McKinsey’s Expanding Free Lunch Program

December 8, 2009

By David L. Levy

eden_low_fruit The Financial Times reported some intriguing new McKinsey data this week on carbon mitigation costs across sectors and countries. The data indicate that there are substantial differences in costs, and predictably, that building efficiency, lighting, and HVAC are the low-hanging fruit available at negative cost. The implication is that US companies should look to efficiency measures at home before buying international offsets, though international offsets might be preferable to renewables in the US.

The surprise in the data is that mitigation costs for most efficiency measures in the US appear to be substantially below those in Europe, China, and India. The cost per (metric) tonne of CO2 saved approaches €50 (Euro) in the US for these efficiency measures, while in Europe the saving is about €25 Euro. In India and China, there is a positive cost to these measures. The exception is lighting, for which the cost saving in Europe, China, and India is €60-90/tonne. Even more surprising is McKinsey’s estimate of mitigation costs from cleaner vehicles (hybrids and pure electrics), at negative €79 in the US and about €35 in Europe (i.e. net savings).

McKinsey mitigation cost international

The Financial Times does not give the basis for these calculations, and the estimates are projected for 2030. It’s unclear if McKinsey is estimating real resource costs, or the costs as viewed by consumers or manufacturers, taking subsidies and taxes into account. Perhaps McKinsey is factoring in much higher fuel prices and lower battery costs by 2030, but these values are highly speculative. I looked at buying hybrid Prius last year, which cost about $6000 more than the Mazda 6 I finally settled on. I would have to drive about 15,000 miles a year for 10 years, with fuel at $3/gallon, to break even (and that ignores discount rates for future savings). My actual mileage is only around 7,000 miles a year, which is why I don’t feel too bad about not buying a hybrid. It’s also unclear why the savings in the US, with it’s cheap gasoline, are more than double those in high-cost Europe. Perhaps its because Europeans are already driving lightweight high-efficiency diesels.   Another mystery is why renewable power is so much cheaper in China and India compared to Europe and the US. Most of the cost in solar and wind is in manufacturing, which is already dispersed through a complex global supply chain. So those costs should be the same wherever the renewables are installed. Installation and maintenance will rely on local labor, which is much cheaper, of course, in developing countries (but might be expected to rise quite sharply over time).

The availability of free carbon lunches has been discussed before on Climate Inc. Mark Sarro and Jurgen Weiss urged caution regarding the hidden costs of energy efficiency, while I noted that the low-hanging fruit might be locked up or hidden away behind misaligned incentives, inertia, and market barriers. Indeed, he fact that negative cost (i.e. profitable) opportunities to reduce carbon are not being exploited points to the importance of these hurdles. Because these barriers are frequently organizational, behavioral, and institutional, putting a price on carbon is not the best way to move ahead: a price high enough to be effective would be politically infeasible.

To repeat what I said in the earlier post: Most companies have traditionally paid little attention to potential energy savings because nobody was paid to do so. Once companies assign managerial responsibility for the task, measure the savings, and evaluate performance accordingly, they start finding a lot of low-hanging fruit. Many of the barriers are more complex, and require restructuring markets and institutions – California is famous for paying utilities to save energy, not sell it. Utilities are also finding that they can nudge consumers in the right direction with non-price signals, such as comparisons with their neighbor’s bills. The booming field of behavioral economics points to all sorts of low-cost ways of shifting behavior.

Of course, these solutions are not cost free – they involve managerial time, some capital, and transaction costs. Some of the barriers are complex and would require large scale institutional restructuring, requiring government-business collaboration. But one person’s transaction costs are another’s business opportunity (the transaction costs of carbon markets will keep financial firms smiling). The key point here is that there are creative organizational and managerial approaches to unlock the doors to low-cost or even negative-cost carbon reductions. The carbon price is, by itself, an inefficient and ineffective tool.

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