March 2020 — Performance contracting is a process used in effecting high-performance investments. It involves engaging a specialist to undertake the project pursuant to a defined set of parameters, with desired goals and objectives for the project after it is completed. The performance is established through a measurement and verification (M&V) process that confirms the project complies with the original parameters and is delivering the results expected.
Energy service companies (ESCO) engage in performance contracting and focus on providing one or more technologies specific to properties. These technologies are related to improving a property’s energy efficiency, producing renewable energy, or in some way reducing energy consumption at a property.
ESCOs do not just offer properties technology, but also installation and the financing necessary to acquire the technology. The ESCO business model revolves around two things:
- The development of technological expertise so that the ESCO can deliver the technology more cost-effectively than a property might on its own.
- The ability to arrange funding for the technology via third parties who are compensated from the operating savings created by the technology.
Thus, the property benefits from the installation of new technology at no capital cost to itself, and generally achieves some level of savings during the contract term. The ESCO makes its profit on the difference between the cost of the funds used to pay for the technology and its installation, and the total energy savings generated at the property level. The property owner foregoes the bulk of the savings until the end of the contract term, which may run from five to 20 years depending on the technology installed.
Depending on the contract, the ESCO may guarantee a certain level of savings, in which case it is likely the cost of the guarantee is built into the pricing of the contract. If a property has limited financial resources and does not have access to personnel who can install and operate the technology, then an ESCO may be an appropriate way for that property to improve its operating technology. On the other hand, if a property is able to fund or independently finance this type of investment and is able to engage professional help if the existing property team does not have the necessary expertise, then it may be better for the property to undertake the work directly and have greater control over both the installation of the technology and its operations.
Mitigating Risk for Performance Contracts
Insurance that backs warranty coverage for alternative energy and energy-efficiency products and installations is a recent innovation in the high-performance investment arena. Third-party coverage to fund projected savings in the event actual savings are lower than the projections removes one of the uncertainties of a performance contract. A property manager can be more willing to move forward with a particular project if the outcome is assured and not dependent on the vendor continuing to support any promises made. As these types of offerings become more readily available, the ESCOs are likely to incorporate this feature into their programs.
Whether insurance coverage is available or not, a performance contract such as those promoted by ESCOs will require certain actions to be taken in order to guarantee the projected results. Energy-efficiency projects are not only about the technology being installed. How the equipment is operated and maintained will have a considerable impact on the actual results. Because of this, vendors mandate specific procedures to be followed for their guarantees to be valid. In some cases, the vendor retains control over the equipment to ensure that the required operating and maintenance requirements are followed strictly. The cost of the additional staff needed to do this is factored into the program’s pricing.
In this situation, the property team will have to determine if subcontracting the maintenance of the equipment to an outside party will make any of their existing staff superfluous. Depending on the length of the performance contract term, it may be economically necessary to lay off excess staff. The downside to this is the potential impact to the surviving staff following a layoff, unless an alternative position or location can be offered to any excess staff.
Support and Training
If a property team is responsible for operating the new equipment, they must be trained, supported, and supervised to ensure that expected operating performance is achieved. Any variables out of the property team’s control should be adjusted to reduce potential negative impacts to operating performance.
The guarantee may be thought of as delivering a certain return to the property, but it is really about the system performing as promised within a defined set of parameters. If variables push the operations outside the boundaries of the operational parameters, the deliverable results will have to change, which may affect the total return through no fault of either the vendor or the property. Having a well-crafted contract will protect both parties legally, and complete and thorough communications among the parties leading up to the contract will set reasonable expectations.
Use of Established Industry Tools
Resources such as BEPC, IPMVP, ASHRAE Guideline 14-2002, Federal Energy Projects M&V Guidelines, and others can be used to support property owners and managers, as well as the vendors who wish to sell energy-efficiency projects to them. The BEPC tool provides contract templates to encourage more transparency about performance expectations for energy-efficiency measures. This neutral view of the transaction allows greater confidence that the terms are appropriately geared to deliver the promised results and offers the mechanisms to verify achieved outcomes.
The tool is flexible enough to accommodate any likely funding source, including direct investment by the property owner, use of a guaranteed performance contract, or even specialized funding such as PACE, and can calculate the relative benefits to be enjoyed by the property following project completion. The provisions found in the templates could even be used as inserts if the parties choose to use an independent contract form. The BEPC toolkit also offers a separate M&V template that helps track actual performance following project installation.
Additionally, how the ESCO is paid can be complicated since the building operating cost pass-through to tenants may be spelled out in the lease. Therefore, a property manager must ensure the cost of the upgrades and saving will be compatible with the lease structure in place. In some cases, the fees can be paid through the existing utility bills. But in other cases, a new bill can be generated based on actual usage of the equipment and calculated savings. The payment details should be determined and understood before a contract is signed and the project is implemented.
This article is adapted from BOMI International’s High-Performance Sustainable Building Investments, part of the new High-Performance Sustainable Buildings credential (BOMI-HP™). More information regarding this course or the BOMI-HP™ credential is available by calling 1-800-235-2664. Visit BOMI International’s website, www.bomi.org.