Residential heat demand poses a significant challenge to the United Kingdom’s 2050 target of cutting CO2 emissions by 80%, relative to 1990s levels, partly due to the largely energy inefficient housing41 stock which accounts for around 13% of the national CO2 emissions42 (CCC, 2016c), and the uptake of energy efficient technology remains stunted (DECC, 2012; CCC, 2016c).
This paper explores the decision to connect to the alternative technology embodied in a district heating system, using a survey of residential energy consumers. The empirical analysis leads to the conclusion that high internal rates of return, around 39%, are consistent with the apparent low uptake of energy efficient technologies by homeowners in the UK.
Yet, when controlling for inattention and heuristic decision-making, the importance of high discount rates as an explanatory factor in the decision to adopt energy efficient technology somewhat diminishes. As there is some evidence that suggesting that the energy efficiency paradox dissipates once controlling for behavioural factors, by around 4 percentage points, at least for homeowners.
However, the diagnostic and robustness tests cannot unanimously support this conclusion and instead point towards the potential existence of a ‘mixed economy’ of consumers with behaviour in line with the classical approach, some bounded in their
41 The average Standard Assessment Procedure (SAP) rating (measured on a 100 point scale) for all
homes in England has increased to 59 in 2015, i.e. a low Band D (DECC, 2015a).
42 Comparably, Birmingham’s residents contribute over one-third of the city’s CO
rationality, and some others who employ behaviour in line with simplifying measures of profitability.
In addition, the consumer’s decision to connect to a district-heating scheme is negatively and significantly affected by an increase in the number of years of payback, with the probability of being ‘definitely likely’ to connect reaching a minimum at around 7-8 years. It is worth noting that the length of time (9 years) estimated for firms’ decisions by Anderson and Newell (2002) is greater, potentially reflecting the willingness of firms to install long-term energy efficiency investments compared to residential consumers. One could claim that consumer behaviour is in accordance with simple strategies or heuristics, which produce decisions that perform well when constrained (e.g. mentally or by time) and more sophisticated approaches are unavailable when evaluating the financial implications of an energy efficiency investment.
The results also reveal some concerning aspects of the adoption decision which seem to be consistent with the possibility that the information about the financial profitability of the investment might become ‘valueless’ beyond a certain time horizon (Anderson and Newell, 2002), in which case consumers may use other heuristic or quick-fire tactics to guide their decision to invest in the technology. In this case, after 7-8 years of payback, households appear to become increasingly interested in the technology once more. Therefore, some consumers appear to be either vulnerable to making inefficient decisions when faced with an increasingly unprofitable investment or are inclined to purchase ‘clean’ technologies at any cost. Of course, as pointed out in Section 2.3, a limitation of this paper arises due to the fact that the participants in the survey do not have to commit to making a real
investment, a form of hypothetical bias (see, e.g. Hensher, 2010). For example, the participants may fail to translate their intentions (underpinning their hypothetical decision to connect to district heating) into action (Kollmuss and Agyeman, 2002). Although this bias is alleviated in part by asking the participants to indicate their strength of interest in participating in a district heating system, rather than treating the outcome as simply dichotomous, the findings could be viewed as too optimistic. Also, the experimental scenario assumes that the private and governmental investors must meet the infrastructural expenditure necessary to connect households to a district heating system, while providing an efficient and competitive service. Future research whereby these assumptions are relaxed would be useful in uncovering whether, on the one hand, the average discount rate of 39% represents a ‘best case’ scenario.
On the other hand, the discount rate might be lower than estimated in this paper (as in Allcott and Wozny’s (2014) study of automobiles in the US). However, the purpose of this study, was not to explain away the whole discount rate, but instead to show that the discount rate is indeed explained empirically in part by inattention and heuristic decision making, as highlighted above.
To conclude, this paper indicates that the classic perspective (i.e. calculating the discount rate) and the behavioural perspective (i.e. the inclusion of the measures of inattention and heuristic decision-making) both contribute to explaining the apparent reluctant uptake of energy efficient technologies by domestic consumers. Therefore, policy may need to be shaped to cope with, for example, the various levels of consumer attention that exist in the energy market and the appropriate measures of contacting or supporting inattentive consumers to implement energy efficient technologies, particularly those with a low-income.
Hence, if grants or subsidies aimed at reducing the upfront cost, such as the Energy Company Obligation, and building standards continue to be preferred policy despite economists arguing in favour of the use of (Pigouvian) taxes, then information provision to consumers may need to be revised. This could be achieved, for example, by introducing new search technologies (similar to price comparison websites) that can be used to calculate payback periods and lifetime costs at the point of purchase for energy efficient technologies, thereby both decreasing the cost of attention as well as tapping into the heuristic methods that appeal to residential consumers.
An interesting avenue of future research would be to identify if such tools can assist consumers when comparing the profitability of alternative energy efficient technologies – for example contained in a simple app or website. There is potential to embed this idea in an online experiment and investigate whether the aggregate (implied discount rate) significantly deviates from the findings presented in this paper when a consumer is asked to decide among technologies with or without access to a financial app or calculator. In addition, an online application of the experiment presented in this paper would also allow one to extend the experiment to a dynamic repeated choice framework and investigate the impact of changes in taste and/or learning effects, which have previously been identified as important determinants of diffusion (Stoneman and Battisti, 2000) but also relevant for decision-making processes. If such research proves fruitful, then rolling out trials of price (and profitability) comparison apps/websites for energy efficient technologies would be a natural extension that would allow the exploration of how interactive methods of choice optimisation can impact decision-making and welfare in an economy containing individuals with varying degrees of cognitive constraints.
Chapter 3
Tenants beware: split-incentives in England’s
privately rented housing market
3 Introduction
Several Government led schemes, including the Energy Company Obligation (ECO) and Green Deal (GD), have endeavoured since 2013 to spur the uptake of energy efficient technologies in the domestic housing sector by reducing or eliminating upfront installation costs. However, both schemes have inspired a limited degree of consumer engagement, with less than 1% of households in Great Britain using available funding for energy efficient improvements by 2015 (DECC, 2015b).
Moreover, the vast majority of GD43 and ECO recipients are homeowners, 95% and
80%, respectively, with the remainder of financing delivered to private and social rented sectors (DECC, 2014a). Thus, the allocation of funding is greatly unbalanced, even though the GD was in part crafted to induce landlords to invest in energy efficiency at zero upfront cost (adhering to the GD ‘golden rule’ which states that the technology can be installed, if and only if, the expected energy savings are greater than the monthly capital repayments).
The GD however was scrapped in 2015 and as a result a more pressing issue is emerging as the scheme was the bedrock for future efficiency standards in the private sector, specifically all privately rented properties are to achieve an Energy Performance Certificate (EPC) rating of E or above by 2023 (CCC, 2016c). In essence, the GD was in place to target the so-called energy efficiency paradox by de-risking home improvements for landlords (and other consumers), offering energy efficient installations at zero upfront cost in accordance with the ‘Golden Rule’. Now there is a significant policy gap. Not least because the standards include a clause which advises
landlords letting properties with an EPC rating below E to make all necessary energy efficiency improvements that satisfy the Golden Rule, in order to achieve said rating by 2023 using Green Deal financing (RLA, 2016). Thus, the regulation is no longer binding (CCC, 2016c: 69).
This paper explores whether the private rental sector has significantly fallen behind in terms of energy efficiency (and its concomitant housing conditions) as compared with other sectors of the English housing market, using a principal-agent framework. It further adds to the literature on problems of agency in the private housing market (see, e.g., Levinson and Niemann, 2004; Davis, 2010; Gillingham, Harding and Rapson, 2012) by investigating whether the subjective assessment of households living in privately rented housing concurs with the objective analysis. In doing so, this paper intends to establish whether the landlords are sufficiently incentivised to install energy efficient technologies on behalf of their tenants. If this is not the case, one begs the question – given the void created by the repeal of the GD – is it not time for mandatory standards stipulating landlords to meet future EPC standards with or without a replacement scheme? To shed light on the potential effects of this proposal, this paper provides some insights into the behaviour of landlords by investigating the potential premia charged following the inception of mandatory EPCs.
Since October 1st 2008, owners of properties have been required by law to obtain and provide an EPC prior to letting (selling) a property to a prospective tenant (buyer). Similar to the eco-labels displayed on domestic appliances, an EPC informs consumers of the energy costs and associated CO2 emissions for a specific building. Impending legislation enables tenants to request energy efficiency improvements whilst preventing landlords from refusing within reason, exerting greater
responsibility upon the tenant. Little is known however about how landlords in the private sector responded to the introduction of mandatory EPC laws in the UK. Energy efficiency is one of the key solutions to what the UK Government calls the ‘energy trilemma’, that is achieving environmental and sustainability goals, while ensuring energy is affordable and ensuring security of supply (DECC, 2014b). The domestic sector’s energy intensity (the energy efficiency of the UK i.e. energy units per unit of GDP) has fallen over the last decade, though primarily attributed to a rise in energy prices, warmer weather conditions and the uptake of energy efficient technologies (DECC, 2015c). Despite these developments, efficiency technologies uptake has stalled in recent years (CCC, 2016b) casting doubt over the UK’s ability to achieve its environmental and social goals (CCC, 2015).
The UK Government must also protect low-income and vulnerable consumers. Affordability of energy and energy efficiency is vital particularly at a time when working age wages in the UK are stagnating and even falling for young workers since the financial crisis (Kahn, M., 2016). All the while, energy bills have increased continuing a process starting in 2002 (ONS, 2016), potentially further eroding household earnings. This leaves households who are unable to invest in energy efficiency at greater risk of fuel poverty. This paper compares the privately rented sector with the owner-occupied and social sector, as the decision to install energy efficient technology is most likely to be in the hands of another agent (i.e. the landlord) weakening the agency of the tenant. Together with high rental prices reported to be increasing the risk of in-work poverty (Peachey, 2016), it is unsurprising that fuel poverty is rife in the private sector, indeed it is the only sector in which the proportion of households in fuel poverty has remained over 20% since 2003 (DECC, 2016b).
This paper’s analysis utilises the English Housing Survey (EHS), a nationally representative repeated cross section of households. The EHS is formed of two blocks, the household survey and the housing stock survey. Since the analysis draws upon information contained in both surveys, the baseline number of households is used, equivalent to around 14,000 observations per fiscal year and weighted to preserve national representativeness.
The findings indicate that split incentives are present in the privately rented market according to both objective and subjective perspectives, compared to owner-occupied properties and housing let by friends, relatives and individual employers. In contrast, the paper finds the comparison with social housing to be more complex. In the accompanying analysis, the results suggest an energy efficiency ‘price premium’ (of around 5 - 6%) exists across the whole rental market for properties rated A-C (compared to D or below), provided that the landlord disclosed the EPC information to the tenant. In addition, the analysis suggests that some landlords may earn price premia using ‘cheap talk’ by 1) exploiting a lack of consumer attention, and 2) by concealing the EPC information for inefficient properties in the social sector. Potential policy implications arising from these findings are discussed, highlighting the possible effects of a mandatory energy efficiency scheme in the private rental sector.
The remainder of this paper is organised as follows. In the next section, the theory surrounding informational asymmetries in the context of the rented property market as well as other relevant research is reviewed. Section 3.2 outlines the data followed by the empirical strategy in Section 3.3. In Section 3.4 the results of the analysis is presented, before providing concluding remarks in Section 3.5.