Fascinating and enlightening article. It may also be useful to compare your analysis results with what has been happening here in Ontario Canada.

Ontario's local utility companies are all distribution-only companies, with generators set up as separate entities. The energy costs paid to generator companies are simply a pass-through to consumers on their utility bills shown separately from "delivery" charges the local utility company uses to pay for their fixed costs. Local utility companies are then given the responsibility of implementing DSM programs because they are the interface from the grid to all customers.

An example of a DSM program in Ontario has been the residential communicating thermostats for reducing peak demand, particularly by cycling one's air conditioning in summer months. They are offered free including free installation to any residential customer interested in having one, promoted to the public by advertising them as an automatic way to marginally lower your energy bills in the summer months. They are controlled by the utility companies using specific systems set up in their offices, and typically communicate with the thermostats over the pager radio system.

The interesting difference here is that Ontario's distribution-only utility companies would normally refuse to fund this program themselves, because to do so they would have to apply to Ontario regulators for substantial unpalatable rate increases in their delivery charges to pay for it. So instead Ontario's government has doled out substantial grants to our utility companies to implement them. The grants pay for all the technology, customer site installation costs, setting up the office systems, and hiring any additional utility staff to run the systems.

It is clear that utility companies MUST be allowed to make additional money from investing in DSM or EE programs through fundamental regulatory reforms, otherwise the investments are not going to happen.

The manufacturing sector of the economy as well as the commercial sector are both major consumers of electric power and both sectors have shrunk. Earlier projects and forecast in regard to future demand for electric power in regions like Ontario became grossly inaccurate. The down turn in the economy had reduced corporate tax revenues in a jurisdiction like Ontario by 48%. Ontario is a distorted power market due to excess government regulation.

Both SSM and DSM have their drawbacks and those drawbacks will become very obvious as the economy contracts even further and governments like Ontario become restrained in their ability to subsidize certain segments of the power generation sector.

Ontario's budget deficit when including lost personal taxes and lost sales taxes is now well over 20% of Ontario's total spending, and climbing. Ontario however is not alone, most other Canadian provincial governments and Canada's federal government are facing similar size deficits as a percentage of their total budgets. I'm sure there are similar disasters in the making among many US state governments and the US feds too.

Nevertheless, DSM is being encouraged on wide scale in both the US and Canada particularly with the adoption of smart grid, and that includes applying it to small residential customers. With increasingly larger numbers of small power producers appearing like renewable energy generation sources, their intermittent nature makes DSM viewed as much more necessary to deal with them.

This article focuses on the economics of utility companies or customers paying for widespread DSM investments, but my point is this will never happen on a wide scale under the current regulatory regimes our utility companies are forced to operate under. When the government subsidies eventually stop in Ontario, or the handouts stop someday from Washington, look for DSM investments to evaporate until utility company regulation changes.

In any other industry we would not ask a supplier to compete with themselves. Reducing peak cost exposure would be offered by companies essentially competing with power generators and distributors. It does not work here due to average cost pricing imposed by regulation. If retail prices reflected the true cost of meeting the peak, with a liquid market for power, then markets would function. Given a chance to see prices that did not lie about costs utility customers would spend their own money, not other cutomers' money, to avoid high peak prices. So.... lets get the label right. This is not a market failure. It is a regulatory failure to allow a functioning market.

If demand response and energy efficiency are worthwhile objectives, we need to start by making sure consumers pay sensible (in the economic sense) prices for electricity that are based on current costs, since all of the alternatives they have to evaluate are also based on current costs. Next, we need to provide customers with competitive alternatives that are NOT under the control of their local utility for products and services that can help them reduce their consumption.

It's pure fantasy to think the same firm that sells electricity is going to be as aggressive about promoting DR and EE as a firm that competes with that seller. I say this not because I think utility employees are heartless ogres, but because they have the same difficulty resolving conflicts of interest as the rest of us do. Asking a utility to sell a product on the one hand and promote lower usage of that same product is a clear conflict of interest.

It's silly the way we throw out the classical economics playbook when talking about electricity. Access to cheap electricity is clearly viewed by policymakers and consumers as an entitlement, yet policymakers insist, through their emphasis on DR and EE, that electricity is a scarce resource. There's a basic disconnect here. If we want conservation, then the price has to be high or most folks will carry on as usual. If we want the commodity to be cheap, then let's stop wasting money on schemes to help consumers use less, because they are largely going to be a waste of time and money.

I have a little different view about mandates like appliance efficiency standards, insulation standards, and the possibility of requiring appliance makers to build smart appliances that can respond to price and other signals at the the option of the device owner.

First, the costs of utility implemented EE programs only consider the costs that are incurred by the utility. This leads to unduly large differences in the cost of EE vs the cost of generation. We need to carefully consider the costs that consumers and businesses bear (investment and sometimes O&M)when a utility program covers only a percentage of the full investment. There is often a tendency because of this to understate utility EE program costs.

Second, the real competitor for utility based EE isn't generation but the cost of implementing much stricter energy codes and standards. Usually these are much less costly than utility programs.

Third, the argument that utilties have an inherent discincentive when faced with selling more electricity or implementing EE programs applies to other industries as well. In particular, it applies to health care, so should we split in the medical profession between those who perform preventative health care from those who have the incentive to do procedures...?

You raise a good analogy if we apply it properly. The primary care doctor is like your independent energy services company that works to get your business by working with you to find the right mix of preventative care (energy efficiency) and procedures (power purchases). Oops, we don't have an independent energy services company in our electric industry structure. Lets take your thought to its logical conclusion and restructure the electric industry to be more like health care.

Note: This is not an endorsement of the health care industry. But it is an indictment of the electric industry.

This is the underlying reason why I believe Len Gould's proposals for an Independent Market for Every Utility Customer (IMEUC) detailed on this website is worth considering as a way out of this problem. It would at the very least expose everyone to real-time prices, and more importantly equip consumers with the proper high-tech tools to properly deal with real-time prices.

Without something similar to or the same as Len's IMEUC, the only other way around the problem in my humble opinion is to change regulation to open the door for utility companies to make money from commercializing conservation technologies, efficiency upgrades, and DR programs. Otherwise not very much is going to change other than the slow rollout of Time-Of-Use billing being enabled by smart meters rolling out.

Governments are slowly recognizing that preventative health care costs can be far less than the costs to dealing health problem costs later. Here in Canada where we have publicly funded health care, this distinction is highly visible. In Ontario for example the province's health care budget is nearly 50% of their entire budget as the single largest expenditure. In times like this with massive budget deficits brought on by the recession, the need to reduce health care costs overall is heightened to unprecedented urgency. And Ontario is waking up, spending much more now on preventative health care measures than ever before.

While I don't like focusing on health care in a website discussion article on the electricity markets, in Ontario there is in fact a direct impact on our energy generation industries by the health care costs. Ontario has taken the unprecedented measure of legislating the complete shutdown of coal fired generation within the next 5 or 6 years for the sole purposes of preventative health care and environmental damage, citing its pollution as a significant root cause of health problems and a big source of carbon emissions. This is all in light of, or should I say in spite of coal being a relatively very low cost source of energy.

It will be even more interesting to see how current electricity regulation practice and markets stand up against the rollout of larger numbers of widespread renewable generation sources like wind, solar PV, and geothermal.

There are no competitive alternatives for customers of utilities that have a monopoly franchise and operate under cost-of-service regulation. In these cases, it is absurd to expect a utility to act in the best interests of its customers with respect to EE and DR.

Along these same lines, and also somewhat related to the whole carbon question, the California PUC has commissioned research that shows energy efficiency to be the most cost-effective means of reducing carbon emissions in the electricity sector. I can assure you the IOUs are not jumping all over this instead of planning for new transmission lines and power plants.

Is it any surprise (to you) that utility companies are not jumping all over EE instead of planning for new transmission and power plants? To repeat what I've been preaching on this website, utility companies will only take interest in EE if they can make money from participating in selling it to customers and making additional money from it over and above their rate base income. Their current regulatory regimes typically do not allow that to happen.

Perhaps I may very well understate the incentive problem. Aside from presenting much more incentives to utility companies, I am also suggesting presenting utility companies true competition for income from getting involved much more in (selling) mainstream DR and EE. They would get paid for DR and EE by customers, not by government handouts.

For example a utility company might want to get into the business of selling consulting advice to customers doing building energy audits, or even possibly selling industrial / commercial DR technologies, and possibly in-home consumer devices for HANs. The latter is analogous to our CATV and telephone companies who provide consumer boxes to enable optional services that some but not all customers pay extra for. It might even include selling smart consumer appliances some day that have built-in DR communications with the grid.

In selling smart consumer appliances utilities would automatically be competing with the likes of Home Depot and other private sector businesses. But if you think about it, utility companies are in a great position to compete very fiercely. Firstly they have a direct marketing pipeline with literally everyone on the grid having already established a billing account typically with a mailer program or web account with them. Secondly, they would be in a position to gather detailed energy audits for any customer from collecting smart meter interval data, and in theory be able to show customers the savings they have realized after adopting DR and EE upgrades sold to them.

I suppose maybe I am dreaming here, since most utilities are probably very comfortable with continuing to just provide energy and nothing else to customers, and probably enjoy the lack of true competition. The last thing they likely want to do is transform their businesses into the Home Depot or Best Buy type of retailers of new technology and services to residential customers.

BTW Len Gould’s IMEUC proposal is quite radical, but if I understand it correctly, it includes fostering much more competition amongst generators and transmission and distribution.

I'm not at all surprised that utilities are paying lip service to DR and EE. I agree that the incentives available to utilities for EE and DR are far less attractive than the long-lived earnings stream from generation and T&D assets. However I am also largely convinced at this point that most utilities are incapable of transforming themselves into energy service companies of the kind that could provide EE and DR products and services.

There's no reason utilities should not be allowed to compete in this space, but only after new entrants had an opportunity to become firmly established. More importantly, regulators would have to change the way electricity is priced so that it more closely reflects the marginal (variable and fixed) costs of production. Otherwise, capital investments on the customer side of the meter will never be competitive with gen, T&D assets that are valued for the purpose of setting retail prices at a combination of historical capital and current variable costs. Finally, in market areas with independent grid operators (IMO, PJM, CAISO, MISO, ERCOT, ISO NewEngland), locational marginal prices energy prices to reflect all wholesale costs. There would be no capacity markets and no reservation payments to provide contingency reserves. Energy prices would be higher and more volatile, but consumers with the sophistication, means and inclination would be able to fully avoid those costs to the extent they reduce energy consumption at critical times.

I agree "regulators would have to change the way electricity is priced" to allow utilities to compete effectively in the EE and DR commercialization space. In fact, regulation of utilities would have to change completely to allow them to raise money from anything over and above rate base income, which is one of the messages I have been repeatedly saying on this website.

Shielding consumers from "higher and more volatile energy prices" that would result are precisely one of the common purposes behind electricity price regulation, so I don't see it happening without large political shifts in the direction of regulators. I guess it would have to start with swaying our politicians in governments, so it's not likely to happen anytime soon. It's unfortunate because adopting Len Gould's IMEUC proposals, or something similar, could have provided the necessary hi-tech tools to consumers to deal with higher and more volatile prices.

Whatever happens in the coming years for EE and DR, I expect our utility companies’ involvement in them will be a slow evolution and not a revolution, driven mostly by either government handouts or alternatively painful rate increases sanctioned by governments.

Of course, merely submitting such an article for publication runs the risk of a good old fashion lynching (death at the hands of a mob), but then again where's the fun in life if once can't live dangerously every now and then.

Len's IMUEC idea or something like it (Ed Cazalet and I were suggesting a similar concept back in the late 1990s) is the only way ideas like demand response and PHEVs have any chance of working.

a) price-regulated monopoly electric utilities are bad for society because their incentives are pointed in the wrong direction (i. the higher they can get their costs, the more profit the shareholders make ii. the more electricity their customers use, the more profit. iii. the greater proportion of electricity is used on-peak hours the more profit.) It's so wrong it's hardly even close and would be laughed out of the market design conference if it wasn't already in place and 100 years old.

b) any system which is planned to replace full price-regulated monopoly should satisfy the following requirements, in order of importance: 1) must provide for new/replacement generation builds to be done in large increments in advance of any of the new capacity being required. 2) must make provision for supplier entities of all sizes to compete on an even footing, from large nuclear to microCHP to solar PV rooftops. 3) Must provide to integrate large amounts of PHEV battery charging and perhaps return in emergencies, at random locations, with billing going to the auto owner and not the receptacle or meter owner. 4) Must provide sufficient forward planning time so that ISO's can prepare dispatch orders far enough in advance so that generation can properly plan. 5) Should provide price penalties (adders) when demand curve is sloping upward, equivalent price subsidies when demand curve is sloping downward, revenue neutral overall.

If that can be done properly (fairly for all customers and at minimum overhead cost) with something less than IMEUC then perhaps IMEUC may not be required, but I've yet to see any workable suggestion.