types of policies chosen can have an impact, officials of DOE's Office of Energy Efficiency and Renewable Energy noted that, in their view, the main point of the October 1997 study is that there are many policies that could be implemented and have a low, if any, net cost.
DOE laboratory officials agreed that the study does not discuss the policies
needed to achieve carbon savings by 2010 but explained that this was not a
study objective or task from DOE. However, the officials also noted that
there is fairly recent historic precedent for the types of behavior by
consumers and industry modeled under the study's most aggressive
scenario. For example, the officials said the growth in the demand for
energy assumed under this scenario (0.13 percent annually through
2010) is more conservative than the actual growth in demand from 1973
through 1986 when the nation's economy grew by about 35 percent while
primary energy demand remained unchanged. Additionally, the American
Council for an Energy-Efficient Economy (ACEEE) indicated that the
study's message is clearer because its focus on technology is
unencumbered by policy discussions.
The study does not address the various broader economic effects on the
nation's economy. The study employed a methodology that, in essence,
involved adding together the estimated net cost or savings to the economy
for the adoption and use of each individual energy-efficient,
carbon-reducing technology, with the savings based on the direct cost of
adopting these technologies compared to the study's estimated energy
savings over the life of these technologies." However, this methodology
focuses on one aspect of the economy-energy-and does not consider
the broader impacts on other non-energy related aspects of the U.S.
economy. Without considering the interrelationships between the changes
that the five-lab study proposes such as imposing a $50 per ton carbon
fee-and other sectors of the economy, the full effects of these changes
are not known. For example, the study does not include any analysis of the
impacts of a $50 per ton carbon fee on energy consumption or economic
activities elsewhere in the U.S. economy, including the impacts of these
fees on energy prices and energy demand, as well as potential employment
impacts. Several of the groups we contacted, such as the Global Climate
Coalition and the International Project for Sustainable Energy Paths,
believe the lack of an economic "feedback effect" in the study's
methodology limits the usefulness of the study's results.
"Direct cost includes the incremental cost of investment in the technologies as well as an allowance for the overall cost of a package of programs and policies required to achieve the carbon emissions reductions.
Disparities in Views
About Key
Assumptions
DOE laboratory officials recognized that the study does not address these
broader economic feedback effects. In their opinion, these impacts would
be minor because only one sector-electricity generation-relies primarily
on the increased price of carbon as an economic stimulus to achieve
significant carbon reductions. The officials noted that the study assumes
that the estimated carbon reductions for two sectors-buildings and
industry-rely primarily on more aggressive policies, and for another
sector-transportation--the estimated carbon reductions rely on
technological breakthroughs. Regarding increased prices for electricity
generation, the officials envisioned that the overall net impact of the most
aggressive scenario on the nation's economy would be small. 12
Additionally, the officials acknowledged that the study does not provide a
quantitative analysis to support their view that the broader effects would
be minor. Officials of DOE'S Office of Energy Efficiency and Renewable
Energy agreed that the full costs to the nation's economy are not
considered in the study but emphasized that neither are the full range of
benefits from energy-efficient technologies, such as the lower cost of state
compliance with Clean Air Act regulations or the decreases in the costs for
oil imports.
The study's calculations of carbon savings depend, in large measure, on the assumptions made about a host of factors in four sectors of the U.S. economy, including assumptions about consumers' purchasing behavior, loan rates, appliance standards, industrial capital constraints, the commercialization of near-term technologies, technological breakthroughs, future costs, and future benefits. Comments from interested and affected parties13 about the reasonableness of selected assumptions illustrated disparities in their views on some key assumptions, including those on discount rates, capital recovery factors, the rate of adoption of new technologies, the timing of technological breakthroughs, and the impact of changing the electricity-generating sector by 2010.
The choice of a discount rate is a key assumption because it can affect whether an investment is viewed as cost-beneficial or not. In the five-lab study, the discount rate is used to value the stream of future benefits, such as estimated energy savings, accruing throughout the lifetime of an
"According to these officials, the impact of the most aggressive scenario would be less than
0.2 percent for the nation's approximately $10 trillion gross domestic product by 2010.
investment. Once these accumulated benefits have been calculated, they are used to determine the cost-effectiveness of a technology (energy savings less added investment cost). The study assumes that only cost-effective technologies will be adopted to achieve the level of carbon reductions estimated for each scenario. Assuming a higher discount rate will, among other things, cause fewer technologies to be viewed as cost-beneficial, whereas a lower discount rate means that more long-term investments with higher initial costs will be viewed as cost-beneficial. The study evaluates costs and benefits from two perspectives. The first, or more optimistic, case uses real discount rates of 7 percent for buildings, 10 percent for transportation, and 12.5 percent for industry. The second case uses higher discount rates-15 percent for buildings and 20 percent for transportation and industry, thus reducing the value of energy savings. According to DOE laboratory officials, the technologies included in the study are cost-effective even with the higher discount rates, and these rates are higher than those recommended by the Office of Management and Budget (OMB) for evaluating the costs and benefits of public policies.
The study's assumed discount rates for the transportation sector were not a significant issue among the groups we contacted; however, some groups were skeptical of the assumption of a 7-percent real discount rate for the building sector. For example, the Association of Home Appliance Manufacturers told us that the consumer discount rate for most replacement appliances, such as refrigerators, clothes washers, clothes dryers, and dishwashers, ranges from 12 to 15 percent. Similarly, officials from the Energy Information Administration (EIA)15 noted that consumers often charge such items on credit cards where the discount rate would range from about 12 to 16 percent, or more. Representatives of the Global Climate Coalition, National Association of Home Builders, and others also found the study's assumption of a 7 percent discount rate for the building sector too optimistic. Some noted, however, that the 7 percent would be reasonable for appliances included in new home purchases. EIA officials and others also noted that some replacement appliances-such as hot water heaters-are often purchased without regard to energy efficiency or cost-effectiveness. The officials explained that, although water heaters are a significant energy item in most homes, when water heaters fail, consumers rarely calculate a life cycle cost analysis, choosing instead to take what the plumber or local appliance store has most readily available.
"Real discount rates have been adjusted for inflation.
EIA is an independent statistical and analytical agency that is required to prepare an annual report containing trends and projections in energy consumption and supply.
Representatives of other groups considered the 7-percent rate for the
building sector reasonable and pointed out that rebates and low-interest
financing, such as past utility-administered energy-efficiency programs,
could lower the effective discount rate on building sector purchases to
7 percent. DOE laboratory officials explained that the 7-percent rate for the
building sector would be consistent with a scenario in which the nation
embarked on a path to reduce carbon emissions that included aggressive
federal policies and programs. Additionally, the officials noted that the
higher discount rates that some groups were more comfortable with are
still within the range of discount rates that the study's most aggressive
scenario concludes are still cost-effective.
Capital Recovery Factors for the Industrial Sector
A key assumption for the industrial sector involves the length of time
expected for a capital investment to recover its costs-known as the
payback period. The study assumes that, for investment planning
purposes, industry can be persuaded to change the length of time
expected for a capital investment to recover its costs for energy-efficiency
investments from about 3 years to nearly 7 years. 16 Under this scenario,
the study assumes industry would install new energy-efficient technologies
on twice as many operations as they would normally.
Most of the representatives of seven industries that used about 80 percent
of the manufacturing energy consumed in the United States in 1994
indicated that the capital recovery factor assumed for the industrial sector
may not realistically consider the capital constraints, market conditions,
and existing manufacturing processes these industries operate under
today. For example, in a November 1997 letter to the Secretary of Energy,
the Chemical Manufacturers Association noted that the study's assumption
that the industry could double the rate of capital stock turnover is
"impossible or at a minimum, highly improbable." Representatives of the
American Petroleum Institute explained that, in a business investment,
(1) there is nothing special about energy-efficiency investments; (2) such
investments have to compete directly with other investments for limited
capital assets; and (3) the longer the payback period, the greater the risk
and the uncertainty associated with an investment. Most of the
representatives of the seven industries indicated that they would not be
able to accept more than a 4-year payback; several said 3 years or less
would remain their industry's normal payback period. Generally, the
According to the study, the historical capital recovery factor (or payback period) for
energy-efficiency investments by industry is about 33 percent (a 3-year payback); the study assumes
that industry will change its capital recovery factor for energy-efficiency investments to 15 percent
(nearly a 7-year payback).
Technology Adoption Rate for the Building Sector
representatives said that a 7-year payback is not realistic because of the higher risks and uncertainties associated with longer investments, the competing demands within their firms for investment capital, and their increasingly global competition.
On the other hand, the Director of ACEEE believed that industry could
achieve this goal with little difficulty, and pointed out that this is
consistent with the Council's 1997 report," which noted that industry
often does not fully account for all the savings (both energy and
nonenergy) in its financial analyses of such projects. DOE laboratory
officials also believed that, given an aggressive package of federal policies
promoting low-carbon technologies, along with federal research and
development funds, industries would begin to look at such investments
more favorably. They noted that for some larger investments-known as
strategic investments-industry has been willing in the past to look at
payback over a longer period of time. This is consistent, they noted, with a
1986 study18 which found that the capital budgeting practices of 12 large
manufacturers varied based on the size of the project, with large projects
having capital recovery rates ranging from 15 to 25 percent (paybacks
ranging from about 7 to 4 years, respectively), and small- and
medium-sized projects having capital recovery rates ranging from 35 to
60 percent (paybacks ranging from about 3 to less than 2 years,
respectively). 19 Many energy-efficiency projects in the industrial sector
would be viewed as large projects.
One of the study's key assumptions involves the choice of "penetration
rates," or the rates of adoption and use of energy-efficient technologies
within a certain time frame. For the building sector, the study assumes a
65-percent penetration rate for its most aggressive scenario. This means
that 65 percent of the energy savings achievable from maximum
cost-effective energy-efficiency improvements are realized in residential
and commercial buildings constructed or renovated from 2000 to 2010 and
in the equipment subject to replacement during this time period.
"Energy Innovations: A Prosperous Path to a Clean Environment, Alliance to Save Energy, ACEEE, Natural Resources Defense Council, Tellus Institute, and Union of Concerned Scientists (June 1997). Capital Budgeting Practices of Twelve Large Manufacturers, M. Ross (Winter 1966).
According to DOE, under the most aggressive scenario, investments in energy-efficient technologies would be on the lower end of the range (15 percent for large projects and 35 percent for small- and medium-sized projects).
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