Breakthrough Generation

You’ll have to forgive me. You see, I thought that the biggest energy story about Japan was its subsidy-fed, awesome deployment of solar PV systems from 1993 to 2005. These deployments led Japan to have one of the largest installed capacities of PV in the world by the early 21^st century. However the McKinsey Global Institute’s Curbing Global Energy Demand Growth: The Energy Productivity Opportunity, helped me see a more profound Japanese strength: EFFICIENCY! Japan represents a beacon of hope for those who wish to reconcile wealth with environmental health. Unfortunately, McKinsey’s analysis of how we can best mimic this Japanese strength falls totally flat.

Whether you want to call it energy efficiency or, as McKinsey does, energy productivity, the basic idea behind these terms is that the amount of wealth countries can squeeze out of a unit of energy is variable. For instance, in 2003 Japan managed to squeeze $229 billion in GDP out of every Quadrillion Btu’s of primary energy consumed. By contrast, in 2003 the US only produced $112 billion in GDP per Quadrillion Btu’s. This means that Japan got over twice as much wealth per unit of energy than the US, and thus much less GHG emissions per unit of GDP.

Much of the reason why the Japanese are so much more efficient in their wealth creation is that they have higher energy costs. They have hardly any domestic oil or gas reserves, and their average price of electricity is much higher than that of the US. Over the years, adapting to an environment with high-energy costs has made them much more efficient in energy use. High-energy costs didn’t make their GDP go down, instead they adapted and managed to reconcile industrial development with energy scarcity.

On the other end of the spectrum are countries that have been spoiled (or blessed, if you’re of that persuasion) with abundant energy supplies for a very long time. You thought the US’s energy productivity was bad? Countries in the middle east get $30 billion in GDP per Quadrillion BTU’s, on average. This is less than 1/3 the energy productivity of the US, and 1/7 that of Japan. Furthermore, in contrast to other developing regions including China and India, energy productivity in the middle East is actually declining, by .3%/year.

Is this geographical determinism? Is the US, and the rest of the world, doomed to a middling efficiency (not being Japan, but then again, not being Qatar)? Not surprisingly, this depends on a few things. An important one is how businesses and other large institutions approach the financial possibilities of energy efficiency. McKinsey estimated that, worldwide, there are enough energy efficiency business opportunities to reduce growth in energy demand by 50% by 2020. That is, there is the potential to use about 150 Quadrillion BTUs less energy in 2020 than we would under business-as-usual estimates of energy growth. All of these energy efficiency projects identified by McKinsey would have at least a 10% internal rate-of-return, and utilize technology that was already commercialized in 2007.

The problem is, this rate of return isn’t enough for most firms. By McKinsey’s own estimates, 73% of industrial firms—which make up the largest chunk of worldwide energy users–require a payback of 2-years or less on energy efficiency investments. This corresponds to returns of over 40%/year. Also, 27% of industrial firms McKinsey surveyed indicated they would not invest in energy efficiency improvements no matter how profitable they were. Surprisingly, in the face of these findings McKinsey recommends privatization of government owned industries as a large part of the solution to increasing energy efficiency use. Their rationale is that as it stands, many of these public and quasi-public industrial firms don’t have adequate incentives to invest in energy efficiency.

But McKinsey demonstrated thoroughly in their report that the problem isn’t adequate incentives, but rather inadequate action. Why, after all, are these firms sitting around when rates of return in excess of 10% are readily available on low-risk investments? McKinsey suggested some reasons: what they term “pro-cyclical” finance– firms invest in super profitable projects during boom periods, then don’t invest in anything during bust period–and high location turnover–firms always moving somewhere new so don’t want to upgrade their facilities shortly before they depart. The result is that the low hanging, but non-glamorous, fruit like energy efficiency don’t get plucked.

What is really surprising is McKinsey’s free market solutions in spite of the fact that many of those most willing to invest in energy efficiency were members of the “MUSH” group: municipalities, universities, schools, and hospitals. Members of this group, hardly paragons of capitalism, were party to 73% of Energy Service Company (ESCO) energy efficiency projects in the year 2000. Being fixed in place, MUSHes are ideal participants for ESCO contracts, which often have a payback of 6 to 12 years. But the problem with the MUSHes, McKinsey finds, are that they often have inadequate capital to invest in ESCO agreements, even considering that these projects little upfront cost. MUSHes are fixed in place, unlike businesses, but also poor, unlike businesses.

What is really surprising to me is that McKinsey never recommends that policymakers simply mandate enforceable energy standards for new building construction and/or provide below market-rate financing for mandatory energy efficiency retrofits financed through municipal bonds. Given that the industrial landscape is either poor—the MUSH–or moves a lot and is extremely volatile—the industry–it would make sense for the public sector to play its best hand: as aggregator of risk and enforcer of standards. Instead of endorsing these sensible regulations, the McKinsey report bows low to the market. And I hate to say it McKinsey, but the volatile passions and irrationalities of American capitalism that drive us further from climate goals, are not going to be remedied by further privatization.