LAUSR

Canada has joined the few countries that have adopted carbon tax in an effort to mitigate CO2 emissions. Since consumption of fossil fuels is the primary source of CO2 emissions, the key mechanism for business to reduce their carbon tax liabilities without reducing their productive activities is through energy savings. While businesses could achieve this goal in the long-run by investing in new energy-efficient technologies, the short-run response is normally to engage in energy conservation and minimization of inefficiencies. The potential for such improvements is, however, unknown. We employ a stochastic energy intensity frontier model to separate energy demand driven by energy prices, other input prices, and indicators of the level of technology from energy demand due to inefficiency. We used the Canadian KLEMS data set covering all business sector industries for the period 1961–2014. We find an average transient energy inefficiency of approximately 8.5%. Inefficiency is particularly high in energy-intensive sectors such as oil and gas extraction. The trend shows that inefficiency has declined substantially over time, particularly after the early 1970s oil price shock. Comparing the trend in energy intensity to the trend in energy inefficiency reveals that reductions of energy inefficiency have contributed to the decline in energy intensity. Our results suggest the potential to further reduce energy inefficiency and, thereby reducing energy consumption and CO2 emissions without reducing output. Existence of such potential is important in determining the economic and environmental impact of a carbon tax.