December 04, 2015

Punishing Efficiency


With the passing of several years since the Great Recession, citizens and governments are making fitful progress in repairing their broken balance sheets. However, everyone remains concerned with mitigating risks to growth. Among other efforts, advanced economies have continued to reduce their exposure to oil supply or price shocks. Yet oil is just one of a number of energy sources on which economic growth depends, and for many it will form a decreasing part of their portfolios in the coming decades.

This is partly due to the rise of new sources of energy. We now have access to much cleaner forms of energy such as natural gas. We also have ‘renewable’ sources in greater quantities in the form of solar, wind, wave, geo-thermal, bio-diesel, and others.

In addition, we have seen steady improvements in energy efficiency as well as ongoing decreases in energy-intensive activities as our economies are driven more by knowledge work, services, and virtual-world value. By analogy, think of your cell phone battery life: it has improved in the last decade, not just because the batteries got better, but also due to advanced power-management software in the electronics themselves.

Meanwhile, the COP21 climate summit in Paris this month aims to make major progress on reducing GHG emissions. This increased attention and work in the energy sector is an encouraging indicator of what may come in the near future. So, too is the recent experience in transitioning away from chlorofluorocarbons (CFC’s) in aerosols, refrigerators and air conditioning units. But it seems clear that, for efforts in Paris to succeed, we must find a path to decouple the Gross Domestic Product (GDP) of nations from energy consumption and the resulting greenhouse gas (GHG) emissions. This is clearly the only way we can sustain economic growth while reducing the devastating quantities of GHGs that are slowly, but surely devastating our natural environment.

A key lever for progress has been to reframe the economic incentives for pollution emitting activities. Energy utilities are making the transition to a world where their revenues are no longer dependent purely on “shipping energy”. Increasingly, utilities are able to generate an economic return from capital investments, as opposed to the quantity of electrons that are sold. In jurisdictions where energy utilities have decoupled revenue from commodity sales in this manner, the rate structure and regulatory environment encourage more judicious use of energy.

Just as energy has been the major resource challenge of the last 100 years, so water is likely to be over the next 100 years and beyond.  Growing global populations and urbanization, increasingly unpredictable weather patterns, as well as deteriorating water supply quality are demanding new solutions. Very few water utilities have yet decoupled their revenues from levels of water production. As we have seen over the past few years, the result has been that some of the most responsible stewards of this precious resource have been economically punished for good behavior. The current economics of water production and delivery are not aligned with improvements in consumption efficiency. In other words, when utilities and their customers are successful at improving water-use efficiency, the resulting drop in revenues creates an untenable financial situation for the utility.

Nobody denies that negotiating the politics of industry restructuring can be tough, particularly if customer communications are mishandled. Yet good solutions are available, and valuable lessons can be learned from the earlier experiences noted above. In general, successful transitions of this sort occur when 3 key elements are in place: data, regulation and markets.

The right data can inform wise regulation. Regulators need to understand resource consumption patterns, how changes in these patterns might impact utility revenues, and what the impact of certain changes may have on the more disadvantaged members of our communities. Informed by accurate data and actionable insights, smart regulation can assist the creation of appropriate incentives that leverage market dynamics. This can result in new tools that allow water utilities to maintain appropriate financial reserves while creating more equitable cost structures for all of us.

While not easy, such reimagining of our commodity pricing design is the best path to improve quality of life and economic activity, all while using less water than in the past. So here’s to reaching a successful agreement in Paris, and all it portends for how we think of our next critical resource challenge.

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