Concept and objectives:
Energy Performance Contracting (EPC) is a form of ‘creative financing’ for capital improvement which allows funding energy upgrades from cost reductions.
Under an EPC arrangement an external organisation (ESCO) implements a project to deliver energy efficiency, or a renewable energy project, and uses the stream of income from the cost savings, or the renewable energy produced, to repay the costs of the project, including the costs of the investment.
Essentially the ESCO will not receive its payment unless the project delivers energy savings as expected.
The approach is based on the transfer of technical risks from the client to the ESCO based on performance guarantees given by the ESCO.
In EPC ESCO remuneration is based on demonstrated performance; a measure of performance is the level of energy savings or energy service.
EPC is a means to deliver infrastructure improvements to facilities that lack energy engineering skills, manpower or management time, capital funding, understanding of risk, or technology information.
- Shared savings: Under a shared savings contract the cost savings are split for a pre-determined length of time in accordance with a pre-arranged percentage: there is no ‘standard’ split as this depends on the cost of the project, the length of the contract and the risks taken by the ESCO and the consumer. However this model tends to create barriers for small companies; small ESCOs that implement projects based on shared savings rapidly become too highly leveraged and unable to contract further debt for subsequent projects. Shared savings concept therefore may limit long-term market growth and competition between ESCOs and between financing institutions: for instance, small and/or new ESCOs with no previous experience in borrowing and few own resources are unlikely to enter the market if such agreements dominate. It focuses the attention on projects with short payback times (‘cream skimming’).
- Guaranteed savings: Under a guaranteed savings contract the ESCO guarantees a certain level of energy savings and in this way shields the client from any performance risk; for this reason it is unlikely to be willing to further assume credit risk. Consequently guaranteed savings contracts rarely go along with TPF with ESCO borrowing (CTI 2003). The customers are financed directly by banks or by a financing agency; an advantages of this model is that finance institutions are better equipped to assess and handle customer’s credit risk than ESCOs.
Other contracting models
While there are numerous ways to structure a contract and hence any attempt to be comprehensive in describing EPC variations is doomed, other contractual arrangements deserve attention.
Here we describe the ‘chauffage’ contract, the ‘first-out’, the Build-Own-Operate-Transfer (BOOT) contract and leasing contract.
A very frequently used type of contract in Europe is the ‘chauffage’ contract, where an ESCO takes over complete responsibility for the provision to the client of an agreed set of energy services (e.g. space heat, lighting, motive power, etc.).
This arrangement is an extreme form of energy management outsourcing. Where the energy supply market is competitive, the ESCO in a chauffage arrangement also takes over full responsibility for fuel/electricity purchasing.
The fee paid by the client under a chauffage arrangement is calculated on the basis of its existing energy bill minus a percentage saving (often in the range of 5-10 %). Thus the client is guaranteed an immediate saving relative to its current bill.
The ESCO takes on the responsibility for providing the agreed level of energy service for lower than the current bill or for providing improved level of service for the same bill.
The more efficiently and cheaply it can do this, the greater its earnings: chauffage contracts give the strongest incentive to ESCOs to provide services in an efficient way.
Such contracts may have an element of shared savings in addition to the guaranteed savings element to provide incentive for the customer.
For instance, all savings up to an agreed figure would go to the ESCO to repay project costs and return on capital; this figure they will be shared between the ESCO and the customer.
Chauffage contracts are typically very long (20-30 years) and the ESCO provides all the associated maintenance and operation during the contract. Chauffage contracts are very useful where the customer wants to outsource facility services and investment.
A BOOT model may involve an ESCO designing, building, financing, owning and operating the equipment for a defined period of time and then transferring this ownership across to the client.
This model resembles a special purpose enterprise created for a particular project.
Clients enter into long term supply contracts with the BOOT operator and are charged accordingly for the service delivered; the service charge includes capital and operating cost recovery and project profit.
BOOT schemes are becoming an increasingly popular means of financing CHP projects in Europe.
In light of the difficulties encountered in developing the ESCO/EPC market in Europe, the European Commission's Directorate-General for Energy has launched in 2013 an EPC campaign to promote and build capacity for EPC and ESCOs throughout Europe.