Should the mandatory six star energy rating be dumped?

The Fairfax press reported yesterday the Victorian Government is considering a proposal to abolish the mandatory 6 star energy rating for new houses and renovations, and replace it with a voluntary industry code. This morning however, The Age reports the Premier, Ted Baillieu, has done an about-face and ruled out any change.

If the Government really was seriously contemplating removing the mandatory rating, I think Mr Baillieu has made the right decision – it should stay. The improvement in the energy efficiency of new homes over the last ten years has been dramatic. A recent study shows the per capita operating energy required by the average new greenfield dwelling in 2008 was about a third lower than it was in 2000 (see exhibit).

In fact it was lower than it was in 1960, nearly 50 years earlier, notwithstanding the size of the average new greenfield dwelling more than doubled over this period, from 112 m2 to 238 m2. It seems quite plausible the mandatory rating system is a key driver of these improvements.

It’s nevertheless worth looking further at the idea of abolishing the mandatory six star rating because all regulations have costs that policy makers should understand. The idea is probably also indicative of the sorts of changes the new Liberal-National Governments in Qld, NSW and Victoria are likely to examine under their red tape reduction programs. In any event, organisations like the Master Builders Association aren’t likely to forget about this one any time soon.

A key argument in support of abolishing the mandatory rating is that the carbon tax will make the need for regulation redundant – the increase in price will provide the appropriate incentive for those who value energy efficiency. Another is that removing the rating would lower the threshold cost of building a home (The Age cites a figure of around $5,000), thereby improving affordability and enhancing choice.

Were the mandatory rating removed, a price on carbon set at a level that reflects its full social cost would still provide many households with sufficient incentive to invest voluntarily in building their new home to six star standard. After all, saving money on energy bills in the medium and long term is a very attractive proposition for households who can find the extra cash up-front and who can afford to think long term. Business is pretty good at up-selling buyers on optional extras so under this scenario I expect there’d be a fair take-up of ‘six star energy packages’ (although builders would apply an added margin).

Some households, though, would jump at the chance of a reduction of up to $5,000 if it were the difference between getting into home ownership or remaining in the rental sector. Some others might use a $5,000 reduction to get into a location closer to key services where they could save on transport costs and emit lower tailpipe emissions, perhaps achieving much the same financial and environmental outcome as under the mandatory code.

Still others – possibly quite a few – might simply apply the $5,000 to buying a bigger or better house. Thanks to the carbon tax, they’d at least be paying a price reflecting the extra cost they impose on society. Moreover, they’d still have a clear price incentive to manage their consumption with care and to retro-fit energy conserving measures down the track as their financial circumstances improved.

There’s a segment of the market – renters – whose options for responding to price incentives is much more limited. It’s harder for them to have a rental property upgraded for greater thermal efficiency.

But assuming the existence of a price on carbon seems academic. Tony Abbott has promised to roll back the carbon tax if, as seems almost certain, he wins the election due by 30 Nov 2013. Perhaps there’s some chance it will remain in place – removing the compensation package might be harder than Mr Abbott expects – but the odds must be pretty long.

If it’s assumed there’s no price on carbon, the mandatory six star rating can be seen as an alternative, ‘second best’ solution. It makes buyers pay some of the social costs of energy consumption. It’s not as economically efficient as a price on carbon, but it has a similar general effect of reducing consumption and hence emissions.

Households enjoy lower ongoing operating costs, eventually getting the $5,000 back, and more. Humans are rather poor at valuing future benefits so some will undervalue the future savings from a six star rating and, given the choice, would forego it. A mandatory system brings greater economic rationality to the decision – it “saves them from themselves”, albeit at the cost of limiting personal choice.

New home buyers and renovators could argue the mandatory six star system is inequitable. The owners of established houses, which are much more numerous, aren’t obligated to upgrade their houses to a similar standard, even on sale or purchase. However that’s not an argument against the mandatory rating – it’s an argument for extending it.

Given Tony Abbott’s undertaking to roll back the carbon tax, I think Ted Baillieu has made the right call.

Update: Today’s editorial in The Age also canvasses this issue.