3 paths to advancing the building energy retrofit market

3 paths to advancing the building energy retrofit market

CC license by angelocesare/Flickr

One obstacle in the way of spreading energy efficiency throughout buildings is the struggle to scale up investments. Ceres, the advocacy coalition for a sustainable global economy, has decided to address that blockage. Under the auspices of its Investor Network on Climate Risk, a network of over 100 institutional investors with market capitalization in excess of $11 trillion, Ceres has issued a new report detailing a comprehensive framework for creating an institutional-scale building energy retrofit industry. A webinar that builds on the report, focusing on investment initiatives in California, will take place June 6.

The Ceres study reports on the results of a March roundtable that assembled a cross-section of 29 institutional investors, energy finance experts and policy leaders to evaluate options for scaling up the building energy retrofit sector. As a participant in the roundtable, I can attest that the report is well worth your attention.

The Ceres roundtable produced three tiers of recommendations to scale the building energy retrofit market:

Utility Market Reform. The utility business model should be reformed to reduce utility revenue loss associated with building energy efficiency. Progress is being made, but more remains to be done. Nearly all states allow for energy-efficiency-program cost recovery and 27 states permit lost-revenue recovery or decoupling policies. Energy efficiency resource standards (EERS), in place in 24 states as of October, require utilities to procure energy from energy-efficient sources to generate mandated energy savings. The strongest EERS requirements exist in Massachusetts and Vermont, which require almost 2.5 percent annual savings.

The experts assembled by Ceres also believe that utilities should be encouraged to create and participate in energy efficiency and energy retrofit programs. Three requirements could facilitate the creation and growth of these programs:

  • Creating a “true-up” mechanism that allows utilities to recover some revenue lost to unpaid energy efficiency loans. (Current regulations already allow utilities to recover revenues from unpaid electricity sales through rate adjustments.)
  • Requiring utilities to provide use and financial data to energy efficiency financiers, thereby facilitating primary and secondary loan and portfolio underwriting.
  • Developing programs with strong contractor standards and evaluation measurement and verification (EM&V) standards to improve loan quality

Demand Driving Policies. Participants in the Ceres roundtable recommended a series of policy reforms to drive market demand for energy retrofits. These include broadening and strengthening codes and standards on building energy efficiency, enacting energy-efficient appliance and equipment standards, and passing building energy disclosure standards that provide data incentivizing energy retrofit demand and producing transparency to facilitate investment analysis. Appropriate standards help to ensure the investment consistency and quality that propels market growth.

Project Finance Mechanisms. Ceres roundtable participants recommended a variety of mechanisms to facilitate financing for energy retrofit loans. Among them are the continued use of property-assessed clean energy (PACE) and on-bill repayment (OBR) programs to create primary building loans for secondary market pools. Both mechanisms have merits and deficiencies:

PACE programs, which secure the energy retrofit loan by adding it to the local property tax lien, must be authorized at the state level and rolled out by local jurisdictions. While highly secure, PACE loans therefore can be slow to scale, although several programs are growing rapidly. In addition, PACE loans are primarily appropriate for commercial and industrial properties because Fannie Mae and Freddie Mac, the leading secondary market buyers of U.S. residential mortgages, refuse to participate in first-lien PACE programs.

OBR programs, which collect the energy retrofit loan through the local utility bill, can be used more broadly to finance residential, commercial and industrial retrofit loans. OBR loans enhance security to the retrofit lender by shutting off the borrower’s utilities in the event of default. One Ceres participant noted, however, that utility delinquency levels should be carefully evaluated in designing OBR programs.

Other recommendations included credit enhancements and master limited partnerships.

Credit enhancements: Participants in the Ceres roundtable recommended that credit enhancements be used to facilitate the pooling and securitization of building energy retrofit programs. Two forms of credit enhancement include loan loss reserves and loan guarantees. Loan guarantees are agreements to cover payments that are based on the credit of the guarantee issuer. Loan loss reserves set aside program funds to repay potential losses. Building energy retrofit programs in Oregon and Michigan use loan loss reserves.

Master limited partnerships: Master limited partnerships (MLPs) are publicly traded vehicles commonly used for energy-related projects, including oil and gas pipelines. The MLP structure is attractive to institutional investors in part because it provides exposure to real assets with the liquidity of investing in a publicly traded security, such as a stock or bond. Extending the MLP tax structure to efficiency projects could provide another channel to securing financing through the capital markets outside of pooled investments. Ceres roundtable participants note that Congress is already considering extending the MLP structure to renewable energy and energy efficiency projects; there is thus a near-term opportunity to make MLPs a tool for energy efficiency finance.

In addition to local PACE and OBR programs, state governments might prove to be efficient developers of building energy retrofit programs. The advantage to a statewide approach is the use of more uniform lending requirements, and the ability to more efficiently bundle loan pools for securitization. State pension plans are potential buyers for the securitized pools. Ceres' June 6 webinar will explore emerging directions in California on this front. And in a variant of this approach, local PACE and OBR programs potentially could provide loan product for state securitizations.  

Image credit: CC license by angelocesare/Flickr