Americans should be warming to energy efficiency

By Diana Farrell and Ted Halstead

In a comment for the Financial Times, Diana Farrell, director, McKinsey Global Institute, and Ted Halstead, president and CEO, New America Foundation, make the case that a concerted effort to boost energy productivity–or the level of output achieved from the energy consumed–could have spectacular results.

Between record petrol prices at home, growing geopolitical instability abroad and mounting concern over climate change, the case for fundamental energy reform has never been stronger. Yet the US energy debate remains disproportionately focused on the supply side: how to secure future supplies and finance alternative sources. Too often ignored is the other - and far more cost-effective - alternative: how Americans can use the energy they consume more efficiently.

New research by the McKinsey Global Institute finds that a concerted effort to boost energy productivity—or the level of output achieved from the energy consumed—could have spectacular results. If policymakers embrace a new drive to improve energy productivity, relying on existing technologies, the US could reduce energy demand growth by the equivalent of 11m barrels of oil per day and greenhouse gas emissions by 1.3bn tonnes a year. This would cap energy demand growth and emissions at today's levels, while strengthening the economy.

Substantial opportunities for energy productivity gains are available in virtually all sectors. The biggest potential, however, lies in the US residential sector, the single largest energy consumer in the world. If readily available technologies to boost productivity are adopted - for instance by using high-efficiency building shells, compact fluorescent lighting and high-efficiency water heating - the sector's energy demand growth could be cut by one-third by 2020. All this would save families money too.

A typical household can replace incandescent bulbs with compact fluorescent lighting fixtures and get a payback in less than a year. It can also replace low-efficiency water heaters with demand-instantaneous or solar water heaters, which would save up to 65 per cent of the energy used in water heating and have a return on investment of some 11 per cent annually. Installing a state-of-the-art heat pump saves 25 per cent on the average annual heating and cooling bill for an extra cost of less than $1,000.

Why have consumers and businesses not seized these opportunities? The answer lies in a range of energy market imperfections that discourage them from seeking energy efficient products or making energy saving investments. Consumers often lack the information and capital to become more energy productive. Businesses, too, tend mistakenly to regard investments in energy efficiency as both costly and risky.

What can the US do about this reluctance? One promising idea is to make energy efficiency tradeable, much in the same way as we trade oil and natural gas, or, indeed, carbon emissions. A system making energy efficiency tradeable in the US - companies would be able to sell credits when they exceeded new standards - would quickly reduce total energy consumption while limiting carbon emissions. Adding a market mechanism to trade efficiency gains would make energy efficiency standards more palatable to industries that have resisted them in the past.

The US should also establish tough energy standards for its biggest energy users. For instance, each 5 milesper gallon increase in corporate average fuel economy standards would reduce US oil demand by 2m barrels per day by 2020. In homes, the standby power consumption of televisions can use up to 60 watts and account for up to 10 per cent of residential power consumption. Yet the technology is already available to reduce standby power to 1 watt. These are just a few of the cases ripe for a mandatory efficiency standard.

US elected officials are taking some cautious steps in this direction. In May, the Senate committee on commerce, science and transportation passed a bipartisan bill to raise the fuel-economy standard for passenger vehicles to an average 35 miles per gallon by 2020, from 25 miles today. At the state level, reforms have been more aggressive.

The US needs a fundamental change in how it approaches energy policy - instead of simply trying to ensure supply, it must reduce demand by spurring a revolution in energy productivity. Without a course correction of this type, it will remain the world's most voracious user of energy and producer of CO2 emissions per capita and continue to subject itself to worldwide criticism as a result. Worse still, it will be wasting its money on increasingly expensive energy that it does not need.

Diana Farrell is the director of the McKinsey Global Institute, McKinsey & Company's economics research arm. Ted Halstead is president and chief executive of the New America Foundation.

This article originally ran in Financial Times.

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