Johannes Jarke-Neuert and Grischa Perino
University of Hamburg, Germany
cite as Jarke-Neuert, Johannes and Perino, Grischa, “When power saving harms the climate“, Sustainable Future Policy Lab: Analyses, 2020-003.
Governments around the globe embrace “energy efficiency” to address climate change. For example, the European Union’s “2030 Climate and Energy Framework” explicitly links the pledge to cut greenhouse gas emissions by 40% until 2030 (from 1990 levels) to the goal of a 32.5% improvement of energy efficiency by the same year (from 2007 levels). A 32.5% boost of energy efficiency is assumed to result in a 32.5% drop in energy consumption and carbon emissions. This reasoning is flawed.
It has been known for decades that energy savings from efficiency improvements will generally be less than what is technically feasible because users will adjust their behavior to changes of relative prices and real income caused by the improvements. The idea behind this so-called rebound effect is simple: Buy a more energy-efficient boiler or flow heater and you will enjoy longer showers. Buy a more energy-efficient car and you will drive faster and longer. Buy more energy-efficient lamps and you will care less of leaving the light on. You name it. In principle, this rebound can be large enough that energy use is greater after the efficiency improvement than before, a version termed backfire effect.
But size matters. It has been argued the rebound effect is overplayed, because it is just too small to derail energy-efficiency policies. In a recent research paper, we argue that this conclusion is premature for two reasons. First, it is incorrect to equate energy and emissions savings because the carbon intensity in energy supply is heterogeneous across different sources of energy and can change simultaneously with the energy efficiency improvement. This change may be different for different types of usable energy. As a result, the rebound with respect to energy use is different from the rebound with respect to emissions.
Second, the energy rebound, and the carbon rebound depend on the type of carbon pricing instrument. To see this, consider an efficiency improvement in a class of electric devices and assume that electricity generation is subject to a cap-and-trade scheme with a fixed cap and partial coverage, such as in the European Union before the 2018 reform. It is easy to see that, given the cap is binding, any carbon effect of a drop in electricity consumption (and production) will be completely offset by increases in emissions elsewhere as the allowance price drops until all allowances saved by the efficiency improvement are used again. This is not a defect of the cap-and-trade scheme since the whole point of that instrument is to directly fix the quantity of emissions (instead of the price). But as a direct consequence, the output dynamics and the emissions dynamics are completely decoupled in the electricity sector, such that any instrument targeted at that sector will not change emissions there at all. This is an instance of the well-known “waterbed effect”.
But it is even worse than that. Due to the increase of efficiency, consumers can enjoy any quantity of energy service with less electricity. As a result, they spend less of their income on electricity, because both price and consumption of electric power drops. This spare income is spent by increasing the consumption of other goods, some of which may be associated with carbon emissions outside the cap-and-trade scheme. Thus, in this setting the energy efficiency improvement generally backfires in a carbon sense: despite electricity consumption going down, carbon emissions go up.
While the “waterbed” problem could be resolved by replacing the cap-and-trade scheme with a carbon tax, that leaves the quantity of emissions variable, energy efficiency promotion would still suffer from rebound effects under a carbon tax, albeit smaller ones than under a fixed cap on emissions. Hence, when considering energy efficiency as a climate policy tool, rebound effects need to be taken into account. Policies promoting energy efficiency in sectors subject to a cap-and-trade scheme seem hard to justify. Effective reductions in emissions occur if – and only if – the number of allowances is reduced.
Given that energy efficiency measures are in place, a generally applicable solution to eliminate rebound effects is to tax away any cost savings from efficiency gains. As a result, those savings cannot be spent on other polluting goods. Such fine-tuning of tax rates seems largely impractical. Within a cap-and-trade scheme, the problem could be mitigated by withdrawing allowances from the market to match the demand reduction due to the energy efficiency improvement. In principle, this is the idea behind the “market stability reserve” (MSR) that is now operational within the EU ETS. It adjusts the cap based on the total number of allowances banked for future use. However, a reduction in the demand for electricity does not directly translate into an increase in the total number of banked allowances, as this depends on the precise response of the electricity market and the timing of the reduction in demand. In the worst case, incentives to bank allowances might drop since an improvement in energy efficiency reduces the demand for allowances permanently reducing future scarcity of allowances. As a result, the MSR would cancel less rather than more allowances in response to the increase in energy efficiency.
Therefore, the question arises, whether energy efficiency promotion even qualifies as a climate policy in the context of cap-and-trade schemes. Their additional impact on emissions is at best much smaller than their advertised impact but might well be non-existent or even counter-productive.
Gillingham, K., Kotchen, M. J., Rapson, D. S., & Wagner, G. (2013). The rebound effect is overplayed. Nature, 493(7433), 475-476.
Jarke-Neuert, J., & Perino, G. (2020). Energy Efficiency Promotion Backfires Under Cap-and-Trade. Resource and Energy Economics, 101189.
Perino, G., Ritz, R. A., & Van Benthem, A. (2019). Understanding overlapping policies: Internal carbon leakage and the punctured waterbed (No. w25643). National Bureau of Economic Research.
Rosendahl, K. E. (2019). EU ETS and the waterbed effect. Nature Climate Change, 9(10), 734-735.