‘Threshold Questions’ Help Find Path to Energy Efficiency Financing

The financing options for an energy efficiency project include third-party contract options, utility on-bill financing, on-bill repayment, and PACE. As part of the process of matching a financing vehicle with the project, a number of "threshold questions" can help determine the best path, says Kim, the lead author of a white paper titled "Innovations and Opportunities in Energy Efficiency Finance." What is the tax appetite of the organization? Does the project include generation (like solar PV or combined heat and power) for which there might be both tax deductions and utility rebates? And how much or how little performance risk (i.e., will energy efficiency measures actually deliver the results expected?) are facility managers willing to accept?

That last question is key to determining a financing option, says Kim, because what performance risk really means is managing which party has accountability for performance, or lack thereof. If an organization wants a guaranteed level of performance, then third-party contract options might be the best solution. But if the organization will accept the performance risk for itself, then the financing options like utility on-bill financing, on-bill repayment, or PACE might be best, assuming they're available.

Partnering For Money

Perhaps the biggest benefit to financing with third-party contracts, other than minimizing performance risk, is that facility managers can choose the level of involvement with which they're most comfortable. Third-party contracting generally includes three categories of agreements: operating lease, energy performance contract, and energy service agreement.

An operating lease is an interesting prospect because it falls in sort of a gray area between the two categories of financing vehicles — it's a third-party contract, but the facility manager inherits all the performance risk.

Of the three, it's the option with the lowest amount of vendor involvement. Indeed, according to Audin, an operating lease is basically, "Here's a chiller. Have a nice day." With an operating lease, the vendor owns the equipment (usually a big-ticket item), and there's generally no guarantee for savings in operations, though if the equipment isn't operating properly, the vendor is obligated to fix or replace it. What "operating properly" means, exactly, should be fleshed out in the contract.

Operating leases are ideal for organizations with no tax appetite because they're accounted as a business expense, or part of the operating budget. Additionally, they don't add debt to an organization's balance sheet — sometimes an attractive prospect for CFOs. And, says Audin, if a building is sold, the lease can be sold with it. That's often more difficult to pull off with a more in-depth energy performance contract or energy service agreement.

One caution with an operating lease, says Gilligan, is that keeping the expense off a balance sheet isn't usual practice in international accounting standards. "This type of arrangement itself isn't being phased out," he says. "But the accounting treatment might be. The idea is that you're paying for a service, and the cost doesn't have to be capitalized."

For organizations that can take advantage of tax deductions for efficiency, another form of lease called a capital lease may be a better bet. Here, the lessee (facility manager's organization) can use the expense for energy efficiency tax deductions, like those offered in the EPAct tax deduction extender package. (See the sidebar titled "Status of 179D 'Tax Extender Package' for Energy Upgrades" with Part III of this article.) Again, the difference in these two leases is how the expense obligations are reflected on a financial statement — as either an operating expense or a capital expense.

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