If you are embarking on a new weight loss plan, it typically makes sense to pursue a mixed strategy of diet and exercise. If you are working to get your finances under control, you should look for ways to increase your household earnings and reduce spending. And so it goes, as we work to reduce carbon emissions from the nation’s power sector, pursuing a mix of supply and demand-side strategies makes good sense.

By Auffhammer’s Yoga Theorem (or, for you purists, Le Chatelier’s principle), the outcome of an emissions regulation that supports compliance flexibility will be less costly than a rule that limits states’ compliance options.  Under the auspices of the Clean Air Act, the EPA has rolled out its metaphorical yoga mat and demonstrated some serious regulatory flexibility with its “outside the fence” approach to compliance.

fence

“Outside the fence” basically means that states can look beyond their existing power plants for ways to reduce emissions cost-effectively. There is evidence to suggest significant untapped potential for cost-effective energy efficiency gains on the demand-side.  Allowing states to use demand-side efficiency improvements to meet their compliance obligations has the potential to significantly reduce compliance costs.  But with these potential cost savings come implementation challenges.

Factoring in the demand side

The EPA has defined a set of state-specific emissions standards based on a detailed assessment of state-specific “best system of emissions reductions” (more details can be found in the  proposed rule).   The EPA chose to define these standards in terms of emissions rates (i.e. tons CO2/MWh), although states can choose to convert their standard to a mass-based (tons of CO2) target.

A state that sticks with the rate-based standard would, for compliance purposes, calculate their emissions rate as follows:eqnThe numerator is simply the tons CO2 emitted from electricity generation.  The denominator is the sum of electricity generation plus “negawatts”.  In principle, negawatts represent the electricity consumption that did not happen thanks to a demand-side efficiency improvement.

Looking at this equation, a state could bring its emissions rate into compliance using supply-side strategies that reduce the emissions rate per MWh of electricity generated. Examples include supply-side operating efficiency improvements and increased reliance on less carbon intensive generation sources.  On the demand-side of the fence,  the state can pursue efficiency improvements in order to reduce the total quantity of electricity generated while increasing its negawatts.

How many megawatts in a negawatt?

Measuring carbon emissions and electricity generated is relatively straightforward because state-level emissions and electricity production are directly observable.  In order to measure negawatts you need to construct a credible estimate of something you cannot observe directly: the “counterfactual” electricity consumption that would have been observed absent the efficiency intervention. Recent studies have looked into how projected savings from energy efficiency programs compare with realized energy savings in a variety of settings.  Whereas some find that savings materialize as expected, others find that realized energy savings fall short of predictions (some recent studies can be found here and here). This can happen for a variety of reasons including mis-calibration of simulation models, sub-standard installation of efficiency measures, rebound, or a failure to fully anticipate free riding behavior.

If energy efficiency savings are over-estimated, the denominator in the above equation will be inflated. If a state’s emissions are divided by an artificially large number, the stringency of the rate-based standard is effectively reduced.  In other words, too many emissions will be permitted per unit of electricity generated. Importantly, damages from these increased emissions will work to offset- or even eliminate-  the relative cost-advantages of demand-side compliance options.

Measurement matters

The moral of this story is *not* that we should throw outside-the-fence compliance flexibility out with the bath water.  The real punchline is that measurement matters. Over-estimates of energy savings make energy efficiency look artificially cheap relative to supply-side strategies. This mis-measurement undermines cost-effectiveness. Under a rate-based standard,  it can also reduce stringency and increase emissions.

The EPA has indicated that it intends to develop guidance for evaluation, monitoring, and verification (EM&V) of demand-side energy efficiency programs for the purpose of this rule. This is a daunting but important task. The good news is that there is lots of work being done by academic researchers, government agencies, and other stakeholders to inform this process and advance the state-of-the-art. Providing clear guidance and resources to help states tackle these EM&V challenges will be key to realizing the real potential of outside-the-fence efficiency improvements.