Market Analysis

Energy efficiency in buildings: A ~$1T opportunity – annually

February 9, 2023
Home insulation
Photo Credit: Eric McLean, Unsplash

In a previous post, we laid out where financing is needed within the climate landscape. Next in our series, we go deep into some of the sectors that require the most capital if we are to achieve Net Zero. Today, we focus on energy efficiency - which, according to the International Renewable Energy Agency (IRENA), will require 22% of investment over the coming decades. This is the largest of any segment.

What is the role of energy efficiency in mitigating climate change?

Improvements in energy efficiency - producing the same output, with less energy - have already had a big hand in reducing the scale of global climate change. Over the last four decades, energy consumption and carbon emissions would have been 60% higher without energy efficiency measures. Energy use has halved relative to the size of the US economy in that time, partly driven by federal appliance efficiency mandates. The International Energy Agency (IEA) now describes energy efficiency as the “first fuel” of the energy transition because it has an effect before any other fuels are even selected.

Energy efficiency spans three core areas:

  • Buildings, worth 28% of global energy-related CO2 emissions in 2019. This includes measures such as improved heating and cooling systems, insulation, lighting, and appliances
  • Industry (42% of energy-related emissions, including the construction industry), particularly in energy-intensive industries such as chemicals production and metals production. Energy efficiency measures include process improvements (e.g., lowering cement clinker discharge temperatures in cement-making) and new technologies (e.g., replacing coal furnaces with electric arc furnaces in steel-making).
  • Transport (23% of energy-related emissions), where energy efficiency includes shifting to different forms of transport, improvements to tire energy efficiency, better fleet and route management, and higher fuel economy standards.

How much more do we need to spend on energy efficiency to achieve Net Zero?

Investment in energy efficiency needs to increase by ~5x in order to achieve Net Zero, from $249B annually to $1.5T annually according to IRENA. This is the most of any segment across the energy transition.

The bulk of this increase will need to come from energy efficiency improvements in buildings, requiring an additional $824B annually (or 65% of the $1.5T in total energy efficiency spending needed). Industrial energy efficiency will require an additional $309B annually (24% of the total) and transport energy efficiency will require another $92B (11%).

In the rest of this article, we focus on the opportunity in the buildings segment given that it is the largest component of this spending. One reason we are excited by the segment is that buildings-based energy efficiency gains are by definition distributed across a huge number of different assets and parties. This means that the opportunity for climate fintech is significant, since capital is needed by many parties rather than for, say, a smaller number of large grid upgrade projects.

What financing is needed to improve energy efficiency in buildings?

The majority of the $1.5T in annual financing required for energy efficiency will likely come from market-rate debt, including commercial lending and capital markets. This would fund a variety of mature technology, including hardware such as heat pumps, insulation, LED lighting, HVAC motors, and efficient water fixtures. It could also be integrated with smart home software platforms, such as thermostat management, lighting and temperature control, and water efficiency programs.

There could be over $600B of demand for market-rate debt for building energy efficiency. If market-rate debt retains its ~60% share of all financing for the energy efficiency sector, this would imply a ~$600B need every year until 2030. The remainder would come from equity, grants, and concessional debt. (In reality, we believe the true figure may be even higher, as energy efficiency technologies continue to mature and transition from equity-based and concessional debt financing to market-rate debt).

How much of a barrier does financing present to decarbonizing buildings?

Financing is one of multiple challenges facing building decarbonization. As our friend Michael Thomas has written, consumers face a number of issues such as the lack of available and qualified contractors in their area, as well as inertia bias (where it is easier to simply replace existing technology rather than scope out new solutions). Moreover, the cost effectiveness of building decarbonization will vary significantly by region, house size and type, and regional energy supply, amongst other factors. This creates complexity in scaling nationally.

Successful entrants in the building decarbonization space will need to offer auxiliary products addressing these other challenges, in addition to financing. Pure financing plays are liable to be undercut by larger financiers. They are also unlikely to move the needle on building decarbonization alone, given the range of challenges facing customers. We therefore believe integrated platforms are best-positioned to succeed in this market. For example, contractors face significant costs in finding customers, assessing potential projects, estimating the full stack of tax credits and funding available, and generating accurate quotes. A successful contractor-facing platform could address some (or all) of these barriers, while also integrating a competitive financing offering too.

What opportunities exist today in financing for residential energy efficiency?

The primary financing challenge for customers is the mismatch between the upfront cost of - and long-term savings generated by - residential heating and cooling.  Insulating the average American home can cost up to ~$10,000 in upfront costs, while the median American has savings of ~$5,300. Savings from energy efficiency improvements can take a significant time to break-even: The EPA estimates that customers save 10-20% on their total energy costs by air-sealing their homes and adding insulation in key areas, meaning the payback period can vary from a matter of months to many years. This is the same for heat pumps: One recent study found that the payback period can be as little as 6 months to over 10 years, depending on what fuel the pump is replacing, the nature of the house, and the region in which the house is located.

Innovative financing mechanisms can bridge the gap between high upfront costs and long-term savings. Some examples we see in the market include:

  • Efficiency-as-a-service, where customers have no upfront cost and pay a recurring fee for a service. For example, US-based Sealed finances heat pump installation and weatherization for consumers by charging them according to energy saved when compared to their previous system. Similarly, Service 1st Financial recently raised a $15M debt facility for its “home comfort as a service” offering, where homeowners pay a monthly recurring lease-to-own fee for electric heat pumps
  • Lease-to-own, where customers pay for a product in monthly lease payments that include an additional fee for the lender. Before the end of the lease, customers can purchase the piece of hardware outright or continue leasing until the end of their contract. An example is Microf, who offer financing for HVAC and heat pumps to customers with poor credit scores, through a network of preferred HVAC distributors.
  • Point-of-sale consumer lending, where fintech players offer contractors a point-of-sale platform to provide customers with conventional consumer loans to pay for hardware installations. For example, GreenSky - operating since 2006 - offers home improvement contractors a point-of-sale tool that directly connects customers with potential sources of financing, including from its recent acquirer Goldman Sachs.

The opportunity in the US for home energy efficiency fintech will be enhanced by the Inflation Reduction Act. The legislation provides $390B of funding for climate, including significant increases in tax credits for home energy efficiency measures such as heat pumps, electric appliances, and hot water systems. This should improve the case for customers to invest in home energy efficiency. As a result, we expect significant growth in the market.

What opportunities exist today in financing for commercial energy efficiency?

Many small- and medium-sized businesses face similar difficulties in financing energy efficiency improvements. Financing that is tailored to the unique profile of energy efficiency investments - and which is offered at the scale required by these businesses - could tap into large demand from business owners.

We also see significant whitespace outside of the US. For example, Europe has a stock of ~50 million homes that would benefit from deep renovation to improve energy efficiency, according to Climate Strategy. The economic case for energy efficiency has been greatly enhanced by the energy crisis Europe faces: Wholesale gas and electricity prices have increased as much as 15x since early 2021. This has trickled down to consumers - in the UK, for example, the average household’s energy bill has increased 80% year-on-year. Across the EU more broadly, consumer energy price inflation rose to ~40% in the year to October, pushing one in four European households into energy poverty. Businesses that help homeowners manage the upfront capital costs of energy efficiency improvements are well-positioned to help consumers manage these costs.

Acknowledgements: Thank you to Baker Shogry and Michael Thomas for their input to this article. We would also like to thank the Climate Policy Initiative for assisting with some of the data used to generate this insight.

As ever, we would love to hear from you:

  • What are the most exciting types of energy efficiency improvements from a fintech perspective?
  • What markets do you see opportunities in for energy efficiency financing?
  • Who is doing this well today, and why?