The method to calculate the economic returns on energy efficiency investments was initially developed in the 1970s by researchers seeking to compare energy supply investments with incremental investments in greater energy efficiency that could, in effect, eliminate the need for the supply investments in the first place (Lovins, 1977). Energy efficiency in the electricity sector was especially targeted. By focusing on specific energy services (lighting, space heating, refrigeration, etc.) researchers compared the capital costs of two technologies that provided the same service. The more efficient device usually had higher capital purchase costs. Using a discount rate, the incremental capital costs of the efficient device could be set in a ratio to the discounted stream of energy savings to calculate a life-cycle cost of conserved or saved energy (for example, $/kWh saved with a more efficient fridge).2
Researchers then extended this analysis from a single choice between two technologies providing the same energy service to an estimate of the quantity of energy conservation that is possible throughout the economy for that service if everyone opted for the more efficient device. For each energy service, an estimate is made of the average efficiency of existing equipment stocks. Then, it is assumed that all these stocks could be converted to higher-efficiency models, which results in an estimate of the total amount of energy that could be saved for that particular end-use and the life-cycle cost per unit of conserved energy. The next step is to graph these economy-wide quantities of conserved energy in ascending order of cost, thus providing a total estimate of the energy efficiency potential at each cost level—an “energy conservation cost curve” or “life-cycle cost of conserved energy curve” (Figure C.1).
The energy conservation cost curve provides information about the value of energy efficiency from different perspectives. First, efficiency investments for which the curve is below zero indicate instances where the efficient device has a lower life-cycle cost than the device it would replace. Second, all efficiency investments whose life cycle costs are below current electricity rates are profitable from the private perspective of the firm or household. Third, if rates do not reflect the full cost of delivering electricity from new supplies (many utilities charge prices reflecting average costs rather than the costs of new supply) then those efficiency investments whose life-cycle costs are less than the cost of new supply are also profitable, albeit this time from a social rather than a private perspective.
Life-cycle cost estimates of energy efficiency became extremely influential in the 1980s in the U.S. electric
These investments were commonly known as energy conservation investments. At the risk of irritating physicists, who note that all energy is conserved since it can be neither created nor destroyed, I follow the common practice of using interchangeably the terms energy efficiency and energy conservation.