Read the other article in this series: An alternative to performance contracting and Risks of performance contracting.
Updated April 8, 2019. Originally published June 1, 2017.
Performance contracting is a partnership with energy and utility contractors for energy efficiency projects. The contractor typically finances the project and is paid from the resultant savings.
It is both convenient and complex. And this complexity has impacts on the bottom line.
K-12 school districts can take advantage of performance contracting to finance large energy efficiency projects – a convenient option when capital funds are not available for facility upgrades. But the complexity of the contracts and the time required for staff to manage the ongoing relationship with contractors can dampen the energy efficiency gains.
Performance contracting can seem to be a convenient approach to energy efficiency, but other options may offer better returns in investments and energy savings.
What is performance contracting?
As covered in a previous blog post, performance contracting (or energy service contracting) is an approach to improve energy efficiency or reduce consumption through a special partnership with a contractor. The performance contractor typically finances a project and is paid back over a period of time through the resultant savings of the project.
Most performance contracts are undertaken by energy service companies (ESCOs). Canada has a relatively long history of forming energy service companies – a 2001 survey of energy service companies in Canada found the first company formed in 1982 and the total value of projects in 2001 was upwards of $100 million USD. Most energy service companies around the world were started in the 1990s (1).
Rede prefers to use an energy management approach instead of performance contracting – read more about K-12 school energy management in a post by Rede CEO, Matthew Redekopp. Rede works with K-12 school districts to save energy and money through an ongoing process of reviewing and improving energy efficiency. K-12 school districts invest in energy efficiency and reap the rewards.
Performance contracting can cost more
Financing is a core part of performance contracting. The resultant savings from an energy efficiency project pay both the costs of the project and to finance the investment.
In the end, performance contracting projects can cost compared to self funded projects.
A 2004 Government Accountability Office report to the United States Senate (4) compared the costs of six performance contracts with the projected costs if the projects were self funded. The performance contracts costed more in every case. One performance contract for a federal courthouse had 54% higher costs compared to self funding the project.
| Project | Term | Cost of up-front financing | Cost of performance contracting | Percentage increase |
|---|---|---|---|---|
| Navy Region South West | 10 years | $13.66 | $14.69 | 8% |
| Patuxent River Naval Air Station | 20 years | $4.33 | $5.77 | 33% |
| Naval Submarine Base Bangor | 9 years | $4.33 | $5.34 | 23% |
| GSA Gulfport Federal Courthouse | 17 years | $1.60 | $2.50 | 56% |
| GSA North Carolina bundled sites | 19 years | $1.39 | $1.93 | 39% |
| GSA Atlanta bundled sites | 20 years | $6.15 | $7.78 | 27% |
Cost analysis of six performance contracts from a 2004 Government Accountability Office report (4)
The economics of performance contracting
With a history lasting well over 30 years, energy service companies have been around for good reason. Projects can be outsourced to companies specializing in energy efficiency and they have the potential to offer a return from a limited investment. They are treated as a service instead of a commodity.
A 2005 review of the economics of energy service contracts (2) found these contracts will be practical when “the expected reduction in the production cost of supplying energy services can more than offset the transaction cost of negotiating and managing the relationship with the energy service provider.”
Calculating production and transaction costs is a multifaceted economics analysis and specific to every contract – it is much easier said than done.
“A challenge for both business strategy and public policy is to identify those situations in which energy service contracting is most likely to be appropriate and the conditions under which it is most likely to succeed.”
As such, determining if performance contracts are the ideal approach for individual projects is not always clear – they are one approach out of many to finance energy efficiency projects.
“The model suggests that, while energy service contracting may have an important role to play in a low carbon economy, a wholesale shift from commodity to service supply is unlikely to be either feasible or desirable.
“Contracting may only be appropriate for a subset of energy services within a subset of organisations, and is particularly unsuitable for final energy services at small sites and process-specific energy uses at large sites.”
This complexity is a cloud of uncertainty in your energy efficiency decisions.
Performance contracts in practice
A 2005 government study by the United States Government Accountability Office (3) looked into 20 agencies that undertook 254 performance contracts between 1999 and 2003. The energy savings over the life of the contracts were estimated to be at least $2.5 billion USD.
The contracts resulted in energy savings, but the benefits of performance contracting are put into risk by the complexity of the contracts and a lack of competition.
The Government Accountability Office “identified concerns in the areas of expertise and related information and competition that are fundamental to ensuring that savings cover costs and to protecting the government’s financial interests in using ESPCs,” stated the report.
“According to agency officials, they often lacked the technical and contracting expertise and information (such as interest rates and markups) to negotiate ESPCs and to monitor contract performance in the long term. The officials also think there may be insufficient competition among finance and energy services companies and that this could lead to higher costs for ESPCs.”
A 2004 Government Accountability Office report to the United States Senate (4) concluded “it is uncertain whether using partnerships is more or less expensive than using up-front financing.”
Private organizations that carry out performance contracts may have fewer costs through less bureaucratic processes, but that is offset by a lack of access to inexpensive financing options.
Performance contracts have the potential for both energy savings and cost savings, but vigilance is required before – during and after a contract is created.
What makes sense for your school?
A key to maximizing the benefits of performance contracts is understanding the economic benefits of a particular contract and comparing that to the alternatives.
Every contract is different and school administrators and facility managers can’t be expected to know the complete details of performance contracts and energy efficiency projects.
An extra set of eyes can go a long way to ensure a performance contract meets the needs of your school and has your best interests throughout the entire agreement. Rede Energy Solutions can help review performance contracts at any stage of a project – from initial proposal to ongoing measurement and verification. Let us help you ensure you get all the savings.
If you’re looking for a better option than performance contracts, an energy management program could be that solution. A good place to start is explore how much energy your school district could save compared to other districts in your province. Fill out the K-12 school energy consumption calculator to find how much energy your district could save.