As regular readers will know I have a great interest in space exploration but today I am writing about another passion that many people may think doesn’t fit with my commitment to energy efficiency and some may not approve of – Formula 1.

Formula 1 is fascinating for a number of reasons. First of all it is still a sporting competition in which you are reminded that you never know what is going to happen next in life. Despite predictions that the new rules in 2014 would remove excitement the opposite was true and the Lewis Hamilton versus Nico Rosberg story had it all, excitement, rivalry and skullduggery   Secondly F1 is based on cutting edge, innovative technology (more of which later) and demonstrates what we can do when we try hard. Like space exploration, it demands the highest standards and attention to detail in everything from design and construction through to the all important execution from the whole team, not just the driver. And of course as we were reminded of in October 2014 with the Jules Bianchi crash there is still, despite great improvements in safety, the ever-present element of danger. Anyway I am an avowed F1 fan and a big fan of the 2014 World Drivers’ Champion Lewis Hamilton who is an incredibly talented driver and exhibited great skill and fortitude in coming from behind many times during the 2014 season.

What are the links between Formula 1 and energy efficiency?

It may be surprising to some but there are some links between Formula 1 and energy efficiency. First of all in 2014 the sport, driven by the large car manufacturers, adopted strict fuel efficiency requirements – a reduction of fuel use of 35% over the previous V8 engines, a maximum fuel load of 100kg and a maximum fuel flow rate of 100 kg/hour. The resulting hybrid power units – they can no longer be called engines – combine 1.6 litre V6 turbo-charged internal combustion engines (ICE), two Energy Recovery Systems (ERS) and an Energy Storage (ES) unit i.e. a battery. The ERS consists of a Motor Generator Unit-Kinetic (MGU-K) which harvests energy that would normally be wasted in braking and a Motor Generator Unit-Heat (MGU-H) which collects energy from the exhaust. The ICE produces 600 hp (485 kW) and the ERS can produce an additional 150 hp (112 kW), giving a total output similar to the old V8 engines.  The integration of the ICE, the ERS and ES is a complex task that can affect strategy. Various other rule changes reduced the all important down force from the car’s aerodynamics and banned actively using the exhaust to improve aerodynamics, making the cars harder to drive.

The new power units brought with them a highly controversial change in the noise levels and tone of F1 cars at full throttle, instead of the piercing high pitch scream the new sound has been described as like a sewing machine (probably not the best description as the noise level is still 138 dB) – judge for yourself here. The positive view is that spectators can now hear other sounds. At the end of the day all noise, and heat, from any process represents energy being wasted.

The Mercedes team and the W05 Hybrid car (both the car and engine were designed and manufactured in the UK) dominated the Championship in 2014 and a major factor in their success seems to have been the use of integrated design principles. I have written before about the principles of integrated design and the significant advantages that true integrated design can bring in terms of energy and material efficiency. Examples abound – from the Empire State Building retrofit to the excellent work carried out in Ireland by the Sustainable Energy Authority of Ireland (SEAI) in applying integrated design in industry.  We need to further promote integrated design in buildings and other areas such as vehicles and there are several examples of integrated design in the 2014 Mercedes F1 car and its 2015 successor.

The compressor and the turbo of the MGU-H are packaged at opposite ends of the internal combustion with the compressor at the cooler front, and the turbo at the hotter back. This meant having a shaft, spinning at c.120,000 rpm between the two passing through the V of the engine – it is a very demanding engineering task to design and build such a shaft without flexing and apparently it took two years to perfect. One consequence of the layout was that the compressor could be larger. The resulting reduction in pipework reduces turbo-lag. Another consequence was lower cooling requirements for the inter-cooler which meant smaller radiators and hence smaller side pods – less frontal area means less drag. Other teams had rear mounted compressors which had to be smaller to fit within the overall packaging of the car.

Another example of integrated design was that even the fuel and lubricants were developed by PETRONAS in conjunction with the development of the power unit. Never before have fuel and lubricants been developed in such close co-operation with the design of the power unit.

One of the regulation changes affecting down force was a reduction in the width of the front wings – which in 2014 could only reach half away across the tyre instead of right across as in previous years. Mercedes used an innovative solution, instead of a conventional V shape for the suspension lower wishbone they used a single arm with a forked arm. This acts as a wing and generates downforce which allowed a bigger gap between the nose and the wing, which allows more airflow through the underfloor and to the rear.  In order to do this, however, meant designing one arm that could do the work of two – a clear example of integrated design.

The rapid rate of technological development in Formula 1 is illustrated by the progress made on the KERS. In 2007 the first development system weighed 107 kg and achieved an energy efficiency of 39 per cent. By 2009 the weight had been brought down to 25.3 kg and the efficiency increased to 70 per cent. By 2012 the weight was less than 24 kg and the efficiency up to 80 per cent. The technological advances of Formula 1 do impact on ordinary vehicles and the MGU-H technology may yet appear in road cars, helping to further improve fuel efficiency.

Another link between Formula 1 and energy efficiency is the importance of large amounts of data, and real time data collection. Modern F1 cars have more than 150 sensors on-board that are feeding information back to the garage and the technical team at headquarters in real time. The telemetry is used to optimize strategy, run simulations and provide feedback to the driver. It is also used to help optimize the car’s on-going development programme. The increasing availability of real time data from buildings allows us to manage energy more effectively as well as model their performance and design better buildings.

The data collection feeds into an enormous effort to understand the interaction of numerous variables including; those which can be influenced by the design and the set-up of the car e.g. down force, brake balance etc; external physical factors such as track conditions – temperature and surface type – wind speed and direction, the effects of following other cars (which disrupts the air flow); and human factors – how the car is driven and how fast pit stops are for example. In building and industrial process energy use we are dealing with a similar interaction of design/set-up, external factors and human factors and just beginning to have the data and the computing power to create a better understanding of how to optimize energy use in real-time.

At the end of the day we are all utterly dependent on engineering and Formula 1 is an example of engineering at its best. We need to celebrate great engineering more.

I mentioned the high performance and quality standards of F1 at the beginning. The constant striving for improvement and the highest standards required from all team members is an example all organizations should learn from, whether they are involved in energy efficiency or not. All too often in many areas of life and business we put up with sloppy performance (I may return to this subject in future posts – the sloppy performance of banks is particularly driving me crazy at the moment). We need more absolute, “unreasonable” insistence on high standards in all areas of business from the board room down to the shop floor.

To sum up, Formula 1 – like it not – is an expression of much of what makes us human, our basic competitiveness which is a positive force (but of course can turn negative), our incredible technological ingenuity, the power of team-work and the importance of demanding high standards. The 2015 F1 season has started well for Lewis Hamilton and Mercedes, although Ferrari seem to have narrowed the performance gap and remain a real threat for the rest of the year, as does Lewis Hamilton’s team mate Nico Rosberg. I look forward to watching the rest of the season and particularly seeing my first-ever live Formula 1 race, the Monaco Grand Prix at the end of May.

I have written before about ESCO (Energy Service Company) obsessions (read here) and how the Energy Performance Contract (EPC) may be part of the problem and not the catch-all solution that some people seem to think it is.

At a recent meeting organized by EASME (the Executive Agency for Small and Medium Enterprises of the European Commission) on the topic of energy efficiency financing, I was reminded once again about the difficulties of communication, both in general and specifically on the subject of EPCs and ESCOs. At the meeting there were representatives from several projects receiving both EC and European Investment Bank support, and many of these are involved in EPCs in some way, either in buildings or street lighting. It seems as if there are many different interpretations of EPC across Europe (and the rest of the world).

Energy Performance Contracts

Personally I tend to use EPC to mean the classical North American model which developed in the 1980s and was successfully exported around the world by USAID funded trade missions in the 1990s. In this the contractor (normally called an ESCO but we will come onto that term) provides a guarantee of energy savings. EPCs are most often talked about, and most often implemented, using external financing and in the US most of the market (80% plus) is public sector and is financed by municipal bonds or federal funds. We should not forget of course that the client can fund an EPC themselves – the best example being the Empire State Building retrofit in which the energy efficiency components were carried out under an EPC but financed by the owners of the building. To my mind the classical EPC has a number of problems including the fact that the contractor is motivated to maximize capex, the contract is complex and it is often a black box to the customer.

ESCOs

The term ESCO is also a minefield of confusion. I am on record as saying we should abolish the term. It is generally taken to mean a developer of energy efficiency projects which provides some form of guarantee of their performance. It is also often used to denote a company that both develops projects and provides, or more likely facilitates, financing for the projects from a third party.

We need to be more precise in our language – in my book “Energy Efficiency” I argued for distinguishing between the concept of shared saving, the entity and the contract form.

The concept – shared savings

The concept of shared savings is straightforward. It is what it says on the tin. Financial savings resulting from some form of energy efficiency improvement are shared over a period of time between the host and the party responsible for producing the savings. The energy efficiency improvement itself could be an investment in technology such as high efficiency lighting, new boilers and controls or a behavioural programme with no investment (less common). However, the implementation of this simple concept is fraught with difficulties in practice and can be effected by a range of different business models, contract forms and financial arrangements. This has led to the confusion around the ESCO and EPC/ESPC concept amongst policy makers, suppliers and customers.

The entity

The entity developing the projects is called a developer in any other field, and could be an ESCO, a Facilities Management (FM) company, a construction company, a consultant or a community group. The term ESCO is usually reserved for companies offering some kind of performance guarantee.

The contract form

The contract form can be one of several variants such as EPC, Energy Savings Performance Contract (ESPC), Managed Energy Services Agreement (MESA), Efficiency Services Agreement (ESA), or some other variant. All these types of contract encapsulate some form of energy services. In addition there is the form traditionally used in France and other parts of Europe, called ‘chauffage’ which involves the sale of heat at an all-in price which covers the capital costs of the boiler and distribution system, operations and maintenance costs, and fuel costs. Chauffage contracts, in their original form at least, do not inherently produce energy savings and in fact during the length of the contract the supplier is actually incentivized to sell the customer more heat, not less. It is true of course that the upfront installation of new heat generating plant, either a boiler or Combined Heat and Power (CHP), can result in an energy saving when it replaces an old inefficient boiler plant and distribution system. In this case the contracts can be said to be shared savings (in some cases) because the total outgoings including repayment of the capital costs during the contract were less than the total outgoings on energy and maintenance prior to the investment. In some cases however, total costs go up in order to pay for the capital expenditure, but these costs are transferred to operational expenditure. Much of the EPC business being done in the public sector such as the UK’s National Health Service involve this kind of infrastructure upgrade and catching up with maintenance backlogs.

Large providers of chauffage contracts in their home markets such as EDF and GDF-Suez in France traditionally used their large cash flows and balance sheets to finance projects, as well as start or acquire operations in new markets, although this is becoming more difficult for them. In the UK these operators entered the energy service market in the 1980s and dominated the market for many years, predominantly selling outsourced operations and maintenance of boiler houses and making savings mainly through automation and demanning. In the 1980s in the UK uniquely, this became known as Contract Energy Management (CEM).

As well as chauffage, selling heat, some energy service companies also expanded into the provision of multiple utilities including cooling, compressed air, treated water, effluent treatment and industrial gases. A leading example of this contract form is the series of Utility Alliance Agreements (UUAs) signed between Diageo and RWE Solutions UK (latter RWE npower) between 2002 and 2003 which were 15 year multi-utility agreements. Like some chauffage contracts, these multi-utility contracts produced large upfront energy and maintenance savings, which were split between the client and the contractor, with the contractor recovering all costs including capital expenditure over the lifetime of the contract. These UAAs are yet another contractual variation of the shared savings concept.

Increased confidence in performance will reduce the need for EPCs

The Investor Confidence Project is working to improve confidence in the performance of energy efficiency by standardizing the development process and documentation. As confidence in the performance of energy efficiency increases, the need for an ESCO to offer a guarantee is reduced – there is no point in a client paying for a guarantee – and they always pay for the guarantee somewhere – if they have confidence in the outcome. The advent of energy efficiency project insurance as offered by companies like Huber Dixon also reduces the need for performance guarantees and the Energy Performance Contract. In time we should move to a more “normal” market where developers develop projects, insurance companies underwrite them, delivery companies implement them and finance companies finance them – just like in the rest of the energy or construction sector.

Anyway in summary we all need to be careful when discussing EPCs and ESCOs. We always need to “mind our language” as it shapes our thinking. ¹ Also, never forget communication is hard – in any language.

As an aside on ESCOs we should not forget of course that as in many things the UK was the pioneer in sharing energy services – although not necessarily the best at exploiting the early lead. Boulton and Watt, using the more efficient Watt steam engine, made a lot of money from the 1770s by replacing the inefficient engines in tin mines and taking one third of the savings in fuel over a period of 25 years. For that they truly deserve their place on the £50 note. Although the “no cure, no pay” option offered by Boulton and Watt was successful even they encountered problems we would recognize today – specifically those of Measurement and Verification and baselining.

“There was some local resistance in Cornwall, where the new engines were certain to save costs in pumping out water from the tin mines, ….., the ‘no cure, no pay’ terms offered by Boulton and Watt – based on one third of the savings in fuel over a period of twenty-five years – saved the day.”

Thomas Crump, The Age of Steam, p58, London, Constable and Robinson, 2007

Keynote address at DENEFF EFFIN event 25th March 2015.

On 25th March I made the keynote address at DENEFF’s (the German energy efficiency trade association) event launching the report on energy efficiency financing resulting from their EFFIN project. Here are the notes of my presentation – the slides can be found here.

Introduction and status report

Good Afternoon everybody.

I am very pleased and honoured to be invited to speak to you all at this critical time for energy efficiency and energy efficiency financing in Germany and in fact across Europe and the rest of the world.

Today I want to give a wide ranging view of where we are on developing the energy efficiency financing market – globally -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.

As I will be speaking about the Investor Confidence Project Europe, which is supported by a €1.9m grant from the Horizon 2020 programme I am obliged to show this disclaimer slide – I will take it that you have all read it.

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

– Those of us who have been working on energy efficiency for a long time have known that the potential for energy efficiency is huge. It is a massive untapped energy resource. Those of us on the inside have known that for decades but it is true to say that the scale of the potential has now been generally recognized. That is a step forward.
– The co-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. There was some great work by the IEA on multiple or co-benefits last year which I highly recommend. We still have a way to go on recognizing and valuing co-benefits but things are improving in that respect.
– We have growing interest in investing in energy efficiency from institutional investors. This is good news.
– However, despite these positive developments the growth of the energy efficiency financing market has been slow. Not just in Europe, but in North America, Asia and everywhere else that I go I encounter the same sense of frustration that things are not happening as fast as they need to.

As one of the bankers in the USA trying to do stuff in this market said: “the trouble with this energy efficiency business is that the ratio of conferences to deals is too high”.

If we think for a minute about what a healthy European energy efficiency market would look like – if everything was rosy – it would have the following characteristics:

– strong demand from building owners and investors for energy efficiency retrofits
– a 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.

Right now we don’t have those characteristics – and in fact I don’t think we have them in any market anywhere in the world.

The jigsaw of energy efficiency financing

Now, this is not one of my holiday photos that slipped into my presentation. Last year I went to Neuschwanstein Castle for the first time ever and I really enjoyed it – although on the day I visited there was so much cloud that we could not see the Castle from the ground.

My mother who is 82 likes doing jigsaws and so when I was at Neuschwanstein I bought her a jigsaw puzzle and this is as far as she has got (up until last Sunday at least).

Looking at the energy efficiency market makes me think of a jigsaw and it has at least six pieces – it is just as well it does not have 1,000 pieces:

– product offerings from the energy efficiency industry
– standardization
– the development gap
– supply side capacity building
– demand side capacity building
– and capacity building in the financial institutions.

I want to say something about each of these but I will start with standardization because that is the area that the Investor Confidence Project is active in.

Now we all know that standardization is essential if you are making cars in a factory or washing machines or in fact any other manufactured product.

Of course people forget that banks are also factories – banks and other financial institutions cannot operate at scale without standardization. Every financial market, whether it be mortgages, car loans or credit cards, needs standardization.

It is not just me saying this. I know that some of you are very familiar with the EEFIG report and indeed some of you contributed to it.

The EEFIG report concluded that standardization was a key factor affecting both the demand and supply of energy efficiency financing.

The Joint Research Centre of the Commission also came to similar conclusions and also highlighted:

– high transaction costs
– the difficulty of predicting savings
– the lack of standardization.

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

– “energy efficiency projects do not yet meet the requirements of capital markets”
– “no two projects or contracts are alike”
– “Say you have 1,000 energy efficiency projects, Standard & Poor’s would have to read 1,000 documents to assess the risk. Fees won’t pay for that level of review.”

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

Energy efficiency financing compared to energy financing

To sum up let’s look at the whole area of energy financing – and I mean energy financing not just energy efficiency. This is what I see.

For oil and gas projects, if you happen to own an oil or gas field, the ways of developing and documenting the project are standardized. You have to hire a Competent Person who will be a geologist and who will follow strict guidelines set down by groups like the Society of Petroleum Engineers and if you have an oil and gas company floated on a stock exchange then the use of certain standards is required by the exchange itself. Oil and gas financing is entirely mainstream. There is a large volume of money available for oil and gas projects from a wide range of sources – although of course this may reduce with the divestment movement.

Now let’s look at renewables, solar and wind. Twenty five years ago when I did some early wind farm projects in the UK the same was not true of renewables, we made it up as we went along and there was only one bank in London we could go to – and they pretty much made it up as they went along. Nowadays of course funding renewables is as standardized, and almost as mainstream as oil and gas and you can go to multiple sources for money.

However, when we look at energy efficiency projects, here represented by the Empire State Building retrofit project, 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.

The Investor Confidence Project

So let’s consider the Investor Confidence Project which is a direct response to the lack of standardization. I want to give you a flavor of the Investor Confidence Project, what it is and what has been achieved in the US, and then talk about the Investor Confidence Project Europe project. Our German representative, Dr. Frederic Brodach of Plus Ultra, is here today and he will be able to talk to you about the project in German and give you more details today or in future.

As we have seen there is currently a lack of standardization on the way that energy efficiency projects are developed and documented. Here we see three different projects that use three different routes through what we call the alphabet soup of different standards and practices.

The lack of standardization imposes several negative things:

– greater performance risk
– higher transaction costs
– financial institutions cannot build capacity around ad hoc processes even if they do want to invest in this area
– financial institutions cannot aggregate projects, aggregation is essential because we know that energy efficiency projects are small compared to the needs of the institutional investors. To get to the debt capital markets and access cheap money we need to aggregate projects.

The Investor Confidence Project Energy Performance Protocols organize the process into the different stages of developing and implementing a project and for each stage define the standard or combination of standards and best practices that should be used. It is not about writing new standards but rather about standardizing the process – organizing the alphabet soup to give more uniformity.

The Protocols are developed working with financiers, building owners, project developers, government agencies and utilities. It is an open source project co-created by the contributers.

In the US six Protocols have been launched and are now being applied in real projects and programmes. They cover different sizes and types of projects in commercial and residential buildings.

As well as Protocols the Investor Confidence Project is also developing accreditation for Project Developers, and they now the first eight accredited developers. There is also a programme of accrediting software, that is project development software that automatically follows the Protocols. In the US they have six accredited software providers and I can tell you that we already have two European software providers working on software that will be ICP Europe compliant. Finally there is a Quality Assurance programe and very soon the ICP will announce its first QA providers in the US.

All of these components come together to make a project “Investor Ready Energy EfficiencyTM”. The final output is a badge, a seal of approval. When we talk to investors, including some of Europe’s largest real estate investors and lenders they say that is what they want – a stamp that gives them confidence that a set process has been followed every time.

So let’s look at the Investor Confidence Project Europe. In our project, which is supported by Horizon 2020, we are focused on getting early adoption of European Protocols in five countries: Germany, the UK, Portugal, Austria and Bulgaria. We will go beyond those countries – and already are – but they are our immediate priorities under the grant.

We have an Investor Confidence Project Europe Steering Group which provides direction and oversight and includes some of Europe’s largest energy and efficiency companies, major lenders and investors, important trade associations representing the energy efficiency industry, and government agencies.

We also have a network of nearly 50 allies already. Please sign up on the website – www.eeperformance.org/europe

It does not cost you anything and gets you in the conversation.

Note these two red boxes – this is an example of how the Investor Confidence Project has already helped put projects in touch with an investor. SEA, an Italian ESCO, was looking for an investor in residential projects and we put them in touch with Joule Assets, a US investor now active in Europe.

The Investor Confidence Project Europe is in three phases:

– creating the tools
o protocols
o accreditation
o labels
o open data

– take the tools to market
o private investors
o public programmes
o developers
o property owners
o utilities
o associations

– be a catalyst for change by:
o inspiring action
o connecting projects to capital
o create working examples of functioning markets for energy efficiency finance

Capacity building on the demand side

Now let’s go back and look at the other parts of the jigsaw – starting with capacity building on the demand side. We have to acknowledge that lack of demand for energy efficiency retrofits is a problem that we have to address. Generally people do not wake up in the morning and say they want to buy some energy efficiency.

We also have to acknowledge something that is hard to accept for those of us who have spent our lives in energy efficiency. Energy efficiency is just boring – for most people most of the time it is extremely dull. People are not interested in energy efficiency or if they are it is only for a fleeting moment now and again. Only when we recognize that can we move forward.

One the most promising ways of making energy efficiency less boring is to talk about the layer cake of benefits that come from energy efficiency. It is always good to talk about cake – especially in Germany. Those co-benefits, or non-energy 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 things such as; improved productivity, increased retail sales, increased quality and reduction in hours lost at work, and they are increasingly being recognized and they are just starting to be measured in a few leading edge organizations. The important thing here is that often the value of these benefits will be much larger than the value of the energy savings alone. Also they are often more likely to lead to a management decision to invest in energy efficiency. For example, when a retailer recognizes that LED lighting retrofits lead to an increase in sales (as some have done) and starts to value that benefit, you can be sure that energy efficiency rises up the management agenda. That subject will be on the board agenda, things will happen.

Capacity building on the demand side should include ISO50001 – which is great for putting in place an energy management system, the importance of valuing the co-benefits, the massive benefits that can come from true integrated design, and consideration and evaluation of outsourced energy services that bring with them external expertise and finance.

Mind the development gap

Let’s talk about the development gap. Anyone familiar with the London Underground will know – we have an expression “mind the gap” – which means don’t fall down the gap between the train and the platform. The gap I am talking about is the gap between potential projects and bankable, actionable projects. We know the potential is huge but still there is a lack of high quality bankable projects, particularly at large scale.

To overcome the development gap requires:

– vision about what is possible at the top level
– technical and financial skills – particularly around the issues of portfolio optimsiation and sub-project interactions
– finance – developing projects, especially big projects, costs money, money that is at risk
– standards – we need to develop multi-building projects all using the same standards which is where the Investor Confidence Project comes in.

We need to learn how to develop these kinds of projects, how to finance the development process and how to increase the rate of project development. In energy supply projects there are established ways of developing and financing the development process but we don’t have that for large scale energy efficiency projects. There is real potential here in cities for instance, which can bring scale quickly, but financing the development process is difficult for cities with tightly constrained budgets.

Product offerings

Let’s talk about the product offerings from the energy efficiency industry.

Let me say that Energy Performance Contracts 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 (public sector) and originally to exploit certain sources of finance that are available in the US – Federal money or municipal bonds. The EPC model has never grown to the extent that people thought it should but when you analyze it there are good reasons including:

– 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

In summary they may work in the public sector but they don’t work in the commercial sector. For too long the energy efficiency industry, new entrants and some policy makers have pushed EPCs as if they are the answer to everything – let me tell you that they are NOT.

Innovation is appearing around the world in the form of services agreements such as ESA, MESA and MEETS and we need more innovation like that.

Building capacity on the supply side

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 the project, not just at the end. As I have said we need to learn how to develop projects at scale and be innovative. Most importantly the energy efficiency needs to understand markets better and sell co-benefits. Traditionally the energy efficiency industry has been very bad at understanding the market’s real needs and motivators and has relied on the rationality theory; “it is a two year payback period project and therefore you should do it – it is a no brainer – it is low hanging fruit”. Well, as the real marketing experts know, people are not rational.

Building capacity within financial institutions

Within financial institutions we need standardization and capacity building on:

– the co-benefits – what they are and how to value them
– technologies
– contract types
– standards
– available support for development and project work such as EC or national programmes.

Assembling the jigsaw

So now we have considered each of the pieces in turn we have to put the whole jigsaw together.

By the way, you can use a laser cutter like this one to make very precise jigsaw pieces but if you don’t have all the pieces you can’t finish the jigsaw. Work on all the pieces together. I think many of the programmes around the world have focused on making one or two very precise pieces but not thought about the other pieces of the puzzle, and then they have problems deploying money.

A few words on policy

I was asked to comment on policy in this area. I am always reticent to talk about policy in other countries but I have some general views that apply everywhere. They are as follows:

– reward all the value streams i.e. all the value that is created by energy efficiency projects, not just the energy component
– design the energy market to value and pay for all the benefits
– consider benefits that cut across normal Ministry or departmental boundaries e.g. spending money on energy efficiency can save money in health budgets. In the UK we are experimenting with doctors prescribing insulation or new boilers to people who are in fuel poverty and as a result have lots of heath problems. It actually works, spending health budgets on insulation actually saves money because after the works are done, the people visit the doctor or the hospital less frequently. Institutionally this is difficult to do but policy makers need to make it happen.
– Ensure that supply-demand decisions are balanced e.g. network operator regulations. In the UK the DNOs acknowledge that in some cases investing in demand side measures like energy efficiency and demand response is more cost-effective than investing in supply side infrastructure upgrade projects such as putting in bigger cables. However, the regulations have not caught up with this and the DNOs are still only incentivized to invest in supply side assets. If we can change that it will have a large effect.
– We need to move away from top down programmes towards creating a real market for energy efficiency. For forty years governments have been carrying out a big experiment in energy efficiency based on the notion that it is somehow special and needs exhortation, public subsidies, energy company obligations or top-down bureaucratic programmes. We need to move towards creating a real market for energy efficiency and we are starting to see the tools for that appear such as Measurement & Verification, new contract forms and the Investor Confidence Project.
– Stable policies or clear policy trajectories are always good. In the UK we have had examples of policies being changed at short notice for short term political expediency. That does not work.

The future

So what about the future? This by the way is a German cigarette card from the 1920s or 1930s which shows two ladies who appear to be using Skype on an early form of iPads! Amazing. If anyone can get me an original set of those cards I would be grateful.

So back to my jigsaw. I am positive and I think we can complete assembling this jigsaw.

What would it look like when we finish the jigsaw? We talked earlier what would a healthy energy efficiency market would look like and how we don’t have that now – clearly if we do build the jigsaw we will have those things in place and there we can focus on other problems.

At that point energy efficiency financing will look just like energy supply financing – it would be:

– standardized
– mainstream
– large volume
– and be available from multiple sources.

In short there would be more deals than conferences and that is a future I would like to live in.

Thank you very much. I look forward to talking to you further and working with you in future on the Investor Confidence Project Europe and putting together the other parts of the jigsaw.

Dr. Steven Fawkes
DENEFF event to launch the EFFIN project report, Berlin, 25th March 2015

Disclaimer

The Investor Confidence Project Europe has received funding from the European Union’s Horizon 2020 research and innovation programme under grant agreement No 649836. The sole responsibility for the content of this presentation lies with the authors. It does not necessarily reflect the opinion of the European Union. Neither the EASME nor the European Commission are responsible for any use that may be made of the information contained therein.

On the 17th March I was on a panel at a meeting of PRAESEG (Parliamentary Renewable and Sustainable Energy Group). The question being addressed was “Ahead of the Election in May, what should incoming government’s priorities be for energy efficiency?”. The other speakers were Dr. Nick Eyre, Dr. Joanne Wade, Simon Roberts and Catrin Maby, all of whom made great contributions with a lot of cross-over. Here are the notes for my remarks – which of course probably ended up somewhat different in practice.

First of all I should start by saying that we should never say or believe that energy efficiency is not working – the evidence is now firmly in and what it shows is that we have decoupled energy use from GDP and that over the last 30 years improved energy efficiency has provided more energy services than any other source of energy. We need to say that loudly and often so that decision makers really get it and move away from the near total domination of the energy debate by the energy supply network. The thing is, however, is that we have achieved all that without really trying and now we need to start trying harder.

What we need to talk about now is how to accelerate the improvement in energy efficiency – at the risk of using an inappropriate analogy it is like we are still in 2nd gear doing 10 mph on a B road and now we need to get into top gear and get moving on the motorway. The end result we want is an acceleration in the reduction in energy intensity (energy/GDP) as we all want a growing economy – having that growing economy with falling energy use is starting to happen and accelerating that decoupling of energy and GDP would help us achieve our energy goals of increased security, reducing environmental impact and having lower energy costs. And as we now know – but has not yet been widely recognized – improving energy efficiency brings with it many valuable co-benefits such as improved health, productivity or customer satisfaction. In fact the co-benefits are often worth more than the energy benefits – they just don’t get recognized, measured or recorded. As well as standing up and shouting that energy efficiency is working we should always talk about co-benefits whenever anyone mentions energy efficiency. Indeed, in many situations the co-benefits will be more attractive to the decision maker than the energy and cost savings.

Governments over the past 40 years have been conducting a grand experiment with the energy efficiency industry in the belief that energy efficiency is something special that needs government action and that it can only be helped by public expenditure, some kind of grant or some kind of government designed programmme. We have had government exhortation campaigns, additional taxes, cumbersome reporting schemes, energy company obligations and clumsily government designed programmes like the Green Deal. These approaches smack of 1970s – or even 1950s – state intervention and just impose a cost – they don’t create a real market for energy efficiency. They are all top down approaches and they will always be limited in their effectiveness.

At this point, we can say that the programme-centric approach to energy efficiency does not appear to be working fast enough, nor can it scale sufficiently. Furthermore, it is highly vulnerable to cyclical political changes, as we saw with the knee-jerk changes to ECO in response to Ed Milliband’s announcement on freezing energy prices and the “green crap” comment. Even if the top down approach worked effectively it can never scale to the level needed given limits on public expenditure and sensitivity to energy price supplements. Even moderately successful scenarios will require an investment in energy efficiency that that vastly exceeds even the most optimistic assessment of available public funds but is easily within the bounds of the debt capital markets. The BPIE estimate that for Europe the required capital just to renovate buildings is €3.5 trillion across Europe, €90 billion per year. We have to design things to mobilize private capital. It is time to move away from the top down programme approach and try something different.

Energy efficiency is a resource just like any other energy resource. It delivers clear public benefits (in addition to enormous private benefits such as improved comfort and lower bills). It creates local jobs, reduces the need for new power plants, improves health, and moves us closer to meeting our emissions goals. We need to think about efficiency just like any resource. Getting paid for the value that efficiency resource creates is not charity; instead, monetizing these unrealized benefits simply aligns interests and pays for this distributed negawatt power plant by rewarding the homeowners and companies making the actual investments energy efficiency — just as if they were building new generation capacity.

Energy efficiency is the cheapest way of meeting energy services but in most cases – if not all cases – there is not a market for energy efficiency in the way that there is a market for energy. Energy generators can forward sell their projected output to get project finance – we need to make a market for efficiency that works like the market for energy. By creating a more transparent marketplace for energy efficiency, we can increase private funding, increase flexibility in delivery, and truly add efficiency to the pool of resources that will make up the future more dynamic energy system.

We have the elements now in terms of smart metering, low cost communications, low cost sensors and M&V protocols, to have energy efficiency meters. Energy efficiency meters are in development and we need to get these regulated just like energy meters and turn them into fiscal meters.

An essential part of building the market for energy efficiency is to standardize the process of developing and documenting energy efficiency projects – at the moment every developer does it differently – this is the aim of the Investor Confidence Project Europe which I chair. As well as project development we need to develop tools for measuring performance of efficiency projects – we have the basics – we need to measure the performance of projects in a standardized way and keep open data so that investors can see the results. At the moment there is an act of faith that it works.

We must engage private capital to invest in this emerging new market that will value energy efficiency as a reliable resource, and we must pay for these investments in the same way we finance power plants — through project finance that monetizes cash flows from savings, rather than the balance sheets of the building owner.

It is also important to talk about demand generation – we hear all the time about “low hanging fruit” – it is time to drop that analogy. A better analogy used by my colleague Matt Golden in the Investor Confidence Project is that the potential is more like wild strawberries, or perhaps in the UK case blackberries – it takes lots of people on their hands and knees a long time to fill a basket. Just relying on the inherent cost-effectiveness of EE is not sufficient – it is not working – there is very low demand despite the fact that it energy efficiency is cost-effective. Just relying on programmes does not work either.

To help drive demand we need to reward people for what we want – reduction in energy use and increase in comfort in fuel poverty and not reward people for creating bureaucratic processes. These processes in top down programmes have to be defined centrally and end up imposing huge costs. In California for example the house retrofit business used to have a customer acquisition cost of a few hundred dollars, then when they introduced a Green Deal type of programme the average acquisition cost went to $14,000 while the average project capital expenditure was $14,000 – which is totally crazy.

The coming paradigm shift would not the eliminate the need for public and funding – particularly in the early days – and regulations to ensure a fair and transparent market, but it will require a different, simplified regulatory role – a role that looks essentially like the public sector involvement in every established market.

• Is the Government at risk of missing the full potential that energy efficiency can play in helping achieve its energy policy goals? There is a real danger around energy security at the moment. The UK’s (and Europe’s) energy dependency is getting worse which has geopolitical as well as economic costs. The UK government has been complacent on this issue, citing the fact that we don’t buy any gas from Russia while ignoring the Russian coal imports and Gazprom’s strategic investments in gas suppliers and pipelines. Energy security is another area where the use of traditional language limits our thinking on the subject. We don’t actually need energy security, security over the physical flow of energy, but we definitely do need security of energy services. Thinking about the subject in this language expands the options and helps to bring energy efficiency into the equation.

• Does Government need to set out a more ambitious, coherent strategy to make the UK more energy efficient? Yes – we need to put energy efficiency truly at the heart of energy policy and make sure efficiency is truly considered as an alternative. One issue here is the historical reality that DECC (and all equivalents like the US Department of Energy) have a very strong historical link to nuclear power (50% plus of DECC budget spent on nuclear issues) and of course are subject to very strong continuous lobbying from the energy supply industry. It was only last year that the demand-side industry managed to get one person seconded into DECC for the first time. Maybe the demand side and energy planning should be entirely separated from DECC or its equivalent in order that modelling and decision making can be made entirely based on demand side modelling rather than supply side modelling.

• Are sectoral energy efficiency targets needed? Yes – we need to have an overall energy per GDP target broken down into sectors, then bring in the sectors to ensure they own the targets and develop sector specific and appropriate plans. The overall targets should be driven by reducing energy dependency.

• Is there a need to link energy efficiency policy with other demand side action, such as decentralised energy, demand side response, smart grids etc? A few years ago, with the CHPA (now the ADE) we coined the term D3 which stood for Demand Management (EE), Demand Response (DR) and Distributed Generation (DG). They are all demand side resources which need to be encouraged. Smart grid is a widely mis-used term – smart distribution systems and end use are tools to enable demand side resources but unless D3 is encouraged then smart grid is just a piece of technology, or lots of technologies, without much application and therefore once public money disappears the initiatives will disappear.

• Does the Government need to set in place longer term energy efficiency strategies for the business and public sectors? Long term stable strategies are always good for investors and industry players. We need a 5 and 10 year target and frequent reporting against the target. Given the energy security situation in relation to Russia and the Middle East we may not have 5 to 10 years but we need to get on with it. Importing >50% of our energy limits our degrees of freedom and is building in problems down the track. We need to use this period of low oil prices to increase investment in energy efficiency. Relying on government programmes or supplier obligations means that they can’t be stable.

• What might a revamped Green Deal and supplier obligation look like? Just pay for what we want which is a) reduction in energy use b) reduction in fuel poverty c) whole house approach – let the market innovate and decide. Don’t favour any particular technology. On the supplier obligation just get rid of it altogether and replace it with payments for results. Charge a tax on energy suppliers, ring fence it and spend it on buying efficiency. Or require every supplier to always review demand side options ahead of supply side options.

These remarks were significantly based on a series of articles by Matt Golden.
Let’s Get Real: The Energy Efficiency Industry Can Do Better
Why Top-Down Efficiency Programs Are So Expensive and What We Can Do About it

Gwyneth Paltrow made the term “conscious uncoupling” famous when she split from Coldplay’s Chris Martin (ed. who he?) but now perhaps the time has come to adopt it in the energy world. I have written before about the decoupling of energy use and GDP (see here). When I was first learning about energy and economics in the late 1970s it was an article of faith that the link between energy use and GDP was fixed and therefore that as economies grew wealthier they would use ever more energy. This fed into (and still feeds into) all official projections of energy use (see here for example), as well as the technical fantasies of the government of the day and bodies such as the old CEGB. The Department of Energy, for example in 1976 estimated energy demand by 2000 would be up 43%, instead it rose by 3%. More recently the decision to proceed with Electricity Market Reform was primarily driven by unrealistic scenarios of greatly increased electricity use – for details see “A Corruption of Governance” by ACE and Unlock Democracy here.

Over the last few years there has been mounting evidence that the link between GDP and energy use has been broken in mature economies including the UK, Europe and the USA. The latest figures from DECC (see here), released on the 26 February, just add to this evidence base. To quote: “Primary energy consumption on a fuel input basis decreased by 7.0 per cent, and on a temperature adjusted basis, was down 3.1 per cent continuing the downward trend of the last nine years.” About 1 per cent of this change (both temperature adjusted and unadjusted) is accounted for by a switch from coal generation to wind as wind and solar are measured as energy output, while losses are recorded in transforming coal to electricity.

UK GDP grew 2.6 per cent in 2014 and so the energy ratio (energy consumption per unit of economic output) has fallen by around 5.6 per cent, above the average of 3 per cent per annum since 2000. UK GDP grew 67 per cent between 2000 and 2014 while primary energy consumption (temperature adjusted) fell by 18 per cent.

In Europe there is a similar story. According to Eurostat Europe’s total gross energy consumption is down 9 per cent from its historical peak in 2006 and is currently at a level last seen in the early 1990s (see here).

This is a great result but I probably should have titled the piece “unconscious uncoupling” because I don’t think we have been very conscious about accelerating energy efficiency over that period. There is an underlying “natural” rate of improvement in energy efficiency that comes about through the introduction of more efficient products and buildings as capital stock turns over – that has been going on over centuries of technological progress. Then overlaying that is the “accelerated” rate of energy efficiency improvement that comes about from active policies and programmes to encourage further gains. I am starting to believe that we have actually improved both of these over the last few years as entrepreneurial talent and investment has increasingly moved into energy efficiency technologies and regulations have forced underlying assets like cars to be inherently more efficient. Having said that we have not yet aggressively set out to accelerate the rate of improvement.

Having sounded a positive note, it is clear from surveying the current energy and energy efficiency scene that there is still a massive potential to improve overall energy efficiency and that there is still too much focus on energy supply side solutions. Efforts like the Investor Confidence Project and new contract structures are helping to make energy efficiency more investable, making it look more like any other source of energy services, and if we can deliver these solutions at scale then we will see further significant improvements in energy per GDP, probably at a level that will greatly surprise the energy supply establishment and governments.

There were some other interesting numbers in the DECC statistical release. Fossil fuel dependency has fallen to 83 per cent, a record low. More alarmingly, given the long-term prospects for the global energy market, and the more immediate geopolitical concerns around Russia and the Middle East, is that import dependency once again increased, reaching 48.7 per cent in Q3 2014, up 5.7 percentage points from Q2 2014 – despite the growth in renewables. Our import dependency, driven by rapidly declining UK Continental Shelf oil and gas production, is a big concern as it leaves us vulnerable to supply disruptions and limits our degrees of freedom on the global stage – a particularly important point at this time. In Europe the energy security situation is even worse with import dependency of 53 per cent and an expenditure on energy imports of more than €500 billion in 2013, that is €1.3 billion a day that was shipped out of Europe. Even with the fall in oil prices this is a major security and economic issue.

It is increasingly clear that our best solution to import dependency and the associated energy supply risks, as well as other energy supply related problems, is to reduce energy demand by aggressively targeting even larger rates of reduction in energy per GDP through accelerating energy efficiency across the economy. Doing so would bring multiple benefits at individual, local, national and global levels.

To learn more about conscious uncoupling see here and here.