Toward an Energy Efficiency Trading System

By Lisa Margonelli
Special to washingtonpost.com's Think Tank Town
Friday, February 9, 2007; 12:00 AM

Now that the Intergovernmental Panel on Climate Change has come out with unequivocal evidence of human caused global warming, all eyes are on Capitol Hill to finally come up with a plan to deal with greenhouse gases and US energy security. More than a decade of wrangling over the details of greenhouse cap and trade, raising CAFE standards, and imposing gasoline taxes has lead to a deadlock that has cost Americans time, opportunities, and (as prices have risen over the last five years) about a trillion dollars in extra energy costs. In order to move forward, we need a breakthrough plan that can get bipartisan support and break the stalemate. One such plan is a market-based energy efficiency trading system, which has the advantage of reducing both our dependence on imported fuels and our greenhouse gas emissions, while stimulating the economy.

Energy efficiency doesn't have a reputation as a sexy policy option, partly because it's associated with Carter-era compact cars and admonitions to "wear a sweater." But since 1970, efficiency has met three-quarters of our new energy needs, avoiding the expense of importing more fuel, building out infrastructure, or coping with pollution. With proper encouragement, efficiency could deliver more benefits quickly and relatively cheaply. In California, where utilities have been reducing electrical demand for more than two decades, citizens use thirty percent less electricity than other Americans, which adds up to a savings of about $400 per person per year. When the gridlock over energy policy ends, efficiency programs could become the new tax cut¿a government action that results in money in voter's pockets.

To start an efficiency program, the US will have to shift emphasis from encouraging energy supply to managing energy demand. We should cap the energy consumed by electrical generation and transportation (which makes up 67 percent of all the energy we use) and then gradually reduce the amount we consume by making our cars, buildings, and appliances more efficient. Utilities and vehicle manufacturers that can't meet their targets can buy "efficiency credits" from the government, or from other companies. And companies that exceed their targets can sell the credits they generate.

Rather than dictating how companies meet their goals, this strategy allows the market to decide the best mix of efficiency and price. Big pick-up trucks, for example, may cost more simply because the manufacturer has to "pay" for their inefficiency. Will the new trucks be worth the price? That's up to consumers, and the market, to decide. This isn't 1970's command and control regulation, with its forced downsizing. The goal is to change the competitive focus of auto makers, utility companies and manufacturers to work creatively to use less fuel, rather than expecting society to pick up the costs of their waste.

Tradable efficiency also offers incentives to people and market players who change their behavior to use less fuel. Lender Fannie Mae, for example, used to encourage borrowers to make their homes more efficient. With tradeable efficiency credits, other lenders would encourage efficiency, because they could sell the credits or add them to their investment portfolios as a hedge. Insurers and auto finance companies might also see opportunities to use their leverage in the marketplace to push efficiency (or encourage consumers to drive less) and make profits. Cities and private companies might install creative, effective mass transit if they knew they could also gather credits to offset their costs.

Tradable efficiency avoids some of the pitfalls of other energy and greenhouse gas plans. The current strategy of doing nothing and allowing energy demand and prices to rise has much in common with the strategy of heavily taxing gasoline¿both are a regressive charge on the poorest 40 percent of Americans. In particular, high energy prices penalize cold rural states (like Wyoming, where residents drive 18,000 miles a year) and benefit warmer states with good transit systems (like Washington DC, where residents drive 6700 miles per year.) Encouraging new supplies of unconventional fuels (like tar sands) or alternative fuels (like ethanol) is expensive and economically and environmentally risky until the technology is better. The flaw in greenhouse gas cap and trade schemes is that they reward the cheapest carbon mitigation strategies, not the best. Greenhouse gas trading will encourage companies to switch from big carbon sources like coal, to littler ones like natural gas, increasing our dependence on fuel imports. However, combining greenhouse gas trading with efficiency trading could lead to solutions that address all of our problems.

While the idea of basing a national energy policy on tradable efficiency is a new one, Europe has years of experience with using the scheme to reduce electrical demand and pilot programs are beginning in Connecticut and Pennsylvania. European studies show that the strategy actually stimulates GDP growth, while anecdotal evidence from the US suggests that credits are already speeding up the commercialization of cutting edge technology. A study by the Congressional Budget Office found that allowing auto makers to trade efficiency to meet their CAFE targets could reduce the cost of a 3.8 mpg improvement in fuel economy by 16 percent. One of efficiency's strengths is that it reallocates capital from energy to investment, enhancing productivity and reducing risks.

Politically, tradable efficiency is a win-win solution to our problems because it combines the security of regulation with the creativity of the market, while enhancing greenhouse gas cap and trade initiatives. Former Secretary of Energy James Schlesinger has said that the United States has two modes regarding energy: complacency and panic. Tradable efficiency is a smart third way, and it would steadily lead us toward greater economic and environment security.

Lisa Margonelli is an Irvine Fellow at the New America Foundation and author of "Oil on the Brain: Adventures from the Pump to the Pipeline.


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