Renewable Energy Policy in the Soviet Republic of New York

Back in the 60's we used to laugh at the 20 year plans of the former Soviet Union, but now we are doing the same things in our renewable energy policy, or what goes for it. To stay close to home for me, plans like PlaNYC (Née 2030, but the target date has been dropped from the nomenclature recently in apparent anticipation of missing the deadline), and its outflows (local laws 84/85/86/87), including the NYC Clean Heat program, all are examples of planned failures, because they drive policy at the detail level from macro-economic views which ensure that average results become the norm and real progress is stymied, because by aiming for "average," below average, or worse, is what comes out.

The problem in this case also goes back to the federal level, the lack of a coherent energy policy, and the way energy incentives have been structured traditionally. In the end, all of this goes back to the beginning of the energy crisis of '73 and the macro economic view that it was cheaper on the margin to reduce energy demand than to increase supply (power plants). Cheaper to insulate your house than to build a new power plant, etc. Energy efficiency thus became sanctified and became a national pastime, regardless if it is good for you or not.

N.B. This is written with a view to New York State, but the same most likely applies with only minor variations to every state of the Union.

The Energy Efficiency Fiasco

Naturally, increasing efficiency of the systems we do have, which are by and large carbon-based energy systems, adds up to making the carbon economy more efficient. If at the same time we realize that we want to wean ourselves from carbon energy, and switch to green energy, then we do not want to just invest our money in making the old system more efficient. In short, if we pursue efficiency of the existing carbon-based system, we are talking ourselves out of the alternative, green energy. Hence the ConEdison GreenTeam should be renamed the BrownTeam. This is what has happened with energy policy in general and specifically with the various incentives, which tend to favor either energy companies manufacturers of certain equipment, if they are focused on simplistic concepts of energy efficiency.

On the whole, renewable energy has literally been marginalized, by treating it as an option to make our energy system more efficient, and comparing it to other efficiency investments. By framing the comparison in this fashion, renewable energy becomes a marginal phenomenon, and is analytically shuffled under the rug, as I have demonstrated in detail in this blog earlier in the case of the NYSERDA MPP program.

The thing we need to do is realize that we have two competing energy paradigms, carbon-based energy and green energy, and that they come with very different opportunities and challenges. Since we already know that carbon-based energy is going to lose, and should lose, our programs need to encourage green energy, and not carbon-based energy, as is most often the case today. Until then, the NYC Clean Heat program should be renamed the NYC Slightly Less Dirty Heat program. We need to stop talking about renewable energy, and start doing something about it--our current programs mostly are preventing it from happening.

Energy Efficiency and Ossified Incentives

The biggest problem with various incentive systems and programs is that they are targeted at too low a level of detail, and it ends up with engineers not being able to specify the right systems because the accountants in the crowd see a bigger tax deduction that year with some other technology, and the accountants don't understand long term economics of the property. This ends up with the blind leading the blind, and has been analyzed in depth in this blog. The alternative that would set green energy free is a portfolio standard for renewable energy retrofits, which I have proposed recently with my consulting company DaBX Demand Side Solutions, Inc.

Green Energy: Square Pegs into Round Holes

The show has been held up by the public focus on "grid parity" and other such irrelevancies, and nobody seems to have noticed the sustained growth of net-zero construction in the last twenty years or more. In short, on the margin, clearly a combination of renewable technologies and energy efficiency is found to be economical, we just have to get serious about doing it at scale, and again, here is where a streamlining of incentives is necessary, so that green energy is no longer marginalized as an "energy efficiency" factor, but given the lead role that it should have. Renewable energy retrofits for existing buildings is where it is at, as proposed by the Urban Green Council in its 90by50 report, and by my own consulting firm in our DaBx PlaNYC2020 report, published in 2011. By now numerous other reports are emerging addressing parts of the issue.

Renewable Energy Policy that Works

Arguably you can not discuss renewable energy policy without having some acquaintance with the pros and cons of the German approach. For one thing they have their priorities straight: first comes the make or buy decision: am I going to buy my energy (gas from Russia, oil from OPEC, etc.), or make my own? Energy Efficiency is only a secondary goal after that, but obviously greater efficiency will reduce the absolute amount of installed capacity needed.

The details do not matter, we are never going to emulate Germany here, but, the Portfolio Standard for Energy Retrofits is one potential component of policy making, and incentive systems which would yield vastly improved outcomes, particularly as soon as property owners really take on board the fact that renewable energy moves energy from the liabilities column to the assets column, and that therefore if they learn to be smart investors, they will steadily improve the asset values of their portfolios.

Green Energy to the Fore

We should abolish the faulty policy frameworks like the NYSERDA MPP which treat renewable energy as a component of energy efficiency. It should be the other way around. Energy efficiency of carbon-based systems is better than nothing, but it will get us nowhere fast, and with the growth of net-zero buildings, building values will eventually start to reflect this. So, if policy making continues to fail, eventually the market will do the job, but it will be a lot more painful than constructive policy making would be.

Conclusion

By framing green energy as an energy efficiency opportunity, it has been systematically marginalized, and renewable energy policy failure has resulted. It is time to bring renewable energy out of the shadows, and understand it as an alternative to carbon-based energy at the building level. Financially, green energy technology offers compound returns in implementation, whereas energy efficiency offers diminishing returns and the two are competing concepts. Renewable energy policy can only succeed if green energy technology is brought to the fore, and energy efficiency is understood as the secondary issue that it is. 

The Fallacies of Energy Efficiency Loan Securitization

Green finance is struggling, judged by the apparent difficulty in the placements of securitized energy efficiency loans, recently by both NYSERDA (NY) and Pennsylvania.

"The market" is always a funny thing, but generally it does work, and, assuming it is working as it should in this case, clearly the message is that the emperor has no clothes on, or at the very least we are not quite sure of the state of his dress. This is in line with some of the observations I have offered in this blog on the state of green finance in general and the NYSERDA programs in particular.

At the crossroads: Energy Efficiency versus Renewable Energy

Following the logic of my proposed Green Finance principles, in essence "energy efficiency" securities are a wasting asset in the extreme. Number one, there is a false appearance of "market beating performance" based on the theoretical better ability to pay because of cash flow improvements thanks to energy efficiency. This is true in the short-term, but very deceptive in the long-term, and it is in effect an investment trap, that might snap shut during the run times of these loans.

The typical 20-30% efficiency improvements are irrelevant in the market because:

1. The improvement is easily wiped out by one or two energy price hikes. Note that even natural gas is now coming off its lows, and note also that in NYC in particular, transportation and delivery is 60-70% of energy bills, and rising faster than inflation as far as the eye can see. The US EIA reference case to 2040 shows flat to mildly rising cost of electricity, and gently rising costs for natural gas and residual fuel.
2. The energy efficiency improvement is further made irrelevant if far greater improvements are feasible - which is the crux of renewable energy, that we can get 70-90% reduction in fossil fuels in the majority of buildings that are now converting to natural gas under the NYC Clean Heat program. As soon as even a few buildings pursue the alternative, the buildings with some marginal energy savings become irrelevant.
3. Even more so, net-zero construction is gaining ground very rapidly, and while it may seem only "marginal," to lay people, it is not from an economic standpoint, for the sustained growth in net-zero construction for the last 20+ years will become the implied reference for energy performance of building portfolios, and NOT the 15, 20 or 25% 'energy savings' over last year. That's mostly narcissistic, not substantive.
4. A further material weakness in the concept of "energy efficiency" loans, as it is practiced today, is that they risk financing short-term improvements with long-term money.
5. The specific investment trap arises because of the diminishing returns on the path of energy efficiency: there is little or no follow-on opportunity after the first 20-30% improvement, and when a building subsequently needs to switch to renewable energy anyway, the initial "investment" in energy efficiency is largely a write-off.

Where the rubber meets the road: Green Finance Politics

The complete political muddle around renewable energy and energy efficiency has resulted in a situation where the dialog has been spoiled by running the two topics together, when in fact they are mutually exclusive, and totally different investment paths. In general there is too much top down reasoning, and too little recognition of the notion that we are a capitalist society, and that the building owner is in the business of maximizing the value of his property, and the regulator should be providing rules and regulations, carrots and sticks, to direct this process towards the public good.

The current regime of incentives is geared towards the energy industry, or towards the manufacturers of specific equipment, but existing programs don't provide the framework or the incentive for property owners to behave rationally. In practice what happens with programs like the NYSERDA MPP, is that building owners try to figure out how they can qualify for the least amount of expenditure. The issue of diminishing returns in energy efficiency upgrades is in effect covered up by the very model the NYSERDA MPP uses, and it sets up an investment trap for property owners.

Why PACE bonds ran afoul of Fannie and Freddie

Green Finance based on Renewable Energy does add up.

PACE bonds should be the poster child of green finance. When the big showdown happened a few years ago between Fannie and Freddie over PACE bond financing, the issue was entirely about the notion that PACE bonds would get priority in case of bankruptcy, and the fact that there was precious little assurance that the programs would achieve greater asset values. Eventually the PACE camp was somewhat able to make the case, but only weakly, because again the confusion over energy efficiency was never far away. The point of PACE is that renewable energy does increase property values, and comes with a greater upfront capital expenditure than your run of the mill energy efficiency program.

If PACE programs are developed with a laser focus on renewable energy, and drop energy efficiency to the second tier status where it belongs, they will be focusing on permanent improvements to properties, and moving energy from liabilities to assets. PACE will promptly become indispensable, and municipalities will support it more and more because it can help them with GHG reductions and Clean Air Act compliance. If energy efficiency is wrongly prioritized, the impact on GHG will be more muted.

How to make Green Finance viable

The one and only constructive solution in green finance is to require that property owners have long-term energy plans. In a world where net-zero construction is the fastest growing segment of new construction for twenty or more years going, net-zero is becoming the de facto benchmark and 20, 25, or 30% improvement over last year will quickly become irrelevant.

To achieve this I have recently published a proposal, which would streamline the whole process, and would make green finance seriously viable, instead of the current muddle. The DaBx Renewable Energy Retrofit Portfolio Standard is a simple and straightforward guideline which would ensure a solid foundation for green finance with a minimum of fuss.

Conclusion:

Green Finance runs into valuation problems as long as it conflates the energy efficiency of carbon based infrastructure with renewable energy alternatives. Renewable Energy produces compound returns by leveraging synergies with different technologies and efficiency measures. If energy efficiency becomes the priority and is applied to a carbon-based energy system, it produces diminishing returns, and competes with renewable energy: the two are not additive, but mutually exclusive. To harmonize the two, green finance should focus on renewable energy first and treat energy efficiency as a subordinate objective, which it is.