forrest through the trees

Ooooookay, hi there. It’s been awhile. How’ve you been? … Oh congratulations! … She really said that? … You’re right, Vince Gilligan would be a sick DJ.

Me? I’ve been busy. Learned a lot working at Greenstart — very excited for their Fall cohort — then signed on as Chief of Staff for one of their Spring companies, RidePal. We provide “a Google bus for the rest of us” by aggregating commuter demand, optimizing routes, handling logistics/customer support, and chartering with transportation providers to put clean, reliable, wifi-enabled shuttles on the road, and my role centers on all the exciting behind-the-scenes stuff: accounting, legal, setting up health benefits and workers’ comp insurance, etc…

But I’ve been negligent, so here’s the plan. I’ll get the occasional, longer, more heavily researched post up everyone once in awhile. And I’ll supplement them with shorter, less research responses to the random things that I read in any given day.

Va bene? Here goes.

Barry Schwartz, NYTimes Sunday Review: February 19, 2012

(Source: The New York Times)

Before I put up a more policy-oriented post about wind’s expiring production tax credit (PTC), here’s my attempt at a quick and dirty breakdown of this Bloomberg white paper — “The Return - and Returns - of Tax Equity for U.S. Renewable Projects” — focused primarily on the historical demand for tax equity and its various structures. 

Background:  The government offers two main tax credits for renewables. The PTC allows a qualified project owner to directly apply a credit to their tax bill for each MWh of energy generated, presently valued at ~$22/MWh. More generated MWh means more credits, but the PTC only applies for the first 10 years of a project. It is indexed to inflation and requires periodic re-approval by Congress. Lapses in 2000, 2002, and 2004 led to significant drops in the number of new wind installations.

The investment tax credit (ITC) is equal to a percentage of the project’s qualified capital expenditure (30%) and can also be directly applied to an owner’s tax bill. In 2008 and 2009, it was expanded to include wind, geothermal, and CHP in addition to solar, fuel cells, and microturbines. 

Because most developers lack the profitability (ie: tax exposure) to make use of these credits, they have turned to third parties who invest in renewables projects in exchange for tax credits and other tax benefits. These partnerships can take a number of forms.

The Three Basic Tax Equity Structures

• Partnership Flip  —  In this two-phased structure, the investor retains near complete ownership (~99%) of the project until a predetermined circumstance triggers an ownership ‘flip’ to the project developer. These arrangements are typically “five or ten year-contingent.”

 

In a five-year partnership, the flip is time-contingent. The investor is the primary owner through the first five years, then ownership reverts to the project developer. The investor’s 45-65% of initial equity is repaid partially through a 2% preferred yield* and partially through tax-related benefits like credits, accelerated depreciation, and loss allocations. In some ITC cases, the size of this equity contribution is a multiple, or syndication rate, of the tax credit. These deals are generally leveraged at the project level. 

*The report’s definition of ‘preferred yield’ as “the yield on the upfront investment which the investor receives each year, drawn from the initial stream of cash flows,” is less clear than this one: “the developer may get the initial cash but, after a certain point, all of the cash and tax benefits will go to the tax equity investors until they get their preferred yield” (30).

In a ten-year partnership, ownership changes hands once the investor has achieved a predetermined internal rate of return (IRR), typically ~8-9%. The ‘ten years’ in question do not set a deadline for ownership transfer, as in the five-year arrangement; rather, they are used to measure out an equity contribution that will achieve a desirable IRR. As such, there is no need for syndication rates. The investment is repaid with a minor percentage (~35%) of cash flows during the first five years, with a major percentage (~60%) in the last five or so years, and with tax credits throughout. These deals are typically “back-leveraged” with money being lent to the project developer.

• Sale Leaseback  —  Here the developer sells the completed project’s assets to the tax equity investor then leases them back, also agreeing to cover its operating expenses. Lease payments equal 100% of project cash flows (not including operating expenses), i.e. they are not fixed.  Ownership eventually reverts back to the developer, either at the lease’s typically ten-year expiration date or in a predetermined ‘early buyout’ arrangement. This, for example, might happen between years 7 and 12 for 30-35% of the project cost. Up until this point, all project tax credits also accrue to the investor.

• Inverted Lease  —  The near opposite of the sale leaseback, this structure sees the developer maintain ownership of the project as it leases assets to the investor. The ITC passes through the lessor to the lessee, whose payments might include ~95% of project cash flows minus a 2% preferred yield. A key investor benefit of this structure is loss allocation; the lessee/investor may own up to 49% of the lessor/developer and thus use up to 49% of the project’s loss allocation to offset tax liabilities elsewhere in its portfolio. As if it weren’t complicated enough, this structure can feature different developer/investor splits for upfront investment, the ITC benefit, and any loss allocation.

An Appetite for Tax Equity

When tax liabilities decreased and tax equity capital dried up as a result of the financial crisis, the government responded through ARRA by establishing a cash grant program offering 30% of a project’s qualified capex instead of the PTC or ITC. (ARRA was also responsible for extending the ITC to wind, but its adoption was minimal because the cash grant was generally more attractive.) Here is Bloomberg’s estimation of how U.S. wind projects were financed between 2007 and 2011 and how the availability of a cash grant impacted the use of tax equity:

Unless a project was fairly certain to have a high capacity factor (thus generating tax credits outweighing the value of the cash grant), a developer generally chose the cash grant over either tax credit. ”The 2008 and 2010 mixes present an interesting contrast – i.e. 2010’s mix is a ‘cash-grantified’ version of 2008” (6). The other exception would be a developer primarily interested in accelerated depreciation benefits. 

Looking forward, they predict that the combination of mandated wind build tied with state renewable standards — “hence the escalation in 2019 in preparation for 2020 targets” — and autonomous wind build by those looking to hedge against increasing oil prices will push demand for tax equity to look like this:

All that results in a paucity of much needed tax equity investment.

Surely there are all sorts of variables to consider when determining A) the parameters of a developer/investor partnership and B) how equitable that partnership should or can be: PTC v. ITC; estimated capacity factor; partnership length and early buyout options; IRR v. NPV analyses; preferred yields; cash flow allocations; syndication rates; loss allocation and accelerated depreciation benefits; and on and on.

Still, this report believes that these complications are significantly outweighed by the investment opportunities created by the current void of tax equity investors.

(Tumblr coding limitations made it difficult to get the whole post to show up in the Dashboard at the same time that the graphs were fully legible, and so I settled for the former. Those graphs are much easier to read in the report itself, again here.)

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For an idea of how the tax equity markets looked just a bit after we plummeted off the cliff — and before anyone knew what ARRA was — take a look at this Chadbourne & Parke November 2008 newsletter beginning on page 22. The discussion covers a full range of wind-related issues: there being fewer players for fewer deals; pre-tax after-tax partnership structures (PAPS) versus PAYGO; the connection between higher yields, lower capital expenditures, policy changes regarding pass-through regulations, “small-ticket” investor syndicates, and an expanded investor pool; the eye-glazing deficit restoration obligation… but it eventually returns to a major issue that, three years later, seems largely unresolved:

We could see the demand for wind tax equity [in 2009] being on the order of $10 billion and the supply peaked in 2007 at $5 billion. Obviously, if you keep on jacking up yields, you can bring other corporate investors into the market, but we will arrive quickly at a point where tax equity is demanding a higher yield than the wind farm itself earns and that’s not a sustainable business model. The bottom line is I think we are going to be talking about the ongoing demand and supply imbalance for tax equity (36).

Greenstart, the San Francisco-based incubator set on helping 500+ commercially viable cleantech start-ups over the next decade, just concluded its inaugural incubation period. As the accelerator works to grow its class size and track towards that ambitious goal, now seems a good time to explore how regional partnerships might affect greater cleantech innovation by connecting the most promising advancements with crucial seed and series A funding.

Mark Muro and Jonathan Rothwell of the Brookings Institute offer a starting point by noting some similarities between modern cleantech and IT’s initial boom in the 1990s. They note the correlation between IT-based productivity gains and the country’s net increase of 23M jobs between 1992 and 2001, even as the IT sector itself accounted for only modest job creation over that same period. Comparing the size of today’s cleantech sector with its computer manufacturing and semiconductor analogues, they say “it’s therefore not unimaginable that, with a few strong years of growth and innovation, cleantech could be large enough to fuel considerable increases in aggregate economic growth.” Greenstart’s overriding goal is to encourage that growth in cleantech innovation.

Muro and Rothwell also note the pivotal role venture capital played in that IT boom. For comparison, the National Venture Capital Association notes that venture capital has funded over 17,000 IT companies but only 900 cleantech start-ups. 

Considering that disparity, it stands to figure that Greenstart’s ability to match cleantech innovation with greater cleantech investment could significantly achieve that objective while having an exponentially beneficial impact on the country’s overall economic growth.

So there’s the altruistic pitch, but what do entrepreneurs have to gain personally from a greater focus on cleantech?

Earth2Tech’s expansive series on the state of cleantech venture capital has some answers. Let’s begin with author Matthew Nordan’s depiction of cleantech investment between 1995 and 2010:

and his projection for cleantech start-up investment through 2015:

The latter might trigger alarm at first blush as it predicts investors eschewing early-round investment for late-stage “retrenchment.” But Nordan argues that this trend represents an opportunity for forward-thinking VCs:

More and more cleantech venture capital is earmarked for late-stage growth equity deals. As a result, these investment rounds are likely to engender price competition that depresses returns. In contrast, Seed/Series A cleantech financing looks to be cyclically underserved, and the enhanced return profile that accompanies scarcer capital could help offset early-stage technology risk. If I were at an LP institution right now, I’d be looking for the sharpest early-stage cleantech investment team that can zig while most investors zag.

Companies working with Greenstart are well positioned to seize on this opportunity. Their value is corroborated by the program’s high profile, strong brand, and rigorous selection process. At the same time, Greenstart already has relationships with many leading venture capital firms, further enhancing a company’s chances of receiving early-round funds. As such, Greenstart is well positioned to benefit each of the companies in its program.

But achieving the broader goal of driving greater cleantech innovation also means conveying these arguments to a larger pool of high-potential applicants. Partnering with programs like Cleantech to Market (C2M), which pairs advanced research with multidisciplinary scrutiny to reveal cleantech solutions that are ripe for commercialization, would go a long way in making that possible. There are a number of similarities, for example, between this electrochromic window project from C2M’s 2011 program and SmarterShade, one of the first four Greenstart companies. These projects have essentially been pre-vetted and represent a source of leading candidates for future Greenstart classes. 

Greenstart already has strong ties to the Berkeley community, so establishing a partnership with C2M is a logical first step, but this rationale applies to collaborations with the broader UC system (through CITRIS, CIEE, and i4energy), Stanford, NREL, and others as well.

These partnerships would expose new and larger pools of qualified candidates to Greenstart’s application process, increasing the volume and viability of subsequent classes. More success stories would in turn strengthen cleantech’s appeal to entrepreneurs and investors, creating a positive feedback loop. All the while, they would signify important sustained momentum as the world at large continues plodding towards a more sustainable energy future.

These four strategies — unifying stakeholders with an overarching focus on economic development; employing financial mechanisms to attract a parade of private investors; innovating for improved performance and reduced costs; enacting consistent energy policy — combine to form a holistic approach capable of matching the complex and manifold challenges of building out clean energy infrastructure. 

Economic Development

Countries must view clean energy as an integral component of economic competitiveness by encouraging growth and efficiency at every level of the clean tech value chain — research > technology innovation > manufacturing > deployment > exports — while extolling and accounting for its tangential encouragement of broader economic growth. State strategies must respect fair trade rules and state support restrictions — the SolarWorld complaint illustrates many of these complexities — but economic development done right can lead to prosperity at home, imitation abroad, and the lowering of clean energy costs on a global scale. National programs will vary by circumstance but should strive to supplement existing economic development trajectories with equity investments in clean energy companies, the encouragement of industry clusters, workforce training programs, and trade and export strategies. Some leading examples:

• CHINA’s accelerating energy demand and need for energy security has lead the country to plan $400-600B in power sector investments over the next decade (21). Its long-term national plan requires government procurement of indigenous clean tech solutions, exempts R&D expenses from taxable income, provides cheap loans via state-owned banks, and matches VC investment with public funds. Upward mobility for local CCP officials is frequently tied in part to development targets. The bonanza of supporting infrastructure — high-speed rail, subway systems, souped-up grid systems — is part of an ambitious strategy of urbanization, which has created development clusters that encourage innovation, diffusion of new ideas, flexibility, and specialization. An abundance of human capital thanks to worker training programs has drawn multinationals like IBM to invest in R&D centers within the country. All the while, the government has taken contentious steps to shelter Chinese investment from international competition through the use of trade barriers and currency depreciation.
• SOUTH KOREA has promised to invest $46B (or 1% of GDP) over five years in solar, LED lighting, nuclear, and hybrid car technologies in order to increase the country’s share of the clean tech export market by 8% (21). The automotive, chemical, semiconductor, and steel industries will be pushed to become low carbon as they pursue targets of 15% green exports in 2013 and 22% by 2020. At the same time, shifting to a more service-based economy should reduce overall energy consumption. Korea’s green energy industry will also benefit from $11B in planned investments through 2030 focusing on R&D and the establishment of a large-scale integrated test bed for green technologies (3).
• The OAPEC oil embargo and Chernobyl led DENMARK to invest heavily in wind power, streamline the implementation process, supply early public funding, and establish a feed-in tariff. While fossil fuels still account for two-thirds of the country’s power generation, the state recently announced its intention of becoming entirely renewables dependent by 2050. The focus on wind, in particular, also established Denmark as an industry leader as nearly half of the world’s wind turbines are produced by Danish manufacturers. 
• In the UNITED STATES, in addition to federal tax and incentive policies, many states have taken lead roles in building out their own green economies by establishing clean energy funds for strategic project investment and, increasingly, broader economic development activities. An increased focus on clean energy and energy efficiency, for example, finds those components catching up to the previously dominant sub-sectors of conservation and pollution mitigation as drivers of the Rocky Mountain region’s robust green economy (4).

Financing Mechanisms

Accelerating adoption of clean energy infrastructure will also require financing efforts to evolve beyond today’s incremental modality. This can be achieved by financing clean energy much the same way we do transportation, energy, telecom, and other types of infrastructure. 

• A green BOND is like any other bond: a fixed-income offering with no extra costs that shields investors from the risk associated with the project that it is financing. As part of its 2008 “Strategic Framework for Development and Climate Change,” the World Bank began the process of issuing green bonds that could draw in up to $30B by 2015. This opens up green investing to large, risk-averse institutional partners looking to indirectly confront climate change or to burnish a green image. At the same, it demonstrates that green investing mustn’t always “involve a catch.”
• There is worry that VENTURE CAPITAL’s general focus on short-term, small scale, less capital-intensive investments is not suited, and could potentially harm, clean energy development that necessarily demands more capital and a protracted timeline. One solution pursued by the European Commission has been its European High Growth and Innovation Small- and Medium-Enterprise (SME) Facility, which as part of the European Investment Fund (EIF) supports VCs that provide EARLY STAGE EQUITY SUPPORT in SME clean tech based on commercial market principles. Having the EU as a marquee backer both catalyzes wider and deeper investments in clean energy. GIF and similar predecessors invested €309M in 39 funds over the course of a decade; this amount, which went to 357 SME firms, accounted for only 17% of their combined total capital. 
• LOAN GUARANTEE PROGRAMS like DOE’s Financial Institution Partnership Program (FIPP) can pair government  resources with qualified private financial institutions like banks to share risk and increase the availability of senior capacity credit to clean energy projects. If generally sound, Solyndra illustrates the many political complications that can arise when projects backstopped by these programs fail. 
• The German scheme administered by Euler Hermes exemplifies the benefits derived from EXPORT CREDIT ASSISTANCE, credits or guarantees shouldered by a private or quasi-governmental institution to bolster exports. A recent study of German exports between 2000 and 2009 found that A) ECA has export-enhancing effects that B) were most pronounced in the aviation, shipbuilding, and transportation sectors which, like clean tech, are characterized by high credit constraints and external financial dependence (21). In the context of clean energy, such assistance supports growing companies by increasing profits while expanding footprints in overseas markets.

The efficacy of these mechanisms requires a specialized knowledge set, expedited approval processes, and sympathetic timelines, which is why governments are creating new institutions specifically designed to support green endeavors. 

• Britain aims to draw 15% of its energy from renewable sources by 2020 — though this goal may take a back seat to economic growth policy — and intends for a proposed GREEN INVESTMENT BANK (GIB) to finance solutions that will make achieving that goal possible. GIB may take first-loss debt positions to mitigate risk, supply capital provisions to tamp down fluctuations in available equity, and co-invest on a pari passu basis to help scale projects with limited sponsor investment. The bank is still very amorphous at present, and there are concerns that government-directed priorities will exclusively benefit pork projects and/or jeopardize European Commission approval. State-owned financial institutions in Germany and France are comparable in their approach to green investing. 
• The EUROPEAN INVESTMENT BANK (EIB), whose loans to the renewable energy sector topped $5.6B in 2009 and $9.4B in 2011, serves a similar risk mitigation role. The IEA report cites concerns that expanding this role dramatically could overheat the renewable sector before stalling out the market (29). On the other hand, a recent analysis by Bankwatch raises questions about the degree of EIB green investing relative to its energy lending on the whole and whether its practices may counter-productively be locking some countries into fossil-fuel dependence for years to come.

Technological and Commercial Innovation

Large-scale establishment of clean energy infrastructure will also require innovative approaches that reduce costs, increase scalability, and maximize performance. Here are a number of general strategies that governments and private firms can adopt to nurture such innovation:

• A SYSTEMS APPROACH looks beyond the initial ‘creation/incubation’ phase of innovation to assess the entire development value chain’s potential for improved performance and profitability. “What this means for governments and private companies is that they must look for more linkages, coordination and collaboration with the many players from scientists and engineers to utilities and regulators” (31).
• Bill Joy’s Law that “the smartest people work for someone else” suggests that innovative companies should look beyond themselves and tap “dispersed global talent” to accelerate problem-solving. Utilizing OPEN INNOVATION and DISTRIBUTION NETWORKS yields new perspectives, unanticipated partnerships and linkages, and a more dynamic process of innovation. Focused primarily on best practices for innovation at the U.S. state level, this NASEO paper nonetheless does a good job of elaborating on the holistic benefits of open innovation in any context.
• Rather than facing off head-to-head with incumbent competitors at the outset, DISRUPTIVE INNOVATION begins with NICHE MARKETS (ie: suitable, not necessarily small) where a technology’s costs and performance can be tweaked and improved as it gradually goes mainstream. Clayton Christensen, the HBS professor who popularized the idea of disruptive innovation in the ’90s, argues that clean energy’s ideal niche market may be “nonconsumers” in the developing world where there is no incumbent competition.
• REVERSE INNOVATION sees technologies designed, created, and manufactured for developing countries before adapting/exporting them to developed countries. Where means of business, production, and distribution models are less defined, there is greater room for adaptation and reinvention. China’s example already suggests the impact reverse innovation will have on low-cost clean tech. 
• PUBLIC/PRIVATE PARTNERSHIPS pair governments with a particular industry and its key players to co-fund research (eg: networking, exchanges, access to infrastructure, studies, conferences) that tackles common challenges and advances the sector as a whole. DOD’s Semiconductor Manufacturing Alliance (SEMATECH) was created in the ’80s amid fears of Japanese competition. The alliance continued even after public funding ended because its joint efforts rebutted high R&D costs, industry consolidation, and market downturns to deliver a 540% annual return on investment (36). 

Policies and Mandates

Smart, consistent, forward-thinking policy can go a long way in creating market demand for new clean technologies and speeding up/streamlining the establishment and scaling of promising new projects. There are already a number of policies that combine financial subsidy and mandatory procurement with proven results:

• FEED-IN TARIFFS  -  These are payments per kWh generated by a renewable resource, set over a long period of time and with a priced-in profit margin. FITs are used in over 45 countries to create stable investment environments and reach mandated renewable use targets and have already had an outsized impact on the development of solar and wind power.

• TENDER SCHEMES  -  The government encourages large-scale development by holding competitive auctions for projects of different technologies or for resource tenders for desirable sites; the winning bidder typically gets a long-term PPA, as well. This approach may lead to cost-efficient support, but it risks imperfect market knowledge and stop-and-go development. There is no history of tender schemes leading to long-term market stability or profitability. 
• RENEWABLE PORTFOLIO STANDARDS  -  An RPS requires that a percentage of a state’s electricity come from renewable resources. Twenty-nine states have them, and ~50% of nationwide retail electricity sales are covered by state RPS policies (11). Because an RPS favors the lowest cost resource (in many cases large scale wind), “carve outs” can be included to aid technologies that would not otherwise be cost-competitive. Some states track RPS compliance with Renewable Energy Certificates (RECs). 

• CAP and TRADE  -  While this strategy is untenable in the U.S. right now, the progress of regional carbon markets alongside the European and now Australian emissions trading schemes will continue to compel discussion about its merits and drawbacks.
• TAX MEASURES  -  Production and Investment Tax Credits deliver predetermined credits per kWh produced (PTC) or credit for a percentage of the cost of a clean energy system purchase (ITC). These credits can then be sold to companies with large tax liabilities, establish a supplemental revenue stream. [UPDATED: GreenTechMedia has this run-down on the wind industry fight to extend their current PTC past its 2012 expiration date.] Another measure, accelerated depreciation rates, encourage EE purchases by generating cash flows for growing businesses while accelerated capital cost allowances allow a company to write off the full purchase value against that year’s profits. 

The aforementioned strategies for encouraging clean energy infrastructure each serve a particular purpose and must be implemented in conjunction with each other to produce an overall forward momentum that can sustain development through political and financial shocks. Replacing or dismantling strategies already in place can also have adverse, disruptive effects on investment, so change should be incremental and integrative whenever possible.

At the same time, the complexity and interconnectedness of the task’s component parts require immediate and sustained action. We are continually reminded how difficult this continues to be, but these economic, financial, innovation, and policy schemata can channel much needed capital, political will, and sweat equity into a highly-developed clean energy infrastructure with immeasurable economic and environmental benefits.

Via The Breakthrough Institute, the Clean Energy Group just released an IEA-commissioned report titled “Strategies to Finance Large-scale Deployment of Renewable Energy Projects: An Economic Development and Infrastructure Approach”. Here is a brief summary of that report’s first dozen-and-a-half introductory pages.

Executive Summary

Even alongside robust conservation and efficiency efforts, there remains an undeniable need for serious investment in clean energy generation to address climate change and increasing global demand. That means serious amounts of large-scale investment which in turn require added incentives and reduced risk to free up private capital, especially considering the present economic climate. In order to drop clean energy investment below an acceptable risk/reward threshold, we must address questions of why public and private investors are currently holding back, how to garner widespread political support for clean tech, and what can be done to lower the incremental costs of clean energy scale-up. 

Broadly speaking, clean energy technology is very capital intensive, heavily reliant on infrastructure, and currently pitted against some very strong incumbent interests. This puts the required capital investment levels, projected time frames, and uncertain reward estimates beyond the comfort range of many investors. These misgivings are compounded by market failures like the absence of carbon pricing schemes to properly relate clean and incumbent energy generation and the limited upside of public goods projects for private investors.

As clean energy has both environmental and economic development ramifications, governments must take the lead: use incentives to spur competition, overcome institutional barriers, and build momentum for the widespread execution of clean energy infrastructure projects; adopt energy and finance policies that reduce private risk by creating a stable investment environment; and address the challenges of assimilating new clean tech into everyday society. Rail and telecommunications both benefited immensely from an economic development approach. Clean energy can as well.

Framing the Clean Energy Challenge

Full-fledged clean energy infrastructure will require tens of trillions of dollars in investments over the coming few decades. The money is out there, but progress will rely heavily on private investment, particularly in the near term given the look of current state balance sheets around the world. Numerous risks must be addressed in order to sweeten the risk:reward deal, align clean energy deployment with private investor interests, and overcome the current “wait and see” mentality.

Technological Risks

Clean energy start-ups tend to have weak balance sheets, increasing uncertainty and the cost of due diligence for prospective investors. This leads to a funding gap — the Valley of Death — between development and commercialization that mirrors the division between high-risk/low-cap VCs and low-risk/high-cap banks. Nor are their technologies price competitive with established energy sources. Further, many come with complementary costs like extended transmission, service, and deployment infrastructures (some of which is still in the development phase.)

Competitive Risks

The downward pressure of tighter lending policies/regulations and a generally gloomy economic climate must be offset by an expanded investor pool. Unfortunately risk-diminishing governmental support is being hindered, both by the uncertainty of unproven technology and by the ease and familiarity of the fossil fuel-based energy paradigm already in place. Add to that uncertainty about how much of a competitive threat is posed by the expanding natural gas industry.

Political Risk

What sort of regulatory scrutiny will clean energy face, and how consistent can government policy remain in today’s divisive political climate?

And who are these private investors? Pension funds are a key target, epitomized by the P8 Group, as are those sovereign funds not wholly beholden to oil exporters. Insurance funds are another potential source of private investment, particularly if incentives like those in California can be enacted elsewhere. So too are profitable corporations like Google, which are investing in green projects for tax equity purposes; we’ll see what sort of a dampening effect the dissolution of RE<C has on this last one.

But these private reserves can only be tapped through an economy-wide approach backed by consistent and comprehensive government imperatives. This is a multifaceted challenge with political, economic, historical, technological, and social components that will require comprehensive strategies across local, state, national, and global levels of governance. 

I’ve been catching up on some reading and an application over the past few days, so I thought I’d recap a couple recent happenings and/or things I came across since the last post.

GreenFinanceSF

Just over a couple months ago, Mayor Lee relaunched the commercial arm of GreenFinanceSF, the PACE financing program first unveiled by the city in April 2010. GreenFinanceSF was initially available to commercial and residential properties before the FHFA effectively shut it down over concerns about lien priority. While the feasibility of residential PACE financing remains in limbo at least until California’s lawsuit against Fannie and Freddie goes to trial late next April, San Francisco has refocused its efforts on making PACE financing available to the city’s 16,000 commercial properties. (Commercial PACE sidesteps the question of lien priority by requiring consent from the property’s other mortgage lender(s) prior to approval.)

GreenFinanceSF eschews preferred ESCOs and lenders, opting instead for an ”open market” model designed to stimulate market competition among investors and contractors while delivering a broader array of options for participants. There is no exposure to the city as the $100M behind the program’s Debt Service Reserve Fund is ARRA money (3). Meanwhile, prerequisites like the exclusion of properties with a history of default or bankruptcy and the stipulation that a property’s combined debt (inclusive of the new financing) does not exceed its present value have been put in place to limit investor risk. 

Also of note as Proposition 13 returns to front-page headlines: GreenFinanceSF’s voluntary special tax is possible thanks to “Mello-Roos” (a.k.a. 1982’s Community Facilities District Act), which enabled the creation of CFDs by local government in order to install additional property taxes. Basically, it described a path for circumventing Prop 13.

San Francisco’s Existing Commercial Building Energy Performance Ordinance

If GreenFinanceSF is the carrot, here is the stick: the ordinance passed this February requires that all existing non-residential buildings larger than 10,000 square feet regularly audit and disclose their energy use by 2014. Results must be benchmarked using EPA’s Portfolio Manager tool — PG&E is helping to streamline the process — and shared with the city, tenants, and prospective buyers. The first report will be considered a “mulligan” and remain confidential, though I couldn’t discern whether subsequent disclosures will be individual or aggregate (10). And here are some related questions:

Who is disclosing?  Generally the building owner is responsible for the disclosure, but that may require tenant data.  What is the process for obtaining that data?  Does the lease address the sharing of such data?  What about the utilities?  Can aggregated data be obtained from the utility to disclose?  California’s Assembly Bill 1103 of 2007 required electric and gas utilities to maintain customer data in a format compatible with Portfolio Manager and to provide that data upon the customer’s request.

What about data protection and confidentiality?  Along with the process of collecting data, impacted parties must consider the liabilities associated with that data.  Does a tenant have sensitive energy usage information?  Is the utility permitted to release customer data to a third party?  Does aggregating the data remedy the concerns?

What about context?  A building may appear to use a great deal of energy when in fact it is the nature of the tenant’s use that drives the energy use.  Perhaps they have 24 hour operations or their own server farm.  How is this information collected and when can it be used to explain building performance?

The city is also leading by example with a 10-year, $35M commitment to invest in EE public facility retrofits.

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I also wanted to note, a few days late, President Obama’s exciting Better Building Initiative announcement and embed President’s Clinton Newshour interview. I’m only maybe forty pages into Back to Work, but it’s my BART reading for the night and I’ll try to have a response up here once I’m finished.

This is the third post summarizing a late 2009 paper by the National Renewable Energy Lab titled “Energy Efficiency Policy in the United States: Overview of Trends at Different Levels of Government” that details various federal, state, and local policies for promoting energy efficiency across a variety of sectors. Part one on buildings is here. Part two on transportation and industry is here.

5. Power

There is significant overlap between power and the industrial and building sectors as it also accounts for 40% of primary U.S. energy consumption. Policies in this arena typically target one side of the supply/demand relationship or the other: plant efficiency/production or end-use efficiency/consumption.

Here again, effective policy requires effective public/private collaboration as utilities continue to play a pivotal role in developing and implementing EE policy. Utilities are key as they have direct contact with their customers, know what their customers need re: delivery and capacity, and can leverage this information to tailor EE pricing systems and incentive programs (eg: by time of day, month, season.)

The federal government typically interacts with the power sector in an indirect, advisory capacity, enacting a “states-must-consider” approach through the Public Utility Regulatory Policies Act (PURPA, 1978) which has since been expanded.* It also offers funding to entice state adoption of certain policies and supports a variety of R&D projects.

There is also the National Action Plan for EE, a federally facilitated strategy for policy implementation collaboratively developed by stakeholders including DOE, EPA, utilities, consumer advocates, and other regulatory agencies. Though this method does not mandate policy, it does provide a mechanism for knowledge sharing, progress tracking, and peer-level exchanges. 

In contrast, state and local involvement tends to be regulatory in nature. In past years much of this has focused on “decoupling” where an inversion of the rate/demand relationship incentivizes utilities to help customers reduce demand, tying utility profits to reduced demand rather than volumetric consumption. Decoupling has been pursued in California (since 1981; again) and nine other states, with legislation pending in five others, but includes implementation challenges that vary state to state. 

5.1 Incentives

Decoupling changed utility incentives, giving them reason to offer customers subsidized energy audits and technical assistance. At the same time, the advent of smart meters can make rate-setting practices more responsive to demand peaks and lulls, in turn giving end-users a financial reason to reduce peak consumption. One strategy focused on reducing total consumption is the tiered pricing structure, which rewards end-users for staying below PUC-determined usage thresholds. State-sponsored EEF models, previously discussed here, also employ incentives to reduce end-user energy consumption.

5.2 Research and Development

The federal government is a major proponent of R&D. More fun examples include high-temperature superconductivity wires, smart grid innovations, and energy storage.

6. Trends in EE Policy Development (Conclusions)

• Leadership is necessary at every level of government  -  State and local government can draw on their diverse political and economic climates to incubate and scale up a variety of innovates ideas (like California has with decoupling, strict building and fueling efficiency standards, the carbon market, etc.) while the federal government leverages its resources, connections, and scale to fuel the impetus for EE.
• There is no widely accepted way of evaluating EE policy  -  Measuring policy impact and effectiveness is critical but difficult owing to the layering of various policies, circumstances, and degrees of public/private/jurisdictional involvement. 
• Coordination among sectors and across levels of government is crucial and can be improved  -  As policies (necessarily/myopically?) focus on individual situations and circumstances, they create a disaggregated and patchwork environment for EE improvement that leads to regulatory uncertainty and inaction in the private sector. We need to harness technological innovations (like the smart grid) to cull a more strategic and cohesive national approach that still takes into account different regional/jurisdictional requirements. Collaborative stakeholder-based projects are a step in the right direction.
• Efficiencies can be gained when one sector’s experience informs another’s progress  -  Returning back to the inherent tension at different levels of government between leveraged investment and tailored policy, each level has its strengths and weaknesses. Acknowledging these differences and internalizing lessons already learned can yield a comprehensive policy approach to EE that allocates decision-making and implementation responsibilities at the most appropriate level. 

*PURPA forced utilities to purchase power from more efficient (read: domestic renewable) producers if that purchase cost would be lower than the utility’s own ‘avoided cost’, or the marginal cost of producing the additional power itself. In this scenario, the supplied renewable power replaces the energy produced at the utility’s more expensive (and generally older, dirtier) facilities. PURPA was implemented to varying degrees at the state level depending on each state’s unique circumstances. The Energy Policy Act of 2005 expanded PURPA, requiring utilities to offer net metering, smart meters, and peak-load reduction agreements. The Energy Independence and Security Act of 2007 further mandated the consideration of integrated resource planning, rate design modification to promote EE investment, and smart grid information and investment at the state level.

This is the second post summarizing a late 2009 paper by the National Renewable Energy Lab titled “Energy Efficiency Policy in the United States: Overview of Trends at Different Levels of Government” that details various federal, state, and local policies for promoting energy efficiency across a variety of sectors. Part one on buildings is here. Part three on power is here.

3. Transportation

These policies focus primarily on developing and deploying new technology to increase fuel efficiency and incentivize changes in transportation patterns, shipping strategies, and consumer behavior. Transportation accounts for 28% of primary U.S. energy consumption.

3.1 Fuel Efficiency Standards

Corporate Average Fuel Economy (CAFE) standards, the federal government’s main tool for increasing the national fleet’s fuel efficiency (FE), were instituted in 1975 in response to the Arab oil embargo. Two weeks ago, the Obama Administration reaffirmed its goal of ratcheting up CAFE standards over the long term: 

While efficiency and fuel use requirements are in place for the federal fleet, DOE determined in 2008 that mandating private and local fleet compliance was not necessary to achieve the Replacement Fuel Goal by 2030.

States can also be key players in the FE conversation, as evidenced by California’s impact on the country’s near-term fuel economy strategy. This is in addition to fleet procurement, through which states can lead by example while expanding the market for FE vehicles. Other state strategies include requiring X number of vehicles sold to be low-emission, establishing standards for tires (both California), and restricting idling. Regional collaboratives are also turning to questions of FE; the Western Climate Initiative plans to include transportation fuel under its cap-and-trade program. 

Local government can implement similar policies. In 1993, Denver set out to reduce GHG emissions from its municipal fleet by 1% each year over 10 years. The city achieved that goal ahead of schedule in early 2000 and continues re-up its efforts.

The direct impact of FE policy is difficult to isolate owing to mitigating factors like fluctuating gas prices, changes in consumer behavior, and technological advancement, but it does maintain a basement for fuel economy when prices drop while reducing vehicle-related pollution in accordance with the Clean Air Act.

3.2 Labeling and Consumer Education

The federal government requires that all new vehicles are labeled with city and highway FE estimates and class comparisons. Consumers can also find this information and do car-by-car comparisons at fueleconomy.gov. Though no reports have drawn a direct correlation between these labels and energy savings, sociological research generally supports this strategy. (Like the Energy Guide program, labeling could still be made more effective.)

3.3 Incentives

There is obviously a lot to absorb when it comes to federal and state-level FE incentives, and a lot has developed since this report was published in December 2009, so I’m going to save the topic of incentives for a more comprehensive post at a later date. At the local level, incentives can be financial (tax rebates on FE vehicle purchases) or non-financial (preferred parking).

3.4 Technical Assistance

Technical assistance programs strive to make the expertise of various federal agencies available to states, municipalities, and private businesses. They include:

The study looks at Clean Cities in particular. The program was created in 1993 to help provide informational, technical, and financial resources as mandated fleets pursued compliance with the Energy Policy Act of 1992. The program has since led to a cumulative reduction in petroleum consumption of 3.1B gallons while leveraging $357M in project awards for twice as much in public and private contributions and spurring the establishment of 90+ local coalitions. These local Clean Cities coalitions exemplify the successful marriage of local, state, and federal efforts advocated by this report.

3.5 Urban Planning and Behavior Change

Zoning and forward-thinking transportation planning can have huge impacts on fuel consumption. State strategies vary as they are developed according to corresponding stakeholder input. Locally, these policies focus on transportation infrastructure, public transportation, population density, land use planning, and limited vehicle miles traveled. Berkeley’s goal of reducing transportation emissions by 30% below 2000 levels by 2020 and 80% by 2050 is a great example.

4. Industrial Sector

This sector accounts for 31% of primary U.S. energy consumption and includes a number of subsectors, each of which has its own unique energy needs and constraints.

4.1 Incentives

Industrial incentives typically aim to A) help with the upfront costs of adopting EE technology and/or B) attract green industries to a particular jurisdiction with an eye towards job creation. 

At the federal level, this includes tax credits for appliance manufacturers and home builders and a loan guarantee program run by DOE. State-level incentives range from reduced-rate loans to tax credits to R&D grants. General state funding programs — PBFs, SBCs, and the like — can also be tapped to fund EE incentives. Locally, municipalities are paying greater attention to (and occasionally working with?) utilities as efficiency-related programs can have a direct impact on economic development and job creation.

4.2 Technical Assistance

This category includes energy audits and information campaigns with the goal of incorporating EE thinking into industry’s systematic decision-making process, helping industry to “learn by doing.” 

Much of this occurs at plant level, typified by DOE’s Industrial Assessment Centers. The program pairs teams of engineering faculty and students from 24 participating universities with small and medium-sized manufacturing plants that might not otherwise have the resources to perform an efficiency assessment that examines “potential savings from EE improvements, waste minimization and pollution prevention, and productivity improvement.” This instance of a successful public/private partnership increases EE in the industrial sector, educates university students and faculty, and aggregates data that can illustrate current conditions while informing future strategies.

The study includes some cool macro and anecdotal evidence re: IACs:

The IAC program has made a total of 105,656 energy-efficiency recommendations since 1981. Leveraging federal IAC funds, companies invested $461M in implementing 47% (49,602) of the recommendations, with a resulting savings of $554M. 

Investments in energy efficiency have also achieved benefits that extend beyond energy and financial savings. For example, in the plastics subsector, an IAC audit led to the implementation of energy savings equivalent to over $340,000 dollars annually ($100,000 over the original estimate). These investments had the ancillary benefit of reducing water consumption by over 1.5 million gallons annually. companies invested $461 million in implementing 47% (49,602) of the recommendations, with a resulting savings of $554 million. (34)

Technical assistance programs at the state level frequently draw from general state funding sources, as well. 

4.3 Research and Development

The federal government is will hopefully continue to be a major proponent of R&D. Fun examples include energy conservation and utilization (gasification, high-efficiency boilers, waste recovery heat exchangers, cogeneration), energy-intensive and high CO2-emitting processes (producing high-quality iron without using metallurgical coke*), and resource recovery and utilization (improved use of recycled materials, waste, and byproducts).  

*I think this is in the same vein as direct reduced iron, which Steve Rowlan mentioned in his Senate subcommittee testimony, but I’m not sure.

Update: More on the new fuel efficiency standards from Earth2Tech.

Update II: And a good op-ed by Thomas Friedman. 

This is my first post summarizing a late 2009 paper put out by the National Renewable Energy Lab titled “Energy Efficiency Policy in the United States: Overview of Trends at Different Levels of Government” that details various federal, state, and local policies for promoting energy efficiency across a variety of sectors. Part two on transportation and industry is here. Part three on power is here.

Setting the table, a review of EE’s many benefits:

• lower energy bills
• reduced pollution
• reduced GHG emissions
• increased energy security
• deferred infrastructure investments for utilities

There are many opportunities out there for increasing EE and garnering these benefits, but there seem to be just as many barriers to adoption. “Government policies should be designed to target these barriers and enable the benefits of EE to be realized” (v).

1. Strengths and weaknesses at each jurisdictional level

Federal

 + Scale - it can offer effective incentives early in the commercialization process, across a national market, that can be leveraged for maximum impact.

+ Uniform standards - for appliances and vehicles, these minimize the regulatory burden of different state mandates while maximizing the potential impact on national energy consumption.

+ Specialized technical assistance - it has the resources to create entities offering guidance and expertise as states, municipalities, and private industry look to identify and implement EE improvements.

- Over-regulation - overzealous federal involvement threatens to constrict market growth and handcuff state/local officials as they address their own specific circumstances.

State

+ Relative scale - they can customize mandates and incentives to specific conditions while still producing relatively broad impact.

+ Incentives + Economic self-interest - they can offer incentives to attract and foster emerging markets (like Colorado’s green economy).

+ Jurisdiction over utilities - this enables demand-side management in an effort to constrain increasing consumption. The use of public benefit funds or system benefits charges can stabilize funding for EE programs apart from fluctuating state budgets, in turn ensuring a safer environment for private investment and growth.

- Funding/Geographical limitations

Local/Municipal

+ Details - they are aware of specific local conditions and can tailor policies accordingly. They can also use this knowledge to implement state and federal policies most effectively.

- Funding/Geographical Limitations

The key policy drivers behind EE — economic development, energy security, environmental conservation — are present at each level but manifest themselves in different ways. There is also “an inherent tensions between leveraging investment and tailoring policy”:

“Understanding how the policies interact and can contribute to a comprehensive efficiency policy is critical to developing a plan to reduce energy consumption” (2).

2. Buildings

Buildings account for 40% of primary energy, 72% of electricity consumption, and 36% of natural gas consumption. They are also the primary driver of power plant construction: 87% of the growth in electricity sales between 1985 and 2006 is attributable to building sector demand, according to the DOE. The totality of policies geared toward market transformation focus on either barrier reduction (standards and mandates; PUSH) or technological accessibility (incentives; PULL). Some also include a “lead by example” element that focuses on fostering EE markets, reducing risk for private investors, and reaping energy savings for the public.

2.1 Buildings Codes

Primarily the domain of state and local governments, building codes govern lighting, building envelopes, and HVAC systems, among other things, and are a key PUSH mechanism for increasing building EE.

The federal government can provide states with technical assistance and pass legislation (like the Recovery Act) that incent states to adopt the latest building codes. The failed Waxman-Markey bill would have mandated a national EE building code and financially punished stragglers.

Most states base their building codes on IECC and ASHRAE standards, though not all are pegged to the most up-to-date standards. Upgrading code with a “phased in” approach allows industry and retail markets to adapt over a period of time while stimulating EE markets, thereby allowing industry to capture cost reductions from the production economies of scale (8).

The local level can establish additional codes and is, more importantly, in charge of enforcement, though training and resources applied vary by jurisdiction. It can also strengthen EE markets by incenting (private sector) or mandating (public) LEED certification. 

Examining the evolution of standards over time shows the effectiveness of building codes. A cited McKinsey (2009) study indicates the 2009 IECC standards were 12-16% more efficient than the 2006 standards and suggests the projected 2012 standards would yield an additional 15% savings (10). 

California’s adoption of a statewide building code and appliances standards in the ’70s also validates the marked impact building codes can have on energy consumption. [It also strongly refutes (14) Jevons-style arguments against EE.]

YET, there are still 14 states stuck with 1998-2003 IECC while 13 states still use the ASHRAE 90.1-1999-2001 standard. There is also widespread lack of energy code compliance as many states lack the resources to comprehensively track code enforcement. Some suggestions for improving this include:

• employing third-party verifiers to spotcheck buildings
• hiring more building officials
• increasing their pay and training
• increasing the objectivity of performance-based code compliance

These strategies, suggested by the McKinsey study, would cost $210M-1B per year but would yield $3.5B in present-value savings (at the $1B estimate, if consistently invested over 10 years) (11).

2.2 Appliance Standards

By mandating standards across entire industries, we can reduce adoption costs while maintaining a level playing field. Standards also minimize the cost of efficiency because firms will naturally seek the most cost-effective ways of meeting the raised standards while remaining competitive. They can also help alleviate the split incentive.

The federal government continues to play the lead on this policy, having passed six key acts from 1975 to 2007 that set, expand, or ratchet up EE standards for appliance. 

This policy also exemplifies how successful public and private collaboration can be in tackling problems of efficiency; the Energy Policy Act of 1992 led the DOE to work directly with manufacturers, regulators, and consumer advocates as they developed standards that took economic and non-economic (national security, environmental) impacts on producers and consumers alike into account.

Fifteen states + D.C. have adopted residential/commercial standards above and beyond the national baseline. See again: California’s adoption of stricter standards in 1976 and its consequent impact.

2.3 Labeling and Education

Labeling is a federal-only approach, mandatory comparative labeling having been launched in 1980. There are two kinds:

• COMPARATIVE (eg: Energy Guide) - informs consumers about a product’s benefits relative to its class
• ENDORSEMENT (eg: ENERGYSTAR) - certifies a product that surpasses an efficiency threshold

The DOE estimated that ENERGYSTAR saved consumers $16B in 2007. The Energy Guide labels could be more effective if they were easier to understand. Both focus on efficiency rather than total consumption while segregating products by class, making comparisons imperfect and the “efficiency” label potentially misleading.

2.4 Financial Incentives

ie: policies that offer grants, loans, rebates, subsidies, and tax breaks to offset the high initial costs of adopting EE technologies. Additional goals differ by sector: with industrial/manufacturing, it is to impact the commercialization process early in order to reduce implementation costs; with commercial/residential/end-users, it is to educate the public and increase EE market penetration.

The chart on page 16 details various federal efforts focusing on the residential, commercial, industrial, manufacturing, and construction sectors. More recently, many of these incentives are focused upstream to optimize intervention costs.

There is also a large variety of state programs, many of which are cataloged at the Database of State Incentives for Renewable Energy and Energy Efficiency (DSIRE). One impediment for state programs is funding, though again, some utilize system benefits charges to maintain a stable cash flow for these projects.

At the local level, there’s the Weatherization Assistance Program which permanently reduces the utility bills of low-income houses by helping to fund one-time EE projects. And there are non-financial incentives like expedited permitting and density/height bonuses based on LEED certification. (The study also cites the now hamstrung residential PACE approach.)

Financial incentives can have their drawbacks. The public may perceive that the effort/cost of attaining an incentive outweighs its benefits. In other instances, the public may take advantage of an incentive even though they would have made a change anyway. These issues may be mitigated by larger incentives for higher and more expansive EE projects.

My roommate pointed out re: this post that there are a number of different EE financing models currently being developed and recommended Capital-E’s incredibly detailed summary of the current EEF landscape. To process it all, I’m breaking the learning process down into digestible chunks. 

Mortgage-backed Energy Efficient Financing (EEM)

The overview for EEMs is very simple. A property owner can roll their EE project into a new or refinanced mortgage to gain a number of benefits: the repayment period is matched with the length of the mortgage, effectively amortizing costs; energy savings are assumed to exceed the amortizing costs, increasing the borrower’s ability to pay and lowering their risk of default – this in turn can justify a lower interest rate; and the combination of EE and mortgage financing significantly reduces transaction costs. 

Maine, New York, and Colorado each have ENERGY STAR Mortgage programs that buy down associated interest rates, but government involvement is not strictly necessary for EEM to be an effective tool for increasing residential energy efficient.

(The ongoing mortgage crisis will have a smothering effect on the refinancing side of things for the foreseeable future.)

Preferential Terms for Green/EE Buildings

In an ideal world, EE building would receive preferable terms for loans and mortgages since they have:

• lower operating costs;
• lower risk of default;
• lower chances of building system failures, shutdowns;
• higher operating incomes;
• higher asset values;
• and higher health/productivity benefits for workers. 

Making this a reality means collecting a wide body of evidence to that effect. That’s a tall task, but the upside to this strategy is that it doesn’t require new programs or bureaucracy, just the attention of investors. 

State/Municipal Loan Programs

Similar to on-bill financing in that home-owners can pay back EE loans via their utility bills, these programs typically originate at the local level and are funded by a combination of federal grant money, rate-payer funds, bond issuance, and systems benefits charges. If states and municipalities can achieve the necessarily high degree of collaboration across departments, agencies, program administrators, and private contractors, this approach can concentrate expertise, opportunity, and funding in a single place — DOE and EPA can offer key technical assistance in this regard. Close coordination can integrate significant job creation while certain program structures also facilitate access to outside capital.

Excellent examples include Portland’s Clean Energy Works Program (CEWP), Pennsylvania’s Keystone HELP, and the Texas LoanSTAR program. (The LoanSTAR link is particularly persuasive.)

The big knock on this approach is the frequently temporary nature of its funding — see: ARRA — though New York’s successful and evolving utilization of a Systems Benefit Charge (SBC) shows how this hurdle might be overcome since SBCs remain stable apart from year-to-year fluctuations in state funding (18). For example, NYSERDA’s New York ENERGY STAR Homes Program had accounted for 24% of new homes in the state as of September 2010 after an initial market penetration of 1% in 2001 (Appendix B, 11).

Sustainable Energy Utilities (SEUs)

Delaware’s SEU is the go-to model, so let’s start there:

The most important feature of the SEU is that energy users can build a relationship with a single organization whose direct interest is to help residents and businesses use less energy and generate their own energy cleanly. Directly put, the SEU becomes the point-of-contact for efficiency and self-generation in the same way that conventional utilities are the point-of-contact for energy supply.

• The SEU does not supplant other private-sector activities, but complements them by providing a focal point for energy efficiency and renewable energy information, expertise, and incentives. The SEU model will encourage inventors, adaptors and entrepreneurs to bring their innovations to the marketplace.

• The SEU is a public/private partnership that uses public funding sources and consumer savings, combined with private sector funds and management skills, to address the shortcomings of traditional approaches. (2)

The SEU takes care of pre-screening projects, establishes measurement and verification practices, and covers the incremental cost between conventional and EE projects. The project’s ESCO then contracts with the customer to repay the loan, typically over 3-5 years. 

SEUs are particularly promising thanks to their compatibility with secondary capital markets. In Delaware, the SEU worked with Citigroup to pool many of these projects and leverage the state’s AAA rating to issue the nation’s first EE tax-exempt bond. This prompted secondary investors to collectively invest $72M in the bond. 

It seems like this model could enjoy wider adoption in better economic times, once state legislature’s a more willing to commit to new state-wide bond authorities.

Carbon Market Funding

This model, predicated on the existence of a carbon market like the Regional Greenhouse Gas Initiative (RGGI) or California’s pending market, would allow property owners who invest in EE projects to monetize the resulting CO2 reductions via the carbon market. It relies heavily on intermediary energy management and demand response firms like EnerNOC; because they already facilitate the measurement and aggregation of data on reduced emissions, the strategy envisions qualifying these DR firms to broker their customers’ carbon offsets on the market. Aggregating data from many individual EE projects through a handful of qualified firms would ensure the savings, validate their market value, and provide the customer an immediate return on their EE investment. 

Property Assessed Clean Energy (PACE) - Commercial

Where authorized by state law, local governments can fund EE projects for commercial, industrial, and 4+ family residential properties with long-term loans secured by a lien on the property and paid via a property tax surcharge. 

Cap-E also cites the regional approach to PACE being explored by the Carbon War Room in which:

• a Project Developer receives exclusive rights to market PACE financing within a particular jurisdiction;
• a Credit-worthy Contractor implements an EE project and ensure the savings in conjunction with;
• a 3rd Party Insurer who underwrites an insurance policy to back the guaranteed savings;
• and a Capital Provider finances the projects with low interest-rate, short-term loans that can be bundled into long-terms bonds and sold to institutional investors.

They estimate that this regional approach, being tested in Sacramento and Miami, will finance around $650M in EE projects over the next few years (24).

The upside: because PACE attaches loans to properties, they can transfer with ownership and extend for longer terms, in turn allowing for more favorable terms and easier refinancing options down the line. Lower rates and longer terms also make these projects more cash flow positive. Sufficient scaling of commercial PACE projects could attract significant funding from institutional investors. And there are no FHFA run-ins because mortgage consent is required.* 

The downside: mortgage consent can be difficult to secure and the program is only available to property owners. There are significant setup costs incurred by the municipality in establish PACE, setting a high bar for project costs ($2,500+, 25). In many instances, Class A building owners prefer self-financing.

*PACE residential went kaput thanks to FHFA protestations over the prioritization of liens.

My roommate pointed out re: this post that there are a number of different EE financing models currently being developed and recommended Capital-E’s incredibly detailed summary of the current EEF landscape. To process it all, I’m breaking the learning process down into digestible chunks.

Energy Services Agreements (ESAs)

ESAs combine a traditional power purchasing agreement (PPA) with the creation of a special purposes entity (SPE) to finance large commercial/industrial EE projects while limiting risk. Under an ESA, the customer contracts with an investment fund to facilitate all aspects of an EE project in exchange for payment of a fixed or floating portion of the energy savings over the duration of the contract. The investment fund establishes an SPE that is capitalized by itself and third-party investors, pays all project costs through an ESPC/ESP, and retains ownership of project equipment. 

 

(14)

This has a number of benefits for the commercial/industrial customer: there are no upfront costs; the contract payments are treated as an operating expense and can be passed on to tenants, resolving the split incentive; payments as an operating expense also keep the costs off balance sheet, removing complications re: credit risk and prior financing; and the customer gets to outsource their EE project to a developer that already knows what it’s doing.

At the same time, SPEs make this model particularly attractive to specialized investors and their prospective partners by cordoning risk by individual project investments. Many projects yield equity rate of returns, and any tax benefits or incentives garnered by the project pass to the investors, as well (9). If the model can be brought to scale, risk could be further reduced across a wide of array of projects and sold to institutional investors. 

But all of this hinges on the ESA’s ability to keep project financing off balance sheet as an operational rather than a capital lease. Financing Efficiency has a good explanation of why this is important and how proposed changes could handicap this approach, but the takeaway is that off balance sheet financing “allows organizations to install energy efficiency retrofits at no up-front cost and without impairing their existing debt picture, or market value.” 

They estimate that just 5% of EE projects are currently structured off balance sheet. Development of an assured ESA framework could greatly increase that number if standards continue to accept this operational approach.

My roommate pointed out re: the last post that legislation is but one of a number of steps that must be taken in order for on-bill financing to be a scalable driver of energy efficient renovations, and that OBF is but one of the many financial models currently being developed to address different building sectors [(R)esidential, (C)ommercial, (I)ndustrial, (M)unicapilities (U)niversities (S)chools (H)ospitals], include different players, and take advantage of different loan repayment types.

He also recommended Capital-E’s incredibly detailed summary of the current energy efficiency financing landscape but warned against “falling too far down the EEF rabbit hole.” Clearly I didn’t listen. For each section or rereading, there seem to be a dozen new directions or white papers to check out. In order to process it all, I’m going to try and break the whole learning process down into digestible chunks, starting with…

Energy Savings Performance Contracting: ESPCs

A property owner – typically in the MUSH market – works with an energy services company (ESCO) to develop, find financing for, and implement an EE project. The ESCO determines baseline energy use alongside projected energy savings, and the contract terms and length (10-20 years) are set so that the energy savings outpace the loan repayment schedule. The ESCO monitors and maintains the project installations over the life of the contract and typically guarantees prescribed savings to the customer, creating a financial commitment from the ESCO to make sure the project is successful. The savings are split between the customer and the loan repayment until the end of the contract, at which point the customer retains all residual savings. 

Everything about ESPCs is done on a large scale: 

• the customers are traditionally large MUSH market entities; 
• the projects are comprehensive, encompassing multiple EE approaches; 
• the funding can come from a variety of sources ranging from debt and tax equity to utility incentives, government grants, and state revolving loan funds; 
• the contract term is typically at least ten years; 
• and the development period can be protracted owing to the complexity of blend funding and credit assessments. 

The 30-year track record of successful ESPCs also yielded the International Performance Measurement and Verification Protocol (IPMVP) whose standardized terms and best practices can facilitate further scaling of this model.

Furthermore, there are benefits to the ESPC approach that are particularly appealing to the MUSH market. Third-party financing curtails the amount of time it would otherwise take to get a large, public project approved and completed. The ESCO selection process emphasizes high qualifications rather than low bids, as with design, bid, bill (DBB). And the ESCO’s full assumption of accountability reduces customer risk should problems arise (4). 

ESPCs, however, are not as yet suited for smaller projects. They are cost- and time-intensive, making smaller projects less appealing for ESCOs. ESPC projects are incredibly varied, making standardization of financing and the establishment of a secondary market difficult. And the Dodd-Frank Act will also impact the role ESCOs play in energy savings performance contracting, as summarized by Senators Landrieu and Coons here.

—-

In 2006, 82% of ESCO industry revenues came from the MUSH market with the remainder divided among the Commercial (9%), Industrial (6%), and Residential (3%) sectors, and yet C/R/I accounts for ~80% of energy use in the United States (19). Which suggests why ESPCs are such a natural starting point…

ESPCs offer a good starting point for a number of reasons. Their established history offers insight into the way customers, providers, financiers, and policymakers come together to approach a particular set of EE questions.

They touch on a number of the issues — regulation, aggregation, securitization, lien priority, sufficient data collection, transaction costs — hindering other forms of EEF.

But most of all, those 2006 numbers indicate the tremendous growth potential that can be unlocked by further innovation in energy efficiency financing.

On October 13th, the Senate Committee on Environment and Public Work’s Subcommittee on Green Jobs and the New Economy held a hearing on “Innovative Practices to Create Jobs and Reduce Pollution” that sought to focus primarily on the use of on-bill financing (OBF) to spur capital investment in energy-saving retrofit projects. To begin, here’s a top-line summation of each witness’s testimony:

• Edward White, Jr. :: VP Energy Products, National Grid – Focusing on energy efficiency addresses issues of job creation, energy security, and environmental impact. MA, NY, and RI (plus 23 other states) offer examples of the successful collaboration of utilities and state regulators in which regulations that require utilities to invest in cost-effective energy efficiency projects before new energy generation projects have yielded a savings of $3-4 per dollar invested. OBF – using utility bill savings to repay the high upfront costs of energy efficient retrofits – has become an increasingly useful tool. These loans enjoy low default rates of 0–3.5% and can draw largely from outside sources of funding. 
• Kyle Kempf :: Sr. Director, Government Affairs, National Small Business Association – OBF is a collaborative effort between utilities, contractors, and customers that has been shown to produce energy cost savings of 15-30% for small businesses. However, capital sourcing is currently a major impediment to widespread implementation, as are time and the availability of reliable information. Addressing these deficiencies would expand OBF and benefit SMB bottom lines, the growing network of energy-efficiency contractors, and the environment.
• Phil Schoen :: CEO, GEO-Enterprises – Geothermal heat pumps utilize naturally stored solar beneath the earth’s surface for heating and cooling, can reduce water heating costs by 40-70%, and have reduced users’ energy consumption by 44-72%. Geothermal still has but a 5% market penetration because, among other things, the initial installation costs are so high. Further, default concerns and the added complexity of administering financing have limited OBF’s effectiveness. A federal loan-loss program would help OBF incentivize geothermal adoption across all 50 states.
• Anne Smith :: SVP, NERA Economic Consulting – The cumulative (rather than individual) impact of four pending EPA regulations will be massive capital investments in energy production through the retirement and/or retrofitting of coal-fired power plants, a corresponding increase in natural gas prices, and significant net loss in jobs beyond the energy sector. 
• Steve Rowlan :: General Manager, Environment, Nucor Corporation – Nucor, the largest domestic steel producers, and the rest of the steel industry have already reduced the energy intensity required to produce a ton of steel by 30% since 1990. Regulatory uncertainty has caused them to pull back in the pursuit of greater energy efficiency while increased regulation puts the American steel industry at a disadvantage on the international stage. Regulations increase energy costs, which companies like Nucor can deal with in one of two ways: increasing the cost of goods to maintain profit margins leads to a loss of market share while absorbing the costs decreases profitability, leading to potential job losses and decreased tax revenue.

I’d come across Mr. White’s testimony some weeks ago and was excited to finally sit down and listen to the entire hearing. Unfortunately, much of the testimony and discussion centered on the EPA and the impact of regulations that have no relevance to on-bill financing; Senator Sessions failed to even address the concept until prompted by Senator Sanders. 

Many of the most germane points came from the first three witnesses. Mr. Schoen cited geothermal’s large potential for expansion into small business and low-income residential markets if on-bill financing can be made available to a larger part of the population. Mr. Kempf touched on the need for utility-approved auditors to increase the credibility of energy audits and increase the likelihood that consumers will proceed with renovations. And Mr. White noted the convenience that OBF affords consumers as financing major work is reduced to a single line item on their monthly utility bill.

The hearing would have benefited greatly from an examination of the Green Jobs/Green New York Act (GJGNY), whose efforts illustrate each of the points above.

Enacted in 2009 and implemented by the New York State Energy Research and Development Authority (NYSERDA), GJGNY was passed to provide free energy audits, support community outreach programs, fund training for green jobs, and eventually establish a revolving loan fund to facilitate energy efficient retrofits. It launched its financing program in November 2010 and within two months had already approved 1,109 free audits (13). These and additional audits have led to approval of 411 applications for retrofit financing “with 24 loans closed, 80 loans approved and awaiting closing, and an additional 140 loans in process for a total of approximately $1.9 million in capital” (13).  

In June, the state’s legislature bolstered GJGNY’s potential by enacting on-bill financing legislation to help NYSERDA raise an estimated $5B in private investment for further energy efficiency work. Take GJGNY’s documented success thus far and extrapolate the potential increase in related retrofit contracting jobs, the rise in property values, and the reduction in energy consumption thanks to this massive new reserve of capital, and the value of on-bill financing becomes abundantly clear.

This as a recent study of 19,000 retrofitted affordable housing units in New York City found savings of 19% in fuel bills and 10% in electricity across the portfolio, totaling $240 and $70 in savings respectively per apartment per year. This goes to Mr. Schoen’s point about the significant potential for energy efficiency improvements of any kind in the low-income residential market, but it also supports the broader claim that retrofits translate into actual savings. 

Taken together, New York’s example suggests the tremendous benefits that could be had if on-bill financing were to receive greater attention across the country (and in the U.S. Senate.)

Each of us needs to eat and drink and breathe to survive. Our society is organized around the supply of and demand for goods and services. Its survival is predicated on economic growth fueled by these exchanges.

This imperative has associated social and environmental externalities that are destructive and difficult to price. Each of these individual, collective, and systemic truths is tied to the others by the act of consumption. If consumption is both necessary and destructive, can we reconcile the two? Can we maintain our near-term prosperity without jeopardizing our long-term vitality? Is there a moral element to consumption?

Can we have our cake and eat it too?

It seems easy to draw from these facts the conclusion that consumption is a necessary but inherently bad thing, an environmental instance of original sin. Instead, here are two sources that have helped me develop a more nuanced understanding of our relationship with consumption: Yale Professor Douglas Rae’s course on Capitalism: Success, Crisis and Reform (which I started listening to during my cross-country drive*) and the opening chapters of Globalizing Responsibility: The Political Rationalities of Ethical Consumption.

Rae begins his course by addressing the varying degrees of development recognizable in the world today: 

… the old Malthusian world, which still exists on parts of the globe but hasn’t existed in the western world for a couple of hundred years, was characterized by very high birthrates and very high death rates. … Then you have the change in the death rate occasioned by infrastructure, most of all, related to clean water. And when the death rate falls, the birthrate doesn’t track with it. The birthrate lags in its change so there is a period, Phase II here, when deaths are falling sharply and births are statically high. In that period you get an enormous surge, you get indeed population growth at an increasing rate. You get the spike, which brought world population to its present level, is occasioned largely by Phase II. Phase III is the period during which the birthrate adjusts to the death rate. You still get growing population, but now at a diminishing rate. At Stage IV there’s an equilibrium between births and deaths, and both have lower rates. So population is again static, and lives are much longer.

A longer lifespan and a low mortality rate are both good things, and their impact on world population could be good or bad depending on the projection, but the transition from Stage I to Stage IV was hugely capital intensive and had a definitively adverse effect on the natural environment. Still, this animation depicting the relationship between life expectancy and per capita income by country over time suggests one undeniable conclusion: “there’s something unambiguously good” about the world’s collective, consumer-driven migration up and out.

This is clear even when the income data is presented on a linear (rather than a logarithmic) axis, but this second representation leads to questions about how egalitarian this process is or should be. What is the relationship between justice – the distribution of costs and benefits by institutionalized systems and players – and ethics – the moral component of personal agency? “Is it the responsibility of ‘everyone’, as consumers, to ‘do their bit’ and ‘play their part’ in reducing the unjust, destructive, unsustainable consequences of consumption? Or does attention need to be focused on structural factors, such as the regulation of markets, the monitoring of production and distribution systems, or re-gearing international finance and trade regimes?” (6) How can a better understanding of that interplay inform our strategies for negating consumerism’s adverse effects?

For an answer, Barnett and his colleagues turn to Iris Marion Young and her model of shared responsibility. Young’s approach begins by affirming “two levels of moral evaluation: ‘one to do with individual interaction and the other to do with the background conditions within which that action takes place’” (7). By separating these two planes of responsibility, Young is able to sidestep the thorny tandem of liability and blame. 

Young instead pursues what she calls a social connection model of political responsibility, in which responsibility is understood to arise from the ways in which different actors are implicated in structural social processes. “Her starting point is a concern not to reproduce a discourse of blame and guilt by applying a single standard of justice to both social structures and individual action … [as] staking claims about responsibility on a liability model is … likely to be counterproductive” (7).

Our ongoing debt debate typifies just how counterproductive this accusatory tack can be. Blame leads to defensiveness and reduced communication while distracting people from the real goal of finding a workable solution. Its emphasis on the role of the individual also makes people question just how (in)consequential any one person’s actions might or might not be. (See also: why we vote.)

By tying responsibility to actions instead of actors, Young’s method of shared responsibility “allows a more discriminating analysis of the partial ways in which actors might understand themselves to be responsible, where this in turn is not just a matter of liability or blame but is closely related to an analysis of the capacity to act” (8). And like that, guilt and blame can be replaced with collective engagement and a proactive mentality.

This has huge implications for the ways in which we question and change our voracious ways. The current system is unsustainable, but systems don’t change by themselves. Change requires motivation and collective action across many roles and networks, and the idea of shared responsibility can foster that kind of cooperation. At the same time, it absolves us of the guilt and the blame without dodging the consequences, clearing the way for more focused and productive thought and action going forward.

The goal is to make consumption a neutral or even net-positive action. Reaching this goal requires that we “close the loop” (or rather millions of smaller loops), which in turn means collective action. Current levels of consumption may have a net negative impact now, but it doesn’t necessarily have to be that way. Applying a mentality of shared responsibility and collective action is a key step in bridging the gap between now and then.

* The joke was that if I happened to swerve into a guardrail or drive off a cliff during the trip, my friends back in Brooklyn would know the reason why. In fact all of the episodes I listened to were wholly enjoyable.