Guaranteed Energy Savings Contracts

Guaranteed Energy Savings Contracts: An Efficient and Viable Procurement Option

By Steven Kowalski
Business Development Manager
Performance Services, Inc.

Over $15 Billion worth of Guaranteed Energy Savings projects have been completed over the past 20 years throughout the nation's K-12 Schools. The majority of states in the US and the Federal Government have enabling legislation governing the use of what is known as Guaranteed Energy Savings Contracts or GESC (sometimes referred to as Energy Performance Contracting). In Illinois, this legislation for K-12 Schools is defined in Article 19b of the school code.

Article 19b:

Allows school districts to partner with an Energy Services Company (ESCO) to provide energy efficiency-related services
Defines how these services can be procured
Requires a financial guarantee from the ESCO to the school district that the savings from the improvements will pay back the cost in 20 years or less.

With literally hundreds of Illinois K-12 Schools utilizing the Article 19b procurement method since its inception over 30 years ago, why are there still so many misconceptions about how this legislation works? Some of the highest-profile school districts in Illinois, with some of the most well-respected business managers in the industry, have chosen this procurement method to address facility improvement needs for the most critical and costly equipment such as boilers, chillers, unit-ventilators, lighting and building controls. So, what challenges are school districts addressing and how does Article 19b help address those problems?

Nationally, NAESCO member projects have produced:

$70 billion in projects paid from savings
$75 billion in savings — guaranteed and verified
650,000 person-years of direct employment
$52 billion in infrastructure improvements in public facilities
560 million tons of CO₂ savings at no additional costs

The Challenges
Similar to the idea that one would never purchase a car without knowing the gas mileage, how can school administrators be expected to purchase millions of dollars for building equipment and systems without considering the total cost of ownership? The lowest upfront cost may be the best option for some of this equipment, but on the other hand, sometimes the cheapest equipment can saddle school districts with decades worth of high energy and maintenance costs.

The nation's 17,450 K-12 school districts spend more than $6 billion annually on energy — more than on computers and textbooks combined. As much as 30 percent of a district's total energy is used inefficiently or unnecessarily. Source: EnergyStar.Gov – An Overview of Energy Use and Energy Efficiency Opportunities.

Equipment such as boilers, chillers, building controls, lighting and solar arrays significantly impact a school's future operating budget. Replacing these systems usually requires more than just a "one for one" replacement. Instead, newer technology, modern building codes and changes in teaching space are just some of the reasons these systems sometimes require complete re-designs by qualified engineers. But with so many decisions on high-efficiency designs and initial cost considerations, how does a district decide to procure new systems? One answer: Guaranteed Energy Savings Contracts.

Renovating buildings to make them more comfortable and energy-efficient is nothing new. In the early 1880s, at what is now the University of Whitewater, Wisconsin, Professor Warren S. Johnson became frustrated that his classroom was either too cold or too hot. The janitors would come in to measure the temperature and manually adjust dampers—disruptive to his teaching. So, Professor Johnson invented, and in 1883 patented, a device called the "electric tele-thermoscope." With this, the industry of controlling classroom comfort was born. Nine years later, Willis Carrier invented air conditioning to help control humidity for a New York printing press. Thus, the modern Heating, Ventilation and Air Conditioning (HVAC) evolution began.

Fast-forward to today, heating, cooling, ventilating and controlling the environment of modern buildings is a given but can be complicated and costly.

Performance contracts have been used for decades to provide cost-effective facility improvements. Over 30 years ago, Illinois adopted Article 19b of the School Code: Schools Energy Conservation and Savings Measures. This legislation allows districts more flexibility in procuring school improvements that reduce long-term energy and operating costs. Districts can choose an Energy Services Company (ESCO) directly via an RFP process. It emphasizes accountability on these companies by requiring financial savings guarantees and allows for more design collaboration between the ESCO, the district and the potential subcontractors.

The concept allows a district to use the future funds it would spend on higher utility and maintenance bills from antiquated and inefficient equipment as a "funding source" for improvements. Why overpay the utility company when you can use those dollars to renovate the equipment instead?

The following provides a high-level view of how this process works in Illinois and addresses a few common misconceptions about the legislation.

RFP Process: Choosing your ESCO is a Competitive Process
The formal procurement process begins with a Request for Proposal (RFP). This process allows the district to choose which ESCO they want to partner with to design, manage and install their project. However, previous to this step, the district may have had discussions with one or more ESCOs to learn more about the feasibility and process for implementing a project. If the district utilizes an ESCO to help prepare the RFP documents, it must disclose that relationship in the RFP.

The RFP illustrates the intent of the district to solicit proposals from qualified ESCOs and outlines the due date, evaluation criteria and instructions for how to respond. The RFP must be posted at least 30 days before the due date. A more detailed list of required items to include in the RFP and timing requirements are outlined in the legislation.

Utilizing an RFP is not a traditional bid process. By design, the RFP process typically does not yield an "apples to apples" comparison of the competing companies Instead, it allows the district to evaluate ESCOs based on creativity, approach, pricing methodology, references and experience.

Once the administration has decided on a company to select, they will ask the board to approve their recommendation to select that provider. In some instances, additional scope and pricing negotiations may need to be finalized before developing and signing a Guaranteed Energy Savings Contract.

Contracting and Subcontracting: Guaranteed Energy Savings Contracts Can Include a Bidding Process
In most cases, the ESCO acts as the primary manager of the entire process, from design to subcontracting through installation. Like the Design-Build concept, the ESCO usually has in-house design engineers and project managers to create increased design quality and constructability. This approach affords the district a single source of accountability for the entire project from start to finish.

While every ESCO may have differing in-house capabilities, it is responsible for building a team of subcontractors. This is how an ESCO might manage subcontractors using a "flat" organizational structure. This type of structure increases accountability for each subcontractor. Another significant benefit is the decrease in mark-ups which often saves the district large installation costs. Different ESCOs have different contracting styles and approaches, so districts are encouraged to review the ESCO's subcontractor selection and project management approach during the RFP stage.

Some districts choose to hire an Energy Services Company to work alongside their architect and other design professionals. That structure allows districts to have each specialized design professional (Architect, ESCO, CM for example) "at the table" during design, bidding and implementation. When addressing facility improvements using multiple design professionals, it is important to bring these teams together early to clearly identify roles and responsibilities early in the process.

Savings and Guarantees: The Savings are Real, Measured and Verified
Most Guaranteed Energy Savings Contracts require the ESCO to calculate the pre-construction and post-construction energy use and report those savings to the district or school board annually. To do this, the ESCO will first calculate a baseline energy use for the buildings. The ESCO will then calculate, using several methods, the energy reduction that will be achieved after the improvements are complete and will continue to monitor savings according to the performance agreement. Typically, the energy savings are measured and verified (M&V) based on methods within the U.S. Department of Energy (DOE) M&V Guidelines: Measurement and Verification for Performance-Based Contracts. Projects may also include operational savings. These savings occur when an improvement implemented under the contract reduces future repair or replacement labor and/or material monies that would have otherwise been expended if the improvement was not implemented. Some energy savings may be stipulated with the district, such as future energy rates, weather and building occupancy.

According to the Energy Analysis and Environmental Impacts Division of Berkeley Labs, only about 63 percent of K-12 districts continue the Measurement and Verification process throughout the project. Many districts utilize the M&V service for around three years until they feel comfortable that they are realizing the savings.

Funding: Districts do NOT Need to be Tied to a Long-Term Contract
The funding for Guaranteed Energy Savings Projects is often misunderstood. These projects are not "Free." And most Illinois K-12 districts do not pay their ESCOs with their future energy savings. Those are called "shared savings programs" and are not often utilized in Illinois K12 schools.

The vast majority of the Guaranteed Energy Savings Contracts for Illinois K12 School districts are funded similarly to how a district would fund any other construction project. The ESCO and the district negotiate a total turnkey price for a set scope of work, and the district pays the ESCO during the construction period based on an agreed-upon payment schedule. For example, districts can use existing capital or debt service options (such as a bond issuance) or some combination. According to Berkeley Labs, about 58 percent of K12 districts use 100 percent financing and 33 percent of districts use a combination of cash and financing to fund the improvements.

The district will also agree to a future annual cost for the ongoing measurement and verification (M&V) of the savings, which is typically less than .5 percent of the project cost annually and, as described earlier, can typically be canceled at any time.

In summary, the district purchases the project upfront and will then "justify" the repayment of its bonds or fund balances with the ongoing savings generated from the project.

Summary
Public school districts in Illinois have several choices for procuring construction projects. Article 19b of the school code governing Guaranteed Energy Savings Projects is one choice. This legislation can be considered when a district is looking to focus on the most critical building components like chillers, boilers, lighting, solar, building controls and other energy conservation measures. Any equipment that will significantly affect future operating budgets can be purchased through this procurement option. For many districts with large construction projects, ESCOs can be hired as part of the overall design team and work alongside the district's architects and construction managers. Hiring an ESCO and an architect does not have to be mutually exclusive.

Illinois legislation provides school districts flexibility when choosing an Energy Services Company through an RFP process. The chosen company will then develop, manage and install a full turnkey project. This streamlined design-build approach eliminates the finger-pointing of having multiple contracts with multiple providers. Additionally, combining these two trades under one roof increases the quality of design and installation. And the financial guarantees create even more accountability to ensure the project is installed and commissioned correctly from the start yielding quantifiable energy savings that are measured and verified for years to come.

The German philosopher Arthur Schopenhauer said, "All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident." The merits of Guaranteed Energy Saving projects as a procurement method for Illinois K12 public schools have arguably become accepted as self-evident with few exceptions.