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Department for Environment, Food & Rural Affairs

Energy Efficiency Measures under the Climate Change Levy Package

Background

1 In his November Pre-Budget Report, the Chancellor announced that, in light of the responses received to the consultation exercise on the climate change levy, he was minded to treble the support for energy efficiency measures under the climate change levy package – meaning that the £50m "energy efficiency" fund for 2001-02, announced in the March Budget, would rise to £150m.

2 This would allow for the introduction of a 100 per cent first year enhanced capital allowances (ECAs) scheme for firms making energy saving investments, to be introduced alongside the £50m fund. Both measures could come on stream in 2001-02 alongside the climate change levy. Depending on take-up, the scheme might cost up to £100 million in the first year of its operation.

3 The Pre-Budget Report also announced the Government's intention to consult business and other interested parties on its plans in order to optimise the effectiveness of this additional support for UK business. These proposals form part of the Government's climate change strategy, which will be published early next year.

Purpose of this Consultation

4 This consultation paper seeks views on:

(a) which technologies and processes might qualify for the enhanced capital allowances scheme; and

(b) the Government's proposals for using the £50m "energy efficiency" fund, which is intended to:

  • provide energy efficiency advice/audits to small and medium sized enterprises;
  • promote the development of "new" sources of renewable energy; and
  • encourage the research and development and take-up of low carbon technologies and energy saving measures through a "carbon trust".

5 These aims for the £50m fund were drawn up following the recommendations made by Lord Marshall in his report published in November 1998, which in turn followed an extensive consultation exercise with business, environmental groups and other interested parties. Final decisions on the use of the £50m fund will be made in the Spending Review 2000.

6 The Government is already consulting widely on the future of renewable sources of power. Consequently this paper focuses primarily on the energy efficiency measures to be supported by the £50m fund. However views are welcomed on the role of renewables in the programme as part of the drive towards a low-carbon economy (see paragraphs 16 and 17 below).

7 Although the document also seeks views on which energy efficient technologies and products might qualify for enhanced allowances, the Government is not seeking detailed proposals from manufacturers or suppliers of proprietary products at this stage. It is anticipated that, in the light of this consultation exercise, further details on the overall scope of the scheme and which investments might qualify will be given in the Chancellor's Spring 2000 Budget. Legislation for the Climate Change Levy will be included in the Finance Bill 2000, with legislation for the ECAs following in the Finance Bill 2001, subject to EU rules on State Aids.

Responding to this Consultation

8 Views on these issues are sought by Friday February 4th 2000. Responses, and requests for further copies of this document, should be sent to the contacts below. Please note that we reserve the right to make responses publicly available unless you clearly and specifically ask us not to do so.

Energy Efficiency Consultation Team
Department of the Environment Transport and the Regions
6/F5 Ashdown House
123 Victoria Street
London SW1E 6DE
e-mail: energy.efficiency@defra.gsi.gov.uk

Allan Mackie
The Enterprise and Lifelong Learning Department
Scottish Executive
Meridian Court
5 Cadogan Street
Glasgow G2 6AT
e-mail: allan.mackie@scotland.gov.uk

Dan Sinton
IRTU
17 Antrim Road
Lisburn
County Antrim
Northern Ireland BT28 3AL
e-mail: d.sinton@dedni.gov.uk

Norma Barry
National Assembly for Wales
Cathays Park
Cardiff CF1 3NQ
e-mail: norma.barry@wales.gsi.gov.uk

The £50m fund – Elements of an Integrated Programme

Synergy

9 The £50m fund and the initial £100m set aside for ECAs are separate; the latter is tax relief, and the former is public spending. However to operate effectively, fiscal incentives under an ECA scheme need to be fully integrated into a wider package of energy efficiency policies and measures. This is in line with established programmes operating in other countries, which aim to speed up technological innovation and to facilitate the diffusion of new technologies by developing synergies between RD&D and advice programmes.

10 The Government therefore intends to adopt a co-ordinated approach. Synergy between the various elements is vital to enable the various policies and measures to work together. The proposed programme elements are therefore designed to form a balanced, integrated programme. This builds on existing programmes, mainly the Energy Efficiency Best Practice Programme (EEBPP), to give the new programme essential momentum - and the confidence that some elements have been tried, tested and successfully applied.

11 Also, where the programme offers a service to business, close integration between the various elements of the scheme will minimise the risk of businesses choosing an inappropriate element of the programme. Thus, for example, companies would have access to energy efficiency advice to identify and rank energy efficiency opportunities before entering into a programme of investment that may qualify for capital allowances.

12 The partnership element of the proposed new programme will be crucial to its effectiveness, and therefore the individual characteristics of Scotland, Wales and Northern Ireland will be taken into account in making decisions on the distribution of the £50m fund. The final decision on the exact use of that part of the £50m fund at the disposal of each Newly Devolved Administration will rest with the relevant Parliament or Assembly.

13 The Government is considering the best way of managing such a programme, drawing on the views expressed during the consultation on the design of the Climate Change Levy, and in this context the Government has noted the proposal from ACBE for independent carbon trusts to promote R&D. However, as outlined above, the Government feels that a new integrated programme under the £50m fund should adopt a broader approach.

Programme Elements

14 To deliver the objectives set out in paragraph 4 in relation to the £50m fund, and based on the experience of the EEBPP, the new programme could include the following elements:

15 The Government welcomes views on the elements listed, on possible additions to the list, on how the various elements could best be made to work together, and on which should receive priority. Of these prospective elements, the Government is minded to place particular emphasis on expanding current levels of effort in RD&D, on training and education, and on energy audits and advice.

Renewables

16 The intention to allow some of the £50m fund to be used to promote the development of "new" sources of renewable energy provides an opportunity to consider options that have yet to receive significant support. Of particular importance are those technologies whose contributions towards energy supply are likely to be significant in the longer-term.

17 Possible options include offshore wind, energy crops, photovoltaic systems, renewables used for heating (for example active solar water heating, biomass heating systems), support for demonstration of UK technologies in developing countries and enhanced information dissemination programme (to address one of the principle barriers to the deployment of renewables). Views are sought on the merits of these various possibilities.

SMEs

18 Representations received in response to the consultation on the design of the climate change levy proposed that the Government should consider the needs and capabilities of the different business sectors – and particularly SMEs. The Government agrees that smaller businesses face special barriers in implementing energy efficiency measures. However this must be balanced with the need for a cost-effective programme.

19 Experience has shown that some smaller businesses can be reluctant to pick up energy efficiency opportunities, even when accompanied by advice, guidance and financial support. Consequently, the Government proposes to ensure that help and advice is available to SMEs in a form they can use, and encourage them to use and apply it. However, to be most cost effective, the programme must be linked in some way to the potential for effective action.

20 Consequently all organisations will be offered a basic service – easy access to best practice information and training for example. This level of service will be designed specifically to address the needs of small businesses. Enhanced Capital Allowances will be open to all businesses. However eligibility for more comprehensive follow-up support, such as site energy audits and consultancy advice, will be targeted towards businesses where energy bills are a significant proportion of their costs and where greater savings are possible.

The Public Sector

21 The Government also intends to make elements of the programme available to public organisations on the grounds that public sector managers and staff have very similar needs and barriers to the private sector in implementing energy efficiency measures.

Enhanced Capital Allowances – a UK Energy Technology List

Objectives

22 There are a number of important objectives for a scheme of enhanced capital allowances for energy efficiency investments:

23 The new programme funded from the £50m fund would play a central role in providing the framework and support needed to achieve these objectives. As part of this programme the Government proposes to establish a new Energy Technology List, which will specify the products, technologies and other investments eligible for ECAs. In doing so the Government is drawing on the model operating in the Netherlands. However the Dutch model has evolved to meet Dutch conditions, and many aspects, for example the specific technologies and measures on the Dutch List, might not be appropriate for the UK.

Technology Categories

24 The Government proposes initially to include on the List five technology categories where the link between the investment and the energy efficiency benefits are thought to be clearest. These are motors, combined heat and power, boiler systems, lighting systems and, possibly, variable speed drives. Further details are in the Annex to this document. The Government welcomes views on this general approach, on the technologies chosen and the potential take-up for each of these sectors.

Criteria for Inclusion

25 To meet the objectives of the scheme set out in paragraph 22, and to help set a level playing field for manufacturers, it is important to set clear, consistent qualification criteria. These may need to be updated from time to time. There are a number of different criteria that can be used. Energy saving criteria are particularly important to deliver environmental benefits cost-effectively. In order to encourage innovation and the diffusion of new technologies, a ceiling could be put on market penetration for a type of product or technology, which would no longer qualify for ECAs once the ceiling was passed. To minimise compliance and administrative costs, a lower limit could be placed on the qualifying investment, for example on the cost or capacity of the product or system, below which no ECAs would be due. In order to limit Exchequer costs an upper limit could be placed on the qualifying investment above which no additional ECAs would be due. Combinations of criteria, for example of upper and lower limits, could be used to target particular sub-sectors, for example small scale CHP. The Government welcomes views on how these, and any other appropriate criteria, could be applied, and how potential disbenefits can be avoided or minimised.

Certification

26 To meet the objectives, in particular those relating to certainty, identifiability, measurability and the control of administrative, compliance and Exchequer costs, the Government proposes that entitlement to ECAs would depend on certification of the qualifying expenditure. This would involve an approach that was able to cover both products and systems.

27 For "off-the-shelf" energy efficient products, including most boilers and motors, the Government proposes that the individual products that qualify for ECAs would be specified in the Energy List by manufacturer and model. One possibility is a "kite mark" approach. The list would be updated at regular intervals, for instance yearly, when products could be added or removed. Manufacturers would be able to apply for products that meet prescribed energy saving criteria to be added to the list. The onus would be on the manufacturer to demonstrate that these criteria were satisfied, for instance through independent test reports by appropriately qualified engineers, or certification by the relevant manufacturers' trade association. In order for businesses to know which investments qualify for ECAs, the manufacturer would provide a certificate on sale that the product was approved. For products such as motors, which are incorporated into other manufactured products, the certificate would confirm how much of the expenditure qualified for ECAs. Views are sought on what approach will place least burden on business while providing clear-cut proof of the energy saving achieved and certification of the qualifying expenditure.

28 A different approach is needed for systems, as these are generally bespoke installations. It is the particular system installed that needs to be approved, rather than a common product. The Government proposes, as with products, to prescribe energy saving criteria that must be met by the system. The onus would be on the claimant to demonstrate that these criteria were satisfied, for instance through an independent test report by an appropriately qualified engineer. ECAs would not be due until the system had been completed and certified. Views are sought on what approach will place least burden on business while providing clear-cut proof of the energy saving achieved and certification of the qualifying expenditure.

29 The Government is considering whether, and if so how, variable speed drives could best be handled. The technology is easily identifiable and can offer significant energy savings, but only in certain applications. This presents problems of certainty in identifying the qualifying expenditure. The Government welcomes views on how these problems could be overcome.

30 The Government is consulting separately on a system of quality criteria for CHP schemes to qualify for exemption from the CCL. It is intended that certification of CHP for ECA support would based on this system, as outlined in the Annex. The Government also plans to consult manufacturer's trade associations on criteria for the technologies to be included in the initial scheme.

Developing the List

31 There are a number of other low-carbon technologies which offer significant energy benefits. These include energy management systems, and technologies such as process control and building fabric insulation, which are currently difficult to certify. This is because they are usually installed as part of complex investment packages, alongside elements with no or minimal energy benefit. It will also be important to consider emerging low carbon technologies, for example those developed under the £50m fund (see paragraph 14). If satisfactory methods of certification can be developed, and subject to cost-effectiveness criteria and controls on Exchequer costs, additional technologies could be added to the List in later years. The Government is open to suggestions as to how these and other technologies not in the initial List could eventually be included, and on the potential take-up for these technologies.

Landlords and Energy Service Companies

32 The Government considers that the scope of ECAs should be designed to maximise the benefit to businesses. One option is that ECAs would only be available if the asset was provided for use in the trade, other than leasing, of the person who incurs the expenditure or, to cover group holding arrangements, connected persons.

33 The Government does not consider that ECAs should be available on assets leased to non-taxpayers. ECAs are intended to provide assistance to businesses in purchasing assets for use in the business through an acceleration of the allowances that would be due to the business. There is no change in the tax paid by the business overall, only in the timing of the relief. It is not intended that ECAs should be used to provide a hidden subsidy to non-taxpayers.

34 CHP, boilers and lighting systems would be fixtures. Where a building is let, such expenditure might be incurred by the landlord or the tenant. On the option proposed above, ECAs would only be available if the tenant incurred the expenditure. This would not be a bar to the availability of ECAs on expenditure financed by the landlord where the building was let, or pre-let, to a qualifying tenant provided suitable arrangements were entered into between the landlord and the tenant.

35 Any extension of ECAs to landlords would add to the complexity of the system. One option would be to allow a landlord to claim ECAs if the building is, or will be, let other than for use by non-taxpayers, with a claw-back if the building is used by a non-taxpayer within five years. Rules would be needed to restrict ECAs to genuine landlords, for instance by excluding arrangements where a main benefit is the obtaining of allowances or where the rental income does not provide a main benefit. The Government would welcome views on the strength of the business case for extending ECAs to landlords and how this could be targeted effectively.

36 It is sometimes suggested that ECAs should be available to lessors in order to allow businesses that do not have sufficient taxable profits to cover the ECAs to benefit indirectly through the lessor. This can over-compensate the business and provide a hidden subsidy, for instance if the business may not be able to use the ECAs for many years or perhaps never. With ECAs at 100% there is also a high risk of abuse, for instance through creating tax shelters for wealthy individuals and the use of highly defeased structures and other devices whose main purpose is to create a financial benefit.

37 Any extension of ECAs to financial lessors would add to the Exchequer cost and limit the range of products and technologies that could qualify for ECA. The Government does not consider that this would provide the best use of the resources available.

38 There may be a case however for allowing ECAs to be claimed by an energy service company where the equipment is provided by the company for use by a taxable business as part of a comprehensive package of energy services. The Government would welcome views on the strength of the business case for extending ECAs to energy service companies and how this could be targeted effectively.

Annex

Energy efficient technologies initially proposed for an energy technology list

The Government's suggested initial selection of energy efficient technologies, as outlined in the main text, is CHP, boiler systems, motors, variable speed drives and lighting systems. Issues concerning the practicalities of defining energy efficient technology and providing investment support are considered for each area in turn.

Combined Heat and Power

CHP has the greatest potential of any single technology for achieving carbon savings in business by 2010. Overall, the present capacity is about one quarter of the estimated cost-effective potential for 2010, although this proportion varies considerably between sectors.

It is proposed to provide ECA support to "Good Quality CHP", which will be defined in terms of a "Quality Index" based on the efficiency of the plant and a number of other factors. Schemes will need to undergo an independent expert assessment as to whether they reach these criteria. Guidance on the definition of "Good Quality CHP" in the context of its exemption from the climate change levy will be published shortly. Copies of this consultation paper will be available from: Tiwalola Fadina at DETR on 020 7944 6681 or by e-mail: tiwalola.fadina@defra.gsi.gov.uk.

It is proposed to set a high "Quality Index" threshold for schemes to qualify for ECAs for two reasons. Firstly, in operation the performance of most schemes will not reach the original design specification. Secondly new CHP plants will be in operation for 10-15 years or more; hence the threshold should be set at a higher level to guarantee long-term environmental benefits.

CHP costs are typically in the range of £600k - £700k per MW for industrial plant, with higher costs for smaller installations. A significant fraction of CHP investment involves third party finance or investment by energy service companies (ESCOs). CHP schemes also increasingly involve mixed applications with heat being supplied to more than one industrial or commercial user.

The Quality Index system for CHP will include a clear definition of the CHP plant itself, as distinct from the heat distribution pipework, gas and electricity connections etc, which will be unique to each particular scheme. For practical purposes, the Government proposes to limit ECA support to the CHP plant alone. However it is recognised that the other parts of the installation can make up a significant fraction of the total investment, and might be considered for ECA support if workable definitions for the qualifying components can be devised.

The Government would welcome views on:

Boiler Systems

Boiler efficiency is easily measured using standard tests, and it should be straightforward to develop a classification scheme as the basis for ECA support. This might also be extended to ancillary equipment such as economisers, blowdown heat recovery and sequence control systems (variable speed drives for boiler fans are considered separately below).

One issue to address is the competition between boilers and CHP, and the possible deleterious effect that ECA support for boiler upgrades could have on CHP uptake, and hence on overall energy consumption and carbon emissions.

The Government would welcome views on:

Energy Efficient Motors

Motors use around 130 TWh of electricity per year in the UK, about half of it in induction motors in the 1 - 300 kW range. These are the most inexpensive type of motor, produced in high volume. Other more specialist types are used for particular applications where energy performance is less of an issue. Induction motors are regarded as a commodity, usually bought on the basis of first cost, in spite of electricity costs dominating the economics in most cases.

All induction motor manufacturers work to the same European standards, so swapping to a higher efficiency type is straightforward and easy to verify. There is an EU-agreed classification scheme for motors, though there are concerns that the efficiency threshold for the highest category is not well suited to the UK market.

Recognising that 70% of motors are sold for incorporation in other equipment, it will be important for the tax benefit to reach the end user, who also needs to be informed sufficiently well to specify high efficiency motors, whether purchased directly or indirectly.

The Government would welcome views on:

Variable speed drives (VSDs)

A variable speed drive is a device for controlling the speed of motors so that energy consumption can be optimised under a range of working conditions. For some applications such as boiler fans, VSDs can save up to 30% of the motor electricity usage, although 10% is more typical as an average. Market penetration is still very low, and is price-sensitive.

VSDs can be readily defined, and used across the full range of motor sizes. However, about 70% of VSDs are purchased primarily for process control reasons, in situations where energy efficiency is not a significant factor. Hence it is necessary to find workable means of limiting ECA support to installations where VSDs can be shown to achieve a target level of energy saving per £ invested. One option would be to limit support to VSDs used with centrifugal pumps and fans.

The Government would welcome views on straightforward means of limiting ECA support to VSD applications in which there is a significant and demonstrable energy saving, e.g. in centrifugal pump and fan installations.

Lighting

Lights in non-domestic buildings use approximately 40 TWh of electricity per year in the UK (14% of total electricity consumption). It is estimated that there is cost-effective potential to halve this consumption through a series of measures including:

Market barriers to efficient systems include lack of awareness and expertise, landlord-tenant conflicts of interest, and tendency for lighting specifications to suffer during late-stage project cost savings.

Because of the location-specific nature of most lighting systems, and the criticality of good design, it will probably be better to base an ECA support scheme on the overall efficiency of a lighting scheme (as already addressed within the Building Regulations), than on a list of approved equipment.

The Government would welcome views on clear and simple means of defining energy efficient lighting systems, and administering an ECA scheme without excessive cost.

Published 10 December 1999
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