III. Background on Issues and Policy

A. Overview of Cost-Benefit Approaches

Our inquiry with regard to DG costs and benefits evolves from our wish to promote as much DG as is sensible for California, but to assure that California ratepayers do not pay more for DG than it is worth to them. DG differs somewhat from other generation resources in that it is small and often versatile, that it may be easier on the environment than more traditional energy resources, and that its operation is controlled by the customer rather than the utility. We have elaborated on the value of DG facilities to California utility customers and its economy in several Commission orders and the Energy Action Plan, issued by this Commission, the CEC, and the California Power Authority.

This order proceeds to identify and specify the quantification of all relevant costs and benefits related to DG. The information may then be used to analyze the wisdom of subsidies for DG projects, the allocation of project development costs between project developers and ratepayers, and the benefits of DG relative to other energy resources available to jurisdictional utilities.

The parties to this proceeding identified a variety of possible costs and benefits associated with DG, either in workshops or during the hearings. Among the potential costs of DG projects are:

· Costs to integrate the DG project with the utility's distribution system impacts;

· Utility revenue loss due to displaced usage of transmission and distribution facilities;

· Utility/DWR revenue loss due to avoided commodity purchase-energy, capacity, bonds;

· DG project costs-investment, maintenance, fuel, metering;

· Improved stability and power quality;

· Ancillary services/VAR support;

· Utility loss of revenue due to displaced thermal load, cost of ratepayer incentives for CHP generators;

· Costs of mitigating air and water pollutants, and noise abatement;

· Reduced utility revenues for sales of natural gas;

· Utility administrative costs; and

· Cost of tax and other incentives.

Among the potential benefits of DG identified by the parties are:

· Reduced transmission and distribution line losses;

· Avoided purchases of other energy and capacity;

· Enhanced reliability;

· Improved stability and power quality;

· Provision of Ancillary Services/VAR support;

· Environmental benefits compared to central station facilities, including reduced air and water pollutants, promotion of environmental equity compared to large central station power plants;

· Thermal load provided in Combined Heat & Power applications;

· Increased responsiveness to load growth resulting from DG's modularity and scale;

· Lower market prices for power;

· Increased employment and tax revenue in California;

· National security benefits associated with reduced security risk to grid;

· Conservation of natural gas;

· Avoided utility capital costs; and

· Avoided utility administrative, maintenance, insurance, and installation costs.

Of the costs and benefits identified in this proceeding, some will be easier to quantify than others and some will be extremely difficult to quantify, such as equity impacts. DG costs and benefits vary based on technology, fuel variable, application, size, location, and frequency and duration of the facility's use. Significantly, the value of DG depends on whether the calculation is from the perspective of the DG project owner, the utility's customer base, or society overall. In D.03-02-068, the Commission found that DG can serve different purposes, such as onsite generation or as a distribution system alternative. The value of a DG project may depend on how the power is used, technology, fuel, and application. For this reason, this order evaluates a variety of methodologies that reflect various perspectives and types of DG.

Creating a cost-benefit methodology for DG facilities is a technically complex exercise but is not a novel one. For many years, the Commission has used cost-benefit tests for energy efficiency programs and avoided costs for assessing the value of and setting prices for "qualifying facilities," privately-owned energy resources that sell power to the utilities under the Public Utilities Regulatory Policies Act of 1981.

In this proceeding, our primary objective is to specify a model or models, that is, to specify variables that would reflect the appropriate costs and benefits to be measured in the model. A secondary but essential objective here is to determine the type of data or information to use to establish values for each of the model's variables.

The parties have used some existing studies and references in advocating for model types and specifications. The Commission has developed and used a cost-benefit model for existing energy efficiency program proposals in the "Standard Practice Manual" (SPM) used to guide energy efficiency program administration. Also providing a foundation for the debate in this proceeding were two reports sponsored by the CEC and the Commission. One, issued by Itron in March 2005, is titled "Framework for Assessing the Cost-Effectiveness of the Self Generation Incentive program" (Itron Report). The other, issued on October 25, 2004, by Energy and Environmental Economics, Inc. (E3), is titled Methodology and Forecast of Long-Term Avoided Cost(s) for the Evaluation of California Energy Efficiency Programs (E3 Report) and was presented in R.04-04-025, the Commission's inquiry into energy avoided costs.

The SPM report presents a cost-benefit model. The SPM model was intended to be used for resource assessments generally but has so far been used primarily to evaluate energy efficiency programs. The Itron report uses the SPM methodology as a starting point, and specifies the model inputs that are relevant for DG projects. The E3 Report presents various avoided cost estimates, which were adopted by the Commission in D.05-04-024. Avoided costs are inputs to cost-benefit models. For example, we could specify a cost-benefit model that measures avoided generation costs and avoided transmission line losses. An avoided cost in this context generally refers to a type of cost the utility avoids when the DG facility serves load the utility would otherwise have to serve. The generic avoided cost calculation may accurately reflect a DG facility's value to the system or it may serve as a baseline to which we might include "adders" in the cost-benefit model to reflect an additional value (or cost) that is specific to a DG facility or DG facilities generally compared to other energy resources. For example, we may find that in addition to avoided transmission costs that are common to all resources that reduce load, we may include an adder in the cost-benefit calculation that recognizes the deferral of investment in a transmission line to serve a specific large customer with a DG facility.

B. Development of Avoided Costs in R.04-04-025

The Commission is currently considering avoided costs in a separate docket, R.04-04-025. In that rulemaking, the Commission intends to adopt avoided costs that are consistent, to the extent appropriate, across technologies, programs, and policies. For example, they may be applied to energy efficiency programs, demand response programs, utility resource planning and procurement, energy supply contracts with qualifying facilities, and DG. The Commission already adopted new avoided costs for energy efficiency programs in D.05-04-024, which were derived from the E3 report.

As the scoping memo issued in this proceeding explains, the avoided costs developed in R.04-04-025 may be useful as elements of the cost-benefit models we adopt in this proceeding. Our intent here has been to identify the types of elements appropriate for a cost-benefit model to assess DG projects, which would include an avoided cost and may include other elements. For example, R.04-04-025 may set a value for the avoided capacity cost that applies to a project that defers utility investments in a central station plant. To the extent a DG project avoids capacity, that avoided cost would be included in the DG cost-benefit model. The variables for that cost-benefit model, however, would not necessarily be limited to the avoided cost developed in R.04-04-025. The project may also provide additional benefits to ratepayers or society, or impose additional costs, relative to those that are incorporated in the avoided cost.

Overall, the purpose of our ongoing effort in R.04-04-025 is to promote some consistency in our application of avoided costs across programs and evaluation exercises. We do not pursue consistency, however, in a vacuum. Where it is sensible to distinguish one type of facility or program from another because of costs or benefits associated with the facility or program, we intend to tailor our analysis. This proceeding pursues that objective to specify cost-benefit models in ways that reflect the SGIP and DG facilities in particular.

We do not intend to wait for the adoption of a permanent set of avoided costs in R.04-04-025 before we apply the cost-benefit models we adopt in this order today. Instead, we adopt interim avoided costs that may be incorporated into the methodology we ultimately adopt.

C. Defining DG for Purposes of Modeling Costs and Benefits

In determining how to measure costs and benefits, CAC/EPUC suggests the Commission here adopt a standard definition for DG. DG facilities vary significantly from the standpoint of technologies, applications, size, and use. However, they all serve load in close proximity to the generation. With this in mind, CAC/EPUC proposes the following definition of DG:

"DG is generation located on a customer's site that produces electricity to serve some portion of the customer's load, or nearby load, or both."

CAC/EPUC suggests that this definition includes combined heat and power (CHP) facilities, also called cogeneration plants. CAC/EPUC argues that cogeneration is reliable, efficient, and environmentally beneficial. CAC/EPUC objects to the CEC Working Group's definition of DG as limited to facilities that are connected to the utility's distribution system. CAC/EPUC believes this definition inappropriately imposes size limits on projects that may be identified as DG (because some large cogeneration plants are connected to the grid at the transmission level). Generally, CAC/EPUC believes there should be no requirement that a project to be connected to the utility grid. CCDC agrees with these comments.

No party objected to this definition. The significance of adopting such a definition for purposes of our inquiry here is, however, unclear. The scope of this order is limited to identifying the appropriate cost-benefit models to use when evaluating DG and related matters. We are not changing program parameters or creating new incentives. The way DG is defined should not in any way affect how or whether a project is subject to state or federal regulation. Regulatory jurisdiction is determined on the basis of a project's specific characteristics. To the extent cost-benefit models precisely and accurately incorporate the characteristics of a DG facility, it matters little how DG is defined. In that context, we have no objection to the definition proposed by CAC/EPUC, but do not make any commitments about how DG might be defined for other applications and for other purposes.

D. Assigning Specific Values to Adopted Variables

In addition to determining the types of models we should use to analyze DG projects, we specify the variables for each and identify data that should be used to calculate actual costs and benefits. This latter exercise is likely to be a moving target since many of the values for each cost-benefit model may change. These values may be derived from various information resources depending on the cost or benefit in question. For example, estimates of utility incentives are available in program guidelines and a total would be estimated according to DG facility energy production forecasts. Some model variables would use avoided costs either already in existence or under study in R.04-04-025.

The parties differ to some extent with regard to whether the Commission has the appropriate data to calculate costs and benefits immediately. ASPv would defer the adoption of final values, stating that third parties do not have ready access to much of the data needed for the models. It suggests conducting further proceedings to develop values for each variable. SCE also would await the final avoided costs adopted for DG in R.04-04-025. Other parties propose using what is available today, subject to future adjustments.

The California Legislature directed the Commission to adopt cost-benefit models for DG projects more than four years ago when it added Section 353.9. We see no reason to delay implementation and believe we have adequate data to begin the process of analyzing DG projects immediately. We also state our intent to modify inputs where existing information, data or estimates may be improved upon.

In order to avoid delay in developing reasonable cost-benefit models, we herein assign values to each variable. Where relevant, we use existing tariffs, incentives and tax rates. In some cases, we are able to use values adopted already in D.05-04-024. We will modify them as information becomes available or underlying values change.