What is an Energy Savings Performance Contract?
Under an Energy Savings Performance Contract (ESPC), 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 ESPC is financed. ESPCs are suited for larger ($1 million+), more complex projects with high upfront costs, though they have sometimes been used for smaller projects. ESPCs are also called energy performance contracts (EPCs).
An ESPC 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 ($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.
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 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.
Advantages and Disadvantages
Most ESPCs include a performance guarantee, reducing project risk for the customer. This is particularly beneficial for large and complex retrofits.
The ESCO handles most aspects of project scoping, implementation, and management, reducing the burden on the customer’s in-house staff.
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.
The market for ESPCs is well established, allowing ESCOs to develop standardized processes.
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.
Because ESPCs 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).
ESPCs 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.
Because of the substantial transaction costs to set up an ESPC, 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.
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 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.
Better Buildings Implementation Models
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.
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.
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).
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.
Massachusetts created an innovative financing model called the Clean Energy Investment Program (CEIP) which invests in projects using bond funding that is repaid from the energy savings generated by the projects.
Learn More About ESPCs
- Better Buildings Initiative — Energy Savings Performance Contracting Accelerator
- Better Buildings Initiative — ESPC Toolkit
- U.S. Department of Energy — Energy Savings Performance Contracting: Improving Infrastructure & Turning Waste into Wins
- Environmental Protection Agency ENERGY STAR® Program — Introduction to Energy Performance Contracting
- Building Owners and Managers Association - BOMA Energy Performance Contracting (BEPC) Model
- Wilson Sonsini Goodrich & Rosati — Innovations and Opportunities in Energy Efficiency Finance
- Deutsche Bank Climate Change Advisors and The Rockefeller Foundation — United States Building Energy Efficiency Retrofits: Market Sizing and Financing Models
- Federal Energy Management Program — Energy Savings Performance Contracts for Federal Agencies
- National Association of Energy Service Companies (NAESCO) — Find a Provider
|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|