Electric utility restructuring, regulation of distribution utilities, and the fallacy of "avoided cost" rules

We show that commonly used "avoided cost" rules, which evaluate investment alternatives by comparing their costs to forecasts of future expected cost, are fundamentally flawed for choosing local area investments in distributi on capacity. Use of avoided cost rules: 1) confuses cost-effectiveness test s with benefit-cost tests; 2) makes inappropriate marginal comparisons and violates necessary optimality conditions because of the "lumpy" nature of m any distribution system investments; 3) fails to incorporate the effects of uncertainty properly; 4) necessarily leads to excess deferral of tradition al distribution capacity investments with distributed generation and DSM in vestments; and 5) does not lead to lowest expected cost investment plans. W e conclude by outlining a more appropriate approach to evaluating distribut ion investments based on evaluations of actual cash flows associated with i nvestment alternatives under uncertainty.