Phoenix Convention Center • Phoenix, Arizona

ESPC Economics Unplugged:Impressive Realizations and Accurate Escalations

Track 5: Project Financing

Session 7: Economics of Financed Projects

Phil ColemanLawrence Berkeley Nat’l. Lab

August 12, 2015

Energy Exchange: Federal Sustainability for the Next Decade2

Savings Realization Rates – ESPC vs. Appropriated (Bid-to-Spec)

Energy Exchange: Federal Sustainability for the Next Decade3

Classic ESCO Sales Pitch

• ESPCs’ savings are guaranteed, so will:a) truly materializeb) persist through the term of the deal (~ 10-20 yrs.)

• Guarantees are legitimate because they’re backed up with M&V– Annual check-up– “IPMVP-compliant!”

Energy Exchange: Federal Sustainability for the Next Decade4

• ESCOs avoid risky measures (ECMs)– So savings inherently more likely to materialize and persist

• They rig their M&V plans so that they can’t fail– Heavy reliance on Option A M&V, least rigorous of the four

IPMVP alternatives– Vague measurement commitments: “trending,”

“monitoring,” etc.

• They conduct the M&V themselves

Classic Cynical Analysts’ Reactions

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• Who knows?– Virtually no studies relating ESCO-reported savings to 3rd-

party, objective findings– And none that compare realization rates of ESPCs vs.

conventionally funded projects

• Does it matter?– Yes: ESPC market was ~ $5 billion per year in 2011, probably

about 40% higher now• Federal gov’t. alone doing > $500M/yr.

– And rest of public sector (gov’ts., schools, universities, etc.) is leaning on ESPC more than ever

So Who’s Right???

Energy Exchange: Federal Sustainability for the Next Decade6

• EISA (2007) requires feds to perform M&V on all their projects– Results reported in FEMP’s Compliance Tracking System

(CTS) database• We looked at CTS-reported savings for both ESPC

and non-ESPC projects– ESPCs’ energy savings: 102% of estimated– Non-ESPCs’: 67% of estimated– Identical (35%) spread for water savings

• Presence of difference unsurprising; magnitude very surprising

What did we do, and find?

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• Sample size small for non-ESPCs– 30 projects, ~ 150,000 MMBtu of est. savings

• Mix of ECMs may vary between populations– Could ESCOs be hewing to safer ECMs?– We doubt it but couldn’t check for this

• M&V performers not consistent …– ESPCs: ESCOs– Non-ESPCs: fed. agency staff or O&M contractors

• … but M&V option distribution very similar– A-70%, B-20%, C-7%, D-3% for non-ESPCs

Caveats

Energy Exchange: Federal Sustainability for the Next Decade8

• Too many caveats to say with confidence that realization rates for ESPC > non-ESPC– Inconsistency of M&V performer is key problem

• But stark difference (35%) is very intriguing– Too big to ignore

• Someone needs to do controlled study– Preferably with objective 3rd-party M&V– And not paid for by anyone with stake in game

• And savings persistence should be inc’d. too– Persistence is another ESCO-touted benefit of ESPCs

Conclusion

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Utility Rate Escalations

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Escalations: small change = big impact

$1,000,000

$1,200,000

$1,400,000

$1,600,000

$1,800,000

$2,000,000

$2,200,000

$2,400,000

$2,600,000

$2,800,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

AN

NU

AL

S

AV

ING

S

YEAR

Annual Savings Given Varying Escalations --1st Year Savings = $1 Million

0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

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• Hypothetical project: 20 years, $1M/yr. savings– Total payments with 2.0% escalation: $24.8M– Total with 2.5% escalation: $26.2M (5.6% higher)– Year 15 payments alone are $100K higher with 2.5%– These are funds that can buy more capital!

• On 20-yr. project, 1% higher escalation increases payments by 11-12%; this permits a similar increase in investment

• Now, assume $10M investment w/ 6% interest rate– Project term with 1% escalation rate: 15 years– Project term with 4% escalation rate: 12 years

• Deal is paid off sooner b/c individual payments are greater; total interest cost is $750,000 less ($4.59M instead of $5.35M)!

Example significance, in numbers …

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• Shooting low may appear to makes sense b/c it prevents breaching one cardinal rule of ESPC:

– Savings must > payments*

• But it introduces other, less obvious risks– If term held constant, customer “under-invests” in EE capital (scope

is reduced) – and is exposed to higher future energy costs – By constraining what can be paid towards contract, customer

increases the ESPC’s interest costs• Lower escalation rates = longer contract term = more interest

• Why the asterisk? EPACT-’92 defined payments:– “Aggregate annual payments by an agency … may not exceed the amount

… the agency would have paid (as estimated through the procedures developed pursuant to this section) without an ESPC.”

Does “conservative” = low? NO!!!

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• Goal should be to balance risks of under- and over-predicting escalation rates– Being unduly careful with one concern (e.g., over-

payments on ESPC) will necessarily sacrifice others (future energy and interest costs for site)

• Assuming downsides to both are equal, goal should be to choose the most accurate rate– i.e., aim for the center

Alternative: “conservative” = accurate

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• DOE’s Energy Information Administration (EIA) makes government’s energy price forecasts

– Tool: National Energy Modeling System (NEMS)– Outputs published each year in Annual Energy Outlook

• NIST takes EIA’s information and packages it into tools for FEMP– Life-cycle cost tools (e.g., BLCC software and “annual

supplements” to Life-Cycle Costing Manual for FEMP) – EERC, a calculator that provides average escalations

given ESPC/UESC project term and area of country

Escalation Rates – Source

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• Easy: Use FEMP EERC tool*– Accept default value for inflation– Start date should be year of award (same as IGA, ideally)– Only caveat: If any energy prices are known for short-term

(e.g., due to fixed supply contract), start with those

• Benefits:– EERC reflects forecasts (for energy prices and inflation) of

government experts and is recommended by DOE• So outcomes are fully defensible – and not yours!

– Dispenses with negotiation over escalations

* download from FEMP ESPC site, “Resources” section

So what should ESPC customers do?

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• Reason 1: Safety factor – since 2000, EIA has fairly consistently shot low – 97% (88/91) of electricity and oil projections through 2012– 57% (54/91) of natural gas projections through 2012

• EIA benefited from the fracking revolution

• Reason 2: Even if you over-escalate, the “over-payment” to the ESCO will be dwarfed by your savings from cheaper-than-expected energy– Over-escalation is applied to savings only– But lower unit prices are applied to all of site usage

Still concerned about shooting high? Don’t be.

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• Escalation rates have a huge impact on ESPCs

• The notion that deliberately under-escalating them is a wise and “conservative” policy is wrong

• EERC is a great tool – figures are developed by experts so are eminently credible– Using it eliminates both site responsibility and

negotiations hassle from already involved ESPC development process

– And DOE policy recommends its use

Conclusion