General ESCO Business Dai Cunfeng Chinese Renewable Energy Industries Association (CREIA) Adviser of Chinese EMC Association (EMCA)

Main Topics About Energy Performance Contracting (EPC)Mechanism About ESCO Business

Energy Performance Contracting (EPC)Mechanism Clients conclude energy service contracts with ESCO. ESCO provides clients with professional energy service. Clients lower their energy expense, and pay ESCO’s service fee and reasonable profit out of the lowered energy expense. An energy conservation investment method that uses the reduced energy expense to pay the total cost of the energy conservation project, allowing clients to upgrade their existing equipment by using their future energy saving.

Client cash flow ESCO cash flow EPC Cash Flow

òAfter energy conservation upgrading, the money previously paid solely for energy can cover both new energy expense and ESCO expense, with positive cash flow for the client. Previous energy expense Client cash flow Pay EMCo New energy expense Without project With project

Set up an ESCO 1 、 Set up an ESCO 2 、 ESCO business plan preparation

Typical Conditions Required before Setting up an ESCO Fund Market Technology ESCO

SWOT Analysis S - What is the strength of a company for it to carry out of ESCO business ？ W – What is the company’s weakness ？ O – What opportunities will the company have? T - What threats and risks will the company face?

Basic Abilities an ESCO Should Have Have energy conservation technology, and have qualified technical professionals. Market development ability Ability to manage project and risk Increasingly strong financing ability

Role of EMCo Business Plan Control investment scale Control target cost Control financing (borrowing) scale Control financial structure rates Ability in profit planning and sustainable development

Business Plan Preparation Assumptions EMCo business growth potential Project duplication potential Consider inflation Consider energy price fluctuation

Balance Sheet Forecast Income Statement Forecast Cast Flow Statement Forecast Sensitivity Analysis Project line data summary Working capital demand forecast Company expense forecast Financing plan Major parameters Project implementation plan Project line Business Plan Model

Suggests Preparation of business plan should be based on existing actual ability. Otherwise it will be meaningless. Constantly compare the business plan with actual situation so as to discover problems, to take them into consideration in company management such as market development and internal management, and to adjust business plan.

ESCO Business

Steps of a Typical EPC Project Energy efficiency auditing Energy-conservation project design Signing energy service contract （ Project financing ） Procurement Construction Check and acceptance, determine energy saved. Training After-sales service Performance of energy service contract Contract performance completed Project development Project implementation Contract performance

Flow Chart of Energy Service Contract Development Initial meeting / contact client Initial audit Detailed energy consumption study Initial proposal Review expense data / saving estimate Client commitment / signing LOI Prepare energy service contract Client commitment / signing LOI Implement End yes no

Common Practice for Project Development –Introduce ESCO to potential clients. Provide energy auditing and energy diagnosis free of charge. Propose potential energy conservation projects. –Organize relevant enterprises and hold project promotion meetings. –Develop project with the support of good equipment vendors, engineering firms and banks. –Completion of a successful project is often the start of a new project. Develop “project accounts”. –Set up client databank

Client Selection and Project Selection Client Selection –Give priority to public utility firms with good operation performance in recent few years, moderate asset/liability rate, big potential for main products / business, and stable revenue. –Good reputation –Entities with existing good working relations –Entities with many potential projects Project selection –Mature and fairly sophisticated technology –Good energy conservation result –Projects of which the energy saved is easy to be determined –Large potential for duplication –Acceptable investment amount

Basic Types of Energy Service Contracts Energy saving sharing contract ESCO prior paid contract Energy saving guarantee Some flexibility should be kept to meet the need of different clients. Whichever way, the following rules should be followed: –Contract be fully understood by ESCO and clients –Fair to both parties, maintain good working relations –Encourage ESCO and clients to maximize energy conservation, and ensure project’s continuous and good operation in whole contract term. –Lawyer’s involvement is critical

Structure and Content of Profit Sharing Contract-1 1.Commercial provisions or basic provisions: –(1) Preamble or general provisions –(2) Project’s name, content and objectives –(3) ESCO obligations –(4) Client obligations –(5) Term and project acceptance –(6) Profit sharing proportion and amount calculation –(7) Payment –(8) Ownership –(9) Early termination of contract –(10) Default provisions –(11) Default remedies

Structure and Content of Profit Sharing Contract-2 2. Normal provisions –Equipment replacement, modification, dismantling or damage –Equipment overhaul –Equipment stoppage / shutdown –Modification and use of client’s own equipment –Modification, annulment and termination of EMCo service standard contract –Assignment of rights and obligations under the contract –Infringement and compensation –Confidentiality –Insurance –Guarantee –Taxes and charges –Force majeure –Dispute settlement –Governing law –Contract coming into force –Attachment to contract

ESCO Risk Management

Risk Management Model Determine own “risk boundary” Quantify risk Complete project / Monitor risk Find ways to lower risk Risk acceptable? Project ends Identify risk NO YES

EMCo Project Risk – Probability Model whether to accept project/ take measure to lower risk end monitormanagement high low low high risk events happening frequency

ESCO project risk can be compensated for by higher return Higher project risk requires higher return! Lower return is acceptable for lower risk! Calculation model Return Determinability Risk return 15% 100% 15% 40% 25% 10%

Risks Usually Encountered by ESCO Project risks –Project fails to operate normally or to get expected return; –Dispute over energy conservation return calculation; –Project fails to be delivered on time; –Client’s production problems, failing to get expected return; –Even if expected return is achieved, client fails to make payment on time for whatever reasons. Company risks –Company has liquidity problem and is in operation crisis; –incurs other losses. Many ESCOs in China have had their lessons, which are most frequently discussed!

ESCO Risks-summary Project risks –Technology risk –Construction risk –Contract risk –Client risk Company risks

Technology Risk Management Select mature technology and solution –Involvement of equipment vendors –Experts review –Should have client’s full agreement Select good products and vendors Quality warranty and after-sales service provisions to diversify risks Personnel training

Construction Risk Management Select qualified construction contractor Carefully plan construction steps. Decide on equipment delivery date before preparing construction schedule. Reserve some time in project schedule for any potential construction delay. Acquire insurance Make ESCO project manager fully responsible for all aspects of project construction, to coordinate suppliers, contractors and clients

Contract Risk Management Clearly define profit sharing method and method to pay ESCO, with client’s full understanding Clearly define “base year” ， ”base line” Conservatively calculate energy saved Clearly define the way to confirm energy saved and the measurement means. Employ qualified measurement agency. Note:Do Not Forget the Lawyer Before You Sign a Contract!

Client Risk Management Understand the client before contract signing: –Basic info: incorporation time, scale and registered capital, major shareholders –Operation info: industry development, main businesses / products, government policies –Financial info: financial statements of recent three years –Find out major facts, any of them recently: system and structure change, important HR change major construction projects, major investment important legal proceedings or guarantee to outsiders material breach of laws and regulations Verify client credibility through its business associates ESCO project sales staff should stay away from client credibility assessment

Investment Decision-making Case Model Not invest Direct investment effective asset pledge bank/specialty guarantee institution/government guarantee credibility guarantee investment amount points

Company Risk Management Make feasible yearly investment plan and financial arrangement Ensure company’s normal cash flow –Balance projects with different investment amounts –Balance projects with different levels of technologies –balance projects with different payback periods –Project lines should be more diversified. –Investment in one client should not exceed 20% of the company’s total asset. Pay attention to financial statements –Sales revenue/profit/receivables and payables/debt due –Ratio analysis: asset-liability ratio 66%, debt-service ratio 1.6, current ratio 2:1. Ratio comparisons both historically and across industry.

Risk Management Summary Risk management should be carried out in all steps and aspects of the project It is impossible and unnecessary to lower all risks to zero. Risk management is a process of lowering and diversifying risks.