Economics of energy efficiency adoption

The discussion so far has illustrated the bumpy route of economic and operational factors that leads to new efficient technologies and stressed the importance of institutional support to create a cycle of continued use with resultant technical improvement and cost reductions. But all of these insights into the process of increasing energy efficiency lead to naught if consumers and firms do not adopt these energy efficient technologies. Of course costs play a pivotal role in the uptake of energy efficiency. Individual efficiency investments have been shown to be induced by rising energy prices (Newell et al., 1999).

When analyzing the uptake of energy efficiency innovations, these technologies have historically poor levels of adoption despite the high projected rates of returns. This has been called the "Energy Paradox" (Jaffe and Stavins, 1993). Explanations have included the additional costs that it poses to organizations to change their method of operation (Cebon, 1992), or that for consumers at least, the idealized engineering-economic projected savings are never approached (Metcalf and Hassett, 1998). Another possibility is that consumers are simply not aware of the technology and potential savings (Brill et al., 1998). Morgenstern (1996) has found that the provision of free technical information is important, but not nearly as important as the effects of energy prices, although it may be that firms need a good information network to keep up with developments in energy efficiency (DeCanio and Watkins, 1998).

A promising avenue of research examines investment under the realistic conditions of uncertainty and irreversibility (Dixit and Pindyck, 1994). This avenue of research is centered on the reality that investments are "lumpy" through time, and are generally irreversible. Thus the uncertainty inherent in decision making assumes a much greater importance and investors are more likely to wait until uncertainty is reduced. Studies looking only at substitutions under conditions of rising prices and increasing uncertainty found that higher net present values were required and the optimal strategy was to delay investment (Hassett and Metcalf, 1993; Farzin et al., 1998).

Another analysis tool is diffusion theory (e.g., Griliches, 1957; Mansfield, 1961). Insights from diffusion theory include the categorization of adopters as innovators and laggards, illustrations of the uptake of individual innovations as an exponential curve with a rapid take-off following early adoption, and the necessity of both mass and personal communications media for successful adoption.

Some proponents of energy efficiency feel that it has such high cost effectiveness that they cannot believe adopters would have any reluctance to investing in it, if only certain market barriers were corrected. For example, as mentioned above, Lovins (1996) likens the non-adoption of energy efficiency measures to pedestrians not picking up a $100 bill on the sidewalk. This analogy certainly holds resonance with engineering economic studies of energy efficiency investments that offer simple payback periods of less than two years, and sometimes even months (e.g., simple energy management measures including automatic sensors for turning off lights in unoccupied rooms). A separate study (Strachan and Dowlatabadi, 1999) shows that adopters do invest in energy efficiency, even though these investments turn out to be poor in comparison to the existing alternative of centrally generated grid electricity and on-site boilers.

Others believe that potential adopters may be inherently reluctant to invest in energy efficiency for a variety of reasons, including expectations of rapid technological change and uncertainty about theoretical returns. Under any of these circumstances, we turn to the non-economic consequences (perceived or real) of investing in energy efficiency to explain adoption or non-adoption behavior, and these are discussed in the next section. It should be noted that potential investors in energy efficiency opportunities compare it not only to existing energy use but also to the range of other spending opportunities for the firm or individual. In addition, energy investment is often discretionary and typically only accounts for a small fraction (~5%) of operating costs. Thus, even if energy efficiency is considered to be a good investment, other (non-energy) investments may be preferred at the expense of efficiency improvements.

4.7.2 Social factors in energy efficiency adoption

Some of the common social barriers to energy efficiency adoption include the lack of information, the cost of making and implementing a decision to change practices, and any difference in the energy services that the new technology offers (for example, reduced lighting output from early compact fluorescent bulbs). However, social processes can equally work to promote energy efficiency. Examples of this (which also reinforce the observation that social feedbacks are as important as economics and technology in determining efficiency levels) include the move towards fitter lifestyles, the construction of bicycle lanes in European cities, and the role of increasing Internet communication including video-conferencing in reducing transportation. Of course, it is possible that more electronic communication could mean more communication in general and perhaps lead to higher total energy use.

The acknowledged limitations of diffusion as a social theory explaining adoption has been taken up by Gruebler (1997), who presents an empirical examination of diffusion as a process of imitation and homogenization, but with clusters and lumps. These discontinuities may be considered as inherent features of the evolutionary process that governs social behavior. Technology clusters have historically been instrumental in alleviating many adverse environmental effects, and the emergence of a new cluster could hold the promise of a more environmentally compatible technological trajectory (Freeman et al., 1982).

Other studies of organizational behavior have shown that organizations follow standard operating procedures (Cyert and March, 1992) and these processes determine which decisions are considered and hence made. Theory on bounded rationality (Simon, 1982) led to the term "satisficing" being coined for when decision-makers settle not for the optimal solution to a problem but on the first solution that suffices a given criterion. Perhaps sadly, in business decision making, especially when energy efficiency investments are discretionary, energy efficiency is unlikely to be that criterion.

Finally, it should be stressed that efficiency gains do not always mean reductions in energy use. Some amount of the gains in energy efficiency may be offset by increasing uses of energy. Increasing wealth often leads to a more energy-intensive lifestyle. As reported in the New York Times (1998), even as the average number of people per household is shrinking, the average size of new homes is growing. And these homes are loaded with energy-consuming features, from central air-conditioning to home theaters. So even if the amount of energy used to heat a square foot of living space is falling, the number of square feet, and thus the total energy use, is growing. Energy use on the roads is rising even faster due to suburban sprawl that increases miles driven and the popularity of sport utility vehicles, minivans and pick-up trucks. Instead of being used to increase fuel efficiency, technological advances have gone largely to increase vehicle power (average horsepower rose from 99 in 1982 to 156 in 1996, with the 0-to-60 mph-time falling from 14.4 to 10.7 seconds).

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