Saving energy: Getting cost effectiveness right
For more information about cost-effectiveness models, consult CEE’s recent white paper, Benefits of Energy Conservation and Minnesota’s Conservation Improvement Program.
As a result of legislation proposed by CEE and enacted by the 2013 Minnesota legislature, Minnesota prioritizes cost-effective energy savings “over all other energy resources” and requires these to be “procured systematically and aggressively.” (Minnesota Statutes, section 216B.2401).
The state’s Conservation Improvement Program (CIP) is the framework by which cost-effective energy savings are procured by utilities from their residential and business customers, helping them to use energy more efficiently and control their energy costs. Cost-effectiveness testing is a central part of CIP — ensuring that the benefits of energy efficiency measures and programs in CIP outweigh the costs.
Every three years, the State works to update CIP’s cost-effectiveness test inputs for the following triennium. This time, the Minnesota Department of Commerce decided to do a more comprehensive review of CIP’s cost-effectiveness tests than in years past, and engaged stakeholders in extensive conversations throughout the process. In a recent decision, the Department decided to extend that work through January of 2020, to continue to work with stakeholders and utilities to review cost-effectiveness discount rates, avoided costs, and opportunities to improve transparency, and to identify other possible cost-effectiveness topics to review for the next triennium.
Given the complexity of the review and the important role of cost-effectiveness tests, we at CEE very much appreciate the Department’s decision, and believe the continued discussions under the leadership of Department staff will be productive and help to ensure that we get things right on cost-effectiveness.
An important part of future conversations will be the discount rate applied to cost-effectiveness testing. A discount rate attempts to accurately reflect the value of a given investment — in this case, energy efficiency — over time. Essentially, the lower the discount rate used in the test, the higher the estimated value of the investment over time.
In the past, the discount rate used to evaluate cost-effectiveness for the utility was the utility’s weighted average cost of capital, or "WACC." The WACC is the weighted average of the utility’s common equity, long-term debt, and short-term debt. WACC is the rate utilities earn on investments in power plants and other energy infrastructure. The Minnesota Department of Commerce estimates the average WACC for Minnesota utilities to be 7 percent.
We believe and have argued that applying the WACC as the discount rate to energy efficiency undervalues the benefits that energy efficiency provides over time. Unlike power plants and pipelines, energy efficiency does not require large, up-front capital investments, and thus poses a lower risk than those investments.
In our view, to judge energy efficiency’s value based on the utility’s cost of capital mismatches the actual risks and potential of the resource. A better option to evaluate the true costs and benefits of energy efficiency investments to utilities would be the societal discount rate. This discount rate reflects the low-risk nature of energy efficiency investments, and emphasizes the long-term value that energy efficiency provides to customers, the utility system, and society more broadly. The Department of Commerce has determined the societal discount rate to be about 3 percent.
The societal discount rate places a high value on the long-term benefits of energy efficiency, and reflects the low-risk nature such investments. Conversely, using the WACC as the discount rate for the utility cost test undervalues the long-term benefits of energy efficiency, overvalues the risk of investment, and is out of alignment with Minnesota’s long-term public policy preference and energy objectives.
When determining the costs and benefits of energy efficiency investments for utilities, using the societal discount rate would make the most of Minnesota’s existing public policy objectives. CEE is grateful for the opportunity to provide input on this issue and looks forward to further discussion with the Department of Commerce and other stakeholders.
MN Department of Commerce: Proposed Decision In the Matter of Inputs to BENCOST for Natural Gas 2020-2022 Conservation Improvement Program Triennium
CEE’s Comments on the Department of Commerce’s Proposed Decision
Benefits of Energy Conservation and Minnesota’s Conservation Improvement Program (CEE, 2019)