ACEEE'S GRAPEVINE ONLINE

October 6, 2004

SAVE ENERGY TO SAVE THE ECONOMY

World oil prices broke the $50 barrier in September, and natural gas prices are headed back above $7/MCF just in time for the heating season. Federal Reserve and private economists say these energy prices are taking a toll on economic growth, and that the number one way to boost the economy is to drop energy prices. Industry experts say that high prices are driven more by surging demand than by supply problems, which suggests that the best way to bring down energy prices is to reduce energy demand. While we in the efficiency community know that efficient technology can deliver enormous benefits along these lines (see Tight Energy Markets Make the Case for Efficiency in this issue), we need public leadership to generate the public awareness and policy commitments to make it happen.

But why do we need government policy action? Economics 101 would tell us that consumers should be reducing their demand in response to high prices, and that markets should be balancing themselves. This is not happening. U.S. energy demand remains high: oil consumption is up 3.6% from last year, home natural gas use is up over 4%, and electricity is up over 3% (based on U.S. Energy Information Administration data). What's going on—why aren't the markets responding?

Those of us who have studied end-use energy markets know that market and institutional barriers continue to limit private investment in efficiency. Yet there is another, more fundamental factor that keeps efficiency investment small. It has to do with the two trends in the U.S economy: falling energy intensity and rising incomes. Falling intensity means we use less energy per unit of economic activity: therefore, energy becomes a smaller fraction of the cost of driving, of homeownership, of running a business. That's fundamentally a good thing for the economy. But it tends to make us less motivated to invest in energy savings, because even when prices rise the net effect is small. This factor is compounded when incomes rise. When people have more discretionary income to spend on the energy services that come with larger homes, bigger cars, and more appliances, this "income elasticity of demand" factor tends to work against efficiency, even when the investments are cost-effective. The bottom line is that with these factors in place, energy prices would have to rise to very high levels to cause enough pain to motivate major new efficiency investments.

So, if the invisible hand of the market isn't working perfectly, what are our options to bring energy markets back into balance? Letting prices rise further risks serious economic damage. Waiting for new supplies to come on line means years of high prices and unstable markets. What can we do now to bring balance to energy markets and keep our economy from tipping back into recession?

The energy bill now in Congress, as well as proposals by the Kerry campaign, contain some of the elements needed to realize these goals. Many states have moved ahead of the federal government in some of these areas. But they are only a start. Stronger action is needed on all these policy fronts if we are to break the debilitating cycle of high energy prices, economic stagnation, and an uncertain energy future.

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