Overview of Energy Efficiency Financing

Financing for energy efficiency projects comes from many different sources. The size and type of projects affect financing needs. Policies and programs can help break down financing barriers.

Energy efficiency is a characteristic of a technology, material, or design. In other words, it is not possible to buy energy efficiency, but it is feasible to buy an air conditioner that uses energy more efficiently than other models. The more efficient model will have a higher level of performance, but may also come with an additional cost.

This incremental cost is one way of looking at the price of energy efficiency. Many efficiency programs are designed to subsidize the incremental cost. For example, they may incentivize consumers through a rebate or other reimbursement mechanism. This approach often makes financial sense because it costs less to reduce energy consumption than it does to increase power generation (a study from McKinsey & Company suggests that developing countries can halve their spending by investing in energy efficiency over electricity generation and distribution). Programs can also try to persuade consumers to pay the incremental cost themselves, by educating them on the energy cost savings associated with efficient products.

For large-scale efficiency improvements in buildings, owners often need to undertake an energy audit first to identify opportunities for savings. The results may point to potential low-cost operational improvements in addition to equipment that should be replaced. A thorough audit will calculate the age of equipment and factor it into recommendations so that owners will prioritize replacing older equipment that they would have updated soon regardless of efficiency objectives. In summary, implementing energy efficiency in buildings is rarely a stand-alone activity. Instead, it is tied to equipment and materials that are needed and purchased to provide a service.

As countries look for cost-effective and clean-energy strategies to support their economic development and improved energy access, many are developing programs to improve the efficiency of buildings, street lighting, and factories. The good news is that many of these large-scale projects will pay for themselves over time. However, most programs to increase the uptake of infrastructure efficiency improvements will require offering access to up-front financing. In addition, public and private sector entities that take on efficiency improvements outside of their normal course of operations will require investment capital.

A barrier to improving energy efficiency in a building or factory is the relatively high transactional cost associated with a large number of small investments. For example, a commercial building retrofit may involve a lighting system redesign, new high-efficiency motors, and air filter cleaning and maintenance. These steps may collectively yield significant energy and cost savings over a relatively short period. However, multiple small investments like these are not necessarily attractive to traditional private sector financiers, who prefer to manage a few large investments such as building expansions or full renovations.

Finally, in general, it is harder to secure or collateralize energy efficiency enhancements than it is with larger energy supply infrastructure projects. This is because lenders typically see supply infrastructure as having an inherent asset value that gives them clear recourse if the borrower defaults. Lenders are assured that the assets will generate enough revenue to cover repayment of loans regardless of who owns them. By contrast, efficiency investments are typically integrated into the property and have limited salvage value, limiting lenders’ recourse to the assets. Consequently, lenders must underwrite a loan based on the borrower’s creditworthiness and not the project’s inherent value. Without clear lines of asset recourse and project valuation, those seeking efficiency investments face challenges in competing for conventional investment capital.

Despite the challenges just described, a number of proven approaches can help attract financing for energy efficiency. Identifying which options are best for a given country will depend on a number of local conditions related to the legislative and regulatory environment, and market maturity. Among the conditions are:

• Supportive Policies and Agreements
  • Do policies create dedicated energy efficiency funding (directly or indirectly)?
  • Has the country signed international agreements that can be leveraged for funding?
  • Which government agency is responsible for energy efficiency programs?
• Reduced Barriers to Access Financing
  • To what extent do potential financiers understand the benefits of energy efficiency? Does supplemental training need to take place?
  • Are energy service companies (ESCOs) capable of competently performing feasibility assessments and evaluating expected energy savings?
• Private Sector Financing Opportunities
  • Are secondary market mechanisms, such as loan pooling and on-bill financing (i.e., loans to consumers repaid via recurring utility bills), available to facilitate strategies?
  • Is there a body of creditworthy project implementers? Is credit enhancement necessary?
  • Are there legal and financial frameworks for credit enhancements?

Learn more about supportive policies and agreements.