An ambitious target of energy consumption
As part of the clean energy for all Europeans' package, Directive 2018/2002 of 11 December 2018 on Energy Efficiency1 contains an ambitious target of at least a 32.5% reduction in energy consumption by 2030.
This poses a significant challenge for all Member States, as substantial investments will be needed, especially to enhance the energy performance of existing buildings. This is particularly true for Belgium, as the real estate stock is characterised by a high proportion of old buildings (more than 70% of residential buildings has been built before 1981).
In this regard, the Energy Performance Contracting (EPC) is a valuable instrument that has been in existence for a few years. Under such a contract, an energy service company (ESCO) implements a project to deliver energy efficiency and uses the income from the cost savings as payment.
In other words, the contractor bears the costs of the energy improvements, and is paid back from the value of the energy saving for over a contractual period, typically between 5 and 10 years, that should allow for a cost-effective investment. The owner of the building will be able to capture the benefits of energy savings after the pays-back period without having to undertake upfront capital expenses. Therefore, the Energy Performance Contract both accelerates the energy transition and eliminates challenges related to funding.
The chance for the EPC to live-up to its potential?
Many energy service companies offer EPC and several examples of successful projects confirm the relevancy of this approach. Investors in the EU also see a great opportunity in EPC. They consider it a profitable and sustainable placement due to the guaranteed income generated by the net difference between the previous and the current energy bill. However, the EPC has not yet reached its full potential.
A lack of understanding of the mechanism probably explains why EPC are not fully exploited by many public entities. Model contracts, exchange of best practice and guidelines should help stimulate demand2, but there is clearly a need for an extra push.
Aware of the need to provide more visibility and clarity on the mechanism, on 7 June 2019 the European Commission released a recommendation reminding the Members States that they are required to support the public sector by providing model contracts for energy performance contracting3. The revised directive on energy efficiency4 stresses the important clarification provided by Eurostat on how to record energy performance contracts in national accounts, which removes uncertainties and facilitates the use of such contracts.
Eurostat confirmed that an Energy Performance Contract could be recorded off government balance sheet if the EPC contractor is considered as the economic owner of the assets installed. Eurostat provides several criteria for obtaining this qualification5. It is therefore key, at the time of conclusion of the contract, to be properly advised so that the investment can be recorded off government balance sheet.
The EPC, an effective instrument for sustainable investment
The main rules concerning the regulatory treatment of EPC have been left unchanged by the revised Directive on Energy Efficiency6:
- Member States shall encourage public bodies, when tendering service contracts with significant energy content, to assess the possibility of concluding long-term Energy Performance Contracts that provide long-term energy savings (Article 6.3.);
- Member States shall promote the energy services market by providing model contracts that covers Annex XIII's list of minimum items and providing information on EPC best practices (article 18 1. (d)); and
- Member States are required, where appropriate, to remove the regulatory and non-regulatory barriers that impede the uptake of energy performance contracting (Article 18 2. (b)).
According to Annex VIII of the directive, the model contracts must address the following minimum items:
- Clear and transparent list of the efficiency measures to be implemented or the efficiency results to be obtained;
- Guaranteed savings to be achieved by implementing the measures of the contract;
- Duration and milestones of the contract, terms and period of notice;
- Clear and transparent lists of the obligations of each contracting party;
- Reference dates by which to establish achieved savings;
- Clear and transparent lists of steps to be performed to implement a measure or package of measures and, where relevant, associated costs;
- Obligation to fully implement the measures in the contract and documentation of all changes made during the project;
- Regulations specifying the inclusion of equivalent requirements in any subcontracting with third parties;
- Clear and transparent display of financial implications of the project and distribution of the share of the parties in the monetary savings achieved (i.e. remuneration of the service provider);
- Clear and transparent provisions on the measurement and verification of the guaranteed savings achieved, quality checks and guarantees;
- Provisions clarifying the procedure to deal with changing framework conditions that affect the content and the outcome of the contract (i.e. changing energy prices, use intensity of an installation); and
- Detailed information on the obligations of each of the contracting parties and of the penalties for their breach.
The EPC in practice
In practice, the EPC is subject to the national and European public procurement rules. Before launching a tender procedure, the public entity should explore the potential of energy saving via EPC, as a minimum amount of energy spending annually is set out to allow for the economic viability of the project in many European Member States. When this amount is not met, different buildings may be bundled into one contract based on the criteria of physical proximity and similarity in energy consumption. Following this assessment, a tender procedure may be launched by a public authority. A cost and efficiency criteria is often relied upon to select the successful bidder.
The proposal should include a final investment assessment, namely the fixed price of the required energy saving, technical measures of the renovation and an estimated sum of energy savings.
During the performance period, the public entity's representatives will inspect and accept delivery of the building. Payment of the ESCO is conducted from the net amount of the savings in energy costs generated by the project, and continues up to the end of the contractually agreed repayment period.
The EPC vehicle must be subjected to VAT in order to allow for the tax deductions during the renovation process.
EPC is a key tool to reach the European climate and energy transition objectives
EPC could and should play a greater part in meeting energy consumption reduction targets in buildings.
The Belgian authorities have recognised, in their draft National Energy and Climate Plan (NECP) of 19 December 2019, that the market for energy service companies and energy performance contracts is still underdeveloped, despite some good individual experiences. All entities made a commitment to further promote this type of contracts7. The unique advantage of EPC compared to other forms of contractual project finance is that all parties to the contract benefit from entering into the agreement:
- The public or the private entity renovates its building at zero cost;
- It decreases energy consumption in the short term whilst benefiting from considerably decreased energy bills on the long term;
- EPC is also beneficial for commercial and industrial facilities that use performance contracts;
- The scheme that funds the project receives a secure full repayment with the applicable interest rates due to the guaranteed income of the ESCO;
- Operation and maintenance is usually handled by the installation company;
- The value of the building increases; and
- It is a useful tool to reach a 32.5% reduction in energy consumption by 2030.
Nevertheless, EPC still constitutes a complex contractual tailor-made commitment, the terms of which are highly detailed and technical. Those interested in EPC investment schemes must attend to the advice of experienced attorneys at all phases of the EPC process.
2 Belgian Energy Efficiency Action Plan according to the Directives 2006/32/EC and 2012/27/EU, April 2014
3 Recommendation (EU) 2019/1019 of 7 June 2019
5 See press release
6 Directive (EU) 2012/27/EU of the European Parliament and of the Council of 25 October 2012 on energy efficiency amending Directives 2009/125/EC and 2010/30/EU and repealing Directives 2004/8/EC and 2006/32/EC
7 Draft of National Energy and Climate Plan, 19 December 2018
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