1. Motivations for energy efficiency programs Charles Sims March 31, 2016 Energy Efficiency, Conservation, and Low-Income Households

2. What do we know? Impetus for many energy efficiency programs is rooted in the energy efficiency gap Energy efficiency gap: The failure of consumers to make seemingly cost-effective investments in energy efficiency This gap is much larger among low-income households

4. Income classImplied discount rate $6,00089% $10,00039% $15,00027% $25,00017% $35,0008.9% $50,0005.1% Hausman 1979 Room air conditioners Income classImplied discount rate < $35,000182% $35,000-$75,00057% >$75,00036% Min et al. 2014 Light bulbs

5. What does this mean in terms of… Economic efficiency: Households could save money in the long-term by making energy efficiency investments (i.e., households seemingly undervalue future energy savings) Technology: slower than expected penetration of energy efficiency technologies Distributional considerations: Low-income households are leaving more future dollars on the table

6. Two critical questions 1.Does the energy efficiency gap really exist? If yes, energy efficiency policies and programs can be justified on economic efficiency grounds Programs focused on low-income households seek to address the greatest inefficiencies ˣ If no, energy efficiency programs may still be justified due to concerns over equity 2.If it does exist, what causes it? Market failure Consumer behavior

7. Reasons the gap may not exist 1.Hidden costs Administrative costs Search and install costs Opportunity costs: alternative investments that consumers forgo to make energy efficiency investments 2.Uncertainty and sunk costs Energy efficiency is a risky investment due to the volatility in energy prices Households have an economic incentive to delay sunk costs investments in energy efficiency when the future returns from these investments is uncertain Investments in energy efficiency would have to be way in the money to trigger investment by households

9. Reaffirms a decision to invest Want to undo a previous investment decision but can’t

10. Decreasing income

11. Two critical questions 1.Does the energy efficiency gap really exist? If yes, energy efficiency policies and programs can be justified on economic efficiency grounds Programs focused on low-income households seek to address the greatest inefficiencies ˣ If no, energy efficiency programs may still be justified due to concerns over equity 2.If it does exist, what causes it? Market failure: Polices should change the choices (tax incentives, rebates, low cost loans, information/technical assistance programs, …) Behavioral anomalies: Policies should change the choice setting but not the choices themselves (nudges)

12. Market failure explanations for the gap: Imperfect information: Consumers may not be able to predict potential energy savings High upfront costs and limited access to credit: Low-income households represent low risk of default but are also more likely to have poor credit Information spillovers: Individual adoption of new energy efficient technology conveys technical information to others Split incentives among renters: Landlord determines energy efficiency investments while tenants pay for electricity use Polices and programs should change the choices (tax incentives, rebates, low cost loans, technical assistance programs)

13. 2015 price ratio

14. Behavioral explanations for the gap: Bounded rationality: households simplify complex energy efficiency investments by processing only a subset of the available information (rules of thumb) Bounded willpower: lack of self-control (make rash decisions, procrastinate) may influence energy efficiency investments Loss aversion: households overweight possible outcomes where energy efficiency is less beneficial than expected Policies and programs should change the choice setting but not the choices themselves (nudges)

15. Take-home points 1.Energy efficiency gap largest among low-income households Both economic efficiency and distributional justifications for focusing on this group Biggest bang for buck when investing public funds 2.Riskiness of efficiency investments a relatively small consideration among low-income households Low-income households less impacted by energy price volatility but less responsive to information campaigns 3.Energy efficiency gap smaller than suggested but market failures likely also play a role A role for tax incentives, rebates, and low cost loans 4.Evidence emerging that behavioral anomalies contribute but more work needed…especially among low-income households