In 2021, the economic costs of climate change were laid bare in the forest fires of one of British Columbia’s key lumber-growing regions and the winter storm that took down part of Texas’ power grid, to name just two extreme weather events. By now, many business leaders are out in front of policymakers on prioritizing the energy transition.
Though the roadmap to reaching net zero is intricate, the value proposition is fairly simple. Delaying action could cost the U.S. $14.5 trillion, estimates Deloitte, while decarbonization could expand the economy by $3 trillion to 2050.
A large piece of this undertaking will be upgrades to every building currently standing, since two-thirds of these will still exist in 2040, according to the nonprofit Architecture 2030, and, in terms of carbon abatement costs, energy efficiency projects outperform other approaches like carbon capture and growth of renewable energy sources. Building upgrades will encompass improved energy efficiency, a shift to renewable energy sources and potentially generation or sourcing of renewable energy.
Energy service companies (ESCO) have been doing this work for decades, dating back to the 1992 Clean Air Act, which introduced provisions to reduce reliance on fossil fuels. Historically, this market has focused on municipalities, universities, schools and hospitals (MUSH); together with federal contracts, this has accounted for 93% of the total ESCO market, according to research by Berkeley Lab. Commercial and infrastructure (C&I) projects currently account for just 7%, but FMI estimates that the commercial opportunity is significantly larger than the federal and MUSH market, and remains largely untapped.
While adoption has been slow in the private sector, we have reached a tipping point. Commercial operators know they need to move toward decarbonization, creating a huge pool of demand, and the key to unlocking the market potential is in the funding model.
The Underpenetrated C&I Market
Energy efficiency is, itself, a resource and ESCOs use the value of that resource to minimize, and in the case of energy savings performance contracts (ESPCs) either partially or fully remove, a customer’s cost to finance an efficiency project. Retrofits can be paid for with future energy savings, which have in the past played out over a 15- to 20-year period. This has been attractive for public owners since they have the ability to issue bonds to fund projects and are focused on the longer-term public good rather than maximization of profits.
FMI sees a huge opportunity, however, in the commercial market for companies who can leverage one of the many innovative contracting approaches now active in the market. There is approximately 100 billion square feet of commercial property in the U.S. that will need to be managed and upgraded in the decades to come. What’s more, the payback period to realize savings can be shortened as technology continues to improve.
A comprehensive HVAC and controls retrofit to a facility can now deliver substantial energy savings to recoup the cost of a project within two to five years. Skilled ESCOs can also leverage energy procurement solutions and distributed energy resources like solar and storage to maximize the energy profile of a commercial customer. That is, they can improve the equation on both the demand and supply side. Incentives from state and utility bodies have also improved as the energy transition has become a bigger priority. Federally, incentives like the 179D deduction for construction expenditures are available, and in the private sphere, environmental, social and governance (ESG) mandates are driving uptake of the tech. Where energy efficiency was once a nice-to-have, it is becoming both more profitable and a cornerstone of corporate compliance.
Stark Tech audited all the current and previous energy agreements for Life Storage, Inc,, which has 1,000 facilities across the U.S., then negotiated lower procurement prices for all deregulated accounts. This created $532,000 of savings1 in the first year—enough to pay for procurement services for the next seven years.
Getting the Funding Model Right
While commercial owners can finance efficiency projects in similar ways to other construction projects, there are now many other potential contracting mechanisms and financing sources. One such option that has gained significant traction lately is the energy as a service (EaaS) model. EaaS providers may cover the full installation costs of projects and continue to own the underlying assets. The customer simply pays the provider an ongoing service fee for operations and maintenance of those assets, turning a capital expense into an operating expense that can be more easily managed.
Some efficiency financing models may not work due to conflicts between tenant and landlord priorities. For situations where the building owner is not paying the utility bills, and may not want to pay for efficiency upgrades, property assessed clean energy (PACE) financing mechanisms can allow for facility upgrades to be included on a utility bill, and to be transferred to subsequent tenants.
We see an increasing shift in the extent to which companies are using their own operating capital to support efficiency and other environmentally friendly initiatives. A healthy bottom line is important, but corporations are recognizing the need to focus on the longer term and lead the way to net zero commitments. This was a big focus in the Infrastructure Investment and Jobs Act (IIJA), which earmarked $50 billion for resilience projects, including weatherizing of homes and federal buildings, and $65 billion for clean energy transmission. The Department of Energy has reported that $724 million of the funding will be spent using ESPCs and utility energy service contracts.
Ally Energy Solutions worked with a big box retailer, performing a close audit of utility tariffs impacting the retailer’s 180 facilities. To eliminate usage penalties and avoid overloading power transformers, Ally Energy Solutions developed a turnkey project to upgrade analytics and equipment specification, then install and verify efficiencies, reporting a return on investment in less than three years, with $950,0002 of savings annually.
How to Get Started
One proven path to success for a commercial ESCO is to target and collect strong national accounts that can offer the ability to scale their offerings across a number of facilities more easily—from Amazon to Target, Prologis, 7/11 and McDonalds, there are countless companies with a large footprint who would be great long-term engagements.
Winning these accounts will become increasingly competitive as more providers enter the space, and procurement officers look for a resume of successful projects that delivered measurable value. Those firms who were established early on or have deep relationships with commercial owners could have an advantage when it comes to landing the next big national account.
To begin, ESCOs need to do their market research and thoroughly assess potential candidates. They may need to educate multiple decision makers as to the viability of certain energy efficiency projects and the various financing mechanisms, then make the case that they have the experience and skill to successfully retrofit and manage a company’s energy services. Zeroing in on potential clients begins with asking “Who has a need today to meet their goals for tomorrow?” and “Who has the access to capital and/or the proper project profiles to do it at scale?”
President Joe Biden has set a target of 50% to 52% reduction in carbon emissions from 2005 levels by the year 2030. Efficiency projects have historically been viewed as a means to greater profitability, and they are increasingly part of a prudent financial plan, but the driver here is a true shift in the energy ecosystem. The transition is being driven by federal and state policy, and by private and public firms that are establishing their own mandates and pushing the envelope on what can be achieved. In many cases executives are being compensated on meeting ESG related metrics and goals. We are behind on progress toward emissions targets and the race is on. To mitigate future harm and be a part of the solution, the C&I energy efficiency market offers a new avenue of opportunity.