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A guaranteed energy savings performance contract provides a method to finance and implement capital improvements and services that save energy and operational dollars. The energy and operational cost savings produced by the project are typically enough to cover all project costs (including financing and any ongoing services) over the contract term.
As with most opportunities to succeed, there are also some potential risks, but in guaranteed energy savings performance contracts they can be mitigated with a little common sense. The potential pitfalls of implementing guaranteed energy savings performance contracts are well documented. When selecting a partner, you should make sure they have an approach that will alleviate these concerns.
Although the concept and process are proven, some energy service companies have taken advantage of schools by failing to explain or inform them of the key technical and financial decisions that need to be made by the administration and board of education. Instead, in such cases, the energy service company made the decisions without administrations involvement and simply crafted the contract to favor the energy service company and not the district. A summary of major pitfalls is listed below:
Utility Bill Guarantee
Some companies have elected to provide a guarantee based on your utility bills, which allows for an energy baseline adjustment. If not done properly, this can create a significant problem for schools in the long term. This provides the potential for arguments and often does not provide the data to make you feel comfortable that you are really achieving savings. The concept of this method is that your bills are entered for three years and that “baseline” is used to compare future energy usage.
But schools are always changing equipment or operating times, so no year is exactly the same as the last year. Therefore a “baseline adjustment” must be made to increase the baseline when more energy is used. For example, if you added more students, there may be a formula designed to consider the heat load that student added to your facility (especially if it negatively impacts the savings guarantee). There will likely be adjustments for things such as weather, attendance, activities, hours of operation, construction, computers, copiers, coffee machines, refrigerators, fans, etc. Are you going to check all the calculations? For each of your buildings?
Are you going to make sure the energy service company considers all the factors that positively affect your savings, so they do not take credit for it? If so, it may end up being a full-time job by itself. But if you do not, you may never be sure you are achieving the savings. Companies that use this method often charge you for all their time to come up with the adjustments. This method of verifying savings tries to track your savings by measuring the effect of everything that consumes energy in the building except for the efficiency measures themselves.
Energy Baseline Adjustment
It is crucial that the district administration participate in establishing the energy baseline, instead of the energy service company establishing the baseline on its own. It is also important that the district administration agree on the definitions and methodology for making any future adjustments to the energy baseline.
The reality is that there are an unlimited number of things in your facilities and how you operate them that can change energy use (weather, attendance, activities, hours of operation, construction, computers, copiers, coffee machines, refrigerators, fans, etc.). There is no way to identify every possible scenario in an up-front contract of how you might have to adjust a baseline for these things.
The district can include a provision that requires or allows third party opinions on adjustments, but unless energy service companies can provide you with all the possible adjustment calculations in the contract, the third party that the district might hire will not have a basis to work from. The utility bill “guarantee” should probably just be avoided.
Maintenance and Operational Savings
These savings include items that are not energy. They can be labor or material savings that result from the implementation of a particular energy conservation measure. For instance, if a school has new lights installed in all classrooms, no labor or materials will be necessary in these areas for changing out lamps or ballasts for a well-defined time period. Temperature control systems will save you time in theory, but you may not actually eliminate any staff.
Any claimed operational savings should be carefully examined and verified by the district before agreements are signed. In some cases (such as the case with labor savings) the savings may never actually be realized and will not show up in the budget (i.e., you do not save labor unless a position is eliminated).
Capital Cost Avoidance Savings
This term applies to implementing measures that will allow districts to avoid future costs but does not always save hard dollars in budgets. For instance, if a school knows that it needs to replace a boiler within the next ten years, it will need to appropriate capital dollars to do so. However, if the school installs a boiler under the guaranteed energy cost savings contract today, it will avoid spending the future capital outlay on the boiler.
Districts need to be careful! When energy service companies propose the inclusion of cost avoidance in calculating savings, districts must make sure they budget for the payments. Districts should not include these so-called savings in their calculations unless they have a stream of future capital dollars that can be earmarked toward the project.
Excessive Finance Charges
There have been instances where energy service companies inflated the interest rate on the funds borrowed to generate additional profits. Districts should check the rates against local banks or other national institutions to make sure they are competitive. Districts may be able to arrange their own financing at lower rates.
Pre-established Escrow Payments
Some companies have decided to set their payments on a pre-established schedule, instead of having you pay based the percent of project completion. This allows the company to obtain better cash flow and additional earnings through interest by collecting your money before they have completed the work. This not only costs you extra money, but also puts you at risk if the project is not completed and you have already paid.
Product Bias
Some companies in this industry are also product providers. They will often utilize their products to attempt to meet your needs regardless of whether they are the right solution, cost, or value for the client. They may even say they will use other vendors product instead of their own but may skew the design to benefit their solutions.
Subcontracting Parts of the Construction to Themselves
A request for proposals (RFP) may require fees and markups to be negotiated and pre-established. This option is impossible to manage when these fees can be circumvented by an energy service company that is a direct provider of products or construction labor. If they provide these services, they will provide them as a subcontract to themselves. It is difficult for these types of energy service companies to get competitive prices on the products and labor they provide because they are asking their everyday competitors for a price and there is significant opportunity for funny business. It is not likely you will get a fair price and these types of companies might not be the best partner. Your interests may become secondary to theirs in not disclosing additional or exaggerated profits in their product or construction pricing.
Required Maintenance Agreements
Some energy service companies have required that the preventive maintenance on facilities also be outsourced to that energy service company. As such, they tie the maintenance agreement to the guarantee agreement. Districts need to be careful! Typically, these maintenance agreements are very expensive in relation to the value provided. Often, the argument for the maintenance agreements by the energy service companies is that if the maintenance is not performed by their staff, they cannot assure that the guaranteed savings will occur. Not all energy service companies agree with this position. In many cases, there are energy service companies willing to guarantee savings while providing training for district maintenance staff so they can handle maintenance requirements.
Lack of Local Facilities Control
There have been abuses in the guaranteed energy saving performance contract business where energy service companies have restricted after-hours building usage. The objective of the performance contract should be to increase comfort and control, and not restrict a valid facility use.
About the author – Paul Harrell is a business development manager with Navitas. His background as a Certified Public Accountant and 33 years of experience in the education sector help him bring a practical approach to developing strategies for school districts wanting guidance in how to manage their overall budget and utility costs. He can be reached at pharrell@navitas.us.com or 913-344-0049