By: Matt Golden, Senior Energy Finance Consultant

A few days ago, economists from the University of Chicago and the University of California, Berkeley released a study that called into question the cost-effectiveness of energy efficiency. The study was based on the team’s analysis of energy savings shortfalls in the Michigan low income Weatherization Assistance Program. Since then, a host of articles have used the study’s results to call into question the value of utility-sponsored energy efficiency programs.

While this study did raise some thought-provoking points, it also contained biased assumptions and reached conclusions that far exceed its scope, lumping together market-based efficiency with low-income weatherization programs.

The report paints what can only be considered a worst case scenario. For example, it counts the costs of delivering health and safety upgrades without measuring the benefits, it assumes energy prices will never rise, and it extrapolates lessons from a publicly-funded social benefits program (designed to serve hard-to-reach citizens) to all sectors of the energy efficiency market. The Natural Resources Defense Council (NRDC) and the Illinois Institute of Technology have published good posts that explore in great detail some of the flaws in the assumptions and conclusions reached in the report.

However, this study also points to some very real and critical challenges, namely that: 1) existing models for estimating efficiency over-predict savings; 2) public programs are an expensive way to deliver services; and 3) public investments in efficiency can be valued in a number of ways producing widely varying results. The authors also correctly assert that we need to be serious about how we invest in carbon abatement, as the problem is so large we can’t afford to waste resources. Let’s unpack their conclusions.

Do energy models over-predict?

It’s fairly well known and understood that current modeling approaches over-predict baseline energy usage, and therefore the savings that result from efficiency upgrades. This is not the first study to show there is a bias toward over-prediction, especially in un-calibrated energy models. This article examines many of the core reasons why this bias exists and there are many efforts underway to correct the problem.

A better approach is to use actual energy data, not just engineering models. One recent study in New York State by Performance System Development shows that calibrating predictions to past bills dramatically improves results. California is taking a different approach with the CalTRACK system, which uses electricity meter data to track actual savings and adjust predictions to match actual performance – all while creating transparency in the marketplace.

Does efficiency have a good payback?

Measuring the cost effectiveness of an energy retrofit simply by dividing the total cost of an improvement by the savings is an oversimplified approach. Considering the host of non-energy benefits in residential retrofitting such as comfort, residential energy efficiency is put at an unfair disadvantage when we compare the full cost of a project against just the energy savings (more on this here). These issues are particularly pronounced for publicly-funded weatherization programs for low-income residents.

Furthermore, comparing public costs associated with low-income weatherization to market-based energy efficiency is inappropriate. Low-income weatherization is much more expensive than market-rate efficiency programs due to a host of factors, some of which were covered in the report. But in summary, compared to low-income programs, the cost of energy efficiency is much lower in market-rate sectors and public dollars are a much smaller percentage of the total investment.

Is efficiency a cost-effective way to mitigate carbon?

Numerous studies have calculated that the public investment in energy efficiency is more cost-effective than procuring new power sources. Even if real costs are higher than previously thought, efficiency provides a critical and immediate opportunity for large-scale emissions reductions that are cost-effective compared to other options.

The important question here is not whether public investment in efficiency is a good value, but rather, how do we maximize our efficiency returns? The energy efficiency industry is ripe with innovative business models, new types of financing, and advanced building technologies driven by a combination of access to data, engaged capital markets, and the existing and impending regulation of carbon emissions in power production. Valuing efficiency savings based on actual results will also complement a carbon price.

The takeaway should not be to give up on efficiency but to aggressively encourage innovation and experimentation that can overcome the barriers to this critical carbon-free resource.

Let’s toss the bathwater and leave the baby

Rather than pay for efficiency through engineering models and upfront rebates, we are now able to track actual energy savings at the electricity meter and pay for actual performance as it is delivered — like every other commodity and energy source. The conclusion that energy efficiency should not be a meaningful part of our country’s climate and energy solution is premature at best.

We must move away from basing efficiency investments on engineering models that incorrectly forecast energy savings, and toward investments in calculated efficiency gains based on the meter. Rather than rely on top-down programs that pay rebate coupons upfront, we should establish markets that price savings based on levelized avoided cost of new generation and pay for results as they occur, just like purchasing capacity (generated electricity from coal, natural gas, or renewable sources like solar).

By leveraging smart meter data, available tools such as the Open EE Meter, which calculates and tracks energy savings based on open standards and code, and systems such as the EDF Investor Confidence Project, which standardizes and certifies energy efficiency projects ready for investment, we can establish markets for energy savings that treat efficiency like a capacity resource. When systems are in place to standardize how reductions in energy use are measured, they can earn a real market value and help avoid building new power plants. These systems will also give investors confidence that energy efficiency projects are reliable, savings are predictable, and risk is manageable.

Power generators finance their investments based on future cash flows from selling energy, also known as project finance. If energy efficiency is going to play its part in the new utility paradigm, it’s time we start financing it like an energy infrastructure investment. Project finance for a power plant is based on the long term cash flows from selling power. When we meter energy efficiency and pay for savings as they are delivered, we turn energy efficiency into a cash flow, which can then be financed.

As this new market-based approach takes hold, utilities and program administrators will finally be able to get out of the business of figuring out how to deliver energy efficiency services through programs, and instead focus on procuring demand-side resources in much the same way they already procure capacity. In a recent California Public Utilities Commission filing, PG&E (one of California’s largest utilities) supported a pilot recommended by NRDC to test just such an approach, saying that it “has the potential to facilitate comprehensive upgrades while simultaneously minimizing implementation costs through leveraging private capital.”

With the private market taking on the risk of upfront investment in energy efficiency programs, regulators will be able to focus on protecting people and businesses through a well-regulated market structure that sends the right price signals, and leaves the business model of energy efficiency up to the private sector.

Building owners will benefit from a competitive industry incentivized to develop innovative business models and products, and the private sector will be able to invest in this critical market with the clarity of a price signal aligned with public policy goals, their bottom line, and customer demand.

Before we judge efficiency, we need to measure and value it. Doing so will allow us to treat efficiency like every other energy resource and enable market forces and competition to determine the winning solutions.

Photo source: PG&E