How the ECO proposals could benefit energy suppliers

Easy targets and missed opportunities

15 April 2014

In the light of his evaluation of the ECO’s first year, CSE’s Ian Preston looks at the implications of the current ECO consultation.

In December’s autumn statement the Government announced changes to the ECO that were designed to ensure that customers were protected from a proposed supplier price rise. DECC’s ‘Future of the ECO’ consultation sets out the changes required to create a £30-35 reduction in average annual energy bills.

However, the consultation fails to justify the need for that bill reduction to be achieved by attacking the one programme funded through bills that was directly designed to reduce them. After all, the best way to insulate people against future energy prices is to insulate their homes.

The consultation also misses a key opportunity to unwind some of the ridiculous bureaucracy which DECC created for the ECO. As outlined below, this made it more expensive to administer and far more difficult to present to customers in an attractive package.

But one of our main concerns is the fact that, once again, a published ECO impact assessment contains a set of flawed assumptions. These in turn reflect a degree of commercial naivety in DECC’s policy design process. This has consistently ensured that there is a mismatch between DECC’s expectations and the actual behaviour of the companies with commercial interests in the market – from energy suppliers to insulation and heating contractors.

This is particularly true of the impact assessment accompanying this current consultation. It dramatically under-estimates ECO activity in the first quarter of 2014. This is in spite of the fact that the proposals specifically reward activity done up to end March 2014, which (unsurprisingly) motivated suppliers to get as much done in that period as possible. This naivety is set to have an unintended but disastrous effect.

Independent analysis from the Association for the Conservation of Energy shows that the actual activity under the CERO strand of ECO in this period is equivalent to 7.2 MtCO2. That’s 36% more than DECC’s estimate of 5.3 MtCO2 up to March of this year. Adding in the proposed changes to CERO – a 33% reduction in the target, the levelisation mechanism, arrangements for additional carry-over – this under-estimate will mean that only 6% of the target will remain to be delivered over the 12 months from April 2014 to March 2015 (as shown below). This is approximately half of DECC’s projection of what would be delivered in this 12-month period.

The suppliers will have almost nothing left to do under CERO until March 2015, essentially bringing activity to a standstill for the next year.

A windfall for energy suppliers

As a result of this reduced ambition for CERO, the likely outcome is that the average cost of the poilcy on each household energy bill should drop from £45 to £3 for the 12 months to March 2015. That's a reduction in pass-through costs – relating to the proposed changes to CERO alone – of £42. Given that the object of the exercise was to make changes to the ECO that would result in a£30-35 saving passed on to consumers, the proposals as they stand result in a gain to the suppliers of between £7 and £12.

Under current proposals, this means an average windfall to suppliers of £9.65 per customer in 2014/15 – or £245 million in total. DECC needs to amend the proposed changes by increasing the new CERO targets sufficiently to ‘use up’ this windfall and maintain the provision of energy efficiency measures to householders under ECO in 2014-15.

Rewarding good performance, or bad?

The proposed changes to the ECO appear to be entirely contrived to ensure that the under- performers in the first year of ECO aren’t penalised too heavily. The proposed ‘levelisation’ mechanism is set at 35% which means that all the ‘big six’ stand to gain from a 1.75 uplift beyond this threshold. This is even true of the two suppliers who have delivered the lowest proportion of their target, who are notably also the largest and therefore likely to have the most political influence.
Indeed, the increase in obligation for those that under-perform of 1.1 is disproportionately lower than that for over-performance (1.75). This sends out entirely the wrong message to suppliers and the industry in general; don’t try too hard as you won’t see any additional benefits compared to the laggards. I suspect that E:on and Scottish Power – over-performers in the first year – are secretly fuming.

The proposed specific uplift for solid wall insulation above the expected delivery profile could also be seen as penalising those suppliers that prioritised solid wall insulation – one of DECC’s key policy objectives for the ECO – during phases 1 and 2. Those suppliers that have installed a high volume of solid wall insulation may have done so when it was expensive (there were lower complimentary subsidies in Wales and Scotland and the market was focussed on hard-to-treat cavity wall insulation). DECC could therefore choose to apply the uplift more generally. However, a more sensible approach would be to penalise the suppliers that under-performed by raising their solid wall minimum target based on delivery below the expected delivery profile.

Understanding the commercial realities

The CERO strand of ECO originally featured two main delivery measures: hard-to-treat cavity wall insulation (HTTC) and solid wall insulation. Whilst HTTC costs more than a standard cavity wall installation, it is significantly cheaper than treating a solid wall. It was surely inevitable that energy suppliers would focus on the cheapest measure and ignore the need to stimulate a solid wall insulation supply chain. There is a similar issue under the HHCRO strand for broken boilers, where the market is focussed entirely on broken gas boilers with no market for oil boilers or electric systems.

The consultation seeks to address these issues. However, we feel that they expose significant limitations in DECC’s commercial understanding, which really need to be addressed within the department’s policy design and implementation processes. This is particularly important given the continuing expectation that DECC’s policies, and the ECO in particular, will be delivered principally by commercially-driven organisations. DECC needs to get a far better grip on how commercial minds will react to their policies.

A missed opportunity to cut costs and improve take-up

Under the previous Carbon Emissions Reduction Target (CERT), the carbon emissions savings resulting from each measure to be installed were deemed using a standard spreadsheet that took into account property type and size.

The current ECO rules, however, require the carbon or bill savings for each property to be calculated individually following a survey. This creates considerable uncertainty for installers, energy suppliers, and other scheme partners (such as local authorities and social landlords) in predicting the ECO savings which will be delivered from any given property or group of properties. Installers tell us that this considerable uncertainty and risk is ‘priced in’. The requirement for house-by-house calculation also makes it very difficult to advertise a straightforward offer to customers, because the ECO value, and therefore the funding available to each household, is not known in advance.

Based on feedback we have received in our recent evaluation of the first year of the ECO for Energy UK, we believe a 15% cost reduction would be achieved (10% in HHCRO) if emissions savings were deemed in advance, being set by Ofgem/DECC for each measure by each property type and fuel type as they were under CERT. DECC could calculate the savings based on those modelled in assessments in the first phase of the ECO. The cost reduction would result from the far lower risk, the reduced administrative burden, and from increased customer take-up thanks to a much more straightforward offer.

To provide confidence that the customer is being offered the appropriate measure and allow compatibility with Green Deal finance, the customer could still be given an assessment using the RdSAP and the EPC framework, but using deemed savings.

The proposed changes to the ECO in this consultation notably do not include this shift to deemed savings, even for low cost, easy-to-treat measures like loft and standard cavity wall insulation. (In those cases, the total cost of the assessment and reporting may sometimes exceed the cost of the measure!) Indeed, to DECC’s shame, the consultation does not even mention this opportunity or seek views on it. That’s in spite of this being by far and away the most frequent recommendation for DECC from the stakeholders surveyed and interviewed in our evaluation– from consumer protection bodies to insulation companies and energy suppliers. It seems like a real missed opportunity.

Read the full report of our evaluation of the first year of the ECO here. Our response to the Future of the ECO consultation will be available on our website shortly.

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