Due to the high degree of fragmentation, investing in energy efficiency at scale is notoriously difficult. But with specialised investment teams and innovative financing structures, the sector can present a highly attractive opportunity for institutional investors, says Alexander Hunzinger from SUSI Partners
The views expressed are those of the author and do not necessarily reflect the position of FORESIGHT Climate & Energy
Interest in proven investment solutions for energy efficiency bound to increase
The energy transition needs to happen on all fronts and reducing the energy intensity of existing infrastructure—be it public or private—is a key lever in the fight against climate change. After all, there is no cleaner form of energy than energy that is not consumed.
There is a wide range of highly effective energy efficiency measures with proven technologies readily available today.
Whether it be LED lighting, waste heat recovery, heat pumps or energetic building refurbishments—for instance replacement of inefficient boilers and chillers with latest technologies, implementation of smart energy management systems, renewal of roofs and windows—the importance of energy efficiency on the path to net-zero greenhouse gas emissions is no longer a subject of debate.
Nevertheless, the financial sector’s attention to it has been rather low.
The key reason for this lack of interest is the high degree of granularity in the market. Single energy efficiency measures generally lack the scale needed to attract institutional capital. If single projects had to be financed individually, the efforts associated with deal origination and inherent transaction costs would simply surpass the financial gains achieved.
At the same time, infrastructure owners, tenants, or municipalities often do not have the budgets, capacities, or the right incentives to take matters into their own hands. Energy efficiency measures require significant upfront capital investment and subsequently deliver energy and cost savings over extended periods of time.
What results is an impasse, in which long-term oriented investors such as pension funds and insurance companies seeking exposure in the energy efficiency segment do not have investment opportunities available through which they could do this at sufficient scale.
The good news is that with specialised investment teams and innovative financing structures, these challenges can be overcome.
Part of the solution lies in establishing long-term mutually beneficial relationships with the companies implementing these measures. These are often specialised energy service companies (ESCOs) or technology providers.
By signing long-term framework agreements with these companies, investment managers leave project origination to these partners, standardise deal execution and finance aggregate project portfolios thus creating the scale required to ensure profitability.
Through securing upfront financing provided by an institutional fund, the ESCO is able to offer contracting-based “Energy/Infrastructure-as-a-Service” solutions to its clients. This business model entails that the ESCO plans, installs, finances, and operates the energy efficiency asset for a certain period of time (usually between 8-15 years), during which the beneficiary of this measure is charged a service fee.
The resulting energy cost savings are utilised to cover interest and amortisation payments to the institutional fund while the remainder will stay with the client.
Ultimately, all three parties involved benefit: the client achieves annual energy cost savings that surpass the amortisation payments thereby lowering the cost base and making the business more competitive; the ESCO can generate more business with less capital; and the investor collects attractive risk-adjusted returns. There is also the significant positive impact of such projects towards climate change mitigation.
Such a financing structure is also applicable to other fragmented sectors of the energy transition market such as self-consumption solar PV, EV charging stations, or the electrification of largely fossil fuel-reliant sectors such as heating.
Nevertheless, the devil is usually in the details. While this roughly sketched financing structure has proven to be highly effective in enabling energy transition projects in fragmented sectors, it still requires a high degree of flexibility to accommodate for the specific needs of all counterparties. Accordingly, it requires the expertise of highly specialised investment managers to be executed in an efficient manner.
As the latest IPCC report made very clear, there is technically enough private capital available to make the energy transition and a path to net zero feasible. Small-scale measures will play a significant role in achieving this target, but ultimately, it will be up to investment managers to come up with innovative solutions that can accelerate the large-scale redirection of capital towards clean energy solutions we desperately need. •
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