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Edmonton’s Energy Transition Plan Clean Energy Financing: Briefing Note 21 October 2013 RICHARD BOYD.

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Presentation on theme: "Edmonton’s Energy Transition Plan Clean Energy Financing: Briefing Note 21 October 2013 RICHARD BOYD."— Presentation transcript:

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2 Edmonton’s Energy Transition Plan Clean Energy Financing: Briefing Note 21 October 2013 RICHARD BOYD

3 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, self- sustaining financing programs. The chosen models must reflect these characteristics. Introduction

4 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

5 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

6 Factors to foster broad participationFactors 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., low- income 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 Table 1: Program elements that foster broad participation and achieve deep improvements

7 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

8 Primary FI lender and secondary investor COE or third- party administrator COE Pre-qualified contractors Provision of LRF or subordinate debt Changes to Municipal Government Act to enable (a) LICs to include clean energy and (b) COE to make loans to private entities GOA (CCEMC) GOA (CCEMC) Identify, and educate potential FI partners Grant for start-up costs, initial admin costs, and any incentives (rebates, coupons) Loan capital (endowment, line of credit, loan) Property owners Marketing and outreach Administrator arranged capital (line of credit, loan) $$ $ Figure 1: Infrastructure for property assessed (Local Income Charge) financing program (based on warehouse model) $ Existing mortgage lenders Consent or approval $ Outreach and education Pre-qualify contractors Establish list of eligible projects ESPC

9 Marketing and outreach Pre-qualified contractors COE or third- party administrator Property owners GOA (CCEMC) GOA (CCEMC) COE Primary FI lender and secondary investor Pre-qualify contractors Establish list of eligible projects ESPC Changes to Municipal Government Act to enable LICs to include clean energy Figure 2: Infrastructure for property assessed (Local Income Charge) financing program (based on open market model) Existing mortgage lenders Consent or approval Outreach and education Identify and pre-qualify lenders that accept LIC securitization and repayment structure Provision of LRF or subordinate debt $ Grant for start-up costs, initial admin costs, and any incentives (rebates, coupons) $ Owner arranged capital (line of credit, loan) $

10 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 cost- effective for single-family residential due to high transaction costs; ● requires complex monitoring and verification of energy savings

11 Figure 3: Infrastructure for energy savings agreement financing program Pre-qualify contractors Establish list of eligible projects ESPC Pre-qualified contractors Property owners COE or third- party administrator Primary FI lender and secondary investor GOA (CCEMC) GOA (CCEMC) COE (Managed) Energy Savings Agreement (ESA) Special Purpose Entity Project capital (line of credit, loan) $ ESPC (large projects) (Managed) ESA (large projects) Large projects $ Provision of LRF or subordinate debt Grant for start-up costs, initial admin costs, and any incentives (rebates, coupons) Project capital (endowment, line of credit, loan) $$ $

12 BAU utility bills % 100% 65% Utility bills before ‘project’ Utility bills before ‘project’ Utility bills after ‘project’ (e.g., 65% of pre-project bills) Utility bills after ‘project’ (e.g., 65% of pre-project bills) Verified energy savings accruing to property owner (e.g., 35% reduction in pre-project utility bills – hence, cash flow positive from day one) Recovery of investment costs (financing cost) plus service costs Recovery of investment costs (financing cost) plus service costs Term of contract Guaranteed by ESPC, protected by insurance Fee paid to administrator under terms of ESA is to collect these costs Figure 4: Cash flow under energy savings agreement

13 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)

14 Approval or enabling legislation (if needed) COE or third- party administrator Utility Pre-qualified contractors Primary FI lender and secondary investor GOA (CCEMC) GOA (CCEMC) AUC Property owners Figure 5: Infrastructure for on-bill tariff repayment financing program COE Mechanism to pass-through project related costs (principle and interest) Marketing and outreach Authority to act Modifications to utility billing system Provision of LRF or subordinate debt Project capital (line of credit, loan) Grant for start-up costs, initial admin costs, and any incentives (rebates, coupons) Project capital (endowment, line of credit, loan) $ $ $ $ Pre-qualify contractors Establish list of eligible projects ESPC

15 Summary of potentially sustainable clean energy financing programs ProgramSectors Source of initial program funds Program administrator Loan originator Repayment vehicle Risk profile Market enabling actions Scalability Property assessed (LIC) Single-family Multi-family Commercial Industrial GOA, COE grants, debt Private FI debt Utility ratepayers (though this requires further steps in terms of giving AUC mandate and waiting approval) COE entity Independent third-party COE entity Independent third-party Private FI (only with open market model) Property tax billPerformance: Property owner, contractor, or insurance provider Recourse: Property Financial: credit enhancement, then investors Changes to LIC part of MGA Consent or approval from first lien mortgage holders LRF, subordinate debt or loan guarantee Large – aggregation and sale or refinancing on secondary capital markets Energy savings agreement (ESA) Multi-family Commercial Industrial GOA, COE grants, debt Private FI debt COE entity Independent third-party COE entity Independent third-party Special purpose entity (only for large projects) Savings agreement (service fee or payments) Performance: SPE, administrator, or insurance provider Recourse: Equipment Financial: credit enhancement, SPE for large projects, then investors Enable public entities to use ESA (unclear as to whether contracts classified as loans, requiring changes to covenants of MGA) LRF, subordinate debt or loan guarantee Large – aggregation and sale or refinancing on secondary capital markets On-bill tariff repayment 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 FIUtility billPerformance: Property owner, contractor, or insurance provider Recourse: Utility service Financial: credit enhancement, then investors 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

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17 Dr Richard Boyd Senior Economist, Research and Analysis Direct Contact details


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