Editor's note: This is a guest post by Sean Casten, president of Recycled Energy Development, which focuses on helping companies capture and recycle waste energy. Yes, it's an energy company, but this is a smart take on a much-overlooked topic (see this earlier post) that's very much worth bringing into the discussion.

As President Obama starts rounding up votes for energy legislation in the coming weeks, he should be commended for insisting that efficiency will play a major role in the country's energy policy. After all, efficiency is the easiest way to achieve Obama's stated aim of making clean energy "the profitable kind of energy." But it remains a misunderstood topic. Usually, when people think of efficiency, they think of small-bore measures like insulating buildings or installing compact fluorescent light bulbs—things that mainly affect how consumers use power. But there's actually a far more important issue to address when it comes to efficiency: how energy is generated in the first place.

A newly released Greenpeace study notes that the typical U.S. electric plant is about 38.5 percent efficient. That means the average plant throws away nearly two-thirds of its fuel before any power reaches consumers—largely in the form of byproduct heat that's vented out smokestacks. Another 3.5 percent of that power disappears while being carried through transmission lines. Other studies paint an even bleaker picture, but the point remains the same: The greenest light bulb in the world can't get all that wasted energy back.

Why so much waste? Most of our country's power comes from centralized power plants that provide electricity for large regions. In this system, power tends to be generated remotely, away from the consumers that use it. This remoteness seems sensible at first: Pollution is emitted far from population centers, and we save on capital costs by building a few giant plants instead of many small ones. But these benefits are illusory. Centralized power that's remote from electricity users creates a great deal of inefficiency, primarily because heat can't travel very far before turning cold. So when remote power plants generate thousands of tons of byproduct heat, it just gets discarded.

By contrast, smaller plants that are located near where electricity is actually consumed can use their waste heat to warm nearby buildings and homes, to power industrial processes, or even to produce more electricity. Transmission losses, meanwhile, are all but eliminated. The result is lower pollution and energy costs. This decentralized way of producing energy is called combined heat & power (CHP) or co-generation, and it can yield efficiency rates of 80 percent—over twice that of a traditional power plant. The United States obtains just 8 percent of its power from CHP. Denmark, by contrast, generates the majority of its power this way—and consequently is far more energy efficient.

There are a variety of ways policymakers could promote this sort of efficiency and decentralization. Most importantly, the United States could remove existing regulatory barriers. For instance, electric utilities that operate central plants tend to enjoy guaranteed profits that are based partly on how much power they sell. At the same time, these utilities are allowed—indeed, mandated—to pass all operating costs onto consumers. Put these two factors together, and most utilities have much to lose and nothing to gain from being efficient. Changing these policies could give efficiency a fighting chance on the open market.

To reduce greenhouse-gas emissions, Congress should still develop the kind of market-based cap-and-trade plan that Obama has advocated. But unlike many of the bills now under consideration, this plan shouldn't specify that some technologies should be rewarded over others—effectively letting the government dictate winners and losers and blunting the incentive for innovation. A better approach would be to set concrete efficiency and pollution targets, reward anyone who can meet them, penalize anyone who can’t, and let the market do the rest. Efficiency would quickly rise, leading both costs and greenhouse-gas emissions to fall.

--Sean Casten