IEA urges governments to mind the energy efficiency gap

(Paris) — 15 October 2007

The global challenges of climate change and energy security require urgent action. “Improving energy efficiency is the most cost-effective concrete action governments can take in the short term to address climate change and energy security concerns,” said Nobuo Tanaka, Executive Director of the International Energy Agency (IEA). Presenting a new IEA publication, Mind the Gap – Quantifying Principal-Agent Problems in Energy Efficiency, he said, “Efficiency presents a unique opportunity: not only does it save energy, it reduces costs and lowers CO2 emissions. Yet, there is a gap between actual and optimal energy use. A significant proportion of potential energy efficiency improvements is wasted, because of barriers in the energy market.”

These obstacles to the efficient use of energy isolate consumers from the consequences of their energy choices. Market barriers take many forms. This new book takes an in-depth look at one pervasive barrier: split incentives – or what economists call “principal-agent” problems – between investors and energy end-users.

Split incentives – a significant barrier to energy efficiency
Principal-agent problems refer to the potential difficulties that arise when two parties engaged in a contract have different goals and different levels of information. A common example is referred to as the landlord-tenant problem. This problem occurs when the landlord provides energy-using appliances (such as a refrigerator or lighting systems), but the tenant pays the electricity bill. In this situation, there is little incentive for the landlord to choose the most energy-efficient appliance.

Drawing on eight case studies from five IEA countries — Japan, the United States, the Netherlands, Norway and Australia — in the residential, commercial and end-use sectors, the study highlights the amount of energy that is being affected by split incentives. For example the IEA identified that almost 100% of all of the 148 million set-top boxes currently in the United States are affected by split incentives. In this case it is because the television service provider supplies the set-top box, while the viewer pays for the electricity. Collectively, this means that about 68 PJ per year are subject to split incentives. This is about 1.5% of total annual US residential electricity use.

Over all the case studies, the book estimates that more than 3 800 PJ per year of energy use is affected by principal-agent problems – equivalent to around 85% the total energy use of Spain in 2005.

We can remove this barrier to energy efficiency – but urgent action is needed
The IEA analysis shows that split incentive problems are complex. As such, no single policy is sufficient to overcome the problems. Instead, governments must design well-targeted policy packages to address principal-agent problems in their specific national contexts, and within the particular constraints of a given sector. These packages should include measures to: a) address contract design to ensure energy-users face energy prices, b) regulate the level of energy efficiency in appliances and buildings, and c) improve access to information about energy efficiency performance.

“The IEA has made it clear what policy actions are required of governments to improve energy efficiency. We know what to do, we know the policies that work – but now governments must do three things: implement, implement, and implement energy efficiency policies. Only then will they mind the energy efficiency gap,” said Mr. Tanaka.