Energy saving obligations for energy companies

Energy saving obligations (ESOs) aim at supporting market breakthrough of energy-efficient solutions, which can and should be required to be very energy-efficient. Energy-efficient user behaviour and building operation may also be promoted. This is achieved through energy efficiency programmes that typically combine information, motivation, financial incentives and or financing, and capacity building. These programmes are implemented by energy companies under regulatory oversight in order to fulfil their obligation to save a certain amount of energy each year.

Worldwide implementation status
As it is a still a relatively new policy mechanism – except for the USA, where it has been in place for around 30 years – implementation of ESO schemes is still not widespread. However, the number of countries that have implemented such schemes is growing. ESO schemes (with or without trading of energy savings (‘white certificates’)) are in place in the following countries or federal states: United Kingdom, Denmark, Italy, France, Belgium (Flanders region), Australia (New South Wales, South Australia, Victoria), Canada (Ontario), United States (California, Connecticut, Massachusetts, Minnesota, New York, Texas, Vermont), China, Korea, Poland (planned) (RAP 2012). The European Union recently passed legislation requiring all Member States to introduce ESO schemes with the target to save 1.5 % of energy each year or alternative policies achieving the same level of savings.

Governance level
All the existing ESO schemes are implemented either at the national or regional/federal state level.
Implementation at local level is not recommended due to high administrative costs and high effort for setting up such a system.

All kinds of energy saving measures in the residential, commercial, industry, and public sectors can be implemented under an ESO scheme. Many of the existing schemes have a focus on the residential sector.

Related sectors

• services
• residential
• industrial

All kinds of energy saving measures can be implemented under an ESO scheme. There is a tendency to favour standardised, easy-to-implement measures such as boiler exchange, installation of CFLs, water saving devices, etc. Consequently the focus is rather on improving existing buildings than on measures for making appliances more energy-efficient.

The primary target group are:

• Energy companies obligated to save a certain amount of energy

Typically, energy saving obligations are placed upon the providers of networked energy (e.g., electricity and natural gas). They can also be placed on providers of other fuels (e.g., LPG, heating oil, transport fuels, district heating), and even on (large) end users of energy (RAP 2012).
With the energy efficiency programmes the energy companies implement in order to achieve their energy saving targets, the policy indirectly also targets mainly the demand-side actors:

• Investor-users 

Depending on the kind of measures that are implemented under an ESO scheme, the following actors may also be targeted:

• Engineering Consultants
• System suppliers
• Manufacturers
• Retailers
• Retail sales staff

Direct beneficiaries

• User

  Users can benefit directly from energy cost savings and co-benefits like increased comfort

• Manufacturer

  Depending on the kind of measures that are implemented under an ESO scheme, manufacturers may also be direct beneficiaries through an increased demand for their products or services under direct contract from the energy companies.

• Utility

  The obligated energy companies can benefit from improved reputation and strengthened customer retention. In existing ESO schemes, some energy companies have started new profitable business units for energy services as a result of the obligation (Fraunhofer ISI et al. 2012).

Indirect beneficiaries

• Energy consultant

  Energy consultants may also indirectly benefit from an increase in their business due to investment by the direct beneficiaries.

• Retail company

  Retail companies may also indirectly benefit from an increase in their business due to investment by the direct beneficiaries.

For the primary target group, i.e. the energy companies, the policy addresses the barrier created by conventional price and market regulation that they earn more by increased energy consumption and there is no recovery of energy efficiency programme costs or no reward for energy savings.
Since energy companies usually assist their customers with energy efficiency programmes, combining information and financial incentives, these programmes mainly address the following barriers:

Relevant barriers

• Knowledge and information barriers: The information component of the programmes will reduce or overcome these important barriers for potential investors but also some suppliers.
• Economic and financial barriers: Financial incentives or financing are direct means to overcome such economic or financial barriers for potential investors in energy efficiency. The signal to the market will also reduce risk and uncertainty for (potential) providers of energy-efficient technologies and solutions that they will find a market.
• Lack of interest and motivation in energy efficiency-improvement: The financial incentives, as well as the information, will motivate investors and suppliers to consider the energy-efficient technologies and solutions supported by the programmes. The programmes should make it easy to actually implement energy efficiency.

Relevant incentives

• Directly increasing earnings or profits for actors on the supply side: Particularly if all three regulatory actions (recovery of programme costs; bonus for energy savings; and decoupling of revenues from energy volume) are implemented, energy companies will have a good incentive to run energy efficiency programmes, as they will increase their profits. The programmes will then also increase profits of suppliers of energy-efficient technologies and solutions to final consumers.
• Improved reputation: Assisting their customers to save energy and costs will increase the reputation of energy companies and may induce them to such programmes, even if the regulator does not offer a bonus payment. However, this is usually a much weaker incentive than the bonus.
• Saved energy costs: These are a major incentive for energy company customers to participate in the programmes and invest in energy efficiency.

In general, governments need to assess and decide which energy efficiency potentials and end-use actions they want to address through an Energy saving obligation for energy companies and the corresponding programmes by the energy companies or alternatively through an Energy efficiency or through programmes directly offered and funded by the government. This will also depend on the general performance of energy companies and the regulator.
ESOs and Energy efficiency funds can also be used complementary to each other. For example, the fund can address fields of action that cannot be or are not addressed by Energy saving obligations for energy companies. For example; energy companies will run standard financial incentive programmes, while funds run motivation and information campaigns, promote innovative technologies and techniques, and address behaviours etc.
Other policies, such as Minimum energy performance standards (MEPS) and Mandatory comparative energy labels or Energy performance certificates, or RD&D funding can provide an important basis for the energy companies in terms of deciding which programmes/ measures to promote. Programmes implemented by energy companies under an ESO should target solutions exceeding MEPS in energy efficiency by far, such as super-efficient appliances. They can thus prepare the next revision of MEPS.

A number of structural pre-conditions are necessary to implement an ESO scheme.

Agencies or other actors responsible for design and implementation
An ESO scheme needs clear regulatory oversight in order to by really effective because there is the strong incentive for the energy companies to minimise both costs and actual energy savings that are additional to baseline energy efficiency trends, (as opposed to the energy savings calculated for proof of target achievement).
A government energy agency and or the energy regulator need to be in charge of developing the calculation methods for proof of target achievement. These agencies can involve stakeholders, and the law may allow obligated parties or even third parties in a ‘white certificate’ scheme to propose methods, as is the case in Italy, but government should retain the right of decision, so that the baselines reflect what markets would do without energy efficiency programmes and do not overestimate calculated savings in relation to actual savings.
The agency also needs to control the eligible actions. By way of example, as soon as the European Union decided to ban incandescent lamps from the market, the UK energy regulator disallowed the promotion of Compact fluorescent lamps for the British ESO scheme.
Finally, the agency needs to control monitoring, reporting and verification, and needs the ability to set penalties in case of non-compliance.

Funding
In terms of funding the programme expenses, three basic ways of providing it have developed in countries having an ESO, which can also be mixed:

1. The law or the regulator allows cost recovery by inclusion of programme costs in regulated or market-based energy prices and tariffs. This is common in the European Union, e.g. in Denmark and the UK, but also partly the case in some states of the USA, e.g. in California.
2. A special levy, often called ‘Public Benefits Charge’, is introduced by law but energy companies are allowed or required to use the funds created for their energy efficiency programmes, as in California and other states of the USA, and also in Brazil.
3. Climate finance (particularly Programmes of Activities – PoA – under the Clean Development Mechanism – CDM and Nationally Appropriate Mitigation Actions – NAMAs) can be used by developing countries and emerging economies to (part-)finance energy efficiency programmes implemented by energy companies. Examples include India’s BLY programme for energy-efficient lighting and some programmes in Brazil.

Test procedures
The ESO scheme needs test procedures for energy efficiency in two ways: for the definition of calculation methods for the proof of energy savings achieved, and for setting and communicating energy efficiency requirements for the actions promoted in the programmes that the energy companies implement to achieve their targets.
The ESO will, therefore, first rely on test procedures that were generated, e.g., in the preparation of MEPS and energy labels for both purposes. However, to the extent that such procedures do not (yet) exist for some types of action, specific test procedures for energy efficiency will need to be developed for the ESO scheme.

Others
An easy-to-monitor, consistent, and unequivocal set of calculation methods for the proof of energy savings achieved needs to be developed. It must cover all energy efficiency actions eligible for the scheme.
The agency and the energy companies need highly qualified staff with knowledge of energy efficiency solutions and potentials as well as programme design, implementation, and evaluation.

Important steps of policy design and implementation include (based on RAP 2012):

Setting policy objectives
The policy objectives of the ESO scheme should be simple and clear, and focussed on achieving energy savings. If the scheme has multiple objectives, the achievement of any non-energy-related objectives should not hinder pursuit of the primary objective to achieve energy savings.

Creating legal authority
A carefully selected combination of legislation, regulation, and ministerial and administrative processes to establish and operate the ESO scheme is advisable.

Defining coverage: fuels, sectors and facilities
This should reflect the overall policy objectives for the scheme and estimates of energy efficiency potentials for the different fuels, sectors and facilities. It will also reflect sector and fuel coverage by existing energy efficiency policies. Countries can also start by covering one or two fuels and then expand the scheme to other fuels as experience is gained.

Setting the energy savings target
Energy savings targets are an integral element of an ESO scheme. Setting the level of the energy savings target for the ESO scheme should reflect the overall policy objectives for the scheme and aim to strike a balance between making progress, the cost to consumers of meeting the target, and what is practically possible based on an assessment of energy efficiency potential. It is advisable to set the target in terms of final energy (i.e., the quantities of energy delivered to, and used by, consumers) unless the scheme covers several different fuels, in which case primary energy is more appropriate. Only if the scheme has a policy objective that relates to greenhouse gas (GHG) emissions reduction, policy makers can consider using carbon dioxide equivalent units. Setting targets for three-year periods has proven practical in many countries but a long timeframe for overall targets, preferably between 10 and 20 years, will increase security for all market actors. Calculating eligible energy savings over the estimated lifetime for each type of energy efficiency action will set the right incentives for the energy companies, but annual (first-year) energy savings should also be reported. In order to ensure that the energy companies do not focus on one or few types of energy efficiency actions but cover a broad range of potentials, the target should be set high enough and sub-targets may be set for different sectors or types of action.

Selecting the obligated parties
The obligated parties in the ESO scheme should be determined according to the fuel coverage of the scheme and the type of energy provider that has the infrastructure and capability to manage the delivery and/or procurement of eligible energy savings. It may be necessary to restrict the obligation to larger energy providers. Allocation of individual energy saving targets to each obligated party will be based on that party’s market share of energy sales or distribution.

Setting up the compliance regime 
An integral component of the ESO scheme is a procedure for obligated parties to report claimed eligible energy savings to an appropriate authority and a process for checking and verifying these savings. A penalty needs to be imposed on obligated parties that fail to meet their individual energy saving targets. The level of the penalty must be high enough to mobilise energy providers to meet their targets. It could be a share of overall company turnover or a price to pay for every kWh not saved that is significantly higher than usual programme costs.

Considering performance incentives
It may be advisable to include performance incentives in the ESO scheme to be awarded to obligated parties that exceed their energy savings targets.

Defining eligible energy savings providers
Enabling non-obligated parties in the EEO scheme to implement energy efficiency projects to produce eligible energy savings will create competition with its economic benefits. The scheme should avoid unnecessary restrictions on the energy efficiency projects or measures that can be implemented to produce eligible energy savings, provided that the energy savings can be verified.

Defining eligible energy efficiency actions
Establishing in the ESO scheme a list of preapproved energy efficiency actions with deemed energy saving values will facilitate implementation of the scheme. However, the scheme should not limit the actions and measures that can be implemented to produce eligible energy savings to only those on the list.

Measurement, reporting, and verification
As an integral component of the ESO scheme, a robust system for measuring, reporting, and verifying energy savings and other activities that contribute to scheme targets needs to be established. We recommend that procedures to verify whether energy savings are additional to what would have happened in the absence of the ESO scheme are also established. This is the task of government, but the obligated companies should deliver the data required.

Ensure funding
As stated above, policy makers need to establish an appropriate mechanism in the ESO scheme to enable recovery of the costs incurred by obligated parties in meeting their individual energy saving targets.

Co-operation of countries
When setting up new ESO schemes, countries can learn from the experiences of others. Under existing schemes, both the regulatory agencies for the schemes and the obligated energy companies can gain a lot from exchanging experiences on energy efficiency programme designs, processes and subjects: What has worked and what has not? This also concerns the methods for calculating energy savings and the compliance regimes.

Monitoring
For the energy efficiency programmes offered by the energy companies, the regulator should request documentation from the energy companies in order to evaluate cost-effectiveness and allow cost recovery. Random checks of the accuracy of the documentation may be useful.
For evaluation of energy savings, the documentation should cover the number of participants or beneficiaries, the energy efficiency actions they have taken (e.g., purchase of energy-efficient buildings or refrigerators), and the unitary gross energy savings achieved by each action (either via agreed deemed savings or ex ante agreed calculations, or via ex-post evaluations) (cf also Staniaszek & Lees 2012). To ensure sufficient and useful monitoring and evaluation, data can be provided from the programmes. The provision of this data should be part of the funding requirements to programme beneficiaries.
For evaluating economic benefits and costs, energy companies need to provide evidence of their costs incurred separately, for the programme design, administration, communication and evaluation costs and for any financial incentives. They must also provide the incremental part of the energy or power (kW) prices that the participants/beneficiaries would have paid for the energy or power they saved. Furthermore, incremental costs incurred by the customers to invest in energy efficiency or operate their premises and equipment in an energy-efficient way need to be estimated via market monitoring or ex-post evaluation.

Evaluation
In order to be credible, evaluation should be done by independent institutes or consultants and not by the energy companies themselves, but costs can be included in the energy prices.
The possibilities and formulas for evaluating energy savings will depend on the type of energy efficiency action supported as well as the type of energy efficiency programme (e.g. information only programmes are more difficult to evaluate than financial incentive programmes -see our detailed files on these types of policies and measures). The same holds for economic benefits and costs from either the customer/participant perspective, or that of the national economy/society. The USA in particular has a long-standing experience in evaluation methods.
In addition to the data directly monitored for the energy efficiency programmes, evaluation of net energy savings compared to baseline trends should address side-effects such as rebound, multiplier, and free-rider effects, and the ‘lifetime’ and potential deterioration of energy savings.
For the economic benefits from the perspective of the national economy/society, standard values for the incremental energy supply costs that will be avoided in the long run for a kWh of energy or a kW of load should be developed by the regulatory authority.

Relevant individual dynamics and side-effects

• Minimising rebound effects: Regulators should also survey the energy companies’ programmes so that they are designed to minimise rebound effects. This can include absolute limits on the energy consumption of energy-efficient appliances promoted, as well as educating consumers on energy-efficient use of buildings and equipment.
• Dynamic market transformation and/or innovation: Standardised measures are typically favoured by an ESO scheme; therefore dynamic incentives for technology innovation tend to be relatively low. Regulators should therefore require the energy companies to aim at dynamic market transformation and or innovation in technologies behavioural or organisational approaches through the programmes they implement. This requires to accordingly define the baselines and calculation methods for determining the energy savings and to frequently update them. On the other hand, if an ESO system is established for a sufficiently long timeframe (at least 10 years), it could give investment security to the markets for energy efficient technologies and services and hence create incentives for innovation.
• Avoiding lost opportunities: As an ESO scheme tends to focus more on single measures than on comprehensive retrofits, some opportunities for achieving even higher savings through an integrated approach may be lost. Regulators should therefore take care that the energy companies’ programmes also aim to avoid lost opportunities by trying to maximise both participation rates and energy savings per participant or for the energy-efficient technologies and solutions promoted. Furthermore, in order to ensure that the energy companies do not focus on only one, or a few types of energy efficiency actions, but cover a broad range of potentials, the target should be set high enough and sub-targets may be set for different sectors or types of action.
• Minimising snap-back effects: Snap-back effects can also be minimised through continuation of programmes as long as needed to mainstream energy-efficient technologies and solutions, maybe for a full renovation cycle to upgrade the whole stock of buildings and equipment to high energy efficiency levels. Securing these levels through legal minimum energy performance standards may reduce the need to continue information and incentive programmes.
• Minimising free-rider effects: The programmes should also be designed to minimise free-rider effects, e.g., by promoting only technologies and solutions with high energy efficiency levels while maximising uptake of these at the expense of low-efficiency solutions.
• Creating Spill-over effects: In order to maximise spill-over effects, the programmes can be discontinued if the energy-efficient technologies and solutions have become the mainstream. However, care needs to be taken that the markets don’t “snap back” to inefficient practices and technologies. Spill-over effects may also be created through the training of specialised contractors and energy consultants. For example, in the United Kingdom and France, the ESO schemes have significantly expanded the number and scope of energy consultants (Fraunhofer ISI et al. 2012).

Sustainability aspects
It depends on target setting, whether there is an incentive or even a requirement for the obligated energy companies to also promote sustainability aspects other than energy savings. For example, the UK government has required that 40 % of the energy savings in the ESO scheme are achieved for low-income customer groups, so as to reduce fuel poverty (the UK scheme only targets the residential sector). The specific calculation methods for energy savings could provide bonuses e.g. for water savings for clothes or dish washers, or limits on water consumption.

Co-benefits
It will depend on the scope and design of energy efficiency programmes implemented under an ESO scheme and on the incentives as mentioned here above, what kind of co-benefits (i.e. “non-energy benefits” such as health improvement, labour market effects etc.) may arise from implementing the ESO scheme. The increasing demand of energy efficiency products and services induced by the implementation of the ESO scheme may enhance the job market in these fields.

The following barriers are possible during the implementation of the policy:
It may be difficult and take quite some time to define the methods for calculation of energy savings required to prove target achievement.
There may also be a lack of experience in energy companies with energy efficiency programmes and projects.
In addition, there may be a lack of energy consultants in the market.
Furthermore, experience shows a tendency of “cherry-picking” among the energy companies - they focus on one or a few types of energy efficiency actions that are the easiest and cheapest to implement, which means lost energy efficiency opportunities in other market segments.

The following measures can be undertaken to overcome the barriers:
Regarding methods for calculation of energy savings, countries starting to introduce an ESO scheme can learn from others with more experience. It is advisable to start with pragmatic approaches, but to update methods and baselines at least every three years to reflect and stimulate market dynamics for energy efficiency.
If there is a lack of experience in energy companies with energy efficiency programmes and or a lack of trained energy consultants, policy makers may start with moderate targets having already decided to communicate their intention to ramp them up each year and each target period. This has been the case in many countries.
In order to ensure that the energy companies do not focus on one or few types of energy efficiency actions but cover a broad range of potentials, the target should be set high enough and sub-targets may be set for different sectors or types of action.

The most successful countries or states achieve gross energy savings equivalent to around 2 % per year and more of the target groups’ energy consumption through energy saving obligations. These include Denmark (around 2 %), Massachusetts (2.4 %), and Vermont (just under 2 %) (RAP 2012). Up to 1.5% per year of these savings are additional to baseline trends of energy efficiency (Thomas 2007; RAP 2012).
The graph shows how Denmark continues to increase its energy savings targets for the energy companies to achieve.

In well-designed ESO schemes, the cost of saving a kWh of energy is usually lower, often much lower, than the cost of the energy supply saved.
The obligated parties will usually carry a certain share of the incremental cost of energy efficiency improvements via financial incentives or sometimes by providing technology (such as Compact fluorescent lamps) for free. In addition, there are costs of programme management and communication, for paying out financial incentives to consumers, and for monitoring, reporting and verification. In well-designed programmes, the latter are around 20 % of the financial incentives provided, e.g., 18 % in the UK (Lees 2012).
The total average programme costs for energy companies may vary between 0.5 and 4 Eurocents per kWh of energy saved, with an average between 2 and 3 Eurocents, depending on the level of targets and the type of programmes (RAP 2012; Lees 2012).
There is evidence that with increasing experience, companies can deliver targets at lower costs to themselves and to consumers. For example, in the UK, despite ever-increasing energy savings targets, the cost to all parties (energy companies, consumers who benefit and others) for saving a kWh of electricity halved to 0.9 pence (1.1 Eurocent) between 1994 and 2008, and for gas it halved to 0.5 pence (0.6 Eurocent) between 2000 and 2008 (Lees 2012). On the other hand, with targets increasing towards 2 % per year, total costs to society may increase as well. In Denmark, they increased from 4.5 Eurocents per kWh in 2005 to 2009 to 5.6 Eurocents per kWh in 2011.
Usually, the programme costs of the energy companies will finally be carried by energy consumers via their energy prices or tariffs. The price elements have usually been between 0.1 and 0.3 Eurocents per kWh, but may increase to 0.5 Eurocents where savings targets are increasing towards 2 % per year (RAP 2012). However, the energy bills of consumers as a whole (which are obtained by multiplication of a much lower energy consumption and a slightly increased price) will decrease as the energy savings are cost-effective (see below). Furthermore, energy savings will defer investment in new power plants and grid expansions and or reduce the market price for energy, which should also reduce energy prices.
There is also a cost for regulatory oversight of the scheme, particularly of auditing and verifying the energy saving projects and ensuring that the energy company has met their target; this cost is borne out by the administrator of the scheme. This is a very small cost, e.g. the British energy regulator, Ofgem, estimated that its costs are less than 0.1% of the energy supplier costs in 2010 (Lees 2012).

In most ESO schemes, the expected cost savings have been much higher than the cost of saving energy, and there is a substantial net benefit both for consumers and society.
For the European Union, Bertoldi et al. (2010) tried an independent comparison of economic impacts of the ESO schemes for France, Italy and GB. In all cases, the total cost estimates of saving a unit of electricity or gas are lower than the electricity and gas residential prices by a factor varying between 2 and 6.
Similar results have been achieved in the USA. For example, in Massachusetts, programme costs for electricity savings were around US$ 235 million, while lifetime economic benefits (cost savings) were just over US$ 1,100 million – 4.5 times as high as costs. Results for programmes saving natural gas were similar (RAP 2012). Generally, the energy savings are cost-effective in all states with ESO schemes, also because regulators make sure they are.