Paper 5: Finance for industry decarbonisation

I am not a finance expert, so what I will propose here is not based on my depth of subject matter expertise, but more based on my 40+ years of experience in trying to make projects proceed in industry from the perspective of a government official (2 years) and a consultant (30 years), and then not for profits (10 years)

In this article, I will not be addressing the drivers and need for finance of the cohort of 40-40 or so industrial companies that are regulated under the safeguard mechanism, as they have a driver to action, though many of the remarks will be as relevant for these companies as for smaller emitting companies.

Finance is a lubricant – it won’t make projects that are unattractive to the business fly, but it can help accelerate solid projects where the up-front capital cost is a major barrier, though as discussed below, it has limitations in its application.

In my experience, business prioritises constrained available capital funds in this manner (after the mandatory activities they need to invest in to keep the business running):

1. Business tends to put production investments first – to improve quality, quantity, new features/advances for clients.
2. Second is often labour productivity projects – automation, AI, and other potential labour savings/productivity enhancements.
3. Other operating cost savings projects like energy, must compete on their own merit based on a fast payback (i.e. less than 3 years) even if low perceived risk, and they tend to have to wait until there the above list is exhausted, which means there generally needs to be another driver.

Other drivers that can put reprioritise these projects:

• Must do them – regulation e.g. safeguard mechanism, safety related.
• Company policy commitment e.g. carbon mitigation (but are they serious when it comes to spend?)
• Desirable to do to protect their license to operate

4. Last on the list, if not above, is environmental improvement projects without clear ROI.

Extra debt finance has limited application in industry

Many companies would be open to taking on more debt to do energy/carbon savings projects that have attractive payback and other benefits, but they often operate close to their debt limits once they have committed funds to the higher priority projects as discussed above. This means that they can’t take on significantly more debt, even if available at competitive interest rates. When I was running Energetics back in the day, we worked with CEFC to establish a debt facility so we could offer discounted debt as a package with energy services to allow a committed ROI for a portfolio of energy savings projects. We abandoned the effort after 6 months of knockbacks from companies that either said they could access debt at lower rates from their international parent or they were too close to their debt ceiling with their primary banker.

So, I am not confident that the traditional discounted interest rate debt model from CEFC will work for most businesses directly, some energy services companies would find it valuable if they don’t have access to this level of debt finance at lower cost.

If the government through CEFC could provide loan guarantees or other mechanisms for reducing risk this would be of great value as the perceived risk of many of these projects using technologies like heat pumps which are not well known and proven with industry in Australia is holding back progress. ??????????

Service offerings to make it easier for business to get attractive projects across the line:

Energy Services Companies (ESCO) (which seem to be of interest to the Commonwealth at present). These businesses have had some success in USA in the public sector, but not much in industry. These models are predicated on the service provider taking some risk for delivering savings, and in most cases make the capital investment as well. ?

The challenge is balancing the risk and reward so both parties have something significant to gain. This is a real challenge in industry as generally the plant operations are out of the control of the service provider, there are so many variables that can change (the simplest being changes in throughput) that developing a commercial model that will work in most eventualities is highly challenging. To do this, the plant needs to have adequate metering in place to measure all the key variables (which is not the case in most operations), and the providers needs to be able to submit a model which the manufacturer agrees to, to determine the savings.

The other challenge for all types of models is the fact that most industrial applications are site specific, so the service provider needs to design each one individually, and there is limited opportunity for taking a successful implementation and replicating it at multiple sites, as they may be able to with office buildings.

Energy as a service model.

In this case the service company purchases (and retains ownership of) the new energy services plant and operates it to minimise costs within parameters agreed by company. The service company then gets its primary revenue stream from selling an energy service e.g. hot water, cold water, steam, or perhaps lighting. Energy retailers may have a particular advantage making this model work through leveraging their expertise in managing energy supply price risk, aided strongly by making investments in site load flexibility (including energy storage – see paper 3).

Some of the challenges with this model include some of the same risk issues above relating to control and risk management. In addition, in this model there is the question about whether companies are willing to hand over any level of control of plant to an external company and be dependant for that company for the supply of key energy services.

Also, these models may be harder to implement where the most economical option for electrification is multiple distributed heat pumps vs. centralised services, but on the other hand the potential savings are much great with this distributed approach where it allows elimination of services distribution heat losses.

Another challenge is determining how/whether services companies can capture other productivity savings, as this is often where the major financial benefits lie for the manufacturer, vs. the energy savings alone.

A variety of these models may succeed, but none will get off the ground without either:

• A mandate for company action
• Additional costs to avoid through doing the projects – i.e. a levy or C tax.
• Grant funding to improve the payback and bring it within the hurdle rate of most companies.
• Other mechanisms for reducing risk for the financier or the end user like load guarantees, particularly in the early years of the electrification programs.

So, finance is a useful lubricant to accelerate good projects, but far from a panacea for driving industrial decarbonisation at scale.

Look out for Paper 6 in this series on some of the research that needs to be done to support decarbonisation of industry, and the earlier 4 papers, all of which are posted on LinkedIn.