Energy service companies (ESCOs) provide energy-management services and creative financing tools to industrial firms. These companies are more a private initiative than a government policy instrument. Through energy performance contracts, ESCOs and firms set the terms for risk-sharing and co-financing industrial energy-efficiency projects.

ESCOs design and provide or arrange financing for the project (and receive payment based on energy services provided by the project), sometimes assume the project performance risk (by guaranteeing a minimum level of energy savings) or the credit risk and install and maintain the equipment. For industrial firms, this approach is an innovative way to finance large industrial energy-efficiency projects without paying cash up front.

Traditional project financing rules may not apply to energy performance contracts, which can be treated as either on- or off-balance sheet transactions. ESCO payments are linked to a firm’s energy performance: no energy savings means no payment. Payments are not to exceed savings, and industrial firms do not make capital investments or capital commitments to the project. Monthly payments to ESCOs are treated as utility expenses and recorded as debt. The payments may vary with the savings, or the savings can be shared between the ESCO and the firm. Since project financing is considered off-balance sheet, no assets accrue to ESCOs, and the firm owns the equipment.

Many developing countries lack the legal and financial framework to enforce the complex contractual models required for ESCOs. International ESCOs, while initially eager to operate in developing countries, acknowledge that many prospective customers require more time and capacity-building to adequately understand and accept such models, and customer credit-worthiness and local credit are not assured.