EPC (With Financing)

Energy Performance Contract

What is an Energy Performance Contract?

Under an Energy Performance Contract (EPC), an energy service company (ESCO) coordinates installation and maintenance of efficiency equipment in a customer’s facilities and is paid from the associated energy savings. The ESCO typically provides a savings guarantee. The improvements are usually owned by the customer and may be installed with little or no upfront cost if the EPC is financed. EPCs are suited for larger, more complex projects with high upfront costs. EPCs are also called energy savings performance contracts (ESPCs).

An EPC may be a good fit if your organization...

  • Is considering many energy conservation measures and wants to outsource measure identification, installation, and project management to a third party
  • Has large projects ($1M+, preferably $5M+) available in one or more facilities
  • Wants a third party to take on performance risk and provide a savings guarantee
  • Is comfortable with a Iong-term contract (typically 10-20 years)

To compare EPCs to other financing options that might be a good fit, answer a few questions about your organization.

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How it Works

The customer partners with an ESCO/contractor to scope, develop, and implement a set of efficiency improvements across one or more facilities. The ESCO often provides upfront energy auditing and assessment to determine which upgrades are available and cost-effective, including the identification of efficiency incentives or rebates. The ESCO then enters into an energy performance contract (sometimes called an energy savings performance contract, or ESPC) with the customer in which the ESCO agrees to implement and manage the upgrades. The ongoing services provided by the ESCO during the term vary by project, but they often include operations and maintenance, repair, service upgrades, and measurement and verification (M&V) of savings. In exchange, the customer makes regular service payments to the ESCO, in addition to repayments to the lender if the project was financed.

EPCs are usually designed to split the cost savings from the upgrade between the customer and the ESCO, such that the customer’s realized savings are greater than the sum of its financing and ESCO payments over the term. In other words, the project is paid for by its own energy savings. The ESCO may provide a guarantee to the customer that a certain amount of energy savings will be achieved. If actual savings are less than this guarantee, the ESCO must pay the difference to the customer. Such a guarantee provides increased confidence to the customer and helps attract financing by lowering the overall risk of default on the project. After the EPC term expires, the customer stops making service payments to the ESCO, takes responsibility for maintaining the equipment, and keeps all future energy savings. EPCs can allow ESCOs to implement deeper retrofits by blending longer-payback energy conservation measures together with more compelling shorter-payback measures in a single contract.

An EPC is not technically a financing solution, but rather a performance contract that may or may not be backed by financing. The customer may pay for the installation out of pocket if it has enough cash on hand, or it may seek financing from a third-party lender to cover some or all of the upfront cost. The majority of financed EPCs are backed by an on-balance sheet financing mechanism such as a loan, capital lease, or bond issuance. Under these structures, the customer owns the equipment throughout the financing term. In some cases, EPCs may be backed by an off-balance sheet financing mechanism in which the third-party financier owns the equipment during the term, such as an ESA or operating lease, or by a tax-exempt lease purchase agreements for public organizations. There are also alternatives to the traditional EPC, such as the BOMA Energy Performance Contract model, which provides some flexibility on the duration of the performance guarantee and may reduce costs.

Historically, ESCOs have often helped their customers arrange financing for EPCs. However, due to passage of the Dodd-Frank Act in 2010, ESCOs are sometimes prohibited from arranging financing as part of their service package without appropriate registration. In some cases, this means customers must now independently arrange financing with a third party.

Advantages and Disadvantages

ENERGY SAVINGS GUARANTEED
Most EPCs include a performance guarantee, reducing project risk for the customer. This is particularly beneficial for large and complex retrofits.
OUTSOURCED PROJECT MANAGEMENT
The ESCO handles most aspects of project scoping, implementation, and management, reducing the burden on the customer’s in-house staff.
ENHANCED RELIABILITY OF OPERATIONS
Projects are maintained through rigorous monitoring and verification by the ESCO, which will typically conduct periodic maintenance and/or adjustments to ensure long-term reliability and performance of the equipment.
STANDARDIZED PROCESS
The market for EPCs is well established, allowing ESCOs to develop standardized processes.
SCALABLE
EPCs can be used for portfolio-wide initiatives, and the large size and deep bench of most ESCOs gives the customer access to a range of vertically integrated services.
LONG CLOSE TIMES
Because EPCs are complex and require the ESCO to take on performance risk, they can have high transaction costs and long negotiation periods (typically over a year).
BUILDING OWNERSHIP CONSTRAINTS
EPCs can be challenging in leased space, particularly if the lease term is shorter than the contract term. For this reason, they are not as common in multi-tenanted properties, but they work well in the public sector where building ownership tends to be longer term.
SIZE LIMITATIONS
Because of the substantial transaction costs to set up an EPC, ESCOs tend to look for larger project sizes. Projects less than $1M in cost rarely are good candidates, and some providers prefer those over $5M.
HIGH COST RELATIVE TO IN-HOUSE IMPLEMENTATION
A substantial portion of the cash flows from the project must be paid to the ESCO and (if financed) the lender during the contract, reducing net operating savings compared to in-house implementation.

State of the Market

Energy performance contracting has existed since the 1980s and has been one of the most widespread structures used for energy efficiency projects. The majority of EPC projects have been done in federal, state, and local government facilities as well as K-12 schools, universities, and healthcare facilities. These sectors tend to have large projects and customers that plan to remain in their buildings for decades, making EPCs a good fit. However, EPCs can also work in commercial & industrial, multifamily, and non-profit sectors provided that project size, building ownership, and capital availability are not an obstacle.

Efforts are currently underway to further standardized the contracting process for EPCs and expand their appeal beyond the MUSH and government sectors. For example, the BOMA Energy Performance Contract model aims to address the limits of the traditional approach by providing standardized documentation and processes.

According to NAESCO, ESCOs have completed $45B in projects since 1990. An annual survey by Lawrence Berkeley National Labs found that new annual ESCO project implementation is around $6B per year. A European Commission study found that approximately half of ESCO projects in the U.S. are self-funded and half are financed. NAESCO’s presentation at the 2016 ACEEE Finance Forum also provides an excellent summary of the EPC market. As one of the most established structures, EPCs will likely continue to play a large role in energy efficiency financing for years to come.

Connect with providers

Better Buildings Implementation Models

Energy Performance Contracting

GM’s creation of an Energy Performance Contracting (EPC) model helped double the amount of money directed towards energy conservation from $40 million to $80 million.

Getting the Most out of Energy Performance Contracts

Jersey City Housing Authority established a sustainability plan in 2008 to implement portfolio-wide energy efficiency measures while increasing resident comfort and reducing utility expenses. The agency’s first step was to enter an $8.5 million EPC and expand its energy efficiency program.

Self-Managed Energy Performance Contracting

The Housing Authority of the City and County of Denver (DHA) completed a traditional energy performance contract (EPC) in 2007 which was administered by an Energy Services Company (ESCo).

Use of Energy Performance Contract Allows Continuous Provision of Quality Affordable Housing

The Rockford Housing Authority engaged in a $7.5 million Energy Performance Contract to evaluate the conduct a comprehensive energy audit and implement energy efficiency measures at eight of its multifamily properties.

Learn More About EPCs

EPCs At-A-Glance
The following table will give you an at-a-glance summary of a typical EPC, including a basic description, contract structure, tax and balance sheet implications, contract terms, and market information. Mouse over the ‘?’ next to each attribute for more information.
Basic Attributes Applicable Sectors?Which economic sectors does this option commonly serve? Common: Government, Private Universities/Schools/Hospitals
Less Common: Commercial & Industrial, Non-Profit, Multifamily, Affordable Multifamily
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? Works well for owned; may occasionally work for leased space if lease term is long enough
Typical Project Size?What range of project sizes does this option typically serve? $1M+; $5M+ preferred by many providers
 
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? High
Parties Involved?Which types of organizations are typically involved in executing the financing option? Customer, ESCO, Lender/Investor
Payment Type?Are customer payments fixed over time or might they be variable based on factors such as energy savings or utility rates? Typically fixed; in cases where savings are split, payments to ESCO may be variable depending on realized savings
Guaranteed Savings?Is the customer typically guaranteed some amount of savings net of payments on the financing contract? Yes
Measurement & Verification?Is measurement and verification (M&V) of project savings typically provided as part of the financing contract? Yes
 
Tax & Balance Sheet Budget Source?Do customer payments made on this financing option typically come from an operating budget ("opex") or capital budget ("capex")? Payments to lender will typically be capex; sometimes 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? Typically on-balance sheet; some underlying financing structures allow 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. Typically depreciation and interest; all payments to lender might be deducted if treated as off-balance sheet
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)? Typically internal unless underlying financing is off-balance sheet
Collateral Source?Which customer assets can the lender use as collateral to secure repayment? Equipment; possibly other customer assets if financed with recourse debt
 
Contract Terms Typical Duration?How long does a typical financing contract last? 10-20 years
Typical Close Time?How long does it typically take to secure financing once you start speaking with providers? Long (9+ months)
 
Market Attributes Market Size?What is the total cumulative dollar value of projects financed under this option? $45B since 1990; ~$6B per year
Time in Market?How long has this financing option been available in the market? Since the late 1980s