Clean Energy Financing

Report
Edmonton’s Energy Transition Plan
Clean Energy Financing: Briefing Note
21 October 2013
RICHARD BOYD
Introduction
Numerous reports by government, non-profits, and private businesses have surveyed approaches for funding clean energy
(energy efficiency and renewable energy) programs and projects, including C3’s Energy Efficiency Funding and Administration
Options for Alberta. The purpose of this note is not to provide another scan of the full spectrum of available approaches, but rather
to focus on innovative solutions that have recently gained traction in the USA, and that are in use, or are being considered for use,
in a Canadian context.
Recent innovations in clean energy financing have developed business models that simultaneously address many recognized
market barriers, including the first-time cost barrier, and that encourage the adoption of cutting-edge technologies and deep
improvements in energy efficiency. These financing strategies also provide scalable solutions, and are designed to use limited
public funds to mobilize, leverage, and support investment in clean energy by private financial institutions (FIs). Leverage ratios of
4:1 (young programs) to 20:1 (mature programs) have been observed in the USA. In the latter case, $3 million of public grant
capital can be turned into $60 million of private lending capital. The path to adequate and sustainable funding of clean energy
programs and projects, requires a shift from the traditional publicly grant-funded world of rebates, towards innovative financing
programs that use public funds to mobilize large amounts of private capital. Given this basic premise, we provide a high-level
overview of three innovative, scalable clean energy financing models that exhibit great promise, namely:
1. Property assessed (Local Improvement Charge) programs;
2. Energy savings agreement programs; and
3. On-bill tariff repayment programs.
A typical financing program – applicable to residential, commercial, and industrial clean energy projects – consists of up to five
major elements: a source(s) of program funds (e.g., private debt or equity, public grants or loans); an administrator(s); a
repayment vehicle (e.g., monthly credit bill, on-bill tariff, property tax assessment, service fee); credit enhancements (e.g., loan
loss reserve fund, subordinate debt structure, loan guarantee); and security (e.g., utility meter, property tax-lien, equipment). For
each of the three program models, we provide a brief description of the underlying model (encompassing each of these elements),
list key strengths and weaknesses, and highlight the roles for the City of Edmonton (COE) and the Government of Alberta (GOA).
Before looking at the three models for clean energy financing, we first outline the main characteristics of cost-effective, selfsustaining financing programs. The chosen models must reflect these characteristics.
Keys to effective, self-sustaining financing programs
Self-sustainability
For a clean energy financing program to be self-sustaining, public funds should be used to mobilize, leverage, and support
participation by private financial institutions, both primary lenders that provide loan capital directly to households and businesses
or indirectly via the program administrator, and investors (in the secondary market) that purchase portfolios of loans from the
primary lenders. To these ends, a clean energy financing program should:
1.
Prove clean energy finance as a viable business line for private financial institutions; and
2.
Develop a secondary market for portfolios of clean energy loans.
1. Make the business case to primary lenders
The path to self-sustainability requires private financial institutions to perceive clean energy financing as profitable, creditworthy,
and a sizeable business line. For only then will public funds successfully mobilize and leverage private capital. Potential partner
financial institutions will want to know:
o
The size of individual loans to households and businesses (and hence transaction costs);
o
The likely total size (total deal flow) of the financing program;
o
The credit characteristics of the target market;
o
Who bears what risks;
o
The size and structure of available credit enhancements (e.g., loan loss reserve funds (LRF), subordinate debt structures,
loan guarantees, interest rate buy-downs, etc.);
o
The administrator’s expectations for interest rates and loan terms; and
o
Responsibilities and expectations for loan servicing and origination.
Keys to effective, self-sustaining financing programs
2. Build the secondary market
Some program administrators and primary lending partners (typically smaller institutions like credit unions) may originate and hold
loans in their portfolio until the loans mature. However, if the goal is to mobilize and leverage as much private capital as possible,
then these individual loans need to be “aggregated” into portfolios (e.g., using a warehouse facility) and either re-financed or sold
to a “secondary market” capital source (e.g., a municipal or private bond, asset-backed securities). Typical portfolio sizes for
transactions in the secondary market are about $20-$25 million. Proceeds from the sale of loans to secondary market investors
allow the program administrator and lending partners to relend their original loan funds more rapidly than they would otherwise be
able to do if they had to wait for each loan to mature. The availability of capital from the secondary market can also help to lower
interest rates.
To attract secondary market investors, the benefits and risk coverage of credit enhancements supporting the primary lenders must
be “assignable” to these investors.
Cost-effectiveness
To maximize cost-effectiveness (i.e., energy savings for a given level of capital) a clean energy financing program should be
designed to both:
o
Support a large number of projects (“broad participation”); and
o
Achieve significant savings per project (“deep improvements”).
Financing alone is not sufficient to spur adequate investment in clean energy and transform energy markets. Effective programs
combine access to financing with clever marketing, project development, and project delivery. Financing has to be part of an
overall program design that drives a steady flow of improvement projects to the administrator for financing. A number of program
design characteristics that play a role in driving program demand and maximizing program energy savings are listed in Table 1.
Keys to effective, self-sustaining financing programs
Table 1: Program elements that foster broad participation and achieve deep improvements
Factors to foster broad participation
Factors to achieve deep improvements
o Effective, ongoing marketing throughout the life of a
program (e.g., employ social and community-based
marketing and concentrated neighborhood approaches)
o Promote a whole house or whole building energy audit to
identify potential energy efficiency improvements
o Strong network of vendors and contractors, trained in
marketing techniques, to function as program champions
and drive the market
o Package rebates, coupons, and other discounts available to
targeted individuals and businesses, and offer them in
conjunction with the financing program – avoid competition
between subsidies (cash upfront) and loans
o Simplified and straightforward application process to
minimize the time and effort the participant must expend
(e.g., a “one-stop-shop” that assists participants with all
aspects of the program, loan approvals over the phone, use
of standardized retail installment contracts)
o Offer tiered benefits to encourage investment in additional,
complementary measures that achieve deeper energy
savings (e.g., if a high efficiency furnace was purchased as
part of the program, offer a lower interest rate if air sealing
and insulation are included as part of the project)
o Offer attractive loan terms, which are comparable to, if not
better than, the terms of a self-arranged private loan (e.g.,
low interest rates, long repayment terms, immediate
positive cash flows, cover full project costs, minimal fees,
allow repayments to be classified as operating expenses)
o Require program participants to use only approved
contractors (that have obtained a specific license or
certificate to demonstrate a minimum level of proficiency) to
ensure poor workmanship or advice does not undermine
potential energy savings
o Target potential participants who will find it difficult to access
financing for clean energy from private lenders (e.g., lowincome households, individuals or businesses with marginal
credit ratings, small to medium-sized businesses) through
the use of credit enhancements, such as loan guarantees.
Avoid competition with private lenders
Property assessed financing programs
Description
Once the Local Improvement Charge (LIC) mechanism in the Municipal Government Act (MGA) is amended, property assessed financing
programs allow the City of Edmonton (COE) to fund clean energy projects with long-term loans. The loan is secured by a lien on the
property and is paid back via a supplemental charge on the property tax bill.
A grant from the COE (or GOA) is needed to cover start-up and admin costs for first 1-2 years (these costs are subsequently recovered in
interest rate spread offered property owners). Incentive payments (e.g., rebates, coupons or discounts) must also be funded from a public
grant (COE or GOA). With the warehouse model (shown in Figure 1) the primary source of capital for the loans can be a line of credit or
loan from the COE, GOA and / or a private FI; it can also be an endowment grant from the COE or GOA. Once a critical mass of loans is
reached, they can be aggregated for sale or refinancing on secondary capital markets. With an open market model (see Figure 2),
businesses use their existing credit status to directly arrange loans or lines of credit with partner FIs.
Note that utility ratepayers (via a systems benefit charge) serve as the primary source of funding for some third-party administered
schemes in the USA. This is also possible in Alberta, though it would require additional steps (involving the AUC and utilities), further
lengthening an already lengthy development process. Hence, this option is not shown in Figure 1 and Figure 2.
Informational barriers (lack of technical expertise on part of property owners) are addressed by administrator partnering with contractors.
For larger customers, uncertainty over energy savings (project performance) can be addressed through Energy Savings Performance
Contracts and / or energy savings insurance products. Credit risk is addressed through (publicly funded) credit enhancements.
Sectors
Single-family and multi-family residential, commercial, and industrial with the warehouse model; only larger commercial (including
commercial multi-family) and industrial with the open market model.
Strengths
● Potential to access unlimited private capital markets; ● no upfront costs for property owner; ● can address split incentive problem
depending on structure of lease agreement; ● tax-lien provides strong security for FIs resulting in more attractive loan terms (and improved
economics); ● repayment obligation stays with property and not owner, addressing misaligned incentives to invest in deep improvements
with longer payback; ● tax assessments may be off-balance sheet preserving borrowing capacity for core business investments
Weaknesses
● Requires changes to LIC mechanism in the MGA; ● if capital for loans is provided by the COE, further changes to the borrowing
covenants (264 and 265) of the MGA may be needed; ● approval or consent of existing mortgage lender may be required; ● available only
to property owners (renters cannot directly access program); ● cannot finance portable clean energy projects; ● can be complex and
challenging to implement; ● may take 9-15 months to launch, and a further 2-9 months before projects are installed
Figure 1: Infrastructure for property assessed (Local Income Charge) financing program (based on warehouse model)
Existing
mortgage
lenders
Consent or
approval
COE
Property
owners
Outreach and
education
Changes to
Municipal
Government
Act to enable
(a) LICs to
include clean
energy and (b)
COE to make
loans to
private entities
$
$
$
Marketing and
outreach
Pre-qualified
contractors
COE or thirdparty
administrator
Provision of
LRF or
subordinate
debt
Loan capital (endowment, line of credit, loan)
Administrator
arranged capital
(line of credit, loan)
Pre-qualify contractors
ESPC
$
Grant for start-up costs, initial admin costs,
and any incentives (rebates, coupons)
$
Establish list of eligible projects
GOA
(CCEMC)
Identify, and educate
potential FI partners
Primary FI
lender and
secondary
investor
Figure 2: Infrastructure for property assessed (Local Income Charge) financing program (based on open market model)
Changes to
Municipal
Government
Act to enable
LICs to include
clean energy
COE
GOA
(CCEMC)
$
$
Grant for start-up costs, initial
admin costs, and any incentives
(rebates, coupons)
COE or thirdparty
administrator
Provision of LRF
or subordinate
debt
Identify and pre-qualify lenders that accept
LIC securitization and repayment structure
Primary FI
lender and
secondary
investor
Outreach and
education
Pre-qualify contractors
Establish list of eligible
projects
$
Marketing and
outreach
ESPC
Consent or
approval
Pre-qualified
contractors
Property
owners
Existing
mortgage
lenders
Owner arranged capital
(line of credit, loan)
Energy savings agreement financing program
Description
Under an energy savings agreement (ESA) or “managed contract” a third party develops clean energy projects, manages their
implementation and operation, and arranges and provides capital to pay for the projects (see Figure 3). The property owner negotiates and
signs a contract with the third party and agrees to pay either a fixed or floating fee for a portion of the verified energy savings received over
the duration of the contract; a portion of the savings accrues to the property owner. During this period the third party retains ownership of
the installed equipment and returns cash flows to investors (see Figure 4). At the end of the contract ownership passes to the property
owner. For large projects the third party may opt to capitalize a Special Purpose Entity to finance and manage the clean energy project.
A grant from the COE (or GOA) is needed to cover start-up and admin costs for first 1-2 years (these costs are subsequently recovered in
fees charged property owners). Incentive payments (e.g., rebates, coupons or discounts), when offered, must also be funded from a public
grant (COE or GOA).
The primary source of capital to fund projects can be a line of credit or loan from the COE, GOA and / or a private FI; it can also be an
endowment grant from the COE or GOA. Once a critical mass of agreements is reached, the contracts can be aggregated for sale on
secondary capital markets.
Informational barriers are addressed by the administrator partnering with contractors. Uncertainty over energy savings is addressed
through covenants in the contracts and / or energy savings insurance products. Credit risk is addressed through (publicly funded) credit
enhancements.
Sectors
Commercial multi-family residential, commercial, and industrial (SPE used for larger projects)
Strengths
● Potential to access unlimited private capital markets; ● does not require enabling legislation; ● no upfront costs for property owner; ● can
address split incentive problem depending on structure of lease agreement; ● property owner pays only for actual energy savings; ●
administrator may be able to develop standardized contracts that reduce transaction costs and appeal to primary and secondary investors;
● fees are off-balance sheet; ● project developer has incentive to maximize energy savings ● property owner has single contact point
Weaknesses
● Uncertainty regarding off-balance sheet status; ● if capital for loans is provided by the COE, clarification is required as to whether the
contracts are classified as loans under the MGA; ● available only to property owners (renters cannot directly access program); ● not costeffective for single-family residential due to high transaction costs; ● requires complex monitoring and verification of energy savings
Figure 3: Infrastructure for energy savings agreement financing program
Property
owners
(Managed) ESA
(large projects)
Special
Purpose Entity
(Managed) Energy
Savings Agreement
(ESA)
$
GOA
(CCEMC)
$
$
COE
$
ESPC
(large projects)
Large projects
Pre-qualify contractors
Pre-qualified
contractors
Establish list of eligible
projects
COE or thirdparty
administrator
ESPC
Grant for start-up costs,
initial admin costs, and any
incentives (rebates,
coupons)
Project capital (endowment,
line of credit, loan)
Project capital
(line of credit, loan)
$
Primary FI
lender and
secondary
investor
Provision of
LRF or
subordinate
debt
Figure 4: Cash flow under energy savings agreement
Fee paid to administrator under terms of
ESA is to collect these costs
BAU utility bills
100%
Recovery of investment
costs (financing cost)
plus service costs
Verified energy savings accruing to
property owner (e.g., 35% reduction
in pre-project utility bills – hence,
cash flow positive from day one)
65%
Utility
bills
before
‘project’
Utility bills after ‘project’
(e.g., 65% of pre-project bills)
0%
-3
0
+3
Term of contract
+6
+9
+12
+15
Guaranteed
by ESPC,
protected by
insurance
On-bill tariff repayment financing program
Description
On-bill tariff repayment programs use capital from third parities to finance clean energy projects, with recipients of the funding repaying the
project costs (principle plus interest) via a supplemental charge on their utility bill. Utilities function simply as a repayment vehicle. This is in
contrast to on-bill loan programs that use utility capital to finance the clean energy projects. Utilities and their regulators are reluctant to
take on any risks associated with making loans to customers using their own capital or ratepayer funds, which also exposes utilities to
consumer lending laws. The basic infrastructure building blocks for an on-bill tariff repayment program as shown in Figure 5.
With on-bill tariff programs the repayment is structured as a tariff (not a loan) that the customer pays in return for “clean energy services”.
The repayment obligation can thus tied to the utility meter and transfers to subsequent owners or tenants.
A grant from the COE (or GOA) is needed to cover start-up and admin costs for first 1-2 years (these costs are subsequently recovered in
interest rate spread offered customers), and to subsidize the potentially high costs for a utility to change its billing system. Incentive
payments (e.g., rebates, coupons or discounts) must also be funded from a public grant (COE or GOA).
The primary source of capital to cover clean energy project costs is the same as with warehouse property assessed programs.
Informational barriers (lack of technical expertise on part of customers) are addressed by the administrator partnering with contractors. For
larger customers, uncertainty over energy savings can be addressed through Energy Savings Performance Contracts and / or energy
savings insurance products. Credit risk is addressed through (publicly funded) credit enhancements.
Sectors
Single-family and multi-family residential, commercial, and industrial
Strengths
● Potential to access unlimited private capital markets; ● no upfront costs for property owner; ● can address split incentive problem
depending on structure of lease agreement; ● shows strong record of repayment by customers to date ● repayment obligation stays with
property (meter) and not owner; ● tariff may be off-balance sheet; ● bundled utility bill clearly shows customer costs and benefits of clean
energy investment; ● leverages existing utility infrastructure and customer relationships to collect payments
Weaknesses
● Threat of utility disconnection subject to legal uncertainty (especially for the residential sector) and is not recognized as recourse
instrument by private FIs ● if capital for projects is provided by the COE, changes to the borrowing covenants of the MGA may be needed;
● may require upfront investment by utilities to modify billing systems; ● cannot finance portable clean energy projects; ● will likely require
regulatory approval by AUC; ● existing programs rely heavily on public funding for support; ● high admin costs (especially for residential)
Figure 5: Infrastructure for on-bill tariff repayment financing program
Property
owners
Modifications
to utility billing
system
Approval or
enabling legislation
(if needed)
Authority to act
Utility
Pre-qualified
contractors
Marketing and
outreach
Mechanism to pass-through
project related costs
(principle and interest)
AUC
GOA
(CCEMC)
$
Pre-qualify contractors
Establish list of eligible projects
COE or thirdparty
administrator
ESPC
Primary FI
lender and
secondary
investor
$
$
Project capital (endowment, line
of credit, loan)
Project capital (line of
credit, loan)
Provision of LRF or
subordinate debt
Grant for start-up costs, initial
admin costs, and any incentives
(rebates, coupons)
COE
$
Summary of potentially sustainable clean energy financing programs
Program
Property
assessed (LIC)
Sectors
Single-family
Multi-family
Commercial
Industrial
Energy savings
agreement (ESA)
Multi-family
Commercial
Industrial
Source of
initial
program
funds
GOA, COE
grants, debt
Private FI debt
Program
administrator
COE entity
COE entity
Independent
third-party
Independent
third-party
Utility ratepayers
(though this
requires further
steps in terms of
giving AUC
mandate and
waiting approval)
GOA, COE
grants, debt
Private FI debt
Loan
originator
Repayment
vehicle
Property tax bill
Private FI (only
with open market
model)
COE entity
COE entity
Independent
third-party
Independent
third-party
Savings
agreement
(service fee or
payments)
Special purpose
entity (only for
large projects)
Risk profile
Performance:
Property owner,
contractor, or
insurance
provider
Single-family
(though legal
uncertainty)
Multi-family
Commercial
Industrial
GOA, COE
grants, debt
Private FI debt
Utility ratepayers
(though utilities
and regulators
reluctant to put
their capital at
risk in loans)
COE entity
Independent
third-party
Utility
Private FI
Recourse:
Property
Financial: credit
enhancement,
then investors
LRF, subordinate
debt or loan
guarantee
Performance:
SPE,
administrator, or
insurance
provider
Enable public
entities to use
ESA (unclear as
to whether
contracts
classified as
loans, requiring
changes to
covenants of
MGA)
Recourse:
Equipment
Utility bill
Changes to LIC
part of MGA
Consent or
approval from
first lien
mortgage
holders
Financial: credit
enhancement,
SPE for large
projects, then
investors
On-bill tariff
repayment
Market
enabling
actions
Performance:
Property owner,
contractor, or
insurance
provider
Recourse: Utility
service
Financial: credit
enhancement,
then investors
Scalability
Large –
aggregation and
sale or
refinancing on
secondary
capital markets
Large –
aggregation and
sale or
refinancing on
secondary
capital markets
LRF, subordinate
debt or loan
guarantee
Regulatory
approval by AUC
Possible
changes to
consumer
lending regs
LRF, subordinate
debt or loan
guarantee
Large – though a
number of issues
need to be dealt
with more
thoroughly to
make on-bill
repayment viable
on a larger scale,
and many
existing
programs rely on
public funding
Contact details
Dr Richard Boyd
Senior Economist, Research and Analysis
Email: [email protected]
Direct 403.517.2702

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