3. Context

Any discussion of EE must take into account five important external forces:

• New technology changes what is possible in terms of reduced energy use.
• Different efficiency standards in other countries, relative to Canada, can both help and hinder EE in Canada.
• Energy prices affect EE-related decision-making in many different ways − sometimes critically, sometimes hardly at all and everything in-between.
• Public policy objectives also vary over time. Over the past decade, concerns about climate change and air quality have led governments to institute policies promoting EE. In the past few years, concerns about security and supply have been added.
• Cultural values underlie personal and business decision-making, as well as public opinion. Values change over time, informed by science and influenced by new technology.

These are discussed below.

3.1 TECHNICAL CHANGE

Technology evolves over time and influences, or even drives the evolving ways that factors of production − labour, capital and energy − are combined to produce useful goods and services. This evolution is called "technical change".

Over time, technical change in industrial economies has tended to be energy-saving. That is, the most productive combinations of capital, labour and energy have tended to use proportionally less energy over time. In most end-use applications, energy efficiency has improved with new technology. The effect is additional to structural shifts that have occurred, such as towards the service sector and away from resources.

New technologies undergo many stages of development. Among all of them, the transition to the first commercial stage is frequently the most difficult. Commercial interests do not want to be first to act; the government does not want to pick favourites. Commercialization barriers in EE are widespread, and there is large potential for emerging EE technologies, but progress can be made without additional commercialization efforts: there are many EE technologies that have some, albeit inadequate market penetration.

There is a great deal of literature on the drivers of technical change. Much of the energy-saving effect relates to technology, such as the flat-screen monitor, that was invented mostly to improve product quality, not reduce energy. However, energy is often a key driver where the cost of a service, but not its attributes are changed. An example would be T8 fluorescent lamps. There are many "mixed" cases as well - some product improvement with some energy savings.

Projections of technical change underlie projections of energy consumption in any future baseline. ³ The long term effects of technical change are so great that some argue for eliminating the "gap" approach to long term policy analysis -- a BAU baseline less projected policy-induced energy savings -- and simply consider designs for alternative futures based on different assumptions about technical change.⁴

Technical change is also an important issue in program design. New technologies such as LED lighting can have disruptive effects on the market, forcing a change in strategy. In designing programs, DSM managers must trade off the certainty of new, but commercially proven technologies against the risk that a better product will be available during the term of the program. The risk is that of locking in energy savings at a lower level than would have been available by waiting for the better technology to prove out commercially.

3.2 INTERNATIONAL STANDARDS AND PRACTICES

Most of the equipment used in Canada is manufactured in North America, or at least is manufactured for the North American market. The US market is roughly ten times the size of the Canadian market, so US efficiency standards have a correspondingly large effect on product design. Mexico is also under the NAFTA umbrella and has its own standards, although these are not generally as developed as those of the US and Canada. In addition, Provinces have the authority for standards for a variety of equipment; energy efficiency statutes have been implemented in British Columbia, Ontario, Quebec, New Brunswick and Nova Scotia.

Standards can both enable higher penetration of energy-efficient equipment and impede it. On the positive side, standards can result in irreversible market transformation (elimination of the production of lower efficiency equipment) However, a jurisdiction with no, or low efficiency standards is a natural repository for low-efficiency equipment that has been blocked from the market elsewhere.⁵,⁶

Standards have a market "push" effect whose effectiveness is increased when combined with labelling programs that tend to "pull" the market. The Energy Star program is an example of a highly successful energy efficiency labelling program based on voluntary efficiency standards that spans both Canada and the US. Energy Star is a target for government procurement policy, PST exemptions and utility DSM.

Harmonization of regulatory requirements within Canada and among Canada, the United States, and Mexico is a key thrust of regulators in Canada. It appears that harmonization tends to increase efficiency - a "highest common denominator" effect. The North American Energy Working Group Energy Efficiency Expert Group suggests that by collaborating the three countries can reduce costs of compliance with standards and mandatory labelling programs and accelerate the replacement of older, less efficient products.⁷

An important pre-requisite of harmonization is the use of common test protocols. Without common protocols, an equipment model that is deemed less efficient than another in one jurisdiction could be considered more efficient in another jurisdiction. Harmonization of test protocols also overcomes two important barriers: having to design equipment to qualify in two different ways; and the cost of separate tests and certifications.

3.3 ENERGY PRICES

Prices of fuels and electricity affect energy consumption levels in the short, medium and long term. All else equal, a price increase drives energy conservation of all kinds, including reduced production or amenity (see Sec. 2) and substitution of other sources of energy, as well as increased EE. High energy prices may also cause energy conservation by reducing investment in new production, or it may displace investment to other countries with lower energy prices.

Prices play a very important role in energy policy generally. In some sectors and end-uses, price dominates all other factors that go into decision-making (e.g., fuel choice in a lime kiln); however, in most sectors and end-uses, price is one of several important factors and often one of the least important (e.g., small appliances). The policy implication is that getting price signals "right" is necessary but not sufficient.⁸

In principle, the "right" price is one that reflects the marginal cost of supply, including (un-priced, negative) externalities. To the extent that externalities are not reflected in prices, these can be increased through taxation in order to achieve an economic optimum. In practice, Canada has predominantly stayed away from environmental taxes on energy; however externality prices are often applied to the costs or bid prices of new power plants for ranking or screening purposes in utility resource acquisition processes.

In Canada, all provinces except Alberta price electricity below marginal cost, through regulated rates and/or heritage contracts that apply to low-cost hydro sites. Natural gas, on the other hand, is traded in competitive markets. Its price tends to marginal cost. There is therefore an economic bias towards electricity in residential and commercial space and water heating where the two fuels compete for market share. The bias acts against energy efficiency where the electricity supply source is a fossil fuel, due to high conversion losses. In low-rise commercial and multi-family residential markets, the problem is compounded by developers' preference for the lowest-capital-cost heating system, which is electric baseboard.

Electricity is also special among energy forms in that, in nearly every power grid, different sources of generation, with widely varying costs, are brought in and out of service to match a load that varies widely by season and within a day. Marginal electricity transmission and distribution costs also vary by season and time of day, since those costs are related to peak demand. Therefore it is often valuable to reduce peak demand to avoid operating higher-cost peaking generation and to defer transmission and distribution investment. This may be accomplished by, for example, shifting peak load to off-peak through the use of seasonal and time-of-day rates.

High energy prices in other countries can also lead to greater energy efficiency in Canada by bringing new technologies to market in those countries, which can then be sold on energy efficiency or other merits in Canada, and/or through the "highest common denominator" effect described above with respect to harmonization of standards. For example, the new generation direct-injection diesel engine was developed in Europe and is now being brought to North America, for example by Volkswagen, where is has achieved a substantial market share.⁹ It might be argued that this technology might not have been invented if the EU had Canadian fuel prices.

3.4 PUBLIC POLICY

Over the past 30-40 years, key drivers for Canadian energy policy have included keeping consumer prices low or competitive, securing tax revenue, avoiding trade imbalances, and reducing environmental impact. Global circumstances have included rapid changes in the price of crude oil and natural gas, varying estimates of remaining fossil fuel reserves, and concerns about air and water pollution, national security and climate change.

EE lies within the convergence of many of these priorities, including competitiveness, supply security and all environmental concerns, all of which are long term problems. Government initiatives across Canada have tended vary up and down in amount, variety and intensity, rather than treat the task of making the economy more energy efficient as continuous. For example, in contrast to Europe, Canada has so far shied away from broad policy instruments such as carbon taxes and comprehensive emissions trading schemes. Instead, the emphasis has been on a variety of targeted measures involving subsidies, information and suasion, along with minimum standards (see Section 5). These have undoubtedly had a role in improving energy efficiency trends (see Section 4); however, the attribution of results and the cost-effectiveness of these measures are subjects of some debate.

Natural gas and electricity utilities supply approximately half of Canada's secondary energy.¹⁰ The selling prices and investments of these utilities are governed by their regulators. There are a variety of price structures that reward energy-efficient behaviour and many cost recovery rules that provide shareholder value for DSM. These mechanisms have been explored by regulators across the country, but not systematically adopted -- different rules applying to natural gas and electricity, for example. In order to bring about better governance, the energy industry has urged governments to treat utility DSM as a matter of policy and guide regulators accordingly.¹¹

3.5 CULTURAL CHANGE

The values of individuals, both as householders and to a large extent in business, are the basis for economic decisions, including energy-consuming behaviour. In a few generations, environmental values have tended towards higher expectations for energy efficiency, and one may expect the trend to continue. One of the key drivers is scientific knowledge. Science continues to lead to a better understanding of nature and to new technologies that have less environmental impact.

Education in schools, for business and for the public at large provides a background condition for change. It helps place into context the significance of any policy to save energy. Canadian efforts in this area need to extend across the full spectrum of individuals with widely-varying assumptions about the environment.

The emerging science of climate change could be a turning point. If the public understands climate change, it will be more likely to approve of governments that take action against it, including energy efficiency measures. Results would not be immediate but would be lasting. Similar cultural shifts have occurred throughout history. In the 19th century, for example, the discovery of bacteria led the government in France to install the first municipal sanitation systems. Considered costly and unnecessary at first, these systems became basic infrastructure for every residence in Western Europe within a century. As public understanding of climate change and its implications increases, the knowledge may become similarly embedded into daily life, and the use of a climate-unfriendly technology considered as acceptable as improper waste disposal.