The Re-emergence of Performance Contracting

By Jeff Gavin | Oct 15, 2008
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Energy efficiency, as a driver for building upgrades or alternative energy adoption, has never been stronger. With tighter budgets and mounting fuel costs, energy performance contracting has re-emerged as a bridge to building improvements for public schools, government offices and private healthcare, manufacturing, hospitality and other markets. This form of contracting can generate business for electrical contractors (ECs) and offers the intrepid an opportunity to become their own general contractor.

Performance contracting for energy services is a methodology and mechanism giving a customer the capital investment and financing, with no upfront costs, to upgrade their energy system and reduce operations and maintenance costs. It is a get- now-and-pay-back-later arrangement using the energy savings. An energy service company (ESCO) is the project developer bringing together a third-party financier, a contractor and equipment provider. That ESCO could, in fact, be the contractor, the equipment or systems supplier.

“The ESCO guarantees up to 30 percent energy savings or more, which goes straight back into the customers’ bottom line after they pay back their loan,” said Charles Hall, an ESCO industry representative. “Contracts can run anywhere from three years to 20.”

Tom Walther, regional sales director, state government solutions, works for Johnson Controls Inc. in Milwaukee, an ESCO for numerous projects.

“One thing subcontractors should understand is performance contracting requires more logistics and planning than simple bid contracts,” he said. “A background in design/build certainly helps, but understanding how this unique form of contracting works is essential to participate.”

The responsibility of an ESCO

A customer looks to an ESCO in ways they do not look to a traditional general contractor. Typically, an ESCO’s responsibilities include the following:

• Spot and evaluate energy-saving prospects

• Develop engineering designs and specifications

• Run the project from design to installation to monitoring

• Assemble financing

• Train customer staff members and possibly provide ongoing maintenance services

• Guarantee that savings will cover all project costs

An ESCO initially submits a request for qualification notably for state or federally funded projects. A more detailed request for proposal then follows that outlines project cost saving measures, measurement and verification (M&V) and the performance contract itself. M&V is conducted once an installation is complete to confirm the estimated savings.

The necessities for success

“The success of a performance contract hinges on verifying that the amount of energy saved closely matches the energy savings guaranteed in the ESCO’s solicitation,” Hall said. “A responsible ESCO in partnership with the customer has real data, not guesstimates. That requires relevant historical data to gauge the actual savings in energy and operations that will pay back the bank note.”

Don Gilligan is president of the National Association of Energy Service Providers (NAESCO) in Washington, D.C. Though NAESCO focuses on large ESCOs, such as Johnson Controls or Siemens Corp., the association is committed to making sure any ESCO or related player provide M&V that is real and verifiable. If the project does not supply returns on the investment, the ESCO must pay the difference.

The International Performance Monitoring and Verification Protocol, developed in mid-1990s by NAESCO, ASHRAE and others, helps standardize documenting energy savings so that projects are bankable for third-party financiers.

“There was a big push in the ESCO industry to get financial institutions to finance these projects, but at one time there wasn’t solid information to make a fair determination—no systematic set of tests,” Gilligan said. “Now there’s this industry standard for the U.S. and other countries.”

Gilligan explained that the standard helps to accurately and consistently measure efforts, such as optimizing lighting and HVAC ranging from new fixtures or lighting systems to more complex, building control systems.

“It’s really a simple measurement of pre- and post-wattage on a retrofit, calculating run hours. Some simulated engineering calculations of the building may also be needed from one set of controls to the other and monitored again once the new controls are put in to verify energy efficiency and projected savings,” he said.

NAESCO also offers an accreditation program.

“Currently there are about 20 NAESCO-accredited ESCOs,” Gilligan said. “Accreditation is also offered for energy service providers [ESP], whose projects involve energy supply and distribution, and energy efficiency contractors [EEC], an opportunity for electrical contractors to validate their value-added capability when pursuing performance contracting projects. An EEC can concentrate on a single efficiency measure, such as lighting, but is not limited to one energy concentration.”

ECs as ESCOs

Rapid Electric in Escanaba, Mich., and Southern Contracting Co. Inc. in San Marcos, Calif., are offering their own ESCO-styled services to customers in their regions.

Rapid Electric has a spinoff company called E2P2 Solutions Inc. Though it bills itself a an “energy services provider,” its ESCO structure is clear as it promises to obtain contractor quotes, secure funding, oversee a project to completion, and provide energy management data to verify savings are meeting or exceeding expectations.

According to the company’s Web site, “during the last three years, E2P2 Solutions has worked with 20 municipalities and school districts in the Upper Peninsula to help them save more than $300,000 annually by becoming more energy efficient.” E2P2 advertises a 15 percent or greater energy savings for its clients.

“We’re now up to 30 projects,” said Ron Lindberg, company president. “E2P2 is becoming a major part of Rapid Electric’s business. School districts are an attractive market for us. If a school district is struggling and does not have the funds for needed energy improvements, they can look to us. For example, if we can reduce their $150,000 annual energy consumption by 20 percent ($30,000) through new lighting or other means, they use that annual savings to pay down the financing with the bank. Our customers ultimately decide how they want to save energy.”

Lindberg said he likes being his own general contractor. To him, his work in performance contracting is changing the view of what an electrical contractor is and can do.

“I’m a better EC,” Lindberg said. “Granted, there was a learning curve, such as understanding the rules and regulations of architectural and engineering firms. Today, our markets have doubled to include municipalities, retirement housing, multi housing, large motels, churches and hospitals. We’ve also increased our business with existing customers.”

Adding alternative energy to the efficiency mix

Performance contracting has dealt in energy efficiency long before terms, such as green power and sustainability, were common. So does it factor into sustainable design and certification? The answer is yes and no.

“LEED [Leadership in Energy and Environmental Design] and performance contracting don’t quite mesh at this point,” Hall said. “LEED will have sustainable solutions and performance contracting could be the vehicle to finance those solutions. Both have goals for energy efficiency and longevity, but some LEED technologies and methods are still a little expensive. They usually have paybacks outside the average finance window of 10 years, a typical performance contracting mandate in many states.”

Southern Contracting Co. has just become active in power purchasing agreements (PPA). PPAs are a type of ESCO. For example, a representative from Southern Contracting Co. might assemble a project for an investor interested in buying power generated from an alternative energy source. A host site agrees to the installation of, say, a solar rooftop array. The investor then buys back the green power.

“In our case, the PPA may also tie into a LEED or other green certification objective,” said Tim McBride, president/CEO of Southern Contracting Co.. “That’s where the two might meet. Beyond increasing alternative energy use, our PPA customers enjoy a fixed kilowatt rate.”

Jim Filanc, director of business development for the firm, said dealing with alternative energy begs the question: What are the real savings for PPA projects?

“A rooftop solar installation designed to produce 1 megawatt of power could cost upwards of $7 million, but the rates of return are longer. And the finance companies are getting pretty good returns and guaranteed income for the longest term they can,” he said.

“From a PPA investor’s perspective, we’re seeing a massive investment in photovoltaic [PV],” Filanc said. “It seems to be enjoying the classic 18-month doubling curve cited by some investors as to why they are keen on jumping into solar technology. They understand silicon [which most commercial panels use] and the advancements made that are helping drive solar adoptability and lower its costs. We are really at that tipping point to PV’s commercial success as performance capacity comes up.”

In its 2003 U.S. DOE Buildings Energy Data Book, the Department of Energy said buildings represent 70 percent of all U.S. electricity consumption. and account for 39 percent of all energy use and CO2 emissions.

“Across America, we waste as much as 30 percent of the energy that is used in buildings because of under-maintained air conditioning, inefficient lighting and improper or no insulation. By eliminating energy wasted in the buildings we work and live in, we will reduce our national energy demand by 12 percent, the equivalent of taking over half of the cars, trucks, planes and trains off America’s highways. I’m not sure who said this but it says it all, ‘The greenest watt of energy is the watt not consumed,’” Filanc said.

Looking before leaping

Gilligan has some advice for contractors intrigued by the prospect of becoming a small or medium-sized ESCO.

“Understand the risks in the development of a project,” Gilligan said. “You have to do your homework first to determine who is willing to invest. Discover who is a real customer. Who are the buyers? Talk to and learn from successful ESCOs.”

For those more inclined to serve as subcontractor ESCOs, he said: “Discover the ESCOs in your area and their project history. They should know who you are, where you operate, your capabilities and expertise if you want a chance to bid on their projects. The bigger ESCOs have a stable of contractors they can count on. Earn your place in their stable. Remember, ESCOs are not taking business away from the EC. They are creating energy-efficiency projects traditional bid and build is not developing.”

GAVIN is the owner of Gavo Communications, a marketing services firm serving the construction, landscaping and related design industries. He can be reached at [email protected].

About The Author

GAVIN, Gavo Communications, is a LEED Green Associate providing marketing services for the energy, construction and urban planning industries. He can be reached at [email protected].





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