When evaluating suitability of an EPC project or a group of energy saving opportunities there are 5 key considerations:
1. The project has to be VIABLE:
– To justify the capital used to implement an energy saving project, savings have to be sufficient to cover the cost of capital and investment return over a number of years (3 to 20 years).
– If the energy and maintenance savings are insufficient, the customer may have to fund a portion of the works as a “cost of ownership”.
– Furthermore, the project must be of sufficient scale to justify the transaction cost and attract finance.
If the project is viable, then one must consider how the capital will be supplied to finance the works, how the savings will be distributed and how the various risks will be allocated. Traditionally these are all born by the customer but an EPC allocates them to the customer – the ESCO and the financer.
2. The CAPITAL can be supplied out of the customer’s own funds, by the ESCO or by a third party (e.g. a public capital fund, a private capital fund, an energy utility, a bank). The overall capital is likely to be financed from a number of sources. If capital is supplied by an ESCO or third party, then a multi-year contract is required so they can recover their investment with interest.
The associated contract options are discussed further in the next section. The cost of this capital is critical and this depends largely on the risks.
3. The next consideration is the RISK. As already discussed there is a risk that equipment will not perform as was expected, or projected savings will not materialise because the underlying assumptions in predicting savings were incorrect. This risk is typically borne by the ESCO, this being their area of expertise and added value. The risk may be borne entirely by the ESCO, such as when the ESCO guarantees the savings, or in part, such as when the savings are shared.
There is also a credit risk, i.e. the risk that the customer can’t, or won’t, pay at some point in the future. This will be assessed by the ESCO or the third party financier and will affect the cost of capital.
Finally there is the energy price risk. If energy prices change, so does the value of the savings. As the customer is already inherently exposed to fluctuations in energy prices and has most to gain if energy prices fall, this risk is typically borne by the customer. This can be done by agreeing a fixed energy price, or an energy price floor, at which savings are valued.
4. The fourth consideration are SAVINGS. Not just the value of savings, but also how those savings are allocated amongst the different parties. Generally the higher the savings, and the greater the proportion of savings that are allocated to the ESCO or financier, the shorter the contract term.
5. In addition, a correct ENERGY BASELINE design is the last consideration. The baseline of the project identifies energy consumption equation, which reflects the energy uses or energy consumption of the client. A rigorous baseline is necessary to know how to act if there are future significant changes in the client’s process during the contract. In a way, the baseline is useful for linking the risk with the savings, for instance, if the client increase or decrease energy consumption during the contract, energy savings have to be calculated from initial baseline. Therefore, in the baseline design clauses taking into account these kinds of deviations must be present.
Typically the contract life is determined by the length of time needed for the savings to repay all the costs of the project (capital, project management, financing costs, etc). It may be extended if the customer wishes the repayment terms to be lower by spreading them over a longer period of time; or where the client wishes the ESCO to guarantee the savings for a longer period of time. There is usually a premium for this.