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.
Last week I participated in a day long energy efficiency finance workshop, hosted and co-produced by Bloomberg’s New Energy Finance Group and the Environmental Defense Fund. Held at Bloomberg’s hip and upbeat headquarters, it had the feel of an investor conference, although most people in the room had yet to make one….
The folks at EDF have been following this emerging market, having introduced a white paper last year, along with my friend Brad Copithorne’s effort to develop a new On Bill Repayment model that will start in California and hopefully work its way across the country in the coming 12-18 months.
The day was kicked off by Dan Doctoroff, Former Deputy Mayor of NYC, now CEO/President of Bloomberg. Dan talked about how PlaNYC (introduced while he was in the NYC administration) is driving NYC building efficiency performance tracking, while investing $800 million of taxpayer capital over the next decade. Although the original program was focused on reducing greenhouse gas emissions, the designers are modeling an attractive 17% annual return on the city’s investment.
The disconnect of NYC needing to make these investments using taxpayer capital was the basis for the conference. Since energy efficiency retrofits like these have strong long term returns, outside private, not taxpayer, capital should be running after this estimated $18-20 billion market.
Dan/Bloomberg’s view is what’s missing is not the capital nor investor interest, but the market data. His point is that new financing markets require measurable data in order to assess risk, track performance and provide liquidity. Bloomberg, founded years ago as the first company to aggregate data, pricing calculators and buyers/sellers of bonds, sees similar characteristics today in the energy efficiency finance market.
But missing data is not the only problem. Each sub-sector is so different that there will likely be unique financing packages for each. The investment which allows a homeowner in Maine to add insulation is very different than the one which pays for a new boiler in a commercial tower, owned by a real estate LLC, with a bank already breathing down its neck. Marshal Salant from Citigroup presented a very useful slide highlighting different energy efficiency finance techniques and their application to the four main sub-sectors: MUSH, residential, commercial and corporate/industrial.
So is the chicken or the egg? Does there need to be enough investment which has historically performed (and generated a stream of supporting data) before investors rush in? Or is there already enough data and it simply needs to be aggregated and distributed more widely?
The note on Marshal’s slide which said “Yes ?” about whether a financing technique would work may have best captured the day’s discussion.
I spent last Wednesday at the California PUC in San Francisco participating in a workshop debating the merits of California’s newly proposed policy for utility on-bill repayment (OBR). (Although being at the workshop necessitated my taking the Boston redeye that night (ugh) my spirits were lifted as I waited at SFO and watched Duke hoop’s last minute upset at UNC – but I digress…)
My friend Brad Copithorne from the Environmental Defense Fund has been in the midst of developing this new OBR program and he had invited me to join these proceedings. Take a look at some of Brad’s thoughts here.
OBR makes a ton of sense. It’s a better version of the existing utility OBF program currently provided by PG&E, SoCal and SDG&E and several other leading utilities around the country. While last year Groom Energy started talking to folks about how the DOE could spur the market by funding OBF, OBR looks like an even better solution.
With the current OBF model utilities loan capital to customers at low or no interest, funding their energy efficiency projects while gaining repayment through their existing billing relationship. Monthly loan charges show up just as another line item on the customer’s regular invoice. As most projects are fast payback, these three to five year OBF loans are cash flow positive from day one.
But the funding pool supporting OBF loans comes only from ratepayers. As this capital gets allocated during slugfest utility/PUC negotiations (which have a lot more at stake) utilities are not positively biased toward OBF. More fundamentally, as utilities are not chartered banks, lending is already outside their corporate charter.
Using the existing OBF model, CA utilities provided @ $32 million through 1,200 loans during 2011.
But CA policy makers know this amount is noise compared to the famous McKinsey 2008 estimate of $500+ billion needed to fund energy efficiency projects across the US.
So the new CA OBR framework proposes that outside bank/finance companies can enter the market, providing what could be unlimited loan capital for customer projects. These bank/finance companies would fund projects upon their completion and have their loans repaid through the existing utility bill, like in OBF. But here the utility operates just as the loan administrator, forwarding the customer’s monthly debt service payments back to the bank/finance companies (whose core business is making loans.)
While the debate on the details is still taking place (what happens if the utility itself goes bankrupt? are credit enhancements necessary for these loans? do the energy savings need to be guaranteed? etc.) it’s clear this model is already profoundly positive for two reasons:
- People pay their utility bills - even during the current recession utilities experienced less than a 1 percent default rate for their billings, versus @ 5% rate for more traditional small business lending. Which means that although OBR is still new and “unproven”, long-term these types of loans are very bankable (meaning low cost and packageable.)
- Capital comes from professional sources. These folks have a day job of assessing risk and loaning money to willing and bankable customers. And this means that the loan terms can be longer, leading to “deeper” retrofit projects with longer, but still attractive and certain returns. It also accommodates energy savings service contracts like our CESA.
So we’ll cross our fingers that the policy review goes well and California kicks off this new model, even if its not perfect. And like other innovative, new energy related programs coming from the Golden State, we can expect to see it rolling out to other states across the US in the next couple of years.
Three years ago, as we were developing our own energy efficiency finance program, I was struck by how few people had yet recognized the market opportunity for financing energy efficient building upgrades through a shared savings approach. Large ESCO performance contract firms continued to rely solely on their customers using tax-exempt bonds to pay for their projects and solar PPA firms focused, surprise, on solar. Only a handful of us were hustling after this emerging market.
Things have really picked up since then.
Last week I attended Citi Group’s conference entitled “Innovations in Energy Efficiency Finance” in NYC – a day long event, just on this topic. Co-produced by our friends at EDF, it was the actually the third time they’ve held the event – the first having 20 attendees, then 50, then this year almost 100. The agenda covered Federal and State government initiatives, things happening around the world and the commercial and industrial market (Groom Energy’s interest area.) The full agenda and some good observations can be found here.
It was reassuring to hear panel discussions confirm the view on the large market opportunity, where even early “competitors” aren’t yet running into each other in their customer negotations. But you coudn’t miss an older gentleman, with an entire career in energy efficiency, commenting from the crowd that “when they were considering this approach 20 years ago” it made a lot of sense then too…It alerted even the most optimistic folks that the shared savings financing approach is not new, but remains a market of the future. The collective hope is that this time adoption will be driven by larger potential energy cost savings and a more willing set of buyers and sellers.
Like any new financing model, buyers will have to trust that they’re getting a good deal in exchange for the perceived risk of signing a multi-year energy savings contract. Unlike banking institutions, new companies like Metrus Energy, Serious Energy, Transcend Equity, Green Campus Partners and Groom Energy have not been around for decades. To address the perceived risk, Transcend says that they perform their projects “open book” – allowing the customer to see actual retrofit costs and returns, so they know what’s behind the curtain. Metrus often works through ESCO partners who presumably have long solid customer relationships. Everyone on the panel claimed they were working through a large funnels of potential projects.
The most significant players yet to enter the market are the utilities. As Groom Energy has learned, when utilities offer on-bill financing in order to accelerate energy efficiency projects, customers move fast to sign these deals. It makes sense – customers are obviously less concerned signing finance contracts with someone who they trust, who bills them every month and who is likely to be around for a long time. But thus far utilities seem not too excited to go beyond limited use of on-bill financing. Although NY recently passed an on-bill financing initiative in their August Power Act of NY bill, it will likely be implemented only for multi-unit housing and residential retrofits and does not include shared savings.
Of course the bankers in the room are crossing their fingers this turns into a more mainstream market, where they can package and resell the energy efficiency obligations as blind pooled bonds. Although this looks a lot like a mortgage backed security, we’ll expect it to have a better outcome.
via How Soon Until We See Energy Efficiency Backed Securities? | Enterprise Smart Grid
Whenever a utility offers our customer on-bill financing we know we’ll be installing this energy efficiency project within a few months. Our hit rate for these projects is literally 100%.
The model is so straight forward it’s no surprise customers quickly say yes. No capital budgeting process, no new banking relationship, just an extension to an existing long-standing utility relationship. Whether its a municipal facility or a large corporation both recognize this option as a smart decision. Their monthly bill stays the same or goes down, with energy savings offsetting the interest and principal on the loan. Once paid off in a few years their monthly cost savings goes up even higher.
So why isn’t on-bill financing offered more widely?
Across the country PUC’s are increasingly mandating energy efficiency goals during their rate negotiations with utilities. As part of the PUC’s rate negotiation they know on-bill financing adds another layer of cost, essentially taxing utilities twice – first requiring them to offer energy efficiency rebates and second having them extend loans to their customers.
Although utilities already take credit risk everyday with their customers, they don’t like being a bank. At the end of 2010 we learned that one publicly traded utility was discontinuing their wildly successful on-bill financing program for this exact reason.
Meanwhile the DOE’s Loan Guarantee program’s stated mission is to “accelerate the domestic commercial deployment of innovative and advanced clean energy technologies.” The controversial program seems to have spent $ billions funding cleantech development (ie. manufacturing) more than deployment.
How about accelerating less sexy, but proven energy efficiency deployment?
Offer utilities a loan guarantee which supports on-bill financing.
With a Federal guarantee for loan repayment, utilities in every region would run fast to deliver on-bill financing. The model would help them hit their PUC negotiated energy efficiency goals and, most importantly, reduce customer consumption. Utilities would continue to source and qualify energy projects – but could then leverage their existing monthly billing relationships to off-load this high quality debt to banks and finance companies. These could even be packaged and resold. Can you say CARBs (Cleantech Account Receivables Bonds)?
Where PACE got derailed because Freddie Mac and Fannie Mae wouldn’t support taking a subordinate position on their mortgages, the on-bill financing model requires very few participants to be initiated – the customer and the utility.
In the past few weeks I’ve pushed this idea with a few folks, including the Environmental Defense Fund, a few utilities and on two Cleantech panels, one hosted by the New England Clean Energy Council, and another hosted by Boston’s Kellogg School of Management alumni group.
As I rarely spend cycles trying to influence Federal policy it occured to me that our blog may be a better way to reach folks who can carry this idea a bit further.