Commercial, Energy Efficiency, Industrial, Finance  -  May 13, 2019 - By Better Buildings, U.S. Department of Energy

What is Efficiency-as-a-Service?

Efficiency-as-a-service is a pay-for-performance, off-balance sheet financing solution that allows customers to implement energy and water efficiency projects with no upfront capital expenditure. The provider pays for project development, construction, and maintenance costs. Once a project is operational, the customer makes service payments that are based on actual energy savings or other equipment performance metrics, resulting in immediate reduced operating expenses. The energy services agreement (ESA) is the most common type of arrangement, but other models such as lumens-as-a-service and energy subscription agreements are also in use.

EFFICIENCY-AS-A-SERVICE MAY BE A GOOD FIT IF YOUR ORGANIZATION...

• Wants to pursue retrofits across your portfolio without spending your own capital
• Prefers off-balance sheet treatment for the delivery of efficiency services
• Wants a pay-for-performance solution where a third party takes on performance risk and provides project management and maintenance
• Is looking for a financing mechanism with a contract term ranging from 5 to 15 years, with periodic buy-out options
• Wants a new way to procure energy efficient technologies across your portfolio without the hassle of ownership

HOW IT WORKS: The ESA
The most common efficiency-as-a-service structure is the energy services agreement (ESA). The provider enters into the ESA directly with the customer for a contracted period (typically 5-15 years). Before equipment is installed, the ESA provider performs a baseline of the customer’s energy consumption and calculates an upfront estimation of savings. The ESA provider then pays and manages a contractor to install the high-efficiency equipment and help maintain the equipment through the contract period. Once project installation is complete, a measurement and verification (M&V) analysis is performed to determine actual savings compared to baseline energy use. 

The customer then enjoys lower utility bills throughout the contract term. The customer pays the ESA provider a charge per unit of energy saved that is set below its baseline utility price, resulting in immediate reduced operating expenses. The ESA payment can be structured either as a percentage of the customer’s utility rate or as a fixed dollar amount per kilowatt-hour saved. The ESA provider retains ownership of the equipment for the duration of the ESA term and pays for maintenance to ensure reliability and performance. New efficiency measures can be added during the duration of the contract. At the end of the contract, the customer can elect to purchase the equipment at fair market value, extend the contract, or (less commonly) return the equipment.

An ESA can be thought of as an energy efficiency version of the Power Purchase Agreement (PPA), a structure commonly used to finance renewable energy systems. Under an ESA, the customer doesn’t bear the project performance risk since it only pays for savings actually achieved. Instead, the ESA provider bears this risk and gets paid less if the project savings are lower than expected. However, ESAs vary significantly in terms of contract structure, method used for measuring realized savings, and how the customer and provider split performance risk and upside. Some ESA providers are exploring the possibility of combining ESAs with on-bill repayment.

Typically, ESA projects are funded through a combination of equity from the ESA provider and outside debt from a lender. The ESA provider typically forms a special purpose entity (SPE) that owns all project equipment and is repaid by customer payments under the ESA.

AN ALTERNATIVE APPROACH: THE MANAGED ENERGY SERVICES AGREEMENT
The Managed Energy Services Agreement (MESA) is a variation on the ESA with a few important distinctions. In a MESA structure, the provider assumes the broader energy management of a customer’s facility, including the responsibility for utility bills. The MESA provider essentially acts as an intermediary between the customer and the utility. The MESA provider will charge the customer an agreed-upon fixed rate based on historical energy consumption, thus protecting the customer from utility rate changes. MESAs are especially of interest in sectors where a “split incentive” between landlord and tenant is an issue, as the structure of the agreement allows MESA charges to be passed through to tenants.

AN ALTERNATIVE APPROACH: OTHER EFFICIENCY-AS-A-SERVICE MODELS
Some providers are offering alternative efficiency-as-a-service models that differ from the ESA and MESA. One example is “lumens-as-a-service,” in which a customer specifies its desired lighting output (which can be framed in terms of footcandles or lumens of light supplied, or other metrics) and the provider delivers a contracted lighting service to achieve those outcomes. Another example is a “subscription agreement,” in which customer payments are based on the function or output of the installed energy equipment rather than measured savings, resulting in a simpler contract. Other models such as “electric vehicle charging stations as-a-service” are also being explored. The “as-a-service” concept can potentially be applied to a wide range of technologies using a variety of structures, and the space continues to rapidly evolve.

ADVANTAGES...

Energy savings pay for projects: Efficiency-as-a-service allows customers to redirect a portion of their current utility spending to pay for efficiency improvements; ESA payments are based on realized energy and operational savings and set below the current utility price.

Off-balance sheet; Efficiency-as-a-service is designed to be an off-balance sheet financing solution, with regular payments that are treated as an operating expense similar to a standard energy utility bill or PPA.

Enhanced reliability of operations: Efficiency-as-a-service providers pay for periodic maintenance services to ensure long-term reliability and performance of the project equipment. Under a MESA, the customer has a single point of contact and a single payment for all utility expenses and the MESA provider actively manages energy consumption at the facility.

Flexible enterprise-scale financing: Many providers can bundle together multiple sites that have smaller project opportunities into a single package (e.g., bundle 10 sites with $500,000 projects into a single $5 million service contract).

...AND DISADVANTAGES

Size limitations: Providers tend to look for larger project sizes ($1M+) and some will not consider smaller projects (less than $250k), though there are exceptions.

Building ownership constraints: While efficiency-as-a-service can work in leased or owned space, it is typically only viable in leased space if the contract term does not exceed the lease term.

Longer close times: Transaction costs can be high if each deal is heavily negotiated; for more complicated retrofits with no preliminary energy audits completed, deals can take 9-12 months or more to close. 

Better Buildings is an initiative of the U.S. Department of Energy designed to drive leadership in energy innovation. Through Better Buildings, DOE partners with leaders in the public and private sectors to make homes, commercial buildings and industrial plants more energy efficient by accelerating investment and sharing of successful best practices.

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