ESPC Pricing and Financing for State and Local Grantees (Text Version)
Chani Vines: Hello. My name is Chani Vines. And on behalf of the U.S. Department of Energy, I'd like to thank you for joining us for this webinar on Energy Savings Performance Contracting Pricing and Financing. This is presented as part of the U.S. Department of Energy's Technical Assistance Program.
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The DOE Technical Assistance Program (TAP) provides state, local and tribal officials the tools and resources needed to implement successful and sustainable clean energy programs. Through TAP, DOE has a launched a $26.4 million effort to assist EECBG and SEP Recovery Act recipients.
This is an effort aimed at accelerating costing, improving project and program performance and increasing the return on Recovery Act investment. TAP offers one-on-one assistance, extensive online resource library, facilitation of peer exchanges on topics including energy efficiency and renewable energy technologies, program design and implementation, financing, performance contracting and state and local capacity building.
With the launch of the Recovery Act, TAP introduced the Solution Center, an online portal for technical assistance resources like best practices, templates, webinars, event calendar and the TAP log. We are continually adding new resources and scheduling additional webinars.
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The DOE Technical Assistance team will continue to provide webinars on various topics related to activities under ARRA funding that might be of interest to you, so please keep checking the calendar for updates on updated webinar schedules.
Now, I'd like to introduce our webinar presenters from the Technical Assistance Team, who specialize in Energy Savings Performance Contracting.
Karl Berntson is a senior engineer with over 30 years of experience in the energy industry. For the last 10 years, he has developed and managed the Energy Savings Performance Contracting for the state and local governments. Working for the State of Maryland in Prince George's County he has demonstrated success in selling and implementing ESPC projects saving the state over $190 million in energy expenditures. He also has an additional 25 years of experience in energy efficiency and the renewable energy industry, including geothermal, biomass, solar and other technologies.
Our other TAP ______ Team provider Irina Bulkley-Hopkins offers 15 years of experience in the energy industry specialized in policy and regulatory analysis, project and program management, operations, strategy development as well as in energy marketing. Irina has experience serving on both sides of the process representing federal agencies, such as the Department of Energy's National Renewable Energy Lab and the Department of Energy's Western Area Power Administration as well as working with the private sector, such as AECOM Government Services and with Xcel Energy.
Irina will be our first speaker.
I. Bulkley-Hopkins: Thank you, Chani, and thank you, everyone, for joining our webinar today. Welcome. Wherever you're from, the weather hopefully is good.
The subject matter today is ESPC pricing and financing for state and local grantees.
But before we get into that, we need to just do a little refresher on what an ESPC is and why you should use the ESPC model. And then, we will go into some more details about how the ESCO prices and ESPC and what you as the owner need to pay particular attention to.
The financing of ESPCs is critical to the success of a project, so we will take a closer look at that and where the funding is coming from.
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So, we covered this. For those of you who attended previous webinars in the summer, we covered this topic in great detail, which is still available on the Solution Center.
But, briefly, an ESPC is a contract between an owner, such as you, grantee, and an Energy Service Company, which we refer to as an ESCO and that has a few distinct parts to it, that contract.
First, there is an audit agreement, which stipulates that the ESCO shall do an investment-grade audit of the facilities in order to be included in the project and it should also develop all possible energy conservation measures, which we will refer to as ECMs. Then, the ESCO develops a detailed implementation proposal. And after an agreement is reached on the scope to be implemented, the actual ESPC contract is signed and the ESCO can begin the installation.
After the installation is complete and commissioned, the project moves to the service and maintenance phase and, sometimes, there is a separate agreement written for that. However, if there is a separate agreement for O&M, it must be detailed in the ESCO's proposals as well, so that there are no surprises when the time comes to sign it. So, please watch out for that.
And, also, the ESCO must guarantee the energy savings. In case of a savings shortfall in any given year, the ESCO shall be responsible for reimbursing the owner for that shortfall.
With the Energy Savings Performance Contract, there is no need for capital funds or additional funds. And, basically, you're just reallocating funds from what usually goes to pay utility bills and instead pay for improvements. As we say, energy savings pay for the project, that's why it's an Energy Savings Contract.
It is important to note that an ESPC in the state and local government market is structured differently than the federal ESPC.
In the federal market, in one of the scenarios, the ESCO bears all upfront installation costs and it also finances the whole project. The ESCO then gets paid annually from the savings generated by the project.
In the state and local government projects, however, the financing is generally a separate contract between the owner and the financing company of the owner's choice. In such case, the owner borrows the funds required to pay the ESCO for the installation and puts the money in an interest-bearing escrow account. And then, the ESCO gets paid on a regular basis during the installation period for the work that is being accomplished.
It is not uncommon for the ESCOs still to be asked to help facilitate or arrange the financing and they have long-standing experience in doing that, so please feel free if that is appropriate for your circumstances to ask them to do that.
It is also important to note, especially to grantees who have never done an ESPC before, that there are no other contracts that really describe what is included in an ESPC. And it is easy to be inclined to just use something old such as a construction contract and just decide to modify it, but we just want to caution you that this generally does not work, because it does not cover everything that must be included into an ESPC and, consequently, will be inadequate. It just will end up being a major headache in the end if you decide to follow that path.
So, there are links to sample contracts on the Solution Center that can be very useful and you should take advantage of those. It certainly is a lot easier than starting from scratch on your own. So, just make sure when you use the samples that there is nothing in the contract that favors one party over another. So, you and the ESCO need to really talk about your contract together.
It is important that you involve your procurement and legal departments as early as possible in the ESPC process, especially if this is the first ESPC that you or your organization is entering into. Frequently, there are jurisdictions in your state that have done ESPC projects before and they very likely might be willing to share their documentation as guides. You might even be able to utilize their contracts, especially if it was issued by your state.
And before we go on, we have a few questions that we would like you as grantees to answer. It will be a quick poll of three questions with the answers that you can pick on your pad there, in the chat pad there.
So, Leslie, can you please give us the poll questions.
Leslie: The first one's up. Okay. The second one is coming on now. Okay. And here comes the next one. Okay.
I. Bulkley-Hopkins: All right. Thank you so much and we're ready to go on to the next slide.
ESPC basic principles. The features of ESPCs that are often most attractive to agencies, to grantees, to the owners are the financing and guarantee of energy savings. With no up-front capital outlaid by the grantee required, the ESCO provides all labor, materials, equipment and engineering designs for improvement projects to reduce energy costs. The contract requires the ESCOs to implement energy conservation measures, ECMs, for their grantee customers and guarantee that these improvements will result in the specified level of annual energy savings. And it is those savings that are then used to pay back the loan to the financing company. So, as I stated earlier, if there is a savings shortfall in any given year, the ESCO reimburses the owner for the shortfall amount.
So, what this slide is depicting is that before the ESPC, the grantee has a certain amount that it spends on utilities and operations and maintenance and it's shown here as grantees cash flow dollars.
The next bar shows what the cash flow distribution is after the ESCO has implemented the ECMs. The utility and O&M cost, you can see that they're significantly lower. And the guaranteed savings are used to pay back the loan that was used to finance the implementation. And then, there might be some savings left over. The ESCOs typically do not guarantee 100 percent of the savings that the estimates will be generated. That is just sound risk management on their part. There's nothing to be alarmed about.
And the third bar, after the loan has been paid back to the financial institution, all the savings are realized by you, the grantee, the owner of the facilities, whoever you are, and they can actually lower your operating budget, those savings, significantly.
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Having looked at what is involved in ESPC, some of you may be wondering why is it that I would do an ESPC? It seems like a complex process. Well, we will now take a look at why a jurisdiction should consider an ESPC and how it helps leverage the EECBG funds.
First of all, capital dollars for facility improvements, all of you are very familiar with that. In any government or in any entity today, they're very hard to come by. ESPC provides a method to make the long-needed facility improvements without capital dollars being involved. The energy savings dollars stay for the improvements. And most governmental jurisdictions never appropriate sufficient funds for facility management to keep up with required equipment maintenance, chillers, boilers, cooling towers, whatnot. And an ESPC does provide the method for getting this all done, either via equipment replacement or just repairs and overhauls. So, per definition, it's an Energy Savings Performance Contract, so it saves energy and the energy savings are guaranteed, so that's another major benefit.
And by upgrading the HVAC in building automation systems, for example, you can improve indoor air quality significantly, which in turn will improve the comfort level of the occupants of your buildings and increase their productivity. So, there is another benefit for you right there.
By utilizing the EECBG funds in an ESPC, ESP conservation measures that have long pay backs and would normally not fit within an ESPC can be included and their savings help to pay for additional projects. So, here is a benefit that allows you to expand your scope of planned energy improvements.
Speaking of the cost of delay, delaying the implementation of energy conservation projects have a cost associated with it. EPA developed an Energy Star and also has a free portfolio manager that gives you an excellent cash flow opportunity calculator and it also has a cost of delay function as well. So, we highly recommend that you use the Energy Star Portfolio Manager both to benchmark your facilities and to investigate the cost and pay back of various ECMs that you're considering, so please take advantage of that.
And with that, I'm going to turn the presentation over to Karl.
Karl Berntson: Thanks, Irina. Now, we're going to take a closer look at the pricing of the ESPC and how you, as a client, can assure yourself that the pricing is fair and reasonable.
Thanks, Irina. Now, we're going to take a closer look at the pricing of the ESPC and how you, as a client, can assure yourself that the pricing is fair and reasonable.
The first is a question you need to have your procurement or legal people answer and that is whether the project is exempt from sales taxes or not. The ESCO needs to know that when you request quotes from their suppliers or when they request quotes from their suppliers and subcontractors and also for the pricing of their internal work. If the project is tax exempt, you will need to provide an exemption number or an ID to the ESCO to use for the specific project.
Then, you need to establish whether there are any minority business enterprise participation requirements. When there are MBE requirements, they generally are expressed as a percent of the project cost. This also is something the ESCO needs to know in planning the project and when they're getting calls from suppliers and subcontractors for all the ECMs, because that's where the minority business participation happens.
And it should be noted that the ESCOs do the audits with their internal resources and therefore MBE requirements do not apply to that part of the project.
It obviously is up to the individual jurisdictions how they handle what pricing information they require from the ESCO. However, in order to expedite the pricing verification, it's beneficial to include the open-book pricing requirements in the audit agreement. That way the ESCO must provide copies of all quotes and price calculations.
Next, consideration should be given to what sequence the project implementation takes place. Are there any ECMs that you want installed as soon as possible, maybe? That could be such things as replacement of equipment to where the existing is very close to failing, or it could be that you want lighting projects started without delay to take advantage of the savings as soon as possible, or it could be specific buildings you want done before the cold weather sets in.
The only possible negative effect could be if you want a specific ECM installed in some buildings, but for some reason that particular ECM cannot be installed in other buildings until later. That could cause a contractor to have to mobilize twice to complete the same ECM and that, obviously, would have a negative pricing effect.
These are things to think about and you should discuss them with your ESCO so they can develop the pricing accordingly.
Contingencies. On regular construction contracts where the contractor makes an estimate based on a set of drawings and specifications, contingencies are included in the contract and that's because there are generally items that are not fully described or they might be missed in the drawings or specifications and they must be included in the construction anyway, so then the contractor can issue a request for a change order.
On an ESPC, however, we don't have that situation. The ESCO does the audit. They walk through the buildings, develop the drawings and they should know exactly what it needs to be included in the project. So, in general terms, there should not be a need for contingencies to be included in ESPC.
However, if you do include contingencies in the contract, it's strongly suggested that you stipulate owner approval for its use and that any unused contingencies at the end of the contract revert back to the owner. And, also, if you include contingencies, make sure that the savings are sufficient to cover the cost should all the contingencies be used.
Also note that by including contingencies, you might be eliminating energy conservation measures from the project equal to the amount of the contingency. In other words, if you didn't have the contingency, you still have the savings and maybe you could do another energy conservation measure for that cost.
When the owner's project manager presents a project to the procurement approval authority if it's a city council or a procurement review board, whatever, he or she then must be able to state that the pricing is fair and reasonable. Therefore, it's very important to have a structured method to verify that the ESCO's pricing for all the project is just that, fair and reasonable.
ESCO develops a cost and savings for each ECM per building, which then establishes the simple pay back for all ECMs individually. This is followed by a joint decision by the owner and the ESCO, which ECMs to include in the overall project.
And, as shown here, the overhead and profit rate, they should be preâ€‘established. Typically, that gets done in the audit phase. That means that the ESCO shall be required to provide those rates, including information on how they are applied. Make sure here that it's understood that this is not margins, which are calculated different than markups, which we are talking about here.
So, based on the agreed upon ECMs, the ESCO develops the total project cost, including all design, engineering, construction, material and labor, project management, overhead, profit, commissioning services, maintenance, training and M&V, measurement and verification.
Even though the final financing method has not been established at this point generally in the contract, although it might be, it depends on when you issued your financing RFP, but you need to get an idea from your financing providers or the intended financing providers what the interest rate will be on the loan, so the ESCO has a reasonable value to use to develop a cash flow analysis to verify that the project can be paid for with a guaranteed savings and within the allowed pay-back period.
Keep in mind that the net cash flow must be positive or zero for each year of the pay-back period. You cannot have negative cash flow in any given year.
Price Verification. Once the total project cost is established, it's helpful if the ESCO submits a preliminary project proposal to the owner, so that the owner can start the pricing verification and initiate negotiations. It's very important that the owner use preliminary drawings and equipment specification sheets to get the fully understanding of all the ECMs in detail.
After the ESCO has provided the preliminary cost data, the owner needs to verify that the cost and the best way to do that is generally to use RS Means construction cost data or a similar accepted industry resource to come up with independent cost level.
It's unrealistic to expect the owner to verify every cost item on the project, but detailed verification should be made for at least a representative sample of ECMs and also obtain a few independent quotes from equipment suppliers.
The issue that can cause some difficulty is when there's demolition involved. Maybe, piping needs to be demolished or rerouted or maybe an electrical panel needs to get moved. In cases like that, it's appropriate to ask the ESCO for a complete breakdown that shows the cost for each individual step involved in the demolition, because, otherwise, it's very difficult to price demolition.
The owner also needs to verify that the engineering and design times are reasonable and charged at reasonable rates. The same goes for project management. These items can be a little more difficult to verify, but you, as the owner, you should be able to find the going rates for designers and engineers in your specific area of the country.
The reasonableness of total hours quoted for each discipline is a judgment call. For design, it might be a question of how many drawings need to be developed. And, remember, you probably need as-built drawings at the end of the project for archiving and for future reference, so simple layouts might not be enough. So, you need to have an idea of how many drawings and how much data needs to be on each of these drawings to figure out or get the sense of how many hours that the designers are going to need to develop them.
As far as project management, is there a need for the ESCO to have more than one project manager or do they need to have project engineer, maybe, a construction superintendent? By answering that, you can assess whether the project management cost is reasonable. And you also need to establish or figure out if there is a need for full-time project management. For smaller projects, maybe, a specific project manager might have 3 or 4 projects going at the same time, so if you only need 25 percent of his time.
Then, the question is, are there any areas where costs can be reduced without affecting savings or quality of the project? Is the ESCO quoting the optimum equipment? Is there another less costly brand that would accomplish the same as what is quoted and, if so, of similar quality?
Also, review the installation schedule to ensure that it is not too conservative. Remember the cost of delay Irina was talking about a while ago? You don't want to be too conservative on your schedule. Obviously, you don't want to be too optimistic either, because then it shows up as a delay in installation.
By the owner having verified the ESCO's proposed cost, it puts the owner and the ESCO in a more playing level field for negotiations, so you have a pretty good idea what the project should cost and compare that to what the ESCO is proposing.
And when you start negotiations, you need to have an idea of where you want to get the negotiations. Maybe, the ESCO price and you are pretty much in agreement and you don't need a lot of negotiation. If there's a big difference, obviously, you need to go through that and discuss it in more detail.
We did have a webinar on negotiations of contracting back on November 18 and you can find that webinar on the Solution Center and you can listen to that. There are both the slides and the audio available. So, we're not going to get into details on negotiations here.
Suffice it to say that you establish where you need to get in the negotiations before you start. Otherwise, if you don't do that, you don't know when you're going to stop negotiations and agree to what the price level is.
Done with that, we're going to switch gear a little and talk about the ESPC financing options.
Prior to developing the financing RFP, the method of project financing must be determined. It's necessary to identify in the ESP, the request for proposal if - the financing request for proposal that is - if the ESCO will be responsible for financing the project cost and construction or for the complete pay-back period. That's typically not happening nowadays. In 10, 15 years ago, the ESCOs sometimes financed the whole project and that also has been happening more in the federal arena.
However, it's important to remember that there are alternative methods of financing usually at the lower interest rate than what the ESCO would be able to provide. If your agency will require financing during the ESCO anyway, then you need to include alternative language in the ESP RFP documents and contract documents. We strongly advise that you work with your financial and legal staff to develop such language.
The method of financing should be established as early on in the project as possible. The financing RFP should be issued and basic financing bids received. You can even sign a basic financing agreement without knowing the exact cost of the project.
In general, there are several alternatives for financing the ESPC and all of them should be considered. The most common method today in the local and state government is a tax-exempt lease purchase agreement. Another method, although not as popular, is through a bond sale. The problem with that is that government entities like to preserve their bonding capacity and don't generally feel an ESPC qualifies as being important enough to finance via bonds. Again, your ESCO might be willing to finance, but it likely will be at significantly higher interest rates than what you can get by going directly to the financing institution.
So, let's take a look at the various sources of funds that might be available.
As with any facility improvement, an ESPC obviously must be paid for. Fundamental source of funds in the energy savings performance contract is the savings generated by the ESPC project. That means a reallocation of a portion of the operating funds from the utility account to a loan payment account. This reallocation must occur every budget year for the pay-back period of the loan used to finance the ESPC. So, it's critical that your budget and finance departments has a full understanding of this and are in agreement and it must be properly documented.
Remember, the pay back can be maybe up to 20 years. There are going to be changes in personnel. The documentation must be available so the people coming on over the years understand what it's involved.
In addition to the main loan, there are several other fund sources that can be utilized to pay for a portion of the project. So, let's take a look at what the financing possibilities are.
We have cash. That's a rare commodity. Most public operations don't have the extra cash available in their operating budgets. The operating budget is generally made up of tax receipts and fees that are imposed on various services. The utility account is part of the operating budget, so the energy savings generated by the ESPC actually reduces the utility line item in the budget, but the savings generated must be paid - or the project must be paid for. So, the reduction in the line item from the utility operating budget must be moved over to a loan line item payment. Cash is the least favorite ESPC payment method.
Capital budget. Most local municipal governments, they get their capital funds through bond sales. In other words, they borrow them with the future tax revenue and out of the revenue streams as collateral. Obviously, capital funds can come from tax receipts as well, but it's probably rare situations where a governmental entity has more tax revenue than needed for daily operation. Typically, the only capital funds available are when funds have been appropriated for equipment replacement and that equipment now will be replaced to the ESPC. If the funds are already appropriated, you most likely will be able to use them in the ESPC contract.
Then we have bonds, the GO bonds, general obligation bonds. They are long-term debt instruments. They're both for investors and are traded as on balance sheet finance. Since bonding capacity is based on outstanding debts and bonds typically being used to provide needed capital for governmental organizations, it's not the favorable method for financing ESPCs. Public entities pledge future tax receipts as security for their general obligation bonds.
State energy offices often have incentive programs, rebates or grants. The state energy office often provides rebates for energy efficiency upgrades. So, contact your state energy efficiency office to see if they have any incentives or grants available.
With all the emphasis on energy conservation, it's also common today to find that your local utility have incentive programs that can provide a portion of your needed funds. And you, obviously, need to contact your utility to find out what's available. Most of the time today, you can find that online in their respective websites.
And as you are EECBG grantee, obviously, hopefully, you plan on using part of that grant for your ESPC. And that grant can be leveraged by including them in your contract. The grant is the same as cash and the savings from ECMs paid with the grant can be used to pay for additional ECMs that you otherwise could not include in the project.
Sometimes, even the county might provide an incentive to municipalities that can help to pay for your ESPC.
And then, we have the tax-exempt lease purchase agreement, TELP for short. That has been the most favored method of financing ESPC projects for at least the last decade. The lessee purchase the equipment through regular payments to the lessor over the term of the lease. From accounting point of view, a TELP can be considered off balance sheet in most states provided the agreement contains a non-appropriation clause. Because the lease payments are subject to appropriations, this type of lease is not considered debt. It's rather considered a fixed stream of the annual leases.
Now, that's technically correct that it's not a debt. However, if the funds don't get appropriated and you can't pay, technically, you're not in default, but the credit rating agency will look at it as if you are, and, obviously, that would hurt your county's or city's or state's credit rating.
Now, it should be noted here that there are forces underfoot that are looking at changes to lease financing regulations. So, even though they have not been considered debt for several years, we don't know what's going to happen in the coming year. There is a chance that that will change, so you need to make sure you discuss this with your financial and legal departments.
Revolving loan funds. State energy offices, they often have lowâ€‘interest revolving loan funds available to state, local and municipal governments in order to promote energy conservation projects. However, typically, the dollar cap of these loans is generally fairly low compared to the total funds needed for your ESPC. But take advantage of any low-interest loans you can get. Typically, the repayment period of RLF, revolving loan fund, is also less than what you can get the regular loan for or TELP. And it's generally less than 10 years. I have seen them up to 12, but that's the absolute maximum I've seen. And the reason for that is the payments go back into the fund, so they can provide loans to other energy conservation projects.
So, to learn more about revolving loan funds, you can go to a link shown here on this slide. And I don't know if you know, it's on the first slide, the slides here will be on the Solution Center. They will also be sent to you in the next few days together with the audio for this webinar, so you don't need to write down the links here.
And as we mentioned, the slides - oh, I have that here.
Capital lease. Lease purchase equipment, that is where a lessee - they purchase the equipment at the bargain purchase option at the end of the lease. The equipment is actually owned by the financing company during the term of the lease. The ownership is transferred at the end of the lease via an actual purchase of the equipment and that's just generally at just a token amount. Capital lease is not commonly used to finance ESPC, but just mentioned here so you are aware it exists. You should talk to your financial people about what they think is the best option in your situation.
Operating lease. The equipment ownership stays with the lessor indefinitely, so this option is not very desirable for most governmental entities. So, it really amounts to nothing more than a rental agreement. From an accounting point of view, an operating lease is off balance sheet.
Then, we have qualifying energy conservation bonds, QECBs. They may be used by certain governmental issuers to finance certain types of energy conservation and renewal energy projects.
QECBs are qualified tax-credit bonds. A tax-credit bond, the issuer of the bond pays back only the principal and the bondholder receives a federal tax credit in lieu of traditional bond interest. The tax credit rate is set daily by the U.S. Treasury Department.
Regulations for QECBs are changing. So, if you go to the Solution Center and click a webcast â€"
Karl Berntson: Okay. Let's move on.
The regulations for QECBs are changing, as I said. So, if you go to the Solution Center and click on the webcast, which is the link shown here, you'll find a webcast on QECBs that was held on September 22nd and that would give you up-to-date information.
And last, we have master lease. Master lease, that's not directly a method of financing, it's however a convenient approach to finance multiple projects without having to issue RFPs and separate contracts for the financing of each project. The master lease is agreement between the financial institution and the property owner that the financial institution will finance several projects to be implemented over a period of time. Typically, there is a dollar limit set on the total amount that can be borrowed under the lease. The interest rate and loan term is set separately for each project. By establishing the basic contractual agreement up front and loan term, it's separately for each project. By establishing the basic contract agreement, the time to finance each project under the master lease is significantly reduced. The work to secure the financing needs to start at the same time the decision is made to use an ESPC to do energy upgrades to your facilities.
And, now, we have one question for you. We'll let that come up before we move on.
Leslie: Karl, is this for a poll?
Karl Berntson: Yes.
Leslie: Here we go. Karl?
Karl Berntson: Yeah?
Leslie: Okay. I took the poll question off.
Karl Berntson: Right, thank you.
Leslie: You're welcome.
Karl Berntson: So, now, we're going to see if we can add this all up. What we're trying to show on this slide is that in order to determine the amount you need to borrow to pay for the ESPC, you start with the total cost and you deduct what other funds you have available to determine how much borrowed funds you need.
The one thing on this chart that needs some discussions with your treasurer is the QECB, like we talked about, qualifying energy conservation bonds. If it works for you and you can issue qualifying energy conservation bonds, it might be beneficial to get all your funds you need to borrow through the sale of QECBs, in which case, you don't need a tax-exempt lease purchase loan. Your financial experts can advise and help with that decision. One concern could be that there generally is quite a bit of time required to establish and sell QECBs.
As you can see here, all the available funds must equal the total cost, which is what you're going to pay the ESCO for the implementation of the ESPC. So, the total cost minus what you have of the top six funds shown here will equal how much you need to borrow in your tax-exempt lease purchase funds, exactly what you need to borrow - the method you're going to use to finance.
Note that this is exactly how much borrowed funds you need. It's not exactly how much you need to borrow and we will get into that shortly.
What we need to establish now is what the interest rate will be on the loan and what the interest rate that is that you will earn on your escrow account. In order to do that, we must have issued an RFP, selected a financing company, unless the state has a performance contract financing contract that you can ride, in which case, you can use that. So, you should check with your state if they have in place a master lease contract, for example, for financing. And, generally, if they do, you can piggyback on that particular contract as a local government or city government in that particular state.
You can find sample financing RFPs on the Solution Center at the link shown here.
Whether you need to issue an RFP or not to select an escrow institution, that, you can find out from your finance department. Most likely, you don't need to do that, because your institution already have a bank it does business with that can act as the escrow agent.
You need to contact the financing company you have selected and get an estimate of what the expected interest rate is going to be about the time when you close the financing. So, you have to give them an idea of when the financing would be closed, if it's 6 months, 12 months or whatever down the road.
The escrow institution will also need to be contacted to see what kind of interest rate you will earn on your escrow account.
So, now, you know how much borrowed funds you need and we also know the interest rate you're going to pay for the loan and the interest rate you're going to earn on your escrow.
So, before we get into how much you actually need to borrow, it's very important to assure that the ESCO provides a realistic and accurate draw-down schedule. You are most likely going to pay the ESCO on a monthly or at least a quarterly basis during the construction period and you need to know how much that's going to be and what the schedule is for those payments. And that's in order to determine how much money you have in your escrow account at any given time, so you can calculate how much interest you are actually earning.
So, two slides back, we show the total cost of the project and all the various funds that we used to pay for it. So, as we said, if we take the total cost and deduct all the other funds you will be using, you'll arrive at how much loan funds you'll need.
So, what this slide here is attempting to show is that the amount of loan funds you need are made up of two sources, namely the original loan amount, that is the amount you're going to borrow, and the interest you earn on the escrow account.
So, the first thing we're going to calculate is how much money is in your escrow account for any given period, which is the original amount you deposited minus what you had drawn down to pay the ESCO plus the interest you have earned. So, generally, that gets calculated on a monthly basis. And, most likely, you will, in the contract, you first pay the ESCO as if you have capital funds. You might spend your grant funds first. And then, you might have the revolving loan funds funds and you use those before you start using your lease purchase loans and, maybe, even before you take down the loan. And you keep the money in the escrow account as long as possible.
Now, based on the interest earned and a draw-down schedule, you can calculate the actual amount you need to borrow.
So, what we have here is a sample Excel calculation that's used to figure out how much you actually need to borrow. Excel has an add-in function that's called Solver and that's used for this calculation.
So, as you can see here at the bottom, this particular sample contract, and you're going to see that in the next slide too, is $12Â million, that's just they picked a number. So, that's what you ultimately are going to pay the ESCO.
The total interest earned in the escrow account shows here as $320,780.59. It also shows the $300,000.00, and it's not clearly spelled out up here, that's a revolving loan fund used to pay the ESCO. What it is - if my arrow actually worked it would be good; there we go - the revolving loan fund, it's shown here as $500,000.00. However, in this case, there's a state energy office fee, because the state energy office, let's say, they handle the project management for you. So, the amount that's going to go to pay the ESCO is the difference, and that's $300,000.00. The total revolving loan - okay. So, we get $300,000.00 for that.
The Solver takes this information and it calculates how much your original loan needs to be to come out to zero when everything is paid. And, in this case, that's $11,379,219.41.
And how Solver works is that you tell Solver that the lower number here - I don't know why I have problems with my arrow - but the lower number here at the bottom should be zero. And so, you tell Solver to make that box zero based on manipulating this number up here, which is F6 in this particular Excel sheet. And then, Solver goes through the iterations to come up with what the number actually will be.
There's another option you can do with this and that will be to simply take out the loan for the $11,700,000.00, that's the $12,000,000.00 minus the $300,000.00 from the revolving loan fund. Then, you can take the - like, I said, the $11,700,000.00, you can put that in an escrow and make the payment to the ESCO per the draw-down schedule. And in the end, the interest you earn will be left in the escrow account, so you could simply use that as part of the first loan payment. In other words, you don't bother doing this here calculation. You take down the money you need in the loan and then the escrow you earn, you just use that to pay part of your first loan payment with it.
And what's not shown here, and this assumes you start paying back the loan - you don't start paying back the loan until the installation is completed. There will be interest accruing during the construction period.
So, in this case, the actual amount owed when you start making payments on this loan, and that's going to show up on the next slide, that's actually $11,981, 455.00 as compared to what you actually borrowed was $11,379,000.00. So, it's gone up by about $600,000.00.
And the interest added while you had - that's interest that is added while you have use of the funds, but you're not making payment and that is called capitalized interest.
So, what we have here is - this is sample cash flow analysis and this shows that the amount you borrowed in the brown background top here on the left, it says $11,379,000.00. Next line shows the accrued interest of $602,000.00 and the payback amount is $11,981,000.00, so that's the total amount you need to pay back.
Now, this particular project had three financing streams. It had the main tax-exempt lease purchase funds that we talked about. Then, it had the revolving loan fund that we also talked about and that's showing repayment over here on that. And there is the amount of the interest you earned in escrow, which is shown up here where the arrow is right now, $320,700.00.
Now, in the cash flow analysis down here - I hate this - the annual cost side, which is over in the middle. Over here, we have the cost side. It's made up of the two loan payments. That's your taxâ€‘exempt lease purchase loan here is principal and interest. It's the revolving loan funds next to it, payment. It's the ESCO service costs, the ESCO's M&V costs. The state energy office is going to help verify that the M&V is accurate, so that's a cost involved with that. There is a guarantee letter of credit.
Now, let me talk about guarantee letter of credit. That is something that's kind of a holdover. Back in the '90s, there were energy performance contracts, where some building owners, they weren't quite sure if they actually received the savings that they were supposed to. There were discussions between ESCOs and owners. In order to avoid that, some owners required a guarantee letter of credit or, maybe, an insurance, and that was in case there was a dispute to make sure that the owner actually had the funds available to pay the loan, and then they could solve the dispute after that.
There are actually very few state governments that require the letter of credit today and the ESCOs have been in business a lot longer. They are generally accredited by NAESCO, the organizations that handle that. If the ESCOs did not perform in today's market, they simply wouldn't be in business anymore. So, the problem is not generally a need for a letter of credit today, but this particular sample just has it in there and that's why I'm bringing it up.
Remember, the guiding principle here for a performance contract is that the savings has to be at least equal or greater than the cost, so that is what shows up as net cash flow here and it cannot be less than zero. It always has to be zero or positive for every given year.
And on the savings side in this particular case, we show we have the ESCO guaranteed energy savings and we also have service, contract and repair savings.
Now, there's a word of caution regarding service and repair savings. They're real savings. But in order for them to help to pay the loan every year, the budget must be kept intact for these items just as if they were still there, even though they are now used to pay a loan instead of paying for a service. So, you need to make sure that your budget and management understand that they have to keep this particular budget item constant or if there are escalations included, they have to escalate that budget item same as they escalate the utility line item. So, it's just a word of caution, because it's not that easy necessarily to transfer that type of operating budget into a loan line item budget.
And as I mentioned earlier, we had $200,000.00 for the state energy office doing project management. And there's a little nuance here, because that is shown coming out of the revolving loan fund.
And the reason for that - well, it's two things here. It shows, first, the project pays for the project management. And the other is the tax-exempt lease purchase financing, typically, but not always, they cannot pay for project management, internal project management. And the reason for that is that you have to have collateral, which is all the equipment that gets installed. But project management is not an asset, so, sometimes, the financing company does not accept that as collateral on the loan, so, therefore, you can't finance it. And that's why you use when you having revolving loan funds or if you have the grant funds, you use those to pay for internal project management.
And just a side note here, it's kind of interesting actually. In this particular case, the interest rate on the loan was 3.46 percent as shown up here in the left column. And on the previous sheet, we actually saw that the interest rate was 3.50 percent. So, you actually earned slightly higher interest on the escrow account than what you paid on the loan.
Then, with that, we have a couple of more poll questions for you and then I'm going to turn this back over to Irina.
Karl Berntson: Hello.
Leslie: Hello. We will put up the next polling questions, then?
Karl Berntson: Right.
Leslie: Here we go. Here's one. Okay. And here is the last polling question that I have for you. Okay. You're back to your presentation.
I. Bulkley-Hopkins: Thank you, Leslie, and I hope that everyone can hear me. Our apologies for some technical difficulties throughout this webinar.
Note on the contact information slide that you see in front of you, if you're writing down our e-mail addresses, they all have an underscore between the first and last name.
And I would also like to encourage you to please ask questions. We have a few minutes remaining before the end of this webinar, so please use your question and answer chat window to ask us questions.
And just so that we know - we mention it again, we will be sending the summary of all the questions we receive and the answers to those questions along with the slides to all of you who attended this webinar.
Leslie: I'm sorry, Irina, are you going to answer the questions that are currently typed?
I. Bulkley-Hopkins: Yes, we will take some questions. What I'm trying to do is get the window with the questions, because I don't have one.
Leslie: Oh, okay. I'm sorry. I was wondering. Here we go. I'll get that for you. You should be able to pull them now.
I. Bulkley-Hopkins: Okay.
Leslie: Can you see them?
I. Bulkley-Hopkins: Yes, thank you.
Leslie: Okay. Just wanted to make sure you're good.
I. Bulkley-Hopkins: I do not seem to be able to expand that as we usually did in previous webinars, but - Karl, do you have access to the questions window?
Karl Berntson: Yes, I do. If you go up to the right-hand in the box, where there is an arrow and a little thing down in the bottom, undock it.
I. Bulkley-Hopkins: Right. That one doesn't work. So, do you mind?
Karl Berntson: Oh, okay.
I. Bulkley-Hopkins: - just taking care of the questions?
Karl Berntson: Well, I have the questions. Let me see what we have.
Oh, it says, I must have missed this. Can you say what MBE stands for? That's for minority business enterprise.
That's the only question I have. All the other thing has to do - no, there's one more.
I. Bulkley-Hopkins: With the technical difficulties, yeah.
Karl Berntson: Yeah. Have ESPCs ever been used for city municipal projects? Yes, it certainly has. There are numerous cities in the country. I obviously don't know all, because there are probably hundreds of them that have used the ESPC. So, that's very common.
I. Bulkley-Hopkins: What is Karl's accent?
Karl Berntson: What is Karl's accent? I'm Swedish.
I. Bulkley-Hopkins: Oh, I am so appalled. Nobody is asking about my accent? It's coming from Saint Petersburg, Russia, in case if anybody is wondering.
So, just a few more minutes, so that we can take care of any questions that you might still realize you have.
Karl Berntson: What is SRA? I don't even know what it stands for. It's the company that we now belong to. It's SRA International. And I cannot tell you what SRA stands for.
Can you define cost savings versus cost avoidance, especially in regard to savings paying for lease payments? In big term, there really is no difference. Some people look at cost savings as the immediate savings you get. Cost avoidance sometimes includes future avoidance. I will take a closer look and see if I can find a better definition and I will put that in writing either tomorrow or next week and get back to you.
Are ESPCs ever used for distributed generation and not just energy efficiency? There have been ESPCs where distributed generation have been part of the project. I don't think I ever seen one that it's just for distributed generation. But it certainly could be if the income from the generation was sufficient to pay for the overall project.
Are you - oh
I. Bulkley-Hopkins: Are you an ESCO? That was a question from one of the attendees. No, we're not an ESCO. We are a part of SRA International, as Karl mentioned. SRA International is one of the largest consulting companies in the world. It's an international consulting company with over 7,000 employees. It was contracted by the Department of Energy for providing technical assistance for ESPCs, in particular, and many other issues for EECBG and the state energy program grantees. So, that's what we do. No, we're definitely not an ESCO.
Karl Berntson: And the next one. What kind of loan terms ______ are available for ESPC municipal projects these days for investment grade and non-investment grade? And I do not have the answer to that. We will find the answer and that will get e-mailed to all the attendees in the next few business days.
And the next question is will community choice aggregation customers still be able to participate in all funding options? I know some rebates and municipal funding is only for customers of the three large utilities in California. I cannot answer that. I don't know what community choice aggregation is. So, we will need to investigate that and see if we can find an answer.
Can water pumping station upgrades be covered under an ESPC contract? And do you know of an average pay-back period if they can be incorporated? I don't know the pay-back period, but I know that water pumping stations and water treatment stations do very well under ESPCs. It obviously depends on what the total ECMs are. If it's just pumps, sometimes if you do either water or waste water treatment, you include filtering and that kind of treatment or upgrades to that. So, I cannot give you an answer on a typical pay-back period. But certainly there are numerous projects for pumping stations and water treatment and waste treatment stations.
Are there insurance products available to back up savings guarantees by ESCOs? Yeah, that's the one I mentioned on the cash flow, that was the letter of credit is used for. There is probably not a great need for that today, but the product is available. At one time, there were bonds available you could get. I don't think there are anymore. I believe there are insurance available, but I would recommend if you can get an irrevocable letter of credit from the company itself, as long as it's written, so you control, if you can draw on it. That's probably less costly. Sometimes, actually, it does not cost anything.
And the thing to watch if you are trying to get an insurance is to make sure you don't need to cover the total savings. You always know that there is some things that will be there. If you change your lights, the savings will be there. So, you need to look at how much of the total savings actually could be at risk and that's the part you should insure, not the total amount, and that just to reduce the cost for insurance product.
Is there additional training available on this topic? Hmm. We have not developed additional training at this point. We have discussed maybe having additional training in the spring. That is not set in stone yet, so we don't know that. But keep an eye on the Solution Center in the webcast tab and see what's coming up, and there is a possibility that we will do something more detailed on this topic.
To assist in writing answer, the cost avoidance question speaks to savings being a contractually defined term and the fact that baseline adjustment are used to normalize savings back to baseline conditions. Okay. We can include that in that answer regarding baseline adjustments. That is part of measurement and verification. We have not had a training session on that and we might. It's not determined either, but there might be one coming up next year.
Do you have experience on these topics from different countries around the world? If so, what can you tell about the differences were? And asked by Eric Huston. No. I do not have direct experience from across the world. I do keep up to a degree with what's going on specifically in Europe. And they are pretty much doing the same as we do here in United States. And there actually are one or two ESCOs operating both in Europe and in United States. So, there are no significant differences.
Can you use capital lease programs for lighting retrofits? My reaction is yes, but I need to take a closer look in that and we'll respond to that via e-mail.
Can you please explain the process in resolving disputes around performance savings and ESPC projects? How common are these disputes? I will probably answer that in writing, but briefly I don't think the disputes are very common nowadays. Say 10, 15 years ago, it was fairly common, but I don't see that today. We have very detailed and defined measurement and verification process in place that have been greatly improved over the last decade and that's the International Performance Measurement and the Verification Protocol and that's used across the world. So, as long as that is followed, there really should not be any reason to have disputes. The trick is for the owner to understand exactly what is in the measurement and verification procedures that are established for their specific projects.
Do you think today is a good time to start an ESCO? I don't know that I have an official opinion on that. I think there is a lot of work to be done in energy efficiency in mainly the local government markets and municipalities market. There still is quite a bit to do in the state governments. They have always been in the lead when it comes to ESPCs. So, I think that would probably be difficult to get into. But the local governments and municipalities, yes, that should be a growing market.
In general, what are the most effective ECMs today? That depends on how you look at it. A lot of people say lighting is the most effective. I always say do not do a lighting project by itself, because that's the shortest pay-back term ECM. If you do that by itself, then you can't use that later to help pay for some of the more difficult ECMs to implement. You should always do an ESPC as big as possible, include as much as you possibly can in one project. I don't know if that answers your question, Phil, but I hope it does.
And I think we need to end this session now. If you have additional questions, keep putting them in and we will answer them via e-mail. Thank you very much.