PROCUREMENT GUIDE: 

SELECTING A CONTRACTOR/PROJECT DEVELOPER 

1. Overview 

CHP project development and 

implementation are similar to many central 

plant construction projects or 

comprehensive energy conservation 

measures. However, a critical distinguishing 

characteristic of CHP system procurement 

is the multi-disciplinary nature of the project: 

CHP project development requires the 

services of mechanical, electrical, and 

structural engineers and contractors; 

equipment suppliers; a project manager; 

environmental consultants; and financiers. 

The acquisition of these services may be 

through a traditional design-bid-build 

approach, which can require the host site or 

owner to provide a high level of oversight 

and project management. An alternate 

approach is to contract with a turnkey CHP 

project developer, who will offer a single 

point of contact for the end-user and provide 

all of the above through in-house capability 

or through subcontracting. 

The selection of a contractor or project 

developer is a critical decision. The 

facility owner often relies on the 

contractor or developer to manage the 

process of transforming a feasible 

concept into a functioning project. Some 

owners have the expertise, resources, 

and desire to lead the development effort 

on their own, but even in this case, 

choosing the right contractor can greatly 

improve the likelihood of project success. 

This section provides guidance to owners 

who are attempting to determine (1) the 

role that they might take in the 

development process and (2) the right 

contractor or project developer to get the 

project successfully developed, financed, 

and built. A number of CHP Partners 

provide both the experience and 

resources required for successful project 

development and management. To 

review a list of CHP Partners, visit 

www.epa.gov/chp/chp_partners.htm. 

From the owner's perspective, there are 

three general ways to structure the 

development of a CHP project:1

 

1. Develop the project internally

This is the traditional design-bid-build 

approach to project development. The 

facility owner or host site hires a 

consultant, plans and manages the 

design-construction effort, and 

maintains ownership control of the 

project. This approach maximizes 

economic returns to the owner, but also 

places most of the project risks on the 

owner (e.g., construction, equipment 

performance, financial performance) 

and requires a high level of oversight 

 

1

 This section does not refer to build-own-operate 

(BOO) projects in which a third party builds, owns and 

operates the CHP plant and sells heat and power to 

the user at established rates. The contractor selection 

process in the BOO case would be very different than 

the selection for an engineering and/or construction 

contractor as described in this section. While the 

selection criteria for BOO partners would include 

many of the experience and capability qualities 

outlined in this section, they would also include critical 

financial terms such as delivered cost of power 

($/kWh) and/or thermal energy ($/MMBtu). The BOO 

option is more fully explained in the “Financing” 

section of the CHP Project Development Process. 

CHP Procurement Guide 1 
and project management from the 

owner. 

 

2. Purchase a “turnkey” project

The facility owner selects a qualified 

project development company to design, 

develop, and build the project on a 

“turnkey” basis, turning over ownership 

and operation of the facility to the owner 

after commissioning. This option shifts 

some risk to the developer, at a price, 

sometimes reducing the economic 

return to the facility owner or limiting the 

types of technologies or equipment 

considered. 

3. Team with a partner

The facility owner teams with an 

equipment vendor, engineering/ 

procurement/construction (EPC) firm, or 

investor to develop the project and to 

share the risks and financial returns 

under various partnership approaches. 

With these structures in mind, a facility 

owner can determine his or her desired role 

in the project development process by 

considering two key questions: 

 Should the owner self-develop, procure 

through a turnkey project, or 

 Find a developer or partner, and 

determine what kind of company best 

complements the owner and the 

project? 

The facility owner can answer the first 

question through an examination of his or 

her own expertise, objectives, and 

resources. The second question is more 

complicated because it entails an 

assessment of the owner's specific needs 

and a search for the right developer or 

partner to complement those needs. 

2. The Development Decision 

Before deciding whether to develop the 

project internally, the facility owner must 

understand the role of the project developer, 

which is outlined in the box on page 3. Next, 

an assessment of the owner's objectives, 

expertise, and resources determines 

whether or not the owner should undertake 

project development independently or find a 

turnkey developer or partner. 

A facility owner with the following attributes 

is a good candidate for developing a project 

independently: 

 Willingness and ability to accept project 

risks (e.g., construction, equipment, 

permitting, financial performance). 

 

 Technical expertise with energy 

equipment and energy projects. 

 Funds and personnel available to 

commit to the construction process. 

3. Selecting Contractors and 

Consultants 

Once the decision to develop a project 

internally is made, the facility owner should 

review the capabilities of individual 

contracting firms that meet the owner's 

general needs. When selecting a contractor, 

there are several qualities and capabilities 

that owner should look for, including: 

 Previous CHP project experience. 

 A successful project track record. 

 In-house resources (e.g., engineering, 

finance, operation), including experience 

with environmental permitting and siting 

issues. 

CHP Procurement Guide 2 
Information about individual firm 

qualifications can be gained from reports, 

brochures, and project descriptions, as well 

as from discussions with references, other 

owners, and engineers. Potential warning 

signs include lawsuits, disputes with 

owners, lack of operating projects, and 

CHP Procurement Guide 3 
failed projects. Published information can be 

obtained by researching trade literature, 

through legal information services, and 

through computer research services. 

4. Selecting a Turnkey Developer 

Selecting a turnkey developer to manage 

the development process is a way for the 

owner to shed development responsibility 

and risks, and get the project built at a 

guaranteed cost. In addition, the developer 

typically provides strong development skills 

and experience. Other reasons for selecting 

a turnkey developer include: 

 

The Role of the Project Developer 

 Carry out project scoping—Includes early-stage tasks such as selecting the location for 

equipment, determining structural and equipment needs, and estimating costs and 

potential energy savings. 

 Conduct feasibility analysis—Includes detailed technical and economic calculations to 

determine the technical feasibility of the project and estimate project revenues and 

expenses. 

 Select CHP configuration—Based on the results of the feasibility analysis, select primary 

equipment and configuration, and contact vendors to assess price, performance, 

schedules, and guarantees. 

 Create a financial pro forma—Model the cash flows of the project to estimate financial 

performance. 

 Obtain environmental and site permits—Acquire all required environmental permits, 

interconnection, and site permits/licenses. 

 Secure financing—Secure financing for the project. 

 Contract with engineering, construction, and equipment supply firms—Select firms, 

negotiate terms and conditions, and execute contracts. 

 Provide overall project management—Provide overall project management services 

through design, engineering, construction, and commissioning of the project. 

 The developer's skills and experience 

may be invaluable in bringing a 

successful project online and keeping it 

operational. 

 Many developers have access to 

financing. 

In return for accepting project risks, most 

turnkey projects cost more than self-built 

systems. The turnkey option is a good 

approach if the owner does not want the risk 

and responsibility of construction. In a 

turnkey approach, the developer assumes 

development responsibility and construction 

risk, builds the facility, and then receives 

payment when the facility is complete and 

CHP Procurement Guide 4 
performing up to specifications. The turnkey 

approach enables each entity to contribute 

what it does best: the developer accepts 

development, construction, and 

performance risk; and the owner accepts 

financial performance risk. 

5. Selecting Other Types of Project 

Partners 

There are a variety of project development 

approaches that can lie between (or extend 

past) developing the project independently 

or opting for a complete turnkey project. 

And there are a number of potential project 

partners to choose from, so the facility 

owner should look for a partner that 

provides the best match for the specific 

CHP project and the owner's in-house 

capabilities. Three general types of project 

development partners, listed in order of 

decreasing scope of services, are: 

 Pure developer

A firm primarily in the business of 

developing, owning, and/or operating 

energy projects. Some developers focus 

on onsite power projects, while others 

may be involved in a broad project 

portfolio of technologies and fuel types. 

Pure developers usually will own the 

completed CHP facility, but sometimes a 

developer will build a turnkey facility. 

 Equipment vendor

A firm primarily in the business of selling 

power or energy equipment, although it 

will participate in project development 

and/or ownership in specific situations 

where its equipment is being used. The 

primary objective of this type of 

developer is to help facilitate purchases 

of its equipment and services. 

 EPC firm

A firm primarily engaged in providing 

engineering, procurement, and 

construction services. Many EPC firms 

have project development groups that 

develop energy projects and/or take an 

ownership position. 

Ideally, a developer or partner can be 

identified that fills specific project needs 

such as the ability to finance the project or 

supply equipment. Issuing a request for 

proposals (RFP) is often a good way to 

attract and evaluate partners. A partner 

reduces risks to the facility owner by 

bearing or sharing the responsibilities of 

project development, although the amount 

of risk reduction provided depends on the 

type of partner chosen. For example, a 

"pure developer" partner will usually take 

the risk/responsibility of construction, 

equipment performance, environmental 

permitting, site permitting, and financing, 

whereas an equipment vendor partner may 

only bear the risks of equipment 

performance.

6. Preparing a Request for Proposals 

A facility owner will most likely find it 

beneficial to issue an RFP for a developer 

or partner because if the RFP is prepared 

correctly, respondents will generally offer 

creative, informative, and useful responses. 

The RFP process is a good way to screen 

proposals and focus on the best one(s) for 

further discussions and negotiation. 

An owner who plans on issuing an RFP 

should carefully examine the needs at the 

facility and ask respondents to propose 

ways to meet those needs or solve 

problems. For example, if ability to secure 

financing or environmental permits is 

important, that should also be stated in the 

RFP. In this way, respondents will be 

encouraged to offer innovative proposals 

that meet the project's specific needs. In 

general, RFP respondents should be asked 

to provide the following information: 

CHP Procurement Guide 5 
 Description of the energy project and 

available options. 

 Scope of services being offered (e.g., 

developer, owner, operator). 

 Project development history and 

performance. 

 Turnkey facility bid (if appropriate). 

 Technology description and 

performance data. 

 Environmental permitting, 

interconnection, and site permitting plan. 

 Financing plan. 

 Schedule. 

 Operation and maintenance plan. 

The RFP should state that the owner 

reserves the right to select none, one, or 

several respondents for further negotiation, 

depending on the proposal's 

responsiveness to the owner's criteria. 

RFPs can be issued for various portions of 

the project development process, including: 

 Investment grade feasibility analysis 

 Equipment 

 Construction 

 Engineering (100% design) 

 Permitting 

 Maintenance 

7. Preparing a Contract 

Once the contractor, developer, or partner 

has been selected, the terms of the project 

structure will be formalized in a contract. 

The contract should accomplish several 

objectives, including allocating risk among 

project participants. Some of the key 

elements of a contract include project 

schedule and milestones, performance 

penalties and bonuses, and potential 

remedies and/or arbitration procedures (see 

the box on page 6). Each contract will be 

different depending on the specific nature of 

the project and the objectives and 

limitations of the participants. Because of 

this complexity, it is often useful for the 

facility owner to consult in-house counsel or 

hire a qualified attorney to serve as a guide 

through the contracting process. 

CHP Procurement Guide 6 
Elements of an Effective Project Development Contract 

 Commercial operation date—Date on which the facility will achieve commercial 

operation. 

 Milestones—Engineering completion, construction commencement, genset delivery, 

start-up. 

 Cost, rates, and fees—Structures include fixed EPC or turnkey price, hourly labor 

rates, cost caps, fee amount or percentage. 

 Performance guarantees—Specified output (kW, MMBtu/hr), heat rate, availability, 

power quality. 

 Warranties—Output, performance degradation, heat rate, outage rates, component 

replacement costs. 

 Acceptance criteria—Testing methods and conditions, calculation formulae. 

 Bonus amounts and conditions—Bonus for early completion, exceeding 

specifications. 

 Penalties and conditions—Damages for late completion, failure to meet 

specifications. 

 Integration/impact of construction on facility operations—Schedules for power 

outages, limits to access, etc. 

CHP Procurement Guide 7 
PROCUREMENT GUIDE: 

CHP FINANCING 

1. Overview 

The decision of whether and how to finance 

a CHP system is a critical step in the 

development of a CHP project. CHP 

systems require an initial investment to 

cover the cost of equipment, installation, 

and regulatory/permitting costs; these costs 

are then typically recovered through lower 

energy costs over the life of the equipment. 

A company might decide to invest in a CHP 

project if the value of the future stream of 

cost savings is greater than the up-front 

investment in equipment. The structure of 

financing can impact project costs, control, 

and flexibility, and affect the company’s 

long-term economic health and ability to 

generate cash. Creative techniques can 

help spread risk among different 

participants and help overcome any capital 

constraints a prospective host may have. 

Financial investors have a primary motive 

that is based on a return on their 

investment/capital. There are a variety of 

capital providers in the market, and different 

investors have different objectives and 

appetites for risk. The terms under which 

capital is provided vary from source to 

source, and will depend on such factors as 

the lender’s appetite for risk, the project’s 

expected return, and the time horizon for 

repayment. 

This section discusses various financing 

methods for CHP, and identifies some 

advantages and disadvantages of each. 

The primary financing options available to 

CHP projects include: 

 Company earnings or internal cash flow 

 Debt financing 

 Equity financing 

 Lease financing 

 Bonds (for public entities) 

 Project or third-party financing 

 BOO options including energy savings 

performance contracting 

CHP projects have been financed using all 

of these approaches. 

2. Financing: What Lenders and 

Investors Look For 

Most lenders and investors decide whether 

or not to lend or invest in a CHP project 

based upon its expected financial 

performance and risks. Financial 

performance is usually evaluated using a 

projection of project cash flows over time. 

Known as a pro forma, this cash flow 

analysis estimates project revenues and 

cost over the life of the project including 

escalations in project expenses, energy 

prices, financing costs, and tax 

considerations (e.g., depreciation, income 

taxes). Thus, preparing an investment grade 

pro forma is an important step in ensuring 

the financial feasibility of a CHP project. 

A lender or investor usually evaluates the 

financial strength of a potential project using 

the two following measures: 

CHP Procurement Guide 8 
 Debt coverage ratio

The main measure of a project’s 

financial strength is the host’s/owner’s 

ability to adequately meet debt 

payments. Debt coverage is the ratio of 

operating income to debt service 

requirements, usually calculated on an 

annual basis. 

 Owner's rate of return (ROR) on 

equity

Required RORs for internal funds 

typically range from 12 to 20 percent for 

most types of CHP projects. Outside 

equity investors will typically expect a 

ROR of 15 to 25 percent or more, 

depending on the project risk profile. 

These RORs reflect early-stage 

investment situations; investments 

made later in the development or 

operational phases of a project typically 

receive lower returns because the risks 

have been substantially reduced. 

The economic viability of a particular CHP 

project is also determined by the quality of 

CHP Project Risks and Mitigation Measures 

 Construction—Execute fixed-price contracts, include penalties for missing 

equipment delivery and construction schedules, establish project acceptance 

standards and warranties. 

 Equipment performance—Select proven, compatible technologies; get performance 

guarantees/warranties from vendor; include equipment vendor as project partner; 

ensure trained and qualified operators; secure full-service O&M contracts. 

 Environmental permitting—Initiate permit process (air, water) prior to financing. 

 Site permitting—Obtain zoning approvals prior to financing. 

 Utility agreements—Confirm interconnection requirements, schedule, and fees; 

have signed contract with utility. 

 Financial performance—Create detailed financial pro forma, calculate cash flows, 

debt coverage, maintain working capital/reserve accounts, budget for major 

equipment overhauls, secure long-term fuel contracts when possible. 

CHP Procurement Guide 9 
supporting project contracts and permits, 

and by risk allocation among project 

participants. The uncertainties about 

whether a project will perform as expected 

or whether assumptions will match reality 

are viewed as risks. To the extent possible, 

the project’s costs, revenues, and risk 

allocation are negotiated through contracts 

with equipment suppliers, fuel suppliers, 

engineering/construction firms, and 

operating firms. The box below summarizes 

the principal project risk categories (viewed 

from the beginning of the development 

process) and presents possible risk 

mitigation strategies, the most important of 

which are usually obtaining contract(s), 

securing project revenues if applicable, and 

applying for environmental and site 

permitting early. Potential lenders and 

investors will look to see how the owner or 

project developer has addressed each risk 

through contracts, permitting actions, 

project structure, or financial strategies. 

3. Project Financing Options 

3.1 Company Earnings or Internal Cash 

Flow 

A potential CHP project owner may choose 

to finance the required capital investment 

out of cash flow generated from ongoing 

company activities. The potential return on 

investment can make this option 

economically attractive. In addition, loan 

transaction costs can be avoided with selffinanced projects. Typically, however, there 

are many demands on internal resources, 

and the CHP project may be competing with 

other investment options for internal funds 

including options tied more directly to 

business expansion or productivity 

improvements. 

3.2 Debt Financing 

Commercial banks and other lenders can 

provide loans to support CHP projects. Most 

lenders look at the credit history and 

financial assets of the owner or developer, 

rather than the cash flow of a project. If the 

facility has good credit, adequate assets, 

and the ability to repay borrowed money, 

lenders will generally provide debt financing 

for up to 80 percent or more of a system’s 

installed cost. Typically, the loan is paid 

back by fixed payments (principal plus 

interest) every month over the period of the 

loan, regardless of the actual project 

performance. 

Debt financing usually provides the option of 

either a fixed-rate loan or a floating-rate 

loan. Floating-rate loans are usually tied to 

an accepted interest rate index like U.S. 

treasury bills. 

For small businesses, the Small Business 

Administration (SBA) can guarantee bank 

loans up to $750,000 for energy efficiency 

projects. The SBA guarantee could improve 

a borrower’s ability to secure a loan. 

Another potential source of loans is vendor 

financing, in which the vendor of the CHP 

system or a major component provides 

financing for the capital investment. 

Vendors can provide financing at attractive 

costs to stimulate markets, which is 

common for energy technologies. Vendor 

financing is generally suitable for small 

projects (below $1,000,000); however, 

some large vendors do provide financing for 

larger projects. 

Host or facility owners should ask potential 

developers and equipment suppliers if debt 

financing is a service they can provide. The 

ability to provide financing may be a key 

consideration when selecting a developer, 

equipment vendors, and/or other partners. 

3.3 Equity Financing 

Private equity financing has been a widely 

used method for financing certain types of 

CHP projects. In order to use private equity 

CHP Procurement Guide 10 
financing, an investor must be located who 

is willing to take an ownership position, 

often temporarily, in the CHP project. In 

return for a significant share of project 

ownership, the investor is willing to fund part 

or all of the project costs using its own 

equity or privately placed equity or debt. 

Some CHP developers are potential equity 

investor/partners, as are some equipment 

vendors and fuel suppliers. Investment 

banks are also potential investors. The 

primary advantage of this method is its 

applicability to most projects. The primary 

disadvantage is its higher cost; the returns 

to the host/owner are reduced to cover the 

off-loading of risk to the investor. 

Equity investors typically provide equity or 

subordinated debt for projects. Equity is 

invested capital that creates ownership in 

the project, like a down-payment in a home 

mortgage. Equity is more expensive than 

debt, because the equity investor accepts 

more risk than the debt lender. (Debt 

lenders usually require that they be paid 

before project earnings get distributed to 

equity investors.) Thus the cost of financing 

with equity is usually significantly higher 

than financing with debt. Subordinated debt 

gets repaid after any senior debt lenders are 

paid and before equity investors are paid. 

Subordinated debt is sometimes viewed as 

an equity-equivalent by senior lenders, 

especially if provided by a credit-worthy 

equipment vendor or industrial company 

partner. 

The equity investor will conduct a thorough 

due diligence analysis to assess the likely 

ROR associated with the project. This 

analysis is similar in scope to a bank’s 

analyses, but is often accomplished in much 

less time because equity investors are more 

entrepreneurial than institutional lenders. 

The equity investor’s due diligence analysis 

will typically include a review of contracts, 

project participants, equity commitments, 

permitting status, technology, and market 

factors. 

The key requirement for most pure equity 

investors is sufficient ROR on their 

investment. The due diligence analysis, 

combined with the cost and operating data 

for the project, will enable the investor to 

calculate the project’s financial performance 

(e.g., cash flows, ROR) and determine its 

investment offer based on anticipated 

returns. An equity investor may be willing to 

finance up to 100% of the project’s installed 

cost, often with the expectation that 

additional equity or debt investors will be 

located later. 

Some types of partners that might provide 

equity or subordinated debt may have 

unique requirements. Potential partners 

such as equipment vendors and fuel 

suppliers generally expect to realize some 

benefit other than just cash flow. The 

desired benefits may include equipment 

sales, service contracts, or tax benefits. For 

example, an engine vendor may provide 

equity or subordinated debt up to the value 

of the engine equipment, with the 

expectation of selling out its interest after 

the project is built. The requirements 

imposed by each of these potential 

investors are sure to include not only an 

analysis of the technical and financial 

viability, but also a consideration of the 

unique objectives of each investor. 

To fully explore the possibilities for private 

equity or subordinated debt financing, host 

or facility owners should ask potential 

developers if this is a service they can 

provide. The second most common source 

of private equity financing is an investment 

bank that specializes in the private 

placement of equity and/or debt. 

Additionally, the equipment vendors that are 

involved in the project may also be willing to 

provide financing for the project, at least 

through the construction phase. The ability 

CHP Procurement Guide 11 
to provide financing can be an important 

consideration when selecting a developer, 

equipment vendors, and/or other partners. 

3.4 Lease Financing 

Leasing can be an attractive financing 

option for smaller CHP projects. The 

operating savings resulting from the 

installation of CHP—the bottom-line impacts 

on facility energy costs—are used to offset 

the monthly lease payments, creating a 

positive cash flow for the company. Lease 

financing encompasses several strategies in 

which a facility owner can lease all or part of 

a project’s assets from the asset owner(s). 

Typically, lease arrangements provide the 

advantage of transferring tax benefits such 

as accelerated depreciation or energy tax 

credits to an entity that can best use them. 

Lease arrangements commonly provide the 

lessee with the option, at pre-determined 

intervals, to purchase the assets or extend 

the lease. Several large equipment vendors 

have subsidiaries that lease equipment, as 

do some financing companies. 

Leasing energy equipment has become the 

fastest-growing equipment activity within the 

leasing industry. The lease payments may 

be bundled to include maintenance 

services, property taxes, and insurance. 

There are several variations on the lease 

concept, including operating, capital, and 

leveraged leases. 

An operating lease appears as an 

operating expense in the financial 

statement. Operating leases are often 

referred to as "off-balance-sheet" financing 

and usually treated as operating expenses. 

To qualify as an operating lease, the 

agreement must NOT: 

 Transfer ownership of the equipment at 

the end of the lease term. 

 Contain a bargain purchase option. 

 Have a term that exceeds 75 percent of 

the useful economic life of the 

equipment. 

 Have a present value at the beginning of 

the lease term of the minimum lease 

payments greater than 90 percent of the 

fair value at the inception of the lease, 

using the incremental borrowing rate of 

the lessee as the discount rate. 

Capital lease obligations are reflected on 

the balance sheet and may be subject to 

lender or internal capital budget constraints. 

The general characteristics of a capital 

lease are: 

 It appears on the balance sheet as debt 

for purchase. 

 It requires transfer of ownership at the 

end of the lease. 

 It specifies the terms of future exchange 

of ownership. 

 The lease term is at least 75 percent of 

the equipment life. 

 The net present value of lease 

payments is about 90 percent of the 

equipment value. 

In a leveraged lease, the lessor provides a 

minimum amount of its own equity, borrows 

the rest of the project capital from a third 

party, and is entitled to the tax benefits of 

asset depreciation. 

 

3.5 Project or Third-Party Financing 

Project or third-party financing is an 

approach to obtaining commercial debt 

financing for the construction of a project in 

which the lenders look at the creditworthiness of the project to ensure debt 

CHP Procurement Guide 12 
 

repayment rather then at the assets of the 

developer/sponsor. Third-party financing 

can involve the creation of a “legally 

independent project company financed with 

non-recourse debt and equity for the 

purpose of financing a single purpose 

industrial asset.”2

 This entails establishing a 

company (e.g., a limited liability corporation) 

solely in order to accomplish a specific task, 

in this case to build and operate a DG/CHP 

facility. Lenders look primarily to the cash 

flows the asset will generate for assurances 

of re-payment. Moreover, they are explicitly 

excluded from recourse to the owners’ 

underlying balance sheets. 

In deciding whether or not to loan money, 

lenders examine the expected financial 

performance of a project and other 

underlying factors of project success. These 

factors include contracts, project 

participants, equity stake, permits, and 

technology. A good project should have 

most, if not all, of the following completed or 

in process: 

 Signed interconnection agreement with 

local electric utility company 

 Fixed-price agreement for construction 

 Equity commitment 

 Environmental permits 

 Any local permits/approval 

Lenders generally expect the owners to put 

up some level of equity commitment using 

their own money and agree to a fixed-term 

(8- to 15-year) repayment schedule. An 

equity commitment demonstrates the 

owner’s financial stake in success, as well 

as implying that the owner will provide 

additional funding if problems arise. The 

 2

 Esty, Benjamin. Modern Project Finance: A Case 

Book. 2004. 

expected debt-equity ratio is usually a 

function of project risk. 

Lenders may also place additional 

requirements on the project owners. 

Requirements may include maintaining a 

certain minimum debt coverage ratio and 

making regular contributions to an 

equipment maintenance account, which will 

be used to fund major equipment overhauls 

when necessary. 

The transaction costs for arranging project 

financing can be relatively high, driven by 

the lender’s need to do extensive due 

diligence; the transaction costs for a 10 MW 

project may be the same as for a 100 MW 

project. For this reason, most of the large 

commercial banks and investment houses 

have minimum project capital requirements 

on the order of $10 to $20 million. 

Developers of smaller CHP projects may 

need to contact the project finance groups 

at smaller investment capital companies 

and banks, or at one of several energy 

investment funds that commonly finance 

smaller projects. Depending on the project 

economics, some of the investment capital 

companies and energy funds may consider 

becoming an equity partner in the project in 

addition to providing debt financing. 

3.6 Build-Own-Operate Options 

A final third-party financing form is the BOO 

option, in which the CHP facility is built, 

owned, and operated by an entity other than 

the host and the host purchases heat and 

power at established or indexed rates from 

the third party.3

 There are also build-owntransfer projects, which are similar to BOO 

projects except that the facility involved is 

transferred to the host after a predetermined 

timeframe. Such projects may be 

implemented by an energy services 

company (ESCO) or sometimes by 

3

 This approach is often called “chauffage.” 

CHP Procurement Guide 13 
equipment suppliers and project developers 

acting as ESCOs. 

In a BOO project, the ESCO finances the 

entire project, owns the system, and incurs 

all costs associated with its design, 

installation, and maintenance. The ESCO 

sells heat and power to the host at a 

specified rate that offers some savings over 

current energy expenditures, or can enter 

into an energy savings performance 

contract (ESPC) with the host. In an ESPC, 

the ESCO and the host agree to share the 

cost savings generated by the project; in 

return, the ESCO guarantees the 

performance of the CHP system. An ESPC 

mitigates the risks associated with new 

technologies for facility owners, and allows 

operation and maintenance of the new 

system by ESCO specialists. 

ESPCs are frequently used for public-sector 

projects. There are no upfront costs other 

than technical and contracting support. 

Traditional ESPCs have three components: 

• A project development agreement 

• An energy services agreement 

• A financing agreement 

As such, an ESPC is not a financing 

agreement by itself, but it may contain the 

financing component. Most lending 

institutions prefer to see the financing 

section as a stand-alone agreement that 

can be sold into the secondary market. This 

helps create demand for this financial 

instrument, usually resulting in better 

pricing. 

The host must usually commit to take a 

specified quantity of energy or to pay a 

minimum service charge. This “take or pay” 

structure is necessary to secure the ESPC. 

The project host gives up some of the 

project’s economic benefits with a BOO or 

ESPC in exchange for the ESCO becoming 

responsible for raising funds, project 

implementation, system operation, system 

ownership or a combination of these 

activities. Some of the disadvantages of this 

approach to financing include accounting 

and liability complexities, as well as the 

possible loss of tax benefits by the facility 

owner. 

3.7 Financing Options for Public Entities 

Public sector facilities have additional 

financing options to consider. 

Bonds. A government entity (e.g., 

municipality, public utility district, county 

government) can issue either tax-exempt 

governmental bonds or private activity 

bonds, which can be either taxable or taxexempt, to raise money for CHP projects. 

Bonds can either be secured by general 

government revenues (revenue bonds), or 

by specific revenues from a project (project 

bonds). The terms for bond financing 

usually do not exceed the useful life of the 

facility, but terms extending up to 30 years 

are not uncommon. 

The primary benefit of governmental bonds 

is that the resulting debt has an interest rate 

that is usually lower (1 to 2 percent) than 

commercial debt. However, in addition to 

initial qualification requirements, many bond 

issuers find that strict debt coverage and 

cash reserve requirements may be imposed 

on an energy project to ensure the financial 

stability of the issuer is preserved. These 

requirements may even be more rigorous 

than those imposed by commercial banks 

under a project finance approach. 

To qualify for a tax-exempt governmental 

bond issue, a project must meet at least two 

criteria: 

CHP Procurement Guide 14 
 Private business use test

No more than 10 percent of the bond 

proceeds are to be used in the business 

of an entity other than a state or local 

government 

 Private security of payment test

No more than 10 percent of the payment 

of principal or interest on the bonds can 

be directly or indirectly secured by 

property used for private business use. 

Federal government facilities. The 

Federal Energy Management Program 

(FEMP) of the Department of Energy has 

signed indefinite quantity contracts with 

ESCOs on a regional basis for streamlining 

energy efficiency improvements, including 

CHP, at federal facilities. The Energy Policy 

Act of 2005, Section 105, extended the 

authority for all federal agencies to use 

ESPCs until September 30, 2016. Realizing 

that awarding a stand-alone ESPC can be 

very complex and time-consuming, FEMP 

created streamlined Super ESPCs. These 

"umbrella" contracts allow agencies to 

undertake multiple energy projects under 

the same contract. An agency that uses a 

Super ESPC can bypass cumbersome 

procurement procedures and partner 

directly with a pre-qualified ESCO to 

develop an energy project. With Super 

ESPCs, FEMP has already completed the 

Federal Acquisition Regulations (FAR) 

procurement process, in compliance with all 

necessary requirements, and awarded 

contracts to selected ESCOs. Federal 

facilities can place and implement a Super 

ESPC in much less time than it takes to 

develop a stand-alone ESPC. As a result, 

Super ESPCs are being used more 

frequently by federal agencies, and they 

appear to have largely supplanted standalone ESPCs. 

Another way for federal agencies to 

implement efficiency and CHP projects is 

through partnerships with their franchised or 

serving utilities. Federal agencies can enter 

into sole-source utility energy service 

contracts (UESCs) to implement energy 

improvements at their facilities. With a 

UESC, the utility typically arranges financing 

to cover the capital costs of the project. 

Then the utility is repaid over the contract 

term from the cost savings generated by the 

energy efficiency measures. With this 

arrangement, agencies can implement 

energy improvements with no initial capital 

investment. The Energy Policy Act of 1992 

authorizes and encourages federal 

agencies to participate in utility energy 

efficiency programs offered by electric and 

gas utilities and by other program 

administrators (e.g., state agencies). These 

programs range from equipment rebates 

(i.e., utility incentives) to delivery of a 

complete turnkey project. Federal legislation 

and numerous legal opinions demonstrate 

that agencies have full authority to enter into 

utility energy service contracts as well as 

take advantage of utility incentive programs. 

CHP Procurement Guide 15 
3.8 Capital Cost Effects of Financing 

Alternatives 

Each financing method produces a different 

weighted cost of capital, which affects the 

amount of resources required to cover CHP 

system installation costs. Generally 

speaking, the financing methods are ranked 

from lowest cost to highest cost as follows: 

 Internal cash flow financing 

 Governmental bond financing 

 Commercial debt financing 

 Project financing 

 Private equity financing 

Governmental bond financing achieves its 

advantage through access to low-interest 

debt. Project finance generally produces a 

higher financing price because funds are 

required to pay interest charges as well as 

ROR on equity. Private equity can be the 

most expensive option because it usually 

demands a higher return on equity than 

project finance, and equity often makes up a 

larger share of the capital requirement. 

BOO and ESPC options remove capital 

financing from the users’ responsibilities. 

CHP Procurement Guide 16 
PROCUREMENT GUIDE: 

CHP SITING AND PERMITTING REQUIREMENTS 

1. Overview 

Obtaining the required utility 

interconnection, environmental compliance, 

and construction permits is an essential 

step in the CHP project development 

process. Permit conditions often affect 

project design, and neither construction nor 

operation may begin until all permits are in 

process or in place. The process of 

permitting a CHP system will typically take 

from 3 to 12 months to complete, depending 

on the location, technology, and site 

characteristics. 

One critical set of requirements are the 

approvals necessary for connection with the 

servicing utilities, both natural gas and 

electric. There are also a number of preconstruction, construction, and operating 

approvals that must be obtained from a 

variety of local government jurisdictions for 

any CHP project. The more involved 

government approval procedures are those 

required by the local planning and building 

departments, fire department, and air quality 

district. Local agencies must ensure that a 

CHP project complies with: 

 Local ordinances (e.g., noise, set-backs, 

general planning and zoning, land use, 

and aesthetics). 

 Standards and codes (e.g., fire safety, 

piping, electrical, and structural). 

 Air emissions requirements (e.g., NOx, 

CO, and particulate standards). 

Approvals may be in the form of a permit or 

license issued after an agency has verified 

conformance with requirements, or may be 

in the form of a program (e.g., landscaping, 

noise monitoring) that must be developed to 

ensure that the environmental impacts are 

mitigated. 

The number of permits and approvals will 

vary depending on project characteristics 

such as the size and complexity of a project, 

the geographic location, the extent of other 

infrastructure modifications (e.g., gas 

pipeline, distribution), and the potential 

environmental impacts of construction and 

operations. Key government agencies and 

other entities involved would be the city or 

county planning agency, the fire marshal at 

the respective fire department/authority, the 

city or county building department, the 

environmental health department, the air 

district, and the local distribution utility. 

2. Required Approvals 

CHP installations typically require the 

following types of permits or approvals: 

 Local utility company approvals 

— Electric utility interconnection study 

and approval 

— Natural gas connection/supply 

 Local jurisdiction pre-construction and 

construction approvals 

— Planning department land use and 

environmental assessment/review 

CHP Permitting Guide 17 
— Building department review and 

approval of project design and 

engineering (based on construction 

drawings) 

— Air quality agency approval for 

construction 

 Local jurisdiction post-construction and 

operating approvals 

— Planning department and building 

department confirmation and inspection 

of installed CHP source 

— Air quality agency confirmation that 

CHP emissions meet emissions 

requirements 

In general, facilities that need a construction 

permit also require an operating permit. 

3. Overall Permitting Process

A typical basic pre-construction/ 

construction-phase permitting process for a 

CHP project within any given entity (utility 

company or government agency) involves 

three major steps: 

1. The owner or developer completes and 

submits application forms, accompanied 

by fee payment(s), to the relevant entity. 

2. The entity reviews the application for 

completeness. In this step, the entity 

and the developer may complete a 

number of rounds of information 

exchange before the application is 

considered complete and accurate. 

3. The entity completes its review and 

issues the relevant approval/permit. 

The approval process may also feature one 

or more meetings between agency or utility 

staff and the project developer or 

development team. More importantly, in 

some states and government agencies, 

public comment periods are added to Step 2 

to allow interested parties to review and 

comment on the completed application. The 

comment periods are usually a minimum of 

30 days in length. The agency then 

addresses the comments received, usually 

explaining why they did or did not 

incorporate or act on specific suggestions. 

Public review processes can add months to 

the approval process. 

The post-construction/operating phase adds 

a fourth step for many state and local 

government approvals and for utility 

interconnection approval: 

4. The agency/organization confirms that 

the installation does not deviate from the 

approved application and/or that it 

conforms to the applicable 

requirements, and issues the related 

approval or permit. This step often 

involves a site inspection by an agency 

official. If the agency determines that the 

project falls short of compliance, the 

developer takes the steps necessary to 

bring it into compliance. As in Step 2 

above, this may be an iterative process, 

with a number of rounds of developer 

corrections and agency re-inspections. 

The success of the permitting process relies 

upon a coordinated effort between the 

developer of the project and the various 

entities that must review project plans and 

analyze their impacts. Project developers 

might have to deal with separate 

government agencies with overlapping 

jurisdictions, underscoring the importance of 

coordinating efforts to minimize difficulties 

and delays. There are a number of steps 

that the developer can take to facilitate the 

permitting process: 

 Hold preliminary meetings with key 

regulatory agencies. Meet with 

regulators to identify permits that may 

CHP Permitting Guide 18 
 

be required and any other issues that 

need to be addressed. These meetings 

also give the developer the opportunity 

to educate regulators about the project, 

since CHP technologies might be 

unfamiliar to regulators. 

 Develop permitting and design plans 

early. Determine the requirements and 

assess agency concerns early on, so 

permit applications can be designed to 

address those concerns and delays will 

be minimized. 

 Submit timely permit applications to 

regulators. Submit complete 

applications as early as possible to 

minimize delays. 

 Negotiate design changes with 

regulators in order to meet 

requirements. Permitting processes 

sometimes provide opportunities to 

negotiate with regulators. If negotiation 

is allowed, it may take into account 

technical as well as economic 

considerations. 

4. Utility Interconnection 

Requirements 

These include the technical and contractual 

requirements for interconnection to the local 

electricity grid for those systems that will 

operate in parallel with the utility. “Parallel 

with the utility” means the CHP system is 

electrically interconnected with the utility 

distribution system at a point of common 

coupling at the site (common busbar), and 

facility loads are met with a combination of 

grid and self-generated power. 

Interconnection requires various levels of 

equipment safeguards and utility approvals 

to ensure that power does not feed into the 

grid during grid outages. 

Historically, negotiating the technical and 

contractual requirements for parallel grid 

interconnection has often been problematic 

for CHP installations. Each utility has had its 

own specific requirements that have 

sometimes appeared to be arbitrary, overly 

complicated and prohibitively expensive. 

The situation is improving, however: 

regulatory intervention, agreement 

standardization and equipment certification 

initiatives at the federal and state levels are 

helping to provide better definition and 

certainty to both the technical and 

contractual requirements for interconnection 

approval.4

 Streamlining and standardization 

of interconnection is being promoted with 

the intent that small, low-impact CHP 

projects can be reviewed quickly and costeffectively, and the technical and equipment 

requirements will be only as complex and 

expensive as required for safe operation. 

While standardization of the technical and 

contractual requirements for parallel grid 

interconnection is not yet nationwide, the 

approval process typically includes the 

following steps: 

1. Application

A formal application is filed with the 

servicing electric utility. This application 

usually asks for information on the 

location, technical and design 

parameters, and operational and 

maintenance procedures for the planned 

CHP system. The level of detail required 

4

 A number of states have developed streamlined 

procedures and established timelines for 

interconnection approval for systems below certain 

capacity levels (New York, Texas, and Delaware 

among others); Both the Federal Energy Regulatory 

Commission (FERC) and the National Association of 

Regulatory Utility Commissioners (NARUC) have 

issued proposed rules and/or model guidelines that 

would promote standardized interconnection 

procedures and business terms for small distributed 

generation resources connected to the grid; IEEE 

1547 has been issued, providing a “Standard for 

Interconnecting Distributed Resources with Electric 

Power Systems” that addresses the performance, 

operating, testing, and safety requirements of 

interconnection hardware and software. 

CHP Permitting Guide 19 
and application fees can vary 

considerably from one utility to another. 

2. Interconnection studies

There are a number of technical 

interconnection studies that might or 

might not be required, depending on the 

size and configuration of the CHP 

system and the specific requirements of 

the servicing utility: 

— Minimum engineering review. 

Designed to identify any adverse system 

impacts that would result from 

interconnection of the CHP system. 

Examples of potential negative impacts 

to the grid include exceeding the short 

circuit capability of any breakers, 

violations of thermal overload or voltage 

limits, and inadequate grounding 

requirements and electric system 

protection. 

— System impact study. Required if any 

adverse impacts are identified in the 

minimum engineering review. Designed 

to identify and detail the impacts to the 

electric system operation and reliability 

of the proposed CHP system, focusing 

on the potential adverse system impacts 

identified in the engineering review. 

— Facility study. Might be required if the 

system impact study indicates that grid 

system reliability would be adversely 

affected by interconnection of the CHP 

system. This study would identify and 

design any required facility or system 

upgrades that might be necessary to 

maintain grid integrity. 

The costs of the studies are typically 

paid by the applicant, but can be 

negotiated with the utility. It is important 

to execute specific agreements with the 

utility if specific studies are required. 

These agreements should outline the 

scope of the study and requirements 

and include a good faith estimate of the 

cost to perform the study. 

3. Interconnection agreement

There are also contractual issues that 

must be addressed in parallel to the 

technical requirements for 

interconnection. The interconnection 

agreement will cover such issues as 

back-up services, metering 

requirements, inspection rights, 

insurance requirements, and the 

responsibilities of each individual party. 

4. Power purchase agreement

If sales of excess power to the grid are 

contemplated, the terms and conditions 

of power purchases would be contained 

in a separate power purchase 

agreement (PPA) between the utility and 

the site. Primary considerations for a 

PPA include: 

— Term. The contract term should be 

sufficient to support financing and/or the 

life of the project. A typical term can be 

10 years or more. 

— Termination grounds. The grounds for 

contract termination should be limited in 

order to protect the long-term interests 

of all parties. 

 

— Assignment. The contract should 

consider assignment for purposes such 

as financing or changes in ownership. 

— Force majeure. Situations that 

constitute force majeure (e.g., storms, 

acts of war) should be identified and 

agreed upon; otherwise this clause 

could be used to interrupt operations or 

payment. 

— Schedule. There should be some 

flexibility allowed for meeting milestone 

dates and extensions (e.g., in penalty 

provisions such as non-performance). 

CHP Permitting Guide 20 
 

This provision is necessary in case 

unforeseen circumstances cause project 

construction delays. 

— Price. The value of sales of power to 

the grid will typically be based on the 

utility’s avoided cost or some negotiated 

rate, either of which will be close to the 

wholesale commodity costs for power 

(i.e., not the higher retail rate displaced 

by power used on-site). Many utilities 

have a standard offer contract for FERC 

qualifying facilities.5

 

The utility should establish a definitive 

period of time in which to process the 

application and studies, and provide one of 

the following notifications to the applicant: 

 Approval to interconnect. 

 Approval to interconnect with a list of 

prescribed changes to the CHP system. 

 Justification and cost estimate for 

prescribed changes to distribution 

5

 In 1978, the Public Utilities Regulatory Policy Act 

(PURPA) required an electric utility to buy electricity 

from power projects that are granted Qualifying 

Facility (QF) status by FERC. Under this provision, 

the electricity would be bought at the utilities’ current 

avoided cost rate. However, the federal Energy Policy 

Act of 2005 amended PURPA; for new contracts, 

utilities are no longer required to buy or sell excess 

power from QFs if the cogeneration facilities have 

access to transmission services and wholesale 

markets. 

In 2006, FERC issued a proposed rule to repeal the 

mandatory purchase obligation in Day 2 Regional 

Transmission Organization (RTO) territories: Midwest 

ISO, PJM, ISO New England, and NYISO. At the time 

of this writing, FERC has not issued a final rule. For 

Day 1 RTOs or markets of comparable competitive 

quality, the mandatory purchase obligation will be 

evaluated on a case-by-case basis. 

A power project is granted QF status as either a 

"small power producer" or a "qualifying cogenerator” 

after meeting certain fuel or efficiency requirements, 

as amended by FERC in 2006 (see FERC Docket No. 

RM05-36-001; Order No. 671). 

systems that are required to 

accommodate the CHP system. 

 Application rejection with justification. 

The time period for the review and approval 

process can vary depending on the number 

and level of studies required and the 

organization of the utility itself. Some utilities 

have assembled a handbook of procedures, 

options, and draft contracts. In these cases, 

the procedures will be relatively orderly and 

straightforward, and the process will be 

expedited. Other utilities have dispersed the 

responsibilities. In such cases it will take 

time to determine the right contacts and all 

the specific interconnection requirements.

States that are streamlining the 

interconnection process have targeted a 

time period of 4 to 6 weeks for review and 

completion of a simple interconnection 

application. In general, the larger the 

project, the more complex the 

interconnection scheme; if there are specific 

issues with the section of the grid being 

accessed (e.g., rural lines or weak 

distribution areas), the higher the costs both 

for studying the interconnection 

configuration and for the necessary 

electrical equipment to interconnect. 

It is recommended that the local utility be 

contacted early in the project development 

process in order to identify interconnection 

requirements and potential issues. A useful 

starting place for a potential applicant is to 

identify existing onsite generation systems 

that have already been connected with the 

utility and gather information on their 

requirements and application process. The 

EPA CHP Partnership can often help 

identify such sites. 

5. Local Zoning/Planning 

Requirements 

Project siting and operation are governed by 

a number of local jurisdictions. It is 

CHP Permitting Guide 21 
 

important to work with the appropriate 

regulatory bodies throughout all stages of 

project development in order to minimize 

permitting delays that cost both time and 

money. Applicable local agencies include: 

 County and city planning bureaus

govern land use and zoning issues. 

They may conduct environmental impact 

assessments, including noise studies, 

and are responsible for compliance with 

local ordinances. For example, most 

local zoning ordinances stipulate the 

allowable decibel levels for noise 

sources and these levels vary, 

depending on the zoning classification 

at the site. The local zoning board or 

planning bureau determines whether or 

not land use criteria are met by a 

particular project, and can usually grant 

variances if conditions warrant. 

 State and local building and fire code 

departments address CHP-related 

safety issues such as exhaust 

temperatures, venting, natural gas 

pressure, fuel storage, space limitations, 

vibration, gas and steam piping, and 

building structural issues. Building 

departments are often part of a city’s 

planning division. Most CHP projects 

require a building permit. 

 The environmental/public health 

department looks out for public health 

and safety, focusing on hazardous 

materials and waste management 

requirements. 

 Water/sewer and public works 

authorities rule on water supply and 

discharge matters. Typically, they 

ensure that a project is compliant with 

the federal Clean Water Act; decide 

whether local water and wastewater 

quality standards will be or are being 

met; and evaluate waste streams that 

empty into lakes, rivers and other bodies 

of water. 

6. Local Air Quality Requirements 

Air quality agencies/districts at the state 

and local levels are responsible for 

administering air quality regulations, with a 

primary focus on air pollution control. The 

primary criteria pollutants of concern include 

NOX, CO, SO2, particulates, and certain 

hazardous air toxics. Local air agencies 

ensure that a project complies with federal 

and state Clean Air Act mandates. These 

authorities issue construction permits based 

on their review of project design and 

performance objectives. After construction 

and installation is complete, projects receive 

operating permits based on emissions 

performance relative to applicable 

emissions thresholds. Issues that air 

agencies consider include exemption 

thresholds6

 (e.g., capacity, emission levels), 

controlled emission levels, type of fuel(s) 

fired, proximity to sensitive receptors (e.g., 

schools, day cares, hospitals), siting at a 

new location or an existing site (e.g., 

commercial building, industrial facility), and 

a demonstration that projected emission 

levels are met via source testing. 

Major characteristics that typically 

differentiate projects for air permitting 

purposes include: 

 Does the CHP system trigger permit 

requirements? If it is not exempt, what 

relevant emissions threshold is it below 

or above? 

6

 Agencies typically have a rule for which equipment 

and processes are exempt from permitting, a rule that 

is often based on whether the equipment falls below a 

given emissions threshold. Exemptions may also exist 

based on the type or function of the equipment, e.g., if 

it is emergency standby generation or a fuel cell 

installation, or if it has been precertified.

CHP Permitting Guide 22 
 Is the site in an attainment area?7

 Nonattainment areas feature more rigorous 

guidelines. 

 Is the site an existing or new facility? Is 

the site currently considered a major 

emissions source or a minor emissions 

source? Adding a new source of 

emissions to an existing major source 

can trigger additional permitting 

requirements; adding a new source to 

an existing minor source may move the 

facility into the major source category. 

 Do emissions of criteria pollutants and 

air toxics affect surrounding 

communities? If it appears that the 

source’s emissions may affect public 

health, air quality modeling or an 

evaluation study may be necessary. 

Up-to-date information on state emissions 

requirements for CHP and other onsite 

generation systems can be found at: 

www.eeainc.com/rrdb/DGRegProject/index.html

 

7

 When an area does not meet the air quality standard 

for one of the criteria pollutants (ozone, nitrogen 

dioxide, carbon monoxide, sulfur oxides, particulate 

matter, and lead), it may be subject to a formal rulemaking process that designates it as in 

“nonattainment.” The Clean Air Act further classifies 

ozone, carbon monoxide, and some particulate matter 

nonattainment areas based on the magnitude of their 

problems. Nonattainment classifications may be used 

to specify what air pollution reduction measures an 

area must adopt, and when the area must reach 

attainment. The technical details underlying these 

classifications are discussed in the Code of Federal 

Regulations, Part 81 (40 CFR 81) and on the U.S. 

EPA Web site: www.epa.gov.

7. Permitting Costs 

Siting and permitting can require significant 

investments of time and money in 

researching, planning, filing applications, 

meeting with officials, and paying fees. 

Interconnection, environmental regulatory, 

and local government agency approval 

costs may approach 3 to 5 percent of 

project costs for smaller systems and need 

to be included in any CHP project economic 

evaluation. Equipment needed to ensure 

compliance, such as air pollution control 

equipment or noise abatement equipment, 

would be in addition to these fees. 

CHP Permitting Guide 23