Expanding the Toolbox: How to Use Demand Response to Increase Grid Reliability

By Doug Lewin

The utility grid has been shaped by a century of regulatory action that provided the infrastructure and framework that allowed it to grow to the safe, reliable grid we know today.

But the energy landscape is rapidly transforming as new technologies emerge and customer preferences change. Utilities and engineers have more tools and opportunities available to them now than ever before. Adding to this, utilities are in an environment with an expanded set of policy goals and customers have an increasing number of alternatives to traditional supply. Combined, these options mean that innovation is more accessible – and potentially more confusing – than ever.

While utilities across the country are adapting to manage and navigate a new energy environment, it can be helpful to look at four states who have implemented innovative regulatory mechanisms to incentivize utilities to help customers better manage their energy.

Energy efficiency programs, in the right regulatory structure, increase system efficiency, empower customers and enhance utility shareholder value.

Illinois Introduces Regulation to Incentivize Energy Efficiency

After Illinois established energy efficiency programs in 2007, they found themselves facing a common challenge. Infrastructure spending came with a return on equity while energy efficiency was treated as an operating expense, meaning shareholders naturally leaned towards infrastructure spending over energy efficiency programs. To fix this (and address myriad other problems), Illinois passed the Future Energy Jobs Act in late 2016 that allowed the state’s electric utilities to earn a return on equity for energy efficiency spending. This model addresses the problem of misaligned incentives without removing the old cost-of-service model, essentially marrying the old with the new: cost of service regulation with incentives for customer empowerment and smart energy management.

Under the Future Energy Jobs Act, the return on equity for utilities equals capital spend if they reach 100 percent of their energy efficiency goal.

For every one percent above its goal, a utility can earn eight additional basis points. If they maximize the benefit, a utility that achieves 125 percent of its goal would be entitled to a return on equity 200 basis points (two percent) higher than its normal return.

This model effectively makes substituting cost-effective energy efficiency for infrastructure more desirable for both shareholders and customers.

Michigan Optimizes for Customer Empowerment

Following regulation put in place in 2008, Michigan recognized the powerful customer savings achieved by energy waste reduction and in 2016, sent a strong signal that consumer empowerment is important to the state by allowing utilities the opportunity to increase their incentives.

While the state removed previous mandates for efficiency after 2021, it allowed the utilities to retain the ability to earn their current incentive levels as long as they maintain a one percent reduction in retail sales each year. And if utilities are able to exceed that goal by 25 percent, they could then earn the lesser of either 17.5 percent of energy efficiency expenditures or 27.5 percent of net benefits. If they were to exceed their goals by 50 percent, they could then earn the lesser of either 20 percent of energy efficiency spend or 30 percent of net benefits.

Using performance incentive calculations from recent years, if utilities meet these aggressive goals, additional incentives could equal $3 million – $6 million for utilities, while their customers would save approximately an additional $30 million per year-a great example of customer and investor benefits.

This new law gives flexibility to the Michigan Public Service Commission to develop an alternative methodology for decoupling and/or other incentives should the commission determine that current methods are insufficient to ensure energy efficiency and demand response are not “disfavored compared to utility supply-side investments.”

Maryland Combines Efficiency, DR and Advanced Metering to Generate ROI

After restructuring in 1999, Maryland utilities discontinued their demand-side management energy efficiency programs. Around 2005, when it was apparent that the competitive retail market was not delivering energy efficiency programs and customer satisfaction was low, stakeholders reconsidered these programs and proposed a combination of energy efficiency, demand response and advanced metering infrastructure to the Public Service Commission.

Maryland created one of the most successful cost-recovery mechanisms for energy efficiency in the country. Operating expenses for energy efficiency and demand response were converted into capital expenditures that were able to earn a full authorized return on investment amortized over five years. In practice, investing roughly $125 million per year into energy efficiency creates a five-year, $500 million regulatory asset-earning ROI.

Additionally, the utilities benefit from full decoupling, removing the disincentive related to energy consumption levels. This, combined with the ability to rate base energy efficiency, has worked extremely well to align utility incentives with decreasing costs for customers.

This arrangement in Maryland has not only created significant return on investment for utilities, but it has boosted customer satisfaction scores. As recently as 2008, its JD Power scores were near the bottom, but have since reached the top quartile.

Utah Replaces Aging Power Plants with Energy Efficiency

In March 2016, the Utah Legislature passed Senate Bill 115, also known as the Sustainable Transportation and Energy Plan Act, allowing Rocky Mountain Power to “capitalize the annual costs incurred for demand-side management” and to “amortize the annual cost for demand side management over a period of 10 years.”

In addition to allowing a return on investment in energy efficiency programs, SB 115 also addresses two other major problems:

Many states are struggling to deal with older power plants – usually fossil fuel or nuclear – that are no longer economically viable due to low natural gas prices, higher adoption of energy efficiency, lower cost of renewables and more stringent environmental regulations.

Energy efficiency is usually paid for upfront and must be cost effective in the first year.

However, many energy efficiency installation measures like HVAC systems, insulation and LED lights are designed to save energy for at least 10 years.

As a result, some energy efficiency programs do not appear to be as cost effective as power plants. If power plants, transmission lines and substations were given the same financial treatment and paid for by ratepayers in the first year, very little infrastructure would ever be built.

SB 115 solves both these problems by making energy efficiency programs a 10-year regulatory asset, which greatly improves their cost effectiveness relative to other energy resources. And because Rocky Mountain Power only needs a portion of the funds from the energy efficiency regulatory asset each year, it can use the remaining funds as accelerated depreciation for an older, economically inefficient plant. This way, Rocky Mountain Power can recover the cost of an aging power plant and retire it early, replacing it with an energy efficiency asset, making for cleaner air and lower costs for consumers, all while increasing energy efficiency.

Meeting the Evolving Regulatory Model

While the four states mentioned previously have made significant progress and implemented innovative programs, much more work needs to be done to ensure that utilities are continuing to provide safe, reliable and affordable energy while meeting the changing needs of today’s customer. And to do this, the engineers within the utility will play a vital role.

The pairing of regulatory environments such as the ones seen in Maryland, Utah, Illinois and Michigan, along with the expectation of today’s consumer to be more involved and informed, indicates a shift to a distributed network model rather than a central power plant model. This will ensure a more reliable, safer and efficient grid and create additional opportunities for engineers to expand their skills and lead the way through this change.

For example, engineers can assess load pockets to identify congested areas and use demand response techniques to increase capacity factors, reduce peak demand and increase usage off-peak, decreasing the need for additional infrastructure. Another scenario could be identifying neighborhoods or commercial building areas where capacity factors are lower and potentially install a solution like thermal storage to manage peak capacity.

The skills traditionally required of utility engineers remain critically important, but as with every profession and skill, they are changing as technology advances and consumer expectations evolve. Therefore, having a strong line of sight into the regulatory changes and how to use demand side resources to increase the optimization of the system is something every engineer should understand.

Doug Lewin is Vice President of Policy for CLEAResult