Comparison of Conventional and Performance Based Financing Options

Considering the previous project financing examples, it is clear that the conventional host-owned debt-financing option is potentially most lucrative to the host if the project performs as anticipated. In addition to the higher return potential, the host facility can utilize depreciation benefits and maintain the flexibility to change operations without the need to negotiate with a third party. However, all performance risk falls on the host/owner. The host/owner must also maintain sole responsibility for OM&R and for equipment and savings performance. Finally, financing is on the owner's balance sheet and may limit access to additional capital.

With virtually any type of performance-based/shared savings arrangement, the host will commonly pay a premium for the performance guarantee and laying off other project risks and responsibilities in the form of reduced potential positive cash flow. The magnitude of the premium will be proportional to the comprehensiveness of the guarantees and obligations committed to by the contractor/third party. With the single-year savings calculation type of performance-based/shared savings agreement, the ESCo is assured payments over the full term if first year performance is as anticipated. Under the yearly savings calculation, the ESCo must continually prove performance throughout the term. This adds further to actual project operating costs and performance risk. Consequently, the percent of operating energy savings and, therefore, the incentive offered to the host in the form of net savings will likely be lower.

However, the ability to enter into a more secure project arrangement and off-load operational responsibilities may be viewed as a major benefit to the host facility. The avoidance or capital and/or debt requirements may also be an attractive feature, though depreciation benefits cannot be utilized by the host/owner. Another potential disadvantage of these arrangements is that as operational changes become necessary, the owner may have to negotiate either operational changes or contract termination with the third party. There may also be potential discrepancies over savings between the host and the ESCo/third party. These risks can be mitigated through well-conceived and carefully reviewed contracts.

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