National Policy Dialogue on “Improving Access to Green Finance for Small and Medium-Sized Enterprises in Georgia” → Role of energy service companies (ESCOs) in mobilising finance for green investments in the SME sector – Lars Lunden

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Role of ESCOs in mobilizing finance for
green investments in the SME sector
Lars Petter Lunden
Partner
Sigra Group
research – analysis - advice

2. WWW.SIGRAGROUP.COM
AgendaEnergy Service Contracting
What are ESCOs – concept and project cycle1
How ESCOs can provide financing and technical risk alleviation for SMEs2
Capital structure of private ESCOs (who often are SMEs themselves)3
Potential for ESCO services to Georgian SMEs4
Policy tools and recommendations for ESCO growth in Georgia5

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ESCO: Turnkey Energy Efficiency Solutions
Energy Audit Investments Implementation
Monitoring &
Optimization
Find profitable measures
ESCO together with
client
<1 month
Bankable contracts
ESCO, client & legal
support
1-6 months
Quality & cost-efficiency
ESCO together with
client
<1 month
Maximize savings
ESCO together with
client
5-10 years

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PORTFOLIO
Total of 27 contracts involving 34 buildings
Value of signed contracts: 1.1 million EUR
Pipeline of 105 projects with an estimated value of 3,7 million EUR
Sigra Group’s ESCO Experience
METRICS
Max two year payback time on Capex
Contract length 5-7 years
Simple and replicable solutions yield IRR average of 50 %
Commercial loan agreement signed with NEFCO

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Extraordinarily Efficient and Profitable
Climate Mitigation Measure
20 x more Co2 reductions per USD
invested
5 x larger return to equity
• ASWAN Eqypt large scale solar
• 450 mUSD in 400 MW
• 350 000 tons Co2 / year displaced
EPC in Russia compared to randomly selected large-scale solar
1286 USD
Capex / ton Co2
15 %
RoE target
67 USD
Capex / ton Co2
50 %
average RoE
• Typical building energy efficiency
• 10 000 USD in heating system retro-fit
• 150 tons Co2 / year displaced per building
Sigra

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ESCO SectorsEnergy Service Contracting
Private initiative, finance and ‘no cure no pay’ guarantee may help overcome coordination
and trust problems in condominiums. ESCOs need firm mandate from general assembly,
efficient voting rules and protection from house-owner volatility.
Housing
Sector
Main market driver. The Public benefits from private project development initiative, finance
and performance guarantee (risk alleviation). ESCOs need administrative support to drive
projects through – should be granted non-exclusively.
Public
Buildings
More complex intervention packages (especially in industrial facilities). Potentially less need
for ESCOs to muster finance. Performance guarantee more important. Complex projects
imply more complex measurement and verification procedures.
Commercial
Sector
SMEs

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ESCO Finance Depends on Contract Choice
Energy costs Owner’s share ESCO Share
Before 5 year contract After
Energy costs Savings
GUARANTEEDSAVINGS
Before After
Mature Markets: Guaranteed Savings
• Owner raises finance based on ESCO guarantee
• Performance guarantee = Max energy costs
• Customer and client share additional savings
• ESCO assumes technological risk only
Immature Markets: Shared Savings
• ESCO raises finance
• Savings are split between owner and ESCO
• ESCO assumes both technological and financial
risk
POTENTIALSAVINGS SPLIT

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ESCO (SME) Capital Structure
• Shared savings is the relevant contractual
framework (since guarantees imply client
finance)
• ESCO takes on both technical and commercial
risk – returns need to justify the risk level
• ESCOs operating under shared savings are
often SMEs themselves, with small balance
sheets and limited credit history
• The structure of ESCO activity is unfamiliar to
traditional banks
• Banks lack experience evaluating risks of
energy efficiency projects
Elements Influencing Cost of Capital Available Sources of Capital
• Private Capital
• Government owned/funded IFIs willing to take
risk for green projects
- Specific loan facilities however often offered on
terms equal to existing credit facilities
- IFIs seem to not like that private owners receive
return
• Commercial loans on equal terms with any
other business
• Typical structure: Private capital initially, then
gradually build credit history and balance sheet
to be eligible for commercial loan facilities

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ESCO-SME Holdup problem
ESCO pre-investment in audit and technical pre-
design
Contract negotiation
1. ESCO interested in profitable investments – but so are the SMEs
2. Low trust in outside expertise in immature markets leads to challenges in efficient contracting
3. Non-valuation of pre-investment before contracting undermines valuation of ESCO services

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Benefits for SMEsEnergy Service Contracting
• If shared savings: no capital outlays and guaranteed lower energy costs
• If guaranteed savings: guaranteed lower energy costs
• Lower energy costs per unit produced/sold implies improved profitability
• ESCO has larger project-specific risk appetite than SMEs since it can manage risk in a portfolio of
projects
• ESCOs have experience in evaluating projects’ technical savings potential
ESCOs have great potential to improve risk-return profiles of energy efficiency activities

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Barriers for SME ESCO ActivityEnergy Service Contracting
Competence, contracting and credit arrangements need to be in place
• Incentive problem:
- Shared savings projects typically have good profitability levels
- SME prefers to finance project itself given access to capital at lower cost than ESCO’s offer
• ESCOs prefer public projects
- Public sector typically underfinanced, which leaves room for ESCOs
- Projects are normally easy to replicate
• Guaranteed savings more adapted to private sector, but requires more technically savvy companies and
working credit facilities for the SMEs

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SME ESCOs may mobilize Green FinanceEnergy Service Contracting
1. SME ESCOs may be a new market segment in Georgia
2. Profits mobilize private initiative – relatively easy to start an ESCO
3. Given access to capital and functioning framework conditions, ESCOs may play an important
role in reducing energy consumption in Georgia
4. Easy and replicable projects exist in Georgia just as everywhere else
1. Lack of legal framework
2. Condominium associations are not legally registered unions in Georgian law
3. Low energy cost and high finance cost,
4. Poor awareness about energy efficiency, ESCO and EPC;
5. Accurate inventory of all public buildings does not exist yet;
6. Underheated buildings
Barriers to ESCO development Identified by the Georgian Ministry of Energy (2016)

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Example of Energy Efficiency Initiative in Georgia
• EUR 5,14 in loans and grants (almost 50/50)
• Refurbishment of 25 public buildings
• Annual savings of 200 000 Euro
• Annual of CO2 reductions of 1 200 tons
• Improved indoor conditions for 10 000 people
• 25 years payback time
Impossible for private ESCOs to compete
with grants and soft loans

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Opportunities and Challenges
Benefits
• Current scheme uses energy efficiency to finance building
upgrades
• Increased comfort is target, not environmental effect
Challenges
• No performance guarantees – all risk on Georgian tax payers
• Expensive control mechanisms – foreign consultants perform pro-
forma quality control
• No mechanism to benefit private sector

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Next Steps – Private Sector Engagement
In line with international development
trends greater private sector
involvement is needed
• Benefit private sector
• Leverage private capital
• Utilize best practice
performance guarantee
mechanisms
Topic for further reseach?

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Simple Policy Recommendations
1. Raise Awareness
a) Energy efficiency measures are often
very simple, but is often not known
b) Returns for simple solutions typically
outperforms a complex approach
3. Focus on framework conditions
a) Quasi-market creatures such as public
ESCOs are a detour
b) Public funding through public entities
may yield favoritism and corruption
risks
2. Focus on enabling private initiative
a) Reduce technical risk by making data
available
b) Profits drive initiative – very high profits will
be limited by competition
c) Explore options for financial solutions for
companies with weak balance sheets
(factoring, contract as collateral etc.)
4. Beware of Grant Displacement Potential
a) Soft funding displaces private capital
b) Reduces reform necessity

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Thank you for the attention!
Green Investment in Growing Markets
Lars Petter Lunden
lars.lunden()sigragroup.com, +4791611515

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International Best PracticeEnergy Service Contracting
• Typically start with shared savings and move to guaranteed savings as market matures
• Start with simple, quick payback projects (low-hanging fruits) and increase complexity with market
maturity
• Policy and funding as important as client demand
• Public sector major client for ESCOs
• Heating, cooling and lighting projects yields the highest effect
• Focus on enabling private ESCOs through regulation and provision of finance
• Factoring enables revolving funds and faster results

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Best Practice ExamplesEnergy Service Contracting
Most Mature Market
• 50+ years of ESCO experience
• Shift from shared to guaranteed savings in the
80s
• Public sector and institutions = 80 % of clients
• Majority of projects within heating and cooling
• Policy and funding more important than client
demand (EEOs and fiscal incentives)
Eastern European Success Story
• Single measures – easy to isolate, predict and
monitor effect
• Public sector and SMEs
• Payback time increased and guaranteed savings
introduced as market matured
• Financial incentives and legal framework
• ESCO association on company initiative
Largest European Market
• SMEs dominate the market of more than 500
ESCOs
• EPCs only 15 % of the market (guaranteed
savings)
• Public sector dwarfs other sectors
• Public Private Partnerships
• Germany drives EPC innovation in the EU
China on the Rise
• Shared savings model dominant in large market (7
billion Euro)
• Guaranteed savings rising for large projects
(difficult to get shared savings 3rd party finance for
projects larger than USD 2 million)
• Outsourcing model (upgrades for a fee less than
energy savings) popular for commercial projects