By Mike Scott
The fragility of the global energy system and its vulnerability to disruption have been highlighted once again by recent events in Japan and the Middle East.
So perhaps now is the time for energy efficiency to come into its own as an investment proposition. The benefits of energy efficiency are well known – according to McKinsey, investment of $170bn a year in existing energy efficiency measures could realise annual energy savings of $900bn a year by 2020 while delivering half of the emissions cuts needed to meet global climate change targets.
“Energy efficiency is the largest source of greenhouse gas reductions,” says Jonathan Maxwell, founding partner at Sustainable Development Capital LLP, which invests in efficiency projects in Asia and Europe.
Yet just 9 per cent of clean energy investment in the US between 2005 and 2010 went to energy efficiency, according to Bloomberg New Energy Finance. If the benefits are so obvious, why is energy efficiency not a more prominent asset class? To some extent, it is a victim of its own success, suggests Nick Robins, head of the climate change centre of excellence at HSBC.
“Because the measures deliver positive returns to anyone who deploys them, policymakers think they can take a back seat even though there are structural and behavioural barriers that mean people do not implement such measures as much as would be rational.”
Energy efficiency involves upfront capital investment, so the question of who pays is crucial, says Ben Caldecott, head of European policy at Climate Change Capital. “This is especially true in households. There has been a lot of research that shows that you literally cannot give away energy efficiency retrofits.
“Even if it is free, it is an intrusive intervention into the home and it can be difficult to demonstrate savings if energy prices are going down,” he adds. “Government policy has an important role to play in encouraging uptake.”
Many opportunities are on a small scale, meaning the transaction costs of funding outweigh the benefits of efficiency, says Mr Maxwell. “You have to find ways of aggregating portfolios of relatively small projects to achieve scale.”
A further issue is that efficiency covers a whole range of economic sectors, including industry, buildings, transport and energy networks, says Lee Clements, an investment manager at Impax Asset Management. There are further sub-sectors within these categories – in buildings, for example, there are opportunities in lighting, heating, cooling, insulation and building controls.
Nonetheless, the sector is seeing strong growth. HSBC estimates India’s energy efficiency market at $77bn, while SDCL’s Mr Maxwell says the European market will be “tens of billions of pounds per year” and the US market is estimated to be worth about $300bn.
Funds such as Impax are investing in companies that provide energy efficiency goods and services. “We have been overweight in this area for the last 18 months to two years,” Mr Clements says. “From the beginning of 2010 to April 21 2011, the FTSE EO Energy Efficiency Index rose by almost 72 per cent, while the FTSE EO Renewable Energy Index was up only 13 per cent.”
Efficiency stocks are generally less reliant on government subsidies than renewables and are therefore less affected by the debt travails of European governments and the policy impasse in the US, he adds. At the same time, there are many regulations boosting efficiency in areas ranging from automotive to buildings. Mandating efficiency is generally less controversial than renewables subsidies because it saves people money.
This is a global trend – moves to reduce energy intensity in countries such as India and China tend to favour energy efficiency projects because the improvements are easy to measure and verify, while schemes such as the UK government’s Green Deal should help to deal with the aggregation issue.
“It is a great investment theme, but it is cyclical. It is performing strongly now but it came off a lot in the downturn,” says Mr Clements.
Climate Change Capital’s private equity fund is invested in Climate Energy, a UK-based energy efficiency company focused on the domestic sector, but it also takes another approach through its Sustainable Property Fund, which buys commercial properties and retrofits them to make them as efficient as possible.
SDCL, which also has an advisory business, focuses on investing directly in energy efficiency projects in Asia and Europe. The firm provides the upfront capital for efficiency projects, which it expects to reduce energy bills by 20 per cent or more, and shares the cost savings with its client.
The opportunity exists, Mr Maxwell says, because even though most projects offer payback in less than five years, the initial outlay is often classed as capital expenditure and finds itself in competition with other uses of capex, including the business’s core activities.
SDCL, which is planning to offer an institutional investment vehicle for energy efficiency later in the year, believes “the shortage is of well-structured investment propositions, rather than of capital per se”.
However, one of the sector’s key advantages over other clean technology areas is that “growth is not going to be led by the environmental impact but by the fact that it makes good business sense”.
© Copyright Mike Scott 2011.