Wednesday, July 29, 2009

Some Questions for McKinsey About its New 1.2 Trillion Dollar Energy "Savings" Report

The McKinsey Consulting firm has identified a big free lunch for how to earn a very high rate of return for making investments in energy efficiency. Roughly 35% of the gains is said to be possible from the residential sector.

I have a question for the partners of McKinsey. Are they willing to put their money where their mouth is? Will they offer my household the following contract? "Professor Kahn, your current monthly electricity bill is $100 a month. You pay us (McKinsey) $85 a month and we will pay all of your electricity bills for the next 5 years but you must let us enter your home and install energy efficiency upgrades and improvements".

This "outsourcing" of energy consumption decisions would lead to more efficient investments but would cause incentive problems because I would now face a zero marginal cost per kilowatt hour consumed. In this case, I might crank up the air conditioning but this can be anticipated. McKinsey could offer me a lower fixed price per month as long as my total consumption does not exceed a tier.

So, my point is that if McKinsey is so confident about the rate of return they are predicting --- shouldn't they stop giving advice and actually open a business and start selling their product?

Now, they may have some doubt about the demand for efficiency --- but my contract offer would induce some households to participate.

Note that my contract would help McKinsey (assuming their numbers are correct), the household would face lower electricity bills, and the electric utility would get a smaller carbon bill because it would be producing less power and this would reduce peak load issues of blackouts in the middle of the summer.

Talk is cheap, let's see some new innovative contracts from the smart guys at McKinsey!

Here is the report:

UPDATE: I hope that these guys are right but at the end of the day, this is a micro-econometric question. Why have diverse individuals and firms been slow to adopt energy efficient investments? Inertia? Belief that energy prices will be low in the future? High discount rate? Risk Aversion and fear of new stuff?

The way to answer this question is by running field experiments and learning about real people rather than simply grabbing a huge number of out "thin air" and hoping to get some blog media play.

I should note that a reader named Josh has asked me not to forget my comparative advantage strongly hinting that I should stick to environmental issues. I'm slightly sympathetic but the UC paycuts have made me nuts and have led me astray.

As I type this, I am writing five new papers on environmental economics: in no particular order;

1. With Dora Costa , on understanding household residential electricity consumption over time and across households as a function of demographics, ideology, housing types, climate conditions.

2. With Erin Mansur, how do industrial energy prices affect where U.S manufacturing clusters? Or will California lose manufacturing jobs because AB32 causes leakage and migration to cheaper energy states?

3. Hopefully with Matt Kotchen, how does environmental public opinion move over the business cycle? Recessions are bad for building support for tightening regulation. So this is a high frequency "J" curve.

4. With Zasloff and Vaughn on the gentrification effects of the California Coastal Boundary Zone regulation; This is "Superstar Cities" applied to the coast line

5. Adaptation to Climate Change --- this is a book --- that is now coming into focus at 200 pages and growing

So, I tell you this to pre-commit that I will return to discussing what I'm supposed to be discussing but please go find my missing 10% of my pay!