To perform this macro-scale analysis, I used the most recent information from the Energy Information Administration (eia.gov) on current usage for space heating and air-conditioning, both in total energy used and total cost. According to the most recent data, the entire US uses:
4.226 quadrillion Btu per year for residential space heating at an annual cost of $64.65 billion
0.635 quadrillion Btu per year for residential air conditioning at an annual cost of $22.27 billion
2.365 quadrillion Btu per year for commercial space heating at an annual cost of $20.32 billion
0.516 quadrillion Btu per year for commercial air conditioning at an annual cost of $12.10 billion
For a total of 7.742 quadrillion Btu per year and an annual cost of about $120 billion. Note that this does not reflect our entire energy consumption across the economy, but only a portion of each of the residential and commercial sectors. This represents the savings opportunity to our country if we can use existing and proven technologies to eliminate energy use for space heating and air-conditioning.*
As pointed out in last week's article, the determination of the rates associated with the time-value of money and energy cost escalation have a significant impact on the overall assessment. In addition, the length of time over which an investment is evaluated will determine the scale of opportunity. Long-term owners like universities, school districts, and government can look at a fifty year or longer time horizon for their investment, while short-term developers might only look at a three-to-five year horizon. In the case of the country as a whole, since our borrowing corresponds to a thirty-year horizon (the timeframe for a treasury note), we can look at that timeframe to make our determination.
Instead of determining a single rate for each of the discount rate, heating energy escalation (natural gas and fuel oil), and air-conditioning energy escalation (primarily electricity), I looked at a range of rates and combinations, then assigned some probabilities for each of these combinations based upon historical trends. For each of the primary rates, the following methodology was used.
The discount rate
Setting the discount rate for this exercise could take up a research paper in and of itself. We can factor in the inflation rate, the yield to be paid on the 30-year treasury, as well as other factors associated with an individual building, state or region. If we look at the trend in the 30-year average annual inflation rate (that is, average inflation rate over the previous thirty years computed each year), we have seen it drop from an average of around 5% for the period of 1960-1990, to a current average of just under 3% for the period 1983-2013. The current yield on a 30-year treasury sits just under 4%, and the institution in last week's analysis uses a discount rate of 4.5%. Given this range, I performed the analysis at each of 0.0%, 1.5%, 3.0%, and 5.0%.
The heating fuel escalation rate
When looking at energy cost trends, the volatility from year to year appears to make it difficult to know what will happen next. This often pushes decision-makers to assume no change in energy prices as a compromise between seemingly equally likely options of increase or decrease. A look at the year-to-year escalation or deflation of natural gas prices would seem to justify this caution.
With prices varying so sharply from year to year, the safe bet would appear to be to assume a constant cost of energy and then absorb any annual shocks. If, however, we are looking out past a two-to-three year horizon toward a twenty or thirty year horizon, these annual shocks smooth out. Looking at the 30-year average escalation rates over the past several decades, we garner more information.
First, note that as we leave the era that includes the Great Depression (30-year averages up until 1970 will include years from the time period traditionally referred to as the Great Depression), the average annual escalation in natural gas prices remains above 4% until we experienced the Great Recession in 2008-2009 where the one-year drop in prices caused a sharp decline in the 30-year average. There remains great debate about what the future holds for natural gas prices (the primary source for home heating in the US). Average escalation rates did start to decline in the early 2000s from highs of 10-12% in the 1980s and 90s. This can be explained by the increase in US production through hydraulic fracturing which had an increasing effect on supply. Until the world fully recovers from the current economic downturn, we will not have enough information to know if the new resources will create a prolonged era of low (2-3%) annual escalation, or if we will return to the era of 10-12%. In order to provide enough information to evaluate the likely range of impact, the analysis looks at 0% escalation, 10% escalation, and the above graph's average value of about 6.4%.
The electricity (air-conditioning source) escalation rate
Thankfully, our analysis has one parameter with some relative certainty to it. Unlike the volatility (especially recently) in natural gas escalation rate, or the variability associated with discount rates, electricity prices have had a steady and relatively predictable climb over the past five decades. Reliable information only extends back to 1960, but over the timeperiod since, we have seen the following year-to-year escalation rates.
We, again, see shocks in the 1980s and 2000s as with natural gas, but relatively frequent rates hovering in the 0-5% range. This bears out in the 30-year average escalation rates starting in 1990. (With data prior to 1960 unavailable or unreliable, the first 30-year average cannot be computed until 1990.)
We note the slow increase to the peak in 2000, then incremental decreases over the past decade with a similar drop noted in the 2008-2009 timeframe. However, even with that drop, over the past nearly 25 years, the average escalation has remained largely in the 3.0-4.5% range. In order to complete the picture on future rates, the analysis looks at rates of 0%, 1.75%, and 3.7%, the maximum of which represents the average over the time period represented by the graph above.
With those parameters determined, the analysis computed the net present value of the annual projected energy expenditures over the thirty-one years from 2013 to 2043. For each discount rate, a run was performed for each combination of the three possible natural gas and electricity escalation rates (a total of nine possibilities). The spreadsheet then weighted the results of each combination based upon a crude estimate of probability that the escalation rate would fall around that value. (Please feel free to contact me for a copy of the spreadsheet with all the probabilities and calculations if you would like to recreate the values.) The analysis assumes a likelihood that natural gas will escalate between 6-10% over a likelihood it will not escalate at all, and assumes that a 3-4% escalation of electricity costs is the most likely scenario. With these included, the present value of the energy expenditures for residential and commercial thermal comfort over the next thirty years (space heating and air-conditioning) is as follows:
Discount rate: Net present value of expenditures:
0.0% $12.4 trillion
1.5% $ 9.0 trillion
3.0% $ 6.8 trillion
5.0% $ 4.7 trillion
This means that if we could dedicate between $4.7 trillion and $12.4 trillion to investment in strategies associated with eliminating the need for space heating and air conditioning (e.g. insulation, geo-exchange systems, on-site renewable energy, battery storage**), over the course of thirty years, the economic value would be equal. In terms of immediate quality of life, however, setting about to put a workforce together to complete this work (even over the next three-to-five years) would provide an immediate and significant jolt to the economy.
Note that this analysis does not count the reduction in direct health costs due to the use of fossil fuels to power our economy (estimated at almost $120 billion), nor does it include the additional annual costs of mitigating and dealing with climate change (average of $200-300 billion per year through 2040). Based on the relative value of these costs to the economy to the direct expenses for energy (and taking into account the fact that the energy costs looked at in the analysis form only a percentage of the total energy usage), we could expect another $4.7 - $8.5 trillion at the 5% discount rate up to $12.4 - $18.6 trillion at the 0% discount rate.
The challenge then, comes in determining first how we can accomplish this technically, then second, finding the financial mechanisms (and political will) that will account for all the benefits. Over the latter part of the last decade, we have seen growth in energy efficiency programs targeted at measurable improvement in existing building performance. Even with these, energy use per capita is back on the rise. We would need both a larger workforce trained and ready to deliver the necessary improvements, and a more rugged infrastructure of financial management to make it happen. The opportunity exists now to put so many Americans back to work, create a more resilient future for our country, and shift the focus of our economy from extractive and damaging sectors (energy generation and mining) toward high-quality of life sectors (construction, maintenance, and energy services).
The question is whether we will continue to make baseless excuses for why we cannot afford to act, or whether we will rise to the challenge as our nation has done so many times before and recognize that the only thing we can afford is to make improvements now.
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