Financing energy and resource efficiency in the built environment

On 1^st February I made a keynote address at COWI, the Danish engineering company, at an event to launch their new tool to help value the multiple benefits of energy efficiency and other projects.

Good afternoon.  I am going to start by saying we are in the midst of a revolution – and I don’t mean the revolution going on in Washington DC.  The revolution I am talking about is an energy revolution.  The old model was the large centralised energy plant sending energy out over a network to consumers.  The new model is one which has two chief characteristics.  Firstly there is a diversity of technologies including renewables, distributed generation, energy efficiency technologies, storage, and smart controls.  Secondly there is a multi-directional model in which there are no longer producers and consumers but rather prosumers.

This revolution has already had a major impact on traditional utilities.  In 2013 the Economist had a story headline on utilities, “How to lose half a trillion euros”.  The number has gotten bigger since then.  The good news is that there is big money in energy efficiency.  The World Business Council on Sustainable Development estimated that the energy efficiency in buildings opportunity is worth $0.9 to $1.3 trillion – yes trillion.  So this is a massive opportunity.  However, everywhere I go in the world I find a sense of frustration, frustration that the market for energy efficiency investment is not growing fast enough.  Why is that?

There is a massive gap between on the one hand the huge potential for cost-effective projects to improve efficiency, a potential that only needs proven technologies, and the massive amount of capital that is looking for profitable investments, especially investments with a green aspect.  This is the gap we have to bridge.  Just in case anyone is unconvinced about the availability of capital, a report from PIMCO stated that there is $12 trillion of institutional capital in global investment grade bonds trading with negative yields and that 15% of bonds within the Barclays Global Aggregate, (a widely used benchmark), was trading with negative yields to maturity.  This huge amount of capital could be usefully deployed into energy efficiency and other green projects.  The demand for green investments is growing rapidly as witnessed by the rise of green bonds.

So how do we start to deploy more capital into energy efficiency?  My view is that there is a jigsaw of energy efficiency financing with four pieces; finance, building pipeline, standardisation and building capacity.  Any project or programme, whether it is funded by public or private funds, needs to address all four parts of the jigsaw.

Let me start with standardisation.  Many studies and market observers have highlighted the lack of standardisation in energy efficiency to be a major barrier to scaling up investment.  The Energy Efficiency Financial Institutions Group (EEFIG) identified this and Michael Eckhart of Citibank has identified it by saying “energy efficiency does not yet meet the needs of the capital markets.   No two projects or contracts are alike”.  The importance of standardisation was brought home to me by a quote from D.E. Purcell who said: “Standards are like DNA.  They are the basic building blocks for all technology and economic systems.”   We could not have had the industrial revolution without standardisation and we could not have any financial market without it.

So why do we need to standardise?

Lack of standardisation introduces a number of problems:

• it increases performance risk
• it introduces uncertainty which in itself reduces demand
• it increases transaction costs as investors and lenders have to spend more money on due diligence
• it makes it difficult for financial institutions to build human capacity – you can’t build teams around ad hoc processes
• it makes it difficult to aggregate projects – and aggregation is vital in energy efficiency because individual projects are small compared to the need of institutional investors

And what do we need to standardise?

Firstly we need to standardise project development and documentation.  This is the province of the Investor Confidence Project and its Investor Ready Energy Efficiency™ system.

Secondly we need to standardise the understanding of risks and value.  This is the subject of the EEFIG “Value and Risk Appraisal Framework for Energy Efficiency Finance and Investments” which we have written with COWI for DG ENERGY and will be published in the summer.

Thirdly we need to standardise contracts.  There have been several European and UK projects to standardise contracts for Energy Performance Contracting but they are still not widely used and different project developers use their own contracts.

Finally we need to standardise performance measurement and reporting.  This is the area of Measurement and Verification (M&V) but it goes beyond M&V and the International Performance Measurement and Verification Protocol (IPMVP).  We need to collect and make available information on project and investment performance.  Several initiatives are working on this including EEFIG’s De-risking Energy Efficiency Platform (DEEP) developed by COWI for DG ENERGY, the Investor Confidence Project’s Building Button, and the Curve.  None of these to date have much in the way of actual performance data – one of the problems with time-series data is that it takes time to collect.

To develop sizable pipelines of projects, which are necessary to attract lower cost institutional capital, two things are needed.  Firstly it is necessary to have a proposition that sells – you have to sell something that is compelling to customers and many existing energy efficiency projects and contracts are simply not compelling. Secondly there is no point taking a building-by-building approach – you have to take a portfolio approach whether that portfolio be owned by a single owner like a company or a city, or whether it is a portfolio made up of buildings with different owners.

One aspect of solving this problem is building better business cases based on selling benefits that are strategic to decision makers.  Energy efficiency projects have multiple non-energy benefits which are increasingly recognised such as; increased asset value, improved health and well-being, reduced staff turn-over or higher productivity.  These benefits are much more strategic, and hence attractive to decision makers, than simple boring old energy savings.  With strategic decisions people don’t question the payback so much.

So to sell energy efficiency better, sell the non-energy benefits that are most likely to be strategic for your organisation – and then when you have the attention of the board, add the fact that this project will save x amount of energy and carbon with a payback period of y.  Don’t start with energy savings and payback – that is a good way to get a “no” when we all want a “yes”.

We also need to understand and be honest about the risks of energy efficiency.  It used to be said that energy efficiency was low risk or even no risk. This simply is not true.  Energy efficiency investments have all kinds of risk, especially performance risk which results from the performance gap – the difference between how much energy the project is designed to save and how much it actually saves.  The limited amount of data on this is pretty worrying if you are an investor.  Then there are other risks like weather risk, change of use risk etc. as well of course the normal credit and counterparty risks.

To better understand risks we need data.  In many areas of investing and lending there are decades of data.  In energy efficiency there is very little data but new data platforms are emerging such as the De-risking Energy Efficiency Platform (DEEP) developed for EEFIG, Building Button developed by the Investor Confidence Project, and the Curve developed by The Crowd.  These data platforms are new and to date have very little actual performance data.  Accessing data is hard, the lack of a common language with which to compare projects is a barrier, and of course collecting time series data takes time.

So to really scale up investment into energy efficiency to the levels we need to – we require new structures and organisations that put together the four pieces of the energy efficiency financing jigsaw: finance, building pipelines, standardisation and building capacity.  A few examples of these organisations exist but we need more models and more innovation.  Good examples include: The Etihad Super ESCO in Dubai, the Carbon & Energy Fund in the UK, and Retrofit Accelerators in the US.

So what of the future?  The real future that is just starting to emerge is about moving from paying for stuff to paying for performance.  All energy efficiency programmes rely on predictive models (many of which don’t work very well), incentives or mandates with no accountability for savings, and high-level performance measurement based on samples.  In Pay for Performance models actual savings would be quantified and paid for on a per unit basis.  This would align risks, innovation and project finance and allow energy efficiency to become a truly scalable, and reliable, resource.  Pay for Performance models are now being used in California which is putting much store on them working, and are being used in pilots in Germany too.

One interesting thought is to take Pay for Performance beyond just energy efficiency.  What do we really want from a building for instance?  Clearly we want a pleasant environment but we also want good indoor air quality (IAQ), and the link between IAQ and productivity and well-being is increasingly being proven.  Why not pay a building provider on a pay for performance contract for maintaining a set level of IAQ?

To sum up:

• we need to standardise:
  • project development and documentation
  • understanding of value and risk
  • contracts
  • performance measurement and reporting
• we need to work on building large pipelines of viable projects which will require both developing new, more compelling business models, and taking a portfolio approach
• we need to consider pay for performance models and using new data and analysis techniques to measure energy efficiency and make it a reliable resource that can truly compete with energy supply options.

Thank you.