The Economics of Energy Efficiency

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Generally the term EE is defined in a technical sense and relates a given level of service to a given level of input. To put it differently, an increase in EE occurs when either energy inputs are reduced for a given level of service or service is increased or enhanced for a given level of input. To be energy efficient per se is to provide services with an energy input that is small relative to a fixed standard or normal input.

It is important to note that EE should not be regarded as an end in itself. It is a means to conserve natural resources, to reduce environmental degradation and to save money. It is true that EE helps to reduce GHG emissions. However, there is a debate about both its cost effectiveness and the policies that should be pursued to enhance EE.33 Improvements in EE will require active intervention in markets to overcome barriers and to stimulate drivers (see Chapter 6 on drivers and barriers). On the other hand, some argue that market barriers to the penetration of EETs do not represent real market failures that reduce economic efficiency. Under certain conditions, such as wrong choice of technology, expensive policy incentives, inefficient implementation, there can be trade-offs between economic efficiency and EE, even though these goals should go hand-in-hand logically. The balance of evidence supports the view that there is not always a 'free lunch' in EE. Nonetheless, a case can be made for the existence of certain inefficiencies in energy technology markets, thus raising the possibility of win-win EE enhancements. These issues are discussed in more detail in Chapters 3, 6 and 9.

The cost effectiveness of an efficiency measure varies, depending on who evaluates the investment and which costs and benefits are considered. For example, from a business perspective, the only relevant costs and benefits are those borne by the energy user. These include expenditures on equipment, installation as well as operation and maintenance costs. The benefits include energy cost savings plus enhanced labour productivity, environmental compliance or product quality. These are the traditional accounting costs and benefits that affect the industry directly. From a societal viewpoint, there is a wider range of relevant costs and benefits. These include monetary, health and environmental costs and benefits that accrue to society. Certain societal benefits, such as reduced local air pollution or diminished threat for climate change are external to the market and are difficult to quantify. Moreover, they accrue to society at large, not directly to the particular party

33 See for example, Newell 2000.

implementing efficiency measures. So it is important to analyze who bears the costs and who gets the benefits. Not until every actor has a positive cost-benefit perception will they participate and the EE system will take off. The EE approach can be termed as tightly coupled.

The key economic question that will determine the pace of the widely anticipated energy revolution is the cost of improving EE relative to various forms of energy generation, such as for instance the cost of extracting fossil fuel and providing services through renewable energy sources. The fundamentals of EE are discussed in greater detail in Chapter 4. It is worth discussing three fundamental relationships here:

• With increasing costs of energy generation, the adoption of EETs will become a viable alternative. Since the contribution of renewable energy sources is marginal to the total energy mix the main economic driver for EE remains the utilization offossil fuels. The more expensive the extraction of these fuels, the more attractive is the reduction in their use through efficiency measures.

• With increasing volatility of energy prices, many countries become vulnerable to such volatility. While the high and volatile oil prices may reduce economic growth in developed economies, they can trigger prolonged economic crisis in developing countries in the form of increasing budget deficits, trade imbalances, increased unemployment and impoverishment. Under these circumstances, the option of efficient utilization of energy becomes an attractive proposition.

• With increasing stability and soundness of economic policies and overall macroeconomic conditions, the probability of increasing EE will be higher. It is generally postulated that macroeconomic conditions matter less with regard to EE area because EE projects are more of a short-term proposition than fossil fuel or nuclear power projects. However, traditional energy investments tend to be large and long term, and hence the political and economic stability of the country is particularly important.

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