Energy & Entrepreneurs #21                                                                                 

Economics and Energy Conservation

by Raymond J. Keating

Too many politicians, government bureaucrats, environmentalists and news reporters apparently think that businesses must be told to conserve energy. The working assumption seems to be that if they're not told, encouraged and/or even coerced into doing so, businesses will mindlessly waste energy.

It is obvious that these people don't understand economics or how businesses are run.

There is a common-sense reason why conservation does not require the poking and prodding of government and environmentalists.  That is, the free market.  Prices and profits send signals to market players - both businesses and consumers - to alter their behavior.

So, what happens when energy costs rise considerably, as has been the case over the last few years?  Businesses have every incentive to conserve. 

But some don't understand this.  For example, in an article ("Not Enough" by Christine Buurma) from a special Energy section in the August 27 Wall Street Journal, Mark Brownstein, from the Environmental Defense Fund, was quoted: "Companies are leaving a lot of opportunities on the table."  And David Hamilton of the Sierra Club added: "Businesses are kind of like the rest of the country in that they have traditionally underestimated what energy costs are."

In reality, the beauty of the free market is that business owners and executives must keep an eye on - and keep in check - all costs.  If not, they lose profits and market share, and eventually fail.  But unlike environmentalists and many politicians, whose focus is on spending any amount of resources on environmental and energy-saving measures, businesses prudently have to consider the entire cost picture.  That is, investment in energy savings, just like any other investment, has to make economic sense. 

We see this in other articles from the Journal's Energy report.

Consider a piece titled "Business Goes on an Energy Diet." While it fell prey in a few spots to the mistaken idea that many businesses do not look at energy costs, the article hinted at some of the economics at work, and highlighted the actions that some companies have taken to reduce energy costs.  For example:

•  "Wal-Mart Stores Inc. -- which by some measures is the world's second-largest energy purchaser after the U.S. government -- has undertaken a multiyear campaign to retrofit older stores with new lighting and air-conditioning systems. Company officials boast that many of these energy projects pay for themselves within two years." It also is noted that Wal-Mart has centralized control over energy consumption decisions, such as temperature changes in individuals stores; and is buying more produce locally in order to save on fuel costs. In the end, a Wal-Mart executive pointed out, "Everything we do comes back to what makes the most sense for the customer." And that, of course, is as it should be.

•  The article made clear that energy costs are just part of the overall business picture. It was noted: "For one thing, they must balance energy efficiency against other concerns. Should a manufacturer replace machinery that still works fine just to bring in more energy-efficient models? Or should it spend that money on much-needed capital improvements? In some cases, companies have made all the easy fixes they can, leaving only expensive measures that will take years to return their cost in energy savings."

And a bit later: "On paper, many industrial companies could achieve quick improvements in energy efficiency by replacing older equipment: steam systems that don't recover enough heat, motors that run constantly and boilers that lack proper insulation. But in the real world, all that new machinery is often costly -- so energy efficiency becomes a series of trade-offs."

These are critical points that many politicians and environmentalists simply don't like to deal with.  They look to impose environmental or energy-related regulations and mandates without understanding or choosing to ignore the economic fact that businesses have only so much to spend or invest.

• The idea of necessary trade-offs was made clear with the example of California Portland Cement Company in Glendale, California. It was reported: "California Portland's manufacturing operations include a mix of Eisenhower- and Nixon-era machinery -- a source of both opportunity and frustration for Steve Coppinger, the company's energy manager. ‘If the upfront costs didn't matter, there are new technologies that are much more energy-efficient and much more environmentally friendly,' he says. But energy-efficiency upgrades ‘have to compete with other investments,' such as new loading systems to provide cement to customers more quickly, or new trucks for the quarry. So, Mr. Coppinger says, the company is upgrading its plants gradually. Energy-efficiency projects need to pay for themselves in three years or less to win financing."

Another article titled "Inside Jobs" highlighted what a unit of Hitachi has been doing in Singapore.  It was noted in the article: "‘Just like everyone else, we're affected by high oil prices and electricity prices,' says Leong Sow Chun, managing director of Hitachi Global Storage Technologies Singapore Pte. Ltd. ‘But those are things you and I can't control, so we have to look internally and push ourselves harder to try to come up with more ideas to reduce energy costs.' ... ‘Just look at the prices of laptops -- you notice prices are always coming down,' says Mr. Leong. ‘We have no choice' but to cut costs, he says, ‘because in the electronics business, we can't go to the customer and say, "Can I increase my price because my electricity bill has gone up?"'"  The piece goes on to note that the company "requires all its units to develop an environmental policy that minimizes waste and reduces energy consumption."  Calling that an environmental policy or not, the fact is that reducing waste and unnecessary energy consumption just makes plain old good business sense.

Indeed, Hitachi's Leong tells the Journal that they are looking at solar power as well.  But it is most certainly not solar power for the sake of pandering to environmentalists. The article noted: "Mr. Leong is even looking at solar power. Most of the solar panels on the market aren't particularly efficient, he says, but some companies have started to produce thin-film solar panels that offer greater efficiency.  ‘I've asked our committee to take a look at it, but to be honest I think it'll be a number of years before something commercially viable will be available. But we are watching that,' he says. ‘If these things turn commercially viable, we'll jump in.'"

Again, businesses cannot just pander to special interest groups.  If they succumb to such temptations, they're bottom line and owners/shareholders will suffer.

Do many businesses - especially smaller firms - need help to get their energy costs under control?  Absolutely.  Many businesses are getting ideas from their own employees, while others are turning to outside assistance.  That improves the well-being of the business.  Business owners don't need politicians, government bureaucrats and environmentalists to tell them this.  They understand it quite well due to the disciplining effects of the competitive marketplace.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.