McKinsey’s Energy Fix for Developing Countries: Efficiency

Share this article

A report by the McKinsey Global Institute (MGI) is warning developing nations against using the recession as an excuse not to invest in energy efficiency — the cheapest form of energy available.

Energy demand in emerging economies is expected to skyrocket in the coming years and supply is headed for a crisis. Efficiency — using less energy for the same output — is the most important and cost-effective fix. In fact, investing solely in existing efficiency technologies would yield billions in future savings across all developing regions, reports MGI in Promoting Energy Efficiency in the Developing World.

The numbers make the case. 

For $90 billion a year over the next 12 years, developing countries could slow the growth of their energy demand by more than 50 percent by 2020, to 1.4 percent a year from 3.4 percent. In doing so, they would shrink energy consumption by 25 percent in 2020 — a reduction larger than total energy consumption in all of China today. Savings would add up to $600 billion a year by 2020, freeing up resources that could be spent elsewhere.

Without efficiency improvements, these economies would need to spend about twice that initial investment on energy infrastructure — some $2 trillion by 2020.

Energy efficiency is a no-brainer fix to the twin challenges of energy and climate — everywhere — but perhaps especially in developing nations, where labor costs are lower. According to McKinsey, the price tag for investing in efficiency is on average 35 percent lower in developing economies than in advanced ones.

Clearly, big gains await those nations and companies that don’t blow the chance. That includes getting a leg up in the global cleantech race:

Companies that pioneer energy efficiency in their home markets will be well placed to carve out a leading position in the global market for "green" products and services before it matures.

McKinsey admits that at present "a range of market failures and information barriers discourage developing countries from increasing their energy productivity." Tighter credit markets top the list, which are squeezing the financing of all investments, including less risky ones like energy efficiency.

But there are options. McKinsey points to four adjustments in energy policy that developing nations can make immediately:

1. Reduce energy subsidies, as they tend to lower energy productivity. The International Energy Agency (IEA) estimates that in 2005, these subsidies totaled more than $250 billion a year in developing countries. That’s more than the annual investment needed to build their electricity supply infrastructure. Says McKinsey: "Protecting the poor from the stress of high energy prices is a legitimate goal. But there are other ways to achieve this and similar welfare goals at a lower cost."

2. Provide incentives for utilities to improve energy efficiency and encourage their customers to do the same. Policy options include "revenue incentives and certification programs that measure and reward progress toward achieving efficiency targets and also encourage the adoption of technologies such as smart metering that help households better manage their energy use."

3. Implement and enforce energy efficiency standards. Such standards are an easy win for nations, boosting production of more efficient appliances and equipment and reduce their cost.

4. Encourage public–private partnerships. These include "collaborations between governments, energy service companies, utilities, and mortgage companies, to finance higher energy efficiency in building."

It must be said: The McKinsey report is not exactly new. The research for the analysis was conducted in October 2008. (The original excellent 45-page paper, Fueling Sustainable Development: The Energy Productivity Solution, can be found here.) It was published as gas prices started to plummet and as the economy began to tank even more.

So the institute crunched the numbers again in light of the new economic and fuel environment, re-publishing its findings in the February 2009 edition of the McKinsey Quarterly. There were hardly any changes at all from the original. In the authors’ words: The weakening economy and falling gas prices "do not affect the long-term projections in the study." 

And that’s the real point here: Developing nations must not use tough economic times as an excuse for inaction on energy efficiency. Wise efficiency investments could help improve the security of their energy supply and help lift their ailing economies. However, "time is of the essence:"

Developing economies will install half or more of the capital stock that will be in place in 2020 between now and then. Every building or industrial plant constructed without optimal energy efficiency represents a lost opportunity to lock in lower energy consumption for decades.

It’s no secret that energy efficiency is the business opportunity of the year. What’s still unclear is whether developing nations will choose to take advantage of it before it’s too late.