Performance Contracting: Making the Grade
Schools and universities need every nickel they can get to educate students. Although many institutions seek ways to control spiraling energy costs, tight budgets often limit the ability to do so. Taxpayers are often unwilling to increase funding or accept debt-creating bonds to cover the costs of upgrading schools.
One alternative used successfully by many — and unsuccessfully by a few — is performance contracting. Under a performance contract, an energy services firm agrees to upgrade an energy-consuming system or facility in exchange for a share of the savings. Unlike shared savings contracts, a performance contract guarantees the performance of the installation. If projected savings do not appear, the energy service company (ESCO) will pay a contractually defined amount to make up the difference. The end result — if all goes as planned — is a risk-free opportunity for a school that could not, on its own, achieve those savings.
In her book Performance Contracting: Expanding Horizons, Shirley Hansen reports that more than 4,000 public schools have entered into performance contracts.
Performance contracting has come a long way since the early shared savings agreements that sometimes went awry over erroneous savings projections, failed ESCO financing or poor installation work. Today’s performance contract process is generally quite structured and involves much more groundwork, verification and analysis.
The first step is usually issuing a request for qualifications to find vendors able to handle an energy project that may involve upgrades to lighting, HVAC, the building envelope and a central plant. Acceptable vendors are sent request for proposals. The two processes may be merged to save time.
Once an ESCO is chosen and an agreement is developed, the next step is an investment-grade energy audit to examine a facility’s energy-using systems, assess operating costs and describe upgrades to cut those costs. A package of options is laid out that, taken together, will generate sufficient savings to provide acceptable returns for both the facility and ESCO. Upgrades needed for reasons other than cutting energy costs, such as fixing a leaky roof that also needs insulation, may be folded into the overall project so that energy savings also cover such deferred maintenance needs.
Crucial to avoiding future problems is the inclusion of measurement and verification procedures in the audit that will be followed later to ensure that savings are properly defined and quantified. Some energy-upgrade projects falter when expected savings are not visible on energy bills, which can be caused by load growth following the upgrades or extreme weather, or are so high that providing a percent of them to a contractor creates political problems for the facility executive. To avoid this situation, many performance contracts now cite one of the options found in the International Performance Measurement & Verification Protocol (IPMVP).
Contract management and control is vital during upgrades to avoid disruption of classes and events. Contractors can’t simply be turned loose on a campus. Control may be improved by parsing a large project into smaller efforts, each overseen by an on-site facility manager or third-party consultant working for the school.
Breaking up a large project also sets up financial and management checkpoints where work can be stopped without disrupting an entire project, in case something goes wrong. Even the best-intended efforts may run aground when asbestos or existing code violations are suddenly uncovered, or when use of a space being upgraded is altered to accommodate a change in an educational program.
Once a project or one of its subparts is completed, the ESCO should provide a synopsis of completed work, its actual costs and the expected savings. When accepted, that part of the project is turned over to the facility, and the measurement and verification of the savings begin. If expected savings fail to appear, the ESCO’s contract may then require that corrections be made to achieve the savings; while that is being done, the ESCO pays the facility the difference between the projected savings and the measured savings.
Laying the Groundwork
Before entering into a performance contract, some basic questions need to be answered regarding energy costs. Who, for example, actually incurs the cost? Some universities and school systems are reimbursed for part of their operating costs, which include energy bills. If so, cutting energy use could actually reduce such reimbursements, which, depending on accounting methods, could result in a net loss for the facility.
On campuses having multiple buildings served by a single electric or gas meter, no savings may be visible on master meters unless a large change is made to a central energy system. Temporary or permanent submeters may need to be part of the installation.
If existing submetering will be used, it should be independently verified for accuracy. In one case, a university’s submeters were wired incorrectly so that a lighting upgrade in one building showed no savings, while power usage in a building that was not part of the project appeared to drop. Operators of the second building were pleasantly surprised at the windfall, but kept it to themselves while the ESCO and operators of the first building fought over the missing savings.
In some cases, ESCOs have skimmed the cream of energy savings by performing only the cheapest options with the shortest paybacks, leaving other worthy options untouched. Doing so may hamstring the ability to perform energy upgrades on systems with longer payback periods. Combining longer-payback projects, such as roofing or window upgrades, with projects having short payback times, such as lighting, creates an overall acceptable payback period that allows the scope of energy upgrades to expand.
In other cases, efforts were pursued without quality standards or specifications that ensure changes to facility systems are tolerable. Instead of replacing high-wattage incandescent lamps with compact fluorescents, for example, one ESCO installed lower-wattage incandescent bulbs. That cut costs but lowered lighting levels too far. In other cases, outside air was reduced so much that odor and mold problems arose. To avoid such problems, the performance contract should cite acceptable standards, such as those developed by the American Society of Heating, Refrigeration and Air-Conditioning Engineers, or the organization’s new construction specifications.
Lindsay Audin is president of EnergyWiz, an energy consulting firm based in Croton, N.Y. He is a contributing editor to Building Operating Management.
Homework Assignment: More on Performance Contracting
For those considering entering a performance contract, many useful and low-cost resources are available to provide guidance.
For additional information on selecting an ESCO, check California’s How to Hire an Energy Service Company. See an example of an RFP for an energy performance contract.
Information on energy management is also available through the National Clearinghouse for Educational Facilities of the National Institute of Building Sciences. State energy offices should also have information, as does the Association of Higher Education Facilities Officers.
To purchase books on energy performance and energy management, including Shirley Hansen’s book, Performance Contracting: Expanding Horizons, visit the online bookstore of the Association of Energy Engineers.
For more details on how performance contracts and other energy-upgrade financing measures work, download a free manual titled How to Finance Public Sector Energy Efficiency Projects.
To read more on the pitfalls of energy performance contracting — and how to avoid them — read about one case between the state of Pennsylvania and a contractor that took 10 years of court battles to settle.
How Much can be Saved?
As with all energy projects, the amount of money that can be saved through a performance contract depends on a variety of factors. Although only a quality energy audit can determine exactly how much can be saved, past performance contracts have yielded savings not only by cutting energy costs but also in avoided maintenance, labor and repair costs.
According to the U.S. General Accounting Office, more than 30 percent of schools need at least $1 million in renovations to return to good overall condition, and 25 percent need HVAC upgrades to do so. Whenever the performance contract process fixes or replaces a failing system, a potentially budget-busting emergency repair has also been avoided. In large or multibuilding facilities, modern energy management systems may also reduce staffing needs, saving more than just energy dollars.
If a savings projection is needed, benchmarking a school system’s buildings against each other may highlight those that use much more fuel or electricity per square foot than others. Be careful, though: If all buildings use energy inefficiently, savings could be seriously underestimated.
The EPA Energy Star program offers its Energy Performance Benchmarking Tool for comparing one’s schools against others nationwide.
Three Key Issues to Consider Before You Sign the Contract
Martin Mozzo, president of M & A Associates, has been active in performance contracting for several decades. In his experience, three important issues need to be addressed when considering the performance contract process. First, look carefully at the qualifications of the ESCO. Take the time to examine past projects, to visit the sites and to talk to the customers involved. Second, understand the financial implications of the contract. A lot of times, people misunderstand how shared savings will be calculated, verified and guaranteed. Mozzo points out, for example, that assumptions may be made regarding the length of time rooms are occupied and lit, only to find later that the lights are routinely shut off for long periods, reducing expected savings cited in the contract.
Finally, Mozzo advises customers to understand their responsibilities as a host by recognizing the contractor’s needs for facility access, time limitations, work areas and other issues. If a customer lacks time to oversee a large project and work with an ESCO, bringing in an independent consultant with experience in performance contracting as a project manager may avoid problems and possible litigation.