3. The Shared-Savings Mechanism Adopted in D.94-10-059

By way of background, it is useful to describe the incentive mechanism that is at issue in this proceeding. Beginning in 1995, the utilities' energy efficiency programs became subject to the "shared-savings" mechanism adopted in D.94-10-059. This mechanism was in effect for all energy efficiency programs implemented, or for longer lead-time activities initiated, during program years 1995 through 1997. It has the following features:

· Ratepayers invest in energy efficiency programs by funding the programs through rates. The "return" on the investment is the net benefits (energy savings less costs) achieved by the programs. This return does not reflect the profits paid under the shared-savings mechanism to utility shareholders.

· Ratepayers and utilities share any positive return (net benefits) as follows: 70% to ratepayers, 30% as profits to utility shareholders. The percentage paid out as profits to utility shareholders (30%) is referred to as the "shared-savings rate."

· The net benefits from energy efficiency programs are calculated on a portfolio basis, e.g., individual programs are grouped together for the purpose of calculating whether there are net benefits, and for the purpose of calculating the profits to utility shareholders. There are two separate portfolios under the mechanism: one made up of all residential programs and one made up of all nonresidential programs.

· Utilities compensate ratepayers for 100% of any losses (negative net benefits) up to the total amount of program costs recovered in rates, on a portfolio basis.

· Before any profits (shareholder earnings) can accrue, the utility must achieve 75% of forecasted performance for each portfolio, as verified in the first earnings claim. That performance threshold is referred to as the "minimum performance standard" or "MPS." Once the utilities meet the MPS, their profits for each portfolio are calculated at the 30% shared-savings rate.⁶

· All energy savings are verified after-the-fact through ex post measurement studies that are filed and litigated before the Commission in AEAPs. The ex post Measurement and Evaluation (M&E) Protocols were adopted by Commission order.

· Net benefits for earnings claims purposes are adjusted to reflect the aggregate measurement and evaluation costs associated with that program year.

· The payout of utility shareholder incentives occurs over four earnings claims, which extend over a 7-10 year period after measure installation. Each installment represents 25% of the total earnings associated with the program.

· The first earnings claim is subject to verification of the program costs and actual number of participants in the program (measures installed), relative to the number projected in initial savings estimates.

· The second earnings claim is subject to ex post verification of the ex ante (forecasted) savings per measure assumed in the initial savings projections.

· The third and fourth earnings claims are subject to ex post verification of the persistence/retention of energy savings over time, e.g., by assessing equipment degradation or removal.

Attachment 2 presents a detailed history of the development of the shared-savings incentive mechanism, and includes a description of how the mechanism functions based on the results of M&E studies. To illustrate how it works for a specific program, the following example from SoCal's 1997 AEAP filing is provided below.⁷ This describes in detail how this process works for SoCal's PY1996 Commercial Energy Efficiency Incentives (CEEI) program, and shows how a study can modify an initial claim and how the earnings are then adjusted. Our discussion below as to what happens with the claim in the 2001 and 2004 AEAPs is hypothetical, since the 2001 AEAP is pending and the 2004 AEAP applications have not yet been filed.

SoCal submitted its first earnings claim for the PY1996 CEEI program in the 1997 AEAP. SoCal became eligible for earnings on the program by demonstrating that it exceeded the 75% minimum performance threshold for the nonresidential portfolio.⁸ In the first earnings claim, SoCal estimated that it would earn a total of $1.138 million for the PY1996 CEEI program over the ten-year measurement period, or 30% of the $3.793 million in net benefits to ratepayers. That is, based on the actual number of measures installed and ex ante estimates of measure savings, SoCal projected that the "return" on ratepayers' investment in the PY1996 CEEI program would be $3.793 million. The actual amount SoCal requested for PY1996 CEEI earnings was 25% of $1.138 million, or $284,000. This represented the first of four claims for the program.

A first-year load impact study was conducted on the CEEI program in 1997, the year subsequent to the program year. Load impact studies are designed to verify per measure savings estimates, using billing data and other ex post measurement approaches. The 1997 study found that the ex post measure savings were significantly lower than what was forecasted in the energy savings calculations used in the first earnings claim. The estimate of $3.793 million in net benefits presented during the first claim (see above) was revised downwards to $1.383 million based on the load impact study. Therefore, as part of the second claim for PY1996 CEEI program (filed in the 1998 AEAP), the lifecycle earnings claim was revised from $1.138 million to $415,000 (i.e., 30% of $1.383 million). The second claim was then 50% of the new lifecycle earnings of the program, minus what was collected in the first claim. In this case, the claim was negative $77,000.⁹ SoCal's total portfolio claim made in the 1998 AEAP reflected this reduction from its CEEI program.

In the pending 2001 AEAP, SoCal has filed its third earnings claim for the PY1996 CEEI program, based on the results of its fourth-year retention study. According to SoCal, the results of that study suggest no change to the ex ante expected useful lives for the measures. Assuming that the study methodology and results are found to be valid in the pending 2001 AEAP, the lifecycle earnings value of $415,000 (derived for the second claim and revised from the original claim) would not change from the second earnings claim. The third claim is 75 percent of the lifecycle earnings for the program, minus what has already been collected as part of the first and second claims. Therefore, SoCal submitted a third earnings claim for $104,250.¹⁰

The M&E Protocols requires a ninth-year retention study to be completed for the program and submitted in 2004. Therefore, SoCal is expected to file its fourth earnings claim in the 2004 AEAP. If it is assumed that the results of the ninth study confirm the expected useful measure life, the fourth earnings claim is equal to 100 percent of the lifecycle earnings ($415,000) minus the earnings recovered from the three previous earnings claims: $284,000 in the first claim, minus $77,000 in the second claim, plus $104,000 in the third claim, totaling $311,000. Therefore, the fourth claim would equal $415,000 minus $311,000 or $104,000.

In this example, the four payments add up to the total lifecycle earnings claim of $415,000 for the PY1996 CEEI Program. This amount represents 30% of the net benefits to ratepayers ($1.383 million), as verified by ex post measurement studies over the ten-year period.

The shared-savings mechanism described above was in place for PY1995-PY1997 for all utilities. It applies to all energy efficiency programs implemented during 1995-1997 or, in the case of long lead-time new construction projects, initiated during that period. Before 1994, the experimental mechanisms were in place that shared savings between ratepayers and shareholders, but that varied by utility. The potential for utility profits under these earlier mechanisms was much lower than under the shared-savings mechanism adopted in D.94-10-059. However, the utilities were not required to measure savings on an ex post basis as a condition for payment, and were not subject to financial penalties if the programs did not prove to be cost-effective.

By D.93-05-063, the Commission modified the existing incentive mechanisms for PY1994 to require a 7- to 10-year payout of utility profits based on ex post measurement. The same measurement protocols and payout conditions were also applied to the shared-savings mechanism adopted in D.94-10-059. Therefore, even though the formula for calculating earnings for PY1994 programs is significantly different than the one adopted in D.94-10-059 for PY1995-PY1997, the payout schedule and ex post measurement requirements are identical. Accordingly, there are still outstanding claims for PY1994 in this and future AEAP proceedings, based on the shared-savings mechanisms in place during that transition year.