Energy Efficiency in Regulated and Deregulated Markets

1. INTRODUCTION AND THESIS The efficient use of electricity is a moral and environmental concern of contested economic validity. Opponents argue that the pursuit of energy efficiency is the pursuit of economic inefficiency. Proponents counter that the pursuit of economic efficiency in the electricity sector is an environmental disaster due to market failures caused by environmental externalities and transaction costs. In the interests of brevity, this paper focuses solely on end-use efficiency, not generation or distribution efficiency. This paper takes the position that there is merit in the pursuit of end-use energy efficiency measures in the electricity sector. Those measures are often called demand side management or DSM. Energy efficiency measures can be effective tools to correct market failures and achieve environmental goals, both in regulated and deregulated markets. Although they are useful tools, energy efficiency measures are certainly not the only tools needed to correct these failures and achieve environmental goals. This paper also explores the effect of the new deregulatory era on the achievement of energy efficiency, arguing that this worthwhile goal can and should be kept. The new deregulated environment has created a different market for electricity, but one that still has problems from an environmental and an economic point of view. An effective policy must provide incentives to the actors who are best suited to overcome market failures in the new regulatory environment. Those incentives must be developed in a way that harmonizes energy efficiency policy with new environmental policies, particularly the development of emissions trading markets and renewable portfolio standards. Part Two of this paper defines energy efficiency. Although there are multiple, conflicting definitions of energy efficiency, here the term is used in a hybrid economic and environmental sense. That is, energy efficiency policies aim at setting social use of electricity at the level that would be set by consumers in a perfect market where price reflects the true social cost of electricity. Since that price does not exist, and cannot be ascertained precisely, energy efficiency measures seek to approximate it. Part Three identifies the relevant features of the regulated and deregulated eras. "Deregulation" does not signal the end of regulation in the electricity sector. It instead represents a new regulatory regime that requires an end to vertically integrated electric monopolies to allow a greater degree of competition, particularly in electricity generation. Distribution is still monopolized, often operated by a regulated non-profit corporation. Retail supply is also monopolized in most American jurisdictions. Thus, there is a substantial role for regulators in a deregulated electricity sector. However, energy efficiency measures developed in the regulated past of the electricity industry require re-examination and change during the new era of deregulation. After establishing what energy efficiency, regulation, and deregulation mean, Part Four examines the policy justifications for energy efficiency regulations. The underlying assumption of this section is that there has always been a role for environmental policy in the regulation of the electricity sector. Determining the optimal way to provide electricity has always been treated by our society as a multi-criteria problem because it is a political problem. The interests of capitalists, consumers, and those affected by the environmental disruption of electricity production are in conflict. Environmental considerations have always been, and will always be, a part of electricity policy. Most justifications for energy efficiency involve market imperfections, although energy security is often mentioned. The core question of any electricity policy in a capitalistic society is the optimal price for electricity. In both a regulated and deregulated market, private actors will step in, where there is sufficient profit, to pursue energy efficiency measures. …