By Kenneth W. Costello
Many state utility regulators, policymakers, utilities and others construct the orthodox, and politically palatable, argument that market failure justifies utility energy efficiency (EE) programs and that the vast majority of those programs would pass a cost-benefit test.
Electric and natural gas utilities together spend about $10 billion annually on energy efficiency. This is in addition to the billions of dollars the federal government spends, boosted substantially by the Inflation Reduction Act (e.g., an expansion of tax incentives for the installation of energy-efficient building upgrades and the construction of energy-efficient homes). Besides all of this, subsidized EE is a major component of state and federal governments’ energy policies, driven in recent years by efforts to combat climate change.
Using the label “no-regrets,” policymakers frequently push actions they endorse as unequivocally good —everyone wins, no one loses. The “free lunches” that EE advocates ascribe to EE programs should therefore seem suspicious to anyone after little thought.
They certainly do to many analysts who have seriously studied the benefits and costs of EE initiatives. If these efforts are such a good deal, then why must government mandate or utilities subsidize them? Why aren’t energy consumers taking advantage of the large benefits that EE supposedly offers them? Are they that irrational and unaware of the benefits from EE to warrant subsidies or mandates; or, more accurately, do consumers just find better ways to invest their limited monies? It may very well be that energy consumers prefer to invest in other things, like home repairs, a new car or college. And it’s not because of market failure.
I am skeptical for two basic reasons. First, the idea that markets are less than perfect should not infer that intervention in the form of utility subsidies or government mandates benefits society. One of the major errors with government actions in a wide array of areas starts with the premise that since markets aren’t perfect, the government should intervene. This more times than not results in a higher cost to society than the benefits received. There is a concept that is often ignored in public policy debate: “government failure.”
One glaring problem is that ostensibly objective analysis of specific EE initiatives often reaches different conclusions from evaluations prepared either by utilities or for utilities.
Why is this, and whose results are more credible? Most utilities or their evaluators fail to apply the best analytical tools to their evaluations of EE programs. These tools include randomized trials and quasi-experimental designs to measure energy savings and account for consumer behavior. The problem with other approaches is that they are unreliable — in some instances grossly flawed — in measuring the actual energy savings from individual EE programs.
Another evident reality is that utilities have a self-interest in portraying their EE programs as cost-effective and, therefore, worthy of favorable treatment by their regulator (e.g., allowing the utility to profit). We cannot forget that regulators and policymakers themselves receive kudos from the public for supporting subsidies whose intent is to tackle climate change, in addition to promising reduced utility bills.
Going back, academic reviews of EE programs conclude that such programs are not the “low-hanging” fruit many people believe. They show that utilities grossly overstate energy savings from EE programs because they rely on engineering estimates that fail to account for consumer behavior (the so-called “rebound effect” or price-elasticity effect) in using, say, their higher energy-efficient air conditioners and heating systems more intensively because of lower operating costs.
Studies also find “free riders” participating in EE programs. These are individuals who would have purchased lower-energy-use appliances or heating and air conditioning systems in the absence of the EE program. It would be wrong to count their energy savings as real benefits, which can show a program as cost effective when in fact it is not. Some studies have shown that participants in utility EE programs primarily are consumers who are wealthier, own their own homes, and are more informed about and attentive to energy costs.
Studies also note that government and utilities often fail to consider “hidden costs” for consumers from the time and effort spent on both energy audits and investments. The combination of these factors, according to some academic studies, has understated the true costs of EE programs by as much as 50% or more.
Policymakers should ask the fundamental question: Why should utilities and the government subsidize EE when energy consumers are capable of making rational decisions for themselves? Is it equitable and good public policy to compel utility customers to pay for EE initiatives that benefit a relative few (who are on average wealthier than the funders of those initiatives) when some of those would have invested in EE without utility assistance?
Kenneth W. Costello is a regulatory economist and independent consultant.