1652323537974 B 0809 Atm Performing Contracting

How Performance Contracting Helps Finance Energy Projects

April 1, 2008

Partnering with an energy service company can make energy-efficiency projects possible - even when little or no funding exists

Every day, millions of dollars are going up the virtual smokestack as they pay for wasted energy. Take a new look at your facilities and processes — they are a revenue source. You're sitting on money that, through greater energy efficiency, could significantly enhance building operations.

Unfortunately, it takes money to recover those precious dollars. And, ironically, higher energy bills often take money away that might have otherwise been used to reduce consumption.

What is Performance Contracting?
Fortunately, there's a way to take future energy cost savings and use them now to bring down kilowatt consumption and operating costs — without front-end capital expenditures. It's called performance contracting, and it involves energy service companies' (ESCOs') assurance of system performance (hence the name "performance contracting").

Performance-contracting payments are based on satisfying specified goals — a measured performance (in this case, energy savings). An ESCO audits the potential client's facilities and/or processes, recommends certain energy-saving measures, initiates the approved measures at no front-end capital expense to the owner, and guarantees that the energy savings will cover the project costs.

Performance contracting isn't new. More than 100 years ago, French company Compagnie Générale de Chauffe guaranteed energy savings to district heating customers. Royal Dutch Shell's subsidiary, Scallop Thermal, applied the idea to demand savings and brought the idea to the United States. From these beginnings, ESCOs have expanded to offer a wide array of services, including:

  • Engineering feasibility studies.
  • Equipment acquisition and installation.
  • Load management.
  • Supply procurement.
  • Facilities management and water management.
  • Outsourcing.
  • Risk management.
  • Automated meter reading.
  • Indoor air quality services.
  • Energy information management.
  • Environmental compliance.

ESCOs also offer energy-efficiency expertise regarding what measures will most cost-effectively reduce consumption. Today, a quality ESCO provides an investment-grade energy audit (IGA), which offers guidance on ways to enhance the value of your facility portfolio. Recommended measures are designed to save energy, cut operating costs, improve the work environment, and reduce emissions. An IGA is a far cry from the old, traditional audit with its list of equipment, which may (or may not) have improved the work environment.

Financing for the project, or help arranging the financing, is also provided by ESCOs. Even if you have the money, having an ESCO arrange access to financing via a bank (with employees who understand cash-flow financing) may prove to be an attractive option.

The ESCO can also provide project management and oversee construction, serving as a partner for the life of the project and assuring that critical savings are realized. Staying on top of the job is more important than it first appears. An ESCO is in a position to do your energy worrying for you — the ESCO's profit depends on it.

Benefits of Performance Contracting
One of the most attractive aspects of performance contracting is that it allows you to use predicted energy cost savings for future years now. For example, a project predicted to save $1 million per year on a 10-year contract allows $10 million to be immediately available for a project. Ten million dollars can buy a lot of services and equipment. Depending on how the deal is structured, the owner can receive a portion of the savings each month throughout the contract in addition to the value of the installed equipment. All of the savings in the post-contract years belong to the owner.

Furthermore, this approach need not require new capital budget allocations. The project money is already in the budget, paying for wasted energy. Performance contracting can redirect existing expenses into a revenue stream. With measures that can pay for themselves in 2 to 4 years, energy efficiency becomes an investment with an ROI of 25 to 50 percent.

It‘s a mistake to compare energy-efficiency investments to potential organizational expenses. Those expenses add to operational costs and can make your organization less competitive. By contrast, through performance contracting, money can be extracted from avoided utility costs, enabling you to reduce operational costs so your organization can be more competitive.

For the public sector, performance contracting can free up dollars to meet special needs. Further, it is great when a public administrator can tell the public that the organization is using private-sector money to conserve tax dollars.

Words of Warning
Should you decide to secure ESCO services, a few cautions are warranted. If your goal is to buy equipment, you are better off going directly to the equipment vender. Performance contracting is not about buying equipment — it's about getting results.

Also, an ESCO is not a bank. The financing should be a means to an end, not an end itself.

Venturing into the unknown can be pretty scary, but performance contracting is actually a risk-shedding opportunity. For instance, an owner no longer needs to fear that new equipment will die the day after the warranty runs out — it's in the ESCO's best interest to keep that equipment operating like new for the life of the project.

There is truly only one major risk for the customer in performance contracting: selecting the right ESCO. Performance contracting is a simple concept, but a complex process. The benefits can be huge; so can the pitfalls. If your organization doesn't have the time or expertise to select the right ESCO or effectively manage a performance contract, consider retaining the services of a consultant. Not enough money to pay a consultant? Consulting fees can be absorbed in the project expenses — just give the ESCOs advance notice in the request for proposal (RFP). Be sure, however, that the money comes to you and that you pay the consultant. If consultants are paid directly by the ESCO, the consultant may forget who they're working for.

The old warning about knowing enough to know what to expect from a consultant still holds true. So, whether you're going to obtain consulting services or move ahead on your own, it pays to review the literature on performance contracting, participate in a seminar, and/or attend an ESCO conference.

The value of performance contracting is already lost if you go looking for an ESCO to finance a list of equipment. The best approach is to decide what results you want first and determine the criteria that are most apt to aid you in selecting an ESCO that can best deliver those results. Then — and only then — should the RFP be developed. There are no rewards for long, involved RFPs. Ideally, it should ask for only the information that's truly needed to weigh the ESCO's qualifications related to your established criteria.

Taking the Next Step
Escalating energy costs have a way of eating up profits and cutting into those special project set-asides. And, it's not going to get better. Energy prices are destined to go well beyond the spiraling pain at the gas pump. Eighty (80) percent of our power plants are still dependent on fossil fuels. Your best option for the environment and the pocketbook is to use fewer kilowatts. As the energy manager of the West Allis School District in West Milwaukee, WI, so astutely observed, "The greenest electron is the one not generated."

Unless your operation is truly energy efficient, you are unnecessarily taking a hit on your bottom line, wasting energy, and polluting the environment. There is an ESCO out there that can help you turn this around; even better, it can guarantee it.

Shirley J. Hansen is CEO at Hansen Associates Inc., a Gig Harbor, WA-based firm known worldwide for performance-contracting consultation and training.

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