1 Shareholder Incentives for Utility-based Energy Efficiency Programs in California*

Energy efficiency is increasingly being recognized as a preferred resource warranting aggressive public investment. The State of California has committed an unprecedented sum of $2.2 billion in ratepayer funds to utility-based energy efficiency programs from 2006 through 2008; the State finalized in 2007 the determination of the shared-savings incentive mechanism for the 2006-2008 programs and beyond. This study seeks to examine whether the adopted incentive mechanism would ensure an efficient delivery of the programs, and what reforms, if any, could be proposed to meet this end. I develop a game theory model for the implementation of the programs, in which a regulator adopts an energy savings target and a shared-savings incentive mechanism before a utility firm proposes program funding, gets the proposal authorized, and begins to manage the programs. The study reveals that each firm requires a minimum level of incentive rate, in order for the mechanism to encourage the firm to achieve the adopted energy savings target, eventually bringing non-negative bill savings to its customers. It also reveals that a higher-than-minimum incentive rate could achieve not only a greater net social benefit but also greater bill savings for customers. Model-based analysis of California energy efficiency programs suggests that a higher-than-adopted incentive rate is warranted and that social efficiency would be improved by customizing incentive mechanisms for individual utilities and updating them on a regular basis