Energy efficiency vs economic efficiency?

Energy efficiency vs economic efficiency?

Energy Polity, Vol 25, No. 4, pp. 445-458, 1997 © 1997 Published by Elsevier Science Ltd Printed in Great Britain. All rights reserved 0301-4215/97 $1...

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Energy Polity, Vol 25, No. 4, pp. 445-458, 1997 © 1997 Published by Elsevier Science Ltd Printed in Great Britain. All rights reserved 0301-4215/97 $17.00 + 0.00

ELSEVIER PII:S0301-4215(97)00018-9

Energy efficiency vs economic efficiency? New Zealand electricity sector reform in the context of the national energy policy objective Calum Gunn Research Engineer, Network Planning Group, Mercury Energy Limited, Private Bag 92008, Auckland 1, New Zealand

in this article, I review the diverse commentaries on New Zealand's ongoing electricity sector reform process, within the context of the Government's energy policy objective. In doing so, my purpose is to highlight the interactions between the concepts of energy efficiency and economic efficiency. In particular, ! ask: how do the various commentators on reform define these concepts; what indicators do they use to measure them; and, what level of each do they prescribe as appropriate? My main objective is not to decide whether any commentator is 'right' or 'wrong'. Rather, I seek to identify the distinct 'world views', or 'paradigms', underlying the commentaries with respect to both energy efficiency and economic efficiency. I conclude that economic efficiency is consistent with a 'supply side paradigm', valuing economic growth, whereas those who value energy efficiency over economic efficiency subscribe to a 'demand side paradigm', recognising the limits to growth. Such a paradigm derives from the ethic of sustainability. I close by posing the (as yet unanswered) question: are these paradigms mutually exclusive? © 1997 Published by Elsevier Science Ltd. All rights reserved.

Energy efficiency and economic efficiency are both en vogue internationally; not least in New Zealand. In the main, the pervasiveness of each concept is respectively due to, the spectre of global warming, and the rise of neo-liberal policies amongst Western governments. Energy efficiency is an essential component of the 'green' ethic of sustainability, and economic efficiency is a key principle behind the restructuring of the New Zealand economy undertaken since 1984. In considering the reforms that have been initiated in New Zealand's electricity sector, these concepts interact. Although both energy efficiency and economic efficiency have been touted by various actors in the reform process as worthwhile 'goals' in their own right, the focus of the New Zealand Government has clearly been on the latter. Any restructuring of the vital electricity sector must be carefully planned and implemented. It should not lose sight of the main objective: to improve efficiency.... There are three key aspects of efficiency forms that electric power companies will need to achieve in economists' terms: productive efficiency; dynamic efficiency; and allocative efficiency.~

Luxton ( 1991a)

Nevertheless, 'improved' energy efficiency was claimed by the Government as being one of the many benefits of the electricity sector reform process, 2 but there are those who were, and still are, sceptical of this claim, including New Zealand's Parliamentary Commissioner for the Environment. 3 Certainly, the narrow focus of government objectives for the electricity industry is in contrast to the broader policy objective for the energy sector as whole. The overall policy objective is to ensure the c6ntinuing avail ability of energy services, at the lowest cost to the economy as a whole, consistent with sustainable development. 4 The phrase 'lowest cost to the economy as a whole' could be interpreted as a reiteration of the goal of economic efficiency, but this is only one of a number of key ideas (each italicised) that are acknowledged in this statement. Although there are already papers in the international literature which comment on the restructuring of New Zealand's energy sector, ~

21bid; and also: Luxton (1991b) 3peterson et al. (1992), pp. 17, 23 and 3l

%uxton (1992), [emphasis added] 5For example: Michaels (1989); and Cocklin (1993)

446 Energy efficiency vs economic efficiency?: C Gunn in this article, I take a different tack. I review and categorise the diverse commentaries that focus on New Zealand's ongoing electricity sector reform process, within the context of each of the ideas addressed in the above policy objective. In doing so, my purpose is to highlight the interactions between the concepts of energy efficiency and economic efficiency. In particular, I ask: how do the various commentators on reform define these concepts; what indicators do they use to measure them; and, what level of each do they prescribe as appropriate? Both the New Zealand Government and its critics accuse each other of ideological viewpoints with respect to electricity sector reform. Although lack of empirical research is often cited as a reason why opposing ideologies can prevail, another view is that even empiricism can be insufficient to overcome the 'world views', or 'paradigms', within which opposing contentions are entrenched. My main objective is not to decide whether any commentator is 'right' or 'wrong'. Rather, I seek to identify the distinct paradigms within which the proponents of energy efficiency and economic efficiency base their arguments. I close by leaving open the question as to whether a synthesis between these conflicting paradigms is possible. The literature on electricity sector reform is extensive, but the associated debates are not restricted to New Zealand. This article should therefore be of interest to readers from countries engaged in, or considering, comparable reforms to their electricity industries (eg the UK, Chile, Sweden, Norway, and parts of the US and Australia). 6 Although I focus on the local commentaries concerning New Zealand's internationally unique electricity industry, I also draw on a number of overseas publications in considering some of the wider issues relating to efficient energy use. Before turning to the New Zealand Government's energy policy objective, in order to categorise the commentaries on electricity sector reform, I begin by examining various definitions of both energy efficiency and economic efficiency, and then by briefly outlining the nature of the structural changes to the electricity sector.

Efficiency in theory-definitions Energy efficiency Energy efficiency is often confused with energy conservation. Conservation simply means using less energy, typically by 'switching things off', whereas efficiency relates to achieving the same quality and level of some 'end-use' of energy (eg heating, cooling, lighting, motive power, and watching TV) with a lower level of energy input. Internationally, many papers on energy use refer to the 'energy efficiency gap', which is the difference between the current level of energy demand, and that which would be obtained from using the most technologically efficient equipment (especially for electricity consumption). The question as to what the optimum level of energy efficiency should be, I shall refer to as the 'energy

6For an introductory overview,see: Tabors (1994)

efficiency debate'. The problem is that for investment in energy efficiency, there is a big difference between the maximum technical potential, the economic potential, the realistically achievable potential, and the naturally occurring potential. 7 Furthermore, not everyone agrees as to an appropriate definition of 'energy efficiency',s There is a growing number of technologists and environmentalists who see reducing the energy efficiency gap as an opportunity for meeting many social and environmental objectives. Proponents of such a view identify at least five key reasons for advocating energy efficiency:

• saving money: by investing in those technologies between the naturally occurring potential and the economic potential; 9 • reducing energy dependence: especially on imports of fossil fuels (and, in countries other than New Zealand, on nuclear energy); • enhancing intergenerational and international equity; • mitigating environmental effects andglobal warming; and, • moving towardsustainability, t° Economic efficiency The theoretical basis for discussions concerning economic efficiency is the concept of Pareto efficiency (or Pareto optimality). A Pareto efficient allocation of society's resources is one where no individual can be made better off without making at least one other individual worse off. The two fundamental theorems of neo-classical welfare economics are that: every perfectly competitive market equilibrium is Pareto efficient; and, conversely that, every Pareto efficient allocation of resources can be achieved from allowing the competitive market mechanism to work, with respect to some initial distribution of the given resources. Herein lies the attraction of competitive markets. Pareto efficiency is often advocated as a policy goal because of its presumed neutrality; ~z it does not presuppose anything at all regarding the initial or relative distribution of society's resources, and so is heralded as allowing the separation of questions concerning efficiency and equity.ZZ As with energy efficiency, there are those who claim that there are definitional problems with the concept of economic efficiency. ~3However, in practice, economic efficiency is often defined as comprising three main components: • pricing or allocative efficiency: which requires that prices 7For example,in the US, the maximum technical potential is cited as a reduction of up to 44% in energy use tbr electrotechnologies. See: Wikler et al. (1993) 8Most estimates of the energy efficiencygap define energyefficiencyin 'first law' efficiencyterms (from the First Law of Thermodynamics). However,a number of researchersbelievethat such a definition provides underestimates of potential efficiencygains, and consider 'second law' efficiencyas beingmore appropriate.See:Gardner and Robinson (1993) 9Even the New Zealand Government has stated that: 'there is considerable scope for improving the efficiencywith which energy is used, at a cost below current electricityprices': Luxton (1992) 1°Anderson (1993), pp. 17-22 i 1Bhattacharrya (1995) 12Blaug (1990), pp. 170 and 181 t3Bhattacharrya (1995)

Energy efficiency vs economic efficiency?. C Gunn 447 equal the marginal costs of producing those goods and/or services, throughout the entire economy; technical or productive efficiency, which requires the minimisation of the cost of operations; and, dynamic efficiency: which requires the optimisation of investment decisions. ~4 Under conditions of perfect competition, these three efficiency conditions coincide, with each other, and with Pareto efficiency. A typical argument is that a competitive environment places pressure on firms to provide better customer service, and to maximise internal efficiency through cost reduction, subsequently resulting in lower average prices. ~5 Exposing companies to the sharemarket is also cited as resulting in better investment decisions, for it promotes greater accountability of management. 16 Perfect competition requires that: markets are not incomplete; neither producers nor consumers individually have any influence over market prices (ie no participant has market power); any negative (or positive) externalities are internalised into marginal social costs; and, all participants in the market have access to 'perfect information', and act according to the economic model of 'rational behaviour'. When market prices depart from marginal costs, for instance, when externalities are not adequately represented, or when agencies with market dominance distort the price, market failure is considered to occur. Market failure has traditionally been used as a justification for government intervention in particular markets. However, developments in economic theory and practice during the 1980s have had a profound effect on influencing the attitude of policymakers in New Zealand away from intervention, and toward liberalisation. Both these developments criticise the perfect competition model as not fully representing reality, and highlight the potential for nonmarket failure (ie intervention by government making the economy less efficient). The first, transaction cost theory, focuses on the costs of running the institutional system that allocates resources. ~7 The perfectly competitive model of the economy assumes that the transaction costs between firms, between firms and individuals, and within firms, are zero. Transaction costs comprise: the search and information costs in setting up a market exchange; the bargaining and decision-making costs in making an agreement; and, the monitoring and policing costs of making sure a contract is honoured. The theory suggests that, given the prior establishment of property rights, the market produces governance structures that minimise not only production costs, but transaction costs as well. As such, it provides the basis behind arguments in favour of privatising state-owned corporations. However, for many of those in favour of using the market mechanism to achieve economic efficiency, the ownership of

14Luxton(1991a) 15Saha (1991) laDeane (1989) WGale(1989), pp. 1-8

firms is a secondary issue. The behaviour of firms, especially in regard to price setting, is the key, and the important consideration is the ability of the regulatory environment to promote competition.~S Under the perfect competition model, traditional pro-competitive regulation, epitomised in the old anti-trust legislation of the US, concentrated onthe number of firms in an industry. By contrast, the theory of contestable markets, which became fashionable during the 1980s, suggests that it is difficult for firms to adjust prices quickly, and therefore the threat of new entrants can even force monopolists to set prices at, or close to, a competitive level (ie at marginal cost). 19 It is this latter market model, in conjunction with transaction cost theory, which has had a major influence on the New Zealand Government's policy choices in the electricity sector. 2o

Electricity sector reform In line with the free market policies of successive New Zealand governments since 1984, the electricity industry has been subjected to major restructuring. Previously, the electricity supply industry was characterised by a licensed state-owned monopoly operator, the New Zealand Electricity Department (NZED), responsible for generation and transmission, and more than 60 electricity supply authorities (ESAs), with set franchise areas for electricity distribution and retailing. The ESAs were either managed by consumer-elected power boards, or by local government, and the national Government considered that for a country with a population of only 3.4 million, such a large number of ESAs was unnecessary Furthermore, the Government perceived that these economically 'inefficient' agencies had produced excessive over-investment in generation capacity, 'gold-plated' transmission and distribution networks, and arbitrary tariff structures distorted by cross-subsidies favouring residential consumers. 21 The New Zealand Ministry of Commerce considered that such crosssubsidisation was sustained by the nature of power board and local government representation. 22 The Government saw the solution to these perceived problems as the achievement of economic efficiency in the electricity industry, predominantly through liberalisation. Effectively this means the process of deregulating the supply industry's potentially competitive elements (ie generation and electricity retailing), and imposing pro-competitive regulation on those elements with natural monopoly characteristics (ie transmission and distribution). Furthermore, liberalisation is promoted as augmenting 'consumer choice', and it

18France(1992) 19Gallagherand Lewis(1988), pp. 44-5 l 2°Kask (1988a), p. 13 21Farley(1991) 22Thisviewfailedto point out that, although non-residentialcustomers paid significantlyhigher tariffs than residential customers on average, the lowestretail prices typicallywent to bulk supply industrial customers. Alternative opinions of the reasons tbr retail price differencesare given by: Kask (1988b, pp. 11-13);and, Jackson (1990), pp. 18-21

448 Energy efficiency vs economic efficiency?: C Gunn typically results in organisations restructuring themselves under the auspices of the 'marketing concept'. 23 The first stage of reform, occurring in 1987, was the corporatisation of the NZED into a State Owned Enterprise (SOE), although this can be seen as part of the Government's programme of corporatising state trading activities, rather than as a specific electricity reform. This new organisation, the Electricity Corporation of New Zealand Limited (ECNZ), was required to allow connection of private generators to its transmission network. However, a number of commentators considered that privatisation would impose more stringent market pressures on electricity sector participants than could corporatisation, and thus privatisation was regarded as the logical next step for all parts of the supply industry (with the possible exception of transmission). Political pressures have so far made the Government stop short of privatising ECNZ, but a number of the new 'energy companies' (ECs), restructured from the existing ESAs, have been transferred into private ownership. As intended, this has led to a process of rationalisation, as the number of companies has reduced significantly through mergers. Reform targeted specifically at the electricity sector began in earnest with the establishment of the Electricity Task Force in 1988, which was required to review the structure of the industry, subject to an overriding objective of economic efficiency. Its key recommendations concerning each part of the supply industry (ie generation, wholesaling, transmission, distribution, and retailing) were that: • barriers to entry in the generation sector should be removed (to promote wholesale competition); • control of the transmission grid should be separated from generation (to allow open access to competitors); • line and energy charges should be separated, with line charges being only subject to light-handed regulation (to minimise cross-subsidisation); and, • retail franchise areas for supply should be removed, and there should be no regulation of energy prices (to promote retail competition). All these recommendations were accepted, and eventually implemented, to create an industry structure that is internationally unique. For instance, in April 1995, Trans Power New Zealand Limited (Trans Power), initially the wholly-owned subsidiary of ECNZ responsible for transmission, was incorporated as a separate SOE. This separation was designed to ensure open access to new generators, and a distinct separation of the generation (competitive) and transmission (monopolistic) components of wholesale electricity prices. It can be seen as a step toward establishing a wholesale electricity market. Retail competition is now possible because the Electricity Act 1992 requires ECs to separate their operations into two transparent business units: the 'energy trader', responsible for purchasing wholesale electricity and on-selling it to enduse consumers; and the 'line business', responsible for operat-


ing and maintaining the distribution network. (Figure 1 includes a simplified representation of the new supply industry structure). The line business must set and disclose 'line charges' for the use of their network. These charges apply whether it is the incumbent energy trader who sells power to customers, or some external energy trader who has entered into a useof-system agreement with the line business, to compete with the incumbent on energy sales. Whoever the energy trader is, they face the same line charge structure, but in setting the price that their end-use customers pay, they can 'rebundle' the line charges, their electricity purchasing costs, the Trans Power transmission charges, and their desired margin, in any manner. Typically, most consumers face at least two price components: a variable charge, dependent on consumption in kilowatt-hours (ie kWh) and/or on demand; and, a fixed charge, usually related to the electrical capacity of a consumer's site. Control of monopolistic behaviour by Trans Power, or any distribution line business, is considered to be provided by a 'light-handed' regulatory regime based on 'information disclosure', and by the requirement that line and energy charges be separated (to make them transparent to the consumer). The Electricity (Information Disclosure) Regulations 1994 require network businesses to publish their pricing methodologies and cost structures, and also various indicators and performance criteria. The philosophy underlying a light-handed regime is that the industry should be encouraged to regulate itself. A key benchmark indicator, used to assess the 'acceptability' of transmission and line business revenue, is the revaluation of all networks using the 'optimised deprival valuation' (ODV) method. 24With respect to energy traders, the only restrictions on the energy component of the bundled retail electricity price are the general provisions concerning anti-competitive behaviour in the Commerce Act 1986. The Government claimed that a key aim of reform was lower electricity prices, as this would lead to lower costs for businesses, further leading to enhanced international and local competitiveness, resulting in jobs and economic growth. Of course, by 'lower prices', what was meant was lower average prices, as the desire to remove cross-subsidies clearly implied that residential retail prices would increase. Apart from reductions in prices, other measures considered to be indicative of efficiency gains included: reductions in unit costs (S/kWh); increases in productivity (kWh per sector employee); and, increases in sales volume (kWh). 25 Other predicted outcomes included: better productivity and investment decisions; reduced CO 2 emissions; and, improved energy efficiency. For instance, the Government suggested that: 'the profit motive, combined with competition, will compel suppliers to offer energy efficiency services 24The ODV is seen as providing a value consistent with contestable market outcomes because it involves an (on-paper) optimisation of network design. 'Unnecessary' or 'overdesigned'parts of the network are optimisedout of the valuableasset base. Each remainingpart of this optimal configurationis then valued at the minimum of its depreciated replacementcost and its economicvalue.Ministryof Commerce(1994a) 25McLay(1993)

Energy efficiency vs economic efficiency?." C Gunn







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Energy I Energy Service !] End-Use Companies I Consumers



Line , Energy _EMCO r" TransPowe..._~r Businesses, Traders , Wholesaling, [Transmission] Distribution ~ ELECTRICITY SALES (kWh)

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Figure 1 New Zealand Electricity Sector Reform: Boundaries-of-Analysis (adapted from ideas in Roberts et al. (1991), on the UK reforms).

as part of their marketing strategy'; 26 perhaps resulting in the formation of specialised 'energy service companies'. Although the Energy Companies Act 1992 states that the 'principal objective of an energy company shall be to operate as a successful business', an explicit, but weak, reference is made to energy efficiency. 'In seeking to attain its principal objective, an energy company shall have regard, among other things, to the desirability of ensuring the efficient use of energy'. However, the 'appropriate' level of energy efficiency is seen by the Government as inextricably linked to the goal of economic efficiency, and its predicted outcome of allocatively efficient prices.

The 'lowest cost to the economy as a whole': economic efficiency A l t h o u g h it could be argued otherwise, the stated i n t e n t i o n in the G o v e r n m e n t ' s energy policy objective for energy services to be available at the 'lowest cost to the economy as a whole', 27 appears to be consistent with the goal of achieving e c o n o m i c efficiency in the electricity sector. Both internationally, a n d

26McTigue (1992) 2VRel'er back to Luxton (1992)

in New Zealand, this has typically meant a focus on allocative efficiency, which requires that prices equal marginal costs. A key government premise appears to be that achieving allocative efficiency in the electricity sector is consistent with an optimal level of energy efficiency. In other words, the objective is to 'get the price right', as this 'levels the playing field' between competing energy sources. 2s Such a view is expressed by the International Energy Agency as follows. Economically efficient energy use"is the use of energy that results, in combination with other inputs, in the least cost production and in optimal allocation of resources, assuming efficient pricing of all inputs. The economic notion of efficient energy use may thus even result in a rational increase in energy use, if the relative prices of energy and other factors of production would dictate such a shift in productive inputs5~

28This view is eloquently expressed, with respect to the US industry, by: Black and Pierce (1993). In New Zealand, the Wholesale Electricity Market Study (WEMS) tbund that: 'The establishment of a wholesale market will ensure that demand at the margin will only be satisfied at marginal cost. Thus retailers will receive a more accurate price signal to pass on to consumers about the real costs of additional consumption. and thus the value of energy efficiency measures': WEMS (1992), p. 19 291nternational Energy Agency ( 1991), p. 44. Such a view is also strongly expressed by: Sutherland (1994)


Energy efficiency vs economic efficiency?: C Gunn

The 'level playing field'

The traditional approach taken in New Zealand to m e e t growth in electricity demand has been through 'supply side' investment in new generation, transmission, and/or distribution capacity. An alternative, or even complementary approach, popularised in the US by the term 'demand side management' (DSM), encompasses investment in energy efficiency. Levelling the playing field, between the supply side and the demand side, means that new power stations or transmission lines can compete with consumer-installed energy efficient technologies, on an equal basis. The New Zealand Government has claimed that electricity sector reform will ensure this. The reforms will be consistent with energy efficiency goals in that the real prices of energy are more fairly reflected. That capital program to upgrade the capacity of a line lie supply side investment], will have to compete with the option of energy efficiency [ie demand side investment]) o In theory, realising the goal of allocative efficiency throughout the economy will automatically result in an efficient level of energy use, but, as noted earlier, this may result in a 'rational increase' in energy consumption. Indeed, a key outcome of reform was supposed to be lower electricity prices, yet the Government also noted that improvements in energy efficiency would actually require higher prices. Savings in electricity bills represent an immediate improvement in costs and living standards for everyone and will help to achieve the Government's target of full employment by 1995.31 If human nature is any guide it is likely that we will not see significant improvements in energy efficiency without increases in energy prices - because that is the only incentive most people need. 32 However, if one subscribes to the view that market forces do provide a 'level playing field' between investments in supply side capacity, and demand side investments in energy efficient technology, then one only needs to examine whether reform has achieved the goal of a competitive electricity market exhibiting significant efficiency gains. Therefore, commentaries on reform, acting within such a context, question whether the policies put in place can in fact attain the desired goal of economic efficiency. The corollary is that, if economic efficiency is not being achieved, then neither is the optimal level of efficient energy use. R e f o r m outcomes

By early 1996, E C N Z was still responsible for around 95%of all electricity generation. Applying government-recognised measures, productive efficiency had increased markedly since establishing E C N Z under the SOE model, and the reduction in wholesale prices of 16% between 1988 and 1993 had been

3°Luxton (1991a) 31Butcher (1990) 32Kidd (1994)

presented as evidence for the success of reform. 33 On the other hand, a study of the corporatisation of E C N Z , performed with the cooperation of the corporation, indicated that the initial part of this reduction at least can be explained as part of a strategy designed to deter competitors. 34 One potential entrant to the generation market also implied that E C N Z had engaged in anti-competitive behaviour, through the planning approval and resource consent processes available under the Resource Management Act 1991. 35 ECNZ's main justification for its behaviour was that it acted to maximise its net worth to its shareholders (ie the Ministers of Finance, and State Owned Enterprises), with a view to maximising the eventual sale price upon privatisation. 36 Moreover, E C N Z was clearly unhappy with the Government's desire to break the corporation up, for the purpose of promoting competition in generation, on the basis that such a policy would also reduce the company's value. 37 The failure of new entrants to emerge in the generation sector came as no surprise to observers of the electricity reforms in the UK, as it followed the pattern of the earlier deregulation there, 3s which had exhibited a similar 'triangular conflict' between liberalisation, privatisation, and noncommercial objectives 39 (see Figure 1). Regulatory controls, whether they promote competitive or social objectives, reduce the potential income stream of both incumbents and entrants, which in turn affects any valuations of the former, and the incentives to enter the market for the latter. Because generation accounts for around 50% of the retail electricity price, even some supporters of reform indicate that without a competitive wholesale market for electricity, retail competition is rendered ineffective. 4o This is because retailing costs only contribute to about 3% of the average consumer's bill, (the rest relates to the mainly fixed costs of transmission and distribution). Subscribers to the view that market forces will produce the right level of energy efficiency, thus describe the lack of competition in generation as a significant problem.

33McLay(1993). Increases in sales per electricity sector employee is a key indicator used as evidence of efficiency gains. For example, from 1988 to 1993, gigawatt-hours (GWh) per employee at ECNZ rose from 5.56 to 9.93. 34Spicer et al. (1991), pp. 28 and 81 35McLachlan (1992) 36Spicer et al. (1991) p. 24 37Fernyhough (1990) 3SOn the UK reforms, see: Roberts et al. (1991), pp. 51-52. It came as no surprise to Kask (1988a), pp. 14-33, who performed an 'impact analysis' of the early reform of the New Zealand generation sector. She stated that, neither the assumption that deregulation leads to entry in the generation market, nor the assumption that entry leads to productive and/or allocative efficiencies, hold. 39Kayand Thompson (1986). Roberts et al. (1991), p. 26: 'Liberalisation may be the ideological companion of privatisation, but in practice liberalisation impedes the pragmatic goals of privatisation. This conflict between the Government's dual goals is often complicated, in the case of nationalised monopolies, by the presence of externalities which necessitate the imposition of non-market objectiveson prospective privatised companies'. For New Zealand, the conflict between privatisation, and the non-market objective of energy eMciency, is examined by: Bertram (1991) 4°For example: Cole (1993); Heffernan (1993); and, Wilson (1994)

Energy efficiency vs economic efficiency?: C Gunn 451 If some tbrm of competing generation does not evolve, this... will impact on the effectiveness of the market to produce energy efficiency benefits through the competitive nature of energy traders and their value added services.41 Indeed, the failure of new generators to appear has also been of clear concern to the Government, and there have been a large number of studies examining possible structures for a wholesale market, and possible mechanisms for breaking up ECNZ. 42 These finally culminated in the decision in June 1995 to split E C N Z into two competing SOEs, effective on I February 1996, and to establish a wholesale trading pool, in October of that year. However, criticisms have already arisen that this will be insufficient for true competition to emerge: 3 The requirement for ECs to make a profit, has led to similar levels of improvement in their indicators of productive efficiency, to those realised by E C N Z (and Trans Power). In the retail electricity market, the removal of traditional franchise rights has led to some limited competition, but primarily over highconsumption customers, and those with nationwide sites.

The price level." effects of deregulation and pro-competitive regulation For prices to be at allocatively efficient levels in the potentially competitive part of the electricity sector, the pre-existing crosssubsidies need to be removed. The question is then whether deregulation has resulted in the desired competition, and if it has, whether the cross subsidies are disappearing as expected. In those parts of the industry acknowledged as being naturally monopolistic, the question is whether pro-competitive regulation is sufficient to keep prices at allocatively efficient levels. Although critical of the reforms at wholesale level, suggesting that the split of E C N Z into a duopoly is a 'minimalist' approach, the Electricity Supply Association of New Zealand (ESANZ) paint a glowing picture of the reforms at retail level. They state that success is already evidenced by a decrease in the retail price, and like others, claim that 'crosssubsidies between domestic and commercial, and small to medium industrial customers, have been all but eliminated'. However, this claim is based on an examination of average prices only. 44A number of commentators suggest that examining prices independently of underlying costs allows no judge41Lough (1994) 42Themost notable of these have been the privately sponsored Wholesale Electricity Market Study (WEMS), and the subsequent report by the Wholesale Electricity Market Development Group (WEMDG), in 1992 and 1994respectively.Earlier reports included:the Cabinet PolicyReport, Ministry of Energy Officials Report, and the Electricity Supply Association of New Zealand (ESANZ) Report, all in 1989;and, ECNZ's own study in 1990. 43O'Sullivan (1995), p. 16 '~ESANZ state that there has been a 0.49% decrease (in real terms) in the average retail electricity price, following the initial removal of retail franchises in April t 993. The use of the term 'price' is somewhat misleading, as price is determined from, the total national residential and/or business revenue, divided by, the total national residential and/or business kWh consumption. Using this measure, the overall price reduction results from an increase in the real residential price of 6.82%, and a decrease in the real business price of 6.29%. These changes have resulted in the domestic to non-domestic price ratio shifting from 0.891 to 1.015, and is the basis of the claim that cross-subsidies have been 'all but eliminated'. Reported by: Leay (1995)

ments to be made concerning cross-subsidisation. 45 Furthermore, some commentators claim that, even where cost information is available, the unique characteristics of individual line companies make inter-company comparisons very difficult, or almost impossible. 46 This view also implies that the ability of light-handed regulation, through information disclosure, to check the 'fairness' of line tariffs is limited, 47 and some critics suggest that all that is occurring is a reshuffling of the pre-existing cross-subsidisation in the opposite direction. These critics consider that competitive pressure on retailers will cause them to negotiate low-price and longterm contracts with their largest customers, and that these contracts can potentially be cross-subsidised by a captive pool of residential consumers. 48 For example, in 1993, there were 33 complaints to the Commerce Commission concerning perceived anti-competitive behaviour of electricity line businesses. 49 The revaluation, using ODV principles, of both Trans Power and the networks of every line business, is another contentious issue, as it has led to a significant increase in the value placed on most networks when compared with their historical book value) ° This puts upward pressure on the line charge component of the retail electricity price. The bulk of the line charge is related to fixed costs, and the theoretically efficient method to recover such costs is through fixed charges, sl This has led some commentators to ask why privatisation has so often been associated with increasing prices. Again, this could be seen as illustrative of the conflict between objectives of liberalisation and privatisation; where markets are not truly contestable, due to significant sunk costs, private sector ownership may reinforce market dominance. Although it was not the Government's stated intention that ODV valuations be used as the basis for tariff setting, the view has been expressed that unless line charges are derived from a rate-of-return on ODV asset value, then allocative inefficiencies will arise.SZ For energy companies in private ownership there is likely to be pressure from shareholders to maximise both returns and share value, implying the desirability of using ODV as the asset base. Recently, the Ministry of Commerce predicted that efficiency gains would more than offset revenue requirements for any line business that sets charges indexed to their

45See: Kask (1988b), pp. 15-18 and 38; and, Jackson (1990), pp. 17-18 46Noble (1992) 47'Fairness' in this context is in the limited sense of 'horizontal equity', which requires that individuals subject to the same conditions (typically costs), should be treated the same. This is basically a restatement of allocative efficiency,and has been popularised in New Zealand by the term 'user pays'. Cross-subsidisation and price discrimination are thus seen by government as being implicitly 'unfair'. 4SNoble (1992) 49Noted by: Lough (1994) s°Wilson (1994), predicted that ODVs of distribution networks would typically be double their historical values. 5,For example: Munasinghe and Warlord (1982), Ch. 5. In New Zealand, this link between economic efficiency and fixed charges lbr fixed costs, was recognised by: Lear (1991) 5ZSaha (1993)

452 Energy efficiency vs economic efficiency?: C Gunn ODV) 3 However, in a 1990 study, the Ministry did recognise that the reforms could result in a high fixed component of the retail price, which in turn might encourage greater consumption of electricity,s4 As it happens, the Government has already expressed concern at some current levels of fixed charges, and 'heavy-handed' regulation has been threatened should fixed charges be deemed excessive. 55 The Minister of Energy has even stated that high fixed charges 'reduce incentives to invest in energy efficiency'.56 However, such comments step outside the narrow focus on economic efficiency, because such a charge structure is itself an outcome of the efficiency process. Returning to this focus, a commentator at ECNZ warned that moves to control fixed charges should be for 'sound economic reasons', as any reduction would act as a distortionary subsidy toward energy efficiency)7 Of course, there are those who might question the motives behind such a declaration. The Government has now conceded that: 'clearly, it is going to be some time before competition is a reality rather than a promise for other than large electricity consumers': s However, it has warned that: 'Cross-subsidising competitive consumers by captive customers, cross-subsidising potentially competitive energy supply from monopoly line businesses, unnecessarily restrictive provisions in line service agreements, and ensuring generation profits off the back of captive consumers, are all examples of behaviour which once identified will not be tolerated') 9 Whether such behaviour is identifiable is still an open question. Moreover, even supporters of the disclosure regime are unclear what measures the Government would take in response. 6° In the current absence of a wholesale electricity market, it is unclear which direction the electricity price level will eventually go. Even though proponents of energy efficiency might be thought to relish the possibility of higher prices, the previous discussion shows that the changes to the price structure, through higher fixed charges, mean that such increases are no guarantee of greater investment by consumers in energy efficient equipment. Furthermore, as is discussed in the next section, consumer behaviour in energy markets is not well understood.

'Energy services': market failures and the demand side Another of the key ideas in New Zealand's energy policy objective is 'energy services'. Referring to this concept, recognises that consumers of electricity are not interested in 53Ministry of Commerce (1994b), p. 11 54Ministry of Commerce (1990), p. 20 55The Government intends to perform a review of the fixed charge component of retail electricity prices during April 1996. In addition, the Electricity Act 1992 explicitly provides for price control of fixed charges (lbr residential consumers only), although this provision expires on 31 March 1997. 56Kidd (1994) 57Lough (1994) 58Kidd (1995) 59Ibid. 6°McLay (1993)

electricity per se, but in the end-uses that electricity provides, such as heating. The policies discussed in the previous two sections have mainly been directed at the structure of the supply side of the electricity industry. Considering consumers, on the demand side of the electricity sector, provides a context for examining two further issues raised by commentators on reform. Firstly, how dependent are indicators of efficiency gains, for both energy or economic efficiency, on the choice of system boundary drawn around the electricity sector? Secondly, assuming that it is possible to 'get the price right', through policies applied to increase allocative efficiency, are there any market failures that tilt the level playing field, and which may justify government intervention? Efficiency indicators and system boundaries The indicators of economic efficiency gains in the electricity sector are typically ratios of outputs to inputs, and the most common output measured is kWh sales. Indicators such as GWh per employee are thus maximised either by reducing employees, or by increasing electricity sales (and consequently consumption). Effectively, such an approach draws an implicit 'boundary-of-analysis' around only the supply side of the electricity sector, rather than around both supply and demand sides (which is shown by the dashed line in Figure 1). Some international researchers suggest that: 'the scope for economic and energy optimization always increases when the boundaries of the system to be optimized are enlarged'. 61 Such a view suggests that the boundary-of-analysis should encompass more than just the electricity sector's supply and demand sides. For instance, many end-uses, especially heating, can be provided by a number of substitutes to electricity, such as gas, albeit at a different cost. This has led ECNZ to maintain that indicators of energy efficiency gains should look at the energy sector as a whole, and not just focus on the electricity industry. 62This is because ECNZ claims that energy efficiency is best promoted through 'electrification', which involves switching from direct use of fossil fuels, to highly efficient electrotechnologies that can provide the same enduse. 63 Although such technologies consume more electricity, they use less energy overall. As indicators may result in implicit boundaries-ofanalysis, some commentators claim that this leads to a 'tilting' of the level playing field. For example, a boundary around the supply side of the electricity sector is seen as giving a perverse incentive for suppliers to maximise electricity sales in order to exhibit efficiency gains, and a subsequent bias against demand side management. 64 In a wider context, the choice of indicators is even seen by some economists as

61Kahane (1991) 62ECNZ (1994), p. 37 631bid, p. 4 64For example: Peterson et al. (1992) p. 31; and (on the Australian reforms): White (1994). One example of this bias appears to be implicit in the use of the ODV method ['or valuing transmission and distribution networks. (Optimal) supply side investment can be included in the asset base for 'allowable' revenue purposes; no such provision seems to be made for any demand side investment.

Energy efficiency vs economic efficiency?," C Gunn ascribing an underlying value-judgement to the concept of efficiency. Consider, lbr example, the notion of efficiency. One can still find economists saying that efficiency is simply a relation between physical variables and has no normative implications. But in application it is a very different thing. The value-judgement here comes in when one classifies variables as inputs or outputs. This is not an arbitrary process at all .... The classification is based on a preliminary - and almost entirely implicit - j u d g e m e n t as to what is valued and what is disvalued in a society. Efficiency is too important to economic analysis to be treated as a norm without seriously damaging the positivist status of the discipline. 65

Market barriers and market failures Even if it is possible to draw a bias free boundary-ofanalysis, and to 'get the price right', some international commentators see this as not enough to level the playing field. In their view, a correct price is a necessary, but not sufficient condition, to strike a balance between the supply side and the demand side. 66 The very existence of the 'energy efficiency gap', particularly in relation to the lack of investment in those efficient technologies which appear to be 'economic', is seen as evidence in favour of this position. The international literature identifies a large number of 'market barriers' to explain aspects of this gap, and many proponents of energy efficiency believe that alleviation of these barriers necessitates government intervention.67 However, others make the distinction that very few market barriers are true market failures. 68 Whereas market failures may require intervention (for instance, regulating price to equal marginal social costs, by accounting for externalities through taxes, rebates, or subsidies), all other barriers are explained away as the economically rational behaviour of consumers simply exhibiting their preferences, so intervention is not justifiable. At an early stage of the reforms the New Zealand Government stated that environmental externalities should be incorporated into prices, but since has implied that the reforms automatically allow consumers to factor such costs into their decisions. 69 Critics declare there is no evidence that government has any serious intention of internalising the various social and environmental costs of energy production and delivery in energy prices, and so artificially low prices add another disincentive to investments in energy efficiency.70

65Ward (1972), p. 211 66Bowie and Nilsson (1995) 671%r example, Anderson (1993), pp. 30-35, cites no less than twenty 'universal' barriers to energy efficiency, grouped into informational, organisational, financial, environmental, and dependence problems. 68jaffe and Stavins (1994) 69Compare Luxton (1991a): 'If there are environmental costs, then these should be incorporated into prices, thereby sending the right signals to investors about the cost of consuming energy'; with: Luxton, quoted in Cocklin (1993): 'The Government expects that, with the implementation of both environmental and electricity reforms, consumers willbe able to lhctor the true cost of electricity,includingenvironmental costs, into their decisions'. 7°Peterson et al. (1992), p. 32; and Peet (1992a)


The 'payback gap' A number of international researchers suggest that the most significant barrier to investment in energy efficient technologies is the 'payback gap' (ie the difference between empirically measured supplier and consumer discount rates). This gap is cited as being much more important than any incorrect signals sent by prices not equalling marginal costs. 7~ Those who see some role for regulatory intervention in energy markets suggest that consumers may not act in accordance with the economic model of the rational utility-maximising man (gender bias implicit), so economic factors and price levels alone are insufficient to explain energy use patterns. 72 There has been a large body of international research analysing consumer behaviour in relation to energy consumption. 73 Some of the results of this research, in combination with work done on transaction cost theory, has been used to argue that the payback gap is a sign of 'common sense', or 'economically rational' behaviour after all; therefore, government intervention is not justified. TM The observed high discount rates are explained to be a result of consumers (and firms) factoring risk and uncertainty into their decisions, and their recognition of the 'option value' in deferring investment. Furthermore, it is claimed that proponents of energy efficiency fail to account for consumer preference in evaluating the unique attributes of particular technologies (e.g., safety, quality, cleanliness, and reliability). The problem is simply that the discount rate should be used solely to isolate the time value of money, rather than being forced to reflect a variety of market imperfections, including risk, uncertainty, transaction costs, access to capital, and preference. The response to this view highlights the danger in contending that any behaviour must be 'rational', simply because it is observed, as this amounts to little more than a tautology. 75 Such arguments have also been present in New Zealand surrounding the debates over the appropriate level of government intervention in energy markets. 76 Leaving behind the argument as to which models of consumer behaviour are appropriate, some proponents of energy efficiency believe that, from a societal perspective, demand side investments in energy efficiency should be applied if they are cheaper at the margin than constructing new supply side capacity, irrespective of producer or consumer discount rates. 77 Such a view prescribes substantial government intervention, but not as substantial as is recommended by those who see any gain in energy efficiency as a worthwhile end in itself.

71Bowieand Nilsson (1995) 72For example: Sanstad and Howarth (1994); and: Robinson (1991) 73A detailed overview is provided by: Stern (1986) 74Black and Pierce (1993); and: Awerbuch and Deehan (1995). The transaction cost view is discussed by: Gale (1989), p. 32 75Sanstad and Howarth (1994); and: Gale (1989), p. 38 76Diverse analyses of market barriers and failures are provided by: Terry (1991), pp. 27-30; ECNZ (1992), pp. 36-37; and: Harris et al. (1993), pp. 11-25 77Bowie and Nilsson (1995)


Energy efficiency vs economic efficiency?: C Gunn

Sustainability and availability: energy efficiency as a merit good? 'Sustainable development' New Zealand's energy policy objective also contains recourse to the concept of 'sustainable development', which appeals to a higher level of social responsibility than immediate economic self-interest. Sustainable development means different things to different people, depending on their personal, cultural or institutional standpoint, TM but it generally encompasses concerns of national, international, and intergenerational equity, by recognising the finite nature of many resources (especially fossil fuels). 79 Sustainability implies 'limits to growth', and the need for a long-term perspective. Subscribing to the ethic of sustainable development provides two main motivations for promoting energy efficiency (and even conservation) as a worthwhile goal in itself. The first motivation is that, because a significant proportion of energy use is dependent on non-renewable resources, society should, within reason, restrain such use until the transition can be made to renewable technologies. Secondly, energy consumption is a prime contributor to the greenhouse effect and global warming, and the New Zealand Government has made a commitment to reduce the growth in gross CO2 emissions, that would have occurred between 1990 and 2000 on a 'business as usual' basis, by 20%. so However, internationally, proponents of economic efficiency maintain that 'environmental quality is achieved at minimum cost by policies that focus on environmental quality, rather than on policies that attempt to reduce energy intensity', sl

'Continuing availability' Another concept in the energy policy objective, which also suggests that a long-term view is appropriate, is the reference to the 'continuing availability' of energy services. Pursuit of immediate self interest, and the valuation of the present at higher levels than the future (especially through the use of discount rates), is considered by a number of environmentalists to create a bias against taking a long-term perspective. 8z For instance, even some economists consider that policies aimed strictly at achieving allocative efficiency may result in

78Theterm 'sustainable development' was popularised after the publication of Our Common Future (more widely known as The Brundtland Report), by the United Nations' World Commission on Environment and Development, in 1987. Many environmentalists consider the word 'sustainable' to have suffered from overuse and misuse, and when paired with the word 'growth', is a contradiction in terms. Peet suggests that sustainability is not an absolute, but should be seen in relative terms, and that it is 'not something to be defined, but to be declared. It is an ethical guiding principle': Peet (1992b), pp. 208-209 79It is interesting to note the use of the term 'sustainable development' in New Zealand's energypolicyobjective,rather than 'sustainablemanagement', which has a legal definition in the Resource Management Act 1991. This Act has the stated purpose of promoting 'the sustainable management of natural and physicalresources', but it specificallyexcludes any consideration of the depletion rate of fossil fuels, by leaving 'minerals' out of the definition of resources. 8°Kidd (1994). This target is regrettably difficult to measure. 81Sutherland (1994) 82Anderson (1993), pp. 78-79

losses in dynamic efficiency (ie optimal investment). 83 A concern is that the electricity sector reform does not guarantee the future security of supply, or provide optimal investment scheduling. 84 Because investments on the demand side can be added in 'small increments', some favour promoting energy efficiency to help avoid 'misallocation of resources'.

Ideologies and paradigms Ideologies Both in New Zealand, and internationally, it is notable how often the commentaries surrounding electricity sector reforms are infused with the word 'ideology'. The New Zealand Government often stands accused of embarking on a reform process based on (free market) ideology alone, s5 The typical response is that its critics are themselves blinded by their own ideologies. Whilst it is hard to compile meaningful data because of commercial/competitive factors, it is clear that power companies are investing and spending considerably more than the Government in promoting energy efficiency and conservation .... You [power companies] are now contbunding your slogan wielding critics. Most of them know nothing of the power for good of competitive market forces because of the political ideology to which they subscribe. You are doing a better job than any government can do. 86 It is important to recognise that the primary debate is over the optimal level of government intervention in energy markets, rather than over the optimal level of energy efficiency, and that some commentators elicit elements of ideology on both sides of this intervention debate, s7 Energy efficiency becomes dragged into the arguments surrounding laissezfaire policies mainly because most energy efficiency proponents are seen as being pro-intervention to some extent. At an international level, the ideology criticism also results in proponents of both energy efficiency and economic efficiency being charged with focussing more on means than ends. s8

Prescription, empiricism, and the burden of proof Some see the debate over the optimal level of energy efficiency as a problem with the application and interpretation of various economic models. One c o m m o n criticism is that such models reveal how people or firms ought to behave, rather than how people or firms actually behave, s9 For example, models of both contestable markets and perfect competition have been cited as prescriptive. 9° A number of commentators suggest that it is the neglect or lack of empirical evidence which is responsible for

S3Gallagher and Lewis (1988), pp. 73-75 84Bertram (1992) SSFor example: Jackson (1990), p. 2; Peet (1992a); Russell (1991); Kelsey (1993), p. 55; and: Noble (1991) 86Kidd (1994) 87Cocklin (1993) 88Regarding energy efficiency, see: Sutherland (1994); and economic efficiency, see: Noble (1991) 89Huntington (1994) 9°Kask (1988b)

Energy efficiency vs economic efficiency?: C Gunn transforming theory into ideology. 91 This transcends aspects of the debate into the methodological arena; perhaps into an overly simplistic division of deductive vs inductive approaches, or of the different perceptions that economists and technologists have of the energy efficiency gap. However, some caution that economic empiricism is grounded in an implicit assumption of the virtues of economic efficiency. Economists embrace the efficiency assumption because it allows them to develop testable hypotheses from the least complex of frameworks.... The efficiency assumption is never tested directly but rather serves as a vehicle for testing other hypotheses. 92 Furthermore, empirical evidence has been insufficient to answer some of the big questions surrounding international reform. For instance, with respect to ownership, even some of the strongest proponents of privatisation concede that the evidence on the relative efficiency of private and public enterprises is inconclusive. When such doubt arises, ideological bias is accused of assigning the 'burden of proof' to one view or the other. In New Zealand, it has been identified that the 'onus is now on the bureaucracy to establish that policy improves outcomes by more than the cost of the bureaucracy', even when market failure is clearly demonstrated. 93 This implies that the fear of non-market failure gives the benefit of the doubt to non-intervention. 94An alternative prescription might be that the government response to the externality market failure should be guided by the 'precautionary principle'. According to this principle, 'the burden of proof shifts so that actions possibly affecting the environment are disallowed unless it can be demonstrated with reasonable confidence that no negative externality is likely'. 95 Such a position calls for much greater intervention in the economy, in a preemptive manner.

'Paradigms' in the energy efficiency debate Exposing differences in the burden of proof can be considered essential to understanding the heart of the energy efficiency debate. It is my contention that every such burden of proof emerges from an underlying 'world view' or 'framework', for which I use the word 'paradigm'. Unfortunately, 'paradigm' is sometimes used interchangeably with 'ideology', and both concepts have significant definitional problems. However, I will use 'paradigm', as distinct from 'ideology', because ideology is so often used in a pejorative sense, and also because there is an international precedent for using a more objective concept in an attempt to understand debates regarding the importance of energy efficiency. For instance, the notion of 'framework level differences' has been used in the US with respect to the energy debate that followed the oil shocks of the 1970s. 9~Roberts et al. (1991), p. 9, commenting on the UK reforms. In New Zealand, see: Gallagher and Lewis (1988), p. 12; and: Gale (1989), p. 28 92Huntington (1994) 93Gale (1989), p. 39 94Gallagher and Lewis (1988), p. 10 95Jaccard (1994)


A common view of the energy problem holds that what is at stake in most energy policy debates are questions of fact that are in principle susceptible to resolution by objective l:actual research.... This view is misguided, and.., underlying many of the factual issues apparently in dispute are differences at the framework level, that is differences in basic presuppositions and the patterns of thinking employed.... In the main these differences manifest themselves in differences concerning the nature of present social reality, the focus of interest of analysis and policy, and the interpretation and use of data. None of these differences, which are often inextricably entwined, can be unambiguously resolved since the criteria in terms of which such a resolution should be made are themselves in dispute. This dispute over criteria is itself a key indication of the framework-determined nature of the debate. 96 One controversial definition of a paradigm, prevalent in the 1960s and early 1970s, emerged from Thomas Kuhn's theory of progress in scientific knowledge. 97 Although this theory soon fell out of favour, in part due to definitional problems regarding the term 'paradigm' (and the theory has been superseded to some extent by the work of Imre Lakatos), Kuhn's concept of a paradigm may come close to expressing what underlies the current energy efficiency debate in New Zealand. Kuhn regarded scientific endeavour as characterised by long periods of 'normal science', during which its practitioners operate within a fixed 'paradigm', even when faced with significant accumulations of disconfirming evidence. The 'burden of proof' is thus dictated by the dominant paradigm. Kuhn's latter description of a paradigm was as a 'disciplinary matrix', being 'the entire constellation of beliefs, values, techniques and so on shared by the given members of a [scientific] community'. 9s This view, when applied to economic science, was not a totally n e w o n e , 99 but it contained the somewhat subversive implication that subscribing to a paradigm prescribes not only the acceptable choice of solutions, but the acceptable choice of problems to be solved. 10oAlthough economic methodologist Mark Blaug maintains that 'the term 'paradigms' ought to be banned from economic literature', he suggests that it should serve 'as a reminder of the fallacy of trying to appraise particular theories without invoking the wider, metaphysical framework in which they are embedded'.~°l Although not directly referring to Kuhn, a few papers have used Kuhnian terminology in discussing aspects of the energy efficiency debates in the US, t°2 with a small number of papers in New Zealand drawing attention to the implicit 'frameworks' and 'criteria' that underlie the commentaries on electricity sector reform. '03 Using Kuhn's definition, if differences lie at this paradigmatic level, then empirical analysis

96Robinson (1982) 97Kuhn (I 970) 9SIbid, pp. 175 and 182, [emphasis added]. Such a definition does bear a striking resemblance to some definitions of an ideology. See: Hall (1986), pp. 36 and 38 99For instance, see strong parallels with: Schumpeter (1949) l°°See Blaug (1980a), p. 30 l°JBlaug (1980b), pp. 149-150 1°2For example: Stern (1986); and, Robinson (1982) 1°3Kask (1988a), p. 35


Energy efficiency vs economic efficiency?: C Gunn

may not help to resolve any conflicts, for a paradigm's underlying assertions might be impossible to verify or falsify. Differences in paradigms may or may not be amenable to mainstream economic analysis depending on the extent to which each leads to sets of testable hypotheses and the degree of difficulty in conducting experiments. TM Within New Zealand, it has not been common for commentators on electricity sector reform to identify the paradigm within which their own analysis proceeds (although there are some notable exceptions). 1°5 It is more c o m m o n for any paradigms or frameworks to be exposed by external observers. 1°6 One reason for this may be that paradigms become so ingrained, that they appear as ' c o m m o n sense' to their advocates. 107 Examining the New Zealand Government's energy policy objective has provided a number o f contexts for categorising the debates surrounding reform. In particular, the contexts of the 'lowest cost to the economy as a whole', 'energy services', and 'sustainable development', allow an identification of the various paradigms associated with reform. Both in the US and New Zealand, there have been those who consider that such debates can occur: within a single paradigm; between different paradigms within a single set of values; and, from differences in values. Disagreement can therefore arise.., from differences in values.... from varying opinions on paradigms,... [and] over interpretation of a paradigm .... The nature of the topic of energy management and public policy is embedded in these deep philosophical issues. Those who would dismiss these matters lightly need only to consult the writings of the world's philosophers and economists in the learnedjournals to discover the intellectualefforts required to discern the difference between faith and truth, c°s If the context of the 'lowest cost to the economy as a whole' is considered to be coincident with a goal o f economic efficiency in the electricity supply industry, then the related debates appear to be mainly disagreements over detail. These disagreements occur within a framework o f general agreement as to the merits of prescribing minimal government intervention, in order to achieve economic efficiency. The fact that the Government has now moved to address some of the criticisms concerning the non-emergence of a wholesale electricity market, suggests that this framework contains

t°4Gallagher and Lewis (1988), p. 81 l°51bid, pp. 10 and 81; and: WEMS (1992), p. 11 l°6For example, Cocklin (1993) l°7Hall (1986), p. 35, notes that: '"Liberalism"... has become a central part of English "common sense". So much so that, to many of those who constantly think within its limits, it does not appear to be an ideology at all, but simply an obvious way of making sense of things "what everybody knows"'. For example, Luxton (1991a): 'Profit should not be regarded as a dirty word in the electricity industry!... Business profit in a service industry is not some New Right theory but common sense. McDonalds, Pizza Hut, the hotel industry, or the rest of the economy outside central or local government are driven by it. Profits are not only consistent with the best interests of consumers, they are essential if costs are to be minimised and efficiency maximised'. l°SGallagher and Lewis (1988), p. 78; and, for the US, see: Robinson (1982)

much o f the criteria for the resolution of potential conflicts. However, the most visible debates over reform occur in a wider 'energy services' context, and revolve around the appropriate level of government intervention in energy markets In this case, distinct paradigms are identifiable. Underlying world views favour either intervention and central planning, or non-intervention and liberalisation, but both of these paradigms seek economic efficiency as an overall goal, and do not provide us with a framework for understanding the motives of energy efficiency advocates. So what are the paradigms associated with the current energy efficiency debate? Possibilities emerge from an examination of the US energy debate of the 1970s. This controversy was commonly labelled the 'hard path' vs 'soft path' debate, and provides a couplet o f paradigms which can be related to the concepts of energy efficiency and economic efficiency. In simple terms, the 'hard path' was a supply side paradigm of continued growth in energy supplies, whereas the 'soft path' was a demand side paradigm prescribing sustainable or even stable levels of energy consumption, through the application of renewable and energy efficient technologies. It has been claimed that these two paradigms are mutually exclusive because of 'cultural incompatibility and resource scarcity'. ~o9 In New Zealand, economic efficiency is promoted as a necessity for economic growth, and so it could conceivably be linked to an underlying 'supply side paradigm'. Choosing efficiency indicators such as G W h per employee is consistent with such a paradigm. However, even those commentators who favour intervention by g o v e r n m e n t to internalise environmental externalities into energy prices, as an incentive to energy efficiency, might also be considered to subscribe to this paradigm. The optimal level of energy efficiency investment that such intervention should result in, is consistent with economic efficiency, and with ascribing economic growth a high value. Rather than sitting at one end of a spectrum of energy efficiency proponents, such commentators appear to have a fundamentally different world view from those who share the neo-Malthusian concern about limits to economic growth.~0 By contrast, the promotion of energy efficiency within a sustainability ethic appears to fit within a ' d e m a n d side paradigm'. A context o f 'sustainable development' values energy efficiency over e c o n o m i c efficiency. ~~ Of course, as noted above, more than these two paradigms are associated with the policy arguments over New Zealand's

tO9Ibid. t H~Forexample: Goodland and Ledec, cited in Peet (1992b), p. 229: '"In microeconomics, growth in production (or consumption) is possible or is considered desirable only to the point where the marginal benefit equals the marginal cost. In macroeconomic theory, there is usually no concept of the optimum size of an economy over the long term; rather bigger is always better. This approach neglects the often severe environmental and other social costs associated with high and growing rates of per-capita natural resource consumption". Society as a whole is encouraged to do what no firm would contemplate rationally: to maximise resource throughputs irrespective of the associated costs'. 11iSutherland (1994), recognisesthis as follows:'The assertion by [conservation advocates] that low energy prices are a market barrier to achieving energy efficiency suggests that they prefer energy efficiency, even when it conflicts with economic efficiency'.

Energy efficiency vs economic efficiency?." C Gunn

electricity sector reform. However, it is the supply side and d e m a n d side p a r a d i g m s which are i m p o r t a n t to o u r u n d e r s t a n d i n g o f why e c o n o m i c efficiency and energy efficiency can be valued so differently by different parties. In trying to explain the energy efficiency gap, both economists and technologists, and proponents of either economic or energy efficiency, might do well to heed Mark Blaug's cautionary comment: Efficiency is necessarily a value-laden concept, and cannot be freed from the notion that it is somehow more desirable than inefficiency. ~2

Coda There are those who might disagree that the debates over the electricity industry and energy efficiency are embedded within o p p o s i n g paradigms, for the concept of a p a r a d i g m is somewhat recursive. ~3 'The importance of framework-level issues are themselves determined by framework-determined premises',~4 and so eventual reconciliation between paradigms may seem impossible in the face of the refusal to acknowledge their existence. However, not all critics of New Zealand's electricity sector reform believe that energy efficiency and economic efficiency are completely incommensurable goals, for economic efficiency is regarded as 'a microeconomic concept concerned with short-run individual behaviour, particularly with presentday allocation of economic resources', whereas sustainable development goals are seen as 'macroeconomic and macroecological and are concerned with long-term aggregate behaviour'. ~15 So, perhaps there is some hope for a synthesis that may relieve the tension between the paradigms associated with energy efficiency and economic efficiency, although, if there is, it will require considerable effort by economists, technologists, and environmentalists. One could perhaps argue that the complex array of ideas referred to in New Zealand's energy policy objective is actually consistent with such a vision, even if the specific policies initiated in the electricity sector appear not to have been.

Acknowledgements This paper is based on an unpublished presentation by the author to the 1995 Joint Conference of the New Zealand Association of Economists, and the Law and Economics Association of New Zealand, held at Lincoln University, Canterbury, New Zealand. The author would like to express sincere thanks to: Karen Vaughan, D e p a r t m e n t of Education; and, Tony Endres and Basil Sharp, D e p a r t m e n t of Economics; all at the University of Auckland, for their help~2Blaug (t990), p. t81 t~3Amory Lovins, the initiator of the 'soft path' view in the US, has made reference to Kuhn in discussing the energy debate. Once commenting on paradigms, he indicated that: 'Stating the problem is itself a part of the problem, leading to an infinite regress': Lovins, quoted in Robinson (1982) l l41bid.

t tSPeet (1992b), p. 229


ful comments and constructive criticism. Financial support has been provided by Mercury Energy Limited. However, any errors and omissions are solely the author's responsibility, and the views expressed do not reflect the views of Mercury Energy Ltd.

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