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Climate Change Policy for Energy-intensive Small and Medium Size Enterprises (SMES)

POL Min (05) 6/6

The Chair

Cabinet Policy Committee

Proposal

1. In response to Cabinet direction in August 2004 (POL Min (04) 19/9 refers), this paper:

  1. reports on progress in implementing policy for small and medium size enterprises, and
  2. proposes additional policy to assist energy-intensive firms to reduce greenhouse gas emissions, and to mitigate the possible adverse effects on them of a carbon charge through improved energy efficiency.

Executive Summary

2. The climate change policy for SMEs agreed in August 2004 included actions by MfE and EECA to provide information and services to assist firms to improve energy efficiency, a requirement to (a) identify potential adverse effects on competitiveness of a carbon charge for firms in energy-intensive industries, and (b) assess alternative measures to mitigate these effects.

3. Progress has been made on these actions and is on track to be completed during 2005. A survey of firms in energy-intensive industries identified the major factors that affect decisions about investment in energy efficiency in these industries. The survey also identified four areas where government support could encourage greater energy efficiency in energy-intensive SMEs. Four policy measures are proposed to provide such support:

  1. A grant scheme to provide assistance to overcome financial barriers, targeted at firms in energy-intensive industries;
  2. Demonstration projects to provide support for innovation and technology uptake, targeted at firms in energy-intensive industries;
  3. Training for company directors to influence a conservation culture in corporate governance, through EECA's Energywise programme;
  4. Education for company managers and staff about a carbon charge and energy efficiency, through EECA's Energywise programme.

Grant scheme

4. Officials considered the following options to provide targeted assistance to overcome financial barriers: loans, a subsidy, a grant, and a tax concession. The grant option is preferred because it most effectively meets the key criterion to reduce payback times.

Demonstration projects

5. EECA and MfE will work with industry associations and companies in energy-intensive industries to identify suitable sites for demonstration projects and appropriate technologies that offer cost-effective energy savings, but that have low uptake.

Training and education

6. To further promote uptake and 'lock in' energy efficiency as a priority for businesses, existing programmes offered by EECA will be expanded to include training and education for top management about energy efficiency and the benefits to business.

Pilot scheme proposed

7. The proposed 2005-06 Budget includes an allocation of $5.0 million to the Ministry for the Environment and the Energy Efficiency and Conservation Authority over three years ($1.667 m per year) to implement the policy measures set out in paragraph 3 above. This level of funding is sufficient to deliver a pilot grant scheme focused on demonstration projects, and programmes for training and education.

8. If the Budget allocation is approved, a pilot grant scheme will offer cash grants to approved firms in target industries during 2005. The grants will be 'tied' to projects that demonstrate the application of technologies that are proven to increase energy efficiency. The pilot scheme is expected to provide information that may be used to support a bid for additional supplementary funding to implement a fully fledged grant scheme in the 2006-07 Budget.

Background

9. To strengthen the October 2002 climate change policy package, Ministers agreed policy in August 2004 to encourage SMEs to improve energy efficiency and reduce greenhouse gas emissions.

10. The August 2004 policy required officials to:

  1. Scope requirements for a review of the EECA website to include information that is more specific to SMEs;
  2. Work with energy retailers to provide access for SMEs to energy use appraisals that allow firms to identify opportunities to improve energy efficiency;
  3. Initiate targeted energy audits in nine energy-intensive industries [Wood processing, food processing, paper products, basic metals, non-metallic industries (e.g. ceramics, rubber), glasshouse crops, fishing, irrigated arable crops, irrigated dairying.];
  4. Prepare and disseminate, in conjunction with these industries, guidelines for action specific to these industries to improve energy efficiency;
  5. Identify potential adverse effects on competitiveness of a carbon charge for firms in energy-intensive industries, and to assess alternative measures to mitigate these effects.

Progress on implementing existing climate change policy for SMEs

Review of EECA website

11. EECA has reviewed the websites it administers and has prepared a plan to establish a portal that provides links to related sources of information. Work is due to be completed by 30 June 2005. EECA has agreed to include additional information for firms in energy-intensive industries in the form of best practice guidelines. These will be added to the Emprove section of the EECA website as they become available.

Access for SMEs to energy use appraisals

12. EECA has achieved agreement with three energy retailers (Contact, Meridian, and Mighty River Power) to provide Energy Challenger - a service that allows SMEs to assess their use and management of energy, and provide them with solutions to improve their energy efficiency. This service is offered at no charge to the customer. Contact and Mighty River expect to begin this service in April this year, followed by Meridian in the third quarter.

Targeted energy audits

13. Energy audits and energy use surveys have been completed for firms in the food (meat) processing, wood processing, and dairy industries. Audits and surveys are underway for firms in non-metallic and glasshouse crop industries, and are planned for basic metals and fishing industries during April-May.

Best practice guidelines

14. Best practice guidelines for energy efficiency and conservation will be prepared for each industry following analysis of the audit results. Officials expect that guidelines will be completed for wood processing and meat processing by 30 June 2005. Guidelines for dairy, non-metallic products, glasshouse crops, basic metals and fishing industries will be completed during the period to December 2005. The guidelines will be distributed through business and industry associations, and be available on government websites (including EECA, CCO).

Energy intensive industries

15. Further work was carried out in November-December 2004 through a survey by PricewaterhouseCoopers to identify potential adverse effects on competitiveness of a carbon charge for firms in energy-intensive industries, and to assess measures to mitigate these effects.

16. The survey found nine factors that influence investment to improve energy efficiency (refer Annex 1 for details). The most important influences are corporate values and attitudes toward energy efficiency, return on investment, and the relatively low priority given to energy efficiency compared with compliance and other business issues.

17. The survey also found that awareness of a carbon charge and impacts of this on firms is relatively low, except among firms that have a strong efficiency and conservation focus and for whom exporting is significant. Firms that supply domestic markets were less concerned because they consider they can pass on the additional costs.

18. The survey identified the following areas where government support could encourage greater energy efficiency in SMEs:

  1. Assistance with capital investment to measure and monitor energy use, and for energy saving projects that do not meet normal investment criteria,
  2. Innovation and technology uptake for energy efficiency, alternative production processes, raw materials, and technologies that reduce energy use,
  3. Corporate governance to influence an energy efficiency and conservation culture and focus through better education of Boards and directors about the long term market and competitiveness benefits of environmental policies,
  4. Education for company managers and staff about a carbon charge and energy efficiency.

Additional policy to assist energy-intensive SMEs

Policy to target all businesses

19. Ministers agreed (POL MIN (04) 19/9 refers) that SMEs are defined as all businesses except those that have successfully negotiated a Negotiated Greenhouse Agreement (NGA). Currently, 26 firms have applied for a NGA out of a total of about 300,000 businesses.

20. SMEs fall roughly into two groups - those that use energy intensively and those that do not. The two groups are expected to respond differently to a carbon charge.

21. The majority of SMEs (over 90 percent) are small firms that are not energy-intensive and for whom the effects of a carbon charge will be small. Most will absorb the additional cost or pass it on.

22. A minority of larger firms may be adversely affected by a carbon charge because they spend a significant proportion of their operating costs on energy, cannot easily pass on cost increases, face limited options for improved energy efficiency, and cannot easily fund major capital investment required to take up these options.

Small firms

23. The most effective way for the majority of SMEs to mitigate the impacts of a carbon charge is to improve energy efficiency. Even small firms that are not energy-intensive and are not likely to suffer materially from a carbon charge, will benefit from (and are capable of) improved energy efficiency.

24. Information is readily available from both private and public sources for all businesses to help them improve energy efficiency. Recommended actions include many that are low (or no) cost and easy to implement. For example, the Energy Challenger service, developed by EECA in conjunction with Meridian, Contact, and Mighty River, offers firms an on-line self-help diagnostic service to improve energy management. Firms answer specific questions and receive recommendations for specific actions and referrals to products, suppliers and services.

25. To date, EECA has focused on the top 300 energy users. The major challenge now is to communicate effectively with a much greater number of firms that are often hard to reach.

26. Campaigns are underway to raise awareness about a carbon charge among small firms and to provide further information about energy efficiency. These include the 4 Million Careful Owners campaign funded through the Climate Change Office, and planned Landcare Research workshops about energy efficiency. These workshops support the Communities for Climate Protection NZ programme and are due to be piloted before 30 June 2005. SMEs are part of the audience for these workshops.

27. Existing and planned services available from EECA, and services available from other providers (such as energy suppliers), are expected to meet the information needs of most small firms that want to improve their energy efficiency.

Energy intensive firms

28. Different measures are required to address the challenges faced by energy-intensive firms. Typically, these firms include foundries, chemical manufacturers, tyre makers, wood processors, food processors, metal coaters, fertiliser manufacturers, and glasshouse crops.

29. The impact of a carbon tax and the responses these firms can make to the tax will vary. Some are capable of immediate improvements in energy efficiency that could mitigate the effects of a carbon tax in the short term. Others are already energy efficient and face limited and often expensive alternatives in the short term, for example, switching to alternative fuels (e.g. from coal to gas or biomass).

30. Barriers to energy efficiency in firms have been extensively researched, both in New Zealand and overseas. The barriers are well-known and fall into three categories: economic, behavioural, and organisational [National Framework for Energy Efficiency, Report No.2 'Barriers to Energy Efficiency', Sustainable Energy Authority, Victoria . Australia . 2002.].

31. Economic barriers include hidden costs, such as the time spent gathering and analysing energy efficiency information, and lack of capital. Behavioural barriers include lack of capacity or interest in considering information on energy efficiency, and resistance to change. Organisational barriers include the low priority given to energy in the management hierarchy.

32. The PricewaterhouseCoopers survey confirmed the existence of these barriers among respondent firms. Very little large scale investment in energy efficiency is undertaken solely to reduce energy consumption. Firms require such investments to meet business case requirements, and these often include 12-18 month paybacks. Lack of equity funding and the reluctance of banks to lend against energy efficiency projects (because they find it difficult to evaluate and monitor loan performance) constrain investment. Most firms acknowledge that there are gains to be made by installing up-to-date technology, but large scale investment usually occurs only as part of a planned upgrade

33. Energy is generally seen as a low priority input, and energy efficiency is not a key driver for investment decisions, especially in NZ-owned firms. By contrast, offshore-owned companies are driven by global benchmarks and key performance indicators that include energy efficiency.

34. Other factors identified in the survey that influence investment in energy efficiency were: return on investment, practicality, requirement to deal with 'more urgent' business and compliance issues, and concerns about security of supply.

35. The following measures are designed to overcome the barriers to investment; to mitigate the effects of a carbon charge, and to encourage energy-intensive firms to improve energy efficiency:

  1. Targeted assistance to overcome financial barriers (in the form of a grant scheme),
  2. Support for innovation and technology uptake (in the form of demonstration projects),
  3. Training for company directors to influence a conservation culture and focus in corporate governance,
  4. Education for company managers about a carbon charge and energy efficiency

Financial barriers

36. Officials have investigated measures to overcome barriers to investment in energy efficiency, including direct cash grants, subsidies for equipment purchases, loans provided by government, underwriting of loan funding from private sector sources, and a tax concession (such as accelerated depreciation).

37. Grants are preferred over loans, subsidies, underwriting, and a tax concession. Loans and loan underwriting have been rejected because for typical investments of the type required, the interest components are relatively small and the incentives cannot deliver sufficient value to ensure that investments are made.

38. The use of subsidies tied to installation of approved equipment would involve significant costs to determine which equipment to subsidise. A subsidy would not contribute to the implementation of those opportunities which involve system and design changes rather than simply substitution of more efficient items of equipment.

39. A tax concession in the form of accelerated depreciation for a list of specified items could reduce payback times, and, unlike loans, would not reduce a firm's ability to raise additional debt. However, the cashflow benefit of accelerated depreciation would depend on whether a firm was in profit in the year depreciation was claimed. The energy efficiency benefit of each item to each firm would vary and may be poorly-related to the fiscal cost. The revenue cost would therefore difficult to forecast. Grants can be more easily targeted and are more flexible (for example, based on an energy audit that identified the firm's energy efficiency needs).

40. Inland Revenue is not in favour of using the income tax system to deliver targeted financial assistance, arguing that the Income Tax Act should be as neutral as possible (despite some historical exceptions).

Grant scheme

41. Advantages of a grant scheme include low administrative costs, flexibility, and the ability to deliver sufficient value to ensure implementation of a substantial number of projects. Grants can be highly effective in reducing payback time, and can be used for any qualifying technology or investment.

42. Available funding is sufficient to implement a pilot grant scheme in 2005-06. The pilot scheme will link grants to specific firms and specific technologies to establish demonstration projects. The scheme will be administered by EECA in conjunction with MfE. Officials will work with industry organisations in the energy intensive industries (see footnote 1 above) to identify suitable firms and appropriate technologies, and to publicise the projects and their outcomes.

43. Information from EECA's energy audit database shows that audits carried out to date have identified potential energy savings of 160 GWh at a cost of $10.6 million [The value of resulting savings is estimated to be $7.6 million per annum. Paybacks vary from less than one year to around three years, with the average being 1.4 years.]. The audits cover 152 firms. EECA estimates that up to 500 firms could be classed as energy-intensive and be potential applicants for a grant. A simple calculation scaling up from 150 firms to 450 firms suggests that up to $30 million could be required to make sufficient grant funding available.

WTO issues

44. Grant assistance (and the other types considered in para 36 above) constitute a subsidy under the WTO Agreement on Subsidies and Countervailing Measures and, if implemented, must be notified to the WTO. The granting of such assistance also entails the risk of WTO Members taking dispute settlement action against New Zealand, or imposing countervailing measures against products that benefit from assistance. MfE and EECA will work with MFAT to design a scheme that is acceptable from an international trade perspective.

Innovation and technology uptake

45. New Zealand firms are primarily technology takers. Energy efficiency technologies are widely available, but uptake is low. Potential energy savings are unrealised as a result. Lack of information about energy efficient technologies and their performance in firm-specific situations is a significant constraint.

46. Demonstration projects are a proven way to overcome this. Establishing demonstration projects in energy-intensive industries provides information to enable firms to evaluate technology performance in their operations.

47. The pilot grant scheme will target firms in energy intensive industries and technologies that offer cost-effective energy efficiency improvements, and establish projects to demonstrate these.

48. Some examples where technology demonstrations could help speed adoption of new technologies include: "airless drying" with superheated steam in the meat industry, fluidised bed boilers for burning wood waste to heat timber drying kilns, heat pumps to recover waste heat from milk chillers to heat water for equipment washing, and variable speed drives on milk vacuum pumps.

Corporate governance

49. It is well known that clear direction from top management is a precondition for behaviour change in firms. Energy efficiency and conservation values are less strongly held in New Zealand-owned companies than in offshore-owned companies operating in New Zealand.

50. Training programmes can influence corporate values and attitudes toward a 'conservation culture', particularly where the focus is on educating Boards and directors on the long term benefits of environmental policies and triple bottom line reporting.

51. EECA's Emprove programme includes a campaign to encourage a commitment to energy efficiency at senior management level. There is a gap in dealing with directors at Board level. A previous EECA programme used a memorandum of understanding with top management to establish energy efficiency as a strategic priority. This approach will be revisited.

52. Stronger measures in the longer term could require an environmental statement in annual reports, and require new directors to meet environmental governance criteria.

Education

53. Education is critical to influencing practices to improve energy efficiency. MfE and EECA will work with business and industry associations to provide education and information about energy efficiency; develop programmes with the Energy Management Association to focus firms on energy efficiency; include information about a carbon tax and about energy efficiency in Biz Info programmes administered by NZTE; and work with NZQA to include environment and energy management training and triple bottom line reporting in NZ business courses.

Other measures

54. The proposed changes to policy and processes for Negotiated Greenhouse Agreements (NGAs) are intended to reduce the transaction costs associated with eligibility assessment and negotiating an agreement. A reduction in transaction costs is likely to attract some energy-intensive SMEs to apply for a NGA.

55. If some energy-intensive SMEs are able to successfully complete NGAs under the proposed changes, the number of firms that may be eligible under the assistance measures proposed above will be reduced.

56. The Electricity Commission is developing a series of programmes to improve electricity efficiency, one of which is a pilot programme to encourage investment in high efficiency electric motors. This programme aims to achieve similar objectives to those sought in the climate change programme. Officials from MfE and EECA will continue to liaise with the Commission to ensure the programmes are complementary.

Consultation

57. This paper takes into account comments from Treasury, Inland Revenue, MED, MAF, EECA, NZTE, FRST, MFAT, and Ministry of Tourism.

58. MfE officials have not yet discussed the proposed measures in detail with industry associations in the manufacturing sector and the primary industries sector. In previous discussions, Business New Zealand, Employers and Manufacturers Associations, Chambers of Commerce, Vegetable Growers Federation, Federated Farmers, NZ Business Council for Sustainable Development, Tourism Industry Association, Timber Industry Association, Meat Industry Association, and the Seafood Industry Council have given a clear indication that a critical element in the policy for SMEs is some form of assistance to overcome financial barriers. The most common preferences are for carbon tax revenue to be recycled in a way that provides visible assistance to improve energy efficiency, or for a scheme (such as grants) that has low transaction costs (including compliance).

Financial implications

59. Funding of $200,000 was approved in 2004-05 for work to progress SME policy. This funding is sufficient to complete current commitments to carry out energy audits with energy-intensive industries and develop and disseminate industry specific guidelines on energy efficiency for firms in these industries.

60. The proposed 2005-06 Budget includes an allocation of $5.0 million over three years ($1.667 m per year) to implement the policy measures set out in paragraph 35 above. This level of funding is sufficient to deliver a pilot grant scheme focused on demonstration projects, and programmes for training and education. If the allocation is approved, the pilot grant scheme will be implemented in 2005-06 and is expected to provide information that may be used to support a bid for funding to implement a fully fledged grant scheme in the 2006-07 Budget. The training and education programmes will be implemented in 2006-07 and 2007-08.

Communication

61. Key tasks to communicate the policy measures to SMEs are:

  1. Make available information about the policy measures (including what they are, where to access information about services and assistance, who to contact for further information) through main-stream media as well as targeted business and industry associations and their publications, accountants, government websites (e.g. MfE, EECA, MED), at business and trade educational events such as forums, workshops and seminars, and through local government programmes for business;
  2. Promote the industry-specific guidelines to firms in target industries, primarily through their industry associations;
  3. Integrate information about policy measures and energy efficiency for SMEs into on-going campaigns such as 4 Million Careful Owners and use links with other government policies such as the Growth and Innovation Framework and the National Energy Efficiency and Conversation Strategy to help facilitate the development and uptake of climate change related opportunities.

Recommendation/s

I recommend that the Committee:

  1. Note the progress made in implementing policy measures to encourage SMEs to become more energy efficient;
  2. Note that existing and planned information and advisory services available from EECA and other providers are expected to meet the information needs of many small, non-energy-intensive firms that want to improve their energy efficiency;
  3. Note the results of the survey of energy-intensive firms by PricewaterhouseCoopers, the factors that influence investment in energy efficiency listed in Annex 1, and the implications of these for policy for energy-intensive SMEs;
  4. Note that some energy-intensive firms are likely to be eligible for a Negotiated Greenhouse Agreement under the proposed changes to the NGA policy and process;
  5. Note that the following measures have been identified to assist energy-intensive firms that are not eligible for a NGA to mitigate the effects of a carbon charge and improve energy efficiency:
    d. A grant scheme to provide assistance to overcome financial barriers, targeted at firms in energy-intensive industries;
    e. Demonstration projects to provide support for innovation and technology uptake, targeted at firms in energy-intensive industries;
    f. Training for company directors to influence a conservation culture in corporate governance, through EECA's Energywise programme;
    g. Education for company managers and staff about a carbon charge and energy efficiency, through EECA's Energywise programme.
  6. Note that the proposed 2005-06 Budget includes an allocation ($5.0 m over three years) to implement additional policy measures for energy intensive SMEs, and if approved, this funding will be used to implement a pilot grant scheme and demonstration projects in 2005-06, and then will fund the demonstration projects, training, and education in 2006-07 and 2007-08.
  7. Agree in principle, that MfE and EECA will trial a pilot grant scheme from 1 July to 30 November 2005 that will offer cash grants to approved firms in energy intensive industries and where the grants will be 'tied' to projects that demonstrate the application of technologies that are proven to increase energy efficiency, subject to Cabinet agreement to relevant funding in the 2005/06 Budget, as noted in paragraph 6;
  8. Note that MfE and EECA will work with industry organisations in wood processing, food processing, basic metals, non-metallic industries, glasshouse crops, dairying and fishing to identify suitable sites and appropriate technologies for demonstration projects; and
  9. Note that the results of the pilot scheme may be used to inform a bid for further funding in the 2006-07 Budget to implement a fully fledged grant scheme.

Hon Pete Hodgson
Convenor Ministerial Group on Climate Change

Annex 1: Factors that influence investment in energy efficiency

The survey found nine factors that have a major influence on investment to improve energy efficiency:

  1. Uncertainty about energy supply, especially gas. Several firms commented that gas suppliers are reluctant to enter long term contracts because they claim they cannot guarantee supply. Coal suppliers offering long term contracts and competitive prices are attracting some firms to consider a switch to coal;
  2. Uncertainty about the future path of energy prices. Recent rises in energy prices have created a high level of uncertainty about future prices and hence uncertainty about the impact on production costs;
  3. Corporate values - firms with a culture that emphasises environmental stewardship focus more on conservation than cost control. These firms measure and report energy use, and invest in energy efficiency. Most NZ owned firms focus more on cost control, don't measure or report on energy use, and invest little on energy efficiency.
  4. Criteria for investment - some energy efficiency projects are not undertaken because they fail to meet requirements such as payback period or return on investment. Firms are reluctant to invest in energy efficiency merely to derive conservation gains. Projects must make good business sense. Energy conservation projects often require extensive plant improvement and high capital costs;
  5. Practicality - some options for energy efficiency conflict with production or service requirements. Some examples are: Steelite tips on lumber saws give small power savings but require costly specialist sharpening equipment; turning off hotel swimming pool heating in winter conflicts with service value objectives;
  6. Energy efficiency is a low priority vis-à-vis compliance and other business issues. Some firms cite compliance requirements, labour shortages, and raw materials shortages as a higher priority for management attention and investment;
  7. Efficiency gains are small in relation to total cost of energy. Several firms use large amounts of energy and have already made energy efficiency improvements. Further gains are possible but considered to be small in relation to the total cost of energy;
  8. Energy use is not measured at process level (only at plant level). The cost of measuring energy use at the process level is high, and managers prefer to wait until plant and equipment is replaced when they can choose new equipment fitted with input monitoring capability; and
  9. Lack of awareness and knowledge about a carbon charge. Only three out of thirteen respondents were knowledgeable about the proposed carbon charge. Most had little knowledge about the timing, level, incidence or impacts of the charge, were taking no action to prepare, and treated it as a compliance issue to be dealt with when it came into effect. Several noted the lack of information from Government about the charge.

Last updated: 20 March 2008