Seattle Trying Innovative Financing Model for Building Efficiency

6/12/13Follow @bromano

Seattle’s municipal utility and the people behind one of the world’s most-efficient commercial buildings are trying to reinvent the business model for financing so-called deep energy efficiency improvements, which could generate hundreds of billions of dollars of construction activity and energy savings, and significantly reduce greenhouse gas emissions.

Seattle City Light and the Bullitt Foundation plan to enter a first-of-its-kind contract that would quantify the energy savings of the Bullitt Center relative to a standard commercial building and pay for them more like utility energy purchases. The goal is to unlock the low-cost capital necessary to do what energy efficiency experts like to call “deep” improvements, projects—far beyond replacing the light bulbs—that can cut a building’s energy use in half.

A pilot project to begin later this year will focus on the 50,000-square-foot Bullitt Center, a new commercial office building meant to showcase and validate the latest in sustainable and efficient designs, technologies, operations, and business models. The building is already distinguished by its solar roof, composting toilets, rainwater harvesting, and other elements.

This latest experiment—which could address flaws in the model for financing deep energy efficiency improvements—”has the potential to be enormously important,” says Denis Hayes, Bullitt Foundation president and CEO. “And it will be one of the most difficult of these elements to push over the many hurdles.”

But it is exactly this sort of ambitious business model innovation that is needed to accelerate deployment of a suite of technologies—many of which are already mature—that could begin to put the brakes on runaway climate change, while also saving money and making people more comfortable.

Hayes, who coordinated the first Earth Day in 1970, says current climate change mitigation efforts amount to “little nibbles around the edges,” unequal to the magnitude of the challenge. “We need to figure out some ways to take some really big bites,” he says.

Buildings offer a full meal. They account for about 74 percent of U.S. electricity consumption, which is itself the source of a third of U.S. greenhouse gas emissions.

While not all buildings are suitable for the deep energy efficiency improvements targeted by this model—which goes by the acronym MEETS for metered energy efficiency transaction structure—backers say this is an opportunity to unlock hundreds of billions of dollars of potential investment, energy savings, and emissions reductions. Buildings accounted for more than $300 billion in U.S. electricity spending in 2010.

Meet MEETS

The concept for MEETS, as well as a key piece of technology underpinning it, is being developed by a Portland company called Energy Resource Management (EnergyRM). It’s headed by Rob Harmon, who a decade ago helped create another novel transaction structure that is at the heart of the renewable energy market: the retail renewable energy credit (REC), which allows the environmental attributes of a unit of renewable power to be tracked and traded separately from the electricity itself.

Harmon

“What I see now, and what I saw more than a decade ago with RECs, was a broken transaction structure, where you couldn’t connect willing buyers and sellers,” Harmon says.

To understand what’s broken about the current market for financing energy efficiency, it’s helpful to review some generalized motivations—or lack thereof—of three key players:

The building owner or operator: Owners may want to upgrade the windows or install a state-of-the-art HVAC system, making their building more comfortable, cheaper to operate, and potentially more valuable. But they don’t really want to delve into the energy business, and it’s hard to justify the expense—even with a utility’s up-front incentives and government tax breaks to defray capital costs—when they can rent out the building as it is. Payback periods may be too long, and financing is scarce. And anyway, owners can pass the utility costs on to the tenants. The tenants, meanwhile, may have some incentive to make efficiency upgrades to lower their bills, but often can’t address the big shared systems, and struggle to justify improving a property they don’t own and might be out of before the upgrades pay for themselves.

The utility: Most utilities have major conservation and efficiency programs. Conservation is Seattle City Light’s first-choice strategy for meeting load growth in its current long-term plan. Utility energy efficiency programs involve incentives for customers or direct capital investments in new equipment, insulation, lighting, and appliances. But once these investments are made, there’s often little follow up to ensure they are properly maintained and continue to provide the efficiency benefits for the long term, Harmon says. Moreover, efficiency improvement programs are often paid for by all ratepayers collectively, even though individual utility customers benefit from them. But perhaps the biggest problem is that energy efficiency—the idea that customers will use less of the utility’s product—runs up against an incentive that is fundamental to the utility business model: every additional kilowatt hour sold contributes to gross income. (Efforts to “decouple” utility profits from unit sales are pending or have been adopted in 25 states.)

The investor: Third-party investors who finance major energy efficiency improvements are few and far between, under the status quo. Investors are typically unwilling to lend money at the low rates and long terms necessary to make significant improvements pencil out. The borrower under the current structure—the building owner—may not be around for the full term of the loan, and may not be seen as a good credit risk.

The MEETS model attempts to reinvent the transaction structure for energy efficiency projects by better aligning the incentives of these three groups. Ultimately, it would create high-quality, quantifiable, and lasting energy efficiency improvements in buildings that, Harmon asserts, could be financed more like power generation projects because the return on the investment would come from a deep-pocketed, creditworthy utility.

Long-term Contract

At the center of MEETS is a long-term contract between a utility and an investor willing to pay for major energy efficiency upgrades in a building. The contract, called a metered energy efficiency purchase agreement or MEEPA, is modeled on the power purchase agreements that are the coin of the realm in the utility industry, and which routinely attract hundreds of millions of dollars of long-term capital financing from the world’s largest banks, insurance companies, and other financial players.

As the name implies, the MEEPA relies on an energy metering system, provided by EnergyRM, that measures actual energy use in a building—normalized for factors including weather and occupancy—before and after efficiency improvements are made. The metered savings are the difference between this “dynamic baseline” of energy usage and the actual energy usage after the improvements.

When a utility purchases power from a wind farm or power plant, it pays by the megawatt for the energy that is actually produced and delivered to the system. With a MEEPA, the utility pays for the amount of electricity it didn’t have to deliver thanks to the efficiency improvements—as measured by the meter, rather than estimated by a model. The utility is effectively purchasing “negawatts”—an energy industry neologism that is actually quite helpful in thinking about the economics of energy efficiency and conservation.

“We’re metering the energy efficiency just as if it’s generation,” Harmon says. “And we’re selling it to the utility just like it’s generation.”

Importantly, the entity selling efficiency to the utility in the MEEPA structure is the investor, not the building owner. The investor makes rental payments to the owner for use of the building as a host of the “efficiency generation,” much as a wind power company might pay a farmer to place a wind turbine on her land.

This structure gives the investor an incentive to maintain the improvements for the duration of the 20-year contract.

The upside for the building owner is a more comfortable, valuable building with no capital investment, and a new revenue stream, in the form of the rental payments from the investor.

The owner of the building still pays the electricity bill, which will be the same as it was before the energy efficiency improvements are made. The difference is the bill will now have two components: the amount of electricity actually used, and the amount of electricity saved, as measured by the energy efficiency meter.

That’s how the utility remains whole financially, despite delivering less electricity to the more efficient building.

For this pilot project, Seattle City Light will continue to collect 6 cents per kilowatt hour from the Bullitt Center for both the electricity it uses and the metered efficiency savings. It will pay the Bullitt Foundation, the investor in this example, 2.5 cents per kilowatt hour—an already-established rate for energy efficiency—plus the 6 cents per kilowatt hour of retail electricity revenue the utility is not losing because of the new transaction structure, Harmon says.

The utility can make up the 2.5 cent efficiency premium by selling the power it no longer has to deliver, thanks to the efficiency improvements, on the wholesale market, Harmon says.

Seattle City Light superintendent Jorge Carrasco calls the structure “one of the most innovative solutions I’ve seen.”

As a conservation-focused municipal utility in a progressive city with political leadership that is engaged on the issue of climate change, Seattle City Light (SCL) is an ideal test bed for MEETS. Its governing structure—with the city council serving as both its board of directors and its regulator—also makes it easier to try an experiment like this. Other utilities—and Harmon says he’s in “active conversations” with a half dozen others—would likewise need approval from their regulators to engage in this new kind of contract.

McGinn, right, and Hayes

(At this point, Seattle City Light leadership has signed off on the elements of the MEETS pilot project, and it has the support of Mayor Mike McGinn and City Councilmember Mike O’Brien, but it still must be formally approved by the city council.)

Investor ROI

Framing an energy efficiency contract more like a utility power purchase contract—in which a deep-pocketed, creditworthy utility is responsible for paying over 20 years rather than a building owner—will attract a new category of investor, able to put more capital to work at lower rates for longer periods of time, Harmon says. This, in turn, unlocks energy efficiency technologies—such as improvements to the building envelope and HVAC system upgrades—that are precluded by the short-term payback periods required of today’s investors and lenders.

“If you have inexpensive money for 20 years, you can get a whole lot deeper into a building than you can if you have expensive money for five years,” Harmon says.

EnergyRM is backed by Equilibrium Capital, which manages a family of sustainability-driven real asset funds tailored for institutional investors. Harmon says he has received lots of interest from large institutional investors who want to put more money to work in energy efficiency.

What sort of return might investors in deep energy efficiency expect under MEETS?

Harmon says it’s too early to discuss it, but investor returns would vary considerably from project to project.

The environmentally-focused foundation behind the Bullitt Center aims to be an open book for others considering deep energy efficiency improvements, but it may prove an awkward example on this specific question.

“This is a great building to prove the concept, but it’s not a great building to calculate a rate of return” on the MEEPA contract, Hayes says.

Hayes

The Bullitt Center was built to meet the Living Building Challenge, among the most stringent building performance standards on the planet.

With features such as computer-controlled, 4-foot-by-10-foot windows that open and close to respond to environmental conditions inside and outside the building, the center is a paragon of energy efficiency—indeed, to satisfy the Living Building Challenge it must achieve “net zero energy, waste, and water, over a minimum of 12 months of continuous occupancy.” But the building is also an integrated unit whose elements serve multiple end goals.

“It’s hard to tell whether the investments that we made in super-efficient windows are part of our day-lighting strategy or part of our fresh air strategy,” Hayes says. “… I don’t know what fraction of the overall cost of this building you can say is the incremental cost of the energy efficiency.”

Which makes it difficult to calculate the Bullitt Foundation’s potential return on investment through the MEEPA. (The calculation is further complicated by the fact that the third party in the transaction—the building operator, which pays the bills to City Light and receives “rent” for the energy efficiency improvements from the Bullitt Foundation—is a foundation subsidiary, BF Blocker. Also, the energy generation from the Bullitt Center’s high-profile solar roof is not included in this transaction for the sake of simplicity.)

Work remains to calculate the baseline to which the Bullitt Center’s actual energy usage—still unknown, since it just opened this spring—will be compared, and thereby the amount of saved energy for which the foundation will be paid by SCL. The baseline will be set by measuring energy usage of a portfolio of buildings built to Seattle’s new energy codes.

Hayes says the foundation’s models suggest an annual payment of roughly $40,000 a year for 20 years, provided, of course, that the efficiency improvements are sustained throughout the contract term. That’s far more than the building could have received in up-front energy efficiency incentives from the utility, Hayes says.

A utility spokesman says that if the pilot project is successful, the intention is to open it up the MEETS to other building owners and investors.

Benjamin Romano is editor of Xconomy Seattle. Email him at bromano [at] xconomy.com. Follow @bromano

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