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

widely accepted as representing low-risk investments, is straightforward, is transparent
and is readily available. It also means that different utilities in a single state will use the
same discount rates across the state, as it eliminates the need to develop utility-specific
risk-adjusted discount rates.
Discount Rate for the Participant Test
The Participant Test considers whether an energy efficiency investment is cost effective
from the program participant’s point of view. This test should be used principally to set
an incentive level that would be sufficient to make consumers implement efficiency
measures. A consumer’s discount rate should be used to discount the costs and benefits
in this test.
However, choosing a consumer’s discount rate is administratively and theoretically
complicated as different customers have different discount rates. There is considerable
uncertainty over what the reference point should be, as some consumers have home
equity credit available, but some only have access to credit card type debt with a much
higher cost.
For residential customers, energy efficiency programs are generally of lower risk than
almost any investment the household can make, but immediate needs tend to put
pressure on household capital, making borrowing rates also a factor. These points
suggest that home equity loan or home mortgage rates might be appropriate, especially
in new construction and remodeling programs, with higher credit card rates being more
applicable to participants in low income programs.
For commercial and industrial customers, a reasonable cost of borrowing proxy could be
local commercial lending rates or a prime rate plus an adder for non-prime businesses,
e.g., a prime rate plus three percent. For large entities with internal capital rationing, it
would be appropriate to use the firm’s internal rate of return hurdle rate or its internal
payback requirement.
Discount Rate for the RIM Test
Discounting is a side issue for the RIM test because the key goal of this test is to
indicate the effect of energy efficiency programs on retail rates. The utility WACC may
be appropriate for this purpose because this is the borrowing cost that ultimately
determines utility rates.
Illustrative Example
Figure 5.1 summarizes the impact on program cost-effectiveness when using different
discount rates. The blue bars present program cost-effectiveness using a nominal
discount rate of 3.2 percent, which is our example utility’s actual discount rate for energy
efficiency screening, based on 10-year US Treasury Bills. The red bars represent
program cost-effectiveness using a high discount rate of 8.5 percent, roughly equal to a
utility’s after-tax WACC.
This figure illustrates that a higher discount rate will reduce program cost-effectiveness,
especially for programs with longer measure lives. As discussed above, the new
construction programs typically have longer measure lives than other energy efficiency
programs, and so discounting the savings from such programs at a higher rate will have
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