While public policy and the media tend to focus on technological innovation as the key to addressing climate change and boosting clean energy, business model innovation (BMI) offers a path to rapid deployment of existing technologies. The concept was popularized and given its current acronym by Mark Johnson, Clayton Christensen, and Henning Kagermann in their Dec. 2008 Harvard Business Review article “Reinventing Your Business Model.” They point out that “Low-cost U.S. airlines grew from a blip on the radar screen to 55% of the market value of all carriers. Fully 11 of the 27 companies born in the last quarter century that grew their way into the Fortune 500 in the past 10 years did so through business model innovation.”

The potential for BMI in the development of the cleantech sector is only just beginning to be appreciated. Rob Day, a partner with Black Coral Capital in Boston, recently wrote about a new wave of startups that run lean and require less capital to scale up, so are less likely to founder in the infamous Valley of Death: “Some of this next wave of startups will be hardware, but many will be software and/or services…  Business model innovation will often be stressed over technological innovation.  They will sometimes marry energy-related market opportunities with Web2.0 and social media business models and platforms.”

A closer look reveals that BMI holds particular promise for unlocking the potential of clean energy and promoting economic competitiveness, investment and employment in high-cost regions. In addition to helping keep startups lean and capital efficient, BMI can develop systemic solutions that overcome some of the many market failures and institutional barriers to energy efficiency and clean energy. McKinsey’s famous Marginal Abatement Curve heralds the good news that about one-third of needed emissions reductions appear to have positive ROI with current technologies. The bad news is that about one-third of needed emissions reductions appear to have positive ROI – yet the necessary investments are not happening, due to these many hurdles. As with Zipcar, BMI provides ways to monetize the ancillary benefits of cutting emissions, and create business models that focus on features that people are willing to pay for.

BMI-based cleantech businesses are also more likely to keep jobs in high wage regions such as the US Northeast and California. Clean energy manufacturing jobs have been moving astonishingly quickly to China, even while there is still rapid technological evolution. Evergreen Solar and A123 Batteries, both based here in Massachusetts, are cases in point. Business model innovation often focuses on software and services, developing strong relationships with customers and building on existing capabilities in the region, so jobs are more likely to stay local. These factors also help to create barriers to entry, protecting the business model. Zipcar’s network of parking spots, for example, negotiated over several years with hundreds of companies and local authorities, would not be easy to replicate.   

Better Place is a powerful example of how BMI can overcome systemic barriers to technology deployment. The company is developing a national replaceable battery infrastructure for pure electric vehicles in Israel, Denmark, and elsewhere that transforms the business model for car ownership and fuel supply. Consumers buy a car without the expensive batteries, then contract with Better Place for battery replacement as a service, which is done in just a few minutes at a network of service stations. This model overcomes the physical limitations of batteries, in terms of range and charging time, and dramatically reduces the cost of new cars for consumers. As with Zipcar, governments are willing to subsidize the operation because it contributes toward reducing congestion and greenhouse gas emissions – again, monetizing ancillary benefits.

Energy efficiency and smart grid provide many opportunities for BMI. EnerNOC’s core business model, for example, is demand response and energy management, using sophisticated software and remote monitoring and control. Enernoc links the utilities, who are willing to pay for energy efficiency and for peak-period demand reduction, to a network of customers. Energy service companies like Ameresco are increasingly offering turnkey projects and performance contracts that reduce risks, capital requirements, and uncertainty for customers. Similarly, companies like Nexamp, Tioga Energy and Borrego offer renewable power purchase agreements based on DBOOM services – a complete package where the company designs, builds, owns, operates and manages the renewable energy installation, while the customer only pays for power.

Not surprisingly, then, these BMI-based companies are among the fastest growing businesses in the cleantech sector. Kevin Doyle, a Principal of Green Economy and Co-Chair of the New England Clean Energy Council’s Workforce Development Group, has pointed to the large number employment opportunities at a range of cleantech companies, a number of which are in energy services and software. As a result, they are not just looking for engineers, but also for a range of business and professional skills and expertise – which highlights the purpose of our new clean energy programs at the University of Massachusetts, Boston!

Massive monolithic figures that cut across horizons, skyscrapers have been symbols of a city’s wealth, prosperity, and architectural ingenuity since their inception. Now, some skyscrapers are taking on another symbolic venture: a green one. New York City is home to one of the most sustainable skyscrapers in the world. The Bank of America Tower is 1,200 feet of green architecture at its finest. The second tallest building in New York City earned LEED “platinum” status in May 2010 as testament to its energy efficiency, and was the first skyscraper to receive platinum status. The $1 billion tower comes with a gray-water system that captures and re-uses rain and waste water that saves 10.3 million gallons of water annually, a crystalline design that allows for maximum use of daylight, and an onsite 4.6-megawatt generator that provides an efficient, clean power source for part of the building’s energy needs. However, energy efficiency isn’t limited to new, green skyscrapers. Some of the tallest skyscrapers in the United States are now aiming also to become some of the greenest.

In April 2009, New York City Mayor Mike Bloomberg announced plans to invest $20 million to make the 79-year-old Empire State Building, which was the first building in the world to top 100 stories, more energy efficient. With the installation of 6,500 energy-efficient windows, extra installation around radiators, and a more efficient lighting system, the improvements are expected to save the building’s owners $4.4 million annually in energy costs when renovations are complete in 2013. The renovations are also expected to reduce the building’s carbon emissions by 105,000 tons in the next 15 years. In April 2010, the John Hancock Tower in Boston was given gold certification by the U.S. Green Building Council for instituting measures to cut water use and carbon emissions.

Almost 800 miles to the west, the owners of the tallest skyscraper in the United States were also lining up to go green. Owners of the Willis Tower (formerly the Sears Tower), announced plans to invest $350 million dollars to renovate the 36-year-old tower.  The 5-year plan will require upgrades to the lighting system and the replacement of more than 16,000 single-pane windows. The building will add solar power and, possibly, wind power, which is expected to provide all energy needs for an adjacent hotel project. Architects had considered changing the building’s trademark black exterior, which attracts heat, with more energy-efficient silver, but such plans have since been discarded.  The aforementioned buildings are just the most well-known examples. The Skyscraper Museum cites 15 buildings that form a “new class” of sustainable skyscrapers in New York City. That class includes the New York Times Building, the Hearst Tower, and the Freedom Tower that will eventually be built on the World Trade Center site. Other cities are greening skyscrapers as well. The owners of the Christman building in Lansing, Michigan recently spent $8.5 million to green the 81-year-old historic building.

The rush to go green

With a credit crunch and one of the worst construction markets in decades, it seems like an odd time for an explosion of green renovation. One of the main reasons is that buildings need tenants in this uncertain market, and a green LEED certification makes the building more attractive. Real estate researcher CoStar Group, Inc. performed an analysis that found that green-certified buildings had fewer vacancies than other similar sized buildings and had $2.05 per square foot rental premium over their non-LEED counterparts. Additionally, the report said that LEED certification has shifted from new buildings to existing building. Existing buildings made up just 15 percent of LEED-EB certifications in 2008 but is up to 35 percent in the first quarter of 2010.  This is not surprising because evidence suggests that green buildings sell or lease better, retain tenants better, and often have more productive tenants than similar non-green buildings.[i]

Renovation projects aimed at greening skyscrapers almost universally include energy-efficient windows and efforts to install lighting that is energy efficient. For instance, some buildings set the lighting to dim automatically when not needed. Most skyscrapers have flat roofs, which provide the potential for solar power. On a city-scale, this could provide quite a boost to the electrical grid. The Willis Tower is expected to include this approach as it moves toward sustainability, but the Empire State Building, with its antenna roof, does not.

The possibility of more energy-efficient skyscrapers bodes well when considering the energy costs associated with buildings.  In New York City, greenhouse gas emissions from its 900,000 buildings, more than 5,000 of them classified as skyscrapers, constitute almost 80 percent of the city’s carbon footprint. In addition to lowering emissions, green buildings consume less energy, which would lower demand on the grid, greenhouse gas emissions, and local pollution.

It also makes good business sense. Renovation costs, which can total tens of millions of dollars, will be recouped via energy savings and possibly water savings depending on the upgrades. The Empire State Building owners expect energy savings of $4.4 million annually. The brown water system in the Bank of America Tower saves millions of gallons of water every year, which also results in cost savings.  The federal stimulus package alone had $4.5 billion in green building grants. This is in addition to an energy-efficient federal tax deduction that could total up to $1.80 per square foot in commercial buildings. States generally offer incentives as well. As Amory B. Lovins said in a New York Times editorial, “Efficiency can save 75 percent of America’s electricity at lower cost than making it at existing power plants. Helping customers reduce or defer usage when electricity is scarce can also increase distribution equipment’s life and reliability.” Customers who reduce power use at peak times can also negotiate lower rates with utilities.

While energy efficiency and tax deductions can usually pay back the costs of renovations there are still barriers to retrofitting skyscrapers, especially famous ones like the Empire State Building or Willis Tower. The most direct obstacle is the bureaucracy of city planning commissions and various zoning or preservation boards. The Empire State Building is a New York City landmark, which means the New York City Landmarks Preservation Commission will have to approve the plans for the retrofit to the exterior and ground floors of the building.

Bureaucracy isn’t the only barrier. Environmentalists and preservations may find themselves at odds if a historic building’s appearance is changed in the name of energy efficiency. As a blogger for the Chicago Tribune noted regarding the proposed changes to the Sears Tower’s trademark black facade, “Sears is not yet a historic landmark, of course, but the very idea that its iconic image could be radically altered in the name of environmentalism sent shockwaves coursing throughout Chicago’s architectural community.” While this doesn’t guarantee an adverse reaction to a greening of landmark buildings, it indicates that many people are reluctant to alter the icons that define their city.

Another potential barrier could be the amount of time it takes to see cost savings from renovations. A recent report by the Department of Energy shows that while carbon reduction is still high, cost-savings of green renovation can vary wildly by city. A computer model projected identical energy-efficiency improvements for imaginary four-story commercial buildings in Chicago, Baltimore, and Newport Beach, Calif. The computer found the improvements had the greatest effect in windy Chicago with a 23 percent energy reduction, which would pay for itself in nine years. Projections for Newport Beach and Baltimore showed lower reductions and estimated that it would take at least 11 years to pay off via energy savings. Environmentalists dispute the study as flawed and argue that there is more research that demonstrates energy savings. But the uncertainty regarding return on investment, partly due to unknown future energy prices, is often cited as a major barrier to investment.

A solution to this dilemma presents itself in the book Natural Capitalism. The authors contend that direct energy savings are only a portion of the equation. Claiming that energy-efficient buildings provide better lighting, improved air quality and a more comfortable environment, the authors argue that building owners also will see savings from increased productivity, reduced absenteeism, and increased occupancy.[ii]Such savings or gains are difficult to quantify, but could be used to sway hesitant business owners. Case studies that document the financial effects of such outcomes may be the most effective way to demonstrate such results in the absence of a savings model for the methods.

Expanding the green skyscraper movement

As President Bill Clinton noted at the announcement of the Empire State Building’s plans, “We have to prove it’s good economics, and we have to prove we know how to do it. Every person on Earth who cares about this knows about the Empire State Building.” The same could be said about Willis Tower. So despite some obstacles, the fact that the tallest and most famous skyscrapers in the United States are striving for energy efficiency may do wonders to encourage other investors to follow suit.

Market pressures in a depressed economy may encourage property owners to make the investment. The Associated Press reports that one of the Empire State Buildings’ incentives was to fill vacant office space. As the article says “Many high-profile tenants won’t even consider moving into a property without the U.S. Green Building Council’s Leadership in Energy and Environmental Design (LEED) certification…They may not even know what the certification means, but they demand it nonetheless.” If the public continues to become more energy conscientious, owners may take steps to cater to them.

In the United States as a whole, buildings account for 38 percent of greenhouse gas emissions and that number jumps to almost 80 percent in a city like New York. As the Bank of America Tower indicates, architects are interested in designing energy efficient buildings and companies are interested in those buildings. Nevertheless, it is still important to note that the greenest building is one that is already built. As New York City’s PlaNYC 2030 estimates, 85 percent of the buildings that will be in New York City in 2030 already exist now. Other major cities are likely to retain old buildings at a similar rate. As New York City Mayor Bloomberg said, “Existing buildings, no matter how tall they are, no matter how old they are, can take steps to significantly reduce their energy consumption.” If a city is going to significantly reduce its carbon footprint, its skyscrapers will have to do just that.

References

[i] Paul Hawken. Natural Capitalism : Creating the Next Industrial Revolution. Ed. Amory B. Lovins and L. Hunter Lovins. Boston: Boston : Little, Brown and Co, 2000.

[ii] Ibid.

“In essence, the rebate on the boiler (which I’ve already paid for via a surcharge on my electricity bill) is captured by the plumber”

by David L. Levy

This week the temperature hit 90F in Boston, and after appropriate procrastination, I finally started replacing the winter clip-on storm windows with fly screens. We survived another winter with our antiquated and rusting steel casement windows in Brookline, Mass. These single pane windows, which date to the1951  construction of the house, are wintertime energy hogs – they are drafty, provide no insulation, and get covered in icy condensation. We were paying more than $600 a month in the coldest part of the winter, and that’s with my sophisticated solar thermal management system: we have huge south-facing windows, so I raise the blinds when the sun is shining to keep the house comfortable in winter, and lower them for some insulation at night (reverse in the summer…).

In an earlier confessional, I explained why we have not yet splashed out the $20,000 to replace the old windows with new energy efficient ones. The return on investment is only 2% at best, and who knows how long we’ll be in the house, or whether new windows would add much to the sale price. Somehow my own personal experiences don’t square with the conventional wisdom on energy efficiency, which is that substantial reductions in energy use (and greenhouse gas emissions) can be obtained while the investments more than pay for themselves in cost savings (i.e. have positive RoI). McKinsey issued a report in July 2009 claiming that “the U.S. economy has the potential to reduce annual non-transportation energy consumption by roughly 23 percent by 2020, eliminating more than $1.2 trillion in waste – well beyond the $520 billion upfront investment that would be required. The reduction in energy use would also result in the abatement of 1.1 gigatons of greenhouse gas emissions annually.”

As Mark Sarro and Jurgen Weiss explained in their guest post last year, the actual costs may be higher than engineering estimates suggest and there are a host of market, institutional, and psychological barriers. McKinsey acknowledges some of these barriers, though they emphasize a lack of financing and the presence of market failures, such as the owner-renter problem and the limited time horizon of residential owners. Most existing efficiency programs at the city and state level, such as Property Assessed Clean Energy (PACE) address these specific issues. My own experiences, however, lead me to think that, in the residential buildings market, an important but overlooked part of the problem is the high retail cost of efficiency investments, due to small scale and lack of competition.   

This point was reinforced by my investigation this winter of options to replace our antique oil furnace. I was stirred to action by a confluence of three events: a promotion arrived in the mail from National Grid promising a 60% discount on a new energy efficient gas boiler, and up to $1500 extra tax credit for a very high efficiency product. Second, the oil company maintenance person said we need to put nearly $1000 into various repairs on the old oil guzzling beast. Third, I began teaching my new MBA Business and Climate Change course and thought that I should make at least some effort to walk the talk. A high efficiency gas boiler promised energy savings of around 15% on efficiency grounds, on top of which gas is currently about 30% cheaper than oil per BTU. The switch to gas would also mean burning a less carbon intensive fuel. With new furnaces running at about $2000 without a subsidy, here was an investment that would burnish my tarnished environmental credentials while appeasing my inner hedge fund manager.

I called the National Grid number, and was assigned a local plumbing company to come by and give us an estimate. The plumber proceeded to recommend an Energy Star high efficiency (85%) Burnham boiler for only $822, including tax, after the 60% rebate. When I asked about installation costs, I got the usual consolation look that electricians and garage service people seem to have perfected prior to giving an outrageous estimate. After poking around a few pipes and the flue, he gave me an estimate of $9200 for installation, plus a few hundred for carting away the old oil tank. Oh, and $1900 for a new gas line into the house, giving a total of well over $12,000.

When I asked about the ultra high efficiency (95%) burners, I was informed in no uncertain terms that this would be a big mistake – these would be less reliable, suffering problems with acidic condensation, and they would need a special flue. Remember, this is the sales pitch from a plumbing company assigned by National Grid for efficiency upgrades! The extra $1500 tax rebate available on these would be more than offset anyway by the higher installation and purchase cost. In any case, didn’t I want some “wasted” heat to keep the basement warm in the winter? We do use it for hanging up clothes to dry, cutting back on our electricity-hungry drier. And our basement boiler sits directly under the living room, keeping the floorboards warm. In any event, the ancient oil relic claims around 78% efficiency on the tag hanging on it, so maybe the energy savings are not so high.

This was a useful lesson for me and for my MBA class. Why the high costs? The old system had accumulated lots of extra pipes and valves over the years, to accommodate several new rooms, making a new installation more complex. Then there are the new regulations, which require a new flue lining and external vent. But I still suspect that the cost estimate is inflated by the lack of competition: National Grid specifies the plumber from their list of preapproved contractors. I found out afterwards that, in principle, I could find my own qualified plumber, but that’s extra hassle (i.e. transaction costs). In essence, the rebate on the boiler (which I’ve already paid for via a surcharge on my electricity bill) is captured by the plumber, who can inflate charges because of the relationship with National Grid. For comparison, I got a quote of $6300 for a new high efficiency (also 85%) oil boiler, all inclusive. Going with gas I save $1200 on the rebate, but pay about $3000 more for installation.

There are clearly some market barriers and problems with existing energy efficiency promotion programs that are not being recognized. One idea we came up with in class to squeeze costs out of the system Walmart-style was to aggregate residential upgrades together. National Grid could bundle 100 jobs into a larger contract that it would put out to bid. Other suggestions included a surcharge, or systems benefit charge, on heating oil to fund upgrades, or a multiyear guaranteed price contract for natural gas. A third is to require houses for sale to undergo an energy audit, and provide relevant numbers, as on a new car or refrigerator. This would help ensure that upgrades get reflected in market value. (Yet the real estate industry is opposed, and a similar measure in the UK was recently repealed.) Note that none of these require direct subsidies – rather, they address the barriers and market failures.

There is also a lesson here on the increasing marginal cost of carbon reductions. If I get new windows, the marginal benefit of replacing the boiler is goes down. When I grab some low hanging fruit, some of the other fruit gets a bit harder to reach. It also illustrates what economists call the rebound effect: if I make the house more efficient, I’ll take some of the benefit in the form of more comfort, keeping the house a bit warmer in winter, a bit cooler in summer. I’ve noticed this myself with compact fluorescent lighting: I used to be a “turn-off-the-lights” nudnik, but am less zealous for a 13 watt bulb than for 60.

Several months later, summer is here, the boiler is silent, and there is no pressure for a decision. As with the international climate negotiations and national cap-and-trade legislation, inertia is the default option. At least I’m ruminating on policies that will stir me to action.

Below I’m reprinting a post  of his about the contradictions of building ‘green’ mansions – with buildings, cars, planes, appliances, and other products, we seem stuck on a treadmill of efficiency improvements offset by growing consumption: bigger houses, more cars, more plane travel, more gadgets, etc. I’ll be following up soon with a post about my own experience of trying to upgrade my own energy-sink of a house!

The “Green” House Effect

By John R. Ehrenfeld (link to original post)

The NY Times carried a story on March 10 about a controversy over plans to build a very large home in Berkeley, CA. The plans which have been approved show a total area of about 10,000 square feet, of which 3,500 are for a garage. The owner, Mitch Kapor, is the founder of Lotus and has used his ample wealth for many philanthropic ends including many concerned with the environment. Perhaps he lost so much of his money in the crash that he plans to operate a public parking lot.

The controversy here rose from the designation by a city board that the house qualified as being “green.” Such designation comes via an evaluation scheme that gives points to green features of a building, for example, the use of low-flow faucets and low-volatility paint. The Kapor plan received a score of 91 points, far above the minimum of 30 needed to qualify for a green designation.

The architect noted Kapor’s environmental largess but offered no details on the process. Neighbors and others are appealing the decision to approve the plans. Another architect, William Harrison who builds big houses for wealthy clients is quoted as defending the practice.

William H. Harrison, an Atlanta architect with a stable of wealthy clients, said penalizing people for building large houses could slow the adoption of green building practices. “The people who can afford the green technologies are going to want large houses,” he said. And those innovations, he said, will trickle down to smaller houses.

Mr. Harrison said that one of his clients is planning to build a 25,000-square-foot house in Los Angeles. But he opted out of the LEED system, Mr. Harrison said, when he learned that it was virtually impossible to get the highest LEED rating, known as platinum.

“He’s a billionaire, and he drives a Prius, for God’s sake,” said Mr. Harrison of his client. “He wants to do the right thing, environmentally. And now he’s being told, ‘You’re not good enough, because your house is too big.’ ”That, Mr. Harrison said, “is about socialism, not sustainability.”

Harrison misses the point entirely. It’s not at all about goodness or intention. It is simply a matter that such large houses create enough negative impacts to overcome the benefits by implementing green features whether according to the LEED or any other scoring system such as is used in Berkeley. What this has to do with socialism is beyond me.

In a 2005 article on the environmental impact of house size in the Journal of Industrial Ecology (Disclosure: I am one of the editors of this journal), the authors, Alex Wilson and Jessica Boehland say:

As house size increases, resource use in buildings goes up, more land is occupied, increased impermeable surface results in more storm-water runoff, construction costs rise, and energy consumption increases. In new, single-family houses constructed in the United States, living area per family member has increased by a factor of 3 since the 1950s. In comparing the energy performance of compact (small) and large single-family houses, we find that a small house built to only moderate energy-performance standards uses substantially less energy for heating and cooling than a large house built to very high energy-performance standards.

The article continues with data that show that the impact of house size is not linear; the impact increases disproportionately with size. A house twice the size of the average dwelling (about 2,500 square feet) would typical have about three times the impact based on the materials used in construction. Heating and cooling energy use depend on the details of the design and cannot be compared in a general way.

There’s another very important lesson here besides the substantive issues of the actual environmental impact. Green scores simply do not tell the whole or even enough of the environmental story to be meaningful. There is always an “other things being equal,” qualifier in the background. In this case it would be another 10,000 square foot house using less effective features. The billionaire’s Prius sounds good compared to a Hummer, but can’t come close to a bicycle’s low impact. I say this not as a value judgment on the choice of a large house, hybrid vehicle, or anything for that matter, but as a criticism of the utility of scores as valid indicators of greenness. Quantity or volume almost always trumps lower scores.

This is a guest contribution by my colleague Dr. Werner Kunz, Assistant Professor of Marketing at the University of Massachusetts, Boston. Professor Kunz recently collaborated with consultants A.T. Kearney in a survey-based study demonstrating little consumer interest but the potential for energy efficiency in the industry.

Marketing experts know that the customer ultimately decides what will be produced in the marketplace. Thus, consideration of the customer’s point of view is critical for  success in business. If sustainability and climate change are increasingly important for the customer, companies need to react and adjust their strategies, even if there are costs involved.

But what happens if customers do not care about environmental impacts, at least in relation to a particular market? A recent study by A.T. Kearney in cooperation with the College of Management, UMass-Boston, shows that only 1.5 percent of the customers in the mobile telecommunications industry place significant value on the environmental efforts and social initiatives of their operators. Most customers do not see the mobile communication industry as a major environmental problem, or look to it for environmental leadership.

So does it make sense for the companies in this industry to pay more attention to energy and the environment? One major reason for the low consumer interest more environmental friendly is lack of knowledge. As the study shows, one-hour of mobile phone use, including related network-wide resources, consumes almost the same power like a washing machine at 100°F. From a marketing as well as energy use perspective, there are critical reasons for mobile telecommunication companies to become more green.

First, it would be very risky for the telecommunications firms to bet that consumers will remain ignorant and indifferent. As more companies move toward measuring carbon and labeling products, consumers are likely to take more interest in the environmental performance of a broader range of products and services. Second, a company that starts today to prepare for a low-emissions future can more efficiently plan investments and the deployment of new assets to achieve these goals. The emissions reductions can be substantial.

Such initiatives can be done thoughtfully and systematically, because in the future they will be a necessity anyway. The advantage is that strategic marketing management offers great branding opportunities as an environmentally friendly company, as well as significant cost savings and emission reductions. The study can be downloaded here (in pdf format).

Yet there are substantial behavioral, institutional, and financial barriers. As I’ve discussed in this blog post, there may well be free lunches available, but they are hidden away behind misaligned incentives, inertia, and market barriers. Consumers are often unaware of the potential cost savings, cannot afford the upfront costs, or fear that home efficiency upgrades will not add much to the market value of a home. For renters, new construction, and commercial property, the people who pay energy bills are often not the same people as those who design buildings or invest in efficiency. At our university, capital budgets for buildings and operating costs come from two separate pockets that don’t necessarily communicate. In the corporate world, few have traditionally paid much attention to potential energy savings because nobody was paid to do so.

Demand response systems raise some particular issues relating to fears regarding privacy and corporate intrusiveness. The Economist article highlights a survey by Parks Associates, a Texas-based market-research company, that indicates that only 15-20% of US consumers would be willing to sign up for DR programs that enable utilities to control their thermostats. Yet the survey also shows that over 80% of households would pay up to $100 for cost-saving equipment if it chopped at least 10% off their monthly electricity bills. Utilities, however, are still in the business of selling electrons, and incentives for energy efficiency, such as California-style rate decoupling, is only making slow progress toward adoption in other states.

Real-time feedback to customers on the price and quantity of electricity they are using can help cut consumption, and new devices can give an analysis by appliance, illustrating the savings from cutting usage or running appliances on lower-cost night-time power. Google announced last year that it’s developing software package called Powermeter to provide real time information about home energy usage by communicating with household devices. But few appliances are ready for smart meters, standards don’t yet exist for Google or other smart meter devices (Google just released the API in early March 2010), and systems will cost several hundred dollars per home. Moreover, as The Economist points out, trying to run a home using this information could become a complex and time-consuming job.         

The next stage in smart buildings is to move from real time information to direct control of power consumption, from devices to heating, and cooling. Companies such as PassivSystems are developing intelligent home controls using multiple sensors, but they are expensive and would still require a lot more programming regarding preferences and trade-offs between cost, convenience, and comfort than your average consumer might be willing to take on. And as the surveys indicate, consumers are wary about ceding control of their homes to computer algorithms. Commercial and industrial buildings are likely to be more lucrative markets than residential in the early stages of this new market, because of the larger scale of opportunities for saving energy, not just in HVAC and lighting but in industrial processes that have some flexibility in load and timing, such as water treatment. Nevertheless, target markets are fragmented by sector and solutions frequently need to be customized.

In my MBA class on Business and Climate Change, several student groups are working with regional companies interested in demand response and smart grid. From my conversations with firms active in the area, a major problem is finding the right channel to potential customers. Facilities managers tend toward a conservative outlook and generally lack the funding and also the authority to implement systemic controls that affect operations. As with other areas of clean energy, the gadgets are cool but the implementation requires overcoming a host of organizational hurdles.

by David L. Levy

When most people think about clean energy, solar and wind are the first things that spring to mind. Markets for these renewable energy sources have exhibited rapid growth of about 25-30% annually, and these sectors have attracted the lion’s share of venture capital funding and investor interest. They also tend to dominate the various Exchange Traded Funds (ETFs) that track clean energy. Yet the clean energy economy extends far beyond renewable energy technologies, including everything from power controls and storage, carbon software and trading, and energy efficiency. In transportation, while auto companies chase expensive dreams of electric cars, more economically viable opportunities lie in mass transit, bicycles, and innovative car rental services such as Zipcar. Clean energy is also generating a vast range of engineering, professional, and financial services. The transition to a clean energy economy will therefore change the employment landscape (see Green Jobs Booming and Training the “Green and White” Collar Workforce). At the same time, it’s creating new investment opportunities to rival electronics and biotech. The best investment opportunities are the unsung heroes that lie in the more cloistered parts of the evolving cleantech economy.

There are two core principles involved in understanding which green sectors have the most potential and which are overhyped. The first is that successful investing requires better insights than the average market investor. Share prices for many cleantech companies already reflect the expectation of rapid growth – companies (or sectors) have to outperform these expectations to generate significant returns. Second, the market is not rational – the efficient market thesis does not hold. This means that share prices do not accurately reflect all the information out there. To complicate matters, these two principles are somewhat contradictory: What is the point of better knowledge, if the market is arbitrary?

Well, the market is not completely arbitrary – to some degree, it’s Predictably Irrational, to use the title of Dan Ariely’s book. Investors exhibit herd behavior, leading to macro market distortions – share prices (and P/E ratios) can expand in frothy bubbles or become mired in gloom, with prices detached from underlying profits and cash flows. There are similar distortions at the sector and individual company level. When a new sector is fashionable, investors pile in, the media provides glossy rationalizations, and even policymakers can jump to support the ‘next big thing’. Many investors don’t care about underlying value and try to ride these waves of momentum, but this market-timing strategy requires nerves of steel and considerable luck.

Eventually, reality catches up and capital move on. Interest in fuel cell powered vehicles, for example, has collapsed while biofuels are on the wane. But distinguishing ‘reality’ from conventional wisdom is a considerable challenge, even within the expert community. Ford and GM’s disastrous experiments with electric vehicles in the 1980s and 1990s created a firm belief in the US auto industry there was no future for electric vehicles of any kind, even hybrids. The institutionalization of this view led US car manufacturers to scoff at the prospect of Toyota and Honda introducing hybrids (HEVs) in the late 1990s, and now the hobbled US companies trail far behind (see my 2002 paper on the auto industry and climate change). Similarly, the failure of concentrating solar thermal pioneer Luz in 1991 put the sector in the freezer for over a decade. For HEVs,  the technologies were premature for commercialization, but CST suffered from capricious public policy and the association with low-tech solar hot water (hard to patent the technology) in comparison with high-tech solar PV.   

Tom Konrad, of AltEnergyStocks.com fame, recently presented a model clean energy investment portfolio that tries to identify undervalued sectors with the best prospects. It is notable for the absence of solar, and the dominance of efficiency, transportation, and electric grid.

In fact, the portfolio substantially diverges from the current market cap of various clean tech sectors given in a BofA Merrill Lynch Global Research report. Solar and wind dominate the pie chart, with each having about one-third of the total market cap. Popular clean energy ETFs are similarly overweighted  in solar and wind.

Konrad assesses each sector in terms of several criteria:
1. How big a role will this sector play in our energy future?
2. How large is the market cap of current firms in the sector?
3. Is the industry likely to be disrupted by new entrants and technologies?
4. Are there underlying enabling technologies that will benefit from the sector’s growth, or constraints that will hold it back?

By these criteria, wind and solar PV are poor investments because although they can play major roles in our clean energy future, they already have large market caps – the growth expectations are already “baked in”. Wind at larger scale is constrained by the lack (and cost and planning issues) of long distance transmission. Even worse for solar PV, the sector is at risk from technological disruption and new entrants, particularly from concentrating solar thermal (CST) or new variants of solar PV.

Konrad identifies transmission, smart grid, and storage as the key enabling technologies for the clean energy infrastructure, which have been somewhat overlooked but now seem ready to catch a wave of investor attention. Despite the recent success of lithium ion battery producer A123’s IPO, Konrad is pessimistic about plug-in vehicles due to their cost and inherent limitations of the technology, leaving automotive batteries highly vulnerable to disruptive innovation (also see John Petersen on this).

Konrad’s basic approach is very sound, especially for those who prefer a sectoral approach to the risks of individual stocks. It provides a useful framework for discussing particular technologies. For example, I would favor CST as a sub-sector because of its prospects to scale up at reasonable cost, the lower technological risk compared with PV, and the prospects for integrating thermal storage (also see this on SolarReserve). The offshore wind sector could also benefit from the $125 billion plan to build up to 25 GW of capacity, for which initial contracts were announced in early January.

I’m less sanguine than Konrad about the prospects for mass transit and high-speed rail, at least in the US, as it requires a level of governmental investment and coordination that seems unlikely in the current financial and political context. I fully concur regarding the outlook for efficiency. A McKinsey report points to the economic attractiveness of efficiency investments and a vast market potential of over $500 billion in the US over the next decade. Pike Research recently issued a report supporting a positive outlook, projecting that the Energy Service Company (ESCO) business in the US would increase from $5.6 billion in 2009 to nearly $20 billion by 2020. Utility demand side management programs are a major stimulus for this growth. The Pike Research report also noted opportunities at the intersection of energy efficiency and information/communications technology.

Although this is not the place for a discussion of particular stocks and mutual funds, it’s worth noting that investing in efficiency tends to be tougher than other sectors, because there are few public pure-play companies or dedicated ETFs. On the one hand, there are many small privately held companies, and on the other, some very large industrial companies for whom energy control systems and services are a relatively minor part of their business, such as Honeywell International and Siemens. The situation is similar with clean energy related professional services and software. Pike Research estimates that the market for carbon software management and services was a modest $380 million global market in 2009, but is poised for growth of more than 40% a year. This neglected part of the clean energy market has a few small players, but is increasingly dominated by the large accounting, management consulting, and enterprise software companies.

The country faces a serious long-term strategic threat from climate change. The largest population centers are along the coastal plain, just a few meters above sea level, and regional projections point to a decline in winter precipitation of 10-20%, increasing the likelihood of severe droughts. Although more than half the population considers climate change to be a serious threat, there has been little governmental attention to emissions until recently, and even the McKinsey report neglects the potential physical impacts of climate change.

During my visit to Israel in December 2009, I gave a talk at the Hebrew University, Jerusalem, on climate governance (drawing from A Tale of Two Meltdowns), and my Israeli colleague from the university organized a meeting with the Minister of Environmental Protection, Gilad Erdan, and several of his staff, to talk about Israel’s plans for reducing GHG emissions and ways of engaging Israeli industry. Historically, environmental protection has been a relatively low priority in Israel, in light of more pressing security and economic development concerns. Israel has a standard of living approaching European levels, yet because it’s still classified as a developing country in the climate regime, it did not have binding obligations under the Kyoto process. Nevertheless, Erdan has been pushing for the country to adopt aggressive emissions targets, and is seeking ways to get the government as well as industry on board.

The key to advancing the climate agenda in this particular environment is to link it to other national priorities, in order to elevate its strategic significance and build the political coalition needed for action and investment. The Environment ministry recognizes this, and the McKinsey report notes four benefits that would accompany climate action:

An important motive for Israel’s ambitious GHG goals is to graduate from developing to developed country status, with a view to joining the OECD. This would offer broader economic benefits through trade and investment as well as improved international legitimacy. Israel’s active engagement in promoting clean development regionally and supplying critical technologies for global emissions reductions would also bolster its international status, enhance exports, and potentially provide a source of carbon credits.            

Energy security is clearly an important goal, as Israel is almost completely dependent on imported fossil fuels, including natural gas from Egypt. Yet current thinking is that energy security means independence through greater reliance on local renewables, primarily solar. My own view is that energy security can be linked to national security and pursued through regional energy collaboration, primarily with Egypt and Jordan. Though the McKinsey report lists solar power, both CST (concentrating solar thermal) and PV as the single largest contributor to Israel’s GHG reduction potential, the reality is that suitable land is quite limited, even in the southern Negev desert. Collaboration with Egypt and Jordan would open up the possibility of developing a regional grid drawing from large-scale CST in the Sinai desert, southern Jordan, even perhaps northern Saudi Arabia. Moreover, the intermittency of solar can be somewhat offset when complemented with wind power, which has very limited potential in Israel (McKinsey estimates at around 600MW), but is far more abundant in neighboring countries.

Of course, Israel does not want to be dependent on its Arab neighbors for energy. A regional grid would provide security through interdependence. Israel could be a key supplier of technology, as well as a conduit of power between Egypt and Jordan. Economic and technological collaboration on the scale required would also, one hopes, improve political relations. During the 1950s and 1960s, Israel made considerable diplomatic gains in Africa and parts of Asia from its contributions to international economic development. More ambitiously, if a Mideast regional grid were tied into the proposed Desertec supergrid, European participation would provide a strong political guarantee of supply security, as well as smoothing out supply intermittency issues (update: PWC released a report in April 2010 with a roadmap to 100% renewable power based on an integrated Europe-N. Africa supergrid).

Israel has a strong clean tech sector as part of the larger high-tech cluster and entrepreneurial culture in the country (see Start-up Nation: The Story of Israel’s Economic Miracle). The solar thermal and PV clusters are particularly well developed, and the country is home to major firms in water purification and desalination, geothermal energy, and other areas (see here and here, and Jonathan Shapira’s excellent blog on Israeli clean tech). The internal market, however, is far too small to benefit very much from Israel’s own emissions reductions efforts. The large economic payoff will come from exports, technology licensing, and international joint ventures in which Israel is the source for R&D, software, and high value components. BrightSource Industries Israel, for example, a descendent of the CST pioneer Luz, is now a subsidiary of California-based Brightsource Energy, and supplies R&D, engineering services, and key components for the company’s global markets. In fact, the Israeli tech sector is remarkable for its success despite the absence of advanced local markets – during my MBA at Tel Aviv University, I wrote some case studies on how Israeli companies operated within virtual clusters, with their major markets and sources of capital in Europe and the US.

Israel’s Greenhouse Gas Reduction Potential

Though Israel’s total emissions are tiny in global terms, at 71 MtCO2e in 2005, they are growing rapidly, and expected to double by 2030 in a “business as usual” scenario. Emissions per head are already 10.2 tons, about the European average, and expected to rise to more than 14 tons by 2030. The structural reasons for this relatively high and growing carbon footprint are the country’s dependence on coal for power, under investment in public transportation, weak building standards, and high rates of economic and population growth. The country is also committed to energy gobbling large-scale water desalination projects.

The McKinsey report estimates that implementation of abatement measures could reduce emissions by about 45 MtCO2e, corresponding to 2/3 of the expected GHG emissions growth and about 1/3 of total expected BAU emissions in 2030. Behavioral changes, such as reduced air conditioning and greater use of bikes and public transportation, could reduce emissions by a further 7 MtCO2e. With characteristic optimism, McKinsey suggests that the net cost would be zero, with negative cost activities such as efficient lighting and car engines offsetting more expensive measures such as solar power. McKinsey’s estimates for large quantities of solar PV at a cost of under €10/tCO2e seems unduly sanguine.

Ten measures account for about 2/3 of the reduction potential:

As always, the core question is how to implement these measures. Just because more than half the abatement potential can be achieved at negative cost does not mean that it will occur spontaneously, due to the multitude of market failures and institutional hurdles (see McKinsey’s Expanding Free Lunch Program). McKinsey recommends four rather uninspiring steps for the Israeli government to consider:

1. Establish ambitious national GHG abatement goals as government policy.
2. Formulate Israel’s Low Carbon Growth Plan (LCGP) defining the mechanisms and timing of implementation.
3. Translate the national abatement plan into detailed operational measures including ways to finance the upfront investment.
4. Establish a central body to monitor progress in implementation.

What is really needed, in Israel and elsewhere, is a much broader mobilization of the public, government agencies, and business to position climate change at the top of the agenda as the critical strategic threat of the century. At the same time, it offers unprecedented potential for innovation, economic transformation, and regional collaborations. Outside the clean tech sector, Israeli business does not yet take climate seriously – my own research shows that the best way to shift perspectives is to engage people with leaders in the field. In addition to the targets and implementation plans, the Israeli government could partner with charismatic climate champions such as Shai Agassi and local clean tech companies to promote the issue and organize a high profile conference of international businesspeople, policymakers, and experts to jumpstart the process and generate local commitment.

The Financial Times reported some intriguing new McKinsey data this week on carbon mitigation costs across sectors and countries. The data indicate that there are substantial differences in costs, and predictably, that building efficiency, lighting, and HVAC are the low-hanging fruit available at negative cost. The implication is that US companies should look to efficiency measures at home before buying international offsets, though international offsets might be preferable to renewables in the US.

The surprise in the data is that mitigation costs for most efficiency measures in the US appear to be substantially below those in Europe, China, and India. The cost per (metric) tonne of CO2 saved approaches €50 (Euro) in the US for these efficiency measures, while in Europe the saving is about €25 Euro. In India and China, there is a positive cost to these measures. The exception is lighting, for which the cost saving in Europe, China, and India is €60-90/tonne. Even more surprising is McKinsey’s estimate of mitigation costs from cleaner vehicles (hybrids and pure electrics), at negative €79 in the US and about €35 in Europe (i.e. net savings).

The Financial Times does not give the basis for these calculations, and the estimates are projected for 2030. It’s unclear if McKinsey is estimating real resource costs, or the costs as viewed by consumers or manufacturers, taking subsidies and taxes into account. Perhaps McKinsey is factoring in much higher fuel prices and lower battery costs by 2030, but these values are highly speculative. I looked at buying hybrid Prius last year, which cost about $6000 more than the Mazda 6 I finally settled on. I would have to drive about 15,000 miles a year for 10 years, with fuel at $3/gallon, to break even (and that ignores discount rates for future savings). My actual mileage is only around 7,000 miles a year, which is why I don’t feel too bad about not buying a hybrid. It’s also unclear why the savings in the US, with it’s cheap gasoline, are more than double those in high-cost Europe. Perhaps its because Europeans are already driving lightweight high-efficiency diesels.   Another mystery is why renewable power is so much cheaper in China and India compared to Europe and the US. Most of the cost in solar and wind is in manufacturing, which is already dispersed through a complex global supply chain. So those costs should be the same wherever the renewables are installed. Installation and maintenance will rely on local labor, which is much cheaper, of course, in developing countries (but might be expected to rise quite sharply over time).

The availability of free carbon lunches has been discussed before on Climate Inc. Mark Sarro and Jurgen Weiss urged caution regarding the hidden costs of energy efficiency, while I noted that the low-hanging fruit might be locked up or hidden away behind misaligned incentives, inertia, and market barriers. Indeed, he fact that negative cost (i.e. profitable) opportunities to reduce carbon are not being exploited points to the importance of these hurdles. Because these barriers are frequently organizational, behavioral, and institutional, putting a price on carbon is not the best way to move ahead: a price high enough to be effective would be politically infeasible.

To repeat what I said in the earlier post: Most companies have traditionally paid little attention to potential energy savings because nobody was paid to do so. Once companies assign managerial responsibility for the task, measure the savings, and evaluate performance accordingly, they start finding a lot of low-hanging fruit. Many of the barriers are more complex, and require restructuring markets and institutions – California is famous for paying utilities to save energy, not sell it. Utilities are also finding that they can nudge consumers in the right direction with non-price signals, such as comparisons with their neighbor’s bills. The booming field of behavioral economics points to all sorts of low-cost ways of shifting behavior.

Of course, these solutions are not cost free – they involve managerial time, some capital, and transaction costs. Some of the barriers are complex and would require large scale institutional restructuring, requiring government-business collaboration. But one person’s transaction costs are another’s business opportunity (the transaction costs of carbon markets will keep financial firms smiling). The key point here is that there are creative organizational and managerial approaches to unlock the doors to low-cost or even negative-cost carbon reductions. The carbon price is, by itself, an inefficient and ineffective tool.

by David L. Levy

Last week a student at our university sheepishly poked his head into my office and asked if I knew where the Center for Sustainable Enterprise and Regional Competitiveness (SERC) was located, as he was interested in the new University of Massachusetts clean energy programs he had heard about. Perhaps he  expected to find the SERC Global Headquarters in a shiny new steel and glass building, but for now my rather grungy office serves the purpose. The student, an African-American business major who grew up in the Roxbury area of Boston, is already interning at an energy efficiency organization serving the inner city. His enthusiasm for our plans for Clean Energy Workforce Training programs was palpable and infectious – he wanted to sign up right away. He didn’t just want a credential – he really understood how clean energy programs, by imparting relevant expertise and skills and connecting with regional businesses, will contribute to employment, economic development, and improved housing. We have the chance to create communities that are sustainable environmentally, economically, and socially. (For Earthday 2010, David was interviewed about green jobs and business opportunities on New England Cable News.)

I’ve spent months of reading about green jobs, building the new center, coordinating meetings, and writing grant proposals, but this was the moment that made it real. I had my first tangible sense of the people we could serve and the potential for our vision to connect with the needs of the community. Later the same day, I was at an event organized by the Energy Interest group of the MIT Enterprise Forum. Aside from the usual ensemble of clean energy businesspeople, venture capitalists, academics, graduate students, and assorted groupies, I was struck by how many people I met who were looking for a career transition into clean energy – accountants, salespeople,  engineers, product managers, lawyers, and others. Some had been laid off during the recession, but some were attracted by the prospect of greener pastures, greater professional opportunities, and aligning their personal values with their work in a fast growing sector. This helped to confirm the market logic behind our plans to offer shorter certificate programs for professionals.

Evidence for the boom in clean tech employment is more than anecdotal. This month Clean Edge launched a new report that provides detailed analysis of employment trends in the sector. They define clean-tech jobs as “those that are a direct result of the development, production, and/or deployment of technologies that harness renewable materials and energy sources; reduce the use of natural resources by using them more efficiently and productively; and cut or eliminate pollution and toxic wastes.” The CleanEdge report notes that the 770,000 clean tech jobs in the US in 2007 (per the June 2009 Pew report) is comparable with more mature US industries such as biotech at 200,000, telecommunications at 989,000, and traditional energy including utilities, coal mining and oil and gas extraction 1.3 million. The Pew report also found that clean-energy jobs are growing fast, increasing by 9.1% annually from 1998 to 2007 compared to 3.7% for all U.S. jobs over the same period.

Neglected in this and other “green jobs” reports is the rapid growth in the clean-tech related service sector. While the numbers are hard to estimate, I keep running into evidence of expansion in several areas. This year has seen an explosion of interest in carbon accounting and management software, with a number of independent firms being bought out by larger integrated corporate software providers such as CA and SAP. Many financial, legal, accounting, and consulting firms are building their capacity in the environmental area. One local consultancy, The Brattle Group, now lists 14 staff with expertise related to policy, economics, regulation, and planning.   

Source: Clean Edge: Clean Tech Job Trends © 2009

The Clean Edge report lists energy, transportation, materials, and water as the four major sectors, but the most activity, in terms of jobs and investment, is in the energy sector: solar, biofuels, efficiency, smart grid, and wind. Efficiency-related employment in utilities represents the largest single employment sector. Perhaps most useful, the last section of the report provides a reasonably comprehensive guide to clean tech employment resources.

A salary survey demonstrates the wide variety of jobs being created by clean tech, from renewable energy project developers with graduate degrees earning more than $100,000 to insulation installers earning $36,000. Technicians, welders, and sheet metal workers without university education are earning around $50,000, while engineers, accountants and business analysts with degrees are earning from $60,000 to $80,000.

The report provides information on the regional distribution of jobs, and points to several large clusters. The largest is in California, followed by the East Coast Washington DC to Boston corridor. But the report stresses that “No one place or region will control any one clean-tech sector. Clusters of clean-tech activity, supported by local technology development, capital flows, and supportive public policies, are springing up across the U.S. and around the world.”

Source: Clean Edge: Clean Tech Job Trends © 2009

One surprise is the table of the global top 10 publicly traded pure-play clean tech companies, which together employ about 100,000 people. Three of the companies are Chinese, and the sectors include energy storage, smart grid, and electric motors. The report also notes that large, diversified multinational companies are also major employers. “Siemens currently has 5,500 employees working for its wind business, BP has more than 2,200 solar employees, and GE Energy, with a diverse portfolio of both conventional and rapidly expanding clean-energy activities, employs 40,000. Other multinationals with significant clean-tech workforces… include Sharp, Toyota, and ABB.”

Source: Clean Edge: Clean Tech Job Trends © 2009

A section titled US Manufacturing Jobs in Transition tries to put a positive spin on the replacement of traditional industrial jobs with clean tech employment. The numbers, however, don’t paint an optimistic picture. Maytag, for example, closed down a home appliance manufacturing facility in Newton, Iowa, in 2007, laying off 1800 people, while TPI Composites, a wind turbine blade manufacturer, has now opened a plant employing 325 people. The truth is that aside from turbine blades, which are hard to ship over large distances, clean energy manufacturing is quickly shifting to low cost countries. It used to be the case that emerging industries enjoyed premium pricing for a number of years before the products became low-cost commodities, and intense competition would drive production offshore. Recently I’ve been hearing that manufacturing of solar, advanced batteries, and other clean energy components is shifting offshore almost as soon as it’s out of the lab and into commercial production. I’ve written academic articles about the offshoring phenomenon (download pdf) and understand how communication technologies and management techniques facilitate the process, but it’s still a shock to see how quickly this is happening in a sector held out to be the great new hope for regions ravaged by de-industrialization. Look out for a future posting on this question of competitiveness and the likely regional distribution of clean tech value added.