Open Letter to Pres. Obama on reducing GHG-emissions

Streamlining Incentives is the Low Cost/No-Cost Option to Speed up Reductions in GHG-emissions by Accelerating Renewable Energy Retrofits and creating Property Appreciation

The following is an open letter to President Barack Obama about ideas to promote faster reductions of GHG-emissions by simplifying incentives for renewable energy retrofits, and basing programs on correct economic and financial principles so that the benefits accrue to the investor (property owner) in the form of property appreciation, and not to the energy companies or equipment manufacturers as is now often the case.
Note that every major statement is backed up with references to relevant articles on this blog. Additionally the search functions allows the reader to drill down deeper.

Open Letter to President Obama on Reducing GHG-emissions, by increasing renewable energy retrofits and creating property appreciation

Note: The letter was sent on the letterhead of DaBx Demand Side Consulting, Inc.
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August 8, 2013

President Barack Obama
The White House
1600 Pennsylvania Avenue NW
Washington, DC 20500

Dear Mr. President:

Re: Climate Change – A Proposal to Make Major Progress to Reduce GHG-Emissions from Buildings by Streamlining Processes.

Please consider this an open letter. I may send copies to such federal and New York agencies and officials as may seem relevant given the topic, and/or the press, and/or publish the information online.

There are a few very simple steps your administration could pursue that would unlock the forces of change to reduce GHG-emissions —without any need for major funding. Such action would also go a long way to shoring up real estate markets and boosting long-term economic competitiveness. These steps would entail both the radical simplification of many subsidies, incentives and programs, along with the proper use of financial solutions such as PACE bonds. These and other vehicles can be used to provide the financing to meet up-front capital requirements for renewable retrofits and to build asset values in real estate markets.

In order to achieve these real estate value-enhancing goals, we would need to abandon all subsidies and incentives for specific technologies, such as ITC for Solar PV( but not for certain other technologies which might be superior fora given building). By targeting the incentives to property owners for GHG emissions reductions for individual buildings, instead of by technologies used, tremendous creativity will be unleashed.

Any engineer experienced in this field has seen optimal solutions rejected because some accountant comes along to point out a tax credit on one technology versus another. Very often, wrong solutions are specified to qualify for incentives. Imagine how much better we could do if a 30% ITC were awarded pro-rata for 50% reduction in GHG-emissions in a building. Perhaps even award extra percentage point for every 10% above 50% reduction. Things would change quickly.

This problem gets really out of hand when finance programs target specifics such as the use of Energy Star rated equipment. Sometimes, the wrong equipment will be selected because the financing depends on it. Again, the incentives should be based on the overall goal of reducing GHG-emissions at the property level. There should be simple, agreed regional standards for such improvements and the related financial computations.

This building-focused approach has been proposed by us in our publication, the DaBx Renewable Energy Retrofit Portfolio Standard (copy enclosed) and is available with supporting references here:

http://www.vliscony.com/2013/06/12/dabx-renewable-energy-retrofit-portfolio-standard/

Also, our proposal has been published in our report to New York City, DaBx PlaNYC2020, in the new 2013 edition, available here:

http://www.scribd.com/doc/58761637/DaBx-PlaNYC2020-Draft

A copy will be gladly provided upon request.

The individual issues referred to above have been discussed extensively on my blog at www.vliscony.com and in the annotated version of the DaBx Renewable Energy Portfolio Standard for Multi-Family Buildings. As previewed earlier, pressing issues documented by our firm include a) the distortions created by ill-conceived incentives b) the distortions in decision making caused by prioritizing energy efficiency over renewable energy, as well as, c) the way many programs incentivize counter-productive financial decisions, whereas d) under a 30 year Capital Asset Pricing, the attractiveness of renewable energy would move to the top of the list. For your ready reference, I have highlighted key issues and proposed fixes as Enclosure I to this letter with references to the relevant DaBx commentaries and documents.

Commending the above to your attention.

Rogier F. van Vlissingen

Encls. DaBx Renewable Energy Retrofit Portfolio Standard for Multi-family Buildings.

c.c.:NYS - Governor Andrew CuomoNYC - Mayor Michael BloombergEPA - Gina McCarthy, AdministratorDOE - Dr. Ernest Moniz, Secretary of EnergyNew York Times - Jill Abramson, Executive EditorBloomberg Business News - Matthew Winkler, Editor In ChiefThe Wall Street Journal – Gerard Baker, Managing EditorFannie Mae – Timothy J. Mayopoulis, President and CEOFreddie Mac - Donald H. Layton, CEO

Enclosure I – Open Letter to President Obama

Proposed Building Code and Energy Policy Revisions to Reduce GHG Emissions and Enhance Real Estate Values

Highlights from DaBx Demand Side Solutions
Commentary & Publications

1. Programs that prioritize energy efficiency as a proxy for reducing of GHG-emissions fail, because they will marginalize renewable energy in favor of efficiency improvements of existing carbon-based infrastructure. Thereby, they effectively crowd out investment in renewables that would, in many cases, create greater enhancements to property values than available through carbon-based energy efficiency. Improving energy efficiency is not a goal in its own right, as it merely lowers the cost and increases demand for energy. Example: http://www.vliscony.com/2013/06/10/energy-efficiency-sinks-green-underwriting/
2. Incentives directed at energy efficiency without regard to the prior (make or buy) decision regarding carbon-based energy versus renewable energy, will always work out as a subsidy to carbon-based energy due to sunk costs. Example: http://www.vliscony.com/2013/06/01/nyserda-mpp-dimishing-returns/
3. Incentives directed towards specific technologies will tend to destroy property values given, first, the inappropriate technology choices they foster in many cases, and, second, their tendency to encourage property owners to make capital decisions on energy infrastructure based on payback of the equipment, instead of based on long term cash flow and increasing building values. Example: http://www.vliscony.com/2013/06/03/energy-retrofits-underwriting-risk/
4. When securitized, the performance of energy-efficiency loan portfolios has not been an unqualified success, because the valuations are dubious. Net zero construction has been the fastest growing segment of the construction market for 20 years. Therefore, the value of reducing your energy use 20-30% over last year diminishes as this new construction upgrades the overall stock of buildings. Energy-efficiency driven finance is merely the latest form of predatory lending offered by Wall Street to Main Street, hi-jacking property appreciation from its rightful owners. Example: Solar PPAs – the current fad: http://www.vliscony.com/2013/05/30/ma-solar-ppa/
5. The single most positive change to help bring about rapid reductions in building-level GHG-emissions—have the financial industry make mortgage lending for rehab/retrofits, including PACE bonds and similar vehicles, contingent upon 30-year cash flow projections for the property. The valuation extension would have the financial effect property by property of moving energy from liability side of the owners balance sheet to the asset side through renewable investment. Once 30-year cash flow models become the norm, the marketplace will start to appreciate that 30 years of no energy bills beats 20-30% of energy “savings.” Moreover, emphasizing property values is the proper, capitalistic approach, in lieu of the 20 year top down plans which are now the norm. These plans reek of the toothless 20 year economic plans proffered in the former Soviet Union to protect the status quo. Such plans subsidize the shareholders of energy companies at the expense of property owners and are generally designed to fail. Example: http://www.vliscony.com/2013/07/21/renewable-energy-policy-new-york/
6. Two simplifications go hand in hand here: 1) policy and regulations should focus on reducing GHG-emissions and 2) building owners should focus on investments that enhance long term property values. Together, these complementary priorities can eliminate vast amounts of red tape and unleash the economic forces that will drive the shift to a less carbon intensive economy.
7. The place to enforce the application of a proper 30 year cash flow model of the property is in the application process for financing and/or incentives. The model of current applications encourages financially counter-productive decision making, which benefits either energy companies (in the case or energy efficiency), or equipment manufacturers (ITC and other incentives), not the property owners, by emphasizing payback of specific equipment or efficiency measures. By shifting to a reporting of the long term improvement in property values, while qualifying for incentives based on reducing GHG-emissions, the correct habits can be enforced seamlessly as part of the process.

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Conclusion: Simplifying Incentives will Speed Up Reductions in GHG-emissions with Renewable Energy Retrofits and Speed Up Property Appreciation

Reducing GHG-emissions can be speeded up tremendously by simplifying regulations and targeting them better towards the real objective, instead of proxies for that objective, which always fail. Renewable energy retrofits in buildings directly reduce GHG-emissions at the source, and will serve to increase property values by moving energy from liabilities to assets for a property, creating property appreciation and constructive engagement of the property owner in reducing GHG-emissions with simple incentives to stimulate those investments.

Green Energy Policy Failures and Real Sustainability

The one thing that is missing in the whole sustainability area and renewable energy policy is a sound focus on the economics and the finance of green energy. With new buildings this is not a problem, but the greater market is retrofits in older buildings and in that arena by and large people are wasting their money with tinkering in the margin instead of making the most of the opportunity.

If it takes 10 years for a new efficiency standard to work its way through the car fleet, then the picture is much worse with buildings, because they typically last a bit longer than cars. Living in one of the older parts of NYC, I'm surrounded by 50+ year old structures, which still have plenty of life left in them.

Policy Failure #1:
Conflating Energy Efficiency and Renewable Energy

Conflating energy efficiency and renewable energy is an obfuscation which serves only the fossil fuel industry, which is why they eagerly embrace "energy efficiency." This is how they compete against renewable alternatives. Energy efficiency is a marketing strategy and a greenwash of the fossil fuel industry, and it is financially disruptive. In various posts on this website, I have demonstrated how this manifests itself across many programs, and acts as a way to divert investment from green technology, even if it would be financially more advantageous to property owners.

Since this approach benefits the fossil fuel industry, this is a typical policy failure, which achieves the opposite of what is intended, and change is in order.

Policy Failure #2:
Arguing over Clean Fuels is like rearranging the deck chairs on the Titanic

As argued in earlier posts, the whole NYC Clean Heat program is a massive example of policy failure in this area. The whole point is we are in a transition away from fossil fuels, and towards renewable energy, and now that we generally realize how much energy is consumed by buildings, and green energy technologies that are suited for mounting on buildings are proliferating, it is time for policy makers to encourage this development, instead of putting road blocks in the way. Even with all of the best intentions, this is how most programs have worked out so far.

Policy Failure #3:
Not seeing the forest for the trees - misguided incentives

Tremendous amounts of time, effort and money are wasted over what technologies are blessed with the Investment Tax Credit, which is good for sales for the companies that make them. However this puts the focus on individual technologies, and not on the whole project, which can only be judged on the property as a whole. If accountants start specifying the wrong components because of ITC, inferior projects will be developed, never mind how good the individual components are. There is a right place for everything. But having accountants make engineering decisions is counter-productive.

Policy Failure #4:
Disregard for long-term financial planning is encouraged by incentive programs

By various forms of incentives on equipment, such as the ITC, or a requirement to specify Energy Star equipment, regardless if it is the best for the job from an engineering standpoint,  suboptimal projects are being developed. What matters is to reduce the Green House Gas emissions on a building level, so the incentives should address the achievements of the building as a whole. Energy Star is fine for a fridge or a micro wave, which are one-off decisions, but specifying the credits on construction components causes accountants to  mess up the best engineering. More importantly the whole industry has gotten in the bad habit of evaluating financial decisions at the component level, based on payoff of that component in terms of savings, which gets in the way of long-term capital plans, which would reveal very different design strategies.

Policy Failure #5:
Absence of simple objectives, such as reducing Green House Gas emissions

Once the policy focuses on the right issues, namely reducing Green House Gas emissions building by building, better designs will proliferate, and long-term capital budgeting becomes the obvious way to design capital plans. Thirty year cash flow models should be the norm, and ideally should be required by financiers and e.g. PACE bonds. The whole point of PACE bonds was to have a way to raise the upfront capital needed for this transition, which would add to long-term asset values. Instead, a lot of PACE money is being wasted on dubious "energy efficiency" projects, and property owners are frittering away the long-term appreciation of their buildings by investing in renewable infrastructure, and moving energy from the liabilities to assets.

Conclusion:
How to Achieve Sustainability in Spite of Policy Failure

In spite of all policy failures, building owners have a vested interest in sustainability, because it increase asset values, and they should be using 30 year capital budgets for energy retrofits with green energy technology; in other words the various programs and incentives should be ignored and the long-term economics of the building should get priority, before you figure out how to qualify for the incentives.

NYC Clean Heat Amounts to Capital Destruction

Recently I demonstrated on this blog why NYC Clean Heat is regressive with respect to Clean Air compliance, because it diverted buildings to natural gas, that would have been perfectly suited for renewable energy deployments. The typical buildings that were (and in some cases still are) burning #6 oil, are ideal candidates for renewable energy conversions. In many cases that would have produced financially and economically superior outcomes for building owners, and certainly for the city in terms of Clean Air, and for tenants in terms of quality of life. Green House Gas Emissions could be reduced far more than is now the case, and NYC Clean Heat was an unqualified victory for the carbon energy industry. Next time we should get our fossil fuels facts, before we argue any fossil fuels pros and cons.

There are several other aspects to the matter, which make the picture even far worse. There is no argument that natural gas burns cleaner than #6 or #4 oil (and even than #2 oil), and produces less CO2 and fewer particulates. However, the reality is that the distribution losses of methane are 30+%, and the uncontrolled release of methane into the air from fracking ("unconventional gas"), add even more environmental burden, since methane is a far worse Green House Gas than CO2. Increasingly, our natural gas is "unconventional gas." Fossil fuels are the problem, and "cleaner fuels" are mostly simply an obfuscation.

Greenwashing Fossil Fuel

As has been pointed out in many ways on this blog, the greenwashing by the power industry is the single biggest PR stunt to halt the conversion to renewable energy. The argument is not over types of fossil fuels. it is a matter of renewable alternatives. With the evidence cited here, and more, it is clear that dubious claims were used to promote natural gas as a clean fuel, and a "bridge fuel," it is mostly a diversionary tactic, and it is absolutely imperative that we transition to renewable energy wherever it is economically feasible. Switching to different forms of fossil fuels is window dressing, not progress.

There are many more opportunities in the city's aging building infrastructure than are now being exploited (see my DaBx PlaNYC2020), because government programs are steering owners away from them. In a more general sense, it is also clear that the obfuscation that results from promoting energy efficiency in fossil fuel based systems makes them more competitive, and fuels the demand, crowding out investment in renewable energy. So energy efficiency of fossil fuel systems is not part of any green agenda, except simply if it is the only thing you can do and arguably better than the alternative.

Methane leaks and more from Fracking

How big is the problem of natural gas (methane) leaks from fracking? As usual the answers depend on who you ask. The article cited here is probably conservative and reports an extreme finding of 14% of production (output) in losses from fracking. And that is only the current leaks, during extraction. What no one knows is how much seeps out in the years following production. As the article notes, it will take a long time before we have an accurate fix on this issue, but it definitely takes away some of the charm of natural gas. The more alarmist view of methane losses from fracking can be found in many places, if you want to arrive at a balanced view. The fossil fuel industry talks of 2% or less, and more independent opinions are as high as 10% of all gas produced.

The only encouraging information is that while methane is anywhere from sixty to one hundred times more destructive than CO2, it dissipates in the atmosphere within 20 years, while CO2 builds up forever. Be that as it may, renewable energy would reduce our green house emissions faster than the natural gas bonanza, and the element of leakage takes away some of the charm of natural gas.

The environmental degradation from fracking may well be equivalent or worse than the toxic sludge from the scrubbers of coal-fired power plants. The jury is still out on this part of the story.

Green House Gas Emissions from Distribution

The distribution loss of Methane (Natural Gas), as you can see in this article, 5%-10% leakage from distribution may be the range in the UK, and according to the calculations cited there, anything over 2.8% leakage may be enough to offset the "clean" advantages of natural gas over coal, which is the dirtiest fuel. In the US losses may be lower. EPA estimates that the losses of natural gas are distributed as follows: 37% from transmission/storage, 24% from distribution, and 27% from production. Overall EPA estimates that globally the losses of methane from leakage are 3.2%, which would largely wipe out the advantages over coal or oil.

Green House Gas Emissions from Burning Natural Gas

Here is where Natural Gas has it over coal and oil, producing far fewer problems, starting with less CO2, but also fewer particulate emissions, as well as various other toxic exhausts, including mercury. This is what allows New York City to claim that a switch from #6 and #4 oil to natural gas would produce reductions in Green House Gas emissions. Evidently NYC is the point of consumption, and the fact that gas is cleaner burning seems to carry the day. However, it should be obvious from even this brief overview, that this may appear to be true locally, it is not true on a complete system-wide view of the matter. Hence the drive to gas conversions is little more than window dressing, particularly in light of the alternatives that are not being pursued.

Government Sponsored Capital Destruction

In short, the drive to convert from oil to gas is largely futile, and to the extent that it is forcing building owners to prematurely change boilers, it amounts to government sponsored capital destruction.

Most importantly, the opportunities discussed on this site, for green energy generation in buildings, which would permanently improve building values, and make huge contributions to Clean Air, are basically being disregarded as a result of the dubious environmental benefits of natural gas, and passing up that financial opportunity alone is yet another form of capital destruction, because with while fossil fuel is an ongoing operating expense, truly renewable, green energy moves energy from liabilities to assets, and permanently improves building values.

Conclusion

In short, NYC is missing the boat by rushing into a pseudo solution that merely shuffles the deck chairs on the Titanic of the fossil fuel economy, that has precious little real environmental benefit to offer in terms of reducing Green House Gas Emissions, except for some very short-term window dressing and greenwashing of the fossil fuel economy, while it passes up the long-term economic potential of substantially reducing Green House Gas emissions, greater building resiliency, and improved economic competitiveness that would result from a greater emphasis on switching to renewable energy within the city. Given the alternatives, the campaign amounts to government sponsored capital destruction.

Geothermal Heat Pumps and the Green Apple

Geothermal heat pumps seem to be a bit of a dark horse in the Big Apple, which these days has aspirations of becoming a Green Apple. In some respects the reasons for it are unclear, because there have certainly been successful geothermal projects. On the most practical level the obstacles seem to be mostly lack of knowledge as well as some quasi-regulatory issues. But geothermal heat pumps are probably the single most strategic renewable energy technology in the City, and it is gratifying to see that City Hall is finally studying the technology.

Lack of knowledge about geothermal heat pumps begins with the fact that people are  uninformed about the different geothermal technologies that exist, and what their applications are. There is deep geothermal, and if you are in Iceland, and you have a geyser or lava stream in your backyard, you may have an opportunity to exploit that technology. This is not what we do in urban environments. The shallow varieties of geothermal are really forms of heat exchange that exploit the largest solar collector in the world: the earth's crust. Below the frost line it is permanently 52 degrees Fahrenheit in NYC, and that is enough to set up a heat exchange which can provide cooling in summer and heating in winter, (HVAC), and perhaps Domestic Hot Water (DHW), and it might be able to heat your pool water, or provide an ice-melt system for your driveway.

NYSERDA MPP hampers geothermal heat pumps

The most practical problem that is holding up geothermal heat pumps may seem to be the difficulty of retrofits. Obviously, new construction is easier, but that issue is not as large as it seems, for the payoff from geothermal can be significant, particularly in the city, where space is a problem and we need to exploit every available angle if we want to generate our own energy. The most practical impediment to geothermal deployment is the NYSERDA MPP program, which penalizes a project (building) for adding any load to the grid. Their objective is reducing load. Besides all the other reasons why this program is an impediment to green energy technology deployment, here is yet another one.

From the standpoint of the overall improvement of the energy economics of buildings, there are few more powerful solutions around, however we've stacked the deck against it, because the focus of the NYSERDA MPP is narrowly defined by reducing electrical demand. This is yet another case where these kinds of programs are targeted to get building owners to do what is good for the utility in the short run, not even in the longer run. As a result, building owners are missing out, and so is the overall energy household of the city.

Geothermal heat pumps: the multiplier effect

The reason geothermal heat pumps are such a strategic technology, is because they create a multiplier effect, which can create compound returns from a renewable energy retrofit. At a Coefficient of Performance of around 4.0, which is the terminology the geothermal industry uses, they return 400% on their energy input. To put it differently, for every one BTU equivalent input, you get 4 BTUs out. Now that's a good trade! It may be marginally economic with grid power, depending on your rates, but you can boost the economics by leveraging time of use rates (for your geothermal field needs recovery time anyway, and you're designing around the objection mentioned above, against increasing demand from a building). Then, if you can generate some serious power from wind or solar, you can create a very powerful, and totally renewable, solution.

In short, if you can cover part of your BTU load from geothermal energy today, you have the option to generate more of your own energy with other means, either solar PV, or a wind turbine (there are more and more building mounted options coming on the market), so that if the electricity prices become to high to your taste, you can probably cover your requirements for your geothermal heat pumps, as well as taking part of your building off line, and there you will have a permanent energy price hedge. And remember, you are competing with retail electricity in your home or apartment building, and in NYC the rates are sky high, because we are far away from power generation, and the long haul transportation is expensive. Only Long Island is higher than the City. In either case the cost of transport is 60-70% of the bill in most cases.

Geothermal Heat Pumps for Multi-family Buildings

In a traditional multi-family building, the most obvious strategy is to replace the Domestic Hot Water (DHW) with either geothermal heat pumps or a solar thermal system. It usually represents 30-50% of the BTU load in the building, at least the for the building owner, who is responsible for heat and hot water.

With the proliferation of building mounted wind turbines, wind energy becomes a logical complement to the geothermal solution, particularly because pre-heated hot water becomes an effective storage solution, and that is the single most difficult aspect of creating an effective green energy infrastructure. It explains why we can create compound investment returns with these types of integrated green energy retrofits.  This way multiple green energy technologies can be exploited within one building and taken together, they produce superior investment returns, while providing enhanced building resiliency.

Conclusion: green energy and property values

The reason geothermal heat pumps are so strategic for a green energy infrastructure in a building is because they represent a multiplier with which you can build an effective energy price hedge into your building, and create a compound return on integrated green energy technology which will accrue to you by raising property values.

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.

The Fads and Foibles of Green Finance

Green Finance is a growing segment of the finance business, and as usual with anything new, it is full of fads and fallacies, and it sometimes does not live up to its billing. One part of green finance is large-scale projects, but since buildings are a large part of the problem in terms of GHG emissions, the opportunity for major renewable energy projects in buildings is huge. Evidently, the term green always risks being useless, and smacks of greenwashing, which in many cases it is. To begin with, the current practice mostly focuses on energy savings, not on improving property values, which only renewable energy would do. As a result, it is focused on marginal contribution, and equipment finance. More importantly, this methodology is by nature conducive to financial instability for the underlying property:

• Relatively small "savings" from energy efficiency: because most 'energy savings' strategies yield only a small incremental improvement--typically in the 20-30% range, which is easily wiped out by a price hike or two, and the effect on property values is negligible;
• Efficiency improvements are not unique in nature: because the same efficiencies are available to everyone, eventually all buildings will catch up, and be the same again. Boilers are now 95+% efficient and replacing older units that were 50-60% efficient, but going from 95% to 96% some day is not meaningful. Same for LEDs replacing fluorescents and incandescents.
• Financing short-term enhancements with long-term money is a risk factor: these programs frequently finance short-term improvements with long-term money, which does not contribute to long-term financial stability of the properties that avail themselves of such financing.
• No follow-on strategy: because of diminishing returns: all "energy savings," or "energy efficiency" strategies suffer from strongly diminishing returns for subsequent investments, so the energy savings strategy is a financial dead-end. Again, not good news for long-term property values.

Considering that the only objective for the property owner should be to maximize property values, and the only objective of the government should be the reduction of GHG-emissions, the current mishmash of rules and incentives adds to the confusion, and frequently creates constraints that prevent the best projects from happening. The supporting roles in creating this confusion are played by the government, including tax incentives which are typically tied to a technology, such as solar panels or water heaters, and programs by the utility industry, and/or semi public institutions such as New York's NYSERDA which provides incentives for property owners to do what's good for the grid.

Good intentions aside, it must be understood that none of these programs are designed to help a property owner maximize property values, which is the only objective the property owner should have. When you put them altogether, these programs amount the a government sponsored capital destruction, to the extent that they tempt property owners to do things that are not conducive to improving property values, in the name of being green.

Green Finance - the theory

What you can do with it is what makes it green

The green finance theory that supports all of these wonderful developments is that at the macro level the highest marginal return is thought to be on improving the efficiency of the systems we do have, and that's why macro-economists tell policy makers to provide incentives for energy efficiency. This approach puts the world on its head exactly, because the first point is that our energy model is wrong. The new model is based on renewable energy, which will increasingly mean buildings producing their own energy. And so, on the margin the biggest advances in "energy efficiency" in aggregate come not from the absolutely moronic spending on more and more energy efficiency, but from finding the low hanging fruit for converting to renewable energy, which is the only permanent solution, and the only one that enhances property values.

Lastly, the reassuring notion that "energy efficiency improvements" are self financing in nature is fallacious. The theory is that it improves operating cash flows, and thus are lenders assured of the ability to repay. This may seem harmless when it pertains to equipment financing, it is still destructive to property values in the long-term, if it crowds out viable renewable energy projects and prioritizes worthless efficiency improvements that fail to make a radical change. It becomes positively disastrous if the financing stretches for longer terms with a real estate collateral. In that case it makes the mistake of financing short-term measures with long-term money. In general, the mistake here is to prioritize the projects that are easy to finance, at the expense of the projects that would add value.

Green Finance - the practice

The unfortunate corollary to the usual energy efficiency financings is that, again because of diminishing returns, only the first few energy savings projects can be financed this way, after which by definition subsequent efficiency projects become prohibitively expensive, and this kind of abusive finance dries up, leaving a property owner stranded.

What happens in practice is that tax incentives, advantageous financing, and various subsidy and incentive programs that are all equipment driven, or driven by the energy suppliers, e.g. subsidized natural gas conversions(NYC Clean Heat), all serve other interests besides the property owner. As a property owner it behooves you to beware of all these wonderful offers. All of these programs have a potential hidden cost, namely they steal asset appreciation from the property owner.

The popular free energy audits are another ally of this fleecing of property owners. They are fine for a renter, to reduce their utility bills, but for a property owner, they are useful information, but no action should be taken unless a proper long-term plan exists with a view to improving property values. They promote frittering away money on trivialities, and never doing the big steps that are necessary. They trade on people's needs to do something, anything, and cheat them out of their money.

Green Finance, resiliency, and Property Values

Just as much as you cannot save yourself rich, all energy savings programs, taken in isolation, produce capital destruction, unless they stand in the context of making the property energy independent with renewable energy. The thing to do as a property owners, is to have your own 30 year DCF (Discounted Cash Flow) model of energy improvements to your property, based on a good grasp of the engineering, for there may be intense engineering interdependencies, which dictate in what sequence things should be done.

What you will learn if you do this long-term capital program, is that once you take one step in the direction of renewable energy, you have the benefit of potentially compounding returns in subsequent phases of implementation. At the very least you will see that you now start having two options at almost every turn, namely either more efficiency (insulation etc.) or more generating capacity - you are doing a direct trade-off.

It should also be noted that building resiliency is another obvious victim of prioritizing energy savings over renewable energy. For again, with making the fossil-fuel, grid-dependent systems more efficient, we are making ourselves dependent on the grid for longer. We are investing our own in customer retention by our energy vendors. No wonder many energy vendors and utilities are only too happy to provide 'subsidised finance' for such programs. Look at the site of the NYC Clean Heat program, and you'll find all the usual suspects there (CPC, NYSERDA and various energy companies), providing a range of green finance options, or so they think.

Of PACE bonds and property values

PACE bonds should have been the savior in this situation, but instead they got embroiled with Fannie and Freddie a few years ago, and since they had made the general mistake of prioritizing energy efficiency, their arguments did not carry much weight and the program had to accept some limitations and trade-offs, so that it cannot presently fully live up to its potential. One can only hope that PACE programs could adopt standards like the DaBX Renewable Retrofit Portfolio Standard, so as to regain their relevance, and indeed prove very clearly why sound renewable energy investments are much more conducive to rising long-term property values than energy efficiency overhauls ever will be.

Conclusion

We only just came off a property bubble resulting from easy money for second mortgages, ARMs, reckless lending and mortgage fraud, which undermined the market for all property owners. Now we risk robbing property owners of asset appreciation in the name of being green if we prioritize energy efficiency over renewable energy where such an alternative exists.

Green Finance, where it pertains to buildings, and any forms of real estate, is deeply flawed in its current form, because of its pre-occupation with energy efficiency. The only way to select meaningful priorities is with a 30 year capital budget for each property. Green finance should prioritize renewable energy over energy efficiency, because that moves energy from a liability to an asset, and is conducive to raising property values as well as improving air quality.