Briefing Note 09/10 77163 Public Procurement of Energy Efficiency Services Getting Started E n e r gy E f f icie n t C ities I n itiati v e Helping Cities Meet their Energy Challenges of the New Century TABLE OF CONTENTS Procuring Energy Efficiency Services 1 Barriers and Emerging Models for ESPCs  7 World Bank Procurement 17 ESPC Financing 24 Getting Started 30 Acronyms and Abbreviations 32 d | Energy Efficient Cities Initiative Procuring Energy Efficiency Services The world’s primary energy needs are expected to grow rapidly over the next two decades, with the largest incremental increase coming from de- veloping countries. This will require over US$25 trillion in energy supply infrastructure investment by 2030. Meeting the growth in energy demand through traditional energy development models is unsustainable from both environmental and energy security perspectives. Finding new ways to meet energy needs sustainably while maintaining robust socioeconomic de- velopment is imperative. Energy efficiency (EE) can be one of the most cost-effective and critical instruments to help meet the global growth in energy demand. Improve- ments in EE contribute to enhanced energy security, increased competi- tiveness, employment generation, load reductions on often overstressed utilities, higher reliability of energy systems, reduced vulnerability to high and volatile energy prices, and lower environmental impacts including greenhouse gas (GHG) emissions. For national governments, EE is seen as a win-win-win option, providing positive returns to the government, en- ergy consumers, and the environment. EE measures are generally viewed as “no regrets� policies, since their net financial cost can be negative— the measures are justified purely based on high financial returns. Unfor- tunately, despite these promising benefits, achieving significant and sus- tained efficiency gains has proved daunting in both developed and de- veloping countries. Broad and timely deployment of EE measures in the coming decades will also help buy time for more technologically advanced GHG mitigation initiatives that will emerge over the longer term. The In- ternational Energy Agency (IEA) estimates that EE could contribute about 58% of GHG reductions potential through 2050 (Figure 1). The public sector1 holds significant potential for improved EE globally and represents a large and important market in all countries. The public sector typically represents 10–20% of a country’s gross domestic product (GDP). Public procurement, alone, can also be substantial. In Europe, for example, public procurement represented some €1,500 billion in 2008 (16% of GDP). Although public energy use as a percent of total energy use is relatively small (about 2–5% in many countries, higher in those with district heating sys- 1  he “public sector� refers to publicly owned institutions subject to public procurement rules and regula- T tions, including federal/municipal buildings, universities/schools, hospitals/clinics, public lighting, water utilities, public transportation stations, community centers, fire stations, libraries, orphanages, etc. Box 1 GETTING STARTED In 2010, ESMAP completed and published a comprehensive report detailing how governments around the world can bundle, finance, and implement energy efficiency measure using energy savings performance contracts (ESPCs). The book, entitled Public Procurement of Energy Efficiency Services: Lessons from International Experience, offers policy advice about ways to overcome some of the more vexing barriers to achieving real energy savings in government-owned facilities. Public Procurement of Energy Efficiency Services was based on an international review of country experiences that have used the ESPC approach in the public sector, along with more in-depth country case studies. Developed country studies included Canada, France, Germany, Japan, and United States. The review also identified project and program examples in Brazil, Bulgaria, China, Croatia, Czech Republic, Egypt, Hungary, India, Poland, and South Africa. This note offers more operational guidance on how to get started with such programs. It starts with a summary of the report’s main findings and then delves into operational modalities of operationalizing these findings for World Bank (WB) operations, including issues of WB procurement and financing. Rather than seek to recommend changes in WB procedures, it presents some ideas and options under current WB processes to formulate operational approaches and strategies to deliver large-scale energy savings to public agencies, at both the national and local levels. English Paperback | 7 x 10 | 234 pp. January 2010 | World Bank ISBN: 978-0-8213-8062-8 Singh, Jas, et al. Public Procurement of Energy Efficiency Services: Lessons from International Experience. Washington, DC: World Bank, 2010. 2 | Energy Efficient Cities Initiative Figure 1 | GHG Mitigation from Energy Efficiency 60 Baseline emissions 57 Gt 55 50 CCS 19% 45 Renewables 17% 40 Nuclear 6% 35 Power generation Gt CO2 30 e ciency and fuel switching 5% 25 End-use fuel 20 switching 15% EE 15 End-use fuel BLUE Map emissions 14 Gt and electricity 10 e ciency 38% 5 WEO 2009 450 ppm case ETP 2010 analysis 0 2010 2015 2020 2025 2030 2035 2040 2045 2050 Source: International Energy Agency (IEA). Energy Technology Perspectives. Paris: IEA, 2010. tems), the government is often the largest single user of energy in a given country. In the United States, federal agencies consumed 38 million tons of oil equivalent (Mtoe; 1.5% of primary energy in 2006) at a cost of US$17.7 billion, and generated 42.8 million tons of carbon dioxide equivalent (CO2e) to operate government buildings, vehicles, and equipments. Further, governments often have many 24-hour-load facilities, such as hospitals, uni- versities, orphanages, etc. The common ownership and homogeneous nature of many of the facilities, particularly those with common functions (e.g., schools, hospitals), offer unique opportunities for bundling many projects together and allowing financing at a large scale. In this way, the public sector can have a catalytic effect on local markets by demonstrating good behavior to the private sector and general public, while stimulating nascent markets for EE goods and services. Additionally, programs to reduce energy use in public facilities can reduce public energy expenses, creating fiscal space to allow governments to expand social services and meet other critical infrastructure investment priorities. Energy efficiency investments in public facilities can also be an attractive eco- nomic stimulus, by creating local jobs to “green� existing infrastructure while upgrading facilities and lowering future operating costs. Public Procurement of Energy Efficiency Services—Getting Started | 3 The Opportunity Although no conclusive estimates exist of EE potential in the public sector globally, anec- dotal evidence suggests that it is substantial. Public facilities tend to have outdated equip- ment; many pay low energy prices or do not consistently pay their utility bills. In middle-in- come countries, in facilities where lighting is the primary energy use, EE savings can be as high as 50%. Many public office buildings in developing countries can easily achieve 20–40% energy savings through retrofits of existing equipment. Savings may not be as significant in many lower income countries, where access to and use of electricity may be relatively low. Key areas for saving include government office buildings, water utilities, public lighting, and institutional facilities (e.g., schools, hospitals). Prevailing Challenges Energy efficiency in the public sector has long been a challenge, even in developed countries. Despite the opportunities identified, implementation of EE measures is constrained by rigid public sector procurement practices that focus on first costs and a lack of discretionary bud- gets to make investments in energy efficient equipment. There is also a principal-agent or split-incentive issue, whereby a parent budgeting agency may determine capital budget needs while the subordinate agency is responsible for paying the monthly energy bills. More- over, many facility managers are not aware of EE products or their performance, and the equipment they have is poorly maintained. Other constraints include: • Government agencies are not typically responsive to price signals since they lack a com- mercial orientation. • Public procedures for equipment and service procurement are not flexible. • Constrained annual budgets make funding for capital upgrades difficult while restrictions on public financing and typical one-year budget appropriations make it difficult to amor- tize costs. Although simple measures and universally applicable policies are lacking, experience from a number of countries shows that large-scale EE gains in the public sector are possible. Many governments have pursued a multipronged approach to encourage EE improvements in pub- lic facilities (Table 1). Energy Savings Performance Contracts—A New Way? Energy savings performance contracts (ESPCs) have been introduced in many countries to help address some of the more difficult issues associated with facilitating EE investments in the public sector. An ESPC involves an energy service provider (ESP; Box 2), providing an energy consumer or “host facility� a range of services related to the adoption of energy effi- cient products, technologies, and equipment. The services provided may also include the fi- nancing of the EE upgrades, so that the host facility has to supply little or no capital. In many cases, the compensation is contingent on demonstrated performance, in terms of EE improvement or some other measure, thereby creating a system where the services and equipment can be paid from the energy cost savings. There are several variations of ESP busi- ness models (Figure 2). 4 | Energy Efficient Cities Initiative Table 1 | Typical Barriers & Actions Taken to Improve EE in the Public Sector BARRIERS INDICATIVE ACTION AND COUNTRY EXAMPLES Lack of awareness and Initiate awareness campaigns, case studies, procurement guidelines, product catalogs/ information, including specifications, information dissemination, demonstrations (Brazil, Canada, China, costs, benefits, risks, France, Germany, Japan, Mexico, Sweden, U.S., Vietnam) products Lack of technical capacity Create nodal agencies to provide TA for EE projects; appoint energy managers; develop for audits, project training/educational programs for facility operators/energy mangers/ESPs, EE analytical design, procurement, tools, ESPC audit and procurement/contracting guidelines, prequalification of ESPs, M&V implementation, protocols (Brazil, Canada, China, Germany, India, Japan, Mexico, Philippines, South Korea, monitoring; trust of EE Thailand, U.S., Ukraine, Vietnam) potential Limited incentives to Revise budgeting to allow retention of energy savings; issue awards for agencies/staff; implement EE (potential include EE in management performance reviews; risk sharing/financing programs; loss of budget), try new EE targets (Brazil, Canada, China, France, India, Mexico, U.S.) approaches, take on risks Lack of agency accounta- Create public sector/agency targets with reporting/monitoring, penalties for bility for energy savings nonperformance, energy performance labeling of buildings (China, Germany, Japan, Mexico, Sweden, U.K., U.S., Ukraine) Restrictive procurement, Revise public policies for EE products (e.g., labeled only, life-cycle costing) and ESPCs; contracting, and financing develop local ESPC models; create public EE funds (Brazil, Canada, China, France, rules Germany, Thailand, U.K., U.S.) Lack of funding for upfront Earmark public EE budgets; create dedicated grant/subsidy programs, public revolving energy audits and project funds, DSM surcharge or “wire charge�; free energy audits (Brazil, China, Denmark, funding France, Germany, Japan, Mexico, Sweden, South Korea, Thailand, U.K., U.S., Vietnam) Small size and high Bundle public EE projects; generate model documents/templates to streamline projects; transaction costs of EE prequalify ESPs; bulk procurement of EE products (Austria, Canada, Germany, Hungary, projects India, Philippines, South Africa, Sweden, U.S.) ESPCs have a number of inherent advantages for addressing the specific difficulties that pub- lic agencies face. Outsourcing an EE project in its entirety—from development to financing to monitoring—allows agencies to reap the gains without the hassles of completing each step of the project on their own, often with multiple procurements taking months, if not years. The ability of ESPCs to allow for off-budget financing and to pay for themselves from the savings makes the mechanism even more attractive to public agencies that have small discre- tionary budgets, or none at all, and a very low tolerance for risk. And ESPCs can leverage expertise from commercial ESPs. Several countries have been able to realize significant ESPC markets in the public sector (Table 2). Although ESPCs may be well suited to address many of the challenges to improving public sector EE, rigid public procurement and budgeting guidelines and procedures are quite poorly suited to making ESPC procurement simple, particularly if full project costs and technical parameters have yet to be determined. Furthermore, the complex nature of ES- PCs requires significant capacity building throughout the public sector to ensure their successful use. Public Procurement of Energy Efficiency Services—Getting Started | 5 Box 2 ESCOs versus ESPs Commercial entities that have implemented projects using the ESPC approach have traditionally been referred to as “energy service companies� or ESCOs. Many governments and donor programs have focused on devel- oping local ESCO companies in order to help tap EE potentials. However, since ESPC projects are simply a bundle of goods and services under one contract, ESPC projects can be implemented by a variety of businesses, including energy suppliers, equipment manufacturers, engineering and installation contractors, construction management firms, etc., that may not be commonly recognized as ESCOs. By issuing public tenders to ESPs, public ESPC projects can bring existing companies into the EE business, building upon existing business models and market precedents. Therefore, the term ESP, rather than ESCO, is used. Figure 2 | ESP Business Models High Full service ESCOs design, implement, verify, and get paid from actual energy saved Service/Risk (“Shared Savings�) Energy supply contracting takes over equipment O&M and sells output at fixed unit price (“Chauffrage�, “outsourcing�, “Contract Energy Management�) ESCOs with third party financing design/implement project, and guarantee minimum level of savings (“Guaranteed Savings�) ESCOs with variable term contract act as full service ESCO, but contract term varies based on actual savings (e.g., “First Out Contract�) ESCOs with 1-year contract design/implement project, receive 60–70% of payment upon successful commissioning and the rest within 6–12 months Supplier credit, an equipment vendor designs, implements, and commissions project and is paid lump-sum or over time based on estimated savings Equipment leasing, similar to supplier credit except payments are generally fixed (based on estimated energy savings) Consultants with performance-based payments assist client to design/implement project and receive payments based on project performance (i.e., fixed payment with penalties or bonuses) Low Consultants with fixed payments help the clients design and implement the project, Service/Risk offers advice, and receive a fixed lump-sum fee 6 | Energy Efficient Cities Initiative Table 2 | Public Sector ESPC Markets and Results from Selected Countries COUNTRY MARKET SIZE RESULTS PROJECTS Canada (FBI) Can$320 million • 20% reduction in energy intensity 85 EPC projects (~US$300 million) • Can $40 million in energy cost savings (7,500+ buildings) 285 kt of CO2 reduction •  Germany €200 million • 20-30% reduction in energy costs 2,000 properties (~US$260 million) • €30–45 million in energy cost savings/yr Japan 10 billion yen • 12% reduction in energy intensity 50 ESPC projects in FY06 (~US$115 million) • 265kt of CO2 reduction South Korea ~223 billion Won n/a ~1,400 public ESPC projects (US$185 million) United States US$3.8 billion • ~30 trillion BTU/yr 500+ ESPC projects (FEMP) • US$11.7 billion in energy cost savings Barriers and Emerging Models for ESPCs When it comes to the specific steps in the procurement process, a number of key issues must be overcome to successfully implement EE projects using ESPCs. Six main steps in the EPSC procurement process, along with key issues and decision points within each step, are presented in Figure 3. In terms of the ESP market, many countries lack the legal and financial infrastructure to adapt to and support such complex business models. New ESPs generally either lack the technical and operational expertise to carry out all the functions typically associated with ESPCs or lack the balance sheets to mobilize the requisite financing such business models require. Local ESPs often have no track record in the market to carry out such sophisti- cated projects while international ESPs, which could bring better expertise and access to capital, are usually not very keen to invest in these emerging markets due to a host of risks (e.g., perceived small markets/projects, unclear legal/regulatory regimes, perceived client creditworthiness concerns, lack of access to appropriate local project financing, etc.). De- veloping countries also have limited equity markets and few investors willing to test new business types. Emerging ESPC models A review of select international experiences reveals a number of different programmatic approaches by governments to deal with the promotion and procurement of ESPCs in the public sector. Whereas some countries, such as Canada and the United States, have ini- tially addressed these issues at the federal level, others, including Germany, focused on developing more local experience first. Some countries, such as South Korea and Belgium, have relied on strong government interventions to support ESPCs, while others, including the Czech Republic and South Africa, have not. The various emerging models for dealing with ESPC procurement, along with some pros and cons, are summarized in Table 3. Public Procurement of Energy Efficiency Services—Getting Started | 7 Figure 3 | Schematic of Typical ESPC—Steps and Issues Minimizing 12.  Level of detail 4.  deviation 1.  Multi-year & funding Defining 5.  8.  Evaulation Financing 10.  Public agency 13.  contracts source project criteria sources capacity Contracting Budget Energy Audit RFP Bid Evaluation Financing and M&V Savings 2.  RFP standardization 6.  9.  Evaluation 11.  Financing Contract 14.  retention 7.  Additional requirements committee structures standardization Line item 3.  capacity Performance 15.  budgeting guarantees, payments, and M&V plans Assisting public agencies through the process of ESPC procurement is complex. The multidisciplinary nature of the various issues posed in each step of the process, from budget regulations to energy auditing to public contracting to project financing, makes navigating the process very challenging. And, many of the procurement and budgeting practices vary from country to country, so solutions must be carefully designed and adapted to fit local situations. Many countries have developed various solutions to deal with these issues, which can serve as valuable references for others. Some general recom- mendations for dealing with the main steps in the procurement process are summarized in Table 4. For each of the issues in the ESPC procurement process, review of international experi- ences reveal a continuum of options for countries to consider. By looking at the range of options, a country may be able to find an appropriate and feasible solution based on what has been done elsewhere. Alternatively, a local government or public agency could mix and match, combine, or develop new solutions based on the many approaches presented. As shown in Figure 4, countries may be able to design suitable procurement processes by calibrating the options for each issue. Of course, in reality, the process is not so simple. Many of the steps are inextricably linked to one another, making the process more com- plex as a solution to one issue may limit the possible solutions to another. For example, if agency or local procurement regulations require more prescriptive technical details in the bidding documents, then a more detailed initial audit may be required. 8 | Energy Efficient Cities Initiative Box 3 Project Bundling One of the major advantages of using ESPCs in the public sector is the opportunity to bundle many facilities together, creating projects large enough to capture significant economies-of-scale while speeding up implementation and attracting the private sector. Some examples of such project bundling, include:  ungary | In 2006, the Ministry of Education issued a tender for • H ESCOs to renovate all schools in the country; OTP Bank and local ESCO (Caminus) signed 20-year agreement with US$250m IFC guarantee; about US$22m implemented as of Aug 2008. ndia | The State of Tamil Nadu’s urban development fund bundled • I street lighting and water pumping in 29 municipalities under a few tenders (30% energy savings requirement, first ESPC with 7 urban local bodies signed in 2008); State of Gujarat recently issued tender for up to 159 local urban bodies (2 phases).  outh Africa | City of Johannesburg issued a tender in 2008 for about • S 50 municipal buildings with support from the Clinton Climate Initiative. • Austria, Belgium, Czech Republic, Germany, South Korea, Israel, and U.S. | All of these countries have have successfully bundled public EE projects using ESPCs. Public Procurement of Energy Efficiency Services—Getting Started | 9 Table 3 | Emerging Models for Public ESP Contracting NO. MODEL DESCRIPTION CASES 1. Indefinite Contracting Umbrella government agency competitively US (USDOE/FEMP), procures one or more ESPs (typically based Hungary (MOE) on general qualifications) and then allows public agencies to enter into direct contracts with selected ESPs without further competition 2. Public ESP ESP is publicly owned, so there is no Ukraine (Rivne City) requirement for a competitive procurement process 2a. Super ESP A variation of the public ESP model, a US (NYPA), Belgium (Fedesco), publicly owned ESP contracts directly Philippines (EC2), India (EESL) with a public entity and then subcontracts with smaller ESPs/ contractors on a competitive basis b. 2 Utility ESP A public entity contracts directly with their US (UESC), Croatia (HEP ESCO), utility for EE services without additional Uruguay (USCO UTE) procurement (since they are already existing supplier) 2c. Utility Demand-Side A publicly owned ESP uses funds from a Brazil Management ESP DSM surcharge to invest in target public agencies at no cost to the agency (so no procurement since there is no contract/ payment) 2d. Internal ESP (PICO) A unit within a public agency acts as ESP, Germany (Stuttgart) providing technical and financial services, and receives payments through internal budget transfers 3. Energy Supply Contracting Public agency contracts out delivery of France, Germany, Austria (Chauffage) an energy service, such as lighting or heating, and selects a service provider based simply on cost per unit of service 4. Procurement Agent A quasi-public entity or NGO helps Germany, US (NYSERDA), government agencies, often on a fee-for- Czech Republic (SEVEn), service basis, develop RFPs and assists Austria, Slovakia (CEVO) them through contract award 5. Project Bundling Umbrella government agency bids out a Austria, Germany, S. Africa group of buildings or facilities for a large (Johannesburg), India (CPWD, ESPC TNUDF, GUDC), U.S. (California) 6. Nodal Agencies A dedicated EE agency is appointed to U.S. (USDOE), S. Korea facilitate procurement (prepare model (KEMCO), India (BEE), Japan documents, share experiences, training, (ECCJ) facilitate financing) 7. Ad Hoc No explicit program or mechanism to support Brazil, South Africa, China, public ESPCs, but no policy to prevent them; Mexico, Egypt, Poland therefore, projects are developed one at a time Acronyms: BEE—Bureau of Energy Efficiency (India); CEVO - Centrum pre Verejné Osvetlenie (Slovakia); CPWD—Central Public Works Department (India); ECCJ—Energy Conservation Center, Japan; EESL—Energy Efficiency Services Ltd. (India); FEMP - Federal Energy Management Program (U.S.); GUDC—Gujarat Urban Development Company (India); HEP ESCO—Hrvatska Elektroprivreda Energy Service Company (Croatia); KEMCO—Korea Energy Management Corporation; MOE—Ministry of Education (Hungary); NYPA—New York Power Authority (U.S.); NYSERDA—New York State Energy Research and Development Authority (U.S.); TNUDF—Tamil Nadu Urban Development Fund (India); UESC—Utility Energy Service Contract (U.S.); USDOE—United States Department of Energy; USCO UTE—Administración de Usinas y Transmisiones Eléctricas Service Company (Uruguay) 10 | Energy Efficient Cities Initiative PROS CONS Allows much easier contracting between Upfront contracting can create barrier to market smaller public agencies and ESPs, with lower entry during contract period; nontransparent direct risks for upfront audits and project design costs contracting approaches; provides less leverage for public entities to negotiate on price Can reduce transaction costs for procurement, Can become monopolistic and may not provide provide greater access to concessional services as efficiently and cost-effectively as private international financing (through sovereign ESPs; may not lead to a sustainable, vibrant ESP loans) while raising comfort level of public market; needs viable exit strategy agencies that know little about EPCs Same advantages of a public ESP while still Creates an artificial barrier between the contractor allowing more private ESP participation and and customer; has very limited track record in competition developing countries; allocation of risk to contractors is tricky Allows bundling of energy and EE services Can create monopolistic utility ESP; may be some with existing utility, public or private, and conflict between EE and energy supply services easier repayment through utility billing; utilities can access cheaper financing Can address the procurement and financing Using DSM surcharges for public agencies can create barrier together perceived unfairness; ESP may not be service- oriented without contractual relationship; often there is no performance guarantee No procurement and the transaction is As with other public options, efficiency relative to internal to the public administration commercial ESP is not clear Well demonstrated and has a very simple Often require long terms (20-30 years) to be viable; procurement and contracting approach focus on supply-side gains only; better suited for (no performance contract) central systems (heating, cooling) More market-based and allows agent to Can lead to monopolistic behavior as agent has no evolve approaches as the market develops incentive to share approaches; agent may not have ability to change public policies; developing countries may not have logical agent candidates Favors competition while expanding project Public agencies have less control in how their sizes and reducing transaction costs projects are bundled; large project sizes may inhibit market entry of new (or local) ESPs Provides a strategic review of procurement Nodal agencies may have limited ability to influence programs and sharing of experiences and procurement, budgeting policies; assistance is model documents general and often excludes detailed transaction support Allows for full innovation and development of Transaction costs for the first project(s) are very high demonstrable approaches before developing and some reinventing the wheel for early projects is guidelines and model documents likely Public Procurement of Energy Efficiency Services—Getting Started | 11 Table 4 | Recommendations for Main Public ESPC Procurement Steps MAIN STEPS RECOMMENDATIONS Budgeting • Start public ESPC procurement schemes with more autonomous public entities first. • Gain support from and work with parent budgeting agencies. After implementing a few ESPCs, develop public financing programs to help address •  budgeting, incentive, and financing issues. • In the longer term, consider changes to the budgeting laws and regulations as needed. Energy Audit Consider level of technical information required by prospective bidders to properly •  define project. In lieu of an audit, provide only basic technical data (facility description, equipment •  inventory, energy bills, etc.). Bidding Documents Define the project carefully to ensure it meets local procurement rules and regulations. •  Consider broader parameters, such as minimum energy savings or target systems, and •  avoid prescriptive requirements. Avoid standardizing the procurement documents too early. Once a critical mass of •  projects has been implemented, standardization can facilitate scale-up and reduce transaction costs. Consider additional steps in the bidding process (e.g., prequalification, detailed audits, •  prebidding conference, oral presentations) based on local needs and capabilities. Evaluation Process Adopt a two-stage evaluation process, where technical bids are scored first and bids •  meeting technical qualifications proceed to the financial evaluation stage. Use NPV or equivalent single, comprehensive indicator in the financial evaluation to allow •  for simple, transparent assessments while also limiting “cream skimming.� Financing In mature capital markets, attract commercial financing for ESPCs with information and •  TA. Where perceived risks are high, use credit/risk guarantees to facilitate commercial ESPC •  financing. In immature markets, particularly where liquidity is an issue, create dedicated EE funds or •  similar mechanisms to support ESPCs. Ensure flexibility of financing programs to allow for maximum market development. •  Contracting Given the inherent complexities, designate institutions (e.g., nodal agencies, agents, •  public ESPs) to facilitate public ESPC projects. Once initial ESPCs have performed successfully, develop standardized contracts to •  further facilitate public energy savings projects. Define performance parameters based on the measure being implemented and include •  a M&P plan in the contract. • Address O&M and client training in the ESPC to ensure savings persist. Is Project Bundling Really Possible? Many countries, regardless of the specific approach they use, have found that common ownership allows the bundling of many smaller public projects together into a single procurement. Typically, this is done through a parent or an umbrella agency, although it has also been done in many countries with multiple municipalities or even agencies within different departments (Box 3). Such an approach increases the aggregate size of projects, which is usually more attractive to ESPs, and lowers the transaction costs for each facility. In developing countries, bundling can send a powerful signal to private firms that there are large opportunities in the public sector ESPC business, which may help encourage more international and local firms to enter the market. However, larg- Public Procurement of Energy Efficiency Services—Getting Started | 13 Figure 4 | Recommendations for Main Public ESPC Procurement Steps BUDGET AUDIT FINANCING Progressive Prescriptive Commercial Agency’s full retention Detailed energy audit Bank lending and of EE benefits after and resulting pre- project financing to reform defined project ESPCs Certain autonomy or Mandate audit Vendor financing or fixed budget provisions leasing of agency Detailed audit from similar, representative Credit or risk guarantee Noncash refund to facility agency from ESPs with Carbon financing to retention of EE benefits Walk-through audits/ boost IRR or extend evaluation ESPC duration Partial EE benefits assigned to agency by Institutional-led low- or Financing and packag- MOF no-cost audit ing by public-private partnerships (PPPs) No agency retention, Completed audit MOF upfront subsidy/ template Financing and packag- grant/special financing ing by public entities Equipment inventory/ (e.g. super-ESPs) No retention but other bill summary incentives (e.g., awards, Public revolving fund Audit by preselected competitions) ESPs under indefinite Public financing No retention; MOF quantity contract (IQC) through public bonds, mandate on agency EE approach etc. implementation No upfront audit; Government budget for No retention; ESP detailed audit by EE projects procurement by MOF/ bidders prior to bid submission Public parent agency Restrictive Flexible er transactions can be more complex and each individual agency will have less control of the overall contract. In developing countries, very large contracts may also prevent smaller firms from participating, particularly local firms with a limited capital base. One approach considered to address this issue is to bundle public sector projects un- der a super or public ESPC, which can reduce transaction costs while still allowing for smaller ESPs to implement projects in smaller bundles. 14 | Energy Efficient Cities Initiative MODEL CONTRACT High ESP risk Performance based Full service—shared Multiyear contract and savings periodic payments based on M&V Energy supply assessment contracting—chauffage, outsourcing, contract Multiyear, flexible term energy management contract until ESP’s agreed return met ESPs with third-party financing—guaranteed Partial payment upon savings commissioning and balance paid 3–6 ESPs with variable-term months —first out contract­ contract Multiyear contract and fixed payments with Supplier credit periodic M&V, equip- ment warranty, and Equipment leasing bonus provisions Consultation with Full payment upon performance-based commissioning with payments some recourse for Consultant with fixed outer years payments Full payment upon Low ESP Risk commissioning Traditional Public Procurement of Energy Efficiency Services—Getting Started | 15 16 | Energy Efficient Cities Initiative World Bank Procurement ESPCs and World Bank Procurement Guidelines Energy savings performance contracts have been promoted in World Bank (WB) investment operations for more than a decade.2 Until now, the procurement aspects of such projects have not been an issue since the ESPC clients have mostly been in the private sector. As such, most of the operations have been classified as financial intermediation projects—where WB administered funds (IBRD, IDA, GEF, CTF) are placed in a financial institution, usually a local commercial or development bank, and on-lent for many smaller EE projects. There have also been a limited number of operations that established publicly owned ESCOs that the WB provided financing to directly. Under this approach, WB procurement was limited to the equipment purchased by the public ESCO and not the contracting between the ESCO and client. Recognizing that many ESCO markets in developed countries (e.g., Canada, Germany, U.S.) were largely developed within the public sector market, combined with renewed government interest in EE due to energy security and climate change concerns, interest in public sector ESPC projects in developing countries is rising. Further, new commitments by the WB to increase EE lending, along with its comparative advantage for providing financing in the public sector, have increased demand for such programs. These drivers have led to questions about suitable options to contract ESCOs for public clients following WB procurement guidelines and procedures. Why is ESPC Procurement Different? Unlike goods, works, or services, ESPC procurement is more complex. Key differences include: • ESPCs use output-based rather than input-based models. Unlike typical bidding doc- uments, ESPCs are bid out without specifying the precise inputs the bidders have to provide. This is needed to avoid costly upfront studies and to encourage innovation by the bidders. • ESPCs involve a blend of goods, works, services, and financing. ESPCs require pro- curement of goods (e.g., appliances, windows, insulation); works, such as revamping existing systems, constructing stand-by power and cogeneration units, etc.; and ser- vices include energy audits, project design, measurement and verification (M&V), op- erations and maintenance (O&M), training, etc. ESPCs may also require the bidders to present a financing plan as part of their bids. • Payments are based on performance rather than time-based or delivery-based con- tracts. Because contracts are based on outputs and not inputs, compensation must be linked to verification of outputs rather than the typical delivery-based schemes. This requires contracts to include clear project baselines, pre-agreed performance indicators and measuring methodologies, contract terms long enough for the outputs to accrue (which can affect typical five-year WB project durations), procedures for payment dis- putes, etc. 2 S  ome of these include: Bulgaria Energy Efficiency (2005), China Energy Conservation I & II (1998, 2002), Croatia Energy Efficiency (2003), India Renewable Energy II (1998), India Tamil Nadu Urban Development II (1999), Poland Krakow En- ergy Efficiency (2001), Romania Energy Efficiency (2002), Tunisia Energy Efficiency (2009), Turkey Private Sector Renew- able Energy and Energy Efficiency (2009), Uruguay Energy Efficiency (2004), and Vietnam Demand-Side Management and Energy Efficiency (2004). Public Procurement of Energy Efficiency Services—Getting Started | 17 • Relatively small contract sizes for ESPCs make complex WB procurement options cumbersome. Many existing bidding documents that utilize output-based, perfor- mance-based provisions are for large, multimillion dollar contracts. Therefore, even though the bid preparation costs are high, the relative transaction costs are manageable. However, most ESPCs for public facilities can be in the US$ 50,000– $100,000 range and few would be over US$ 500,000. Although some bundling is possible, many WB projects also have developmental goals related to local ESP market development, and smaller, local ESPs are often unable to bid on very large, bundled packages. • ESPCs require credible, upfront technical information. Since ESPCs are designed to solicit bids from ESPs to improve operations of an existing facility or system, the need for reliable baseline data is critical. This can be done through prefeasibility studies, au- dits, baseline surveys, or similar schemes—conducted by credible professionals. • ESPCs are often finalized after contract signing. In order to reduce bidding costs for ESPCs, detailed energy audits or project designs are generally not required as part of the initial bids; rather bidders are asked to propose their best estimate based on the avail- able information and their past experience. Once selected, an ESP then performs a de- tailed or investment grade energy audit (IGA), which establishes the detailed project baseline and determines the precise scope and investment of the project. Such a process, however, creates a risk that bidders may overpromise at the bidding stage and then re- duce the level of energy savings at the IGA stage. It also may present opportunities for bidders to inflate project costs after the IGA stage. Procurement Precedents Although ESPCs possess unique characteristics, dealing with these issues under WB procurement can be done. In fact, the WB has been moving towards output-based pro- curement schemes over the past several years and piloting a number of performance contracts. In addition, there has been growing recognition that new procurement ap- proaches may be needed to foster public-private partnerships (PPPs), such as ESPCs, which do not fit traditional contracting. A few existing models that create strong prece- dents for ESPCs include: ➜ Management services contracts. Although management services contracts are typi- cally for private firms to take over operations of utilities, the mechanics are similar to ESPCs: (i) both blend goods, works, and services; (ii) both use output-based rather than input-based requirements; (iii) both use financial bid evaluation methods other than lowest cost; (iv) both make payments based on performance; and (v) both require firms to bring in some of their own financing. However, such bidding procedures are complex and typically only used for high value contracts. ➜ Output-based or performance-based contracts. Output-based contracts have been used for a variety of infrastructure projects, but tend to be deployed mostly for improv- ing access to infrastructure services, such as water and electricity. Thus, payments are based on measurable service provisions (e.g., number of new connections, kilometers of road construction/maintenance, volume of wastewater treated). Contracts may in- clude payment reductions for lower quality levels of outputs and, in certain cases, pre- miums for exceeding the minimum quality requirements. Some infrastructure con- 18 | Energy Efficient Cities Initiative tracts also have used a “design-build� variation, which allows for design to be included in the overall contract. ➜ Cost-plus contracts. Where the precise project size is not known, the WB has used cost-plus contracts, which work like open book ESPCs. Rather than providing a spe- cific financial bid, bidders offer costs per hour for required services, agreed mark-ups for equipment and subcontracts, and use bills of quantities to itemize their expenses. ➜ Two-stage bidding. Where the technical approach is not known, unpriced technical bids may be requested first to see what solutions bidders propose. Precautions can be taken to ensure proprietary technical solutions are kept fully confidential. Issues relat- ed to minimum energy savings, ESP financing abilities, etc., can be explored in the first stage before refining requirements of the bidding documents for the second stage. However, such a process increases the costs to the bidders. Based on the existing precedents, some preliminary ideas and options for implementing EE projects using WB procurement are discussed below. Split Design and Construction Contracts Currently, most EE projects are done in two phases. Under the first phase, a consulting contract is used for an energy audit and project design. This generally involves: (i) assess- ing the current energy consumption within the facility, documenting key energy-using equipment, facility age and function, floor space, review of 12–24 months of energy bills, etc.; (ii) assessing EE potential and cost-effectiveness of various measures; and (iii) pro- posal of a project design. Often this also involves having the consultant prepare the tech- nical specifications and bidding documents for the equipment. Under the second phase, a construction firm is hired to procure and install the equipment. (Several projects in the past used two contracts for the second phase, first purchasing the equipment and then hiring a firm to construct or install, but a growing number of WB projects found com- bining the equipment and installation under a single supply and install contract was more efficient.) Such an approach is commonly used and, thus, all parties understand it. However, this method creates split accountability between the two contractors. In the event the project does not perform as expected, neither contractor will accept fault and are likely to blame the other. Further, this split does not allow design firms to develop hands-on experience with actual project performance. Similarly, construction firms are generally not allowed to propose adjustments to the design (based on their past experience), creating a suboptimal project. Nevertheless, where combining design and construction are not feasible, this may be the only way forward in the near term (Table 5A). Combined Design and Construction Contracts There has been strong interest for a number of years to combine the design and construc- tion contracts in order to reduce the number of procurements, create clearer lines of ac- countability, encourage more innovation at the design stage, and better link payments to performance. Such precedents have been used in other sectors, most notably in output- based aid contracts for infrastructure service access. However, this creates some chal- lenges for the procurement process, namely: (i) defining the parameters of the project is Public Procurement of Energy Efficiency Services—Getting Started | 19 tricky, since the design has not yet taken place; (ii) developing binding cost proposals for bidders is difficult without knowing the exact level of investment, equipment needs, etc.; (iii) fairly and transparently evaluating vastly different financial bids can be complicated; and (iv) defining and measuring the outputs for determining payments becomes more challenging. Countries that have used ESPCs have, of course, developed strategies and solutions to each of these issues. However, there is no one-size-fits-all solution. The first decision point may be to agree on the method of procurement to use, from which the other aspects will follow (Table 5B). While some of the approaches proposed can be done with existing bidding document templates, others may require some adjustments. Additional Contractual Challenges • Defining the project. A basic issue in the procurement of EE services relates to what is actually being procured. As noted earlier, ESPCs are a combination of goods, works, and services, so bidding documents need to be developed to allow for this. Additionally, the definition should be based on desired outputs, rather than pre- scriptive inputs, and include verifiable outputs on which payments would be based. WB guidelines require the establishment of key parameters that define the project in the bidding documents to ensure transparency in the subsequent evaluation of the bids. Bidding documents must, therefore, provide clear project objectives from which various approaches will be measured against, as well as outline a clear meth- odology for evaluating dissimilar bids. Some countries have relied on their upfront energy audit to prescribe the specific EE measures to be installed (most restrictive; Options 1–3, Table 5A). Others prescribe the systems to be retrofitted but not the technical solutions to be used. Some simply set a minimum set of mandatory EE measures while allowing bidders to propose additional measures. Still others speci- fy a minimum level of energy savings and then allowing bidders to develop alterna- tive ways to achieve the target level at the lowest cost (most flexible; Options 4–8, Table 5B). • Developing binding cost bids. Ensuring that bidders can adequately develop binding cost bids before the project design has taken place is critical to a project’s success. Under separate design and construction contracts, agencies can conduct in-depth upfront energy audits and then prescribe the project, making preparation of financial bids straightforward (Options 1–3, Table 5A). For combined design and construction schemes, bidding documents can either require bidders to offer full project designs during the bidding process (Options 5, 6, 8, Table 5B), request a best estimate to be confirmed after the IGA (Option 4, Table 5B), or develop unit costing with the exact design to be defined at the IGA stage (Option 7, Table 5B). Where basic facility information can be provided—such as facility function, age, energy use profile, equipment inventory, 18 to 24 months of billing data, etc.—it can greatly help bidders prepare bids within minimal upfront cost, allowing for in- novation at the bidding stage, and better establish baselines from which the project outputs would be determined. Providing case studies of similar types of facilities, and their investment costs and energy savings, can also help bidders develop proj- ect cost estimates. 20 | Energy Efficient Cities Initiative • Bid evaluation. Evaluating bids requires special attention to prevent bidders from “gaming the system� in order to maximize their scores. Picking the best overall bid must consider the evaluation of dissimilar bids, energy cost savings, and project in- vestments. For technical evaluations, WB recommends a pass-fail criteria-based evaluation. In terms of the financial evaluation, use of a single indicator, such as net present value (NPV)3, may be the most appropriate since it allows for various finan- cial factors to be aggregated into one clear indicator. Use of NPV also helps to pre- vent “cream skimming� and can enhance transparency in bid evaluation. • Defining and measuring outputs. Under an ESPC, payment to the ESP is based on the project performance. For “shared savings� ESPCs, where the ESP finances the project, the host facility is entitled to reduce the ESP payments when the savings fall below the agreed levels. For “guaranteed savings� contracts, where financing is pro- vided from the host or third party, the ESP is required to reimburse the agency for any shortfall in the guaranteed savings. For WB-financed contracts, neither model can be used as defined. For example, it is difficult to finance long-term contracts given the relatively short WB project disbursement periods. Similarly, it is difficult to require ESPs to reimburse the host or WB for payments made under the “guaranteed savings� approach. For these reasons, the procurement options presented generally involve paying the ESP in full within one to two years, before the full energy savings have accrued. Some countries have considered using performance bonds or escrow accounts (for about 10% of the contract amount) to allow for some enforceable re- course should project performance deteriorate in outer years. Project M&V is also critical, as it forms the basis for making payments. Where project EE measures are relatively simple and the level of expertise limited, simpler methods, such as deemed savings4 may be suitable. Where simpler approaches are not desirable or practical, developing proper baseline energy uses, developing clear measurement frequencies and methodologies, agreeing on factors that would change the baseline (e.g., chang- es in operating conditions, occupancy, addition of new equipment, etc.), deciding who measures and who pays for measurement, and outlining how disputes are han- dled should also be included in the M&V plan. Because this represents a markedly new approach, a number of these options will have to be tested and tailored to individual countries/programs before successful precedents can be established. And, as noted earlier, the procurement options may be constrained by the project flow of funds and WB financing program designs (see �ESPC Financing�). Ongoing innovations in alternative procurement strategies for other types of PPPs may also lead to additional viable procurement methods applicable for ESPCs. A first genera- tion of WB operations using various forms of ESPCs is now under development and results will be available and disseminated in the months ahead.5 3 WB procurement allows NPV as a criterion for goods but generally not for works. 4  eemed savings is a predetermined, validated estimate of energy savings attributable to an EE measure instead of through D additional M&V activities. Under the deemed savings approach, the public agency and the ESP agree to a simplified savings calculation procedure and the savings are then “deemed� or calculated using this procedure. For less developed markets, use of deemed savings can greatly reduce M&V costs, although it shifts some of the actual project performance risk back to the public client. 5  ee, for example, the Armenia Electricity Supply Reliability and Energy Efficiency Project (concept note approved March S 2010). Public Procurement of Energy Efficiency Services—Getting Started | 21 Preliminary Procurement Options for Public Sector EE Projects— Table 5A |  Split Design & Construction Contracts NO. MODEL DESCRIPTION 1. Standard design & civil works Agency hires consultant to conduct an audit/project design, including (CW) contracts technical specifications and bidding documents. Then procures a firm to supply and construct project. Payments are based on completion of project per design. 2. Standard design w/ output- As with Option 1, an audit is completed. Then, bidding documents are based CW contract and fixed developed based on EE output (e.g., minimum savings), allowing bidders to payments offer alternate designs. Evaluation would be based on (a) meeting minimum savings targets with technically feasible measures, and (b) lowest cost to achieve these savings. Payments would be based on delivery of project. 3. Standard design w/ output- As with Option 2, an audit is conducted and bidding documents developed based CW contract and based on EE outputs. Evaluation is based on lowest cost to feasibly achieve performance-based target. The bidding document must provide an M&V plan for how savings payments would be measured. Payments can be fully or partially based on verified savings, but would be done soon after commissioning (e.g., 60–80% at commissioning and the balance over 12–24 months). Preliminary Procurement Options for Public Sector EE Projects—Combined Table 5B |  Design & Construction Contracts NO. MODEL DESCRIPTION 4. Combined design and Unlike Options 1–3, there is no upfront design, only basic facility technical output-based CW contract information is provided (e.g., building age, area/drawings, 12–24 months of w/ fixed payments energy bills, equipment inventory). Agency issues bidding documents to design and implement EE retrofits w/ output-based requirements. Bidders submit combined technical and financial bids, which are evaluated based on technical feasibility and lowest cost to achieve the savings target. First task is design, which must be approved by client before construction. Payments are based on verification of the project based on the approved design. 5. Combined design and Similar to Option 4, except financial evaluation is based on the highest project output-based CW contract NPV and bidding documents include an M&V plan for how savings would be w/ performance-based verified. Payments could be fully or partially performance-based, with the bulk payments soon after commissioning and the balance 12–24 months later. 6. Two-Stage bidding w/ Similar to Options 4 and 5, there is no upfront audit but basic facility technical output-based CW and information provided in the bidding documents, which require a minimum performance-based of energy savings. This allows bidders to submit unpriced technical level pro- payments posals first, after which the bidding documents can be refined before requesting final technical and financial bids. Final bids are evaluated based on their tech- nical feasibility to meet the minimum savings, and lowest cost or NPV. Payments could be partially or fully based on project performance with suitable M&V plan. 7. Cost-plus CW Agency issues bidding documents with basic facility information and request bidders to provide their technical approach and unit costs/mark-ups for cost comparisons based on minimum level of energy savings. Evaluation would be lowest cost structures of technically qualified proposals. After detailed audit, the project costs are determined based on the bid unit costs. Payments would largely be based on delivery of the project with possible bonus/penalty for significant variations from minimum savings. 8. Management services As with Options 4 and 5, there is no audit but basic facility technical information contract provided in bidding documents, which specify desired outputs. Evaluation is based on minimum technical threshold; financial bids would be assessed based on highest NPV. Contract would have two phases: (i) IGA and (ii) project implementation and verification. Contract value could be amended after first phase. Payments would be based on the proposed payment schedule, but the principle defined in the biding documents would be from energy savings based on agreed M&V plan. 22 | Energy Efficient Cities Initiative PROS CONS Simplest approach, which public agencies and bidders Split accountability means public agency assumes full project understand. Good competition for bid packages performance risk. Agencies have to do two procurements. can be expected. Allows for some innovation by the bidders while better More complex bidding documents and evaluation process. linking contract awards with energy savings. Upfront audit can be redundant. Output-based bidding documents with input-based payments can create incentives for bidders to overpromise. No incentive for bidders to exceed minimum savings target. Agencies have to do two procurements. Allows for innovation by bidders. Includes performance- Requires two procurements and no incentives for bidders to based payments to shift risk to contractor and hold exceed minimum savings target. Bidders have to base their them accountable for their designs. Payments can shift bid (and payments) in part on third party designs. Bid from mostly fixed to performance-based over time, as evaluation and M&V is more complex. Public agency assumes bidders’ experience improves and markets become project performance risk in outer years. more sophisticated. PROS CONS Approach combines the design and construction tasks No incentives for bidders to exceed minimum savings target. which improves accountability of project performance Bid evaluation is complex since there is no standard design and allows bidders more ability to innovate. Involves upfront. Output-based bidding documents with input-based single procurement. payments can lead bidders to overpromise. Approach combines the design and construction tasks Evaluation is complex. High bid preparation costs by bidders which improves accountability. Use of NPV allows since there is no upfront project design. High risk to bidders to bidders to innovate and provides incentive to maximize develop binding cost bids without detailed audit. Performance- cost-effective savings. Involves single procurement. based payments may make access to working capital more difficult. These may result in fewer qualified bids. Approach combines the design and construction tasks Evaluation is complex and bidders have no incentive to which improves accountability and ability to innovate. exceed minimum savings. High bid preparation costs (since First stage may lead to additional opportunities for there is no upfront project design) and high risk to bidders energy savings not initially identified by the public to develop binding cost proposals without detailed audit; agency. Involves single procurement. these may result in fewer responsive bids. Can take long time and may not be suitable for small projects. Approach takes away much of the bidding risk from the Cost structure comparisons may not yield lowest cost project firms by not requiring them to provide full project costs since quantities of inputs is not known during evaluation. before the project has been designed. This can Payments are less performance-based which creates risk to encourage firms to participate and result in lower risk agency and limits incentive for firms to exceed energy savings premiums and lower overall project costs. Evaluation target. is more straightforward. Approach promotes maximum innovation, maximizes Complex and requires long lead times to develop suitable benefits to the public agency, shifts performance risk bidding documents and process, train agency staff and to the private sector, mobilizes commercial financing, prospective bidders. Transaction costs will be high. Not etc. Involves single procurement. suited for small projects. Few bidders may qualify/participate. Public Procurement of Energy Efficiency Services—Getting Started | 23 ESPC Financing Financing Models and Options A critical aspect of ESPCs is the nature of project financing, which will have implications on the procurement type and method. Some governments may prefer to finance such proj- ects on their own, especially if they are able to access lower cost financing than a commer- cial ESP. Examples include municipalities that can sometimes access low-cost (or tax-ex- empt) bonds, governments that can access long-term multilateral development bank or concessional donor loans, public revolving funds, DSM programs, etc. In other cases, gov- ernments may view ESPCs as an attractive mechanism precisely because they represent an alternate way for governments to finance EE projects off-budget. Despite the attractiveness of the latter option, the ability for ESPs, particularly local firms in developing countries, to actually mobilize financing on their own balance sheets can be limited. A range of financ- ing options should be carefully assessed and the one(s) most likely to succeed in a given market developed should be further developed. The selected financing scheme then must be clearly presented in the bidding documents. For WB-financed projects, there are a number of plausible options for ESPC financing (Table 6 and Figure 6). A brief discussion of these alternatives is presented below. • Credit lines. By far the most common option, used extensively by the WB, is to es- tablish a credit line either through a development or commercial bank. The bank then uses the loan proceeds to provide many subloans to eligible borrowers for EE projects, which can be in the public or private sectors. Credit lines may offer a range of products, such as on-balance sheet financing, working capital loans to ESPs, proj- ect financing (against future energy savings cash flow), or project refinancing—that is, the purchase of ESP project receivables from completed projects (also known as factoring or forfeiting). Where the sub-borrower is private—either a private client or ESP—the WB requires that acceptable commercial practices (CP) be used for the procurement of goods and services. For public sub-borrowers, local public procure- ment rules typically apply. • Credit Guarantees. Where sufficient liquidity in the market exists, the WB has sought to leverage commercial financing for EE projects, including ESPCs, using partial cred- it or risk guarantees—often using GEF grants. Such an approach has been used where the perceived risks for EE and ESPC projects are high, the target market has greater credit risks (e.g., small and medium enterprises or SMEs, housing cooperatives), or the credit market terms (loan tenors, collateral requirements) make EE projects unattract- ive. These are usually administered by commercial banks, but in some cases were done through a development bank, guarantee company, or other qualified institution. Since WB funds are used to cover defaults or other losses, and not finance projects directly, WB procurement has not applied.  ublic ESPs. Another option is to lend directly to a public ESP for financing a portfolio • P of subprojects. The public ESP or public ESCO model has been more commonly used in recent years, with some form of public ESP now in about a dozen countries (Table 3). As noted in “Procuring Energy Efficiency Services,� because public sector clients and the ESP are both publicly owned, no competitive procurement is usually required. 24 | Energy Efficient Cities Initiative Figure 6 | Decision Tree for Public EE Financing Options Do local commercial banks Are banks willing to on-lend other funds to public agencies/ have sufficient liquidity? NO ESPs and accept reasonable credit risks? YES NO YES Create credit line or Explore public financing, Why aren’t banks lending revolving fund fund, or public ESP for EE now? Lack know-how to appraise • Provide TA to banks EE projects and assess risks • Create fund/credit guarantee to demonstrate EE project performance and risks Restrictive on-lending • Explore lending through municipalities/ESPs, refinancing ESP projects, public terms or project financing, wholesale lending to other banks/funds • Assess feasibility of public ESP Projects are too small • Bundle public EE projects under one city, province, ministry, etc. • Develop pooled financing through a fund or ESP (public or private) No or low quality loan • Provide TA to public agencies and ESPs to prepare quality, bankable projects applications • Disseminate templates and case studies, training • Issue ESP tenders, offer partial grant support, etc., to generate early pipeline Restrictions on lending to • Assess feasibility of credit guarantees, fund, refinancing of ESP projects, or public agencies public financing to help lower security requirements, extend loan tenors, etc. • Explore viability of creating public ESP to help demonstrate market viability No ESPs to develop and • Issue public tenders for ESPs; develop large bundles for international ESPs implement projects • Develop simple ESPC approaches using local business models, offer ESP training • Consider partial project grants to help prime market in short term Public Procurement of Energy Efficiency Services—Getting Started | 25 Table 6 |  Financing Options for ESPC Projects under WB Projects FINANCING MECHANISM MARKET CONDITIONS EXAMPLES Credit lines Many small subprojects in the public and private sectors India Renewable Energy II (1998) •  Good banking partners willing to lend and assume risks  China EE Financing I & II (2006, 2010) •  ESPs exist in market to provide basic services •  Turkey Private Sector RE & EE (2009) Liquidity is an issue •  Tunisia EE (2009) Credit Many small subprojects in the public and private •  China Energy Conservation II (2002) guarantees sectors Philippines Electric Cooperative System Good banking partners willing to lend and share risks •  Loss Reduction (2004) ESPs exist in market to provide basic services •  Tunisia EE Program/Industrial Sector Liquidity is not an issue •  (2004) Other projects IFC Hungary Commercial EE Financing (1997) IFC CEEF (2002) IFC China Utility-based EE Finance (2006) Public ESPs • No local ESPs willing or able to serve public sector China Energy Conservation (1998) clients or finance Croatia EE (2003) Traditional on-balance sheet financing insufficient •  Poland EE (2004) to develop EE market China Shandong EE (2011)—proposed Public procurement rules make hiring of ESP •  problematic Other projects Credible public entity exists with demonstrated •  EBRD Ukraine ESCO Financing (1998) capacity to service public sector, take on debt, and ADB Philippines EE—EC2 (2009) capacity to subcontract and manage subprojects Funds Many small subprojects •  Bulgaria EE (2005) Local commercial banks unable or unwilling to enter •  India Tamil Nadu Urban Development II into EE market (1999) ESPs exist in market and willing to provide basic •  Romania EE (2002) services Uruguay EE (2004) Some subproject cofinancing is available •  Armenia Electricity Supply Reliability and Credible and proactive fund managers can be •  EE (2011)—proposed recruited Public • Target market is public sector only Ukraine Kiev Public Buildings EE (1999) financing Credible ESPs willing and able to bid on bundled •  packages and access working capital Public budgeting and financing allow for such project •  financing and repayments Project • Large, credible local and/or international ESPs able WB projects (none) financing and willing to bid on bundled package •  Strong central public entity able to bundle and Other projects organize subprojects IFC Hungary OTP Sub-Sovereign Relatively homogeneous bundles of facilities exist •  Schools EE (2006) and willing to undertake project 26 | Energy Efficient Cities Initiative PROS CONS Relatively straightforward to prepare and only a small Relies on banking partners and existing market to identify and portion of projects need to be identified upfront; allows prepare projects, which may not be enough to catalyze market; for flexibility of financing structures and procurement ESPs take time to develop; developing ongoing robust pipeline methods. has been difficult; partnering with one bank can inhibit com- petition; banks prefer on-balance sheet loans to creditworthy customers making development of new markets more difficult. Relatively straightforward to prepare and only a small Guarantees to cover nonpayment of public entities can create portion of projects need to be identified upfront; allows moral hazard; requires proper risk sharing that some banks for maximum flexibility of financing structures and may not be willing to accept; ESPs take time to develop; procurement methods; leverages local commercial developing ongoing robust pipeline has been difficult. financing; can result in more sustainable, competitive Can eliminate public procurement issues and reduce Public ESCO can be monopolistic and may be subject to transactions costs; more easily channel WB/public public sector bureaucracies (procurement, staffing, financing ESPC projects, potentially allow for more budgeting); some appropriate exit strategy for the public bundling of projects and equipment procurement; ESCO may be needed if private ESPs wish to enter the market. can proactively drive market; can help foster commercial ESPs through subcontracting. Can provide more flexibility than credit line if Creation of new fund requires governance structure, staffing, guarantees, mezzanine financing are allowed; can piggy business plan, etc., which can take time; relies on fund back on existing development fund; fund may be able manager/ partners to identify and prepare projects, which to bundle public projects and procure ESPs directly; may not be enough to catalyze market; developing ongoing can incentivize fund manager to target underdeveloped robust pipeline has been difficult; fund can act monopolistic. markets. Scheme overcomes the critical hurdle of ESPs inability Value-added of WB financing of ESPC directly may be limited; to take on large debt with public third party financing; under alternate schemes, ESP is required to use WB procure- WB-backed contracts can help reduce perceived ment rules, which can discourage equipment suppliers from contractual risks by international ESPs. bidding, or offering full performance guarantees; enforcement of guaranteed savings contract would be more problematic. No need for business and investment plans, pipeline Project size must be large, which makes transaction more development, ongoing TA, etc., as there is only one risky; few ESPs may have capacity and ability to bid; requires transaction; transaction costs will be low given the large coordination across many agencies to work; WB processing project size; options for bulk equipment procurement, more complex with risks of delays (from appraisal to sampling of audits/ M&V, etc., exist to further reduce effectiveness) once procurement is completed. project costs. Public Procurement of Energy Efficiency Services—Getting Started | 27 In these cases, however, goods and services (e.g., equipment, engineering and audit services, installation subcontracts) procured by the public ESP receiving the WB loan are subject to WB procurement rules. Typically, this has meant use of international competitive bidding (ICB) for larger procurements; national competitive bidding (NCB); international and national shopping for medium-sized procurements; and CP for small procurements.6  unds. Where banks are not desirable or feasible, another option is to channel WB fi- • F nancing through special funds, which can include special purpose funds (Bulgaria, Romania, Uruguay), municipal development funds (Tamil Nadu, West Bank), public revolving funds (Armenia), etc. This is more common when the primary beneficiaries are public or seek to serve a market underserved by traditional commercial financial institutions (e.g., schools, municipalities, SMEs). Funds can be publicly or privately managed, often with performance-based fee structures, and sometimes have both pub- lic and private capital sources. When they target private borrowers, CP generally ap- plies. However, for public sub-borrowers, WB procurement rules apply. Use of some of the procurement and contracting options presented in �World Bank Procurement� may be required. • Public Financing. Another option involves WB lending to a public entity, such as the Ministry of Finance (MOF) or a municipality directly.7 Under this scenario, the ESP can either be required to mobilize financing or not. In the former case, the ESP would mobilize its own financing and implement the project. The public client could then use the WB loan proceeds to cover the ESPC payments. The ESP would still be required to conduct M&V to justify payments.8 Since the host facility’s energy sav- ings would not be used to pay the ESP, these funds could be held back by the MOF to eventually repay the WB loan or used to create a revolving fund to finance addi- tional public sector ESPC projects. Another option is to use the WB loan to make accelerated payments to the ESP (perhaps a 60-80% payment upon commissioning and the rest over 12–24 months), and then use the energy savings stream to repay MOF (Option 5, Table 5B). If ESP financing is not deemed necessary or feasible, then the proceeds of the WB loan can be used to actually finance the project with the ESP providing a savings guar- antee, where they assure the client that the savings will be sufficient to service debt re- payment obligations. However, as noted earlier, in practice this can be difficult to en- force since most public contracts (including those of the WB) do not include provisions for contractors to reimburse public clients for poor performance (although some form of bank guarantees, trust/escrow accounts, performance bonds, etc., may help address 6  hresholds for these vary. For China Energy Conservation, ICB was required for contracts over US$ 2 million, NCB T for contracts under US$ 1 million, and shopping for the rest (with aggregate thresholds). Under Poland and Croatia EE Projects, ICB was required for contracts over US$ 350k and CP for smaller contracts (with an aggregate threshold). However, this was revised for the Croatia project during supervision to allow for CP under US$ 750k with the aggregate threshold removed. 7  ne approach now being considered in Macedonia involves “budget capture,� where MOF borrows funds, provides funding O for EE improvements through annual municipal budget provisions, and then captures the repayments (from energy cost savings) in future budget allocations. 8 S  uch a scheme does raise questions about the value-added of the WB loan, since the creation of an energy savings stream would allow the agency to make payments to the ESPC. However, many ESPs, particularly international ones, may be more willing to enter into medium-term contracts with WB backing (alleviating concerns over contractual, political, or other risks). Further, many public entities may not be capable of entering into such complex contracts on their own or local pro- curement rules may not allow for such contracting options. 28 | Energy Efficient Cities Initiative such issues). In such cases, a few options exist: (i) the ESP designs the project and serves as a procurement agent on behalf of the municipality using the WB loan; (ii) the municipality uses a cost-plus arrangement where the ESP is reimbursed for their ex- penses (Option 7, Table 5B); (iii) the ESP is hired under a guaranteed savings contract, where the client has the ability to assess penalties for underperformance; or (iv) the ESP is hired under a management services contract with the ability to be reimbursed periodically for procurements from the proceeds of the WB loan (Option 8, Table 5B). In these cases, any procurement requirements for the selected ESP must be noted clearly in the bidding documents.  roject Financing. Another approach is to finance a large ESPC project directly. • P For example, if a municipality planned to retrofit a large bundle of buildings, say 100 to 200, then the entire project could be bid out under a single tender using ICB, and the WB proceeds used to finance the contract. Such a transaction would only be appropriate for large contracts, but may be attractive for smaller countries where no local ESP markets exist. Under such a scheme, the borrower may be the national or municipal government. The choice of financing mechanism, of course, depends on many factors, including the coun- try context, state of the ESP and credit markets, institutional capabilities, subproject needs, business models, procurement restrictions, etc. Deciding on the most suitable mechanism should be based on a holistic market analysis, identification of key barriers, and stakeholder Public Procurement of Energy Efficiency Services—Getting Started | 29 dialogue. Where possible, partner financial institutions should be selected competitively to ensure strong commitment and suitable terms. Such programs should also be flexible to al- low a greater variety of financing schemes (i.e., loans to ESPs, clients, project finance, leases, etc.). And, project bundling can greatly help lower transaction costs while ensuring strong disbursement and utilization rates. Getting Started Before one becomes too involved in the details of the procurement or financing schemes, it is advised to get a solid understanding of the market and its failures, assess institutional capabilities and needs, and identify other opportunities and constraints. Identifying viable business and contractual models for ESPs to operate in a particular country or region should be done before any complex financing and procurement schemes are contemplated. Early consultations with procurement staff, both WB and local staff, is also important to help formulate coherent strategies. It is advisable to begin with simpler models first and develop more complex transactions as the market develops. Familiarity with ESPC models developed in OECD countries can be important in understanding the range of options but those models need to be carefully adapted to work in developing countries. Where local ESPC experience exists, it may be prudent to build on successful transactions and institu- tionalize those aspects that have worked well. It may also be worth considering efforts to bundle projects to reduce transactions costs and make such projects more attractive to larger ESPs. In addition, assessing the relative capacities of the ESP industry and public agency staff is critical to ensure success. The level of sophistication of ESPCs, the ability of local firms to access and provide financing, and the willingness of local firms to assume project risks and other factors must be evaluated. Efforts should be devoted to developing incremental ad- justments to existing procedures and practices, rather than seeking broad changes to local laws and regulations. Some key steps to consider include: 1. Conduct an upfront market survey of ESPs to gauge their level of interest in serving the public sector market, their capacity to offer various services (e.g., design and con- struction, financing, performance guarantees), and their technical capabilities. Also assess public agency needs and abilities for complex contracting and accessing financ- ing (i.e., creditworthiness). 2. Hold stakeholder consultations to analyze barriers, assess the types of constraints ex- pected in public procurement of ESPCs, and define the nature and relative priority of the main barriers. Stakeholders should include public officers (budgeting, procure- ment, technical, legal), prospective ESPs, financiers, etc. 3. Formulate a list of options for surmounting each of the main barriers, as an approach to developing possible road maps to navigate the procurement process. Consider sim- ple approaches first, such as one-year contracts, fixed payments with bonuses, simpler technical systems (e.g., lighting), etc. 4. Once procurement plans are developed, test small procurements, documenting all the challenges faced, and work collectively to refine the procurement process. Projects may need to allow for alternate procurement options to be tested in order to assess which 30 | Energy Efficient Cities Initiative ones are most effective at meeting the project objectives. 5. Efforts should then be made to expand and replicate successful schemes, seeking op- tions to scale up by broadening the range of target systems and bundling of facilities together. As successful models are validated, institutionalize systems by developing model tem- 6.  plates and documents, aggressively disseminating results, seeking longer term changes to public procurement and budgeting systems, creating incentive schemes and financ- ing programs, instituting ESP prequalification/certification, and setting targets and out- lining M&V frameworks. As simple schemes are implemented and yield results, the program can develop a system- atic approach to market evolution—moving to more sophisticated models, larger bundles, increasing commercial leverage, etc. In such a way, the market can be developed through a series of incremental enhancements (Figure 7). As the public sector market thrives, ESPC models developed and promoted in the public sector are likely to have significant ripple effects in the private sector, as private firms ob- serve what the public sector is doing, and participating ESPs enhance their capabilities and begin to market their services to other sectors. While private sector models may ultimately determine their own paths, the precedents and expertise established in the public sector will be critical to help foster a sustainable ESP industry that is capable of serving the entire market and delivering scalable EE gains in the years ahead. FIGURE 7 |  Building the Market—Step by Step Full commercial financing “Full service� ESPCs Lo an gu ara nte e fu nd Combined design/supply contracts with Re vol partial performance-based payments vin g fun d Bu Contracts with deferred final payment dg et sup po rt Contracts with small energy savings bonus Supply and install contracts with energy savings reporting Public Procurement of Energy Efficiency Services—Getting Started | 31 ACRONYMS AND ABBREVIATIONS € Euro BTU British thermal unit CCS carbon capture and storage CO2e carbon dioxide equivalent CP commercial practices CTF Clean Technology Fund CW civil works DSM demand-side management EE energy efficiency ESP energy service provider ESPC energy savings performance contract ETP Energy Technology Perspectives (IEA publication) FBI Federal Building Initiative (Canada) FEMP Federal Energy Management Program (United States) GDP gross domestic product GEF Global Environment Facility GHG greenhouse gas Gt gigatonne IBRD International Bank for Reconstruction and Development ICB international competitive bidding IDA International Development Association IEA International Energy Agency IFC International Finance Corporation IGA investment grade audit IQC inadequate quantity contract IRR internal rate of return Kt kilotonnes M&V measurement and verification MOF Ministry of Finance Mt million tonnes Mtoe million tonnes of oil equivalent NCB national competitive bidding NPV net present value OECD Organisation for Economic Co-operation and Development O&M operations and maintenance OTP Országos Takarékpénztár Bank (Hungary) PICO public internal performance contracting ppm parts per million PPP public-private partnership RFP request for proposal SME small and medium enterprise TA technical assistance US$ United States dollar WB World Bank WEO World Energy Outlook (IEA publication) 32 | Energy Efficient Cities Initiative Photo Credits Cover: S. Constantio / The World Bank. Pages 2, 9, 16, 29 and inside front cover: stock.xchng. Pages 12 & 15: iStockphoto. Production Credits Design: Naylor Design, Inc. Printing: Automatic Graphic Systems, Inc. Copyright © November 2010 The International Bank for Reconstruction and Development/THE WORLD BANK GROUP 1818 H Street, NW, Washington, D.C. 20433, USA The text of this publication may be reproduced in whole or in part and in any form for educational or nonprofit uses, without special permission provided acknowledgement of the source is made. Requests for permission to reproduce portions for resale or commercial purposes should be sent to the ESMAP Manager at the address above. ESMAP encourages dissemination of its work and normally gives permission promptly. The ESMAP Manager would appreciate receiving a copy of the publication that uses this publication for its source sent in care of the address above. All images remain the sole property of their source and may not be used for any purpose without written permission from the source. Public Procurement of Energy Efficiency Services—Getting Started | 33 The Energy Sector Management Assistance Program (ESMAP) is a global knowledge and technical assistance program administered by the World Bank that assists low- and middle-income countries to increase know how and institutional capacity to achieve environmentally sustainable energy solutions for poverty reduction and economic growth. We welcome the opportunity to hear what your city has done to meet these energy challenges at: esmap@worldbank.org. To learn more about Energy Efficient Cities Initiative, please visit our website at: www.esmap.org or write to us at: Energy Sector Management Assistance Program The World Bank 1818 H Street, NW Washington, DC 20433 USA email: esmap@worldbank.org web: www.esmap.org