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2.5.5 Hidden Costs

Hidden costs are the explanatory variable for the 'gap'; the argument against the 'efficient gap' hypothesis (DeCanio & Watkins, 1998). In fact, cost effective measures are not cost-effective when such hidden costs are included. According to Nichols (1994) technical studies fail to account for either the reductions in benefits associated with the investments or the additional costs associated with them and as a result they overestimate the efficiency potential. Sorrell et al. (2004) present the following three broad categories of hidden costs: general overhead costs of energy management, costs specific to a technology investment and loss of benefits associated with an efficient technology.

2.5.6 Access to Capital

Usually technologies that are energy-efficient are more expensive to purchase than alternative ones (Hirst & Brown, 1990). This means that these technologies require a substantial upfront cost. According to Jaffe et al. (2004) there is a behavioral bias that causes purchasers to focus more on this cost than they do on the lifetime operating costs of investments. There are, then, two possibilities to obtain this access to capital, either the firm has sufficient capital though internal funds or it has to borrow them.

The financing barrier, also called the liquidity constraint, refers to the restrictions on capital availability for potential borrowers and in practice small firms are frequently unable to borrow as a results of their economic status or 'credit-worthiness' (Golove & Eto, 1996) and also due to the lender's difficulty in estimating the performance of the investment, both of which also involve the hidden cost to acquire the necessary information. Energy efficiency projects tend to be evaluated based on payback periods rather than discounted cashflow analyses (Schleich, 2009). The required rate of return implied by short payback periods exceeds those for business development projects, which is obviously the case for most energy-efficient investments. As a result, firms usually have a priority list to allocate the available finance and energy efficient projects in many cases come at the bottom of the list mainly due to Information gaps, institutional barriers, short time horizons, and non-separability of energy equipment may also be apparent (Brown, 2001).

2.5.7 Split Incentives

It is quite usual that costs and benefits of energy efficient investments accrue to different agents, splitting the incentive to invest. The most well-known example for split incentives is the landlord/tenant or user/investor dilemma, see IEA (2009) for more. For example, in construction of new system, builders may have difficulty conveying the benefits of energy conserving technologies to prospective buyers, because these technologies (and their future energy use consequences) are not observable, which is usually the case of asymmetric information. In addition, the adopter of the energy efficient technology may not be able to recover all of the value of such investments (in the form of higher rents) in the case where the renter pays the energy bills but the owner makes the investment; and tenants who make these investments in cases where the landlord pays the energy bill may not be able to get reduced rents (Jaffe & Stavins, 1994). The latter is also the case where the tenant is likely to move out before fully benefited from the reduced energy bills (Schleich, 1990). In theory (Jaffe and Stavings, 1994), this so-called principal-agent problem could be avoided if the informer can transmit the information of the future benefits (which then transforms this to an 'imperfect information' barrier) and all transaction cost (the case of 'hidden costs' barrier) are taken into account.

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