Performance Contracting Frequently Asked Questions
What is an ESCO?
An ESCO, or Energy Service Company, is a business that develops, installs, and arranges financing for projects designed to improve the energy efficiency and maintenance costs for facilities over a certain amount of time. ESCOs act as project developer for a wide range of tasks and assume the risks associated with the project. Typically, they offer the following services:
- Develop, design, and arrange financing for energy efficiency projects;
- Install and maintain the energy efficient equipment involved;
- Measure, monitor, and verify the project's energy savings; and
- Ensure that the project will save the amount of energy estimated.
These services are bundled into the project's cost and are repaid through the dollar savings generated.
The Governor’s Energy Office (GEO) has pre-qualified ESCOs through its Performance Contracting Program.
Who should be involved in a performance contract for the project to be successful?
Because a comprehensive performance contract project is both technical and financial it is important that decision makers at all levels are involved in the process. For example, facility personnel, financial personnel, as well as administrative personnel should be involved. Many state and local governments now have energy and sustainability managers both of whom should be involved. However, it is important that one person act as “project manager” or “champion” to be the primary facilitator/administrator of the process and point of contact.
How does TABOR affect EPC?
In the state of Colorado, the Tax Payers’ Bill of Rights, or the TABOR amendment, essentially states that government agencies may enter into multi-year financial obligations without voter approval. Performance contracts involve multi-year financing, typically through a tax-exempt lease purchase agreement. Through the GEO’s Performance Contracting Program, lease purchase agreements include language that specifically states that the financing agreements are “annually renewable” and subject to the agency’s annual appropriation of funds and are therefore not subject to TABOR restrictions. State agencies should contact their legal counsel with questions.
How is our debt services affected by a performance contract?
Theoretically, a performance contract does not incur debt in the strictest of terms. This is because when a local or state government enters into a multi-year lease purchase agreement its repayment funds are generated from verified and guaranteed reductions in utility budgets. So, the guaranteed cash results from redirecting already existing or budgeted funds to cover the lease purchase payments. Officially, no money is borrowed in the traditional sense. Because this topic is open to interpretation by individual agencies, contact your financial officer for clarification.
Does a performance contract guarantee energy savings OR energy cost savings?
An energy performance contract guarantees annual energy savings. Cost savings depend on utility rates and are projected as a part of the contract process. Typically, over a multi-year performance contract, utility rates are expected to increase. For each year of the agreement, the ESCO will apply a mutually agreed to utility cost escalation rate (an educated best guess) that will be applied to the cost savings calculations each year of the agreement.
A number of resources are consulted for to generate the predictions. The U.S. Department of Energy’s Energy Information Administration (EIA) is one of the more used resources for these forecasts. It is important to note that if the predicted annual rate increases are over-stated and not actualized, the contract’s guaranteed energy cost savings may then exceed the “real” annual cost savings. Consult with the GEO when developing this metric.
What is the difference between “liquidated damages” and a “performance bond”?
In a performance contract, liquidated damages are assessed to the ESCO as a monetary penalty for not meeting contractual timeline obligations. This is typically set as a specific amount penalized each day beyond the deadline. For example, a school district might have a contract completion date prior to the beginning of the school year. If the ESCO does not meet this important timeline, liquidated damage penalties may be assessed, assuming there is no other mutually agreed to mitigating circumstances. Liquidated damages are direct reductions from an agreed contract amount.
A performance bond is a surety bond issued by an insurance company or a bank to guarantee satisfactory completion of a project by a contractor. For example, a contractor may cause a performance bond to be issued in favor of a client for whom the contractor is constructing a building. If the contractor fails to construct the building according to the contract, the client is guaranteed compensation for any monetary loss up to the amount of the performance bond.
Performance bonds are commonly used in the development of real property, where an owner or investor may require the developer to assure that contractors or project managers guarantee that the value of the work will not be lost in the case of an unfortunate event (such as the contractor going bankrupt). In typical performance contract projects, the customer pays for the performance bond.
What is “contingency” and how is it used in the GEO's Energy Performance Contracting Program?
A percentage (typically between 5% and 10%, depending on the complexity of the project) of the overall construction costs are set aside as contingency dollars to be used to fund unforeseen issues that can add cost to the project. For example, a hidden object may be discovered behind a wall that obstructs the location of a piece of equipment that was not known about during the design of the measure and it may require additional funding to remedy the situation. It would have been unreasonable for the ESCO to know about this object, so contingency funds could be used to keep the project on track. However, contingency funds do not cover the cost of design errors made by the ESCO. At the end of the project construction period, any remaining contingency funds become the agency's to use as they see fit and can consider reinvesting the money into additional upgrades.
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