Questions mount over effectiveness of tax breaks for energy efficiency

The enhanced capital allowances scheme offers tax breaks to companies in a bid to encourage investment in energy-efficient equipment and products. Remarkably, however, the Carbon Trust - which administers the scheme - has admitted that it cannot measure its uptake. Investigations by ENDS suggest that many purchasers are unaware of the scheme or do not think it worthwhile - although it is acting as a spur for equipment manufacturers to improve the efficiency of their products.

The Government's policies to encourage business to improve its energy efficiency are a mixture of stick and carrot. The main sticks are the climate change levy and its supporting network of negotiated climate change agreements. These will soon be joined by binding caps on many companies' carbon dioxide emissions under the EU emissions trading scheme (see pp 5-6 ).

In parallel, the Government is offering several incentives for business - the most prominent of which are enhanced capital allowances (ECAs). These tax breaks, administered by the Carbon Trust, are intended to help overcome one of the barriers to uptake of efficient technology - the high capital cost of investment - so hastening market penetration (see box ).

The Treasury anticipated that up to £100 million of capital expenditure would be offset by ECAs in 2001/02, rising to £140 million in 2002/03. The climate change programme expects ECAs to reduce carbon emissions by up to 0.5 million tonnes by 2010 - a modest but far from insignificant contribution to the Government's targets.

No information on uptake
The scheme has now been running for two and a half years - but remarkably, nobody appears to be able to measure its success.

In February, MPs on the House of Commons Environmental Audit Committee asked Tom Delay, chief executive of the Carbon Trust, how successful ECAs have been. "The simple answer is that we do not know and we are pretty confident that nobody else knows," he replied. "There is simply no way of measuring the uptake of the ECA scheme."

The Trust's strategy director, Michael Rea, added that the Inland Revenue had resisted adding another question on the tax return form because they do not believe that the increase in "red tape" would be justified.

This situation appears to be completely at odds with the Treasury's declared approach to environmental economic instruments. This says that new instruments should be monitored for a period after their introduction, both to draw general lessons and to adjust the design if it is not achieving the desired objective. Yet remarkably, the Inland Revenue appears still to be actively blocking such an evaluation.

To get some idea of uptake, the Trust is now carrying out an impact assessment of the scheme on behalf of the Environment Department. This is likely to lead to a review of how the scheme can be further promoted to improve its uptake.

"Just because there is not a structural mechanism in place does not mean that one cannot attempt to analyse take up of ECAs," says Peter Stones, the Trust's financial programmes manager.

An earlier attempt to assess take-up of ECAs after their first year failed to provide a clear picture. However, Mr Stones is more confident that the current survey, based on telephone interviews with end users, will give better results.

One thing is clear however - a growing number of manufacturers are listing energy-efficient technologies that qualify for ECAs. At the end of January, more than 7,000 individual products from 328 manufacturers appeared on the ECAs product list.

Interviews with manufacturers confirm that sales of many of these products are rising. Much of this may be due to the normal process of technological improvement, and there is little doubt that the climate change levy and negotiated agreements are providing a further incentive.

However, it is much less certain whether ECAs are playing an important role in influencing companies' purchase decisions. Indeed, the scheme's main benefit may have been a secondary one - as the qualification criteria have encouraged some manufacturers to improve the efficiency of their product ranges.

Boiler efficiency gains
One key technology found on the vast majority of commercial and industrial sites is boilers.

Kevin Stones, engineering director of Newark-based boiler manufacturer Hoval, says there has been a "significant trend" towards commercial and industrial condensing boilers. But he does not believe that ECAs have played a significant part.

"ECAs should enable buyers to get some money back, but I think people are just buying this efficient kit anyway," he says. "We're not seeing a large number of orders where they specify that it should be on the ECA list."

However, changes to the ECA eligibility criteria in August 2003 forced Hoval to improve some of its products. The qualifying efficiency was raised from 91% to 93% - a level which can be easily reached by condensing boilers, but which excludes many conventional models.

Hoval is currently redesigning some of its boilers to qualify. For example, it is having to install types of burner which themselves are on the list. "Before the update you could almost get any bit of kit on the list," Mr Stones says. "But they've raised the game for [boilers] above 400kW and the industry is now playing catch-up."

The list now contains only an "elite" set of products - which carry a price premium because they cost more to manufacture, Mr Stones added.

"A lot of manufacturers have boilers listed, but others haven't even bothered to register as they don't see it as a particularly worthwhile exercise," said Paul Sands, sales director with rival manufacturer Stockvis, which has around 90% of its boilers listed. "Interest in ECAs is just starting to catch on, but it's still minimal. End users need to be hit directly with some publicity."

Driving motors onto the list
Although less common than boilers, motors are widely used in the process industries and present considerable opportunities for energy savings.

Efficient motors can save around 1% compared to the industry average, says Ashley Galloway from manufacturers Leroy Somer, offering "phenomenal financial savings". But the demands on motors often varies over time - and savings of up to 50% can be made if motors are fitted with variable speed drives to adjust the power input.

The market for variable speed drives has undergone a "step change," Mr Galloway told ENDS. Five years ago one in ten motors sold by Somer was fitted with variable drives - but the proportion is now one in three and the company expects this to increase to 50% shortly.

However, Mr Galloway says the market transformation is entirely down to the energy savings - and "not driven by enhanced capital allowances at all."

Motors below 30kW form the bulk of Somer's sales, and Mr Galloway suspects that many companies account for these as part of the maintenance budget rather than capital expenditure. His own company only classifies expenditure over £500 as capital, and for some larger companies the limit may be as high as £5,000.

As an example, Mr Galloway cited one of Somer's customers - a large chlorine manufacturing plant, with hundreds of motors up to 22kW. This firm is keen to replace motors with variable speed drives - but Mr Galloway believes that this is motivated mainly by its climate change agreement. Even when Leroy Somer reminded the company about ECAs they were not interested, he said

As with boilers, however, the introduction of ECAs appears to have provided a spur to equipment manufacturers. A key driver appears to be that for a large piece of kit to qualify for ECAs, the major components also need to be ECA-listed.

For example, Ingersoll Rand manufactures compressor motors which use Leroy Somer drives. Ingersoll was concerned that it might lose market share in the UK if its products were not on the ECA list so it pressured Leroy Somer to have its drives ECA listed.

Similar pressure has come from manufacturers in Germany and Italy whose products also include Somer's motors or drives, Mr Galloway said. Following advice from their UK distributors, companies in those countries were "quite fearful" that they would not be able to sell in the UK if their products were not ECA listed.

Lighting suppliers in the dark
A key opportunity for cutting energy costs in all types of industrial and commercial sites is lighting.

Modern fluorescent strip lamps combined with high frequency control gear and reflective fittings can reduce energy consumption by up to 30% compared to standard fluorescent lights with copper iron ballasts, says Trevor Blair, technical advisor with global market leader Philips.

Each week, Mr Blair receives about half a dozen e-mail or telephone enquiries about ECAs. "I wouldn't say that enquiries are flooding in, but people are more aware of ECA benefits, either through the website or through our wholesalers - who we are pushing towards high frequency equipment."

But David White, Dagenham branch manager of one of Philips's largest wholesalers, WF Electrical, told ENDS he had never heard of ECAs - despite supplying lighting and other electrical equipment to a range of commercial and industrial sites including public utilities and oil rigs.

"Clients never, ever ask about it," he said. "Most people are just interested in the bottom line on the invoice." The specification for fittings and lamps in new buildings comes from the architects, not the building's future users, he added.

Philips' technical manager Ted Glenny agreed that most work by specialist consultants and installers is based on the lowest purchase cost. This is especially true when sites and buildings are rented, he said, but it is also often the case when the company owns the building.

"The first barrier to be overcome is for people making the capital investment to take whole life costs into account," he said. "Often energy costs and capital investments aren't handled by the same people and the money comes out of different budgets."

Transforming the market?
Peter Stones of the Carbon Trust says it is premature to judge the success of the ECA scheme in advance of the assessment. He insists it is effective for financially marginal technologies.

"The purpose of the list is to drive uptake of technology where there is a financial market barrier," says Mr Stones. "It's not a broadband panacea - it looks at a particular part of the uptake curve for technologies that have a [purchase] price premium."

Mr Stones points to refrigeration where the most efficient technology is 5% more expensive than standard equipment. The ECA benefit is roughly equivalent to this premium - offering a potentially important effect in such marginal investment decisions. However, Mr Stones added that the ECA effect would be "less powerful" if the price differential were 10-20%.

Technologies on the list must have a top-of-the-range energy efficiency and carry only a modest price premium, Mr Stones told ENDS. If mass production brings costs down or if rival, more efficient technologies emerge, the Trust will remove the product from the list.

Mr Stones believes that the list could have a wider impact: "Companies can also use the list as a source of ideas for efficient products which they could buy - even if they don't actually make a claim."

But Andrew Warren from the Association for the Conservation of Energy sees this as a mixed blessing. "The list does become a de facto register of good energy saving products that firms could consider buying. But the inference that can be taken is that items excluded from the list, such as insulation or new windows, are of less value."

This exclusion is "discriminating against useful measures", simply because they are regarded as maintenance rather than capital expenditure. Mr Warren argues that some technology classes appear arbitrary, such as the inclusion of pipework lagging but the exclusion of other insulation products. The discrepancy appears to stem from the Inland Revenue's definition of plant and machinery.

The Environmental Industries Commission and ACE are pressing for ECAs to be raised to 150% of capital expenditure and for firms that install qualifying products in domestic premises to be included. However, such measures may have little impact unless more end users are aware of the scheme and its benefits.

Mr Stones accepts that so far the Carbon Trust has concentrated on working with manufacturers and "filling up the shop window" - but says there is now a shifting emphasis towards raising awareness with final users.

Even so, the lack of awareness of the scheme, and the apparent apathy shown by end users and even some manufacturers, calls into doubt the effectiveness of ECAs. The picture may become clearer once DEFRA and the Trust complete their assessment - but there already appears to be a strong case for the system to be overhauled.

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