Risks Associated with Energy-saving Projects

Published on Thursday, 30 October 2014 16:14:35    Written by Marc
I think anyone will agree that with any project or investment comes with some form of risk. Any investment we make carries some risk. The goal is obviously to understand what the risk is and to mitigate it as much as possible.

We often discuss, in this blog, about energy-saving projects or measures and their benefits. Today, I want to analyze the risks involving these projects.

I recently watched a video about an interview that a well-known ESCO (energy-saving company) was giving. In the exchange, the interviewee spoke about how they assumed the risk of savings for their clients and how they had to be careful. Unfortunately, he did not talk about how much premium was charged to the client for this service, because it is well known that at the end of the day, it is the clients that pay for the risks. By having the ESCO guarantee the energy savings, the client is paying a premium just like purchasing an insurance policy. In addition, as we know, the higher the risk, the higher the cost of the insurance policy.

The difference with a normal insurance policy is that normally people know what the cost of the insurance is. If you insure a car or a house, the insurance contract price is well indicated and it is a separate contract from the contract you had when you purchased the car or the house.

In the case of ESCO contracts, where the energy savings are guaranteed, the cost of the insurance is normally embedded in the cost of the energy-saving project. It is somewhat as if your car purchase included insurance.

Now, this is not necessarily a bad thing, as many building owners and managers welcome the fact that their energy-saving project is guaranteed to provide the savings that their ESCO promised. The only thing is that these costs of insurance should be clearly known before agreeing to the contract.

Any building owner of manager contemplating to do an ESCO backed energy-saving project could ask him or herself a few questions before requesting from the ESCO that that energy savings be guaranteed. The first question is how much are the insurance costs. The only real way to be able to find this out is to ask to have the insurance (the guarantee of achieving the energy savings) removed. While it is possible to ask for this after receiving a proposal, which include the insurance, I prefer by far to start by asking the ESCO NOT to guarantee the savings and then later ask for how much more the project would cost if the ESCO were to guarantee the savings (this way you can have a before and after price). Doing it the other way around exposes you to have your ESCO give you only a portion of the insurance back because they know that you have no idea of what the insurance premium is in the first place.

So, how much premium is normally added to a project in order to guarantee the savings? Unfortunately, because every single project is different, the answer comes back to the generic, "It depends." I have done projects in which the premium was as low as about 15% and others that I learned, after the project unfortunately, that the premium was closer to 40%.

How much of a premium is fair? Again, answering this question depends on the complexity of the underlined project itself and because each project is different, there is no standard number. If we take a project, which is straightforward, like a small lighting retrofit (say the retrofit of exits lights in a building), the risks associated with the project are easy to identify and measure. If you know the number of hours that your lights will be on, then it is only a matter of calculating how much energy you will save. However, depending on how many lamps you retrofit and the energy reduction, you might need to calculate also the crossed effects; these are the effects on heating and cooling that come from the lighting retrofit.

For example, if you do a complete lighting retrofit in an office building, installing lamps that take less energy will also help save on the cooling in the summer because the lamps normally tend to provide less heat. However, you might need to heat a little more in the winter because you lose some of the heat the older lamps provided. In the first case, the small lighting retrofit, the risks are low since it involves little calculation. In this case, an insurance in the form of a premium to an ESCO would also be minimal. In the second case, a complete lighting retrofit in an office building will require the calculations of the crossed effects and implies some additional risk. In that case, the premium to be paid could be higher than in the first example.

If the project includes a number of other components, such as chiller replacement, pumps and variable speed drives just to name a few, then you can probably expect the insurance premium to increase because the ESCO will need to protect itself from errors and variances associated with the calculation. We must remember that if the ESCO misses the target, in theory it will cut you (as the client) a check for the shortfall. In reality, the ESCOs normally protect themselves by indicating that their calculations are based on environment factors such as clients habits (hours of operations for example) and temperature (degree-days of cooling and heating).

When combining these two groups of factors together, good luck in getting a check from the ESCO if the energy-saving targets are not met. We have to remember that the guaranteed savings are there to protect the client in case of major errors from the ESCO, not really if there is relatively small difference between the result and the target. If your targets are not been met by a few percentage points, you might be in for a long argument with your ESCO if you seek a refund. A few years ago, we did a retrofit in a 530,000 sq-ft office tower with one of the world’s leader in ESCO projects and our savings were about 70% of what we were expecting, so naturally we challenged it.

What started as a request for payment for the shortfall turned into countless spreadsheets of data provided by the ESCO, piling on our desks to attempt to show us that the combination of weather and building occupancy confirmed their calculations? By the time we finished going back and forth with our ESCO, many months had passed and we were already in the second year and although the weather and occupancy had both reversed (weather was more clement and occupancy was slightly down), they started to provide us different arguments than the ones we were presented the previous year. In the end, we never got a refund but from that, point on we did all our energy-saving projects without using the ESCO formula.

More than fifteen later I still highly favor doing good calculations and assuming the risk of the energy-saving project than going with an ESCO formula. I guess you are burnt once and then you think about your options. However, ESCOs do have their benefits and I do know companies that have received a check from their ESCO when energy savings did not materialize as expected. It really boils down to knowing how much premium you will pay and deciding if the premium is worth it considering the potential risk that the energy-saving project carries.