The Energy Efficiency Debate

vs.

The Economics of Energy and Climate Change

Spring 2009

Professor William Nordhaus

Student Adrian Horotan

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Table of Contents
1. About This Paper ............................................................................................................................... 3
2. Background........................................................................................................................................ 3
3. Rates of Return and Market Barriers .................................................................................................. 5
3.1 Rates of Return............................................................................................................................. 5
3.2 Market Barriers ............................................................................................................................. 8
3.2.1 Misplaced Incentives .............................................................................................................10
3.2.2 Financing ..............................................................................................................................10
3.2.3 Market Structure....................................................................................................................11
3.2.4 Gold Plating...........................................................................................................................11
3.2.5 Consumer Heterogeneity.......................................................................................................11
3.2.6 Diffusion Rates......................................................................................................................11
3.2.7 High Discount Rates are a Normal Reflection of Risk............................................................12
3.2.8 Hidden Costs.........................................................................................................................13
3.2.9 Externalities...........................................................................................................................13
3.2.10 Imperfect Competition .........................................................................................................14
3.2.11 Public Goods.......................................................................................................................14
3.2.12 Imperfect Information / Information Costs............................................................................14
3.2.13 Market Barriers Summary....................................................................................................15
4. Illustration of Energy Efficiency Pain Points.......................................................................................15
5. Private Sector Innovation ..................................................................................................................17
6. Conclusions.......................................................................................................................................18
Tables and Charts.................................................................................................................................19
References............................................................................................................................................22

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1. About This Paper

This class paper is prepared for The Economics of Energy and Climate Change at Yale University in

Spring 2009. The paper examines the debate between two scientific communities around the existence

of what came to be known as “the efficiency gap” and about how to address it. The objective of the

paper is to understand the state of the debate and form an opinion whether there are private sector

opportunities in energy efficiency financing.

The paper is structured as follows. Section 2 provides an introduction to the energy efficiency gap

debate. Section 3 then reviews the energy efficiency gap debate in more detail focusing on the rates of

return and market barriers arguments. Section 4 grounds the discussion by providing an illustrative

example for a hypothetical decision process by a residential customer looking to invest in energy

efficiency. Section 5 provides some high level thoughts on how private sector innovation could help

energy efficiency investment become reality and Sections 6 some conclusions.

2. Background

Figure 1 (Enkvist et al, 2007) represents estimates of annual abatement costs in EUR per ton of

avoided emissions of greenhouse gases (the y axis) as well as the abatement potential in giga tons of

greenhouse gases for each of the approaches (the x axis). This cost curve came to be widely known

and quoted outside academic circles as the “McKinsey abatement curve”.

The puzzling item for the “fresh eye” on this figure is that it suggests that a significant reduction in CO2

emissions can be obtained at a negative cost through energy efficiency / conservation measures. This

assertion runs counter to intuition, and to what many climate change impact assessment models and

studies have suggested: that “Reducing GHGs, particularly if the reductions are to be deep, will

primarily require taking costly steps to reduce CO2 emissions.” (Nordhaus, 2008).

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Figure 2 (Brown et al, 2008) shows a similar estimate, this time of energy savings potential in TWh (the

x axis) from various residential energy efficiency measures plotted against the cost of such measures in

cents per KWh (the y axis). This curve also somewhat counter intuitively suggests that significant (30

percent) energy savings are achievable in the residential sector at an equivalent cost per KWh that is

significantly below the residential retail electricity price.

Similar cost / supply curves have been drawn since the early 1980’s showing the end use energy

efficiency savings potential. They are usually known as “technological costing” or “engineering”

estimates or “bottom-up” models. There have been hundreds of academic papers published on this

subject since the 1980’s “reflecting a perspective developed at Lawrence Berkeley Laboratory (LBL),

which has been perhaps the leading research institution in the country in the area of energy efficiency in

buildings” (Sutherland, 1992).

What came to be known as the “conservation community” perspective suggests that there are

tremendous and un-tapped opportunities for residential and commercial energy efficiency measures but

there are “market barriers” that prevent them from happening leading to an in-efficient allocation of

economic resources (market failure). The corollary of this view is that, to correct for these market

barriers and promote a diffusion rate for the energy efficiency technologies consistent with economic

efficiency, active state policy measures are required such as building codes, equipment standards, state

/ utility programs, financing programs, government procurement, tax credits, fundamental R&D funding,

adjusting the price for environmental externalities.

This view and the policy corollary have been hotly contested by another group of authors that mainly

identify with the neoclassical economics and finance theory perspective on the issue. The economists

argue that most of the market barriers highlighted by “the engineers” are not market failures but nothing

else than normal and efficient markets functioning under conditions of uncertainty, risk, consumer

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capital allocation choices, transaction and information costs. The economists further argue that the

supply / cost curves and the market barriers highlighted by the engineers are at best mostly irrelevant

for policy design purposes and that some of the policies proposed by the other group, if implemented,

may lead to harmful and in-equitable outcomes (Sutherland, 1991, 1992). The economists however

agree with some of the policies that would correct what they perceive as the “legitimate” market failures

stemming from imperfect competition in the energy markets, environmental externalities, imperfect

information and public goods.

Even if the various authors writing on this issue are not necessarily affiliated with the same institutions

and there are subtle differences that also evolved in time, for ease of expression, in the following

paragraphs, I will use “the engineers” or “conservation community” on one hand and “the economists”

on the other hand to identify the two scientific communities and opposing lines of reasoning involved in

the debate about energy efficiency described above. I will also use energy efficiency and energy

conservation interchangeably.

3. Rates of Return and Market Barriers

3.1 Rates of Return

One of the most frequent tools used by the engineers to argue their point is the very high implicit

discount rates or hurdle return rates that seem to be applied to or required from energy efficiency

investments. These high implicit discount rates are just a different expression of the negative costs

mentioned in the example of the McKinsey curve above. High return rates combined with low

penetration rates for the energy efficient technologies are at the core of the argument the engineers

make for the existence of market barriers.

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In this section I briefly examine the return rates and low market share arguments and how the two

opposing lines of reasoning view them.

The internal rate of return (IRR) for an energy efficiency project is calculated using an estimate of the

initial required investment (technology and installation cost), the useful time of the investment, the

estimated energy savings and energy price over the useful life of the investment.

To illustrate how a typical IRR works in an energy efficiency scenario, Figure 3 provides a “back of the

envelope” calculation example for compact fluorescent light-bulbs (CFL’s) in a residence. I used

estimations from my own house replacing 21, 100 Watts incandescent light bulbs with 23 Watts CFL’s

that run 2.25 hours per day per bulb on average. I assumed a 3 year CFL lifetime, no savings from

longer CFL lifetime, no reduction in light quality, no impact on heating or cooling. CFL’s are a well

known technology with no performance risks. Therefore, I assume the only “transaction costs” are time:

a one hour trip to the supermarket and a one hour installation time without the need of professional

assistance. Without the “transaction costs”, the IRR on this project is 291 percent. To bring the IRR to

12 percent in this case, one would need to value her own time at $267 per hour or an annual gross

salary equivalent of around $900,000. If this case is representative, only a very small fraction of the US

population should have a time opportunity cost so high as to ignore the investment in CFL’s.

Figure 4 shows a summary of several studies showing that the implicit discount rates from energy

efficiency projects (Sanstad et al, 1995) range from 25 percent to 300 percent. Both the engineers and

the economists agree that consumers and companies seem to require return rates upward of 30

percent for their energy investments. They disagree however on the significance of this implicit level for

the hurdle rate of return.

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For the engineers, the high return rates expected from energy efficiency investments together with a low

market penetration of the energy efficiency technologies (compared to their expectations) are an

expression of economic resource misallocation. This leads to the conclusion that market barriers are

primarily responsible for the misallocation.

One of the most thorough studies providing an example in support of this view focused on the magnetic

fluorescent ballasts market (Koomey et al, 1995). In this study, the authors argue that despite efficient

magnetic ballasts representing an excellent investment (between 40 and 200 percent IRR) for more

than 99 percent of the commercial building floor stock they were only being adopted in the 1980s at a

rate commensurate with the enactment of appliance efficiency standards in various states. The authors

argue that they accounted for the omitted costs, the aggregation bias and the inherent time lags which

plagued some of the previous engineering estimates. The authors conclude that “In this particular case,

efficiency standards undeniably improved economic welfare and counteracted the effect of market

imperfections.” (Koomey et al, 1995).

In contrast, using standard economics and finance theory, the economists argue that “…such discount

rates reflect real costs to consumers in competitive markets. A consumer…is rational in requiring a

much higher discount rate on a risky and illiquid energy-efficiency investment” (Sutherland, 1991).

Hassett and Metcalf reach a similar conclusion using an option pricing model that accounts for the sunk

costs and the multiple uncertainties entailed by energy efficiency investments (Hassett and Metcalf

1993). Hassett and Metcalf find that investors should require rates of return from energy efficiency

investments that are four times larger normal rates of return to account for the illiquidity, risks and

uncertainties of the investment.

As stated at the beginning of this section, high return rates expected from energy efficiency investments

together with a low market penetration of the energy efficiency technologies are at the core of the

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argument the engineers make for the existence of market barriers. In the CFL example above I showed

an existing efficient technology with a very high rate of return. To complete the example I take a look at

the CFL market share to see how the two sides of the argument may interpret it.

U.S. Department of Energy “CFL Market Profile” report from March 2009 shows that CFL’s shipments

have grown at a compound annual growth rate of 52 percent over the last three years reaching around

20 percent market share of shipments in 2008. The economists would probably argue that this is a

healthy growth rate, and that CFL technology diffusion is happening at the right pace.

However in the same report outlines that, in 2008, in the residential sector, CFL’s still occupy only

around 11 percent of the available estimated sockets that would fit them. Also, over 1.3 billion

incandescent light bulbs were shipped in 2008. The engineers would probably argue that every

incandescent light bulb purchased means forgoing a 200 to 300 percent return on investment and that

is not an efficient resource allocation.

3.2 Market Barriers

In a much summarized way, the engineers make the following argument. The unusual high return rates

combined with low penetration rates for energy efficiency technologies is a sign of inefficient resource

allocation and suggests there are specific market barriers preventing energy efficiency investments. The

government should intervene with policies to correct for these market barriers.

The existence and significance of market barriers is at the heart of this debate. Kulakowski provides

some background for the term market barrier: “… was invented by energy engineers and is used in the

literature in two ways: first as a catch-all phrase to describe anything which appears to impede adoption

of energy efficiency technologies (including market failures), and second as phenomena distinct from

and in addition to market failures that prevent firms from optimizing energy-efficiency investment. Much

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of the controversy over the severity of the efficiency gap seems to have been caused by disagreement

over what constitutes a market failure versus a market barrier.” (Kulakowski, 1999)

A 1996 paper published by William H. Golove and Joseph H. Eto (Golove and Eto, 1996) provides a

good summary of the efficiency gap debate including the arguments and counterarguments around

market barriers. I will extensively use this paper to provide a summary of the views the two opposing

lines of reasoning have on market barriers.

Based on Golove and Eto, 1996, I distinguish the following differences:

1. Market barriers originally identified by the engineering studies:

a. misplaced incentives or principal–agent issues;

b. lack of access to financing;

c. flaws in market structure; and

d. gold plating.

2. The explanations provided by the economists for the market barriers as being either over-

estimated or misconstrued:

a. the heterogeneity of consumers;

b. the natural diffusion rate of any new technology;

c. high discount rates are just an expression of high risks; and

d. hidden costs.

3. And finally, the market failures the engineers and economists seem to agree upon are:

a. environmental externalities;

b. imperfect competition;

c. public goods; and

d. imperfect information.

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In the following paragraphs of this section I will review the “market barriers”, outlined above one by one

briefly describing them and discussing the arguments used by the two sides of the debate. I will start by

reviewing the market barriers hypothesis originally developed by the conservation community.

3.2.1 Misplaced Incentives

“Misplaced, or split, incentives are transactions or exchanges where the economic benefits of energy

conservation do not accrue to the person who is trying to conserve” (Golove and Eto, 1996). The term is

usually exemplified by landlord – tenant relationships. When the tenant pays the utility bills, the landlord

has little incentive to invest in efficient equipment because the benefits will not accrue to her. In order to

re-arrange the benefits a costly contract re-negotiation would be required so status quo reigns.

The economists have argued that, if the economic savings would really be significant, then such a re-

negotiation would actually occur and that this hypothesis should be developed in terms of transaction

costs and tested (Sutherland, 1992).

3.2.2 Financing

Lack of access to capital (liquidity constraints, in-ability to borrow) inhibits investments in energy

efficiency by certain classes of consumers, especially low income consumers (Golove and Eto, 1996).

This market barrier is also sometimes referred to as “high first cost” or “high upfront investment”.

The economists have argued that financial markets are highly efficient in allocating capital, that they do

not have a systematic bias against energy efficiency investments and that the consumer debt market

(mortgages, cars etc.) is extremely large. (Sutherland, 1992).

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3.2.3 Market Structure

A complex building supply chain with many actors involved in which some manufacturers have

significant market power has led to difficulties in introducing new energy efficiency technologies. Golove

and Eto contend that this point has not been systematically developed in the efficiency gap literature.

3.2.4 Gold Plating

Gold plating means that “energy efficiency is frequently coupled with other costly features and is not

available separately” (Golove and Eto, 1996). An example would be installing more efficient windows in

a residence may have to be combined with structural fixes turning into a major renovation project.

Having reviewed the market barriers hypothesis originally developed by the conservation community I

will now move to the group of concepts used by the economists to critique the market barriers

hypothesis and argue that what is observed in the energy efficiency investments market is normal.

3.2.5 Consumer Heterogeneity

This critique to market barriers suggests that “although a technology may be cost-effective on average

for a class of users in aggregate, the class itself consists of a distribution of consumers” and the

technology may be very cost effective only for a small subclass and not cost effective for the rest. This

has also been referred to as the aggregation bias (Golove and Eto, 1996).

3.2.6 Diffusion Rates

The diffusion rate argument states that many of the efficiency gap arguments assumed that cost and

energy efficient technologies should be adopted instantaneously while technology diffusion is a social

phenomenon that usually follows adoption curves described by a logistic function or “s curve”, with very

slow initial stages followed by a period of fast growth and then market saturation. The economists argue

that it takes time for new technologies to get adopted and low penetration rates are sometimes normal.

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3.2.7 High Discount Rates are a Normal Reflection of Risk

The risk and discount rate critique to market barriers argues that high discount rates for energy

efficiency investments are normal and commensurate with the risk and the specific characteristics of

energy efficiency investments (Sutherland, 1991, 1992, Hassett and Metcalf 1993).

Energy efficiency investments are risky because:

• they are irreversible / illiquid and have negligible residual value;

• they are non diversifiable; and

• they have compounded uncertainties:

- actual equipment performance;

- contractor performance; and

- potential wasteful behavior subsequent to energy efficiency investments.

Standard financial practice used in investment valuation is to expect a reward for taking systemic,

market correlated, non diversifiable risk (known as beta), in the form of a high expected return (high

discount rate) and to diversify away idiosyncratic risk (known as alpha). In practice this translates into

basing the discount rate on the beta part of the risk and adjusting the cash flows downwards for the

alpha part of the risk. For example, for a pharmaceutical company researching a new drug, the discount

rate should reflect the beta risk (some adjusted expected level of covariance with the market for the

pharmaceutical sector) while the projected cash flows should be adjusted to reflect the alpha risk (the

probability that the new drug will or will not be successful).

In the case of energy efficiency investments, there is no secondary market so diversification is not

possible and there is no estimate for the beta. Engineering models usually do not risk-adjust the cash-

flows so all risks will be implicitly lumped all into the discount rate.

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3.2.8 Hidden Costs

The hidden costs critique to market barriers argues that there are many costs not usually included in the

engineering calculations that may have a significant impact on investment decisions. Such costs may

be reduced performance in other dimensions than energy efficiency, time to acquire the information,

training, arrangements, negotiations and supervising.

In response, authors on the conservation side of the debate have shown that there are cases of

products equivalent in every way except for the energy efficiency dimension; and that the hidden costs

do not fully explain the difference in consumer preference (Koomey and Sanstad, 1994).

Having reviewed the original market barriers hypothesis developed by the conservation community

(misplaced incentives, financing, market structure, gold plating) and some of the critiques used by the

economists (heterogeneity, diffusion rate, risk and discount rate, hidden costs) I now move to review

some of the areas both engineers and economists seem to agree may be viewed as market failures.

3.2.9 Externalities

The argument here is that by not reflecting the total social cost including environmental degradation

energy prices are lower than they should be leading to inefficiency. “…environmental degradation where

the costs incurred by one economic unit are shifted to others. Environmental externalities are

particularly applicable to energy markets. The generation of electricity from coal produces acid rain,

greenhouse gases and other environmental costs. ... The consequence of these externalities is that

market prices … do not reflect their true social costs. The divergence between a private and social cost

is a market failure that results in an inefficient level of consumption.” (Sutherland 1991).

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3.2.10 Imperfect Competition

The argument here is that energy regulation introduces price distortions that prevent energy efficiency

investments from happening. “Inefficient pricing due to regulation has long been recognized to

characterize electricity, but it characterizes gas as well…Artificially low gas prices during the summer

months discourage the commercialization and use of gas cooling technologies.” (Sutherland, 1992).

3.2.11 Public Goods

Both economists and efficiency advocates agree that public good market failures affect the energy

services market (Golove and Eto, 1996). Investment in basic research is believed to be subject to this

shortcoming. Information and value created as a result of basic research may not be captured by the

group who produced the research because it is not easily protected by patent or property rights. This

results in a disincentive to produce such information, and is widely believed to result in an

underinvestment in basic research. (Golove and Eto, 1996).

3.2.12 Imperfect Information / Information Costs

If one tries to look at a list of potential energy efficiency investments (such as efficient lighting, air

tightness, shell insulation, windows, power management, efficient heating / cooling, efficient appliances,

smart / instantaneous metering, etc.) as a portfolio of financial investments, in order to construct an

efficient portfolio (with the highest return for a given risk or the lowest risk for a given return), she would

have to assess 1. initial cost, 2. expected return (energy savings), 3. risks (standard deviation from

expected returns) and 4. covariance among the various investments, all customized to her own specific

situation.

In spite of the many efforts to do this to date, I am not aware of any comprehensive source for such

highly customized information about costs, returns, risks and covariance at a cost that is comparable to

the information costs for similar home or automobile investments. Every potential consumer’s baseline

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will be unique. While some equipment and installation costs and efficiency improvement estimates are

available through the admirable efforts of groups like the End Use Project at Lawrence Berkeley

Laboratory, actual performance data is not widely available for most energy efficiency investments.

Figure 5 shows the illustrative costs of a home energy audit being at least one order of magnitude

higher as a percentage of total investment compared with similar information costs for purchasing a car

or a home. The figures are based on anecdotal research in the North East. The cost of information for a

used car ranges from a $20 Carfax report and a $110 mechanic inspection. The costs for a home

inspection are based on a range of prices found on Connecticut authorized home inspectors websites.

The cost of an energy audit is usually same or higher as an inspection but is applied to a lower base.

To conclude on the imperfect information: reliable and customized information about cost, performance

and risk for energy efficiency investments is either not available or costly.

3.2.13 Market Barriers Summary

Energy efficiency investments present a significant opportunity but there are real challenges preventing

them from happening. I will not take a side in the debate whether government policy is the best solution

to address these challenges. In the next section I try to show where private sector innovation may help.

4. Illustration of Energy Efficiency Pain Points

Let’s assume I am a Connecticut resident looking to invest in home insulation and to change my

windows in order to save on energy bills. For simplicity, I will assume that I am looking to invest “out of

the pocket”. I know from a friend that such a job would cost around $8,000. Online research confirms

that this amount is in line with the average loans made by utility efficiency programs (Fuller, 2008).

Further online research uncovers that I can expect around 30 percent efficiency savings from the

investment. I assume energy prices remain the same as today and I also assume that I will save on

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heating oil during the winter months and on electricity during the summer months. My total energy bills

for one year (heating oil and electricity) are $10,700. A quick back of the envelope aggregated savings

calculation for the insulation and windows installation yields $ 2745 per year, or 26 percent of my total

energy bills. Assuming a useful life of 10 years, the IRR on this investment is 32 percent. This looks to

be in line with what I should expect from the literature on energy efficiency. Not bad, especially during a

recession. Figure 6 shows a summary of my calculations.

However, after I do a little bit of thinking I decide to adjust the figures. I find out that an energy audit for

the house would really be helpful and that it will cost $600. Then I realize that I already spent quite a bit

of time on this project and I am likely to continue to spend some more if I go ahead with it. I decide to

include the time spent in the projects costs at 36 hours in total at the per hour equivalent of an annual

gross salary of $ 60,000. Next I ask myself, what if the contractor does a poor job? I don’t know

anything about this and I would not even be able to tell. I decide to include in the model a probability of

20 percent that the contractor will do a poor job and there will not be any savings. Finally I also question

whether the 30 percent savings figure is really accurate. After all I got that from the internet and no one

guarantees it. I decide to include in the model another 20 percent probability that the performance

improvement will be insignificant. The return is now more than half the previous version at 14 percent.

Figure 7 shows a summary of my calculations. If I change the two probabilities to 50 percent my return

moves into negative territory.

Doing some more thinking I realize that leaving the energy prices unchanged in my back of the

envelope calculation was probably not the best idea, but I don’t know how to integrate energy price

volatility into my calculation. I hear energy is a global commodity and that prices go up and down as

they have done several times in the past. I realize that, by doing this energy efficiency investment, I am

basically taking a bet on energy prices going up.

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I decide to wait on my energy efficiency project until I get a better picture of the prices, or of the savings.

I also decide to change the thermostat settings, ask my family to be more conscious about saving

energy, and install CFL’s wherever I still have incandescent light bulbs.

This of course was a highly un-scientific but somewhat realistic exercise intended to illustrate how

uncertainties and transaction costs can compound very fast to the point where they can be discouraging

even for the bravest energy efficiency investor.

5. Private Sector Innovation

Private sector technological and business model innovation can, and probably will, play a big role in

making energy efficiency investments a significant reality through reducing transaction costs and

uncertainties. Below are a few examples of potential capabilities a successful energy efficiency

company would build:

• Metering, monitoring, instantaneous consumer feedback, power management delivered using

advanced information technology and sensor technology.

• Cheap and accurate virtual energy audit and prioritization of energy efficiency measures delivered

using assessment tools that combine utility bill history with home physics modeling and appliance

inventory (the latter potentially done by the home owner).

• Capability to identify the consumers with the most significant savings potential.

• Capability to monitor savings and share them with consumers using a progressive split schedule.

• Ability to aggregate the savings to participate in the spot and forward electricity market.

• Ability to understand cost, returns, risk and correlations of different efficiency measures across

many projects in a climactic region. Treating energy efficiency projects as a pool of investments

would help manage risks (equipment performance, contractor performance etc.), design business

models that take the risk away from the consumer and price right.

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A significant issue that may need to be dealt with by policy is the role utilities will have to play in energy

efficiency investments. Utilities hold the key to the consumer. Unfortunately any reduction in energy

sales is equivalent with a reduction in revenues and therefore against their interest. Policies that

decouple electricity sales from utility profits and offer utilities profit incentives for efficiency investments

have been tried successfully in California and should be extended nationwide (Koomey, 2008).

6. Conclusions

The intense debate around the existence of an energy efficiency gap caused by market barriers that

have similar effects to market failures has been going for almost 30 years. The debate is far from

reaching a final verdict and the two sides have enriched and deepened the argument in the process.

There are many areas of further potential research. One very helpful direction would be developing a

deep understanding of the performance, cost, risks and covariance associated with the various types of

energy efficiency investments.

The Obama administration seems to believe in the energy efficiency argument as a significant portion of

the American Reinvestment and Recovery Act of 2009 money is slated against objectives associated

with energy efficiency ($6.3 billion for Energy Efficiency and Conservation Grants for states, $5 billion

for the Weatherization Assistance Program, $4.5 billion to make Federal Buildings more energy

efficient, $4.5 billion for R&D for the Smart Grid Investment Program).

If energy efficiency is to have a material future in residences and small businesses across the nation,

the private sector needs to step up to this opportunity and develop the innovative technologies and

business models that will address the very real transaction costs and uncertainty challenges.

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Tables and Charts
Figure 1 The McKinsey Abatement Curve

Source: Enkvist et al, 2007

Figure 2 Residential Electricity Efficiency Supply Curve

Source Brown et al, 2008

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Figure 3 The CFL Investment Case

CFL Investment Case Month0 Month1 Year1 Year2 Year3

Investment ($) 88
Baseline Consumption (KWh) 144 1,723 1,723 1,723
Post Investment Consumption (KWh) 33 396 396 396
Savings (KWh) 111 1,327 1,327 1,327
Retail Energy Price (cents / KWh) 19.5 19.5 19.5 19.5
Savings ($) 22 259 259 259
IRR 291%
Payback (30% Discount rate) 5 months
Levelized c / KWh equivalend cost (30% Discount rate) 3.6
Assumptions
- Baseline based on 21 100W incandescent light bulbs running 2.25 hours / day / bulb on average.
- Efficient scenario based on replacing all incandescent bulbs with 23W Sylvania CFL at $ 4.16 / bulb.
- CFL's assumed 3 year lifetime, savings from longer CFL lifetime not included.
- No change in light quality, no impact on heating or cooling.

Figure 4 Implicit Discount Rates for Energy Efficiency Investments

Source Sanstad et al, 1995

Figure 5 Illustrative Cost of Energy Audit

Typical Investment Average Investment ($) Cost of Finding

Low High Low % High %
Buying a Used Car 12,000 20 110 0.17% 0.92%
Buying a Home 100,000 200 600 0.20% 0.60%
Energy Efficiency Investment 5,000 100 600 2.00% 12.00%

Figure 6 Home Insulation Project Return

Insulation Project Return 0 1 2 3 4 5 6 7 8 9 10

Investment ($) 8,000
Savings ($) 2,745 2,745 2,745 2,745 2,745 2,745 2,745 2,745 2,745 2,745
Cash flow ($) (8,000) 2,745 2,745 2,745 2,745 2,745 2,745 2,745 2,745 2,745 2,745
IRR (%) 32%

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Figure 7 Home Insulation Project Return - Adjusted

Adjustments
Energy Audit Costs 600
Other Costs 654
Bad Contractor Probability 20%
Bad Performance Probability 20%
Total Risk 36%

Insulation Project Return - Adjusted 0 1 2 3 4 5 6 7 8 9 10

Investment ($) 9,254
Savings ($) 1,757 1,757 1,757 1,757 1,757 1,757 1,757 1,757 1,757 1,757
Cash flow ($) (9,254) 1,757 1,757 1,757 1,757 1,757 1,757 1,757 1,757 1,757 1,757
IRR 14%

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References

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