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An Important, and Sometimes Overlooked, Energy Efficiency Tool

The developing world will account for a huge share of the growth in energy demand in the future. But, if the rising demand is met with energy-efficient technologies – everything from efficient appliances for first-time purchasers to efficient industrial processes – energy demand, and hence greenhouse gas emissions, will be lower than forecast.

So, are there steps that governments in the developing world, lending agencies like the IMF or World Bank, or US policymakers (e.g. through offset programs) can take to encourage energy efficiency in the developing world? And, are there lessons we can draw from US energy-efficiency programs? Unfortunately, given the huge energy subsidies in much of the developing world, the lessons from the US are limited.

Cheap Gas
A Broken Gas Pump in the US, but Venezuelans Get an Even Better Deal

In the US, many policymakers trumpet energy efficiency as one of the most cost-effective carbon-mitigation strategies. McKinsey has famously identified a number of situations where a consumer’s investment in energy efficiency seems to pay off given the savings it would generate at current energy prices. Since consumers appear to be leaving proverbial $20 bills on the sidewalk, some of the current programs to promote energy efficiency involve informing consumers—essentially waving the bills in their faces. For example, the EPA promotes Energy Star labels for efficient appliances and cities like New York and San Francisco now require large commercial building owners to disclose their energy usage.

Better information is unlikely to promote energy efficiency in many parts of the developing world, where current energy prices are seriously out of whack and cover very little of the private costs of energy production (i.e., the costs before accounting for environmental and other externalities).

A recent IMF report documents energy subsidies around the world, and they are staggering, amounting to almost 1 percent of worldwide GDP.

Consider that:

  • Residents of Venezuela pay less than 10 cents per gallon of gasoline.
  • Nearly 30 percent of the electricity generated in India is not paid for, most of it written off as a “nontechnical loss,” basically a euphemism for theft.
  • Residential electricity rates in Mexico cover less than half the estimated costs.

One of the most fundamental tenets of economics holds that when prices are low, consumers will demand more of the good. Chris Knittel has noted this relationship in gasoline consumption across developed economies, where countries with high gasoline prices (driven by high gasoline taxes) consume far less per person than the countries with lower gasoline price. Presumably the usage (after adjusting for lower income levels) would be even higher at low, Venezuelan-style prices.

Reducing Petroleum Consumption from Transportation

To help the citizens of the world make efficient choices about energy, it’s important to get the prices right. The IMF report concludes on an optimistic note with case studies of several countries that have reformed their subsidies. But, the recent riots in Indonesia over proposals to remove fuel subsidies highlight just how controversial this task is. In the battle against dangerous climate change, though, we need to pursue all possible tools.

Catherine Wolfram View All

Catherine Wolfram is the Cora Jane Flood Professor of Business Administration at the Haas School of Business, Co-Director of the Energy Institute at Haas, and a Faculty Director of The E2e Project. Her research analyzes the impact of environmental regulation on energy markets and the effects of electricity industry privatization and restructuring around the world. She is currently implementing several randomized control trials to evaluate energy efficiency programs.

10 thoughts on “An Important, and Sometimes Overlooked, Energy Efficiency Tool Leave a comment

  1. If you control for population density and income, the price elasticity would be much small, with the three outliers (US, CA, Australia), being low density and relatively high income (Luxeemborg as well).

  2. When you consume a resource, you have consumed it, finis. Consuming more slowly or consuming less does not forestall the day when the resource runs out entirely. The value of energy efficiency is entirely subjective. Energy efficiency is really about how you value the speed at which a resource is consumed. Some people prefer to consume slowly or in small amounts, and some prefer to consume quickly or in large amounts. No amount of advertising or public information on energy efficiency is going to change their value system. Some, after insulating their home, will keep the thermostat the same and enjoy savings. Most, after insulating their home will crank up the AC and enjoy a cooler summer indoors. When you advertise that such and such AC is high efficiency, you will project to some a dollar savings but to most you will project a cooler house for the same price.

  3. I have long argued that if governments want to subsidize lifestyles, they should do that through the tax code and not by artificially lowering electricity rates. In California, we have the CARE rates that provide discounts of 20% and above for low-income folks. That encourges energy inefficiency and waste. A much better approach would be to provide income payments to such customers; that way, they will have the option of using energy efficiently and using the savings on their utility bill to buy things of greater value. We don’t subsidize the price of food; we have food stamps. We could do the same by creating tax-payer funded “energy stamps” and liberate energy prices from having to carry the weight of energy subsidies. Of course, the problem is much worse in the developing world, as pointed out in the blog posting. In Kuwait, the price of power is less than half a penny a kWh and people use desalinated water to wash streets. In other Middle Eastern countries, prices are in the two cents per kWh range and people leave their air conditioners running when they are away on vacation. Fuel oil is being sold to the electric utilities at $5/bbl and even then they cannot recover that cost in electric rates. Those countries need to think of the opportunity cost of oil when setting electric rates. Of course, sudden change can be injurious in more ways than one. It has to be phased in over a three to five year period.

  4. Why is this blog focusing on the developing world when clearly the figure shows that the United States is the elephant in the room We directly subsidize fossil fuels to the tune of $20 billion a year and indirectly to $550 billion which the IMF report points out.

  5. It is not just the price that matters. Consumption also depends on available income and competing needs for it. Despite very low and subsidized prices, many people like you point out, resort to theft–as even at those low prices, they have more important uses for their limited cash. Public utilitities income is also diverted to pay for other government services; resulting in less than adequate service and maintaining social stability.

  6. Lester Lave once described energy efficiency as $50 bills (not $20s) lying on sidewalk, but they are glued down, and we have to figure out how to scrape them off without destroying them.

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