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Regulatory Impact Statement

Victorian Energy Efficiency Target Regulations

Download the PDF version of this document: VEET Regulatory Impact Statement Part 2

March 2011

4 Options to achieve objectives

There is a range of options that could potentially meet the Government’s objectives in light of the barriers identified. Many of the alternatives (education, direct regulation to reduce consumption, energy standards etc) that would typically be considered as part of such an options analysis have already been implemented and form part of the base case. Further, as demonstrated in the previous chapter, there remain problems that prevent households and SMEs from making optimal investment decisions (even with alternative measures in place).

This RIS considers the following options over the next phase of the scheme (2012 –2014):

• target of 2.7 Mt CO2
• target of 4.2 Mt CO2
• target of 5.4 Mt CO2
• a rebate scheme for certain activities.

Consideration was given to options that would see a target set for a number of subsequent phases of the scheme. Stakeholder feedback suggested that setting the target for more than three years would not provide greater certainty for scheme participants, and on these grounds only options considering three year targets have been selected.

It is important to highlight that, in expanding the scheme to SMEs, regulations will need to define both:

• eligibility for participation in the scheme (ie defining ‘SME’ to identify those who may undertake the prescribed activities)
• the customers of electricity and gas who are relevant in determining a retailer’s scheme acquisitions for the purpose of calculating a retailer's VEET scheme liability.

DPI sought comment on both these aspects in DPI’s Expansion of Energy Saver Incentive: Issues Paper that it released in October 2010 as well as directly contacting retailers and accredited parties participating in the scheme. Stakeholders generally agreed that scheme eligibility should ideally be as wide as possible so as to maximise the potential for least cost activities to be undertaken.

A simple definition that does not increase costs for participants, create barriers to participation or liability issues is preferred.³⁹

The VEET scheme aims to achieve reductions in GHG emissions that would not otherwise have occurred if not for the existence of the scheme. Accordingly, it is DPI’s intention to limit scheme eligibility to those businesses that are not already subject to existing statutory energy efficiency schemes or reporting requirements such as the Environment and Resource Efficiency Plan (EREP) and Commonwealth Energy Efficiency Opportunities program (EEO) (see page 27 for detail of these schemes).

In light of these considerations it is proposed that scheme eligibility is described on an ‘exclusions’ basis. This ensures the definition is wide, but excludes those who are not eligible to participate such as very large consuming companies who participate in EEO and EREP. DPI acknowledges that such a definition is likely to allow VEET activities to be undertaken for some larger consuming businesses that would not typically be described as a ‘small to medium enterprise’.

Ideally, the scope of both scheme eligibility and scheme acquisitions would align as closely as possible to ensure that the customer acquisitions on which a retailer’s scheme liability is based, are the same customers that are eligible to participate. In practice however it is difficult to precisely align both aspects. DPI proposes an option that it believes strikes an appropriate balance between matching the scope of the definitions and ensuring administrative simplicity for audit and compliance purposes.

The proposed Regulations define the class of customers relevant to scheme acquisitions as ‘all of a relevant entity’s customers of electricity’ (which has the effect of excluding all large electricity users who purchase directly from the wholesale market) and ‘all of a relevant entity’s customers of gas other than customers who are…a gas -fired electricity generator…’.

In addition to excluding the largest users of gas who purchase gas directly from the gas wholesale market, this definition excludes gas consumed by gas-fired electricity generators many of which, despite being large customers of gas, purchase their gas through a retailer. The rationale for doing this is to avoid, for the purposes of calculating a relevant entity’s scheme liability, double counting that would arise if both the gas consumed by a generator as well as the electricity produced from that generator that may be consumed by a prescribed (electricity) customer were counted.

5 Cost-benefit analysis

The fundamental purpose of the RIS process is to present evidence as to the most appropriate means of resolving the problem in question, and achieving the stated objective of government intervention. In order to provide this evidence, a comprehensive assessment of the costs and benefits of each of the viable options is undertaken to gauge the net benefit/cost to society as a whole. Cost-benefit analysis (CBA) is a technique that provides a systematic approach to ensuring this requirement is met.

According to the Victorian Guide to Regulation, one of the first tasks in any CBA is to separate the allocative (or ‘real’) effects of a proposal from its distributional effects (or transfers between groups that do not affect overall welfare):

• Allocative effects impact on the overall level of welfare in society. They change what, and how much, society can produce which, in turn, determines what is available for the community to consume. Since total resources are limited, the decision to use resources to undertake a particular initiative will mean that the resources cannot be used for other purposes. This represents an allocative cost in terms of production and consumption opportunities foregone – a concept commonly referred to as opportunity costs.
• Distributional effects represent transfers in welfare between different groups in society, but do not alter the total level of welfare on society (unless a judgement is made that one group derives more value from the resources than other group). In other words, some groups may be made better off as the result of undertaking a course of action at the expense of other groups who become correspondingly worse off.

It is important to identify both the allocative and distributional effects of particular proposals, but these effects need to be kept separate to ensure that the distributional effects are not included in the overall net impact of a proposal. For example, if savings to energy consumers are offset by a loss of generator profits, this could be considered to be a transfer.

It is also useful to differentiate between private and social impacts (noting that ultimately CBA focuses on the net benefit to society as a whole). According to the Prime Minister’s Taskforce on Energy Efficiency:

• If an entity invests in an energy efficiency improvement, the private cost is the amount that the relevant entity pays for that improvement. Private costs do not include the costs that the improvement might impose on others. The private benefit associated with that improvement is the advantage that accrues to the relevant entity. Private benefits do not include the benefits that the improvement might yield to others in the economy (for example, through decreased greenhouse gas emissions).
• The social cost of an energy efficiency improvement is the sum of the private cost to the entity making the improvement and any costs that the improvement imposes on others in the economy. The social benefit of an energy efficiency improvement is the sum of the private benefit to the entity making the improvement and any benefits that the improvement yields for others in the economy (for example, through decreased greenhouse gas emissions).

So, for example, in this case:

• the private cost of an energy efficiency improvement is the upfront capital costs for participating households and SMEs, whereas the private benefit is the bill savings enjoyed by participating households and SMEs as a direct consequence of undertaking the energy efficiency improvement (that is, savings due to a more efficient product being installed)
• these improvements yield benefits to others in the economy, for example through:
• • reduced demand for energy which in turn puts downward pressure on wholesale and retail prices compared to BAU
  • deferring the need for investment in generation capacity
  • reduced GHG emissions.

The sections that follow estimate the costs and benefits of the options set out in Chapter 4, relative to the base case (described below), and provides evidence of the most appropriate solution to the problem set out in Chapter 2. The analysis includes the:

• base case
• modelling methodology
• stakeholders affected by the options
• household and SME energy efficiency upgrades expected
• costs and benefits of the options based on the Net Present Value (NPV) of each.

CBA period

The CBA was calculated from 1 January 2012 until 2030. The analysis required modelling of the behaviour of the national electricity and gas markets. Uncertainty in modelling the behaviour of such a complex market increases over time, and it was considered that it would be preferable not to rely on projections of market behaviour after 2030.

Further examination of the impact of the scheme was undertaken up to 2038, but excluded from the CBA. Such additional information has been presented in some following tables, where relevant, for the information of stakeholders. 2038 is the period by which the activity with the ‘longest life’ is considered to have ceased functional operation. This is consistent with the operation of VEET, in which the lifetime GHG abatement associated with activities is ‘deemed’ upfront for the purposes of calculating certificates. This results in excluding 8 years of benefits from the analysis. Although the amount of energy saved over this period can be determined, the impact on the energy market is more difficult to determine. For this reason the period was excluded from the CBA.

Although the assumed lifetime varies between activities (a standard light bulb replaced with a CFL⁴⁰ is typically deemed a life of 15,000 hours, whereas the life of ceiling insulation is deemed to be 25 years) the majority of benefits will be realised in the first 20 years of the scheme.

This analysis shows results for the period 2012 to 2030 (in 2011 dollars).

Results are also provided in summary tables showing NPVs over ten years from 2012 to 2021 (in 2011 dollars).⁴¹

Base Case

In identifying the costs and benefits likely to arise from the viable options, the base case needs to be defined for comparison purposes (ie what are the potential costs and benefits compared to the situation where the proposed approach is not adopted).

If no further action is taken, retailers would still be technically obliged to surrender certificates against the existing target:

• Failure to set a target in the Regulations by 31 May 2011 for the next phase of the scheme (1 January 2012 to 31 December 2014) would result in there being no scheme target.
• Operationally however, even if no target is technically prescribed in Regulations, there is nothing in the Act that prevents greenhouse gas reduction rates being fixed under section 32 to impose scheme liabilities on retailers. The Act does not tie an Order in Council made under section 32 to targets defined in section 30.
• Further, section 32(3) states that if a greenhouse gas reduction rate for electricity or gas is not fixed by an Order in Council in any year, then the rate for the previous year applies.
• The liability on retailers is set by the prohibition from having a shortfall (section 27) the shortfall is calculated using the greenhouse gas reduction rates set by the Order in Council, not directly from the scheme target.

Therefore, if no action is taken – ie no target is fixed by regulation and no new greenhouse reduction rate order is made – retailers may still be technically obliged to surrender certificates against an obligation determined using the current greenhouse reduction rates until the year commencing 1 January 2030 when the obligation in section 27 ceases.

In practice however, DPI advises that it would take action to remove the remnant legislative architecture. As such, this analysis starts from a base case of no VEET target or scheme. In order to anticipate the most likely treatment of carbon in future, and consistent with the approach taken in the energy market modelling, the base case also includes the Federal Government’s Carbon Pollution Reduction Scheme with a five per cent reduction target (CPRS-5 scheme), and a price on carbon from 1 July 2013.

Modelling Methodology

Three key stages were undertaken in order to determine the costs and benefits of each scheme option:

• Modelling to understand how the VEET market would respond to a number of target scenarios and expansion to the SME sector. This was used to estimate the maximum certificate price required to achieve the three targets, as well as the mix (type and number) of energy efficiency measures which would be implemented under each scenario. The key outputs from this modelling were a maximum certificate price in each year, and a time series of energy (electricity and gas) savings. This time series of energy savings was the main input into the energy sector modelling undertaken by ACIL-Tasman. (VEET activities modelling undertaken by DPI, with assistance from SV and VECCI).
• Input the energy savings and certificate price into a model of the National Energy Market (energy market modelling undertaken by ACIL Tasman) to determine the impact on energy prices.
• Include the impacts from the VEET activities modelling and energy market modelling into a cost benefit analysis for each VEET scheme option.

These stages are described in more detail below.

VEET Activities Modelling

Modelling of the likely uptake of VEET measures was first undertaken in 2007. This modelling has been updated, extended and revised to reflect best available current data. The modelling was found to be indicative of market behaviour in most respects, except for over-predicting the cost of VEET certificates. This was linked to under-predicting the maximum delivery possible for low cost measures that respond to simple delivery models.

Where possible the updated model revises these assumptions. For newly introduced measures it is possible that the revised model will under-predict maximum possible delivery of some measures, which make it a conservative analysis. Market based schemes, by their nature, incentivise low cost delivery, and the modelling is based on conservative assumptions of market innovation.

The modelling in this RIS has been undertaken on the assumption that the scheme will be expanded to include SMEs from 1 January 2012. The Government is committed to ensuring that the scheme has safeguards in place to prevent rorting, and the expansion will therefore be timed to ensure that the auditing and compliance framework (administered by the ESC) is sufficiently robust prior to expansion. If the timing of the inclusion of SMEs needs to be deferred until such safeguards are developed, the target that is implemented for the period 2012-2014 may need to be revised to take account of the reduced size of energy efficiency opportunities and the impact on the modelled results.

In conducting the VEET activities modelling:

• DPI convened a panel, which included SV and VECCI, to examine the energy efficiency activities that may be undertaken in the next phase of the scheme. The panel examined the energy savings potential of each measure to determine what incentive it would receive through VEET. Based on this incentive, the panel made forecast predictions on uptake rates for each measure, under a range of certificate price scenarios.⁴²
• DPI examined the VEET activities modelling outputsto identify appropriate break points where certificate prices and mitigation levels warranted further investigation. For example, DPI was able to determine that there was an upper limit where the additional cost burden of certificate prices did not yield a commensurate level of abatement .
• Three greenhouse gas targets were then tested through detailed energy market modelling by ACIL Tasman to determine the costs and benefits to energy markets and consumers.

The options chosen are as follows:

• Option 1 - target of 2.7 Mt CO2 (maximum certificate price of $21.50) over the next phase of the scheme (2012 – 2014). This option represents the previous VEET scheme target, with an expansion to SMEs.
• Option 2 - target of 4.2 Mt CO2 (maximum certificate price of $25) over the next phase of the scheme (2012 – 2014), with an expansion to SMEs. This option represents an optimal target that the VEET activities modelling suggested was likely to warrant further testing (to allow full quantification of impacts through the CBA).
• Option 3 - target of 5.4 Mt CO2 (maximum certificate price of $35) over the next phase of the scheme (2012 – 2014). This option doubles the target and expands the scheme to SMEs.

Key VEET Activity Modelling assumptions Modelling results should be considered indicative rather than predictive and is based on the best available evidence at the time of modelling. All measures undertaken are additional to current and anticipated mandatory requirements. Consideration of the ‘pool’ of measures: there has been significant uptake of some measures due to existing schemes such as VEET, rebates and other incentives. The modelling considers the total pool of currently available actions. Where activities are exhausted the measure is then eliminated from the modelling. A rebound factor is included for relevant measures where this may occur. For detailed rebound discussion see Appendix D. The certificate price includes a certificate registration fee to the ESC of $1 and a 10 per cent allowance for the administration costs of retailers, certificate creators and participating households and SMEs. The available certificate value is calculated after accounting for these costs. All measures have an assumed life of savings which relates to the lifetime of the product (abatement is deemed). The maximum product lifetime is 25 years for insulation and double glazing, noting that this is a shorter period of efficacy than likely to occur in the field. Other measures are modelled with a shorter lifetime. Incentive generated for a given measure= available certificate value x number of certificates allocated to that measure (based on an average installation).

 

The modelling considered each measure individually and, utilising peer reviewed expert opinion, determined the level of uptake likely at a given certificate price. This was set individually for each measure dependent on the cost of the measure, the ease of installation, ease of locating opportunities in the field, previous uptake under phase 1 of VEET and under similar programs such as rebates.

This has been refined from, and varies from the modelling approach undertaken under phase 1 of VEET which focused on payback periods. The approach utilised in the current round of modelling considers the range of barriers to uptake, and the necessary incentives likely to be required to overcome them.

The modelling takes account of the impact of other regulatory interventions that may impact the level of benefits attributed to activities. For example, where incandescent light globes are replaced with CFLs, the impact of MEPS is factored into the attributed abatement of the activity. More specifically, the abatement from this activity presumes:

• MEPS-compliant incandescent globes may be sold (for example, halogen globes) that are about 20 per cent more efficient that the old tungsten-filament globes (which are currently being phased out)
• the base energy saving is based on replacing a MEPS-compliant incandescent lamp with a CFL
• this saving is further discounted by 50 per cent, to take account of the assumed increased uptake of CFLs since the MEPS have been implemented.

Key activities incentivised under each option

The VEET Activities Modelling considered a range of likely VEET measures, most of which are already available for residential customers, and modelled the likely uptake at the certificate prices required to achieve certain targets. Both residential and SME measures were modelled.

Consultation question: Details of the activities modelled are contained in Appendix D; stakeholders are invited to comment on these assumptions.

 

The results below report the main measures that deliver the savings modelled under the three options.
The outputs of the modelling are indicative, rather than predictive. An incentive exists to deliver measures at the lowest cost. This can drive market innovation and may result in a different outcome than that modelled. The results reported below should be considered in this light.

Option 1: Target of 2.7 Mt CO2

The residential sector generated 69 per cent of all certificates. Of these certificates, 86 per cent were generated by four measures, including installing standby power controllers (35 per cent of the residential total), also installing ceiling insulation in uninsulated homes, low flow shower rose installation, and replacing incandescent lamps with a CFL. A total of 13 measures were active in the market.

Low flow shower rose installation was the only measure that was exhausted during year three.⁴³

The SME sector generated 31 per cent of certificates. 80 per cent of these certificates were generated by water heating measures, installation of low flow shower rose and standby power controller. The largest number of certificates were generated by improved efficiency of water heaters (61 per cent), mostly solar electric or heat pump replaces electric water heater. A total of nine measures were active.

Option 2: Target of 4.2 Mt CO2

The residential sector generated 62 per cent of all certificates. Of these certificates, 88 per cent were generated by the measures listed above with an additional measure contributing to this uptake:- replacing an existing halogen lamp with a low energy lamp. Standby power controllers generated the largest volume of certificates at 37 per cent. A total of 16 measures were active.

The SME sector generated 38 per cent of certificates. 81 per cent of these certificates were generated by the same measures in option 1. Water heating measures generated the largest volume of certificates at 61 per cent. A total of 12 measures were active.

Option 3: Target of 5.4 Mt CO2

The residential sector generated 69 per cent of all certificates. Of these certificates 84 per cent were generated by the same measures in option 2. Ceiling insulation generated the largest volume of certificates at 37 per cent. A total of 23 measures were active.
Ceiling insulation was also exhausted in year three under this option.

The SME sector generated 31 per cent of certificates. 81 per cent of these certificates were generated by the same measures in option 1. Water heating measures generated the largest volume of certificates at 57 per cent. A total of 15 measures were active.

Comparison with VEET activity to date

VEET activity between 1 January 2009 and 31 January 2010 is described in Table 6 (Section 2 – Nature and extent of the problem). The scheme currently only covers the residential sector. Certificates were created primarily through lighting (79 per cent) and water heating measures (16 per cent).

A total of 17 measures were active.

Analysis of the VEET Activities Modelling

More measures are likely to be active than were modelled

More activities are active in the existing VEET market than is predicted in the modelling. There is good reason to assume that this will continue.

This outcome is expected as the modelling considers only average costs and payback periods, whereas in reality some situations will generate much better payback periods (for example regional areas with cold climates generate much faster paybacks and generate more certificates than the average). This will provide a significant incentive for low levels of activity in some measures, which will not be predicted by the modelling.

Activity generated by these drivers is low and difficult to predict, and it is unlikely to have significant overall impact on certificate generation, and hence the modelling results.

Modelling indicates activity will be spread more evenly over measures and certificate prices will rise

During the first phase of the scheme, a large portion of the activity resulted from a small number of eligible measures, and close to 79 per cent of all activity was due to the replacement of incandescent globes with energy efficient CFL globes. The modelling for the next phase of the scheme assumes a reduction in the number of certificates awarded to this activity. This accounts for a potential future amendment to this measure that is being considered to ensure emission reductions remain ‘additional’, considering advances in minimum standards. Furthermore, the modelling assumes that the maximum uptake rate for CFL replacing incandescent declines as the market becomes saturated.

Likewise, the modelling also assumes amendments to existing VEET water heating measures in consideration of the planned mandatory phase out of electric water heaters in class one dwellings. This reduces the available pool of opportunities. This generates the result that under option 1 (continuation of the current target), certificate prices are modelled to be higher than current spot prices.

Resultant certificate price increase will therefore provide a greater incentive for moderate cost measures to play a more active part in the market. In this case, low cost opportunities are not generally exhausted in the three year period (except in the two cases listed above). There is a physical limit however, to the ability to access these opportunities (the maximum uptake rate). When this is reached, and the certificate price is sufficient, the market expands into a range of moderate cost measures.

Energy market modelling

ACIL Tasman was engaged by DPI to undertake analysis of the impact of each option on the energy market (see Appendix F for detail). ACIL Tasman drew on the certificate price and reduction in energy modelled by the VEET Activities Modelling. Outputs were utilised in the cost-benefit analysis and include:

• energy generation
• wholesale energy prices
• retail energy prices
• generator profits.

Cost-benefit modelling

PwC’s cost-benefit modelling uses a NPV approach to compare each option on the basis of their respective cost and revenue streams projected over time. The PwC modelling attributes costs to upfront capital costs for participating households and SMEs reflecting the cost of purchase and installation of energy efficiency measures.

Administration costs to government, energy retailers, certificate creators, households and SMEs are reflected in the certificate price derived from the VEET activities modelling and so are not modelled separately (although they are discussed in the relevant section below).
The benefits associated with the various options primarily relate to:

• Avoided energy expenditure – the net impact on retail energy prices as a result of reduced demand for energy on the one hand, and the cost of certificates on the other. Some of this represents a transfer from generators’ profitability, which is also shown as a ‘cost’ item.
• Avoided GHG emissions – as a result of decreases in energy consumption and a conversion of some appliances to gas (which creates lower GHG emissions). The quantum of GHG emissions avoided is known and represented through the target. GHG emissions are currently an unpriced ‘externality’ in the energy market, hence valuing this benefit is subject to uncertainty. The energy market modelling used places a value on the emission reductions from 2013, and this is internalised in the energy price, hence only the GHG emissions that occur during 2012 have not been valued. Given the small quantum involved and the need for a wide range of assumptions which would ultimately limit the robustness of the resulting estimates, this calculation has not been undertaken. Nevertheless, this does suggest that the net benefits of the options are likely to be slightly higher than shown here if such benefits were quantified (all else held constant).

The net cash flows for each cost and benefit are discounted back at two discount rates (3.5 per cent as recommended by the Victorian Guide to Regulation and 7 per cent) to determine the value of each scheme option in today’s dollars. In calculating the net cash flow of costs and benefits, the model uses outputs and assumptions from the VEET Activities Modelling and ACIL Tasman’s energy market modelling.

The NPV is calculated from 1 January 2012 to 2030 based on impacts (mainly benefits in the later years).. Estimating benefits after a 10 year period is subject to some uncertainty and hence results are also provided in summary tables showing NPVs over ten years from 2012 to 2021 (in 2011 dollars). A full set of assumptions used in the cost-benefit modelling is detailed in this section, and further in Appendix C.

Costs and benefits of the options

The following section outlines the costs and benefits of the options.

Upfront capital costs for participating households and SMEs

The total capital cost of VEET scheme measures is dependent on the pattern of uptake of energy efficiency measures generated by each option. The cost is inclusive of the upfront cost of purchase and installation.

Modelling the upfront cost of purchase and installation of equipment varies according to activity, and is based on:

• The current retail price for the items, based on available data.
• Whether the consumer would or would not have been in the market for a product of that nature anyway – albeit a less energy efficient one (marginal versus full costs). These are based on estimates of normal consumer purchasing cycles for appliances, based on available data.
• Any rebates likely to be available from Government. These are based on the rebates currently available from the Victorian and Federal Governments and currently include rebates for hot water. However, it should be noted that rebate programs are not (typically) unconstrained: they are usually provided through a limited pool of funds and cease when the fund is exhausted. This feature helps to ensure that there is no ‘additional’ cost to government in the presence of VEET. Furthermore, while the modelling factors in the impact of rebates on uptake of VEET measures, the scheme is designed so that this overlap of incentives can be managed to minimise “double-dipping”:
• • Firstly, VEET measures may be discounted by a Ministerial declaration which acts to address any uncertainty associated with the reduction of greenhouse gas emissions that would eventuate from a prescribed activity or class of activities but for the existence of the scheme. A ‘discount factor’ was declared in 2009 to discount abatement associated with the ceiling insulation measure under VEET following the Federal Government’s energy efficiency homes package. The Federal Government’s package provided a rebate which covered the costs associated with the installation of ceiling insulation in an average sized home.⁴⁴
  • Secondly, rebate programs offered in Victoria through Sustainability Victoria factor in incentives provided by VEET. Rebates are adjusted (downward) where VEET activities impact the same appliance measure.⁴⁵ The cost to government of these rebates is capped and therefore no additional costs are incurred due to the VEET scheme.
• Cost reductions available from bulk purchasing.
• DPI estimates of the length of time required to undertake the activity in question.
• Whether the labour required to install the item was skilled or unskilled. For each measure the likely average cost for labour for an average installation was based on industry quotes and peer reviewed expert opinion.

The modelling assumes that appliance upgrades occur at point of retirement with the exception of removal of a pre-1996 fridge or freezer, double glazing, lighting and showerhead replacements. It is assumed that householders will make their own assessment as to whether an offer by a certificate creator warranted the early retirement of an existing asset which includes any cost of foregone useful life.⁴⁶

Summary of capital costs

Some activities encouraged by the VEET may cost participating households and SMEs more in terms of upfront purchase and installation costs than the value of the VEET scheme incentive that is created. This is shown in Table 8.

Table 8 : Net cost of purchases and installation for households/SMEs

Option	3.5% NPV ($m)	7% NPV ($m)
Option 1	62.6	56.7
Option 2	81.4	73.7
Option 3	96.3	87.4

For other activities, the VEET scheme incentive exceeds the upfront cost of purchase and installation, which generates a ‘capital surplus’. Real world market behaviour is likely to manage this in a range of ways. For example the capital surplus may effectively reduce the cost of creating certificates (although the extent to which this may actually occur is unknown). As such, the capital surplus appears as a ‘negative cost’ in brackets in the summary NPV tables. This allows readers to freely consider how this benefit could act in the market.

Activities that create a surplus in the model, under option 1 include installation of low flow shower roses, replacing incandescent lamps with CFLs and replacing existing electric water heating with gas (SME only).

As the price of the certificates increases, so does the value of the incentive. Therefore, option 3 with a $35 maximum certificate value has more measures where the value of the incentive outweighs the out of pocket costs for participating households and SMEs, and hence the overall surplus for this option is greater. See Appendix D for a more detailed analysis of this issue.

The total capital surplus for each option is set out in Table 9 below.

Table 9 : Total capital surplus

Option	3.5% NPV ($m)	7% NPV ($m)
Option 1	(9.6)	(8.8)
Option 2	(22.2)	(20.1)
Option 3	(94.9)	(86.1)

Capital surpluses are negative as they represent a negative cost, and hence they represent positive capital surpluses.

Administrative costs

The administrative costs below have been incorporated into the cost of certificates which then flows through into the retail price of energy in the cost benefit analysis.

Government

The options require an administrator (the ESC) to manage the relevant legislation and its enforcement. At a minimum, the administrator will:

• be responsible for the general administration of the Act
• accredit persons who may create certificates
• monitor and administer the creation, registration, transfer and surrender of the certificates
• enforce the imposition of the energy efficiency shortfall penalties
• undertake audits and monitoring compliance with the Act
• report to the relevant Minister on performance of the scheme.

These costs are recovered in the form of fees charged to certificate creators.

Certificate creators

The costs to all certificate creators (accredited persons under the Act) include all costs that must be incurred in order to operate within the requirements of the scheme, over and above those costs described elsewhere (ie capital costs, scheme administrator fees). These would be expected to include marketing, advertising, research and business administration costs.
The VEEC creator costs are driven by the:

• generation of certificates: locating opportunities and ensuring that a (certificate generating) measure is installed
• verification activities required by the ESC to support certificate generation
• processing of the VEECs for trading.

Consultation question: Feedback is sought about the assumed level of certificate creators’ administrative overheads (see Appendix E for further detail on these overheads)

 

Energy retailers

The scheme imposes an obligation on energy retailers servicing more than 5,000 Victorian customers. These businesses will be obligated to annually acquire a quantity of certificates as stated in the Order-in-Council. In practice, these businesses already employ staff to service existing obligations of a similar nature.

Households and SMEs

Households and SMEs incur a transaction cost associated with participating in VEET. This reflects the time taken to supply any additional data over and above what would have been required in the absence of the scheme.

Impact on energy prices

This section discusses the impact of the options on wholesale and retail energy prices.

The scheme will decrease gas and electricity demand through improved energy efficiency, which is expected to primarily create downward pressure on wholesale electricity prices, compared with BAU. The cost of generating the certificates will be imposed on retailers who will ‘pass through’ this cost, with other retailer costs, creating the overall impact on energy prices. Therefore, within this analysis, retail energy prices include both the benefits of reduced wholesale energy (electricity) prices and the costs of generating the certificates.

The cost of certificates is passed through to consumers and hence is included in the cost benefit analysis through this approach, however it is also useful to separately identify the yearly cost of certificates to retailers for each year of the next phase of the scheme (see Table 10).

(Note modelling indicated for options 2 and 3, that market behaviour would generate ‘banking activity’ where lower cost opportunities would be taken up in the early years and banked for use in the third year of the scheme. This is supported by the performance of phase 1 of VEET (eg see Table 6) where ‘banking activity’ has occurred.

Table 10 : Total certificate cost

Option	2012 ($ mil)	2013 ($ mil)	2014 ($ mil)
Option 1	55.1	55.1	62.5
Option 2	108.5	108.5	101.3
Option 3	199.8	199.8	167.7

Electricity

The options change the retail price of electricity, and the amount consumed. The impact of the options on electricity consumers is calculated by comparing the retail price × quantity of electricity consumed each year under the base case, and the retail price × quantity of electricity consumed, under each of the options.

Table 11 shows the modelled change in electricity demand over time under the options and the base case.

Table 11 : Projected Victorian electricity demand for each scenario (GWh)

Year	Base case	$21 certificate price	$25 certificate price	$35 certificate price
2010	50,003	50,003	50,003	50,003
2011	50,437	50,437	50,437	50,437
2012	51,700	51,517	51,398	51,363
2013	52,607	52,241	52,002	51,934
2014	52,024	51,438	51,138	51,041
2015	51,886	51,300	51,001	50,903
2016	52,830	52,244	51,944	51,846
2017	53,583	52,997	52,697	52,600
2018	54,109	53,523	53,224	53,129
2019	54,732	54,152	53,853	53,761
2020	55,445	54,878	54,580	54,493
2025	59,080	58,901	58,752	58,685
2030	62,807	62,769	62,755	62,723

Note: Includes impact of expanded RET, CPRS as assumed in the CPRS-5 case.

Data source: 2009 Annual Planning Reviews for New South Wales, Queensland, South Australia and Victoria, 2008 NEMMCO SOO for Tasmania, Federal Government CPRS White Paper, DPI analysis and ACIL Tasman analysis.

Impacts on large businesses have been calculated using both the change in the retail price and the electricity consumption of large business (there is no change in demand as larger businesses do not participate in the scheme). The change in the electricity price has been taken from Victorian retail tariff data projected by ACIL Tasman. The electricity consumption of large business is estimated by using the annual projected Victorian electricity demand provided by ACIL Tasman, and subtracting the components of demand allocated to residential and small business.

Modelling indicates that electricity price pressure varies from year-to-year reflecting the balances of supply and demand. As the supply-demand balance tightens, prices start to go up but, as new plant enters the market, there is a dip in price due to the large size of new plant being greater than annual load growth. The options change the timing of entry of new plant to a small degree, which in turn leads to a different saw-tooth pattern of prices. Again, this impact is passed onto consumers via retail prices. The magnitude of these impacts is driven by the energy savings generated by each option.

As advised by ACIL Tasman, the retail electricity price impact (detailed below) is inclusive of the impact of power-plant costs, royalties, interconnector flows and capacity additions resulting from each of the options. It is assumed that retailers are able to fully realise any benefits of reductions in wholesale market prices, and pass through any costs associated with certificate acquisition to households and SMEs. Consequently there is no net impact on energy retailers.
While retail prices for electricity and gas decrease as an aggregate measure over the relevant period, prices for electricity and gas fluctuate between increases and decreases on an annual basis in relation to the base case. Although the modelling shows relatively volatile price impacts, markets can act to smooth price volatility through a range of management techniques (eg futures contracts) so the volatility is likely to be overstated. The results can be understood as the ‘pressure’ on energy prices generated by the options, rather than a prediction of exact annual retail energy prices.

The initial drop in retail electricity prices (compared to BAU), through to 2015 can be explained through the uptake of additional energy efficient measures. Under the base case, it is assumed additional power plant investments would take place around 2016. Each VEET scheme option however, defers the need for additional investments until approximately 2018. This explains the drop in price against the base case around 2016, and subsequent spike in 2018 (see Appendix F; Table 15).

Table 12 shows the net impact on retail electricity prices on a $/MWh basis compared to BAU. Where costs are negative, this represents a decrease in energy retail prices, and resulting saving to households and SMEs when compared to BAU.

Table 12 : Impact on retail electricity prices compared to BAU

Option	2012	2013	2014	2015	2020	2025	2030
Option 1
Households ($/MWh)	1.2	-1.2	-4.8	-6.2	-3.9	0.2	-0.8
SMEs ($/MWh)	1.2	-1.0	-4.3	-5.7	-3.6	0.2	-0.8
Large business ($/MWh)	-0.6	-2.1	-4.3	-3.8	-2.4	0.1	0.5
Option 2
Households ($/MWh)	-1.3	-1.1	-4.7	-5.8	0.6	1.5	-2.2
SMEs ($/MWh)	-1.0	-0.8	-4.1	-5.4	0.5	1.4	-2.0
Large business ($/MWh)	-3.3	-3.1	-5.4	-3.6	0.4	1.0	-1.3
Option 3
Households ($/MWh)	1.8	0.6	-0.6	-9.7	-3.6	0.4	-2.2
SMEs ($/MWh)	2.1	1.0	-0.1	-9.0	-3.3	0.4	-2.0
Large business ($/MWh)	-3.3	-4.0	-4.8	-6.0	-2.2	0.2	-1.3

Gas

The cost of generating certificates related to gas acquisitions is shown in Table 13. This is calculated by multiplying the expected (marginal) cost of certificates by the anticipated number of certificates allocated to gas.

Table 13 : Gas price impacts

Option	3.5% 3 year NPV ($m)	7% 3 year NPV ($m)
Option 1 – Household cost	22.1	20.0
Option 1 – SME cost	14.7	13.3
Option 2 – Household cost	40.2	36.5
Option 2 – SME cost	26.8	24.3
Option 3 – Household cost	71.4	64.7
Option 3 – SME cost	47.6	43.2

The benefits of reduced gas demand⁴⁷ have been calculated by multiplying the reduction in demand under each option by the retail price of gas.

The gas market has fundamentally different characteristics to the electricity market. Electricity cannot be stored and so the need to balance supply and demand in real time is critical to ensure supply security. As a result, the wholesale electricity price is sensitive to the supply demand balance and can be volatile. Conversely, gas can be stored and so the wholesale gas price tends to be very stable.

The VEET has a negligible impact on the demand for gas and therefore no impact on the wholesale gas price. There is thus no price impact on gas producers and also considering the demand impact, ACIL Tasman notes that the impact on gas producers is likely to be to be negligible.⁴⁸

Benefits to participating households/SMEs

In contrast to the preceding discussion, which largely focuses on ‘societal’ costs and benefits, the tables below show the indicative yearly bill savings (the ‘private benefits’) for average participating households and SMEs. The societal estimates above encompass private benefits as a result of considering both changes in price and demand.

This information provides a snapshot of how the options may influence the energy bills of an average household or SME.

For the purposes of this analysis an average annual electricity bill for a residential household in 2012 under BAU has been estimated at $1,104.50. For a small to medium enterprise an average annual electricity bill of $4,521.96 has been used for comparison. It is assumed that this average customer is an average participant in VEET (ie undertakes an average amount of the modelled energy efficiency activities, they then benefit from reduced consumption and an overall reduced tariff (from the BAU).

For gas for this analysis, the average annual bill (for residential and SME customers) was estimated at $1,100 (noting that gas bills vary significantly between retailers and distribution zones).

On average a participating household will save $308 in electricity and $39 in gas under option 3 in the first five years of the scheme.

Where a household does not take up the energy efficiency measures then they are only impacted by the overall reduced electricity tariff.

The following tables show the impact on ‘average’ annual bills and assume the average level VEET driven energy efficiency activities have been undertaken.

Table 14: Annual electricity savings
(negative values indicate savings and positive values indicate bill increases )

Electricity impact	2012	2013	2014	2015	2020	2025	2030
Option 1
Households ($ savings per electricity bill)	-2.5	-26.8	-64.5	-74.6	-63.2	-8.4	-9.9
SMEs ($ savings per electricity bill)	-8.6	-109.2	-256.3	-300.6	-252.6	-84.8	-19.5
Option 2
Households ($ savings per electricity bill)	-22.5	-38.4	-79.5	-89.0	-56.2	-6.7	-18.6
SMEs ($ savings per electricity bill)	-92.2	-165.3	-350.5	-397.0	-266.2	-146.2	-55.4
Option 3
Households ($ savings per electricity bill)	-7.5	-34.1	-65.0	-118.9	-87.1	-21.6	-22.6
SMEs ($ savings per electricity bill)	-19.6	-127.8	-264.9	-494.7	-370.8	-174.0	-57.8

Table 15: Annual gas savings:

Gas impact	2012	2013	2014	2015	2020	2025	2030
Option 1
$ net impact on bill	3.1	-1.5	-4.3	-11.8	-11.3	-6.6	-4.5
Option 2
$ net impact on bill	8.1	2.1	-2.4	-15.9	-15.3	-10.5	-8.2
Option 3
$ net impact on bill	14.4	3.5	-3.0	-26.9	-25.8	-20.6	-17.0

One of the effects of the VEET scheme is to reduce expenditure on energy compared to BAU.⁴⁹ This downward pressure on energy prices is only one input into forward retail energy prices, other market pressures unrelated to VEET generate upward pressure on energy prices. The modelling projects that energy prices will rise under all options, but under all options, energy prices rise less than under business as usual.

Impact on existing generators

According to ACIL, the reduction in electricity demand in turn results in a reduction in output (from the major four existing generators) thereby reducing their profitability. This is offset, somewhat, in later years by an increase in profitability from the higher wholesale electricity pool prices around 2019 resulting from the deferral of new generation investment.

As the demand for electricity increases relative to supply, the wholesale electricity price will increase. When the wholesale electricity price is sufficiently high, there will be new investment in generation. The wholesale electricity price will then fall. New generation is introduced in large blocks resulting in significant swings in wholesale electricity price as the new generation is brought on line, resulting in a seesaw in prices over time. There will be large differences in the wholesale electricity price from one scenario to another around the time that new generation is brought on line. For example, assume new generation comes on line under scenario A in 2018. The wholesale electricity price will be high in 2017 and will fall significantly in 2018. If under scenario B the new generation is deferred to 2019, the wholesale electricity price will be high in 2018 and fall significantly in 2019. The variance in wholesale electricity price will be relatively small in 2017 and 2019, but much greater in 2018.

Wholesale electricity prices directly impact retail electricity prices for consumers and profitability for generators. If the wholesale electricity price increases (or decreases), the pressure on retail electricity price increases (or decreases) and the profitability for generators increases (or decreases).

Impact on existing generators

According to ACIL Tasman analysis, the options change the timing under which new generators become operational, and therefore impact on their profitability in given years. The estimates on the impact on new generators from ACIL reflects the difference in EBITDA⁵⁰ = (Revenue less variable costs less fixed costs) for the scenario less (Revenue less variable costs less fixed costs) for the base case. Assuming that the fixed costs are the same, then this reduces to: Difference in EBITDA = (Revenue less variable costs) for the scenario less (Revenue less variable costs) for the base case.

It is not clear, however, the extent to which the capital that would otherwise be invested by the new generators could be invested elsewhere and potentially gain an alternative rate of return. Alternative investment of these funds has therefore not been considered in the analysis. This has the impact of potentially overstating the impact on profitability for new generators, and hence decreasing the NPV of the options considered.

Energy efficiency impacts on electricity generators profitability by reducing demand, but benefits customers by reducing electricity bills. In this CBA the benefits to customers have been offset by reduced generator profitability- for both new generation (yet to be built) and existing generators. Stakeholders may wish to comment on this treatment

 

Modelling Results

Option 1: Maintain existing target and expand scope to include SMEs

The tables below summarise the costs and benefits associated with option 1.

Table 16 : Option 1 – Total costs (2012 – 2030 in 2011 dollars)

Stakeholder	Cost	3.5% NPV ($m)	7% NPV ($m)
All consumers	Gas price impact	36.8	33.3
Households	Upfront purchase and installation (capital costs)	54.7	49.6
SMEs	Upfront purchase and installation (capital costs)	7.9	7.2
Generators	Reduction in profits – existing generators	604.4	483.0
	Reduction in profits – new generators	172.5	134.4
Certificate creators	Capital surplus (reduction in cost of creating certificates)	(9.6)	(8.8)
Total cost		866.6	698.7

Table 17 : Option 1 – Total benefits (2012 – 2030 in 2011 dollars)

Stakeholder		Benefit		3.5% NPV ($m)	7% NPV ($m)
Large business		Electricity savings to large business through changes in retail prices		480.8	385.9
Households		Electricity savings to households through changes in retail prices		1,129.2	859.8
SMEs		Electricity savings to SMEs through changes in retail prices		680.3	512.6
Household and SMEs		Gas savings		179.2	136.1
Total benefit				2,469.5	1,894.4

Table 18: NPV of Option 1(2012 – 2030 in 2011 dollars)

Option 1
VEET target (certificates)	2.7 million
Installation date from	1 January 2012
Scheme duration	3 years
NPV discounted at 3.5% ($m)	1,602.8
NPV discounted at 7% ($m)	1,195.7

Option 2: Increase target to 4.2 million tonnes of abatement and expand scope to include SMEs

The tables below summarise the costs and benefits associated with option 2.

Table 19: Option 2 – Total costs (2012 – 2030 in 2011 dollars)

Stakeholder	Cost	3.5% NPV ($m)	7% NPV ($m)
All consumers	Gas price impacts	67.1	60.8
Households	Upfront purchase and installation (capital costs)	65.6	59.5
SMEs	Upfront purchase and installation (capital costs)	15.8	14.3
Generators	Reduction in profits – existing generators	439.3	394.6
	Reduction in profits – new generators	120.2	100.4
Certificate creators	Capital surplus (reduction in cost of creating certificates)	(22.1)	(20.1)
Total cost		685.9	609.4

Table 20: Option 2 – Total benefits (2012 – 2030 in 2011 dollars)

Stakeholder	Benefit	3.5% NPV ($m)	7% NPV ($m)
Large business	Electricity savings to large business through changes in retail prices	234.5	236.6
Households	Electricity savings to households through changes in retail prices	1,263.5	978.8
SMEs	Electricity savings to SMEs through changes in retail prices	930.0	702.3
Households and SMEs	Gas savings	253.5	190.3
Total benefit		2,681.4	2,108.0

Table 21: NPV of Option 2. (2012 – 2030 in 2011 dollars)

Option 2
VEET target (certificates)	4.2 million
Installation date from	1 January 2012
Scheme duration	3 years
NPV discounted at 3.5% ($m)	1,995.5
NPV discounted at 7%($m)	1,498.6

Option 3: Double the target and expand scope to include SMEs

The tables below summarise the costs and benefits associated with option 3.

Table 22 : Option 3 – Total costs (2012 – 2030 in 2011 dollars)

Stakeholder	Cost	3.5% NPV ($m)	7% NPV ($m)
All consumers	Gas price impacts	119.0	107.9
Households	Upfront purchase and installation (capital costs)	86.6	78.6
SMEs	Upfront purchase and installation (capital costs)	9.8	8.8
Generators	Reduction in profits – existing generators	855.3	704.6
	Reduction in profits – new generators	247.7	186.9
Certificate creators	Capital surplus (reduction in cost of creating certificates)	(94.9)	(86.1)
Total cost		1,223.4	1,000.7

*SME capital costs are a benefit to SMEs

Table 23 : Option 3 – Total benefits (2012 – 2030 in 2011 dollars)

Stakeholder	Benefit	3.5% NPV ($m)	7% NPV ($m)
Large business	Electricity savings to large business through changes in retail prices	650.6	538.1
Households	Electricity savings to households through changes in retail prices	1,700.4	1,273.7
SMEs	Electricity savings to SMEs through changes in retail prices	1,068.0	791.1
Households and SMEs	Gas savings	450.7	335.5
Total benefit		3,869.7	2,938.5

Table 24: NPV of Option 3(2012 – 2030 in 2011 dollars)

Double the target
VEET target (certificates)	5.4 million
Installation date from	1 January 2012
Scheme duration	3 years
NPV discounted at 3.5% ($m)	2,646.3
NPV discounted at 7% ($m)	1,937.8

Summary of costs and benefits in relation to the base case

Table 25 shows the total costs and benefits of the options on a stakeholder basis.

Table 25 : Summary of costs and benefits of the VEET scheme (2012 – 2030 in 2011 dollars)

Stakeholder	Cost / Benefit	Option 1		Option 2		Option 3
		3.5% NPV ($m)	7% NPV ($m)	3.5% NPV ($m)	7% NPV ($m)	3.5% NPV ($m)	7% NPV ($m)
Costs
Households	Upfront purchase and installation	54.7	49.6	65.6	59.5	86.6	78.6
SMEs	Upfront purchase and installation	7.9	7.2	15.8	14.3	9.8	8.8
Households and SMEs	Gas price impact	36.8	33.3	67.1	60.8	119.0	107.9
Existing electricity generators	Decreased profits	604.4	483.0	439.3	394.6	855.3	704.6
New electricity generators	Decreased profits	172.5	134.4	120.2	100.4	247.7	186.9
Certificate creators	Capital surplus (reduction in cost of creating certificates)	(9.6)	(8.8)	(22.1)	(20.1)	(94.9)	(86.1)
Total cost		866.7	698.7	685.9	609.4	1,223.4	1,000.7
Benefits
Large business	Electricity savings	480.8	385.9	234.5	236.6	650.6	538.1
Households	Electricity savings	1,129.2	859.8	1,263.5	978.8	1,700.4	1,273.7
SMEs	Electricity savings	680.3	512.6	930.0	702.3	1,068.0	791.1
Households and SMEs	Gas savings	179.2	136.1	253.5	190.3	450.7	335.5
Total benefit		2,469.5	1,894.4	2,681.4	2,108.0	3,869.7	2,938.5
Net benefit (cost)		1,602.8	1,195.7	1,995.5	1,498.6	2,646.3	1,937.8

Please note the totals may not sum to figures show due to rounding in the presentation of sub components.

Based on an NPV analysis of each option, Option 3: Double the target has the highest NPV and so is preferred.

Table 26 shows NPV values over the first 10 year period. Estimating benefits after a 10 year period is subject to significant uncertainty and hence this data is presented as a comparison.

Table 26 : Costs and benefits of the VEET scheme (2012 – 2021 in 2011 dollars)

Stakeholder	Cost / Benefit	Option 1		Option 2		Option 3
		3.5% NPV ($m)	7% NPV ($m)	3.5% NPV ($m)	7% NPV ($m)	3.5% NPV ($m)	7% NPV ($m)
Costs
Households	Upfront purchase and installation	54.7	49.6	65.6	59.5	86.6	78.6
SMEs	Upfront purchase and installation	7.9	7.2	15.8	14.3	9.8	8.8
Households and SMEs	Gas price impact	36.8	33.3	67.1	60.8	119.0	107.9
Existing electricity generators	Decreased profits	493.8	414.8	411.0	382.2	719.3	624.4
New electricity generators	Decreased profits	154.1	122.9	124.5	107.0	188.0	153.8
Certificate creators	Capital surplus (reduction in cost of creating certificates)	(9.6)	(8.8)	(22.1)	(20.1)	(94.9)	(86.1)
Total cost		737.6	619.0	661.8	603.6	1,027.8	887.4
Benefits
Large business	Electricity savings	404.3	338.4	261.5	258.5	543.3	475.3
Households	Electricity savings	885.2	708.2	1,006.4	822.7	1,244.3	994.9
SMEs	Electricity savings	503.5	402.6	663.0	538.9	738.1	588.1
Households and SMEs	Gas savings	135.0	109.3	181.8	147.0	309.7	250.7
Total benefit		1,928.1	1,558.4	2,112.6	1,767.1	2,835.3	2,309.0
Net benefit (cost)		1,190.5	939.4	1,450.9	1,163.4	1,807.6	1,421.5

Modelling of further options was not considered warranted due to the rapid increase in certificate prices required to achieve higher targets.

Caveats/Limitations to the modelling results

Energy market modelling produces projections of future energy market outcomes based on a range of assumptions. There is currently a high level of uncertainty associated with these assumptions arising from the uncertainty in energy and climate change policy. In this environment, assumptions that can vary can be generally categorised as those relating to:

• the carbon price – both the timing of the introduction of a carbon price and the level of the carbon price
• the demand for electricity – both the peak demand and energy requirements
• fuel prices – both for coal and gas
• the capital costs associated with new entrant generators.

Rebates for energy efficiency activities

An alternative way of achieving the Government’s objectives would be to use rebates to generate similar energy efficient measures as generated under VEET.

Under this option, rebates would be offered by the Victorian Government to households and SMEs undertaking energy efficiency measures. The scheme could operate in a similar way to existing rebate schemes administered by Sustainability Victoria but with the aim of meeting objectives consistent with the VEET scheme including increasing energy efficiency and reducing greenhouse gas emissions.

As discussed above, rebates provide governments with a means to overcome a range of barriers to energy efficiency improvements. Rebates can provide an incentive to purchase energy efficiency products by offsetting the purchase cost and thereby lowering the associated pay-back period.

Rebates can result in many of the same impacts incentivised under a VEET style scheme, notably:

• less intensive use of existing equipment
• purchase and installation of new energy saving products, which would not have been purchased in the absence of the rebate
• purchase and installation of new equipment which is marginally superior to what would have been purchased in the absence of the rebate
• early retirement of existing equipment and its replacement with a more energy efficient variety.

As with the VEET scheme, the benefits associated with these activities are a reduction in demand for energy, with consequential flow through impacts for wholesale and retail prices (which are enjoyed by all energy users), and reduced GHG emissions.

Any new rebate scheme would still rely on consumers to identify energy efficiency opportunities and on the government to identify and effectively stimulate the lowest cost suite of measures to achieve its energy efficiency or GHG reduction target objectives. As stated previously, households and SMEs are generally time poor, and there is a number of steps required in order to claim a rebate (retaining receipts, finding bank account details, filling out a form and then submitting the form and the receipt/s). The implications of creating a new rebate scheme to fulfil energy efficiency objective or target is that:

• it may be harder to obtain sufficient take up at a given price to meet a specified target or objective
• the time and effort involved in clarifying eligibility and then applying for a rebate may mean that households and SMEs are not sufficiently incentivised to undertake very low cost activities
• government may be less effective than the market in consistently identifying least cost energy efficiency opportunities for a given target.

Depending on their structure, rebates can be costly for governments to administer. Further, a rebate policy provides less certainty to investors to stimulate the development of an energy efficiency industry – one of the objects of the Act. A case in point is provided by the photovoltaic industry, which has suffered a boom-bust pattern of growth in Australia due to sudden and unexpected contractions in government spending. In contrast, the legislation for the VEET scheme provides a degree of certainty over each three year phase of the scheme. Further, the RIS requirement effectively telegraphs any changes in target to the subsequent phase of the scheme before that occurs.

Indicative modelling of impacts

DPI undertook indicative modelling around a potential rebate scheme based on data in the VEET measures cost curve. The analysis indicates that a target of around 2.9Mt could be achieved, but at a price that equates to around $36/certificate (expressed this way to provide a comparison with the CBA for the VEET options). Higher targets would require a higher certificate price. This effectively excludes rebates from further consideration.

The modelling was re-run to generate expected market performance for a rebate scheme. Utilising the same basic assumptions generated for the VEET modelling, the modelling also assumed that:

• Administration must be cost effective. Rebates are only considered on those measures where there is some opportunity for volumes of emission reduction that would help to reach a quantum in the range of the existing target (this included measures with an opportunity of more than 250,000 t CO2e over the three years). This is considered appropriate to ensure that the administration costs for individual activities do not exceed the value of the incentive.
• Compliance. Some measures have been eliminated from the rebate model where effective compliance is deemed to be unrealistic under rebate scheme administration. VEET requires that evidence is provided to ensure the measure has been installed (under the VEET scheme this is generated by certificate creators). Without this evidence there is a risk that a secondary market for reselling these products could be created. Only products installed by a third party or white goods are therefore included for further consideration.

Modelling

Once the modelling was run on these parameters, it revealed five residential measures that warrant consideration for rebates:

• ceiling insulation in uninsulated homes
• solar gas replaces gas water heater
• three heating measures: high efficiency gas ducted replaces central electric heating, heating duct work upgrades, and high efficiency gas ducted replaces existing gas ducted.

Furthermore, three SME measures were considered to warrant consideration for rebates:

• electric water heater replaced with solar or heat pump
• commercial lighting - reflectors/delamping)
• ceiling insulation in uninsulated premises.

Inclusion of any further measures that have potential for volumes of abatement would require a high rebate (equivalent to a VEET certificate price of over $50), and hence were excluded.

The modelling revealed that a maximum abatement that could be achieved by a rebate scheme covering these eight measures would be equivalent to a target of 2,963,000 tonnes of CO2 (each year for a three year period). The value of the rebates required to achieve this uptake would achieve an equivalent certificate price of $36. Higher levels of emission reduction would require a significantly higher certificate price than this.

Of the measures considered viable under a rebates program, ceiling insulation was considered to warrant additional compliance checking, and the heating measures would require a specific marketing campaign to reach the relatively small potential audience.

6 Preferred approach

Summary of preferred option

As detailed in the cost-benefit analysis, Option 3: Double the target for the next phase of the scheme is the preferred approach as it will provide the most significant benefits to Victoria in comparison to the base case. The following summarises Option 3:

• 5.4 million certificates
• eligibility will be all Victorian residential customers and SMEs
• a three year duration of the scheme, commencing on 1 January 2012 and concluding on 31 December 2014. Energy savings are modelled until 2030.

It should be noted that the VEET scheme is not intended to last indefinitely. DPI expects that, over the course of the next two decades, Australia will be on track to achieve its emissions reduction objective, and Victorian households and SMEs will be sufficiently resilient and prepared to adapt to consequent changes in our energy markets.

The VEET scheme is being implemented to assist certain sectors during the transition period. The Act specifies that the scheme will end on 31 December 2029. In addition, the scheme is comprised of three year phases, with key scheme design elements (such as annual targets, eligible activities and abatement methodologies) to be potentially reset, through new regulations, at every phase change. In addition, an independent review of the Act must occur by 31 December 2011, to ensure it has achieved its objectives. The reasons for these time bounds (ie the three year phases) relate to the uncertainty regarding the policy problems being addressed. The timing and nature of other mechanisms (such as a carbon price, a national VEET scheme etc.) are uncertain, and the scheme design allows the Government to adjust to any of these broader developments at ongoing intervals.

The impact of the preferred option on bills (as compared to BAU) is shown below in Table 27. The data and modelling upon which these average bill impacts are based considers a single ‘average’ consumer. There is insufficient data available to calculate numbers of consumers that could benefit from VEET as this depends on individual consumer behaviour, including what measures and what combinations of measures a particular consumer takes up.

Table 27 : Average bill impacts for preferred option compared to BAU

Impact	2012	2013	2014	2015	2020	2025	2030
Residential electricity users	-$7.5	-$34.1	-$65.0	-$118.9	-$87.1	-$21.6	-$22.6
SME electricity users	-$19.6	-$127.8	-$264.9	-$494.7	-$370.8	-$174.0	-$57.8
Residential and SME gas users	-$14.4	-$3.5	-$3.0	-$26.9	-$25.8	-$25.6	-$23.3

Implementation and enforcement

Implementation

The departments and agencies involved, and their roles in, administering and enforcing the preferred option include:

Department of Primary Industries:

• design and setup of the scheme
• engage relevant stakeholders on an ongoing basis, particularly scheme participants (energy retailers and accredited persons)
• facilitate reviews of eligible scheme activities
• facilitate the evaluation of the VEET scheme at the end of each three year phase.

Essential Services Commission:

• general administration of the scheme
• accredit persons who may create certificates
• monitor and administer the creation, registration, transfer and surrender of the certificates
• enforce the imposition of the energy efficiency shortfall penalties
• undertake audits and monitoring compliance with the Act and the preferred option
• assist with reviews of eligible scheme activities
• report to the relevant Minister.

Sustainability Victoria:

• assist with reviews of eligible scheme activities
• offers technical advice to DPI as necessary.

Scheme acquisitions

It is important to highlight that in expanding the scheme to SMEs that regulations will need to define both:

• eligibility for participation in the scheme (ie those who may undertake the prescribed activities)⁵¹
• the customers of electricity and gas who are relevant in determining a retailer’s scheme acquisitions for the purpose of calculating a retailer's VEET scheme liability.

DPI sought comment on both these aspects in the October 2010 Issues Paper as well as directly contacting retailers and accredited parties participating in the scheme. Stakeholders generally agreed that scheme eligibility should ideally be as wide as possible so as to maximise the potential for least cost activities to be undertaken.

A simple definition that does not create barriers to participation or liability issues (and therefore increased costs for participants) is preferred.⁵²

The VEET scheme aims to achieve reductions in greenhouse gas emissions that would not otherwise have occurred if not for the existence of the scheme. Accordingly, it is DPI’s intention to limit scheme eligibility to those businesses that are not already subject to existing statutory energy efficiency schemes or reporting requirements such as the Environment and Resource Efficiency Plans (EREP) and Commonwealth Energy Efficiency Opportunities (EEO).

In light of these considerations it is proposed that scheme eligibility is described on an ‘exclusions’ basis. This ensures the definition is wide, but excludes those who are not eligible to participate such as very large consuming companies who participate in EEO and EREP. DPI acknowledges that such a definition is likely to allow VEET activities to be undertaken for some larger consuming businesses that would not typically be described as a ‘small to medium enterprise’.

Ideally, scope of both scheme eligibility and scheme acquisitions would align as closely as possible to ensure that the customer acquisitions on which a retailer’s scheme liability is based, are the same customers that are eligible to participate. However, in practice it is difficult to precisely align both aspects and DPI therefore proposes an option that it believes strikes an appropriate balance between matching the scope of the definitions and ensuring administrative simplicity for audit and compliance purposes.

The proposed Regulations define the class of customers relevant to scheme acquisitions as “all of a relevant entity’s customers of electricity” (which has the effect of excluding all large electricity users who purchase directly from the wholesale market) and “all of a relevant entity’s customers of gas other than customers who are…a gas -fired electricity generator …”.

In addition to excluding the largest users of gas who purchase gas directly from the gas wholesale market, this definition excludes gas consumed by gas-fired electricity generators many of which, despite being large customers of gas, purchase their gas through a retailer. The rationale for doing this is to avoid, for the purposes of calculating a relevant entity’s scheme liability, from double counting that would arise if both the gas consumed by a generator as well as the electricity produced from that generator that may be consumed by a prescribed (electricity) customer were counted.

Consultation question: DPI seeks feedback from stakeholders on the proposed definition of scheme acquisitions outlined above.

 

Auditing and compliance – prevention of rorting

The Victorian Government is committed to a VEET scheme that has appropriate safeguards to prevent rorting.⁵³

The ESC’s existing audit framework is designed to ensure that APs are properly creating certificates. The audit framework comprises risk assessments, and field, desktop and phone audits of accredited persons. The Commission also regularly meets with accredited persons.

ESC existing auditing framework has been implemented to provide assurance that accredited persons are properly creating certificates. The audit framework comprises accredited persons undergoing risk assessments, field, desktop and phone audits. The Commission also regularly meets with accredited persons.

Audit activities of accredited parties have identified non compliant activities such as the improper creation of certificates which required accredited parties to “make good”. These instances may occur as a result of administrative errors or improper behaviour by the accredited person. The Commission has worked with accredited persons to resolve improper creation issues and to date accredited persons have voluntarily surrendered approximately 1 per cent of the total number of VEECs registered in the scheme.

When serious creation issues are identified the Commission may conduct an investigation. These investigations have resulted in the Commission suspending the accreditation of three businesses. During the period of the suspension, the accredited person is prohibited from creating certificates or completing prescribed activities.

A very small number of compliance-related complaints were received during the first year of the scheme. The ESC reported that in the first year of the scheme the Commission investigated 47 compliance-related complaints noting that activities occurred in over 400,000 households.⁵⁴

In expanding the scheme to the SME sector, it will be necessary to minimise any new compliance risks through the careful design of activities and the enhancement of the compliance regime as outlined above. Opportunities to improve the auditing and compliance framework are continually examined by DPI and the ESC. Furthermore, the framework will also be examined as part of an independent legislated scheme review which must be completed before 31 December 2011.

Consultation question: How can auditing and compliance be improved to minimise any new compliance risks if VEET is expanded to include SMEs?

 

7 Additional considerations

Change in the regulatory burden

As a result of the Victorian Government’s 2010 Victorian Regulatory Change Measurement Manual all significant new regulatory burdens created by legislation or regulation are required to be measured using the Regulatory Change Measurement methodology, established by the DTF.

A Regulatory Change Measurement analysis is required where there is prima facie evidence that the change in regulatory burden is likely to be material. A regulatory change is material if the change in administrative burden experienced by the affected sector is greater than $250,000 per annum or the change in the sum of regulatory burdens within scope of RRB initiative (that is, substantive compliance and delay costs) is greater than $500,000 per annum.

An RCM will be prepared subsequent to this RIS within 12 months (by 2012).

Impact on small business

An assessment of the small business impacts must consider matters such as:

• variation in the compliance burden
• whether any compliance flexibility option have been considered that will assist small businesses to meet the requirements of the proposed measure
• the likely extent of compliance by small versus large business
• the distribution of benefits arising from the proposed measure the relative impacts of penalties and fines for non-compliance.

The expansion of the scheme to allow SMEs to participate means that the impact on small business is generally a beneficial one. The scheme will create an incentive for SMEs to take up energy efficiency measures. Participating SMEs will experience reduced energy consumption, and lower bills, modelled in Table 28.⁵⁵

Table 28 : Impact on small business

Impact	2012 ($)	2013 ($)	2014 ($)	2015 ($)	2020 ($)	2025 ($)	2030 ($)
SMEs (net impact per electricity bill)	-19.6	-127.8	-264.9	-494.7	-370.8	-174.0	-57.8
SMEs (net impact per gas bill)	14.4	3.5	-3.0	-26.9	-25.8	-25.6	-23.3

Small businesses, such as tradespeople that install energy efficient products, are also likely to benefit from the scheme. Also, the cost of certificates will generally be recovered from all consumers.

Impact on competition

Considerations of national competition policy include identifying any restrictions to competition in the preferred option, showing that the restriction is necessary to achieve the objective, and assessing whether the benefits of the restriction outweigh the costs in each particular case.

Any new legislation in Victoria must not restrict competition unless it can be demonstrated that:

• the benefits of the restriction, as a whole, outweigh the costs
• the objectives of the legislation can only be achieved by restricting competition.

The VEET scheme may place a competitive restriction on businesses by favouring existing energy retailers. New entrants to the energy market would have less access to lowest-cost certificates (assuming certificate prices increase over time). The VEET scheme attempts to mitigate this risk by:

• establishing a minimum size threshold for liability under the scheme
• imposing the liability in a way that is expected to be proportional to the organisation’s capacity to meet it.

Threshold

The Act places a mandatory obligation for the surrender of VEECs on energy retailers with more than 5000 customers. This threshold ensures entry into the market by new, small energy retailers is not inhibited.

Proportional liabilities

An energy retailer’s liability is proportional to their share of the retail market. Section 31 of the Act demonstrates how a retailer’s liability can be calculated. The liability is a function of the amount of electricity and/or gas acquired in that year, multiplied by the GHG rate for that fuel. This methodology of calculating liabilities under VEET mitigates the potential risk of inhibiting new market entrants.

Eligible Product List

During phase 1 of the VEET scheme a prescribed list of 25 activities was outlined. DPI is of the opinion that this may impose a potential barrier to entry for activities that are not eligible under the scheme. A number of activities were excluded due to their inability to deliver measurable and low cost abatement. DPI convenes an Eligible Activities Review Panel that actively encourages innovation and enhances competition. The list of eligible activities will also be examined during the evaluation process at the end of 2011, reviewing the merits of removing activities, adding activities or modifying abatement factors applying to these activities. The structure of the VEET scheme also allows for new activities to be considered during a particular phase, based on a stakeholder proposal. As discussed in chapter 2, various activities were added to the prescribed list in October 2010.

Evaluation strategy

The previous RIS detailed an extensive strategy to evaluate the extent to which the scheme meets the government’s objectives. The key points of the strategy are outlined below. The strategy is ongoing, and will also be used to evaluate aspects of the proposed Regulations.
In addition, the independent review of the Act (and by implication the Regulations) will provide a more extensive opportunity to evaluate progress to date. The independent review is also described below.

Reduce greenhouse gas emissions

DPI intends to use data on certificate creation and surrender, compiled by the scheme administrator, to determine whether the objective of achieving the stated quantity of GHG emissions reductions has been met. If liable energy retailers meet their annual targets, the scheme will have been successful in achieving the quantum of abatement sought. If any of these parties fail to meet their target, the scheme will have been unsuccessful in this regard.

DPI intends to examine actual avoided energy savings and GHG abatement which occurs during each phase. This will be a function of the volume of certificates created for specific activities, divided by the average lifespan assumed for those activities in the certificate creation methodology.

Encourage efficient use of electricity and gas

DPI plans to work with the ESC to interrogate the information provided by certificate surrender to determine the actual energy use avoided as a result of the VEET scheme. DPI also intends to evaluate the impact of rebound on the efficient use of electricity and gas. During the evaluation of the scheme, DPI plans to facilitate qualitative surveys with a reasonable sample of householders that engaged in the scheme to evaluate their energy consumption behaviour following the purchase/installation of an eligible energy efficiency product. The results of the survey are expected to offer DPI an indication on the impact of rebound under the scheme.

Encourage investment, employment and technology development in the energy efficient industry

DPI proposes to survey accredited certificate creators in order to determine the extent to which the VEET scheme has encouraged employment in the energy efficiency industry. The evaluation will aim to examine the opportunity costs to the economy of the possible shift in employment to the energy efficiency sector and the macro impact of these changes.

The extent to which identified residual market failures are addressed

One possible means of determining the extent to which individual market failures have been addressed is by follow-up surveys of householders that have hosted activities under the VEET scheme. DPI intends to complete such surveys as part of the evaluation of the first phase of the VEET scheme to specifically assess the effectiveness of the scheme in addressing the identified residual market failures, such as information gaps and split incentives. Focusing these surveys on sectors likely to suffer from split incentives, and further understanding the information gaps that exist will be beneficial in this evaluation.

In 2011, DPI intends to conduct a survey on the first phase of the VEET scheme that examines the impact of the VEET scheme in addressing the residual market failures. DPI also intends to undertake such a survey of certificate creators as part of the scheme evaluation.

Independent review

Section 76 of the Act states that an independent review of the Act must be undertaken by 31 December 2011 and must consider:

• the extent to which the objects of this Act have been achieved
• the VEET scheme target applying under this Act
• technological developments in industries which supply goods or services which reduce the use of electricity and gas by consumers
• the level of penalties provided for under this Act.

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³⁹ For example, liability issues may arise where consent to undertake an activity is sought from one party, however the legal liability for that action may rest with another. This is likely to arise where a number of different parties are involved in decisions about energy at a site, for example the building owner, tenant, site or facilities manager may all have a role in making decisions about aspects of energy at that site.
⁴⁰ Compact Fluorescent Lamp.
⁴¹ Energy market modelling was run to 2030, and from 2020 outputs were generated for five year points. For the long run NPV calculations linear interpolation was used to generate figures for those years not modelled.
⁴³ ‘Exhausted’ means that the majority of the accessible opportunity for that measure will have been found by the market. It should not be interpreted that this means every low efficiency installation will have been changed over. The model assumes that some opportunities will never be accessible to the market for a range of reasons.
⁴⁴ To date, a discount factor has only been applied in respect of ceiling insulation activity under the VEET scheme.
⁴⁵ At present, some solar and gas hot water activities eligible under the VEET scheme may also attract a Government rebate where the householder satisfies the rebate eligibility criteria.
⁴⁶ Estimating the costs of foregone useful life is particularly problematic for low cost measures such as light globes and shower roses. In these instances the remaining 'foregone' value of these products is included in the offer to consumers to install a more energy efficient version. In accepting an offer, the consumer regards the incentive as sufficient to cover the foregone value.
⁴⁷ The consumption figure has been derived from the VEET Measures Model and calculated without rounding error.
⁴⁸ Particularly compared to the impact from the increase in demand for gas with the introduction of a carbon price.
⁴⁹ For example also see Australian Industry Group Feb 2011, Energy Shock: Confronting Higher Prices.
⁵⁰ Earnings Before Interest, Taxes, Depreciation and Amortization.
⁵¹ Note that scheme eligibility is not being defined in the proposed “Victorian Energy Efficiency Target Amendment (Scheme Target) Regulations 2011”. Only the class of customers prescribed for the purposes of the definition of scheme acquisition will be in the draft Regulations. Scheme eligibility will be addressed in the amendment Regulations that accompany new prescribed activities
⁵² For example, liability issues may arise where consent to undertake an activity is sought from one party however the legal liability for that action may rest with another. This is likely to arise where a number of different parties are involved in decisions about energy at a site, for example the building owner, tenant, site or facilities manager may all have a role in making decisions about aspects of energy at that site.
⁵³ Victorian Liberals Nationals Coalition Plan for Energy and Resources (p.18).
⁵⁴ Victorian Energy Efficiency Target scheme, Performance Report 2009 (p. 19). www.esc.vic.gov.au
⁵⁵ There is upward pressure on gas bills for the first two years due to the cost of generating VEECs.