Posted by Daniel Hall on October 18, 2007
I’ve had several conversations over the last few days about the numerous opportunities that apparently exist within the economy to reduce energy use and save money — opportunities that energy consumers have so far failed to take advantage of. Since economists don’t typically think that people knowingly leave $20 bills lying on the sidewalk, some explanation is needed for why exactly these apparently ‘negative cost’ energy-saving opportunities persist.
Part of the explanation is provided by a recent article in the Washington Post about a plan to reduce energy use by increasing the energy efficiency of buildings:
Virginia Tech officials announced plans yesterday to give some of the Washington area’s buildings a sweeping green makeover, using $500 million from an investor to pay for energy-saving upgrades at 100 or more properties throughout the region.
The plan, which calls for such additions as more efficient light bulbs and cooling systems, is intended to bring about significant reductions in electricity use in the area and in emissions from its power plants. It also allows for-profit investor Hannon Armstrong in Annapolis to take a slice of the money that building owners will save.
If this is a good deal for both investors and building owners, however, then surely it would be a better deal for just building owners. Why haven’t building owners previously made these energy-reducing investments and captured all the savings for themselves? The article clues us in:
In Washington, officials said the building retrofits would begin with a visit from “energy auditors” from Pepco Energy Services, a division of Pepco Holdings, who will look for places where energy is wasted. …
… upgrades would then be paid for by Hannon Armstrong, which will raise the capital by selling its securities, Eckel said. Building owners would repay Hannon Armstrong out of the money they save, officials said. The agreements would be designed so that building owners would still make money off the savings or at least break even.
The first paragraph indicates that there is a knowledge problem, or asymmetric information: building owners don’t have the same specialized knowledge that the energy auditors presumably do.
The second paragraph makes it sound like building owners don’t have as ready access to capital as the investors. Although it isn’t clear from the article whether this is the case here, many times in building management the use of energy is troubled by principal-agent problems. A classic example is a landlord and tenant: the landlord has access to capital but lacks a day-to-day incentive to save energy, while the tenant would like to save energy but lacks a long-term incentive to make capital investments to do so.
These are both examples of the types of market failures that allow energy-saving opportunities to go unexploited. The investors highlighted in the article are trying to capitalize on the business opportunity that these market failures present. By pointing them out as notable, however, the article raises the question of why more firms aren’t trying to make money in this gap between perfect market efficiency and the much-less-efficient real world. There are, after all, apparently gold in them ‘thar walls.
H/T: Ryan Avent