Financing energy efficiency retrofits cost-effectively
SCOTT BOCSKAY, Total Facilities 2012 speaker and chief executive of Sustainable Melbourne Fund, explains how environmental upgrade agreements allow the realisation of cost-effective energy efficiency gains.
The former National Bank building at 460 Collins Street Melbourne was constructed in 1939 and completed at a time when the world was entering into World War II. The building is an important part of Melbourne’s history, being the first within the western sector of the CBD to be constructed to the full height allowed by the City of Melbourne at that time. Consequently, the building is seen as having a determining effect on the future development of that part of the Melbourne CBD and in 1942 the building was awarded the Institute of Architects’ Street Architecture Medal for its revival architecture style.
460 Collins Street continues to play a part in Melbourne’s history by being the first building to enter into an environmental upgrade agreement (EUA) for the improvement of its operational performance through a retrofit to replace its antiquated chiller and controls. Indeed, as the first pilot for this form of finance, in years to come it may be recognised once again for its role in determining the future development of the City of Melbourne.
It all began with the owners needing to undertake works to improve the performance of their building. Years of maintenance to the dated valve controlled system no longer provided the service tenants demanded and the building owner needed to take action. Faced with the cost of undertaking this work and an upcoming rollover of finance, the building owner found an EUA to be an attractive form of finance to undertake these environmental works.
WHAT ARE EUAs?
EUAs can currently be used in Victoria and New South Wales. They are an agreement between three parties: a local municipality, a financier and a building owner. The City of Melbourne set up and established the first EUA program and legislation in Australia and in partnership with Sustainable Melbourne Fund it has financed the first three projects.
EUAs enable building owners to work with their tenants and to undertake comprehensive building upgrades (both base building and tenancy lighting). An EUA enables this through the nature of the environmental upgrade charge (EUC), which may be shared between building owners and their tenants.
An EUC is a statutory charge enshrined in the relevant local government act that is placed upon the building by the local municipality as part of the EUA process. As a statutory charge, it may be passed through to tenants under most net leases. EUCs, therefore, overcome the ‘split incentive’ – where building owners have a disincentive to invest in efficiency measures as tenants pay the utility bills and, therefore, receive the savings generated by the building owner’s investment.
For financiers to participate in EUAs, it is important that they understand the different risk dynamics. EUAs can be financed by any financier as long as they are regulated by the appropriate authorities. The NAB has partnered with Low Carbon Australia and Eureka Funds Management to establish a product to invest through the mechanism. This product is able to invest into EUAs with up to 10-year tenors at fixed interest. These extended tenors as enabled by the EUA mechanism greatly enhance the economics of retrofitting buildings for utility efficiency upgrades, including water.
It is important to recognise the difference between an EUA and a traditional finance product. Take for example a project with a 6.9-year simple payback financed through traditional debt available at three years 8 percent principle and interest repayments. Such a project would be significantly cash negative and unattractive to a building owner in its own right.
Compare that to the same project financed through the NAB product over 10 years – it becomes cash flow positive in year one, where tenants are engaged and have their lighting upgraded as part of the project. Even without the tenants participating, such as at 460 Collins Street, the project becomes more attractive when financed out to 10 years on a cash basis. The nature of long-term finance products at fixed interest better aligns with the benefits of energy efficiency.
CAPTURING THE FULL BENEFITS OF RETROFITS WITH EUAs
Building owners and chief financial officers must consider the debt terms available and weigh the savings generated within the context of available debt. Where an energy efficiency intervention has a simple payback of five years – meaning the savings generated have paid for the capital outlay (principal) and debt is only available over three years – the cash flow implications are such that the building owners will have an increased cost in undertaking that activity. The debt service on a monthly basis is greater than the monthly savings that are generated. So, while it is true that, over the life of an asset, energy efficiency pays for itself, the way in which it is paid for may not make it an attractive nor feasible opportunity.
Whether a building owner uses an EUA for its full potential – that is works with tenants to undertake comprehensive projects – or whether they use EUAs simply as an attractive form of finance to better manage cash flows with retrofit projects is immaterial. What is important is that building owners and tenants understand that EUAs offer both parties the opportunity to better manage and allocate currently wasted money for retrofitting the buildings we live, work and play in.
Scott Bocskay is the chief executive of Sustainable Melbourne Fund. Reporting to a board of trustees, Bocskay is charged with leading his team to deliver positive environmental outcomes in a commercial and innovative manner. Bocskay and his team are currently delivering a new environmental upgrade financing mechanism for the City of Melbourne and administering its 1200 Buildings program, which is aimed at generating $2 billion in retrofit activity within the municipality.