February 8, 2011
ENERGY PERFORMANCE CONTRACTING FOR MUNICIPALITIES
By: Kevin E. McCarthy, Principal Analyst
You asked for a discussion of energy performance contracting for municipalities. Much of the overview of such contracts is taken from a February 2003 article on the subject in Government Finance Review (attached).
In an energy performance contract, an energy services company (ESCO) or other entity provides customers with a comprehensive set of energy efficiency measures. The ESCO often arranges for long-term project financing from a third-party. The ESCO normally guarantees that the project's savings will be sufficient to cover the cost of project financing for the life of the project. One common performance contracting approach is a shared savings agreement under which the customer and the ESCO share the value of the energy savings based on a distribution specified in advance in a contract.
As discussed in OLR report 2010-R-0004, the statutes do not explicitly authorize municipalities to enter into performance contract, and some municipal attorneys have questioned whether they have authority to do so. Nevertheless, a number of Connecticut municipalities have entered into energy performance contracts. These include Branford, Bristol, Bridgeport, Cromwell, East Hartford, Fairfield, Farmington, Mansfield, Naugatuck, and Windham. In addition, Cheshire recently issued a request for proposals for a performance contracting project.
This report describes the performance contracting experience of the Bridgeport Housing Authority, the town of East Hartford, and the borough of Naugatuck. Each municipality contracted with an ESCO for a variety of energy efficiency improvements. In all three cases, the improvements substantially reduced energy consumption and saved the municipality money. In addition, the efficiency measures reduced emissions of carbon dioxide (a greenhouse gas), sulfur dioxide, and nitrogen oxides.
ENERGY PERFORMANCE CONTRACTING
In an energy performance contract, an ESCO or other entity typically provides all of the services needed to design and implement an energy efficiency project. These can include energy audits, design engineering, construction management, commissioning (verifying that the project works the way it was designed), operations and maintenance, and savings monitoring and verification. The efficiency measures can address: lighting; heating, ventilation, and air conditioning; energy management systems; and building envelope improvements such as insulation, new roofs, and windows. A contract may also include installation of on-site renewable energy or other forms of distributed generation and water conservation measures.
The ESCO often arranges for long-term project financing from a third-party. Among the major finance companies are Bank of America, Citibank, and GE Capital. Financing most commonly takes the form of an operating lease or municipal lease. The latter, also called a tax-exempt lease purchase agreement, allows the customer to finance a project without carrying a liability on its balance sheet. Municipal and state governments sometimes finance projects by issuing bonds.
The ESCO normally guarantees that the project's savings will be enough to cover the cost of project financing for the life of the project, with the guarantee often backed by a performance bond or letter of credit. If the savings do not materialize, the ESCO pays the difference. The ESCO bears the risk of interest rate changes and utility cost increases beyond the escalation clause.
One common approach to performance contracting is a shared savings agreement. Under such agreements, the value of the measured energy savings is divided between the customer and the ESCO, based on a distribution that is agreed upon in advance under the performance contract. The ESCO normally receives a higher percentage of the savings at the beginning of the contract to pay the cost of the equipment. If there are no savings in a given period, the customer pays its energy bill and owes the ESCO nothing for that period. The ESCO typically agrees that in no instance will the customer pay more for utilities and to the ESCO than it paid for utilities at the start of the contract. At the end of the contract, ownership of the energy improvements transfers to the customer as specified in the contract.
About 80% of the contracts are performed by ESCOs that are subsidiaries of large companies, primarily equipment manufacturers. In some cases, nonprofit entities provide performance contract services. For example, the Connecticut Conference of Municipalities provides such services for municipalities in the state.
Examples of Performance Contracting in Connecticut
Bridgeport. In June 2009, the Bridgeport Housing Authority (BHA) entered into a performance contract with Siemens Building Technologies, Inc., for energy efficiency and other improvements to single- and multi-unit federally-funded public housing throughout the BHA system. The project consists of boiler upgrades and new controls; replacement of hot water systems, refrigerators, and windows; installation of new cooling systems, toilets, and other water-using appliances; replacement of common area and exterior lighting; and weatherization with a total value of $24 million. United Illuminating is contributing approximately $1.8 million in rebates, materials, and other contributions to the project.
The project affects 2,543 units within 6 major developments and 543 scattered site buildings. Siemens will manage the project and direct the delivery and implementation of the measures. It will also implement wireless building automation systems, which allow for remote system operation via the Internet, at 5 of 6 major BHA sites. Under the guaranteed energy savings provision of the contract, avoided energy expenses over the next 20 years will provide the basis for the equity used for the loans financing the project.
The project also engages BHA residents and will promote local hiring and jobs. Siemens' Building Education Program awarded a $62,000 grant to the Green Team, a local not-for-profit organization that trains BHA residents in weatherization techniques such as installing door seals and caulking.
BHA believes that the performance contract will substantially reduce energy use, reduce energy costs, create jobs, and provide more comfortable living conditions for residents. According to BHA, the energy efficiency work will reduce electricity, natural gas, and water use by 35%, 24%, and 45%, respectively. Once the system upgrades and improvements are made, Siemens guarantees 837,637 kilowatt-hours of annual electricity savings and 279,971 hundred cubic feet in reduced annual natural gas consumption. Over the 20-year life of the contract, Siemens states the energy saved will result in an overall reduction in greenhouse gas emissions of nearly 97 million pounds, the equivalent of removing nearly 10,000 cars from the road, planting 13,145 acres of trees, or reducing gasoline consumption by nearly 5 million gallons. Further information about the initiative is available in a Siemen's press release.
East Hartford. The town issued a request for proposals for energy efficiency services in 2005 and six firms responded. A committee consisting of town and board of education staff interviewed the firms. The committee reviewed the firms' performance contracting experience, financial approach, and guarantees.
In 2007, the town engaged Johnston Controls Inc. (JCI) to retrofit and install facility improvement measures in town and board of education buildings. The project received $750,000 in utility rebates. The town borrowed $5 million through Bank of America over a 12-year repayment period using a tax-exempt lease. JCI indicated the efficiency measures would save the town about 30% on energy costs in those buildings. East Hartford hired an independent energy consultant to verify JCI's estimates and calculations. The town estimates this phase of the project reduced energy expenditures for the affected buildings by 33%. It estimates that this phase of the project saved more than $1 million in energy costs as of December 2010 and projects that over the life of the contract the net savings could amount to $6.9 million.
In 2009, the town began a second phase of energy performance contracting for $7.3 million and again engaged JCI to do the work in nine town buildings and eight schools. The town coupled the energy performance contracting with qualified energy conservation bond funding to finance the second phase. The bonds can be used for capital expenditures for projects that reduce energy consumption in public buildings by at least 20%.
The town estimates that this phase of the project will save the town about $500,000 annually for the next 18 years. Further information about this phase of the project is available at http://www.ci.east-hartford.ct.us/Public_Documents/EastHartfordCT_WebDocs/Phase%20II%20Upgrades.pdf.
Naugatuck. The borough has entered into a four-phase 10-year performance contract with Siemens to perform a wide variety of energy efficiency projects at borough and board of education buildings. Among the projects implemented since 2008 have been the replacement of two boilers at the high school with four high efficiency natural gas-fired boilers, replacing the electric water heating system at City Hall Middle School with a new oil-fired heater, and installing energy management systems in various borough buildings.
The contract provides four methods to verify energy savings. These are:
1. measured capacity, which compares the energy efficiency of old and new equipment;
2. measured consumption, for example the number of kilowatt-hours of electricity used per month by a building's lighting system;
3. energy consumption measurements for entire building or all of the electric load served by a single meter; and
4. stipulated agreements in cases where operational efficiency, energy consumption, industry standard efficiencies, or other parameters are known in advance and are used in a calculation or analysis method that will stipulate the outcome, with both the borough and Siemens agreeing to the inputs and outcomes of the analysis methodology.
The savings are verified by an independent third party. According to the borough's 2010 report on the program, the actual total annual savings for all four phases of the program have been approximately $926,000, compared to a guaranteed savings of approximately $565,000 per year. The report estimates that the efficiency measures have reduced electricity consumption by approximately 3.5 million kilowatt-hours per year and natural gas consumption by approximately 184,000 therms per year (a therm is about 100 cubic feet of natural gas). The report also estimates that the program's electric efficiency measures have reduced annual emissions of carbon dioxide, sulfur dioxide, and nitrogen oxides by about 6.6 million pounds, 5,200 pounds, and 6,500 pounds, respectively. The reductions for the gas efficiency measures are about 2.2. million pounds, 12 pounds, and 2,800 pounds (natural gas is a low sulfur fuel, so reducing its consumption has little effect on sulfur dioxide
emissions). The report is available at http://images.pcmac.org/Uploads/NaugatuckPublic/NaugatuckPublic/Divisions/DocumentsCategories/Documents/2010%20MV%20Report%204-17-10%20R1.pdf.