California sees success tying energy efficiency rebates to real results

For the past few years, California has been trying out a new way to do energy efficiency. Rather than measuring the value of efficiency investments based on estimates — the dominant method throughout the U.S. — the new approach uses real-world data to pay providers based on how useful their projects are to the power grid.

Now data from some of these efforts is coming in — and the results look promising. 

So says Matt Golden, CEO of Recurve, the company that created the software platforms to administer many of the ​“pay-for-performance” programs that have rolled out across parts of California.

According to that data, Recurve’s structure — called ​“FLEXmarket” — has helped boost the efficacy of improvements like efficiency retrofits and HVAC and lighting upgrades for commercial buildings.

In particular, over the past two years, they’ve delivered $44.7 million in ​“total system benefit” (TSB), a measure of how effective an efficiency program is at cutting customers’ electricity use during the hours and seasons when power is the most expensive to buy and the most carbon-intensive to generate. According to Recurve’s analysis of the data, each of the 508 ​“lifetime gigawatt-hours” of energy-use reduction achieved through these FLEXmarket programs to date — a measure of the total energy savings over the effective life of each project — has delivered twice the TSB per megawatt-hour compared to the average for the state’s other commercial efficiency programs.

Golden attributed the strong performance to the FLEXmarket structure, which provides contractors and aggregators with ​“an incentive to deliver grid value, because that’s the price signal they follow.”

In other words, it encourages contractors to find the customers with the greatest potential to save power when it’s most valuable for California’s grid, and then get paid based on the real-world results proven out by utility smart-meter data delivered via open-source tools pioneered in the state.

Study after study has shown that energy-efficiency improvements are vital to reducing carbon emissions. The International Energy Agency dubs efficiency the ​“first fuel” for the clean-energy transition due to its cost-effectiveness compared to increasing the supply of clean power, with the added benefits of reducing utility bills and improving resiliency in the face of energy disruptions.

But the potential for efficiency to cut carbon emissions and ease grid strains is far larger than the funding now available, industry experts say. Energy-efficiency programs, which are mainly funded by utilities and governments, have suffered from a combination of underinvestment and overly critical scrutiny of their cost-effectiveness. Reorienting incentives around outcomes rather than projections could be key to getting more return on every efficiency dollar — and potentially drawing more capital into a field that’s struggled to attract it.

Now, California regulators are requiring the state’s three big utilities Pacific Gas & Electric, Southern California Edison and San Diego Gas & Electric to incorporate this measured pay-for-performance approach. That requirement applies to the programs that are slated to direct nearly $9 billion in efficiency portfolio spending through 2031. Pay-for-performance has actually been an official goal of California efficiency policy since a 2015 law made it so — but the complexities of the industry have held back implementation until recently.

Moving from old-school estimates to real-world data

Right now, most of the billions of dollars spent on energy efficiency in the U.S. each year is allocated without much visibility into how well the investment has performed in the real world. Instead, the government agencies and utilities that fund efficiency and the contractors and program administrators that deploy that money have relied on a complicated method called ​“deemed savings” to estimate the efficacy of insulation upgrades, sealing air ducts and windows and installing efficient lighting, HVAC and appliances.

According to Jane McClellan, principal at Taper, a general-contractor subsidiary of nonprofit efficiency program administrator Ecology Action, these estimates are ​“usually pretty conservative,” in order to avoid overpaying customers and contractors from utility ratepayer-funded programs.

These payments are averaged out across an entire portfolio of buildings and projects, with contractors and efficiency aggregators getting paid out of a limited pool of funds based on the number of projects they complete rather than on how much homes and businesses actually end up saving on their utility bills. That means it’s hard to tell whether contractors are choosing quantity over quality in their work, which has led to ever-more complex structures to police their performance.

What’s more, these efficiency methods don’t take into account the key factor of when those homes and businesses use energy. That’s a critical oversight because electricity can be cheap and plentiful during some hours — like when excess solar power is flooding California’s grid — and scarce and costly at other times, like when the sun goes down on a hot summer evening and lots of households crank up the AC, putting California’s grid at risk of blackouts.

In other words, the traditional deemed-savings approach is ​“not doing anything to prioritize projects that are more beneficial for the grid,” McClellan explained. 

The pay-for-performance programs that Taper has been participating in over the past few years in Northern California are much different, she said. ​“We’re moving from this world of paying rebates based on average savings during any hour of the day, to a world where we can really home in on paying rebates for savings that are going to make the greatest impact on the grid.”

One example of a high-impact project is targeting lighting and HVAC improvements for commercial buildings that stay open in the evenings, when California grid stress reaches its peak. But commercial customers aren’t the only valuable target, Golden noted.

He cited the example of a measured-savings project that efficiency program administrator Franklin Energy carried out for Pacific Gas & Electric under the Northern California utility’s Comfortable Home Rebates program.

“Franklin took all that data to find the right customers and created simple measure-based implementations for the contractors,” he said, like insulation and air sealing, replacing old furnaces and air conditioners with heat pumps and installing smart thermostats. The results were then measured using smart-meter data to track changes in electricity and fossil gas usage and customer costs, and Franklin was paid based on what was delivered, with a bonus for peak savings.

By tying performance to individual homes, Franklin avoided key pitfalls of the deemed-savings approach, such as installing as much equipment as possible instead of maximizing results for the customer and the grid, Golden said.

The measured-performance approach also helped clarify a key point of confusion for energy-efficiency programs, he said: the value of reducing energy use during different hours and seasons.

Many of Franklin Energy’s contractors targeted homes in California’s hot Central Valley, where heating needs are low but air-conditioning loads are heavy, to replace old air conditioners and gas furnaces with two-way heat pumps that both heat and cool homes. That significantly reduced how much electricity they used during hot summer days, but also replaced gas usage with increased electricity usage during the winter, leading to an overall increase in electricity use over the year.

An efficiency program that simply measured total energy usage over the course of a year would have deemed that a failure, Golden said. But a program that prioritizes grid needs will reward investments that help shift electricity use from summer — when California’s grid is under the greatest stress — to the winter, when power is plentiful and grid capacity is ample.

“These are not some subtle changes,” Golden insisted. Instead, ​“it’s a fundamental pivot from efficiency being a rebate program” for insulation and better HVAC systems ​“to energy efficiency as a baseload virtual power plant.”

The term ​“virtual power plant” usually describes systems that actively control large aggregated groups of customers’ backup batteries, electric vehicle chargers and other technologies. But the same concept could apply to efficiency investments that shift energy demand away from grid peaks, he said.

“Focusing on insulating attics or replacing really bad air conditioners creates a long-term load impact” on summer grid peaks in hot climates, he said. While emergency load-reduction and demand-response programs that encourage people to cut energy use during grid emergencies are important, ​“the bulk of potential can be found in energy efficiency — when it’s optimized for the grid.”

California’s long road to pay-for-performance efficiency 

Averaging out efficiency spending and results made sense back when utility electric meters were mechanical devices that needed to be manually read by utility workers every month. 

But California’s three major utilities have had smart meters deployed across their customer base since the early 2010s, giving them and their customers the data to make efficiency programs far more effective.

That’s why California lawmakers ordered state regulators and utilities to make pay-for-performance the primary method to implement energy efficiency in AB 802 and SB 350, two laws passed in 2015. SB 350 upped the state’s efficiency goals, and AB 802 set building benchmarking and energy-data collection mandates to tie the rewards for efficiency programs and contractors to real-world performance.

Utilities started rolling out their first measured pay-for-performance pilot programs a few years after these laws were passed. But progress was slow and stymied by uncertainties regarding how to properly measure performance. ​“There have been a lot of fits and starts,” said McClellan, who worked at PG&E up until 2017, when its first pay-for-performance programs were rolling out.

But an emergency grid-reliability order passed by the California Public Utilities Commission in late 2021 in response to the state’s 2020 blackouts included a requirement for the state’s three big utilities to create ​“Market Access” programs to pay contractors and customers for the grid value of energy-efficiency improvements.

Also in 2021, the CPUC issued an order for all efficiency programs in the state to measure their impact based on the ​“total system benefit” metric, which includes values for lessening grid stress, reducing greenhouse gas emissions and shifting energy demand from fossil gas to electricity.

Earlier this year, the CPUC set down its most aggressive mandate yet for California’s big utilities to base their efficiency efforts on performance measured by smart-meter data. In this order, the CPUC notes that many utility efficiency programs have continued to use deemed-savings methods, despite AB 802’s mandate to use measured-performance data instead.

Starting in 2024, the CPUC’s order states, all efficiency programs will be ​“required” to use meter-data-based measurements unless ​“using these methods is not feasible and/​or cost-effective.” It also highlighted the Market Access programs as ​“an approach that we would like to see expanded in the main energy efficiency portfolio.”

That’s a big deal, Golden said, because it sets in clear language a demand to follow through with a mandate that’s technically been official California policy since AB 802 was passed in 2015. Now, nearly eight years later, ​“they’re finally doing it.”

While California’s big three utilities move ahead with their Market Access program implementations and start to meet the CPUC’s new demand for using meter-based methods for all of their efficiency programs, other entities are launching measured pay-for-performance programs.

Those include California’s community choice aggregators — the city- and county-based entities that have taken over energy procurement for customers across a growing swath of the state. MCE, formerly Marin Clean Energy, launched its Demand FLEXmarket program in 2021, and others are now preparing to launch programs, Golden said.

Other adopters include California’s regional energy networks, or RENs — entities created by county governments and authorized by the CPUC to administer a portion of the state’s multibillion-dollar efficiency program spending.

In the last year, the Bay Area Regional Energy Network launched its FLEXmarket rebate program for commercial building efficiency, and 3C-REN, a partnership of San Luis Obispo, Santa Barbara and Ventura counties, launched a FLEXmarket program focused on low- and moderate-income single-family homes.

“One thing that’s been really cool is how we could take this idea and this platform from Recurve and shape it to meet our programmatic and regional REN goals,” said April Price, 3C-REN program manager. For example, 3C-REN wants to help customers install heat pumps to replace gas furnaces and water heaters, which emit greenhouse gases and fumes harmful to health — a goal it shares with many other California city, county and state policymakers.

The structure of Recurve’s platform places a high value on kilowatt-hour reductions, but heat pumps actually increase electricity consumption as they decrease fossil gas consumption. To counter that, 3C-REN increased the value of reductions in gas consumption in its formula to calculate incentives for contractors and customers ​“so that the increased electrical load associated with heat-pump adoption wouldn’t kill the economics of a project,” Price said.

3C-REN also boosted the incentives for serving harder-to-reach customers, such as lower-income customers and those whose primary language isn’t English, she said.

“The goal was that contractors would have a huge incentive to work with hard-to-reach customers — because they’d be paid more — and to deliver electrification projects that delivered true energy savings.”

From pilot programs to multibillion-dollar business models?

That’s not to say that the switch to pay-for-performance is simple, Price said. One challenge is that it delays the typical flow of funds from programs to contractors and customers, she noted. What were once upfront incentives have become after-the-fact performance payments.

To counter this, ​“We’ve modified our incentive structure so that about half of our forecasted incentives are paid upfront, and those incentives are paid to our customers.” 

McClellan with Taper agreed that performance-based payments introduce a new variable to the standard deemed-savings efficiency paradigm.

“It’s a transition for customers to think about getting paid based on the actual savings they see at the meter. And that performance period is a long time — it’s a year after the installation,” which forces contractors to either convince customers to wait longer for incentive payments or to take on the risk of paying them in advance and then waiting for results to see if they hit the mark.

At the same time, smart meters can offer an invaluable source of data for forecasting the impact of different efficiency investments for different customers, as well as the up-to-date proof of the impact of those investments, she said. That’s the kind of data that could undergird financing structures that allow program administrators and contractors to pay in advance for the future value of efficiency improvements.

That’s how Andy Frank, CTO of New York–based efficiency aggregator Sealed, sees the pay-for-performance market developing. Sealed uses forecasting and shared-savings agreements to provide efficiency and electrification improvements to residential customers at low to no upfront cost in the U.S. Northeast, and it recently launched a pilot project with 3C-REN to do similar work in California.

“We’re providing an upfront rebate to the contractor and the homeowner, very similar to what we’re doing today with our core direct-to-consumer business, where we provide the upfront capital as part of the financing of the project,” Frank said of Sealed’s 3C-REN pilot. That allows contractors to ​“get paid quicker with less paperwork and get rewarded for quality work,” while Sealed is ​“paid back over time based on actual energy savings.”

This approach carries a significant amount of risk for the company providing the upfront payment, he acknowledged. Sealed relies on data analysis to pinpoint customers that it can reliably forecast will see significant utility-bill savings from weatherization and fossil-fuel-to-heat-pump replacements to guard against the risk of losing money on its business model.

But at least in California, the regulatory risk of this approach appears to be fading with the state’s recent steps to expand the role of performance-based efficiency, Frank said.

“My interpretation of it is that it doubles down on measured savings and puts the onus on program administrators to show why measured savings will not work,” he said ​“That’s a signal that California is open for business when it comes to measured-savings programs.”