The Virtuous Cycle: Internal Energy Revolving Funds for Small Water Systems

Written by: David Tucker
David Tucker is a Project Director with the Environmental Finance Center at the University of North Carolina. 

How can small (and large) water systems pay for energy efficiency and renewable energy, helping cut utility costs? As energy is often the largest variable expense in a water system’s operating budget, this is a recurring question for the ongoing Smart Management for Small Water Systems project. There are many answers on how to pay for energy savings projects, such as in my previous blog post on energy savings performance contracting, and throughout the UNC EFC’s clean energy finance work. One such financing mechanism which water systems could employ is the Internal Energy Revolving Fund. How do these funds work?

The Internal Energy Revolving Fund Concept

Basic Diagram of an Internal Energy Revolving Fund

An Internal Energy Revolving Fund (IERF), also known as an “Energy Bank” or “Green Revolving Fund,” is a fund that is “internal” to an organization (e.g. a water system), where the fund makes loans to units within that organization to finance clean energy projects (e.g. pumps and motors, lighting, HVAC equipment, solar panels, etc.), and the fund “revolves.” Internal loans are repaid to the fund from the savings from the project’s energy conservation measures. An initial investment (seed money) is needed to capitalize the fund. And once the fund is recapitalized (when loans are repaid), additional internal loans can be made for other energy savings projects – thus a “virtuous cycle” is established for long-term success. It is like having your own energy bank within your organization, from which departments can borrow to fund clean energy projects. The fund stays internal to the organization, so no external applications for loans are accepted.

The IERF concept has been used by many U.S. colleges and universities, as well as some local governments. For example, at the University of North Carolina at Chapel Hill, two IERF’s have been established, both the university’s Green Revolving Fund (GRF), and the Renewable Energy Special Projects Committee Revolving Fund, run by dedicated UNC students. One GRF-funded project is to outfit a campus building with LED lighting, saving $1,000,000 in energy and maintenance costs across 20 years, with less than a 3 year simple payback period. Similarly, Harvard University’s Green Revolving Fund has a $12 million fund which has supported nearly 200 projects, yielding $4 million in energy savings annually. Over 80 American institutions of higher learning have IERF’s, as described here on our blog. The Town of Chapel Hill (with a $500,000 IERF), and Union County (funding projects expected to save $210,000 annually), among other N.C. local governments, have set up their own IERF’s to save on the “low-hanging fruit” of energy efficiency. What are some of the chief pros and cons of this approach?

Advantages and Opportunities

Establishing an IERF can have several advantages. First, it allows your organization to provide a continual stream of funds for energy improvements without tapping into existing capital cycles. In other words, if you have sufficient funds in your IERF, you may be able to finance energy management projects just from that source, without having to apply for loans or grants externally. This, in turn, can lead to simpler project management, at least in terms of the funding source and its associated application and reporting requirements. Also, you may be able to combine this clean energy funding mechanism with others. For example, for an external grant to finance energy projects, instead of spending the funds on a once-only project, you could use the grant as seed money for a new IERF – or to increase an existing one. Also, potential returns on investment for projects funded by your IERF may be attractively high (as Harvard has found with their GRF’s performance).

Challenges and Questions

There are challenges and questions to consider for an IERF. First, do you have a way to initially capitalize the fund, and at a scale large enough to fund significant energy management projects? You can always start small and “work your way up.” But finding a sizeable grant application for seed money, or issuing a bond referendum, etc., may prove challenging in itself.

Secondly, how much of the energy savings will be returned to the fund, and at what rate of repayment, for energy projects? Will 100% of the savings be returned to the IERF until the loan is repaid, or a percentage? Also, IERF’s are often set up to require projects have a maximum simple payback period, such asthe Town of Chapel Hill, N.C., with a seven-year max. Some energy projects may not fit within such a timeframe.

Thirdly, water utilities that are owned by local governments are subject to Generally Accepted Accounting Principles, including best practices for Enterprise Funds (e.g. for drinking water) to be run largely financially independently from the General Fund. Thus if a town has an existing IERF for the General Fund, it may not be advisable or possible to simply expand it into the water system’s operations – a separate IERF may need to be set up.

Then there are a series of interrelated administrative questions. Has an energy assessment been done first, to establish the energy usage baseline? Even if so,has a clear method been established to monitor and verify (M&V) what the actual energy savings are for the project – and thus what a reasonable loan repayment schedule will be? Has the administrative task to track the performance of the IERF, take funding applications, process repayments, etc., been adequately staffed and planned for? Has the structure of, and procedures for, the fund been clearly laid out in writing, to help protect against confusion or temptation (e.g. to “raid the fund” for purposes other than energy management)?

Finally, the governing body to whom the IERF is accountable (e.g. a Town Board, a Board of County Commissioners, etc.) may set out reporting requirements for the life of the loan for which the system must plan. A good illustration of this comes from Chapel Hill, for quarterly reports by staff to the Town Board, including elements such as:

  • Savings in Kwh of electricity, CCF of natural gas, or gallons of water
  • Dollar savings (including normalizing for utility rate changes)
  • Weather normalization using heating/cooling degree day data for the period covered

Not every governing board may require all such reporting elements. And this may still be easier and less time consuming than reporting requirements for an external funding agency (e.g. a bank or a state/federal agency). Despite the cautions above, all energy financing mechanisms have their trade-offs. Internal Energy Revolving Funds are a way of financing energy savings for water systems, to promote the virtuous cycle of clean energy work in the drinking water sector.