Capital Financing: Partnerships and Energy Savings Performance Contracts Raise Budgeting and Monitoring Concerns
Published: 2004-12-16T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: ESPCs finance energy-saving capital improvements, such as lighting retrofits for federal facilities, without the government incurring the full cost up front. Partnerships tap the capital and expertise of the private sector to develop real property. This report describes (1) what specific attributes of ESPCs and partnerships contributed to budget scoring decisions, (2) the costs of financing through ESPCs compared to the costs of financing via timely, full, and up-front appropriations, and (3) how ESPCs and partnerships are monitored. Using case studies, GAO reviewed GSA and Navy ESPCs and DOE and VA partnerships.
section_title: What GAO Found
paragraphs: Energy savings performance contracts (ESPC) and public/private partnership arrangements we examined were authorized by Congress and did not require reporting of the full, long-term costs up front in the budget. ESPCs are financed over time through annual cost savings from energy conservation measures (ECM) and only their initial-year costs must be recognized up front. OMB policy determined how agencies obligated ESPCs in their budgets. With partnerships, agencies sometimes used short-term leases to acquire assets constructed for the government's long-term use and benefit. As a result, budgetary decisions may favor alternatively financed assets. However, spreading costs over time enabled agencies to acquire capital that might not have been obtainable if full, up-front appropriations were required. A number of factors may cause third-party financing to be more expensive than timely, full, and up-front appropriations. For example, a higher rate of interest is incurred by using ESPCs and partnerships than if the same capital is acquired through timely, full, and up-front appropriations. For our six ESPC case studies, the government's costs of acquiring assets increased 8 to 56 percent by using ESPCs rather than timely, full, and up-front appropriations. However, officials noted that there are opportunity costs, such as foregone energy and maintenance savings, associated with delayed appropriations, but there are insufficient data to measure this effect. For ESPC and partnership case studies, agency officials said they did not specifically consider or request full up-front appropriations because they did not believe funds would be available in a timely manner and because alternative mechanisms were authorized. An evaluation of funding alternatives on a present value basis could have helped agencies determine the most appropriate way of funding capital projects. Implementation and monitoring of ESPCs is a relatively uniform process. Since partnerships take a variety of forms, their implementation and monitoring is more complex. Although third-party financing can make it easier for agencies to manage within a given amount of budget authority, it also increases the need for effective implementation and monitoring by agencies to ensure the government's interests are protected.

section_title: Letter
paragraphs: As you know, one of the major recommendations of the 1967 Commission  on Budget Concepts dealt with coverage of the budget.  According to the  Commission, the “budget should…be comprehensive of the full range of  Federal activities.  Borderline agencies and transactions should be  included in the budget unless there are exceptionally persuasive reasons  for exclusion.”  With specific regard to capital investments, the  Commission recommended strongly against a capital budget that would  spread outlays over an asset’s life, noting that it would likely “distort  decisions about the allocation of resources.”  We have long supported an  inclusive budget that discloses up-front the full commitments of the  government.  However, in an era of limited resources and growing mission  demands, Congress has authorized agencies to use approaches other than  full, up-front funding to finance capital acquisitions such as land  improvement projects, buildings, and equipment.  Accordingly, these  alternative financing mechanisms have been used by agencies to acquire  assets by spreading the cost over a number of years in their budgets.  Thus,  the full cost of an asset is not presented or recognized in the budget at the time the decision is made to acquire it.  As a result, resource allocation  decisions made through the budgeting process may not consider the full  financial commitment the U.S. government is making and, consequently,  assets financed through alternative approaches may be preferred over  other equally worthy projects that are competing for full funding.
From an agency’s perspective, the ability to record the acquisition costs of  a capital asset over the life of that asset can be very attractive because the  capital asset could be obtained without first having to secure sufficient  appropriations to cover the full cost of that asset.  From the agency’s  standpoint, absorbing the entire cost of these relatively high-priced assets  in a single year’s budget may seem prohibitively expensive, particularly in  light of the long-term benefits of the assets.  Accordingly, alternative  financing mechanisms are frequently desirable to agencies because they  make it easier for them to quickly meet mission capital demands within a  given amount of budget authority.  From a governmentwide budget  perspective, however, the situation can be different.  The costs associated  with these financing approaches may be greater than would be the case  with timely, full, and up-front budget authority due, in part, to higher  interest costs.  This is of particular concern at a time of rising budget  deficits and concern about underrecognition of long-term costs and  commitments.  Moreover, when capital costs are not fully recognized up- front, before funds are committed, important information about the full  budgetary effects may not be considered as trade-offs are made among  competing priorities.  For the purchase of any given capital equipment,  agencies receive the same program benefits regardless of the financing  approach used.
Agencies have estimated restoration and repair needed to address the  alarming state of deterioration of many federal assets to be in the tens of  billions of dollars.  Given this estimate agencies have relied heavily on  costly leasing instead of ownership to meet new needs.  Since the budget  scorekeeping rules were established, decision makers have struggled to  address agencies’ tendencies to choose operating leases instead of  ownership.  One option we have suggested be considered would be to  recognize that many operating leases are used for long-term needs and  should be treated on the same basis as purchases.  This would entail  scoring up front the payments covering the same time period used to  analyze ownership options.  We have suggested this scoring for those  leases that are perceived by all sides as long-term federal commitments so  that all options are treated equally.  Although this could be viable, there  would be implementation challenges if this were pursued, including the  need to evaluate the validity of agencies’ requirements based on their long- term plans.  Finding a solution for this problem has been difficult.  While  leasing to meet long-term needs almost always results in excessive long- term costs to taxpayers and does not necessarily reflect the best approach  to capital asset management, it also provides the government opportunities  to spend more on other mission objectives.  This same problem arises for  any asset that is acquired to meet long-term needs.
In August 2003, based on your request, we issued a report that identified  and briefly described 10 different capital financing approaches used by 1 or  more of 13 federal agencies.  Subsequently, as requested, we have  analyzed in greater detail two of the identified approaches: Energy Savings  Performance Contracts (ESPC) and public/private partnerships  (partnerships).  In particular, we determined (1) what specific attributes  of ESPCs and partnerships contributed to budget scoring decisions, (2) the  costs of financing through ESPCs and partnerships compared to the costs  of financing via timely, full, and up-front appropriations, and (3) how  ESPCs and partnerships are implemented and monitored.
To obtain the detail necessary to respond to this request, we used a case  study approach, which does not allow us to generalize our findings across  the government.  In order to understand the budgetary treatment and  oversight of ESPCs and partnerships, we reviewed relevant legislation,  ESPC files, partnership agreements, and relevant guidance issued by  agencies and the Office of Management and Budget (OMB).  We selected  case studies from agencies that had awarded a large dollar volume of  ESPCs awarded under the Department of Energy’s (DOE) Federal Energy  Management Program’s (FEMP) umbrella contract, had broad partnership  authority, or were discussed in our prior report.  We also interviewed staff  within the General Services Administration (GSA), the Department of  Defense (DOD), the Department of Veterans Affairs (VA), the Department  of Energy (DOE), the Congressional Budget Office (CBO), and OMB to  understand the features of ESPCs and partnerships, and how the  arrangements were scored.  In addition, we spoke with representatives of  Energy Service Companies (ESCO) and UT-Battelle, agency contractors  involved in our case studies.   In total, we analyzed 11 case studies—6  ESPCs and 5 partnerships—across 4 agencies.  Because of our focus on  budget scoring, our analysis was confined to the government’s acquisition  cost and was not a cost-benefit analysis.  To analyze ESPC costs, we  reviewed the delivery orders of each of our six ESPC case studies.   Although we were able to analyze ESPC costs and savings, we were unable  to perform a similar analysis of the partnerships we reviewed because we  were unable to evaluate claims that other factors, such as lower labor costs  and fewer bureaucratic requirements available to private partners, may  have reduced costs.  All of the partnership case studies we reviewed were  executed before OMB's 2003 changes to its instructions on the budgetary  treatment of lease-purchases and leases of capital assets.  According to  OMB staff, some of these partnerships may have been scored differently  under the revised instructions.  Our work was done in accordance with  generally accepted government auditing standards, from September 2003  through November 2004, in Washington, D.C., Atlanta, Ga., Oak Ridge,  Tenn., and Port Hueneme, Calif.  A complete description of our objectives,  scope, and methodology can be found in appendix I.  Appendix II provides  a summary of our ESPC case studies and appendix III summarizes our  partnership case studies.  Written comments from DOD, DOE, GSA, and VA  are reproduced and addressed in appendixes IV through VII.  OMB  provided oral comments.  We have incorporated these comments as  appropriate throughout.  Key contributors to this report are listed in  appendix VIII.
subsections: section_title: Background
paragraphs: The extent to which capital costs are reflected in the budget depends on  how they are “scored.”  CBO and OMB separately “score” or track budget  authority, receipts, outlays, and the surplus or deficit estimated to result as  legislation is considered and enacted.  CBO develops estimates of the  budgetary impact of bills reported by the different congressional  committees.  For the many individual transactions done under existing  authorities (thus not requiring annual legislation), CBO’s estimates play no  role in determining how much budget authority must be obligated.  However, OMB interprets the scorekeeping guidelines to determine the  costs that should be recognized and recorded as an obligation at the time  the agency signs a contract or enters into a lease.  It is not always obvious  whether a transaction or activity should be included in the budget.  Where  there is a question, OMB normally follows the recommendation of the 1967  President’s Commission on Budget Concepts to be comprehensive of the  full range of federal agencies, programs, and activities.  However, under  some circumstances, it may choose not to record obligations and outlays  up front.
Budget scorekeeping rules and OMB instructions on the budgetary  treatment of lease-purchases and leases of capital assets are published in  OMB Circular A-11.  Revised in 2003 to address lease-backs from  partnerships, among other things, these instructions consider both the  government’s legal obligation and how risk is shared between the  government and the contractor for three types of leases: capital leases,  lease-purchases, and operating leases.  The instructions state that when  agencies enter into a capital lease contract or lease-purchase, budget  authority is scored in the year in which the authority is first made available  in the amount of the net present value of the government’s total estimated  legal obligations over the life of the contract.   Alternatively, for operating  leases that include a cancellation clause, agencies only need budget  authority sufficient to cover the first year’s lease payments, plus  cancellation costs.  Figure 1 summarizes the criteria and other guidelines  for defining an operating lease.
While we have previously reported that up-front funding permits disclosure  of the full costs to which the government is being committed, OMB’s  budget scorekeeping instructions allow costly operating leases to appear  cheaper in the short term and have encouraged an overreliance on them for  satisfying long-term needs.
Partnerships must conform with OMB’s scorekeeping instructions. The  instructions for partnerships consider the degree of private participation in  the partnership to determine its scoring.  Private participation is judged by  the level of substantial private participation and private sector risk as  evidenced by the absence of substantial government risk.  Substantial  private participation means (1) the nonfederal partner has a majority  ownership share of the partnership and its revenues, (2) the nonfederal  partner has contributed at least 20 percent of the total value of the assets  owned by the partnership, and (3) the government has not provided  indirect guarantees of the project, such as a rental agreement or a  requirement to pay higher rent if it reduces its use of space.  If government  risk is considered high and private participation not deemed substantial,  the partnership would be considered governmental for budget purposes  and its transactions would be scored.  Figure 2 presents OMB’s illustrative  criteria for assessing private sector risk.
Using ESPCs and partnerships, agencies have been allowed to spread the  costs of capital assets over several years.  Agencies sometimes used these  financing mechanisms when they believed that timely, full, and up-front  appropriations would not be made available to support capital needs.   Moreover, they believe these alternative mechanisms enabled them to  avoid costs, such as higher utility bills associated with waiting for  appropriations.  Nevertheless, several of the agencies we spoke with agree  that they could acquire capital less expensively through timely, full, and up- front appropriations.
subsections: section_title: Energy Savings Performance Contracts
paragraphs: ESPCs finance energy-saving capital improvements such as lighting  retrofits and ventilation systems for federal facilities without the  government recording the full cost up-front.  According to DOE, ESPCs  have been used as an alternative financing mechanism to finance over a  billion dollars of energy system upgrades and installations.  Federal  agencies’ use of ESPCs was authorized and encouraged by both Congress  and the executive branch.  In Executive Order 13123, dated June 3, 1999,  the executive branch defined requirements for agencies to meet specific  energy reduction goals and supported the use of ESPCs to achieve them.   The Energy Policy Act of 1992 and Executive Order 13123 require federal  agencies to reduce their consumption of energy in federal buildings. The  act set a goal for the agencies of lowering their consumption per gross  square foot by 20 percent below fiscal year 1985 baseline consumption  levels by fiscal year 2000.  Executive Order 13123 requires a 30 percent  reduction from 1985 levels by the year 2005 and a 35 percent reduction by  2010.
Under the Energy Policy Act of 1992, federal agencies had the authority to  enter into ESPCs for as long as 25 years with qualified ESCOs that purchase  and install new energy systems in federal buildings.  The ESCO assumes  much of the up-front capital costs and, in return, receives a portion (nearly  all) of the annual energy savings attributable to the improvements until the  principal and interest have been repaid.  The ESCOs guarantee the  performance of the equipment installed, within certain parameters, for the  term of the ESPC.  The agency makes the payment to the ESCO from funds  that the agency would otherwise have used to pay the higher utility costs  (which are lower because of the ECM installed by the ESCO).   Consequently, agencies argue that they will not need an increase in future  appropriations relative to the current amount of appropriations in order to  pay the ESCOs.
Agencies other than DOD and GSA must transfer 50 percent of the energy  savings realized from energy savings performance contracts (after paying  the negotiated amount to the contractor) to the Treasury.  The remaining 50  percent saved may be retained and is available for additional energy and  water conservation projects until expended.
According to FEMP, 18 federal agencies and departments have  implemented ESPC projects worth $1.7 billion.  Without ESPCs, agencies  would have to reassess their budget plans to accommodate investments in  ECMs and/or Congress would be asked to appropriate funds today to  finance investments to meet currently required energy consumption goals.
Proponents of ESPCs argue that, as an alternative financing method, these  contracts help agencies overcome the problem of insufficient funding to  meet federal energy reduction goals.  Without ESPCs, agencies would need  to adjust their program plans within expected appropriation levels to make  energy efficiency improvements or possibly do nothing if the funds are  unavailable in a given year.  In this regard, proponents note that delays of  even 1 year can result in greater utility, maintenance, and other costs.   Moreover, by using ESPCs, agencies did not have to make some difficult  trade-offs between purchasing ECMs and other claims on resources.
Critics of ESPCs, however, point out that for any given ECM the direct  purchase of more efficient energy systems would allow all future savings to  accrue to the government, rather than paying out a percentage of the  savings to private contractors.  In addition, the government incurs certain  costs in using an ESPC, such as the M&V fees paid to the contractor, that it  would not necessarily incur if the energy improvements were financed up  front with federal appropriations.  The ESCO’s also pay a higher cost of  capital than the federal government.  As a result, over the long term,  financing ECMs through ESPCs is likely to be more expensive than  acquiring them through timely, full, and up-front appropriations.  Finally,  dependence on the annual budget cycle is the process by which decision  makers weigh competing federal priorities.  Permitting ESPCs to be  recorded in the budget at less than their full cost up front affects this  process, possibly resulting in lower priorities receiving funding ahead of  higher priorities.  Not addressing some difficult resource allocation  decisions is seen as an advantage to agencies.  However, long-standing  budget concepts hold that a budget should be a forum for resource  allocation decisions and that all competing claims should be compared on a  consistent basis.
CBO and OMB disagree over the appropriate budget scoring for ESPCs.   CBO recognizes that the law enables agencies to use ESPCs to pay for  ECMs over a period of up to 25 years without an appropriation for the full  amount of the purchase price.  However, the law does not prohibit scoring  the full cost of the contract up front.  In CBO’s view, the obligation to make  payments for the energy efficient equipment and the financing costs is  incurred when the government signs the ESPC.  Further, CBO believes it is  consistent with governmentwide accounting principles that the budget  reflect this commitment as new obligations at the time that an ESPC is  signed.  Accordingly, CBO scored recent ESPC legislation such that the  total (long-term) commitments to an ESCO would be counted in the budget  at the time the ESPC delivery order is signed.  In contrast, OMB recognizes  obligations, budget authority, and outlays for ESPCs on a year-to-year basis.   According to OMB staff, this decision was based on the savings component  of ESPCs and agencies’ statutory authority to enter into a multiyear  contract even if funds are available only to pay for the first year of the  contract.
section_title: Public/Private Partnerships
paragraphs: Partnerships are designed to tap the capital and expertise of the private  sector to improve or redevelop federal real property assets.  Partnerships  are sometimes used when excess capacity, such as unused land, exists  within a federal asset.  Ideally, the partnerships are designed such that each  participant makes complementary contributions that offer benefits to all  parties.  From a budget scoring perspective, recording an agency’s full  commitments up front in the budget can be difficult because the precise  level of an agency’s financial commitment and control in the partnership  may be unclear.
Congress has enacted a variety of laws that provide agencies with authority  to enter into partnerships with private firms.  For instance, VA possesses  enhanced use (EU) lease authority to outlease federal real property to  private firms (see fig. 3).  Alternatively, GSA possesses limited authority for  specific situations.  For example, GSA entered into a partnership with the  Georgia Cooperative Services for the Blind to operate a food court within  the Atlanta Federal Center, using authority provided by the Randolph  Shepard Act.  GSA has also used authorities granted in other legislation,  such as the Public Buildings Cooperative Use Act of 1976, as amended,  and the National Historic Preservation Act, as amended, to work with  nonfederal partners.  Despite the significance of GSA’s role in federal  property management, its limited authority to enter into partnerships has  prevented it from taking a substantive role in partnership activities.
Proponents of partnerships argue that the approach provides a realistic,  less costly alternative to leasing when planning and budgeting for real  property needs.  Proponents also note that federal partners benefit from  improved, modernized, or new facilities plus a minority share of the income  stream generated by the partnership or use of the asset at a lower cost than  a commercial lease.
Critics of partnerships caution that these ventures are not the least  expensive means of meeting capital needs, although they may appear to be  in the short term.  They remind policymakers that up-front funding with  appropriated funds is the least expensive way to obtain assets and results  in the inclusion of the government’s long-term commitments in the budget.
Our prior work has shown that, as part of a capital review and approval  process, leading organizations develop decision packages, such as business  case analyses, to justify capital project requests.  A business case analysis  is a planning and decision support tool used to ensure that (1) the  objectives for a proposed facility-related investment are clearly defined,   (2) a broad range of alternatives for meeting the objectives are developed,  (3) the alternatives are evaluated to determine how well the objectives will  be met, and (4) trade-offs are explicit.  The overriding purpose of a  business case analysis is to make transparent to the various decision  making and operating groups all of the objectives to be met by the  investment, the underlying assumptions, and the attendant costs and  potential consequences of alternative questions.  Business case analyses  are supported by detailed economic and financial analyses such as cost- benefit, return on investment, life-cycle cost, and comparative alternative  analyses, and recommend the most cost-effective option.
section_title: Various Features Enabled Agencies to Delay Recognition in the Budget
paragraphs: ESPCs and partnership arrangements were authorized by Congress.  With  these arrangements, both the government and third parties share the risk of  a long-term financial commitment.  However, agencies were not required to  reflect the full cost of these commitments up front in the budget when the  commitments were being made.  For example, ESPCs finance energy- efficient equipment over time by using savings in agencies' utility bills to  repay ESCOs for the up-front equipment and installation costs.  Because  the ESCOs are repaid over time, the full up-front costs of ECMs are not  reflected in the budget.  (Fig. 8 on page 55 illustrates how ESPCs affect  agencies' cash flows before, during, and after the contract term.)  With  respect to most of the partnerships we reviewed, scoring decisions were  driven by the transfer of government land from agencies to third parties.   Case study agencies sometimes leased assets in short-term increments that  third parties constructed on the transferred land specifically for the  government’s use and benefit.  As a result, the full cost of the assets were  not required to be reflected in the budget.  Given that the federal budget is  primarily measured on a cash and obligations basis, some of the  partnerships we examined were completely invisible in the budget because  they involved noncash transactions.  The financial commitment of the  government is illustrated in figure 4—although costs through third-party  financing that appear in the budget may be initially lower, the government  is committed to years of future payments.
subsections: section_title: ESPC Commitments Are Not Fully Recognized Up Front in the Budget
paragraphs: ESPCs represent long-term commitments of the government.  Agencies  generally retain control of capital assets acquired through ESPCs for their  entire life cycle, and frequently contractors transfer title of the assets to the  government after the assets are installed and accepted by the government.   Moreover, the term of ESPC delivery orders spans as long as 25 years.   Finally, agencies’ termination liability for ESPCs typically corresponds to  their outstanding principal balance.
Although these arrangements represent long-term commitments, funds for  ESPCs are obligated on an annual basis.  Therefore, the budget does not  recognize the government’s long-term commitment up front, when  decisions are made.  This policy was formalized in a 1998 OMB  memorandum that stated ESPC obligations, budget authority, and outlays  would be recognized on an annual basis.  The memorandum did not discuss  OMB’s rationale for scoring ESPCs in this manner.  According to OMB staff,  this memorandum reflected OMB’s early examination of the issues.   Specifically, the policy was based on the savings component of the  contracts and the statutory authority to enter into a multiyear contract  even if funds are available only to pay for the first year of the contract.
section_title: Long-term Partnership Arrangements Were Not Fully Recognized Up Front in the Budget
paragraphs: Capital assets acquired through the partnership arrangements we reviewed  were structured such that third parties have an ongoing, long-term  relationship with the government.  However, OMB’s budget scoring  instructions required that only the short-term costs associated with assets  acquired through case study partnerships be scored in the budget.  As  shown previously in figure 1, the definition of an operating lease (which  permits obligations to be scored annually) specifies that the lease term may  not exceed 75 percent of the estimated economic life of the asset.  Assets  we reviewed were constructed in areas where case study agencies have  long maintained a presence and have a continuing mission.  It seems  unlikely that the agencies will vacate or abandon these assets before the  end of their economically useful lives.  To the extent agencies continue to  occupy leased spaces, the 75 percent criteria for an operating lease may be  exceeded.
For example, through a series of transactions, DOE entered into a  partnership with the nonprofit UT-Battelle Development Corporation  (UTBDC) to revitalize its Oak Ridge National Laboratory (ORNL) in the  state of Tennessee.  ORNL was first established in 1943 and is DOE’s  largest science and energy laboratory.  Many of the buildings on the ORNL  reservation have become obsolete, dilapidated, and expensive to maintain.   Accordingly, UTBDC arranged for the sale of bonds through Keenan  Development Associates of Tennessee to finance and construct three  general-use office buildings at ORNL (specifically to support DOE  research).  UT-Battelle, LLC, on behalf of DOE, leased the buildings  through a series of leases extending to 25 years and involving UTBDC and  Keenan.  (See app. III for a full explanation of this complicated  arrangement.)  DOE’s ORNL Project Manager told us that, even if ORNL’s  mission was downsized, it was unlikely that DOE would terminate any of  the leases of the three new, state-of-the art buildings to reoccupy the now  empty, dilapidated buildings.  Figure 5 shows one vacant office building  and an artist’s rendition of the revitalized ORNL reservation, including the  three privately financed buildings.
Evidence of ORNL’s long-term commitment is further bolstered by  Standard and Poor’s A+ rating of the ORNL bond issuance.  The rating  report stated that a strong lease revenue stream from DOE, for a period of  up to 25 years, would be pledged as security for the payment of the bonds.   Moreover, the unique mission of ORNL makes it unlikely that DOE will  move its operations from the Oak Ridge site.  DOE officials stated that the  likelihood that ORNL will close during the term of the bonds is very low, so  DOE is unlikely to terminate any part of the leases.
According to DOE officials, DOE transferred the government-owned land  on which the buildings are located to UTBDC via quitclaim deed so that  appropriations for the full, up-front costs of the three buildings were  unnecessary.  DOE later approved the facility subleases between UTBDC  and UT-Battelle, LLC.  DOE then obtained the use of the newly constructed  buildings from UT-Battelle, LLC, reimbursing UT-Battelle, LLC, for the  sublease rents.  DOE officials told us the deal was deliberately structured  with a quitclaim deed to ensure that the arrangement was scored as an  operating lease rather than a capital lease.  Because OMB allowed DOE to  record this arrangement as an operating lease, DOE needed to obligate only  the annual cost of the lease payments, rather than the full cost of the  construction.
In another case study, VA entered into an enhanced use (EU) lease for up to  35 years with the Dekalb County Development Authority (the Authority)  to finance and construct VA’s Atlanta Regional Office (VARO) building and  parking area.  Dekalb County issued 35-year revenue bonds to finance the  project.  VA officials said construction of the new building allowed the  agency to collocate its regional office with an existing VA medical center  and provide enhanced “one-stop” service for veterans.  Although VA leases  the facilities from the Authority in 2-year increments, there is no current  plan to vacate the property in the near future and the leases automatically  renew unless VA takes positive action to terminate.  Additionally, VA  agreed not to replace the regional office building financed by the Authority  with another regional administration or headquarters building in Georgia  using its EU leasing authority during the term of the bonds. VA may enter  into another EU lease in the Atlanta region so long as the new building does  not disrupt VA’s occupancy within the collocated office.
VA did not need to obligate the full up-front cost of the regional office  building and parking area because it used its EU lease authority to outlease  the government-owned land to the Authority on which the Authority could  build.  VA then leased the newly constructed building and parking area  from the Authority’s developer through 2-year operating leases, which  automatically renew for up to nine consecutive terms unless VA takes  positive action to terminate the automatic renewal clause.  Accordingly,  OMB only required the annual lease payments and any termination costs  to be reflected in the budget.
section_title: Some Partnerships May Not Be Included in the Budget Because They Involve Noncash Consideration
paragraphs: In some cases, partnerships are arranged for reasons other than an  agency’s belief that appropriations are not available.  For example, VA  entered into an EU lease with the City of Vancouver’s Housing Authority to  construct an estimated $4 million homeless shelter on VA property.  In  exchange, veterans receive priority placement in 50 percent of the shelter  units; VA receives no cash consideration.  Because VA can discharge  patients into the homeless shelter rather than extending inpatient care in  VA medical facilities, VA estimated that it avoids costs of roughly   $1.8 million annually.  Additionally, VA anticipated that the homeless  shelter would provide veterans with greater outpatient services and  improve the availability of affordable housing for single homeless  individuals.  Because the partnership involves no cash consideration, it is  not reflected in the budget.
section_title: Higher Interest Rates and Other Factors May Increase the Cost of Third-Party Financing Compared to Timely, Full, and Up-Front Appropriations
paragraphs: A number of factors may cause third-party financing to be more expensive  than timely, full, and up-front appropriations.  For example, case study  agencies incurred a higher rate of interest by using ESPCs and partnerships  than if they had obtained that same capital through timely, full, and up-front  appropriations.  Also, for ESPCs, officials told us that the government  likely incurred additional costs for the measurement and verification  (M&V) of equipment performance.  In our six ESPC case studies, use of  ESPCs increased the government’s costs of acquiring ECMs by 8 to 56  percent compared to the use of timely, full, and up-front appropriations.   None of the partnership case studies lent themselves to this type of cost  analysis because comparable data were not available.  Some of the  partnerships did not involve cash consideration.  For others, although the  government incurred higher interest costs compared to up-front funding,  we did not evaluate claims that other factors such as lower labor costs and  fewer bureaucratic requirements might lower costs because data were not  readily available.  Thus, we were unable to judge whether partnerships  could be less expensive overall.  For both ESPCs and partnerships, agency  officials said they did not request full, up-front appropriations to finance  the specific capital projects we reviewed.  Frequently, they said this was  because they did not believe funds would be available in a timely manner  and they had statutory authority to use the alternative mechanisms.   However, there are insufficient data to measure this effect.
subsections: section_title: Acquiring Capital through ESPCs Is More Expensive Than Acquiring the Same Capital through Timely, Full, and Up-Front Appropriations in Our Case Studies
paragraphs: Since the federal government’s cost of capital is lower than that of the  private sector, alternative financing mechanisms may be more expensive  than timely, full, and up-front appropriations.  Accordingly, all case study  agencies could have acquired the same ECMs less expensively through  timely, full, and up-front appropriations than through ESPCs.
In addition to a higher cost of capital, agencies also likely incur additional  M&V costs when they finance ECMs through ESPCs rather than timely, full,  and up-front appropriations.  Agencies contract for M&V of energy savings  financed through ESPCs because they are required to show that annual  savings generated by ECMs meet or exceed annual contractor payments.   M&V of savings also acts as insurance; if actual savings fall below those  guaranteed by the contractor, the contractor may be obligated to take  corrective actions at its own expense.  Officials we spoke with said they  believed that M&V resulted in higher sustained savings but is an expense  that would not be incurred if the ECMs were acquired through timely, full,  and up-front appropriations.  Representatives from the ESCOs said that  their private sector clients do not always purchase M&V, and, if they do, it  is for a shorter period than contracts secured by the federal government.
Table 1 presents cost comparisons using the installation and construction  price of ECMs (based on delivery order files) as a proxy estimate for timely,  full, and up-front appropriations costs.  It shows that ECMs obtained  through our six ESPC case studies might be roughly 8 to 56 percent more  expensive than they could have been for the same ECMs had they been  obtained through timely, full, and up-front appropriations.  The percentage  difference between financing through ESPCs and estimated timely, full, and  up-front appropriations is shown in the far right column.  The difference in costs between the two financing mechanisms is a function of (1) the higher  cost of capital incurred through ESPC financing and (2) the M&V costs  incurred through ESPC financing.
The performance of ECMs installed through the use of ESPCs are  guaranteed to reduce energy use during the term of the contract so that  payments to the contractor can be made from the savings from lower utility  bills.  ESPCs contain assumptions for such things as hours of operation and  ECM efficiency which, taken together, determine estimated savings.   However, if the assumptions are incorrect and estimated savings are not  achieved, the agency is still required by contract to pay the ESCO the  agreed-upon savings specified in the ESPC.  According to agency officials,  ECMs may continue to accrue savings beyond the contract cycle as they  continue to operate more efficiently than the equipment they replace.  The  additional savings along with the savings realized during the contract cycle  may cover the entire cost of the equipment. (See app. II for additional detail  on verification of ESPC savings.)
As shown in figure 6, for all six ESPC case studies, contract cycle energy  cost savings specified by the contractor did not fully cover total contract  cycle costs (including O&M expenses) because agencies made up-front  payments. All six of the case study ESPCs used a combination of funds  from their existing budgets and third-party financing via an ESPC to  implement packages of ECMs. The up-front payments from their existing  budgets covered the difference between total contract cycle costs and  savings.  Accordingly, the agencies reduced the amount they had to finance  through ESPCs, thereby reducing their interest payments.  In the case of  the ESPCs for the Bangor Naval Submarine Base and Navy Region  Southwest, some of these up-front payments came out of a special  appropriation provided to address energy supply shortages in the West.   With respect to the ESPCs at North Carolina, Atlanta, and Patuxent River,  funds used to pay down the principal on the ESPC had previously been  appropriated to renovate, renew, or repair old energy consuming systems.   Since implementation of the ESPC made these activities unnecessary and  may be providing benefits other than costs savings, such as maintaining an  acceptable level of service, the funds from the avoided costs were put  toward the ESPC.  According to guidance issued by DOE’s Federal Energy  Management Program (FEMP), agencies are permitted to use funds  generated by these types of avoided costs to pay for ESPCs.  For the six ESPC case studies, up-front payments ranged between 2 and 45 percent of  total contract cycle costs.
section_title: Full Cost of Partnerships Is Unclear
paragraphs: None of our five partnership case studies lent themselves to a budgetary  cost analysis because comparable data were not available.  Two did not  involve cash transfers of any kind.  In the case of the other three, it was  unclear how much the projects would have cost had they used timely, full,  and up-front appropriations rather than partnership financing.  In these  cases, agencies sometimes incurred higher interest costs by using  partnership financing rather than timely, full, and up-front appropriations.   For example, DOE benefited from the use of a roughly $70 million private  bond offering to finance the revitalization of three buildings at ORNL.  The  financing structure used over the course of 25 years means DOE actually  will obligate funds equaling approximately $96 million, present value (PV).   Similarly, VA will obligate funds equaling approximately $43 million (PV)  over 35 years to pay off the approximately $33 million in bonds the  Authority issued to finance the construction of an office building and  parking area in Dekalb County, Ga.
However, officials said that other factors associated with partnerships,  such as lower labor costs and fewer bureaucratic requirements, could  make partnership financing overall less expensive than financing through  timely, full, and up-front appropriations.  For example, officials with DOE’s  M&O contractor said that, in the case of the ORNL revitalization project,  greater efficiencies existed in private sector construction since the  government would have had to enter into more costly union labor  agreements had it financed the project through timely, full, and up-front  appropriations.  Similarly, a VA official said that using an EU lease to  construct an energy center would be less expensive than financing the  asset through timely, full, and up-front appropriations because federal  labor agreements and acquisition regulations created inefficiencies in  federal construction.  As part of this engagement, we did not analyze these  claims to determine whether the efficiencies associated with private sector  construction would offset the higher interest costs of partnership  financing.
section_title: Uncertainty and Timing of Appropriations Affect Cost Effectiveness
paragraphs: Some agency officials said that ESPCs and partnerships are cost effective  because they allow agencies to acquire capital more quickly than through  appropriations.  They noted that it is uncertain when or whether timely,  full, and up-front appropriations will be made available.  Officials from  Navy, DOE, and GSA expressed their belief that funds obtained through  third parties would be available much more quickly than through  appropriations.  Consequently, officials said that agencies could accrue  more savings and avoid more costs using ESPCs and partnerships than they  would have if they had waited for appropriations.  For example, Navy  officials said that, had they not used ESPCs, Naval installations would have  had to pay higher utility bills while waiting for appropriations to finance  ECMs.  Similarly, at ORNL, one DOE official pointed out that although the  idea for three privately financed buildings was conceived at the same time  as the highest priority federally funded building, the three privately  financed buildings were completed and occupied at least a year in advance  of the one funded through appropriations.  Other DOE officials said that  the costs of maintaining obsolete, dilapidated buildings at ORNL while  waiting for appropriations would have added to the cost of waiting for full,  up-front appropriations.  Thus, according to these officials, capital  obtained through ESPCs and partnerships may be less expensive relative to  full, up-front appropriations than it seems.
Since the agencies did not request additional appropriations or adjust their  plans to accommodate needed capital investments, it cannot be known  whether agencies were correct in assuming that timely appropriations  would not be available.  Agencies are responsible for establishing funding  priorities to achieve their missions, including capital needs and mandated  energy savings.  Capital plans supported by strong analysis could help them  in setting priorities for funding requests.
section_title: Agencies Did Not Request Full, Up-Front Appropriations before Entering into ESPCs or Partnerships
paragraphs: Given the federal government’s ability to obtain capital at lower interest  rates than private companies, officials from each of our case study  agencies agreed that timely, full, and up-front appropriations were the  least-cost alternative for financing capital acquisitions.  However, officials  also stated that they did not request additional appropriations for the case  studies we reviewed because they were authorized to use the alternative  financing mechanism.  Further, they did not believe appropriations would  have been available in a timely manner.  For example, DOE officials said  that they had not requested full, up-front appropriations for certain aspects  of the ORNL revitalization project because, in the past, they had tried and  failed to obtain funding for similar projects.  The Director of DOE’s Office  of Science stated that it was particularly difficult to obtain funding for  general use office buildings compared to buildings specifically designed for  scientific research.  However, the poor condition of these general use  buildings negatively affected DOE’s ability to recruit and retain high-quality  scientists.  Because the agencies never requested appropriations for these  specific projects, it is impossible to know whether their assumptions were  correct.
GSA and Navy officials also said recent declines in up-front appropriations  for ECMs affected their decision to use ESPCs.  For example, according to  GSA officials, GSA’s budget authority for energy efficiency projects  declined from $20 million in fiscal year 1999 to $4.2 million in fiscal year  2004, and it received no funds in fiscal years 2002 and 2003.  They also  pointed to GSA’s $6 billion backlog of identified repair and alteration needs.   According to Navy officials, appropriations for its Energy Conservation  Improvement Program dropped from $21.7 million in fiscal year 1999 to  zero dollars in fiscal year 2000.  Although funding has increased in recent  years, it still remains well below 1999 levels.  According to the Director of  the Navy’s Energy Programs Division, the department receives less than   10 percent of the estimated $140 million needed each year to meet energy  savings goals.  Navy officials said that other priorities in the Navy’s budget  had taken precedence over energy reduction projects.  According to FEMP,  ESPC projects worth $1.7 billion have been implemented by 18 federal  agencies and departments.  Without ESPCs, agencies would have to  reassess their budget plans to accommodate investments in ECMs and/or  Congress would be asked to appropriate funds today to meet currently  required energy consumption standards.
Officials also pointed out that agencies had been granted statutory  authority to use ESPCs and partnerships.  For example, the Energy Policy  Act of 1992 authorized agencies to fund ECMs through ESPCs.
Additionally, OMB issued two memorandums encouraging agencies to use  ESPCs to achieve long-term energy savings.  In addition, the Atomic Energy  Act granted DOE authority to give away land for mission purposes and  enabled it to finance improvements on that land through private sector  financing.  Similarly, VA officials said that the agency’s EU lease authority  specifically enabled it to enter into partnerships with nonfederal sector  entities to finance capital.
section_title: Different Financing Alternatives Present Different Implementation and Monitoring Challenges
paragraphs: Third-party financing can make it easier for agencies to manage in the short  term within a given amount of budget authority but may have additional  long-term costs.  With ESPCs, case study agencies relied heavily on ESCOs  to recommend potential ECMs, install the equipment, and then verify that  the recommended improvements yield intended results.  Partnership  arrangements generally entail a government agency engaging another party  to, among other things, renovate, construct, operate, or maintain a public  facility.  Such relationships increase the need for effective implementation  and monitoring by agencies to ensure the government’s interests are  protected.  For example, reliance on outside parties can leave the  government open to problems resulting from conflicts of interest and  presents monitoring challenges.  The ESPCs and one of the partnerships  we reviewed highlighted these vulnerabilities.  An evaluation of funding  alternatives was not always done to determine the most appropriate way of  funding capital projects.  Finally, VA has used partnership financing to  engage in an activity that is not related to VA’s mission and which it  ordinarily would not fund through full, up-front appropriations.
subsections: section_title: Third-Party Financing Increases the Risk of Conflicts of Interest and Presents Monitoring Challenges
paragraphs: As the government teams with outside parties to acquire capital, it must  ensure that its welfare is protected from conflicts of interest.  ESPCs  introduce concerns over conflicts of interest due to the heavy reliance  upon ESCOs.  Partnership arrangements can also create management  challenges as outside participants gain influence over projects.  Active  participation and scrutiny by agencies can help ensure the government’s  interests are not compromised.
subsections: section_title: ESPC Process Creates Potential for Conflicts of Interest
paragraphs: Once agencies decide to use an ESPC and select an ESCO to work with,  they must ensure that the government’s interests are protected from the  potential conflicts of interest that may arise from the ESCO’s  comprehensive role in recommending what ECMs are needed and then in  monitoring and verifying the performance of the equipment that they  recommended, installed, and guaranteed.  For example, an ESCO  prepares a Detailed Energy Survey (DES), which is an investment-grade  audit that determines what ECMs will be installed as part of the ESPC.   This serves as the basis for the project’s estimated savings, M&V, and O&M,  and is used to develop the final energy project proposal.  After the ESCO  installs the ECMs, it measures and verifies that the contractually  guaranteed savings it estimated are being achieved.  To ensure the  government’s interests were protected, staff at both GSA and the Navy  reviewed documentation and participated throughout the ESPC process.   Given its decentralized process for managing ESPCs, GSA uses a FEMP  project facilitator for technical assistance on its ESPC delivery orders.  To  the extent desired by federal agencies using its Super ESPC, FEMP  provides assistance through training, project development tools, and  technical support.  According to FEMP and Navy officials, the Navy’s  centralized process for managing ESPCs enables it to maintain sufficient  in-house technical expertise and the Navy does not typically employ  FEMP’s assistance.  However, the Navy frequently uses FEMP’s free  services, such as reviewing proposals, and has purchased FEMP’s support  in special circumstances.
Although both GSA and the Navy took an active role in negotiating the case  study ESPCs to protect the government’s interests, the process by which  these contracts are structured can still introduce problems resulting from  ESCO’s conflicts of interest.  For example, case study agencies relied  heavily upon the ESCOs to estimate facilities’ energy use after ECM  installation compared to what baseline energy use would have been if  ECMs had not been installed.  Projected energy savings are calculated by  subtracting estimated energy use after ECMs have been installed from  baseline energy use.  According to FEMP guidance, these calculations  should be examined in detail because they are the basis for determining  whether the contractually guaranteed savings are achieved.  Nonetheless, a  number of Army Audit Agency reports issued over the last several years  stated that energy savings baselines established by the ESCOs were faulty,  resulting in overpayments to the ESCO.  For example, some baselines used  incorrect assumptions such as overstated operating hours.   Representatives from two ESCOs noted that the greater the experience of  the government team, the greater the intensity of the negotiations.   Therefore, FEMP assistance is particularly important for agencies with  relatively little ESPC experience.  Given agencies’ reliance on the ESCOs in  the ESPC process, agencies must be diligent to ensure that the  government’s best interests are protected.  Employing best practices in  using ESPCs also may provide opportunities to better ensure the  government receives the best value for its investment.
section_title: Monitoring Challenges Existed for Complicated ORNL Partnership
paragraphs: The partnership between DOE, its management and operations (M&O)  contractor UT-Battelle, LLC, and UTBDC, created monitoring challenges.   Although we found no evidence of fraud, waste, or abuse, these challenges  were created when officers of the M&O contractor recommended that DOE  transfer land, without charge, to UTBDC.   The same officers of the M&O  contractor that recommended this course of action to DOE also served as  officers of UTBDC, the organization that received the land.  UT-Battelle,  LLC, contracted with UTBDC, which arranged for the private financing to  construct three general-use office buildings.
Accordingly, because the M&O contractor, not DOE, was directly involved  in the contract, DOE was presented with monitoring challenges.  DOE  counsel both at Oak Ridge and headquarters told us that DOE’s risk was  minimal and that monitoring of the partnership was not necessary.  At Oak  Ridge, counsel told us that so long as the end product was what they  wanted, DOE did not have much of a role.  At headquarters, counsel told us  that DOE does not provide oversight or micromanage how M&O  contractors work with subcontractors.  Further, we were told that DOE  does not question M&O contractors’ practices because DOE officials  believe these contractors to be trustworthy.  Nonetheless, the primary  purpose of the partnership was to obtain facilities for DOE’s use and  ultimately the revenue stream supporting the financing will be paid through  DOE appropriations.  Thus, we believe greater monitoring and oversight  was warranted to ensure that the contractor operates in the government’s  best interest.
section_title: Business Case Analysis Needed to Ensure Third- Party Financing Is in the Government’s Best Interest
paragraphs: Our prior work has shown that, as part of a capital review and approval  process, leading organizations develop decision packages, such as business  case analyses, to justify capital project requests.  These packages are  supported by detailed economic and financial analyses such as cost- benefit, return on investment, life-cycle costs, and comparative alternative  analyses, and recommend the most cost-effective option.  Both OMB and  our guidance stress that, when a performance gap between needed and  current capabilities has been identified, it is important that organizations  carefully consider how best to bridge the gap by identifying and evaluating  a full range of alternatives to construct or purchase a new capital asset.   This type of analysis was not always performed for the case studies we  reviewed.  For example, large buy-downs of ESPC principal raised  questions about the need for ESPC financing.  A business case analysis  might have demonstrated that sufficient funds were available to purchase  ECMs in smaller, useable segments, when technically feasible.  In addition,  not all partnerships included a business case analysis to determine whether  third-party financing was the most cost-effective alternative.
subsections: section_title: Large Buy-Downs of Principal Raise Questions About the Need for ESPC Financing
paragraphs: One key attraction for using ESPCs is that they enable agencies to acquire  ECMs even if funds are available only to pay for the first year of the  contract.  However, three of the six case studies we reviewed obligated and  paid a significant portion of the total cost of the ECMs in the first year of  the contract.  These large buy-downs of principal avoided repair,  replacement, and renovation costs as a result of implementing the ESPC.   They also imply opportunities exist to acquire ECMs in smaller, useful  segments, when technically feasible with timely, full, and up-front  appropriations instead of through ESPCs.  For example, agencies could  individually acquire an ECM such as an air chiller without bundling it into  an ESPC.  Navy and GSA officials indicated they typically did not consider  financing ECMs through useful segments or through full and up-front  appropriations.  They also told us they did not did not perform a business  case analysis before deciding to use ESPCs because of the administrative  cost of such an analysis since they believed there was no other viable  option.  Officials explained that their agencies did not request full, up-front  appropriations since appropriations might not have been made available in  a timely manner and the use of ESPCs had been authorized.  Analyzing the  full range of funding alternatives would help agencies determine if  acquiring ECMs in these useful segments would be a more cost-effective  alternative.
As previously discussed, FEMP guidance permits agencies to apply avoided  repair or replacement expenses for large equipment as one-time cost  savings to buy-down principal.  For three of our case studies that followed  this guidance, these one-time savings were approximately 7 percent, 38  percent, and 39 percent of contract cycle costs.  According to GSA and  Navy officials, these funds had already been appropriated for the repair or  replacement of old equipment.  The ESPC made this repair or replacement  unnecessary and thus freed-up funds for other uses, such as buying down  the ESPC principal.  Although paying down principal up-front has the  benefit of reducing financing costs to the government, the availability of  these funds highlights the need for an analysis of the feasibility of  purchasing ECMs in useful segments rather than through an ESPC.
Agency officials expressed concern that acquiring ECMs in smaller, useful  segments would mean that some energy inefficient equipment would be  kept in use longer than if acquired in bulk through the ESPCs.  In addition,  they noted that buying the ECMs in smaller quantities might cause the  government to lose economies of scale achieved through the larger  contracts.  This concern was echoed by an ESCO representative, who  pointed out that fixed costs for smaller contracts would be similar to those  of larger projects.  Nonetheless, given the higher financing and likely  additional M&V expenses, agencies should formally assess the costs, on a  present value basis, to determine the most cost-effective alternative.
section_title: Agencies Did Not Always Assess the Cost-Effectiveness of Partnership Arrangements
paragraphs: Three of the five partnership arrangements we reviewed were undertaken  to obtain project financing.  Leading capital practices for capital decision- making would call for business case analyses in such cases, which include  analyzing the full range of funding alternatives.  However, for two of these  three partnerships, agencies did not assess the full range of alternatives to  determine how best to fund the project.  For example, DOE officials could  not provide evidence that the department had prepared or reviewed a  business case analysis for the financing arrangement at ORNL.  While  ORNL’s M&O contractor, UT-Battelle, LLC told DOE employees that private  financing of three general-use office buildings was in the government’s best  interest, in our opinion the data provided to DOE were summarized at such  a high level that DOE could not have done a comparative analysis of  financing alternatives.  Although UT-Battelle, LLC’s detailed analysis was  readily available to the department, UT-Battelle, LLC officials told us that  data were not requested from nor provided to DOE.  This analysis  contained much greater detail, including an analysis of the cost of  maintaining old, dilapidated buildings but did not analyze timely up-front  appropriations as an alternative.  DOE staff informed us that they had a  good relationship with UT-Battelle, LLC and had no reason to doubt the  summary analysis provided.  However, a memorandum issued by DOE’s  Assistant General Counsel for General Law regarding the applicability of  OMB Circular A-11 to the Oak Ridge National Laboratory land transfer  proposal said that the department’s policy would require DOE to do a  comparative cost-analysis between using appropriated funds to build the  facilities now and the cost of funding UT-Battelle, LLC’s sublease payments.
VA did not compare the cost of financing the regional office building  through up-front appropriations to the cost of financing it through  Georgia’s DeKalb County Development Authority.  To avoid steep rent  increases in GSA leased space and to collocate its regional office with an  existing medical center, VA formed a partnership with the Authority to  finance the construction of its new regional office building on VA-owned  land.  Although VA prepared a business case analysis comparing leasing  from GSA to financing construction through the Authority, VA told us it did  not compare the cost of financing through the Authority versus up-front  appropriations.
section_title: One Partnership Led to Involvement in a Nonmission-Related Activity
paragraphs: VA has used partnership financing to engage in an activity that is not  related to its mission and in which it ordinarily would not fund through full,  up-front appropriations.  In one instance VA used its EU lease authority to  construct a power plant for its North Chicago campus.  VA officials said  that it is doubtful that VA would ever construct and operate a power plant  on its own since (1) power generation is not a core activity within VA’s  mission and (2) VA does not possess the necessary expertise.  However,  according to VA officials, the Navy, the only provider of steam in the area,  had been charging VA rates above those charged by other suppliers to  consumers in neighboring areas of Chicago and this EU lease enabled VA to  reduce its energy costs.
section_title: Conclusions
paragraphs: ESPCs and partnerships that we reviewed were authorized by Congress.   The financing approaches used in many of the case studies were structured  to include features for which OMB did not require up-front budget  recognition even though they established long-term commitments of the  government.  One or more of the following features were used by case  study agencies: (1) the transfer of government land to third parties, (2) use  of a third-party rather than the U.S. Treasury to finance assets over time,  (3) use of short-term leases for potentially long-term needs, (4) noncash  transactions, (5) contractually guaranteed savings, and (6) statutory  authority to enter into ESPCs without funds to obligate the full contract  price.  In the case studies we reviewed, the capital assets acquired offered  benefits to the government such as energy conservation and a collocated  VA regional office and medical center.  It is not the purpose of this report to  second guess the benefits of the assets.  This report focuses only on the  budgetary process of justifying the means of acquiring and financing assets.   Even though project financing may be obtained more quickly by using  alternative financing mechanisms, these mechanisms do not disclose the  federal government’s measure of long-term obligations in the budget.  As a  result, when resource allocation decisions are made, costs are not shown  on comparable bases.  This can favor capital programs financed through  these mechanisms over other programs (including capital) that include  their full costs up front in the budget.
In our work on capital planning, we noted that leading practices include  analyzing alternative approaches to financing capital by using methods,  such as net present value analysis, to analyze relevant alternatives to  address capital needs. OMB's capital planning guidance also suggests that  agencies need to select the alternative with the most cost-effective results  over the long term, based on a present value analysis. This analysis would  include all relevant federal financing costs associated with the alternatives  and any potential savings that can be attributed to the various alternatives.
Long-standing federal budget concepts and our own work reinforce the  principle that full accountability for budgetary decisions is best guaranteed  by recognizing the full costs of federal initiatives at the time when the  decision is made to commit federal resources.  One way to ensure that  costs of assets used for long-term commitments are appropriately  considered in the budget would be to score up front the expected payments  over the same period of time used to analyze ownership options.  This  would require going beyond the strict terms of a proposed transaction and  scoring based on the substance of the deal.  Although ensuring the validity  of agencies’ long-term plans may pose implementation challenges, such as  the need to validate agencies’ long-term capital requirements, such scoring  could result in a better reflection of the government’s full commitment.
In addition to potentially affecting budget decisions, our case studies  showed that funding capital projects through alternative financing  mechanisms may be more expensive to the government than funding  through appropriations because the private sector’s cost of capital is  generally higher than the federal government’s.  Other factors such as  additional M&V and lower labor costs also may affect the cost of  alternative financing.  Using a proxy of their cost to the government, ECMs  obtained through ESPCs we reviewed at the Navy and GSA cost between 8  and 56 percent more than the same ECMs funded through up-front  appropriations.  Also, agencies did not specifically analyze and compare all  alternatives, nor did they investigate the feasibility of purchasing ECMs in  useful segments.  Given the federal government’s ability to obtain capital at  lower interest rates than private companies, officials at case study agencies  agreed that funding through timely, full, and up-front appropriations is less  expensive than third-party financing.  However, with respect to  partnerships, other factors such as lower labor and fewer bureaucratic  requirements may offset higher financing costs.  Therefore, it is uncertain  whether using partnerships is more or less expensive than using up-front  financing.  Agencies did not adjust their capital plans to accommodate  needed capital investments nor request appropriations to finance capital  projects because they did not believe sufficient appropriations would be  available in a timely manner.  Instead, they used the authorities provided to  them to finance projects over time, through third parties.  By incurring  potentially higher costs in the future to avoid making difficult trade-offs  today, agencies merely defer the trade-offs to a later date and a subsequent  Congress.  These trade-offs would lead Congress to either increase  appropriations to maintain the current level of investment or fund fewer  projects.
Agencies are faced with requirements for energy savings and need  appropriations to implement energy conservation measures.  At the same  time, Congress is faced with allocating scarce resources for many needs  across the government.  Recently, Congress expressed its current priorities  for energy saving projects by extending ESPC authority until October 1,  2006, to permit the financing of such projects through private companies  over time.  As shown in our report, this favorable budget treatment comes  at a cost—a cost that Congress needs to monitor as these contracts are  used during the next 2 years.
Implementation and monitoring of ESPCs is a relatively uniform process.   Since partnerships take a variety of forms, their implementation and  monitoring is more complex.  While third-party financing can make it easier  for agencies to quickly finance projects within a given amount of budget  authority, it also presents monitoring challenges.  In a federal setting, even  the appearance of a problem such as a conflict of interest is of concern  because it can erode the public’s confidence in the government and  ultimately degrade an agency’s ability to carry out its mission.  The use of  third-party participants increases the importance of ensuring that the  government’s interests are protected and the performance of these third- party participants should be carefully monitored and verified.
section_title: Matter for Congressional Consideration
paragraphs: Given the competing pressures faced by Congress to support energy saving  investments while at the same time seeking to ensure budgetary  transparency of full program costs, Congress should consider requiring  agencies that use ESPCs to present Congress with an annual analysis  comparing the total contract cycle costs of ESPCs entered into during the  fiscal year with estimated up-front funding costs for the same ECMs.   Congress could use this information in evaluating whether to further  extend ESPC authority beyond its current expiration date.
section_title: Recommendations for Executive Action
paragraphs: First, we recommend that the Director of OMB instruct agencies that use  ESPCs to report to OMB and to their committees of jurisdiction an annual  analysis comparing the total contract cycle costs of ESPCs entered into  during the fiscal year with estimated up-front funding costs for the same  ECMs. Congress could use this information in evaluating whether to  further extend ESPC authority beyond its current expiration date.
Second, we recommend that the Director of OMB work with the  scorekeepers to develop a scorekeeping rule for the acquisition of capital  assets to ensure that the budget reflects the full commitment of the  government for partnerships, considering the substance of all underlying  agreements, when third-party financing is employed.
Finally, we recommend the Secretaries of Energy, VA, and the Navy and the  GSA Administrator perform business case analyses and ensure that the full  range of funding alternatives, including the technical feasibility of useful  segments, are analyzed when making capital financing decisions.
section_title: Agency Comments and Our Response
paragraphs: In a draft of this report, we had a recommendation that the Director of  OMB work with scorekeepers to develop a rule that would ensure that the  full commitments of ESPCs are reflected in the budget.  Several agencies  did not agree with this recommendation, citing concerns that such a rule  would likely discourage or prevent agencies from entering into ESPCs.  In  light of Congress’ recent expression of its current priorities by extending  ESPC authority through fiscal year 2006, we dropped this recommendation  with respect to ESPCs and included instead the first recommendation to  OMB and the matter for congressional consideration described above.
We obtained comments from OMB and our case study agencies—DOD,  DOE, VA, and GSA.  OMB agreed in concept with our second  recommendation that OMB work with scorekeepers to develop a rule for  partnerships that would ensure the budget reflects the full commitment of  the government, considering the substance of all underlying agreements.   DOE and VA disagreed with this recommendation based on concerns that  such a rule would effectively make alternative financing unavailable to  federal agencies. While it is not our intent to discourage or eliminate  partnerships with the private sector, recognizing the full commitment up- front in the budget enhances transparency and enables decision makers to  make appropriate resource allocation choices among competing demands  that all have their full costs recorded in the budget.  GSA did not address  this recommendation in its comments.  DOE, GSA, and VA agreed at least in  part with our final recommendation, that case study agencies should  perform business case analyses to ensure the full range of funding  alternatives are analyzed when making capital financing decisions.  DOD  disagreed with this recommendation and OMB did not address it in its  comments.  Business case analyses are well accepted as a leading practice  among public and private entities and OMB requires all executive branch  agencies to prepare such analyses for major investments as part of their  budget submissions to OMB.  Therefore, we believe our recommendation is  appropriate.
Representatives from OMB, including staff from the Office of General  Counsel, provided oral comments on our draft.  These representatives  stated that OMB “meets regularly with Congressional scorekeepers to  review the scorekeeping rules and updates A-11 guidance in order to  accurately reflect the types of transactions and obligations the government  is entering into. OMB staff stated that they would take into consideration  the findings of the report and the agencies’ comments on the report,  including whether contractually guaranteed savings are equitably  considered and given due credit when evaluating ESPCs.  OMB staff also  noted that recent updates in 2003 to scorekeeping guidance related to  lease-backs from public/private partnerships may address some of the  concerns GAO noted in the draft.”  OMB staff said that the new  scorekeeping guidance attempts to ensure that the substance of the entire  transaction is scored.  We have clarified in the report that OMB’s  instructions were revised in 2003 and the possible effect on how case  studies were scored.
With respect to ESPCs, OMB representatives said there is no current plan  to revisit the 1998 decision to obligate funds on an annual basis.  They said  ESPCs are treated differently from partnerships in part because of the  savings component and in part because they believe doing so would negate  the statutory authority provision permitting agencies to enter into a  multiyear contract even if funds are available only to pay for the first year  of the contract.  We recognize the statutory authority enabling agencies to  enter into ESPC multiyear contracts without funds available for the full  contract price but note that the budget does not reflect full ESPC  commitments as new obligations at the time that ESPCs are signed.  In light  of these circumstances and Congress’ recent action to extend ESPC  authority through fiscal year 2006, we removed our scorekeeping  recommendation with respect to ESPCs and are now suggesting that  Congress consider requiring agencies that use ESPCs to present Congress  with an annual analysis comparing the total contract cycle costs of ESPCs  entered into during the fiscal year with estimated up-front funding costs for  the same ECMs.  Congress could use this information in evaluating whether  to further extend ESPC authority beyond its current expiration date.
DOD partially concurred with our recommendation (now deleted) about  developing a new scorekeeping rule for ESPCs.  In his letter, the Principal  Assistant Deputy Under Secretary of Defense (Installations and  Environment) said DOD would concur in full if the recommendation was  modified to properly consider guaranteed savings.  As we note in our  report, recognizing the full commitment up-front in the budget when the  commitment is made enables decision makers to make more informed  resource allocation choices among competing demands from equally  worthy projects that all have their full costs recorded in the budget.  DOD  stated that it did not concur with our recommendation that business case  analyses should be performed when making capital financing decisions  because such an analysis would only increase administrative costs to the  department in the absence of a viable option to directly finance energy  conservation projects.  Business case analyses are well accepted as a  leading practice among public and private entities and OMB requires all  executive agencies to prepare a business case analysis for major  investments as part of their budget submissions.  Only by doing a business  case analysis can the government ensure that it selects the best alternative  and that taxpayers’ interests are protected.  Therefore, we believe our  recommendation is valid.  DOD also provided technical comments on the  draft.  DOD’s complete comments and our responses are contained in  appendix IV.
The Acting Under Secretary for Energy, Science and Environment agreed  with our recommendation that agencies should perform business case  analyses and we commend DOE for drafting a policy that will require a  business case analysis for public/private partnerships.  However, DOE  strongly disagreed with our recommendation on scoring ESPCs (now  deleted) primarily because it believes it would negate the congressional  objective of promoting energy conservation through the use of ESPCs.  It is  not the intent of this report to discourage or to eliminate energy  conservation efforts.  We do not believe that up-front funding would  necessarily lead to reduced support as long as energy conservation was  viewed as a priority within the appropriations process.  However,  recognizing the full commitment up front in the budget when the  commitment is made enhances transparency and enables decision makers  to make more informed resource allocation choices among competing  demands that all have their full costs recorded in the budget.  We believe  our recommendation that OMB require and our suggestion that Congress  consider requiring agencies to provide an annual analysis comparing total  contract cycle costs of ESPCs with estimated up-front funding costs for the  same ECMs would be an appropriate balance between budget transparency  and energy savings at this time.  DOE’s complete comments and our  responses are contained in appendix V.
Because GSA does not normally engage in public/private partnerships, its  comments were confined to ESPCs.  The GSA Administrator noted that  GSA’s policy is to perform business case analyses, but that such analyses do  not always consider the full range of funding alternatives for ECMs.  An  official from GSA’s Atlanta region noted that, given GSA’s $6 billion  alterations and repair backlog, other financing alternatives may not be  viable.  GSA also said it has decided to revise its energy conservation  project evaluation process to include consideration of useful segments.  We  commend GSA’s decision to do so.  Finally, GSA pointed out that, aside  from ancillary up-front costs that must be incurred to carry out the project,  ESCOs guarantee that project savings will be met or exceeded during the  contract term and that GSA enforces these guarantees.  Because these up- front payments are part of the costs in the delivery orders we reviewed, we  included them in our analysis of total contract cycle costs—the payments  ranged between 2 and 45 percent of the total contract cycle costs.  For each  of the three GSA ESPCs we reviewed, total contract cycle costs exceeded  contract cycle savings.  GSA’s written comments and our complete  response are contained in appendix VI.
VA disagreed with our report’s conclusions and recommendation to OMB.   Although our report only looked at VA partnerships, VA chose to comment  both on partnerships and ESPCs.  In the Secretary’s comments, he noted  that implementation of the recommendation to develop a new  scorekeeping rule would limit, discourage, and possibly eliminate the  enhanced-use lease program, thus resulting in a loss of benefits and  services to veterans.   Again, it is not the intent of this report to discourage  or to eliminate energy conservation efforts or partnerships with the private  sector.  However, from a budgetary standpoint, recognizing the full  commitment up front in the budget when the commitment is made enables  decision makers to make more informed resource allocation choices  among competing demands.  With respect to our second recommendation  regarding the need for business case analyses, VA noted that it had a  process for this to occur for capital investments above a threshold amount.    VA’s complete comments and our responses are contained in appendix VII.
As agreed with your office, unless you release this report earlier, we will  not distribute it until 30 days from the date of the letter.  At that time, we  will send copies of this report to the Ranking Minority Member of the  Senate Committee on the Budget and the Chairman and Ranking Minority  Member of the House Committee on the Budget.  We will also send copies  to the Chairmen and Ranking Minority Members of the House and Senate  Appropriations Committees, House and Senate Veterans Committees, and  House and Senate Energy Committees.  In addition, we are sending copies  to the Secretaries of Defense, Energy, and Veterans Affairs as well as the  Administrator of the General Services Administration and the Director of  the Office of Management and Budget.  Copies will also be made available  to others upon request.  In addition, the report is available at no charge on  GAO’s Web site at http://www.gao.gov.
This report was prepared under the direction of Susan J. Irving, Director,  Federal Budget Analysis, Strategic Issues, who can be reached at   (202) 512-9142 or irvings@gao.gov and Mark L. Goldstein, Director,  Physical Infrastructure Issues, who can be reached at (202) 512-6670,  goldsteinm@gao.gov.  Questions may also be directed to Christine Bonham,  Assistant Director, Strategic Issues, at (202) 512-9576 or bonhamc@gao.gov.   Other key contributors to this report are listed in appendix VIII.
section_title: Objectives, Scope, and Methodology
paragraphs: The objectives of this study were to determine (1) what specific attributes  of energy savings performance contracts (ESPC) and public/private  partnerships (partnerships) contributed to budget scoring decisions,   (2) the costs of financing through ESPCs and partnerships compared to the  costs of financing via timely, full, and up-front appropriations, and (3) how  ESPCs and partnerships are implemented and monitored.  To obtain the  detail necessary to respond to this request, we used a case study approach.   Accordingly, our findings cannot be used to generalize across the  government.  We selected case study agencies based on our August 2003  report on alternative approaches to finance capital.  In total, we analyzed  11 case studies—6 ESPCs and 5 partnerships—across 4 agencies.
For ESPCs, we selected case studies at the General Services  Administration (GSA) and the Department of the Navy (Navy).  We chose  these two agencies because they had awarded the largest dollar volume of  delivery orders under the Department of Energy’s (DOE) super ESPC  program.  In addition, our discussions with DOE's Federal Energy  Management Program (FEMP) officials, who administer the Super ESPC  program, indicated that the differences in the way GSA and the Navy  administer ESPCs (decentralized versus centralized, respectively) might  provide some interesting insights.  Finally, the Committee’s request  specifically asked us to include a military department in our review of  ESPCs.
For partnerships, we selected case studies at the Departments of Veterans  Affairs (VA) and Energy.  We chose VA because of its broad authority to  enter into enhanced use (EU) lease partnerships and the significant  number of EU leases that have been awarded.  We selected one case from  DOE based on the preliminary work on the Oak Ridge National Laboratory  (ORNL) partnership done for our August 2003 report.  Also, it was our  understanding that this type of transaction might be replicated at other  DOE facilities.
The initial selection of case studies within each agency was based on   (1) project costs, (2) availability/location of data, and (3) time frame of the  project.  These criteria narrowed the number of available case studies and  we judgmentally selected cases from this pool.  We chose three ESPC  projects each from GSA and the Navy.  Also, we chose to review one  partnership case study from DOE and four from VA.  Table 2 lists the case  studies reviewed at each agency.
Case studies were selected based on their cost and data availability.  Data  for the selected cases were in Washington, D.C., for VA cases; Atlanta,  Georgia, for GSA cases; Port Hueneme, California, for Navy cases; and Oak  Ridge, Tennessee, for the DOE case study.  We selected ESPCs for which  contracts/delivery orders were awarded no later than fiscal year 2001 so  that the respective agencies would have had opportunities to analyze  whether cost savings realized to date approximate expected savings.
To understand the features of the selected ESPCs and partnerships, we  reviewed laws authorizing the agencies to enter into ESPCs and  partnerships, relevant GAO products, and ESPC files and partnership  agreements.  We interviewed officials and/or staff from the Office of  Management and Budget (OMB) and agencies involved in the development  of the selected ESPCs and partnerships.  We interviewed officials from  FEMP in order to understand the general features of ESPCs.  In addition,  we met with officers of UT-Battelle, LLC—ORNL’s management and  operations (M&O) contractor—to gain a better appreciation of the DOE  partnership.
To gain an understanding of how the selected ESPCs and partnerships were  scored and the reasoning behind the scoring, we reviewed relevant  portions of OMB’s Circular A-11, analyzed the terms and conditions of the  selected case studies relative to the budget scoring rules, reviewed relevant  Congressional Budget Office (CBO) scoring reports, and met with agency,  CBO, and OMB officials and staff.  All of the partnership case studies we  reviewed were executed before OMB's 2003 changes to its instructions on  the budgetary treatment of lease-purchases and leases of capital assets.   According to OMB staff, some of these partnerships may have been scored  differently under the revised instructions.
To analyze ESPC costs, we reviewed the final delivery orders of each of our  six ESPC case studies.  Cash flow schedules associated with these delivery  orders specified the case studies' expected savings and costs, such as  principal payments, interest payments, measurement and verification  (M&V) fees, operations and maintenance (O&M) fees, and energy service  company (ESCO) mark-ups.  Using these documents, we identified costs,  on a present value (PV) basis (using A-94 guidance), that agencies would  not necessarily have incurred had they financed the asset acquisition  through timely, full, and up-front appropriations instead of ESPCs.   Although we had planned to perform a similar cost analysis of our  partnership case studies, we were unable to do so because comparable  data were not available.
To allow us to describe how ESPCs and partnerships are implemented and  monitored, we met with OMB, GSA, VA, Department of Defense (DOD),  and FEMP officials and staff.  We also spoke with representatives of certain  ESCOs to help us understand how agencies negotiate and monitor ESPC  contracts.  Finally, we reviewed agencies’ documentation of how ESPC  baselines were estimated and how actual savings would be determined.
Written comments from DOD, DOE, GSA, and VA are included and  addressed in appendixes IV through VII.  OMB provided oral comments.   We have incorporated changes as a result of these comments throughout,  as appropriate.
Our work was done in accordance with generally accepted government  auditing standards, from September 2003 through November 2004, in  Washington, D.C., Atlanta, Ga., Oak Ridge, Tenn., and Port Hueneme, Calif.
section_title: ESPC Case Studies
paragraphs: The Energy Policy Act of 1992 and Executive Order 13123 require federal  agencies to reduce their consumption of energy in federal buildings. The  act set a goal for the agencies of lowering their consumption per gross  square foot by fiscal year 2000 to a level 20 percent below fiscal year 1985  baseline consumption levels.  Executive Order 13123 requires a 30 percent  reduction from 1985 levels by the year 2005 and a 35 percent reduction by  2010.  ESPCs allow federal agencies to acquire energy conservation  measures (ECM) to meet these goals and implement energy-efficiency  projects without having to request the full amount of appropriations from  the federal budget.  Under an ESPC, the ESCOs assume much of the up- front capital costs associated with the improvements.  The government  then uses a portion of annual energy-related cost savings attributable to the  improvements to repay the ESCO for its investment over time, which may  be as long as 25 years.  This means that, although the government’s energy  use may drop immediately, its expenses are generally not significantly  reduced until after the ESPC is paid off (see fig. 8).  The ESCOs guarantee  the performance of the equipment, within certain parameters, for the term  of the ESPC.  Agencies frequently acquire multiple or “bundled” ECMs  through ESPCs so that ECMs yielding more dollar savings can subsidize  those yielding less savings.
Within DOE, the FEMP provides assistance to agencies seeking project  financing through a number of methods, such as ESPCs.  According to  FEMP guidance, energy-related savings result from reduced energy use,  improved patterns of energy use, avoided renovation, and reduced  operations, maintenance, and repair costs.  Thus, if agencies can avoid  scheduled renovations or maintenance of older equipment by  implementing ESPCs, they may use those avoided costs to “buy-down” the  ESPCs.
To streamline the procurement process, agencies have awarded multiple- award, indefinite-delivery-indefinite quantity (IDIQ) contracts to a number  of ESCOs in different regions of the country.  With these multiple-award  contracts in place, federal agencies can place and implement delivery  orders against the contracts in a fraction of the time it takes to develop a  stand-alone ESPC because the competitive selection process has already  been completed and key terms of the contract, such as maximum markup  ceilings, have already been negotiated.   FEMP’s IDIQ contract, known as a  super ESPC, is used by many agencies.  Figure 9 shows the distribution of  agencies using FEMP’s super ESPC from fiscal years 1998 through 2003.   The bar on the right of the figure shows in more detail the 25 awards at  other agencies using FEMP’s super ESPCs.
GSA generally writes delivery orders against FEMP’s super ESPC, while the  Navy writes delivery orders against a variety of IDIQ contracts, referred to  as contracting vehicles.  Figure 10 shows the distribution of Navy ESPC  awards by contract vehicle from fiscal years 1998 through 2003.
FEMP has issued guidelines and offered training and other support to help  agencies use its Super ESPC.  A typical suite of FEMP services, costing an  estimated $30,000, includes, but is not limited to, a review of the ESCO  submittals and advice on:  detailed energy surveys (DES) and related energy baseline data;  appropriateness of (M&V) plan for proposed ECMs;   technical and economic feasibility of proposed ECMs;  pricing and financing of ECMs and post-installation services submitted  in price schedules;  issues to address during agency/ESCO negotiations;  commissioning and postinstallation M&V reports and advice on project   annual M&V reports to verify annual energy savings or issues to resolve  before resuming payments.
GSA sometimes uses FEMP’s services.  Because the Navy has a centralized  technical and contracting team that is familiar with ESPCs, it uses its own  staff rather than FEMP's contracting officers and facilitators to support  projects.  However, the Navy has used some FEMP’s services, such as  reviews of initial project proposals, free of charge, and has purchased other  FEMP support in special circumstances.
The process for selecting and implementing ESPCs varies among agencies.   GSA and the Navy generally delegate the decision of whether to finance  ECMs through full, up-front appropriations or ESPCs to regional  coordinators and installations’ commanding officers, respectively.  Once  the decision to use an ESPC has been made, GSA and the Navy build  support and consensus for the project inside the agency.  FEMP guidance  also suggests agencies meet informally with prequalified ESCOs before  selecting an ESCO for the contract.  The Navy may invite vendors to  participate in oral presentations covering a range of topics, including their  qualifications and past performance with ECMs as well as their technical  approach for projects.  Based on these presentations, the local facility  makes its selection.
After the contractor has been selected, the project team schedules an initial  meeting, referred to as a “kick-off” meeting, to discuss, among other things,  the scope of an initial energy survey, payback terms and restrictions, O&M  requirements, M&V approaches, and site-specific information.  The  contractor then performs a preliminary site survey, based on a building  walk-through and spot metering as well as an analysis of various data, such  as utility rate structure and energy consumption statistics.  Upon  completion of the energy audit, the contractor submits an initial proposal  that includes a summary of ECMs investigated and cost and savings  estimates.  Based on a review of this initial proposal, the agency decides  whether or not to proceed with the ESPC.  If it decides to go forward, the  agency transmits a letter confirming its intention to award the delivery  order to the ESCO (the Notice of Intent to Award) and issues a delivery  order request for proposal.  It is only after the agency issues the Notice of  Intent to Award that the ESCO’s expenses may be recoverable from the  government.
The contractor then performs a DES and submits a report that is the basis  for the project’s contractually guaranteed savings, M&V, and O&M.  The  DES is the ESCO’s comprehensive audit of facilities and energy systems at  the project site.  The DES augments, refines, and updates the preliminary  site survey data and provides the information needed to update the  feasibility analyses of the various ECMs under consideration for the  project. The agency’s project team reviews the proposal and submits its  comments to the ESCO.  Based upon these comments, the ESCO develops  a final energy project proposal.  For projects with a cancellation ceiling in  excess of $10 million, the agency must notify Congress of the project no  later than 30 days before the task order award.  After the agency approves  the project and negotiates the price or determines the price to be fair and  reasonable, the project is awarded.
During the project execution phase, the contractor completes the project  design and then installs the ECMs.  Title of the equipment and systems built  or installed under the delivery order is transferred from the ESCO to the  agency at the time of delivery order award, installation, or contract  closeout.  ESPCs do not involve change orders since contractors  guarantee certain levels of performance and are obligated to make changes  necessary to achieve those levels at their own expense.  However, the  agency and the contractor may modify the delivery order to, for example,  authorize the installation of additional ECMs.  Once the project has been  successfully completed and accepted by the government, payments begin.   Contractors are required to guarantee equipment performance; therefore,  some level of M&V is required to ensure guaranteed performance is  realized.  M&V is performed by the ESCO that installs the equipment.  The  level of M&V is negotiated between the government and the contractor and  must be specified in the signed delivery order.  Agency officials said that  the type of M&V employed depends on the interaction of various factors,  including climate, the people using the facilities, the facilities’ mission, and  the operation of the equipment.  The contractor may also perform the O&M  for the ESPC-installed equipment.  Facilities with in-house expertise may  take on these responsibilities themselves.  As part of the DES, the ESCO  and agency negotiate a responsibility matrix specifying the O&M duties to  be performed by each party.  FEMP guidance calls for negotiating a  responsibility matrix across a comprehensive set of issues, O&M duties  being only one.
During the term of the contract, an ECM’s energy cost savings are used to  pay the ESCO.  If annual savings resulting from the ESPC exceed annual  contractor payments, agencies other than the DOD and GSA may retain 50  percent of this excess; the other 50 percent must be returned to Treasury.   GSA may deposit all of the excess savings in the Federal Buildings Fund.   As of fiscal year 2004, the Navy may retain 100 percent of its excess funds, a  change from the previous requirement to return one third of the excess  savings to Treasury while retaining the other two thirds.  The Navy is  required to use one half of the retained savings for energy reduction  projects or water conservation activities and the other half for Navy  welfare, morale, and recreation projects, among other things.  An official  responsible for the Navy’s Shore Energy program said that, prior to 2004,  the Navy had not returned funds to Treasury since, to their knowledge,  there were no cases in which actual ESPC savings exceeded those  guaranteed by the contractor.  However, according to other Navy officials,  the Navy’s Comptroller has not issued guidance on the return of savings to  Treasury.  Because the Navy does not maintain a central system to track  savings, it would be difficult to determine whether the actual savings  generated by an ESPC have ever exceeded guaranteed savings.  In other  words, the Navy does not know if it should have paid some portion of its  energy savings to Treasury.
Implementing M&V strategies is required for ESPCs to verify the  achievement of guaranteed energy cost savings each year.  According to  FEMP, M&V involves three major steps:  baseline definition,  postinstallation verification, and regular-interval verification.  Annual M&V  only needs to show that the overall savings guarantee has been met, not  determine actual savings for each ECM.
M&V methodologies are grouped into four categories and may vary  depending on the ECM installed.  When choosing among M&V  methodologies, agencies must balance the accuracy of their energy savings  estimates with the costs of verifying those estimates.  For example, where  the performance of the installed equipment is relatively certain, as is the  case for lighting retrofits, it may not be cost effective to measure actual  energy use throughout the term of the contract.  In this case,  postinstallation and baseline energy use is estimated using engineering  calculations or system models.  As long as the potential to perform is  verified, the savings are as originally claimed and do not vary over the  contract term.  Alternatively, for projects with large elements of  uncertainty, such as chillers and chiller plants, contractors might  continually measure the energy use of equipment throughout the contract.   Continuous monitoring may greatly reduce uncertainty that savings are  actually being achieved, but will also cost more than less rigorous methods  of M&V.
M&V strategies allocate risk between the ESCO and the agency in advance.   Both ESCOs and agencies are reluctant to assume responsibility for factors  they cannot control.  For example, the ESCO generally does not assume  responsibility for risk related to operational factors, such as weather, how  many hours the equipment is used, and maintenance practices.   Alternatively, the agency typically does not assume the responsibility for  risk associated with equipment performance since the ESCO selects,  designs, and installs the equipment.
If the actual annual savings are less than the annual guaranteed savings  amount, the ESCO must correct or resolve the situation or negotiate a  change in the contract.  For two ESPCs, an annual M&V report identified  performance problems with installed ECMs.  In these cases, the ESCOs  resolved the performance problems by either replacing or installing new  equipment.  Even without the ESPC’s guarantee, the manufacturer’s  warranty would have indemnified the government in at least one of these  cases.  However, according to Navy officials, without the M&V process of  ESPC, the equipment deficiencies might have gone unnoticed during the  equipment warranty period.
The rest of this appendix contains summaries of our six case studies from  GSA and the Navy.  Following is a list of these ESPCs.
subsections: section_title: Navy Region Southwest, California
paragraphs: The primary contractor for the ESPC for the Navy Region Southwest,  California, was NORESCO, ERI Services Division.  The delivery order for  the contract was awarded on September 26, 2001, and specified that title to  all equipment installed by the contractor would be transferred to the  government upon project acceptance.  As of December 18, 2003, all ECMs  had been physically installed and accepted by the government and were  operating and yielding savings.  NORESCO and the Navy share  responsibility for the proper O&M of ECMs installed under this delivery  order.
According to the final delivery order, the Navy Region Southwest ESPC  consists of five ECMs: microturbine, heat recovery, and variable  frequency drives; an irrigation systems upgrade; a compressed air systems  upgrade; heating, ventilating and air conditioning systems improvements;  and a solar photovoltaic system.
In addition to reductions in energy use and operating costs, NORESCO  claimed the ESPC provided the following ancillary benefits:  A world-class solar photovoltaic system that was, at one time, the  largest photovoltaic installation in the United States and the largest  covered parking solar photovoltaic system in the world.   This covered  parking also allows sailors to leave their cars in a protected  environment while at sea (see fig. 11).
A demonstration project for the Navy to determine the environmental  benefits of microturbine technology.
The term of the contract is 10 years, with an interest rate of 9.32 percent.   As shown in table 3, the PV cost of the ECMs financed through an ESPC is  approximately $14.7 million, approximately $1 million more than the  estimated cost of the ECMs financed through timely, full, and up-front  appropriations.  The PV guaranteed cost savings specified in the delivery  order was about $6.8 million less than the PV of the ESPC’s total contract  cycle costs, including O&M payments.  However, according to Navy  officials, over the life of the equipment, the projected cost savings will  exceed the projected costs.  Navy Region Southwest used the $6.9 million  in special energy project funds it received from the Office of the Secretary  of Defense (OSD) and the Navy to buy down the project’s principal balance  upon acceptance.  The OSD funds were appropriated to help offset the cost  of energy projects in California, in an effort to address the energy supply  shortages in the state.
The ECMs under this delivery order were installed and accepted over a  number of months, with final acceptance of all ECMs in December 2003.   An initial M&V report issued in March 2004 provided a baseline to ensure  that all installed ECMs were performing as guaranteed.  The initial  verification process did not reveal any major maintenance or operational  issues that would negatively affect performance.  Verified savings through  the end of the first year amounted to roughly $1.4 million, which exceeded  the savings guaranteed in the delivery order.
section_title: Patuxent River Naval Air Station, Maryland
paragraphs: The prime contractor for the ESPC for Patuxent River Naval Air Station  was Energy Assets; the prime subcontractor was Co Energy Group.  The  delivery order for the contract was awarded on September 28, 2000, and  specified that title to all equipment installed by the contractor would be  transferred to the government upon project acceptance.  As of April 10,  2002, all ECMs had been physically installed, were operating, and were  yielding energy savings.
The Patuxent River ESPC consists of three ECMs: ground source heat  pump (GSHP) installation at nine buildings; process cooling water system  modification at one building; and lighting efficiency improvements at seven  buildings.
In addition to energy savings and capital improvements, Energy Assets  claimed the ESPC provided ancillary benefits:  There was enhanced personnel safety and landscape aesthetics in the  station’s Logistic Industrial Complex.  Prior to the ESPC, steam  distribution piping leaks created a safety hazard and were an eyesore.
There was environmental compliance for one building at the station.
Prior to the ESPC, a cooling water system at the building was configured  to discharge chlorinated water into the Chesapeake Bay.
The term of the contract is 20 years, with an interest rate of 9 percent.  As  shown in table 4, the PV cost of the ECMs financed through an ESPC is  approximately $5.8 million, approximately $1.4 more than the estimated  cost of the ECMs financed through timely, full, and up-front appropriations.   The PV guaranteed cost savings specified in the delivery order was about  $1.9 million less than the PV of the ESPC’s total contract cycle costs,  including O&M payments.  However, according to Navy officials, over the  life of the equipment, the projected cost savings will exceed the projected  costs.  To reduce financing costs, the Navy made a $2.3 million down  payment on the project after awarding the delivery order.  According to  Navy officials this down payment was equivalent to the sum of one-time  avoided costs resulting from the project, such as avoiding environment- related upgrades to existing cooling water systems.
According to the postimplementation and first annual monitoring and  verification reports issued by the contractor in August of 2002 and  December of 2003, respectively, all ECMs were operational and performing  as expected.  Although energy savings goals were met in the first year, one  ECM did not perform according to the performance requirements of the  contract.  During the summer of 2002, it was reported that a process  cooling water system installed under the ESPC did not meet the demands  of Navy laboratory test equipment.  The Navy and the contractor agreed  that the resolution of the problem was the responsibility of the contractor  and that the contractor would not, at any time, bill the government for  costs incurred to resolve the problem.
section_title: Naval Submarine Base, Bangor, Washington
paragraphs: The prime contractor for the ESPC at the Bangor Submarine Base in  Washington was Johnson Controls.  The delivery order for the contract was  issued on September 27, 2001.  As of March 1, 2003, all ECMs had been  installed, were operating, and were yielding savings.  Upon government  acceptance of the completed project, title to the equipment installed under  the ESPC was transferred to the government.
Six ECMs were installed at the Bangor Submarine Base, including chiller  plant modifications, air handling unit modifications, chilled water supply  and pumping modifications, and lighting modifications for various  buildings.
The term of the contract is 9 years, with an interest rate of 7.44 percent.  As  shown in table 5, the PV cost of the ECMs financed through an ESPC is  approximately $5.34 million, approximately $1 million more than the  estimated cost of the ECMs financed through timely, full, and up-front  appropriations.  The PV guaranteed cost savings specified in the delivery  order was about $1.3 million less than the PV of the ESPC’s total contract  cycle costs, including O&M payments.  However, according to a Navy  official, over the life of the equipment, the projected cost savings will  exceed the projected costs.  The Navy was authorized by the Office of the  Secretary of Defense (OSD) to use a fiscal year 2001 supplemental  appropriation for the western power grid crisis to make an up-front  payment of roughly $1 million to reduce ESPC-related financed costs.  The  government also made a roughly $214,000 up-front payment using savings  generated during the construction period.
According to the postimplementation report issued by the ESCO, the  projected cost savings for the first year of the project were roughly  $752,000, exceeding the ESCO’s savings guarantee of about $634,000.   These projected cost savings include about $734,000 from reduced energy  consumption and about $17,000 from avoided O&M costs.
section_title: GSA Gulfport Federal Courthouse, Mississippi
paragraphs: The prime contractor for the ESPC at GSA’s Federal Courthouse in  Gulfport, Mississippi, was Sempra Energy Services.  Unlike our other ESPC  case studies, the Gulfport ESPC did not retrofit existing systems but  installed ECMs in new construction.  GSA’s Office of General Counsel  determined that using ESPCs to finance ECMs was appropriate for the  costs of improvements over the “baseline” design (e.g., the difference in  cost between a standard chiller and a highly efficient chiller) rather than  the entire cost of the improved system.  The delivery order for the contract  was awarded on September 28, 2001.  As of September 19, 2003, all ECMs  had been physically installed and were operating and had the potential to  deliver the guaranteed annual savings as reflected in the ESPC delivery  order.
According to the final delivery order, the ESPC for the Gulfport Federal  Courthouse consists of 14 ECMs, including variable frequency drives for  chilled water pumps and hot water pumps, lighting controls, energy  efficient chillers, and occupancy controlled ventilation.
The term of the contract is 17 years, with an interest rate of 8.4 percent.  As  shown in table 6, the PV cost of the ECMs financed through an ESPC is  approximately $2.5 million, approximately $0.9 million more than the  estimated cost of the ECMs financed through timely, full, and up-front  appropriations.  The PV guaranteed cost savings specified in the delivery  order was about $90,000 less than the PV of the ESPC’s total contract cycle  costs, including O&M payments.  However, according to GSA officials, over  the life of the equipment, the projected cost savings will exceed the  projected costs.  The government also made an $88,000 up-front payment to  cover certain O&M expenses.
Since GSA installed ECMs in new construction, there was no historical  baseline to which the performance of the Gulfport Federal Courthouse  equipment could be compared.  Thus, GSA hired a consulting firm to model  a conceptual building and, from that model, determined baseline energy  consumption for the new building with less efficient equipment.  The first  annual M&V report for the project was issued in December 2004, after we  had completed our analysis.
section_title: GSA North Carolina Bundled Sites
paragraphs: GSA awarded the ESPC for multiple GSA-owned buildings in North  Carolina, the Greensboro IRS Building, the Greensboro Federal  Courthouse, the Raleigh Federal Building and Courthouse, the Winston- Salem Federal Building and Courthouse, and the Wilmington Federal  Building to DukeSolutions (now AmerescoSolutions).  The delivery order  for the contract was awarded on September 27, 2000.  As of November  2001, GSA found the work performed under the ESPC to be sufficiently  complete.
According to the September 20, 2000, contract, the ESPC involved  multifaceted ECMs for multiple federal buildings within North Carolina.   The 10 ECMs include lighting retrofits, the installation of energy  management systems, replacement of motors for mechanical equipment  and air flow fans, and replacement of chillers.
The term of the contract is 19 years, with an interest rate of 8.59 percent.   As shown in table 7, the PV cost of the ECMs financed through an ESPC is  approximately $1.93 million, approximately $0.54 million more than the  estimated cost of the ECMs financed through timely, full, and up-front  appropriations.  The PV guaranteed cost savings specified in the delivery  order was about $1.1 million less than the PV of the ESPC’s total contract  cycle costs, including O&M payments.  However, according to GSA  officials, over the life of the equipment, the projected cost savings will  exceed the projected costs.  As part of the $3.1 million contract cycle costs,  GSA made a $1.2 million up-front payment.  These funds had already been  appropriated for energy efficiency improvements to GSA buildings  involved in the project.  However, the improvements became unnecessary  after GSA accepted the ESPC.
According to the M&V report issued in April 2003, all ECMs were operating  and would continue to operate as intended.
section_title: GSA Atlanta Bundled Sites, Georgia
paragraphs: GSA awarded an ESPC for multiple sites in Atlanta, Georgia, including the  Richard B. Russell, Peachtree Summit, and Court of Appeals buildings, to  NORESCO (formerly ERI Services, Inc.).  The delivery order for the GSA  Atlanta “bundled sites” was awarded on September 30, 1999, and as of May  31, 2000, all ECMs had been installed, were operating, and were yielding  energy savings.  Upon acceptance of the project, GSA took title to all  equipment, and NORESCO will be responsible for maintenance and repair  services for all ECMs.
The Atlanta bundled sites ESPC consists of five ECMs: energy efficient  lighting upgrades, variable frequency drives, two chiller plant upgrades,  and outside air reduction.  The term of the contract is 20 years,with an  interest rate of 8.50 percent.  As shown in table 8, the PV cost of the ECMs  financed through an ESPC is approximately $7.8 million, approximately  $1.6 million more than the estimated cost of the ECMs financed through  timely, full, and up-front appropriations. The PV guaranteed cost savings  specified in the delivery order was about $500,000 less than the PV of the  ESPC’s total contract cycle costs, including O&M payments.  However,  according to GSA officials, over the life of the equipment, the projected  cost savings will exceed the projected costs.  A one-time energy-related  operations and maintenance payment in the amount of $900,000 was paid  upon completion and acceptance of all ECMs.  The $900,000 represented  funds that had already been appropriated to replace a chiller for one of the  buildings involved in the project.
NORESCO submitted annual verification reports for the first 3 years of the  project.   Based on postinstallation and annual M&V activities, project  savings were verified and exceeded the guaranteed actual savings by  approximately 5 percent in years 1 and 2, and 1.6 percent for year 3 of the  contract.
Three of the ECMs installed under the ESPC experienced problems at one  point during the first 3 years of the contract.  According to the M&V  reports, the contractor worked with GSA Atlanta to resolve two of these  problems.  However, absent the ESPC’s guarantee, it may be that the  manufacturer’s warranty would have covered the problems. The contractor  determined that the third problem was part of a larger issue and,  consequently, was outside of the scope of the ESPC.  According to a GSA  official, GSA does not always receive the savings guaranteed by the ESCO.   When actual savings fall below the guaranteed level, the ESCOs might  claim that they are not at fault and, consequently, are not financially  responsible.
section_title: Public/Private Partnership Case Studies
paragraphs: Unlike ESPCs, which are fairly uniform in their structure, the term  partnership can be used to describe many different types of arrangements  since partnerships may take a variety of forms.  For the purposes of this  report, these arrangements typically involve a government agency  contracting with a third party to renovate, construct, operate, maintain, or  manage a facility or system, in part or in whole, which provides a public  service.  Under these arrangements the agency may or may not retain  ownership of the public facility or system, but the private party generally  invests its own capital to design and develop the properties.
Congress has already enacted legislation that provides specific agencies  with statutory authority to enter into partnerships.  Four of the five  partnerships we reviewed were done under a specific law that enabled VA  to enter into a type of partnership known as enhanced use (EU) leases.  An  EU lease is an asset management tool used by VA that includes a variety of  different leasing arrangements (i.e., lease/develop/operate,  build/develop/operate).  EU leases enable VA to outlease VA-controlled  property to the private sector or other public entities to be improved for  either VA’s use or non-VA uses.  In return, VA receives fair consideration  (monetary or in-kind) that enhances its mission or programs.  Agencies  without specific partnership authority, such as DOE, have used other  authorities as the basis for partnerships.
Potential benefits of partnerships include  attainment of efficient and repaired federal space,   reduction of costs incurred from using functionally inefficient buildings,   development of underutilized federal real property,  access to private sector expertise.
Critics of partnerships caution, however, that these ventures are not the  least expensive means of meeting capital needs, although in the short term  they may appear to be.  For example, OMB staff have indicated that where  there is a long-term need for property by the federal government, it is  doubtful that a partnership would be a more economical means of  financing than directly appropriating funds for renovation.
Partnerships must conform to budget scorekeeping rules and OMB  instructions published in OMB Circular A-11.  According to A-11,  partnerships should not be used solely or primarily as a vehicle for  obtaining private financing for federal construction or renovation projects.   Ultimately, partnerships need to be evaluated on a case-by-case basis to  determine the best economic value for the government.
In some instances, case study agencies used partnerships to acquire capital  assets without having to obtain congressional appropriations for the full  costs up front.  For example, one agency used existing authority  specifically to work around OMB budget scorekeeping instructions,  allowing the agency to obligate annual lease payments rather than the full  cost of the project it would have otherwise needed to obligate up front.
This appendix contains summaries of our five case studies from two  agencies: DOE and VA.
Oak Ridge National Laboratory, Tennessee Atlanta Regional Office Collocation, Georgia Medical Campus at Mountain Home, Tennessee Vancouver Single Room Occupancy, Washington North Chicago Energy Center, Illinois For each case study, we describe the background and structure of the  partnership, its risks, costs and benefits, and budget scoring issues.  We  were unable to compare the costs agencies would have incurred had they  financed the assets through timely, full, and up-front appropriations instead  of partnerships.  Although the government incurs higher interest costs  compared to up-front financing, we were unable to evaluate claims that  other factors, such as lower labor costs and fewer bureaucratic  requirements available to private partners, may have reduced costs.  Thus,  we were unable to judge whether partnerships could be less expensive  overall.
subsections: section_title: DOE Oak Ridge National Laboratory, Tennessee
paragraphs: DOE used existing law to structure a partnership that enabled it to obtain  the use of facilities for up to 25 years without recording large up-front  obligations and outlays.  DOE’s contractor, UT-Battelle, LLC, obtained  about $70 million in private financing for new office and research facilities  at Oak Ridge National Laboratory (ORNL).  ORNL is DOE’s largest science  and energy laboratory.  ORNL was established in 1943 as part of the  Manhattan Project to pioneer a method for producing and separating  plutonium.  Today, ORNL leads the development of new energy sources,  technologies, and materials and the advancement of knowledge in the  biological, chemical, computational, engineering, environmental, physical,  and social sciences.  Since April 2000 ORNL has been managed and  operated by a private, limited liability partnership between the University  of Tennessee and Battelle Memorial Institute, UT-Battelle, LLC.  As ORNL’s  management and operations (M&O) contractor, UT-Battelle, LLC’s primary  client is DOE.  The M&O contract with DOE is a 5-year performance-based  contract with an option for DOE to renew for an additional 5-year term.
Shortly upon winning the M&O contract, UT-Battelle, LLC, submitted a  Strategic Facilities Revitalization Plan for construction of a total of 11 new  facilities and renovation of existing facilities at ORNL during the first 5-year  phase of the program.  Given the magnitude of needed facilities  improvements and the historical funding levels, this plan proposed a  partnership to secure funding for new construction and renovation of  existing space through a combination of federal, state, and private funds— about $225 million, $26 million, and $70 million, respectively.
One key component of this proposal was the transfer of land ownership  from DOE to a special-purpose entity to allow for construction and lease of  buildings by the private sector.  Section 161(g) of the Atomic Energy Act  permitted DOE to transfer at no cost, via quitclaim deed, 6.6 acres of land  at ORNL to a special-purpose entity, UT-Battelle Development Corporation  (UTBDC), for the construction of three buildings.  UTBDC, a 501(3)(c)  nonprofit corporation, was created for the sole purpose of implementing  the privately financed elements of the revitalization project, and the  selection of UTBDC was not based on a competitive process.  However,  upon receiving the land, UTBDC issued a 25-year ground lease for the 6.6- acre site to Keenan Development Associates, of Tennessee, LLC (Keenan),  a private developer competitively selected to build the new facilities.  As  described below, UTBDC provided design specifications and construction  oversight and functioned essentially as a pass-through entity for the land,  financing, and leasing of the three buildings reviewed in this case study.
Once private financing (bonds) was obtained and construction of the three  buildings was completed, Keenan implemented three prenegotiated facility  leases for these buildings with UTBDC for a term of 25 years.  UTBDC, in  turn, implemented subleases of the three facilities to UT-Battelle, LLC, for  DOE’s ultimate use, with a lease-term up to 25 years.  Accordingly, DOE  reimburses UT-Battelle, LLC, for the sublease payments, which flow back  to Keenan to pay off the outstanding bonds.  Figure 12 depicts the full  partnership arrangement used to revitalize ORNL, including the financing  just described.
subsections: section_title: Risk
paragraphs: Ultimately, the principal and interest on the bonds are covered by DOE’s  sublease payments (if the subleases run for their full 25-year term), as  specifically recognized by Standard and Poor’s (S&P) A+ rating of the  bonds.  However, DOE officials told us they neither reviewed the private  bond-offering memorandum nor asked to see it.  According to DOE’s  Counsel, a DOE review of the bond-offering memorandum would not have  been consistent with the fact that this was a private transaction between  Keenan and private investors.  In addition, UTBDC’s Counsel said he was  careful to make clear that the sublease contained a 1-year termination  clause to ensure DOE’s involvement was not misrepresented; instead  UTBDC and its backers bear the risk associated with the bond repayments.   Furthermore, UTBDC officials told us that in excess of $1 million of  UTBDC private funds were expended in support of the construction effort.   Although UT-Battelle officials were unwilling to provide us a copy of the  bond-offering memorandum, S&P’s A+ bond rating report states that its  rating was based, in part, on a pledge of DOE rent payments, since DOE  was unlikely to vacate the facilities.
section_title: Costs and Benefits
paragraphs: DOE officials could not provide us with any documentation showing that  the agency had performed an independent cost-benefit or business case  analysis of the private financing arrangement.  The Chief Financial Officer  (CFO) of DOE’s Oak Ridge Operations office asserted that private financing  and construction would be less expensive than appropriations because the  accelerated completion time would enable them to more quickly vacate  dilapidated buildings that were expensive to operate and maintain.   According to DOE officials, in addition to dollar costs, the obsolete  buildings were affecting the recruitment and retention of top-quality  scientists needed to further DOE’s mission.  Although no appraisal was  made of the land prior to turning it over via quitclaim deed, which was  given to UTBDC free of charge, several DOE officials said they believed the  land was without value.  Moreover, although unable to provide supporting  documentation, several officials said they believed that DOE’s then CFO  would have looked into the costs and benefits.  According to UT-Battelle,  LLC’s Deputy Director for Operations, the former CFO received summary  analyses addressing the cost-benefit study performed by UT-Battelle, LLC.   The Deputy Director further explained that the former CFO visited ORNL  for a full day briefing and walk-around to review the proposed project.  The  summary information provided by UT-Battelle, LLC, to the former DOE  CFO was, in our opinion, not sufficient for a detailed, business case  analysis.  The type of underlying data needed to perform such an analysis  had been prepared by UT-Battelle, LLC, and was readily supplied to us  upon request.  UT-Battelle, LLC, officials said that DOE also would have  been provided this data had it been requested.  According to UT-Battelle,  LLC’s estimates prior to the start of the project, the privately-contracted  construction that was used would have cost about $45 million compared to  about $101 million had DOE contracted directly for the construction  itself.
The value of the bonds issued by Keenan to construct the three buildings  totaled about $70 million. However, the actual cost to construct, according  to UTBDC’s analysis, was about $54 million.  Our analysis of DOE’s  subleases shows that the 25-year PV that DOE will pay to lease the three  privately financed buildings will total about $96 million.
section_title: Budget Scoring
paragraphs: According to DOE and UT-Battelle officials, a key concern of the financing  arrangement was ensuring that it would score as an operating lease and  thus only require the annual sublease payments (plus cancellation costs) to  be obligated and shown in the budget.  Had it not met the operating lease  criteria, DOE would have had to obligate in the first year of the sublease  sufficient budget authority to cover the PV of the government’s sublease  payments over the full 25-year lease term.  Given this concern, the terms of  the partnership were carefully constructed to ensure it would be scored as  an operating lease.  For example, by giving the land to UTBDC, DOE  ensured that the project would not be located on government property.   Also, by establishing short-term subleases, UT-Battelle, LLC, ensured the  lease term did not exceed 75 percent of the estimated economic life of the  asset.  Had the buildings been constructed on government land or the lease  term exceeded 75 percent of the economic life of the asset, the  arrangement might have been treated as a capital lease and DOE would  have had to obligate the full costs of the project up front.
section_title: VA Atlanta Regional Office Collocation, Georgia
paragraphs: In 1998, VA used its EU lease authority to leverage more than $32 million in  private financing for the collocation of the Atlanta VA Regional Office  (VARO) on department-owned property adjoining the VA Medical Center in  Dekalb County, Georgia.  The collocation provides both benefits and  medical services on a single campus resulting in increased convenience to  veterans receiving services from VARO and the VA medical center.   Previously, the Atlanta VARO had been located in a GSA-controlled  building in midtown Atlanta.  With its lease scheduled to expire, VA  considered moving the VARO into a new GSA-controlled building in  downtown Atlanta, known as the Atlanta Federal Center (AFC).  However  several factors prompted VA to research other alternatives.  The move to  the AFC would have (1) tripled VARO’s rent to GSA; (2) separated VARO’s  offices over more space than required; and (3) according to the Georgia VA  Commissioner, provided inadequate parking access for disabled veterans.
VA ultimately collocated the VARO onto property adjoining the VA Medical  Center in Dekalb County by entering into a 35-year partnership with the  Dekalb County Development Authority (the Authority).  According to the  EU lease, the VARO project would increase employment and expand  economic development in Dekalb County.  Under the partnership, VA  outleased six acres of VA-owned property to the Authority for a 35-year  period.  In exchange for the lease, the Authority agreed to finance, develop,  own, operate, and maintain a furnished and equipped office building and  parking garage.  To finance the project, the Authority issued revenue bonds  in excess of $32 million.  VA then leased back the office space needed from  the Authority’s developer through 2-year operating leases, which  automatically renew for up to nine consecutive terms unless VA takes  positive action to terminate the automatic renewal clause.  At each  renewal of the lease, VA maintains the right to reduce the amount of office  space it occupies if its requirements change.
subsections: section_title: Risk
paragraphs: According to the EU lease, the construction of the VARO building and  parking was a private undertaking of the Authority and not an undertaking  of VA.  Additionally, the Authority bears the risk and responsibility to  operate, maintain, repair, and replace assets in the event of a causality loss,  and holds the title to the office building and parking garage as long as the  revenue bonds are outstanding.  At any time during the ground lease, VA  has the right to acquire the improvements from the Authority for a  purchase price equal to the sum necessary to make the payment of the  bonds.  Upon expiration or termination of the EU lease, title to all  improvements on the land automatically transfers to VA.
To mitigate the risks to the Authority if VA does not renew the lease or  reduces the amount of space it occupies in the VARO building, VA  deposited $1.8 million into a “renovation reserve fund” when the lease was  executed.  The Authority may draw from this fund to renovate or  reconfigure rental space for new tenants should VA vacate some part of the  VARO building during the term of the bonds.  VA officials said that by  agreeing to a reserve fund, VA’s rent would be reduced because bonds were  sold to investors at a lower interest rate, thus reducing the Authority’s debt  service and, in turn, VA’s rental payments.  VA also mitigated the Authority’s  risk by agreeing not to replace the VARO building with another regional  administration or headquarters building in Georgia using its EU lease  authority during the term of the bonds.  According to VA, the Authority  passed on additional risk mitigation savings to the department by obtaining  bond insurance that guaranteed timely payment of principal and interest to  bondholders.
section_title: Costs and Benefits
paragraphs: Thirty-five-year PV life-cycle costs for the project were estimated to total  about $43 million, while the Authority bond issue totaled about $33 million.   Although VA compared the cost of the collocation to the costs of moving  into the AFC, the department decided not to compare the costs of  construction via EU lease to full, up-front financing.  According to VA  officials (1) VA did not believe it would receive up-front appropriations for  VARO construction and (2) internal VA protocol did not require economic  comparisons between all possible acquisition alternatives.
section_title: Budget Scoring
paragraphs: Because the VARO collocation project was scored as an operating lease,  VA’s 2-year lease payments to the Authority are the only aspects of the  arrangement reflected in the budget.  VA officials said this scoring  treatment is appropriate since VA may decide to vacate part or all of the  building before the 35-year ground lease expires.  The officials explained  that VA may need less office space when electronic filing systems  eventually replace existing paper-based systems.  Also they noted that a  short-term lease provides flexibility in the event that VA’s field structure  changes over time.  However, it is not clear that VA’s need for the space is  necessarily short-term.  For example, prior to the collocation of the Atlanta  regional office with the medical center, the regional office had occupied  offices in the Atlanta area for over 25 years.  Scoring the EU lease as an  operating lease assumes that its need is short-term, even though VA has no  current plans to vacate the space.
section_title: VA Medical Campus at Mountain Home, Tennessee
paragraphs: In 1998, VA entered into an EU lease with its local affiliate, James H.  Quillen College of Medicine of East Tennessee State University (ETSU),  and the State of Tennessee.  Under the EU lease, VA transferred to ETSU  the long-term maintenance and development responsibilities of 31 acres of  land, including nine buildings, on VA’s medical campus property in  Mountain Home, Tennessee, for a term of 35-years.  After the expiration of  the lease, VA may transfer the fee simple title to the property to the State of  Tennessee; however, VA made no guarantees to any such transfer.  The EU  lease superseded existing leases of buildings and land where ETSU  occupied the facilities while VA was responsible for the maintenance and  capital improvements, without reimbursement from ETSU.
subsections: section_title: Risk
paragraphs: Under the EU lease, the federal government retains a fee simple ownership  interest in the property.  However, during the term of the lease, VA is not  responsible for damages to the property or for injuries to persons on the  property, except as provided for by applicable law.  In the event that any  part of the property is damaged or destroyed, other than as a result of VA’s  negligence, the state is obligated to repair, restore, or rebuild the property.
section_title: Costs and Benefits
paragraphs: VA projected that the initiative would result in a cost avoidance of  approximately $34.6 million (PV) in capital management costs over the  lease term.  Also, through the term of the lease, an additional $6.3 million  (PV) of “in kind consideration” medical services and possible  groundskeeping services would be provided to VA by ETSU staff and  residents each year.  According to VA’s capital asset management study,  these benefits were equivalent to the $40.9 million value of the capital  assets to be leased to ETSU.
According to VA officials, ETSU assumed responsibility for the  maintenance of the buildings so that it could make capital improvements  that VA was unwilling to undertake, such as the renovation of labs and  heating, ventilation, and air conditioning systems.  VA’s business case states  that VA would also benefit from the improved medical school facilities  since the improvements would increase funding of research, including  equipment, supplies, and technicians for VA physicians working at the  medical school, where such resources are not provided by grants.
section_title: Budget Scoring
paragraphs: Because the arrangement did not involve cash transfers, the EU lease is not  reflected in the budget.
section_title: VA Vancouver Single Room Occupancy, Washington
paragraphs: In 1998, VA outleased about 1.4 acres of vacant, undeveloped land  adjacent to the Vancouver Division of the Portland VA Medical Center.  The  35-year, no-cost outlease was awarded to the City of Vancouver’s Housing  Authority (Housing Authority).  The Housing Authority subsequently  financed, designed, and built a 126-bed single room occupancy (SRO)  structure on the property in order to provide transitional and permanent  housing for single homeless individuals of southwest Washington.  The  Housing Authority agreed to give veterans referred by the Portland VA  Medical Center priority placement for at least 50 percent of the occupancy  of the SRO property.
subsections: section_title: Risk
paragraphs: The EU lease required the Housing Authority to bear all costs and  responsibility for developing and constructing the SRO.  In addition, the  lease made the Housing Authority (1) responsible for all repair and  maintenance costs associated with the SRO and (2) subject to the risk of  loss or damage occurring on the property.
Unless VA decides to dispose of the property, the Housing Authority must  surrender the SRO and other improvements on the property to VA upon  termination or expiration of the lease. The Authority is responsible for the  development, construction, repair, and maintenance of the SRO.  Although  in our opinion VA bears minimal risk, the construction on the property  represents an opportunity cost to VA.
section_title: Costs and Benefits
paragraphs: According to a VA official, the property would likely have remained unused  without the EU lease arrangement.  Although priority placement enables  VA to reduce costs by expediting the release of patients from its medical  center, VA stated it had not previously considered using the land until the  Housing Authority approached VA with the SRO idea.
section_title: Budget Scoring
paragraphs: Because the transaction did not involve cash consideration, it was not  reflected in the budget.
section_title: VA North Chicago Energy Center, Illinois
paragraphs: In 2002, VA used its EU lease authority to initiate the development of a  cogeneration facility that could provide chilled water, electricity, and steam  to its 190-acre campus in North Chicago, Illinois.  Prior to this EU lease, VA  purchased electricity from the local utility and steam from an adjacent  Navy facility.  According to a study, VA determined that VA’s energy costs in  North Chicago were 60 percent higher than average and VA determined that  the rates charged by the Navy for steam were above market rates.
According to VA’s analysis, VA determined that using an EU lease for the  development, construction, and O&M from a third party of an energy center  on the campus would be the most efficient and cost-effective way to meet  the energy requirements of the North Chicago VA Medical Center,  compared to federally contracted construction or purchasing energy  (steam and electric) from local sources.  In 2002 VA signed a 35-year EU  lease with Cole Taylor Bank as trustee of the North Chicago Energy Trust  (Trust) to lease approximately 1 acre of land appraised at $110,000.  In  return the Trust hired Energy Systems Group as the developer to (1)  develop, design, equip, construct, operate, and maintain the Energy Center;  (2) engage in sales of energy services to third parties; (3) provide energy- related services including operating and maintaining the VA Medical  Center’s systems for chilled water, electricity, steam, and its respective  distribution systems; and (4) undertake energy savings initiatives at the VA  Medical Center and other VA facilities in the area.  The Trust’s trustee  borrowed on behalf of the Trust through the Illinois Development Finance  Authority (IDFA) about $37 million in bonds, secured by the leasehold  interest and its improvements. VA is the sole beneficiary of the Trust.
subsections: section_title: Risk
paragraphs: The energy service agreement between VA and the Trust sets the standards  and terms for VA to purchase steam and electricity generated by the energy  center.  VA may terminate the agreement under default provisions if the  developer cannot complete the development or perform and supply energy  as specified in the agreement.  According to a VA official, VA then would in  sequence (1) request that the Trust select another firm to run the center or  (2) take over operation of the center.  The bonds were issued by IDFA and  the Owner Trust is responsible for repayment of the bonds in the event of a  failure to perform or any other breach of the agreement.  The EU lease  holds the developer responsible for any loss, cost, or liability of an  environmental nature that arises out of the developer’s acts or omissions in  conjunction with the property.  The Owner Trust is responsible in the event  there is a loss of assets, such as through fire.  If VA vacates the campus as  part of its mission, VA has no responsibility or liability for any future  payment of the bonds.  In accordance with its legislative authority, VA may  elect to transfer its interest in the land that the energy center was built on  to the Owner Trust, so that the Trust may continue operations or pay off the  bonds.  According to VA officials, they initiated the Trust arrangement for  this EU lease to protect the government in the event of bankruptcy or  foreclosure of a developer/operator and if the developer did not or could  not complete the project.  By using a trust, the bond revenues belong to the  Trust and are paid to the developer.  The Trust maintains title to  improvements during the lease term, afterwards title transfers to VA at the  end of the lease term.
section_title: Costs and Benefits
paragraphs: VA contributed no funding for the development of the energy center.   According to VA officials, constructing and running energy centers is not  within VA’s mission and it would not have put forward a request to do so.   VA estimated that a new energy center would save VA about $12.7 million  (net present value) over 10 years compared to its current costs for  electricity and steam.  The new energy center system runs parallel to the  local utility, which gives VA a backup source of electricity.  At one point  before VA entered into the EU lease, it was paying the Navy over $3 million  for steam and the local utility over $1 million for electricity.  VA accounted  for 14 percent of the steam generated by the Navy facility and, according to  VA’s business plan, VA could end its steam purchases without creating a  substantial loss to the Navy.  The Navy would be able to reduce its steam  pressure and in turn increase its efficiency.  Navy officials confirmed that  while the Navy had lost revenue, VA steam consumption was not a  significant portion of its business.
section_title: Budget Scoring
paragraphs: The utility costs for the VA complex are reflected in the budget on an  annual basis but no other scoring for this project is reflected in the budget.   After this EU lease was signed, OMB has stated that under new scoring  instructions the costs associated with trusts should be scored up-front  since (1) VA maintains control of the assets acquired through the trust and  (2) VA bears the risk for these assets.
section_title: Comments from the Department of Defense
paragraphs: The following are GAO's comments on the Department of Defense's letter  dated October 25, 2004.
subsections: section_title: GAO's Comments
paragraphs: 1. We do not agree that our recommendation needs to be modified to  further consider savings.  We compared acquisition costs for a given set  of ECMs.  Therefore the savings should not vary.  Regardless of how  they are financed, the same given set of ECMs acquired for the same  energy reduction projects should yield the same energy savings. 2. Only by doing a business case analysis can the government ensure that  it selects the best alternative and that taxpayers’ interests are  protected. Life-cycle cost analysis is only one part of a business case  analysis, which includes economic and financial analyses such as cost- benefit and comparative alternative analyses.  We recognize that using  full, up-front appropriations to fund ECMs would likely affect some  other aspect of the budget.  It is not the intent of this report to  discourage or to eliminate energy conservation efforts or partnerships  with the private sector.  However, recognizing the full commitment up- front in the budget enhances transparency and enables decision makers  to make appropriate resource allocation choices among competing  demands that all have their full costs recorded in the budget. One of the  primary purposes of budgeting is to make resource allocation decisions  among competing claims that all have their full costs recorded in the  budget.   3. Measuring opportunity costs requires estimates of how long the delay  in obtaining ECMs would be and the cost of that delay.  To do that, GAO  would have to make an assumption about when obtaining an ECM  would be of sufficiently high priority in comparison to the other  programs for which an agency would request full funding.  Our report  does not address agencies’ resource allocation decisions, but points out  that the decision to acquire ECMs through ESPCs is more expensive  than through timely, full, and up-front appropriations—a point with  which agency officials agreed.  We believe that such an analysis is more  appropriately conducted by agencies as part of the business case  analysis of alternatives. 4. Given our case study approach, our report does not imply a statistical  relevance to any of our case study findings.  We selected case studies  based on their cost and data availability.  The case study result that  DOD questions is a delivery order awarded by GSA.  Because this ESPC  involved new construction, GSA noted that the result of this case would  be unique but interesting; GSA agreed with our selection of cases.  We  note DOD’s comment that these ESPCs usually increase the  government’s costs by 25 to 35 percent.  While this is less than the 56  percent in the GSA case study, it is not an insignificant cost differential. 5. Our report acknowledges that M&V of savings acts as a type of  insurance and that M&V strategies allocate risk between the agency  and the ESCO.  M&V is an explicit cost in ESPCs.  However, agencies  could choose to purchase M&V for ECMs financed through full, up- front appropriations if, after conducting a business case analysis, they  believed it was in the best interest of the government.  With respect to  the savings guarantee, as discussed on p. 29, ESPCs contain  assumptions that determine estimated savings.  If the assumptions are  not correct and savings are not achieved, the agency is still required to  pay the ESCO the agreed-upon savings specified in the contract.   Finally, we clarified that the M&V comparison is to estimated savings. 6. We agree that appropriations are recognized in the budget.  However,  ESPC commitments are not in fact fully recognized up front in the  budget.  OMB has scored the acquisition costs of assets acquired  through ESPCs annually, over time, even though ESPCs represent long- term commitments of the government.  For example, agencies  generally retain control of the assets acquired for the entire life of the  asset.  Also, agencies’ termination liabilities for ESPCs typically  correspond to the outstanding principal balances due to the ESCOs. 7. We did not analyze the validity of DOD’s claims because DOD could  provide no data supporting its claims.  For example, the Navy does not  maintain a central system to track savings.  Therefore, it could not  provide data on the amount of cost savings attributable to the use of  ESPCs.  DOD also did not provide sensitivity analysis reflecting the  opportunity costs of waiting for appropriations.  We did review the one  Oak Ridge National Laboratory cost study recommended to us,  Evaluation of Federal Energy Savings Performance Contracting— Methodology For Comparing Processes and Costs of ESPC and  Appropriations-Funded Energy Projects (March 2003).  In addition to  our own review of the study, we interviewed the authors of the study  and talked with agency officials about the study’s methodology.  Based  on our analyses we found two major flaws with the study: (1) we agreed  with the study authors that the sample size was too small and was not  applicable to the entire federal sector and (2) the study compares the  costs and savings across various types of ESPCs installed in several  different federal facilities, making it difficult to compare energy savings  because the savings would depend upon too many unpredictable  factors.  Also, as discussed on pages 29 and 30, we did discuss with GSA  and Navy officials their historical funding experiences.  We note that  DOD itself (see comment 4) says that ESPCs increase the cost to the  government by 25 to 35 percent compared to timely, full, and up-front  funding. 8. Our analysis recognizes the value of the technical expertise provided by  ESCOs by assuming that detailed energy surveys would be needed and  purchased under either funding scenario.  We include the cost of this  type of service in our proxy for the amount Congress would have to  appropriate had ECMs been financed through timely, full, and up-front  appropriations.  Further, our report notes that agencies’ heavy reliance  on the ESCOs to recommend, install, and perform M&V to verify results  on their recommended ECMs creates potential conflicts of interest that  require active participation and scrutiny by agencies. 9. See comment 3. 10. See comment 5. 11. This information was taken directly from a FEMP document that FEMP  provided in one of its training courses offered to agencies (Super ESPC  Agency Project Binder, July 2004).  On page 6 of the chapter entitled,  “Introduction to M&V for DOE Super ESPC Projects” it says, “In the  event that the stipulated values overstate the savings or reductions in  use decrease the savings, the agency must still pay the ESCO for the  agreed-upon savings.” 12. In our opinion, because large buy-downs indicate the availability of  funds in the first year of the contract, they imply there may have been  opportunities to purchase ECMs in smaller, useable segments, when  technically feasible.  However, because DOD prepared no business case  analysis to determine the viability of this alternative, it cannot be  known whether this would have been cost effective or not.  Business  case analyses are well accepted as a leading practice among public and  private entities.  OMB requires all executive branch agencies to prepare  business case analyses for major investments as part of their budget  submissions to OMB. 13. For our case studies, buy-downs did not always represent an  “extremely small percentage of the overall contract.”  As discussed on  page 39 of the report, three of the six case studies we reviewed  obligated and paid a significant portion of the total cost of the ECMs in  the first year of the contract.  These three case studies used one-time  savings to pay down about 7 percent, 38 percent, and 39 percent of  contract cycle costs.  We believe this shows that opportunities exist to  acquire ECMs in smaller, useful segments when technically feasible.  The other three case studies are not used to support our conclusion  because the up-front payments on these delivery orders stemmed from  federal funding unexpectedly made available to mitigate energy  shortages in California during fiscal year 2000 or because the up-front  payment was minimal.  We are not asserting that these opportunities  exist in every case but we remain of the view that they should be  explored as part of a business case analysis. 14. As stated on pages 35 and 36, we found that GSA and the Navy took an  active role in negotiating case study ESPCs to protect the government’s  interest.  However, the potential for problems has been demonstrated  through numerous Army Audit Agency reports issued over the last  several years on ESPCs awarded by the Army.  These reports stated  that energy savings baselines established by the ESCOs were faulty,  resulting in overpayments to the ESCO.  Accordingly, we believe our  conclusion is both warranted and relevant.
section_title: Comments from the Department of Energy
paragraphs: The following are GAO's comments on the Department of Energy's letter  dated October 25, 2004.
subsections: section_title: GAO’s Comments
paragraphs: 1. Our report does not state that the 1967 Commission on Budget  Concepts explicitly addressed operating leases such as those at Oak  Ridge.  As stated, the budgetary principle advanced by the 1967  Commission on Budget Concepts is that the federal budget should be as  comprehensive as possible; that is, all activities of the federal  government should be shown within a unified budget.  GAO has long  supported an inclusive budget that discloses up-front the full  commitments of the government. 2. Ensuring that the full commitment of the government is recognized in  the budget will provide greater transparency for effective congressional  and public oversight.  Moreover, it ensures that decision makers have  the information needed to make the trade-offs inherent in allocating  resources among competing demands.  Further, this report recognizes  the difficulty in ensuring the validity of agencies’ long-term plans, but  scoring that is based on the substance of a transaction could result in a  better reflection of the government’s full commitment.
3.
It is not the intent of this report to discourage or to eliminate energy  conservation efforts or partnerships with the private sector.  Given  recent congressional action to extend ESPC authority through fiscal  year 2006, we have revised our draft to recommend that OMB require,  and suggest that Congress consider requiring agencies that use ESPCs  to present to Congress an analysis comparing total contract cycle costs  of ESPCs entered into during the fiscal year with estimated up-front  funding costs for the same ECMs.  However, recognizing the full  commitment up-front in the budget enhances transparency and enables  decision makers to make appropriate resource allocation choices  among competing demands that all have their full costs recorded in the  budget.
4.
In our August 2003 report (Budget Issues: Alternative Approaches to  Finance Federal Capital, GAO-03-1011) we identified 10 capital  financing approaches that have been used by federal agencies to  finance capital.  Subsequently, as requested by the Senate Chairman,  Committee on the Budget, we analyzed in greater detail two examples  of these alternative approaches: public/private partnerships and Energy  Savings Performance Contracts.  Although this report includes our  findings both on ESPCs and partnerships, our analysis of these two  financing mechanisms was prepared separately and considered the  unique circumstances of each case study. 5. Financing asset acquisition through the United States Treasury always  has a lower interest cost than third-party financing.  We looked only at  acquisitions because we recognize that if the need for an asset is short- term, the government would not need to acquire it.  Also, see comment  2. 6.
In a constrained budget environment, agencies need to prioritize their  projects needing resources and request funds for those of the highest  priority.  The excerpt DOE cites from our 1998 Executive Guide  recognizes—as we do on page 2 of this report—that from an agency’s  point of view the ability to record acquisition costs of a capital asset  over the life of that asset can be very attractive.  However, from the  point of view of the government as a whole, these provisions may  increase costs.  It is the Congress’ role to allocate resources across  agencies.  The same paragraph cited by DOE further states, “some  strategies currently exist at the federal level that allow agencies a  certain amount of flexibility in funding capital projects without a loss of  fiscal control.  These strategies include budgeting for stand-alone  stages….” 7. Our report does not suggest excluding the status quo from  consideration when agencies evaluate the full range of alternatives in  business case analyses.  Our focus is on acquisition costs and whether  or not alternative financing arrangements increase or decrease the total  cost of capital acquisition.  We do not question agencies’ decisions to  acquire assets and assume that the same assets would be acquired  regardless of how they are financed.   8. DOE and VA officials have stated that lower labor costs and fewer  bureaucratic requirements could make partnership financing overall  less expensive than financing through full, up-front appropriations.   Despite this assertion officials were not able to provide documentation  to support these claims.  DOE contractors did provide a cost-benefit  analyses for the financing arrangement at ORNL; however, it was  inconclusive because the analyses compared private financing versus  receiving federal appropriations over a 10-year period and did not  compare receiving full, up-front appropriations. 9. We commend DOE on drafting a policy that will require a business case  analysis for public/private partnerships. 10. As we have testified and reported in the past, we believe the budget  should reflect the full commitment of the government, considering the  substance of all underlying agreements, when third-party financing is  employed.  According to OMB staff, some of the partnerships we  reviewed may have been scored differently under the revised A-11  guidelines.  However, even given the 2003 revisions, we believe the  scorekeeping rules should continue to be refined to ensure that the full  commitment of the government is considered in the budget.  In its  comments on our draft report, OMB agreed in concept with this  recommendation and stated that reflecting the full commitment of the  government has always been its goal.
In our conclusions, we discuss agencies’ long-term capital plans as  indicative of their long-term capital requirements and as useful in  determining the substance of underlying agreements to obtain capital.   We recommend that the scorekeepers develop rules that would include  consideration of these plans.  We recognize that ensuring the validity of  such plans may pose implementation challenges such as the need to  validate agencies’ long-term capital requirements. 11. The report has been changed to indicate the partnership was scored  according to OMB’s interpretation. 12. We recognize that DOE did not purchase the three privately financed  buildings at ORNL.  However, the buildings were clearly constructed  for DOE’s benefit and we do not believe it likely DOE would abandon  these state-of-the art buildings to reoccupy the currently dilapidated  buildings. 13. See comments 3 and 10.  We disagree with DOE about whether only the  legal commitment should be reflected in the budget or whether the  underlying substance of the deal should be reflected.   14. As discussed throughout our report, we believe up-front recognition of  the full cost enhances budget transparency.  Further, we believe the  specific standards to be incorporated in any change in scorekeeping  guidelines would most appropriately be established by the  scorekeepers.  Consideration of the substance of all underlying  agreements should be part of any specific standards, as we  recommend. 15. GAO suggests that agencies’ long-term capital plans be considered in  determining the substance of the underlying agreement. 16. We fully understand that the ORNL transactions were deliberately  structured to be considered operating leases.  As is clear from DOE’s  earlier comments, we simply disagree with DOE about whether only  the legal commitment should be reflected in the budget or the  underlying substance of the deal.  During our review DOE and UT- Battelle, LLC, officials reviewed and agreed with our description of the  ORNL transaction included as figure 12, “Partnerships and Financing of  ORNL’s Revitalization.” 17. Standard and Poor’s A+ bond rating analysis explicitly discussed “a  strong lease revenue stream” from DOE for a period up to 25 years and  that the trustee would have a valid security interest in the rent stream.”    Therefore, the private sector clearly viewed this as a long-term  commitment by DOE. 18. See comment 16.  Also, neither DOE nor its contractors provided GAO  with documentation to support its assertion that reserve funds were  established by the private sector Bond Trustee to cover any shortfall in  rent beyond the 1-year period in the event of termination.  Additionally,  Standard and Poor’s bond rating did not state reserve funds were  established to cover any shortfall in rent beyond the 1-year period in  the event of termination.  Rather, it cites a “debt service reserve fund  equal to one month’s base rent.”   19. See comments 14 and 15. 20. Our report did not seek to analyze ESPCs from a traditional  government contracts perspective.  Our report does analyze ESPCs and  partnerships from a budget scorekeeping perspective.  Also, see  comment 3. 21. Whether or not Standard and Poor’s was correct in citing that DOE had  pledged a lease revenue stream as security for the payment of the  bonds, such a statement could have affected bond investors’ decisions  to purchase.  Furthermore, clearly the private sector considered the  substance of the underlying agreements in making this assessment.  We  have clarified in figure 7 that the Development Corporation arranged  for the private financing which, as shown in figure 12, was secured by  Keenan Development Associates of TN, LLC, through Banc of America. 22. All of our six ESPC case studies paid more to obtain energy  conservation measures through ESPCs than they would have paid  through full, up-front appropriations.  Given FEMP’s assertions that 18  federal agencies and departments have implemented ESPC projects  worth $1.7 billion, we believe that “no cost to federal customers” is a  misnomer.  Furthermore, agencies do acquire assets through ESPCs.   As stated in FEMP guidance, ownership of the asset usually transfers  from the ESCO to the agency when the equipment has been installed  and accepted and after initial confirmation of the guaranteed savings.   Nonetheless, given recent congressional action to extend ESPC  authority through fiscal year 2006, we have revised our draft such that  ESPCs have been deleted from the first recommendation.  Instead, we  have suggested that Congress should consider requiring agencies that  use ESPCs to present to Congress an analysis comparing total contract  cycle costs of ESPCs entered into during the fiscal year with estimated  up-front funding costs for the same ECMs.   23. Given the mandates to reduce energy consumption, we do not believe  the ability of the government to invest in needed capital improvements  would be crippled by the requirement to recognize costs up front in the  budget.  Congress can decide what constitutes priority claims on  resources.  Also see comment 3 and 22. 24. We acknowledge that waiting for funds to be appropriated may result in  opportunity costs.  However, DOE did not provide sufficient  documentation to support its assertion that waiting for appropriations  before proceeding with the ESPC process will cause serious, costly, and  irreparable harm to federal energy and infrastructure goals.  As stated  in our report, we recommend to the heads of case study agencies,  including DOE, that business case analyses be performed and that the  full range of funding alternatives be analyzed.  Such an analysis could  include the effect of not obtaining timely appropriations. 25. Our report does not state that DOE acquired any of the assets that were  the subject of the Oak Ridge transaction, nor did our analyses look at  UT-Battelle’s modernization program implemented through the State of  Tennessee. Rather our report states that DOE used existing law to  structure a partnership that enabled it to obtain the long-term use of  facilities that was arranged through private financing. 26. Our report takes a broad definition of partnerships.  Also, we  specifically identified the transactions at Oak Ridge National  Laboratory as an example of a public/private partnership in our report,  Budget Issues: Alternative Approaches to Finance Federal Capital,  GAO-03-1011 (Washington, D.C.: Aug. 21, 2003), pages 5, 48, and 52-53. 27. We clarified our report to remove any implication that the 75 percent  criteria for operating leases was violated.   28. We disagree.  Our draft report states the financing approaches used in  many of the case studies were structured to include features that do not  require up-front budget recognition even though they established long- term commitments of the government.  As stated in our report, UTBDC  implemented subleases of three facilities to UT-Battelle, LLC, for DOE’s  ultimate use, each with a lease term of up to 25 years.   29. According to a UT-Battelle, LLC, official, UTBDC was created for the  purpose of securing private financing.  Thus, our report does assert that  the ORNL transaction was undertaken to obtain private financing.  We  do not see this as inconsistent with DOE’s comment that the  “transaction was undertaken…as a means by which DOE could obtain  something of value to it—the use of a new building.” 30. References to DOE legal opinions in our draft are based on  documentation given to us by the DOE Chief Counsel in Oak Ridge  based on the relevance to the Oak Ridge National Laboratory  public/private partnership.  All statements in our report are within the  context of how the citations were written.  We clarified the author of  the legal opinion and the subject of the memo.   31. Our report does not say that a conflict of interest and potential for  fraud or wrongdoing existed in the Oak Ridge National Laboratory  partnership.  Rather, our report states that partnerships require  monitoring because of the complicated relationships involved.   32. Our report states we used a case study approach and notes that this  does not allow us to generalize our findings across the government.  To  analyze ESPC costs, we reviewed the delivery orders, given to us by  GSA and the Navy, for each of our six ESPC case studies.  In the course  of our audit work we reviewed the ORNL study (Oak Ridge National  Laboratory, Evaluation of Federal Energy Savings Performance  Contracting-Methodology For Comparing Processes and Costs of  ESPC and Appropriations-Funded Energy Projects, March 2003),  interviewed the authors of the study, and talked with agency officials  about the study’s methodology.  Based on our analyses we found two  major flaws in the study:  (1) as agreed with the study authors the  sample size was too small and was not applicable to the entire federal  sector and (2) the study compares the costs and savings across various  types of ESPCs installed in several different federal facilities, making it  difficult to compare energy savings because the savings would depend  upon too many unpredictable factors.  Also, as discussed on page 30,  we did discuss with GSA and Navy officials their historical funding  experiences. 33. It is the executive branch’s long-standing position that the levels of  internal executive branch funding requests are predecisional  deliberative documents and therefore unavailable to us. 34. We acknowledge in our report that officials we spoke with said they  believed M&V results in higher sustained savings.  In this report, we  take no position on whether M&V should be purchased, but agency  officials said that measurement and verification is an expense that  would not be incurred if the energy conservation measures were  acquired through full, up-front appropriations.  Additionally,  representatives from energy service companies said that their private  sector clients do not always purchase M&V and verification, and if they  do, it is for a shorter period than contracts secured by the government.   The lack of M&V being purchased in the private sector suggests it is  worth exploring whether the amount of M&V purchased is a necessary  expense for the government to incur whether the project is directly  funded or obtained with an ESPC. 35. We include M&V in ESPCs costs because they are a required  component of ESPCs to demonstrate that annual savings generated by  ECMs meet or exceed contract payments.  However, we exclude M&V  from our proxy estimate of the cost if the ECMs were acquired through  timely, full, and up-front appropriations because agency officials told us  that M&V is an expense that would not be incurred if the ECMs were  acquired through timely, full, and up-front appropriations.  See also  comment 34. 36. While it may be that ESPCs do not result in an increase in agencies’  utility bills, the ECMs acquired by all of our six ESPC case studies were  more expensive than if ECMs had been acquired through timely, full,  up-front appropriations.  Thus, we do not consider ESPCs to be budget  neutral over the long-term. 37. Our analyses were based on data obtained from final awarded delivery  orders from case study contract files given to us by the Navy and GSA  and was reviewed as part of technical comments on the appendixes by  both the Navy and GSA. 38. It is unclear to us how DOE derived the “maximum possible percent  increase (PV) financed through ESPCs over cost if direct funded.”   Using the data contained in the case studies’ delivery orders, we  attempted to replicate DOE’s “best case assumptions” by subtracting  M&V costs out of the comparison.  We found that M&V represented a  relatively small percentage of the ESPC contract cycle costs and thus  did not significantly affect the increase in the costs attributed to ESPC  financing versus timely, full, and up-front appropriations.  For example,  in the case of the federal courthouse in Gulfport, Mississippi, removing  M&V costs from the comparison caused the percentage difference to  decline from 56 percent to 51 percent, not to 26 percent as DOE  suggests.  The 51 percent difference reflects interest costs that GSA  must pay to the ESCO over the course of the contract. 39. Funds for ESPCs are obligated on an annual basis; therefore, the  budget does not recognize the government’s full long-term commitment  up front, when the decisions are made.   40. Since we used the delivery order to derive our proxy estimate, any  avoided costs that were counted as a saving in that delivery were also  counted as a saving in our proxy estimate.  Our analysis assumes  agencies acquire the same assets and avoid the same costs regardless  of funding approach.  Also, the savings from the avoided costs were  used to make up-front payments in the contracts. 41. We do not contest agencies’ use of simplified assumptions in M&V  strategies.  Rather, our concern is focused on the statement contained  in FEMP’s July 2004 Super ESPC Agency Project Binder.  On page 6 of  the chapter entitled, “Introduction to M&V for Super ESPC Projects” it  says, “In the event that the stipulated values overstate the savings or  reductions in use decrease the savings, the agency must still pay the  ESCO for the agreed-upon savings.”  It does not discuss other remedies  against the ESCO nor does DOE’s comment elaborate on what these  remedies might include. 42. Our report acknowledges agencies’ past experiences on page 33.  Also  see comment 32.  43. Large buy-downs indicate the availability of funds in the first year of the  contract and so imply opportunities exist to acquire ECMs in smaller,  useful segments, when technically feasible, with full, up-front  appropriations instead of through ESPCs.  Navy and GSA officials  indicated to us that they typically did not consider financing ECMs  through useful segments before deciding to use ESPCs.  Moreover, we  did not include the up-front payments made by Navy Region Southwest  or Naval Submarine Base Bangor in this statement because these  payments were made from an unexpected federal appropriation, which  will not likely occur again. 44. As stated in our draft report agencies did not request full, up-front  appropriations for the case studies reviewed in our report.  Thus, it  cannot be known how much might have been needed to develop  surveys and studies to define projects in order to request direct  appropriations.  Business case analyses are well accepted as a leading  practice among public and private entities.  OMB requires all executive  branch agencies to prepare business case analyses for major  investments as part of their budget submissions to OMB.  Also see  comment 32. 45. See comments 24, 34, and 35.
section_title: Comments from the General Services Administration
paragraphs: The following are GAO's comments on the General Services  Administration's letter dated November 5, 2004.
subsections: section_title: GAO’s Comments
paragraphs: 1. While we recognize GSA’s current procedures to perform life-cycle cost  analyses as part of its ESPC evaluation process, life-cycle costing is  only one aspect of a business case analysis.  Both OMB’s guidance and  our Executive Guide to Leading Practices in Capital Decision- Making stress the importance of alternatives analysis as another  component of building a business case.  Such an analysis would  consider the full range of funding alternatives.  GSA does not analyze  the full range of funding alternatives and therefore has an incomplete  business case analysis. 2. We asked GSA staff in Atlanta whether GSA had requested  appropriations for any of the case study ESPC projects we reviewed  and were told that the field office had not submitted a request to  headquarters because, given the $6 billion backlog of repairs and  alterations needed, the field office considered it unlikely that such  funding would be approved.  At headquarters, GSA budget officials told  us that they do not specifically request funds up-front for ECMs  because they are financed over time through ESPCs.   3. We recognize that it is not always possible to undertake energy  conservation measures as stand-alone projects.  Accordingly, our  recommendation asks that the technical feasibility of useful segments  be considered when making capital financing decisions.  We commend  GSA’s decision to revise its energy conservation project evaluation  process to include consideration of useful segments. 4. We agree that ESPC delivery orders are written to specify that project  savings meet or exceed financed costs.  However, the ancillary up-front  costs also are specifically included in the contract and thus are a part of  total contract cycle costs.
section_title: Comments from Veterans Affairs
paragraphs: The following are GAO's comments on the Veterans Affair's letter dated  October 25, 2004.
subsections: section_title: GAO’s Comments
paragraphs: 1. Given recent congressional action to extend ESPC authority through  fiscal year 2006, we have revised our draft to recommend that OMB  require, and suggest that Congress should consider requiring agencies  that use ESPCs to present to Congress an analysis comparing total  contract cycle costs of ESPCs entered into during the fiscal year with  estimated up-front funding costs for the same ECMs.
We have better emphasized and clarified in the report that OMB  updated and revised its instructions in 2003 to address lease-backs  from public/private partnerships.  According to OMB staff, some of the  partnerships we reviewed may have been scored differently under the  revised guidelines.  However, we still believe the scorekeeping rules  should continue to be refined to ensure that the full commitment of the  government is considered in the budget. 2. We have added language to clarify further that our report looked at the  government’s cost of acquiring assets.  Evaluating the benefits of the  assets was not one of our objectives.  We assume that the same assets  would be acquired regardless of how they are financed and thus they  would have identical benefits and operating costs.  Given our  objectives, focusing our analysis on the government’s cost of financing  the assets’ acquisition was the appropriate approach for this report.   Recognizing costs up front does not prohibit discussion of future  benefits when requesting appropriations.   3. The statement that ESPC commitments are not fully recognized up- front in the budget does not refer to VA’s enhanced use leases.  Further,  although congressional notification is an important and valuable  process, it does not constitute recognition in the budget.   4. Our report does not state that VA or other agencies included in our  review have deliberately hidden budgetary information from Congress.   Nor do we dispute that Congress has continued to encourage VA’s use  of enhanced-use leasing.  Clearly, enhanced-use leases were explicitly  authorized by law.  Rather, when these leases are structured such that  developed property is leased-back in short-term increments, OMB’s  interpretation of the budget scoring rules permitted only the short-term  costs associated with these assets to be scored in the budget.  Finally,  with respect to prior requests for appropriated funds, VA officials  explained to us that while requests had been submitted for regional  offices, requests had not been submitted for the Atlanta regional office  or other case studies in our review. 5. The lease-back agreements we reviewed had features that indicated a  long-term commitment by the government.  They were structured such  that the government’s legal commitment was confined to short-term  periods.  Accordingly, OMB’s interpretation of the budget scorekeeping  rules required that only these short-term costs to be recognized up- front in the budget.  However, recording only the 2-year legal  commitment understates the likely longer term costs of the  government.  For example, prior to the enhanced-use lease used to  develop a collocated regional office in Atlanta, the regional office had  occupied offices in that area for over 25 years.  While it is certainly  possible that VA may choose to discontinue operations in the Atlanta  area, in our opinion reflecting zero cost beyond the 2-year legal  commitment overstates the chances of this occurring.
section_title: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: In addition to the contact person named above, Carol Henn, Maria  Edelstein, Sandra Beattie, Dewi Djunaidy, Scott Farrow, Hannah Laufe,  David Nicholson, and Adam Shapiro also made significant contributions to  this report.
section_title: GAO’s Mission
paragraphs: The Government Accountability Office, the audit, evaluation and  investigative arm of Congress, exists to support Congress in meeting its  constitutional responsibilities and to help improve the performance and  accountability of the federal government for the American people. GAO  examines the use of public funds; evaluates federal programs and policies;  and provides analyses, recommendations, and other assistance to help  Congress make informed oversight, policy, and funding decisions. GAO’s  commitment to good government is reflected in its core values of  accountability, integrity, and reliability.
section_title: Obtaining Copies of GAO Reports and Testimony
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