How to make energy efficiency affordable

Energy efficiency is a tortoise in the green energy race. Not glamorous like solar, wind or smart grid, it tends to plod along in the back of the pack, attracting little media attention. But being last can be a good thing; you learn from the frontrunners.

Such is the case when it comes to financing. EE is beginning to borrow from strategies that have spurred tremendous growth for solar and other energy resources. These include customer aggregation and a kind of power purchase agreement with a twist. The idea is to make it easier for businesses to install efficient motors, chillers, pumps, lighting, windows and other improvements in today’s tough economic climate.

Consider the transaction that Metrus Energy, an EE developer and financer, announced in December with defense manufacturer BAE Systems, Siemens Industry and Bank of America. Under the deal, BAE Systems’ facility in Greenlawn, New York will install $2 million in energy efficiency with no upfront payment or capital investment.

This may sound like a traditional energy service performance contract, which also spares the customer from an upfront capital investment. But Bob Hinkle, Metrus Energy CEO, explained that the deal is quite different. Called an energy services agreement, or ESA, it is more akin to a solar power purchase agreement (SPPA), except there is no power to be purchased. What’s monetized is energy saved.

“Customers do not have to use their own capital. It is like a power purchase agreement where the customer is charged only for the output,” Hinkle said. “But in energy efficiency, the output is not a kilowatt-hour generated; it is a kilowatt-hour saved, or a therm saved.”

When it was introduced in the last decade, the SPPA helped spur a dramatic increase in solar installations, particularly among businesses and institutions, in part because it took away the need by the customer to make the hefty upfront payment for solar panels.  Also called third-party contracts, such deals typically have three main parties: the customer who receives the solar panel, the energy company that installs and maintains it, and the investor that finances the deal.

The ESA is similar except it runs about 10 years, while the SPPA typically extends to 20 years. The three parties are the customer, the energy services company and the ESA provider. The energy services company installs and maintains the efficiency equipment, which is owned and financed by the ESA provider. The customer pays the ESA a regularly scheduled bill, much like it does its electric or gas utility. But the payment is based on the cost of avoided energy ($/avoided cost of kWh) or share of energy savings.

And like an energy services performance contract (a financial mechanism that has been around since the 1970s), an ESA spares the customer from coming up with money to pay for the new equipment. The two types of contracts, however, differ significantly from there.

The performance contract works under a shared, guaranteed savings model. The energy services company guarantees a certain amount of savings from the system. If the savings do not materialize, the energy service company pays the difference. But the customer must still secure financing (although the energy services company may help them do this). In contrast, financing is an integral part of an ESA.

In addition, performance contracts are used heavily by government. Metrus Energy sees the ESA as a contract more likely to appeal to commercial and industrial energy users.

BAE Systems expects to achieve $300,000 in savings annually through its ESA. The company will install a range of energy efficiency measures to reduce electric and natural gas consumption, including heating and cooling system upgrades, high-efficiency pumps, motors and controls.

The California Clean Energy Fund (CalCEF), a $30 million venture fund that invests in clean technology, is pursuing a sophisticated use of the ESA model that involves aggregating customers into a kind of purchasing pool. Other segments of the energy industry have used the aggregation model for quite some time. For example, retail energy suppliers often pool customers to create advantage of scale. Pooled, the customers have more clout in the marketplace to achieve favorable price and terms for their power and natural gas.

Recently, a major foundation approached CalCEF because it had received an application for funds from a business chamber of commerce, the kind of group that often joins forces to purchase energy. But this time they were looking to purchase efficiency installations as a group. The foundation liked the proposal but was unable to provide funds to the chamber because it is prohibited from directly serving for-profit entities. It asked CalCEF for help.

“The solution we’ve come up with is to use our nonprofit investment to hold capital and deploy the capital with the [chamber] members,” said Paul Frankel, CalCEF managing director. “A company like Metrus can manage the project on our behalf. This is a nice way to channel a lot of foundation money into the world of private industry.”

The non-profit fund could serve as the third-party owner of the energy efficiency installations, collecting payment from the shared savings achieved by the businesses. The fund could then recycle the profits to pay for other clean technology projects.

Frankel sees the model working, not only for chambers of commerce, but also other types of business trade associations.

“Energy efficiency is where we would like to spend a lot more time and effort and money. It is highly cost effective,” he said.

However, energy efficiency suffers a handicap not shouldered by renewable energy. It is unclear if efficiency projects can take the kind of federal tax deductions that make third-party contracts particularly attractive for solar investors. In addition, efficiency is denied an accelerated depreciation schedule available to solar projects under the federal tax code.

CalCEF and others are working on persuading the federal government to rethink these policies and put efficiency on equal footing with solar energy. If that happens, watch out hare, the tortoise is coming.

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