An EPC (Energy Performance Contracting) is a contract that transfers the financial risks from the project owner to a third party called the Energy Service Company (ESCo).
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An Energy Performance Contract (EPC) is a type of contractual arrangement that transfers the financial risks from the project commissioner to a third party usually called an Energy Service Company (ESCO). Energy efficiency measures are typical types of projects financed through energy performance contracting. The project infrastructure or upgrade delivered by the ESCO is funded through energy cost reductions, and importantly, the ESCO is not paid unless the promised energy savings are delivered
- Funded project phase: Design, build, operate
- Typical project size: Up to £10 million
EPC is a form of ‘creative financing’ for capital improvement which allows energy upgrades to be funded from cost reductions. Under an EPC arrangement an external organisation (ESCO) implements a project to deliver energy efficiency, or a renewable energy project, and uses the stream of income from the cost savings, or the renewable energy produced, to repay the costs of the project, including the costs of the investment. Essentially the ESCO will not receive its payment unless the project delivers energy savings as expected.
There are 2 types of existing EPC models.
EPC with guaranteed savings model
Under this scheme, the local authority is the contracting party of debt-based funding such as SALIX loans and Public Works Loan Board (PWLB). The ESCO is contracted to deliver the project, providing a guarantee on the energy savings achieved through the implemented measures. The savings are used to pay back the loan and cover the ESCO’s costs and profit element. If the savings are not sufficient to repay the loan, then the ESCO’s guarantee obligation would make up the shortfall.
This means that the local authority continues to pay the amount that corresponds to the energy expenditures prior to the implementation of the measures. Once the debt is fully paid back, the local authority receives the full amount of savings.
In summary, under the guaranteed savings model, the performance under the contract is assessed by the amount of energy savings delivered, the ESCO takes performance risk and the local authority takes credit risk (and funds the cost of the project).
EPC with shared savings model
With an EPC shared savings model, the ESCO is the contracting party for debt-based funding. Similarly to the previous model, the local authority will pay back the project through energy savings. The ESCO is therefore taking the risk of both performance of the project and the credit risk (risk of non-payment) off its client.
However, under this model there is the possibility for the transaction to be off balance sheet (in other words, not disclosed in the local authority’s financial statements). This means that the EPC does not affect the local authority’s ability to take out other loans. Additionally, this model incentivises the ESCO to deliver more energy savings.
Under the shared savings model, the contract performance is measured by the cost of energy saved. The ESCO takes on both performance and credit risk, and (usually) raises the funding for the project – hence the debt is not on the balance sheet of the local authority.
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