WP-029: Katrina Jessoe, Maya Papineau, and David Rapson, "Utilities Included: Split Incentives in Commercial Electricity Contracts" (January 2018)

When a person or firm doesn’t pay directly for the energy they use, this can create a “split incentive,” where the party who pays for the energy is not the one making decisions about usage. This problem has been frequently cited as creating incentives for energy over-consumption. Understanding this split incentive problem for commercial customers is important because they are large in size, accounting for over 35 percent of end-use electricity consumption in the U.S. At the same time, they are relatively few in number. Conservation at a single large firm may achieve the same energy savings as a proportional reduction by thousands of households.

In this new paper, Katrina Jessoe (UC Davis), Maya Papineau (Carleton University) and David Rapson (UC Davis) focus on the split incentive problems created when energy bills are bundled into the monthly rental commercial contract by comparing electricity usage across tenant-paid versus owner-paid contracts. When a building occupant rents space and does not pay for their monthly energy bill, they face no additional cost for increasing their energy use and there is little incentive for them to invest in energy efficiency. This creates opportunities for energy to be wasted; for example, commercial buildings tend to be over-cooled in the summer months.

The study finds that among the top ten percent highest commercial energy users, customers on tenant-paid contracts use 6-14% less electricity in summer months.  Interestingly, for the other 90 percent of commercial customers, contract type does not noticeably impact consumption decisions. Perhaps bill savings from changing consumption are too insignificant to warrant attention for small firms.

The authors ask the question: “does it make sense to switch large commercial customers from owner-pay to tenant-pay contracts by retrofitting building with submeters?” The answer is “yes.” They conclude that a targeted policy of submetering and tenant-paid contract promotion would be an effective conservation strategy for policymakers, particularly due to the high concentration of electricity use among the largest commercial customers. This switch has a private payback period of less than one year.  Remarkably, fixing the split incentives problem for large commercial firms nationwide would save more energy than doing so for the entire residential electricity sector. The environmental benefits are also large relative to other popular conservation strategies. Aligning incentives at the largest firms will produce greenhouse gas savings of between 615-1200 thousand tons of CO2 per year, or roughly 3.3 to 6.6 times the average annual savings achieved from a year of Weatherization Assistance Program retrofits.

When compared to other locations, the study’s estimated consumption and bill savings may represent a lower bound.  The study analyzed the split incentives in Connecticut, where most customers rely on natural gas for heating and summer temperatures may be relatively mild. In locations with a high penetration of electric heating, the contract type may influence demand for heating as well. In the southwestern and southeastern states with warmer temperatures and higher air conditioning usage, the savings from restructuring contracts may also be larger. In fact, in this study when air-conditioning demand rises, the difference in usage between tenant-paid and owner-paid contracts becomes even more pronounced.