Energy efficiency Europe: The battle for project financing

As the European energy efficiency sector gains traction, why are financiers holding back?
Published: Wed 08 Feb 2017

In Europe, the market for energy savings companies (ESCO) is showing signs of growth. Revenues amounted to $2.7bn in 2015, according to Navigant Research.

And the Energy Efficiency Directive in 2012 - with its target of cutting energy consumption by 20% less by 2020 - is a regulatory move to standardise and develop the sector.

But does the ESCO market have investor confidence? Not at the moment, says private equity company SI Capital.

Founding Partner Sebastian Waldburg told Engerati that the financial sector classifies energy efficiency projects such as building retrofitting under renewable energy.

“Renewable energy is heavily regulated and based on feed-in tariffs for example, whereas energy efficiency is based on a commercial proposition.

“That’s what has to be made clear to investors - that this is a standalone commercial proposition that makes sense without regulatory support,” says Waldburg.

Another issue is the length of energy efficiency projects. “Money doesn’t like to be locked up for a long time.” he says. “Longer-term projects will have to generate higher returns for the people who have put up the money whether that’s a fund or insurance company.”

Waldburg estimates higher returns equate to 8-12% for a project lasting 10 years. Renewable energy projects used to demand similar returns but most investors have lowered rates to 4-6%.

“It’s about experience, comfort level and volume of money that has gone in. When there is competition of money, this brings down the returns. At the moment, energy efficiency projects are attracting mostly equity money, but rates might come down with bank involvement to around 6-7%.”

Energy efficiency Europe - commercial banks

One bank that is showing interest in the ESCO and European energy efficiency market is Banco Português de Investimento (BPI), a major privately owned bank in Portugal.

Tiago Simoes de Almeida, Head of Project Finance at Banco BPI, agrees that the financial community is approaching the energy efficiency market in a similar way to early renewable energy projects.

De Almeida told Engerati in a video interview: “The first wind project BPI financed was 1.2MW. Our term was five years and we obtained a personal guarantee from the sponsor and his wife. Now the largest wind farm we have supported is 1.5GW wind farm on a leveraged basis of 85:15.”

However, he believes the bank will make a quicker transition to backing large-scale projects within the energy efficiency sector. 

Why? BPI is doing its homework by studying technical, regulatory and best practices of the energy efficiency market through training, interviews and meetings with market players. BPI is also “learning to accept certain risks,” he concedes.

As part of its dive into the sector, BPI says it has uncovered what ESCOs believe are the shortcomings of commercial banks.

High on the list was a lack of adequate credit lines, false perception of risks and insistence on personal guarantees.

ESCOs also perceive commercial lenders to not make a proper technical evaluation of energy efficiency projects, not being adapted to back small-scale projects and lacking an overall lack of knowledge.

In Portugal all of these shortcomings are true, says De Almeida. BPI, however, is embracing this learning curve as it is “trying to bet on sector”.

Bridging ESCO financing gap

As part of its drive to become the reference financial institution for energy efficiency in Portugal, BPI has joined the Investor Confidence Project as a member of the Portugal steering committee.

The initiative aims to unlock access to financing for the building renovation market. The project is supported by the Sustainable Energy Asset Evaluation and Optimisation Framework (SEAF), a two-year drive to develop an IT platform for European small and medium-sized ESCOs and investors.

The five-partner project is focusing its work on Italy, Spain and Portugal because “small companies don’t have access to financing, which is smothering their ability to grow,” says Jessica Stromback, Chairman of Joule Assets, an investor in sustainable energy assets and key member of SEAF.

Stromback explains that over 85% of energy efficiency projects need an investment of €1m and below. “The issue is risk assessment and due diligence costs the same amount whatever the size of the project.”

SEAF has built an IT tool that automates the preliminary risk assessment and due diligence in a one-stop-shop with ICP Certification and Energy Efficiency Insurance from HSB.

Projects are then matched directly to finance through the SEAF Investor Network, speeding deal closure and building trust between the two parties.

“This significantly reduces the heavy lifting for a small and medium-sized ESCO and the investor has saved €15,000 in reviewing that project,” says Stromback.

ESCO sector and EC regulation

While SEAF is working to improve access to financing for the energy management sector, Stromback says the regulatory environment is not helping the development of the European ESCO sector.

She cites the real barrier as accounting rules and the European Commission’s interpretation of them.

“These rules are set for when you buy things and pay them off, but with energy efficiency, the thing you’ve bought isn’t earning you anything. The rules will force a municipality to take 100% of an energy efficiency investment as debt, which means they have made their financial situation worse. And municipalities are only allowed a 3% margin of debt.”

Stromback says that SEAF is lobbying EuroStat, which falls under European Commission jurisdiction, to ask why they have made energy efficiency upgrades for municipalities illegal and extremely difficult for everyone else.

Amid a backdrop of unfavourable accounting regulation and scarce funding, Stromback says small and medium-sized ESCOs can offer customer two choices.

They either recommend that the customer pays to replace inefficient lights, which the customer is unlikely to do.

Alternatively, the ESCO pays for lights themselves and bills the client each month, which again is not appealing to the commercial and industrial customer or municipality.

Add some financing and the ESCO can say we’re going to pay for lights and take a bit of your energy bill to pay for them. This allows for a “more interesting sales proposition”, concludes Stromback.

Energy efficiency Europe - event series

This article is the first in a series on SEAF and the Investor Confidence Project. The next SEAF Investor Forum event for the ESCO and investor community will be held in Milan, Italy, on 8 March, 2017. Attendance is free.

 

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