Performing Energy Contracts: 5 Pitfalls

Government entities should be aware of the pitfalls of energy performance contracts, which present some unique challenges to consider before commencing an expensive infrastructure project.

FREMONT, CA:  Many cash-strapped government entities invest in energy performance or savings contracts to update ageing infrastructure. Under these deals, the capital costs of infrastructure projects must be financed by "guaranteed" savings from improved energy efficiency and decreased operating expenses.

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Still, in practice, these contracts may be based on meaningless guarantees, leaving city and county governments paying off pricey capital projects for years into the future with little or no cost savings.

Before commencing an expensive infrastructure project, government entities should understand the pitfalls of energy performance contracts, which present unique challenges.  

1. Avoid unnecessary scope items

Utilizing an energy performance contract often comes from contractors and service companies vying for infrastructure work. For example, a contractor may tell a local government that it loses thousands of dollars monthly in increased utility costs and operating charges for ageing facilities.

According to the contractor, the solution is an energy performance contract that will generate sufficient "savings" to pay for the project's cost. With the pledge of a project that will pay for itself, the contractor may propose summing items to the scope of work that is not priorities for the government entity. For example, what began as a project to address specific public facilities may expand to a city-wide project to renovate HVAC systems, lighting, plumbing, and perhaps even water meter and billing systems.

Although the alleged "guarantees," energy performance contracts are not risk-free. Governments should avoid utilizing energy performance contracts to finance unnecessary upgrades as part of a package deal, specifically when the project delays other critical infrastructure work.

2. Employ an outside consultant for project evaluation and verification

Few government entities have the skill to fully evaluate an energy performance contract and measure its supposed savings. The savings calculation is complicated and often obscures the true nature of the "guarantees." Cities and counties thus should regard engaging an experienced outside consultant to recognize issues with the contract structure and project scope before the deal is completed.

Moreover, ongoing measurement and verification of savings are critical for energy performance contracts. Rather than enabling a contractor to measure its performance, government entities should consider requiring the contractor to pay for a third party to escort independent testing of the project advancements to ensure savings are realized.

3. Repel on front-loaded payment schedules

The payment plan for the project is another crucial factor. Contractors will force payments to begin as early as possible, with most of the milestone amounts owing near the front end of the project. This reduces the contractor's financing costs and allows the contractor to switch risk to the government entity before assuring that the project has accomplished the promised savings.

Government bodies should push back on such payment schedules. Most payments should be delayed if feasible until substantial project completion, and initial cost savings from the project improvements are verified.  

4. Scrutinize "guaranteed savings" provisions, which may ensure nothing

Guaranteed savings are the core of an energy performance contract. However, the computation of such savings in the contract is typically complicated by multiple components that obscure the true nature of the guarantee.

As a result, the contract may not truly guarantee the recoupment of specified dollar amounts. For instance, certain savings may be "stipulated" in the contract. If those savings fail to materialize after the project, the government entity bears the burden of the shortfall. Such "stipulated" savings essentially guarantee nothing.

Benchmarks utilized to measure energy savings also may be skewed in favour of the contractor. This may follow in a contractor satisfying the savings benchmark on paper while the government entity has not understood any savings. Though the contractor may report that the savings assurances were satisfied, the government entity could conclude in a poor financial position than before the advancements.

5. Exercise caution as long as water meter system upgrades

Lastly, water meter system updates are particularly problematic. For instance, an energy performance contract may promise "guaranteed savings" through increased revenue generated by a new automated water meter system and avoided costs of operating an old manual system. Nevertheless, these types of projects often fail to guarantee, much less deliver, actual savings or revenue.

For instance, although a contract may ensure that an individual meter accurately measures water intake when tested in a lab, this does not needfully lead to increased revenue. Gathering revenue from water usage needs the transmission of accurate meter readings over the wireless network to the billing system. Without guaranteeing the performance of the water meter system, there is no real guarantee of revenue or "savings" of any kind.

On top of the flimsy assurances of individual meter measurements, the "secured savings" calculation commonly contains "stipulated" savings components that decamp from reality in the field.

The contract assumes that the government entity will realize certain savings from the new water meter system, regardless of whether those savings occur. When the new water meter system becomes more complicated and costly to operate than contemplated by the assumed savings, the government entity is oppressed by those costs into the future. This beats the actual aim of the water meter upgrades.