Strategy Symposium Final Paper

Transform the Environment. Transform Your Wallet.

Introduction With the dawn of the Industrial Revolution, ideas became property and mans ability to harness nature enabled dramatic productivity gains. But while it was easy to quantify and seek out the lowest price for a manufactured widget, the degradation to the environment was not factored into the free market, and externalities such as pollution went un-priced. Over the last 150 years, we have seen as the parts per million of carbon in the atmosphere has gone from 300 to 400 reaching a level not seen in over 3 million years and for when the oceans were 60-80 feet higher1. The world is being correspondingly transformed: glaciers are shrinking worldwide, water stresses are now occurring for hundreds of millions, and global areas affected by drought have increased2. Although globally humanity is transforming the environment with carbon output, decreasing carbon output does not have to be costly. In fact, McKinsey in a 2007 report, shows that it is possible to save consumers money while abating considerable amounts of carbon. While McKinsey focused on the abatement potential for buildings and appliances, transportation, industry, carbon sinks, and power, we are limiting this paper to just the energy efficiency of buildings and appliances, where it is possible to both nearly 40 billion dollars annually (see Appendix B) while eliminating nearly 10% of the USs annual carbon emissions3. This paper is structured to two particular areas: 1) what choices Booth students should know after they graduate with regards to energy efficiency, and 2) what broad policy options the US or specific states should use to ensure that there is market efficiency. Booth Specific Recommendations We wanted to create a series of recommendations for our classmates, because we felt that our message of energy sustainability through efficiency fit with the themes of our education at Booth,
1

http://www.nytimes.com/2013/05/11/science/earth/carbon-dioxide-level-passes-long-fearedmilestone.html?pagewanted=all&_r=0 2 http://climate.nasa.gov/effects
3

Reducing U.S. Greenhouse Gas Emissions: How Much at What Cost?. McKinsey Executive Report December 2007.

combining a social mission with attractive investment returns. We realize that Booth is but a small slice of society, but its surely a start and we hope youll implement some of these measures and even pass the message on through your networks!

I.

Survey Results

We found two main insights from the survey of Booth second years. First that the class generally cares about these issues:

Importance
5
4 3 2

Neutral

1
0 Carbon Emissions Energy Efficiency The Environment Sustainability

Another lesson we can draw here is that even for a highly educated audience like Booth, that likely has read about rising carbon emissions, it simply is too nebulous of a concept to care too much about. Further, carbon emissions are complicated by a lack of global coordination making it hard to generate the political will to take an economic hit on carbon reduction in the US when we have no control over the policies of other carbon-intensive countries (such as China). However, it is encouraging to see that Booth students care above average on issues such as efficiency, sustainability, and environment. Our second key insight is that Booth students were highly responsive to ROI data on light bulb choices; this is not surprising given the emphasis on ROI as a decision making metric.

Light Bulb Choice

No Info
ROI Info

Incandescent

CFL

LED

In one survey question, we asked the class if they would prefer incandescent, compact fluorescent lamps (CFL), or light-emitting-diode (LED) light bulbs. Then we presented them information on the total cost of ownership information for each of these light bulbs, and asked them the same question. When presented with total cost of ownership, the class moved significantly away from incandescent lights and towards CFL and LED replacements. Therefore in making our recommendations we will focus on presenting ROI metrics on various efficiency products and solutions.

II.

Qualitative issues

The survey also allowed us to get some qualitative responses which we feel would be valuable to address: LED payback period Some people responded that they were concerned about the longer payback period for LED lights, and perhaps not being able to capture the full benefit before moving again for example. We concede that LED prices are still high, and havent reached the scale of CFLs yet, meaning that it takes longer to see a return. However in high cases of use or higher than average electricity costs these lights can still represent a strong return and we encourage you to take your LEDs with you when you move to take advantage of their long lifespan.

LED/CFL breakage These products, especially if certified by Energy Star have strict minimum warranty requirements: 2 years for CFL bulbs and 3 years for LED bulbs. These required minimum guarantees generally exceed industry standard practice and you often dont even need the original purchase information to get a replacement.

LED Light Quality Some people commented that they dont like the lighting hue of LEDs because they are not warm. While this is a legitimate matter of taste, manufacturers are responding to it by warming up the quality of light by adding materials such as phosphorus. LEDs objectively emit very high quality light; the Rijksmusuem in Amsterdam for example has recently reopened with LEDs to light up their paintings because they dont emit excess heat or UV rays4.

CFLs and Mercury CFL bulbs do contain a small quantity of mercury, about 4mg. Manufacturers have been working to reduce this and products are available with as low as 1mg. This does mean that you should take additional care not to break the bulbs when handling and disposing of them, but the risk is minimal. In terms of mercury pollution, most mercury pollution comes from electricity production, so reducing electricity usage will lead to a net decrease in mercury.

http://www.newscenter.philips.com/main/standard/news/press/2013/20130403-new-rijksmuseum-illuminatedwith-philips-led-lighting.wpd

Recycling programs for CFLs are expanding to safely dispose of them. But even in a worst case if all 272 million CFLs sold in 2009 were landfilled, they would add 0.12% to the US mercury emissions, before taking into the account the reduction in electricitywhich reduces the amount of mercury associated with electricity generation5. II. IRR Calculations

We show cash flows (defined as initial cost, then savings) for several efficiency products relative to their conventional counterparts

Light Bulbs Case

http://www.energystar.gov/ia/partners/promotions/change_light/downloads/Fact_Sheet_Mercury.pdf

Savings by Year
$10.00

$5.00

$-

$(5.00)

CFL Savings LED Savings

$(10.00)

$(15.00)

$(20.00)
10 5 0 0 -5 -10 -15 -20 -25 -30 1 2 3 4 5

Cash Flows

CFL CF
LED CF

CFL 5 Yr IRR: 208% LED 5Yr IRR: 11%

Assumptions:

Average National Energy Cost: $0.115/kWh 3hrs/day of daily use

Source: EPA Research 2012 Conclusion: At this time, CFLs represent a much better investment case than LEDs, primarily driven by the high initial cost of LEDs. These returns can become even more attractive as costs of these new bulbs go down, or if your use and electricity costs are above national averages. Note: these calculations are different from the initial ones we showed in class, due to new data on average costs and residential usage from the EPA study

Appliances Case

Cash Flows of Efficient Appliances

$60.00
$40.00 $20.00 $Y0 $(20.00) $(40.00) $(60.00) Y1 Y2 Y3 Y4 Y5 Washer Dishwasher

Refrigerator

Washer 5 Yr IRR: 120% Dishwasher 5Yr IRR: 81% Refrigerator 5Yr IRR: 25%

Assumptions: Average National Energy Cost: $0.115/kWh Average National Gas Cost: $1.08/therm Average National Water Cost: $8.37/thousand gallons Washer:

o 6 loads/wk o 3.10 cubic feet o 6.00 Water Factor o Additional cost of Energy Star model: $50 Dishwasher: o 4 cycles/wk o Rated electricity/year: 295kWh o Rated water/cycle: 4.25 gallons o Additional cost of Energy Star model: $10 Refrigerator: o 22.7 cubic feet o Rated electricity/year: 513kWh o Additional cost of Energy Star model: $40

Source: EPA Research 2012 Conclusion: Its important to note that these benefits are measured when deciding to buy a new appliance and deciding between the conventional model or a more expensive energy star model. The return case for replacing an older model with a brand new model will be much more variable and complex given the high initial cost of appliances and wide variety. In general we can see that it is worthwhile to pay for more a more efficient device if making a new purchase decision. If you are making a replacement decision, Energy Star provides calculators which allow you to manipulate variables and will give you ROI data, which we also used for data in our calculations.
See: http://www.energystar.gov/ia/business/bulk_purchasing/bpsavings_calc/appliance_calculator.xlsx

III.

Call to Action

Efficiency Solution 5 Yr IRR CFL 208% Washer (new) 120% Dishwasher (new) 81% Refrigerator (new) 25% LED 11%

We have presented a spectrum of solutions that have very high returns in addition to advancing a worthy social cause. This list is by no means comprehensive, we avoided other solutions such as insulation/HVAC which are highly project specific. However our main goal was to show everyone how

thinking about efficiency can have a high payoff. We believe that our peers at Booth represent a unique group that is can understand and appreciate these ROI arguments, care about making a difference, and are fortunate enough to generally have the income to afford the additional upfront cost of these investments. Policy Mechanisms

Through classroom surveys, a qualtrics survey, academic research, and discussion with energy efficiency experts, we identified five policy measures that have been effective in changing consumers behavior to move towards energy efficiency. We particularly wanted to focus on agency issues. As McKinsey describes it, Agency issues complicate alignment of businesses and consumers toward desirable abatement outcomes; the builder of a condominium, for example, is usually not responsible for paying the energy bill. Put simply, the potential for energy efficiency is real and large, but without a change in policy or approach, this potential will remain out of reach. The mechanisms that we examined were:

Policy Measure Government Mandate Tax Credit/Rebate

Educational Campaign Peer pressure Market mechanism

Explanation Requiring at the federal, local or state level that utilities must save a certain percentage of electricity demand through energy efficiency Incentivizing at the local, state or federal level through an upfront or delayed tax credit or rebate that would steer consumers to making alternative buying decisions towards areas that are more energy efficient Having the government fund either government agencies or non-governmental organizations to educate a targeted populace on the benefits of energy efficiency Using peer networks to encourage changes in buying decisions towards more energy efficiency products or to use more energy efficiency in homes Relying on the free market and assuming that buyers are rational

We focused on research on energy efficient light bulbs as they are easy to understand, have a large amount of data, and almost everyone in America has them. There are three particular types of light bulbs that were studied for this analysis (see previous section for full explanation on each light bulb): incandescent, CFL and LED.

To document the efficiency of these light bulbs, we used the case study model.

I.

Mandates: EU decided to phase out incandescent light bulbs by 20126

The EU endorsed regulation in December of 2008 to start a phase out from the European Union market starting in 2009 and finishing in 2012. Starting with non-clear incandescent lamps being phased out in September 2009, this automatically shifted consumers to CFLs, which save about 80% of the energy of incandescent light bulbs.

For those customers using clear light bulbs (100W and above), the levels of outputs were made consistently stricter from 2009 to 2012, with halogen clear light bulbs being on the market until 2016. Special exemptions for special purpose incandescent light bulbs (such as those used in ovens or traffic lights) were included.

The EU estimated this would negative affect (and make redundant) 2000-3000 of the 50,000 people producing light bulbs in the EU, compared to the 5 to 10 billion euros saved from energy bills that can be invested in other economic activities. Tax Credit Individual utilities have given tax credits for energy efficiency programs

II.

In 2007, the Illinois legislature passed a law requiring utilities to establish annual energy-savings goals and to reduce energy delivered and peak demand. The utilities are required to meet this energy efficiency reduction (see mandate above) but can spend up to 2.015% of the amount paid per kwh by customers in 20077.

ComEd decided to meet the energy efficiency reduction partly by offering on-the-spot tax credits in the first year of having energy efficiency requirements. ComEds goal was to change more than 11

http://ec.europa.eu/energy/efficiency/ecodesign/doc/committee/2008_12_08_technical_briefing_household_la mps.pdf 7 http://www.dsireusa.org/incentives/incentive.cfm?Incentive_Code=IL19R&re=0&ee=1

million incandescent bulbs to CFLs in three years. 8 They did this through partnering with local hardware stores (such as Ace or Lowes) to lower the cost of CFL light bulbs to the price of incandescent, and giving the rebate directly to the hardware store and on-the-spot savings to individual customers. Through May 2010, ComEd paid $9 million in incentives to reduce the light bulb prices of 8 million light bulbs for energy savings of 145,650 MWh (roughly 6 cents/kwh)9.

One Illinois utility, Commonwealth Edison, gave away CFLs to small businesses. However, only 37% of customers had installed the CFLs within one month of receiving them, and about a third of the CFLs that were installed went into homes (people took them home) reducing in reduced operating hours and lower kwh10. Educational campaign the Department of Energy regularly funds energy efficiency campaigns

III.

The US Department of Energy, through the Energy Efficiency & Renewable Energy division, financially supports the Energy Efficiency and Conservation Block Grant Program, which is designed to deploy the cheapest, cleanest and most reliable technologies the US hasnamely energy efficiency and conservationacross the country. Nearly half a billion of competitive grants were awarded, which were used for energy efficiency and conservation programs, including education.

Half of this money was used for the Home Weatherization Assistance program, with a portion dedicated to Consumer Education. While this program boasts savings of $437/house per year11, we were not able to find any conclusive data on how effective the educational portion of this is and

http://www.energycentral.com/enduse/energyefficiency/news/vpr/6080/Results-Exceed-ComEd-ExpectationsSix-Months-After-Launch-of-Smart-Ideas-for-Your-Home-Energy-Efficiency-Program 9 http://ilsag.org/yahoo_site_admin/assets/docs/PY2_QTR_Four_without_financials.259111452.pdf 10 http://meeaconference.org/fck_uploads/MES_2010_presentations/MES_2010_Melloch_1-13-2010.pdf 11 http://www1.eere.energy.gov/wip/wap.html

how consumers respond when shown the data on how much they save from energy efficiency lighting.

We discussed with an Illinois energy efficiency expert from the Environmental Law and Policy Center12, who advised that education was tricky, as even though consumers say they want more information when faced with the data they still dont change their behavior. She advised that mandates were the best way to change consumer behavior. Peer Pressure What your neighbors are doing

IV.

Academic research, followed by new companies entering the market (most notably OPOWER) are now sending in select markets letters to residential utility customers to compare their energy usage versus those of their neighbors. At a study of 600,000 homes, the average program reduces energy consumption by 2% -- the equivalent of increasing energy prices by 11 to 20% to show the same reduction in demand13. Each user is shown how they are doing compared to their efficient neighbors, as well as all neighbors, and are assigned a smiley face or a frowny face:

The cost effectiveness of this program, on average, is roughly 3.31 cents per kwh saved.

Conclusion
12 13

Interview with Sarah Wochos, Environmental Law and Policy Center. June 4, 2013 http://opower.com/uploads/library/file/1/allcott_2011_jpubec_-_social_norms_and_energy_conservation.pdf

Even in light of all the overwhelming evidence that efficiency solutions are market efficient and will save consumers and businesses money, they face low market penetration due to various factors such as the higher initial cost and apathy. It is estimated that as a percentage of sockets, CFLs have a roughly 20% saturation varying by state, with California having the max at 30%14. A lot of money and energy savings are being left on the table. Based on the case studies, analysis and conversations with experts, we feel that mandates are the best way to change consumer behavior towards energy efficiency. This does two things: provides a clear market for producers; the certainty of a long-term market for energy efficiency should allow more competitors to enter this space; and uses government levers to change consumer behavior for their own benefit. We caution however that mandates have shown to be politically unpopular in the US, and perhaps a state level approach is best because it takes into account local factors such as energy prices. Instead of a direct mandate like Europe, in which the phasing out of incandescent light bulbs is mandated, it might make more sense to have it gradually be done in the US per the Environmental Protection Agency in higher and higher standards for lighting efficiency, to avoid the unpopular policy of a direct mandate. Although of course for our classmates we feel like weve presented a compelling investment case using only market mechanisms! We hope that armed with this knowledge you might change your behavior and encourage others to join you.

14

http://www.energystar.gov/ia/products/downloads/CFL_Market_Profile_2010.pdf

Appendix A

Appendix B Tech Cost/ CO2 Ton Potential CO2 abatement Total US savings Challenges Opportunities

Lighting

-$87/ton

240 Megaton of carbon

$20.9 bn annually

Ownership issues; lifetime payback Education

Substitution from incandescent to LED and CFL Conversion to Energy Star or similar Initial installation; retrofits New buildings

Electronic equipment

-$93/ton

120 Megaton of carbon

$11.2 bn annually

HVAC equipment Combined Heat and Power Building shell

-$45/ton

100 Megaton of carbon 70 Megaton of carbon

$4.5 bn annually $2.5 bn annually

Ownership issues How to implement

-$36/ton

-$42/ton

50 Megaton of carbon

$2.1 bn annually

Ownership issues

New buildings

* Over 21,300 Megatons of carbon are emitted each year into the atmosphere