Estimation of Avoided Costs for Electric Utility Demand-Side Planning

Avoided costs originated with federal laws designed to encourage renewable energy and small power production. When estimated properly, they provide an unbundled characterization of the short- and long-run cost structure of a utility. We review current practices for estimating avoided costs for use in electric utility demand-side management (DSM) resource planning. For large DSM resource options, using avoided costs to estimate value is more accurate than using short-run marginal costs; avoided costs are simpler to use than traditional supply planning methods. We describe various administrative approaches for estimating avoided power generation costs and discuss modeling issues that arise in the estimation process. We also discuss emerging, market-based approaches for estimating avoided costs and describe current estimation practices for the additional, often substantial, non-generation-related costs avoided by DSM programs. Finally, we discuss special considerations in using avoided costs to estimate the system value of DSM.