The economics of the Green Investment Bank: costs and benefits, rationale and value for money Report prepared for The Department for Business, Innovation & Skills Final report October 2011 The economics of the Green Investment Bank: cost and benefits, rationale and value for money 2 Acknowledgements This report was commissioned by the Department of Business, Innovation and Skills (BIS). Vivid Economics would like to thank BIS staff for their practical support in the review of outputs throughout this project. We would like to thank McKinsey and Deloitte for their valuable assistance in delivering this project from start to finish. In addition, we would like to thank the Department of Energy and Climate Change (DECC), the Department for Environment, Food and Rural Affairs (Defra), the Committee on Climate Change (CCC), the Carbon Trust and Sustainable Development Capital LLP (SDCL), for their valuable support and advice at various stages of the research. We are grateful to the many individuals in the financial sector and the energy, waste, water, transport and environmental industries for sharing their insights with us. The contents of this report reflect the views of the authors and not those of BIS or any other party, and the authors take responsibility for any errors or omissions. An appropriate citation for this report is: Vivid Economics in association with McKinsey & Co, The economics of the Green Investment Bank: costs and benefits, rationale and value for money, report prepared for The Department for Business, Innovation & Skills, October 2011 The economics of the Green Investment Bank: cost and benefits, rationale and value for money 3 Executive Summary The UK Government is committed to achieving the transition to a green economy and delivering long-term sustainable growth. However, this transition requires unprecedented investment over the coming decades, with an estimated investment of up to £200 billion in the energy system alone over the period to 2020 (Ofgem, 2009), and further significant investment in other key green sectors such as transport, waste, water and flood defences. The Government announced the Green Investment Bank (GIB) in the Government’s Coalition Agreement in 2010 and committed in the 2011 Budget to fund the GIB with £3 billion over the period to 2015. The GIB will become a key component of the transition to a green economy, complementing other green policies to help accelerate additional investment. This paper has been developed in the context of work to establish the GIB led by the Department for Business and Skills (BIS). It summarises the results of the workstream on the Economic Rationale for the GIB and draws on work by separate workstreams on product design and the GIB organisation. The paper seeks to address the following questions for establishing the GIB: – Of the sectors selected by government as being of policy importance, which have market failures or areas of capital shortage for the GIB to address? If they do exist, critically, how big are they and are they likely to be permanent or transitory? – Does the GIB as envisioned, with a targeted set of interventions and a £3 billion capitalisation, offer value for money compared to alternative policies? – What is the likely impact on economic growth in the UK? The purpose of the work was to answer these questions, and so inform the establishment of a GIB by providing a robust and objective evidence base, through a set of analyses reported here. Illustrative priority sector assessment and rationale for intervention Fifteen sectors were identified by the GIB project team in conjunction with other government departments for their importance to the green economy and suitability as possible candidates for financial intervention. Broadly, most of the sectors examined share a common attribute that creates a challenge for investment: novelty. For many, it is novelty of technology. They vary in their stages of technology development. In some cases though, they are not novel, namely rolling stock, flood defence, photovoltaics and onshore wind, and in other cases they are, for example, carbon capture and storage, wave power and electric vehicle charging infrastructure. Some on the list are so new that they are not yet ready to be deployed commercially, such as marine energy and carbon capture and storage. For other sectors, the novelty is reflected in the business model or commercial arrangements. One example is the Green Deal, where loans are secured against a receivables contract tied to the meter point, and some contract energy management models within non- domestic energy efficiency, again using finance secured against receivables. At the same time, the UK government is aiming to achieve ambitious targets to decarbonise the economy which means that investment in green sectors needs to be increased more quickly than is likely to happen without government intervention. This speed of adoption is being hampered by a number of sector-related The economics of the Green Investment Bank: cost and benefits, rationale and value for money 4 market failures and constraints in the financial markets. Sector-related market failures include externalities, information asymmetries, market power and complements. On the financial market failure side, issues relate to unfamiliarity with the new types of technology and business model risks related to carbon technologies, as well as companies’ ability to expand their balance sheets. While players would become accustomed to these risks and scale up investment over time, this would happen at a rate that is too slow given the pace of investment now defined by policy. The GIB will therefore need to complement and add to the existing policy framework with tailored and targeted financial interventions that help to address market failures, overcome risk aversion, high transaction costs, and the resulting lack of capital. The GIB can be particularly effective by helping to expand the pool of potential investors, improving economics of marginal projects and sharing information to reduce risk perception of the key sectors. The GIB will need to identify which sectors to focus on. Following a wide, but non-exhaustive, review of different needs across the green economy and a high level assessment of where a GIB intervention would be beneficial, this report highlights in particular three sectors to illustrate the evidence of market failure and the opportunity for GIB intervention, and assess the case for value for money in detail: offshore wind; non- domestic energy efficiency; and, non-Local Authority collected commercial and industrial waste. The sectors were assessed for their potential green impact, the scale of required investment, the potential financing gap and potential market failures and the approach to GIB intervention. The work suggests that there is a case for GIB intervention in all three sectors: Offshore wind has the largest expected investment need of the three sectors, totalling around £50 to £130 billion (nominal) between now and 2020, which will be critical to meet government European renewable energy targets. While multiple large scale offshore wind farms have been built, the industry is pushing the technical frontier moving into deeper waters as a result. Therefore, risks are not yet well understood and only a limited number of players are active in the space. Consequently, the scale up in investment is not happening at the pace required by policy. The GIB could intervene to increase the number of new investors and help finance marginal plants that would not otherwise happen without its intervention. A £1 billion investment in offshore wind could produce an additional 1TWh per annum of renewable energy, which is around one per cent of the renewable electricity target in 2020, and reduce emissions by 0.3 mtCO2 pa over the lifetime of the investment. Non domestic energy efficiency could be applied across many industrial and commercial businesses. Total investment could amount to £16 billion by 2020. Delivering non domestic energy efficiency is not only one of the solutions to reduce carbon emissions in the UK with the lowest costs, it would also help to improve energy security and long term competitiveness of UK industry. While policies have been put in place to deliver non-domestic energy efficiency, multiple market failures including lack of financing in specific areas prevent investment from happening. The GIB could help by mobilising financing for smaller projects by aggregating investment and by helping to finance larger scale project finance. In non-domestic energy efficiency, the estimated benefits are a reduction in energy demand of 3.5 TWh per annum, and carbon emissions savings of 1.1 mtCO2 pa. Non-Local Authority Commercial and industrial waste is a smaller sector in absolute terms, with investment most likely around £1 billion by 2020. While there is no direct target for the commercial and industrial waste sector to meet, the sector can make an important contribution to the The economics of the Green Investment Bank: cost and benefits, rationale and value for money 5 government’s target of reducing landfill, generating renewable heat and reducing carbon emissions. There seem to be fewer market failures in this sector given that a large share of landfill is already diverted. However, it appears that there might be some financing issues related to merchant plants as well as new technologies. The GIB could focus on these areas to increase investment in the sector if and where appropriate. A £1 billion waste market (a roughly 50-50 split between EFW and MRF in most scenarios) intervention might generate 0.4 TWh electricity per annum (from energy from waste plant) and reduce emissions by 2.6 mtCO2pa (mostly from materials recovery facilities). In summary, the GIB can act as a catalyst to expand the pool of investors and capital available to fund the transition to a green economy. Its interventions should help to improve the mobilisation of new investors for both debt and equity, enhance the pricing of risk in financial markets through increased transparency, and provide investment for marginal projects that would otherwise not have happened.