Financing Energy Productivity Growth. My presentation to the 7th Forum on Energy for Sustainable Development in Baku, Azerbaijan

Between the 18^th and 20^th October I was fortunate to attend the 7^th Forum on Energy for Sustainable Development in Baku and to present a short summary of the work at KAPSARC on financing the transition to high energy productivity growth.  It was great to visit Baku which is one of the real birthplaces of the oil industry.  The first oil derrick was built there in 1871 – only 12 years after Drake struck oil in Pennsylvania – although there is evidence that Baku’s oil was used in the 3rd and 4th centuries and it was referred to by Marco Polo (1254 – 1324).  It is a very interesting city, particularly the old town.

As usual when I report my presentation this is the ideal, cleaned up text of my speaking remarks and may not reflect my actual words on the day. 

Good afternoon everybody. I wear several hats, all to do with financing energy efficiency and as you heard earlier from Panama one of those hats is the Investor Confidence Project.  Today though I am wearing a KAPSARC hat.

Yesterday Nick Howarth introduced the KAPSARC work on energy productivity.  In the interests of time I am not going to rehearse the arguments for using energy productivity as an indicator but I will stress one thing on this slide: “significant capital investment is needed to transition to higher energy productivity growth”.  Everyone can agree that we need to accelerate the rate of improvement in energy productivity (or efficiency) to achieve climate goals, we heard earlier someone say we need to accelerate the rate of improvement to 4% per annum from current levels of 1 to 1.5%.  This acceleration requires significant increases in the investment going into improving energy productivity.

So how do we do that?  Firstly we need to understand the different types of investment that drive improvements in energy productivity.  There are four types.

Energy efficiency retrofits – these are the investments in things like LEDS or new Building Management Systems that are added to an existing building, industrial facility, transport system or energy facility with the purpose of improving energy efficiency.  It is these investments that much of the energy efficiency industry and most energy managers are most concerned with.  They are important but they are only one small part of the big picture.

Next we have investments that refurbish buildings or industrial facilities[1] where the main purpose is not energy efficiency.  It is something else like bringing a building up to date to make it more attractive to tenants.  One of the best known energy efficiency case studies of recent years was the Empire State Building project but this was widely mis-understood.  The main project was a $500m refurbishment to bring the building into the 21^st century and combat declining rental income.  The energy efficiency parts were an add-on, and a very good example of what can be done and opportunities that are being missed every day of the week as building and industrial facilities are refurbished with no real attention being paid to energy efficiency.  It is true of course that refurbished buildings tend to be more efficient than unrefurbished – although this is not automatically true – they may use more energy as improved services and comfort levels are achieved.

Next we have new build, buildings, industrial facilities, transport systems or energy systems. Again new facilities tend to be more efficient than old ones – especially as building codes and Minimum Energy Performance Standards on things like electric motors come into force, and technologies just get better.  However, as in refurbishment projects many, many cost-effective energy efficiency opportunities are being missed every day.  Project owners have other objectives, speed, minimum capital cost etc – and often a lack of knowledge of what can be done with just a little more thought and effort at the design stage.  On the supply side engineers and designers tend to repeat the conventional designs even though they are not optimum in terms of energy efficiency.

Finally we have those investments that change the structure of an economy towards a less energy intensive mix of activities.  Examples would be a Middle Eastern country investing in a car assembly plant, or a shift towards financial services.

The first type, energy efficiency retrofits, I call “energy efficiency investments”, the others I call “normal investments”.  These are investments that are happening every day of the week – as we speak investment committees and boards are making decisions to invest in these kinds of things all over the world.  And in many, if not nearly all, of these cases, the potential for cost-effective energy investment is not being taken up and therefore we are locking in a higher energy future than we need to.  We need to maximize the use of all these cost-effective opportunities – so how do we do that?

At KAPSARC we have summarized some of the possible tools to increase investment in both energy efficiency and normal investments.  So let’s start with the energy efficiency investments category.

For energy efficiency investments for many years the energy efficiency industry has complained that the problem is a lack of investment and in response to that, in many countries, specialized energy efficiency funds have been set up – mainly with public money but increasingly private capital.  What we have learnt is that providing money for projects is not enough – you need four elements in what I call the jigsaw of energy efficiency finance:

• finance – project finance but also development finance, the really risky money that is used to develop projects to the stage at which project investors can invest
• a pipeline of well developed bankable projects. We all know the potential for energy efficiency is huge but there is a massive gulf between potential and real, well developed bankable projects.
• capacity building – especially in the financial sector which is new to all this stuff, but also in the supply side (the efficiency industry so they know how to deliver bankable projects), and the project hosts so they know what is possible.
• The lack of standardization has been identified as one of the major barriers to more capital flowing into energy efficiency.  Standardization means standardization of the development and evaluation process (that is where the Investor Confidence Project comes in), standardization of contracts, and standardization of Measurement and Verification.  Without standardization you cannot have functioning markets.

As I said earlier, traditionally energy efficiency has been thought of as something that is the province of public finance but there is increasing interest from institutional investors in energy efficiency.  It produces safe yield and can work without subsidies.  In countries like the GCC where energy prices are low the split of benefits between governments and end-users is different than that in countries with high energy prices – this suggests Public Private Partnerships may be appropriate mechanisms.

Everywhere there is growing private investor interest in energy efficiency but everywhere, even in the US and Europe it is a nascent market.

So to maximize investment into cost-effective energy efficiency opportunities we need:

Specialised funds – which recognize the need to have all the pieces of the jigsaw I referred to above.  There are good examples of funds all around the world now, albeit mainly using public funds.

ESCO-EPC facilitation – ESCos and EPCs were referred to by an earlier speaker.  They are an important component but as I have said many times they are not the be all and end all solution some people seem to think.  They work well in certain situations – particularly in the public sector.  We do need to facilitate and grow the ESCO-EPC market and again there are great examples of how to do this around the world including: RE:FIT in the UK, the Berlin Energy Agency’s work over many years, and in the GCC the Etihad Super-ESCO which is a world class example.

Then we need to put in place the market infrastructure, the standardization I described above but also evidence bases to help derisk energy efficiency for the financial sector, and capacity building at many levels.

By the way, all of these tools are of course supported by “normal” energy efficiency policies like strong building codes and MEPS, and building energy management capacity through ISO50001.

Now let us look at “normal investments”.

One of the easiest measures is to adjust the investment criteria of existing public investment infrastructure funds.  Many countries have public investment funds that invest in new buildings, factories and infrastructure of all types.  They are often deploying billions of dollars.  By incorporating energy productivity into their investment criteria of these funds we could capture more of those cost-effective opportunities that are currently being missed and have a big impact.  As well as changes to investment rules, for example including the requirement for a new building or facility to be in the top quartile, or even top decile, of energy productivity, technical assistance can be provided to help project hosts identity and develop cost-effective improvements to their base designs.  These base designs are usually more efficient than existing buildings or factories because of tightening codes and better technology, but they almost always miss cost-effective opportunities to go beyond Business As Usual – something that we really need to do.  This is the approach used successfully for many years by the EBRD to incorporate energy efficiency into all investments.  It has two effects, it helps improve cash flows for the project host, thus reducing risks, and it increases loan amounts for the fund – helping capital deployment.

As well as using existing funding mechanisms it is of course also possible to create new funding vehicles specifically aimed at improving energy productivity. These can be financed through green bonds (although this requires scale and standardization), or Sharia’ complaint funding.  A green bond or green sukuk financed umbrella fund could be created as part of sovereign wealth funds with pockets aimed at different types of projects.  Creating a new fund or vehicles though is always more difficult that adjusting those you have already. On the plus side they have a clear focus.

A more radical idea we are working on is the negabarrel market.  For oil producing countries a barrel of oil saved domestically has several positive economic effects, it reduces government spending on energy subsidies (where these are still in place) and it frees up a barrel for export or for higher added value purposes such as petrochemical production.  The monetary value of these benefits to the government can be calculated and a price per negabarrel set.  If negabarrels can be delivered by project developers at less than that price – either through energy efficiency investments or through high energy productivity normal investments – it is worth the government buying negabarrels from the market.  This incentive will encourage the development of high energy productivity projects and provide extra revenue to project hosts to offset any additional capital costs (although additional capital is not always required). There are issues of measurement and verification but these can be overcome with clear transparent standards and modern M&V techniques.

At KAPSARC we have assessed the likely impact and the difficulty of implementing all these tools.  The easiest, large impact measure would undoubtedly be changing the investment criteria of existing funds to include energy productivity targets and providing technical assistance to identify opportunities for improvement within normal projects.    At the other end of the scale in terms of ease of implementation is the negabarrel market concept.

You can read much more detail in the KAPSARC paper.

So to conclude:

• we need to massively ramp up investment into energy productivity,
• to do that we need to increase investment into pure energy efficiency projects and ensure “normal” projects go beyond Business As Usual in their energy productivity.
• there is growing interest in investing in energy efficiency from institutional investors which can be tapped into, ultimately through the green bond or green sukuk markets.
• governments can take a range of measures to maximize investment into increasing energy productivity ranging from the simple adjustment of investment criteria for existing infrastructure funds through to creating a negabarrel market.

If we can implement some or all of these ideas I think we will be surprised how fast we can accelerate the improvement in energy productivity.

Thank you.

[1] or transport systems or energy systems