Every contractor (and therefore household) participating in an energy efficiency rebate program incurs what are often called “carrying costs.” These carrying costs are essentially the hard or soft costs related to the time between when a project is installed and when that rebate is paid out by the program.
These costs can impact contractors and the broader market in a variety of ways. For example, some contractors refuse to participate in rebate programs to avoid being saddled with these added costs. Other times, contractors make use of financing partners that can provide advances of most of the rebate funds in exchange for a fee—usually a percentage of the rebate amount. Contractors may also simply not be able to grow their business because they have to hold a larger cash balance to deal with cashflow lags, thus delaying hiring and other expansion activities that are essential for building market capacity (leasing trucks, warehouse space, etc.).
Minimizing carrying costs has always been important. But keeping them as low as possible is even more important now that the historic Inflation Reduction Act (IRA) Home Energy Rebates are hitting the market. Typically the size of the rebate influences the total amount of carrying costs, which means contractors (and households) could be in a world of pain with the high-value IRA rebates if states don’t take appropriate steps to minimize these costs.
So one key question that must be answered as states begin rolling out the IRA Home Energy Rebates is how do we make carrying costs to contractors and households as low as possible?
Paying rebates quickly is the simplest ways to minimizing carrying costs for contractors and homeowners
Paying rebates as quickly as possible is one simple way to minimize carrying costs. Programs that pay in less than 30 days usually have the smallest carrying costs (and typically less than two weeks is preferred by contractors). Not coincidentally, that amount of time fits conveniently within payroll cycles and the time it usually takes to make payments on a credit card or other short-term credit lines.
Financing partners can also help minimize carrying costs. These “factoring” companies can provide most of the rebate value upfront, but contractors have to pay fees, which typically range from 1-5% of the rebate value per month.
The faster rebate programs pay, the less costly these financing arrangements are — and the less likely they’re needed in the first place. No wonder, then, that the U.S. Department of Energy is asking states to pay out rebates to contractors within four weeks of project completion.
“Partial payments” can minimize carrying costs in measured savings programs
Measured savings programs are increasingly popular (for good reason) but they can result in additional carrying costs for aggregators if programs are not thoughtful about how to manage them. (For reference, aggregators are companies or non-profits that make it easier for contractors to participate in rebate programs.)
In measured savings programs, aggregators provide rebates upfront and immediately to contractors and homeowners, and take on the performance risk during the measurement period (typically a year). Measured savings programs provide many consumer protection, grid reliability, and market transformation benefits—but they also have the potential to increase carrying costs given the additional time required to verify actual energy savings.
So how do we balance the advantages of measured savings with the accompanying carrying costs? The answer: partial payments.
Programs can provide partial payments to aggregators over the course of the measurement period based on project milestones. Project milestones for measured savings programs typically include upfront payments after project installation as well as quarterly true-up periods based on actual energy savings.
Partial payments are standard practice in existing measured savings programs in California. For example, the 3C-REN Single Family Residential Program provides 50% partial payments to aggregators upfront after installation which can reduce carrying costs to less than 3.5% of total rebate value, which is fairly similar to costs incurred by traditional programs. (Assumes aggregator receives 50% advance rate 1 month after installation, 10% interest rate, and remaining partial payments 12 and 15 months after project installation.)
Part of the beauty of measured savings is that it rewards actual energy savings. And in any project, energy upgrades can run the risk of underperformance. In measured savings programs, aggregators take on this risk. The higher the upfront partial payments, the lower the carrying costs, even as the total rebate amount paid is the same. So, programs need to ensure that they are balancing minimizing carrying costs and having aggregators be on the hook for ensuring energy savings come to fruition.
Therefore, programs need to be thoughtful in how they set the upfront rebate to ensure it’s not too high. For example, if upfront partial payments are 80% of expected rebates and the “realization rate” (actual savings divided by predicted savings) of an aggregator’s portfolio is 60%, then 20% of the rebate would need to be clawed back in some form.
It’s worth noting that programs are sometimes tempted to provide upfront partial payments based on deemed or modeled estimates, but this can just add additional risk since these estimates could not only be overly aggressive, but can also add unnecessary complexity.
Additional tools can further reduce carrying costs while maintaining performance accountability
There are tools programs can use to further minimize carrying costs — while also minimizing, or even eliminating, the risk of overpayment.
For example, insurance is used in many industries to mitigate third-party risk, and can also apply to energy efficiency programs. Insurance companies like HSB can provide energy savings insurance that guarantees program reimbursement from the aggregator if final rebates are lower than expected rebates.
Programs can also potentially leverage low-cost financing sources, potentially including the IRA’s Greenhouse Gas Reduction Fund, to provide low-interest financing to aggregators that will minimize carrying costs.
Finally, states can choose to further optimize their programs by taking a data-driven approach by rewarding the aggregators that accurately predict energy savings with higher upfront partial payments. This creates a “race to the top” dynamic for aggregators that have demonstrated predictive accuracy.
While carrying costs are nothing new for energy efficiency rebates, the IRA demands that we take carrying costs seriously. While some amount of carrying costs in all programs (including measured savings programs) is inevitable, those costs should be much lower than other soft costs, so long as they are offset by a simpler, more accountable program design.
Through smart program design, we can successfully address these added costs, while ensuring that households, and the country, enjoy the numerous benefits of measured savings programs.