Water and Energy Tariffs for Sustainability

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1 Water and Energy Tariffs for Sustainability Waste Not, Want Not Sustainable Water Tariffs A report by Paul Herrington for WWF-UK Waste Not, Want Not Energy Tariffs for Sustainability A report by the Centre for Sustainable Energy for WWF-UK

2 Summary In recent decades there has been a rapid increase in household demand for both energy and water: between 1990 and 2006, energy demand from UK households increased by 18%; and, since 1980, household water use has increased by 55%. Such levels of energy use are fuelling human-induced climate change, and the demand for water has caused significant damage to our rivers and wetlands. Yet all projections suggest that household energy and water demand will continue to rise if nothing is done. Block Price (eg pence per unit) Despite these unsustainable increases, the prices that we pay for energy and water do not penalise excessive and wasteful use. Less than a third of households in England and Wales have a water meter, meaning that bills in no way reflect water use. And energy tariff structures result in higher users paying less for each unit of energy than lower users do: the more you use, the cheaper it gets. In reports on sustainable tariffs for water and energy, WWF-UK recommends that the perverse current situation should be changed, and that sustainable tariffs should be introduced that provide affordable energy and water for essential use, but penalise excessive and wasteful use. Such tariffs should take the form of an Increasing Block Tariff (IBT) that provides a certain quantity of energy or water at a low price, with prices then increasing at higher levels of use B l o c k s ( c o n s u m p t i o n r a n g e s ) Increasing block tariffs have been shown to have a significant impact on demand: For energy, international experience and simulations conducted for WWF-UK suggest that reductions in demand of up to 8% could be achieved from the introduction of IBTs, leading to a reduction in CO2 emissions of almost 10 million tonnes per year. For water, more than 90 studies of international experience and UK trials have unambiguously demonstrated that introducing metering and IBTs would lead to a sustained reduction in demand of at least 10%, with reductions of up to 30% in peak (summer) demand, when water availability is at its lowest. The introduction of IBTs could also make a significant contribution towards addressing fuel and water poverty by reducing bills for vulnerable households and providing a cheaper supply of energy and water for essential use. IBTs can be accompanied by schemes to support vulnerable households that have particular reasons for high demand. For example, additional funding and demand reduction schemes can be introduced for households with older, inefficient appliances or without insulation; and special water tariffs can be used where particular medical conditions necessitate high water use. The current regulatory approach adopted by Ofgem (the Office of Gas and Electricity Markets) and Ofwat (the Office of Water Services) fails to encourage and on occasion actively works against the introduction of sustainable tariffs. Clear guidance is therefore required from the government to Ofgem, Ofwat and the water and energy industries that sustainable pricing structures should be introduced.

3 Waste Not, Want Not Sustainable Water Tariffs A report by Paul Herrington for WWF-UK

4 What is the problem? Domestic water use in England and Wales has grown significantly in the last 30 years, and is projected to rise by between 13% and 16% over the next two decades. This poses very significant environmental risks, in particular in south-east England where available water supplies are fully exploited. Many rivers already suffer from chronic over-abstraction, and some even run completely dry. The reduced precipitation forecast in England as a result of climate change will make this problem worse, especially in summer the time of both peak demand and the greatest threat to rivers. Evidence shows that water meters can significantly help to reduce demand. So it is alarming that less than a third of households in England and Wales have a water meter installed, in contrast to the 100% use of water meters across most of Europe. As a result, most households have no incentive or reward for careful use of water, and face no penalty for wasteful or unnecessary use. Many rivers and wetlands in England and Wales suffer from overabstraction. Among these, the River Mimram in Hertfordshire dries completely as a result of the use of water in homes.

5 The current approach to water pricing for un-metered customers is based on the rateable values of homes, last re-assessed in In many cases these provide a very unsatisfactory indication of the value of a property. No serious effort has been made to introduce water pricing schemes that are designed to address affordability constraints for low-income households. The slow growth of metering is due to water companies and the government shying away from compulsory metering because low-income households of above average size would be hit hard financially by such an enforced switch. There is therefore an urgent need for tariff structures that encourage sustainability in the water sector while simultaneously addressing affordability. Block Price (eg pence per unit) What is the solution? Full metering should be introduced, accompanied by a pricing structure known as an Increasing Block Tariff (IBT). This approach can simultaneously address both sustainability and affordability. The tariff gives a very strong conservation message. Under an IBT, a first, lower-price block of basic water use is provided at a lower cost. The extent of the basic block can be set for an appropriate household size. This provides cheap basic water for essential purposes and strong incentives for sustainable use. If supplies are very scarce, the tariff can be accompanied by increased summer prices for the higher use (or non-essential) blocks. IBTs of a variety of types are standard in the Mediterranean and a number of countries in the Far East B l o c k s ( c o n s u m p t i o n r a n g e s ) Figure 1: Pricing structures with an Increasing Block Tariff Note: for larger families the size of Block 1 should be geared to the size of the household How much water will be saved? A detailed survey published by WWF-UK provides conclusive evidence that the introduction of water meters and tariffs that charge by volume lead to significant and sustained reductions in water use: The more robust UK studies between 1970 and 1993 revealed that introducing meters led to a reduction of 10-15% in average demands. Experience from the Continent suggests a reduction in demand of 9-17%. Significantly, peak (summer) demands in the UK have fallen by 20-30% when metering is introduced. Evidence on the impact of the introducing new tariff structures for already-metered customers is of necessity from overseas (Barcelona, the US): switching to IBT tariffs from orthodox non-ibt ones has been associated with average demand reductions of 10-14%. Introducing seasonal tariffs for already-metered customers when the impacts on the environment are most significant has resulted in further demand reductions of 8-14%. Between them, the introduction of metering and IBTs could therefore make a very significant contribution to offsetting the projected increase in demand for water in the coming years without the need for expensive new reservoirs. Reduction in demand could also help to reverse the existing and ongoing damage to our rivers from our over-use of water.

6 What would the impact be on vunerable households? The introduction of charging based on use can significantly assist vulnerable households at the same time as protecting ecosystems. Extensive desk studies have assessed the impact of introducing IBTs. These have found clear advantages for lower-income households already on a standard metering tariff. Potential advantages exist for low-income households on fixed charges (such as rateable values), but there may be a need for targeted demand-management programmes for certain high water-use households with older, inefficient appliances. If required, an IBT pricing structure could also be accompanied by a targeted passport tariff that provides assistance for particularly vulnerable groups of customers, for example households in which members have medical conditions requiring high water consumption. Is our current regulatory approach satisfactory? Any changes in water charging arrangements in England and Wales would need to have regard for the current regulatory and legislative context. Subtle legislative changes over recent years appear at times to have been pulling in different directions. One of the main results is that while promotion of the consumer objective now figures more prominently in the legislative duties of the economic regulator and the Secretary of State, Ofwat s devotion to the clause on no undue discrimination or undue preference in water charges remains virtually undiminished. As a result, the current framework may create difficulties for the widespread introduction of sustainability tariffs. A change in attitude by Ofwat or a change in its regulatory duties may be required to allow for the widespread introduction of sustainability tariffs. Failing this, it may be necessary and appropriate for the Secretary of State to issue new guidelines to Ofwat concerning the interpretation of its new statutory duty to contribute to the achievement of sustainable development. The mission of WWF is to stop the degradation of the planet s natural environment and to build a future in which humans live in harmony with nature, by conserving the world s biological diversity ensuring that the use of renewable natural resources is sustainable reducing pollution and wasteful consumption wwf.org.uk WWF-UK Panda House, Weyside Park Godalming, Surrey GU7 1XR t: +44 (0) f: +44 (0) supported by WWF-UK registered charity number A company limited by guarantee number Panda symbol and WWF Registered Trademark of WWF-World Wide Fund For Nature (Formerly World Wildlife Fund) All photography is Caroline Irby and Jiri Rezac / WWF-UK Project number 2340 / Aug 2007

7 Waste Not, Want Not Energy Tariffs for Sustainability A report by the Centre for Sustainable Energy for WWF-UK

8 Background context In its 2007 Energy White Paper the government stated that it would introduce some form of cap and trade system (a Supplier Obligation) on UK energy suppliers from 2011 to 2020 and that it would consult on proposals in early Such a system could operate either at the level of the enduser (downstream), or of the supplier (upstream). The Supplier Obligation currently being discussed by the government as a successor to the new CERT scheme is an example of the latter, and would set a limit on the total emissions from household gas and electricity consumption, with compliance the responsibility of gas and electricity suppliers. Under such a system, gas and electricity suppliers would face (presumably harsh) penalties for non-compliance thus encouraging them to assist or stimulate customers to reduce their emissions, or requiring them to buy surplus emissions credits from their competitors. The most cost-efficient way to achieve this would be through demand reduction, achieved via energy efficiency improvements and behaviour change. The more expensive alternative is the development of lower-carbon sources of heat and power. In the former scenario, energy suppliers could see different tariff structures, such as IBTs, as a potentially cost-effective option for encouraging household customers to be more energy efficient and so ensuring compliance with their targets under the Supplier Obligation.

9 What is the purpose of the report? A new report, UK Energy Tariffs for Sustainability, builds on WWF s work to address the negative environmental impacts of the UK energy sector, in particular on climate change. This report also complements WWF s One Planet Living Campaign which focuses on ways to help reduce resource consumption and the impacts of our homes and lifestyles. WWF-UK commissioned the Centre for Sustainable Energy (CSE) to investigate the following: The present energy supply market and tariff structure in the UK and whether it is fit for purpose at a time when the overriding need is to cut CO2 emissions and eradicate fuel poverty. Examples from around the world where different tariff structures are in use, and evidence of their impacts on household energy demand. The potential environmental, social and economic impacts of restructuring electricity and gas tariffs for UK households so that the price of a unit of gas or electricity increases with use. What is the problem? Energy demand from UK households increased by 18% between 1990 and 2006, and continues to rise by 1-2% per year. Nearly 30% of UK total carbon emissions are from energy used in households, and CO2 reductions from this sector are therefore an essential part of the UK s effort to meet its reduction targets under the Kyoto Protocol and the UK Climate Change Bill. In this context it is alarming to note that in the UK current household energy tariffs are structured in such a way that they reward, rather than discourage, high energy use. In the current tariff structure used by energy supply companies, the more energy that is used, the cheaper per unit it becomes. This is a perverse situation given the threat of climate change. In addition, it is estimated that 11 million of the 26 million households in the UK still do not have any or adequate cavity wall or loft insulation, despite the introduction of the Energy Efficiency Commitment (EEC) on energy suppliers. Also, almost 3 million people in the UK are still unable to affordably heat their homes to an adequate standard, partly owing to low incomes in poorlyinsulated households. The government has promised to address this problem, and has a target of eradicating fuel poverty in vulnerable households in England by However, the government is not on track to meet either its CO2 emissions or its fuel poverty reduction targets. What is a possible solution? One possible approach is the introduction of a new tariff structure, known as IBTs, across all energy suppliers to households in the UK. This would reward low energy use and discourage profligate use. Under an IBT, the unit price of energy increases with use. This provides relatively cheap basic energy for essential purposes and strong incentives to reward efficient use. Similar tariffs have been trialled and introduced successfully elsewhere around the world to manage demand. For example, in , the California Public Utilities Commission (CPUC) authorised a state-wide pilot of 2,500 residential and small commercial consumers to assess demand response to critical peak pricing with smart meters. Demand response marketing and customer education programmes were run alongside the trials. The effects ranged from 27% reductions for automated demand response to 5-10% reductions without automated demand response. The trial found that there was no impact on overall demand it was merely shifted to off-peak periods. However, an analysis of 16 other time-of-use tariffs found an average reduction effect of 4% (Charles Rivers Associates, 2005). As a result of the trials, the CPUC authorised state-wide installation of smart meters for all residential and small commercial consumers by The trial also established that despite the cost of smart meters, the overall cost-benefit was positive due to the value of the reduction in peak demand. The trial also found that costs exceeded benefits if the demand response benefits were not taken into effect. Block Price (eg pence per unit) B l o c k s ( c o n s u m p t i o n r a n g e s ) Figure 1: Pricing structures with an Increasing Block Tariff WWF-Canon / Andrew KERRY

10 How much energy would be saved? This report examines three different options of tariff structures for household energy use in the UK, as well as illustrating examples from around the developed world where different tariffs have been successfully introduced for social and/or environmental reasons. CSE s modelling of UK household IBTs structured for optimum reductions in energy demand suggests that large energy and carbon reductions could be achieved: reductions in electricity and gas demand of 7-8%; leading to annual CO2 reductions of almost 10 million tonnes. CSE also modelled two other types of IBT ( revenue neutral and redistribution tariffs), which generated smaller overall energy and carbon savings, but larger cost reductions for low income households. While the demand reduction tariffs achieve the biggest reductions in demand and emissions, they also entail cost increases for the vast majority of households, and increased unit revenues to suppliers. Revenue neutral tariffs lead to more modest demand and emissions reductions, but do not significantly affect supplier revenues, and would create the smallest number of lowincome losers. Redistribution tariffs create the largest aggregate transfer of wealth from high income households to low income households, while reducing demand slightly more than revenue neutral tariffs. However, they also create significant numbers of highincome winners. More importantly, these tariffs would lead to a transfer of wealth between low-income households, as well as from high to low income households. Consequently the redistribution tariffs lead to larger losses among those low income households that do lose out. Furthermore, in conjunction with IBTs, the roll-out of smarter meters and better billing could make a significant contribution to reducing household energy demand and alleviating fuel poverty. Such policies could also reduce the (perceived) need to invest heavily in further large centralised coal and nuclear power stations and other conventional energy infrastructure. What would the impacts be on vulnerable households? This report illustrates where different tariff structures are in use around the developed world and compiles information from studies to show how these have impacted to varying degrees on household energy demand though mainly in relation to peak load demand shifting, rather than overall demand reduction. On average, all the IBTs presented in this report alter household energy costs in proportion to incomes, and are therefore socially progressive overall. However, the wide variation in energy use within income deciles (bands) means that there are always some low-income losers (many of whom will be fuel poor), and some high-income winners. The more ambitious demand reduction type of IBT that CSE modelled delivers the greatest prediction of energy and carbon savings, but could also exacerbate fuel poverty unless government and industry strongly commit to carefully planned and targeted assistance for vulnerable households. Therefore, if carefully-planned demand reduction IBTs for sustainability were introduced across the market, complemented with commitments from government and the energy industry to adequately fund a large investment programme to insulate every fuel-poor home, along with the roll-out of smarter meters by 2010, this could present an excellent opportunity a policy recommendation that is both environmentally and socially progressive. The predicted increase in revenue that energy supply companies may make from IBTs could easily be ring-fenced and recycled under the supervision of the regulator, Ofgem, to help to pay for this investment programme in household energy efficiency improvements.

11 Is our current regulatory approach satisfactory? In short the answer is no. The findings from this report show that the current way in which tariffs are structured is inadequate and even perverse for today s major challenges in tackling climate change and fuel poverty. Furthermore, since the removal of remaining price controls in 2002, Ofgem does not have sufficient duties or powers. This has important implications for the introduction of IBTs, but these can be resolved, as the Secretary of State for Energy has reserve powers to adjust charges if he or she decides that disadvantaged customers are being treated unfairly. However, these powers are yet to be invoked. WWF-UK therefore believes that Ofgem s present light-touch approach to regulation is not adequate for the challenges we face, and that stronger regulation is urgently needed to help reduce energy demand and carbon emissions from the household sector, as well as tackling fuel poverty. Policy recommendations WWF-UK is attracted to the idea of the UK Supplier Obligation, as it is a way of curtailing the continual growth in household energy demand (through a cap) and encouraging the development of energy services-type business models in the UK energy market. This report assesses three basic options for different tariff structures for sustainability in the UK which have provided useful findings. WWF-UK views the IBTs as a very interesting tool for government and industry to seriously consider and investigate, and perhaps trial under CERT We recommend that the government: undertakes a review of the current energy pricing regime of tariffs in the UK; gives serious consideration and conducts further research into the impacts and trialling of the Increasing Block Tariffs pricing model for UK household electricity and gas use in the period of CERT , possibly as an eligible innovative measure within the CERT scheme; rolls out smarter meters and more informative bills to households by 2010, ready for the start of the Supplier Obligation in 2011; and reviews and updates the primary duties and controls of the regulator Ofgem so it is able to monitor such changes to energy tariff structures and trials. The mission of WWF is to stop the degradation of the planet s natural environment and to build a future in which humans live in harmony with nature, by conserving the world s biological diversity ensuring that the use of renewable natural resources is sustainable reducing pollution and wasteful consumption wwf.org.uk In order to mitigate the potential social impacts of these changes in policy it essential that, in parallel, the government also commits to and provides much more funding upfront for programmes to eradicate fuel poverty. One option would be to ensure that any windfall profits the energy suppliers make from changing to Increased Block Tariffs are ring-fenced to directly fund the energy efficiency improvement schemes of fuel poor households under the CERT obligation. One Planet Living is a joint initiative of BioRegional and WWF based on 10 guiding principles of sustainability. The vision of One Planet Living is a world in which people everywhere can lead happy, healthy lives within their fair share of the Earth s resources. This Summary paper was written by Dr. Tom Le Quesne and Andrea Kaszewski, WWF-UK. WWF-UK Panda House, Weyside Park Godalming, Surrey GU7 1XR t: +44 (0) f: +44 (0) WWF-UK registered charity number A company limited by guarantee number Panda symbol and WWF Registered Trademark of WWF-World Wide Fund For Nature (Formerly World Wildlife Fund) Unless stated all photography is Caroline Irby and Jiri Rezac / WWF-UK Project number 2340 / September 2007