Energy Efficiency Finance & Origin of Energy Efficiency Bonds

Industrial revolution which occurred between 1760 and 1840 marked the transition of manufacturing processes from using bio fuels to coal. This caused immense improvement in the efficiency of manufacturing and thereby development in the economy. The key reason for the massive growth of economies in Europe and other major countries around the world was the discovery of new energy sources and using it for industrial processes. With the discovery of petroleum in 1859 the industrial development took a new turn. During the early 20th century petroleum became the biggest source of energy.

With the discovery of petroleum, industrialization gained pace and petroleum along with coal became the source of power for industries, and raw material for electricity generation. With the increase in demand and increase in population, we have reached a point where if energy is not used with caution we may end up without it. This is the point where we reach a need of energy conservation or energy efficiency. Renewable energy and energy efficiency has become a widely discussed topic in the last 10 years.

Energy infrastructure usually has a large capital investment. Due to the high capital costs transition from older technology to new energy efficient technology becomes a difficult decision for companies, be it the energy generation companies or high energy consuming companies. But for achieving higher efficiency in energy usage or generation this investment is inevitable. Thus a new market emerged for financing energy efficiency projects and technology.

Energy Efficiency Bonds

Debt financing has become one of the most effective ways of financing energy efficiency. Though it was looked upon with lot of skepticism during its introduction, now it has proved to be good investment for investors and has become popular.

US government introduced Property Assessed Clean Energy (PACE) loans in 2005 in San Francisco. This allowed renewable energy and energy efficiency projects to be mortgaged. Later the further developments allowed securitization of these loans. In March 2014, the first ever ABS backed energy efficiency bond was introduced in the US. The bonds offered 4.75% coupons with 11 years maturity. This is used in  funding residential renewable-energy and energy-efficient projects – known as Property Assessed Clean Energy (PACE)loans.

The property-assessed clean energy (PACE) model is an innovative mechanism for financing energy efficiency and renewable energy improvements on private property. PACE programs allow local governments, state governments, or other inter-jurisdictional authorities, when authorized by state law, to fund the up-front cost of energy improvements. The local government issues bonds to fund projects with a public purpose.

Steps involved in securitization of energy efficiency projects

  1. Identifying energy efficiency or clean energy projects which has a positive economic impact
  2. Technical analysis of the project- commonly called as a feasibility analysis: This is usually done by engineering consulting companies
  3. Identification of technology and solutions
  4. Capital budgeting of the project
  5. Securitization of the project: This is the stage where with the assistance of an investment bank the project is securitized into bonds
  6. Selling the bonds to investors

(Source: Greenleaf Green Solutions )

Limitations of energy bonds

The protections put in place by such securities, to protect borrowers and existing mortgage holders may result in origination fees between 2-3%. For example, a 1% fee is often charged to cover a third-party technical analysis. This has come down in the recent years and is expected to be further lower soon.

In the case of PACE, several problems have been raised regarding residential PACE, but commercial PACE is far less controversial. This is mainly due to the failure of smaller projects like residential projects. This might not be necessarily due to the failure of the project but due to bad maintenance of projects or lack of regulatory systems for proper disclosure of the performance. With the new and advance technology, the performance is easily monitored and the failure of projects have become nearly zero.