Small Business Energy Efficiency: Utilities Court a Historically Underserved Market

Around the country, a quiet revolution is taking place. Small businesses - who at times have played the part of ugly stepsister in the energy efficiency dance - may finally be getting their invitation to the ball. As utilities seek to reduce their customers' consumption of energy (for regulatory compliance or to postpone costly infrastructure upgrades), they are extending a hand to the 22.9 million small businesses country-wide with incentive programs that better meet the needs of these smaller consumers.

"From the neighborhood pizza parlor, dry cleaner and grocery store to service, health care and technology companies, small businesses have become the cornerstone of our economy. However, with all of this power to drive economies, small businesses have been left out of many cost-saving programs. This is especially true with utility-sponsored energy efficiency programs. Why? Small commercial accounts are very disparate and (until now) have been difficult to segment into actionable groups by utilities. Data about these small commercial accounts are often incomplete and difficult to gather, and yet, this is a sector that has great potential to help the environment by becoming greener -- and add precious dollars to their bottom lines."

A huge sector of the economy whose participation in energy efficiency can make a significant impact on the environment and their own financial health? It's hard to imagine that more effective utility programs haven't yet been delivered. Much of this is due to the split incentive (i.e., many small businesses do not own the properties they utilize, and thus are reluctant to invest in facility improvements) and a lack of quality information:

"Typically, utility data consist of the business' name, primary contact, phone number, address and type of business... This lack of information leads to another roadblock to outreach: the current benchmarking process. Utilities review year-over-year data on a business. Did a specific business use more or less energy last year? Have there been unexplained spikes or troughs in consumption? If there were more data points to consider and analyze, the utility would be in a better position to offer customized information about energy usage and recommend energy-efficiency programs; thus, truly offering something useful and economically sound to the business owner."

Thankfully, new technological developments will make it easier for utilities to build a solid knowledge base about their small commercial customers, which in turn will allow them to offer more customized and enticing incentives that speed attainment of the utility's own goals. And, the financial equation is only improving: Utilities are developing more lucrative rebates and incentives, and new financing programs (such as Octus's Building Energy Savings program, PACE financing, and utility-company on-bill financing) are proliferating.

We at Octus have seen many investor- and municipal-owned utilities get in the game by designing and delivering programs with the small commercial customer in mind - programs such as Roseville Electric's Small Business Commercial Lighting Program, for which Octus was one of four approved energy efficiency specialists. But we believe that the utilities are just warming up. And as their ability to better segment and target this diverse - but enormous - slice of the economy grows, so too will participating small business' bottom lines.

Johnson Controls Paints a Promising Picture for the Future of Energy Efficiency

Johnson Controls is the world's largest provider of energy efficiency solutions for commercial buildings. While their approach -- provision of services as an ESCO (primarily for governmental organizations) and the sale of large-scale, proprietary energy management systems -- differs a bit from what we do at Octus Energy, our focus is the same: Generate sustainable energy savings through various means for commercial building owners. JCI is big brother. When they speak, people and companies and analysts take note.

At last week's CleanTech analyst day -- as summarized in an investment brief by analyst Canaccord|Genuity -- Johnson Controls shared a few interesting morsels:

The cleantech “megatrend.” Clean technology is now a “long-term global growth megatrend,” according to JCI management. Management specifically noted that buildings in North America and Europe, which together account for 40% of the world’s energy consumption and 70% of electricity usage, represent the single biggest opportunity for cleantech.

$24 billion opportunity. JCI estimates the energy solutions market is a $24 billion global opportunity, growing at approximately 9%-14% per year. Key market drivers for the energy solutions market include: 1) climate legislation and energy security; 2) corporate climate commitments; 3) volatile energy costs; 4) innovative funding models (including PACE, as Octus discussed here and here); 5) deployment of smart-grid technology; and 6) energy efficiency renewable resource standards.

Feds step up. Legislation and regulation are key drivers in the energy efficiency marketplace. In the United States, there have been energy efficiency bills in both the lower and upper house (the American Energy and Security Act of 2009 in the House and the American Clean Leadership Act of 2009 in the Senate). The Senate bill has been passed out of committee and includes the following features:

• National electricity and renewable electricity standard
• Energy efficiency building retrofit program
• Energy efficiency programs for states
• Building codes incentives
• Building performance information
• New clean energy deployment administration

Meanwhile, recent events in the Gulf of Mexico are spurring interest in energy and climate bills that otherwise would not have been brought up or passed this year.

PACE financing programs gaining momentum. Property Assessed Clean Energy, or PACE, is a financing solution that enables property owners to pay for energy efficiency, renewable energy and water efficiency projects via an additional assessment on their property tax bill over a five to ten-year term. The PACE program benefits building owners by: 1) eliminating the need for large upfront cash payments; 2) offering a competitive cost of capital; 3) solving credit rating collateral issues; 4) potentially moving the projects off-balance sheet; and 5) allowing owners to pass through retrofit costs to tenants. Johnson Controls echoed our sentiment that PACE financing will be one of the keys to unlocking the huge retrofit opportunity in the commercial building sector.

IT convergence. JCI sees the “smart building” as the starting point that is needed before a “smart grid” is even possible; again, echoing Octus's energy management and building automation strategy through our Smart Energy Platform. Put simply, the “smart grid” can’t analyze much without a “smart building” providing it with real-time information. The company noted that the integration of equipment and controls coming together in one product has been a major advancement for the industry.

PACE Financing: Mass * Velocity = Momentum

We wrote a few weeks ago about PACE (property assessed clean energy) financing for commercial building energy efficiency projects. While it may not be a panacea nor tipping point for the development of energy efficiency measures, it's certainly a tremendous boost, particularly for small-to-mid-sized commercial and industrial building owners. At Octus, we're becoming increasingly involved and engaged -- by the day -- in PACE and its implementation.

Earlier this week, GoingGreen featured an interview with Dennis Tsu, who manages Business Development for Commercial PACE with Renewable Funding. Based in Oakland, Renewable Funding is the leader in the turnkey administration of PACE programs. They get it and they're catalyzing the momentum of PACE. In the interview, Tsu engaged how PACE financing differs from traditional bank loans, therein nailing the virtue and viability of the financial vehicle:

If a property owner were to go to a large commercial bank today and say, “I want to borrow 500,000 dollars to swap out all the lighting systems in my big office building, and I can get a three-year payback on the investment,” the bank will then reply, “Okay, we will give you a three year loan.”

Then for the first three years of the life of those lights – which is typically about ten years – you haven’t made any money and you haven’t saved any money. You’ve saved energy, but all the energy savings you had is going to repay the bank loan. So, it’s not until year four that you start to see cash using a traditional bank loan.

One of the fundamental elements of PACE is that you can amortize the cost of the project over its anticipated useful life. You can take that half-million-dollar lighting project and amortize it over ten years, and your energy savings are going to be greater than your property tax assessment from the very start. So, you actually start generating cash in year one, instead of having to wait until year four.

In most of the projects we’ve examined, property owners can save money and immediately generate cash by taking advantage of PACE. In today’s economic environment, this makes PACE compelling.

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Post-script (21 June 2010): Pike Research released a report today forecasting PACE financing for commercial buildings will reach $2.5 billion by 2015. “PACE programs are gaining momentum around the country, and they represent a very promising mechanism for overcoming many of the barriers to energy efficiency retrofits for commercial buildings,” says managing director Clint Wheelock. “The majority of buildings would benefit from energy retrofits, with neutral to positive cash flow in addition to the other environmental and social benefits.”

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Post-script (1 July 2010): Great piece in CoStar's newsletter today, amplifying the opportunity. Summary:

[PACE] helps commercial property owners overcome the hurdle of the high upfront cost of energy upgrades. While the industry has come to agree that retrofits can sharply reduce energy costs and consumption and offset greenhouse gas emissions, private owners have struggled to finance such improvements due to capital constraints, especially in today’s economy.

Aggressive NOI goals and the need to split the benefits of tax credits and other incentives with tenants present other barriers for owners. PACE financing has emerged as a promising, albeit untested, tool for commercial owners.

“The opportunities are really tremendous from an energy retrofit perspective,” Hasner tells CoStar. “A lot of the hesitation from building owners comes from the upstream expenses and not wanting to make those expenditures. This type of financing can help alleviate some of those concerns and convince owners to make these types of investments, which are going to be cost effective as well as energy efficient in the long run.”

California cities and counties set the PACE in financing energy efficiency projects

Amongst the barriers of implementing energy efficiency solutions, project financing often tops the list. It’s a decades old paradox: Most (smart) energy efficiency projects generate sufficient energy savings (cash flow) to pay for the facility improvements over time, but property owners and tenants often lack the up-front capital to finance projects. What to do?

Fortunately, a number of new and pragmatic energy efficiency project financing mechanisms are emerging. And, not too soon, particularly given the tremendous waste (energy and money in inefficient buildings) and lucrative incentives (federal, state, local and utility incentives). Given our focus at Octus Energy to rapidly implement smart energy solutions, we’re acutely focused on what’s available and what’s in the pipe.

Property Accessed Clean Energy (PACE) financing is an innovative solution that might be the – or, at least, an -- answer to mitigate the financing migraine. This financing program was originally developed by Berkeley-based Renewable Funding, when they partnered up with the City of Berkeley to create BerkeleyFIRST. PACE programs, according to Renewable Funding, “enable local governments to finance clean energy and energy efficiency projects on private property, including residential, commercial and industrial properties.”

Here’s how it works:

1. Local government creates an improvement district;
2. A bond, secured by property within the district, is issued;
3. Bond proceeds are used to fund renewable energy and energy efficiency projects; and,
4. Property owners repay the debt service in fixed payments as part of their property tax bill over a period of up to 20 years.

Simple, clean and, hopefully, catalytic. Following Berkeley’s lead, other California cities and counties have sagely developed analogous financing programs, including:

• Palm Desert’s Energy Independence Program
  
• Sonoma County’s Energy Independence Program
  
• San Francisco’s GreenFinanceSF
  
• Placer County’s mPower Placer

CaliforniaFIRST, established by the California Statewide Communities Development Authority (CSCDA) with a program team that includes Renewable Funding as the program administrator and Royal Bank of Canada, is primed to be a statewide PACE. The pilot phase of the program includes 14 counties and more than 120 cities throughout California. Utilizing ARRA stimulus funds, the California Energy Commission awarded CaliforniaFIRST $16.5 million to pilot the programs as part of the State Energy Program, with Sacramento County as the lead grant contractor.

Paradox solved? At Octus, we’re bullish. As the economics of energy efficiency continue to improve with the advent of more efficacious technologies, smart financing solutions – presuming common sense and economic theory prevail – will hopefully proliferate.