- University and hospital projects
- Current market trends
Chris Dalgarno-Platt (00:07):
A P3 or an energy as a service type transaction will often be an overarching transaction advisor as well. So you'll often see that there is a legal advisor such as Matt and his firm, there'll be a technical advisor as well as then a financial advisor. And usually there's somebody who brings it all together and will usually be the sort of first person through the door to help an owner who's maybe considering is there a reason why I want to change the way in which I'm delivering my utility services. So energy as a service is, we are really seeing that in terms of being a change from the active delivery of a utility service, which can be everything from steam plant, it can be chilled water onsite electricity generation usually based at a campus type institution is often the place where we'll be operating, say university or hospital airport. Somebody who has got a major need for energy production on site and they're typically undertaking that work themselves and are looking usually have a good reason for considering why would I want to continue doing that work myself. So, if things are occurring along, there isn't any obvious reason to change the delivery structure or the way in which the services are being delivered, then typically a P3 or energy as a service as a concept may not be right. However, in changing sort of circumstances, particularly things like having to hit externally mandated sustainability goals is a particular reason. If you've got a lot of deferred maintenance that's been building up over time, maybe you need to expand the energy system in order to support a wider expansion of your institution or campus. Those might be reasons why you need to move from a steady state along quite well to maybe needing to bring someone in a partner who basically does this 24 7 across multiple sites and who can help with that transition and then manage the steady state from that point onwards. So really that's often the sort of genesis of the consideration of these types of processes and when you might get advisors in is to kind of look at the feasibility dip it in the water and see are there reasons for changing the steady state that might be operating pretty well.
Daniel Allen (02:33):
To kind of piggyback on that, what we see a lot of times is customers are not in the business, they're in the business of educating students, serving patients in the healthcare space, etcetera. They are not experts of running their own, their own facilities and we're talking facilities that could be chilled, water, steam co-generation, solar assets, whatever it may be they have, it's this usually the small scale down staff that gets last resources they don't usually get a plant manager's gonna say I need X, Y, Z and through whether it be through a state appropriation process, whatever it may be, capital funding may be limited. And so we think of it a lot of times as a subscription based model in lieu of habitous stroke checks, there are ways of bringing in experts that can operate these assets, can build these assets and do it over a long term and make it to where it pays for itself compared to the status quo with energy savings. So I think a lot of times there's the intrinsic value provided with the project allows for the things such as monetizations if you've got a good project that starts at the baseline. But again, it's all about operating performance at the end of the day is kind of the key to the energy as a service.
Matthew Neuringer (03:54):
Got it. So basically you've got a private developer that can be procured either through a soul source if you're talking about a private institution like a private hospital or private university or if it's a public agency through some type of competitive procurement. And you can come in through some type of fixed price up front say look, we've analyzed your data based on your usage of water and energy and we've looked and done some type of audit of your assets and based on this we think we can make these upgrades and install these additional assets and as a result generate this type of long term savings. And behind that you're guaranteeing those savings. Is that right? Yeah,
Daniel Allen (04:35):
So I take it almost like a ESCO 2.0 or 3.0 where you would had done years ago the basic lighting changes or things you get core customer funded improvements where now we would come in do all of those things. You would know energy audits, site surveys, et cetera and determine, hey, this is a scope of work that can generate say 3 million dollars a year in savings and what can we do if we basically were to extract those savings and further improve your plant keep you budget neutral or flow neutral. And one of the things we talked about is the difference between energy to service and that kind of ESCO model is really comes down to the ability to monetize the assets if that's a wish. And really the transfer of risk for capital repair deferred maintenance and capital renewal from the customer to the third party on an ongoing basis. And then again that risk, that O and M risk transfer guaranteed savings guarantees on availability is a way to optimize a transaction.
Chris Dalgarno-Platt (05:50):
And I mean I would just also add to that as well. I think what you're seeing here is various reasons for doing an energy as a service type contract and I think monetization is one that often gets bandied around and I think one of the advantages of having a long term relationship rather than that short term energy as a service contract traditional model, you can actually monetize over a longer period of time and generate a larger amount of cash upfront if that is the main reason for doing the partnership in the first place. And I think having that clarity of objectives front is sort of critical to the decision whether to employ a partnership or not.
Matthew Neuringer (06:30):
Yeah, Thanks for that Chris. So I think that's a good sort of transition into our next question is there's a lot of people in the municipal finance market that historically, hey, we know how to do design bid build, we know how to issue debt and build projects in a sort of traditional way. So why should we explore something that is a little bit more complicated that might require a bit more time and analysis up front? Where is the value proposition and how can we sell that to our constituents, whether it be our board of directors, our taxpayers that this makes sense And so maybe we can discuss some of the current structures in the market for energy as a service. And then what have been some of the benefits to each of those structures and why? And so two of the structures that we've hit on initially are the monetization and then the other that's somewhat prevalent in the market right now is availability payment structure. And so maybe just talk a little bit about the differences between the two and then the benefits and at some point we'll talk about the other side of it as well, Yeah.
Daniel Allen (07:41):
So, really when I think about it, we'll talk about, I'm use an example of a transaction. This is a private university down on the coast. When I say the coast the Louisiana coast hurricane zone has huge carbon neutrality plans. They wanna be truly carbon neutral by I believe 2040 or 2050 and get, there was the big question that we kind of started out the discussion with well rated. So, they didn't necessarily need third party money but they needed improvements on their assets. So, we worked with them to determine how do we craft a project that Az reduces your energy consumption, which was step one, improve your resiliency for hurricanes because they had been through Hurricane Ida hit, the campus was dark for weeks at one point in time last year. And so we spent a tremendous amount of time with engineering architects due diligence and crafted a package that what it ended up achieving was work to their chilled water systems work to combine heat and power and have full backup power generation so they could go off grid which is important when you live in a hurricane zone backup power, backup power building automation to help run these assets efficiently.
(09:16)
And then some renewables in the form of solar they had some land issues. So solar was a little bit limited and where we ended up was we did 110 million scope of work about 116 million in monetization, which is where this kind of fell into a hybrid. But the interesting thing was is it reduced their energy use intensity by about 31% which seems like a big deal but when you're trying to reach that carbon neutrality they got a long way to go. So we narrowed it down to scope one and scope two emissions scope two emissions were decreased by 20% and it paid for itself. So that was the unique thing about that project. We can get into more on some of the meat on the callbacks, et cetera, but Sure,
Matthew Neuringer (10:09):
Sure. I mean maybe just talk a little bit about what that means from what is a monetization and what can they do with the money that they get and then also how are you paid? Is it an availability payment or is it a revenue risk?
Daniel Allen (10:22):
Yes certainly. The transaction was actually structured as a thermal service charge. So the customer's paying a charge and we are doing the work so it's swapping out things within their budget. The monetization came from the fact that we generated sufficient savings, operational savings that are a big chunk were guaranteed. Some of 'em are stipulated due to energy prices and so we were able to lower their operating budget by x millions of dollars between hard costs and guarantees avoided capital. So, by doing these improvements, they're pulling items forward from their budget from future years that they will no longer have to fund and they pay that payment to us monthly. It's like clockwork. I think of it as a, being a former banker it's a debt service payment but it's out of their O and M budget. So it truly is an opex. So was I part of that.
Matthew Neuringer (11:22):
So I think as far as the monetization goes, so you paid them 116 give or take million and that was sized based on the fact that you're making these improvements and let's say it was gonna cost them 300 million for energy and water over the next 20 or 30 years. Now it's only gonna cost them 200 million. And so you're returning to them today that a hundred million in savings, which they can then take for any purpose.
Daniel Allen (11:52):
So that hundred 16 you're spot on. We basically think of it, I think of it in public finance terms as a refunding and we took our savings at closing as opposed to taking it over time that money was free and clear because the debt was taken out by the SPE or by the developer. So, it's not tax exempt. We do have a little bit of occasionally some private use issues that we have to work through, but they were very minor and the university could have spent it for anything. Quite honestly. They could have set it on fire and we would've been okay with it theoretically, but that's truly they had it's unrestricted. So while nobody will disclose exactly what it was, I would assume it's probably in an endowment part earning something. So that gets into the whole risk and the reward and we'll talk about later about some of the challenges with the market on how that can be optimized or dealt with.
Chris Dalgarno-Platt (12:47):
Okay. And I would just add, I think that gets back to the objectives for doing the deal in the first place. Cuz I think tole, I presume you can say it. Yeah. So it is a deal where there was a general desire to improve efficiency, deal with some underlying technical issues associated with the plant and things like that. That was first and foremost the reason for doing it. And that meant that the value of the monetization payment was generated, one might say, or sort organically from monetizing the savings that were being met over time. If you take the ends of the spectrum, there are some very common monetization projects in the market such as the Ohio State University one, which folk may be familiar with, generated a billion dollar payment to the university. But that was where there was a lot of focus on generating that payment so it could go into the university's endowment so it could then accrue interest over time and then the university could extract value for purposes that were unrelated to the energy system. So, they had a very clear objective, which was to focus everything on how to generate a large monetization payment that could then be extracted over time. The other end of the spectrum is if you take a university, I was thinking of CSU Fresno where they entered into a deal about 18 months ago where they were focused on meeting sustainability goals and targets. They didn't require a monetization payment at all. They were just happy to take the savings on their utility costs from the efficiency and energy efficiency as those came to you. And so the, there's sort of a balance there of saying do I need the payment up front at which point you get it to use at that point but you are discounting the value of that payment over time or do I just take it as it arises and potentially get a hundred percent of the value but you get it drifted over a concession period. So, there's kind of three sort of broad structures if you take the hybrid in the middle. But again, that clarity of objectives upfront is sort of critical in making that decision.
Matthew Neuringer (14:58):
Yeah, I have you brought up Fresno cause I think you have the Fresno and OSU and of the different sides of the spectrum and then in the middle is sort of the tooling. And so from a legal perspective there's also just some nuances to be aware of. So, in the Fresno scenario there, like I said in the intro, the university's retaining all ownership. There's no transfer whatsoever either sort of synthetically or legally it's purely a concession for delivery of these energy services over time. And so what that means is that in some of these structures where you do have a ownership transfer of the asset and then a lease back there is also typically some type of a leasing of the employees as well who previously worked on and serviced those plants. And so where we've seen some legal complexities is around well how do you transfer employees from those assets that the private developer wants to continue to utilize on a go forward basis? And so where you don't have the ownership transfer that's not necessarily the same sort of legal issue that you end up dealing with on a pure availability payment project on the Fresno case. The other is also around if you're dealing with a private sector client like a university, private university or private hospital there is a potential opportunity, and Chris could talk about this a little more around balance sheet treatment. Typically if you're a public sector client, that's not something that's going to be possible based on the relevant accounting rules. So, the actual transfer of ownership again is not necessarily something that's needed in order to achieve that objective of off balance sheet treatment. And then ultimately as well with respect to the upfront payment, when you're do doing an availability payment structure there isn't an upfront payment. And so again, there isn't that sort of need for having some type of mechanic around how you transfer interest for purposes of getting and receiving an upfront payment. So I dont know if you wanna add anything on that or
Chris Dalgarno-Platt (17:34):
Although I would say I think we'll talk about challenges of these types of partnerships in a second, but I think what you've hit on is that there are some benefits that sort of accrue to energy as a service type contracts similar to other P3 type contracts and you picked up one there, which is the potential for off balance sheet treatment and the rationale being there, it allows an institution to potentially free up debt capacity for other projects. So if you are doing a distribution system that you need to upgrade, there aren't necessarily folk out there or donors and philanthropists at a university who necessarily want to have their name attached to the new sunken tunnel that's going to contain the conduit for electricity or pipe or steam pipe. However, what if you can use the project for an off fall sheet type scenario, free up debt capacity from that project, you can then create more capacity to invest in the new business school or something then that is more of a strategic goal for the institution itself. And so there are ways in which you can use what appears on the face of it to be a less attractive asset for that type of investment as they lever to be able to create value for other parts of the institution that are maybe needing to be developed for more prioritization.
Daniel Allen (19:00):
So are you saying that chillers is not sexy?
Chris Dalgarno-Platt (19:03):
I'm really sorry darling.
Daniel Allen (19:07):
So, I think you're spot on and the irony is we've had projects that had significant capital improvements, yet the solar might be the only thing that really gets pressed because it's something tangible. It's something that the various stakeholders, whether it be the students or hospitals, the doctors, et cetera, they can see it. It's something that's very tangible to them. They don't realize that the other improvements are what allows their operating room or their dorms to stay at a constant temperature but they don't care about that until it doesn't work. So, that's the irony is there's this, depending on who the stakeholders are it's always very interesting conversation.
Matthew Neuringer (19:51):
No, appreciate that. And also one of the things that we've seen as a common feature, especially on the university side is some type of educational component as well where there's some type of programming where the developer agrees that as part of the deal they're going to work with the university to have some engineering students or otherwise be a part of the project in some sense.
Daniel Allen (20:10):
We actually have arrangements with most of our university type customers for whether it be internships recruitment lecturers. We've actually had a two lane recently, we actually were down there and had an entire group of engineers and folks from the business school that toured the facilities learned about the practical and real world benefits of what was going on. And so they could take what they were learning in class and see the real world example but we use it as recruitment as well.
Chris Dalgarno-Platt (20:44):
So the only other thing I was gonna say, I think a lot of our background is on universities and campus type projects, but knowing the audience here and looking at municipal type institutions generally a lot of municipalities have say a central plant or utility system that will be used to supply major institutions or buildings like hospitals and stores and whatever down in a downtown type arrangements. And the energy as a service piece can be particularly useful for a municipality that's got a very wide range of responsibilities that any opportunity to slim down and focus on those that are particularly relevant and particularly noticed by the community can be a very helpful aspect of going down a P3 type route for the municipal provision of energy services as well. Not to mention the ability to in usually that central location can be used to generate additional connections, additional third party revenues and additional sources of funding beyond the typical tax base and municipal sources of finance that are available as well. So it's not just an institution type or campus type solution. It can work wider than that too.
Daniel Allen (22:03):
I would say there's actually, we've seen some good examples where state governments were in a downtown, they had a lot of state office buildings and they were on a central utility or it's basically a district energy system but it was wholly owned and we've assisted them in making improvements and then also adding redundancy and tying them into it's actually under development tying them into for profit or really general non-governmental type entities that are in a related area. You've got some geographic constraints, particularly for chilled steam mostly, but chilled water you can't go too far. But serving third party off takers and revenue, sharing that back with the host so a developer can be incentivized to not only provide you your services but use those assets that may be underutilized and generate revenue from a different source. And so that's a unique way of that where you truly do have that public private partnership not just in the developer and the owner but also another public aspect in the private sector of potentially sharing assets. And ultimately the goal is driving, bringing down the cost to the owner
Matthew Neuringer (23:18):
Yeah, on the sharing of assets. And we've seen deals where you might have a company already has an existing facility nearby or adjacent then that can be utilized this additional redundancy and value add. I would say, I guess on that end of the spectrum we heading more on the monetization type structure rather than the availability payment where the entity that's providing those services is more of a standalone corporate enterprise to speak that has the ability to monetize not only within that specific client but beyond and as a result needs to have bit of more of a flavor of a privatization than a sort of traditional concession. And so with that, what types of constraints are owners putting on deals from a capacity perspective? Are they demanding that a hundred percent of their capacity has to be met first and then anything in excess of that can go to the third market?
Daniel Allen (24:17):
So the ones I've seen and I can't speak to, obviously we do have competitors but ultimately it's gotta provide a hundred percent availability to the host customer typically. So let's say we've got a hospital in New Orleans that did not evacuate during ida the city was dark. So we are a hundred percent responsible for water backup power and chillers, boilers, steam, et cetera. And so the obligation is that we provide them 24/7, 365 service. And to do that we have typically in plus one redundancy. So we've got significant excess capacity in theory. So you're right, they get first if there is a curtailment of something catastrophic happens, the off takers get cut to they are the first to go customer gets all of the benefit. And those are, there's ways to contractually handle that. Cause usually we're not a sole provider for a third party off taker.
Matthew Neuringer (25:26):
Awesome. So, we're at a bond buyer conference so can't not be up here and talk about bonds a little bit especially with you as a banker Dan. So let's just talk about some of the types of debt I guess we've seen on these projects and maybe also talk a little bit al about the role that your firm plays in particular both either equity on or no equity. And then we can also talk a little bit about green bond eligibility. The Fresno deal for example, was done with the green bond adds sort of a layer of additional accountability to the developer from a long term perspective to the financing parties. So let's just start of first different types of debt and then get into the rest of it.
Daniel Allen (26:07):
So I think of the debt as a former banker, my goal was always lowest cost of capital, lowest cost of capital however we got there. And so the way some of these deals are structured is there is a fixed payment in the form of a thermal service charge or an energy service charge. And that's gonna be broken up into two pieces conceptually a capacity charge and an o m charge and a portion of that would be used to service debt. In some other transactions that Chris has worked on, they serve it, they fund the equity return as well. So the debt that we would raise and so it's our debt, it's not on the books of the customer we would raise it to date. We've done it in the private placement market, we'll go out to, these are 30 year deals. So your big life insurance companies, big asset managers will come in, fund it, typically it's taxable, typically tenure, make whole, it's not usually optionality is very expensive in that market. And then we have so elected that if the goal is to fund this at the lowest cost, typically equity is more expensive that I guess that goes back to basic finance classes. And so though the more equity that has to be injected, it's gonna raise that ultimate cost and either erode the savings or really erode the savings is what it ends up doing. So we have been able to leverage it a hundred percent with appropriate mechanisms in place through the private placement market to get everybody comfortable as opposed to an availability, more of an availability structure that's gonna have equity, the equity partners credit is gonna be brought into the picture. We've been able to really isolate the repayment source in a way that ultimately drives down the cost of capital.
Matthew Neuringer (27:58):
And just before Chris, you jump on, I just want to drill down a little bit on how you guys be structures it, which I think is a little unique and also says a bit about the business in that typically with these project finance structures, equity is backstop by some type of equity letter of credit and that is the equity commitment for the deal. And then the s special purpose vehicle spv is a bankruptcy remote entity that once that equity is drawn down on, that's it right? There's no additional recourse to the actual developer in your structure you have apparent guarantee from your company so that if there is an issue for example debts taking a haircut as a result of a either payment termination payment that's discounted or frankly no termination payment, you guys are coming in and that is.
Daniel Allen (28:48):
Yeah, so wewe've actually addressed that a couple ways to limit the exposure on the debt side, the termination payment doesn't necessarily flow through our credit. So there's not a haircut on the lenders. The worst case scenario would be at par. Granted the owner has their teeth into us, there's a few mechanisms. Liquidated damages is kind of the first step. So if we were to fail to provide 24 7 within the agreeable terms perform KPIs, so let's say chilled waters off by a degree, we start getting hit with liquidated damages hour one typically depending on the calls. And so those are parent guaranteed backstop. So it does go through that non-recourse spe because ultimately the way we have structured is we're being vertically integrated. We have our own construction and o and m divisions. So we actually bear that risk. Who better to do it than folks who do that for a living?
(29:51)
They say that until there's a draw. So we'll see how that works down the road. But that is something where as opposed to having equity at risk, we have legitimate cash or skin in the game in the form of liquidated damages. We also guarantee energy the savings. So the utility savings not gonna guarantee your bill, but what we do guarantee is as a reduction in your gas or electricity consumption. So if we were to miss that there are rebates effectively or we would pay damages on that. And then you think about one step further is tax consequences that on some of our projects we do have tax ownership to where we are able to get certain tax credits or depreciation and share that back to the customer and if there was a termination early and we have the recapture of that depreciation and those tax consequences are not insignificant. So there are ways to get skin in the game without having a developer stroke and equity check at a higher cost of capital.
Chris Dalgarno-Platt (30:56):
I think that sum things up very well. I think the only thing I would add is when you're talking about P3 s in the introduction of private finance in any capacity, whether it's equity or debt sort of brought in from another source for public owners, there is always a question about is tax exempt debt is going to be a lower cost of capital for most public sector entities? And that's a big hurdle for making a decision to consciously take on a project that is going to introduce more expensive debt or equity. And so I think the two things as far as energy as a service where it's particularly relevant to consider the more expensive option is one in terms of the risk transfer that Matt was talking about. And what you get with to an extent with equity and certainly with the debt provision as well is you get a continuity of ownership and skin in the game I suppose from an equity provider through from the commencement of the project and the design and construction of any assets that are added to the project.
(32:05)
But then in terms of the onm moving forward by introducing that private finance piece, you have an interested party who is connected to that project in a lot of cases for the full concession length, which can be 30 to 50 years, a lot of equity providers in particular hold those investments for an extended period of time on behalf of large pension large pensions and the like who are looking for steady long term returns. But that means you get somebody who is connected to that project and if something goes wrong with it, they're on the hook regardless of what stage of the project you're at. So there is a genuine value in having the private finance take that kind of connective tissue between the different stages of the project. The other very specific circumstance in terms of monetization is where the use of proceeds for tax exempt debt is quite highly prescribed and the opportunity in a monetization type deal where you're effectively borrowing from the balance sheet of your private provider is the use of those proceeds can often be less restrained or constrained then would be the case if you issued tax exempt debt for the same use. So if we go back to the Ohio State University example they were effectively borrowing from the NG balance sheet able to invest the proceeds in their endowment and then arbitrage the value between the returns on the endowment and the cost of capital of the provider. So that isn't an option that's generally available for the use of tax exempt debt proceeds. And so that if you are confident that you can make that arbitrage work, then that can be another reason to take on what is ostensibly more expensive debt if you know that you can arbitrage it. Now we'll talk about challenges and whether the current economic climate really allows for that to be a sustainable future model, but that's certainly been the rationale in the past.
Daniel Allen (34:03):
Yeah, I would just add one thing on the risk transfer is there's a lot of, most people here obviously are probably finance people, but the reality is there's more to this than just the money. We have numerous customers who have challenges on the o and m side, whether they're budget constrained or they're potentially a state university, they're getting appropriations for maintenance and repairs, but they're not necessarily getting a capital truly replacing a boiler. And so there's ways that we could work with them to optimize that to where we can extract some dollars and not necessarily have to go to the debt markets. The other thing is from just a day to day operations, we've had CFOs that are actively involved in procuring wood chips for their boilers and it's like I don't have time to be procuring wood chips for my boilers. I've got the university's audits due, whatever it may be. And so there's a practical operational side of it that really comes into play. Numbers have to make sense, but if outside of that, the day to day who runs this gonna, when the pipe breaks in the middle of the night, who's gonna fix it? Is it my staff or do we have a third party who is effectively responsible for it and they have significant dollars per hour to get to incentivize them to get it it fixed. The other aspect is share risk. You can also share benefits. We see utility savings sharing mechanisms to where if a third party developer is able to outperform whatever is negotiated day one, they get a piece of it. So at that point everybody's interests are aligned and incentivized to move in the same direction. So, if the university or the customer gets more savings, the developer gets basically a bonus payment in effect. So it does, there are ways to get everybody's interest moving in the same direction.
Matthew Neuringer (36:09):
Awesome. Now thanks Dan. And I think that's a good transition to some of the challenges and maybe Chris also you just talk about from your role as a trusted advisor to owners, making sure that if you were gonna structure something like that the developer's not setting the benchmark so low that they are on day one getting some type of a shit right.
Daniel Allen (36:28):
Developers would never do that.
Matthew Neuringer (36:29):
Right? So just some of the challenges that we see and then maybe we could talk a little about next steps in the market, what we're seeing in the market and how owners might be able to get involved.
Chris Dalgarno-Platt (36:40):
Sure. Yeah. So I think I'm becoming a bit of a broken record I think on in terms of objectives in so far as one of the biggest challenges that we've seen in projects regardless of the nature of the P3 transaction or the sector has been a lack of clarity around what the genuine objectives are and a clear sighted sort of view of what the purpose of a partnership would be and why would we enter it. So, in the energy as a service perspective as we said, is it to generate revenue for a particular purpose that might be external to the utility system? Is it about needing to generate cash in order to improve credit rating and thereby of decrease the overall cost of capital for the institution or something similar to that. Or is it something where you've got either an internally or externally generated objective for carbon neutrality by a certain date and you just not got really any idea how to transform the system that you're operating today into a carbon neutral system and manage that transition over time.
(37:49)
So if there is clarity on that, then that can certainly improve things. And one of the difficulties we've seen in the past is as you're looking at the feasibility of a project, it can be quite wooly and fluffy about why I'd bring a private sort of partner in to look at this. And so positing the challenge, positing the mitigation. I think that dipping the toe in early and kind of saying through some kind of feasibility analysis or something that allows all of the stakeholders within the institution who might have different interests as well, if you are a plant manager versus the CFO, you've potentially got different interests in what the project is gonna look like using some kind of analysis to bring those people into the room together and say do we have alignment internally on what our objectives would be and is bringing a partner actually gonna genuinely address those objectives or can we do it ourselves? And so I think solving that conundrum is like 80% of the problems that then surface during a procurement or anything are from a lack of clarity in the origination of the project.
Matthew Neuringer (38:56):
No, I think that's a great point cuz where we see clients start running astray is like once you get into details and the meat of the deal and you start to figure out risk allocation and you get really focused on something that you think is super important but it's actually not part of the core objective, it becomes a distraction. And we've seen clients walk away clients on the developer side from deals because of owners getting distracted from core risk points that really aren't core to their primary mission objective and doing the procurement to begin with. And so I think focusing on the right objectives and not the minute sort of details that get in the way that aren't consistent with those objectives. So, for example, Dan mentioned before that he'd get a liquidated damage if the chilled water is a degree off. Having those hair trigger defaults or LDS in certain types of arrangements make sense and certain times they don't and they can tend to be no go issues for developers. And if your core objective is carbon neutrality by 2030, 2040 and now you're focused on these really hair trigger points that are forcing your developers to walk away and as a result you end up achieving lower value from money in the end because you have less competition, you've completely lost your way. And we see that time and time again.
Daniel Allen (40:10):
So I would say thinking about that, it's been in, we're down to the wire and these are the conversations that are occurring between developers, owners, advisors, technical advisors, legal counsel and what is mission critical for a hospital? One degree matters because that operating room has to be at a certain temperature and so knowing is it the same mission critical for a university? Cuz really we could turn the chillers off and it's gonna take hours depending on where you are for the room temperature to ever get to a point where you notice it. Anybody, if you go home tonight, turn your AC off, you're not gonna notice it for a little while. If you live in Miami it's probably different than if you're in DC. So those are really where you get back to what is important. I I think it's also good to just remember that nothing's free, you start transferring risk, there is some cost to somebody you can't take.
(41:08)
We were talking about commodity risk. If nobody's gonna take commodity risk for next 30 years, we can't hedge it so how could we really be expected to take it? So that's kind of like being everybody taking a step back in these projects and be like common sense needs to prevail at some point I think is the biggest thing that I see. Just if there are willing parties and you talked about operations, various finance, either party can tank a transaction and they can tank it at the last minute. And so making sure that the customer and all the parties are very much aligned of this is the direction we're going, we'll have some bumps, but if the goals in carbon neutrality will get there, not sure how we will all get there by that in 2050 at a reasonable cost, but we'll see.
Matthew Neuringer (41:54):
So just as of next steps as folks have takeaways on this, if you're thinking about you're an owner and thinking about wanting to do a project like this or explore a project like this or what's the first right steps to take on
Daniel Allen (42:06):
You call me. Yeah, first step, call me.
Chris Dalgarno-Platt (42:13):
Yeah, well I'm gonna keep banging on about a feasibility and objectives. I think it's kind of sitting down obviously I would say as an advisor our sort of raise on detra is to kind of enter these types of transactions as early as possible to help of shape what the discussion will be, to have an eye to the objectives of the owner but also then to have an understanding of what the potential partners are going to be, what their interests will be as well. And so to help align those two things. And if there is a misalignment, a genuine misalignment that then to advise honestly and independently and kind of say maybe P3 s not the route that works here but to really establish early on what the scope and nature and objectives of the project are. Is it a feasible solution to go down a partnership type option and then engage with market participants at that point. So I think really dipping that toe in establishing objectives and establishing that sort of feasibility piece is very much the next step if you're interested.
Daniel Allen (43:20):
So I'm, going to deviate that just a little cause I obviously have little different standpoint or role in the transactions is first does it even make sense? I mean your advisors can help you on that but while your advisors aren't gonna go out and do a site survey or do a investment grade audit, et cetera. And so I think you've gotta have some baseline of this is what we're, our assets are brand new, well we're really probably not gonna get you savings. We've been in facilities that are like, we really wanna do a deal. And it's like, yeah you could have told us that you replaced your chillers like three years ago and they're state of the art, how can we really improve on this? So that's kind of where I think you it's does it make sense from a business or operational standpoint? And then there are numerous parties that have that ability that can do, you know, go down the path of concessions, not really the thing monetization's not right? Maybe it's a design build or DSPC or an ESCO type transaction that actually will provide you the value you want. So it doesn't mean you spend all your time and you get nothing. There are off ramps or basically second options that could still get you where you want to go once you get into due diligence.
Matthew Neuringer (44:36):
Yeah, appreciate that. I think one thing we've seen a lot of clients try to do upfront as well is around sort of feasibility, what does that mean? And it's sort of weighing the different options through what some people might call a value for money analysis or equivalent where you weighing, okay traditional cost to capital taxable private tax exam, private public, et cetera design build design, bid build and then all the way up through design, build, finance, operate, maintain, and then looking holistically both at the qualitative and quantitative elements of that and making a determination that in the long run over the full 20, 30 year life of these assets, where are you actually achieving your value for money? And so it's making the right investment not just for the next five years, for the next 10 years but for the next 30 years and doing that analysis and testing a lot of different sensitivities to ensure that you're not missing the mark up front is critical. But then also to the Dan's point, there are developers out there who are willing to go and kick the tires through of a preliminary investment grade audit process. Which folks, if you're familiar with the ESCO industry, energy savers companies industry, they'll come out and actually do audits to help inform that value for money process. So it seems like there's a bit of a collaboration potentially between an advisor, developers and almost like a request for information process before running to market and trying to procure a deal.
Daniel Allen (46:10):
Yeah, you about a lot of work can be done prior to a formal procurement process that really informs what your options are and ultimately what value you get out of it. But again, if the goal is raising money, I don't know that these are the cheapest way to get capital to anybody that ever thinks this is cheaper than you borrowing it yourself. That's not always, that's probably not the case, but it's the risk transfers, it's the ability to use proceeds for any purpose. So it's gotta look at it from a big picture, not just necessarily a cost of debt in that we have a lot of folks that get nail pigeonholed of, well your cost of capital's higher, but yes, but there's also savings guarantees, there's things that go along with it that help bring back an effective cost to capital much more in line or even below depending on your arbitrage assumptions.
Matthew Neuringer (47:08):
Awesome. Well thanks so much for the conversation Is any questions? I think we've got a couple of minutes. Any questions from the group here?
Audience Member 1 (47:20):
I just had a general question on project size. Where does it start to make sense to look?
Chris Dalgarno-Platt (47:27):
It's a great point.
Daniel Allen (47:31):
It depends on where you are in the country at what utility you're on. A lots of things but really I think these cuz of the time and the cost involved, I mean you're really, you're getting into 20 to 50 million projects. We've seen them done smaller but they are very inefficient just because the work advisory work, the legal work that goes into it is still as much sometimes as it is on a big project. But that's every case is unique though.
Chris Dalgarno-Platt (48:03):
Yeah, I think the monetization can skew this, the project size a little bit as well because what might be a fairly small capital project potentially you can introduce as much private finance as you like if you're wanting to inflate the amount of monetization payment you get up front. So, that can be attractive to market participants who might say the capital projects a bit small, but if they know that they can commit capital for increasing monetization payment for the investment in an endowment or for other arbitrage purposes, then that can kind of create a larger project. But to Dan's point, it tends to be the larger projects given the amount of effort needed up front to procure them.
Daniel Allen (48:47):
But we've actually worked on one that was as small as 16,17. Okay. Didn't close but we spent a lot of time on it so.
Matthew Neuringer (48:59):
Any other questions? Oh the back.
Audience Member 2 (49:03):
So you talked about cost and capital as well as operating efficiencies, risk transfer. So why can you not optimized by doing both? Why is the industry not been able to embrace a tax exempt structure but also a risk transfer since you're so good at designing, building and operating and on what
Daniel Allen (49:30):
The IRS is part of it? I don't know that it's necessarily impossible to do it on a tax exempt structure. Has it been done to date? I don't know that there's any, I've not come across an example. There may be one or two you get into how the third party is compensated is a big driver of that and how KPIs work really qualified management contracts is really where you end up. And with that there is some, it was more the IRA's gonna help that. I think with the tax credits, the fact that particularly if you have a solar or renewal aspect of it now that as a governmental entity you could potentially get that credit paid directly to you as opposed to having to have a third party owner to monetize that. It's not impossible, it's just difficult.
Matthew Neuringer (50:29):
Yeah, I mean it's something that our team is certainly looking at and it's something that at this point we do see a potential path forward there but at this point I don't believe there's been a deal that's closed.
Daniel Allen (50:46):
One thing I would add is that when we've actually, we have done the analysis and gotten deep in the weeds on it and by the time you factor in everything else, and this may be a different situation if ratio really tax exempt taxable ratios change and the private placement market is less efficient. Last few years it's been extremely efficient in how big life code will come in and buy a hundred million dollar project very efficiently cuz they're looking through who's the counterparties. If that were to say ratios were to gap out dramatically or tax exempt taxable fundings just were way outta whack. I think that analysis is probably different, but the economics were marginally to the point that the brain damage on a couple projects we've looked at, it's like this is marginal, we're not gonna recreate the wheel for this marginal benefit. But Ben, if you want to, we would be happy to run the analysis for you.
Matthew Neuringer (51:43):
For you.Yeah, I mean fwe've done some creative stuff in the past to be able to make it happen on other types of asset classes, so happy to chat about that further off offline. Any other questions? Okay, well this was fun. Great to see you guys. Thanks everybody for your time.