It’s time for the energy efficiency industry to get what it pays for
While it is two to three times more cost-effective to save a kilowatt than generate one, energy efficiency (EE) has fallen short of its potential in contributing to a more modern and clean electricity system. Whether the goal is upgrading energy infrastructure or reducing greenhouse gas emissions, EE remains the most cost-effective solution and should be a primary option for utilities, regulators, and investors. However, traditional procurement models have failed to monetize EE’s true value.
Historically, many utility and state EE policies have relied on a pay-in-advance model to promote EE and overcome barriers to scale. Through this model, the customer receives a rebate for installing EE technology based on estimated savings, regardless of the ultimate near- or long-term performance. This method creates two problems. First, by tying rebate value to estimated savings (or up-front cost as proxy) regardless of actual measured performance, such rebates undermine market signals that drive increased performance. Second, such programs put a disproportionate emphasis on modeling and estimation to evaluate performance, which studies have found to be inconsistent and sometimes highly inaccurate. Adding insult to injury, such evaluation requires a labor-intensive and backward-looking process that eats up $200 million in EE program dollars annually.3
Ironically, the pay-in-advance approach has also failed in its primary reason for being—overcoming barriers to scale. By their very nature, pay-in-advance EE programs contribute to rather than solve many of the documented barriers to energy efficiency market growth—including fragmented and opaque market structures, absence of price transparency, and lack of access to capital. These barriers are especially problematic in small and mid-sized commercial businesses (SME)—a sought after but difficult to-reach market segment that accounts for 98% of commercial building stock.
A New Paradigm: Smart EE
The good news is that technologies with the ability to cost-effectively control, measure, and verify energy reduction (often in near real-time) already exist. Solutions that pair sensors, power meters, Building Management Systems, and continuous commissioning can replace engineering estimates with actual metered savings that can be measured, verified, maintained—and even bought and sold—creating a new paradigm for EE. The ability to measure and deliver energy reduction when and where it is needed, makes it possible for “Smart EE” to offset costly generation, transmission, and distribution upgrades.
With expected investments of $400 billion required to bring the grid to modern standards according to EPRI, Smart EE has a valuable role to play—and monetizing that value will be an increasing focus of utility programs. Such “non-wires alternatives” represent a category of grid investment that is growing exponentially. Con Edison’s Brooklyn Queens Demand Management (BQDM) program is an industry-leading example, seeking 52MW of demand side resources to avoid $1.2 billion in more traditional transmission and distribution system upgrades.
Private Capital Investment in the Grid of the Future
As states and utilities look for even more from EE, another transition is under way. New York and California are leading a growing number of states in redesigning their EE programs with the specific goal of attracting private capital investment to replace public funds. A critical goal of New York’s Reforming the Energy Vision (REV) initiative is “market animation,” i.e. specifically structuring programs to attract private capital to create efficiency at scale. A measured performance requirement enables a transactional model that goes a long way towards meeting these goals.
Still, attracting mainstream capital sources to EE investments requires standardization, streamlined processes, and the ability to understand and manage performance risk. Pay-for-performance models support these outcomes by creating a standard measure for energy reduction as an asset. The Investor Confidence Project (ICP), an initiative of the Environmental Defense Fund that is now part of the US Green Building Council, includes an Investor Ready Energy EfficiencyTM certification that creates projects with uniform project development and performance tracking requirements, so that SMEs can benefit from the same sophisticated financing that large commercial buildings have enjoyed for years. ICP certification provides a “seal of approval” that increases property owner’s confidence in EE vendors and enhances market efficiency. These are real steps forward, but more is needed.
Pay-for-performance models also allow for greater mitigation of investor risk. The ability to quantify EE savings allows for new financial instruments to increase the flow of capital in EE investment. Hartford Steam Boiler Inspection and Insurance Company (HSB), a subsidiary of Munich Re, has entered the market with an EE performance insurance product designed around the needs of the SME market. This product relies on standardized methods of EE measurement and verification to manage risk at the portfolio level. The result is a cost-effective means of addressing the unique needs of this market. Full disclosure, HSB’s first performance insurance policy for SME was written for JouleSmart.
We now have the tools to use foresight, not hindsight, to understand the value that EE brings. When the performance of EE investments can be measured, guaranteed, and insured through an investment grade counterparty, the private market has demonstrated its ability to take on and manage performance risk for the benefit of property owners and utility program managers alike. As the industry aligns around pay-for-performance standards through pilots in NY, CA and two other states, this may be the breakthrough we need for “smart” efficiency to take its proper role in the grid of the future.