Energy Performance Contracting

What is an Energy Performance Contract (EPC)?

An Energy Performance Contract (EPC) is a contractual and funding mechanism which provides energy efficiency retrofit to a building to improve its energy performance while minimising risk to the building’s owner. Any upfront capital investment is recouped through energy cost savings over a period of time, usually between 7-20 years. The contractor is generally termed an Energy Service Company (ESCO).

Commonly used in the United States, the use of EPCs is gaining ground in both the UK and the EU. The Energy Efficiency Directive imposes a requirement on all member states to introduce a framework of measures to promote energy efficiency (to be implemented into national law by
5 June 2014).

A contract for improved energy efficiency (primarily by way of retrofit) can take various forms:

– the installation of energy efficient plant and equipment only, for example LED lighting in a warehouse or a Combined Heat and Power (CHP) unit in an apartment block or hospital

– a facilities management contract which provides incentives to the contractor to achieve energy efficiency, for example through lifecycle and maintenance works with the contractor taking the energy consumption risk, as has been used extensively in the leisure management industry

– an EPC: combined installation and management contract under which the contractor provides a turnkey solution, designing an energy efficiency package for a building or series of buildings, maintaining and operating the installations to achieve continued optimum efficiency and guaranteeing energy savings to the building’s owner. This latter option has been promoted and used through the Mayor of London’s Re:Fit framework available to the public sector and is being used increasingly by the private sector, particularly in energy intensive manufacture. An EPC contract can be financed by the building owner, as in the Re:Fit model, or by the ESCO (as often occurs in State-side contracts).

Energy efficiency retrofit is suitable for any type of building – industrial, retail, office or domestic. However, the success and suitability of an EPC often depends on a strong corporate desire and strategy to improve the energy performance of its property portfolio combined with a portfolio that, for either individual buildings or in aggregate, can provide a sufficiently bankable payback. Clear data is key to any energy efficiency retrofit project. Knowing the current energy consumption of your stock, your energy needs and the use of your stock creates a baseline against which performance enhancements can be monitored, and creates a business case for both internal and funder support. 

The principal benefit of an EPC is reduced energy costs through lower energy consumption. However, other benefits include reducing CRC Energy Efficiency Scheme liability, income generation through incentives such as the Renewable Heat Incentive and Feed-in Tariffs, providing an anchor load for wider sustainable infrastructure such as district and community heating schemes, and/or allowable off-site solutions for zero carbon new build. 

Key contractual and legal considerations

– Term of contract – this will depend on the terms of the finance of the EPC. Lifecycle replacement requirements within the length of term need to be factored into both the performance specification and the payment and default termination provisions

– Performance risk – an ESCO will guarantee a minimum level of energy consumption savings either through a fixed guarantee under which it will reimburse the owner for failing to achieve the minimum guaranteed savings, or through a gain sharing mechanism, or a combination of both. Measurement and verification is critical: the contract should identify a baseline measurement relating to categories of savings measured, seasonality and hours of usage, and address modifications to buildings and occupancy. An ESCO will not take the risk on those elements it cannot control. Plant and equipment warranties and mechanisms to share excess savings should also be considered

– Time critical delivery and delay – delays in energising a building or reaching full energy output may have serious consequences for your business. A clear testing and commissioning process is needed and possibly liquidated damages for delay

– Default and termination – default and termination triggers should not be so stringent as to produce hair trigger termination. Conversely, if contract performance depends on a range of energy efficient measures or involves several buildings, the performance, payment and termination mechanisms must ensure that the poor performance of any one measure or building cannot be masked by the overall performance to the owner’s detriment

– Interface arrangements – the advantage of a turnkey EPC approach is that performance-related pay structures create a fit between installation and operation of measures. An ESCO will consider the lifecycle and maintenance provisions in its design of the installation. If installation and maintenance are contracted separately, an installer may have insufficient regard to the performance and lifecycle of measures, and a maintenance contractor may be unwilling to take the performance risk of equipment which has no track record and which it did not design. In addition, any existing facilities management contracts and the interface of those contracts with the EPC need consideration

– Power purchase and incentives – who will be responsible for contracting for utilities? If energy generation measures are installed, will the owner purchase all energy and heat from the measures and who will get the benefit of the sale of any surplus energy or Government incentives from the generation of renewable energy and/or heat?

Funding an EPC

– Incentives and sale proceeds – if the energy efficiency solution uses energy or heat generation, how will any onward sale of excess energy and heat or income derived from Government incentives be factored into the project and impact on the funding required?

– Who funds? – funding could be from owner borrowing or ESCO funding. Higher value projects which produce larger energy savings are more suited to third party or ESCO project funding models. Owners may be able to recoup some or all of the costs of energy retrofit from occupier contributions

– Funder requirements – the funding source will impact on the performance and payment provisions within an EPC, including the term of the contract, to accommodate payback. Funders, particularly in an asset or operating lease funding package, are likely to require a range of direct agreements and step-in rights with the EPC parties. A robust business case based on energy consumption and usage data will make a project more bankable and provide cheaper and more varied funding options.

– Other funding options – specialist funding and grants are available for low carbon retrofit, including Green Deal input which provides for upfront funding of certain energy efficiency measures that are repayable by occupiers through the utility bills.

Walker Morris LLP’s work in energy efficiency contracting is spearheaded by the Renewables Energy and Resources Group, a multi-disciplinary group drawing from experts across the firm. Its observations draw on both its direct experience of EPCs and its wider experience in the public sector and facilities management arenas.