Energy Management

Should low energy prices kill efficiency investments?

Peter Garforth explores the challenge of acting locally in the current global oil, gas, and electricity market.

By Peter Garforth

The drop in oil prices by well over a half in recent months, combined with historically low natural gas prices in North America, inevitably raises the question about whether this is a good time to be investing aggressively in energy efficiency. This is a question as much for all levels of government as it is for industry and private consumers. There is a somewhat counter-intuitive case to be made that there can never be a better time to implement significant energy efficiency measures.

As well having low natural gas and oil-based fuel prices relative its domestic history, North America also has some of the lowest prices compared to most of the rest of the world. In a world of global completion, the United States and Canada currently have a substantial competitive edge when it comes to energy costs. It would be naive to believe this is a situation that will last forever.

Multiple scenarios could result in a leveling of the gas and oil products around the world. The most obvious would be the increase in exports of liquefied natural gas (LNG) from the United States and Canada to higher-priced European and Asian markets. In a small scale, this effect is already hitting Australia as they ramp up gas exports.

In today’s picture, companies with high energy costs have the most obvious and immediate need to invest in efficiency compared with what their North American competitors need to simply stand still. On the flip side, North American companies could see lower than expected energy costs as a reason to delay efficiency investments, due to both the lower return on investment and the immediate profit opportunity.

This latter reaction is arguably unwise from a number of aspects. The most obvious is the future competitive risk: if my competitor has invested in efficiency and I have not, when prices rise and globalize, the competitor has a clear and sustained advantage. This will usually occur when global markets are healthy; a time when management focus should be on growing the business not playing catch-up on efficiency investments.

From an affordability standpoint, investing now makes sense. Energy budget estimates for the immediate future for most American companies are likely to be higher than the actual costs. These estimates are baked into the overall profitability assessment of the company. It is a relatively painless decision to allocate a part of the gap between estimated and actual energy costs to investments in energy efficiency. This still leaves some windfall profit, and has minimal impact on relative global competitiveness.

The formula to allocate these investments can obviously be a mix of fixed and variable components, such that it could grow if prices fall further or shrink if the reverse is true. In the real world, companies that choose to prioritize efficiency in a low price energy market will be in the minority. Those swimming against the trend will find suppliers of energy efficiency services and technology hungry to make deals, giving them the choice of the best players in the market at the lowest possible prices.

While all the headlines have focused on gas and oil-products, the electricity side of the cost equation is much more complex. Rather than falling, electricity prices in most American markets have been stable or are increasing. While still cheaper than many parts of the world, the price gap is much smaller.

The probability of sustained increases in American electricity prices is significant for a variety of infrastructure and regulatory reasons. This is yet another reason to take the windfall benefits of gas and oil prices and assign part of them to overall energy efficiency. This helps manage a much more immediate and local cost risk. In some senses the low price of gas can be used to subsidize investment in electrical efficiency.

It doesn’t take too much imagination to translate this idea to a government policy level. From June last year to today the average gasoline price has dropped from $3.70 per gallon to $2.05. The average federal and local taxes are a constant of 48.5 cents. Some countries structure fuel tax to fall as the underlying fuel price rises, and to increase as it falls.

If this approach were in play at the moment in the United States or Canada, there would be substantial revenues available to upgrade roads and other transport infrastructure. The consumer would still reap the lion’s share of the falling oil price and would feel a little less pain when prices rise. In a similar way, if the falling natural gas prices were allowed to fall a little less, with the difference rebated back into building and industrial efficiency, the consumer and the community would be well positioned to deal with future increases.

The industrial energy manager should probably be sharpening the arguments to support that this is the time for more, not less, aggressive investments in efficiency.

Read Peter Garforth's monthly column, Energy Expert.