Over the last year we’ve participated in an increasing number of interviews, conferences and panels discussing the energy-efficiency finance market, including commercial PACE and on-bill repayment programs. Awareness is high, with many policy, government and utility executives generally convinced that if low-cost capital were more readily available, energy-efficiency adoption across residential, institutional, government and commercial/industrial markets would surge.
Limited access to low-cost capital is the market impediment.
Or is it?
Do buyers really believe what they’re buying will work, such that low-cost financing is all it takes for them to start buying more energy-efficiency?
The $5 billion ESCO market, which utilizes low-cost tax-exempt bonds to finance energy-efficiency investments, has been growing at 15-20% per year. Not the highest in its 40-year history, but not too bad in today’s market. In these financings the ESCO customer tells potential bondholders that the energy saving investment will provide future cash flow, that in turn can be used to pay back their bonds. The bond market makes the credit decision. The ESCO provides its “guarantee” for the energy savings and installs the project, getting paid with the proceeds from the bond offering.
Interestingly, the number of times an ESCO has made a payout on their guarantee is stunningly low. The reason is that ESCOs only insure what they control, i.e. their energy calculations. And before any project is started the customer must sign off on the building operating assumptions that drive the energy savings calculations. So in most cases an ESCO really just guarantees that its math is correct – like fancy wrapping paper around an empty box.
But this ESCO guarantee is still required to make the public financing work.
Beyond the institutional market, is low-cost capital alone enough to catalyze the commercial and industrial market?
Consider this. Today most major corporations are already flush with cash on their balance sheets. And for those that aren’t, the last time I checked the cost to borrow money was pretty close to an all-time low. So you have to ask the question, do corporations really need lower cost financing?
Of course some do. But this could be negative self-selection, with only companies in poor financial health taking the offer. In which case lenders might be nervous – and require some sort of guarantee to backstop their low-cost capital lending to a high-risk company.
Typically Groom Energy’s customers pay us outright to perform our installation upgrades. The capital comes from their annual capital budget or their on-going maintenance or production budgets. While we’re often asked to propose both a purchase and a financed option, not surprisingly companies rarely choose the latter for fast payback projects.
We’ve deliver financing three different ways:
1. Shared Savings: With long-standing customers we’ve used our own shared-savings financing whereby we install, own and maintain assets and get paid over time as the energy savings materialize. With this approach (called our CESA) we’re responsible for everything – designing, installing, maintaining the system, the utility incentive and the credit risk. The meter is the guarantee and tells our customer how much they owe us. But CESA isn’t for everyone – it requires a performance contract-like agreement and a sophisticated customer who must provide us legal lease access to their facility.
2. Capital Leasing: Occasionally we also bring in an outside capital leasing partner who makes their own credit decision on a general purpose loan to our customer. During the credit review process our project development team is left hoping this wasn’t negative self selection In taking on the loan our customer relies on our energy model to assure them that the project will be cash-flow positive (or at least cash-flow neutral.) If we’ve managed our project development process appropriately (using metering, a demonstration implementation, and involved their local utility) they’re typically confident that our model is close to reality. They trust us.
3. Utility On-Bill Finance: Where it has been available we’ve brought in the customer’s local utility to offer a project incentive and an on-bill finance option. We just announced this recent project with National Grid utilizing this model. It’s powerful because the customer already has a relationship with their utility, the utility reviews our energy model before supporting it and the customer trusts that we’re not geared toward gaming them. We’re all in it together.
This has been the most efficient of all three options and the reason we’re excited about the emerging on-bill repayment program in CA, which will expand the number & size of project financing available.
Beyond the financing question, occasionally we hear the question “will you guarantee it?”
This always leaves our project development team wondering if our initial two-year payback estimate looks too good? Or maybe the customer has previously been burned by another vendor?
Either way they don’t yet trust us.
With any energy-efficiency model we can always change our assumptions to make it look better or worse. The art of it is to make sure our customer participates with our engineers in building assumptions, be it for a single system like compressed air, RTUs or lighting or interdependent system like air handlers with VFDs attached to a manufacturing process. Everything we model must be done collaboratively – with our customer’s input and guidance.
Some customers take a hand’s off approach, listening to our savings estimates but instead requiring that we fully meter everything, engage with a heavily negotiated contract that puts the screws to Groom Energy if we’ve over estimated the savings, or even defers payment if savings have yet to materialize.
Sounds like a fun and trusting relationship, right?
Fortunately, most of our customers realize that if Groom Energy doesn’t deliver the savings, the biggest pain with be ours, as that customer will won’t work with us in the future. They know based on our customer resumé that we’re absolutely goal aligned to over perform.
But in the end, if they’re still asking “can you guarantee it” we have failed at establishing trust.
In which case they’re unlikely to adopt – with us, or any other provider.
Trust and low-cost capital together are the most powerful combination for accelerating energy-efficiency adoption.
Today I’m attending the 27th annual NAESCO conference in Phoenix, AZ, a conference that serves as an annual checkpoint for the ESCO industry.
Yesterday’s panel, “Does the ESCO Business Model Version 2010 Still Get The Job Done?” featured a number of ESCO legends (senior executives with 20+ years of industry experience) and each openly discussed how the ESCO market is evolving, good and bad, and where things may be headed.
Four topics stuck out:
1. Is the Stimulus program finally done? Thank god…With their focus on performance contracts for tax-exempt MUSH (municipal, university, schools, hospitals) customers, ESCOs were slowed in 2009/2010 by the ARRA/Stimulus program, which tentatively assigned “free” grant capital to their customers. (We heard this last year as well) In practice customers paused on ESCO contract decisions while waiting to see if they would get a grant. One executive said this market stall cost his firm “$50-60 million in project bookings last year alone.”
2. Lobby like the Solar Industry. The solar lobby in Washington and around the country has successfully convinced several state PUC’s to mandate green energy production (i.e. you must buy solar PV), and gained huge solar PV specific ARRA dollars. One panelist commented that “although it makes no sense to put a solar array on an energy inefficient building,” his firm was recently forced to do exactly this as his customer was told by the DOE they “could only get money for a solar array” (which produced a 30-year return on investment). How about the DOE mandating an energy efficient building retrofit with a 10-year return?
3. Its a BIG market – if the capital is made available. According to the McKinsey estimate, there’s a $520 billion total available US market for energy efficiency upgrades. Retrofitting the whole market would generate $1.2 trillion in savings, or a $680 billion stimulus to the economy. Like the US Federal government stepped in for TARP or General Motors and will ultimately gain back their lendings through loan repayment and sale of GM stock in their IPO, a Federally delivered loan program for energy efficiency retrofits could be a massive catalyst.
4. We sell “stuff” because “our customers need stuff.” The ESCOs have a great model, enabling MUSH customers to replace their aging infrastructure. Their customers don’t buy energy savings (like C&I customers), they buy stuff. It just so happens they pay for this stuff with operating savings from their energy bills. MUSH customers have even less money today than a few years ago, but they do have the capacity to borrow through issuing tax exempt bonds. Which means they can pay for the stuff. Even in the rare case where a municipal customer goes bankrupt the ESCOs know that that the customer “will always be around.” And after the bankrupt municipal bonds get restructured? They’ll buy more stuff. What a wonderful model.
I’m here in Los Angeles at the Beverly Hilton for the 26th annual NAESCO conference called Energy Efficiency, Kicks it up a Notch. Many of the attendees have been involved in the ESCO industry for a long time and yesterday’s discussions were a lot about “our time has finally come.”
With pending climate legislation, challenging economic times, a higher motivation for becoming energy efficient and a recognition that energy efficiency is lower cost than renewable energy, all the stars seem to be aligned. The consensus here is that over the next few years this industry could experience tremendous growth, heading from $5 billion to $15-30 billion depending on who you’re talking to….or maybe not.
In general, the ESCO industry provides turn-key energy efficiency upgrades for tax exempt customers such as states, cities, municipals, schools and hospitals. The ESCO identifies the savings through an investment grade energy audit, installs the energy efficiency upgrades, provides a financial guarantee that the energy savings will be achieved, and the customer pays the ESCO with proceeds from their issuance of tax exempt bonds.
With the introduction of the American Recovery and Reinvestment Act (ARRA), these same customer prospects are now the potential recipients of lots of grant $$$$$$. This additional “free” money means they should be doing even a greater number of projects, right?
Today there remains a lot of confusion about how exactly they can spend these grants if they receive them. Maybe they should use the ARRA money just to buy these upgrades instead of borrowing to pay for them? Can they co-mingle the ARRA grants with State grants through the EECBG program? Can they buy down part of the project cost and issue less debt? And, by the way, the reporting and administration hooks that come with any of these grants are even more confusing. All of which has contributed to the slowing of decision making….
Which leaves the ESCO’s thinking maybe this wasn’t such a good thing after all.