Energy Savings Performance Contracts: Reauthorization Issues
Released: 2004-09-01T00:00:00

Introduction

From the mid-1980s to the end of FY2003, federal agencies had been authorized to enter intoEnergy Savings Performance Contracts (ESPCs) with contractors that privately financed andinstalled energy conservation measures in federal buildings and facilities. In return, the contractorsreceived specified shares of any resulting energy cost savings. The term "energy conservationmeasure" (ECM) applies to energy-efficiency improvements such as energy- and water-savingequipment, and renewable energy systems such as solar energy panels. (1)

The contractor, referred to as an Energy Service Company (ESCO), provided the design,acquisition, installation, testing, operation, maintenance, and repair services for the ECM. TheESCO also had to guarantee a fixed amount of energy and cost savings throughout the term of thecontract, and bore the risk of the ECM's failure to produce a projected energy savings. The sum ofthe ECM cost and its reduced level of energy cost could not exceed the pre-ESPC energy cost. Theterm "energy savings" was applied to the measured reduction in the base cost of energy used by anexisting federally owned building or facility, as established through methods specified in thecontract.

To date more than 340 ESPCs have been awarded, according to the Department of Energy(DOE), and no ESCO has failed to produce an energy and cost savings. (2) A recent Department ofDefense (DOD) proposal would have expanded ESPCs' application beyond fixed facilities intomobile systems. ESPCs were suggested as means of replacing the engines of the Air Force's agingB-52 bomber fleet with more efficient jet engines that would burn less fuel, thus qualifying as energyconservation measures. (3)

Congress is currently considering ESPC reauthorization. Even though authorizing legislationhas expired, ESPCs awarded prior to the expiration date of October 1, 2003, continue in effect untiltheir completion dates. This report reviews the legislative history of ESPCs, the federal program topromote them, the Congressional Budget Office's (CBO's) scoring rationale, and ESPCs' cost andbenefits. The report also discuss the debate as to whether ESPCs offer the best contract means forinstalling ECMs, and policy considerations for Congress.

Enabling Legislation

Though Energy Savings Performance Contracts were authorized in 1992, they built on earlierCongressional mandates to improve the energy efficiency of federal buildings. Subsequentlegislation required federal agencies to audit their effectiveness, authorized federal agencies to retain50% of the resulting savings, raised the dollar threshold for notifying Congress, and temporarilyextended their authorization. The enabling legislation is summarized below.

Department of Energy Rules

EPAct directed DOE to develop rules for federal use of ESPCs consistent with FederalAcquisition Regulations (FAR). DOE published the final energy savings performance contractingregulations (10 C.F.R. 436) in April 1995. (5) These provisions superseded those in the FAR. Federal agencieswere encouraged to make use of ESPCs' innovative contracting mechanisms, namely, the use ofprivate sector financing that did not require prior appropriations. (6) The financing supportedenergy-efficiency improvements to help reduce energy costs and meet federal energy reduction goals.

DOE's rules also required that federal agencies document progress toward energy savinggoals by submitting an annual report, implementation plan, energy scorecard, and energymanagement data report to the President and Congress. (7) The annual report describes energy management activities infederal facilities program operations, and progress in implementing NECPA requirements and inattaining the energy-efficiency improvement goals of Executive Order 13123, Greening theGovernment Through Efficient Energy Management. (8) The order directs federal agencies to maximize their use ofavailable alternative financing contracting mechanisms, such as ESPCs.

DOE's Federal Energy Management Program (FEMP) established a "Qualified List of EnergyService Companies." (9) Thelist includes all private industry firms that submitted an application and were qualified by a ReviewBoard, consisting of Federal Interagency Energy Management Task Force representatives and DOEstaff. Recognizing that awarding a stand-alone ESPC could be very complex and time-consuming,FEMP also created streamlined "Super ESPCs" as umbrella contracts that allowed agencies toundertake multiple ESPCs under one contract.

ESPCs' Cost and Benefits

Federal agencies reported new EPSC commitments through an annual Energy Scorecard thatlisted the number of contracts, projected annual savings in millions of British thermal units (Btu),total investment value, cumulative guaranteed cost savings, and contract award value.

For FY1998, FEMP reported that federal agencies awarded $79 million in conventionalESPCs and another $6.6 million as Super ESPCs, excluding the Department of Defense. (10) By FY2000, conventionalawards rose to $225 million as Super ESPC awards rose to $62 million (for a total of $287 million),including Defense. (11) For FY2003, FEMP estimates that the private sector committed $252 million to finance ESPCs. Figure 1 shows the value of Super ESPCs versus conventional ESPCs awarded between FY1998and FY2003 in nominal dollars. Few if any conventional ESPCs are reported as being awarded after2001, as indicated by the abrupt drop-off of the graph curve.

How effective are ESPCs' contribution to meeting federal energy reduction goals? FederalESPC projects have achieved about a 30% higher energy savings (per-square-foot basis) thanmunicipal/state governments, universities, schools, and hospitals (MUSH). (12) The median for federalenergy savings is about 18,000 Btu per square foot (Btu/ft 2 ) compared to 14,000 Btu/ft 2 for MUSH. Annual federal government electricity consumption also declined from 1992 to 2002 by 1.14 billionkilowatt-hours. (13)

Figure 1. Super ESPC vs. Conventional ESPC

How do the savings translate in terms of net economic benefit? In an analysis of 214 federalprojects, using a 7% discount (interest) rate, Lawrence Berkeley National Laboratory (LBNL)projected $550 million in benefits that would go to the taxpayer. (14)

ESPC savings projections may or may not be achieved depending upon whether the buildingor facility is fully used after the energy improvement. (15) If savings were smaller than projected, future operation andmaintenance (O&M) spending would need to be larger than projected. The ESPCs' savings freedup funds that otherwise would have been appropriated for O&M. (16)

Though authorized for up to 25 years, ESPC contract terms have been averaging 14 years inlength. (17) Normally,ESPC cost savings are used to pay the contractor first and then offset other base operating expensesafter the contract completion. (18) In an unconventional approach, DOD deferred some ESPCs' costsavings until contract completion to shorten the contract term and accelerate payoff of the energyconservation improvement. These contracts reduced energy consumption but did not reduce the totalcost of operation until contract expiration. Although CBO would score such ESPCs as futurefinancial obligations, the length of the obligation would be reduced, as would the interest chargesthat the ESCO would pass on to the government (discussed below).

ESPC vs. Appropriations- Funded Energy Conservation Measures

The federal market for ESPCs has produced at least 340 projects valued at approximately$1.6 billion in private sector investments. (19) In comparison to ESPCs, $3.17 billion in appropriated funds wasinvested in energy-reducing capital improvements between FY1985 and FY2001.Appropriations-funded projects peaked at $288 million in FY1995 and declined to $131 million byFY2001. Figure 2 shows the rate of spending between 1985 and 2001.

Figure 2. Appropriations-Funded Energy Conservation Measures

Are the costs of energy conservation measures installed under ESPCs as favorable as thecosts obtained through competitive sourcing with appropriated funds? To answer the question, OakRidge National Laboratory (ORNL) conducted a cost evaluation comparing energy projectscompleted under ESPCs with those completed under appropriated funds. (20) ORNL's evaluationconcluded that the "pricing under Super-ESPCs, using a design-build approach negotiated for bestvalue, was as good as the pricing obtained for the appropriations-funded projects in the traditional'bid-to-specification' competitive program." In sum, ORNL found that energy conservation measurescompleted under an ESPC were no more costly than those completed under direct appropriations.

Are energy conservation measures under appropriated funds more time- consuming thanunder ESPCs? Based on data for 71 awarded projects, ORNL found that Super ESPCs averaged 15months to award the contract and 12 months for design and construction -- 27 months in durationfrom start to finish for an average implementation price of $3.26 million. (21) Based on data for 23energy projects, appropriations-funded projects averaged 63 months in duration. Only 12 of the 39ECMs studied were ultimately funded (some projects having more than one ECM).

How does project financing compare between ESPCs and appropriations-funded contracts? Since ESCOs pay interest charges on money borrowed to finance the energy conservation measures,they recover the cost over the life cycle of the ESPC. Under an appropriations-funded project, acontractor's commercial finance charges would also be passed through as part the project's cost, butthe length of financing and therefore cost of financing would be considerably less than with ESPCs.

A key measure for comparing the ESPC funding alternative to appropriations-funded projectslies in the life-cycle cost. This accounts for the costs of the initial survey and feasibility study,installation, and owning and operating the ECM over its useful life. ORNL devised parametrictables (22) to assist federalmanagers in deciding whether to fund ECMs through ESPCs or wait for appropriated funding. Forproject duration times between 28 and 68 months, ORNL found that appropriations-funded projectshad lower life-cycle costs as long as the up-front survey/study costs stayed below 18% of thedesign/completion costs. (23) However, when the annual energy savings fromappropriations-funded projects decreased by as little as 2% from the projected savings, the projectsbegin to lose their competitiveness with ESPCs.

Congressional Budget Office Scoring

Under the 1990 Budget Enforcement Act (BEA, P.L. 101-508 ) pay-as-you-go (PAYGO)rules, increases in mandatory spending scored by CBO had to be offset by mandatory spending cutsor increased revenues. These enforcement mechanisms were extended through FY2002 in theBudget Enforcement Act of 1997 ( P.L. 105-33 ). In addition, the BEA imposed limits ondiscretionary spending, that is, on funds provided through the annual appropriations process.

Under the BEA budget constraints from FY1991 through FY2002, CBO remained silent onscoring the budgetary cost of ESPCs. After an extensive review of whether ESPCs imposed a futurefinancial obligation on the federal government, CBO began scoring ESPCs as mandatory spending,coinciding with the expiration of the BEA. (24) The CBO scoring reflects how ESPCs create futurecommitments to appropriations. It is consistent with how appropriations-funded energy conservationprojects would be scored throughout the budget. CBO assumed in scoring H.R. 6 thatbecause the federal building inventory is aging, ESPCs would continue to be awarded at least at thesame rate as in FY2003. (25) Thus, authorizing an extension of ESPCs as included in the H.R.6 conference report could commit upwards of $2.5 billion over the next 10 years, basedon an estimated $252 million commitment in FY2003.

Policy Considerations

Since the 1970s, both the executive branch and Congress have promoted energy efficiencywithin federal agencies. When the federal government's energy-efficiency and conservationprograms received severe budget cuts in the 1980s, Shared Energy Savings and later Energy SavingsPerformance Contracts were devised as part of the strategy to meet federal energy reduction goals. Appropriations-funded energy conservation projects have been declining since FY1995, and federalmanagers have increasingly turned to ESPCs as a remedy to fund energy conservation measures.

EPAct had authorized federal agencies to incur obligations through ESPCs to finance energyconservation measures provided that guaranteed savings exceeded the debt service requirements. Nevertheless, CBO scores ESPCs as future commitments to appropriations, consistent with thescoring of commitments for appropriations-funded energy conservation projects throughout thebudget. O&M funds that would pay for ESPCs must be appropriated. Upwards of $2.5 billion overthe next 10 years would be scored as a future commitment if ESPCs were reauthorized.

In effect, the federal government borrows money when it authorizes energy-efficiencyimprovements through ESPCs. When there is a deficit, the Treasury must also borrow moneyneeded by government to pay its bills, which government borrows by selling Treasury securities suchas T-bills, notes, Treasury Inflation-Protected securities, and savings bonds to the public.

Proponents of ESPCs may argue that ESPCs represent a financially smart choice because ofthe guarantee that all costs, including debt repayment, will be covered by the cost savings producedby new ECMs. Further, the real cost of energy conservation measures under ESPCs is zero giventhat the capital improvement costs and reduced energy costs are less than what the governmentwould continue to pay without the improvements. Further arguments may be made that ESPCsrequire shorter lead times than improvements made with appropriated funds. Hence, energyreductions can be achieved sooner with ESPCs, as supported by the ORNL study. However, thelife-cycle cost of the ECM favors appropriations-funded projects within certain parameters, andESPC funding under other parameters.

ESPCs were devised by Congress as a means of decreasing future obligations by reducingoperation and maintenance spending on energy. In recognizing that ESPCs do impose futurefinancial obligations, as scored by CBO, Congress may consider retaining the sunset provision.

Despite declining appropriations for energy-efficiency improvements and the necessity tolimit future financial obligations, Congress may still choose to encourage energy-efficiencyimprovements in federal facilities. Congress may decide once again to extend the sunset provision,as had been authorized in the 1998 legislation. Further, Congress may consider amending theprovisions of ESPCs to promote early payback strategies to reduce long-term obligations, orexpanding their application to mobile systems for additional energy-savings potential.