ENERGY-CONSERVATION INVESTMENT - DO CONSUMERS DISCOUNT THE FUTURE CORRECTLY

We argue that the apparently high discount rates attributed to investors making energy conservation investments are not irrational or the result of some market failure. Rather they may result from an investor recognizing that many conservation investments entail substantial sunk costs. In the presence of these costs and uncertainty over future conservation savings, consumers should use a higher hurdle rate for investment than if there were no uncertainty. Simulations suggest that the hurdle rate should be about four times greater than the standard rate. An implication of our model is that tax subsidies for the purchase of conservation capital are likely to be ineffective. We discuss alternative policy approaches which are more likely to increase energy-efficient investment, namely mandatory efficiency standards and energy taxes.