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Is Third-Party Financing for Energy Efficiency Ready for Prime Time?

July 29, 2014 posted by Eric Christensen

In recent years, innovations in finance helped spark explosive growth in distributed generation technologies such as roof-top solar. New and creative rooftop leasing transactions allow third-party investors, rather than homeowners, to fund project development. These structures overcome high upfront costs, one of the primary barriers to energy investments for ordinary homeowners and small businesses, while creating solid returns for investors. Third-party investment in energy efficiency, by contrast, has lagged. Several recent developments suggest this may be about to change. First, Wall Street's interest in large-scale energy efficiency investments is growing, as demonstrated by a new Wall Street investment funds dedicated to energy efficiency that have been capitalized to the tune of hundreds of millions of dollars. The strong investor interest in efficiency investments is not surprising given the potential profits. A McKinsey & Company study, for example, estimates that the United States has the potential to reduce non-transportation energy consumption by 23%, which would produce present-value savings of $1.2 trillion, creating a solid return on the $520 billion upfront investment required. Energy savings on this magnitude would also reduce greenhouse gas emissions by 1.1 gigatons, equivalent to taking the entire U.S. transportation fleet off the road. Second, as with third-party financing of rooftop solar projects, recent innovations in energy efficiency financing will help overcome high upfront capital costs and other barriers that have held back efficiency investments. On this front, a wide variety of financing arrangements have been proposed. For example, one promising innovation is the Metered Energy Efficiency Transaction Structure ("MEETS"), which is aimed at catalyzing efficiency investments in the commercial building sector. Investments in this arena must overcome not only high upfront costs, but also the disconnect between commercial tenants, who generally pay energy bills, and building owners. Because the building owner must pay for most efficiency measures, the owner has little incentive to invest in measures that will reduce bills paid for by tenants. Similarly, tenants, who often operate under one-year or even month-to-month leases, have little incentive to invest in conservation measures that pay off only over the long term. MEETS holds the promise of overcoming these barriers. MEETS rests on a foundation of advanced meter technology to measure efficiency gains achieved by installation of advanced efficiency measures in commercial structures. Third-party financing is possible because these savings are purchased by the utility serving the building. Investors, which capitalize the efficiency measures upfront and pay for their maintenance, are repaid from this revenue stream. The participating utility can then either resell the energy it would otherwise have used to serve the building or reduce its wholesale purchases. These benefits help the utility overcome the "rate problem," the decline in rates that ordinarily follows from energy efficiency programs where the utility's revenues are tied to the volume of energy it sells. The building owner benefits because it receives lease payments from the investors. The building tenants are effectively held harmless, paying the same for energy services as they otherwise would have paid without the installation of efficiency measures. The transaction depends upon all parties receiving high-quality, reliable information about the amount of energy saved. The third innovation that may make widespread use of transactions such as MEETS possible is the development of sophisticated meters that can measure energy saved after efficiency measures are installed against a pre-installation baseline, properly adjusted for weather, time of day, and other extraneous factors that affect energy consumption. Advanced meters fitting this description are now entering the market. For example, Portland-based start-up EnergyRM now markets meters and software designed to enable large MEETS-based investments in energy efficiency. MEETS is now being field-tested in a joint program involving Seattle City Light, EnergyRM, and the Bullitt Foundation, which recently completed construction of the Bullitt Center, perhaps the most advanced building in the world from the perspective of energy, water, and waste treatment. These technical advances are complemented by systemic efforts to improve investor confidence and access to capital. For example, the Investor Confidence Project, aims to standardize, simplify, and verify energy conservation programs to encourage broad-scale third-party investment. And the Warehouse for Energy Efficiency Loans ("WHEEL") is the first formal mechanism to create a secondary market for energy efficiency loans, where loans are pooled and sold to investors, creating access to private capital and leveraging public investments in energy efficiency. Ultimately, these advances may encourage investments in energy conservation through securitization and other investment vehicles commonly used in other arenas. If you have any questions about energy efficiency programs, energy finance, or other matters involving energy or environmental law, please contact a member of GTH's Energy, Telecommunications, and Utilities or Environment & Natural Resources practice groups. We're proud that our partner Jim Waldo was recently named 2013 Lawyer of the Year for Energy and Natural Resources Law, and six practice members were recently recognized as Washington Super Lawyers.