ap-4-10.dvi


Acta Polytechnica Vol. 50 No. 4/2010

Barriers to Energy Efficiency – Focus on Transaction Costs

M. Valentová

Abstract

This paper assesses the main barriers that prevent economic energy efficiency potential from being realized. The main
barriers discussed here include energy prices (and prices of technology), limited access to capital, lack of information,
incorrect risk assessment (i.e. setting a discount rate), the principal-agent problem and transaction costs. Transaction costs
are analyzed in greater detail, as they are one way or another related to all of the barriers mentioned here. Based on the
analysis, there is a discussion of implications for effective policy making. These are specially needed for transaction costs,
where the availability of empirical data is very limited.

Keywords: barriers to energy efficiency, transaction costs, energy efficiency gap, energy efficiency instruments.

1 Introduction
Energy demand has become a major political topic,
both on a national level and on an international level.
With increasing energy prices and steady depletion of
classical fossil fuels, energy issues are likely to become
even more important in future.
Thebenefits of increased energyefficiency (EE)are

widely known. Apart from lower energy demand and
lower energy costs as such, it can provide a better
working environment, environmental benefits, or from
the macroeconomic point of view, job creation and
lower import dependence. Political targets have been
set atEU level and at international level (the so called
20-20-20 target for 2020, or the Kyoto targets). En-
ergy efficiency as a strategic goal is clearly mentioned
in the State energy concept of the Czech Republic.
The economic potential for energy savings is not

negligible; it is estimated to be around 20 to 30 %.
However, this potential remains to a large extent un-
exploited. This is because of the barriers to energy
efficiency.
The paper analyzes the main barriers to energy ef-

ficiency, specifically focusingontransactioncosts1. On
the basis of this analysis, the paper presents possible
implications for effective policies to overcome them.

2 Barriers to efficiency

The main barriers to energy efficiency are2 energy
prices (and technology prices), limited access to capi-
tal, lack of information, incorrect risk assessment (i.e.
setting a discount rate), the principal-agent problem
and transaction costs. It is important to keep in mind
though that the analyzed barriers never stand alone.
On the contrary, the barriers are usually all intercon-
nected and they may even reinforce each other [1],

which renders potential policymaking evenmore com-
plex.

2.1 Energy prices and prices of the
technology

Energy prices affect the implementation of energy ef-
ficiency measures in various ways. One factor is the
actual share of energy costs in total costs, while an-
other factor is the development of energy prices.
Energy costs very often form (except in energy

intensive industries) only a small proportion of the
overall expenditures. Also, when making a decision
about an investment, energy consumption is only one
of many criteria for decision [2]. This may negatively
impact the implementation of otherwise cost-effective
efficiency measures.
The development of energy prices is another key

determinant of adoption or non-adoption of efficiency
measures. Basically, increasing energy prices will lead
to the use of more efficient technologies [3].
By the same logic, one could induce that, con-

versely, low energy prices will lead to the use of ineffi-
cient technologies. This is however true only to certain
extent. Birol and Keppler [3] call this a ratchet effect,
meaning that some level of efficient technologies will
remain in place even if energy prices fall (e.g. house-
holds will not tear down new insulation just because
energy prices decreased).
However, at the same time, there will always be

some level of rebound effect, which is the increase in
demand for energy services (and eventually in energy)
due to the de facto lower price of energy (because of
efficiency measures) measured in terms of energy ser-
vices or efficiencyunits. The level of the reboundeffect
cannot be conceptually determined (only empirically),

1The special interest in transaction costs is because they are in one way or another related to all of the other barriers (either
stemming from the other barriers or including them).
2Not in order of relevance.

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Acta Polytechnica Vol. 50 No. 4/2010

but it will always be a fraction between zero and one.
When the rebound effect is one, it means that all the
costs saved through efficiency measures will be trans-
lated into higher demand for energy services. Current
empirical studies showthat the level of the rebound ef-
fect varies inmost cases between 10%and30% [4, 5].

2.2 Limited access to capital

Another barrier that is usually mentioned in relation
to energy efficiency measures is the often high upfront
costs of energy efficiency investments3. The problem
itself concerns potentially limited access to capital.
There are two groups of actors that are particularly
influenced by this barrier: small and medium size en-
terprises (SMEs) and lower income households.
Paradoxically, it is the lattergroupthat couldmake

the highest efficiency gains [6]. At the same time
though, it is low income households that have very
difficult access to capital and to credit (and are also
more likely to be unable to repay the loan).
Another issue with households (irrespective of in-

come levels) is that energy efficiency investments have
to competewithmanyother investments that a house-
hold has to make [7]. Households in general tend to
be averse toward risk and towards credit.
Like low incomehouseholds, small andmediumsize

enterprises tend to have worse access to credit (with
less favorable conditions than bigger companies).
An important sector for energyefficiencymeasures,

the public sector, is in general a trustworthy client for
the banks, because the risk of non-repayment is rel-
atively low. Therefore, public sector actors will not
usually have problems with access to capital per se.
The constraint is different here – very often the level
of indebtedness will be limited by law [7], therefore
even though the public authorities could obtain credit
for energy efficiency investment, they will not be al-
lowed to do so.

2.3 Lack of information

One of the major barriers to energy efficiency is the
lack of information of potential investors (both house-
holds and organizations). Due to lack of information,
the costs of energy savingmeasures are likely to exceed
the benefits for individual users [8]4.
As in previous section, lack of information

tends to be more relevant to households and

SMEs5. E.g. households will usually only com-
pare the investment costs, but not the operation
costs [1].
Some authors [1, 9] mention the problem of lack of

billing information. Households and also most small
and medium enterprises very often get information on
energy consumption once a year, not split down into
different end-uses. Bills are frequently paid through
monthly (fixed) payments with one clearance at the
end of the year. It is therefore almost impossible to
baseone’sdecisionsonenergyconsumption– thus spot
the biggest energy users6.
The problem is not only lack of information,

but also asymmetry in information. Sanstad and
Howarth [6] call this a special case of imperfect in-
formation when “two parties have access to different
levels of information”. Typically this would be a case
of producers versus consumers. Asymmetry in infor-
mation levels is, according to the authors, a rule rather
than an exception.
Schleich and Gruber [7] offer audits as a solution

to the information barrier. Nonetheless, they add in
the same breath that those who would make use of it
are usually the ones who will also lack the resources
for such an audit.
Finally, even if we suppose that the actors do re-

ceive all the needed information, anotherbarrier seems
tobe a lackof knowledgeor capacity to evaluate it cor-
rectly and draw correct conclusions. This is the prob-
lem of households, and also of SMEs, which typically
do not have a specialized energy expert.

2.4 Incorrect risk assessment

Generally, using an excessively high discount rate7 in
assessing the economic effectiveness of energy saving
measures is thought to be another major source of
the so-called “efficiency gap” [11, 12]. Many empir-
ical studies have shown that customers (households
and firms) discount the energy savings by tens %,
thus significantly lowering their present value (see
e.g. [11, 6, 13]). Howarth and Anderson [8] estimate
that the discount rates start from 20–25 % but can
reach up to 800 %, much more than the returns on
other investments would be. According to Vine et
al. [14], the level of the discount rate can reach up
to 50 %. There are various reasons for this, but all of
them together very often reflect the barriers discussed
so far.

3However, this is by no means always true, as shown e.g. in [2] where a study on refrigerators and freezers is cited in which
little correlation was found between upfront costs and energy performance. In addition, there is strong role of behavior which can be
important but, of course, has a zero cost.
4This is very much related to the issue of transaction costs, which is elaborated in detail below.
5Though Reddy [2] notes that the problem of insufficient information will appear also at governmental level, related to policy

making.
6A solution to this seems to lie in a transition to smart grids and smart meters. Apart from advantages for energy suppliers, it

is believed that smart meters encourage energy savings through real time provision of information on energy consumption, which can
also be further split down to end-uses. More on the discussion on smart meters e.g. in [10].
7It is important to keep in mind that here we are discussing the discount rate used by investors in the meaning of investors’

opportunity cost, not really the interest rate that the bank will give to the investor. This is discussed in the section on access to capital.

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Acta Polytechnica Vol. 50 No. 4/2010

One of the main determinants influencing the risk
of achieving future energy savings is seen to be the
energy price. This is why e.g. Thompson [11] pro-
poses using two different discounts, one for the old
equipment and the other for the new, efficient equip-
ment, because if the energy source is changedwith the
efficiency measure, then it may also be necessary to
consider a different risk in energy prices for the two
(old and new) installations. Another example would
be the transition to a different tariff and also with the
two-part price of energy changing the type of equip-
ment can lead to a change in the fixed part of the
price.
Apart from the future energy price, another deter-

minant is energy consumption. If the energy efficiency
measure is rather common or not too complex (e.g.
lighting), future energy consumption can be well es-
timated from the technical parameters of the equip-
ment. Withmore complex installations, future energy
consumption can also represent a risk or an uncer-
tainty, and thus may provide a reason for a higher
discount rate. This is also related to the fact that
energy-efficient equipment is often new to the market
and thus investors will attach more risk to it [8]8.
In general, both above analyzed risks or uncertain-

ties lead to the use of a higher discount rate. Stochas-
tic energy prices will, as Schleich andGruber [7] note,
raise the investor’s required rate of investment (dis-
count). Thompson [11] however argues that with en-
ergy savingmeasures, the correctmethod would be to
actually use a lower discount rate. The reason is that
the main source of uncertainty towards the future is
the energy price (and energy consumption), whereas
the energy efficiencymeasurewill then lead to a “lower
variation in investor wealth” [11].
Other explanation would be through the Capital

Assets Pricing Model (CAPM). Using more efficient
equipment and thus achieving energy savingswill lead
to a decrease in the systemic risk [15]. The reason is
that lower incomes of the market will usually corre-
late with higher energy prices, which on the contrary
advantages energy saving measures. In other words,
energy saving measures can serve as a “safety fuse”
against price volatility.

2.5 The principal/agent problem

The “principle-agent” problem is basically a barrier
of split incentives (or of the separation of responsi-
bilities for energy expenditures and conservation ac-
tions [1]). The owners of the facility (of the rental
unit) do have the incentive to invest in the efficiency
measure. However, they will have no control over the
use of the efficient equipment and thus no control over
the efficiency gains. Furthermore, the owner does not

receive the benefits of the measure, because it is the
user who pays lower energy bills.
Conversely, the user receives all the benefits from

the efficiency measure, but has no incentive to invest,
as there is high uncertainty as to length of the con-
tract. It is likely that the user will not be able to
benefit fully from the cost savings (will simply have to
move out before all the cost savings can be realized),
which makes the investment economically disadvanta-
geous.
Schleich andGruber [7] however point out that the

barrier of split incentives ismore significant for house-
holds than for private companies and for public sector,
as theseusuallyhave longer rental contracts than is the
case for households.

2.6 Transaction costs in energy
efficiency

The reason why transaction costs are depicted sepa-
rately is that they tend to include or stem fromall the
above barriers.
The level of transaction costs is not negligible, and

is likely to prevent energy efficiencymeasures frombe-
ing implemented. However, the exact size of transac-
tion costs remains still rather unclear, partly because
there is no common method for evaluating them and
including them in decision making.
Most authors state that the transaction costs in

energy efficiency are real and are on a significant level.
They may hamper the implementation of energy ef-
ficiency projects, or may even outweigh the gains of
energy efficiency improvements and thus lead to their
non-realization, or to a preference for inefficient or
standard technologies.
A suitable definition of transaction costs in en-

ergy efficiency seems to be providedbyMatthews [16]:
“. . .the costs of arranging a contract ex ante andmon-
itoring and enforcing it ex post, as opposed to produc-
tion costs.” This can be applied both to investments
in efficiency measures, and to policy instruments (in
this case, the contract can be subsituted for a policy
instrument).
The transaction costs are borne either by the

project developers, by the programmemanagers or by
the beneficiaries of EE programmes. The transaction
costs therefore pertain to the costs related to invest-
ment, operation andmaintenance, verification, and/or
administrative costs. Lack of information and trans-
action costs are sometimes interchanged [7].
Energy efficiency transaction costs can be divided

into four main stages in which transaction costs can
occur: the planning phase, the implementation phase,
monitoring phase and the verification phase (Ta-
ble 1).

8In addition, future consumption is not dependent only on technical specifications, but to large extent also on the consumer’s
behavior and usage. Similarly, future energy consumption will depend on the reference scenario, i.e. the future energy consumption of
existing equipment.

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Table 1: Sources of transaction costs. Source [17]

Project phase Nature of transaction costs

Planning • Search for information
• Search for costumers
• Legal fees
• Development of proposal
(including development of
baseline, M&V
methodologies, etc.)

• Project identification and
evaluation

Implementation • Megotiation of contracts
• Procurement
• Project validation

Monitoring and
verification

• Mechanisms to monitor,
quantify and verify savings
and related GHG
emissions reductions
(including installation of
required equipment)

Theplanningphasemostly consists of searching for
information, project identification, evaluationandpro-
posal. In the implementation phase, the negotiation
process is important. The last phase basically means
monitoring and verifying the energy savings and/or
GHG emissions reductions. Björkqvist and Wene [18]
also emphasize the importance of including the poten-
tial active rejection in the calculation. Active rejection
means that the actors actually considered the option
and actively rejected it. Those actors also incur trans-
action costs.
General knowledge about the negative impact of

transaction has been supported by a number of stud-
ies (eg. in [19, 20, 2, 6]). However, empirical data
is still lacking. The reasons for this include the fact
that the actors are often reluctant to disclose informa-
tion. Also, there is a lackof ex-post evaluations,which
serve as an important source for estimates of transac-

tion costs. In addition, transaction costs are relatively
case specific [21].
Some of the small number of studies that evaluate

the level of transaction costs of different programmes
are presented here. It is important to keep in mind
though, thatbecausedifferentmethods andsectors are
being analyzed, the studies are not directly compara-
ble.
Björkqvist and Wene [18] udnertook a study of

transaction costs in families that participated in
a demand side management (DSM) programme in
Göteborg. They analyzed 51 families who decided to
invest in upgrading their heating systems. The trans-
action costs were not measured in monetary terms,
but in hours spent by the families. The authors found
that on an average the families spent 18 hours on the
decision making process. They also assessed the time
spent by non-investors (active rejection), which was
only 6 hours. Importantly, a lot of information was
provided by the energy supplier, whowas the initiator
of theDSMprogramme(e.g. the potential suppliers of
energy efficiency equipment, information on options,
etc). In this way, some time for information search-
ing was definitely saved. The authors transposed the
hours into monetary terms, using labor costs as a
proxy. The transaction costs then represented 28 %
of the average investment if gross income was taken,
or 13 % if net income was used. The authors ad-
mit that the numbersmaybeunderestimatedbecause,
firstly, the households may not have remembered ev-
eryminute of the time they spent on the decision and,
secondly, because part of the decision stage was not
included as it was provided by the distribution com-
pany.
Michaelowa and Jotzo [22] evaluated the transac-

tion costs of several GHG emissions schemes, namely
the AIJ in Sweden (the predecessor of the Joint Im-
plementation Mechanism) and the CDM. The main
sources of transaction costs under these schemes are
the search costs, baseline development, approval costs
(to have the CO2 emission reduction approved by
the approving authority), validation, registration and
monitoring. The main findings are that there is a sig-
nificant fixed part in the transaction cost in the GHG

Table 2: Empirical estimates of transaction costs. Compiled by author

Study Level of TCs Field Note

Björkqvist et al. [18] 28 % (13 %) Households If gross (net) income referred to

Michaelowa and Jotzo [22] 20.5 % CDM

Mundaca [21] 10–20 % Audit scheme % of the audit costs

Mundaca [21] 8–12 % Lighting Energy saving target programme

Mundaca [21] 24–36 % Insulation Energy saving target programme

Sathaye [23] 9–19 % Not specified

Easton Consultants [24] 20–40 % ESCOs

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schemes. This means that there is a certain threshold
of CO2 savings belowwhich the transaction costs out-
weigh the gains of the project. One study finds this
threshold at a level of 50000 t CO2/yr for a 20-year
project; another value is that the transaction costs
should not be more than 25 % of the proceeds from
permit sales in order to make a project viable [22].
Overall, the level of transaction costs was estimated
at ca 20.5 % of total project costs.
Mundaca [21] analyzed two energy efficiency pro-

grammes: free of charge energy audits in Den-
mark, and the energy efficiency commitment in Great
Britain. The results of the former cannot really be
considered as statistically relevant, as theywere based
only on 5 replies. Nevertheless, a qualitative analy-
sis was made. The idea is that the energy providers
have to make some number of energy audits of their
customers. The rationale behind the programme is
that the market agents have asymmetric information
and thus they will not materialize all the energy im-
provements. The transaction costs are related mainly
to finding clients for the audit as such, carrying out
the audit, and also to follow up measures, such as the
search for partners if the client decides to implement
some measures. Another source of TCs is the accredi-
tation process, as the energy audit has to be reported
as part of the programme. The transaction costs were
estimated as10–20% of the direct costs of the energy
audit (not the costs of potential resulting investment).
The British programme sets an energy saving tar-

get to be fulfilled by energy supply companies. The
companies can trade the savings among themselves.
The author [21] interviewed suppliers and asked them
to identify and quantify the transaction costs related
to the programme. The identified transaction costs
were mainly searches for information (searches for
households that could save), persuading customers or
approval of measures by the authority. In the imple-
mentation phase the main source of TC was in ne-
gotiating agreements or contracts with a third party
and in monitoring and verification. Random quality
checks were the main source. All together, the level
of TC differed according to the measure undertaken.
In lighting, the transaction costs ranged from 8 % to
12 %, and with insulation measures the range was
24–36 % of the investment costs.
Sathaye [23] analysed various emission reduction

projects (not only energy efficiency) in North and
SouthAmericaandAsia, andestimated that the trans-
action costs ranged from9 % to 19% of total project
costs. The transaction costs arisemainly from the ne-
gotiationprocess amongparties, feasibility studies (in-
cludingbaselines andadditionality), negotiation,mon-
itoringandevaluationandalsoapproval fromtheman-
aging authority. Sathayealsobelieves that the key fac-
tor determining the level of transaction costs (at least
in GHG projects) is project size.

A few studies have focused on the transaction costs
borne byEnergyServiceCompanies (ESCOs). Easton
Consultants [24] estimated that the transaction costs
of energy efficiciency projects carried out by ESCOs
represented from 20 % to 40 % of the total value of
the project (Figure 1).

Fig. 1: Costs associated with the ESCO project.
Source [24]

3 Policy implications

Various policy instruments are needed to help remov-
ing the different barriers to energy efficiency. The in-
struments range from providing a regulatory frame-
work, which should allow the market to develop,
through hard regulatory instruments (minimum ef-
ficiency standards, building codes), financial incen-
tives (subsidies, loans) to soft (information)measures.
There is no silver bullet, but a set of instruments has
to be put in place.
From practice, the barrier of lack of information

has been dealt with using various policy instruments.
On the EU level, depending on the sector or the end-
use, hard regulations or labelling have been adopted.
The former (in the form of minimum efficiency stan-
dards) passes the difficulty and costs that the con-
sumers incur while searching for information on the
producers. If minimum efficiency standards (MEPS)
are adopted, consumers are sure to buy efficient prod-
ucts insteadofhaving to look for them. This is the case
for example for standby regulation, where the search
for information at each individual appliance would be
too costly.
The labelling approach is an example of a suc-

cessful soft, information measure, which has helped in
achievingenergyefficiencyat lowcosts. Ithasbeen the
most effective in the caseof appliances that representa
significnatportionofahouseholdbudget (e.g. refriger-
ators or washing machines). Conversely, the labelling
hasnotworked for lighting, thoughthe savingsandthe
related economic effectiveness are unquestionnable.
In addition, in one of the above-mentioned case

studies, the lack of information (and thus high trans-
action costs in the initial planning phase) was solved

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by passing the burden to a distribution company. The
informationwas gathered and pooled at a single place
and then distributed to the households, which reduced
the transaction costs for the families and increased the
effectiveness of the actions [18].
In some cases, it is sufficient to set up the right

regulatory framework. That is the case for e.g. the
principal/agentdilemma. SchleichandGruber [7] sug-
gest that this barrier couldbe avoided if “the investing
party were able to credibly transmit the information
about the benefits (i.e., future cost savings) arising
from the investment, and to enter into a contractwith
those benefiting from the investment”. One can imag-
ine a policy instrument that will help in establishing
the environment for such information transfer (by e.g.
providing standard documents for both parties).
As to risk management, a solution offered e.g. by

Mills [25] is to use insurance in energy saving projects.
Another way is to use real options, well developed in
other sectors, but not yet in energy saving projects.
Someauthors also imply that incorrect risk assessment
is only a result of the other barriers. Therefore, re-
moving this barrierwill depend on removing the other
barriers.

3.1 Transaction cost policy
implications

The stakeholders are usually aware of the existence of
transaction costs in energy efficiency projects andpro-
grammes, but knowneither their structure nor the ex-
act levels. Therefore, a common method is needed for
including them indecisionmaking, both at the level of
the investor and also at the level of the policy makers.
This will also allow a direct comparison, which is not
possible at the moment.
From the case studies mentioned above, some pre-

liminary ideas for the development of such a method
are drawn. Firstly, there is an indirect relation be-
tween the size of the project and the transaction costs,
which thus justifies streamlining. In other words,
bundling and standardizing projects could reduce the
fixed part of the transaction costs, which tends to be
an inhibitor of efficiency measures in smaller projects
(SMEs, households, and others). Economies of scale
play an important role in programmes,where the fixed
part of the transaction costs is significant [22].
The need to assess the transaction costs with re-

spect to time is also stressed, as there may be a
learning curve in (at least some forms of) transaction
costs, depending on the general context of the pro-
gramme [22].
It seems that the transaction costs tend to vary

from sector to sector. In the household sector, the

transaction costs are higher than in the commercial
sector and the industry. The reason probably relates
to the importance of project size. The commercial
and industrial sector will alsomore likely benefit from
economies of scale and from fewer market imperfec-
tions.
Providing a framework for developing the energy

service9 market may be a useful supplementary tool.
The ESCO, from the very nature of the business, has
an interest in including all the costs in their calcula-
tions [19], thus alsoall the transactionandmore gener-
ally hidden costs. Energy efficiency services can solve
the problem of limited access to capital, as one of the
potential services is tooffer repaymentof the loan from
guaranteed savings, thus removing the financial risk to
the client.

Acknowledgement

Research described in the paper was supervised by
doc. Ing. JaroslavKnápek,CSc., FEECTU inPrague.

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About the author

Michaela VALENTOVÁ, MSc. was born in
Prague. She graduated from Central European Uni-
versity in Budapest and is currently a PhD student at
the Faculty of Electrical Engineering, Czech Techni-
cal University in Prague. Her major area of research
is barriers to energy efficiency and evaluation of en-
ergy efficiency policy instruments and their economic
effectiveness.

Michaela Valentová
E-mail: valenmi7@fel.cvut.cz
Dept. of Economics, Management and Humanities
Faculty of Electrical Engineering
Czech Technical University
Technická 2, 166 27 Praha, Czech Republic

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