Energy Efficiency (EE) workshop Simon Coates Concept Consulting 23 - PowerPoint PPT Presentation

Funding is critical to successful long-term EE implementation Countries that took care in developing good funding mechanisms tend to have: • well-developed energy efficiency industries • a history of continuous energy efficiency improvements “Stop - go” funding can be a perennial problem e.g. if EE funding is dependent on annual government budget budgets are cutback in adverse economic conditions EE funding is constrained or stopped hard to maintain continuity of effort needed to • build new EE industries • accomplish market transformation objectives 18

Main sources of funding for government EE activities • Within-country funding options – General government taxation – Earmarked energy / environmental taxes – System public benefits charges on utility bills – Fee-for-service arrangements – Stimulus funding – Green bonds (addressed in subsequent session) • Out-of-country funding: – Donor funding and international development assistance – Carbon financing 19

General government taxation • Appropriations from government budgets most common form of EE funding • Money comes from general government taxation (income, corporate, GST, etc.) • Government budget appropriations particularly used for: – funding EE agencies, and – nationally-funded EE programmes • Governed by general budget requirements and processes – Typically annual budget cycle • Normally national government, but may also be other levels of government – state funding in federal systems (USA, Australia) – supra-national organisations (e.g. European Union) – municipal government 20

Key challenges for EE funding from government taxation • Susceptible to stop / go funding – At times of economic downturn, funding can be drastically cut – Changes in government can result in radical changes in funding • Agency ‘hierarchies’ can matter – Smaller or less-well connected institutions, including NGOs and statutory authorities, can find it hard to compete with other agencies / dept’s for government money • Countries with no EE law or national strategy particularly susceptible to stop / go funding • Major problem as most EE initiatives require sustained input to transform consumer and business behaviour 21

Energy and environmental taxes • Many countries impose specific taxes on certain activities which are additional to general taxation – Motor vehicle charges (Fuel excise duty, road user charges, congestion charges, vehicle licensing, etc.) – Energy / CO2 charges – Other pollution charges – Taxes on high-consuming / large appliances • Account for ≈ 5% of all tax revenues in OECD countries Source: “Environmental taxation. A guide for policymakers”, OECD, 2011 22

Environmental taxes can be a powerful instrument • Some of these taxes are attempting to correct for ‘externalities’, such as pollution or congestion – ‘Causer pays’, or ‘polluter pays’ – Sometimes directly (e.g. CO2 tax) or indirectly using a proxy (e.g. energy) • Send price signals to consumers / business to alter behaviour to reduce pollution – Market forces generally better at delivering outcomes than central planning approaches (e.g. subsidies, regulations) • By raising money through taxing ‘ bads ’, governments can reduce tax on ‘goods’, e.g. income tax • Key challenges and trade- offs to ‘do it right’ – Setting the right rate • Not too high or low • Credible and predictable – Broad base & consistent incentives VS distributional impacts (e.g. fuel ‘ poor) & competition impacts 23

Some energy / environmental taxes are ‘earmarked’ for specific government spending – including EE in some cases • Many energy / environmental taxes go towards general government funds • Some are ‘earmarked’ for specific purposes – also known as ‘ring - fencing’ or ‘hypothecation’ of taxes • In some cases, earmarking has clear ‘causer pays’ justification – E.g. vehicle taxes to pay for road building • Causer pays economically efficient means of recovering costs • In other cases, not such a direct link – E.g. CO2 or petroleum taxes used to fund EE activities 24

Earmarking for EE funding has pros and cons … and lots of controversy • Earmarked taxes can deliver a stable source of funding for EE agencies and initiatives – Help deliver the certainty required to enable steady transformation of consumer and business behaviour • But earmarking is criticised by many economists, particularly where no strong causer-pays, or beneficiary-pays justification – May add to price and market distortions created by other fiscal and tax policies – Sometimes concerns that, without annual budget bid, insufficient oversight on use of funds – At times of economic downturn, is it really better that schools & hospitals should get less money, but EE programs don’t suffer cuts? 25

Earmarking needs to be seen in broader ‘political economy’ context • Earmarking can help stakeholder acceptance of energy / environmental taxes – E.g. funding social EE programs (e.g. energy efficiency for low income households) – Particularly if there is a beneficiary-pays linkage. E.g. levies on residential utility bills funding predominantly residential programmes – Beneficiary-pays targeting of funding also helps deliver economic efficiency. Reduces distortions on sectors paying tax. • But earmarking generally, can be associated with ‘pork barrel’ politics 26

Good governance is critical to gaining and maintaining support for earmarked EE funding • Need for government to clearly demonstrate net public benefit from EE funding – Address issues where no strong beneficiary pays approach (e.g. tax on industry, paying for residential EE) • Oversight by independent agency • Review after sensible period of time – Time-limiting support via sunset clause to ear-marked funding can give further stakeholder reassurance 27

System public benefit charges • Also known as public benefit charges, public service charges, essential service levies etc. • Differ from energy/environment taxes: – revenues are collected by energy providers from their customers (not by governments from taxpayers) – revenues do not pass through tax or public finance system – usually under purview of industry-specific regulator who earmarks revenue purpose • EE or social programs (e.g. rebates for fuel poor) are common uses • Often emerged as part of unbundling & de-regulation of utilities (e.g. in US) – Utilities facing competition unwilling to continue public benefit programs – Blanket SPBCs overcome such concerns • Sometimes emerged as means of addressing political economy considerations – E.g. in New Zealand, electricity levy used to fund electricity EE initiatives 28

Pros and cons are very similar to ear-marked energy / environment taxes • SPBCs can provide stable, long-term source of funding for EE, less susceptible to vagaries of political intervention • But similar economic and governance concerns to earmarked energy / environmental taxes • Same measures to address concerns – Improve acceptance (and economic efficiency) through linking programmes to sources of funding on beneficiary pays basis • Electricity levies for electricity EE programmes • Levies on residential consumers for residential EE programmes – Good governance and oversight 29

Fee-for-service arrangements Many EE institutions fund certain services through charging fees • eg. for audits, project preparation, project management, training Fee-for-service can be a significant funding source • particularly for NGOs, statutory authorities, parastatal* companies Energy Conservation Centre of Thailand  government provided initial capital  agreement that centre would achieve funding autonomy after 5 years  in 2010, fees provided two thirds of its revenue (energy audits, project management, training, consultancies)  balance of funding from donors such as EU and Japan International Co-operation Agency * Parastatal = Organisation separate from government, but whose activities serve the state 30

Stimulus funding New mechanism, post Global Financial Crisis reflecting emerging role of EE programmes in stimulating investment and creating jobs America Relief and Other Recovery Act 2009 examples  over USD 13 billion 2009-11 for EE  French Environment & Energy Management  funds transferred to state/local govt Agency  local agencies disburse funds subject  European Union to federal govt guidelines and rules 31

Stimulus funding – some difficulties Although funding is generally appreciated, stimulus mechanism is not ideal from EE governance perspective • EE administrators have no control over funding quantum or duration • accommodating large funding additions with short time-frame for disbursement creates administrative challenges (and possibility for abuse) • stimulus funds can dry up very quickly and with little warning Good EE governance practice  scale-up EE programmes and administrative procedures gradually  have a strategy for filling funding gaps when short-term stimulus money is depleted 32

So what is the best option for countries wanting to fund their own EE activities? • It depends • Generally, countries have combinations of funding mechanisms • Economic purity vs political economy considerations • Effective EE agencies and programmes require adequate, stable, long-term sources of funding • Achieving this requires managing the political economy of a country’s particular situation • Good governance is critical to building & maintaining support 33

Main sources of funding for government EE activities • Within-country funding options – General government taxation – Earmarked energy / environmental taxes – System public benefits charges on utility bills – Fee-for-service arrangements – Stimulus funding – Green bonds (addressed in subsequent session) • Out-of-country funding: – Donor funding and international development assistance – Carbon financing 34

Donor funding and international development assistance can be a key source of EE funding • Many bi-lateral and multi-lateral donors develop and fund EE initiatives, eg: – World Bank, UNDP, EBRD, USAID • Key source of funding for many developing countries • Particularly important in early years of institutional development – building awareness of importance of EE – supporting development of legal frameworks – building technical capacity – encouraging private sector involvement 35

However, donor funding has its challenges • Durability of EE change: – When donor funding is removed, some institutions don’t survive – Many donors seek to address this through explicitly working towards EE institutions becoming self-financing – building capability to deliver commercial services and developing other funding options • Incentive / governance issues: – Sometimes not as much recipient commitment to 100% donor funded projects, as joint- funded projects where recipient country has some ‘skin in the game’ 36

Carbon financing – Clean Development Mechanism and Joint Implementation Funds generated from carbon measures • emissions trading • project transactions • programmatic transactions In principle, carbon finance can be significant additional revenue stream for EE  signed first contract with Japan in 2009 Czech Republic  immediately launched Green Saving Programme: finances EE measures & renewables in residential sector  Power Development Board used programmatic Clean Bangladesh Development Mechanisms to co-fund national roll-out of 10 million compact fluorescent lightbulbs In practice, high transaction costs, coupled with low CO2 prices, has significantly reduced effectiveness of such mechanisms 37

Energy efficiency funding options – Options for accessing private sector capital 38

Two aspects of funding considered • Funding for government EE activities – Paying for EE agencies – Funding specific programmes • Accessing private sector capital to fund EE initiatives Focus of this session 39

A variety of mechanisms have been used to incentivise private sector EE investment • Finance mechanisms to encourage private sector capital • Public-private partnerships with private sector ESCOs to provide energy services to public sector organisations • Incentivising private sector (businesses and individual home owners) to undertake energy audits • Obligations on utilities to undertake EE measures • Today’s workshop only focusses on the first mechanism 40

Accessing private capital: Problem definition • Businesses often need to finance EE investments through bank lending from ‘local financial institutions’ (LFIs) – i.e. banks. Either: – Directly to business; or – To ESCO undertaking EE initiative on business’ behalf • However ‘usual’ LFI lending not well suited to EE – Typically only lend up to 70-80% of collateral value of asset (to be claimed in case of default) • However, often EE investments don’t have significant collateral value – Savings from EE are often harder to directly measure than an investment, say, to increase plant production capacity  benefits viewed as more intangible and ‘risky’  higher risk premium • The reality is often that EE initiatives are actually less risky than other business investments – Individual projects are often relatively small  high transaction costs dealing with a bank • Compounded by often technical nature of EE initiatives 41

Accessing private capital markets: Problem definition (cont’d) • Thus, although collectively there are large quantities of potential savings from EE investments, individually they are hard to finance, particularly due to the high transaction costs • The consequence is that LFIs often have little experience in EE investments, or desire to gain such experience. A situation that is often hard to break without some form of government intervention. • Three different types of approaches to addressing this financing problem are examined: A. Direct financial incentives on LFIs to undertake EE lending B. Cluster financing C. Green Bonds 42

A) Direct financial incentives for LFIs to lend for EE investments • Government creates finance facility available for LFIs undertaking EE- related lending • Positive incentive encourages private sector capital • Several key benefits – Public money used for finance facility leverages significant amounts of private money – A self-sustaining EE industry can start to develop which ultimately will not require public sector finance • LFIs start to build capability in understanding EE investments • ESCOs can start to develop: key vehicles to deliver EE, and for whom capital constraints can limit growth • Two main types of finance facility considered 43

Finance facility 1: Dedicated credit lines • LFI makes a margin on money provided via credit line  incentivised to lend money (including some of its own, as often requirement to provide own funds) • Outcome: Projects get access to finance, often at rates which are lower than marketCredit line often accompanied with provision of technical assistance to LFIs to build capability • Several successful examples: China Energy Efficiency Financing programme, Thailand Energy Efficiency Revolving Fund, Indian KfW SME credit line 44

Finance facility 2: Risk sharing facilities • Public agency signs Guarantee Facility Agreement (GFA) with LFIs, providing partial guarantee to share in any losses from EE loan defaults. Either: – Portfolio guarantee  LFI entirely responsible for each EE loan due diligence – Individual project guarantee  Public agency also involved in EE loan due diligence (only suitable for large EE projects) • Overcomes barriers associated with LFIs perceiving EE investments as being risky 45

Different structures are possible for risk sharing facilities • Different sharing of risk by public agency (typically between 50% to 80%), sometimes split between a ‘first loss’ amount and a ‘second loss’ tranche • For example, IFC / GEF China Utility Energy Efficiency Programme (i.e. LFIs) 46

A risk sharing facility has been used to help develop ESCOs in China (State-owned national guarantee company) 47

B) Cluster financing • Specifically aimed at overcoming the transaction costs associated with loans for small projects to SMEs • Mechanism aggregates similar types of financing requests and presents them to a banker as a single bundled project • One of early examples was in India, with programmes developed by State Bank of India (SBI) and Small Industries Development Bank of India (SIDBI) – Banks contracted external industry experts, and SIDBI created specialised agency to pro-actively assist SMEs and help aggregate their funding requests for financing • Originally developed to help financing of any investments SMEs may require (including non-energy investments) • Success meant sub-programmes developed targeting specific requirements, including EE investments – more recently facilitated by Indian Bureau of Energy Efficiency (BEE) 48

C) Green Bonds • There is appetite from many individuals and institutions to want to finance projects which help tackle climate change • However, often hard for such investors to find such projects – particularly when projects are small – even though there are many projects needing such finance • Green bonds attempt to bridge this gap • Financial institution: – Issues bonds which can be bought by green investors – Uses the proceeds to lend to green projects • Difference between the bond rate and the lending rate to green projects covers the financial institution’s: – costs of administering the scheme • Includes developing the expertise to assess green projects – profit margin 49

Advantages of green bonds • Creates a ‘demand’ for financial institutions to develop the expertise and arrangements to actively find green projects – Financial institutions typically create special units to administer green bonds • Lowers the cost of borrowing for green projects – Transaction costs significant reduced through financial institution setting up targeted arrangements for green projects – In some cases, even lower cost of capital if green investors willing to accept lower returns in order to achieve climate change objectives 50

Examples of green bonds • World Bank Green Bonds – Over $6.5bn raised since being launched in 2008 – Raises money from private capital markets (e.g. pension funds, banks) – Loans money to green projects through IBRD. – Typically used to fund larger renewables, forestry or water initiatives, although some funding of public sector EE initiatives • Property Assessed Clean Energy (PACE) bonds in USA – State and local governments issue bonds which are used to finance EE improvements on commercial or residential properties – Property owners pay-back PACE loans through adjustments to their property tax – Loan is attached to the property, not the individual. • Allows homeowners to ‘mortgage’ benefits and only pay for the benefits they derive when they own the home. Addresses risk that full benefits wouldn’t be reflected in capital value of home • However, some issues regarding the fact that PACE loans have seniority relative to mortgage debt. Caused Fannie Mae and Freddie Mac to stop lending to properties with PACE loans 51

Different types of green bonds emerging • Corporate self-labelled – Issued by major corporates with proceeds ring-fenced for green projects, although repayments are from general corporate funds • Asset-backed securities, where debt is collateralised by specific assets. Examples include – SolarCity in US, allowing householders to lease PV systems, with lease repayments forming collateral – Toyota where auto-loans for Electric Vehicles form collateral – Many PACE loans • Project bonds – Only used to date for major renewable energy projects • Supranational bonds – e.g. World Bank, European Investment Bank, ADB • National / municipal bonds – Fund government EE initiatives 52

The green bond market is growing significantly • Since starting in late 2000’s green bonds have grown significantly – Approximately $40bn in 2014 – triple the 2013 issuance – (Although still tiny compared to overall bond market) • Growth in green bonds have resulted in major banks developing Green Bond Principles to help govern (albeit informally) market – Voluntary guidelines on designating, managing and reporting on the use of proceeds from a green bond 53

Summary of finance mechanisms • Three different approaches examined: A. Direct financial incentives on LFIs to undertake EE lending B. Cluster financing C. Green Bonds • For all three, the measures fundamentally tackle the transaction costs associated with EE financing • Apart from PACE Green Bond initiative, these have generally been most successful for raising money for larger EE investments • Addressing mass-market EE barriers likely to require additional measures 54

The success of finance mechanisms is often significantly influenced by other, related initiatives • Programmes to provide technical expertise to LFIs, to help them develop technical understanding of EE – Facilitating agencies are key instruments to help this • Standardising EE contractual framework, and measurement & verification (M&V) approach. E.g. – International Energy Efficiency Financing Protocol produced by www.evo- world.org – Green Bond Principles • Unless these other aspects are addressed, it is likely that the finance mechanisms will be significantly less effective 55

Best practice policy development 56

Today’s workshop focuses on two key foundations Strategies and action plans • Key elements • Differences between strategies & action plans • Learnings from overseas • Best practice policy development • EE barriers / policy justification • ‘Classical’ economics • Behavioural economics focus of remaining sessions • Rebound / take-back Funding mechanisms • Description of options • Advantages and disadvantages • Learnings from overseas 57

Energy efficiency policies need to be based on rigorous analysis Al All • Government interventions carry considerable cost and risk – Money may be diverted away from more useful purposes (e.g. hospitals, schools, roads, etc.) – Create distortions on individual incentives, with potential unintended consequences • A strong analytical underpinning needs to demonstrate that the benefits of intervention will significantly outweigh the costs. Otherwise: – Good policies may not get the support they deserve – Poor policies may be implemented which will ultimately fail. (And potentially damage other good policies by association) 58

Any policy, large or small, in any field, needs to be developed as part of a rigorous policy cycle Define the • Same problem approach should apply Consult & to national Identify all engage Refine strategy, as to the options specific policy instrument Consult & engage Identify best Evaluate approach (if any) Consult & engage Monitor Implement 59

So what are some of the main reasons why some policies fail? All these issues (and more) are • A linear policy process addressed in this excellent policy guide produced by the New Zealand Ministry for the • Lack of consultation Environment • Poor analysis Source: http://mfe.govt.nz/about/policy-advice.html 60

Common failings (1) – A linear process, with no feedback loops • Too often the policy process ends at implementation • The best policies embed the processes for monitoring, evaluation, and subsequent refinement even before the policy has been implemented • Monitoring, evaluation & refinement enables: – The policy to be improved over time • Rectify issues which weren’t anticipated • Adapt to changing circumstances • Sometimes to repeal the policy if it hasn’t worked or is no longer needed! – The development of future policies to learn from the experiences of past policies • Requires – Resources and timetable to be assigned ahead of time • Sometimes embedded within legislation – Good division of responsibility / accountability 61

Common failings (2) – Lack of (meaningful) consultation • Policies which are developed without consultation: – Will be less likely to have considered all the issues and options  less likely to be as effective – Will be less likely to have stakeholder support  less likely to be implemented and/or be durable • Poor consultation can sometimes be just as bad as no consultation • Meaningful consultation requires: – Adequate information presented to stakeholders – Sufficient time and opportunity for them to submit information and views – A genuine willingness and ability to change a proposed approach based on submissions • The amount of consultation / engagement required will vary significantly with issue. As much an art as a science! 62

Consultation à la Hitchhikers Guide to the Galaxy! "But Mr Dent, the plans have been available in the local planning office for the last nine months." "Oh yes, well as soon as I heard I went straight round to see them, yesterday afternoon. You hadn't exactly gone out of your way to call attention to them, had you? I mean, like actually telling anybody or anything." "But the plans were on display ..." "On display? I eventually had to go down to the cellar to find them." "That's the display department." "With a flashlight." "Ah, well the lights had probably gone." "So had the stairs." "But look, you found the notice didn't you?" "Yes," said Arthur, "yes I did. It was on display in the bottom of a locked filing cabinet stuck in a disused lavatory with a sign on the door saying 'Beware of the Leopard' ." 63

Common failings (3) – Poor analysis • Inadequate cost-benefit analysis – Just because something is green, does not mean it is worthy of government intervention • Not considering possible unintended consequences – The “cobra effect” 64

Or, to put it another way… 65

An intervention framework for energy efficiency 66

EE intervention framework • This section sets out an intervention framework in high level terms • Framework is grounded in economic principles – there may be other ‘non - economic’ factors to consider – but not considered at this point • Framework: – draws on ‘traditional’ neoclassical economics to consider merits of energy efficiency – also considers the more recent branch of ‘behavioural’ economics which is increasingly influential 67

Economic framework for intervention – a sequence of key questions Are there energy efficiency improvements NO to be made that yield a public benefit? YES Will these public benefits be realised YES without government action? take NO no action Can most ‘barriers’ be explained Can some ‘barriers’ be explained NO by neoclassical economics? NO by behavioural economics? YES YES Are there cost-effective interventions that can be made to overcome the barriers identified and deliver a net public NO benefit? YES design and undertake appropriate intervention(s) taking into account the nature of the barriers identified 68

Economic framework for intervention – a sequence of key questions Are there energy efficiency improvements NO to be made that yield a public benefit? YES Will these public benefits be realised YES without government action? take NO no action Can most ‘barriers’ be explained Can some ‘barriers’ be explained NO by neoclassical economics? NO by behavioural economics? YES YES Are there cost-effective interventions that can be made to overcome the barriers identified and deliver a net public NO benefit? YES design and undertake appropriate intervention(s) taking into account the nature of the barriers identified 69

Energy efficiency – some key terms • energy using less energy to achieve achieving more service OR efficiency: same level of service with same amount of energy achieving same level achieving higher level eg: OR of home heating, of home heating, using less energy using same amount of energy • energy efficiency initiatives typically targeted at delivering energy savings – other benefits can accrue also (refer next slide) 70

Other potential “public” benefits Level Examples • GHG emissions International • moderated energy prices • energy security National • job creation • reduced energy-related public expenditure • industrial productivity and competitiveness Sectoral • infrastructure benefits • health and well-being Individual • increased disposable income • poverty alleviation (energy access and energy affordability) Many of these other benefits of energy efficiency align with wider Government policy initiatives Source: “Spreading the net: the multiple benefits of energy efficiency improvements” , by Ryan and Campbell, OECD/IEA 2012 71

Public versus Private benefits • Useful to distinguish energy efficiency benefits between: – Public Benefits : those that accrue to society overall, and – Private Benefits : those that accrue to private individuals or entities • Benefits should be considered carefully to avoid double-counting eg. improved energy efficiency of fossil fuel use in an industrial production process Private Benefits include: Public Benefits include: • reduced energy costs • reduced GHG emissions • enhanced brand positioning • reduced air pollutants • improved energy security (reduced reliance on fossil fuel) • reduced demands on health sector and improved productivity The public vs private benefits distinction is particularly relevant when considering possible use of public money in energy efficiency initiatives 72

Economic framework for intervention – a sequence of key questions Are there energy efficiency improvements NO to be made that yield a public benefit? YES Will these public benefits be realised YES without government action? take NO no action Can most ‘barriers’ be explained Can some ‘barriers’ be explained NO by neoclassical economics? NO by behavioural economics? YES YES Are there cost-effective interventions that can be made to overcome the barriers identified and deliver a net public NO benefit? YES design and undertake appropriate intervention(s) taking into account the nature of the barriers identified 73

“Energy efficiency gap” is widely acknowledged & well -documented • The “energy efficiency gap”: – Numerous international studies point to substantial opportunities to improve energy efficiency and yield net public benefits – Despite their size (billions at international level) the opportunities often go unrealised – N ote that some international ‘gap’ estimates have been criticised as failing to account for all costs – but not true of all estimates • Examples in the literature include: – Hirst & Brown (1990), “Closing the efficiency gap: barriers to the efficient use of energy”, Resources, Conservation and Recycling, Volume 3 Issue 4 – Jaffe & Stavins (1994), “The energy -efficiency gap - What does it mean?”, Energy Policy, Volume 22 Issue 10 – Allcott and Greenstone (2012), “Is There an Energy Efficiency Gap?”, National Bureau of Economic Research Persistence of the energy efficiency gap can be explained by neoclassical ‘market barriers’ such as externalities and by behavioural economics 74

Economic framework for intervention – a sequence of key questions Are there energy efficiency improvements NO to be made that yield a public benefit? YES Will these public benefits be realised YES without government action? take NO no action Can most ‘barriers’ be explained Can some ‘barriers’ be explained NO by neoclassical economics? NO by behavioural economics? YES YES Are there cost-effective interventions that can be made to overcome the barriers identified and deliver a net public NO benefit? YES design and undertake appropriate intervention(s) taking into account the nature of the barriers identified 75

Neoclassical economic framework • Neoclassical economics assumes: – decision-makers have full information – individuals behave rationally – decision-maker will act to realise an expected net benefit • In neoclassical world, intervention may be justified if: – excessive transaction costs (refer later slide) or – misalignment of incentives between private decision maker and public good (i.e. externalities exist):  decision-maker does not bear full cost, or cannot capture full benefit, of its actions.  e.g. a transport fleet operator bears full cost of investing in fuel efficiency measures, but does not capture wider benefits such as improved air quality • Misaligned incentives may emerge through – some costs or benefits not being priced (so-called price externalities, e.g. carbon and air quality not properly priced) – split incentives arising from the decision maker not facing the consequences of their actions (also known as principal-agent issues) Analysis of the private vs public costs and benefits may demonstrate a case for intervention 76

Neoclassical economics – intervention logic $ Public net benefit  invest Public Private net cost  do not invest Private Costs Benefits Intervention logic based on expected ‘wedge’ between net benefits/cost for private decision maker versus society as a whole 77

Key assumptions drive this neoclassical analysis • What discount rate should be applied? – NZ Treasury specifies 8% real as default rate for regulatory proposals • Over what term should the analysis be undertaken? – NZ EECA typically uses a 10 year horizon for general analysis – specific projects (eg lighting, boilers) may warrant shorter/longer horizon • What is the value of energy savings? – Generally appropriate to use marginal cost of supply, not average cost. • How should other benefits be quantified? – Approach tends to be specific to nature of benefit in question – Can be complex and may require judgement (subjective) Choice of these parameters can have a significant impact on the outcome of the analysis 78

Often EE cost-benefit analyses require specific techniques to address inherent challenges • Often data is inadequate (sometimes non-existent) on key parameters • There can be significant inherent uncertainties regarding future levels of key parameters (e.g. oil prices, GDP, etc.) • Best practice techniques to address these challenges include: – Use Scenario / sensitivity analysis. If option ‘B’ is best (and NPV positive) across a range of plausible scenarios and assumptions, it doesn’t matter if the value of option ‘B’ can’t be determined with accuracy – Similarly, sometimes focussing on factors which will affect the relativity of options (rather than their absolute value) can make the problem simpler and more robust – Determine which assumptions have the greatest effect on choice of options  effort can be focussed on removing uncertainty on these assumptions – ‘What would you have to believe’ and ‘ Reductio ad absurdum’ are useful techniques to establish whether something is likely to be generally true rather than specifically the case depending on assumptions – Good model (e.g. spreadsheet) design. (Modular, assumptions sourced, transparent and auditable, etc.) – Ensure internal consistency of assumptions – Occam’s razor, or KISS. Don’t make anything more complex than it needs to be. E.g. Pointless developing sophisticated modelling techniques to deliver ‘accuracy’ to within 1%, when there is inherent uncertainty in input assumptions of 20%. – Sanity check: If ‘A’ has value of ‘X’ then ‘B’ must have value of ‘Y’. Does this feel right? Does it ‘triangulate’ with other data points? Are ‘A’ or ‘B’ of the right order of magnitude? 79

Example of cost-benefit analysis using some of these techniques • http://knowledge.neri.org.nz/assets/uploads/files/b3554-Concept-Consulting--- Study-of-non-residential-building-energy-rating-schemes--BERS--Jun-2009.pdf 80

Transaction costs – further barriers to profitable action • “access to information” and “access to capital” can be significant barriers to individuals undertaking profitable actions • These difficulties in finding the right information, or getting capital to undertake a profitable investment, are examples of “transaction costs” • A central agency may be able to significantly lower the transaction costs associated with access to information and capital for actions which deliver a public as well as a private benefit Excessive transaction costs may also justify intervention in a neoclassical framework 81

The special nature of energy explains why intervention may be justified for EE, but not other goods and services • Consumers frequently pay ‘too much’ for many different goods and services, ranging from sugar to insurance • Why is it that central agency involvement may be needed for energy efficiency but not these other goods and services? • The energy characteristics of an appliance are often of minor consideration relative to its core characteristics • Even with all the information it is hard to evaluate the potential cost- benefit from different appliances • However, energy use is pan-economy  Need and opportunity for central facilitation to overcome transaction costs – However, difficult balancing act to stop facilitation descending into central planning 82

Neoclassical frameworks can only take you so far • In a rigid neoclassical world, the only interventions required are: – Fix any price externalities – Provide information • Job done! • But is it… 83

The potential from energy efficiency measures are like the $100 note lying on the side of the road Some economists think they don’t exist! • Many efficiency measures are projected to have hugely negative costs • The scale of unrealised potential is more than can be explained purely by neoclassical economics • So why aren’t people and businesses doing them? 84

Economic framework for intervention – a sequence of key questions Are there energy efficiency improvements NO to be made that yield a public benefit? YES Will these public benefits be realised YES without government action? take NO no action Can most ‘barriers’ be explained Can some ‘barriers’ be explained NO by neoclassical economics? NO by behavioural economics? YES YES Are there cost-effective interventions that can be made to overcome the barriers identified and deliver a net public NO benefit? YES design and undertake appropriate intervention(s) taking into account the nature of the barriers identified 85

Behavioural economics • ‘Conventional’ economics makes a number of simplifying assumptions, including that consumers can readily identify the best product for them • However, psychological studies are increasingly demonstrating that this is not the case: – Limitations in the way people process information means that they can easily make poor choices – Differences in the way information is presented can exacerbate or ameliorate such outcomes • Study of such phenomena is known as behavioural economics • Has moved beyond academic literature and now informing competition policy and the design of market arrangements 86

Behavioural economics framework • Behavioural economics uses insights from psychology to increase explanatory power of economics • Behavioural economics literature has strong empirical basis: – Time preference – hyperbolic discount rates – Reference points – loss aversion, endowment effect, status quo bias – Bounded rationality – choice overload, heuristics – Pro-social behaviour – other-regarding , ‘warm glow’ effect • Intervention may be justified to overcome these issues: – using behavioural interventions to ‘nudge’ decision makers in the right direction – other interventions if behavioural interventions are insufficient to overcome the behavioural barriers A number of the above behavioural barriers are highly relevant in the context of decisions about energy efficiency 87

Behavioural economics has become ‘mainstream’ • Behavioural economics now being used to inform design of government policy in a number of countries • “Nudge” was co-authored by Profs Thaler and Sunstein at University of Chicago in 2008 – Prof Thaler now advising number of governments on policy design – Prof Sunstein appointed as President Obama’s regulation ‘tsar’ • UK Government set up Behavioural Insights Team (‘Nudge Unit’) within Cabinet Office in 2010 (Oliver Letwin, Minister of State, Cabinet Office) – highly successful and well-regarded – inspiring governments in Canada, France, Denmark, Australia, Saudi, Singapore – Obama Administration has similar unit 88

Behavioural economics – relevance to energy efficiency Area Relevance Time preference issues Creates decision bias against actions with upfront costs but benefits in future Reference points ‘Irrationally’ strong attachment to current practices – - Loss aversion especially given lack of familiarity with issues and limited - Endowment effect ‘trust’ Fear of making a wrong decision  no decision - Status quo bias Bounded rationality Energy efficiency choices often complex – limited - Choice overload experience and infrequent decision points make it harder - Heuristics for decision makers to evaluate options - Failure to assess probabilities Pro-social behaviour May reinforce positive decisions if successfully harnessed Source: “The Role of Behavioural Economics in Energy and Climate Policy” , by Pollitt and Shaorshadze, University of Cambridge Electricity Policy Research Group, UK, Dec 2011 Behavioural economics can help explain the “unbelievably high discount rates in the context of energy efficiency investments” ( Behavioural Economics in Energy and Environmental Policy, OECD, March 2013) 89

Or to put it another way… 90

Status quo bias Habits matter Energy is often purchased on ‘evergreen’ contracts  no natural points requiring an active decision to be made  energy is not as ‘front of mind’ as other purchase decisions Often people will only change something if it is demonstrably broken. (If it ain’t broke, don’t fix it). Result: No decision to implement EE 91

Loss aversion Consumers typically fear losses more than they value gains Particularly a problem for energy because of the complexity of issues. Heightens perceived risk of ‘getting it wrong’. Result – no decision to implement EE. 92

Paradox of choice Too much choice = overload For example, people are less likely to choose a meal at a restaurant with lots of menu options, than one with limited choices. The increasing number of means of delivering energy services means many different choices – compounded by the choices and complexity of retail tariffs  energy is ‘scary’. Result – no decision to implement EE. 93

Efficient lighting – temporary subsidy led to sustained change in consumer behaviour CFLs become CFL direct CFL direct widely available to subsidy subsidy domestic consumers starts ceases in late 1990s Strong NPV Subsidy programme overcomes CFL usage maintained at much benefit to consumer aversion - significant higher levels than before even consumers, increase in CFL use though subsidy withdrawn 30.0 but low CFL uptake due to Information campaign Information campaign loss aversion etc in parallel with subsidy programme continued 25.0 Market Share (%) 21.5 20.0 19.4 18.4 16.5 15.0 14.9 14.6 13.6 13.0 10.4 10.0 Market Share of Efficient Light Bulbs Calendar year average market share by volume 5.0 4.1 Total Efficient 3.0 1.9 0.0 Late 1990s Year 2002 Year 2003 Year 2004 Year 2005 Year 2006 Year 2007 Year 2008 Year 2009 Year 2010 Year 2011 Year 2012 YTD To 28/07/13 Source: adapted from Electricity Authority and EECA Levy Consultation , Sept13 94

NZ EECA interviews with large energy users support behavioural findings • Recent EECA interviews with 25 large energy-using businesses • Sizeable unrealised potential for energy efficiency, particularly in industrial sector • Interviews indicate there are some behavioural challenges to be addressed: – heavily production focused with low tolerance of perceived risks to production – energy efficiency, particularly in relation to core processes, is perceived as difficult (status quo prevails) – managers need convincing and want an action plan they can understand, sell and adopt – overseas reporting and management hierarchy disempowers some managers – negative views of service providers, consultants, product-sellers (not independent) • Examples of what large users say they would value include: – a trusted source of information and advice, to the right level and at the right time – a tailored action plan that fits with their current priorities and won’t risk production – to be part of a peer forum sharing ideas on improvements – recognition from private and public sector leaders for taking the ‘right’ action – a good news story they can tell their stakeholders 95

Interventions should be informed by nature of barriers Can most ‘barriers’ be explained Can some ‘barriers’ be explained NO by neoclassical economics? NO by behavioural economics? take YES YES no action Are there cost-effective interventions that can be made to overcome the barriers identified NO and deliver a net public benefit? YES design and undertake appropriate intervention(s) taking into account the nature of the barriers identified Addressing neoclassical barriers Addressing behavioural barriers • • correct pricing misalignments generally seek to ‘nudge’ incentives • • define property rights improve information/trust • • improve information reframe choices/decision context • • tax negative externalities harness pro-social incentives • subsidise positive externalities Other, non-behavioural interventions may be justified if behavioural interventions are insufficient to overcome behavioural barriers 96

Cost of possible interventions must be taken into account = Net public benefit Energy efficiency benefits + Non-energy efficiency benefits − Cost of intervention (measured at societal level) Potential non-energy efficiency benefits Potential costs of intervention • Reduced GHG costs • Deadweight cost of tax/levy • Reduced particulate emissions • Unintended efficiency costs • Improved energy security • Health benefits • Poverty alleviation • Public finance benefits • Job creation Based on: “Spreading the net: the multiple benefits of energy efficiency improvements” , by Ryan and Campbell, OECD/IEA 2012 97

Rebound / take-back • EE measures  consumers save money  spend on goods and services, some of which consume more energy • Two types of phenomena – Re-spend (also sometimes known as rebound!): use the extra income to spend on energy-consuming activities. (e.g. flights to a foreign holiday) – Take back (sometimes known as rebound): use the same amount of energy for an activity which has had an EE measure, but get a better service. E.g. warmer homes • Critics of EE suggest re-spend and take-back can invalidate EE measures, and point to studies which show average household energy consumption has risen, despite appliances and houses becoming more efficient 98

Rebound / take-back (contd.) • Many of the studies pointed to by EE critics significantly over-estimate the extent of rebound / take-back – Often not taking into account general rise in household income which is main driver behind increased household energy consumption – If appliances and households hadn’t become more efficient, the rise in household energy consumption would likely have been significantly greater • That said, EE measures do result in take-back or re-spend outcomes • But does this matter? • If EE measures result in consumers or businesses having more money, should society be concerned how they spend their money? Why is spending on fashion, or music supposedly better than energy-consuming activities? – Provided energy and these other goods and services are appropriately priced, whatever consumers decide to spend their money on will be welfare enhancing – In the specific case of take-back, warmer drier homes can yield significant health benefits 99

Workshop summary 100