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ENERGY EFFICIENCY PERFORMANCE STANDARDS: the Cornerstone of Consumer-Friendly Energy Policy

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ENERGY EFFICIENCY PERFORMANCE STANDARDS: the Cornerstone of Consumer-Friendly Energy Policy ENERGY EFFICIENCY PERFORMANCE STANDARDS: The Cornerstone of Consumer-Friendly Energy Policy Mark Cooper Director of Research October 2013 TABLE OF CONTENTS EXECUTIVE SUMMARY 1 INTRODUCTION: THE CONSUMER STAKE IN REDUCING THE EFFICIENCY GAP (SECTION I) COMPREHENSIVE FRAMEWORKS AND EMPIRICAL EVIDENCE ON THE EFFICIENCY GAP (SECTION II) COST-BENEFIT ANALYSIS (SECTION III) THE DIFFUSIONS OF INNOVATION (SECTION V) THE INTERSECTION OF THE EFFICIENCY GAP AND CLIMATE CHANGE LITERATURES (SECTION VI) I. INTRODUCTION 6 A. PURPOSE B. THE CONSUMER INTEREST IN CLOSING THE EFFICIENCY GAP Residential Appliances Cars and Light Duty Trucks C. AN OPPOSING VIEW D. THE EFFICIENCY GAP: PAST AND PRESENT E. OUTLINE PART I: RECENT EFFICIENCY GAP ANALYSIS II. COMPREHENSIVE FRAMEWORKS AND EMPIRICAL EVIDENCE 17 ON THE EFFICIENCY GAP A. THE LBL FRAMEWORK B. THE RFF FRAMEWORK C. OTHER RECENT COMPREHENSIVE EFFICIENCY GAP FRAMEWORKS The United Nations Industrial Development Organization McKinsey and Company California Institute for Energy and the Environment D. THE DIFFUSION OF INNOVATION E. EMPIRICAL EVIDENCE ON MARKET BARRIERS AND IMPERFECTIONS Market Barriers and Imperfections Climate Change Analysis F. PERFORMANCE STANDARDS AS A POLICY RESPONSE TO THE EFFICIENCY GAP III. COST/ BENEFIT ANALYSIS 30 A. COST AND QUANTITY OF ENERGY SAVINGS Cost Quanity B. OVERESTIMATION OF COSTS C. NON-ENERGY BENEFITS D. MACROECONOMIC BENEFITS OF PERFORMANCE STANDARDS The Rebound Effect E. CONCLUSION: VALUING AND ACHIEVING THE BENEFITS OF PERFORMANCE STANDARDS i Strategic Considerations for Well-Designed Standards Mobilizing Public Support. PART II: ANALYSIS OF COMPLEMENTARY FIELDS IV. DIFFUSION OF INNOVATION AND THE IMPORTANCE OF THE 49 SUPPLY-SIDE OF THE MARKET A. RECOGNIZING THE ROLE OF SUPPLY AND DEMAND B. THE IMPORTANCE OF TRANSACTION COSTS AND BEHAVIORAL FACTORS C. MARKET BARRIERS AND THE INNOVATION DIFFUSION PROCESS V. THE INTERSECTION OF THE EFFICIENCY GAP AND CLIMATE 59 CHANGE LITERATURES A. THE CENTRAL ECONOMIC DEBATE IN THE CLIMATE POLICY ARENA B. EMPIRICAL EVIDENCE ON THE IMPORTANCE OF MARKET BARRIERS AND IMPERFECTIONS Supply-Side Demand-side C. BROAD FRAMEWORKS D. CONCLUSION: THE INCREASING URGENCY OF CLOSING THE EFFICIENCY GAP APPENDIX A: ANNOTATED VERSIONS OF SECTION II EXHIBITS 69 APPENDIX B: KEY CHARACTERISTICS AND FINDINGS OF 78 EMPIRICAL STUDIES APPENDIX C: ANNOTATED VERSIONS OF SECTION VI EXHIBITS 85 BIBLIOGRAPHY 92 LIST OF EXHIBITS I-1: The Size of the Efficiency Gap Across Energy Markets: Technically 8 Feasible, Economically Practicable Potential Energy Savings I-2: The Cost of Saving Energy is Much Lower than the Price Paid to 9 Consume Energy I- 3: The Benefits and Costs of the Proposed Higher Fuel Economy 12 Standards: Combined Cars and Trucks, 3% Discount II-1: Penetration of Mitigation Technologies: A Conceptual Framework 17 II-2: Market Barriers to Energy Efficiency 18 II-3: Market and Behavioral Factors Relevant to Energy Efficiency 20 II-4: Barriers to Industrial Energy Efficiency 21 II-5: McKinsey and Company Market Barriers to Home Energy Efficiency 22 II-6: Market Failures, Barriers and Non-Economic Factors 23 II-7: Recent Empirical Evidence on Market Failures, Barriers and Imperfections 24 ii II-8: Policy Instrument for Reducing Greenhouse Gas Emissions from Buildings 26 II-9: Assessment of Policy Instruments in Place in the European Union 27 II-10: Evaluation of 20 Policies 28 II-11: Causes of Market Failure Addressed by Standards 29 III-1: Utility Cost of Saved Energy (2006$/MWH) vs. Incremental Annual 30 Savings as a % of Sales III-2: The Cost of Saved Electricity 31 III-3: Utility Energy Efficiency Spending and Savings 33 III-4: The Projected Costs of Regulation Exceed the Actual Costs: Ratio of 36 Estimated Cost to Actual Cost by Source III-5: Estimated and Actual Cost Increases Associated with Recent Standards 37 for Major Appliances III-6: Gradual Improvement in Fuel Economy Causes a Slow and Steady Price 38 Increase while the Industry has Handled Quality Improvement with Much Greater Costs III-7: Summary of Outcomes from Improvement in Energy Efficiency 39 III-8: Non-Energy Benefits from Whole House Retrofits 40 III-9: Impacts of the 2012-2016 Corporate Average Fuel Economy Rule: 41 Savings and Increases in Economic Activity III-10: Labor Intensity of Key Economic Sectors in the U.S. 42 III-11: Consumer Expenditures for Energy and Energy Using Durables 44 III-12: Conceptualization of the Impact of Underestimation of Benefits and 45 Overestimation of Cost on the Evaluation of Benefit/Cost Ratios III-13: Key Design Features of Effective Performance Standards 46 III-14: Social Action in Support of Energy Policy Change 47 IV-1: The Interaction of Supply and Demand in the Creation/Diffusion of 50 Innovative Technologies IV-2: Causal Factors that Drive the Supply and Diffusion of Innovative Products 52 IV-3: Decision Theoretic Approaches to Modeling Diffusion 55 IV-4: Integrated Model to Evaluate Determinants of Energy Efficient 57 Technology Uptake IV-5: Market Barriers and Imperfections and the Causal Factors that Drive 58 the Supply and Diffusion of Innovation V-1: Market Barriers & Imperfections: Nordhaus, Weyant and Noll 59 V-2: Market Barriers and Imperfection in Climate Change Analysis 63 V-3: Causes of Carbon Lock-In 65 V-4: Comparison of Barriers to Industrial Energy Efficiency with Iron 66 Triangle of Barriers V-5: Typology of Policy Challenges and Responses 68 A-II-2: Market Barriers to Energy Efficiency 69 A-II-3: Market and Behavioral Failures Relevant to Energy Efficiency 71 iii A-II-4: Barriers to Industrial Energy Efficiency 72 A-II-5: McKinsey and Company Market Barriers to Home 73 Energy Efficiency A-II-7: Recent Empirical Evidence on Market Failures, Barriers and Imperfections 74 A-V-2: Market Barriers and Imperfection in Climate Change Analysis 85 A-V-3: Causes of Carbon Lock-In 90 iv ENERGY EFFICIENCY PERFORMANCE STANDARDS: The Cornerstone of Consumer-Friendly Energy Policy Executive Summary Introduction: The Consumer Stake in Reducing the Efficiency Gap (Section I) Consumer expenditures on household energy (electricity and natural gas at home and gasoline for transportation) average about $4600 per year. This makes household energy one of the largest items in the consumer budget – more than groceries (food at home, ~$3800), health care (~$3300), entertainment (~$2572), and clothing (~$1700). Yet, economic analysis shows that technologies are available that could lower those bills substantially. Even after the cost of energy savings technologies are paid, consumer pocketbook savings approaching $1000 per year are possible. Moreover, the failure to capture cost-effective energy savings is not limited to the residential consumer market, it affects the commercial and industrial sectors as well. Given this potential savings, it is not surprising to find that energy efficiency performance standards, which increase the minimum efficiency of energy using durable goods, receive a great deal of attention from policy makers and support from the public. In fact, proceedings affecting (or relating to) performance standards for almost two dozen consumer products are pending at the federal and state levels. Yet, the existence of the large energy savings potential has always engendered doubts among some analysts because it implies a significant market failure. In our market economy, we would expect economically beneficial opportunities for investment like this to be quickly exploited. If markets are functioning well, there should not be an efficiency gap. Although the efficiency gap has been the subject of considerable study since the oil price shocks of the 1970s, the past decade has witnessed a flowering of analysis that vastly improves the understanding of the causes of the efficiency gap and the policies that can help to close it. With the wide ranging scope of pending energy performance standards and the key role they are likely to play not only in energy policy, but also in the response to climate change, this is an appropriate juncture to review the empirical evidence on performance standards as a response to the efficiency gap. Purpose and Outline This paper reviews the conceptual and empirical analysis of the efficiency gap literature of the past decade and weaves the discrete pieces of empirical evidence and the broad conceptual frameworks into a comprehensive explanation of the efficiency gap. Part I discusses the major conceptualization offered by academics, thinks tanks, private sector firms and government agencies and ties them to four dozen empirical studies completed in the past decade. It then evaluates estimates of costs and benefits of policies to enhance energy efficiency. It concludes with a discussion of the studies that show that performance standards are an economically attractive and effective approach to closing the efficiency gap. 1 Part II of the paper places the efficiency gap analysis in the context of two broader frameworks that add important depth to the understanding of the efficiency gap. The central themes in the diffusion of innovation literature and the climate change literature reinforce the conclusions drawn from the efficiency gap literature. The slow diffusion of energy saving technologies can be seen as an example of the broad process of the diffusion of innovation, which has a very long and rich literature. Concerns about climate change have focused a great deal of attention on the challenge of inducing change in energy consumption using behavior, which at heart is the same problem as
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