GREEN FINANCE INSTITUTE – WRITTEN EVIDENCE ESI0034 – UK ENERGY SUPPLY AND INVESTMENT

1. Are the Government’s policies for reducing the impact of higher energy prices on consumers sustainable and in line with long-term energy objectives? If not, what alternatives are there?

The announcements made in the British Energy Security Strategy (BESS) were notable for including no tangible new commitments to increase investment into energy efficiency upgrades for buildings. This is the single biggest short-term opportunity to sustainably reduce the impact of rising energy prices on consumers, while accelerating the transition to a net zero economy and delivering energy security.  Given that the OBR expects to see energy bills increase again by another 40% in October[1], this seems to be an area in need to urgent attention and fiscal and regulatory commitments from Government. In its 2020 report, the GFI’s Coalition for Energy Efficiency in Buildings (CEEB) has laid out a number of stimulus actions and reforms for the net zero building and retrofit sectors that could be used by Government to increase energy security, accelerate growth and deliver GHG emission reductions in the UK[2]. These have been developed with the financial institutions, business and consumer affairs groups who are key to ensuring the successful acceptance and delivery of a robust energy efficiency upgrade programme in the UK. Some of these have been adopted – such a reducing VAT on energy efficiency products – but others ranging from property-linked finance solutions and salary sacrifice schemes to stamp duty reforms to encourage uptake, remain unenacted.

Of notable importance is the fact that UK banks are proactively standing ready to respond to an increase in demand for green finance products to support these investments, if and when the fiscal and regulatory levers to drive demand are put in place. See the letter from banks to the Chancellor sent in October 2021, which advocated stamp duty and other reforms[3].

2. What level of investment will be needed in the UK’s energy supply to secure an orderly transition, particularly over the next decade? Is sufficient private capital being invested in reliable and affordable energy sources that are in line with climate objectives, including the commitment to net zero (for example, hydrogen and nuclear)?

While the focus of this inquiry may well be on centralised energy infrastructure deployment, it is worth noting also the important role of decentralised energy investment – and the key role of local authorities.

Last year, the UK Government’s Net Zero Strategy outlined that of all UK emissions, 82% are “within the scope of influence of local authorities”, underscoring the transformative role local governments

could play in achieving national net zero ambitions. Local authority powers, including on accessing finance, and duties need to be commensurate with funding provided to deliver. GFI is starting to work with cities and local authorities and sees, particularly in smaller authorities, issues with financial capacity to develop technical and business plans that can then be financed – this is a gap that needs to be addressed with urgency.

In summary, while initiatives such as BEIS’ Local Energy Hubs are providing technical assistance funding to local authorities and others wanting to develop project pipelines for investment, demand outstrips the supply of funding support. Financial advisory capability is also needed to enable local authorities to draw on a full range of suitable public and private financing instruments – and move beyond Public Works Loan Board funding, which is almost at capacity and provides for more the 75% of local authority debt finance.   Given the £50bn pa investment needed from 2030-2050, UK Infrastructure bank could be an off-balance source of funding to crowd in private co-investment but will likely need to see its lending cap increased to fulfil its potential as a market catalyst.

3a. What effect is financial services regulation, and the commitments made by financial services providers to achieve net zero in 2050, having on energy investment?

EU and UK financial services regulation including the EU’s Sustainability in Financial Services Regulation (SFDR) and taxonomy as well as the UK’s proposed Sustainability-related Disclosure Regulation (SDR) and taxonomy along with commitments to require Taskforce on Climate-Related Financial Disclosure reporting in the UK has transformed the way climate change and wider sustainability risk is considered within financial institutions. Operations are changing to take sustainability data and real-world impacts (positive and negative) into account; green and sustainable products are proliferating; and underpinning this demand for in house sustainability expertise has created a hot market for these experts.

It has spurred a massive growth in sustainability-themed funds in the market (nearly 6000 at the end of 2021 compared to a couple of hundred in 2019)[4]. Within the GFI’s Coalition for Energy Efficiency in Buildings (CEEB), the number of green mortgages on the market has increased in the last 3 years from 2 to more than 35[5]. Looking more broadly, appetite to mobilise capital into net zero transition-aligned investment and lending is significant and far exceeds viable opportunities. For example, the UK’s first sovereign bond (£10bn) was x10 oversubscribed; it’s second (£6bn) x12 oversubscribed. This should not be a surprise given the US$130trillion in assets that have now made Net Zero Pledges under GFANZ[6].

In short, appetite to invest is immense. The supply of investible projects (that provide competitive risk-adjusted returns relative to business-as-usual transactions) and markets is not.

3b. Specifically, is regulation getting the right balance between encouraging investment in renewable energy and supporting the green transition, while also ensuring security of supply?

The green transition and the energy security agendas seem to be being presented as opposing agendas that need to be balanced. This seems a rather outdated notion given the progress the UK is

making in phasing our fossil fuels from its energy system and the spiking gas prices that are making the economics of renewables, demand side reduction and even nuclear look ever more attractive.

A key test for the Government on its intent here will be the upcoming UK Green Taxonomy consultation, which was originally set for Q1 2022. In our opinion, the taxonomy is but one tool the Government can use to direct investment to where it is needed to help transition the UK to a net zero economy by 2050. It sets out activities that reflect the future economy we need to deliver. To drive confidence in the market and among wider interested stakeholders it should be science-based and robust, based on the Government’s commitment to ensuring the tool takes an objective and science-based approach to assessing sustainability, which in turn will help address greenwashing and direct capital to where it is needed to deliver the UK’s net zero commitments. Given the Committee on Climate Change has indicated that to deliver the 6th Carbon Budget by 2035, all new unabated gas will need to be off the system and this infers, therefore, that unabated gas should not be included in the taxonomy[7].

Any interim support for unabated gas or new UK oil and gas exploration to address energy security concerns should be dealt with through separate policy instruments, so as not to send mixed and therefore unhelpful signals to the market.

The taxonomy is but one tool among the many needed to drive the net zero transition. Delivering the UK’s specific energy objectives, as set out in the Net Zero Strategy and Ten Point Plan ultimately requires building new markets. There is no getting away from the fact that the policy environment remains a critical enabler of success – given existing policy and regulation in the real economy sectors of interest were created under a different set of operating and market conditions.

For mature energy technologies feed in tariffs (FiTs) and the more recent contracts for difference (CfDs) have worked well. Greater energy security can be delivered at relatively low cost by lifting the CfD auction cap for offshore wind and solar combined from its current 5GW to include the nearly 11GW that already have planning permission and could be built quickly[8]. For newer technologies and market development the role of guarantees in crowding in private finance – including for hydrogen and CCUS but also more widely – should be a core part of government considerations.

For earlier stage market development and technology demonstration, grants are often the default public finance mechanism selected because they are generally easy to deploy and it is clear what the impact of the spending has been. However, they run the risk of creating unsustainable stop start market opportunities. For example, the time-limited nature of the Green Homes Grant Scheme and the limited infrastructure in place to deploy the funds meant that 95% of the £1.5bn grant component for the first tranche of the scheme was not spent. In short, demand was high, execution was low. Grants, when not designed to target financial inequality or other explicit social challenges, can also be an inefficient (and therefore costly) use of public funding because they crowd the private sector out instead of in. The same can often be said of capital allowances, which tend to encourage marginal rather than transformative balance sheet-focused capex deployment into green solutions.

The level of ambition for the impact of public finance interventions needs to be increased by several orders of magnitude. Research cited by the OECD has found guarantee funds operating for five years can achieve leverage of x5 increasing to x10, dependent on risk appetite and level of claims[9].

Greater use of well-designed guarantee funds that target public capital with a laser like focus on clearly articulated perceived risks the market cannot address alone both ensures public pounds go further but also accelerates the creation of green finance solutions as markets become comfortable quicker with new business models, technologies and their related risks. This also enables the public sector to step away more quickly, as they mainstream. The UK Infrastructure Bank would be well placed to work with relevant government department as well as experts such as the GFI to develop such guarantee structures.

4. What should the Government do to incentivise and enable investment in, and financing of, reliable and affordable energy that is in line with its climate objectives, including net zero by 2050?

As set out above one of the key insights from the GFI’s 3-year track record in working with the market to develop and deploy blended finance solutions that will crowd in private capital at the scale and pace needed to deliver headline policy goals is that the default historic means of deploying public capital need to change. To date, with the notable exceptions of FiTs and CfDs, public capital has principally been allocated through grant funds, capital allowances or tax breaks. While this direct support has no doubt delivered some progress, it has not acted to crowd in private capital at the scale needed. The scale of the challenge means new uses of public capital are needed to deliver the estimated ramp up to £50bn pa of investment needed between 2030-2050 to deliver the UK’s Net Zero Strategy[10].

The Government also needs to bring a financial lens to public policy-making early on. This will avoid the situation where public policy frameworks are developed that fail to drive investment at the scale

and pace needed. There is no off-the-shelf solution to doing this, but some basic principles could be introduced to do this - perhaps included in an updated Green Book.

Finally, there should be a commitment by Government to set a clear carbon price trajectory reaching a minimum of £75/tCO2e by 2030 charged ‘upstream’ on the producers of greenhouse gases – but couple this with diverting revenues to support schemes to help those affected transition to a net zero aligned position. The exception to this should be transport – which will need bespoke solutions. For other sectors the government should amalgamate a large number of overlapping pricing instruments into a simple carbon charge. This includes: the Carbon Price Support (CPS); the UK Emissions Trading System (UK ETS); differentiated Climate Change Levy charges (CCL); and Climate Change Agreements (CCAs). This should not replace existing renewable support such as ROCs, FiTs and CfDs, which will still be needed[11].

5.What incentives could the Government provide to households and businesses to reduce demand for energy or to improve energy efficiency?

The principal ideas from GFI CEEB’s aforementioned report[12] are set out below and focus on consumers rather than business. The report also detailed supply side actions that can be taken to enable the market in concert – including on scaling up supply chains to deliver the physical retrofits.

• Energy efficient technology rebate system Similar to the US ‘Cash for Clunkers’ scheme, property owners are incentivised to upgrade inefficient or fossil fuel technologies (e.g. old windows, boilers) to efficient and clean ones through a government grant or voucher scheme. The proposed Clean Heat Grant from 2022 could be brought forward to this year and offered alongside, Renewable Heat Incentive support. While providing immediate stimulus to eligible technologies and associated supply chains, the scheme also increases household disposable income.

• Landlord and business energy saving allowance Reintroduce the Landlords Energy Saving Allowance (LESA) that allows the cost of acquiring and installing certain energy-saving items to be deducted when calculating taxable profits, made to Landlords who exceed Minimum Energy Efficiency Standard (MEES) requirements. The allowance could be extended to SMEs by reinstating the Enhanced Capital Allowances scheme for energy and water-efficient equipment, and targeted communications could improve uptake.

• Domestic energy efficiency salary sacrifice scheme Comparable to the ‘Ride to Work’ scheme, employees draw a loan through their employer to invest into home energy improvements and repay the financing via gross salary contributions.

• Property Assessed Clean Energy (PACE) financing Financial institutions provide long-term capital for retrofit projects, while local authorities or associated independent third parties collect repayments via an additional property charge that is passed through to the lender. Proven models in Australia, Spain and US.

• Sliding ‘bonus-malus’ Stamp Duty scale As recommended by the Green Finance Taskforce, a sliding scale of Stamp Duty designed to be fiscally neutral and linked to energy performance could drive demand for more energy efficient properties. Could be preceded by near term action in the form of a Stamp Duty rebate for the purchase of highly efficient properties. A pilot scheme may be of potential interest to Welsh or Scottish Governments.

• Improved data and education Improvements to the quality and availability of energy efficiency data, plus accessible tools to inform retrofit decisions, will help educate and encourage property owners to invest into efficiency improvements. The CEEB is exploring several pilot projects to enhance the existing data infrastructure
• Green Help-To-Buy (HTB) scheme The current HTB scheme could be extended beyond new-build housing and repurposed to preferentially support first-time buyers to purchase an energy-efficient and resilient home, through minimum EPC criteria or government guarantees to support energy improvements once the property has been purchased.

• The value of energy efficiency Any government-backed schemes should educate the market on the long-term financial and wider benefits of energy efficient buildings, thereby encouraging a value differential for high performing buildings and incentivising homeowners to retrofit. The current lockdown has increased public appreciation of the environment and benefits of a comfortable home, providing an opportunity to capture and leverage that momentum.

• Fiscal incentives for energy efficient social housing Grants, subsidised funding and technical assistance for new social housing developments that achieve energy efficiency and resiliency standards that are far in excess of those required, aimed at stimulating low-carbon construction and demonstrating best practice to the industry.

• Planning reforms to incentivise energy performance Reforms to expedite the planning permission process for developments that meet high energy efficiency, resiliency and social value standards offer an incentive for housebuilders to deliver higher-quality building stock.

3 May 2022

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