Changing Electricity and Energy Efficiency in the United Kingdom

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1 Presented at the DA/DSM DistribuTECH Europe 97 Conference, Amsterdam, October 1997 DSM and Energy Efficiency for Changing Electricity Business Environments Task VI of the IEA DSM Programme David Crossley, Energy Futures Australia Anna Engleryd, NUTEK, Sweden

2 SYNOPSIS Restructuring of electricity supply industries and implementing DSM programmes are often seen as contradictory activities. Instead, we believe that simultaneously they can help to diminish the imbalance between the supply and demand side in energy markets leading to more concentration on energy efficiency and thus better environmental outcomes. Task VI of the International Energy Agency DSM Programme seeks to increase the understanding of how these two activities can function simultaneously and promote the choice and implementation of DSM in restructured electricity markets. ABSTRACT Task VI of the International Energy Agency DSM Programme is designed to develop in detail a range of practical mechanisms whereby economically justifiable DSM and energy efficiency can be incorporated into changing electricity business environments, such as restructured electricity industries and competitive electricity markets. The mechanisms which will be considered in Task VI are not DSM and energy efficiency programmes. Rather they assist the implementation of such programmes. Two types of mechanisms are to be investigated. First there are policy and regulatory measures which can be implemented by governments and regulators to promote DSM and energy efficiency. Second there are mechanisms which enable electricity businesses to make a commercial return on DSM and energy efficiency programmes. Task VI will: develop a range of practical mechanisms whereby economically justifiable DSM and energy efficiency can be incorporated into changing electricity business environments; identify the public policy implications of these mechanisms; communicate a range of information about the mechanisms. Task VI is not aiming to tell governments and industry regulators what they should do. Neither will it make comparisons between countries in relation to their relative success or otherwise in promoting DSM and energy efficiency. Rather the new work will make available to responsible authorities, objective factual information about the mechanisms they could use to promote DSM and energy efficiency in changing electricity business environments. The decision on whether to implement any of the mechanisms clearly lies with the responsible authorities in each sovereign country. The information provided by the Task is intended to assist and inform this decision. INTRODUCTION The concept of demand-side management (DSM) was born out of the regulated electricity utility business in the United States. For some years the concept was vigorously promoted by the utility regulators in the United States and by regulators, governments and even utilities themselves in other countries. However, DSM has been more or less abandoned in those countries which have undertaken the restructuring of their electricity supply industries. The various functions of the electricity supply industry (ESI) namely generation, transmission, distribution and retail supply had for long been regarded as being natural monopolies. Frequently, all of these functions were carried out within vertically integrated, monopolistic utilities. Even where some of the functions were carried out by separate utility businesses, each business was still regarded as being a monopoly.

3 The structural transformation that the ESIs in many countries are undergoing, or may soon undergo, involves separating out the ESI functions into individual businesses and exposing some of these businesses to competition. Typically, generation and retail supply are regarded as being open to competition, whereas the transmission and distribution wires businesses are still seen as being natural monopolies. In several countries, another element of the industry restructuring involves the privatisation of utility businesses where these are currently government-owned. The impact of these structural changes alters the context in which DSM and energy efficiency programs can be carried out. The changes may establish new roles for utilities, governments and non-utility businesses to facilitate and participate in the delivery of DSM and energy efficiency programs. At the same time as this restructuring is occurring, bringing with it less concentration on DSM and energy efficiency, climatic and environmental concerns are resulting in requests for more vigorous work to improve end-use energy efficiency. Mostly these concerns are expressed in terms of a need to lower emissions of CO 2. From these insights has grown an awareness of ecological sustainability and an idea that such sustainability can only be achieved when there is a delicate balance between the provision and use of energy services and the availability of renewable energy resources (i.e. biofuel, wind, sun etc). However, with current technologies, using renewable energy resources to provide energy services is markedly more expensive than using fossil fuels. Therefore, the inefficient use of energy has to be eliminated if an increasing proportion of energy services is to be provided by using renewable energy resources. This is a prerequisite if ecological sustainability is ever to be achieved. In the context of energy systems it is obvious that one has to work on both the supply side and the demand side to achieve ecologically sustainable development. There is no contradiction between the restructuring of ESIs and implementing DSM programs. They could both be promoted simultaneously. When DSM was forced upon utilities it was often perceived as undermining the businesses and profits, but many successful companies translated DSM into a competitive advantage. The challenge now is to enable electricity businesses to continue to develop their expertise in DSM and energy efficiency into a competitive advantage applicable to restructured electricity markets. RESTORING THE BALANCE Until recently, electricity utilities had a good overview of their investment opportunities with a franchised area of customers, a monopoly, and a fairly defined set of prices for fuels. Their investment calculations were characterised by low discount rates meaning riskless business. On the other hand the customers, who knew very little about alternatives to energy supply, found energy to be an insignificant proportion of their budget and did not think about what the future could hold in terms of risks. Their investments were characterised by a high discount rate. This situation resulted in heavy investments on the supply side of the energy use equation, but poor investments in alternatives, such as energy efficiency, from the demand side. There was an imbalance, often referred to as the pay-back gap. Because of this gap, the societal benefit from shifting from supply side investments to demand side investments could be significant. The restructuring of electricity markets has changed part of this situation making investments riskier for electricity businesses. The pay-back gap is closing from above (see picture over page). What remains is the closing from below, the demand side. This can be seen as the economic rationale of future DSM. This picture shows how a restructuring of the ESI in combination with DSM activities can help to restore the balance in the market.

4 Investment The pay-back gap 20,00 kr 18,00 kr 16,00 kr 14,00 kr 12,00 kr Restructuring 10,00 kr 8,00 kr 6,00 kr 4,00 kr Customer Confidence (DSM) 2,00 kr 0,00 kr Discount rate The most appropriate DSM programmes and structure for a particular ESI depends on the specific situation and reflects the way a specific country has chosen to deal with the energy problem. At present, only a handful of countries have any experience in attempting to incorporate DSM and energy efficiency into restructured ESIs. Norway included energy efficiency considerations into the establishment of its competitive electricity market. The regulator of the England and Wales electricity market has made several attempts to encourage energy efficiency after the competitive market was established. In Australia and New Zealand, extensive policy work on the role of DSM and energy efficiency has been completed prior to the establishment of competitive electricity markets, but these markets are not yet fully functional. Finally, substantial work is underway in the United States on mechanisms to promote DSM within an ESI where customers have a choice of supplier. Many other countries are currently planning the restructuring of their ESIs and there are significant opportunities to incorporate DSM and energy efficiency into these plans. However, a major problem is the lack of precedents and examples to show sceptical legislators and government officials how it can be done. There is still a strong lobby in some countries which maintains that establishing competition is all that is required to achieve effective uptake of all economically viable energy efficiency despite the years of work on market barriers to energy efficiency. This lack of precedents and examples is being addressed by the International Energy Agency DSM Programme. TASK VI OF THE IEA DSM PROGRAMME The IEA DSM Programme is an international collaboration of 17 participating countries and organisations working to clarify and promote opportunities for DSM and energy efficiency, mainly in the electricity industry. Through co-operative activities, participants collaborate to assist DSM and energy efficiency technologies reach their full market potential. The work of the IEA DSM Programme is organised in several Tasks. The incorporation of DSM and energy efficiency into restructured ESIs has been, and is being, addressed by two of these Tasks.

5 Task IV concerned originally the development of improved methods for integrating demand-side options into resource planning, but was extended to also look at DSM in new business environments. Existing mechanisms to promote DSM and energy efficiency were reviewed and documented, and the development of new mechanisms was briefly discussed. Task VI can be seen as a continuation and development of the work carried out during the last phases of Task IV. Task VI is titled DSM and Energy Efficiency for Changing Electricity Business Environments. The Task is aiming to develop a range of practical mechanisms whereby economically justifiable DSM and energy efficiency can be incorporated into changing electricity business environments, such as restructured ESIs and competitive electricity markets. Task VI is not aiming to tell governments and industry regulators what they should do. Neither will it make comparisons between countries in relation to their relative success or otherwise in promoting DSM and energy efficiency. Rather the work will make available to responsible authorities objective factual information about the mechanisms they could use to promote DSM and energy efficiency in changing electricity business environments. The decision on whether to implement any of the mechanisms clearly lies with the responsible authorities in each sovereign country. The information provided by the Task is intended to assist and inform this decision. There are 12 countries and organisations participating in Task VI. These are: Australia, Denmark, European Commission, Finland, France, Japan, Korea, Netherlands, Norway, Spain, Sweden and United Kingdom. Task VI is probably the only research project in the world carrying out comparative analysis of, and developing, DSM mechanisms across countries. International analysis is of great importance in a new area like this one, since there are significant opportunities and potential in learning from the mistakes and successes of others. The work on Task VI is being led by an Operating Agent, Energy Futures Australia Pty Ltd. EFA is a consultancy company, based in Sydney, Australia, which specialises in advising on energy and environmental policy and programs. Objectives The objectives of Task VI are as follows: to develop in detail a range of practical mechanisms whereby economically justifiable DSM and energy efficiency can be incorporated into changing electricity business environments; to identify the public policy implications which would follow a decision by the responsible authorities to implement each of the various mechanisms, including; actions which would be required by, and changes to the responsibilities of, privately- and publicly-owned utilities, governments, and industry regulators; impacts of the mechanism on market structures and oversight; effects of the mechanism on trading and financial arrangements; consequences of the mechanism for new industry structures, codes of conduct, consumer interests, legislation and regulation; to identify and discuss the transitional issues for existing DSM programmes arising from changing electricity business environments; to communicate and disseminate a range of information about the mechanisms.

6 Workplan The workplan for Task VI comprises three subtasks Subtask VI/1 Detailed development of new mechanisms and evaluation criteria; Subtask VI/2 Communication of information about the mechanisms; Subtask VI/3 Identification of the public policy implications that would follow a decision by the responsible authorities to implement each of the various mechanisms. Definition of Mechanisms The mechanisms being investigated by Task VI are not DSM and energy efficiency programmes. Rather they assist the implementation of such programmes. Two types of mechanisms are being investigated: policy and regulatory mechanisms which can be implemented by governments and regulators to promote DSM and energy efficiency; commercial return mechanisms which enable electricity businesses to make a commercial return on DSM and energy efficiency programs. Mechanisms are targeted at organisations which develop and implement DSM and energy efficiency programs and are intended to make it easier for these programs to be implemented. In contrast, DSM and energy efficiency programmes are actions taken by electricity businesses and others. They are targeted at energy end-users and are intended to change the way in which energy is used and therefore achieve commercial outcomes for the programme implementor. Examples of Mechanisms The following examples are provided to illustrate the distinction between mechanisms and programs. Mechanism A regulator allowing electricity businesses to increase their electricity prices to cover the cost of providing cash rebates to customers who purchase energy efficient appliances A Government establishing an energy efficiency funding agency such as the United Kingdom s Energy Saving Trust A wholesale electricity pool establishing a protocol for demand bidding into the pool An electricity business implementing performance contracting where the cost of services provided by the business is only paid for by customers if specified results are achieved Program An electricity business providing cash rebates to customers who purchase energy efficient appliances An electricity business participating in the funding agency s programs directed at customers An electricity business offering low-priced interruptible electricity supply to customers and then bidding demand reductions into the pool An electricity business offering to provide customers with energy efficiency improvements through performance contracting where the cost of the improvements is paid for from reductions in the customer s electricity bill

7 Expected Outcomes Successful completion of Task VI will: provide the participating countries with the information needed to follow emerging trends in relation to the role of DSM and energy efficiency in electricity supply industries; enable participating countries to understand how to ensure effective DSM and energy efficiency programs are implemented in restructured ESIs; enable participating countries to identify opportunities to achieve both improved system efficiency and financial and environmental benefits from DSM and energy efficiency. CONCLUSIONS The restructuring of electricity supply industries around the world often results in abandonment of DSM programmes and discontinuation of energy efficiency activities within electricity utilities. However, there is no contradiction between restructuring ESIs and implementing DSM programmes. Simultaneously promoting restructuring and DSM may help to restorethe investment balance between the supply and demand sides in energy markets. Given that ESI restructuring and DSM programmes in combination can help to achieve ecological sustainability in the energy system, policy makers must be made aware of the opportunities in their countries. By co-operating internationally through Task VI of the IEA DSM Programme we are able to take advantage of the existing limited experience with DSM in restructured markets, and learn through each others mistakes and successes. Through some innovative thinking, taking into consideration all different market structures, cultures and policies we can provide policy makers with a guide to what may work in their specific situations. CONTACT DETAILS The IEA DSM Programme Internet Web site can be visited at: