The Regional Greenhouse Initiative - Part 3

In Part 1 and Part 2 of my posts on the Regional Greenhouse Gas Initiative (RGGI), I reviewed the money flows in the program and presented data on the remarkable decrease in carbon dioxide (CO₂) emissions that we have seen since its implementation. In this post, I present some of the pros and cons of the RGGI program and some evidence that supports the assertion that RGGI has been responsible, in large part, for the decrease in regional CO₂ emissions.

Based on my research, the RGGI program seems to have some positive attributes, as well as some downsides. The advantages can be listed as follows:

• Since implementation of the program, CO₂ emissions have declined significantly. See figure below.
• The program puts a price on carbon in the electricity markets and provides incentives for us and the market to make economic choices regarding our electricity generation. Carbon pricing should lead the market to prefer lower carbon sources and thus provide economic support for low-emission sources, such as renewables.
• It is a market-based program, which provides generators with choices. They are required to participate but they can choose to purchase allowances or make investments in lower-carbon technologies to ensure that their carbon generation falls within their share of the particular cap specified at the time.
• The allowances generate a pool of money that is shared between participating states. This is returned to ratepayers in the form of direct rebates and used to fund energy-efficiency (EE) programs. The EE portion creates a virtuous cycle, in which carbon prices fund EE measures, which then lead to further reductions in energy use and carbon dioxide emissions.

One of the biggest criticisms leveled at the RGGI program is that the regional reductions in CO₂ emissions, noted in Part 2 of this series, are not attributable to more efficient plant operations induced by the RGGI program; rather, they are due to less in-state generation, conversion to natural gas which was already underway, and a slower post-recession economy.

A recent economic study examined this issue directly and reviewed reasons behind the decline in emissions. The authors of the study highlighted the following facts:

Carbon dioxide emissions from the RGGI states have declined, but the decrease is due to a number of factors, including:

1. The 2008/2009 Great Recession: with the economic slowdown, came reduced energy demand, less generation, and therefore fewer emissions;
2. Low natural gas prices, created by increased supply from the implementation of fracking technology: natural gas produces less CO₂ emissions per unit of generated electricity when compared with coal;
3. State programs promoting EE project implementation or renewable energy generation, such as renewable portfolio standards;
4. The RGGI program, which puts a price on carbon dioxide emissions.

The authors then carried out a complicated economic analysis to disentangle the effect of each factor on regional CO₂ emissions. What they concluded is the following:

• Without the impact of all the factors noted above, CO₂ emissions would have been 60% higher;
•  The bulk of decrease in emissions is, in fact, due to the RGGI program;
• Substitution by natural gas was an important factor, but less so than the RGGI impact;
• The impact of the recession on CO₂ emissions was minor;
• Some of the benefits of the RGGI program are undone by neighboring non-RGGI states that sell electricity into the regional power pools. Their coal-fired generation without the RGGI adder then becomes competitive and so more electricity is generated from their high-CO₂-emissions plants.

This provides good evidence to support the direct impact of the RGGI program, but is just a single economic study. I look forward to seeing others.

Other criticisms of the RGGI program include the following:

• It increases electricity costs to consumers in a region that already has high electricity rates.
• The implications of RGGI are only now starting to kick in. After recent implementation of the Adjusted Cap, CO₂ allowance prices have increased significantly and this could further impact electricity rates going forward.
• RGGI sets up unfair competition by neighboring states that don’t have these requirements. Their costs of generation do not include RGGI costs so their electricity is cheaper and they can sell into the RGGI markets with a built-in cost advantage.
• There are a lot of free riders – RGGI ratepayers lead by example by paying for reduced CO₂ emissions, but residents of non-RGGI states benefit from the cleaner air.
•  RGGI funds making their way to the states have been raided for other purposes, such as balancing state budgets, and are not always used to fund EE and renewable energy projects, which was the original intention of the program.
• Carbon pricing through the RGGI program is unfair to electricity ratepayers because other regional CO₂ emissions, such as those from transportation and heating, are not subject to carbon pricing.  

The argument that the RGGI program does increase the cost of electricity is valid, but it is important to put this into context. Let’s examine what the present carbon price means for individual ratepayers in terms of electricity rates. A review of RGGI state data from the Energy Information Agency (EIA) indicated the RGGI states, on average, emit 0.34 tons CO₂ per MWh of generated electricity. We can then calculate that a CO₂ price of $5/ton leads to an incremental cost of $1.70/MWh or 0.17 cent/kWh. If you use 600 kWh per month, this represents $1.02 in incremental costs on your bill. However, this calculation does not take into account that House Bill 1490 legislation mandated that only the first $1/ton CO₂ from the CO₂ emissions allowance auction proceeds could be used towards EE: anything beyond that has to be rebated directly to electricity ratepayers. As a result, most NH RGGI funds now go to direct bill rebates, so (assuming a $5/ton carbon price) ratepayers get about 80% of the RGGI costs back. If we back out the rebate, the cost to ratepayers is of the order of $0.20/month or 0.034 cents/kWh for 600 kWh/month electricity usage. This is in line with the rate impact calculations presented in the recent annual report on the RGGI program in NH. As you can see, there is an impact of RGGI on electricity rates, but the total amount paid by an individual ratepayer is tiny.

As I wrap up this three-part series on RGGI, it is clear that it is a complicated—but important—program. There is evidence that it appears to be having significant impact on regional carbon emissions, but, at the same time, it does impacts regional electricity prices; however, after including bill rebates, the utility bill impact to the average NH rate payer is tiny. A few years ago RGGI was viewed as a model program for the rest of the country and, if implementation of the EPA’s Clean Power Program had proceeded, participating states would have a considerable head start. Unfortunately, it looks like RGGI will remain a regional initiative only because there is no support from the Trump Administration for clean power or carbon pricing mechanisms. The most important development in the RGGI world is the review of the program that is currently underway, as this will set the tone for the RGGI program, carbon prices, and regional electricity rates going forward.

Until my next post, do your bit to reduce carbon emissions by remembering to turn off the lights when you leave the room.

Mike Mooiman

Franklin Pierce University

mooimanm@franklinpierce.edu

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The Regional Greenhouse Initiative - Part 2

In Part 1 of this series of posts on the Regional Greenhouse Gas Initiative (RGGI), I reviewed how money flows from ratepayers, to the utility companies, to the electricity generators, to the participating states, and then back to the ratepayers as direct bill rebates or to investments in energy-efficiency (EE) initiatives. With an understanding of what happens to our ratepayer dollars in this program, let’s now take a look at the actual allowance caps and what has happened to regional carbon dioxide (CO₂)  emissions since the program was implemented in 2008.

The chart below presents data on the emission caps, the actual CO₂ emissions from power plants in the RGGI states, as well as the average prices achieved in the RGGI auctions of emissions allowances. The first regional cap (shown in blue) was implemented in 2009. For the first few years of the program, actual emissions (shown in green), which were already trending downward due to extensive use of natural gas generation, were substantially lower than the cap. This made compliance easy and resulted in lower prices for the allowances (as shown on the bar graph). In 2014, after a review of the program, there was a big downward adjustment in the cap and the compliance margin narrowed considerably.

The intent of the shrinking cap in cap-and-trade program is to issue fewer emission allowances every year. In theory, this should increase allowance prices and make fossil fuel operations with high CO₂ emissions, such as coal plants, the more expensive producers in the electricity marketplace. High generation prices would force these operations out of business or drive them to make changes to reduce carbon emissions. However, during the first period of the RGGI program from 2008 to 2014, when the cap was so much higher than the actual emissions, allowances prices were low (of the order of $2 to $3/ton CO₂) and RGGI participants were able to buy and bank over 120 tons of emissions allowances. This is more than one year’s worth of allowances.

The problem with these banked allowances is that they can be used at any time, so their availability puts downward pressure on the prices at auction. To take this large volume of banked credits into account and flush them out of the system, the RGGI program then implemented a further downward adjustment in the cap in 2014 – the Adjusted Cap (shown in red). With this change, actual emissions are now well above the Adjusted Cap and it is anticipated that this will increase the price for emissions allowances and draw those banked credits into the market. With these changes, allowance prices did indeed rise in 2014 and 2015; however, since 2016, when the Supreme Court suspended implementation of the Clean Power Plan and Donald Trump, with his antagonistic view of regulation,  was elected President, allowance prices have again fallen. There is also an interim review of the RGGI program underway, so participants are awaiting its outcomes and indications as to what the caps will be after 2020. The successful continuation of the RGGI program, the magnitude of the future caps, and the utilization of the banked allowances should have a significant impact on allowance prices going forward.

Carbon emissions from power plants in NH have also fallen, as is evident from the figure below, which also shows the NH-specific RGGI caps and adjusted caps.  Emissions from NH operations dropped by 67% since 2005, compared with a 56% decrease for all the RGGI states. A great deal of this improvement was driven by reduced in-state coal-fired generation. Even with the adjustment, NH CO₂ emissions were below the cap in 2016.  In the RGGI states, there are over 160 carbon-emitting generating operations that need to comply with the program, but, of the 31 generating plants in NH, only five  (Merrimack, Schiller, Newington, Granite Ridge Energy, and Essential Power Newington Energy LLC) are affected.  

In these first looks at the RGGI program, I have taken a rather simple view of the program by considering where the money flows, the cap values, and the actual CO₂ emissions. There are many interesting aspects of the program that I have not covered. These include offsets, where generators can invest in projects such as landfill methane gas capture, re-forestation, EE investments in the building sector, etc., to offset their carbon emissions. There is also a two-sided cost containment reserve – a reserve pricing mechanism that provides a floor price for carbon and a high-price trigger that allows sale of banked allowances to provide a lid on prices: in 2017, the minimum carbon price is $2.15/ton CO₂ and the high-price trigger is $10/ton CO₂. These might be good topics for future posts.

We can conclude that, since the start of the RGGI program, CO₂ emissions have decreased significantly and have been way below the established caps. This has resulted in low allowance prices and the banking of a large volume of allowances by generators that can be used in the future. This has perpetuated low emissions pricing and, to compensate, the RGGI program recently implemented an even lower Adjusted Cap, which is hoped will draw banked allowances into the market and result in higher emissions prices in the future. The RGGI program has been in place since 2008 and a lot has been learned along the way. It was viewed as a model program for other regions when the Obama Administration’s Clean Power Plan (CPP) was in play. With that plan on hold for the foreseeable future, the future of the RGGI program remains a regional matter and the program review that is presently underway is crucial to its successful continuation beyond 2020. 

In my next post, I will take a look at the reasons behind that dramatic decrease in CO₂ emissions over the past few years and the role of RGGI in this. Until then, do your part to keep emissions low by turning off the lights when you leave the room.

Mike Mooiman

Franklin Pierce University

mooimanm@franklinpierce.edu

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The Regional Greenhouse Initiative - Part 1

Like the snow in winter, there are annual legislative proposals we can count on: one of them is legislative action to pull New Hampshire out of the Regional Greenhouse Gas Initiative (RGGI). This has become a perennial component of the energy debate in NH, so I thought it would be useful to get a better understanding of this initiative and an appreciation of its pros and cons.

Understanding electricity rates in NH is a complicated business. There are transmission and distribution charges, systems benefit charges (some of which go into energy efficiency), and stranded costs. On top of these is the actual cost of electricity, which includes the cost of generation plus costs associated with RGGI and the NH renewable portfolio standard.

Let’s start by learning what RGGI is. The Regional Greenhouse Gas Initiative is a multistate carbon cap-and-trade plan that started in 2009. Nine states (Vermont, Massachusetts, Maine, Rhode Island, Connecticut, New York, Maryland, Delaware and New Hampshire) have agreed to cap regional emissions of carbon dioxide (CO₂) from their power plants. (New Jersey was a member for a few years but withdrew in 2012.) Allowances for each ton of CO₂ emissions, equal to the cap value, are issued by the RGGI program. Power generators are then required to purchase emissions allowances equivalent to the value of their own CO₂ emissions in an auction market.  

A key feature of the program is that the cap ratchets down every year and fewer emission allowances become available.  Power generators adapt by reducing emissions through more efficient operations or equipment, by using renewable energy generation (such as solar or wind), or, if these alternatives are not possible, by purchasing CO₂ emission allowances from the available pool. Over time, the reduction in emission allowance availability should make them more expensive and drive generation toward lower-carbon-emitting generation resources.

The appeal of this approach is that it uses market mechanisms—instead of regulatory command and control actions or carbon taxes—to reduce CO₂ emissions. Generators make their own decisions as to what is best for their business and they can delay big investment decisions by simply purchasing emissions credits. Moreover, to meet the shrinking cap, the market creates incentives to find better and cheaper ways to reduce emissions through the use of technology. In the process, we and the planet benefit from reduced emissions. It is important to realize that this is not a zero-sum game. This mechanism puts a price on carbon and we, as ratepayers, fund the program; as the cap ratchets down every year, the cost of carbon will go up.

Cap-and-trade programs are not new. One of the most successful focused on acid rain. To deal with this problem, a national cap-and-trade system for sulfur dioxide (SO₂) emissions was established. The market went to work, resulting in a 69% drop in SO₂ emissions from 2005 to 2014.  The European Union also has a carbon emissions trading program, as do California and Quebec.

In the RGGI program, the money raised in the carbon allowance auction is returned to the participating states, so, because I am always interested in the money flow in these programs, I prepared the figure below to aid my understanding.

Let’s start on the left side of the diagram with the generators. A power plant generates electricity and is required to purchase the corresponding carbon allowance equivalent to their emissions through the RGGI auctions. The cost of the allowance becomes part of the cost of electricity costs that the generator charges to the utilities. The utilities then turn around and charge the ratepayers for the costs of electricity, which include the embedded RGGI costs (red arrows). As a result, there is a money flow from the ratepayers to the utilities to the generators to the RGGI auction pool (blue arrows). Proceeds from the RGGI auctions are returned to the states, where some of the money returns directly to ratepayers in the form of annual RGGI rebates or is used to fund state energy-efficiency (EE) programs. Within this money flow, good things happen, as shown by the green arrows: local jobs in the EE marketplace are created, appliances and materials are purchased from NH businesses, energy demand is reduced (which should help reduce electrical rates increases in the future), and CO₂ emissions from electricity generation are reduced.   

From 2009 to 2016, $2.63 billion of RGGI auction funds were raised, of which NH received $116 million in proceeds. Participating states make their own choices as to how the funds are allocated: these are typically directed to EE, renewable and clean energy, greenhouse gas abatement, and direct bill-assistance programs. But, for some, RGGI funds represent a tempting target and various participating states have, at different times, redirected those funds to other purposes: even NH, in 2010, directed $3.1 million in RGGI proceeds to the NH general fund to meet budget shortfalls.

During the early years of the program, most of the RGGI funds returned to NH were used for EE programs. In 2012, however, House Bill 1490 legislation mandated that only the first $1/ton CO₂ from the  CO₂ emissions allowance auction proceeds could be used towards EE: anything beyond that has to be rebated directly to electricity ratepayers. This significantly reduced funds available for EE investments and these remaining funds were then allocated through NH’s Core EE program.  This is important because recent auction prices for carbon emissions have been of the order of $3 to $5/ton, so only a small fraction of RGGI proceeds are directed to EE, with the larger portion now going to direct bill rebates. There have been other tweaks to program, including a required allocation of 15% of the funds to low-income weatherization programs and $2 million set aside for municipal EE programs.

The RGGI program reports how the participating states use their funds in a series of annual reports, but these are not particularly current: the most recently available only includes data to 2014. To provide updated results, I used the RGGI auction results for 2015 and 2016, factored in the administration and RGGI Inc. costs, and split the remaining funds, taking in account that only the first $1/ton CO₂ of the auction proceeds are allocated to EE. The rest goes to direct bill rebates. My estimates for the cumulative allocation of the funds since inception of the program are presented below. This indicates that, so far, the funds have been split evenly between EE and bill rebates. With time and higher CO₂ allowance prices, however, we will see direct bill rebates becoming a larger part of the allocation pie in the future. 

In conclusion, the RGGI program has raised a great deal of money from ratepayers through higher electricity rates since 2009 and NH has received ~$115 million of the RGGI proceeds. To date, about half this money has been returned to rate payers and the other half has gone to EE initiatives. The EE portion is particularly important as it creates a virtuous circle of sales of local goods and services, the creation of local jobs, reduced energy usage, and lower carbon dioxide emissions.

With most of the NH RGGI funds now going to direct bill rebates, we have created this odd construct in which ratepayers pay RGGI costs monthly through their electricity bills and then once a year they get a rebate for most of those cumulated RGGI costs. In this money flow, some of the funds make their way to important and beneficial EE projects, but there is also a portion (~5%) that goes to supporting the administration and overheads associated with the RGGI program.

Even though this money flow might appear convoluted and inefficient, we should not lose sight that the objective of the RGGI program is to put a carbon price on electricity generation, to use market mechanisms to create the incentives to reduce carbon emissions, and to direct some money to beneficial EE projects.  

Until my next post, in which I will look at how successful the RGGI program has been in reducing CO₂ emissions, do your bit to reduce carbon emissions by remembering to turn off the lights when you leave the room.

Mike Mooiman

Franklin Pierce University

mooimanm@franklinpierce.edu

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Man in the Mirror* - Why We Don’t Invest in Energy Efficiency

It’s strange: we view ourselves as rational creatures, but then we don’t do what we should, even when we know what the right thing to do is. That’s a mouthful, I know, but I have been thinking a lot about energy efficiency (EE) of late. We all know that EE is good for us and the planet, but the problem is that we often don’t make the investments. This divide between knowing that EE is the right thing but failing to take action is known as the energy efficiency gap.

It is important to understand the reasons for the separation between knowledge and action. We often read that we don’t need to make investments in energy infrastructure, such as power plants, natural gas pipelines, wind farms, or transmission lines; instead, we read that all we need to do is to make investments in energy efficiency. We are told that such investments would curtail our growing energy demand and we could make do with the existing supply. In principle, I agree wholeheartedly and endorse this idea, but the sad truth is that we don’t make the necessary EE investments. Instead, our energy consumption grows and we end up having to make the investments in energy infrastructure anyway. The fact of the matter is that we often fail at making decisions in our own best interest. This failure to act in favor of our long-term interest is at the heart of our problems with energy.

Consideration of, support for, and implementation of EE plans are very important parts of any state or national energy plan. The importance and benefits of EE, such as reduced energy demand, lower costs, and lower greenhouse gas emissions, have been long recognized: As I noted in a previous blog, EE can be considered as an energy source in its own right.  The  International Energy Agency (IEA) now refers to energy efficiency as the first fuel because the savings from avoided energy use are now greater than the supply of any single energy source (oil, electricity, or natural gas) in Australia, USA, and certain EU countries. EE is, in fact, considered an energy source in its own right. In other words, more can now be achieved by EE measures than by increasing the supply of a particular energy resource. Moreover, much of the potential from EE remains untapped.

We face two choices as our demand for energy increases: we either build new power plants or we become more efficient in our consumption to curtail our demand. It is not widely appreciated that EE is the lowest cost option when compared with installing new power production capacity. The consulting company, Lazard, carries out an interesting analysis every year,  in which they examine renewable and fossil-fuel electricity generation options and calculate the levelized cost of energy or LCOE. This parameter takes into account the initial cost of an operation, its electrical output, the annual cost of fuel, annual maintenance, and an interest cost (normally set by the minimum rate of return one would like to earn on a project, often equivalent to the bank loan interest rate to purchase the equipment). These costs are then evenly distributed over the life of the project to yield a single “levelized” cost for energy. The attraction of this approach is that it allows a side-by-side comparison of different projects and energy sources that have very different financial requirements and expense flows. For example, it allows comparison of a solar system with high capital but low operating costs with a diesel generator project that has low capital but high operating costs. LCOE provides a means for determining which project is better from a lifecycle energy cost point of view. In the figure below, I have rearranged the Lazard data, showing renewable technologies in green and fossil fuel options in blue. On an LCOE basis, it is clear that that EE (shown in red) is the lowest cost option, with an average value of 2.5 cents/kWh. By way of comparison, I noted in my last post that the EE numbers for NH through the NH EE Core program were of the order of 3.7 cents/kWh for EE investments.

Source: Lazard

So, if EE is so clearly the lowest cost option, why don’t we do more of it? Why is there this energy efficiency gap?

The biggest issue is that it requires long-term thinking and making big investments now to reap benefits far into the future. This is not something that we are good at. EE costs money and is not always popular, especially with politicians wrestling with the fallout of high energy prices. Here in NE, energy prices are already high and EE adds to these costs. The approach adopted by some is to kick the can down the road by saying No to EE investment and make high energy consumption a problem for future generations.

I have been wrestling with this this EE paradox: if we know EE is good for us, why don’t we do it? It is like exercise! We are bombarded with messages about the benefits of exercise and healthy lifestyles, but often we come home, crack open a beer, open a bag of Doritos, sit in front of the TV for the evening— and tell ourselves that we will start exercising tomorrow.

In my thinking about energy efficiency, I have taken a hard look at the man in the mirror* and my own actions in this regard. I write about and research energy matters, I teach energy efficiency classes to MBA students, and I write papers on energy efficiency, but I have not implemented all the EE measures in my life that I could have. Compared with most folks, my knowledge of these measures is much deeper, but I still don’t take all the action that I should. Clearly, I am still on the beer, Doritos, and TV train.  Why is this so and why I am standing on the other side of the energy efficiency gap? What accounts for this paradoxical behavior?

It turns out that this issue has been studied in a fair amount of depth by economists, but the challenge is that these studies are often shrouded in arcane language, economic theories, and complicated equations, which makes them difficult to understand. I wanted to share some of the thinking behind the reasons for the energy efficiency paradox, so I turned to one of my recently graduated students, Alexander Ziko, and asked him to explain, in non-economic language, the reasons for the EE gap.  Take it away, Alex.

This is Alex Ziko, a 2016 graduate from the Franklin Pierce University MBA in Energy and Sustainability Studies program. I have been studying energy matters with Prof. Mooiman for the past two years. Having graduated, I thought I was all done with energy assignments from Prof. Mooiman, but he posed an interesting question to me and, as I am interested in energy efficiency and behavioral economics, I decided to tackle the question as to why there is an energy efficiency gap.

As a brief introduction, I would describe myself as a native New Englander, recreationalist, and environmentalist living in the White Mountains of New Hampshire. I work as a data analyst for a small analytics software company; and spend my spare time reading and studying the intersection of economics, energy, and sustainability. This fall, when Prof. Mooiman posed to me an interesting question about the EE gap, he assumed I would balk at the opportunity of completing yet another assignment regarding energy economics – especially as this one would be on my own time. However, accepting Prof. Mooiman’s challenges always proves to be a personally enlightening experience. So let’s get comfortable as I attempt to turn the economically arcane into the intellectually engaging.

Why We Don’t Invest in Energy Efficiency When We Should

Increasing energy efficiency is a trend that Americans have been seeing for years. The idea of saving energy (and thus money) is a frequent topic on news broadcasts and daytime television; EE goods and services are given approving nods from consumers (think EnergyStar products and LED lighting); and when you crunch the numbers, EE investments almost always make long-term financial sense. However, consumers still act imprudently and opt not to make the investments –  once again proving that “rational economic actors” (an economist’s term for everyday people) aren’t always rational with their choices. Why? Why is there a gap between what is available to the consumer and what the consumer chooses to do – the so-called energy efficiency gap? The reasons why consumers choose not to adopt energy efficient options are complex and different for everyone. One cannot point to one specific area because there three main reasons for this energy efficiency paradox that can explain why, for an energy consumer, knowledge does not lead to action.

Modeling Flaws - The best decisions are made with good data – the world of EE is no different. Just as a bank would require accurate and convincing data before offering you a small business loan, a consumer looking to invest in EE hardware needs to be convinced of its short- and long-term value. Let’s use insulation as an example. Upgrading insulation has become a ubiquitous investment by homeowners as a way to save on energy (electricity, oil, natural gas, etc.). However, the savings available to a consumer depend greatly on: the state in which they live, the energy rates in that area, customer behavior, and the capacity to which the upgraded insulation would reduce heat losses. This puts a lot of pressure on the forecasting model used by firms that consult on and commission EE projects to provide an accurate forecast when proposing an energy project. Factors like the current income and cash flow (how much you make and spend each month) and budget allocations of the homeowner also need to be taken into account, along with an analysis of the opportunity cost associated with the project (opportunity cost can be thought of as the cost of the “next-best” option for a client). The homeowner’s opportunity cost for investing upfront cash for better insulation may present itself in the form of not being able to afford to take a family vacation this year or passing on orthodontic work for little Billy. In addition, one of the reasons for investment hesitation with energy investments is the concern that energy prices will not remain high enough to allow a return on a sizeable upfront investment. For example, in New England, the primary source of home heat is heating oil. In the past two years, heating oil prices have fallen. With opportunity costs in mind, and a relatively low market price for oil, consumers may not see sufficient benefits to warrant paying to upgrade the insulation in their home, especially in an economic climate of stagnant wages. Instead, they choose to keep the money in savings or perhaps spend it on that orthodontic work.

One overlooked and unaccounted for economic result that doesn’t always show up in an initial energy model is what is known as the rebound effect. This is the additional consumption of a product, or the additional emission of negative effects (like pollution), because you change your consumption habit due to your investment. Sound complicated? It makes sense if you think about our very human behavior. Let’s use the example of a hybrid vehicle. Perhaps you traded in your inefficient SUV for a new or used hybrid; heck, maybe you even acquired the car through a private sale and got a really good deal. However, with that new car, it is likely that some of your driving habits are going to change. Because you now buy less fuel, you might drive more than you did when you were more conscientious of every mile per gallon. Even though you are driving a more energy efficient vehicle, you undo some of the EE gains by driving more. Or, in the case of upgrading your insulation, you perhaps increase your thermostat setpoint by a few degrees because you don’t burn as much oil as before. These negative effects are seldom included in the calculation of EE gains, which could lead to their overstatement. When determining EE benefits, it is important to monitor energy consumption behavior afterwards to make sure that you really are achieving your forecasted savings.

Market Failures - Market failures sound complex, but they are actually very simple. When the supply of a resource is not matched by its demand, market failures are present. These can be found in many areas of the EE universe. Whenever a subsidy for an investment is given, or whenever pollution is emitted without accounting for its clean up, an imbalance in the true cost of production and the price of the product is created: this imbalance is a market failure. For example, subsidizing a homeowner’s EE investments is a market failure (albeit arguably a positive one) because the homeowner does not bear the full cost of the investment – they are subsidized by other ratepayers, thereby creating a market distortion. Then there are the indirect benefits that the neighbors benefit accrue from the EE investment, such as: improved resiliency of the energy-delivery systems because less energy has to be sourced, lower costs because fewer power plants have to be built, our resources last longer, less pollution and greenhouse gas emissions are reduced, local job creation, etc., as alluded to by Prof. Mooiman in his blog.  Sometimes, market failures can take the shape of incomplete information. Energy consumers don’t have the same information that is available to suppliers of EE products or service: there is a fear that the projected savings might not materialize and that perceived risk can be an obstacle in moving forward with an investment.

Another market failure occurs when multiple people are responsible for the same energy system: those individuals may not view the system in the same way. This can be found in apartment buildings where a landlord may not have an incentive to properly insulate and upgrade the building if the tenant is responsible for the heating bill. Whenever multiple people have the ability to change the consumption of energy, there is a possibility that the usage will not happen in an efficient manner. In economic speak, this is known as the principal/agent or split incentive problem. Anyone who has grown up in New England can attest to the paternal fallout that may happen if you touch the thermostat in the living room lest you decline to put on a sweater.

Other forms of market failures also fall within the realm of credit constraints.  EE investments normally require high upfront costs: lenders generally have a poor view of the potential return on these investments and can be reluctant to lend money for these projects.

Behavioral Failures - A very common explanation for the EE gap can be found in the way that people behave. I cannot stress enough that Economics is much, much more than the examination of dollars and cents; it’s an examination into how communities and individuals use their finite resources. Improved understanding of economic behavior has been aided by the field of behavioral economics, which looks at the differences in the ways that people, as rational beings making efficient economic choices, are predicted to act and how they actually behave in real life when they are presented with options. This is what makes behavioral economics a fascinating and worthy study, because it is just as much about psychology and philosophy as it is statistics and quantitative analysis. Behavioral reasons for an EE gap may be centered around personal beliefs, personal decision making, and personal preferences. For example, consider a homeowner who uses oil as a heating source. They may have a personal belief that the future price of heating oil will only go down in the future as less expensive forms of energy, such as those released by hydraulic fracking, become available; and therefore it is not financially worthwhile to invest in a solar hot water system. An example of a personal preference may be found in the decision to keep driving an inefficient vehicle rather than a hybrid vehicle, because the owner identifies more with the model of car they own – a personal identification that is worth more to them than potential fuel savings. Consumers may also be wary of the reality of energy savings, and are perturbed by the motives of a sales person looking to make a commission rather than the true effectiveness of potential energy savings that would result.

Other behavioral failures include: inattentiveness and salience, myopia, prospect theory, and bounded rationality. Inattentiveness addresses the fact that we are bombarded by information and have limited capacity to deal with it all and that we have to make choices regarding what we do pay attention to. As a result, doing the research (remember our definition of Economics as resource management, not just dollars and cents), contacting the vendor, and finding the money for an EE investment tends to be far down the list of what catches our attention. This is difficult because it requires more critical thinking and economic creativity than we usually ask of ourselves in our daily life. We also don’t pay attention to the long-term energy savings. Instead, we focus on the upfront cost of the investment – the feature that is most relevant (salient) to us at the time of the decision.  When buying a car, the upfront premium on a hybrid vehicle and the increased taxes can be more important to us than the long-term savings. We also tend to discount the importance of something like much higher fuel prices that might happen in the future.

Prospect theory suggests that we, as consumers, are more concerned about the possibility of loss than the prospect of long-term gains. We tend to weigh losses more heavily than gains. The spending of $1000 on EE has a greater emotional impact on us than $2000 of future gains.  In other words, we are concerned about our EE investment being a bad one and are risk-adverse to the possible gains. Future money is more abstract than the current balance on the bank account.

Bounded rationality is another behavioral economics explanation and explains that it is impossible to analyze and understand all information associated with a decision, especially a complex technical one. As a result, we resort to short cuts. For example, in buying a car, we simply might not have time to analyze all the data, so we might resort to a short cut, such as using Consumer Report ratings. Or perhaps we simply follow the lead of our neighbors and buy a similar car.  

As you can see, explaining why there is a slowness to adopt EE measures is not simple. There are many layered and nuanced economic reasons for why customers don’t install LED light bulbs, continue to use inefficient home appliances, drive inefficient vehicles, and delay upgrading home energy systems. Some of this reasoning lies in the information gap between EE suppliers and energy consumers, but a lot is wrapped up in the way that consumers view their budgets, the future benefits of changing their actions, and their preference to the way that they do things now, information overload, and other choices that draw them away from making EE investments. Getting people to make EE efficiency investments is not straightforward. Consultants and EE experts face significant barriers in helping residents and businesses see through these situations and getting them to make the right decision; while at the same time learning from their own forecasting errors and mastering a more accurate prediction of energy savings.

Thanks Alex. So, there we have an explanation as to why I can sometimes be such an EE slacker. It is a combination of too little information, and, at times, too much information, inattention, short-term thinking, other opportunities to spend my money, and more concern about spending money now rather than long-term energy savings. Overall, the point is that we are not always rational in our approach and it takes work to get humans to think in the long term, to do the right thing, and to make those EE investments.  As a result, depending on voluntary EE action is limited in its effectiveness. This is why Federal programs, such as appliance and fuel economy standards, or State programs, such as building codes or the Energy Efficiency Resource Standard (EERS) programs, are so important. They get us to make the right EE decisions by making EE the default option or by providing incentives such as subsidies for EE investments.

It has been noted by the International Energy Agency in their 2016 Energy Efficiency Market Report that policy is the key driver for EE improvements. These policies take one of five forms:

1.    Mandatory standards, e.g., building energy codes;
2.    Mandatory energy savings targets, such as those in the NH EERS program;
3.    Information and labelling, e.g., Energy Star Appliances;
4.    Financial incentives, such as the subsidies provided by the NH EERS program; and
5.    Financial disincentives, e.g., consumption taxes, like fuel taxes.

With this powerful range of tools, our legislators have the ability to make a profound impact on our energy consumption, should they take a long view. Quite frankly, if EE policy is not used as a tool, our demand will continue to grow until the point that diminished energy resources and excessive energy prices will provide the incentive to curtail our energy usage. Escalating demand will also, by necessity, lead to increased supply: bringing in that increased supply—renewable or not—will have an impact and, one way or another, we will end up paying for it. It must be appreciated that every energy project, whether renewable, nuclear, or fossil-fuel based, has an impact on somebody somewhere. There is no free lunch when it comes to energy. The choice is a stark one: we can work to moderate our energy consumption through policy and voluntary action, or wait for increased demand, higher energy prices, and impacts on our society and environment to drive our actions. With EE, we have the ability to moderate, over the long term, our demand in a controllable and less drastic fashion.

I understand the dilemma faced by our elected representatives. They are concerned about high energy prices in New England and the negative impact that they have on local companies that need to remain competitive. It takes foresight and courage, especially when you are up for election, to support programs that may marginally increase energy costs, despite their enormous long-term positive energy usage impact. We and our elected representatives should take courage and lessons from the many local companies that do take action and make investments to improve their energy efficiency by utilizing EE programs like CORE and EERS, discussed in my last post. I suspect that a company can do more to control their energy use through EE actions than by waiting and lobbying for lower energy prices.

We are often reminded that NH has amongst the highest energy prices: there are states with rates 50% lower. This  is an outcome of the fact that we are in New England and have little in the way of cheap hydropower, wind, or fossil-fuel resources. We are a densely populated area with a lot of energy infrastructure and, in many respects, we are at the end of the energy pipeline. On top of this, we are closing down aging coal and nuclear power plants and are notoriously reluctant to deal with and commit to new generation or supply infrastructure. Our higher prices should not be a surprise and we will never be able to match those low electricity prices in other states. However, we can and should deal with the situation then by curtailing our energy use. We can put our Yankee ingenuity to work. We can take action, drop the thermostat temperature by a degree, put on a sweater, make those EE investments, and encourage our politicians to make a commitment to EE programs. Energy efficiency is indeed the first fuel and let’s encourage our politicians to support it.

In the meantime, think about your own actions with regard to energy efficiency. Like me, take a look at the man in the mirror* and ask yourself if there is more you can do to reduce your energy consumption—and then take action.  And, as usual, start with remembering to turn off the lights when you leave the room.

Mike Mooiman

Franklin Pierce University

mooimanm@franklinpierce.edu

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(*Man in the Mirror: One of my favorite Michael Jackson tunes. From the album Bad released in 1987. Enjoy Man in the Mirror)