Financing ESCO Projects

1. Financing ESCO Projects By G C DATTA ROY DSCL ENERGY SERVICES COMPANY LTD. Presented at Workshop on EE in Buildings & Building Code Organized by Bureau f Energy Efficiency New Delhi, Oct,2006

2. Presentation Structure • About DSCL Energy Services Co Ltd • Need for financing EE market • Financing EE projects-experiences • Project implementation-Why ESCOs • Financing ESCOs-Global & Indian status • Development & design of financial mechanisms • Conclusions

3. Manufacturing Platform Service Platform Agri Retailing ‘fenesta’ Window system Speciality plastics Energy Services DSCLES Agri Business Plastics Chemicals Fertiliser Agri-Marketing Sugar Bioseed PVC Carbide Chlor Alkali DSCL-Rs 2000 Crs Manufacturing & Service Conglomerate

4. DSCL Energy Services • Set up in February 1999-With 50 engineers, largest in India • Delivered over 100 EE and RE projects globally (India,USA, China, Algeria, Kenya, Tajikistan, South Africa, Bangladesh) • Estimated contribution in India-Over 100MW • Another 150 MW in the pipeline • Service offerings include • Energy Efficiency consulting and performance contract (India & Global) • Captive and RE power generation • CDM • Best ESCO award (PCRA) for past consecutive 3 years

5. Financing Need • Is lack of appropriate financial mechanisms a barrier against implementation of EE projects? • Strategic issue • Barrier removal? • Market development enabler? • Important for deliberation by all concerned stake holders

6. EE Financing-some experiences • Large industries (Over 25 cases in Paper, Sugar, Metal, Chemical & other industries)-Financing not an issue • SME Industries (WB 3CEE & GEF SRRM) • Profitable industries manage from operation/project budget • Others require but no access • Commercial buildings (GOI buildings) • Requirement for building EE service provider credibility • ESCOs (Over 15 projects in industrial & commercial) • Mostly not qualified under current norms • Essential for market development New mechanisms required as market enabler for stressed SMEs & ESCOs May be later for Agri EE

7. Implementation-Option & Issues Option-I Option-II Option-III By Owner By Vendors By ESCOs • External-internal • audit • Project selected • Self financed • Lowest cost • Quick execution • Often minimalist • approach • PMV usually not • carried out • Sustenance often • doubted • New technology • developed • Volunteer found • Results established • Vendor financed • Vendor risk at start • Guarantee/warranty • Limited choice • Sustainability • Minimalist • Maximum savings • No risk for owner • Often ESCO financed • Stringent PMV • Maximum • sustainability • O&M risk to ESCO • Higher soft cost • ESCO cash flow risk • Evolving business

8. Why ESCOs preferred for Government Facilities • Achieving highest savings • Robust M&V system-establishment of credible & verifiable performance • Better comfort for occupants • Better maintenance performance • Sustaining savings • No upfront cash flow from Facility budget • Generation of positive cash flow without investment by the facility

9. Globally ESCO a preferred model for public facilities-yet market development quite challenging ESCOs have been widely accepted by the Bank as an attractive business model for bridging thegap between end-users and financing. It involves private sector participation and financing,allows technical risks to be transferred away from end-users and financiers, and includes inherentbusiness incentives for ESCOs to proactively develop projects. ESCOs can also specialize inpackaging smaller EE projects, bundling procurement of goods across several projects and takingon project performance and credit risks. Thus ESCOs can be seen as a mechanism to removemany of the commonly cited barriers to EE investments. Despite these promising attributes,creating strong and credible ESCOs, not to mention full ESCO markets, has proven verychallenging. Excerpts from WB-GEF report, 2004

10. ESCO Financing-Some Successful Global Experiences • Hungary-WB IFC PCG program • China-WB ESCO program • Brazil-Electricity cess for ESCO program • Korea-Petroleum cess for ESCO program • Thailand-Utility DSM & ESCO projects • Japan-Utility ESCO development

11. India Experiences • USAID-EMCAT project-financed large number of EE projects thru traditional financing mechanism-catalysed usage of EE equipments in Industry • WB-IREDA project-Few traditional project lending • USAID ECO project-yet to achieve financing break through • WB 3C EE Project-schemes of commercial banks • New mechanisms-ADB PPTA project/CDMfor ESCOs Indian market still awaiting financing innovation

12. Typical ESCO business models • Full service ESCO-Financed & Implemented under shared savings • Non-Financed Performance contract-ESCO fee linked to project performance as % of savings • Tariff model-Energy managed by ESCO at predetermined tariff • Consultancy-Fee with or without performance linkage • Traditional leasing/suppliers credit

13. Development of Financing Mechanism Under ADB India PPTA Project, 2003

14. Financing Needs Of ESCOs Project Cost and Working Capital • Meeting Development Expenditure • Financing a part of project Cost • Sponsor support under Risk Sharing • Principles • Customized solutions for different segments • Credit Enhancement to catalyzed development/establishment of ESCO/EE market • A credit program approach if feasible for some segments • Risk sharing leading to leveraging • Refinancing through Capital Markets EQUITY MEZZANINE DEBT SENIOR DEBT WORKING CAPITAL

15. Financial Products – Key Needs • Risk-Sharing approach • Credit enhancement of the borrower • Formal risk assessment and mitigation • Payment Security Mechanism • Reduction of financial transaction costs • Customisation for target market segments • Ability to finance “small” projects • Potential for re-financing through capital markets Several new products & delivery mechanisms Designed in consultation with Banks Under ADB PPTA project

16. Potential Financial Products • Equity Capital for ESCOs • Venture capital for corporate and/or project equity • Guarantee Fund • Use of a portion of ADB (Public Sector) loan funds to provide loan guarantees, or • Partial Credit Guarantee from ADB Private Sector Window • Payment Security Mechanism • Mechanism to secure the cash flows from energy savings for debt service • Streamlined (Program-based) approach for small projects • Development of standardised project approval parameters that mitigate risks on a portfolio basis

17. Public Sector Window Letter of Comfort ADB GOI Risk Sharing Follow on Loan fees Repayment EE Projects (Large) ESCO Loan EA PSM Repayment Guarantee Mechanism (fully funded) Risk Sharing Gtee Agreement Fees Loan Lender 1 Lender 2 Lender n E E Projects(Small) Borrower 1 Borrower n PSM Repayment

18. Private Sector Window ADB Risk Sharing Partial Credit Gtee Fees EE Projects (Large) ESCO Loan EA PSM Repayment Guarantee Mechanism (unfunded) Risk Sharing Gtee Agreement Fees Lender 1 Lender 2 Lender n E E Projects(Small) Borrower 1 Borrower n Loan PSM Repayment

19. ADB - Pvt Sector Window Partial credit guarantee Commission Fees FI EA Guarantee Mechanism Fees Lender ESCO Sponsors Project Screening Mechanism PSM Repayments Completion Support contract Equity Term loan ESCO Host Energy Performance Contract Equipment supply contract Equipment Supplier Industrial & Pvt Commercial Segment – Small Projects (Total project cost < Rs 10 Million) Project Structure-Lending to Host

20. Shortfall in expenses or Debt service Host EA (with ADB PCG) Funding of the CC Account CC Account Statutory Dues • Amount equal to Avg. Billing for the last year • Freq. to match billing freq. Of energy supplier TRA Funding of TRA Actual Energy (Power and Fuel) Bill Other Operational Costs Debt Service Replenishment of CC Limit Top up of PCG for past utilisations Excess flows back to Host Excess flows back to CC Account Mechanism may also envisage creation of reserves from energy savings Assignment of a) Rights under Equipment supply and ESCO performance contracts to liquidated damages b) ESCO’s energy efficiency assets (insurance policy) Cash flows Industrial & Pvt Commercial Segment – Small Projects (Total project cost < Rs 10 Million) • Payment security mechanism- Lending to Host

21. ADB Partial credit guarantee Commission fees Guarantee Mechanism FI EA Fees Lender Direct Term Loan Project Screening Mechanism Repayment Term loan Energy Performance Contract ESCO Host Equipment Supplier PSM Completion Support contract Equipment supply Contract Sharing of energy savings Equity ESCO Sponsors Industrial & Pvt Commercial Segment – Large Projects (Total project cost > Rs 10 Million) • Projects to be appraised on a stand alone basis on a limited recourse basis • Industry sub segments as per segmentation exercise • Project Structure (Lending to ESCOs)

22. EA (with ADB PCG) ESCO Shortfall in expenses or Debt service TRA Host Statutory Dues • Funding of Energy Savings due to ESCO • Freq. to match billing freq. Of energy supplier Operating Expenses Debt Service Top up of PCG for past utilisations Excess flows to ESCO Mechanism may also envisage creation of reserves from energy savings Assignment of a) Rights under Equipment supply contract to liquidated damages b) ESCO’s energy efficiency assets (insurance policy) Cash flows Industrial & Pvt Commercial Segment – Large Projects (Total project cost > Rs 10 Million) • Payment security mechanism (Lending to ESCO)

23. Lender Project Screening Mechanism Repayment Energy Performance Contract Term loan Host ESCO Equipment Supplier PSM Equipment supply Contract Sharing of energy savings Completion Support contract Equity ESCO Sponsors Union Govt. Segment • Project Structure – Lending to ESCO

24. ESCO TRA Host Statutory Dues Funding of Energy (Power and Fuel & maintenance) Savings due to ESCO Operating Expenses Debt Service Excess flows to ESCO Mechanism may also envisage creation of reserves from energy savings Assignment of a) Rights under Equipment supply contract to liquidated damages b) ESCO’s energy efficiency assets (insurance policy) Cash flows Union Govt. Segment • Payment security mechanism (Lending to ESCO)

25. So far to the best of our information, only One project has successfully implemented One of the new mechanism

26. CDM-Exciting new development tool • Increasing global concern on very few CDM EE projects • Inherent disadvantage due to • Small project size • Sustenance questions • Complex M&E mechanism • ESCOs could address to some of the issues (robust M&E system, bundling for size, better risk sharing) • METI of Japan has initiated TA project under “Future CDM Project” • DSCLES involved in development of new methodology for project bundling

27. Conclusions • In India innovative financing required primarily as a EE & ESCO market development tool • Number of new initiatives launched-development challenges are many • Rapid implementation of ESCO projects using mechanisms developed under ADB PPTA particularly for GOI buildings can help achieve break-through • CDM offers great opportunity for ESCOs

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