A program that targets cost-effective opportunities in energy productivity could halve the growth in energy demand, cut emissions of greenhouse gases, and generate attractive returns.
Diana Farrell and Jaana K. Remes
July 2008
One hundred and seventy billion dollars a year invested in efforts to boost energy efficiency from now until 2020 could halve the projected growth in global energy demand. What’s more, these investments could also deliver up to half of the emission abatement required to cap the long-term concentration of atmospheric greenhouse gases at 450 parts per million, the level experts suggest will be needed to prevent the global mean temperature from rising by more than two degrees centigrade.
The key to achieving these results will be carefully targeting cost-effective opportunities to boost energy productivity—the level of output achieved from the energy consumed. In previously published work, the McKinsey Global Institute (MGI) and McKinsey’s global energy and materials practice have described the possibilities for improving the efficiency of lighting, cooling, and heating systems, and of other technologies like vehicles and factory machinery.1 Concerted action could reduce global energy consumption in 2020 by 135 quadrillion British thermal units (QBTU) a year, the equivalent of roughly 64 million barrels of petroleum a day.
We arrived at the figure of $170 billion by estimating the market price of all the large and small investments needed to realize the energy productivity opportunities identified in our previous work.2 The average internal rate of return (IRR) of these investments would be 17 percent, and each of them would generate an IRR of at least 10 percent.3 The total annual energy savings would come to roughly $900 billion by 2020.4 All of the investments, representing just 0.4 percent of current global GDP a year, involve existing technologies—and none require compromising the consumer’s comfort or convenience.
Nevertheless, real obstacles stand in the way of these investments and the energy savings they could generate. One is a set of market and policy imperfections. To name just a few, consumers don’t have enough information about energy-efficient options, fuel subsidies discourage efficient energy use, and landlords and tenants alike resist energy-efficient investments they believe would mostly benefit the other party. A second challenge is that two-thirds of the investment opportunity lies in developing countries, where consumers and businesses face a variety of competing demands for their scarce investment dollars. China alone would need to account for 16 percent of the annual investment that our analysis suggests is needed.
The public and private sectors can do much to overcome these obstacles and facilitate the necessary investments, however. Policy priorities include setting energy efficiency standards for appliances and equipment, as well as removing subsidies and tax breaks for energy consumption. Businesses can raise their efficiency standards and innovate to overcome the information and agency barriers that keep both them and consumers from making economically and environmentally sound choices. In this way, the leaders will capture the significant financial benefits of efficiency and perhaps even create entirely new markets.
How to invest $170 billion a year
The energy productivity investment opportunity varies dramatically by sector and region. Industrial sectors around the world could remuneratively deploy just under half of the $170 billion a year, residential sectors about a quarter. The commercial and transportation sectors would absorb the remaining investment, in roughly equal proportions (Exhibit 1). About two-thirds of the $170 billion would go to developing economies, where the cost of abating a unit of energy demand is about 35 percent lower than it is in the developed world, because these economies are growing rapidly, consume energy in a relatively inefficient way, and have large supplies of cheap labor.5
