Dec. 23, 2017

Energy services, prospects and conditions for the new market in Ukraine

It’s no secret that Ukraine consumes from 3 to 3.5 times as much energy per 1$ GDP as the European Union. This means that under normal circumstances our economy can’t compete in open markets. That is why encouragement of energy efficiency has been top priority for the Ukrainian government these last two years.

Experts of the State Agency on Energy Efficiency and Energy Saving of Ukraine estimate the investment required for modernizing energy-intensive facilities in budget sector alone at 7 billion euros.

Some of those market demands will be covered by Ukrainian financial sector. Public and private banks have already started implementing “energy efficient” crediting programs for apartment building co-owners association (housing cooperatives) and individuals.

However, a lot of entities in the country aren’t included in state support programs: municipal and public institutions, educational institutions, hospitals. Banks can offer them loans, but with a floating charge, which is usually a deal breaker. This category includes private and municipal companies that also have difficulties securing their obligations. 

The situation laid the foundation for a new market in Ukraine, worth over 7 billion euros – the market of energy services.

Energy services. How does it work?

Energy services are steps for achieving material or financial savings through efficient use of energy resources.

Energy services companies, or ESCO, are counting on a part of the money saved in this manner as payment for services rendered.

This mechanism has been developing in the US and the EU for over 30 years and includes two main legal incarnations.

1. Energy performance contract: ESCO provides more efficient use of energy resources at a facility. The client in turn pays the ESCO after actual savings have been achieved.

2. Chauffage, or energy supply contract: the contractor undertakes the obligation to provide services on energy supply at the client’s facility in the most efficient manner possible. As a rule, ESCO’s remuneration is determined at the signing of the contract as the client’s expenses for acquiring energy resources with 5-10% discount.

Within those legal frameworks, the parties can set various project success criteria, risk distribution, and remuneration. Unlike turn-key, supply or lease contracts, ESCO receives most of its remuneration not after implementing measures for energy efficiency, but based on the money saved.

As a result, the client solves the need to look for investors and gets an improved facility with minimal or zero expenses, plus a contractor who is interested in supporting the project and bears related risks.

Energy services in the legal field of Ukraine

With the adoption of On Introduction of New Investment Opportunities, Guaranteeing of Rights and Legally Protected Interests of Business Entities for Major Energy Modernization Act of Ukraine of 9 April 2015, No.327-VIII the definitions of energy services and energy service contracts have been introduced to Article 11 of On Energy Saving Act of Ukraine of 1 July 1994, No.74/94-ВР.

Energy services are defined as a series of energy saving (energy efficient) measures aimed at decreasing consumption or costs of energy resources.

As means of implementing energy services, legislature provided legal and private entities with an opportunity to make energy service contracts.

The features of such contracts include:

  1. The subject, i.e. providing energy services and reaching guaranteed amount of savings;
  2. Remuneration: in cash, as part of the amount saved on energy resources.

Thus, Ukrainian legislation provides for energy performance contract model.

However, from a legal standpoint, such contracts contain elements from entirely different legal constructs.
In case of energy audit or consultations on picking the best energy saving measures, energy service is defined as a service on thermal modernization of a building – that is as a independent contract work, whereas it is considered a lease purchase when old equipment is replaced.

This mechanism also has elements of a joint venture where parties join their assets and efforts to reach a common goal of energy saving.

Legal entities and individuals in private sector aren’t limited in their choice of terms and conditions for their contracts, including energy service ones, which makes it easier to regulate their legal relations. Restrictions in this field would create framework rather than opportunities.

Nevertheless, full freedom of contracts and the novelty of energy service frameworks bring not just new possibilities, but also risks due to poor understanding on the part of regulatory authorities.

It is important to clearly define the aspects that set energy service contracts apart from other contracts in Ukrainian law.

Those aspects include implementation of energy services, that are measures aimed at decreasing consumption of energy resources or related costs; guarantee that savings will be provided as a clause in the contract; and remuneration based on and at the expense of the money saved only.

Legislation has additional rules for providing energy services at budget sector facilities. On Introduction of New Investment Opportunities, Guaranteeing of Rights and Legally Protected Interests of Business Entities for Major Energy Modernization Act of Ukraine of 9 April 2015, No.327-VIII determined aspects of energy services acquisition and terms of energy service contracts for such facilities.

The key feature of energy service acquisition is the main assessment criterion – contract’s efficiency for the client.

Since the client pays ESCO from the actual amount saved, the budget bears no additional expenses for energy services. The contract price has only formal impact on the budget. The goal of energy service projects is to provide long-term savings.

For this purpose, contract efficiency- that is net present value of the contract for the client (NPV) - is used to assess ESCO offers. It is the difference between budget money saved and money paid to ESCO discounted by the rate of the National Bank of Ukraine over a 20-year period. It shows which tender participant will be able to provide the highest long-term net savings.

The act also regulates material terms of energy service contracts with clients from budget sector:

  1. Duration of such contracts should not exceed 10 years.
  2. Contract price constitutes 80-90% of the amount of guaranteed savings, which should be ensured by the contractor for the whole period of the contract.

Calculations for energy service contracts are based on the client’s money actually saved during a certain period, taking into account prices of energy resources for that period. If the actual amount saved is higher than the guaranteed one, the client pays ESCO the whole contract price before expiration date. In this case the contract is to be terminated, and all equipment should be handed over to the client.

On Amendment to the Budget Code of Ukraine Regarding Introduction of New Investment Opportunities, Guaranteeing of Rights and Legally Protected Interests of Business Entities for Major Energy Modernization Act of Ukraine of 9 April 2015, No.328-VIII introduced some changes to the Budget Code of Ukraine of 8 July 2010, No.2456-VI and established new rules for budget allocation in energy service contracts. For instance, the concept of long-term energy service obligations appeared in the Code. These are the obligations of the budget holder under energy service contracts that requires payments to be made during the future and/or current budget periods within the amount of money saved as a reduction of expenses on utility services and energy payments [Paragraph 211 part 1 Article 2 of the Budget Code of Ukraine of 8 July 2010, No.2456-VI.].

This allows clients to ensure payment for ESCO services for the period of the energy service contract and to account for corresponding budget expenses in future budget periods.

The new legal basis paved the way for more than 20 energy service projects  implemented in 2016 in budget sector facilities. The market is expected to grow upon adoption of draft law No. 4549 and launch of energy services procurement through ProZorro platform.

The role of legal advisor in energy service projects

Lawyers usually have their hands full when there are loopholes in legislation, or when the parties enjoy too much freedom in shaping contracts. Energy services are no exception.

The long-term nature and goals of the projects demand special attention to be paid to energy service contracts. Such contracts must serve not just as a basis for conducting energy efficiency improvements by ESCO and for remuneration by the client. It is a kind of a “nuptial agreement”, a detailed instruction for the parties on how to go about implementing the project over the course of several years.

It is essential that the parties fully understand the terms and their roles in the project before signing the contract.Legal advisors should find a balance between the interests of ESCO and potential clients based on energy and economic aspects of the project, as well as public procurement and budgetary processes.

 

Sergiy Silchenko, parrtner ILF

Ivan Bondarchuk, senior associate ILF

Published on The Ukrainian Journal of Business Law №12