What is Efficiency-As-A-Service?
Efficiency-as-a-service is a pay-for-performance, off-balance sheet financing solution that allows customers to implement energy and water efficiency projects with no upfront capital expenditure. The provider pays for project development, construction, and maintenance costs. Once a project is operational, the customer makes service payments that are based on actual energy savings or other equipment performance metrics, resulting in immediate reduced operating expenses. The energy services agreement (ESA) is the most common type of arrangement, but other models such as lumens-as-a-service and energy subscription agreements are also in use.
Efficiency-As-A-Service may be a good fit if your organization...
Wants to pursue retrofits across your portfolio without spending your own capital
Prefers off-balance sheet treatment for the delivery of efficiency services
Wants a pay-for-performance solution where a third party takes on performance risk and provides project management and maintenance
Is looking for a financing mechanism with a contract term ranging from 5 to 15 years, with periodic buy-out options
Wants a new way to procure energy efficient technologies across your portfolio without the hassle of ownership
To compare efficiency-as-a-service to other financing options that might be a good fit, answer a few questions about your organization.
How it Works
This section begins by describing a typical energy services agreement (ESA) because it is the most common efficiency-as-a-service structure. Then the two “Alternative Approach” sections will discuss different structures in comparison with the ESA. Note that efficiency-as-a-service space is rapidly evolving, so many different arrangements are in use, and more are in development.
Under an ESA, the provider enters into the ESA directly with the customer for a contracted period (typically 5-15 years). Before equipment is installed, the ESA provider performs a baseline of the customer’s energy consumption and calculates an upfront estimation of savings. The ESA provider then pays and manages a contractor to install the high-efficiency equipment and help maintain the equipment through the contract period. Once project installation is complete, a measurement and verification (M&V) analysis is performed to determine actual savings compared to baseline energy use.
The customer then enjoys lower utility bills throughout the contract term. The customer pays the ESA provider a charge per unit of energy saved that is set below its baseline utility price, resulting in immediate reduced operating expenses. The ESA payment can be structured either as a percentage of the customer’s utility rate or as a fixed dollar amount per kilowatt-hour saved. The ESA provider retains ownership of the equipment for the duration of the ESA term and pays for maintenance to ensure reliability and performance. New efficiency measures can be added during the duration of the contract. At the end of the contract, the customer can elect to purchase the equipment at fair market value, extend the contract, or (less commonly) return the equipment.
An ESA can be thought of as an energy efficiency version of the Power Purchase Agreement (PPA), a structure commonly used to finance renewable energy systems. Under an ESA, the customer doesn’t bear the project performance risk since it only pays for savings actually achieved. Instead, the ESA provider bears this risk and gets paid less if the project savings are lower than expected. However, ESAs vary significantly in terms of contract structure, method used for measuring realized savings, and how the customer and provider split performance risk and upside. Some ESA providers are exploring the possibility of combining ESAs with on-bill repayment.
Typically, ESA projects are funded through a combination of equity from the ESA provider and outside debt from a lender. The ESA provider typically forms a special purpose entity (SPE) that owns all project equipment and is repaid by customer payments under the ESA.
An Alternative Approach: The Managed Energy Services Agreement
The Managed Energy Services Agreement (MESA) is a variation on the ESA with a few important distinctions. In a MESA structure, the provider assumes the broader energy management of a customer’s facility, including the responsibility for utility bills. The MESA provider essentially acts as an intermediary between the customer and the utility. The MESA provider will charge the customer an agreed-upon fixed rate based on historical energy consumption, thus protecting the customer from utility rate changes. MESAs are especially of interest in sectors where a “split incentive” between landlord and tenant is an issue, as the structure of the agreement allows MESA charges to be passed through to tenants.
An Alternative Approach: Other Efficiency-as-a-service Models
Some providers are offering alternative efficiency-as-a-service models that differ from the ESA and MESA. One example is “lumens-as-a-service,” in which a customer specifies its desired lighting output (which can be framed in terms of footcandles or lumens of light supplied, or other metrics) and the provider delivers a contracted lighting service to achieve those outcomes. Another example is a “subscription agreement,” in which customer payments are based on the function or output of the installed energy equipment rather than measured savings, resulting in a simpler contract. Other models such as “electric vehicle charging stations as-a-service” are also being explored. The “as-a-service” concept can potentially be applied to a wide range of technologies using a variety of structures, and the space continues to rapidly evolve.
Advantages and Disadvantages
State of the Market
Efficiency-as-a-service is a relatively new but proven structure that has been used to implement multi-million dollar retrofit projects in Fortune 500 companies and major facilities across the U.S. It is most common in the commercial & industrial and MUSH (municipalities, universities, schools, and hospitals) sectors, but it can work for any sector. Efficiency-as-a-service is a flexible financing mechanism that can incorporate a wide range of efficiency measures, including water.
Efficiency-as-a-service is gaining popularity because it overcomes market barriers that other mechanisms do not, and it limits customer performance risk while still providing an avenue for short-term energy and cost savings. With the upcoming Financial Accounting Standards Board changes to lease accounting that will bring operating leases onto the balance sheet, efficiency-as-a-service will likely be one of the few remaining efficiency financing options to be consistently considered off-balance sheet. Efficiency-as-a-service represents part of a larger shift across the industry away from customer equipment ownership and toward an “as a service” model, where the customer does not own the efficiency equipment but instead pays for energy savings or output like a service.
The efficiency-as-a-service market is thought to be growing quickly, but no thorough and up-to-date analysis of current market size has been conducted. Navigant has estimated global revenues from the lighting-as-a-service alone could become $2.6 billion by 2026. A 2012 analysis by Deutsche Bank Climate Change Advisors and the Rockefeller Foundation estimated that more than 100 ESA projects had been completed, with a pipeline for potential ESA projects of approximately $500 million across all firms. These numbers have likely grown substantially since then. Within the Better Buildings program, the Financial Allies completed over $172 million in efficiency-as-a-service projects from 2012 to 2017. Financing small and medium size projects has proven challenging due to high transaction costs, but through aggregation and streamlined business models, efficiency-as-a-service has the potential to help unlock this market which many traditional energy performance contract (EPC) models are unable to address.
Better Buildings Implementation Models
This implementation model describes how Citi used an innovative third-party energy services agreement to deliver efficient electricity and cooling at its London data center, and plans to implement this model at other U.S. facilities in the future.
This implementation model describes how Metrus Energy funded 100% of critical facility improvements and equipment upgrades for Kuakini Medical Center through a projected 25% reduction in its total utility bill.
This implementation model highlights a financing mechanism developed by Metrus Energy; the company created an Efficiency Services Agreement to deploy multi-measure energy efficiency retrofits in BAE Systems facilities with no upfront costs.
Learn More About Efficiency-As-A-Service
- Environmental Defense Fund — Show Me the Money: Energy Efficiency Financing Barriers and Opportunities
- Deutsche Bank Climate Change Advisors and The Rockefeller Foundation — United States Building Energy Efficiency Retrofits: Market Sizing and Financing Models
- Wilson Sonsini Goodrich & Rosati — Innovations and Opportunities in Energy Efficiency Finance
- Metrus Energy — INFOGRAPHIC: Which Financing Vehicle Gets You on the Road to Energy Efficiency?
|Basic Attributes||Project Types?Which project types can be financed using this option?||Energy Efficiency|
|Applicable Sectors?Which economic sectors does this option commonly serve?||Common: Commercial & Industrial, Private Universities/Schools/Hospitals, Multifamily, Non-profit
Less Common: Affordable Multifamily, Government
|Geographic Scope?Is the financing option available throughout the U.S., or limited to certain areas that have the appropriate policies and programs in place?||Nationwide|
|Building Ownership?Does this option work well for projects in leased space, owned space, or both?||Owned or Leased|
|Typical Project Size?What range of project sizes does this option typically serve?||Typically $250k+, but some providers serve smaller projects|
|Contract Structure||Contract Complexity?How complex is the financing option from the customer’s perspective, in terms of the size and complexity of the financing contract, the number of parties involved, and other factors?||Medium|
|Parties Involved?Which types of organizations are typically involved in executing the financing option?||Customer, Efficiency-as-a-service Provider, Contractor/ESCO|
|Payment Type?Are customer payments fixed over time or might they be variable based on factors such as energy savings or utility rates?||Typically variable; fixed in some structures|
|Performance Risk?Which party bears the risk that the installed equipment may not perform as expected?||Borne by provider|
|Tax & Balance Sheet||Budget Source?Do customer payments made on this financing option typically come from an operating budget ("opex") or capital budget ("capex")?||Opex|
|Balance Sheet Treatment?According to industry best practices, does the financing option typically appear as a liability on the customer’s balance sheet, or is it off-balance sheet?||Off balance sheet|
|Tax Deductions?Which amounts can a customer typically deduct from its taxes under this financing option? In some cases all payments are deductible, and in other cases only interest and depreciation are deductible.||All Payments|
|Equipment Ownership?During the financing term, is the efficiency equipment typically owned by the customer (internal) or by an outside party such as the lender or contractor (external)?||External|
|Collateral Source?Which customer assets can the lender use as collateral to secure repayment?||Equipment, discontinuation of service (sometimes), non-payment of utility bill (MESA only)|
|Contract Terms||Typical Duration?How long does a typical financing contract last?||5-15 years; generally does not exceed useful life of equipment|
|Typical Close Time?How long does it typically take to secure financing once you start speaking with providers?||Medium (3-9 months)|
|Market Attributes||Market Size?What is the total cumulative dollar value of projects financed under this option?||$172M+ since 2012; 100+ deals cumulatively|
|Time in Market?How long has this financing option been available in the market?||Since the ~2000s|