LED street lighting Climate Group Document - Financial Section. 09 December 2013

Transcription

1 LED street lighting Climate Group Document - Financial Section 09 December 2013

2 Important notice This Report has been prepared by PricewaterhouseCoopers LLP ( PwC ) for the The Climate Change Organization in connection with LED street lighting document under the terms of the engagement letter dated 11th October 2011 ( Engagement ) and its contents are strictly confidential. This Report contains information obtained or derived from information gained from a variety of sources, and other publicly available sources. PwC has not sought to establish the reliability of those sources or verified the information so provided. Accordingly, no representation or warranty of any kind (whether express or implied) is given by PwC to any person (except to the Climate Change Organization) under the relevant terms of the Engagement) as to the accuracy or completeness of the Report. Moreover the Report is not intended to form the basis of any investment decisions and does not absolve any third party from conducting its own due diligence in order to verify its contents. PwC accepts no duty of care to any person (except to the Climate Change Organisation under the relevant terms of the Engagement) for the preparation of the Report. Accordingly, regardless of the form of action, whether in contract, tort or otherwise, and to the extent permitted by applicable law, PwC accepts no liability of any kind and disclaims all responsibility for the consequences of any person (other than the Climate Change Organisation on the above basis) acting or refraining to act in reliance on the report or for any decisions made or not made which are based upon such Report.

3 Table of contents 1. Financial model overview Self- funding Third Party Finance Public-Private Partnerships (PPPs) Energy Services Companies (ESCos) Leasing/ Debt financing 7 2. Assignment/ Ownership of Financial Risks 9 3. Case Studies Lessons learned Future trends and concepts: 17

4 1. Financial model overview In the past the lack of available funding to cover the initial costs of converting to LED technology has been a significant barrier to starting sizable projects. However, in many regions the range of options for obtaining the necessary finance has increased. There has been a greater focus from central governments on the need to implement projects that both reduce greenhouse gas emissions and lead to urban regeneration, which has led to new sources of government funding. In addition, structures involving private finance, including potentially from energy companies or LED equipment manufacturers, have further developed. There are a large range of potential financial and commercial models that can be used to implement LED lighting. The most appropriate option depends on factors including: The financial constraints of the procurer, particularly in terms of financing upfront costs The desired risk allocation The size of the intended installation The availability of third party finance in the local market The internal capabilities and resources of the procurer The required timetable for installation Local regulatory factors Track record of deliverability of product in territory How well developed PPP/ ESCo and leasing arrangements are in the country. The below sets out the basic grouping of financial structures Self- funding Description This bypasses the need to attract third-party capital and is an option for procurers with sufficient budgetary flexibility to provide upfront finance to the project. This initial investment can then be recouped in cost-savings over a number of years. The investment can either come from cash reserves/ revenue of the procurer, grants sought from central government or multi-lateral bodies, or from them raising finance themselves. For example, this finance could be raised through local bonds or raising debt from commercial banks. In some regions there are central bodies that will provide grants and/ or finance to procurers in order to fund LED street lighting schemes. In the self-funded model, this finance is not lent directly to the project, and therefore does not take risk on the performance of the project, but rather is provided to the procurer to enable the project to take place. In recent years, we have seen growth in these central sources of funding that are targeted on urban regeneration and/ or greenhouse gas emissions reduction. For example, Washington and Seattle in the US have accessed grants from the American Recovery and Reinvestment Act initiative, or in the UK the Green Investment Bank (a government backed organisation) has funding available to invest in carbon reduction projects such as LED street lighting. Under self-funding models, risks can still be significantly transferred across to a contractor if desired. For example, a contactor can be used that will guarantee a certain level of energy savings, or will provide fixed prices for the installation and/ or maintenance of street lighting. Joint ventures between the procurer and the installation company have also been used as a method of sharing risks, for example in Copenhagen (Denmark) and Salford (UK). Therefore, self-funding does not rule out using commercial structures, such as Energy Performance Contracting, that transfers across risk to another entity. However, even under these structures, the procurer still ultimately retains some risk that the funding it is providing will not be repaid. Advantages The procurer can retain full ownership and greater control of the project. There is no necessity for complex contracts and risk allocation as this is a simple, familiar and fast method of financing projects. However, commercial arrangements that share risks can be used if this is preferred. Procurer can receive the full benefit of cost savings made over the longer term. These savings can be realised to directly offset the cost of financing the investment. PwC 4

5 For many procurers, their own cost of finance (where available) will be below the cost of third party finance (though this depends on their credit worthiness) and this therefore allows greater surplus savings to be made. Disadvantages Self-funded models typically retain greater technical and financial risk with the procurer, though commercial structures can be used that transfer across significant risk to contractors if desired. The priorities for using limited internal financing capability and resource may lie elsewhere, meaning approval is difficult to achieve, or in times of austerity and budgetary constraints may not be achievable. The indebtedness of the procurer increases which could affect its financial position. The procurer has to provide resource and expertise in managing the investment and details of the project. Who does it suit? Large cities with the capacity to finance the project on their balance sheet at low cost, and the resource and expertise to manage the project and risks. This is most applicable in countries that have well developed local finance structures, such as in the US, Canada, and European countries. Examples Los Angeles (US) 140,000 lights, cost of c.$57m 1 Seattle (US) 41,000 lights, cost of c.$18m 2 Edmonton (Canada) 13,000 lights installed by 2013, another 87,000 over period of following 5 years (c. CAD$60m) 3 Boston (US) total of 38,000 lights, cost of c.$20.6m 4 Anchorage (US) 4,000 lights, cost of c.$2.2m 5 Salford (UK) 26,000 lights, cost of c. 14m Third Party Finance Description This describes structures in which someone other than the procurer raises the finance required to undertake the initial investment. They are then paid an amount by the procurer over time for provision of the asset or lighting services. There are a number of various commercial structures in which this can take place, and a range of potential sources for the finance Public-Private Partnerships (PPPs) Description Through a public lighting PPP, the procurer outsources the design, installation, maintenance and finance to the contractor over a substantial period (e.g years). The procurer then pays for the lighting service provided as opposed to an asset. This payment is generally based on the performance of the contractor in providing the service to pre-agreed standards, with deductions to payments for poor performance. PPPs can cover a wider spectrum of services of which LED lighting is only a part (e.g. within overall road maintenance services). The contractor can raise finance from various potential sources, including commercial banks, capital markets, and central government/ multi-lateral funding entities (e.g. European Investment Bank). Alternatively it can 1 For further information: m_report.pdf 2 For further information: UL%20Lighting%20Roadshow%20(3).pdf 3 For further information; 4 For further information: 5 For further information: 6 For further information: PwC 5

6 use its own reserves if it has capital available for the project. Once the annual payment for services has been agreed, the installation and maintenance cost risks are passed to the contractor, who will also generally bear a significant portion or all of the energy efficiency risk of the LEDs. PPPs offer procurers a way to undertake large scale LED retrofits with private sector financing and management expertise, with the potential for the initial investment to be off balance sheet Energy Services Companies (ESCos) Description An ESCo is a company that provides energy efficiency related and other energy related services, where performance contracting is a core part of its business 8. This means that payments are based on the performance of the equipment and services, particularly in relation to energy savings. Similar to PPPs, ESCos and Energy Performance Contracting (EPC) enable the procurer to transfer the design, implementation and maintenance risk associated with the newer lighting technology, as well as the responsibility to raise the initial finance, to the ESCo. However, ESCos tend to be focused more directly on providing energy and therefore cost savings to the procurer. They are often paid based on a fixed fee for maintenance, but with an additional amount that is directly related to the energy savings that they can generate. The savings can either be shared with the procurer or a guaranteed level of savings may be provided. This allows you to directly leverage the savings from making infrastructure improvements in order to pay for them. This is therefore a savings based repayment model, which is viable when the savings are sufficient to meet the ongoing finance costs. They often have a shorter contract life than PPPs and/ or are used for smaller projects, though they should be of a size that justifies the initial transaction costs involved. A range of companies can act as ESCos including utility companies, LED equipment manufacturers (keen to promote said of their equipment), or engineering firms. The finance can be self-funded by the owner of the ESCo, for example the manufacturer of the equipment or the energy company providing finance 9, or it can be sought from third part sources or the procurer can partially fund the project itself. 10 Advantages Private sector expertise is harnessed to manage and undertake the full range of activities on the project The procurer does not need to raise the initial finance, meaning its finance can be spent elsewhere or in the case where there is significant budgetary pressure on the procurer this route allows them to undertake the investment. The private company assumes much of the risk over the costs of installation, maintenance and the performance risk of the equipment. The contractor is incentivised to install the lowest cost option on a whole life basis, taking account of maintenance and replacement costs, and energy savings produced. This can often generate cost savings and helps to ensure poor quality items are not installed. Procurer pays for the level of service provided, which means the contractor has a strong incentive to manage the project effectively. If energy savings outweigh ongoing cost of the contract, the project can provide net savings. If competitively procured, this competition can lead to greater innovation and drive down costs. 7 For additional information on PPP financing structures for street lighting: For additional information on performance contracting: 9 For an example of this type of finance: 10 For further analysis of the role of ESCOs internationally: D=AJPERES For more information on ESCOs in India: For more information on ESCOs in Europe: PwC 6

7 Contractors may find it easier to source initial finance, particularly if they are of a high credit quality. Disadvantages Can be more expensive overall due to the premiums charged by the contractor to take on various risks and the need for the project to achieve private sector rates of return. PPPs in particular can be complex, meaning procuring them can take a significant amount of time and be costly. ESCos tend to be smaller and more standard projects though. Once the contract has been signed, it can be difficult/ expensive to vary the services provided, which reduces the procurer s flexibility over the length of the contract. Cities transfer some or all control over assets. Arrangements can be controversial for privatizing public services. Cost of finance can often be higher than for self-funding structures, reducing the overall savings made. Who does it suit? PPPs best suit cities with large installations where the initial cost in procuring the service are relatively small in comparison to total size of contract. ESCos can be undertaken on more medium size projects. Cities with financial constraints that mean they cannot self-finance the project. Cities that have limited internal capability or resources to manage the project and associated risks. This is most appropriate for countries where PPP or ESCo frameworks are well developed and third party finance is easily available such as in Western Europe, Canada, India and Australia. 11 Examples Birmingham (UK) 95,000 lights - c. 70m on street lighting, part of a c. 2.7bil overall highways project 12 Sheffield (UK) 68,0000 lights part of a c. 2bil overall highways project 13 Isle of Wight (UK) 12,068 lights part of a c. 750m overall highways project 14 Alabama (US) - $25m Welland (Canada) 4,300 lights c. CAD$2.74m Leasing/ Debt financing Description Leasing is a common way of removing the initial upfront cost of expensive equipment. It is a way of obtaining the right to use an asset (rather than ownership of this asset), in return for payments over a given period. Leasing is a suitable option for projects where physical assets rather than labour or services form the greater bulk of the expenditure, and where continued use of the asset may be denied the ultimate owner in the event of default. The risks on the performance and maintenance costs of the equipment can be shared with the lessor, depending on the terms of the lease. Advantages The procurer does not need to raise finance for upfront investment. The financial risk and cost is spread over time. For the period of leasing, the rental expenses may be treated as an operating rather than a capital cost, which can be offset by energy savings. Depending on accounting analysis, a lease value may not show up on the lessee s balance sheet or increase indebtedness. The operating lease can allow the lessee to transfer some of the risks of ownership and performance of the equipment to the lessor. 11 For further information on sources of finance: 12 For further information: 13 For more information: 14 For more information: Highways-PFI-Project 15 For further information on financing LED street lighting in Canada: PwC 7

8 Disadvantages Likely to have a higher long-term cost than direct self-financing, due to the partial transfer of risk to the lessor, and because the cost of finance is often higher. The lessee risks reduced control over the asset, and the lessor has an incentive to cut corners where possible to minimize their costs. A capital/finance lease may increase the lessee s indebtedness even if they do not need to raise the actual finance. Who does it suit? Cities that have difficulty financing the initial costs and whose accounting position means it will not be included on their balance sheet. Cities that want to retain responsibility and flexibility over the installation and maintenance of street lights, or are looking at relatively small scale initiatives. Examples US Private University (US) c.$1.1m Texas Schools c.$9.2m City in Central Pennsylvania c.$2.9m PwC 8

9 2. Assignment/ Ownership of Financial Risks The desired allocation of financial risks is critical to identifying the finance and commercial model that will be best suited for a project. In general, risks should sit with the party that is best able to manage them, as this will ensure that they are incentivised to perform. However, affordability and financing constraints will also play a role. The factors that could determine the preferred allocation include: The capabilities and resources that the purchaser already has, and therefore how well they may be able to manage various risks internally; The risk appetite of the purchaser; The affordability constraints of the purchaser. Transferring certain risks to another party could push the costs above an acceptable level even where others are best placed to manage them, due to the risk contingency that will be priced into the costs; The local regulatory and legal framework; The local energy and lighting market structures that exist; Constraints on raising finance to pay for the required upfront investment. Time constraints. Developing a complex risk sharing or joint venture structure or seeking to transfer risks across a long time period (e.g. PPP contracts) can result in longer procurement periods. The key financial risks involved in LED street lighting projects are set out in the table below. There is a considerable flexibility around the commercial structure used, that can be designed to suit the local needs and preferences of the procurer. They can either be managed individually through contracts related to particular services, or packaged and transferred within an overall structure. For example, PPP structures, EPCs or direct contracting with providers can be used to transfer or share risks to a greater or lesser extent. Joint ventures can also be an attractive way to structure the project, as it allows the procurer to access outside expertise while retaining a level of control and involvement in the actual work undertaken. In this case the procurer will often jointly own the entity undertaking the installation and maintenance with an outside entity, who in many cases will have taken the lead in developing the original proposal for the project. This structure allows for joint oversight and governance of the project, while sharing the financial risks between the parties. Therefore a vast array of possible risk allocation is possible with the ideal outcome dependent on factors above. Risk Comment Position under different finance structures LED Equipment Costs Level of Energy Savings/ Efficiency Light Performance Equipment costs are generally falling. The decisions on which provider to use and the type of equipment can be retained or left with the contractor, as can the responsibility for purchasing and paying for the equipment. More data from trials and large scale installations mean this risk is reducing. The risk can be retained, passed to contractor/ equipment provider through guarantees of energy savings that will be made, or shared with a split of the benefits or capping transfer of risk. Performance agreements with contractors can either refer to them providing a certain level of light output/ coverage, or just level Under PPP or ESCo structures, this responsibility and risk would normally be passed to contractor. Under self-finance or leasing, this responsibility could be retained if capability is there. Under PPP or ESCo structures, this risk would normally be passed to contractor/ equipment provider or shared with them. Under self-finance or leasing, this responsibility is often retained over the long term, though commercial arrangements can be put in place to limit the risk. In both self-funded and third party finance models, this risk can be transferred to the equipment PwC 9

10 Energy Prices Design and installation Costs Maintenance Costs and equipment lifespan Lighting Demand of maintenance undertaken. Can seek to at least share this risk with contractor, through a guarantee/ sharing mechanism based on money saved rather than just energy saved. However, the time over which this can be transferred may be limited and the price for transfer of risk may be high given volatile nature of energy prices. Period of transfer may be determined by how long energy companies can fix prices over and hedging available in local market. Design and installation can either be done in-house, contracted out or form part of a wider risk transfer structure. Again this is an area were risks are reducing as greater evidence and reliability on the performance of LED equipment over long periods become credible. Manufacturers can provide guarantees/ warranties around the lifespan and maintenance costs of equipment over a set period. Alternatively, the risks can be transferred over a longer period (i.e years in PPPs), or retained in house. It will largely be the procurer s responsibility to decide on the lighting standards and areas that will be covered by street lighting. Therefore this risk is likely to be retained. However, the extent to which services remain flexible to changes in desired standards/ areas covered can be an important factor in deciding upon commercial structure. manufacturer through warranties for limited periods. Performance measures on PPP/ ESCo structures often refer to a mix of light output and equipment maintenance metrics. Under self-finance or leasing, this risk can be retained over the long term. Under PPP structure, energy price risk is often retained, as it is difficult for contractor to manage. ESCo arrangement can transfer, retain, or share this risk depending on whether savings are quoted in energy or costs. Self-finance or leasing will normally retain this risk. PPP and ESCo structures are likely to transfer these risks as part of an overall package. Self-funding or leasing can allow the contracting out of this service, or allow the procurer to retain responsibility. PPP and ESCo structures will often transfer the responsibility for maintenance over longer periods, though benchmarking milestones can be used to limit this transfer period within a longer contract. Self-funded or leasing arrangements can be used to retain a greater degree of the risks. In either case, the risk can be mitigated by warranties from the equipment manufacturer over the lifespan of the products. Under PPP/ ESCo arrangements, the ability of the procurer to change the standards and areas covered will be written into agreements. Self-funded or leasing arrangements can allow the procurer to retain greater flexibility if desired. PwC 10

11 3. Case Studies Isle of Wight PPP Scheme (UK): The Island has a PPP scheme in place for the upgrade, management and maintenance of its highways over a 25 year period. This includes enhancing or replacing 12,068 street lights using LED technology, work on which began in April 2013, with a central management system to allow light levels to be varied by street. The contractor undertakes the initial investment in the infrastructure over a 7.5 year period using private finance, and receives payments over the following 17.5 years based on its performance. Under this structure, the contractor takes risk on the cost of purchasing, installing and maintaining the LED lights. It also takes the risk on the performance of the equipment, including level of energy savings, meaning these risks can be managed holistically. The Council retains risk on energy prices and the level of lighting being demanded, as these are outside the control and management of the contractor. This street lighting element is part of a wider risk transfer on road maintenance overall. Edmonton (Canada): The Edmonton street lighting system consists of over 67,000 poles, with over 97,000 luminaires. It undertook a major 12 month pilot in 2009/10 to test various LED solutions. Following on from these successful pilots, it was decided to undertake a major renewal of the street lighting assets to upgrade them to LED technology. By the start of 2013, approximately 13,000 LEDs had already been installed, and the city now has plans to convert the remaining c. 87,000 over a 5 year period. This programme has been self-funded from existing and new capital budgets, including from neighbourhood renewal, arterial renewal and street lighting budgets. Seattle (US): Seattle started pilots on LED street lights in In 2009, it decided to undertake a major installation programme, with 31,000 street lights installed by the start of 2012, and a total project scope of 41,000. This initiative has been largely self-funded, but it also secured a federal grant of $1m from the American Recovery and Reinvestment Act scheme. The total budget for the scheme was c. $18m with a payback period of less than 9 years. Kolkata (India): In 2010, Kolkata undertook an initial trial of LED technology involving 272 lights at a cost of c. $300,000. After these successful trials showing energy savings of over 50%, a scale up project was put in place that would significantly accelerate the programme of LED investment. It is now planning to replace a substantial proportion of the existing street lights with LED over the next decade. 16 Birmingham (UK): As part of an overall 2.7bil highways maintenance PPP scheme, approximately 55,000 new LED street lights will be installed. Birmingham City Council will become the first city in Europe to have LED street lights operating across all residential streets with a full City wide Control and Management System (CMS) with the ability to dynamically, proactively and flexibly manage, monitor and control the street lighting apparatus. The project includes an initial 5 year investment period, with maintenance and operations ongoing for the following 20 years. The contractor, Amey, has provided a guaranteed energy consumption profile and commitment to the Council for the full 25 year contract period. As part of this, Amey secured relevant warranties from suppliers to assist with the risk mitigation and to promote confidence in durability, service and performance. On the lights installed to date, the energy savings have amounted to over 40%. Los Angeles (US): After a number of successful trials, Los Angeles decided to undertake a major LED conversion programme in In total, 140,000 street lights have now been converted over a 4 year period. As part of the initiative, it decided to install a remote monitoring system that gives it high levels of control over the output of the lights. The total cost of the initiative was $57m, with $40m initial cost covered by a utility energy efficiency loan that the city secured from the Los Angeles Department of Water and Power. This investment is now producing energy savings of $7.5m a year and a maintenance saving of $2.5m for year, with 16 For further information on LED market in India: April_24_2013.pdf PwC 11

12 an overall programme payback period estimated at 7 years. The utility loan secured is being paid back using these savings, with the rest of the savings going to the city procurers. In total, the city has seen a reduction of 40,500 tons of CO2 each year. Salford City Council (UK): Salford has set up a joint venture (JV) with the private sector to deliver its road maintenance services. In 2012, this JV started a wholesale LED retrofit of the area s street lights, including 26,000 Lanterns being converted to LEDs that have a 20 design life. The lighting bill is expected to reduce by c.50% with savings on maintenance of c.70%. The savings are further invested in the retrofit solution to produce a virtuous cycle of investment and saving, with funding for initial investment self-funded by the Council. The risks on costs of installing and maintaining the equipment, and its performance, are shared between the Council and private sector investor through the JV arrangements, and with the equipment provider through a warranty covering the 20 year design life. The street lighting work is part of an overall JV for road maintenance and so is part of wider risk transfer arrangements. PwC 12

13 4. Lessons learned 1. Transferring financial risks to person best placed to manage them When considering where financial risks should be allocated within any deal, the primary focus should be on identifying who is best placed to manage them, and the extent to which that party is robust enough financially to take on these risks. Aligning the risk correctly means that each party will be incentivised to minimise the probability/ impact of the risks over which it has responsibility. This will be partially based on the internal capabilities and resources, as to whether the procurer feels they are able to manage the risk themselves (e.g. on maintenance) or whether this is best undertaken by a contractor. In cases where an extreme downside risk occurring would undermine the financial viability of an organisation, risk sharing arrangement (e.g. capping financial exposure) can be used. Given the advance in technology, procurers should shop around to find suppliers willing to take risk over the long term on the lighting performance and maintenance costs of LED equipment. However, private sector entities are likely to charge a high premium for taking on risks they cannot manage, or which will undermine its stability if the risk occurs. Energy prices and lighting demand are potentially two such risks. On energy prices, parties should consider who is best placed to negotiate lowest prices from the provider (often the person that buys in greatest bulk) and obtaining longer fixed rate terms can be investigated. However, this risk is so significant that the procurer is likely to only be able to transfer risk for a limited period. The issue of risk transferal needs to be considered no matter which financing structure is chosen. However, it is particularly important where the procurer is transferring a large range of risks as part of one overall contract over a long time period, as is the case in PPP contracts. Once these contracts have been agreed, it is vital that the incentives and penalties related to the risks work effectively so that the contract can be managed over the long term. 2. Importance of understanding financial constraints and objectives upfront The financial constraints on the procurer, particularly in terms of its own ability to fund initial investment, accept greater indebtedness and any rate of return hurdle expected on investments are vital in deciding the most appropriate commercial and financial structure to use. There are a range of structures available to meet the particular constraints of each procurer to allow them to access the savings that can be made. In particular, the increased availability of structures with private finance should allow for solutions where no or minimal upfront investment is required from the procurer. The credit worthiness of the procurer will also be important in determining the options open to it on financing. Funding larger projects with greater risk transfer from third party commercial funding will either be more expensive or not possible for procurers with low credit worthiness. Therefore being clear about these financial constraints upfront will ensure that the correct model and project structure is chosen from the outset. Equally, being clear on objectives upfront means that the structure can be designed to hit them. The balance of importance between improved lighting service, energy cost and maintenance savings, job creation or wider social benefits needs to be clear to evaluate different structures. This will also help to get buy-in from all parties by helping to make clear the rationale for decisions being made. 3. Size of project has a vital bearing on finance solution The size of the project can help determine which finance solutions are available to a project. To attract third party finance, particularly in PPP structures, the project needs to be of sufficient size to make the initial procurement costs and effort worth the financial payback for the procurer, contractors and financiers (i.e. c.$30m + initial capital expenditure). However, projects over a certain size (i.e. c. $400m+ of initial capital PwC 13

14 expenditure) may find it difficult to attract sufficient bank/ capital market finance to deliver the project, given the risks associated with a street lighting LED project. ESCos can be more easily undertaken with smaller project sizes, but economies of scale dictate that the project needs to be sufficiently large to generate the savings for private sector investment to receive a reasonable level of return. Smaller projects (i.e. under c.$10m of initial capital expenditure) are often based on self-finance as this keeps the complexity and initial contract costs low. 4. Making best use of all sources of finance available In many countries and regions, pots of central finance are available on attractive terms for projects that reduce carbon outputs and facilitate infrastructure investment. No matter which overall funding structure is used, these additional sources of finance can be vital. For self-funded structures, they can often provide an initial source of capital that can be used to start up the project, particularly if grants are available for project development costs. For larger PPP/ ESCo structures, the central finance sources can be important in bringing down the overall cost of the finance, and therefore the project in total. For example, European Infrastructure Bank funding in Europe (e.g. JESSICA funding) or state wide carbon funds in the US could provide vital sources of initial finance. Investigating and preparing thorough applications for these funds could allow access to funding for initial investment that would not otherwise be possible, which can help generate a virtuous cycle of savings and investment. In some cases this can be free money - grants which initiate a programme to show benefits that can then be widened in scope. 5. Adapting to changing market conditions During the development phase of projects, the funding plans need to be resilient to deal with changes in financing conditions, particularly if they rely on private finance. In many regions, the availability and pricing of private finance has been more volatile over recent years. Therefore, it is necessary to have alternative plans if the initial preferred route becomes less attractive, and understand fall back options. Where possible, retaining competition between different sources of funds can help to provide this resilience. This also emphasizes the need for strong political and strategic backing to ensure projects can continue through potential setbacks. Where third party finance is used, this ability to adapt has shown itself to be important in recent projects. In the recent volatile markets, funders have often removed themselves from deals at short notice, or found that their funding costs have increased right up until the deal is finally closed. 6. Retaining flexibility/ control When entering into a long term contract to provide street lighting services and/ or equipment, it is important to consider how the requirements can be flexed. Lighting demand (i.e. coverage and standards) is one key area where provisions need to be made so that this can be varied without challenging uncompetitive negotiations in which achieving a good deal is difficult for example to incorporate dimming and trimming strategies. Given that technology is constantly improving, retaining the ability to require and benefit from technology enhancements is also important. In terms of lighting demand, flexibility can be best achieved through a central management system from which the lighting to individual streets/ lamps can be controlled. While this requires more upfront investment, it can produce greater savings later in terms of ability to control energy consumption. Therefore this increased control upfront is generally seen as worth the extra investment. Additional investment future-proofing solutions so that they can adapt to improvement in technology (e.g. retrofitted for equipment upgrades) also needs to be considered when choosing a solution. Considerations around flexibility and control are particularly important when the provisions of services is outsourced over the long term, as is the case in many third party funding structures. However, even in more PwC 14

15 short term arrangements, political pressures can suddenly mean that lighting requirements for certain areas change at short notice. 7. Getting performance output requirements right with clarity on payments If the provision of lighting services is to be outsourced to an external party, choosing the right performance metrics / thresholds and ensuring they are properly linked into payments is vital. A variety of metrics need to be chosen to incentivise all areas of performance (e.g. response times to faults, accurate reporting as well as light output) and should be specific and measurable. Using model specifications (e.g. available across nation/ state) or current performance targets are often good places to start 17. Output based metrics (e.g. actual light produced) are the purest form of measurement. It is particularly important for LEDs, whose performance changes over time, that a full range of output metrics are considered. This includes the brightness, coverage, and colour quality of the light. However, photometric based tests that measure light characteristics can be unreliable and therefore a balance of output and input (e.g. amount of maintenance done) metrics are usually best combined. Making clear how the performance metrics then relate to the payments to the contractor is also important. Both funders and the contractors themselves need to have clarity and confidence in the payment structure and amounts to take on the risks of the project. Getting the specifications right will be particularly important in any long term deal, where the flexibility to change them mid-contract can be limited. 8. Resourcing the project properly During the development phase of the project, the procurer needs to ensure that the correct expertise is used to cover technical and financial areas. This often means using inter-departmental teams, so that various interested parties can feed into elements such as the performance specification. Otherwise there is a risk that decisions are made without understanding the impact on other areas of the procurer (e.g. unnecessarily high technical/ performance specifications lead to higher costs that are not affordable). Understanding the internal financial capabilities of the procurer and where this needs to be supplemented by external advisers will be important. Strong project management is also important. Often the engineers or providers of street lighting can be reluctant to move away from their current standard solutions. Demonstrating the savings that can be made through initial small scale initiatives, or using the experience of nearby procurers that have used LEDs, and using this to gain engagement and momentum internally can be an effective leadership tool. Once the contract has been agreed, the procurer needs to ensure that resource is put aside to keep proper monitoring and reporting of performance, particularly for large, long term contracts (e.g. for PPP). These monitoring systems can often be self-funding as the additional deductions from payment performance can outweigh the additional monitoring costs, and will incentivise a high standard of performance from the contractor. The transition point from project development to project operations can often be difficult as those operating the contract need to understand the details and performance levers included in the contract. 9. Understanding your current position Before setting out on an upgrade, understanding the current scale and condition of street lighting assets is vital no matter which financial/ commercial structure is being used. This will allow for a clear view on the work that needs to be done. Data on number of columns, energy connections, energy consumption, condition of lamps/ other assets, backlog maintenance will all allow either the internal team and bidders (if outsourced) to accurately cost the required retrofits or upgrades, and will reduce the risk associated with installations. This light mapping will also provide a good measure to base objectives and evaluations of the 17 For more information on lighting specifications: PwC 15

16 project against. This can be just as important to projects which are internally managed and funded as those which outsource services over a longer time period or use third party finance. Being able to set out a detailed plan and showing how projects have performed against these plans will be vital to realizing benefits. PwC 16

17 5. Future trends and concepts: LED technology has developed rapidly over the last five years. From a position where the upfront costs were prohibitively expensive, and the savings were not enough to justify the investment, the installation costs have now reduced dramatically with the size and reliability of savings significantly improved. These savings have been further enhanced in many countries by the rising cost of energy, another significant driver of LED uptake. These factors have vastly increased the range of financial viable projects, and means that cities globally can now benefit. As the LED street lighting market matures with the confidence in LED performance improved, a number of trends are likely to emerge. The reduction in financial risks mean delivery structures where these risks are transferred to the private sector become more attractive, opening up private finance structures to a far greater range of cities. 1. Greater use of private finance with risk transfer Many procurers are currently struggling with financial pressures, and find it difficult to fund the initial investment costs of LED street lighting, even where this will produce greater savings over the lifetime. Therefore they naturally look towards private finance solutions, such as in ESCos and PPPs in regions where this structure is established and politically acceptable. At the same time, the reduction in financial risks of LEDs mean that private finance (whether from commercial banks, capital markets, or companies involved in the installations) will be more willing to take the risk on performance of LED street lighting. The private sector will also be more willing to take risk as the savings increase from improved technology and installation/ maintenance solutions. We are already seeing a greater number of cities turning towards private finance to fund these projects. For example, there are currently regions and cities in India, Brazil and Eastern Europe that are developing LED projects which rely on private finance. Within these, the substantial part of LED performance, and installation and maintenance cost risks are transferred to the private sector. As the performance risk reduces, the availability of finance should improve and at lower costs, meaning the overall economics of projects improve. 2. Stronger guarantees/ warranties on performance of equipment We have already seen the length and extent of warranties that manufacturers are willing to provide on the performance and maintenance of their equipment increase significantly. This again reflects the reduced risk associated with the equipment, and it reduces the financial risks to the other parties involved in the project the procurer, the installer/ operator, and the funder. This should therefore allow for more and more sizable installations to become financially viable. Private finance will be more willing to fund projects and companies (e.g. ESCos) will be more willing to guarantee savings. This should therefore drive increased uptake of LED street lighting. 3. More retrofit and leapfrog initiatives based on savings Many of the major LED installations thus far have been in areas where the previous street lights were in need of replacement. The primary driver has been the need to replace the current infrastructure, rather than generate energy/ cost savings. Many of the PPPs have also covered overall road maintenance services rather than just street lighting, which meant that the risk on LED performance was part of portfolio of risks within the overall contract. PwC 17

18 However, with the greater evidence and payback from LED performance and therefore reduced risks, procurers are more likely to initiate projects based on energy/ cost savings rather than current equipment coming to the end of its life. This means retrofit solutions will increase with a greater focus on the savings that can be produced. It also means there will be more projects focused exclusively on LED technology, rather than needing to be part of a wider set of road maintenance services. This focus on street lighting should allow procurers to structure the projects more directly to their requirements just on this service, including the flexibilities required in this area, with less overall complexity related to other services. Some areas that currently do not have systematic street lighting may also find that installations become economically viable given the reduced costs. This would allow these areas to leapfrog the current mainstream technology and instead go to benefiting directly from the new generation of LEDs. 4. Greater use of national/ regional support available for carbon reducing projects In many ways LED street lighting is an ideal opportunity for governments and multi-lateral organisations. It creates jobs and economic activity through investment that pays for itself over the long term, and reduces carbon emissions. It is therefore an ideal way of cost effectively reducing greenhouse gas emissions. Therefore, we can expect to see regional and national governments encouraging investment in LED street lighting, including through grants, funds, guarantees for funding, and providing structures (including legislative) that encourage this investment. For example, in India, the Bureau of Energy Efficiency (BEE) is expected to soon implement a structure where it will provide a partial risk guarantee on funding. 5. Greater use of output metrics in performance standards and outsourcing The improved reliability and use of photometric measuring means that cities can focus more on output metrics within the performance standards they set. In other words, when outsourcing services, they can demand a certain level of lighting in individual streets/ areas and leave the contractor to determine the best design of meeting these standards cost effectively. This is as opposed to relying on basic input metrics such as number of columns being constructed/ checked, number of lamps installed, etc, to set the payments received. Authorities will set its demand in terms of the amount of light rather than an amount of work or equipment. This means contractors will be incentivised to invest more upfront if it means greater savings can be made later on energy or maintenance. Using private sector expertise and management skills to make these decisions through providing the right financial incentives for them should make outsourcing of services more attractive. 6. Increased ESCo market As the energy savings from LED technology have increased, and the risks associated with them reduced, this has improved the potential viability and profitability of ESCos offering to undertake lighting projects. Increasing energy cost in many areas has also improved the potential rates of return from investing in energy saving measures. This means ESCos are more willing to take the risks associated with guaranteeing energy/ money savings to the procurer, or being paid from a share of the savings made. This trend is only likely to increase as confidence in the technology builds and energy prices potential increase further. They will also target larger opportunities as the ability to produce savings from the initial investment is demonstrated. For example, the ESCo market in Indian street lighting is starting to develop quicker having successfully completed some smaller projects. 7. More standard solutions As the market matures, you would expect to see LED street lighting in terms of both the technical solutions and commercial/ financial structures to become more standardised across regions. As cities learn from the PwC 18