Answer by Alejandro Morell (Creara)
Concept of ESCO and EPC
ESCO is a firm that provides solutions for achieving energy cost reductions, and whose overall compensation can be linked (in part or in full) to the performance of the implemented solutions. In that context, an ESCO can handle projects, mobilize financial resources (not necessary its own equity), offer turn-key services (either on its own or through collaborating with other market players) and assume performance risks.
Energy Performance Contracting (EPC) means a contractual arrangement between the beneficiary and the provider of an energy efficiency improvement measure, verified and monitored during the entire term of the contract, where investment in that measure are paid for in relation to a contractually agreed level of energy efficiency improvement or other agreed energy performance criteria, such as financial savings.
Thus, ESCO is related to the company offering energy efficiency services and EPC is the contractual model that governs the relationship between the ESCO and the client.
What are the advantages of an ESCO project?
Usually, the service offered by an ESCO integrates all energy services for all of the phases of the project through a single contract. Furthermore, the ESCO, grounding its benefits in energy savings, offers a guarantee of obtaining rational solutions consistent with the customer needs. Thus hiring an ESCO enables customers to renew their technology and improve competitiveness and productive assets.
Why and when it is interesting to negotiate with an ESCO?
The underlying logic of an ESCO model is to offer a solution whereby private contractors convert energy inefficiencies into future cash flows and energy saving investments are repaid from savings resulting from the analysis.
EPC is highly recommended when the client needs to change its equipment and technologies to obtain gains in term of energy efficiency but the large up-front investments discourage this action.
Other added values of the ESCOs come from:
- An ESCO enables its client to outsource energy management activities that are usually not in the client core business
- An ESCO focuses on the reduction of energy costs through best management practices, including M&V
Consequently, it is interesting to enter into negotiations with an ESCO whenever a high initial investment is needed, since such an initial investment is minimized or eliminated by an ESCO. In the case where the ESCO provides funding for the implementation of projects, the borrowing capacity of the client will not be affected. The Client can then employ its financial resources for other needs.
What are the differences between EPC and other energy contracts?
An ESCO can generally offer two main models of contracts for energy services:
- Energy Supply Contracting (ESC): In order to reduce the price of the energy bill of the client, a long term arrangement with the ESCO is signed. The ESCO may install more efficient equipment, employ more affordable fuels or implement solutions in order to achieve the savings.
- Energy Performance Contracting (EPC): EPC is an agreement between the ESCO and the client on the share of the energy savings and its inherent risks as a result of the implementation of energy efficiency measures.
Thus, in the case of ESC, the service simply provides power to the customer, while the EPC offers a more complex and complete service, since it covers both the optimization of energy supply and increases the energy efficiency in the client’s facilities. Therefore, the EPC option has the greatest potential of savings.
There are three main types of EPC:
- Shared savings: under a shared savings contract, the investment is assumed entirely by the ESCO, including investment financing, management and control of energy consumption.
This mechanism is attractive for the ESCO as long as it excludes penalties in the event that the implemented measures perform poorly or the initial estimation proves to be too low.
In return for providing financing, the ESCO undertakes comprehensive management. In order to compensate for the managerial complexity involved, the ESCO typically prefers large or medium-sized customers.
- Guaranteed savings: conversely under guaranteed savings contract, the client assumes the entire investment required.
In this case, the ESCO shall ensure real savings and if they are not enough to cover debt service, then ESCO might pay the difference. If however, the savings exceed the guaranteed level, then the customer must pay an agreed upon percentage of the savings to the ESCO.
This mechanism is typically used when the investment associated with the project is undertaken by the customer. This is why this type of contract is only suited for clients with sufficient financing, typically large or medium size companies.
- Mixed savings: this kind of contracting is a highbred combination of the two previous models.
The ESCO guarantees savings to the client with any additional savings shared between the ESCO and the client.
Thus, the ESCO makes the investment in the new equipment, which is owned by the ESCO for the duration of the contract. Ownership of the equipment is transferred to the client at the end of the contract.
Usually, there is a fixed payment (investment amortization) a maintenance fee and a variable payment based on the savings achieved (shared savings).
Regarding to the risks, both the ESCO and the client share the risk of performance and, sometimes, the risk of changes to the price of energy. However, the credit risk is usually assumed by the ESCO.
Last update April 21, 2015