Structuring the Deal: Funding Options and Financial Incentives for On-site Renewable Energy Projects
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1 Structuring the Deal: Funding Options and Financial Incentives for On-site Renewable Energy Projects Derek Price Program Manager Renewable Energy Solutions Johnson Controls, Inc.
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3 Introduction More public and private sector organizations than ever before are helping meet their energy needs with on-site renewable energy facilities. Power produced from biomass, wind turbines and solar panels is helping schools, colleges and universities, state and local governments, businesses and other organizations stabilize their energy costs, improve the reliability of their energy supplies and lower greenhouse gas emissions while contributing to stronger local economies and generating other benefits. One key to the long-term success of an on-site renewable project is financing: how will construction be funded and what incentives can be leveraged to ensure the financial feasibility of the project? A variety of tax credits, rebates and other incentives are available from governments at all levels as well as utilities to help offset the costs of installing renewable energy facilities. In addition, organizations may be able to sell renewable energy, energy efficiency and emissions reductions credits generated by renewable energy facilities to help recoup installation costs and create long-term sources of revenue. Finally, performance contracting, when combined with other incentives, often provides the best overall solution since performance can be guaranteed, the risk of ownership is reduced, and benefits can be realized quickly without a significant up-front investment. When ownership of the renewable energy source is not essential, third-party ownership can further minimize the risks associated with renewable energy generation. This white paper seeks to shed light on: Performance contracting and third-party ownership as potential deal structures Financing options available to public and private sector organizations Government, utility and market incentives for on-site renewable energy projects Funding Options Most on-site renewable projects are funded in one of two ways: Performance contracting which permits organizations to fund renewable energy facilities with cost savings from energy efficiency measures through loan or lease mechanisms Third-party ownership which enables organizations to enjoy some of the benefits of renewable energy through service contracts while avoiding some of the risks associated with ownership Performance Contracting Performance contracting enables organizations to fund energy efficiency and renewable energy projects in the absence of available capital. This makes performance contracting an especially attractive funding option for public sector organizations such as schools, colleges and universities, as well as local and state governments. Many of these organizations cannot raise the capital required to install an on-site renewable energy facility without raising taxes or issuing bonds through a referendum. Performance contracting eliminates the need to do either. Here s how performance contracting works: 1. A detailed investment-grade sustainability audit is performed on the organization s facilities. The audit conducted by a trained professional identifies opportunities to improve the energy efficiency of building envelopes (such as leaky windows, doors and wall seams), lighting, heating/air conditioning/ ventilation systems, and other systems. The audit sets sustainability achievement objectives, estimates energy and other savings, defines specific measures to achieve those savings, estimates the costs of those measures, outlines monitoring and verification plans to ensure the objectives are met, and provides a detailed cash flow analysis. 2. Results of the sustainability audit then undergo a technical review to confirm their accuracy. If discrepancies are discovered, they can be corrected at this point. 3. Following the technical review, a performance contract is drawn up. The contract specifies the scope of the energy efficiency improvements to be made, associated costs, estimated energy and other savings, and the resulting cost savings the organization is guaranteed to receive. These guaranteed cost savings can then be used as a basis to justify the cost of implementing the new, higher energy efficient facility improvement measures as well as the construction of an on-site renewable energy project all using money from existing budgets. 1
4 4. Once the contract is executed, energy efficiency measures can be performed and construction of the on-site renewable energy facility can begin. 5. When the construction phase is completed, all new equipment and the renewable energy facility must be properly operated and maintained over the course of the contract which can run from 10 to 20 years to ensure that the projected energy efficiency and renewable energy production estimates are achieved. 6. In addition, cost savings are tracked over this same period to ensure they equal or exceed guaranteed cost savings spelled out in the performance contract. The energy savings guaranteed in a performance contract enable organizations to finance up-front costs of energy efficiency measures and installation of on-site renewable energy facilities in the manner that best suits their financial objectives. In some cases, public sector organizations may be required to own new equipment and facilities, in which case a traditional loan or lease-toown funding can be obtained from a financial institution. A number of leasing options exist to fit the particular needs of the organization: A capital or financed lease arrangement under which the lessee purchases the equipment for a nominal fee at the end of the lease period. A tax-exempt or municipal lease for state and local governments, state universities, school districts, fire and police departments. An operating lease arrangement under which the lessee does not own the equipment at the end of the lease, but has a right to purchase it at fair market value. A shared savings arrangement in which the vendor installs the equipment at its cost and receives a negotiated percentage of the cost savings it generates. The organization may purchase the equipment at fair market value at the end of the lease term. Among the additional benefits of using performance contracting: Every aspect of securing funding is handled by a qualified third party. Energy and cost savings can be guaranteed. If they aren t achieved, the contractor cuts a check to the organization for the difference. The organization owns the Renewable Energy Certificates (RECs) that accompany generation of renewable energy and can sell them on the open market. The Pennsylvania state prison at Laurel Highlands is an excellent example of how performance contracting enables organizations to finance energy savings and renewable energy projects in the absence of available capital. Laurel Highlands a minimum security prison for men in southwestern Pennsylvania was under intense pressure from federal and state environmental agencies to reduce emissions from coal-fired boilers that provide heat and steam to the institution. The state of Pennsylvania, however, lacked the capital budget to make necessary upgrades. Fortunately, Johnson Controls suggested an imaginative and affordable solution. Under the plan: Energy efficiency improvements will be made to roofs, windows, lighting, plumbing fixtures, HVAC systems and controls, insulation and other building features at the prison. Electricity and steam for the prison will be produced by a new co-generation facility that will burn methane gas produced as a by-product of the decomposition of garbage in a nearby landfill a renewable energy resource that, until now, has been literally going up in smoke as the landfill uses flares to burn off the gas. Surplus electricity will be sold to the utility grid to generate an ongoing revenue stream for the prison system, which will use some of the funds to help repay the costs of making the energy efficiency upgrades and installing the renewable energy facility. In the end, this performance contract enables the prison to solve the emissions problems created by its old boilers, dramatically improve the energy efficiency of its facilities, and make good use of a renewable source of energy all without investing any capital funds. Third-party ownership As an alternative to performance contracting, thirdparty ownership is gaining in popularity. Under a third-party arrangement an organization permits another organization or third party to install on-site renewable facilities on its property. For example: a company may enter into an agreement with a financial 2
5 institution to install solar photovoltaic cells on the rooftops of its buildings. The company then purchases the power generated by the solar panels, but does not own the panels themselves. The financial institution, which actually owns the solar panels, benefits from the many tax credits and other financial incentives that accompany the installation and operation of renewable energy facilities. For example, the financial institution may receive federal investment tax credits or production tax credits, accelerated depreciation on the installed equipment, rebates and other incentives from state and local governments, as well as similar rebates and incentives from utilities. In addition, the financial institution owns the RECs and can sell them on the open market. Third-party funding of on-site renewable energy facilities is particularly popular in states where: Peak electricity rates are relatively high State and utility incentives are available Special renewable energy incentives such as higher REC prices for power produced from solar photovoltaic cells are offered Among the advantages of third-party ownership: The third party is responsible for installing, operating and maintaining the on-site renewable energy facility resulting in low operational risk for the organization. By negotiating a long-term agreement to purchase power from the renewable energy facility for anywhere from 6 to 25 years an organization can lock in energy costs in the event prices rise. If the organization is tax-exempt, thus not eligible for tax credits, it can still make use of these and other tax incentives to install on-site renewable energy facilities by partnering with a third-party that can benefit from them. Disadvantages of third-party ownership include: Long-term contracts are often required. In the event electric rates fall unlikely as that is an organization could find itself locked into purchasing power at a higher rate. The third party that owns the renewable energy facilities also owns the right to claim it is using power produced from renewable sources. This is a critically important consideration for organizations that wish to enhance or improve their public image by letting stakeholders know that they are using renewable energy. The owner of the RECs from a renewable energy facility is the only party that can make that claim and, in this case, that is the third party. Pioneer Hospital located in Los Angeles County illustrates how third-party ownership can be the right deal structure for some renewable energy projects. Under a contract with Johnson Controls, Pioneer is installing solar photovoltaic panels that will generate 100 kilowatts of electricity. Given the plentiful sunshine in Southern California, hospital administrators felt it was the right thing to do for the local community, and hope it will encourage other businesses to install renewable energy facilities. Funding for installation of the solar panels is coming from three primary sources: 1. A grant from the local electric utility 2. The sale of renewable energy credits generated by the project 3. Local investors The investors will actually own the solar equipment and sell the electricity it generates to the hospital at rates lower than the local utility is charging. This shields the hospital from volatility in electric rates. Third-party ownership of the solar equipment has other distinct advantages for Pioneer Hospital. It enables the hospital to avoid spending out of pocket dollars on the project, and it enables the hospital to keep the installation costs off of its balance sheet as debt an important consideration in this particular case. Other Funding Sources Funding for renewable energy projects can also be provided by State Public Benefit Funds and State Clean Energy Funds. State Public Benefit Funds These funds are typically financed through small surcharges on consumers utility bills. At least 15 states use these funds to provide financial support for renewable energy projects. i For example: Vermont s Clean Energy Development Fund has set aside approximately $6 million - $7.2 million annually to provide financial support for energy efficiency and renewable-energy projects through March Eligible renewable energy project include solar photovoltaics; solar-thermal; wind; geothermal heat pumps; farm, landfill and sewer methane recovery; 3
6 low-emission, advanced biomass; and combined heat and power (CHP) systems using biomass fuels such as wood, agricultural or food wastes, energy crops and organic refuse-derived waste. Eligible organizations include industrial manufacturers, colleges and universities, hospitals, large office buildings, K-12 schools, municipalities and others. ii State Clean Energy Funds These are funds state governments set aside to finance development of renewable energy facilities. iii For example: the Illinois Wind Energy Production Development Program provides financial support for the development of new wind energy projects with a capacity of at least 0.5 Megawatts, though smaller projects may be funded under special circumstances. Eligible organizations include commercial, nonprofit, schools, local governments, state government agencies, agricultural and institutional organizations. Funds may be used for development of business plans, engineering designs and drawings, advanced market studies and financial analyses, technical assistance, and other business development activities, as well as the purchase of equipment and/or materials. The maximum grant award is $25,000, although this maximum may be waived under certain circumstances. iv Financial Incentives To encourage organizations to install on-site renewable energy generation facilities, a variety of financial incentives are offered by governments at the state and federal level, as well as by utilities. These include: Federal Investment Tax Credits for Solar Photovoltaic and Fuel Cell Projects Adopted as part of the federal Energy Policy Act in 2005, these incentives provide homeowners and businesses with a 30% tax credit for investments in renewable energy facilities that produce power from solar photovoltaic cells and fuel cells. The credits expire at the end of 2008 and they were not renewed in the energy bill recently passed by the Congress and signed by the President. However, Congress may try again to renew these tax credits before they expire. v Utility Rebate Programs Because renewable energy systems can delay (or even avoid) construction of new generating capacity, reduce peak loads and distribute power generation, many utilities provide financial incentives to customers who install them. For example: The Modesto Irrigation District is a publicly-owned utility that provides light and water in California s Central Valley. Under the utility s Photovoltaic Rebate Program, all customers commercial, residential, nonprofit, local government, state government, agricultural can receive a rebate for installing solar-pv systems. The peak output capacity of a system must be 1 kw or greater to participate. The rebate is $2.80 per installed watt, not to exceed 50% of total project costs up to 30 kw. Public agencies can receive an additional $0.50 per watt, bringing their incentive up to $3.30 per watt up to 30 kw. vi Federal Incentives for Commercial and Industrial Businesses The Modified Accelerated Cost-Recovery System allows depreciation deductions for solar water heat, solar space heat, solar thermal electric, solar thermal process heat, solar photovoltaics, wind, geothermal electric, fuel cells, solar hybrid lighting, direct use geothermal or microturbine equipment. vii The Business Energy Tax Credit provides tax credits for the same renewable energy facilities listed above. viii The Renewable Electricity Production Tax Credit provides tax credits for landfill gas, wind, biomass, hydroelectric, geothermal electric, municipal solid waste, refined coal, Indian coal or small hydroelectric projects. ix Federal Incentives for Public Sector Organizations The Renewable Energy Production Incentive (REPI) pays 1.5 cents per kwh to Tribal Government, Municipal Utility, Rural Electric Cooperative, and State/local governments that generate electricity from solar thermal electric, solar photovoltaics, landfill gas, wind, biomass, geothermal electric, livestock methane, tidal energy, wave energy, ocean thermal, and fuel cells using renewable fuels. The organization must sell at least some of the electricity generated to a utility or someone else. x 4
7 Monetizing the Attributes of Renewable Energy When an organization reduces its emissions of greenhouse gases and other pollutants through energy efficiency and renewable energy projects, those reductions have financial value. Companies, utilities, governments and others are willing to purchase those emissions reductions to either voluntarily offset their own emissions or satisfy government mandates that they do so. For example, roughly half the states in the U.S. have adopted Renewable Portfolio Standards (RPS) that require utilities to generate a percentage of their power from renewable resources. Utilities can meet these requirements by either producing electricity from wind turbines, solar power or other renewable resources, or by purchasing Renewable Energy Certificates (RECs) from organizations that do. xi Renewable Energy Certificates Also known as Green Tags or Tradable Renewable Certificates (TRCs), RECs represent the environmental attributes of electricity generated from renewable resources such as biomass, wind, solar, or others and then delivered to the power grid. In other words, RECs represent the emissions avoided greenhouse gases and pollutants when electricity is generated from a renewable resource rather than fossil fuels such as coal or natural gas. xii For example, when a municipality generates electricity from landfill gas and sells it to its utility, it earns one REC for every 1,000 kwh of power generated. The RECs can be sold on the open market to anyone wishing to offset their use of electricity produced from fossil fuels. The purchaser of a REC can legally claim to have purchased renewable energy. Each REC is assigned a number by a certifying agency to assure that it can t be sold more than once. Energy Efficiency Certificates (EECs) EECs are similar to RECs except that they are earned for reductions in electricity usage through energy efficiency measures. Each EEC represents 1,000 kwh of electricity savings. The credits are created when an organization upgrades equipment, lighting, energy management systems or operations, resulting in lower usage of electricity. Three states Connecticut, Pennsylvania and Nevada incorporate energy efficiency into their portfolio standard. Many other states are currently considering adopting similar mandates. EECs are purchased on the open market by companies and others seeking to offset their greenhouse gas emissions. xiii Verified Emissions Reductions VERs sometimes also known as Verified Emission Reductions represent reductions in CO2 emissions resulting from renewable energy projects and certain other agricultural or forest management activities that reduce carbon emissions. VERs are measured in metric tons of carbon equivalent (MTE) emissions avoided and are sold on open markets for carbon offsets, often alongside RECs. xiv To maximize their market value, VERs should meet certain minimum requirements that include: Additionality meaning that the underlying project was in addition to business-as-usual and would not have occurred if it didn t generate VERs that could be sold to produce revenue. Sustainability renewable energy projects that in addition to reducing emissions also have a positive impact on the sustainability of local communities are preferred by VER buyers. Verifiability VERs should be certified by accredited, independent third-party organizations. Reliability VERs should also be registered to ensure that they aren t sold to multiple parties. xv Certified Emissions Reductions CERs were created by the Kyoto Protocol to represent reductions in greenhouse gas emissions from projects in developing countries. These credits can be sold to developed countries to help them meet their greenhouse gas emission reduction targets. However, projects that reduce greenhouse gas emissions in the United States cannot be used to create CERs, because the U.S. did not ratify the Kyoto Protocol. One CER is equivalent to a reduction of one metric ton of CO2 emissions. xvi 5
8 Summary Organizations seeking to finance renewable energy initiatives can select a funding approach that best fits their needs: Performance contracting permits organizations to use costs savings from energy efficiency improvements to fund renewable energy facilities Third-party ownership offers organizations an alternative funding mechanism that limits their overall risk. A variety of tax credits, rebates and other incentives are available from governments at all levels as well as utilities to help offset the costs of installing renewable energy facilities. In addition, organizations may be able to sell renewable energy, energy efficiency and emissions reductions credits generated by renewable energy facilities to help recoup installation costs and create long-term sources of revenue. Organizations seeking to accelerate their pursuit of sustainability through installation of on-site renewable energy facilities need not be discouraged by financial concerns. By working with experienced experts such as Johnson Controls, organizations can find the right financing package to ensure the overall success of their renewable energy projects. Resources i ii bioenergy.htm CEDF%20Loan%20Brochure.pdf iii iv v vi vii viii ix x xi xii xiii xiv xv xvi Energy_Recycling/Energy/Clean+Energy/ 04-wind_energy.htm incentive2.cfm?incentive_code=us02f&state=federal ¤tpageid=1&ee=1&re=1 incentive2.cfm?incentive_code=ca147f&state= CA&CurrentPageID=1&RE=1&EE=1 incentive2.cfm?incentive_code=us06f&state=federal ¤tpageid=1&ee=1&re=1 incentive2.cfm?incentive_code=us02f&state=federal ¤tpageid=1&ee=1&re=1 incentive2.cfm?incentive_code=us13f&state=federal& currentpageid=1&ee=1&re=1 incentive2.cfm?incentive_code=us33f&state=federal ¤tpageid=1&ee=1&re=1 renewable_portfolio_states.cfm certificates.shtml?page=0 WG1_NYS_PSC_Final_Comments.pdf Johnson Controls, Inc. P. O. Box 423, Milwaukee, WI Printed in USA PUBL-5309 (4/08)
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