Financing Energy Efficiency Investments (Podcast)

[00:00:04.930] – Aristeidis Tsakiris
Hello, and welcome to the Podcast series Scaling up energy efficiency. This is episode seven and today’s topic is Financing Energy Efficiency Investments. We are podcasting from Denmark, one of Europe’s most energy efficient economies, reflecting decades long history of cooperation between the public and private sector in terms of development of technologies, solutions, knowhow and policies within energy efficiency. My name is Aristeidis and I work as a project officer at the Copenhagen Center on Energy Efficiency a part of the UNEP Copenhagen Climate Center. So without further ado, here is your host, Elisabeth Resch, finance project manager and advisor, who will moderate today’s podcast.

[00:00:55.710] – Elisabeth Resch
Hello and welcome. My name is Elisabeth Resch and I’m greeting you today from the UN City in Copenhagen. This podcast is part of a series to shed light on how to mobilise financing for the large market for energy efficiency investments. It’s a critical time for energy efficiency. Despite the recognized importance, improvements in energy efficiency globally have fallen short of expectations. They have amounted to around 2% between the years 2011 and 2020 and took a hard hit during the Covid-19 pandemic. The International Energy Agency finds that progress on energy efficiency globally recovered in the pre-pandemic world, but remained well short of what we needed to help put the world on a track to reach net zero emissions by midcentury. The inadequate improvements stem from insufficient energy efficiency investments. Despite the ostensibly strong business case for energy efficiency, there is a gap. Investments in wind and solar power have increased substantially, while investments in energy efficiency investments have not grown at an equal pace. Global investments in energy efficiency have not increased significantly in the last years. Today I will be speaking to Alexander Ablaza from Climargy. Climargy is a company that enables climate smart energy with derisked and quicker decisions. Alexander will share his view on the role of energy efficiency in the climate agenda and dive into how energy efficiency investments are financed based on his professional experience. Most intriguingly, he will share his perspective on equity financing for energy efficiency. Here at the UNEP Copenhagen Climate Centre, we host the Copenhagen Center for Energy Efficiency. Moreover, we support mission efficiency. Mission efficiency is part of an effort to build the ecosystem needed to drive progress on energy efficiency. And with this in mind, I would like to now start the interview with Alexander. Alexander, welcome. Thank you for taking time for us.

[00:02:56.440] – Alexander Ablaza
Well, thank you Elisabeth. Well, energy efficiency has always been a passion of mine. I’ve worked on energy efficiency, finance, policy investments and market transformation across 14 markets spanning in Asia and a little bit in the Middle East. So it’s something that’s been a commitment to grow in spite of the different constraints and barriers across markets. I have founded Climargy as a solution because after leaving the development banking world, because I was previously the energy efficiency anchor of the Asian Development Bank and moving over to IFC’s Global climate Finance unit. I handled the Asia portfolio of climate finance of which 80% to 90% was on energy efficiency. And I’ve seen that there were many constraints. And one is that debt- financed and self financed energy efficiency could not achieve scale in many markets, whether developed or emerging economies. This is why I had to design a model which I call Climargy right now, that would flow energy efficiency capital outside the balance sheets of ESCOs and the end-users. So that’s the innovation that we bring to the market today.

[00:04:14.690] – Elisabeth Resch
That is very interesting. I’d like to ask you more questions about the scale that’s brought on by equity based financing later on. But first, in your own words, why is energy efficiency so important to reaching the goals of the Paris Agreement and the climate agenda at large?

[00:04:31.290] – Alexander Ablaza
Well, energy efficiency should be achieved ahead of all other Paris Climate Agreement obligations, ahead of other clean energy transition activities including renewable energy. Efficiency first, because what we can shave off, we don’t have to build, what we can shave off, we don’t have to convert from fossils to decarbonised sources like renewables. So energy efficiency should be seen as a resource, something that’s got to be mined and harvested from the end use of energy markets and we’ve got to find more creative, innovative way of bringing capital to that act of harvesting waste energy from energy end use.

[00:05:20.310] – Elisabeth Resch
That’s true. I remember that the IEA calls it the first fuel energy efficiency and also the COP 26 final statement in November ’21 underscored the need for scaling up energy efficiency measures. And it’s evident in the figures that it’s not just the first fuel, but it’s an indispensable fuel. So the energy needs that we have cannot only be filled by renewable energy, but by improving also how we use energy. That is true. In fact, I believe that the Sustainable Energy Forum For All estimates that some 40% of the emission cuts needed to be achieved under the Paris Agreement need to be achieved through energy efficiency measures. Is that correct?

[00:06:03.950] – Alexander Ablaza
Absolutely. In fact, IEA, aside from the 40% of emissions cuts through energy efficiency, IEA threw a figure in 2018 that the whole world will need to mobilize something like 24 and a half trillion dollars of energy efficiency capital. Now, while we see private sector capital, government funding and development funding moving at a steady pace towards renewables, we don’t see that same velocity towards end-use or demand-side energy efficiency. So that means that in spite of the innovation in technology, we need a lot of innovation in financial modalities as well as delivery models, business delivery models. And this is where that innovation Climargy brings. I personally believe that out of the 24 and a half trillion, this is not an IEA estimate, but my personal estimate that up to two-thirds of that volume will need to flow as off-balance sheet capital.

[00:07:08.250] – Elisabeth Resch
Can you expand more on that? How does Climargy specifically finance energy efficiency?

[00:07:13.260] – Alexander Ablaza
Well, it’s all about flowing capital outside the balance sheets of both the implementing entity which is called the ESCO, the energy service company and the host entity which is typically the building owner or the factory owner. And if you do that, then you remove the barriers or the credit risk or the lack of credit worthiness of both these entities. And that’s a large portion of the behavioural inertia that the world presents today, their lack of credit worthiness, the lack of access to finance. It’s not that the ESCOs and the building owners could not borrow, but typically their lack of credit worthiness would limit their borrowing capacity. And I’ll throw you an average figure, let’s say after three project loans, a typical energy service company would max out their credit limit so they could not borrow for project number four, project number five up to, let’s say 20 projects in their pipeline. So what happens to projects four to 20? They don’t get implemented at all. Only the first three projects get implemented and they’re able to service their loans. So that tells us that debt finance is a good growth strategy in many markets, but it’s not the scale-up strategy that the world needs. We need to flow innovative finance outside the balance sheet. So what Climargy is doing, is it’s a private-sector attempt to form what governments call a super ESCO, a platform that flows equity capital and owns the ESCO project assets across a portfolio of 30, 40 or maybe 50 performance contracts hosted by commercial and industrial entities in a market. So, by being a super ESCO-like fund structure, you’re able to own the assets, you’re able to manage those assets, you’re able to transfer those assets, you’re able to aggregate them, you’re even able to flow development funding to derisk that portfolio because there’s still a lot of barriers, even though we are a private sector entity, there’s still a lot of development risk. There still are barriers that will need to be gapped to make the portfolio investments, investment-grade or commercially viable. So we need to remove the risk upfront, let’s say investment grade audits in markets. We need to remove the risk of, let’s say, energy savings performance issued by small and medium ESCOs in many markets. We need to remove customer credit risk, especially if you go down from the large corporates to middle-market to even the larger of the SMEs in each of the markets. So there’s still a lot of risk to remove, to manage, to mitigate and for Climargy to attract more equity capital. So we’re like the plumbing right? In energy efficiency, I’d like to say that it’s not the lack of climate funding, but it’s the lack of plumbing to bring it from point A to point B. And a lot of this capital funding is happening for renewables, for grid-tied solar parks, for wind farms, for hydropower plants, but it’s not happening across, let’s say, sub 5 million, sub $3 million dollar ESCO projects happening in markets right now. And this is exactly why we have Climargy. We will do it outside the balance sheet. We are a nonbank specialist vehicle for off-balance-sheet capital. We also provide indirectly capacity building as we build up the projects until they are investment-grade.

[00:11:13.410] – Elisabeth Resch
Thank you. You just described the number of cost and risk associated with your investment and mentioned that you use development financing. Is that to do it? It sounded a little bit like a blended financing approach. Or how can you give more detail how you use development financing in Climargy?

[00:11:30.000] – Alexander Ablaza
Well, we started just last month. We signed a Grant Support Agreement with UNOPS managed Southeast Asia Energy Transition Partnership, or ETP. And this is for the conduct of roughly a dozen investment grade audits across markets. And investment-grade audit may be an expensive upfront barrier for many ESCO projects because regardless of the cost of the energy efficiency project, it may be a lump sum of 20, 25, 30 thousand dollars. So who’s going to carry that cost? The building owner? The ESCOs? Or will they share it or will they not? They’ve not programmed such budget and they are unaware of the outcome of the energy audit. So how do they recover the cost of that audit, especially in markets where it’s not a regulatory requirement? So this is one form of development funding. We derisk upfront project development costs by subsidizing the cost of investment grade audits. Blended finance also works. What if we have to buy down, we have equity portions. If we are able to borrow or mobilize debt finance, for example, for a portfolio of projects, then it’s the equity portion that we will need. It could also be blended finance working through a development financial institution or multilateral development bank of buying down the sub-commercial rates. So at the end of the day, the portfolio becomes attractive and viable for private sector investors.

[00:13:17.730] – Elisabeth Resch
Thank you. You already touched a little bit about it. And development finance as an equity partner, your particular expertise is equity-based financing for energy efficiency. I’m familiar with debt financed models which we mentioned do not reach the sufficient scale. Can you shed more light about the promise that equity based financing holds for energy efficiency and the particularities and what is required to make it work?

[00:13:47.300] – Alexander Ablaza
Right. It’s all about the asset class called grid-tied renewables versus, let’s say, ESCO implemented energy efficiency projects. Grid-tied renewable projects can attract project finance from commercial banks. There are very clear cash flows. They have the scale. They have the right deal sizes for a major universal bank to lend a huge portion of a project amount for grid-tied solar or grid-tied wind power. But that’s not the case for sub-3 million, sub-2 million dollar ESCO projects. They have a deal size problem. So in many markets, we don’t have that aggregator of many small projects. And if you have sizes of sub-2 million, sub-3 million, project finance unfortunately, does not work. So it’s very difficult for a commercial bank to increase its exposure to this new asset class called ESCO project. Yes, they’ll be able to lend one, two, three, very good for their green score card, but they will not be able to achieve scale. They will not be able to build up a portfolio that would fill more sustainable development projects in that bank’s lending portofolio. And this is where equity comes in. Equity addresses the problem of having the asset sits in another balance sheet. In this case, it’s in Climargy’s, as a third-party project developer. Most of the ESCOs in developing Asia, I would even include developed economies like Singapore. 98% of ESCOs do not have suitable access to bank lending. 98%. Only the 2%, like in China when I was in IFC, only 2% of the ESCOs, and there were 5500 ESCOs at the time of the study in 2013, had access to $7 million lending from banks. Beyond that, they were not able to borrow. So it’s severe. It’s the mere fact that ESCOs and their lack of credit worthiness should be recognized. It’s very easy to say, oh, let’s flow climate funding to banks. But if we continue to do that, and we continue to grow and flow energy efficiency capital through banks, it will be constrained because the uptake will be very slow, because ESCOs do not have that kind of borrowing capacity as those of the, let’s say, renewable energy project developers. So we need to flow equity and equity outside the balance sheet of the ESCOs. In this way, we’re able to use the energy management electromechanical engineering talent of ESCOs without them having to worry about financial engineering. So Climargy will provide the financial engineering while harnessing their strengths. They’re very good in cooling and lighting and building insulation. They’re very good in harvesting that waste energy and converting it to useful energy. That’s what they’re good at. But ESCOs generally are not good in financial engineering. So this is where Climargy comes in. We get the best of their engineering and their energy management projects and bring capital to them in a way that would not affect their books.

[00:17:41.500] – Elisabeth Resch
Thank you. Yes. You identified ESCOs and their access to finance already basically is the major bottleneck to driving more finance to energy efficiency. And that is well set and taken. You have experience of different markets in Asia. You must have seen different policy environments. So I wonder, you must have an idea or a wish of what an ideal policy environment is that is conducive to energy, to energy investments, to the uptick of the measures, and to the ease of the financing. Can you share this? What is their policy, why is that missing or that needs to be there, or what would you wish for in the market?

[00:18:19.990] – Alexander Ablaza
We need very strong energy efficiency laws actually that’s more ambitious, more inclusive, that will incentivise private sector investments. Without mentioning country names because I have been responsible for leading teams that have effected energy efficiency regulation or laws in certain countries. But without naming country names, I would say that countries should be careful not to set up government institutions that would rob energy efficiency opportunities away from private sector players like ESCOs. Instead, they should feed work through the ESCOs. And that is the reason why the US and the China ESCO sectors are the two largest ESCO sectors in the world with 15 billion for China and about 7 billion for the US. It’s because governments fed them work. Governments trusted their capacities. Governments made sure that they had the volumes to grow their respective ESCO markets. We should review or propose energy efficiency legislation that would be more inclusive. We have to bring down consumption thresholds. Some countries have very high consumption thresholds before an end user starts to have or be faced with obligations. In the Philippines there’s a law that was signed in 2019. Anyone consuming 500,000 kilowatt hours in fuel and electricity per year are now faced with a long list of obligations, whether it’s ISO 50001, mandatory energy audits, the hiring of a certified energy manager and the list goes on, including the targeted reduction of specific energy consumption of that entity. In some countries it’s still very high. So we have to work progressively to bring down and bring it down from the large corporates to middle-market and even embrace the larger of the SMEs, give them obligations. And that would accelerate now the uptake of energy efficiency finance. That will also increase uptake and deployment of energy efficiency technologies because it shifts now from a mere voluntary to mandatory regime if you bring down the consumption thresholds to something that’s more inclusive in the market.

[00:21:04.350] – Elisabeth Resch
So to summarize, strong energy laws and adequate thresholds for what constitutes a high energy consumers and the associated responsibilities to foster energy efficiencies in their operations.

[00:21:15.595] – Alexander Ablaza
And ESCO regulation as well.

[00:21:15.730] – Elisabeth Resch
And ESCO regulation as well, of course. Thank you very much Alexander. Now you’re in town to participate in our financing energy efficiency charette here at the UN City tomorrow. It’s a charette, so it’s a collaborative brainstorming and consultation process. This is a term that we adopted from the discipline of the architect to tackle tomorrow the problem of bringing together the financing community and the energy efficiency community. So you’re a natural guest, of course, for that. What do you hope for tomorrow? What do you hope in the exchange on financing energy efficiency?

[00:21:52.460] – Alexander Ablaza
Well, it should be a very good two-way exchange. There will be other experts in the room in debt finance. There will be others who have experience of flowing investments to industries, to buildings and even to household appliances and vehicles. But when I say two-way street, I also hope I could share my experience on how debt finance had its constraints in both developed and emerging markets and that equity was a solution, especially if ESCOs are involved to flow off-balance sheet capital to more commercial, industrial and even government end users. So it should be a nice brainstorm where everybody puts ideas on the table and maybe once assembled, it could be a very good toolkit for different countries and markets to address their energy efficiency financing gaps.

[00:22:56.110] – Elisabeth Resch
Thank you. We hope we deliver tomorrow on that promise. Now, this is the end of this podcast. Please check out our other podcast if you’re interested in financing energy efficiency and in the policy environment around energy efficiency. For now, thank you very much Alexander, and we hope to see you again on this podcast.

[00:23:16.100] – Alexander Ablaza
My pleasure. Thank you Elisabeth.

[00:23:22.250] – Aristeidis Tsakiris
Thanks for listening to the podcast Financing Energy Efficiency Investments with Alexander Ablaza and Elisabeth Resch. If you liked our show, share it on your social network. And if you want to know more about today’s topic, check the Copenhagen Center on Energy Efficiency web page. Stay tuned and subscribe to receive notification about our next podcast. See you at the next episode. And do not forget “energy efficiency is a journey, not a destination”. Cheers.