by C. Baird Brown

Energy service companies (ESCOs) are often capable of doing more than they initially offer to do. In working with ESCOs over many years, on behalf of governments and governmental agencies operating energy efficiency programs, we have developed what we feel are best practices for contracting with ESCOs. Some of our experience works best in pooled financing programs where the collective procurement process gives more leverage to the governmental agency, but much of it makes sense in any performance-contracting context.

Procurement rules applicable to governmental entities vary widely by state, but many states have adopted performance-contracting statutes that allow more flexible procurement processes for energy savings performance contracts. Where it is permitted, a request-for-qualifications process before an audit is conducted is valuable whether on a pooled basis (leading to a qualified pool) or for an individual customer. The agent or customer can specify in advance the contract terms and other matters that ESCOs must accept to participate (or else make their objections known in advance). Once selected, an ESCO should provide a preliminary audit for free, and if a governmental customer agrees to proceed, the investment-grade audit should also be free unless the customer elects not to enter into a performance contract after receiving an investment-grade audit that provides at least 90% of the savings promised in the preliminary audit.

Selection of energy-conservation measures should be based on potential measures identified in the audit, estimated escalation of energy prices, and expected financing costs. The program or the customer shouldselect the escalation rates for electricity, gas, or other commodities conservatively, but not so conservatively as to eliminate measures reasonably likely to pay off over time. ESCOs sometimes advance very high estimated rates that make almost any savings measure look good. The test (which is explicitly required in some state statutes) should be whether the selected measures will save more each year than the installment payment for that year needed to retire the financing. For measures with long lives, longer-term financing makes deeper retrofits possible. The interest rate for the financing should be explicit, whether from third parties or the ESCO. Pooled financing can often be more efficient than individual financing, and an individual customer should always explore third-party financing options.

The selected measures should be embedded in a fixed-price, fixed-schedule contract, with payments made subject to completion of auditable milestones reviewed by the customer. Following completion, most customers prefer to operate their own equipment, but the ESCO will want to conduct ongoing measurement and verification (M&V) activities as a condition of its guarantee. Only directly verifiable energy savings should count toward the guarantee even though the customer may also recognize operational savings or avoid deferred maintenance costs. The ESCO should agree to use the M&V process as a diagnostic tool, and seek to revise or add additional measures to meet the dollar guarantee.

A well-structured energy savings performance contract should reduce all-in energy costs and serve as a source of credit strength to the customer.

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C. Baird Brown is a partner in the firm’s Environment and Energy Practice Group. His practice includes the development and financing of electric generating facilities, waste disposal and recycling facilities, water and wastewater facilities, and other infrastructure projects. Baird currently focuses on renewable energy, energy efficiency and sustainable infrastructure. He can be reached at 215-988-3338 or