Written evidence submitted by the Centre on Innovation and Energy Demand, SPRU, University of Sussex (HEE 0012)

Introduction

Improving household energy efficiency is critically important for fuel poverty alleviation, energy security and CO2 emission reduction. However, progress in the UK is stalling. We therefore welcome the Committee prioritising this topic for Session 2015-16.

Our response provides evidence on the impact of previous UK energy efficiency policies, focusing in particular upon ‘supplier obligations’ (SO) such as the Carbon Emissions Reduction Target. We argue that these obligations proved highly effective until 2012, when they were replaced with the Green Deal and the Energy Company Obligation (ECO). Both the Green Deal and ECO have failed to deliver, leading to a significant decline in the rate of energy efficiency investment, and slowing progress towards meeting our climate change and fuel poverty targets. With policy in this area at a critical juncture, it is essential that lessons are learnt from this experience.

Our response addresses the following questions:

• Why have previous approaches to energy efficiency failed to deliver significant results?
• What lessons can be learnt from current and previous schemes including Green Deal, Green Deal Home Improvement Fund, and ECO?

Historical context of UK household energy efficiency policy

With one of the leakiest building stocks in Western Europe,[1] there is enormous potential for improving the energy efficiency of UK homes, which are responsible for 25% of the UK’s greenhouse gas emissions[2]. Over the past three decades, successive governments have sought to tap this potential through a mix of taxpayer-funded grant programmes (e.g. Warm Front and similar programmes) and energy or carbon-saving obligations on energy suppliers (e.g. Carbon Emissions Reduction Target (CERT) and its predecessors)[3]. These programmes have had a mix of rationales, including overcoming failures in the market for energy efficiency, encouraging least cost supply of energy services, delivering carbon emission reductions and helping to reduce fuel poverty. While the emphasis given to these different objectives has shifted over time, the overall ambition of the supplier obligations increased approximately seventy-fold between 1994 and 2012 (Figure 1). Throughout this time, most effort was focused upon low-cost energy efficiency measures such as cavity wall, loft insulation and lighting replacement.

Figure 1 Implicit annual energy saving targets in GB supplier obligations

Source: Rosenow, J. (2012): Rosenow, J., Eyre, N. (2015): Re-energising the UK's approach to domestic energy efficiency. In: Proceedings of ECEEE Summer Study 2015

Note: Target metrics have changed over time making direct comparison difficult.

There is good evidence that these obligations have contributed to significant reductions in UK household energy consumption. For example, total household energy use decreased by 19% between 2000 and 2014, despite a 12% increase in the number of households and a 9.7% increase in population.[4] On average, individual households now use 37% less energy than they did in 1970, with the bulk of this decrease occurring since 2004. Between 2004 and 2011, total household gas consumption decreased by 5% per year on average, or approximately 3.6% per year after temperature correction (Figure 2).

Figure 2: Gas consumption by UK households (2002-2013)

Source: DECC 2014, Energy consumption in the UK. London, DECC and DECC 2014, Energy trends section 7: weather. Online: https://www.gov.uk/government/statistics/energy-trends-section-7-weather

These changes in consumption were driven by changes in the number and size of households, income, average internal temperature and appliance ownership; together with investment in energy efficiency measures. While it is not straightforward to estimate the relative contribution of each, the Centre for Economics and Business Research[5] estimate that energy efficiency measures provided the greatest contribution to the reduction in gas consumption. Specifically, approximately two thirds of the reduction in household gas consumption between 2006 and 2009 (4.9%/year) was attributed to energy efficiency, of which 36% was due to insulation, 36% to condensing boilers and the remainder to behavioural change. As the majority of these measures were subsidised by the supplier obligations, it appears likely that the latter were the primary driver of energy savings over this period.[6]

Analysis by the Odyssee-MURE team, a pan-European research project, confirms that the majority of the downward trend is due energy savings (Figure 3).

Figure 3: Estimated contributors to the change in UK household energy consumption 2004-2012

Source: Odyssee Decomposition Facility

This assessment is corroborated by other studies. For example, a bottom-up ex-ante evaluation of CERT suggests that it achieved annual savings of around 1% of final household energy consumption (based on 2007 and all fuels) over the period 2008-2012.[7] Alongside CERT ran the Community Energy Savings Programme (CESP), another supplier obligation, with a focus on area-based delivery and higher cost measures. Since CESP had a target equivalent to about 10% of CERT, we estimate that these two obligations combined delivered a reduction of ~1.1% in household energy use between 2008 in 2012. Earlier evaluations of the supplier obligations also suggest that they were highly cost effective, with discounted costs of energy savings that were significantly below average household energy prices.[8] The final evaluation of CERT illustrates that energy companies delivered their obligations even more cost-effectively than before.[9]

In summary, previous supplier obligations have proved highly cost effective and had a significant impact on the energy efficiency of homes. Whilst those policies were by no means perfect, they drove the uptake of energy efficiency measures at scale.

Impact of recent policy changes

Despite this apparent success, the UK government decided to radically overhaul the existing system in 2011/2012. CERT and CESP came to an end, the Green Deal was launched and a substantially different supplier obligation - the Energy Company Obligation (ECO) was introduced.

The Green Deal was intended to overcome the barriers of split incentives and high upfront costs by financing energy efficiency measures through loans that were tied to the building rather than the occupant and paid through instalments on electricity bills. Since the Golden Rule prescribed that the cost savings from these measures must be larger than the repayments, only investments with high rates of return were eligible for full funding. These measures (e.g. cavity wall insulation) were previously targeted by the supplier obligations - whose targets gave some confidence that particular levels of energy savings would be achieved. In contrast, the Green Deal did not require a specific level of delivery, with the result that the outcome was highly uncertain.

With the Green Deal targeting high payback investments, ECO was largely directed towards more expensive measures with low rates of return, such as solid wall insulation (SWI). This represented a significant departure from UK and international experience, where supplier obligations have primarily been used to encourage relatively cost-effective measures.[10],[11] Part of the rationale was that the potential for cost-effective measures was declining, requiring a mechanism to support more expensive retrofits in the longer term. From 2013, most support for cost-effective measures was supposed to come through the Green Deal.

In addition to the changes resulting from the Green Deal, the publicly funded fuel poverty programme Warm Front was terminated. For the first time since 1978, there will be no taxpayer funded energy efficiency programme for the most vulnerable. The only remaining fuel poverty policy consists of provisions for low-income households in ECO even though the evidence suggests that energy efficiency obligations are not very suitable to deliver energy efficiency improvements to fuel poor households[12]. The changes result in a reduction of the resources spent on fuel poverty by about 30%.[13]

Early assessments of these proposals forecast that the introduction of the Green Deal and the restructuring of the energy efficiency obligations would lead to a decline in energy savings of around 80%.[14] Whilst such forecasts are always uncertain, recent figures confirm that they were if anything an overestimate of the energy savings, with the rate of energy efficiency improvements dramatically slowing down. Estimates from the Committee on Climate Change[15] and DECC[16] suggest that the average delivery rate for loft insulation has dropped by 90% since 2012, cavity wall insulation is down by 62%, and solid wall insulation has declined by 57% (Figure 3). The latter trend is particularly notable, given the intended focus of ECO on SWI. With increasing uptake, there are fewer properties left that require insulation. However, the potential for low-cost insulation measures is still significant. According to the Committee on Climate Change, 4.5 million cavity walls still need to be insulated, 10 million easy-to-treat lofts could benefit from further insulation and there are more than 7 million solid walls without insulation. Of the cavity walls which remain uninsulated, 65% are classed as hard-to-treat. [17]

Figure 3 : Delivery rates of key insulation measures

Source: based on Committee on Climate Change[18] and DECC[19]

The uptake of the Green Deal has been minimal. Initially it was expected that up to 14 million households could benefit from the Green Deal, but in practice less than 20,000 have signed up to the scheme since its launch. The reasons for this failure include:

• the inability of the scheme to address other barriers such as lack of awareness and hidden costs;
• the marketing focus on the financial savings from energy efficiency rather than other benefits and motivations;
• the disincentives created by the need to provide top-up finance for measures that did not comply with the Golden Rule;
• the poor communication about the scheme and the consequent misunderstanding and mistrust among the public;
• the complex process for obtaining finance; and the perception that Green Deal loans might inhibit subsequent property sale; and
• the unattractive financial offer - with interest rates well above 7% at a time when mortgage rates were at historical lows. As a consequence, homeowners with equity took little interest in the scheme.

Overall, the move from mandated investment by energy suppliers to incentivised but voluntary investment by energy consumers must be judged a failure.

The reorientation of ECO towards higher cost measures also created difficulties. Most obviously, the energy saving target was approximately 85-90% lower than its predecessor (CERT), despite anticipated expenditure being about the same[20]. With fewer households benefiting from efficiency improvements, the anticipated distributional impacts of ECO were more regressive. Concern over the impact on bills subsequently led to a further 25% reduction of the energy-saving target,[21] while the associated reintroduction of low cost measures led to conflict with the Green Deal.

To conclude, it is now clear that the Green Deal has failed to deliver any significant investment in energy efficiency. Its existence also resulted in ECO being focussed in areas in which it was less immediately effective, with the result that the energy-saving targets have now been reduced. Together, the Green Deal and ECO have been a major setback for UK energy efficiency policy.

International experience suggests that there are three options to deliver energy efficiency in homes at scale: a) large subsidy programmes (loans, tax rebates and grants) such as the KfW programme in Germany, b) energy efficiency obligations or levies earmarked for energy efficiency, and c) regulation requiring home owners to install energy efficiency measures. The potential for voluntary unsubsidised measures based upon on-bill finance (e.g. Green Deal) is relatively limited without associated subsidies.

Guidelines for future policies

The lessons learned from this experience should inform future policy design. It is evident that:

1)      Supplier Obligations:

1. Supplier Obligations can be highly effective but should not be prescriptive about the type of measure and should allow cost-effective. Internationally, the vast majority of energy efficiency obligations target such measures[22],[23] thereby ensuring that a high proportion of customers benefit from the obligation. In contrast, high-cost measures allocate the benefits to a limited number of customers and can place disproportional burdens upon low income groups. Also, low-cost measures are usually standardisable and easily replicable.
2. Previous Supplier Obligations included also many non-insulation and heating system measures such as energy efficient appliances, lighting and behavioural change.[24] There is currently a lack of support for innovative technologies such as LED lighting and future obligations should be refocused with a view of including such technologies. Also, energy suppliers could propose including additional innovative measures to Ofgem supported by evidence of the savings these can achieve.
3. Reliance upon deemed saving estimates is recommended to avoid excessive administrative costs.
4. Unexpected policy changes such as the reduction of the ECO target in 2014 need to be avoided to create long-term policy stability and investor confidence.

2)      On-bill financing:

1. The interest rate of the Green Deal was not attractive and significantly above current mortgage rates and high street loans which is a benchmark used by consumers when assessing the interest rate of such programmes.[25] A low-interest mortgage or loan with interest rates of around 2-3% is an attractive proposition for investment in energy efficiency, and the interest rate should be reduced depending on the take up of the scheme. Consumer research in the UK[26] and experience from other countries supports this[27]. Such a measure is likely to require government guarantee of the loans and/or subsidies to a financial organisation offering the loans.
2. The Green Deal’s focus on low-cost measures (limited through the Golden Rule) did not allow for more comprehensive retrofits without additional finance. For low-cost measures market research undertaken for the government showed that commercial loans have very limited attractiveness for most consumers.[28] Future on-bill financing schemes as well as other types of loans should therefore focus on medium- and high-cost measures.
3. The Green Deal was primarily marketed as a financial proposition saving households money on their bills. Instead of a universal, top-down, marketing approach, we should learn from DECC’s own survey evidence that a multitude of factors beyond purely financial considerations motivate people to improve the energy efficiency of their home.[29] A comprehensive study from the US also stresses that focusing on issues such as comfort and health greatly enhances the attractiveness of energy efficiency from the consumers’ perspective.[30] A more effective marketing strategy

4. needs to draw on those insights and speak a language that addresses consumers’ desires and requirements.

About the Centre on Innovation and Energy Demand.

The Centre on Innovation and Energy Demand (CIED) is one of six Research Centres on End Use Energy Demand funded by the RCUK Energy Programme. CIED investigates the drivers and barriers to low energy innovations throughout the economy and the implications of these innovations for energy demand. The research programme aims to develop a socio-technical understanding of the emergence, diffusion and impact of low energy innovations, including new technologies (e.g. heat pumps), organisational arrangements (e.g. car sharing) and modes of behaviour (e.g. cycling) that are expected to improve energy efficiency and/or reduce energy demand. CIED is a collaboration between researchers from the Sussex Energy Group (SEG) at SPRU, University of Sussex; the Transport Studies Unit (TSU) at the University of Oxford; and the Sustainable Consumption Institute (SCI) at the University of Manchester.

About Sussex Energy Group

The Sussex Energy Group at SPRU undertakes academically rigorous, interdisciplinary research that engages with policy-makers and practitioners. The aim of the research is to identify ways of achieving the transition to sustainable, low carbon energy systems whilst addressing other important policy objectives such as energy security and the long-term challenge of combatting climate change. While we start from the UK energy system, we also work on European issues and the developing world. Issues range from the local (e.g. community energy, city-scale sustainability) to the national (e.g. interaction of different national policy instruments) to the global (e.g. transfer of low carbon technologies to the developing world.)

About SPRU

With almost 50 years of experience, SPRU is internationally recognised as a leading centre of interdisciplinary research on science, technology and innovation policy. Our research addresses pressing global policy agendas, including the future of industrial policy, inclusive economic growth, the politics of scientific expertise, energy policy, security issues, entrepreneurship, and pathways to a more sustainable future. At SPRU, we are driven by a desire to tackle real-world questions, whilst also contributing to a deeper theoretical understanding of how innovation is shaping today’s world. Currently, with 50 research staff, over 70 doctoral students, over £7m of ongoing Research Council projects, as well as the leading journal in its field, Research Policy, SPRU is at the forefront of new ideas, problem-orientated research, inspiring teaching, and creative, high impact engagement with decision makers across government, business and civil society.

October 2015