Local authorities are taking an increasingly active role in bringing about a clean energy future. Their biggest worry: how to finance their efforts. One way is outsourcing to energy service companies, another is crowdfunding. But perhaps the most effective method to raise substantial money is by giving out municipal bonds. Clare Taylor takes a look at the blossoming municipal bond market for sustainable energy projects in Europe and the US and identifies some of the secrets to success: “Stability is the key word”.
“A radical change of course at the global level is long overdue.” said International Energy Agency (IEA) Executive Director Maria van der Hoeven recently in Seoul, citing a new IEA report which finds that an additional US$44 trillion in investment is needed to secure a clean-energy future by 2050. So that’s round-about a trillion a year – rather a dizzying global number.
Think global, act local is what they said in the 1970s. But where do the local and global meet nowadays?
Across Europe, local and regional authorities account for two-thirds (€178.9 billion in 2011) of total public investment expenditure. Local governments in more than 300 regions and 91,000 municipalities have a major role to play in key sectors such as education, the environment, transport and economic development. European energy legislation has repeatedly targeted the public sector to lead in achieving climate and energy targets. Partly as a consequence of the popular Covenant of Mayors initiative, more than 3,000 local governments now have sustainable energy action plans in place – and the political and legislative support for decarbonising local and regional public services.
The big question for them is how to fund these actions. The public purse can only stretch so far. Estimates of the size of public sector investment in energy efficiency and renewables needed in Europe vary considerably but are generally in the order of tens of billions per year. Given the decentralised, heterogenous nature of the sector – from sizeable city-states to tiny rural municipalities – there’s no simple solution here.
Not for everyone
Outsourced energy services are routinely touted as a solution by policymakers – such as the European Commission’s Directorate-General for Energy’s recent Energy Performance Contracting campaign.
In essence, in energy performance contracting an energy service company (ESCO) is engaged to improve the energy efficiency of a facility, with the energy savings paying for the capital investment required. Overall the ESCO market in Western Europe has a volume of around €3 billion (2012). The business model for simple projects with short payback times – such as energy efficient street lighting, a responsibility for most municipalities – is reasonably well-established. Deep renovation of buildings with payback periods of 15-20 years is a trickier proposition for investors, but essential to achieve decarbonisation of the buildings sector.
In Denmark, due to an increasing number of ESCO projects in the public sector, the ESCO and EPC market has boomed in recent years. Crucially, capital investment here has been enabled by central government soft loans, and a single ESCO-provider (Schneider Electric) has a large share of the market (approximately half of all contracts so far).
In the UK, a nationwide rollout of the Greater London Authority project RE:FIT is opening up the public sector market for outsourced energy services by providing standardised contracts and a limited number of suppliers. The RE:FIT Framework streamlines the procurement process for energy services by providing pre-negotiated, EU-regulation-compliant contracts that can be used with a group of 13 pre-qualified ESCOs. In Ireland, a recently launched investment fund seeded by a combination of public and private money will lend to ESCO projects in the public and private sector.
It’s not for everyone however. There is still a widespread skepticism towards the ESCO-concept amongst many municipalities, and the debate is ongoing on the pros and cons of ESCO-contracting. As well as views on the transaction costs and economic viability of the ESCO-model, there is also a degree of wariness about long-term collaboration, loss of control and uncertainty over managing future changes in the building portfolio (e.g. if a municipality wants to sell buildings during the contract period).
Small is beautiful
What other ways are there for private capital to invest in local sustainable energy projects? Given the mandate of local authorities in providing community facilities, it’s mooted that community finance might have a role to play here, and be suited to the investment scale at local level.
Typically, a major energy efficiency retrofit for a large hospital may only account for €10-20 million investment capital maximum, and many projects will be in the €1-5 million range. Still more projects will be measured in the thousands or perhaps hundreds of thousands of Euros. The most successful crowdfunding campaigns have generated funding around the tens-of-millions mark – so topping out at about the same level as the hospital retrofit.
Small is beautiful, but it would take a hell of a lot of crowdfunding campaigns to get to the trillion dollars-a-year investment level. And the cost of transitioning to a low carbon society gets bigger and the consequences more dangerous the longer we wait. Serious amounts of investment capital can only come from the money markets.
So where does local government connect with the global markets?
Bonds. No, not James Bond – but municipal bonds. The municipal bonds market is well developed in the U.S. (extending to some US$2,800 billion), but a lot less so in Europe. Basically a bond is a debt in which the authorised issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (coupon) and/or to repay the principal at a later date, termed maturity. Thus the issuer is the borrower (debtor), the holder is the lender (creditor), and the coupon is the interest.
The two types of municipal bonds are general obligation bonds (principal and interest are secured by the full faith and credit of the issuer and usually supported by the issuer’s taxing power, and revenue bonds (principal and interest are secured by revenues derived from tolls, charges or rents from the facility built with the proceeds of the bond issue).
Back in 2002, the city of Varna in Bulgaria issued municipal bonds to obtain financing for an energy efficiency project involving retrofit and modernisation of the city’s street lighting. The bonds raised €3 million, and the simple payback of the project was 2 years and 9 months. The municipality collected relatively high volumes of financing by issuing general obligation bonds at 9%. Repayment of the bonds was done in three equal portions during a three year period, primarily as revenue bond emission through the savings.
But usually bonds are issued on a much greater scale – typically in the range of hundreds of millions of Euros. For this scale, a dedicated municipal bonds agency is required – to aggregate the borrowings from a number of local governments, raise capital on the financial markets through the sale of bonds and lend on the proceeds to eligible councils at a lower rate than if the councils were to issue their own bonds.
A leading example of a national (municipal bonds) funding agency in Europe is Kommuninvest in Sweden. Set up in 1986, Kommuninvest is triple A rated and borrows using bonds. It lends the funds to 260 local authorities to fund projects such as roads and renewable energy. In 2012 its target was to lend more than €20 billion. And last September, the Swedish city of Gothenburg issued a 6-year ‘green’ bond to fund public transport, water management, energy and waste management projects. This raised €50 million and was oversubscribed. A second issuance is planned for the coming weeks. Three French provinces have also raised money via bond issuance to fund green social housing, renewable energy and energy efficiency projects.
Although public budgets have been squeezed hard in the recession, local governments on the whole show a healthier balance sheet than national government. Local governments have an average debt level of around 7% of GDP, in comparison with a central government average of more than 80% of GDP. A case in point is the city of Birmingham in the UK, which has the benefit of a triple A rating from Moodys and AA+ from Standard and Poors – a better rating than Germany.
And so far, investors appear to have quite an appetite for ‘green muni’ bonds. Last year, the state of Massachusetts issued a US$100 million green bond alongside regular bonds with exactly the same yield. The state hoped to raise US$1 billion from the regular bonds, but found that it could only sell US$575 million, while the green bond was 30% oversubscribed. It also found that the green bond attracted a whole new set of institutions, helping it to diversify its investor base.
In Europe national municipal bond agencies exist in Finland, Sweden, Denmark, the Netherlands, Switzerland, and Italy. France just recently joined the club with the creation of Agence France Locale, and the UK Local Government Association is set to follow suit, reckoning that the local government collective municipal bond agency could save councils more than €1 billion in borrowing costs. The cofounder of Kommuninvest and advisor to local authorities, Lars M. Andersson, says that Germany, Spain, Turkey, Mexico, and South Africa are showing strong interest in creating national municipal bond agencies.
What conditions are required for setting up municipal bond agencies? “Stability is the key word here” says Andersson. Local governments must have the power to raise taxes, or be assured of consistent funding via national government. The politics of the matter are about decentralisation – and how much the central government’s ministry of finance is willing to trust the local authorities.
Fiscal decentralisation (the proportion of the national budget being spent at local and regional level) varies considerably across the EU. In 2011, Denmark was ranked at the top with around 64% of total expenditure being carried out on the subnational level. In contrast, Malta had only a 2% share. British councils raise less than 5% of their revenue locally, against 60% for their counterparts in Germany.
The global economic crisis has had a profound impact on national and regional budgets, limiting availability of funding across all areas of investment. In the EU as a whole, public investment declined by 20% in real terms between 2008 and 2013. In Greece, Spain and Ireland, the decline was around 60%. In the central and eastern countries public investment fell by a third.
The correlation of public investments and growth has been established by a number of studies undertaken by IMF, OECD, the World Bank and EIB. Nobel Prize winner Paul Krugman has emphasised its importance by writing: ‘Everything we know about economic growth says that a well-educated population and high-quality infrastructure are crucial’.
Local green growth, powered by the global capital markets. It’s a tantalizing vision…
Clare Taylor is a communicator specialised in energy and environment, and a chronic idealist. Follow @Clare__Taylor
If you want to learn more about new ways of financing local government, you may like to attend the Financing Urban Develoment Conference in Paris on 3-4 July.
 Greening Public Buildings: ESCO-Contracting in Danish Municipalities http://www.mdpi.com/journal/energies