Energy efficiency and energy
demand
3.1. One of Government's fundamental goals is
to promote economic growth and prosperity. For this to be combined
with the reduction of greenhouse gas emissions there will have
to be a "decoupling" of economic growth from its environmental
impacts. Such decoupling was advanced as an objective by both
British and Swedish Governments, in the joint letter sent by the
Prime Minister and his Swedish counterpart, Mr Persson, to the
European Commission in February 2003.[25]
The object of this chapter is to analyse some of the arguments
underpinning this objective.
3.2. Underpinning the discussion of "decoupling"
is the progressive fall in the energy intensity (that is, energy
use per unit of GDP) of developed countries. Data provided by
the International Energy Agency (IEA), itself established in 1974
in the wake of the oil crisis, show that the ratio of total primary
energy supply to GDP (or "energy intensity") in IEA
members has fallen by more than a third since 1973.[26]
This is presented by some as evidence that "partial decoupling"
of energy use from environmental degradation has already occurred.[27]
As Lord Whitty said, "we have decoupled in the relative sense
quite dramatically on energy and I see no reason why we should
not decouple in an absolute sense on energy as well" (Q 710).
Figure 6, which derives from the DTI, illustrates the extent of
such "partial decoupling" in the United Kingdom since
1970.
3.3. However, while Figure 6 illustrates the
changing relationship between GDP and energy use, it does not
in itself demonstrate any reduction in environmental degradation.
When emissions are added to the equation, the picture becomes
more complicated. Figure 7 illustrates the relationship between
per capita GDP, energy use and emissions in four countries—the
United Kingdom, United States, Australia and Sweden. It reveals
significant differences in the relationship between GDP and energy
use—indeed, the United Kingdom has the lowest energy intensity
of the four. However, there are much more dramatic differences
in emissions. Australia and Sweden, for instance, have almost
identical per capita energy consumption, but Australia's per capita
emissions are almost three times Sweden's. Thus while energy intensity
may play a part in "decoupling", the most dramatic gains
are likely to be made in addressing the carbon intensity of the
fuel mix.
FIGURE 6
UK energy intensity, 1970 - 2003
Source: DTI, Office for National Statistics.
3.4. Moreover, the nature of the link between
energy consumption and GDP is in fact the subject of considerable
debate among economists.[28]
In particular, there is a school of thought, deriving from the
work of the nineteenth century economist Stanley Jevons, which
argues that while increased energy efficiency at the microeconomic
level may lead to a reduction in energy use, at the macroeconomic
level it in fact leads to an increase in overall energy use. This
proposition is known as the "Khazzoom-Brookes postulate",
after the economists Daniel Khazzoom and Leonard Brookes, who
independently published papers putting forward this argument in
1979-80. We received evidence on this debate from a number of
sources, including the Institution of Electrical Engineers and
A Power for Good Ltd, as well as from Dr Brookes himself.
FIGURE 7
De-coupling: the relationship between
GDP, energy use and emissions
Sources: World Bank (2003 GDP and population);
IEA (2002 energy consumption); European Commission, US Department
of Energy, UK and Australian Greenhouse Gas Inventories (2003
emissions).
3.5. Dr Brookes' argument is that for any resource,
including energy, "to offer greater utility per unit is for
it to enjoy a reduction in its implicit price". Cheaper energy
has two effects: the substitution of energy for other factors
of production, which are now relatively more expensive, and the
release of income which can then be reinvested in new production
capacity, and so on. As a result, Dr Brookes argues, developed
countries have, since the Industrial Revolution, seen "rising
energy productivity outstripped by rising total factor productivity,
hence rising energy consumption alongside rising energy
productivity".
3.6. A further consequence of this argument is
that while rises in the price of energy may stimulate improvements
in energy efficiency, such improvements, rather than leading to
a lasting fall in energy use, may serve to accommodate the price
rise, with the result that energy consumption stabilises at a
higher level than it otherwise would.
3.7. The "Khazzoom-Brookes postulate",
though it has not been proven empirically, is consistent with
classical economic theory, and offers a plausible explanation
of patterns of energy use in developed economies. As Professor
Paul Ekins, head of the Environment Group at the Policies Studies
Institute and co-Director of the new United Kingdom Energy Research
Centre (UKERC), told us, "In the economics literature it
is … well known that increased efficiency in the use of a
resource leads over time to greater use of that resource and not
less use of it" (Q 261).[29]
This might explain, for instance, why there appears to be no example
of a developed society that has succeeded in combining sustained
reductions in energy consumption with economic growth. Mr Alan
Meier, of the IEA, referred to "several countries that, for
brief periods, reduced their electricity consumption or their
energy consumption"—often in response to short-term
supply crises—but such reductions in demand have never been
sustained. This does not mean that sustained reductions in energy
consumption are impossible—simply that it is yet to be demonstrated
that they are possible. (Q 424)
3.8. We pressed a number of witnesses on the
macroeconomic effects of energy efficiency, but did not receive
convincing answers. Mr Meier openly admitted that "I always
have to retreat to a micro analysis here" (Q 416). Lord Whitty
also argued at the microeconomic level, as did his officials,
though without Mr Meier's acknowledgement that there might be
difficulties in so doing (QQ 717, 9-15). At this microeconomic
level, for instance in the case of an individual household, savings
that are made through, for instance, improved insulation, release
money that will be spent on other goods. These will entail some
energy consumption, creating a "rebound effect", but
in practice the money that has been released, which was previously
being spent essentially on either primary fuel (e.g. gas or oil)
or on electricity, is unlikely to be spent on anything equally
energy intensive.[30]
Absolute reductions in energy consumption are thus possible at
the microeconomic level.
3.9. However, this does not mean that an analogy
can be made with macroeconomic effects. Apart from anything else,
the substitution effects observable at the macroeconomic level
cannot be replicated by households, where demand for a range of
goods is relatively inelastic. If energy becomes, in effect, cheaper,
there is very limited scope for the individual simply to divert
money, say from food to energy. A business, on the other hand,
could respond to cheaper energy by deliberately increasing consumption—using
a more energy intensive process, which would allow savings to
be made elsewhere, for instance in manpower.
3.10. We have recently learnt that the UKERC
is proposing to commission work on the both the "rebound
effect" and the Khazzoom-Brookes postulate under its programme
of technology and policy assessments. Results should be available
in 2006. While this is welcome, pending the outcome of this work
the possibility remains that many of the arguments about the extent
of "decoupling" may, at least so far as business and
industry are concerned, be fundamentally misplaced. Many improvements
in energy efficiency, particularly within industry, are simply
products of technical and economic development—investment
in new machinery, for example, that optimises productivity across
the spectrum, including energy consumption. What the Minister
described as the "relative decoupling" of energy use
from economic growth may thus simply reflect the fact that greater
efficiency in the use of energy is one of the drivers of that
growth. We have already noted, with regard to the evidence from
Defra, regarding "real relative savings", that savings
against a "what might have been" scenario are not real
savings at all.
3.11. The Government's proposition that improvements
in energy efficiency can lead to significant reductions in energy
demand and hence in greenhouse gas emissions remains the subject
of debate among economists. The "Khazzoom-Brookes postulate",
while not proven, offers at least a plausible explanation of why
in recent years improvements in "energy intensity" at
the macroeconomic level have stubbornly refused to be translated
into reductions in overall energy demand. The Government have
so far failed to engage with this fundamental issue, appearing
to rely instead on an analogy between micro- and macroeconomic
effects.
3.12. We welcome the UKERC project to investigate
the "rebound effect" and the empirical basis for the
"Khazzoom-Brookes postulate", and recommend that the
Government, in parallel with the establishment of a more robust
measure for energy efficiency, take full account of the project's
progress and results in developing future policies in this area.
Cost-effectiveness
3.13. A related issue is the Government's use
of the term "cost-effective". The meaning of the term
is of course dependent on circumstances, time horizons, and so
on, but few of these subtleties are reflected in the Government's
use of the term. We are all, as individuals and businesses, free
to choose where to invest our resources. In the case of a business,
for any action to be "cost-effective", it is not enough
that it is cheap, or even that it pays for itself over an arbitrary
period—one year, say, or five years. Rather, it must represent
the optimal use of resources at that moment. This point was forcefully
made to us by Dr Brookes:
"Fuel or any other source of energy—and
indeed any other economic resource—cannot be used with greater
economic efficiency than in a system in which all the resources
involved are used with maximum economic efficiency" (p 181).
3.14. It follows that if a business can, by investing
a sum of money in energy efficiency, achieve a return on its investment
within three years, but by investing the same sum of money in
new plant or processes can achieve that return within two years,
investment in energy efficiency is not in itself "cost-effective".
As Mr Matthew Farrow, of the Confederation of British Industry,
said, "it is a competitive world out there", and any
proposal for investment "has to be compared against whatever
else it can be used for in the business" (Q 572). It is notable
that the only period in recent time in which significant reductions
in energy use were achieved was the late 1970s, when the economic
imperative was enormously strengthened by the oil crises. Significant
rises in energy prices today might similarly encourage investment
in energy efficiency—but at serious cost to the economy
as a whole, and, in the absence of effective measures to reduce
the cost to low-income households, to the Government's legally
binding commitment to reducing fuel poverty.
3.15. This confusion over cost-effectiveness
is typified by the widely reported statement that there is an
overall cost-effective potential to reduce energy use by 30 percent.
This derives from the 2002 Energy Review[31]
by the Performance and Innovation Unit (now the Prime Minister's
Strategy Unit), and is repeated in the Action Plan and in the
Government's written evidence to this inquiry (p 11). But as Professor
Ian Fells pointed out, these savings are simply not being achieved—because,
he argued, "they are the technical potential for saving rather
than the economic". Savings that are not "economic"
cannot be regarded as "cost-effective".
3.16. On the other hand, there are circumstances
in which "cost-effectiveness" may not by itself be an
optimal test of investment decisions. In the building sector,
for instance, the assessment of cost-effectiveness is distorted
by the predominance in this country of "build for sale"
development, as distinct from the "build and manage"
approach which dominates elsewhere in Europe. This leads the developer
to minimise capital expenditure, even where this increases the
cost of subsequent occupation of the building. For example, at
the point of installation electrical resistive heating is the
cheapest form of heating. However, it is associated with both
the highest carbon emissions and the highest running-costs, which
makes it a significant contributor both to climate change and
fuel poverty.[32] The
division between the interests of the builder, and the ongoing
interests of the subsequent occupants and society at large, means
that merely commercial decisions on "cost-effectiveness"
are unlikely to be optimal, and Government may have to intervene
by means of regulation. Similar issues arise in the rented housing
sector, where the economic interest of a landlord is to minimise
expenditure on capital and maintenance.
3.17. There are also circumstances in which longer
time-horizons are appropriate in making investment decisions.
The public sector is subject to rules set out in the Treasury's
Green Book, which is based on a 25-year horizon to compare all
discounted costs, incomes and benefits. This is intended to avoid
perverse decisions based solely on first cost without considering
lifetime costs.
3.18. We recommend that the Government exercise
caution in using the potentially misleading term "cost-effective"
to describe investment in energy efficiency. They should seek
to demonstrate realism as to what is economically achievable by
means of private sector investment in energy efficiency.
3.19. We further recommend that the Government
promote the application of the Green Book guidelines, encouraging
decision-makers at all levels, including local authorities, housing
associations, PFI projects and other private sector providers
to the public sector, to consider lifetime costs in committing
expenditure to long-term capital projects.
25 See http://www.defra.gov.uk/environment/business/envtech/pdf/blair-persson.pdf.
Back
26
30 Years of Energy Use in IEA Countries, OECD/IEA (2004), p 42. Back
27
A detailed account of "decoupling" can be found in Decoupling:
Past trends and prospects for the future, Swedish Environmental
Advisory Council (2002). Back
28
For a summary of this debate, see Horace Herring, "Does
Energy Efficiency Save Energy: The Economists Debate",
Open University Energy and Environment Research Unit Report, 74,
July 1998. Back
29
See also the evidence from Mr Paul Spare, who, while accepting
that the deduction might seem "counter-intuitive", stated
that there was "substantial and varied evidence … to
demonstrate that increased efficiency increases consumption."
(p 338) Back
30
A possible exception would be if the money was spent on short-haul
air travel; however, this would have to be replicated universally
for the "rebound effect" to exceed the original saving. Back
31
See Annex 6, Table 1 of the PIU Energy Review: http://www.strategy.gov.uk/downloads/su/energy/TheEnergyReview.pdf.
Back
32
22nd Report, Energy-the Changing Climate, 2000 (Cm 4749). Back
