Frequently Asked Questions About Energy Efficiency

Q: What is energy efficiency?

Energy efficiency is a measure of the energy productivity of an economic good or service. The less energy required to produce a unit of output, the more energy efficient that economic activity is. Energy efficiency is correlated to energy intensity, a commonly used measurement of economic goods, services, and even whole industries and sectors. Energy intensity is typically expressed in some unit E (for energy) over GDP (gross domestic product), or E/GDP.

Q: How does energy efficiency improve over time?

Energy efficiency improves when our economies grow and our technologies get better. Examples of improving energy efficiency include requiring less gasoline to drive the same number of miles; improving the thermal efficiency of a power plant to generate more electricity with less fuel; step-wise substitutions towards more energy-efficient technologies (such as the transition from kerosene to incandescent bulbs to compact fluorescents and LEDs); and the general, long-term path of economic growth from more energy-intensive sectors (such as agriculture and industry) towards less energy-intensive sectors (services and knowledge).

Q: Should energy efficiency be pursued?

Yes, absolutely. Unlocking the full potential of efficiency is the difference between a richer, more efficient world, and a poorer, less efficient world. Broadly speaking, when car engines, computers, and light bulbs were less efficient, they used less absolute energy. As they became more efficient and delivered services faster, we produced and used more of them, leading to greater energy use overall. Improving the energy efficiency of a technology or service allows for wider spread diffusion and attendant increases in economic growth, human development, resilient infrastructure, and a host of other benefits. Improving energy efficiency has a consistent tendency to spur technological diffusion, economic growth, and the freeing up of energy resources to be used on novel, productive energy services.¹

Q: How does energy efficiency contribute to economic growth?

At the microeconomic level, below-cost energy efficiency improvements lead to cost savings, allowing consumers or firms to spend or invest on economic activities. At the macroeconomic, economy-wide level, widespread energy efficiency improvements could increase the overall productivity of the economy, resulting in increased economic growth.²

In some cases, energy efficiency improvements lead to the efficiency of other factors of production, such as capital or labor. Consider how the introduction of electric arc furnaces to steelmaking in the United States allowed scrap steel to be recycled for the first time, bypassing the most energy intensive step of the incumbent technology (the blast furnace) and greatly improving the energy efficiency of the industry. But arc furnaces greatly improved capital efficiency as well, compounding the overall productivity improvement.³

Another way that energy efficiency improvements may lead to economic growth is when more efficient energy technologies and services open up new markets or enable new, widespread energy-using applications, products, or industries – a so-called “frontier effect."⁴ Frontier effects are most likely to occur following the commercialization of energy efficient technologies have “a wide scope for improvement and elaboration, have potential for use in a wide variety of products and processes, and have strong complementarities with existing or potential new technologies.” Energy efficiency improvements in such general-purpose technologies (GPTs) can open up new frontiers of economic activity, particularly when the efficiency improvements occur at an early stage of development and diffusion of the technology.⁵

Q: Is energy efficiency good for developing economies?

Yes. As today’s rich countries did, the developing world will continue to experience major improvements in energy efficiency at the technical, sectoral, and economy-wide levels. And unlike in industrialized economies where the demand for many basic services like electricity and water is mostly provided for, in developing economies the unmet demand for such services is large. Cost savings from energy efficiency improvements are quickly reabsorbed into further production and provision of such services, helping to lift these economies out of poverty. On the consumer side, access to more energy efficient technologies (eg, switching from wood and dung burning to oil and gas burning) saves much-needed time and money for these consumers, but also saves lives by reducing local pollutants.⁶

Q: Is energy efficiency an effective climate strategy?

Many analysts used to assume that energy efficiency leads to a one-to-one reduction in energy consumption and greenhouse gas emissions. Increasing the efficiency of buildings, vehicles, appliances, and industry plays “a key role” in climate mitigation scenarios envisioned by today’s leading environmental and consulting organization, including McKinsey, the National Resource Defense Council,⁷ Rocky Mountain Institute,⁸ and the ClimateWorks Foundation.⁹ But in recent years a growing number of economists and energy analysts have challenged the assumptions and methods behind these studies.¹⁰ These economists and energy analysts have criticized many of most bullish efficiency reports and projections, faulting them for underestimating the technical, financial, and information barriers to pursuing energy efficiency improvements.

Crucially, there is also a rapidly growing recognition that below-cost energy efficiency improvements can lead to an increase in demand for energy through a number of economic mechanisms known as “rebound effects.”¹¹ While the magnitude of such rebound effects is debated and depends on the context, such effects could render energy efficiency ineffective at reducing energy consumption and greenhouse gas emissions, particularly in developing economies where most of the world’s future energy demand growth is expected. Rebound effects are important for understanding climate mitigation. As the International Energy Agency writes, “correct accounting for the rebound effect may reduce the potential contribution of energy efficiency to climate change mitigation, possibly altering the relative priority of different CO2 abatement policies."¹²

Q: What are "rebound effects?"

A "rebound effect” is when an improvement in energy efficiency triggers an increase in demand for energy.^13-17 When the efficiency of an energy consumptive activity improves, the cost of the service derived is lowered. Individuals and firms respond to price changes in two general ways: 1) Increase the use of that energy service to increase outputs or incomes. For example, a low-income resident may now heat his or her home more often or more areas of the home after weatherizing because it is now more affordable to heat. 2) Rearrange the factors of production, or goods and services consumed, to substitute now-cheaper energy services for other goods or services (maintaining the same level of output or income). For example, a more efficient heat plant may enable a chemicals plant to raise temperatures in industrial processes to extract high quality product from poorer quality inputs (substituting energy for materials) or to reduce process times (substituting energy for labor).¹⁸ Likewise, lower energy prices will increase total factor productivity, increasing economic growth and attendant energy consumption; this is called “economy-wide” rebound.

Q: Why do rebound effects matter?

The magnitude of rebound effects determines how effective efficiency improvements are at contributing to lasting reductions in total energy use (and therefore greenhouse gas emissions). Energy efficiency is frequently cited as the single greatest contributor to emissions reduction. The problem is that all of these estimates are based on an assumption: that energy efficiency reduces energy demand in a linear, direct, and one-to-one manner. An X% gain in efficiency leads to an equivalent X% reduction in total energy use. The economy is anything but direct, linear, and simple, especially when responding to changes in the relative price of goods and services. If we don't accurately and rigorously account for rebound effects, we risk over-relying on energy efficiency to deliver lasting reductions in energy use and greenhouse gas emissions, and we might fall dangerously short of climate mitigation goals.¹⁹

Q: Are rebound effects large or small?

Rebound effects differ in scale depending on the type of energy efficiency improvements, and in which part of the economy they occur. Over 100 academic studies have examined the empirical evidence, conducted modeling inquiries, and otherwise tested the scale of rebound effects. While there is much more work to be done to determine the precise scale and impact of rebound effects in different circumstances, the conclusion is that rebound effects are significant and cannot be ignored in energy and climate analysis and policymaking.

Q: Do rebound effects wipe out all of the expected energy savings from efficiency improvements?

Not usually. Combined rebound effects drive total economy-wide increases in energy demand with the potential to erode much (and in some cases all) of the expected reductions in energy consumption. In certain cases, efficiency improvements will "backfire," driving a rebound in energy that fully compensates for the initial energy savings, increasing energy demand overall. Think of it this way: for every two steps forward we take in energy savings through efficiency, rebound effects take us one (and sometimes more) steps backwards.²⁰ On the other hand, rebound effects equate to a net increase in consumer and social welfare, and thus should not necessarily be viewed negatively.

Q: How large would rebound be if we improve end-use consumer energy services like personal transportation, home heating, or appliances?

In rich, developed nations, if we improve the efficiency of end-use consumer energy services, like cars, home heating and cooling, or appliances, the literature indicates that direct rebound effects are typically on the scale of 10 to 30 percent of the initial energy savings.²¹ Additional indirect and macroeconomic effects may mean total rebound erodes roughly one-quarter to one-half of expected energy savings.²² Rebound is smallest in cases when demand for the energy service in question is already saturated (that is, we use as much of it as we would care to use), and highest in cases where the cost of the energy service is a key constraint on fulfilling demand for that service.

For example, if a wealthy homeowner already reliably heats all the rooms in his or her house to 70 degrees, he/she wouldn't increase the thermostat to 77 degrees just because our heating system got 10 percent more efficient. But if a poorer household can't afford to turn the thermostat up, or only heats one room of the house with a small space heater, then if the house gets weatherized and more efficient, that household is likely to use more energy to heat their home. In general, end-use consumer efficiency improvements in rich, developed economies will still lead to a net savings in energy, although rebound effects shouldn't be ignored even here.

Q: Should we expect rebounds to be the same in rich and poor nations?

No. Rebound and backfire effects are both most important and least understood in emerging economies. Rebound effects are almost certainly larger in poorer, developing nations. In terms of efficiency improvements in end-use consumer energy services in developing nations, direct rebound effects are likely to be much higher than in richer nations, possibly reaching at least as high as 100 percent.^23-26 Rebound is higher because demand for energy services is far from saturated and more elastic, and the cost of energy services is often a key constraint on the enjoyment of energy services. This is important because growing demand in developing nations is the principal driver of energy demand growth worldwide. Long-term price elasticities of demand also tend to be higher during early stages of development.^27,28 Since expanding the supply of energy services is a key constraint on economic activity in developing nations, the macroeconomic impact of efficiency improvements in developing economies is likely to be more significant, helping developing economies grow faster (and thus consume more energy).

Q: What about industrial efficiency improvements?

Rebound is particularly high in productive sectors of the economy – such as electric power or steel production – and sectors where efficiency improvements can motivate significant consumption increases and “frontier effects,” or whole new energy services.²⁹ While further study of rebound effects for efficiency improvements at production firms is needed, the literature to date indicates that direct rebound effects in developed countries may be on the order of 20 to 70 percent for industrial sectors, with additional rebound due to indirect and macroeconomic effects. In developing countries, rebound in industrial sectors may be on the order of 50 to 90 percent.³⁰

Q: What determines the magnitude of industrial-scale rebound?

Rebound effects in firms depend principally on the ability of firms to take better advantage of now-cheaper energy services. This is especially true for new productive capacity. If long-term substitution is high, rebound effects can be substantial. In addition, output effects contribute to rebound for energy intensive firms with a high elasticity of demand for their products (that is, where consumers are very responsive to changes in the price of their products and demand more product as prices fall).³¹

Improvements in energy productivity at firms can also contribute to greater economic activity and growth, driving up energy demand overall. In general, rebound effects are higher for efficiency in productive sectors of the economy than for end-use consumer efficiency. This is notable, because two-thirds of the energy consumed in the United States is consumed in the productive sectors of the economy and "embedded" in the non-energy goods and services purchased by consumers.³² In China, India, and many other developing economies, an even greater share of energy is consumed for productive activities.

Q: What happens if we pursue efficiency improvements across an entire sector or economy?

At the economy-wide, macroeconomic scale, the aggregate impacts of widespread energy efficiency improvements can lead to substantial rebound effects. As producers and consumers respond in turn to various cascading changes in the price of goods and services, the pace of economic growth quickens, and market prices for fuels may fall, driving further rebound. A number of 'Computable General Equilibrium' (CGE) models generally show rebound at the scale of a national economy at 40 to 60 percent for developed economies, and 50 percent to much greater than 100 percent (‘backfire) for developing economies.³³ These studies look at national economies and thus ignore global, macroeconomic impacts beyond national borders, which can add additional rebound in energy consumption. 'Integrative modeling' found that if the world adopted all of the "no regrets" energy efficiency policies suggested by the IEA, then rebounds effects would erode more than half of expected savings (52 percent) in the long-term. There are also several reasons to think this is may be a conservative estimate.³⁴

Q: Are rebound effects are the reason energy use has continued to rise?

Rebound effects are part of the reason that energy use is still growing, even as the economy gets more and more efficient. True, economic growth drives up energy use, even as we get more efficient. But those two terms – economic growth, and energy efficiency – are related, and rebound effects describe the relationship between the two. Part of the reason the economy continues to grow is because below-cost energy efficiency improvements grow the supply of energy services and increase the productivity of the economy – we get more economic activity and income and welfare out of the same amount of energy – and productivity improvements are a key driver of economic growth.

Some economists argue that the supply of energy services is a key enabling force in economic growth: think about the impact of electric motors, industrial lasers, computing, automation, and all of the other ways in which we use energy to greatly improve the productivity of our economy.³⁵ Efficiently expanding the supply of energy services may thus be one of the principal factors determining the rate of economic growth in rich and poor nations alike. That said, there are definitely other factors driving economic growth, including improvements in the productivity of other inputs to the economy, such as labor, capital, and other materials.³⁶

Q: If we work harder at gains in efficiency, can't we outpace the rate of economic growth and finally decouple the economy from consuming ever-more energy?

As it stands, economic growth continues to outpace energy efficiency improvements, and energy use continues to grow overall. The global economy has been growing at the rate of roughly 3 percent per year. Historically, there has been roughly 1 to 1.5 percent improvement in energy use per unit of economic output (energy intensity or productivity) each year. For energy efficiency gains to outstrip the increase in energy demand driven by the growing economy, the economy must improve energy intensity/productivity by at least 3 percent per year, roughly doubling or tripling the historic rate of improvement.³⁷

Efficiency advocates argue that if we work harder at capturing energy efficiency opportunities, we can more than double or triple this rate of efficiency improvement and bend global energy use downwards. That's a big task, and there at least two factors make this challenge even harder:

1) a large portion of changes in energy intensity over time can be attributed to structural changes in the economy, as economies shift from agricultural to industrial to services-oriented.³⁷ These aren't the technical improvements energy efficiency policies are concerned with, and these trends are hard to accelerate or affect through policy; 2) rebound makes the doubling/tripling goal even more challenging, as it means efficiency feeds back into energy consumption and economic growth (increasing both) and makes the horizon we're reaching toward recede even further.