Energy Efficiency

McKinsey report urges investment in existing technologies to lower global energy demand growth

A new report out by the McKinsey Global Institute analyzes the relationship between energy demand and productivity in five main consumption sectors including the residential, commercial, road-transportation, air-transportation and industrial sectors. During today's E&ETV Event Coverage, Diana Farrell, director of the McKinsey Global Institute, discusses the new report entitled, "Curbing Global Energy Demand Growth: The Energy Productivity Opportunity." Farrell explains how implementing the correct policies and investing in existing technologies could significantly lower global energy demand growth by 2020. Click here to view the full report at the McKinsey Global Institute's Web site.


Diana Farrell: Good morning. Good morning and thank you.

I wanted to say how encouraged I am by some of the discussion we heard earlier today, mostly because our view, as we've entered the energy debate, has been that the demand side of the equation has been largely ignored in this. And that there's so much effort and attention put on the supply side, and yet our finding suggests that the demand side may be the most fruitful area for focus.

So that's what I want to center a lot of my comments on today, and to provide for you what is really difficult to do, but that I think is something we specialize in at the Mackenzie Global Institute, which is to provide a true global context for what is happening, a true unit of measure across the various pieces of the numbers that we hear and get cited all the time. So that we can really focus in on what are the biggest opportunities and what are the best kinds of interventions to try and solve some of these important issues, like the energy one.

So I want to start my remarks today with a general context on the global energy demand picture, and then move quickly to the U.S. specific opportunity, which we find to be very, very large. After much painstaking work in developing a common unit of energy measure across all sectors, all regions, all fuel types, which is quads of British thermal units, we can provide for you a true global map of what's happening around the world.

There are a couple of things that are very important about this view that we've developed. The first one is that it is an end-user view of demand. So, unlike the final and primary demand views that the industry uses or that many experts out there use, our view takes the generation of power and the losses associated with the generation of power and feeds it through the end-use segment so that we have a real understanding of what's driving demand and how policy changes can really best be effected. So think about what you do every day when you turn on a light, you turn on an appliance or turn it off. Every time you make that decision, every kilowatt hour that you turn on actually has a $3 consumption impact because of the power and losses associated with getting you that 1 kilowatt hour.

So what we have here is end-user segments, commercial, residential, transportation and industry, like CL Chemical and otherwise, with the power and losses associated with it. That's very important. So what do we learn when we look at this picture? Well, the first thing is that the total global energy consumption is 422 quad Btu. It breaks down primarily in industry, but of course this is spread out across a large number of sectors throughout the economy.

Next is commercial and residential and then, very importantly, transportation. Of course, this differs by country. And we find that the U.S., at 22 percent of global energy demand, is as much a transportation story as some of the others, or at least much more so than other countries. China, on the other hand, is still very much an industrial story.

Now let me call your attention to the demand by fuel type, which is an important part of the picture too. Oil is king and a good reason why we spend a lot of time talking about it, 34 percent of energy demand is satisfied through oil. But of course coal and natural gas are very important parts of the equation and we can't forget those, especially since they have very different CO2 implications.

Another thing that comes from this view is just how disproportionately the U.S. and Europe are dependent on oil relative to some of the younger economies, although they too are gaining dependence on oil very quickly.

Now, as we go forward, this is the picture today, but as we go forward we will see, in almost all reasonable scenarios, an acceleration of demand for energy. So to date we've had a 1.7 percent growth over the last 20 years. Going forward we will see that grow to 2.2 percent, and that is really across all sectors in the economy. That in itself would be disturbing, but when you consider the CO2 implications of this growth we actually get more profound growth in CO2 because many of the sources of energy will be higher CO2 intensive sources, like coal in China for example.

Now, I want to share two key observations about this growth that are very, very important.

The first one, which is probably not that surprising to people who have been following the debate, is that growth is a developing country story. Now, most people know that. What they may not know is that 85 percent of the growth is going to come from the developing markets. China we all know about, that's about 30 percent of the growth and it's growing fastest at 4.4, almost fastest as 4.4 percent. India, surprisingly, while it too will grow, is not as big a part of the story as is usually believed to be. And that's partly because India is in a much lower stage of economic development and it's still electrifying and, in fact, using some sources more efficiently than it has been in the past. The big surprise is the Middle East where we do see its growth rate at 4.5 percent actually surpassing China's growth rate. And we see the Middle East, which we usually think of as an oil-producing region, becoming a meaningful oil consuming region as well. And we think that'll actually play a big role in the story going forward.

Now that's the first observation, developing country story, China clearly, Middle East surprisingly, India surprisingly not as big as is usually perceived to be.

The second observation I'd make about this growth is that it is primarily driven by consumers. So we still have, many of us, a perception that energy is primarily an industrial issue. More and more, especially as countries become developed it becomes what we describe as a consumer issue. It's driven by the choices we make residentially. It's driven by the choices we make commercially in our workplaces, in our retail outlets, etc. It's driven, importantly, by our transportation choices, both in road and air transport. The industrial component, of course, is still important, but becomes less important overtime as economies get wealthier. This is an important point because it really speaks to the call for intervention that we talked about before, for standards and otherwise, because consumers will make choices differently as a result of their preference for style, comfort, convenience, and may not always capture the efficiencies that are available, even if they're high return efficiencies.

Now, as we go forward and think about the 2.2 percent growth that I talked about, I'll point out that this isn't a prediction. At the end of the day this is just a forecast of what will happen under the current trends. And so we probe hard as we understand the microdynamics of demand, what would change that picture? What would actually change it? Because this is, of course, how policy may play a role.

Well, the first obvious thing that would change it is changes in GDP. If we see faster growth we will actually consume more. If we see slower growth we will consume less. Nobody wants a policy around reducing GDP growth, but that would certainly change the equation. Interestingly, people talk a lot about oil prices and if we just increased oil prices dramatically it'd really affect the energy demand equation. Now it is true that we would find, in instances like transportation for example, a reduction in the use of oil if prices go up. But even if you take an extreme case, a 70 percent rise in oil, $70 from the base case of $50, what we see is much less global energy demand abatement as a result of that. Why? Because while we see some reduction in transportation in the U.S. and other places we see an offsetting in energy use in the Middle East, because as it becomes even cheaper for them to use it they actually use it more. And that, in effect, offsets the relationship. We don't have, at the global level, an ability to impact significant energy demand abatement through oil price changes.

There is one thing, however, that would make a very big difference to the picture going forward, and that is what we call energy productivity. In fact, we could reduce the base case of 613 quad Btu by 2020 by 135 quad. Let me try and explain what we mean by this energy productivity, and then come back to the specifics of what it means. The concept of energy productivity is a little bit different than the concept of energy efficiency in that it doesn't require the S word, the sacrifice in the traditional sense. We are talking about opportunities to achieve efficiency gains that meet the hurdle of 10 percent or higher IRRs. In other words, it's opportunities to make investments that will yield savings and, therefore, just improve the level of output provided by the level of unit GDP, not necessarily make different choices.

Beyond that there is the opportunity to make different choices, and I'll come to talk about that, but narrowly these are energy productivity opportunities to use energy more effectively, to create as much output for the same level, as much output for less energy or, in effect, to reduce the energy we use to create the same output.

Now, let me talk about energy productivity for a moment. Over the past 20 years energy productivity has been improving. So what you see here in 1980, $59 billion per quad of Btus was the output that the world could achieve in terms of its energy productivity. That improved at about 1.3 percent over the last 20 years. It's now $79 billion per quad Btu. As we go forward we will continue to see improvements and we will see that that will go to $94 billion per quad Btu. But we'll begin to see a reduction in the rate of improvement from 1.3 now to just almost 1 percent.

Now, why is this happening? Why do we have a general energy productivity inherent in the economy? Reason number one is because there's been a worldwide shift to services, which are less energy intensive than manufacturing. Even China, the manufacturing shop floor of the world, has lost 50 million manufacturing jobs in the last 10 years. So this shift towards manufacturing is one of the things.

Certainly the second one is we have introduced a lot of energy efficiencies into the economy and although they're not always adopted at the same rate around the world, they contribute significantly to energy productivity. There's also something about the economics of energy conversion in refining that introduces capacity always at higher levels of energy efficiency and then, in fact, moves up the average as you increase demand.

So all these things suggest that we have had energy productivity improvements over the past, we will have them again, but they will not be sufficient to do anything about this accelerating growth in energy demand to 2.2 percent. We asked ourselves, well, how can we alter this picture? Could we alter this picture? Could we dramatically improve the energy productivity? That is achieving the same level of output, but just using less energy. Not requiring us to give up growth, not requiring us to give up consumer preferences or desires, but simply using energy more effectively. And the good news is that we found there are very large opportunities around the world to do exactly that, to improve energy efficiency at very attractive rates of return.

We see it in residential. For example, 15 percent of residential use of energy could be reduced through these productivity improvement opportunities, 50 percent of some industrial uses, 30 percent of commercial. And what you see here is sector by sector, through the micro cases that we've done, an understanding of how big are the opportunities to achieve efficiency improvements while still achieving these high rates of return. And it is quite big. Put another way, this 135 quad Btu reduction is equivalent to taking that 2.2 percent growth, base case growth rate I talked about before, and bringing it down to 0.7 percent. It's pretty dramatic. Under almost any scenario you could imagine, of GDP growth or oil prices or otherwise, we would see growth rates reduced to below 1 percent.

Now this is a material impact on our energy use without stepping into the achieving higher cost or sacrifice or otherwise. And we would argue this is an essential component of any good energy policy going forward.

Now I want to begin the transition to the regional story and to note that while these opportunities that I just described across all sectors exists around the world, in the developed world the U.S. clearly stands out as the area most prime for potential improvements.

In the developing world, I mentioned this before, China, of course, is 21 percent of the opportunity, but the Middle East will become a major opportunity going forward.

Now I want to pause for a minute, before we turn to the U.S., on the CO2 impact of what I just said. Because CO2 is actually growing faster than energy, any impact we can have on energy will also have an impact on CO2. In fact, it will have a disproportionately large impact on CO2. And we see here that the base case growth rate in CO2 emissions of 2.4 could be reduced to significantly under one percent through these energy productivity opportunities. So we have an opportunity to improve the economic dimension at the same time that we make a real dent on the environmental issue. Indeed, when we have, in separate work with our colleagues, tried to inform this notion of what would it cost to abate the CO2 out there in the world, to achieve the standards that most experts believe are necessary, 450 ppm to 550 ppm, to keep the temperature below a 2 degree change? We find that these energy productivity opportunities I'm talking about, and, again, let me just state again, efficiencies that yield a 10 percent or higher IRR, would get us a pretty far way along the targets that have been set to try and maintain the CO2 emissions within the desirable range. We estimate that up to 50 percent of the targets could be met through these energy productivity improvements. Beyond that, of course, you do incur costs to take the next level of CO2 out. And the work that we've done in that has some good estimates of what that cost would be. But I want to keep the focus on this notion of energy productivity that would make a material dent in the environmental issues that many people are so concerned about.

So let me turn now to the U.S. story, because I think for many of you that is the interesting one now that we have the global context.

Now I said before that the U.S. is 22 percent of global energy demand, that's 92 quad Btu. And it is growing not as fast as the world as a whole because developing countries, of course, are driving most of the growth, but faster than any other developed country at 1.1 percent. And what we see, of course the point I mentioned before, it's largely a consumer story around transportation, commercial, and residential, and that will only become more so by the year 2020. I know, in particular, that while air transport is small right now in terms of the global picture, it is by far growing fastest and has real important energy consumption and CO2 implications. Now the implications of this energy demand story, which is the business as usual one, on CO2 is the following.

Already the U.S. is the more energy intense, Ted, you made reference to this earlier, both on a energy used per dollar of GDP, at least relative to the developed world. At 8,900 Btus per dollar of GDP the U.S. is 25 percent more intensive than Europe, and two and a half times more intensive than Japan. On a per person basis the U.S. is five times the global average. And many of you have seen the statistics. I think what's disturbing is that even as we project out to 2020 those ratios, to a large degree, remain. We will still be four times more energy consuming per capita than the global average.

The CO2 story is no different. We will continue to have very high levels of CO2 output per dollar of GDP. Again, within the developed world we are twice the average. If we go to the global picture we are four to five times the global per capita emissions. So this is not a very uplifting story about the current state of affairs. And I think it's disturbing, when you look behind each of the sectors, that we find this dynamic to be true sector by sector by sector.

So take residential for example, energy productivity improvements in the U.S. are slated under business as usual policies to increase at a rate of 0.2 percent, whereas, all other countries are achieving more than one percent in that dimension. Similarly in commercial, similarly in road, and so when somebody asked the question earlier what do you say to regulation? How do you defend the need for some kind of intervention? We turn to something like this and say, clearly, what other countries have achieved through the introduction of standards, through the introduction of various market-based interventions, is a much more productive energy story than we have or are slated to unless we have material interventions of some sort or the other.

Now if we do pursue the opportunities I talked about before, in the U.S. alone the picture looks a little brighter. And so we find that we could take the 92 quad BTU energy demand that is currently in place and actually reverse the growth trend. Instead of a 1.1 percent growth, which is what the business as usual situation would have, we could reduce our energy needs to 88 quad.

Again, remember, these are all yielding 10 percent or higher IRR. There's no cost to the economy of doing this and we could actually reverse the growth trend. And in our view this has got to be a primary focus for any kind of energy policy. So let me try to make this a little bit more tangible because I think at this level many people will say, oh sure, you can't do it. In theory, in theory. I think the tangibility here really provides the basis for optimism and the basis for concerted action. Take the residential sector, the residential sector is the single largest sector in the global economy, in terms of energy use it's 25 percent. And it is growing, at least in the U.S., at about 1 percent a year. It will reach 21 quad Btu by 2020.

Now what's going on here relative to other countries? Well, U.S. households, on average, have much bigger houses. They have much less standard insulation, so they're less well insulated. We use many more, larger appliances than other countries do. And we don't embed, in those appliances, the latest energy efficiency technologies. So under current policies we actually have a pretty large gap with other countries. We will have an even bigger gap with other countries, but that could change if we pursued the energy productivity interventions that we're talking about, that is on standards for appliances, heating and air-conditioning, and particularly lighting. We could dramatically alter this picture. We could go from 21 quad Btu down to 13 quad Btu in the residential sector alone.

And I'll give you a very specific example that really brings this to life. Think about standby power in our homes. The average television uses 60 watts of standby power just sitting there doing nothing. Technology exists to reduce that down to 1 watt per hour. Now the consumer mode, when you buy a television the last thing you're thinking about is standby power. A mandate of that sort, an intervention of that sort, which will actually pay off over two years quickly, is actually a positive story in that it yields these efficiency improvements to the economy, but achieving higher rates of return for those investments. That's a particular kind of intervention. And we would support standard settings in terms of fuel-efficiency, building codes for insulation, lighting mandates for fluorescent and otherwise that have been so successful in some of the other countries I pointed to.

Let's take transportation, which is important, not only because it's large, but because it particularly links to the oil dependency issues. In transportation, what we find is that the U.S. -- let me actually put it this way. To travel one mile in the U.S. requires 37 percent more fuel than to travel a mile in Europe or Japan. Why is that? Well, that's because we have much less standards, much less strict standards on fuel efficiency than those countries do, and also because we drive bigger cars, and so both of those things play out, particularly in the current environment. Going forward, two thirds of the story, unless we actually intervene here, will be stricter standards in other countries.

Now the gap with other countries, the traveling one mile at 37 percent more fuel than other countries use to travel that one mile, will actually grow to 42 percent more fuel than other countries. Again, we would argue this is a case for market-based intervention. Why? Because when consumers go to buy a car, while they might look at the fuel efficiency they don't always factor in the savings properly and truly understand what the economics of that situation is. When these standards are mandated the manufacturers make the investments, they pass them on as price increases to the consumer, but within a short amount of time those savings accrue to the consumer and the economy is better off.

We've achieved efficiencies at a rate of return that's 10 percent or higher. In industrial we have the same kinds of opportunities and there are actually quite a large -- oh, actually, let me just point out one important thing. If we were to improve our standards, fuel efficiency standards, to Europe and Japan's, that alone would result in a 4 million barrel a day reduction in our oil use. It's just really important to consider. That's a material impact and it's something that other countries have done without too much pushback from the citizen.

Industrial, another area. Again, this is harder to some degree to capture because it's spread across so many different sectors. But we find, particularly in heat recovery in the production of mechanical electrical power, very large opportunities to impact demand. We find in the optimization of motor driven systems for pumps and compressors very large opportunities to change this. And, of course, any of you here who are business people or economists would say, well, if there are all these investments out there that will yield a 10 percent return, why aren't businesses doing them? Why do we need something to happen to get businesses to do this? And I think what we learn is that, as a general rule, businesses put a very high hurdle rate, even higher than 10 percent on these investments, because they lack the familiarity with energy efficiency issues. They have not seen it done. They don't have energy audits. And there is a role for market interventions that will create demonstrations to show how this is done, we've seen that successfully in Europe and Japan, that will provide the energy audits and know-how to achieve these energy efficiencies. And, in many cases, provide the financing to offset what are in effect very variable prices and otherwise that make these investments seem much riskier than some of the other things that people do.

So, again, targeted interventions to overcome market inefficiencies would yield a big result in the industrial sector. With that level of specificity I'll just come back to the big point that I would make, energy policy is increasingly on the agenda of many citizens and it's increasingly on the agenda of many candidates. We would say the first and most important place to start is in this notion of those efficiencies that are actually good for the economy, that will drive us to lower levels of demand use, lower levels of CO2 use, without curtailing demand. Beyond that of course, there may be opportunities to do more, and I think that has to enter the political debate in the right way.

So a couple of thoughts, which I hope you've come away with. We do think that this energy productivity story has to be an important part of energy demand. There are spectacular opportunities to achieve these. And in our work with businesses around the world, as we worked through each of these examples, which you can find in the report that is out there, you can find on our Web site, these are tangible. They're real. They just require certain interventions to get over the market inefficiencies. And if so, we could really achieve a win-win situation for businesses, for consumers, and for the country as a whole. Let me encourage you, if you're interested, to go to our web site and see the full report because there's a lot of wealth, there's 16 months worth of work and details in the sectors.

Thank you for your time.

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