Performance Contracting Underwater: An Overview

By David Clamage

The business of performance contracting is one of the largest and most stable platforms for executing energy efficiency and reduction strategies in the global building and facilities stock — buildings for people to live and work in; others for manufacturing and governing our nation, states, cities and counties; properties ranging from multi-family to entire schools, hospitals colleges and universities; and, of course water treatment and delivery systems.

An April 2017 report from the Lawrence Berkeley National Laboratory estimates that ESCO investment in energy efficiency retrofit projects currently runs about $5 billion a year. Since 1990, ESCOs have delivered:

  • $50 billion in projects paid from savings;
  • $55 billion savings — guaranteed and verified;
  • 450,000 person-years of direct employment;
  • $33 billion of infrastructure improvements in public facilities; and
  • 450 million tons of CO2 savings at no additional cost.

It’s estimated that there was more than $68 billion in projects implemented in 2016 alone. These are project that are designed to be repaid with savings — savings that are, primarily, from the reduction in energy and operational expense.

There are the three common models available for you to finance these kinds of projects — as well as other needs you have within your system (discussed in details in WF&M’s May 2017 article, Bucks, Bonds or Borrowing).

  • Bucks are your own capital — cash on hand.
  • Bonds are generally the lowest cost of borrowing and typically require a vote of your community.
  • Borrowing typically refers to tax exempt lease purchase or notes.

Here, let’s discuss the key concepts of several issues that will help you analyze your pending performance contract and some questions you can ask of your contractor and finance team to make sure your project is tailored to you.

  • Unique “State by State” perspectives on contracting/funding
  • Firm term vs. non-appropriation financing
  • P3/PPA models impacted by state public utilities commission
  • Larger systems vs. smaller systems — what’s different about ESPC projects for these?
  • Other “water centric” issues in performance contracting

The State of Your State

Virtually all 50 states have a strong commitment to energy efficiency and environmental stewardship. And, unique elements to local laws re: both performance contracting and finance. There are very valuable resources for you to rely on and use as resources to research the tools distinct to your market:

The State Energy Office

In Colorado, they have the Colorado Energy Office with their toolbox containing a wide range of tools including sample documents for issuing RFPs, contracting and managing your project, as well as securing the best possible financing. While much of this is “Colorado Centric,” you’ll find many of the best practices we’ve tested and used over many years and they are yours to use. And, as a member of the National Association of State Energy Officials, you will find that your state has women and men dedicated to keeping current on these issues and very willing to share.

Key points regarding finance are in our May 2017 article covering non-appropriation as common in all states with Indiana and California using the abatement form, as well as non-appropriation and with only very subtle differences between both. And your state’s statutes re: performance contracting — are available to you through our office, your NASEO Member as well as members of your local chapter of the Energy Services Coalition. While we are not here to provide legal advice, there can be key points in your marketplace that can often be addressed by your bond counsel as well.

Firm Term vs. Non-Appropriation

This is a document model that’s been used very successfully with many water providers throughout the country. The concept is straight forward: While most of you are chartered as governments in your state with the ability to issue tax exempt debt, you likely do not levy taxes and it is that levy and collection of taxes that generally requires non-appropriation as only the voters can promise to be taxed to repay debt on a firm term vs. non-appropriation basis. However, many of you rely solely on tap, consumption and user fees with those being a function of the size and growth rate of your service area. This distinction may allow you to issue “firm term” debt eliminating the non-appropriation risk many lenders need to consider when approving your project and pricing your financing. We strongly encourage you reach out to your legal counsel — the right answer to this question can often provide you with a lower cost of funds.

The PPA or P3 Model

It is increasing in popularity that all users of energy assets look for techniques that may allow them to outsource some or all of these tasks. This outsourcing can come in the form of PPAs (power purchase agreements), and P3s (public private partnerships). These models come in a very long list of options from 100 percent third party ownership with that owner being either, both or a combination of pure investor or technology provider. There are some very important criteria you should apply to your evaluation and that should begin with dialogue with your state public utilities commission. A good resource to begin that conversation is the Advanced Energy Economy PowerSuite. You can often glean an understanding of your state’s policies about important issues such as:

Non-Regulated/Non-Utility Ownership of Energy Assets

  • Many states have very strict policies regarding who can and cannot sell power, i.e. electricity, gas, and thermal energy. While this is more aggressively regulated on a “wheeling” basis where you may have surplus power from your system and seek to sell it to another party, it can often impact “behind the meter” use on your own campus.

Rate Structures

  • How the rates for your commodity are controlled, i.e. are there restrictions regarding the price your PPA or P3 partner can charge and how that rate may or may not be protected and taxed

Of course, there are many other concerns in dealing with your state regulator and engaging early will guide you on what can and cannot work for your water agency.

A pure PPA would be true 3rd party ownership of your system — for example, you may seek to recover gas from your water treatment facility and use that gas on your campus to reduce the cost you pay your utility. That could be as mundane as running a boiler or as sophisticated as the process of cleaning to drive turbines to make electricity for your use. While I’m not an engineer, (thought I play one on TV), some of the elements of a PPA for you to focus on are:

GMP

  • Guaranteed Maximum Price of the system installed; the time of that installation; and, the financial and technical wherewithal of the party making those representations.

Technology and System Guarantees

  • Who is warranting the performance of your system and what are those conditions?
  • How does this guaranty and operation effect your day to day operation as well as long term strategy?

Operations and Maintenance

  • Who has these responsibilities and under what conditions as to cost, response time and more. And you can’t really get too granular and want your current plant personnel actively involved.

Costs

  • What are the recurring costs for the commodity of energy or reduction of energy; how are they metered and defined; what are the long-term rates; are they taxed by your state and local authorities; and, what is the disposition of the system at the end of term. Do you automatically own it or are their other criteria such as fair market value purchase or renewal options?
  • Who is responsible for local taxes, i.e. sales, use and property tax and who must insure the casualty and operation risks of the system.
  • Are there tax benefits to be monetized and how do they benefit your net cost of energy?
  • Is your PPA provider stable and is their capital assured for the duration of your contract.
  • What is the legal mandate imposed on you to purchase power? Is it “take or pay”; “take and pay”; or, other models that will have impacts to you for many years to come.

As with a P3, the accounting impacts to your financial statements, bonding capacity, and ratings and ratios are important. We strongly suggest these are discussions to be had early with your auditors, financial advisors and counsel to be sure that you’re heading down a path that is viable for your operations.

The P3 model is also growing in popularity and can often have even more variations in that you may also be a partial owner in these assets. The National Council for Public Private Partnerships (NCPPP) is another excellent and objective resource for you with many considerations that mirror and add to your review of a PPA.

We believe your goals should focus on:

  • Who has ultimate responsibility for system cost and performance.
  • What are the accounting benefits or detriments to your final cost?

Remember, many times when you cede ownership of these assets, your net cost may go up as you trade your tax-exempt ownership as you shed operational and accounting risk.

Larger systems vs. Smaller systems

Scale is important to you and your staff, as well as to both your ESCO or technology provider and finance source. Our experience has shown that there are many fine local contractors that can and do focus on smaller projects, i.e. less than $5 million and often even less than $1 million in project size. Your contractor review is then well focused on the relative size of the firm and project — keeping in mind the proportionality of installation and long-term performance risk. Where your project size is smaller and the technology well known and proven, the risk is measurably lower and you can often consider smaller firms.

However, money is the ultimate commodity in that the more you “buy” the less it costs and many times you will be limited to term and interest cost on smaller projects. Also, the options of PPA and P3 models may also not be available to you on smaller projects as the developer and investor community has many costs to amortize in documentation, vetting tax benefits and incentives, allocating equity and debt and many more considerations. You too will have a fair bit of internal and external due diligence so we encourage you to consider both finance and accounting goals in concert with your research on the availability of capital. A quick rule of thumb might be:

Bonds: $10 million and up
Tax Exempt Lease Purchase: $50,000 and up
PPA: $2 million minimum
P3: $2 million minimum

Summary

We’ve only scratched the surface on the many elements involved in acquiring and financing energy focused and performance contracting based systems for your water business. We hope we’ve inspired new and creative thinking on your part and inspired you to take up this important effort as well as shared some resources you’ll find valuable in your efforts. 


David Clamage
Founder | Saulsbury Hill Financial, LLC

David Clamage is the founder of Saulsbury Hill Financial, based in Denver. Founded in 1976, it is one of the oldest municipal leasing companies in the United States, and specializes in multi-sector state and local government leasing, including large project and lease financing for virtually all terms and asset types.

Leave a Reply

Your email address will not be published. Required fields are marked *

*