Energy Services Contracts
Energy services company (ESCO) contracts can vary widely. They are more common in some sectors where the organisation effectively ‘contracts out’ its entire energy facilities. An example of this would be the provision of energy services to a hospital under a Public Private Partnership (PPP) contract.
In some instances, the ESCO contractor will design, install, finance, operate and maintain a CHP plant on the organisation’s site. In other cases, the organisation subcontracts only the operation and maintenance of CHP plant that has been installed by other contractors under a capital purchase arrangement. In both cases, the ESCO contractor supplies heat and power to the organisation at agreed rates.The ESCO contractor will also normally take responsibility for fuel purchase, for other on-site energy plant and for the purchase of conventional energy.
From a financing point of view, the basis of an agreement of this type is the transfer of CHP plant capital and operating costs, together with all the technical and operating risks of CHP, from the end user to the ESCO contractor.
The organisation’s savings when funding a CHP plant within an ESCO arrangement would normally be less than under a capital purchase arrangement because the ESCO contractor needs to recover the cost of the capital investment and cover operating costs, overheads and profit. However, under certain circumstances, the savings can be greater than with a capital purchase arrangement. For example, the ESCO contractor may be able to size a CHP plant to meet the heat requirement of the organisation and produce surplus electricity that can be exported and sold. The organisation will still receive only part of the value of the energy savings but, because the energy savings are greater, the organisation’s share may have a value greater than the savings that would have been achieved under a smaller capital purchase scheme. The ESCO contractor will also be able to increase the benefits compared with an in-house solution by avoiding the ‘learning curve’ costs.
Different ESCO contractors may produce widely differing proposals, depending on the organisation’s requirements and the ESCO contractor’s objectives. Among the many variables to be resolved will be:
- Who will operate the plant on a day-to-day basis and, therefore, bear the performance risk?
- Who will maintain the plant?
- Who will own the plant at the end of the initial agreement period of 10-15 years and at what ongoing cost?
Any transaction with an ESCO contractor involves a long-term commitment by the organisation. The organisation’s audited accounts should contain a summary of this commitment. Evidence will also be needed to satisfy the organisation’s auditors that the arrangement is an operating lease and not a finance lease. If ownership transfer to the organisation is implied or stated in the contract, the arrangement must appear on the organisation’s balance sheet.
It should also be noted that an ESCO contract and finance are not intrinsically linked. It is possible to enjoy the core benefits of an ESCO arrangement – cost reduction and operational risk transfer – irrespective of the finance route chosen.
Next: Balancesheet Financing