The process of valuing energy resources can be very complex. As a result, the current model for assessing value is a reflection of the assets that have traditionally populated the grid, such as large centralized power plants, sprawling transmission and distribution lines, and the inherent costs for operating and managing this system. The valuation model has been to compensate these big investments over long periods of time through consumer’s electricity bills.

However, there is a transformation underway that is uprooting this model. Since distributed energy -- including energy efficiency, demand response, distributed generation, andstorage-- reduces consumer’s bills, the value it offers must be fairly accounted for and compensated.

A new paper from Travis Bradford of Columbia University and Anne Hoskins of Princeton University has tackled this issue head on, laying the groundwork for an expert energy policy roundtable that will aim to come up with a new model for valuing distributed energy. The full report has two important points:

1) A new valuation model must consider both the energy and capacity value of distributed energy. This requires understanding the difference between long- and short-term energy value, and accounting for the next best alternatives so that economic savings from avoided costs are included.

2) A new valuation model should consider both the costs and benefits of distributed energy. New technologies present new challenges and benefits that have nuances not always captured in traditional models. This includes cost-shifting to customers who do not use distributed resources, as well as benefits like hedging against volatile fuel prices. Other unique benefits can also be included, such as environmental preservation, greenhouse gas abatement, and job creation.

So how do you know what energy is really worth?

For starters, there needs to be a new understanding of the energy and capacity value of distributed energy technologies. Short-term energy value is usually the marginal costs of operation, including fuel costs and equipment maintenance. Long-term value is the average cost of capital investments and fuel over the life of the equipment. Either way, the criteria for determining the value of distributed energy would be based on “the value of the next best alternative for energy being fed into the grid at a specific place and time.”

Capacity value for distributed energy is assessed in capacity markets, which secure resources years in advance to maintain system reliability. The Effective Load Carry Capacity and Loss of Load Potential models are steps in the right direction, but most fail to incorporate the avoided costs from not building new transmission and distribution infrastructure. The bottom line is that variable resources like wind or solar can contribute to reliability even if they aren’t valued at 100 percent.

Considering the Full Range of Costs and Benefits

In addition to assessing the value of distributed energy, new technologies also have real costs. Those include loss of revenue, where generators will be online and wires will be transporting electrons, but increased use of distributed energy relegates the grid to “interim storage and backup supply.” The costs of operating and maintaining the grid are then shifted to other consumers. These costs may fall as the system downsizes to include fewer centralized generators and wires.

There will also be firming expenses as operational changes are enacted to manage a grid with higher penetrations of renewables, including forecasting technology and the costs of backup generation. Bidirectional electricity flows enable consumers to be transactional with the grid and leverage their personal resources like solar panels, but there will be additional wear and tear on circuits and costs for new security measures.

This is not to downplay the benefits. Reducing the need for transmission and distribution lines eliminates new construction costs, line losses, and congestion. Also, since electricity clearing prices are set by the most expensive unit required to meet demand, reducing peak demand means electricity demand is being met at a lower cost to consumers. Distributed energy is also a hedge against volatile fuel costs for coal-fired power plants and combined-cycle natural gas plants. Additional benefits, including environmental protection, greenhouse gas abatement, energy security, and local job creation, can be factored in as well.

Creating a New Valuation Model

Based on these findings, the authors suggest a new model for valuing distributed resources. The alphabet-soup version is "E+C-Co+Be+Ext." In layman’s terms, this means adding the savings from offsetting wholesale energy purchases (E) to the savings from avoided capacity investments (C), subtracting the range of costs listed above (Co), and adding the benefits (Be). The “Ext” part of the equation is the right of states to assess environmental, security, and job creation into the mix and value those benefits accordingly.

This is actually very straightforward. The equation boils down to valuing energy based on the savings from using distributed energy compared to using the next best option, along with considering the balance from a cost-benefit analysis perspective. There are a few real-world examples of this, but unfortunately, as the report notes, “none of them are comprehensive.” Examples include net energy metering, which allows consumers to be compensated for the electricity they generate, but only assesses retail energy value and not the long-term energy and capacity values or the costs and benefits.

There is also the Market Price Referent approach, which assesses the levelized cost of the energy by modeling cash flow for a proxy combined cycle gas turbine, factoring in capital costs, natural gas fuel costs, operations, maintenance, and environmental compliance.

Austin’s Value of Solar Tariff takes into account the avoided fuel costs for the marginal resource that isn’t being used, avoided costs of new capital investments to accommodate peak demand, avoided transmission and distribution investments and losses, and the environmental benefits.

Locational Marginal Pricing only values energy, congestion and losses, but in some places demand response is permitted to bid. State Integrated Resource Plans, long-term visions for a state’s energy mix, can also value distributed energy -- but few have.

The report is meant to inform and guide the discussion for creating a framework for minimizing costs, maximizing benefits and most importantly, finding the real value of distributed energy.

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Adam James is a Research Assistant for Energy Policy at the Center for American Progress and the Executive Director of the Clean Energy Leadership Institute. You can email him at ajames@americanprogress.org and follow him on Twitter @adam_s_james.