Future Bright predicts Energy Efficiency as an asset class will ’emerge’ in 2015. While traditionally understood and captured by energy service companies (ESCO’s) and utilities, savings in efficiency retrofits have been stunted due to numerous structural impediments and in particular stakeholder misalignment and capital gaps. These problems are being solved today and taking a page from the renewables growth story, energy efficiency is set to scale.
ENERGY EFFICIENCY AS AN ASSET CLASS
Future’s Bright deeper dive ‘The Sleeping Giant’ is below
The Takeaway: We’ve been sleeping on a pile of cash. The opportunity in Energy Efficiency is being driven by improving technology, supportive policy and adapting financial innovation. Innovations in the renewables industry will speed the creation of an energy efficiency asset class. Energy Efficiency as an asset class represents an attractive uncorrelated alternative to hybrid fixed income instruments. The opportunity represents another trillion-dollar sustainability option. It’s time to wake the Sleeping Giant.
The giant is snoring loudly—he’s waking his neighbors—there’s dollars to be made. In July 2014, HSBC estimated the investment opportunity in energy efficiency could be worth up to $365B globally. The opportunity in the US alone could be around $200B (HSBC, Deutsche Bank). The bulk of that opportunity lies in retrofits to existing commercial, industrial and residential buildings.
Risk-Reward: From an investment lens, capturing waste and turning it into dollars through energy efficiency shared savings should be quite attractive. After all, no one is competing for these wasted dollars; they simply evaporate from the bottom line. Investment vehicles to access these captive returns are gaining recognition because they pool a portfolio of shared savings retrofits and give investors access to potentially uncorrelated returns. Depending on investment structure, energy efficiency can be seen as a hedge against a slowing economy for both businesses and investors and as a potential credit enhancement for the business and or tenet (through lower operational costs).
Still, complexities in the marketplace have made waking the giant more difficult. Stakeholder misalignment and opacity in commercial credit standards have hindered strategic origination and investor comfort. Some of these impediments seem to be lifting as adaptive policy, awareness and the search for diversified yield drive interest.
The value of retrofits is determined by the payback period for retrofitting with new technology and financial structure. The payback period is determined by the cost of new technology and energy prices. As the cost of technology falls or energy prices rise the value of retrofits increases. Further, retrofits often hold more value for businesses where facilities are operating for 8-16 hours per day.
At the technological core are light-emitting diodes or LED’s. Lighting efficiency is measured in lumens per watt or the amount of energy required to produce light. The more lumens, the brighter the light. The graphs from the US Energy Information Agency show us that LED’s are ~6X more powerful than incandescent bulbs and can last 30X as long.
The cost of LED lighting has fallen more than 80% since 2010 making payback periods often less than a year. Let’s illustrate with a simple example.
Building A has 100 60W incandescent lights (IC) and is exploring the value of an energy efficiency upgrade to LED’s. Lights currently run 16 hours per day and energy costs are $0.15/kwh.
For our example, we assume that LED equivalents are four times more expensive than IC comparable. Channel checks show competition and gains in efficiency that are above and beyond the analysis above.
Further gains in technological efficiency are expected while cost declines are predicted as well. The EIA forecasts lumens per watt to reach 150 by 2020 with a concurrent cost differential to be around 2. Regardless, the current environment appears to afford enough excess return (do we call it uncorrelated alpha?) to satisfy all required stakeholders at the tea party.
This trend bodes well for businesses geared to LED’s like vertical farming. Contact Future Bright to learn about transforming trends in sustainable agriculture.
LED are one facet of the energy efficiency equation. Gain and intelligence in smart grid technology can optimize and building energy usage further. Green boilers, grey water systems and improved insulation add to the bottom line and one cannot overlook the omnipresent chatter on the benefits of batteries and battery price parity (See Future Bright’s upcoming article, ‘Closing the Loop’ on batteries).
It is clear from the above example for LED’s that a compelling opportunity exists in energy efficiency retrofits but how do we unlock these saving. There are many challenges to scaling the market including matching the capital expenditure cycle for businesses, stakeholder misalignment and origination and scaling issues. We now address a few of the policy and financial engineering innovations addressing these impediments.
Financial Innovation / Supportive Policy:
PACE or Property Assessed Clean Energy is a means of financing retrofits through an increase in property tax liens. PACE is an innovation born of California that is now spreading nationally and from the residential market into the commercial market. PACE is attractive to financiers due to the lien status and value of residuals available in securitization. PACE programs continue to work through hurdles of aligning interests with the mortgage industry and bridge loan requirements but interest and investor appetite appears to be scaling.
Energy Services Agreements (ESA) fund off-balance sheet retrofits in exchange for shared savings. The shared savings are split between investors, investment managers and energy service companies in an innovation to overcome capital expenditure hurdles and bring new investors to the segment. ESA’s may prove attractive as they allows hosts to realize operational cost savings immediately with no capital expenditure. ESA’s are also less sensitive to regulatory or incentive structure although certain models could benefit from tailwinds in these areas. Challenges that exist in benchmarking and portfolio construction can be addressed with strategic origination channels, technology and insurance. ESA typical resemble the power purchase agreement (PPA) an innovation used to unlock financial interest in the solar market. In the case of ESA, contracts are for savings units as opposed to produced energy.
EE Loan: Traditional secured loans may provide more comfort for investors targeting and stable bond like return. Energy Efficiency loans can take many forms with some allocating a mix of shared savings in addition to a fixed rate of return. Collateral can be extended beyond the retrofit equipment in some cases.
Policy Support is driven by the will to invest in a low carbon economy. Efficiency fits into the equation of economic value add through localization. The dual mandates of mitigation of climate risk and more economic resilience through reduced operational cost volatility should keep policy support accommodating.
There are numerous other iterations in the marketplace vying for access to captive returns from energy efficiency retrofits. As the market scales and securitizations increase, more investors are sure to be attracted to the risk-reward characteristics and expectations for continued improvements in technology.
Investments: In terms of investing in energy efficiency—there are many potential articulations from securitized bonds, to equity, to PE-style investment vehicles. One company worth mentioning is Hannon Armstong (HASI). HASI is organized as a sustainable REIT and invests in renewable energy and energy efficiency projects typically in the form of loans. The stock is up 39% year to date and sports a 5.46% dividend yield so investors may want to consider relative performance.
From a platform perspective, large investors and institutions should take a close look at building capacity in the energy efficiency asset class. Some are taking note, as evidenced by GE’s announcement this week of the formation of Current, a wholly owned subsidiary to capture momentum in new energy trends including energy efficiency. GE is reported to have committed $1B in balance sheet to the problem. Now let’s see if they can solve the strategic origination problem.
One thing is for sure. The Giant is no longer sleeping deep. He’s yawning and beginning to stretch. Soon he will carry those who took notice of the opportunity.
Disclosure: Future Bright is a think tank and advisory in sustainability and investing. Future Bright has worked with renewable energy developers, energy efficiency funds, assets managers and vertical farms on progressing solutions towards sustainability. This note is not an offer of services or investment of any kind. This is a blog post for informational purposes only. Those interested in consulting services, design work or industry analysis should contact Future Bright directly. (www.futurebrightblog.com)