Energy Efficiency Financing: The Absent, Invisible Hand

By Sandra Kwak

"How many of you live in a building that has had a deep energy efficiency audit? Do you even know? What about the building that you work in?" Marshall Salant, the Head of Citigroup's Alternative Energy Finance Department, taunted the audience at the ARPA-E Energy Innovation Summit, during a panel entitled “The Future of Financing Energy Efficiency.”

Despite present market opportunities, over $50 billion in commercial sector and $80 billion in industrial sector, that would yield over $1.2 trillion in savings, the 'free' market has failed to finance retrofits.

"The volume of truly low-hanging fruit, with less than an eight-year payback, is enormous," said Dr. John Byrne, distinguished professor of Energy at University Delaware and advisor to the IPCC. The panel’s moderator Richard Kauffman, Senior Advisor to the Secretary of Energy Steven Chu, likened the efficiency savings left lying on the table to the old finance joke in which two economists walk away from a $20 bill on the ground because "if it was really there, someone would have picked it up already."

Efficiency projects face barriers that include: lack of education about services and benefits, complicated financing mechanisms, and a landscape of standards that looks like the wild west. However, emerging IT platforms and business models are succeeding in breaking through economic barriers while adding dollars to their customers’ bottom line.

What is the deal with efficiency financing?  

Following the wake of Fannie Mae and Freddie Mac's pullout from the PACE program, residential retrofits have suffered with very little loan support for energy efficiency and renewable installations. However, despite Fannie Mae and Freddie Mac’s exit, 16 states have moved forward, ruling that municipalities can set up their own PACE programs.  Several states have sued the Federal Housing Finance Authority (FHFA) for directing Fannie and Freddy to refuse to purchase mortgages on properties subject to PACE with first-priority liens. California has succeeded in forcing the FHFA to issue a new Notice of Proposed Rulemaking regarding PACE, comments are due on July 30, 2012.

While the commercial sector was not as affected by PACE as the residential sector, there are still large gaps to fill before this market reaches full potential. “Financing mechanisms must be made easily available. Incentives need to be aligned and methodology for measuring risk must to be standardized,” states Byrne. There is also the issue of split incentives, the opposing interests of landlords and tenants.  However, some building owners and utilities are using structures such as triple net (NNN) leases, where all costs are passed on to tenants, or on-bill financing to address split incentives.  The market needs more innovation mechanisms in order to fill the gaps.

One promising financing mechanism, On-Bill Financing (OBF), keeps costs completely off the balance sheet. Utilities will sponsor 100 percent of the upfront costs of a retrofit and allow the customer to pay back the investment through their monthly utility bills. Because customers are saving money through efficiency from day one, they are able to pay back the loan and interest, without ever having to swallow capital costs.

At least 20 states have on-bill financing programs, yet there is a low participation rate of only 1 percent, according to ACEEE. Customers' slow uptake may be attributed to lack of awareness around the programs, or by utilities stringent standards to qualify for on-bill financing.

"What we suffer from is ignorance in the market," says Jeff Bartos, "not just on the part of the customer, but between institutions." Bartos is President and CEO of Mark Group that conducts 6,000 efficiency upgrades a week out of 25 offices internationally. "There is a lack of understanding between public policy makers, lenders, investors and consumers on how to combine public dollars with private capital to do good," says Kerry O'Neill, Co-founder and President of Earth Markets.

Considering the low default rate on paying utility bills (most people will do what it takes to keep the lights on), and given the fact that efficiency retrofits start saving money immediately, efficiency financing investments ought be considered extremely low-risk.

Another potential source of financing (not discussed on the panel) is an efficiency bond, or E-Bond.  If a government-backed note with a stable, long-term interest rate, the E-Bond, were to be created, it would be a very attractive place for investors to put blue-chip funds.

Retrofitting the situation 

To impart efficiency on a massive scale and reap all of the benefits that it would bring in terms of cost savings, job creation, reduced emissions, grid security and economic growth, there are several easy steps the market can take:

1. Engagement in the forms of education and competition

2. An 'outfit approach' by segment

3. Create additional financing mechanisms

4. Secure financing

5. National standardization

1. Engagement: Teach the will to win!

Selling efficiency requires appealing to the behavioral economics that drive decisions.

"A competitive dynamic makes things interesting very quickly," says Riggs Kubiak, CEO of Honest Buildings. "There are already competitive metrics – data from each building and also from cities with benchmarking laws. If you can create a competitive dynamic, the conversations around ROI, IRR and energy efficiency investments become a lot easier to have."

Competition and loss aversion are bigger motivators than savings. "Saying 'stop wasting energy' is preachy," says Bartos, "tell [people] they are losing $1000 a month and the only reason they are not mad is that they don't know." In an example provided by Byrne, when savings information from one institution was presented to others, facilities managers were quick to say "Why are they saving so much and we are not?" In hotels when guests were asked to hang up their towels to "Save the Planet" there were low participation rates, but when they were told that 75 percent of others who stayed in the room hung up their towels, participation rates climbed. 

Drawing on the neighbor spirit, O'Neill has conducted successful neighbor-to-neighbor residential efficiency challenges in Connecticut; she says homeowners exclaim, "I never knew how uncomfortable I was until I did these retrofits!" 

2. The outfit approach 

There is not a one-size-fits all approach in the efficiency market, each sector has "a different flavor," explains Salant. As with any market, there are formulas for selling to different verticals. He outlined eleven sectors including CNI (commercial and industrial), residential, and MUSH (municipalities, universities, schools and hospitals), citing examples of successful programs that have been tailored to a specific sector. In Delaware, the government supported a massive project to retrofit highly inefficient prison buildings. In the MUSH market, 50 projects were pooled to total a $400M investment since none of them were big enough to standalone.

Customizing different outfit approaches for retrofits by sector includes creating the financing mechanisms that make the most sense for each. 

3. Create additional financing mechanisms 

On bundled projects, securities such as E-Bonds could provide cash to cover equipment and installation. Individual investors looking for secure investments could purchase E-Bonds as a safe place to grow their money and because the facilities would be paying back interest and principal with immediate efficiency savings, the bonds could yield a higher interest rate and rate than T-Bills and lower risk than preferred stock.

4. Secure Financing 

"If we want to store value in instruments, energy efficiency has much lower risk and higher reward," says Byrne.

At Citigroup, Salant created an alternative energy finance group that has provided capital for three building power projects and rooftop solar deals. "When we did transactions for Solar City, SunEdison and Solar Constellation, we saw a business model that worked really well," said Salant. "Solar financing through savings with a locked in lease was a great business model." This led to the creation of a similar model for energy efficiency financing.

A concern for banks around efficiency securities is that assets are more difficult to reposess and sell. As compared with foreclosing houses, it is much more difficult to take out lightbulbs, boilers, and insulation. However, unlike predatory lending, efficient business is good business. Those who demonstrate the foresight to invest in energy efficiency are also highly likely to demonstrate operational and capital efficiency and will outperform the market. 

5. National Standardization  

Facilities that desire energy efficient ratings are presently faced with a plethora of options and results may vary depending on the expertise of the auditor. High profile trade organizations have been pioneers in setting standards, ASHRAE provides three levels of audits, and the USGBC council awards several LEED points for efficiency. The government-backed Energy Star program has a national database of buildings and awards ratings based on comparisons to industry peers tabulating only electricity bills, square footage and industry.

Legislation for efficiency is speckled (much like the patchwork of support for renewable energy). As forerunners, five cities nationwide have passed Benchmarking laws which require commercial buildings to get an Energy Star rating. In Austin, TX even homes must conduct an energy audit and disclose the results before being sold. Beginning in 2011, California requires new construction to include sustainability guidelines under the CalGreen code.

The Federal government has expressed support for efficiency programs and all of the jobs they create. Obama and Clinton announced the Better Buildings Initiative, public-private partnership, in December 2011 that will dedicate $4B to commercial efficiency upgrades. The White House CTO, in response to the smart grid, worked with utilities to create a “GreenButton” that customers can use to access their energy data.  However,  this impetus must be taken a step further to turn information into action. A national standard for audits, benchmarking, green building and disclosure is necessary.

Energy efficiency is not a leap of faith. The dollars are on the ground (and in the walls, windows, and control systems).  However, policy, market mechanisms, smart strategy, and customer psychology need to be advanced in order for efficiency to show businesses, individuals, investors, the government and the environment the returns they are looking for.

Sandra Kwak is an energy efficiency entrepreneur with Powerzoa and D-Light Energy.

image: mystuart via Flickr cc (some rights reserved)