Mind the Gap: Coordinating Energy Efficiency and Demand Response

Abstract

Traditionally, energy demand-side management programs are each designed in isolation. Breaking with this tradition, we examine the interactions between long-term energy efficiency upgrades and daily demand response participation at an industrial firm. Using a representative model of the firm’s production and society’s energy generation, we show that energy efficiency and demand response act as substitutes. A larger incentive to participate in demand response leads to a reduced investment in energy efficiency. Upon re-examining the long-studied energy efficiency gap, we find that the gap is typically smaller when demand response is considered. Policies aiming to close or reduce the energy efficiency gap, such as investment subsidies and carbon taxes, may fail to achieve their desired outcomes when firms participate in demand response. We propose an Extended Demand Response Baseline Policy that simplifies the design and implementation of other energy efficiency policy initiatives by removing the firm’s disincentive to install energy efficiency in the presence of demand response.