March 27, 2019

Is a Dual Revenue Stream EPC Bankable for European investors?

A New Model Combining Energy Efficiency and Demand Response

 

As part of the NOVICE project, Joule Assets Europe conducted a research study measuring the appeal and financial viability of the NOVICE dual revenue stream Energy Performance Contract (EPC), which looks to combine Energy Efficiency (EE) and Demand Response (DR). At the outset, the NOVICE consortium hypothesized that combining DR and ER in a single contract—the NOVICE dual revenue stream EPC—would increase revenue and reduce payback time, therefore rendering projects more appealing to investors.  To better understand what investors would require in an EPC, Joule created a questionnaire and enlisted the participation of ten investors, representing a range of the most common investment risks. Joule then came up with an average risk/return profile of the stakeholders being surveyed. The results of the study have been published in a recent project deliverable—revealing some surprising findings.

 

Two Programs with Complementary Measures?

 

“Energy efficiency” is a term often used to refer to the specific technologies used to reduce energy consumption. EE projects, (like the installation of efficient heating and cooling equipment, wall or roof insulation, new windows etc), are installed in a building to reduce its energy consumption and hence reduce its annual energy bills. “Demand response” manipulates consumption according to the requirements of the electricity grid operator so that consumers use less energy at times of peak demand and more energy at times when energy is cheap or when there is an abundance of clean renewable energy available. Often consumers make use of an administrator (usually a demand response aggregator) to control energy consumption patterns according to the needs of the grid operator and receive payments for providing such services via the aggregator.  

 

A key difference for investors, however, is that the revenues from demand response measures are variable, while those of energy efficiency measures are static. For many investors, demand response is also an unfamiliar program with unpredictable revenue. When considering demand response measures, the consumer is often faced with additional long-term financial questions: Will the volatility of the electricity market render DR a poor investment? Will the return on investment be large enough to justify the risk of using new, unproven technology? In considering the “bankability” of the new dual revenue stream model, investors participating in Joule’s study explained that demand response did not explicitly fit with their internal criteria for a project.

 

When it came down to the question of bankability, Joule found that the dual revenue stream EPC model did not fit the sample group’s criteria for financial viability either.  In order for the investors to even consider financing the project, it would need to be financially justifiable on the basis of EE alone, with any additional revenue from DR simply a “bonus.” However, according to Joule’s investor network, the success rate of investing in EE projects not paired with DR remains low. It is therefore risky for investors to finance a project on the basis of a single EE revenue stream, let alone on the basis of a dual revenue stream that includes DR.

 

Why these findings matter

 

Rather than identifying a common definition of bankability among investors, Joule’s discussions with investors revealed that bankability cannot be —and might not ever be able to be—standardized. Each investor has separate interests, and while there is always some crossover regarding certain risk criteria, each fund is ultimately bound to its own internal investment criteria, which ultimately decides whether or not a given project is “bankable” for them and their shareholders. Given this, it is difficult to conclude whether any given EPC can ever be deemed 100% “bankable” today in Europe, with or without demand response projects included.

The study did, however, reveal that if the savings are substantial and the demand response aspect can be justified, the project may be bankable for investors whose investment criteria is not technology specific, and rather includes “green” or “sustainable” energy projects. Through the process of conducting this research, Joule gained valuable information about investors, including a more specific understanding of their internal risk profiles. This insight led to the conclusion that for a more robust pre-investment understanding of the bankability of a given project – NOVICE or otherwise – a standardized risk-assessment and due diligence procedure for investors needs to be built out in Europe so that projects can be modelled accordingly. Such a procedure does not yet exist because the market is still relatively immature, but it’s clear that this would assist investors to make robust investment decisions on energy related projects.

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