ESPC (With Financing)

• Is considering many energy conservation measures and wants to outsource measure identification, installation, and project management to a third party
• Has large projects ($500K+, 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 ESPCs to other financing options that might be a good fit, answer a few questions about your organization.

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 savings performance contract (sometimes called an energy performance contract, or EPC) 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.

ESPCs 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 ESPC term expires, the customer stops making service payments to the ESCO, takes responsibility for maintaining the equipment, and keeps all future energy savings. ESPCs 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 ESPC 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 ESPCs 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, ESPCs 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. 

The Department of Energy has developed model documents that can help you launch energy efficiency projects using an ESPC. There are also alternatives to the traditional ESPC, 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 ESPCs. 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.

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 ESPC 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 ESPCs a good fit. However, ESPCs 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 ESPCs 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 $50B 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 ESPC market. As one of the most established structures, ESPCs will likely continue to play a large role in energy efficiency financing for years to come.