Energy efficiency and the limits of market forces: The example of the electric motor market in France

Energy efficiency and the limits of market forces: The example of the electric motor market in France

Energy Policy. Vol. 26, No. 8, pp. 643— 653, 1998 ( 1998 Elsevier Science Ltd. All rights reserved Printed in Great Britain 0301-4215/98 $ 19.00#0.00 ...

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Energy Policy. Vol. 26, No. 8, pp. 643— 653, 1998 ( 1998 Elsevier Science Ltd. All rights reserved Printed in Great Britain 0301-4215/98 $ 19.00#0.00

PII: S0301-4215(98)00023-8

Energy efficiency and the limits of market forces: The example of the electric motor market in France Edmar Luiz Fagundes de Almeida Researcher at Institut d+Economie et de Politique de l+Energie. IEPE - Universite´ des Sciences Sociales - BP 47 - 38 040 Grenoble cedex 09, France

This paper addresses the limits of market forces as the exclusive driving force for energy efficiency. The electric motor market in France is analysed, with particular emphasis on the structure and functioning of the market, as well as the decision-making practices of the main agents. The study shows that market forces are constrained by the variety of transaction types and by the decision-making practices of agents, in an environment characterised by lack of information and split incentives for adopting energy-efficient technological options. The paper argues that public intervention is a necessary condition for organising the market and promoting energy efficiency. The article points out the main obstacles to the diffusion of efficient electric motor technologies and suggests some initiatives for market transformation.( 1998 Elsevier Science Ltd. All rights reserved Keywords : Electric motors; Energy efficiency; Market limits

Introduction

through the diffusion of HEM technology has been identified and a large share of this potential corresponds to opportunities where investment payback time is very attractive. Although a $2000 investment in a motor represents expenditure in electricity that might reach $50000 over the motor’s lifetime, the investment cost is often considered to the detriment of lifetime cost. It is widely accepted that agents frequently do not consider the total cost of the service. An intriguing question for economic analysts is ‘Why do economic agents neglect opportunities to increase their profits through energy efficiency?’ Energy economists have traditionally explained agents’ failure to optimise their choice of technology by pointing to market failures.4 The key market failures traditionally mentioned in the literature5 are: inadequate market regulation, leading to pricing distortions, agents’ imperfect information,6 asymmetric information, supply infrastructure limitations, and imperfections in capital

There are two kinds of general purpose electric motors available in the market place today: standard motors and high-efficiency motors — HEMs. This latter technology was introduced in world markets in the late 1970s after the oil crisis. In 1995, these motors represented 20% of induction motor production and sales on the American market.1 In Europe, however, they still have a negligible market share.2 This discrepancy in the market share between North America and Europe can be attributed to the absence of active market transformation initiatives in Europe.3 Considerable potential for energy savings

1 In Canada, the rate of diffusion of HEM technology is currently of 60%. 2 Around 1%. In France the share of HEM in total motor sales is only 0.5%. 3 In North America, the electricity utilities have created programs for the diffusion of HEM as part of demand side management (DSM), which explains the higher level of diffusion of these motors. Currently, 160 electricity utilities in the USA have some kind of motor DSM program. These programs may involve direct rebates, loans, energy audits, bidding, and so on.

4 See Krause (1994). 5 See Sutherland (1991), Sanstad and Howarth (1994), Krause (1994), Carlsmith et al. (1990) and Finon (1996). 6 Information on prices, costs and the technology itself.

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Energy efficiency and the limits of market forces: E L F de Almeida

markets.7 This Neoclassical approach considers that, in cases where the market fails to provide adequate information or signals, agents will require higher rates of return to compensate for the greater risks associated with the uncertainty level. Firms and individual consumers are assumed to be rational agents and to have profit-maximising behaviour. This approach maintains that agents are able to change their investment choices if the market failure to provide accurate information is corrected. Hence, if the problem of imperfect information or signals were solved, agents would be more certain about energy saving investments and would require lower rates of return, making these investments viable.8 This approach has been used by energy economists to build an efficiency supply curve, which is based on a sequence of energy conservation opportunities with increasing costs.9 These costs are associated with the costs of correcting market failures, assuming that once the market failures are corrected rational consumers will strive to close the efficiency gap.10 However, in the history of DSM programs, the cost of ‘negawatts’ has frequently exceeded the estimates of the efficiency curves.11 DSM case studies have related the excess in negawatt costs to structural market barriers or behavioural barriers that cannot be corrected within the framework of market forces. In other words, empirical markets may have a certain number of barriers to cost minimisation, even in a situation where all market failures are corrected. These barriers are linked to the insufficiently rational behaviour of agents, which means that there are market limits to achieving optimum resource allocation. Economists have developed an alternative approach to the Neoclassical theory to explain the failure of agents to maximise their objective function. This approach is based on the concept of bounded rationality.12 The basic hypothesis of the concept of bounded rationality is that agents’ behaviour is limited by lack of knowledge, which cannot be expressed in terms of probability. This approach assumes that ‘there is (2) a fundamental difference between a situation in which a decision maker is uncertain about the state of X and a situation in which the decision maker has not given any thought to whether X matters or not, between a situation in which a prethought

7 Agents do not have uniform access to capital markets at common rates of interest. 8 This approach was influenced by Friedman (1953), who founded the Neoclassic tradition in the theory of the firm, where maximisation is considered in terms of expected returns. This means that, based on available information, firms can draw up probability representations of prices and costs in order to proceed with ex ante maximisation. 9 This curve has been called ‘negawatts’ in efficiency economics literature. For energy conservation curves, see Stoft (1995) and Joskow and Marron (1992). 10 Krause (1994) defines the ‘efficiency gap’ as a gap between costminimising levels of energy efficiency and actual levels of energy efficiency. 11 See Joskow and Marron (1992). 12 This concept was introduced by Simon (1955), ‘A behaviorual model of rational choice’. Quartely Journal of Economics, no. 69.

event judged of low probability occurs and a situation in which something occurs that never has been thought about, between judging an action unlikely to succeed and never thinking about an action’ (Nelson and Winter, 1982, p. 67). Based on this observation, alternative decision-making rules have been adopted to represent the micro-foundations of economic transactions. The evolutionary theory of economic change has developed a new framework of economic analysis based on the notion of routines as decision rules. It corresponds to all regular and predictable behavioural patterns of the firms.13 Thus, this approach argues that firms use routines to simplify their decision procedures, taking into account their capability and the objective of making profits. An established routine is not related to the goal of profit maximisation, but rather to the achievement of satisfactory results. Firms try to adapt their decision routines to ensure a satisfactory profit level in comparison with their competitors.14 A recent study on the functioning and organisation of the electric motor market in France15 revealed the presence of not only market failures but also market limits16 which prevent consumers from making the best decisions with respect to energy efficiency. This study provides valuable information for analysing the question of appropriate policy for effective market transformation towards energy efficiency. Through an analysis of the structure and functioning of the electric motor market in France, the present paper tries to distinguish market failures from market limits. The paper claims that market failures cannot always explain the extent to which energy efficiency is taken into account by agents in electric motor transactions. Thus, effective market transformation activities should take into consideration the market limits. The present paper is organised as follows. First, the potential for energy conservation through the diffusion of HEM technology is assessed in order to identify the efficiency gap in the electric motor market. The structure and functioning of the electric motor market is then analysed, with an examination of the decision-making practices of the main actors in each market segment. Finally, the paper attempts to provide a comprehensive view of the market failures and limits for the diffusion of HEM technology in order to understand some of the initiatives which could lead to market transformation.

The potential for energy conservation Electric motors are the main electricity consuming technology in France. Motors account for 70% of electricity

13 See Nelson and Winter (1982:14). 14 Idem p.4. 15 See Almeida (1997). This study was developed as part of the SAVE program of the European Community. 16 In this paper, all barriers that cannot be corrected in the framework of market forces are called market limits.

Energy efficiency and the limits of market forces: E L F de Almeida

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Figure 1 Payback time of investment in HEM: current HEM and mandatory level HEM (5000 h/y) Source: Own data.

demand in French industry, corresponding to approximately 83 TWh of the 120 TWh which represented total industrial electricity demand in 1995. Several types of motor technology are available today,17 though the induction motor can be considered a ‘dominant design’,18 since it accounts for about 90% of all motors. Similarly, general-purpose induction motors are responsible for about 90% of energy consumption by motors. HEMs and standard induction motors are basically the same type of motor. Their main technological differences are their design characteristics and the quality of raw materials.19 HEMs are induction motors specially designed to minimise energy consumption. The main improvement in HEM design is the larger-size components, which means that more raw materials are used than for standard motors. The price difference between HEMs and standard motors depends on the power level. On average, it is about 30% in France today.20 The first obstacle to motor market transformation is the fact that HEM is in competition with the cheaper standard motor, which is a mature technology that performs the same type of technical service. The principal technical difference between the two motor types is the better energy performance of the HEM.21 In addition, there is strong competition in terms of price in the national and international motor markets.22 The calculation of energy savings potential through the diffusion of HEM technology is no easy task. The

17 The main types of Electric motors are AC motors (reluctance synchronous motor, permanent magnet synchronous motor, classic synchronous motor, and induction motor) and DC motors (permanent magnet and classic DC motor). 18 See Abernathy and Utterback (1975). 19 The main innovations have been the development of more efficient insulation material, better magnetic material such as low-carbon silicon steel plates and light aluminium alloys. 20 See Castanet and Gibielle (1993). 21 It should be remembered, however, that HEMs usually have a longer lifetime. Since HEM designs use more raw materials, they heat less, helping to limit material degradation (mainly insulator material). 22 See Almeida and Oliveira (1996).

main problem is the absence of a technical standard for defining an HEM. Each European motor manufacturer has its own criteria for classifying motors, and an HEM from one manufacturer may be less efficient than a standard motor from another manufacturer.23 The potential for energy savings therefore depends on how the HEM is defined in Europe. Almeida and Fonseca (1997) estimated the energy savings potential in the year 2010 through the diffusion of efficient motor technology in Europe24 at 2.7% for the industrial sector and 4.2% for the tertiary sector, amounting to a total of 27 TWh.25 This is a considerable potential saving, since it is the equivalent of the total electricity consumption of a country like Portugal. If we consider the difference in energy efficiency between standard motors and HEMs currently available on the European market, the potential energy savings would be significantly lower than Almeida and Fonseca’s figure. However, there is no reason to accept current HEMs as the best possible motor technology today. In the framework of market transformation initiatives, more ambitious ‘mandatory’ efficiency levels have been defined for the purpose of technology procurement programs.26 Calculations of payback time of investment in currently available HEMs and HEMs with mandatory efficiency levels show that, in applications where motors are used intensively27 the HEM can be an attractive technological option in economic terms. In both cases, payback time is less than 3 years, which is the limit generally accepted by end-users (see Figure 1). 23 EDF laboratory tests on different motors available in the French market identified some of these cases (see David et al., 1995). 24 This paper presents the results of an extensive research project sponsored by the European Commission (DG XII), on actions to promote energy efficient electric motors. 25 This study used the HEM definition from the American NEMA standard. 26 See Haataja and Harkonen (1997:5). 27 In France, 88% of industrial compressors, 75% of pumps and 70% of fans run for more than 4000 hours/year. See Castanet and Gibielle (1993).

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Energy efficiency and the limits of market forces: E L F de Almeida

Figure 2 Market delivery channels for electric motors.

The French industrial motor market corresponds to roughly one billion francs. Approximately 700 million francs come from sales to (Original Equipment Manufacturers29 (OEMs) and another 300 million from sales to end-users. In France, a few motor producers dominate the market. The four largest motor manufacturers have about 80% of the market share of the general-purpose motor market.30 At the European level, France is an important motor producer, with 14% of the market share in monetary terms. On average, 40% of this production is exported, mainly to other European countries. Exported motor may be either non-integrated or integrated into other electric equipment (mainly pumps, fans and compressors). As can be seen in Figure 2, a long, complex road separates end-users from motor manufacturers. Several different actors play a role in the choice of motor technology according to market segment. Motor choice is a result of the interaction of these different actors, with different patterns of profit-seeking behaviour. In general, large

motor manufacturers sell their products through their commercial representatives. These representatives are organised on a regional basis31 and are the commercial arms of the manufacturers, selling both to final users and to OEMs. Smaller motor producers sell very few products directly to final users. Their clients are generally OEMs and motors distributors. For low-power motor markets (mainly the residential, agricultural and tertiary sectors), there are also small independent resellers, many of which also offer repair services. Resellers account for roughly one third of motor sales to end-users in monetary terms. Engineering Service Companies (ESCs) are firms that provide plant engineering, equipment procurement and installation services. Some ESCs, such as large industrial equipment manufacturers (Siemens, ABB, etc.), can provide all these services and offer ‘turnkey plants’. Other companies only sell plant engineering services. Finally, there are many small companies which offer equipment installation services. On average, there are 60 installation companies for motors and variable speed drives (VSDs)32 for each French Department33 Electric motors reach end-users by five different channels. Most are integrated in equipment supplied by OEMs (channel 1). OEMs play a more significant role in lower power levels (up to 30 kW). The second channel corresponds essentially to replacement motor sales to small end-users. This type of end-user does not usually keep motors in stock and when a motor fails a new one is acquired from the nearest reseller, who has stocks available for immediate delivery. The third channel represents sales of replacement motors to large end-users, which order larger quantities of motors to keep in their stocks.

28 See Almeida (1997). 29 These are companies such as pump, compressor and fans manufacturers that install electric motors in their products, 30 Non-custom-made motors selected from catalogues.

31 For example, Leroy-Somer has 43 representatives distributed in 6 regions in France. These representatives sell to final users and OEMs. 32 VSDs are electronic devices which control the speed of the motor according to the requirements of the appliance. 33 Metropolitan France is divided into 96 administrative Departments.

This short analysis of electric motor use in France shows that there is a significant efficiency gap, which would justify efforts aimed at transformation of the electric motor market. Why, therefore, do economic agents not consider the adoption of HEM technology in those cases where it clearly represents an economic gain? In order to answer this question, an extensive survey of the main actors in this market was conducted so as to analyse their decision-making practices as well as the structure and functioning of the market.28

The structure of the electric motor market

Energy efficiency and the limits of market forces: E L F de Almeida

¹he fourth channel corresponds to transactions in which ESCs are responsible for motor choice and installation. This type of contract is quite common in new industrial plant construction or plant expansion. The role of ESCs is more important in higher power levels. In general, large motor applications involve complex engineering, so that firms are more likely to make use of external services. Finally, the fifth channel corresponds to direct sales between the motor manufacturer and the end-user. This type of transaction occurs only for special large end-users, who are preferential clients. Motor manufacturers prefer to negotiate directly with such clients.

Decision-making practices of main actors The many actors in the electric motor market have very different patterns of behaviour when it comes to motor selection. Depending on the distribution channel, different actors can play a dominant role in motor selection. It is therefore important to understand how each actor perceives the question of energy efficiency. The survey of the French electric motor market included a detailed analysis of the decision-making practices of the main actors in order to draw up a general pattern of how the market functions. Behaviour of motor suppliers Motor manufacturers have to adapt their marketing strategy to the complex market structure, adopting different strategies for each market segment. For example, in order to maximise their potential revenues, motor manufacturers adopt price discrimination strategies, cooperating fairly closely with agents such as resellers and OEMs. Transactions in the motor market are performed essentially through cooperative arrangements rather than pure market mechanisms. One of the most difficult tasks is ascertaining the real price of motors from motor manufacturers. Their list prices can be reduced by up to 60%, depending on the buyer’s bargaining power. This bargaining power is related to the quantity of motors procured and frequency of purchase. For example, OEMs are offered much lower prices than final users who purchase motors only for replacement. ¹he main motor manufacturers and representatives have no special interest in selling HEM technology. They manufacture very diverse product lines and there are no significant economies of scale to gain at the manufacturing level for HEMs. In addition, there is no significant difference in profit margin between the two types of motor lines. However, there are potential economies of scale at the commercial level. In general, motors manufacturers consider that HEMs have been a market fiasco. Market responses to the marketing efforts for HEMs have been very unfavourable. Consequently, the large

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motor manufacturers have adopted a passive marketing strategy as far as the HEM is concerned, only proposing this technology when clients specify energy efficiency as an important factor. No special marketing strategy is used since minimum sales results would be necessary to make such an effort worthwhile. Resellers repair shops have an important role in small motor transactions. Like motor manufacturers, resellers have no special interest in selling HEM technology. Their profit margin for this option is no greater than for any other. In fact, since there is no significant demand for HEMs, resellers do not usually stock them. Thus, small end-users who buy individual motors do not, in practice, have the option of buying an HEM. Moreover, combined motor resellers/repair shops normally prefer to rewind a failed motor rather than selling a new one. Their profit margin is larger for repair services than for new motor sales. It is important to note that rewound motors have a reduction in efficiency which can vary from 1% to 3% depending on the rewinding technique, This is a significant efficiency loss, considering that it is generally large power motors that are rewound. Clearly, resellers are not concerned with the lifetime cost of a motor, which is not surprising since they are not responsible for energy costs.

Behaviour of motor buyers Original equipment manufacturers — OEMs The main types of OEMs in France are the manufacturers of pumps, compressors and fans. These appliances are the main energy consumers among industrial motor applications. They are responsible for 63% of total energy consumption by motors (compressors 30%, pumps 20% and fans 13%). In general, large OEMs have sufficient technical capability to analyse the technical requirements of motors in relation to equipment performance. The criteria for motor selection depend on the type of OEM and the application concerned. However, all OEMs emphasise price and reliability, since their main concern is to avoid motor failure during the warranty period. Compressor manufacturers. Compressors are the main type of motor application as far as energy consumption is concerned. Nowadays, there are relatively few com pressor manufacturers in France. Only five companies effectively manufacture their products and buy electric motors in France.34 The compressor market is a very competitive segment of the industrial equipment market. As with electric motors, compressor technology is already standardised and there is little variety in product design. As a result, the compressor market has undergone a major structural transformation, with the compressor industry increasingly concentrated in a few large international industrial groups.

34 Some of these producers also import compressors equipped with motors from abroad (mainly the USA and Germany).

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Energy efficiency and the limits of market forces: E L F de Almeida

The attitude of compressor producers towards motor purchase varies with the power of the equipment. Energy efficiency is an important issue at the higher power levels (over 70 kW). Since high-power compressor applications are used intensively, end-users are quite concerned about energy costs. The principal compressor manufacturers in France offer product options with improved energy efficiency. These options embrace improvements in compressor core technologies35 and/or HEM and/or advanced compressor electric control technologies.36 Efficient electric motors are thus considered to be a relevant technological option for higher power level equipment. For low- and medium-power compressors (up to 70 kW), OEMs usually buy standard motors, claiming that end-users do not consider energy efficiency as a purchasing criterion. At this power level, the technological strategy of the main OEMs is to produce compressors with energy efficiency similar to the average level in industry. Consequently, there is little difference in energy efficiency between brands.37 The competition is focused mainly on price, product availability, trademark reputation and distribution networks. It is important to note that the technological potential of HEMs is of particular importance at lower-power levels, considering the greater difference in energy efficiency between standard motors and HEMs. A significant proportion of low-power compressor applications are used intensively. The problem seems to be related to the lack of information and awareness on the part of final users regarding the potential for energy savings. Pump manufacturers. France is an important pump producer in the European Union, with a total of ten firms producing pumps on the French market. A large number of pump designs are available to suit different service requirements. For instance, one of the French market leaders in large industrial pumps produces 140 different types of pumps.38 Pump energy efficiency depends on the type of design and the application. In the industrial pump segment, energy efficiency can vary between 40% and 90%, depending on the design and the application. The correct choice of the pump design is therefore extremely important as far as energy efficiency is concerned. According to OEMs, the end-users of low-power pumps are not particularly concerned about energy efficiency. Competition between the manufacturers of lowpower pumps focuses essentially on price. Considering that the price of the motor is an important factor in the total cost of the pump,39 pump manufacturers claim that

35 For example, two-stage compressors and compressors with energy recovery mechanisms. 36 VSDs for instance. 37 Information obtained in an interview at Sullair Europe. 38 Ingersoll-Dresser Pompes Co. 39 The cost of electric motors represents, in general, between 20% and 40% of the cost of the pump. In the lower power range, motor cost can be as much as 40% of the total pomp cost.

it is very difficult to compete in the market if HEMs are built into low-power pumps. Manufacturers do not usually buy HEMs to equip their higher power pumps either, because of the limited gain in efficiency compared with standard motors (between 1% and 4%). Their argument is that they have greater scope for energy efficiency if they concentrate on pump design. Generally speaking, end-users do not specify the type of motor they require for a pump. When they do, they tend to specify motor power in relation to pump capacity; as well as motor noise level, starting current, etc. When buying a pump, the client generally specifies minimum energy efficiency rating for the entire unit (pump and motor). The sale of large pump units is a complex operation. Once the pump manufacturer or its sale representatives receive an order, the pump manufacturer’s technical personnel must visit the client’s plant in order to determine the characteristics of the pump application. On completion of this technical study, the pump manufacturer proposes a product. On the other hand, the sale of low-power water pumps involves much less complex technical operations. This type of pump is usually purchased through a reseller and no special technical study is needed to help with selection and installation. Endusers do not specify minimum energy efficiency requirements and purchasing criteria are based essentially on price, trademark reputation, reliability, delivery time, etc. End-users Given that end-users are responsible not only for the investment costs of the motor but also for energy costs, it is they who are most concerned by the choice of electric motor. The behaviour of end-users towards motor selection differs considerably according to the size of the buyer (small and large end-users) and the type of purchase (replacement motor or motor for a new application), New equipment transactions. As mentioned earlier, most motors for new applications are selected by ESCs or OEMs. In such cases, end-users are concerned by the technical performance of the whole system (an entire assembly line or a machine). For an assembly line, the focus is mainly on productivity. Industries are concerned about reducing operation and maintenance costs. In most cases, energy expenses represent only a small part of the operating costs. When end-users agree to purchase new assembly lines through ESCs, they do not specify the type of electric motor required. This question is felt to be a minor, non-strategic technical detail compared with the other stakes involved in this type of transaction. Similarly, when end-users purchase equipment directly from an OEM, they rarely specify the type of motor required. If they have the technical capability (large enduser) they will focus on the entire system, playing only an indirect role in motor selection and leaving it to the OEM to select the sub-system technologies to fill customers requirements. Where a large end-user purchases motors for new installations direct from the manufacturer,

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Table 1 Role of different market actors in motor choice by type of sale Type of purchase - Client

Replacement

New Integrated

New non-integrated

Main actors

Share in sales*

End-user personnel

Agents of End-user

Resellers

OEMs

Motors represent.

Large End-user Small End-User

###

#

#

#

#

15%

##

##

###

#

#

10%

Large End-user Small End-user

#

##

!

###

!

25%

#

#

!

###

!

20%

###

##

!

!

##

15%

#

###

#

!

##

10%

Large End-User Small End-user

### Major role. ## Important role. # Possible role. ! Not relevant. * Approximate figures for motors sold on French market, based on rough estimates of motor manufacturers interviewed.

the transaction is subject to a sophisticated decisionmaking process, since this type of purchase is considered to be capital expenditures. The transaction is normally analysed by technical personnel and needs the approval of several decision levels in the firm.40 HEMs might be considered if there is available information in the firm about this technological option. Motor replacement transactions. End-users’ decisionmaking practices in the case of replacement motor selection are much less sophisticated. Since small end-users do not have motor stocks, a failed motor is normally replaced in an emergency situation. A few hours of inactivity can mean loss of revenue equal to several times the price of the motor. The small end-user therefore has no time for acquiring and analysing detailed information on motors. The normal procedure is to go to the nearest retailer and purchase a replacement motor, of the same type and brand as the failed motor. The priority is to restore motor operations as quickly as possible.41 Large end-users have greater technical capability in terms of evaluating, purchasing and installing electric motors. They have their own motor stocks, so that they have more time to analyse information before selecting a motor. However, even in the case of large end-users, reliability and motor price are generally the principal criteria affecting choice. The main reason for this behaviour is the structural organisation of large firms. In large industrial firms, the maintenance department is com-

40 According to the motor manufacturer officials interviewed, the number of signatures required on the client side for conclusion of a contract increases with the value of the purchase order. 41 Motor market surveys in the USA showed that 52% of industrial clients seeking replacement motors bought the same brand and model as the failed motor. Another one-third of buyers procured the same brand (DOE, 1993:9).

pletely separated from the finance department and motor replacement is dealt with directly by maintenance personnel. Less time is devoted to technical analysis than is the case for new equipment transactions. Maintenance departments are concerned essentially with process reliability. If only one or two motors are being purchased, the operation will involve a very simple decision-making process such as buying a motor similar to the failed one. The reason is that maintenance personnel are evaluated according to the failure rate of the production process and costs incurred in terms of material and human resources. Energy costs fall under general costs and are generally not the concern of maintenance departments. Engineering service companies ESCs play an important role in selecting motors for new plants or plant expansion projects. Depending on the type of contract, ESCs may be involved in equipment procurement (turnkey plant or assembly lines) or simply specification of assembly line technologies and ‘architecture’. In the latter case, engineering companies may also specify the type and brand of motor. If the contract between end-users and engineering companies depends only on the final price of the new plant-assembly line, and does not specify the type of motor to be procured, engineering companies will not take energy efficiency into account. They will only consider motor price/costs and reliability, since in this type of contract they try to minimise equipment costs to maintain their profit margin. Equipment installation companies have an important role as interface between the motor retailer (usually the manufacturer’s representative) and the end-user. In addition to installing equipment, they also provide technical advice, which can be an important factor in motor selection by small end-users. For each type of motor transaction, agents play different roles in motor selection. Table 1 provides an

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Energy efficiency and the limits of market forces: E L F de Almeida

evaluation of the influence of different types of actors in the motor purchase decision-making process. Market transactions are classified according to type of purchase (replacement motors, new motors integrated and nonintegrated in equipment), and according to type of client (large end-user and small end-user).

From market failures to market limits: a view of the obstacles to energy efficiency In the analysis of the structure and functioning of the electric motor market, a number of market failures have been identified. The most important failure is the lack of market transparency regarding technological options. There is no technical standard defining an HEM. Each European motor manufacturer has its own criteria for classifying motors as HEM. In addition, several motor manufacturers use different standards for energy efficiency measurements. As a result, buyers do not have sufficient information to accurately compare the efficiency of motors listed in motor catalogues.42 A first step towards improving the pattern of motor selection is to produce reliable and comparable data concerning the products available in the market. The other types of market failures, which were mentioned earlier, do not apply to the electric motor market. First, the cost of energy generally justifies investment in HEM technology. Second, imperfections in the capital market is not an issue of concern in this case, since all the end-users interviewed in the French survey confirmed the absence of important financial obstacles. Finally, the supply infrastructure is not a major obstacle. The main motor representatives can propose HEM technology if the client can accept a longer delivery time. In fact, it is because of the lack of market interest in HEM technology that motor representatives and independent resellers do not systematically stock HEMs. The survey provided strong evidence that end-users’ behaviour cannot be entirely explained by the wrong market signals. The attitude of motor end-user is characterised by bounded rationality where they adopt ‘rule of thumb’ routines because of the complex structure of the market and the organisation of firms. This complexity of market structure and functioning makes it difficult for motors end-users to get all the information they need to make an optimum decision concerning allocation of resources. Agents are limited in their capacity to process information, so that routine often explains behaviour related to motor selection. When small end-users have to buy replacement motors in an emergency, the only parameters they consider are delivery time and price. The rule of thumb is to buy the same type and brand as the failed

42 The EU General Directorate for Energy (DG XVII) is aware of this problem and has already proposed a directive to promote the development of a new European standard for motor efficiency measurement.

motor from the nearest retailer. Similarly, maintenance departments in large firms do not systematically consider energy efficiency if they are evaluated only in terms of maintenance costs and process reliability. The same problem of bounded rationality exists when end-users purchase integrated motors. In general, endusers are only concerned about ‘more important’ issues such as the overall performance of a machine, and energy efficiency is rarely a key factor in this performance. Motor selection is therefore often left to the OEM or ESC, which are not responsible for energy costs. In some types of motor applications (mainly pumps), OEMs can contribute to greater energy savings by working on equipment design rather than simply adopting HEMs. In a situation where there is significant unexplored savings potential in equipment technology, or where the correct choice of core technology for equipment can provide substantial energy savings (the case of pumps), it is very difficult to convince OEMs to pay 30% more for the motor in order to gain between one to 6% in energy efficiency. It is thus very difficult to obtain the participation of OEMs in programs which focus only on improving motor efficiency. Since OEMs and ESCs are not responsible for energy costs, they have no direct interest in HEMs. The introduction of a new decision-making approach to motor selection would involve certain changes in agents’ economic routines. These routines are not entirely determined by market signals. Intra-firm organisational aspects, industry structure and consumers’ habits and preferences are also important determinants. A change in market signals to provide better information concerning product prices and technological characteristics can have only a partial effect on the work routines of firms. Neoclassical energy economists have systematically neglected this type of market limit. Different arguments have been used to justify this point of view. Some authors argue that these limits are ‘normal’ market characteristics and are thus optimal from the point of view of energy users.43 Others say that to have optimum resource allocation, these limits should not be considered because they cannot be eliminated at an acceptable cost.44 However, what can be said if these limits are a prevailing feature of market operation, as in the case of the HEM market? In such cases, effective market transformation initiatives must take market limits into account. Hence, in addition to the correction of market failures, non-price regulatory policies should be considered to cope with the limits of market forces.45

Policies for market transformation As mentioned earlier, information diffusion is one of the most effective ways of correcting market failures. As far 43 See Sutherland (1991). 44 Jaffe and Stavins (1994). 45 See Sanstad and Howarth (1994).

Energy efficiency and the limits of market forces: E L F de Almeida

as HEMs is concerned, most end-users are not aware of their availability and of the present-day potential for energy savings. Large-scale information campaigns can thus make a significant contribution to transforming the electric motor systems market. Effective information campaigns should include a variety of elements, such as the creation of software tools for helping with motor choice, diffusion of these tools via workshops, training programs and conferences, preparation of showcase demonstrations and special training programs for motor sellers. However, considering the present market structure and agents’ routines, it is unlikely that market forces will create appropriate demand patterns as far as energy efficiency is concerned. If society considers energy efficiency to be desirable, there would have to be some sort of public intervention in this market, not only to correct market failures but also to investigate and overcome the limits of market forces. In North America, programs for the diffusion of HEMs have been part of DSM activities since the 1980s. Today, about 160 American utilities have some kind of program concerning efficient motor technologies.46 Most DSM motor programs in North America have emphasised correction of market failures by promoting information campaigns and providing rebates to cover the additional cost of HEMs compared with standard motors. However, these programs have not led to a general diffusion of HEM technology. The diffusion rate increased at the expense of costly rebate programs. As soon as these rebates were discontinued by certain utilities, the diffusion rate started to decrease.47 The reason for this reversal in the diffusion rate is that the price differential between HEM and standard motors has tended to stabilise at about 25%.48 Motor producers claim that there is no significant economy of scale at the manufacturing level. In addition, HEM technology is very similar to standard motor technology and the technological innovations that reduce HEM costs also reduce standard motor prices. It is therefore unlikely that HEMs could completely take the place of standard motors as a result of market forces. In some parts of motors applications, HEM is not the best option economically. In low intensity applications, energy savings do not make up for the difference in motor price. Given the difficulties of promoting HEMs through market channels, American public authorities decided to regulate the motor market through minimum efficiency standards. In 1992, Congress adopted minimum efficiency standards for motors as a part of the Energy Policy Act. In practice, this act will gradually exclude standard motors from the market.49 North American experience

46 See DOE (1996). 47 See DOE (1993). 48 In the last ten years, the price difference between standard and HEM motors in the USA has remained stable at about 25%. The growth in production of HEMs has not helped close this gap. 49 This act came into effect in October 1997.

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has shown that market transformation strategies focused only on the electric motor have not been effective. The lack of a systemic approach for the DSM programs has been identified as the main cause of the program’s poor performance. As a result, the US Department of Energy created the Motor Challenge Program in 1993 to promote a wide range of market transformation programs related to electric motor systems.50 In Europe, given the diversity of national contexts, market regulation through minimum efficiency standards for motors is unlikely to be adopted. Moreover, this approach is not necessarily the best, since it implies generalised adoption of HEMs, even for applications where this motor is not the best economic choice. One option for market transformation that could be tried at the national and European levels is the Technological Procurement Program — TPP. This market intervention initiative concerns the organisation of demand for selected products. Potential HEM buyers are identified and joint procurement of the products is arranged.51 Thus, the TPP is a method of ‘establishing a demand pull, as a trigger for supply push, resulting in a market transformation’.52 As shown, the split incentives create a vicious circle in the electric motor market. Motor retailers do not propose HEM technology because they assume clients do not want it, while motor buyers do not ask for HEM because they do not know about it and would find it very costly to obtain the necessary detailed information. The TPP can help to break this vicious circle. Effective market transformation would require the commitment of all the key market actors described above. However, a TPP is not sufficient in itself. A combination of market transformation strategies is required, in which the procurement program can play an essential role. The procurement program can be an instrument for promoting technological development in the motor industry by encouraging the creation of new voluntary efficiency standards and labelling programs and reorganising energy efficiency incentives in the different segments of the electric motor market. The systemic approach of the TPP must cover all the parts of this technological system: VSDs, electric motors and mechanical systems (pump, compressors, fans, etc.). It is unlikely that OEMs will be interested in HEM if nobody cares, for example, about ‘high efficiency’ pumps or compressors. In some market segments, such as compressors and pumps, electric motors account for a relatively small part of total energy losses. End-users are not aware of the type of motor that is built into equipment. In these cases, information programs should focus on the equipment itself, and not simply on the motor. Given the important role of OEMs in the motor market, incentives for their participation in procurement groups should be created. These might

50 See DOE (1996). 51 See Nilsson (1995). 52 Idem.

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include labels indicating that OEMs use HEMs in their products, advertising based on this label, energy efficiency prizes combined with procurement programs for OEM products. Aside from OEMs, large end-users which make intensive use of electric motors could also strengthen the buyer group. Large end-users keep stocks of motors and could participate in a long-term purchasing program to supply their motor inventories. An attractive way to encourage OEMs and large end-users to participate in the procurement program would be to offer a rebate for HEM purchases through the program. The rebate could be offered by the electricity utility, and could be a key factor in the success of the procurement program. Economic incentives could also be offered to motor manufacturers who decide to participate in the program. National governments or the European Commission could finance R&D activities of motor manufacturers wishing to participate in the program by providing special research grants. The British government’s Best Practice Program is a good example of this kind of economic support.53

Conclusion This paper has identified some of the limits of market forces as the driving force for energy efficiency through the diffusion of more efficient electric motor technology. Although there is considerable potential for improvement in the energy efficiency of electric motors, the market structure and current decision-making practices are obstacles to the accomplishment of this potential. The analysis of the decision-making process in motor transactions provides significant empirical evidence that the main agents in the motor market do not consider energy efficiency in their economic choices. Firms have special work routines and decision-making practices in different segments of the motor market, reflecting their specific priorities. Motor manufacturers try to adapt their commercial strategy to this pattern of market organisation by creating cooperative channels and adopting price discrimination strategies according to market segment. Given the limits of current market forces in promoting the use of more efficient motor technologies, public intervention is necessary in the motor market if agents’ routines and decision-making practices are to be changed. Experience in North America has shown that attempting to correct market failures is not sufficient to initiate general diffusion of HEM technology. Following an extended period of DSM programs focused on information campaigns rebates to end-users, American authorities have opted for market regulation through minimum efficiency standards. However, considering that minimum efficiency standards might be difficult to impose in the

52 Idem.

context of the European Union, this paper suggests some alternative technological initiatives to encourage transformation of the electric motor market. The main type of initiatives proposed are: the creation of appropriate standards and quality labelling programs for electric motors; the adoption of a systemic approach in DSM programs where all parts of the motorization system are considered; and finally the use of procurement programs to encourage all the concerned actors to contribute to the market transformation effort.

Acknowledgements The author would like to thank Dominique Finon (Director of IEPE), Phillipe Menanteau (IEPE), and Katrin Ostertag (ISI) for their comments on this paper.

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