The impact of carbon pricing on energy efficiency program potential

The impact of carbon pricing on energy efficiency program potential
By Ali Bozorgi, Ph.D. and Pratik Dhoot
Nov 30, 2023

The International Energy Agency calls energy efficiency the “first fuel” as it is abundant and cheap to exploit. Of course, the cleanest, most climate friendly and economical fuel is one that's not needed in the first place—and that’s where energy efficiency holds great promise.

It is widely argued that energy efficiency is one of most cost-effective strategies in reducing carbon emission and combating climate change. It not only lowers energy related carbon emissions and offers a range of economic, environmental, and health benefits, but also helps with the energy transition to renewable and low-carbon energy sources.

Governments around the world have recognized the importance of energy efficiency as they continue to implement policies to address climate change. On the other hand, many climate change economists believe that “carbon pricing” is the most effective policy in reducing carbon emission and combating climate change.

Over the last few decades, ICF has helped governments and utilities around the world with assessing, designing, and implementing programs to promote energy efficiency and decarbonization. Our team has also conducted distributed energy resources potential studies for several utilities in North America that include energy efficiency, demand response, electrification, combined heat and power, solar, and storage.

This article demonstrates how the energy efficiency potential would be impacted if the United States had a carbon tax mechanism in place. We quantified the impact of carbon tax on energy efficiency programs through modeling different scenarios on actual utility energy efficiency portfolios. The insights gained from this analysis can help inform future policies and initiatives aimed at reducing carbon emissions and promoting energy efficiency. This article does not focus on the politics associated with carbon pricing, such as who should be responsible for paying it.

If the federal government and states mandate a carbon price on utilities, it would allow energy efficiency programs to include measures that may not be cost effective today but hold promise for the future.

What is carbon pricing?

Carbon pricing refers to imposing a price on carbon emissions to mitigate the negative externalities of greenhouse gas emissions by discouraging the use of fossil fuels, and/or encouraging shifting to less-polluting fuels. There are two common structures:

  • Carbon tax: A fixed fee that firms must pay for every ton of carbon they emit. In this system, the price of carbon is known. More straightforward to administer because they can be piggybacked on existing fuel taxes.
  • Carbon cap and trade: This system caps carbon emissions at a specified level for a group of companies or industrial plants and then issues emissions allowances according to this level. Firms must obtain an allowance—either directly from the government or through trading with one another—for every ton of carbon they wish to emit. In this system, the price on carbon fluctuates according to market demand for emissions, but the total amount of emissions is known.

Since 2019, every jurisdiction in Canada has had a price in the form of a carbon tax on carbon pollution. Any province can design its own pricing system tailored to local needs or can choose the federal pricing system. The federal government sets minimum national stringency standards (the federal “benchmark”) that all systems must meet to ensure they are comparable and effective in reducing greenhouse gas emissions. If a province or territory decides not to price pollution or proposes a system that does not meet these standards, the federal system is put in place.

This ensures consistency and fairness for all Canadians. The federal government published strengthened standards in August 2021 for the 2023 to 2030 period. The minimum national carbon price starts from $65 CAD ($47 USD) in 2023 and goes up to $170 CAC ($124 USD) in 2030. As shown in this map, currently only three provinces in Canada apply the minimum price.

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Carbon pollution pricing systems across Canada

Carbon tax map

In the U.S., 14 states have a regional cap-and-trade mechanism in place including California, Washington and 12 Northeast states. Together they’ve established a regional cap on CO2 emissions, referred to as the Regional Greenhouse Gas Initiative, which sets a limit on emissions from regulated power plants within these states because the price of carbon is determined based on market demand relative to the cap.

Due to various factors, when comparing the carbon price in the U.S. with that of Canada, the price of carbon from the cap-and-trade system in the U.S. is lower than the price of carbon from the minimum federal carbon tax in Canada. This has been a major critique of existing carbon pricing systems in the U.S.; their price is too low to effectively reduce emissions.

How does carbon price impact energy efficiency programs?

Both carbon taxes and cap-and-trade programs affect energy efficiency in two ways. Firstly, they can raise energy prices, which results in increasing the value of energy efficiency from both cost-effectiveness and customer adoption perspectives. They would improve the cost-effectiveness of energy efficiency measures as well as increase energy retail rates, which would improve customer payback and adoption of energy efficiency measures.

Secondly, in most jurisdictions in the U.S., some of the funds collected are invested in energy efficiency as well as programs that would benefit low-income population such as bill assistance to low-income households and local businesses. That could also result in an increase in customer adoption of energy efficiency measures as well as advancing equity through revenue redistribution.

Quantification of impact of carbon pricing on energy efficiency potential

There are three levels of energy efficiency potential.

  • Technical potential is the total energy that could be saved by efficiency measures, without consideration of cost or willingness of users to adopt the measures.
  • Economic potential is the subset of technical potential that is considered cost-effective compared to a supply-side energy resource alternative (i.e., energy generation).
  • Achievable potential, a subset of economic potential, is the energy savings that could be realistically achieved given real-world constraints, including market and programmatic barriers.

To better understand how a carbon price benefits efficiency program potential, ICF’s Flexible Load Management team selected three of its recent energy efficiency potential forecast studies for utilities and quantified the impact of carbon prices on the energy efficiency economic and achievable potential. To do so, we developed separate forecast scenarios with and without carbon price for the three selected utilities: a gas utility in Canada and two U.S. utilities, one dual fuel provider in the Midwest and an electricity provider in the Southeast.

In the case of the Canadian utility, we observed that exclusion of carbon tax is likely to reduce the economic potential by almost 50%. The economic potential decreases from 83% to 55% of technical potential if carbon taxes are excluded. 
Achievable GJ potential comparison

The achievable potential decreased on an average of 20% annually in the scenario when carbon taxes were excluded for this Canadian gas utility.

We developed “what if” scenarios for the two U.S. utilities to assess the potential impacts of a carbon tax on their energy efficiency potentials. For this analysis, we used the Nordhaus estimate of a carbon tax of $44 per ton in 2025 rising to $52 a ton in 2030.

When a carbon tax was considered at the Midwest utility, the economic potential of energy efficiency rose by 17%, garnering 91% of technical potential, compared to 78% of technical potential without the tax. The carbon tax led to 25.08 million mBTU in energy savings compared to 21.43 million mBTU in savings without a carbon tax.

In addition, the achievable potential of energy savings when a carbon tax was applied was more than double, or about 106% higher toward the end of a five-year study of energy savings. This is the combined impact of both electric and gas energy efficiency programs.
Energy potential comparison graph
In the case of the electric utility in the U.S. Southeast, there was a 12% rise in economic potential when a carbon tax was applied. For this utility, the economic potential in the scenario with considering carbon costs was determined to be 11.66 million megawatt hours saved. That was almost equal to the technical potential of 11.67 million (MWh) saved, meaning almost all measures proposed to increase energy efficiency became cost efficient. 

The achievable potential in the scenario where the carbon costs are considered is 1.24% higher towards the end of year five. It should be noted that this portfolio was very cost-effective without carbon tax, which is why the impact of carbon tax is minimal compared to the previous cases.  

Based on the three utilities we assessed, the economic potential of energy efficiency programs increases by 10% to 50% and achievable potential can increase by 1.5% to 100%.

The impact depends on various factors such as fuel type mix in generation and at demand side, emission factors, location, and types of energy efficiency programs. Accordingly, it is important that states and utilities assess the impact of carbon price on their portfolio on a case-by-case basis.

Note that our approach in this analysis was conservative as we only modeled the impact of carbon tax on cost-effectiveness of energy efficiency programs and did not model the impact on increased adoption of energy efficiency measures. While this article focuses on energy efficiency program potential, we anticipate similar results with other non-emitting generation types such as renewables.

Meet the authors
  1. Ali Bozorgi, Ph.D., Senior Manager, Distributed Energy Resources Analytics

    Ali is a distributed energy resources expert with experience working on energy economic analysis and forecasting with advanced modeling tools and optimization to support our utility clients. View bio

  2. Pratik Dhoot, Senior Energy Markets Consultant, Analytics

    Pratik is a seasoned energy industry consultant with over six years of experience. He specializes in demand-side management (DSM) and focuses on developing DSM potential studies, program designs, and non-wires alternatives solutions for North American utility clients. Pratik serves as the product manager for our distributed energy resource planning tool and other assessment tools used in DSM projects.