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A Solution to the Residential Energy Efficiency "Split Incentive" Problem

Words by Presidio Capital Markets
Energy & Environment

The following is part of an "open letter" project by MBA students at the Presidio Graduate School in the Capital Markets Spring 2012 class.  Read the rest here.

An open letter to CleanPowerSF requesting the adoption of a "Green Rental Network" and on-bill financing strategy to remedy the split incentive problem in residency energy efficiency upgrades.

Dear CleanPowerSF Administrator:

As MBA candidates in Sustainable Management at Presidio Graduate School, we write to you today to propose a fix to the principal-agent issue involving residential energy efficiency upgrades. A problem exists because neither the residential building tenant, who pays monthly utilities, nor the building owner, who is responsible for making capital improvements, wants to pay for efficiency upgrades because the incentives don’t align.

San Francisco’s Community Choice Aggregation (CCA) program, CleanPowerSF can help remedy this issue by building energy efficiency into its service offering to close the price gap between renewable power and power from the utility grid. Community Choice Aggregation (CCA) programs are by definition concerned about community development, local jobs creation and reducing dependence on fossil fuel consumption, and a CleanPowerSF product offering that includes energy efficiency can meet the CCA’s objectives. We propose a way to enact energy efficiency initiatives via a "Green Rental Network" that will help circumvent the residential split incentive problem and add value to CleanPowerSF.

A "Green Rental Network" curated by CleanPowerSF

Traditionally, enacting energy efficiency via “passthroughs” for capital improvements, “green leases,” green lease workarounds due to rent control, Property Assessed Clean Energy (PACE) programs or the San Francisco Residential Energy Conservation Ordinance (RECO) all have had limited effectiveness because of each program’s complexity and the inability to effectively reach the total market with energy efficiency incentives or mandates.

We propose the creation of a searchable database of energy efficient, “green labeled,” rental properties. If information about efficient properties is more easily available, demand will increase.  An interesting model to emulate is the Home Energy Ratings System (HERS) index administered by the Residential Energy Services Network (RESNET) that is used to model the energy efficiency of a house before construction. Applying the HERS model to multifamily residential properties would allow a potential renter to screen and prioritize rental units of interest.

A network of affiliated contractors, builders, auditors and resources under the umbrella of CleanPowerSF could create a closed-loop system that meets the parameters of eco-minded renters while providing leasing and servicing strategies for appliances and energy efficiency devices currently only available to property owners as “capital improvements.” The experts and capital for leasing opportunities would be part of the product offering. There would be no need to find appropriate “green-minded” experts because they would already be part of the system.

The described structure combines the municipal bonding authority of the San Francisco Public Utilities Commission (SFPUC), the administrator of CleanPowerSF, with the expertise of an Energy Services Company (ESCO). The housing index provides a measurable catalog of energy efficiency opportunities that the ESCO uses to perform and track energy efficiency upgrades for landlords. In return, the ESCO gets a percentage of the retrofitted energy savings. If the ESCO does not meet the predetermined performance targets as outlined by CleanPowerSF, the ESCO pays and the government entity does not. Because the ESCO absorbs the risk of the program's potential failure (and loss of investment) and not CleanPowerSF, both are incentivized to closely monitor performance targets. On-bill financing of a few cents per kilowatt-hour on CCA customer bills will enable energy efficiency retrofit bond revenues to be repaid to investors. The California Public Utilities Commission has already released an on-bill financing proposal from the Environmental Defense Fund (EDF) that we hope that you will incorporate into a "Green Rental Network” to help alleviate the split incentive problem in residential energy efficiency.

Sincerely, Julien Gervreau, Jonathan Gibson, James Parle and Chad Reese 2012 MBA Candidates, Presidio Graduate School


Presidio Capital Markets

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