A paradigm shift in assessing its contributions to development

Background, challenges, and context

Energy efficiency is one of the cheapest, cleanest, locally available, and quickest to deploy options for meeting developing countries’ growing demand for energy services. The International Energy Agency has even argued that energy efficiency deserves to be labelled the ‘first fuel’ of a sustainable global energy system.

Yet, energy efficiency’s economic potential remains largely untapped. Many developing countries do not include energy efficiency on their energy sector priority actions and many economically viable investments are not being implemented. The barriers range from policy and regulatory issues to high project costs and behavioural inertia.

In addition to these barriers, energy efficiency is often ‘tough to sell’ in developing countries since the traditional narrative has focused on energy efficiency as a means of reducing energy consumption. This narrative has been well received in developed countries, where living standards are high and demand for essential services – electricity for appliances and lighting, water supply and sanitation, space heating or cooling – is largely met. However, it does not resonate in a developing country context where demand for such goods and services is unmet.

There is a need for energy efficiency initiatives to shift from focusing almost exclusively on energy saved towards recognising the outputs brought about through energy efficiency – be it more industrial output or more and better lighting, heating, and cooling. A sound framework for the economic analysis of energy efficiency measures must recognise the benefits of additional goods and services and strengthen the case for energy efficiency investments that bring those benefits.

Research overview and objectives

The objective was to demonstrate how energy efficiency can enable developing countries to provide more and better goods and services in line with their development aspirations and to provide a sound framework for economic analysis that captures these benefits. By improving productivity, energy efficiency can enable countries to extract more from each unit of their expanding energy base – e.g. more goods from industry, trucks travelling further to reach more customers, more space cooling, more refrigeration for foods and medicine, more better-lit and better-equipped schools to improve education – all of which will promote development.

The project’s primary research question was: How do we change the lens with which we evaluate energy efficiency investments, from one that focuses on energy and cost savings of the investment to one that emphasises the additional goods and services that can be produced as a result of the investment?

Research methodology

The research included a review of literature and guidance documents for economic analysis in multilateral development banks (MDBs), a consultation process with international energy efficiency experts (including MDBs, academia, think tanks, and NGOs), and a review of a sample of 26 recent World Bank projects with energy efficiency components.

The main objective of this review and consultation was to determine the extent to which literature identifies a different role for energy efficiency in developing countries than in developed ones, how economic analyses for energy efficiency investments in developing countries are currently being carried out, and how other benefits that go beyond energy savings are reflected in the economic analysis. Based on the findings, the authors suggest a framework for economic analysis of energy efficiency projects in developing countries.

Research results, key messages, and recommendations

From the review, the team concluded that in projects where the objectives focus on energy efficiency, the economic benefits quantified are almost exclusively the economic cost of energy saved and the associated reductions in greenhouse gas emissions. While both the literature and the descriptions of the reviewed projects recognise there are additional economic benefits, it is typically noted that these are difficult to quantify (and the projects were economically justified without them). Where energy efficiency investments do lead to an increase in the production of goods and services, existing guidance captures the benefits using an ‘adjusted baseline’ methodology. This approach shows energy savings relative to a hypothetical counterfactual case in which an equivalent amount of goods and services was produced in a less energy-efficient fashion. However, if the benefits of an energy efficiency project shift from energy savings toward providing more goods or better services, it may be preferable that the focus of the project objective and the economic analysis should shift accordingly.

A framework for the economic analysis was developed to cover three demand-side energy efficiency project categories: (i) brownfield energy efficiency projects that aim to reduce absolute and specific energy consumption but do not aim to change the level of goods or services provided; (ii) brownfield energy efficiency projects that aim to reduce specific energy consumption while raising the level of goods or services provided; and (iii) greenfield energy efficiency projects that aim to provide additional goods or services through the addition of new infrastructure or equipment (as opposed to replacing existing equipment), with energy consumption increasing compared to the status quo. The framework describes the main steps of the economic analysis with two possible counterfactuals: (a) a status quo counterfactual, in which there is no change in the level of goods or services provided and (b) an alternative scenario counterfactual, in which the same level of goods or services is provided as under the project.

The framework was applied to a case study on investing in energy efficient air conditioners, comparing a brownfield energy efficiency project where existing air conditioning units were replaced by more efficient ones, and a greenfield energy efficiency project in which new air conditioning units were installed in a previously unconditioned space.

The application of this framework (or of economic analyses that value the increase in production or service levels from energy efficiency projects in general) could favour a shift from brownfield energy efficiency projects that save energy in absolute terms towards brownfield energy efficiency projects that increase goods and services, and towards greenfield energy efficiency projects. The framework also helps to address concerns about the rebound effect, which is often raised when discussing energy efficiency measures. The rebound effect is the reduction in expected energy savings/economic benefits from energy efficiency measures because of behavioural responses (for example, improved lighting efficiency in households can reduce the incentive to switch off lights in empty rooms). The framework clarifies that the rebound effect does not necessarily reduce the economic benefit of an energy efficiency project and provides guidance on how the additional utility resulting from the rebound effect can be valued. As long as prices reflect economic costs and those costs are borne by those making the decision to consume more goods or services, continued consumption at the expense of energy savings increases net welfare.

As a result of the research, World Bank guidelines for economic analysis of energy efficiency projects have been extended to better describe how an improvement in the level of goods or services provided can be quantified. Communications products were developed to accompany and disseminate the framework for the economic analysis.