Description
Energy performance contracting (EPC) is a form of packaged financing and capital works, where financial savings from energy conservation measures are used to fund the cost of the measures.[1] EPC involves an energy service company (ESCO) that provides various services, including finances and guaranteed energy savings. The ESCO has a stake in energy savings for the client, which leads to accountable energy and carbon savings. The ESCO may be required to absorb some of the lost savings if savings do not materialise as expected, which commercially incentivises ESCOs to complete optimal investments.[2]
The attraction of EPC is that it enables end-users to secure energy-saving investments without drawing on capital or balance sheet payments. The private ESCO companies provide the financing, and so reduce the debt burden of the municipal authorities. Eurostat confirmed that EPC investments are off balance sheet for public clients and provided a related guide for practitioners.[3] There are some examples of policymakers embracing this opportunity for public-sector energy efficiency investments, having obtained Eurostat’s clarification, for example, in the Slovak Republic.[4] There is also evidence that specific investment costs are lower, while energy savings are higher, when applying EPC rather than regular public procurement of projects.[5]
The ESCO is the economic owner of the asset and bears most of the risks and rewards of the investment. The ESCO is also responsible for the proper operation of the installed equipment and bears the maintenance and refurbishment risks.[6] It stays involved in the measurement and verification process for the energy savings during the repayment period. ESCOs and energy performance contracting are mostly found in the public sector and to a lesser extent in the industrial and commercial building sectors.
EPC policy instruments can include (i) the promotion of energy performance contracting through awareness-raising, (ii) the removal of legal barriers to the use of innovative financial instruments, (iii) the preparation of sample contracts and procedures, (iv) the provision of expert support, primarily to the public sector for preparing energy performance and supply projects, contracts and evaluating the projects results and (v) the establishment of a qualified energy services provider scheme.
Resource implications and key requirements
EPC requires sufficient technical capacity and often necessitates capacity-building due to the extent to which it differs from traditional public procurement processes. Additional efforts will be needed in market sounding and preparation of EPC. To enable EPC to take place, it is important that the municipal budget law allows city authorities to sign medium-term to long-term service contracts. Depending on the length of the EPC contract duration, a stable, reliable economic and political system and rule of law are prerequisites. For instance, in Slovenia, contract durations of up to 20 years are common.
Potential private-sector participation
EPC involves the private sector directly through the creation of a market for ESCOs, including a wide range of possible contractors, such as engineering companies, utility firms and equipment providers. Furthermore, ESCO structures are, alongside PPPs, one of the few financial structures that would allow the introduction of more private-sector finance into energy efficiency investments than the mere debt capacity of ESCO clients would allow, thereby helping to bridge the existing finance gap.[7]
Implementation obstacles and solutions
A lack of awareness in both the private and public sectors is often the first barrier to EPC. This can be tackled through capacity-building. A lack of resources to prepare related EPC tenders in the public sector is another barrier. This can be improved through information provision and through providing technical support in procuring EPC projects.
Prohibitive public budget and procurement regulations are another barrier. For example, in many European countries, budgetary restrictions imposing lending limits on local governments leave capital-strapped administrations little room to pay for the upfront costs of performance contracting.[8] Regulatory reforms can be used to treat EPC investments as off-balance-sheet (no new public debt) and the aforementioned Eurostat clarification should give EU member states and accession candidates sufficient confidence. Furthermore, extending the contract duration is required, too, with deep building-retrofit projects in Slovenia, for example, having EPC contract durations of 20 years. Public procurement regulation may also need to be reformed to include lifecycle cost analysis and functional tenders that use energy efficiency criteria as selection criteria in public procurement contracts and leave the technical solutions up to the contractor.
Financing constraints are yet another barrier. Credit markets remain constrained and lending institutions may be unwilling to offer energy performance contract financing despite provisions to guarantee ESCO performance. Smaller ESCOs that are new on the market lack the creditworthiness required by banks. As a response, governments can provide guarantee schemes for energy efficiency loans provided to ESCOs. An alternative solution is to create a project pipeline, which investment banks such as the EBRD can then fund.
However, it is more than the availability of debt that prevents ESCO market development: it is the limited borrowing capacity of ESCOs that limit the capacity to finance many deep-retrofit EPC projects with 20-year contract durations. The solution to this is the sale of receivables of ESCOs to financiers that can understand, price and accept the 20-year limited-recourse finance risk. Supporting the development of such innovative financial (forfeiting) instruments through risk-sharing or other support mechanisms could be part of the policy mix backed by local authorities.
The Czech Republic provides a good example of the development of a market for EPCs. There, facilitating has become an indispensable part of EPC projects in the public sector. In addition, competitive bidding has been developed into a standardised procedure, which increases the quality of EPC projects for clients. The European Code of Conduct for Energy Performance Contracting has been widely used and complies with the actual practice in the country.
References
[1] World Energy Council and Arup (2016), “Perspective input into the World Energy Council Scenarios: ‘Innovating Urban Energy’”, October 2016.
[2] Institute for Building Efficiency (2010a), “Energy Performance Contracting in the European Union: Creating Common ‘Model’ Definitions, Processes 194 and Contracts”, Issue Brief, September 2010.
[3] Eurostat and EIB (2018), “A Guide to the Statistical Treatment of Energy Performance Contracts”, May 2018.
[4] Ministry of Finance of the Slovak Republic (n.d.), “Platobny mechanizmus vychadzajuci zo Vzorovej zmluvy o energetickej efektivnosti s garantovanou usporou energie”.
[5] D. Staničić (2019) Jo,žef Stefan Institute, Energy Efficiency Centre; presentation 28 March 2019, slide 3.
[6] I. Šerić (2017), “The EPC market in Croatia and the new Eurostat rules on EPC accounting”, European Union, November 2017.
[7] European Commission (2018), “Financing a Sustainable European Economy – Final Report 2018 by the High-Level Expert Group on Sustainable Finance”, p. 7.
[8] Institute for Building Efficiency (2010b), “Energy Performance Contracting in the European Union: Introduction, Barriers and Prospects”, Issue Brief, August 2010.
