Financing Energy Efficiency

Financing Energy Efficiency 2015 Report

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Energy Efficiency: Why the disconnect between the projects and finance?

By Tim McManan-Smith, editor, theenergyst Energyst Media has conducted numerous surveys across various media and audiences. The perennial answer to questions regarding the main barriers to implementing energy efficiency is finance. So we put that to financiers. But they suggest that money is not the problem; they have “oodles” of capital. Yet they cannot find the projects in which to invest.

So finance companies struggle to find bankable projects and energy professionals say they are thwarted by lack of finance. A puzzling disconnect.

To investigate this in more detail we surveyed theenergyst’s readership in association with Cofely.

The findings suggest that both parties are right, but for different reasons. Energy managers do appear to have access to finance but they strugle to persuade the

MISTRUST That may seem obvious. But the survey suggests a significant level of mistrust or understanding of financial products and service contracts.

Financiers need to communicate their offering to all parties in a clear and understandable way, which suggests a level of market education is required, or that products must be simplified to the point that they do not require detailed financial knowledge.

TOO CONSERVATIVE ESCOs and kit manufacturers need to do the same and to potentially have more conviction when it comes to achievable savings. If there is a 30% potential energy saving but the service contract only guarantees 10% to mitigate technology risk, it is little wonder that uptake is limited outside of the cash-poor public sector.

Surely it is better to have an ESCO, try for 30% and reach 27% than guarantee 10% and reach it? board that it is something worth investing in, whether with the businesses’ own capital or from external sources. That implies that finance is not the problem, but securing a budget.

The survey also suggested that respondents lacked financial knowledge, which may be hampering their ability to present business cases to the financial controllers that will sign them off.

ESCOs, equipment manufacturers and third party finance companies need to communicate to boards and to energy managers that not only is finance available, but that by choosing an appropriate instrument, the business can deploy its own capital to core functions. They must also underline how it can benefit a company to act now rather than delay even when taking into account the cost of capital.

If financial institutions are so keen to get cash away, could contacts be written to be more flexible for ESCOs if they narrowly fail? Surely it is better to have an ESCO, try for 30% and reach 27% than guarantee 10% and reach it?

On the flipside, should ESCOs be more confident in their ability to deliver more significant savings and take a greater share of risk?

Equally energy professionals need to argue the business case for energy efficiency projects more effectively and in terms that will persuade the finance team or the board. Not kWh savings but money; internal rates of return not payback, whether on or off balance sheet, internally or externally financed.

Perhaps they need to think beyond energy efficiency and package projects as broader, longer term measures to make their

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organisations more robust.

So it seems that in many cases money isn’t the problem after all.

However, understanding its treatment in accounting terms and how it is pitched at board level is now critical knowledge for the energy professional. The survey showed a very mixed picture in that sense. It is possibly that lack of knowledge lies behind some of the suspicion of third party finance.

COLLABORATE OR FAIL If that is the case, then all parties must work to meet in the middle or risk a missed opportunity, particularly within the SME market that, falling outside of ESOS, has no real impetus to take action and take control of costs that may soon be much higher than at present.

I hope you find the results of the survey and the insight provided by the report interesting and that it can contribute in some small way toward better collaboration that delivers a properly functioning energy efficiency market.

Capacity for loss or gain?

However it is financed, UK firms must invest in energy efficiency. We may soon feel the full costs of failure to do so, writes Brendan Coyne UK energy policy appears to be in a state of constant flux. But one constant is the fact that decarbonisation will not come cheap. Market reform measures appear to be focused on a centralised approach to building new lower carbon capacity, arguably upon an overestimate of the level of power we will consume in the future.

While new generation to replace retiring plant is imperative, one of the ironies of implementing market reforms over the last five years is whether that plant will now be built in time to avoid system shocks.

Energy prices are currently low, thanks to global developments such as US shale and Opec’s belated countermeasures. But the macro impact is that the UK’s older fossil plant has burned through more cheap coal than anticipated. With capacity margins already thin, the next few years could be tighter than previously anticipated.

BLACKOUTS AND PRICE SHOCKS Lord Redesdale, chair of the Energy Managers Association, believes that the security of supply issue is underplayed. He thinks supply shortages could lead to brownouts or blackouts “by the end of the year” and that energy prices may rise by 25% within 12 months.

Those factors should make energy efficiency an easier sell. Yet energy managers polled for this report suggest otherwise, as did financiers.

Along with the issues of trust, financial knowledge, and the performance of energy performance contracts as outlined on page 3, short-termism appears to be a constant. Respondents suggested that payback periods longer than two to three years were unpalatable at board level.

Those factors, along with how contracts are structured, have hampered market growth.

But financiers see light at the end of the tunnel. The Green Investment bank has invested more than £250 million into energy efficiency projects.

SDCL says its UK energy efficiency fund is over £100m. Other financiers interviewed suggested that they anticipate increasing their investment in UK energy efficiency projects markedly, one firm expecting to double its nine figure business over the next two years.

ESOS APATHY? The government’s Energy Savings Opportunity Scheme (ESOS) also represents a once in every four

balance sheet, Lord Redesdale thinks that the tightening of European laws will make that “very unlikely… boards have got to treat this as on balance sheet and understand that they have to invest”.

Scale is another issue: one of the energy managers interviewed said that his FTSE-listed company had considered an EPC but that the level of commitment required was too high for the board.

Aggregating projects so that end users can access financing for smaller projects at volumes to create sufficient liquidity and market scale may be one solution.

Boards have got to treat this as on balance sheet and understand that they have to invest. year opportunity, although energy managers polled suggest that so far this has made little impact on board level attitudes.

However, the fact that 14,000 businesses must complete energy audits by 5 December presents the chance to pitch business cases to the director obliged to sign it off. Equally, ESOS represents an opportunity for equipment and service providers to step up marketing efforts and accelerate the development of the energy efficiency market.

However, many energy efficiency measures do not require high capital expenditure. According to consultant Mervyn Bowden, former head of energy at Marks & Spencer, no- and low-cost measures can save 10-20% of energy use.

REGULATORY RISK Of the capital projects that do materialise, service companies and their finance partners may struggle to convince clients that they are receiving value for money while allaying balance sheet concerns. And while much effort has been invested into making energy management off

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That requires standardisation of projects so that they can be easily replicated, and transaction costs reduced, and confidence in the data upon which payback assumptions are made. But can projects genuinely be standardised, given the the variables involved? Some believe the most important aspects can (see Steven Fawkes’ article on p28-29).

EDUCATION AND LEGISLATION Market education may be another solution, requiring financiers, service providers and equipment suppliers to engage more closely with end users.

Government also has a role to play by recognising that energy efficiency is likely to be the cheapest means of achieving security, affordability and decarbonisation, and embedding it within the next Energy Act. But if Lord Redesdale is right, a systemic shock could actually mature the energy efficiency market more swiftly than any other factor.

For that reason, he says, “it could be a fantastic time to be an energy manager. Suddenly companies are going to see energy as a massive risk”.

Reader survey: What readers think about energy efficiency projects and finance We surveyed subscribers of theenergyst about their views on the barriers to implementing energy efficiency measures as well as their understanding of service contracts and finance. More than 100 readers responded during April and May. Respondents were largely energy managers, directors and consultants across the public and private sector. Here are their responses.

88% of respondents were either private sector companies or consultants with 12% from the public sector.

Around a quarter of respondents specifically cited that they were implementing lighting projects, although many stated that they were implementing numerous measures, in which lighting is likely to be included. Building controls and solar PV were the next most popular measures. Around 3% of respondents stated that they were implementing CHP projects.

Have you implemented any energy efficiency projects yourself or on behalf of your client?

As would be expected, the vast majority, 77%, have implemented energy efficiency projects. A further 14% plan to do so within the next year.

The rest of the survey splits here between those that have not implemented efficiency projects – displayed in red, and those that have or who plan to do so – displayed in green.

This is to provide a to contrast as to whether opinions to finance vary depending on this factor (i.e. for those not planning projects, it may not currently relevant).

Yes: 77%

Planning to in the next year: 13% No: 10%

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How have you financed or how do you plan to finance energy efficiency projects?

The vast majority of people use the firm’s own capital when financing energy efficiency projects. All the other forms of financing were considered with kit manufacturers being the highest as a considered option. Despite that it ultimately had the lowest uptake, at 10%, alongside those opting for an ESCO/shared savings model.

More than half of respondents did not consider the ESCO option.

Third party finance was considered by nearly half the respondents with 23% utilising it. * Numbers do not round due the question being presented as a matrix option.

Businesses own capital

3rd party finance through financial institutions

3rd party finance through equipment supplier

An ESCO / shared savings model

We chose this option

84%

23%

10%

10%

We did consider this

18%

46%

56%

34%

We didn't consider at all

3%

35%

35%

58%

What has stopped any projects being implemented?

Projects are predominantly not being implemented through a perceived lack of board interest.

Esos may well help raise the profile of this later in the year when it starts to become essential to have lead assessors sign off the audits which the board must subsequently authorise. However, that factor does not apply to the majority of the SME sector, which are not covered by the obligation.

A strong factor

A strong factor

A strong factor

A strong factor

Influenced this a little

Influenced this a little

Influenced this a little

Influenced this a little

Didn't influence at all

Didn't influence at all

Didn't influence at all

Didn't influence at all

3rd party finance rates

Failed internal tests for self-financing

An ESCO / shared savings scheme not appealing

Board has no interest

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Why do you think that financing energy efficiency projects is a problem in general?

Nearly half of respondents think that the problem lies in the fact that firms do not prioritise energy efficiency. Of the remainder, a significant proportion (27%) cite proof of the claimed savings as an issue. The recent exposure given to the international measurement and verification standard IPMVP is a step in the right direction.

That energy efficiency is not enough of a priority at board level puts the onus on to energy professionals to propose a compelling broader business case.

27%

47%

Board confidence in the claimed savings (M&V)

Not enough of a priority

41%

41%

Board confidence in the claimed savings (M&V)

Not enough of a priority

7%

19%

60%

50%

40%

30%

20%

10%

The responses from those who are not planning to implement energy efficiency measures are perhaps more telling: Distrust in measurement and verification is much higher.

Board won't release Issues with getting any funds at all accounting

7%

11%

60%

50%

The opposite side of the IPMVP argument is that it can potentially be manipulated to achieve desired results, according to one energy manager (see p18). That could be a factor in such high levels of M&V distrust.

40%

30%

20%

10%

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Board won't release Issues with getting any funds at all accounting

Has the introduction of Esos changed attitudes to investment at board level?

Two-thirds of respondents say that the introduction of Esos mandatory energy auditing for companies larger than SME - has had no effect in raising the appetitive for the board to invest in energy efficiency measures.

Don't know / what's Esos: 12%

Yes: 21%

Perhaps one answer is that it is too early. The Environment Agency confirmed at the end of May that just 32 companies of 14,000 to whom Esos is applicable had filed reports. This suggests a looming scramble ahead of the 5th December deadline. The prospect of large fines may deliver a steep attitude adjustment given that a board director is required to sign off the report.

No: 67%

The responses for those that have not implemented or do not yet plan to implement energy efficiency projects are broadly similar to those that do plan to take action.

Don't know / what's ESOS: 18%

The overwhelming response is that Esos is yet to bite.

No: 67%

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Yes: 15%

Is there a lack of trust or understanding in utilising 3rd party finance for energy efficiency?

Nearly 70% believe that there is a lack of trust and understanding of 3rd party finance. This is something that the financial community must address.

Energy professionals interviewed for this report agreed that there should be a financial component in energy management education courses. Equally some financiers felt that equipment suppliers were far less mature in their approach towards finance as a core sales proposition than other industries such as fleet and IT leasing.

Yes: 70%

No: 30%

Yes: 61%

No: 39%

With 61% suggesting that there is a lack of trust or understanding, there is clearly work to be done to communicate the effectiveness of the proposition. However, a lack of trust is borne by lack of understanding; you can’t fully trust what you don’t fully understand. But the fact that almost 40% do understand and do trust 3rd party finance is encouraging.

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Is there a lack of trust or understanding in utilising energy performance contracts?

Is it a lack of trust or is it a lack of understanding? Arguably it’s the former because the contracts themselves are relatively straightforward to understand.

Shared savings equipment that is paid for by accrued savings is not rocket science. This poses the question: how can those providing them solve trust issues around EPCs?

Interestingly, those that do not plan to implement measures appear to trust EPCs to a greater extent.

No: 28%

Yes: 72%

No: 39%

Yes: 61%

But in both groups the majority do not appear to have much faith in the instrument.

A criticism of EPCs suggests that they are too conservative in their asserts for the client.

Should ESCOs be more bold in terms of guaranteeing higher levels of savings? There are some in the industry that think this may be the way forward.

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If a project has an effective payback or IRR (Internal Rate of Return) why is it not implemented?

This question permitted individual answers as opposed to multiple choice options. What prevents projects being actioned even if they make sense economically? They are presented here as a word cloud. The larger the word, the more it cropped up in responses.

The qualitative answers reinforced many respondents’ view that interest at board level is lacking, leading to insufficient capital budgets. As becomes clear throughout the report, energy is not yet seen as a major risk issue by many businesses.

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Are the people who could finance & facilitate energy solutions communicating and marketing effectively with the people who sign off projects?

Finance departments sign off budgets and projects. These responses suggest that the marcomms efforts of Escos, kit suppliers and finance providers achieve a four out of ten, at best a C minus. Financiers acknowledge the need to get closer to their customers’ customers and some believe there is a need to upskill equipment suppliers’ sales forces so that financial solutions are core to the sales proposition.

No: 61%

Yes: 39%

Those not planning to implement energy efficiency projects also rate the marketing and communications efforts of finance and solutions providers as mediocre, although their view is slightly more positive than those that are planning projects.

Both sets of results suggest that Escos, equipment providers and financiers must better communicate their solutions not just to those that will specify them, but those that sign the contracts.

No: 54%

Yes: 46%

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What is your interpretation of what ‘off balance sheet’ means?

The vast majority of respondents displayed an understanding of off balance sheet treatment. But there appears to be a mixed view as to whether contract structures that bundle large amounts of fixed assets into service type contracts will be acceptable to authorities. Energy Managers Association chief executive Lord Redesdale believes tightening European legislation may require on balance sheet structures.

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From an accounting perspective, does your business have a preference to either:

The fact that almost half of respondents do not know is a telling statistic, it supports the theory that technically proficient energy professionals must become financially conversant and try to move closer to those signing the cheques. The other notable statistic is that there is an appetite for service contracts, with around a third of respondents stating that is their preferred model. That tallies with the answers on page 7 in terms of consideration. However, it is at odds with the statistics on the same page that suggest only 10% of projects were implemented via the service model.

A higher proportion of those not planning to implement energy efficiency projects do not know their employers accounting preferences. Could that be a contributory factor towards their inertia? But of those that do, the service contracts again show traction, which is interesting, given only around 10% of respondents were from the public sector.

9%

13%

33%

45%

Finance lease

Operating lease

Service contracts or contractual / accounting arrangements

Don't know

11%

11%

27%

51%

Finance lease

Operating lease

Service contracts or contractual / accounting arrangements

Don't know

70%

60%

50%

40%

30%

20%

10%

70%

60%

50%

40%

30%

20%

10%

15

Do you feel the problem is a lack of finance available for energy efficiency projects or it is more to do with the treatment of the contract in accounting terms?

This statistic is telling. Despite earlier surveys suggesting finance itself was a key barrier, here only a quarter of respondents cite it as the blockage. Four in ten think contract treatment creates the barrier, reinforcing the argument that innovation is required, both in terms of contract structures and communication efforts.

25% Lack of finance

41%

34%

Contract in accounting terms

Don't know

The vast majority of those not considering energy projects don’t know the answer. That is perhaps unsurprising given they have not had to consider it. But it is possible that the two factors are linked.

15% Lack of finance

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16% Contract in accounting terms

69% Don't know

Survey respondents’ demographic breakdown

Annual turnover

Number of employees

28.6%

33.1% 44.7%

42.8% 2.9%

17.4%

8.7% 3.8% 6.8%

11.2%

● <£5m ● £5m - £20m

● £20m - £100m ● £100m+

● 0 - 49 ● 50 - 99 ● 100 - 249

Primary job function

● 250 - 499 ● 500 - 999 ● 1000+

Job title

100%

27.8%

73.1%

28.8%

23.1%

20% 34%

75%

50%

25%

46% 0%

Financial

Operational Procurement / Technical

Other

● Director ● Manager ● Consultant

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Board apathy or poor business cases?

End users on why projects fail Brendan Coyne asked survey repsondents for more detail on why they struggle to sign off and finance energy efficiency projects theenergyst’s survey data found that almost half of respondents feel energy efficiency is not enough of a priority at board level. More than a quarter think that boards lack confidence in the savings promised by technology and service providers.

The survey also suggests a lack of financial knowledge among respondents.. Some 48% of respondents did not know their organisation’s accounting preferences.

Energy managers subsequently interviewed agree that financial literacy could be improved within the profession. But not all are convinced that the board is to blame for canning energy projects.

“I think a lot of the problem is actually getting in front of the board,” says Nando’s energy manager Julie Allen. “It depends on how many hoops you have to jump through to get there.”

Allen cites previous roles where her

WILL ESOS CHANGE BOARD ATTITUDES? Two thirds of survey respondents said Esos had not changed board level attitudes toward investment.

While some feel it is too early to tell, Allen is sceptical whether Esos will drive energy efficiency any further up the chain. She views it as “another administrative burden to tell me exactly what I know”.

Although Allen agrees that many companies will find the exercise useful, “I don’t think Esos is the way forward, reporting on exactly the same thing as the CRC.”

CAPEX VERSUS OPEX While survey data suggests a lack of trust or understanding of third party finance, Allen believes the inability to create compelling business cases is a bigger barrier to project sign off. She added that Nando’s had never refused to back a project if it was proven to be beneficial, and that she had

I don’t know that the newer entrants into energy management are necessarily prepared.

There should be a compulsory finance module. business case has been “scuppered” two rungs up the management ladder.

“I think a lot of the time it doesn’t even get to board level, so you can’t blame the board for not adopting them. It could be any number of touch points within that hierarchy that prevent it getting through.”

Should the energy management function be closer to the board, given energy costs can be a big ticket?

Allen is unconvinced.

“You say that, but my utility spend at Nando’s is about £15 million.

Compared to how much we pay for chicken, it’s a drop in the ocean. I could save 10% and that is done quite easily.

That’s £1.5m,” says Allen, “and we saved that on our purchase of chips.

So it is low down on the hierarchy.”

a £50,000 innovation budget to research and prove proposals.

As such, Allen could not say whether the firm would consider third party finance. But, for those firms that might consider finance, she agreed with the views of financiers that there was confusion about where the budget sat, whether operational or capital. “There is reluctance to go to banks if they don’t know where the money sits,” she said.

Similarly, she said that firms slow to adopt lifecycle cost analysis were hampering project sign off.

DISTRUST IN M&V? The survey also suggests a lack of trust in the claimed savings of energy efficiency technologies

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and services. Allen said that the ability to manipulate data to create the desired outcome within some measurement and verification standards contributed to that distrust.

She cited the International Performance Measurement and Verification Protocol (IPMVP), by way of example.

“I am not sure it is much help. I have seen how IPMVP works at a specific company. I did an analysis on exactly the same data and we came up with completely different results,” says Allen. “That’s because of the way IPMVP works: If you don’t like the data, if you are not getting the results you want, you just take it out. Yes, you have to justify [your decision to exclude that data] but…”

It can be a fudge?

“Yes.”

FINANCIAL EDUCATION Allen agreed with Society Generale’s Chris Jones (see page 22) that energy managers require deeper financial knowledge.

“Yes they do, because you need to build business cases. I see an awful lot of energy managers turning into sustainability managers, which means it is more about the environment and reporting than actually building business cases,” she said.

“The original energy managers are disappearing, their roles are expanding, and I don’t know that the newer entrants into the job market are necessarily prepared. I think there should be a compulsory finance module in any further education that they take.”

Peter Wilson, UK technical services manager at Reed Elsevier agrees that financial acumen would help energy managers drive forward energy efficiency.

“The people who are presenting [energy efficiency projects] at grass roots level don’t have all the

necessary financial knowledge and skills,” he says. “Absolutely it would help.”

Wilson says it is “too early” to say whether Esos has changed board level attitudes to energy efficiency, but remains hopeful.

“Our new CFO is [former Centrica finance director] Nick Luft. So we are hoping there might be a bit more focus [on energy efficiency and management].”

THE LEASING PROBLEM While confident Esos will be useful, Wilson is not sure how much difference it will ultimately make to businesses like Reed’s, given often short term nature of building leases.

“We have done LED lighting, swapped out UPS units for more efficient technology, installed voltage optimisation and a lot of lighting control and management systems,” he says. “But if the payback is any

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longer than three to five years, with leases being shorter you can’t depreciate investment over the length of the life of the lease.”

Whether the building owner or managing agent has any appetite to install measures, given they are often incentivised on utility expenditure, is another issue.

“The difficulty is a lot of our buildings that we occupy are multitenancy and the buildings are run by

the landlord or agent. So we have little to no influence on the vast majority or services that relate to energy efficiency. The only bit we can make more efficient are our own lighting and power systems on our part of the floor because we don’t often have control of the rest of the plant, which is the big energy using plant.”

FINANCIAL COMMITMENT Even where the company owns the building, the board may have other priorities, said Wilson. “We did look at a project to install PV on the Oxford building that we own,” he says. “But the board wanted to invest the money into new product development. That is often the stumbling block.”

A financing solution and service provision contract was put forward for the project, says Wilson “but [service providers] really want you to commit to spending significant amounts”.

So the issue was not a lack of trust around the service contract or the financial product, more the level of commitment? “Yes,” says Wilson.

Wilson agrees with Nando’s Allen that it is more about board priorities rather than a lack of board interest in energy efficiency that can see projects wither.

“Sometimes it is a difficult balance for people at boardroom level to look at investing money in capital projects that don’t have much visibility for the business.

That is difficult when they are thinking about expanding the business, acquisitions, new product development… it can tie up a lot of money.”

ESOS TO DRIVE SERVICE CONTRACTS? Two thirds of survey respondents said there was a lack of trust or understanding of energy performance contracts (EPCs) Consultant Mervyn Bowden, formerly head of energy at Marks & Spencer’s turned MD of Intuitive Energy Solutions, thinks Esos may possibly drive EPC uptake. But he thinks they are too conservative in what EPCs deliver.

“From my observation, the contractors will be overly cautious.

If the end user has the potential to save 30% of energy consumption, they will probably get a guaranteed saving from the contractor of about 10%.” Which, says Bowden, “is a

doddle you could do with your eyes shut. It’s to make life very easy for the funders and contractors, not to achieve stretched targets for the end users and clients.”

Bowden said he would not normally envisage EPCs making much headway outside of the cashstrapped public sector, but suspects that “Esos might trigger quite a lot. Because it is an easy option to show you are doing something and achieves some sort of savings on energy, carbon and maybe even water”.

But he thinks that businesses could save 10-20% of their energy bill or carbon output by simply focusing on low or no cost measures, such as lining up energy management with maintenance contracts and properly calibrating building management systems.

“Everybody assumes that Esos [and energy efficiency] is all about capital investment. But it really isn’t.

The low and no cost measures will

After that, says Bowden, it is simply a question of “working out how quickly you want to get there, working out what the kilowatt hours and carbon are worth in monetary terms and what that makes possible [financially]”.

That long-term approach will throw up options and inform spending plans, says Bowden. “Then it pretty much depends on an organisation’s governance processes around budgets.”

ALIGNING FINANCE AND ENERGY DEPARTMENTS Bowden agrees with Nando’s Allen that one of the biggest challenges is for energy managers to become conversant with finance and for finance departments to understand lifecycle cost analysis.

“Yes [energy managers] need to be far more financially aware.

They need to be far more adept at building business cases. They need to understand the various financial

The key to all of this is having a master plan.

With energy efficiency and renewables, the more long term you can make it, the better. make quite big inroads for companies that have done little or nothing [on energy efficiency],” he says. “You can then use the money you have saved on energy and carbon to finance some of the capital schemes later on.”

NO MASTER PLAN, NO BUDGET Ultimately, Bowden says that however projects are financed “whether internally, via the Green Investment Bank, your own bank, other third parties, even your pension fund”, they will not reach that stage without the presence of a strategic, long term view.

“The key to all of this is having a master plan,” says Bowden. “With energy efficiency and renewables, the more long term you can make it, the better.

“If you can go out five years, fantastic, ten years even better.

Work out how many kilowatt hours you want to save; what percentage of the total; whether it is going to be a relative or an absolute target; whether you are going to measure it in consumption per square area, for example. Or whether it is going to be a total number of kilowatt hours or a total amount of carbon saved.”

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options and not just simple cash payback,” says Bowden. “They are not helped by the fact that most internal finance departments still don’t get lifecycle cost analysis.”

Using payback as the sole metric can undermine even relatively low cost projects such as LED lighting, he says.

“LED lighting swap outs don’t look half as attractive if you use simple cash back on energy. They look incredibly attractive - returns of less than a year - if you use lifecycle cost analysis. You are not re-lamping, maintaining, and replacing failures because the LED lights last much longer than the fluorescents you are replacing.”

Given the survey data suggests most firms have a two year payback rule, encouraging a shift to lifecycle cost analysis within finance departments could be the catalyst to unlocking energy efficiency projects - and creating a bigger market for those aiming to compete within it.

Financiers on why energy efficiency projects fail Firms surveyed by theenergyst say that finance, or lack of it, is one of the biggest barriers to energy efficiency projects. Yet financiers say that there is abundant capital seeking a good home. Brendan Coyne asked four finance providers for their view on the apparent disconnect “We are consistently growing our level of Clean Technology business, but we have the capacity to do much more. This perhaps confirms the view of your report; that there is money out there but the deals are not being done,” says Michael Bavington, Clean Technology Specialist at DLL. The Rabobank Group subsidiary has invested “significant” sums in UK energy efficiency projects over the last 18 months and Bavington says the firm is committed to the energy efficiency market. “DLL is very serious about the potential that exists within this sector,” he says. “We have appetite to not just continue, but to increase our level of investment over the next couple of years” That commitment suggests confidence that the barriers to getting deals over the line will be overcome. Bavington thinks that the biggest hurdle is contract treatment.

year they will get the benefit through reduced energy costs, and one would hope more profit,” says Bavington.

“But if on day one they have got to put a liability on the balance sheet for the future payments for the capital element of the investment, they still have to show the asset they have invested in, and then there’s a corresponding liability against that asset.”

Bavington says that is where the mismatch lies.

“When we are talking about energy savings, energy efficiency, we are talking about reducing costs which come from the profit and loss which are revenue costs. There is a desire to try and line up these contracts so they are complete revenue contracts rather than part capital, part revenue.”

ON VERSUS OFF BALANCE SHEET

The solution, he says, lies with setting up service contracts where the Energy Services Company (ESCO) takes a share of the risk.

“If the energy services contract shows sufficient risk transfer between the end-customer and the energy service company, which may not be backed off or mirrored by the financier, that will go a long way to determining whether that contract is deemed a service contract,” says Bavington.

“It is in that analysis of the contract [that the solution lies]. We believe at DLL that we’ve got some funding structures that can go into these energy service contracts. But this is all predicated on the energy services company being prepared to say, ‘we can reduce your energy bills by 30% per annum for the next 10 years’ and to stand behind that. Then we put a funding solution in place that is linked

“If businesses are taking measures to reduce their energy, they are going to reduce their cost base on their profit and loss and become more profitable,” says Bavington. “I think where the tension comes in is when you put a funding solution into an EPC or an energy service contract, the analysis then is [whether] that capital budget then becomes a financial liability for the company? Which is when we get into the on-off balance sheet discussion.”

If the contract is deemed to be finance leasing, the end user then has a balance sheet liability for the capital costs. Yet the financial benefits delivered by energy savings will accrue over time through the profit and loss account.

“If it is via a ten year contract, every

to payments from the customer.”

“But if the 30% savings are not being reached at the full level, we would have to look to the ESCO to make up a shortfall in the payments.

So we have to look at a blend of risk for our repayment in the contract.

But the positive part is that the end customer has a variable, energysaving related contract. Arguments are then brought forward that this is a kind of service contract, it is not a financing or leasing contract. It is then achieved as a revenue cost.”

ENERGY MANAGER VERSUS FINANCE DIRECTOR Bavington says another critical element is bringing together those with energy expertise – the energy managers – with the finance departments signing off the contracts.

You have a customer who is not used to finance and you have a supplier who is in the same boat.

RISK TRANSFER

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“Given the complexity of these transactions, there needs to be involvement from the finance department as well [as the energy managers]. Because [however it is classified] they are entering into a contract that has got long term commitments.”

Are equipment suppliers and Escos therefore speaking to the wrong people?

“I think the more sophisticated ESCOs are trying to involve the finance people as well as the energy people. They recognise the need to do that, but it is an area that perhaps needs some work,” says Bavington.

Equally, he says “some of the ESCOs are very good on technology but perhaps not so familiar with speaking to the finance guys. They recognise the need, but perhaps there needs to be some education there.”

UPSKILLING SALESFORCES Chris Jones, Head of Vendor Programmes, Hi-Tech & Structured Finance at Societe Generale Equipment Finance, agrees that there is a need for education.

“For me the main obstacle is twofold. One is that customers themselves, end users, are not used to being offered a financial solution to acquire this kind of equipment. It is a basic barrier but it is definitely there,” says Jones.

“Secondly suppliers of energy efficient equipment and solutions are also unfamiliar with offering a financial solution to complement their sales efforts and push this technology out. So you have a customer who is not used to finance and you have a supplier who is in the same boat.”

Jones believes energy efficiency technology providers must embed finance as part of their core sales proposition, and that financiers must play their part in upskilling them. But training large salesforces in financial solutions takes resource from both parties that may not be available.

“We are doing it piece by piece, but it is a slow process,” says Jones.

“It takes time to get people to understand what financial solutions mean in their context and for their salesforces to build confidence and knowledge and present it as an option to the customer. At the moment they still see a financial solution as a ‘nice to have’ rather than a ‘need to have’. I don’t think the suppliers always appreciate the benefits that a strategic and coordinated financial offering can bring to their sales effort and the benefit it can bring to their customers.

“So it’s chicken and egg. I don’t see how that is going to change other than over time.”

LED AT END OF THE TUNNEL Jones has spent five years trying to crack the market, but admits growth is slower than anticipated. “If you look at the amount we invest in LED lighting and solar, it is probably a couple of million [pounds] a year,” says Jones. “I would like to be doing ten times that.”

Although Jones thinks it may take another five years for the energy efficiency finance market to fully mature, he sees some positive signals.

“I believe it will take the industry a while to skill-up and for finance to

become part of the sales culture,” he says. “That said, I had a recent meeting with an LED lighting supplier which is pushing [an integral] finance solution. They have spotted a niche because the market is underserved.

And they are going to mop up because they know what they are doing. So the market is maturing a little bit. New entrants who are used to selling finance are coming in with new ideas, so that is beginning to happen.”

DON’T EDUCATE, SIMPLIFY Jonathan Maxwell, CEO of SDCL, has a different view on the need for education of end users.

SDCL was established specifically to fund energy efficiency projects and takes its returns from energy savings achieved. Maxwell founded the firm.

He thinks it is incumbent on service industry to come up with compelling offers and communicate them effectively so that the client buys in.

“I don’t think we can go around hoping that we can educate clients to talk our language,” says Maxwell. “I think we have to be able to give them a solution to their problem.”

Similarly, he says it is difficult to compare financing energy efficient

“The first thing is that you have three counterparties to any deal: The client; an ESCO or technology supplier; and an investor. That can get complicated because there is work to do for each individual party to agree terms with each other and do a deal.”

Then the parties have to agree collectively, which can become more challenging than a standard two-way agreement.

“So I think that is the first point: the discipline is making sure those three parties at the table can work in a partnership and towards a common goal and do so simply with low transaction costs, relatively small amounts of time involved while providing comfort that there is value for money and a good deal for all parties” says Maxwell. “Those are the ingredients that have made deals work for us, working in strong partnerships and delivering value for money.”

Then there is another set of three.

“You need technical skills to understand the equipment and services involved in the project. You need commercial skills to be able to do a deal. You need financial skills in order to price and structure the investment.

And it is relatively rare and/or relatively difficult to integrate all of those three disciplines – technical, commercial, financial,” says Maxwell.

“The successful players will be able to

It is not that board members don’t get it, they do. But they don’t necessarily dedicate someone to focus on it full time with the necessary skillsets. equipment to traditional asset finance, where the financier may take an interest in the asset and realise it on the secondary market.

“It is not like a traditional asset finance business, because the residual assets are different, much more variable and the content of the projects can be quite heavily service orientated. So again, I don’t want to blame the technology companies. It is a different type of financial solution that is needed to deliver these type of projects, compared to [leasing] cars and aircraft.”

THREE-WAY DISCIPLINE Where does Maxwell see that apparent disconnect between abundant capital and the perception that projects are failing for lack of finance? It is “a story of threes”, he says.

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do so in such a way that it is relatively simple, bears low transaction costs and doesn’t take too much time.”

Are there any other critical factors?

“Those are the really important functions that I see. Most deals fall down, if they fall down, because a deal isn’t being done between the parties or there isn’t sufficient integration of those skillsets to get a project over the line.”

So how can financiers help to smooth that over and get deals over the line?

“What SDCL has created as a firm is designed to integrate technical, commercial and financial thinking and skills so that hopefully when we come into a project we can provide help as well as capital to get it done,” says Maxwell. “That is our mitigation to that risk, having the right team here to be able to address the disciplines

You need technical skills to understand the equipment and services involved in the project. You need commercial skills to be able to do a deal. You need financial skills in order to price and structure the investment. And it is relatively rare and/or relatively difficult to integrate all of those three disciplines

needed to do a deal and that includes the legal and accounting aspects of the transaction.”

In the broader market, Maxwell says the key to success is working proactively with the right partners to solve client problems.

“Because that is what this is all about, providing solutions to clients.

It is incumbent on us to work with our services and technology partners to provide a solution for a client - and that has to be sufficiently simple and good value for money.”

BUILD BETTER BUSINESS CASES Miles Alexander, Director, Energy Efficiency at the Green Investment Bank, disagrees that projects are failing for lack of finance. He believes they fail because the business case for energy efficiency is not being presented sufficiently strongly.

“Finance isn’t a barrier because there is plenty of capital out there, both within companies and externally,” says Alexander.

“Often people say they can’t get financing. But actually they can’t get financing because they haven’t necessarily put forward the right

terms to a CFO, then that project is going to lose out to the plant. People are going to say, ‘that plant is core business’.”

Alexander sees leadership around energy efficiency as the crux of the issue.

“It is not that CEOs and board members don’t get it, they do,” he says. “But they don’t necessarily dedicate someone to focus on it full time with the skillset to understand about the energy side as well as build the business case, work through contracts and basically be a champion for pushing projects forward.”

same time has a sustainability positive impact,” says Alexander.

Businesses have to take that approach and look long term – and not purely at payback, says Alexander, because it is the “wrong measurement” to use for energy efficiency. He says Internal Rate of Return (IRR) is more appropriate.

“If it is a positive rate of return, then they should be going ahead with it. If it doesn’t reach their internal criteria on IRRs then that is a different story and they can get third party financing in.”

THINK BEYOND LIGHTING

Companies that select only the low hanging fruit such as lighting and BMS projects also risk making bigger savings unobtainable later, warns Alexander.

“It is important to bundle technologies across the spectrum taking in the short term and long term return so you can average that down. Companies shouldn’t just be cherry picking and saying that ‘I will only do everything under two years [payback]’. Otherwise they are making it harder to do the longer term ones which somebody else [e.g. an ESCO] would pick up if they could also do the shorter term measures [as part of a package].”

If businesses think more strategically and businesses cases can be presented effectively, taking up third party financing should be a straightforward decision, says Alexander.

“Companies should basically be investing into their core business.

Energy efficiency isn’t part of that.

Therefore it would be better to get third parties to finance energy efficiency so they can reinvest the capital they do have into their core business.”

The Green Investment Bank has commissioned a quarterly report via Bloomberg New Energy Finance and EEVS Insight. The most recent report confirms similar data from Energyst Media’s reader survey that lighting and building management systems are the most popular choices for energy efficiency investments. It also confirms that many firms will not commit to projects with payback periods longer than two or three years.

Alexander says that short term view is myopic.

“You can’t get a two or three year payback on CHP. For LED lighting, yes you can. But if you are doing it that

It is relatively difficult to integrate all of those three disciplines – technical, commercial, financial. business case. For example, one that can compete internally against a plant manager in China who is putting in a request to central office for £10m to build out a new plant. Unless those projects are packaged up into - not just megawatt hours or tonnes of carbon dioxide saved - but in financial

way you are only doing the simple decarbonisation.

“It is really important that companies look across their portfolio and at what improvements they could make to their business that would save costs, make their business more robust and at the

SMALL WINS MAY BE BIG LOSSES

e Part of one of Europe’s largest banks, Societe Generale Equipment Finance provides equipment and vendor finance to clean energy and energy efficiency projects, such as LEDs, solar PV, biomass and CHP, through its Hi-Tech division. It can support deal sizes from £5K up to individual transactions of £25m+. f DLL is a provider of asset based financial solutions and a fully owned subsidiary of Rabobank Group.

Its cleantech solutions include capital leases, customised solutions, managed equipment services, operating leases, progress payments and structured finance.

f SDCL’s investment business is focused exclusively on energy efficiency. The funds invest in energy efficiency retrofit projects, typically building retrofits, CHP, renewable heat and urban infrastructure, and seek a return based on savings achieved. The UK fund totals in excess of £100m including £50m committed by the Green Investment Bank. e The Green Investment Bank invests through four key areas: energy efficiency, offshore wind, waste and biomass and community scale renewables. It can put forward capital for much longer periods than most banks, even beyond 25 years. Established by the government in 2012 it has £3.8bn of taxpayer funds, of which it has committed some £2bn. More than £250m has been committed to energy efficiency.

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A language barrier? – energy managers must understand finance What does the modern energy professional have to know to be able to do their job effectively?

It’s a tall order but they need to be both technically and financially literate, and understand how to balance the two. Tim McMananSmith spoke with former Tesco energy honcho James Summerbell James Summerbell, founder of JES Advisory and former head of group energy, energy buying and risk management at Tesco, agrees that there is a tendency for many energy managers to focus perhaps too much on the technology and not enough on the energy deal.

“They love the way the kit works, most energy managers are not hugely interested in financial side of it. It is not their ability. Not that they’re not capable of understanding the finer commercial points of an EPC or Esco contract it’s just not what they are interested in. They miss a proper appreciation of the financial risk the firm is taking when

carrying out such projects.”

He suggests that a typical example would be the energy manager bringing an energy efficient project proposal to a board for sign off.

“A lot of their focus in on the kit and how great it’s going to be from a CSR point of view. The underlying finance arrangements are left to someone else and they rely on support from a finance manager. So when they are presenting they don’t have a thorough understanding of the financial technicalities”, he continues.

“Often payback is discussed but what needs to be understood is: what is the underlying cost; what are we giving away with this deal?”

When considering finance deals, many view success as simply enabling them to get hold of the equipment with the upfront costs recouped from the energy savings.

While this can work Summerbell underlines the need to consider whether this is the right method for your individual financial situation.

Questions must be asked, he says, such as, “How much are we leaving on the table by doing this? Are there other ways in doing this other than giving away value to a third party?”

“There is absolutely a place for third party finance,” says Summerbell, “but it can’t be properly negotiated unless you get into underlying details.”

It is sometimes not obvious, he says, “that it may be structured in a way that the third party is making [a lot] of money from you. If it sounds too good to be true probably is.

Energy professionals need the financial nous to weigh up this sort of assessment”.

The deal and all parties involved need to be open and upfront on the issue of finance. Energy management, says Summerbell, doesn’t really get into the underlying detail of capital enough and this can mean that projects are either not implemented or that they are not structured in an in efficient way from a financial perspective.

A historical perspective – where are we now? progress. While the need to push behavioural change has re-emerged, that is roughly where we are now.

Aside from some forward looking companies and some industrial facilities and hospitals, technologies such as CHP have been underutilised. That is purely because of cost; these are generally large capital projects with significant payback periods. Implemented these projects demands an understanding and use of effective financial models is required. Many CHP projects, for instance, have been commissioned through some form of energy performance contract with the energy services provider facilitating the finance for the capital cost of the project. How do we move to a situation where energy managers can get complex projects across the line?

As Green Investment Bank energy efficiency director Miles Alexander suggests, bundling quick payback technology into larger more complex projects can facilitate an acceptable overall rate of return.

However it is financed, capital or operational, on or off balance sheet, companies must take a more holistic view of their business operations and not just seek easy wins. That means energy professionals must be empowered to look beyond compliance and day-to-day management and, in terms of financial support and acumen, given the right tools for the job.

Energy management as a technical discipline came into being following the oil crises in the 1970s. Prior to this fuel efficiency was seen to be something worth attaining but it was viewed very much as an extension of the engineering department. This continued throughout the 1970s and into the 1980s. Energy management become more of its own discipline throughout the 1980s with the advent of building management systems along with monitoring and targeting systems. These enabled better control of building services, benchmarking, bill validation, and account was taken of degree days, production, occupancy levels and so on.

The 1990s saw a decline in these energy management activities and even engineering improvements because it was cheaper and easier to purchase energy cheaper following the liberalisation of the electricity and gas industries. From around the year 2000, with the climate change agenda setting the scene, energy management again rose up the agenda.

However, it was still seen as mostly as an operational and engineering function that operated on the whole with simple paybacks and new technology – and that is still very much a part of reducing energy consumption within businesses. Without new and better technology and people that are aware of how to implement and operate such kit effectively and efficiently there will be very little

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Gearing up for bottom line savings through Energy Performance Contracting ESCOs are becoming a significant driving force behind the delivery of many energy saving initiatives but what are they and how do they work? Cofely’s Tony Crane sheds some light on the subject In recent years we have seen considerable discussion around the subject of ESCOs and their potential for delivering energy savings for organisations. These are already proving popular in the public sector through a number frameworks at their disposal (Carbon &Energy Fund, RE:FIT, and Essentia to name a few) and will continue to grow in popularity in response to the new EU directive on energy efficiency.

ESCOs are also beginning to make inroads into the private sector, while the use of ESCOs in community projects is still in its infancy though this too can be expected to grow.

However, there is some lack of consistency in the ways that the terminology is used, so it is important to be clear about the subject of this article.

As most readers will already be aware, ESCO stands for ‘energy services company’. If this term is used literally it can clearly be applied to any company that is involved in the delivery of energy services. It is becoming common practise for a Special Purpose Vehicle or SPV to be set up to deliver a specific service to a client or clients..

It should be noted however that there remain a number of energy services companies active in the market that continue to contract directly as well, so it can sometimes be difficult to truly compare like for like. Typically the service will be delivered through an Energy Performance Contract (EPC) – not to be confused with an Energy Performance Certificate Further potential complication comes from the fact that there is no defined market standard or offthe-shelf EPC that can be applied to every project. Each solution is typically unique and tailored to the specific outputs, commercial structure, requirements of the client

and the assets involved.

There is, however, a growing move towards standardising on the major characteristics of EPC projects; in terms of defining the fundamental principles of preparing and implementing such projects. Similarly, the post-project measurement and verification of energy savings can, to some extent, be standardised in line best practice. I would suggest that these are both areas that building operators should consider when entering into an EPC with an ESCO.

EPC STANDARISATION For instance the existing public sector frameworks have brought with them a level of standardisation within their respective models. A lot of good work is being undertaken by the The Transparense project (www.transparense.eu), which is pan-European project which began in April 2013 and will be completed in September 2015, bringing together 20 European partners. One of its main outputs is a Code of Conduct for the implementation of EPC projects, the purpose of which is to guarantee the quality of EPC projects delivered by ESCOs that adhere to the Code. ESCOs that sign up to the Code of Conduct, therefore, are demonstrating that they are willing to work consistently within standard definitions. The Energy Managers Association (EMA) is also a strong force in this agenda which encourages similar principles and standardisation.

Finally, Scottish Futures Trust is also finalising a commercial framework for Non-Domestic Energy Efficiency (NDEE) projects which is sure to be a catalyst North of the border.

MEASUREMENT & VERIFICATION Similarly, there is an international

protocol that defines the measurement and verification of energy savings, called the International Performance Measurement and Verification Protocol (IPMVP). This defines a best practice framework for quantifying the results and benefits of energy efficiency investments, ensuring there is clarity and transparency for all stakeholders.

Again, many ESCOs are using IPMVP as the basis for their methodology of validating the results of EPCs. In this respect one of the major challenges is finding a baseline against which to measure energy savings. The levels of historical energy data can differ widely between clients and sometimes the required information is not readily available so it may sometimes be necessary to develop a temporary or permanent metering/data logging strategy to gather data over a period of time before a baseline can be drawn.

This can present a problem, insofar as gathering data for a short period of time does not provide a true history of seasonal variation so that adjustments have to be made based on estimates. On the other hand, an organisation that has committed to reducing its energy consumption may not want to wait for 12 months to gather baseline data.

It is therefore also possible to structure an EPC with a deemed baseline, however both parties need to understand the commercial aspects of doing so.

This is clearly something that needs to be discussed very early on in discussions between ESCOs and their clients, with agreement on how this baseline data will be calculated and how it relates to the contract’s performance guarantees. This early agreement is a key element of structuring the right solution for a client.

Standardisation allows mass-market financial products such as mortgages, car loans, credit cards etc., and the bonds being issued to ultimately finance them. Unless we can get to that stage with energy efficiency finance we can’t finance the huge amount of investment that we need.

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We aim to have the first draft European Protocols published by Q3 2015. The industry is just too disaggregated. No two projects or contracts are alike.

Securitisation is not practical or possible under these circumstances.

EARLY UNDERSTANDING OF THE FINANCIAL AND ACCOUNTING IMPLICATIONS As noted above, the actual delivery of an EPC will vary from one project to another but one thing they all have in common is the need to be very clear about how they will be financed.

Ideally, this should also be a subject for discussion very early on in the feasibility stage.

Experience has shown that if the initial discussions ignore the financial and sometimes accounting impact of a project, it can go a long way into the development phase and then can encounter finance obstacles that fundamentally alter the way that the desired energy savings can be delivered.

On the subject of financing, it is interesting to note that there are a number of loan schemes open to the public sector energy saving projects which do not appear to be accessed as often as they possibly could. This is an area where an ESCO, not driven by the need to maximse an underlying investment, can provide guidance and support to its public sector clients.

Often there can be significant savings in delivering a number of energy efficiency measures in one single project on a single site of even across a portfolio of sites The improved efficiency of development and the installation and project management cost, a blend of savings supporting longer pay back technologies, and possibly bringing into play lower cost of capital funding are just some of the benefits that

can be generated.

Given all of these considerations it is clear that the key to a successful delivery of an Energy Performance Contract by an ESCO is early engagement between all stakeholders to ensure there is a clear strategy for how and why the energy saving project will be implemented. In this way all parties are clear about the objectives and how those objectives will be achieved.

The building blocks of energy-savings Experience has shown that when it comes to delivering energy savings there are a number of core technologies that play a key role. These include: e Retrofitting additional control e LED lighting. technologies. e Variable speed (inverter) drives. e Improving the thermal e Solar PV and thermal. performance of the building e Biomass (heating and CHP). fabric. e Gas-fired CHP. e Heat pumps.

Behavioural change can also e Upgrading process cooling play a role but while an ESCO plant. can facilitate this it is difficult for e Upgrading compressed air plant. a contractor to control another e Upgrading controls such as organisationâ&#x20AC;&#x2122;s employees.

BMS.

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Making energy efficiency investable – the Investor Confidence Project Dr Steven Fawkes, senior advisor, Investor Confidence Project discusses the need for standardisation One of the essential pieces of the jigsaw that we have to build to accelerate investment into energy efficiency, particularly third party investment, is the standardization of project development and documentation.

Standardisation is normal for developing and financing energy supply projects but not for efficiency projects. This is the area addressed by the Investor Confidence Project, an initiative started by the Environmental Defense Fund in the USA which has created Protocols for developing projects in different categories of building and has considerable traction with banks, investors, the energy efficiency industry, and city and state programmes. As well as Protocols the Project has launched a Quality Assurance system called “Investor Ready Energy Efficiency SM” and an open data initiative.

1,000 energy efficiency projects, Standard & Poor’s would have to read 1,000 documents to assess the risk. Fees won’t pay for that level of review.”

By standardising the development and documentation of efficiency projects in buildings due diligence time and cost, and variability in results will be reduced. It will also enable aggregation of projects and ultimately support a secondary market in energy efficiency finance such as the issuance of bonds. It will also allow banks and financial institutions to build teams around

standardized processes – no bank or investor can build a team around an ad hoc approach where every project is different as is currently the case in energy efficiency. In time it will allow the collection of standardized performance data which can be used by investors. All of these things are necessary to facilitate a thriving and much enlarged energy efficiency financing market as no large-scale financial market can exist without commonly agreed standards. Standardization allows mass-market financial products such as mortgages, car loans, credit cards

There is no off-the-shelf EPC that can be applied to every project. Each solution must be unique and tailored.

CONFIDENCE BREEDS SUCCESS The Investor Confidence Project seeks to bridge the gap between project developers and building owners, who see a lot of potential energy efficiency projects, and investors and lenders who like the idea of investing in energy efficiency but either don’t have enough confidence in the results, can’t deal with the high transaction costs or simply can’t find enough truly bankable projects. Although there is strong interest in energy efficiency from institutional investors it currently is not “investor ready”. Michael Eckhart, Managing Director & Global Head of Finance and Sustainability at Citigroup, summed up the problems with energy efficiency from the investors perspective by saying: “Energy efficiency is in a category by itself. Energy efficiency projects do not yet meet the requirements of capital markets. The industry is just too disaggregated. No two projects or contracts are alike. Securitization is not practical or possible under these circumstances. Say you have

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etc, and the bonds being issued to ultimately finance them. Unless we can get to that stage with energy efficiency finance we can’t finance the huge amount of investment that we need to achieve environmental and energy security goals. The Building Performance Institute Europe estimates that between €500 billion and €1,000 billion needs to be invested in energy efficient renovation of Europe’s buildings by 2050. This level of finance can only come from the private sector.

NEW PROTOCOLS NOT STANDARDS It is important to understand what the Investor Confidence Project is not. It is not developing new technical standards – plenty of these exist, rather it is about using the available standards in a common way through the entire process of developing and documenting energy efficiency projects. It is not about limiting engineering creativity. It is

not about standardizing contracts – there have been previous attempts at this in Europe particularly around Energy Performance Contracts.

We do need innovation in contract forms but the Investor Confidence Project Protocols can be used with any contract form, or any source of funds – including internal corporate funds (always remember that CFOs are investors too). In Europe the Investor Confidence Project Europe is not about enforcing a US model – the process of developing a project goes through the same stages everywhere but uses different engineering standards. What will be common between the US and Europe is an approach, not specific standards or protocols. This is essential because the world of finance is international and many of the large institutional investors who want to invest in energy efficiency, but are currently constrained from doing so, operate around the world.

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EUROPEAN BACKING The Investor Confidence Project Europe concept has great support, the EU and UNEP Energy Efficiency Finance Investors Group (EEFIG) in its report, “Energy Efficiency – the first fuel for the EU Economy,” specifically highlighted the Investor Confidence Project and said that “[Europe needs the] launch of an EUwide initiative to develop a common set of procedures and standards for energy efficiency and buildings refurbishment underwriting for both debt and equity investments”. The International Energy Agency in its “Energy Efficiency Market Report 2014”, issued on 8th October said: “[Investor Confidence Project] will facilitate a global market for financings by institutional investors that look to rely on standardized products rather than project-specific structuring and due diligence.” The project has also been granted €1.9m from the EC’s Horizon 2020 programme.

We have built a powerful panEuropean coalition of banks, development banks, investors, property owners, ESCOs, energy efficiency companies, government agencies, NGOs and others who are supporting the Investor Confidence Project Europe. We have a European Steering Group, a Technical Forum to contribute to and oversee the drafting of the protocols to ensure they can be readily used, and national Steering Groups being formed by our advocates in the UK, Portugal, Germany, Austria and Bulgaria, as well as strong interest in other countries including Italy, France and Ireland. We are looking to further engage with investors, banks, cities and regions looking to accelerate investment into energy efficiency and anyone can sign up to be an Ally, join the Technical Forum or volunteer for a National Steering Group.

We aim to have the first draft European Protocols published by Q3 2015 and are already working with developers of actual projects to incorporate their use into the development and due diligence processes of real projects and investors. We welcome working with any investors, project developers and building owners, to help make energy efficiency a more investable asset class. We look forward to a future in which energy efficiency is considered just as investable as energy supply assets.

What is the best technology to invest in?

Picking technology winners is not easy. But there are methodologies to help inform the decision process. Tim McManan-Smith delves into MAC curves, return rates and technology bundling It is difficult to know the best investment to make in new technology. There are obvious options such as installing LED lighting, upgrading boiler kit or behavioural change. Meanwhile CHP is a highly efficient way of generating heat and power but has a high capital costs. So how do you make such decisions? One method of ranking is McKinsey’s marginal abatement costs (MAC) curve. A MAC curve allows the user to compare the cost-effectiveness of carbon dioxide (CO2) reduction options in the context of CO2 emissions savings. In other words, a single graph allows users to compare options both in terms of cost effectiveness and CO2 reductions.

The vertical axis (y-axis) of the MAC curve shows the costeffectiveness (£/tCO2) based on NPV costs and lifetime CO2 savings while the horizontal axis (x- axis) shows the annual carbon savings.

The cumulative annual savings (the full width of all the blocks on the MAC curve) give an indication of the maximum potential carbon savings.

The MAC curve also includes a list of the measures in decreasing order of cost-effectiveness (£/tCO2) so that you can identify which option is represented by which block of the MAC curve.

The use of a MAC curve allows an informed selection of the efficacy of various technologies to be conducted. However, caution must be exercised.

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PROBLEMS WITH MAC CURVES McKinsey’s cost curve’s deceptively simple graphics give a comparison between various options for reducing greenhouse gas emissions.

Greenpeace describes McKinsey’s cost curve as “an optical illusion.”

Expert-based MAC curves, assess the cost and reduction potential of each single abatement measure based on educated opinions, while model-derived curves are based on the calculation of energy models. UCL Energy Institute’s Fabian Kesicki in his paper Marginal abatement cost curves for policy making – expertbased vs. model-derived curves, suggests the concept of MAC curves contains several shortcomings.

Kesicki states: “One weakness

Types of technology that can be considered for projects e e e e e e e e e e e

Energy efficient lighting Improve lighting controls Energy awareness campaign Turn down thermostat by 1°C Improve efficiency of steam plant or boiler plant Biomass boiler Decentralisation of hot water boilers Conventional boiler replacement Office electrical equipment improvements Improve the efficiency of chillers Building management system optimisation

concerns the transparency of assumptions. Firstly, the assumptions concerning the baseline development and assumptions on the costs of abatement technologies are often not stated. In order to increase the confidence of decision makers using this research tool and to increase the accuracy of the decisions made, publishing key assumptions together with the MAC curves can be helpful.

Secondly, MAC curves represent the abatement cost for a single point in time. Due to this representation, they cannot capture differences in the emission pathway and are subject to intertemporal dynamics. This means that the marginal abatement costs depend on abatement actions realised in earlier time periods and expectations about later time periods.” MAC curves are not able to capture the full amount of market distortions and several types of interactions that limit the CO2 abatement potential.

ADVANTAGES e e e e

Present the marginal abatement cost for any given total reduction amount Give the total cost necessary to abate a defined amount of carbon emissions Allow the calculation of average abatement costs Expert-based MAC curves

DISADVANTAGES e e e e e e

Limited to one point in time No representation of path dependency Limited representation of uncertainty Lacking transparency of assumptions No consideration of ancillary benefits No integration of interactions

e e e e e e

e e e e e e e e e

Improve heating controls Roof insulation Wall insulation Improve building insulation levels Insulation - window glazing and draught proofing Improve Insulation to pipework, and/in boiler house Voltage optimisation Variable speed drives Combined heat & power

and dependencies between mitigation measures No representation of intertemporal interactions Simplified technological cost structure No macroeconomic feedbacks Risk of penny-switching No technological detail in representation of MAC curve Assumption of a rational agent, disregarding most market distortions

recession, this is unlikely to have increased. The International Facility Management Association also found that the average maximum ROI is 3.4 years. This means that projects with longer paybacks tend not to get done unless the board has a long-term vision to reduce energy consumption. Ingenious Investments, an external financing company for clean energy projects, says one method to approach this problem is to package up measures.

Only 25% of companies surveyed by Siemens would accept an internal rate of return of more than three years.

There seems to be no reason why large savings cannot be made by most businesses in this field if they manage and operate their site effectively. Former US secretary of energy Steven Chu has said that “energy efficiency is not just lowhanging fruit; it is fruit that is lying on the ground”. So the obvious thing that most organisations do is to go for this low-hanging fruit first; the low-cost and no-cost measures.

Bank those easy wins and then think about the more complex and longer term solutions for reducing energy consumption within the business.

This sounds reasonable enough.

However, it can create a problem that entails the stalling of future energy efficiency projects.

Larger projects such a large CHP installation, boilers and chillers or geothermal heating and cooling, for instance, can have paybacks that exceed what most businesses are willing to accept. In 2010, only 25% of companies surveyed by Siemens would accept an internal rate of return of more than three years. Following a prolonged

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By bundling technologies into a broader energy efficiency project it is possible to achieve an acceptable payback period. The low-hanging fruit, such as LED lighting and building management systems, which may have payback periods of one year when aligned with maintenance contracts, combined with CHP, which could have a five year payback, could potentially result in an overall payback of three years, meaning that the CHP project becomes more viable.

As the Green Investment Bank’s head of energy efficiency Miles Alexander outlined (p24), by cherry picking easy projects first, it is harder to implement the longer payback projects later on. So by bundling the whole thing as a comprehensive energy reduction solution the best technology is utilized and the payback acceptable.

Of course, a company can go for the low-hanging fruit and then move on to the larger things if it ring fences the savings from the early projects.

But in most businesses, this rarely happens.

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