Insights If Your Community had a Million Dollars: Understanding Performance Contracting
By Jeff Suderman, Senior Strategist, IBTS and Dustin Knutson, Director, Energy Services
What Could Your Locality do with an Extra Million Dollars?
Most of us can still hum the 90’s song, If I Had a Million Dollars. While wealth today is more often measured in billions of dollars, most of us would be quite pleased to receive an unexpected million!
In our work with governments across our country, we are surprised at how often million-dollar savings remain undiscovered. Why, you might ask? In most cases, it is simply a lack of awareness of the amazing potential of Energy Savings Performance Contracts (ESPCs). The past 20 years have increased the quality and availability of ESPCs through advances in innovation, a diversity of financing options, and the benefits of deregulation. However, we find that many city and county officials are either unaware of the potential, fearful from stories they may have heard, or simply don’t know where to get good information on how to get started. This article will provide an overview of ESPCs, how they work, things to watch out for and why it may be your secret to uncovering a million dollars that you didn’t know you had!
What is an ESPC and How Do They Work?
An Energy Saving Performance Contract is a guaranteed way to reduce energy and water usage in municipal, county, state, university, school, and hospital buildings. When they were emerging in the early 80’s, an ESPC was a progressive strategy for local governments. As they have matured over the past 30 years they are now a mainstream and widely accepted solution that reduces costs and negative environmental impacts.
The implementation of a performance contract consists of replacing outdated, inefficient building components such as light fixtures, heating, ventilation, and air conditioning mechanical systems (HVAC) with new, efficient systems. As a result of these upgrades, governments realize energy cost savings and these avoided costs create the funding stream used to pay back the initial cost of the upgrades. One of the unique aspects of an ESPC is that the project costs are assumed by a third-party Energy Service Company (ESCO). It is their role to arrange the financing, the purchase and installation of the upgrades, and the guarantee of results.
Typically, there are no out-of-pocket expenses when a building owner undertakes a performance contract. This is because ESCOs help local governments maximize financing options by utilizing resources such as tax-exempt municipal leases, bonds, and private loans to fund the upfront improvement costs. While an ESPC involves financing, this cost is minimal and is factored into the overall savings projections to ensure that there is a reasonable return on investment. As a result, the money invested (and more!) is recouped by energy-related savings realized from the project.
A key concern about undertaking an ESPC is that it may replace some components that are still working. While the “don’t-fix-it-until-it-breaks” perspective is common, it is an emergency maintenance strategy that is more costly in the long run. Studies have shown that it is more cost-effective to replace outdated equipment proactively instead of waiting until equipment fails or doing it on a replacing it on a piece-by-piece basis. In short, this is due to the potential savings that are wasted when one waits until equipment failure to replace the equipment.
Traditionally, an ESPC process is led by an Energy Services Company (ESCO). A key advantage an ESCO provides is that they will guarantee a specific amount of energy savings once the project is complete. Using mutually agreed upon information and baselines, they develop energy models and use engineering calculations backed by measurements which will clearly project the savings for a retrofit project. This information is then used to provide performance guarantees specific to each retrofit for local governments. The combination of all the retrofits and their associated measurement and verification strategies form the total project guarantee. Some well-known national ESCOs include Trane, Johnson Controls, Ameresco, Noresco, Siemens, Schneider Electric and Honeywell, among others. There are also a wide variety of other local or general contractors, construction management or engineering firms and consultants equally capable of administering, managing, and performing the ESPC process. Thus, it is wise for a local government to compare their options before beginning and utilize third party experts to provide assistance in this area.
Today, government localities have the opportunity to take advantage of ESPCs to reduce their facility operational costs, create local jobs, and set a strong environmental and fiscal example. As they consider their ESCO and contractor options, governments need to carefully consider the pros and cons between using national ESCOs versus local consultants and advisors. Generally, national ESCOs bring diverse experience and knowledge that will help the process. However, there is also the potential to pay more for their services due to their size and minimum acceptable rate of return (MARR) or internal margin requirements.
Alternatively, as you consider local consultants and advisors, you will find that some are not large enough to handle every kind of ESCO project. However, their understanding of the local market often provides significant advantages. Their knowledge allows them to effectively arrange teams of local electrical, mechanical, lighting, and HVAC contractors. This ensures that money stays in the local economy, expedites the process and uses contractors who have already performed work in municipal facilities. This often results in lower overall costs as well. The final decision is achieved by weighing quality, cost and time tradeoffs between national and local options.
Larger communities who have a dedicated Energy Manager position in-house can be in an ideal position to capitalize on ESPCs. This resource means that they have the potential to implement multiple projects each year. However, even smaller communities that may not have the necessary resources to manage the process can hire a temporary energy manager or consultant to manage the process, paid by savings that result.
What to Watch For
In order to enter into an ESPC, a contract must be established between the local government and the ESCO. The risks associated with the written contract agreement and city or county are substantial and need careful consideration. The template agreement should be based on industry standard form documents available by reputable governmental or non-profit associations, such as the US Department of Energy, the Energy Services Coalition, or other State Energy Offices with successful programs, and should always be reviewed by a third-party. This ensures that the details are reviewed by someone who is acting in the best interest of the municipality or county and who has no affiliation with the contracting company. The written contract agreement sets the tone for the entire contract and there are many areas that should be thoroughly reviewed in operations, finance, and performance risk. As a trusted advisor and non-profit, IBTS provides third-party contract review as a stand-alone service to protect the end-user’s best interest for nominal fees that become cost neutral or cash positive when covered by project savings.
The contract provides a performance guarantee of energy savings over the duration of the contract that translates to monetary savings by the associated rate paid for energy used. This guarantee is the sum of the ESPC contract documents and it details the monetary savings which are used to pay for the investment in building improvements plus how energy savings are calculated by each measure. The ESCO not only sets this guarantee level in the contract, but is also held accountable for it. This means that there must be enough financial benefit for the ESCO to be interested in the project that can be paid through resultant energy savings over a reasonable period of return. The initial feasibility study and energy audits should be reviewed thoroughly to ensure all interests are being addressed when setting the guarantee as well as before final contracts are signed to ensure promises made during a Request for Proposal (RFP) response are kept. IBTS reviews project guarantees and measurement and verification options as part of the contract review process. In doing so, IBTS also helps expedite the process with your ESCO so that you can close your deal faster and with more confidence.
Measurement and Verification
Guarantees are enforced through an agreed upon Measurement and Verification process (M&V). Similar to the need to do your homework in the contract and guarantee process, reliable and reasonable M&V standards must be set beforehand in order to ensure the guarantees are achieved. Measurements of energy loads and time of use are both important to this process.
Contracts with weak M&V guarantees may have the following characteristics:
- Too much stipulation
- Not enough or the right type of measurement for the retrofit
- Not measuring both loads and hours to some level or statistically relevant sampling
- Overestimating water savings or daily use estimates
- Estimates based on interviews of staff without metered hours of operation
- M&V Options not appropriate to create a real guarantee for the measure
- Guarantees based solely on models left unchecked or uncalibrated
- Guarantees based on one-time post installation measurements without ongoing checks
- Under-sized or over-sized equipment boilers, chillers, other HVAC systems
- Renewable energy solar or wind projects based on weather data alone without combining with metered data
The most common threats to achieving guaranteed savings are:
- A lack of continuous Commissioning (Cx) (e.g., ensuring actual operation is consistent with both design and more importantly the intended operation)
- Minimal or improper M&V
- Improper design and/or lack of post-installation Cx
- Lack of equipment repair and replacement funds or responsibility when equipment fails before the end of the contract
- Not estimating the life of equipment or its critical parts
- Unclear boundary lines defining a retrofit from its interconnected parts or associated systems required for its operation
- Shared maintenance responsibility without clear boundaries and roles for preventive maintenance and witnessing or confirming its completion
One of the biggest changes that updated systems may bring is the need to train your maintenance team. New heating and cooling equipment, building controls and lighting systems may be different. This will require facility managers to learn new skills so they both understand and can maintain the new system at optimal levels after implementation.
It is common that new total building management control systems are installed and then not properly utilized to maximize efficiency. The ESPC process may include training and recorded sessions, if requested, so staff may revisit training as often as they prefer. However, staff turnover and poor oversight of this transition can also leave facility managers frustrated and struggling to use the systems as intended. This concern should be addressed during the contract process to ensure project goals are achieved over the long term by creating a “Life of Contract Management Plan” that documents key staff, responsibilities, and the location of critical documents. A trusted advisor can help local governments create this document to be used as an ongoing desk reference. Templates are also available through the US Department of Energy.
Finally, a successful ESPC process requires the leadership of a dedicated process owner. They will lead processes such as capturing project funding, organizational education, change leadership, communication, working with boards and unions, IT infrastructure and security, and understanding and navigating the nuances of State law. There is hard work involved in bringing a project through to completion. The process owner is not likely to be effective if acting in this role in addition to their day job responsibilities. It can be a great benefit to work with an outside advisor dedicated to understand and focus on the needs of the municipality without distraction.
As a 501(c)(3) nonprofit organization, IBTS serves as an advocate, enabler, and trusted advisor of ESPC projects and believes in their ability to create local jobs, reduce energy costs, and enhance environmental stewardship awareness, when performed in the best interest of the building owner.
IBTS offers a comprehensive program to support local government, building owners and managers in participating in ESPC contracts with ESCOs, offering the support and guidance of a trusted advisor.
This unique and invaluable service aimed to both promote and enhance the benefits provided by an ESPC while also mitigating the specific risks to which the municipal, university, K-12 school and hospital building owners are too often exposed. Services start with a no-cost consultation, preliminary RFP or contract review, or total owner’s representation services from start to finish, priced appropriate to the end-user, contract size, and type of assistance needed.
IBTS can help you identify the savings hiding in your facilities. Who knows? This just might help you save a million dollars!
To speak with IBTS about your locality’s specific needs, contact Dustin Knutson, Director of Energy Services, at 757-333-7525 or email firstname.lastname@example.org.
The Institute for Building Technology and Safety (IBTS) is an energy trainer for local, city, state and federal governments. We help identify energy needs and then turn these ideas into action. As a non-profit 501 (C) organization, IBTS specializes in providing solutions in the built environment for governments who lack the necessary staff, time or expertise. We work with governments to facilitate improvements that assist your energy conservation and innovation.
 The song 'If I had a Million Dollars' is in the album 'Gordon' released by a Canadian music group called 'Barenaked Ladies' in the year 1992. It was composed by band members Steven Page and Ed Robertson. The song became a hit in the UK with several cover versions being done by the same group in latter years (www.ask.com).