Energy Bill

Memorandum submitted by Dr Nick Eyre, University of Oxford (EN 26)

Energy Saving Feed-in Tariffs

Executive Summary

· Energy saving feed-in tariffs (ESFITs) are a relatively new concept and are designed to use the same principles as Feed in Tariffs for renewable energy (REFITs).

· They offer a promising way of improving electricity efficiency and reducing electricity demand, thereby decreasing carbon emissions.

· The Electricity Market Reform (EMR) proposals currently provide a bias towards investment in new supply that could be addressed using ESFITs.

· In the context of EMR, ESFITs offer a means of delivering decarbonisation with a lower impact on consumer bills.

· Because ESFITs do not rely on energy companies, they would provide incentives for innovation in project delivery in a much wider range of actors including householders, community groups, local authorities and small businesses.

· The concept of ESFITs is simple, but there are detailed policy design issues that still need to be addressed.

· Primary legislation will be required and could be included in the Energy Bill.

1. Introduction

A key aim of energy policy is to reduce carbon emissions. UKERC and other analysis shows that to achieve this at reasonable cost, it is necessary to both develop cleaner energy supplies and reduce energy demand.

Existing Feed-in tariffs for renewable energy (REFITs), which offer generators of renewable energy a guaranteed level of payment for energy they produce, are designed to promote the development of clean, carbon free electricity generation. Energy Saving feed-in tariffs (ESFITs) would be designed to use a similar approach to encourage reductions in energy use. This evidence is based on a very recent paper (Eyre, 2013) in the journal Energy Policy, which is the world’s first peer-reviewed publication on this topic.

Historically energy efficiency improvements have made a far greater impact on reducing UK carbon emissions than supply side changes. Recent Government estimates (in the Electricity Demand Reduction consultation , DECC, November 2012 ) indicate that improving the energy efficiency of electricity could reduce demand by more than 40% by 2030. However, in their current form, the EMR proposals offer significant subsidies for all low carbon generation technologies, but none for reducing demand. This risks an inefficient outcome with higher bills for consumers than are necessary to deliver the key aim – secure energy services with carbon emissions reduction. ESFITs could play an important role in meeting energy and carbon goals, but will require policy change to do so.

2. FITs for Megawatts or Negawatts?

REFITs were first set up in Germany in 1990 to encourage the development of renewable electricity generation. They are a market mechanism, designed to encourage growth and innovation among renewable generators. Renewable electricity is currently more expensive that electricity produced in conventional fossil fuel power plants. By supporting growth in the renewables market, the aim is to cut the cost of these technologies, and ultimately eliminate the need for subsidies.

In the UK, REFITs are currently used to help only small scale renewable electricity generators. However, the EMR proposals include contracts for difference (CFDs), which are essentially FITs for all new low carbon power generation - renewables, nuclear power and fossil fuel generators that use carbon capture and storage (CCS). However, neither REFITs nor CFDs address the issue of the need to improve efficiency and reduce energy demand.

ESFITs, by contrast, are conceived specifically as a way to reduce energy demand, thus reducing the need for new generation. The basic idea is to offer a fixed price subsidy for each unit of energy saved. This would encourage investment in ‘negawatts’ as an alternative to generation. Savings delivered via demand reduction can be thought of as creating a ‘negawatt’ power station. ‘Generating’ negawatts, rather than simply building new generating capacity, offers a number of advantages. It is generally cheaper than generating more electricity, does not require the building of large new infrastructure, and therefore can be delivered more quickly.

3. ESFIT Advantages

The introduction of ESFITs would offer a number of advantages. They are well suited to the proposed GB electricity market structure under EMR, as they would offer incentives to demand reduction that are consistent with those proposed for electricity generation.

ESFITs would largely support energy saving technologies that are already cost effective. This would increase the economic efficiency of providing electricity services - enabling decarbonisation at the lowest cost to consumers. It would also mean less pressure to increase electricity production as quickly, which can be problematic in terms of, for example, securing planning consent, deploying new unproven technologies, and increasing consumer prices.

By offering a transparent, guaranteed price support system, ESFITs would encourage awareness of the importance of energy efficiency, especially its role in reducing carbon emissions. And because ESFITs do not rely on energy companies for delivery, they would provide incentives for innovation in project delivery in a much wider range of actors including householders, community groups, local authorities and small businesses.

4. Design issues

To deliver the potential advantages ESFITs offer, there are policy design issues to be addressed.

4.1 Measuring and calculating payments

The basis for calculating ESFIT payments is a key issue. Unlike electricity generated, a quantity which can be metered, ESFITs payments would be based on energy efficiency savings that are harder to measure. Adopting a simple approach – such as using the annual reduction in energy use – risks offering payments for savings that occur due to factors unrelated to energy efficiency improvement, such as building occupancy or manufacturing output. In industrial settings it will be possible to use well-established monitoring and verification methods to address this. But for households and small companies this is not realistic. A more feasible approach is to use the expected average (deemed) savings for each technology deployed, an approach that has been well established in UK energy efficiency programmes (ECO and its predecessors) for nearly 20 years.

The most important issue is to determine the size of the appropriate payments. Equity with the treatment of low carbon generation technologies in EMR implies that ESFITs should be set at a level equal to the premium payment of the ‘strike price’ for these technologies above the wholesale market price for electricity. For example if the latter is £80/MWh and low carbon generation technologies are paid at least £118/MWh, an ESFIT of £38/MWh (3.8 p/kWh) is justified. However, there are arguments for even higher payments to address the well-established additional barriers faced by energy efficiency investments. These could be as high as the strike price itself. These arguments are provided in detail in the peer reviewed publication upon which this evidence is based (Eyre, 2013).

4.2 Different fuels

The treatment of different fuels needs consideration. Most discussion of FITs focuses on electricity, but direct use of fossil fuels also leads to carbon emissions and can also be reduced by energy efficiency. Moreover, much analysis of climate change mitigation indicates that electricity may need to replace fossil fuels for heating, and therefore that energy efficiency improvements in buildings that largely save gas today may ultimately save electricity. This points to including such measures within the scope of ESFITs.

4.3 Approaches to ESFIT payment

The method of payment also needs attention. The biggest individual users of electricity are in the industrial sector, but two thirds of the electricity generated in the UK is used in households and non-domestic buildings. This highlights the need to target electricity saving measures at all users, and to designing approaches appropriate for all. For very large industrial users capable of participation in the electricity wholesale market, payments might be made based on half hourly wholesale price. But for the vast majority of users, payments will need to be made through the retail market. Moreover, capital grants are expected to be more effective than kWh payments spread over the life of the project (see Eyre, 2013). The appropriate scale of these payments for common technologies is set out in the table appended to this evidence.

5. General conclusions

My conclusion is that, despite the complexity of some issues, ESFITs could be designed to reward the benefits of energy efficiency, and would fit well with proposed new policies under EMR. They would provide a transparent incentive to households and companies alike to adopt technology and procedures to save electricity. Important details remain to be worked out, but ESFITs would provide an effective complement to the proposed CFDs in EMR, improving market efficiency in delivering carbon reduction.

6. Implications for the Energy Bill

The logic for including FITs for energy saving in the EMR proposals is based on the simple proposition that the fairest and most economic approach to decarbonisation requires equal treatment of low carbon generation and energy saving. But the appropriate mechanisms may need to be different. The reason is that generators interact with the electricity wholesale market, whereas energy users predominantly access the retail market.

In principle it would be possible for FITs for energy saving to be paid via the wholesale market through aggregation of many individual energy saving actions. However, this would involve additional complexity and cost. Moreover it would entail the public and system benefits of energy saving being subject to trading by the dominant actors in the wholesale market, the vertically integrated ‘Big 6’, for whom there is no business case for successful energy demand reduction. A more effective and transparent approach will be to pay ESFITs directly to final users or their agents.

For the reasons set out above, there will be a requirement for many detailed rules, for example on eligible technologies and techniques, accreditation, customer complaints, monitoring and verification, and payments by energy suppliers. None of these need to be fundamentally more difficult than what is done in the existing arrangements for energy supplier energy efficiency obligations (ECO and its predecessors) and payment of renewable electricity FITs. But the arrangements will be complex and therefore require consultation on the detail. They are therefore better done through Statutory Instrument (SI) than included in primary legislation.

But without primary legislation, ESFITs cannot be adopted, and the Energy Bill provides the logical place to do this. I am not a lawyer, and therefore do not propose to set out proposed amendments to the Bill. But from my experience of the operation of existing energy legislation, I suggest that the Energy Bill needs amendment in four important ways.

a. Most importantly, to provide the powers to the Secretary of State to introduce statutory instruments (SIs) to provide for ESFITs. And specifically within this framework:

b. To specify that payments may be made for fixed sums for using energy saving technologies and techniques, on a range of timescales (e.g. annually or as a single payment) both for electricity users and, for the reasons set out above, energy users more broadly. These should be based on verification techniques to be set out in the SIs. The legislation should ensure that payments may be made to both energy users directly, or to other agents of energy efficiency improvement, including energy suppliers, energy service companies, equipment retailers, local authorities and third sector organisations.

c. To allow for licence modifications of all classes of energy suppliers to enable the SIs to recover the costs of ESFITs from energy suppliers and, by implication, to socialise the costs across their customers. Fairness indicates that this should allow for costs to be specific to classes of licence, e.g. for household electricity efficiency improvement costs to fall on domestic supply licence holders.

d.  To provide for the formation of a counter-party to make the ESFIT payments and recoup their costs. This counterparty will need to be backed by HMG, for the same reasons as the CfD supply counterparty. In my view it is an open question whether the counterparty should be the same as for the supply CfDs. Arguments in favour would be institutional simplicity and effective management of the Levy Control Framework. Arguments against would be that the focus is very different – retail market, end users and the energy efficiency industry in this case – compared to wholesale market participants for CfDs. I believe this question of the choice of counterparty does not need to be resolved at this stage, but the existence of one with the relevant powers and duties does need to be in the primary legislation.

Reference

Eyre, N. (2013). "Energy saving in energy market reform-The feed-in tariffs option." Energy Policy 52(0): 190-198.

Table: Indicative ESFIT payments

Energy efficiency technology	Initial heating technology	ESFIT single capital payment (£)
Loft insulation	Gas	£483
Cavity wall insulation	Gas	£977
A rated boiler	Gas	£145
Solid wall insulation	Gas	£2,802
Solid wall insulation	Electricity	£7,004
80% carbon reduction retrofit	Gas	£5,194
Light emitting diode lamp	Electricity	£16
A+ wet appliance	Electricity	£37
Real time display	Gas	£7
Ground source heat pump	Electricity	£6,172
Fuel cell micro-CHP	Gas	£1,753

[These calculations are based on the assumptions that ESFITs would be paid as a single capital grants, equivalent to £38/MWh saved over the lifetime of the project. £38/MWh is DECC’s estimate for the difference between the levelised costs of offshore wind and gas fired generation in 2012. More detail on the energy saving calculation methodology is given in Eyre (2013).]

January 2013