Chapter 10: The Energy Efficiency Gap

Contents10.1: Introduction....................................................................................................................................1

10.2: The Potential..................................................................................................................................2

10.3: Trends to Date................................................................................................................................4

10.4: Barriers To Change.........................................................................................................................6

10.5: Consumers as Drivers of Emissions...............................................................................................11

10.6: The bigger picture.........................................................................................................................13

10.1: Introduction

Energy efficiency looks like a powerful way to address multiple problems. Chapter four pointed out that the entire energy system, with all its attendant problems, is driven by a few major categories of demand – in homes and offices, in industry, and in transport – and that in each of these, there are abundant technological options to do more with less. Reducing energy demand can address energy security and energy poverty, whilst promoting economic growth and carbon abatement, with little associated costs or risk. Energy efficiency looks like a ‘win-win-win’. Who, after all, could oppose being more efficient?

No-one; and everyone. Consumer decisions are the ultimate driver of energy and emissions, in multiple ways. The simplest division is between what we do, and what we buy. What we do – consumption patterns and lifestyle choices - is widely considered sovereign, delicate terrain; what we buy – consumer purchase decisions – is far easier to consider. In terms of our energy habits, the former has become associated with ‘conversation’, or doing less; the latter, with ‘being efficient’, or doing more using less. Part III of this book does indeed focus mostly on the latter – efficiency – though in its final argument comes full circle to consider also more deeply-rooted questions of consumption patterns and choices.

As sketched in Chapter 4, the potential for energy efficiency is huge, but at the heart of this observation lies a paradox about our own behaviour, and deep-rooted assumptions about our economic systems. Whilst engineers point to long lists of potentially better technologies, economists point out that if they were really “better” then people would buy them, and use them. The classical argument has been that if energy efficiency is so good, then it will succeed

anyway. To some degree, the engineers singing the multiple praises of efficient technologies have, from a policy perspective, been their own worst enemies – the implication is that efficiency will come forth, and save us from having to do anything difficult. In practice, we observe a big gap between what is available – let alone possible – and what people actually buy, and use. This chapter is about what we have learned about the ‘energy efficiency gap’.

10.2: The PotentialTechnologies that could provide more using less are abundant. Estimates of the global potential vary, but one widespread approach expresses it in terms of a ‘cost curve’ – most of which is negative. The ‘McKinsey Curve,’ as featured in chapter 3, suggests that the world could by 2030 cut its projected growth of emissions by more than 35% compared to 1990 levels, at ‘negative cost’ – ie. economic benefit. Most of this is associated with energy efficiency – and would help to address fossil fuel dependence as well.

Figure 10.2: McKinsey Cost Curve, aggregated to energy efficiency

Source: Carbon Trust (2009), using McKinsey data from Pathways to a Low carbon Economy (2009)

Specifically, improving building energy efficiency could cut emissions by 3.5GtCO2 annually, with net cost savings of €32/ tCO2. Water heating, air conditioning, and lighting are also found

to save more money can they would cost. Similarly improving the efficiency of the entire fleet of road transport could reduce emissions by 1.5GtCO2 per year, with a net cost saving of €10/tCO2. Overall the McKinsey Global Institute indicates that 6.5-8 Gt of carbon abatement could be achieved from energy efficiency at an average rate of return of 17%, (McKinsey and Company, 2008).

At the consumer level the financial benefits from investing in energy efficiency appear to be tremendous. Lighting improvements offer pay back periods between six months and two years, insulation instalment should lead to net savings after 2 years, while draught proofing measures can take up to eight years, and CHP (combined heat and power) or smart building management systems may take longer accrue (Energy Saving Trust, 2009)

In the UK, through their collaboration with multiple market actors, the Carbon Trust has calculated that there is an opportunity for £2.5 billion annual savings and 37 MtCO2 if businesses and organisations operated at their most efficient level (Carbon Trust, 2009). The Energy Saving Trust, who provide a similar service for the residential sector, have reported that there remains a potential for a saving of £300 annually on energy costs for the average household, amounting to 1.5 tonnes of CO2 (EST, 2010).

In practice, for multiple reasons it is very difficult to calculate with certainty what the potential for energy savings from efficiency might be. The interaction of technological, economic, regulatory, and cultural variables distorts a clear perception of the real driving forces underlying efficiency gains. Finally and perhaps more significantly, we are not capable of measuring with certainty the influence behavioural factors bear.

A further complication in the calculation occurs because the technological turn-over is rapid, and the application of new technologies is often more specialized and thus only suits only a few. There are associated hidden costs involved in the acquisition of new information, making new investments, and adapting to new methods.

However, take-up of such technologies seems to lag far behind the potential. Classical economics assumes that consumers will choose least-cost options, trading off purchase costs against the value of energy savings. This rationale has not prevailed. Inferior technologies continue to drive an wholly unecessarily level and cost of energy use. This pattern appears to be consistant accross investments in buildings, transport, and industry.

The enduring discrepancy between the most economical energy basket, and consumers’ real choices is known as the ‘energy efficiency gap’ or the ‘energy paradox’. Not only does the energy efficiency gap indicate that people are not operating at the most efficient level

economically, but that more greenhouse gasses than necessary, given current technologies, are being released into the atmosphere.

10.3: Trends to DateThe prevalence and endurance of the energy efficiency gap – for it is not a new observation - gives the impression of a little progress in energy end-use, and could breed cyncism. In fact, the potential endures despite great advances in energy efficiency, that have contributed remarkabley to reducing energy consumption.

Figure 10.2: Efficiency gains from enhanced heating technologies in UK

19701973

19761979

19821985

19881991

19941997

20002003

2006-

10.020.030.040.050.060.070.080.090.0

100.0

Energy savings due to insulation and heating ef -ficiency improvements in Great Britain 1970 to

2006

Heating efficiency saving1Insulating saving1Energy consumption

TOE

(mill

ion)

Source: DECC (2009) Energy Consumption in the United Kingdom

In Britain today it requires almost 50% less energy to heat the average home, than it did in 1970, primarily due to the availability of greater heating and insulating technologies (DECC 2009). This remains far from the amrket potential. In Britain only 39% of suitable houses have cavity wall insulation, 50% have double galzed windows accross the house, 57% have the maximum depth of loft insulation, and only 5% have the maximum insulation on their water tank, (DECC 2009).

Internationally, an assessment suggests that enhanced energy efficiency since 1990 have met 58% of the new demands for energy-related goods and services, while new energy supplies have

met only 42% of those demands, (Laitner, 2010). In the US advancements in energy efficiency have 75% of growth in energy demand since 1970.

Its not just households. Within manufacturing, average energy efficiency among 21 IEA countries increased 32% between 1990 and 2006, primarily driven by improvements in energy efficiency, (IEA Scorebaord, 2009). Yet once again despite these great gains in energy efficiency, analysis of ‘best avaiable’ or ‘best practice’ technologies across energy-intensive sectors (iron and steel, cement, pulp and paper, chemicals and petrochemicals, and aluminium), showed that a reduction of final energy consumption by 13% to 29% could be achieved with greater up-take of these currently available methods, (IEA Scoreboard, 2009).

Up-take thus continues to lag far behind technological potential. The remarkably slow adoption of the most efficient technologies among households, businesses, and industry, indicates a potential failure in the market. It is not financial benefits or carbon reduction oportunities alone that are under achieved, but there is a range of positive externalities not realized. These include other GHG reductions, reduced fuel poverty, enhanced security of energy supply, and the promotion of economic growth by supporting new niche markets, (UNFCCC, 2007).

Moreover, the rates of improvement observed in aggregate are not enough. As outlined in Chapter 4 (Fig4.4), to get to where we need to be, far greater leaps in energy efficiency are required. It has brought us some way, and offers great potential, but a greater rate and scale of up-take will be required.

For an economy to move towards a higher level of energy efficiency, technological progress is one factor, and only half the journey. The second half is driven by consumer choice. Apparent economic benefits on their own seem insufficient to motivate uptake; something else is getting in the way. 

It may be the case that the consumer is making irrational or poor investment decisions, but that they never consider energy – an abstract, invisible and untouchable commodity. Adoption of energy efficiency is not only a case of weighing up the capital cost verses longer term savings, but brings with it a need for a change of habits. Society has learned a single mode of providing, consuming, and applying energy, and now assumes this to be the norm. Technological advancements can offer a new energy culture without reducing welfare. Rather than assuming energy to be a necessary overhead or cost of living, lateral thinking about why and how we use energy might lead to simple savings. Using space heating as an example again, before central heating was widely available, insulation of a living space was the first protocol in heat provision. Historically, habited spaces have been constructed with thick walls and roofs, and limited gaps for air entry or exit. We can see similar patterns in animal behaviour, as many burrow holes in the ground to hibernate for the winter. So why did we throw these basic skills with the coming of a new technologies? Surely efficient means of creating heat, should act as a compliment to those

insulation skills already harboured. Instead we choose to pay for a service that is beyond what we require given skills acquired.

10.4:Barriers To Change Faced with the ‘energy efficiency paradox’, an economist’s first instinct – beyond denial - is to seek out what impedes a rational response to the apparent economic (and other) benefits. The barriers frequently cited can be usefully grouped into financial and hidden costs, market misalignments, and behavioural factors.

Some components of these barriers are illustrated in Figure 10.2 – which also captures the observation that the barriers are currently outweighing the drivers for efficiency up-take. However some of the behavioural barriers, with a change in culture, could shift to put greater force behind the drivers.

Cost Savings

Corporate Social ResponsibilityInherent Environmental ValueFashionSocial Pressure

Cost of Not Changing- Higher Emissions- Inferior Equipment- Market Demand

Capital Constraints

Cost of Change- Incompatability-Performance Risk-Management Time-Other Transaction Costs

DiscountingInvisibility + Intangibility of Electricity / CarbonProcrastination

NormsRisk / UncertaintyOption ValueVicarious Learning

Financial Costs & Benefits

Hidden & Intangible Costs

Behavioural Factors

Barriers Drivers

Split Incentives- Tenant / Landlord- Builder / Buyer

Market Misalignment

Figure10.2: Barriers and Drivers of Energy Efficiency up-take

10.5.1 Capital Constraints

The capital cost of maximizing one’s energy efficiency may pose a large barrier to those wishing to make the long term investment. Up-front costs may form an insurmountable barrier, if a household or organisation simply cannot make the capital available for such an investment. High initial costs will contribute to a consumer’s perception of risk when making an investment in an unfamiliar technology. The rapid technological turnover, implying what may be a good investment today, will be the inferior option tomorrow, further enhances this sense of risk.

10.5.2 Hidden Costs

If consumers are not responding to positive price signals it is commonly assumed that there must be hidden costs, not accounted for in economic valuations.

Insufficient information is one cost inherent in pursuing new investment options. There is a cost associated with gaining the correct information - whether it is optimal to up-grade energy stock, which is best suited, and understanding the installation or application and up-keep of the new technology. Once information is available to consumers there remains the complication of the credibility of that information and its’ reliability. Trust is key to develop when addressing the public. In terms of energy education this poses a great challenge, given past contradicting information on climate change.

10.5.3 Split Incentives

‘Split incentives’ or the ‘principal-agent’ problem occurs when two people share an econmoic relationship, but one is concerned only with the up-front cost of investments, and the other with the longer term costs. A landlord will seek the least-first-cost option, while a tenant may be interested in greater energy efficiency which would impose an initial financial expense. If investments in infrastructural improvements are not transparent on the market, it is not worth the cost for a principal actor, e.g. a builder will only install the most energy efficient technologies if he will receive a worthy return for the higher investment and his effort.

Given the nature of these barriers, invisible or too ambiguous to measure, it is difficult to calculate with accuracy the level of impact they have in the market. Perhaps we are naive to the gravity of the barriers in impeding technology up-take. It could also be the case that the gains from a more sophisticated use of energy and eliminating inefficient waste (e.g. exergy, as outlined in chapter seven) make the potential far greater than we realize.

Removing these barriers in the market, should, based on classical economic argument, free up boundedly rational consumers to make the most price sensible decisions. The equilibrium point should move to where the demand for efficiency meets the full technological potential. However this assumes that people are agents of price, choosing their purchases based on a willingness to pay. Does money make the world go around? We argue that it is a narrow definition of human

motivations and desires to assume that people respond to money alone. The success of the entire marketing industry hinges on the idea that demand is affected by other factors than price. It may be that consumers are optimizing, based on a broader set of criteria, omitted in classical economic calculations.

10.5.4 Behavioural Factors

There are a number of behavioural anomalies which have been linked with economic decision processes, including social norms, rules of thumb, uncertainty, endowment, and many more. Some factors bear an impact on household and organisation decision making processes, while others are specific either to the individuals or to organisation design.

10.5.4(i) Individuals

In additional to the capital strain of investments in energy efficiency, people tend to have high hurdle rates, inherent in any decision making process. We apply discount rates to gains and losses that accrue in the future, i.e. a greater weight is put on short-term circumstances. We also tend to value losses more than gains – prospect theory{Kahneman, 1979 #6}. That implies that the present loss associated with the cost of investment holds a greater weight than the long term benefits. This is not necessarily an irrational heuristic, causing sub-optimal decision making processes. It is in fact a useful means of making decisions. The sheer speed of technological turnover brings with it an inherent uncertainty about the quality of the new and unknown. While waiting before investing, consumers benefit from option value, that is they retain the freedom to choose at any time. Investing in high cost technologies now, they are potentially locking themselves in. Waiting before investing also allows the consumer to enjoy a period of exploration, during which they can observe others’ behaviours. This has been dubbed the experience curve effect. If those around them invest they may learn vicariously what the best route to invest is. These effects of uncertainty are further enhanced by the nature of changing energy prices, and evolving energy and climate change legislation. Uncertainty is a driver for more behavioural factors enhancing staying behaviour.

When faced with uncertainty people tend towards social norms to inform their decisions. With the introduction of new technology or a new piece of research, we cannot look inside ourselves for the answer, so people look to those nearest, for evidence on how to act. Under uncertainty the most popular response is to opt for no change. There are many reasons for this. The current status quo is the only way we know, and thus the least risky path to undertake. Another cause for staying behaviour might be that of the endowment effect. We tend to value what we already have above what we do not possess, thus, despite evidence to the contrary, we may bias in favour of no change, genuinely believing it to be the best option available. This description of decision making processes outlines a circular pattern of behaviour, and could very well play a role in the slow diffusion of new technologies. Uncertainty according to this description is the prevailing factor driving no change, and thus may be drawn back to information as a barrier in the market. However uncertainty does not indicate that we require more information alone. It is broader than that. People may not be aware of information availability, or they may find it difficult to distinguish between the information being offered from a variety of sources. If it is the latter that is driving no change, a further bombardment of information may only serve to create more staying behaviour.

There are still more behavioural factors, impeding price driven consumer behaviour that will be drawn upon in more depth in chapter 12.

10.5.4 (ii)Organisational Inefficiencies

In private businesses where profit maximisation is the primary driving force for investment decisions, energy stock and service seem to have fallen outside the realm of consideration for many. It may be that energy is an assumed overhead, and that the standard of energy service has not been considered as a variable in cost estimates. The margin could be too small relative to other investment decisions, that consideration of energy stock never features high enough on priorities.

Other inefficiencies occur within businesses and organisations as energy use is divided among many, though not all are accountable. There is a divide between energy managers and decisions makers, or the decision chain is too long, or nobody within the management circle are concerned with energy investment, and things fall by the way side.

There are however no over-reaching definitions for the catalyst of the energy efficiency gap. There are a number of factors causing sub-optimal decision making processes, which vary in

their impact across different scenarios. If policy is to intervene in the market it must recognise what the driving force for energy decisions really is, at the consumer and organisational level. These will vary in their mix, across communities and sectors, and thus the design of sophisticated policy has been a challenge, and remains so.

10.5: Consumers as Drivers of Emissions Figure 10.3 shows how the consumer role in emissions is spread accross three categories of energy consumption; embodied emissions from the production process of goods and services, implied emissions from the actual use of a good or service consumed, and consumer activity the choices to invest in one technology, how they apply their energy stock i.e. is a window above a radiator left open.

Figure 10.3: Consumer Driven Emissions

Buildings

Purchasing the most

efficient appliances

Clever use of energy stock (close windows while heating is on)

Efficiency of

infrastructure

Materials used

Practices during

construction

Industry

Purchase and

application of most efficient energy stock

Management /

organisation structure + decision making processes

Fuel / electricity

system Energy used per unit

of output

Raw materials used

Efficiency of

equipment used

Transport

Mode of transport

used Mpg of vehicle

purchased Maintenance of

vehicle

Power fuel Mpg

Shipping of imported

materials

Consumer Driven

Emissions

Activity Implied Embodied

These categorisations of the consumers’ part are not entirely independent of one another. For example the emissions from the industrial process make up the embodied emissions of consumer goods and services. However as a method to understand each agent’s impact, this diagram is a means of viewing the link between decision making processes and emissions.

Another component of the consumer footprint, not incorporated into the diagram, is the ever climbing pattern of demand. A concern raised with the enhancement of energy efficiency, and

thus the cost savings on energy consuming activities, is that consumers will respond with greater consumption. This is known as the rebound effect (ref). If cars allow for more miles per gallon, consumers can afford to drive more, faster, or purchase larger vehicles. Certainly demand for energy has been scaling up, but the size of the rebound effect and its role in policy has been a matter of controversy. The primary implication of this concept is that energy saving potentials from enhanced energy efficiency, and the role and cost effectiveness of policy are uncertain and in quantifiable. It is likely that the magnitude of energy savings will be overestimated without consideration of this behavioural pattern.

10.6: The bigger picture Energy efficiency has been the subject of many optimistic evaluations on mitigation potentials. The IPCC forecast that doubling the rate of energy efficiency would allow the world to hold CO2 concentrations below 550ppmv, avoid $3.0 trillion worth of new generation, and save consumers $500 billion per year by 2030, (IPCC, 2007). Looking at past trends, where we see great gains achieved in energy efficiency applications, such as the case of space and water heating in the UK above, we can see that despite lowering energy required per unit of activity, an upward scaling demand negated any reductions in energy use and emissions. In the context of housing, demand has increased not only due to more residential properties occupied, but on average they are getting bigger, people are using more powered devices, and we are wealthier, thus pushing overall consumption up. Globally demand hikes among consumers can be largely attributed to increases in wealth, and to population growth in developing nations. In terms of energy there is no diminishing marginal utility does not apply. As part of our nature we will always want more, want things bigger, and want to do everything faster. Sufficiency will never be a reality, and thus efficiency must be brought to its absolute. Embodied emissions may be a harder challenge to face as any attempts at promoting conservation will no doubt face strong criticisms. Through enhanced efficiency in the production process, embodied emissions may of course be tackled, and there is some scope for substitution for low carbon inputs at the industrial level, but we are still relying on behavioural process. People, whether they are investing in their production process, or purchasing goods and services for their own use, must opt for low carbon. Price signals seem to be limited in their impact, so where do we turn now?

With a more sophisticated insight into consumer optimisation processes, we may gain a new perspective on past policy successes and short-comings. The first step will be to understand where the intuition driving consumer choice lies. Provided with the right mechanism, could environmentalism be a factor influencing consumer decision making? If price is indeed not the only factor driving preferences, an understanding of what is, and whether a sense of social

responsibility can play a role in efficiency up-take and embodied emissions considerations may be the tool to realize the forecasted benefits of enhanced efficiency.