healthier, happier and richer

The UK energy regulator, Ofgem, has produced a report on Project Discovery (see 11 February 2010: UK regulator discovers failings of free market) that has been a wake-up call to all of us concerned about climate change. The era of cheap energy appears behind us. According to Ofgem, the industry might have to spend between £140 billion and £240 billion between now and 2020 on generation, transmission and distribution infrastructure. How we are finance this investment is a huge challenge for the new government.

However, aside from this supply side story, there is another story evident in public discourse – one of distributed generation, of local and community level schemes and of whole-house improvements to people’s homes. The UK government hasn’t put a figure on how much households need to invest in improving their homes, especially the difficult to treat homes with solid walls or which are not on the gas grid. On the other hand, consumers instinctively like the idea of less wasteful and more energy efficient homes, of surplus heat from power plants being exploited and of ‘clean’ local energy like solar panels.

But what is missing is a coherent plan of how the programme set out will be financed or delivered. Certainly, there is a plethora of different schemes and inducements to bring about this vision: Renewables Obligation (RO), Carbon Emissions Reductions Target (CERT), Community Energy Savings Programme (CESP), Carbon Reduction Commitment (now renamed CRC Energy Efficiency Scheme), Warm Front, Decent Homes, to name just a few. How many could confidently convert this alphabet soup of acronyms into words and explain their intent? The sad reality is the well-meaning schemes, designed in silos, fail to deliver what is really needed, which is a system that discourages energy waste, targets help to those people most at risk of falling into fuel poverty, provides secure energy and ensures that investment is undertaken in the most cost-effective and efficient manner.

Such criticisms are easy to write-down, but hard to remedy. Just to take the final point – cost-effective investment – in theory, consumers’ desire for sustainable warmth might be met either by improved energy efficiency, renewable energy sources like solar water heaters or biomass, heat pumps powered by decarbonised electricity or by district heating. However, the field on which these approaches compete is far from level. The investment in gas and power networks has either been paid off already or is financed cheaply because investors’ interests are protected by the energy regulator. Insulation for the able to pay consumer has to be funded at whatever interest rate the household can borrow money at. At present, the renewable heat technologies are unsupported in the UK, but will be incentivised through the renewable heat incentive from 2011. Investment in district heating is largely financed by property developers as a consequence of planning agreements and is, therefore, kept to the barest minimum. A hotchpotch of measures such as these, each worthwhile in isolation, is bound to lead to an inefficient allocation of resources. This, of course, means the customer has to pay more than he or she strictly needs to keep warm.

A New Energy Infrastructure is a paper that Ed Mayo and I wrote to provoke debate on this issue. We set down some ideas for discussion. We do not have all the solutions, but we feel now is the time to have this debate with the new government considering how to meet its climate goals without incurring new public spending commitments and ideally without worsening fuel poverty.

There are six main elements to our proposal:

1. Integrated plans for community energy efficiency, network development and decentralised heat generation lead by local authorities.
2. Franchising investment. Introducing competition to build and operate the planned investment.
3. Establishing a new class of regulated assets.
4. Integrating the social and energy efficiency schemes.
5. Assessing bids for least cost, social and environmental objectives.
6. Rolling-out community energy services.

Deciding which low carbon technology should be deployed is as much a local political issue as it is an economic and technological issue. Anyone in the on-shore wind or energy-from-waste business knows this already. We suggest that local authorities are best placed to broker the necessary compromises, especially if they have local carbon budgets to meet.

Our second and third suggestions are that the investment programme should be delivered through local franchises. The local authority, working with advisors, would define its technical requirements. There might be good reason to offer multiple contracts covering energy efficiency, district heating and distributed generation. To reduce the cost to the consumer, we argue that the franchise is funded by creating a new Regulated Asset Base, which is the “cheap” way we finance investment in electricity and gas networks. Money would be raised through money markets, perhaps by issuing green bonds. Once the investment is available for use, the franchisee would levy a charge on the consumer, similar to how gas and electricity networks recoup a return on their assets. The payment itself could be made either through one of the existing utility bills (water, gas or power) or through council tax. The Energy Savings Trust is presently trialling the Pay-As-You-Save (PAYS) concept to see how consumers respond to different payment vehicles. The results of this pilot will be of relevance to this debate too.

The fourth suggestion is that the plethora of different cross subsidies and grants to help households at risk of fuel poverty – including Decent Homes, Warm Front, Winter Fuel Payment, CESP and priority group CERT – be simplified and routed through the franchise. This might either be a reduction in the PAYS charge mentioned above or a contribution to the investment cost, when costs are first incurred.

Local authorities are unlikely to have the skills to fully manage the process of franchising and defining performance and standard of service criteria. In our fifth point, we suggest Ofgem has a prominent role in supervising the awarding of the franchise and benchmarking the franchisee’s performance. It is already fulfilling a similar role in the Offshore Electricity Transmission franchise. Ofgem already also operates the UK government’s CESP, CERT and RO schemes, so has many of the requisite skills needed to assess the economic, carbon and social strengths of bids.

Getting the infrastructure decision right is important, but so too is encouraging reduction in demand. The ideas described above create mechanisms and contracts that can roll-out investment in decentralised energy provision and energy efficiency according to local priorities. However, gas and electricity suppliers still have no incentive to encourage behavioural change and manage demand for energy. A community Energy Service Companies (ESCO), which could be formed by an energy supply company or as a mutual or co-operative, could be a key institution in addition to traditional supply companies, to engender the changes in energy use behaviour. This is described more fully in the full paper.

There are still many issues to be thrashed out. Three major ones are:

• Will local authorities be capable of taking on a more substantial role in energy planning? Local authorities do not have the skills to develop or implement this type of energy plan, but they do already have familiarity with letting large complex infrastructure contracts, deciding local spatial planning and zoning, and working with housing associations and arm’s length management organisations (ALMOs) to reduce their energy use. With more resources and training, they might grow into the broader role we describe.
• Will franchise holders be able to recover funds to service their debt service charges from those liable for payment, especially if payment is due when the facility is available for the customer to use, which is potentially before the customer is actually using the facility? In electricity and gas networks, once investment has been approved, it is added to the Regulated Asset Base and a ‘network use of system charge’ is levied upon the supplier and passed through to the customer. This automatic pass through ensures there is little risk to investors and the cost of financing the investment is low – the cost of capital is around 6% – much less than that paid by consumers wishing to install high-cost energy efficiency. A low cost of capital is a great prize for any large scale investment programme and greatly helps customers. However, once the franchisee installs external insulation or micro-generation, how will this charge be levied and what are the consequences of non-payment on the customer? Customers cannot be ‘cut off’ from their external insulation.
• Will poor performance of the technology or poor implementation mean that savings in energy use will be insufficient to save the customer money? Might this approach encourage uneconomic levels of investment in energy efficiency, new heat networks or micro-renewables, resulting in long term increase in customer bills – the risk of ‘white elephant projects’? This is a real risk. Our approach is that there is no substitute for careful and sceptical appraisal of energy investment plans and awareness that major investment franchise is prone to cost escalation pressures once let. In short, the ideas in this article are not a substitute for project appraisal and good economics. What these ideas represent is an effort to provide access to low cost private finance to investments that usually cannot currently access them.

Prashant Vaze is Chief Economist at Consumer Focus and author of The Economical Environmentalist.