Save content
Have you found this content useful? Use the button above to save it to your profile.
AIA

Guide to financing energy efficiency

by
15th Aug 2011
Save content
Have you found this content useful? Use the button above to save it to your profile.

With utility bills continuing to rise, enhancing energy efficiency can have a significant impact on a company’s bottom line, reports the Carbon Trust Advisory’s Hugh Jones.

Research by Carbon Trust Advisory has shown that UK businesses could achieve cost savings of at least £3bn per annum and up to £1.6bn per annum for large businesses. 

A lack of funds is not the key barrier for most businesses.

With many energy efficiency projects delivering quick returns (generally less than three years), the barriers to adoption are often non-financial issues. Key barriers include low overall financial materiality of energy costs, lack of motivation and internal technical expertise, limited time, misaligned incentives (such as a tenant making changes that will only benefit a landlord), and concerns over business disruption. 

Once the business case is clearly understood, most large businesses that have taken action to demonstrate leadership in energy management have found ways to address these barriers and have chosen to use internal funds to implement energy efficiency measures. Some business leaders are taking specific steps to prioritise the allocation of internal funds to energy efficiency measures, including establishing energy and carbon targets, ring-fencing internal funds for energy efficiency, accelerating the approval process and developing an overall business culture that prioritises energy efficiency and CO2 reduction. Business leaders are also introducing preferential financial appraisal criteria for energy saving investments to extend the proportion of opportunities taken up, for example by extending standard payback criteria from three to five years (or more).

There are a growing number of third party funding solutions emerging for capital projects.

Substantial progress has been made with specialist energy efficiency finance. The repayment terms of these types of specialist energy efficiency finance are determined by anticipated cost savings, improving affordability. This dedicated finance includes Energy Performance Contracts (EPCs) being offered by a number of UK energy suppliers and Energy Service Companies. It also includes a new energy efficiency financing partnership between the Carbon Trust and Siemens Financial Services, which started in March 2011 which will provide up to £550m of loans and other finance to UK businesses of all sizes over the next three years. 

Additional sources of energy efficiency finance are under development. These include the Green Deal, an energy efficiency financing initiative for UK businesses and households. Under current proposals the Green Deal will be launched in late 2012 and will be designed to enable businesses to pay for energy efficiency measures over time from anticipated savings on future energy bills. The Green Investment Bank (GIB), also scheduled to start in 2012, is expected to provide funding for large scale business energy efficiency measures, though full details are yet to be announced.

However, while behavioural change measures, centred on training and communications, have some of the highest returns available, there is limited third party finance available for these non-asset-based measures. Business leaders who adequately determine the business case for energy efficiency are able to justify the use of internal funds for these types of measures. For capital constrained businesses it may make sense to use third party finance for capital projects to preserve funds for behavioural change measures.

The level of internal expertise can shape financing decisions.

A business that chooses to use its own funds, or funding through conventional loans, will need to access the necessary expertise internally or from third parties. Without appropriate technical know-how, however, measures may not deliver anticipated energy savings. Companies which have carbon reduction ambitions, but do not wish to invest in the necessary expertise, may benefit from specialist energy efficiency finance options which are provided with technical support. 

However, with energy prices anticipated to rise considerably over the next decade (the government predicts a 40% increase in energy prices for business by 2020), many businesses stand to benefit from taking steps to build their own internal energy efficiency capabilities. Such an approach will not only open up more financing options but will also promote the development of business cultures that are able to effectively mitigate the risks of rising, and potentially more volatile, energy bills in the long term. 

Key business considerations when selecting finance for energy efficient technologies

Cost of finance. The cost of finance (inherent interest rate and other fees) will vary depending on the credit rating of the business seeking finance and the financing option. Generally speaking, cost of finance will be lowest for specialist energy efficiency loans and leases. Interest rates associated with hire purchase agreements can in some cases be lower than for standard loans. Standard loans and leases are likely to be broadly comparable for small to medium sized businesses (reflecting the fact that standard loans tend to require security). Financing options that include energy performance guarantees and maintenance support, such as EPCs, are likely to be more expensive but can be beneficial for businesses that lack technical capabilities.

Underlying technology cost. The equipment cost can vary according to the financing approach adopted. By obtaining specialist energy efficiency finance or funding via energy supply chain businesses it may be possible to access lower cost technologies given the purchasing and supply chain convening power of these businesses and initiatives.

Cashflow management considerations. All financing options, other than a business’ own internal funds, can have cashflow management benefits. Third party finance enables a business to spread the cost of the energy efficient asset over a number of years or its full lifetime. Specialised energy efficiency finance offers the strongest link between the savings that will be generated by the technology and repayments. Operating leases can have particular benefits where the technology may not be used throughout its entire life, potentially enabling the business to pay less than the technology cost. Operating leases can, however, prove more expensive in the long term. With financing options involving an upfront payment for a technology, negotiating with suppliers to stagger payments over a period of time can have significant cashflow, IRR and payback benefits.

Tax considerations. Different financing options have varying tax benefits. Financing options that enable a business to own an energy efficient asset (e.g. loans, hire purchase agreements, finance leases and EPCs) can enable a business to benefit from standard or enhanced capital allowances. Other businesses may prefer to benefit from annual operating profit tax benefits of lease finance.

Balance sheet considerations. Businesses should consider whether they wish to bring the asset and any related liability onto their balance sheet and the impact this will have on their capital ratios (debt to equity, interest coverage). 

Technical expertise and likelihood of achieving savings. Technical measures require good quality installation and maintenance expertise if they are to deliver anticipated energy savings. While this expertise is available in the market it can be accessed, potentially more efficiently, via certain financing packages provided by technology suppliers, specialised energy efficiency finance and EPCs.

Contracting risks. For all third party financing options there is a risk that a business can be tied into a financing agreement for longer than needed. A business must carefully check that the length of the contract is closely linked to the required payback or lifetime of the energy efficiency measure and takes account of any potential changes to a business that may result in an early end use date.

An analysis of 1,000 energy efficiency investments between 2006 and 2009 has shown that the average cost saving potential available from energy efficiency measures offers attractive internal rates of return of 48% and significantly exceeds typical business requirements for new projects (usually an average of around 11.5%). With this in mind, whichever solution you choose, this level of return should leave most financing options open and enable finance professionals to make the case for leading change in their organisations.

Hugh Jones is the managing director for Carbon Trust Advisory. Jones joined the Carbon Trust in 2005 and was responsible for all business and public sector low carbon advice and services from January 2008 until October 2010.

Replies (1)

Please login or register to join the discussion.

avatar
By ringi
16th Aug 2011 14:00

Related, but not directly,

We have thought about having solar panels installed on our home, but decided not to, as:

The good return is over many years, but will not change our lifes.The next owner may wish to put in a loft extension, and therefore not wish to pay more for the home to take account the return on the panels.  (The south roof is too small for panel and loft windows)Having solar panels may make our life’s more complex and is not a “core” part of our life.So we have decided to get a lower return by paying down our mortgage as it is easy.

I think a lot of companies hit the same issues, a long term cost saving must be very great to provide a better return on time and “brain power” then just spending the time getting the “core” right.

Thanks (0)