Energy Savings: Performance Contracts Offer Benefits, but Vigilance Is Needed to Protect Government Interests
Published: 2005-06-22T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The federal government is the nation's largest energy consumer, spending, by latest accounting, $3.7 billion on energy for its 500,000 facilities. Upfront funding for energy-efficiency improvements has been difficult to obtain because of budget constraints and competing agency missions. The Congress in 1986 authorized agencies to use Energy Savings Performance Contracts (ESPCs) to privately finance these improvements. The law requires that annual payments for ESPCs not exceed the annual savings generated by the improvements. GAO was asked to identify (1) the extent to which agencies used ESPCs; (2) what energy savings, financial savings, and other benefits agencies expect to achieve; (3) the extent to which actual financial savings cover costs; and (4) what areas, if any, require steps to protect the government's financial interests in using ESPCs.
section_title: What GAO Found
paragraphs: Although comprehensive data on federal agencies' use of ESPCs are not available, in fiscal years 1999 through 2003, we found that 20 federal agencies undertook 254 ESPCs to finance investments in energy-saving improvements for 5 to 25 years. Through the ESPCs, federal agencies plan to make annual payments amounting to at least $2.5 billion spread over the lifetime of the contracts. Agencies expect to achieve benefits that include energy savings worth at least $2.5 billion over the life of the contracts, as well as other benefits that cannot be easily quantified, such as improved reliability of the newer equipment over the aging equipment it replaced, environmental improvements, and additional energy and financial savings once the contracts have been paid for. While these benefits could be achieved using upfront funds and with lower financing costs, agencies stated that they generally have not received sufficient funds upfront for doing so and see ESPCs as a necessary supplement to upfront funding in order to achieve the benefits cited. Agencies believe that ESPCs also provide unique benefits such as a partial shift of risk from agencies to private energy services companies and a more integrated approach to providing efficiency measures. Agencies structure ESPCs so that financial savings cover costs and they reported that many do. However, GAO could not verify that conclusion using the data on ESPCs, and GAO work and agency audits disclosed ESPCs in which unfavorable contract terms, missing documentation, and other problems caused GAO to question how consistently savings cover costs. Furthermore, differing interpretations of the law establishing ESPCs about what components of costs must be paid for from the savings generated by the project or may be paid for using other funding sources have contributed to uncertainties about whether savings are appropriately covering costs. GAO identified concerns in the areas of expertise and related information and competition that are fundamental to ensuring that savings cover costs and to protecting the government's financial interests in using ESPCs. According to agency officials, they often lacked the technical and contracting expertise and information (such as interest rates and markups) to negotiate ESPCs and to monitor contract performance in the long term. The officials also think there may be insufficient competition among finance and energy services companies and that this could lead to higher costs for ESPCs.

section_title: Letter
paragraphs: The federal government is the single largest energy consumer in the nation,  spending about $3.7 billion in fiscal year 2002on energy for its  approximately 500,000 facilities in the United States. The Energy Policy Act  of 1992 and several subsequent executive orders require federal agencies to  reduce their consumption of energy in federal facilities. Most notably,  Executive Order 13123, issued in 1999, requires agencies, by 2010, to  reduce energy consumption by 35 percent from a 1985 baseline. Additional  provisions in the act and various executive orders have added other goals,  such as conserving water and using renewable fuels.
Whether to pay for energy-efficiency improvements that reduce energy  consumption through up-front appropriations or through private financing  is a matter of concern to many. Agencies and members of the Congress  have long recognized that upfront funding for energy-efficiency  improvements has often been difficult to obtain because of budget  constraints and competing agency mission priorities. In 1986, the Congress  provided agencies with an alternative mechanism for obtaining energy- efficiency improvements when it authorized agencies to use Energy  Savings Performance Contracts (ESPCs), a type of share-in-savings  contract, to privately finance the improvements. This step reflected the  trend in the federal government toward increased reliance on performance- based contracting to improve the services agencies receive from  contractors. In performance-based contracting, the agency specifies the  result it desires and leaves it to the contractor to decide how best to  achieve the desired result. Through share-in-savings contracting, one  performance-based technique, the agency compensates a contractor from  the financial benefits derived as a result of contract performance. Under an  ESPC, agencies enter into a long-term contract (up to 25 years) with a  private energy services company in which the company installs energy- efficiency improvements financed from private funds. The agency then  repays the company until the improvements have been paid for. The law  requires that annual payments for the ESPCs not exceed the value of the  annual utility savings generated by the installed energy-efficiency  improvements. As part of an ESPC, the agency and the energy services  company estimate the annual energy and financial savings and develop a  plan to monitor and verify that the expected savings actually occur. ESPCs  are designed to shift performance risk associated with energy-efficiency  improvements from the agency to the company. This shift is to be made by  conditioning annual payments to the company on verification that the  expected financial savings have been realized. These savings are to be  calculated as the difference between the baseline cost for energy  consumption that would have been incurred without the ESPC and the cost  of the energy consumption with the ESPC’s energy-efficiency  improvements in place.
Agencies tended to use ESPCs sparingly during the late 1980s and early  1990s, largely because negotiating an ESPC can be a highly technical and  time-consuming process. Agencies began using ESPCs more during the late  1990s. Agencies’ energy reduction goals became more ambitious as a result  of Executive Order 13123, and the new goals required agencies to allocate  additional funds to install energy-efficiency improvements. To help simplify  and shorten the ESPC negotiation process, the Department of Energy’s  (DOE) Federal Energy Management Program (FEMP) negotiated “super”  ESPCs with energy services companies that FEMP prequalified, via a  competitive process, to provide services under the contracts. FEMP’s super  ESPCs are umbrella contracts that federal agencies may use to purchase  energy equipment and services. The Department of the Air Force and the  U.S. Army Corps of Engineers negotiated similar “super” ESPCs. Agencies  have the option to use the super ESPCs to take advantage of some  prenegotiated terms and conditions. In this regard, agencies can implement  delivery orders more quickly using the super ESPCs because the  competitive selection process has already been completed and key terms of  the contract negotiated. Alternatively, the agencies may still enter into  “stand-alone” ESPCs with energy services companies using a separate  competitive selection process.
The use of ESPCs in recent years has raised questions about how these  contracts should be reflected in the federal budget. At present, they are not  reflected—“scored”--upfront in the budget when the contract is signed, and  budget agencies disagree about whether they should be. The  Congressional Budget Office believes that the obligation to make payments  for the energy-efficiency improvements and the financing costs is incurred  when the government signs the ESPC and that scoring the full cost is  consistent with governmentwide accounting principles that the budget  reflect this commitment as a new obligation at the time of signing. The  Office of Management and Budget, on the other hand, includes the costs of  ESPCs in the budget on an annual basis as they are incurred. The scoring  treatment is based on the contingent nature of the contract—payments are  contingent on achieving expected financial savings and, therefore, the  government is not fully committed to the entire long-term cost of the ESPC  at the time it is signed. Agencies have statutory authority to enter into a  multiyear contract even if funds are available only to pay for the first year  of the contract. Although authorization for ESPCs lapsed on October 1,  2003, it was renewed on October 28, 2004, through fiscal year 2006, and  retroactive authorization was provided for any ESPCs signed between the  time the authority expired and was reinstated.
In this context, you asked us to determine, for contracts agencies  undertook in fiscal years 1999 through 2003, (1) the extent to which  agencies used ESPCs; (2) what energy savings, financial savings, and other  benefits agencies expect to achieve; (3) the extent to which actual financial  savings from ESPCs cover costs; and (4) what areas, if any, require steps to  protect the government’s financial interests in using ESPCs.
To answer these questions, we first obtained basic contract data from the  databases of the four federal contracting centers that assist agencies with  ESPCs—the Air Force Civil Engineer Support Agency, the U.S. Army Corps  of Engineers’ Huntsville Center, FEMP, and the Naval Facilities Engineering  Service Center, which reflect the majority of all federal ESPCs undertaken  during fiscal years 1999 through 2003. We did not completely assess these  data for reliability; however, we reviewed the steps each agency took to  ensure the data were reliable and determined that these steps were  sufficient for our reporting purposes. We also obtained more detailed  contract data for the same period from the seven federal agencies having  the most facility floor space and highest energy use and, therefore, the  most potential to use ESPCs. These agencies were DOE; the Departments  of the Air Force, the Army, the Navy (including the Marine Corps), Justice,  and Veterans Affairs; and the General Services Administration. We did not  perform formal benefit/cost analyses of individual ESPC projects or of  ESPCs as a whole because of data limitations. Consequently, to assess the  costs and benefits of ESPCs, we supplemented the limited data analysis we  were able to conduct with agencies’ assessments of their own ESPCs and  the additional information we obtained from agency files and through more  than 60 interviews with officials from the agencies, energy services  companies, and financiers. We also reviewed relevant regulations, policies,  and agency procedures. For more information regarding the scope and  method we followed, see appendix I. We conducted our work from January  2004 through May 2005 in accordance with generally accepted government  auditing standards.
subsections: section_title: Background
paragraphs: Federal agency use of ESPCs was authorized by the Congress to provide an  alternative to direct appropriations for funding energy-efficiency  improvements in federal facilities. Many agencies were hard-pressed to  pay for planned maintenance and repairs in their facilities, let alone make  more significant building improvements. As a result of this situation, many  federal facilities were in a state of deterioration with agencies estimating  restoration and repair needs in the tens of billions of dollars. Although  energy-efficiency improvements were likely to save money over the life of  the investments and replace aging infrastructure, budgetary constraints  prevented agencies many times from receiving appropriations for such  investments. Under the ESPC legislation, agencies could take advantage of  private-sector expertise, often lacking at the agencies, with little or no  upfront cost to the government. Under these contracts, private-sector firms  are supposed to bear the risk of equipment performance in return for a  share of the savings. This arrangement permitted agencies to meet mission  requirements and upgrade their energy efficiency to reduce energy usage at  the same time, while recognizing only the first year’s cost upfront in the  budget. The Congress authorized agencies to retain some or all of any  annual savings available after required contractual payments to the energy  services companies have been made.
subsections: section_title: ESPC Process
paragraphs: To begin an ESPC project, agency officials work on their own or with the  assistance of one of the federal contracting centers at the U.S. Air Force,  the U.S. Army Corps of Engineers’ Huntsville Center, the Navy, or FEMP, to  choose an energy services company for the project and to identify the  energy-efficiency improvements the company will finance for the agency.  Usually, multiple companies submit initial proposals that include  information on their qualifications and preliminary cost and savings  projections for the project. During this phase, all costs are borne by the  companies.
To continue developing the project, the agency chooses one company and  agrees to pay for a detailed energy survey. According to contracting center  officials, this survey typically takes up to 1 year and includes such items as  an assessment of baseline energy use and cost, projections of energy use  and savings once the improvements have been put in place, maintenance  schedules, and prices. Improvements must be “life-cycle cost effective,”  that is, the benefits must meet or exceed total costs over the contract.  Determining life-cycle cost effectiveness is an agency responsibility, but the  agency can request this service from the company, generally for a separate  fee. A final proposal that includes the detailed survey becomes the basis for  comment and negotiation between the agency and/or contracting center  and the company. Included in these negotiations are such contract terms as  the “markups” added to the direct cost of each improvement to cover the  energy services company’s indirect costs and profit associated with its  implementation, operations and maintenance arrangements, guaranteed  savings amounts, financing, and methods to verify that savings are  achieved.
Once the agency and energy services company have reached final  agreement on contract terms, the company designs and installs the energy- efficiency improvements and tests the improvements’ operating  performance. Agency officials review test results and have the company  make any necessary corrections. To install, test, and accept the  improvements typically takes up to 2 years to complete. Upon accepting  the project, the agency starts payments to the company, which must be  supported by regular measurement and verification reviews.
Although agencies may develop an ESPC themselves, doing so can be a  complicated process; consequently, most agencies seek assistance from  one of the contracting centers at DOD or FEMP. To streamline the  procurement process, three of these contracting centers—Air Force, U.S.  Army Corps of Engineers’ Huntsville Center, and FEMP—have awarded  super ESPCs, from which multiple projects can be developed, to  prequalified energy services companies in different regions of the country.  The super ESPC awards to selected energy services companies complied  with Federal Acquisition Regulation rules and requirements for  competition. With these multiple-award contracts in place, agencies can  implement ESPCs in a fraction of the time it would take to undertake an  ESPC alone because the competitive process to select qualified companies  has been completed and key terms of the contract broadly negotiated, such  as setting maximum markups the companies may charge. In addition to  managing the super ESPCs, the contracting centers support agencies in  negotiating aspects of specific projects for a separate fee. For example,  FEMP provides facilitation services, where a third party assists the agency  and energy services company in agreeing on terms such as markup rates,  financing options, and the appropriateness of plans to measure and verify  savings for proposed improvements. In addition, FEMP issues guidelines,  offers training, and provides other support to agencies using the FEMP  super ESPC.
section_title: ESPC Savings Are Intended to Cover Contract Costs
paragraphs: Under an ESPC, company-incurred costs are paid from savings resulting  from improvements during the life of the contract. These savings include  such things as reductions in energy costs, operation and maintenance  costs, and repair and replacement costs directly related to the new  efficiency improvements. In addition to direct costs for the improvements,  other costs that savings should cover include financing charges, monitoring  services, and company-provided maintenance. Savings to an agency must  exceed payments to the energy services company. By law, aggregate annual  payments by an agency to both utilities and energy services companies  under an ESPC may not exceed the amount that the agency would have  paid for utilities without the ESPC. To ensure that energy savings cover the  contract costs, companies are required to guarantee the performance of the  new equipment and assume the risk for its operation and maintenance  during the contract, even though the agency may perform the maintenance.  Agencies still assume some risks, for example, for changes in utility rates  and in hours of operation, over which the energy services company has no  control.
To measure and verify that the guaranteed savings are achieved, an agency  compares baseline energy usage and costs prior to the ESPC with  consumption and costs after the improvements have been installed.  Typically, the company develops a baseline during its detailed survey, while  the agency is responsible for ensuring that the baseline has been properly  defined. The company then estimates the energy that will be saved by  installing the improvements and calculates the financial savings expected  in the future. At least annually, and sometimes more often, the company  provides measurement and verification inspections and reports to the  agency to substantiate the expected savings.
Several measurement and verification protocols are available to determine  energy savings. For example, under FEMP guidelines, four options are  discussed that range in complexity and costs. The simplest, and perhaps  least expensive, option is to measure the capacity or efficiency of the new  equipment and “stipulate” hours of operation, expected energy  consumption, and other factors rather than specifically measure them.  Such stipulation is often used for simpler improvements, such as lighting. A  more costly option might include constant monitoring of energy usage  through metering or computer simulation models of whole building energy  consumption. These methods may involve metering performance and  operating factors before and after the installation of the improvements.  When choosing among the alternatives, agencies balance the need for  accuracy of their estimates with the costs of verifying those estimates. As  part of its guidance, FEMP includes a matrix that describes a number of  factors and associated risks involving financial, operational, and  performance issues. When guaranteed savings are not achieved directly  due to the performance of the equipment, the agency may withhold  payment from the energy services company until the conditions are  corrected.
section_title: Prior GAO Work Compared the Financing Costs of ESPCs with Upfront Funding
paragraphs: As we reported in December 2004, while ESPCs provide an alternative  financing mechanism for agencies’ energy-efficiency improvements, for the  cases we examined, such funding was more expensive than using timely  upfront appropriations. This is because the federal government is able to  obtain capital at a lower financing rate than private companies can. In this  regard, our earlier work examining six projects found that financing these  projects with ESPCs cost 8 to 56 percent more than had the projects been  funded at the same time with upfront funds. The report noted that other  factors, such as required measurement and verification of savings, may also  affect the cost of projects financed with ESPCs. Agency officials  commenting on this work agreed that timely upfront appropriations would  be less costly than privately financing energy-efficiency improvements, if  such appropriations were available, but stated that any delays in funding  would result in a subsequent loss of energy and cost savings and these  losses over time could offset the lower financing costs of the upfront  funding. We did not analyze the likelihood nor the costs of such delays.
section_title: Many Agencies Used ESPCs, Although the Extent of Use Varied
paragraphs: During fiscal years 1999 through 2003, numerous agencies undertook  ESPCs to finance energy-efficiency improvements, committing the federal  government to annual payments totaling about $2.5 billion over the terms  of these contracts. The use of ESPCs has been geographically widespread,  with many types of equipment installed, and the extent of use has varied  across the agencies.
During our review, we found that there is no source of comprehensive data  on federal agencies’ use of ESPCs, either in DOE, the contracting centers,  or the agencies. DOE is required to collect data on the numbers, costs, and  expected energy and financial savings for the new ESPCs that agencies  undertake each year and report these data annually to the Congress. The  data in DOE’s reports, however, were not adequate for our review for  several reasons: they did not include some critical elements, such as actual  energy savings; they were not cumulative from year to year; and they did  not include ESPCs begun in fiscal year 2003 because DOE has not yet  issued the report for that year. Similarly, the DOD and FEMP contracting  centers’ data were not comprehensive enough for our purposes. The  centers’ data were limited to those contracts for which they provided  assistance; like DOE’s reports, they did not include certain critical  elements; and, with the exception of Navy’s, did not incorporate  information on modifications or progress on the contracts past the point at  which the centers’ assistance to the agency was completed—usually only  up to 1 year after the contract was signed. Furthermore, most agencies do  not have a comprehensive, centralized electronic or paper system for  tracking their ESPCs and keep some contract data only in project files at  the facilities where the contracts are being implemented.
Consequently, to examine ESPC use across the federal government, we  obtained data from the four contracting centers and from the seven  agencies included in our review. We combined the data from all the  agencies into a consistent format, deleted duplicate records, and  performed basic tests to ascertain the reliability of the data. Although the  data for some projects were incomplete, the overall results of our analyses  appear to be consistent with information published from other sources.  The results of our analyses follow.
subsections: section_title: Twenty Agencies Used ESPCs
paragraphs: During fiscal years 1999 through 2003, 20 agencies undertook 254 ESPC  projects to finance investments in energy-efficiency improvements. The  ESPCs commit the federal government to annual payments totaling about  $2.5 billion over the terms of these contracts, conditional on either the  savings guaranteed in the contracts being verified or as stipulated in the  contracts. Because energy services companies are accountable for  guaranteeing the performance of the equipment installed, if savings are  reduced due to equipment performance, the company must correct any  related problems. In some instances, the contract may stipulate an amount  of savings that will be achieved. In the event that this stipulation overstates  actual savings, the agency must still make payments based on the amount  of savings stipulated. However, if stipulation understates savings, the  agency obtains the additional savings at no additional cost. Table 1 shows  the numbers and costs of ESPCs the 20 agencies undertook, as well as the  percentage of total ESPCs attributable to each agency.
The size of ESPC projects varied greatly over the 5-year period, ranging  from $241,943 to $137,515,074. About 72 percent of the projects in this time  period are valued at $10 million or less, as shown in figure 1. The contract  length of all ESPC projects ranges from 5 to 25 years, with an average of  15.8 years.
Using the ESPCs, agencies financed energy-efficiency improvements that  have been or are in the process of being installed at locations in 49 states  and on U.S. military installations in Guam, Cuba, Italy, Germany, and Korea.  Numerous types of energy-efficiency improvements were financed,  including replacement of boiler and chiller plants for heating and cooling,  energy management control systems, geothermal heat pumps, and lighting.  In the largest ESPC project during the 5-year period, the Marine Corps  committed to spend almost $138 million at a facility in California to install a  cogeneration plant, solar hot water and photovoltaic systems, heating,  ventilating, and air conditioning at various sites, and waste water pump  upgrades. This ESPC project, awarded in July 2002, has a contract term of  18 years.
section_title: Extent of ESPC Use Varied Across Agencies
paragraphs: The extent to which agencies have used ESPC financed projects has varied,  as shown in table 1. DOD agencies have used the contracts the most,  undertaking about 153 ESPCs to finance about $1.8 billion in costs at about  100 military installations during the 5-year period. DOD officials told us  they relied heavily on ESPCs to achieve energy infrastructure  improvements, in part because of difficulties they encountered in obtaining  adequate upfront funding for energy projects that were not categorized as  being mission-critical. They noted that these improvements also helped the  agencies meet other national energy goals as well.
After DOD, the General Services Administration (GSA) and Veterans  Affairs (VA) used ESPCs the most during the 5-year period, undertaking 30  and 24 projects, respectively. Together these agencies account for about 21  percent of projects. Both GSA and VA officials told us that adequate  upfront funding for their energy projects has been difficult to obtain in  recent years. At the same time, they have faced increasing backlogs of  these projects in their capital management plans. Consequently, the  agencies have moved toward using more ESPCs to meet mandated energy  reduction goals and to make badly needed upgrades to aging and inefficient  equipment.
DOE’s departmental ESPC projects represent about 4 percent of the total  projects undertaken over the period, valued at about $38 million. DOE  officials told us that the agency has mainly used ESPCs since 1999 to  supplement limitations in upfront funding for energy-efficiency projects.  After GSA and VA, among civilian agencies, DOE has a high percentage of  federal facility square footage; however, the agency has not been among the  largest users of ESPCs for two reasons. First, the agency has found it  relatively easy to meet its mandated energy reduction goals because it has  in recent years closed a number of its facilities, such as those producing  nuclear weapons, that were no longer needed. Furthermore, many DOE  facilities have negotiated low utility rates or are in regions of the country  where utility rates are relatively low. This makes developing an ESPC for  which savings will cover costs difficult, because the low utility rates hold  down the amounts that can be saved with the energy-efficiency  improvements. As a result, DOE’s major goal in using ESPCs, we were told,  has been for energy infrastructure improvement.
Of the seven agencies in our review, the Department of Justice (Justice)  used ESPCs the least, undertaking only two ESPCs totaling about $43  million in costs. According to Justice officials, because many of their  facilities are prisons, security concerns can make undertaking energy- efficiency projects on existing buildings difficult. Nonetheless, the agency  undertook two ESPC projects in 2003, one each under the Bureau of  Prisons and the Federal Bureau of Investigation. According to the officials,  the agency undertook the ESPCs because it was concerned about meeting  the mandated energy reductions, and upfront funding for energy-efficiency  projects was decreasing. In addition, for one of the projects, the agency  saw a chance to use an ESPC to accomplish environmental goals  established by Executive Order 13123, such as making more use of  renewable energy. In that case, the agency undertook a project at a  California prison site. After the California energy crises in 2000 and 2001,  the agency sought to decrease its dependence on the electricity grid, so the  project included installation of renewable energy sources, including a wind  turbine and photovoltaic panel, which furthered the agency’s energy  security interests as well as helping it meet its energy reduction and  environmental goals.
Finally, five agencies—the Departments of Commerce and State, the  Environmental Protection Agency, the John F. Kennedy Center for the  Performing Arts, and the National Gallery of Art—that we did not contact  for additional information for our review each undertook one project  during the 5-year period. We did not receive cost data for the Kennedy  Center. The other four totaled about $35 million in costs.
section_title: Agencies Increasingly Used FEMP’s Services
paragraphs: Figure 2 shows agency use of the contracting centers at the Air Force, the  U.S. Army Corps of Engineers’ Huntsville Center, the Navy, and FEMP for  fiscal years 1999 through 2003. With the exception of 2002, the data show  that, over the period, agencies increasingly used FEMP’s contracting center  more relative to the other agencies’ centers. Although there was an average  of 51 ESPC financed projects undertaken each year, there was a 54 percent  increase in projects awarded from 2002 (37 projects) to 2003 (57 projects).  According to agency officials, this increase was largely because agencies  put significant effort into awarding ESPC financed projects, anticipating  the sunset of the legislation on October 1, 2003. This was particularly true  for ESPCs done through FEMP’s contracting center. As discussed  previously, on October 28, 2004, ESPC authority was renewed through  fiscal year 2006.
section_title: Agencies Expect ESPC-Financed Projects to Result in Energy Savings As Well As Other Benefits
paragraphs: ESPCs awarded by federal agencies to finance energy-efficiency  improvements are expected to achieve energy savings worth at least $2.5  billion during the life of their contracts. Agencies estimate that they are  annually reducing energy use by at least 9 million MMBTUs. Some savings  are also expected to continue after the ESPCs end. Agencies receive other  benefits through ESPCs as well, such as environmental improvements and  better mission capability resulting from replacing aging infrastructure with  more reliable equipment. Although these benefits could be achieved  through up-front appropriations at a lower cost, this funding has often not  been available on a timely basis. Furthermore, ESPCs provide additional  benefits not typically associated with investments purchased through  upfront appropriations, such as shifting some of the performance risk of  the equipment to the energy services companies and allowing agencies to  more easily combine multiple energy-efficiency improvements into an  integrated package.
subsections: section_title: ESPC-Financed Projects Have Reduced Energy Use and Agencies Expect to Achieve Energy Savings Worth At Least $2.5 Billion
paragraphs: Over the life of the ESPC financed projects included in our review, agencies  expect to achieve energy savings worth at least $2.5 billion and amounting  to over 9 million MMBTUs, as shown in table 2. These estimated savings are  likely to be understated because the agencies did not report financial  savings for 17 projects and energy savings for 45 projects. The military  services account for about 64 percent of the financial savings and about 71  percent of energy savings for the ESPCs awarded during the 5 years.  Savings at some specific locations are expected to be substantial. For  example, reported data show that total estimated savings at each of three  military installations will exceed $100 million, ranging from $117 to $138  million for a total of $378 million. The ESPC at Elmendorf Air Force Base in  Alaska is expected to reduce the base’s energy consumption by more than 1  million MMBTUs per year, which are valued at $123 million for the 22-year  contract term. According to the base energy manager, this is the largest  ESPC ever awarded by the Air Force.
The installation of energy efficient equipment has already resulted in some  energy savings and is expected to result in further savings, lower utility  bills, and reduced operations and maintenance expenses. Over the 5-year  period, the agencies estimate they reduced their energy use by at least 9  million MMBTUs annually. According to agency officials, these reductions  have assisted, and will continue to assist, agencies in meeting their  mandated goals for reducing BTUs of energy used. For example, agencies  reported that they exceeded by 4 percent their goal for fiscal year 2000—a  20 percent reduction in BTUs of energy consumed relative to their fiscal  year 1985 usage. Agencies report their progress in meeting the goals by  each agency as a whole and do not indicate the portion that could be  attributed to the agency’s ESPCs. However, officials we interviewed  representing most of the agencies believe they would not have met the 2000  goal without the contracts. Furthermore, they expect their ability to meet  the remaining goals—30 percent reduction by fiscal year 2005 and 35  percent by fiscal year 2010—depends largely on being able to use ESPCs to  finance energy efficiency improvements. DOD officials told us that in  recent years ESPCs have accounted for over half of DOD agencies’ annual  energy savings. Furthermore, they believe that DOD will have significant  difficulty in achieving the 2005 energy reduction goal because a number of  ESPC projects planned for fiscal years 2004 and early 2005 were not  undertaken because authority for ESPCs was suspended during that time.  DOE is an exception—according to DOE officials, the agency has already  met its goals for 2005 and 2010, largely because it has closed facilities that  produced nuclear weapons, thereby significantly reducing the energy  consumed by the agency.
Agencies may also benefit from substantial energy and financial savings  once the contracts are paid for. Energy and related financial savings should  continue beyond a project’s payback period through annual energy saving,  as well as through reduced operations and maintenance costs. Currently,  financial savings retained by agencies are small because most agencies use  their savings to pay off their contracts with the energy services companies  as quickly as possible, thereby reducing debt more rapidly and saving  interest costs to the government. For example, GSA, which currently pays  energy services companies 98 percent of the agency’s annual financial  savings from ESPCs, estimates that it will save about $16 million annually  from its 30 projects after it has repaid the companies. Similarly, data  provided by the Air Force and the Navy show expected annual financial  savings for those agencies of almost $45 and $40 million, respectively, once  the contracts are paid for, and Army and Marine Corps projects also expect  to garner financial savings past the contract terms. In another instance,  officials at Fort Bragg told us that they would continue to obtain lower  utility rates, which were negotiated as part of the ESPC by the energy  services company, even after the contract period.
section_title: ESPC Financed Projects Offer Additional Benefits
paragraphs: In addition to energy savings and lower overall utility costs, ESPC-financed  projects, like projects funded with upfront appropriations, can provide  agencies with environmental benefits through installation of newer, cleaner  technologies. The ESPC financed projects in our review, we were told, are  assisting the agencies in eliminating environmental hazards, reducing  outdoor air pollution, and improving indoor air quality. The project at  Elmendorf Air Force Base allowed the Air Force to replace old steam  plants insulated with asbestos, a known environmental hazard. In another  instance, in the ESPC at Portsmouth Naval Shipyard, in Maine, the Navy  installed a cogeneration unit for generating power. As a result, the shipyard  eliminated its reliance on bunker fuel oil and is producing significantly  fewer greenhouse gas emissions.
ESPC-financed projects also allow agencies to replace aging infrastructure  without having to obtain upfront appropriations. Officials at six of the  seven agencies in our review noted the importance of using ESPCs to  replace aging infrastructure. The upgrades, the officials told us, improved  the agencies’ abilities to carry out their primary missions and provide a  more comfortable work environment for employees. At Elmendorf Air  Force Base, for example, the energy manager told us the base was able to  replace a 50-year-old cogeneration power plant with a new, much more  efficient decentralized natural gas system. Navy officials told us they faced  a similar situation with a power plant built in 1945, which was failing at  their Portsmouth facility. The backlog of maintenance work on the power  plant was continuing to increase. Due to the geographic location in Maine,  with severe winter weather and the continual repairs needed on the old  power plant, an upgrade was essential to support the nuclear submarines at  the shipyard. The officials noted each day’s loss of power cost the shipyard  $1.5 million. By using an ESPC to replace the power plant, the base was  able to eliminate eight full-time staff positions (saving about $448,000  annually) because the new power plant is easier to operate and does not  require frequent emergency maintenance, as the old one did.
section_title: Upfront Funds Could Provide These Benefits But Are Often Not Available on a Timely Basis
paragraphs: Although the benefits from ESPC financed projects discussed above could  be achieved using upfront funding, agencies have found that sufficient  amounts of such funding were generally not available—making it necessary  for the agencies to use ESPCs to supplement the upfront funding they  receive in order to obtain these benefits. A study by Oak Ridge National  Laboratory that compared ESPCs with upfront funded projects concluded  that when sufficient upfront funds are not available, the most expensive  choice may be to do nothing, allowing inefficient equipment to remain in  service and wasting funds on unnecessary energy use and emergency  repairs and replacement. Officials at six of the seven agencies we  reviewed—the Air Force, the Army, GSA, Justice, the Navy, and VA—told  us that, in spite of attempts to obtain upfront appropriations for energy  projects, adequate amounts of such funds were generally not available.    For example:   GSA officials said the agency received no funds for any energy- efficiency work included in their capital management plans for fiscal  years 2002 and 2003, although they requested $32 million and $8 million,  respectively. As a result, they used other financing options, such as  ESPCs.
Army officials at Aberdeen Proving Ground noted that failing heating  and air conditioning systems in the base’s family housing had become a  fire hazard and were too expensive to maintain. These officials said they  repeatedly attempted to obtain upfront appropriations for the upgrades  but, being unsuccessful, negotiated an ESPC.
Navy officials told us their planned investments for energy-efficiency  projects range from $100 million to $150 million annually in order to  meet their BTU reduction goals. However, because the Congress will  only provide $50 million for all of DOD, and the Navy only gets about  $15 million of that amount—or none, as in fiscal year 2000—the Navy  questions the usefulness of requesting the funds while foregoing making  energy-efficiency improvements.
Furthermore, officials at both the VA and the Navy told us that even when  they can obtain upfront funds, the project typically takes 4 to 5 years to  obtain approval and be completed, compared with about 2 years for an  ESPC. Navy officials pointed out that up-front-funded projects take longer  because projects must be submitted 2 years in advance of the budget year;  in addition, they said that most projects are not fully funded and have to be  resubmitted in subsequent years. According to these and other agency  officials, their agencies were achieving savings through lower utility bills  and reduced operation and maintenance costs during the extra years that  equipment installed under ESPCs was operational. DOE’s Oak Ridge  National Laboratory reported in March 2003 that, on average, upfront  funded projects that were approved took 63 months to award, design, and  construct, compared with 27 months for ESPCs.
In a recent report, GAO performed a case study analysis of six ESPC  projects and compared the actual costs of financing the energy-efficiency  improvements incurred in the ESPCs with an estimate of what the financial  costs would have been had the improvements been paid for through timely  upfront appropriations. We found that the financial cost to the  government of private financing was significantly higher than the financial  costs of upfront appropriations and also that monitoring and verification  costs—included with ESPCs but typically not included in projects paid for  with up-front appropriations—also added to the cost difference between  private versus upfront financing. Specifically, our case studies found that  ESPC financed projects increased the government’s cost of acquiring the  energy-efficiency improvements by 8 to 56 percent compared to timely, full,  upfront appropriations. Our analysis assumed that the energy savings and  other benefits associated with the energy-efficiency improvements were  independent of how they were financed.
While our earlier work found higher financing costs associated with the use  of ESPCs, a recent study of ESPCs, undertaken by the Lawrence Berkeley  National Laboratory, analyzed both the costs and government benefits of  109 ESPCs and compared the net benefits of these projects with the net  benefits under several alternative scenarios involving direct, upfront  appropriations. The study assumed that the performance of the  equipment installed was dependent to varying degrees on which financing  method was used. Specifically, they evaluated scenarios in which energy  savings from equipment installed using upfront appropriations decay over  time (1 or 2 percent per year) because projects funded up-front typically do  not include the same level of monitoring and verification to ensure  sustained performance of the equipment. The study concluded that “delays  of more than one year in obtaining congressional appropriations result in  reduced net benefits relative to ESPC-financed projects.” Although we did  not independently verify all of the study’s assumptions, data, and results,  we did review several studies of energy audits that the Lawrence Berkeley  authors used to support their assumption regarding savings decay to verify  their assumption that energy systems’ savings decay in the absence of  proper monitoring and verification. In discussions with experts on the  performance of energy equipment, we were told that many of the energy- efficiency improvements require careful monitoring and verification to  ensure that they perform up to their specifications and that, without such  monitoring and verification, energy savings would indeed decay over time,  in some cases very quickly; however, we found that agencies often lack  sufficient expertise in monitoring and verifying performance of energy  equipment on their own. Thus, although we could not conclude on the  actual extent of savings decay for upfront-funded projects, there is  evidence that savings decay occurs. While it is likely that agencies could  purchase monitoring and verification services from the private sector in the  case of equipment paid for with up-front appropriations, they have typically  not done so in the past and the additional cost of doing so is unknown. We  cannot conclude definitively the extent to which decreased savings decay  and other benefits from ESPC-financed projects may offset the significant  savings achieved from using upfront funding that we found previously in  six case studies.
section_title: Some ESPC Benefits Not Readily Available With Up- front Funding
paragraphs: ESPCs also provide two benefits not typically associated with investments  purchased through upfront appropriations: (1) some performance risk is  shifted from the government to the energy services companies and (2)  agencies find it easier to combine multiple energy-efficiency improvements  into an integrated package. First, as noted by agency officials and industry  experts, because ESPCs require energy services companies to guarantee  equipment performance over the lifetime of the contract, which in turn  yields energy savings, agencies benefit as these risks are shifted from the  agencies to the companies. As part of these guarantees, energy services  companies are ultimately responsible for insuring that adequate operations  and maintenance are conducted and for any repairing and replacing  equipment if it fails. These requirements reduce the risks from possible  faulty engineering, poor equipment installation, or equipment failure. For  projects funded with upfront appropriations, energy services companies  are generally only responsible for equipment risks during the warranty  period, which typically is shorter than an ESPC’s contract guarantee. While  it may be possible to supplement upfront-funded projects with additional  warranty or performance coverage, agency officials told us that this would  add costs and typically is not done. According to FEMP ESPC program  managers, ESPCs create an incentive for energy services companies to  develop highly efficient improvements and maintain the equipment so that  it is in peak operating condition. This incentive occurs because the  companies’ compensation is directly linked to the savings achieved through  their work. Officials from both the Navy and the Army told us that because  the value of energy savings must cover the annual payments to the energy  services company, the company bears the risk when it encounters  problems. For any problems related to the performance of the equipment  that are defined as company risks and that were not explicitly determined  to be an agency risk, the agency can withhold future payments from the  energy services company until the problem has been corrected. Officials at  Fort Bragg told us that they withheld payment from a contractor for a short  period until an equipment problem was fixed on their ESPC. In many cases,  the agency, rather than the energy services company, performs the  operations and maintenance. An official from the DOE departmental  energy management program, however, noted that it is not altogether clear  when a piece of equipment fails, whether payment to the energy services  company can be stopped directly or whether a review of maintenance  records, for example must be performed to determine if the agency or the  company is responsible for the failure. Typically, when problems occur for  equipment purchased with up-front funds, if the warranty period is over,  the agency is responsible for fixing or replacing the equipment at its own  expense.
Second, with ESPC-financed projects agencies find it easier to bundle a  number of energy-efficiency improvements so they can function as an  integrated system. In this way, one energy services company is responsible  for the guaranteed performance of all the equipment. Agency officials told  us that, due to tight budgets, upfront funding is limited even when it is  available and the agency can typically install only a few of the necessary  energy-efficiency improvements. They said it may be years before the  agency receives authority to fund additional projects and, due to the  competition requirements of federal procurement practices, it is quite  possible a different energy services company would be selected to install  them. Besides potential problems of integrating the controls for system  components installed by two different companies, some savings that would  have been obtained if all energy-efficiency improvements had been  installed without delay at one time are lost. Energy savings can be achieved  more quickly through an integrated approach than implementing efficiency  improvements on a piecemeal basis. The lack of a performance guarantee  over the life of the equipment purchased with up-front funding and the  uncertain, episodic nature of upfront funding can make those projects  more risky and less capable of generating an integrated approach to energy  management for new and existing equipment.
section_title: Agencies Believe Financial Savings Cover Costs, but Whether Savings Actually Do So Is Uncertain
paragraphs: Agencies generally believe that ESPCs’ financial savings cover the costs  because they design their contracts to cover costs and because they must  obtain verification reports from the energy services companies that  confirm this point or take steps to correct shortfalls in savings. They cited  examples of projects that realized savings in excess of costs and provided  data on verified savings for most of their projects. However, the data  provided were insufficient to conclude whether savings covered costs of  the projects in our review. Furthermore, our work, agency audits of ESPCs,  and agencies’ differing interpretations about the components of costs that  must be covered by savings caused us to question whether savings  consistently cover costs. FEMP officials recognize the difficulty in ensuring  that actual savings cover costs and have formed a special working group to  address uncertainties regarding savings.
subsections: section_title: Agencies Generally Believe That Savings Cover Costs Because They Are Designed to Do So and Because Companies Must Verify Savings, but Uncertainties Arise from Limitations of Available Data
paragraphs: In response to statutory requirements, agencies design ESPCs so that  savings are sufficient to cover costs. In addition, the agencies refrain from  committing themselves to ESPCs when they determine beforehand that  savings will be inadequate or when the payback will exceed their preferred  time frames for the contracts. For example, a DOE official cited several  departmental projects that advanced to the final proposal stage but that the  agency dropped because the economics for the projects were either poor  or the agency did not agree with the savings projections. For one project,  the low utility rate (which reduced the amount of savings that could be  accrued) and the high cost of performing the work in an area with access  controlled for security reasons forced the project’s abandonment. In  another case, the agency did not agree with the company’s projected  savings and believed that very little savings would be achieved. FEMP  officials noted a requirement for performing a life-cycle cost analysis of  individual energy-efficiency improvements, which are then bundled to  ensure that the project’s overall savings cover costs.
Another reason for agencies’ general confidence regarding savings is that  energy services companies are required to submit annual measurement and  verification reports confirming the savings and, in case of a shortfall, take  corrective steps to recoup the savings. These annual reports provide the  specific figures on which agencies base their payments to the energy  services companies. In some cases, the reports are updated quarterly to  give the officials monitoring the project more current data on the  performance of equipment, enabling them to spot shortfalls in savings and  have the energy services company correct them quickly. In addition, agency  officials cited projects that realized savings in excess of costs. For  example, the ESPC at Fairchild Air Force Base in Washington State has  garnered about $180,000 more per year than it cost. The extra savings have  resulted from the equipment operating more efficiently than estimated and  actual utility costs that were higher than estimated in the contract.
We asked the seven agencies in our review to provide data on verified  savings for each of their projects. In many cases, the projects have not  entered their performance periods, so verified savings data are not yet  available. To approximate the number of projects that should have verified  savings available, we looked at the 111 projects (about 44 percent of the  projects) that had been under way for 3 years or more and could  reasonably be expected to have at least 1 year of verified savings to  report. In this regard, the seven agencies reported verified savings for  most of the 111 projects, but they did not provide cost data that could be  compared with the annual verified savings. We did not take steps to obtain  the data, which are contained in files at projects located across the country.  Thus, we could not conclude from the data provided to us that verified  savings were, in fact, covering the costs of these projects. Furthermore,  while federal officials are expected to accompany energy services company  officials when the data are being gathered for the reports to provide an  extra level of confidence in the data’s validity, FEMP officials cautioned  that this added check may not be happening as often as it should.
An additional limitation of the data is that the measurement and  verification process relies not only on actual measurements but on  estimates as well. As will be discussed more fully later, estimates may be  used extensively in this process, introducing the possibility of incorrect  assumptions and errors in the calculations. Moreover, the process  evaluates not only the performance of the equipment, but additional factors  such as the cost of energy that affect actual savings.
section_title: Agency Officials and Audits Cite Projects for Which Savings May Not Cover Costs
paragraphs: Agencies cited specific projects in which the savings have not covered  costs. According to a DOE departmental official, savings for 4 of its 10  projects have fallen short of costs because of unexpected problems. DOE’s  analysis has shown that, in three of the four instances where savings are  inadequate, the shortfall has resulted from unpredictable mission changes  in the use of the facilities. For example, in one of these cases, the discovery  of beryllium contamination forced the closure of some of the buildings  involved in the contract. Reductions in electricity consumption accounted  for the fourth case. In this instance, in 7 out of 12 months each year, DOE is  not meeting the minimum required demand cost that was projected and has  to pay for the electrical demand it does not use. As a result, for 7 months of  the year, the new equipment associated with the project is not providing  any electrical demand savings, so the overall cost savings of the equipment  is less than expected. In general, according to the DOE official, it is  extremely difficult to accurately predict all the variables that affect energy  savings over the 10 to 15 year ESPC contract term, so agencies have to bear  some of the risk of inaccurate assumptions at the outset.
While most agencies have not audited their ESPCs, the Army and Air Force  audits of ESPCs have found several instances in which savings may not  have covered costs. For example, a 2002 Army audit of a 1999 project  covering five locations found the Army could pay about $96 million that  may not be covered by savings over the 18-year life of the project because  savings that the Army agreed to were overestimated. First, the report found  the baselines were incorrect because the contractor inflated labor costs for  the operation and maintenance baseline by $66 million over the life of the  project. Second, it found the contractor also overstated the baselines for  electrical consumption and water conservation by more than $30 million  over the life of the project. This inflation of both baselines occurred,  according to the report, because the agency relied heavily on the  contractor to prepare them. Other major contributing factors, the report  stated, appeared to be insufficient time to review contract proposals and a  desire to award the contract and pay the contractor prematurely. As a  consequence, the report concluded, the agency could pay for nonexistent  savings over the term of the contract. As another example of questionable  estimates, the contractor for an Air Force ESPC increased the original  consumption baseline by over 11,000 kilowatts with no indication that Air  Force officials questioned this adjustment.
Poor documentation adds to the problem of ensuring that savings cover  costs. For example, energy services companies at 8 locations reviewed in a  2003 Air Force audit reported savings of $6.7 million associated with $78  million in ESPC investments, but civil engineering officials could not  provide support that they reviewed or validated these numbers. The  auditors projected the results for the sample of 8 locations to the 36  included in their review and concluded that the lack of documentation  made it impossible to assess the savings that the agency will receive for  about $600 million in costs for energy efficient equipment. As noted in the  report, this condition occurred because Air Force guidelines did not  specifically require maintenance of baseline supporting documentation, a  methodology for savings computation, or validation of cost savings. In  response to recommendations in the report, Air Force officials stated that  they were taking steps to correct these problems. However, we could not  determine the status of the payments for either the Army or the Air Force  projects in these audits because the audit documentation did not indicate  whether payments were made despite the potential savings shortfalls.
section_title: Difficulties in Calculating Savings, Ensuring Adequate Equipment Maintenance, and Verifying Savings Also Contribute to Uncertainty About Savings Covering Costs
paragraphs: Accurately calculating financial savings is fundamentally difficult for  agency officials to do. Major components of financial savings—baseline  energy consumption, the consumption once the energy efficiency  improvements have been installed, and the cost of energy associated with  both the baseline and the later consumption—are partly stipulated, or  estimated, rather than actually measured. In this regard, striking the “right”  balance between stipulation (which is less costly but also less accurate)  and measurement (which is more costly but also more accurate) is a  challenge for agencies. To the extent that stipulation is used in lieu of  actual measurement, according to DOE officials, savings calculations may  be based on inadequate data or incorrect assumptions, which contribute to  uncertainties about the actual savings.
Agency officials commented on how difficult it is to identify the  consumption and cost of energy, which forms the basic equation  (consumption times cost) that establishes the energy-related baseline and  the future financial savings. For example, contractual arrangements with  regard to consumption can affect the savings. In the case of “take-or-pay”  contracts, agencies may have to pay for a certain amount of projected  minimum demand even if they do not actually use it. As noted earlier, this  situation has occurred in one of DOE’s ESPCs and has reduced its savings  to the point where savings will not cover payments under the contract. The  cost of energy, as shown in utility rates, can also be difficult to determine.  Given their potential complexity, it is easy for energy services companies or  federal officials to provide incorrect utility rates, which in turn will have  important consequences for the level of savings. Rates need not only to be  determined accurately to establish the baseline but also projected as  accurately as possible into the future to determine eventual savings. These  rates are projected 10 years into the future in ESPC contracts, according to  agency officials, but the actual rates can change at any point during the  contract period. Anomalies due to weather, fluctuations in energy prices, or  other influences can affect the rates. In general, if utility rates go down or  increase more slowly than projected, then the actual savings will not  materialize. In essence, these rates are stipulated, and the agency bears the  risk.
Ensuring that the equipment installed under ESPCs has been adequately  operated and maintained is essential for agencies and can affect whether  savings cover costs. According to an expert who has worked on Army and  Air Force ESPCs, calculations of guaranteed savings assume a high level of  operation and maintenance activities, but rapid loss of energy efficiency if  equipment output is not maintained can jeopardize savings. He said that  typically a 10 to 20 percent degradation in savings occurs annually on a  given ESPC in the event of improper operation and maintenance. He cited  the virtual ruin of a chiller (for air conditioning) in only 3 years as a result  of improper maintenance.
Similarly, measurement and verification are critical in the longer term for  achieving guaranteed savings. In determining these savings, however,  energy services companies blend the use of measurement with stipulations  in their reporting process. The expert who has worked on Army and Air  Force ESPCs noted that, despite the importance of using measurement in  addition to stipulation, there are numerous barriers to performing actual  measurements. These barriers include a lack of appropriate metered  equipment and reluctance by energy services companies to perform  measurement and verification because it might work against their interests.  An Air Force official observed that in his experience energy services  companies prefer stipulation and have limited the number of actual  measurement for projects as much as possible. A report for FEMP  examining seven ESPCs noted the reliance on stipulation in the projects’  measurement and verification plans. The primary reason for using this  method was its low cost; however, the report concluded that the large use  of stipulated savings left the agencies at risk of unrealized savings. To help  agencies use stipulation correctly, in 2000, FEMP issued supplemental  guidance on measurement and verification that specifies that some  stipulation may be used in lieu of measurement when there is a reasonable  degree of certainty about the stipulated values, their contribution to overall  uncertainty is small, and they are based on reliable and documented  sources of information.
section_title: A Special Working Group Has Been Formed to Address These Uncertainties
paragraphs: DOD and FEMP recently established a special working group to address  the uncertainties about actual savings. The Energy Savings Discrepancy  Resolution Working Group, formed in late 2004, is developing approaches  to compare projected and actual savings and to explain any deviations.  Because it has just commenced these studies, the group has obtained  preliminary results regarding only one project. The group found that the  projected savings for this project were diminished by consolidations of  agency missions, expanded construction, and new demands for energy that  had nothing to do with the ESPC. Officials said they chose this project  because it came with a well-developed baseline, which is often not  available for careful evaluations of this sort.
section_title: Agencies’ Differing Interpretations of the Components of Costs That Must Be Covered by Savings under the ESPC Legislation Add to Uncertainty That Savings Cover Costs
paragraphs: The statute governing ESPCs provides that “aggregate annual payments”  under an ESPC may not exceed the amount the agency would have paid for  energy without such a contract. However, agencies differ in their  interpretation of this statute. In practice, it remains uncertain whether  contract payments may be made only from utility savings resulting from the  ESPC or from funds already earmarked for equipment replacement and  other sources to reduce the length of the contract and finance charges.  Within DOE, for example, disagreement about the interpretation of the  statute is shown by a FEMP guide on the one hand and an opinion provided  by DOE’s Office of General Counsel on the other.
According to a DOE departmental official, the main source of guidance for  agencies regarding lump-sum payments is FEMP’s “Practical Guide to  Savings and Payments in Super ESPC Delivery Orders,” issued in January  2003. Section 3.6 explains that agencies may use existing funds that would  otherwise be used for operation and maintenance and repair and  replacement projects (1) to increase ESPC project investment and include  a more comprehensive set of energy-efficiency improvements than would  be possible otherwise, or (2) to lower the financed amount and shorten the  term, thereby reducing interest costs over the term. The section adds that  one-time energy-related cost savings are often applied as a  preperformance-period payment to the energy services company. However,  such payments may also be scheduled as payments during the contract  performance period.
Similarly, section 4.4.1 of the FEMP guide states that if appropriated funds  are available for general maintenance, operation, repair, and replacement  of energy-consuming systems (as opposed to being earmarked for a  specific project via a capital line item), they may be used for payments to  the energy services company. Adding that one-time savings and payments  from general operation and maintenance and repair and replacement  accounts merit further clarification, the discussion notes that the intent of  the ESPC statute is to permit the use of funds available in general operation  and maintenance and repair and replacement accounts that could be used  for energy-related purposes for preperformance-period ESPC payments. It  also notes that one-time payments scheduled during the performance  period may not exceed the amount planned and budgeted in the general  operation and maintenance and repair and replacement accounts for the  avoided project.
Despite the FEMP guide’s attempt to clarify allowable sources of funding  for ESPC projects, some uncertainties remain. Even within DOE, for  example, the General Counsel’s office expressed an opinion at variance  with the FEMP guide. A memo from the General Counsel’s office to the  assistant secretary for Energy Efficiency and Renewable Energy in August  2000 stated that, in the case of buyouts and buydowns in super ESPC  projects, energy cost savings must exceed payments in each of the contract  years. The memo added that, because ESPCs are performance contracts,  payment is conditional upon the realization of energy cost savings. The  memo stated that buy downs are in effect prepayments which, in any  contract year, may not exceed guaranteed and verified energy costs savings  for that year. The memo concluded that prepayments have the effect of  paying a contractor before the savings have occurred and under this  analysis such prepayments are prohibited.
GSA’s policy regarding buydowns is drawn primarily from the FEMP guide.  In GSA, the motivation for using the funds allowed by this guide is the low  utility rates in some of its regions. These low utility rates reduce the  savings accrued by a proposed project, necessitating a longer contract term  so that sufficient savings can be generated for covering costs. According to  GSA officials, the agency has used upfront buydowns frequently, which has  enabled GSA to reduce the cost and length of its contracts. They noted that  even a small buy down has a large impact over the typical length of such  contracts.
GSA officials told us that the lack of clarity regarding financial terms in  earlier FEMP guidance led to GSA being unable to buy down ESPCs in  some cases. One of GSA’s main complaints in this regard stemmed from  inconsistencies across its regions about what funding sources could be  applied to buy downs. Following comments to FEMP and FEMP’s revision  of the guidance, GSA officials noted that there have been no complaints  since October 2002. Asked if there are any remaining improvements needed  for the sake of clarity, GSA officials told us that there is still some  uncertainty about how much can be financed and how much can be bought  down on any given ESPC project.
The Navy has no written policy on the use of buydowns and defers to  contracting officers to determine when additional payments can be made.  Because of the lack of clarity in this area, the Energy Programs division  director at the Naval Facilities Engineering Service Center has asked for  written guidance from the Navy but has not received it. The director told us  that contracting officers evaluate the legislation and the terms of the  contract and apply them to individual contracts and situations. He said that  there have been three different situations in which the Navy has used  buydowns. First, before or during construction, the Navy has identified  avoided costs for equipment whose purchase is already included in the  budget but that will not be needed as a result of an ESPC. Funds associated  with these avoided costs can be used to reduce the amount of money owed  in the contract because the Navy views these avoided costs as resulting  directly from the ESPC. Second, during the actual performance period of  the contract, the Navy has used other utilities budget monies from its  working capital fund and mission funding to reduce the amount of money  owed. However, it has stopped this practice because GAO raised concerns  about the money not being linked with savings from the ESPC. Third, in  cases of terminating specific energy efficiency improvements or  terminating a number of years from a contract, the Navy has used funds  from its utilities budget. The division director stated that greater clarity  regarding the use of funds to make additional performance period  payments from the utilities budget, but not directly associated with the  ESPC, would be helpful because these payments can reduce long-term  financing costs and save money for the government.
section_title: Agencies Are Concerned About Officials’ Lack of Necessary Expertise and Information and About Competitiveness of the Super ESPCs
paragraphs: Agencies expressed concerns about the expertise and information needs of  the agencies and insufficient competition among financiers and energy  services companies, all of which can affect agencies’ ability to protect the  government’s financial interests in using ESPCs. Regarding expertise and  information, agency officials many times lacked technical and contracting  expertise and information on past contracts needed to effectively evaluate  the ESPC proposals and monitor the contracts for savings. As a result, they  often relied on the energy services companies, calling into question the  quality of the deals the officials struck and their certainty that guaranteed  savings were realized. Expertise was lacking mainly because of  inexperience with ESPCs, and information was lacking mainly because  agencies are not required to collect and disseminate it. Regarding  insufficient competition, agencies believe there may not be enough  competition among finance companies and energy services companies. As  a result, agencies may be paying too much for financing and other terms of  the contracts and may be getting poor services after the contracts have  been signed. In recognition of these shortcomings, the agencies are taking a  number of corrective steps on an ad hoc basis and have developed an  interagency steering committee to address some of them collectively. We  did not assess the effectiveness of the agencies’ efforts.
subsections: section_title: Agencies Often Lacked the Expertise and Information Needed to Effectively Develop and Monitor ESPCs
paragraphs: Those project officials we interviewed who were able to marshal the  expertise and information they needed believe that having adequate  expertise and information are critical to the success of the ESPC. For  example, officials at the Portsmouth Naval Shipyard, which undertook a  $43 million ESPC in 1999 to upgrade its power plant system, relied on the  U.S. Army Corps of Engineers’ Huntsville Center and the Navy contracting  centers for technical and contracting support and on a consultant for  engineering support and analysis of utilities forecasting. According to the  Navy official who developed and oversees the Portsmouth project, the  expertise provided by the three sources was essential to the success of the  project. In particular, the consultant’s analysis of electricity rate  projections, made possible because of the consultant’s knowledge of utility  markets in New England, allowed the Portsmouth officials to question the  energy services company’s rate projections and negotiate more favorable  rates for the ESPC.
As previously discussed, developing and monitoring an ESPC are difficult,  requiring both technical and contracting expertise. In particular, for the  development phase of ESPCs, we learned that agencies frequently had  difficulty with technical responsibilities such as accurately calculating  energy-use baselines and forecasting utility rates. For example, the Air  Force and Army audits of ESPCs noted a number of instances in which  baselines were incorrectly established, and numerous officials told us how  difficult it is to accurately establish these baselines. Along those lines, the  manager of DOE’s departmental energy management program told us that  officials at the project level do not always have the necessary expertise to  forecast utility rates and, given the complexity of forecasting these rates,  particularly over the long terms typical of ESPCs, it is easy for the officials  to agree to incorrect estimates. ESPC experts at DOE’s Oak Ridge National  Laboratory agreed, saying it may be unrealistic to expect a government  contracting officer to be able to effectively negotiate some contract terms  such as utility rates because they are technically difficult to understand and  forecast.
Regarding monitoring ESPCs once the energy-efficiency improvements are  in place and operating, the measurement and verification reports the  energy services companies submit to substantiate savings pose a challenge  for agencies because of their technical nature. A number of the officials we  interviewed told us that the level of expertise at the project level is often  inadequate to perform a thorough evaluation of the measurement and  verification reports. The manager of DOE’s departmental energy  management program noted that, in the past, DOE has not reviewed  measurement and verification reports. The challenge of effectively  reviewing these reports, however, has led DOE to consider requiring that  DOE headquarters become involved in measurement and verification  evaluations. In addition, according to an expert in measurement and  verification for the Air Force, lack of technical knowledge is the primary  cause for agencies’ failure to conduct appropriate measurement and  verification oversight. In this regard, a lack of basic adherence to  measurement and verification plans has also been observed. The project  manager of the Air Force audit noted that, among the eight bases included  in his review, only one had properly followed its plan.
Another area requiring technical expertise involves a careful balance  between stipulation and measurement and striking this balance has been  difficult for agencies. According to DOE officials, key guidelines for  measurement and verification do not define the best method for each  energy-efficiency improvement that balances the trade-offs between cost  and accuracy. Consequently, the “right” amount of measurement and  verification for many improvements remains uncertain and requires  expertise to determine in each case. Agency officials have generally agreed  that measurement and verification, at least in the first years of using the  super-ESPC contracts, tended to rely more heavily on stipulation than on  actual measurements for determining long-term savings. An Air Force  official told us that, in his view, the heavy reliance on stipulation during the  earlier years of the program worked to his agency’s disadvantage with  regard to savings. In more recent contracts, however, he believes that a  better balance between stipulation and measurement has been reached  because there has been a greater reliance on expertise in this area.
In some cases, we were told, the officials may have the technical, but not  contracting, expertise they need. Managers of the VA’s ESPC program are  confident that the agency’s project-level officials have enough engineering  know-how to understand the technology and construction process involved  with ESPCs; however, the Managers are concerned that project level  officials do not understand the financing, markups, or other aspects of the  business end of ESPCs well enough, giving the energy services companies  an advantage over the agency officials, who, in turn, may not be able to  make the best business decisions for government. For example, according  to the Manager of DOE’s departmental energy management program, in his  experience, markups and financing rates often go unchallenged by project- level staff, even though they are negotiable, because the project officials do  not have the expertise to challenge them. Furthermore, officials who  oversee GSA’s energy program told us that GSA energy managers have had  to negotiate with energy services companies on markups and financing  terms, even though they were not adequately trained in that contracting  technique.
Related to expertise, ESPC project-level officials also may not have the  information at their disposal that would help them develop the best  possible contracts and effectively oversee contract implementation. A  number of officials we interviewed said they had neither benchmarking  data on prices and other contract terms agreed to for other ESPCs, nor  knowledge of “lessons learned” on other contracts, making it difficult for  the officials to evaluate project proposals and to negotiate effectively. Of  the seven agencies included in our review, DOE, GSA, and the Navy  compile and maintain some data on their ESPCs in one location. Although  individual project files contain some data that could be used for  benchmarking prices and terms, agencies are not required to compile and  disseminate such information across their ESPCs, and the other four  agencies told us they do not. Similarly, as discussed previously, although  agencies are required to monitor the performance of energy services  companies on individual projects to determine whether expected savings  are being realized, they are not required to keep track of that information at  the agency level. As a result, the agencies may not have historical  information on contract performance to use in choosing energy services  companies and developing terms of the contracts, such as the  measurement and verification plans.
Officials responsible for ESPCs do not always have the expertise and  related information they need for a number of reasons. Many of the project- level officials are inexperienced with ESPCs. In that regard, several of the  military project officials we interviewed said that their current experience  is their first encounter with an ESPC, and the limited training they received  did not adequately prepare them. Furthermore, DOD officials told us that  because military staff are frequently reassigned after a few years, it is not  likely that one person will be on site throughout the entire ESPC contract,  and the officials expect their replacements to be similarly inexperienced  with the contracts. Further exacerbating the problem, we were told that  many of the military and civilian officials charged with developing and  overseeing ESPCs only work on the contracts part-time so the efforts they  can devote to the process are limited.
Most agencies do not require their officials to use the contracting centers in  DOD and FEMP when developing ESPC projects; nonetheless, most of  them do. In the case of interviews with officials from 27 projects in which  the officials discussed their use of contracting centers or other sources of  expertise in detail, officials from 26 of these projects said they found the  expertise helpful. However, for 13 of the 26 projects that got assistance,  officials cited areas of the ESPC development process in particular for  which they could have used more expertise. For example, GSA and VA  officials told us that their FEMP project facilitators, which cost the agency  $30,000 for each project, did not perform some functions that the agencies  thought would have been beneficial, such as preparing estimates of project  costs or advocating for the agencies during contract negotiations. Some  project officials that used the contracting centers found the centers to be  inadequately funded. For example, one Air Force project official told us  that the Air Force’s center provided the project with excellent support, but  could not visit the project site due to resource constraints. Similarly,  another official told us he did not consider using the U.S. Army Corps of  Engineers' Huntsville Center because he thought, based on his previous  experience with the center, that it was understaffed and would not be able  to devote enough effort to the project.
As a result, we were told that agencies often rely on the energy services  companies to provide much of the needed expertise to develop and  monitor the ESPC projects, potentially raising a conflict of interest. One  company representative told us that agency officials are typically not  familiar with the energy savings potential of the new equipment being  proposed for installation, for example, and another representative said that  agencies need more ESPC expertise. A number of agency officials agreed  that they rely on the energy services companies because they lack certain  expertise themselves. For example, an Air Force official told us that project  officials on remote air bases tend to have less-experienced staff and rely on  the energy services companies for essential ESPC activities such as  performing life-cycle cost analyses.
section_title: Agencies Expressed Concerns About Competition Among Finance Companies and Energy Services Companies
paragraphs: Some agency officials we spoke with expressed concerns that there may  not be enough competition among finance companies and that this could  lead to higher than necessary financing costs for ESPCs. Some agency  officials told us they believe the financing rates for ESPCs are high  compared with rates to finance energy-efficiency improvements by other  means. For example, according to VA ESPC program managers, the rates  VA has negotiated to purchase energy-related equipment via another  financing mechanism—enhanced–use leases—are generally lower than its  ESPC rates. For the 241 ESPC delivery orders for which we received  financing data, financing rates ranged from 5 to 13 percent, with an average  across all projects of almost 8 percent. According to an ESPC expert at  DOE’s Oak Ridge National Laboratory, improving the financing of ESPC  projects is one of the most important ways to achieve a better deal for the  government.
Agency officials stated that there may be too few companies available to  finance ESPCs. For example, the head of the Navy’s ESPC program told us  that there have been difficulties in finding investors for its ESPCs and  needs more investors in the program. VA officials responsible for  overseeing the agency’s ESPCs echoed this concern. They believe there are  only three or four “boutique” companies that specialize in financing ESPCs,  and that the absence of more financing companies drives up the financing  rates. They cited findings by a consultant the agency hired to review ESPCs  that reported that the lack of competition among energy financiers creates  higher rates, and the officials believe that injecting more competition into  the process may result in better rates. The head of FEMP’s Super ESPC  Program estimates that there are eight financiers that have provided bids  for financing ESPCs.
Agency officials also said they have seen little evidence that the energy  services companies are seeking out the most favorable financing rates.  Historically, energy services companies were not required to provide  documentation of having sought favorable rates. According to a  contracting officer who reviews the Army ESPCs, the agency has  sometimes obtained better rates when it required at least three quotes from  financiers. According to the Air Force and Navy officials responsible for  reviewing ESPC proposals, some proposals did not contain sufficient  information to adequately determine if the financing costs were  reasonable. The Deputy Manager of DOE’s departmental energy  management program told us that including documentation of competition  among financiers in the ESPC proposals is needed to provide better  assurances that the government is getting the best financing rates. In his  experience, an energy services company often wants to use a single  financier for all of its ESPCs, so he believes little or no competition for  financing exists for those contracts. The energy services company  representatives rebut this contention, saying they consistently seek the  most favorable financing for ESPCs. They told us that lower financing costs  allow more of the project’s savings to be spent on energy-efficiency  improvements, from which the companies profit, rather than on finance  costs.
Other agency officials and representatives of finance companies and an  energy services company have offered other explanations for why finance  rates for ESPCs are as high as they are. For example, according to FEMP  and GSA ESPC program managers, as well as representatives of the three  financing companies in our review, agency officials generally do not  understand that certain characteristics of ESPCs increase the risk of  financing those contracts and may drive the rates up. Chronic late  payments by agencies are one such characteristic. Others include the  possibility that the agency will withhold its payments if the savings  guaranteed in the contract are not realized, the additional uncertainty  about contract performance due to the long contract terms typical of an  ESPC, and the possibility that the agency will make unscheduled payments  that will reduce the financier’s return on the contract. According to GSA’s  ESPC Program Manager, these risk factors limit the number of companies  willing to finance ESPCs, and the complexity of the contracts drives  financing rates higher.
We were unable in the scope of this work to determine the extent, if any, to  which a lack of competition, rather than other factors, has caused finance  rates for ESPCs to be higher than for other methods of financing energy- efficiency improvements. However, due to the large number of questions  raised by agencies, we believe this question should be explored in more  depth.
Some agency officials also expressed concern that there may not be  enough competition among energy services companies. In general, they  told us there may be too few companies on the lists and those companies  may be charging prices that are too high and providing inadequate services.  Regarding the number of companies available, some officials told us that  often only the large companies on the lists are willing to undertake ESPCs,  effectively limiting agencies to three or four companies to choose from.  FEMP ESPC program managers affirmed that it may be only the largest  companies that can afford the extended negotiation and contract  implementation periods of ESPCs before getting paid for their services.  Further, GSA ESPC managers told us they have received complaints from  energy services companies that would like to take on smaller ESPCs, but  believe they are disadvantaged in obtaining that business because they are  not on the lists and have not been given a sufficient chance to compete for  that status. In that regard, officials from some agencies told us that the  companies approved for the lists often will not bid on projects unless they  are worth at least $1 to $2 million. As a result, the agencies must forego  undertaking the smaller projects or combine multiple locations into a  project to meet the threshold. According to DOE and GSA officials, it is  more difficult to manage projects with multiple locations. In addition,  according to the head of FEMP’s Super ESPC program, multiple energy  services companies that did not compete in the original super ESPC  competitions have communicated their desire to participate in a  recompetition and to be added to lists of prequalified energy services  companies.
Some agency officials linked a perceived lack of competition among energy  services companies with high markups and prices for other components of  ESPCs and poor services—especially after the contract is signed.  Regarding markups, energy services companies charge a percentage of the  cost of each energy-efficiency improvement to cover company costs for,  among other things, overhead, sales, markup on subcontractor-supplied  materials and labor, and profit. Both the Army and FEMP super ESPCs  contain pre-negotiated markup maximums that are intended to cap the  amount of markup that the energy services company can add to the basic  price of each energy-efficiency improvement covered by the contracts.  FEMP’s markup maximums typically range from 26 to 31 percent—but may  be as low as 5 percent and as high as 100 percent—depending on the  energy-efficiency improvement on which they are based and the region of  the country the improvement is implemented. The markup maximums the  U.S. Army Corps of Engineers’ Huntsville Center provided to us range from  15 to 30 percent. A number of agency officials told us that, as a practical  matter, the energy services companies resist agencies’ efforts to negotiate  markups that are lower than the caps. According to an Air Force  contracting center official, the Air Force super ESPCs do not contain  prenegotiated markup maximums for energy-efficiency improvements and  the negotiators that use the Air Force super ESPCs typically obtain more  favorable markups than those who use the Army Corps of Engineers’  Huntsville Center’s or FEMP’s super ESPCs. To test this assertion, we  examined data on markups in ongoing ESPCs that agencies reported to us.  The reported markups ranged from 10 to 40 percent for projects under  FEMP’s super ESPC, from 13 to 32 percent for the U.S. Army Corps of  Engineers’ Huntsville Center’s, and from 9 to 29 percent for the Air Force’s.  However, because the agencies did not report markups for all of the  projects in our review and because data did not tie markups to individual  energy-efficiency improvements, we could not determine whether the  projects using the Air Force super ESPC actually resulted in more  favorable markups.
With regard to prices of some components of ESPCs, a number of agency  officials we interviewed expressed concern about their ability to negotiate  reasonable prices in their ESPCs. DOD agencies are required to give all  energy services companies prequalified for a super ESPC an opportunity to  participate in a limited competition at the initial proposal stage of a project.  The competition is limited because, ostensibly, the companies have already  passed government scrutiny in order to be included on the super contract.  Although civilian agencies do not have the same requirement, they may  choose to conduct a limited competition, and most did for the projects in  our review. For the limited competition, the agencies provide the  companies with such information as current utility rates and the types of  improvements the agency is considering that the companies can use to  develop their initial proposals. The initial proposals contain preliminary  cost estimates and other information the agencies use to narrow the field to  the single company it will do business with on the project. Prices are not  discussed with any specificity until after the selected company has  prepared its formal project proposal, even though the formal proposal can  take more than 6 months to complete and review. By that time, we were  told, the agency may feel pressure to continue with the company, possibly  accepting prices that are too high because it is too costly to start over with  another company. Lacking the ability to force the energy companies to  compete more rigorously on prices, ESPCs may cost more than they  should.
Finally, some officials complained about the unsatisfactory services  provided by the energy services companies. For example, one Air Force  energy manager told us that the quality of work by the energy services  company declined substantially after the delivery order was awarded.  According to this official, the energy services company lacked the internal  capability to properly do the work yet resisted hiring additional staff. In  addition, the company did not use the subcontractor identified in the  project proposal; as a result, the agency could not determine if the costs  claimed by the company were valid. Some other problems cited by officials  included inflated costs and over-billing for equipment and labor,  insufficient and/or redundant design work, substitution of cheaper  materials, untimely responses, and disruptive staffing changes.
None of the companies on the super ESPC lists have had to re-compete for  their positions on the lists since they won them 6 to 9 years ago, and the re- competitions planned for them will not occur for another 1 to 2 years. The  companies on those lists have not changed unless they merged with others,  went out of business, or chose to be taken off the list. While there are no  requirements for how frequently the super ESPCs must be put out for  competition, GSA’s practice regarding its contracts for the Federal Supply  Schedule, which are multiyear contracts similar to the super ESPCs, is to  renegotiate the contracts every 5 years to help ensure the contracts remain  competitive. According to the head of FEMP’s Super ESPC Program, DOE  policy calls for re-competing contracts such as the super ESPCs every 5  years.
Our own analysis of agency data on ESPC use indicates that ESPC  contracts appear to be highly concentrated among a relative few  companies in some regions. We calculated the Herfindahl-Hirschman Index  (HHI)—an index used by the Federal Trade Commission and the  Department of Justice to evaluate mergers—for each of the six regions  defined by the FEMP super ESPCs. In four of the six FEMP regions, the  HHI was above the level at which industries are typically considered to be  moderately to severely concentrated. While such measures do not by  themselves indicate a lack of competition, they do suggest that a more  complete evaluation of the competitiveness of the ESPC contracts is  warranted.
section_title: Individual Agencies and the Contracting Centers Are Taking Steps to Address Concerns about Expertise, Information, and Competition
paragraphs: Individual agencies have taken steps to address concerns about expertise  and related information and competition. Among other steps, to bring  expertise and information from previous ESPCs to bear on new ones being  undertaken by their agencies, DOE and the Navy each require ESPC  proposals be reviewed by experts either in-house or at FEMP and do not  allow the projects to proceed into implementation without approval of  these experts. DOE and GSA compiled lists of lessons learned and have  shared them among project officials within their agencies. In addition, the  Air Force, the Army, the Navy, DOE, GSA, and VA each have begun  requesting evidence of competition for financing rates before they will  agree to an ESPC for their agencies. Furthermore, rather than relying  exclusively on the super ESPC contracts, officials from VA are pursuing  alternatives to introduce price competition into the process.
The contracting centers have also taken steps to bolster the expertise and  information available to their officials and to address the competitiveness  problems with the super ESPCs. Most notably, all the centers have, among  other things, issued guidance to help agencies with developing and  monitoring their ESPCs and begun requiring that project proposals contain  documentation of multiple financing bids. Furthermore, the centers are  working to have newly competed super ESPCs available to agencies  between fiscal years 2007 and 2008. The U.S. Army Corps of Engineers’  Huntsville Center plans to have its new super ESPCs in place by the  beginning of fiscal year 2008 and has begun that process. According to a  U.S. Army Corps of Engineers’ Huntsville Center contracting office official,  the center has not recompeted its super ESPCs because the current  contracts do not expire until the end of 2007 and developing the revisions  to the contracts has proven to be a slow process that requires coordinated  input from multiple ESPC experts and contracting centers. FEMP also  plans to recompete its super ESPCs. It plans to begin the process in 2006  and have the new contracts in place sometime in 2007. According to the  FEMP Super ESPC Program manager, FEMP has not recompeted its super  ESPCs to date primarily because FEMP has focused its efforts on helping  agencies undertake successful ESPCs and developing guidance for the  agencies to use. The Air Force does not presently plan to recompete its  contracts but will reconsider that decision over the next 2 years. According  to managers of Air Force’s contracting center, Air Force ESPC projects are  increasingly using FEMP’s super ESPCs because doing so provides the  project-level officials with more contract and energy services company  options. Consequently, rather than re-competing the Air Force super  ESPCs, the managers may begin to phase out their agency’s use of the Air  Force super ESPCs as they increasingly use FEMP’s with Air Force-specific  clauses added.
Although most of the steps agencies and contracting centers have taken to  address expertise, information, and competition needs have been ad hoc,  they have recently begun to address them more collectively via an  interagency steering committee and its working groups. The purposes of  the steering committee include sharing experiences and lessons learned  among the federal agencies that use ESPCs the most, identifying process  and procedural improvements, and developing best practices. The steering  committee plans to develop performance metrics by which its efforts can  be evaluated by June 2005. In addition, the steering committee and its  working groups have accomplished some of their objectives to date. For  example, the working group on measurement and verification issued a  template standardizing the measurement and verification process. Each of  the contracting centers used some of the group’s recommendations when it  developed new measurement and verification guidance. See table 3 for a  more complete list of steps the contracting centers have taken.
We believe that many of the steps the individual agencies and contracting  centers have taken to address expertise, information, and competition  issues promise to help improve those areas. However, because of their ad- hoc nature and because many are relatively new and untested, we did not  attempt to assess their effectiveness.
section_title: Conclusions
paragraphs: ESPCs provide a valuable and practical tool that federal agencies use to  meet energy reduction, environmental, infrastructure, and other goals.  Clearly, agencies that have used ESPCs to install more efficient, energy- saving equipment have reduced their energy consumption and associated  environmental impacts. Further, by using private financing, agencies have  also been able to more quickly and consistently replace an aging and  energy-wasting infrastructure—an infrastructure that the agencies have  identified in their capital management plans as being in need of billons of  dollars of repair and restoration.
While using ESPC-financed projects has permitted agencies to reduce  energy consumption and achieve other goals, the extent to which savings  cover costs as required by legislation remains uncertain. The complexity of  ESPCs accounts for much of this uncertainty. ESPCs are complicated  because of the wide array of technical, financial, legal, and energy-related  issues that must be resolved both in the short and long-term. Because of  this complexity and the cost of more extensive reliance on actual  measurements, agencies have tended in the past to defer to the expertise of  energy services companies and the use of stipulation in lieu of  measurements. In doing so, they may have paid contractors for energy  savings that did not occur or may have negotiated contracts that are more  expensive than necessary. Limited agency audits and our interviews have  disclosed indications of these problems in dozens of projects. Since most  agencies have not audited their use of ESPCs and broad performance  information and documentation are unavailable, we could not determine  how widespread these problems are. Without comprehensive information  on actual performance of the contracts once they have begun to unfold,  however, the agencies’ task of overseeing the contracts becomes difficult.  In turn, the lack of comprehensive information on ESPC performance  makes it more difficult for the Congress to determine the level of support it  should lend to agency use of the financing mechanism. Finally, because  DOE reports to the Congress about agencies’ progress toward achieving  energy goals, the lack of comprehensive data on the results of ESPCs also  reduces congressional awareness in this area. In a more general context,  additional information would be useful in comparing the costs and benefits  of ESPCs relative to alternative financing mechanisms. This information  could include, among other things, the effects of deterioration of energy  efficiency savings in the absence of measurement and verification and  delays in obtaining up-front appropriations relative to obtaining funds  through ESPCs.
In response to these problems, agencies have begun to recognize the  importance of developing and using their own expertise more effectively,  but this has occurred only recently and, at this point, they have not ensured  that it is brought to bear during negotiations and in the longer term. The  ability to correct these problems requires the availability of high-quality  information and the expertise to use it effectively during negotiations and  throughout the life of these long-term contracts. In developing and using  appropriate expertise and information, agencies can also begin to assemble  better information about governmentwide experiences with ESPCs,  including ways of improving such areas as measurement and verification.  They can also draw conclusions regarding the effectiveness of agencies’  working relationships with individual energy services companies, which  could provide another valuable tool for agencies to consider. Finally, as  ESPC use continues, sharing best practices or lessons learned in all of  these areas would go a long way toward making ESPCs as cost effective as  possible while also helping to ensure that the federal government’s  financial interests are protected. Absent further efforts to rely on  appropriate expertise and improve the quality of information, agencies will  continue to be at a disadvantage in negotiating effective ESPCs and less  likely to achieve long-term energy and financial savings.
Agencies have expressed concerns about the adequacy of competition  among financiers and energy services companies in developing ESPCs and  consequently their ability protect their interests. Agency officials and  others expressed concerns that financing costs may be too high because  there may be too few companies that finance ESPCs and energy services  companies may not seek the most favorable financing. Other problems  such as the length of time between competitions for the approved list of  energy services companies and the lack of price competition inherent in  using the super ESPCs also reinforce these concerns. Agency officials have  taken some steps to address these concerns, but the question of sufficient  competition points toward the need for further measures such as requiring  greater competition among financial service companies to potentially  reduce interest rates and putting the super ESPCs out for competition more  frequently.
Differing agency interpretations of the law establishing ESPCs have  contributed to agency uncertainties about the use of funding sources other  than savings for reducing investments in ESPCs through upfront payments.  Within DOE, inconsistencies and uncertainties about interpretation of the  statute are apparent. In practice, some agencies believe that contract  payments may be made only from utility savings resulting from the ESPC  while other agencies make a lump-sum payment on the contract—from  funds already earmarked for equipment replacement or from other  sources—to reduce the length of the contract and finance charges. In our  view, these inconsistencies reflect a lack of clarity about the use of down  payments in general and what does—or does not—constitute a legitimate  source of funds for such down payments if they are allowed.
section_title: Matter for Congressional Consideration
paragraphs: To ensure that agencies use ESPCs as the Congress intends, we  recommend that the Congress consider revising the relevant statute to  more clearly define the components of costs that must be covered by  savings. In particular, the Congress could clarify whether agencies may  make lump sum payments using funds other than their current year utility  savings.
section_title: Recommendations for Executive Action
paragraphs: To better ensure that federal agencies undertake only those ESPCs having  the greatest likelihood that savings will cover costs and that the agencies  negotiate the best possible contract terms and monitor the contracts  properly, we are making recommendations to the heads of those agencies  included in our review, namely the Secretaries of Defense, Energy, and  Veterans Affairs, the Attorney General of the Department of Justice, and  the Administrator of the General Services Administration. Our  recommendations focus on the areas of information, expertise, and audits:  Collect and use ESPC-related data more effectively by (1) compiling  information on key contract terms—such as interest rates and markups  for energy-efficiency equipment—for each ESPC and as a key part of  best practices make information accessible to agency officials in  negotiating subsequent ESPCs and (2) tracking actual costs, verified  savings, and any changes to ESPC projects that may affect these costs  and savings.
Ensure that the agency officials responsible for ESPC decision-making  use appropriate expertise when they undertake an ESPC. If the officials  do not have sufficient expertise themselves, they should be required to  obtain it from such independent sources as a centralized pool within the  agency; the contracting centers of the Air Force, the U.S. Army Corps of  Engineers, the Navy, and FEMP; or from private parties. The costs of  acquiring this expertise should be considered in deciding whether to use  an ESPC.
Require, as appropriate and in line with available resources, that  inspectors general or other audit offices conduct audits of ESPC  projects to ensure the projects are achieving their expected results.
Because the contracting centers can play an important role in helping the  agencies develop and monitor their ESPCs, we recommend that the  secretaries of Defense and Energy require the contracting centers to  work with the agencies that use them to ensure that the contracting  centers have the information and expertise needed to effectively  develop and monitor their ESPCs; and   continue and expand their ongoing efforts regarding competition,  including taking steps such as re-competing the super ESPCs as soon as  possible and then more regularly.
Finally, to strengthen the information available to the Congress for  assessing the progress and effectiveness of ESPCs, we recommend that the  Secretary of Energy collect more extensive information on agencies’  ESPCs, including such critical elements as cumulative verified savings and  costs, and include that information in its annual report to the Congress. As  a part of this effort, we also recommend that the Secretary compare  projects funded by ESPCs with projects funded by upfront appropriations  to determine their relative costs and benefits. Specifically, the Secretary  should determine, among other things, the effects of deterioration of  energy efficiency savings in the absence of measurement and verification  and delays in obtaining upfront appropriations relative to obtaining funds  through ESPCs.
section_title: Agency Comments
paragraphs: We provided the Departments of Defense, Energy, Justice, and Veterans  Affairs, and the General Services Administration, with a draft of this report  for their review and comment. DOD, DOE, VA, and GSA provided written  comments, which are presented in appendixes II through V. The  Department of Justice responded by email on June 2, 2005. All of the  agencies generally concurred with the findings, conclusions, and  recommendations and stated their intention of implementing the  recommendations. The agencies also submitted technical and clarifying  comments, which we have incorporated as appropriate.
In addition, DOE expressed concerns in two areas. First, regarding our  discussion about confusion over the allowable sources of funding for  ESPCs, DOE expressed the view that its General Counsel’s office’s opinion  regarding prepayments was not at variance with FEMP guidance as we  reported. Nevertheless, the agency noted that it will take steps to ensure  that FEMP guidance is consistent on this point to avoid future confusion.  Furthermore, DOE supports our recommendation that the Congress more  clearly define the components of ESPC costs that must be covered by  savings and the agency stated that it will address the issue in a report to the  Congress on ESPCs that is currently in the review and approval process  within the agency. We have added language to the report noting DOE’s  disagreement with our discussion of this issue. Second, DOE expressed  concern that FEMP does not have authority to do more to facilitate  oversight of ESPCs, as we recommended. While we recognize DOE’s  concern with taking on additional oversight responsibilities, we note that,  in commenting on our draft report, all of the agencies stated their intention  to work cooperatively with DOE and the other agencies to implement our  recommendations. In recommending that DOE facilitate oversight of  ESPCs, we intended that the agency take such actions as collecting data on  verified savings and costs and reporting such information to the Congress,  as well as to the agencies themselves, to aid the Congress and the agencies  in their ESPC oversight actions. We believe that it is appropriate at this  point for DOE and the other agencies to continue to use a cooperative  approach, such as through the Federal ESPC Steering Committee, to  develop and implement consistent and best practices for ESPCs.
As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  date of this letter.  At that time, we will send copies of this report to the  appropriate congressional committees; the Secretaries of Defense, Energy,  and Veterans Affairs; the Attorney General; the Administrator, GSA; and  other interested parties.  We will also make copies available to others upon  request.  In addition, the report will be available at no charge on the GAO  Web site at http://www.gao.gov.
If you or your staff have any questions, please call me at (202) 512-3841.  Contact points for our Offices of Congressional Relations and Public  Affairs may be found on the last page of this report. GAO staff who made  key contributors to this report are listed in appendix VI.
section_title: Objectives, Scope and Methodology
subsections: section_title: Objectives
paragraphs: We were asked to determine (1) the extent to which federal agencies used  ESPCs; (2) what energy savings, financial savings, and other benefits  agencies expect to achieve; (3) the extent to which actual financial savings  from ESPCs cover costs; and (4) what areas, if any, require steps to protect  the government’s financial interests in using ESPCs.
section_title: Scope and Methodology
paragraphs: To satisfy these objectives, we included in our review any ESPCs that  agencies undertook in fiscal years 1999 through 2003. We did not perform  formal cost benefit analyses of individual ESPC projects or of ESPCs as a  whole because of data limitations.
To address the data analysis component of these objectives, we first  obtained basic contract data from the four federal contracting centers that  assist agencies with ESPCs-the Air Force Civil Engineer Support Agency,  the U.S. Army Corps of Engineers’ Huntsville Center, the Naval Facilities  Engineering Service Center, and (FEMP), which reflect the majority of all  ESPCs undertaken during fiscal years 1999 through 2003. We did not  completely assess these data for reliability; however, we reviewed the steps  that the contracting centers take to ensure data reliability and determined  that these steps were sufficient for our reporting purposes. We obtained  more detailed contract data for the same period from the seven federal  agencies in our review having the most facility floor space and the highest  energy use and therefore the highest potential to use ESPCs. These  agencies were the Departments of the Air Force, the Army, the Navy  (including the Marine Corps), Energy, Justice, Veterans Affairs, and the  General Services Administration.
Before analyzing the contract data, we combined the data from the  contracting centers and the agencies into a single data set. Because some  agency contract data could also be included in the contracting center data,  we identified the projects that appeared to have duplicate records. We  asked each agency to confirm those records that were duplicates and,  using our best judgment, retained those records with the most complete  information.
To address the objectives overall, we interviewed and obtained  documentation from a wide range of stakeholders. From the seven  agencies and four contracting centers, we talked with officials at  headquarters, in regions, and at specific project sites. We also discussed the  issues with officials from the Congressional Research Service; Oak Ridge  National Laboratory; Lawrence Berkeley National Laboratory; the Defense  Energy Support Service Center; and the states of Maryland and Louisiana,  both of which use ESPCs extensively. In addition, we talked with officials  from the energy services and financial services sectors and an academic  expert knowledgeable about ESPCs. We also reviewed relevant legislation,  regulations, policies, and agency procedures.
We also reviewed studies by the Oak Ridge National Laboratory and the  Lawrence Berkeley National Laboratory that analyzed the costs and  benefits of ESPCs and compared net benefits of using ESPCs to finance  energy savings improvements with the net benefits of using direct  appropriations. To evaluate these studies, we interviewed some of the  authors and reviewed other studies and reports that the authors had  referred to and which supported some of the assumptions they used to  model the net benefits. In particular, we asked the authors of the Lawrence  Berkeley National Laboratory study about their support for the assumption  that energy savings decay over time in the absence of monitoring and  verification. They referred us to a body of literature on energy  commissioning—essentially energy audits of buildings—in which there is  evidence of energy savings decay. We reviewed several studies from this  literature and concluded that there was sufficient evidence for savings  decay to warrant inclusion of the Lawrence Berkeley National Laboratory  study results, with the proper caveat that we could not definitively  conclude on the extent of savings decay or on the extent to which  decreased savings decay and other benefits from ESPC-funded projects  may offset the significant savings achieved from using upfront funding that  we found previously in six case studies.
To better understand specific benefits, problems and suggested  improvements for ESPCs as well as evaluate whether savings were  covering costs, we interviewed and obtained appropriate documentation  from officials who either negotiated and/or currently manage specific  ESPC projects at 15 geographically dispersed locations. We judgmentally  selected these officials from lists of knowledgeable officials provided to us  by the ESPC program managers of each agency. We also discussed these  issues in general for an additional 10 projects with the officials who  manage DOE’s departmental ESPCs. Furthermore, we reviewed 13 audit  reports conducted by the Army Audit Agency or Air Force Audit Agency  and discussed the results with auditors involved in the reviews; reviewed a  report by a consultant hired by VA to assess that agency’s use of ESPCs;  reviewed relevant GAO reports and consulted with subject matter experts  at GAO; and reviewed other reports and information on ESPCs identified  by searching the literature.
We conducted our work from January 2004 through May 2005 in  accordance with generally accepted government auditing standards.
section_title: Comments from the Department of Defense
section_title: Comments from the Department of Energy
section_title: Comments from the Department of Veterans Affairs
section_title: Comments from the General Services Administration
section_title: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Dan Haas, Dennis Carroll, Randy  Jones, Hugh Paquette, Frank Rusco, Karla Springer, Barbara Timmerman,  and Jena Whitley made key contributions to this report.  Chris Bonham,  Carol Henn, Cynthia Norris, and Jena Sinkfield also contributed.