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Curbing the growth of global energy demand

Continued From Last Week

The opportunities for improvement are huge, but market forces alone won't realize them.

Opportunities and barriers (Last Week)

• Residential buildings
• Commercial buildings
• Road transport
• Industry

Capturing opportunities (This Week)

• Developed versus developing economies
• Overcoming market failures
• Environmental benefits

Developed versus developing economies

To a large extent, capturing the 135 QBTUs of opportunities for energy-productivity improvement we've identified will depend on the commitment of the developing world, which accounts for nearly three- quarters of them (Exhibit 5). The reason is that developing countries tend to start from a much lower base of capital stock (industrial-production capacity, for instance, or fleets of vehicles) and grow more rapidly than developed economies. What's more, it is much cheaper to incorporate energy-saving features in new capital than to retrofit. The additional cost of installing energy-saving double-pane windows in a new building, for instance, is significantly less than the cost of upgrading an existing one's single-pane windows.

China, in particular, will play a crucial role because of its size and rapidly growing influence in the world economy. Indeed, we estimate that in 2020 China's opportunity for energy productivity improvement will be as high as 31 QBTUs-5 percent of global energy demand in that year. China's power sector alone will generate 16 percent of the global growth in energy demand that we expect from 2003 to 2020, so it really matters whether the country meets that demand with power plants at current efficiency levels or with new, high-efficiency plants. Although addressing such issues will be difficult, we believe that measures to improve energy productivity can actually help China's economy. In fact, given the country's relatively low labor costs in building, these opportunities may well have higher returns there than the 10 percent or so we have observed elsewhere. Moreover, China could be a considerable source of innovation as it develops and tests new energy- efficient devices for use in markets around the world.

Overcoming market failures

For leaders in developing and developed markets alike, improving energy productivity is an obvious point of departure for achieving energy policy objectives of all stripes. But as we've seen, market forces alone won't capture the opportunities. How can governments remove the distortions and market inefficiencies holding back energy productivity and, at the same time, create an environment that encourages businesses to seek innovative ways of tapping into the resulting opportunities?

Incentive programs implemented through energy intermediaries are an attractive option in the residential and commercial sectors. Today, the returns of many utilities are based on the volume of electricity delivered, which encourages them to promote growth in demand. Instead, governments could reward improvements in energy efficiency among end users. Such an environment would encourage companies to find ways to overcome information barriers as well as agency problems.

For their part, utilities can establish technologies for two-way communication between themselves and their customers that facilitate changes in the way consumers use energy. With advanced metering, for instance, consumers can see how their electricity consumption varies over time. This information, coupled with differential pricing (charging premium prices for energy used during peak times, and vice versa) gives customers an incentive to shift their consumption patterns away from peak times. By doing so, demand for expensive peak power-generation capacity can be reduced. Companies such as CenterPoint Energy, Entergy, and Pacific Gas and Electric (PG&E) are already implementing these technologies in the United States. Adopting these and other demand-side programs across the United States could accelerate the efficiency improvements that utilities could intermediate by about 1 percent a year relative to the business-as-usual scenario.

Once utilities can itemize their bills, other interesting options become viable for them. Some are already experimenting with market-based programs that allow energy services companies to identify and compete for energy-saving opportunities as an alternative to building new power-generation capacity. These companies can, for example, combine the engineering expertise needed to reduce energy consumption with financial services that would help municipalities, universities, schools, and hospitals to bridge the gap between their current expenditures and future energy savings. In new-housing developments, energy services companies could help builders find new ways of financing positive-return investments in energy-efficient homes. Similarly, energy productivity gains could be accelerated if incentives were created to upgrade existing assets when they change hands, by providing lower financing costs for buyers of energy- efficient homes, requiring commercial upgrades and expansions to meet new building codes, or developing consumer-financing vehicles of longer duration for efficiency investments.

In addition to fostering innovative market solutions, governments may want to consider tighter standards. By 2020, applying stricter fuel economy rules to the US transport sector (along the lines of those planned in Europe and Japan) would improve the world's fuel economy by four miles a gallon-the equivalent of saving four million barrels of oil a day. Likewise, in China we estimate that introducing world- class insulation standards and energy-efficient heating and cooling packages in new residential construction would save eight QBTUs by 2020, or 6 percent of the global energy productivity opportunity we identified.

Governments also have an important role to play in areas such as power plants and refineries, where new, high-efficiency assets could replace old, less efficient ones, thus raising energy productivity and generating attractive economic returns. Appropriate energy and environmental policies could help provide incentives for the upgrades. In areas such as the manufacture of appliances, evidence suggests that targeted standards encourage economies of scale that could relatively quickly make the price of high- efficiency appliances comparable to that of less efficient equipment under the previous standard. The premium consumers now pay for above-standard efficiency often acts as a disincentive.

Environmental benefits

If the concerted efforts of companies and policy makers can improve the world's energy productivity to the extent we believe possible, the environmental benefits would be significant; this is fortunate because addressing global externalities (such as greenhouse gases) is extremely difficult. Even the price mechanism can have perverse effects. Our research shows that a shift to $70 for a barrel of oil, from $30, makes power generators shift from oil to coal, which is more carbon dioxide-intensive, thus increasing carbon dioxide emissions from the power- generation sector by 8 percent globally.

These dynamics make the possibility of curbing emissions by pursuing positive-return energy productivity opportunities particularly alluring. We estimate that capturing them would contribute up to half of the emission abatement required to cap the long-term concentration of greenhouse gasses in the atmosphere at 450 to 550 parts per million, a range that some experts suggest would meet the goal of preventing average global temperatures from rising by more than 2 degrees Celsius (3.6 degrees Fahrenheit).

Source: McKinsey & Company, 2007

http://www.mckinseyquarterly.com/article_abstract. aspx?ar=2025&l2=3&l3=41&srid=17&gp=0