On the Value of Input-Efficiency, Capacity-Efficiency, and the Flexibility to Rebalance Them

A common characteristic of basic material manufacturers (which account for 85% of all industrial energy use) and of cleantech manufacturers is that they are price-takers in their input and output markets. Variability in those prices has implications for how much a manufacturer should invest in three fundamental types of process improvement. Input price variability reduces the value of improving input-efficiency (output produced per unit input) but increases that of capacity efficiency (the rate at which a production facility can convert input into output). Output price variability increases the value of capacity-efficiency, but it increases the value of input-efficiency if and only if the expected margin is small. Moreover, as the expected input cost rises, the value of input-efficiency decreases. A third type of process improvement is to develop flexibility in input efficiency versus capacity-efficiency (the ability to respond to a rise in input cost or fall in output price by increasing input-efficiency at the expense of capacity-efficiency). The value of this flexibility decreases with variability in input and output prices, if and only if the expected margin is thin. Together, these results suggest that a carbon tax or cap-and-trade system may reduce investment by basic material manufacturers in improving energy-efficiency.