Avoided cost analysis is a widely accepted method for estimating the economic benefits associated with renewable energy, energy efficiency, or conservation programs. Naturally, the term “avoided cost” refers to the cost no longer incurred as the result of a project or action. For a program to be considered economic, the avoided cost must outweigh the program’s expense.
Regulatory commissions often use avoided cost analyses to judge the cost-effectiveness of programs developed at the utility level. Typically, a commission will work with utilities to establish a metric for evaluating and approving investments in demand-side management or renewable energy procurement programs. For example, in March 2014, Minnesota became the first state to adopt a “value of solar” policy, which assesses avoided costs to determine how much utilities should pay for solar power. Likewise, Maryland will rely, in part, on an avoided cost assessment developed by Exeter (with the benefit of input from a collaborative process) to select among possible energy efficiency initiatives.
The graphs below are samples from a preliminary version of Maryland’s EmPOWER
2015-2017 Cost Effectiveness Framework. They show how measures installed by Baltimore Gas and Electric Company (BGE) in 2015 would avoid both energy and capacity costs. (T&D stands for Transmission and Distribution. DRIPE stands for Demand Reduction Induced Price Effects.)
Large end-use customers, such as military bases, schools, and hospitals, can use an avoided cost approach to evaluate on-site generation projects. Such assessments compare the added costs of a project (capital costs, fixed and variable O&M, and added utility charges that may be incurred, such as standby charges) to the costs that the project would reduce or eliminate (energy and capacity costs, transmission and distribution charges, renewable portfolio standard charges, franchise fees, universal service charges, and other charges based on through-the-meter energy consumption or peak demand). Avoided cost analyses cannot be “generically” employed since local conditions regarding energy and capacity prices, as well as specific tariff elements, can vary significantly. For example, California utilities can assess “departing load charges” on customers who install renewable energy generation above a certain size. These charges effectively negate the benefit that would otherwise be associated with avoided distribution charges, among others.
The assessment of avoided costs depends not only on the project or action under consideration but also on the perspective of the party conducting the analysis. For example, a state agency evaluating an energy conservation initiative might include the reductions in adverse health effects associated with air emissions. An energy customer contemplating the same type of initiative would likely omit health effects on third parties, to the extent that they exist, and focus instead on power supply costs.
Avoided cost analyses are, by nature, forward looking, and uncertainty is inherent in many long-term projections. Areas of uncertainty include: fuel and purchased power costs, environmental regulation and associated compliance costs, load growth, and generation efficiency and construction costs. If the uncertainly is substantial enough, an analyst may opt to develop multiple scenarios for evaluation, such as alternative scenarios based on high (or low) natural gas prices or more (or less) stringent environmental regulations. It is relatively easy to run multiple scenarios; however, judging the relative importance of alternative scenarios can be challenging.