The Energy Efficiency Opportunity

The Energy Efficiency Opportunity

          
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The Energy Efficiency Opportunity

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    A Nascent Market Awakens

    Pundits have long believed that the EE industry, because of its very compelling fundamentals, is poised for growth. EE efforts are widely recognized as a highly cost-effective lever in the fight against climate change—they outcompete all renewable energy sources, biofuels, nuclear power, and carbon capture and storage in terms of carbon abatement costs—and in endeavors to improve countries’ energy security. To harvest this potential and foster investment, governments around the world have been tightening EE standards and launching incentive mechanisms. Simultaneously, consumers in many countries are experiencing rising energy costs as developing economies wrestle with the effects of spiraling demand and as mature economies invest to update their energy infrastructures for the twenty-first century.

    The potential to increase the efficiency of energy utilization is enormous. We calculate that by 2020, in Europe alone, investment in more efficient equipment and processes (excluding insulation and windows) could reduce annual energy consumption by approximately 250 megatonnes of oil equivalent (Mtoe), which represents about 16 percent of Europe’s total demand. In the U.S., the potential annual energy savings amount to approximately 200 Mtoe, or 20 percent of demand. And, critically, these savings could be achieved without compromising consumers’ physical comfort or countries’ industrial competitiveness. Moreover, many EE initiatives are highly economical, yielding positive returns on investment and short payback periods. Payback periods for some measures, such as light-emitting-diode (LED) retrofits, can be as short as two or three years.

    Challenges have constrained growth to date. Still, the industry’s expansion has been moderate, with only a few countries—including Germany, the UK, and the U.S.—exhibiting annual growth approaching 10 percent. Several factors account for this. First, customers often perceive EE projects as risky and are unsure whether they can deliver the promised reductions in consumption. Industry players must therefore make substantial efforts to explain those projects’ economics to potential customers. Second, not all buyers of energy-efficiency products and services are themselves the beneficiaries—a landlord might invest in efficient lighting for his building, for example, while his tenants realize lower utility bills. Third, many companies struggle to free up capital for projects that have payback periods of more than three years, even if they see the projects’ value. Fourth, since energy costs in many businesses do not rank high on management’s agenda, EE is relegated to the back burner.

    Serving the market can also be a struggle. Customers’ heterogeneous requirements and long decision-making processes increase the effort necessary to convert leads. The business can also be capital intensive, and ongoing economic weakness in several countries has made it difficult for EE companies to secure funding for expansion. In addition, the complexity of multidiscipline EE projects, and a scarcity of technical project managers experienced in handling them, impedes rapid scale-up of business.

    As a result of these factors, few EE markets so far have reached maturity in terms of actual demand, the regulatory environment, and industry professionalization. The most developed markets today are in Europe, led by Belgium, Germany, Luxembourg, the Netherlands, Norway, and the UK. In the U.S., market maturity varies significantly by state, with Massachusetts and California leading the way.

    Structural drivers for the industry are improving. Despite those challenges, however, the industry’s structural drivers are improving. Technological progress in efficient equipment and intelligent controls is making EE offerings increasingly potent, affordable, and easy to use. (See the Appendix.) Advanced IT solutions are affording energy users greater transparency into, and control of, consumption. Driven by a number of government initiatives in China, the EU, Japan, the U.S., and elsewhere, regulatory pressure and the availability of public funds, both for indirect incentive programs and for direct efficiency investments in public buildings, are increasing. Further, public incentive mechanisms, including both direct regulatory intervention and the provision of investment subsidies, are becoming more refined as regulators leverage lessons learned from more than a decade’s worth of experimentation. Examples of successful initiatives include the £100 million London Energy Efficiency Fund, a lending program promoting EE investments in that city, and the EE investment programs that a number of U.S. states have mandated for utilities.

    Private investors have started to recognize the industry’s potential and are further alleviating capital scarcity through investments in energy service companies (ESCOs), individual projects, and EE funds. Simultaneously, historically low interest rates and decreasing perceived risks are driving down capital costs. The industry is also rapidly professionalizing, and companies are developing innovative business models that unlock new demand. Nonstandard financing structures—such as performance contracting, where payment for an efficiency investment does not occur up front but rather is generated through the energy savings produced over time—are removing investment hurdles for private building owners.

    Sustained double-digit growth is likely—but prospects vary by market. Given this confluence of forces, we expect the market to enter an extended period of double-digit growth, with revenues increasing 10 to 15 percent annually up to and beyond 2020. Growth will not be universal, however. The most robust expansion will be in countries with high energy prices, determined regulators, a stable regulatory environment, and already-established EE markets.

    By region, Europe has particularly strong prospects, driven especially by its high energy prices, increasing EU policy pressure, and a backlog of investments in public infrastructure. We expect the European EE market to reach nearly €30 billion in 2020, with markets in many countries growing by about 10 to 15 percent per year. This figure could rise even further in the event of additional support from regulators or a stronger investment push from new market entrants. We expect the most dynamic growth to take place in the region’s more mature markets, such as France, Germany, Italy, and the UK. Prospects for much of southern Europe are impeded by the current economic climate, which will likely decelerate regulator activity and reduce available capital for efficiency projects. Markets in eastern Europe are still immature and will need time to develop.

    The U.S. market also has much promise, with double-digit annual growth likely for the remainder of this decade. Key factors supporting U.S. growth include an increasingly favorable regulatory environment in many states, such as laws mandating the aforementioned EE-investment programs by utilities; strong ongoing demand from the MUSH sector (municipalities, universities, schools, and hospitals), fueled by constituents’ cost consciousness and comfort with long payback periods; and expanded public funding across jurisdictions. Growth will also be spurred by the launch of new business models, such as the performance-contracting and energy-management offerings currently pushing into the market.

    In the medium term, we also see highly attractive prospects in the BRIC countries (Brazil, Russia, India, and China). China, in particular, shows a lot of promise, fueled by an anticipated government push for increased energy savings. Most of these markets, though, will be difficult for nonlocal companies to penetrate.

    Investment in insulation and energy-efficient windows is excluded because such items are typically supplied and installed by a set of players outside the scope of this report.
    Energy Efficient Buildings: Global Outlook, Pike Research, November 2011.