Best Practices in Energy Efficiency Program Screening - Synapse ...

investing in society, and should be analyzed using a discount rate appropriate to society
as a whole.
The social discount rate should reflect the benefit to society as a whole, and should also
take into account both the reduced risk of energy efficiency investments, as well as
society’s reduced time preference for a societal payback. This social discount rate is
typically the lowest discount rate that reflects increased value in future savings. The
Societal Cost test also includes environmental externality costs, which should arguably
be discounted at a very low discount rate, if at all.
Discount Rate for the PAC and TRC Tests
The purpose of the TRC and PAC tests is to compare energy efficiency investments with
the decision-maker’s other investment options. Historically, the discounting challenge
was relatively straightforward for these tests: the primary decision maker was the utility,
and its WACC was used. (See, for example, NAPEE 2008, p.4-8.) This was seen as
treating energy efficiency investments comparable to investments in supply-side
resources, assuming that consumers would be paying the same cost of capital on any
utility investment.
More recently, it has become clear that there are significant differences in the financial
risks associated with supply- and demand-side resource investments. Energy efficiency
investments are typically funded by a system benefit charge or a balancing account in
utility rates. In either case, there is little risk to the utility associated with these
investments because they are passed directly on to customers independent of utility
operations, utility performance or other risk factors. Consequently, an energy efficiency
investment is less risky than a supply-side investment on a purely financial basis, in
addition to being less risky with regard to planning, construction and operation.
Therefore, a lower discount rate than the WACC (i.e., a risk-adjusted discount rate)
should be used in applying the PAC test or the TRC test.
This lower risk also exists in those instances where a third party administers the energy
efficiency programs (e.g., Delaware, Hawaii, Maine, New York, Oregon, Vermont). In
these cases, the utility WACC would clearly not be an appropriate discount rate,
because that rate does not represent the time value of money to the third-party
administrator. The discount rate for third-party administrator programs should be low for
the same reason that discount rates for utility-administered programs funded by system
benefits charges should be low: there is very little financial risk associated with the
funding source, since there is no long-term financing involved.
One option for developing a lower, risk-adjusted discount rate is to remove some, or all,
of the risk premium and time preference embedded in the utility’s WACC. This could be
achieved by comparing the utility’s financial risk profile to that of other companies with
lower risks or with other market indicators of low-risk investment rates.
Another option is to use a more generic, market indicator of a low-risk investment. For
example the interest rates on US Treasury Bills are widely regarded as a good indication
of low-risk investments. We are aware of at least three states that use the interest rates
on US Treasury bills as a low-risk discount rate for assessing the cost-effectiveness of
energy efficiency programs (ODC 2012; MADPU 2010; Efficiency ME 2009).
We recommend that states use the interest rates on long-term (e.g., 10-year) US
Treasury Bills as the discount rate for the PAC and the TRC tests. This indicator is
| 52 Best Practices in Energy Efficiency Program Screening | www.nhpci.org