Policy Analysis No. 189
March 9, 1993
ENERGY CONSERVATION AND EFFICIENCY:
THE CASE AGAINST COERCION
by Jerry Taylor
Jerry Taylor is director of
natural resource studies at the Cato Institute.
Executive Summary
Energy conservation is becoming the political tonic of
the 1990s. President Clinton promised in his campaign to
make efficiency the keystone of his energy policy in order to
increase the competitiveness of American business and con-
serve natural resources. Energy Secretary Hazel O'Leary has
long been an outspoken advocate of subsidized energy-conser-
vation measures. And Clinton's energy tax has been justified
largely as a measure to increase energy efficiency, decrease
America's reliance on foreign oil, and reduce pollution.
State public utility commissions are relying on energy-con-
servation programs to meet 75 percent of America's antici-
pated energy needs by the year 2000.
Yet careful analysis reveals that, contrary to popular
belief, energy is more abundant today than ever before; there
is no wrenching scarcity on the horizon. And America is one
of the most energy-efficient nations on earth, not the energy
glutton of the media caricatures. Nor do free markets fail
to provide for efficient energy use; the so-called market
failures of the energy economy either do not exist or are
more appropriately labeled "government failures." Finally,
programs that subsidize energy-efficiency measures for con-
sumers, known as demand-side management programs, impose
unnecessary costs on consumers while wasting, not conserving,
energy.
Experience has shown that the invisible hand of the
marketplace is far superior in providing for efficient energy
use and conservation than is the dead hand of government
planners, even if they belong to the Clinton administration
or state public utility commissions.
Introduction
[Stalin] seemed to live in a half-real
and
half-dreamy world of statistical figures and indi-
ces, of industrial orders and instructions, a
world in which no target, and no objective, seemed
to be beyond his and the party's grasp.
--Isaac Deutscher
Energy conservation is the great political tonic. Both
Republicans and Democrats prescribe government-mandated
energy conservation as the magic cure for perceived economic
and environmental ills ranging from impending energy scarci-
ty, foreign oil dependence, and decreasing international
competitiveness to global warming and air pollution. Al-
though there is some disagreement about how large the dose
should be and how the medicine ought to be administered, the
belief that government knows best how to efficiently use and
conserve energy is nearly universal, not only in Washington
but in the 50 state capitals as well.
That belief has gained currency because it rests on the
theory of market failure and a Malthusian conviction that
resources are strictly limited and finite. Otherwise sober
advocates of the free market succumb to the argument that
energy markets are so riddled with imperfections and
externalities that some degree of government intervention is
necessary.
This study explores the case for government interven-
tion in the energy economy to secure more efficient energy
use. When put under the microscope, however, the arguments
advanced by the conservation lobby display both theoretical
and empirical flaws. Central planning for energy efficiency
in the United States is doomed to fail for the same reasons
that central planning has proved such an abysmal failure in
Eastern Europe, the old Soviet Union, Cuba, and everywhere
else it has been tried.
Unfortunately, the energy-management experiment is en-
tering a new, more intensive phase in the United States, and
its focus is the nation's electric utilities. Called "de-
mand-side management," the idea involves changing the tradi-
tional role of the public utility from energy supplier to
energy-use planner. Tens of billions of dollars and Amer-
ica's future supply of electricity are being gambled on an
experiment in centrally planned conservation that is highly
unlikely to succeed.
No one opposes energy conservation or efficiency. Yet
it is abundantly clear that only a free and unfettered mar
ket, which reflects the desires and accumulated knowledge of
millions of consumers, can give rise to efficient produc-
tion, use, and distribution of energy.
Pressing the Panic Button
Energy conservation is virtually always discussed in
the context of impending shortage. If we don't act to re-
strict the use of energy now, we are told, we will soon run
out of energy altogether. Robert Watson of the Natural
Resources Defense Council, for instance, argues that govern-
ment intervention in energy use is urgent because "people
are not willing to give up amenities right now. They're
going to force our kids to do that."(1) A television host
proclaimed recently, "If we don't act to conserve energy
now, we may soon run out."(2) That perception of impending
scarcity, hanging over society like the sword of Damocles,
is one of the main reasons the public is receptive to calls
for energy-conservation mandates.
Yet, as noted by MIT economist Morris Adelman, one of
America's foremost energy experts, "The great oil shortage
is like the horizon, always receding as one moves toward
it."(3) Indeed, society has experienced a steady increase,
not decrease, in oil reserves and energy capacity. The
world now has almost 10 times the proven oil reserves it had
in 1950 and twice the known reserves of 1970. Proven re-
serves of coal and natural gas have increased just as dra-
matically.(4) In fact, known oil reserves are greater today
than at any other time in recorded history.(5)
Often misunderstood, however, is the fact that "proven
reserves" are a function of the price of oil and the tech-
nologies of oil extraction. With low petroleum prices,
there is little incentive for oil companies to explore for
oil. There is little profit in it. When oil is scarce,
however, increasing oil prices provide incentives for explo-
ration and lead invariably to corresponding increases in oil
supply, since companies are more likely to receive a return
on their investment. The evolution of extraction technolo-
gy, such as the development of horizontal drilling, also
allows industry to extract oil previously considered unre-
coverable and discover new reserves.
Unfortunately, many people continue to believe that the
world's stock of known reserves represents an estimate of
how much is left. If the proven oil reserves of 1950 had
actually represented all the oil that was left on earth, the
world would have run out of oil in 1970.(6) That misunder-
standing of resource economics, Thomas DiLorenzo and James
Bennett point out, has led otherwise intelligent people to
make breathtakingly ignorant statements about energy sup-
plies.(7)
_ The Department of the Interior announced in 1939 that
U.S. oil supplies would run out by 1952. New oil found
since then, however, exceeds the 13-year known reserves
of 1939.(8)
_ The Department of State concluded in 1947 that no new
oil reserves were left in the United States. Yet in
1948, 4.8 billion barrels of oil were discovered, the
largest discovery in American history.(9)
_ The secretary of the interior announced in 1949 that
the end of U.S. oil supplies was in sight. U.S. oil
production then rose by more than 1 million barrels a
day over the next five years.(10)
_ The State Department predicted in 1951 that global
oil reserves would run dry by 1964. World oil reserves
subsequently grew 1,000 percent by 1990.(11)
_ The International Energy Agency warned in 1979 that
the world's 645 billion barrels of known oil reserves
would be largely depleted by 1985. Yet by 1990 only 320
billion barrels of that oil had actually been drawn
down, and global oil reserves approached 1 trillion
barrels.(12)
Although no one really knows how much oil is below the
earth's surface, today's best guesses are that, at current
rates of consumption, 650 years' worth of oil remains for
future generations.(13) Moreover, as those resources are used
and demand outpaces dwindling supply, other energy sources
will inevitably be found to replace petroleum. If oil
prices were to rise to around $30 a barrel, for example,
liquefied coal, heavy oil, and tar sands would become worth
developing and could provide 3.5 trillion additional barrels
of oil.(14) At approximately $40 a barrel, oil shale could
provide another 2 trillion barrels.(15) Alternative fuels
such as compressed natural gas and methanol could replace
gasoline if oil prices ever rose high enough to make use of
those fuels economical. Even in the distant future, seven
generations hence, the depletion of oil will not mean that
we will run out of energy.
The fact that oil is more plentiful today than ever
before can be readily seen by examining historical price
data. The more plentiful a resource is, relative to a given
demand, the lower its price. It is therefore interesting to
note that retail gasoline prices, in constant 1990 dollars,
are 6 percent lower today than they were in 1972, 25 percent
lower than in 1963, and 30 percent lower than in 1947.(16)
Whereas 3.2 percent of total household expenditures were
devoted to gasoline in 1972 (the smallest percentage since
1952), American households today devote but 2.6 percent of
total expenditures to gasoline purchases.(17)
Of course, we cannot be sure that the market is right
about the extent of future supply, given that a "price"
is a
distillation of conflicting facts and opinions. In light of
the market's sensitivity to all available information, how-
ever, the market price is the best predictor of future sup-
ply and demand. Those who believe that oil is more scarce
than is indicated by the market price are free to buy re-
serves and hold them off the market for future use and prof-
it. Indeed, if future supply and demand for a commodity are
poorly reflected by its market price, those individuals who
know better have every incentive to act on their superior
knowledge to garner large future profits. Fortunes have
been built by such activity, and there is every reason to
believe that if such a gross market error occurred, profit-
seeking individuals would step up to ensure that society's
future needs would be met.
In command-and-control economies, however, the conse-
quences of errors are much greater. Unlike the marketplace,
those economies have no means by which people can correct
for the misjudgment or ignorance of experts. As Nobel lau-
reate economist F. A. Hayek pointed out:
Industrial development would have been greatly
retarded if sixty or eighty years ago the warning
of the conservationists about the threatened ex-
haustion of the supply of coal had been heeded;
and the internal combustion engine would never
have revolutionized transport if its use had been
limited to the known supplies of oil. . . . Though
it is important that on all these matters the
opinion of the experts about the physical facts
should be heard, the result in most instances
would have been very detrimental if they had [had]
the power to enforce their views on policy.(18)
America the Wasteful
Another oft-heard refrain from the conservation lobby
is that America is one of the most energy-wasteful nations
on earth. Amory Lovins, founder and vice president of the
Rocky Mountain Institute and a leading spokesman of the
conservation lobby, argues that "the U.S. spends 11 to
12
percent of its GNP on energy, compared to 5 percent for
Japan; this difference gives typical Japanese exports an
automatic 5 percent cost advantage." Moreover, Lovins
ar-
gues that "Japan is not only more energy-efficient than
the
U.S.; it is becoming even more efficient much faster. In
four major industries, electric intensity per ton is falling
in Japan but rising in the U.S. In 1986, a dollar of Japa-
nese GNP used 36 percent less electricity than a dollar of
American GNP."(19)
Comparisons of U.S. energy use per dollar of GNP with
that of Japan or Europe, however, are misleading for several
reasons. First, the standard of living in the United States
is far higher than it is in Japan. The average American
household has 2.5 times more living space than the average
Japanese household, which obviously means more heating and
cooling.(20) That difference is compounded by the fact that
only 20 percent of Japanese homes have central heating and
only a third of the housing units built since 1990 have that
basic American comfort. Instead, millions of Japanese rely
on kerosene-burning camp stoves, electric blankets, electric
carpets, and even heated tables to provide warmth.(21) The
typical Japanese apartment, the kind in which 80 percent of
the population lives, is also unlikely to have a water heat-
er, a washer, a dryer, a refrigerator, or a stove.(22)
Second, Japan has a much greater population density
than does the United States, which means that energy con-
sumption for transportation is naturally much lower in Japan
(the entire country is roughly equivalent in size to the
state of Montana).(23)
Third, the United States has historically held a com-
parative advantage in abundance of natural resources and
energy supplies vis-Ö-vis the rest of the world. That
has
resulted in the development of large energy-intensive,
though not necessarily inefficient, industries. For exam-
ple, nine of America's most energy-intensive industries
account for 70 percent of industrial energy use.(24) Those
industries, such as petrochemicals, chemicals, primary met-
als, and paper, are major exporters not only because of
their comparative advantages but because higher energy taxes
and tariffs abroad encourage the importation of goods the
production of which requires large amounts of energy. Thus,
the industrial structure of the United States skews simple
readings of energy intensity per dollar of gross national
product.(25)
When standards of living, population density, and in-
dustrial structures are controlled for, the Energy Informa
tion Administration finds that the United States is no less
energy efficient than Japan and more energy efficient than
many of the Group of Seven (G-7) nations.(26)
Nor is Japan making greater strides in energy efficien-
cy than the United States. Quite the opposite. From 1980
to 1987 the United States improved its energy efficiency at
twice the rate of Japan.(27) In fact, no other nation save
Canada increased its energy efficiency more than the United
States did between 1980 and 1987.(28) The fact that electric
intensity (the amount of electricity required per unit of
output) is increasing in the United States and decreasing in
Japan is one of the main reasons for those U.S. conservation
gains (more on that later).
Another popular indictment of U.S. energy use is that,
as noted by the Partnership for Sustainable Development,
"with only 5 percent of the world's population, the United
States consumes 25 percent of the total commercial energy
used in the world each year," and that "the average
American
consumes 15 times more energy than the average citizen in
the developing world."(29) Of course, the high American
stan-
dard of living has something to do with the amount of energy
used in the United States in comparison with the developing
world. To live outside poverty is not necessarily to
"waste" energy. Such comparisons also ignore the
fact that,
although the United States does consume some 25 percent of
total commercial energy, it also produces about the same
amount of the world's goods and services and produces more
food than any other nation.
Indeed, the facts demonstrate that the United States
has made tremendous strides in energy efficiency.
_ Producing one dollar's worth of goods and
services
today requires 39 percent less oil and gas than was
required in 1973.(30)
_ The United States is 52 percent more efficient in its
use of oil today than it was in 1973.(31)
_ The energy intensity of the U.S. economy (defined as
the ratio of primary energy use to national output) has
declined 28 percent since 1973.(32)
_ Between 1973 and 1989 the value of goods and services
produced in the United States increased by 50 percent
while industrial energy use declined by 6 percent.(33)
_ From 1980 to 1990 the amount of energy needed to pro-
duce a dollar of GNP fell by 21 percent while per capi-
ta energy consumption fell by 7 percent.(34)
_ Homes built today use 50 percent less energy than
those built before 1973.(35)
Those gains in energy efficiency are part of a continu-
ing trend in the U.S. economy. Energy consumption per
$1,000 of GNP has been declining at about 1 percent annually
for the past 60 years. In 1989 the United States used 55
percent less energy per $1,000 of GNP than it did in 1929.(36)
The argument forwarded by the conservationists--that post-
1973 energy-conservation mandates are primarily responsible
for recent gains in energy efficiency--is clearly con-
strained by lack of familiarity with historical trends. In
fact, a recent study has found that, after correcting for
shifts in the industrial sector, higher energy prices (not
government conservation mandates) account for 80 percent of
total U.S. energy efficiency gains since 1973.(37)
Energy and Externalities
The idea that energy markets are rife with negative
externalities is virtually universal among policymakers.
Since those externalities impose costs on society, it is
argued, they should be, but are not typically, reflected in
the price of energy. Even President Bush's National Energy
Strategy justified state intervention in the energy market
by repairing to this externality doctrine:
The goals of a healthy environment and reduced
dependence on insecure suppliers represent nation-
al security, foreign policy, and social benefits
to which markets are unlikely to give adequate
weight. Hence, government must act, alone or in
concert with private markets, to incorporate these
considerations.(38)
Conservation mandates are thus called for to correct
for the overuse of energy resources that results from prices
that are lower than they would be if those externalities
were accounted for.
Although that argument is superficially attractive, it
is based on dubious analysis and impossible assumptions.
Let us examine the "externality" of foreign oil dependence
and the recessions of 1973-74, 1979-80, and 1990-92. All
three were alleged to have been triggered by sharply higher
energy prices resulting from oil supply disruptions in the
Middle East. Yet drawing from existing research and examin-
ing data from manufacturing sectors in Germany, Japan, Great
Britain, and the United States, Douglas Bohi, a senior fel-
low at Resources for the Future, concludes that energy price
shocks had little to do with those three recessions. Bohi
convincingly demonstrates that deflationary monetary policy,
not oil "price shock," was the true culprit in the
reces-
sionary 1970s.(39) How else to explain the fact that Japan,
the nation most dependent on foreign oil imports in the
1970s, avoided those recessions while Great Britain, virtu-
ally self-sufficient in oil thanks to its North Sea re-
serves, was hit harder in 1979 than virtually any other
industrialized nation? The key difference between the two
economies was their monetary policies.
Bear in mind that the cost of oil is small in relation
to the economy, accounting for about 2 percent of GNP. Even
a large increase in oil prices will have only a small impact
on the economy. The 1973 oil price shock, for example, is
estimated to have accounted for only a 0.35 percent reduc-
tion in GNP during 1973-74.(40) And if oil prices play such
a
dramatic role in economic well-being, why did the dramatic
collapse in oil prices in 1986 not usher in an economic boom
as large as the economic collapse that rising prices had
supposedly triggered twice previously?
Analysts have long observed that energy independence
provides little protection against domestic price shocks
because the energy economy is global in nature. A global
shortage of oil production, for example, will be reflected
in price hikes for West Texas crude regardless of America's
relative dependence on oil imports. The argument that ener-
gy conservation will make us less dependent on imported oil,
and therefore less vulnerable to oil price shocks, violates
virtually any reading of economic theory or history. For
example, two-thirds of the oil consumed in the United States
before the 1973 oil embargo was produced domestically. The
reserves of the Organization of Petroleum Exporting Coun-
tries accounted for only a small fraction of U.S. oil con-
sumption, yet the United States was affected by the oil sup-
ply disruptions of 1973. As Bohi points out:
As long as the United States maintains an open
economy, foreign oil disruption will drive up do-
mestic oil prices in line with world oil prices no
matter how much oil the U.S. imports. . . . The
economic costs of oil disruption caused by changes
in oil prices cannot be lowered by reducing oil
imports.(41)
Nor is it altogether clear that energy conservation
will actually work to reduce pollution from energy sources.
Consider the fact that the conservation lobby supports man-
datory energy conservation as an alternative to the con-
struction of new power plants. Deferring or canceling con-
struction of new power plants, most of which would be envi-
ronmentally preferable to older, existing plants, could
result in more pollution than would otherwise exist. That
is because older plants, which would be shut down as newer,
more efficient, and less polluting plants began operations,
are given an artificial lease on life.
Moreover, energy-conservation programs would, at best,
displace the need for additional generation capacity and, if
very successful, lead utilities to reduce energy output from
their most expensive plants. Since energy output from the
cheapest utility plants would be largely unaffected by ener-
gy efficiency programs, even Richard Ayres of the National
Clean Air Coalition concedes that energy conservation would
have little effect on pollution for at least 10 years. That
is because the cheapest generating plants are the main
source of energy-based air emissions since they are typical-
ly older and far more polluting than modern facilities.(42)
The idea that energy use is a major source of pollu-
tion, moreover, ignores the vast carrying capacity of the
atmosphere and its demonstrated ability to absorb and dilute
pollutants. For example, all of the pollution mankind has
produced since Adam has been less in quantity and less toxic
than that caused by just three volcanic eruptions: Krakatoa
in 1883, Katmai in 1912, and Helka in 1947.(43)
It is also important to note that, although energy con-
sumption has negative environmental impacts, our ability to
quantify and price those impacts is limited. And it is un-
clear that the price of energy really fails to fully incor-
porate those costs since the cost of regulatory compliance
is reflected in the price we pay for energy. The Environ-
mental Protection Agency estimates that environmental regu-
lations cost the economy approximately $115 billion annually
and will cost $185 billion a year by 2000.(44) Even those
figures are questioned by a growing number of economists who
believe that the costs of environmental regulations are far
greater than estimated by the EPA.(45) Are the regulatory
costs of environmental compliance, then, greater or less
than the costs of any environmental damage that energy con-
sumption may cause?
Nobody really knows because, absent private ownership
of environmental resources and a market structure for ex-
changes of and contracts for resources, prices for environ
mental goods are impossible to ascertain. Since we cannot
"price" environmental goods outside the marketplace
(any
more than we can "price" tractors accurately in a
command
economy), we are incapable of ascertaining the actual "cost"
of environmental degradation.(46) That is not, however, an
example of market failure. It is an example of the failure
of the government to provide for private ownership of envi-
ronmental resources and to maintain legal institutions to
protect property rights.(47)
The Myth of Market Failure
Given that market economies are, on average, 2.75 times
more energy efficient per $1,000 of GNP than are centrally
planned economies (a margin of difference that has grown
steadily over time), it should be abundantly clear to all
that consumers are better able to provide for efficient
energy use than are central planners.(48) Yet the conserva-
tion lobby has succeeded in convincing policymakers that
there are inherent in energy markets numerous imperfections
and failures that necessitate government intervention.
A brief examination of the alleged imperfections in the
energy market, however, reveals that the assertion of market
failure is spurious.(49) Accusations of market failure usual-
ly mean that markets fail to act as the critics would pre-
fer.(50)
Regulated Pricing
Perhaps the most common charge of market failure is
leveled at the regulated pricing practices of state public
utility commissions (PUCs). PUCs typically set electricity
rates on the basis of the average cost of electrical ser-
vice, whereas most private businesses set prices on the
basis of the cost of new, or marginal, production. Conser-
vationists point out that, because it costs more to produce
electricity from new power plants than from existing genera-
tion facilities, the average cost of electricity is below
its marginal cost, and thus consumers pay an unrealistically
low price for electricity.
That was undoubtedly true during the mid-1970s and
early 1980s, but it is not entirely clear that marginal
costs for electricity today are higher than average costs.
A survey conducted by National Economic Research Associates
(NERA) found that 17 of 41 responding utilities (41 percent)
would raise less revenue by charging rates based on marginal
rather than average electricity costs. NERA also found
that, when calculated on a capacity-weighted average basis,
the existing electricity rates of those 41 utilities ex-
ceeded marginal costs by 22 percent.(51) Moreover, Califor-
nia's Standard Practice Manual for evaluating electricity
conservation programs candidly notes that, for California
utilities, "average rates substantially exceed marginal
costs."(52)
Although the conservationists are correct that current
PUC pricing standards are irrational, that irrationality is
a result not of market but of government failure. Such
practices can and should be easily remedied by reforming PUC
ratemaking practices (or scrapping the PUC structure entire-
ly).(53) In any case, there is little substance to the claim
that electricity prices are in general artificially low
today because of the relatively high marginal cost of new
baseline power.
Future Price Uncertainty
"Leaving energy to the free market means leaving it
to
the roller coaster of alternating shortages and gluts,"
ar-
gues the Washington Post. "These wild swings in oil prices
are characteristic of all commodity markets, and in the case
of oil they are aggravated by the concentration of reserves
in a place that, in terms of its politics, you can fairly
describe as the world's least stable."(54) Because of
price
uncertainty, it is argued, consumers have no basis for plan-
ning and are thus reluctant to invest in technologies with
high front-end costs.
But oil is like any other commodity. Would the Post
argue that prices of other commodities should also be con-
trolled by the government, or that the government has a
right to regulate the purchase and use of all commodities
because they undergo "wild swings" in price?
Most energy price fluctuations are the result not of
naturally functioning energy markets but of government in-
tervention in the marketplace. Oil prices spiked and then
quickly came down in the summer and fall of 1990, for exam-
ple, because of an international blockade of Iraq and Ku-
wait, not because oil is more price sensitive than other
goods. Price instability in the 1970s was similarly a re-
sult of massive government intervention in oil prices, dis-
tribution, sale, and use. Artificial scarcities that af-
fected energy costs were created. Again, that was a regula-
tory or government failure, not a market failure. One could
certainly argue that the best way of correcting for price
fluctuations would be to get the government out of the ener-
gy market entirely.
A recent study by Bharat Trehan of the San Francisco
Federal Reserve found that "changes in the value of the
dol-
lar account for almost half of the variation in oil prices
over the period 1958-85."(55) Since prices are by definition
a function of the ratio of dollars to goods, it should be no
surprise that changes in the supply of and demand for dol-
lars, rather than changes in the supply of and demand for
oil, account for half of all oil price changes.
Limited Access to Capital
Individuals and corporations, it is argued, use irra-
tionally high discount rates because of their limited access
to capital. According to Amory Lovins, the clearest mani-
festation of pervasive market failure is that most customers
require payback horizons of one to two years for energy sav-
ings, even as utilities cheerfully accept power-plant pay-
back periods ranging from decades to infinity. That dispar-
ity in discount rates makes society buy too many power
plants and save too little.(56) Thus, government must step
in
to ensure the adoption of energy-efficient technologies that
have long-term benefits.
Although there is obviously limited access to capital
on the part of individuals and corporations (people simply
do not have as much money as they would like), consumers are
not generally averse to making long-term investment deci-
sions incorporating low discount rates. If consumers actu-
ally used such high discount rates for all their invest-
ments, they would never save for their children's education
or for a down payment on a house or car. Nor would people
put money in savings accounts, which pay single-digit re-
turns. A cursory examination of common business practices
also reveals that new product lines, plant expansions, and
marketing activities all demand investments that take more
than just a few years to pay off.
Actually, it is difficult to reach definitive conclu-
sions about the discount rates used by consumers when making
judgments about energy-conservation investments. Dozens of
studies have been conducted and untidy results abound. Con-
sumers, for example, appear to use different discount rates
for different technologies: typically higher discount rates
for air conditioners, refrigerators, and other appliances
and lower discount rates for insulation, window replacement,
sources of heating fuel, and overall residential energy
efficiency in new housing units.(57) Researchers have also
found that age, income, and homeowner status can have sig-
nificant impacts on consumer discount rates, though the data
are sometimes contradictory.(58)
If consumers are generally not averse to making rela-
tively long-term investments in many areas of their lives,
why are they so averse to making long-term investments in
some energy-efficient technologies but not in others? The
conservation lobby argues that it is simply a reflection of
"market failure," although "consumer failure"
would probably
be a more apt term. The market has not failed to offer op-
portunities for the purchase of energy-efficient technolo-
gies. Consumers, according to the conservation lobby, have
simply failed to act in what is evidently in their best
interests.
Yet it is hard to reconcile the results of studies that
show high implicit discount rates for certain appliances
with the dramatic improvements in the energy efficiency of
those very same appliances. From 1972 to 1978, for example,
the energy efficiency of new refrigerators increased 29
percent; by 1980 the energy efficiency of new refrigerators
was 46 percent higher than in 1972, and by 1990 average
refrigerator energy efficiency more than doubled. Likewise,
the energy efficiency of new air conditioners increased 46
percent from 1972 to 1990.(59) Moreover, those gains in the
energy efficiency of refrigerators and air conditioners were
made entirely in the context of the free market. There were
no federal mandatory efficiency standards for those appli-
ances before 1990.
When consumers prove reluctant to invest in certain
energy-efficient measures, studies by NERA's Albert Nichols
and Professor Douglas Houston of the University of Kansas
indicate that the reluctance is due not to economic igno-
rance but to a perfectly rational judgment of economic gain.
For example, energy-conservation investments yield uncertain
gains given the steadily dropping price of energy and the
unreliable performance record of many technologies. Consum-
ers may also perceive additional costs not included in the
conservationists' calculations, such as transaction costs or
differences in quality or convenience. Lower income fami-
lies may have little opportunity to make effective use of
energy-efficient investments because of household and family
constraints and instabilities. Many energy-conservation
investments are "sunk"--tied to the house--and therefore
the
value of the conservation investment is linked with the
property value of the house. Finally, the heavily front-
loaded cost of many conservation investments requires the
consumer to consider fully the costs of social goals un
attained, economic investments not made, personal opportuni-
ties forgone, and desires unfulfilled.(60)
Likewise, businesses must consider the opportunity cost
of a conservation investment. After all, $1 million in-
vested in corporate energy efficiency is $1 million not in-
vested in advanced research and development, product market-
ing, new product lines, or expanded plant capacity. For
expenditures on energy efficiency to make sense to the busi-
nessman, they must not only prove profitable, they must also
provide a higher rate of return than would alternative in-
vestments such as the ones mentioned above. The fact that a
$1 million investment in energy efficiency will pay for it-
self after five years is insufficient reason for making that
investment. It must provide a higher rate of return than
would other potential investments. In fact, in all the lit-
erature about the supposed cost savings of investments in
energy efficiency, nowhere is the question of opportunity
cost even addressed.
The conservation lobby is correct, however, to point
out that there is limited access to capital, particularly
given today's federal, state, and local fiscal policies.
Cutting taxes and government spending would free capital for
all kinds of private investment, including investments in
energy efficiency. Moreover, as pointed out by the Heritage
Foundation's William Laffer:
There is one very good reason to believe that
mar-
ket prices in the United States systematically
fail to reflect future scarce conditions--and
hence the value of investments in new technolo-
gies, or of conservation--fully. Current tax and
monetary policies in the United States substan-
tially raise the real cost of capital, thereby
shortening the time horizons of U.S. firms. As a
result, it is quite likely that U.S. firms system-
atically undervalue future profits, and hence
future profit opportunities, such as the opportu-
nity to profit by saving some of one's oil to sell
in the future, rather than selling it all now, or
the opportunity to profit in the future by invest-
ing in the development of new technologies. In-
vestment and conservation efforts which companies
in other countries, such as Japan, may find at-
tractive will be less attractive to American firms
because they face a higher real cost of capital.(61)
Whether the conservation lobby will embrace laissez-
faire economics in order to reach greater energy efficiency
remains to be seen. Yet it cannot be denied that the gov
ernment's voracious demand for private capital drains the
economy of resources that might otherwise be invested in
energy efficiency and discourages the very kind of long-term
investments advocated by the conservation lobby.
Government Subsidies for Energy Production
To the extent that federal policies subsidize energy
production, energy prices are lower than they otherwise
would be and thus energy use is higher than it would be
under optimal conditions. Although there are some subsidies
for energy production (the Price-Anderson Act subsidizes the
nuclear-power industry by providing government-backed insur-
ance, for example), those subsidies are somewhat counter-
balanced by the tax code's unfair penalization of energy
production.(62) The conservation lobby, however, tends to
argue that provisions of the tax code (e.g., accelerated
depreciation allowances, investment tax credits, and tax-
exempt bonds for publicly owned utilities) amount to "sub-
sidies" for energy production.(63)
Subsidies, however, are hardly an example of market
failure. Instead, they are an example of government fail-
ure. The best method of dealing with distortions caused by
subsidies is to eliminate the subsidies in question, not to
create a competing set of distortions in the marketplace.(64)
Inelasticity of Energy Demand
A coalition of energy-conservation lobbies recently
released a much-heralded report entitled America's Energy
Choices: Investing in a Strong Economy and a Clean Environ-
ment, in which it was argued that "the literature suggests
that for most end-uses in the residential and commercial
building sectors, energy demand is not very sensitive to
changes in prices."(65)
Actually, the weight of economic literature concludes
just the opposite. The long-run elasticity of total energy
demand for industrial applications appears to be about -0.8.
In other words, for every 10 percent increase in price, a
corresponding 8 percent decrease in demand will probably
occur. The evidence suggests that total demand for energy
in the residential sector has a long-run elasticity of -1.1,
while elasticity of demand in the transportation sector ap-
pears to be -1.0.(66) Thus, any theory of market failure is
further discredited by the earlier examination of trends in
American energy efficiency. Simply put, energy prices have
been the dominant factor in America's increasingly efficient
use of energy.
Limitations of the Supply Infrastructure
The conservation lobby points to several alleged market
failures of the supply infrastructure. First, they point
out that, because of limited demand, many technologies are
available only in certain regions, and thus not all consum-
ers have the option of using energy-saving devices. Yet the
market is reacting rationally to the lack of demand for the
technologies in question. The fact that professional base-
ball is not played in Sioux City, Iowa, for example, does
not imply that the baseball market has somehow "failed."
Second, it is argued that a lack of skilled employees
trained in energy efficiency proves that companies under-
invest in conservation training programs. But lacking de-
tailed knowledge of each company's position in the market-
place, how can anyone presume to know whether company x, or
even industry x, is underinvesting in conservation training
programs? Moreover, what specific flaw in the marketplace
leads companies to underinvest in conservation training? Do
companies underinvest in all types of employee training? If
not, then why do they underinvest in conservation training
and nowhere else? Again, it appears that the conservation
lobby has found that markets do not necessarily act as they
would prefer. They therefore conclude that there obviously
must be some imperfection in the market.
Third, it is argued that a chicken-and-egg problem ex-
ists with respect to new technologies and fuels that require
an extensive investment in infrastructure. Automakers are
reluctant to build methanol-fueled cars, for example, be-
cause few filling stations offer methanol fuel and there is
no infrastructure to deliver or store methanol. Distrib-
utors and retailers of fuel are reluctant to invest in the
expensive infrastructure necessary to provide retail metha-
nol because few cars run on that fuel. Thus, unless govern-
ment steps in, the promise of methanol will be forever un-
realized.
If that is true, how do we account for the fact that
new technologies with similar problems--television, fax
machines, compact disc players, and computer software, for
example--developed without any help from the government?
There is nothing that prevents an investor in methanol from
providing both the vehicles and the infrastructure necessary
to establish a market. Hardly any major technological ad-
vance would have occurred in the 20th century if the
chicken-and-egg problem were insurmountable in the free
market.
Negative Public Attitudes toward Energy Efficiency
Analysts at the Oak Ridge Laboratory argue that "the
public places a high premium on comfort, ease, and conve-
nience, goals that may appear to conflict with energy effi-
ciency. Thus, it is unclear whether the positive attitudes
that Americans have for improving energy efficiency will be
reflected in their energy-related purchase and operating
decisions."(67) The fact that free markets allow consumers
to
make choices about how they will live their lives is hardly
market failure. If consumers perceive that the benefits of
energy conservation outweigh the costs, then consumers will
indeed conserve energy. If consumers' perception of energy-
conservation costs is incorrect, then information campaigns,
aggressive marketing, and innovative sales practices can
certainly correct for any public misinformation. There is
nothing inherent in the marketplace that prevents the public
from developing positive attitudes toward energy conserva-
tion.
Perceived Riskiness of Investments in Energy Efficiency
Given the high up-front costs of many energy-efficient
technologies, conservation lobbies argue that lingering
uncertainty about long-term energy prices prevents people
from making investments that would be in their own best in-
terests. The public, however, has every reason to believe
that energy prices will decrease in the future. After all,
energy prices have been steadily decreasing for years.
Moreover, consumers have good reason to believe that taking
the advice of energy-conservation experts is risky, given
their recent track record.
For instance, many people believed the conservation
lobby's rhetoric about future gasoline prices and purchased
diesel-powered automobiles in the late 1970s and early
1980s. The result was poor car performance, wasted economic
resources, and far less energy savings than were promised.
Similarly, in the 1970s policymakers listened to what the
conservation lobby said about future gasoline costs and the
promise of fuel alternatives. The result was that billions
of dollars were sunk into one of the biggest government
boondoggles in history, the federal Synfuels program.
Being prudent with one's own money is an example not of
market failure but of rationality. Perhaps the reason
would-be energy planners fail to exercise such caution is
that the money they spend and the resources they invest are
not their own but other people's.
Information Gaps
Analysts at Oak Ridge Laboratory also argue that "in-
formation regarding the technical and economic viability of
such [efficient energy] technologies under full-scale, actu-
al usage conditions is often scarce. The absence of such
data leads to greater perceived risks and a reluctance to
adopt such systems."(68) Moreover, energy supply curves,
show-
ing which technologies are cost effective at various energy
prices "for most technologies, . . . are not available."(69)
The authors of America's Energy Choices go even further when
they assert that "because they [consumers] lack important
information, businesses and consumers often fail to take
actions that are in their own best interest."(70)
But if information about the actual cost and perfor-
mance of technology is scarce, is society not well advised
to consider such investments at least potentially risky?
And how, without that information, do the authors of Amer-
ica's Energy Choices know what is in the best interests of
consumers and businesses?
Although consumers clearly lack perfect information
about energy-efficiency measures (at least the kind of om-
niscient knowledge assumed in elementary textbook models of
rational economic decisionmaking), the same can be said
about any area of economic life. If imperfect knowledge
means market failure, then the market fails across the board
and it is a wonder that our economy functions at all. In
reality, however, information can be costly to obtain and
process and there are often diminishing returns on the ac-
quisition of additional information. The frequently heavy
"transaction costs" associated with information gathering
mean that perfect knowledge is rarely obtainable or even
feasible in the economy.
If experts believe that consumers' perception of risk
is unjustified or misinformed, an aggressive information
campaign would certainly seem to make sense. In the past,
other industries have used marketing and sales campaigns to
fill public information gaps and have successfully convinced
consumers of the wisdom of purchasing goods and services
without government help.
Misplaced Incentives
Industrial buyers, writers of product specifications,
architects, engineers, and builders, it is argued, have lit-
tle incentive to provide energy efficiency since they are
not paying the full life-cycle cost of inefficiency. Yet if
consumers truly demanded energy efficiency in products or
homes, suppliers would have every incentive to provide it,
and they would loudly advertise the energy-efficient attri-
butes of their goods and services.(71) The fact that that is
not happening to the extent desired by the conservationists
proves, not that there is a failure in the market process,
but that there is little demand for the kind of energy effi-
ciencies preferred by the conservation lobby.(72) If that
were not so, some investors would be getting rich right now
by monopolizing a market niche and providing goods and ser-
vices that the public desired. As Albert Nichols explained:
Profit-maximizing firms have strong incentives
to
take account of their customers' preferences. To
the extent that they can provide a characteristic
or feature at lower cost than the customer values
it, they can earn profits (at least until compet-
ing firms also offer that feature). Problems can
arise if the customer cannot judge the impacts of
various characteristics, but those problems occur
whether or not an "intermediary" is involved.
Indeed, an important role of many intermediaries
(particularly architects and engineers in the case
of buildings) is to use their technical knowledge
to better translate the customers' broader prefer-
ences (e.g., low operating costs) into action
(e.g., the purchase of a more reliable or energy
efficient heating system).(73)
Any empirical or theoretical analysis shows that
charges of market failure are unfounded. If we define "mar-
ket failure" as the failure of the free market to sustain
"desirable" activities or to stop "undesirable"
activities,
then there is absolutely no evidence on which to base such a
charge. As noted previously, the United States is one of
the most energy-efficient nations in the world.
Moreover, the conservationists are unable to answer the
most central question related to a charge of market failure:
given that free markets are unexcelled in meeting public
demands for desired goods and services (that, as a matter of
fact, is how profits are made), exactly what economic barri-
ers exist to the delivery of energy-efficient technologies
that are unique to the energy economy? The barriers alleged
by the conservationists, as we have seen, are either com
pletely unrelated to the institution of the marketplace or
are characteristic of every sector of the American economy.
Since those barriers are demonstrably surmountable in the
marketplace, they are not really barriers at all and thus
fail to substantiate the charge of market failure.
The Theoretical Construction of Demand-Side Management
Although the number of government programs mandating,
subsidizing, and regulating efficient energy use is legion,
the most sweeping and ambitious attempt to intervene in the
energy marketplace today is demand-side management of elec-
tricity generation and consumption.
Demand-side management (DSM) programs, which have been
a growing part of utility planning since the 1970s, are
designed to reduce consumer demand for electricity rather
than increase generating capacity. The theory behind DSM is
that energy conservation and increased efficiency are cheap-
er than generating new energy. Public utility commissions
thus often require that utilities offer consumers services,
such as free energy audits, and heavily subsidized technolo-
gies designed to reduce demand for electricity. The costs
of those subsidies are then passed on to ratepayers, who in
theory will be required to pay less for the conservation
program than they would have had to pay for new generation
capacity.
In fact, Lovins argues that energy conservation is
actually a source of energy that he refers to as "negawatts"
(that, of course, is akin to arguing that dieting is a major
source of food, or "negacalories"). Today 31 states
have
some form of demand-side management program in place, and 10
others are considering adopting the practice. As of 1990,
500 utilities had undertaken over 1,400 DSM programs. Ap-
proximately $2 billion was spent in 1991 on utility-spon-
sored conservation programs, and projected costs are stag-
gering. In California and New York alone, nearly $20 bil-
lion will be invested in DSM in the next decade.(74) The pub-
lic utility commissions of many states are vetoing the con-
struction of new electricity generating plants in the expec-
tation that DSM programs will avoid almost three-quarters of
the growth in electricity demand that would otherwise occur
by the year 2000.(75)
Robert Wirtshafter of the University of Pennsylvania
observes that DSM today dominates supply-side energy invest-
ments to nearly the same degree that nuclear power dominated
supply-side investments in the early 1960s. DSM expendi-
tures are nearly as large as nuclear power investments were
during the boom era of the 1960s, and the unrealistic prom-
ises of DSM are but 30-year echoes of the "too cheap to
meter" claims once made by proponents of nuclear power.(76)
Is the DSM bandwagon of the 1990s doomed to meet the
same fate as the 1960s nuclear bandwagon? Wirstshafter, a
proponent of DSM, observes that "the nuclear industry col-
lapsed in large part due to stunning cost escalations and
poor operating performance. These problems did not occur
suddenly. . . . Using the nuclear experience as a guide, we
can see a number of danger signs in the current development
of DSM."(77)
The "Big Brother" Electric Company
Although it is certainly true that people in the mar-
ketplace ought to be comparing the cost of energy conserva-
tion with the cost of electricity generation (and making
economic choices accordingly), it is not altogether clear
that electric utility companies are the best candidates for
that task. The energy market is far too large and complex
to allow any one economic actor or state public utility
planner to consider all the options involved in energy gen-
eration and use.
Suppliers can be relied on to produce fuel in the most
efficient manner possible and to sell at prices reflecting
the resulting costs. Utilities have no need to second-guess
the decisions of the coal, oil, or gas industries. They are
well advised to simply plan business activities on the basis
of the price of the various fuel stocks available in the
marketplace. By the same token, energy consumers and the
firms that specialize in servicing them can be trusted to
ascertain how to use electricity in the most efficient man-
ner possible.
The decentralization and specialization of the economy,
with each economic unit maximizing efficiency within its
defined boundary and interacting with others through prices
and markets, are far more likely to result in efficient use
of resources than is reliance on dictates from central eco-
nomic planners, even if they are perched in the corporate
headquarters of electric utilities. F. A. Hayek outlined
the reason for that at the turn of the century. He argued
that knowledge is diffuse and concentrated in millions of
tidbits of information that are hardly discoverable by cen-
tral planners. Given the diffusion of economic information,
only a decentralized economy, characterized by specializa-
tion, property rights, and free markets, could possibly
assimilate the sum of that knowledge into economically use-
ful information via the price mechanism.(78)
Yet the advocates of DSM presume otherwise. The ex-
plicit assumption of DSM programs is that the electric util-
ity (or its consultants, such as Amory Lovins) knows better
than consumers of electricity how to most efficiently use
energy. The impossibility of such an assumption is ex-
plained by economist Larry Ruff.
The cost-effectiveness of any specific
DSM
device in any specific application by any specific
consumer depends on details of the device, the
consumer, the application, the timing, the deliv-
ery method, etc., in ways that are not directly
observable or controllable by the utility. There
are now high information and transaction costs
involved in implementing a utility DSM program--
unless one is willing to accept the assumption
. . . that utilities have, at near-zero cost,
near-perfect knowledge of and control over the
detailed preferences, options, and actions of
millions of economic consumers.
There is a name for a utility with the knowl-
edge and control necessary to implement a DSM
give-away program efficiently: God. Even to come
reasonably close to the truly cost-effective re-
sult in any but the simplest cases requires a
degree of knowledge and control that is unrealis-
tic for any real-world institution. Mere mortals
or even utility regulators cannot hope to handle
this job by centralized command-and-control
methods.(79)
The economic experience of the 20th century has shown
conclusively that central planning is incapable of effi-
ciently allocating and using resources. The chief obstacles
to efficiency faced by DSM programs include the negative
consequences of subsidies; the difficulty of judging, out-
side the marketplace, whether a program is cost-effective;
problems in measuring success; and the difficulty of pro-
jecting energy savings and costs of emerging technologies.
It should not be surprising, therefore, that virtually every
rigorous examination of utility-driven DSM finds that actual
conservation gains are far less than projected and program
costs spiral far beyond anyone's expectations.
Why Subsidize Efficiency?
The key element of DSM is the subsidy provided for
energy-efficient technologies. As long as the subsidies are
less than the cost of new generating capacity, however, they
are deemed efficient. Of course, if investments in energy
efficiency were wise in the first place, subsidies would
scarcely be necessary. As noted earlier, American industry
has made great strides in energy efficiency and is obviously
not averse to investing in new technology.
The availability of heavy subsidies, however, means
that consumers (commercial, industrial, and residential)
have an incentive to take advantage of subsidized programs
to meet investment needs that would have been undertaken
regardless of the existence of DSM programs. Those consum-
ers are known as free riders. Virginia Kreitler of Syn-
egetic Resources Co. reviewed dozens of detailed studies of
utility-sponsored DSM programs and found that free riders
constituted, on average, 71 percent of all participants in
refrigerator subsidy programs, 53 percent of all partici-
pants in air conditioner rebate programs, 62 percent of all
participants in air conditioner loan programs, 60 percent of
all participants in heat pump rebate programs, 31 percent of
all participants in weatherization programs, 41 percent of
all participants in efficient water heater purchase subsidy
programs, and 38 percent of all participants in commercial
and industrial lighting programs.(80) Kreitler's findings not
only cast doubt on the economic wisdom of subsidy programs;
they also bring into question the alleged gains of DSM pro-
grams, given that most of the gains would have occurred in
the free market.
Moreover, consumers are given an incentive to put off
major efficiency improvements not covered by existing DSM
programs if they believe that subsidies for such purchases
may be or could be forthcoming. James Clarkson of Southwire
Co., a firm that has annual sales in excess of $1 billion
and consumes over $100 million in electricity each year,
notes that "anticipation of conservation subsidies will
act
to slow the overall natural pace of equipment upgrading by
industry."(81)
Former New York Public Service Commission chairman Al-
fred E. Kahn also points out that subsidizing energy effi-
ciency may actually have the effect of increasing energy
waste.
There is a value in individual responsibility.
If
the only way consumers can be induced to do things
that are in their own interests is to be subsi-
dized by others, then many of us would contend
that it is a better society that permits them to
suffer the consequences of their errors rather
than one that, paternalistically, does it for
them, at the expense of others who behaved pru
dently. Departures from this principle have the
unhappy side effect of discouraging responsible
behavior by third parties as well. If the utility
company is going to subsidize people who will not
act in their own self-interest, it becomes ration-
al for others as well to refrain, in anticipation
of the subsidy.(82)
The Electricity Consumers Resource Council, a major
association of industrial energy users, concurs fully.
Some companies have done more [toward energy
effi-
ciency] than others. Some have done more at some
of their plants than others. That is part of the
competitive process. There are winners and los-
ers. Those that make the greatest efforts should
be the winners. Unfortunately, the implementation
of subsidized conservation programs helps the
laggards at the expense of the farsighted competi-
tors. That tilts the tables in ways that can be
very harmful to competition.(83)
The degree of competitive harm being inflicted on cer-
tain commercial enterprises in the name of DSM was unders-
cored recently in hearings in New York. Industrial energy
users in that state that have long promoted energy-efficien-
cy measures in their own facilities are now being soaked by
New York's aggressive DSM efforts.
- Camden Wire received only $740 in rebates for DSM
measures from 1990 to 1992 but will be forced to pay
approximately $150,000 in DSM-related surcharges over a
12-month period. Since Camden Wire has long been an
industry leader in energy efficiency, it has little
opportunity to receive DSM rebates for additional im-
provements.
- Blud Circle Cement's Ravena plant received
slightly
over $100,000 in DSM rebates but will pay approximately
$683,000 in DSM-related surcharges.
- Bristol Myers' Squibb facility received less than
$2,000 in DSM rebates in return for a $700,000 DSM bill
payable over 12 months.
- General Motors' Insland Fisher plant received only
$3,415 in DSM rebates from 1990 to 1992 but estimates
that it will pay approximately $300,000 in DSM-related
surcharges over a 12-month period.
_ Champion International qualified for a $3,200 DSM
rebate but will be forced to pay approximately $900,000
in DSM-related surcharges over a 12-month period.(84)
Although energy audits and conservation services often
make sense, utility entry into the energy-conservation in-
dustry, subsidized as it is by the ratepayers, will only
serve to crowd out private enterprise and stifle competi-
tion. There are thousands of independent contractors and
firms, known as energy service companies, selling and in-
stalling energy-efficiency technology. The growth of DSM,
with its heavily subsidized services, will put most of those
firms out of business.
That is not just conjecture. In New Jersey, for exam-
ple, the Coalition Against Unfair Utility Practices (CAUUP),
which is composed of 14 trade associations including those
representing plumbers, heating and cooling contractors, and
sheet metal workers, argues that DSM programs, which are
subsidized through the rate base, unfairly capture markets
from existing private conservation firms and consultants.
CAUUP alleges that over the past two years DSM programs in
New Jersey have raised the utilities' share of the energy-
conservation market from 5 percent to 85 percent and been
directly responsible for the unemployment of approximately
5,000 private contractors.(85)
Finally, the same incentives that encourage utilities
to provide power inefficiently will continue to exist under
DSM planning and will lead to inefficiencies in the subsi-
dized conservation programs. Utility companies, after all,
do well by doing badly. Since the rate of return allowed a
utility is determined by a set percentage of its annual
business costs, utility executives have every incentive to
raise costs; waste resources; ignore new, efficient technol-
ogies; and otherwise maximize business inputs. Thus, utili-
ties have no incentive to minimize the cost of DSM programs.
On the contrary, they are encouraged to run them as ineffi-
ciently as possible, or at least as inefficiently as they
can get away with.(86)
Insufficient Energy Use: The Flip Side of the Coin
DSM programs also damage economic efficiency because of
the double bonus that is given to the subsidized industry.
Observes economist Benjamin Zycher: "Electricity in this
sense is no different than any other good; I am rewarded for
not consuming an apple, thus releasing it for someone else
to consume, by the money I save by not buying it. Were the
supermarket to pay me the price of the apple that I do not
consume, I would consume too few apples."(87)
This is typically a hard concept for conservationists
to grasp: society can be just as easily harmed by insuffi-
cient energy use as it can by excessive energy use. Remem-
ber that energy is but one economic input typically compet-
ing with other inputs such as capital and labor. When ener-
gy prices go down relative to the price of other inputs,
businesses are well advised to substitute energy inputs for
other competing inputs wherever possible. That helps not
only the business in question (by reducing overhead and
increasing profit margins) but also society at large. The
scarcest resources will have the highest prices, and substi-
tution ensures that resources that are in relative abundance
(reflected in their lower prices) will be used to the exclu-
sion of scarce resources wherever possible.
Energy-conservation subsidies in situations in which
energy is dropping in price will be very expensive to main-
tain and will act to distort the proper decisionmaking of
resource consumers. Other resources that are scarcer than
energy will be excessively depleted, and consumer prices in
general will be higher than they would have been absent the
subsidies.
Aggregate Conservation Potential: Crunching the Numbers
The energy-conservation lobby maintains that massive
energy savings could be realized by adopting certain effi-
cient technologies that, by and large, are not being adopted
quickly enough or frequently enough to satisfy the conserva-
tionists. Lovins, for example, maintains that adoption of
currently available cost-effective technology could cut U.S.
electricity use by 75 percent.(88) The Electric Power Re-
search Institute (EPRI), which is much more conservative,
alleges that cost-effective technology could reduce elec-
tricity use by 24 to 44 percent.(89) The authors of America's
Energy Choices believe that the potential for energy conser-
vation is somewhere between those two estimates but closer
to Lovins's estimate than to EPRI's.(90)
Those estimates vary a great deal, revealing the amount
of speculation involved in such projections. Yet the con-
clusions are all the same--America is not using energy as
efficiently as it should, and government intervention is
warranted to ensure conservation.
But would the recommended investments be truly cost-
effective in the sense that more would be saved than in-
vested? Even aside from the question of opportunity costs,
there are many reasons to doubt the conclusions of both the
conservationists and EPRI.
Total Resource Cost Tests
DSM advocates make a superficially attractive case for
conservation measures by arguing that, as long as a util-
ity's DSM expenditure to save x kilowatt-hours costs less
than a similar supply-side expenditure to generate x kilo-
watt-hours, efficiency and cost-effectiveness are served and
ratepayers come out ahead. Consider, however, a situation
outlined by economist Larry Ruff, in which that very scenar-
io is played out.
Suppose a utility has avoided supply costs
of nine
cents per kilowatt hour, is charging a price of
seven cents per kilowatt hour, and offers to pay
five cents toward the cost of [conservation] mea-
sure "M" for any customer. For customer "X,"
mea-
sure M will save one kilowatt hour and seven cents
(the retail rate) at a cost to X of only three
cents, and hence X will accept the utility offer.
When X does so, nine cents in utility generation
costs are avoided for only eight cents (the five-
cent utility program cost plus the three-cent
customer cost)--the result is cost-effective.
However, the utility loses 12 cents (the five-cent
program cost plus the seven-cent loss in revenue)
to avoid nine cents in production costs, and hence
rates must increase to make up the three-cent
difference.(91)
It is striking that, although 12 cents is being spent
to save electricity, which costs only 9 cents per kilowatt-
hour to produce, the above scenario passes the DSM test for
cost-effectiveness. That scenario is not an extreme case;
it is typical of the economics-made-simple of DSMs.(92) Even
Wirtshafter concedes that "if DSM is forced to satisfy
strict, short-term cost justification, then it will never
have the opportunity to develop fully."(93)
The conservation lobby argues, however, that the total
costs and benefits of DSM must be measured before we make a
decision about economic efficiency. Yet that is just what
prices do: they measure the total costs--of capital, labor,
energy, and other natural resources--of a good or service.
Consumers then examine the price of the good and add to it
other costs, such as opportunity costs, that are particular
to their unique situation and compare them to the benefits
they expect to derive from purchase of the good in question.
Consumers are the best judges of what is cost-effective and
what is not given their unique financial conditions, prefer-
ences, tastes, and personal circumstances.
DSM advocates support the total resource cost-effec-
tiveness of their programs by marshaling purely hypothetical
assertions about cost and benefits, even when the evidence
from the real-world market points to contrary conclusions.
A recent study commissioned by the Environmental Protection
Agency underscored that fact by concluding that energy sav-
ings for DSM can be found only when total resource costs are
disregarded. That study, commissioned from National Econom-
ic Research Associates, examined two of the purportedly most
successful DSM programs in the nation: those of Massachu-
setts Electric Co. and Central Hudson Gas and Electric.(94)
Although the utilities released rather sophisticated analy-
ses showing that benefits outweighed costs by a factor of 2
or more, NERA found that
upon closer examination, however, it becomes
clear
that costs and benefits reported by the two utili-
ties are highly incomplete and bear little rela-
tionship to what most economists would regard as
appropriate accounting for the costs and benefits
to all relevant parties [emphasis in the origi-
nal]. Both ignore some costs borne by the utili-
ties (and ultimately their ratepayers or share-
holders), and neither deals explicitly with the
costs and benefits to the participants. Because
their components are so incomplete, the reported
benefit-cost ratios (or net savings) have little
meaning.(95)
NERA's calculations indicated that Central Hudson's DSM
programs cost ratepayers $20.7 million and provided benefits
of only $9.2 million, for an overall net loss to ratepayers
of $11.5 million annually ($7.4 million if the utility's
optimistic projection of future units-avoided costs actually
pans out). Similarly, Massachusetts Electric's DSM programs
cost ratepayers $192.6 million and provided benefits of only
$142.8 million, an annual net loss of almost $50 million to
the ratepayers.(96) Overall net costs to society were esti-
mated at between $5.7 million and $9.7 million for Central
Hudson's DSM programs (again, depending on projections of
future avoided-unit costs) and $29 million for those of
Massachusetts Electric.(97)
Ruff appropriately challenges the DSM lobby to "prove
that total resource costs are reduced by asking those who
get the benefits to pay the (presumably lower) costs and see
if they are pleased."(98) In other words, no subsidies.
Of course, conservationists argue that consumers (resi-
dential, commercial, and industrial) systematically under-
estimate the value of conservation measures for the various
reasons described earlier.(99) Yet NERA concludes that the
customers of Central Hudson and Massachusetts Electric, for
example, would have to underestimate the benefits of energy
efficiency by factors of 7 and 3, respectively, for program
benefits to equal costs.(100) Misperceptions of the effec-
tiveness of energy efficiency there may be, but of that
magnitude? Such claims are particularly striking given that
those two utilities devote almost 90 percent of their DSM
expenditures to commercial and industrial customers. One
can perhaps envision harried housewives or busy families
overlooking the opportunities for energy savings in their
homes, but businessmen concerned with the bottom line are
very unlikely to have such extreme misperceptions. "Al-
though it is clear that firms and households are highly
imperfect at making estimates of costs and benefits, it is
hard to believe that they make the kinds of very large sys-
tematic errors that would be needed to explain away our
results," says Albert Nichols. "If one believes that
these
large businesses make highly irrational choices about well-
defined options like efficient lighting, presumably one
should favor government programs to intervene in businesses'
investment decisions about a huge array of issues, not just
energy conservation."(101)
If bureaucratic planners could accurately judge the
costs and benefits of goods and services without recourse to
the marketplace, West Germans would have taken to the
streets to demand an East German economic system.
The Rating Game: Discount and Interest Calculations
The conservation lobby does, however, make a compelling
argument when it offers technology after technology that
allegedly will "pay for itself" in energy savings
after so
many years. If a technology is capable of doing so, it is
deemed cost-effective and qualifies for consideration under
DSM programs. How quickly must a technology pay for itself
in order to be deemed cost-effective? Lovins provides for
an infinite pay-back time for investments, examining "long-
term potential, however long it takes to achieve."(102)
EPRI,
on the other hand, variably limits pay-back time to qualify
a technology as cost-effective.(103) The authors of America's
Energy Choices require pay-back times of 14 years for resi
dential and commercial technologies and 20 years for indus-
trial technologies.(104)
Yet simple economic calculations of pay-back time are
fraught with uncertainty, largely because assumptions about
interest and discount rates can dramatically alter what we
consider cost-effective. Nowhere in any of the estimates of
pay-back time are interest rates even considered--they are
assumed to be zero. Given the heavy front-end nature of
those costs and the extremely long pay-back time for many of
the technologies, interest is bound to dramatically restrict
what can be considered cost-efficient and increase projected
conservation costs.
Similarly, there is the question of discount rates.
Both EPRI and Lovins assume a real discount rate of 5 per-
cent. The authors of America's Energy Choices go even fur-
ther and use a 3 percent discount rate. Those "social
dis-
count rates" supposedly are preferable to private discount
rates because of imperfections in the capital markets (cred-
it restrictions and limited availability of capital are the
examples given), differing perceptions of risk from private
and public perspectives, and "different values placed on
future consumption." America's Energy Choices argues that
"society may prefer to treat consumption for all generations
as equally valuable, in contrast with individuals, who may
value current consumption more highly than future consump-
tion."(105)
There is little reason, however, to believe that free
markets give scant attention to the needs of future genera-
tions. As discussed earlier, the profit motive ensures that
people will act to ensure the well-being of generations to
come. Government planners and regulators, however, have a
notorious disregard for future generations; the budget defi-
cit, the savings-and-loan fiasco, and numerous other exam-
ples prove the point.
There is no better "social discount rate" than
the rate
arrived at by millions of transactions among millions of
savers and borrowers.(106) As was noted earlier, the discount
rate used by private consumers investing in energy conserva-
tion can be as high as 20 percent. According to Douglas
Houston:
The riskiness (and resulting high discount
rates)
applied by households means that consumers inter-
pret DSM programs to be less beneficial than do
the planners. When a DSM program's subsidies
overcome a consumer's reticence to invest, this
merely replaces the judgement of the consumer with
the judgement of the planner far removed from the
specific problems faced in this household. Since
no information is added to the decision process,
it cannot be said that DSM programs provide infor-
mation that reduces uncertainty about the invest-
ment. Therefore, the standard practice of apply-
ing low "social" rates of discount to DSM invest-
ments amounts to a disavowal that these costs and
risks involved are real, a denial that the real-
world concerns of individuals matter.(107)
The discount rate used is important because it has a
tremendous impact on the projected costs and savings of in-
vestments in energy efficiency. The Oak Ridge National
Laboratory, for example, estimates that an ambitious nation-
al DSM program using a 5 percent discount rate could save
$205 billion over the next 20 years. Yet use of a real-
world 20 percent discount rate yields a net savings of only
$86 billion over the next 20 years.(108) Similarly, the au-
thors of America's Energy Choices estimate that their sce-
nario for aggressive conservation programs would yield, at a
3 percent discount rate, $2.3 trillion in savings over the
next 40 years. Even shifting the discount rate to 7 per-
cent, the typical value used for most private-sector invest-
ments (the pretax return on investment), reduces savings to
$560 billion, only about one-quarter the savings estimated
using a 3 percent discount rate.(109) Those adjusted savings
are still significant, but they are from one-half to one-
quarter the size alleged by DSM proponents. Even assuming
that all the assertions of DSM effectiveness are accurate,
the savings potential is still but a fraction of that al-
leged by the conservation lobby.
Shooting in the Economic Dark
In addition to the micro- and macroeconomic distortions
caused by subsidies (e.g., free-rider problems, correspond-
ing overuse of competing resource inputs, competitive in-
equities, none of which are considered in the calculation of
DSM costs), there are a number of other dubious assumptions
built into the estimates of the cost savings of DSM.
The aggregate costs of DSM and energy-conservation pro-
grams estimated by EPRI and Lovins ignore direct administra-
tive costs. Program design, market research, advertising,
bid development and review, inspections for quality control,
recruitment, staff training, metering, accounting, evalua-
tion, periodic reporting, legal fees, office space, and the
obvious high cost of personnel and consultant services are
all rolled into utility DSM costs. A review of studies
available on current utility DSM programs indicates that
those costs are extremely high--they typically account for
20 to 50 percent of total program costs.(110) MIT Professors
Paul Joskow and Donald Marron found administrative costs to
be even higher, ranging from 70 to 107 percent of direct
measured costs of the utilities they examined.(111)
Energy cost savings estimated by both EPRI and Lovins
include not only reductions in energy use but the avoided
cost of building new generation capacity. Those estimates
of avoided costs, however, assume that the marginal cost of
constructing new capacity will be 5 cents per kilowatt-hour.
Although they assume rapid technological advances in effi-
ciency, EPRI and Lovins also assume that electricity produc-
tion technologies and efficiencies will remain stagnant.
That is hardly realistic.
Finally, there is the question of the specific cost
estimates for each technology that went into the aggregate
savings projections used by EPRI and Lovins. As noted ear-
lier by the Oak Ridge Laboratory, "Information regarding
the
technical and economic viability of such [efficient energy]
technologies under full-scale, actual usage conditions is
often scarce." Moreover, an energy supply curve, showing
which technologies are cost effective at various energy
prices "for most technologies, . . . is not available."(112)
In other words, the various cost and savings projections of
EPRI and Lovins are little more than speculation.(113)
Since so little is known about the cost and savings
potential of many advanced energy-saving technologies, it
comes as something of a shock to hear Lovins state with such
certainty that "the long-run supply curve for electricity
[savings] is so flat and slopes so gently that the market-
clearing price [of electricity] will never be high enough to
justify building more central thermal power stations."(114)
Economist Benjamin Zycher asks pointedly:
How can anyone know the slope of any cost or
sup-
ply function for technologies that Lovins claims
are now newly emerging and which are continuing to
evolve rapidly? Even for the most mundane and
familiar goods and activities, cost functions are
difficult to estimate econometrically. Functional
forms are not known with any degree of certainty.
Accounting data obscure the more relevant parame-
ters of opportunity cost. Statistical problems
affect the reliability of estimates, often in ways
that are subject only to guesswork. Despite all
this, we have Lovins making confident assertions
about cost functions for things that are newly
arrived and that have yet to be invented!(115)
Likewise, Lovins's "Competitek" data base, which
he
cites in support of his aggregate energy-saving claims,
"seeks . . . adequate accuracy more than utterly rigorous
completeness in every detail."(116) Zycher points out
that
"since 'adequate' is not defined, errors, omissions, and
other violations of rigor can fit nicely within Competitek's
methodology."(117)
Since we are dealing with presumably "educated"
guesses
about costs and benefits, how confident can we be about the
general accuracy of projections? A cursory examination of
Lovins's published writings and public testimony provides
little reason to trust the figures so often bandied about by
the conservation lobby. Analysts who have double-checked
Lovins's facts and figures on the availability, performance,
and cost of technologies have found that his work is replete
with misleading conclusions, errors in calculation, factual
inaccuracies, and wildly speculative assumptions.(118) Zycher
concludes bluntly that "Lovins has distorted and/or fabri-
cated virtually all of his 'evidence.'"(119) The EPRI
report
and America's Energy Choices share many if not most of those
flaws.
The Failure of Central Planning
Analysts who have examined conservation programs close-
ly have found that actual energy gains have been but a frac-
tion of what had been expected. An examination of three
energy-conservation programs administered by the Bonneville
Power Administration indicated that observed savings were
only 50 percent of what had been expected by the program
administrators.(120) Six demand-side management programs ad-
ministered by Central Maine Power were found to produce only
27 percent of the energy savings expected at triple the cost
projected by the utility, making the programs far more ex-
pensive than the marginal cost of new generation capac-
ity.(121) Similarly, homes participating in a refrigerator
rebate program administered by Wisconsin Electric Power Co.
actually increased their energy consumption.(122) An examina-
tion of conservation programs administered by the San Diego
Gas and Electric Co. found that actual electricity savings
were 50 to 80 percent of the estimated savings and gas sav-
ings were less than 50 percent of the estimates.(123)
Moreover, those findings are not aberrations; they are
typical of the actual performance of utility-sponsored ener-
gy-conservation programs. Economist Phoebe Caner examined
34 DSM programs recently and found that actual savings for
27 of those programs were less than projected by the manag-
ing utility. More than half of those programs yielded less
than 50 percent of projected savings.(124) Likewise, Steven
Nadel of the American Council for an Energy Efficient Econo-
my (an active proponent of DSM) and Kenneth Keating of the
Bonneville Power Administration examined 37 separate DSM
programs and found that retrofit, residential appliance, and
lighting programs yielded substantially less energy savings
than had been projected. Residential retrofits, typically
involving energy audits and weatherization, saved 52 percent
less energy than had been estimated by the various utili-
ties; residential appliance programs likewise saved 57 per-
cent less than estimated. And commercial and industrial
lighting programs saved 43 percent less energy than pro-
jected.(125)
Studies to date indicate that utilities that have in-
stituted DSM programs have experienced no reduction in cus-
tomer electricity demand relative to utilities that have yet
to jump on the DSM bandwagon. Central Maine Power, for
example, has experienced a slight increase in residential
consumer demand for electricity per meter over the past 10
years despite its aggressive DSM efforts. By contrast,
Green Mountain Power of Vermont has experienced a slight
reduction in consumer demand per meter without having
adopted any major DSM program until recently.(126) The pat-
terns of residential customers' kilowatt-hour usage exhibit
similar fluctuations for both utilities, indicating the
similarities in regional climate and demographic profiles of
their respective consumers. Likewise, Osage Municipal Util-
ities in Iowa (OMU), a utility much heralded for its aggres-
sive DSM program, has experienced a significant decline in
natural gas consumption per meter over the past 20 years,
but that decline has been offset by an even greater increase
in per capita consumption of electricity. Yet even OMU's
decrease in natural gas use per residential meter is re-
flected by similar trends experienced by other Iowa utili-
ties (Iowa Southern, Iowa-Illinois, and Midwest Resources)
that have not embarked on the advanced DSM path blazed by
OMU.(127)
Clearly, if DSM programs were successful in reducing
demand, evidence of that fact could be found by examining
the bottom-line demand figures of utilities. Yet virtually
all the utilities participating in DSM today fail to show
any reductions in consumer demand per meter beyond those
experienced by non-DSM utilities.
Studies that purport to show successful DSM programs
invariably report calculated savings rather than actual re
sults based on extensive monitoring, fail to adjust for sav-
ings in consumption that occurred independent of the program
(such as price variation and weather changes), ignore the
impact of free riders who would have invested in energy
efficiencies regardless of the program's existence, fail to
use control groups to ascertain legitimate comparisons of
behavior, or incompletely total resource costs.(128) Con-
sequently, the General Accounting Office concluded that
"regulators in states we selected expressed limited confi-
dence in the accuracy of a utility's estimates of demand-
side management electricity savings."(129)
There are many additional reasons for the failure of
centrally planned conservation programs. First, programs
directed at premature replacement of relatively energy-
inefficient machinery and appliances are doomed to fail be-
cause of what we might call "the refrigerator effect."
When
an old refrigerator is replaced by a new energy-efficient
refrigerator, consumers often put the old appliance down in
the basement to serve as a reserve storage space for food
and beverages. Thus, rebates or subsidized sales of appli-
ances to consumers often result in increased energy use.
Second, according to analyst Kent Anderson, "engineer-
ing models simply exaggerate the effectiveness of conserva-
tion devices in practice. This may reflect the practical
problems that occur in installing and using these devices in
real-life circumstances."(130) Synergic Resources Corporation
(SRC), for example, recently examined 16 types of commercial
buildings that had participated in the Bonneville Power
Administration's pilot DSM program. After extensive inves-
tigation, SRC found that half of the participants had aban-
doned energy-efficiency measures instituted under the pro-
gram, claiming for the most part that design and performance
problems were the chief reasons.(131)
As noted by NERA's Albert Nichols:
Estimates of the savings from DSM programs
are plagued by many difficulties that limit their
accuracy. Estimates based on engineering analysis
appear to be especially unreliable, particularly
when behavioral factors (such as free ridership or
snapback) are important. In many cases, engineer-
ing estimates also suffer from inaccurate assump-
tions about such basic factors as hours of opera-
tion; not surprisingly, these kinds of errors tend
to be most severe when the calculations rely upon
generalized assumptions rather than site-specific
estimates.
The evidence available suggests that not only
are engineering estimates often inaccurate, they
generally have a strong upward bias. Some of the
bias results from the fact that most engineering
calculations make no adjustments for free riders,
but even if the free-rider issue is eliminated,
there appears to be a tendency towards overestima-
tion.(132)
Compounding that problem, of course, is the speculative na-
ture of many of the cost-savings estimates being relied on
in the first place, as was mentioned earlier.
Third, most energy-saving projections are based on the
profile of an average user: the statistically "average"
house, manufacturing plant, or appliance. Consumers who use
energy most intensively are more likely to already have
efficient equipment than are smaller energy consumers.
Thus, using data based on the "average" consumer in
a user
category will probably overstate the amount of energy sav-
ings possible under a given program.
"Negawatts" vs. "Ecowatts"
Paradoxically, the energy-efficiency programs endorsed
by the conservation lobby may actually act to increase ener-
gy use and reduce efficiency gains that would otherwise
occur. That is because those programs generally address the
one form of energy that has been responsible for most of the
efficiency gains experienced over the past 20--electricity.
"Electricity, being the costliest form of energy,
is
the most lucrative form [of energy] to save," argues Lov-
ins.(133) Nothing, however, could be further from the truth.
A recent report issued by Science Concepts, Inc., points out
that
the myth that electricity is wasteful results
from
ignoring the efficiency with which fuels are used
in the marketplace. For example, the best power
plants convert 40 percent of the energy consumed
into electricity. However, electric motors con-
vert 90 percent of electricity into useful motion.
By comparison, even the most efficient automobile
converts less than 20 percent of its fuel energy
into the drive shaft. In other words, the effi-
ciency with which electricity can be used more
than offsets the inefficiency of making electrici-
ty. Meanwhile, the efficiency with which fossil
fuels can be used is remarkably low in most appli
cations and, for reasons of fundamental physics,
inherently limited.(134)
Thus, the electrification of society is not a symptom
of energy wastefulness but a crucial element of energy effi-
ciency. For example, fax machines, powered by electricity,
have substituted for the much more energy intensive practice
of transporting mail via the postal service. Laser cutting
tools have reduced the number of product rejects and the
amount of cutting waste that would require energy to re-
place. Microwave ovens are far more efficient than gas
stoves. It is no coincidence that since 1973 electricity
generation has increased by 50 percent while energy effi-
ciency has actually improved by 40 percent when measured
against GNP.(135)
The tremendous potential for further gains in energy
efficiency through electrification--termed "ecowatts"
by
Science Concepts, Inc.--far outweighs the potential of "neg-
awatts." Even using the dubious assumptions of EPRI, the
full use of existing energy-conservation technology would
save 220 gigawatts of energy a year. EPRI concedes that,
even if restricted to only "cost-effective" conservation
technology, total savings would drop to 69 gigawatts annual-
ly. On the other hand, according to Science Concepts, the
full use of existing electrical technology--"ecowatts"--
could save a total of 970 gigawatts annually, 300 gigawatts
of which would be cost-effective.(136)
Subsidizing or mandating energy-conservation technolo-
gies will stymie, not advance, continuing gains in energy
efficiency. As Science Concepts points out:
Programs devoted to achieving energy efficiency
consume capital. Regulators can provide an arti-
ficial environment in which investments in energy
efficiency are more fiscally attractive to busi-
nesses. If this reduces the capital available for
the installation of more productive equipment, the
overall long-term effect will be to delay funda-
mental technology progress and its associated im-
provements in energy use and environmental qual-
ity.(137)
The Danger of Coercion
Energy policy debates often serve as cover for hidden
agendas concerning how life should be lived, resources used,
and incomes distributed. Markets are distrusted by the con-
servation lobby because they allow choices that the conser
vationists would restrict. Control over the lifeblood of
modern society--energy--would transfer tremendous power to
the state at the expense of the individual.
The past statements of many of the leaders of the con-
servation lobby call into question their true motivation in
this debate. "It would be little short of disastrous for
us
to discover a source of clean, cheap, abundant energy be-
cause of what we might do with it. We ought to be looking
for energy sources that don't give us the excesses of con-
centrated energy with which we could do mischief to the
earth and each other," says Lovins.(138) Professor Paul
Ehr-
lich argues that "giving society cheap, abundant energy
. . . would be the equivalent of giving an idiot child a
machine gun."(139) The universal alarm expressed by the
con-
servation lobby at the possibility of cold fusion betrayed
an anti-growth mentality inconsistent with their public
allegiance to "negawatts" as a cheap, affordable,
and pain-
less energy source. Jeremy Rifkin, for example, cried that
the discovery of cold fusion would be "the worst thing
that
could happen to our planet."(140)
America is not running out of energy. The free market
has provided and will continue to provide for energy effi-
ciency. The invisible hand of the market is far superior to
the dead hand of central planning. By eliminating the re-
maining barriers to energy exploration, generation, distri-
bution, and use, America will ensure that affordable and
abundant energy is available for future generations. By
reducing the size of government, we can provide for energy
efficiency gains and technological advances that are un-
dreamed of today without sacrificing the freedom to live as
we choose.
Notes
(1) Martha Hamilton and Warren Brown, "Conservation Compla
cency in the U.S.," Washington Post, August 12, 1990,
p. A26.
(2) The Real Story, Cable News and Business Network, Decem
ber 6, 1991.
(3) Morris Adelman, "Oil Fallacies," Foreign Policy
82
(Spring 1991): 10.
(4) "Energy and the Environment: A Power for Good, a
Power
for Ill," The Economist, August 31, 1991, Survey, p. 5.
(5) Michael Canes, "Oil's Tenacious Lock on Health of
Econ
omy," Forum for Applied Research and Public Policy 7, no.
1
(Spring 1992): 18.
(6) "Energy, Economy, and the Environment: A Balanced
Poli
cy for the 1990s," Hudson Institute, Indianapolis, September
1991, p. 19.
(7) James Bennett and Thomas J. DiLorenzo, Official Lies:
How Washington Misleads Us (Alexandria, Va.: Groom Books,
1992), pp. 142-43.
(8) U.S. Congress, House of Representatives, Presidential
Energy Program, Hearings before the House Subcommittee on
Energy and Power on the implications of the president's
proposals in the Energy Independence Act of 1975, 94th
Cong., 1st sess., 1975, p. 643.
(9) Ibid.
(10) Ibid.
(11) "Fear Is Expressed of U.S. Oil Scarcity," New
York
Times, June 11, 1950, p. 49.
(12) Richard McKenzie, "The Sense and Nonsense of Energy
Conservation," American Petroleum Institute, Washington,
July 1991, p. 12.
(13) "Energy and the Environment."
(14) Michael Lynch, "Future Oil Supplies: Is Wolf Really
at
Door?" Forum for Applied Research and Public Policy 7,
no. 1
(Spring 1992): 25.
(15) Ibid.
(16) Daniel Yergin, "Gasoline and the American People,"
Cambridge Energy Research Associates, Cambridge, Mass., June
1991, p. 15.
(17) Ibid., p. 17.
(18) F. A. Hayek, The Constitution of Liberty (Chicago:
University of Chicago Press, 1960), pp. 369-70.
(19) Amory Lovins, "Balancing Energy Supply and Demand,"
in
Meeting the Energy Challenges of the 1990s: Experts Define
the Key Policy Issues, GAO/RCED-91-66 (Washington: GAO,
March 1991), p. 40.
(20) Likewise, the average European household has 50 to 80
percent less living space than its American counterpart.
"Energy and the Environment," p. 12.
(21) T. R. Reid, "Japan's Housing: Pricey, Chilly, and
Toilet-Poor," Washington Post, March 4, 1991, p. A9.
(22) Thomas J. DiLorenzo, "Japanese Mercantilism,"
The En
terpriser, August 1991, p. 7.
(23) If Japanese energy use is compared to that of New York
City, a comparison which is more appropriate given popula
tion density, one finds little difference between the two in
terms of energy efficiency. "Energy, Economy, and the
Envi
ronment," p. 19. Although the U.S. population is 5 to
10
times less concentrated than that of many of the G-7 na
tions, the amount of energy used for transportation is only
5 to 10 percent greater than in those countries. That is
all the more impressive when one considers that the distance
between population centers makes mass transit less practical
for the United States than for our G-7 counterparts. See
"Energy Policy: What Now?" Nuclear Industry (First
Quarter
1991): 39-40.
(24) U.S. Department of Energy, National Energy Strategy,
1st ed. (Washington: Government Publishing Office, February
1991), p. 24.
(25) When industrial energy use is measured in terms of
energy intensity per unit of non-raw-materials manufactur
ing, there is little difference in energy use among the G-7
nations. See "Energy Policy."
(26) Ibid. Further evidence of the fallacious nature of per
capita energy comparisons appears when one considers the
fact that energy use varies greatly from state to state;
some states use 4.5 times more energy than others. The
biggest U.S. energy users are Alaska, Wyoming, Louisiana,
Texas, and North Dakota. Does that mean that residents of
those states are more "wasteful" than others? Of
course
not. It reflects the fact that those states have low popu
lation density and are home to industries that by their very
nature require large amounts of energy to operate. Roughly
two-thirds of the energy those states consume is devoted to
their respective industrial sectors. U.S. Department of
Energy, p. 26.
(27) "Energy, Economy, and the Environment," p. 5.
(28) Ibid.
(29) "For the Record," Washington Post, June 18,
1991,
p. A20.
(30) Matthew Wald, "Gulf Victory: An Energy Defeat?"
New
York Times, June 18, 1991, p. D9.
(31) Hamilton and Brown, p. A1.
(32) U.S. Department of Energy, p. 76. This figure under-
estimates actual efficiency gains by failing to account for
the indirect energy savings stemming from electrification.
The use of fax machines, for example, reduces the energy
demands of traditional mail transportation. Laser cutting
produces less waste material and reduces the number of re
jected products. Dozens of examples such as those are not
normally calculated or accounted for in energy conservation
models or programs.
(33) Ibid., p. 55.
(34) "U.S. Energy Efficiency," Response no. 451,
American
Petroleum Institute, Washington, October 3, 1990.
(35) H. Jane Lehman, "Interest in Energy Efficiency Expected
to Heat Up," Washington Post, August 25, 1990, p. E1.
(36) Mikhail Bernstam, The Wealth of Nations and the Envi
ronment, Occasional Paper no. 45 (London: Institute for
Economic Affairs, January 1991), p. 27.
(37) "Energy Security White Paper: U.S. Decisions and
Global
Trends," American Petroleum Institute, Washington, 1988,
pp. 83-85.
(38) U.S. Department of Energy, p. 2.
(39) Douglas Bohi, Energy Price Shocks and Macroeconomic
Performance (Washington: Resources for the Future, 1989).
(40) Douglas Bohi, "Thinking through Energy Security
Issues," American Enterprise, September-October 1991, p.
34.
(41) Ibid., p. 33.
(42) "Conservation Could Help Reduce Acid Rain Control
Costs, Study Says," Bureau of National Affairs Environmental
Reporter, May 5, 1989, p. 11.
(43) Dixy Lee Ray and Lou Guzzo, Trashing the Planet (Wash
ington: Regnery Gateway, 1990), pp. 37-38.
(44) Environmental Protection Agency, Office of Policy,
Planning, and Evaluation, Environmental Investments: The
Cost of a Clean Environment: A Summary, EPA-230-12-90-084
(Washington: EPA, December 1990), p. 2-1.
(45) See, for example, Michael Hazilla and Raymond Kopp,
"Social Cost of Environmental Quality Regulations: A General
Equilibrium Analysis," Journal of Political Economy 98,
no.
4 (1990): 853; William Niskanen, "The Total Cost of Regu
lation?" Regulation 14, no. 3 (Summer 1991): 23-25; and
William Niskanen, "The Costs of Regulation (continued),"
Regulation 15, no. 2 (Spring 1992): 25-26.
(46) Roy Cordato, "Assessing the Case for Energy Taxes,"
Paper presented at Cato Institute conference "National
Ener
gy Strategy: Markets or Mandates?" Washington, January
16,
1992.
(47) See generally Terry Anderson and Donald Leal, Free
Market Environmentalism (San Francisco: Westview, 1991); and
Cato Symposium on Pollution, Cato Journal 2, no. 1 (Spring
1982).
(48) Bernstam, p. 24.
(49) This roster of alleged market failures is drawn largely
from arguments found in Roger Carlsmith et al., "Energy
Efficiency: How Far Can We Go?" ORNL/TM-11441, Oak Ridge
National Laboratory, January 1990, pp. 26-30; and Alliance
to Save Energy et al., America's Energy Choices: Investing
in a Strong Economy and a Clean Environment (Cambridge,
Mass.: Union of Concerned Scientists, 1991).
(50) For a more complete examination of this issue, see The
Theory of Market Failure, ed. Tyler Cowen (Fairfax, Va.:
George Mason University Press, 1988).
(51) Hethie Parmesano and William Bridgman, "The Role
of
Nature and Marginal and Avoided Costs in Ratemaking: A Sur
vey," Working Paper no. 15, National Economic Research
Asso
ciates, Inc., White Plains, N.Y., February 1992.
(52) California Public Utilities Commission and California
Energy Commission, "Standard Practice Manual: Economic
Anal
ysis of Demand-Side Management Programs," Staff report,
December 1987, p. 3.
(53) See generally Electric Power: Deregulation and the
Public Interest, ed. John Moorhouse (San Francisco: Pacific
Research Institute for Public Policy, 1986).
(54) "Still Not Serious about Energy," Washington
Post,
February 12, 1991, p. A18.
(55) Alan Reynolds, "Malign Neglect," Forbes, December
10,
1990, p. 318.
(56) Amory Lovins, "Invited Comments on Kenneth W. Cos
tello's Article 'Should Utilities Promote Energy Conserva
tion?'" Electric Potential, March-April 1986, p. 4.
(57) Albert Nichols, "How Well Do Market Failures Support
the Need for Demand Side Management?" National Economic
Research Associates, Inc., White Plains, N.Y., 1992,
pp. 21-24.
(58) Ibid., pp. 21-22.
(59) Lewis Perl, rebuttal testimony before the Florida Pub
lic Service Commission, Docket no. 910883-EI, November 20,
1991, p. 27.
(60) Douglas Houston, "Demand-Side Management: Conservation
for Conservation's Sake?" Draft monograph, Institute for
Energy Research, Houston, October 1991, p. 9; and Nichols,
"How Well Do Market Failures Support the Need for Demand
Side Management?" pp. 24-25.
(61) William Laffer, "The Effect of Taxes and Regulations
on
Time Horizons," Heritage Foundation, Washington, July 31,
1991, p. 2.
(62) The lack of an oil depletion allowance (every other
industry is allowed capital depletion), a 24 percent tax on
"intangible drilling costs" (only the petroleum industry
faces a tax on normal business expenses), the "Superfund"
tax, and gasoline taxes are all unique tax penalties imposed
on no other industry in America (except that the Superfund
tax is also applied to the closely related chemical indus
try).
(63) Benjamin Zycher, "The Theoretical and Empirical Fanta
sies of Amory Lovins," Paper presented at the annual meeting
of the Western Economic Association International, Seattle,
June 29-July 3, 1991, p. 5.
(64) This point is underscored strongly by Douglas Koplow of
the Harvard Business School in an upcoming study for the
Alliance to Save Energy titled "Federal Subsidies to the
U.S. Energy Sector in FY 1989."
(65) Alliance to Save Energy et al., p. 24.
(66) Richard Pindyck, "Inter-fuel Substitution and the
In
dustrial Demand for Energy: An International Comparison,"
Review of Economics and Statistics, May 1979, pp. 169-79.
(67) "Energy Efficiency," p. 29.
(68) Ibid.
(69) Ibid., p. 30.
(70) Alliance to Save Energy et al., p. 24.
(71) This holds true even for rental markets that are, ac
cording to conservationists, less likely to reflect energy
efficiency in rents, which in turn leads to underinvestment
in energy efficiency. Nichols, "How Well Do Market Failures
Support the Need for Demand Side Management?" pp. 26-29.
(72) Matthew Wald, "Saving Energy: Still a Tough Sell,"
New
York Times, March 30, 1991, p. 25.
(73) Nichols, "How Well Do Market Failures Support the
Need
for Demand Side Management?" p. 30.
(74) Written statement of the Electricity Consumers Resource
Council to the House Banking Subcommittee on Economic Stabi
lization, November 6, 1991, p. 3.
(75) Lawrence Prete et al., "Electric Utility Demand-Side
Management," Electric Power Monthly, April 1992, pp. 19-33.
(76) Robert Wirtshafter, "The Dramatic Growth in DSM:
Too
Much, Too Soon?" Electricity Journal, November 1992,
pp. 36-46.
(77) Ibid., p. 39.
(78) F. A. Hayek, Individualism and Economic Order (South
Bend, Ind.: Regnery Gateway, 1948), "The Use of Knowledge
in
Society," pp. 77-91.
(79) Larry Ruff, "Equity v. Efficiency: Getting DSM Pricing
Right," Electricity Journal, November 1992, pp. 27, 29.
(80) Virginia Kreitler, "On Customer Choice and Free Rider
ship in Utility Programs," in Energy Program Evaluation:
Uses, Methods, and Results, Proceedings of the 1991 Interna
tional Energy Program Evaluation Conference, Chicago, August
21-23, 1991, p. 304.
(81) James Clarkson, Southwire Company, Testimony before the
Georgia Public Service Commission, June 1, 1992, p. 7.
(82) Quoted in Written statement of the Electricity Consum
ers Resource Council, p. 20.
(83) Ibid., p. 4.
(84) John Hughes and Barbara Brenner, "DSM: When Should
Industrials Just Say No?" Abstract, forthcoming in the
Pro
ceedings of the 6th National Demand-Side Management Confer
ence, March 24-26, 1992, Miami Beach, p. 6.
(85) "State Lawmakers Eye Plan to Ban Utilities from Servic
ing Appliances," Electric Power Alert, April 15, 1992,
p. 32.
(86) Bernstam, p. 49.
(87) Zycher, p. 7.
(88) Amory Lovins et al., "Efficient Use of Electricity,"
Scientific American, September 1990, pp. 65-74.
(89) General Accounting Office, Electricity Supply: Utility
Demand-Side Management Programs Can Reduce Electricity Use,
GAO/ RCED-92-13 (Washington: GAO, October 1991), p. 12.
(90) Alliance to Save Energy et al., pp. 45-49.
(91) Larry Ruff, "Least-Cost Planning and Demand-Side
Man
agement: Six Common Fallacies and One Simple Truth," Public
Utilities Fortnightly, April 28, 1988, p. 23.
(92) For a more thorough discussion of the economic falla
cies surrounding least-cost planning, see Paul Joskow,
"Should Conservation Proposals Be Included in Competitive
Bidding Programs?" in Competition in Electricity: New Mar
kets and New Structures, ed. James Plummer and Susan Tropp
man (Palo Alto: QED Research, Inc., and Public Utilities
Reports, Inc., 1990), pp. 241-52.
(93) Wirtshafter, p. 45. DSM would "satisfy strict, short-
term cost justification" if the subsidy were restricted
to
those cases in which marginal electricity costs exceeded
average costs, and then they would be limited to only the
difference between price and marginal cost. In the example
provided by Ruff ("Least Cost Planning"), for instance,
if
the marginal cost of producing another kilowatt-hour of
electricity is 9 cents, but the price to the consumer is
only 7 cents, it is worth up to 2 cents (not 7 cents!) to
induce that consumer to reduce consumption by a kilowatt-
hour. See Joskow and Nichols, p. 9.
(94) As the NERA notes: "It is clear that in some ways
the
utilities examined in this study are unrepresentative.
However, for the most part, these unrepresentative charac
teristics seem likely to increase the attractiveness of DSM
for these utilities relative to others. Both utilities are
investor-owned and have relatively high costs; most propo
nents of DSM believe it is most attractive when supply-side
options are expensive. Both are located in states that have
been requiring DSM programs for a relatively long time, so
that both are likely to be relatively experienced, and are
unlikely to have unusually high start-up costs. Both utili
ties have focussed their efforts on the commercial/industri
al sector, emphasizing lighting, which is widely considered
the most cost-effective type of DSM effort. Moreover, both
have sponsored extensive evaluation efforts. Taken togeth
er, all of these factors suggest the programs considered
here are likely to be substantially better than average."
Albert Nichols, "Estimating the Net Benefits of Demand-Side
Management Programs Based on Limited Information," National
Economic Research Associates, Inc., revised draft, prepared
for Energy Policy Branch, Office of Policy, Planning, and
Evaluation, Environmental Protection Agency, January 25,
1993, p. 38.
(95) Ibid., p. 3.
(96) Ibid., pp. 23, 25.
(97) Ibid., pp. 26-27, 29.
(98) Ruff, "Equity v. Efficiency," p. 34.
(99) Studies such as the NERA's rely on demand curves to
measure the net benefits of conservation measures to DSM
program participants. That technique is not unique to DSM
studies; it is a standard, accepted tool for economic analy
sis.
(100) Nichols, "Estimating the Net Benefits," pp.
32-33.
(101) Ibid., p. 35.
(102) Lovins, "Balancing Energy Supply and Demand,"
pp. 42-47.
(103) Lovins et al.
(104) Alliance to Save Energy et al., p. 82.
(105) Ibid., p. 35.
(106) Ironically, the conservation lobby has long opposed the
use of similarly low discount rates by the Army Corps of
Engineers in justifying dam construction. The corps, like
the conservation lobby, argues that the social rate of dis
count is lower than that revealed in the marketplace. Con
sistency is apparently not the conservation lobby's strong
suit. See Houston, pp. 9-10.
(107) Ibid., p. 10.
(108) Ibid., p, 20.
(109) Alliance to Save Energy et al., p. 49.
(110) Kent Anderson, "Key Issues in Least-Cost Planning,"
Working Paper no. 10, National Economic Research Associates,
Los Angeles, August 1991, p. 9.
(111) Paul Joskow and Donald Marron, "What Does a Negawatt
Really Cost?" MIT Economics Department Discussion Paper
no.
596, December 1991, pp. 28-31.
(112) Carlsmith et al.
(113) Alliance to Save Energy et al., p. 4.
(114) Amory Lovins, "Saving Gigabucks with Negawatts,"
Public
Utilities Fortnightly, March 21, 1985, p. 21.
(115) Zycher, pp. 9-10.
(116) Ibid., p. 20.
(117) Ibid.
(118) Zycher, pp. 22-39. See also J. M. Gallagher, "Lovins'
Data Source," Science, December 22, 1978, pp. 1242-43;
and
P. L. Olgard, An Experience from the Energy Debate: Mr.
Lovins and Manipulations, Technical University of Denmark,
Department of Electrophysics, June 1978; cited in Petr Beck
mann, Why Soft Energy Will Not Be America's Energy Salvation
(Boulder: Golum, 1979), p. 9. The Illinois Commerce Commis
sion concluded after hearings in 1985, for example, that
"the evidence reveals that Mr. Lovins has underestimated
the
total costs of his proposed energy savings. . . . In large
measure, Mr. Lovins' testimony was not based on actual con
servation experienced in the Edison service territory. . . .
The Commission is not persuaded of the accuracy of Mr. Lov
ins' estimates of the cost of energy technologies." Cited
in Kenneth Costello, "The Debate Continues," Electric
Poten
tial, July-August 1986, p. 15.
(119) Zycher, p. 39.
(120) Anderson, p. 10.
(121) Ibid., p. 11.
(122) Eric Rogers, "Evaluation of a Residential Appliance
Rebate Program Using Billing Record Analysis," Energy Pro
gram Evaluation: Conservation and Resource Management: Pro
ceedings of the August 23-25, 1989, Conference (Argonne,
Ill.: Argonne National Laboratory, 1990), pp. 263-69.
(123) Frederick Sebold and Eric Fox, "Realized Savings
from
Residential Conservation Activity," Energy Journal, April
1985, pp. 73-85.
(124) Phoebe Caner, "The Drive to Verify Energy Savings,"
Electricity Journal, May 1992, p. 45.
(125) Steven Nadel and Kenneth Keating, "Engineering Esti
mates v. Impact Evaluation Results: How Do They Compare and
Why?" Energy Program Evaluation: Use, Methods, and Results,
1991; cited in Nichols, "How Much Energy Do DSM Programs
Really Save," pp. 4-6.
Nadel and Keating did find that 11 miscellaneous com
mercial, industrial, and agricultural programs saved only 11
percent less energy than was projected, yet those 11 pro
grams were fairly unique and specialized efforts tailored to
particular facilities. Of course, engineering estimates of
savings are going to be more accurate in those cases, but
the very uniqueness of those programs makes it more diffi
cult to define appropriate control groups for impact evalua
tions. Nadel and Keating, in fact, were not able to assem
ble control groups to more accurately measure energy sav
ings, so their findings with regard to those 11 programs are
a bit suspect.
(126) Andrew Rudin, Presentation before the Florida Public
Service Commission, August 17, 1992, p. 6.
(127) Ibid., p. 9.
(128) See generally Nichols, "Estimating the Net Benefits
of
Demand-Side Management Programs Based on Limited Informa
tion"; idem, "How Much Energy Do DSM Programs Really
Save";
and Anderson, pp. 9-12.
(129) General Accounting Office, Electricity Supply: Utility
Demand-Side Management Programs Can Reduce Electricity Use,
GAO/RCED-92-13(Washington: GAO, October 1991), p. 29.
(130) Anderson, p. 8.
(131) Rudin, "DSM--An Exorbitant Free Ride," p. 5.
(132) Nichols, "How Much Energy Do DSM Programs Really
Save,"
p. 13.
(133) Amory Lovins, "Abating Air Pollution at Negative
Cost
via Energy Efficiency," Journal of the Air and Waste Manage
ment Association, November 1989, p. 1432.
(134) Science Concepts, Inc., Ecowatts: The Clean Switch,
(Bethesda, Md.: Science Concepts, Inc., April 1991), p. 4.
(135) Ibid., p. 8.
(136) Ibid., pp. 24-25.
(137) Ibid., p. 28
(138) Mother Jones, November-December 1977; cited in Beck
mann, p. 12.
(139) "An Ecologist's Perspective on Nuclear Power,"
Federal
Academy of Science Public Issue Report, May-June 1975; cited
in Beckmann, p. 14.
(140) Paul Ciotti, "Fear of Fusion: What If It Works?"
Los
Angeles Times, April 19, 1989, p. 5-1.
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