Understanding why we need to unlock investments in energy efficiency

Recently, the International Energy Agency published its latest market report on energy efficiency. Jennifer Romero-Torres, Senior Financial Sector Specialist for the South Asia Regional Department at the Asian Development Bank uses that report to discuss investments in energy efficiency in an article on the Eco-Business website.

 

Energy efficiency: Why not enough is being invested

Increasing energy efficiency is considered by many experts as low-hanging fruit to reduce a given carbon footprint. So, why is no one picking it yet? Let’s look at the numbers to find out why.

Global energy intensity—the amount of energy used to produce a unit of GDP, and often used as a measure of energy efficiency—improved by 1.8 per cent in 2015 compared to 1.5 per cent in the previous year and three times more than the annual average of 0.6 per cent between 2003 and 2013, according to a 2016 report by the International Energy Agency (IEA). This is certainly good news, as oil prices have been falling by as much as 60 per cent since 2014.

Energy efficiency gains were higher in emerging and developing countries (2.5 per cent) than in industrialised countries (2 per cent), a global trend driven largely by the People’s Republic of China (PRC).

The PRC improved its energy intensity by 5.6 per cent in 2015, up from an annual average of 3.1 per cent in the last decade. Between 2006 and 2014, PRC investment in energy efficiency reached $370 billion, generating multiple benefits including reduced air pollution and lower energy costs. The energy savings from efficiency were as large as those delivered by the country’s entire renewable energy supply.

Efficiency gains made redundant over $230 billion of investment for a new coal-fired electricity generation, and cut 1.2 billion tons from the PRC’s greenhouse gas emissions in 2014—equivalent to the total emissions of Japan. Although the economy grew strongly at 7 per cent in 2015, the PRC’s primary energy demand increased by less than 1 per cent that year.

Notwithstanding these achievements, global progress on energy intensity remains sluggish and does not provide a sustainable pathway toward a decarbonised energy system.

For that pathway to emerge, the IEA estimates that global energy intensity must improve 2.6 per cent annually until 2030.

The IEA’s projection is consistent with the 2015 Paris Agreement on climate change. As such, energy efficiency should account for 38 per cent of total emissions reduction through 2050, while promoting renewable energy is only responsible for 32 per cent.

At present, an average of about $130 billion per year is invested in global energy efficiency improvement. This is equivalent to 15 per cent of fossil fuel investment, and 20 per cent of power sector investment.

The IEA outlook also estimates that investment in low-carbon power generation would need to triple from 2014 to 2035 to reach the 2°C target, and investment in energy efficiency across different sectors would have to rise by eight-fold. Cumulative investments in energy efficiency would thus reach $13.4 trillion by 2035.

It should be acknowledged, however, that Paris aims to limit global temperature increase to “well below” 2°C, and suggests 1.5°C as a more ambitious goal. This would require putting aside even more money for energy efficiency.

Low-hanging fruit

Energy efficiency is widely recognised as an effective and low-cost route to achieving significant emissions reductions as well as ensuring long-term energy security. So, why is it failing to attract enough investment?

First, an enabling policy framework is critical to mobilise and effectively channel finance to energy efficiency investments. This includes support for low-carbon technologies, removing fossil fuel subsidies, implementing extensive energy market reforms, and building market infrastructure.

Second, investments in energy efficiency are driven by global energy policies that establish the framework and incentives for achieving the set goals. The global market is heavily influenced by the G20 economies, which are collectively responsible for more than 80 per cent of global energy-related CO2 emissions.

Asia and the Pacific, though, is a diverse region, and energy demands vary between countries. National priorities differ across countries, environmental conditions and stages of economic development.

Many economies in developing Asia still rely almost exclusively on fossil fuels. Mature and developed economies, on the other hand, are focused on replacing aging, energy-inefficient infrastructure; they have a combination of the enabling policies, financial resources, institutional support and even market size to spur new investment in energy efficiency.

As a sector, energy efficiency is currently not an attractive enough for institutional investors in capital markets. There isn’t the critical mass of big energy efficiency projects to justify securitisation or bond issuances.

Energy efficiency projects are typically small-scale, and are developed on a piecemeal basis rather than across portfolios. Projects differ from each other in terms of the technologies and measures used to enhance energy efficiency, and how these measures are understood by investors and financiers. This makes standardising the investment process quite difficult.

Financing energy efficiency projects is based on “savings,” unlike traditional infrastructure or energy projects, which are underpinned by predictable revenue streams. The bankability of the latter requires predictable cash flows subject to legal obligations or contractual arrangements.

Savings need to be measured and verified before they can be accepted by traditional investors and lenders alike. A limited understanding of energy efficiency creates a perception of high risk among investors, which translates to high financing costs.

To unlock investments in energy efficiency, we must remove all barriers to standardisation and aggregation of small projects. This way, we can create a critical mass and pipeline of bankable projects, which in turn increase investor confidence and investment appetite amongst financiers.

We also need to make energy efficiency into something that can be easily understood and financed by institutional capital. Otherwise we will continue to ignore the low-hanging fruit.

 

 

3 thoughts on “Understanding why we need to unlock investments in energy efficiency

  1. Having been asked after the 2008 financial crash to conduct research into the institutions and instruments necessary for resilient markets and infrastructure I have come to the conclusion that the solutions do not lie within the commodity market paradigm that led to the crash but in a services market paradigm.

    Moreover there is a sound commercial reason for the emergence of a complementary market in energy as a service, which is simply that services require ‘smart’ intellectual capital (I regard Intellect as the true ‘Fifth Fuel’ and a University as a refinery) whereas the commodity market paradigm is capital intensive both in terms of funding assets, and financing market & credit risk.

    That is why I have been working with collaborators on the complementary institutions of risk sharing agreements (guarantee societies/P&I Clubs) and production sharing agreements (capital partnerships/energy swaps) and instruments (energy credits/promises returnable in payment for energy). This recent presentation at Bogazici sets out some of the thinking.

    We are very much interested in working with anyone who considers they may be able to contribute to the development of this emerging services market paradigm.

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