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

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