Nationwide, there’s an ever growing push to decarbonize buildings — a task that will require heat pumps, weatherization, and many other “deep” energy efficiency retrofits. To achieve this, many utilities are increasing their investments in residential energy efficiency programs, including in “deep retrofit” programs.
In order to justify increased utility investments in energy efficiency, regulators typically require that the money spent (ultimately by their customers or “ratepayers”) meets some form of “cost-effectiveness” test. Yet the traditional way cost-effectiveness has been determined is outdated in ways that clash directly with state energy and decarbonization goals as well as common sense.
To be clear, cost-effectiveness is not the enemy: it’s important that utilities make smart investments that both decarbonize buildings and provide value to our energy system. But these cost-effectiveness tests are often designed in a way that actually ends up unnecessarily hurting decarbonization efforts. It’s time to update our definition of cost-effectiveness so that we can effectively decarbonize buildings.
Cost-effectiveness tests are heavily biased based on what costs and benefits are included
Cost-effectiveness tests come in different flavors, but they’re all used to determine whether the benefits of an energy efficiency program outweigh the costs. At the end of the day, these tests help policymakers, utilities, regulators, and program administrators determine if certain energy efficiency programs are providing value to ratepayers—and ultimately if they should continue or not.
While there are many different types of tests, it comes down to what costs or benefits regulators value. Because different cost-effectiveness tests value different benefits and costs, they are biased by what is a “cost” and what is a “benefit.” In turn, this means that the type of test regulators choose and how that test is administered is very important.
When it comes to gauging cost-effectiveness, most states rely on one of these tests (or a combination):
- Total Resource Cost (TRC)
- Societal Cost Test (SCT)
- Participant Cost Test (PCT)
- Utility/Program Administrator Cost Test (UCT)
- Rate Impact Measure (RIM)
- Program Administrator Cost Test (PAC)
The most common cost-effectiveness tests heavily weight participant costs
State regulators are using these cost-effectiveness tests as a screening tool to judge which programs are worth the money.
Yet the flaw in many of these tests is that they focus on participant costs instead of program costs.
Consider this example: You could have a weatherization and heat pump project that delivers $10,000 in ratepayer benefits, costs $5,000 to deliver (including rebates and administrative costs), but requires $30,000 upfront to install. Under the logic of the TRC test, this project would have a 0.33 TRC (the $10,000 benefit divided by the $30,000 cost), which is less than 1 and therefore considered “not cost-effective.”
In practice, that means that deep retrofit measures that cost more money upfront — weatherization, heat pumps, and the like — fail the TRC test.
This, of course, doesn’t make sense. The homeowner is paying $25,000+ of the $30,000 based on their own needs to heat and cool their home, or to be more comfortable, or to live sustainably. It’s the private market that’s shouldering most of the expense. In other words, the TRC results in a private investment penalty.
What makes more sense in the given example? To consider the public cost. Ratepayers are on the hook for just $5,000 compared to $10,000 in benefits. Using a different measuring tool, like the Program Administrator Cost (PAC) test, shows a cost-effectiveness score of 2 ($10,000 in benefits divided by $5,000 in public money). This time, it’s greater than 1, and therefore more cost-effective.
Some regulators and policy stakeholders believe the best way to address the financial disparity in the above example is to calculate “non-energy benefits,” like being comfortable or living sustainably in one’s own home. The challenge is that it’s hard to measure these subjective, though very real, benefits — which is why the various cost-effectiveness tests rely on what can be measured.
For regulators that want (or need) to retain the TRC test, it would make more sense to assume non-energy benefits are equal to the participant costs. After all, if the subjective benefit of having a better heating and cooling system does not exceed the costs, it stands to reason a homeowner wouldn’t pay to have it installed.
Cost-effectiveness tests are hurting decarbonization efforts
Today, some of the most common cost-effectiveness tests including the TRC are biased toward programs that incentivize low- or no-cost measures, like lighting, rather than deep retrofits that are necessary to decarbonize buildings. And without the right incentives in place, weird things happen.
California, for example, has aggressive building decarbonization goals, including the deployment of 6 million heat pumps by 2030. At the same time, California requires program portfolios to pass the TRC test, which means it’s exceedingly difficult for utilities and other energy efficiency program administrators to offer programs with deep retrofits because those high impact and high cost measures don’t pass the test.
Most of the building decarbonization rebate programs are therefore being funded through legislative action with programs like TECH Clean California Program and Equitable Building Decarbonization (EBD) Program that do not require passing cost-effectiveness testing. While these efforts are noble, legislative action is much less sustainable than ratepayer investments.
Regulators need to evolve their cost-effectiveness frameworks
The driver of the cost-effectiveness framework stems from an outdated view of the purpose of energy efficiency programs. Historically, energy efficiency programs were designed to hit worthy but ultimately arbitrary energy savings goals set by policymakers. It’s somewhat understandable, then, that regulators have focused on tests that take a broad view of all costs.
Energy efficiency, however, is quickly becoming a true energy resource on par with other clean (and dirty) energy resources like wind power and solar energy. In a nutshell, energy efficiency increasingly contributes to our energy and climate needs.
Again, look to California: While the state retains the TRC test, it also requires programs to pay out rebates based on measured energy reductions. The state is investing in many different Virtual Power Plant programs as well.
As regulators shift from a compliance to a resource paradigm, the need for traditional cost-effectiveness tests is going away, and new benefit and cost frameworks are emerging.
In New York the Value of Distributed Energy Resources (“VDER”) created a “value stack” for certain distributed energy resources. In California, the Total System Benefit framework similarly defines a value stack that values energy savings more at specific times and locations, and also incorporates the value of greenhouse gas reductions
Ultimately, now is the time for regulators to retire (or modify) the TRC and other cost-effectiveness tests that discourage building decarbonization. Climate change and clean energy are big enough challenges to confront without arbitrary, artificial regulatory constraints.
Utility regulators need to start viewing ratepayer energy efficiency investments as a true resource. Because if we are going to affordably decarbonize our buildings and support market transformation, we need more private capital investments, not less.