Using ESPCs to Finance Federal Investments in Energy-Efficient Equipment

A variety of laws and executive orders require federal agencies to improve the energy efficiency of their facilities and to pursue a range of other energy-related goals. Because the availability of annual appropriations is limited, the Administration encourages federal agencies to use other types of financing—such as energy savings performance contracts (ESPCs)—to fund investments related to energy efficiency.

Under an ESPC, a private party agrees to pay to design, acquire, install, and, in some cases, operate and maintain energy-conservation equipment—such as new windows, lighting, or heating, ventilation, and air conditioning (HVAC) systems—in a federal facility. In return, the federal agency agrees to pay for those services and equipment over time, as well as for the vendor’s financing costs, on the basis of anticipated and realized reductions in the agency’s energy costs.

Such contracts are examples of third-party financing, in which vendors privately fund investments for federal agencies. In the case of an ESPC, the vendor is usually an energy service company (a business that focuses on projects and technologies to reduce energy use). Similar arrangements exist, called utility energy service contracts (also known as UESCs), in which the services and equipment are provided by a utility. Although data about the characteristics and results of utility energy service contracts are less readily available than similar data about ESPCs, the discussion of ESPCs in this report generally applies to those other contracts as well.

How Large Are the Energy Reductions Associated With Energy Savings Performance Contracts?

Investments in more efficient equipment generally reduce federal agencies’ energy-related costs. According to analysts in the Department of Energy’s (DOE’s) Federal Energy Management Program, measurements of actual energy consumption and calculations from engineering models suggest that energy-efficiency equipment recently installed for federal agencies through ESPCs is reducing energy consumption by an average of about 20 percent, relative to estimates of what energy use would have been without such investments. (Those reductions result from the equipment that is acquired rather than from the particular type of financing involved.) The results of individual projects vary considerably, and savings can be much larger or smaller than that average.

What Are the Cost Implications of Using ESPCs?

A vendor participating in an ESPC generally receives annual payments from the federal government—which are based on the government’s anticipated energy savings—until the vendor’s up-front and financing costs have been covered and the contract expires. During that payment period, a federal agency typically retains only a small portion of the projected savings in energy costs, but once the contract ends, all further savings accrue to the federal government. That contractual arrangement means that most of the cost savings that the government realizes from ESPC-funded equipment do not occur until the contract expires, often 15 years or more after it was initiated. However, ESPCs are designed so that—if the installed equipment is effective and is used at anticipated levels, and if energy prices remain close to projections—the value of the energy saved over the life of the equipment will more than cover the costs of the contract.

Given constraints on discretionary appropriations, the use of such contracts may make it easier for agencies to invest in energy efficiency and thus may lead to reductions in agencies’ energy costs that might not otherwise occur. However, compared with paying for energy-saving equipment and services up front with appropriated funds, relying on ESPCs to finance those investments results in greater financing costs to the government.

In CBO’s assessment, the government’s financing costs are higher under ESPCs because of three main factors: The energy service companies assume some financial risk that would otherwise be borne by the government; those companies face more difficulties raising funds in the markets for capital than the federal government does; and even within the capital markets to which those companies have access, they may not be obtaining financing at the lowest possible cost. The first of those factors provides economic value to the government, but the other two do not.

How Are the Budgetary Effects of ESPCs Shown in CBO’s Cost Estimates?

When a federal agency enters into an ESPC, it promises to make a stream of payments to a private contractor over a period of years to cover the costs of the equipment or services acquired through the contract. In the agency’s budget, those payments typically come from annual appropriations and are recorded as discretionary outlays over the full duration of the contract. The payments to the vendor are offset, at least in part, by whatever annual savings the investment produces.

In CBO’s judgment, however, when an agency enters into an ESPC, it is making an obligation on behalf of the government—a commitment of government resources—for the full costs of the equipment to be acquired, but without the appropriations needed to pay those costs. In CBO’s view, therefore, legislation authorizing ESPCs creates the authority to make such obligations, and in the absence of appropriations sufficient to cover the contractual costs, that authority is a form of mandatory rather than discretionary spending.

Thus, in order to accurately reflect both the timing and the size of the government’s obligations when they are made—and to be consistent with the principles underlying federal budgeting and with CBO’s long-standing practice—CBO’s cost estimates for legislation that would affect agencies’ use of ESPCs show those effects as mandatory budget authority in the years when the contractual commitments are expected to be made. The outlays estimated to result from that budget authority are shown as mandatory spending. Projected savings in energy costs and related costs are shown as potential future reductions in agencies’ discretionary appropriations.

CBO’s cost estimates for legislative proposals related to ESPCs are thus complicated by two factors:

• The additional spending required for an ESPC falls into one budget category, mandatory spending, whereas potential future savings from the contract fall into a different category, discretionary spending. In the Congressional budget process, budgetary effects in those two categories are not combined because they are subject to different budget enforcement rules.
• Much or all of the additional spending for an ESPC occurs during the 10-year period covered by CBO’s cost estimates, whereas much of the savings occur later.

Those factors—along with the fact that the federal budget generally records spending year by year on a cash basis—make it difficult to assess, in a comprehensive way, the budgetary impact of federal investments carried out using ESPCs. That difficulty is not unique to ESPCs; many investments authorized and funded through federal legislation may affect the government’s need for funding in future years, but such effects do not always fall within the scope of CBO’s cost estimates for legislation.