In 2005, Kentucky procured a statewide LED traffic signal retrofit. Not only did this project make it the second state — after Delaware — to use LED modules in all its traffic signals on state-maintained routes, but it also decreased the state's traffic signalization energy costs by 95%, at an estimated annual energy savings of $1.7 million. In addition, the retrofit decreased annual maintenance costs to the tune of $1.5 million. And for all of this, the commonwealth wasn't out-of-pocket a single taxpayer cent.

Kentucky's traffic signal retrofit required no up-front capital expenditures because the funding comes exclusively from the energy cost savings resulting from the upgrades. The decrease in maintenance fees is just the cherry on top for the state. In fact, over the life of its six-year energy savings performance contract (ESPC), the project actually may save the state $10.2 million.

An ESPC is an agreement between an energy services company (ESCO) and a building owner. The owner reimburses the ESCO for the project from the energy savings on a monthly basis over the contract term (usually between five and 10 years) and receives long-term energy savings and new technology benefits. Once the contract is completed, the customer is able to enjoy the benefits of lower energy costs as well as new energy-efficient systems and equipment.

ESPCs have been used since the 1970s, but until recently, with increasingly stricter state and federal mandates for energy efficiency in public buildings and projects, they were considered a form of “alternative” financing. It's only been within the last decade that ESPCs have become more mainstream — especially for schools (see “Old School” below) — but almost any project that saves energy or produces energy can be funded through an ESPC.

“Of course traffic signals are government projects, but you usually associate schools or municipal office buildings with ESPCs,” says Jami Hall, certified lighting management consultant (CLMC) and president, Stones River Electric, Nashville. “Many people don't think about the traffic signals.”

Hall's firm, the subcontractor on the Kentucky traffic signal retrofit, replaced 78,000 incandescent signals at nearly 3,000 intersections and almost 500 school flashers, flashing beacons, and advance-warning flashers with LED technology within a period of six months.

Projects built using ESPCs, Hall says, are just one of the many ways for electrical contractors to expand their businesses. In particular, firms with lighting experience have a distinct advantage over energy management or design firms that participate in ESPCs. When Stones River began working with ESCOs on these projects six years ago, its roots in electrical contracting proved advantageous. The company was able to position itself as one that could provide the energy audits as well as the installations, self-performing most of its own work. Since its entry into ESPC vertical markets, the company has worked on lighting projects that average between $1 million and $1.5 million, with its largest project to date totaling $4.5 million. “It's a good opportunity for electrical contractors if they learn the business,” but it's an entirely different business than your standard contracting business,” Hall says.

Different strokes

Electrical contractors that work in the public sector are used to strict bidding laws. Because ESPC regulations vary from state to state, the agreements may be exempt from these laws, depending on which state you work in. For example, Kentucky requires a procurement process with a request for proposals (RFP), whereas Tennessee treats ESPCs as professional services so projects can be negotiated. (Guides and advice regarding RFPs by state are available from Rebuild America, a network of community-based partnerships dedicated to saving energy in buildings, at www.rebuild.org or at state energy offices, which can provide RFP guidelines specific to their states.)

Variations on ESPCs include projects that can be negotiated down through the subcontractors, a negotiated contract between ESCO and facility owner with the subcontracts out to bid, or the contract between ESCO and the building owner is bid out.

In most cases, ESCOs provide the financing and also may arrange for a variety of other services, such as conducting a facility energy study, identifying cost-effective projects, project design, project management, commissioning, and the hiring of subcontractors. The form of the contract may vary from a set price for a fixed scope of work to a form in which the electrical contractor, as the ESCO's subcontractor, would share some of the risk of project development in order to negotiate a higher price for its work. “In all of the cases I'm familiar with, the electrical contractor works as a subcontractor to an ESCO in a performance contract,” says Donald Gilligan, president, National Association of Energy Service Companies (NAESCO), Washington, D.C. “But the ESCOs could be helped by an electrical subcontractor, depending on the state.”

A typical ESPC has a single RFP covering all aspects of the project and one set of contract documents with the selected ESCO. The process begins with an evaluation of a facility's potential for energy-efficiency improvements by the facility staff. If the potential seems promising, the agency prepares an RFP. This RFP covers engineering, equipment purchasing, construction, and commissioning. The agency awards the contract to a single contractor who is accountable for all services and guarantees a level of savings to the facility.

Management of the design and construction phase of the performance contract is essentially the same as the management of a large design/build retrofit or repair and maintenance project. However, performance contracts incorporate several other elements that are not associated with conventional retrofits — which Hall refers to as “low-hanging fruit” — and aren't nearly as comprehensive. Stones River Electric's approach to a standard lighting retrofit project is to assess the best lighting upgrade at the best price to meet the client's needs. Those clients aren't interested in energy management systems or controls. “They already know what they want, and you're just going to price it up for them,” she says.

Performance contracts require a comprehensive program. “We look for a real turnkey approach to everything about their electrical system,” says Hall, explaining that this includes a room-by-room detail of the light fixtures, controls, transformers, emergency generators, energy management systems, and exterior lighting and the potential energy savings from the retrofit. The firm provides a complete investment-grade audit with the various energy calculations on each energy conservation measure.

An electrical company that doesn't understand the nature of performance contracting could be in over its head when starting out, according to Rhonda Courtney, business development manager, Stones River Electric. The mistake lies in treating the project as if it were a time and materials (T&M) issue instead of from a design standpoint. “We can look at that scope of work and cost it up, and then also we look at the energy savings side of it,” she says. “We understand the payback requirements and the things that are important to end-users as well as ESCOs.”

Check, please

Performance contracting is a safe method for government agencies, particularly schools, to get work done. ESPCs are rarely funded with capital, and the money the agencies pay to the ESCOs is already earmarked for previous higher utility costs or maintenance and repairs. So once the project's developed, the agencies merely realign those funds within their existing budgets. They don't have to ask taxpayers for more money.

However, the method is not totally risk-free. The ESCO has guaranteed the owner a certain amount of energy savings with which to pay for the project. “The ESCO owns it from a guarantee standpoint, that if the savings are not achieved as they've laid out in the contract to the client, they have to write the owner a check,” says Courtney.

Essentially, the ESCOs are selling a financial proposition in the form of a performance contract. Unlike bid and spec, the responsibility of pricing and performance is off the owner and lies directly with the ESCO and the electrical contractor hired as the subcontractor. The design is created with high-performance and commissioning in mind. “We have to live and die by our design,” Courtney says. “When we design a project, unless the client wants something new or over and above what's been designed, there are no change orders. We deliver to our design.” Therefore, if the electrical contractor doesn't do an accurate count of lights, or if the design doesn't meet the lighting requirements, the contractor or the ESCO could pay for it — literally.

Howdy, partner

Because the ESCOs could be the ones paying for mistakes, their engineers verify and approve the final package for the retrofit. “They're the ones guaranteeing it, so of course they're going to make absolutely sure that they agree with our calculations,” Hall says. “But they're depending on us to know about the electrical system and what the energy savings per each piece of equipment is.”

Therefore, working for ESCOs in this capacity is more like cultivating a relationship than a business agreement. “Many ESCOs won't just pick up the phone and work with any electrical contractor they run into,” Hall says. “They have to really trust the proposal given to them.”

In this sense, a performance contract is a much more cooperative arrangement than many construction contracts, which are sort of adversarial, according to Gilligan. ESCOs looking to hire an electrical contractor want qualifications such as flexibility and an ability to understand the cooperative nature of the contract. “This is not really the kind of zero-sum game that a normal construction project is,” Gilligan says. “There's more flexibility, particularly in developing the scope of work and negotiating that with the building owner.”

The real trick to success in working with ESCOs may be to forget everything firms have learned working for general contractors (GCs). Courtney warns that ESCOs don't run things the same way as the familiar GCs. They depend on the subcontractor to track material, even when it numbers into the hundreds of thousands, and employ workers who understand energy audits and the systems and software used to generate the savings reports. In addition, you have to be willing to wait. “You have to be able to go through some highs and lows waiting for your proposal to go to contract,” she says. “You'll do a survey and then that might not go to contract for months or a year. You don't have the control over when they go to contract, and that's very difficult for a company. You hire people, you get geared up to do some work, and you can't control when that contract is coming.”

Keeping the firm at a maintainable size is also key. The way Stones River approaches this challenge is by cross training its lighting crew with its electrical crew. For the most part, this is not the type of work journeymen electricians want to do, Courtney says. “They will do it on occasion to fill in a gap here or help out to finish a project, but we employ more lighting techs than we do journeymen electricians,” she says.

It's only after the project is completed that it starts to feel like more of a typical construction project. Despite several attempts to include a maintenance program with some of its projects, Stones River has been turned down. Instead, it closes out of the contract and the document and offers a one-year warranty period. By contrast, the ESCO stays with the client for the duration of the contract, sometimes between 10 and 12 years. “We don't do any monitoring once our project's done,” Hall says. “But what we will do is take light-level and wattage readings and give them all that information so they know, just as part of their measurement verification, these were the savings before and after.”



Sidebar: Old School

When the economy falters, the maintenance budgets of K-12 schools are often the first to feel the squeeze. According to the U.S. Department of Energy's Energy Efficiency and Renewable Energy's brochure, “Performance Contracting: Financing Better Schools Through Energy Cost Savings,” many schools respond by deferring maintenance to the detriment of the learning environment. This is bad news given that the average school in the United States is 42 years old. Fortunately, many school districts are hearing the word about performance contracting as a way to reduce energy costs without up-front payments for the products and installation. For more information on performance contracting in schools and to read some case studies, download the full text of the DOE's brochure at www.asbointl.org/ASBO/files/CCPAGECONTENT/docfilename/0000003168/Performance_Contracting_in_K-12_Schools.pdf or read “Sign Up For Savings” by Mike Kennedy in the October 2002 issue of American School & University at http://asumag.com/Maintenance/business/university_sign_savings/



Sidebar: Glossary of Performance Contracting Terms

  • End-use: A general category of energy use within buildings (e.g., lighting, space cooling, water heating, etc.)

  • Energy baseline: A calculation or measurement of each type of energy that would have been consumed in existing facilities or technologies, if the contractor had not installed energy-efficiency measures. The baseline is used in the measurement of energy savings from the project.

  • Energy efficiency measure (EEM) or energy conservation measure (ECM): The installation of new equipment, modification of existing equipment, or revised operations or maintenance procedures to reduce energy costs by improving efficiency of use or conservation.

  • Energy performance contract: An agreement between a private company and a facility for the provision of energy services and equipment, including (but not limited to) building energy conservation enhancing retrofits and alternate energy technologies. The private company agrees to finance, design, construct, install, maintain, operate, or manage energy systems or equipment to improve the energy efficiency or produce energy in connection with the facility in exchange for a portion of energy cost savings, lease payments, or specified revenues. The level of payments is made contingent upon the measured energy cost savings or energy production.

  • Energy service company (ESCO): A private company providing energy management equipment and services, including feasibility studies, design, installation, maintenance, and financing.

  • Guaranteed savings: A type of performance contract under which the facility pays a lump sum price (usually in monthly installments) for the energy-savings improvements, and the contractor guarantees that energy cost savings will equal or exceed this payment.

  • Municipal lease: A contract granting use of property during a specified period in exchange for a specified rent. When a public agency is the user of the property, the income from the lease is exempt from income taxes. These tax savings are passed on to the agency by a reduced interest rate.

  • Priority-listed proposer: Those responsive and responsible proposers who are selected for the priority list when numerous proposals are submitted.

  • Shared savings: A type of performance contract in which the facility and contractor agree to share the measured energy savings on a pre-determined basis. Under a shared savings contract, the agreement to share savings may be for a fixed time period or until a fixed amount has been paid. Shared savings contracts are not recommended by the State of Hawaii.

  • Simple pay-back or pay-back period: A measure of project economic effectiveness, the pay-back period is calculated by dividing the initial project cost by the annual project savings.

Source: Alliant Energy-Interstate Power and Light Co., “Performance Contracting Brochure”