Tuesday, 8 December 2009

Energy Efficiency: Loans First, Rebates Second

Obama is now looking at spending the unexpected TARP windfall on stimulus, including home energy efficiency. While I haven't studied any of the proposal specifics, I would like to discuss the difference between loans and rebates in the context of financing residential energy efficiency.

First, it's worth noting that lower income property owners will likely bear a disproportionate amount of the climate mitigation and adaptation burden. This is for a variety of reasons.

  1. Homeowners of lower incomes tend to live in older housing stock. At least in California, the pre mid 70's housing stock in relatively inefficient. These homes have less energy-efficient appliances, HVAC and lighting systems, and are less well insulated so require more use of this relatively inefficient equipment.
  2. Smart investments in energy efficiency are NPV-positive and have a relatively short payback period, but these investments require up-front financing. Lower income homeowners have less of an ability to finance energy efficiency projects than homeowners with higher incomes.
  3. The combination of energy prices increases and a warming climate will place a significant burden on households unable to adapt. As these factors increase the relative costs of inefficiency, homeowners that are able to weatherize and make their homes more energy efficient will do so.


Up-front rebates are a good economic stimulus policy, as they will, lower the direct private cost of an energy efficiency and weatherization retrofit. This will spur new demand, which will drive both construction and manufacturing job growth. The homeowner will benefit from lower energy bills, and more monthly free cashflow, which will further stimulate the economy (provided it is spent in a sector with a higher multiplier than energy, and most consumer sectors do).

However, unless they eliminate all financing needs, up-front rebates do not assist those who are least able to afford a home retrofit. To serve these households, a financing system is needed. The state of California allows a financing system that allows households to engage in NPV-positive investments that will decrease energy bills and increase free-cash-flows. California's AB 811 allows property tax financing of renewable energy and energy efficiency. Property tax financing has many advantages to a private loan.

  1. Debt is a tax lien and is senior to all other claims on the house (first mortgage, subsequent mortgages). Thus, it is very low-risk and the interest rate can be substantially lower than for a private loan.
  2. No money down. No credit check required. Because of the low risk, the loan can be provided at no up-front cost. This eliminates all financing barriers for homeowners.
  3. The loan term can be 5, 10, 15, or 20 years. The burden of higher property taxes is spread over a long time, and the homeowner can immediately reap the benefits of decreased energy costs. The homeowner is cash-flow positive from month 1, and provided the investment was smart, remains better off after the semi-annual payments.
  4. The cost of the improvements are passed to subsequent owners of the house, virtually eliminating the possibility that a homeowner's energy efficiency investment will be unrecouped on-sale. This removes a significant barrier: energy efficiency investments can be hard to value in residential real estate markets.
One of the biggest advantages of property-tax financing is that it comes from a revolving fund: that means money paid out is paid back - with interest. Rebates are not directly repaid, but do have a place in energy efficiency financing policy.

This policy sounds like a win-win, but California local governments have been slow to adopt such property-tax financing. Anecdotal evidence indicates that high financing costs in municipal bond markets may be to blame. If this is the case, making TARP funds available to local governments would greatly stimulate the establishment of revolving funds for property-tax financing of energy efficiency projects. While the policy could be structured in such a way that when municipal financial markets improve the TARP funds are eventually replaced by Municipal Bonds and repaid to the federal government, I think that the idea that these funds be permanent should be explored. There is a huge need for energy efficiency financing in this country, and I believe that the initial success of a large-scale ($25B or more) property-tax financing program will open municipal bond markets up to finance program expansion.

There are some further policy challenges: ensuring that low income homeowners only engage in NPV-positive investments, eliminating potential for fraud and abuse that comes with free-money programs. Further study is needed into the administrative effectiveness of local programs, which currently exist in Palm Desert, Sonoma County, and Berkeley and are expanding to other areas of the state. Also needed is evaluation of individual projects (analysis of NPV of various projects will allow policymakers to better understand how to affect consumer choice toward NPV-positive projects).

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For more information about the distributional effects of climate change, see The Climate Gap, a USC report on the distribution of climate change impacts in California.