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Rewarding energy efficiency for energy system services through markets: Opportunities and challenges in Europe

Jan Rosenow; Samuel Thomas

Energy efficiency provides value to energy systems in many ways. It reduces energy costs, avoids the need for costly capacity, lowers carbon emissions enabling environmental standards to be met more cheaply, avoids or defers the need for costly network upgrades and allows heating and cooling systems to be used more flexibly. These diverse value streams are often not recognised, with energy efficiency providers under-rewarded for the services they provide. As a result, fewer energy efficiency measures are undertaken, energy systems cost more to maintain, bill payers are worse off and, because of the non-energy benefits that energy efficiency provides, the wider society suffers. This report examines the mechanisms that are in place in the United States (U.S.) and Europe to reward energy efficiency as an energy system resource and draws conclusions for the focus of future efforts in the European Union (EU).

Dedicated energy efficiency markets are a proven way of rewarding energy efficiency. Energy efficiency is not dispatchable in the traditional sense; it is automatically dispatched alongside the load that it moderates. This means that energy-only markets cannot reward energy efficiency directly. However, the value that energy efficiency brings, in terms of lowering the marginal cost of meeting demand, was a key justification behind the setting up of Energy Efficiency Resource Standards in the United States. These Energy Efficiency Obligations (EEOs) on energy utilities to procure energy efficiency gains have also been developed in many European countries in recent years, often with a broader set of objectives beyond energy system efficiency. Some European EEOs employ market mechanisms that enable energy efficiency providers to produce and sell White Certificates to obligated parties. In some European countries, funds levied from bill payers have been used to set up centrally operated auction or tender mechanisms to directly procure energy efficiency improvements in a competitive environment. 

Capacity markets should enable energy efficiency to compete on a level playing field. While capacity markets are not a first best solution to issues of electricity system adequacy and reliability, where they are in place, energy efficiency is often excluded either explicitly or implicitly from participating. The capacity markets in New England and the PJM areas in the U.S. are examples of markets where energy efficiency is allowed to be bid into auctions, with increasing amounts being cleared over the course of the last 10 years. However, the rules associated with the participation of energy efficiency need to be carefully designed to ensure a level playing field. Rules around the minimum size of bids can act to effectively exclude many efficiency actions, and assumptions around the length of time that efficiency measures can bid for can be severe.

Network operators should be regulated to align their incentives with energy system goals. If network operators were regulated through incentives aligned with societal goals, they would also reward energy efficiency for the services it provides. However, many network operators are faced with a disincentive to reduce load, where revenues are not decoupled from throughput. To address this, performance-based regulation (PBR) is needed to base rewards on outputs instead of inputs, so that network utilities are just as likely to invest in equivalently priced demand-side resources as supply-side equivalents. Given the lack of familiarity with energy efficiency programming amongst network operators, additional incentives to invest in the demand side are justified, at least in the short run. This was the approach taken in the Brooklyn Queens Demand Management Program in the United States and has been part of the inspiration for recent pilot programmes in the United Kingdom.

The adoption by the EU of the Energy Efficiency First principle puts the onus on the energy efficiency industry to prove its value. A key issue for the energy efficiency industry is to be able to produce energy efficiency-based demand reductions that system operators and network utilities can rely upon. As the energy sector and National Regulatory Authorities begin to implement the new elements of the 4th energy package, demanding that distribution network plans provide “transparency on the medium- and long-term flexibility services needed … (and also) include the use of demand response, energy efficiency, energy storage facilities or other resources that [the] distribution system operator is using as an alternative to system expansion,” the energy efficiency industry and policymakers need to ensure that they are ready to respond. Similarly, as capacity mechanisms take steps to become “open to participation of all resources, including storage and demand-side management that are capable of providing the required technical performance,” energy efficiency service providers need to be able to show that energy efficiency resources can deliver at least as effectively as alternative options.

High quality measurement and verification are preconditions for market participation. System operators and network utilities, with their focus on system adequacy and reliability, need to be sufficiently satisfied, in turn, that energy savings are both adequate and reliable. In addition, as end-use electrification and intermittent renewable energy supply grow in importance, the value of energy efficiency varies increasingly by location, time of day and season. Recent developments in advanced metering infrastructure mean that more and more energy efficiency actions are open to more accurate and granular measurement, meaning that energy efficiency providers should be able to offer services based on metered energy consumption when and where it is most needed. A review of pay-for-performance programmes for energy efficiency will be the topic of the forthcoming deliverable 4.4 of the SENSEI project.

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