Development of an Area Based Energy Service Company (ESCO) model for Solar Water Heating in India

20 Sep 2010
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Summary

The publication focuses on how to develop an area-based Energy Service Company (ESCO) model for solar water heating (SWH), and to assess the potential of carbon financing to achieve scale in SWH development in the country.



Internationally, solar water heating has been identified as one of the most promising decentralized solar applications, having significant potential to reduce electricity consumption and consequent emissions reduction. It is being increasingly recognized as an application that can help urban areas and industries in reducing their dependence on grid and reducing diesel/gas consumption.



India has been bestowed with abundant solar energy, available almost around the year. The gross potential for solar water heating systems in India has been estimated at 140 million sq. m. of collector area. Of this, 40 million sq. m. has been estimated as the realizable techno-economic potential at this stage. All over the world, high initial cost of the Solar Water Heating System (SWHS) has been found to be the major hurdle for large-scale deployment of SWHS. In India, a total of 3.53 million sq. m of collector area has been installed so far in the country, for SWH. The achievement so far has been modest compared to the overall potential. However, a reasonable infrastructure has emerged and experience is available for manufacture and installation of SWHS.



Several schemes for promotion of solar water heaters have been in operation in the country. While most of these schemes were developed and coordinated by Ministry of New and Renewable Energy (MNRE), some schemes were developed at the State level. Some of the incentives from the central government included provision of soft loans to the users under the interest subsidy scheme through a network of financial institutions, public/private sector banks, scheduled co-operative banks, RBI approved non-banking financing companies. In addition, capital subsidy has been made available to builders and developers/ development authorities/ housing boards/ cooperatives/ Group Housing Societies for providing solar water heating systems in new buildings and housing/ commercial/institutional complexes.



The Energy Conservation Act 2001 authorises the Bureau of Energy Efficiency (BEE) to prescribe guidelines for Energy Conservation Buildings Code (ECBC). BEE has developed ECBC, which sets minimum energy efficiency standard for design and construction. ECBC is expected to impact and promote market development of various energy efficient products including solar water heaters. SWHS are included among the building components covered under ECBC. SWHS are required to meet at least 20% of the design capacity for water heating.



In view of the high solar radiation over the country and with the twin objective of contributing to India’s long-term energy security and its ecologically sustainable growth, the Prime Minister launched the Jawaharlal Nehru National Solar Mission (JNNSM) on January 11, 2010. The Mission will constitute a major contribution by India to the global effort to meet the challenges of climate change. This Mission is one of the eight key National Missions, which comprise India’s National Action Plan on Climate Change (NAPCC). The objective of the National Solar Mission is to establish India as a global leader in solar energy, by creating the policy conditions for its diffusion across the country as quickly as possible.The Mission includes a major programme titled ‘The Below 800C Challenge – Solar Collectors’ for Solar Thermal Technology.



A target of 7 million sq. m. has been set by the JNNSM by the end of the first phase of the Mission (2010-13) and a goal of 20 million sq. m by the end of the third phase of the Mission (2017-22).As mentioned earlier, the MNRE has been at the forefront of devising promotional measures for greater off-take of SWH. However, in order to achieve scalability in these measures and to achieve the objectives of SWH penetration in the JNNSM period and beyond, there is a need to extend the existing schemes and design innovative service delivery mechanisms to leverage SWH investments. One such model is the Fee-for-Service model where people buy a service, in this case hot water, from an energy services company (ESCO), rather than energy to perform the service (e.g. purchasing electricity so it can be used to heat water).



An ESCO is defined as a company that would install, own and operate RE systems,which in this case would be SWH systems and provide energy services to consumers. Such companies are characterized by the following features:



1) It guarantees the energy savings and/or provision of the same level of energy service at lower cost



2) Its remuneration is directly tied to the energy savings achieved



3) It can either finance, or assist in arranging financing for the installation of an energy project they implement by providing a savings guarantee.



Internationally, SWH is a mature, well-developed technology and numerous manufacturers of high quality SWH products exist in many countries. Solar Water Heating is widely applied for domestic and industrial hot water and pool heating. In South Africa, for instance, although the Government support for SWH has generally been limited, there exist innovative programs to stimulate markets for SWH. One such program is the ESCO model or ‘fee-for-service’ mechanism suggested by Renewable Energy and Energy Efficiency Partnership (REEEP) and Sustainable Energy Africa (SEA) for large-scale deployment of SWHS in South Africa. The Implementing Agent/ESCO plays a key role in co-coordinating the model in its area of jurisdiction. It could be a public/private company that puts together a suitable SWHS financing package, drawing on the Eskom DSM incentive, carbon funding and/or bulk financing deals. The ESCO is also able to negotiate a reduction in current SWHS unit costs through mass purchase of systems. It enters into a contract with the SWHS users and thereafter gets the SWHS installed and maintains it in individual households at its own cost. ESCO retains ownership of the system and sells hot water to the owner/business in any of the following ways:



1) Metering the hot water/volume



2) A lease or hire/purchase agreement for a fixed period



3) A fixed monthly fee



An example of this model is an existing SWH ESCO program in Pretoria. Power cuts resulting in increased dissatisfaction among tenants led a private retirement centre in Pretoria to convert its water heating system from a conventional electric system to a solar heating system with an electric back-up, in 2005. The retirement centre is home to 100 residents. The solar water heating system has been fitted by an ESCO. The retirement centre leases the system and only pays for the energy consumed during the month. Solar panels with a collector surface area of 120 sq. mtrs were installed with a maximum demand control unit built into the circulation unit. The storage capacity of the system is 9000 Litres. The system uses a forced pump circulation, and has a differential thermostat control together with antifreeze protection. The savings accrued at this centre are:



1) Energy savings (90 panels) = 197.1MWh per year



2) Financial Savings: USD7,745 – USD8,298 per year



3) Environmental Saving: 18tons of coal, 90 tons annual CO2 emissions avoided



Emerging markets for international trade in GHG reduction credits offer important opportunities to overcome barriers and help advance SWH technology. For developing nations, the Kyoto Protocol’s Clean Development Mechanism (CDM) provides the opportunity for carbon trading to support environmental protection and economic development. Emission reduction revenue can help to surmount a multitude of barriers for SWH technology. Foremost, carbon finance can help to increase system affordability to end-users and enhance the viability of SWH projects and businesses. Financial arrangements that address constraints on SWH affordability, such as third-party financing and fee-for-service operations, could gain substantially by leveraging underlying and additional finance where project participants establish emission reduction purchase agreements with creditworthy CER buyers.



Carbon trading can also help to overcome institutional, technical and other barriers to the development of SWH markets. In this context, SWH projects could potentially use carbon reduction revenue for market development, training, awareness raising and other activities to overcome barriers that constrain broader SWH dissemination, such as the establishment and enforcement of quality standards. SWH systems can also be eligible for market based mechanisms such as renewable energy certificates and/or energy saving/white certificates. There are various examples of countries that are successfully operating such mechanisms. Such mechanisms alleviate the cost burden of these systems by providing an additional stream of revenue to the energy service company/utility/user depending on the obligated entity.



Internationally, there are standard ESCO contracting models. The two predominant types of contracting models are, (i) energy performance contracting models and (ii) energy supply contracting models.



1) Energy Performance contracting models- Energy Performance Contracting (EPC) can be defined as ‘a form of ‘creative financing’ for capital improvement which allows the funding of energy efficiency upgrades from cost reductions’. Performance guarantees are given by the ESCO in terms of the level of energy service or the level of cost and/or energy savings. The savings are then split between the ESCO and the client who could potentially reinvest this into more improvements. The two types of EPC models are:



a) Shared savings- Under this model, the ESCO finances the project either through its own funds or by borrowing from a third party. The ESCO takes on the performance risk of the project. The cost savings are divided between the ESCO and customer at a prearranged percentage for an agreed length of time.



In this case, the customer finances the design and installation of the project by borrowing funds from a third party such as a bank or through leasing the equipment. The ESCO has no contractual arrangement with the bank but does assume the project risk and guarantees the energy savings made. If the savings do not reach agreed minimums the ESCO covers the difference; if they are exceeded then the customer agrees to share the savings with the ESCO.



2) Energy supply contracting models- This type of service tends to be delivered on a low risk – low margin basis with suppliers’ business models often focusing on developing long term operation and maintenance contracts. The two types of energy supply contracts are:



a) The Chauffage contract- This contract provides a structure in which end users are sold energy. The contractor charges agreed rates for providing required energy services to a guaranteed level and has the freedom to act and make decisions on the installation of energy efficiency measures to reduce their own operating costs. The contractor provides all associated maintenance and operations support throughout the duration of the project.



b) The Build-Own-Operate-Transfer (BOOT) contract- In this contract model, the ownership of equipment is transferred from the ESCO to the client at the end of a long term contract with the BOOT operator, before which the ESCO may have designed, built, financed and operated the equipment. The charge incurred by the client includes the recovery of operating costs, capital and project profit.



A detailed assessment of these contracting models was carried out during the course of this assignment. Along with this, a fairly detailed stakeholder consultation was carried out among existing SWH based hot water service providers in India. Based on this, various types of business models for operation of SWH ESCOs in India have been proposed in this assignment.



From MNRE’s perspective, this study is intended to draw out a set of implementation guidelines for facilitating service based delivery of hot water through SWH systems. As mentioned earlier, such a delivery model has the potential to scale solar water heating development in the country. This study is intended to address the above objective of MNRE and frame a set of implementation guidelines in this regard.



The limited experience in SWH ESCO models reveals that,



Monitoring and verification of hot water service is critical in an SWH ESCO model even though metering of hot water in some applications may be a challenge



Commercial operation risks – it is extremely important to address payment default risks by certain category of end-users



ESCO model is techno-economically more efficient to cater to large volumes of hot water, typically in industries and large institutions



Rather than catering to individual demand segments, an area based approach comprising of a cluster of different types of demand segments can reduce the risks for an ESCO



Given the nature of business and the type of risks involved, the ESCO will need necessary support from the Government and will be accountable for any kind of financial incentive that is provided


Subsequent to the announcement of the National Solar Mission, in order to give practical shape to the vision and objectives outlined in the Mission, two sets of guidelines were announced by MNRE on June 16, 2010. These are Guidelines for, (i) Off-grid and Decentralized solar applications and (ii) Rooftop and other small solar power plants. The scope of the guidelines for off-grid and decentralized solar applications includes off-grid solar photovoltaic systems/applications up to a maximum capacity of 100kWp per site and off-grid and decentralized solar thermal applications, to meet/supplement lighting, electricity/power, heating and cooling energy requirements, and, mini-grids for rural electrification up to a maximum capacity of 250kW per site.



The provisions of the off-grid solar guidelines provide a channel for mainstreaming the ESCOs as important players in the implementation of the off-grid program under the Mission. The provisions of these guidelines have been assessed in detail in order to dovetail these with the implementation guidelines for the area based ESCO program in order to harmonize some of the common features of the two schemes.



Our assignment has evaluated international and national experience in the development of SWH ESCO projects, carbon financing and market based instruments and provided an integrated financial and business model with guidelines for implementation in four types of demand clusters:



1) Remote or Hilly region



2) Industry cluster



3) Residential cluster



4) Religious township/tourist centre



As we have mentioned, the ESCO model of operation for SWH would not be without risks. Hence it would be important to assess each model on merits in terms of end-user payment default risk, ESCO non-performance risk and Bank’s loan repayment default risk. These risks would need to be appropriately addressed in order to ensure successful operation of the program. Considering the significant SWH potential in the country, a properly designed area-based ESCO program will contribute significantly in scaling-up solar water heating development in the country.



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