What is an Energy Services Agreement?
An Energy Services Agreement (ESA) 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 ESA 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, resulting in immediate reduced operating expenses.
An ESA 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
To compare ESAs to other financing options that might be a good fit, answer a few questions about your organization.
How it Works
The ESA 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.
Advantages and Disadvantages
State of the Market
The ESA 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. ESAs are most common in the commercial & industrial, MUSH (municipalities, universities, schools, and hospitals), and government sectors, but they can work for any sector. ESAs are flexible financing mechanisms that can incorporate a wide range of efficiency measures, including water.
ESAs are gaining popularity because they overcome market barriers that other mechanisms do not, and they limit 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, ESAs will likely be one of the few remaining efficiency financing options to be consistently considered off-balance sheet. ESAs represent 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 like a service.
The ESA market is thought to be growing quickly, but no thorough and up-to-date analysis of current market size has been conducted. 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 $110 million in ESA projects from 2012 to 2016. Financing small and medium size projects has proven challenging due to high transaction costs, but through aggregation and streamlined business models, ESAs have 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 ESAs
- 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||Applicable Sectors?Which economic sectors does this option commonly serve?||Common: Commercial & Industrial, Private Universities/Schools/Hospitals, Multifamily
Less Common: Non-profit, 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, ESA 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|
|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")?||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?||$110M+ since 2012; 100+ deals cumulatively|
|Time in Market?How long has this financing option been available in the market?||Since the ~2000s|