4. Scope of Phase 1 and Definitions of Incentive Design Parameters
As outlined in the Assigned Commissioner's May 24, 2006 Scoping Ruling, the purpose of Phase 1 is to develop a shareholder risk/reward incentive mechanism for energy efficiency "consistent with the policy rules, performance basis and associated updating/true-up determinations adopted in [R.] 01-08-028 and related proceedings."22 The ruling recognizes that we have already addressed certain threshold incentive design issues for energy efficiency, and therefore excludes these issues from the scope of this proceeding. In particular, in D.05-04-051 we directed that energy efficiency performance should be evaluated based on overall portfolio achievements, rather than on the performance of each individual program. We also determined what metric will be used to establish a dollar value for energy efficiency performance, which we refer to as the "performance earnings basis" or "PEB." We adopted a PEB that represents the net benefits to ratepayers (resource benefits minus costs) from their investment in energy efficiency.
More specifically, to calculate the PEB, the energy savings (kW, kWh and therm reductions) are assigned a dollar value that reflects Commission-adopted avoided costs, that is, the supply-side generation, transmission, distribution and environmental costs avoided by those reductions in demand.23 As discussed in Section 8 below, these savings levels are verified based on EM&V activities undertaken by the Commission staff and their consultants. When valued at avoided costs, these verified savings become the "resource benefits" used in the PEB calculation.
The costs of implementing the energy efficiency portfolio are then subtracted from the resource benefits to yield the "net benefits" value for the PEB. Positive net benefits accrue only when the portfolio is cost-effective, that is, when resource benefits are greater than costs. Conversely, negative net benefits accrue when the portfolio costs are greater than the resource benefits.24 We refer to "net benefits" and "performance earnings basis" or "PEB" interchangeably in this decision.
By defining the PEB in this manner, we established that shareholder earnings would represent some percentage ("earnings rate" or "shared-savings rate") of the net benefits achieved by the energy efficiency portfolio. We also directed that before any of these earnings would accrue, the portfolio must achieve a minimum threshold of gigawatt-hour (GWh), megawatt (MW) and million therm (MTherm) savings tied to the achievement of the Commission's savings goals for energy efficiency. We left it to this phase of the proceeding to establish the level of this threshold, referred to as the "minimum performance standard" or "MPS".25 These design parameters are incorporated into parties' proposals, as discussed further below.
By today's decision, we address the remaining design and implementation issues associated with a risk/reward incentive mechanism for energy efficiency, which primarily involves defining the parameters of the earnings/penalty "curve," as follows:
1. What is the minimum performance standard or "MPS," that is, what minimum threshold of performance must the energy efficiency programs achieve before any shareholder earnings will accrue?
2. If the MPS is not achieved, what will trigger penalties and what penalty rate(s) will then apply?
3. Once the MPS is achieved, what will be the earnings rate(s), that is, what percentage of the PEB will accrue to shareholders? The earnings rate(s) are also referred to as the shared- savings or sharing rate(s).
4. Will there be caps on the absolute level of earnings or penalties and, if so, at what level(s)?
5. What program activities will count towards the MPS and towards the PEB of the mechanism?
6. What will be the earnings claim and recovery process, as well as the precise linkage of incentive payout to EM&V results?
These and other design and implementation issues are within the scope of Phase 1, and addressed in today's decision. We also address two issues that were identified in the scoping of Phase 1 to further clarify how cost-effectiveness calculations should be performed. (See Section 10.)
Consistent with the Commission's direction in D.05-04-051, all parties presented proposals for a risk/reward incentive mechanism that result in a sharing of net benefits between shareholders and ratepayers once the portfolio achieves a minimum level of savings relative to the savings goals. Moreover, all parties recommend that the sharing rate (also referred to as the "earnings" or "shared-savings" rate in today's decision) be tiered so that the percentage of net benefits going to shareholders will increase with higher and higher levels of achievement relative to those savings goals. They also presented proposals for penalty provisions under the incentive mechanism. However, parties strongly disagree on a number of specific design parameters that define the earnings/penalty curve.
Attachments 2 through 4 summarize the positions of the parties on incentive design and implementation issues and the level of potential earnings and penalties under each incentive proposal. In the sections that follow, we refer to these attachments in describing the range of positions on each issue before discussing the reasoning behind our determinations. As usual in such proceedings, the record is voluminous. We concentrate on the chief points of contention, rather than summarizing every nuance in individual positions.
22 Assigned Commissioner's Ruling and Scoping Memo and Notice of Phase 1 Workshops, May 24, 2006, p. 3. We use the term "energy efficiency" to refer to non-low income energy efficiency activities authorized by this Commission, except where otherwise indicated. Low-income energy efficiency programs are funded separately from non-low income energy efficiency programs, and are subject to a separate performance-adder incentive mechanism. As discussed in the ruling referenced above, we do not address that mechanism in today's decision. For a description of the current performance adder mechanism for these low-income programs, see D.05-10-041, Attachment 3.
23 The methodology and values established for energy efficiency avoided costs were most recently addressed in the 2006 update of avoided costs, in Rulemaking 04-04-025. See D.06-06-063.
24 See Section 10 below for further description of the adopted PEB metric, which is actually a weighted average of two cost-effectiveness tests. For the Commission's determination on PEB-related issues, see D.05-04-051, mimeo., pp. 38-43, 60-64. See also Administrative Law Judge's Ruling on EM&V Protocol Issues, September 2, 2005 in R.01-08-028, pp. 2-6, 14-15.
25 D.05-04-051, p. 43.
