Research into the costs and benefits of energy efficiency (EE) technologies has shown that the expected value of long-run savings frequently exceeds the costs, and EE programs have the additional benefit of producing no harmful emissions. From 2007 to the present, several more states have adopted long-term goals for EE and have designated utilities, and in a few cases third party entities, as the program administrators. Despite the programs being beneficial and cost-effective to society and to utility systems, traditional regulation creates a substantial disincentive for utilities to pursue EE programs.

Traditional cost-of-service ratemaking collects a utility’s total costs, fixed and variable, largely through volumetric rates. A large portion of an electric, gas, or water utility’s costs is fixed in the short run and does not vary with the quantity of the service provided (kWh, Therms, or Cubic feet). A successful EE program will reduce the volume of sales, which will simultaneously reduce the recovery of fixed costs. If sales are lower than expected when rates are set, a utility will not fully recover its authorized fixed-cost revenue requirement; and if sales are higher than expected, a utility will over-collect its revenue requirement. As a result, utilities have what is often called a “throughput incentive” that conflicts with the objectives of EE programs.

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