To set up our upcoming online event (April 13th & 14th) “China: Carbon Neutral by 2060 -EFFICIENCY FIRST” we look at how Buildings Efficiency is being tackled by Energy Management Contracting (EMC), when an ESCO (energy service company) provides energy retrofit services and gets paid for the future energy savings. The up-front investment cost is recouped over the multi-year lifetime of the service contract by taking a cut of the genuine energy savings made. Brian Yang at the ECECP interviews Guangkui Pan, CEO of Warmland, a leading Chinese ESCO. As China focusses on Buildings Efficiency he is well positioned to answer questions about the opportunities and problems, and the role European partners can play. The Chinese EMC market (worth €54bn in 2017) represents over half the global EMC market. Most of it is in the industrial sector, but the underserved buildings sector is next. EMC matters even more when European solutions are offered as they are more advanced and expensive than current Chinese ones. The cost and the fine-tuned implementation demand a business model that spreads that cost and, importantly, maintains a quality ongoing service. Pan gives thorough answers to ten questions, including matters of government policy, financing, risk management, performance monitoring, supply chains, customer education and more, and stresses that both EU and Chinese ESCOs need to get better at the service and management side of their business.
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EPC (Energy Performance Contracting) or EMC (Energy Management Contracting) is a market mechanism whereby an ESCO (energy service company) provides energy retrofit services from an energy user and gets paid for the future energy savings.
EMC was first introduced to China in 1998 and has become one of the most important drivers of China’s energy efficiency growth. The CNY 415 billion (€54bn) Chinese EMC market in 2017 represents more than half of the global EMC market.
EMC: Where Industry leads, Buildings must follow
However, industry has accounted for more than 70% of the total domestic EMC market in China since 2005, while the building sector accounted for only 18% in 2011-2016 (Zhang et al., 2018). This is not only due to the huge potential for energy saving in the industrial sector, but also the lower upfront cost and shorter investment period. By way of comparison, investment in EMC within the industrial sector is about CNY 2,000 (€258) per tonne of coal equivalent (tce), with a three year payback period, while in the building sector investment is CNY 4,000/tce with a five year payback period (Zhou et al., 2020). This means there is significant capacity for introduction of EMC into the building sector.
As EU-China energy cooperation develops in the private sector, many companies are aiming to introduce European technologies to the Chinese market. The high cost of these technologies means that financing is one of the biggest obstacles to this area of market development. Due to its convenience and reliability for energy users, EMC could be the ideal solution.
The Chinese company Warmland, founded as a building sector ESCO in 2008, is one of the first ESCOs to introduce European building energy efficiency technologies to the Chinese market. It used EMC to finance these technologies and ensure they were affordable for Chinese consumers.
We conducted a virtual interview with Guangkui Pan, founder and CEO of Warmland, to learn about how EMC can be applied to the Chinese building energy efficiency sector.
- First, EMC provided a solution to the problem of financing a project in its early stages. Users are unwilling to pay for expensive technologies when the results are not yet known, but they will pay when they see the actual energy-saving effect. The ‘zero up-front investment’ of the EMC model is attractive to consumers. The ESCO finances the construction of projects that reduce energy consumption and cut costs and shares the benefits with energy users. Users do not need to pay upfront in order to save money, and the ESCO also reaps rewards. This is a win-win situation.
- Second, EMC is trusted by end users. End users don’t have expertise in energy efficiency management. They cannot accurately evaluate the results of projects, and they need to turn to technicians for help. Under EMC, the end users pay according to the actual energy-saving effect, which is more reliable and convenient. This has been evident within our own business. Years ago, we had to provide users with illustrations to explain the EMC model, but now they have started to reach out actively to us for deals. They are getting to know and understand the EMC.
Pan：Our projects range in size from RMB 300,000 (€39k) to RMB 5,000,000 (€645k), with a static payback period of 3-5 years. There are three traditional financing methods.
- First, relying on the company’s own money, basically a combination of equity and liability. Most of the big and scaled up companies are likely to adopt this approach. Some companies also rely partly on government subsidies.
- Second, some state-owned or large companies will use their own funds to invest upfront in large projects.
- Third, using company’s own money to make rolling investments. Here, companies use the revenue from previous projects to invest in subsequent projects. This process takes longer than other approaches, and is adopted mainly by small and medium-sized companies. It’s also one major reason why the building sector EMC market has yet to be scaled up. Even if there were enough companies and projects in the market, too many companies are using this approach.
Q3：According to research, the building sector EMC market share is smaller than that of the industrial sector. How do you think this situation is likely to change in the future?
Pan：In fact, EMC works much the same in both sectors, and the payback periods are also similar. I think the main reason for the market difference is that the building sector consists mainly of private enterprises, with scattered projects and small capital structures, while clients from the industrial sector tend to have larger capital structures. A large-scale EMC project in the building sector might be worth RMB 10 million (€1.3m), yet one in the industrial sector could easily be as high as RMB 200 million (€26m). Large companies with plenty of capital are more willing to enter the industrial sector than the building sector. In addition, data collection from private enterprises is more difficult, which may lead to discrepancies between statistical results and actual market conditions.
I think this situation will change in the next few years, because the domestic subsidy policies for the industrial sector have been withdrawn, while subsidy policies for the building sector have received strong support. The guidance offered by this type of policy will help to make the market more transparent. Although the market size in the industrial sector will definitely stay bigger than that of the building sector, a large number of companies and funds will choose to enter the building sector in the years to come, creating tremendous opportunities.
Pan：Yes. I have participated in a few industrial sector projects since 2015, but after doing some research I decided to quit, because there are big differences between the building and industrial sectors.
- First, clients from the industrial sector often know more about energy efficiency technologies: these lie at the heart of the industrial sector, yet only act as auxiliary services in the building sector. Therefore, large industrial customers with sufficient resources (power plants, steel plants, etc.) often set up internal teams to deal with energy efficiency management. They are unlikely to adopt external services.
- Second, we are more willing to provide fully outsourced services. As I’ve said, industrial customers always understand more about energy efficiency management technologies than customers who work in construction. As a result, it is possible that our technology might be handled and even copied by industrial clients, which would bring trouble. We often see litigation between industrial customers and service companies. We don’t want this to happen.
- Third, the idea of EMC is still not fully understood by the Chinese market. Most users think of it simply as a way to fund projects, whereas in fact EMC is a whole system of management and service. Large customers that have no trouble with funding won’t use the ESCO’s external investment and related services if they think of it simply in terms of funding.
- Fourth, an industrial customer is much larger than an ESCO in terms of volume, technology, capital scale, and so on, which could make it difficult for ESCOs to negotiate and cooperate with them. Customers in the building sector are often much smaller in scale and have less mastery of energy efficiency technologies. Private ESCOs have more opportunity to solve problems for these users using professional methods and technologies.
Q5: Could you tell us more about services included in EMC? Many post-EMC projects didn’t operate as expected. Is it because of a lack of services?
Pan: The idea with EMC is to use contracts to solidify the relationship between customers and the ESCO. The ESCO invests in construction or upgrading of the energy efficiency systems, and then provides customers with long-term operating services. The investment represents only the early stage of EMC, while the operating services, which include all subsequent services, form the core.
If the ESCO provides poor or non-existent services and the customer then manages the new systems as they always have done, the equipment will not be fully functional and the investment will be wasted. Even some ESCOs don’t understand the importance of the services. They start charging right after the completion of construction without offering any after service at all. When customers question the outcome, disputes can ensue. This is the main reason of the failure of some EMC projects. The costs of the services, including equipment maintenance, depreciation, and so on are paid by the ESCOs, and the rest of the revenue is shared between the customer and the ESCO in line with the contract. The ESCO will normally get a larger share of revenues during the contract period.
Pan: We had to refer to previous cases in earlier years. Now that our business is approaching maturity, we have identified two main solutions that have proved to be effective.
- The first method is based on technology. Energy consumption is related to technical parameters such as flow rate and calorific value. We can benchmark these technical parameters to measure the actual energy savings.
- The second relates to finance. Customers have historic energy consumption data. We take this data as a baseline, and then compare the new projects with that baseline to get an accurate measure of the results. For example, the year before we stepped in, a building used USD 10 million in energy. That figure has been cut to USD 8 million. The USD 2 million represents the value of the project and is shared between the customer and the ESCO. These methods will be written into the contracts.
Pan: First, we make technical calculations, looking at factors such as the power of the machines in the early design. The value added when we decrease the power from 1,000kW to 800kW is clear.
Second, we have projects in almost every latitude of China. The various factors, data, and models in these cases can help us evaluate new projects.
Finally, we can understand the customer’s energy consumption through the customer’s invoice.
Taking all these aspects into account, we conduct data analysis in the early stages, come up with a relatively reasonable index, agree on a fault tolerance range, and make upward or downward adjustments based on a consensus of both parties within a certain period of time. This approach can effectively avoid risks. As we expand our business, risk management skills will become increasingly well-established. Every company has its own method of risk management and control: this is just our approach.
Pan: In general, although Europe and the United States have the most advanced technologies in specific fields, it is the Chinese market that has the ability to integrate these technologies due to China’s large market size. Take the German company I worked with as an example. For the past 10 years or so, its sales have stayed at EUR 20 million. Yet a single province in China can match that market size.
China is also a world leader in EMC applications. In Europe, The EMC model has been talked about for a long time, yet due to the market size, it hasn’t been sufficiently applied in industry. EMC is still being used mainly to help customers save money, and not enough work has been done on services and management, as I mentioned before. It’s rare, too, to find EMC being used for public buildings.
Q9: From a private sector perspective, how do you think EMC could contribute to EU-China cooperation?
Pan：First, cost is always the biggest obstacle to non-governmental technical cooperation between China and Europe. Companies face a lot of additional fees, such as materials, technology, intellectual property rights, tariffs, transportation, miscellaneous fees, and so on when they try to introduce European products to China. Prices for these products can rise up to 10 times or more when going through dealers in China. Private companies are all about profit, and they would never be willing to pay such high prices. However, under the EMC model, this part of the price is borne by the ESCO and the user pays for the energy-saving effect, so that the high price of European technology can be absorbed. Of course, the amount that EMC can absorb is limited, and the model also needs promotion and support from all the governments involved.
Second, EMC can help private enterprises to think about long-term benefits. For example, more than 95% of Chinese companies use normal pipes in their waterway systems, but our company insists on using stainless steel, which is 10 times more expensive. In the short term, this will undoubtedly increase the cost, but in the long term, we won’t need to worry about pipes anymore. This spirit of pursuing details and striving for perfection impresses our customers. It is fully in alignment with the EMC concept, which is to provide a long-term service for customers. Although European technologies are more expensive than domestic ones, they are better at solving problems and meeting customers’ needs, so they should be adopted. The EMC model provides the best solution for ESCO companies to apply these technologies.
Pan: I think I have three pieces of advice.
- First, the private sector doesn’t have as many information sources as the state sector. We need to actively participate in exhibitions and events, and be demand-oriented on the events. For example, we identified the current radiant heating business because we’ve been actively searching for solutions to tall spaces and outdoor spaces heating for years. Private enterprises have to stay practical if they want to be part of this cross-border cooperation.
- Second, Chinese private enterprises need to respect intellectual property rights, pay attention to the interests of customers, and stop copying technology from others while flagging it as ‘digestion and absorption’.
- Third, European companies also need to adjust their strategies. There are huge differences between the market environment in China and its counterpart in Europe. If they want to scale up their business in China and make the fullest use of their technology, they should no longer regard China simply as a sales target. They’d do better to develop their supply chains in China, make use of China’s advantages, and strive to reduce the additional fees, so as to achieve full localisation in China.
This article was first published in the EU-China Energy Magazine 2021 Spring Double Issue, available in English and Chinese