23 March 2010 – Property owners who fail to comply with the mandatory disclosure legislation now before Parliament will face fines of up to $100,000 through a National Administrative Unit, if the bill goes through in its current form.

As foreshadowed in our article published yesterday, the proposed legislation includes stiff fines for non compliance.

The scheme will require a NABERS energy rating, a tenancy  lighting report and energy efficiency guidance for buildings.

The regulatory impact statement (RIS), now publicly available, outlined the three key scenarios considered under the proposal – including mandatory minimum energy efficiency – and the reasons for the preferred option.

The explanatory memorandum of the RIS is a thorough and extensive analysis of the Australian commercial property market and its energy efficiency framework. It bears close reading.

Following are key highlights. The full set of documents is available here

The scheme is to be implemented under Commonwealth legislation based on the corporations power of the Australian Constitution to ensure coverage of at least all constitutional corporations and the consistent application of the scheme across the States and Territories.

It will apply when:

  • a whole building with more than the 2000 square metres threshold of net lettable area is sold
  • a whole building with an NLA above the threshold is leased or subleased; and
  • when a part of a building with an NLA above the threshold is leased or subleased.

The requirements will be for

  • a NABERS Energy base building rating
  • tenant lighting details
  • energy efficiency guidance for buildings

The proposed regulations will not  apply to new buildings unless they have been occupied for at least 12 months, in order to allow for the 12 months of energy data required for  a NABERS energy rating.

Short-term leases of less than 12 months will be exempted from the scheme.

Office buildings that have been substantially refurbished in the previous 12 months will need to have a  star rating to be modelled in accordance with the NABERS energy simulation protocol.

Cost of assessments
Accredited assessors conduct NABERS Energy assessments. Once accredited, assessors are able to set their own prices for assessments. For this impact analysis, the cost of assessments was estimated using the median of 48 quotes for assessments received by NSW DECC (who manage NABERS Energy).

The costs of a full base-building plus tenancy light and power assessment for properties greater than 2000 sq m is estimated to cost the property owner $5919. This is the cost for:

  • a NABERS Energy base building assessment ($3100)
  • a tenancy lighting assessment and advisory report ($1500)
  • registration fee ($905)
  • eight hours spent preparing information for the assessor ($414).

Under a mandatory scheme, it has been assumed that there will be an initial cost increase for assessments (20 per cent above the current average price for assessments). This growth in costs will result from an increase in demand for assessments without an increase in assessors.

It has been further assumed that over the first five years of the program the number of assessors will grow to meet demand and the cost of assessments (in real terms) will return to historical levels. The potential impact of an increase in assessment costs is also included in sensitivity analysis at the end of this chapter.

The National Administrative Unit
The National Administrative Unit will oversee delivery of the scheme and will reside within the Department of the Environment, Water, Heritage and the Arts.

It will have overall responsibility for training, accreditation, auditing and quality control under the scheme. The NAU may engage other government agencies, including New South Wales Department of Environment and Climate Change, to perform some of these functions.

It is proposed that the legislation/regulations would provide the discretion for the NAU to convene advisory committees, as it deemed necessary and appropriate including an advisory committee and a technical committee..

Funding
Funding of $5.3 million over four years was committed by the Government in the 2009-10 Mandatory disclosure of commercial building energy efficiency was proposed in December 2004 under the Stage One implementation plan of the National Framework for Energy Efficiency (NFEE) — a joint initiative of the Commonwealth, State and Territory Governments under the Ministerial Council on Energy (MCE).

Costs of scheme
The impact analysis of options found that this scheme would cost $18.7 million over 10 years (NPV). These costs include costs to building owners of purchasing energy efficiency information and costs to government of administering the scheme. The costs also include time costs for building owners in providing information for assessments on their property.

Benefits
Benefits (through energy savings) in the range of $13.5 million to $54 million.

These incremental improvements can be achieved through low cost opportunities such as improved management, maintenance or behavioural change on the part of occupants. A key factor in this analysis is that as these improvements are voluntary — they should only occur where owners consider the improvement are cost effective for their property (that is, specific improvements are not mandated).

Complementary
An information-based scheme such as mandatory disclosure can complement pricebased policy tools where information works to address market failures. Where information asymmetries exist, price signals in the market (such as new taxes or subsidies) can have limited effectiveness.

Where higher prices are used to provide an incentive to change behaviour, information asymmetries can block this incentive if they do not allow consumers to act on the price signal. Research commissioned by the Australian Sustainable Built Environment Council supports this conclusion, indicating that energy efficiency improvements in the building sector will support the CPRS, and lower the cost of the scheme because investments in energy efficiency will lower the cost of permits in the scheme (due to lower demand) (ASBEC 2008).

On this basis, mandatory disclosure can complement the Carbon Pollution Reduction Scheme. Analysis in this RIS suggests that a carbon price is unlikely to place significant cost pressures in the commercial office building sector within the next 10 years, if the Carbon Pollution Reduction Scheme commences with a low to moderate carbon price trajectory

Extent of the problem
The size of the commercial office property market in Australia is not known exactly, however, there are good data on the number of buildings and the floor space of commercial office buildings in the major builtup areas in and around the capital cities.
Currently, there are:

  • over 21 million square metres of commercial office property in major Australian business centres
  • spread across 3980 buildings (Property Council of Australia 2008)
  • Of this, around 19 million sq m are accounted for by 2170 buildings with NLA of greater than 2000 sq m,
  • Just over 16 million square metres are accounted for by 1174 buildings with NLA of greater than 5000 sq m (Property Council of Australia 2008).

The commercial building sector (of which office buildings are one component) has experienced sustained growth in energy use in the 15 years to 2006 (87 per cent growth between 1990-91 and 2005-06), a trend likely driven by strong economic conditions, expanded working hours in the services sector and greater use of energy-intense equipment, such as computers, and fixtures, such as air-conditioning and feature lighting.

This growth in energy use does not necessarily correlate with lower energy efficiency performance — energy efficiency is a measure of the ratio of inputs to outputs, therefore efficiency can improve while use increases. Growth in energy use does indicate, however, that efficiency is more important for that sector, as the potential gains from higher efficiency are increased at higher rates of energy use.

Understanding the potential problem in relation to energy efficiency requires an assessment of current performance. The actual energy efficiency performance of the commercial office building stock may be determined by assessing current building energy efficiency ratings, as well as identifying where there are minimum standards for performance (such as through building regulation).

Impediments
The RIS found a number of factors in the market for commercial office space in Australia that impede the take-up of economically feasible energy efficiency improvements:

  • there are information asymmetries between building owners and prospective tenants or buyers, where tenants and buyers are placed at a disadvantage in understanding the energy efficiency performance of premises on the market;
  • split incentives occur in the market, where those in the best position to effect change have little or no incentive to do so; and
  • organisational failures exist, where there are information asymmetries and split incentives within firms which mean that low or no cost opportunities are not taken-up.

Existing measures do not currently address these problems. The Carbon Pollution Reduction Scheme will assist in reflecting environmental costs of energy use, but will not necessarily address information failures and split incentives in the market. This RIS therefore focuses on potential options that will address these barriers.

Barriers
A number of these barriers can be characterised as organisational barriers — problems within the decision making process or management arrangements within firms, which limit the firm’s capacity to make sound judgements on the financial benefits of energy efficiency improvements.

Research by the Warren Centre sought information from firms on a range of organisational characteristics, and tested these against energy efficiency performance. The study found the following important relationship between management and organisational factors and energy efficiency:

  • Buildings perform better where all members of the building management chain feel they can influence building energy efficiency.
  • Buildings perform better when the manager reports a higher level of energy efficiency knowledge.
  • Buildings perform better when there is an energy efficiency training program in place.
  • Sites where managers were conservative about the implementation of efficiency measures tended to perform poorer than sites where managers were prepared to accept some risk in efficiency outcomes.
  • Managers who considered that they had a greater level of energy efficiency skills were generally found to operate buildings more efficiently. (Warren Centre 2009)

Measurement
Unfortunately, in Australia, while the proportion of rated stock is growing each year, a majority of buildings are currently not rated for energy efficiency. Those that are rated, are predominantly large and higher grade quality buildings (that is, Premium, A or B grade buildings). Even in the large end of the market, a majority of buildings have not yet been rated for the energy efficiency:

  • for properties between 2000sq m and 5000sq m in size, only 13 per cent of properties have had a NABERS assessment.
  • in the over 5000sq m category, it is estimated that up to 70 per cent of properties have not had at least one NABERS assessment in the period from 1999 to 2007.

Measurement can lead to improvement
Buildings rated between 2004 and 2008 found average rating of 2.8 stars (without adjustments for green power) for a first assessment, and 3 stars for a second assessment.

Industry best practice is currently defined as a rating of 3 stars under NABERS Energy. This was determined in 1999 when the scheme was established. However, a more recent survey of ratings indicates that a performance of 4 to 4.5 NABERS stars is a more accurate indication of best practice.

It is reasonable to estimate that industry (on average) is lagging at least one to one and a half stars behind current best practice – this equates to a 20 to 30 per cent lag in energy efficiency between the an average building and industry best practice.

Energy efficiency gap
The Productivity Commission defines the energy efficiency gap as ‘the gap between actual energy efficiency and the level of energy efficiency believed to be achievable and affordable’. (PC 2006, p.xxvi).
It is estimated that current technologies can produce energy savings of 60 to 70 per cent (NFEE 2003). However, not all current technologies are currently economically feasible.

Energy efficiency technologies in the built environment commonly include efficient heating, ventilation and air conditioning (HVAC), motor systems, efficient lighting systems and (for new buildings) insulation. Industry estimates put the economically feasible abatement potential in the building industry at 30-35 per cent (Centre for International Economics 2008).

McKinsey & Company
McKinsey & Company identified that the building sector has the lowest average cost of abatement — the sector could reduce 60Mt of CO2e per annum by 2030 at a negative cost of $130 per tonne.

The fact that investments in these improvements are not being made by all businesses suggests barriers to investment in energy efficiency improvement. As the McKinsey study notes:

  • Most of these positive- return (or ‘negative-cost’) opportunities are energy-efficiency measures related to improvements in buildings and appliances.
  • Many can be categorised as market failures arising from misaligned incentives, for example, those between builders and tenants, where it benefits the tenant but not the builder to install insulation or energy-efficient lighting. (McKinsey & Company 2008, p.6)

Consultations for this RIS heard views that there are potentially considerable energy savings available immediately through improved maintenance of building systems (such as HVAC, hot water boilers) with no additional costs or requirements for capital investment. In this context, facility management practices and maintenance programs were considered to play a critical role in the delivery of ‘quick wins’ as well as contributing to ongoing energy efficiency and cost savings.

If this is the case, then the Australian economy has an opportunity to reduce energy usage and greenhouse gas emissions in an economically efficient manner, by taking advantage of these ‘no regrets’ opportunities.

Cost to others
In light of Australia’s commitment to reducing greenhouse gas emissions, a failure to exploit these ‘no regrets’ opportunities would mean the cost of abatement would shift onto other activities — most likely at higher cost.

This naturally raises the question of why, if these opportunities are both technically and economically feasible, industry is not already adopting these initiatives?

CPRS impact
In practice the impact of the CPRS on the commercial office building sector is likely to be minimal. This is due to the following three factors.

It is quite feasible that the carbon price will remain within a range of $10-$40 per tonne CO2e out to 2018, with the Australian government signalling a preference for an ‘easing-in’ period for obligations under the CPRS and a low start carbon price during the Kyoto period. The recent announcement of a revised start date of July 2011 and a fixed price of $10 per tonne CO2e for the first year confirms this outlook.

And uncertainty associated with the passage of the legislation continues to undermine planning around a future carbon price regime and its level.

At these carbon price levels, the impact on energy expenditure for commercial office buildings will only be in the order of an additional $3/sq m in energy costs by 2018 (i.e. at $40 per tonne CO2e).

Energy costs only account for around 3-5 per cent of total occupancy costs in the commercial office building sector, making a small increase in these costs relatively insignificant for owners and tenants.

The price impact from CPRS is likely to be small, however, this RIS has factored in a small growth in assessment activity on the basis of a carbon price. It depicts a 1.4 per cent total growth in assessments from 2011 to 2019.

Options rejected
Two sub options were considered and no supported by the economic analysis:

  • Option 1(b): tenants of properties over 2000sq m be required to conduct annual NABERS Energy tenancy assessments; and
  • Option 1(c): owners of new buildings be required to disclose an energy efficiency rating through using a NABERS Energy simulation protocol (similar to the modelling requirements  of a NABERS Energy Commitment Agreement).

Option 2 for an industry code of practice and Option 3 for mandatory minimum energy efficiency standards were also not supported.

Analysis of Option 3 is of interest.
Minimum energy efficiency standards have a direct, quantifiable benefit — savings from energy expenditure attributable to a more efficient use of energy.

Under the option, building owners (and potentially also tenants) will benefit from the energy cost savings achieved through the operation of a better performing building.

These benefits will accrue to building owners who own a building which is under the threshold point of 3 NABERS Energy stars and is required to be upgraded (i.e. for those owners with buildings already meeting the threshold, there is no change).

The estimates of benefit are taken on the basis of a 1 star improvement in the building stock, based on estimates of the average building stock performance, though in practice some buildings will not require any upgrades, while others will require more than a 1 star improvement.

Benefits to owners and tenants are estimated using the $3/sq m saving estimate for upgrading by 1 star (as used in previous estimates for benefits for Options 1 and 2). This  $3/sq m saving estimate is based on energy savings alone and represents a conservative approach to estimating the benefits of upgrading by one star.

It is highly probable that during the course of the ten-year period over which the costs and benefits are modelled, energy prices will increase as a result of increased demand and the introduction of the CPRS.

However, given the uncertainty over when and by how much the cost of energy will increase, no increase in energy costs have been assumed in this analysis. This price also does not include the other benefits associated with investing in a more energy efficient office environment such as: avoided pollution, improvements in staff morale and health and green marketing benefits.

Over the 10 year period following the investment in the upgrade, benefits are estimated to be:

  • $360 million for the 2000 sq m or larger group
  • $300 million for the 5000 sq m or larger group.
  • As noted in Section 4.2 above, the costs of this measure are estimated to be:
  • $694 million for the 2000 sq m or larger group
  • $577 million for the 5000 sq m or larger group.
  • Hence, requiring mandatory minimum energy efficiency standards comes at a net cost of:
  • $334 million for the 2000 sq m or larger group
  • $277 million for the 5000 sq m or larger group.

These estimates are based on the aggregate estimate that a 1 star improvement will cost between $61/sq m and $35/sq m to implement. It is important to note that these estimates are based on a 10 year horizon, to be comparable with the other options in this RIS. In practice, benefits of improvements will likely continue to accrue beyond this period (though this will depend on the type of upgrades conducted, and the economic life of assets purchased).
The assessment of this option shows the net costs associated with a relatively blunt approach to mandatory minimum energy efficiency improvement. The costs of the scheme are high because the average costs factors in the potential that some building owners may be required to invest in energy efficiency improvements through moderate or high cost upgrades.

It is reasonable to assume that, faced with a requirement to upgrade, owners will seek the lowest cost option for them. For some owners, these options will be incurred at a lower cost than that estimated for this option, but for others the costs will be higher (as discussed in the previous discussion on costs of this option).

This means that, for some building owners, investing in upgrades will result in a direct net benefit through energy savings, because they are able to implement lower cost upgrades. For others, however, there will be a net cost (as they do not have a flexibility in this option to not invest in upgrades at a higher cost).

There are potentially other forms of a mandatory investment approach that would incur lower costs than this Option. For instance, an alternative approach would be to require mandatory investment where the pay-back period is below a defined threshold. This type of approach, linked to energy audit procedures, takes the economics and pay-offs of particular options into account. It recognises a menu of energy improvement options available in particular locations and specifically targets those offering the greatest economic pay-off (that is the “low hanging fruit”).

Consultation
Overall the consultations found broad support expressed for the proposal for mandatory disclosure, though there were some specific aspect of the proposed scheme which stakeholders had some concerns about.

As a result of this process a number of changes have been made to the scheme that was originally proposed in the Consultation Regulation Document.  The two most significant changes are described below.

The Consultation Regulation Document proposed that NABERS Energy tenancy ratings be disclosed at the point of sale and lease in addition to NABERS Energy base building ratings.  It also proposed the disclosure of separate energy efficiency assessment reports, which would be valid for seven years.

The following concerns were raised with respect to these two requirements:

  • NABERS Energy tenancy ratings are generally a measure of tenant behaviour rather than the energy efficiency of the tenancy itself.
  • There are significant legal, practical and technical barriers to obtaining the necessary energy use information from tenants in a timely manner prior to a sale or lease transaction.
  • The configuration and area of tenancies can vary substantially from one tenant to the next.
  • Tenancy energy efficiency is largely beyond the control of building owners, hence the disclosure of NABERS Energy tenancy ratings should be the responsibility of the tenant.
  • Metering limitations could prevent building owners from obtaining tenancy ratings for older office buildings.
  • Concern was raised about the usefulness of the information to be provided in energy efficiency assessment reports, the additional burden they created and whether the seven-year validity period is too long.
  • Energy efficiency assessment reports should be more comprehensive if they are to be useful to potential purchasers and lessees.
  • Specific expertise is required to produce accurate energy efficiency assessment reports and there is a general skills shortage in this area.

The most important way in which stakeholder comments have been reflected in this Decision RIS is through changes to the options for mandatory disclosure (Option 1 and sub-options).

In response to concerns listed above, the following refinements were made to Option 1 (Mandatory disclosure):

  • the requirement for full tenancy assessments was removed from Option 1 (all sub-options) and replaced with a requirement for disclosure of tenancy lighting power density and lighting control details because tenancy lighting commonly transfers to the incoming tenants.
  • the sub-option for mandatory disclosure with separate energy efficiency assessment reports (which was tested as Option 1(d) in the Consultation RIS) was removed. Option 1 (a) was adjusted to require guidance on potential energy efficiency improvements to be assessed concurrently and disclosed as part of BEECs. This will streamline the assessment process and ensure that the guidance provided is meaningful and up-to-date. BEECs will remain valid for 12 months, which means that the energy efficiency guidance will need to be updated on a more regular basis than was proposed for the separate energy efficiency assessment reports.

As a result of these changes, the number of sub-options assessed under Option 1 reduced from four to three.
The impact analysis in this RIS was revised to reflect stakeholder comments on the estimates for the cost of assessment, and changes to the composition of the options that impacted on the cost of assessment.

Stakeholder comments received included some concern that the estimates did not properly reflect the cost of very large buildings, and that there should be a greater reflection of the potential impact of assessment costs as a result of constrained supply of accredited assessors.

The estimates in the Consultation RIS already reflected an increase in assessment costs in the first five years of the scheme (highest in year 1, reducing to year 5).

The costs used in this Decision RIS are higher than those in the Consultation RIS, reflecting:

  • the new options including energy efficiency advice to be provided with all NABERS Energy assessments — estimates for these costs were provided by a sample of assessors, as advised by DEWHA
  • Revised registration fees estimates, as advised by NSW DECC
  • Advice from stakeholders on the potential cost for assessment of larger buildings.

Assessment costs there increased from $3129 (2000sq m) and $3392 (5000sq m) in the Consultation RIS to $5919 (2000sq m) and $6219 (5000sq m) in the Decision RIS.