Synopsis: This article explores mechanisms for growing the energy efficiency market through third-party financing. First, to evaluate the opportunity for third-party investors, the article outlines the size of the energy efficiency market and highlights certain relevant sectors. The energy efficiency implications of recent and pending legislative stimuli to energy efficiency investing, such as the American Recovery and Reinvestment Act of 2009 are discussed, as well as the hazards of over-reliance on government funding. Structural challenges to the growth of the market are reviewed as well as promising solutions and current deal structures. Lastly, of particular interest to those seeking financing, a comparison of the appropriate cost of capital for energy efficiency projects is compared to the potential returns available to investors showcasing a significant investment opportunity.
Multiple factors are converging to focus private citizens and policymakers on energy efficiency. First, proposed legislation calls for a reduction of greenhouse gas emissions,1 about forty percent of which can be achieved through energy efficiency at a negative marginal cost.2 Second, energy efficiency offers a $170 billion per year investment opportunity that some experts predict can provide an average seventeen percent internal rate of return.3 Third, both the American Recovery and Reinvestment Act of 2009 (ARRA)4 and pending House5 and Senate6 legislation provide significant funds and incentives for energy efficiency investments. Lastly, the recent spike in energy prices, combined with concerns about the political trajectory of many energy producing countries (e.g., Russia, Iran, Iraq, Saudi Arabia), has raised concerns about energy security. Energy efficiency could reduce these concerns by slowing the flow of funds to these potentially volatile countries.7
Given these developments, it is not surprising that President Barack Obama calls energy efficiency "the cheapest, cleanest, fastest energy source[,]"8 while World Bank economists declare that "[w]henever energy-efficiency rises, individual and societal welfare is increased."9 Despite these trends and pronouncements, however, there are still multiple barriers to increasing energy efficiency, such as principal-agent,10 informational, measurement and verification, and transaction cost issues. Financing is one key to solving these problems: the market is most likely to break down these barriers if it can turn a profit.
After reviewing the potential size of the energy efficiency market and challenges to its growth, this article explores whether energy efficiency investments are likely to yield a sufficient return on investment, relative to traditional investments stocks and bonds to motivate investors and financial intermediaries to drive the market forward.
II. THE SIZE OF THE ENERGY EFFICIENCY MARKET
A. Market Size
The demand for energy efficiency grows in conjunction with the energy market. Global energy demand is forecast to increase by 2.2 percent per year until 2020; however energy efficiency could cut this demand growth down to 0.7 percent per annum: a savings of 18 quadrillion BTUs per year in the United States according to McKinsey & Company.11 To support its calculations, McKinsey has identified specific energy efficiency savings that have an Internal Rate of Return (LRR) of at least ten percent and "avoid compromising the comfort or convenience valued by consumers."12 These energy efficiency savings, all of which are predicated solely on technological rather than behavioral evolution, are projected to be worth about $35 billion per year by 203 0.13 Moreover, twenty to twenty-four percent of total energy demand in 2020 could be met by deploying existing energy efficiency technologies in lieu of new generation capacity.14
In the United States, experts estimate that energy efficiency investments can save between $170 billion15 and $932 billion per year in energy expenses right now, 16 rising to a savings of $900 billion by 202017 and $3. …