Avoided costs originated with federal laws designed to encourage renew
able 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 avo
ided costs for use in electric utility demand-side management (DSM) re
source planning. For large DSM resource options, using avoided costs t
o estimate value is more accurate than using short-run marginal costs;
avoided costs are simpler to use than traditional supply planning met
hods. We describe various administrative approaches for estimating avo
ided power generation costs and discuss modeling issues that arise in
the estimation process. We also discuss emerging, market-based approac
hes for estimating avoided costs and describe current estimation pract
ices for the additional, often substantial, non-generation-related cos
ts avoided by DSM programs. Finally, we discuss special considerations
in using avoided costs to estimate the system value of DSM.