Cleantech Market Intelligence
ESCOs Start to Recover from the Recovery Act
By many accounts, the American Recovery and Reinvestment Act (ARRA) was a boon for the American economy in the wake of the financial crisis of 2008. The availability of $25 billion in federal funds for energy efficiency measures sent the building industry into action at a time when sluggishness in new construction was shifting attention to existing buildings, and concepts such as corporate sustainability and carbon regulation were in their infancy. Leading energy service companies (ESCOs) such as Johnson Controls and Ameresco, which use a financing structure known as energy performance contracting (EPC) to guarantee energy savings for customers in long-term contracts, scaled up their energy efficiency capabilities to benefit from these generous incentives.
Briefly, it seemed that ARRA would be a net positive for the ESCO market. From a base of $3.9 billion in annual revenues in 2008, the market peaked in 2011 with annual revenues of $5.6 billion. Interestingly, ARRA actually had a negative impact in 2009, when many would-be ESCO customers deferred plans to hire ESCOs while awaiting the distribution of stimulus funds for 2010 and 2011.
And that was the first of several unforeseen consequences of ARRA for the ESCO market. In 2012, the market underwent a painful contraction, with annual revenues shrinking to $4.8 billion – a 13% decline. The causes of this decline were diverse, and include a range of factors such as the federal sequester and pervasive concerns among municipalities about ESCO-related debt (as EPCs typically show up on customer balance sheets as debt service obligations). A more insidious cause of the decline was the fact that ARRA funds, which were largely exhausted by the end of 2011, created an expectation of low-interest financing and widespread rebates for energy efficiency measures among municipal customers, the core market for ESCOs. As those financing facilities evaporated, so did many customers’ willingness to take on long-term EPCs characterized by pre-ARRA interest rates. As a result, many municipalities now view the extended payback periods of EPCs (which are, in reality, consistent with the payback periods in the pre-ARRA period) as unacceptably long.
ESCO Revenue, United States: 2010-2020
(Source: Navigant Research)
Even in the post-ARRA era, though, EPCs represent a low-risk way for cash-strapped customers to reduce their long-term facility operating costs and finance other non-energy-related infrastructural improvements. Changing the mindset in the municipal sector will be critical in resuscitating the ESCO market in the United States and placing it on a pathway for strong growth.
The good news for ESCOs is that the federal government has been aggressively promoting EPCs through the $2 billion Better Buildings Initiative and other policies, which will lead activity in that sector to grow considerably in 2014. In our recent report, The U.S. Energy Service Market, Navigant Research forecasted that the market will grow from $4.9 billion in 2013 to $8.2 billion by 2020. The municipal sector will only recover to pre-ARRA levels of EPC activity, though, when municipal decision-makers recall the diverse cost reduction benefits afforded by ESCOs that they once enjoyed.