Two months ago, I was talking to an experienced entrepreneur who was
exploring business models to provide geothermal
heat pumps to households. At first blush, it seems like a great
idea. Geothermal heat pumps often
have payback periods of under five years, which translates into internal
rates or return in excess of 20% over the 30 year life of the system. With
plenty of room for a business to recoup its cost of capital and leave some money
on the table for the consumer, it's amazing that there isn't a company in every jurisdiction
already active in the market.
In fact, sellers of geothermal heat pumps are few and far between. Google searches for "buy
geothermal heat pump" and "buy
geoexchange" (an alternate name) drew less than 300,000 hits combined,
while searches for "buy
furnace" and "buy
air conditioner" drew over 2,500,000 hits each. Why is that?
Barriers to Energy Efficiency
When I spoke to the same prospective geothermal heat pump entrepreneur again
a month later, he told me he couldn't figure out how to make money
on the deal. Nor can I. The economics work best with new construction, but builders have no
incentive to save their customers money on their utility bills. In a
case study from Delta-Montrose Rural Electric Association (DMEA), a
progressive Colorado electric cooperative, they identified purchase cost as the
main barrier to adoption. DMEA was able to overcome that by financing the
systems for their members (customers) with a payment on their monthly utility
bill, something they are in a unique position to do, because they are also the
Most utilities will not support energy efficiency programs without regulatory
intervention. Since energy efficiency programs reduce the total
electricity sold, and electric rates are set by regulators, without decoupling,
energy efficiency measures reduce the utilities profits. A utility helping
its customers reduce their usage would be like General Motors encouraging people
to carpool so they could buy fewer cars.
Utility rate decoupling
can fix this disincentive for a utility to work with consumers to reduce their
usage, but a mental shift is also necessary for utilities to take on the
challenge of working with customers to help them reduce their rates. After
all, DMEA is one of a very few rural electric cooperatives with an aggressive
energy efficiency program. Despite the fact that the co-ops are owned by
their members, and so, unlike investor owned utilities, they should be more
interested in their customers' welfare, some investor owned utilities (usually
spurred on by regulators-- Coops, because of their mutual structure, are mostly
unregulated), as wells as municipally owned utilities which are much more likely
to embrace energy efficiency programs.
Hirst of Oak Ridge National Laboratory identifies
these barriers to energy efficiency improvements:
|Barriers to improving U.S. energy efficiency
|Structural barriers—conditions beyond the control of
the end user
- distortions in electricity pricing
- supply infrastructure limitations
|Behavioral barriers—conditions that characterize end users
- efficiency attitudes and awareness
- perceived riskiness of efficiency measures
- obtaining and processing information
- limited access to capital
- misplaced incentives
- inconvenience, loss of amenities
For investor owned utilities (IOUs), the problems are mostly those of
misplaced incentives, and attitudes. When the state regulator changes the
incentives, a well run IOU will quickly change its attitude. IOUs are in
business to make money, and so they respond to incentives. For a rural
cooperative, I believe the main barriers are attitudes, awareness, limited
ability to obtain an process information, and possibly perceived riskiness.
Since co-ops are responsible only to their members, and their customers are
typically even less educated about the potential for improved efficiency to
increase their well being than the utility that serves them, there is no reason
for the coop to change its way of doing business. Co-op boards' main
incentive is to keep their members happy. Often the simplest way to do
that is my keeping them ignorant.
Barriers for Business
The landscape for a traditional business to make money for energy efficiency
is different. The main barriers confronting a business such as an
entrepreneur wanting to sell geothermal heat pumps, will be problems of
misplaced incentives and the attitudes, awareness, perceptions, and general
level of knowledge of their potential consumers.
Continuing with the heat pump example, if an entrepreneur tries to sell the
ground source heat pumps to homebuilders, who would be able to install it most
cheaply and thus achieve the highest rates of return, he is confronted by
misplaced incentives. The builder will not be pay the future utility costs
of the house he is building, and so does not have any incentive to pay extra for
a system from which he will not receive the benefit. If the entrepreneur
attempts to sell the heat pump to the homeowner, he is confronted with the
difficulties of drilling holes for the geoexchange loops next to an existing
home, which will greatly increase the price of the system and lower the
effective rate of return. If, despite this, the system still has an
attractive rate of return, he will still be confronted by the homeowner's
limited access to capital or, if he finances the purchase for the customer,
there will be the inconvenience and added cost of billing the customer on a
regular basis (an inconvenience that DMEA was able to avoid by including the
costs in their electric bill.)
There are Opportunities
This is not to say that business will never be successful selling energy
efficiency measures to consumers, only that it takes more sophisticated business
models and an understanding of the barriers to adoption for the business to succeed.
One type of business that has been successfully overcoming these barriers for a
long time are performance
contracting companies, which I wrote about a few weeks ago. By
providing its members with comfortable homes rather than simply electricity,
DMEA is in some sense following the performance contracting model.
For investors, it is important to understand that a product has to be more
than just financially compelling to be successful in the marketplace. I
think the compact fluorescent light bulb (CFL) is an excellent example of how
compelling economics are not enough to ensure the adoption of a product.
For CFLs, the economics are clear; the energy savings for a 14 watt bulb used
just two hours a day amount to around $3 a year, which is more than the current
price of a bulb which will last a decade or more. Even in the late 1990s,
when such a bulb cost three times as much, the internal rate of return for the
investment exceeded 30% per annum, which is comparable to the returns that were
captivating investors in tech stocks at the time.
Despite these economics, and countless endorsements from Al
Winfrey, and the US
Department of Energy, CFLs currently only have around 5%
of the US market. You'd think that endorsements as powerful as those
would have people rushing out to buy them.
While CFLs are not suitable for some applications (outdoors
in cold climates, and places where they will experience a lot of vibration such
as ceiling fans, which leads to premature breakage), these weaknesses do not
account for our slowness to adopt them. Instead, I believe the barriers to
adopt them are Hirst's behavioral barriers. For a $2-3 bulb, access to
capital is clearly not the problem, but perceived riskiness is definitely part
of it: CFL's mercury content has earned them much bad press (they
actually contain less mercury than they save by reducing usage of coal plants),
despite the fact that the mercury content is much lower than traditional
fluorescent bulbs about which I have never heard a complaint about mercury...
except from people who don't want to got to the trouble of disposing them
There are often also complaints about light quality, which was indeed a
problem with early bulbs. Recent ones, however, uniformly out scored an
incandescent bulb in a blind
test by Popular Mechanics in several measures of light quality. In my
mind, I feel the real motivation for consumer resistance is fear of
change. While the returns are gigantic when phrased in terms of a return
on investment, in absolute terms the gains from using compact fluorescents are
fairly small, just a few dollars a year per bulb. For that amount of
money, most people are not willing to go to the mental effort required to change
an ingrained way of doing things, and so they latch on to any "reason"
not to change they find, and use it to justify it to themselves.
It's cynical, but I believe that your average person would rather waste hundreds
of dollars rather than change his habit and learn something new.
Energy Efficiency Success Stories
If I am right that the slow progress of CFLs is really resistance to change,
we can use that information to figure out which energy efficient technologies
will be most successful: not the ones that have the best economics, but the ones
that require nothing of the people who purchase them to do nothing more than
provide the cash. Performance contractors and DMEA's heat pump program
have been relative successes because they ask so little of customers. It's
interesting to note that DMEA includes a "Geoexchange Comfort Club" or
social aspect to their program. I wonder how many people joined the
program just to get a free dinner.
This, I believe is the secret behind the runaway success of the Prius.
Although Toyota is lambasted for it today, the early ads for the Prius
emphasized that, unlike the doomed EV1, it never had to be plugged in. But
on the financial side, there is much debate about how much money they save you, if
any. When stacked against hybrids, comparable
diesels get similar mileage for lower upfront cost, and for serious global
warming fanatics like myself, they have the advantage of being able to burn
biodiesel without any modification. Yet people look at me strangely when I
tell them I have a Jeep Liberty diesel, but they're impressed that I bought a
Prius in 2001.
Another example of convenience trumping cents is solar power. Solar
domestic hot water (SHW) has been around since the 70s, and the financial rate
of return varies from 5% to 20%, depending on a wide variety of factors.
Solar Photovoltaics (PV), on the other hand has a financial return of between 1
and 5%, depending mainly on rebates (these are all my calculations; your results
may vary, but there is a
strong consensus that SHW is a better financial bet than PV.) Yet
again, PV is popular, and SHW is a "hidden gem" pushed by earnest
environmentalists. Yet people are used to complex electronics in their
lives, but the plumbing is something they only see when there is a leak and they
have to call a plumber. So while PV is much higher tech than SHW,
electronics are something people are used to, while plumbing (SHW) is something
they only associate with inconvenience.
The Bottom Line: It's Not the Bottom Line.
When it comes to selling energy efficiency to consumers, businesses need to
remember that the financial and environmental outcomes are only a tiny part of
most consumers decisions. Recent evolutionary psychology research implies
do good deeds as a strategy to attract mates, and so they want to be
seen doing those good deeds. Businesses that realize that the good energy
efficiency does for the environment is a better selling point will succeed where
businesses peddling economics will fail. Why was the Accord
Hybrid discontinued and Hybrid
SUVs are struggling while Prius sales hit records? I believe it's
because they are not conspicuously green. People want to be seen to be
green a lot more than they want to save a few dollars on gas. The Japanese
who buy fake solar panels don't ask about the payback period. Many PV
installers have already realized this, and they have learned to counter
arguments about the economics of PV by asking, "What
is the payback period of granite countertops?"
This lesson can also be turned on its head. By making energy efficiency
an item for display, just like a Terrapass
window decal, energy efficiency can become something people aspire to.
When our utility bills are on the internet for everyone to see, that's when
we'll see geothermal heat pumps and Built
Green and Energy Star homes take off. Even infrared
images of homes posted on Google
Street View might do the trick. Efficiency needs to be conspicuous to