Finding the finance for Europe’s neighbourhood energy transition
Energy generation is the easy part. Today’s more complex investments require more knowledge. Is the energy transition fair? That’s the hard part.”
Triodos Bank N.V.
This is a quote from our recent interview series held with 15 investors, SMEs, and venture capital firms, discussing the financing challenges and opportunities for Positive Energy Neighbourhoods (PENs). And it’s instructive of the problems that Europe’s residential energy transition now faces.
When it comes to building neighbourhoods that can power themselves with green electricity, desirability and demand is not the issue. The European Union has signalled clearly that it wants to see 100 Positive Energy Neighbourhoods by 2025.
High levels of technology readiness mean these systems are also already technically feasible – we’ve seen this first-hand through our support for the cities of Genk, Pamplona and Tartu. But Europe’s next big barrier to scaling green, self-sufficient neighbourhoods across Europe is one of financial and business readiness. How do we pay for these systems? And who is best positioned to invest, under what conditions, and expecting what benefits?
For now, at least, mainstream finance does not have all the answers. Commercial investors typically expect high returns over short periods (up to 10 years). This is unsuitable for positive energy neighbourhoods, which deliver modest commercial benefits (but generate significant social and environmental good) over several decades.
There are even challenges for the more sustainable and long-term finance institutions. Despite its ambitions, the European Union’s EU Taxonomy framework, which guides investment standards towards sustainable activities, does not capture all the benefits of a Positive Energy Neighbourhood, meaning that a significant component of the PEN value proposition goes ignored.
Despite the multiple factors which make PENs an excellent ESG investment for citizens, local businesses, and local governments – including participatory processes, climate change mitigation, new jobs, and the social and heritage benefits of retrofitting – these advantages are not well reflected in current investment assessments, which mainly focus on return-on-investment as the core guiding metric.
As well, many of the potential revenue streams that could make such local energy projects highly lucrative investments simply cannot be monetised yet. When we spoke to Cleanwatts, an integrated solar PV-as-as-service provider to rural communities in Portugal, they noted “Battery revenue from flexibility markets is not yet permitted by regulation in Portugal”. This excludes hundreds of thousands of euros of potential income from the business case of these systems, leaving them to rely on energy savings through solar generation alone.
Despite these large-scale challenges to regulation and investment valuation, promising business models are emerging that could soon support the business case for local energy production through PEN projects. Specifically, the Local Energy Systems team at Bax & Company is investigating three models through the Horizon Europe project oPEN Lab.
Finance stacking and blended finance
A common technique in financing large projects, the first possibility for local energy systems, is to ‘stack’ or ‘blend’ multiple sources of public and private funding. As the table below shows, there are many instruments that, when stacked together, can be combined to support a viable investment case – and which benefit from a diversity of different financing conditions from multi-sectoral investors with different expectations and time horizons. For example, public sector investors may accept low financial returns in favour of positive socio-economic outcomes, while more aggressive commercial lenders would require higher financial payback.
Take, for example, a typical commercial bank: it generally requires the project developer to provide 20-30% of the total cost upfront before it agrees to finance the remaining amount through an interest-bearing loan. To meet this equity requirement, a combination of public grants, subsidies, and community shares obtained via crowdfunding can be utilised.
This was the model employed by the Amsterdam Cooperative De Warren, which stacked equity to reach the 25% threshold offered by ethical German bank GLS. The stacking included €300,000 raised through community shares, alongside subsidies and contributions from the province. With the 25% secured, De Warren then borrowed the remaining €8 million at a low 3% interest rate from the bank.
Table adapted from Positive Energy Neighbourhoods: Overcoming financial and market barriers and based on Bertoldi et al., 2020;10 Papapostolou et al., 202311
Energy as a Service (EaaS)
Servitisation is an increasingly popular business model across all sectors – from Spotify for music to Airbnb for accommodation. The clean energy sector is no exception. This model involves an energy company taking on a substantial portion of the capital expenditure (CAPEX) and maintenance costs of an energy system, thereby lowering the barrier for building owners and communities to establish their own systems. It eliminates the need for sourcing upfront capital and hiring ongoing maintenance expertise. To recover their costs, the energy company retains a portion of the savings achieved through the energy system.
This is also a much more attractive model for banks, who are wary of taking on bulky, highly illiquid assets like the apparatus of an energy system. Energy companies are also typically more reliable debtors than local communities, which may have unclear governance structures and limited business management expertise. As energy finance experts at BASE Energy told us, “Banks do not like to own assets and are increasingly moving towards a service model. Banks would not sign a contract with end customers but rather with solution providers”.
This Energy-as-a-service (EaaS) model typically means better outcomes for customers too. Service providers usually issue an Energy Performance Contract, ensuring operational efficiency and cost savings for the end-user, and frequently transferring asset ownership to them eventually.
This model is particularly appealing for financing and implementing Positive Energy Neighbourhoods, as there’s no certainty that stakeholders in a PEN possess the requisite energy expertise or the initial capital to overcome the high CAPEX barrier. Collaborating with an energy service company (ESCO) to provide energy generation and efficiency services, thereby forming the financial backbone for PENs, could be a practical approach for building owners and tenants accustomed to conventional energy billing methods.”
Sustainable long-term financial calculations
The final area of potential development in financing PENs concerns the risk factors banks consider during due diligence for loans to energy systems. Currently, most banks adopt a limited perspective on such investments, focusing on key metrics like the debt-equity ratio (D/E) and debt-service coverage ratio (DSCR) to evaluate investability.
A focus on short-term recuperation of funds clashes with the fundamentally long-term nature and benefits potential of PEN energy and housing projects. When considering only the debt-service coverage ratio and a short 7-to-10-year repayment period, many of the long-term benefits are hidden from view. These include increased property value for mortgaged homes (with examples in the US and Europe showing a 20-30% increase after energy efficiency measures were implemented) – decreased financial pressure on homeowners, lower local grid investment, and the comfort and health benefits associated with energy renovations.
Although these non-monetary societal benefits may have little appeal to fully commercial banks, financial institutions with a leaning towards long-term green and ‘patient’ capital investments could widen the consideration of economic benefit when analysing PENs. The role of public guarantees here becomes crucial. Public banks, such as the European Investment Bank (EIB), could underwrite private loans for ambitious ESG projects in the case of default, therefore unlocking new private investments that might otherwise be overlooked.
To the Future
Blended finance, service models, and public-backed ‘patient’ capital could be some of the tools to meaningfully advance financial readiness for the energy transition in the short-to-medium term. Within the next five years, we expect to see a mortgage for a solar-storage energy system just as you would for a house.
But on a longer time horizon, over the next 5 to 10 years, the most likely scenario is that mortgages will encompass both the house and its energy system. With the European Union aiming for a 55% reduction in carbon emissions by 2030, every new construction will need to incorporate a well-considered renewable energy strategy.
In our experience, the simplest way to make this happen is to integrate energy systems into the construction of houses. This approach would allow for the financing of both the home and its clean energy system under a single mortgage. Such a model would apply not only to single-occupancy homes but also to apartment complexes, office buildings, and industrial centres.
Increasing FRL through collaboration
Currently, Europe is a long way off from having a mature set of financial products that can effectively incentivise combined investments into energy systems and dwellings. The only path to progress lies in the cooperation between public authorities with ambitious ESG support programmes (such as public guarantees, and municipal green bonds), the construction sector which can build (or better, renovate) them, and the finance sector that can find a positive financial case for them.
Together, these sectors must develop a new generation of innovative public-private solutions leveraging their respective sectoral capacities and mandates, scaling local energy systems with both attractive business models and inclusive social and environmental benefits for all.
To achieve this, stakeholders will need to adopt a methodical yet ambitious strategy to improve the financial readiness level (FRL). This is precisely what Bax & Company is supporting the oPEN Lab alliance in doing.
Learn more about financing PENs
Learn more about financing positive energy neighbourhoods.
Talk to Dom or read the full financing report in partnership with oPEN Lab here.