- Overview of Energy Savings Performance Contracts
- October 8, 2010
- Law Firm: Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. - Boston Office
Energy savings performance contracts (ESPCs) are partnerships between energy services companies (ESCOs) and their customers for the purpose of financing and implementing cost-saving energy efficiency improvements. An ESCO’s principal service under an ESPC is the development, design, engineering, and installation of projects that reduce the energy and operations and maintenance (O&M) costs of customers’ facilities. These projects typically include a variety of measures customized for the facility and designed to improve the efficiency of major building systems, such as heating, ventilation, air conditioning, and lighting systems. When they enter into ESPCs, ESCOs typically commit to their customers that the energy efficiency projects will satisfy agreed-upon performance standards upon installation or achieve specified increases in energy efficiency. In most cases, the forecasted lifetime energy and operating cost savings of the energy efficiency measures will defray all or almost all of the cost of such measures. In many cases, ESCOs can assist customers in obtaining third-party financing for the cost of constructing the facility improvements, resulting in little or no upfront capital expenditure by the customer. After a project is complete, most ESCOs have the capacity to operate, maintain, and repair the customer’s energy systems under a multi-year O&M contract if the customer desires such services. The market for ESPCs has seen significant growth in recent years, driven largely by rising energy prices, advances in energy efficiency and renewable energy technologies, governmental support for energy efficiency programs, and growing customer awareness of energy and environmental issues. End-users, utilities, and governmental agencies are increasingly viewing energy efficiency measures as a cost-effective solution for saving energy, renewing aging facility infrastructure, and reducing harmful emissions.
The first step for a potential customer in determining whether an ESPC is a viable solution is to conduct an internal audit of its facilities, staff, and financial position. Conditions that make entering into an ESPC favorable include:
- aging buildings and equipment,
- recurring maintenance problems or high maintenance costs,
- limited budgetary resources,
- lack of energy management expertise among staff,
- no recent upgrades to lighting or controls systems, and
- energy-using equipment that is ready for replacement.
If it is determined that an ESPC is a viable solution, the customer will generally prepare a request for proposal (RFP) that will help identify interested ESCOs and their project proposals. In addition to setting ground rules for the project, an RFP should also include information regarding the facility, such as energy use, existing equipment, operating schedule, maintenance problems, and planned equipment replacement or renovation plans. Interested ESCOs will typically want to visit the facilities and interview facility staff before submitting a response. The winning ESCO will conduct a much more detailed energy audit and use that audit for the basis of the project costs included in the revised and final proposal. The cost of the detailed audit should be rolled into the cost of the ESPC; however, it is common for ESCOs to require that customers pay for the audit out-of-pocket if an ESPC is not ultimately entered into. ESPC payback terms can range from a few years up to 20 years in some instances. Therefore, choosing the right ESCO is a very important step, as the customer and the ESCO may be partners in the energy savings project for a relatively long period of time.
Once an ESCO has been selected and a detailed energy audit conducted, an ESPC will be negotiated by the customer and the ESCO. The terms of the ESPC will govern the development, design, engineering, and construction of a project and also guaranty that the project will satisfy agreed-upon performance standards. Commitments generally fall into three categories: pre-agreed, equipment-level, and whole building-level. Under a pre-agreed energy reduction commitment, the customer reviews the project design in advance and agrees that upon or shortly after completion of installation of the specified equipment comprising the project, the commitment will have been met. Under an equipment-level commitment, the ESCO commits to a level of energy use reduction based on the difference in use measured first with the existing equipment and then with the replacement equipment. A whole building-level commitment requires demonstration of energy usage reduction for a whole building, often based on readings of the utility meter where usage is measured. Depending on the terms of the ESPC, the measurement and demonstration may be required only once, upon installation, based on an analysis of one or more sample installations, or may be required to be repeated at agreed upon intervals, generally over the term of the ESPC.
ESCOs typically do not take responsibility for a wide variety of factors outside their control, and attempt to exclude or adjust for such factors in ESPCs. These factors include variations in energy prices and utility rates, weather, facility occupancy schedules, the amount of energy-using equipment in a facility, and failure of the customer to operate or maintain the project properly. In addition, performance commitments typically apply to the aggregate overall performance of a project and not to individual energy efficiency measures. Therefore, to the extent an individual measure underperforms, it may be offset by other measures that overperform during the same period. If an energy efficiency project does not perform according to the agreed-upon specifications, ESPC terms typically allow ESCOs to satisfy their obligation by adjusting or modifying the installed equipment, installing additional measures to provide substitute energy savings, or paying the customer for lost energy savings based on the assumed conditions specified in the agreement. Upon completion of the project, customers must ensure that facilities are operated and maintained as called for in the ESPC, as failure to do so will most likely relieve the ESCO of some or all of its responsibilities under the energy savings guaranties.
As discussed in this overview, ESPCs can be an excellent alternative for financing capital improvements to the energy infrastructure of large-scale facilities in certain circumstances, so long as care is taken in determining whether an ESPC is the appropriate solution for a facility’s needs, requesting proposals from interested ESCOs, selecting the ESCO that will perform the project, and operating and maintaining facilities following completion of the project.