In recent years, more and more research has started exploring the area of energy efficiency (EE) and models that have been developed within such projects. Due to the fact that EE projects have become a crucial policy tool for fostering public sector investments and a driver of the construction sector in many countries [1
], as well as the rising public sector debt and budget deficit, many decision makers in the public sector have started to introduce new delivery models for the provision of public services [2
]. According to the European Investment Bank (EIB) [3
], energy performance contracts (EPC) and public-private partnership (PPP) are some of the most common options for the implementation of the public sector EE projects and are called alternative procurement models.
According to the European Commission (EC), the energy sector is one of the main elements of the Europe 2020 flagship initiative for a resource-efficient Europe [4
]. For this reason, the EC proposed an update to the Energy Efficiency Directive [5
] in 2016, which is mainly focused on three main pillars: “putting energy efficiency (EE) first, achieving global leadership in renewable energies and providing a fair deal for consumers“ with the main purpose of cutting CO2
emission by at least 40% by 2030. Today, about 75% of buildings are energy inefficient and, depending on the member state, only 0.4–1.2% of the stock is renewed each year [6
]. While the majority of EU funding resources will be realized in more traditional, purely grant-funded procurement models, the new Investment Plan for Europe for the programming period 2014–2020 has focused on supporting higher private sector involvement in infrastructure investments, energy performance projects, research and innovation initiatives, etc., in order to achieve the EU Strategy 20/20/20 goals. Considering that the fundamental purpose of investing in infrastructure is investing in providing public services, the involvement of the private sector is only possible through applying some alternative procurement models such as EPCs or PPPs.
According to Sorrell [7
] these contracts typically include obligations during the whole life cycle period. Polzin et al. [8
] state that the private sector can identify public needs better and deliver public services through EPCs at a lower cost than current prices. According to Hannon et al. [9
] and Marino et al. [10
] the key element of success in these contracts is the involvement of the private sector not only during construction period, but during the whole life cycle of the contract. Bertoldi and Boza-Kiss [11
] have made an analysis of barriers to the development of the EE markets in Europe. They have analyzed the EE market in EU member states and Southeast and East European countries. In their conclusion they state that EE markets vary widely across Europe, i.e., only a few countries such as Malta, Cyprus and Estonia lack any EE activity whatsoever, while the South-East Europe markets are at a high level of development, which can present a certain challenge if public sector decision makers want to achieve goals identified in the new Investment Plan for Europe. Recently, the European Court of Auditors published a report [12
] where they stated that EU funds have not been sufficiently absorbed for providing alternative procurement models and that the legal and institutional framework in many EU member states is not yet adequate for EU supported PPP projects.
In Croatia, several researchers have investigated investments in the EE sector and their impact on the economic growth and development. In 2007 Bukarica, Morvaj and Tomšić [13
] investigated potentials for cost-effective EE project improvements. They found that “policy measures should shift from strictly end-users oriented approach towards whole market approach.” Pavković, Zanki and Čačić [14
] have carried out an analysis of results obtained through selected energy audits and preliminary energy studies of public buildings in Croatia. In their conclusion, they have prescribed methodologies when implementing activities that are being undertaken in the preparation of basic documents that precede the realization of EE projects (such as EE studies, EE energy audits, etc.). Bukarica and Robić [15
] have conducted a comprehensive research of the energy efficiency gap in Croatia on four groups of stakeholders: public institutions, businesses, civil society organizations and the media. The authors have concluded that relevant stakeholders of the overall EE development in Croatia attribute the EE gap in Croatia to the lack of a serious and strong political commitment to adopting and implementing EE policies.
As there is still a significant lack of scientific and professional research in this field, this paper represents an attempt to identify the process of allocation of EU funds with alternative procurement models for the purpose of implementing EE projects. This process is called blending.
The main aim of this paper is to assess the effectiveness of blending, i.e., using alternative procurement models with available EU resources within the new Investment Plan for Europe. The analysis is based on a Croatian case study in the energy efficiency sector. As the maximum effectiveness of each transaction can be achieved through the synergy of the public and private sector capacities, the overall objectives of this paper are: (i) to examine the possibility of applying alternative procurement models for the implementation of EE projects based on a Croatian case study in the operational phase, (ii) to analyze different funding mechanisms for the implementation of EE projects, (iii) to demonstrate a possible concept and effectiveness of EE project blending using a Croatian case study.
According to the set objectives, the main motive for choosing Croatia as a case study is the availability of historical data and the fact that Croatia is one of the EU pioneers in developing detailed methodology for blending EU funds with alternative procurement models.
This paper has the following structure: The research starts with an introduction and a review of past research of the private sector involvement in energy efficiency (EE) sector. The second chapter offers an overview of procurement models and funding mechanisms, while the third chapter is a detailed elaboration of a Croatian case study and the concept of blending with results. The fourth chapter offers a discussion and the last chapter is a conclusion.
2. Procurement Models and Funding Mechanisms: An Overview
Investments in public sector EE projects, such as renovation/deep renovation of public buildings, street lighting projects, etc., are an important backbone of GDP growth. According to the European Court of Auditors [16
] increasing effectiveness in providing such projects means using less energy input for at least the same level of economic activity or service. A typical EE project in the provision of public service can include the deep renovation of public buildings, replacing energy-inefficient constructions and equipment such as street lighting, district heating systems or other parts that cause increased energy consumption [17
]. Many local units in the EU are facing difficulties in preparing, procuring and implementing EE projects [18
]. According to Bratt et al. [19
] these investments can mitigate financial constraints in the long term and help public sector units to meet their targets in line with the EU Strategy 20/20/20. An important tool for achieving these targets is a model known as energy performance contracting (EPC) and/or public-private partnerships (PPP) [20
]. In these models, public authorities implement EE projects without buying new equipment or providing construction upgrades. Instead, the authorities buy public services or energy savings [21
]. Procuring public EE projects can be done in several ways. One of the most common implementation models, instead of the traditional procurement, is to apply one of the alternative procurement models such as the energy service company (ESCO), services contracts or public-private partnerships. As the new Investment Plan for Europe for the programming period 2014–2020 focuses on supporting higher private sector involvement in infrastructure investments than traditional procurement, the aim of this paper is more focused on alternative procurement models, where the private sector bears the operational risks of the projects. That means that the private sector is responsible for the design process, construction process, operation and maintenance of infrastructure [22
2.1. Traditional and Alternative Delivery Models in EE Projects
The traditional procurement model or the standard procurement model is still widely used in providing public infrastructure across the globe. In many countries this is the only model applied. The main characteristic of the traditional model is the fact that the public sector is fully responsible for the provision of public services and efficiency. All the project phases, from the beginning of project preparation, through to the project construction, maintenance and operational period, are a responsibility of the public sector. All the project risks are borne by the public sector. During the project implementation the public sector is not only responsible for financing and procurement of the asset, but also for achieving technological optimization and effectiveness throughout the whole life cycle period. By applying the traditional model, the private sector has a very small influence, usually during the construction period only, therefore it is questionable if the public sector has the knowledge and skills to optimally manage and operate project risks in the long term.
Besides the traditional model, several alternative procurement models are widely used. One of them is the energy service company model or ESCO model. ESCO involves the private sector in the implementation of EE projects on the basis of EPC. During the implementation of EE projects, a private company guarantees to the authorities that the project implementation will result in a measurable estimated improvement of energy efficiency and/or in savings in energy consumption [23
]. According to Nolden et al. [18
], the main advantage of the ESCO model is that the authorities do not have to take out a loan or invest any money into the implementation of EE projects. Figure 1
shows a typical ESCO transaction structure.
In a typical transaction structure, ESCOs normally guarantee projected savings [2
], while their remuneration is linked to project performance, i.e., directly linked to the amount of energy saved in physical or monetary terms [24
]. However, the cost of projected energy savings is not the sole cost of the project and it depends on various external factors, i.e., in EE building renovation projects, on the behavior of end users. Usually, in order to maximize profits ESCOs focus on lower cost measures and do not take a comprehensive approach which provides deeper savings [25
], e.g., in street lighting projects, ESCOs only improve (change) the street lighting “bulb” without any improvements in power cables, pillars and other infrastructure. This lost opportunity, in the case of materialization of the project’s risks, can cost much more in the long term than the energy savings at the beginning of the project. According to Nolden et al. [18
], one of the main disadvantages of the ESCOs is their exclusive focus on energy saving instead of improving the entire infrastructure of the project.
Although the main focus of the ESCO model is on savings, another alternative model is usually applied. It is the public-private partnership model or the PPP model. According to Grimsey and Lewis [22
] the main focus of public-private partnership (PPP) is on providing public services. In general, the PPP is a form of cooperation between the private and the public sector in the provision of public infrastructure [26
]. The PPP model may involve financing, design, construction, operation and/or maintenance of infrastructure, which is traditionally procured and provided by the public sector such as economic infrastructure, social infrastructure, etc. [27
]. Due to the fact that many public EE projects have some characteristics of PPP (provision of public services, transfer of construction risk, availability risk etc.), they can be realized through the PPP model. In a typical PPP structure, the private sector bears risks related to construction and/or reconstruction and at least one of the following risks: availability risk or demand risk [28
]. The main advantages of using PPPs in EE projects derive from the comprehensive preparation and implementation of the public infrastructure EE projects. The main purpose of implementing the EE PPP projects is reflected in the provision of public services, not only in realizing energy savings (as it is the case with the ESCO model). During implementation, PPP contracts can connect different elements of infrastructure projects, i.e., link the design and construction with one or all of the finance, operation and maintenance elements [29
]. The PPPs also have a better scope for transferring risks compared to the traditional or ESCO procurement methods. For example, public sector payments are not fixed and are not based on expected savings, but they may be withheld until assets are in operation thereby “encouraging” contractors to complete EE projects on time and within budget [30
]. Therefore, public authorities only focus on setting output specifications and realizing the expected value-for-money [31
Unlike the traditional model, the use of alternative procurement models has to be justified by different analytical techniques. One of the most common techniques is called “Value-for-Money”(VfM) analysis. VfM is an analytical tool for comparison of different delivery options [32
]. It includes all costs of possible EE projects in the whole life cycle. All the values in VfM analysis are in the form of “unique unitary charge” [33
]. Figure 2
shows a typical example of the final result of VfM analysis with three possible procurement options (traditional procurement, ESCO model, PPP model).
shows the net-present-value (NPV) of unique unitary charges of three different procurement options and indicates that the most favorable option is the PPP model. That means that if the public sector wants to implement a certain EE project, the maximum value-for-money in the whole life cycle will be achieved by the PPP model, taking into account all costs in a 30 year period of the project life.
2.2. Traditional and Alternative Funding Mechanisms in EE Projects
Procuring EE projects requires significant funding resources. While the public sector is usually more focused on traditional, budget or purely grant-funded models, there are several other (alternative) funding mechanisms available. All of them can be divided into two main groups: (i) on-balance sheet funding mechanisms and (ii) off-balance sheet funding mechanisms.
The first group, (i) on-balance sheet mechanism, is a situation where a central or local authority lends financing resources from third parties and present a traditional funding mechanism. It is called “on-balance” because it causes public deficit and debt increase. It comes in the form of classic (A) debt funding, where financial institutions (usually banks) provide financial instruments to public authorities for purchasing new EE equipment or meet construction costs of EE projects. Another type of on-balance mechanism is (B) equity financing, where a project sponsor usually provides an instrument in the form of subordinated debt in exchange for a stake in an EE project or it can be in the form of subsidies or grants from various third parties, such as national funds, EU funds etc. The third type of funding is a combination of equity funding and debt funding called (C) mezzanine financing. It is usually provided when there is a funding gap between equity and debt instruments. It allows holders to convert mezzanine debt into equity or debt.
The second group, (ii) off-balance mechanism, is used in funding EE projects when some private sector participation exists and presents an alternative funding mechanism. It is called “non-recourse finance”, because the only collateral for repayment is future cash flow from the investment. It can be in form of project finance or leasing. Project finance transactions can take the same form as on-balance sheet mechanisms (equity finance, mezzanine finance and debt finance) but with different collateral, while leasing instruments are usually used for financing equipment rather than investments in fixed assets.
The relationship between traditional and alternative funding mechanisms should be observed through their financial impact on the whole life cycle costs. Such values are analyzed in the Value-for-Money analysis and their goal is to show how much the applications of different mechanisms will contribute to achieving savings in the whole life cycle period. By the application of exclusively traditional or exclusively alternative mechanisms, the possible savings from the synergistic effects of blending cannot be achieved. According to the report of the European Court of Auditors [12
], the European Commission during 2000–2014 supported 17 PPPs through different traditional funding mechanisms, usually in the form of equity and debt instruments, which contributed significantly to the sustainability of such projects. The potential advantages of using different mechanisms as well as projections of possible savings are shown on the basis of the case study, which is presented in the next chapter.
Nowadays there is a significant lack of research focusing on the efficiency of blending alternative procurement models with different financing mechanisms. In the available papers by Sorell [7
], Polzin et al. [8
] Hanon et al. [9
], the authors focused solely on the private sector participation through PPP or ESCO models without using any real or case study data. Some authors focused on some parts of blending effectiveness only. For example, Juričić and Kušljić [51
] focused only on combining PPP and EU grants, while Ferrer and Behrens [52
] focused only on combining traditional procurement and financial instruments. In our paper we have taken a step forward and we have assessed the effectiveness of using alternative procurement models with available EU resources, i.e., blending using a case study simulation.
Although many EU member states have a long tradition of publicly led and financed infrastructure through traditional procurement, rising public sector deficit and debt has become a significant obstacle to purely-granted EE investments. The European Commission has fostered more private sector participation through the new Investment Plan for Europe. According to Bertoldi and Boza-Kiss [11
], it is crucial to develop new or improve existing policies. The efficiency of blending shows higher value-for-money for the public sector, even if the lowest possible level of grants and financial instruments is applied. It is possible to assess the impact of certain WLC project variables using sensitivity analysis. Thus, a small impact on capital cost change can cause significant changes in the structure of WLC. Seeing that using grants and financial instruments significantly reduces the total costs of projects, their combined application contributes to the aimed project efficiency.
This research has effectively demonstrated synergistic effects of (i) efficiency of private sector participation in alternative procurement model and (ii) simulation of possible blending effectiveness with both EU grants and financial instruments, based on a real case study.
The aim of this paper was to test the efficiency of the application of possible alternative procurement models with available EU funding mechanisms, based on a Croatian case study. According to the analysis, three possible procurement options have been identified. Besides the traditional procurement, PPP and ESCO models have been found. The key difference between different procurement options is transferring operational project risks to the private sector. While ESCOs carry a limited risk transfer and are more focused on projected savings, PPPs are based on providing overall public services within fully private responsibility, whether or not the savings are realized. The analysed financial mechanisms are observed with regard to fiscal treatment of projects, therefore on-balance and off-balance mechanisms are defined. Although the European Court of Auditors has [12
] pointed out that the use of different funding mechanisms (traditional and alternative) contributes to the sustainability of projects, there has still not been a sufficient number of such EU-level projects to draw concrete conclusions and recommendations based on “lessons learnt” principles.
The effectiveness of blending solutions using EU grants and financial instruments that are currently available through the new Investment Plan for Europe has been tested, based on a Croatian case study and data of contracted and paid unitary charge in an operational period. The analysis has shown that it is possible to increase the level of effectiveness in the whole life cycle costs by more than 25% compared to traditional procurement. Additional private sector discipline and payment mechanisms based on the “100% availability means 100% payment and vice versa 0% availability means 0% payment” rule has demonstrated significant public sector savings through paying only for those services that have actually been delivered. Any incomplete provision of service or partial availability of EE infrastructure automatically causes public sector payment deduction.
In traditional procurement, EE projects are usually financed from classic budget finance and available public sector grants, while possible combinations of grants and other mechanisms are possible only if there is enough institutional and administrative public sector capacity that understands all advantages and drawbacks of such operations. The situation in Croatia has changed significantly during the last few years, mostly because of improvements of the legal framework [53
], which defines the process of preparation, proposal and approval of EE projects. It is, however questionable whether Croatia, due to the lack of political support and the focus on traditional procurement, has the institutional readiness for the implementation of these projects in comparison with other EU member states.
This paper has outlined an attempt to identify the process of allocation of EU funds with alternative procurement models and an effectiveness estimate of the blending process. The findings of this paper can aid decision makers in selecting the optimal EE project implementation model which would offer the highest value-for-money to the public sector. However, seeing that this paper and the findings are based on a case study of an EE building renovation project, it is highly recommended to conduct additional research and efficiency estimates in other EE sectors such as street lighting, district heating, etc.