∫ Energy Efficiency Finance

What a boring title. Those pendulous words, however, describe one of today’s most exciting and far-encompassing opportunities to help the environment while saving individuals and companies money.

Much time is spent talking about solar project finance. Not least of all by us: here, here, and here. There are a number of reasons for this: solar projects involve large dollar amounts, they are more commonly financed than efficiency projects, and they are highly visible. They are, however, generally less profitable investments than energy efficiency projects. Which leads to a reasonable question: why don’t more people implement energy efficiency projects?

Reasonable, but mysterious. This question has caused a lot of headache and heartache for energy developers, financiers, contractors, and policy makers for decades. And for good reason. If you were guaranteed a 60% return on your money, you would take it. Unless, apparently, it were an energy efficiency project. It happens all the time. Last week, Carbon Lighthouse identified an equipment controls opportunity that provided a property owner a 141% internal rate of return. The project paid for itself in six months. We guaranteed the savings. The office building owner remains undecided. Our team isn’t surprised. Why not?

Energy Efficiency Projects

Let’s back up for a moment to consider what exactly is an energy efficiency project. There is all kinds of equipment in buildings, and the lights over your head and your desktop computer and monitor (hopefully an energy efficient flat screen) are just the beginning. Rooftop heat pumps suck up electricity to compress refrigerant fluid. Supply fans blast air through ducts and into rooms. Return fans suck stale air back out to the roof. Giant pumps thrust chilled and hot water through loops inside the building’s skeleton. Induction motors power chillers and elevator banks. Natural gas combusts inside small locomotives of boilers. It’s busy.

All this equipment not only obsolesces, but also stops working as designed, is not properly maintained, and is often running when no one needs it. You can replace the old motors and lights with more efficient ones. You can control fans and chillers and waste much less energy by putting VFDs on them. You can adjust heat pumps so that they turn off automatically when people don’t need them so that, for example, they don’t consume energy at 4 am on a Sunday when the building is locked. To implement an energy efficiency project means to identify these opportunities and put in new lights, motors, pumps, fans, controls, and drives and save people a whole lot of energy, carbon, and money.

EE Financing

The paybacks on such energy efficiency projects can be very high, but the initial capital cost is sometimes too much for a property owner. For example, if a school can implement a $50,000 lighting project that saves $20,000 annually for seven years, it should; but it might not have $50,000 available.

This is where energy efficiency financing becomes so critical. The school does not have to pay anything up front; it can simply split the savings for five years with a financier who will pay for the project. The school receives less savings than it would if it had paid for the project itself, but doesn’t need to front the capital. After five years, the school enjoys the full savings of the project. Because energy efficiency projects are so profitable, they are an easy way for both school and financier to make or save money while benefitting the environment.

It’s not a new idea. In 1985, the US government authorized the first Shared Energy Savings (SES) agreements. These contracts were ultimately enshrined as Energy Savings Performance Contracts (ESPC), energy efficiency project financing mechanisms used throughout  the federal government. Energy efficiency expert John Frenkil has an excellent piece on their history. But while ESPCs in federal contracts are a promising mechanism and have provided proven savings, as of 2008 only 500 projects had been implemented. There are 5 million commercial buildings in the United States. There’s a bit of room to grow and accelerate.

So why isn’t energy efficiency finance a bigger industry? What are some of the chief obstacles?

Let’s Count the Ways

  • Agency problems between corporate managers and facilities engineers have resulted in underinvestment. Many corporations do not view infrastructure upgrades as investments, and facilities engineers with set annual budgets do not receive economic returns from efficiency projects. Any project that takes longer than 12 months to pay for itself is not implemented. (We’ve been delighted to note that several property management firms we’ve met with of late now provide their facilities chiefs with 36 month budgets).
  • Interest Rate mindset. Energy efficiency savings sharing agreements (like solar power purchase agreements) provide financing so the purchaser saves money without having to pay anything up front. It would be a more profitable investment for the facility if it put forward its own capital, and this unsettles CFOs. They know their organization can borrow money at say, 7% interest, and instead of thinking about the project as an energy savings agreement, they take the stream of payments they’re making to the financier and try to back out an effective interest rate. While rational, this misses the opportunity for what it is: a chance to save money without spending any. The problem is that too often the organization looks into borrowing more money, decides it doesn’t want to take on more debt, but also decides it doesn’t want anybody else’s money either and shelves the energy savings agreement and leaves the efficiency opportunity to languish. This makes the environment cry and cry. Just look at poor Niagara falls. Won’t stop weeping.
  • Energy is cheap compared to rent. Even now, if office space in Manhattan costs $50/sq ft, utilities only cost $6/sq ft. To commercial real estate owners, lowering energy expenses only merits so much attention when compared with retrofitting a lobby or finding other ways to improve property values.
  • Are the savings real? Measurement and verification has much improved over the past few decades. Data logging methods and equipment now produce reliable analyses of energy consumption. Those who conduct energy studies, as we do, have a bevy of mechanical and statistical tools at their disposal. Temperature, humidity, occupancy rate, and operating hours can all be accounted for when baselining energy usage over many months and compared year to year. The Department of Energy’s eQuest program is an impressive piece of software, and the scope of the DOE’s guidelines on implementing M&V for energy savings contracts reveals how far energy savings measurement has come. As a result, a quality energy study can determine with very high accuracy the savings created, enough for energy service companies to guarantee them. But few property managers understand this, nor are they used to structuring contracts around energy savings.
  • Financing risk: If an energy efficiency financier is only funding a handful of projects there is credit risk that a single default could imperil the investments. In theory, financing hundreds of short-term efficiency projects should obviate some risk. Lax mortgage underwriting practices of course, recently showed some of the limits to the power of bundling, as you may recall, and the larger financing entities are still trying to wrap their heads around how to provide financing for energy efficiency.
  • Secured collateral concerns: If a property owner goes bankrupt and can no longer meet its energy savings payments, the collateral, half-used lamps and ballasts, have minimal resale value. So too, with a variable speed drive. Even in the best market conditions, half-used energy efficiency equipment will not command half the initial sale price. If a customer is delinquent but not bankrupt, however, the threat of removing or remotely disabling the equipment can be an effective lever.
  • Collapse of PACE: PACE (Property Assessed Clean Energy) financing is a recent mechanism through which special, local bonds are issued for purposes of investment in (principally) residential energy efficiency and solar projects. PACE could have quickly deployed far-reaching efficiency project investments. Due to concerns about municipalities taking a lien senior to that of mortgage lenders, however, the Federal Housing Finance Agency asked local governments to reconsider. Interestingly, the battle between mortgage lenders and local government over property lien seniority is nothing new.
  • On Bill Financing is still being worked out. Some utilities finance energy efficiency measures, with customers making monthly payments to pay down the project cost via their utility bills. But balancing rebate levels, loan terms, and loan amounts to incent owners to sign up has been challenging to get right, and these programs still remain uncommon.
  • Efficiency is unsexy. Solar panels look sleek to most. Windmills enrapture some. Light bulbs are boring to all. Ditto for motors. Ditto for going through a rusty roof hatch and taking a metal panel off a rooftop cooling system to install an evaporative condensor. But this perception is partly a marketing shortfall on the part energy efficiency service providers. The environmental good of efficiency is as real as solar, and the financial implications to the customer a heck of a lot better. It is the best first step to take.

In summary, obstacles abound. That’s the bad news. The good news is they are surmountable. And as organizations and companies seek to help the environment in the most cost-effective ways possible, the potential for energy efficiency finance expands. We already find certain subsectors much more interested in financing than others, and who will lead the way is still up for grabs. The opportunity is enormous, and we at Carbon Lighthouse are trying to make it real.

3 Responses to ∫ Energy Efficiency Finance

  1. Luke Knowles says:

    Hey Raphael – interesting and useful overview of some of the problems associated with the financing problems, i wonder what your opinion is on hedging options? Is there any way to insure recovery of the initial investment in a non-litigious way? Especially as the utility companies and many other groups may be ahead of you in the case of bankruptcy? Is there any way to retain ownership of the energy saving measures and write off the depreciation in their value through a taxation allowance? Is this something common in the US?


    • Luke – A great series of follow up questions. The legal protections for efficienct equipment is a very interesting topic (assuming one likes legal questions). For some light reading you can check out the Uniform Commercial Code’s Article 9 on Secured Transactions.

      It’s possible to put a lien on equipment that is senior to most other interests in the property. In the US, mechanic’s liens are an especially powerful tool, and there are others as well.

      The depreciation of the equipment provides an opportunity for tax benefits in most cases; however, unlike solar power, the chief value of efficiency projects is the energy savings not the tax incentives. So if the property owner is delinquent in payments the primary cash flow stream for the investment is derailed.

  2. I think you described project inertia fairly well. Energy efficiency may have fantastic returns, long terms savings, and office improvement, but it requires numerous small steps and a variety of skill sets. I’m excited that a one-stop-shop like Carbon Lighthouse offers a compelling and comprehensive package that can avoid the frustration of hiring numerous contractors.


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