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The Value of Price Risk Reduction in Energy Efficiency Improvements in Buildings

This paper presents a method for calculating the value of price risk reduction to a consumer that can be achieved with investments in energy efficiency. The examples presented deal with buildings and electricity for heating, but the principles can be applied to other contexts. The value of price risk reduction is largely overlooked so far in literature concerning the costs and benefits of energy efficiency in buildings. The topic is discussed to some length but in the literature reviewed for this paper no methodology for calculating the value was presented. Here we suggest such a method. The problem of valuating price risk reduction is approached using a variation of the Black–Scholes model by considering a hypothetical financial instrument that a consumer would purchase to insure herself against unexpected price hikes. A rational consumer is prepared for a certain amount of growth in energy prices. If, however, the energy price rises more than expected, it might be very undesirable for the consumer. The consumer could, at least in theory, prepare for the unexpected rise by buying a cap contract on energy prices which would provide compensation for that unexpected rise. Case examples calculated for typical single family houses in Finland are presented. The calculations concentrate on heating energy only, because there it is relatively easy to find examples of investments that reduce energy consumption, making it well-suited for demonstrating the issues at hand. Moreover, they concentrate on electricity as an energy carrier, as volatility data are needed and such data are available from the relatively well functioning electricity market in the Nordic countries. The results show that the price risk entailed in household energy consumption can be reduced by a meaningful amount with energy efficiency investments, and that the monetary value of this reduction can be calculated using a variation of the Black–Scholes method. It is argued that this often overlooked benefit of energy efficiency investments merits more consideration in future studies.