Motivating Energy Conservation at the Root

By Robert Wieland

11/17/2009

Some time ago, the well-known environmental writer, Tom Horton, proposed an interesting idea. He suggested, in the middle of a stream of other important suggestions, "a power company selling energy efficiency versus more energy." This is a powerful idea because it gets to the root of what we are trying to do with respect to reducing environmental harm from energy use.

There are two sorts of things we can do to accomplish that. We can make our energy use less harmful (i.e., capturing and returning the carbon in the fossil fuels we burn back into subterranean storage, using non-fossil energy sources, and planting more trees), or, we can reduce our energy use. It seems likely that we will have to do both of these things if we want to significantly reduce the volume of greenhouse gases we are putting into the atmosphere.

But consider the energy sector. Investors place their funds in energy companies precisely for the purpose of getting positive returns. Energy companies make a return for their investors by earning a margin on the units of energy that they sell. They can improve that margin if they reduce their costs - if they get the machine working as efficiently as possible. But they can also increase their returns if demand increases. The way you and I use energy is, of course, the demand in this picture.

So, as the market for energy is currently configured, greater energy demand (what we use) is an attractive thing to producers. In general, the greater demand, the better their return on investment. And, since we must have whatever it is we want, regardless of its energy costs, we consumers have been accommodating to the energy industry in that way.

How do we change that? How do we change incentives so that energy companies make better returns when energy is used more sparingly? An energy economist (I am not one) may provide a more detailed answer, but, from what I know about markets and incentives, I suggest that a tax on fossil fuels with abatements for energy efficiency, to be shared between the energy companies and consumers, would do the trick.

What does that mean? Well, if you tax fossil fuels, you make the energy those fuels generate more expensive and therefore less attractive, relative to non-fossil fuel energy. The energy industry would pass the tax on to the consumers and, because this would raise energy costs, people would be more careful about consuming energy.

If you structured the tax so consumers with below average energy efficiency paid the bulk of the tax, the burden would fall on the profligate.

The abatements would entail refunding some portion of the tax to the energy company if its consumers show above average energy efficiency, giving the companies an incentive to convince their consumers to conserve. The energy companies would have to share a portion of the tax abatement with consumers to really make that happen.

There will be a devil in the details of sorting out what "above average energy efficiency" means, and in how to share the abatement between consumers and company. But clearly some energy customers use energy more wastefully than others, and it should be possible to reduce those differences to a number.

Without creating a raft of new regulations or some new bureaucracy, a tax and abatement scheme such as this would allocate the pain of higher energy costs equitably among consumers and point the energy companies in the right direction.

Ensuring that energy companies get better returns, the better their customers conserve energy, is a radical solution to the problem. It will have opponents on the left who think too conservatively to imagine capitalist incentives pushing firms toward less environmental harm. And it will have opponents on the right who cannot conceive that some taxes move you toward social optimality, not away from it. So it goes with radical solutions.

But Horton's idea was a good one and it makes you wonder, who's working on that?