Why Energy Efficiency Remains a Business Priority

Energy consumption can create a negative externality when the emissions associated with it impose costs on third parties.  The price on the meter reflects what energy costs a business, but it does not necessarily reflect the wider costs of emissions, which can fall on third parties.  Because these external costs sit outside the price mechanism, the market may under-price energy relative to its full social cost, giving businesses less incentive to reduce consumption than would be socially optimal. 

The UK's carbon price rose from around £21 per tonne in 2020 to around £73 in 2022, before falling to about £35 in 2024. From January 2027, the UK's Carbon Border Adjustment Mechanism (CBAM) will place a carbon price on emissions embodied in specified carbon-intensive imports. The mechanism is designed to ensure that specified carbon-intensive imports face a comparable carbon price to similar goods produced in the UK. 

But knowing the theory doesn't explain why so many businesses still leave profitable efficiency measures on the table.

The Energy-Efficiency Gap

The energy-efficiency gap was examined by Adam Jaffe and Robert Stavins in their 1994 paper, “The Energy-Efficiency Gap: What Does It Mean?”. The paper examined the idea of a gap between actual and optimal levels of energy efficiency and explored how different definitions of “optimal" affect the size and interpretation of the gap. In their research, Jaffe and Stavins argued that the apparent gap could have several explanations, including market failures and factors that do not necessarily represent market failure. 

Potential barriers include imperfect information, principal-agent problems such as split incentives, and financial constraints. These factors can make it difficult for businesses to invest in energy-efficient technologies, particularly when they face higher upfront costs and uncertainty about future savings. 

Why Sound Investments Still Stall

These barriers don't just make efficiency upgrades harder to justify in principle, they change how such upgrades fare against the alternative uses of a business's capital. Even when energy-efficiency upgrades appear financially attractive, they may still be overlooked when businesses compare them with alternative investment opportunities. Businesses must compare the upfront investment and expected savings with the potential returns from alternative investments, considering the opportunity cost of using capital for energy-efficiency improvements.   

Cheap Gains First, Diminishing Returns After

Energy-efficiency measures do not all offer the same financial returns. Some of the more cost-effective measures, such as programming the building's heating, ventilation and air-conditioning (HVAC) system to operate when occupied and using appropriate temperature settings and controls to avoid unnecessary heating or cooling, will generally have a quicker payback period. Once those inexpensive and easily implemented measures are completed, further reductions in energy use may require larger investments, while the cost-effectiveness of additional measures may decline. Therefore, it’s wise to implement the inexpensive and obvious measures first, then look at the larger projects on a case-by-case basis according to their expected costs, savings and payback periods. 

What This Means in Practice

Measurement is important for assessing whether energy-efficiency measures are delivering the expected results. Tracking measures such as energy use per square metre or per unit of output can help businesses assess changes in energy efficiency. Adjusting for factors such as a milder winter, which can reduce heating demand, can also help facilities managers distinguish changes in consumption from changes in energy prices. Done consistently, that can turn energy efficiency from a one-off project into an ongoing business practice.