Power Purchase Agreement
Three years ago, as we were developing our own energy efficiency finance program, I was struck by how few people had yet recognized the market opportunity for financing energy efficient building upgrades through a shared savings approach. Large ESCO performance contract firms continued to rely solely on their customers using tax-exempt bonds to pay for their projects and solar PPA firms focused, surprise, on solar. Only a handful of us were hustling after this emerging market.
Things have really picked up since then.
Last week I attended Citi Group’s conference entitled “Innovations in Energy Efficiency Finance” in NYC – a day long event, just on this topic. Co-produced by our friends at EDF, it was the actually the third time they’ve held the event – the first having 20 attendees, then 50, then this year almost 100. The agenda covered Federal and State government initiatives, things happening around the world and the commercial and industrial market (Groom Energy’s interest area.) The full agenda and some good observations can be found here.
It was reassuring to hear panel discussions confirm the view on the large market opportunity, where even early “competitors” aren’t yet running into each other in their customer negotations. But you coudn’t miss an older gentleman, with an entire career in energy efficiency, commenting from the crowd that “when they were considering this approach 20 years ago” it made a lot of sense then too…It alerted even the most optimistic folks that the shared savings financing approach is not new, but remains a market of the future. The collective hope is that this time adoption will be driven by larger potential energy cost savings and a more willing set of buyers and sellers.
Like any new financing model, buyers will have to trust that they’re getting a good deal in exchange for the perceived risk of signing a multi-year energy savings contract. Unlike banking institutions, new companies like Metrus Energy, Serious Energy, Transcend Equity, Green Campus Partners and Groom Energy have not been around for decades. To address the perceived risk, Transcend says that they perform their projects “open book” – allowing the customer to see actual retrofit costs and returns, so they know what’s behind the curtain. Metrus often works through ESCO partners who presumably have long solid customer relationships. Everyone on the panel claimed they were working through a large funnels of potential projects.
The most significant players yet to enter the market are the utilities. As Groom Energy has learned, when utilities offer on-bill financing in order to accelerate energy efficiency projects, customers move fast to sign these deals. It makes sense – customers are obviously less concerned signing finance contracts with someone who they trust, who bills them every month and who is likely to be around for a long time. But thus far utilities seem not too excited to go beyond limited use of on-bill financing. Although NY recently passed an on-bill financing initiative in their August Power Act of NY bill, it will likely be implemented only for multi-unit housing and residential retrofits and does not include shared savings.
Of course the bankers in the room are crossing their fingers this turns into a more mainstream market, where they can package and resell the energy efficiency obligations as blind pooled bonds. Although this looks a lot like a mortgage backed security, we’ll expect it to have a better outcome.
via How Soon Until We See Energy Efficiency Backed Securities? | Enterprise Smart Grid
There are two sides to a company’s energy profile – consumption of energy by its facility assets (HVAC, lighting, etc.) and it’s purchase of utility services (electricity, gas, etc.) In practice energy engineering teams (including ours) spend most of their time identifying opportunities for energy efficient equipment upgrades or behavior changes. Purchased utility services are usually taken as a given, with utility bills being studied for historical inflation rates, usage patterns and demand charges.
But the Enterprise Smart Grid framework highlights that to operate most efficiently companies need Visibility, Control and Management Integration for both of these elements. And here there’s a useful lesson to be taken from the information technology industry.
In the 1970′s corporations used time-sharing to access mainframe computing, paying on a per-minute, per-job basis – call it computing as a service. A decade later, microprocessor advances made it financially practical to bring PC and server computing in-house. By the late 90′s software as a service, using low cost Ethernet connected servers, made it equally attractive for companies to move their computing back out to the network, this time the Internet.
So over a thirty year period technology advances shifted the best economics for corporate IT from pay-for-service, to owning and back to pay-for-service.
Power stations (electricity as a service) predate corporate IT by almost a century, first being delivered in the late 1880′s. Like the mainframe model, utility providers centrally manage a high capital cost system (a generator) and deliver the service (electrons) over the network (the electrical grid) with customers paying as they go for what they consume. Generally they’ve had few alternatives to buying their electricity in this local utility pay-for-service model. Only a handful of the largest industrials have been able to cost justify installing and operating their own on-site primary generators. Also, in the last decade companies in deregulated markets have been able to hedge a portion of their electricity costs by purchasing third-party power generation.
With the latest solar PV technology advances (and renewable incentives) some have considered bringing a portion of their electricity generation back in-house. But with today’s average US cost of $0.11kWh, the math still points to pay-for-service (i.e. solar PPAs) and that only in four to five states in the country.
Steam as a service (Saas) is less well known, but has also been in existence for almost a century. The industry’s trade association (International District Energy Association) started in 1909. Universities and hospitals have run their own steam systems for a long time; with Harvard’s Blackstone plant having been in service since the late 1800′s. NYC’s ConEd network, operating since 1882, is the largest in the US.
As with electric utilities, the Saas model runs a centrally managed high capital cost system (a boiler or cogen plant) to deliver the service (Btus) over the network (physical steam piping.) Technology has not changed so rapidly in steam generation, with the latest large boilers moving from @ 70 to 80 percent efficient over the last 50 years. While 90% efficient systems are in development, their high cost likely make them impractical for quite some time.
The corporate alternative to Saas involves installing a large on-site steam boiler and retrofitting a building’s mechanical system. Where PV is renewable, solid state and overproduction can be sold back to the grid, financially modeling on-site steam is more complicated, including estimating future gas prices, a total maintainance cost for a lot of moving parts and a less clear excess steam utility sell back model. (For an reference point on the cost of running a 100-mile steam pipe network check out ConEd’s 2010 long-term investment plan)
Recently we performed an energy assessment on a 20-story New York City commercial building still using district steam from ConEd. Our analysis confirmed a three-year 40% increase in our customer’s cost of steam, this coming principally through newly assessed demand charges. So the bring it in-house payback model needed to forecast the future cost of ConEd steam versus the new boiler and retrofit cost, the future cost of gas at a 20% premium to ConEd’s high volume cost, the on-going maintenance costs, with the ConEd incentives which supported this retrofit. (Another reminder of why utility incentives needed to be decoupled)
The simple payback was 5 years. Which means NYC steam as a service has officially priced itself out of the market and we’ll be working with this customer to bring their “mainframe” in-house.
Another alternative for the largest corporate users is a pay-for-service delivered by a non-utility third party. Like solar PPAs for electricity, these vendors specialize in owning, operating and maintaining large traditional boilers, chillers, cogen and electric generator systems for single or multiple tenants, selling chilled/heated water, electricity or heat with long term purchase contracts. But these agreements do have their challenges – and don’t lend themselves towards a customer changing their mind after a few years.
In a world where utility rates and incentives are dynamic, energy costs are likely to be accelerating (after a three-year hiatus) and new energy technology development is being introduced, our engineers should expect to be performing more of this in-house vs. pay-for-service tradeoff analysis.
With our $2.6 million investment announcement we described that a portion of these proceeds would fund our CESA (Corporate Energy Services Agreement), our PPA for energy efficiency we began delivering in 2009.
For the background on how we developed our CESA let’s go back to 2007 to 2008, pre-financial market collapse, when solar power purchase agreements (PPAs) were all the rage in cleantech finance.
Cash starved tax-exempt customers with facilities in California (US Air Force, UC San Diego, etc.) were signing PPA contracts, outsourcing the ownership, maintenance and monetization of federal tax credits in exchange for “fixed” long term green electricity performance contracts. A flurry of fund raising in 2007/2008 by Sun Edison, Solar Power Partners, Tioga and Recurrent gave everyone the impression that real money was being made…
At that time retail companies, including BJ Wholesalers, North Face and Wal-Mart, signed PPAs with grand carbon reduction statements. In some cases they even projected saving real money – just consider Wal-Mart’s project in Hawaii where kWh is > $0.25/kWh. But in most cases the actual $ cost savings per year for signing these PPA’s was a non-event. Post the market collapse these corporate solar PPA deals have all but disappeared.
Corporate solar PPAs have been like teen sex. Most companies talk about how they’ve considered them, even negotiated contracts – but very few have closed the deal. Think about it – as a corporate manager, do you want to sign up your employer for a 20-year purchase contract, with kWh rate escalation, where the bulk savings are likely to occur after you’re retired? The evidence says no.
However, the PPA craze did catalyze corporate debate about outsourcing energy projects, be they solar PV or energy efficiency. While managers didn’t like a 20-year contract owned by a solar finance company with whom they’d never done business, they did like the no-cash down performance based services model. Which is where we saw the opportunity for CESA.
Energy efficiency upgrade projects often get mired in the corporate capital budgeting process, taking 1 to 2 years to get approved. Ironically some of these projects have a 1 to 2 year return on capital (causing us to wonder about the real capital efficiency of corporate investing.) Also, as utility incentives change regularly, including them in budget payback calculations for projects to be purchased 18 months from now is an imperfect science to say the least.
In early 2009 we began developing our first CESA with an existing Groom Energy customer who was frustrated with their budgeting process. Unlike their view of a third-party solar PV finance company, they wanted Groom Energy to own it – as a long term service partner. The economic trade was a shared savings model which would eliminate their one to two year budgeting lag, guarantee them energy savings and outsource the maintainance and energy monitoring to someone who was already doing projects inside their facilities. It also allowed us to put our money where our mouth was….we jumped at the opportunity.
By definition we’ve made our CESA structure performance based – priced in flat rate kWh or therms delivered – meaning if we don’t produce the energy (such as from a PV system) or reduce the energy (such as by adding VFDs) the company doesn’t pay anything. And the company doesn’t need to speculate on energy rates 5 years from now in order to get comfortable with the savings opportunity. Today’s low cost metering and software produces utility-like reporting for both our customer and our engineering team.
And while any contract structure can get complicated, our CESA terms are typically 5 years long, which is more consistent with a business plan, not a retirement plan – and means that we celebrate the results during the lifespan of our respective careers.
Labor Day typically marks the time when our year-end project installation schedule becomes more clear. Our corporate customers, often operating on a fiscal-calendar year for budgeting, also exhibit end-of-year psychology and “get it done by year end” becomes a priority. Normal product lead times, procurement contracts, permits, and even potential interruptions from winter weather means by Labor Day our construction year is pretty much set.
This year many cleantech project developers have even more tension leading up to their 2011 New Year’s party planning. With Section 1603, the US Federal program for renewable Grants in Lieu of an Investment Tax Credit (ITC), set to expire at the end of 2010, projects which are not at least 5% underway by year end will miss the proverbial party. Read the rest of this entry »
Recently a customer had us model the energy production and financial return for a new 2MW cogen system at their manufacturing site in the United Kingdom.
Our analysis considered their contract cost for kWh and natural gas, the system’s energy production in kWh and therms, its full installation and annual maintenance cost and their UK tax benefits, including a reduced carbon tax from the UK’s Carbon Reduction Commitment. All in, the capital investment had a simple payback of 2.3 years.
When we built the system’s 10 year PPA model there was one big question – what escalation rate for kWh and gas should we use? Read the rest of this entry »
Today I’m attending and speaking at the SolarTech Conference in San Ramon, CA.
The conference format broke the day into working sessions covering all major areas relating to Solar PV: permitting, finance, installation, interconnection, and a new one for the market – energy efficiency (which I’ll come back to later). At the end of the day, the entire audience voted on the key initiatives for each of working session and these rankings become the basis for 2010 SolarTech working agenda. Makes great sense. Read the rest of this entry »