshop participants discussed how best to ensure continuity of the input assumptions and calculations for the tests of cost-effectiveness presented to the Commission during the program planning process. We have included language in the Rules clarifying that the Database for Energy Efficiency Resources (DEER) should be the source of all assumptions that are used to estimate load impacts, to the extent possible. (Rule IV.11.) Funded by ratepayers, this database has been jointly developed by the CEC and this Commission, with input and support from the IOUs and other interested stakeholders. It is designed to be the primary source for energy savings and cost-effectiveness input assumptions for program planning. We believe it is reasonable to continue to use DEER for this purpose. As discussed in Section 4 below, the EM&V protocols will include a schedule and process for updating DEER on a regular basis.

In addition, we will adopt the ALJ's workshop recommendation that Energy Division or its consultants independently review the cost-effectiveness calculations presented by the IOUs in their PY2006-PY2008 program applications and compliance filings. The IOUs should work closely with Energy Division to ensure that the input assumptions and cost-effectiveness calculations required for this review are clearly presented in work papers, without delay.

3.3. Other Issues

In their pre-workshop comments, NRDC and ORA suggested adding additional sections to the Draft Rules to reflect the Commission's recent decision on energy efficiency administrative structure, D.05-10-055. These included sections on Advisory Groups, Performance-Based Risk and Reward Incentive Mechanisms, Reporting Requirements and Affiliate Rules. We have made such additions in the attached Rules.

In addition, we have made other corrections and clarifications to the Draft Rules in response to pre-workshop comments and the workshop discussion. In particular, we respond to SCE's concern that the collection and allocation of PGC funds must comply with Pub. Util. Code §§ 381, 381.1, 399 and 890-900 by adding language from the current version of the Energy Efficiency Policy Manual that reflects these statutory requirements.²² (Rule II.10.)

We also respond to the concerns expressed by the County of Los Angeles, Proctor Engineering and others at workshops that the need for peak demand reductions is not adequately reflected in our Rules by clarifying that the savings goals established by the Commission are expressed in terms of annual and cumulative peak megawatt load reductions. (Rule II.2.) In addition, as discussed above, we add language to the Rules directing the IOUs to "demonstrate in their program planning applications for PY2006-PY2008 how their proposed portfolio will aggressively increase overall capacity utilization and lower peak loads through the deployment of low load factor/high critical peak saving measures." (Rule II.5.)

In its comments on the Draft Rules, ORA proposed specific "fund shifting rules" that would define how much flexibility the IOUs have to shift funds from one program to another during the three-year program cycle. We prefer to take the approach recommended by the ALJ, namely, to allow the IOUs and their advisory groups to develop fund-shifting rules for our consideration over the coming weeks, and submit them for our review with the PY2006-PY2008 program plans. The Rules reflect this approach.

In developing these fund shifting rules for our consideration, the IOUs and their advisory groups should also address the issue of adding new programs to the portfolio during the three-year program cycle. We believe that the IOUs should have some flexibility to add program designs or measures that were not considered during the program planning process, but that reveal themselves during the course of the program cycle as being capable of improving the cost-effectiveness of their portfolios, improving portfolio resource savings, or both. In addition, the fund shifting rules will need to address the circumstances under which the IOUs can shift funds out of programs identified in the program plans that are not performing, or underperforming relative to other energy efficiency options, as well as expand programs that are clearly "winners" in terms of cost-effectiveness and savings as the implementation unfolds.

On the one hand, we seek to provide the IOUs with sufficient flexibility so that they can effectively manage their portfolios during the program cycle to meet the Commission-adopted savings goals with a cost-effective portfolio of programs. For example, we would not want to continue the current practice of requiring ALJ authorization for numerous fund shifting and contract extension requests during each program cycle. At the same time, the Commission will need to adopt program plans that are meaningful in its funding decisions in order to commit such a large amount of ratepayer funding to them and to inform resource planning decisions. Therefore, we anticipate that most of what is contained in the program plans and compliance filings approved by the Commission will be implemented without major changes. The challenge will be to develop fund shifting rules that achieve the appropriate balance.

At the workshops, the County of Los Angeles and others recommended that the reporting requirements be carefully reviewed to ensure that the frequency of reports, amount of data and format provide information that is useful to the Program Administrators and Energy Division for their respective administrative functions, but not overly onerous to program implementers. We share this concern, not only for the program implementers but for the IOU program administrators as well. In consultation with the Assigned Commissioner and ALJ, Energy Division should develop program-specific, portfolio-level and financial reporting requirements for PY2006 and beyond that are responsive to these concerns. To this end, Energy Division is already planning to thoroughly review the frequency and amount of data provided monthly to it under the current reporting requirements, with input from the IOUs, interested stakeholders and the public.

Today's adopted Rules also respond to workshop comments of the Climate Change Action Registry by adding language that recognizes that energy efficiency is critical to achieving reduction in the environmental impacts, including greenhouse gas emissions, associated with the State's energy consumption. (Rule II.1.) As discussed at the workshops, we intend to closely coordinate with the Climate Change Action Registry so that the environmental adders we develop in our avoided cost proceeding will continue to be informed by the work that organization is undertaking to develop protocols for quantifying and reporting the greenhouse gas emission reductions associated with energy efficiency programs.

In response to comments on the Draft Decision, we clarify that solar water heaters should be eligible energy efficiency measures for PY2006 and beyond, under certain conditions. This is appropriate because, as NRDC, ORA, CCSF and others point out, the effect of solar water heating is indistinguishable from other efficiency measures that reduce natural gas or electricity consumption at the end user site (such as water heater wraps, pipe insulation, etc.). In contrast, photovoltaic and solar-thermal electric technologies generate electricity and therefore should be considered renewable technologies. In sum, solar water heating reduces end-use energy consumption, while photovoltaic and solar-thermal electric are energy production technologies. Moreover, as NRDC points out in its comments on the draft decision, the potential studies that we relied upon in establishing the energy savings goals for energy efficiency included solar hot water heating as an energy efficiency measure.

For the above reasons, we find that solar water heating should be included in the definition of energy efficiency measure for the purpose of considering funding solar water heating installations with energy efficiency funds. However, we also agree with SDG&E/SoCalGas that the contribution of solar water heating to the energy efficiency portfolio should depend upon its cost-effectiveness. In particular, energy efficiency funding should not be used to encourage the deployment of non cost-effective solar water heating technologies (i.e., by bundling them with cost-effective energy efficiency measures). Therefore, we will require that solar water heating installations be cost-effective on a stand-alone basis to be eligible for funding. The IOUs should work with their advisory groups to determine whether and how to best incorporate this new measure into their 2006-2008 energy efficiency portfolios and to develop quality warranty and installation requirements. Rule IV.7 and the appended definition of "energy efficiency measure" now reflect the inclusion of solar water heaters and our cost-effectiveness requirement for this measure.

In their comments on the draft decision, NRDC and other parties request clarification regarding whether program implementers can "count" savings associated with early replacement programs (i.e., by using the existing inefficient equipment as the baseline rather than the current code), similar to the current appliance recycling programs. As SDG&E/SoCalGas note, the Rules do not prohibit early replacements, but appropriate EM&V protocols should be developed to specify how to quantify savings from them. ²³ We are particularly concerned, however, with the notion that customers would be approached to replace functioning air conditioners (for example) without recognizing that there is still capital value to that equipment for the remaining useful life-even if the customer can save energy by replacing it sooner. Joint Staff should present its recommendations on this and other EM&V issues related to early replacement programs in the EM&V protocol submittals required by this decision.

Finally, PG&E requests us to count "spillover effects" in the calculations of cost-effectiveness and performance basis, that is, the effect of a program to induce other customers to invest in energy efficiency even without a program incentive. PG&E proposes to add a definition of "spillover effects" and modify the definitions of "net to gross" and "incremental measure cost" contained in the draft decision to reflect this proposal. We do not make these changes. In our view, the speculative nature of any attempts to quantify these indirect benefits significantly reduces their applicability as an analytical tool at this time. Moreover, as TURN points out in its reply comments, discounting the accounting of free-ridership through "spillover" would make it particularly difficult to attribute indirect program benefits to education and information programs, without double-counting those benefits.