Wednesday 26 February 2014

There is a tangible sense of frustration at the slow progress being made in scaling up the European energy efficiency market. But traditional players need to learn from the more dynamic markets in the US or risk being overtaken by rivals with new business models.

 

The science fiction writer Arthur C Clarke once said: “New ideas pass through three periods: 1) It can’t be done; 2) It probably can be done, but it’s not worth doing; 3) I knew it was a good idea all along!”

 

The idea that energy efficiency can be a major factor in addressing environmental and economic problems, and benefit from its own major financing market seems to be somewhere in stage two – at least for those outside the space.

 

Now efficiency is rising up the policy agenda as practical cost and technical problems with low-carbon energy sources, both renewables and nuclear, become more obvious.  There has also been increasing commitment from financial institutions to find ways to deploy money into energy efficiency. But at the same time the market remains small and the early participants report problems finding good projects, even in the US.

 

Right at the centre of this problem/opportunity is the Esco industry which met in January for the 10th annual Esco Europe conference, in Barcelona.

 

One of the problems with energy efficiency is the plethora of acronyms, and the first one to address is ‘Esco’, the definition of which remains a mystery to many, including many in the industry. Different definitions abound but fundamentally an Esco (energy service company) offers EPCs – energy performance contracts. EPCs guarantee a set level of energy savings, sufficient for the client to pay back any finance taken out to fund the capital cost of the energy efficiency projects, which are still often called ECMs – energy conservation measures.

 

The Esco/EPC combination grew up in the US in the 1980s, and in Europe and elsewhere is often seen as a model to be replicated. Yet the EPC model in the US has largely been in the Mush (Municipal, University, Schools and Hospital) and Federal government markets. Although it is growing, it is only worth $5 billion a year, with most financing being through municipal bonds and direct from federal budgets.

 

Attempts to transfer the Esco/EPC model to the commercial sector have not been successful due to its complexity and high transaction costs as well as problems such as the split incentive.  The current level of activity needs to be compared with a potential investment opportunity of $100 billion in the US Mush market, (as estimated by the Lawrence Berkeley Laboratory) and what Deutsche Bank estimates to be a $280 billion investment opportunity across all real estate in the US.  According to the International Energy Agency’s first Energy Efficiency Market Report there was £300 billion of energy efficiency investment in 2011 and, given the potential still to be exploited (‘the efficiency gap’), this could grow significantly. The World Business Council for Sustainable Development estimates that energy efficiency could become a trillion dollar market.

 

So, we have increasing policy attention on energy efficiency everywhere, we have more money being committed to energy efficiency, we know the potential is huge, and more deals are slowly being done. But there is an overwhelming sense of frustration that not enough is happening, and in the European Esco industry that frustration is palpable.

 

Several sessions at Esco Europe focused on how to transform the Esco market, with presentations from across Europe.  From these, and experiences in North America and Asia, it is clear that the issues are the same everywhere: small project size, insufficient volume to access the bond market, high project development costs, lack of capacity in both the customer base and financial institutions, and insufficient confidence in energy savings.

 

Measurement of savings has always been an issue for many, but we have had the solution for years in the shape of the IPMVP (International Performance Measurement and Verification Protocol), which is in use globally.  A good Esco contract will have a Measurement & Verification (M&V) plan audited by an independent M&V professional.  The availability of near real-time measurement enabled by reduced cost of sensors and IT is reducing M&V costs.  Organisations with good energy efficiency programmes should be measuring the results of their own efforts anyway.

 

The traditional Esco/EPC model can work well in specific segments of the market and above a certain project size, notably the public sector, and it can bring many advantages other than energy efficiency, including infrastructure upgrades, catching up with maintenance backlogs, and reduced operations costs. In other market segments, such as multi-tenant commercial offices it does not work, and the Esco industry and finance industry need to acknowledge this and innovate new models.

 

There are signs that a wave of innovation and growth in efficiency financing is starting to build, mainly in the US where the use of financing models such as PACE (a charge on property tax), Efficiency Services Agreements (ESAs) and Measured Energy Efficiency Transaction Structure (Meets) are growing. The European Esco industry and finance industry needs to learn from this rather than just focusing on the traditional Esco/EPC model.  If the incumbents don’t recognise this they will be overtaken by new entrants with new business models.

 

One of the problems of energy efficiency financing is that the efficiency industry does not speak the same language as the finance industry.  It was good that Esco Europe brought in more sources of finance than ever before.  From the public sector there was the EIB – which has made a big commitment to efficiency – the EBRD, which has always pushed the agenda in its area of operation, and the EU, which is supporting efficiency financing through its Horizon 2020 programme.

 

From the private sector it was good to hear from SUSI, a Swiss efficiency fund that recently closed a €65 million fund aimed at large building projects, and Joule Assets, a US company with a different model of financing residential retrofits, which recently announced a $100 million fund.  We need to make more effort to bring together the efficiency and finance industries and evolve a common language, and that requires “mashing” them together.

 

Markets cannot operate without standardisation. A presentation by Matt Golden of the Investor Confidence Project (ICP), which is supported in the US by NGO the Environmental Defense Fund, explained how the ICP is developing protocols for different building types that set out standards for developing and documenting efficiency projects.  It does not set out to design new technical standards – that task lies with the technical standards organisations – but rather to provide a common approach that investors can recognise and have confidence in.  It reduces transaction costs, facilitates a portfolio approach, and allows different actors, project developers, insurance companies, investors, M&V specialists, to do what they do best rather than trying to address the whole problem.  The Environmental Defense Fund is working with European partners to develop an ICP equivalent in Europe – a common approach would facilitate a global market and enable global investors to address efficiency.

 

It is clear from Esco Europe that activity in efficiency financing is gearing up but many barriers remain.  It is also clear that much of the energy efficiency and financing discussion focuses on what the public sector can do, and implies that increasing efficiency requires increased regulation and complex centralised programmes.  We need to move the focus to be much more about creating real markets that reward exploiting the efficiency resource by actually delivering megawatt-hours saved, rather than programmes in which governments specify expensive processes.  This is the real problem with programmes such as the Green Deal and, its equivalent in California which was recently reported as costing $15,000 per customer who then made an average investment of $18,000 – such high costs are clearly uneconomic and unsustainable.

 

Financial markets are made by buyers and sellers coming together and agreeing standards and protocols.  This happened in the energy supply industry many decades ago, in renewables from the 1990s, but is yet to happen in efficiency.  If we can do that over the next few years we will create a trillion dollar market and have a major impact on environmental problems.

 

This piece was originally published in Environmental Finance on 30th January

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Dr Steven Fawkes

Welcome to my blog on energy efficiency and energy efficiency financing. The first question people ask is why my blog is called 'only eleven percent' - the answer is here. I look forward to engaging with you!

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