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Using Benefit-Cost Analysis to Improve Distribution System Investment Decisions: Issue Brief

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Electric utility regulators are paying closer attention than ever before to individual distribution system investment decisions, in part because of the rapid growth in distributed energy resources and the need for new grid modernization investments.

To achieve the best outcomes for ratepayers and society, regulators need robust and comprehensive tools for evaluating utility investments. Benefit-cost analysis is, in many cases, a superior analytical tool to traditional least cost/best fit methods. It can recognize and maximize a wider range of benefits and consider a broader range of impacts. It also allows for a more detailed analysis.

This issue brief compares the two analytical approaches and describes the many opportunities to use benefit-cost analysis (BCA) in new and better ways.

Author John Shenot and contributors Elaine Prause and Jessica Shipley also explore five crucial questions that regulators must answer as they shape benefit-cost analysis policies for their jurisdictions:

  • In what proceedings will we use BCA methods?
  • Who will conduct BCAs?
  • How will we engage stakeholders?
  • Which cost-effectiveness test(s) will we use?
  • How will we use BCA results to make decisions?

For those interested in a more thorough treatment of the topic, a companion reference report offers more detail as well as many examples from state regulatory proceedings.

Using Benefit-Cost Analysis to Improve Distribution System Investment Decisions: Reference Report

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Electric utility regulators are paying closer attention than ever before to individual distribution system investment decisions, in part because of the rapid growth in distributed energy resources and the need for new grid modernization investments.

To achieve the best outcomes for ratepayers and society, regulators need robust and comprehensive tools for evaluating utility investments. Benefit-cost analysis is, in many cases, a superior analytical tool to traditional least cost/best fit methods. It can recognize and maximize a wider range of benefits and consider a broader range of impacts. It also allows for a more detailed analysis.

This reference report compares the two analytical approaches and describes the many opportunities to use benefit-cost analysis (BCA) in new and better ways.

Author John Shenot and contributors Elaine Prause and Jessica Shipley also explore five crucial questions that regulators must answer as they shape benefit-cost analysis policies for their jurisdictions:

  • In what proceedings will we use BCA methods?
  • Who will conduct BCAs?
  • How will we engage stakeholders?
  • Which cost-effectiveness test(s) will we use?
  • How will we use BCA results to make decisions?

The reference report includes many examples of BCA use from state regulatory proceedings.

A companion issue brief offers a condensed treatment of the topic for those seeking a summary.

A policy toolkit for global mass heat pump deployment

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Heat pumps, a critical technology for clean energy systems, are poised to become the most important technology for heating decarbonisation. Currently, the vast majority of heat is provided by fossil fuels. In order to promote and encourage heat pump installations across the globe, the Regulatory Assistance Project, CLASP and the Global Buildings Performance Network have developed this heat pump policy toolkit, which provides a suite of tools, and advice on how to use them, for policymakers interested in promoting this critical technology.

The structure of the toolkit is loosely based on that of a Greek temple, with foundations and pillars, supporting a rapidly growing heat pump market. The interactive toolkit (which includes clickable links throughout) also features short videos that give an overview of each relevant element of the toolkit. These videos make up a short series which complements this document.

This toolkit works as a synthesis of policy approaches to heat pump deployment and a guide to designing the best packages of policies. As you’ll see in the toolkit (and in the graphic below), a complete policy package needs to consider foundational elements and must also take account of each pillar. We provide details, examples and potential issues, and solutions within the various policy elements discussed.

Heat Pump Toolkit temple

Foundational elements of this toolkit recognise the need for coordination and communication around heat pump policy efforts and strategies.

Pillar 1 considers economic and market-based instruments. These instruments are fundamentally associated with balancing the economics of heat use towards clean options, such as heat pumps, so that their lifetime costs are cheaper than fossil-based alternatives.

Pillar 2 considers financial support. Within this pillar, we identify three key elements of financial support for heat pumps — grants and tax rebates, loans and heat-as-a-service packages.

Pillar 3 considers regulations and standards. We look at buildings codes and standards, appliance standards and heat planning and zoning.

To build an effective heat pump policy package, policymakers must consider foundational elements as well as each of the pillars. And even within each pillar, combinations of elements may be appropriate.

Cleaning up heat: The changing economics for heat pumps in Poland

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Over the past two years, Poland has become a remarkable success story for deployment of clean heat systems, especially heat pumps. Its progress is due to strong policy support for phasing out coal for individual heating. However, Poland’s dependence on fossil fuels for heating is still high, and Russia’s invasion of Ukraine has shown that countries heavily reliant on fossil fuels are exposed to extreme price risk.

Duncan Gibb and Monika Morawiecka show that investment in a heat pump makes sense for Polish households from an economic, environmental, climate and energy security standpoint. This analysis investigates two current economic cases and makes several recommendations to make sure that policies for clean heating consider long-term objectives of decarbonisation, air quality and social impacts. These include properly pricing externalities into fossil fuels, strengthening clean air legislation and effectively regulating to decarbonise heating.

Getting the hydrogen network we need for decarbonisation

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Clean hydrogen provides a tool that can open up new opportunities for decarbonisation. But it is just one tool, and an expensive one at that. If policymakers allow, or even support, continuation of the current ‘hydrogen rush,’ we will end up with a larger hydrogen network than needed — with high costs for consumers.

Policymakers have the right tools in their toolbox — including unbundling, transparency requirements and regulatory oversight — to ensure that hydrogen supports rather than hinders decarbonisation efforts. The regulation of the fossil gas sector provides important lessons to be considered for hydrogen regulation. Megan Anderson and Andreas Jahn explain how independent, unbundled ownership can allow for the hydrogen network to be efficiently planned, developed and operated.

Make the Swap: Why it’s Time for Heat Pumps, Not ACs

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Amidst rising gas prices and groundbreaking US climate legislation, heat pumps are in the national spotlight. Now is the time to accelerate the deployment of this super-efficient technology across the country. But on a practical level, what is the most feasible and cost-effective path for consumers to adopt and operate heat pumps in their homes?

CLASP and RAP co-hosted a dynamic conversation about the opportunities to increase the deployment of heat pumps by using them to replace end-of-life air conditioners. This unique solution, in which the legacy heating system remains in place as a backup for high heating loads, offers consumers leading cost and energy savings while taking vital steps toward full home heating decarbonization.

Participants heard from leaders across the policy, research, industry, and installer communities to learn more about how this solution is already contributing to state and federal decarbonization goals.

For background information and analysis of this opportunity, please see the latest report from CLASP and RAP or the two-page summary.

A Win for Building Electrification: EPA Elevates Heat Pumps over One-Way ACs

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Millions of U.S. homes have central air conditioning for the summer and separate fossil fuel heating systems for the winter. A great way to boost home heating electrification is to replace those central air conditioners with look-alike “two-way” heat pump units, which can provide highly efficient heating in addition to cooling, at little extra up-front cost. CLASP and RAP analyzed ways to make this happen in a recent report. Our recommendations included revising appliance standards to require ACs to have two-way operation.

Central AC vs. Heat Pumps

Earlier this month, the Environmental Protection Agency put this idea into policy, saying that two-way heat pumps deserve the agency’s coveted Energy Star “Most Efficient” rating — and that even the best traditional one-way air conditioners no longer do.

This is big news for building electrification. It means that the hybrid electrification idea — where households ease into electrification, retaining their old fossil systems only for backup on the coldest days — is gaining ground. This approach has the immediate benefit of cutting fossil-fuel use, as households use their legacy fossil systems less. It also helps to smooth the path to full home electrification by boosting demand for heat pumps, increasing the capacity of heat pump contractors and installers, and raising consumer familiarity with heat pumps.

The details of EPA’s move: The agency issued final recognition criteria for specific products to qualify in 2023 as Energy Star Most Efficient. In its response to stakeholders who encouraged the EPA to remove one-way central AC units from the Most Efficient program, the agency wrote that it “expects 2023 to be the last year we recognize central air conditioners” as qualifying for the rating. It went on to state that it “agrees that hybrid heating is the logical next step for retrofits in existing homes, given the modest incremental cost to install a heat pump instead of an AC.” Furthermore, it indicated that it is adjusting its “marketing and communication strategy accordingly.”

In encouraging the EPA to reach such a conclusion, stakeholders pointed out that traditional central AC units only provide cooling and are currently paired with a fossil-fuel-fired furnace that delivers 100% of a home’s heating needs. By contrast, switching from central AC to heat pumps would allow consumers to use a cleaner and more efficient appliance for at least some of their heating needs. That in turn would avoid approximately 250 million tons of CO2 over 10 years, save $27 billion on heating bills, and produce an additional $80 billion in societal benefits.

The hybrid heating strategy, as a way to kickstart home electrification in the United States, is described in detail in CLASP and RAP’s report: Combating High Fuel Prices with Hybrid Heating: The Case for Swapping Air Conditioners for Heat Pumps. We make the case for appliance standards requiring ACs to have two-way operation, and the EPA decision is an important step in that direction. We also provide analyses of four major heating fuel types — oil, propane, methane and electric resistance — and outline key recommendations for how state governments and utilities can support accelerated heat pump adoption across the country.

The Energy Star Most Efficient designation is intended for use at point-of-sale on materials and product literature. The goal of the program is to encourage new, more energy-efficient products into the market more quickly by targeting early adopters. With the EPA’s decision, consumers will now have better information about the most efficient choices to make for cooling appliances.

This change should also have significant effects on state- and utility-run efficiency programs across the country due to their reliance on Energy Star information to decide what appliances to support. Fifty-four million American homes have one-way central ACs that can be easily swapped for a two-way heat pump, which would run in a hybrid configuration to both cool and heat the home, with the existing heating system as colder-weather backup. In a world where fossil fuel prices are high and volatile, the electric grid is getting cleaner, heat pumps are getting more and more efficient, and the demand for air conditioning is increasing, a big push for a swap of air conditioners to heat pumps over the next five to 10 years will smooth the way for full building electrification.

Turning off the gas: Stronger and coherent EU policy to accelerate the fossil gas phaseout

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Rapidly phasing out fossil gas demand has become a top priority in Europe. Existing European legislation is expected to achieve only moderate reductions by 2030. The ongoing energy crisis has provided an opportunity to aim for even more extensive decreases in fossil gas demand. Legislation under negotiation, informed by the European Commission’s REPowerEU plan, is expected to go further, yet more ambitious targets and a unified policy approach could achieve potential reductions currently left on the table.  

RAP’s analysis finds that even with full implementation of the REPowerEU plan, by 2030 natural gas demand in Europe will remain roughly equivalent to Russian gas imports in 2021. A stronger energy efficiency target in the Energy Efficiency Directive (EED) and a higher renewable energy target in the Renewable Energy Directive (RED) could reduce gas demand and eliminate Russian gas imports. 

Furthermore, the Hydrogen and Decarbonised Gas Market package should emphasize integrated planning and targeted applications of alternative gases to ensure its consistent with a fossil gas phaseout. 

A joint, coherent policy approach — addressing more ambitious targets for the EED and the RED and complementary metrics applied to the Hydrogen and Decarbonised Gas Market package — would guarantee that fossil gas use is rapidly reduced and the infrastructure is in place to meet the remaining demand equitably and efficiently.

How the European Union incentivises inefficient renewable heating

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The EU’s renewables directives count what fuel is burned for heating, as opposed to the amount of heat produced.

Never has the spotlight shone so brightly on Europe’s heating and cooling sector. And for a good reason. Fossil gas makes up around 39% of the energy used to heat buildings and much of Europe wants to rapidly phase it out.

To help do so, the European Parliament recently voted in favour of a key amendment to the Renewable Energy Directive (RED): raising the annual target for the share of renewable energy in heating and cooling.

The new goal—a 2.3 percentage-point increase each year until 2030—is roughly double the one proposed in the Fit-for-55 package unveiled in 2021.

The clear signal has been set, yet there is something off with the way the metric is measured. By counting fuel burned instead of heat produced and not including electricity used for heating or cooling, the RED favours inefficient technologies.

Ignoring the mushy peas on the floor

Imagine a toddler having lunch. Her father has prepared a bowl of 300 grams of mushy peas and figures that this meal should meet half of the two-year-old’s nutrient needs for the day. She is a messy eater though and jettisons around half of her food on the ground. Once her dad sees the empty plate, he pats himself on the back, thinking that he filled her belly. He should look at the floor.

Measuring the renewable share of heating and cooling in the RED is simple. It tallies all the energy used to heat and cool from renewable sources, then divides it by the total. The key question is: which energy counts as renewable?

Unfortunately, the RED’s answer to this is flawed. It only counts final energy use or, in other words, the fuel that is delivered to the customer to use in their heating appliance. That means if someone burns a log in a fireplace at 50% efficiency and it produces 100 kilowatt-hours (kWh) of heat, how much “renewable heat” does that account for?

If you were thinking “100 kWh” you would be wrong. The RED counts that as 200 kWh, since that is the energy content of the biomass that was combusted at 50% efficiency.

That is a big problem because heating systems have different efficiencies. An electric heat pump typically produces 100 kWh of heat with 33 kWh of input electricity. The remaining 67 kWh is drawn from the ambient air for free. An 85% efficient pellet boiler needs 117 kWh.

The point: Less efficient technologies need more input energy for the same useful heat outcome. The RED discourages switching to more efficient heating appliances and electrification. It counts the full weight of the mushy peas, not just those that were eaten.

Anti-electrification policy

The other problem with the RED methodology is its scope. It does not consider the renewable electricity used for heating and cooling at all. Whether it is used to drive a heat pump or just an electrical resistance heater, it does not count toward the renewable heating and cooling target. Even for cooling, which is virtually only based on electricity.

This is an effort to avoid double-counting. The data wranglers do not want to count renewable electricity in both the power sector and the heating and cooling sector. As a data wrangler myself, I appreciate their commitment to neat allocation. But in this case, neatness has its downside.

Electricity providing a heating or cooling service should be considered towards the renewable heating and cooling target. Otherwise, heat pumps could be undervalued in terms of their contributions. If the methodology does not even consider where the electricity comes from, the heat output of the heat pump can never be fully renewable.

If the renewable share of electricity would be considered in the RED’s methodology as a heating and cooling service, the incentive to promote heat pumps would even be stronger. Member States will thus be encouraged to implement policies that aim to achieve the heating and cooling target, with the ancillary benefit of growing the deployment of efficient heat pumps to do so.

As it stands, the least efficient and least electric technologies are those that have the most potential to meet the goals under the RED. More efficient and electricity-based heating appliances risk falling behind.

The way forward

Getting metrics right is crucial to ensuring a rapid and balanced transition to clean heating and cooling. The Renewable Energy Directive’s goal should be to promote efficient heating and cooling technologies that maximise useful energy while minimising input energy.

This means counting the useful heat that is produced by a heating system, not the input energy needed. It also means including the electricity used for renewable heating and cooling.

Since electricity realistically contributes to both the headline renewable energy target (32% in the RED II and voted to increase to 45% by the European Parliament), as well as the renewable heating and cooling target. Both calculations should factor it in so that the statistics are accurate.

Double-counting can be avoided by ignoring the electricity used in the heating and cooling sector when calculating the headline target.

Metrics matter. Only by counting the useful heat produced can the Renewable Energy Directive provide the right incentives for phasing out fossil gas and spurring the clean electrification of heat.

 

A version of this article originally appeared on Foresight Climate & Energy.

Photo: Holger Schué from Pexels.

Facilitating Distributed Energy Resources Requires Policy Actions

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Distributed energy resources can provide key opportunities that would empower India’s retail customers to improve system efficiency, lower costs, and reduce emissions. In the first part of our DER series, we laid out the arguments for how deploying distributed energy resources (DER) in scale provides a key opportunity to empower customers.

DERs include elements such as energy efficiency, demand response, storage resources, distributed generation closer to load (such as rooftop solar), and more. DERs help customers modify their electric usage in ways that will save them money, offer reliability products to electric wholesale system operators and discoms to increase reliability and efficiency of the system, and help reduce emissions. The promotion of DERs, however, requires affirmative action by utility regulators and policy makers.

In the second part our series, we outline policies that will facilitate the entry of DER providers.