This latest episode in our Corporate Insights Podcast features Christine Rishton from Weightmans and Steven Heape from the Carbon and Energy Fund, who come together to discuss energy performance contracts (EPCs). They explain how EPCs work as agreements between clients and energy service companies (ESCOs), to finance and implement renewable energy projects without upfront capital investment.
The discussion covers the assessment and implementation process, the shift from cost-saving to decarbonisation focus driven by net zero targets, and the importance of measuring performance through proper monitoring and verification systems. Christine and Steven emphasise the need for technical expertise when entering these typically 15–25-year contracts, being open-minded about technology solutions, and focusing on desired outputs rather than specific equipment.
The conversation highlights how EPCs transfer risk to the right parties while making renewable energy projects financially viable and bankable for funders.
Transcript
Right, so welcome to one of Weightmans podcasts. My name is Christine Rishton. I am a Principal Associate here at Weightmans working in the commercial team with a particular focus on energy matters and in particular energy performance contracts, which is what we're here to talk about today.
I am joined by a friend and former colleague, Steve If I could just ask him to introduce himself.
Thank you, Chrissy. I am Steven Heape, as you said, and I am Head of Project Development for the Carbon and Energy Fund, and I'm also chair of the Institute of Healthcare Engineering and Estates Management's Sustainability Advisory Panel. Thank you for having me here today.
You are very welcome.
So as I mentioned, we are here today to talk about energy performance contracts and why they are so important and so relevant today. And just a quick heads up that these are not to be confused with energy performance certificates of the type you get on your home or commercial premises. We are talking about energy performance contracts or EPCs that are a contract between a consumer or a customer, maybe a business or a public body, and an energy service company, or what we like to call an ESCO. The nuts and bolts of these EPCs are that ESCO finances and implements renewable energy projects, possibly along with other energy efficiency measures. And then the client will repay the ESCO as some which represents the initial capital investment along with payment for ongoing services, typically funded from the savings that the project delivers, so hopefully cost neutral to the client.
Steve, can you give us some insight into how these EPCs typically work in practice from sort of assessment stage and then on to implementation?
Yes, of course. So the nub of all of this is that if you just buy a piece of equipment and somebody puts it on the roof of your house or puts it in your boiler room to make heat and power or whatever that technology might be, how do you know you're gonna get the outputs that it's set on the tin? And ultimately, if somebody you've just paid somebody incentive to install it in the right way, to the right standard, and to oversee that equipment giving the outputs that you, as the consumer, wanted to have. The energy performance contract spins that on its head and says, well, actually, we'll what we'll do is we're instead of necessarily buying the piece of equipment per se, we're gonna buy through a contract a guaranteed performance position.
So if we're buying solar panels, for example, if we don't if we're buying a number of kilowatt hours that come off the system rather than the capacity of the system necessarily and we're guaranteeing that. So it bakes in that the experts who manufacture and install the equipment do the job in the right way because they are responsible and it's about transferring the risk to the right people.
Cool. So that's a nice little nutshell. I like the way you've described it, you're not just buying the kit or even the performance of the kit, you're buying its actual performance and what it's capable of doing it and holding the ESCO to that standard.
And a lot of people aren't always clear about what makes an EPC different from a standard procurement or service contract.
And the key features or the key attraction for me is the fact that there's no need for an upfront capital investment, investment, which is what seems to put a lot of people off energy performance and energy efficiency measures, or otherwise any kind of renewables infrastructure being installed, because there's obviously, they're cost heavy.
And that transference of risk away from the client to the ESCO in terms of ensuring performance is obviously very attractive.
So it's for the ESCO to commit to performance standards that will ensure that the energy savings are sufficient to meet the payments that the client must make over the term of the contract. So it's really about creating an opportunity for the ESCO that the client can take the benefit of in that sense, isn't it? So they are given the opportunity to install equipment, deliver the savings, which is for the benefit of the client, but then reap the reward of performing well through the payments that they'll receive over the term of the contract.
Yeah. So I guess what you're saying there is, and and that's absolutely right, is that particularly with larger multimillion pound projects, if you go to the back, if you don't have an EPC contract, you just do it in a traditional, you pay a consultant to design it and you pay somebody to install it, the bank is going to charge you an awful lot to borrow the money if you haven't already got it. With an EPC contract, it has it's what we call bankable. So it means that funders will want to fund those projects because the outputs are guaranteed. So it's a safe place for a funder to place the money, and therefore the money comes in at a really, really cost effective rate. So it makes the project better value for money.
And, of course, I guess, with some EPC contracts, if you've got the money, you can put the money into the contract yourself. If you happen to have that money sat around on your balance sheet and you want to use it, that's possible. And but you still are guaranteeing the performance.
Super. So in terms then of the practicality of it, how do you assess what technologies or measures should be included? What's the process that's involved there?
So, well, that's a very, very good question. So, and something that's quite close to my heart because it's what I do on most days. Every organisation is different. Every business is different and the issues and their stage on the journey will be different.
So the most important thing, I suppose, is to gather the basic energy data, you know, how much electricity and gas and oil and whatever does the facility or it could be facilities if it's more than one building, it could be multiple buildings, how much they consume and then look at what the opportunities are to reduce that consumption, first and foremost, and then how can you provide that with a low carbon technology. And in all of these energy performance contracts, they were all being driven now towards net zero, the NHS by two thousand and forty and the rest of the country by two thousand and fifty.
So we are looking for all of those net zero carbon measures. In doing that, in the old days, we used to all love a gas fired CHP engine because they produced a huge amount of revenue savings. But as the grid has decarbonized, they now emit more carbon than they save. So you don't get many brownie points for installing one.
But the other technologies like heat pumps cost a huge amount more to operate even though they do get you to net zero. So the trick is to look at not thinking there's one solution that's gonna solve all of your problems. It's about how maybe you layer those solutions together. So maybe you install heat pump and a CHP engine and you run your CHP engine for a short period of time, maybe six years, and generate the revenue that pays for the rest of the equipment. But also you have to look at where you're located. There are a number of projects now looking at deep, sort of two kilometer deep geothermal. There are some projects which are located near to sources of hydrogen taking advantage of the government's hydrogen grants.
I mean, it's all very situationally specific.
That's interesting. So when we talk about these EPCs and the savings that they guarantee, typically I always see performance in financial terms being guaranteed because of the history of EPCs has always been that the savings generated pays for the cost of the contract, as it were. But are we seeing, or are you increasingly seeing more carbon measurements factored in?
Or is that more of an assessment because you feel using grant funding there might be a carbon intensity that's required or?
Well, there's definitely in the last six or seven years a progressive and now a more quite rapid shift towards the decarbonisation agenda rather than a cost saving agenda, particularly in EPC contracts.
But at the same time, they will have to try and be cash positive in one way or another. There are very few finance directors that will be prepared to look at a decarbonisation project and take a big hit on it, especially if that's not their core business. If you take NHS as an example, the NHS is in the business of fixing people and never have enough money to do it. If you rock up to your board with a business case that says we can get to net zero by two thousand and forty but it's going to cost seventeen million pounds there's only one answer to that question.
The job of the people that are developing EPC projects is to find a way to make that net zero project happen at a neutral or better price point.
So in terms then of a typical EPC and its contractual structure, it's important to note that there would ordinarily be a works phase that delivers the infrastructure project itself, and then an operational phase where the ESCO operates operates and maintains the kit and equipment that have been installed as part of the workspace.
So you can expect to see a fairly lengthy contract, typically fifteen to twenty five years long in my experience.
You can expect to see provisions that go along with a lengthy term of contract, such as what happens if there's a change of law that impacts upon the delivery of services. You could also expect to see, because there are guarantees involved, you can expect to see some sort of excusing provisions that will let the ESCO off the hook in terms of any guarantees. They're typically focused on the client having done something wrong or there being a breach of the energy performance contract.
Sometimes they're linked with force majeure events or possibly change in law.
And these will amount to a relief from the requirement to achieve the guaranteed savings, and yet the minimum service payment will still be payable. And that does potentially lead to a scenario where the savings don't quite cover the cost of the contract. But that's something to keep your eyes open to if you're considering an EPC.
Where there is an installation of new kit or equipment, then there should be some method of demarcation indicating clearly where the responsibility of the ESCO runs up to and beyond which the client will retain responsibility for.
And those are all the sorts of things that the technical experts, you will point people like Steve will help you with and assist with.
So just by way of a mini overview, in terms of entering into an EPZ, there's some feasibility exercise to be done. Somebody like Steve will come along and discuss with you what the art of the possible is. And he's mentioned that it's about layering up solutions. It's never a one size fits all approach. We talk about a whole building solution. So you might even have a whole portfolio of buildings that are looked at.
There's inevitably going to be some initial design phase, although you'll often find the detailed design is done under the terms of the energy performance contract itself. And there may be some procurement elements that will ultimately lead to the contract.
But in essence, what you're looking for is a project that pays for itself in terms of the energy savings, covering the cost of the infrastructure that's installed and then operated and maintained. And it all sounds too good to be true, but there are some key risks and liabilities that you should be aware of when entering into the EPC. The first of them, as I've already mentioned, is that it's a long contract, typically fifteen to twenty five years.
And that's in order to enable the ESCO to recover the cost of their capital investment and make some profit.
The energy savings that are yielded from the project should cover the cost of the monthly payments, but they are benchmarked against what the client was paying before the agreement was entered into. And so in the event of changes to your energy demand, that could potentially have an impact.
And the big issue, biggest issue really in terms of risk is in the event of early termination.
Notwithstanding, it's typically fifteen to twenty five years long, obviously, if there was a fundamental breach of the contract or some force majeure event that led to the early termination of the contract, you're still left with some very expensive kit that's been installed and not paid for. And so typically, even where the termination is as a result of the ESCO default, there will be a termination payment payable that will ultimately transfer the title in the equipment that's been installed to the consumer, to the client.
But it is something you need to be mindful of, there's often compensation tables included in your contract. They might be separated and different depending on whether it's an ESCO default, client default, force majeure event, but ultimately there will be a payment to be made on the basis of it. But we've talked about how hopefully, all things being well, the savings that are generated will pay for the contract through its lifetime.
How do you then measure those savings and how do you measure performance, Steve? How can it be verified?
Well, yes, I think that's an important point.
But I think before I answer that, I'd say that what if you're going to market for an EPC, it's important to step away from the mindset of you want to buy solar panels or you want to buy a biomass boiler or you want to buy a heat pump. You want to think about, because you don't really want a heat pump. You want to net zero heat perhaps or you want net zero electricity.
So think about the outputs that you want, not about the equipment.
And then once you've got all of that equipment installed, delivering the outputs, then it's about installing the right metering as part of that project.
So if you say it's a heat pump, that you measure the electricity into it and the heat out of it, you can, and you have a system that collects that data automatically and shares it with both you and the contractor so you can both independently review it and say, well, in our EPC it says we need to use this much electricity to generate this much heat, and are we actually doing that? And if we're not doing it, why are we not doing it? So you have the granularity to interrogate it. But that is what we call monitoring and verification and there international standards for that which are usually written into EPC contracts as to how it should be done in best practice.
But yes, it's essential in any EPC contract should have all of that built into it.
Excellent. Yeah, it is a key feature and just picking up on your point that you shouldn't be too focused on having a heat pump or having solar or whatever. You need to be, as you suggested, it's often governed by where you're located, what your building is, how you hold the building, whether it's freehold or leasehold, planning restrictions locally.
So, you know, we're going to have a little look at top tips later, or my top tips anyway, I hope Steve's got some too, but it's the sort of thing you really determine that you want to save, get to net zero, determine that you want to save potentially on energy costs, determine that you need to improve your building because things like boilers etc. Have reached their end of life. Make decisions on those bare seeds, but then determine what the art of the possible is in terms of the project that meets your needs best.
So in terms of how savings are defined and enforced, it can become quite complex, and I've seen it done in a variety of ways, but ultimately, the very sort of headlines of it all is that there's a benchmark assessment of what energy demand and cost is at the outset. Then there is an analysis of what the energy saving measures can deliver in terms of savings.
Those will feed into your guaranteed savings level and then subject to any excusing causes that the ESCO might be able to claim, they should meet those guaranteed savings. And there should be some sort of mechanism when there is a shortfall, whether it's to offset or to have a repayment, but there should be some mechanism to ensure that the consumer or the client gets their money back or has any shortfall offset against their monthly service payment.
And then sort of the flip side to that is there may well be excess savings as well. So potentially through operation of the equipment, might find that the savings yielded are greater than the guarantee, and you'll often find a mechanism for sharing that. And I would, people often get a little bit perplexed or, know, upset that there are savings being generated that they're not taking the benefit of, that they're sharing with the ESCO. And my only point to that would be you're encouraging the ESCO to perform well by giving them a share of that win.
Obviously it needs to be measured, shouldn't be sort of too much in the way of a windfall, but it is an encouragement for positive behaviour to see them overperform rather than Yeah.
And if I was sat here with an ESCO hat on, I would say that if they've overperformed, it's because they've used the assets more and have therefore have higher servicing and replacement costs. So it's not they're not just taking a huge ticket. They they'll Yeah. You a huge profit. They'll be using some of that money to provide those additional savings.
Yeah, I mean, that's a good point. You don't know what they've done to ensure that those additional savings have been achieved, whether it's, you know, better maintenance or whatever, yeah, that's a good point.
So just then wrapping it up now. Thank you everybody for listening and just keep listening for a few more minutes. We've talked about what an EPC is, we've talked about how it starts, how it's got a workspace and an operational phase, some of the typical features of a typical EPC in terms of contractual structure.
In terms of top tips with any EPC, my go to that I always share with every client is to make sure you get very good technical input, because ultimately this is an extremely long contract that you are going to live with, and you'll live with it while technology elsewhere advances, while the grid gets greener. And so what might look great right now might not be great in five years' time.
So we've talked about CHPs and stuff like that, and how they're becoming less green or net zero, you know, because they're not, you would explain it best to me, but they're not as good as they used to be in that sense. However, if you use the right expertise and engage with the right technical expert, they will have all of that foresight in mind, and they will be best placed to determine what savings are achievable, what your loads are likely to be. They can have a think about your loads in the future, you know, what your energy consumptions look likely to be in the future.
And, you know, all of those things are not perfectly predictable, but they are predictable.
So that's my top tip. Get a good technical expert involved right from the start.
Yes, well I'd also say have a good legal expert.
But I can say it's important to get the contract right. But on top of that, I would say be ready. They take a little bit of work to put together even if you've got good advisers around you.
But you need to be ready with your with data to provide to the contractors.
I would also say be open minded. Ask for the output specification and embrace the options that different companies will bring forward to you through a well structured procurement process. It's much more interesting to say these are the outputs that I want and then let the market come to you. Different contractors have different expertise and what you want is the best financially attractive opportunity to offer to get the outputs that you you require.
I think those would be my absolute top tips.
Excellent, excellent. Well, that just about wraps things up for our little overview of energy performance contracts. Thanks again, Steve, for joining me on this podcast. Hopefully we'll do more in the future.
The podcast will be posted our contact details. If anybody has any questions, I would urge you to get in touch. Thank you.
Thank you for having me.
