By Peter V.K. Funk, Jr.
Presented at World Energy Engineering Congress
September 23, 2016
This article provides an overview of the legal and contractual considerations involved in certain energy performance contracts for a conservation and on-site generation project at a public housing authority (PHA). It also focuses on the importance of achieving an effective and comprehensive audit agreement as a first step in the process. It considers HUD requirements together with construction, financing and guarantee considerations.
Public housing authorities (PHAs) are public bodies formed by cities and governed by city and state statutes, but are also regulated and partially funded by the United States Department of Housing and Urban Development (HUD).
PHA facilities exist in cities throughout the United States and provide affordable residential housing. PHAs may include diverse structures such as multifamily apartment buildings, “scattered sites” and other residences, meeting hall locations, sports facilities, administrative offices, district energy electric or thermal plants, garages, and other facilities necessary to serve the PHA residential communities.
Providing an adequate supply of affordable housing to low-income residents is of major importance in many areas of the country, and PHAs serve as one of the solutions to that need. Yet, how can PHAs that financially depend upon rents paid by limited income residents, although supplemented by HUD subsidies, achieve the funding to meet the capital costs required to implement large-scale energy efficiency, energy conservation and on-site generation projects?
This need can be met by a combination of strategies and incentives that a PHA can utilize to finance the projects required to implement energy projects. One of the HUD incentives is the "frozen baseline" method, discussed in more detail below, by performance contracting utilizing energy performance contracts (EPCs) with energy services companies (ESCOs). PHAs are able to fund energy projects with the savings achieved through the implementation of energy measures such as retrofit lighting and HVAC together with energy-efficient boilers and controls together with other measures.
Energy performance contracting takes several different forms but all such projects share the characteristic that the savings generated by the project must amortize the capital cost of the energy conservation measures (ECMs), among other things, and the ESCO undertakes the risk of achieving such savings by guaranteeing that the projected savings will actually be produced over the contract term.
The ESCO serves as a design-build general contractor to provide all the services required to audit and evaluate existing facilities and equipment, recommend ECMs, and design, procure, construct and implement a comprehensive project at the customer’s facilities to include long-term monitoring. ECMs and other measures implemented by the ESCO are designed to address the requirements of each PHA facility and may include energy efficiency and conservation, cogeneration, renewable energy generation, water conservation and sustainable materials and operations.
Many EPCs provide that the ESCO will provide measurement and verifications (M&V) services in order to determine project savings. A PHA should also hire its own independent energy consultant to verify the energy savings in the event that it doesn’t have that capability in-house. That having been said, there are various ways to structure an M&V process which are beyond the scope of this article.
After performing a preliminary walk-through, the ESCO whose proposal is accepted will enter into an audit agreement with the PHA to conduct a comprehensive energy audit of the PHA’s facilities in order to develop a baseline of energy usage and identify potential improvements for achieving energy efficiency and cost savings. The audit agreement is important and should be carefully drafted and negotiated.
Financing PHA Performance Contracting and Obtaining HUD Incentives
The role of the ESCO may also include arranging for financing with a third-party financier, although some ESCOs may be reluctant to do so in light of liability concerns under the Dodd-Frank Act. Some ESCO’s specifically provide that they will not be acting as “municipal advisors” in the EPC. The reason for such language is that, effective January 2014, the Dodd-Frank Act was amended to create a new class of regulated persons, “municipal advisors,” who must register with the Commission prior to offering financial advice concerning, in brief, municipal financial products such as structure, timing and terms of financial products. Although the term “municipal advisor” appears to partially exempt ESCOs by excluding engineers providing engineering advice, which is in turn defined to include “feasibility studies, cash flow analyses, and similar activities,” or “projections of output capacity, utility project rates, project market demand, or project revenues” 17 C.F.R Parts 200, 240 + 249; see: SEC rule at pages 226 - 7, Dodd-Frank represents a sweeping overview of financial dealings. For that reason, it is understandable that ESCOs want to be careful before providing any advice that could be deemed to come under Dodd-Frank regulated activities.
HUD financial support for PHAs includes providing funding for the cost of utilities, including electricity and gas, together with other energy commodities. In order to incentivize PHAs to implement ECMs, HUD permits “frozen baseline” financing. Under frozen baseline financing, a PHA can implement an energy conservation project that substantially reduces energy consumption. HUD, however, will continue to make payments for utilities to the PHA at the pre-project baseline level (i.e., before the baseline is frozen) as though it had not reduced its energy consumption. The PHA can use the amounts paid by HUD in excess of the cost of the utilities to pay the cost of debt service and certain other expenses. By guaranteeing the amount of the energy savings, the ESCO, in essence, guarantees that the PHA will be able to pay for the energy conservation project out of the savings generated by the project. In addition to frozen baseline incentives, HUD also may provide several possible opportunities for PHAs to gain financing for projects as follows: Frozen Baseline Incentives (24 CFR §990.185(a)(1)(i)); Add-On Subsidy Incentives (24 CFR § 990.185(a)(3)(i)); Resident Paid Incentives (24 CFR. § 185 (a)(2)(i)); and Rate Reduction Incentives (24 CFR § 185 (b)).
Financing options for a PHA may include bond financings and, to the extent permitted by state law, may also include “municipal lease” financing, provided that the ESCO provides a savings guarantee. A municipal lease may be viewed as a hybrid between a true lease and time purchase agreement. Unlike a true lease, upon installation and acceptance of the ECMs, the PHA owns the ECMs and the lessor (typically a bank) retains a security interest.
It is not an easy or short process for a PHA to go from A to Z in implementing such projects. Such energy projects for PHAs are often large and complex and involve many steps and processes beginning with requesting and analyzing proposals and continuing with contract preparation and negotiations in connection with audit agreements, EPCs and other related agreements. These steps also include securing HUD, utility and any other incentives that may be available, and arranging for financing and the administration, implementation and operation of the project. PHAs often rely on specialized consulting and professional services to provide guidance, assistance, and support. A PHA must also comply with complex HUD regulations together with any applicable federal, state and local laws. It is also reasonable to anticipate that HUD approval for project and the EPC may take months. Keeping the board of the PHA informed and involved is also important since the project cannot proceed without board approvals and the complexity of such projects and the related financings can require time in order to familiarize the board with the on-going status of the projects.
Another factor which must be considered is the need to take into account the necessity of replacing critical equipment before failure or compromise. For example, in one project, boilers in several residential building complexes of a PHA required replacement prior to the next heating season. Long lead time for ordering the boilers was necessary in order to make sure that these were installed in sufficient time, but HUD approval of the project was still pending as the lead time was expiring. Under those pressing circumstances, it was necessary (and fortunately possible) to make use of a type of contract called an “agreement to proceed” so as to allow work to proceed on the boiler procurement pending final HUD approval of the project. The boilers were thereby ordered in time to be installed prior to the onset of cold weather. The project was approved by HUD in time for the boilers to be installed, and the agreement to proceed was superseded by the EPC between the ESCO and the PHA.
Energy Savings Guarantees
Energy savings guarantees should be written carefully and attention should be paid by each party to the type of guarantee being offered. A poorly written guarantee can result in needless misunderstandings and disputes. Guarantees are more than part of the pitch; they are a specific promise that, if not met, can be the path to liability on the part of any ESCO or regret on the part of any PHA that fails to understand the guarantee.
Energy savings guarantees form the “heart” of EPCs and certain other types of energy services agreements. Following are examples of types of energy savings guarantees and elements of comprehensive guarantees:
(1) Payments Based Upon Deemed Savings. Since lighting is typically a large percentage of a PHA’s electrical load, retrofit lighting such as sensor-controlled, light-emitting diodes can provide significant reductions in electric demand and consumption when compared to fluorescents. LEDs also produce less workspace heat than fluorescents. Since the delta between the power requirements of the units to be replaced and the new lighting units can be projected (wholly or partially) in advance based upon manufacturers’ specifications and data, the energy savings to be produced by lighting retrofit projects is sometimes determined by stipulating in advance (deeming) the level of savings to be achieved by each fixture to be used for the purposes of calculating energy savings.
Following is an example of a portion of a deemed savings provision:
- Baseline Consumption. Electrical demand and electric energy consumption will be stipulated for each baseline lamp/ballast fluorescent combination based on the manufacturer’s rated consumption and demand for each lamp/ballast combination.
- Energy Savings Calculation. Electric energy and demand savings will be calculated as the difference between the baseline for each fixture and the manufacturer’s data for each sensor-controlled LED fixture’s electric energy demand and consumption, adjusted for the percentage of dimming time recorded by the LED control system. Total energy savings will be calculated using the electric energy and demand savings for each fixture (calculated as provided herein) multiplied by the operating hours and actual fixture counts.
(2) Payments Based Upon Achieved Savings. Following is a type of guarantee which puts the burden upon the ESCO to produce savings based upon measured savings multiplied by an “index” price that changes, subject to a floor price, throughout the term based upon the actual cost of electric commodity to the customer:
- Electric Commodity. The Unit Price per kWh to be used to determine Electric Commodity Savings with respect to each month following the Commencement Date shall be the same as the price per kWh charged PHA by the Utility during that month under Account: _______ (or successor account having the same Utility Service Classification). During the Term, the Electric Commodity Unit Price shall not be less than the Unit Price per kWh for said account charged to PHA with respect to the first month following the Commencement Date.
- Energy and Cost Savings Calculation Algorithms. The ESCO shall base its calculations of Savings upon the following examples: [algorithms not included in this article]. The ESCO may use other reasonable algorithms or methodologies to calculate Savings with the PHA’s advance written permission which may not unreasonably be withheld.
As with the first example, this above example shows how the savings calculation is to be performed. Of course, there are several other factors that have to be addressed so as to achieve an “apples” to “apples” comparison between baseline energy consumption and post-installation energy consumption. Of particular importance is the need to adjust the baseline whenever the facility’s equipment, occupancy or hours of use change and to adjust for differences in degree days.
Engineering Services (Consulting Services)
A word about the importance of a consulting engineer: it is key for a PHA to have engineering and or other technical consultants experienced in dealing with ESCOs performing EPCs for the PHA. These transactions involve complex contracts which typically relate to the installation of numerous measures and can include on-site generation coupled with financing dependent upon performance over a period of years. Without solid experience and understanding of the process, it is very difficult for most PHAs – other than those with highly experienced in-house capabilities – to fully participate in an EPC in a cost-effective manner. Your author was surprised in connection with one of the smaller PHAs he has represented to find that it had no in-house experience with EPCs and no outside consultant. Upon his recommendation, the PHA hired highly experienced outside consultants who were able to substantially and cost-effectively assist the PHA in achieving its objectives. In another case, a PHA was able to save millions of dollars in on-going M&V costs by using outside consulting to perform such services rather than having the ESCO perform comprehensive M&V.
Regulatory Considerations (Consulting Services)
Like the consulting engineer, it is key for a PHA to have consultants experienced in dealing with HUD in connection with energy projects performed by EPCs on a performance contracting basis. Such consultants typically bring years of experience with HUD to these projects and can prove invaluable in dealing with the ESCO and addressing HUD requirements and concerns.
On-site Generation and Microgrids
A typical large PHA has a reasonably consistent load profile from day to day and operates on a continual basis. It requires a very high degree of reliability and resilience for its energy supply. Its relative inflexibility of demand means that the PHA is generally not in a position to take advantage of lower off-peak pricing by purchasing power from its utility under a Time-of Use (TOU) service classification. However, although the PHA itself may not be in a position to readily curtail or “shave” load in residential buildings during periods of high electricity prices in order to purchase power during lower price periods, administrative or maintenance buildings or equipment operated by a PHA may be able to do so.
While there are technological strategies which enable customers to take TOU power, such as generating power for peak shaving purposes or using energy storage (such as thermal storage) in connection with a TOU service classification, such strategies require a significant investment which may not be feasible for a PHA. Although a PHA may well have back-up generation capacity, without on-site generation, such as cogeneration, it is “stuck” with the utility pricing and operational capabilities. Any utility distribution grid outage becomes a PHA outage unless the PHA has back-up generation or cogeneration capable of synchronous operation (i.e., it can operate without being “excited” by the grid). Without a CHP unit or other form of generation, a PHA has limited control, limited flexibility and fewer opportunities to achieve environmental benefits.
- Interconnection Considerations. A traditional microgrid which contemplates synchronous generation with the utility distribution grid to enable sale of utility electric power, back-up and/or selling excess electric energy to the utility can require time-consuming interconnection approvals. It may also be necessary for the PHA to pay for new or costly upgrading of utility distribution lines or transmission lines above certain voltage levels which costs are likely to be impractical for a PHA. At PHA voltage levels, it is necessary to enter into an interconnection agreement with the local distribution utility. Some microgrids might even be rejected for interconnection. Interconnection requirements include the imposition of utility tariffs and the applicability of state PSC or PUC regulations. In addition, independent system operators (ISOs) may impose requirements. For these reasons, microgrids may only be feasible for certain large PHAs.
- Qualified Facility (QF) Compliance and Exemption. Will generation within an interconnected microgrid be a QF subject to regulation? A PHA or operator of a generating facility with a maximum net power production capacity of greater than 1 MW may obtain QF status with the Federal Energy Regulatory Commission (FERC) by filing with FERC. In the event that it satisfies the FERC requirements of a QF, the CHP unit will generally be exempt from most federal and state regulation.
Making use of energy performance contracting to perform energy projects as described above can enable a PHA to perform projects that it would not otherwise be able accomplish. EPCs (and related agreements) rely heavily upon contractual commitments by the ESCO to the PHA and must be carefully drafted and effectively negotiated.
Note: This article is of a general nature and not intended to be legal advice. Readers should consult an attorney for legal advice.