The increased use of zero-emission vehicles, both for personal use and for public transport, is a key focus of the UK's transport decarbonisation plan and is intended to play a large part in achieving net-zero by 2050. The bus industry is no exception and one of the big topics for the industry at the moment is the move to electric buses.

The model for procuring and financing diesel, petrol and hybrid buses has developed and evolved over many years, so there is generally an established risk allocation between the manufacturer, the operator and the financier. However, the risks associated with procuring and financing electric buses are very different. Currently there is no established precedent for who should take what risks, so the parties involved are having to pave the way themselves.

So how should you "conduct" discussions in relation to the manufacture, finance and maintenance of electric buses? Whilst this article focuses on electric buses, many of the points are equally relevant to the financing other types of electric vehicles and machinery.

Zero-emission buses are an exciting new area of the sector, but the fact that the technology itself is still rapidly developing makes things a bit more complicated. It means that there is some uncertainty about the extent of the risks associated with operating and financing electric buses. Even if a party is prepared to take a particular risk, it is often difficult for them to confidently ascertain the costs of taking that risk. Of course, more risks may also come to light during the life of the buses. So, there is much discussion in the market about who should take which risks, particularly where that risk is uncertain or unknown. However, this makes the sector even more interesting and offers potential opportunities for the parties involved to make the most of the developing market.

In this article we will identify some of the key risks associated with financing and operating electric buses for public transport purposes and consider how they might be allocated between the manufacturer, the operator and the financier.

Residual value

Residual value is a key issue in relation to electric buses, mainly because of the uncertainty about how the price of batteries will change in the coming years. This uncertainty is largely due to the fact that the industry is still developing and there is still a lot of experimentation taking place in relation to the technology. There is also some residual value risk in the chassis, but most chassis are compatible with more than one type of battery, so the value of the chassis is less uncertain, and this is less of a risk.

A lot of the uncertainty when it comes to residual value relates to supply and demand for buses – and of course passenger demand for bus services. In seven years' time, when new buses delivered in 2023 are likely to need replacement batteries, or in fifteen years' time, when the buses themselves reach the end of their first life use, there may be more batteries and zero-emission buses available in the market, meaning prices may have fallen significantly and residual values dropped. On the other hand, prices may have gone up, making replacement more expensive than originally predicted, but also leading to a thriving secondary market, meaning that residual values exceed expectations.

There is an expectation that electric batteries will still have a useful life after they are no longer fit for their original purpose. We expect that this will lead to the development of a secondary market for used batteries. This may still be bus operations, just on less onerous routes outside of London, or it may be using batteries for something other than electric buses. This expectation has an effect on perceived residual value and the financing options available to operators. However, secondary market values are still unknown, which raises the question as to what residual value should be given to the batteries (and the applicable depreciation profile) on entry into the financing arrangements. There is also a question as to who is best placed to maximise the value of the first life battery when it can be sold or reused down the line.

In London and other franchised bus markets (which are poised to become increasingly common), franchise terms are generally fairly short. For example, Transport for London bus concessions are usually seven years, which is shorter than the life of most electric buses. Under some franchise agreements, the authority will ensure that buses are taken on by any incoming successor operator, with mechanisms to calculate the residual value that the outgoing operator would be entitled to. In other cases, there is an argument that financiers are best placed to retain residual value, as at the end of the franchise term they can either re-lease the buses to another operator or re-use batteries that are no longer suitable for public transport vehicles in other second life uses. The position is likely to be different in entirely commercial operations, where the operator has more certainty and control over where and for how long it operates.

Many financiers are prepared to take residual value risk, but, if they do, they want to have a high level of control over the in-life use of the battery, as well as its return condition. They want to make sure to maintain the health of the battery and therefore maximise its residual value. Some financiers may even want to have control over when batteries are replaced, as they may consider the idea of replacing batteries earlier to optimise residual value. Operators choosing this type of financing should look closely at the return conditions in their lease to see what state the batteries have to be in on return and check that they have the flexibility they need to operate efficiently. Operators should also be aware that stringent return conditions can have the effect of them taking the state of charge risk in the batteries.

Battery replacement

The financing term for electric buses is often longer than the life of the batteries installed on them, as the current useable lifespan of most bus batteries is around seven to eight years, significantly less than the lifespan of the buses themselves. Therefore, the electric bus market has to factor in the costs and risks associated with battery replacement. The key risks for battery replacement are the uncertainty about how the price of batteries will change over time and the supply of batteries.

When the buses are manufactured and delivered, it is very difficult to ascertain how much replacement batteries will cost when required, making it difficult to price this risk. If a financier takes the risk of battery replacement, it will have to price for this on day one, unless there is an adjustment mechanism in the financing document. There has been an assumption in recent years that the price of batteries will drop as the technology develops and becomes more widespread, but so far prices are not showing signs of reducing.

There's also a risk that the party that takes on responsibility for battery replacement will be unable to get hold of the right batteries at the required time due to supply issues. There are a wide range of factors leading to uncertainty of battery production and supply (which in turn contributes to price uncertainty) including:

• the developing nature of battery technology;
• supply chain issues as a result of most batteries and components coming from outside the UK;
• concern about supplies of raw materials, such as lithium; and
• uncertainty caused by the current dominance of the Chinese manufacturers and the developing production market in other areas of the world.

There is also support for refurbishing rather than replacing batteries when performance declines. This allows the parties to re-use materials where possible and increase whole life sustainability of electric buses. This is likely to be attractive to the party financing the replacement batteries and contributes to meeting operators' sustainability requirements and ambitions, but may be incompatible with operators' key focus on performance and may interrupt operations.

Warranties

Manufacturers tend to give certain warranties concerning the chassis and the batteries they supply. Generally, electric buses are supplied by the chassis manufacturer, who purchases the batteries from a specialist battery manufacturer. The battery manufacturer will give certain warranties relating to the battery to the chassis manufacturer, who will then pass on those warranties to the purchaser of the buses. This means that the purchaser has a single point of contact for warranty claims. However, it also leads to a question of which party should take the risk (credit and performance) of the battery supplier if the battery supplier fails to perform and the warranties can't be effectively enforced.

Manufacturer warranties are generally tailored to the individual operator depending on the intended use of the buses, including the number of miles they will travel and the topography of the route. This is based on modelling of a route before the buses are manufactured and the batteries are sourced. This will also inform the size of the battery and the battery chemistry required. Telemetry is then used to monitor performance against that model during operation in order to predict and resolve any potential issues before they occur and optimise bus and battery life. Generally, all parties have the same goals in relation to maintaining battery performance, so there is incentive to work collaboratively. However, there may be negotiation about the level of control the financier has over operations and the responsibility for spotting potential issues.

One potential issue for an operator is the extent of the warranties given and what happens if there is a fault which is not covered by the warranties – either during or after the warranty period. This is also a risk for non-electric buses but, due to the technology being relatively new, it can be a greater risk for electric buses. Upgrades may also become necessary as technology develops: batteries for electric buses are being improved all the time either as different faults become evident or just simply as the engineers make the batteries better. To the extent these are not covered by warranties, there may be a question as to who takes these risks.

Performance

We have already mentioned that, where bus franchising is the relevant delivery model, bus operating concessions tend to be shorter than the useful life of the bus chassis and battery. With operators incentivised to deliver high performing bus routes, they need guaranteed performance of the hardware throughout the life of the concession or franchise, with the cost being spread over its entire term. Performance guarantees from manufacturers or financiers are key for operators, as they are likely to incur lost mileage charges under concessions if they are unable to operate the routes using an electric bus. In the Netherlands, concession periods are up to fifteen years – more than double the current UK market position – to allow for better structuring of financing.

Data

A huge amount of data relating to the operation and performance of a bus is recorded. Operators want this to be standardised across their fleets and for it to be used to work with the manufacturer to maximise performance, rather than the manufacturer using it against them to show that specific warranty conditions have been breached. It is not just a question of recording data, but also effective use of the data to monitor performance. Ownership of this data is also a point for negotiation, including each party's rights to access and share the data. Depending on what risk the financier is taking, they are likely to want access to the data, in order to monitor the performance of the batteries to see if there are changes that can be made to spread the risk over the whole fleet.

Procurement

Procurement of electric buses is quite different to non-electric buses, as there are new factors to consider. Operators and owners are considering whole life costs of electric buses rather than focussing on initial capital costs, while, as mentioned above, there is a big focus on performance for operators. There is a need for operators to consider procurement of buses for a particular route further in advance when bidding for that route. Buses are often designed to be optimised for a particular route based on the modelling discussed above, although this doesn’t in itself mean that they can't be used to operate other routes. The issues with supply chain availability of batteries mentioned above also means that there is a need to have a sophisticated plan in place, allowing plenty of time, for procurement of replacement batteries.

Given the intricacies of procuring electric buses, some financiers are now considering offering a turnkey solution to operators. They will procure the manufacture of the buses, as well as the on-going and long-term maintenance, and offer the buses to operators as one finance package. This has the potential to take a lot of the risk away from the operator and is also intended to make procurement a lot easier for the operator.

Charging infrastructure

Charging infrastructure introduces another risk in relation to electric buses, in particular in relation to the interaction with the batteries and identifying where any issue that arises lies. This could potentially be a risk, especially if the battery and chassis are financed separately from the charging infrastructure. Charging infrastructure feeds into charging strategy, which significantly impacts battery performance. Operators are generally more comfortable with starting the day with fully charged batteries to avoid any potential issues with not having enough charge, but only charging to the percentage needed for the route has the potential to improve battery performance and save costs.

Technology

One final thing to consider is the risk that electric battery powered buses are superseded by another zero-emission technology. The industry is currently going all guns blazing for electric buses, what about hydrogen on the horizon? That said, the scale of investment in both the electric buses themselves and the necessary infrastructure to operate them suggests that a large proportion of the industry are confident that electric buses will be used for a long time to come and will not be superseded by other forms of zero-emission buses. This gives financiers some degree of comfort on the economic life of the buses and operators comfort on their infrastructure investment. It is also worth noting that investment required in infrastructure for other technologies, such as hydrogen, is much greater.

Conclusion

The new world of electric buses brings with it a number of new risks. It will be interesting to see how the allocation of those risks develops alongside the development of the sector, as the focus on the shift to electric buses as part of achieving decarbonation targets continues. The uncertainty that the still-developing technology brings is a big factor, in particular in relation to residual value and battery replacement. Only time will tell the direction in which the market will move, but for now there is a lot of negotiation to be had.