Financing Energy Efficiency Projects

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Buildings use more than 70 percent of the electricity generated and more than 40 percent of the natural gas used in the United States. The existing U.S. building stock is extremely energy inefficient. The DOE's Energy Information Agency estimates that 30 percent of energy used in commercial buildings is wasted. In a 2009 report, McKinsey & Company estimated that energy savings worth $1.2 trillion are available if the full amount of economically viable and commercially available energy efficiency projects is implemented in the U.S. through 2020. Achieving these savings would require an upfront investment of $520 billion.

Of course, not all economically viable and commercially available energy efficiency projects will be built, and it will take a number of years to approach the deep market penetration referenced in the McKinsey study. At the same time, energy efficiency technologies and applications are advancing at a rapid pace, resulting in an ever-growing market. As is often said in the industry, energy efficiency is the "low-hanging fruit that continues to regrow."

The estimates of the current size of the annual building energy efficiency market vary depending on the definition of the market measured, but all studies indicate that the market is large and growing. Using a narrow definition of the traditional Energy Service Company (ESCO) market, Lawrence Berkeley National Laboratory (LBNL) estimates it at approximately $7 billion in 2011. This narrow definition does not include companies such as engineering and architectural firms, HVAC, lighting, windows, or insulation contractors and consultants that offer energy efficiency services but typically do not enter into long-term contracts that link compensation to the project's energy savings and/or performance. Using a broader definition of the market, which includes the types of entities excluded from the LBNL report, FMI estimates the market at more than $20 billion in 2011. Regardless of the starting point to continued growth over the next several years, most often 10 percent or greater. FMI's current estimates show about a 15-percent compound annual growth rate through 2020.

Even with such a huge and obvious value- creation opportunity, certain obstacles limit the growth of this market. Typical growth constraints cited include:

  • Lack of awareness and focus on energy efficiency opportunities
  • Skepticism regarding the economics of energy efficiency opportunities
  • Unduly complex, nonstandardized, and expensive transaction structures
  • Scarcity of skilled project development talent
  • Lack of prepackaged, simplified project funding - particularly in the commercial real estate (CRE) sector
  • Split incentives (e.g., in certain situations when a building owner, who will incur the retrofit capital expenditure, is not the building occupant, who will benefit from reduced operating costs)

Companies that lessen any of these constraints to the building energy efficiency retrofit markets should grow quickly and capture strong profits.

This article focuses on the project financing constraint mentioned above and how companies can work with third-party financiers to deliver a prepackaged financing solution to clients. More specifically, it will look at the project financing markets for four building energy efficiency retrofit verticals - federal, MUSH (municipals, universities, schools, hospitals), institutional, and commercial and industrial. Projects in each of these markets are financed differently.

 A FINANCIER’S PERSPECTIVE OF ENERGY EFFICIENCY PROJECT FINANCING

Most energy efficiency retrofit projects funded by third-party financiers are considered performance contracts since the ESCO provides some form of guarantee regarding the energy savings (in units of energy, not dollars) that will be generated by the project.

The value proposition of a performance co