The PACE idea is powerful: Property Assessed Clean Energy. It was recognized that the switch to clean energy for existing buildings was going to be capital-intensive, and PACE financing was designed to enable projects with longer paybacks, by providing longer term financing. Lenders were given the assurance of low risk because collection was done through property taxes. For the property owner, there was the advantage that the building could be sold with the existing PACE finance being assumed by the new owners - it did not need to be refinanced. But then the energy efficiency lobby kicked in by co-opting the moniker "clean energy." I am not sure of the exact historical circumstances, but the fossil fuel business has a vested interest in selling energy efficiency as a functional equivalent to "clean energy," and calling themselves "green." It is not, but PACE organizations bought into this fallacious argument.
GSE Trouble
Fannie and Freddie did not like PACE one bit, because it would get seniority over existing mortgages. In the end, a compromise was reached, limiting PACE financing to 10% of the assessed value. The PACE team could only barely show some positive impact of Energy Efficiency on home value, but they produced a study that seemed to confirm the relationship. Apparently unbeknownst to them (believe it or not), energy efficiency and clean energy are not the same thing. Energy Efficiency is pointless as a primary objective, from financial, economic and environmental points of view, not to mention it is pointless with respect to building property values, for it produces diminishing returns. Only renewable energy will reduce GHG-emissions, and only renewable energy is an investment, because it moves energy from liabilities to assets.
The choice is between fossil fuels or renewable energy, and whatever system you choose, you want to make it as efficient as is economically feasible. The choice is not, not ever, between energy efficiency and renewable energy. If the PACE folks had focused on Clean Energy as the name implies they would have convinced Fannie and Freddie hands down to not only allow PACE (with restrictions), but to promote renewable energy retrofits with PACE finance as constructive to asset values. The only thing holding it back was the absence of an effective underwriting policy. With our (see www.dabxdemandsidesolutions.com) Green Underwriting 2.0 initiative, we have proposed an alternative that focuses on projects with in excess of 50% GHG-reduction, which would help building values, increase resilience, and could only be done with various types of renewable energy solutions, because they offer compound returns, particularly if more than one type can be implemented.
Energy Efficiency: the lightbulb moment
Energy Efficiency is the prevailing religion, but it is financially disastrous and environmentally regressive. It buys short-term gains with long-term financing, and creates a temporary lift which masks the fact that the underlying problem gets worse. If our problem is emitting green house gases (GHGs), then the solution cannot be to make it cheaper to burn more GHGs, and thereby expand the market, and encourage people to keep on emitting them for longer periods of time. Doing so, the problem becomes more entrenched. The solution must be to switch to renewable energy as fast as possible. And the way you do that in a capitalist system is focusing on the low hanging fruit, meaning the most profitable projects, not with soviet-style 20 year plans that never work. Energy efficiency is pointless, and causes capital destruction because of diminishing returns.
A simple lightbulb can demonstrate the point:
- We used to use a 60 Watt bulb that cost $1
- We then switched to a 14 Watt CFL that cost $2 (actually a four pack at Home Depot today has them as low as $1.25). This savings was 46 Watts or 77%. At $0.35 per kWh, we saved $0.0161 per hour, and paid for it in 62 hours.
- Now we are considering a switch to LEDs, which in the same range go for $15 at the moment. The incremental savings is 6 Watt, or 43% against the CFL, but only an incremental 10% against the original incandescent. At the same electrical rate we save $0.021 per hour, and pay for it in 3095 hours (8.5 years at 2 hrs a day).
In short, the first "energy-saving step" books impressive results for a small incremental marginal expenditure, and it makes obvious sense. The next step is financially absurd, because of the math of diminishing returns. Our further incremental investment buys us only a 10% savings off the original base consumption of 60 Watts. In dollars, it cost us $1 to save 46 Watts in step one, or $0.02 per watt saved. But in step two the price is $2.17 per watt saved. This is typical in energy efficiency spending, the first step or steps look good, but there is no economically viable follow-on. Many, if not most, government programs incentivize the first few steps of energy efficiency (my preferred example in NY is the NYSERDA MPP program), and leave the property owner stranded in a cul-de-sac, with no alternative but some day writing off most of what they did.
PACE finance for EE: Painting lipstick on a pig
Renewable energy (Solar, Wind, Geothermal, Hydro, etc.) moves energy from liability to asset, and moreover if we can combine multiple technologies, or appropriate energy efficiencies, we can produce compound returns. Energy efficiency reduces, but does not eliminate a liability, but it can be made irrelevant easily, among others by the following:
- Growth in net-zero and near zero properties in the market, making the typical 15-25% efficiency "savings" all but irrelevant.
- A few energy price hikes, or even if energy prices were to stay stable, the delivery cost of the grid may continue to increase (in NYC ca 65% of the bill).
- Growing numbers of similar properties go the renewable route, and achieve 50-90% GHG-reductions, making the 15-25% reductions look paltry.
- Any form of carbon taxation in the future. (Note e.g. that adaptation of the Baucus energy tax reform if it includes the demand side, like well it should, would indirectly have the same effect)
Energy efficiency is a limit function, and environmentally it is dubious, it produces a short-term gain, but a long-term increase in CO2 emissions. The problem becomes more entrenched, instead of coming closer to a solution. Financially, Energy Efficiency is a secondary issue, and operational savings, not a capital decision. The real choice is fossil fuels or renewable energy. And all the elements that make PACE financing attractive to investors are wasted, if they are used to dress-up energy efficiency loans. It's like putting lipstick on a pig.
PACE and EE: mismatched maturities
From a pure financial standpoint, the four points listed above, of how and why an "energy efficiency" investment can go sour very easily, all are variations on the theme that the financial value of the "investment" could evaporate easily, meaning that the effective ability to pay may be threatened over time. And thus it's the mismatch of short-term investments with long-term maturities which is the most pressing issue here.
PACE, as it was clearly intended and as its name implies, was meant to finance permanent capital improvements with long-term money, so that energy retrofits with longish paybacks could get done. Mostly the asset backed approach for the equipment does not tend to out too far. If PACE financing is wasted on energy efficiency projects, it will self-destruct sooner rather than later. PACE should be limited to projects with a principal focus on renewable energy, that clearly move energy from liability to asset, and therefore improve the underlying value of the property. That will ensure the viability of the project, if it is otherwise designed right. Typical projects should achieve 50% or better GHG-reductions. If this is not done, PACE finance has every potential of becoming the next sub-prime scandal, right along with solar PPAs.
Conclusion
PACE finance is a brilliant solution that is being misapplied by purposing it for short-term energy efficiency projects rather than long-term renewable energy projects.
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