Financing Energy Efficiency Projects

Dr David Telford, Client Services Director at Hurley Palmer Flatt, ”You don’t get owt for nowt, nowhere is this more true than in energy efficiency.”

It takes time, information, expertise and in most instances capital to achieve worthwhile energy and carbon savings.

Almost three quarters of non domestic buildings were constructed prior to 1985 (before Part L), and many now require extensive energy efficient retrofit.

In the current economic climate, where capital budgets and corporate profits are under intense pressure, investment that relies on internal balance sheet resources is unlikely to happen.

The good news is that with energy costs currently growing at over 7% per annum, investment in energy efficient measures (EEMs) retrofit is a financial investment with high and secure rates of return (IRR in the range 10-100% are not uncommon). There is however no one-size-fits-all financing solution and often a mix of options will be required. In this article we aim to provide some insight into the range of possibilities and the some of the inherent trade-offs.

Direct funding

The simplest and most direct way estate managers fund energy efficiency is direct internal funding. All savings from increased efficiency are realised and it is simplest to administer. In today’s challenging economic climate, this route is only attractive for very short payback (EEMs’), if at all. Very often cash is simply not available for a discretionary investment like energy efficiency. At best a small number of low cost measures will be implemented but these will be piecemeal and will not address the deeper energy efficient retrofit that would be part of an integrated programme.

Debt financing

Direct financing through banks or other types of traditional lenders is possible where the capital cost is rolled into the debt structure of the company. This solution may be attractive where the energy-saving plant and machinery qualifies for Enhanced Capital Allowances and businesses can write off the whole of the capital cost of their investment in these technologies against their taxable profits of the period during which they make the investment.

This mechanism can deliver a cash flow boost and shorten payback periods. 100% of the savings are retained to service the debt. However companies may be reluctant to, or incapable of, increasing debt levels. In both direct funding and debt financing companies also retain all of the underperformance risk and energy mangers may have difficulty convincing the company that EEMs are a priority investment.

Lease / lease purchase agreements

Leasing and lease-purchase agreements can provide a means to reduce or avoid the up-front capital investment for energy efficiency improvements. These agreements are offered by commercial leasing companies, investment firms and very often equipment manufacturers. It is possible to match lease payments with the projected energy savings, thereby creating a form of cash flow financing.

Depending on the detailed nature of the lease

/ lease purchase agreement it may be treated for tax purposes either an operational expense or a capital purchase. However, the types of EEM that are suitable for leasing arrangements may be limited, and financing can be significantly more expensive when compared to other options.

Energy performance contracts

Various types of energy performance contracts (EPCs) exist, including ‘shared savings’ contracts, ‘paid from savings’ contracts, and ‘guaranteed savings’ contracts. In principle, these also offer a route to cashflow funding where the package of EEMs are paid for from the savings achieved and in this instance the risk for underperformance is transferred to the supplier.

Energy performance contracts can be a pay-for-performance solution where energy efficiency is in effect bought as a service. EPCs’ may be linked to a facility management contract or offered as part of an ESCO type of design build and operate contract.

In EPC service providers assume ownership and maintenance responsibility for specified assets over the lifetime of the project. There are several models; some offer a service fee based on historical energy costs. The provider in turn, pays the utility bill and earns its fee from savings generated by the efficiency improvements. The fee payable then becomes an operating expense that replaces the utility bill. At the end of the term the specified asset pass back to the owner.

Under alternative models you retain responsibility for payment of the (now reduced) utility bill but also pay a fee or bonus separately out of the delivered energy savings.

ESCO financed

An energy service company (ESCO) represents a one-stop shop for finance, project development, installation and operation. Projects are typically large-scale with the contract period covering a 10 year period or longer suitable for projects such as a new energy centre, biomass boiler or CHP plant. Building owners have no upfront cost, no capital requirement, and 100% of the project cost is financed, owners contract to purchase energy from the ESCO for a fixed duration at a rate tied to the energy market. The ESCO may, in addition, be extended include aspects of EPCs’.

Soft loans and green investment funds

There are a number of schemes offering finance at below commercial rates. These tend to be targeted at specific types of opportunities or specific organisations. For example, The Public Works Loan Board lends money to public sector bodies for energy efficiency projects, while Salix is an independent not-for-profit body that delivers interest invest to save loans for a wide range of EEMs’ also across the public sector.

The Carbon Trust / Siemens loans scheme provides commercial loans and leases from Siemens finance with payments offset against energy cost savings for both public and private sectors, but in this instance projects need to be assessed by the Carbon Trust.

There are also a number of revolving green funds, these make commercial or sub-commercial rates of return based on energy savings and the repayments then fund further investments.

For example LEEF (The London Energy Efficiency Fund) which is a £100m revolving fund to invest in energy efficiency retrofit to publicly owned or occupied buildings either directly or through an ESCO or landlord supplying the public body. This fund is looking for projects in the £1m to £20m which will deliver 20% carbon reduction. Similar funds exist in Scotland and Wales.

The European Energy Efficiency Fund (EEE-F) was launched in July 2011 offers a wide range of financial products including loans, guarantees and equity investments in energy efficiency retrofit for public and private sector.

Green Investment Bank (GIB)

Starting this year the GIB (currently operating as UK Green Investments, BIS) has been launched with a starting capital of £3bn. GIB is seeking to fund commercially viable non-domestic energy efficiency and Green Deal compliant projects. GIB is seeking investments that will leverage in private sector finance from other sources.

Green Deal

Green Deal is a new Government initiative (due to be launched later this year) designed to help homes and business meet the upfront cost of EEMs’. Green Deal is a cashflow funded mechanism, to allow improvements to be paid for with the savings on the fuel bill.

The repayment is attached to the utility meter and collected by the electricity provider. Green Deal loans are attached to the building not the occupier and require a prescribed format upfront energy assessment.

If you move, the new occupant will pick up the charge while also benefiting from a more energy-efficient property. Non-domestic Green Deal will apply to commercial property, but its introduction is likely to be delayed until after the domestic Green Deal is put in place.

Commercial funds

Green Deal funding providers are now in place and a number of institutional investors are beginning to view energy efficiency financing as a mainstream asset class with unique properties. It is an investment with no exit risk and a secure and predictable return that is not linked to general stock market performance.

hurleyplamerflatt Energy Services Division help organisations prepare an investment ready business cases matched to appropriate funding opportunities.