Solving the Energy Efficiency Puzzle

In 2008 and 2009, McKinsey & Company published two leading reports that describe the vast potential for economic and environmental gains that are possible through energy efficiency measures.  However, it’s almost 2011 and we have yet to see widespread investment in such (EE) measures.  This begs the question, “why don’t we see more businesses and investors pursuing energy efficiency as cost-savings and investment strategies?”

What we find is that many of the investment barriers that were in place in 2008 and 2009 are still present today.  The fact is, business models to address these barriers have not emerged successfully within the marketplace. As a result, an increasing amount of discussion is now taking place at energy conferences to clarify the investment barriers and to discuss the financial mechanisms that can address those challenges.

A survey of recent reports and presentations indicate that the key barriers include:

High upfront costs of capital – EE investments compete for limited budget dollars alongside investments in products and services that are more directly related to a company’s core business focus.

Long payback periods – Although EE advocates claim that efficiency measures can provide an average 17% rate of return in two to five years, investors remain weary with uncertainty regarding the potential savings.

Split incentives – when a building is not owner-occupied, the principle agent problem occurs where efficiency investments made by the tenant or the owner do not inherently benefit the other party.  This barrier creates a strong disincentive for investment.

Aggregation – because efficiency projects are widely dispersed and in high volume, efficiency projects need to be bundled into single investment opportunities to attract institutional investors with an large return and reduced transaction costs.

Although all of these barriers play a role, the real business opportunity lies in solving the aggregation issue, and here’s why…

High upfront costs of capital will always be a challenge for any investment and addressing this challenge simply requires making a compelling, data-driven business case that outlines the risk, return and reward of the investment.  There’s no way around that.

Long payback periods are a misconception; data from past EE investments demonstrate the financial viability of these projects and the market needs to do a better job of communicating these proof points to investors. So, we have to get better at telling the energy efficiency story.

Split incentives present a critical challenge inherent in the relationship between tenants and property owners. However, we have the opportunity to gain momentum with EE by targeting owner-occupied properties with high energy-related expenses, such as commercial and industrial facilities.

Aggregation remains as the “un-cracked nut” that when solved, will unleash a significant amount of the market potential. For years, analysts have claimed that growth in EE investments has stalled because efficiency measures are not as attractive as solar panels or wind turbines; and that may be true if you’re talking to someone who’s concerned with growing brand equity and responding to shareholder concerns regarding environmental management practices. But to the investor, there’s nothing more attractive than a single low-risk investment that delivers a 17% rate of return in two to five years.

In order to create that single investment opportunity, we need a business model that can bundle disparate projects into a single investment opportunity that meets institutional investor criteria.  Aggregating the projects secures the financing that will enable a business to provide property owners with no-cost opportunities to reduce energy expenses through efficiency measures managed via a leasing program or an ESA (energy services agreement), which is similar to the PPA (power purchase agreement) model that has gained traction in the solar industry.

The final piece of the puzzle is designing the business model with a full-service offering where customers are offered not just the necessary financing but also, the initial energy auditing, project design, equipment installation and maintenance.

It sounds easy but it’s not.  If it were, this market would have already boomed.  A number of companies such as PEMCO, Metrus, Transcend Equity and EqRM are chipping away at solving this puzzle and are worth keeping your eye on in the days to come.

David received his undergraduate degree in Geographic Information Sciences from James Madison University and completed an M.A. in International Development at Clark University. With over 10 years of experience in the field of environmental sustainability, David has worked for organizations such as Environmental Defense Fund, USDA, USGS and the Smithsonian Institute.Currently, David is a NetImpact member and an MBA candidate at the Presidio School of Management where his research focus is on developing market incentives for investment in environmental sustainability.

3 responses

  1. In the UK this problem seems like it may have been addressed with the introduction of feed in tariffs, where by the National Grid is obliged to buy back any surplus energy produced at above market rate.

    This has led to the appearance of numerous private companies who will fit micro generation technologies for free, and pay 10% to 20% of electricity bills for the house / business in question.

    The bill payer gets cheaper utility bills, and the installer makes money from the electricity they generate. It seems like a good system.

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