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Energy efficiency: The fifth fuel or fool's gold?

The famous American physicist and environmental scientist Amory Lovins coined the term "fifth fuel" almost three decades ago to represent units of power saved by energy efficiency.

Improved energy efficiency leads to less energy being used in delivering services such as heating, lighting or transport. After coal, oil, natural gas and nuclear power, he argued, the fifth fuel or "saved energy" is overlooked.

After cities around the world marked Earth Day by shutting off the lights in their respective iconic buildings this past weekend, it seems appropriate to look at the claims of energy efficiency in the cold light of day.

Since Dr Lovins' phrase gained currency, improving energy efficiency has been widely championed as a means of fulfilling multiple objectives. It reduces costs for households and companies, it helps energy-importing countries like Singapore improve their trade balances and enhances their national security. Not least, energy efficiency also helps improve the environment by reducing carbon emissions. While many highlight the gains made in enhancing energy efficiency, a lack of rigorous analyses may make them significantly less than what we are led to believe, or even non-existent. Most countries now implement a range of policies to improve energy efficiency. A survey by the World Energy Council in 76 major countries found that a majority have adopted national energy-efficiency programmes and set up energy-efficiency agencies.

Subsidies, tax incentives, appliance-performance standards and information programmes are often applied in various sectors of the economy, including buildings, commercial and industrial equipment, power utilities, industrial processes, residential appliances and transport vehicles.

Workers in Indonesia at a candlelit event to mark Earth Day in Jakarta last Saturday when the city dimmed some of its lights for an hour. Regulations for promoting energy efficiency, if poorly thought out, can be costly and unintentionally cause large welfare losses. It is vital that new regulations meet the tests of careful cost-benefit analysis, says the writer. PHOTO: EUROPEAN PRESSPHOTO AGENCY

Despite the vital role energy efficiency is seen to play in cutting energy demand cost-effectively, "only a small part of its economic potential is exploited" as the World Energy Council observed. The fact that options to improve energy efficiency are not being adopted on a large scale has led to notions of an "energy-efficiency gap". The alleged gap is the difference between the level of energy efficiency actually achieved and the level judged to be achievable economically.

The paradox that apparently cheap energy-efficient technologies are not being adopted has been explained by analysts as the result of "market barriers" which discourage investments in such technologies.

In a well-publicised study, the consultancy McKinsey noted that by 2020, the United States could reduce its annual energy consumption by 23 per cent from business-as-usual by encouraging energy-efficiency measures.

It concluded that these savings have not been achieved because significant barriers impede the use of energy-efficient practices and technologies.

Despite the many claims of energy-efficiency proponents, there is a lack of careful analyses to measure the real cost of energy savings achieved. Such claims are often touted by manufacturers and suppliers of energy-efficient appliances and equipment. They are typically based on engineering studies which assume the behaviour of the "typical" household or company. However, such studies can be at odds with actual conditions surrounding decisions to invest or purchase. They also cannot capture the variety of preferences and budgets across households and firms for whom energy efficiency is only one among many factors considered.

A typical example of the variance between engineering analyses and studies which consider observed consumer responses is a Mexican government subsidy to replace older refrigerators and air-conditioners with more energy-efficient ones.

The programme was projected to save energy by 30 per cent. However, a follow-up economic analysis of the subsidy programme estimated energy savings of only 7 per cent once actual consumer responses were observed.

Buyers chose larger refrigerators with newer energy-using features, while many lowered their thermostat temperatures or installed more air-conditioning units in their homes because of the subsidy. The "rebound" effects of cheaper energy on increased energy demand are not captured by engineering estimates.

It is thus not clear whether energy-efficiency policies have generally been a good use of taxpayers' money. For instance, the European Court of Auditors reported that European Union spending on programmes to spur energy savings has "gone to waste", and some of its building-insulation projects were found to be "so inefficient that it would take longer than the lifetime of an improved building to recover the costs".

Accurately measuring the costs and benefits of the different energy-efficiency policies is difficult for several reasons.

A key challenge is to define baselines which measure the energy-efficiency improvements that would have occurred in the absence of such regulations.

Another issue relates to the existence of "free riders", that is those who receive subsidies for energy-efficient appliances or equipment that they would have bought anyway. The presence of "rebound effects" further complicates matters and often leads to over-estimating the energy savings achieved.

It is thus not surprising to find that evidence on the cost effectiveness of energy-efficiency programmes is mixed. Recent studies suggest that on average the scale of profitable unexploited investment opportunities is much smaller than engineering studies suggest.

While inefficiencies in energy use can appear in some settings, there is limited evidence to suggest a vast "energy-efficiency gap".

Regulations for promoting energy efficiency, if poorly thought out, can be costly and unintentionally cause large welfare losses. Energy, like transport and telecommunications, is a key input in most sectors of the economy and distortions in its price or reliability can have large economic and social costs. It is vital that new regulations meet the tests of careful cost-benefit analysis. Faulty notions of costs and benefits can lead to unnecessary and significant burdens being imposed on society.

Private decision makers could well differ from "expert" views of costs and benefits for good reasons. It is, after all, the consumer or the businessman who ultimately bears those costs or benefits.

  • The writer is a consultant in the energy sector and author of a recently published book, Singapore Chronicles: Energy.