Energy Service Companies

At the heart of innovative financing models for efficiency

Energy service companies (ESCOs) deliver energy efficiency projects that are financed based on energy savings. Given the need to rapidly and significantly increase financing for energy efficiency, interest in ESCO business models is growing.


United States of America




Insights

The public sector dominates the ESCO market in the US. There are several reasons for this, but a main consideration is the long term versus short term thinking of building owners. Public sector customers have long payback horizons and use ESCO projects to supply capital for neglected building maintenance and building modernization. Privately owned commercial buildings, particularly rental buildings, generally will not implement long-payback projects. They look for a quick paybacks through the implementation of a single technology project (e.g. lighting or controls upgrades), because short-payback projects produce short-term increases in net operating income, which increases the capital value of the building. Therefore commercial rental buildings are not the target customer base for an ESCO.

The way that a guaranteed savings project works in the US non-federal markets is that the financial institution (FI) executes a loan/lease/bond and advances the project funding to the customer. The customer pays the ESCO for the project on completion of construction. If the project does not produce its guaranteed savings, the customer has a claim against the ESCO. In addition, the customer may make some ongoing, modest payments to the ESCO for operation and maintenance services on some equipment or the annual cost of the M&V reports. 

This model was pioneered in the mid-90s because it separates the project credit risk from the project technical risk. The FI takes the credit risk and the ESCO takes the technical risk.  Guaranteed savings financing also provides 100% debt financing, which is cheaper than shared savings financing, which has debt and equity components.

FIs also prefer projects for government customers, because the credit risk to the FI is lower than for private customers. Most of the financing is tax-exempt, which results in low interest rates.

Average duration of contract is 10-20 years.

Non-residential buildings including commercial spaces, municipalities, utilities, schools, or hospitals is the main source of ESCO business in the USA. This is due to the incentives and legislation, such as the 2007 Clinton Climate Initiative’s (CCI) Energy Efficiency Building Retrofit Program (EEBRP) which brings together ESCOs, global financial institutions, the suppliers of energy efficient equipment, and municipal, commercial, and educational building owners to reduce energy consumption in existing buildings. Another policy that changed how the public sector could borrow debt with preference to the energy service market was the Dodd Frank Act.

Other practices that contribute to the success of the ESCO market are the preferential interest rates on loans for energy related projects as created by the 2005 Energy Policy Act . Rigorous reporting standards that occur on both federal and state levels including impact assessments of each ESCO project helps provide success stories and share best practices throughout the industry and demonstrate the value of each ESCO project to the local community.