Productivity of growing global energy demand: A microeconomic perspective
McKinsey Global Institute
To date, the global debate about energy has focused too narrowly on curbing demand. We argue that, rather than seeking to reduce end-user demand, and thereby the choice, comfort, convenience, and economic welfare desired by consumers, the best way to meet the challenge of growing global energy demand is to focus on energy productivity—how to use energy more productively—which reconciles both demand abatement and energy-efficiency.
According to McKinsey Global Institute (MGI) research, global energy demand will grow more quickly over the next 15 years than it has in the last 15. Demand will grow at a rate of 2.2 per cent per year in our base-case scenario, boosted by developing countries and consumer-driven segments of developed economies.
This acceleration in demand growth—particularly problematic amidst escalating world-wide concerns about the growing costs of energy, global dependence on volatile oil-producing regions, and harmful global climate change—will take place despite global energy productivity continuing to improve by 1.0 percent a year.
MGI’s in-depth case studies indicate that there are substantial and economically viable opportunities to boost energy productivity that have not been captured—an estimated 150 QBTUs (1), which could represent a 15 to 25 percent cut in the end-use energy demand by 2020. This would translate into a deceleration of global energy-demand growth to less than 1 percent a year, compared with the 2.2 percent anticipated in our base-case scenario—without impacting economic growth prospects or consumer well-being.
Unfortunately, market-distorting subsidies, information gaps, agency issues, and other market inefficiencies, are currently impeding improvements in energy productivity. Overall energy demand is not highly responsive, even under high energy-price scenarios. Consumers lack the information and capital they need to become more energy-productive, and tend to make comfort, safety, and convenience higher priorities than price. The small and fragmented nature of energy costs tends to deter businesses from seeking higher energy productivity.
In addition, a range of policies dampen price signals and reduce incentives for end-users to adopt viable energy-productive improvements. These include, for instance, fuel subsidies in many oil-exporting countries; lack of metering in Russian residential gas usage; and widespread energy subsidies to state-owned enterprise.
Shifting global energy demand from its current rapid growth trajectory will require the removal of existing policy distortions; improving transparency in the pricing and usage of energy; and the selective deployment of demand-side energy policies, such as standards. Policies will need to be targeted at and tailored to the various large end-user segments to encourage higher energy productivity; they will only be effective if they are predicated on a real understanding of the microeconomic dynamics of demand within specific end-use segments.
This report, “Productivity of Growing Energy Demand: A Microeconomic Perspective”, is the first of a two-stage series by MGI to introduce microeconomic analysis of end-use segments to the global-energy debate. Building on detailed global case-sector studies, it provides a useful context for discussing global energy demand and its complex dynamics. A further report, which we will publish in early 2007, will elaborate on our findings—particularly those at the sectoral
and fuel mix levels—and on their broader implications for the global economy.
(1) In view of a multitude of energy-demand definitions, we use Quadrillion British Thermal Units—QBTUs—as the base unit for all energy-demand segments in this document.
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What is Energy Productivity?
Like labor or capital productivity, energy productivity measures the output and quality of goods and services generated with a given set of inputs. MGI measures it as the ratio of value added to energy inputs, which is the inverse of energy intensity of GDP, measured as a ratio of energy inputs to GDP.
Energy productivity is a useful tool with which to analyze the public-policy aims of demand abatement and energy-efficiency because it encapsulates both. By looking merely in terms of shrinking demand, there is a danger of denying opportunities to consumers—particularly those in developing economies who are an increasingly dominant force in global energy-demand growth. Rather than seeking to reduce end-user demand—and thus the level of comfort, convenience, and economic welfare demanded by consumers—there should be a focus on using the benefits of energy most productively.
The concept of energy productivity provides an overarching framework for understanding the evolving relationship between energy demand and economic growth. Energy-productivity improvements can come either from reducing the energy inputs required to produce the same level of energy services, or from increasing the quantity or quality of economic output. Within each of these, there are multiple components that can change over time.
The same level of energy services can be produced with fewer inputs if use is less intensive (e.g., smaller appliances); if technical efficiency improves (e.g., higher-mileage-car engines); or if fuel-mix shifts, say, from biomass to more efficient electricity. In turn, output can grow more quickly than demand for energy services because of sectoral shifts—say, from energy-intensive industrial sectors to services—or from an increasing share of growth taken by non-energy-intensive, high value-added activities within a sector (e.g., increasing share of investment banking versus retail banking).
By being explicit about the relative importance of each, energy productivity acts as a useful tool to enable us better to understand the nature and source of change and more effectively seek to improve growth and energy outcomes.