ESPCs and the Cost of Capital

To comprehend the relationship between Energy Savings Performance Contracts and cost of capital, it helps to have a clear picture of their function. Authorized by Congress, ESPCs are partnership agreements between a federal or state agency and an Energy Service Company — a private contractor — to improve the energy efficiency of a given facility or installation. The intent of the program’s creation was to encourage federal agencies to employ more energy-conserving measures in their facilities by simultaneously gaining the means to decrease the costs of the improvements. The latter element was the most appealing inducement. The amount of usual upfront capital needed for extensively large-scale projects, as most agencies required, was daunting to prohibitive. The utilization of ESPCs eradicated that dilemma; the contracts’ terms call for the ESCO to procure the initial financing. 

The steps for implementing the program are well defined. Armed with a list of specified goals, the governmental agency solicits bids from a list of ESCOs. The selected company then performs a detailed examination of the agency’s facility, identifying areas needing improvements to save energy. Of paramount importance, the ESCO’s assessment will also include how much annual savings in dollars may be expected from the upgrades or improvements. Later, these figures will prove advantageous to the ESCO not only in terms of repayment for its services but in obtaining the financing. There will be hard evidence documenting equal consideration of debt and equity costs and highlighting the required return necessary to make the project worthy of investment; in other words, the cost of capital. 

Following its evaluation of the facility, and in consultation with the agency, the ESCO designs a project geared to fulfill the agency’s desired goals for energy efficiency. Aside from securing the start-work capital, the ESCO is tasked with the acquisition and installation of all equipment essential to the project. Additionally, the contractor provides any required maintenance of the equipment throughout the contract’s life; a period of no more than 25 years. Ultimately, the ESCO receives payment for its labor and expertise from the amount of savings the agency reaps as a direct result of its energy-efficient improvements. 

Federal facilities, as well as those under state administration, are utilizing ESPCs with great success. Billions of dollars are being saved by agencies including the EPA and the US Department of Energy. Likewise, the concept has proven a boon for large-facility managers and owners.

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