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Non-domestic energy efficiency – policy design principles

Dr Peter Mallaburn is Director of Policy and Governance at the Energy Institute, University College London, and Editor of Climate Policy Journal. He has represented the UK on air pollution, climate modelling and energy policy in the EU, OECD and the IEA and worked on international climate negotiations. Peter helped write the UK’s first Climate Change Programme, set up the Carbon Trust, was Salix Finance’s first CEO, and set up his own consultancy, Policy to Practice, in 2008.

The government is currently reviewing its non-domestic energy efficiency policies as well as its wider policy portfolio as part of the Carbon Plan. DECC’s 2016 Departmental Plan provides some context:

Although the energy intensity of the UK economy has fallen by 24% since 2004, there remains significant untapped potential for energy saving in the business sector. Realising this potential will improve businesses’ productivity and will also support growth. But the business energy tax and policy framework is complex and businesses tell us it does not provide the incentive it could to reduce energy consumption. 

This article contributes to this process by outlining our state of knowledge on energy efficiency and identifies some key policy principles around which a new energy efficiency programme could develop. It is drawn both from the literature and from direct policy experience in the UK and overseas.

Salience: energy efficiency in an investment context

Investments in energy efficiency require very high rates of return compared to similar non-energy projects. This is the energy efficiency “paradox”, and the conventional economic wisdom was that hidden costs and barriers eroded the apparent cost effectiveness of the investment, preventing the company, as a rational economic actor, from making the right, profit-maximising decision.

However, observational evidence from the early US programmes1, showed that many companies implemented seemingly unprofitable investments. Clearly, for these companies, energy efficiency had gained a value, or “salience” that outweighed simple economic considerations. Further research uncovered a range of salience “drivers” operating on these companies, including reputation, competitiveness and the regulatory landscape. Taking reputation as an example:

  • Companies that deal with the public use energy and environmental performance to enhance their reputation and gain a competitive advantage in constrained markets. Examples are retail, banking and energy as well as public bodies such as Universities and charities.
  • Companies that primarily deal with each other are less likely to respond to reputational drivers. Examples are construction, component manufacturing, corporate finance and commercial leasing.

Salience drivers were subsequently shown to work by acting directly on the company’s internal investment decision-making process2. The default for non-energy intensive companies is that energy efficiency is generally seen as a non-core, discretionary issue. Salience drivers flip energy efficiency from being an operational issue to a to strategic one, making the investment much more likely to go ahead. To adopt a physical analogy, salience drivers increase the “signal to noise ratio” in the company.

Lessons for energy efficiency policy

Experience from programme development studies carried out in the early 2000s is that there are two requirements for designing a new incentive programme. Firstly, the right “pressure points” had to be located in the normal business investment cycle where government intervention could boost salience, but without conflicting with other priorities such as competitiveness and growth. For example:

  • Investment is part of a three stage process: recognition, identifying options and evaluation. However, most research (and therefore most evidence-based policy) has focused on the econometric analysis leading up to the final decision.
  • Lack of funding is rarely a barrier except in smaller companies. More commonly is it the lack of the right sort of funding, e.g. lack of capital or debt, and sometimes, particularly in the public sector, it is simply the lack of a budget line or the ability to transfer between budgets.
  • Because of its contingent nature (cost followed by benefit), the way energy efficiency investment is described or “framed” is very important. For example, using “avoided loss” works better for many companies than “efficiency gain”. Similarly net present value (today’s value of all future returns on the investment, net of investment and maintenance costs, is a better metric than payback (the time it takes until the investment cost is recouped).
  • It is important to understand how the organisational and cultural aspects of the company influence salience: how energy managers work with senior management “champions”, the role of the Board and the value that the workforce places on a strong company reputation.
  • Visibility is very important: energy efficiency is generally seen as one of a number of routine, operational decisions, all competing for limited staff and resource. Increasing salience involves finding ways in raising it above the operational fray.
  • The organisational and culture aspects of salience have considerable potential within a sector: peer-to-peer networks, supply chains, mentoring and benchmarking are powerful drivers because no company wants to be left behind or placed at a competitive disadvantage.

Second, policies had to be deployed at these pressure points to encourage the organisation to switch investment towards energy efficiency. There is less dedicated research on this. However there are some studies that have generated insights into the interaction between policy and salience
3. For example:

  • Performance reporting is perhaps the most comprehensive policy tool because it acts on a number of pressure points: making energy visible, gathering and understanding performance information, and connecting energy management teams with senior management.
  • Making reporting mandatory, or penalising poor performance with stricter regulations, amplifies the salience effect by putting energy efficiency firmly onto the company’s risk register, which automatically involves the Board.
  • However, management and reporting standards and other regulatory policies need to be carefully calibrated and selectively applied. Highly regulated sectors can actually prefer mandatory reporting as long as their competitors are similarly constrained. Other sectors respond better to more co-operative approaches such as voluntary agreements.
  • Fiscal policies are valuable in themselves but they also can have impact beyond their financial value by engaging the finance director, demonstrating the value of energy efficiency and embedding energy efficiency in the accounts (particularly for public sector organisations).
  • Financial instruments based around the tax system (rebates, discounts) have a strong behavioural impact because, to the finance director, the best sort of avoided loss is taxation.
  • Product- and technology-based rebates (such as Enhanced Capital Allowances) can also stimulate innovation and technology diffusion. They can also be used to stimulate the manufacturing sector to develop, innovate and market energy efficiency products and services.

Elements of a new incentive programme

Evidence for assembling policies into programmes comes mainly from the experience of governments that have done this already in countries with similar political and market conditions to the UK. There are a wide range of international policies and measures databases with this sort of information (International Energy Agency, UN Framework Convention on Climate Change, the EU) as well a limited number of dedicated reviews4. The main insights include:

  • Programme design needs to focus on two aspects to increase the salience of energy efficiency: (1) how to get energy efficiency noticed and valued by an organisation, and once that is done, (2) giving the company the support it needs to make sure that the investment happens and that the savings are made and maintained.
  • Investment processes are complex and company-wide, and policies need to reflect this by ensuring that incentives are co-ordinated and deployed to match the normal investment cycle. So, for example, the imposition of performance reporting standards needs to be complemented by controlled energy audits and energy management advice.
  • The audit programmes operating in many countries offer a model of how to implement co-ordinated incentive programmes. These focus government interventions around company audit and energy management programmes so that support is deployed according to need and progressively removed as performance improves.
  • An alternative model is the network and supply chain programmes operating in Germany and Switzerland. These encourage large and small companies to co-operate in delivering collective energy saving targets, with government support taking second place to self-help, mentoring and other networking activities.

What is also illuminating from all this research is our growing understanding of why the programmes designed in the early 2000s are no longer fit for purpose. These insights should allow us to review and adapt these programmes rather than invent brand new ones. The Energy Savings Opportunity Scheme (ESOS) would be a prime candidate for this approach.

Further work and recommendations

This paper is a very superficial skim over the evidence and experience on designing energy efficiency incentive programmes. A much more structured comprehensive evidence review would be needed if the government wanted to take this work forward.

There are also a number of major research gaps in our understanding. The main ones include:

  • Developing a policy typology: the way companies react to salience drivers is, to a large extent, predictable and it should be possible to assemble a typology of companies based on energy behaviours. The government has used typologies to analyse other environmental issues5 and this methodology could be adapted to energy use and efficiency.
  • Energy behaviours of some sectors are well researched, particularly industry and commercial offices. However most other sectors are poorly understood: SMEs, schools, retail, government estate, public offices, sports, heritage, entertainment, healthcare, transport and communications.
  • The role of non-energy drivers: how energy efficiency policy interacts with asset value, growth, competitiveness, staff welfare and productivity, peer positioning and other similar business drivers, both positively and negatively.
  • Networks and supply chain effects offer significant potential benefits and yet are poorly understood. For example, sector “cohesiveness” is known to have an impact on how risk is managed and yet very little is known about how this effect works and how it could be exploited.
  • Lessons from international programmes are valuable, but more analysis needs to be done to extract the key features of relevance to the UK and also to understand the cost-effectiveness and deliverability of these programmes.
  1. Decanio, S. J. (1998): The efficiency paradox: bureaucratic and organizational barriers to profitable energy-saving investments. Energy Policy, 26 (5): 441–454.
  2. Cooremans, C. (2011): “Investment in energy efficiency: do the characteristics of investments matter?” Energy Efficiency, 5: 497-518.
  3. DECC (2012): What are the factors influencing energy behaviours and decision-making in the non-domestic sector? DECC, London.
  4. Mallaburn, P. (2015): International non-domestic energy efficiency policies: lessons for the UK. DECC, London.
  5. Defra (2008): A framework for pro-environmental behaviours. Defra, London.

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