Reports & papers

Issue paper: Bonneville Conservation Acquisition 2002-2006

December 8, 1999  |  document 99-18

Related link: Recommendations document 2000-3

Contents:

Summary
Background
Resource Potential, Distribution and Cost
Alternative approaches to Bonneville Conservation Acquisition
Analysis
Implementation Issues
Other Issues ? Application of Section 6(c) of the Northwest Power Act
Staff Draft Recommendations
Request for Public Comment
Appendix A ? Legal Requirements
Appendix B -- Comparison of 1998 plan's Forecast of Future Market Prices with Council's Analysis of the Bonneville Power Administration's Potential Future Costs and Revenues (Medium Forecast)
Appendix C ? Bonneville Draft Augmentation Principles

Summary

The Bonneville Power Administration intends to augment its power supplies by 800 to 1,000 average megawatts (aMW) to meet expected loads during the 2002 ? 2006 rate period. It intends to accomplish this primarily through market purchases but recognizes that the acquisition of cost-effective conservation must also be part of the mix. The intent of this issue paper is to explore ways in which Bonneville can acquire cost-effective conservation in ways that are compatible with the circumstances it faces.

Potential

The paper reviews the reasons for the conservation mandates of the Northwest Power Act and the experience of the last almost 20 years in implementing conservation, leading to the current situation. The conservation analysis of the 1998 Power Plan is reviewed to provide an estimate of the amount of conservation that is cost-effective for implementation in the 2002 ? 2006 period according to the definitions of the Northwest Power Act. These estimates take into account the changes in expected value of power since the 1998 plan's estimates were developed. The analysis indicates that the approximate development schedule of the cost-effective conservation potential for loads expected to be served by Bonneville would amount to approximately 30 aMW per year at a total cost of approximately $60 million per year. However, the cost to Bonneville should be significantly less because of customer and end-user contributions.

Three Approaches

The paper describes three possible approaches to acquiring conservation for the 2002 ? 2006 period. One is the traditional, long-term approach in which conservation investments are valued over their useful life. This approach has proven effective in the past but exposes Bonneville to the risk that it will not receive the full benefit of its investments if customers take load off at the end of the contract period. A second approach is intended to have effects for Bonneville that are as much as possible like a relatively short-term purchase of power on the market. In this approach, Bonneville would limit what it pays for conservation to the value the conservation delivers during the contract period, capped at a level that ensures there would be no impact on Bonneville's rates. This removes most risk from Bonneville but seems unlikely to produce additional conservation that would not have occurred in response to market forces. Finally, a "middle ground" approach is described in which Bonneville is willing to pay for conservation savings as long as and to the extent that a customer keeps load on Bonneville. Bonneville would endeavor to limit what it pays to have minimal impact on its net revenue requirement. This approach limits Bonneville's risk while opening the door to the development of longer payback, but still cost-effective conservation. The effectiveness of this approach depends on whether customers will see the risk they would bear as a significant deterrent to participating in Bonneville conservation efforts.

Analysis

The paper presents an analysis of the three approaches looking at two metrics ? the long-term net benefit to the region and the effect on Bonneville rates or, more accurately, its net revenue requirement. It finds that the long-term approach would yield a net benefit, in terms of reduced regional expenditures for electricity, of $235 million for conservation that would be implemented in the 2002 ? 2006 period. This does not reflect any environmental benefits nor does it reflect possible location-specific transmission and distribution savings. The "market purchase look-alike" is judged to produce little in the way of net benefit because staff believes it is unlikely to produce significant incremental conservation investment. The "middle ground" could produce benefits approaching $235 million if the risks that customers would bear are not perceived to be significant.

The analysis of the impact on Bonneville's rates is necessarily a rough approximation. It assumes that: Bonneville pays, on average, 50 percent of the conservation costs; pays those costs as they are incurred; and pays for all of it from the amounts budgeted for power augmentation. With those assumptions, the effect on Bonneville's net revenue requirement is an increase of approximately $27 million or a little more than 1 percent. This would be reduced if potential conservation development from activities already included in Bonneville's revenue requirement were counted.[1] It would be further reduced if Bonneville were to pay for savings as they are delivered. Unlike the market purchase, the investment in conservation will continue to return benefits beyond the five-year rate period. The "market-purchase look-alike" is judged to have no impact while the "middle ground" approach could have effects similar to the long-term approach.

[Footnote 1] Such activities include the Conservation and Renewables Rate Discount, low-income weatherization, and the Northwest Energy Efficiency Alliance.

Implementation Issues

The paper examines some implementation issues. One of these is the potential for using the Conservation and Renewables (C&R) Discount as the basis for Bonneville's conservation acquisition activities. Another is the suggestion that Bonneville use a Request for Proposals process, potentially including the participation of third parties, as a primary implementation mechanism.

Staff Recommendations

Bonneville has proposed a set of draft principles to use to guide conservation acquisition. In general, the staff finds that these principles embody policies that seek to implement the "middle ground" alternative for conservation acquisition described above. Staff recommends that the Council endorse this approach.

Bonneville states in its principles that it will target for acquisition its share of the cost-effective conservation identified in the Council's current plan. Staff estimates this to be a minimum of 150 aMW of conservation over the subscription period. Staff recommends that the Council endorse this as the minimum goal for Bonneville's conservation activities during the 2002 ?2006 period including the C&R Discount, low-income weatherization efforts not included in the C&R Discount, the activities of NEEA and conservation acquisition undertaken as part of the augmentation effort.

In addition to Council endorsement of Bonneville's "augmentation principles", the staff offers three additional recommendations.

Staff recommends that Bonneville's Transmission Business Line (TBL) also participate in supporting conservation and demand management efforts in cooperation with the efforts sponsored by Bonneville's Power Business Line (PBL). TBL faces the need to make significant, long-lived investments in transmission infrastructure to be able to serve growing loads. Efforts that reduce those loads may make it possible to avoid part of that investment. While the TBL will be more oriented toward peak shaving and shifting than traditional conservation, many measures provide both kinds of benefits, and therefore benefit both business lines. In addition, there may be synergies between conservation and demand management efforts.

The staff recommends that Bonneville give serious consideration to modifying the proposed C&R Discount to serve as a platform for acquiring conservation from Bonneville's customers. Staff recognizes Bonneville's concerns that changing the C&R Discount could affect the schedule of the rate case. However, the potential confusion and duplication resulting from two parallel efforts argue for consolidation.

The staff also recommends that the Council support Bonneville's implementation of a program to acquire conservation through a competitive bidding. Indeed, the staff believes that unless the Rate Discount program design features are altered, Bonneville should place its greatest emphasis on establishing a "bidding" or "competitive procurement" process to acquire conservation. This process should be open to subscribing customers as well as other parties who have arrangements with end-use consumers served by Bonneville's customers.

Request for Public Comment

[The comment period ended January 21, 2000.] The Council is seeking public comment on the following questions:

1. Do you agree with the staff recommendation endorsing the general approach to conservation acquisition embodied in Bonneville's principles? If not, what approach would you recommend and why?
2. Do you agree with the staff recommendation endorsing the 150 aMW cost-effective conservation target for the FY 2002 ? 2006 rate period? If not, what would you recommend and why?
3. Do you agree with the staff recommendation that Bonneville's Transmission Business Line participate in supporting conservation and demand management efforts in cooperation with the efforts sponsored by Bonneville's Power Business Line? If not, why?
4. Do you agree with the staff recommendation that Bonneville seek to modify the C&R Discount to serve as the basis for conservation acquisition? If not, why?
5. Do you agree with the staff recommendation that Bonneville implement a competitive bidding process for conservation implementation? If not, what approach would you recommend and why?
6. Are there other important issues regarding Bonneville conservation acquisition as part of its resource augmentation that you believe should be addressed? What are they?

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Background

The Bonneville Power Administration expects to augment its power supplies with approximately 800 to 1000 aMW of power to meet anticipated loads during the 2002 ? 2006 rate period. This comes about because of the perceived attractiveness of Bonneville power in relation to expected market prices during that period and reductions in federal system capability over the past few years. Bonneville intends to meet much of this need through relatively short-term market purchases. However, consistent with its statutory directive, Bonneville needs to acquire cost-effective conservation as part of the mix.

The Basis for Bonneville Conservation Acquisition

The basis for Bonneville conservation acquisition is both legal and economic. The Northwest Power Act requires that in acquiring resources, Bonneville must act in a manner consistent with the Council's power plan. The Act directs the Council, in its power planning, to give priority to resources that are cost-effective with priority given first to conservation, second to renewable resources, then "high efficiency" resources and then to all other resources. (The Act's relevant conservation provisions are summarized in Appendix A.) These provisions, however, have their roots in economics. In 1980, it was clear that there were opportunities for improving the efficiency of electricity use that cost less on a per kilowatt-hour basis than new generation. However, the economic signals for the development of those efficiency improvements were distorted. Retail rates were below the cost of new resources. Bonneville's rates were also well below the cost of new resources and were expected to continue to be so. Therefore, Bonneville's customers did not see an accurate price signal that would be an incentive for them to invest in improved efficiency of electricity use, even when it cost less than the alternative. From an economist's point of view, Bonneville-funded conservation acquisition was a "second best" solution intended to compensate for the lack of an accurate price signal and the other market barriers faced by conservation.

Success and controversy

In the almost 20 years since the passage of the Northwest Power Act, conservation has made a major impact on the Northwest's electricity system. Through 1997, utility conservation programs in the region accounted for approximately 1,440 aMW of energy savings, enough to power the cities of Seattle, Washington and Eugene, Oregon, combined. They accomplished this at an average cost less than the cost of the avoided resources. Approximately 47 percent of this was accomplished through Bonneville-funded programs.

By these measures, conservation was a success. However, it also attracted more than its share of controversy. Some customers objected to what they perceived as the centralized "command and control" nature of the Bonneville programs. There were also concerns on the part of Bonneville and many of its customers regarding the "bow wave" of increasing fixed costs caused by capitalizing conservation investments. There were also equity concerns arising from the flow of conservation investment toward the more populous areas west of the Cascades, and real and perceived disparities between full and partial requirements customers. Moreover, there were equity concerns within local utilities. Because utility retail rate structures typically recover much of the utility's fixed costs in the per kilowatt-hour energy charge, conservation, which reduces energy use, results in lost revenues. The portion of those revenues that goes to cover fixed costs must be recovered through increased rates. The irony of conservation is that it reduces total electricity costs, while at the same time it can require rates and the electricity bills of some to increase.

Around the circle?

During the mid-1990s, Bonneville's power rates and market prices converged. Many customers sought to reduce their dependence on Bonneville. Many believed that in the future, customers would turn to the market to meet their load growth and would see the market price of electricity as their avoided cost. It was generally concluded that Bonneville should no longer be in the business of acquiring new resources, whether generation or conservation. Bonneville virtually eliminated new funding for local conservation programs and allowed utilities to extend their existing contracts until October 1999.[2]  The reduced level of Bonneville funding was, with a few exceptions, not compensated for with additional utility funding, and many utilities indicated little interest in continuing conservation activities after the Bonneville funding ran out. Bonneville's conservation spending dropped by $80 million between 1995 and 1997. Even some of the region's utilities that had historically invested most heavily in conservation decreased their conservation spending from roughly $55 million to around $33 million, collectively, over this same period.

[Footnote 2] Bonneville continues to provide $15 million annually in funding for regional market transformation initiatives through its support of the Northwest Energy Efficiency Alliance.

• General load growth;
• Public customers that diversified their supplies and are expected to return loads to Bonneville;
• Out-of-region sales lasting into the 2002-2006 period that were contracted when Bonneville's ability to sell its inventory within the region was in doubt;
• The decision to provide an amount of actual power for residential and small farm customers of investor owned utilities (IOUs) instead of the cash transaction of the residential exchange; and
• The decision to continue to provide power for the loads of the Direct Service Industries (DSIs), albeit at a reduced level.

Bonneville has chosen to average the cost of this additional energy in with the base costs of the federal system (as opposed to charging a separate cost-based rate for loads served with the newly acquired resources ? frequently called "tiered rates"). Consequently, customers will not see an accurate marginal cost signal, creating again the rationale for a Bonneville-funded conservation program.

In some respects, however, the situation has not come full circle. Few if any are considering 20-year power sales contracts as was the case in 1981 but until contracts are signed, one cannot say with certainty what the duration of the contracts will be. While some may be for 10 years, many may be five years in duration and some even less than that. There is some risk that at the end of the contract periods, Bonneville could lose load if its costs rise and/or market prices fall.

In addition, the "avoided cost" is not what it used to be. Ultimately the avoided resource is a new natural gas-fueled combined cycle combustion turbine (CCCT). The cost of that resource is considerably less than the cost of power from new coal-fired power plants that were the marginal resource in the 1980s. Moreover, from Bonneville's standpoint, in the short-term the avoided resource is a market purchase.

Reliance on the market exposes the purchaser to price volatility and the risk of rising market prices. Conservation investment can reduce the exposure to this risk. On the other hand, market purchases, unlike investment in conservation, require no up-front capital investment or long-term financial commitment. In addition, they can be more easily tailored to fit the period in which the need is expected. Consequently, market purchases reduce the risk of so-called "stranded investment"[3] or risk of not receiving the return on their investment if Bonneville loses load at the end of the contract period

[Footnote 3] Stranded investments are fixed costs that cannot be recovered at market prices.

The Council's most recent power plan identifies a significant amount of conservation potential that is cost-effective in relation to anticipated power prices. If cost-effective conservation is not developed, the effect is a total higher cost for electricity services in the region. But the issues just raised present new obstacles that were not considered in the process of crafting the Council's earlier conservation acquisition strategies. The question that this issue paper addresses is this: "How can Bonneville meet its legal obligations and acquire the conservation that is cost-effective in a way that is consistent with the risk and opportunities faced by Bonneville and its customers?"

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Resource Potential, Distribution and Cost

Distribution and Cost

The first step is to analyze the amount of conservation available and cost-effective for development in the 2002 ? 2006 period.

Conservation Potential from the 1998 Plan

The amount of conservation that is cost-effective to develop depends upon how fast the demand for electricity grows, future natural gas prices, and year-to-year variations in water conditions.[4]  Based on the Council's 1998 Plan, the amount of conservation that would be cost-effective to develop in the region across all of these futures ranges from a low of 835 aMW, when demand growth and gas prices are low, to a high of 2,150 aMW, corresponding to a future of high demand and high gas prices. The average amount of regionally cost-effective conservation the Council has identified is approximately 1,535 aMW. It is important to note that while these estimates incorporate estimates of line losses and "generic" transmission and distribution benefits, they do not incorporate the potential location-specific transmission and distribution system benefits that could result from some conservation investments.

[Footnote 4] For example, if economic growth occurs according to the Council's medium low forecast, the region will need to add approximately 145 aMW of new resources each year. However, if regionally economic growth is at the Council's medium high forecast, nearly 425 aMW of new resources will be needed each year.

[Footnote 5] These levelized costs are in 1997$ and do not include the 10 percent credit provided for conservation under the Northwest Power Act.  The levelized cost takes the present value of the costs over the life of the measure and converts them into an equivalent equal annual rate.

Not all of this conservation can be (or need be) developed at once. Figure 2 shows the annual pace of regional conservation acquisition that results in the lowest present value electricity cost for the Northwest based on the 1998 Plan. The annual amount of conservation that needs to be acquired regionally under the expected value of future demand ranges between 60 and 90 aMW over the period between 2000 and 2015, averaging about 75 aMW per year.

Figure 2 also shows the annual total capital cost (including program administration) of acquiring these conservation resources. The annual capital cost of acquiring these conservation savings ranges between $130 and $190 million, averaging about $165 million per year. It should be stressed that Figure 2 depicts the total regional cost of conservation, regardless of who pays for the measures. As noted previously, Bonneville and utility conservation programs have historically shared these costs with the end use customers who directly benefit from the savings. Thus, the values shown in Figure 2 should be viewed more as an "upper bound" than as a "floor" for budgeting purposes.

Figure 2. Annual Regional Conservation Resource Acquisition Levels and Costs 2000 - 2015

Estimates of Updated Cost-effectiveness Limits

As noted above, the 1998 plan's estimates of cost-effective conservation are based on a regional avoided cost of new power supplies of approximately 30mills/kWh. Since the adoption of the 1998 Plan, the Council has conducted another assessment of the future power market prices. This assessment was done to evaluate Bonneville's ability to compete in the evolving deregulated wholesale power market.[6] The prices in this more recent market forecast are generally above that used to establish the conservation potential in the 1998 Plan. Moreover, the newer forecast also exhibits greater variance over the course of the year. Compared to the 1998 plan's market price forecast, the "on-peak" prices for the summer months and August in particular are substantially above those used in the Plan. This is reflective of the maturing and increasingly transparent West Coast power market where summer air conditioning demands in California and the desert Southwest are driving market prices during this period of the year. Appendix B contains a comparison of the 1998 plan's forecast of market prices compared to the Council's more recent estimates.

[Footnote 6]  Analysis of the Bonneville Power Administration's Potential Future Costs and Revenues, Northwest Power Planning Council Paper 98-11, July 1998.

Table 1 compares the "cost-effectiveness limit" derived for twelve different end use loads based on the 1998 plan's avoided cost and on those used in the BPA Competitiveness study published in July of 1998. The "cost-effectiveness limit" represents the maximum levelized cost that can be paid for a conservation measure with one of the twelve load shapes shown and still achieve a benefit-to-cost ratio of 1.0 (i.e., a positive net present value.) Table 1 reveals that use of the more recent avoided cost forecast produces cost-effectiveness limits for most conservation measures that are 15 to 20 percent higher than in the 1998 Plan.

The important exception to this general finding is that conservation measures that improve the efficiency of a summer-peaking end use, such as central air conditioning, have a cost-effectiveness limit that is nearly 30 percent higher with the more recent forecast of avoided cost. Also noteworthy is the fact that the avoided cost for residential space heating, historically the most significant component driving the need for additional power generating capacity in the region, is lower than for central air conditioning.

It should be noted that the July 1998 price forecast has lower on peak prices than the market clearing prices being used in the Bonneville rate case and preliminary results from the Council's ongoing analysis of regional power supply adequacy. This reflects a conservative approach in the current analysis.

Table 1. Impact of Load Shape on Conservation Cost-Effectiveness Limits by Market Price Forecast
 

These higher "cost-effectiveness limits" increase the amount of conservation that is cost-effective to acquire. The Council's 1998 Plan contained conservation resource supply estimates in 10 mills/kWh increments for avoided costs up to 60 mills/kWh (1995 dollars.) In developing the 1998 Plan, the Council analyzed the benefits of acquiring conservation at each of these alternative avoided costs in order to determine which level of acquisition produced the lowest present value system cost. Therefore, it is possible to use this prior analysis to estimate the amount of conservation that would be cost-effective to acquire using the Bonneville competitiveness study's forecast of avoided cost. Figure 3 shows the amount of conservation that is cost-effective to acquire by year at up to 30 mills/kWh (1997 dollars) and the additional amount that would be cost effective to acquire at up to 40 mills/kWh using 1998 plan's expected value or average load growth forecast.[7]

[Footnote 7] A levelized cost of 30 mills/kWh in 1995 dollars converts to just over 31 mills in 1997 dollars.  Adjusting this value upward by 20 percent to account for higher estimates of avoided costs results in a cost-effectiveness limit of slightly more than 37 mills/kWh, which was rounded to 40 mill/kWh for use in developing the approximate impact of higher avoided cost on conservation availability.

Figure 3. Annual Regional Conservation Acquisitions from 2000 to 2015 for Measures Below 30 Mills/kWh and Below 40 Mills/kWh (1997 dollars) Corresponding to Market Prices from the July 1998 Bonneville Competitiveness Analysis

Figure 3 shows that beginning in 2006, the use of the more recent forecast of market prices typically adds about 15 aMW to the annual amount of conservation that the region should target for development.

Figure 4 shows the annual total cost of acquiring the conservation resources according to the schedule displayed in Figure 3. The development of these additional 15 aMW of conservation adds about $75 million annually to the regional total resource cost of conservation acquisition. However, it should be noted that the higher-cost conservation resources (30 to 40 mills/kWh) are not scheduled for acquisition until 2006, the end of Bonneville's next subscription period. The amount of cost-effective conservation that should be acquired during the 2002 - 2006 rate period is not appreciably different than indicated in the 1998 plan.

Figure 4. Annual Regional Conservation Acquisition Costs from 2000 to 2015 for Measures Below 30 Mills/kWh and Below 40 Mills/kWh (1997 dollars) Corresponding to Market Prices from the July 1998 Bonneville Competitiveness Analysis

Bonneville's "Share"

Under the Northwest Power Act, Bonneville is obligated to meet the net firm power loads of all of the region's public body, cooperative and investor-owned utilities should those utilities request to be served by the agency. However, Bonneville does not currently have sufficient resources to meet all its expected loads without augmenting the federal system. Under Bonneville's Power Subscription Strategy, Bonneville proposed to make available power (and/or money in the case of the investor-owned utilities? residential and small farm loads) to its customers. Table 2 shows the proposed allocation by customer class. Table 2 also shows the proportion of the region's total anticipated electricity sales that are forecast to be met by Bonneville. Under the conditions shown in Table 2, it would appear that Bonneville would be serving approximately one-third of the region's loads during the subscription period (assuming pre-subscription sales are not subject to a conservation requirement). Therefore, Bonneville could be expected to target one-third of the region's conservation potential for acquisition through its proposed resource augmentation processes and other conservation activities. If the pre-subscription sales are included, Bonneville's share goes up to approximately 37 percent.

Table 2. Bonneville's Subscription Power Allocations

Figure 5 shows the annual conservation resource acquisition levels for the region and for Bonneville during the 2002 to 2006 subscription period based how much of the region's load the agency is meeting. Figure 5 shows that Bonneville and its subscribing customers need to acquire roughly 30 aMW of conservation annually between 2002 and 2006, or 150 aMW over the subscription period. If the pre-subscription sales are included, Bonneville and its subscribing customers would need to acquire approximately 32 aMW annually. For purposes of comparison, Bonneville and its utility customers acquired an average of nearly 60 aMW annually between 1993 and 1997.

Figure 5. Regional and Bonneville Conservation Acquisition Levels for 2002 - 2006

Figure 6 shows the total resource cost that Bonneville, its customers and their consumers would need to share in order to develop these resources. Figure 6 shows that the annual total cost of acquisition of conservation for loads served by Bonneville's subscription power sales averages approximately $64 million (1997 dollars). Again, if pre-subscription sales are included, the total cost would average approximately $72 Million. Note again that this represents conservation's total cost, and these costs have traditionally been shared between utilities and consumers. It seems likely that Bonneville will be able to secure such cost-sharing in the future.

Figure 6. Total Resource Cost of Conservation Acquisitions 2002 - 2006

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Alternative Approaches to Bonneville Conservation Acquisition

Given the challenges posed by the changed electricity industry environment, we have postulated three alternative approaches by which Bonneville might acquire the conservation potential identified above. The first is a description of the framework for past conservation efforts. The second is an attempt to describe an approach that mirrors a market purchase as closely as possible. The third is an attempt to find some middle ground.

Traditional Long Term Acquisition

The goal that has guided the Council's plans and, consequently, Bonneville's conservation programs has been to minimize the cost of electricity services to the region over the long term. An efficiency improvement was judged to be cost-effective if the life-cycle cost of an energy efficiency improvement was equal to or less than 110 percent of the life-cycle cost of supplying an equivalent amount of energy by conventional means. Quantifiable environmental costs and benefits were to be included in the calculation. The 110 percent factor was included by Congress in the Northwest Power Act to give conservation a boost in the competition with conventional resources. The practical effect of this provision has been small since the amount of conservation that has cost less than the competing conventional resources has always been large compared to the amount of new resources required. This is reflected in the fact that the average cost of the conservation acquired has been well under the cost of the avoided resource.

The long-term approach has meant that the Council's plan and Bonneville's conservation programs have included measures, like improvements in the thermal efficiency of the shells of new housing, that might have 70-year lifetimes. However, longer lifetime measures are subject to greater risk that new innovations and changing market conditions may make them less cost-effective over time. Bonneville was not required to pay the full cost of cost-effective conservation measures. Because conservation delivers benefits to the end-use consumer, consumers have usually been willing to share in the cost. Typically, the cost to Bonneville has been significantly less than the full cost of the conservation.

The so-called "rate impact" test has not been an explicit element of Bonneville's historic long-term conservation acquisition approach. The rate impact test reflects the fact that when conservation reduces Bonneville's sales to a customer, Bonneville loses the contribution of those revenues to its fixed costs. Those revenues must be made up by increasing rates. The rate impact test would limit what Bonneville could spend for conservation to an amount that did not require Bonneville to raise rates.[8]  The effect of employing a rate-impact test could be to leave a great deal of cost-effective conservation undeveloped.

[Footnote 8]  Under the ?no losers? or ?rate impact? test Bonneville's conservation acquisition costs would be limited to the difference between its rates and the cost of power purchases, rather than 110% of power purchase costs

Market Purchase Look-alike

The intent here is to define a conservation acquisition strategy that, in terms of the effects on Bonneville, mirrors as closely as possible purchasing power on the market.

There are two principal components to such a strategy. They are:

• Employ a rate impact test that limits what Bonneville will pay to the difference between its avoided cost and its wholesale power rate. This ensures that Bonneville rates would be no higher than they would be with the market purchase.
• Pay only for savings delivered during the contract period. This means that Bonneville would be making no commitments beyond the initial contract periods. If customers were to choose to take load off Bonneville at the end of the contract period, Bonneville would have no stranded costs and no risk of losing the benefits for which it had paid.

The principle of paying only for conservation delivered during the contract period is probably the more significant in terms of its effect on the ability to capture the cost-effective conservation identified in the Council's plan. Figure 7 shows the regional conservation potential in the Council's current plan that has simple payback of less than five years at an electricity price of 2.6 cents per kilowatt-hour. Assuming five years is typical of the average contract length, at a payback period of five years or less, only 250 aMW of conservation of the 1535 aMW of the regionally cost-effective conservation in the Council's Plan are available. Moreover, not all of this is available between 2002 and 2006. Of the 250 aMW of total potential, only 100 to 130 aMW is available during the subscription period. The remaining potential is in new commercial buildings not be yet built and/or in major renovations/remodels of existing commercial buildings that will not occur during this time period. Since Bonneville anticipates that it will only be serving approximately one third of the region's loads, roughly one-third (33 ? 40 aMW) of these limited conservation opportunities are available in its customers? service territories. Conservation that came on line later in the contract period would have even less time in which to pay for itself. While updated market price estimates will raise the level of this curve somewhat, the basic message is the same, i.e. there are very limited conservation opportunities available that can pay for themselves in a relatively short contract period.

Moreover, much of this very low cost conservation (three-year payback and less) is conservation consumers are more likely to do on their own. Targeting programs at this conservation is unlikely to yield significant incremental savings. The majority of the conservation that is cost-effective on a longer-term basis would go largely undeveloped.

Figure 7. Regional Conservation Potential from the 1998 Plan by Simple Payback Period 1996-2015

A Possible Middle Ground

The traditional long-term acquisition approach would most likely result in the largest amount of conservation developed and the lowest total long-term electricity service costs for the region. Emissions and other environmental effects would probably be lower as well. Long-term benefits would, of course, be subject to uncertainty regarding future power technologies and their costs. Depending on what Bonneville has to pay for the conservation and whether or not they would choose to capitalize those costs, this approach might or might not result in Bonneville raising near-term rates above what they would be with the alternative of purchasing power on the market. There is, however, the risk that Bonneville might not receive the full benefits of the investment in conservation if some customers leave Bonneville at the end of their contracts.

On the other hand, the market purchase look-alike is intended to protect Bonneville from the risk of having made unnecessary and unproductive investments should it lose loads after the upcoming contract period. This approach would pay only for benefits Bonneville receives during the contract period. It would also limit what Bonneville pays for conservation so as to have no impact on rates. As noted in the previous section, of these two conditions, the former seems likely to have the greatest impact on achieving conservation targets.

If all the utilities in whose service territories Bonneville's funds were invested in longer-lived conservation were to take their loads off Bonneville at the end of their contracts, those investments would yield no further benefit to Bonneville. If Bonneville expenses its investments, it will not have the risk of a stranded investment.

It is important to note that in the event Bonneville does lose load, the benefits of Bonneville's conservation investment would not be lost to the region and, more specifically, to those who participated in the conservation programs funded by Bonneville. The region as a whole will be spending less for electricity services.

How likely is it that Bonneville will lose contract load at the end of the rate period? This is impossible to know with any certainty. The Council's analysis of Bonneville's potential future costs and revenues, completed in 1998, found that for the "medium" market price forecast, Bonneville continued to be a value relative to market prices through the 2007 ? 2011 period for all but the most aggressive dam removal scenarios.[9]  Since the time of that analysis, most expectations regarding market prices have increased. To be sure, there could be combinations of low market prices and increased costs that could make Bonneville rates unattractive. However, there appears to be a very good chance that Bonneville will continue to be attractive relative to the market after the 2002 ? 2006 rate period. Bonneville's fixed costs begin to drop significantly in 2012 as the Energy Northwest (formerly Washington Public Power Supply System) debt begins to be retired. Absent a revolutionary new energy technology or political intervention, Bonneville seems likely to be extremely attractive relative to the market in 2012 and beyond.

[Footnote 9]  Analysis of the Bonneville Power Administration's Potential Future Costs and Revenues, Northwest Power Planning Council Paper 98-11, July 1998.  Pp. 6-8.

Given these considerations, Bonneville could commit to paying for savings achieved beyond the initial contract period to the extent the customer kept load on Bonneville. If the customer keeps the same proportion of its load on Bonneville, Bonneville could pay the full amount to which it had committed. If the customer were to take some load off Bonneville, Bonneville's payment would be reduced proportionately.

As far as the amount of the payment is concerned, it seems unwise to commit Bonneville to a particular payment level. It should attempt to get the conservation for as low a cost to Bonneville as possible to minimize any adverse effect on its net revenues. However, it should be open to paying more for some conservation and less for other, depending on the value of the savings.

In the event a customer might like to remove load from Bonneville after the initial contract period, the customer would no longer receive payment from Bonneville for savings produced after the initial contract period. If the customer had received a lump sum payment for conservation and removed load after the initial contract period, it could pay an "exit fee" that compensated Bonneville for unrealized benefits of the conservation investment. That seems entirely appropriate.

An important question is whether this risk would prove to be a significant disincentive to customers participating in Bonneville's conservation programs or cause them "cream skim,", i.e. go after only the cheapest opportunities available. The negative effect of cream skimming is that many opportunities in new construction would become lost opportunities. If the assessment is that Bonneville is likely to be very attractive relative to the market for many years to come, the risk might be judged to be quite low and not a deterrent to participation. However, a different assessment of Bonneville's future attractiveness in the market could lead to a different conclusion.

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Analysis

The alternative approaches described above were analyzed to provide estimates of their possible effects on two metrics ? the total cost of electricity services and Bonneville's rates. The former reflects the perspective of the Northwest Power Act, the latter reflects legitimate concerns about Bonneville's position in a competitive wholesale electricity market. The following analysis considers only conservation undertaken as part of Bonneville's augmentation effort. It does not reflect the conservation that will be implemented as a result of Bonneville's contribution to market transformation efforts through the Northwest Energy Efficiency Alliance, the C&R Discount or low-income weatherization activities.

Total Cost of Electricity Services

Long-term Acquisition

Historically the Council's plan has attempted to identify the power supply resource mix and development schedule that minimizes the total regional cost of providing electricity services over the long term. From this perspective, all of the benefits and costs associated with providing electricity services are measured at the regional level. The allocation of these benefits and costs across individuals, utilities or Bonneville, while of interest, is not the primary decision criteria. Therefore, the value of Bonneville's development of conservation through its augmentation process from this perspective is not different from conservation's value to the region.

Conservation's regional value is a function of its cost and availability, the cost and availability of alternative resources, the magnitude and timing of the need for new resources and the risks associated with making the "wrong" decision (e.g., buying too much or too little). The value of conservation resources to the region estimated in the 1998 plan at up to 3.0 cents/kWh was just under $2.4 billion (1997 dollars). Including conservation resources costing up to 4.0 cents/kWh that are cost-effective given more recent estimates of avoided costs would increase this value.

If Bonneville acquires roughly 150 aMW of conservation between 2002 and 2006, the regional present-value cost of providing electric services would be approximately $235 million lower than if this conservation goes undeveloped.[10]  Given current views of future market prices, this would be a conservative estimate of the benefits of the reduction in present-value cost of these acquisitions, since it was derived using the 1998 plan's forecast of future market prices. As noted earlier, this does not include the value of environmental benefits or potential location-specific transmission and distribution system benefits that result from conservation investments. The latter are benefits that accrue to the local utility and to Bonneville's Transmission Business Line in the form of avoided costs for distribution or transmission system reinforcement.

[Footnote 10]  This was estimated by apportioning the regional benefits according to the share of conservation resources developed on Bonneville's system compared to the amount scheduled for development in the remainder of the region over the period between 2002 and 2006.

Effect on Bonneville Rates

As shown in Figure 6, the total resource cost of acquiring the 150 aMW of conservation from the loads expected to be served by Bonneville is roughly $64 million per year for a total of $320 million over five years. Some of the funds for conservation are already in Bonneville's revenue requirement. This includes some part of the $30 million per year for the Conservation and C&R Discount and $12 million per year for Bonneville's contribution to the Northwest Energy Efficiency Alliance (NEEA). However, we do not have estimates of how much conservation these activities are likely to produce in the near term. As conservatism, we assume that all the conservation must be acquired through the dollars allocated for augmentation. We also assume that Bonneville pays for the conservation up front in the year the conservation goes on line as opposed to paying for kWh as they are produced. We also assume that Bonneville will be able to share approximately 50 percent of these costs with its customers and their consumers. Therefore it would require that the agency allocate approximately $32 million per year would spend for augmentation for conservation. The average energy savings produced over the rate period would be 85 aMW (less in the first year, more in the last year). This means that an average of additional $11 million per year would be required for power purchases to meet the 800 aMW augmentation target. This is illustrated in Table 3.

Table 3. Comparative Cost of Market Purchase versus Conservation Plus Market Purchase
 

The other impact on its rates would be the lost revenues associated with the acquisition of 30 aMW of conservation savings annually. As demonstrated in Table 3, if conservation savings average 85 aMW over the rate period, the lost revenue at 22 mills/kWh averages about $16 million per year. Combined with the additional power purchase cost of $11 million per year, the total impact on Bonneville revenue requirement would be approximately $27 million per year.

A rough rule of thumb for estimating the impact of additional costs on Bonneville rates is that a $30 million change in revenue requirements translates into a 0.5 mills/kWh change in rates. Therefore, a net change in its revenue requirements of about $27 million each year would mean it would have to increase its rates by approximately 0.46 mills/kWh. This result would be reduced to the extent that the conservation were achieved through other funding already in Bonneville's budget for conservation, (the C&R Discount, low-income weatherization and NEEA) or the conservation was paid for as the savings were produced rather that in one payment up front. The investment in conservation is also quantitatively different in that much of it will continue to produce benefits beyond the five-year rate period whereas the market purchases will not.

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Implementation Issues

How can Bonneville be Assured it is Getting What it Pays For?

Bonneville's conservation acquisition is intended to be a less costly alternative to market purchases. Bonneville must be assured of actually (within a reasonable band of uncertainty) getting the kWh savings in the amounts and at the times expected. Otherwise, it will have to incur the costs of purchases (or market revenues forgone) to ensure meeting its obligations. How Bonneville gets this assurance is probably a function of the power product the customer is purchasing and the associated contractual relationship between Bonneville and the customer.

Compatibility, Confusion or Conflict with the Conservation and Renewables Rate Discount

Bonneville is moving toward implementing a C&R Discount for qualifying customer investments in conservation and renewables and low income weatherization. This effort was initiated prior to the realization of the need to acquire resources to meet 2002 ? 2006 loads. The initial rate proposal allocates $30 million per year for the rate discount. That is about half what staff estimates to be the annual cost of Bonneville's share of the total cost of the least-cost conservation implementation schedule in the Council's current plan. The logical question is why cannot the rate discount be the vehicle for meeting the conservation acquisition targets for 2002 ? 2006?

The C&R Discount was not designed nor advertised as an acquisition. The C&R Discount was intended to help utilities remain involved in conservation and renewable resource development and low income weatherization. Within the range of conservation, renewable resources and low income weatherization, what is done and how funds are allocated among these activities is up to the local utilities.[11] Some of the activities that are likely to be eligible for the discount cannot be counted upon to produce actual savings required of an acquisition or satisfy the cost-effectiveness criterion. Moreover, Bonneville's augmentation needs are for specific amounts of energy and/or capacity during specific times of the day and year. It is not clear that the conservation resources pursued by individual utilities will coincide with Bonneville's resource needs. The provisions for verification and evaluation are limited.

[Footnote 11]   If the utilities' use of the C&R Discount is disproportionate in one direction or another, Bonneville has committed to providing funding to assure a viable effort in each of the areas.

Because the C&R Discount is part of the current rate case, Bonneville has been reluctant to consider making the kinds of changes to the C&R Discount that would be necessary for it to qualify as an acquisition program. Bonneville places a high priority on completing the rate case on schedule and is concerned that making such changes could delay the rate case. There may, however, be ways in which the acquisition program can "piggy back" on the structure of C&R Discount to minimize confusion and increase efficiency.

Northwest Energy Efficiency Alliance

The Northwest Energy Efficiency Alliance (NEEA) is an activity co-funded by Bonneville and its customers and the investor-owned utilities of the region to pursue "market transformation." Market transformation is the concept of intervening in the market for targeted energy efficiency technologies (products, services or practices) to effect permanent changes in those markets. Market transformation is generally NOT delivering energy conservation services at the retail level.

Instead, the focus is on developing a thorough understanding of the markets for promising energy efficiency technologies and then undertaking activities that have the potential to shift market preference toward those technologies. On one end of the spectrum, these activities might look a lot like research, development and demonstration. On the other end, there might be consumer incentives designed to boost market share and encourage manufacturers to commit the investment necessary to achieve economies of scale that will bring the cost of the technology down. However, the payoff is generally long term. In most cases, there will be near-term savings produced by NEEA programs, and NEEA is committed to thorough evaluation of its efforts to verify those savings. In those instances, the savings should count toward conservation targets. In general, however, NEEA's focus is on effecting long-term changes in the market, and it should not be diverted from that objective.

Alternative Delivery Mechanisms

The restarting of Bonneville conservation acquisition provides an opportunity to try to avoid some of the criticisms of earlier efforts. Much of the criticism stemmed from what was perceived as the rigid, prescriptive, command and control nature of early Bonneville programs. Many, if not all, of those criticisms were addressed as Bonneville's conservation efforts evolved and matured. It should be possible to build on those experiences. Some possibilities are described below.

However, third parties ? state or local governments, energy service companies ? might well be interested in participating in a Bonneville conservation acquisition. If the local utility is not inclined to participate, these entities could be allowed to bid their conservation to Bonneville. However, a working partnership with the serving utility could be necessary to assure Bonneville of receiving the savings. In addition, these entities would have to face the possibility that the utility might choose to take load off Bonneville after the initial contract period, putting the Bonneville payment to the third party at risk. It may be very difficult to find third parties willing to accept that risk. Some means of mitigating that risk would probably have to be devised if third parties are to have a realistic role.

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Other Issues ? Application of Section 6(c) of the Northwest Power Act

Section 6(c) of the Northwest Power Act requires Bonneville to conduct a public process on any proposal to acquire a major generating resource, to implement an equivalent conservation measure, to pay or reimburse investigation and preconstruction expenses to the sponsor of a major resource, or to grant billing credits or services involving a major resource. One of the findings Bonneville must make is whether the proposed action is consistent with the Council's plan. The Council may choose to make its own determination of consistency. A major resource is one that is greater than 50 aMW and is acquired for more than five years. Staff understands that in its power purchases for augmentation Bonneville does not anticipate individual purchases that will be greater than 50 aMW and that in no case will contracts be for more than five years. Similarly, while Bonneville's conservation acquisitions will extend beyond five years, in is unlikely any individual contract will be for 50 aMW or more. These resources then, do not meet the definition of a major resource, that would trigger Section 6(c). Even if a winning argument were made that somehow these resource acquisitions required review under 6(c) the staff's preliminary view is that Bonneville's proposed acquisitions through market purchases and conservation efforts, would meet the Council's 6(c) criterion. That is, they are "so structured that [they] will achieve substantially the goals and objectives of the plan. ?"

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Staff Draft Recommendations

Bonneville has proposed a set of draft principles to guide their conservation acquisition. Those principles are reproduced in Appendix C. In general the staff finds that these principles embody policies that seek to implement the "middle-ground" alternative for conservation acquisition described above. Staff recommends that the Council endorse this approach. Staff believes this approach is capable of meeting cost-effective conservation acquisition targets and is appropriate for the situation in which Bonneville finds itself.

Bonneville states in its principles that it will target for acquisition its share of the cost-effective conservation identified in the Council's current plan. Staff estimates this to be a minimum of 150 aMW of conservation over the subscription period. Staff recommends that the Council endorse this as minimum goal for Bonneville's conservation activities during the 2002 ?2006 period including the C&R Discount, low-income weatherization efforts not included in the C&R Discount, the activities of NEEA and conservation acquisition undertaken as part of the augmentation effort.

In addition to Council endorsement of Bonneville's "augmentation principles," the staff has three additional recommendations.

Staff recommends that Bonneville's Transmission Business Line (TBL) also participate in supporting conservation and demand management efforts in cooperation with the efforts sponsored by Bonneville's Power Business Line (PBL). TBL faces the need to make significant, long-lived investments in transmission infrastructure to be able to serve growing loads. Efforts that reduce those loads may make it possible to avoid part of that investment. While the TBL will be more oriented toward peak shaving and shifting than traditional conservation, many measures provide both kinds of benefits, and therefore benefit both business lines. In addition, there may be synergies between conservation and demand management efforts.

The staff recommends that Bonneville consider modifying the proposed Conservation and Renewable Resource Discount to serve as a platform for acquiring conservation from Bonneville's customers. Staff recognizes Bonneville's concerns that changing the C&R Discount could affect the schedule of the rate case. However, the potential confusion and duplication resulting from two parallel efforts argue for consolidation. As currently proposed, the program does not contain sufficient incentives for utilities to aggressively seek consumer cost-sharing so as to leverage the discount. Since all utilities under the program have the option of just claiming cost reimbursement up to the total discount amount for which they are eligible, it seems unlikely that it will engender acquisitions that are as cost-efficient (from Bonneville's standpoint) as is possible. These shortcomings must be addressed if the Rate C & R Discount is to serve as an acquisition tool.

The staff also recommends that the Council support Bonneville's implementation of a program to acquire conservation through a competitive bidding process. Given the lead time required to develop proposals, Bonneville should initiate efforts to communicate with customers and third parties regarding its needs as soon as possible. Indeed, the staff believes that unless the C & R Discount program design features are altered, Bonneville should place its greatest emphasis on establishing a "bidding" or "competitive procurement" process to acquire conservation. This process should be open to subscribing customers as well as other parties who have arrangements with end-use consumers served by Bonneville's customers. Staff recommends that Bonneville solicit bids for conservation savings (both energy and capacity) that to the extent workable mirror the range of market power products it is also buying. For example, if the agency is soliciting bids for high-load-hour energy or capacity during the winter months delivered to major load centers, it should ask for comparable conservation products. It should base its determination of the cost-effectiveness of these conservation savings against the price of comparable market power purchases.

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Request for Public Comment

[The comment period ended January 21, 2000.] The Council is seeking public comment on the following questions:

1. Do you agree with the staff recommendation endorsing the general approach to conservation acquisition embodied in Bonneville's principles? If not, what approach would you recommend and why?
2. Do you agree with the staff recommendation endorsing the 150 aMW cost-effective conservation target for the Fiscal Year 2002 ? 2006 rate period? If not, what would you recommend and why?
3. Do you agree with the staff recommendation that Bonneville's Transmission Business Line participate in supporting conservation and demand management efforts in cooperation with the efforts sponsored by Bonneville's Power Business Line? If not, why?
4. Do you agree with the staff recommendation that Bonneville seek to modify the C&R Discount to serve as the basis for conservation acquisition? If not, why?
5. Do you agree with the staff recommendation that Bonneville implement a competitive bidding process for conservation implementation? If not, what approach would you recommend and why?
6. Are there other important issues regarding Bonneville conservation acquisition as part of its resource augmentation that you believe should be addressed? What are they?

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Appendix A ? Legal Requirements

The Northwest Power Act gave the Bonneville administrator, for the fist time, authority to acquire resources to meet the load requirements of customers it is obligated to serve. To provide the region with some oversight of Bonneville's choices, the Act requires that the administrator's resource acquisitions and related activities shall be consistent with the Council's 20-year power plan, with certain narrowly limited exceptions. Section 4(d)(2).

The Northwest Power Act requires the Council's plan to give priority to resources the Council determines to be cost-effective. First priority goes to conservation, second to renewables, third, to generating resources using waste heat or of high fuel conversion efficiency, and fourth, to all other resources.

A cost-effective resource is one that is forecast to be reliable and available within the time it is needed and that has an incremental system cost no greater than that of the least-cost similarly reliable and available alternative resource. System cost includes all direct costs over the life of the resource, including distribution and transmission costs, waste-disposal costs, end-of-cycle costs, and fuel costs. It also includes quantifiable environmental costs and benefits directly attributable to the resource. Conservation gets a 10 percent credit in the cost-effectiveness calculation.

The Act plainly intends that the Administrator shall acquire conservation and renewables to the maximum extent practicable. Section 6(e)(1). Even though the administrator may have acquired other resources, as authorized by the Act, the administrator still has a responsibility to pursue conservation. "Notwithstanding any acquisition of resources pursuant to this section, the administrator shall not reduce efforts to achieve conservation and to acquire renewable resources. ?" Section 6(b)(5).

In devising mechanisms to deliver conservation that involve direct arrangements with consumers, the Act directs the administrator to "make maximum practicable use" of local utilities and other local entities that can effect such arrangements. Section 6(e)(2). While the Act does not define "local entities," one could imagine an energy services provider or a local governmental unit fitting within that term.

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Appendix B -- Comparison of 1998 plan's Forecast of Future Market Prices with Council's Analysis of the Bonneville Power Administration's Potential Future Costs and Revenues (Medium Forecast)

Figures B-1 and B-2 compare the medium forecast contained in the Council's Analysis of the Bonneville Power Administration's Potential Future Costs and Revenues with 1998 plan's forecast of future market prices for on-peak and off-peak spot power purchases by month from January 1999 through December 2016.

A review of Figure B-1 shows that the 1998 plan's forecast of avoided cost for power purchases during peak periods of power-demand are below the July 1998 estimate. Figure B-2 shows that during low power-demand periods, the more recent forecasts of avoided costs are both higher and lower than the 1998 plan's forecast. Overall, however, this more recent market price forecast is generally above that used to establish the conservation potential in the 1998 Plan. Moreover, the newer forecast also exhibits greater variance over the course of the year. Compared to the 1998 plan's market price forecast, the on-peak prices for the summer months, and August in particular, are substantially above those used in the Plan. This is due to the fact that the summer air conditioning demands in California and the desert Southwest are driving the entire West Coast's power market during this period of the year.

Figure B-1. Comparison of Future Monthly On-Peak Wholesale Power Market Prices January 1999 to December 2016

Figure B-2. Comparison of Future Monthly Off-Peak Wholesale Power Market Prices January 1999 to December 2016

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Appendix C ? Bonneville Draft Augmentation Principles

Bonneville Power Administration
Draft Principles for Conservation as Part of BPA's Augmentation Program

1. BPA will maximize conservation's role in reducing the amount of power required for augmentation within appropriate cost and reliability parameters.
2. During the augmentation timeframe (2002 to 2006), BPA expects to meet or exceed the conservation target established for BPA in the Council's most recent Power Plan. All of BPA's conservation activities (i.e., the proposed C&R Discount, NEEA funding, low-income weatherization support, etc.) will contribute to the achievement of this target.
3. In order to "leave room" for additional conservation efforts as part of its augmentation program, BPA will reserve approximately 150 aMW (over the 5-year rate period) of the amount of power purchases needed for augmentation purposes. Either conservation or, if needed, short-term power purchases, could fill this amount of augmentation need.
4. BPA will purchase conservation resources through this program at as low a system cost as possible.
5. BPA must adhere to the constraints of the current rate case outcome, including recognition of BPA's Treasury borrowing limits.
6. BPA will actively pursue conservation resources within the following guidelines:

1. Conservation resources will be evaluated in accordance with the "cost effective" definition as specified in section 3(4) of the Northwest Power Act.
2. BPA recognizes that the measure life of many conservation resources may extend beyond the Subscription contract period. In order to accommodate this reality, BPA will value the investments in conservation resources over their measure life (not to exceed in aggregate 20-years) to the extent customers continue to place their load on BPA under power sales contracts.
3. Conservation resources that are flexible and can be curtailed when the Federal system is surplus, will be given a cost advantage (i.e., surplus firm power will be used to meet a significant portion of the augmentation requirements, particularly in the spring months). Resources that provide seasonal and other peak savings will be similarly valued.
4. Conservation resources must result in a reduction in the amount of power BPA will need to purchase to meet its regional firm load.

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