A Risk-Adjusted Financial Feasibility Model for ESCOs: Introducing Payment from Savings (PFS) Concept

• Identifies Key Barriers: ESCO projects face financial risk due to high initial costs and uncertainty in shared savings revenue. • Proposes Two Innovations: Introduces a risk-adjusted financial feasibility model and a novel “Payment from Savings” (PFS) approach. • Analyses Optimal Shared Savings: Determines that optimal shared savings rates, particularly in public street lighting, should be very low (≤5%), even potentially 0 %. • Demonstrates PFS Benefits: Shows that even with a 0% shared savings rate (PFS), the client receives significantly greater marginal cost-benefits (7.84 times more than the ESCO). • Advocates for PFS Adoption: Argues for adopting the PFS concept due to its increased benefits for clients, exceedingly even scenarios where no partnership exists. The comprehensive energy solutions offered by ESCOs (Energy Service Companies), encompassing energy audits, design, implementation, financing, and guaranteed savings, are often hampered by high initial costs and the uncertain revenue generated through shared savings agreements, thereby posing substantial financial risk for the ESCO. To address these challenges, this paper proposes two innovative concepts: (1) a risk-adjusted financial feasibility model, and (2) a novel “Payment from Savings” (PFS) approach, grounded in an analysis of optimal shared savings rates within energy efficiency projects, resulting in a 0% shared savings scheme for the client. This financial model incorporates a risk assessment, utilising the Capital Asset Pricing Model (CAPM) along with exchange rate and inflation volatility to derive the discount rate. The adjusted discount rate is then applied within Net Present Value (NPV) and Internal Rate of Return (IRR) calculations to assess the economic viability of various shared savings schemes. Results indicate that the optimal shared savings rate for public street lighting should not exceed 5%. Significantly, even under a 0% shared savings rate, or the proposed PFS concept (where 100% of savings are allocated to the ESCO), the ESCO still faces a moderate level of risk, with the IRR remaining below the calculated discount rate in our 30-year case study. Nevertheless, clients enjoy considerably greater marginal cost-benefits, exceeding those of the ESCO by a factor of 7.84, and proving 1.17 times more favourable than pursuing no partnership. Consequently, this paper advocates for the adoption of the PFS concept.