EFFICIENT LIGHTING INITIATIVE WORKSHOP: FINANCE & TRANSACTION SUPPORT PROGRAMS

1. EFFICIENT LIGHTING INITIATIVE WORKSHOP:FINANCE & TRANSACTION SUPPORT PROGRAMS Presented by: John C. MacLean, IFC Consultant Energy Efficiency Finance Corp., Seattle, WA ph. 206-381-9106; fax 206-381-9107 e-mail: maclean@aa.net July13-14, 2000

3. FINANCE & TRANSACTION SUPPORTWORKSHOP OBJECTIVES • Review E.E. finance & transaction structures applicable for ELI • Define methods for ELI to deliver finance & transaction support services working with partner organizations • Identify finance & transaction support applications planned for each country • Work through cases at practical level of detail • Identify resources, tools & next steps to develop these applications

4. E.E. FINANCE PROGRAM DESIGN • Need for market aggregation & to work programmatically with market actors • To promote E.E. finance, work the project development cycle & prepare projects for investment. How to market & accelerate the project cycle is a key challenge. • Address commercial objectives of project participants: end-users, utilities, EE businesses, FIs • Build on existing capacities • Focus where EE economics are most compelling • Address EE & financial market barriers & conditions • Achieve maximum leverage of concessional funds • "Financial engineering” is needed Begin with the End in Mind” • Seek replication

5. TYPICAL MARKET CONDITIONS • CAPITAL MARKETS ARE NOT YET MOBILIZED FOR E.E.; BUT EXTENSIVE PROJECT, EQUIP. & COMMERCIAL FINANCE EXPERIENCE RELEVANT & APPLICABLE TO EE FINANCING • (STRONG) BASE OF E.E.-RELATED BUSINESSES EXISTS, BUT CAPACITIES REQUIRE ORGANIZATION TO MARKET, DEVELOP & FINANCE TURNKEY PROJECTS BASED ON SAVINGS • PRINCIPAL BARRIERS: Lack of readily available financing crafted for EE Credit risks, at end-user & ESCO level Lack of fully capable, capitalized project sponsors Lack of well-prepared projects; high devel. costs Knowledge barriers at all levels

6. Finance & Transaction Support Program Development • Market Research: market actors, EE economics, finance sources, project opportunities • Selection of Partners; Screening Criteria include economic opportunities, strong financial interest top management commitment & clear decision-making • Define objectives & interests of partners economic/financial criteria for project implementation preferred finance & contract structure legal & procurement • Define Project/Program Functions Distribution of Functions, Responsibilities and Risks Documentation Requirements Define & obtain commitments of partners; MOU • Execution: work project cycle & all transaction details

7. Model 1: End-User as Borrower Energy Services Agreement End User Turnkey EE Project Installation & Services Loan/Lease Finance payments Project Purchase $ Capital $ Financial Institution ESCO/ Contractor

8. Model 2: ESCO as Borrower, Typical Performance Contract Structure Energy End Users Energy Services Agreement: turnkey project installation and services Payment based on “savings” ESCO Debt/Service payments and assignment of project security Loan/Investment Agreement: capital for project installation Financial Institution

9. Model 1 vs. Model 2Advantages & Disadvantages Issue1. End-user as Borrower2. ESCO as Borrower

10. Typical Project Risk & Role Distribution Risk/Role:Assumed by:

11. Utility-Based Residential CFL Finance Program End Users . . . Distribution of CFLs Payments on utility bill (partial or full cost recovery) Equip. Mfg./Distributor Loan for bulk purchases Utility ESCO Bulk purchases of CFLs Financial Institution Loan debt service payments

12. UTILITY-BASED RESIDENTIALCFL FINANCE PROGRAM • Objectives: • market aggregation • overcome first cost barrier • deliver finance @ point-of sale/distribution • gain utility system benefits • offer positive cash flow for end-user • Program Functions • purchase & bulk procurement of CFLs • financing initial purchase • marketing & promotion • distribution of CFLs • originate documentation with end-user • billing & collection of finance payments with end-user

13. UTILITY-BASED RESIDENTIALCFL FINANCE PROGRAM (2) • Key Risks & Risk Distribution • end-user credit & payment risk: borne by utility • level of sales/distribution achieved by program: by utility • CFL performance & warranties: by manufacturer/supplier • credit of utility: by FI • Program Design Issues • Cost/Benefit Analysis: Utility and End-User • Utility share of Equipment & Program Costs • Complete Program Costs: admin., start-up, allowance for bad debts, inventory interest cost, collections • Financing offer to end-user: term, rate, pricing

14. UTILITY-BASED RESIDENTIALCFL FINANCE PROGRAM (3) • Program Design Issues, (continued) • Credit Structure of Financing to End-user: “lien at the meter”, estimated default, risk premium • collections mechanism issues • CFL distribution via utility offices, retailer channels, both? • Documentation methods: coupons • # units per household, customer benefits, hours of operation • Total program capital demand estimate & timing • Does utility need financing (loan) for the program? • What functions will utility perform or contract out? • Applications of utility-based finance with other sectors

15. Utility Motivations & Issues • Possible Utility Benefits • peak load shaving & load shaping • avoid losses on retail sales where tariff is < cost of service • improved customer service & public relations benefit • avoided costs of new generation & distribution • Issues in utility C/B analysis: • coincidence of residential lighting load with system peak • value of peak load reductions • real lost revenues: “take back”, power sales to other customers & T&D savings • creating tariffs that provide incentives for residential EE • utility cost recovery plans: proposals to regulators • societal economic & environmental benefits

16. ELI-PERU: RESIDENTIAL CFL PROGRAM CONCEPT Retailers Residential End-users CFL Mfg.s & Suppliers Distribution of CFLs Payments on electric bill Distribution of CFLs Service Agreement Bulk Purchase EDELNOR Electro Oriente Payments per CFL Loan Program Development Program Development Bank ELI John MacLean, Dec. 13, 1999

17. OTHER HOUSEHOLD/CONSUMER FINANCE CHANNELS • Payroll deduction programs • Credit co-ops • micro-enterprise lenders • Credit card companies • Opportunities to market CFLs via these types of consumer finance companies • Inventory finance for retailers: short-term working capital • Issues: managing transaction costs; is finance needed?

18. "ESCO" Development Programs • Provide business development assistance, e.g., • Provide training to Lighting EE businesses • Assist E.E. businesses complete their ESCO offerings • Assist in Business planning • Provide business tools, e.g., contracts, M&V, proposal models, financial analysis • Market research • Facilitate JV’s between domestic & international firms • Arrange project & ESCO finance facilities • identify sources of finance; educate lenders • evaluate finance alternatives, structure and arrange financing • prepare finance placement memoranda • various types of finance, including corporate equity

19. "ESCO" Development Programs • Assist in development of model transactions • ESCO is project-based business • apply ESCO tools • Work with end-users & associations to develop project pipelines • Get them “decision ready”; accelerate sales cycle • Provide preliminary audits & cost/benefit analyses • Value in serving as an “honest broker” • Assist with procurements • Remove contractual, procurement, institutional barriers • Assist in capturing carbon offset values through aggregation, verification & brokering

20. Typical Reasons for Outsourcing Energy & E.E. Services • Obtain specialized expertise in energy supply, project development, plant operations and E.E. technologies • Mobilize capital for investment program • Obtain “off-balance sheet” financing; preserve internal resources for other purposes • Manage & transfer project risk to the project developer/contractor

21. “ESCO” Functions • Sales & marketing to end-users • Project development • Contract development • Engineering, each project stage, preliminary, whole system integration • equipment procurement • installation/construction • operations services: planned & emergency maintenance, consulting to end-user, MIS functions • savings measurement & verification • project finance • administer projects & manage project assets

22. TYPICAL ESCO PROJECT DEVELOPMENT CYCLE • Energy audit of facilities conducted • End-user credit pre-screening • ESCO Proposal -- defines anticipated EE measures, their economics, the project finance/contract structure & terms, development path and responsibilities • Planning agreement, with break-up fee typically • Full scale engineering, final proposal and end-user project approvals & decision to implement; permits • Negotiate & execute Energy Services Agreement; complete finance arrangements • Finance closing • Project installation, completion, acceptance, start-up • On-going O&M, contract administration, savings measurement & verification (as applicable)

23. KEY TERMS OF ENERGY SERVICES AGREEMENTS (1) • 1. PROJECT SCOPE Schedule of EE measures & equipment Commissioning & Acceptance testing Schedule of operations period services Energy Services Standards & Performance Guarantees • 2. PROJECT OWNERSHIP: ESCO, BANK, END-USER Purchase Options Pre-payment & End-of-Term (renewal, transfer, purchase) Assignment for financing purposes • 3. CONTRACT TERM; TERMINATION; DEFAULT & REMEDIES

24. KEY TERMS OF ENERGY SERVICES AGREEMENTS (2) • 4. DIVISION OF OPS. & MAINTENANCE DUTIES: by ESCO or End-user; end-user staff training • 5. CUSTOMER PAYMENT FORMULA Fixed Payments, or Payments based on “Savings”: (many variations) loan/lease with Guaranteed Savings Shared Savings, fixed term Paid-from-Savings, variable term Stipulated Savings Energy Output Sales Complete Energy Supply & System Ops. Performance & risk incentive payments Billing & payment terms

25. KEY TERMS OF ENERGY SERVICES AGREEMENTS (3) • 6. DEFINITION OF "SAVINGS” Baseline Energy Use & Costs Minimum Energy Load/Use Provisions Measure-by-measure vs. Full Facility Savings Calc. Post-installation measurements: one-time vs. real time (monthly) Modification to Baseline: new loads, change in op hrs Annual, Periodic & Cumulative Reconciliations KWbefore - KWafter = KWsavings x hrs = KWh savings; KWh savings x $/KWh = cost savings • 7. WARRANTIES, EXTENDED WARRANTIES, REPAIR, INSURANCE, LOSS/DAMAGE

26. END-USER SELF-ASSESSMENT QUESTIONS/TOPICS • Capital budgeting procedures & resources • Financial criteria for EE investments: hurdle rates of return for use of own capital; positive cashflow • Finance structuring: on- vs. off-balance sheet; use of outside financing; preferred structures; for ex risk • Desired services; assessment of plant operations capacities; in-house resources for EE program; EE measures taken to date • Risk preferences: construction, operations, technical performance, achieving savings • Decision-making procedures: who is involved, plant engineering, finance, corporate, parent • Assessment of pro’s/con’s of EE/energy outsourcing

27. END-USER PREPARATIONS for ESCO PURCHASING • Assemble energy cost/consumption & system/equipment inventory information; review EE measures/audits to date • Assemble company credit information • Perform self-assessment (see questions) • Establish decision-making criteria & process • Determine project development path • Qualify ESCOs, contractors and EE equip/service providers w/respect to: experience, prior projects w/similar end-users, business & pricing methods, ESA terms, financing capacities/sources, risk assumption

28. STREETLIGHTING: THE OPPORTUNITY * PUBLIC LIGHTING IS AN ESSENTIAL SERVICE FOR PUBLIC HEALTH & SAFETY; INVESTMENT NEEDED TO (1) IMPROVE EFFICIENCY, and (2) EXTEND/UPGRADE SERVICE TO UNDERSERVED AREAS * PUBLIC LIGHTING HAS STABLE, PREDICTABLE HOURS OF OPERATION, ~4000 HOURS/YEAR; SAVINGS IN ELECTRIC USE OF 30-50% POSSIBLE, Paybacks of 3-6 YRS * USEFUL LIFE OF NEW EQUIPMENT IS LONGER; MAINTENANCE SAVINGS CAN BE SIGNIFICANT * MUNICIPALITIES & COMPANIES NEED ASSISTANCE IN PROJECT PLANNING, PROCUREMENT, FINANCING, CREDIT ACCESS, OVERCOMING INSTITUTIONAL BARRIERS

29. IFC/GEF ARGENTINA STREETLIGHTING PROGRAM MUNICIPALITY IFC/GEF STREETLIGHTING PROGRAM Turnkey Public lighting project and services contract Project Development Support/Services Utility billing/collecting EQUIP. SUPPLIERS & INSTALLERS . ELECTRIC UTILITY Subcontract(s) for equipment, & installation Loan $ for Project capital costs Utility customers Payments for public lighting services on utility bill Debt service payments BANK

33. IFC/GEF Hungary E.E. Finance Guarantee Program Stage 2 IFC adds $8-10M in reserves Grant $ GEF I.F.C. GEF $ $ 4.25M reserves Guarantee Facility Agreement Portfolio Guarantee, co-fund loss reserve Transaction Guarantee LOCAL F. I. LOCAL FINANCIAL INSTITUTION Loss Reserve EE Project Loans Small loans & leases to end-users ESCO End-user Leasing Co. .... Energy Services Agreement Lease Portfolio End-user End-user

36. Finance & Transaction Support Tools • Energy Service Agreements • Public Sector EE Project or ESCO Procurement documents • CFL Bulk Purchase Procurement documents • Sample Project Development Plans • Sample ESCO business plan or B.P. outline • Sample M.O.U.s • Sample project debt term sheet & finance placement memorandum • Financial Advisor T.O.R.s • Sample utility cost/benefit analysis • Sample project financial analysis: end-user & ESCO perspectives

37. Sources of Financing • Local banks and leasing companies first Commercial and development banks end-users’ existing banks initial appraisal of these sources meet FI objectives: volume of creditworthy financings • IFC applications FIs that are IFC investees or borrowers IFC direct investment: utilities, ESCOs, mfgs, FIs existing & new IFC/GEF EE finance initiatives, e.g., guarantee program Renewable Energy & Efficiency Fund (RE/EEF) • Other International sources of finance • Carbon values