Energy Contracting Developing into a Model for Success

Through solid refinancing contractors are able to provide modern and environmentally friendly power plants.

Rising energy prices and rapid technological advances mean that firms, municipalities as well as private households are making increasing use of the possibility of not buying their own energy supply systems but, instead, concluding contracting agreements for their use. This is a growth market for energy suppliers and other contractors. In order to secure refinancing through a financing partner you have a choice of different types of agreements.

Where is Contracting Used?

The areas of application for contracting are diverse. Here, energy supply contracting is the most widespread in the market. Verena Joswig, a Customer Adviser for Leasing and Contracting at NORD/LB, cites the areas that are suitable for contracting: “For example, there are customers who need compressed air for their production plants. Hospitals depend on a reliable supply of both power and light as well as heating and cooling. Administration buildings and the rental apartments sector need energy and municipalities are converting street lighting to LED. Here, contracting is an alternative to purchasing the systems.” The benefits for end users are obvious. They themselves do not have to invest in an energy facility and purchase fuels or electricity. Instead, the contractor takes over planning and construction as well as the operation of the facility. The end customer pays a basic charge in addition to a usage charge for the energy consumption.

Contracting Requires a Special Agreement

Contractors have the choice of leasing the energy facility through a leasing company or buying it themselves. As NORD/LB has many years’ experience of refinancing leasing agreements, in recent years, the related business of contracting via leasing companies has also seen an increase. The leasing companies, for their part, have contacts to contractors and most energy suppliers are among them. The business requires specific and very complex agreements. For contractors, reliable refinancing of their agreements is crucial because they normally have a long maturity period of more than 10 years.

Contracting with a Leasing Model

In the case of a leasing model, the contractor looks for a leasing company that will finance a facility for it and concludes a lease agreement with that company. Here, the facility does not appear in the balance sheet. The lessor transfers the facility as a leased asset to the contractor for its use and in return the lessor receives a lease payment in the amount of the basic charge claim in the contracting agreement. The contracting principal, thus the end customer, pays this basic charge, which is payable even if no energy or any other agreed service has been obtained. The basic charge claim becomes undisputed through a waiver of defences declaration. The end customer thus cannot oppose the claim in any way. The waiver of defences declaration is made vis à vis the leasing company or the refinancing bank. For the bank the indisputability of the claims is important insofar as it is thus able to assign the claim to the end customer. The owner of the energy facility is the leasing company. The contractor transfers the leased facility to the contracting principal for its use. On account of the financing agreement with the leasing company, ownership is transferred to the bank by way of security. The bank buys the leasing payments, which correspond to the undisputed basic charge claim, from the leasing company as refinancing funds. This model thus functions in a similar way to typical leasing only that, in addition, a contracting agreement forms the basis. “Due to the particularity that the bank is able to take into account the end customer’s credit rating, we have many individual borrowers. So, we do not have to provide the Contractor with a large financing framework on an ongoing basis that could become problematic at some point. As a result the Contractor gains greater financial leeway”, explains Verena Joswig.

Contracting with the Double Purchase of Receivables

The second contracting model includes the double purchase of receivables. The contractor does not conclude a leasing agreement with a leasing company but, instead, sells the undisputed basic charge claim in the contracting agreement with the contracting principal - for example, a municipality - to the leasing company. The bank, in turn, buys these claims from the leasing company. In this case, too, the credit risk is with the end user and once again ownership of the energy facility is transferred to the bank by way of security while the contractor is the owner.

Contracting Principals with Excellent Credit Ratings Only

It is mainly larger leasing companies that are engaging in the contracting business because the volume of business is usually considerable and the agreements are complicated. Furthermore, maturity periods of more than 10 years are uncharacteristically long for lease agreements. However, contractors pay close attention to the credit rating of their customers. In many cases, cities and municipalities are the end customers so that the default risks are low. If nevertheless a contracting principal were to become insolvent then it can be generally assumed that a successor operator would take over the facility and the associated agreements.

Contracting is a Growth Market

In order for contracting to work the credit ratings of the end customers are just as important as having a reliable partner for the refinancing. Municipal Utilities are Increasingly Entering the Contracting Business NORD/LB is able to support these transactions either through its own leasing business or by referring them to its leasing partners that are active in the relevant area. Currently, work is in progress on a product concept that would provide for bundled financing for smaller contracting agreements that could be offered by energy suppliers, for example, to private households for heating systems. “The market for contracting is growing”, Verena Joswig is certain of that. “Another reason why NORD/LB is engaging in contracting is because it is an opportunity to use innovative and environmentally friendly technology and, at the same time, to save costs in energy consumption. In this way, the energy transformation will be easier to realise.”