Shareholder Incentives and Milestones

Having reviewed the applications and considered the parties' comments, we believe that it is important to give the utilities direction on shareholder incentives and milestones at this time. We establish a mechanism and targets for shareholder incentives tied to energy savings and defer a determination with respect to the proposed milestones and incentives related to market effects and information programs to the final decision.

Background

Prior to 1998, the utilities earned incentives on net energy benefits based upon ex post verification of actual energy savings over a period of time. After enactment of AB 970, and during the interim period in which the utilities were to act as program administrators, shareholder incentives have been based upon milestones related to performance of specific program activities, under a system designed by the CBEE. For PY 2000, this system resulted in 170 milestones among the four utilities. Evaluating the milestones became a virtually impossible task, so in D.00-07-017 we indicated our intent to simplify the shareholder incentive structure and to subject the individual milestones to more rigorous scrutiny going forward. We also stated our preference for tying performance incentives to energy savings or cost-effectiveness. (Id., mimeo at pp. 194-195.)

During the planning process, pursuant to the ALJ's direction, the parties held a workshop to discuss development of a new mechanism. While the parties did not complete work on the milestone and incentive mechanism, they agreed on some basic principles, including that the primary mechanism should be based on energy and demand savings. Further direction was given in the ACR Implementing AB 970 regarding peak demand savings, the ALJ's Ruling Giving Direction for Program Year 2001 Planning issued on October 25, 2000 (ALJ Ruling on Planning) which set forth principles to guide development of new milestones and incentives,¹⁴ and Commission President Lynch's concurring opinion in D.00-09-038, approving shareholder incentives for PY 1998 energy efficiency programs but expressing dissatisfaction with the vague, unverifiable, unmeasurable, and disconnected nature of the milestones.

Given the increased emphasis in PY 2001 programs on reducing peak demand and the goal of PY 2001 programs to maximize energy savings, but balancing the prior directive for market transformation programs, the ALJ Ruling on Planning provided the following guidance:

1. There should be two types of milestones:

a. Verifiable energy and demand savings; and

b. Verifiable market share. If market share data is not available, the milestones should be based on market effects. Some of these milestones may also reflect a performance adder for information-type programs.

2. Energy and demand savings will be based on ex ante impact projections based on ex post evaluations from prior program years or engineering estimates. Awards will be based on verified program savings as a scalable percentage of ex ante goals.

3. A substantial portion of the milestones should be based on energy and demand savings and should track program budget and design.

4. The incentive structure used for PY 2000 programs (base, activity, market effects, and aggressive implementation) should not be used. There should not be milestones for program roll-out, activity, or aggressive implementation.

5. Milestones should clearly state the program theory or goal.

The utilities used this basic guidance in submitting their proposals.

Utilities' Proposal

The utilities propose a shareholder incentive mechanism that divides milestones into three categories: 1) energy savings; 2) market effects; and 3) a performance adder for information programs. The majority of earnings are based on energy savings.

For programs projected to produce measurable and verifiable energy savings and peak demand reductions, the utilities propose to base earnings on energy savings and peak demand reduction targets at the program portfolio level, and to scale the award based on the ex ante net energy savings and peak demand reductions obtained based upon the most recent load impact studies where available and the adopted net-to-gross ratios.¹⁵ The load impact targets are scaled with the awards, allowing immediate award for energy savings.

For programs that cannot be tied to energy savings but promote market transformation, the utilities propose particular market effects milestones and incentives, designed to represent changes in market actor(s) behavior, awareness, knowledge, and market share. They propose two levels of earnings, generally an award for 70% attainment and for 100% attainment.¹⁶ The utilities propose a total of 20 milestones for market effects; PG&E proposes 6; Edison proposes 6; SDG&E proposes 5; and SoCalGas proposes 3.

For information programs and energy centers, which support program delivery but do not produce directly measurable energy savings or market effects results, the utilities propose that incentives be paid as a "performance adder." These incentives are based upon total program budget expenditures on the included programs; the utilities propose to achieve awards for recording 60% of the total programs' budgets associated with these activities, increasing linearly to 95% of the recorded target.

The utilities propose the following award weighting among categories:

Milestones: Weighting and Amounts

			PG&E		SDG&E		SCE		SCG
			Mechanism Weighting	Maximum Award	Mechanism Weighting	Maximum Award	Mechanism Weighting	Maximum Award	Mechanism Weighting	Maximum Award
Energy Savings			76.50%	8.278	80%	2.165	80%	4.473	80%	1.665
Market Effects			6.40%	0.688	10%	0.271	10%	0.559	10%	0.208
Performance Adder			17.10%	1.853	10%	0.271	10%	0.559	10%	0.208
Totals			100.00%	10.819	100%	2.706	100.00%	5.591	100.00%	2.081
At 110% of the cap (7.7%)				10.82		2.976		6.15		2.29
7% Cap				9.84		2.706		5.591		2.082
Program Budgets				140.51		38.654		79.869		29.739

Energy Savings and Weightings

	PG&E					SDG&E						SCE					SCG
	Award Weight	Target Award		Energy Savings		Award Weight		Target Award		Energy Savings		Award Weight		Target Award	Energy Savings		Award Weight		Target Award		Energy Savings
MW	22%	$ 1.791		63.9		20%		$ 0.433		18.5		25%		$ 1.118	47.89
MWh	65%	$ 5.373		210,696		59%		$ 1.277		112,606		75%		$ 3.355	247,566		34%		$ 0.566		13,767
Therms (000s)	13%	$ 1.114		3,864		21%		$ 0.455		2,809							66%		$ 1.099		7,899

Weighting

We believe that the overall structure and weighting provided is reasonable. However, it should be standardized across all utilities. Thus, PG&E should use the same 80%-10%-10% weighting for energy savings, market effects, and performance adders, respectively, as proposed by the other utilities.

Further, the proposed incentives should add up to 100% of the 7% earnings cap¹⁷ and not 110% as proposed by PG&E. We do not believe that there is any reason to include a 10% performance factor because earnings are based primarily on energy savings and not on individual milestones that may or may not be met.

Incentives for Energy Savings

Several parties have questioned the utilities' proposed energy savings estimates. The CEC points out that the utilities provide little rationale to justify their estimates. TURN and REECH object to the utilities' earning incentives on budgets that include carry-over funds since they have had one or more opportunities to earn incentives on those budgets in prior years.

Our preliminary review shows that PG&E's and Edison's estimated electric energy savings for PY 2001 programs are substantially less than both recorded electric savings in PY 1999 and projected electric savings for PY 2000.¹⁸ Only SDG&E's projected electric savings are greater than savings recorded in 1999 and projected for 2000. Further, SoCalGas' estimated therms saved are substantially less than recorded therms saved in PY 1998 and PY 1999 and projected therms saved for PY 2000. While there have been some changes in the cost-effectiveness inputs on the benefits side, those changes do not explain the drastically reduced energy savings estimated for PY 2001. This is particularly true since we have encouraged the utilities to increase emphasis on energy savings and peak demand savings in PY 2001 while PY 1999 and PY 2000 programs were based to a greater extent on market tranformation programs, under which it is more difficult to assess short-term energy savings.

Given the above, we have substantial doubts regarding the legitimacy of PG&E's, Edison's, and SoCalGas' estimated energy savings for PY 2001. We also have substantial concerns about the proposed design of the performance award mechanism. While it appropriately is based on energy and peak demand savings, the estimated savings are very low and the mechanism provides for scaled performance awards with the attainment of minimal energy savings. This proposal neither meets our objective of encouraging maximum energy and peak demand savings in PY 2001 programs nor provides a fair balance of risk and reward. Thus, we conclude that this proposal is not appropriate for use with PY 2001 programs.

We believe that the utilities should make every effort to maximize energy savings and peak demand savings for PY 2001 and that energy and peak demand savings should meet or exceed prior years' savings. The utilities' historical experience provides an appropriate starting point for setting milestones based on energy and peak demand savings. Further, to encourage the utilities to maximize savings, we believe that the utilities should meet a threshold before earnings are awarded.

Thus, we will set the energy and demand savings portion of the milestones to absolute savings targets. This mechanism will ensure that each utility has a clear goal and clear metrics for earning shareholder incentives. By adopting the mechanism set forth below, we believe that earnings appropriately will be based on a balance of risk and reward. While we increase the energy savings that must be attained before an award is earned, for all utilities except SDG&E, we also give the utilities discretion to manage their programs and shift program funds as the need arises. Thus, the utilities are provided with both the incentive and the means to earn these awards, while producing increased energy and peak demand savings to their own benefit and the benefit of ratepayers. This mechanism also obviates the need to address TURN's and REECH's objection to providing incentives on budgets based on carry-over funds because it ensures that the utilities have the incentive to maximize energy savings while providing a stretch over the utilities' estimated energy savings.

The table below summarizes the electric energy (kWh), electric peak demand (kW), and gas (therms) savings goals for each utility. The first set of columns represents the minimum or threshold level of savings that each utility is required to meet in order to earn any shareholder incentives. Once the utility has met this threshold, it will automatically be eligible for 50% of the 80% of shareholder incentives allocated to energy or demand savings. If the utility meets the maximum savings targets in the second set of columns, it will be eligible to earn 100% of their 80% of savings-related shareholder incentives. Shareholder incentive awards will be scalable between the minimum and maximum savings levels reflected in the table below, and between 50% and 100% of potential earnings, respectively. Thus, for example, a 1% increase in savings over the minimum threshold level will result in 52% of shareholder earnings awarded, once savings are verified and reported.

The targets in the table below are based on the 80% of budgets approved on an interim basis in this decision. When a final decision is adopted by the Commission, these savings targets will be adjusted to reflect the final approved budgets for each utility.

Shareholder Earnings Targets

(based on 80% of authorized budget)

	Minimum/Threshold (50% earnings)			Maximum (100% earnings)
PProgram Area	Million kWh	MW	Million therms	Million kWh	MW	Million therms
PG&E
Residential	98.0	37.3	2.3	122.5	46.6	2.9
Nonresidential	249.1	40.6	4.1	311.4	50.8	5.1
New Construction	24.9	6.3	0.2	31.1	7.9	0.2
Total	372.0	84.2	6.6	464.9	105.3	8.3
SCE
Residential	69.8	26.6		87.2	33.2
Nonresidential	155.0	25.3		193.7	31.6
New Construction	55.2	14.0		69.0	17.5
Total	280.0	65.8		349.9	82.3
SDG&E
Residential	14.9	5.7	0.6	18.7	7.1	0.7
Nonresidential	37.5	6.1	0.2	46.8	7.6	0.3
New Construction	26.6	6.7	0.1	33.2	8.4	0.2
Total	79.0	18.5	0.9	98.7	23.2	1.1
SoCalGas
Residential	2.7	1.0	2.5	3.4	1.3	3.1
Nonresidential	1.4	0.2	6.0	1.7	0.3	7.4
New Construction	4.5	1.2	0.5	5.7	1.4	0.6
Total	8.7	2.4	8.9	10.9	3.0	11.1
Grand Total	739.5	171.0	16.4	924.4	213.7	20.5

These targets have been set based on an analysis of historical effectiveness of utility investment in energy efficiency programs (measured in dollars per kWh or dollars per therm). Peak demand (MW) savings targets were calculated assuming load factors of 30% for the residential sector, 70% for the nonresidential sector, and 45% for new construction. In most cases, the average $/savings figures were averaged over the past three program years (1998-2000) and then adjusted to reflect:

· Differences in net-to-gross ratio assumptions for programs from year to year

· The likelihood that energy savings become more expensive to achieve over time

· The likelihood that some higher program costs may be warranted in 2001 because of the need to "jump start" efficiency activities, through increased marketing or incentive levels, to increase consumer participation.

For achievement of the savings goals above, each utility will be eligible for the following maximum award levels. The percentage earnings are weighted appropriately for each utility, as shown in the table.

	Maximum Earnings Potential ($ million)
PProgram Area	kWh savings	Peak MW savings	Therm Savings	Total
PG&E
Residential	1.35	0.45	0.45	2.25
Nonresidential	1.67	0.56	0.56	2.78
New Construction	0.76	0.25	0.25	1.26
Total	3.78	1.26	1.26	6.29
Weighting	60%	20%	20%
SCE
Residential	0.97	0.32		1.30
Nonresidential	1.17	0.39		1.56
New Construction	0.54	0.18		0.72
Total	2.68	0.89		3.58
Weighting	75%	25%
SDG&E
Residential	0.40	0.13	0.13	0.66
Nonresidential	0.42	0.14	0.14	0.70
New Construction	0.22	0.07	0.07	0.37
Total	1.04	0.35	0.35	1.73
Weighting	60^	20%	20%
SoCalGas
Residential	0.08	0.08	0.24	0.40
Nonresidential	0.13	0.13	0.39	0.65
New Construction	0.05	0.05	0.16	0.27
Total	0.27	0.27	0.80	1.33
Weighting	20%	20%	60%
Grand Total	7.77	2.77	2.40	12.94

Shareholder Incentives and Milestones for Market Effects and Information Programs

We do not at this time adopt the specific performance award milestones and associated incentive levels related to market effects programs and the performance adder, pending further review. As the CEC has pointed out, proper baselines are not always provided and there are substantial issues regarding the appropriateness of the selected milestones.

Further, the proposed performance adder has no parameters, assumes that each activity has value, and is virtually risk-free. While we agree that the use of information programs is an essential part of the utilities' programs, the relevant issue to be addressed concerns the type of information program and the success of the program in reaching customers. It is not met by simply spending the money allocated for information programs. The performance adder should be tied to targeted outreach of underserved communities and new distribution/marketing methods instead of on spending funds for more bill inserts or other information programs that have not produced results in the past.

These performance award milestones and incentive levels for PY 2000 programs will be adopted when we issue our final decision at the conclusion of this proceeding. While the market effects and information performance adder milestones will not be in effect during this interim period, the utilities will be allowed to use all accomplishments achieved during PY 2001 to meet the milestones that are approved. We expect the utilities to proceed to implement the authorized programs, and expend the authorized funds, as directed.

No Ex Post Measurement of Net Benefits

We do not adopt ORA's proposal to return to pre-1998 recorded net benefits milestones for calculating shareholder incentives based on ex post savings measurement. While there is merit to this approach, we believe that it is best considered with respect to post-PY 2001 program planning. We have stated our intention to revisit our policies with respect to energy efficiency programs for PY 2002 and beyond, including the goals and objectives of the programs and the desirability of independent administration. ORA's proposals are appropriately considered at that time. Further, since ORA's proposal requires major overhaul of policy rules and reporting requirements, as well as measurement and verification activities that occur over several years, it does not make sense to adopt it for only one year - PY 2001. And, were we so inclined to adopt this approach, we note that it would be virtually impossible to accomplish what ORA would have us do within the next few months.

Finally, ORA's proposed incentive mechanism is not appropriate for all the programs set forth in the utilities' portfolios. This mechanism is designed for resource-procurement-based energy efficiency programs. However, as the utilities note and we discuss above, the PY 2001 program is a mixture of resource procurement, market transformation, and information programs. Since shareholder incentives should relate to programs, this mechanism would not be appropriate as a measurement for some of the programs.

¹⁴ The general principles are:

1. The milestones should be simplified, in structure, number, and verification;

2. There should be a clear link between activities and rewards;

3. They should be specific, measurable, and quantifiable;

4. They should have readily available baseline data;

5. They should represent a fair balance between risk and reward; the utilities should have a fair opportunity to earn the milestones but earning should not be guaranteed; and

6. They should not exceed 7% of overall program budgets.