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Are Building Owners Leaving Money on the Energy Efficiency Table?

August 01, 2012

By: Elizabeth Brooke Stein

In the hot summer of 2012, why would it still be necessary to convince anyone that saving energy is a good idea? With energy security and climate change concerns converging on energy efficiency as a key adaptive opportunity, it seems entirely self-evident from many perspectives. New buildings are increasingly designed and constructed with energy in mind, as building codes have increasingly required new buildings to meet higher efficiency standards — and in some real estate market segments, such as high-end office properties, certifications that buildings exceed the standards imposed by code (e.g., EnergyStar or LEED) increasingly represent a market norm.

But the existing building stock presents a conundrum. Buildings are made to last — and buildings constructed in accordance with the prevailing norms of another era may not meet today's (or tomorrow's) expectations with respect to energy. Since wasted energy = wasted money, we often tell ourselves that ending energy waste is a no-brainer — we only need to get the word out, and some portion of the problem will take care of itself. If there is a $20 bill lying on the table, surely building owners will pick it up. Right?

Well, yes and no. Of course building owners don't like to leave money on the table. But it is by no means clear that they are ignoring their self-interest when they do not perform energy upgrades that are expected to be "cost-effective". While energy upgrades have real, tangible benefits, the disadvantages of performing upgrades are real too and they are not limited to the upfront costs that inform a cost-effectiveness calculation. For example:

• Energy upgrades aren't free. All upgrades have upfront costs, and some may not meet the building owner's desired payback period, or may not be cost-effective over any horizon.

• The expected savings, even where real, may be of insufficient magnitude to attract a building owner's attention, given competing demands.

• In property that is not entirely owner-occupied, projected efficiency savings may accrue to someone other than the building owner — hence the "split incentive" problem.

• Energy upgrades, like any construction, can be disruptive to current building occupants.

• Even where a building owner sees the potential for energy upgrades to save money over some time horizon, he or she may not be in a position to spend cash upfront to complete the upgrade.

• Favorable financing may not be available, particularly since parties interested in financing such upgrades have limited avenues, if any, for obtaining a security interest in the "savings stream" that an upgrade is expected to generate.

Today, these "barriers" to energy efficiency upgrades are well recognized and well understood, and market participants as well as government entities are hard at work developing and promulgating solutions to many of them. Less well understood is a question lurking in the background: To what extent should building owners take the "expected" savings — whatever they may be with respect to a particular property — at face value?

The bad news is that the answer is probably "It depends". The good news is that the factors upon which it depends are potentially knowable, and somewhat in the control of those who undertake projects, and that rapid innovation in how energy efficiency projects are undertaken is creating new opportunities to ensure that they live up to their potential.

We have all heard wonderful energy-saving success stories, and many of those undertaking energy upgrades in various sectors are persuaded that these upgrades yield substantial benefits (in comfort, quality of life, and asset value, for example) quite apart from reduced energy costs. It is probably safe to say that upgrades involving installation of energy-efficient lighting and fixtures will perform as promised. Nonetheless, although the growing universe of benchmarking data is starting to give us a much fuller sense of how buildings perform, actuarial data concerning energy efficiency project performance is scarce. In some projects, performance is never measured — and where it is, the purpose is often to determine whether payments must be made on performance guarantees, and the findings are typically kept confidential by the contract parties.

Common sense alone should tell us that, in light of the complexity that characterizes buildings and their users, it would be unreasonable to expect post-retrofit performance for any given building to be precisely in line with projections. At best, outcomes would likely be arrayed along a normal distribution, hopefully clustered in the vicinity of what was projected — some overperforming, others underperforming, but most hitting close to the mark. For building owners who do not own large portfolios, this distribution matters; if you own a single building and your energy project misses the mark, you don't take much solace in knowing that there is another building out there that achieved better than projected results.

In addition to base line variability that inevitably will keep outcomes from aligning precisely with projections, some of the divergence between projections and outcomes may arise from the myriad risks associated with any energy upgrade project, including:

• Project Formulation and Savings Projection Risk — The audit, or the savings potential identified in the audit, may be inaccurate, and "broken" buildings are very hard to model; it could be that no matter how well the work plan is executed and the building managed in the years that follow, the projected savings are unattainable.

• Construction Risk — Improper construction or installation of improvements can cause even well-designed projects not to perform as designed.

• Commissioning Risk — Even after competent construction or installation, building systems must be kept properly tuned if performance gains are to be realized.

• Ongoing Operational Risk — How the building is actually operated and occupied over time — not just how base systems are operated by building management, but also unanticipated tenant and occupant behavior — can cause energy performance diverge from what is expected in a way that can wipe out anticipated savings.

A lot of opportunities for outcomes to diverge from projections! And indeed, while data is scarce, those few studies that have examined "realization rates" (the percentage of energy savings anticipated at the outset of a project that ultimately materialize) in various sectors have made findings that suggest all those risks, accumulating over time, may exert downward pressure on results. Consider the following evidence:

In the case of LoanSTAR, a revolving loan program dedicated to performing energy upgrades on public buildings in the State of Texas, a close examination of project performance found in 1996 that whereas audits projected an average payback period of 3.8 years, actual payback periods were 5.1 years. [See also: Sallan Snapshot Finding the Proof of Energy Retrofits; Haberl, J et al., Loan Star After 11 Years: A Report on the Successes and Lessons Learned from the LoanSTAR Program, Texas A&M University System, Energy Systems Laboratory (December 2002); and Public Building Pudding: Finding the Proof of Energy Retrofits (Oral presentation, Michael Bobker, Building Performance Lab, CUNY Institute for Urban Systems, May 19, 2010).]

Deutsche Bank/Living Cities' study of 231 retrofits done on multifamily housing (21,000 units of housing) in New York City found that across the projects studied, "the fuel realization rate was 61%, with a 90% confidence interval of +/-14%".

A new white paper, Modeled vs Actual Energy Savings examines single-family retrofits performed in California found actual savings, based on utility bills, averaging approximately 2/3 of what was predicted using a model.

The fact is that while energy efficiency retrofits are commonly performed, and there are market sectors (notably the MUSH and government sectors) in which workable deal structures have been used with some success for decades, available data does not appear to provide sufficient evidence that for a given energy-saving retrofit, projected savings will materialize in full.

Now the good news: energy efficiency upgrades do not have to be faith-based enterprises. Many developers and funders of energy efficiency upgrade projects in large buildings can take affirmative steps to protect themselves against underperformance.

Believe it or not, LoanSTAR is actually a success story. The disappointing results identified early on inspired researchers to invent a process they called Continuous CommissioningSM — a practice of frequently measuring performance, identifying faults, and Continuous CommissioningSM isn't free, but it represents a relatively small incremental cost (the requisite metering adds 3.5% to the cost of retrofits, and annual reporting adds an additional 1%), and the improved performance of projects within the program is notable. In the year 2000, the program was slightly overperforming — $53.2 million of forecasted savings had become $53.4 of measured savings and "Continuous CommissioningSM is credited with 25% of those savings. Moreover, the rigorous data collection involved has allowed Texas A&M to continue to advance building science in the direction of better forecasting and better savings realization. The Energy Systems Laboratory at Texas A&M has done numerous analyses of this program and along with the papers cited above, more research papers are available at its digital library

But Continuous CommissioningSM and similar approaches to fault correction have not become universal; instead, it is not uncommon in many sectors to effectively end a project, never looking back, once installation is complete, or to use measurement only to determine whether payment must be made under a performance guarantee. Even where continuous commissioning is practiced, it might protect against some causes of underperformance but not others. For example, fault detection and correction will not save the day if audit projections themselves are faulty from the start. In addition, even with top-notch performance assurance, there remains the inevitable normal distribution of outcomes.

This leads to our crucial question: How can a building owner who is interested in maximizing the performance of a single project, rather than a portfolio, proceed with confidence?

For a building owner who simply wishes to undertake energy upgrades while minimizing the risk of underperformance (and who is focused solely on the energy bottom line and not on other benefits that might accrue from an energy upgrade), one option, where available, is to seek out deal structures that shift the risk of underperformance to another party — likely a party who is better positioned than the building owner to reasonably predict or manage outcomes. The traditional energy service performance contract, where available, may be used to achieve this result; other options may include energy service agreements and third-party insurance of the savings increment. Ideally, contracts like these could insulate building owners from the risks which they lack the expertise to control while creating appropriate incentives for someone who does have the expertise to employ state of the art performance assurance throughout the life of the project.

For those of us (such as environmental advocates) who want something more, i.e., for energy efficiency to play the starring role in systemic decarbonization that McKinsey and others have said it can, support for innovation in deal structures is a necessity, but it's not enough. We should also demand, and do what we can to facilitate, significant advances in what constitutes the market expectation for rigor in project design and execution. Indeed, the success of innovative deal structures demands such advances, because the lack of clarity in what rigor the market expects is detrimental to the establishment and success of innovative deal structures. Third parties who might be in a position to insulate building owners from risk of underperformance will themselves need to be insulated from — or at least be in a position to fully understand and assign a price to — the risk that they are taking on. In fact, building owners who would like to use such third parties to manage project performance risk should be forewarned that at present, architectural and engineering practice is so varied and quality so difficult to prove that an energy audit done on a standalone basis before the third party is brought in may turn out not to meet that party's requirements, even if it is "investment grade." Therefore, partnering with such a party, if anticipated, should be explored in advance of the audit.

If all this uncertainty and performance assurance is confusing, let me be perfectly clear on the following fundamental: As the planet continues to warm, energy efficiency retrofits' propensity to fall short of their potential is a tragedy, even if building owners' financial exposure can be limited.

To draw a reasonably straight line from predicted savings to actual results demands that architects and engineers in all their diversity, non-engineer building professionals, and the investment community agree on the fundamentals of how retrofits should be undertaken, from conception to implementation and beyond. Environmental Defense Fund has convened such an effort — our Investor Confidence Project (ICP) — to identify a commercially-reasonable state of the art approach to performance assurance for energy efficiency upgrades in large commercial buildings, bringing diverse practices together into a single framework. The work of energy upgrades is never done — post-retrofit performance may someday be the baseline for another generation of retrofits — and so the ICP framework conceives of the retrofit lifecycle as a continuous loop. Similarly, opportunities for continuous feedback on how well various methods are performing should be harnessed wherever and whenever possible. With help from a clearer consensus as to what data matter most, data from actual projects can be benchmarked, aggregated and leveraged to ensure that the set of practices underlying energy efficiency upgrades continues to improve, and that the relationship between forecast and performance grows stronger over time.

Elizabeth Brooke Stein is an attorney in EDF’s Energy Program, focusing on energy efficiency in large commercial buildings and the development of the smart grid.

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