CBS Newsletter
Summer 1994
pg. 7

Is Demand-Side Management Economically Justified?

With billions of dollars being spent on demand-side management programs in the U.S. every year, the rationale for and performance of these programs are coming under increasing scrutiny. Three projects in the Energy Analysis Program are making significant contributions to the DSM debate.

*Total Resource Cost Test Ratio = ratio of utility avoided costs (i.e., benefits) divided by total cost of program (i.e., Administrative Cost + Incentive Cost + Consumer Cost)

In May, Joe Eto, Ed Vine, Leslie Shown, Chris Payne, and I released the first in a series of reports we authored from the Database on Energy Efficiency Programs (DEEP) project. The objective of DEEP is to document the measured cost and performance of utility-sponsored energy-efficiency DSM programs. This objective is elusive because problems with data consistency, evaluation methodology, and data-reporting formats continue to inhibit the usefulness and comparability of individual program results. The first report investigates the results from 20 recent commercial lighting DSM programs. Unlike previous reports of its kind, the DEEP team's compared each utility's DSM definitions and methodologies for computing costs and savings and made adjustments to standardize reported program results. All 20 programs were judged cost-effective when compared to avoided costs in their local areas. At an average cost of 3.9 cents/kWh, however, utility-sponsored energy-efficiency programs are not "too cheap to meter." It seems obvious that utilities must take active measures to minimize program costs and rate impacts. However, it is less apparent to the utilities that the industry's adoption of standard definitions and reporting formats will encourage identification of the best program designs.

Following several economists' misapplication of willingness-to-pay theory to the realm of DSM, Mark Levine and I investigated customer decisions to participate in DSM programs and sought out hidden costs associated with program participation. Using survey data collected by Massachusetts Electric Company's Energy Initiative and Design 2000 programs, we found empirical evidence that consumers systematically underestimate the value of energy-efficient equipment, suggesting an important role for DSM as a means of alleviating market imperfections. We also conclude that there is little evidence that extensive hidden costs are incurred by program participants. Finally, our work suggests that the industry give additional consideration to the potential for DSM programs to transform markets; this can cause the Total Resource Cost test (traditionally used by utilities to calculate DSM program net benefits) to underestimate the benefits of the utility DSM program, possibly by a considerable margin.

A more general treatment of market failures related to energy efficiency can be found in a new report by researchers at LBL and Oak Ridge National Laboratory. Eric Hirst of ORNL and LBL's Mark Levine, Jon Koomey, Jim McMahon, and Alan Sanstad provide a comprehensive discussion of this important area. They present a rigorous empirical framework for identifying such market failures and give examples of energy-efficient technologies whose adoption has been impeded by market failures. They discuss the economic theory of market failures, showing how this applies to energy efficiency. Finally, they discuss the rationale for utility DSM in promoting energy efficiency and review the success of appliance standards in overcoming market failures affecting energy efficiency in consumer products. This report, which is drawing wide attention, may be the most complete statement to date of the technologically oriented perspective on the performance of markets and policies related to energy efficiency.

—Richard Sonnenblick

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Database on Energy Efficiency Programs
Ed Vine
(510) 486-6047
Joe Eto
(510) 486-7284

Market Barriers
Mark Levine
(510) 486-5238

For copies of the DEEP report, contact Patricia A Juergens, (510) 486-4266;
for the Market Barriers report, contact Karen Olson, (510) 486-7489

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