How To Make a Bundle on Energy Efficiency
Wall Street’s new strategy for investing in good deeds.
Photograph by David McNew/Getty Images.
If you're a geek for gadgets that help you live more energy efficiently, this is a glorious time. Never before has the market so overflowed with cool new kit designed to cut the amount of juice you use—for a premium price. There are LED bulbs light years ahead of Edison’s incandescents. There are windows that darken automatically as the sun sweeps across the sky. There are sleek, smart thermostats that monitor your daily activity and adjust your home’s systems to provide only as much heating and air conditioning as the electronic brains determine you need.
Slick as they are, these devices aren’t yet making a meaningful dent in the nation’s energy consumption or in its greenhouse-gas emissions. That’s because they’re not being deployed at a large scale. Most Americans aren’t geeks for energy-efficiency gadgets. If they’re aware at all that these devices exist, they’ve decided they’re not interested in buying them—even though, over time, lower electricity bills more than pay back the extra initial expense.
There is, in short, a gap between what technologists are selling and what consumers are buying. That gap has big environmental costs, given the vast amounts of energy the United States wastes each year through leaky buildings and inefficient machines. Now, a growing cadre of savvy investors is betting there’s money to be made bridging that divide. They’re designing complex financial instruments to bankroll energy-efficiency improvements in houses and other buildings across the country. And they’re setting themselves up as the middlemen.
This is a potential energy revolution of the back-office sort. It’s about developing new business models rather than developing new metal. It’s wonky, opaque, and largely untested. It’s just beginning, and it still could fizzle, because scaling it up would require resolving a thicket of thorny technical and financial questions. But if it works, it could make some investors a lot of money. And, theoretically at least, it could do more for the planet than a roomful of futuristic energy-saving devices that sit, sparkling and unused, on a shelf.
Steven Vierengel, a Citigroup director and Wall Street veteran, is among the pinstriped new promoters of this energy-efficiency push. For some 15 years, he has worked at Citigroup securitizing debt, on everything from cars to industrial equipment. The drill: Citigroup finances pools of loans from the original lenders, slicing up the loans based on their different levels of default risk and then reselling the slices to institutional investors. Everyone gets a piece of the action: The original lenders receive new cash to make more loans; the institutional buyers earn interest; Citigroup gets a fee.
Earlier this year, Vierengel began eyeing the possibility of applying the securitization model to a different kind of loan: loans to consumers who invest in home energy-efficiency improvements, from better-burning furnaces to insulated windows. He expects the first round of this newfangled debt to hit the market early next year. He won’t disclose the amount he’s targeting for the first offering, but he says he hopes the market soon will grow to the point where, every year, it issues four or five pools of securitized energy-efficiency debt, each pool totaling between $150 million and $500 million. That still would be smaller than many new-car loan pools, but it would be big in the context of the energy-efficiency market. Ultimately, he hopes to crank out a steady stream of energy-efficiency securitizations, cookie-cutter style. His strategy: “Repeat, repeat, repeat,” he says. “I want to be able to show folks across the country how to deliver scale.”
Few people doubt the opportunity. For years, studies have concluded the economy is groaning under the weight of energy inefficiencies that, if fixed, would pay for themselves through reduced energy costs. In the insiders’ parlance, energy efficiency is the “low-hanging fruit” that, if picked, could provide for a more economically and environmentally sustainable energy system.
A variety of messy market realities has left most of the low-hanging fruit unharvested. To cite just one, the fruit doesn’t grow conveniently on a single tree. It’s spread across the vast field of the national economy—a strawberry in this house’s leaky walls, an orange in that apartment building’s inefficient boiler. The potential efficiency gains are dispersed “across more than 100 million buildings and literally billions of devices,” consultant McKinsey & Co. noted in a 2009 report. “This dispersion ensures that efficiency is the highest priority for virtually no one.”
Creative financiers have tried a variety of financial tools to snag more of the fruit. In one of the more common approaches, contractors known as energy service companies guarantee commercial clients set reductions in energy use if the clients buy new energy-saving equipment. But those deals have focused on governments, schools, and hospitals—big, centralized energy users where the energy efficiencies are relatively easy to pick. The residential sector—which is massively more fragmented but, studies say, offers a collectively greater opportunity for energy-efficiency upgrades—has gone largely untouched.
Those who have attempted to finance residential energy-efficiency improvements in a big way have had a tough go. In a particularly ambitious attempt, launched in 2008, laws have been passed in some two dozen states allowing governments to slap an additional levy on the property-tax bills of homeowners or commercial-building owners who want to upgrade their property to make it more energy-efficient. The owners take out a loan for the cost of the project; the money they fork over through the added levy goes to repay the loan. But other market players have cried foul.
In 2010, the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, the home-mortgage packagers, protested that the residential portion of the program put taxpayer-backed mortgages at risk. Its reasoning: Property taxes generally must be repaid before a mortgage when a house is foreclosed. Advocates of the program disagree, and the fight continues before regulators and in the courts. But it has stunted the program’s growth.
Wall Street now is considering more advanced approaches. One is to amalgamate money from institutional investors, such as unions and pension funds, into managed funds that would bankroll energy-efficiency upgrades at buildings across the country. The funds then would become, in essence, energy middlemen for the buildings. The owners of the buildings, in return for the upgrades, would pay the funds an agreed monthly amount based on the buildings’ electricity use. The banks’ bet is that those fees would outweigh the banks’ costs: costs both for the new equipment and for the reduced amount of electricity that the banks would have to buy from the local grid to keep the lights on in the newly energy-efficient buildings.
“The Wall Street guys are looking to put together funds to invest in this stuff,” says Mark Zimring, a veteran of Deutsche Bank's convertible-bond department who, in a sign of the times, now is a program manager at the federal government’s Lawrence Berkeley National Laboratory, in Berkeley, Calif., working with governments and utilities to ramp up innovative financing methods for energy efficiency and renewable energy across the country. “We’re throwing lots of ideas and lots of capital at this space.”
Big, complex barriers stand in the way of building this market. One is getting the market’s various players to agree on common standards for measuring a home’s energy performance. Another is improving the accuracy of computer models that predict how a given energy-efficiency improvement actually will affect a home’s energy use. A third is ensuring there’s robust, accurate data predicting how a specific reduction in a home’s energy bills is likely to affect the ability of the homeowner to repay an energy-efficiency loan. Resolving all of these questions, market players say, is crucial to bringing down the cost of energy-efficiency financing—and thus to making the energy-efficient improvements happen. “We need better data,” says Matt Golden, a California consultant who has long worked on scaling up residential energy-efficiency improvements. “This is what it really takes to get the market going.”
Citigroup’s Vierengel is pushing to be out front. Since he began looking earlier this year into securitizing home energy-efficiency loans, he says, he has had to do plenty of “spadework” to build a case. He has been mining data about the past performance of energy-efficiency loans, an effort to convince the agencies that rate prospective securitized debt that the pools of energy-efficiency loans he wants to float will be relatively safe investments. “No one has done it yet,” he says of this new twist on bankrolling energy-efficiency upgrades. “But, come next year, I think we’ll be there.”
Jeffrey Ball is scholar-in-residence at Stanford University’s Steyer-Taylor Center for Energy Policy and Finance. Previously he worked at the Wall Street Journal, where he was environment editor and a longtime energy reporter. Follow him on Twitter at @jeff_ball.