Cost Benefit Analysis and the Energy Transition: Toward a New Strategy

In the coming years, key decisions that will greatly impact state efforts to address climate change will be made by agencies that the public often thinks very little about. Public utility commissions (PUCs) are state agencies that regulate energy markets. They set electricity prices, plan energy resource development, and oversee the utility providers within their states. For decades, these agencies have advanced an energy policy that is informed by a straightforward need to provide dependable electricity to consumers at fair rates.

However, climate change requires a rethinking of PUCs' approach to energy policy. The demands of the clean energy transition are unlike any policy challenges they have faced in the past. Meeting these challenges successfully will thus require PUCs to adopt significant reforms in how they think about resource management and design.

Fortunately, PUCs have a variety of tools to address the impacts of climate change under their regulatory mandates. Beyond ratemaking and explicit statutory directives to consider climate impacts, PUCs can also have an outsized impact in their permitting and siting decisions. But there is one area of opportunity for significant impact that is currently not being properly explored.

This additional area: resource planning capabilities, the process through which PUCs determine the mix between investments in energy supply, transmission, and distribution versus expanding energy efficiency programs. Energy efficiency programs are a cost-effective way of reaching environmental targets that can reduce overall stress to the grid, support more resilient infrastructure, and provide many non-energy benefits beyond simple electricity generation and distribution considerations. Thus, an approach favoring these programs is beneficial to PUCs in their mission to transition the grid.

But how are these programs valued? Balancing the various interests — consumers, producers, societal — in determining an overall approach toward developing energy policy requires a thorough investigation of the pros and cons of resource planning decisions. While expanding infrastructure may seem like an initial solution to climate problems, increasing energy efficiency throughout the system is a way to have a significant impact while requiring less of a capital outlay. A well-structured analysis is essential for carefully comparing such alternatives.

Current resource planning tests

Currently, PUCs do not use one central, standardized test when engaging in resource planning, but rather pick and choose from a bank of five tests. The choice of what test and thus what to value can have dramatic impacts on the decisions made by PUCs. Therefore, highlighting the need for honest accounting of energy efficiency benefits in these calculations is paramount to ensuring reliability and that the public is not saddled paying for stranded assets that are no longer needed.

Currently, the PUCs utilize the following approaches: 

• Total Resource Cost Test (TRC): The most popular test employed by state PUCs for resource planning decisions, the “Total Resource Cost Test” examines efficiency from the viewpoint of an entire service territory. This test compares the program benefits of avoided supply costs to costs for administering a program and the cost of upgrading equipment. When a program passes the TRC, this indicates total resource costs will drop, and the total cost of energy services for an average customer will fall.
• Societal Cost Test (SCT): This test expands the point-of-view from the service territory to society’s perspective. The TRC and the SCT differ in two important ways: 1) while the TRC uses an average cost of capital discount rate, the SCT uses a societal discount rate; and 2) the SCT also includes all quantifiable benefits attributable to a program, such as avoided pollutants, water savings, detergent savings, and other non-energy benefits. But even when performing this analysis, debates exist over whether these benefits are properly valued.
• Ratepayer Impact Test (RIM): Originally known as the Non-Participant Test, RIM is also known as the “no losers test.” The RIM tests from the viewpoint of a utility’s customers, measuring distributional impacts of conservation programs. The test measures what happens to average price levels due to changes in utility revenues and operating costs caused by a program.
• Utility Cost Test (UCT): This test measures cost-effectiveness from the viewpoint of the sponsoring utility or program administrator. If avoided supply costs exceed costs incurred by the program administrator, average costs decrease.
• Participant Test (PCT): This test measures the benefits and costs to customers participating in demand-side management (DSM) programs. The test compares bill savings against incremental costs of efficient equipment. It measures a program’s economic attractiveness to customers and can be used to set rebate levels and forecast participation.

The problem is that none of these tests offers the kind of deference to a sustainable energy policy necessary to secure a clean energy future. To do this, PUCs need to embrace their role in supporting state mandates to achieve clean energy standards and design modeling approaches that favor a wholistic valuing of all possibilities to get there. This may require the creation of a new test, or the tweaking of inputs to the old standbys, but a decision to do more is the first step in addressing the problem.

A different approach

The current multi-test process can be contrasted with a more unified, single-test approach adopted at the federal level. For decades, the White House Office of Information and Regulatory Affairs (OIRA) has supervised agency use of cost-benefit analysis as the predominant tool for evaluating regulatory decisions. Though not perfect, the agency’s shift in recent years to prioritize a more inclusive process serves as an example for PUCs in adapting their tests or selecting a more unified approach altogether.

To meet the needs of this historic moment, PUCs need to modernize and streamline their processes to ensure they are in line with emissions reduction and climate goals. This will lead to better decision-making that produces a unified approach to environmental and energy policy, which is necessary for an orderly generation transition. By reevaluating how energy efficiency standards are valued in the portfolio mix, PUCs have an opportunity to add another tool to their toolkit to make serious progress toward emissions goals.