A growing number of states are committing to bolder clean electricity standards, driving increased adoption of cost-competitive renewables but also requiring additional system flexibility to support variable wind and solar generation while maintaining reliable service. Customer demand itself can be a zero-carbon source of grid flexibility – but it is still barely being tapped.

Demand flexibility can generate $15 billion per year in economic benefits and becomes an even larger opportunity to reduce emissions on today’s grid with increased electrification of transportation and buildings, which will grow historically flat electricity demand. So how can utilities take advantage of these cost-effective strategies and enable further emissions reductions?

Fortunately, many strategies can increase demand flexibility and reduce demand. However, while the technology exists get us there, implementation has been stifled because utilities are inherently not in favor of demand reduction due to their business model. Performance-based regulation can help overcome utility business model barriers.

New research from American Council for Energy-Efficient Economy (ACEEE) and Energy Innovation investigates novel state approaches to performance-based regulation that encourage utilities to deliver energy savings at specific times to optimize the power grid.

Strategic demand reduction lowers costs and emissions

Energy efficiency (using less energy for the same level of service) and demand response (reducing and/or shifting energy use to a less expensive time of use) are essential tools to affordably and rapidly drive down the cost and greenhouse gas (GHG) emissions of electricity systems. The U.S. power system is built around “peak demand”, or the anticipated maximum electricity use at a given time, but it’s very expensive to run our system at peak or even close to it.

Significant cost savings can be realized by reducing overall energy use, as well as shifting energy use so that demand throughout a given period of time is relatively flat. Energy efficiency and demand response can reduce demand at specific times to optimize the power grid, a function we term “strategic demand reduction” (SDR). SDR reduces the cost to serve electricity customers by displacing the need for services traditionally provided by supply options, including substations, wires, and power plants.

Many demand-side management services are available over a range of timeframes. ENERGY INNOVATION, ACEEE

SDR can deliver massive economic benefits by creating up to 200 GW in load flexibility. For reference, the power plant fleet today registers about 1,000 GW of capacity. Additionally, study after study has found clear economic benefits to utilities implementing energy efficiency programs.

Despite clear evidence of SDR’s value, utilities are just beginning to integrate SDR into their grid planning, investments, and operations, predominately due to conflicting business interest. One reason is that they depend on increasing capital investment to drive shareholder returns. Since SDR is often less expensive than traditional supply-side alternatives, it can limit investment in resources that shareholders depend on for continued growth. Another challenge is the reduced electricity sales that result from energy efficiency, one primary option for delivering SDR.

An Emerging Solution: Performance-Based Regulation

One emerging solution to these business model barriers is performance-based regulation (PBR), a regulatory approach promoting revenue models that reward utility performance in meeting policy priorities, such as cost containment and GHG reductions. PBR is on the rise, with policy efforts in more than 19 states and the District of Columbia, including recently launched efforts in Michigan and Colorado. PBR has several policy tools, including performance incentive mechanisms (PIMs) that reward utilities for energy efficiency investments that meet specific, measurable goals.

Energy Innovation has previously shown that PIMs can be an effective tool for motivating utilities to invest in energy efficiency. This new research takes a broader look at how these tools can drive SDR at critical times for the grid.

Strategic Demand Reduction PIMs on the Rise Across the Country

Our research found that 13 states (shown in map below) currently have SDR PIMs for electric utilities.

States with SDR PIMs for electric utilities. ENERGY INNOVATION, ACEEE

We profiled seven of these states and found diverse approaches to rewarding utilities for their SDR. Some states used traditional utility procurement approaches to peak demand reduction by acquiring demand response technology, such as in Hawaii and Texas; in contrast, Massachusetts and New York used newer methods of encouraging SDR by compensating the utility for a mix of actions and outcomes. In other words, not just purchasing the technology expected to deliver strategic demand reduction, but also providing proof of that SDR outcome, e.g. reduced summer peak demand, to achieve the incentive.

Long-term, iterative PIMs largely successful in driving SDR

We found that PIMs are an effective tool for unlocking SDR. Of the five cases we studied with available results, four program administrators — in Massachusetts, New York, Texas, and Vermont — met or exceeded their targets, while the last state, Hawaii, failed for structural reasons.

A common feature of successful PIMs was a process for iterative or repetitive updates. With the advantage of several program review cycles, utilities could count on the regulatory certainty and stability needed to develop sophisticated programs, while still enabling regulators to update incentives to protect ratepayer interests and motivate continuous improvement. Adaptive approaches to regulation work: policymakers hesitant to incorporate new approaches can build iteration and continuous improvement into the regulatory process.

The research also found states show increasing interest in moving demand from one time of day to another and grid-balancing measures targeting times when renewables create steep ramps in available supply (to deal with the time-limited but predictable availability of wind and solar). These approaches can better support distributed energy resources and renewables integration, and are well suited to integrate electric vehicles and electric water heaters to provide grid benefits.

PIMs are one policy tool among many needed to accelerate SDR

Though they are vital and promising policies, PIMs alone are not enough to deliver the strong and varied SDR needed to reduce costs, shrink emissions, and accelerate grid integration of renewables. We need strong state and regional policies, including clean energy targets such as Energy Efficiency Resource Standards (EERS), and business model reforms including decoupling and other forms of performance-based regulation. Prices and participation models in wholesale markets, rate design, and distribution and integrated resource planning will be crucial to properly valuing SDR.

Looking ahead to a new decade of renewable energy advances and state policy goals to address climate and economic issues, the importance of SDR will continue to grow. Building and transportation electrification will dramatically grow electricity demand in the U.S. Tying power sector decarbonization to other sectors in this way will help us meet climate goals, but electrification policies must be combined with SDR to keep costs contained and emissions minimal.

Utility regulators should include more SDR elements in their electricity policy portfolios to align electric utilities with broader climate and customer goals. This trend has already started. States across the country, from New Hampshire to Michigan , are assessing their PIMs for SDR, and other states like Minnesota and Hawaii may consider these metrics in PBR efforts. Recent legislation in Washington calls for demand response targets and establishes authority for PBR, opening the door for demand reduction PIMs.

SDR can help us continue to drive down emissions as the power sector decreases in carbon intensity, as well as keep costs contained as electricity demand grows in the coming decades. SDR PIMs unlock a win-win-win outcome for utilities, ratepayers, and regulators.