A Cautionary Tale About Energy Efficiency Initiatives: If these programs are such bargains, then why does government mandate them and energy utilities push for them?

Author:Costello, Kenneth W.
Position:ENERGY & ENVIRONMENT
 
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I constantly hear about how wonderful utility and government-mandated energy efficiency (EE) initiatives are. Many EE supporters claim these efforts to push consumers to buy higher-efficiency appliances and use more insulating materials are "negative-cost" ways to reduce carbon emissions--that by reducing energy consumption along with emissions, these changes more than pay for themselves.

For instance, in 2009 the consulting firm McKinsey & Co. estimated that adoption of cost-effective EE investments in the United States could generate $700 billion in net private cost savings. Amory Lovins, an environmental scientist and chairman of the Rocky Mountain Institute, once remarked that EE is the "lunch you are paid to eat."

Yet these free lunches seem suspicious to me--and to many analysts who have studied the benefits and costs of EE initiatives. If these efforts are such a bargain, then why must government mandate them and utilities push for them?

WHY DO WE NEED EE POLICY?

The conventional economic defense for government-imposed EE standards begins by assuming deep flaws in consumer rationality, barriers to information, or underpricing of energy. Supposedly, these factors lead to consumers making incorrect calculations and tradeoffs between the initial costs of appliances and their subsequent energy-use costs. Consumers allegedly are unwilling to pay more initially for consumer durables that would use less energy and save money in present value. Instead, they buy cheap durables that are costlier to run over time. Mandatory energy standards force consumers to make the "correct" tradeoff between initial and operating costs, "purchase" more energy efficiency, and eliminate the so-called "EE gap."

In the typical EE gap study, analysts often calculate the savings in energy costs over the lifetime of an appliance by using a discount rate converting the stream of annual costs into a present value. If the present value of cost savings from an efficient appliance is greater than the incremental cost of the efficient appliance relative to a conventional substitute, then an EE gap is said to exist. Said differently, the discount rate that consumers appear to use in their decisions about paying more initially for later energy savings is "too high" relative to the "market" discount rate used by the analyst.

This gap provides the justification for both government EE standards and utility EE initiatives. Policymakers attribute the "low" adoption of EE investments to market failure or consumer-behavioral problems. The presumption is that consumers are incapable of making the correct calculations or else make decisions contrary to their self-interest.

Hence, there is an economic rationale for government policies such as energy building codes, appliance standards, and utility subsidies. However, this rationale includes two assumptions that often go unrecognized by EE supporters:

* The gap truly represents a market or behavioral failure.

* The benefits from correcting this failure are greater than the costs.

Just because market problems exist that might hinder EE investments does not mean that utility or governmental intervention is socially desirable.

RECONCILING AN EE GAP AND RATIONAL CONSUMERS

Energy consumers who do not invest in seemingly cost-effective EE can be acting rationally...

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