Energy performance contracting and public-private partnership: The importance of technological advanced systems for performance monitoring

Martiniello L.;Morea D.

;Paolone F.;Tiscini R.

2020-01-01

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Abstract

Public Private Partnership (PPPs) arrangements are a well known tool used by the public sector to build and manage public infrastructures or other assets through private partners able to improve efficiency, reduce risks and ensure financial resources. In recent years, promoting energy efficiency of public buildings ensuring environmental and social sustainability, became a central issue for Public Administrations (PA). For this reason, many Administrations are signing Energy Performance Contracts (EPC) mainly with Energy Service Company (ESCO), to perform one or more activities related to the provision of energy services generally involving initial investments for co-generations plants, heating, ventilation and air-conditioning assets, thermal insulation of buildings and installation of solar panels or led lights. The implementation of these energy efficiency systems is normally accompanied by the introduction of technological advanced systems for performance monitoring. These systems are based on intelligent building energy monitoring and on the Internet of Things (IoT), considered useful technologies to achieve real-time monitoring and control, and improve the energy-saving of intelligent building (Chuyuan and Yongzhen, 2011). These monitoring and control systems are even more important in the context of PPP because they allow a correct allocation of risks between partners and give, to the Public Administration, the possibility to develop control activities necessary to set better pay for performance mechanisms. The research question of this paper is consistent with this framework and focuses on how the main risks of energy efficiency investments through EPC contracts fit with PPP schemes. The issue of the higher public-to-private risk transfer will consequently be examined, showing that advanced monitoring system impact positively on risk allocation. Experience shows that unconditional payments to the private players may easily be transformed into undeserved rents. It will be shown that better contract agreements in terms of benefit sharing can be reached when monitoring activities can be managed by the public partner, through technological advanced control systems. The EPC contracts, define parties' obligations and rights and can be based on different models for delivering public energy efficiency projects. According to literature their adoption is still far from its potential mainly because of two unresolved issues (Carbonara and Pellegrino 2018): i) “the dilemma of equally sharing the benefits between the public and private parties so as assuring a win-win condition, and ii) the lack of adequate public procedures that support the selection of the most appropriate EPC scheme given certain circumstances and projects' characteristics”. These authors classify under the EPC contracts umbrella three different contractual agreements: i) Guaranteed savings contracts, in which the ESCO is responsible for the design, implementation and performance of the project but not for its financing; ii) Shared savings contracts, in which the ESCO is responsible for the design, implementation and performance of the project and share an agreed percentage of energy savings with the client, also bearing credit risk; iii) First-out contracts, in which the ESCO is responsible for the design, implementation and performance and retain 100% of the energy savings until the end of the contract. In this case the greater the savings the shorter should be the contract, and ESCO bears credit risk. Another vein of literature (Zhijian and Shuai, 2016; Zhenfeng et al., 2019) observe that Energy Performance Contracting faces many severe risks that hinder its development. These authors identify the key risk factors, and proposing some policy implications for China's decision-makers to draft effective measures and policies to promote the harmonious development of EPC. They focus on 21 risk factors divided in five categories including: 1) external environmental risks, 2) managerial and operational risks, 3) financial and market risks, 4) technical risks, and 5) client risks. Moreover, literature analyze the advantages of EPC mechanism for delivering energy efficiency projects and explored the critical success factors of EPC (Fiaschi et al., 2012; Roshchanka and Evans, 2016) identifying three main barriers to carry out these projects in the public sector: i) budget constraints, ii) lack of effective and efficient management, iii) lack of technical skills (Lee et al., 2003). While many authors focused on advantages, disadvantages, efficiency and risks of EPC contracts, the peculiarity of public procurement process and the necessity of choice between different EPC schemes to balance the private sector's profitability needs and the public sector's economic and non-economic interests, have been little addressed by the literature. At the same time a gap in literature regards the advantages of energy performance monitoring systems for the public administration. It seems necessary to fill this gap by answering to the following research questions. 1) Which kind of “PPP- EPC contracts are able to provide an optimal allocation of the risks ensuring value for money for the partners? 2) Technological advanced monitoring and control systems are a useful tools for the public partner, able to ensure a better risk transfer? In particular, the first part the paper aims at identifying and discuss the main risks that discourage or limit the adoption of EPC contracts, including on-off balance accounting treatment of the energy investments, looking for solutions to mitigate risks and promote successful and sustainable partnerships. The second part of the paper discuss the usefulness of IT monitoring solution for the PA to ensure a better allocation of risks between partners The third part of the paper, building upon the model proposed by Carbonara and Pellegrino (2018) for assessing and benchmarking the net benefit of the different EPC structures, aims at indenting contractual structures able to minimize the difference between the Net Present Value (NPV) gained by the contractual parties’ in a long term agreement. To test the thesis of this paper a case study is implemented. It refers to the sign of a EPC-PPP contract for building energy efficiency in the health sector. In particular, the AL Hospital launched a public procurement to identify a private operator able to realize 16 million euro investments and manage the related energy services for a value of about 10 million euro per year. Simulation on the NPV achieved by the project under different allocation of risks and under different contractual agreements are carried out to demonstrate that the optimal contractual structure arises from a mix of different existing contractual schemes and that investments in intelligent monitoring technologies are able to enhance value for money ensuring an optimal allocation of risks and better pay for performance mechanisms. Data for the case study are collected from internal documents and semi-structured interviews with the Public officer in charge of this project. We use the Carbonara and Pellegrino (2018) model as an interpretative lens to understand which net benefit are gained by each party through EPC contract and to look for the existence of new contractual agreements able to ensure balanced economic benefits for the parties in a long term concession. Thus, our findings show that nevertheless the theory identify the “First out” contract as the contract that satisfies both the ESCO and the PA by minimizing the difference between NPVEsco and NPVG, in a long term contact a mix of “First-out” contracts clauses and “Shared savings” clauses can avoid the distortion (identified in literature) of excessive benefits gained by the ESCO during the concession period. Additionally, the results of this paper support the public authority in the decision-making process about the adoption of advanced monitoring system in energy efficiency project in PPP. The paper is novel because it provides significant results on the value of public choices, feeding decision-making in a logic of improved value for money for the public partner. The results of this paper can be used by the academic community, practitioners and policymakers as theoretical and practical advances.