Economists Ask If Energy Efficiency Is A Good Investment

As if we economists do not stir up enough trouble by pontificating on national monetary policy, we have now hit the hornet's nest on energy efficiency. Recent economic analysis points to energy-efficiency investments delivering as little as half of their promoted savings. This is more than a little upsetting to an environmental community attempting to protect humanity from global warming. Will we investigate Santa Claus next?

Economic questions about energy efficiency

Take two air conditioners and run them side by side. The less efficient one will use more energy. The more efficient one will use less. For engineers, that is all they need to know to validate that energy efficiency saves money.

We economists are such troublemakers. We want to research how energy efficiency actually works inside a home with real humans that pay a monopoly a monthly electricity bill. What this type of economic research has found is that energy efficiency is not an obvious money-saver.

How human behavior impacts energy efficiency

There are two key factors that impact the return on energy-efficiency investments. One is human behavior. For example, people buy air conditioners to be cool. They hate paying large electricity bills. So, those pesky humans make a totally rational economic decision: They buy a more energy efficient air conditioner, crank it to 70 degrees, enjoy cool air and keep their electricity bill from soaring ever higher.

Since less than one-tenth of 1 percent of consumers can correctly self-calculate their electricity bills (that arrives a month after they use their air conditioners), they have little economic basis to do anything other than focus on their thermostat and its ability to clearly message a spouse’s desire to be cool.

How utility pricing complexity impacts energy-efficiency investments

Electric utilities are the second key factor influencing energy efficiency ROI. Utilities are masters at making their prices and bill calculations highly complex. Price complexity distorts the ability of most consumers to make economically rational decisions.

Here is an example that illustrates how utility rate design can alter the ROI on energy-efficiency or renewable-energy investments. I am analyzing the return on renewable-energy and energy-efficiency investments for a medical office building. The building pays for its electricity through a highly complex utility rate in which half of the monthly bill is determined by something the utility industry calls a “15 minute non-coincident demand charge.” Let me try to explain how this type of price complexity can deter customer investment in energy efficiency and renewable energy.

Electric demand is the rate of electrical use. Non-coincident means a consumer is setting a higher rate of use at a time that does not align with the time period a utility is setting its system peak rate of use. For example, a consumer could set their rate of use at midnight in the winter when the utility sets its rate of use at noon in the summer. This is a big deal in allocating utility costs. Utilities want to charge more to customers who set their rate of use at the same time they set theirs. But a utility wants to charge customers less (or nothing) went they do not contribute to the setting of that utility’s rate of use.

Now let’s assume you invest in energy efficiency or renewable energy. You do so because you will reduce your energy consumption and you think you will reduce your demand. You think you will save money. But for one 15-minute period during a 8,760-hour year, your building could set a higher demand than estimated in calculating the ROI on an energy-efficiency or renewable-energy investment. Even if this demand occurs at a time when the utility’s system demand is not setting its own peak, you will face a year of higher electric bills!

Clear as mud right? Because it is not, this explains why home- and building-owners maybe underinvesting in energy efficiency and renewable energy. Investors are not attracted to investments that have a precept threat to the targeted rate of return. Utility pricing is too often a perceived threat because it combines the principal of “you can’t beat city hall” (in this case a monopoly utility’s complex pricing) and the principal of “fool me once shame on you, but fool me twice ...” Too many customers view utility pricing (and its regulation) as skewed toward the utility, and too many customers have invested in energy efficiency and have not seen the anticipated savings in their electricity bills as utilities raise rates and change rate designs.

Free utility customers!

How could we promote energy efficiency and investments in renewable energy by home- and building-owners? We economists have an obvious answer. Free consumers from complex utility-rate designs that create uncertainty for customer-owned investments in energy efficiency and renewable energy.

How would this work? The current regulatory process fundamentally designs rates to enable utility investments. Prices are designed to ensure that a utility’s investments delivers a target ROI. What if regulation were to focus instead on insuring that customer investment in energy efficiency and renewable energy delivered a target ROI?

Under such a system, the utility becomes a “network” provider. It profits not from its investments but from its role in enabling customers to profit from their own investments in energy efficiency and renewable energy. In effect, the utility becomes the integrator of customer-owned Zero Net Energy buildings that optimize building performance around cost and environmental impacts. The utility profits when the customer profits, and the utility profits when the customer achieves a lower environmental footprint.

Could the Clean Power Plan open the door?

The Clean Power Plan could open the door for states to adopt a customer-centric investment model to realize cost-effective and cleaner power generation. The Clean Power Plan charges states with designing plans to reduce global warming emissions. One path for a state would be to focus on paying utilities to shut down polluting power plants and to build power plants that pollute less.

An alternative path would be for states to shift the investment opportunity to consumers. The reason for doing so is because the most promising technology innovations in electricity generation and consumption (like the Nest smart thermostat, rooftop solar and LED lighting) are on the customers’ side of the meter. These technologies offer a path to lower consumer electricity bills plus reduced environmental impacts. In comparison, a utility-centric Clean Power Plan would focus on fossil fuel technologies that will not deliver reduced customer bills and will only deliver modest reductions in global warming emissions compared to our most polluting power plants.

Regulatory crossroads

The regulatory choice could not be more stark. One path will empower customers to invest in energy efficiency, smart building technologies and renewable energy. The other path will empower utilities to invest in natural gas power plants, a utility-centric “smart grid” and hopefully more renewable energy. The only path that leads to guaranteed lower electricity bills is to empower consumers. How regulators address this crossroads will shape our economy’s competitiveness and our ability to stop global warming.

Image credit: Flickr/Jan Tik