Closing The Conservation Gap In Electric Power

Today, as U.S. electric power demand grows and environmental and energy security issues become more urgent, there is a growing concern that the current balance encourages the construction of new power plants rather than investment in the conservation of electric power.

This subject is coming to the fore, in part, because of the capacity challenges that the electric power industry will start facing in the next few years. But at least as important is that conservation is coming to the top of the agenda across the U.S. economy-an emphasis that has not been seen for decades.

That, in turn, forces us to focus on the dynamics of conservation or, as it is also called, energy efficiency. Most industry observers agree that there is indeed a "power conservation investment gap" in the U.S. But the gap does not exist for the reasons most people think.

Misperceptions about the reasons behind the conservation gap lead to a focus on the wrong set of fixes and set unrealistic expectations. To close the gap, we must first address these misperceptions and identify the gap's real causes.

The first misperception is that power conservation potential has hardly been tapped. The reality is quite different-a great deal of power conservation has already occurred. The U.S. has slowly but steadily reduced its electric intensity-the amount of power used per unit of economic output-over the past two decades.

Overall, the weather-normalized electric intensity of the U.S. economy has declined 18 percent since the mid-1980s. And most of these efficiency gains occurred during a period when the real price of power was steadily declining.

The cumulative effect is quite dramatic-if the U.S. consumed electricity with the same intensity it did in 1987, its power system today would need the daily operation of additional power supply equal in size to the combined power systems of Texas and California.

Misperception Number Two is that conservation and efficiency are free-that the benefits to consumers and producers far outweigh the costs-and that cost is not an issue. But conservation is not just a matter of switching off lamps and turning thermostats down in winter and up in summer. Substantial and sustained power conservation involves real effort and requires real up-front investment and ongoing costs.

Misperception Number Three is that power users underinvest in conservation because they are chronically ill-informed about its benefits. Due to this view, the most common public policy solution for conservation underinvestment today is funding consumer education programs.

Yet the concept that households make poor decisions when it comes to conservation simply does not square with observed data on consumer behavior. Over the past several decades, the statistical evidence is quite compelling-power consumers act quite rationally and in an informed manner by consistently responding to real increases in power prices by consuming less. Last year was a good example.

Consumers responded to some of the biggest price increases they have seen in quite some time by reducing their consumption of electricity. As a result, power demand stayed flat, even though inflation-adjusted economic growth exceeded 3 percent on the year.

Misperception Number Four is that power engineers are just genetically conditioned toward building big and advanced power plants rather than pursuing small and beautiful conservation options. This idea stems from the perception that if cost-effective conservation potential exists, then power producers should naturally invest in conservation rather than production.

Yet when power producers actually do invest in conservation, they find it hard to pay for the investment because the benefits naturally flow to the consumers who end up using less power.

So even if regulators do allow producers to treat these investments the same way they treat production investments-allowing these costs onto the balance
sheet as the basis for approved cost recovery-the effect is that higher costs must be recovered from a smaller base of sales. In order to break even, the producer needs a price increase. And that is something customers and politicians typically resist. And this represents the current best case for producers.

Most states do not provide such cost recovery, and no state in the U.S. has put together a regulatory and incentive package that encourages power producers to seek the proper balance of conservation and production investments.

Although the conventional wisdom concerning power conservation underinvestment may not be accurate and current policy is lacking, there are nevertheless real reasons to expect a conservation gap. Power deregulation has created bigger and more liquid wholesale power markets that express the cost of power at any point in time. One lesson from the emergence of power markets is clear: the cost of electricity varies considerably through time and is often well above the price that most customers face.

This is especially true during peak periods of power demand when the cost of electric production (and conversely the value of conservation) is many times higher than the prices customers are being charged. This is intentional-consumers, regulators and politicians want stable and predictable power prices that do not reflect the cost of power during its most expensive times.

It is not surprising that these stakeholders work together to fetter wholesale prices with price caps and disconnect retail power prices from costs with a variety of mechanisms in order to make them less volatile and more predictable. The net result is that the prices customers see are often lower than the costs of the power they are consuming.

Customers invest in conservation based on the retail prices they face. Yet, it is the more volatile cost of power that determines how much conservation is truly cost effective. When confronted with typical retail prices instead of the costs of power, consumers quite sensibly invest in some but not all of the cost effective conservation. The unintended consequence of this well-intended retail price regime is the continuing underinvestment in power conservation from the consumer side.

From this perspective, the root cause of the power conservation investment gap is not an uneducated consumer but rather an informed consumer rationally responding to the prices they face.

The implication is clear: there is a very real electric power conservation gap, and it is on the consumer side of the power sector. Further, the simple fix of confronting consumers with real-time power prices is not desirable. There are very good reasons not to have grandmothers living on social security paying real power costs to keep their air conditioners going in August. Therefore, if the objective is to have power producers invest in the cost effective conservation that consumers do not invest in, then regulatory policies must create a set of incentives for them to do so.

Although some attempts have been made, so far, no state in the U.S. has created a structure that gives power producers sufficient incentive to close the conservation gap. With the renewed focus on energy efficiency, the time is right to meet the challenge and close the conservation gap in order to balance the investment playing field between new power plants and
conservation.

Doing so will certainly not eliminate the need for new power plants in the future. But it will reduce power plant requirements, lessen price increases, create environmental benefits, increase energy security and create greater incentives for long-term research and development in efficiency.

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