Performance Contracting Delivers Maximum Flexibility, Upgrades

How to Have Your Cake and Eat It, Too

Energy Savings Performance Contracting Delivers Maximum Flexibility Along with Upgrades

By Pete Thomson & Mike Hanna

People who judge sports, video gaming and baking competitions often consider “degree of difficulty” in evaluating performance. That consideration should also apply to today’s utility managers, who must keep rates low while responding to increasingly demanding regulations, escalating operating costs, and aging infrastructure.1

Traditionally, as costs increased, the manager’s choices would be to raise rates, delay capital expenditures, or forego maintenance. Now, customer expectations regarding rates and service levels make that more difficult, regulatory and enforcement pressures can limit capital expenditure delays and assets are failing at an alarming rate. Mangers often have to choose between one pressing priority and another – unless they are able to take full advantage of a delivery approach that allows them to have their cake and eat it too.

Energy Savings Performance Contracting (performance contracting) is generally understood as a delivery approach to improve operating efficiency and address capital needs while minimizing financial impact to the utility. But it also delivers flexibility for those who understand it. Although it isn’t a panacea, an Energy Savings Performance Contract (ESPC) that is properly applied can be a powerful way to address the issues facing the modern utility.

ESPC Ingredients

An ESPC is an agreement with an energy service company (ESCO) for the scope development, design and construction of system and infrastructure improvements that will result in annual energy and operational cost savings sufficient to cover the cost of the project.

Performance contracting is a turnkey service, sometimes compared to progressive design-build delivery, with the addition of a long-term project savings guarantee. The phases of a typical ESPC project follow.

  • The utility and the ESCO enter into an agreement to execute an Investment Grade Audit. At the outset of this phase of work, staff members of both organizations meet and the ESCO personnel tour the facilities, gather data, and develop a list of potential upgrades. They work with utility staff to refine the list and develop preliminary estimates of construction cost and operational savings. This is usually an iterative process and can take significant time and effort.
  • Once the utility and the ESCO agree on a set of upgrades that are technically feasible and meet the utility’s financial requirements, the ESCO performs preliminary engineering and cost estimating to develop a guaranteed maximum price, then completes the Investment Grade Audit. The audit consists of four major deliverables: the preliminary design, the guaranteed maximum price, the savings that the ESCO guarantees the utility will achieve after executing the upgrades, and a plan for measurement and verification of the savings annually for the duration of the contract.
  • If the utility elects to move forward with the work and signs the ESPC, the ESCO completes the design, purchases the equipment, and constructs the upgrades. At that point the utility pays the ESCO the guaranteed maximum price for the construction. A utility that elects not to sign the contract pays the ESCO a pre-negotiated fee to compensate the ESCO for the work completed, and the two part ways.
  • Once the upgrades are complete, the project enters the measurement-and- verification phase of the work. In this phase, which can extend as long as 20 years, the ESCO annually assesses the performance of the upgrades and, following a pre-approved methodology, calculates the actual savings achieved each year. If the actual savings exceed the guaranteed savings, the utility pockets 100 percent of the savings. If the actual savings fall short of the guaranteed savings, the ESCO must make up the difference to the utility.
An opportunity to reduce operating costs that may not be readily apparent is the implementation of Biological Nutrient Removal (BNR) to reduce aeration costs while improving effluent quality (Photo credit: Black & Veatch).

An opportunity to reduce operating costs that may not be readily apparent is the implementation of Biological Nutrient Removal (BNR) to reduce aeration costs while improving effluent quality (Courtesy of Black & Veatch).

Flexibility Action

Performance contracting is more than merely a means of delivering energy efficiency upgrades. An ESPC offers flexibility that isn’t always apparent to those unfamiliar with such contracts.

An ESPC, regardless of the energy component in the name, can be used to construct not just electrical efficiency improvements, but any improvements that increase operational efficiency by saving energy, chemicals, labor, or maintenance, or even improvements that generate new revenue for the utility. The intent of the contracting method is to deliver improvements that pay for themselves – improvements that generate savings greater than the debt service to finance the improvements. This allows utilities to execute improvements without raising rates or impacting overall budgets, essentially enabling them to execute facility improvements for free.

Consider the wastewater utility in northern Virginia that executed a $45 million project to construct a new solids handling facility, including high-strength waste receiving and cogeneration, at its largest wastewater treatment plant. The ESPC encompassed all upgrades and major maintenance for the treatment plant’s capital improvement plan (CIP). The savings and new revenue from high-strength waste receiving are more than adequate to cover the debt service while also providing for a projection of zero rate increases over the next 20 years. The utility had the flexibility to incorporate not only a completely new solids train (thickening, digestion, and dewatering) but also a refurbished aeration system (new blowers, diffusers, and aeration control) into the ESPC, thereby addressing the CIP needs for the next 20 years with a net reduction in total annual budget.

In addition to enabling budget-neutral execution of efficiency improvements, an ESPC can be used to implement other upgrades if the efficiency improvements generate more savings than are necessary to cover the associated debt service. In that case, the extra savings can be applied to fund other upgrades that don’t necessarily generate any savings at all. A Maryland utility used this flexibility by adding a grit removal upgrade to an ESPC that generated extra savings.

An easily-identified opportunity to reduce electricity consumption is the installation of high-efficiency blowers, often installed as jockey blowers to meet normal aeration demands (Photo credit: Black & Veatch).

An easily-identified opportunity to reduce electricity consumption is the installation of high-efficiency blowers, often installed as jockey blowers to meet normal aeration demands (Photo credit: Black & Veatch).

In fact, it isn’t absolutely necessary for the savings to cover the cost of the debt service. In some cases, the avoidance of future capital expenditures can be used to fund a project. This approach, called capital avoidance, allows utilities to cover some or all of the project costs by applying future capital expenditures, which are presumably incorporated into the budget and rates, to the current project. An extreme example of this occurred in upstate New York, where an ESCO replaced a water filtration plant’s underdrains and implemented filter upgrades that increased capacity of the filters. The project was paid for by reallocating budget from a planned future capital project to expand the plant.

Performance contracting flexibility extends to the method as well as the scope of project implementation. Open-book pricing, which makes pricing details fully available to the owner, typically is used to establish the guaranteed maximum price and for the overall project. This provides a great deal of flexibility because it is not absolutely necessary to select the low bid on equipment or construction subcontractors. It is possible and easy to look at best value on every piece of the work, selecting for reliability, cost-effectiveness, savings, or other reasons. This is exemplified at a project in Northeast Ohio, where the ESCO and the utility plan to meet to select the optimal vendor for each piece of equipment. This is a far cry from hard-bid traditional work where utilities are often forced to accept lowest-common-denominator “equal” products or pay stiff change orders.

Performance contracting is authorized at the state level, typically by a statute entirely separate from procurement requirements. Frequently, the statutes specifically exempt ESPC projects from procurement requirements. As a result, the utility has a great deal of flexibility for sole sourcing equipment, if desired. Any need for competitive selection can be met when the ESCO is selected; from that point forward, flexibility flourishes. Utilities can simply sole source some equipment or have the ESCO compete the equipment to get the lowest price and then select a specific manufacturer. In an industry full of requirements, it’s nice for a utility manager to have this option.

When executing an ESPC in an open-book way, a utility gains additional flexibility in the ability to use left-over contingency to execute additional scope if so desired. If significant contingency funds remain as a project nears the end of the base scope, the utility and the ESCO may choose to use remaining contingency to develop and execute additional scope of work. With an open-book execution model in place, this is a relatively simple process that can benefit both parties.

A final form of flexibility is found in financing the ESPC. A utility has many choices in this area, more than are available with traditional delivery methods. Projects can be financed through CIP funds, loans and bonds as traditional projects are. Grants and other incentives can be applied when they are available. In addition to the normal options, private money can be brought to bear. This often takes the form of a lease-purchase arrangement where the ESCO or other third party finances the construction and receives payments from the owner. Lease-purchase contracts can be adapted with a wide variety of payment structures, which can match up well with cash flows. For example, the payment schedule can be set up to escalate over time to match increases in savings associated with inflation.

Having It All

In the right hands, ESPC offers myriad benefits for utilities. It’s one of the most flexible, as well as financially sound, delivery approaches for water and wastewater system upgrades.

An ESPC enables utility managers to fund projects by reallocating the guaranteed savings to a utility’s budget with no impact on the utility’s capital budget or rates. It provides multiple options to address myriad challenges. The flexibility to put excess savings to work on other needs and/or to select equipment based on criteria other than just low cost, for example, means utilities that use Energy Savings Performance Contracting to full advantage can indeed have it all.

Pete Thomson
Pete Thomson, P.E., leads the Energy Savings Performance Contracting Business Line in the water business of Black & Veatch.

Mike HannaMike Hanna, P.E., is a project manager in the water business of Black & Veatch, a global leader in engineering, procurement and construction services for water, energy and telecommunications.

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