7. The Energy Services Industry

7. The Energy Services Industry This section summarises the results of additional research into the energy services industry in Germany and Ireland. Similar research was conducted for the UK, but time constraints have prevented the production of a UK report. The energy service industry was included as it provides a potentially important means of overcoming barriers to energy efficiency that appears particularly appropriate within liberalised energy markets. The full results from the German and Irish studies are contained in the relevant country reports (Annex 1). In addition, each of the individual country/sector reports discuss the scope for energy service companies within that sector. The research took the form of 3-4 case studies on energy service companies in each country. These used semi-structured interviews with company representatives, supplemented by additional interviews with sector specialists. 7.1 INTRODUCTION A central element of sustainability is the recasting of final demand in the economy as a collection of services (mobility, light, refrigeration, nutrition etc.) rather than a collection of products. The development of the energy services industry is one of the first visible manifestations of this trend. Here, suppliers compete to reduce the total bill for energy services, rather than the unit price of energy commodities. This is achieved through combining the supply of energy with assistance in improving the efficiency of equipment and buildings and investment in boilers and combined heat & power. Energy service companies (ESCOs) offer either guaranteed supplies of heat and power or guaranteed levels of service provision. The services provided include: monitoring and targeting; energy management systems; energy audits; installation, operation and maintenance of equipment; low cost finance; and fuel and electricity purchasing. The contract allows the host company to lower risk, avoid capital expenditure, reduce energy costs and concentrate attention on the core business. As a consequence, energy service companies may provide an effective means of overcoming a wide range of barriers to energy efficiency. They may therefore make an important contribution to the achievement of short term carbon targets as well as to the longer term transition to a sustainable energy economy. The energy services market is well established in Germany and the UK in the form of contract energy management (CEM). Development of the market in Ireland is, at present, much more limited. But even in Germany an Ireland the market is relatively small, confined to a small number of sectors, and primarily focused on CHP. It is also largely conducted by companies other than energy suppliers. The development of energy services has been encouraged by the general trend towards outsourcing of non-core operations in both public and private sectors. As part of this, many companies outsource facilities management (FM), which includes a broad range of responsibilities such as cleaning, decoration, waste management and day-to-day maintenance of building fabric and electrical distribution. Facilities management companies may therefore 152

get involved in energy management, although this is usually a secondary activity. At present therefore, facilities management and contract energy management are largely separate markets and separate activities. Contract energy management usually involves: a) the provision of technical services for the energy management of a building or process; and b) the provision of finance for energy management investment. The majority of contracts tend to be confined to energy supply, including investment and operation of boilers and CHP equipment. There are many different types of contract and terminology has yet to become standardised. The following is one way of categorising energy service contracts: Heat service contracts: Under this type of contract, the ESCO assumes responsibility for providing energy supplies to a site, together with some control of the energy used. The ESCO is typically responsible for the supply of electricity and heat, and sometimes also compressed air and industrial gases. The ESCO is charged for energy on the basis of the amount received. With this contract, the ESCO has little incentive to be concerned with end-use efficiency so investments in this do not usually form part of the contract. Shared savings contract: Here, the ESCO takes over responsibility for the client s energy bills and the client pays a monthly fee set at an agreed percentage of the client s energy costs prior to the CEM contract. For example, the fee could be 95% of previous energy bills. Such contracts typically include the possibility of the client achieving further savings depending upon the total savings achieved - this is designed to give the client an incentive to ensure efficient use. So, for example, the ESCO may retain all savings beyond the customer s agreed 5% up to 25%, with savings above that level being shared between the CEM and the client. These contracts frequently involve investment in CHP. Fixed fee contracts: These are similar to Type 2 shared savings contracts except that the client gets only the fixed amount of energy savings agreed in the contract. Contracts usually involve installation of BEMS under the control of the ESCO. These contracts have mainly been developed by companies which have traditional offered facilities management - HVAC, security, cleaning etc. 7.1 THE ENERGY SERVICES MARKET IN GERMANY 7.1.1 Characterising the German energy services sector In 1998 there were about 480 suppliers of energy services in Germany, which supplied about 93,000 objects (i.e. buildings, industrial sites). These include both energy utilities and dedicated ESCOs. In the same year, the German energy service market had reached an overall volume of 4,300 million Euros with an average turnover per object of 45,000 Euros. The average investment per object is about 70,000 Euros. The main focus of the energy services market is heating services and combined heat and power (CHP), where CHP-projects are approximately 15 to 20 times larger than projects with space heating systems only. These services together account for roughly 80 % of the market volume. Only a small fraction of market volume (10 %) is related to technologies for reducing energy demand (e. g. lighting, insulation, control engineering). The remaining 10 % consists of other supply technologies such as process-heat and compressed air. As far as installed heating capacities, energy service companies are the major players with a market share of 49 %, while utilities account for a 153

market share of 30 %. In terms of ownership, the share of utilities is higher, since many utilities have outsourced their energy service activities into subsidiaries. There are three main types of energy service contracts: (1) energy equipment contracting, (2) energy equipment operating and (3) performance contracting. Energy equipment contracting and operating constitute for about 90 % of all contracts. Performance contracting is mainly demand side oriented, where the customer pays a certain amount of the saved energy costs for the investment made by the ESCO. The liberalisation of the electricity market in 1998 caused a 15% decrease in electricity prices. In individual cases in industry, prices dropped by 50 %. A major reason for the price drop is the current excess generation capacity of 10 GWe which forces the utilities to charge not much more than variable costs of electricity generation, and sometimes below. In the short run, this implies decreasing investment in large CHP projects regardless of whether the project is realised as an internal investment of the company or as a contract energy management (CEM) project. To avoid a further deterioration of CHP, and to support municipally owned utilities with a high share of CHP, the German government has introduced minimum prices for CHP-generated electricity and is planning to introduce a tradable quota system for electricity from CHP in 2001. But liberalisation has also broken up the monopoly power of utilities and has allowed ESCOs to establish a market for energy services. Now, energy supply can be optimised for a group of customers using the existing infrastructure, electricity from CHP can be sold to other customers, and energy service providers can bundle electricity demand from their contracts and thereby offer lower prices. For utilities, CEM is an efficient means to bind customers. Generally, the liberalisation has increased awareness for energy costs and has led to a search for new possibilities to reduce those costs. Focusing on the costs of energy services rather than energy supply, is a crucial strategy to achieve that goal. The potential for CEM is estimated to be very high, with only 7,4 % of the theoretical potential being realised in 1998. Annual growth rates for the energy service sector are estimated to be around 20 %. By 2004, the turnover of the industry is expected to be 9,000 million Euros. Future developments in the energy services sector are likely to include more complete technical services for buildings, such as additional water and waste water related services, and facilities management solutions. Space heating is expected to remain dominant, but as awareness of CEM grows, demand side services and process-oriented technology solutions are likely to gain market shares. 7.1.2Case studies of energy service companies in Germany Four case studies were carried out of companies in the energy service sector. In each company not a high-ranked person in charge of energy services was interviewed and asked about market development, services offered, contract types, customer motivations and barriers to the expansion of the market. The following table summarises the key features of each case study. 154

Table 7.1 Summary of case studies of German energy service companies Feature Company A Company B Company C Company D Type Consulting and manufacturing engineering company Subsidiary of large utility Manufacturer of energy supply equipment (boilers, CHP) Manufacturer of compressors Main energy services offered Full range, CHP, BEMS, heating, facility management CHP, heating, lighting, BEMS, compressed air Heating, CHP Compressed air Number of employees 3,000 210 400 2,500 Turnover (Mio.?) 600 35 50 250 Share of energy services 100 % 100 % 40 % 5 % on turnover Customer sectors Industry, commercial, housing Industry and commercial (80 %), Industry and commercial (54 %), housing Industry and commercial (100 %) companies, public, equal shares public (20 %) companies (46 %) Contract duration - operating contracting 10-15 years 5-lifetime N/A N/A - performance contr. 8-10 years 5-11 years Negotiating costs in % of investment costs 8-10 % 5 % unknown 5 % 7.1.3 The role of ESCOs in the case-study sectors Based on interviews conducted with the four energy service companies, and the case studies for the higher education, brewery and mechanical engineering sectors, this section summarises the arguments for why energy service companies may help overcome barriers to RUE, and which obstacles still exist. More detail is provided in the individual summaries of the sector case studies. Main factors in favour of ESCOs The main reasons for why ESCOs may help to improve energy efficiency in these sectors include: ESCOs generally accept longer payback periods. In the public sector, there is low financial risk, a sufficiently large project volume, and fairly homogenous technologies facilitate customer focusing strategies. Especially in smaller companies, ESCOs may help overcome the barriers lack of capital, lack of know-how and lack of manpower. The increasing tendency of companies to concentrate on their core business and outsource non-core functions provides ESCOs with business opportunities. Main Barriers to ESCOs Barriers to contract energy management and ESCOs in the German higher education, brewery, mechanical engineering sectors include: 155

Outsourcing or privatisation of specific areas is often associated with the loss of jobs. ESCOs suffer from a lack of credibility and trust. Many companies lack information and knowledge about energy efficiency in general and CEM in particular. Falling electricity prices and increased uncertainty in liberalised energy markets may dissuade companies from entering into long-term contracts. Large industrial customers generally have sufficient know-how to operate the energy equipment, and have sufficient capital to finance an investment. Many companies, especially want to keep control over the production process (especially breweries), or prefer to own all their equipment (especially SMEs). In smaller companies, the contract volume is not large enough (especially in mechanical engineering), or the financial risk for ESCOs is prohibitive (smaller breweries). Savings potentials identified by ESCOs reflects poorly on those historically in charge. ESCOs do not know the user needs as well as company staff 7.1.4 Policy implications In general, all policies that improve the rational use of energy will help ESCOs and CEM. Such general, rather indirect policies include: increasing the price of energy supply (relative to the price of energy services) via energy/co 2 taxes; tradable emission permits; stricter energy consumption standards for buildings or equipment; and information and organisational measures. More specific strategies include the foundation of an association or a round table of ESCOs that provide basic information about CEM and effective lobbying.. 7.2 THE ENERGY SERVICES MARKET IN IRELAND 7.2.1 Characterising the Irish energy services sector ESCOs offer services to customers who wish to contract out management of some or all aspects of their energy affairs to a company that specialises in them. There are relatively few companies in Ireland that offer ESCO-type services and most of these are involved in only a subset of ESCO activities. Companies operating in Ireland tend to fall into three groups: a) companies supplying mainly CHP; b) facilities management (FM) companies that deal with a broad range of services, such as energy, water, and cleaning; and c) companies offering contract energy management (CEM). It is often agreed that a competent in-house energy manager in a potential client company would be able to bring about higher energy savings than an outside body such as an ESCO. In reality conditions in many but the larger firms could prevent this from being the case, because energy use represents only one or two per cent of turnover and specialist knowledge about energy on the part of the person managing energy will not be to hand. In fact many firms do not have an individual who sees it as their job to take overall charge of energy matters. Any energy saving brought about by ESCOs ought to yield sufficient financial savings to reimburse the ESCO s costs as well as still being attractive to the potential client. We will see 156

that energy saving is indeed not the major product of ESCO activity, rather, the main products are management and supply of equipment. Liberalisation of the Irish energy market is proceeding and the market is gradually being opened up. The present situation for CHP is restrictive in that suppliers can only sell their excess electricity to eligible customers (who can buy on the open market and represent about 30 per cent of the electricity market) or to the power procurer, currently the Electricity Supply Board, at what is perceived to be an unfavourable rate. With extension of eligible customers to 100 per cent of the market by 2005, the situation for CHP should improve. In the meantime a critical mass of CHP schemes has developed with the aid of support under the Energy Investment Support Scheme of the Irish Energy Centre. The National Development Plan 2000-2006 envisages an allocation of 4 million to support CHP development. The market for gas is also opening up but the extent of the gas network, though extending, is limited. This restricts the scope for CHP compared to, for example, the UK. In general the end result of liberalisation is likely to be a lowering of energy prices, which is not encouraging for the development of CHP nor indeed for energy efficiency. On the other hand, more bodies are now allowed to supply CHP. Unbundling of energy costs and increased transparency in pricing could direct more attention to costs and encourage efficiency. The outlook in the medium term might improve if serious attempts to meet the Kyoto targets raise the price of energy, in a manner that does not give rise to uncertainty. 7.2.2 Case studies of energy service companies in Ireland The three types of ESCO activity listed above are covered in the three cases studied. One is a company that engages in facilities management but intends to broaden its activities into other ESCO-type functions like energy conservation. A second company is engaged in CHP and contract energy management and is a branch of an energy supplier. The third company is a facilities management company Some findings emerge quite strongly from this, albeit unrepresentative, set of discussions with three ESCOs. In the first place the ESCO market is fairly undeveloped and people are not familiar with the potential and probably need reassurance. On the other hand the market is growing along with the trend to outsourcing and with increased focus on energy costs consequent on deregulation. The uncertainty surrounding deregulation is however impeding development of ESCOs. Interviewees said that they generally searched for clients with large energy bills and while they would tend to sell on the basis of reduced energy costs, these reductions did not necessarily reflect reduced energy use. The verdict is that end use of energy was not much of a consideration and consistent with this, building insulation and similar issues are virtually ignored at present in ESCO activity. It was not feasible to gauge the size of the ESCO market from information provided in the interviews. The imputed current market for ESCO services might add to some 30 million to 40 million, but the method of imputation was too crude and a proper survey would need to be undertaken in order to have a reliable estimate. By considering total expenditure on (nontransport) energy by the industrial, commercial and public sectors and by taking a simple 157

proportion, such as ten per cent, suggests that 150 million of savings might be possible, to be shared out between client and ESCO. 7.2.3 The role of ESCOs in the case-study sectors A brief assessment was made of the role that energy service companies can play in the higher education sector, the brewing sector, and the mechanical engineering sector. The assessment is primarily based on the interviews conducted in these client sectors and in the ESCO sector as described above. The role of ESCOs in the higher education sector Establishments in the higher education sector were well aware of ESCOs and of companies offering contract energy management, pointing out that these services were not well developed in Ireland. Most respondents charged with responsibility for energy felt that they could manage energy better themselves. They observed that ESCOs are good on energy supply but not on the demand side, that is, they would not engage in much energy conservation. Some respondents had bad experiences with ESCOs in the past, though this did not apply to CHP. Large energy bills and absence of risk were factors that could make the higher education sector attractive to ESCOs though it did not seem to be outsourcing in the same way that some other sectors were doing. The present problematic funding arrangements for investment in the sector also would make ESCOs attractive, though arrangements for borrowing are currently under review. Incumbent energy managers may not wish to see their tasks taken over, though their statements about having insufficient time to deal with energy could work in ESCOs favour. In general, however, a lack of enthusiasm for ESCOs was evident on the part of energy managers in the higher education sector. The role of ESCOs in the brewing sector The respondents that were interviewed in the brewing sector make no regular use of outside contract energy management or of ESCOs, other than for CHP (in relation to which it was clear that any impediment to selling on electricity from CHP plant that is excess to requirements would be a disincentive to energy conservation). Brewery personnel were openminded on the issue of engaging ESCOs or contract energy management in particular. Being users of large amounts of energy in homogeneous processes on a 24-hour basis, breweries would be attractive to ESCOs in general. While the uncertain future of specific establishments is a negative factor, the outlook for brewing as a whole is relatively less risky. However ESCOs trying to break into the brewing sector would need to show themselves to be able to offer superior management capability than provided at present by incumbent energy managers. The role of ESCOs in the mechanical engineering sector The companies in the mechanical engineering sector that were interviewed had generally not heard of ESCOs, and had not availed of such services except audits and some investment advice. Some companies thought that the organisations that had undertaken their audits were ESCOs but it is likely that these had been specialist energy audit firms rather than full-blown ESCOs. 158

Opinions as to the desirability of engaging ESCOs varied widely, ranging from statements that the respondents could do it themselves, to absence of trust and the observation that it would reflect badly on them if the ESCO saved money. Three firms had an open mind. In fact the sector could benefit from engaging ESCOs. The sector s energy use would be generic in many instances and not specialised, management time is very scarce, and regulation and safety issues bear heavily on management time and expertise. Production is paramount in the present growth phase and distraction by non-core issues is particularly irksome. Despite these factors that would encourage companies in the mechanical engineering sector to engage ESCOs, the sector would not generally appeal to ESCOs. This unfortunate mismatch stems from the sector s low energy consumption except, that is, in the few larger firms. 7.2.4 Policies to support ESCOs Some pointers for policies to help ESCOs to attain their potential were investigated, as well as to help them become more supportive of energy use efficiency. Barriers identified were the problems of information and trust, regulations surrounding CHP, procedural issues with contracts, uncertainties as to performance and price changes leading to risk averse behaviour, and lack of profitability owing to low energy prices. Table 7.2 summarises the barriers of high importance to the development of ESCOs. Policy can be directed at the political/legislative level, at the informational and organisational level and, thirdly, at the economic or fiscal level. At political/legal level measures can be introduced to counteract distrust of ESCOs. One way might be to have a certification or accreditation system, entrusted to the Irish Energy Centre or to a new body. A proven ESCO track record, with case studies could help, along with reassurance that the ESCO sector itself is competitive and not sourcing from just a few suppliers. Measures to improve information and to dispel distrust would include more widespread use of sectoral guidelines and benchmarks. These could enable people to judge their plant and the ESCO s proposals in an informed manner using objective criteria. Given the questioning of ESCOs objectives on the energy efficiency front, independent checks on efficiency would be helpful. The environment for CHP should be fair and soundly based. Transparency in pricing and facilitation of measurement and comparisons would help, in order to give correct signals all along the line. The problem at the level of the smaller company and ESCOs hesitation about engaging with low energy users could be addressed by tapping in to trade associations. Certain types of potential customer, grouped by process or product, could negotiate through their association, with guidance from the Irish Energy Centre, perhaps. Schemes could usefully include an energy audit and energy efficiency investment. Grant-aid might be needed to some extent. The specification of the ESCO contract with customers needs some consideration to ensure that correct incentives are incorporated and to overcome some of the complexities that would constitute barriers. Possible models for typical contracts are the subject of investigation in several fora abroad. 159

Economic or fiscal measures include grants and subsidies on the one hand and taxes or charges on the other. ESCO involvement with small and medium sized enterprises would probably require aid. Raising the price of energy through taxes on emissions (with respending of revenues that helps overcome the vulnerability of certain sectors) would improve the bottom line for ESCO activity and energy efficiency in general. Given the importance of a stable energy price environment, emissions taxes would be better than a system of tradable emissions permits for addressing the problem of global warming and the achievement of Kyoto targets. The low price of energy was a frequent theme running through the comments made by respondents on the obstacles to energy efficiency investment. Table 7.2 Barriers to the development of ESCOs in Ireland Barrier Potential clients do not trust ESCOs who are perceived to be uninterested in energy efficiency. Regulatory regime on CHP is unhelpful to CHP. Small size of client companies which would benefit most from ESCOs. Procedural problems with contracts and the like. Uncertainty as to price and performance. Low and uncertain potential profitability due to low or variable energy prices. Policy Certification and evidence of track record. Performance of ESCOs clients illustrated by sectoral benchmarks. Enable excess electricity to be sold on. Companies trade associations or process-user groups organize schemes for engaging ESCOs, with grant aid. Investigate current examples of model contracts with a view to establishing model contracts for Irish conditions. Certification, model contracts and tax policies (see policies for other barriers) Impose a tax according to the polluting damage of fuels. 160