Energy Efficiency Policy and Carbon Pricing

While carbon pricing is a prerequisite for least-cost carbon mitigation strategies, carbon pricing is not enough to overcome all the barriers to cost-effective energy efficiency actions. Energy efficiency policy should be designed carefully for each sector to ensure optimal outcomes for a combination of economic, social and climate change goals. This report aims to examine the justification for specific energy efficiency policies in economies with carbon pricing in place. It begins with an inventory of existing market failures that attempt to explain the limited uptake of energy efficiency. These market failures are investigated to see which can be overcome by carbon pricing in two sub-sectors – electricity use in residential appliances and heating energy use in buildings. This analysis finds that carbon pricing addresses energy efficiency market failures such as externalities and imperfect energy markets. However, several market and behavioural failures in the two sub-sectors are identified that appear not to be addressed by carbon pricing. These include: imperfect information; principal-agent problems; and behavioural failures. In this analysis, the policies that address these market failures are identified as complementary to carbon pricing and their level of interaction with carbon pricing policies is relatively positive.