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Fueling sustainable development, the energy productivity solution from McKinsey
Source: BI-ME , Author: Justin Smith
Posted: Wed October 29, 2008 12:00 am

INTERNATIONAL. By choosing more energy efficient cars and appliances, improving insulation in buildings, and selecting lower-energy-consuming lighting and production technologies, developing countries could cut their energy demand growth by half from 3.4% to 1.4% a year.

Scaling back energy demand growth to this extent would leave energy demand in these regions some 22% lower in 2020 than it would otherwise have been - an abatement equivalent to the entire energy consumption of China today - according to new research by the McKinsey Global Institute (MGI), McKinsey & Company’s economics research arm.

The report 'Fueling Sustainable Development: The Energy Productivity Solution', maps developing countries’ energy demand across countries, end-users, and fuel-type. MGI finds that under current policies energy demand in developing countries will increase by 65% in the period to 2020, representing 80% of global energy demand growth.

These countries currently account for 51% of global energy demand today and this share will rise to 60% in 2020 without further action. Measured on a per capita basis, however, developing countries’ energy consumption will still be less than 40% of that of developed regions by 2020.

MGI research indicates that by boosting energy productivity - the level of output achieved from the energy consumed - developing countries could reduce fuel imports, lower the expense of building new energy-supply infrastructure, decrease vulnerabilties to future energy shocks, and lock in lower energy demand for generations to come.

Because of their positive returns, energy efficiency investments are not only economically attractive but also the cheapest way to meet growing energy needs. The economic case for improving demand-side efficiency is particularly strong in light of the current uncertain economic outlook and financial turmoil. The solutions included in MGI’s assessment all generate an internal rate of return of 10% or more in lower energy costs. Solely using existing technologies that pay back for themselves in future energy savings, consumers and businesses in developing countries could secure savings of an estimated US$600 billion a year by 2020.

Moreover, MGI finds that developing countries could productively invest some $90 billion annually over the next 12 years in energy efficiency improvements with positive returns. According to IEA analysis, it would take almost twice as much investment - US$2 trillion over 12 years - to expand the supply capacity for the additional 22 percent of energy consumption that would occur without an improvement in energy productivity.

Indeed, because of their lower labor costs, the price tag for investing in energy productivity is on average 35% lower in developing economies than it would be in advanced economies. Moreover, the relatively early stage of economic development in these regions works to their advantage. Many developing countries will build more than half of the capital stock that will be in place in 2020 between now and then.

This gives these economies an opportunity to leapfrog to more energy-efficient technologies and lock in lower energy consumption (whereas more advanced economies will have to retrofit for higher energy efficiency, a much more costly proposition). Because of the huge program of capital stock building, it is vital that developing countries move quickly to boost energy efficiency, the research suggests.

MGI finds there are large differences in energy productivity among developing countries at similar levels of income. Three structural factors explain roughly half of the variation. In order of importance, these are energy policies, the structure of an economy, and the climate. Policy-related factors - subsidised or taxed fuel and electricity prices, and the level of corruption in a particular country or region - explain a quarter of the variance; energy subsidies tend to reduce energy productivity, and taxes increase it.

The structure of an economy explains another 21%; countries with large manufacturing sectors tend to consume more energy and have lower energy productivity. Climate contributes another 13%; the more extreme the weather, the more heating and/or cooling is necessary, and the more energy is required per unit of GDP.

Yet less than 50% of the energy productivity differences that exist are due to these structural variations. This strongly suggests that most countries have room to improve their energy productivity by adopting best practices developed elsewhere. However, despite the attractive economics of higher energy productivity, developing countries have thus far left much of the potential on the table. The research examines the array of policy distortions, market failures, and information barriers that today stand in the way of consumers and businesses seizing energy productivity opportunities within reach.

MGI highlights four priorities for policy makers. Reducing energy subsidies is the first. MGI finds that reducing fuel subsidies by 80% globally, largely in the Middle East, Venezuela, and Mexico, could reduce global demand for road transportation fuel by 5 percentthe equivalent of 2.5 million barrels of oil per day. Recognising the political challenges, the research suggests easing the transition by providing financing for upgrading to more efficient capital and equipment, and using some of the savings to target poor segments of the population.

The second area for action is reforming utility incentives. Today, governments typically reward utilities for the volume of electricity delivered; instead they could award bonuses for encouraging energy efficiency among their customers. Other policy options that governments can introduce include white-certificate programs that measure and reward progress toward achieving energy efficiency targets, as well as the adoption of technologies such as user-friendly smart metering to help better manage household energy use patterns, and smart grids to reduce transmission losses.

A third area for action is implementing and enforcing efficiency standards, an effective, low-cost way of coordinating a transition to more efficient appliances, consumer-electronics products, vehicles, and lighting. 

A fourth priority is encouraging public-private partnerships that can run information campaigns to help consumers make energy-efficient choices; forge new collaborations between governments, energy-service companies, utilities, and mortgage companies to finance higher efficiency in buildings; and overcome capital constraints.

The research also examines the opportunities for business in developing countries. Not only can companies save significantly on their energy bills; they can build on innovation in energy-efficient solutions in their home markets to carve out a leading position in the global market for green products and services before this market matures. MGI has identified seven priority areas for businesses: building-technology products, electrical devices and other household equipment, transportation, transparency-creating products, customized solutions, energy services, and financing energy efficiency investment.

Country and regional findings

Today, China consumes 16% of the worldwide total while Russia and Eastern Europe account for another 9%. Latin America, Asia, Africa, and the Middle East collectively represent 26%. With the exception of Russia and Eastern Europe, per capita energy consumption in developing regions is significantly lower than in developed regions.

China alone represents 34% of the global energy demand growth that MGI projects to 2020. Even with the significant energy efficiency improvements expected under current policies in China, continuing industrialization and quickly expanding demand from the country’s growing ranks of middle-class consumers will fuel rapid energy demand growth.

India represents a much smaller share of energy demand growth (8% of the global total) than China. There are three reasons for this. First, India has a lower income level than China and thus a lower penetration of energy-consuming appliances. Second, India is at an earlier stage in its industrialization and has a lower share of heavy manufacturing, and its industry therefore consumes less energy than industry in China. And third, a shift in India’s fuel mix from biomass to more efficient electricity will act to mitigate energy demand growth.

On the other hand, the Middle East will account for 11% of energy demand by 2020, making it the second-largest contributor to the overall growth in energy demand of developing countries. These countries’ energy-heavy development strategies along with large energy subsidies to consumers will continue to make growth highly energy intensive.

Latin America and Asia (not including China and India) will represent 8% and 5% respectively of overall growth in energy demand, with both industrial and consumer end-use sectors driving expansion. Russia and Eastern Europe is an exception among developing countries in that this region will witness slower energy demand growth of 1.4% per year. This is due to the fact that these economies are shifting away from the extremely energy-intensive and inefficient production of the Soviet era.

Note: The Middle East region here refers to Bahrain, Iraq, Iran, Kuwait, Kyrgyzstan, Oman, Pakistan, Qatar, Saudi Arabia, Syria, Tajikistan, UAE and Yemen.

The full report can be downloaded free of charge at www.mckinsey.com

 

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