Energy Efficiency Economics

Department of Mechanical Engineering,
Pulchowk campus, Institute of Engineering,

Tribhuvan University
ENERGY EFFICIENCY AND AUDIT

(Section 2)
Energy Efficiency Economics
Dr. Shree Raj Shakya

2021
Definitions
Energy Efficiency: energy services (output) provided per unit of

energy input
Energy Productivity: getting the most output for the least energy
input
• Energy Intensity: energy consumed (TPES or TFEC) per unit of
Gross Domestic Product
• Aggregate energy productivity for economy: Gross Domestic
Product per unit of energy consumed
Economic Efficiency: getting the most output for the least cost
• Energy efficiency does not always lead to economic efficiency
(and vice versa)
Source: https://www.un.org/sustainabledevelopment/energy/
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Global Energy Intensity Trend
Source: https://www.eia.gov/todayinenergy/detail.php?id=27032#
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Global Energy Intensity Trend
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Global Energy Productivity Trend
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Global Energy Productivity
What Leads to Energy Productivity Improvements?

• Structural changes in the economy toward less energy intensive
industries
• Energy efficiency improvement
– Policies promoting energy efficiency
– High energy prices
• Adoption of more efficient equipment
• Energy-efficient innovation
• Economic forces that drive total factor productivity growth
• Energy prices induce factor substitution and technical change
Source: https://www.slideshare.net/maggiewinslow/energy-efficiency-economics
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Energy Efficiency is Cheapest Form of Energy
Source: http://aceee.org/sites/default/files/publications/researchreports/u1402.pdf
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Cost of Saved Energy (CSE) for
Utility Energy Efficiency Programs
Source: http://aceee.org/sites/default/files/publications/researchreports/u1402.pdf
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Energy Efficiency as a Win-Win Opportunity
• Less money spent on energy

• Less environmental degradation
• McKinsey & Co. 2009 report, Unlocking Energy Efficiency in the U.S.
Economy:
– $1.2 trillion in energy cost savings
– 23% of projected demand savings
– 1.1 gigatons of GHG savings annually
• However, we are not obtaining the economically efficient level of
energy efficiency.
Source: https://www.slideshare.net/maggiewinslow/energy-efficiency-economics
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McKinsey Global GHG Marginal Abatement Cost (MAC) Curve for 2010
Source: McKinsey and Co. Impact of the financial crisis on carbon economics: Version 2.1 of the global greenhouse gas abatement cost curve
http://www.mckinsey.com/client_service/sustainability/latest_thinking/greenhouse_gas_abatement_cost_curves
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Consumer Decision-making in Energy Efficiency
K= Initial capital Cost

E = Energy Operating Cost
(Energy Efficiency)
• Capital (K) and Energy (E) are viewed as inputs into the production of energy
services
• Isoquont: The combinations of inputs (K, E) that yield the producer the same level
of output (energy service).
• The shape of an isoquant reflects the ease with which a producer can substitute
among inputs while maintaining the same level of output.
(A) Energy Efficiency Improving

Substitution
Source:
https://media.rff.org/archive/files/sharepoint/Wor
kImages/Download/RFF-DP-09-13.pdf
• households may move along the energy services isoquant by substituting

capital for energy in response to a change in relative prices (from P0 to P1).
• the relative price will depend on the capital cost of efficiency
improvements, the discount rate, expected energy prices, equipment
utilization, and decision time horizon.
(B) Energy Saving Technological

Change
Source:
https://media.rff.org/archive/files/sharepoint/Wor
kImages/Download/RFF-DP-09-13.pdf
• Technological change that shifts the isoquant in a way favoring (i.e., biased toward)
greater energy efficiency (with isoquant0 shifting to isoquant1) could change the
production possibilities available to households.
• In contrast, energy conservation not driven by energy efficiency improvements
would be associated with a lower level of energy services (i.e., a lesser isoquant)
• Energy poverty ? S.R.Shakya – S1 13
Energy Efficiency Choices
• Higher initial investment

• Lower future costs
• Assessing future costs requires information about
• Future energy prices
• Energy savings with use
• Amount product will be used
• Life of the product
• Potential regulatory effect (e.g. carbon tax)
• Discount rate
Minimizing Individual and Social Costs
• Individual wants to minimize private costs

• Society wants to minimize social costs (externalities)
• Rational decision-making by individual may not provide best
social outcome
Effect of Elasticity of Demand

• Demand responsiveness to change in price of energy
(elasticity of demand) can determine if decision making will be
economical and energy efficient.
• Long run and short run elasticities are different due to
purchase of energy using durables with long life spans.
• Change in energy prices have found to influence the adoption
of energy saving equipment.
Source: https://media.rff.org/archive/files/sharepoint/WorkImages/Download/RFF-DP-09-13.pdf
Ranges of Estimates of Energy Own-Price Elasticities
(absolute values shown; all values are negative)
Energy Efficiency Gap
• The wedge between the cost-minimizing level
of energy efficiency and the level actually
realized.
• We have not achieved the energy efficiency
improvements that engineering and economic
analyses suggest would be economically
efficient
Energy Efficiency Gap Cause
• Private decision-making regarding energy
efficiency may not be economically efficient
– Information may be inadequate
– High consumer discount rates – studies found ranges
of 25 to 100%
– Behavioral “failures” – irrational behavior
• Can lead to systematic under-investment in energy
efficiency
Other Energy Efficiency Gap Causes
• Hidden costs not accounted for by the analyst

– search costs
– reductions in other product attributes such as lighting
quality
• Lower energy savings than assumed by the
analyst
• Uncertain future energy savings
• The irreversibility of energy efficiency
investments and the associated option value of
waiting to invest later
• Liquidity Constraints
• Split incentives – builder vs. buyer, landlord vs.

tenant
– Relevant to 25% of refrigerators, 66% of water
heaters, 48% space heaters (2006)
– Tenants with electricity included in their rent use
more energy
– Tenants will not pay more for apartments with
energy efficient equipment
• Social cost not reflected in decision making

because energy prices don’t account for
externalities
• Average cost (AC) pricing rather than MC pricing
for electricity
– prices too high
• AC pricing rather than time of use pricing so
prices are too low or too high at times
• Lack of information about future operating costs
Classes of Market Failures Related to Energy Efficiency
• Externalities
– Costs of externalities, in particular air emissions, not
included in energy conservation and efficiency decision
making.
• Investment inefficiencies
– Inadequate information provision (lack of information
about actual savings)
– Split incentives (landlord and renter for example)
– Lack of access to capital for investment in energy
efficient equipment, technologies.
Classes of Market Failures Related to Energy Efficiency
(Xi)
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n
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n
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What if consumer doesn’t buy it and difference is
$300?
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$300?
n
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$300?
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$300?
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https://www.sciencedirect.com/science/article/pii/S1364032122008759
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Thank you !
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Department of Mechanical Engineering,

Pulchowk campus, Institute of Engineering,

ENERGY EFFICIENCY AND AUDIT

Dr. Shree Raj Shakya

Energy Efficiency: energy services (output) provided per unit of

What Leads to Energy Productivity Improvements?

• Less money spent on energy

K= Initial capital Cost

(A) Energy Efficiency Improving

• households may move along the energy services isoquant by substituting

(B) Energy Saving Technological

• Higher initial investment

• Individual wants to minimize private costs

Effect of Elasticity of Demand

• Hidden costs not accounted for by the analyst

• Split incentives – builder vs. buyer, landlord vs.

• Social cost not reflected in decision making

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