EPC Financing in practice. Lieven Vanstraelen, Senior Partner, Energinvest

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2 EPC Financing in practice Lieven Vanstraelen, Senior Partner, Energinvest

3 Content EPC Financing: general principles How to financially evaluate an EPC project? How to (pre)finance an EPC project? Public sector: introduction to new Eurostat rules

4 EPC Financing general principles

5 What do we mean by EPC Financing? Who finances the investment that is done through an EPC contract? Or rather who prefinances the investment? We use all or part of the savings to reimburse the party that (pre)financed the investment. It can be a partial prefinancing of the investment e.g. 40% by Customer, 60% by third party We can use different sources = mixed financing

6 4) Customer financing or own funds Prefinancing can come from 4 main sources 1) ESCO Financing Customer ESCO 3) TPFinancing (via FI) or FI Financing 2) TPFinancing (via ESCO) Bank/Fund or TPF/Citizens

7 Financial Design: Energy savings pay for investment «Budget neutral»

8 Financial Design: It is all very flexible «Increase investment, increase budget» «Immediate net savings» «Increase contract duration to stay budget neutral» «Increase contract duration to realize net savings»

9 Maintenance & EPC? Basic maintenance of only energy measures or replaced equipment Full maintenance of all installations in the building Full maintenance of all installations with total guarantee Full maintenance of all installations based on NEN2767

10 In that case what is the «real» baseline? Repair & replacement cost «before» Maintenance cost «before» Net savings Gross savings NEN2767 cost «after» Energy cost «before» Energy cost «after»

11 How to financially evaluate an EPC Project?

12 How to financially evaluate an EPC-proposal in the design or award phase? Using LCCBA = Life Cycle Cost & Benefit Analysis Looks at Total Cost of Ownership (TCO) Based on Net Present Value = Recalculating money flows to value of «today»

13 Typical financial award criterion for an EPC-contract Net Present Value (NPV) of COSTS & BENEFITS over an agreed period (= Cashflows) Costs Investment (one-off or yearly fee) Financial costs = interests in case of prefinancing Operations and Maintenance fee (e.g. for NEN2767 maintenance) Other, e.g. project management, energy management, margin, Benefits Guaranteed energy savings Typically, measures with positive NPV will be included by the ESCO

14 Over which period? Often contract duration Can be longer, to stimulate measures with longer payback time Can be shorter, to generate net financial savings In complex projects with multiple measures, the life cycle of the observed measures can differ and by extension the lifetime of the projects can differ. So, we look either at: The longest life cycle of any representative measure (e.g. 20 years for a boiler) The life cycle of the building (e.g. 40 years) An average accepted economic life cycle (e.g. 5, 10, 15 or 20 years) The life cycle of the contract (e.g. 15 year EPC contract)

15 Discount rate The «interest» rate at which the future cashflows are discounted to their present value For a company, typically corresponds to the WACC = Weighted Average Cost of Capital = minimum return that a company must earn on an asset financed by capital For a public entity = typically the interest rate at which they can borrow externally (e.g. 2,5%)

16 Building Value If you can get the ESCO to agree to a guaranteed «Surplus Building Value» at the end of the project, you can discount this in your award criterion This «Rest Value», based on Condition Scores (NEN2767) is a measure for future energy savings AFTER the contract Doing this will stimulate ESCO s to propose measures with longer life cycles (e.g. insulation) that generate more savings for a longer time This allows to disconnect the PBT from the contract duration The customer is still paying for the extra investment This option can be used in the «smartepc» model

17 17 Case study: EPC project A city has decided to tender for a M-EPC project (Maintenance and Energy Performance Contract) for 13 rented buildings 5 ESCOs were selected of which 3 entered a proposal The aim is to analyze these 3 proposals and to decide with whom to negotiate in the next round

18 18 LCCBA Steps Step 1: Time periods The initial investment is to be performed during the first year The contract duration equals the remaining rental period, which is different for each building Step 2: Cost & Benefit elements (= LCCB Analysis) We take into account: Annual maintenance costs (or maintenance savings) Annual energy savings Step 3: Calculate NPV

19 19 Step 4: Computing LCCB (d = 3%) ESCO 1 ESCO 1 Geactualiseerd Onderhoudsvergoeding onderhouds- Energiebesp. Jaar 2 n Energiebesparing Geactualiseerde Energiebesp. Geactualiseerde Duur e Investering Gebouw huurcontract Investering ( ) ( /jaar) vergoeding ( ) Jaar 1 ( /jaar) ( ) Gebouw , , , , , ,89 Gebouw , , , , , ,41 Gebouw , , , , , ,01 Gebouw , , , , , ,52 Gebouw , , , , , ,58 Gebouw , , , , , ,26 Gebouw , , , , , ,95 Gebouw , , , , , ,35 Gebouw , , , , , ,26 Gebouw , , , , , ,96 Gebouw , , , , , ,84 Gebouw , , , , , ,26 Gebouw , , , , , ,26 Totaal , , , , , ,55

20 20 Step 4: Computing LCCB (d = 3%) ESCO 2 ESCO 2 Geactualiseerd e Investering ( ) Onderhoudsvergoeding ( /jaar) Geactualiseerde onderhoudsvergoeding ( ) Energiebesparin Energiebesparin g Jaar 2 n ( /jaar) Geactualiseerde Energiebesparing ( ) Gebouw Duur huurcontract Investering g Jaar 1 Gebouw , , , , , ,79 Gebouw , , , , , ,99 Gebouw , , , , , ,08 Gebouw , , , , , ,78 Gebouw , , , , , ,16 Gebouw , , , , , ,52 Gebouw , , , , , ,86 Gebouw , , , , , ,41 Gebouw , , , , , ,52 Gebouw , , , , , ,52 Gebouw , , , , , ,53 Gebouw , , , , , ,43 Gebouw , , , , , ,64 Totaal , , , , , ,24

21 21 Step 4: Computing LCCB (d = 3%) ESCO 3 ESCO 3 Duur huurcontrac t Geactualiseerd e Investering ( ) Onderhoudsvergoeding ( /jaar) Geactualiseerde onderhoudsvergoeding ( ) Energiebesparin g Jaar 2 n Geactualiseerde Energiebesparing ( ) Energiebesparin Gebouw Investering g Jaar 1 ( /jaar) Gebouw , , , , , ,27 Gebouw , , , , , ,11 Gebouw , , , , , ,45 Gebouw , , , , , ,09 Gebouw , , , , , ,52 Gebouw , , , , , ,27 Gebouw , , , , , ,99 Gebouw , , , , , ,94 Gebouw , , , , , ,96 Gebouw , , , , , ,89 Gebouw , , , , , ,27 Gebouw , , , , , ,21 Gebouw , , , , , ,02 Totaal , , , , , ,99

22 22 Step 5: Analyse (Compare) ESCO 1 ESCO 2 ESCO 3 Geactualiseerde Investering ( ) , , ,72 Geactualiseerde onderhoudsvergoeding ( ) , , ,46 Geactualiseerde Energiebesparing ( ) , , ,99 LCCB , , ,19 Totaal op 70 punten 68,78 55,01 70,00 ESCO 3 (lowest LCCB) represents the economically most interesting offer (most cost-effective) with relatively high energy savings and reasonable investment and maintenance costs Other qualitative award criteria (for 30 points) can however influence the overall conclusion

23 Sensitivity analysis

24 Look at financial indicators Most important are Pay Back Time (PBT) < economic life cycle time or internal standard NPV (Net Present Value) 0 Internal Rate of Return (IRR) Discount rate at which NPV = 0 Profitability Index (PI) > 1 NPV/Investment

25 Multiple Benefits

26 MB Classification

27 Examples in case of Deep Energy Retrofit (DER)

28 Calculating financial benefits for stakeholders

29 How to (pre)finance an EPC Project?

30 1. ESCO financing Advantage = single contract for energy services and financing Other advantage = may be easier if credit rating is an issue Based on ESCO s equity Typically credit financing or financial lease for customer Can be «off-balance» under certain conditions, i.e. equivalent of operational lease Public customer: If ESCO retains «economic property» under new Eurostat rules Private customer: quite difficult because transfer of legal and thus economic property through «incorporation» into building. Only for moveable assets (e.g. PV solar panels, CHP, ), not for relighting, boiler, regulation, insulation, etc. There needs to be a second hand market for the ESCO, which is rarely the case.

31 2. TPFinancing (via ESCO) Similar to ESCO Financing ESCO finances through FI/Bank or Fund e.g. Belfius Smart Cities for Sustainable Development Fund, Belfius PF4EE Fund, SUSI Fund, PMV ESCO Fund Not equity, but debt for ESCO Typically credit financing or financial lease for customer Can be off-balance for customer, under similar conditions, i.e. equivalent to operational lease > Public sector= Eurostat Can be result of refinancing, e.g. cession and forfaiting Watch out for conditions to stay off-balance You may have to check if clauses are foreseen in your tender See P4FEE (BEEP) offer presented by Belfius for private AND public sector

32 3. FI Financing Directly financed by Financial Institution/Bank or Fund Typically credit financing (variants: bullet, roll-over) or Financial leasing Disadvantage = 2 contracts, one for the EPC, one for its financing Advantage = possibly better interest rate than from ESCO, in particular for public customers Can be incorporated in a more global financing deal See P4FEE (BEEP) offer presented by Belfius for private sector

33 4. Own funding (Equity) Not always least expensive way of financing the investment, compared to FI Financing contrary to common believe that it s always cheaper if you finance it yourself Positive impact on solvability and debt ratio But negative impact on liquidity position No financial leverage effect But in any case a strategic or political choice has to be made between investing in energy efficiency or another asset (e.g. a new swimming pool for a municipality or a new production unit for a company) Comparing NPV of alternatives can be interesting If NPVEPC > NPVALT, then go for EPC

34 4.B. Alternatives for large companies and larger public institutions: relatively similar to own funding Mezzanine financing = hybrid of debt and equity Subordinated Bond Loan Convertible Bond Reverse Convertible Bond Obligation with Warrant Government or Municipal Bond

35 Other instruments (classical) EU ERDF (European Regional Development Fund) Europees Fonds voor Regionale Ontwikkeling (EFRO)/ Fonds Européen de Développement Régional (FEDER) Government investment subsidies (e.g. KMO Portefeuille) Credit lines to financial institutions (e.g. EIB) Soft loans Investment funds E.g. PMV ESCO Fund, SUSI Fund Guarantee funds (risk sharing facility) Recommanded by BELESCO in its Position Paper

36 Other instruments (innovative) Crowd funding Loans/Participations Limited to 300 k per project, 1k per investor If > 300 k, obligation to publish prospectus Citizen funding Cooperatives E.g. Parents & grand parents (co)financing EPC in school E.g. RESCOOP-EE

37 Special Purpose Vehicle Project financing via a specially created company to allow for off-balance financing Often with Public Private Partnerships (PPP) Mainly for larger projects: > 10 million Eurostat PPP rules in line with Eurostat new EPC rules

38 Other option Sale & Lease Back Mainly used to finance overall building refurbishment projects Purpose is to cash «hidden reserves» e.g. in public buildings If a Sale & Lease Back financing is used it is strongly recommended to write minimum performance standards for thermal refurbishment and to require maximum energy consumption garantees in the terms of reference

39 Subsidies A first source of financing is always available subsidies Investment subsidies Green certificates (PV), CHP certificates Check if you are eligible to subsidies in case you are using an EPC-model with an ESCO There may be a need for «technical specifications» There may be an issue if the ESCO is «economic owner» You may have to check if clauses are foreseen in your tender But often the disadvantage of not getting the subsidies does not outweigh the advantage of getting the project on the road Particularly if you have to wait for 10 years to get your subsidy as is the case for most schools

40 Which criteria to choose financing source & instrument? Direct financing cost: interest rates, fees, subsidies Legal aspects: financing term, cancellation, legal/economic ownership, transfer of ownership at end of contract Collateral: securities, guarantees Taxation: tax deduction, depreciation, VAT Balance sheet/accounting: Off/On-Balance, Balance performance ratios Management expenditure/transaction costs «If you are uncertain, ask your Facilitator for advice»

41 Technical Assistance (TA) or Project Development Assistance (PDA) = Subsidies for Project Accompaniment or Facilitation European Investment Bank ELENA: Not for small municipalities unless aggregation Min. 30 million invested, leverage min. 20:1 and 90% subsidised Provinces E.g. POM Oost-Vlaanderen for SMEs: Energieke bedrijven Horizon2020 PDA: Not for small municipalities unless high ambition or aggregation (Min. 7.5 million invested, leverage min. 15:1 and 90% subsidised) Other Innovation/R&D-calls E.g. H2020 EE9, Flux50 You can join a consortium with a facilitator or ESCO as pilot project, e.g. for an innovative financing or technical solution

42 Your financing from the banker s point of view Your negotiation position with the bank depends on Public vs. private organisation Financial situation of the organisation For a company: patrimony and financial situation of the owner(s) Relation of trust Performance and experiences from the past (track record) Life cycle stage of the organisation (E.g. Growth stage vs. Cash machine) Industry, sector, Economic cycle

43 The banker and your solvability Points of attention for the bank Capacity of the lender to pay back the loan or credit Sufficient equity Professional skills in the light of solvability requirements for banks (Basel accords) Basel I, Basel II en Basel III Possible collateral/guarantees and insurances Personal guarantee/security Mortgage settlement Mortgage mandate Credit insurance

44 Public sector: introduction to new Eurostat rules

45 Why is this important? If energy efficiency investments that are prefinanced by a third party can be treated off-balance, in other words as operating expenses, they do not contribute to the total debt of our country This has a positive impact on our lending capacity and the interest rates we pay on our debt This is also true at the local or regional level

46 Background «Excessive Deficit Procedure (PDE)» of Maastricht Treaty (article 104) 1 st Eurostat guidance note on statistical treatment of EPC (August 2015) 2 nd Eurostat guidance note on statistical treatment of EPC (September 2017) EIB practitioner's guide (May 2018) Aligned on most recent work of «Working Group on Excessive Deficit Procedure statistics» Inspired by EIB guide on PPP (Sep 2016) 46

47 47 Scope of the Note Eurostat rules only applicable to arrangements qualified as EPC according to the Eurostat definition If the arrangements are no EPC according to the Eurostat definition then the rules don t apply

48 48 Scope and limitation of the EIB Practitioner s Guide Guide based on (1) ESA2010 rules, (2) the most recent version of the Manual on Government Deficit and Debt (2016) and (3) on the Eurostat guidance note 2017 In case of conflict the Guide prevails over the 2017 Note The Guide does not cover all of the EPC provisions that could have an impact on their statistical treatment The rules cover the economical substance and the effect of the provisions that regulate the EPC arrangement Interpretation of the guide as a whole Final decision on the statistical treatment remains with Eurostat Eurostat Consultation in case of doubt, through the statistical authorities, is highly recommended

49 Key principle for the statistical treatment of EPC Concept of economic ownership The economic owner is the party that supports the majority of the risks and receives the majority of the benefits from the EPC assets If that is the EPC Provider (ESCO), the EPC can be accounted for as Operational Lease or Buy & Lease Back, both off balance for the customer The EPC is accounted on the balance for the ESCO Legal ownership is not important -> governement = economic owner è on balance -> governement economic owner è off balance 49

50 How to determine the economic owner? EPC contractor bears maintenance and refurbishment risks EPC contractor bears most of the technical risks, construction risks and behavioural risks of occupiers EPC contractor bears credit risks (e.g. payments from Govt.) EPC contractor usually keeps all benefits and rewards during contract

51 Operating Lease Can be used both for removable assets (e.g. boiler) and non-removable assets (e.g. insulation)

52 Buy & Lease Back Purchase EPC Assets Public Authority Legal ownership Neutralized EPC Provider Economic ownership Financial Lease

53 In case of Factoring If EPC is combined with factoring without recourse agreement (ESCO-Bank) then asset to be recorded in the Government balance

54 54 EPC Definition according to Eurostat (1) In practice various EPC definitions/arrangements with following characteristics: EPC Provider/ESCO: Initial investment in energy efficiency measures Provides guarantee on energy savings Beneficiary/Client/Public Authority: Periodic payments (incl. maintenance, replacement investments and possibly reimbursement of initial investment, ). Often system of Penalties if ESCO does not reach guaranteed savings Bonus if ESCO exceeds guaranteed savings

55 EPC Definition according to Eurostat (2) Criteria according to Eurostat (1): Statistical sectorial classification of the Public Authority (BA) Has to be in sector of public administration Statistical sectorial classification of the EPC Provider Has to be outside of sector of public administration If Special Purpose Vehicle, has to be controlled by EPC Provider Types of assets Designed to improve energy efficiency of the existing infrastructure through energy consumption savings HVAC, relighting, insulation, and also CHP (exception) an (usefull) energy production Energy production: Investment <50% of total investment 55

56 EPC Definition according to Eurostat (2) Criteria according to Eurostat (2): Contract duration: Minimum 8 year Scope of services provided by the EPC Provider : Obligation of maintenance and replacement of EPC assets to insure their aptitude/capacity to generate permanent energy savings Total amount of services can not exceed the amount of savings! 56

57 Mechanism for interpretation of statistical treatment Based on analysis of occurance and categorization of «issues» This goes beyond introduction and is treated in the Expert Workshops 57

58 Contact details Lieven Vanstraelen Senior Partner Energinvest Rue Joseph Coosemansstraat Brussels M 0495/ lvanstraelen@energinvest.be