Research on value and factors of the guarantee payment in the energy performance contracting in China

Abstract

Mistrust of the Energy Using Organisation (EUO) in Energy Services Company (ESCO) is a key factor that hinders the development of Energy Performance Contracting Projects (EPCPs) in China, especially the EPCP is the shared savings type. A payment guarantee that is able to hedge the credit risk of the EUO is the rational choice for the ESCO. Considering an EPCP payment guarantee with a limit on the total amount that is essentially a multi-period European put option portfolio with multiple uncertain exercise prices that the guarantor sells to the ESCO, this paper constructs a valuation formula of an EPCP payment guarantee, in which the exercise price follows the geometric Brownian motion with a Poisson jump, and analyses the effects of the factors on the value of the payment guarantee. The results revealed the following. First, the value of the payment guarantee is affected by the total guaranteed amount, uncertainty in ESCO’s revenue, and uncertainty in EUO’s net cash flow, and consideration of the impact of unexpected shocks on the exercise price can avoid overrating the value. Second, the value of the payment guarantee for each period within the scope of the full guarantee increases with an increase in the ESCO’s initial revenue flow, proportion of the revenue sharing and expected revenue growth rate, and it decreases with an increase in the risk-adjusted discount rate and EUO’s initial net cash flow; the value of the payment guarantee for each period within the scope of the full guarantee first decreases and subsequently increases with an increase in the risk-level of ESCO’s revenue and the EUO’s net cash flow. Third, the results of the Sobol’s sensitivity analysis indicate that, within the scope of the full guarantee, the ESCO’s initial revenue flow, proportion of the revenue sharing, the risk-adjusted discount rate and EUO’s initial net cash flow play relatively important roles in changing the EPCP payment guarantee and its exercise prices. According to the above conclusions, the payment guarantee contract can provide the ESCO with a basis for decision-making in the formulation of a strategy to safeguard energy conservation revenues in accordance with the relationships embodied by the value of the payment guarantee. Finally, the policy recommendations about relieving the mistrust between EUOs and ESCOs are provided.