ESCO 2.0 And Your Next Project
While each element of the energy equation is important, questions immediately start to arise such as:
• How do I prioritize ECMs?
• How do I finance?
• What if I choose a dead-end technology?
• How does this all get integrated?
• How do I differentiate between vendor A and vendor B?
• How do I avoid getting locked in to something that does not perform?
These are just a few of the considerations important to the stakeholders responsible for finance, operations, energy procurement, labor negotiations, risk and life safety, contract management, and other departments in facilities that influence and drive decision making .
As every facility manager knows, without an adequate operating budget, it isn’t possible to maintain buildings and equipment. Hand in hand with the operating budget is capital, which is hard to accumulate in this economic climate, and which must be available to renew and upgrade infrastructure. In this complex environment, building owners are constrained but open to proven business models that can have positive impacts on both budgets. Using traditional channels, the justification and approval process to get funding is a time-consuming and multi-hoop endeavor, even in the best of times. Elevating a typical building to “high performance” is an even more complex undertaking that requires sophisticated interoperability between dissimilar equipment and systems.
A basic dilemma faced by owners is choosing between maintaining a legacy system and moving to high-performance technologies to replace equipment. The economics that support this decision-making process are not as clear or well defined as the simple ROI we are all used to: efficiencies and avoided costs after project installation equals savings that pay for the project.
When the concept of the smart grid is introduced, the issues around justifying expenditures increase. When renewable energy and distributed generation resources become part of the project equation, the complexities around financial modeling become exponential. When multiple vendors only offer slices of the project, the price and cost of aligning the vendors can quickly outweigh the benefits.
Accordingly, a number of companies that serve this space are looking at providing more end-to-end solutions and are starting to offer software and hardware applications to provide more solutions for a customer’s energy chain from supply-side strategies selling energy to demand-side management efficiency and capital asset management. With all of these options, the questions become who is the prime vendor, what technologies do we use, how does this all fit together, and how are we going to pay for it?
In terms of a business model focusing on implementing efficiency, renewable energy resources, and financing vehicles for capital upgrade projects, the energy service company (ESCO) model is seeing a resurgence among building owners. This is particularly true for owners who have scarce capital and marginal credit ratings. That said, energy services is a broad topic and includes a wide range of offerings, but at its heart, the model entails a combination of three critical elements. Those elements are engineering self-funding energy measures; financing based upon a revenue stream (typically from savings that are calculated and, in some cases, guaranteed; and implementation. During this time of continuing stress on capital project funding, energy services is seeing an evolution in its financing optionalities, beyond the “plain vanilla” versions, increasingly towards what is becoming known as ESCO 2.0.
ESCO 2.0 is a variation on the proven theme that has been called performance contracting over the past three decades. The “2.0” is an outgrowth of Web 2.0, which, according to Wikipedia, “is a loosely defined intersection of web application features that facilitate participatory information sharing, interoperability, user-centered design, and collaboration on the World Wide scale.”
With ESCO 2.0, access to the web is critical, but the “application features” in this case are designed to access new revenue streams and create larger and more exciting capital projects. So the ESCO 2.0 phenomenon seems to be upon us, and forward-looking companies have embraced it by incorporating smart grid and DR strategies to tap into positive cashflow revenue stream that is creating a 2.0 self-funding matrix. ESCOs are those organizations that specialize in delivering this model, but of course, all ESCOs are not created equal.
This article is intended to reacquaint the reader with the complex topic of energy services, and to cover some of the evolution that has occurred in recent years. If the reader has not kept abreast of those changes, it is time to do so, because it could make the difference between go and no-go on your next project. We will revisit the history of energy services or performance contracting, address current ESCO best practices and describe the next generation ESCO 2.0 models that are a best-kept secret.
Energy services may be one of the most exciting concepts to hit the energy and buildings business over the last several decades. Yet this business model, and the industry that it spawned, has experienced many transitions over that time. Recent studies of performance contracting, combined with general observations of trends, indicate that many projects are doomed to languish without it.
Equally important, energy services is poised for a next wave that will be characterized by broader forms of both technology applied and financing approaches. Integral to these new elements will be traditional efficiency coupled with DR using the OpenADR Standards to leverage more smart grid functionality, which will contribute more dollars to the financing pool. Before exploring all of these developments, however, it may be helpful to revisit the origins of this model.
Energy services seems like a timely topic, but the model itself has been around for decades. This method of implementing energy and capital into projects originated in Europe after World War II, when it was called “chauffage,” which means “heat” in French. At that time, the idea was to address two major challenges: the need to rebuild and renew capital infrastructure that was ravaged during the war years, and the need to control astronomical energy costs for building owners. Chauffage was a solution that provided building owners with energy sources, delivered by a third party that turnkeyed the engineering, facility management, and financing for projects. At the same time, the model provided entrepreneurs with the opportunity to convert the risk associated with building renewal into a viable business opportunity. The term win-win could be used because building owners got problems fixed, investors made money, and the workforce got jobs.
The concept of energy services or performance contracting came to the U.S. in the late 1970s under the name “shared savings.” Shared savings is a concept that has seen some resurgence recently, in the form of power purchase agreements (PPAs) for renewable energy. Uncertainty in the energy markets, impacted by dramatic changes in oil/gas supply and energy price drops in the mid-1980s, resulted in changes to the model. Price volatility let the industry to decide that it would exit the business of speculating on energy futures and focus on engineering self-funding projects. As a result, the energy-services model developed, sometimes referred to as performance contracting. This is usually where a story reads, “and the rest is history.” However, that’s not the case for performance contracting because new electricity programs from rebates to DR are positioning the industry to enter new territory.
A key point with performance contracting is that ultimately the limiting factors are energy cost and the enabling legislation in a particular state. (Readers who want to learn more about enabling legislation in specific states may start by visiting www.dsireusa.org and clicking on the states of interest.) Critical aspects of the legislation, such as the term (some number of years) that is enabled for such agreements and the types of energy measures that are allowed, will define the technologies that can be implemented. By the same token, the local cost of energy (particularly electricity) and the presence of utility rebates are also keys.
In addition to the site above, there are a number of other sites containing a wealth of information available over the Internet. Two websites that include great data on performance contracting are the National Association of Energy Service Companies (NAESCO), www.naesco.org/index.htm and the Energy Service Coalition (ESC) www.escperform.org/. NAESCO, the major ESCO trade association, operates a website offering information to better understand the process, the pitfalls and answers to many other questions. All three offer web resources and sponsor seminars throughout the year.
The ESC is a national nonprofit organization composed of experts from wide-ranging organizations working at state and local levels to increase the number of building energy upgrades completed through performance contracting. This organization also offers sample documents like requests for proposals or performance contract documents. The ESC website also has list of providers and other industry professionals. The LBNL study also has good basic information and it may be downloaded at http://eetd.lbl.gov/ea/EMS/EMS_pubs.html.
THE NEXT WAVE
The adoption of IT-related nomenclature to describe next generation buildings represents awareness that buildings are huge consumers of energy, particularly electricity. Among many important data points is that buildings make up as much as half of U.S. electricity consumption. The Energy Information Administration (EIA) puts buildings at 17% of overall U.S. energy consumption, but buildings alone account for 35% of electric consumption, thus the building industry is very important to electricity companies.
On the flipside, EIA data also indicates that electricity represents 75% of the energy bill for commercial buildings and presents some real impact on occupants in a number of ways. According to EPRI, power outages decimate productivity costing U.S. businesses $80 billion per year and detract from comfort and environmental safety by interrupting HVAC.
Targeting the energy-cost metric, the first ESCO wave completely focused on efficiency and third-party financing, but this next iteration will address new funding opportunities from the other side of the meter. Mc Gowan coined the term “electricity capital” to address this new category of funding opportunities. Electricity capital is relatively new as electric utilities across the country are creating all sorts of mechanisms to promote implementation of buildings energy projects. There are a host of drivers, including renewable portfolio standards, commission mandates, forecasts that predict electricity demand to grow as economic recovery unfolds, etc.
One example is that a number of utilities, both electric and gas, offer on-bill financing for efficiency projects including BAS. Quite simply, the building owner may be able to finance a building automation or other efficiency measure on the utility bill. Similarly, property-assessed clean energy (PACE) has been reborn offering funding to building owners for such improvements by increasing their property tax. These programs, along with a resurgence of interest in energy, coupled with scarce capital from traditional sources, have led to more alternative financing models like energy services.
Many ESCOs are teaming with smart grid and utility rebate experts to provide turnkey solutions. Of course many building automation manufacturers are already ESCOs, but more contractors are also adopting this model all the time. At the heart of all these new trends sit smart building technology and cloud-based software applications; they enable the building to save more and fund projects, as well as to perform analytics that are necessary to validate the performance.
Electricity capital also programs like DR that pays customers to respond to curtailment events through deployment of strategies in the BAS to shed load. OpenADR is the standard developed at the well-known Lawrence Berkley Labs, but exhibitors at far-ranging events including AHR Expo, Niagara Summit, Realcomm/IBcon, and the World Energy Engineering Congress are touting their ability to integrate OpenADR into BAS just like BACnet or LON. Some manufacturers provide pre-programmed DR algorithms, working with customers to deploy DR creating a revenue stream to fund a BAS.
One DR provider has completed projects with multi-location customers that are paying for DR enablement and a new BAS with electricity capital. Under this model, the owner gets technology installed with no upfront cost and is able to finance the deployment and repay it through DR payments from the utility over time. Stay tuned, because electricity capital will grow to include a wide range of additional funding mechanisms for the savvy owner and provider.
With ESCO 1.0, no one disputes that efficiency investments made by building owners are “bankable” and cost-effective. These investments also help utilities with only one of their two concerns. When considering electricity, there are two important topics: energy use and energy demand. Efficiency helps utilities with energy use, and it makes sense to optimize building energy consumption because it reduces operating cost.
Electric demand growth and emerging electricity markets present new utility concerns, and most building owners are unaware of the financial benefits they can offer. Those managers with graying temples remember demand limiting, etc., from the 1980s, but that is just part of the story. It is a shock that 25% of the multibillion dollar electric infrastructure (power plants, transmission and distribution lines, etc.) exists to keep the lights on for just ~100 hours/year of peak demand. That’s because the monopolistic electricity business model traditionally sets one price for units of power, $/kWh, no matter when it is consumed. The demand charge, $/kW, is applied to commercial bills, but that does not begin to match wholesale electric price volatility before, during, and after periods of peak electric use.
ESCO 2.0 is about tapping into fees that utilities are willing to pay the owner for developing strategies to support the utility in keeping the lights on. ESCO projects have typically generated two types of savings: energy and O&M. The 2.0 generates a new type of cashflow that is not “savings” but “income.” DR is an early example of this income that has been widely embraced, but that is just the beginning. Utilizing the same technology that has been put in place to enable DR, many electricity users have begun to offer capacity back to the grid at peak times… for a price. The price is income. In summary, these income strategies combined savings strategies can create the opportunity for larger and more exciting ESCO projects
A key point that can be overlooked here however is that the 2.0 in ESCO 2.0 is first an indicator that this is truly a next-generation business model. Central to this model, however, is also the deployment of next generation technologies. ESCO 2.0 will provide a mechanism to achieve smart buildings, and with the energy techno-strategies deploy by local and cloud based technology, the building with be an energy profit center by participating in both efficiency and the electricity markets.
Quite simply, as shown here, ESCO 2.0 will be made up of smart buildings that use energy in clean, efficient, and cost-effective ways and are therefore green buildings, but more importantly they are green in the environmental sense, as well as in the economic sense. Those buildings that integrate more functionality in will benefit from more robust the participation. ESCO 1.0
Buildings often overlooked the smart clean tech implementation, but 2.0 will start with commissioned, effectively operated BAS, electric submetering, dashboard technology to visualize building performance, and analytics to evaluate performance over time and develop benchmarks for comparison. Buildings enabled like this can participate in DR immediately by implementing technology to receive electronic event notifications, via the OpenADR standard, when DR events are called. The building then reacts to that event by modifying equipment operation to reduce an agreed upon number of (kilowatt) kW.
Programs vary in the amount of notice that customers receive, usually “day ahead,” “day of,” or “10 min” notice. Programs also vary in the amount of money paid for participation but customers typically receive payments between $50 and $300 per kW. For example, a 200 -kW enrollment would net an annual payment between $10,000 and $60,000.
With most programs, a customer gets paid whether an event is called or not, and in California, the utilities will even pay to install the technology. That all sounds pretty good, but it is just the beginning. This same smart grid/DR technology can be used to enable customers to sell electricity they agree not to use back to electric markets. We call this “day trading for energy,” and it gives customers another way to leverage financial value from smart grid. Adding this income to the arbitrage mix will create those larger projects.
At first, building owners may think this is too complicated and maybe it’s not worth it. The same could have been said of many technologies now widely used, when they were first introduced. That could also be said of green building recognition systems that have become the norm. Even more compelling, customers that leverage these technologies and programs effectively, can literally spin the meter backwards, while at the same time leveraging third-party capital and make debt service with REC payments from the utility and cost reduction on energy bills while optimizing building performance and tenant comfort.
The ideal scenario is when customers go further and expand building technologies to include energy storage (thermal or battery) and onsite generation (or what are now called “microgrids”). The idea is to take the renewed challenges many parts of the country are facing with electricity reliability and apply entrepreneurship to turn buildings into profit centers for energy.
DR has gotten a great deal of traction and is paying dividends for many building owners, but the next step is to insulate the tenants from any inconvenience that might be caused by DR. This is done by leveraging automation systems to precool, for example, focusing strategies on shutting down nonessential equipment and leveraging onsite generation, but numerous other options exist. Using advanced DR and OpenADR based technology, owners can also aggregate across multiple buildings and opt in or opt out based on what is going on in the building.
The challenge in today’s economy is finding ways to fund these technologies, and ESCO 2.0 could be the answer. Equally exciting is that owners can leverage the intelligence deployed in these systems to make performance repeatable, and can apply analytics that make it possible to evaluate the project in real time, not just once a year. All of these ideas mean that ESCO 2.0 amounts to free money and no one can afford to turn that down in this economy. HPB