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Energy efficiency: the missing piece in the Energy Cost Review jigsaw

Prof. Nick Eyre, Research Councils’ Energy Demand Research Champion, responds to the Cost of Energy Review

The exclusion of gas and transport fuels from the Review is odd, given that both of which form major parts of energy costs. However, these remarks follow the review in focusing on electricity.

Energy Efficiency Evidence

The diversity and scale of energy efficiency research evidence far exceeds what can be set out here.  The Research Council funded End Use Energy Demand Centres alone have produced more than 500 outputs in the last 5 years.  In addition, there is relevant evidence from the work of the UK Energy Research Centre and the Tyndall Centre, as well as research by specialist organisations outside universities (e.g. BRE, EST, NEF, ACE and NEA) and evidence commissioned by Government (e.g. the Bonfield Review and the Electricity Demand Reduction project).  It appears that none of this has informed the Review.

Energy Efficiency: the dominant driver of cost reduction

Energy bills, in commodity driven tariff structures, are the product of unit price and demand.  Even with more complex tariffs in future, energy costs will remain a function of supply price and energy demand.

Historically, energy prices have fluctuated, but energy efficiency has improved monotonically.  Over any significant historical period energy efficiency has therefore been the dominant driver of cost reduction.  UK final energy demand is now lower than in 1970, and 15% below the peak demand year of 2004, despite huge growth in economic activity and energy service demand in the intervening years.  This is due to energy efficiency.  It is widely accepted that this reduction trend will need to accelerate if energy policy goals are to be met.  The Committee on Climate Change projects a 25% energy efficiency improvement in the years 2014-2030 (1).

The CCC recognises that this pace of improvement is not automatic.  Energy efficiency policy interventions are necessary and have historically been highly effective in reducing energy bills.  The Cost of Energy Review recognises this historical effect of policy (2) but does not review the policy intervention options or their outcomes going forward.  This is a major gap in its analysis.

The impact of recent policy changes

The Review also contains very limited analysis of the effectiveness of current (as opposed to historical) energy efficiency policy.  There have been substantial reductions in policy effectiveness in recent years.  The largest change results from the move from the 2008-2012 supplier obligation (CERT) to the far less ambitious current scheme (ECO).  The efficient use of electricity (other than in heating) is excluded from this more recent obligation.  This change was accompanied by the introduction of the unsuccessful Green Deal scheme, but the reduction in supplier obligation activity rather than the failure of the Green Deal was the dominant effect.  In the same period, other energy efficiency policies have been abandoned or reduced in effectiveness, including the CRC Energy Efficiency Scheme and the Zero Carbon Homes policy.  These changes have increased energy costs.

Given this context, we must be careful how we interpret the energy efficiency policy picture painted by the Review.  Two of its key diagrams (Figures 42 and 43) could easily be misinterpreted to show increasing energy efficiency activity. In fact, both start in 2012, i.e. the year in which policy effectiveness was substantially reduced, obscuring this change; and they show cumulative savings, so the rising curves only indicate some policy activity, not an improving policy environment. Even with the policies set out in the Clean Growth Strategy, current policy instrument plans are significantly less ambitious than this in operation before 2012, and they are inadequate to deliver long term policy goals.

The Energy Efficiency Policies that we need

Policy intervention is justified where there are market failures that reduce economic efficiency, such as non-price barriers to cost-effective energy efficiency.  There is a very large literature on these barriers and UK research has played a major role in their analysis.  Much of the evidence supports the assertion in the Review that standards are an appropriate policy response.  The Government’s Electricity Demand Reduction project identified EU product standards as the most important future policy instrument, especially in the residential sector.

However, standards are not a panacea for addressing the market failures that constrain energy efficiency.  Indeed the range of policy interventions set out by the Review (3), and criticised for being too complex, can largely be ascribed to the number of sectors and barriers that need to be addressed.

Existing buildings are particularly problematic, given their long lifetimes.  Given this, the Review does not justify its rejection of supplier obligations as a mechanism for addressing market failures.  The obligations were introduced by the Major Government in 1994 explicitly to address the market failure of suppliers having a vested interest in increasing demand. Data cited by the Review (4) shows how cost-effective the current obligation is.  Widespread international experience, as well as evaluations of previous phases of the GB supplier obligations, confirm this more generally.

Supplier obligations and related mechanisms essentially shift investment from generation to end use efficiency.  By doing this, they enable the same level of energy services to be delivered at lower total cost and therefore with lower overall consumer bills.  In other words, the scale of the market failure is reduced and economic efficiency is improved.  There is good evidence to suggest that supplier obligations alone will not be sufficient to deliver the necessary scale of deep refurbishment of existing buildings, but that is not a reason for their abolition.

Fuel poverty and economic efficiency

The Review recognises the nature of electricity supply as a public good and the implications for a universal supply obligation.  However, it takes the classical economic approach of separating consideration of economic efficiency from distributional issues.  It considers fuel poverty as a social and distributional issue, which it is not appropriate to address through energy market obligations.

Of course, there is much that can be done to address fuel poverty via social policy.  However, fuel poverty is associated with a failure in capital markets, in that low income house-owners are constrained from undertaking energy efficiency investment by lack of access to capital, not the absence of cost-effective projects.  Distributional issues therefore directly affect the market failure of under-investment in energy efficiency, and therefore economic efficiency.

Reasonable people can, and do, take different positions on the relative roles of energy levies and general taxation in funding fuel poverty programmes, but fuel poverty cannot easily be separated from economic efficiency.

In summary

End use efficiency is the largest, long-term driver of energy costs, reducing costs at all of the upstream stages focused on by the Review.  Energy efficiency improvement has been a major driver of cost reduction and carbon emissions reduction, and it will be necessary for this to continue if energy policy goals are to be delivered.

The Review neglects the large evidence base now available on energy efficiency in the UK and its policy drivers. It recognises energy efficiency’s broad role in reducing costs but there is no analysis of the implications for public policy, in particular the complexity of addressing the relevant market failures.

The Review fails to recognise that changes in UK energy efficiency policy since 2012 have seriously undermined policy effectiveness, increasing energy costs.  It appears to assume that energy efficiency improvement can continue at faster than historical rates with weaker than historical levels of policy intervention.  This assumption is not supported by the available evidence.  As a result, the Review does not adequately consider options for stronger energy efficiency policy.  Moreover, it recommends, without justification, the discontinuation of highly effective policy instruments, which would further weaken policy.

In short, the Review is highly skewed towards considering supply-side issues and away from demand side policy.  It will be necessary to undertake a parallel review and analysis of the potential, barriers, and policy instruments for energy efficiency, if a reliable policy framework on energy costs is to be developed.

(1) Committee on Climate Change (2015), Advice on the Fifth Carbon Budget, as quoted in the Cost of Energy Review, Figure 3, p12

(2) Figure 14 and Chart 7, page 43

(3) Table 3, page 41

(4) Page 185

(Image courtesy of TaxRebate.org.uk)

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