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Uncertainty regarding energy prices is hampering investment in energy efficiency

Researchers of the BC3 (Basque Centre for Climate Change) and the UPV/EHU-University of the Basque Country develop a model to analyse the conditions under which it is appropriate to invest

According to the model developed by BC3 and UPV/EHU researchers, energy price uncertainty is having a negative effect on investment in energy efficiency. Furthermore, they conclude that higher prices of energy and CO2 emission allowances would encourage such investments. They have published these results in the prestigious Journal of Environmental Management. Energy efficiency is an increasingly significant component in energy and climate policy. The positive implications of an increase in energy efficiency are not only economic but also environmental, as they enable greenhouse gas emissions and other contaminants to be reduced. “Our work comes within the framework of the concern about studying the measures that would encourage investments of this type and move them forward in time,” says Dr Luis María Abadie, Research Professor of BC3 — Basque Centre for Climate Change, created by UPV/EHU, Ihobe and Ikerbasque— and first author of the paper Valuing uncertain cash flows from investments that enhance energy efficiency published in the Journal of Environmental Management. “There are some perfectly viable technologies, but owing to a number of causes, investments are frequently not made yet they are ones that could be profitable,” points out Abadie. These causes include lack of information, budgeting and cash-flow difficulties, red tape, and lack of funding. But one of the most important is the uncertainty: while the cost of such investments is considerable, their benefits are uncertain, because future prices (for example, that of electrical power) are also uncertain. In this work, Luis María Abadie, Jose Manuel Chamorro and Mikel Gonzalez-Eguino analyse the conditions under which there would (or would not) be an investment in energy efficiency at a power station that uses coal and emits CO2. “We have included the CO2 because intensive energy consumption industries that operate around us are already paying for emission allowances," says Abadie. By investing in efficiency, the power station would use less coal and would make savings in emission allowances. With the current parameters, emission allowances are of lesser importance, but it is something that could change in the future: “Right now, as there are more emission allowances than needed, the prices are low. But a political decision could change this." In any case, emission allowances are another component that could help in investment decisions. Using real market data they have applied uncertainty-based rating techniques and have added three risk factors: investment costs, fuel prices, and the price of emission allowances. “This is the first time that such a model has been proposed (with three factors) to rate investment in energy efficiency,” says Abadie. The strength of the method lies in its capacity to quantify the monetary threshold under which investment would be most favourable, despite the uncertainty, in a way consistent with the prices quoted on the markets. If the conditions change (for example owing to a regulatory change affecting the CO2 permit market), the method proposed includes the option of investing under the new conditions to be analysed and rated. The results of the work show that less uncertainty and higher energy prices and higher emission allowances encourage investment in efficiency. In a previous piece of work applied in the United States Abadie recalls “seeing that the years in which energy costs rose the most was when the most was invested in energy efficiency.” On the other hand, the results indicate that a temporary subvention, available only at a given moment, would also encourage the making of these investments. Many governments and agencies have begun to include energy efficiency among their aims. The European Union, for example, is planning to increase energy efficiency by 20% by 2020 (2012/27/EU Energy Efficiency Directive). “It will be almost compulsory to invest in energy efficiency," says Abadie. “What is more, what the International Energy Agency is hoping is that the improvements in energy efficiency will be a more significant factor in cutting CO2 emissions. So we believe this is a key factor. And if energy and environmental policy fails to take into consideration the impact of uncertainty, many profitable investments may never be made, or may be postponed until conditions are more favourable." The Low Carbon Programme Group The authors of the paper belong to the Low Carbon Programme research group, a multidisciplinary team made up of researchers of the UPV/EHU-University of the Basque Country and the BC3 (Basque Centre for Climate Change, created by UPV/EHU, Ihobe and Ikerbasque) and which has funding from Repsol. Economists and engineers work together to overcome the dividing line existing between the economic analysis and the design of climate change policy. Right now, they are running several projects. "We are working on wind energy matters to rate the various systems of returns from wind energy; and we are analysing the economic value and the economic cost of the facilities for capturing and storing CO2, which is another of the measures that people are hoping to implement in the future and which could be somewhat controversial.” Abadie and Chamorro are also working on a book for the Springer publishing house dealing with rating energy investments. In the book, they will be describing the methodology they have used in this latest piece of work and will be applying the methodology to many more cases. References Abadie L.M. Chamorro J.M. and González-Eguino, M. 2013. Valuing uncertain cash flows from investments that enhance energy efficiency. Journal of Environmental Management. 116. 113-124. Abadie L.M Ortiz R.A. and Galarraga I. 2012. Determinants of Energy Efficiency Investments in the U.S. Energy Policy. 45. 551-566. 10.1016/j.enpol.2012.03.002.