32 Comments

This episode was so good. Here's to hoping having an energy tenant becomes the new normal among older, larger buildings. Maybe I'll even dare to hope we soon hear Germany's finance minister say they're all in on supporting the "gemessene Energieeffizienz-Transaktionsstruktur" as one way to transition from Russian oil and gas.

The discussion you had about the value utilities provide to tenants is an important one. This is a problem somewhat similar to one we have in the accounting industry. Traditionally accountants have billed their time by the hour, and new staff accountants in firms that bill by the hour learn very quickly that the key thing their boss wants from them is to "keep the charge hours up." Nobody's happy with an employee who figures out how to do the same work in half the time, because then the firm's revenue has been halved. And so, predictable habits set in: people putter around the office looking for excuses to make tasks take longer, they work 60+ hours a week (remember white-collar workers are exempt from overtime rules), and more than anything else, people become convinced that what they sell is their time. But of course, as emotionally difficult as it is to admit, the client doesn't care how much time you spent on their tax return--what they care about is that they got a correctly-prepared tax return. Whether it took 10 hours or 2, its the same value to them. Similarly, tenants in a building don't care how many kWh of electricity the utility delivered; they care about having enough electricity to run their business or live the lifestyle to which they've become accustomed. Whether the utility delivers that service using megawatts or negawatts (to use a bad word, apparently), the tenant has no reason to care.

A pricing method that punishes businesses for delivering the same value to the customer in a more cost-efficient, pro-social way is a dysfunctional pricing method. And I suspect it's a problem in more industries than just energy utilities and accounting. In my experience, pricing methods are too often decided by what's easy to measure, or what fits some people's intuitions of what's "fair," rather than by thinking about the consequences to parties' incentives.

Expand full comment

Brilliant analogies. Thank you. If you have pathways to open the conversation in Europe, few (work-related) things would make me happier than seeing MEETS take hold there.

Expand full comment

David, that was insanely great. Seems like the concept is getting some traction. I've been thinking a lot about the disconnect between political statements/targets of "decarbonizing" and the glacial pace of "deep retrofit" and electrification market adoption. Activists and staffers seem to keep trying to sweeten a pot of pretty stale "incentives." When there are still few takers, folks just say, "Ohhh well we need to wait for innovation," meaning technical innovation or cost declines which ain't gonna happen.

I think I have Mr. Harmon beat on one count. I worked on my first energy efficiency project in 1980 or so. A Beadwall solar greenhouse. Fortunately I was just a laborer, not the contractor or owner.

Expand full comment

I agree that folks who are not "in the mix" of stakeholders keep thinking that innovation in "things" is going to fix the problem. But we already have the vast majority of the "things" we need to fix the problem. And we have the money ready to invest. What we lack is innovation on the transaction structure side.

Until it becomes more profitable to heal the planet than harm it, we will continue to harm it. I wish that were not the case, but it undoubtedly is.

Expand full comment

I posted a link to this podcast to a national real estate lawyers listserv, hope you get a ton of inquiries and some business as a result.

Expand full comment

Thank you.

Expand full comment

David, Thanks for the fun time. If folks want more info, they can find it at MeetsCoalition.org

Expand full comment

As the team leader on that 1982 energy conservation project you mentioned, I am more than impressed about where your work and thinking have led. Projects like that were abundantly available then, and probably still are. We did the gritty work of retrofits that called to us for attention. There were no lack of opportunities for improvements. It was hard to document the results of our work. That is the major breakthrough in expanding a bright idea into a real program. Congratulations in making the connections and refining the presentation.

Expand full comment

Tom, Wonderful to see your name on my screen. I could not agree more with your observations. There is a good argument to be made that I would not be doing what I'm doing were it not for your mentorship. I still remember walking into your office and applying for the job. This fall, that will be 40 years ago.

Expand full comment

Fantastic episode - what a creative solution to a tricky problem. Really enjoying this series on innovative ways to reduce demand for fossil fuels. Thanks David and Rob!

Expand full comment

That was wonderful! I bought a volts subscription after hearing this episode.

If I'm envisioning the energy tenant's role correctly, ensuring the performance of the system would make them responsible for a lot of the physical plant maintenance. They'd need to be involved with fixing roof leaks, window repairs, HVAC maintenance, maybe even landscaping if that's part of the efficiency package.

If that's the case, then the landlord stands to reap savings over and above the rent paid by the energy tenant. I don't know how much big commercial landlords spend running and maintaining their physical plant, but I'd expect that to be quite a lot of $$$ that they no longer need to spend.

Wouldn't that alone be sufficient incentive for the landlords to take on the energy tenant? Maybe you don't need rent to make the system work?

Expand full comment

One of the advantages of paying even modest rent is that it makes the EnergyTenant (developer) an asset, not a liability for the building owner.

We agree that reduced O&M is a major benefit as well.

Expand full comment

This was a great episode. Thank you Rob and David!

I would dearly love to make all sorts of energy upgrades to my home, but for various reasons I find myself in a rented house with an uninterested landlord and a split incentive problem. I've been lamenting this sort of problem myself for a little while, and I'm thrilled to learn that serious people are working on this in serious ways.

What are the prospects for generalizing this approach beyond large commercial real estate? Does the model break down in meaningful ways when the transaction scale shrinks to, for instance, a single-family home?

Expand full comment

It is hard to make the model work for small buildings where it is difficult to establish a baseline.

I had a similar landlord problem a decade ago. I ran the math for him.

1) You pay $2k to do XYX.

2) I save $500/year on my energy bill

3) I pay you $400/year more in rent.

4) In five years, you have all your money back and they you are making $400/year.

5) Compare that to what you make in your savings account.

Expand full comment

Fantastic episode. But I left it with two rather large holes in my understanding, and feel like I might need to go back for a second listen:

1. How is efficiency metered? What actually happens now, that didn't happen in the past, to make that possible?

2. What does an energy tenant actually do? The term "energy nanny" makes it sound like an actual person who goes around turning down the HVAC system or unused lights or whatever. Or is it closer to some collection of smart plugs, or something else? Or is it a contractor who makes a bunch of physical changes to the building and then sells energy to the building?

Expand full comment

1) Whole building, all fuels, dynamic baseline metering was invented. It learns how the building performs in a baseline period. Some of the software understands that thermodynamically. You can then keep the baseline calibrated over time as the building changes. This is discussed in a report you can download here: https://www.meetscoalition.org/in-the-news/

2) The EnergyTenant(tm) (developer) improves the building and maintains the building. (Videos on the MEETS Coalition website.) They rent "space" in the building to do this. They also sign the long term contract with the utility. The utility continues to sell energy to the building (from the grid and from Efficiency).

Expand full comment

Rob, great interview thanks. I have a follow-up question here, based on my inability to get my head around a piece of this: If the baseline is calibrated dynamically, does the value of the efficiency energy unit degrade over time? For example, at the initial point if one swaps an Incandescent bulb for an LED bulb, let's posit you get 50% efficiency. Now the utility delivers .5 units of energy and .5 units of efficiency to the tenant and the tenant pays the same. Makes sense for that point in time. But X years later LED bulbs are now the norm in like commercial buildings. Does the value of the Efficiency Energy unit go to zero based on a new baseline? Are tenants expected to pay the 20 year old differential to baseline as they approach the end of the contract? How do you write a 20 year PPA based on that?

Related, you mentioned 2 of the buildings you are working with in Washington are Passive House. So their initial baseline is going to be extremely good for efficiency. If you use that as the baseline, can you get enough additional efficiency to make entering a program like this meaningful? Or is the baseline "like buildings" that are not Passive House level efficient? And if so, isn't that like "deeming" instead of measuring?

Expand full comment

Great question.

The value of the efficiency does not degrade over time because of changes in codes. There are some good reasons for this.

Remember that an investor is investing based on a cashflow. The cashflow is based on what we know today. We don't know where codes will be. Remember that 5 (or so) years ago, auto efficiency standards went backwards. That could happen to codes too. We can't know. We also can't tell an investor that the cashflow is based on the whims of local codes.

In addition, the fact that codes change does not mean that buildings will suddenly be brought up to code. We can't know when/if that will happen. There are plenty of stories of building owners actually *delaying* upgrades because they don't want to spend the money to meet new code requirements.

So, you write a 20-year PPA based on the *existing* conditions baseline. That is all that you know is true.

Remember also that, in the end, tenants in a building are going to pay (one way or another) for changes in the building. That includes ones involving code changes. Under MEETS, that is simply dealt with by energy professionals using the value of delivered energy (including Efficiency Energy) as the mechanism to pay for all kinds of useful energy improvements in the building.

Finally, remember the 3-30-300 rule (of thumb).

In a commercial building a tenant pays:

$3/sq' for energy

$30/sq' for rent

$300/sq' for people.

So, we are "worried" about the $3/sq' number and whether it is "fair." The tenants want a better building for their $30/sq', and happier $300/sq' employees. Moving the $3/sq' number 10% is 30 cents/sq'. The energy community spends a lot of time wringing its hands over that number. I think we can agree that re-thinking that might be in order.

Regarding the Passive House buildings in Seattle -- The baseline is based on Seattle's building code at the time of permitting. Passive House is about 40% more efficient than code, so there is your basis for the cashflow. The idea is that the MEETS payments will make Passive House cost-neutral with a code building. Then Passive House is the new normal.

Expand full comment

Thank you!

Expand full comment

Of course. I appreciate the thoughtful questions.

Expand full comment

I found this fascinating though admit that I had some challenges understanding parts of the structure. I think it is the discomfort with efficiency as a type of energy that is hard to overcome. Anyway, I had a few questions:

1. Is there any challenge finding the energy tenants?

2. Is there any conflict between actual tenants and energy tenants in terms of defining the efficiency measures. It was described as though everything was win/win - is this always the case?

3. I did not understand how this would work with new passive house or very high building standards. Are you defining efficiency gains against a counterfactual benchmark?

4. Related to this, what are the characteristics of buildings for which this model works best? 9is it about available/affordable efficiency gains, or about the types of tenants and PPA, etc?).

Thank you.

Expand full comment

I'd like to chime in here and make one comment about something you mentioned in question 2. (Rob said this in the podcast, but it went by so quick I worry people missed it and it's such an important point.)

The energy tenant is no less a tenant than any other tenant. The word "lease," as a legal term, refers to a contract where person A owns some piece of property, person B would like to use that property, and so person B will pay person A for the right to use that property. This payment from person B to person A is called "rent." This is an accurate description of the relationship between the energy tenant and the building owner; the energy tenant is paying the building owner for the right to use the building in the energy tenant's business.

The fact that the energy tenant is truly a tenant and the payments from energy tenant to building owner are rent is critical for getting the transaction to work for several reasons. One reason is that bigger buildings are often owned by a type of investment fund called a "real estate investment trust," or "REIT" for short. REIT is a preferable tax status, and one of the rules these funds need to follow to keep that status is at least 75% of the building's income needs to be rent (or something similar to rent).

Another reason its so important to make clear this is a landlord-tenant relationship are tax depreciation rules. If an energy tenant is going to pay for the improvements to the building, they'll want to claim an income tax deduction for the cost of those improvements as a business expense. But the federal income tax code's general rule says a business has to own an asset to claim a deduction for depreciation expense. ("Depreciation," by the way, is just the word accountants use for the cost of a big expensive investment that will produce income over many years--it has nothing to do with an asset losing value. Confusing, I know.) One key exception to the general rule? Unreimbursed tenant improvements. So again, understanding and acknowledging that an energy tenant is a tenant is a key part of understanding why this transaction structure really works.

Expand full comment

Being a tenant also helps if the building is put into bankruptcy. Tenants are assets, not liabilities. Judges tend to want them to keep paying rent. Tenants also have rights.

Expand full comment

1) No. There are several organizations interested in playing that role. You can see them on the MEETS website. https://www.meetscoalition.org/about-the-coalition/members/

2) The goal is that the tenants go on with their work/life as usual. Just more efficiently. At the Bullitt Center, the tenants also receive benefits if they meet certain energy use targets. All of this is left up to the stakeholders to decide.

3) Seattle uses the City energy code as the benchmark/baseline. Any performance better than that is paid for under the MEETS agreement. The two Passive House (multi-family) buildings are targeted at ~40% better than (a pretty strict) code.

4) Buildings larger that 50,000 sq' are ideal. High energy use raises the potential efficiency gains to harvest (along with the grid and climate benefits). Split incentives create additional benefits to harvest, but the structure helps regardless.

Expand full comment

Thanks for clarifying

Expand full comment

You bet.

Expand full comment

Excellent episode. Brilliant concept. I wonder if Tesla is considering the future of its energy+roofing division as an "EESCO" since they have yet to finalize/formalize their relationship with CA and its utilities...

Expand full comment

This was so fascinating, thanks so much for a great discussion.

The part of the model I had trouble figuring out is how the long time horizons for payoff of efficiency investments works. As I understand it, the energy tenant finds the money to make investments in energy efficiency that may be expensive and take decades to pay off. But their source of income is selling efficiency back to the utilities, presumably at the price per kWh that the utility sells energy.

At the beginning of that time horizon it is easy to see how the value of that efficiency is predictable and easy to price so the revenue from selling to the utility is knowable and stable. But 15 years from now or more, how do you know the value of the energy savings at prevailing rates in the future? Especially given the uncertainty associated with bringing more inexpensive renewable energy online.

And, secondarily, how do you make sure that the utility (or, importantly, a utility's successor) honors the agreement for the duration of the payback horizon? Once the investment is made by the energy tenant, the utility has gotten all the benefit forever. If it stops paying the energy tenant for energy efficiency, it's not like the energy tenant can go back and remove insulation from the building or convert it back to a natural gas furnace.

Expand full comment

I think maybe the answer to the first question is that everyone involved agrees to use a metering tool (such as EnergyRM's DeltaMeter), and part of the contract is that everyone involved agrees that the DeltaMeter's word is gospel.

I think probably the answer to the second question is lawyers.

Expand full comment

Does a metering tool solve the problem though? As I understand it a metering tool would help you measure the energy savings, but it wouldn't necessarily price the value of those savings.

I guess as a lawyer I have an answer for #2 which is - contract around it. But I am the wrong kind of lawyer to know exactly how that would work especially in case of successor companies (or a utility bankruptcy). I suppose those are somewhat predictable/measurable risks for the energy tenant as they sign the contracts today.

Expand full comment

Think about a windfarm. We don't ask these questions of a windfarm. MEETS is like a windfarm.

We are dealing with *project* not *widget* finance. No one asks which wind turbines have which "paybacks." It is a *project* that is being financed, based on a *contract* with the utility.

The contract terms are establishes at the beginning. They are legally binding.

Remember that utilities are regulated entities. They pay their bills.

In addition, the "value" of the efficiency simply can't equal the "price" for any prolonged period of time because the investor wants a known price and the value will fluctuate. But that is true in all long-term contracts.

Expand full comment

Hm, well I'm now out of my depth, but here is a link to Seattle City Light's detailed documents on their version of MEETS, if it helps.

https://powerlines.seattle.gov/eeas/

Expand full comment