An Energy Efficiency Trading System
Lisa Margonelli
T
he United States consumes en- consumers to use more—not less—en-
ergy so lavishly that the cost is ergy. Consequently, they are now spend-
equivalent to nearly 10 percent of ing more money on fuel without being
our GDP, reducing our competitive- able to cut back.
ness, constraining our foreign policy, The government needs to make a
and producing a fourth of the world’s fundamental change in the way it ap-
greenhouse gases. And because the U.S. proaches energy policy—instead of
economy is far more energy dependent simply trying to ensure supply, it needs
than the economies of other advanced to begin reducing demand by spurring
industrialized nations, American indus- a revolution in energy efficiency. Set-
try and families are far more vulnerable ting tough energy standards for Amer-
to natural catastrophes like hurricanes ica’s biggest energy users, and mak-
or political upheavals in oil- and gas- ing energy efficiency tradable—much
producing countries than industry and the way we now trade oil and natural
families in Europe and Japan. In the gas—would quickly reduce our total en-
coming decade that vulnerability will ergy consumption while limiting carbon
only increase, as more and more of our emissions, stimulating productivity, and
energy supply will be concentrated in creating jobs. Higher taxes on gasoline
politically unstable regions. Reducing are political poison, but tougher energy
the economic and environmental risks standards have overwhelming support
of excessive energy use therefore must among both Democrats and Republi-
become one of America’s most impor- cans—well above 70 percent. Adding a
tant national goals. market mechanism to trade efficiency
Nearly a century of government ef- gains would make energy efficiency
forts to make energy abundant has led standards more palatable to industries
many Americans to see cheap energy as that have resisted them in the past, at
a virtual right, creating political rigor the same time raising economic growth
mortis with respect to energy policy. and providing incentives for technologi-
Higher energy taxes are unpopular, and cal innovation.
manufacturers have fought the imposi-
tion of tighter energy standards for ap- Rethinking the Old Supply-
pliances and automobiles. So the gov- Side Bargain
ernment has abdicated responsibility for The American way of using energy is
reining in energy use to “market forces.” based on a grand bargain dating back
But low prices in the 1990s encouraged to the 1930s, in which the government
23
An Energy Efficiency Trading System
focused on energy supply rather than demand. The them to carry more energy will be costly and time
goal of American policy was to secure new cheap consuming. Some isolated sections of the electrical
supplies of energy by providing tax incentives and grid are actually facing supply shortfalls within the
other forms of government support for produc- next two years. In these and other cases, reducing
ers and by pursuing “oil diplomacy” internation- demand would solve the bottleneck more quickly
ally. Using military power than increasing supply.
Efficiency is America’s to protect shipping lanes Reducing energy demand is both cheaper and
and pipelines, and making faster than is the alternative of securing new sup-
largest and most cost- special deals with key pro- plies by exploring new oil fields or building more
ducers like Saudi Arabia, power plants. Efficiency is America’s largest and
effective potential allowed the United States most cost-effective potential energy resource, and
to promise cheap energy it has already provided three-quarters of our new
energy resource. to the world, while offer- energy needs since 1970. There is much more ef-
ing energy markets to our ficiency to be found. Conservative estimates sug-
trading partners. This ap- gest that buildings and vehicles could halve their
proach virtually sanctioned waste, with the result energy use without radical changes in design and
that more than 40 percent of the energy the United construction. Emerging technologies, like sensors
States uses is lost as waste heat. and supercomputing, nanotechnology, computa-
Increasing competition for global oil and natural tional fluid dynamics, and bioengineering hold the
gas supplies, on the one hand, and declining U.S. possibility of radically changing our relationship to
reserves, on the other, mean that the old bargain is energy and improving standards of living.
no longer effective insurance against either price Promoting efficiency, however, has been an un-
spikes or the exercise of market power by the Or- derutilized policy option. In fact, many current
ganization of the Petroleum Exporting Countries government policies do not reward conservation
(OPEC). Despite some gains in efficiency in the or, worse, encourage waste. The Internal Revenue
1980s, the U.S. economy remains vulnerable to Service, for example, creates a perverse incentive
high oil prices. Any increase in gasoline prices acts to waste energy by allowing commercial landlords
as an almost instant regressive tax on American to write off their energy costs every year. At the
drivers, who rely on the automobile much more same time, it requires building costs to be depre-
than their counterparts in other advanced indus- ciated on a 30-year schedule, effectively devaluing
trialized economies. It also creates an increasing investments in energy efficiency. Removing such
fiscal burden for the American economy, driving perverse incentives would help encourage greater
up America’s international deficit. In the first two efficiency but alone would not be enough to spur
quarters of 2006, petroleum imports accounted for the efficiency gains we need. Without positive gov-
nearly a third of the U.S. trade deficit. ernment incentives, it often does not make sense
Despite higher prices, both oil and electricity for individual purchasers to spend more on a more
demand continues to grow fast. Overall U.S. elec- efficient car or building, either because they can-
trical demand is expected to grow by 19 percent by not afford the higher initial investment or because
2015, while new power generation will expand by they are not sure they will see a return on their
only 6 percent. To manage the gap, utilities will investment given the volatility of energy costs. For
have to consider reducing demand. Another barrier example, under most scenarios, it is unrealistic for
to meeting America’s expanding need for energy is the purchaser of a hybrid car to expect the fuel cost
that the domestic infrastructure for delivering oil savings to exceed the higher purchase price. Thus,
and electricity is old, and in some areas pipelines relying on the market alone does not often yield
and grids are operating near capacity. Expanding greater efficiency because it does not take into ac-
24
Ten Big Ideas for a New America
count the externalities of using energy—pollution, iting electrical demand through efficiency for the
greenhouse gases, road wear by heavy vehicles, en- past 30 years. Residents now use 30 percent less
ergy security costs, and tax breaks to the energy electricity per capita than the country as a whole
industry—which are borne by society as a whole, and the state has avoided building many power
but not by the individual purchaser. plants. This prevents the emission of an estimated
New research from the United States and Eu- 18 million tons of carbon, while allowing every
rope suggests that improved efficiency brings with Californian to spend $400 per year on things other
it a multiplier value that far exceeds the fuel savings than energy. The state program has stimulated the
realized by the individual. To return to the meta- rapid commercialization of such technologies as
phor of the hybrid car: its real value may lie not in compact fluorescent light bulbs and energy-saving
the energy savings to the individual owner but in refrigerators and air conditioners. New refrigera-
the jobs it creates, the technology it stimulates, and tors use just 25 percent as much energy as the old;
the reallocation of capital from energy to invest- even better, their prices have fallen by more than
ment it encourages. Efficiency is a productivity- half. The benefits don’t stop at California’s bor-
enhancing tool, raising the return on capital and ders: energy-saving appliances have proliferated
increasing GDP output. Reducing energy demand everywhere from China to New York.
has also lowered energy prices, notably oil prices
during the mid-1980s; and forecasts suggest that How to Trade Efficiency
small drops in U.S. electricity use could precipitate The United States needs to remodel its energy
a dramatic fall in the price of natural gas. portfolio, abandoning incentives for wasted en-
One example of the benefits of energy standards ergy and putting in place a framework to support
can be found in California, which has been lim- increasing energy efficiency. Like carbon cap-and-
U.S. REFRIGERATOR ENERGY USE VS. TIME WITH REAL PRICE
Average Energy Use Per Unit (KWh/yr.) and Price (2002 US$)
2400
US Sales Weighted Average Energy Use
2200 $22
Adj. Volume (ft3)
2000 Real Price
1800 $18
1978 CA Standard
1600 1980 CA Standard
1400 $1,272.03 $14
1987 CA Standard
1200
1990 NAECA Standard
$999.08
1000 $893.58 $10
1993 DOE
800
600 $576.11 $6
400 $462.99
200 2003 DOE Standard $2
0
2003
2001
1959
1963
1965
1969
1983
1985
1989
1993
1995
1999
1949
1953
1955
1967
1987
1957
1973
1975
1979
1997
1947
1961
1977
1981
1951
1991
1971
Year Manufactured or Priced
Source: David Goldstein, Natural Resources Defense Council.
25
An Energy Efficiency Trading System
ENERGY FLOW, 2005
Petroleum
Exports 4.64
2.46
Coal
23.05 Otherg 2.18
Residentiall
Natural Gas 21.87
Coal
18.76 22.83
Fossil Fuels
Crude Oila 54.97 Commerciall
10.84 Domestic Natural Gash 17.97
Production 22.64 Fossil
Supply Fuelsj
69.17 104.54 Comsumptionk
NGPLb 2.32 85.96
99.89 Industriall
Nuclear Electric Power 8.13 31.98
Petroleumi
Renewable Energyc 6.06 40.44
Imports 34.26 Transportationl
Nuclear Electric Power 8.13 28.06
Petroleumd 28.87 Renewable Energyc 6.06
Adjustmentsf 1.11
Othere 5.39
a Includes lease condensate.
b Natural gas plant liquids.
c Conventional hydroelectric power, wood, waste, ethanol blended into motor gasoline, geothermal, solar, and wind.
d Crude oil and petroleum products. Includes imports into the Strategic Petroleum Reserve.
e Natural gas, coal, coal coke, and electricity.
f Stock changes, losses, gains, miscellaneous blending components, and unaccounted-for supply.
g Coal, natural gas, coal coke, and electricity.
h Includes supplemental gaseous fuels.
i Petroleum products, including natural gas plant liquids.
j Includes 0.04 quadrillion Btu of coal coke net imports.
k Includes, in quadrillion Btu, 0.34 ethanol blended into motor gasoline, which is accounted for in both fossil fuels and renewable
energy but counted only once in total consumption; and 0.08 electricity net imports.
l Primary consumption, electricity retail sales, and electrical system energy losses, which are allocated to the end-use sectors in pro
portion to each sector’s share of total electricity retail sales.
Source: Annual Energy Review 2005, Energy Information Administration.
Notes: Data are preliminary. Values are derived from source data prior to rounding for publication. Totals may not equal sum of com-
ponents due to independent rounding.
26
Ten Big Ideas for a New America
trade programs, the energy efficiency initiative “price” of credits for the pickups and still sell extra
proposed here would combine setting national lim- credits. Gradually, though, the cost of inefficiency
its on energy use with letting the market determine would be integrated into the purchase price of the
who pays. By instituting efficiency standards that pickup truck, changing the market.
increase over time, the government will be able to Targets for vehicles will need to be set for at
guarantee that the country’s economy will become least ten years in advance,
more efficient by at least 1–2 percent a year over the requiring perhaps a one Phasing in tough
next decade and beyond. As with carbon cap-and- mpg improvement a year
trade programs, businesses that exceed their effi- for the fi rst five years, and energy standards
ciency targets can sell excess credits, while those a two mpg a year improve-
that fail to meet them can buy credits from other ment for the second five for America’s
producers or the government. This differs from years. The point of this
the policies of the 1970s, when government “com- system is that it is flexible biggest energy
mand-and-control” regulations essentially picked but insures results. As the
which products would succeed. The key is to in- standards go into effect, users – and making
ternalize the true costs of energy inefficiency and and the valuation of effi-
allow the market to work out which users should ciency credits begins, the energy efficiency
produce or consume efficiency gains. government will be able
The place to begin implementing standards is to influence the price of tradable – would
with transportation and electricity—together these efficiency credits by sell-
two sources account for 67 percent of the energy ing them, which will give quickly reduce total
the United States uses. Both vehicle manufacturers the emerging market a
and utilities are source producers, able to employ safety valve and prevent energy consumption
a variety of strategies to reduce energy demand prices from getting pro-
while being relatively easy to identify and regulate. hibitively high. while limiting carbon
Once standards are in place and trading has begun, Vehicle makers will be
standards could be extended to other markets, such able to use many strategies emissions.
as industry and buildings, and trading could be al- to meet the standards—
lowed between categories. from buying credits to
Corporate Average Fuel Economy (CAFE) stan- changing marketing and sales practices, substituting
dards have allowed overall fleet efficiency to fall more efficient components like air conditioners and
since the late 1980s because there are separate re- tires, changing the way they finance and lease, as
quirements for cars and for light trucks, and none at well as altering vehicle designs, materials, and power
all for heavy trucks. More effective standards should trains. A study by the Congressional Budget Office
be set to include all vehicles in the fleet so that the found that tradable credits would allow automakers
total amount of fuel used is reduced. Fleet efficiency to increase the fuel economy of cars and trucks by
is calculated by multiplying the amount of gasoline 3.8 miles per gallon for 17 percent less cost.
consumed by each model car over its lifetime by the As targets for standards, utilities have proven to
number of units sold, so that the targets apply to all be powerful actors because they can use efficiency
the vehicles a company makes. If Ford produces a investments to avoid buying peak power and build-
pickup that gets, say, 22 miles per gallon (mpg), the ing power plants, both expensive undertakings. The
company would need to buy credits to bring it up ability to promote more efficient appliances, build-
to the fleet target of 30 mpg. If, on the other hand, ings, and transmission systems among their custom-
Ford also produces twice as many Escorts getting ers gives utilities extraordinary leverage over con-
40 mpg as pickups, it would be able to cover the sumer markets. Utility standards could be phased in
27
An Energy Efficiency Trading System
U.S. ENERGY CONSUMPTION BY FUEL (1980–2030)
60%
Petroleum Natural Gas Coal
Nuclear Hydropower Renewable/Other (excl. Hydro.)
50%
40%
30%
20%
10%
0%
1980 1990 2004 2010 2020 2030
Source: U.S. Department of Energy, Energy Information Administration.
so that the first year might require half a percent of to invest in energy efficiency, could start collecting
reduced demand a year; years two to four, 1 percent those improvements into credits to sell, providing
a year; years five to seven, 2 percent; and years eight greater penetration of very high-efficiency build-
to ten, 3 percent. In addition to reducing demand, ings. An American city considering a massive neigh-
utilities also have the ability make their generation borhood-by-neighborhood efficiency program to
facilities and transmission lines much more efficient, save as much as 20 percent of the region’s power
and if those goals are added to the program, the tar- would be able to aggregate and sell credits.
gets should be set accordingly. While the vehicle and electrical credits would
Utilities that beat their targets can aggregate not be immediately interchangeable, it is reason-
their savings into bundles of efficiency—usually a able to expect to see outside players aggregating
megawatt of demand—called white tags. European credits here too. Cascade Sierra Solutions, an Or-
utilities have already begun trading white tags, and egon-based nonprofit, already has a program to
Connecticut and Pennsylvania are now preparing help truckers install inexpensive kits to retrofit
to do so. In the late 1990s, the energy service com- their long-haul trucks and save as much as 5,000
pany Enron began experimenting with standard- gallons of fuel a year. United Parcel Service has
izing and trading efficiency. Now a Georgia-based developed software that saves fuel by optimizing
company called Sterling Planet is launching a sys- delivery routes, using information about package
tem for verifying and trading white tags. weights and GPS route setting. Other companies
Once these trading systems were in place, a num- might decide to use their leverage over employees
ber of related secondary trading systems would be- or suppliers to acquire credits. Wal-Mart, for ex-
come possible. For example, consumers could reduce ample, might provide scheduled van pools for em-
their energy use and aggregate the savings to sell to ployees, and bundle and sell the commuter miles
a utility much the way a producer of wind electric- saved. (These companies would also save money
ity might sell back power. A mortgage company like by not providing employee parking spaces, and
Fannie Mae, which already encourages homeowners see benefits from on-time employees and reduced
28
Ten Big Ideas for a New America
road congestion.) Auto insurers might start offer- the United States would save as much as $2 billion
ing low-cost insurance rewarding drivers who limit in electrical costs and eliminate a million tons of
their miles, aggregating and selling the credits. greenhouse gases, according to the Environmental
Protection Agency. This kind of market failure is
The Advantages of the Tradable best fi xed by a combination of standards and mar-
Efficiency Option ketable efficiency because it discourages manufac-
Combining standards and tradable efficiency would turers from cutting corners on energy efficiency,
have some clear advantages over the conventional Re- while allowing the
publican and Democratic policy approaches for reduc- market to decide The ability to trade
ing energy use and greenhouse gas emissions. Unlike which combina-
voluntary measures, this approach would ensure re- tion of price and efficiency gains
sults; but unlike taxes and the command-and-control efficiency works
strategies often associated with liberal Democrats, it best. would make energy
would not constrain the economy or hurt economic Many Demo-
growth. While traditional Democratic and Republi- crats favor raising efficiency standards
can approaches to energy have led to policy gridlock, energy taxes to en-
tradable efficiency offers a third way with wider and courage consum- more palatable to
deeper benefits—and fewer drawbacks—than the ers to conserve.
commonly discussed alternatives. But this idea does industries that have
Republican solutions to energy issues tend to en- not make either
courage energy supply while leaving demand man- political or eco- resisted them in
agement to the market or voluntary initiatives. But nomic sense. A
without new incentives and penalties, neither in- regressive tax on the past.
dustries nor consumers are likely to become more fuel will hurt not
efficient. In 1998, utilities in Texas voluntarily saved only businesses
a modest 300 million kilowatt hours of electricity. but also poorer working families and rural drivers
By 2003, under a utility efficiency standard signed without access to public transportation while doing
by former Governor George W. Bush, they saved 5 little to reduce the amount of gasoline middle-class
billion kilowatt hours, greatly exceeding their tar- consumers use. Although they complain vocifer-
gets. Although the efficiency programs were cost- ously about fuel prices, American drivers do not
effective, the utilities were reluctant to adopt a new use significantly less gas when prices are high. And
business model without being pushed. high fuel costs do not consistently inspire them to
Market choices do not always favor efficiency, buy fuel-efficient cars. Even in Europe, where taxes
either because manufacturers have other priori- make gasoline very expensive, governments have
ties or because consumers lack information. Take still found it necessary to institute voluntary fuel
cell phones, for example. Because consumers are economy targets for automakers. A program that
focused on features, manufacturers save money by combined fuel economy standards and tradable ef-
using inefficient chargers that draw 2–5 watts per ficiency would produce much better results because
hour, even when they are not charging. Highly effi- manufacturers would need to ensure that the fleet’s
cient chargers use just half a watt, and cost slightly fuel consumption falls, thus making fuel-efficient
more, but who chooses a phone by the charger? cars less expensive and fuel-inefficient ones more
Left to individual choice, consumers end up buy- expensive. It might also lead to more transportation
ing power vampires whether they want to or not. choices for many poor and rural families because
Imposing standards on the billion chargers (for governments would have more incentive to provide
phones, computers, and other appliances) used in public transportation for these populations.
29
An Energy Efficiency Trading System
Limiting greenhouse gas emissions through a powerful productivity-enhancing tool in the same
cap-and-trade system is another favorite liberal idea. vein as supply-chain management, just-in-time
But it is not a substitute for an efficiency trading sys- production, and financial instruments like deriva-
tem and in fact would work best if it were combined tives. Just as the potential for new technology to
with one. One problem with carbon cap-and-trade save energy is unknown, the potential uses of trad-
proposals is that the initial value of carbon cred- able efficiency may be much greater than we can
its may be too low to change energy-use patterns. grasp now. Failing to encourage efficiency, by con-
Thus they tend to encourage responses that put trast, may have a high opportunity cost for U.S.-
the emphasis on carbon mitigation rather than on based manufacturers because the European Union,
energy reduction. This may encourage a different Japan, South Korea, and China all have committed
choice of energy—natural gas rather than coal—but themselves to aggressive energy standards.
not result in new technologies to reduce energy use
in any significant way. When tradable efficiency is An Opportunity for a New Grand Bargain
combined with cap and trade, however, companies Energy is an intensely politicized subject in the
would be able to leverage both efficiency credits and United States. Steep gasoline prices have led to the
emissions credits to achieve their goals faster. defeat of at least one president, while California’s
One of the clear benefits of a standards-and-ef- electricity crises caused the recall of one governor.
ficiency trading system is that it will spur both tech- The high political stakes of another crisis and pub-
nological innovation and the diffusion of that tech- lic anxiety about energy security make this a fertile
nology more rapidly than other policy alternatives. time to make a new grand bargain. The standoff
Already there is evidence that combining standards between liberals and conservatives on the topic
with tradable credits can speed up the commercial- of energy makes America vulnerable to a crisis of
ization of cutting-edge technology. A fuel-cell gen- cripplingly high prices. In the longer term, energy
erator normally has a payback time of more than prices will be volatile, and the costs of emitting
three years, which most companies consider to be carbon (whether explicit carbon credits or implicit
too long to justify the investment. With tradable ef- rising temperatures) will become very high.
ficiency credits soon to be available in Connecticut, Tradable efficiency, coupled with high stan-
one large company found that the payback time for dards, is a grand bargain that combines the secu-
the fuel cell fell to just over two years, making it a rity of regulation with the creativity of the market.
much more feasible investment. This plan not only reduces U.S. exposure to high
A standards-and-efficiency trading system has energy costs, it offers considerable economic and
other advantages as well. For one thing, it is busi- environmental benefits. The objection to most de-
ness friendly in that it gives businesses more ways mand-side energy proposals is that they could be
to meet their targets, encouraging both experi- “forced downsizing,” but a market-based efficiency
mentation and innovation. For another, it is market program will stimulate productivity. Tradable ef-
oriented in that it begins the process of reallocating ficiency has the potential to remodel the American
the price of inefficient energy use to the purchase economy by harnessing emerging technologies and
price of a product, thus changing buying patterns new tools for managing information and finances
by use of the market. Thirdly, energy service com- to tackle one of our most intractable problems.
panies, new industries, and even nonprofits like cit- James Schlesinger, former secretary of energy,
ies and states may begin to bundle efficiency, tak- once said that the United States has two modes
ing advantage of synergies between efficiency and regarding energy: complacency and panic. Adopt-
other economic and social goals. And finally, when ing energy efficiency is a smart third mode, and it
it is more thoroughly fi nancialized and packaged would steadily lead us toward greater economic and
as a credit, efficiency has the potential to become a security.
environmental security.❖
30