Project Finance, Energy Efficiency and Implications for Project Managers

The European Union has enhanced the quantity of public finances offered for efficiency schemes:

Featured Project Management article from Dr Yiannis Anagnostopolous from Kingston Business School

Within the last twenty years there has been a marked increasing and destabilising trend in energy prices with such trend forecasted to continue in the long-run. As an example, in the UK, gas and electricity prices have increased by over 80 per cent on average. According to DECC’s (Department of Energy and Climate Change, 2014) energy projections, electricity prices in the services sector are forecasted to increase by 66 per cent over and above inflation compared to the base of 2013 prices, whilst over the same period, gas prices are expected to increase by 31 per cent by 2030 (see Chart 1 below).

The European Union does not fare much better either; EU’s reliance and expenditure, on energy imports amounts to over €400 billion every year (EEFIG, 2015) with the scale of investment needed to meet the EU’s 2020 energy efficiency (EE) target estimated at around €100 billion per year. Energy price instability coupled with the need to transition to a competitive low carbon and resilient modern economy model leads to energy-efficient investments as the most cost effective manner to reduce the energy risks and to overcome the well documented challenges for up-scaled investments into energy efficiency. Energy provision needs to remain competitive, within a well-regulated internal energy market and at its core build a secure and sustainable energy system.

Needles to mention, energy is also an important outlay to many institutions and it has grown significantly as a percentage of total outflows over the last ten years (see chart 2 below).
All energy reliant organisations have to control energy expenditure if they are to control the effect of energy price shocks on the products/services they offer. In this context as well, the issue of energy efficiency investment has never been more pressing.

There have been concerted efforts (both from the UK and the EU) to enhance the volume of public finance offered for energy efficiency indeed. The European Union has enhanced the quantity of public finances offered for efficiency schemes, but there is a persistent call for increasing institutional energy efficiency investments via a targeted utilisation of constitutional funds, the growth of vigorous asset investments and maintenance activity for project developers and managers and the associated project finance. Investment in energy efficient equipment makes sound business and environmental sense especially when this is combined with the know-how of sophisticated, private specialists in finance. It has been well documented (DECC, 2015) that a myriad of flexible financing schemes can deliver numerous benefits both for customers and suppliers. The European Union Industry leads the way according to the latest figures but still there are substantial economic and environmental benefits yet untapped (see figure 3 below).

Chart 3. Energy Efficiency Index (ODEX) Manufacturing in the EU

For example, customer benefits include – but not limited to – conservation of working capital via ‘cash neutral’ funding, budgeting flexibility, affordability, maintenance of (existing) credit lines, tax efficiency, reputational gains and most importantly future proofed schemes in recognition of the fast-paced changing nature of technology that guarantees finance continuity as business requirements change because of technology-driven changes.

Equally, suppliers directly benefit from energy efficiency financing by essentially acquiring the rights to alternatives to outright cash purchases and at the same time acquiring direct payments/receipts translating to improved cash flows for further financing. Most importantly though, the main characteristic is that of service orientation and private initiatives can ensure controlled/less emissions, better customer control and quality services as well as the added benefits or quality training and continued support.

The aim of this report is not to fully analyse and connect the financial instruments available for energy efficiency financing but rather to open up a more useful discussion regarding pressing issues in project finance and the associated project management. Furthermore, we aim to shed some light as well as in their material interconnection effects for public-private collaboration that is required to deliver multiples of existing energy efficiency investment flows by 2030.

PROJECT FINANCE & ENERGY EFFICIENCY

Growing the current levels of energy efficiency financing corresponds to one of the most significant and promising prospects to expanding economic growth and job creation. Compared to other investments, its costs can be justified in that it effectively generates more distributed professions, trims down energy costs for organisations and households of all income echelons, reduces air contamination and greenhouse gases and augments domestic security (CAP-E, 2011). This is also reflected in the EU’s recent statement emerging from the very recent roundtable discussions regarding energy efficiency as ‘changing finance, financing change’ and ‘Energy Efficiency: First Fuel for the Economy’ (2014).

Currently, for projects within the EU and the US, energy efficiency investment is around only one-fifth its cost-effectual dynamic combined. This gap (if addressed) corresponds to the prospects of strengthening much further the EU economies, increasing their competitiveness through strengthening domestic production and at the same time leading to job production as well as reinforcing exports (EEFIG, 2015). The decisive measure to addressing this gap is to transform energy efficiency financing into a widely-accepted, conventional economic asset division characterized by a high degree of regulation and transparency, standardization, predictability, stability and scale.

There is a well-built, viable proposal for blending public investments with private sector financing in order to attain the levels of funding required and deal with the energy threats. What modern companies and institutions need – regardless of size – is the creation and expansion of elegant funding devices that are tailor-made, by sector and sub-sector, in order to produce an enduring, viable and cost-efficient decline of energy usage in industry and the SMEs. Currently, as stated above, there are deficient both public and private funds in EE in the heavy industry and the SMEs. Industries and consequently economies will be hugely disadvantaged from the benefits EE investment can offer if this tendency persists.

Already, many leading financial institutions (for example, CitiGroup, J.P. Morgan, ING, Deutsche Bank and Aviva among others) identify with the prospect of developing highly specific, sophisticated financial products in this domain and are progressively more dedicated to expanding funds for energy efficiency. Banks, nowadays, are in search of building up performance-related efficiency statistics and construct scalable efficiency financing models; and these relate to the whole spectrum of scales: residential, commercial and industrial. In turn, each financing product and model – as every other model – has its own limits related to scale/size, sources/uses of funds, program administration structure, settlement vehicle and project risk allocation.

Hence such an initiative requires also a high degree of institutional and ‘household’ research but also strong, public promotion. In order to provide for a ‘statistical picture’ of the importance of EE financing we should also mention that approximately 45% of the interested participants in the last EE roundtable discussions in 2015 either work or represent financial institutions, policy makers, users of finance such as SMEs and larger companies.

For example, the EU has identified 22 million Small and Medium Enterprises within its borders that constitute 99% of the EU active enterprises which employ around 100 million employees alone; yet, it maintains that such institutions lack the capacity to systematically exploit energy savings via energy efficiency financing due to limited information dissemination and limited project expertise (see table 1 below and the above section for project management expertise discussion).

One can understand, that, such is the importance of project financing for EE (energy efficient) investments especially for SMEs that finance expertise can go a long way. Furthermore, project finance knowledge within the project management domain has real, practical and material consequences in releasing funds targeted for such investments.

As a simple example, one can consider Mortgage (Asset) -Backed Financing (ABF) that can endow the borrower with increased funding capacity and/or more favourable conditions to debtors by buying a new energy efficient asset (home) or investing the available funds in targeted energy improvements in the existing asset; where in the case of an SME, the funding is rolled-over into the home/asset/building mortgage. The mortgage instrument is in effect broadened to provide a solo low cost resource of funds to acquire cost-efficient energy measures as part of a re-bundled or new mortgage.

As a further example of ‘unknown’/’untapped’ sources of finance is what experts call the utility-on-bill-financing where the utility or an intermediary (external) sponsor bears the initial, upfront outlay of an efficiency upgrading and then the customer refunds the investment through a fee on their utility expense monthly.

Such a method for example, avoids financing set-up hurdles by capitalising on the existing transactional relationship that utilities have (i.e. invoicing) with existing customers and re-assembles financing on the ‘admittance’ utilities have to information pertaining to energy usage which is also linked to disbursement records and hence transparency, stability and creditworthiness. There are also other types of EE financing instruments such as preferential loans, risk re-allocation (for the interested parties, a list of indicative project finance techniques is provided at the end of this paper).

Regardless of the financing method/instrument, the overarching principle for managers that consider EE funding is an understanding of the processes involved in project financing within the energy efficiency context; for example, a relatively new initiative, the Private Finance for Energy Efficiency (PF4EE) is an innovative financial mechanism financed by two assisting pillars of the European Commission: the newly created ‘LIFE’ agenda and the European Investment Bank. This mechanism endows institutions with various types of funds such as loans, risk-sharing and expert support to financial intermediaries; in turn such intermediaries increase investments in EE projects in EU Member States through some of the instruments provided above. Thus, it is vital for managers and decision makers to understand that this finance mechanism as currently set gives priority to operations where EE investment requirements are the most pressing or where the use of EE finance is undersized/unused or where the capability to issue loan finance to ultimate beneficiaries is limited. Furthermore the scheme operates on a “first-come first-served” basis. It is also important to emphasize the imminent problems to surmount (see table 2 below) and that this financing scheme is currently active with applications of interest for this scheme are currently open until June 2017 in order to be taken forward on a long-term plan until 2030.

Hence, it is also imperative for a project manager to posses knowledge of project financing as well as the associated qualifying criteria for such schemes that include experience, knowledge, training & resources, project capacity, coherence of the business case and demonstration of effect & replicability among others (EC, 2014).
 

PROJECT MANAGEMENT and ENERGY EFFICIENCY

No action comes without a reaction though, in that all challenges lie ahead in anticipation of the future benefits; as well as controlling increasing energy-related costs, it is also highly possible that many organisations will need to manage project compliance with more rigorous energy efficiency requirements. By forward planning and acting proactively, institutions are better positioned to meet the emerging issues but at the same time all these pose problems to be faced by modern project managers. Institutions will have to build up a business case in order to secure investment.

Within a project management environment, and as with any other types of projects, whilst finance is a key concern, project direction also remains the means to releasing the resources to deliver successful projects and deal effectively with barriers.
Modern project management calls for a holistic understanding not only of skills and procedures management but also of other, ‘peripheral’ yet equally important aspects. For example, while the budgetary rules and procedures regarding capital expenditure may vary across organisations, at the same time most organisations will follow generally analogous principles in developing an investment/business case and managing its risk. This is a skill-set that modern project managers must be capable of at least understanding if not mastering. Such skills typically focus on the subsequent characteristics (with the concept of value underlining these):

– Strategic Context – How effectively does the project fit with the institution’s strategic objectives?

For example, the case for energy efficiency/cutting waste may be linked to more than a single institutional main concern such as cost-cutting; it can also naturally fit within a wider environmental programme (i.e. reputational gain etc. see above). Decision makers/project owners will set the strategic context; project managers must make sure that such opportunities are captured fully within project planning.

– Affordability – Availability of financial resources within existing sources of funding for the proposed project?

Principally, it should define the long-term financing needs over the life of a project or project programme set and measured against the sources of financing (for example, key variables such as existing approved budgets, external loans etc) and should evaluate the impact of increasing energy-related expenditure. The material and immaterial returns to an institution advancing its energy efficiency can be materially superior than are attainable via say investing cash on short-term, liquid investments (i.e. deposits); a comprehensive project management approach should take the above into account in terms of discharging their obligation. Such emblematic key variables and measures are schedule, budget and quality; in other words they affect performance. The feedback loop is that they are measured at frequent intervals throughout the life of the project and ideally they will at all stages derive from the original purpose of the project. That is, the best measures will plot back to the business and strategic drivers. These metrics should go beyond financial metrics into the core of the procedure – and give a project leader a device to communicate in the language of the management at corporate level.

– Cost/Benefits Analysis – What is the net impact of the options under consideration, in terms of current/up-front costs to the organisation vis-a-vis the expected benefits to be realised?

Many investments in energy efficiency schemes involve a (significant) direct investment resulting in decreased energy wastage and lower costs. Such investments also need to evaluate the effects of continuation and operational costs especially when some investments are characterised by irreversibility. There are a number of different approaches to investment appraisal.

As an example, for simple, low value projects ‘payback periods’ are the most common metric used; whereas for larger projects, Net Present Value seems to be the preferred option; irrespectively of the methods discussed above the modern project manager also needs to attain knowledge of ‘quantifying’ techniques and tools and with respect to project irreversibility, project success is paramount.

– Value – not the same as above; it is about a ‘wider’ consideration of the benefits/costs analysis compared to other, societal factors of the proposals.

In our specific case, regulatory and compliance concerns have to be considered under the same range of options as the financial appraisal above but from a wider (social) perspective. The renewable energy sector/ energy efficiency schemes for example need to assess the net effect of regulatory and compliance standards on the organisation. For example, the investor confidence project in Europe aims to develop a set of best practice standards for use in the process of renovating buildings to make them more energy efficient that should reduce transaction costs and make risk manageable for investors; project managers have an indispensable role; they need to ensure that they understand this quantification of value.

– Risk Management – Energy efficiency related investments can be administered delivered and controlled in a multitude of approaches i.e. bigger investments call for a more vigorous risk assessment and management preparation.

However, all organisations have to comply with EU mandatory regulations. This will affect project financing as well as management. Such investments, for example, may necessitate peripheral consultants to the point where such skills do not reside in-house. The options of risk management activities depend on a variety of features: the degree to which an institution previously had the technical know-how to identify the industrial solution; the magnitude of the project (or programme of projects) drawn alongside the potential transaction costs of the corporate body and the supplier; and the desire of the institution to acknowledge technical risk, measured vis-a-vis the costs of transferring risk to outsiders.

Concluding this section, privately funded projects have a tendency to be more multifaceted than publicly sponsored projects. Some key aspects related to utilising private investment that affect the extent of project financing are:

i) Assessments of whether the benefits obtained under a risk transfer agreement prevail over any supplementary finance expenses and other potential drawbacks (such as agency/monitoring costs).
ii) Assurance of whether the ‘accounting officer’(*) declares that the project is feasible and the suitability of risk transfer engagements to a third party.
iii) An assessment of whether the continuation value of the project is potentially adequate to rationalize the business costs.
iv) The consideration given to flexibility.

(*) For the aspects set out above, it is usual for institutions to ‘acquire’ professional knowledge either from in-house or peripheral consultants when utilising private finance, (although the latter increases costs substantially). For example, in project management it is not uncommon for two professions to rely on each other; that of the project manager and the project accountant. For this reason interesting responses in terms of modern project management have been ‘borrowed’ from investment banking practices; maintaining control, know-how and swift risk responses comes from within either by training or ‘buying out’ experts in an effort to combine specialized financial skills along with unique project management procedural knowledge.

Agile project financing (and risk) management demands narrowing the crucial gaps among the disciplines of business management, strategic skills and technical capabilities. While not fairly straightforward to fulfil within a project manager’s domain without overreaching duties the fundamental aspect is to peg certain metrics (and knowledge of) back to the company’s strategy. Hence instead of intensifying and escalating one’s own accountabilities as a project manager, emphasizing on these capacities above during the lifecycle of the project could provide for a more comprehensive and ‘all-season’ project manager.

Bibliography

DECC, (2011), Energy Price Statistics
https://www.gov.uk/government/collections/energy-price-statistics

DECC, (2011) Energy Price Projections
https://www.gov.uk/government/collections/energy-and-emissions-projections#2011-projections

EEFIG, (2015), ‘Energy Efficiency – the first fuel for the EU Economy. How to drive new finance for energy efficiency investments’, EU Conference, Brussels, February 26th.

EPEC: Guidance on Energy Efficiency in Public Buildings
http://www.eib.org/epec/resources/epec_ guidance_ee_public_buildings_en.pdf

European Commission, (2014), ‘Private Finance for Energy Efficiency: 2014-2017’

Freehling, J. (2011), ‘Energy Efficiency Finance 101: Understanding the Marketplace’, ACEEE White Paper, August
Government Procurement Service Frameworks
http://gps.cabinetoffice.gov.uk/i-am-buyer/categories/energy

Kats, G. and Menkin, A. (2011), ‘Energy Efficiency Financing: Models and Strategies’, The Energy Foundation, October

APPENDIX 1
LIST OF FINANCING INSTRUMENTS /MODELS / PROVISION OF FUNDS
 

ENERGY EFFICIENCY FINANCING MODELS:
Energy Savings Performance Contracting
Energy Services Agreements
E.U State Loan Programs
Sustainable Energy Utilities
Carbon Market Funding
Mortgage-Backed EE Financing
Preferential Terms for Green/EE Buildings
Utility On-Bill Financing
Property Assessed Clean Energy (PACE) Commercial
Property Assessed Clean Energy (PACE) Residential

ENERGY EFFICIENCY FINANCING STRATEGIES
Intermediary Aggregated Scale Purchasing
Revolving Loan Fund
Preferential Loans
Risk Reallocation
Point of Purchase Interest Rate Buy-Down

Dr Yiannis Anagnostopolous is a Senior Lecturer with the Kingston Business School. He lectures in the areas of financial reporting, corporate / business finance, financial management, banking, portfolio management and risk management. He is also an external Consultant for the United Nations Renewable Energy Research and Education.