Memorandum by the Energy Retail Association
1. INTRODUCTION
This paper has been produced by the domestic
energy suppliers forming the Energy Retail Association (ERA).
The Energy Retail Association established in October last year
is the only dedicated trade association for UK energy suppliers.
All the main energy suppliers operating in the domestic market
in the UK are members of the association: British Gas, Scottish
& Southern Energy, RWE npower, E.ON Powergen, EDF Energy and
ScottishPower.
In terms of energy supply the greatest contribution
to energy efficiency is the obligation to achieve energy savings
through the Energy Efficiency Commitment, which is currently being
re-assessed with a view to doubling the carbon savings targets.
ERA members support the principle of extending the Energy Efficiency
commitment from April 2005 and have played an active role in the
work of the Department of the Environment, Food and Rural Affairs
(Defra) High Level Advisory Committee and Target Setting Sub-Groups
during the past year.
In addition, we have strongly supported the
discussions that have taken place in the past 12 months and have
contributed to the debate by producing various reports co-ordinated
by the ERA.
We have welcomed the approach taken by Defra
to elicit widespread input from the various stakeholders having
an interest in energy efficiency and acknowledge that Defra has
already made some modifications to its views on some of the key
issues.
However, we remain extremely concerned that
some of the assumptions made by Defra have not been fully validated
and that insufficient consideration has been given to future price
trends and the impact on energy costs, particularly for our disadvantaged
customers.
Whilst there has been considerable debate about
consumer apathy and the commercial reality of a stagnant market,
it is apparent that Defra believes that energy suppliers can solve
the problem. This is not a view that ERA members share.
2. BACKGROUND
The Energy Efficiency Commitment began in April
2002 and requires energy suppliers to achieve a target amount
of domestic energy efficiency improvements by 31 March 2005.
Suppliers are currently required to spend the
equivalent of £3.60 per customer on energy savings. This
needs to increase by over £10 per fuel by 2008 under EEC2.
The Government sets targets on how much energy savings must be
achieved through the sale of a range of energy saving measures
such as cavity wall and loft insulation, energy efficient light
bulbs and heating system upgrades.
The ERA believes that the industry needs the
widest flexibility in order to deliver energy savings and that
the Government will need to offer fiscal incentives to encourage
house owners and landlords to invest in home energy efficiency
measures. Recent research shows that there is no consumer interest
in insulting cavity walls and lofts at current market prices.
The ERA is working closely with government officials to draw up
a workable Energy Efficiency Commitment that provides the flexibility
for innovation and sets realistic targets for energy savings.
The EEC requires electricity and gas suppliers
to achieve targets for the promotion of improvements in energy
efficiency in the household sector, with a particular focus on
helping low-income consumers. The targets will be met by a combination
of measures; however due to the inflexibility of the proposed
scheme, the key ones are likely to be cavity wall insulation and
loft insulation.
3. KEY CONCERNS
ERA members have many concerns about the proposals,
which even at this late stage in the statutory process are incomplete,
but wish to highlight the following key concerns:
— Consumer appetite to buy products
at the assumed costs and volumes required.
— Dependence on insulation products,
particularly cavity wall insulation and the reliance on the insulation
industry (manufacturers and installers) to invest and grow at
the required rate.
— Base cost assumptions and exposure
to future cost increases.
These are examined in turn in the following
pages.
3.1 Consumer appetite to buy products at the
assumed costs and volumes required
Since the commencement of energy saving programmes
what has been confirmed time and time again is the lack of interest
from consumers in energy saving products and services. Home owners'
latent desire to improve energy saving has had to be targeted
by a range of inducements that has seen the price of measures
to consumers fall while the cost of delivery and installation
has continued to rise. In our collective judgement, this trend
will continue throughout EEC2. This view is supported by the Energy
Savings Trust in its Response to HM Treasury/Defra consultation
on Economic Instruments to Improve Household Energy Efficiency.
The EST study confirmed that whilst consumers
recognise the benefits of energy efficiency measures, they are
not compelled to act. The reason for this was found to be that
consumers believe that it should be the Government and then energy
suppliers who should take responsibility for tackling energy efficiency,
ahead of them being required to do anything. In particular consumers
become disengaged when the issue is linked to wider climate change.
Research has also shown that consumers would be significantly
more likely to invest in energy efficiency if the Government offered
fiscal incentives.
Additionally, the cost of lead generation will
face significant upwards pressure as campaigns aimed at target
group customers not only have to capture the interest and imagination
of customers but also compete with an array of marketing messages
that are increasingly sophisticated in order to elicit a positive
response. It must be recognised that suppliers will find it increasingly
difficult to absorb additional costs and this will need to be
passed through to the customer.
The slump in demand during the summer months
is characteristic of the market for all forms of household insulation
and has traditionally resulted in high levels of unutilized capacity
among installers. The ability of contractors more effectively
to exploit this potential spare capacity is the key to improving
productivity in the sector. The principal instrument to stimulate
demand during summer months, and thereby keep crews busy, is marketing.
Addressing consumer apathy is the key to achieving
the UK's energy efficiency targets. We, therefore, strongly recommend
that fiscal incentives are developed and introduced during the
first phase of EEC2. We continue to support the proposal put forward
by the Energy Savings Trust and Association for the Conservation
of Energy for stamp duty rebates for households that install energy
efficiency measures. This proposal should be incorporated into
the Home Information Packs currently being developed by the Office
of the Deputy Prime Minister.
3.2 Loss of flexibility
Why have suppliers always met previous energy
efficiency targets?
Flexibility has been a key factor towards success
and suppliers must continue to be able to innovate. At the time
EEC1 was introduced the market conditions and policy environment
were different. For example,
— Earlier programmes were significantly
smaller, focussed initially on electrically heated homes and insulation
represented a much smaller proportion of the earlier schemes eg
EESoP1 and EESoP2.
— Emerging opportunities using energy
efficient appliances and low energy lighting presented significant
and viable alternatives to insulation products.
— Earlier programmes included working
with some business customers (up to 100kW ie not SME's) which
widened the scope for products and customer targeting.
— Timescales were more flexible allowing
suppliers to take longer than the programme timescales if necessary
and many suppliers needed to take advantage of this.
— Within a notional/assumed mix of
measures suppliers had much greater flexibility to develop a wide
range of schemes.
— EESoP3 included gas customers for
the first time widening the choice for suppliers to develop boiler
schemes and more insulation work. Even greater interest was developed
in appliance schemes and lower lamp costs meant greater volumes
were delivered.
— In later programmes Local Authorities
became much more interested which has opened up opportunities
for greater volumes through joint working in social housing.
— Availability of social housing has
been a key factor in ensuring targets for EEC1 will be met.
— In all previous programmes, suppliers
felt able to endorse the targets because realistic assumptions
had been made.
In summary, earlier schemes gave plenty of choices
for suppliers via an array of new product options, a growing commitment
from appliance manufacturers, retailers and social housing providers,
a wider audience after gas homes were included and suppliers felt
able to endorse the targets.
Flexibility was the key to success and this
was verified at completion of the scheme, which showed that programmes
were achieved but with a mix of measures that was very different
to that envisaged in the original target models.
EEC2 is also the first programme that is greater
than the current capacity of the energy efficiency industry.
Why EEC2 is a different case?
Apart from the obvious difference of scale between
EEC2 and earlier programmes the loss of flexibility and over reliance
on cavity wall insulation are the main concerns.
There appears little prospect that anything
new will be added to the product portfolio and some of the previous
measures are unlikely to feature in EEC2 despite being included
in Defra's target model.
The following factors illustrate loss of flexibility
and increased challenges imposed by changes in targeting and accreditation:
In particular;
— Some 82 per cent of EEC2 target is
anticipated to come from insulation products.
— Some 2 million appliances are expected
to deliver about 1 per cent of target but the removal of the uplift
factor and the inclusion of the heat replacement effect will seriously
affect this channel as a viable option to suppliers.
— Lighting schemes have become less
attractive through the imposition of the heat replacement effect
and additional constraints on targeting and verification currently
being considered by Ofgem make direct mail and charitable schemes
unattractive.
— Boilers, whilst still included, are
less attractive and at this stage the details of the 1 million
"exception boilers" is unknown. Additional monitoring
requirements proposed by Ofgem (testing of boiler interlocks)
are also likely to close this channel as a viable option due to
the increased cost.
— Additional verification requirements
and correction factors make DIY loft insulation less economic.
— Heating controls are less likely
to be delivered unless linked to boiler upgrades.
In summary, there will be too strong a dependence
on Cavity Wall Insulation and little flexibility to make a contribution
from other products.
3.3 Dependence on insulation products, particularly
cavity wall insulation and the reliance on the insulation industry
(manufacturers and installers) to invest and grow at the required
rate
There can be no doubt that the high dependence
on cavity wall and loft insulation poses a serious risk to the
delivery of the energy savings target and also to the programme
cost.
We have valid concerns about the capability
of the insulation industry to grow at the required rate and are
not convinced that sufficient infrastructure exists, as claimed.
The insulation industry's position that 1,000 machines is enough,
so long as the demand can be lifted for delivery evenly throughout
the year is in our view an implausible argument.
We do not believe it will be possible to smear
demand in the way we would all wish, at the national volumes required.
Equally, we do not believe that the industry
would have previously invested in a capacity capable of delivering
annual volumes of some 600,000 installations when historically
the annual demand has never exceeded about 300,000.
The ERA commissioned an independent study of
the insulation industry. We understand that this is the only in
depth assessment of the industry's ability to deliver at the rate
anticipated by the targets.
The number of installations currently achievable
using currently operational machines at full productivity is insufficient
to fulfil the target number of installations. Even at maximum
productivity, only around 70 per cent of the required installations
could be filled using the machines currently operational.
Assuming that capacity remains static, it is
estimated that the productivity of existing crews would have to
increase from 2.14 installations per day to 4.44 installations
per day over the three years from 2004-05 to 2007-08 in order
to achieve the EEC2 targets. This is significantly greater than
2.5 installations per day, the estimated maximum number of average
daily installations. There appears to be only modest scope for
achieving productivity improvements over the coming years (say
5 per cent per year), unless there is a significant smoothing
of demand across the year.
Assuming, conservatively, that there is no growth
in the number of non-EEC installations (including new build and
domestic non-EEC) over the period between 2005-06 and 2007-08,
the EEC targets imply that some 2.1 million cavity wall installations
must be carried out of which 1.7 million (more than 80 per cent)
will comply with the requirements of EEC2.
Whilst the sector expresses confidence in its
ability to meet the EEC2 targets, it is unclear how the scale
of change can be achieved given the challenges faced. Assuming
that the contractor sector achieved annual growth in capacity
and productivity of 10 per cent and 5 per cent respectively over
the period between 2004-05 and 2007-08, it is estimated that the
shortfall in installations compared with the EEC2 targets would
be in the region of 400,000.
3.4 Price trends and risk to energy prices
As expressed previously, we are concerned that
the base cost assumptions included in the EEC2 model prepared
by Defra are vastly different from those experienced in the market
place. Assumed future cost trends do not sufficiently take account
of the investment that will be necessary in the insulation industry
in particular.
The recent imposition of a 20 per cent increase
in the cost of loft insulation is a clear example of the volatility
of the insulation sector and in our view this scale of increase
is likely to be repeated on a frequent basis in the future.
There appears to have been of the order of 4-5
per cent increases in the costs of cavity wall insulation in the
space of around a year, in both the social and private segments
of the market.
Loft insulation costs appear to have risen by
even more (between 5 per cent and 10 per cent depending on grade
of insulation) in the private segment, but there has not been
a material change in cost levels in the social segment. ERA members
have recently re-tendered for supplies of both CWI and LI for
the EEC2 period—we understand that the tender prices received
range from 10 per cent to 35 per cent above current EEC1 costs
depending on the material and intended use.
4. KEY FACTORS
FOR SUCCESS
ERA members believe that for EEC2 to be successful
in delivering its environmental target other factors must be taken
into account:
— Meeting the energy savings target.
— Mitigating the effects of fuel poverty.
— Developing an efficient manufacturer/installer
infrastructure.
— Delivering high quality & safety
standards.
— Transforming the market for energy
efficiency products & services.
— Delivering good customer experience
& supplier branding.
— Within the budget forecasts.
5. ACTIONS/RECOMMENDATIONS
— Defra should urgently review its
target setting model in light of the comments noted above and
in particular come forward with more reasonable target savings
that can be met for the costs envisaged.
— We have indicated that the industry
can achieve a maximum of 1.3 million cavity wall insulation installations.
We must either increase the spend to over £10 per customer
per fuel or reduce the overall target.
— ERA members support the proposal
to expand the initiative by energy suppliers to commission an
independent review into the insulation industry with a view to
provided Defra with more accurate information to inform its target
setting.
— Further consideration needs to be
given to the proportion of savings targeted at the priority group.
Indeed, we do not believe that the current proposals are realistic
and may not represent the most effective means of targeting priority
customers.
6. OTHER ISSUES
Disability Living Allowance and Attendance Allowance
We believe that customers in receipt of the
DLA or AA should be included within the definition of the Priority
Group. It is very difficult to define the factors that contribute
to fuel poverty, but low income is not the only symptom. Any improvement
for vulnerable customers must be welcomed and the current qualifying
criteria should be sustained. The less attractive option would
be to reduce the priority group share in line with the number
of households no longer eligible because otherwise the 50 per
cent target is unrealistic.
Interaction between EEC2 and Warm Front
ERA members are generally supportive of closer
working so long as this is optional for individual companies and
have contributed to recent discussions to establish suitable arrangements
Energy Service Enhancements
ERA members support Government's proposal to
provide an incentive for energy services for the first year of
EEC2 but believe this should be extended for the whole of EEC2.
It is not yet clear to what extent energy services will contribute
towards achieving EEC2 targets. Energy service packages require
sustained investment by suppliers and any extension to the pilot
allows time for the impact of the initiative to be properly assessed.
— Defra and Ofgem should urgently review
their proposals to ensure consistency. In particular, Ofgem's
proposals for additional monitoring, targeting and verification
will, if implemented, effectively remove a number of measures
from EEC2 that Defra have included in their target model. Clearly,
this does not represent a coherent approach to setting reasonable
targets on suppliers for EEC2.
— We welcome the proposal for a high
level advisory group to be established with the necessary powers
to intervene and review EEC2 if necessary. ERA members look forward
to playing a constructive part in defining the scope of the high
level advisory group and setting realistic review implementation
levels.
October 2004
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