- The Trust – The Oxford University Hospitals NHS Foundation Trust
- Vital – Vital Energi, an energy systems contractor
- CEF – The Carbon & Energy Fund, consultants and financial intermediaries specialising in energy projects
- Aviva – an insurance company
Phase 1 – Setting it up (Design and Procurement)
At the JR and Churchill hospitals, the Trust had old, clapped-out boilers which were increasingly expensive to maintain, gobbled fuel and belched out huge quantities of carbon dioxide. The old-fashioned heating systems were wasteful and difficult to control. They needed to do something about it, but what? They didn’t know much about modern energy systems for buildings like theirs and they didn’t have much money to spend on new systems. So they teamed up with CEF.
CEF specialise in energy systems. They have worked with quite a few hospitals and other public sector organisations, providing the expertise and experience to design systems that will work efficiently, save money and reduce carbon emissions. And just as importantly they have access to money from financial institutions who trust them to set up good projects which will give them a safe return on their investment.
CEF and the Trust worked together to decide the best technical solution. They agreed how much money and carbon emissions the system would save the Trust. They found Aviva to lend the money to build the new system. They would find a specialist contractor who would build it and run it for the Trust for the next 25 years. They drew up the specification and invited bids. Vital won the contract.
Aviva paid the initial CEF fees through Vital under the main project agreement. Otherwise at this stage each player had met their own costs.
Phase 2 – Building it (Construction and Installation)
Vital scrap the old boilers, order and install new ones, dig trenches, lay pipes and cables, install valves, thermostats and control systems and even change 7000 lightbulbs. They invoice Aviva who pay for the work and own the equipment (‘assets’).
Through this process CEF works closely with the Trust to oversee the contract. They check the constructed project meets all the technical requirements and approve sign-off of completion. Their fees are paid by Vital out of the money from Aviva.
So far the Trust hasn’t paid out any significant money apart from their Phase 1 costs and other minor incidentals.
When all the work is finished, an Important Person (will it be Jeremy Hunt?) comes along to press a big red START button. Cameras flash, journalists scribble, TV interviewers look for people to talk to on camera, champagne corks pop and everyone gives each other little Perspex mementos of the project which they put on shelves in their offices.
They move on to ……
Phase 3 – Running it (Operation)
Vital’s work switches from building the system to running it. They are responsible for running and maintaining the system for 25 years. The contract includes a schedule of how much the Trust will pay them: the amount depends on how well the system performs in saving energy costs and reducing carbon emissions. The better the system works the more the Trust pays Vital, but the savings will more than cover the costs. CEF are responsible for monitoring the performance and savings.
In their turn Vital have to pay Aviva interest on the money Aviva has lent them (‘service the debt’), and annual fees to CEF. These payments are included in the fees the Trust pays them.
At the end of the 25 year contract at least some of the assets will still have some life expectancy beyond 25 years. The Trust will continue to be able to use these for their energy requirements should they wish to do so.
Everybody wins – or do they?
It seems everyone should be happy, and they will be as long as nothing goes wrong. The Trust will have a state-of-the-art energy system and will save plenty of money. Vital will make a profit on the Build, Operate and Maintain contract. Aviva get a return on their investment from a steady income stream from a public sector organisation. CEF will get their consultancy and intermediary fees from the Trust’s payments under the contract.
We have to ask though, “What happens if it starts to go wrong?” Let’s say the system doesn’t work as well as everyone expected. The Trust doesn’t pay Vital as much as predicted. Vital start losing money on the contract. Perhaps the only solution is to put in another big boiler, but Vital can’t raise the money. Another of their contracts goes bad, and they go into receivership. What then?
The Trust needs someone else to operate the system, but now it’s not working well they can’t find anyone to take it on without a big hike in costs. Aviva own the assets and they want a return on their capital. It could leave the Trust with a big problem.
Other downside scenarios are possible. Vital could decide to sell their contract to a third party. Aviva could sell the debt to a hedge fund. What effect would these moves have?
We can’t say, of course, but these things can happen with private sector contracts so it’s at least reassuring that the potential problems have been thought of at the start. I’m grateful to the Trust’s Project Manager for his help in answering my questions, so I’ll end with his words [my italics]:
Should the contractor get into difficulties … the Client [the Trust] and Funder [Aviva] can then insert another contractor. … [if the Funder] should decide to sell the debt there are again a series of clauses to protect us as Client before the debt can be sold.