Energy Efficiency: Policy Puzzles

1. Energy Efficiency: Policy Puzzles Tim Brennan Professor, Public Policy and Economics, UMBC Senior Fellow, Resources for the Future, Washington, DC brennan@umbc.edu 30th USAEE/IAEE North American Conference Washington, DC October 12, 2011 Paper available: http://www.rff.org/RFF/Documents/RFF-DP-11-27%20revised.pdf

2. Energy efficiency definition, backdrop • More energy service per unit of energy consumed • CFL, high “efficiency” air conditioner/furnace, etc. • Long-time interest increasing • Excessive energy use due to lack of effective real-time pricing • Greenhouse gas emissions • NIMBY concerns regarding generator, transmission expansion • Types of energy efficiency programs (MD, BGE) • EmPOWER MD – 15% reduction by 2015 (rhymes?) • Incentives for replacing old HVAC equipment • Energy audits and residential retrofits; low interest loans • Small commercial, low income subsidies Brennan: Energy Efficiency Puzzles

3. What makes energy efficiency interesting? • Does energy efficiency really reduce use? • “Rebound effect”: Possible or inevitable? • Interactions with related policies, esp. RPS • Consumer choice failure as subsidy rationale • MD: People use too much, and price too high--Yikes! • Evaluation when revealed preference doesn’t reveal benefit? • Decoupling: Bring back guaranteed-profit regulation? • Could energy efficiency really about monopsony? • Consumer or total welfare? What do regulators do? • Should utilities be involved with energy efficiency? • Separating competitive sectors from regulated monopolies Brennan: Energy Efficiency Puzzles

4. P P Less efficiency Less efficiency Moreefficiency More efficiency Q Q 1. Is energy efficiency a substitute for energy? • Presumably, efficiency increases consumer benefit from a given quantity of energy used • Marginal benefit (“willingness to pay”) must go up for some values of energy • Implies demand curve pivots, not falls Brennan: Energy Efficiency Puzzles

5. Could real-time pricing, EE conflict? Need to assume, can’t conclude, that efficiency, use are substitutes, BUT … With real-time pricing increasing critical peak prices by a factor of 10-20, could energy efficiency lead to more energy use? P P More efficiency Less efficiency Less efficiency More efficiency Q Q Brennan: Energy Efficiency Puzzles

6. 2. Energy efficiency and related policies Brennan: Energy Efficiency Puzzles • Use energy efficiency savings to count toward renewable requirement • Policy substitute, not complement!! • Convert the requirement to a fossil fuel permit • Should nuclear count as a renewable? • Should hydro not count as a renewable? • Crucial issue—the baseline • How to calculate what energy use would have been to get credit • (Also problem with selling savings into capacity market) • Increased energy use at margin counts multiplies marginal RPS compliance cost • Palmer: Use hypothetical rather than actual savings?

7. 3. Efficiency policy: “2nd best” or consumer error? • Necessary assumption for EE if energy price too high • Invoking behavioral economics: Negative cost • WTP to avoid unobserved quality degradation? • Or look at all the $20 bills on sidewalk? Brennan: Energy Efficiency Puzzles

8. What do we do for policy evaluation? • Not defending or advocating, but part of the debate • Gillingham, Newell, Palmer • Information, capital market failure • Or just can’t figure it out? • [If not this, what can consumers do? • What to count? Full increase in consumer surplus? • Even though that would have implied adoption with no subsidy • With that effect, can get net benefits even if price too high • Develop endogenous subsidy effect on electricity price • Measuring net effects of energy efficiency policies:“free riders” Brennan: Energy Efficiency Puzzles

9. 4. Which brings us to decoupling Divorce distribution utility profits from energy delivered Raise Y’s and Z’s rates if X reduces use Not lump-sum payment Decoupling’s advocates’ positions Utilities “lose revenue and profits from sales not made as a result of successful energy programs” Political economy: Shifts risk from utility to customer Opponents’ responses When to adjust revenues, profits? By customer class? ELCON: “Promotes mediocrity”; get prices right instead OPCs: Should public have right to intervene? Guaranteed revenue reduces incentive to restore power? Brennan: Energy Efficiency Puzzles

10. Decoupling’s challenge to regulatory economics Profit-control regulation => distortions, inefficiency Replace profit control with price caps “Night of the Living Dead”? How do decoupling’s challenges hold up? Price-capped utility will withhold demand-reducing info May subsidize complements to boost demand Neither holds if utility sells energy, when peak price too low Enhances EE reductions if reduced use raises energy price Real rationales political, not economic Covering utility's cost so it does not oppose energy efficiency This was what stranded cost recovery was about in the 90s Not necessarily bad; make policy closer to uniformly beneficial Brennan: Energy Efficiency Puzzles

11. 5. Speaking of politics – could it be monopsony? price P consumer surplus gain from lower prices demand consumer surplus loss from rationing P = MC comp P marginal cost MC monopsony P quantity Q monopsony Q efficient Q Getting around the monopsony rationing problem? Increases consumer (not total) welfare to subsidize electricity efficiency : reduce price and ration demand Brennan: Energy Efficiency Puzzles

12. Multiple caveats • “Capture” theory of regulation is that regulator works for firm, not the consumers • A consumer-oriented regulator might set p and q together, choose q to maximize total surplus and then choose p = AC to transfer all surplus to consumers • Could a consumer-oriented regulatory monopsonize? • Is electricity susceptible to monopsony? • General picture: “hockey stick” pricing • Misleading portrait of “marginal cost” • But would monopsony then be legal? • Nevertheless, actual “buyer market power” allegations in New England capacity markets Brennan: Energy Efficiency Puzzles

13. 6. Should utilities handle energy efficiency? • Huge in the US • Demand-side management programs • EERS utility obligations • Energy efficiency subsidy programs (CFLs, weatherizing) • Remote HVAC control (more for peak load) • Energy audits • Financing feed-in tariffs, renewable obligations • Obama administration: Utilities as “engines of economic progress” through green jobs Brennan: Energy Efficiency Puzzles

14. Is utility involvement a good idea? • Decades-long dedication to providing energy • Changing utilities from “energy” to “energy services” • Energy services, energy efficiency, look competitive • Are there huge fixed costs that make these natural monopolies? • Entrepreneurial ideas, start-ups (vs. stodgy utilities?) • Main risk: Discrimination against downstream rivals • Issue not just “foxes guarding the henhouse” or “cost of changing the business plan” • Denying or providing inferior access to regulated services • Delayed transmission lines, noisier connections • Create artificial competitive advantage to capture excess profits denied by regulation Brennan: Energy Efficiency Puzzles

15. Separation policy, and what may be different here • History • 1970s: Keeping oil pipelines from being owned by shippers • 1980s: :US v. AT&T Getting regulated local telephone monopolies out of competitive long distance, equipment, information services markets • 1990s: Orders 888, 2000: Separating control of electricity transmission, distribution, from ownership of generation • Why? Taxation through the regulator • Utilities justify expenses through of cost recovery • The PUC approves rate increases to cover the cost • Legislatures don’t have to get involved • Let utilities collect the money, fund competitive efficiency programs via auction? Brennan: Energy Efficiency Puzzles

16. Overall … Brennan: Energy Efficiency Puzzles • Energy efficiency important, but puzzles remain • Greater efficiency need not reduce electricity use • Interaction with “complementary “ policies • Subsidize with high prices => consumer choice failure • Decoupling: Justification more politics than economics • Efficiency policy could be a monopsony device • Consumer vs. total welfare debate may matter more for regulation • Having utilities manage efficiency could allow regulated monopolies to distort competitive markets • Politics of financing efficiency subsidies?