Understanding Cost-Effectiveness 

of Energy Effi ciency Programs: 

Best Practices, Technical Methods, and Emerging 

Issues for Policy-Makers 

A RESOURCE OF THE NATIONAL ACTION PLAN 

FOR ENERGY EFFICIENCY 

NOVEMBER 2008 
About This Document 

This paper, Understanding Cost-Effectiveness of Energy Effi ciency Programs, is provided to assist utility regulators, gas and electric utilities, 

and others in meeting the 10 implementation goals of the National 

Action Plan for Energy Effi ciency’s Vision to achieve all cost-effective 

energy effi ciency by 2025. 

This paper reviews the issues and approaches involved in considering 

and adopting cost-effectiveness tests for energy effi ciency, including 

discussing each perspective represented by the fi ve standard costeffectiveness tests and clarifying key terms. 

The intended audience for the paper is any stakeholder interested in 

learning more about how to evaluate energy effi ciency through the use 

of cost-effectiveness tests. All stakeholders, including public utility commissions, city councils, and utilities, can use this paper to understand 

the key issues and terminology, as well as the various perspectives each 

cost-effectiveness test provides, and how the cost-effectiveness tests 

can be implemented to capture additional energy effi ciency. 
Understanding Cost-Effectiveness 

of Energy Efficiency Programs: 

Best Practices, Technical Methods, and 

Emerging Issues for Policy-Makers 

A RESOURCE OF THE NATIONAL ACTION PLAN FOR 

ENERGY EFFICIENCY 

NOVEMBER 2008 
The Leadership Group of the National Action Plan for Energy Efficiency is committed to taking 

action to increase investment in cost-effective energy efficiency. Understanding CostEffectiveness of Energy Efficiency Programs: Best Practices, Technical Methods, and Emerging 

Issues for Policy-Makers was developed under the guidance of and with input from the 

Leadership Group. The document does not necessarily represent a consensus view and does 

not represent an endorsement by the organizations of Leadership Group members. 

Understanding Cost-Effectiveness of Energy Efficiency Programs: Best Practices, Technical 

Methods, and Emerging Issues for Policy-Makers is a product of the National Action Plan for 

Energy Efficiency and does not reflect the views, policies, or otherwise of the federal 

government. The role of the U.S. Department of Energy and U.S. Environmental Protection 

Agency is limited to facilitation of the Action Plan. 

If this document is referenced, it should be cited as: 

National Action Plan for Energy Efficiency (2008). Understanding Cost-Effectiveness of Energy 

Efficiency Programs: Best Practices, Technical Methods, and Emerging Issues for PolicyMakers. Energy and Environmental Economics, Inc. and Regulatory Assistance Project. 

<www.epa.gov/eeactionplan> 

For More Information 

Regarding Understanding Cost-Effectiveness of Energy Efficiency Programs: Best Practices, Technical Methods, and 

Emerging Issues for Policy-Makers, please contact: 

Katrina Pielli 

U.S. Environmental Protection Agency 

Office of Air and Radiation 

Climate Protection Partnerships Division 

Tel: (202) 343-9610 

E-mail: pielli.katrina@epa.gov

Regarding the National Action Plan for Energy Efficiency, please contact: 

Stacy Angel Larry Mansueti 

U.S. Environmental Protection Agency U.S. Department of Energy 

Office of Air and Radiation Office of Electricity Delivery and Energy Reliability 

Climate Protection Partnerships Division Tel: (202) 586-2588 

Tel: (202) 343-9606 E-mail: lawrence.mansueti@hq.doe.gov 

E-mail: angel.stacy@epa.gov

or visit www.epa.gov/eeactionplan
Table of Contents 

List of Figures ...............................................................................................................................iii 

List of Tables.................................................................................................................................iii 

List of Abbreviations and Acronyms.............................................................................................. v 

Acknowledgements...................................................................................................................... vi 

Executive Summary ................................................................................................ ES-1 

1: Introduction ........................................................................................................ 1-1

1.1 Background on Cost-effectiveness Tests....................................................................1-1

1.2 About the Paper ..........................................................................................................1-2

1.3 Structure of the Paper.................................................................................................1-3

1.4 Development of the Paper...........................................................................................1-4

1.5 Notes...........................................................................................................................1-4

2: Getting Started: Overview of the Cost-Effectiveness Tests ........................... 2-1

2.1 Structure of the Cost-Effectiveness Tests...................................................................2-1

2.2 The Five Cost-Effectiveness Tests and Their Origins .................................................2-2

2.3 Cost-Effectiveness Test Results in Best Practice Programs.......................................2-2

2.4 Notes...........................................................................................................................2-3

3: Cost-Effectiveness Test Review—Interpreting the Results............................ 3-1

3.1 Example: Southern California Edison Residential Energy Efficiency Program ...........3-1

3.2 Considerations When Using Cost-Effectiveness Tests ...............................................3-9

3.3 Notes.........................................................................................................................3-12

4: Key Drivers in the Cost-Effectiveness Calculation ......................................... 4-1

4.1 Framework for Cost-Effectiveness Evaluation ............................................................4-1

4.2 Choosing Which Benefits to Include............................................................................4-2

4.3 Level of Complexity When Forecasting Avoided Costs...............................................4-3

4.4 Forecasts of Avoided Costs ........................................................................................4-3

4.5 Area- and Time-Specific Marginal Costs.....................................................................4-6

4.6 Net Present Value and Discount Rates.......................................................................4-7

4.7 Establishing the Net-to-Gross Ratio............................................................................4-9

4.8 Codes and Standards ...............................................................................................4-10

4.9 Non-Energy Benefits and Costs................................................................................4-10

4.10 Incentive Mechanisms...............................................................................................4-11

National Action Plan for Energy Efficiency i
ii Understanding Cost-Effectiveness of Energy Efficiency Programs

4.11 Greenhouse Gas Emissions......................................................................................4-12

4.12 Renewable Portfolio Standards.................................................................................4-13

4.13 Defining Incremental Cost.........................................................................................4-14

4.14 Notes.........................................................................................................................4-16

5: Guidelines for Policy-Makers ............................................................................ 5-1

5.1 Emphasizing Cost-Effectiveness Tests.......................................................................5-1

5.2 Picking Appropriate Costs, Benefits, and Methodology ..............................................5-5

6: Detailed Cost-Effectiveness Test Comparison—How Is Each CostEffectiveness Test Used?.................................................................................. 6-1

6.1 Participant Cost Test...................................................................................................6-1

6.2 Program Administrator Cost Test................................................................................6-2

6.3 Ratepayer Impact Measure.........................................................................................6-4

6.4 Total Resource Cost Test............................................................................................6-5

6.5 Societal Cost Test .......................................................................................................6-7

6.6 Notes...........................................................................................................................6-9

 Appendix A: National Action Plan for Energy Efficiency Leadership Group...... A-1

 Appendix B: Glossary.............................................................................................. B-1

 Appendix C: Cost-Effectiveness Tables of Best Practice Programs................... C-1

Southern California Edison Residential Incentive Program .................................................. C-1

Avista Regular Income Programs ......................................................................................... C-5

Puget Sound Energy Commercial/Industrial Retrofit Program.............................................. C-8

National Grid MassSAVE Program ..................................................................................... C-12

 Appendix D: References.......................................................................................... D-1
List of Figures 

Figure 1-1. Ten Implementation Goals of the National Action Plan for Energy Efficiency 

Vision for 2025: A Framework for Change ............................................................1-3

Figure 3-1. Hypothetical Cost-Effectiveness at Measure, Program, and Portfolio Levels..........3-9

Figure 3-2. Timeline of Distributional Impacts When PCT > 1 and RIM < 1 ............................3-11

Figure 4-1. Implication of Time-of-Use on Avoided Costs .........................................................4-7

Figure 4-2. Comparison of Marginal CO2 Emission Rates for a Summer Day in California 

and Wisconsin.....................................................................................................4-13

Figure 4-3. Natural Gas, Energy Efficiency, and Renewable Supply Curves for California.....4-14

List of Tables 

Table 1-1. Cost-Effectiveness Tests in Use by Different States as Primary or Secondary 

Consideration ........................................................................................................1-2

Table 2-1. Basic Approach for Calculating and Representing Cost-Effectiveness Tests...........2-1

Table 2-2. The Five Principal Cost-Effectiveness Tests Used in Energy Efficiency ..................2-2

Table 2-3. Summary of Cost-effectiveness Test Results for Four Energy Efficiency 

Programs...............................................................................................................2-3

Table 3-1. Summary of Benefits and Costs Included in Each Cost-Effectiveness Test.............3-2

Table 3-2. Summary of Benefits and Costs Included in Each Cost-Effectiveness Test.............3-3

Table 3-3. SCE Residential Energy Efficiency Incentive Program Benefits...............................3-4

Table 3-4. SCE Residential Energy Efficiency Incentive Program Costs...................................3-4

Table 3-5. Summary of Cost-Effectiveness Test Results ($Million)...........................................3-5

Table 3-6. Participant Cost Test for SCE Residential Energy Efficiency Program ....................3-5

Table 3-7. Program Administrator Cost Test for SCE Residential Efficiency Program..............3-6

Table 3-8. Ratepayer Impact Measure for SCE Residential Energy Efficiency Program...........3-7

Table 3-9. Total Resource Cost Test for SCE Residential Energy Efficiency Program .............3-8

Table 3-10. Societal Cost Test for SCE Residential Energy Efficiency Program.......................3-8

Table 4-1. Universe of Energy and Capacity Benefits for Electricity and Natural Gas ..............4-2

Table 4-2. Approaches to Valuing Avoided Energy and Capacity Costs by Utility Type............4-4

Table 4-3. The Use of Discount Rates in Cost-Effectiveness Tests ..........................................4-8

Table 4-4. Defining Customer Decision Types Targeted by Energy Efficiency Measures.......4-15

Table 4-5. Defining Costs and Impacts of Energy Efficiency Measures ..................................4-16

Table 5-1. Primary Cost-Effectiveness Test Used by Different States ......................................5-1

National Action Plan for Energy Efficiency iii
iv Understanding Cost-Effectiveness of Energy Efficiency Programs

Table 5-2. Cost-Effectiveness Tests in Use by Different States as Primary or Secondary 

Consideration ........................................................................................................5-2

Table 5-3. Use of Cost-Effectiveness Tests by States...............................................................5-4

Table 6-1. Benefits and Costs Included in the Participant Cost Test.........................................6-1

Table 6-2. Benefits and Costs Included in the Program Administrator Test ..............................6-3

Table 6-3. Benefits and Costs Included in the Rate Impact Measure Test................................6-4

Table 6-4. Benefits and Costs Included in the Total Resource Cost Test .................................6-6

Table 6-5. Benefits and Costs Included in the Societal Cost Test .............................................6-7

Table C-1. SCE Program Costs................................................................................................C-2 

Table C-2. SCE Program Benefits ............................................................................................C-3 

Table C-3. SCE Program Cost-Effectiveness Test Results ......................................................C-4 

Table C-4. Avista Program Costs .............................................................................................C-5 

Table C-5. Avista Program Benefits..........................................................................................C-6 

Table C-6. Avista Program Cost-Effectiveness Test Results....................................................C-7 

Table C-7. PSE Program Costs ................................................................................................C-9 

Table C-8. PSE Program Benefits ..........................................................................................C-10 

Table C-9. PSE Program Cost-Effectiveness Test Results ....................................................C-11 

Table C-10. National Grid Program Costs ..............................................................................C-13 

Table C-11. National Grid Program Benefits ..........................................................................C-14 

Table C-12. National Grid Program Cost-Effectiveness Test Results.....................................C-15 
List of Abbreviations and Acronyms 

AEO Annual Energy Outlook 

Btu British thermal unit 

CCGT combined cycle gas turbine 

CDM conservation and demand management 

CEC California Energy Commission 

CFL compact fluorescent light bulb 

CO2 carbon dioxide 

DCR debt-coverage ratio 

DOE U.S. Department of Energy 

DR demand response 

DSM demand-side management 

EPA U.S. Environmental Protection Agency 

GHG greenhouse gas 

HP horsepower 

HVAC heating, ventilation, and air conditioning 

ICAP installed capacity 

IOU investor-owned utility 

IRP integrated resource planning 

kW kilowatt 

kWh kilowatt-hour 

LNG liquefied natural gas 

LSE load serving entity 

MMBtu million Btu 

MW megawatt 

MWh megawatt-hour 

NEBs non-energy benefits 

NOx nitrogen oxides 

NPV net present value 

NTG net-to-gross ratio 

NWPCC Northwest Power and Conservation Council 

NYSERDA New York State Energy Research and Development Authority 

PACT program administrator cost test (same as UCT) 

PCT participant cost test 

PSE Puget Sound Energy 

RIM ratepayer impact measure test 

ROE return on equity 

RPS renewable portfolio standard 

SCE Southern California Edison 

SCT societal cost test 

SEER Seasonal Energy Efficiency Ratio 

SOx sulfur oxides 

T&D transmission and distribution 

TOU time of use 

TRC total resource cost test 

TWh terawatt-hour 

UCAP unforced capacity 

UCT utility cost test (same as PACT) 

VOC volatile organic compound 

WACC weighted average cost of capital 

National Action Plan for Energy Efficiency v
Acknowledgements 

This technical issue paper, Understanding Cost-Effectiveness of Energy Efficiency Programs, is 

a key product of the Year Three Work Plan for the National Action Plan for Energy Efficiency. 

This work plan was developed based on Action Plan Leadership Group discussions and 

feedback expressed during and in response to the January 7, 2008, Leadership Group Meeting 

and the February 2008 Initial Draft Work Plan. A full list of Leadership Group members is 

provided in Appendix A. 

With direction and comment by the Action Plan Leadership Group, the paper’s development 

was led by Snuller Price, Energy and Environmental Economics, Inc., under contract to the U.S. 

Environmental Protection Agency (EPA). Additional preparation was performed by Eric Cutter 

and Rebecca Ghanadan of Energy and Environmental Economics, Inc. 

Rich Sedano and Brenda Hausauer of the Regulatory Assistance Project supplied information 

on the use of cost-effectiveness tests by states and provided their expertise during the review 

and editing of the paper. Alison Silverstein also provided expertise during the review and editing 

of the paper. 

EPA and the U.S. Department of Energy (DOE) facilitate the National Action Plan for Energy 

Efficiency. Key staff include Larry Mansueti (DOE Office of Electricity Delivery and Energy 

Reliability), Dan Beckley (DOE Office of Energy Efficiency and Renewable Energy), and 

Kathleen Hogan, Katrina Pielli, and Stacy Angel (EPA Climate Protection Partnership Division). 

Eastern Research Group, Inc., provided copyediting, graphics, and production services. 

vi Understanding Cost-Effectiveness of Energy Efficiency Programs
Executive Summary 

This paper, Understanding Cost-Effectiveness of Energy Efficiency Programs, reviews 

the issues and approaches involved in considering and adopting cost-effectiveness tests 

for energy efficiency, including discussing each perspective represented by the five 

standard cost-effectiveness tests and clarifying key terms. This paper is provided to 

assist organizations in meeting the 10 implementation goals of the National Action Plan 

for Energy Efficiency’s Vision to achieve all cost-effective energy efficiency by 2025. 

Improving energy efficiency in our homes, businesses, schools, governments, and industries—

which consume more than 70 percent of the natural gas and electricity used in the country—is 

one of the most constructive, cost-effective ways to address the challenges of high energy 

prices, energy security and independence, air pollution, and global climate change. Despite 

these benefits and the success of energy efficiency programs in some regions of the country, 

energy efficiency remains critically underutilized in the nation’s energy portfolio. It is time to take 

advantage of more than two decades of experience with successful energy efficiency programs, 

broaden and expand these efforts, and capture the savings that energy efficiency offers. 

Understanding energy efficiency cost-effectiveness tests and the various stakeholder 

perspectives each test represents is key to establishing the policy framework to capture these 

benefits. 

This paper has been developed to help parties pursue the key policy recommendations and 

implementation goals of the National Action Plan for Energy Efficiency. The Action Plan was 

released in July 2006 as a call to action to bring diverse stakeholders together at the national, 

regional, state, or utility level, as appropriate, and foster the discussions, decision-making, and 

commitments necessary to take investment in energy efficiency to a new level. This paper 

directly supports the National Action Plan’s Vision for 2025 implementation goal three, which 

encourages state agencies along with key stakeholders to establish cost-effectiveness tests for 

energy efficiency. This goal highlights the policy step to establish a process to examine how to 

define cost-effective energy efficiency practices that capture the long-term resource value of 

energy efficiency. 

Evaluating the cost-effectiveness of energy efficiency is essential to identifying how much of our 

country’s potential for energy efficiency resources will be captured. Based on studies, energy 

efficiency resources may be able to meet 50 percent or more of the expected load growth by 

2025 (National Action Plan for Energy Efficiency, 2008). Defining cost-effectiveness helps 

energy efficiency compete with the broad range of other resource options in order for energy 

efficiency to get the attention and funding necessary to succeed. 

In its simplest form, energy efficiency cost-effectiveness is measured by comparing the benefits 

of an investment with the costs. Five key cost-effectiveness tests have, with minor updates, 

been used for over 20 years as the principal approaches for energy efficiency program 

evaluation. These five cost-effectiveness tests are the participant cost test (PCT), the 

utility/program administrator cost test (PACT), the ratepayer impact measure test (RIM), the 

total resource cost test (TRC), and the societal cost test (SCT). 

The key points from this paper include: 

• There is no single best test for evaluating the cost-effectiveness of energy efficiency. 

National Action Plan for Energy Efficiency ES-1
• Each of the cost-effectiveness tests provides different information about the impacts of 

energy efficiency programs from distinct vantage points in the energy system. Together, 

multiple tests provide a comprehensive approach. 

• Jurisdictions seeking to increase efficiency implementation may choose to emphasize 

the PACT, which compares energy efficiency as a utility investment on a par with other 

resources. 

• The most common primary measurement of energy efficiency cost-effectiveness is the 

TRC, followed closely by the SCT. A positive TRC result indicates that the program will 

produce a net reduction in energy costs in the utility service territory over the lifetime of 

the program. The distributional tests (PCT, PACT, and RIM) are then used to indicate 

how different stakeholders are affected. Historically, reliance on the RIM test has limited 

energy efficiency investment, as it is the most restrictive of the five cost-effectiveness 

tests. 

There are a number of choices in developing the costs and benefits of energy efficiency that can 

significantly affect the cost-effectiveness results. Several major choices available to utilities, 

analysts, and policy-makers are described below. 

• Where in the process to apply the cost-effectiveness tests: The choice of where to 

apply each cost-effectiveness test has a significant impact on the ultimate set of 

measures offered to customers. In general, there are three places to evaluate the costeffectiveness test: at the “measure” level, the “program” level, and the “portfolio” level. 

Applying cost-effectiveness tests at the program or portfolio levels allows some noncost-effective measures or programs to be offered as long as their shortfall is more than 

offset by cost-effective measures and programs. 

• Which benefits to include: There are two main categories of avoided costs: energyrelated and capacity-related. Energy-related avoided costs refer to market prices of 

energy, fuel costs, natural gas commodity prices, and other variable costs. Capacityrelated avoided costs refer to infrastructure investments such as power plants, 

transmission and distribution lines, and pipelines. From an environmental point of view, 

saving energy reduces air emissions, including greenhouse gases (GHGs). Within each 

of these categories, policy-makers must decide which specific benefits are sufficiently 

known and quantifiable to be included in the cost-effectiveness evaluation. 

• Net present value and discount rates: A significant driver of overall cost-effectiveness 

of energy efficiency is the discount rate assumption used to calculate the net present 

value (NPV) of the annual costs and benefits. Since costs typically occur upfront and 

savings occur over time, the lower the discount rate the more likely the costeffectiveness result is to be positive. As each cost-effectiveness test portrays a specific 

stakeholder’s view, each cost-effectiveness test should use the discount rate associated 

with its perspective. For a household, the consumer lending rate is used, since this is the 

debt cost that a private individual would pay to finance an energy efficiency investment. 

For a business firm, the discount rate is the firm’s weighted average cost of capital, 

typically in the 10 to 12 percent range. However, commercial and industrial customers 

often demand payback periods of two years or less, implying a discount rate well in 

excess of 20 percent. The PACT, RIM, and TRC should reflect the utility weighted 

average cost of capital. The social discount rate (typically the lowest rate) should be 

used for the SCT to reflect the benefit to society over the long term. 

ES-2 Understanding Cost-Effectiveness of Energy Efficiency Programs 
National Action Plan for Energy Efficiency ES-3

• Net-to-gross ratio (NTG): The NTG can be a significant driver in the results of TRC, 

PACT, RIM, and SCT. The NTG adjusts the impacts of the programs so that they only 

reflect those energy efficiency gains that are the result of the energy efficiency program. 

Therefore, the NTG deducts energy savings that would have been achieved without the 

efficiency program (e.g., “free-riders”) and increases savings for any “spillover” effect 

that occurs as an indirect result of the program. Since the NTG attempts to measure 

what customers would have done in the absence of the energy efficiency program, it can 

be difficult to determine precisely. 

• Non-energy benefits (NEBs): Energy efficiency measures often have additional 

benefits (and costs) beyond energy savings, such as improved comfort, productivity, 

health, convenience and aesthetics. However, these benefits can be difficult to quantify. 

Some jurisdictions choose to include NEBs and costs in some of the cost-effectiveness 

tests, often focusing on specific issues emphasized in state policy. 

• GHG emissions: There is increasing interest in valuing the energy efficiency’s effect on 

reducing GHG emissions in the cost-effectiveness tests. The first step is to determine 

the quantity of avoided carbon dioxide (CO2) emissions from the efficiency program. 

Once the amount of CO2 reductions has been determined, its economic value can be 

calculated and added to the net benefits of the energy efficiency measures used to 

achieve the reductions. Currently, some jurisdictions use an explicit monetary CO2 value 

in cost-benefit calculations and some do not. 

• Renewable portfolio standards (RPS): The interdependence between energy 

efficiency and RPS goals is an emerging issue in energy efficiency. Unlike supply-side 

investments, energy efficiency, by reducing load, can reduce the amount of renewable 

energy that must be procured pursuant to RPS targets. This reduces RPS compliance 

cost, which is a benefit that should be considered in energy efficiency cost-effectiveness 

evaluation. 

1: Introduction 

Improving the energy efficiency of homes, businesses, schools, governments, and industries—

which consume more than 70 percent of the natural gas and electricity used in the United 

States—is one of the most constructive, cost-effective ways to address the challenges of high 

energy prices, energy security and independence, air pollution, and global climate change. 

Mining this efficiency could help us meet on the order of 50 percent or more of the expected 

growth in U.S. consumption of electricity and natural gas in the coming decades, yielding many 

billions of dollars in saved energy bills and avoiding significant emissions of greenhouse gases 

and other air pollutants.1

Recognizing this large opportunity, more than 60 leading organizations representing diverse 

stakeholders from across the country joined together to develop the National Action Plan for 

Energy Efficiency. The Action Plan identifies many of the key barriers contributing to 

underinvestment in energy efficiency; outlines five policy recommendations for achieving all 

cost-effective energy efficiency; and offers a wealth of resources and tools for parties to 

advance these recommendations, including a Vision for 2025. As of November 2008, over 120 

organizations have endorsed the Action Plan recommendations and made public commitments 

to implement them in their areas. Establishing cost-effectiveness tests for energy efficiency 

investments is key to making the Action Plan a reality. 

1.1 Background on Cost-effectiveness Tests 

The question of how to define the cost-effectiveness of energy efficiency investments is a critical 

issue to address when advancing energy efficiency as a key resource in meeting future energy 

needs. How cost-effectiveness is defined substantially affects how much of our nation’s 

efficiency potential will be accessed and whether consumers will benefit from the lower energy 

costs and environmental impacts that would result. The decisions on how to define costeffectiveness or which tests to use are largely made by state utility commissions and their 

utilities, and with critical input from consumers and other stakeholders. This paper is provided to 

help facilitate these discussions. 

Cost-effectiveness in its simplest form is a measure of whether an investment’s benefits exceed 

its costs. Key differences among the cost-effectiveness tests that are currently used include the 

following: 

• The stakeholder perspective of the test. Is it from the perspective of an energy 

efficiency program participant, the organization offering the energy efficiency program, a 

non-participating ratepayer, or society in general? Each of these perspectives represents 

a valid viewpoint and has a role in assessing energy efficiency programs. 

• The key elements included in the costs and the benefits. Do they reflect avoided 

energy use, incentives for energy efficiency, avoided need for new generation and new 

transmission and distribution, and avoided environmental impacts? 

• The baseline against which the cost and benefits are measured. What costs and 

benefits would have been realized absent investment in energy efficiency? 

National Action Plan for Energy Efficiency 1-1
The five cost-effectiveness tests commonly used across the country are listed below: 

• Participant cost test (PCT). 

• Program administrator cost test (PACT).2

• Ratepayer impact measure test (RIM). 

• Total resource cost test (TRC). 

• Societal cost test (SCT). 

These cost-effectiveness tests are used differently in different states. Some states require all of 

the tests, some require no specific tests, and others designate a primary test. Table 1-1 

provides a quick overview of which tests are used in which states. Chapter 5 presents more 

information and guidelines on the use of the cost-effectiveness tests by the states. 

Table 1-1. Cost-Effectiveness Tests in Use by Different States as Primary or 

Secondary Consideration 

PCT PACT RIM TRC SCT 

AT, CA, CT, HI, 

IA, IN, MN, NO, 

NV, OR, UT, 

VA, TX

AR, DC, FL, 

GA, HI, IA, 

IN, KS, MN, 

NH, VA 

AR, CA, CO, CT, 

DE, FL, GA, HI, 

IL, IN, KS, MA, 

MN, MO, MT, 

NH, NM, NY, UT, 

VA 

AZ, CO, GA, 

HI, IA, IN, MW, 

ME, MN, MT, 

NV, OR, VA, 

VT, WI

AR, FL, GA, 

HI, IA, IN, 

MN, VA 

Source: Regulatory Assistance Project (RAP) analysis. 

Note: Boldface indicates the primary cost-effectiveness test used by each state. 

1.2 About the Paper 

This paper examines the five standard costeffectiveness tests that are regularly used to 

assess the cost-effectiveness of energy efficiency, 

the perspectives each test represents, and how 

states are currently using the tests. It also 

discusses how the tests can be used to provide a 

more comprehensive picture of the costeffectiveness of energy efficiency as a resource. 

Use of a single cost-effectiveness test as a 

primary cost-effectiveness test may lead to an 

efficiency portfolio that does not balance the 

benefits and costs between stakeholder 

perspectives. Overall, using all five costeffectiveness tests provides a more comprehensive picture than using any one test alone. 

Paper Objective 

After reading this paper, the reader 

should be able to understand the 

perspective represented by each of the 

five standard cost tests, understand that 

all five tests provide a more 

comprehensive picture than any one test 

alone, have clarity around key terms and 

definitions, and use this information to 

shape how the cost-effectiveness of 

energy efficiency programs is treated. 

This paper was prepared in response to a need identified by the Action Plan Leadership Group 

(see Appendix A) for a practical discussion of the key considerations and technical terms 

involved in defining cost-effectiveness and establishing which cost-effectiveness tests to use in 

developing an energy efficiency program portfolio. The Leadership Group offers this reference 

to program designers and policy-makers who are involved in adopting and implementing costeffectiveness tests for evaluating efficiency investments. 

1-2 Understanding Cost-Effectiveness of Energy Efficiency Programs 
This paper supports the National Action Plan for Energy Efficiency Vision for 2025: A 

Framework for Change (National Action Plan for Energy Efficiency, 2008). This Vision 

establishes a long-term aspirational goal to achieve all cost-effective energy efficiency by 2025 

and outlines 10 goals for implementing the Leadership Group’s recommendations (see Figure 1-

1). This paper directly supports the Vision’s third implementation goal, which encourages states 

and key stakeholders to establish cost-effectiveness tests for energy efficiency. This goal 

encourages applicable state agencies, along with key stakeholders, to establish a process to 

examine how to define cost-effective energy efficiency practices that capture the long-term 

resource value of energy efficiency. 

Figure 1-1. Ten Implementation Goals of the National Action Plan for Energy 

Efficiency Vision for 2025: A Framework for Change

Goal One: Establishing Cost-Effective Energy Efficiency as a High-Priority 

Goal Two: Developing Processes to Align Utility and Other Program Administrator 

Incentives Such That Efficiency and Supply Resources Are on a Level Playing 

Field 

Goal Three: Establishing Cost-Effectiveness Tests 

Goal Four: Establishing Evaluation, Measurement, and Verification Mechanisms 

Goal Five: Establishing Effective Energy Efficiency Delivery Mechanisms 

Goal Six: Developing State Policies to Ensure Robust Energy Efficiency Practices 

Goal Seven: Aligning Customer Pricing and Incentives to Encourage Investment in Energy 

Efficiency 

Goal Eight: Establishing State of the Art Billing Systems 

Goal Nine: Implementing State of the Art Efficiency Information Sharing and Delivery 

Systems 

Goal Ten: Implementing Advanced Technologies 

1.3 Structure of the Paper 

This paper walks the reader through the basics of cost-effectiveness tests and the perspectives 

they represent, issues in determining the costs and benefits to include in the cost-effectiveness 

tests, emerging issues, how states are currently using cost-effectiveness tests, and guidelines 

for policy-makers. 

The key chapters of the paper are the following: 

• Chapter 2. This chapter discusses the five standard cost-effectiveness tests and their 

application in four utility best practice programs. 

• Chapter 3. This chapter briefly describes the interpretation of each test and presents a 

calculation of each cost-effectiveness test using an example residential program from 

Southern California Edison. 

National Action Plan for Energy Efficiency 1-3
1-4 Understanding Cost-Effectiveness of Energy Efficiency Programs 

• Chapter 4. This chapter presents the key factors and issues in the determination of an 

energy efficiency program’s cost-effectiveness. It also discusses key emerging issues 

that are shaping energy efficiency programs, including the impact greenhouse gas 

(GHG) reduction targets and renewable portfolio standards (RPS) may have on energy 

efficiency programs. 

• Chapter 5. This chapter gives guidelines and examples for policy-makers to consider 

when choosing which cost-effectiveness test(s) to emphasize, and summarizes of the 

use of the cost-effectiveness tests in each state. 

• Chapter 6. This chapter describes the calculation of each cost-effectiveness test in 

detail, as well as the key considerations when reviewing and using cost-effectiveness 

tests and the pros and cons of each test in relation to increased efficiency investment. 

• Appendix C. This chapter gives further detail on the four example programs included in 

Chapter 2. It also describes how the cost-effectiveness test results were calculated for 

each program. 

1.4 Development of the Paper 

Understanding Cost-Effectiveness of Energy Efficiency Programs is a product of the Year Three 

Work Plan for the National Action Plan for Energy Efficiency. With direction and comment by the 

Action Plan Leadership Group (see Appendix A for a list of group members), the paper’s 

development was led by Snuller Price, Eric Cutter, and Rebecca Ghanadan of Energy and 

Environmental Economics, Inc., under contract to the U.S. Environmental Protection Agency 

and the U.S. Department of Energy. Chapter 5 was authored by Rich Sedano and Brenda 

Hausauer of the Regulatory Assistance Project, under contract to the U.S. Department of 

Energy. 

1.5 Notes 

1

 See the National Action Plan for Energy Efficiency Vision for 2025: A Framework for Change (National 

Action Plan for Energy Efficiency, 2008). 

2

 The program administrator cost test, or PACT, was originally named the utility cost test (UCT). As 

program management has expanded to government agencies, nonprofit groups, and other parties, the 

term “program administrator cost test” has come into use, but the computations are the same. This 

document refers to the UCT/PACT as the “PACT” for simplicity. See Section 6.2 for more information 

on the test. 
2: Getting Started: Overview of the CostEffectiveness Tests 

This chapter provides a brief overview of the cost-effectiveness tests used to evaluate 

energy efficiency measures and programs. All the cost-effectiveness tests use the same 

fundamental approach in comparing costs and benefits. However, each test is designed 

to address different questions regarding the cost-effectiveness of energy efficiency 

programs. 

2.1 Structure of the Cost-Effectiveness Tests 

Each of the tests provides a different kind of information about the impacts of energy efficiency 

programs from different vantage points in the energy system. On its own, each test provides a 

single stakeholder perspective. Together, multiple tests provide a comprehensive approach for 

asking: Is the program effective overall? Is it balanced? Are some costs or incentives too high or 

too low? What is the effect on rates? What adjustments are needed to improve the alignment? 

Each test contributes one of the aspects necessary to understanding these questions and 

answering them. 

The basic structure of each cost-effectiveness test involves a calculation of the total benefits 

and the total costs in dollar terms from a certain vantage point to determine whether or not the 

overall benefits exceed the costs. A test is positive if the benefit-to-cost ratio is greater than one, 

and negative if it is less than one. Results are reported either in net present value (NPV) dollars 

(method by difference) or as a ratio (i.e., benefits/costs). Table 2-1 outlines the basic approach 

underlying cost-effectiveness tests. 

Table 2-1. Basic Approach for Calculating and Representing Cost-Effectiveness 

Tests 

Net Benefits Net Benefitsa = NPV ∑ benefitsa (dollars) - NPV ∑ costs a (dollars) 

(Difference) (dollars) 

Benefit-Cost Benefit-Cost = NPV ∑ benefitsa (dollars) 

Ratio Ratioa NPV ∑ costs a (dollars) 

Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects. 

Note: “NPV” refers to the net present value of benefits and costs. See Section 4.6. 

Cost-effectiveness test results compare relative benefits and costs from different 

perspectives. A benefit-cost ratio above 1 means the program has positive net benefits. A 

benefit-cost ratio below 1 means the costs exceed the benefits. A first step in analyzing 

programs is to see which cost-effectiveness tests are produce results above or below 1. 

National Action Plan for Energy Efficiency 2-1
2.2 The Five Cost-Effectiveness Tests and Their Origins 

Currently, five key tests are used to compare the costs and benefits of energy efficiency and 

demand response programs. These tests all originated in California. In 1974, the Warren Alquist 

Act established the California Energy Commission (CEC) and specified cost-effectiveness as a 

leading resource planning principle. In 1983, California’s Standard Practice for Cost-Benefit 

Analysis of Conservation and Load Management Programs manual developed five costeffectiveness tests for evaluating energy efficiency programs. These approaches, with minor 

updates, continue to be used today and are the principal approaches used for evaluating energy 

efficiency programs across the United States.1

 

Table 2-2 summarizes the five tests in terms of the questions they help answer and the key 

elements of the comparison. 

Table 2-2. The Five Principal Cost-Effectiveness Tests Used in Energy Efficiency 

Key Question Test Acronym Summary Approach Answered 

Participant PCT Will the participants Comparison of costs and benefits 

cost test benefit over the measure of the customer installing the 

life? measure 

Program PACT Will utility bills increase? Comparison of program 

administrator administrator costs to supply-side 

cost test resource costs 

Ratepayer RIM Will utility rates Comparison of administrator costs 

impact measure increase? and utility bill reductions to supplyside resource costs 

Total resource TRC Will the total costs of Comparison of program 

cost test energy in the utility administrator and customer costs 

service territory to utility resource savings 

decrease? 

Societal cost SCT Is the utility, state, or Comparison of society’s costs of 

test nation better off as a energy efficiency to resource 

whole? savings and non-cash costs and 

benefits 

Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects. 

2.3 Cost-Effectiveness Test Results in Best Practice Programs 

Illustrating cost-effectiveness test calculations, Table 2-3 shows benefit-cost ratio results from 

four successful energy efficiency programs from across the country.2

 The Southern California 

Edison (SCE) Residential Energy Efficiency Incentive Program provides customer incentives for 

efficient lighting and appliances. Avista’s results are for its Regular Income Portfolio, which 

includes a variety of programs targeted to residential users. Puget Sound Energy’s 

Commercial/Industrial Retrofit Program encourages commercial customers to install cost- and 

energy-efficient equipment, adopt energy-efficient designs, and use energy-efficient operations 

2-2 Understanding Cost-Effectiveness of Energy Efficiency Programs 
National Action Plan for Energy Efficiency 2-3

at their facilities. Finally, the National Grid’s MassSAVE residential program provides residential 

in-home audits and incentives for comprehensive whole-house improvements. 

All the programs presented have been determined to be cost-effective by the relevant utilities3

and regulators. Nevertheless, the results of the five cost-effectiveness tests vary significantly for 

each program. Furthermore, the result of each cost-effectiveness test across the four programs 

is also quite different. (Puget Sound Energy is the only utility for which all five cost-effectiveness 

tests are positive.) The test results show a range of values that reflect the program designs and 

the individual choices made by the program administrators and policy-makers for their 

evaluation. As later chapters discuss, both the individual tests and the relationships between 

test results offer useful information for assessing programs. 

Table 2-3. Summary of Cost-effectiveness Test Results for Four Energy Efficiency 

Programs 

Test 

Southern California 

Edison Residential 

Energy Efficiency 

Incentive Program 

Avista Regular 

Income 

Portfolio 

Puget Sound Energy 

Commercial/ 

Industrial Retrofit 

Program 

National Grid 

MassSAVE 

Residential 

Benefit-Cost Ratio 

PCT 7.14 3.47 1.72 8.81 

PACT 9.91 4.18 4.19 2.64 

RIM 0.63 0.85 1.15 0.54 

TRC 4.21 2.26 1.90 1.73 

SCT 4.21 2.26 1.90 1.75 

Source: E3 analysis; see Appendix C. 

Note: The calculation of each cost-effectiveness test varies slightly by jurisdiction. See Appendix C for 

more details. 

The choice of cost-effectiveness test depends on the policy goals and circumstances of a given 

program and state. Multiple tests yield a more comprehensive assessment than any test on its 

own. 

2.4 Notes 

1

 The California standard practice manual was first developed in February 1983. It was later revised and 

updated in 1987–88 and 2001; a Correction Memo was issued in 2007. The 2001 California SPM and 

2007 Correction Memo can be found at 

<http://www.cpuc.ca.gov/PUC/energy/electric/Energy+Efficiency/EM+and+V/>. 

2

 The cost-effectiveness test results of each program are described further in Appendix C. 

3

 “Utility” refers to any organization that delivers electric and gas utility services to end users, including 

investor-owned, cooperatively owned, and publicly owned utilities. 

3: Cost-Effectiveness Test Review—Interpreting the 

Results 

This chapter discusses the benefit and cost components included in each costeffectiveness test, and profiles how a residential lighting and appliance incentive 

program fares under each test. It also provides an overview of important considerations 

when using cost-effectiveness tests. 

Overall, the results of all five cost-effectiveness tests provide a more comprehensive picture 

than the use of any one test alone. The TRC and SCT cost tests help to answer whether energy 

efficiency is cost-effective overall. The PCT, PACT, and RIM help to answer whether the 

selection of measures and design of the program is balanced from participant, utility, and nonparticipant perspectives respectively. Looking at the cost-effectiveness tests together helps to 

characterize the attributes of a program or measure to enable decision making, to determine 

whether some measures or programs are too costly, whether some costs or incentives are too 

high or too low, and what adjustments need to be made to improve distribution of costs and 

benefits among stakeholders. The scope of the benefit and cost components included in each 

test is summarized in Table 3-1 and Table 3-2. 

The broad categories of costs and benefits included in each cost-effectiveness test are 

consistent across all regions and applications. However, the specific components included in 

each test may vary across different regions, market structures, and utility types. Transmission 

and distribution investment may be considered deferrable through energy efficiency in some 

areas and not in others. Likewise, the TRC and SCT may consider just natural gas or electricity 

resource savings in some cases, but also include co-benefits of other savings streams (such as 

water and fuel oil) in others. Considerations regarding the application of each cost-effectiveness 

test and which cost and benefit components to include are the subject of Chapter 5. 

3.1 Example: Southern California Edison Residential Energy 

Efficiency Program 

The Southern California Edison (SCE) Residential Energy Efficiency Incentive Program 

provides customer incentives for efficient lighting and appliances (not including HVAC). It is part 

of a statewide mass market efficiency program that coordinates marketing and outreach efforts. 

This section summarizes how to calculate cost-effectiveness for each cost-effectiveness test 

using the SCE Residential Energy Efficiency Incentive Program as an example. Calculations for 

three additional programs from other utilities are evaluated in Appendix C. 

National Action Plan for Energy Efficiency 3-1
Table 3-1. Summary of Benefits and Costs Included in Each Cost-Effectiveness 

Test 

Test Benefits Costs 

PCT Benefits and costs from the perspective of the customer installing the measure 

 Incentive payments  Incremental equipment costs 

 Bill savings  Incremental installation costs 

 Applicable tax credits or incentives 

PACT Perspective of utility, government agency, or third party implementing the program 

 Energy-related costs avoided by the utility  Program overhead costs 

 Capacity-related costs avoided by the  Utility/program administrator 

utility, including generation, transmission, incentive costs 

and distribution  Utility/program administrator 

installation costs 

RIM Impact of efficiency measure on non-participating ratepayers overall 

 Energy-related costs avoided by the utility  Program overhead costs 

 Capacity-related costs avoided by the  Utility/program administrator 

utility, including generation, transmission, incentive costs 

and distribution  Utility/program administrator 

installation costs 

 Lost revenue due to reduced 

energy bills 

Benefits and costs from the perspective of all utility customers (participants and nonparticipants) in the utility service territory TRC 

 Energy-related costs avoided by the utility  Program overhead costs 

 Capacity-related costs avoided by the  Program installation costs 

utility, including generation, transmission,  Incremental measure costs 

and distribution (whether paid by the customer or 

 Additional resource savings (i.e., gas and utility) 

water if utility is electric) 

 Monetized environmental and non-energy 

benefits (see Section 4.9) 

 Applicable tax credits (see Section 6.4) 

SCT Benefits and costs to all in the utility service territory, state, or nation as a whole 

 Energy-related costs avoided by the utility  Program overhead costs 

 Capacity-related costs avoided by the  Program installation costs 

utility, including generation, transmission,  Incremental measure costs 

and distribution (whether paid by the customer or 

 Additional resource savings (i.e., gas and utility) 

water if utility is electric) 

 Non-monetized benefits (and costs) such 

as cleaner air or health impacts 

Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects. 

3-2 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Table 3-2. Summary of Benefits and Costs Included in Each Cost-Effectiveness 

Test 

Component PCT PACT RIM TRC SCT 

Energy- and capacity-related avoided Benefit Benefit Benefit Benefit costs 

Additional resource savings Benefit Benefit 

Non-monetized benefits Benefit 

Incremental equipment and Cost Cost installation costs 

Program overhead costs Cost Cost Cost Cost 

Incentive payments Benefit Cost Cost 

Bill savings Benefit Cost 

Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects. 

Note: Incentive payments include any equipment and installation costs paid by the program administrator. 

3.1.1 Overview of the Program 

The SCE Residential Energy Efficiency Incentive Program resulted in costs of: 

• $3.5 million in administration and marketing for SCE. 

• $15.5 million in customer incentives, direct installation, and upstream payments 

combined for SCE. 

• $41.1 million in measure installation costs for customers (before incentives). 

The reduced energy consumption achieved as a result of the program resulted in: 

• $188 million in avoided cost savings to the utility. 

• $278 million in bill savings to the customers (and reduced revenue to SCE). 

1 • Reduced nitrogen oxides (NOx), PM10, and carbon dioxide (CO2) emissions. 

The costs and savings are presented on a “net” basis, after the application of the net-to-gross 

ratio (NTG). The determination of the NTG is described in Section 4.7. The benefits and costs of 

the SCE program are presented in Table 3-3 and Table 3-4. Together, these two tables provide 

the key parameters for employing individual cost-effectiveness tests, as well as the calculations 

leading to each test are discussed in turn. 

National Action Plan for Energy Efficiency 3-3
Table 3-3. SCE Residential Energy Efficiency Incentive Program Benefits 

Net Benefit Inputs 

Resource savings Units $ 

 Energy (MWh) 2,795,290 $ 187,904,906

 Peak demand (kW) 55,067 — 

 Total resource savings $ 187,904,906

Participant bill savings $ 278,187,587

Emission savings Tons

 NOx 421,633

 PM10 203,065

 CO2 1,576,374

Source: E3 analysis; see Appendix C. 

Table 3-4. SCE Residential Energy Efficiency Incentive Program Costs 

Cost Inputs 

Program overhead 

Program administration $ 898,548

Marketing and outreach $ 559,503

Rebate processing $ 1,044,539

Other $ 992,029

Total program administration $ 3,494,619

Program incentives 

Rebates and incentives $ 1,269,393

Direct installation costs $ 564,027

Upstream payments $ 13,624,460

Total incentives $ 15,457,880

Total program costs $ 18,952,499

Net measure equipment and installation $ 41,102,993

Source: E3 analysis; see Appendix C. 

3.1.2 Cost-Effectiveness Test Results Overview 

The results of each of the five cost-effectiveness tests for 2006 (based on the information in the 

fourth quarter 2006 SCE filing) are presented in 2 Table 3-5 A first level assessment shows that 

the SCE program is very cost-effective for the participant (PCT), the utility (PACT), and the 

region as a whole (TRC). The program will reduce average energy bills, and a RIM below 1.0 

suggests that the program will increase customer rates. Greater detail on the application of each 

of these cost-effectiveness tests is provided below. 

3-4 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Table 3-5. Summary of Cost-Effectiveness Test Results ($Million) 

Test Cost Benefits Ratio Result 

Bill savings are more than seven times greater than PCT $41 $294 7.14 customer costs. 

The value of saved energy is nearly 10 times PACT $19 $188 9.91 greater than the program cost. 

The reduced revenue and program cost is greater RIM $297 $188 0.63 than utility savings. 

Overall benefits are four times greater than the total TRC $45 $188 4.21 costs. 

Same as the TRC, as no additional benefits are SCT $45 $188 4.21 currently included in the SCT in California. 

Source: E3 analysis; see Appendix C. 

3.1.3 Calculating the PCT 

The PCT assesses the costs and benefits from the perspective of the customer installing the 

measure. Overall, customers received $294 million in benefits (derived from utility program 

incentives and bill savings from reduced energy use). The incremental costs to customers were 

$41 million. This yields an overall net benefit of $252 million and a benefit-cost ratio of 7.14. The 

PCT shows that bill savings are seven times customer costs—a cost-effective program for the 

participant. PCT calculation terms from the SCE program data are presented in Table 3-6. 

Table 3-6. Participant Cost Test for SCE Residential Energy Efficiency Program 

PCT Calculations 

Benefits Costs 

Program overhead 

Program incentives $ 15,457,880

Measure costs $ 41,102,993

Energy savings 

Bill savings $ 278,187,587

Monetized emissions 

Non-energy benefits 

 Total $ 293,645,466 $ 41,102,993

Net benefit $252,542,473 

Benefit-cost ratio 7.1 

Source: E3 analysis; see Appendix C. 

National Action Plan for Energy Efficiency 3-5
3.1.4 Calculating the PACT 

The PACT calculates the costs and benefits of the program from the perspective of SCE as the 

utility implementing the program. SCE’s avoided costs of energy are $188 million (energy 

savings). Overhead and incentive costs to SCE are $19 million. These figures yield an overall 

net benefit of $169 million and a benefit-to-cost ratio of 9.91. The PACT result shows that the 

value of saved energy is nearly 10 times greater than the program cost: high cost-effectiveness 

from the perspective of the utility’s administration of the program. Table 3-7 shows the 

breakdown of costs and benefits yielding the positive PACT result. 

Table 3-7. Program Administrator Cost Test for SCE Residential Efficiency 

Program 

PACT Calculations 

Benefits Costs 

Program overhead $ 3,494,619

Program incentives $ 15,457,880

Measure costs 

Energy savings (net) $ 187,904,906

Bill savings 

Monetized emissions (net) $ 0

Non-energy benefits 

 Total $ 187,904,906 $ 18,952,499

Net benefit $168,952,407 

Benefit-cost ratio 9.91 

Source: E3 analysis; see Appendix C. 

3.1.5 Calculating the RIM 

The RIM examines the potential impact the energy efficiency program has on rates overall. The 

net benefits are the avoided cost of energy (same as PACT). The net costs include the 

overhead and incentive costs (same as PACT), but also include utility lost revenues from 

customer bill savings. The result of the SCE program is a loss of $109 million and a benefit-tocost ratio of 0.63. This result suggests that, all other things being equal, the hypothetical impact 

of the program on rates would be for rates to increase. However, in practice, non-participants 

are unaffected until rates are adjusted through a rate case or a decoupling mechanism. In the 

long term, energy efficiency may reduce the capacity needs of the system; this can lead to 

either higher or lower rates to non-participants depending on the level of capital costs saved. 

Energy efficiency can be a lower-cost investment than other supply-side resources to meet 

customer demand, thereby keeping rates lower than they otherwise would be. (This is 

discussed in more detail in Section 3.2.2.) Thus it is important to recognize the RIM as 

examining the potential impacts on rates, but also recognizing that a negative RIM does not 

necessarily mean that rates will actually increase. Section 6.3 discusses impacts over time in 

greater detail. Table 3-8 breaks down the costs and benefits included in the RIM. 

3-6 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Table 3-8. Ratepayer Impact Measure for SCE Residential Energy Efficiency 

Program 

RIM Calculations 

Benefits Costs 

Program overhead $ 3,494,619

Program incentives $ 15,457,880

Measure costs 

Energy savings (net) $ 187,904,906

Bill savings (net) $ 278,187,587

Monetized emissions (net) $ 0

Non-energy benefits 

 Total $ 187,904,906 $ 297,140,085

Net benefit ($109,235,180) 

Benefit-cost ratio 0.63 

Source: E3 analysis; see Appendix C. 

3.1.6 Calculating the TRC 

The TRC reflects the total benefits and costs to all customers (participants and non-participants) 

in the SCE service territory. The key difference between the TRC and the PACT is that the 

former does not include program incentives, which are considered zero net transfers in a 

regional perspective (i.e., costs to the utility and benefits to the customers). Instead, the TRC 

includes the net measure costs of $41 million. Net benefits in the TRC are the avoided costs of 

energy, $188 million. The regional perspective yields an overall benefit of $143 million and a 

benefit-to-cost ratio of 4.21. In California, the TRC includes an adder that internalizes the 

benefits of avoiding the emission of NOx, CO2, sulfur oxides (SOx), and volatile organic 

compounds (VOCs). The adder is incorporated into energy savings (and not broken out as a 

separate category).3

 In many jurisdictions, the avoided costs are based on a market price that is 

presumed to implicitly include emissions permit costs and an explicit calculation of permit costs 

for regulated emissions is not made. The TRC shows that overall benefits are four times greater 

than total costs (a lower benefits-to-cost ratio than the PACT and PCT, but still positive overall). 

Table 3-9 shows the costs and benefits included in the TRC calculation. 

National Action Plan for Energy Efficiency 3-7
Table 3-9. Total Resource Cost Test for SCE Residential Energy Efficiency 

Program 

TRC Calculations 

 Benefits Costs 

Program overhead $ 3,494,619

Program incentives 

Measure costs (net) $ 41,102,993

Energy savings (net) $ 187,904,906

Bill savings 

Monetized emissions (net) (included in energy savings above) 

Non-energy benefits 

 Total $ 187,904,906 $ 44,597,612

Net benefit $143,307,294 

Benefit-cost ratio 4.21 

Source: E3 analysis; see Appendix C. 

3.1.7 Calculating the SCT 

In California, the avoided costs of emissions are included directly in energy savings. These 

benefits are included in both TRC and SCT values, and as a result, their test outputs are the 

same (see Table 3-10). 

Table 3-10. Societal Cost Test for SCE Residential Energy Efficiency Program 

SCT Calculations 

 Benefits Costs 

Program overhead $ 3,494,619

Program incentives 

Measure costs (net) $ 41,102,993

Energy savings (net) $ 187,904,906

Bill savings 

Monetized emissions (net) (included in energy savings above) 

Non-energy benefits (net) $ 0

 Total $ 187,904,906 $ 44,597,612

Net benefit $143,307,294 

Benefit-cost ratio 4.21 

Source: E3 analysis; see Appendix C. 

3-8 Understanding Cost-Effectiveness of Energy Efficiency Programs 
3.2 Considerations When Using Cost-Effectiveness Tests 

3.2.1 Application of Cost-Effectiveness Tests 

Cost-effectiveness tests can be applied at different points in the design of the energy efficiency 

portfolio, and the choice of when to apply each cost-effectiveness test has a significant impact 

on the ultimate set of measures offered to customers. In general, there are three places to 

evaluate the cost-effectiveness test: the “measure” level, the “program” level, and at the 

“portfolio” level. Evaluating cost-effectiveness at the measure level means that each individual 

component of a utility program must be cost-effective. Evaluation at the utility program level 

means that collectively the measures under a program must be cost-effective, but some 

measures can be uneconomical if there are other measures that more than make up for them. 

Evaluating cost-effectiveness at the portfolio level means that all of the programs taken together 

must be cost-effective, but individual programs can be positive or negative. Figure 3-1 illustrates 

a hypothetical portfolio in which cost-effectiveness is evaluated at the portfolio level, allowing 

some measures and programs that are not cost-effective even as the overall portfolio remains 

positive. If cost-effectiveness were evaluated at a measure level, those measures in red—the 

low-income program—could be eliminated as not cost-effective and would not be offered to 

customers. 

Figure 3-1. Hypothetical Cost-Effectiveness at Measure, Program, and Portfolio 

Levels 

National Action Plan for Energy Efficiency 3-9
Applying cost-effectiveness tests at the measure level is the most restrictive. With this 

approach, the analyst or policy-maker is explicitly or implicitly emphasizing the costeffectiveness rather than the total energy savings of the efficiency portfolio. In contrast, applying 

cost-effectiveness tests at the portfolio level allows utilities greater flexibility to experiment with 

different strategies and technologies and results in greater overall energy savings, though at the 

expense of a less cost-effective portfolio overall. California applies the cost-effectiveness tests 

at the portfolio level specifically to allow and encourage the implementation of emerging 

technology and market transformation programs that promote important policy goals but do not 

themselves pass the TRC or PCT. 

Strictly applying cost-effectiveness at the measure or even the program level can often result in 

the need for specific exceptions. At the measure level, variations in climate, building vintage, 

building type and end use may affect the cost-effectiveness of a measure. For marketing clarity, 

a rebate might be provided service-territory-wide even if some eligible climate zones and 

customer types are not cost-effective since differentiating among customer types may 

complicate the advertising message and make the program less effective (the program 

designers make sure the measure is cost-effective overall). At the program level, some 

programs—such as low-income programs—generally need higher incentive levels and 

marketing focus and may not be cost-effective, but are desired in the overall portfolio for social 

equity and other policy reasons. Similarly, some programs, such as those for emerging 

technologies or Home Performance with ENERGY STAR, ramp up slowly over time and 

typically do not achieve cost-effectiveness within the first three years, but do provide energy 

efficiency benefits. Also, the program and portfolio approaches make it easier to include 

supporting programs such as informational campaigns that raise overall awareness and 

complement other programs, but may not be cost-effective on a stand-alone basis. 

Summing up the benefits of multiple measures at the program level may require some 

adjustment for what are known as “interactive effects” between related measures. Interactive 

effects occur when multiple measures installed together affect each other’s impacts. When 

measures affect the same end use, their combined effect when implemented together may be 

less than the sum of each measure’s individually estimated impact. An insulation and air 

conditioning measure may each save 500 kilowatt-hours (kWh) individually, but less than 1,000 

kWh when installed together. Alternatively, some measures may have additional benefits when 

other end uses are also present (i.e., “interactive effects”). For example, replacing incandescent 

bulbs with compact fluorescent light bulbs (CFLs) also reduces cooling loads in buildings with 

air conditioning. 

3.2.2 Impacts Over Time of the Distribution Tests 

Cost-effectiveness tests are evaluated on a life-cycle basis; however, they do not show the way 

impacts vary or adjust over time. As a result, it is important to recognize the ways in which 

program impacts may vary over time in order to properly interpret cost-effectiveness test results. 

For example, the RIM estimates the impact of the energy efficiency program on nonparticipants. Yet non-participants are actually unaffected until rates are adjusted through a rate 

case or a decoupling mechanism. Figure 3-2 illustrates the distributional impacts on the 

participant, non-participant, and utility over time in the common test-result case where energy 

efficiency has a PCT above 1 and a RIM below 1.4

Consider three time periods from the point at which the energy efficiency measure is first 

installed: the short term, medium term, and long term. The short term is defined as the period 

between installing the energy efficiency and adjusting the rate levels. The medium term begins 

3-10 Understanding Cost-Effectiveness of Energy Efficiency Programs 
once rates are adjusted and lasts until the change in energy efficiency results in an adjustment 

to the capital plan. The long term begins once the capital expansion plan has been changed. 

Figure 3-2. Timeline of Distributional Impacts When PCT > 1 and RIM < 1 

From a participant perspective, because the PCT is above 1.0, the participant is better off once 

an investment in energy efficiency is made, as the utility bill is lower than it would have been 

throughout the time horizon. In the short term, the non-participant is indifferent since rates have 

not been adjusted.5

 However, because the RIM is below 1.0, the utility is saving less than the 

drop in revenue from the participant and will therefore have lower return on equity (ROE), or 

debt-coverage ratio (DCR) for a public utility, compared to the case without energy efficiency. 

Note that for utilities with decoupling mechanisms or annual fuel cost adjustments, some or all 

of the rate impact may be felt before the next regular rate case cycle. 

In the medium term, rates will be increased to hit the target ROE or DCR and the utility will be 

indifferent to the energy efficiency. This rate increase, however, affects the non-participating 

customers who have the same consumption as they otherwise would have, but now face higher 

rates. Finally, in the long term, energy efficiency may reduce the capacity needs of the system, 

as the capital expansion requirements of the utility are reduced. The long-term rate impact will 

depend on the level of fixed capital costs included in the avoided costs to value the energy 

savings. If the avoided costs include the long-term capacity cost savings realized through 

energy efficiency, a RIM ratio below 1.0 would indicate that rates will be higher in the long term. 

In many cases, however, avoided costs are based primarily on market prices, which tend to 

represent a short-term view. Thus, it may be that energy efficiency will meet load growth at a 

lower cost than that of alternative utility investments, and rates will be lower than they otherwise 

would have been even if the RIM ratio is below 1.0. To the extent that less capital is needed, 

earnings will be lower for the utility since the utility will be smaller relative to the no-efficiency 

case. However, ROE or DCR will be unchanged in the long term since rates will be adjusted 

periodically based on the target ROE or DCR. 

National Action Plan for Energy Efficiency 3-11
3-12 Understanding Cost-Effectiveness of Energy Efficiency Programs 

3.3 Notes 

1

 PM10 is particulate matter with an aerodynamic diameter less than or equal to a nominal 10 

micrometers. 

2

 Calculations of the cost tests were made by the paper’s authors using a simplified analysis tool. This 

serves to illustrate the concepts, but may not match exactly what each utility has reported based on 

their own analysis. 

3

 The inclusion of the environmental adder in the TRC is an effort to directly internalize the externalities 

of environmental impacts into California’s primary cost test, which is the TRC (see Section 5.1.1). 

4

 More detailed analysis of impacts over time can be evaluated with the National Action Plan for Energy 

Efficiency’s Energy Efficiency Benefits Calculator, using a set of assumptions that can be modified to 

fit a particular utility. See 

<http://www.epa.gov/cleanenergy/energy-programs/napee/resources/calculator.html>. 

5

 If the load forecasts used in rate-making are adjusted to reflect projected efficiency savings, rates may 

increase in the short term as well. 
4: Key Drivers in the Cost-Effectiveness Calculation 

In addition to the cost-effectiveness tests themselves, there are a number of choices in 

developing the costs and benefits that can significantly affect the cost-effectiveness 

results. This chapter describes some of the major choices available to analysts and 

policy-makers; it is a resource and reference for identifying and better understanding the 

variations in possible terms and approaches and developing a more robust 

understanding of possible evaluation techniques and their trade-offs. Because energy 

efficiency programs vary in different energy sectors and have different embedded 

savings and cost values, the variations on these terms are considerable. Thus, this 

chapter cannot be a step-by-step guide of all possible conditions. 

Issues covered in this chapter include: 

• Which benefits to include in each cost-effectiveness test. 

• Whether to emphasize accuracy or transparency. 

• Which methodology to use to forecast future benefits of energy and capacity savings. 

• What time period to consider when assessing costs and benefits. 

• Whether to determine demand- and supply-side resource requirements in the same 

analysis (true “integrated resource planning”). 

• Whether to use a public, non-proprietary data set to develop the benefits, or rely on 

proprietary forecasts and estimates. 

• Which discount rates to use in NPV analysis. 

• Whether to incorporate non-energy benefits (NEBs) and costs in the calculation. 

• What NTG to use. 

• Whether to include CO2 emissions reductions in the analysis. 

• Whether to include RPS procurement costs in the analysis. 

Ultimately, the types of costs, benefits, and methodology used depend on the policy goals. This 

chapter outlines the key terms that will need to be addressed in weighing and evaluating 

efficiency programs. It also provides a discussion of key factors in applying cost-effectiveness 

test terms. 

4.1 Framework for Cost-Effectiveness Evaluation 

The typical approach for quantifying the benefits of energy efficiency is to forecast long-term 

“avoided costs,” defined as costs that would have been spent if the energy efficiency savings 

measure had not been put in place. For example, if an electric distribution utility expects to 

purchase energy at a cost of $70 per megawatt-hour (MWh) on behalf of customers, then 

$70/MWh is the value of reduced purchases from energy efficiency. In addition, the utility may 

not have to purchase as much system capacity (ICAP or UCAP),1

 make as many upgrades to 

distribution or transmission systems, buy as many emissions offsets, or incur as many other 

costs. All such cost savings resulting from efficiency are directly counted as “avoided cost” 

benefits. In addition to the directly counted benefits, the state regulatory commission or 

governing councils may request that the utility account for indirect cost savings that are not 

priced by the market (e.g., reduced CO2 emissions). For additional information on avoided 

costs, refer to the National Action Plan’s Guide to Resource Planning with Energy Efficiency 

(National Action Plan for Energy Efficiency, 2007b [Chapter 2]).

National Action Plan for Energy Efficiency 4-1
4.2 Choosing Which Benefits to Include 

There are two main categories of avoided costs: energy-related and capacity-related avoided 

costs. Energy-related avoided costs involve market prices of energy, losses, natural gas 

commodity prices, and other benefits associated with energy production such as reduced air 

emissions and water usage. Capacity-related avoided costs involve infrastructure investments 

such as power plants, transmission and distribution lines, pipelines, and liquefied natural gas 

(LNG) terminals. Environmental benefits make up a third category of benefits that are frequently 

included in avoided costs. Saving energy reduces air emissions including GHGs, and saving 

capacity addresses land use and siting issues such as new transmission corridors and power 

plants. 

Table 4-1 lists the range of avoided cost components that may be included in avoided cost 

benefits calculations for electricity and natural gas energy efficiency programs. The most 

commonly included components (and which comprise the majority of avoided costs) for electric 

utilities are both energy and capacity. Natural gas utilities will typically include energy and may 

or may not include the capacity savings.2

 Depending on the utility and the focus of the state 

regulatory commission or governing council, others may also be included. 

Table 4-1. Universe of Energy and Capacity Benefits for Electricity and Natural 

Gas 

Electricity Energy Efficiency 

Energy Savings Capacity Savings 

Market purchases or fuel and operation and Capacity purchases or generator construction 

maintenance costs 

System losses System losses (peak load) 

Ancillary services related to energy Transmission facilities 

Energy market price reductions Distribution facilities 

Co-benefits in water, natural gas, fuel oil, etc. Ancillary services related to capacity 

Air emissions Capacity market price reductions 

Hedging costs Land use 

Natural Gas Energy Efficiency 

Energy Savings Capacity Savings 

Market purchases at city gate Extraction facilities 

Losses Pipelines 

Air emissions Cold weather action/pressurization activities 

Market price reductions Storage facilities 

Co-benefits in water, natural gas, fuel oil, etc. LNG terminals 

Hedging costs 

Note: More detail on each of these components can be found in Chapter 3 of the Action Plan’s Guide to 

Resource Planning with Energy Efficiency (National Action Plan for Energy Efficiency, 2007b). 

4-2 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Most states select a subset to analyze from within this “universe” of benefits when evaluating 

energy efficiency. No state considers them all. The most important factor in choosing the 

components is to inform the decisions on energy efficiency given the policy backdrop and 

situation of the state. As an example of how calculations may be adopted to specific conditions, 

California chose to include market price reduction effects in evaluating energy efficiency 

programs during the California Energy Crisis. Similarly, large capital projects such as LNG 

terminals or power plants, or a focus on GHGs or local environment, might lead to emphasizing 

these components over others. There may be diminishing value to detailed analysis of small 

components of the avoided cost that will not change the fundamental decisions. 

4.3 Level of Complexity When Forecasting Avoided Costs 

Within the avoided cost framework, there are many ways to estimate the benefits. The approach 

may be as simple as estimating the fixed and variable costs of displaced generation and using 

them as the avoided costs (as is done in Texas). An alternative approach is to use a more 

sophisticated integrated resource planning (IRP) approach that simultaneously evaluates both 

supply- and demand-side investments. This IRP analysis may include a simulation of the utility 

system with representation of all of the generation, transmission constraints, and loads over 

time (for example, see the Northwest Power Planning and Conservation Council 5th Power 

Plan3 4 or PacifiCorp Integrated Resource Planning ). This requires a much more complex set of 

analysis tools, but provides more information on the right timing, desired quantity, and value of 

energy efficiency with respect to the existing utility system and its expected future loads. 

In general, more sophisticated and accurate estimates of benefits are better. However, other 

considerations include the following: 

• Availability of resources needed to complete the analysis and stakeholders’ review 

before adoption may be a problem in states without intervener compensation. 

• Time taken to complete the analysis with sophisticated IRP approaches could delay 

implementation of energy efficiency. The regulatory landscape in many states is littered 

with IRP proceedings that are contentious and have taken years to complete. 

• Transparency of the approach to a broad set of stakeholders is also valued and may 

be easier to achieve without sophisticated models to achieve broader support. 

4.4 Forecasts of Avoided Costs 

Depending on the utility type and market structure in a region, there are a number of 

methodology options for developing avoided natural gas and electricity costs. The first approach 

is to use forward and futures market data, which are publicly available and transparent to all 

stakeholders. However, energy efficiency is likely to have a life longer than available market 

prices, and a supplemental approach will also be needed to estimate long-term costs. 

The second approach is to use public or private long-run forecast of electricity and natural gas 

costs, such as those produced by the Department of Energy’s Energy Information Agency and 

many state agencies (utilities participating in wholesale markets will also have proprietary 

forward market forecasts to inform trading activities). 

National Action Plan for Energy Efficiency 4-3
The third approach is to develop simple long run estimates of future electricity value by 

choosing a typical “marginal resource” such as a combined cycle natural gas plant and 

forecasting its variable costs into the future. A more sophisticated variation would be to 

incorporate production simulation modeling of the electricity system into this analysis. Overall, it 

is important to understand the underlying assumptions of the forecasting approach and assess 

whether or not these assumptions are appropriate for the intended purpose. Table 4-2

summarizes avoided costs approaches by utility type and each is described in more detail 

below. 

Table 4-2. Approaches to Valuing Avoided Energy and Capacity Costs by Utility 

Type 

Long-Term Analysis Near-Term Analysis Utility Type (i.e., No Market Data (i.e., Market Data Available) Available) 

Distribution electric or Current forward market prices Long-term forecast of market 

natural gas utility of energy and capacity prices of energy and capacity 

Electric vertically Current forward market prices Long-term forecast of market 

integrated utility of energy and capacity prices of energy and capacity 

or or 

Expected production cost of Expected production cost of 

electricity and value of electricity and value of 

deferring generation projects deferring generation projects 

4.4.1 Market Data 

For utilities that are tightly integrated into the wholesale energy market, forward market prices 

provide a good basis for establishing avoided costs. If the utility is buying electricity, energy 

efficiency reduces the need to purchase electricity. If the utility can sell excess electricity, 

energy savings enables additional sales, resulting in incremental revenue. In either case, the 

market price is the per kWh value of energy efficiency. Forward market electricity prices are 

publicly available through services such as Platt’s “Megawatt Daily,” which surveys wholesale 

electricity brokers. This data is typically available extending three or four years into the future 

depending on the market. 

The market price is also a good approach for natural gas utilities. The NYMEX futures market 

for natural gas provides market prices as far as 12 years in advance by month.5

 The market 

currently has active trading daily over the next three to five years. The NYMEX market also 

includes basis swaps that provide the price difference between Henry Hub and most delivery 

points in the United States.6

 Some analysts hesitate to use market data such as NYMEX 

beyond the period of active trading for fear that low volume of trading creates liquidity problems 

and prices that are not meaningful. While more liquid markets provide more rigor in the prices, 

the less liquid long-term markets are still available for trading and are therefore unbiased 

estimates of future market prices and may still be the best source of data. 

Market prices provide a relatively simple, transparent, and readily accessible basis for 

quantifying avoided costs. On the other hand, market prices tend to be influenced primarily by 

current market conditions and variable operating costs, particularly in the near term. Market 

prices alone may not adequately represent long-term and/or fixed operating costs. The 

4-4 Understanding Cost-Effectiveness of Energy Efficiency Programs 
production simulation and proxy plant approaches described below provide alternative 

approaches that address long-term fixed costs. 

4.4.2 Production Simulation Models 

For self-resourced electric utilities that do not have wholesale market access or actively trade 

electricity, a “production simulation” forecast may be the best approach to forecast energy costs. 

A production simulation model is a software tool that performs system dispatch decisions to 

serve load at least cost, subject to constraints of transmission system, air permitting, and other 

operational parameters. The operating cost of the “marginal unit” in each hour or time period is 

used to establish the avoided cost of energy. The downside of production simulation models is 

that they are complex, rely on sophisticated algorithms that can appear as a “black box” to 

stakeholders, and have to be updated when market prices of inputs such as natural gas change. 

In addition, these types of models can have difficulty predicting market prices since the marginal 

energy cost is based on production cost, rather than supply and demand interactions in a 

competitive electricity market. If production simulation produces prices that differ from those 

actually seen in the market, energy efficiency can end up facing a cost hurdle that differs from 

the hurdles faced by supply-side resources. Long-term natural gas forecasts also often rely on 

production simulation to model regional supply, demand, and transportation dynamics and 

estimate the equilibrium market prices. 

4.4.3 Long-Run Marginal Cost and the “Proxy Plant” 

Developing a “proxy plant” is an alternative to production simulation approaches and may be 

used when market data is not available or appropriate. Under this approach, a fixed hypothetical 

plant is used as a proxy for the resources that will be built to meet incremental load.7

 Selecting 

the proxy-plant, the construction costs, financial assumptions, and operating characteristics are 

all assessed from its characteristics. As an example, the variable costs of a combined cycle 

natural gas plant may be used as a proxy for energy costs. The annual fixed cost of a 

combustion turbine may be used as a proxy for capacity costs. Several methods can be used to 

allocate fixed costs, adjust the variable operating costs, or otherwise shape the costs of the 

plant(s) across different time-of-use (TOU) periods. These methods include applying market 

price or system load shapes, loss of load probabilities, or marginal heat rates to vary prices by 

TOU. Another commonly used method is the peaker methodology, which uses an allocation of 

the capacity costs associated with peaking resources (typically combustion turbines) and the 

marginal system energy cost by hour (system lambda) to estimate avoided electricity costs in 

each hour or TOU period. These costs are then used to estimate the costs of the energy and 

capacity in the avoided costs calculations. The proxy plant approach is more transparent and 

understandable to many stakeholders (particularly in comparison to production simulation). The 

proxy plant approach may be used in conjunction with market data, to estimate costs for the 

periods beyond the time horizons when existing market data are available. 

4.4.4 Proprietary and Public Forecasts 

The easiest approach for a utility to develop long-term avoided costs may be to use its own 

internal forecast of market prices. This approach provides estimates of avoided cost that are 

closely linked to the utility operations. However, the methodology may be confidential since 

utilities involved in procuring electricity or natural gas on the market may not to reveal their 

expectations of future prices publicly. Therefore, the use of internal forecasts can significantly 

limit the stakeholder review process for evaluation of energy efficiency programs. 

National Action Plan for Energy Efficiency 4-5
Public forecasts of avoided costs may also be used to develop a more open process for energy 

efficiency evaluation and planning. California, Texas, the Northwest Power Planning Council, 

Ontario, and others use a non-proprietary methodology. An open process allows non-utility 

stakeholders to evaluate and comment on the methodology, thereby increasing the confidence 

that the analysis is fair. This approach also makes it possible for energy efficiency contractors to 

evaluate the cost-effectiveness of proposed energy efficiency upgrades. Unfortunately, this 

open process may diverge from internal forecasts and introduce some discrepancy between the 

publicly adopted numbers and those actually used by utilities in resource planning and 

procurement decisions. States balance these concerns and generally commit to one path or the 

other. 

Policy-makers may also rely on existing publicly available forecasts of electricity or natural gas. 

The most universal source of forecasts is the Annual Energy Outlook (AEO), provided by the 

Department of Energy’s Energy Information Agency.8

 This public forecast provides regional 

long-term forecasts of electricity and natural gas. In addition to the AEO, state energy agencies 

or regional groups may provide their own independent forecasts, which may include sensitivity 

analysis. Some parties, however, view publicly developed forecasts with some skepticism, as 

they may be seen as being overly influenced by political considerations or the compromises 

necessary to gain wide support in a public process. 

4.4.5 Risk Analysis 

Electricity and natural gas prices are quite volatile and subject to cyclical ups and downs. In 

reducing load, energy efficiency also reduces a utility’s exposure to fluctuating market prices. 

This provides an option or hedge value that can be quantified with risk analysis, but which is 

omitted when a single forecast of avoided costs is used. 

Increasingly, utilities have used scenario and risk analysis to assess the benefits of different 

investment options under a range of future scenarios. One of the simpler approaches is to 

compare the cost-effectiveness results under multiple scenarios, using a high, expected, and 

low energy price forecast for example. More advanced techniques, such as Monte Carlo 

simulation, may be used to evaluate the performance of various resource plans under a wide 

range of possible outcomes. 

4.5 Area- and Time-Specific Marginal Costs 

For all of the forecasting approaches for avoided costs, the analyst must decide the level of 

disaggregation by area and time used in developing the forecasts. The marginal costs of 

electricity can vary significantly hour to hour and both electricity and natural gas prices vary by 

area and time of year. Similarly, the load reductions provided by energy efficiency measures 

also vary by season and time of day. Figure 4-1 shows the differences that can result when 

using hourly, TOU, and annual average avoided costs for different end uses, based on a study 

of air conditioning, outdoor lighting, and refrigeration end uses in California. The significance of 

using either TOU or average annual costs is highly dependent on the end use and demand/cost 

characteristics of the region in question. In California, the decision to use hourly avoided costs 

was made in order to appropriately value air conditioning energy efficiency.9

 This approach 

almost doubles the value of air conditioning measures relative to a flat annual average 

assessment of avoided cost (~$0.12/kWh vs. ~$0.07). In the case of other end uses, such as 

outdoor lighting efficiency, there is very little difference between hourly and TOU costs for end 

4-6 Understanding Cost-Effectiveness of Energy Efficiency Programs 
uses that operate evenly within a 24-hour period (e.g., refrigeration), there is no difference in 

method. 

Figure 4-1. Implication of Time-of-Use on Avoided Costs 

Source: California Proceeding on Avoided Costs of Energy Efficiency; R.04-04-025. 

Another consideration of time-dependent avoided cost analysis is the need to correctly evaluate 

the tradeoffs between different types of energy efficiency measures. Hourly avoided costs are 

highly detailed, capturing the cost variance within and across major time periods. Annual 

average costs ignore the timing of energy savings. In the example above, using an annual 

average method, CFLs and outdoor lighting efficiency would receive the same value as air 

conditioning energy efficiency, while in actuality air conditioning energy efficiency is much more 

valuable to the system overall because it reduces the peak load significantly. The use of hourly 

avoided costs in this case reveals the large potential avoided cost value of air conditioning 

savings relative to other efficiency measures. 

4.6 Net Present Value and Discount Rates 

A significant driver of overall cost-effectiveness of energy efficiency is the discount rate 

assumption. Each cost-effectiveness test compares the NPV of the annual costs and benefits 

over the life of an efficiency measure or program. Typically, energy efficiency measures require 

an upfront investment, while the energy savings and maintenance costs accrue over several 

years. The calculation of the NPV requires a discount rate assumption, which can be different 

for the stakeholder perspective of each cost-effectiveness test. 

As each perspective portrays a specific stakeholder’s view, each perspective comes with its 

own discount rate. The five cost-effectiveness tests are listed in Table 4-3, along with the 

National Action Plan for Energy Efficiency 4-7
appropriate discount rate and an illustrative value. Using the appropriate discount rate is 

essential for correctly calculating the net benefits of an investment in energy efficiency. 

Table 4-3. The Use of Discount Rates in Cost-Effectiveness Tests 

Present Value of Today’s Value of the Tests and Discount Rate Illustrative 

Perspective Used Value $1 a Year for 20 $1 Received in Year 

Years* 20 

Participant’s PCT 10% $8.51 $0.15 discount rate 

RIM Utility WACC 8.5% $9.46 $0.20 

PACT Utility WACC 8.5% $9.46 $0.20 

TRC Utility WACC 8.5% $9.46 $0.20 

Social discount SCT 5% $12.46 $0.38 rate 

Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects. 

* This value is the same as not having to purchase $1 of electricity per year for 20 years. 

Three kinds of discount rates are used, depending on which test is being calculated. For the 

PCT, the discount rate of an individual or business is used. For a household, this is taken to be 

the consumer lending rate, since this is the debt cost that a private individual would pay to 

finance an energy efficiency investment. It is typically the highest discount rate used in the costeffectiveness tests. However, since there are potentially many different participants, with very 

different borrowing rates, it can be difficult to choose a single appropriate discount rate. Based 

on the current consumer loan market environment, a typical value may be in the 8 to 10 percent 

range (though a credit card rate might be much higher). For a business firm, the discount rate is 

the firm’s weighted average cost of capital (WACC). In today’s capital market environment, a 

typical value would be in the 10 to 12 percent range—though it can be as high as 20 percent, 

depending on the firm’s credit worthiness and debt-equity structure. Businesses may also 

assume higher discount rates if they perceive several attractive investment opportunities as 

competing for their limited capital dollars. Commercial and industrial customers can have 

payback thresholds of two years or less, implying a discount rate well in excess of 20 percent. 

For the SCT, the social discount rate is used. The social discount rate reflects the benefit to 

society over the long term, and takes into account the reduced risk of an investment that is 

spread across all of society, such as the entire state or region. This is typically the lowest 

discount rate. For example, California uses a 3 percent real discount rate (~5 percent nominal) 

in evaluating the cost-effectiveness of the Title 24 Building Standards. 

Finally, for the TRC, RIM, or PACT, the utility’s average cost of borrowing is typically used as 

the discount rate. This discount rate is typically called the WACC and takes into account the 

debt and equity costs and the proportion of financing obtained from each. The WACC is typically 

between the participant discount rate and the social discount rate. For example, California 

currently uses 8.6 percent in evaluating the investor-owned utility energy efficiency programs. 

4-8 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Using these illustrative values for each cost-effectiveness test, the third column of Table 4-3

shows the value of receiving $1 per year for 20 years from each perspective. This is analogous 

to the value of not having to purchase $1 of electricity per year. From a participant perspective 

assuming a 10 percent discount rate, this stream is worth $8.51; from a utility perspective, it is 

worth $9.46; and from a societal perspective, it is worth $12.46. The effect of the discount rate 

increases over time. The value today of the $1 received in the 20th year ranges from $0.15 from 

the participant perspective to $0.38 in the societal perspective, more than twice as much. Since 

the present value of a benefit decreases more over time with higher discount rates, the choice 

of discount rate has a greater impact on energy efficiency measures with longer expected useful 

lives. 

4.7 Establishing the Net-to-Gross Ratio 

A key requirement for cost benefit analysis is estimating the NTG. The NTG adjusts the costeffectiveness results so that they only reflect those energy efficiency gains that are attributed to, 

and are the direct result of, the energy efficiency program in question. It gives evaluators an 

estimate of savings achieved as a direct result of program expenditures by removing savings 

that would have occurred even absent a conservation program. Establishing the NTG is critical 

to understanding overall program success and identifying ways to improve program 

performance. For more information on NTG in the context of efficiency program evaluation, see 

Chapter 5 of the National Action Plan for Energy Efficiency’s Model Energy Efficiency Program 

Impact Evaluation Guide (National Action Plan for Energy Efficiency, 2007c). 

Gross energy impacts are the changes in energy consumption and/or demand that result 

directly from program-related actions taken by energy consumers that are exposed to the 

program. Estimates of gross energy impacts always involve a comparison of changes in energy 

use over time among customers who installed measures versus some baseline level of usage. 

Net energy impacts are the percentage of the gross energy impact that is attributable to the 

program. The NTG reduces gross energy savings estimates to reflect three types of 

adjustments: 

• Deduction of energy savings that would have been achieved even without a 

conservation program. 

• Deduction of energy savings that are not actually achieved in real world implementation. 

• Addition of energy savings that occur as an indirect result of the conservation program. 

Key factors addressed through the NTG are: 

• Free riders. A number of customers take advantage of rebates or cost savings available 

through conservation programs even though they would have installed the efficient 

equipment on their own. Such customers are commonly referred to as “free riders.” 

• Installation rate. In many cases the customer does not ultimately install the equipment. 

In other cases, efficient equipment that is installed as part of an energy conservation 

program is later bypassed or removed by the customer. This is common for CFL 

programs. 

National Action Plan for Energy Efficiency 4-9
• Persistence/failure. A certain percentage of installed equipment can be expected to fail 

or be replaced before the end of its useful life. Such early failure reduces the achieved 

savings as compared to pre-installation savings estimates. 

• Rebound effect. Some conservation measures may result in savings during certain 

periods, but increase energy use before or after the period in which the savings occur. In 

addition, customers may use efficiency equipment more often due to actual or perceived 

savings. 

• Take-back effect. A number of customers will use the reduction in bills/energy to 

increase their plug load or comfort by adjusting thermostat temperatures. 

• Spillover. Spillover is the opposite of the free rider effect: customers that adopt 

efficiency measures because they are influenced by program-related information and 

marketing efforts, though they do not actually participate in the program. 

4.8 Codes and Standards 

Another way to encourage energy efficiency is to adopt increasingly strict codes and standards 

for energy use in buildings and appliances. This process is occurring in parallel with energy 

efficiency programs in most states, as each approach has its advantages and disadvantages. 

Codes and standards can be adopted for the state as a whole and do not demand the same 

level of state or utility funding as incentive programs. They do, on the other hand, impose 

regulatory and compliance costs on businesses and residents. Codes and standards generally 

involve a more complicated and potentially contentious legislative process than utility energy 

efficiency programs overseen by regulatory agencies. They also present enforcement 

challenges; local planning departments often do not have the staff, budget, or expertise to focus 

on state regulations related to energy use. 

Increasingly strict codes and standards effectively raise the baseline that efficiency measures 

are compared against over time. This will reduce the energy savings and net benefits of 

efficiency measures, either by reducing the estimated savings or increasing the NTG. 

4.9 Non-Energy Benefits and Costs 

Conservation measures often have additional benefits beyond energy savings. These benefits 

include improved comfort, health, convenience, and aesthetics and are often referred to as nonenergy effects (to include costs as well as benefits) or NEBs. None of the five cost-effectiveness 

tests explicitly recognizes changes in NEBs. Unless specifically cited, databases and studies 

generally exclude NEBs. 

Examples of NEBs include: 

• From the customer perspective, increased comfort, air quality, and convenience. For 

example, a demand response event that turns off air conditioning can reduce comfort 

and be a “cost” to the customer. Conversely, participants who gain improved heating and 

insulation can experience increased comfort, gaining an overall benefit. 

• From the utility perspective, NEBs have been shown to reduce the number of shut-off 

notices issued or bill complaints received, particularly in low-income communities. 

4-10 Understanding Cost-Effectiveness of Energy Efficiency Programs 
• From a societal perspective, efficiency programs can provide regional benefits in 

increased community health and improved aesthetics. On a larger scale, energy 

efficiency also reduces reliance on imported energy sources and provides national 

security benefits. 

Studies attempting to estimate the value of NEBs are limited. Such studies often rely on 

participant surveys, which are designed to indicate their willingness to pay for NEBs or 

comparative valuation of various NEBs. Other studies rely on statistical analysis of survey data 

to estimate or “reveal” participant preferences toward NEBs. Both survey and statistical 

methods have significant limitations, and it is difficult to account for changing preferences 

across different income levels, cultural backgrounds, and household types. When values are not 

available, the judgment of regulators or program managers may be used. Examples of 

accounting for NEBs include decreasing costs or increasing benefits by a fixed percentage in 

the cost-effectiveness tests. To date, more emphasis has been placed on including NEBs than 

on non-energy costs. Nevertheless, as NEBs are incorporated in cost-effectiveness evaluation, 

non-energy costs should be evaluated on an equivalent basis. Examples of non-energy costs 

include reduced convenience and increased disposal or recycling costs. 

4.10 Incentive Mechanisms 

An area of growing interest in the application of cost-effectiveness tests is in establishing 

incentive mechanisms for utility efficiency programs. There exist two natural disincentives for 

utilities to invest in energy efficiency programs. First, energy efficiency reduces sales, which 

puts upward pressure on rates and can affect utility earnings. Second, utilities make money 

through a return on their capital investments or rate base. The financial disincentives for utilities 

are discussed thoroughly in the National Action Plan for Energy Efficiency’s paper Aligning 

Utility Incentives with Energy Efficiency Investment (National Action Plan for Energy Efficiency, 

2007a). 

To address the reduced earnings from energy efficiency, states are increasingly exploring 

incentive mechanisms that allow a utility to earn a return on energy efficiency expenditures 

similar to the return on invested capital. The intent is to give the utility an equal (or greater) 

financial incentive to invest in energy efficiency as compared to traditional utility infrastructure. 

The cost-effectiveness test results are increasingly being used as a metric to measure the 

incentive payment to the utility, based on the performance of the energy efficiency program. 

However, as discussed previously, no single cost-effectiveness test captures all of the goals of 

the efficiency program. Therefore, some states, such as California, have developed “weighting” 

approaches that combine the results of the cost-effectiveness tests. California has established a 

Performance Earnings Basis that is based on two-thirds of the TRC portfolio net benefits result 

and one-third of the PACT portfolio net benefits result. An incentive is then paid based on the 

utilities’ combined results using this metric if the utilities’ portfolio of savings meets or exceeds 

the utility commission’s established energy savings goals. 

When the cost-effectiveness tests are used in the payment of shareholder incentives, there will 

be additional scrutiny on the input assumptions and key drivers in the calculation. With this 

additional pressure, transparency and stakeholder review of the methodology becomes more 

important. Finally, the cost-effectiveness tests’ use and their weights must be considered with 

care to align the utility objectives with the goals of the energy efficiency policy. 

National Action Plan for Energy Efficiency 4-11
4.11 Greenhouse Gas Emissions 

Another factor to consider when determining the cost-effectiveness of an energy efficiency 

program is how to value the program’s effect on GHG emissions. The first step is to determine 

the quantity of avoided CO2 emissions from the efficiency program. Once that quantity has been 

determined, its economic value can be calculated and added to the net benefits of the energy 

efficiency measures used to achieve the reductions. Currently, some jurisdictions use an explicit 

monetary CO2 value in cost-benefit calculations, and some do not. California includes a forecast 

of GHG values in the avoided costs used to perform the cost-effectiveness tests and Oregon 

requires that future GHG compliance costs be explicitly considered in utility resource planning. 

Several utilities, including Idaho Power, PacifiCorp, and Public Service Company of Colorado, 

include GHG emissions and costs when evaluating supply- and demand-side options, including 

energy efficiency, in their IRP process. 

The GHG emissions emitted through the end use of natural gas and heating oil are driven by 

the carbon content of the fuel and do not vary significantly by region or time of use. The GHG 

profiles of electricity generation do differ greatly by technology, fuel mix, and region. A very 

rough estimate of GHG emissions savings from energy efficiency can be obtained by multiplying 

the kWh saved by an average emission factor. Alternatively, it can be estimated based upon a 

weighted average of the heat rates and emission factors for the different types of generators in 

a utility’s generation mix. Such “back of the envelope” methods are useful for agency staff and 

others who wish to quickly check that results from more sophisticated methods are 

approximately accurate. 

A formal cost-effectiveness evaluation uses marginal emission rates that more accurately reflect 

the change in emissions due to energy efficiency and have an hourly profile that varies by 

region. For states in which natural gas is both a base load and peaking fuel, marginal emissions 

will be higher during peak hours because of the lower thermal efficiency of peaking plants, and 

therefore energy efficiency measures that focus their kWh savings on-peak will have the highest 

avoided GHG emissions per kWh saved. However, in states in which coal is the dominant fuel, 

off-peak marginal emission rates may actually be higher than on-peak if the off-peak generation 

is coal and on-peak generation is natural gas. Figure 4-2 illustrates this difference, comparing 

reported marginal emission rates for California and Wisconsin. 

To date, monetary values for GHG emissions have been drawn primarily from studies and 

journal articles and applied in regulatory programs. While there is widespread agreement that 

GHG reduction policies are likely to impose some cost on CO2 emissions, achieving consensus 

on a specific $/ton price for the electricity sector is challenging. As Congress and individual 

states consider specific GHG legislation, a number of the policy considerations that will affect 

the CO2 price remain in flux. 

4-12 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Figure 4-2. Comparison of Marginal CO2 Emission Rates for a Summer Day in 

California and Wisconsin 

Source: Erickson et al. (2004). 

Note: The on-peak marginal emissions rate of each state is set by natural gas peaking units. The off-peak 

rates are quite different, reflecting the dominance of coal base load generation in Wisconsin and natural 

gas combined cycle in California. 

4.12 Renewable Portfolio Standards 

An emerging topic in energy efficiency cost-effectiveness is how to treat the interdependence 

between energy efficiency and RPS. RPS goals are typically established state by state as a 

percentage of retail loads in a future target year (e.g., 20 percent renewable energy purchases 

by 2020). Unlike supply-side investments, energy efficiency, by reducing load, can reduce the 

amount of renewable energy that must be procured pursuant to RPS targets, thereby reducing 

RPS compliance cost. 

Some renewable technologies can provide energy at costs close to that of conventional 

generation. However, for many states, the marginal cost of complying with state RPS goals will 

be set either by more expensive technologies or by distant resources with significant 

transmission costs. When the cost of renewable energy needed to meet RPS goals is 

significantly higher than the avoided cost for conventional generation, energy efficiency provides 

additional savings by reducing RPS compliance costs. 

The additional RPS-related savings from energy efficiency for California are illustrated in Figure 

4-3. In California, as in many regions, the least-cost conventional base-load resource is 

combined cycle gas turbine (CCGT), shown here with a cost of $82/MWh. The avoided costs 

against which energy efficiency has historically been evaluated are based on such conventional 

generation. This has limited the promotion of energy efficiency to technologies with costs below 

$80/MWh. In practice, given limited budgets and staff, utilities have focused primarily on 

technologies with costs of $40/MWh or below. 

National Action Plan for Energy Efficiency 4-13
In comparison, the estimated cost of renewable energy needed to meet California’s 20 percent 

RPS standard is over $130/MWh. So for every 1,000 MWh saved by energy efficiency, the 

utilities avoid the purchase 800 MWh of conventional generation at $82/MWh and 200 MWh of 

renewable generation at $130/MWh. Thus the RPS standard increases the cost of avoided 

energy purchases from $82/MWh to $92/MWh ($82/MWh + [130/MWh - $82/MWh] × 20%). 

Utilities in California have begun to incorporate the higher cost of renewable generation in their 

internal evaluation of load reduction strategies. However, as in most jurisdictions, the cost of 

meeting RPS targets has not yet been formally included in the adopted avoided cost forecasts 

against which energy efficiency programs are officially evaluated. 

Figure 4-3. Natural Gas, Energy Efficiency, and Renewable Supply Curves for 

California 

Source: Mahone et al. (2008). 

4.13 Defining Incremental Cost 

In order to apply the avoided cost approach in evaluating benefits of energy efficiency costeffectiveness, the analyst must also determine the incremental cost of the measures. Energy 

efficiency portfolio costs are easier to evaluate than benefits, since they are directly observable 

and auditable. For example, marketing costs, measurement and evaluation costs, incentive 

costs, and administration costs all have established budgets. The exception to this is in 

estimating the incremental measure cost. This is a necessary input for the TRC, SCT, and PCT 

calculations. 

4-14 Understanding Cost-Effectiveness of Energy Efficiency Programs 
For each of these tests, the appropriate cost to use is the cost of the energy efficiency device in 

excess of what the customer would otherwise have made. Therefore, the incremental measure 

costs must be evaluated with respect to a baseline. For example, a program that provides an 

incentive to a customer to upgrade to a high-efficiency refrigerator would use the premium of 

that refrigerator over the base model that would otherwise have been purchased. 

Establishing the appropriate baseline depends on the type of measure. In cases where the 

customer would not have otherwise made a purchase, for example the early replacement of a 

working refrigerator, the appropriate baseline is zero expenditure.10 In this case, the incremental 

cost is the full cost of the new high-efficiency unit. The four basic measure decision types are 

described in Table 4-4 along with different names often used for each decision type. 

Table 4-4. Defining Customer Decision Types Targeted by Energy Efficiency 

Measures 

Decision Type Definition Example 

New Encourages builders and Utility offers certification or award to 

New construction 

Lost opportunity 

developers to install energy builder of new homes that meet or 

efficiency measures that go above exceed targets for the efficient use 

and beyond building standards at of energy. 

the time of construction 

Replacement Customer is in the market for a The utility provides a rebate that 

Failure replacement 

Natural replacement 

Replace on burnout 

new appliance because their encourages the customer to 

existing appliance has worn out or purchase a more expensive, but 

otherwise needs replacing. more efficient and longer-lasting 

Measure encourages customer to CFL bulb instead of an 

purchase and install efficient incandescent bulb. 

instead of standard appliance. 

Retrofit Customer’s existing appliance is The utility provides a rebate toward 

Early replacement working with several years of the purchase of a new, more 

useful life remaining. Measure efficient refrigerator upon the 

encourages customer to replace removal of an older, but still 

and dispose of old appliance with working refrigerator. 

a new, more efficient one. 

Retire Customer is encouraged to The utility pays for the removal and 

remove, but not replace existing disposal of older but still working 

fixture. “second” refrigerators (e.g., in the 

garage) that customer can 

conveniently do without. 

Table 4-5 summarizes the calculation of measure costs for each of the decision types described 

above. In the table, “efficient device” refers to the equipment that replaces an existing, lessefficient piece of equipment. “Standard device” refers to the equipment that would be used in 

industry standard practice to replace an existing device. “Old device” refers to the existing 

equipment to be replaced. 

National Action Plan for Energy Efficiency 4-15
4-16 Understanding Cost-Effectiveness of Energy Efficiency Programs 

Table 4-5. Defining Costs and Impacts of Energy Efficiency Measures 

Type of Measure Measure Cost 

($/Unit) 

Impact Measurement 

(kWh/Unit and kW/Unit) 

New 

New construction 

Lost opportunity 

Cost of efficient device 

minus cost of standard device 

(Incremental) 

Consumption of standard device 

minus consumption of efficient device

Replacement 

Failure 

replacement 

Natural 

replacement 

Replace on 

burnout 

Cost of efficient device 

minus cost of standard device 

(Incremental) 

Consumption of standard device 

minus consumption of efficient device

Retrofit 

Early 

replacement 

(Simple) 

Cost of efficient device 

plus installation costs 

(Full) 

Consumption of old device 

minus consumption of efficient device

Retrofit 

Early 

replacement 

(Advanced)* 

Cost of efficient device 

minus cost of standard device 

plus remaining present value 

During remaining life of old device: 

Consumption of old device 

minus consumption of efficient device

After remaining life of old device: 

Consumption of standard device 

minus consumption of efficient device

Retire Cost of removing old device Consumption of old device 

* The advanced retrofit case is essentially a combination of the simple retrofit treatment (for the time 

period during which the existing measure would have otherwise remained in service) and the failure 

replacement treatment for the years after the existing device would have been replaced. “Present Value” 

indicates that the early replacement costs should be discounted to reflect the time value of money 

associated with the installation of the efficient device compared to the installation of the standard device 

that would have occurred at a later date. 

4.14 Notes 

1

 Installed capacity (ICAP), or unforced capacity (UCAP) in some markets, is an obligation of the electric 

utility (load serving entity, or LSE) to purchase sufficient capacity to maintain system reliability. The 

amount of ICAP an LSE must typically procure is equal to its forecasted peak load plus a reserve 

margin. Therefore, reduction in peak load due to energy efficiency reduces the ICAP obligation. 

2

 The ability to store natural gas, and to manage the gas system to serve peak demand periods by 

varying the pressure, reduces the share of gas costs associated with capacity relative to electricity. 
3

 See <http://www.nwcouncil.org/energy/powerplan/5/Default.htm>. 

4

 See <http://www.pacificorp.com/Navigation/Navigation23807.html>. 

5

 See <http://www.nymex.com/ng_fut_csf.aspx> for current market prices at Henry Hub. 

6

 See <http://www.nymex.com/cp_produc.aspx> for available basis swap products. 

7

 The specifications may be developed by the utility or developed through a regulatory process with 

stakeholder input. 

8

 Forecasts are available at <res://ieframe.dll/tabswelcome.htm>. 

See <http://www.eia.doe.gov/oiaf/aeo/> for the latest edition of the Annual Energy Outlook. 

9

 See <http://www.ethree.com/CPUC/E3_Avoided_Costs_Final.pdf> for a detailed description of the 

development of avoided costs in California. 

10 A simplifying assumption of zero as the baseline expenditure is often used, even though the 

equipment may have a limited remaining useful life and need replacement in a few years. 

presents a more detailed calculation that can be used for early replacement programs. 

Table 4-5

National Action Plan for Energy Efficiency 4-17

5: Guidelines for Policy-Makers 

A common misperception is that there is a “best” perspective for evaluating the costeffectiveness of energy efficiency. On the contrary, no single test is more or less 

appropriate for a given jurisdiction. A useful analogy for the value of the five costeffectiveness tests is the way doctors use multiple diagnostics to assess the overall 

health of a patient: each test reflects different aspects of the patient’s health. This 

chapter describes how individual states use each of the five cost-effectiveness tests and 

why states might choose to emphasize some tests over others. Four hypothetical 

situations are presented to illustrate how states may emphasize particular tests in 

pursuit of specific policy goals. 

5.1 Emphasizing Cost-Effectiveness Tests 

Nationwide, the most common primary measurement of energy efficiency cost-effectiveness is 

the TRC, followed closely by the SCT. A positive TRC result indicates that the program will, over 

its lifetime, produce a net reduction in energy costs in the utility service territory. A positive SCT 

result indicates that the region (the utility, the state, or the United States) will be better off on the 

whole. Table 5-1 shows the distribution of primary cost-effectiveness tests used by state. 

Table 5-1. Primary Cost-Effectiveness Test Used by Different States 

PCT PACT RIM TRC SCT Unspecified 

CT, TX, UT FL CA, MA, AZ, ME, MN, AR, CO, DC, 

MO, NH, 

NM, 

VT, WI DE, GA, HI, IA, 

ID, IL, IN, KS, 

KY, MD, MT, 

NC, ND, NJ, NV, 

OK, OR, PA, RI, 

SC, VA, WA, 

WY 

Source: Regulatory Assistance Project (RAP) analysis. 

Cost-effectiveness overall as analyzed by the TRC and SCT is not necessarily the only 

important aspect to evaluate when designing an energy efficiency portfolio. Even if benefits 

outweigh costs, some stakeholders can be net winners and others net losers. Therefore, many 

states also include one or more of the distributional tests to evaluate cost-effectiveness from 

individual vantage points. Using the results of the distribution tests, the energy efficiency 

measures and programs offered, their incentive levels, and other elements in the portfolio 

design can be balanced to provide a reasonable distribution of costs and benefits among 

stakeholders. Table 5-2 shows the distribution of cost-effectiveness tests used by states for 

either the primary or secondary consideration. 

National Action Plan for Energy Efficiency 5-1
Table 5-2. Cost-Effectiveness Tests in Use by Different States as Primary or 

Secondary Consideration 

PCT PACT RIM TRC SCT 

AR, FL, GA, HI, AT, CA, CT, HI, AR, DC, FL, GA, AR, CA, CO, AZ, CO, GA, HI, 

IA, IN, MN, VA IA, IN, MN, NO, 

NV, OR, UT, 

VA, TX 

HI, IA, IN, KS, 

MN, NH, VA 

CT, DE, FL, GA, IA, IN, MW, MN, 

HI, IL, IN, KS, MT, NV, OR, 

MA, MN, MO, VA, VT, WI 

MT, NH, NM, 

NY, UT, VA 

Source: Regulatory Assistance Project (RAP) analysis. 

Using the PCT. The PCT provides two key pieces of information helpful in program design: at 

the measure level it provides some sense of the potential adoption rate, and it can help in 

setting the appropriate incentive level so as not to provide too small or too unnecessarily large 

an incentive. Setting the incentive levels is part art and part science. The goal is to get the most 

participation with the least cost. There is a balance between the PCT results with the PACT and 

RIM results. The higher the incentive, the higher the PCT benefit cost ratio and the lower the 

PACT and RIM benefit-cost ratio. 

Using the PACT. The PACT provides an 

indication of how the energy efficiency program 

compares with supply-side investments. This is 

used to balance the incentive levels with the PCT. 

A poor PACT may also result from a low NTG, if, 

for example, a large number of customers would 

make the efficiency investment without the 

program. A poor PACT might also suggest that 

large incentives are required to induce sufficient 

adoption of a particular measure. 

Using the RIM. The RIM as a primary 

consideration test is not as common as the other 

two distributional tests. If used, it is typically a 

secondary consideration test done on a portfolio 

basis to evaluate relative impacts of the overall 

energy efficiency program on rates. The results will provide a high-level understanding of the 

likely pressure on rates attributable to the energy efficiency portfolio. A RIM value below 1.0 can 

be acceptable if a state chooses to accept the rate effect in exchange for resource and other 

benefits. Efficiency measures with a RIM value below 1.0 can nevertheless represent the leastcost resource for a utility, depending on the time period and long-term fixed costs included in the 

avoided costs. 

“You get what you measure” 

When selecting cost-effectiveness tests 

to use as metrics for portfolio, remember 

the saying, “you get what you measure.” 

If a single distributional test is used as a 

primary cost-effectiveness test, the 

portfolio may not balance benefits and 

costs between stakeholders. This is 

particularly true as utility incentive 

mechanisms are introduced that rely on 

cost-effectiveness results. Overall the 

results of all five cost tests provide a 

more comprehensive picture than any 

one test alone. 

5.1.1 Use of Cost-Effectiveness Tests by State 

Table 5-3 shows how states use cost-effectiveness tests. Many states use multiple costeffectiveness tests to provide a more complete picture of energy efficiency cost-effectiveness. 

Eighteen states use two or more cost-effectiveness tests for some aspect of efficiency 

evaluation; four of those require all five tests. For example, Hawaii requires that all five tests be 

included in the analysis of supply and demand options in utility IRPs. Indiana uses all five tests 

5-2 Understanding Cost-Effectiveness of Energy Efficiency Programs 
National Action Plan for Energy Efficiency 5-3

to screen demand-side management (DSM) programs. Minnesota uses all five tests, but 

considers the SCT to be the most important. Many other states use two or three tests with 

different weights assigned to each test, or with separate tests being used for separate parts of 

the process. Several states have adopted formal and in some cases unique modifications to the 

standard forms of the tests. 

The choice of tests and their applications reveal the priorities of the states and the perspectives 

of their regulatory commissions—the extent to which energy efficiency is considered a resource 

or the extent to which rates dominate policy implementation of energy efficiency. Some 

commissions like having a clear formula, using only one or two tests with threshold values to 

establish program scope. 

The following are several examples of the types of decisions regulatory commissions have 

made regarding cost-effectiveness tests: 

• In Colorado, a 2004 settlement with Xcel Energy required the TRC. A 2007 statute 

requires the use of a variation of the SCT that includes the utility’s avoided costs, the 

valuation of avoided emissions, and NEBs as determined by the regulatory commission. 

• Connecticut uses the PACT to screen individual DSM programs and the TRC to evaluate 

the total benefit of conservation and load management programs and to determine 

performance incentives. 

• In the District of Columbia, the RIM is used for DSM programs. Those which have a 

cost-benefit ratio of 0.8 and 1.0 may be evaluated for other benefits, including long-term 

savings, market transformation, peak savings, and societal benefits. 

• Iowa requires utilities to analyze DSM programs using the SCT, RIM, PACT, and PCT. 

According to statute, if the utility uses a test other than the SCT to determine the costeffectiveness of energy efficiency programs and plans, it must describe and justify its 

use of the alternative test. 

• In Montana, the SCT and TRC are used for the traditionally regulated utility that 

prepares IRPs. Neither test is required for the utility that conducts portfolio management, 

although statute specifies that the RIM should not be used. 

• Utah requires that DSM programs meet the TRC and PACT in IRP. For supply and 

demand resources, the primary test is the PACT, calculated under a variety of scenarios; 

other tests may also be considered. 

• California weighs the results of two of the cost-effectiveness tests, TRC and PACT, in 

this program screening process. California adopted a “Dual-Test” that uses the PACT to 

ensure that utilities are not over spending on incentives for programs that pass the TRC. 

The recently adopted shareholder incentive mechanisms use a weighting of two-thirds of 

the TRC portfolio net benefits result and one-third of the PACT portfolio net benefits 

result. An incentive is then paid based on the utility’s combined results using this metric 

if the utility’s portfolio of savings meets or exceeds the Commission’s established energy 

savings goals. 
5-4 Understanding Cost-Effectiveness of Energy Efficiency Programs 

Table 5-3. Use of Cost-Effectiveness Tests by States 

State Requires 

All 

Primary 

Test TRC SCT PCT PACT RIM Other NonSpecific 

AK • 

AL • 

AR • • • • 

AZ* SCT • 

CA TRC • • 

CO • • 

CT PACT • • 

DC • • 

DE* • 

FL RIM • • • 

GA • • • • 

HI • • • • • • 

IA • • • • 

ID† • • • • 

IL • 

IN • • • • • • 

KS* • • 

KY • 

LA • 

MA TRC • 

MD* • 

ME SCT • 

MI • 

MN • SCT • • • • • 

MO TRC • • 

MS • 

MT • • 

NC • 

ND • 

NE • 

NH TRC • • 

NJ • 

NM TRC • 

NV • • • 

NY TRC • 

OH • 

OK • 

OR* • • 

PA • 

RI • 

SC • 

SD • 

UT PACT • • 

VA • • • • • • 

VT SCT • 

TN • 

TX PACT • 

WA • 

WI SCT • 

WV • 

WY • 

* Proposed or not yet codified in statute/Commission Order. 

†

 Allows any or all tests, though the RIM may not be used as primary or limiting cost-effectiveness test. 

Source: Regulatory Assistance Project (RAP) analysis.
5.2 Picking Appropriate Costs, Benefits, and Methodology 

With the cost-effectiveness tests determined, it is equally important to pick the appropriate 

costs, benefits, and methodology to align the energy efficiency portfolio with the overall policy 

goals and context for energy efficiency. The choices should ultimately reflect the situation of the 

utility and the state, its history in implementing energy efficiency, and other considerations. To 

provide some guidance, four hypothetical situations are considered along with several 

recommendations of possible approaches in each situation. Since the hypothetical situations do 

not consider any specific state, they should be viewed as a starting point for discussion and not 

specific policy recommendation for every context. 

5.2.1 Situation A: Peak Load Growth and Upcoming Capital Investments 

States or regions that are experiencing high peak load growth and associated large capital 

investments will want to ensure that the energy efficiency portfolio appropriately targets the 

peak and also provides higher benefits for peak load reduction that can be used to justify 

higher-cost energy efficiency such as air conditioner incentives or demand response. 

One approach is to introduce time-specific avoided costs by hour, or by TOU. In addition, it will 

be important to initiate system planning studies that integrate supply- and demand-side planning 

so that the energy efficiency programs have the opportunity to defer or delay the supply-side 

capital investments. Unless the two processes are linked in some way, the energy efficiency 

program may be successful in reducing peak loads only to find that the capital projects also 

built. This could create a situation with too much capacity, and overspending on peak load 

reductions. In order to coordinate demand- and supply-side planning, it is important to start 

early. The lead time for large supply-side projects can be five or even 10 years. In addition, it is 

much easier to defer or eliminate the need for the project before the supply-side project 

proponents are deeply vested in its outcome. 

5.2.2 Situation B: Utility Financial Problems 

In a situation with a utility with financial problems, due to low load growth and/or a rate freeze, a 

different set of energy efficiency policies might be considered. Though the problem probably 

cannot be fixed with energy efficiency program design, there is no need to make it worse. 

There are several approaches to encourage energy efficiency without straining the utility 

financially. One approach is to introduce decoupling or another automatic rate adjustment for 

reduced sales from energy efficiency to ensure recovery of fixed costs that have already been 

allowed in a prior rate case. A rate adjustment, whether tied to decoupling or not, may also help 

improve the utility financial situation. 

If rate adjustments are not possible (whether through direct adjustment, decoupling, or another 

approach), another option may be to limit the impact of energy efficiency by specifying a 

minimum portfolio RIM. This will reduce the level of energy that can be saved but allow the 

portfolio to continue, perhaps with some lower-scoring programs placed on hiatus, while the 

financial issues of the utility are addressed. 

National Action Plan for Energy Efficiency 5-5
5-6 Understanding Cost-Effectiveness of Energy Efficiency Programs 

5.2.3 Situation C: Targeting Load Pockets 

If a utility has areas of growing load that require new transmission and/or generation 

investments to be made, energy efficiency may provide an alternative. In this case, it may be 

less expensive to use energy efficiency and demand response to reduce peak loads than to 

build new supply-side infrastructure. Using demand-side resources to alleviate a load pocket 

also has a lower impact on the environment. 

In order to target the load pockets, the energy efficiency portfolio should include programs that 

specifically target peak load reduction in these areas. This can be done by increasing marketing 

of the same programs used service-territory-wide, or by developing a specific program to target 

peak load reductions in an area. Area- and time-specific costing should be introduced to 

estimate the value of the peak load reductions. Energy efficiency program managers should be 

given the authority to target certain areas. In this case, the equity of providing all of the same 

measures service-territory-wide may be overshadowed by value of a targeted program. 

Targeting marketing and implementation is, by definition, discriminatory, but for legitimate, costbased reasons. Targeting efficiency for areas with capacity constraints can be a prudent and 

least-cost means of accommodating load growth or meeting reliability criteria. While they may 

appear to favor certain customers, targeted efforts can provide sufficient incremental value to 

offer net benefits for all customers. 

As in Situation A, it will be important in Situation B to initiate system planning studies that 

integrate supply- and demand-side planning so that the energy efficiency programs have the 

opportunity to defer or delay the supply-side load pocket mitigation measures. 

5.2.4 Situation D: Aggressive Greenhouse Gas and RPS Policies 

Many states are introducing the RPS and beginning to implement aggressive GHG policies. In 

these situations, policy-makers will need to emphasize energy savings. One approach to 

consider is to focus on the TRC or SCT, and not to use the RIM results. Policy-makers might 

also consider including a forecast of avoided CO2 reductions in the avoided costs. In addition, 

including the avoided costs of the renewable energy or low-carbon resource that would 

otherwise be purchased (nuclear, renewables, carbon-capture, and sequestration) as the 

marginal resource can increase the avoided costs. This raises the quantity of efficiency 

measures and programs considered cost-effective. Finally, policy-makers will want to focus the 

cost-effectiveness tests at the portfolio level, rather than at the program or measure level. 
6: Detailed Cost-Effectiveness Test Comparison—

How Is Each Cost-Effectiveness Test Used? 

This chapter describes the cost-effectiveness tests in order to provide greater 

understanding of calculation, results, and appropriate use of each test. Information is 

provided on the perspective, purpose, costs, benefits, and other considerations for each 

of the cost-effectiveness tests. 

6.1 Participant Cost Test 

The PCT examines the costs and benefits from the perspective of the customer installing the 

energy efficiency measure (homeowner, business, etc.). Costs include the incremental costs of 

purchasing and installing the efficient equipment, above the cost of standard equipment, that 

are borne by the customer. The benefits include bill savings realized to the customer through 

reduced energy consumption and the incentives received by the customer, including any 

applicable tax credits. Table 6-1 outlines the benefits and costs included in the PCT. In some 

cases the NPV of incremental operations and maintenance costs (or savings) may also be 

included. 

Table 6-1. Benefits and Costs Included in the Participant Cost Test 

Benefits and Costs from the Perspective of the Customer Installing the Measure 

Benefits Costs 

 Incentive payments  Incremental equipment costs 

 Bill savings realized  Incremental installation costs 

 Applicable tax credits or incentives 

Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects. 

The primary use of the PCT is to assess the appeal of an energy efficiency measure to potential 

participants. The higher the PCT, the stronger the economic incentive to participate. The PCT 

functions similarly to a simple payback calculation, which determines how many years it takes to 

recover the costs of purchasing and installing a device through bill savings. A cost-effective 

measure will have a high PCT (above 1) and a low payback period. The PCT also provides 

useful information for designing appropriate customer incentive levels. A high incentive level will 

produce a high PCT benefit-cost ratio, but reduce the PACT and RIM results. This is because 

incentives given to customers are seen as “costs” to the utility. The PCT, PACT, and RIM 

register incentive payments in different ways based on their perspective. Utilities must balance 

the participant payback with the goal of also minimizing costs to the utility and ratepayers. 

A positive PCT (above 1) shows that energy efficiency provides net savings for the customer 

over the expected useful life of the efficiency measure. 

National Action Plan for Energy Efficiency 6-1
6-2 Understanding Cost-Effectiveness of Energy Efficiency Programs 

6.1.1 Additional Considerations 

As a measure of payback period or economic appeal, the PCT reflects an important aspect of 

potential participation rates. However, it is not a comprehensive evaluation of all the 

determinants that influence customer participation. For example, the PCT does not consider the 

level of marketing and outreach efforts (or expenditures) to promote the program, and marketing 

can be a major driver of adoption rates. In addition, new technologies may have high upfront 

costs, or steep learning curves, which yield limited adoption despite high PCT ratios. As a key 

example, energy-efficient CFLs generally reach a plateau despite high cost-effectiveness, 

indicating the importance of other factors in behavior besides bill savings.1

 This can be due to 

several factors including customer resistance and limited availability of premium features, such 

as the ability to dim. 

Ideally the PCT will be performed using the marginal retail rate avoided by the customer. In 

practice the PCT is often performed using the utility’s average rates for an applicable customer 

class. With tiered and TOU rates, the marginal rate paid by individual customers can vary 

significantly, which makes the use of marginal rate savings in the PCT somewhat more difficult. 

Furthermore, the impact of energy efficiency on a customer’s peak load is difficult to predict, 

making changes in customer demand charges hard to estimate. In practice, the level of effort 

required to estimate the customers’ actual savings given their consumption profile and 

applicable rate schedule is significant. Often utilities find it is not worth the effort at the program 

design or evaluation level, though it may be useful for individual customer audits. Thus the PCT 

gives an indication of the direct cost-based incentives for customers to participate in a given 

energy efficiency program. 

6.2 Program Administrator Cost Test 

The PACT examines the costs and benefits of the energy efficiency program from the 

perspective of the entity implementing the program (utility, government agency, nonprofit, or 

other third party). The costs included in the PACT include overhead and incentive costs. 

Overhead costs are administration, marketing, research and development, evaluation, and 

measurement and verification.2

 Incentive costs are payments made to the customers to offset 

purchase or installations costs (mentioned earlier in the PCT as benefits).3

 The benefits from 

the utility perspective are the savings derived from not delivering the energy to customers. 

Depending on the jurisdiction and type of utility, the “avoided costs” can include reduced 

wholesale electricity or natural gas purchases, generation costs, power plant construction, 

transmission and distribution facilities, ancillary service and system operating costs, and other 

components.4

 These elements are discussed in more detail in Chapter 4. The benefits and 

costs included in the PACT are summarized in Table 6-2. 
Table 6-2. Benefits and Costs Included in the Program Administrator Test 

Benefits and Costs to the Utility, Government Agency, 

or Third Party Implementing the Program 

Benefits Costs 

 Energy-related costs avoided by the utility  Program overhead costs 

 Capacity-related costs avoided by the  Utility/program administrator incentive costs

utility, including generation, transmission,  Utility/program administrator installation and distribution costs 

Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects. 

The PACT allows utilities to evaluate costs and benefits of energy efficiency programs (and/or 

demand response and distributed generation) on a comparable basis with supply-side 

investments. A positive PACT indicates that energy efficiency programs are lower-cost 

approaches to meeting load growth than wholesale energy purchases and new generation 

resources (including delivery and system costs). States with large needs for new supply 

resources may emphasize the PACT to build efficiency alternatives into procurement planning.5

 

A positive PACT indicates that the total costs to save energy are less than the costs of the 

utility delivering the same power. A positive PACT also shows that customer average bills will 

eventually go down if efficiency is implemented. 

6.2.1 Additional Considerations 

The PACT provides an estimate of energy efficiency costs as a utility resource. Even the most 

comprehensive avoided cost estimates cannot capture all of the attributes of energy valued by 

the utility. In addition, the PACT only includes the program administrator costs and not those 

costs borne by customers. Therefore the PACT may not be seen as sufficiently comprehensive 

as a primary determinant of cost-effectiveness. 

As with all of the cost-effectiveness tests, there are simplifications made in the calculation that 

should be understood when they are applied. For example, the PACT does not incorporate the 

different regulatory and financial treatment of utility investments in energy efficiency versus 

utility infrastructure. Therefore, while the PACT provides an estimate of energy efficiency as a 

resource, a positive PACT result does not imply that a utility will be better off financially. Finally, 

in order to get meaningful results on the PACT, care must be taken to estimate the actual 

resource savings to the utility from the energy efficiency program, including the timing and 

certainty of load reductions and the resulting impact on the utility supply costs. 

Since the PACT includes the full savings to the utility but not the full costs of purchasing and 

installing the energy efficiency measures (which are paid by participants), the PACT is usually 

the easiest cost-effectiveness test to pass. In the SCE program featured in Appendix C, for 

example, the PACT ratio is 9.9—a higher value than that produced by any other costeffectiveness test. 

National Action Plan for Energy Efficiency 6-3
Jurisdictions seeking to increase efficiency implementation may choose to emphasize the 

PACT, which compares energy efficiency as a utility investment on par with other resources. 

Because the PACT includes only utility costs (and not customer contributions), the PACT is 

often the most permissive (and most positive) cost-effectiveness test. 

6.3 Ratepayer Impact Measure 

The RIM examines the impact of energy efficiency programs on utility rates. Unlike typical 

supply-side investments, energy efficiency programs reduce energy sales. Reduced energy 

sales can lower revenues and put upward pressure on retail rates as the remaining fixed costs 

are spread over fewer kWh. The costs included in the RIM are program overhead and incentive 

payments and the cost of lost revenues due to reduced sales.6

 The benefits included in the RIM 

are the avoided costs of energy saved through the efficiency measure (same as the PACT). 

Table 6-3 outlines the benefits and costs included in the RIM. 

Table 6-3. Benefits and Costs Included in the Rate Impact Measure Test 

Benefits and Costs to Ratepayers Overall; Would Rates Need to Increase? 

Benefits Costs 

 Energy-related costs avoided by the  Program overhead costs 

utility  Utility/program administrator incentive costs 

 Capacity-related costs avoided by the  Utility/program administrator installation costs utility, including generation,  Lost revenue due to reduced energy bills transmission, and distribution 

Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects. 

Note: The PACT and the RIM use the same benefits. 

The RIM also gives an indication of the distributional impacts of efficiency programs on nonparticipants. Participants may see net benefits (by lowering their bills through reduced energy 

consumption) while non-participating customers may experience rate increases due to the same 

programs. As the impacts on non-participating customers depend on many factors including the 

timing of adjustments to rates, the RIM is only an approximation of these impacts. 

The RIM answers the question, “All other things being equal, what is the impact of the energy 

efficiency program on utility rates if they were to be adjusted to account for the program?” A 

negative RIM implies that rates would need to increase for the utility to achieve the same 

7 level of earnings in the short term.

In the vast majority of cases, the RIM is negative since the retail rate is typically higher than the 

utility’s avoided cost. The RIM may be negative, even at the same time as average bills 

decrease (as evaluated using the PACT). Therefore, policy-makers have to decide whether to 

emphasize customer bills by using the PACT or customer rates by using the RIM.8

 The main 

reason cited for use of the RIM is to protect customer classes. Chapter 2 of the National Action 

Plan for Energy Efficiency Report (National Action Plan for Energy Efficiency, 2006) suggests 

effective ways to protect customer groups from rate increases in the rate design process that do 

6-4 Understanding Cost-Effectiveness of Energy Efficiency Programs 
not limit the use of energy efficiency. As described in Section 5.1 above, most jurisdictions do 

not choose the RIM as a primary test; many use it as a secondary consideration, if at all.9

6.3.1 Additional Considerations 

It is sometimes observed that even least-cost utility investments made to maintain reliability 

often lead to a rate increase, yet the RIM has not been applied to these initiatives. One key 

consideration in assessing the RIM is that there is typically an allocation of fixed costs in the 

variable $/kWh rate. The fixed costs included in rates reflect the utility’s existing revenue 

requirement and do not necessarily reflect future capital costs avoided through energy 

efficiency. Customers are often resistant to high fixed charges and lumpy utility investments are 

not always considered avoidable through efficiency savings that are realized gradually over 

time. In addition, avoided costs are often based on market prices, which tend to emphasize 

variable and short-term as opposed to long-term costs. Because many utilities have multiple 

standard, tiered, and TOU rate options, the actual marginal revenue loses to the utility can be 

difficult to estimate and not accurately captured when customer class average rates are used in 

the RIM calculation. Other considerations in the RIM, including the relationship to utility financial 

health over time and capacity-focused programs that yield higher RIM results, are discussed in 

further detail in Section 3.2.2 above. 

The RIM is the most restrictive of the five cost-effectiveness tests. When the utility’s retail 

rates are higher than its avoided costs, the RIM will almost always be negative. Thus policymakers may choose to emphasize the PACT and use the RIM as a secondary consideration 

for balancing the distribution of rate impacts. 

6.4 Total Resource Cost Test 

The TRC measures the net benefits of the energy efficiency program for the region as a whole. 

Costs included in the TRC are costs to purchase and install the energy efficiency measure and 

overhead costs of running the energy efficiency program. The benefits included are the avoided 

costs of energy (as with the PACT and the RIM). Table 6-4 outlines the benefits and costs in the 

TRC. 

National Action Plan for Energy Efficiency 6-5
Table 6-4. Benefits and Costs Included in the Total Resource Cost Test 

Benefits and Costs from the Perspective of All Utility Customers 

(Participants and Non-Participants) in the Utility Service Territory 

Benefits Costs 

 Energy-related costs avoided by the  Program overhead costs 

utility  Program installation costs 

 Capacity-related costs avoided by the  Incremental measure costs (whether paid by utility, including generation, transmission, the customer or the utility) and distribution 

 Additional resource savings (e.g., gas 

and water if utility is electric) 

 Monetized environmental and nonenergy benefits (see Section 4.9) 

 Applicable tax credits (see text) 

Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects. 

The primary purpose of the TRC is to evaluate the net benefits of energy efficiency measures to 

the region as a whole. Unlike the tests describe above, the TRC does not take the view of 

individual stakeholders. It does not include bill savings and incentive payments, as they yield an 

intra-regional transfer of zero (“benefits” to customers and “costs” to the utility that cancel each 

other on a regional level). For some utilities, the region considered may be limited strictly to its 

own service territory, ignoring benefits (and costs) to neighboring areas (a distribution-only utility 

may, for example, consider only the impacts to its distribution system). In other cases, the 

region is defined as the state as a whole, allowing the TRC to include benefits to other 

stakeholders (e.g., other utilities, water utilities, local communities). The TRC is useful for 

jurisdictions wishing to value energy efficiency as a resource not just for the utility, but for the 

entire region. Thus the TRC is often the primary test considered by those states seeking to 

include the benefits not just to the utility and its ratepayers, but to other constituents as well. The 

TRC may be considered the sum of the PCT and RIM, that is, the participant and nonparticipant cost-effectiveness tests. The TRC is also useful when energy efficiency might fall 

through the cracks taken from the perspective of individual stakeholders, but would yield 

benefits on a wider regional level.10 

The inclusion of tax credits or incentives depends to some extent on the region considered. A 

municipal utility might consider state and federal tax incentives as a benefit from outside the 

region defined for the TRC. For a utility with a service territory that includes all or most of a 

particular state, state tax incentives would be an intra-regional transfer that is not included in the 

TRC. Some jurisdictions chose to consider all tax incentives as transfers excluded from the 

TRC. Generally speaking, tax incentives in the TRC should be treated consistently with the 

other resources to which energy efficiency may be compared. 

The TRC shows the net benefits of the energy efficiency program as a whole. It can be used 

to evaluate energy efficiency alongside other regional resources and communicate with other 

planning agencies and constituencies. 

6-6 Understanding Cost-Effectiveness of Energy Efficiency Programs 
6.4.1 Additional Considerations 

The TRC is similar to the PACT except that it considers the cost of the measure itself rather 

than the incentive paid by the utility. Because the incentives are less than the cost of the 

measure in most cases, the TRC is usually lower than the PACT. Therefore, the TRC will be a 

more restrictive test than the PACT and fewer measures will pass the TRC. Indeed, it is not 

unusual for a measure to fail the TRC while appearing economical both to the utility (PACT) and 

to the participant (PCT). Due to the incentives paid by the utility, the participant and the utility 

each pay only a portion of the full incremental cost of the measure, which is the cost to the 

region as a whole considered by the TRC. 

The TRC says nothing about the distributional impacts of the costs of energy efficiency. To 

address distributional effects, many jurisdictions that use the TRC as the primary criteria also 

look at other cost-effectiveness tests. In situations where budgets constrain the amount of 

energy efficiency investment, a threshold value may be used. A lower threshold may be applied 

to programs that serve low-income or hard-to-reach groups, representing the distinct societal 

value of reaching these customer groups that is not reflected in the benefit-cost calculation. 

The TRC is more restrictive than the PACT because it includes the full cost of the energy 

efficiency measure and not just the incentives paid by the utility. As a result, a program may 

have a positive PACT and PCT but still not pass the TRC, because the utility and customer 

pay a fraction of the total measure cost that is included in the TRC. 

6.5 Societal Cost Test 

The SCT includes all of the costs and benefits of the TRC, but it also includes environmental 

and other non-energy benefits that are not currently valued by the market. The SCT may also 

include non-energy costs, such as reduced customer comfort levels. Table 6-5 outlines the 

benefits and costs in the SCT. 

Table 6-5. Benefits and Costs Included in the Societal Cost Test 

Benefits and Costs to All in the Service Territory, State, or Nation as a Whole 

Benefits Costs 

 Energy-related costs avoided by the  Program overhead costs 

utility  Program installation costs 

 Capacity-related costs avoided by the  Incremental measure costs (whether paid utility, including generation, by the customer or the utility) transmission, and distribution 

 Additional resource savings (e.g., gas 

and water if utility is electric) 

 Non-monetized benefits (and costs) 

such as cleaner air or health impacts 

Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects. 

In some cases, emissions costs are included in the market price used to determine avoided 

costs or are otherwise explicitly included in the TRC calculation (as in the SCE program 

National Action Plan for Energy Efficiency 6-7
11 example ). Emissions permit costs may already be included in the market price of electricity in 

some jurisdictions. In other jurisdictions, emissions are included in the SCT.12 

As with the TRC, the inclusion of tax incentives varies by jurisdiction. Those using a broad 

definition of the society exclude tax incentives as a transfer. Others will include tax incentives 

originating from outside the immediate region considered. 

The SCT includes costs and benefits beyond the immediate region and those that are not 

monetized in the TRC, such as environmental benefits or GHG reductions. 

6.5.1 Additional Considerations 

Increasingly, benefits historically included only in the SCT are being included in the TRC in 

some jurisdictions. Including a cost for carbon dioxide (CO2) emissions is a prime example. 

Though the future cost associated with CO2 emissions remains highly uncertain and difficult to 

quantify, many utilities believe it is increasingly unlikely that the cost will be zero. In California, 

an approximate forecast is developed through a survey of available studies and literature. The 

IRPs of many utilities now include a risk or portfolio analysis to calculate an “expected” carbon 

value or to determine if the additional cost of a flexible portfolio is sufficiently robust under a 

range of possible futures. 

Water savings are also being explicitly included in the TRC instead of the SCT. This helps 

promote measures such as front-loading clothes washers, which provide water savings that are 

of value to the region but beyond the direct purview of electric and natural gas utilities. There is 

also increasing interest in the West, where water supply is particularly energy intensive, in 

targeting the energy savings possible through water conservation.13 

Some commissions eschew the SCT because factors not included in the TRC are found to be 

beyond their jurisdiction. Where this is the case, legislation would be needed to create or clarify 

the opportunity for commissions to consider the SCT. On the other hand, some states require 

that the societal test be considered when commissions evaluate energy efficiency programs. 

Some states adopt the California methodology, while other states adopt modified versions, 

adding or deleting costs or benefits consistent with state priorities. For example, Illinois uses a 

modified TRC defined in statute, in which gas savings are not included in electricity program 

evaluation. The New York State Energy Research and Development Authority (NYSERDA) 

calculates the TRC for three scenarios, adding non-energy benefits in Scenario 2 and 

macroeconomic benefits in Scenario 3. 

Energy efficiency is among the most cost-effective ways to reduce carbon emissions. The 

SCT is a useful test for jurisdictions seeking to implement or comply with GHG reduction 

goals. It can also be used to evaluate water savings. 

6-8 Understanding Cost-Effectiveness of Energy Efficiency Programs 
National Action Plan for Energy Efficiency 6-9

6.6 Notes 

1

 The PCT is only one of the determinants of customer participation, and bill savings are not the sole 

factor in a customer’s decision to implement energy efficiency. Marketing and customer decisionmaking studies can be used to better understand the levels of customer participation more directly. 

See Golove and Eto, 1996; Schleich and Gruber, 2008. 

2

 At a minimum, overhead costs generally include the salary (and benefits) of those employees directly 

involved in promoting energy efficiency. Some jurisdictions opt to include an allocation of fixed costs 

(i.e., office space) while others do not. To the extent they are applicable, research and development, 

marketing, evaluation, measurement, and verification and other costs may be included in the overall 

total, or reported individually as they are for the SCE example shown here. In cases where energy 

efficiency program costs are subject to special treatment (e.g., public funding and shareholder 

incentive mechanisms), detailed definitions of what may be included as an overhead cost are often 

required. 

3

 The simplest example is a rebate paid to the customer for the purchase of an efficient appliance. 

However, as programs have grown in scope and complexity, so has the definition of an incentive. Two 

additional types of incentive are common: direct install costs and upstream payments. In many cases, 

the utility performs or pays for the labor and installation associated with an efficiency measure. Such 

payments, which are not for the equipment itself, but nevertheless reduce the cost to the customer, 

are considered direct install costs. Another approach, which is now common for CFL programs, calls 

for utilities to pay incentives directly to manufacturers and distributors. These upstream payments 

lower the retail cost of the product, though no rebate is paid directly to the customer. 

4

 Avoided cost benefits vary according to the time and location of the energy savings. Chapter 5 

describes various alternative approaches for estimating the benefits of energy efficiency. 

5

 A specialized application of the PACT is in local IRPs. When a local area is at or near the system’s 

capacity to serve its load, significant infrastructure investments are often required. If such investments 

can be deferred by reducing loads or load growth, there is additional value to the utility in installing 

energy efficiency and other distributed resources in that area. The additional savings that can be 

realized by the utility can justify increased customer incentives and marketing for a targeted efficiency 

program. 

6

 The RIM, PACT, and PCT assess the impacts of the program from different, but interconnected 

stakeholder perspectives. The RIM includes the overhead and incentive payments included as costs in 

the PACT, but also includes revenue losses. The RIM recognizes the incentives and bill savings 

reported as benefits in the PCT, but the RIM reports these terms as costs (revenues losses). 

7

 Even with a negative RIM result, efficiency may still be the most cost-effective means of meeting load 

growth. The full array of long-term investment options considered in utility resource planning cannot 

always be captured in the avoided costs used to evaluate energy efficiency. 

8

 The exception to the predominance of the negative RIM result are utilities that can serve most of their 

loads with existing, low-cost generation, but are facing high costs to build new generation. In such 

cases, the avoided costs for energy efficiency may well be higher that the utility’s retail rates. 
9

 In practice, since utility rates are often frozen between rate-setting cycles and not continuously reset, 

the utility itself absorbs the losses (or gains) in its earnings until rates are adjusted. These adjustments 

can be made in several ways: the regular rate-setting cycle, a decoupling mechanism, or a revenue 

adjustment mechanism. In the long run, the reduced capital investments necessary as a result of 

energy efficiency will mitigate the rate increases. The National Action Plan for Energy Efficiency’s 

Energy Efficiency Benefits Calculator can evaluate these impacts over time: 

<http://www.epa.gov/cleanenergy/energy-programs/napee/resources/calculator.html>.This is 

discussed in more detail in Chapter 4. 

10 As an example, in areas of competitive procurement, distribution-only utilities may not see energy 

efficiency as an immediate interest because it may not yield significant T&D savings (and generation 

costs are not part of their purview). In such a case, the utility may not implement energy efficiency 

even if it is cost-effective from a regional perspective. As a result, regulators may ask the utility to 

focus on the TRC rather than the PACT when evaluating efficiency programs. 

11 California includes emissions permits and trading costs in the avoided cost calculations of the TRC. 

12 Tax incentives paid by the state or federal governments and financing costs are excluded from the 

SCT, because they are considered a zero net transfer. A wide range of NEBs have been considered 

and evaluated throughout the United States. For the participant and community, these NEBs resulted 

in increased comfort, improved air quality, greater convenience, and improved health and aesthetic 

benefits. For the utility, fewer shut-off notices or bill complaints occurred. 

13 The California Public Utilities Commission has approved pilot programs for investor-owned utilities to 

partner with water agencies and provide funding for water conservation incentives that provide energy 

savings (A.07-01-024). 

6-10 Understanding Cost-Effectiveness of Energy Efficiency Programs 
National Action Plan for Energy Efficiency A-1

Appendix A: National Action Plan for Energy 

Efficiency Leadership Group 

Co-Chairs 

Marsha Smith 

Commissioner, Idaho Public 

Utilities Commission 

President, National Association 

of Regulatory Utility 

Commissioners 

James E. Rogers 

Chairman, President, and 

C.E.O. 

Duke Energy 

Leadership Group 

Barry Abramson 

Senior Vice President 

Servidyne Systems, LLC 

Tracy Babbidge 

Director, Air Planning 

Connecticut Department of 

Environmental Protection 

Angela Beehler 

Senior Director, Energy 

Regulation/Legislation 

Wal-Mart Stores, Inc. 

Sheila Boeckman 

Manager of Business 

Operations and Development 

Waverly Light and Power 

Bruce Braine 

Vice President, Strategic Policy 

Analysis 

American Electric Power 

Jeff Burks 

Director of Environmental 

Sustainability 

PNM Resources 

Kateri Callahan 

President 

Alliance to Save Energy 

Jorge Carrasco 

Superintendent 

Seattle City Light 

Lonnie Carter 

President and C.E.O. 

Santee Cooper 

Sheryl Carter 

Co-Director, Energy Program 

Natural Resources Defense 

Council 

Gary Connett 

Director of Environmental 

Stewardship and Member 

Services 

Great River Energy 

Larry Downes 

Chairman and C.E.O. 

New Jersey Natural Gas (New 

Jersey Resources Corporation) 

Roger Duncan 

Deputy General Manager, 

Distributed Energy Services 

Austin Energy 

Angelo Esposito 

Senior Vice President, Energy 

Services and Technology 

New York Power Authority 

Jeanne Fox 

President 

New Jersey Board of Public 

Utilities 

Philip Giudice 

Commissioner 

Massachusetts Division of 

Energy Resources 

Dian Grueneich 

Commissioner 

California Public Utilities 

Commission 

Blair Hamilton 

Policy Director 

Vermont Energy Investment 

Corporation 

Maureen Harris 

Commissioner 

New York State Public Service 

Commission 

Mary Healey 

Consumer Counsel for the State 

of Connecticut 

Connecticut Consumer Counsel 

Joe Hoagland 

Vice President, Energy 

Efficiency and Demand 

Response 

Tennessee Valley Authority 

Sandy Hochstetter 

Vice President, Strategic Affairs 

Arkansas Electric Cooperative 

Corporation 

Helen Howes 

Vice President, Environment, 

Health and Safety 

Exelon 

Mary Kenkel 

Consultant, Alliance One 

Duke Energy 

Ruth Kiselewich 

Director, Conservation 

Programs 

Baltimore Gas and Electric 

Company 
Larry Shirley 

Division Director 

North Carolina Energy Office 

Jed Nosal 

Chief, Office of Ratepayer 

Advocacy 

Massachusetts Office of 

Attorney General Martha 

Coakley 

Martin Kushler 

Director, Utilities Program 

American Council for an 

Energy-Efficient Economy 

Paul Sotkiewicz 

Senior Economist, Market 

Services Division 

PJM Interconnection 

Rick Leuthauser 

Manager of Energy Efficiency 

MidAmerican Energy Company Pat Oshie 

Commissioner 

Washington Utilities and 

Transportation Commission 

Jim Spiers 

Senior Manager, Planning, 

Rates, and Member Services 

Tristate Generation and 

Transmission Association, Inc. 

Harris McDowell 

Senator 

Delaware General Assembly 

John Perkins 

Consumer Advocate 

Iowa Office of Consumer 

Advocate 

Ed Melendreras 

Vice President, Sales and 

Marketing 

Entergy Corporation 

Susan Story 

President and C.E.O. 

Gulf Power Company (Southern 

Company) 

Douglas Petitt 

Vice President, Government 

Affairs 

Vectren Corporation 

Janine Migden-Ostrander 

Consumers’ Counsel 

Office of the Ohio Consumers’ 

Counsel 

Tim Stout 

Vice President, Energy 

Efficiency 

National Grid 

Phyllis Reha 

Commissioner 

Minnesota Public Utilities 

Commission 

Michael Moehn 

Vice President, Corporate 

Planning 

Ameren Services 

Deb Sundin 

Director, Business Product 

Marketing 

Xcel Energy 

Roland Risser 

Director, Customer Energy 

Efficiency 

Pacific Gas and Electric 

Fred Moore 

Director, Manufacturing and 

Technology, Energy 

The Dow Chemical Company 

Paul Suskie 

Chairman 

Arkansas Public Service 

Commission 

Gene Rodrigues 

Director, Energy Efficiency 

Southern California Edison 

Richard Morgan 

Commissioner 

District of Columbia Public 

Service Commission 

Dub Taylor 

Director 

Texas State Energy 

Conservation Office 

Wayne Rosa 

Energy and Maintenance 

Manager 

Food Lion, LLC 

Clay Nesler 

Vice President, Global Energy 

and Sustainability 

Johnson Controls, Inc. 

David Van Holde 

Energy Manager, Department of 

Natural Resources and Parks 

King County, Washington 

Art Rosenfeld 

Commissioner 

Brock Nicholson California Energy Commission 

Deputy Director, Division of Air 

Quality 

North Carolina Department of 

Environment and Natural 

Resources 

Jan Schori 

General Manager 

Sacramento Municipal Utility 

District 

Brenna Walraven 

Managing Director, National 

Property Management 

USAA Realty Company 

Ted Schultz 

Vice President, Energy 

Efficiency 

Duke Energy 

J. Mack Wathen 

Vice President, Regulatory 

Affairs 

Pepco Holdings, Inc. 

A-2 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Kate Marks 

Energy Program Manager 

National Conference of State 

Legislatures 

Sue Gander 

Director, Environment, Energy, 

and Natural Resources Division 

National Governors 

Association—Center for Best 

Practices 

Mike Weedall 

Vice President, Energy 

Efficiency 

Bonneville Power Administration 

Meg Matt 

President and C.E.O. 

Association of Energy Services 

Professionals 

Michael Wehling 

Strategic Planning and 

Research 

Puget Sound Energy 

Jeff Genzer 

General Counsel 

National Association of State 

Energy Officials Joseph Mattingly 

Vice President, Secretary and 

General Counsel 

Gas Appliance Manufacturers 

Association 

Henry Yoshimura 

Manager, Demand Response 

ISO New England, Inc. Donald Gilligan 

President 

National Association of Energy 

Service Companies 

Dan Zaweski 

Assistant Vice President of 

Energy Efficiency and 

Distributed Generation 

Long Island Power Authority 

Kenneth Mentzer 

President and C.E.O. 

North American Insulation 

Manufacturers Association 

Chuck Gray 

Executive Director 

National Association of 

Regulatory Utility 

Commissioners 

Observers 

Ellen Petrill 

Director, Public/Private 

Partnerships 

Electric Power Research 

Institute 

Rex Boynton 

President 

North American Technician 

Excellence 

Steve Hauser 

President 

GridWise Alliance 

Steven Schiller 

Board Director 

Efficiency Valuation 

Organization 

William Hederman 

Member, IEEE-USA Energy 

Policy Committee 

Institute of Electrical and 

Electronics Engineers 

James W. (Jay) Brew 

Counsel 

Steel Manufacturers Association 

Roger Cooper 

Executive Vice President, Policy 

and Planning 

American Gas Association 

Jerry Schwartz 

Senior Director 

American Forest and Paper 

Association 

Marc Hoffman 

Executive Director 

Consortium for Energy 

Efficiency Mark Crisson 

President and C.E.O. 

American Public Power 

Association 

Andrew Spahn 

Executive Director 

National Council on Electricity 

Policy 

John Holt 

Senior Manager of Generation 

and Fuel 

National Rural Electric 

Cooperative Association Dan Delurey 

Executive Director 

Demand Response 

Coordinating Committee 

Rick Tempchin 

Director, Retail Distribution 

Policy 

Edison Electric Institute 

Eric Hsieh 

Manager of Government 

Relations 

National Electrical 

Manufacturers Association 

Reid Detchon 

Executive Director 

Energy Future Coalition 

Mark Wolfe 

Executive Director 

Energy Programs Consortium 

Lisa Jacobson 

Executive Director 

Business Council for 

Sustainable Energy 

Ron Edelstein 

Director, Regulatory and 

Government Relations 

Gas Technology Institute 

Lisa Wood 

Executive Director 

Institute for Electric Efficiency 

National Action Plan for Energy Efficiency A-3
A-4 Understanding Cost-Effectiveness of Energy Efficiency Programs 

Facilitators 

U.S. Department of Energy 

U.S. Environmental Protection 

Agency 
Appendix B: Glossary 

Avoided costs: The forecasted economic benefits of energy savings. These are the costs that 

would have been spent if the energy efficiency had not been put in place. 

Discount rate: A measure of the time value of money. The choice of discount rate can have a 

large impact on the cost-effectiveness results for energy efficiency. As each cost-effectiveness 

test compares the net present value of costs and benefits for a given stakeholder perspective, 

its computation requires a discount rate assumption. 

Energy efficiency: The use of less energy to provide the same or an improved level of service 

to the energy consumer in an economically efficient way. “Energy conservation” is a term that 

has also been used, but it has the connotation of doing without in order to save energy rather 

than using less energy to perform the same or better function. 

Evaluation, measurement, and verification: The process of determining and documenting the 

results, benefits, and lessons learned from an energy efficiency program. The term “evaluation” 

refers to any real time and/or retrospective assessment of the performance and implementation 

of a program. “Measurement and verification” is a subset of evaluation that includes activities 

undertaken in the calculation of energy and demand savings from individual sites or projects. 

Free rider: A program participant who would have implemented the program measure or 

practice in the absence of the program. 

Impact evaluation: Used to determine the actual savings achieved by different programs and 

specific measures. 

Integrated resource planning: A public planning process and framework within which the 

costs and benefits of both demand- and supply-side resources are evaluated to develop the 

least-total-cost mix of utility resource options. In many states, integrated resource planning 

includes a means for considering environmental damages caused by electricity 

supply/transmission and identifying cost-effective energy efficiency and renewable energy 

alternatives. 

Levelized cost: A constant value or payment that, if applied in each year of the analysis, would 

result in a net present value equivalent to the actual values or payments which change (usually 

increase) each year. Often used to represent, on a consistent basis, the cost of energy saved by 

various efficiency measures with different useful lives. 

Marginal cost: The sum that has to be paid for the next increment of product or service. The 

marginal cost of electricity is the price to be paid for kilowatt-hours above and beyond those 

supplied by presently available generating capacity. 

Marginal emission rates: The emissions associated with the marginal generating unit in each 

hour of the day. 

National Action Plan for Energy Efficiency B-1
Market effects evaluation: Used to estimate a program’s influence on encouraging future 

energy efficiency projects because of changes in the energy marketplace. All categories of 

programs can have market effects evaluations; however, these evaluations are primarily 

associated with market transformation programs that indirectly achieve impacts. 

Market transformation: A reduction in market barriers resulting from a market intervention, as 

evidenced by a set of market effects, that lasts after the intervention has been withdrawn, 

reduced, or changed. 

Measures: Installation of equipment, installation of subsystems or systems, or modification of 

equipment, subsystems, systems, or operations on the customer side of the meter, in order to 

improve energy efficiency. 

Net-to-gross ratio: A key requirement for program-level evaluation, measurement, and 

verification. This ratio accounts for only those energy efficiency gains that are attributed to, and 

the direct result of, the energy efficiency program in question. It gives evaluators an estimate of 

savings that would have occurred even without program incentives. 

Net present value: The value of a stream of cash flows converted to a single sum in a specific 

year, usually the first year of the analysis. It can also be thought of as the equivalent worth of all 

cash flows relative to a base point called the present. 

Nominal: For dollars, “nominal” means the figure representing the actual number of dollars 

exchanged in each year, without accounting for the effect of inflation on the value or purchasing 

power. For interest or discount rates, “nominal” means that the rate includes the rate of inflation 

(real rate plus inflation rate equals the nominal rate). 

Participant cost test: A cost-effectiveness test that measures the economic impact to the 

participating customer of adopting an energy efficiency measure. 

Planning study: A study of energy efficiency potential used by demand-side planners within 

utilities to incorporate efficiency into an integrated resource planning process. The objective of a 

planning study is to identify energy efficiency opportunities that are cost-effective alternatives to 

supply-side resources in generation, transmission, or distribution. 

Portfolio: Either (a) a collection of similar programs addressing the same market, technology, 

or mechanisms or (b) the set of all programs conducted by one organization. 

Potential study: A study conducted to assess market baselines and energy efficiency savings 

potentials for different technologies and customer markets. Potential is typically defined in terms 

of technical, economic, achievable, and program potential. 

Program administrators: Typically procure various types of energy efficiency services from 

contractors (e.g., consultants, vendors, engineering firms, architects, academic institutions, 

community-based organizations), as part of managing, implementing, and evaluating their 

B-2 Understanding Cost-Effectiveness of Energy Efficiency Programs 
National Action Plan for Energy Efficiency B-3

portfolio of energy efficiency programs. Program administrators in many states are the utilities; 

in some states they are state energy agencies or third parties. 

Program design potential study: Can be undertaken by a utility or third party for the purpose 

of developing specific measures for the energy efficiency portfolio. 

Ratepayer impact measure: A cost-effectiveness test that measures the impact on utility 

operating margin and whether rates would have to increase to maintain the current levels of 

margin if a customer installed energy efficient measures. 

Real: For dollars, “real” means that the dollars are expressed in a specific base year in order to 

provide a consistent means of comparison after accounting for inflation. For interest and 

discount rates, “real” means the inflation rate is not included (the nominal rate minus the 

inflation rate equals the real rate). 

Societal cost test: A cost-effectiveness test that measures the net economic benefit to the 

utility service territory, state, or region, as measured by the total resource cost test, plus indirect 

benefits such as environmental benefits. 

Time-of-use periods: Blocks of time defined by the relative cost of electricity during each block. 

Time-of-use periods are usually divided into three or four time blocks per 24-hour period (onpeak, mid-peak, off-peak, and sometimes super off-peak) and by seasons of the year (summer 

and winter). 

Total resource cost test: A cost-effectiveness test that measures the net direct economic 

impact to the utility service territory, state, or region. 

Utility/program administrator cost test: The program administrator cost test, also known as 

the utility cost test, is a cost-effectiveness test that measures the change in the amount the 

utility must collect from the customers every year to meet an earnings target—e.g., a change in 

revenue requirement. In a number of states, this test is referred to as the program administrator 

cost test. In those cases, the definition of the “utility” is expanded to program administrators 

(utility or third party). 

Appendix C: Cost-Effectiveness Tables of Best 

Practice Programs 

Southern California Edison Residential Incentive Program 

SCE’s Residential Energy Efficiency Incentive Program provides customer incentives for 

efficient lighting and appliances (not including HVAC). It is part of a coordinated statewide mass 

market efficiency program that coordinates marketing and outreach efforts. This program is 

used as the example in Section 3.1 to illustrate the calculation of each of the cost-effectiveness 

tests. 

The values shown in Tables C-1, C-2 and C-3 are for the fourth quarter of 2006. Note that dollar 

benefits associated with emissions reductions are included in the forecasted avoided cost of 

energy, and are therefore not separately reported. The other category in this case includes 

direct implementation activity costs incurred by SCE that are over and above the cost of the 

efficiency measure. Direct installation costs paid by the utility that offset the cost of the measure 

are included under “program incentives.” 

National Action Plan for Energy Efficiency C-1
Table C-1. SCE Program Costs 

Cost Inputs Var. 

Program overhead 

Program administration $ 898,548

Marketing and outreach $ 559,503

Rebate processing $ 1,044,539

Research and development — 

Evaluation, measurement, and verification — 

Shareholder incentive — 

Other $ 992,029

Total program administration $ 3,494,619 O 

Program incentives 

Rebates and incentives $ 1,269,393

Direct installation costs $ 564,027

Upstream payments $ 13,624,460

Total incentives $ 15,457,880 I 

Total program costs $ 18,952,499

Net measure equipment and installation $ 41,102,993 M 

Source: SCE 4TH Quarter 2006 EE Report & Program Calculators, 

<http://www.sce.com/AboutSCE/Regulatory/eefilings/Quarterly.htm>. 

C-2 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Table C-2. SCE Program Benefits 

Net Benefit Inputs Var. 

Resource savings Units $ 

Energy (MWh) 2,795,290 $ 187,904,906 

Peak demand (kW) 55,067 — 

Total electric — $ 187,904,906 

Natural gas (MMBtu) — — 

Total resource savings $ 187,904,906 S 

Participant bill savings Electric $ 278,187,587 B 

Gas — 

Monetized emission savings Tons 

NOx 421,633 — 

SOx — — 

PM10 203,065 — 

CO2 1,576,374 — 

Total emissions $ — E 

Non-monetized emissions (externalities) Tons 

NOx — — 

SOx — — 

PM10 — — 

CO2 — — 

Total emissions — EXT 

Non-energy benefits $ — NEB 

Source: SCE 4TH Quarter 2006 EE Report & Program Calculators, 

<http://www.sce.com/AboutSCE/Regulatory/eefilings/Quarterly.htm>. 

National Action Plan for Energy Efficiency C-3
Table C-3. SCE Program Cost-Effectiveness Test Results 

Summary of Cost-Effectiveness Results 

Lifecycle costs and benefits 

Test Cost Benefits Ratio 

PCT $ 41,102,993 $ 293,645,467 7.14 

PAC $ 18,952,499 $ 187,904,906 9.91 

RIM $ 297,140,086 $ 187,904,906 0.63 

TRC $ 44,597,612 $ 187,904,906 4.21 

SCT $ 44,597,612 $ 187,904,906 4.21 

Costs and benefits included in each test

PCT = M = B + I 

PAC = O + I = S 

RIM = O + I + B = S 

TRC = O + M = S + E 

SCT = O + M = S + E + EXT + NEB 

Estimated levelized costs and benefits 

Test Cost $/kWh Benefits $/kWh 

PCT $0.026 $0.184 

PAC $0.012 $0.117 

RIM $0.186 $0.117 

TRC $0.028 $0.117 

SCT $0.028 $0.117 

Assumptions for levelized calculations 

Average measure life 14 

WACC 8.50% 

Discount factor for savings 57% 

Source: SCE 4TH Quarter 2006 EE Report & Program Calculators, 

<http://www.sce.com/AboutSCE/Regulatory/eefilings/Quarterly.htm>. 

Note: The discount factor uses an estimate of average measure life and the utility weighted average cost 

of capital to convert the net present value of costs and benefits into levelized annual figures. The 

levelized annual costs and benefits are then used to calculate costs and benefits on a $/kWh basis. 

C-4 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Avista Regular Income Programs 

Avista is an electric and natural gas utility in the Northwest with headquarters in Spokane, 

Washington. The best practice program highlighted here represents the 2007 Regular Income 

Portfolio of electricity energy efficiency measures implemented by Avista. The numbers were 

obtained from the Triple-E Report produced by the Avista Demand-Side Management Team 

(Table 13E). 

Avista reports gross results, which do not take free riders into account. Installation rates, 

persistence/failure and rebound (“snap-back” or “take-back”) are taken into account in Avista’s 

estimates of energy savings. Avista does consider NEBs when they are quantifiable and 

defensible, which are predominately benefits from the customer’s perspective. 

Avista contributed to projects saving over 53 million kWh and 1.5 million therms in 2007. The 

HVAC and lighting categories made up 81 percent of the electric savings while 97 percent of the 

natural gas savings were in the HVAC and Shell categories. 

Avista incorporates quantifiable labor and operation and maintenance as non-energy benefits, 

which are included in the PCT, SCT, and TRC cost-effectiveness tests. 

Table C-4. Avista Program Costs 

Cost Inputs Var. 

Program overhead 

Program administration $ 2,564,894

Marketing and outreach — 

Rebate processing — 

Research and development — 

Evaluation, measurement, and verification — 

Shareholder incentive — 

Other — 

Total program administration $ 2,564,894 O 

Program incentives 

Rebates and incentives $ 4,721,881

Direct installation costs — 

Upstream payments — 

Total incentives $ 4,721,881 I 

Total program costs $ 7,286,775

Net measure equipment and installation $ 16,478,257 M 

Source: Avista Triple-E Report , January 1, 2007—December 31, 2007. 

National Action Plan for Energy Efficiency C-5
Table C-5. Avista Program Benefits 

Net Benefit Inputs Var. 

Resource savings Units $ 

 Energy (MWh) — $ 30,813,091 

 Peak demand (kW) — — 

 Total electric — $ 30,813,091 

 Natural gas (MMBtu) — $ (355,426) 

 Total resource savings $ 30,457,665 S 

 

Participant bill savings Electric $ 28,782,475 B 

 Gas $ (630,028) 

 

Monetized emission savings Tons 

 NOx — — 

 SOx — — 

 PM10 — — 

 CO2 — — 

 Total emissions $ — E 

 

Non-monetized emissions (externalities) Tons 

 NOx — — 

 SOx — — 

 PM10 — — 

 CO2 — — 

 Total emissions — EXT 

 

Non-energy benefits $ 12,595,276 NEB 

Source: Avista Triple-E Report , January 1, 2007—December 31, 2007. 

C-6 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Table C-6. Avista Program Cost-Effectiveness Test Results 

Summary of Cost-Effectiveness Results 

Lifecycle costs and benefits 

Test Cost Benefits Ratio 

PCT $ 11,756,376 $ 40,747,723 3.47 

PAC $ 7,286,775 $ 30,457,665 4.18 

RIM $ 36,069,250 $ 30,813,091 0.85 

TRC $ 19,043,151 $ 43,052,941 2.26 

SCT $ 19,043,151 $ 43,052,941 2.26 

 

Costs and benefits included in each test 

PCT = M - I = B + NEB 

PAC = O + I = S 

RIM = O + I + B = S 

TRC = O + M = S + E + NEB 

SCT = O + M = S + E + EXT + NEB 

 

Assumptions for levelized calculations 

Average measure life 14 

WACC 8.50% 

Discount factor for savings 57% 

Source: Avista Triple-E Report , January 1, 2007—December 31, 2007. 

National Action Plan for Energy Efficiency C-7
Puget Sound Energy Commercial/Industrial Retrofit Program 

Puget Sound Energy’s (PSE’s) Commercial/Industrial Retrofit Program encourages customers 

to use electric and natural gas efficiently by installing cost- and energy-efficient equipment, 

adopting energy efficient designs, and using energy-efficient operations at their facilities. In 

addition, incentives are available for fuel switch measures that convert from electric to natural 

gas while serving the same end use. Applicable Commercial and Industrial Retrofit measure 

category headings include, but are not limited to: HVAC and refrigeration, controls, process 

efficiency improvements, lighting improvements, building thermal improvements, water heating 

improvements, and building commissioning. 

Customers provide PSE with project costs and estimated savings. Customers assume full 

responsibility for selecting and contracting with third-party service providers. Projects must be 

approved for funding prior to installation/implementation. Maximum grants for hardware changes 

are based on PSE’s cost-effectiveness standard. Grants for projects are made available as a 

percentage of the measure cost. Electric and gas measures may receive incentive grants up to 

70 percent of the measure cost where the grant incentive does not exceed the costeffectiveness standard minus program administration costs. Measures exceeding the costeffectiveness standard will receive grants that are on a declining scale and will be less than 70 

percent of the measure cost. Electric and gas measures that have a simple payback of less than 

a year are not eligible for a grant incentive. 

Unlike the other programs presented in this document, PSE shows a positive RIM. A positive 

RIM is possible in the Pacific Northwest because of the allocation of low-cost hydro generation 

from the Bonniville Power Administration to municipal utilities. In some cases the marginal cost 

of avoided generation is determined by higher-cost thermal generation and is higher than the 

utility’s average retail rate. 

C-8 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Table C-7. PSE Program Costs 

Cost Inputs Var. 

Program overhead 

Program administration $ 2,745,048

Marketing and outreach — 

Rebate processing — 

Research and development — 

Evaluation, measurement, and verification — 

Shareholder incentive — 

Other — 

Total program administration $ 2,745,048 O 

Program incentives 

Rebates and incentives $ 9,914,463

Direct installation costs — 

Upstream payments — 

Total incentives $ 9,914,463 I 

Total program costs $ 12,659,511

Net measure equipment and installation $ 25,103,588* M 

Source: Data provided by Laura Feinstein at PSE. 

* Total value 

National Action Plan for Energy Efficiency C-9
Table C-8. PSE Program Benefits 

Net Benefit Inputs Var. 

Resource savings Units $ 

 Energy (MWh) 775,469 $ 50,465,421 

 Peak demand (kW) — — 

 Total electric — $ 50,465,421 

 Natural gas (MMBtu) 661,480 $ 2,575,451 

 Total resource savings $ 53,040,873 S 

 

Participant bill savings Electric $ 33,297,727 B 

 Gas — 

 

Monetized emission savings Tons 

 NOx — — 

 SOx — — 

 PM10 — — 

 CO2 1,576,374 — 

 Total emissions $ — E 

 

Non-monetized emissions (externalities) Tons 

 NOx — — 

 SOx — — 

 PM10 — — 

 CO2 — — 

 Total emissions — EXT 

 

Non-energy benefits $ — NEB 

Source: Data provided by Laura Feinstein at PSE. 

C-10 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Table C-9. PSE Program Cost-Effectiveness Test Results 

Summary of Cost-Effectiveness Results 

Lifecycle costs and benefits 

Test Cost Benefits Ratio 

PCT $ 25,103,588 $ 43,212,190 1.72 

PAC $ 12,659,511 $ 53,040,873 4.19 

RIM $ 45,957,238 $ 53,040,873 1.15 

TRC $ 27,848,636 $ 53,040,873 1.90 

SCT $ 27,848,636 $ 53,040,873 1.90 

 

Costs and benefits included in each test 

PCT = M = B + I 

PAC = O + I = S 

RIM = O + I + B = S 

TRC = O + M = S + E 

SCT = O + M = S + E + EXT + NEB 

Estimated levelized costs and benefits 

Test Cost $/kWh Benefits $/kWh 

PCT $0.05 $0.09 

PAC $0.03 $0.11 

RIM $0.10 $0.11 

TRC $0.06 $0.11 

SCT $0.06 $0.11 

Test Cost $/MMBtu Benefits $/MMBtu 

PCT $3.22 $5.54 

PAC $1.62 $6.80 

RIM $5.90 $6.80 

TRC $3.57 $6.80 

SCT $3.57 $6.80 

Assumptions for levelized calculations 

Average measure life 14 

WACC 8.50% 

Discount factor for savings 57% 

Source: Data provided by Laura Feinstein at PSE.

National Action Plan for Energy Efficiency C-11
National Grid MassSAVE Program 

The Massachusetts MassSAVE program is a residential conservation program targeting 

electricity and natural gas savings. The data shown in the tables that follow are taken from the 

National Grid 2006 Energy Efficiency Annual Report, submitted to the Massachusettes 

Department of Energy Resources and Department of Public Utilities in August 2007. 

In the residential sector, there are diminishing energy savings available from single-measure 

incentive programs, in part due to federal appliance and lighting standards, as well as rapid 

progress in increasing the market penetration of CFLs relative to incandescent lighting. As a 

result, more utilities are seeking to develop program models that tackle harder-to reach 

opportunities and offer more comprehensive savings. National Grid’s Home Performance with 

ENERGY STAR is one such program model. This program offers comprehensive whole-house 

improvements (insulation, air sealing, duct sealing, and HVAC improvements) for homeowners. 

Customers receive in-home services, step-by-step guidance, incentives for energy measures, 

quality installations and inspections, and low-interest financing. 

Since contractors that deliver home performance services are in short supply in most markets, 

an infrastructure building phase is typically needed. During the initial two- to three-year startup 

phase, program costs may be high relative to energy savings. However, as contracting services 

increase over time, energy savings tend to increase dramatically. Limiting cost-effectiveness 

tests to three-year program cycles or less may inadvertently limit the development of these longterm, comprehensive program models. National Grid was able to reduce administrative costs 

associated with contractor recruitment, training, and quality assurance by limiting contractor 

participation in program startup and by requiring participating contractors to directly install some 

measures. 

Comprehensive, whole-building program models such as Home Performance with ENERGY 

STAR may face a number of additional challenges using commonly employed practice for 

calculating cost-effectiveness. For example, installing air sealing and insulation reduce heating 

and cooling loads, which reduces the savings associated with installing efficient HVAC 

equipment (interactive effects; see Section 3.2.1). However, reduced heating and cooling loads 

can also provide opportunities for downsizing heating and cooling systems, which are not 

captured by the cost-effectiveness tests. Furthermore, whole-house improvements provide a 

variety of non-energy benefits (Section 4.9) that can be difficult to quantify and are often not 

included as benefits in the cost-effectiveness tests. 

More information can be found online at <http://www.masssave.com/customers/>. 

C-12 Understanding Cost-Effectiveness of Energy Efficiency Programs 
Table C-10. National Grid Program Costs 

Cost Inputs Var. 

Program overhead 

 Program administration $ 760,324 

 Marketing and outreach $ 296,628 

 Rebate processing — 

 Research and development — 

 Evaluation, measurement, and verification $ 134,077 

 Shareholder incentive — 

 Other — 

 Total program administration $ 1,191,029 O 

 

Program incentives 

 Rebates and incentives $ 3,507,691 

 Direct installation costs — 

 Upstream payments — 

 Total incentives $ 3,507,691 I 

 

Total program costs $ 4,698,720 

 

Net measure equipment and installation $ 2,452,985 M 

Source: Data provided by Lynn Ross at National Grid. 

National Action Plan for Energy Efficiency C-13
Table C-11. National Grid Program Benefits 

Net Benefit Inputs Var. 

Resource Savings Units $ 

 Energy (MWh) 46,385 $ 2,550,000 

 Peak demand (kW) 6,921 3,328,000 

 Total electric — $ 5,878,000 

 Natural gas (MMBtu) 655,547 6,506,048 

 Total resource savings $ 12,384,048 S 

 

Participant bill savings Electric $ 679,800 B 

 Gas — 

 

Monetized emission savings Tons 

 NOx 7 — 

 SOx 19 — 

 PM10 — — 

 CO2 1,576,374 — 

 Total emissions $ — E 

 

Non-monetized emissions (externalities) Tons 

 NOx — — 

 SOx — — 

 PM10 — — 

 CO2 — — 

 Total emissions — EXT 

 

Non-energy benefits $ 155,601 NEB 

Source: Data provided by Lynn Ross at National Grid. 

C-14 Understanding Cost-Effectiveness of Energy Efficiency Programs 
National Action Plan for Energy Efficiency C-15

Table C-12. National Grid Program Cost-Effectiveness Test Results 

Summary of Cost-Effectiveness Results 

Lifecycle costs and benefits 

Test Cost Benefits Ratio 

PCT $ 2,452,985 $ 4,187,491 1.71 

PAC $ 4,698,720 $ 12,384,048 2.64 

RIM $ 5,378,520 $ 12,384,048 2.30 

TRC $ 7,151,705 $ 12,384,048 1.73 

SCT $ 7,151,705 $ 12,539,649 1.75 

 

Costs and benefits included in each test 

PCT = M = B + I 

PAC = O + I = S 

RIM = O + I + B = S 

TRC = O + M = S + E 

SCT = O + M = S + E + EXT + NEB 

 

Estimated levelized costs and benefits 

Test Cost $/kWh Benefits $/kWh 

PCT $0.04 $0.06 

PAC $0.07 $0.18 

RIM $0.08 $0.18 

TRC $0.10 $0.18 

SCT $0.10 $0.18 

Test Cost $/MMBtu Benefits $/MMBtu 

PCT $2.79 $4.76 

PAC $5.34 $14.08 

RIM $6.11 $14.08 

TRC $8.13 $14.08 

SCT $8.13 $14.26 

Assumptions for levelized calculations 

Average measure life 8 

WACC 8.50% 

Discount factor for savings 70% 

Source: Data provided by Lynn Ross at National Grid. 

National Action Plan for Energy Efficiency D-1

Appendix D: References 

Erickson, J., B. Ward, and J. Mapp (2004). Peak Demand Reduction vs. Emissions Savings: 

When Does It Pay to Chase Emissions? ACEEE Summer Study paper. 

Golove, W.H., and J.H. Eto (1996). Market Barriers to Energy Efficiency: A Critical Reappraisal 

of the Rationale for Public Policies to Promote Energy Efficiency. Lawrence Berkeley National 

Laboratory LBL-38059. 

Mahone, A., J. Moore, J. Williams, and C.K. Woo (2008). Energy Efficiency’s Impact on 

California’s Renewable Energy Development. 2008 ACEEE Summer Study on Energy 

Efficiency in Buildings, August 17–22, 2008, Pacific Grove, CA. 

National Action Plan for Energy Efficiency (2006). The National Action Plan for Energy 

Efficiency. <http://www.epa.gov/cleanenergy/energy-programs/napee/resources/actionplan.html> 

National Action Plan for Energy Efficiency (2007a). Aligning Utility Incentives with Energy 

Efficiency Investment. Prepared by Val R. Jensen, ICF International. 

<http://www.epa.gov/eeactionplan> 

National Action Plan for Energy Efficiency (2007b). Guide to Resource Planning with Energy 

Efficiency. Prepared by Snuller Price et al., Energy and Environmental Economics, Inc. 

<http://www.epa.gov/eeactionplan> 

National Action Plan for Energy Efficiency (2007c). Model Energy Efficiency Program Impact 

Evaluation Guide. Prepared by Steven R. Schiller, Schiller Consulting, Inc. 

<http://www.epa.gov/eeactionplan> 

National Action Plan for Energy Efficiency (2008). National Action Plan for Energy Efficiency 

Vision for 2025: A Framework for Change. <http://www.epa.gov/eeactionplan> 

Schleich, J., and E. Gruber (2008). Beyond case studies: Barriers to energy efficiency in 

commerce and the services sector. Energy Economics 30: 449-464. 

<http://eetd.lbl.gov/ea/emp/reports/38059.pdf> 


Funding and printing for this report was provided by the U.S. Department of Energy and U.S. Environmental 

Protection Agency in their capacity as co-sponsors for the National Action Plan for Energy Effi ciency.