Energy Efficient Scotland programme: analysis of delivery mechanism

9 Outline economic case

9.1 Key points

This chapter sets out the justification for reform by exploring the socio-economic benefits that EES is expected to provide over the course of the programme. Below, a review of the scale of potential transitionary and administrative costs of delivery is presented. The chapter then looks to outline how different delivery architectures could have the potential to better realise benefits of EES overtime.

In summary, the expected “net” incremental costs to be incurred from developing any new delivery architecture, in advance of the counterfactual, are potentially inconsequential. Over the course of the entire 20 year programme of EES, the additional set up costs of any bodies could be dwarfed by the scale of benefits and operational costs the programme has the potential to deliver. A key driver of the economic case in future iterations of the business plan will be the extent to which different delivery models can deliver programme benefits.

Although at this stage, it has not been considered to quantify the potential impacts of different models on these factors over time, it is deemed that they could potentially negatively influence costs, and positively influence benefits to such an extent, that net impacts are larger than under the counterfactual. At this stage, options are not ruled out based on their economic performance.

9.2 Introduction

The justification for the use of other delivery models, such as the creation of a specific EES Directorate, or new arm’s length body, requires that these options have incremental net economic benefits above that out the counterfactual. This chapter explores:

• Whether additional reform in advanced of the counterfactual could deliver net economic benefits to the programme; and
• The next steps required to better understand the potential relative merits of each of the options to maximise net economic gains.

Due to the uncertainties at this stage, including a lack of information on costs, benefits, and scope, it has not been sought to provide an individual quantitative assessment of the net benefits of each individual option. Rather, an illustrative outlook into the potential benefits required to justify reform in advance of the counterfactual has been provided.

9.3 Justification for reform

EES is predicted to provide a number of socio-economic benefits across Scotland. These potential benefits to be realised across the course of the programme until 2050, include but are not limited to:^[36]

• Increasing the overall energy efficiency of the built environment to improve energy productivity;
• Energy (and cost) savings generated by reduced energy use for heating, particularly for consumers who could be considered vulnerable;
• Reduction in CO2 levels significantly contributing to Scotland meeting its climate change targets;
• Potential of supporting jobs and businesses within local and national economy and reducing the cost of EE measures; and
• Health issues relating to fuel poverty thus helping to the health of a significant percentage of Scottish residents.

The case for additional reform of the current delivery architecture is therefore reliant on whether any new potential delivery models leads to a higher net positive economic impact of the EES programme itself. The economic case for reform for the architecture therefore requires that either:

• Any new delivery architecture, leads to an increased likelihood of meeting programme objectives and decrease in risks of programme delivery; and/or
• Any new delivery architecture leads to a greater realisation of primary potential benefits of the overarching EES programme, or a realisation of these in a more timely manger; and/or
• That any new delivery architecture leads to net savings in the costs of administering and delivering EES.

9.4 Transitionary and administrative costs

Whether any delivery reform is justified must rely on whether the costs of its creation, are outweighed by the benefits brought by that new architecture. Independently of the ability of different models to realise programme benefits, it can be considered whether reform is justified by better understanding the costs of the programme over time.

All options, including that of the counterfactual, are expected to incur costs to fulfil the required roles to support programme delivery. While in addition, the transition to new delivery models away from the counterfactual will incur additional set up costs.

Below, a high level estimate of what these costs could be has been provided. It is then considered whether the potential incremental costs of delivery of different options negate any potential benefits which might be seen in programme delivery.

9.4.1 Cost

Operational costs

At present, only indicative estimates of the cost of programme delivery can be made. The estimates presented below should not be treated as an estimate of what a delivery mechanism may cost, as the costs may vary greatly depending on the functions that a delivery mechanism ultimately carries out, and the nature of EES delivery (e.g. local or national). In addition, operational costs are likely to vary over time, particularly as the delivery mechanism takes on more functions. Costs will need to be assessed in much more detail at any Business Case stage, when more clarity around the functions of the delivery mechanism has emerged.

Scottish Government estimated that in meeting the programme goals for domestic properties, delivery costs could be in the region of £8bn.^[37]

Alongside delivery costs (for instance the costs of installation), it is also expected that there would be administrative and operational costs incurred, for operating the overarching EES programme^[38]. Over the course of such a lengthy and capital intensive programme, it could be expected that these costs will be significant.

A significant percentage of these operational costs are likely to arise regardless of whether an NDM is implemented. For instance, under the counterfactual, the completion of many of the 10 Roles might still be expected, and their administrative functions, at least partially.

Therefore, it is assumed that the incremental costs of any new delivery architecture would consist of only the incremental set up costs for which it incurred, and any potential changes in operational efficiency which it might deliver. It is therefore worth considering how both these setup up and operational costs compare.

Although there is limited information on the scale of administrative and operational costs of the programme at present, one approach to outline an estimate is to examine the costs of administering similar schemes across GB. One example is the Energy Company Obligation (ECO) energy efficiency scheme. ECO aims to reduce carbon emissions and tackle fuel poverty. As part of ECO, energy suppliers stimulate the delivery of measures that reduce the cost of heating homes for households.

The administrative functions carried out by suppliers in support of ECO are similar to the envisaged roles carried out under a reformed delivery architecture which is expected to be completed even within the counterfactual, these include but are not limited^[39] to:

• Promoting the installation of measures to achieve obligations;
• Calculating the carbon saving/cost score of each measure; and
• Performing technical and score monitoring of measures and reporting of results.

Costs for the delivery of these administrative functions are estimated at around £175m, around 11% of the £1624m scheme costs of the ECO3 extension. ^[40] These estimates do not include administrative costs applicable to the regulator, Ofgem, which undertakes a wider monitoring function.

If similar cost profiles were expected for the administrative and operational costs of delivering EES, it might be extrapolated that over the course of the programme, annual administrative costs could total around £44m^[41]. Table 14 below outline an indicative level of these administrative and operational delivery costs. It is note that these estimates represent, the “average” year across the course of the programme. It would be expected that during the initial startup phase that administrative costs would be significantly lower.

Table 14: Indicative annual administrative cost estimate^[42]

Value	Cost of administration
Administrative proportion	11%
Administration costs	£40m

It could also be that these potential costs are an underestimate, as they would not take into account the completion of all the required roles outlined in the Financial Case, for instance there is no estimate for enforcement activities undertaken by Suppliers under the ECO framework.

Set up and transitionary costs

There will also be set up and transitionary costs involved in the creation of a new body. These set up costs are one off costs associated with initial hiring and contractual requirements of setting up the new delivery organisation. At this stage, a monetised estimate of these costs has not been provided.

As an indicative example, the costs recently assessed as the potential set up costs for the Public Corporation Energy Supplier for the Scottish Government, totaled a maximum of £3.5m^[43]. Relative to the operational costs outlined above, it is believed that these costs will be immaterial over the course of the programme.

9.4.2 Net costs of reform

The profile for operational costs over time will vary between models. Some models, such as those with more commercial functions further from government control, have higher set up costs.

Over the course of the entire 20 year delivery programme, differences in efficiency of different models could lead to differences in costs however the key consideration is less about cost and more about the delivery of the benefits expected of the programme.

• Relative to the net expected impact of the programme (£8bn), and the potential administration costs over time, expected set up and transitionary costs to any new delivery architecture are likely to be inconsequential, when compared with the benefits.
• Due to the potentially large administration and operational costs of Programme delivery over time, further consideration should be given to delivery models which could be effectively incentivised or directed to achieve operational savings in Programme delivery.

Therefore, the economic case need to consider whether the benefits are secured but also consider the scope for cost reduction.

9.5 Delivery of benefits

Over and above the potential impact on costs of delivery, different delivery architectures could have the ability to reduce the risks of delivery itself. These models could have the potential to better realise benefits of EES over time. Due to the significant potential programme benefits over a long timer scale, even marginal increases in potential delivery effectiveness could lead to significant net economic gains.

9.5.1 Expected impact

The economic benefits of the overarching EES programmes have previously been considered and quantified by the University of Strathclyde^[44]. These benefits include but are not limited to:

• Delivery of a gross undiscounted cumulative boost of £7.8billion to real Scottish GDP over the next 30 years. (Corresponding to a projected £1.56billion public spending).
• An anticipated 9.6% reduction in energy required to run Scottish households by the end of the 20 year programme.
• 6,000 sustained (full-time equivalent) jobs.

These benefits have been calculated relying on several key assumptions notably that around 75% of Scotland’s private sector housing is upgraded to EPC C and around 50% of its social rented sector properties are upgraded to EPC B by the end of the programme. The outcomes depend financial contributions from households following those of the Scottish Government, and households successfully working with retrofit technology to reduce their energy requirements.

Realisation of these benefits primarily relies on the EES rollout meeting expected timeframes, with an accompanying significant take up of private (household backed) financial investment in domestic retrofit schemes to minimise the required government financial backing required. Without this take up of private financial input, the net multipliers of benefits from government spending on the project would reduce. While, unsurprisingly, missing project deadlines for roll out also negatively impacts the expected net benefits of the programme.

If EES is able to achieve the anticipated roll out, the benefits over the course of the programme will be substantial. A 9.6% reduction in Scottish household energy demand today, equates to approximately^[45] 4000 GWh of energy consumption across the domestic sector on an annual basis, and around 0.60^[46] Mt CO2e.

9.5.2 Increasing likelihood of successful delivery

Under the counterfactual scenario, completion of the 10 Roles would be delivered using additional functions within the Scottish Government Directorates to enable delivery. This decentralised model, as assessed as part of the role assessment in Chapter 8, would involve a significant spread of delivery partners across Scottish Government and a number of different Local Authorities, without a central point of reference.

However, it is noted that there are several potential risks associated with this model regarding some key areas of delivery, notably that the counterfactual scenario is likely to perform poorly in two roles which are key for meeting the required assumptions to realise the benefits of the programme:

• Role 5: Provide a central EES focal point and coordination service; and
• Role 8: Facilitate access to project funding and finance.

A key aspect of assessing NDM options is whether they can be used to mitigate the risk associated with these roles.

9.5.3 Performance of similar delivery bodies

Two potential models that represent the next steps of development beyond the counterfactual are: i) the creation of specialist EES Directorate, accountable for delivery of the overarching programme; and ii) the use of a wide spread partnership with Local Authorities. A recent example of a model combining both features is the delivery body working on the rollout of Broadband as part of the UK Universal Service Commitment.

This body is very similar in structure to that of Option 3 combined with Option 4, the establishment of a new Directorate alongside Local Authorities. Crucially, this body has shown that these models can work well performing similar roles to the 10 Roles that are envisioned as part of EES, particularly in Roles 5 and 8 which are identified as lacking within the counterfactual.

Broadband Delivery UK (BDUK)^[47], a specific directorate which sits within the Department for Culture, Media and Sport, is working to facilitate the roll-out of next generation access (NGA) infrastructure to support the delivery of superfast broadband speeds across the UK. BDUK is primarily aimed at stimulating private sector investment, and has been tasked with managing the national level, locally lead delivery of the NGA roll-out.

BDUK is responsible for the development and management of the overall approach to the delivery. It acts as the conduit for the central fund, development of national approaches to sourcing, and providing support and guidance to local bodies.

The programme of work from BDUK was delivered in partnership with Local Authorities and the devolved administrations (DAs)^[48], in acknowledgement that delivery would need to address locally specific issues. Conversely to the counterfactual, this model has relied on a central point of reference while working on the ground with Local Authorities to enable delivery. BDUK’s roles have included:

• Development of a national procurement framework (the Broadband Delivery Framework) to provide local bodies with a panel of potential suppliers capable of delivering the design, build and operation of a local broadband project.
• The National Procurement role would be performed by Scottish Procurement working with officials in the directorate.
• Delivery of compliance reviews of tendering process and contractual terms.
• Established processes to ensure that projects are compliant with the requirements of the Decision and the Broadband Guidelines.
• Delivered guidance documents and industry information events to contractor support delivery.

Overall as part of an economic review^[49] into the schemes effectiveness, there has been early indications that this model has delivered successfully, particularly relating to key areas of the programme risks which should be mitigated to realise the benefits of delivery. As outlined within the economic review, these included:

• Scheme delivery under BDUK leading to significantly greater investment, in broadband and extension of coverage in rural areas in the UK than would otherwise have occurred;
• BDUK is on track to deliver its Phase One and Phase Two objectives regarding superfast broadband coverage with a material impact on the number of premises receiving coverage; and
• Value for money protected, BDUK’s value-for-money safeguards are sufficiently robust to ensure that the supplier is paid only for costs incurred under clearly defined criteria.

One issue initially faced was the existence of incentives for suppliers to overspend, due to information asymmetry between BDUK and the programme cost base. This is a problem which could potentially arise under any procurement undertaken by Local Authorities and the Scottish Government with supplier’s delivering EES measures, particularly under a de-centralised mechanism such as the counterfactual. However, over time, BDUK as a central body developed learning to evolve the contractual mechanisms to drive cost efficiency.

In summary, BDUKs structure has been assessed by Oxera as being successful in delivering many aspects expected of EES. Therefore, there is significant scope for the potential realisation of programme benefits under more centralized models considered for EES.