Custom CHP Financing Options
Financing options can be divided into two key groups, i.e. those that appear on a company’s balance sheet and those that do not. The table below shows both groups.
Possible financing methods for CHP projects
Capital purchase or 'on-balance-sheet' financing
Operating lease or 'off-balance-sheet financing
Choosing between On/Off Balance-sheet Financing
Choosing an appropriate method of financing will depend on the state of the company’s profit/loss account and balance sheet, and also on the degree of risk and benefit associated with the project.
If a company opts for a capital purchase, i.e. an onbalance-sheet approach to funding, it may obtain the maximum benefits but it will also carry all the risk. A capital purchase may produce the highest NPV, but the initial cash flow will be negative.
As already discussed, many companies will not, or cannot, provide the funds for the capital purchase of a CHP plant. There are several reasons for this:
- The return on investment for such a project may be lower than – and would, therefore, have an adverse impact on – the company’s return on capital employed.
- Even if the return on investment is satisfactory, there may be other, more attractive claims on the company’s cash resources.
- A capital purchase may increase the company’s gearing or reduce liquidity to unacceptable levels.
Such a company may, therefore, prefer an off-balance-sheet financing option. Where a scheme is financed under an operating lease arrangement, the overall NPV will be lower than for the capital purchase option but the cash flow will always be positive – unless the project is only marginally viable or the lender’s charges for money borrowed are high.
Much ingenuity has been expended by ESCOs in devising schemes that combine the off-balancesheet advantages of operating leases with retention of the benefits of capital purchase. However, in recent years, accounting standards have become increasingly strict, and any such scheme is now subject to the provisions of Financial Reporting Standard FRS 5 – Reporting the Substance of Transactions.
It is possible to involve an ESCO contractor with a project, regardless of the financing method chosen. Such a company may well have a valuable role to play in managing and lessening the risks to the end-user.
When choosing a financing option, remember that:
- All potential financing options should be evaluated with equal care.
- The commitment from the end-user will be the same, i.e. high, whichever route is chosen.
- The choice of funding route should generally be secondary to the decision to proceed with the project.
Whichever method of financing is chosen, the decision to invest in large-scale CHP involves a long-term commitment.
A number of large-scale CHP schemes have recently been funded as joint ventures between the end-user and an ESCO contractor. Joint ventures are a highly specific form of legal entity and are normally only warranted for large, complex schemes which can justify the high set-up costs. In such cases, the joint venture serves to ‘ring fence’ the operation and limit the financial liabilities of the partners.