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4 Ways Residential Pay-For-Performance Will Change The Market

Posted by Charley Cormany, EFCA Executive Director

PG&E has sent out a request for proposals (RFP) to create a residential pay-for-performance (P4P) pilot incentive program for energy efficiency. Given the frequent changes and updates in efficiency rebate programs over the years, it could be tempting to easily dismiss this as just more of the same. In reality though, this new pilot is much more significant than you might realize. If you’re a contractor you need to pay attention–because this pilot could mark a real turning point for the industry.

First off we should congratulate the folks at PG&E and at the CPUC. After many years of doing the same thing and expecting a different result, a group of dedicated individuals have worked together to provide a new approach to rewarding homeowners for investing in energy efficiency upgrades. This was by no means an easy feat and has required dedication and perseverance to see it come to fruition.

While pay-for-performance models have been used in other parts of the building efficiency market, (including the commercial sector), this is the first residential pay-for-performance incentive program in the nation. Recently Leif Magnusson, a senior program manager for PG&E, shared a PowerPoint presentation that outlines some of the specifics of the pilot. I suggest you review his presentation, PG&E Res P4P Summary.

So what’s changing? There are several things that make this pilot unique.

Incentives Based on Measured Savings

First, the use of measured data is a big change. For years we’ve been searching for ways to measure the effectiveness of residential energy retrofits. But until recently it’s been difficult to quantify the actual savings from whole house energy upgrades. This problem has been compounded by the challenge of obtaining energy use data from the utilities, mostly due to privacy concerns. Today we can validate the effectiveness of energy upgrades by using AMI (Smart Meter) data to measure energy use before and after retrofits, without compromising the customer’s privacy. The combination of utility bill data and real time feedback is setting the stage for radical changes in rebate program design.

Lower Program Costs

Second, the Evaluation, Measurement, and Verification (EM&V) costs will be much less. Utilities typically offer a variety of incentive programs, some are easy to produce and some are more complex, naturally this means some programs cost more than others. The cost of a complicated incentive program, such as the Energy Upgrade California Home Upgrade program, is much more than a lighting rebate or similar program. While the whole house approach to savings can be very effective, these programs are incredibly expensive to produce. When an incentive program requires more than one dollar in administrative costs for every dollar spent on incentives, that program is no longer a cost-effective, long-term solution. To compound the problem, these programs are funded with ratepayer funds, which brings regulation and oversight. Much of this administrative burden is due to the need to physically verify a certain amount of jobs to ensure the savings are being realized.

With a pay-for-performance program, the system checks itself, as a result EM&V costs are dramatically reduced. To put it simply, if there are no savings there is no incentive. This simplifies the administrative burden, and all but eliminates the measurement and verification portion of EM&V. Overall it has the potential to be much simpler, and therefore a much more cost-effective solution.

New Incentive Ideas

Thirdly, the new program rewards innovation. In a P4P program, getting actual energy savings is the only thing that matters. This creates an environment that rewards innovative approaches that produce real savings. For example, occupant behavior has been excluded from current program designs, as humans are unpredictable. Instead, current programs rely on asset ratings–essentially how a building performs regardless of the humans inside. But with P4P approach that rewards savings no matter how it is achieved, you could design an entire incentive program around changing behavior, as long as it saved energy over a period of time. This doesn’t mean there will be no oversight of pay-for-performance programs as they are developed–this isn’t the Wild West. The use of ratepayer funding means the CPUC will be responsible for consumer protections on this program, just as it does with the other programs currently in place.

Influx of Private Capital

Fourth, the program will potentially bring in huge amounts of private capital. This part is where things get interesting. Private capital has been waiting on the sidelines for an opportunity to make a profit in the energy efficiency sector. When financial offers or incentive programs are run by business people who need to make a profit to survive, the results are often much different than municipal or state run efforts. The recent surge in PACE financing can be directly linked to private capital entering the marketplace.

What role does private capital play in the residential P4P program? Part of the beauty of this pilot is that it allows private capital to design and run their own incentive programs. When the goal is measured savings, the way you achieve those savings can be vastly different from what we see today. You can focus your efforts on whole house retrofits, concentrate on operational designs that include things like smart thermostats and smart appliances, or focus on behavior with things like demand response. As long as the net result is energy savings, the way you get there is much less restrictive than we see today.

In the PG&E Pilot, the private capital comes in the form of an aggregator. Here’s how it works in a nutshell. The aggregator agrees to pay out incentives based on the results of their program effort, whatever approach they choose to pursue. The aggregator will need to measure results over a period of time to determine if their program saves the energy they projected. For this pilot, that period of time is two years. PG&E, in turn, pays out funds for measured energy savings to the aggregator. Does this mean the contractor and consumer will have to wait two years to get paid? Probably not. Because the aggregator can pay out incentives as it sees fit, in most cases we expect the contractor and the homeowner to get paid upfront by the aggregator, who then will be compensated by PG&E over time. In reality is some jobs will save more energy than others but when you combine or “aggregate” the savings the average is pretty consistent. This means the aggregators will win on some and loose on a few but overall they will come out ahead and make a profit.

So why would someone choose to be an aggregator? The real answer is the secondary market of procurement. Procurement is really a fancy way of saying buying. Utilities procure energy from a variety of sources. This can be from traditional sources like gas fired power plants, hydro-electric, or other typical energy sources. In most cases, they are required to procure a certain percentage of “clean energy” as part of this mix. Typically we think of solar or wind or perhaps geothermal as clean energy sources. In reality the cleanest energy you can get is the energy you never use. With measured savings energy efficiency can now be used by utilities as a means to meet their clean energy requirements. This means the aggregators can bundle the savings from EE projects and sell them on the procurement market.

A Brand New Approach

The bottom line: this is a new approach. It has the potential to provide incentives and consumer protection at a much lower cost than our current model. It allows for a variety of business models including those based on behavior. It will allow private capital to enter the marketplace and create new and innovative solutions that support contractors. Incentive programs will no longer dictate business models by their restrictive design. With the pay-for-performance model, aggregators make more money as contractors do more jobs. For the first time, the program implementers have a vested interest in partnering with and developing successful contractors.

Is this a sure thing? Only time will tell. Can it bring scale to the marketplace? It certainly can reduce program administration costs, and this is a major barrier to achieving scale with our current programs.

What are the roadblocks? Obviously there are many details to be worked out, that’s why this PG&E is starting with a pilot program. Without a doubt there will be mistakes made and bumps along the road that is to be expected in any new endeavor. But overall, having the program administration (aggregators) motivated by profit will go a long way to reducing costs and streamlining efforts.

Pay-for-performance has the ability to reduce costs and greatly simplify the process of saving energy. I encourage you to learn more about the process, ask difficult questions, and participate. The real question is what happens if we don’t try new methods and approaches?

Charles Cormany
Executive Director
Efficiency First California

Image from iStock.