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The Abuses of Net Present Value in Energy Efficiency Standards

27 Pages Posted: 7 Aug 2017  

Syed Abul Basher

East West University

David G. Raboy

NOVA Community College ; George Mason University

Date Written: August 2, 2017

Abstract

Consumers are often blamed for not making necessary investments in energy-efficient durables despite that these investments have positive net present value (NPV). Several papers have argued that when investments have option-like characteristics (e.g., irreversibility, uncertainty, flexible timing, and lumpiness), the aphorism “invest if the net present value of investing exceeds zero” isn’t the best advice. Yet, curiously, the Department of Energy (DOE) in the United States proposes new regulations mandating higher energy efficiency standards for consumer durables on the basis of positive NPV over an investment’s lifetime. In this paper, we provide a step-by-step deconstruction of DOE’s NPV methodology and show that DOE’s method purges volatility, volatility persistence, and nonstationarity that are otherwise present in energy prices. As a result, DOE’s projections of future energy prices are artificially smooth and statistically biased, casting serious doubt on the reliability of the magnitude of energy savings from energy-efficient durables. Our results, therefore, support the notion that consumers’ behavior isn’t irrational.

Keywords: Net present value, energy efficiency, Nonstationarity, Volatility, Electricity and gas prices

JEL Classification: C22, Q40, Q41, Q47

Suggested Citation

Basher, Syed Abul and Raboy, David G., The Abuses of Net Present Value in Energy Efficiency Standards (August 2, 2017). Available at SSRN: https://ssrn.com/abstract=3013804

Syed Basher (Contact Author)

East West University ( email )

Aftabnagar Main Road
Plot No. A-2
Dhaka, 1219
Bangladesh

HOME PAGE: http://syedbasher.org

David Raboy

NOVA Community College ( email )

Sterling, VA 20164-8699
United States

George Mason University

VA
United States

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