The Abuses of Net Present Value in Energy Efficiency Standards
27 Pages Posted: 7 Aug 2017
Date Written: August 2, 2017
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: Suggested Citation