The Covenant of Mayors: Energy efficiency and Local Authorities, How to finance it? Paolo Bertoldi European Commission – Joint Research Centre www.jrc.ec.europa.eu Serving society Stimulating innovation Supporting legislation What is the CoM? Voluntary initiative launched by DG ENERGY in 2008 to support local authorities in the sustainable energy development and the fight against climate change Mayors commit to go beyond EU energy and climate objectives at least 20% CO2 reduction in their respective territories by 2020 Define a Baseline Emission Inventory (BEI) Prepare a Sustainable Energy Action Plan (SEAP) Implement their Action Plan and report periodically on progress Involve citizens and other stakeholders Adapt city structures and allocate sufficient resources Encourage other cities to join 2 What we would like to see in signatories’ territories in 2020 Lower CO2 emissions per capita (tCO2 per capita/year) – possibly for each key Covenant sector Higher energy efficiency in buildings (kWh/m2 year) Higher efficiency in transport (kWh/p km) Increased production of electricity and heat from renewable sources (MWh/year) Increased share of energy consumed in the territory coming from Local Energy production (%) Economic savings and local reinvestments Better opportunities for local jobs What is a SEAP? Its nature is threefold Political document: it shows how CoM signatories want to reach their target: detailed measures and medium-long term strategies. Technical document: it starts from the results of the baseline emission inventory to identify the most appropriate actions Communication tool: a clear and structured document addressed to citizens and stakeholders Example: SEAP of Genova The Covenant stepby-step The adhesion to the CoM initiates a process within the local authority An unprecedented growth Some figures from the initiative 5342 Signatories 141 Coordinators 89 Supporters An unprecedented growth SEAPs over time (EU and beyond) No. of SEAPs per population range As of 1st April 2014 SEAPs Inhabitants 3534 >145.7 million Most of the SEAPs come from municipalities <10,000 inhabitants Data from Baseline Emission Inventories Breakdown of energy consumption and GHG emissions by sector Final energy consumption GHG emissions Some common measures • 5586 measures in public lighting in 3203 SEAPs (87% of SEAPs include at least one measure in public lighting) • 3645 measures in schools in 1598 SEAPs (44% of SEAPs include at least on measure in schools) Many LAs ask us how to finance these EE measure? Background • The most frequently cited reason for local authorities not engaging in energy efficiency projects is a perceived "lack of capital". • Even cash starved local authorities can take advantage of different financing methodologies to get the work done from pre-feasibility analysis to monitoring and verification of energy savings. • It is a matter of knowing whereto look for the capital and how to structure the form that the capital will take in the transaction that will best suit the energy efficiency investment. The issues What are project risks and how to analyse and manage them? How to present information to the financial institutions ? How to improve the (perceived) financial feasibility of projects? How to utilise limited amounts of own source (funds) (leveraged by third party funds)? How to access EU funds, and different types of finance ? What are typical issues in preparing and implementing projects, how others succeeded to handle those ? 11 Cause of Financing Barriers • Problem not caused by a lack of available funding capacity in many/most local markets. • Caused by an inability of EEPs to access existing funds due to a “disconnect” between traditional Asset-based lending to corporations versus Cash Flow-based project financing to EEPs. • Solution to problem difficult because energy efficiency markets are not developed enough to motivate local banks to invest in setting up an EEP lending infrastructure. • Difficulties for LAs to prepare bankable EE projects. “Difficulty” of Financing EEPs Local Financing Institutions (LFIs) typically: • Are accustomed to providing “asset-based” lending at 70%-80% of the market value of assets being financed, or other collateral. • Do not recognize the Cash Flow generated by EEPs as a new asset to be valued in the financing structure (credit enhancement). • Are not familiar with the intricacies of financing EEPs - creating a perceived high-risk lending profile for EEPs. • Do not have the internal capacity to properly evaluate EEP risks/benefits nor to structure their financing in market-acceptable ways. • Are unwilling to invest the time and resources needed to develop lending infrastructure due to relatively small size of each EEP. • Experience market conditions that preclude commercially-viable financing to EEPs (high interest rates and short repayment terms). Why is access difficult ? • Lending from Local Financial Institutions (“LFIs”) traditional business - Corporate Lending – generally Asset based - Energy investment risks not understood – - Risks perceived too high - Interest Rates too high - Repayment Term too Short • Lending from International “IFIs” not applicable: - Size of Projects too small - Due diligence too cumbersome - Require hard currency repayment - EEP not Capital Structure Debt Financing On-balance-sheet Bank loan Equity Financing Off-balance-sheet ESCO Leasing Security behind the loan Collateral Guarantees Insurance Internal sources In-kind Cash contribution External sources Investor Revenue EU funding Carbon finance Third Party Financing • The easiest way for LAs to undertake EE projects is to allow someone else to provide the capital and to take the financial risk. With these alternative methods of financing, one can expect a higher cost to reflect the fact that the debt resides on someone else's balance sheet. • Nonetheless, as it should become clear, the interest rate is only one factor among many that should be considered in determining the suitability of a project financing vehicle. Off balance sheet financing: • • • • Operational leasing – Rental in which the period of contract is less than the life of the equipment and the lessor pays all maintenance and servicing costs. ESCO – Energy Service Company taking charge of (i) project identification, (ii) engineering, design, and permitting, (iii) construction, (iv) operation and maintenance, (v) administration of billing, (vi) and organization of financing for the above. Forfeiting - In case of forfeiting the supplier forgoes its accounts receivable to the benefit of the bank or financial institute, which in return does assume all associated risks, and passes up its right of reclaims. Forfeiting is used for medium and long term outstanding receivables or annuities. Public Private Partnership  BOO(T) - Build, Own, Operate and Transfer of infrastructure projects, promoted and financed by the private sector, whereby the promoter builds, owns and operates the project and only after a specified number of years does it transfers it the ownership back to the public sector.  Concession - An understanding between a company and the host government that specifies the rules under which the company can provide service locally. Energy Service Companies Energy Service Companies (ESCOs) offer the same services of Energy Service Provider Companies (ESPCs). However, ESCOs differ from ESPCs in the following ways: • ESCOs guarantee the energy savings (a performance guarantee can revolve around the actual flow of energy savings from a project, or can stipulate that the energy savings will be sufficient to repay monthly debt service costs). • The remuneration of ESCOs is directly tied to the energy savings achieved; • ESCOs can finance, or assist in arranging financing for the operation of an energy system by providing a savings guarantee. • Retains an on-going operational role in M&V over Financing is a Key Issue • ESCO is a Service Company not a Bank; • Some ESCOs cannot invest their working capital to develop & implement Energy Efficiency Projects unless “reliable” and “commercially viable” long-term Project Financing is available. Shared savings Guaranteed Energy Savings Energy Efficiency in public buildings (Province of Milano, Italy) 22 Creating Bankable Projects • Bankable projects are a clearly documented economically viable projects. • The key components are properly assessed and the plan to effectively manage is clearly presented. Each component carries a risk factor, and each risk factor carries a price tag. • ESCOs know how to assess the components: e.g. customer pre-qualification, audit quality, equipment selection and installation, and savings verification, and how to package them into a project that can be financed. “Deep retrofits" versus "cream skimming" • Often LAs opt for short paybacks on EEPs yielding rates of return from 20%-30% a year with paybacks to coincide with terms of office, and it may allow the project manager to boast a "high" return on investment. • All profitable EE options should be considered, i.e. also those yielding a rate of return greater than the interest rate of the investment capital. This approach will translate into greater savings over the long term. • If a LA continues to do incremental work by upgrading the lighting, but fails to do other system upgrades, it loses the opportunity to "crosssubsidize" the lighting savings with more capital intensive work like boilers, HVAC, controls, and building envelopes, which may carry a longer payback term. • Quick paybacks on investments, means too often organisations do not think of "life-cycle costing" when it comes to procurement policy. Why would LAs look only for a 2 or 3 year energy retrofit project on an existing building that is 15 years old when the building's life cycle will be 25-50 years? Energy Audit Quality • A standard energy audit with its “snap shot” of current conditions in not good enough for performance contracting. When an ESCO takes the risks on future savings, these assumptions must be tested through an careful risk assessment procedure. • Only an investment grade audit that adds specific risk appraisals to the standard nameplate/run calculations will meet performance contracting needs. An investment grade audit (IGA) goes beyond these engineering skills and requires the art of assessing people; the level of commitment of management to the project, the extent to which the occupants are informed and supportive as well as the O”&M staff’s abilities, manpower depth and attitude. • The ESCO that consistently delivers a quality IGA, which in turn accurately predicts potential savings, builds a track record that financiers find acceptable. A good IGA is at the heart of the bankable project. When the total project plan is wrapped around a quality IGA and delivered by an ESCO, who can back its predictions with a solid history of successful projects, financiers can accept it. Savings Verification • When the contract is on the level of savings achieved, all parties should be comfortable with how the achieved savings are verified and attributed to the work performed by the ESCO. The ESCO and owner should jointly decide on the level of verification and attribution necessary. It id basically a case of cost vs. accuracy, and it is possible to reach the point of diminishing returns rather quickly. With the verification burden becoming so great that a measure is no longer economically viable. • The financier wants some sense that the projects benefits are measurable and they are measured through accepted protocols. Too often verification procedures are basically passive, a negative drain on the cash flow, and the investors are not interested in funding a gold plated M&V approach that offers little or no return on investment. Example of financial support Alicante Provincial Energy Saving Plan, ES  “Provincial Energy Saving Plan” aimed at supporting municipalities in delivering their Covenant of Mayors commitments.  Financing of investments that help reduce municipal energy bills  Only municipalities which have signed the Covenant of Mayors and developed their Emission Inventories and Sustainable Energy Action Plans are eligible for such aid.  €3 million for the 2014-2015 earmarked 27 EU Funding: ELENA & MLEI PDA ELENA (European Local ENergy Assistance)  Province of Barcelona, Spain  Province of Milan, Italy  Province of Modena, Italy  Province of Chieti, Italy  Provinces of Padova and Rovigo, Italy MLEI PDA  Province of Teramo : street lighting  Limburg : ESCO development  Huelva, Torino, Marche… 28 Conclusions From the CoM to Smart Cities The CoM is a “platform” for sustainable energy and climate policy at local level: it encompasses the fundamental governance challenges and provides a methodological and scientific framework for action. The CoM is the living laboratory of energy/climate policy at local level including financing: smart solutions are already planned in several SEAPs The Smart Cities initiative could help the CoM signatories to better devise, implement and integrate the most advanced low carbon solutions, allowing them to set more ambitious objectives. Covenant is a basis for systemic, integrated sustainable energy evolution, while Smart cities can be a part of the solution to help this evolution materialize. Thank you! Paolo Bertoldi +39 0332 78 9299 [email protected] Joint Research Centre (JRC) IET - Institute for Energy and Transport Petten - The Netherlands & Ispra - Italy http://iet.jrc.ec.europa.eu/ http://www.jrc.ec.europa.eu