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Role of energy service companies (ESCOs) in mobilising finance for green investments in the SME sector

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National Policy Dialogue on “Improving Access to Green Finance for Small and Medium-Sized Enterprises in Georgia”
→ Role of energy service companies (ESCOs) in mobilising finance for green investments in the SME sector – Lars Lunden

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Role of energy service companies (ESCOs) in mobilising finance for green investments in the SME sector

  1. 1. WWW.SIGRAGROUP.COM Role of ESCOs in mobilizing finance for green investments in the SME sector Lars Petter Lunden Partner Sigra Group research – analysis - advice
  2. 2. WWW.SIGRAGROUP.COM AgendaEnergy Service Contracting What are ESCOs – concept and project cycle1 How ESCOs can provide financing and technical risk alleviation for SMEs2 Capital structure of private ESCOs (who often are SMEs themselves)3 Potential for ESCO services to Georgian SMEs4 Policy tools and recommendations for ESCO growth in Georgia5
  3. 3. WWW.SIGRAGROUP.COM ESCO: Turnkey Energy Efficiency Solutions Energy Audit Investments Implementation Monitoring & Optimization Find profitable measures ESCO together with client <1 month Bankable contracts ESCO, client & legal support 1-6 months Quality & cost-efficiency ESCO together with client <1 month Maximize savings ESCO together with client 5-10 years
  4. 4. WWW.SIGRAGROUP.COM PORTFOLIO Total of 27 contracts involving 34 buildings Value of signed contracts: 1.1 million EUR Pipeline of 105 projects with an estimated value of 3,7 million EUR Sigra Group’s ESCO Experience METRICS Max two year payback time on Capex Contract length 5-7 years Simple and replicable solutions yield IRR average of 50 % Commercial loan agreement signed with NEFCO
  5. 5. WWW.SIGRAGROUP.COM Extraordinarily Efficient and Profitable Climate Mitigation Measure 20 x more Co2 reductions per USD invested 5 x larger return to equity • ASWAN Eqypt large scale solar • 450 mUSD in 400 MW • 350 000 tons Co2 / year displaced EPC in Russia compared to randomly selected large-scale solar 1286 USD Capex / ton Co2 15 % RoE target 67 USD Capex / ton Co2 50 % average RoE • Typical building energy efficiency • 10 000 USD in heating system retro-fit • 150 tons Co2 / year displaced per building Sigra
  6. 6. WWW.SIGRAGROUP.COM ESCO SectorsEnergy Service Contracting Private initiative, finance and ‘no cure no pay’ guarantee may help overcome coordination and trust problems in condominiums. ESCOs need firm mandate from general assembly, efficient voting rules and protection from house-owner volatility. Housing Sector Main market driver. The Public benefits from private project development initiative, finance and performance guarantee (risk alleviation). ESCOs need administrative support to drive projects through – should be granted non-exclusively. Public Buildings More complex intervention packages (especially in industrial facilities). Potentially less need for ESCOs to muster finance. Performance guarantee more important. Complex projects imply more complex measurement and verification procedures. Commercial Sector SMEs
  7. 7. WWW.SIGRAGROUP.COM ESCO Finance Depends on Contract Choice Energy costs Owner’s share ESCO Share Before 5 year contract After Energy costs Savings GUARANTEEDSAVINGS Before After Mature Markets: Guaranteed Savings • Owner raises finance based on ESCO guarantee • Performance guarantee = Max energy costs • Customer and client share additional savings • ESCO assumes technological risk only Immature Markets: Shared Savings • ESCO raises finance • Savings are split between owner and ESCO • ESCO assumes both technological and financial risk POTENTIALSAVINGS SPLIT
  8. 8. WWW.SIGRAGROUP.COM ESCO (SME) Capital Structure • Shared savings is the relevant contractual framework (since guarantees imply client finance) • ESCO takes on both technical and commercial risk – returns need to justify the risk level • ESCOs operating under shared savings are often SMEs themselves, with small balance sheets and limited credit history • The structure of ESCO activity is unfamiliar to traditional banks • Banks lack experience evaluating risks of energy efficiency projects Elements Influencing Cost of Capital Available Sources of Capital • Private Capital • Government owned/funded IFIs willing to take risk for green projects - Specific loan facilities however often offered on terms equal to existing credit facilities - IFIs seem to not like that private owners receive return • Commercial loans on equal terms with any other business • Typical structure: Private capital initially, then gradually build credit history and balance sheet to be eligible for commercial loan facilities
  9. 9. WWW.SIGRAGROUP.COM ESCO-SME Holdup problem ESCO pre-investment in audit and technical pre- design Contract negotiation 1. ESCO interested in profitable investments – but so are the SMEs 2. Low trust in outside expertise in immature markets leads to challenges in efficient contracting 3. Non-valuation of pre-investment before contracting undermines valuation of ESCO services
  10. 10. WWW.SIGRAGROUP.COM Benefits for SMEsEnergy Service Contracting • If shared savings: no capital outlays and guaranteed lower energy costs • If guaranteed savings: guaranteed lower energy costs • Lower energy costs per unit produced/sold implies improved profitability • ESCO has larger project-specific risk appetite than SMEs since it can manage risk in a portfolio of projects • ESCOs have experience in evaluating projects’ technical savings potential ESCOs have great potential to improve risk-return profiles of energy efficiency activities
  11. 11. WWW.SIGRAGROUP.COM Barriers for SME ESCO ActivityEnergy Service Contracting Competence, contracting and credit arrangements need to be in place • Incentive problem: - Shared savings projects typically have good profitability levels - SME prefers to finance project itself given access to capital at lower cost than ESCO’s offer • ESCOs prefer public projects - Public sector typically underfinanced, which leaves room for ESCOs - Projects are normally easy to replicate • Guaranteed savings more adapted to private sector, but requires more technically savvy companies and working credit facilities for the SMEs
  12. 12. WWW.SIGRAGROUP.COM SME ESCOs may mobilize Green FinanceEnergy Service Contracting 1. SME ESCOs may be a new market segment in Georgia 2. Profits mobilize private initiative – relatively easy to start an ESCO 3. Given access to capital and functioning framework conditions, ESCOs may play an important role in reducing energy consumption in Georgia 4. Easy and replicable projects exist in Georgia just as everywhere else 1. Lack of legal framework 2. Condominium associations are not legally registered unions in Georgian law 3. Low energy cost and high finance cost, 4. Poor awareness about energy efficiency, ESCO and EPC; 5. Accurate inventory of all public buildings does not exist yet; 6. Underheated buildings Barriers to ESCO development Identified by the Georgian Ministry of Energy (2016)
  13. 13. WWW.SIGRAGROUP.COM Example of Energy Efficiency Initiative in Georgia • EUR 5,14 in loans and grants (almost 50/50) • Refurbishment of 25 public buildings • Annual savings of 200 000 Euro • Annual of CO2 reductions of 1 200 tons • Improved indoor conditions for 10 000 people • 25 years payback time Impossible for private ESCOs to compete with grants and soft loans
  14. 14. WWW.SIGRAGROUP.COM Opportunities and Challenges Benefits • Current scheme uses energy efficiency to finance building upgrades • Increased comfort is target, not environmental effect Challenges • No performance guarantees – all risk on Georgian tax payers • Expensive control mechanisms – foreign consultants perform pro- forma quality control • No mechanism to benefit private sector
  15. 15. WWW.SIGRAGROUP.COM Next Steps – Private Sector Engagement In line with international development trends greater private sector involvement is needed • Benefit private sector • Leverage private capital • Utilize best practice performance guarantee mechanisms Topic for further reseach?
  16. 16. WWW.SIGRAGROUP.COM Simple Policy Recommendations 1. Raise Awareness a) Energy efficiency measures are often very simple, but is often not known b) Returns for simple solutions typically outperforms a complex approach 3. Focus on framework conditions a) Quasi-market creatures such as public ESCOs are a detour b) Public funding through public entities may yield favoritism and corruption risks 2. Focus on enabling private initiative a) Reduce technical risk by making data available b) Profits drive initiative – very high profits will be limited by competition c) Explore options for financial solutions for companies with weak balance sheets (factoring, contract as collateral etc.) 4. Beware of Grant Displacement Potential a) Soft funding displaces private capital b) Reduces reform necessity
  17. 17. WWW.SIGRAGROUP.COM Thank you for the attention! Green Investment in Growing Markets Lars Petter Lunden lars.lunden()sigragroup.com, +4791611515
  18. 18. WWW.SIGRAGROUP.COM International Best PracticeEnergy Service Contracting • Typically start with shared savings and move to guaranteed savings as market matures • Start with simple, quick payback projects (low-hanging fruits) and increase complexity with market maturity • Policy and funding as important as client demand • Public sector major client for ESCOs • Heating, cooling and lighting projects yields the highest effect • Focus on enabling private ESCOs through regulation and provision of finance • Factoring enables revolving funds and faster results
  19. 19. WWW.SIGRAGROUP.COM Best Practice ExamplesEnergy Service Contracting Most Mature Market • 50+ years of ESCO experience • Shift from shared to guaranteed savings in the 80s • Public sector and institutions = 80 % of clients • Majority of projects within heating and cooling • Policy and funding more important than client demand (EEOs and fiscal incentives) Eastern European Success Story • Single measures – easy to isolate, predict and monitor effect • Public sector and SMEs • Payback time increased and guaranteed savings introduced as market matured • Financial incentives and legal framework • ESCO association on company initiative Largest European Market • SMEs dominate the market of more than 500 ESCOs • EPCs only 15 % of the market (guaranteed savings) • Public sector dwarfs other sectors • Public Private Partnerships • Germany drives EPC innovation in the EU China on the Rise • Shared savings model dominant in large market (7 billion Euro) • Guaranteed savings rising for large projects (difficult to get shared savings 3rd party finance for projects larger than USD 2 million) • Outsourcing model (upgrades for a fee less than energy savings) popular for commercial projects

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