WHEN the city of Brea, Calif., about 25 miles southeast of Los Angeles, set out to reduce its carbon emissions and save money on energy costs, the challenge was the same faced by many other cities nationwide: allocating the funds to pay for the program.
Finding projects to make city buildings more energy efficient was far easier. So the city turned to a form of financing that has become common among government agencies at all levels: an energy-savings performance contract that requires no upfront costs and allows the city to pay for the project over time using the savings on utility bills.
“There is no other way we could have undertaken this scope of project in this efficient a manner or time frame,” said Charlie View, Brea’s director of public works. The project included installing high-efficiency lighting systems in 14 city buildings and 4,000 street lamps, updating heating and cooling systems at six buildings and installing 1.8 megawatts of solar panels at three sites.
An energy service company, Chevron Energy Solutions, a unit of the Chevron Corporation, performed all the work and provided all the new equipment. The company’s contract with the city guarantees the project will deliver a certain level of savings on energy costs. If the project fails to perform to the guarantee, the energy service company is on the hook to make up the difference. If savings exceed the guarantee, the city keeps the excess.
The project, completed in 2011, is expected to save the city 40 percent on energy costs and $13 million over the next 25 years. Performance shows the project is exceeding these estimates by about 10 percent, said Mr. View. From the savings, the city will pay off two bonds issued to finance the project; the payback period is about 20 years, which is common for these types of projects.
The business model and performance-based contracting offered by energy service companies are not new; the market began to form in the early 1980s after the energy crises of the previous decade, which saw prices rise drastically. Today, about 35 large energy service companies offering contracts with guaranteed savings as their core business model dominate the market, according to the National Association of Energy Service Companies, a trade association.
What has changed is the growing appeal of the model among public entities. Now, 80 to 90 percent of energy service company revenues come from projects with municipalities, public universities and schools, hospitals and federal government agencies.
“Most public facilities in most parts of the country are starved for any kind of investment for improvements,” said Don Gilligan, the trade association president. Many of these aging buildings are wasting 25 to 35 percent of what they pay on their energy bills, he estimated.
“A performance contract allows them to redirect the money they currently spend on wasted energy to pay for the capital cost of an improvement with no tax increases,” he said. “That is a very big payment stream and a very attractive driver for public institutions.”
At the federal level, since 1998, 25 agencies have used performance contracts on about 580 projects, saving $13.4 billion and enough energy to power a city of 900,000 residents for a year, according to the Federal Energy Management Program.
Wide use of performance-based contracts has also required a reworking of purchasing policies for public agencies. Long-term agreements with vendors were outside the bounds of traditional procurement rules, so legislation authorizing the use of performance contracts for federal agencies was enacted as part of the Energy Policy Act of 1992. Now almost all states have passed similar legislation.
Unlike some aspects of energy policy, the legislation has generally received bipartisan support, said Charles H. Goldman, a senior scientist at Lawrence Berkeley National Laboratory in Berkeley, Calif., who has studied the market since 2000. The energy service company market “is an example of a successful private sector industry that is relatively self-sustaining and doesn’t rely on a lot of incentives or subsidies outside the basic economics of these projects,” he said.
Today, energy service companies account for 10 to 15 percent of the jobs created among companies that provide energy efficiency improvements, and many of these jobs are local, Mr. Goldman said, because there “are often provisions in the contracts that strongly encourage the use of local small businesses as subcontractors.”
Still, performance-based contracts are not suitable for every market, every project or every type of building, said Brittany Gibson, an analyst with Pike Research, an energy research and consulting company — notably for residential or private commercial property owners, for a variety of reasons.
In the commercial sector, the hurdle is often the so-called split-incentive problem, she said. Renters in commercial buildings typically pay their own energy bills. This reduces the incentive for building owners to commit to long-term contracts to pay for energy-efficiency improvements because the owners do not benefit from the savings.
Yet in the public sector, opportunity abounds, she said. Based on a study completed this year, Pike Research is expecting the energy services market to grow annually by 11 to 14 percent through the end of the decade, reaching an estimated $13 billion to $16.5 billion by 2020.
Driving this growth, said Ms. Gibson, are federal and state policies that set aggressive energy conservation goals for their buildings. At the same time, she said she expected capital budgets for such projects to remain tight.
In 2007, for example, Congress passed a law requiring all federal agencies to improve the energy efficiency of their buildings 30 percent by 2015. And in December 2011, President Obama directed agencies to spend $2 billion on energy efficiency projects through the end of 2013, specifically using performance-based contracts. Suitable projects should be easy to find; federal agencies occupy nearly half a million buildings.
This article has been revised to reflect the following correction:
Correction: October 29, 2012
An article on Wednesday, about the popularity of energy efficiency programs guaranteed by utility companies, misstated the origin of a mandate on energy use in buildings that house federal agencies and described the mandate itself incorrectly. The mandate requires a 30 percent increase in energy efficiency by 2015, not a 30 percent reduction in energy consumption by that time, and it resulted from a law passed by Congress in 2007, not an executive order signed by President Obama in 2009.
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