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Economic Currents

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Revisiting the Energy Paradox: Do Quantity and Price of Energy Efficient Appliances Respond to Changes in Energy Prices and Interest Rates?

The WEER Student Blog Series features student reviews of presentations from UHERO's Workshop on Energy and Environmental Policy

Abstract: The notion of an energy efficiency gap posits that people under-invest in energy efficiency, since the present value of savings from more energy-efficient appliances, cars and other energy-consuming durable goods tends to far exceed their additional up-front cost. A considerable literature demonstrates this gap, and it has been a key factor underpinning energy-efficiency regulations. Critics contend that evidence backing an energy efficiency gap is mainly cross-sectional, and may be confounded by unobserved attributes of durable goods that are associated with energy efficiency. Taking an approach somewhat similar to recent work by Alcott and Wozny (2014), we use data on prices and quantities for a near population of sales of individual models of refrigerators, clothes washers, dishwashers and room air conditioners to revisit the question of whether an energy efficiency gap exists and how large it may be. Specifically, we consider whether changes in interest rates and electricity prices, which can significantly influence the present value of more efficient versus less efficient appliances, affect changes in sales and relative prices of more versus less efficient appliances. Model fixed effects control for unobserved attributes. We find that lower interest rates and higher electricity prices have driven sharp increases in sales of more energy efficient appliances, but that these changes tend to drive prices for more energy efficient appliances down, not up, with the exception of room air conditioners. The results suggest persistence of a very large energy efficiency gap. The results also suggest that economies of scale and imperfect competition likely complicate cost-benefit analysis of energy standards and other efficiency-related policies.​

 - Hyun-Gyu Kim and Michael Roberts, University of Hawaii Department of Economics and UHERO

Presentation slides available here

Review by Arlan Brucal

On February 12, 2016 the Department of Energy (DOE) proposed another energy efficiency standard (expressed in minimum lumen output per watt) for General Service Lamp (GSL), better known as light bulbs. Based on DOE’s calculation, the proposed energy conservation standards for GSLs would save households up to 16 percent of energy use relative to the no-new-standards case. This translates to total consumer savings ranging from $4.4 billion to $9.1 billion,1 compared to just $221 million estimated cost to manufacturers. This rule is expected to be issued by January 1, 2017.

If DOE’s information on cost savings is accurate, wouldn’t it be in consumers’ best interest to invest in more energy efficient lightbulbs (e.g. light emitting diode or LEDs)? Then how come incandescent halogens2 still represent roughly 50 percent of recent new bulb shipments to U.S. retailers?3 Does this mean that consumers are not making the most economically rational decision?  Do we have sufficient evidence to say that there exist market imperfections to merit the imposition of more stringent energy efficiency standards? Do consumers need government intervention to help them achieve greater cost savings (and significant reductions in carbon emissions as well)?  And if they do, is imposing standards the most efficient way to achieve that or it just more politically feasible? Does the so-called energy efficiency gap exist and how big is it?

To help revisit the issue on energy efficiency gap – the tendency of consumers to discount future energy savings against upfront cost, Hyun-Gyu Kim, a PhD candidate at the Department of Economics at UH Manoa, presents his work with Michael Roberts that measures the value of energy efficiency in major US appliances and verifies if the energy efficiency gap is indeed large and significant. Using the most recent data on US major appliances and an up-to-date empirical strategy, they find that the price of energy efficient products relative to non-energy efficient products was surprisingly decreasing.

The figure below illustrates the predicted change in the price of Energy Star-certified appliances relative to non-certified appliances using the estimated coefficients (the blue line) and the coefficient signifying consumers’ equal valuation between upfront cost and future energy savings (red dashed line). The green vertical line indicates the Energy-Star certification threshold in terms of annual electricity use (kWh). If consumers equally value the extra cost of buying Energy Star refrigerators and the present value of future energy savings, then the price of refrigerators should have increased by $152 (see top left panel). However, their estimates imply that the relative price may have actually decreased by $510. The same findings apply to clothes washers (top right panel) and dishwashers (bottom left panel), indicating a decline in the relative price of Energy Star-certified to non-certified appliances by $139 and $206, respectively. Room AC (bottom right panel) illustrates a different trend, indicating consumers’ undervaluation of future energy cost (i.e. the relative price should have increased by $90 as opposed to the observed price that remained relatively constant.

Figure 1. Estimated price change with $0.10 increase in electricity price.

 

Hyun-Gyu explained that this seemingly unusual relationship between the extra upfront cost and the present value of operating cost (PVOC) is likely driven by imperfections in the market. Manufacturers may be facing declining cost with respect to producing more energy-efficient products due to technological advance (e.g. increased automation) or competitive sourcing of components.4 If this is true, any shift in market demand for more energy-efficient products would translate into a drop in the price of these products relative to non-efficient ones.

Consumers may also exhibit more elastic demand due to continuous increases in electricity prices, and thus in PVOC. As PVOC increases, more consumers start looking at more energy efficient appliances. This makes demand shift and become flatter, making the relative price to fall (See figure below). 

Figure 2. Market demand for Energy Star certified products become more elastic

Note: The figure illustrates the changes in price and quantity when the demand for Energy Star (ES)-certified appliance becomes more elastic (D1 to D2). The y-axis of the graph indicates the price difference between ES and non-ES certified appliances, and the x-axis shows the sales of ES certified appliances. The black solid line denotes the (constant) marginal cost of an additional ES certified appliance in the market.


While the study did not explicitly answer the question of whether the energy efficiency gap is small or not, it puts more qualifications on the issue by demonstrating that the dynamics behind the energy efficiency gap is more complex than most of us think. Certainly, the market on energy-using durable goods is characterized by a number of market failures, including, among others, information asymmetry, externalities and imperfect competition. Whether consumers indeed undervalue future energy savings or just do not have that many options in the market to choose from or it is a combination both demand and supply factors, remains an empirical question.

 

Arlan Brucal is a postdoctoral researcher at the University of Hawai`i Economic Research Organization (UHERO). 


1The estimates are based on Net Present Value at 7-percent and 3-percent discount rate, respectively.

2 Incandescent halogens are the tweaked incandescent bulbs introduced to meet the first phase of the standards that went into effect between 2012 and 2014. These bulbs are less energy efficient than LEDs.

3 Extracted from 
.
 

 

4 Ellis, M., Jollands, N., Harrington, L., & Meier, A. (2007, June). Do energy efficient appliances cost more. In Proceedings of the ECEEE 2007 Conference, Summer Study, Panel (Vol. 6).


Can Cheap Oil Hurt Net Importers? Evidence from the Philippine Economy

The WEER Student Blog Series features student reviews of presentations from UHERO's Workshop on Energy and Environmental Policy

Abstract:  Conventional wisdom suggests that oil price increases have a negative effect on the output of oil-importing countries. This is grounded in the experience of the US between 1940s and late 1980s where recessions are generally preceded by oil price increases. In this paper, we evaluate the impact of oil price shocks on the Philippines--– a developing country and a net oil-importing economy. Following Kilian's (2008) structural decomposition of real oil price change, we find indications that the recent oil price decline may have lowered the Philippine economy's output growth, potentially due to the economy's reliance on remittances from abroad and the export market.

- Arlan Brucal and Michael Abrigo, University of Hawaii Economic Research Organization (UHERO), East West Center, September 12, 2016.

Presentation slides available here

Review by Trevor Fitzpatrick

Since the beginning of 2016, oil prices have hovered around $30 to $50 a barrel. These current prices are about a third of the 2008 peak crude oil price of $145 per barrel. The recent significant drop in oil prices are the greatest we have seen since the 1980s. Like many other price fluctuations in goods, the recent drop in oil prices have benefited some more than others. Conventional wisdom suggests that low oil prices will benefit oil consumers while oil exporters will suffer. As the case may be, the effect of low oil prices is not that simple.

On September 12, Arlan Brucal highlighted the importance of looking at the causes of recent oil price changes, and their direct and indirect effect to an economy through international trade and factor mobility. Focusing on the Philippine’s economy as a test case, Arlan finds an indication that the recent oil price drop may have slowed down the growth of the country’s gross domestic product (GDP) by 5.5 percent. This seemingly counterintuitive result is largely due to the fact that the Philippine economy is heavily reliant on service exports, a component of the national output that suffered heavily from the recent oil price drop. Demand for crude oil has not recovered from the 2014 slump, and still cripples oil-exporting economies, which host most of the overseas Filipino workers (OFWs). Over the past decade, remittances received by the Philippines from abroad account for about 15% of the country’s GDP. The share of remittances to Philippines’ total output is significantly higher than India and China – the two biggest recipients of remittances in 2014 – and much higher than world averages.

Arlan and Mike’s study employs Kilian’s (2008) vector autoregression (VAR), which decomposes oil price shocks into supply shocks, aggregate demand shocks and oil-specific demand shocks. Supply shocks are unanticipated changes in the global crude oil supply. These supply shocks could emanate from exogenous geopolitical conflicts, discovery or new resources, or technology (i.e. fracking). Aggregate demand shocks are unanticipated changes in real economic activity, which includes economic booms in China or economic recessions that reduce the demand for industrial commodities including crude oil. Oil-specific demand shocks are changes in the demand for crude oil that are not related to aggregate demand shocks. These shocks include precautionary demand shocks associated with the future oil demand-supply conditions. An example of which would be a sudden drop in the price of oil because of the looming conflict in the Persian Gulf in the early 2000s. The study finds indications that the recent drop in oil prices are driven by a combination of both aggregate demand and oil-specific demand shocks. These findings are in contrast to the popular view that cheap oil is due to an oil oversupply caused by the surge in US oil production (Figure 1). 

Figure 1. Historical Decomposition of World Crude Oil Price Changes

Note: Each bar reflects the relative contribution of each estimated structural shock to oil price changes for the period 1976-2015.

Source: Brucal and Abrigo (2016)

 

While the results appear to be quite convincing, their external validity is yet to be established. Indonesia presents a potentially good comparison example for this study. Indonesia and the Philippines share many commonalities: multicultural/ethnic, developing countries, nations that consists of many islands, exportation of laborers to many oil producing countries, etc. Does Indonesia have a similar pattern of remittances from overseas workers in oil producing countries, and do cheap oil prices negatively affect these remittances to Indonesia like they do in the Philippines? The fact that Indonesia is an exporter of oil could make the comparison difficult, but there are recent arguments and evidence that Indonesia’s oil production is starting to decline and that it is starting to consume more oil than it is producing. While Indonesia presents one interesting case to compare the Philippines with, further research could be expanded to include a number of countries with a wide range of dependence on remittances, which might help to establish if remittances is indeed a major mechanism.

Additionally, it was pointed out that the Filipino diaspora in the US was not accounted for, or that the US-Filipino diaspora did not make up a noticeable population and source of remittance as some the other overseas Filipino populations. One would assume that the US Filipino diaspora would still be a large population. Taking into account that cheap oil prices have been associated with economic booms in the US, we could possibly hypothesize that remittances from Filipinos in the US would increase. Could this US-Filipino remittance recover the losses felt from the loss of petro-dollars and remittances from Filipinos that work in oil producing countries? This could be another aspect to consider.

The negative impacts that Arlan’s findings could have are possibly reflected in the lack of sophistication of the Philippines workforce. Continued export of unskilled laborers to oil producing countries and the reliance on their income partly being shifted back to the Philippines is potentially holding its economy back. However, if the Philippines is labor abundant and capital poor, the Philippines may be better off by exporting workers to labor deprived countries. Perhaps further development of the workforce could help decrease some of the reliance on service jobs in oil producing countries. Further education and development in human capital can certainly help. The Philippines could also encourage more foreign direct investments as well although negative impacts particularly on natural environment would have to be monitored.

Arlan and Mike’s study is part of a bigger project that studies the impact of oil price-related shocks to developing countries. Most of the current literature has focused on the more advanced economies of the world like the US. Hopefully, Arlan and Mike’s study will help fill the void in the literature on the impacts of oil prices on developing countries. Future studies building upon what Arlan and Mike have done are highly anticipated.


 Trevor Fitzpatrick is a graduate student at the Department of Urban and Regional Planning (DURP) – University of Hawaii at Manoa