Energy efficiency – or more accurately, "demand side management" – is a term that can include many services, such as: energy performance contracts; energy supply contracting; off-site power purchase agreements; balancing services arrangements; flexible supply contracts; smart metering; and sustainable supply chain management.

Given that Bird & Bird has a strong sector focus and great expertise in each of these areas, we thought that now is an appropriate time to look at some of the key developments that have taken place over the last few months, as the Government begins to attach increasing importance to demand side management.

1. The Wider Context

1.1 The measures we cover in this article do need to be placed in the wider context.

1.2 For example, Ofgem issued a consultation – "Creating the right environment for demand-side response" – which closed on 28 June, but interestingly highlighted three essential pre-conditions for the longer-term development of demand-side response:

1.2.1 "Industry parties need to be confident that there is value for them in demand-side response which justifies the investment" – regulatory and commercial arrangements need to create the right environment for parties to be confident to invest;

1.2.2 "The value of offering different demand-side responses services needs to be signalled effectively to customers"; and

1.2.3 "Customers need to be aware of the opportunities to provide demand-side response, able readily to access information on options and able to act".

1.3 Furthermore, the Energy Efficiency Strategy[1] examined four barriers to energy efficiency take-up: an embryonic energy efficiency market; lack of trusted and appropriate energy efficiency information; misaligned financial incentives; and undervaluing the long-term benefits of energy efficiency.

1.4 Finally, a Rapid Evidence Assessment carried out for DECC examined the factors influencing energy behaviours and decision-making in the non-domestic sector[2]. It sets out a useful overview of existing research evidence and notes that: there are barriers to investment decision-making, such as access to capital and business investments in energy efficiency generally appearing to require very high rates of return (sometimes much higher than other investments with comparable risks); there are differences in organisational energy behaviours that are strongly linked to size and sector; energy efficiency strategies differ across organisations and reflect their different motivations; voluntary agreements, energy audits and reporting requirements can successfully increase energy efficiency; but there are many research gaps, presenting the need for further work.

1.5 All three documents highlight some crucial challenges in taking forward energy efficiency initiatives. Whether the measures covered in this note meet these challenges remains open to debate.

1.6 Furthermore, and as Ofgem rightly notes, "Demand-side response is not an end in itself". There are competing and complementary solutions including, for example, energy storage and interconnection, that can help our electricity system adapt in the long-term to meet future demand securely and economically whilst meeting carbon reduction objectives. In addition, there are other vital considerations such as shifting planning regulations and construction requirements that generators, suppliers, developers and consumers need to bear in mind[3].

2. The Energy Savings Opportunity Scheme ("ESOS")

2.1 On 11 July, the Energy Efficiency Deployment Office within DECC issued a consultation on the ESOS – a consultation on implementation of Article 8 of the EU Energy Efficiency Directive[4]. "Energy audits" are defined in that Directive as, "a systematic procedure with the purpose of obtaining adequate knowledge of the existing energy consumption profile of a building or group of buildings, an industrial or commercial operation or installation or a private or public service, identifying and quantifying cost-effective energy savings opportunities, and reporting the findings"[5]. The Government claims that the ESOS will complement other initiatives aimed at encouraging investment in energy efficiency, including the non-domestic Green Deal, electricity demand reduction measures and enhanced capital allowances for energy-saving plant and machinery and states that this scheme "will enable companies to identify opportunities to save money on energy bills through improved energy efficiency and could benefit the UK by £1.9 billion" (and also, it argues, increase competitiveness). The consultation closed on 3 October and can be downloaded via: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/211977/20130708_-_ESOS_Consultation_Document_FINAL.pdf .

2.2 The ESOS will target all large enterprises: those with more than 250 employees will participate; and those with 250 employees or less will also be included if both their annual turnover exceeds €50 million and the annual balance sheet total exceeds €43 million. The Government does also encourage SMEs to consider carrying out ESOS assessments on a voluntary basis. Public sector organisations are not covered – the Government's rationale for this is that other articles in the 2012 Directive require public sector action on energy efficiency[6].

2.3 Key aspects of the ESOS include[7]:

2.3.1 Approved assessors will carry out Article 8 compliant ESOS assessments, to identify energy saving recommendations;

2.3.2 Regulations will set out the legal framework for the operation of ESOS, supported by non-statutory, good practice guidance;

2.3.3 Whilst the scheme does not include SMEs per se, it will include those that are part of a corporate group – as long as that group has one or more large (non-SME) UK companies within it. The consultation states, "With regards to ‘group enterprises’, the Government proposes to target the highest UK parent company in respect of all UK legal entities within the group as a whole, using the definitions contained in the Companies Act 2006. All organisations within a ‘large group enterprise', irrespective of whether some subsidiaries are SMEs, will need to be subject to an energy audit". The inclusion of subsidiaries is also a feature of the CRC Energy Efficiency Scheme and the consultation states that, "This means that enterprises that already measure their energy use under the CRC should find it easier to comply with energy audits. The Government wishes to avoid the administrative burden of organisations having to count their energy use twice". If the group as a whole is an SME, then the group would not be covered by the scheme; likewise if every single legal entity within the group is an SME. Corporate groups will however, be allowed to disaggregate so that subsidiaries (whether SME or non-SME) would be allowed to undertake ESOS assessments separately but please note that the consultation states quite emphatically that, "Disaggregation would not exempt subsidiaries". As the consultation itself notes, "This approach corresponds with the disaggregation that the Government has allowed under the recently simplified CRC";

2.3.4 Franchisors will not be required to account for energy use by their franchisees and organisations will not need to include energy use of subcontractors.

2.3.5 Legislation will require that ESOS assessments provide the following information at a minimum: a review of the total energy use and energy efficiency of the organisation; and clear information on potential savings which identify and quantify cost-effective energy savings opportunities. The ESOS should only cover that energy use which an organisation directly pays for or produces itself. The Government also emphasises that an ESOS assessment should be "proportionate and sufficiently representative". There are also proposals to exempt de minimis energy use in order to secure a cost-effective approach (currently proposed to be based on a percentage of total organisational energy spend).

2.3.6 There will be no legal requirement to implement the energy savings measures identified.

2.3.7 The initial ESOS assessment has to be carried out by 5 December 2015, and then renewed at least every four years thereafter.

2.3.8 A scheme administrator will be established to ensure compliance with the ESOS – it would also have an enforcement role (including the power to impose civil sanctions for certain breaches of the scheme as an option of last resort). Presently, the Government seems to prefer the choice of the Environment Agency, to mirror CRC arrangements as much as possible (as most organisations targeted by ESOS should already be covered by the CRC Energy Efficiency Scheme).

2.3.9 The Government has at least recognised the overlap with reporting under the CRC Energy Efficiency Scheme, Climate Change Agreements, the EU Emissions Trading System and mandatory greenhouse gas reporting and proposes that, "[A]s a part of ESOS, organisations would be allowed to make use of the energy data they have collected under existing schemes in order to minimise the costs of compliance", including allowing some flexibility regarding the period of time for which energy data is collected. No matter what flexibility etc. is allowed within the ESOS, it will have an additional impact on top of existing policies as each assessment will have to include detailed recommendations for energy savings improvements.

2.3.10 A number of technical and procedural issues are still being considered, for example: different potential approaches to compliance reporting (should there be notification of compliance to the regulator? Should there be public disclosure of the assessments? How and when do you set the qualification date for the scheme?). The Government is also suggesting that an organisation which has only building energy use (i.e. no transport or industrial process energy use) could choose to undertake a non-domestic Green Deal assessment or obtain a Display Energy Certificate for specific buildings, removing those buildings from the scope of the ESOS assessment – the ESOS assessor need then only confirm that the organisation has no other significant energy use.

2.3.11 The Government also proposes that any organisation with a current EN ISO50001 certificate (energy management systems) or audit meeting EN16247 standards would be deemed in compliance with ESOS, as would those with an ISO14001 certificate (provided the approach taken in the ISO14001 included an energy audit meeting the minimum requirements of the Directive).

2.4 The Government intends to review the operation of ESOS in 2016, following completion of the first round of the assessments.

3. Electricity Market Reform – Capacity Market

3.1 On 11 October 2013, DECC issued a consultation on proposals for implementation of two mechanisms involved in the Electricity Market Reform: Contracts for Difference and the Capacity Market (following on from the initial detailed design proposals for the Capacity Market published by DECC in June 2013). DECC believes that a Capacity Market should bring forward cost effectively the amount of capacity needed to ensure security of electricity supply. Whilst initially focussing on electricity supply, DECC now also suggests that demand side response ("DSR") (including embedded generation and smaller storage) can participate, supported by two stages of transitional arrangements. The consultation suggests rules to govern participation by DSR – capacity auctions are proposed to be first run in November 2014, for delivery during Winter 2018/19 (subject to State Aid approval) although the government proposes to run DSR-only auctions on an annual basis in the early years in order to help develop the DSR market. DSR capacity providers will be required to meet their capacity obligations by reducing or shifting demand below a baseline at times of system stress.

3.2 Bird & Bird recently worked with SmartGrid GB on an initial report, "Energy Bill 2013: Demand Side Response and the Capacity Market in focus"[8] (August 2013), which outlined SmartGrid GB members' initial views on the implications of the Government's proposals for DSR (as published in June). Whilst acknowledging that the development of the Capacity Market presents a substantial opportunity for the energy sector and wider economy, the report highlights, for example, that: long-term investment in DSR might benefit from a delay in the production of the design for the DSR aspects of the Capacity Market; a "one-size-fits-all" design may exclude certain DSR potential; and inappropriate penalty structures for non-performance may deter participation. The current consultation proposals do deal with many of these issues (for example, penalties during transitional arrangements).

3.3 Furthermore, the Government has amended the Energy Bill so that projects that deliver permanent reductions in electricity demand ("EDR") could also participate in the Capacity Market, alongside DSR and generation. The Government has proposed a pilot to test the feasibility of EDR participation, and will take final decisions on EDR implementation on the basis of evidence from the pilot (covering issues such as market appetite and monitoring and verification) – see para. 3.4 below.

3.4 On 15 September, DECC announced that the EDR pilot – backed with at least £20 million of funding – would be launched, to provide financial incentives to businesses and other organisations that install measures delivering verifiable reductions in electricity demand (such as more efficient motors, air conditioning and lighting). The results of the pilot will allow a decision to be made on financial support for EDR going forward, including how EDR measures can best participate in the Capacity Market. The key aspects of the scheme that are known thus far are:

3.4.1 Support will be decided through a competitive process, probably an auction and likely involving a maximum and minimum bid size – so presumably, bidders will bid using the EDR savings they can offer and the price they are willing to accept to deliver those savings;

3.4.2 Successful bidders will enter into an agreement to ensure that the EDR measures are installed and provide EDR savings within a specified time – projects that are already supported through existing initiatives may not be eligible;

3.4.3 More details on the pilot design and delivery body will be announced in the future within the Energy Efficiency Strategy (planned to be published by November 2013); and

3.4.4 The pilot is expected to start in summer 2014 and should run for two years[9].

3.5 The latest DECC consultation on proposals for the implementation of the Electricity Market Reform will close on 24 December 2013[10].

4. Building Regulations 2010, Part L (conservation of fuel and power)

4.1 We have now seen the very brief and long-delayed Government response to its consultation on Part L of the Building Regulations. Whilst there is still no published, full consultation response, the Department for Communities and Local Government ("DCLG") states that, "Regulations introducing the changes will be laid in Parliament soon" and the new regulations will be implemented in April 2014.

4.2 The proposal set out in the response would mean that new homes will only need to cut emissions by 6% on average across the build mix compared with 2010 (rather than 8% as originally proposed) and the non-domestic sector must meet a 9% improvement, again aggregated across the build mix (the consultation had preferred a 20% improvement). There will be no immediate measures to tackle poor regulatory enforcement, no regulatory quality assurance and no action to raise energy efficiency standards for home extensions – the so-called "conservatory tax". There will however, be a strengthening of the minimum energy efficiency standards that apply when specific building services work is carried out, such as air conditioning and chiller and lighting replacements in existing non-domestic buildings.

4.3 Commentators argue that the lack of ambition does not do enough to encourage the construction industry to move towards the targets of zero carbon new homes in 2016 and zero carbon new non-domestic buildings in 2019 (even though the Government expects Part L to be the regulatory vehicle for achieving the on-site elements of these zero carbon standards). On the other hand, the Government argues that the changes are an interim step on the trajectory towards achieving those zero carbon standards and aim to strike a balance between the Government's ongoing commitment to improving energy efficiency requirements whilst ensuring that the overall effect of regulation upon consumers and businesses does not stifle growth.

5. Allowable Solutions

5.1 Linked closely to the changes to Part L of the Building Regulations is the consultation issued by DCLG on 6 August 2013 regarding "Allowable Solutions", which enable house builders to meet their carbon obligations with offsite work. The consulation closed on 15 October 2013, but can still be downloaded via: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/226610/130731_ALLOWABLE_SOLUTIONS_CONDOC_FOR_PUBLISHING.pdf

Whilst the Part L proposals have been widely viewed as a watering down of ambitions regarding onsite emission standards, this consultation builds on 2011 proposals that zero carbon requirements in new buildings can be met through a combination of: onsite fabric energy efficiency (such as insulation, efficient services and high specification windows); carbon compliance (such as onsite solar panels and other renewable energy measures); and offsite measures, known as Allowable Solutions. The consultation emphasises that, "The government is committed to requiring all new homes from 2016 to meet the zero carbon standard". The consultation states that requirements for fabric energy efficiency and carbon compliance are to be achieved by measures incorporated within or on the development site, including by direct connection to community energy schemes.

5.2 The consultation also proposes some basic design principles for Allowable Solutions:

5.2.1 It is right that house builders decide how they meet the obligation to mitigate the carbon emissions arising from regulated energy;

5.2.2 The government wishes to develop a framework which gives builders choice and flexibility in how to meet their obligations;

5.2.3 The carbon savings deriving from Allowable Solutions should be additional – over and above the carbon savings that would have been delivered without the availability of Allowable Solutions;

5.2.4 Allowable Solutions should deliver cost effective carbon savings; and

5.2.5 Steps must be taken to minimise the administration overheads while ensuring that the key elements of the delivery scheme are robust (most notably the verification system).

5.3 The basic model[11] should work as follows – the house builder should work out exactly how much carbon they need to abate through Allowable Solutions, using the National Calculation Methodology (an established process under the Building Regulations) and then decide what mix of options offers him the most cost effective method of meeting the carbon abatement requirement, either:

5.3.1 Undertaking 100% of carbon abatement on site or through connected measures, such as a heat network;

5.3.2 Meeting the remaining carbon abatement requirement himself through offsite carbon abatement actions – the "DIY option", for example, improving other existing buildings, renewable heat or energy schemes or building to a higher standard than the requirements in Part L of the Building Regulations 2010 on developments with extant planning permission before October 2016. The consultation does not specify that these measures have to be physically linked to the development in question, but does note that the measure would need to be checked by building control. The consultation does also ask the question whether there should be any spatial limitations on Allowable Solutions (such as the solution being limited to projects located in the locality of the development, for example);

5.3.3 Contracting with a third party provider of Allowable Solutions for it to deliver carbon abatement measures sufficient to meet the builder's obligations; or

5.3.4 Paying into a fund which then invests in projects that will deliver carbon abatement on behalf of the builder.

5.4 The consultation proposes to set a maximum capped price (expenditure per tonne of CO² abated) for Allowable Solutions, to give the builder greater certainty of the costs they are likely to incur. Such cap would be reviewed and potentially reset every three years. The government also stresses the need for, and invites views on, an appropriate verification regime.

5.5 The consultation also considers what carbon abatement measures should be supported by Allowable Solutions. The government's starting point is that maximising flexibility is a significant consideration, whilst a prescribed list or criteria could provide certainty to builders. The consultation considers this set of draft criteria for Allowable Solutions' measures:

5.5.1 Complementarity to projects supported separately by other government programmes (i.e. no double subsidy). It is not clear how this criteria interacts with schemes such as Feed-in Tariffs or the Renewable Heat Incentive;

5.5.2 Market additionality – "Projects or measures would be those which would not otherwise have been brought forward by the market because of delivery barriers. This recognises that there is a deadweight risk". It is not clear how this could be demonstrated;

5.5.3 Cost effectiveness (achieved by setting a ceiling price);

5.5.4 Carbon impacts (i.e. measures capable of delivering verifiable carbon savings); and

5.5.5 Spatial criteria –measures should not be confined to domestic buildings but should not support projects outside the UK.

5.6 Furthermore, a number of measures have been suggested to the government as specific Allowable Solutions measures, including:

5.6.1 Creation or expansion of sustainable energy infrastructure;

5.6.2 Retro-fitting of low carbon technologies in existing technologies;

5.6.3 Investment in low carbon electricity generation assets and in energy efficiency infrastructure;

5.6.4 Energy storage solutions and demand side management;

5.6.5 Energy from waste plants; and

5.6.6 Low carbon cooling.

5.7 However, in the consultation, the government seems to favour an approach based on criteria, rather than a definitive list, particularly as such an approach provides flexibility and adaptability to changing technologies.

6. Market Movements

6.1 It is clear that commercial considerations are also playing an increasingly important role in demand side management – rising energy costs, regulatory requirements and CSR are pushing energy efficiency up the corporate agenda. There have been a few developments over the past months that indicate even more clearly there is money to be made in energy efficiency services:

6.1.1 The CBI has published a report[12] stating that, "Energy efficiency can boost overall business and economic competitiveness". The report urges company boards to adopt action plans to improve energy efficiency (including measuring and managing energy use and driving efficiency down the supply chain and across sectors) and also encouraging government to deliver coherent energy efficiency policies to support positive investments;

6.1.2 John Lewis has just launched an energy labelling scheme, in conjunction with DECC, to provide customers with lifetime electricity running costs on washing machines, washer dryers and tumble dryers;

6.1.3 E.ON has announced that its E.ON Connecting Energies Efficiency arm is to acquire European energy efficiency services firm, Matrix (subject to Austrian merger control clearance). The purchase price is understood to be worth around £85m;

6.1.4 Likewise, Scottish Equity Partners and Hermes fund manager have acquired a stake in energy efficiency services specialist, Anesco;

6.1.5 London Zoo has announced that it is to be accredited under the Energy Managers Association's Low Energy Company scheme – under the programme, the zoo has committed to train around 600 employees in basic energy management, as well as encouraging its supply chain to join the scheme. A number of big corporate names are also rumoured to be discussing joining the scheme which is due to be launched later this year; and finally

6.1.6 The Companies Act 2006 (Strategic Report and Directors' Report) Regulations 2013 (the "2013 Regulations") came into force on 1 October 2013. The 2013 Regulations – amongst other things – amend the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 to impose a duty on quoted companies to report their greenhouse gas emissions (in tonnes of carbon dioxide equivalent, "CO²e") as part of their directors' reports for financial years ending on or after 30 September 2013. Combined with increased stakeholder scrutiny of large organisations' environmental impacts – see for example, recent criticism by the World Development Movement of RBS' reporting of its emissions (and in particular, its financed carbon emissions as opposed to its operational carbon emissions) as well as praise for those companies that report fully and clearly – it is evident that mandatory carbon reporting is a "hot topic". It is widely acknowledged that effective green reporting can help companies take control of and manage their environmental impacts, as well as potentially help them to achieve a reputational advantage, reduce operational costs (such as energy bills), face less exposure to volatile energy prices and even identify new business opportunities.

6.2 We hope this article demonstrates that not only commercial developments but also advances in regulatory and policy thinking are creating significant opportunities in relation to demand side management. Canny consumers, property developers and construction companies, generators and energy services companies in particular should ensure they take maximum advantage from these benefits. The real question is whether these regulatory and policy advances can keep pace with the market's appetite.



[1]The Energy Efficiency Strategy: The Energy Efficiency Opportunity in the UK, Department of Energy and Climate Change ("DECC"), November 2012

[2] What are the factors influencing energy behaviours and decision-making in the non-domestic sector?, A Rapid Evidence Assessment, Centre for Sustainable Energy and the Environmental Change Institute, University of Oxford, November 2012

[3] For example, the Greater London Authority has issued for public consultation draft supplementary planning guidance on Sustainable Design and Construction. This includes guidance on energy efficient design, energy demand assessments, decentralised energy, carbon dioxide offsetting, demand side response and retro-fitting measures – to help developers achieve the carbon dioxide and water consumption targets set out in the London Plan.
[4] Directive 2012/27/EU of the European Parliament and of the Council of 25 October 2012 on energy efficiency, amending Directives 2009/125/EC and 2012/30/EU and repealing Directives 2004/8/EC and 2006/32/EC, OJ L 315, 14.11.2012, p.1
[5] Article 8 of the Directive requires Member States to comply with the following main obligations: promote the availability of high quality energy audits to all final customers; ensure mandatory and regular (every four years) audits for large enterprises; establish transparent and non-discriminatory minimum criteria for energy audits, based on Annex VI of the Directive; and establish requirements (including qualification criteria and quality assurance) for energy auditors and for supervision by independent authorities under national legislation. It also requires Member States to: develop programmes to encourage small and medium enterprises to undergo energy audits and implement the recommendations from these audits; and develop programmes to raise awareness among households about the benefits of energy audits. This is complemented by Article 16 (concerning certification, accreditation and/or qualification schemes for the providers of energy audits) and Article 17 regarding dissemination of information and training.
[6] Article 5 requires Member States to achieve energy savings in central government buildings, for example.
[7] Please note that these are consultation proposals – not decisions on how the scheme will operate.
[8] Available via: http://smartgridgb.org/policy-regulation/item/293-sggb-releases-new-report-on-capacity-market-and-dsr.html
[9] DECC issued a fact sheet on the pilot – see: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/248873/EDR_Pilot_factsheet.pdf .
[10] The consultation can be downloaded via: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/249591/EMR_Consultation_on_Implementation_proposals.pdf .
[11] The Government expects requirements for Allowable Solutions to be brought forward in future changes to the Building Regulations, but expects the next policy stage to involve a detailed design model which will be the subject of further consultation – there are certainly issues associated with offsite solutions and complementarity, for example, that do require further clarification. Other issues require further analysis – for example, does the proposal to limit Allowable Solutions to projects within the UK contravene any legislation regarding free movement of goods and services?
[12] See CBI report, "Shining a light: Uncovering the business energy efficiency opportunity", August 2013: http://www.cbi.org.uk/media/934998/shining_a_light_-_uncovering_the_business_energy_efficiency_opportunity_cbi_report_aug_2013_screen.pdf