Why we don’t have to choose between energy efficiency programs and market-driven solutions

Blog Post | February 10, 2015 - 12:00 am
By Steven Nadel , Executive Director

Part One in a series where ACEEE examines the most effective roles for energy efficiency programs and market-driven solutions in scaling the deployment of energy efficiency.

The fundamental question that policymakers ask themselves is, Are we being the most responsible stewards of public dollars? For those tasked with finding ways to increase cost-effective energy savings, the gold standard for the last 30 years has been ratepayer-funded programs administered by utilities, or in some cases, by state agencies or third parties. This model has worked very well, saving customers billions of dollars and helping to contain increases in energy prices.

In the search for even more effective policy solutions, some have periodically asked if states and utilities should bow out and allow private-sector service providers in the market to completely take over. The reasoning is that the energy efficiency market will never mature as long as energy efficiency programs exist, so we must choose between these programs and the private sector. Our belief, founded on over 30 years of research, is that this is a false choice: private-sector providers are already the dominant player when it comes to energy efficiency, and energy efficiency programs still fulfill a vital role due to their proven track record of success and the impediments to energy efficiency that they address.

An extensive body of research documents the many factors that result in customers' underutilization of energy efficiency in the absence of energy efficiency programs. These factors include a lack of information, the scarcity of high-efficiency options in the local market, local suppliers' and contractors' lack of training and experience in the latest high-efficiency techniques, customer economic payback requirements that are vastly different than the utility system, the hassle factor of having to arrange an energy efficiency retrofit, and split incentives between building owners and tenants. Well-designed energy efficiency programs help overcome these barriers and allow private-market actors to provide their services more effectively.

This partnership between markets and programs should not be abandoned. As we discuss below, our research indicates that at the present time, private service providers alone will deliver less energy savings than if they continue to work together with successful energy efficiency programs. That said, we are excited about the possibilities of leveraging even more private-sector dollars and activity in the future as a vital complement to customer-funded programs.

In our research we find that the private market has done a lot to promote energy efficiency in the past, and even more may be possible in the future. There are some market segments, such as large institutions, where the private market has done well, but many others where the success of market-focused approaches has been limited. We should encourage the private market where it works well and experiment with new market-based approaches in other promising market segments. But we should also continue to use proven approaches like energy efficiency programs, transitioning to alternative approaches only when such alternatives prove their efficacy in specific market segments. If we reduce proven program approaches prematurely, energy efficiency savings will likely be lower, consumer costs higher, and impacts on the environment more severe.

This blog post is the first in a multipart series on these issues. Today’s blog post summarizes our findings but does not include the underlying details. In the coming weeks we will publish two additional posts: one on our findings from past programs, and one looking at recent developments and potential opportunities ahead. Subsequent posts in this series will look into the role of financing and the New York REV proposal in particular.

Our findings can be summarized in five points.

The market is already a major force in delivering energy efficiency.

2013 ACEEE study estimated that about $70–100 billion was spent in 2010 on energy efficiency measures, with a substantial majority of this funding coming from the private market. Well-developed and well-deployed energy efficiency programs leverage and enhance the role of private retailers and service providers. Utility incentives typically cover a third to half of the cost of measures, leaving end users to pay the rest. Efficiency measures are mostly purchased through privately-owned stores and service providers. And many customers will invest in efficiency without utility or government involvement. The question is not whether to rely on the market, since we already do that; the question is whether we can rely even more on the market in the future.

Energy efficiency programs have a record of cost-effective success.

Energy efficiency programs have done a very good job of improving energy efficiency cost effectively. Utilities and other program implementers began offering energy-efficiency programs in the 1980s because it generally cost less to save a kWh of energy than to build a power plant and generate a kWh. These programs have ramped up since then and are now offered in most states. According to data compiled by the Energy Information Administration (EIA), these programs reduced electricity use by about 138 billion kWh in 2012, enough to power more than 13 million average American homes for a year. A 2014 ACEEE study found that on average, these programs cost utilities 2.8 cents per kWh saved, which is less than half the cost of new generating plants. The EIA data show that some states have used energy efficiency programs to reduce energy use by more than 10% over multiyear periods.

Past experience shows us the pitfalls of abandoning energy efficiency programs.

It is instructive to look at times when policymakers sought to rely more on markets. For example, there was a major push for market-based solutions in the 1990s. A 2001 ACEEE evaluation of these efforts found that private-sector energy service companies could play an important role, but they primarily reached institutional and large commercial customers and showed little interest in and ability to serve residential and small business customers. They also had limited success serving industrial markets.

Likewise, the retail electricity commodity supplier industry did not show itself to be an effective vehicle for achieving energy efficiency improvements, due to such challenges as a high failure rate among supplier firms, their mixed interest in energy efficiency, their minimal effort to actually market tangible energy efficiency measures, and a lack of customer interest in obtaining energy efficiency from them. This period also saw experiments in which bids were solicited for energy efficiency improvements and "standard performance contracts" were offered; in both cases private firms received payments per kWh and/or kW saved. These experiments tended to yield only certain types of savings (such as lighting improvements) and relatively high prices—higher per kWh saved than the cost of utility-operated programs.

So far we also have seen limitations in the energy efficiency financing market. We agree that financing is an important and useful tool, and we encourage efforts to experiment with new strategies in order to extend financing's reach. However, financing should not be the only tool in our kitbag. Lack of access to capital is just one of the key barriers to energy efficiency, and not all customers want to or can access financing. Many firms currently have large cash reserves, and capital is available for low-risk customers at very attractive rates. For other customers, past experience indicates that while some of them will take out loans, others will not for a variety of reasons. These may include a poor credit rating, aversion to debt, or financial procedures that make on-the-books financing difficult for some companies. This limited use of loans is documented in a 2011 ACEEE report that looks at leading energy efficiency loan programs around the country and is also illustrated by reports from private small lenders convened as part of ACEEE’s Small Lender Energy Efficiency Community (SLEEC).

The future of the energy efficiency market is promising, although not a universal solution.

It is also important to look at what may be possible in the present and near future—and what may not. The past decade has seen market and technology developments that could enhance the role of market players in future years. For example, energy service companies have refined their offerings and now are doing nearly $6 billion a year in business, primarily in energy-saving performance contracts that guarantee a level of savings, often for ten years or more. These contracts are still primarily with institutional customers, with many fewer commercial and industrial customers and very little in the residential sector. There are also new smart thermostats available for homes that, while expensive, have been popular with early adopters. And in the commercial sector, new smart building services can help optimize building operations , saving 10% or more in some applications.

These are promising developments, but still only a fraction of the 20% plus savings opportunity from cost-effective energy efficiency measures that studies have found. In addition, these service providers tend to emphasize the largest businesses and upscale consumers, meaning that many customers are not receiving services.

The best results come from the market and energy efficiency programs working together.

Cooperation between the market and energy efficiency programs often produces the best results. For example, quite a few energy efficiency programs have promoted smart thermostats, contributing to their market growth. The Connecticut Green Bank has undertaken more than 20 projects with Commercial Property-Assessed Clean Energy (C-PACE) finance; most of these projects have also received rebates from energy efficiency programs. The ENERGY STAR® program has helped increase the market share of energy-efficient equipment, aided by program promotion efforts and incentives. Energy efficiency programs have also helped to advance efficiency in new construction by working with developers, architects, and engineers. We will provide further information on these and other examples in the third post in this series.

We believe the fundamental question is not which approach works best—markets or energy efficiency programs—but how to build upon a cooperative endeavor that has proven itself effective and that is already providing billions of dollars of energy savings. Look for subsequent posts in our series on this topic. We also encourage you to join the conversation in the comments section below; we will try to reply to as many posts as we can.

Click here to continue to Part Two.