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The US stimulus program: Investing in energy efficiency

There may be tensions among the current administration’s goals, but nearly $100 billion in new spending on energy-related projects will have a huge impact.

July 2009 | byScott Jacobs and Rob McNish

This essay is part of a package of articles that examines the US stimulus broadly and explores its impact on three sectors in particular: health care, energy, and broadband.

President Obama has made no secret of his ambition to transform the energy base of the United States. The administration’s seriousness in pursuing its goals—boosting energy and economic security while mitigating the threat of global warming—became clear with the unveiling of the American Recovery and Reinvestment Act. The ARRA appropriates $97 billion in energy-related funding (exhibit) and aims to mobilize roughly $100 billion more in private capital.

Exhibit

Energy-related stimulus spending

The American Recovery and Reinvestment Act (ARRA) appropriates $97 billion in clean energy and energy-related funding.

The unprecedented speed and scale of the government’s commitment to technologies that use or generate energy efficiently, with minimal impact on the environment, will dislocate strategies and disrupt market shares in the energy sector for years to come. With the government assuming the role of primary banker and customer in many energy markets, executives must decide whether to rethink, and in some cases completely redraw, their capital and marketing plans.

As industry executives wrestle with these decisions, the government itself must come to terms with a series of competing objectives embedded in the stimulus. The ARRA, for example, has a bias toward job creation and “shovel readiness,” which could favor established over nascent renewable-energy players, potentially compromising the long-term goal of transforming the US energy base. The act also relies heavily on public–private coinvestment, which may be difficult to pull off given the growing concern among business leaders about entanglement with the public sector, not to mention the current state of credit markets. Finally, the ARRA emphasizes energy efficiency, a goal to be met primarily through the efforts of state and local governments that aren’t fully prepared to deploy the proposed funds.

Plugging a gap

For the US renewable-energy sector, the stimulus comes at an opportune moment: the financial crisis dried up credit for projects, and lower energy demand and declining power prices have made many alternative-energy investments less attractive economically. Falling corporate profitability throughout the economy has had the same effect on tax-advantaged investments in renewable energy.

The stimulus should help plug the investment gap, though it remains to be seen if the Department of Energy (DOE) and other federal agencies can meet the ARRA’s job creation goals by spending most of the $97 billion over the next 18 months. That pace would require a dramatic acceleration of the federal government’s traditional operating practices: the DOE, for example, took nearly four years to issue its first renewable-energy loan guarantee, earlier this year. Getting the money out rapidly and to the best projects will be hard. The technical complexity, siting challenges, and permit requirements of major projects are compounded by the realities of interlocking decision-making and process-approval layers in federal, state, and local governments.

Big bets, big tensions

The stimulus places major strategic bets: for example, it steers significant funds toward renewable energy and the electrification of the passenger vehicle fleet. Such bets have the potential for unintended consequences. The heavy emphasis on solar and wind, for example, comes at the expense not only of coal-fired generation but also of more novel renewables, as well as of natural gas–fired generation, which emits about half the carbon dioxide that coal does. Similarly, heavy investments to create a domestic battery industry from scratch mean less funding for alternative technologies, such as hydrogen fuel cells and biofuel-based power trains.

Whether the stimulus places the right bets or meets its stated goals, there’s no doubt that the impact on energy-investment patterns and markets will be significant. Three big numbers help paint a picture of the forces the ARRA will unleash and of the tensions inherent in it: 300,000 (the number of jobs the administration hopes it will create), $100 billion (the level of private-sector coinvestment the administration hopes to unleash), and 20 (the amount by which spending on many forms of energy efficiency will multiply).

Jobs

The administration’s primary goal is to create or retain jobs—roughly 300,000, according to President Obama—through the energy-related elements of the stimulus package. Achieving this level of job creation and retention will be challenging, and even if the goal is met it will be difficult to know the full role the ARRA played or the degree to which it may have displaced private-sector initiatives. Moreover, it isn’t clear that the jobs will be sustainable without continued government support beyond the stimulus.

Leaving those issues aside, the bias to near-term job creation means that more mature technologies will probably receive the majority of funds. Many projects that developers and investors approved before the financial crisis began will be natural early recipients, dampening the ability of the stimulus to accelerate the learning curves that new technologies must progress down as they mature. Indeed, more established players and proven technologies may increase their competitive lead over smaller players with developing ones.

Such tensions are particularly evident in the solar subsector: larger companies will find it easier to tap into renewable-energy loan guarantees because these players can make a more credible case that they will add manufacturing capacity and create jobs. They also are more likely than smaller players to get private-sector banks to participate alongside the government. Furthermore, the investment tax credits in the stimulus can be used as grants for people who buy solar products—by definition, from companies with existing inventories and manufacturing capacity.

The government appears to recognize this potential “maturity bias,” as the stimulus also contains substantial increases in funding for research and development. There’s $400 million, for example, to finance a new Advanced Research Projects Agency-Energy (ARPA-E) modeled after the Defense Advanced Research Projects Agency (DARPA), which helped create the Internet, among many other innovations. Nearly $800 million will be used to create energy-frontier research centers. Still, the general orientation toward short-term job creation is strong, and countervailing forces probably won’t fully overcome the maturity bias.

One likely implication is an uptick in partnerships among players both big and small. Teaming up with other companies can help all of them enhance their contracting positions with the government and meet the insistence of federal agencies on rapid, integrated solutions. Alliances also can improve access to capital for smaller players, while boosting the odds that their new technologies will capture the attention of established government contractors.

Private-sector coinvestment

Nearly all of the federal funding initiatives require coinvestment by the private sector. The $6 billion Innovative Technology Loan Guarantee Program, for example, aims to support $60 billion in loans from private-sector banks for renewable-energy projects. Separately, recipients of grants for smart grids and the manufacture of batteries must finance, from their own coffers, an amount equal to what they receive from the government.

That approach encourages responsible project proposals and the sharing of risk with the private sector but may slow or perhaps limit the deployment of federal funds. For starters, developers may struggle to secure private-sector financing in currently weak credit markets. Furthermore, it’s not clear to what extent energy sector participants and investors will be willing to play ball with the administration. Companies incur transaction costs securing government money, and it remains to be seen how many of them will risk significant amounts of their own—often, in the millions of dollars—to craft solid proposals and have officials review their applications.

In addition, energy players have long struggled with the inconsistency and uncertainty of US policy, exemplified by the annual renewal of production tax credits for renewables (specifically, wind power) and policy flip-flops on nuclear power. Anxiety about the potential ramifications of coinvesting or otherwise partnering with the government compounds the problem; energy players are watching with interest the fate of automotive and financial-services companies as their ties with the government deepen.

Despite the administration’s clear policy direction, no short-term stimulus, nor even the longer-term energy policy bills now under development, will completely resolve the suspicions of private-sector investors. Yet competitive pressures could serve as an important motivator: the prospect that companies may secure government support could inspire their rivals to seek it as well. Because many executives feel they’ve been through similar situations in the past, large, mature companies who do not need the government’s money may prove to be the most reluctant of all to deepen ties with the federal government; this potential adverse selection bias adds another twist to the tension between the administration’s goals in near-term job creation and the longer-term acceleration of technology.

Additional energy-efficiency spending

About one-third of the $97 billion in energy-related funds will be allocated to energy-efficiency investments. The administration hopes they will help overcome key market imperfections—such as information gaps and misaligned incentives—that now discourage businesses, consumers, and the public sector from undertaking many net-present-value-positive efficiency investments.1 Big-ticket items include $4.5 billion for retrofits of federal buildings (20 times 2008 spending) and $5 billion for the DOE’s weatherization program (another 20-fold increase over last year).

An obvious challenge: to deploy much of the efficiency funding, the DOE will rely on state and local administrative bodies that aren’t fully prepared for such large budget increases. Another issue is whether and when companies in the energy-efficiency supply chain can ramp up to meet spikes in demand for building materials and devices and for the skilled workers needed to use them in projects. A related question is whether the near-term spending surge will generate sustained investments or instead end up as a one-time jolt.

Policy makers and the public at large should be realistic about the ability of any short-term spending program, no matter how well conceived, to transform a large, complex sector in a fundamental way. Yet executives in the energy sector shouldn’t underestimate the impact that $97 billion, quickly deployed, will have on its future shape. Despite the tensions inherent in the stimulus package, technology learning curves will probably accelerate, innovative new players should gain a measure of strength, and successful programs sustained by future government support are likely to emerge. And of course, the stimulus may be only the first step. Additional energy and climate bills, along with the 2010 budget, could go further in recasting the sector’s economics.

The task before companies now is to develop careful, coherent plans for dealing with the government as a new shaping force in the energy sector. Two obvious steps are establishing or enhancing regulatory affairs efforts and hiring new salespeople in key places around the country. And while large international energy companies and regulated utilities are used to having governments play a significant role, it represents a novelty for many technology firms and emerging players. Their executives must decide where to put the federal, state, and local governments in their customer account lists and learn how to compete for and do business with these very different new customers.

About the authors

Scott Jacobs is a consultant in McKinsey’s San Francisco office, and Rob McNish is a director in the Washington, DC, office.

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