Energy efficiency needs incentives


David Robinson,
Senior Adviser,
Brattle Group
Brussels, Belgium — (METERING.COM) — May 16, 2008  – Electricity and gas suppliers in most retail markets have a clear profit incentive to promote increased consumption of energy, but with the right incentives these companies would be able and willing to promote efficient energy use and conservation.

This is among the conclusions of a new discussion paper, “Energy efficiency: The Belle of the Ball in Bali” by David G. Robinson, senior adviser of the Brattle Group, which explores why energy efficiency has not yet delivered its promised savings, especially among smaller customers, in developed countries.

The paper finds that policies for promoting energy efficiency through energy suppliers are very different in liberalized retail markets than in regulated ones. Under the U.S.-style rate-of-return regulation of retail tariffs, regulators adjust the method for setting tariffs to provide incentives for local utilities to promote energy efficiency. In competitive retail markets, on the other hand, the regulator loses this regulatory instrument and has to rely on other tools to encourage energy suppliers to promote energy efficiency.

Second, there is a growing concern in the U.S. that regulated energy utilities are not delivering the necessary efficiency improvements in a cost effective manner. In some cases, policy makers have chosen to bypass the traditional energy utilities and their regulators by creating new publicly owned energy efficiency utilities, e.g., Vermont. On the other hand, some states, such as California, have been successful in providing incentives for their utilities to promote energy efficiency.

In countries that are committed to liberalized (deregulated) retail markets, one of the great challenges is to make liberalization compatible with the promotion of energy efficiency and other environmental objectives. In the U.S., as environmental concerns have grown, regulators have re-regulated some retail markets, reducing customer rights to seek alternative suppliers, partly to provide certainty of cost recovery for utilities that are introducing energy efficiency programs.

Nevertheless improving energy efficiency does not lead inexorably to re-regulation. New environmental challenges are, rather, a commercial opportunity for forward-looking energy supply companies in liberalised retail markets. If these companies are able to understand what customers truly value, and price and sell services accordingly, they may well find that it is profitable to promote energy efficiency. Indeed, some energy suppliers have adopted this approach on the grounds that customers are loyal to energy suppliers who encourage energy efficiency and promote responsible consumption. Some retail suppliers in Europe see the provision of smart meters as a way to capture and/or retain clients.

The issue of efficient price signals is central to promoting energy efficiency, and prices should reflect the underlying marginal costs, including the cost of environmental externalities such as CO2 emissions. Furthermore, customers need to see those signals, e.g., through smart metering, otherwise they make inefficient investment and consumption decisions – in particular consuming too much if prices are too low.

Efficient signals are possible under tariff regulation, but regulators are often reluctant to pass on these signals, especially when there is no market price for important externalities like CO2. Likewise, in a competitive retail market with a parallel CO2 emissions market, as in the E.U., electricity price signals should reflect underlying costs. Unfortunately, regulators are also reluctant to let these price signals reach customers, instead offering below cost tariffs. These subsidised tariffs undermine liberalisation, and discourage retail competition (if they do not kill it) and investment in energy efficiency.

The wider question is how to ensure that, this time, the potential to reduce energy consumption and CO2 emissions is realized through improved energy efficiency. Broadly speaking, policy makers have thus far concentrated on codes and standards for appliances and buildings, on information campaigns and on overcoming various barriers to investment. While these are necessary measures and have helped to create a market for companies specializing in energy efficiency, it seems that the next and urgent public policy challenge is to change the incentives faced by consumers of electricity and their suppliers.

A start should be to set prices that reflect the full cost of supply, including CO2 emissions, and ensure that customers have the ability to respond to those prices. In addition, it should be profitable for energy suppliers to promote the intelligent consumption of energy. Energy supply companies have more to gain than to lose by leading the way.