Energy as a Service – are you at ease with EaaS?

Additionally, energy-as-a-service (“EaaS”) arrangements are not a new concept, but the current energy crisis combined with the continued organisational energy transition push means that EaaS has seen a resurgence in popularity.    One reason for this is that many energy consumers (particularly large energy consuming organisations with significant physical assets) cannot fully achieve their energy transitional / net zero goals through just corporate PPAs.  EaaS arrangements can also have other (economic) benefits including enhanced energy security, re-using what would otherwise be waste outputs (heat, CO2, production by-products that can be used as a fuel source, etc.), cost savings and new income streams.  There are now more energy services companies (“ESCOs”) and funders (with energy transition funding pots) in the market offering various EaaS commercial, technical and legal solutions.

EaaS deals can be structured in a variety of ways.  The four fundamental questions are: who undertakes the core activities (design, build, operation and maintenance of assets necessary to provide the EaaS)? who funds those activities? who owns the underlying EaaS assets? and what is the service / payment model?   Often energy consumers procuring EaaS solutions want a deal structure in which the ESCO undertakes the core activities (at the ESCO’s cost) with the ESCO then providing the EaaS (through the EaaS assets owned by the ESCO with a contractual process regarding what happens to the assets on expiry or early termination) in return for a service fee.  Sometimes, this may not be the optimal deal structure – e.g. the energy consumer may: be better placed to undertake (or procure the undertaking) of some of the core activities (including potentially as the ESCO’s contractor); fund some of those activities (e.g. to assist with bankability); and/or own the EaaS assets (e.g. where such assets are operationally critical).

The service delivered by the ESCO (and the associated payments) can themselves be structured in a variety of ways, often driven by the underlying solution(s) that the ESCO is providing.  Options include guaranteed / performance savings, availability, avoided costs and metered supply.

A key consideration is the accounting treatment.  In this paragraph we share some thoughts from a legal perspective (recognising that we are not accountants).  Although an EaaS deal structure does not have to be so structured, it is common for the energy consumer to require that the EaaS deal is structured such that the EaaS assets must be “off-balance sheet” on the basis it is not a “lease” (e.g. under IFRS 16 (Leases) and associated standards such as IFRS 9 (Financial Instruments)).   In that situation, the  internal and external legal teams’ collective role is to work with the energy consumer and ESCO’s respective accountants and auditors to document the deal in a way that reflects guidance from such accountants and auditors.  Sometimes it is not optimal to structure an EaaS deal this way (e.g. because of other priority commercial objectives).  Even in this situation, the legal teams’ role is to work with such accountants and auditors as well as others (e.g. the deal’s commercial and technical teams) to document the deal in a way that enables such accountants and auditors to identify (among other things): which identifiable assets are the subject of a “lease” (potential relevant if any assets are of low value) – e.g. by having a detailed list of such assets in the contract; and which parts of the service and service payments are lease payments (e.g. the contract provides a description of each service and the associated payment with a clear indication of the extent to which payments are fixed or variable).

Other key considerations for an EaaS include:

• Determining when EaaS is the optimal solution for an energy consumer: among other factors in the decision making process, it is important to undertake technical, commercial and legal due diligence.  On legal this can include the energy consumer diligencing such things as its existing property, financing, regulatory and operational legal arrangements to determine if there are any barriers (and how they can be overcome) in implementing EaaS solutions.
• Standardisation to achieve scalability: the objective here is to create standard documentation and processes (including legal) that enables an energy consumer to roll out EaaS as an organisation wide programme done in a timely and cost effective manner.  We have seen both public and private energy consumers taking their own lead on this.  Some ESCO’s and other stakeholders (e.g. energy transition funders) are also creating EaaS commercial contract and financing tools to assist energy consumers.    Government bodies and industry organisations also have an important role with some good examples of template contracts and guidance documents (e.g. on procuring EaaS).
• Change Management Programme: EaaS deals typically require input from a range of decision makers and implementers within an energy consumer’s organisation, both to document the deal and to manage the contractual and commercial relationship and monitor on-site performance.   Such people may be less familiar with EaaS deals.  This may require a capacity building and change management programme within the energy consumer’s organisation (which can form part of a broader energy transition / net zero programme).
• Contractual risk / reward allocation: energy consumers will want to pass on as much risk as possible to the ESCO.  The ESCO (and their funders and supply chain) will want the risks allocated to it to be proportionate to the reward derived from providing the EaaS.  Natural tensions can arise – a key one being the extent of each party’s liability to the other for economic loss and the extent such liability can be mitigated and managed beyond allocating such liability to either party.  Mitigation examples include technical solutions which provide operational early warnings (combined with appropriate contractual problem identification and rectification mechanisms) as well as increasingly innovative insurance products tailored to the EaaS market (whether such products are standalone or extensions / modifications to usual policies).
• Dealing with change: if the contractual term is longer than a few years, then any on-site changes, such as plant and equipment upgrades, or change in law, will need to be dealt with in the contract.

The same trends which are revolutionising other industries are also revolutionising the energy markets. As new digital and green technologies and an increased customer demand for flexibility have risen, so has the EaaS model. Energy consuming organisations should take the time to understand EaaS model and the extent to which it can form part of their energy transition / net zero strategy.  As the model evolves, so will its application to other utilities (e.g. water) and resources creating the possibility of it being rolled out to a broader range of activities.