Cash-Strapped Colleges Turn to Businesses for Energy-Saving Deals

As funds for facilities dry up, colleges sign energy-efficiency contracts that don't always work out

Robert Allan, Johnson Controls

Cranes work in 2008 on the development of TCF Bank Stadium at the U. of Minnesota's Twin Cities campus, as part of contract with an energy-services company.
March 07, 2010

Six years of hassle and headache came to an end with the swipe of a pen at the University of Kansas in January. In 2003 the university signed an $18-million deal with a company, which was soon acquired by Chevron Energy Solutions, to install energy-efficient windows, lights, ventilation systems, and other conservation measures on the campus.

"They guaranteed us a million a year in energy savings," says Donald W. Steeples, senior vice provost for scholarly support. That money would be used to pay off the bond the university had taken out for the work. Unfortunately, he says, "we were getting about half that."

Each year that followed, the two parties held lengthy negotiations over the missing $500,000 and how large a check Chevron should write. "We would end up arguing every year over every little thing we do that would affect our energy usage, positively or negatively," Mr. Steeples says. Finally, this year, the university and Chevron hammered out an agreement: The company will pay the university $400,000 a year for the next 12 years, no questions asked.

While the energy-services industry has had a successful record in higher education for many years, stories like this one serve as timely cautionary tales. With dwindling state resources, tight budgets, and a renewed focus on energy efficiency, more colleges are turning to energy-services companies, commonly known as ESCO's, for facilities projects. At the same time, companies that have not traditionally worked as ESCO's are joining that market, raising risks that colleges will be stuck with deals that overpromise and underdeliver.

A Growing Market

The business models of ESCO's have varied over the years, but today most agreements between energy-services companies and colleges follow a fairly straightforward plan: The college and the company do a detailed accounting of the college's current energy use and decide on a set of projects that will yield energy savings. The college gets a loan to cover the cost of the work to be done by the ESCO and pays back the loan through the energy savings. If the savings are not as high as the company estimated, often it will pay the difference.

Energy-services companies did an estimated $4.1-billion in business in 2008, up from an estimated $2-billion in 2000. Public colleges and prisons have been among their most prominent clients, says Charles A. Goldman, a staff scientist at the Lawrence Berkeley National Laboratory who studies the energy-services market. In the early 1990s, he says, ESCO's developed bad reputations because some standards—including those for measuring energy savings and models for paying the companies—had not been hammered out. By now most of those problems have been resolved.

Among some college facilities directors, ESCO's have a reputation for going after only low-cost projects with fast paybacks, like lighting replacements. But Mr. Goldman says the companies will pursue deals of any size. One example, announced in November, is a $79-million plan to switch a coal plant to biomass at Eastern Illinois University, to be performed by Honeywell International. The main limiting factor in an ESCO's scope, he says, is a college's tolerance for return on investment. College expectations of paybacks of less than 10 years force ESCO's to shoot for easy work.

Tightened state budgets have been a main driver in the growth of the energy-services market. College administrators see working with the companies as a way to handle their crumbling infrastructure without having to wait for legislative appropriations. John G. Peters, president of Northern Illinois University, says his campus has 11 energy-performance contracts in the works. Because the state has not paid its public colleges hundreds of millions of dollars it had pledged for this fiscal year, the colleges have had to pull money from facilities departments simply to make payrolls. At Northern Illinois alone, "we have half a billion dollars in deferred maintenance that isn't just a wish list—it's a real need," Mr. Peters says. "People have gone to performance contracts ... to fund these things."

Jim Simpson, who directs the higher-education business at Johnson Controls Inc., a leading ESCO, says his company estimates that deferred maintenance is a $36-billion problem in higher education, bound to get worse. He sees an increasing number of competitors chasing that market. Small, traditional architecture and engineering firms have been hit hard by the slowdown in construction, and some of them are looking for work as ESCO's. Mr. Simpson even sees nontraditional players, like Cisco Systems and IBM, dipping into the energy-performance-contracting market.

New faces in the business might bring additional competition, new services, and lower prices. But energy-performance contracting is a complicated business, in which technical experience and a familiarity with the clients can help avoid problems later on.

Are You Experienced?

Lack of experience may have been the primary problem in the University of Kansas' case. Mr. Steeples, the senior vice provost, says the company officials who devised the university's contract did not understand campus culture. "They overestimated what they could do to train people to turn lights off when they leave the room, or close the sash on the fume hoods," he says. The company was used to working with the private sector, he adds. "I don't think they realized that faculty and students aren't under the thumb of some vice presidents the way that they are in corporations."

Juliet C. Don, a spokeswoman for Chevron Energy Solutions, said that the company's predictions had fallen flat in terms of building controls and water savings at Kansas, but that Chevron meets its goals 98 percent of the time. Most ESCO's and colleges by now have stopped counting on behavioral change as a way to get energy savings in an energy-performance contract.

The resulting disagreements had impacts beyond mere hassle. Mr. Steeples says he wanted to set up incentives for energy efficiency on the campus. For example, energy use by departments in their buildings would be closely monitored, and those that kept their energy use below a set level would get some of the money they helped save. But he could not set up that program during the dispute with Chevron, because any efficiency could be claimed by the energy-services company during the yearly negotiations.

"There was a disincentive for us to go beyond what was done with the contract," he says. Resolving that dispute "will open up the door to do some things on our own without having to argue with someone."

Check and Doublecheck

David M. Birr, an engineer who is president of Synchronous Energy Solutions, advises colleges on their ESCO contracts and serves as an expert witness in litigation. His advice is simple: Hire an experienced company, and do due diligence on the contract. He is involved in a case at one college that is now going into settlement after six years of litigation. Financial administrators at the college were "imprudent," he says, and the ESCO made unrealistic economic assumptions and exaggerated the potential savings.

"Naïve owners and ESCO's that are eager to sell their deals don't always make good contracts between themselves," he says. "The blame is rarely all on one side."

Too often, Mr. Birr says, colleges apply the most rigor to the measurement and verification stages, when engineers from the college and the ESCO look at the energy bills to see if the renovations or lighting replacements have actually saved money. More institutions should look at the process holistically: Focus on the contract, monitor the quality of construction and other labor, and make sure the new equipment is properly commissioned.

"If you're going to try to fix everything at the end, it's a lost cause for everyone—the ESCO and the owner," he says.

For the most part, though, he says, colleges tend to perform good technical and economic analyses of their deals with ESCO's. Energy-performance contracting has found widespread acceptance in academe. The American College & University Presidents' Climate Commitment has endorsed the practice as one way to reduce carbon emissions, and has produced a series of reports outlining the best methods for working with ESCO's.

Lee College, a community college in Texas, served as the climate commitment's primary case study. The college formed a $10-million deal with Johnson Controls to upgrade boilers, manage computer power, conserve water, and do other projects; Lee is to pay off its loan through energy savings within 15 years.

Even the University of Kansas is in negotiations to sign a contract with another ESCO. This time, says Mr. Steeples, the deal will focus on a handful of research buildings that "use energy like a big dog," rather than on scattershot projects all over campus.

He has some reservations and some reluctance about the prospects, given the university's experience. "If they have overestimated what we think they can save, then we'll be right back to where we were," he says. "If we can save as much or more, then we are off to the races."