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The economics of energy service contracts
journal contributionposted on 2023-06-07, 19:53 authored by Steven SorrellSteven Sorrell
Energy service contracting can provide a cost-effective route to overcoming barriers to energy efficiency. Energy service contracts allow the client to reduce operating costs, transfer risk and concentrate attention on core activities. However, the energy services model may only be appropriate for a subset of energy services and energy using organisations. A challenge for both business strategy and public policy is to identify those situations in which energy service contracting is most likely to be appropriate and the conditions under which it is most likely to succeed. Energy service contracting is a form of outsourcing. It will only be chosen where the expected reduction in the production cost of supplying energy services can more than offset the transaction cost of negotiating and managing the relationship with the energy service provider. Production costs will be determined by a combination of the physical characteristics of the energy system and the technical efficiency of the relevant organisational arrangements, including economies of scale and specialisation. Transaction costs, in turn, will be determined by the complexity of the energy service, the 'specificity' of the investments made by the contractor, the competitiveness of the energy services market and the relevant legal, financial and regulatory rules. This paper develops these ideas into a general framework that may be used to assess the feasibility of energy service contracting in different circumstances. The framework leads to a number of hypotheses that are suitable for empirical test.
Department affiliated with
- SPRU - Science Policy Research Unit Publications
NotesThe recent trend towards energy service contracts essentially outsourcing particular services has gone with little academic attention or economic analysis. This paper applies a transaction cost approach that differentiates the determinants of production costs from those of transaction costs. The two can then be combined into a general model to assess economic feasibility of any particular contractual situation.
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