Performance Contracting for Accelerated Energy Efficiency

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					              Performance Contracting for Accelerated
                        Energy Efficiency


Dr. Antonio Capozza
Via Rubattino, 54
IT-20134 Milan, Italy

Dr. Hans Westling
Promandat AB
P.O. Box 24205
SE-104 51 Stockholm, Sweden

2nd Int. Conf. on Improving Electricity Efficiency in Commercial Buildings -


Energy Efficiency, Energy Services, ESCO, Performance Contracting, Procurement, Third Party Financing,


The objective of this collaborative project within the International Energy Agency is to facilitate the use of
performance contracts and other energy service company (ESCO) contracts. Many examples show energy
savings by 20-40 %.
Performance Contracting is a mechanism for promoting the installation of energy efficient building equip-
ment and systems. Facility owners and energy service contractors use this method to retrofit equipment to
save money on building operations. The savings in energy bills due to the installation of the more efficient
equipment is then shared between the facility owner and the ESCO under the terms of an agreement.

The eight countries participating in this work summarise the present situation in the individual countries.
Some countries have already a long experience (e.g. regarding contractual, legal or financing issues) and
can identify many lessons learned and suggest measures for further development of the mechanism. Other
countries will formulate their needs and barriers for the introduction and development of Energy Perform-
ance Contracting (EPC). All the countries will suggest actions, prepare country plans and facilitate
demonstration projects.

Innovation and relevance
Specifications in terms of performance criteria will encourage the contractors to develop and introduce
more efficient solutions, which will contribute to realising the climate and environment goals. This mecha-

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nism will be of special interest for organisations obliged by law to comply with energy saving targets, since
it allows them to outsource energy services to specialists, the ESCOs, with reciprocal advantages. Property
owners will have the opportunity to refurbish their facilities without spending investment capital.

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The country reports presented have already pointed out very interesting action areas. These include the
creation of guidelines for procurement and contracts, information activities (e.g. national/international
workshops, communications, etc.) and raising the awareness of the use of EPC-contracts through
government bodies leading the way with pilot projects. This will contribute to the enlargement of the
market for EPC-contracts.


The purpose of this collaborative project within the International Energy Agency (IEA) is to facilitate the
use of Performance Contracts and other Energy Service Company (ESCO) contracts. Performance Con-
tracting is a mechanism for promoting the installation of energy efficient building equipment and systems.
Many examples show energy savings between 20–40 per cent. Facility owners and energy service con-
tractors use this method to retrofit equipment to save money on building operations. The savings in energy
bills due to the installation of the more efficient equipment are then shared between the facility owner and
the ESCO under the terms of an agreement. The financing can either be by the ESCO, by suppliers of the
systems or components, or by an outside party – or in different combinations. Leasing arrangements can
also be considered. Different problems and barriers have reduced the introduction and wider spreading of
this method. A collaborative project within the IEA Demand-Side Management (DSM) Implementing
Agreement - Task X Performance Contracting - has started with eight countries participating: Finland,
France, Italy, Japan, The Netherlands, Norway, Sweden, and the United States. Valuable experiences have
also been received through collaborative actions within earlier IEA projects (Westling, 2000).


The objectives of Task X are to:
    Facilitate the greater use of Performance Contracts and other Energy Service Company (ESCO)
     financial options and services in the participating countries.
    It is a business-to-business task, limited to efforts involving the Performance Contracting Agreements
     and other ESCO related financial options and services between client, businesses, and all types of
     companies offering these services.
In short this is a mechanism introducing “payment in relation to performance”.

3.     MOTIVES

There may be different motives for choosing a Performance Contract:
    For some facility owners and users the main reason can be lack of investment capital.
    For others it is a simple economical business strategy. We only pay when we see value-added
     functions, such as reduced energy bills.
    For ESCOs it is a good business argument, and a way of connecting with customers and starting new
     business relations.
    For some companies and government organisations it can be a very efficient way of inspiring
     innovation and facilitating introduction of more efficient solutions.

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    Spreading of the use of Performance Contracts to more markets.
    Joint multinational IEA projects contribute to an expanding international market for Performance


The participating countries summarise the present situation in their respective countries. Some countries
have already long experience (e.g. regarding contractual, legal, or financing issues) and can identify many
lessons learned and suggest measures for further development of the Performance Contracting mechanism.
Other countries will specify needs and barriers for the introduction and development of Energy Per-
formance Contracting (EPC). All countries will suggest actions, prepare country plans or “toolboxes for
national activities”, and facilitate demonstration projects (IEA Task X, 2002).
Different stakeholders - property owners and contractors, financiers, legal specialists, and people specialis-
ing in benchmarking, measurement and verification issues - have been invited to meetings and workshops.
The country experts have raised questions to these stakeholders have received comments from them. They
have also been invited to meetings. Analysis of written material and comments received during meetings
and interviews has formed a background for country reports.


There are of course important limitations for the findings in the reports. The results are based to a large
extent on experience of the current situation in the participating countries. The situation differs to a large
extent between countries. Some have large experience of Performance Contracting work, as for example
the United States, while others have only been working with Performance Contracting arrangements during
shorter periods and have both good and bad experience. Finally, the introduction of this method has just
started in some countries, but they find it valuable to prepare for the ongoing deregulation and privatisation
of the energy market. The limited experience in countries in transition and developing countries is also an
important limitation. Efforts are being made to expand Performance Contracting to some of these markets,
where a keen interest has already been noticed (IEA/CTI, 2001). The method has partly been used in
Poland, Brazil, the Czech Republic, and Hungary for instance. Important influence on the work has also
been received from some countries that are not formally participating in Task X as Austria, Germany and
the United Kingdom (WEEA, 1999, Papousek, 1999, BRECSU, 2000).


The countries have agreed to use certain definitions and some examples are given here. Performance
Contracting Arrangements means all business-to-business legal arrangements between a property owner
and an energy service company. In these arrangements, the investments in more efficient and better
performing systems are financed, totally or partly, by another organisation than the owner and paid back
during a period of years after the commissioning of the systems in relation to the actual performance of the
systems or the whole new, or refurbished building.
An Energy Service Company (ESCO) is defined as a company engaged in developing, installing and
financing comprehensive, performance-based facility improvement projects, typically 7-10 years in
duration, centred around improving the energy efficiency and reducing maintenance costs for facilities
owned or operated by customers (NAESCO, 1997). The cost savings achieved by the energy efficiency
measures implemented are used to pay for the project. Performance requirements distinguish ESCOs from
consulting engineers, specialising in efficiency improvements. They are typically paid a fee for technical

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advice and do not assume the risk. Their recommendations will yield actual cost savings or energy
consumption reductions.
Third Party Financing (TPF) is in this context regarded as the same as Energy Performance Contracting.


7.1    Fundamental areas

Fundamental services that always are included are illustrated in Figure 1.

Fig. 1. Fundamental services, or core areas, in Energy Performance Contracting.

These services include several frequent technical areas, such as installation of more efficient air distri-
bution systems, boilers, chillers, or better control systems. It can also be lighting and HVAC products and
services. There is always a guarantee of performance of some kind included, as well as measuring and
monitoring of energy during shorter or longer periods before and after the upgrading. One key issue is to
what extent the financing also is the full responsibility of the ESCO or the owner. This is described more in
detail below. The material collected in the different country reports show a whole range of different
services that may be included in EPC. There is a general tendency among Energy Service Companies to
expand into additional service areas, such as for example technological and advisory services and
operation and maintenance.

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7.2   The process

The process differs somewhat between the countries, especially whether or not an introductory energy audit
is made by the owner, sometimes in collaboration with an energy agency (and to some part subsidised) or
initiated by the contractor. The most frequent stages of the Energy Performance Contracting process are
illustrated in Figure 2.

Fig. 2. The most frequent stages of the Energy Performance Contracting process.

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7.3    Different financing and responsibility

There are two important alternatives with different responsibility for the customer/property owner and the
ESCO as illustrated in Figures 3 and 4 below.

                                     Shared Savings
                                             C u s to m e r

                                               “ E SC O ”
                                           P e r fo r m a n c e &
                                              C r e di t R i s k

            P r o j e c t S e r vi c e s                              L e n d e r / In v e s t o r
          S a vi n g s G u a r a n t e e                              1 0 0 % F u n di n g

Fig. 3. Shared Savings (from the U.S. Country Report).

                                 Guaranteed Savings
                                              “Market Risk”


                               Savings                                    Fixed
                             Guarantee                                   Schedule

                       ESCO                                              Lender/Investor

              “Performance Risk”                                              “Credit Risk”

Fig. 4. Guaranteed Savings (from the U.S. Country Report).

Shared savings means that the ESCO takes the performance as well as the credit risk, and guaranteed
savings means that the customer takes the credit risk and the ESCO carries the risk for the savings
guarantee. There are also other different guarantees used in some cases, for example a guaranteed energy
price, a sort of continuous delivery of the cheapest source, or a security of supply in some areas. Some
examples of models for contracts and financing are shown in Figure 5. There are different situations
concerning the financing possibilities: self-financing, debt-financing, or third party financing. This is
currently described, especially in the U.S. report, and will be looked further into during the future work.

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Fig. 5. Examples of models for contracts and financing.


The countries have identified a number of problems or barriers. Below are some examples of such barriers.
    Slow movement from buyers.
    Lack of understanding of the opportunities.
    Lack of information.
    Time-consuming work for
     – raising interest in general – formulation of contracts – measurement and verification.
    Lack of public recognition - positive attitude and culture.
    Lack of generally accepted procedures for EPC projects.
    Procurement rules (absence of bidding system).
    Lack of General Conditions.
    Lack of technical experts.
    Lack of capital.
    Different responsibilities for investment and operation.
    Low energy prices.

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At a different level of detail, barriers for engaging ESCOs often exist as a consequence of end-users'
management difficulties, such as:

    Impossibility of having an independent expenditure budget.
    Difficulties in finding and organising data on energy consumption and expenditure.
    Limited time available for the organisation’s energy manager, who has often been given that role as an
     addition to his main function.
    Problem of roles overlapping between the energy manager and other external energy operators.
    Lack of motivation, at the root of which there is a scarce interest in the topic of efficient use of energy
     resources combined with the uncertainty concerning in which budget the energy costs will, in the long
     run, be covered.

From the ESCO viewpoint, some barriers, which discourage ESCO operation, follow from:
    Insufficient knowledge of the specific problem and suitable contractual procedures.
    Too low profits expected compared with the risks envisaged.
    Legal barriers connected with bureaucratic difficulties in coping with public administrations' tenders.

As for this last item, it should be remarked that regulations govern "procurements of services" and "pro-
curements of related works" in quite a different way (in different Public Procurement Directives). In
particular, the former case (more suitable in principle for ESCO contracts) foresees much more straight-
forward tender formalities and procedures, as well as less severe requirements of the candidates. However,
the atypical nature of the EPC contract (a mixed one: procurement of service + work) brings about diffi-
culties on how to interpret and apply the law.
The lack of guidelines supporting the decision-making process is stressed as an important barrier in an EU
study about Third Party Financing (E.V.A, 2000).


The substantial energy savings received have been identified as the most important opportunity when using
this mechanism. Cases studied show examples of up to 50% savings. A U.S. NAESCO report points at
median savings of 23% of the total electric bills for a large number of projects studied (Kogan, 2002).

Advantages of the EPC/TPF procedure can be:
For the ESCO:
    Profit.
    Growth and diversification.
    Synergy with other own activities (apart from possible conflicts of interest).
    Law incentives.
For the end-user:
    More rapid implementation.
    Transfer of management responsibility to the ESCO.

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   Better quality and reliability of the service received.
   Savings.
   Improvement of indoor conditions.
   Outsourcing of non-core-business activities: e.g. this allows a public administration to give lower
    priority to accessory or ancillary activities with respect to the main one(s), with the advantage of
    guaranteed service supply and savings.
   Updating of plants to standard.

Particular advantages in using the EPC/TPF procedure are envisaged when the end-user is a Public
Administration (PA) (Capozza, 2001, Baretti, 2002).
From an administrative viewpoint:
   A single procurement procedure performed against a number of different procurements (design,
    installation, fuel supply, management, maintenance, etc).
   Resources for an investment plan for energy efficiency derived from the ordinary budget for energy
    costs (the availability of which is generally beyond dispute).
   Administrative simplifications attained through outsourcing of energy services and devolution of
    relevant responsibility to the ESCO.
From a technical viewpoint:
   Possible technical/management shortcomings of the PA in the energy field can be overcome.
   Technical risks relevant to interventions and management of the energy services are transferred from
    the PA to the ESCO.
   Warranty on the service quality is obtained, connected with the efficiency conditions which the ESCO
    is bound to assure in its service, under penalty of economic damage.
From a financial viewpoint the EPC/TPF procedure will:
   Overcome the problem of chronic lack of budget for project financing, which is typical for public
   Allow the PA to route financial resources (already available on capital account) towards other kinds of
    investments, more relevant to their corporate calling.
   Allow the PA to implement their plan of refurbishment at a lower cost, owing to the stronger
    bargaining power of ESCOs in the market of energy technologies and products.
   Allow the PA to gain immediate economic savings with respect to the historical costs, against no direct
   Grant the PA to take over the energy efficient devices and plants included in the ESCO supply service,
    upon expiration of the contract.

One estimate has put the market size to 70 billion Euro per annum. In order to achieve such a market, other
services supplied in combination with energy savings will be essential and necessary components in ESCO
offers to their customers (Lambert, 1999).

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10.    ACTIONS

A number of actions, including different government policy initiatives, clarifications of legal framework,
information, etc, have been identified in order to build up trust, see Figure 6.

Fig. 6. The EPC Process: Problems – Actions - Results

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The European Commission has taken actions in the communication on the implementation of the first phase
of the European Climate Change Programme with initiatives and proposals for directives, such as:
     Proposal for a Framework Directive for Minimum Efficiency Requirements for End-Use Equipment.
     Proposal for a Directive on Linking Project-based Mechanisms including JI and CDM to EC Emissions
      Trading Scheme.
     Proposal for a Directive on Energy Demand Management.
     Initiatives on increased energy-efficient public procurement.
The new Proposal for a Directive of the European Parliament and of the Council on the Promotion by
Energy Suppliers of End-Use Efficiency includes among others new services and programmes, energy
audits, EPC, TPF and other market-based financial initiatives.
The use of performance criteria has been observed by CIB, the International Council for Building Research,
at congresses and in projects (Westling, 2001, CIB, 2001).


Specifications in terms of performance criteria will encourage contractors to develop and introduce more
efficient solutions, which will contribute to realising the climate and environment goals. The EPC mecha-
nism will be of special interest for organisations, obliged by law to comply with energy saving targets,
since it will allow them to outsource energy services to specialists, ESCOs, with reciprocal advantages.
This is the case in Italy, where recent legislation compels electricity and gas distributors to perform energy
efficiency measures which are associated to tradable energy efficiency certificates and which can be
outsourced to ESCOs. Through this mechanism, ESCOs find a supplementary chance for incentives and co-
financing (and further drives for their operation). Finally, property owners will have the opportunity to
refurbish their facilities without spending investment capital.

The project is ongoing and its next Experts Meeting will be held in Italy in June 2002. Then especially the
procurement guidelines will be discussed in order to find out how the EPC model can fit into existing
public procurement regulations, such as the WTO Agreement on Government Procurement, the European
Procurement Directives and existing rules in Japan and the United States. All the countries see the role of
one large government or public organisation as crucial which can take the initiative and show good morals
and examples for the further use of Performance Contracting arrangements. It will be very important when
the trading of certificates will be further introduced as an important instrument for the in time changed


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