(Article published in www.sustainabilityoutlook.

in on May 22, 2012

http://www.sustainabilityoutlook.in/content/financing-models-energy-efficiency-project--
overview )

Financing models of energy

efficiency projects an overview
As the market for energy efficiency evolves, new financing models involving third party lenders or
investors are also emerging in order to address specific needs of the owners and service
providers.

The market for energy efficiency products and services in India has gained momentum in the
recent years. This is due to both regulatory impetus and commercial incentives for green building
and industrial process efficiency. Energy saving products and services in India could offer
interesting capital investment opportunities. It is estimated that such projects could save up to
49billion kWh for industries and another 4.5billion kWh in commercial and municipal buildings
(refer B Natarajans presentation at the Asia Clean Energy Forum 2008).As per the Planning
Commission data and based on national average tariff paid by these two consumer categories
such figures, in monetary terms, potentially translate into US$4.6 billion and US$320 million
respectively.

Energy efficiency projects often involve an energy saving performance contract (ESPC) between
facility owner and a service provider, called the Energy Service Company (ESCo). The
performance contract contains legal provisions between the two parties and lays out a code of
best practices, liabilities, default22222 conditions and remedies, indemnification provisions and
insurance requirements. The ESCo carries out design and implementation of the project and this
can take several forms including retrofits, process design and modification, installation of new
equipment as well as control and management systems. Since performance contracts are
negotiated based on future savings estimates, the role of proper monitoring and verification (M&V)
of actual savings at pre-defined intervals during the contract period remains a key issue.
Initially the funding sources of energy efficiency projects could be either the owner or the ESCo
who then earns returns based on saving on energy bills compared to a baseline. But as market
evolves, new financing models are emerging in order to address specific needs of the owners and
service providers. Six of such financing models are discussed briefly in the following sections.

Guaranteed saving model

The guaranteed saving model (see Figure 1) is termed so because the ESPC comprises
performance guarantee by the project implementing ESCo. Third party lender finances the project
and the facility owner provides it with recourse to their balance sheet. Therefore creditworthiness
of the owner is a necessary condition. The owner in turn has recourse to the ESCos guarantee
and is able to share some risks of the project. After repayment of loans and project payments to
the ESCo, the owner earns the realized savings from their energy bill which effectively constitute
the investment returns. It is also possible that the lender requires a guarantee from the ESCo for
its payments.

Shared saving model

In the shared saving model (see Figure 2), it is the ESCo who invests in the project and assumes
higher risk than the facility owner. This type of model is particularly helpful in case where the
creditworthiness of the facility owner is an issue. One mitigation arrangement is to create a
separate escrow account under the contract. The owner pays up all accrued saving into this
account and all repayments of finance are channeled through it. Third party, who may lent to the
ESCo, would normally have the first access to this account. Thereafter, ESCo receives its
payment (an agreed percentage of the savings) and any excess is availed by the owner. However,
unlike the first case, this last share of accrued savings to the owner is not guaranteed.

Lease models ESCo as the Lessor

When energy efficiency project involves installation of tools and equipment, lease finance as an
option can be explored with the ESCo as the lessor (See Figure 3). As with any other lease, lesse
i.e. the facility owner pays a fixed rent for new installations for pre-agreed period and amounts.
The ESCo avails secured loans for purchasing tools and equipment and the balance of lease rent
and loan repayment are its returns. Surplus in the savings on energy bills of the facility owners
are retained by them.

Lease aggregation
Lease aggregation (see Figure 4) is possible if individual facilities do not amount to significant
investment. In such cases, the ESCo may float a special purpose vehicle (SPV) which aggregates
the leases and channels the repayments. Equipment manufacturers and third party investors may
also acquire holdings in the SPV.
Development finance model
Development finance has played an important role in encouraging the markets for energy
efficiency in India. This has particularly been noteworthy in supporting small, micro and medium
enterprises with access to soft capital through a number of refinancing institutions (see Figure 5).
A facility owner (or the enterprise) procures soft loan under favorable conditions and this helps
covering their capital expenses. The performance contract between the owner and the ESCo can
be structured on lines of the regular models such as guaranteed or shared saving as discussed
earlier in this article.

Energy Service Agreement model Investor/Lender at the center stage

This particular model has typically been used in relatively mature markets such as the US where
a lender or investor takes the center stage in the energy efficiency project implementation and
saving realization. In this model, the lender or investor executes an energy service agreement
(ESA) with the facility owner to fund their entire cost of energy saving installation, upgradation
and maintenance. In return, the investor or lender assumes responsibility of the utility bill
payments and thereby captures all savings that accrue from the baseline, effectively charging the
owner for avoided energy costs. There is a minimum pre-implementation energy bill criterion
(typically US$ 1 million per annum or above) that facility owners need to satisfy under this model.
Also, projects attract much higher capital than experienced in the previous models.

On the other hand, the lender or investor carries out a performance contract with the ESCo to
provide capital for installation and maintenance services (or, even active energy management) at
the owners facility on an ongoing basis. Such a contract may also have a provision for the ESCo
to share profits from accrued savings.
Clearly, as the market develops, variants under each of the discussed financing models willsee
evolution in maturity and complexity. Also, new and innovative financial instruments are likely to
appear for support and risk allocation amongst involved parties. Therefore, it is not only the
industries, building sector and ESCos but also the financial institutionsthatare looking at energy
efficiency with great interest.

References
Planning Commission (2011) Data table on Power, Energy and Irrigation Related [Available
online http://planningcommission.nic.in/data/datatable/index.php?data=datatab, accessed on
10th May 2012]
Natarajan B (2008) EE Finance in India-some progress and what next? Asia Clean Energy
Forum 2008 ADB Headquarters, Manila
The Rockefeller Foundation & DB Climate Change Advisors (2012) United States Building
Energy Efficiency Retrofits White Paper [Available online
http://www.rockefellerfoundation.org/news/publications/united-states-bui..., accessed on 10May
2012]
IFC (2007) India Manual for Development of Municipal Energy Efficiency Projects [Available
online http://www.beeindia.in/schemes/documents/agricultural_and_municipal_dsm/...,
accessed on 10th May 2012]