#cap-e

[forrestthroughthetrees]

Energy Efficiency Financing Models: Energy Services Agreements (ESAs)

My roommate pointed out re: this post that there are a number of different EE financing models currently being developed and recommended Capital-E’s incredibly detailed summary of the current EEF landscape. To process it all, I'm breaking the learning process down into digestible chunks.

Energy Services Agreements (ESAs)

ESAs combine a traditional power purchasing agreement (PPA) with the creation of a special purposes entity (SPE) to finance large commercial/industrial EE projects while limiting risk. Under an ESA, the customer contracts with an investment fund to facilitate all aspects of an EE project in exchange for payment of a fixed or floating portion of the energy savings over the duration of the contract. The investment fund establishes an SPE that is capitalized by itself and third-party investors, pays all project costs through an ESPC/ESP, and retains ownership of project equipment. 

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This has a number of benefits for the commercial/industrial customer: there are no upfront costs; the contract payments are treated as an operating expense and can be passed on to tenants, resolving the split incentive; payments as an operating expense also keep the costs off balance sheet, removing complications re: credit risk and prior financing; and the customer gets to outsource their EE project to a developer that already knows what it's doing.

At the same time, SPEs make this model particularly attractive to specialized investors and their prospective partners by cordoning risk by individual project investments. Many projects yield equity rate of returns, and any tax benefits or incentives garnered by the project pass to the investors, as well (9). If the model can be brought to scale, risk could be further reduced across a wide of array of projects and sold to institutional investors. 

But all of this hinges on the ESA’s ability to keep project financing off balance sheet as an operational rather than a capital lease. Financing Efficiency has a good explanation of why this is important and how proposed changes could handicap this approach, but the takeaway is that off balance sheet financing “allows organizations to install energy efficiency retrofits at no up-front cost and without impairing their existing debt picture, or market value.” 

They estimate that just 5% of EE projects are currently structured off balance sheet. Development of an assured ESA framework could greatly increase that number if standards continue to accept this operational approach.

[forrestthroughthetrees]

Energy Efficiency Financing Models: Energy Savings Performance Contracting (ESPCs)

My roommate pointed out re: the last post that legislation is but one of a number of steps that must be taken in order for on-bill financing to be a scalable driver of energy efficient renovations, and that OBF is but one of the many financial models currently being developed to address different building sectors [(R)esidential, (C)ommercial, (I)ndustrial, (M)unicapilities (U)niversities (S)chools (H)ospitals], include different players, and take advantage of different loan repayment types.

He also recommended Capital-E’s incredibly detailed summary of the current energy efficiency financing landscape but warned against "falling too far down the EEF rabbit hole." Clearly I didn't listen. For each section or rereading, there seem to be a dozen new directions or white papers to check out. In order to process it all, I'm going to try and break the whole learning process down into digestible chunks, starting with...

Energy Savings Performance Contracting: ESPCs

A property owner – typically in the MUSH market – works with an energy services company (ESCO) to develop, find financing for, and implement an EE project. The ESCO determines baseline energy use alongside projected energy savings, and the contract terms and length (10-20 years) are set so that the energy savings outpace the loan repayment schedule. The ESCO monitors and maintains the project installations over the life of the contract and typically guarantees prescribed savings to the customer, creating a financial commitment from the ESCO to make sure the project is successful. The savings are split between the customer and the loan repayment until the end of the contract, at which point the customer retains all residual savings. 

Everything about ESPCs is done on a large scale: 

the customers are traditionally large MUSH market entities; 

the projects are comprehensive, encompassing multiple EE approaches; 

the funding can come from a variety of sources ranging from debt and tax equity to utility incentives, government grants, and state revolving loan funds; 

the contract term is typically at least ten years; 

and the development period can be protracted owing to the complexity of blend funding and credit assessments. 

The 30-year track record of successful ESPCs also yielded the International Performance Measurement and Verification Protocol (IPMVP) whose standardized terms and best practices can facilitate further scaling of this model.

Furthermore, there are benefits to the ESPC approach that are particularly appealing to the MUSH market. Third-party financing curtails the amount of time it would otherwise take to get a large, public project approved and completed. The ESCO selection process emphasizes high qualifications rather than low bids, as with design, bid, bill (DBB). And the ESCO's full assumption of accountability reduces customer risk should problems arise (4). 

ESPCs, however, are not as yet suited for smaller projects. They are cost- and time-intensive, making smaller projects less appealing for ESCOs. ESPC projects are incredibly varied, making standardization of financing and the establishment of a secondary market difficult. And the Dodd-Frank Act will also impact the role ESCOs play in energy savings performance contracting, as summarized by Senators Landrieu and Coons here.

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In 2006, 82% of ESCO industry revenues came from the MUSH market with the remainder divided among the Commercial (9%), Industrial (6%), and Residential (3%) sectors, and yet C/R/I accounts for ~80% of energy use in the United States (19). Which suggests why ESPCs are such a natural starting point...

ESPCs offer a good starting point for a number of reasons. Their established history offers insight into the way customers, providers, financiers, and policymakers come together to approach a particular set of EE questions.

They touch on a number of the issues -- regulation, aggregation, securitization, lien priority, sufficient data collection, transaction costs -- hindering other forms of EEF.

But most of all, those 2006 numbers indicate the tremendous growth potential that can be unlocked by further innovation in energy efficiency financing.