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Financing Energy Efficiency

Nov. 16, 2015
Vehicles for funding energy-efficient solutions, including energy-savings performance contracts, utility incentives, and on-bill financing and PACE programs.

Often cited as a barrier to the deployment of proven, energy-efficient solutions is a lack of funding or funding mechanisms. There are, however, funding vehicles that have proven successful—when made a priority.

Market-Driven Approach

Efforts to finance energy efficiency should begin with a market-driven approach. Markets have proven to be very powerful drivers of energy efficiency in parts of the world. Countries as different as Denmark and Japan have in common a high price of energy; as a result, high-efficiency solutions have been broadly deployed and accepted in both countries. In Japan, for example, virtually 100 percent of home air-conditioning systems are variable-speed, using about 30 percent less energy than their fixed-speed counterparts. In the United States, where energy is comparatively cheap, only about 1 percent of home air-conditioning systems are variable-speed. More broadly, in countries in which energy is subsidized, interest in conservation and means of achieving it is weaker; waste is not recognized as waste without an associated cost. Variations such as this point to a clear advantage to a market-based approach driving energy efficiency.

Energy-Savings Performance Contracts

At many levels, government seeks a leadership role in energy efficiency, providing leadership by example, spurring product development, reaping cost savings, and gaining other advantages flowing from waste reduction. However, government lacks capital. It should come as no surprise, then, that government has been a leader in utilizing energy-savings performance contracts (ESPCs), a market-based approach to financing energy-efficiency projects that has been around for several decades.

In brief, ESPCs allow investment in projects for the chance to earn revenue from energy savings. Several building-equipment companies offer such contracts. These contracts work because, lacking capital, government agencies often are required to buy equipment from the lowest bidder. By selling the savings revenue stream separately or holding it themselves, equipment providers can bring the “first cost” of advanced equipment down to levels that are competitive with less-sophisticated technology.

Some companies are working hard to encourage the expanded use of ESPCs by the federal government—not because they can take advantage of them directly, but because their customers can. The expanded use of these contracts would be beneficial throughout the industry, as it would help to stimulate high-efficiency-equipment business.

Utility Incentives

In the United States and Canada, utilities provide about $7.5 billion (USD) in incentives for energy savings annually. Most incentives are in the form of rebates for the purchase of high-efficiency products.

Rebates vary in design from state to state, utility to utility, and regulatory agency to regulatory agency. Some are structured to incentivize annual energy savings or energy efficiency, while others reward peak-load reduction. Obviously, such differences influence the role rebates play in financing energy efficiency. And because utility regulation is inherently bureaucratic, there are many economic inefficiencies and zones of arbitrariness.

For example, each program and incentive is subjected to a calculation to determine its cost-effectiveness and then verified by the state public utility commission—a complex business. And the rules vary by state. Some states “rate base” payments for energy incentives, while others empower utilities to add charges to utility rates. Programs have to be cost-effective to both the participating customer and to the utility’s general body of rate payers, a sometimes vague and varied target.

Other issues exist. For example, state regulators frequently sidestep incentivizing the replacement of old and inefficient equipment, reasoning that it soon will be replaced out of necessity anyway. Incentives may, therefore, be calculated on energy savings above the level of the federal minimum efficiency standard, giving little encouragement to replace old, inefficient equipment with modern equipment that uses perhaps half the energy of its out-of-date equivalent.

OBF and PACE Programs

Still, utility incentives can be powerful and effective tools. Many utilities offer on-bill financing (OBF), which allows customers to invest in energy-efficiency upgrades or improvements and repay the cost through charges added to their utility bills. The upside of OBF is that it reduces or eliminates upfront costs and aligns timing of costs and benefits to generate positive cash flow. Also, OBF programs can complement rebates, grants, or tax incentives for energy-efficient products to further reduce upfront costs.

Similar to OBF, PACE (Property Assessed Clean Energy) programs are financing mechanisms that support energy-efficiency upgrades by providing upfront capital that is repaid through a special assessment on property taxes.

PACE funding is provided or arranged by a local government for 100 percent of a project’s costs. It allows owners to benefit immediately from energy upgrades and is repaid with an assessment over a term of up to 20 years. Unlike other financing vehicles, PACE funds are tied to properties, not property owners, and can be transferred to a new owner or shared by tenants.

PACE programs are locally based, with energy-service contractors providing the initial energy-savings assessment. The programs essentially are simple mechanisms that are easy to tap into and provide a direct and immediate economic impact. They may well provide a model of how to get benefits from—and avoid downsides of—utility incentives.

Removing Barriers

Providing and encouraging effective avenues of finance is critical to expanding the impact of energy-efficient technology in buildings. Perhaps no less important is the removal of barriers to effective finance.

In the case of the built environment, two specific barriers to finance stand out:

  • “Split incentives,” which occur when the owner of a building does not pay for the energy consumed and is, therefore, not incentivized to make energy-efficiency upgrades a priority.
  • Tax laws. HVAC equipment is depreciated over a 39-year period, which far exceeds the life of the equipment. These depreciation rules incentivize retaining antiquated equipment and, in effect, amount to a subsidy for energy inefficiency.

Barriers such as split incentives and misdirected depreciation rules are not in place without reason. Each has its own rationale. But as energy efficiency moves up the list of public priorities, those reasons need to be reassessed to make energy efficiency and high-efficiency, sophisticated technology financially feasible.

Finance drives the economy. The energetic flow of financial resources to energy efficiency is vital to making efficiency work in the buildings marketplace. A fresh look at the place of efficiency among our national priorities and rethinking policies that are, in effect, barriers to enhanced building efficiency should be a principal goal of public- and private-sector leaders who are committed to sustainable progress.

Lisa Tryson is director of corporate communications and public relations for Danfoss North America, manufacturer of controls and components for HVAC and allied industries. Previously, she headed global marketing communications for the company’s Refrigeration & Air Conditioning division in Denmark. She leads Danfoss’ EnVisioneering thought-leadership program.

Did you find this article useful? Send comments and suggestions to Executive Editor Scott Arnold at [email protected].