How ESCos can fund green energy

Energy service companies (ESCos) are increasingly being used to fund power infrastructure on new and existing developments. From central government there is a growing recognition of the importance of decentralised low-carbon energy and there has been considerable support for the combined heat and power industry energy.

There has also been a significant stimulus from legislation, including the climate change supplement to PPS1 and Merton Rule policies implemented by local authorities. This has been mirrored by higher design levels spearheaded by the Code for Sustainable Homes and BREEAM. Developers are realising that the outsourcing of energy infrastructure is a way to ensure projects are compliant with new and impending legislative planning requirements.

The flexibility of ESCos is an important factor in allowing developers to meet these demands. ESCos can incorporate some or all aspects of the design, build, finance, ownership and operation of energy assets, through to the provision of energy efficiency advice and installation of energy efficiency measures. It is possible to combine energy generating and energy saving activities into the same ESCo. In some instances investment can be provided by specialist companies, depending on the size of the project and whether or not the investment returns are sufficient. Companies that will consider investing in energy solutions for large property developments include EcoCentroGen, Utilicom, Elyo Suez, Fontenergy and Dalkia.

Such companies have different offerings: some will be interested simply in selling and operating energy generating equipment such as combined heat and power plants, whereas others may want to put equity into projects and invest in private energy networks, supply customer services and billing operations, or provide turnkey solutions. The nature of their involvement is, again, dependent on the scale of the project, how bankable it is and the predicted energy demands and profiles. They can adapt according to the needs of each project.

This adaptability helps them to deliver energy efficiency as well as energy generation. The Energy Centre for Sustainable Communities (ECSC), a sustainable energy consultancy, is involved in an energy study and business plan for Peterborough which will explore the potential of using an ESCo to free up capacity of the existing centralised energy infrastructure, thought to be at capacity. This study involves tackling the complex issue of how best to reduce carbon in the existing building stock. There may be scope to create an ESCo to generate energy from low-carbon sources and for working with existing partners to deliver local solutions.

In Surrey, Woking council is planning a low- carbon homes programme, focused on cutting emissions in the existing stock, through its ESCo, called Thameswey. This scheme is likely to be the first of its kind, going beyond simply providing advice and making it easy for residents to change to a lower-carbon lifestyle. It is significant because it demonstrates how a council-owned ESCo can engage with the community on wider carbon reduction initiatives.

When setting up an ESCo there are a number of company forms that should be considered, including limited company, limited liability partnership, charity status, industrial and provident societies, and community interest companies. The choice is ultimately determined by the characteristics of the project partners and the aims of the project. There are also many views about optimal levels of debt and equity. This should be determined by the specific nature of the project and, in the current climate of low interest rates, it may be desirable to have more debt in projects. There is no “one size fits all” financing model for ESCos.

It is important that ESCo models from other projects are not replicated directly, that the aims of the ESCo are set out clearly at the beginning, and the aspirations of partners are aligned. For certain projects, accessing funding sources such as government grants may be a priority and therefore this should be reflected in the financing structure. This could involve, for example, choosing charitable status or, if cash flow would benefit from enhanced capital allowances, then private sector partners to an ESCo will need to be able to access these.

Putting energy assets into a separate company allows them to be considered as a standalone investment opportunity

Investment benefits

It is becoming accepted that utility services can be decentralised and the incorporation of energy, water, waste and data services is being considered on a number of projects. This can lead to the creation of a multi-utility services company (MUSCo). A good example is the proposed regeneration of Elephant and Castle in south London, led by Southwark council,

where a consortium of Dalkia, Veolia Water and Independent Fibre Networks has been selected as the commercial partner.

Many engineering consultancies are adding ESCo/MUSCo services to their operations and masterplanners are making energy centres an integral part of developments rather than relying on the existing electricity and gas grids. Such energy centres can include energy generating assets (eg combined heat and power plants, biomass boilers or wind turbines) and distribution networks (wires and/or pipes).

Putting energy assets into a separate company has a number of benefits for developers. Importantly, it allows them to be considered as a standalone investment opportunity from the main project. This means the additional capital cost of energy infrastructure does not have to be considered as part of the conventional financing approach for the whole development. Instead, the focus is on which types of partners are able and willing to contribute towards the capital cost of the energy assets, for what type of return, and over what timescale.

The risk/reward profiles for potential investors become important and allow a finance-raising process to be initiated so that the energy infrastructure costs are not solely borne by one party, ie the developer. In the current economic climate, when normal funding routes are under pressure and budgets are increasingly being cut, this type of approach may be the only way to finance energy projects.

As a general rule, developers tend to seek high-risk projects for high rewards over short timescales, while local authorities are usually more comfortable taking lower risks for lower returns. To raise finance, the energy project needs to be “de-risked” for potential investors. Typically, this is done as part of the finance-raising process and involves the production of a business plan and financial model. For example, a key perceived risk may be the ability for properties to connect to the ESCo’s energy supply. This could be mitigated by putting in place contractual agreements to ensure that properties are designed from the outset with a view to connecting to the supply, so the design team is provided with all necessary information from the equipment supplier. If a project’s profits are marginal from the start, the developer may view the additional cost of sustainable energy generation simply as an increase on the capital cost, with the only possible return from the sale of the properties. This cost increase may not be viable, especially in such turbulent economic times. However, if the increased capital cost for sustainable energy generation is separated out into a company, it can be viewed as an investment opportunity and a process to raise finance can be undertaken. Typical financial returns on investing in energy-generating assets tend to be 10-15%, and are lower than the returns developers may be used to. Investment opportunities that have cash-flow benefits and share risks and rewards with partners are, then, looking a lot more attractive in today’s financial climate.

Holding energy assets in separate companies also facilitates investment from the public sector, which is generally used to taking a longer-term investment outlook. The public sector may also see sustainable energy generation as integral to reducing carbon emissions, so financial return will not be the only important criterion. Councils can use instruments such as the Power of Wellbeing as a basis for considering investment in an ESCo. Tower Hamlets borough council and Southampton city council, as well as Woking borough council, have already established their own ESCo solutions to deliver energy projects.