DSM Shareholder Incentives: Current Designs and Economic Theory

This report reviews recent DSM shareholder incentive designs and performance at 10 U.S. utilities and identifies opportunities for regulators to improve the design of DSM shareholder incentive mechanisms to increase the procurement of cost-effective DSM resources. We develop six recommendations:

1. apply shared-savings incentives to DSM resource programs;
2. use markup incentives for individual programs only when net benefits are difficult to measure, but are known to be positive;
3. set expected incentive payments based on covering a utility's "hidden costs," which include some transitional management and risk adjusted opportunity costs;
4. use higher marginal incentives rates than are currently found in practice, but limit total incentive payments by adding a fixed charge;
5. mitigate risks to regulators and utilities by lowering marginal incentive rates at high and low performance levels; and
6. use an aggregate incentive mechanism for all DSM resource programs, with limited exceptions (e.g., information programs where markups are more appropriate).