In 2011, Ernst & Young was asked by British Gas to undertake an independent study on the Non-Domestic Green Deal (NDGD). The two objectives of the study were to provide a realistic assessment of the chances of success for the NDGD and to stimulate debate on how best the NDGD could be established.
A key finding was that the NDGD is an important addition to the energy efficiency policy inventory and could be capable of creating a market worth up to £800 million a year by the end of the decade. It is targeted directly at a gap in the coverage of other non-domestic carbon reduction policies – the small and medium-sized enterprise (SME) sector. This is potentially a dynamic sector of the economy, and the benefits created for energy users could have a tangible impact on investment and growth.
The report estimated that if 10 per cent of the UK’s SMEs took up the NDGD, the annual market size for energy efficiency measures could reach £800 million by 2020. Since all measures that pass the Golden Rule (see box) deliver savings higher than costs, this would equate to a substantial reduction in the energy costs and emissions from the adopting companies. This should also create secondary benefits by helping to create liquidity elsewhere in the economy through the financial securitisation of the NDGD scheme.
To realise this potential, the report identified a number of overarching challenges that will need to be overcome. The first is a problem of perception: energy efficiency has a low level of take-up by business; there is uncertainty around transaction costs; and potential benefits are not fully understood. This means the response is unlikely to happen by itself and a considerable degree of push will be needed. The second challenge is policy design. The target market is diverse, and different NDGD design details would suit business types. So a one size fits all approach is unlikely to work.
No less than 65 per cent of SMEs occupy rented premises. A key issue is aligning incentives appropriately between landlords and tenants. Unless there is appreciation in property or rental values, the landlord may see no direct financial benefit from the Green Deal, but still bear the risks from vacant properties. Tenants would only benefit from reduced energy bills so long as they remained in the property. This is compounded by the fact that the average length of a new lease is less than six years – shorter than the payback period for some measures.
One common theme permeating each of these challenges is the need for policymakers to adopt a business-centric viewpoint. For example, the Golden Rule makes sense from the policy design perspective. However, passing the rule says little about whether the materiality of savings will be sufficient to overcome the observed reluctance to participate. Nor does it consider additional risks that businesses may perceive they have taken on. Hence, the NDGD is a necessary but not sufficient step in encouraging business to be energy efficient.
In the context of all of these challenges, the report identified two key decisions on how the NDGD should progress in the immediate future. The first concerns whether participation will continue to be voluntary, or whether it will be mandatory in some way. The second question concerns how best to launch such a scheme. While a full-scale rollout could achieve the mass needed, the challenge of diversity and lack of detailed information on SMEs would suggest adopting a cautious approach. Selective targeting or pilot projects could be feasible. However, this would mean accepting that the intended carbon savings would take longer to realise.
The other key factor that may have an impact on decisions is policymakers’ perceptions around market potential. Interestingly, the consultation document from the Department for Environment, Food and Rural Affairs (Decc) suggests a future market size of around £125 million a year, which is less than a sixth of the size suggested by our report.
The two key drivers behind this appear to be a lower level of predicted take-up, with only around 5 per cent of customers assumed to participate; and an assumption by Decc that only very low-cost measures are adopted. While recognising that it can be challenging to make market projections with any degree of confidence, it is difficult to feel optimistic about the success of a policy that is only expected to achieve 5 per cent take-up.
Ultimately, one important element of the success of the policy will be the appropriate allocation of risks and costs among players. Although the benefits to SMEs of adopting the NDGD are considerable in the long term, there is a pressing need for the policy to be acceptable to policymakers, business and providers. The NDGD is currently framed from a policy-centric perspective, and for it to be acceptable to SMEs the benefits will need to be clearly articulated.
The willingness of providers to enter the NDGD market will also need to be scrutinised. We suspect that providers will look closely at the chances of success, the costs of early-stage participation and the likelihood of a first-mover advantage. Striking the right balance among these players is essential to the eventual success of the NDGD.
Bill Easton is in the utilities sector team at Ernst & Young.
The NDGD in a nutshell
The NDGD aims to curb emissions from non-domestic energy users by encouraging cost-effective energy efficiency. The key thrust of the policy is to facilitate access to finance, making it easier and cheaper for business to invest in energy efficiency measures.
Like the domestic Green Deal, the financing mechanism allows businesses to make efficiency improvements without upfront costs – costs are repaid in instalments attached to electricity bills. The Golden Rule also applies – only those measures that deliver more savings than they cost are eligible for the NDGD.
The successful execution of the NDGD involves the participation of different players at different stages of the process:
* assessment of the property by an accredited, authorised assessor;
* installation of measures by providers, who could be energy companies;
* finance arrangements by third-party finance providers;
* payment collection through energy bills by energy companies.
The detail surrounding the policy design and decisions regarding its rollout and implementation will affect each of these agents, and so due attention must be paid to their motivation and buy-in.
This article first appeared in Utility Week’s print edition of 27 January 2012.
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