Imagine extreme heatwaves at least once every 5 years blighting billions; severe drought and water scarcity threatening hundreds of millions more people; a 50% reduction in the geographic range of flora and fauna; fires, floods, extreme weather; two-thirds of the world’s coastlines affected by elevated sea levels; oceanic dead zones unable to support life; hits to GDP, food security, and soaring disease rates…

Such is the legacy of failing to keep global temperature levels below 2 degrees according to the Intergovernmental Panel on Climate Change.

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And yet there is unlikely salvation from all that catastrophe in the form of a lightbulb. Hyperbole aside, replacing traditional lightbulbs with efficient ones illustrates the outsized effectiveness energy efficiency (EE) measures can have: a 70-90% reduction in power consumption.

Energy efficiency is the Swiss Army Knife of the energy transition, the multitool to tackle climate catastrophe. There are myriad methods for achieving energy efficiency, but one vital result: a drop in CO2, the gas responsible for rising temperatures.

Moreover, such measures can be implemented for profit. Investment in the sector to date has been the preserve of just a handful of dedicated players. To illustrate, the energy efficiency fund universe saw a proportionally-significant expansion with the launch of 2 new strategies in November 2020.

Still rather few considering the opportunity is enormous. A sleeping great, green giant with an appetite for many billions of investment every year.

Projections by the International Energy Agency show that capital backing energy efficiency will match then overtake renewables spending by 2030. Almost $1 trillion is forecast for the sector by 2040, supporting almost 60 million jobs.

Returns on energy efficiency projects are in line with renewables investments – high single-digits are achievable.

Managers and institutional investors have the opportunity to ride the wave of a significant decade of focus in this field. Respectable returns and a boost to ESG credentials are the prize for partnering to address the deficiency in energy efficiency.

Applications

With energy efficiency, more is less – energy efficiency measures allow for the same or better performance with less energy consumption.

It is for that reason that the International Energy Agency described gains in energy efficiency as the ‘first fuel’ of a sustainable global energy system, i.e. as source of energy in its own right.

Another critical advantage of such measures is that the reduction in net energy consumption allows for an increase in the proportion of energy supplied by renewable energy sources and storage systems, further eliminating recourse to carbon-intensive energy.

Measures also benefits energy security. Jonathan Maxwell, chief executive and founder of Sustainable Development Capital, says: "We keep getting close to the maximum levels of generation to meet supply in the UK, but there is grid instability. The increasing penetration of renewables, which we all celebrate, creates a degree of volatility of supply on the grid. So resilience becomes a bigger topic."

Consumers of energy, be they businesses or households, also benefit from implementing EE technologies through reductions in overall energy bills.

What, then, constitutes an energy efficiency measure?

There are numerous technologies and techniques that address energy consumption where there is excess energy waste whether at the point of production or consumption.

Buildings account for 40% of primary energy consumption in the EU and US, and as such are major targets for reducing consumption and emissions.

Heating and cooling structures will be a significant area of efficiency drives as billions more in emerging and developing economies increase demand for indoor climate control.

Improvements to building envelopes (walls, roof, windows e.g.) can be made and include the addition of insulating materials, and ‘tightening’ to reduce air inflows and outflows, thereby lowering heating and cooling costs.

Heat pumps may be installed – these are an alternative heating method which works by transferring heat from cooler to warmer environments with a far higher degree of efficiency to electric resistance heating.

These form part of wider opportunities across mechanical systems in buildings: the installation of efficient heating, ventilating, and air condition (HVAC) systems by retrofit or at the point of construction.

Buildings can benefit in other ways. Lighting is a favourite example: a simple exchange of incandescent bulbs for LED lamps can reduce energy consumption enormously. Outdoor lighting can benefit too.

In industrial, business, and healthcare settings, implementation of cogeneration or combined heat and power engines can provide heat and power simultaneously on-site. Trigeneration models provide cooling in addition.

Such a measure is an example of decentralised energy, an essential component of the energy efficiency strategy. Some fuels in centralised power stations produce efficiency as low as 31% (average world average efficiency for coal-fired stations according to Energie-Fakten).

Moreover, the transmission and distribution of power from centralised power sources leads to energy losses in the single digits (one estimate is 6% and 4% respectively lost through heat).

Decentralised energy, then, can reduce wastage by producing energy needs on site with cleaner fuels such as gas or biomass, and use waste heat from power generation for heating.

Another decentralised energy technique is the installation of solar panels on rooftops wherefrom energy can supply the building.

Heat networks such as district heating and cooling are another effective method of boosting efficiency, particularly when combined with power generation with high levels of heat wastage.

Efficiency in transport following the anticipated growth of electric vehicle adoption and wider electrification of transport and hydrogen fuels produced through renewables will be key themes in years to come.

It is patent from the wide range of energy efficiency options that to implement them all would be costly. Homeowners, businesses, and other entities can scarcely countenance even one. It is here the investment opportunity lies.

Players

There are two principal strategies for investment in energy efficiency: acquisition and refinancing of existing, yielding assets and financing of new efficiency projects backed by long-term contracts.

This, along with the diversity of energy efficiency technologies, creates scope for a varied ecosystem of strategies.

To date there are two LSE listed vehicles: the SDCL Energy Efficiency Trust (SEEIT) launched in 2018, and the Triple Point Energy Efficiency Infrastructure Company which launched in November 2020.

The private fund side is dispersed across Europe.

Since 2011, the European Energy Efficiency Fund (EEEF) has fostered energy efficiency and renewables through public-private partnerships within the EU with large sponsors like the EIB, European Commission and Cassa Depositi e Prestiti (CDP). It has provided debt and equity, to municipal, regional, and private partners such as utilities and energy service companies (ESCOs), and has committed €200 million since inception.

In 2012, Sustainable Development Capital (SDCL) launched the UK Energy Efficiency Investments Fund, a private equity infrastructure fund backed by the UK Government and EIB. It launched a listed vehicle, SDCL Energy Efficiency Income Trust (SEEIT), in 2018.

Amber Infrastructure has two UK Government-backed vehicles: the London Energy Efficiency Fund (LEEF) which dates from 2011 and the Mayor of London’s Energy Efficiency Fund (MEEF).

SUSI Partners has two dedicated energy efficiency funds – SUSI Energy Efficiency Fund I and II – which launched fundraising in 2013 and 2018 respectively, but it has decided to continue EE activity as part of its SUSI Global Energy Transition Fund, which incorporates renewable generation and storage into the strategy.

In Spain, Suma Capital has also launched two strategies. Suma Capital Energy and Environment Fund I (SCEEF I) launched in 2014 and the second iteration in 2017 (SCEEF II).

Fondo Italiano per l’Efficienza Energetica launched in 2014 as the first such Italian vehicle. It held a first close on its second vehicle in August 2020 with €127.5 million of a €175 million target.

The latest entrant to the private European fund space is Aquila Capital, known already for its renewable investment activity, which announced its maiden investment through the Aquila Capital Energy Efficiency Strategy in November 2020.

There is another major contingent to the players in this space: energy service companies (ESCOs) and technology companies. All investment houses involved in energy efficiency agree that strong relationships with these entities is essentially.

Franco Hauri (pictured), senior investment manager within the Aquila Capital energy efficiency team, explains what they are and why these relationships are the lifeblood of EE vehicles.

"Building a pipeline really comes down to selecting and building relationships with partners. Fundamentally there are two types: energy service companies, they are in the hundreds in European countries and an important source of deals; technology suppliers are also important.

"Historically they have focused on selling products, but there is a trend among these suppliers to transform the product into a service. The trend is to support product sales through a financing solution and position their products as a service (light, heat e.g.). It’s possible to forge right of first refusal agreements with some of these companies."

This service can include connecting a client of an ESCO with a fund manager with deeper pockets than they have, an important strategy for some investors in the space.

Clients form the wide base of the triangle, the multitudes of residences, businesses, industrial actors, state institutions in health and education, municipalities and other government bodies that benefit financially and existentially from energy efficiency upgrades.

Strategies

The variety of energy efficiency fund strategies is a pleasing parallel to the variety of efficiency measures available. There are listed and unlisted players, hyper-local and global target areas, ‘greenfield’ and ‘brownfield’.

One common deal model for developers of projects involves a fund providing capital to an ESCO to implement an energy efficiency measure on behalf of a counterparty seeking cost reduction. Yield is generated through long tenor agreements connected to supply of energy, heating, lighting for example.

The share of savings can be fixed and defined upfront – paid, for example, on a quarterly basis or in a variable way, or as a PPA (i.e. selling to a client who pays a defined price across the duration of the contract).

SUSI Partners describes this as the "off-balance sheet contracting model" or "tri-partite transaction structuring". The fund takes on project risk for transactions involving energy service companies and their customers, thereby funding projects without impacting customer balance sheets.

This is an attractive proposition for investors. As Joanne Patrick, director of Amber’s London Energy Efficiency Fund (LEEF) and Mayor of London Energy Efficiency Fund (MEEF) explains, "Investors can leverage off the upfront scoping and due diligence work that we as the fund manager do. We do a lot of the heavy lifting that they would otherwise have to do in house."

These two funds exemplify hyper local fund styles, though such a description ought not lead one to doubt the opportunities afforded by such vehicles. The model largely provides debt to public sector counterparties (local authorities, education, health, not for profits) with some allowance for SMEs and ESCOs (30%).

LEEF was established in 2011 through the European Commission’s Joint European Support for Sustainable Investment in City Areas (JESSICA) initiative to stimulate investment in underserved segments of the energy efficiency and low carbon sectors. At the end of its investment period, the fund had invested c.£90 million by 2018 in 13 projects.

It focuses on energy efficiency retrofit to existing buildings, building controls, communal and district heating and cooling, and small-scale renewable energy in Greater London.

Peter Radford, Investment Director at the Amber evokes the entrepreneurial spirit Amber’s strategy necessitated as newcomers to the field in the early 2010s: "As well as approaching ESCOs that were active at the time in energy efficiency we went direct to a lot of the largest estate holders in London."

"One of the things we did back then was look at a full building retrofit rather than specific technology like LEDs. That did give you a slightly different payback profile. Back in 2011 this was stepping into a new world for some because they hadn’t looked at their building stock and energy bills in that way."

The award of the MEEF mandate to Amber in 2018 has subsequently brought an expansion of its low carbon remit to include alternative fuel charging infrastructure, e-mobility, and street lighting. It was also designed as a 20-year fund for extended project payback periods so that it could fund longer term projects such as district heating.

On the strategy’s geographical remit and potential for replication, Patrick says: "Some may argue it is a constraint, because people want this kind of investment all over the country. However, having already allocated nearly all of the initial public sector funding two years into a five-year investment period, demand in London is clearly there. The distinguishing feature of our MEEF fund is the blending of public sector funding with private capital to bring about as much investment in the sector as quickly as possible. I see a lot of interest from cities up and down the UK in this type of model."

Triple Point’s recently listed offering launched in November 2020, and takes the UK as its investment domain. The company, which has wider investment interests in housing and energy, won a Europe-wide competitive process in 2018 to set up the process for projects to apply for grants toward soft loan finance for heat network development in the UK. It developed its strategy with this expertise under its belt, and 10 years managing investments in solar, hydro, CHP, gas peakers, and anaerobic digestion.

The fund is looking for operational projects predominately (75%) in low carbon heat such as combined heat and power and heat networks – heat accounts for a third of all UK carbon emissions – social housing retrofit and industrial energy efficiency, and distributed generation.

Jonathan Parr, partner and head of energy, describes the UK pipeline: "We see quite a lot of existing　operational　projects as well as exciting new build opportunities. In the pipeline there’s a good mix of projects across assets like heat networks, combined heat and power plants held by investors seeking an exit,　and　opportunities to acquire existing energy efficiency projects aggregated by a developer looking for a refinance before going to secure additional assets."

The fund will use savings-based contracts to allow end users to replace equipment, again without having to pay the cost up front. Instead, it will recoup the cost from a portion of the savings from the energy bill.

Availability contracts are offered by Triple Point too; an example is a tomato growing business to which it provides heat, energy, and CO2. Off-take agreements for generated energy also form part of the strategy.

Triple Point plans to distinguish itself through deal flow sourced from strong relationships with local authorities which may yield sponsored heat networks, housing associations in need of retrofit, which in itself would be a substantial portfolio.

Aquila Capital’s vehicle, which aims to back projects to the tune of €50-70 million per annum during the investment phase, has a pan-European remit. It plans to address the built environment, transport, and industry with energy efficiency measures and decentralised power generation.

Alex Betts (pictured), senior investment manager at Aquila, is confident that many commercial and industrial clients are now amenable to energy efficiency projects.

"Company boards have a focus on reaching net zero as part of their strategy, and you can’t get to that point without an energy efficiency strategy. You improve your productivity and savings. The question is do you provide that capital yourself or seek third party capital."

Colleague Franco Hauri explains how Aquila will differentiate itself with those companies in mind: "We have a truly pan-European focus and are willing to finance smaller opportunities – 80% of projects in the non-residential space require investment between €100,000 and €3 million. The opportunity with this geography and segment is enormous."

Listed entity SEEIT has the broadest reach to date, having struck deals in North America, Europe, and its first in Asia this year.

Chief executive Jonathan Maxwell explains why the company chose a listed product having managed a private EE fund: "Private markets in general are very good at building things whereas public markets are extremely good at owning infrastructure. Having stable, predictable revenues is what you need as a public vehicle. They’re two quite different markets. In the private markets you can focus on the shorter term, higher risk part of the project lifecycle, whereas in the public markets you can take a much more efficient, longer-term view to owning the operational cash flows."

Roughly 75% of the portfolio benefits from availability (light or energy as a service), regulated or fixed payments. The remainder is capacity-based contracts, and a small amount from ancillary services.

Existing renewable energy funds, provided they can make the connections, may implement energy efficiency and renewable strategies concurrently as SUSI has done with its Global Energy Transition Fund.

Challenges

EE investing isn’t as easy as renewables investing, perhaps part of the explanation why there are so few funds comparatively speaking. Part of the difficulty is the nature of striking deals in energy efficiency.

All the managers spoken to acknowledge greater complexity in negotiating to meet the requirements of at least three counterparties.

Beyond that "Each project is unique and it is necessary to fit the solution to the requirement specific to that building or heat network," says Peter Radford.

The greater deal volume with smaller payback in EE compared to energy efficiency adds to the idea that the area is a challenge.

Aquila’s Alex Betts agrees nevertheless highlights advantages: "What is interesting about this area is that individual projects, while they’re being done for the largest corporates in the world, can be relatively small. That’s part of the reason this segment has taken longer to get going. We are not moving large amounts of money in individual projects, but there is a great deal of value in aggregate.

"The returns have similar risk/reward characteristics to renewable projects. Arguably some of these projects are lower risk because there isn’t the same exposure to commodity prices. They are resilient and reliable. You’re delivering a saving irrespective of the weather!"

Visibility is often cited as an issue for the sector, and arguably one of the reasons for the failure of the European Union to meet its 20% improvement energy efficiency target this year, though it will meet greenhouse gas and renewable ones.

Renewable generation was the focus of the previous decade, but, as Triple Point puts it, the greenest energy is that which is never used. Investors are comfortable with owning physical assets, but owning a contract can feel synthetic.

Jonathan Parr elaborates and also sees advantage where others do not: "Energy efficiency, which is all about reducing energy use,　is　not as　easy　a concept　to understand　as renewable　energy generation, which essentially involves putting more power onto the grid. I would say that energy efficiency is in the same space that renewables was in in the UK about 10-12 years ago. There was little penetration for solar in the UK, but the feed in tariff changed everything."

"We can deliver all of our energy needs in the UK through reducing the waste. There has been a great rejection of single-use plastics; people have become aware of what gets sent to landfill and what impacts society more generally. I think the same is true of energy, but because it is largely invisible it’s more difficult to see. Precisely because it has been underserved in the last decade, means there is a good opportunity in the space."

An evolving sector

The field is a lot more disaggregated. One can put a great deal of money into an offshore wind array quite quickly. The market is still being established for EE, and the opportunities are getting larger. Driving significant value through aggregating portfolios of assets, and driving it further through that portfolio effect will be the mission of EE fund managers.

At any rate, several events are certain to make the space more visible in the next 10 years, including the election of Joe Biden as a US president sympathetic to green causes.

‘Policy earthquake’ the Renovation Wave from the EU will deliver refurbished and improved building stock in the EU as part of its European Green Deal with billions earmarked for the space. About 75% of buildings in the EU are energy inefficient at present. It marks a fundamental acceptance that EE offers the best means of reducing emissions.

This may go some way to cracking the domestic retrofit nut, which is yet to be cracked by an investment fund.

The EU has now set a 32.5% improvement in EE compared to business as usual by 2030, and managers surveyed are optimistic the target can be reached.

With growing political support, additional managers launching vehicles, and consciousness of the sector developing among institutional investors the energy efficiency green giant is stirring.