Deliverable 1.6: Review of Business Models & Energy Management Strategies

Transcription

1 FP Collaborative Project Decision support Advisor for innovative business models and user engagement for smart Energy Efficient Districts DAREED Deliverable 1.6: Review of Business Models & Energy Management Strategies Authors: Detlef Olschewski, Garyfallos Fragidis. Reviewers José Pablo Sánchez (Isotrol) Delivery due date Actual submission date Status DEFINITIVE

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3 1.1 Executive Summary The business model is a new concept of analysis that emphasizes on explaining how firms do business and how they create and capture value. A business model refers to the business logic that provides answers to the fundamental questions: what we do here, why we do it and how we do it. Business modelling is a valuable tool for the analysis of business operations, especially in industries undergoing fundamental changes, such as the energy. The energy sector is undergoing remarkable transformations under the influence of a variety of factor related largely to the development of new energy efficient technologies, the impact of ICT on energy grids and the possibility of small scale energy production from the consumers and other parties. Energy companies face great pressure today to reassess their business models to accommodate the changes of the business environment and improve the efficiency and quality of their services. The task of business modelling provides the baseline for the conception and the development of innovative business approaches in energy efficiency (i.e. business model innovation). This deliverable provides an overview of the current business models used for energy efficiency initiatives at district and urban level and provide an in-depth analysis of their characteristics and expected outcomes with concern to the total business aspects and the roles of all the stakeholders involved. The deliverable supports the general purpose of the project, to deliver an ICT service platform that will enable the development of new services and practices for energy efficiency and low carbon activities at neighbourhood, city and district levels. In particular, the deliverable can support the development of new and innovative business models for energy efficient projects and can contribute in the business exploitation of the results of the project by energy providers, after the end of the project. The methodology used moves beyond the conventional financial aspects of a business models to examine comprehensively the business operations with regard to energy efficiency practices. In addition, we see the role of other stakeholders with a focus on the role of the consumers and we describe the key technologies used and the technological trends. As a state of the art analysis, the deliverable focuses on the existing knowledge on energy efficiency business models. For this, we analyze the business models and business practices applied in previous EU-funded 3

4 research programmes for energy efficiency, especially the ones that focus on district levels. The deliverable includes also a limited input from the review of the literature, as well as input from consulting companies and other organisations that analyze the trends and foresee the future of the energy sector. The deliverable begins with the anatomy of the typical business models used by energy companies for the development of efficient energy solutions, such as the Energy Performance Contracting model and its variations (e.g. shared-savings/ guaranteed EPC), the Energy Supply Contracting model and its variations (e.g. the Chauffage model), the Integrated Energy Contracting model and lastly business models for renewable energy solutions (e.g. the Green Power business model). The role of other stakeholders, such as public bodies and local authorities, building managers/ owners and urban planners/ designers, in these models and in general in energy efficiency project is also discussed. Emphasis is put on the new role of the energy consumer, who is empowered by renewable energy technologies and by ICT technologies to produce and disseminate energy at a micro scale. This knowledge provides the foundational layer for the development of new and innovative business models for energy efficiency projects. The second part of the state of the art analysis refers to the practices and business models that derive from the implementation of European R&D project that have similar scope and objectives to the DAREED project. Here we move from the general knowledge provided by the literature to get in the details of the specific models developed in similar projects and the evaluation of the experiences gained. The goal here is to analyze the practical implications of the business models, explore the roles of the critical stakeholders, identify the critical success factors, investigate the barriers and the anticipated risk factors, review the key technologies used and the technological trends. This part provides practical insights and implications for the development of new and innovative business models. The deliverable ends with an overview of some modern approaches to business models with regard to value creation and the participation of the customer in the value creation processes that originate in the area of service management and service science. We present some foundational concepts of service systems that explain the operation and can support the development of 4

5 innovative service models. We continue with the concept of value co-creation, which incorporates the customer and other suppliers and stakeholders. Value co-creation and the new role of the customer in energy efficiency projects is not only related to energy pro-sumption, but affects also the efforts for customer awareness and engagement in efficient energy practices. In the last part we present some alternative business models that emphasize on network-based and collaborative approaches, as well as examples from other service fields, such as the tourism sector and urban utilities 5

6 Contents 1.1 Executive Summary Introduction Energy Efficiency Business Models Introduction to business models and business modeling methodologies Business models for energy providers Shared-savings EPC Guaranteed savings EPC Energy Supply Contract Integrated Energy Contracting Business models for renewable energies The role of public bodies, building managers and district planners in business models The role of public bodies The role of building managers The role of district urban planners and managers The role of energy consumers The role of consumers in multi-sided energy platforms Business models for energy prosumption Analysis of Business Practices Related projects reviewed Business models in related projects Method of analysis The market

7 Business models New roles of the stakeholders Technologies and technological trends Success factors, challenges, barriers and risks New conceptualizations in service models Foundations of service systems Value co-creation and customer-oriented business models The concept of value co-creation New roles for the customer in value co-creation Other business models Network-based business models Alternative business models from related fields Conclusions References

8 List of figures Figure 1: The emerging electricity value chain 13 Figure 2: Business opportunities in distributed energy 16 Figure 3: The Business Model Canvas (Osterwalder and Pigneur, 2010) 18 Figure 4: The Shared-Savings EPC Model 27 Figure 5: The Guaranteed Savings EPC Model 28 Figure 6: The Energy Supply Contract Model 30 Figure 7: Integrated Energy Contracting business model 31 Figure 8: Green Power business model 32 Figure 9: Reciprocal value creation in the energy sector (source: IBM Institute for Business Value) 41 Figure 10: Multi-sided energy platforms as an energy marketing 43 Figure 11: Multi-sided energy platforms with an energy aggregator 44 Figure 12: The business model for the tourism industry (Werthner and Ricci, 2004) 90 List of tables Table 1: Examples of potential multisided platforms in electricity 45 8

9 1.2 Introduction Energy efficiency is at the forefront of energy policies in EU. According to the last Commission's Energy Efficiency Directive (2012) all the EU countries are required to use energy more efficiently at all stages of the energy chain, from the transformation of energy and its distribution to its final consumption, with the goal to cut energy consumption by 20% until The strategy followed includes a mix of measures that involve efficiency in energy generation, new obligations for energy producers and distributors, new initiatives by the government, new roles and more empowerment to the consumers. The new policy framework, accompanied by the emergence and the evolution of the energy efficiency technologies and the change of consumer demands and societal needs shape a new, complex and demanding business environment in the energy sector. The Energy Efficiency Directive of 2012 defines energy service as the physical benefit, utility or good derived from a combination of energy with energy-efficient technology or with action, which may include the operations, maintenance and control necessary to deliver the service, which is delivered on the basis of a contract and in normal circumstances has proven to result in verifiable and measurable or estimable energy efficiency improvement or primary energy savings. The energy companies face great pressure to reassess their business models to accommodate the changes of the environment and improve the efficiency and quality of their services. Key drivers for the need for business models are the increasing energy rates, the environmental concerns, the high cost of infrastructure investment, the development of new energy efficient technologies, the impact of ICT on energy networks and the possibility of consumers or others to produce energy, too, at a small scale. The success, hence, in energy efficiency is not only a matter of policies, measures or technologies, but also of developing and applying the right business model, that will implement in a proper way these measures and policies, will take advantage of the new technologies and will develop attractive energy offers. The business model is a new concept of analysis that emphasizes on explaining how firms do business and how they create and capture value. A business model refers to the business 9

10 logic, the intellectual base for doing business, which can be described by answering the three fundamental questions: what we do here, why we do it and how we do it. In other words, the business model describes the purpose of a company, the way it is organized to achieve the purpose and the basic operations performed. Energy efficiency business models and strategies refer mostly to the business practices of the energy providers and tend cover mainly the financial aspects for the development and management of energy efficiency projects/ solutions (e.g. investments, funding, energy rates, etc.). For instance, a typical business model is the Energy Performance Contracting (EPC), in which the energy provider finances the total investment of a project and is totally responsible for repaying the loan, while the customer pays the energy provider a percentage (or it can be a fixed amount) of its achieved savings from the project. In this deliverable we adopt a more general approach on energy efficiency business modelling. We define energy efficiency business model as the business logic of how an organization creates, delivers, and captures value related to energy efficiency. For this, we extend the analytical framework in two ways: a) we move beyond the financial aspects of a business model and examine totally the business operations with regard to energy efficiency practices, b) we examine the role of other stakeholders in the implementation of the business model and their contribution to its success (or failure), such as urban planners and public spaces managers, building owner or managers and the citizens. The proposed approach is in alignment with the general perspective of the DAREED project that emphasizes on energy efficiency initiatives at community level, i.e. at neighbourhood, city and district levels, with the involvement of all the stakeholders who have an active role in the decision making about energy efficiency initiatives. The purpose of this deliverable, hence, is to provide an overview of the current business models used for energy efficiency initiatives at urban level and provide an in-depth analysis of their characteristics and expected outcomes with concern to the total business aspects and the roles of all the stakeholders involved. The deliverable support the general purpose of the project, to deliver an ICT service platform that will enable the development of new services and practices for energy efficiency and low carbon activities at neighbourhood, city and district levels. In particular, 10

11 the deliverable can contribute in the business exploitation of the results of the project by energy providers, after the end of the project. The concept of the business model is a valuable tool for the analysis of business operations, especially in industries undergoing fundamental changes, such as the energy. For instance, roles of energy producers, suppliers, distributors, etc., their operations and their potential need to be redefined in an era of self-generation of energy, smart grids and demand-side management. Under the existing fast moving environment and the dramatic changes in a variety of factors that shape the energy sector, it is estimated that all kinds of energy companies will need to adapt their business models to respond to the new business situation. For the purposes of this deliverable we use Business Model Canvas, a recent methodology developed by Osterwalder and Pigneur (2010), which has been acquired wide recognition and acceptance. According to the Business Model Canvas, a business model can best be described through nine elements (basic building blocks) that show the logic of how a company intends to create and deliver value and make money: Customer segments, value propositions, customer relationships, channels, key activities, key resources, key partners, revenue streams and cost structure. The Business Model Canvas can be considered as a complete methodology for the description of a business model, which extends well beyond the description simply of the organisational and financial structure of a business operation or the analysis of Strengths, Weaknesses, Opportunities and Threats (SWOT), which are two conventional ways of analysing a business model. As a state of the art analysis, the deliverable focuses on the existing knowledge on energy efficiency business models. For this, the methodology used is based on the analysis of business practices and business models applied in previous EU-funded research programmes for energy efficiency, especially the ones that focus on district levels. The deliverable includes also a limited review of the literature, when it is necessary, and the analysis of reports of consulting companies or other organisations for the trends and the future of the energy sector. The deliverable consists of 5 chapters, including the introduction. In chapter 2 we present the analysis of energy efficiency business models with the use of the methodological framework of 11

12 the Business Model Canvas. In particular, we analyse business models for energy providers and we pay attention to the role of public bodies, building managers, urban planners and managers and the role of citizens/ consumers. In chapter 3 we present the practices from relevant EU funded projects emphasizing topics such as feasibility and efficiency, implied risks, tools and services employed for knowledge management and decision support, simulation and other visualization tools, demand management systems and energy bidding services. In chapter 4 we present some alternative aspects of business models, emphasizing on the role of the customers and the community and learning from related fields. 1.3 Energy Efficiency Business Models Business models and business operations are largely shaped by the concept of value chain. The value chain consists of a series of activities which are performed in a row and connect the company's supply side with its demand side. The value chain is based on the premise that value is created by transforming inputs into products. The aim of the value chain framework is to maximize value creation while minimizing costs. The product is the medium for transferring value between the firm and its customers. Energy provides a typical example of the value chain model - even though it is typically an operation that belongs to the service sector. The traditional electricity value chain consists of the generation, transmission, distribution and selling activities from energy providers to the end users. These operations are used to take place in a serial and uni-directional way, with the electricity provider playing all the roles and the user being restrained in a passive role related to the dissemination of the service (only large industrial customers can play a role). Even customer feedback is passive, derived from the consumption usage. However, a variety of factors that are beyond the scope of the analysis of this deliverable, has changed both the operations and the value creation processes in energy. The value chain acquired more dimensions and has by now become a value grid. A similar process of increased 12

13 density of means and proliferation of the potential value adding activities applied to the development of e-business from the previous performed linear business model (Rayport, and Sviokla, 1995). The digitalization of electricity networks and the introduction of smart grid technologies added complexity to the network, moving power and information in multiple directions, introducing new actors and enabling new business models (Valocchi, Juliano and Schurr, 2010). Business models are impacted in several important ways by a new information model, a new relationship with the consumer and the introduction of distributed energy sources. The end users themselves, who may be capable of providing some combination of demand response, power or energy storage to the system, become became active players and an integral part of the new value chain. The emerging electricity value chain is depicted in figure 1 (Valocchi, Juliano and Schurr, 2010). Figure 1: The emerging electricity value chain The factors that already shape and will drive the future developments on the energy (electricity) value chain are the following (IBM Institute for Business Value/ Valocchi, Juliano and Schurr, 2010): The value chain will extend further, grow more complex and involve a wide variety of new participants that traditionally have not been directly involved in the industry. The consumer, before now a passive recipient of the value chain product (power), will become an active, empowered value chain participant requiring integration into the network. 13

14 Both information and power will flow in multiple directions and, as business models emerge to leverage the exponential increase in information flow on the network, tremendous value will be added to the ecosystem. Distributed resources (e.g., distributed generation, storage and electric vehicles) will play an increasingly vital role in both operations and value creation and, in the longer term, may ultimately be positioned to radically disrupt the portion of the value chain comprised of the traditional generation- transmission-distribution-retail electricity pathway. According to a recent research by PriceWaterhouseCoopers (2013) managers expect the existing power utility business model in their market to transform, even in an unrecognisable way, in the period between now and A percentage 94% predicts complete transformation or important changes to the power utility business model. The same study recognizes a number of potentially disruptive changes that will drive the changes in the business models. Decentralised generation is already eating into revenues and partly marginalising conventional generation. Ultimately it could shrink the role of unwary power utility companies to operators of back-up infrastructure. The growth of distributed generation and its threat to the power utility business model depends on technological developments and cost. Its rise in Europe has been subsidy-driven. Cost barriers remain in the way. The future will be also be shaped by a variety of other reasons related to the energy efficiency, falling solar prices, demand-side management and smart grid technology, as well as the cost of sources of fossil fuel, etc. In a similar way, Bain Consulting (Hannes and Abbott, 2013) distinguish the trend for distributed energy, i.e. smaller power-generation systems for homes, businesses and communities, as a response to environmental concerns, rising power prices and regulatory pressures and incentives. Growth of distributed energy will force change on the traditional energy suppliers business models, as some customers will reduce their power consumption from the central grid in favour of locally produced power. These customers may still depend on the central grid for their emergency or peak use, so utilities will have to maintain their costly infrastructure and powergenerating capabilities even as revenues from consumption decline. Unlike centralized power generation, distributed energy relies on smaller networks of power generation, consumed on-site or distributed locally through a low- or medium-voltage community network. Utilities have three main business opportunities in the new environment of distributed energy: helping customers 14

15 generate their own energy supply, managing end-user demand for energy and controlling the distribution and consumption of energy within the network (see fig. 2.2). Opportunities in demand management. They refer to working with customers (mostly industrial and commercial ones) to reduce their power consumption (overall and peak) and related expenses through more efficient heating and cooling systems, better building insulation and smarter electric drives in automated equipment. Demand managers can also help customers smooth energy consumption curves by shifting demand into off-peak times with lower prices Controlling a distributed energy network. Utilities manage a distributed energy network in real time, via a control center that monitors generation capacity from various sources and distributes it according to demand. Analysis of data over time allows the controller to predict usage and balance loads in order to reduce overall investment in power generation. Distributed energy supply. Typical power sources for these energy systems include: solar photovoltaic installations, small combined heat and power plants (CHPP) for households and small and midsize businesses or larger CHPPs for commercial and industrial environments, larger PV installations, onshore wind parks that industrial and commercial organizations rely on to generate their own electricity or feed it into the grid. The opportunities in this part of the value chain include planning, building, installing and operating the physical assets, as well as the commercial opportunities in financing and managing risk. Utilities can exploit contractor models in which they buy, install and maintain equipment, leasing the supply of electricity to customers. 15

16 Figure 2: Business opportunities in distributed energy In the previous figure we can distinguish three different categories of energy services and the corresponding business models: The commercial/ industrial segment includes energy services for commercial and industrial customers, that are based mostly on facilities management or performance contract models; this category is the most well-developed and mature currently. The community segment includes services, such as heating, are offered to a group of customers in the same location (e.g. neighbourhood, community residential buildings, social housing, etc.). This segment is facing great growth currently and it is at the epicentre of research and commercial efforts. The household segment includes energy suppliers, contractors or equipment suppliers that target residential customers. This is the least developed segment, however it has great potential, because of the huge number of households, as well as new technologies for distributed energy production at micro-level. 16

17 1.3.1 Introduction to business models and business modeling methodologies A business model describes the business logic of a firm (Osterwalder, Pigneur and Tucci, 2005), i.e. the intellectual base for doing business, which can be described by answering the three fundamental questions: what we do here, why we do it and how we do it. In other words, the business model describes the purpose of a company, the way it is organized to achieve the purpose and the basic operations performed. Zott, Amit and Massa (2010) suggest that there is a widespread acknowledgement that the business model is a new unit of analysis that emphasizes on a system-level, holistic approach to explaining how firms do business and how they create and capture value. Every business operation has a business model, which can be sometimes conceived and described explicitly, or exist and refer to the business logic implicitly (i.e. the company operates in a specific way, without understanding the implications) (Magretta, 2002). The business model, hence, helps to capture, visualize, understand, communicate and share the business logic. In addition, business models can function as blueprints for business operations and for the comparison of companies or markets in a structured way, providing the basis for the identification of critical success factors. There is variety of business model methodologies (e.g. Afuah and Tucci, 2001; Chesbrough and Rosenbloom, 2002), the analysis or even the presentation of which is beyond the scope of this deliverable. To create a common base for discussion and the conditions for mutual understanding, we present briefly the Business Model Canvas, a recent methodology developed by Osterwalder and Pigneur (2010), which has been acquired wide recognition and acceptance as a comprehensive and state-of the-art approach to business modelling. The Business Model Canvas is depicted in figure 3. According to the Business Model Canvas, a business model can best be described through nine elements (basic building blocks) that show the logic of how a company intends to create and deliver value and make money: Customer segments Value propositions Customer relationships Channels 17

18 Key activities Key resources Key partners Revenue streams Cost structure Figure 3: The Business Model Canvas (Osterwalder and Pigneur, 2010) The nine blocks cover the four main areas of a business: Customers (Customer segments, Customer relationships, Channels) Offer (Value propositions) Infrastructure (Key activities, Key resources, Key partners) Financial viability (Revenue streams, Cost structure). 18

19 Customer segments: It defines the different groups of people or organizations an enterprise aims to reach and serve. Customers comprise the heart of any business model, as without (profitable) customers, no company can survive for long. In order to better satisfy customers, a company may group them into distinct segments with common needs, common behaviors, or other attributes. A business must make a conscious decision about which segments to serve and which segments to ignore. Some examples of different types of customer segments are: mass market, niche market, segmented market. Value propositions: It is the business offer (i.e. distinct mix of elements) that creates value for the customer, by resolving problems and satisfying needs. The Value Proposition is the reason why customers buy and choose to one company over another. The Value Proposition is an aggregation of benefits that a company offers and are considered important by the customer and it resolves a customer problem or satisfies a customer need. Some Value Propositions may be innovative and represent a new or disruptive offer. Others may be similar to existing market offers, but with added features and attributes. The elements of value creation can be based on attributes of the product/ service such as the following: newness, performance, customization, design, usability, status (brand), price, cost reduction, risk reduction, accessibility. Customer relationships: They are established and maintained with each Customer Segment. Relationships can range from personal to automated. They influence the overall customer experience. Some types of Customer Relationship are the following: personal assistance, selfservice, automated services, communities, etc. Channels: They are connecting the company with the Customer Segment in order to deliver the Value Proposition. Channels are customer touch points and provide an interface for interaction with the customers. Channels serve several functions, including: communication (raising awareness among customers about a company s products and services, helping customers evaluate a company s Value Proposition, providing post-purchase customer support, etc.), distribution (delivering a Value Proposition to customers) and sales (enabling customers to purchase specific products and services). Key activities: They refer to the most important things a company must do to make its business model work. Every business model requires some key activities to create and offer a Value 19

20 Proposition, maintain Channels to reach markets, maintain Customer Relationships with Customer Segments and have Revenues. Key Activities can be related to production, problem solving, management, platform/network, communication, etc. Key resources: The assets and capabilities required to make a business model work. Key resources enable a business enterprise to create and offer a Value Proposition, maintain Channels to reach markets, maintain Customer Relationships with Customer Segments and have Revenues. Different Key Resources are needed depending on the type of business model, such as physical, financial, intellectual (brands, proprietary knowledge, patents and copyrights, partnerships, customer databases) or human. Key partners: They are the network of suppliers and partners that make the business model work. Key Partnerships are all the relationships, except for with the Customers. Companies create partnerships to optimize their business models, reduce risk, or acquire resources. Motivations for creating partnerships include: optimization and economy of scale, reduction of risk and uncertainty, acquisition of particular resources and activities, etc. We can distinguish between four different types of partnerships: strategic alliances (between non-competitors), co-opetition (strategic partnerships between competitors), joint ventures to develop new businesses, and buyer-supplier relationships to assure reliable supplies. Revenue streams: They are the arteries of the business model. Revenue Streams result from Value Propositions successfully offered/ delivered to Customers, according to the pricing decisions. A company may have one or more different Revenue Stream from each Customer Segment. Revenue Streams can take place with some pof the following ways: sale, usage fee, subscription fee, renting, leasing, brokerage fees, advertising, etc. Cost structure: The cost resulting from the execution of the business model elements: Creating Value, Delivering Value, maintaining Customer Relationships and Partnerships, and generating Revenue, all incur costs. Such costs can stem from Key Resources, Key Activities, and Key Partnerships. Cost Structures can have some of the following characteristics: fixed costs, variable costs, economies of scale, economies of scope, etc. 20

21 1.3.2 Business models for energy providers In this study we use the term energy providers to include the utilities and the Energy Service Providers/ Companies (ESCOs). Notice that in the energy grid era the roles sometimes tend to be mixed and a single company can play different roles in the market. Utilities are seen as institutional players that deliver energy and care for energy efficiency. Utilities can act as aggregators of consumer demand and create positive system benefits through energy efficiency programs. According to the EU Energy Services Directive 1 (2006) an ESCO is a natural or legal person that delivers energy services and/or other energy efficiency improvement measures in a user s facility or premises, and accepts some degree of financial risk in so doing. As it is implied in the Energy Services Directive, an ESCO is a business model in itself, perhaps the typical one in the context of energy efficiency initiatives. The heart of the business model is the concept of the energy performance-based contracting (EPC). An EPC is a contractual arrangement between the beneficiary/ customer and the provider (i.e. ESCO) of an energy efficiency improvement measure or initiative, where investments in that measure or initiative are paid for in relation to a contractually agreed level of energy efficiency improvement. Hence, the payment for the services delivered by ESCOs is based (either wholly or in part) on the achievement of energy efficiency improvements and on the meeting of the other agreed performance criteria. An EPC allows the beneficiary/ customer to upgrade the energy efficient equipment, with no need for upfront capital. Services provided by an ESCO include energy audits, energy management, supply of equipment or energy and energy services (process or space heat, lighting, etc.). Accordingly, an ESCO is a company that offers energy services that may include implementing energy-efficiency projects, as well as and also renewable energy projects. ESCOs achieve energy savings, usually by providing the same level of energy service at lower cost, and their remuneration is directly tied to the energy savings achieved. Therefore ESCOs accept some degree of risk for the achievement of improved energy efficiency in a user s facility and have their payment for the services delivered based (either in whole or at least in part) on the achievement 1 Directive 2006/32/EC, Energy End-use Efficiency and Energy Services (Energy Services Directive) 21

22 of those energy efficiency improvements. Quite often the energy-efficiency projects are provided with the turn-key method and the energy savings are sufficient to repay monthly debt service costs. ESCOs usually finance or assist in arranging financing for the operation of a new energyefficiency project. The fundamental concept of the ESCO business model is that the client does not have to come up with any upfront capital investment and is only responsible for repaying the investment made or arranged by the ESCO. Melland (2010) describes ESCOs as specialists in providing a broad range of comprehensive energy solutions including designs and implementations of energy savings projects, energy conservation, energy infrastructure outsourcing, power generation and energy supply, and risk management. More specifically, an ESCO could be responsible for the following: Guarantee a reduction in energy consumption/costs together with a predefined level of comfort/service level Delivery of energy, heating and cooling Finance (or assist in financing) the project development, installation and operation of facilities Steer the operation and efficiency of facilities during the financing period Relate profits to achieved savings and service level offered Reduce risk through aggregating portfolios of customers Provide standardization of contracts, technologies, operation processes and delivery partners. According to the Institute for Energy and Transport, a typical ESCO project may include the following elements: Site survey and preliminary evaluation. Energy audit. Identification of possible energy saving and efficiency improving actions. Financial analysis of the project and guarantee of the results. Project financing. Comprehensive engineering and project design and specifications. Procurement and installation of equipment; final design and construction. 22

23 Project management. Facility and equipment operation & maintenance for the contract period. Purchase of fuel & electricity (to provide heat, comfort, light, etc.). Measurement and verifications of the savings results. The Institute for Energy and Transport provides a related to ESCOs category of companies are the Energy Service Provider Companies (ESPCs). They offer energy services to final energy users, including the supply and installation of energy-efficient equipment, the supply of energy, and/or building refurbishment, maintenance and operation, facility management for a fixed fee or as added value to the supply of equipment or energy. Often the full cost of energy services is recovered in the fee, and the ESPC does not assume any (technical or financial) risk in case of underperformance. EPSC is paid a fee for their advice or equipment rather than being paid based on the results of their recommendations. ESPC may have some incentives to reduce consumption, but these are not as clear as in the ESCO approach. EPSCs may be consultants specialised in efficiency improvements, equipment manufacturers or utilities. Typical projects implemented by ESPCs are related to primary energy conversion equipment (boilers, CHPs). In such projects the ESPC is unlikely to guarantee a reduction in the delivered energy consumption because it may have no control or ongoing responsibility over the efficiency of secondary conversion equipment (such as radiators, motors, drives) and over the demand for final energy services (such as space heating, motive power and light). According to this, ESCOs differ from ESPCs in that they guarantee savings for their clients, their profit is linked to the performance of a project, and they often arrange financing. In general, ESCOs develop, design, and finance energy efficiency projects, install and maintain the equipment installed, measure, monitor and verify the project s savings, and assume the risk involved in the expected amount of savings (Ürge-Vorsatz, 2007). Thus, ESCOs provide consumers with the energy services they desire, rather than the commodity itself, and incentives are aligned to provide the greatest level of energy service with the lowest amount of energy consumption. The International Finance Corporation (2011) classifies ESCOs into the following four categories based on their composition and ownership: 23

24 Independent ESCOs. They are independent in the sense that they are not owned by an electric or gas utility, an equipment/controls manufacturer or an energy supply company. Many independent ESCOs concentrate on a few geographic markets and/or target specific client market segments. Building equipment manufacturers. They are owned by building equipment or controls manufacturers. Many of these ESCOs have an extensive network of branch offices that provides a national (and international) footprint, with sales forces and specialized national staff providing packages of EE, renewables and distributed generation solutions to client market segments. Utility companies. They are owned by regulated or state-owned electric or gas utilities. Many utility-owned ESCOs currently concentrate on regional markets or focus on the service territories of their parent utilities. Other energy/engineering companies. They are owned by international oil/gas companies, nonregulated energy suppliers or large engineering firms. Boait (2009) recognized three categories of ESCOs: a) business-to-business ESCOs, b) retail energy suppliers and c) local ESCOs. Business-to-business ESCOs are subsidiaries of large control companies, oil companies or utilities, that offer comprehensive energy services targeted at medium and large scale businesses and public sector organisations. Their services are procured as an aspect of outsourcing of non core activity. Retail energy suppliers include retail gas and electricity suppliers. They offer services such as maintenance contracts for a fixed fee commit to rectify all faults in a domestic heating system within a specified time period, and home energy assessments, etc. Local ESCOs is related to local authority or community initiatives operating in a district area, often on the basis of some form of public-private partnership. They typically offer at least some of their customers both electricity and heat that comes from a combined heat and power plant (CHP). The market for ESCOs in European Union has been analyzed in a series of three reports provided by the Joint Research Centre Institute for Energy (the more recent one was developed by Marino et al. in 2010 and we refer to this one). The report recognized increased complexity in the analysis of the ESCOs characteristics and business models. ESCO markets in Europe have been found to be at diverse stages of development. Certain countries (like Germany, Italy and France) have large number of ESCOs, while in most countries there are only a few ESCOs 24

25 established and often complemented by engineering consultancies and energy efficiency technology providers offering solutions that can include some typical ESCO services. The report revealed the following trends: Increasing awareness Enabling public procurement rules Active public support Economic downturn Diverse market trends across national markets The same report identified also the following barriers or risks for the development of the service market provided by ESCOs (Marinova et al., 2010): Legislative framework, including public procurement rules Low and fluctuating energy prices Lack of reliable energy prices Lack of reliable energy consumption data Financial crises and economic downturn Real and perceived high business and technical risks Mistrust in ESCO model both from customers and from financing institutions Collaboration, commitment and cultural issues There are two basic types of energy performance contracting (EPC) models for ESCOs (International Finance Corporation, 2011): shared-savings EPC and guaranteed savings EPC. Other business model variations include the Energy Supply Contract, the Chauffage model and the Integrated Energy Contracting (King et al., 2007). Next we provide an overview of each of them. These variations are related mostly to the range of services delivered under the contracts and to the question how the required investments are financed. 25

26 Shared-savings EPC In a shared-savings EPC, the ESCO finances the total investment of the project and it is totally responsible for repaying the loan (if it was incurred). The investment can include a variety of improvements and replacements, such as the replacement of boilers, insulation, cooling systems, lighting, renewable energy systems, temperature automation controls, energy data management software, etc. The projects usually follow the turnkey project model and the ESCO undertakes all phases of the project from the preliminary tasks (e.g. energy audits, design, etc.) to the development, installation and preparation for the operation. The customer pays the ESCO a percentage (in practice, in certain agreements it can be a fixed amount) of its achieved savings from the project, which are set at a level to be able to repay the investment cost of the project, cover the functional cost and any other cost associated to the project. An important benefit for the customer is that received the benefits/ energy savings from the beginning of the project. It is evident that the shared savings model requires very financially strong ESCOs and practically it is used by the big utility companies or their affiliates, as well as by constructing companies in energy projects. Since the customer does not participate in financing the project, the model it is appropriate for markets in which the customers either lack the resources to finance energy efficient projects or they have limited motivation for this (e.g. they lack awareness for energy efficiency projects and their benefits). Hence, the shared-savings EPC model is appropriate for energy efficiency initiatives that target first of all at the citizens, who suffer from both of these factors. In addition, it can be applied both in industrial projects, especially when SMEs are involves, as well as in civic projects at district level. 26

27 Figure 4: The Shared-Savings EPC Model Guaranteed savings EPC In a guaranteed savings EPC, the ESCO guarantees energy cost savings to the customer (i.e. that the project will bring a certain amount of cost savings). If the agreed/ target cost savings are not achieved, then the ESCO compensates the customer, that is pays to the customer the different in money. But contrary to the shared-savings EPC model, the investment cost is incurred by the customer and the ESCO has no involvement in the investment and bears no financial debt obligation. Hence, there is a difference in the kind of business risk undertaken by the ESCO: in shared-savings EPC model it is financial risk, while in the guaranteed savings EPC it is functional/ performance risk. In case that savings are higher than the guaranteed level, the surplus can be either taken by the ESCO as a bonus for the extra energy savings, or it can be split between the ESCO and the customer according to a predetermined agreement. 27

28 The guaranteed savings EPC can be applied even by small size and independent ESCOs, because it does not require large capital assets. The key capabilities of the ESCO must be in the operational and the management side and related to the exploitation of new technologies. The model is appropriate for customers that have the financial capability to invest for the project and want to receive a financial guarantee to being able to pay back the incurred investment cost (e.g. protect of raise in energy prizes) by stabilizing the related to the energy consumption cash flows. Figure 5: The Guaranteed Savings EPC Model Energy Supply Contract Another type of energy business model is based on the Energy Supply Contract (ESC). King et al. (2007) name this business model fee-for-service business model and premium service business model. Here the ESCO or other utility company contracts with a customer for the delivery of specified energy services, named useful energy, such as heating, cooling, water, lighting, etc. Hence, here the ESCO does not provide energy, but a specific service related to 28

29 energy or even added value energy service. The ESCO is responsible for the delivery of the service and will take care of everything needed to make sure the customer gets the service. The ESCO manages the cost and risk of delivering the contracted service, and potentially assumes ownership or direct operation of customer energy infrastructure. In return the ESCO receives a fee for the service it provides at a pre-determined rate, either at a flat rate for every level of service received, or escalating according to the service use level. ESC contracts are generally more orientated towards distributed (local) power supply. If the scale of the project in large enough, the ESCO will usually install a local power plant at customer s facilities and will operate and manage it. The ESCO has a constant incentive for optimization the plant, because the reduction of the energy production cost will mean greater profit margin. As implied before, the service provider will usually own this plant during the contract period. The customer in the ESC models is an industry or recently building blocks managers or local authorities. The key benefit for the customer is the cost efficiency of the solution, the standard quality of the service and the no need to worry about the instalment and maintenance of the energy production facilities. This way the customer saves also resources related to investment and operation/ management of the energy production facilities. 29

30 Figure 6: The Energy Supply Contract Model Integrated Energy Contracting An ESC is related to another model, named Chauffage, or comfort contracting. It is a contract form that is developed in order to provide a function. The chauffage model incorporates energy efficiency measures on both the supply side and the demand side. A variation of it is the Integrated Energy Contracting (IEC), which is a newly developed business model that combines elements from both ESC and EPC. The model can be said to extend the ESC model by including demand side measures. The IEC service model combines two objectives: reduction of energy demand through the implementation of energy efficiency measures in the fields of building technology (e.g. HVAC, lighting), and efficient supply of the remaining useful energy demand, preferably from renewable energy sources (Bleyl-Androschin, 2011). As compared to standard Energy Supply Contracting, the range of services and thus the saving potential to be utilized is extended to the overall building or enterprise. The scope is 30

31 extended to include heat, electricity, water or compressed air. The results to be achieved by the energy efficiency service encompass modernization of the installations, lower consumption and maintenance costs and improvement of the energy indicators (e.g. energy performance certificate or benchmarking of buildings). In addition, non-energy-benefits such as emission reductions or increase in comfort and image shall be achieved. Figure 7: Integrated Energy Contracting business model Business models for renewable energies King et al. (2007) refer to the Green Power business model, which is a specific form of fee for service that ties more directly to the utility generation mix. In this model, a utility offers green power to consumers who are willing to pay the full incremental cost of green power or offsets. This type of offering is designed to offer a value creating product to the green market segments. 31