My talk at the Berlin Energy Transition 2016

I was honored to speak on a panel at the Berlin Energy Transition 2016 on the 18th March 2016.

Here is an edited and improved version of my speaking notes from the event. It is what I would have said given more time and more eloquence. The event made me think of an additional law of energy efficiency (see my others here) – “while Amory Lovins shows that energy efficiency has produced 30x as much energy services as renewables over the last forty years, energy conference organizers only give energy efficiency 1/30th of the time they give to renewables”. Seriously though, a big thank you to the German Federal Foreign Office and Federal Ministry of Economic Affairs and Energy for the invitation to speak at such a prestigious and well attended event, and thank you to my fellow panelists, the panel chair Sylvia Kreibiehl and of course the audience.

I am very pleased and honored to be invited to speak to you today about energy efficiency financing. This is a very interesting time for energy efficiency and energy efficiency financing around the world and we are starting to see real understanding and progress emerge – slowly but surely.

It is good to start by putting some scale on the problem and the opportunity. The IEA estimate that investment in energy efficiency must multiply by a factor of 3x by 2035 to achieve the 450ppm scenario. The EU estimate that investment in building retrofits need to increase by a factor of 5x to achieve climate goals. Various estimates of the potential market exist but a round trillion dollars is a good number to use – big enough to excite even institutional investors.

Today I will give a overview of where we are on developing the energy efficiency financing market and my own views on what we need to do to grow that market to the levels that we know are needed to achieve our medium term energy goals around energy security and the environment. So I am going to talk about the current status, some of the problems, some of the solutions and then a brief look to the future.

I want to start with a status report on energy efficiency financing:

• The massive economic potential for energy efficiency has nw been largely recognized. Those of us like Amory Lovins and myself who have been working on energy efficiency and talking about the potential for energy efficiency for decades it is surprising how long it has taken but it is a step forward. Recognizing the potential is the 1st step.
• Following some good work from the IEA and others the non-energy benefits of energy efficiency – and by that I mean all the other benefits that come with energy efficiency other than just energy and cost savings – are now increasingly recognized and starting to be valued. We still have a way to go on this important issue but things are improving.
• We now have strong and growing interest in investing in energy efficiency from institutional investors. This is a new development over the last few years.
• However, despite these positive developments the growth of the energy efficiency financing market has been slower than we would like and slower than we need. Not just in Europe, but in North America and Asia there is a sense of frustration that things are not happening as fast as they need to. As one of the US bankers involved in energy efficiency financing said: “the trouble with this energy efficiency business is that the ratio of conferences to deals is too high”.

If we dream for a minute about what a healthy, growing and dynamic energy efficiency finance market would look like, it would have:

• strong demand from building owners and investors
• highly skilled and accredited workforce
• a mix of financing products at different rates
• standardized tools for tracking and quantifying savings
• and finally a secondary market that the primary investor can sell onto – ultimately the debt capital markets.

In fact it would look like the markets for financing conventional energy infrastructure, and by conventional I mean oil and gas and solar and wind power. In fact it would like any other financial market. At the moment it does not look like that anywhere – it is nascent, very niche and very hard to invest in. Only the real enthusiasts – the pioneers, the early adopters – are investing at the moment.

To sum up, when I look at the whole area of energy financing this is what I see. For oil and gas projects, if you happen to own an oil field, the ways of developing, documenting and valuing the project are standardized, and there is a large volume of money available for such projects from a wide range of sources across the value chain.

Twenty five years when I did some early wind farm projects in the UK the same was not true for wind power, we made it up as we went along and there was only one bank in London we could go to who I suspect were also making it up as they went along. Nowadays of course funding renewables is fairly standardized, and almost as mainstream as oil and gas and you can go to multiple sources for money across the value chain.

However, when we look at energy efficiency projects, we see something completely different. Processes and documentation are not standardized, it is not mainstream, there is only a small amount of lending/investing going on and there are only a few sources you can go to. Investing in energy efficiency is hard, even when you want to.

So how do we make the vitally important energy efficiency financing market grow and look more like other financial markets? Looking at this problem I see a jigsaw and it has four main pieces:

• product offerings
• bridging the development gap
• capacity building

standardization.

We need to put all the pieces together if we want to grow this market – and not just make perfectly formed single pieces. I want to say something about each of these pieces in turn.

Product offerings

Let’s talk briefly about product offerings from the energy efficiency industry. Whenever energy efficiency financing is brought up people say “Energy Performance Contracts” – usually followed by some cliché about how they are the solution.

Let me only say that Energy Performance Contracts (EPCs) are not the answer that some people seem to think they are. It is a model that evolved to meet the needs of a particular market segment (the US public sector) and was exported around the world but has always been a source of frustration for its boosters and others. The EPC model has never grown to the extent that people think it should for a number of reasons:

• debt is on the balance sheet of the host
• debt is constrained by mortgage covenants or finance structure
• the guarantee is not a credit enhancement
• transaction costs are high
• they don’t address the split incentive.

For too long the energy efficiency industry, and some policy makers have pushed EPCs as if they are the answer to everything – they are not.

We are now seeing innovation in contract forms and business models appearing around the world, these include acronyms such as ESA (Efficiency Services Agreement), MESA (Managed Energy Services Agreement) and MEETS (Measured Energy Efficiency Transaction Structure). We need, and I am sure will see, much more innovation in different sectors. By the way, one of the problems with the energy efficiency industry is that like the space industry it likes acronyms too much.Bridging the development gap

The development gap is the gap between what we know is a massive potential for viable projects and actual, bankable, actionable projects.

To overcome the development gap requires:

• vision and knowledge about what is possible
• technical and financial skills
• finance – developing projects, especially big projects, costs money and this is risk money like all development whether it be energy efficiency, energy projects or property development
• standards – we need to develop multi-building projects in portfolios using the same standards and document sets.

We need to learn how to finance the development process at scale. We have an established way of doing that in energy supply projects but not for large-scale, multi-building energy efficiency projects – although there are a few good examples out there like the Etihad Super ESCO in Dubai.

Capacity building

Now let’s look at capacity building which has to happen on the demand side, the supply side and the in the financial sector. On the demand side we have to acknowledge that lack of demand for energy efficiency projects is a problem that we have to address.

We also have to acknowledge something that is hard for those of us who have spent our lives in energy efficiency to accept. Energy efficiency is just simply boring – for most people most of the time it is extremely dull. Only when we recognize that can we move forward.

One the most promising ways of making energy efficiency a lot less boring is to talk about the non-energy benefits that come from energy efficiency. Those benefits occur at different levels; in the energy supply system, in the participant or host, and in society at large. Here I am only concerned with the benefits to the host, the project owner.

These benefits include amongst others: improved productivity, increased retail sales, increased quality and reduction in hours lost at work. These are increasingly being recognized and they are starting to be measured. Often the value of these benefits will be much larger than the value of the energy savings alone – the IEA estimate 4x more valuable in some industrial cases. Also they are much more strategic and the more strategic an investment proposition the more likely a management decision to invest. For example, if a retailer recognizes that LED lighting retrofits, or better still natural lighting, leads to an increase in sales (as some have done) and starts to value that benefit, you can be sure that energy efficiency becomes strategic and rises up the management agenda.

Capacity building on the demand side – that is the customer side – should also include tools like ISO50001 and integrated design as well as knowledge of outsourced energy services that bring with them expertise and finance. Companies frequently finance or outsource assets of all types, particularly those that are non-core business, but rarely energy assets or efficiency.

On the supply side we need to build capacity in different ways. The energy efficiency industry needs to learn to work with the finance industry right at the start of a project, not just at the end. We need to learn how to develop projects at scale, understand financial markets better and sell non-energy benefits and not just energy savings. Traditionally the energy efficiency industry has been very bad at understanding its markets and tended to assume that because a project has a two or three year payback on energy grounds alone it is “no brainer”. Often when you look at other factors it is not.

Within financial institutions we need to build capacity around:

• non-energy benefits
• the risks of energy efficiency investment – and there are definitely risks – it is not the “no risk” investment some have described in the past
• the proven energy efficiency technologies
• the various contract types
• tools for standardization
• available support for development and project work.

The EIB and others are doing good work in this area but we are starting from a low base.

Standardization

Finally the last piece of the jigsaw – and what I and many others think is the key piece – standardization.

We all know that standardization is essential if you are making cars in a factory or in fact any other manufactured product. Standardization was the key to the industrial revolution.

Of course people forget that banks and financial institutions are also factories – they cannot operate at scale without standardization. Every financial market, whether it be mortgages, car loans, commodity trading, stock exchanges, bonds or credit cards, is based on standardization. Lack of standardization is the major barrier to growing the energy efficiency financing market.

It is not just me saying this. Various institutions, groups, banks and individuals have said it. The Energy Efficiency Financial Institutions Group, a group of 100 banks and financial institutions set up by the European Commission and the UNEP Finance Initiative, concluded that lack of standardization was a key factor in impeding both the demand and supply of energy efficiency financing.

The Joint Research Committee of the European Commission also came to similar conclusions.

Michael Eckhart, the head of Finance & Sustainability at Citi said it well when he said:

• “energy efficiency projects do not yet meet the requirements of capital markets
• No two projects or contracts are alike.”

He also highlighted the high transaction costs that come with lack of standardization.

And finally the IEA concluded that standardization was important and that the Investor Confidence Project, which I will talk about now, could “facilitate a global market for financing by institutional markets that look to rely on standardized products”.

The current lack of standardization in the way that energy efficiency projects are developed and documented has several consequences:

• greater performance risk
• higher transaction costs
• financial institutions cannot build capacity even if they want to invest in this area
• institutions cannot aggregate projects – which is essential because we know that energy efficiency projects are small compared to the needs of the institutional investors.

So let’s consider an important and significant response to the lack of standardization – the Investor Confidence Project. This was a US project that I brought over to Europe and secured Horizon 2020 funding for. I want to give you a flavor of the Investor Confidence Project, what it is and what has been achieved in the US and Europe and where we are going.

Working with the finance and energy efficiency industries the Investor Confidence Project has developed open source Protocols that organize the process of developing and documenting a project and for each stage of a project define the standard or combination of standards and best practices that should be used – as well as the format of the output. It is not about writing new standards but rather about standardizing the process.

In both the US and Europe six Protocols – each matched to local needs – have been launched and are now being applied in real projects and programmes. They cover different types of projects in commercial and residential buildings. As well as Protocols the Investor Confidence Project has also developed accreditation for project developers and software.

The Protocols and the accreditation come together in a label; “Investor Ready Energy Efficiency”. When we talk to investors, including some of Europe’s largest real estate investors and lenders they say that is what they want – a label that gives them confidence that best practice process has been followed. Underneath the label the process reduces transaction costs, facilitates aggregation and ensures on-going measurement of savings, something that will become more important as secondary markets such as green bonds emerge.

The Investor Confidence Project is supported by some 200 Allies in the US and Europe – anyone who supports the ideal can sign up on the website:

eeperformance.org (for the US) or Europe.eeperformance.org (for Europe)

So having created the tools – the Protocols and the Investor Ready Energy Efficiency label – to standardize the development and documentation of energy efficiency projects in buildings the Investor Confidence Project is now applying those tools to a wide range of projects and programmes across Europe and the US, working with leading property companies, energy efficiency developers, financial institutions and frameworks. We have a network of the most active investors and work to link them to projects, as well as with developers to make projects more bankable.

So that is my jigsaw of energy efficiency financing.

What would it look like if we finished the jigsaw? We would have a dynamic and rapidly growing energy efficiency financing industry with the characteristics I described at the start:

• strong demand from building owners and investors
• highly skilled and accredited workforce
• a mix of financing products at different rates
• standardized tools for tracking and quantifying savings
• and finally a secondary market that the primary investor can sell onto – ultimately the debt capital markets.

I think we have identified the jigsaw pieces and in few cases we have put them together, now we need to replicate those cases widely. If we do that I believe we will be surprised by how big the energy efficiency financing market becomes and just how much demand we can take out of the system through economically and financially attractive efficiency investments.

That is the future the Investor Confidence Project is helping to build and we would welcome working with anyone else who shares that vision.

Thank you.

Dr. Steven Fawkes

Senior Adviser, Investor Confidence

Project

18th March 2016

The video of the talk can be found here:

https://www.energiewende2016.com/view-the-conference/

See Session 7: Access to Finance – starting at 1:09.