“A standardised policy framework that provides a template for the energy service company sector on how energy performance contracting is formulated and managed, including rebalancing profit sharing and costing is required” – Zubir Ansori bin Yahaya, Managing Director / CEO, Malaysia Debt Ventures.
Financing sustainable growth
Malaysia has taken significant strides in recent years to finance the development of green technology and renewable energy projects. This move have been propelled by government efforts to boost the strategic growth of high-priority sectors in order to facilitate the country’s move towards advanced-nation status and a low-carbon future.
The evolution of the financing environment for sustainable initiatives has emerged following the introduction of distinct programmes, such as the Green Technology Financing Scheme (GTFS). Officially established by the government in 2010 to promote investment in green technology projects, the GTFS is administered by the Malaysian Green Technology Corporation (MGTC) and provides eligible parties with a soft loan. Once an applicant proposal has received a Green Project Certificate issued by the MGTC and been evaluated by the Credit Guarantee Corporation (CGC), the government provides assistance in the form of CGC guarantee cover for 60 per cent of the loan, in addition to a 2 per cent subsidy on the loan amount.
While the GTFS initially targeted only green technology projects, its scope has evolved to include initiatives with an energy efficiency component. Since its inception, it has catalysed the development of green projects nationwide and is testament to the growing maturity and increasing sophistication of the national financing environment around sustainable projects.
Beyond the GTFS, additional schemes are facilitating both financiers and project developers to enter the field, such as the Feed-in Tariff Mechanism and Malaysia Debt Ventures (MDV) own Energy Performance Contracting (EPC) Fund. In conjunction, these more structured financing approaches are significant because they are providing financial institutions (FIs) with tangible incentives to fund both renewable energy and energy efficiency projects.
Focus on energy efficiency: the EPC fund
The EPC Fund was introduced by MDV in 2017 to specifically boost financing for energy efficiency. The Fund totals MYR200 million and its core objective is to facilitate financing for the cost of capital investment in energy-saving measures undertaken by energy service companies (ESCOs) in the building sector.
The EPC Fund is smaller in scale than the GTFS, but has a more targeted focus on components directly related to energy efficiency, such as retrofitting, equipment and efficiency buy-ins from related actors. The feedback we have received shows that the Fund is generating positive impacts for all relevant stakeholders, from building owners and users of the energy-efficient equipment on the demand side, to ESCOs on the service provision side.
While both the EPC Fund and GTFS are successful funding models, they differ in a fundamental way. On one hand, the GTFS provides an incentive to companies to fulfil government targets on renewable energy generation, which in turn ensures that banks are keen to invest in the increasingly expanding renewable energy market. On the other, the energy efficiency ecosystem is less developed and so there are opportunities to enhance behaviour and procedures therein. This includes: communicating the benefits of energy efficiency to building owners who are not yet convinced; refining the business model in which ESCOs can formulate attractive propositions for themselves and their customers; and standardising guidelines to foster increased FI funding for energy efficiency projects.
Common standards and awareness
The majority of EPC Fund recipients, to date, are brownfield developers and companies that retrofit existing buildings, such as university campuses. Such developments are being implemented under EPC conditions and the outlook for these projects is very positive. Nevertheless, the ESCO market as a whole remains a ‘work in progress’, primarily due to one key obstacle that is impeding the Malaysian EPC mechanism from fulfilling its potential: a lack of definitive standards on how a contract should be devised and managed. The current situation results in every single project being structured differently, which has not been conducive to the growth of either individual ESCOs or the wider sector.
Consequently, ESCOs encounter considerable challenges when negotiating EPCs, particularly with larger building owners. First, the unbalanced relationship between the two parties has traditionally placed the financial burden on the ESCO to borrow money to implement the required project, with zero capital outlay from the larger client. Second, large building owners benefit disproportionately from the profit-sharing component built into the EPC mechanism, whereby the share of the savings arising from energy efficiency projects is distributed heavily in favour of the client.
Companies cannot survive on a subsistence margin alone and require capital to grow. Therefore, a standardised policy framework that provides a template for the ESCO sector on how EPCs are formulated and managed, including rebalancing profit sharing and costing is required. This would increase transparency and enable ESCOs to plan on a sustainable basis and is critical in helping to foster a financially viable and sustainable ESCO industry.
In turn, a viable and sustainable industry will facilitate the process of communicating the associated benefits of EPCs to building owners, such as primary energy savings and the chance to use energy efficiency to build corporate branding via green building certification. Raising awareness would also help to counter the prevailing mindset, found across the business community, that views energy efficiency as a cost rather than an investment.
Lessons on how to standardise the framework are afforded by similar mechanisms and sectors, such as the private finance initiative model in which agreements are standardised and expense details outlined upfront. Similarly, standards could be replicated from the renewable energy sector, such as kilowatt/hour tariffs. A newly standardised framework could also categorise distinct segments, such as retrofitting, chillers, lighting and other appliances, and incorporate existing standards from leading State agencies. It is also important to include feedback from ESCO associations to ensure any new template incorporates market-specific concerns.
The importance of financial institutions
The success of a standardised template will depend on its ability to generate support from FIs. The reason that FIs have not channelled frequent funding towards energy efficiency projects to date is twofold: first, the lack of standardisation in the segment has generated uncertainty regarding project viability; second, return on investment is generally between seven and ten years, which longer than projects in other sectors.
Therefore, the key to enhancing the EPC financing ecosystem is multifaceted. On one hand, it involves a state-level move to structure the promotion of energy efficiency by assigning a specialised body to standardise practices. This includes the implementation of a clearly defined procedure through which ESCOs pitch their project proposals to banks. On the other hand, processes need to change within FIs regarding energy efficiency business models. This includes introducing defined templates to improve due diligence and facilitate understanding of project viability, as well as to reduce uncertainty among investors and minimise risk.
The implementation of a system similar to the GTFS may therefore be necessary. The GTFS has ensured that FIs look beyond the size and prestige of the implementing organisation and more towards the viability of the project itself. The scheme has also helped to demonstrate to banks that there are business opportunities in green technology.
The EPC Fund goes some way towards replicating this for energy efficiency and MDV places greater weight on the viability of the project than the track record of the company being considered for funding. This contrasts with the traditional FI outlook of financing that focuses first and foremost on the implementing organisation’s balance sheet, which is the result of counterparty risk. This risk is accentuated due to the relative immaturity of the ESCO market, which is a point that must not be overlooked. However, this mindset must change and additional FIs need to play a more central role, in line with MDV’s efforts via the EPC Fund, in order to mainstream energy efficiency investment.
Securing a sustainable future
The future prospects for energy efficiency in Malaysia are bright, but their fulfilment will require a concerted effort by all stakeholders. MDV is playing its part via the EPC Fund; it will be a game changer in the ESCO market. Nevertheless, a sector-wide scheme that underpins awareness raising and facilitates EPC project financing, and which goes beyond the scope of the EPC Fund, is required to realise the potential of energy efficiency across the Malaysian economy.
While the EPC Fund is implemented in conjunction with the Ministry of Energy, Green Technology and Water, there is scope for the ministry to expand its reach. For example, other FIs could formalise a similar funding relationship to create a standardised mechanism through which different banks finance energy efficiency projects. MDV is not big enough to cover the entire ecosystem and so this approach would be another way to mainstream energy efficiency financing.
Given its solid track record of funding successful EPC projects in a broad range of sectors, from municipality towns and federal highway initiatives, to building projects such as educational facilities and offices, MDV is well positioned to be involved in this expansion. By working together, the government, FIs and the ESCO market are set to enjoy a prosperous and highly efficient energy future.