The Role of Uncertainty in Shaping Individual Preferences for Residential Energy Renovation Decisions.

• Author: Bakaloglou, Salome

1. INTRODUCTION

The housing sector accounts for approximately 30% of worldwide energy consumption. Urgent issues such as fighting climate change, enhancing energy transition, and improving energy security have put the residential sector of many Western countries in the spotlight because of its sizeable energy-savings potential, achievable through energy efficiency investment (Belaid et al., 2019). However, energy efficiency investments in the residential sector seem to lag behind public policy objectives set in several countries. The economics literature has extensively investigated the energy gap paradox- a significant and persistent difference between the socially optimal levels of investment in energy efficiency- broadly defined as a significant and persistent difference between the levels of investment in energy efficiency and the investments households actually pursue (Jaffe and Stavins, 1994; Gerarden et al., 2015). More generally, the literature on the barriers to energy efficiency investment has raised debates for many years (Sutherland, 1991). Within this literature stream, several theoretical studies, but few empirical works, have noted that uncertainty about energy renovation benefits could have a crucial role in explaining under-investment in efficient energy retrofit (Alberini et al., 2013; Newell and al., 2015; Sutherland, 1991)we surveyed 473 Swiss home-owners about their preferences for energy efficiency home renovations. We find that homeowners are responsive to the upfront costs of the renovation projects, government-offered rebates, savings in energy expenses, time horizon over which such savings would be realized, and thermal comfort improvement. The implicit discount rate is low, ranging from 1.5 to 3%, depending on model specification. This is consistent with Hassett and Metcalf (1993. Contributing to this literature, we address two questions: Does uncertainty about energy retrofit quality and future energy cost matter in the energy efficiency decisions of French homeowners? and What is the role of household heterogeneity in explaining energy retrofit decision making and the role of uncertainty?

For this purpose, we collected a rich dataset consisting of 3000 French private homeowners. We use the flexibility of the discrete choice experiment (DCE) methodology to determine the extent to which household values reduced uncertainty on expected savings and thereby influenced decisions to invest. We then use a mixed logit (ML) model to investigate the nature of systematic heterogeneity in household preferences for the attributes of energy renovation solutions and its link with some individual characteristics.

This empirical research contributes to the nascent literature on energy efficiency investment related to the risk and uncertainty barriers. Although some theoretical studies address this topic, to our knowledge, our study is the first to empirically investigate the role of perceived uncertainty in explaining decision making related to energy-efficient investment for two sources of uncertainty and from a household perspective.

This article makes three methodological contributions. First, we develop a stated preference methodology based on a DCE to examine the importance of the uncertainty barrier in shaping household energy renovation decisions. Second, we implement econometric choice models accounting for heterogeneity in preferences for energy renovations.Third, we empirically measure individual characteristics such as risk aversion and perceptions of the changes in future energy prices and use them to explain this heterogeneity.1 Despite the rich theoretical literature supporting the idea that technical and economic risk and uncertainty could play a crucial role in explaining under-investment in energy efficiency, empirical evidence remains scarce (Brent and Ward, 2018; Fowlie et al, 2015). Several difficulties in addressing this issue with empirical work account for this research gap. The effects of different individual factors, such as individual risk aversion and subjective perception of the economic environment, must be disentangled or at least consistently examined. Then, from a methodological perspective, time consistency between energy efficiency decisions and the measure of different individual characteristics should be considered. Moreover, various sources of risk and uncertainty should be ta ken into account.

To overcome these difficulties, we investigate the relevant sources of uncertainty and their importance in the decision-making process of energy efficiency investment, along with the relationship to household characteristics, using a DCE to examine our research hypothesis with rich data gathered from an extensive French sample. The DCE overcomes the following shortcomings of standard revealed preference approaches. First, standard revealed preference approaches do not rigorously account for the relationship between individual perceptions, preferences, and beliefs (about energy pricing, defects, and risk aversion) and action (energy efficiency investment). Second, they require a larger sample to control for all heterogeneity sources because several other characteristics can affect decisions (e.g., the type of retrofit, housing characteristics). Last, they do not adequately value the potential benefits of reducing uncertainty (in terms of change in utility or change in the energy retrofit rate). Although the DCE has some limitations when respondents are not overly familiar with the object of the experiment, we were careful to provide respondents a homogeneous framework within which they could make informed decisions.2

Our results indicate some potential avenues for action to increase energy efficiency investment. First, they suggest that uncertainty about energy prices and energy retrofit quality negatively affect the energy-retrofit decision-making process. Indeed, we provide evidence that French homeowners value greater certainty about future trends in energy pricing and quality of the renovation when making decisions (i.e., greater certainty has a positive impact on utility). Consistent with theory, the impact on the utility of reduced uncertainty is higher for risk-averse individuals. Furthermore, willingness to pay (WTP) for insurance with regard to energy retrofit quality and a fixed energy price contract is cheerful and heterogeneous among respondents: A larger share of homeowners preferred quality insurance to the fixed energy price contract. Finally, we use our results to simulate the impact of specific initiatives and show how they could substantially increase the energy retrofit rate of French homeowners. We found that introducing insurance for retrofit quality over 10 years increases the energy renovation rate by 10%--15% compared with the reference scenario. This result paves the way for new strategies that policymakers should consider to increase energy retrofit rates.

The remainder of this article proceeds as follows. Section 2 provides a review of the literature that helped inform both our research question and approach. Section 3 details the dataset, the design of our DCE, and the data analysis of the variables of interest. Section 4 provides the theoretical framework, econometric specification, and the estimation technique. Section 5 presents the main results and simulation to enlighten discussion, and Section 6 provides concluding remarks and policy insights.

(2.) LITERATURE REVIEW

This research builds on the nascent literature investigating the barriers to energy efficiency investment, the role of individual preferences in impeding the adoption of energy-efficient technology, and the energy efficiency gap or energy paradox (Gillingham and Palmer, 2014; Jaffe and Stavins, 1994; Sutherland, 1991). These studies assume that market failures (e.g., energy prices do not account for environmental externalities, asymmetric information, split incentives between tenants and landlords), market barriers (e.g., contextual uncertainty, heterogeneity, hidden costs), and behavioral failures (e.g., individual preferences, behavioral bias) have a major role in explaining the under-investment in energy efficiency in the residential sector (Gerarden et al., 2015; Gillingham and Palmer, 2014; Sorrell and O'Malley, 2004; Sutherland, 1991). This research relates to at least four strands of research.

The first strand comprises studies focusing specifically on the uncertainty associated with energy-efficient investment. This uncertainty can be a barrier to investment in energy efficiency. Market failures (e.g., environmental negative externalities, split incentives between tenants and landlords) can lead to an under-investment in energy technologies. Several sources of risk and uncertainty are commonly associated with energy efficiency investments in the residential sector. First, technical uncertainty, which arises from the 'innovation' status of energy efficiency technologies, suggests limited accessibility to robust feedback and the inaccuracy of performance measures (and energy savings). Thus, savings resulting from energy efficiency investment cannot be fully guaranteed. Some empirical works have provided evidence that actual energy savings are heterogeneous and often far from the expected savings in commercial and residential buildings (Laurent et al., 2013; McCoy and Kotsch 2018; Qiu and Kahn, 2019; Sutherland, 1991). The literature suggests three possible explanations for this discrepancy between realized and projected savings, including technological instability, changes in occupant behavior and modelling errors (Qiu and Kahn, 2019).

Second, adverse selection and moral hazard that occur in a principal-agent relationship (see Laffont and Martimort, 2009) can lead to defects in retrofit quality, which results in uncertain outcomes relative to retrofit quality and energy savings being potentially lower and less efficient than expected (e.g., Giraudet...