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ENERGY PERFORMANCE CONTRACTING GUIDELINE FOR SMES

Preparation of Guidelines for EPC Contracting for ESCOs and Case Study Development

Turkish Ministry of Energy and Natural Resources

Prepared for:

SME Energy Efficiency Project

Final

February 14, 2017

Energy Performance Contracting Guideline for SMEs Preparation of Guidelines for EPC Contracting for ESCOs and Case Study Development



Project No. 6008 ii

ABBREVIATIONS

ECM Energy conservation measure

EE Energy efficiency

EMO Energy management outsourcing

EOI Expression of interest

EPC Energy performance contracting

ESCO Energy service company

IGA Investment-grade audit

IRR Internal rate of return

LOI Letter of intent

M&V Measurement and verification

NPV Net present value

O&M Operation and maintenance

RE Renewable energy

RFP Request for proposal

SME Small and medium enterprises

TPF Third-party financing

WTA Walkthrough audit




Project No. 6008 iii

TABLE OF CONTENTS

INTRODUCTION ................................................................................................................................... 1

1 EPC CONCEPT ............................................................................................................................ 2

1.1 Energy Service Company (ESCO) ...................................................................................... 2

1.1.1 Types of ESCOs ............................................................................................................... 4

1.2 Advantages of working with an ESCO for SMEs ............................................................... 4

1.2.1 Technical Risk Management ............................................................................................ 4

1.2.2 Project Financing and Benefits ......................................................................................... 4

1.2.3 Guaranteed Savings ......................................................................................................... 4

1.2.4 Expertise ........................................................................................................................... 5

1.2.5 Environment ..................................................................................................................... 5

2 EPC PROCUREMENT MECHANISMS AND IMPLEMENTATION STEPS ................................. 6

2.1 Initial Project Development Phase ...................................................................................... 7

2.1.1 Tender Process ................................................................................................................ 8

2.1.2 Spontaneous Process ...................................................................................................... 9

2.2 Project Design and Implementation Phase ...................................................................... 12

2.2.1 IGA Preparation .............................................................................................................. 12

2.2.2 EPC Contract Negotiation and Signature ....................................................................... 13

2.2.3 Project Design Finalization and Implementation ............................................................. 13

2.2.4 Project Commissioning ................................................................................................... 14

2.2.5 Savings Management and Reporting ............................................................................. 14

3 FINANCING MECHANISMS: EPC, CONTRACTUAL AND NEGOTIATION ELEMENTS ........ 15

3.1 Guaranteed Savings ........................................................................................................... 15

3.2 Verified Savings ................................................................................................................. 16

3.3 Lease Contract Model ........................................................................................................ 17

3.4 Comparative Analysis of Models ...................................................................................... 18

4 MEASUREMENT AND VERIFICATION OF SAVINGS ............................................................. 19

5 OPERATION AND MAINTENANCE AND CAPACITY BUILDING............................................ 20

APPENDIX I MAIN SERVICES OF AN ESCO .................................................................................... 21

APPENDIX II RFP GUIDELINES ........................................................................................................ 23

APPENDIX III EXAMPLES OF RFP EVALUATION CRITERIA ......................................................... 24

APPENDIX IV M&V PLAN GUIDELINES ........................................................................................... 25




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LIST OF FIGURES

Figure 1: Traditional Approach ............................................................................................................... 3 Figure 2: ESCO Approach ..................................................................................................................... 3 Figure 3: EPC Development Process .................................................................................................... 7 Figure 4: Guaranteed-Savings EPC .................................................................................................... 15 Figure 5: Verified-Savings EPC ........................................................................................................... 16




Project No. 6008 v

The present guidebook is intended to provide guidance and advice to SMEs on the use of the energy

performance contracting (EPC). It provides them with a basic introduction to the main process to be

followed in order to develop a successful contractual relationship with Energy Service Companies

(ESCOs) to develop and implement energy efficiency (EE) projects in the specific context of Turkey.




Project No. 6008 1

INTRODUCTION

EPC is a contractual scheme that aims to eliminate the market barriers that prevent the implementation

of EE projects at end users facilities. The major difference between an EPC is not based on the

successful implementation of a project based on requested equipment installations but rather a scheme

then focuses on projects performance where the contractor (the ESCO) payment is linked in some ways

to such performance. The final aim of the partnership established between an SME and an ESCO under

an EPC is to enable the implementation of a successful EE project where the needed investment has

to be covered by the generated financial savings over a pre-defined time frame.

Even if quite different as per its nature, EPC shares many similarities with conventional engineering

work design and construction practices. However, EPC’s distinctive differences from conventional

practices can provide SMEs with opportunities to install EE equipment that could not be otherwise

implemented when using a conventional process.

Section 1 of this report provides a basic introduction to the EPC model, ESCO services and the benefits

of doing business with an ESCO.

Section 2 presents the implementation steps for an EPC project development and implementation by

detailing the main stages to be completed before and after the signature of an EPC contract between

the parties.

Section 3 presents the different type of financing mechanisms related to the use of different contractual

approaches that can be used under an EPC contractual scheme. It also presents the different specific

elements of each type of contracts to be used including contractual and negotiation process.

Section 4 outlines the main characteristics and components of an effective measurement and

verification (M&V) plan, which should be prepared in the EPC development phase

Section 5 introduces the additional services that can be offered under an EPC approach and the benefits

that an end users can get as an added value through them.




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1 EPC CONCEPT

An EPC is defined as “a contractual arrangement between the beneficiary and the provider of an EE

improvement measure, according to which the payment for the investment made by the provider is in

relation to a contractually agreed level of EE improvement or other agreed-upon energy performance

criteria, such as financial savings”.1 Therefore, an EPC has the following specific characteristics:

› An EPC is a contract between two parties — the beneficiary and the service provider.

- The beneficiary is the institution, the industry or the building owner that seeks to implement

energy-saving measures or an EE project.

- The service provider is the ESCO that is contracted to implement the energy savings project.

› An EPC defines the terms of the contract, i.e., the responsibilities of each party.

› In most cases, compensation for the services provided by the ESCO is based on the level of

energy savings or the reduction in energy expenditures after project completion.

› The EPC is time bound and has a typical duration ranging from five years for small projects to

over 20 years for very large projects.

Lack of access to financing should not be seen by the Turkish SMEs as a barrier to EE improvement

since EPC is getting better known by local financial institutions who can help provide an alternative

financing adapted to the scheme in order to help secure funding for EE measures.

1.1 Energy Service Company (ESCO)

An ESCO is a company specialized in developing and implementing measures aimed at reducing

energy consumption in facilities by identifying and implementing EE measures and measuring and

verifying the results achieved. In order to perform these activities, the ESCO signs a contract called an

EPC with their clients.

ESCOs in Turkey can offer a wide range of services, including one or several of the following: energy

auditing, design engineering, financing, equipment supply, installation, operation, maintenance and

upgrades, energy management, and measurement and verification of energy savings.

From the Turkish SME perspective, the most attractive aspect of the ESCO model is perhaps that it

deals with a single entity in handling all the project components throughout all stages of the project

cycle, rather than with several institutions (design office, entrepreneurs, energy suppliers, equipment

manufacturers, financing institutions, government bodies, etc.). This “one-stop” feature greatly reduces

the transaction costs for the SME, and these costs are often the biggest obstacle to EE project

implementation.

1 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52011PC0370&from=EN

http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52011PC0370&from=EN




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Figure 1: Traditional Approach

Figure 2: ESCO Approach

Information on the detailed services that could be offered by an ESCO is presented in Appendix I.

Professional Consulting Engineer

Contractors

Equipment

Manufacturers

Governments

Financial

Institutions

Energy

Suppliers

SMEs

Professional Consulting

Engineer

Equipment Manufacturers .

Governments

Financial

Institutions .

Energy

Suppliers .

SMEs

Guarantee

• Analysis • Concept • Installation • Financing • Monitoring

• Training

ESCO

Contractors




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1.1.1 Types of ESCOs

ESCOs in Turkey are generally classified into the following three categories based on their composition

and ownership:

› Independent ESCO: ESCOs that are not owned by an electric or gas utility, an equipment/control

manufacturer or an energy supply company. Many independent ESCOs focus on a few geographic

markets and/or target specific SME market segments.

› Equipment manufacturer: This type of ESCO is owned by an equipment or control manufacturer.

Some of these ESCOs have an extensive network of branch offices that provides nationwide and

international coverage, with sales forces and specialized national staff providing packages of EE

to SME market segments.

› Other energy/engineering companies: This type of ESCO is owned by international oil or gas

companies, non-regulated energy suppliers or large engineering firms.

1.2 Advantages of working with an ESCO for SMEs

The following subsections summarize the main benefits of EPC projects as implemented by ESCOs for

SMEs.

1.2.1 Technical Risk Management

ESCOs are responsible for bearing the technical risks associated with the project, which is not possible

in a business-as-usual project. This means that the ESCO ensures that the project will perform as it is

designed in order to recover the costs as revenues are tied to the performance of the equipment installed

or the energy management plan implemented. Furthermore, the ESCO ensures that the equipment

installed operates properly and is well maintained during the EPC duration, and that there will be no

budget overruns despite technical difficulties.

1.2.2 Project Financing and Benefits

EPC projects can be financed through the energy savings, i.e., the cash flow generated by the EPC

project implementation is sufficient to repay the ESCO service costs, thus avoiding capital expenditures

for the company. Furthermore, depending on the terms of the EPC, a part of the cash flow generated is

returned to the SME as benefits from the EPC.

1.2.3 Guaranteed Savings

ESCOs are responsible for ensuring that the claimed savings are obtained over the contractual period

of the agreement. If not, they have to pay for the shortfalls, as set out in the contract. The guaranteed

savings help predict stable cash flows and negotiate financing arrangements.




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1.2.4 Expertise

ESCOs bring expertise from previous work experience to new SME projects. Because ESCOs have

strong skills and proven track records, it is advisable to deal with an ESCO as a one-stop contact on a

project providing turnkey solutions than to have multiple intermediaries. Also, because the benefits

expected by the ESCO are tied to the level of energy savings, it works continuously to improve the level

of energy savings, thus putting to good use its expertise in equipment operation and maintenance.

1.2.5 Environment

EE is one of the key solutions to mitigate climate change. The ESCO business model and/or EPC are

policy instruments widely used to enable the implementation of EE projects that do generate carbon

emission reduction that are at the source of climate change.




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2 EPC PROCUREMENT MECHANISMS AND IMPLEMENTATION STEPS

Turkish SMEs can implement an EPC by receiving a spontaneous offer from an ESCO or by issuing a

call for tenders to choose from different proposals:

› In the spontaneous process, the ESCO selects the SME based on various criteria, including

financial, technical, marketing and promotion criteria, as well as the level of risk. The ESCO

initiates project development and invests its time and effort in developing the EE project and in

convincing the SME to go forward with the implementation.

› In the tender process, the SME takes the initiative for EE project development. In this process

the SME selects the best ESCO proposal based on its own evaluation criteria and pre-defined

needs.

The difference between the two approaches lies in the project’s initial development phase, after which

both processes follow the same path during the project design and implementation phase, starting with

the development of the investment-grade audit, as shown in Figure 3 below.




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Figure 3: EPC Development Process

2.1 Initial Project Development Phase

The EPC project development can be initiated by the ESCO or the SME. In the spontaneous process

the SME is approached by an ESCO where the latter completes a series of steps to make the best

proposal to the SME. In the tender process, the SME will take the initiative to request proposals from

the ESCOs. This section presents the initial development phase of the two approaches.

RFP to (shortlisted) ESCOs

Proposals Preparation by ESCOs

RFP Evaluation and ESCO Selection

IGA Preparation

Contract Negotiation and Signature

Project Design Finalization and Implementation

Project Commissioning

Savings Management and Reporting

Letter of Intent (optional)

Walkthrough Audit (WTA)

Spontaneous Process Tender Process

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IGA Agreement Preparation




Project No. 6008 8

2.1.1 Tender Process

If the SME wishes to develop an EPC with an ESCO, it is a good indication that it is most probably aware

of the company’s current energy situation, EE level and energy consumption patterns, and that it wishes

to improve its energy performance and efficiency.

Having gathered energy consumption indicators and assessed energy savings opportunities will

certainly help the SME establish and evaluate the EE project milestones, such as the ECM to be

considered, the energy savings goals, the project’s financial and technical boundaries, etc.

Request for Proposal (RFP)

To initiate the process, the SME should proceed with issuing a Request for Proposal (RFP), inviting

ESCOs and energy service providers to prepare proposals for an EPC. For this purpose, the SME

should prepare the RFP, including supporting tendering documents, such as a statement of work and

an energy performance contract. The RFP also includes a description of the expected scope of work

and mandatory rated criteria. Mandatory rated criteria are a minimum set of specific and objective criteria

that all ESCOs must meet. These criteria will help bidders submit complete and competitive proposals

and help the SME assess proposals adequately. Rated criteria can include:

› Financial merit;

› Technical merit;

› Implementation approach;

› Operation and maintenance approach;

› Project management approach;

› Training and awareness approach;

› Performance measurement and verification approach.

Appendix II presents some guidelines for the contents of the RFP.

Proposal Preparation by ESCOs

ESCOs preparing responses to the RFP will require access to the facilities as well as time with staff.

The quality of the proposal is directly related to how well ESCOs understand the facility, the opportunities

available and any restrictions on how they can implement them. It is normal, though not essential for all

ESCOs, to attend site visits together. This ensures no ESCO has an advantage over another. It also

minimizes the time the SME staff has to devote to the process.

It should be noted that the SME can select a shortlisted ESCO or invite only those selected in the RFP.

The main purpose of this is to identify and qualify the ESCOs able and willing to offer proposals for the

project.




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RFP Evaluation and ESCO Selection

This stage involves selecting the ESCO for the project design and implementation phase. The evaluation

criteria should place considerable weight on the originality, creativity and technical soundness of the

approach.

A system should be set up to evaluate each proposal based on the requirements of the SME. The

selected ESCO is given the opportunity to negotiate an EPC with the SME. As the proposals

considerably vary in approach, the use of a conventional weighted scoring method at this stage can

skew the result significantly. It is thus recommended, if possible, that the SME create a best-case

scenario, and choosing the closest fit to this scenario will produce more reliable results. Financing, if

requested or desired, should be assessed as part of the proposal with the weighing of the option defined

in the evaluation criteria.

Cost (or lowest cost) is not the main driver for the selection of the ESCOs, since detailed project costing

cannot be carried out until the IGA has been conducted. Consequently, originality, understanding and

approach are usually given significantly more weight. Appendix II presents an example of evaluation

criteria of an RFP.

It is recommended that the evaluation be completed during a face-to-face meeting with each of the

participating ESCOs since some clarifications are normally necessary.

2.1.2 Spontaneous Process

This process is followed by ESCOs when selecting their clients in order to “sell” their services by

investigating the opportunities for EPC in the client facilities. Each of the ESCOs has their own business

plan and consequently a specific list of sectors or clients to contact in order to offer their services and

develop a project. Once the ESCO has approached the SME and agreed to collaborate, some ESCOs

prepare a letter of intent (LOI) for the SME to sign. This LOI is optional, but recommended to establish

a common understanding between the ESCO and the SME.

Letter of Intent (optional)

This letter is designed to confirm to the ESCO that the SME is willing to enter into an EPC agreement,

to address the SME’s energy concerns and to establish a schedule for project development.

This should be regarded as the beginning of the trust-building process. Generally no analysis of the

SME’s facility will be undertaken until the SME and the ESCO sign such letter.

Objective of the LOI

To reach a common understanding between the ESCO and the SME regarding the EPC’s objectives




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The Walk-through Audit Stage

Once the LOI is signed, the ESCO will need to perform a preliminary analysis of the energy consumption

and cost data by conducting a walkthrough audit (WTA). Data and additional information not yet obtained

can be requested from the SME, including bills and other relevant records.

The functions, conditions and approximate ages of all major mechanical and electrical systems are

reviewed and the retrofit opportunities are identified. Any other building/facility/business issues and

requirements set by the SME should also be noted, including security, air quality, communications,

energy information, transportation, infrastructure and waste disposal. To the greatest extent possible,

these should be addressed in line with the priorities of the SME.

A preliminary budget and savings estimate for the potential project should be established at this stage.

The preliminary analysis of the SME’s energy bills, facility survey, operating procedure survey and

operating cost data will be used as the basis for the presentation of a proposal to the SME for the

development and implementation of an energy and cost reduction project.

The review of this preliminary information should be done with the SME before the preliminary IGA

agreement proposal is formally submitted as to avoid any surprises for decision-makers.

Ultimately, this information is packaged together in a preliminary proposal and presented in the WTA

report. The word “preliminary” is key for a number of reasons:

› Preliminary nature of the various EE strategies under consideration;

› Preliminary nature of the energy savings estimates;

› Rough retrofit and equipment cost estimates;

› Need to limit the amount of information transmitted to the SME when it still has the option of

considering suppliers or mechanisms other than those proposed by the ESCO’s integrated

services;

› ESCO’s needs to have product and design flexibility during the IGA stage and before the final

implementation contract is proposed to the SME.

Objective of the Walkthrough Audit

› To enable the ESCO to gain insights into the range of facility equipment/systems and their age and condition, operating conditions/factors, and to listen to the operating personnel’s concerns and experiences with the operation.

› To collect data to support a preliminary budget analysis of the project, including the range of probable retrofits and corresponding energy savings to support a preliminary cost estimate.

› To enable the ESCO to communicate to the SME the overall scope of the project, and to demonstrate the ESCO’s ability to address the critical issues of the project.




Project No. 6008 11

Preparation of Investment-Grade Audit (IGA) Agreement

The ESCO is responsible for preparing an IGA agreement, which includes a preliminary financial plan

and references to the walkthrough report. This preliminary agreement to conduct the IGA is usually

submitted at the same time as the WTA presentation. The last point in the walk-through audit report

presentation should be a review of the main clauses of the IGA agreement to highlight the main

obligations to be met by both parties for the project’s next step.

An IGA must be completed in order to develop a more precise project scope, estimate the savings,

gather the cost data and gain a better understanding of the effects and benefits the anticipated efficiency

measures will have on operations and maintenance. It is important to differentiate the contents of an

IGA from those of a “traditional” energy audit done by an engineering firm so that the SME understands

that they are two different audits with different costs and results. Among other things, the IGA will have

to include the preparation of an adapted M&V plan to demonstrate the savings that will be generated by

the proposed projects.

Because it requires a large amount of the ESCO’s resources to complete the IGA, it usually cannot be

offered by the ESCO without seeking a strong commitment from the SME prior to its realisation. An IGA

agreement is therefore designed to define the terms and conditions under which the IGA will be

performed and how the services will be paid for by the SME, whether the SME chooses to or not to

proceed with the implementation stage.

The IGA agreement generally states that the ESCO shall undertake an IGA at a specified cost. If the

IGA confirms the preliminary findings from the walkthrough audit, the SME will agree to enter into a full

EPC agreement with the ESCO and go forward with the project. The cost of the IGA can then generally

be financed as part of the total cost of the project and reimbursed from the energy savings in the future.

The agreement further stipulates that, in the event that the SME chooses, for any reason, not to move

forward with the EPC, following the completion and submission of the IGA report, the SME’s only

obligation will be to pay for the cost of the IGA. An important element of the agreement is the provision

of a performance feature regarding the results of the IGA. If the results of the IGA fail to confirm the

predictions of the preliminary proposal, the SME has no obligation to pay for the IGA.

Objective of the IGA Agreement

› To secure the commitment and authorization from the SME for the ESCO to proceed with the IGA. If the preliminary findings in the preliminary proposal are confirmed, actions can be taken in a timely fashion to enter into a full EPC contractual agreement.




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2.2 Project Design and Implementation Phase

Once the SME has selected the ESCO through the tender process or signed the IGA agreement in the

spontaneous process, the project design and implementation phase is started by the development of

the IGA.

2.2.1 IGA Preparation

ECM Identification and Design

It may take between a few weeks and a few months to complete a typical IGA, depending on the size

of the facility targeted and the number of measures to be evaluated.

ESCOs investigate all opportunities that will deliver a project within the required return on investment,

the overall capital budget, the payback period or any other indicators that meet the SME’s requirement

or wishes. The strength of an EPC is that ESCOs identify all potential opportunities, not only those within

the predefined scope of work. While the SME still has the final say, a more complete picture of

opportunities can be evaluated.

As the EE measures and strategies are developed, the ESCO should check the following items with the

SME:

› Final operational savings estimates (and potential sharing);

› Final energy savings estimates;

› Final EE measures and strategies to be implemented.

It is vital that the SME and the ESCO work as partners, responding to the each other’s needs and

requirements. Mutual and continuous dialogue is essential as it helps foster understanding between the

parties though discussion and negotiation and obtain the best possible result and contract.

Measurement and Verification Plan

It is within the IGA preparation that the measurement and verification (M&V) plan has to be designed. It

becomes a fundamental part of the IGA.

Presentation of the IGA, Final Financial Plan and IGA Acceptance

Once the IGA has been completed, a formal presentation should be made to the SME’s senior

executives. An initial implementation plan should be presented along with a review of the key elements

of the EPC. This presentation will also be an opportunity to cover contract-related questions.




Project No. 6008 13

The main topics to be presented and discussed are the following:

› Contract term;

› Verified savings or guaranteed savings;

› Floor and ceiling price for energy by source;

› Financing condition and parameters;

› Invoicing;

› Ownership;

› Additional services, maintenance, and energy management.

The SME should request time to study the results and consider alternatives, or ask additional questions.

The IGA might need further work to adjust to SME’s selected ECMs or additional requests.

2.2.2 EPC Contract Negotiation and Signature

With the final approval of the IGA by the SME and the confirmation of the list of measures to be

implemented, the EPC can be drafted by the ESCO and presented to the SME based on the earlier

discussions and SME’s requirements. This draft version will be the basis for the SME and the ESCO to

engage in negotiations.

Once all the negotiations have been completed, the EPC is finalized, and implementation work

commences. In the case where final negotiations do not result in a signed EPC, the SME may be

required to pay for the IGA as per the cost indicated in the signed IGA agreement.

2.2.3 Project Design Finalization and Implementation

Most ESCOs will not have finished all final engineering designs upon completion of the IGA and prior to

signing the EPC. This is to avoid unnecessary upfront costs and reduce commercial risk should the

project not go forward. Once the EPC is signed by all parties, the SME will notify the ESCO to start the

implementation phase. The ESCO will take on the role of project manager by ensuring that the

specifications and drawings have been properly prepared, by inviting qualified contractors to bid (where

necessary), and by supervising and managing the installation process.

Objective of the IGA Presentation

› To present an overview of the project and explain its benefits and critical elements; to present the finalized energy services contract documents




Project No. 6008 14

At this stage, a detailed program work chart should be prepared and the final components of the EPC

complied with. With the detailed work specifications and schedule in place, the ESCO starts hiring

subcontractors as necessary and organizing the site for work on the project. All these activities must be

coordinated with the SME as to ensure any special requirements or restrictions are taken into account

(planned shutdowns, critical periods of operations, public holidays, vacations, etc.).

2.2.4 Project Commissioning

This task is typically performed by the ESCO, but it is strongly recommended that the SME’s operational

staff also participate to learn more about the performance aspects of the project. Commissioning is

typically not a static process, particularly when several ECMs are involved. Also, with EPCs the SME

may find that the commissioning process is more about fine-tuning until the ECMs deliver on the

expected energy savings proposed by the ESCO. As in the construction phase, the commissioning

process should be well documented and scheduled according to the SME’s and ESCO’s requirements.

Finally, the commissioning process is an ideal opportunity to train the operational staff on the detailed

aspects of each of the ECMs — it is advisable that the SME discuss this opportunity with the ESCO and

incorporate such option in the scope of work, if appropriate.

2.2.5 Savings Management and Reporting

Once project implementation has been completed, the ESCO will evaluate the energy savings

generated at the SME’s facility as per the M&V plan agreed upon at the IGA stage. The ESCO will

measure and verify the actual levels of energy savings achieved and compare these with the forecasted

levels in the proposals. The ESCO will prepare the required report as per the M&V Plan and determine

the monetary value of the savings. The cost recovery phase will continue until the entire investment has

been recovered or until the contract expires.




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3 FINANCING MECHANISMS: EPC, CONTRACTUAL AND NEGOTIATION ELEMENTS

The EPC models presented below are those that were identified as the most appropriate to be used for

private-sector transactions in Turkey.

Three types of performance-based contract structures will be notably used by ESCOs in Turkey, namely

“guaranteed savings”, “verified savings” and lease agreement. A template for each contract type has

been prepared and should be used as a basis for contract preparation. It should be noted that these

templates can be adjusted and adapted to the SME’s situation, project risk exposure and general project

specificities.

3.1 Guaranteed Savings

The guaranteed-savings structure is an arrangement whereby the “SME makes regular fixed debt

service payments to a third-party financial institution in the amount required to repay the ESCO’s turnkey

project price, plus the financing costs”. Under this approach, the ESCO guarantees the SME that the

achieved savings from the project will be equal to all project payments, including debt service plus any

downstream fees to the ESCO for its ongoing M&V, operation and maintenance services, under a fix

time duration. If the achieved savings fall short of the project payments made by the SME, the ESCO

will pay the difference between the achieved savings and the project payments. If the achieved savings

exceed the project payments, the SME and the ESCO may share the surplus, depending on the risk

taken and the extent of services provided by the ESCO.

Under the guaranteed-savings model, the SME uses the loan from the financial institution to finance the

project, thus bearing the financial risk of the project. The ESCO is then responsible for the design,

installation and technical performance of the installation (i.e. the operational risk) by guaranteeing the

energy savings. It can help design the loan according the expected cash flow of the project based on

the energy savings. The guaranteed energy savings model is shown in the figure below.

Figure 4: Guaranteed-Savings EPC




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The ESCO is paid for its services after the installation is complete and once the performance parameters

(energy savings or cost savings) have been confirmed.

3.2 Verified Savings

The verified-savings structure refers to an arrangement whereby the ESCO partly pays for the project

and bears the obligation to repay the Lender for its investment. Under this contract model, the SME

commits, under an EPC, to providing a down payment to the ESCO for project implementation

amounting to about 50% of the initial investment and to repaying the remainder of the investment,

financed by the ESCO, through monthly installments within a limited period (up to 12-month period) as

of the project completion date. Each of the payments is paid after the ESCO has confirmed the project’s

expected savings.

Figure 5: Verified-Savings EPC

The monthly payment amounts are agreed upon by both parties on the day of signing of the contract,

and it will be tied to the savings achievement. Failure to achieve the savings will have a proportional

impact on the amount due to the ESCO by the SME based on the SME incurred losses.

The ESCO assumes the project performance risk, but also the credit risk of the SME by being obligated

to repay the Lender, even if the SME does not pay the ESCO the agreed monthly installments. Due to

the increased risk assumed by the ESCO, the SME is typically charged a higher cost for financing

the project.




Project No. 6008 17

3.3 Lease Contract Model

A lease is in essence an extended rental agreement whereby the owner of the equipment (the ESCO)

allows the user (the SME) to operate or otherwise make use of the equipment in exchange for periodic

lease payments while still retaining ownership. Leasing is a process by which a firm can obtain the use

of a certain fixed asset for which it must pay a series of periodic, contractual and tax deductible

payments.

There are a number of reasons that companies prefer to lease equipment rather than buying it. The

main advantage of leasing lies in a business’ ability to attain assets without outlaying essential cash,

but there are many other reasons. For example, there may be good tax reasons if the operator cannot

use the depreciation tax shield; it would then make sense to sell the equipment to someone who can.

Also, the lessor may be in a better position to bear the risk of obsolescence or resell second-hand

assets. The lessor may be able to offer a very good maintenance deal. Finally, it may be much less

costly in time and effort to arrange a simple lease contract than a regular EPC.

The main advantages for leasing can be summarized as follows:

› Leasing is less capital intensive than purchasing, which means if a business has capital

constraints, it can grow more rapidly by leasing rather than purchasing property.

› Capital assets may fluctuate in value, whereas leasing transfers the risks to the ESCO.

› Depreciation of capital assets has a different tax and financial reporting treatment from ordinary

business expenses. Lease payments are considered expenses rather than assets, which can be

set off against revenue when calculating taxable profits at the end of the relevant tax accounting

period.

› Regarding tax benefits, the ESCO owns the equipment for tax reporting purposes. In a tax lease,

the SME is trading the tax benefits of equipment ownership (amortization) with the ESCO for

favourable payments and more flexible tax management. Depending on the SME’s specific tax

situation, this lease feature can significantly lower the total cost of equipment.

› Regarding maintenance, this option generally results in higher lease payments, but is often money

well spent. Under the terms of a full-service lease, the ESCO is responsible for all maintenance

associated with the leased equipment.

Under an EPC agreement using the leasing approach, the ESCO will provide a savings guarantee as

per the one found in the guaranteed savings model.

https://www.boundless.com/finance/definition/fixed-assets

https://www.boundless.com/finance/definition/fixed-assets

http://www.referenceforbusiness.com/knowledge/Depreciation.html

http://www.referenceforbusiness.com/knowledge/Obsolescence.html




Project No. 6008 18

3.4 Comparative Analysis of Models

Guaranteed Savings Verified Savings Lease Agreement

Performance related to the level of energy saved, typically verified monthly, quarterly or annually

Performance related to the level of energy saved, usually verified with a single commissioning test

Performance related to the level of energy saved, usually verified based on engineering estimates.

Value of energy saved is guaranteed to meet debt service obligations down to a floor price, with the ESCO covering any shortfalls.

Lump sum payments are based on achievement of key milestones, mostly based on a commissioning test and the final payment occurs after 6-12 months of successful operation.

Value of energy saved is calculated to be sufficient to cover the lease payments.

The ESCO bears performance risk; the financier bears the SME’s credit risk.

The ESCO bears the performance risk at the commissioning test; the SME bears performance risk over the life of the equipment; the financier bears the SME’s credit risk.

The ESCO bears performance risk at the commissioning test; the SME bears credit risk, risk as the lessor; the SME bears performance risk over the life of the equipment.

Because the SME takes out a loan to finance the project, the debt appears on its balance sheet.

Because the SME takes out a loan to finance the project, the debt appears on its balance sheet. But a portion of the loan is not disbursed until the commissioning test is successful.

The lease is on the balance sheet of the ESCO/lessor; there is no debt on the SME’s balance sheet.

Requires creditworthy SME. Requires creditworthy SME. Does not require credit worthiness of the SME

Requires a creditworthy ESCO;

Periodic M&V required One-time M&V required One-time M&V required

The ESCO can implement more projects without being burdened by credit/equity investments, although it will have some contingent liability.

The ESCO can recover its investment cost within a short period

The ESCO can implement more projects without being burdened by credit/equity investments.




Project No. 6008 19

4 MEASUREMENT AND VERIFICATION OF SAVINGS

M&V is used to measure and verify, in a defined, disciplined, rigorous and transparent way, the energy

savings resulting from the implementation of ECMs to improve the energy performance of a specific

facility.

The preparation of an M&V plan is a fundamental part of an EPC. Advance planning ensures that all

data needed for savings determination will be available after the implementation of the ECMs within an

acceptable budget. The M&V methods appropriate for a given measure will depend on the equipment

type, the operational predictability and the complexity involved in the retrofit. The ESCO should develop

a project-specific M&V plan based on the project’s ECMs and site conditions prior to implementation.

Appendix IV presents the different approaches that can be used for measuring and verifying savings.




Project No. 6008 20

5 OPERATION AND MAINTENANCE AND CAPACITY BUILDING

Under the EPC agreement, the operation and maintenance (O&M) responsibilities must be defined. This

is done to ensure that all maintenance requirements are being complied with, and that maintenance

issues do not cause lower-than-expected savings.

Based on the type of project and implemented technologies, some ESCOs can take charge of the entire

operation and maintenance of the system or simply follow up on and verify O&M activities realized by

the end user’s team, as specified by the ESCO. Potential additional savings can be generated by such

an additional service.

ESCOs can also provide ongoing energy management and training services to industrial clients

throughout the contract period to ensure that projected savings are achieved. As the M&V and

maintenance tasks are being performed, the ESCO can be constantly fine-tuning the savings from the

ECMs to reduce its risks, and if appropriate, maximize savings. This task may also include identifying

ECMs that are not performing as planned, and introducing new ECMs to make up for the loss in savings.

This continuous improvement can also frequently identify new savings opportunities in the SME

facilities, which the ESCO may from time to time present to the SME.

ESCOs can finally provide customized training and capacity building through industrial energy

management programs to help SME staff follow energy consumption, and put in place the required tools

and structures to comply with different national and international norms like ISO 50001.




Project No. 6008 21

APPENDIX I MAIN SERVICES OF AN ESCO

The following sections describe some of the main services that an ESCO can provide to SMEs. This list

is by no means exhaustive.

Energy Auditing

An essential component of the service package offered by an ESCO is the detailed energy audit, without

which it would be impossible to identify the potential for energy cost savings that the ESCO relies on to

earn its revenues. While a typical energy consultant usually considers an energy analysis to be the final

product, the key feature of an ESCO is that this analysis is only the starting point in project

implementation.

Project Design and Implementation

The ESCO is responsible for project design, hardware specifications, procurement and installation. The

ESCO usually also oversees the operation of the new equipment over a specified period of time.

Financing

Traditional Financing

One important role frequently played by ESCOs is to participate in the development of an adapted

financing mechanism for project implementation. Although the ESCO plays no formal role in the

financing agreement itself (the guarantee is based on the SME’s balance sheet and not on the ESCO’s),

the fact that they are willing to enter into a performance contract can help increase the bank’s confidence

in the proposed project.

The financing package negotiated by the ESCO in such case is fairly conventional, consisting of a

combination of self-financing using the SME’s own resources and a typical term loan offered by a

financial institution. This type of loan appears on the SME’s balance sheet. However, the involvement

of the ESCO in developing and negotiating the loan can lead to more favourable loan terms than what

could be achieved if the SME applied for it through regular channels.

Third-Party Financing

Unlike traditional financing models, under third-party financing (TPF) the ESCO not only develops the

adapted financing mechanism, but also provides the bulk of the financing needed to implement the

project, either by investing its own money or borrowing it from a financial institution. The expected

guarantee made to the financial institution is based on the project’s value or the ESCO’s balance sheet.

The SME may or may not be expected to commit to making a small investment from its own resources.




Project No. 6008 22

In addition, the SME is effectively shielded from any financial risk related to project performance. In

order to protect itself against default by the SME, the ESCO may retain some form of legal title to the

project equipment throughout the duration of the contract.

Measurement and Verification of Savings

The ESCO must perform rigorous M&V on the energy savings in order to convince stakeholders that

the savings are sufficient to repay the investment. M&V essentially means ongoing verification of energy

savings, sometimes by periodically comparing an energy end-user’s energy bills with an established

pre-project baseline, or by performing a direct measurement of the energy consumption before and after

the implementation of the energy conservation measure on the targeted equipment or systems. The

performance of an ongoing M&V not only ensures that the project’s savings have been achieved, but

that they will persist over time by monitoring the quality and effectiveness of ongoing maintenance,

which is key to sustained efficiency and more importantly to being able to manage the return on

investment for EE projects.

Energy Management

The services offered by an ESCO to an SME may include energy management. Energy management

outsourcing (EMO) allows the SME to use external specialists to perform this function rather than using

its in-house staff. This way, the SME can devote more of its own management resources to what it does

best—focusing on its core competency areas. Energy management services are likely to require

relatively modest capital expenditures to achieve most of the cost savings through improved

management systems rather than through the installation of new hardware, but will greatly contribute to

achieving the expected savings.




Project No. 6008 23

APPENDIX II RFP GUIDELINES

The RFP is the mechanism used to select the ESCO with which the SME chooses to negotiate an EPC.

The RFP defines the general scope of work, along with specific requirements that must be addressed

in a performance contract. Typically, the RFP will include information on the following aspects:

› List of facilities under investigation

› Projects already identified

› Maximum contract duration (if applicable)

› Maintenance and operational requirements and

› Selection criteria

› Financial targets

Financial targets might, for example, include any of the following conditions:

› Have a minimum internal rate of return (IRR) (e.g., 15% over a specific number of years) or reach

a net present value (NPV) greater than a set value.

› Project cost must be below a present maximum capital limit.

› Contract cannot be extended beyond a maximum number of years.

› Fixed minimum annual savings or a maximum cost.

› Contract structured with a neutral or positive annual cash flow.

› Savings must be guaranteed.

The evaluation criteria include the specific requirements above and may also require information on the

following aspects:

1 Proposed savings

2 Financing options

3 Additional opportunities beyond those identified in the tender documents

The RFP is not meant to be a detailed specification of works. The main focus of the proposal is to state

the basic methodology to guarantee savings, the general EPC details, how the scope identified in the

RFP would be approached, and other opportunities the ESCO feels offer value for the SME.

The evaluation process should also be described, so that the ESCO can ensure it provides all necessary

information. This typically involves deciding on the essential requirements of the contract, giving each

requirement a weighted score and compiling results into a table. The evaluation table should be included

in the RFP document without the weighted scores.




Project No. 6008 24

APPENDIX III EXAMPLES OF RFP EVALUATION CRITERIA

The criteria listed below can be used by SMEs to evaluate written proposals and the subsequent

interviews. The scoring weight is listed for each criterion.

These criteria can be applied and interpreted solely at the discretion of the SME. Proposals should

include all necessary information relevant to these evaluation criteria. Additional information required

for the proper assessment of proposals may be requested from the ESCO at the discretion of the

Customer.

The criteria are not listed in order of importance. The subcriteria are approximately of equal weight.

1. QUALIFICATIONS AND EXPERTISE (Scoring Weight: 50%)

a. Firm Experience: › General experience in energy-related and performance contracting services.

b. Scope of Services:

› Comprehensiveness of the proposed management, maintenance and monitoring services.

c. Financial Soundness: › Financial soundness, bonding capability and stability of the ESCO. › Completeness and strength (financial viability) of the most recent annual financial

statements.

d. Staff Information: › Qualifications and relevant experience of the engineering and project management staff, in

addition to staff in other areas of importance.

2. LEVEL OF PROPOSED SAVINGS WITHIN A GIVEN PERIOD OF TIME (Scoring Weight: 50%)

a. Project Scope: › Understanding of conditions in existing facilities, systems, and operation and maintenance

projects




Project No. 6008 25

APPENDIX IV M&V PLAN GUIDELINES

Measurement and Verification (M&V) of energy savings generated is the process of using measurement

to reliably determine actual savings created within an individual facility by an energy management

program. Since savings cannot be measured directly because they represent the absence of energy

use, they have to be determined by comparing measured use before and after implementation of a

project and by making appropriate adjustments for changes in conditions during this process.

Depending on the type and size of the project, M&V activities include some or all of the following:

development of the M&V plan, operational verification, meter installation, calibration and maintenance,

data gathering and screening, development of a computation method, adoption of acceptable estimates,

computations with measured data, and reporting, quality assurance, and third party verification of

reports.

Energy savings generated by an EE project can be measured using several techniques. This section

provides an overview of each option and provides a recommendation in which case it is most appropriate

to use each option when considering Turkey’s market specifics.

Retrofit Isolation / Key Parameter Measurement

Savings are determined by field measurements (spot / short-term measurements at component / system

level during baseline & reporting period) of the key performance parameters. Wherever a parameter,

known to vary independently, is not measured, it can be estimated. Typically, those estimates are based

on historical and/or manufacturer’s data.

This option can be preferred when savings are below 10% - 20% of total facility consumption and when

relevant performance and/or usage parameters can be estimated, (e.g. in case of a lighting upgrade in

which existing lamps are replaced by high efficiency versions, the consumption per lamp can usually be

estimated with sufficient accuracy and reliability).

Retrofit Isolation / All Parameter Measurement

Savings are determined by field measurements of the energy use such that all performance parameters

at component / system level are included.

This option can be preferred when the expected savings are below 10% - 20% of the total facility

consumption and none of the performance and usage parameters are sufficiently constant to allow

estimation. Measurement of the key parameters will typically be short-term and should be documented

in detail in the M&V plan.




Project No. 6008 26

Whole Facility

Savings are determined by measuring energy use at the whole facility or sub-facility level.

This option can be preferred when many different EE measures are implemented and when expected

savings are in excess of 10% - 20% of the energy consumption that is measured on a facility or sub-

facility level.

Deemed Savings

Savings are determined based on engineering calculations using typical equipment characteristics and

operating schedules without field testing or metering. Instead, verification may consist of checking units

installed & confirmation of proper operation of the equipment / measure.

This option can be preferred when the EE projects have relatively low expected savings, typically less

than 10% of the facility’s total energy consumption, that can be calculated sufficiently accurately based

on constant performance and usage parameters. Often this requires the availability of reliable, accurate

and validated engineering calculations to determine the expected savings per ECM related equipment

/ change.

Additional information

More information on M&V can be found at evo-world.org through the International Performance

Measurement and Verification Protocol (IPMVP).

160, rue Saint-Paul, bureau 200, Québec (Québec) G1K 3W1 CANADA | Tél. : +1 418 692-2592 Téléc. : +1 418 692-4899

www.econoler.com

http://www.econoler.com/

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