The Economics of Conservation Programs

Demand side management (DSM) is one of the most topical issues in regulating electric utilities, both in the United States and internationally. What is DSM? It consists of various measures at the level of demand (households, commerce, industry, others), which are at least partially financed by electric utilities and which should either conserve energy or reduce the peak load. The practice of DSM originates from The Public Utility Regulatory Policy Act of 1978 (PURPA) that provided the political and legal framework to set energy conservation as a national goal, which encouraged regulatory commissions to initiate utility conservation programs; see e.g., Nowell-Tschirhart (1990) and Fox-Penner (1990). Moreover, integrated resource planning, which must account for DSM on a level playing field with supply, is written into the 1992 Energy Policy Act as the U.S. Government's preferred method of electric power planning. Although PURPA set energy conservation as a national priority, its implementation was left to the states with the consequence of considerable differences concerning efforts and rules. By 1993 16 states had already implemented integrated resource planning, 9 were in the process of doing so and further 9 considered implementation, (EPRI 1993b). Due to the Clean Air Act of 1990, 24 states are considering to include external costs in integrated resource planning.

1 Introduction.- 2 Economic analysis of energy conservation.- 2.1 Consumers.- 2.2 Firms.- 2.3 Estimation of price elasticities and assessment of the rebound effect: an application to transportation.- 2.4 The energy efficiency of supplied technologies.- 2.5 Derivation of an intertemporal R&D strategy.- 2.6 Energy demand, technology and taxes.- 3 The normative case for demand-side conservation.- 3.1 Market failures.- 3.2 The first best social optimum.- 3.3 Second best efficiency standards for electricity price regulation.- 3.4 Imperfect capital markets.- 3.5 Subsidies when the electricity price is regulated and capital markets are imperfect.- 3.6 Assessment of the social gain from conservation.- 4 Least cost planning.- 5 Incentives to the utility.- 5.1 Shared savings.- 5.2 Mark-ups.- 5.3 Bonus.- 5.4 Optimal conservation incentives to utilities.- 6 Incentives for consumers.- 6.1 A constant investment bonus.- 6.2 Linear bonuses for financial outlays.- 6.3 Conservation bonus according to Lovins.- 6.4 Energy service and third party conservation companies.- 6.5 Bidding for negawatts and price differentiation.- 7 Asymmetric information and strategic consumer reactions.- 7.1 Adverse selection among program participants.- 7.2 Negawatt auctions induce moral hazard.- 7.3 Moral hazard induced by conservation programs.- 7.4 Moral hazard under least cost planning DSM.- 7.5 Standards.- 7.6 United States experience.- 8 Optimal conservation incentives under asymmetric information.- 8.1 Socially optimal incentives.- 8.2 Optimal least cost planning conservation incentives when efficiency is observable.- 8.3 Optimal conservation incentives when efficiency is not observable.- 9 Rate-of-return regulation and incentives.- 9.1 Rate-of-return regulation, no incentives.- 9.2 Rate-of-return regulation plus incentives (shared savings).- 9.3 Review of literature.- 10 Efficiency of DSM and positive explanations.- 10.1 Impact of United States DSM on electricity demand.- 10.2 Problems on the demand side.- 10.3 Regulation.- 11 Summary and concluding remarks.- 12 References.