Glossary
Executive Summary
I. Introduction
II. Benefits of Energy Conservation
1. Emissions Reductions
2. Environmental Externalities
3. Financial Benefits
4. Cost of Capital
5. Low Energy Prices
6. Hedging Energy Price Risk
III. Barriers to Implementation
1. Capital Constraints
2. Bureaucratic Hurdles
3. Lack of Incentives
4. Information Constraints
5. Low Political Priority
6. Mission of Overseeing Agency
IV. Framework for Analysis
1. Environmental Impact
2. Amount of Cost Savings
3. Barriers
4. Implementability
5. Start up Costs
6. Ongoing Costs
7. Degree of state control
8. Capacity to expand financing
9. Coverage of energy conservation project types
10. Sustainability
V. Policy Options
1. GO Bond Financing: Public Procurement Process
2. ESCo Financing: Shared Savings Program
3. Utility Financing: Demand Side Management
4. Independent Financing: Clean State Revolving Fund
VI. Conclusions and Recommendations
A. Getting Incentives Right
1. Allow Retention
2. A&F Guarantees
3. Personal Incentives
B. Recommendations for Existing Programs
1. Encourage DSM at State Agencies
2. Move Shared Savings beyond "Pilot Phase"
3. Relax DCPO Oversight of Shared Savings
4. Avoid Public Procurement
Appendix A. Clean State Revolving Fund
1. Sharing CSRF Savings
2. CSRF Process
3. ESCos guarantee savings
4. Start with $4 million but allow expansion
5. Cross-subsidize other Clean State projects
Appendix B. Reinventing Government
1. The Budget and Clean State Barriers
2. Barriers to Budget Reform
Appendix C. Other Programs
1. New Jersey
2. New Hampshire
3. New York
4. Connecticut
5. Minnesota
6. Federal Government
7. Massachusetts DSM
8. Massachusetts ICP
9. Harvard and MIT
10. Summary of differences
Appendix D. Public Procurement Process
Appendix E. Shared Savings Process
Appendix F. The Budgetary Process
Appendix G. The Capital Spending Process
A&F Executive Office of Administration and Finance Bond Public debt is measured in "bonds" of $1,000 increments CAA Clean Air Act CSRF Clean State Revolving Fund CSI Clean State Initiative DCPO Division of Capital Planning and Operations DOER Division of Energy Resources DSB Design Selection Board (volunteer oversight committee) DSM Demand Side Management EOEA Executive Office of Environmental Affairs ERC Emission Reduction Credits for sulfur dioxide ESCo Energy Service Company (perform audits and installation) GO General Obligation bonds (on full faith & credit of the state) MWPAT Mass. Water Pollution Abatement Trust Fund (also known as the SRF) MWRA Massachusetts Water Resource Authority (Metro Boston's supplier) P2/RC Pollution Prevention / Resource Conservation RFP Request for Proposal SRF State Revolving Fund (finances water pollution abatement projects)
Since 1985, when energy conservation began in earnest, the Commonwealth has invested $35.2 million in approximately 125 large-scale energy conservation projects in state facilities. For each million dollars invested in projects completed since 1985, the Commonwealth receives following financial and environmental benefits:
In February 1993, Governor Weld issued the "Clean State Executive Order," to encourage pollution prevention and resource conservation within state government.[1] The executive order also established the Clean State Coordinating Council to address regulatory and policy impediments that prevent implementation of the Clean State Initiative. This report begins to identify and address those impediments. Specifically, it focuses on energy conservation projects in government facilities, one of the nine goals of the Clean State Initiative. This report details the benefits of energy conservation, identifies barriers that prevent the Commonwealth from achieving its energy efficiency goals,[2] analyzes current programs that addresses these barriers, and explores the creation of a revolving loan fund.
Many environmental programs have financial costs, but non-financial benefits. Often this acts as a barrier that prevents government from implementing environmental improvements. Even when the environmental benefits outweigh the financial costs, financial considerations often receive greater attention. Energy conservation, on the other hand, has both an environmental benefit and a positive financial return. Improving energy efficiency conserves natural resources, reduces air pollution, and lowers government spending. Chapter Two details the financial and environmental benefits of energy conservation practices.
Despite these benefits, several barriers still prevent government agencies from investing in cost-effective energy conservation measures. (1) Government agencies lack sufficient incentives to pursue energy conservation investments; (2) the bureaucratic process required for agencies to obtain project approval is complex and time consuming; (3) government agencies lack the financial resources required to invest in energy conservation projects; and (4) in some cases government agencies may be unaware of opportunities for energy conservation. As a result of these barriers, Massachusetts is missing out on opportunities to save both energy and money. Chapter Three discusses these barriers in detail.
In its September 1993 report, the Clean State Coordinating Council cited energy conservation as a priority of the Clean State Initiative;[3] and in the Massachusetts Energy Plan, the Division of Energy Resources has set the goal of making Massachusetts "the most energy efficient state in the nation."[4] The Clean State Initiative directs state government to lead through example. The Commonwealth can make state government buildings a model of energy efficiency for the private sector to emulate, and it can assist local governments to do the same in municipal facilities.
The Commonwealth has four available options for financing its energy efficiency goals: (1) Bond financing, (2) the Shared Savings Program, (3) Demand Side Management (DSM) and (4) creation of a revolving loan fund. Chapter Four develops a framework for analyzing each of these options, and Chapter Five applies each of these options to the analytical framework. This analysis leads to recommendations in Chapter Six. We recommend actions that the Commonwealth should take to overcome the barriers presented in Chapter Three.
Energy conservation projects have both financial and environmental benefits. The financial benefits alone make these projects attractive. But energy conservation also produces positive environmental externalities. The combined financial and environmental benefits justify devoting the Commonwealth's time, effort, and resources to energy conservation opportunities in Massachusetts.
The Commonwealth's energy expenses are not "budget busters." Total expenditures on energy in state-operated facilities amount to $90 million per year, or 0.6% of the budget. Annual savings from the Commonwealth's previous conservation efforts total $10.9 million, or less than 0.1% of the budget.[5] Nevertheless, energy conservation projects have positive net present values, and high rates of return.
Energy conservation also reduces air pollution, which reduces health risks and avoids pollution mitigation costs. The size of these benefits depends upon the fuel mix that would have been used to produce the Commonwealth's energy. First, we quantify the total economic benefits of energy conservation, both financial and environmental. Then, we discuss the factors which affect the size of these economic benefits.
On average, every million dollars of capital invested on energy conservation projects in Massachusetts since 1985 produces avoided costs of over $300,000. The average discounted payback period on these projects is about five years.
Energy conservation projects have consistently maintained a high rate of return. The DCPO Energy Team has overseen the investment of $35.2 million in about 125 energy conservation projects since 1985.[6] That investment has generated a gross savings of $10.9 million per year, for a rate of return of 30.9%. The average discounted payback period for these projects at the Commonwealth's current cost of capital is slightly over five years.[7] From a financial perspective, energy conservation projects are attractive investments.
On average, every million dollars of capital invested on energy conservation projects in Massachusetts reduces annual emissions of air pollutants by 5,300 tons of CO2, 34 tons of SO2, and 23 tons of NOx.
Energy conservation creates an environmental benefit by reducing emissions of air pollutants. Massachusetts' electricity is primarily generated by oil and natural gas.[8] Burning fossil fuels emits large amounts of airborne pollutants, primarily carbon dioxide, sulfur dioxide, and nitric oxides. Table 2.1 indicates Massachusetts' average emission reductions for each million dollars of capital invested between 1985 and 1993.
CO2 SO2 NOx Tons of annual reductions 185,600 tons 1,199 tons 809 tons Tons per million invested 5,270 tons/$M 34.1 tons/$M 23.0 tons/$M New reductions in FY93 60,800 tons 487 tons 170 tons Tons per million in FY93 7,670 tons/$M 61.5 tons/$M 21.5 tons/$M
"Tons of annual reductions" (the first row of Table 2.1) indicates the level of emissions that the Commonwealth avoids each year as a result of all energy conservation projects completed since 1985. For example, Massachusetts emits 1,200 tons less sulfur dioxide per year than would have been emitted had these projects not been implemented. Each year, more emission reductions accumulate, as more energy conservation projects are completed. The environmental benefits last for the life of the installed equipment. The last two rows of Table 2.1 indicate the avoided emissions for projects completed during fiscal year 1993, as well as the environmental effect of those projects.
The Commonwealth could sell some of its SO2 emission reductions under the Clean Air Act Acid Rain Program. The Commonwealth could "opt in" to the Acid Rain Program as a source of SO2 emission reductions, under the CAA Amendments of 1990. Emission reduction credits (ERCs) for SO2 currently sell on the Chicago Mercantile Exchange for about $200 per ton. Only emissions which originate from primary consumption are eligible for ERCs (electricity reductions are not eligible).[10]
On average, every million dollars of capital invested on energy conservation projects in Massachusetts generates $88,000 per year in external environmental benefits. This represents the value of the lower emissions of air pollutants in Finding 2.2.
In addition to the financial benefits of $309,000 per million invested, energy conservation projects add $88,000 per million in environmental benefits. The economic benefits of energy conservation projects (the sum of financial and environmental benefits) amount to $397,000 per million invested (see Table 2.2). Massachusetts' investment of $35.2 million has generated an economic rate of return of 39.7%.
CO2 SO2 NOx Total Annual external benefits $0.83 mil $1.98 mil $0.28 mil $3.08 mil Benefit per million invested $23,500/$M $56,200/$M $7,900/$M $88,000/$M Annual financial benefits $10.9 mil Benefit per million invested $309,000/$M Financial plus external benefits $10.9 mil Benefit per million invested $397,000/$M
Massachusetts state government should evaluate projects based on the economic benefits of energy conservation, not merely on the financial benefits. There is precedent for this practice in the Commonwealth. Specifically, the Massachusetts DPU cites "external economies or diseconomies (e.g., environmental attributes)" as a possible non-price criteria in evaluating energy resources.[12] Although we do not detail the environmental benefits of energy conservation any further in this report, an additional 8.8% savings should be added when considering the same savings in environmental economic terms.
Energy conservation projects since 1985 have accumulated an annual environmental benefit of $3.1 million, in addition to the annual financial benefit of $10.9 million (last column of Table 2.2). The environmental benefits accrue from the reduction in fuel consumption due to energy conservation (for our calculations, we use electricity consumption as a proxy measure of fuel consumption).[13] Each additional megawatt-hour of energy conserved will add $28 in external benefits,[14] in addition to the financial savings of $115.[15]
CO2 SO2 NOx (A) EPA emission estimates 1.1 lbs/kWh 4.0 gm/kWh 1.4 gm/kWh (B) DOE external cost estimates 0.68 ¢/lb 0.45 ¢/gm 0.18 ¢/gm (A/B) External benefit $7.48/MWh $17.90/MWh $2.53/MWh
Cost of capital affects the financial benefits of energy conservation projects. To promote energy efficiency, the Commonwealth should seek ways to lower its cost of capital.
Since the Commonwealth can issue tax-exempt debt to finance conservation projects, its cost of capital is low. The interest rates on the Commonwealth's recent general obligation (GO) bond issue ranged between 4% and 5% (for different maturity dates). Further, since the Commonwealth regularly issues large amounts of GO debt, its cost of issuance per bond is low. Therefore, it can evaluate energy conservation projects at a favorably low discount rate. As interest rates increase, the net present value of energy conservation projects diminishes.
To make energy conservation projects appear more attractive, the Commonwealth should take advantage of federal subsidies. Subsidies represent transfers between the federal and state governments; they do not increase social welfare, nor do they increase the benefits of conservation projects. Nevertheless, implementing energy conservation projects generates positive environmental externalities by improving air quality. Often that benefit extends beyond state borders. Although there is not necessarily a correlation between the size of the subsidy and the size of the environmental externality, a federal subsidy increases the return on a state's capital investment. This may change the state's decision criteria to allow the implementation of projects with longer payback periods.
The Commonwealth can encourage energy conservation projects in local government facilities by providing subsidized loans to municipalities. Chapter Five describes and evaluates the revolving loan fund concept for financing energy conservation in Massachusetts. The "Clean State Revolving Fund" would be partly capitalized with federal subsidies. The Commonwealth could use the CSRF to provide subsidized loans to municipalities for their energy conservation projects. As the CSRF increases its level of subsidy, energy conservation projects become more financially beneficial to municipalities, and discounted payback periods on these projects decrease. This would allow municipal participants to implement more projects that they otherwise would.
Low energy prices make conservation projects less financially attractive. But the Commonwealth should not set energy conservation policy based on current or "expected" prices because energy prices are volatile and unpredictable.
Real energy prices have been falling and are at a 15-year low. Figure 2.4 shows the real price of energy, which is currently at its lowest point since the last "oil price shock" in 1978.[17] Low energy prices reduce the financial benefits of energy conservation projects because as energy prices fall, the annual savings from conserved energy falls.
Energy prices are unpredictable. If energy prices were expected to rise, the Commonwealth would be wise to undertake more energy conservation projects. But energy prices are volatile and hard to forecast.[18] Economic theory predicts a slow rise in real energy prices over time. But Figure 2.4 demonstrates that energy prices do not follow economic theory, and Figure 2.5 shows that energy inflation is more volatile than general price inflation.
1960 1970 1980 1990
The unpredictability and volatility of energy prices creates budgeting risk for government. The Commonwealth can hedge this risk with energy price swaps.
Energy price swaps allow the public sector to manage its energy price risk exposure and to remove the uncertainty in budgeting energy expenses.[19] An energy price swap is a financial instrument, administered by an investment bank, which allows the Commonwealth to buy energy at a fixed price, regardless of the true "spot price." Speculative investors capitalize on the Commonwealth's energy price risk aversion. They make money if energy prices fall, and lose money if energy prices rise. Either way, the Commonwealth can purchase energy at a fixed negotiated fee.
1960 1970 1980 1990
If the Commonwealth decides to hedge its energy price risk, it could calculate the financial benefits of energy conservation projects with certainty. However, the reason to enter into these contracts is not to ensure that energy conservation projects hold their value, but rather because the Commonwealth may want to eliminate energy price uncertainty in budgeting its expenses.
Massachusetts is missing out on opportunities to save money and energy. Despite the benefits of energy conservation, several barriers prevent the Commonwealth from making cost-effective capital investments. (1) Government agencies lack sufficient incentives to pursue energy conservation investments; (2) the bureaucratic process required for agencies to obtain capital funding is complex and time consuming; (3) government agencies lack the financial resources required to invest in energy conservation projects; and (4) in some cases government agencies may be unaware of available cost saving technologies.
The budgetary and appropriations process removes incentives for government agencies to pursue opportunities for efficiency improvement. Under present budgeting practices, state agencies do not reap the financial rewards of their efforts. This significantly reduces an agency's profit incentive to pursue energy conservation.
Following the implementation of an energy conservation project, an agency's operating budget would begin to accrue savings. However, budgetary appropriations specify exactly how an agency may spend its money. Therefore, when savings accrue to an agency's energy expense account, the agency may not use its savings for other purposes without the approval of A&F and the Ways and Means Committees.[20] At any one time the Administration has specific spending priorities and the Legislature has its own. Given the many worthy public projects which the government cannot afford to fund, it is unlikely that A&F and the Legislature would allow the agency to retain and spend its savings.
The Budget Bureau's diligence in identifying retained revenues depends in large part upon the state's revenue projections and cash flow for that year. In a year of abundant tax revenues (usually resulting from an unexpectedly strong economy), the Budget Bureau might overlook surpluses in an agency's accounts. However, during an economic downturn or fiscal crisis, the Budget Bureau will actively search for unspent appropriations. A&F has the power to "reverse" unspent revenues during the current fiscal year, and to cut the agency's budget in the next cycle. This "use it or lose it" policy reduces the incentive for government agencies to identify and implement any cost-saving measure.
A&F's policy toward surplus reversion is critical to the agency's decision whether to implement energy conservation projects. Although A&F has considered the idea of allowing agencies to keep a portion of the savings, in practice that objective is hard to implement. A&F's promises are not wholly credible given the potential for shifts in the Administration's priorities. Further, neither house of the Legislature would look kindly on large sums of retained savings which could otherwise fund their priority initiatives. After conservation measures had been adopted, A&F and the Legislature would still have to balance programs which they consider important against the uses agencies would have for their retained savings. For these reasons, developing incentives for long term investment in state facilities presents a difficult challenge for state government.
The bureaucratic process required to obtain capital funding is complex and time consuming. This increases the cost of implementing energy efficiency projects and impedes conservation efforts. Whenever a state facility wants to make capital investments which exceed $100,000, it must seek assistance from DCPO. DCPO oversight guards against waste, fraud, and abuse in the procurement of government contracts. Further, DCPO is responsible for monitoring safety regulations in state facilities, and therefore, it must approve the soundness of any proposed capital project. The public procurement process, which applies to most capital improvements in state facilities, can take up to 45 months from the time when DCPO announces its intention to implement capital improvements, until project completion. (Figure 5.1 presents a flow chart of the public procurement process.[21] For a more detailed description see Appendix D.) The Shared Savings Program circumvents part of this bureaucratic burden due to special provisions written into its enabling legislation. (Figure 5.2 presents a flow chart of the Shared Savings Program. For a more detailed description see Appendix E.) The bureaucracy involved to implement capital improvements represents a cost to state agencies in terms of the time, effort, and resources required for project approval. These costs reduce the attractiveness of capital improvements and deter agencies from pursuing energy efficiency opportunities.
Energy conservation is a low political priority. It is not central to the mission of most government agencies, and as a result, they fail to receive sufficient funds for these projects. Energy conservation projects have up-front capital requirements that range from a few thousand dollars to a few million dollars. Some of these projects have payback periods of less than a year, while others have payback periods of over ten years.[22] In the absence of capital constraints, the Commonwealth could implement every energy conservation project that had a positive net present value, regardless of capital requirement or payback period. The Commonwealth does have limitations on its ability to issue debt, and the state's debt policy prohibits bonding for any energy efficiency project with a simple payback period of greater than five years. These limitations prevent the state from investing in energy conservation at a cost-effective level.
Energy efficiency projects increase capital spending, which violates the Weld Administration's debt management objectives. The Commonwealth is currently a high debt state. In 1993, the state's ratio of tax-supported debt to personal income ranked the fourth highest in the nation[23] and its per capita tax-supported debt ranked third highest.[24] Between fiscal years 1987 and 1989, annual capital spending in the state grew by 62% from approximately $600 million to $971 million.[25] To address this problem, the Commonwealth has taken two important debt management measures. In 1989, the Legislature imposed a limit on the amount of "direct"[26] bonds that the Commonwealth may have outstanding at any one time.[27] In August 1991, Governor Weld instituted a five year capital spending plan, which is updated every year. The plan also sets self-imposed limits on new debt issuance (as opposed to the Legislature's limit on total debt outstanding). As a result of its efforts, the Commonwealth received two separate upgrades in its GO bond rating during 1993. Maintaining a favorable credit rating remains a priority for the Weld Administration.
The Weld Administration would rather spend general obligation debt on Clean State Initiative projects with larger environmental impact and higher political appeal. Given the Commonwealth's legislative limits on outstanding debt, the Administration's limits on new debt issuance and the restrictions of the five year capital spending plan, general obligation bond financed projects must all compete for limited capital funds. Energy conservation, however, is not politically important enough to attract a substantial amount of these scarce funds. The Commonwealth has not capitalized DCPO's energy audit accounts since 1988,[28] and since 1985 it has only spent $5.2 million of bond revenues on energy efficiency investments.[29] Since capital requirements can be high and payback periods can extend beyond the election cycle, implementing energy conservation projects does not yield high political returns; the political appointee who undertakes higher debt today, may not be in office to enjoy the cost reductions of tomorrow.
State agencies cannot finance energy conservation projects on their own because legal restrictions prohibit an agency from shifting funds between operating and capital accounts. Projects that generate annual savings large enough to compensate for capital expenditures within one budgetary cycle could potentially be financed from out of an agency's appropriated operating revenue. For example, if it cost $900 to replace a facility's lighting system with energy efficient fixtures that would reduce the facility's utility bills by $1000 per year, then the agency could afford to pay for the capital improvements from its appropriated utility expenses within one budgetary cycle. By the end of the fiscal year, the agency would have a $100 surplus in its operating budget, as well as an improved lighting system. Unfortunately, it is illegal for an agency to spend appropriations from its operating budget on capital investments; shifting money among expense accounts represents a misappropriation of funds.[30]
State agencies cannot save money to pay for energy conservation projects by reducing their spending because the budgetary and appropriations process does not allow them to retain savings. By identifying areas of fiscal waste, an agency could reduce its spending to save the difference between appropriated and expended funds. Over several years, sufficient savings might accrue to finance an energy conservation project. However, as described above in the incentives barrier section, the Budget Bureau monitors the accounts of each state agency to identify surplus revenues. Usually, the Budget Bureau "reverses"[31] unexpended funds and A&F cuts the budget of any agency that it has overfunded.
Public facility managers may be unaware of conservation opportunities, available technology, and/or sources of funding. Since energy conservation is not central to the mission of most government agencies, and since these agencies often do not receive the financial rewards of their conservation efforts, there is little incentive for public facility managers to develop the technical expertise necessary to identify energy efficiency opportunities. Hiring engineering firms to perform energy audits can help to inform facility managers as to potential cost-saving measures. However, before a state agency can perform an energy audit, it must receive authorization by the Legislature; selection of a firm to perform the audit is subject to the public procurement process; and energy audits can be costly. The Commonwealth has not performed energy audits for several years at many state facilities.
Decentralization and diversity of facilities exacerbate the information barrier. Small public facilities have difficulty keeping informed as to available technology and sources of funding. Conversely, information constraints are less prevalent at large, centralized agencies. Government agencies can reduce information barriers by sharing their knowledge and experiences with one another. But this becomes very difficult when public facilities are decentralized and diverse; decentralization makes inter-facility communication difficult, and diversity of facilities makes information sharing less relevant. Successful energy conservation programs include education as part of their mission. For example, the Federal ICP program disseminates information through frequent mailings to potential program participants and announcements in industry periodicals. (For a detailed description of this program see Appendix C-7).
This chapter develops a framework for analyzing the energy conservation programs available to the Commonwealth. Below, we describe ten evaluative criteria in detail. Chapter Five applies these criteria to four policy options.
Energy conservation projects have fiscal benefits because they reduce the host facility's utility expenditures (see Chapter 2, Finding 2.1). The fiscal benefit which accrues to the Commonwealth, however, depends upon the amount of revenue returned to the General Fund. Essentially, this category measures the potential for each option to lower taxes, or to generate revenue for spending on new projects.
Specifically, we assess fiscal savings based on two criteria. (1) What portion of the savings accrues to the General Fund (versus how much accrues to outside entities)? and (2) How much total savings typically accrues to the General Fund under each program?
Identifiable barriers prevent the implementation of energy conservation projects (see Chapter Three for detailed discussion). This category measures the difficulty with which host facilities implement energy conservation projects under each program. We assess the barriers to implementation based on three criteria:
(1) Incentives to host facilities: How much does the host facility benefit directly from the energy savings? Are there incentives directed towards the host facility, to make up for the time and effort of pursuing energy conservation?
(2) Bureaucratic hurdles: How difficult is the process of implementation? How much time is spent on oversight and control functions, relative to substantive components of the process? How long is the delay between authorization and equipment installation?
(3) Capital constraints: How readily available is funding?
This category estimates how well each policy option will be received in the current political climate. For any energy conservation program to be implemented, it will need some combination of support from the Governor, A&F, EOEA, DCPO, and the Legislature.
We assess implementability based on two criteria. (1) Political viability: How likely are projects to get done under each policy option? (2) Political "attractiveness": Does the policy have a "high political profile" or strong public support?
We assess implementability based on two interrelated criteria. (1) Legislative Requirements: Does the option require legislative action to be implemented? (2) Institutional Hurdles: Does implementation fall within the repertoire of established government institutions or will it require new bureaucracy?
Once implemented, a policy has ongoing costs which are independent of its startup costs. We assess the ongoing costs based on three criteria: source of investment capital for each project; administrative costs; and risk that the equipment will not save energy.
(1) Source of capital: Does the Commonwealth have to cover capital costs? Does the Commonwealth receive subsidies? Does someone else pay entirely?
(2) Administrative and maintenance costs: How much time and effort are required on the part of the host facility and oversight agencies to administer the program? Are regular inspections of equipment or utility bills necessary? Is maintenance of the equipment the responsibility of the host facility?
(3) Risk of equipment inefficacy: Who assumes the risk of the equipment's not performing up to expectations? Conservation equipment might fail to perform not only because of poor installation or poor choice of equipment, but also because personnel may need training in its use.
The Commonwealth does not act based on profit motives, and is therefore subject to misspending if there are not sufficient controls. State control guards against corruption in awarding government contracts and ensures that the Commonwealth uses its money wisely. This category assesses the degree of control that the Commonwealth maintains in each program.
(1) Prevention of waste, fraud, and abuse: The usual means of controlling potential corruption is by oversight, certification, and registration requirements, and by independent agency involvement throughout the spending process. How much oversight and state involvement is there under each policy option?
(2) Control over Equipment Quality: Does the Commonwealth retain control over the quality of installed equipment? Are there incentives to purchase equipment that is cost-effective over its expected operating life? Do incentives reward the purchase of inexpensive equipment that may break down quickly, or generate smaller annual savings?
This criterion assesses the applicability of the policy option to other beneficiaries and for other environmental projects. While this report is concerned primarily with financing energy conservation projects at state agencies, the policy options explored here are potentially applicable to other projects and other sites as well.
(1) Municipal benefit: Does the policy option benefit only state facilities or could municipalities benefit from the policy option?
(2) Project Types: Could this option be used for financing a range of environmental programs that go beyond energy conservation? Other goals of the Clean State Initiative do not produce cost savings -- could the financing option be used for projects which have financial costs and environmental benefits?
This criterion assesses each program's capacity to implement a diversity of project types (large, small, highly profitable, capital intensive, etc.). How restrictive are the program's criteria for selection of projects?
Will energy conservation projects survive under this financing scheme? Can the program be easily abandoned following a change in administration or due to a shift in the Administration's spending priorities? How permanent is this option and what will ensure its longevity?
The Commonwealth has four financing options for implementing energy efficiency projects: (1) Bond financing, (2) the Shared Savings Program, (3) the creation of a revolving loan fund, and (4) Demand Side Management. This chapter describes each of these options and applies them to the criteria of our framework outlined in Chapter Four. We describe each option in greater detail, for those unfamiliar with the programs, in appendices: Appendix D for Bond Financing and the public procurement process; Appendix E for the Shared Savings Program process; Appendix A for suggestions for setting up the Clean State Revolving Fund; and Appendix C-6 for Demand Side Management's incentive system and economic implications.
The Commonwealth has reduced its reliance on bond financing for energy conservation projects in recent years. Bond financing allows the Commonwealth to issue general obligation debt to pay for any approved capital project within state government. But since 1985, the Commonwealth has spent only $5.2 million of bond revenue on energy efficiency in state facilities. The Legislature last authorized $2 million in bond funds for energy conservation projects in 1988, and DCPO has yet to utilize these funds. When financing capital projects with bond revenues, the Commonwealth bears the full cost of installing equipment, the full burden of maintaining that equipment, and the full risk of that equipment's failing to produce expected fiscal savings. However, the Commonwealth captures all of the savings that accrue from its capital investments.
Bond financed energy conservation projects "crowd out" other potential bond financed projects. As discussed in Chapter Three, the Commonwealth is limited in its ability to issue GO debt. An issuer's credit rating, its ability and legal authority to collect tax revenues, the interest rate, and the political environment all determine how much GO debt any one issuer can borrow. Given this limitation, financing energy conservation projects with bond revenue precludes the implementation of programs that would otherwise receive funding. Considering the Weld Administration's goals of reducing new debt issuance within the Commonwealth, bond financing has few advantages. „PPP„ chart, 3.1 goes here Public Procurement Process diagram
The Shared Savings Program addresses some of the barriers that prevent government agencies from implementing cost-effective energy conservation projects, but it has drawbacks. The Shared Savings Program overcomes capital constraints and reduces bureaucratic hurdles. However, under the Shared Savings Program agencies still lack financial incentives to pursue energy efficiency; the Commonwealth does not capture the full savings from its capital improvements; and many types of facilities are not considered for project implementation. The Shared Savings Program is still officially only in a pilot phase.
Implementing Shared Savings projects cost the Commonwealth nothing up front because ESCos satisfy all capital costs. The Commonwealth's only cost is the time spent negotiating the contract and monitoring the installation of equipment. Under the Shared Savings Program, DCPO hires
The Commonwealth pays nothing to an ESCo if expected energy savings do not accrue. In return for the Commonwealth's pledge to share savings, ESCos "guarantee" that their capital improvement will generate reductions in energy costs. A typical contract lasts seven to ten years, during which time the ESCo is paid a predetermined percentage of the energy savings generated (usually between 60%-80%). The savings are calculated based on a negotiated formula which controls for previous energy usage, degree days, hours of operation, and other factors that impact energy cost. A typical contract limits the ESCo to a profit margin of 20% above the cost of installation; if the "cap" is reached, the contract terminates early and the host facility makes no further payments to the ESCo. „SSP„ (Shared Savings Process diagram) fig 3-2 goes here
DSM programs overcome most of the barriers to energy conservation projects at state facilities. Capital constraints are removed, because utilities provide equipment at their own expense. Bureaucratic hurdles are low, because the state facility participating in DSM does not provide any funds of its own, and hence is not subject to public procurement restrictions. Incentives at state facilities are provided by getting new equipment, which often provides a better working environment. Information constraints are minimized because utilities themselves solicit customers for DSM projects, and provide customers with a choice of contractors to implement the conservation measures.
DSM programs have been implemented since the mid-1980s, for both private customers and for state facilities. DSM programs provide about $160 million annually in capital for Massachusetts overall, of which about $2.1 million annually goes to state facilities.[32] DSM programs apply strictly to electricity usage, since electric utilities provide the services. DSM cannot be used for achieving Clean State goals other than energy conservation, nor even for energy conservation measures other than lowering electricity consumption (such as heating systems).
Utilities have an incentive to implement energy conservation measures in order to reduce peak demand, and to maintain a good public image.[33] The purpose of DSM, from the utility's perspective, is not to avoid plant construction -- in Massachusetts, there is currently excess capacity, and a new plant will not be needed for at least ten years. The purpose of DSM is also not to reduce electricity consumption -- utilities earn their revenue from increasing consumption, and reducing consumption is a side-effect of reducing peak demand. Nevertheless, DSM projects reduce electricity usage and hence fulfill the energy conservation goal of the Clean State Initiative.
The more seed money that CSRF receives, the more projects it can implement. The Clean State Revolving Fund would receive its initial seed money from a combination of federal grants and state matching funds. Title 1 of the Federal Energy Policy Act of 1992 provides for a $1 million federal grant (to be matched by $3 million in state funds) for the creation of a revolving fund, explicitly for energy conservation projects.[34] Currently, the federal Department of Energy has budgeted $11 million to capitalize revolving loan funds nationwide. The Congress has not yet appropriated these funds. Although the federal government will only contribute $1 million to the CSRF, the Commonwealth may choose to invest more than $3 million. The CSRF could supplement the Shared Savings program by financing smaller or less profitable energy conservation projects in the Commonwealth, which ESCos typically do not pursue.
The Clean State Revolving Fund could assist both state and municipal facilities to implement energy conservation. Although the Clean State Executive Order does not specifically mention environmental projects outside of state government, assisting municipalities throughout the state to realize their energy conservation goals is well within the spirit of the Clean State Order. As long as its enabling legislation provides the appropriate authorization, the Clean State Revolving Fund could lend money to many types of government entities, including any "town, city, district, commission, agency, authority, board or other instrumentality of the Commonwealth."[35]
With leveraged loans, the Commonwealth receives $8 for every $3 it invests in the CSRF. For every $3 that the Commonwealth invests in the Clean State Revolving Fund (up to $3 million) the federal government contributes $1. Through leveraged bond financing, the CSRF can double that $4 to attract $8 in bond revenue. Therefore, with a $3 million investment CSRF can attract $8 million in leveraged loans.[36] To issue leveraged loans, the CSRF must establish a 50% debt reserve fund. The reserve fund would provide a measure of financial security to bond holders. If program participants were to default on their debt service obligations, the CSRF would have money on hand to repay the bondholders' investment.
The debt service reserve fund allows CSRF to offer program participants loans at highly subsidized rates. The CSRF can invest the debt service reserve fund and earn investment income on that account. If the CSRF were to borrow $8 million at 6% interest, and were to invest its original $4 million at a similar rate, then it could earn half of its interest obligation from the investment income on its debt service fund.[37,38] In turn, revolving funds pass this benefit on to program participants in the form of subsidized loans. Often revolving funds lend money to program participants at one-half of the interest rate that each participant would have paid if it were to issue bonds on its own.39 By subsidizing loans, the CSRF would provide greater incentives for public facilities to pursue energy conservation opportunities.
Shared Savings Program: strong impact. Environmental impact is not central to the Shared Savings Program's mission. ESCos are profit motivated, thus they implement projects that have the highest financial reward, not necessarily the highest environmental impact. Nevertheless, DCPO oversight maintains a level of environmental conscientiousness. The Commonwealth has implemented $11.5 million worth of energy efficiency projects through Shared Savings since 1985.
Clean State Revolving Fund: potential for high impact. The CSRF would not be strictly profit motivated, and therefore could base project decisions on both net present value and environmental benefits. As a result, CSRF could implement some projects with low financial return and high environmental impact. CSRF's environmental benefits will depend on the amount of seed money it receives. More money means more projects, which means more emission reductions.
DSM: highest impact. Utility companies that offer DSM services seek to reduce system-wide energy consumption in order to smooth out peak demand. Improving the energy efficiency is the means to that end, and therefore, environmental benefits are not part of DSM's mission. Nevertheless, DSM accounted for $18.5 million in investment -- more energy capital investment than Shared Savings and bond funding combined.
Shared Savings Program: moderate portion. Host facilities share savings with ESCos when financing projects. Typically ESCos receive 60%-80% of savings. The General Fund's portion of these savings depends upon the Budget Bureau's diligence in identifying retained revenues.
Clean State Revolving Fund: moderate portion. The Clean State Revolving Fund and the General Fund will share savings from energy conservation. Program participants pay debt service to re-capitalize the CSRF. Remaining savings revert to the General Fund.
DSM: high portion. Host facilities capture all savings. The General Fund's portion of these savings depends upon the Budget Bureau's diligence in identifying retained revenues.
Shared Savings Program: strong potential. ESCos tend to seek out projects with large savings potential and the state finances many projects by this method.
Clean State Revolving Fund: strong potential. The CSRF's level of capitalization will determine its total savings potential. The more money it has, the more projects it can implement and the more savings it can produce.
DSM: highest potential. Since 1985, DSM has accumulated $5.8 million in annual reductions in utility expenses, by implementing environmental projects in state facilities. Net savings to the Commonwealth from DSM reflects its favorable total savings potential.
Shared Savings Program: not a constraint. ESCos provide all investment capital.
Clean State Revolving Fund: potentially not a constraint. CSRF overcomes capital constraints to the extent that the Commonwealth provides sufficient seed money.
DSM: not a constraint. Utility companies provide all investment capital.
Shared Savings Program: some constraints. This program circumvents many bureaucratic requirements through legislative provisions in the pilot program's enabling act.
Clean State Revolving Fund: potential for some constraints. For CSRF to be effective, the Commonwealth should set it up in the same manner as the Shared Savings Program. CSRF should be exempted from most of the public procurement process.
DSM: few constraints. State agencies require DCPO oversight to ensure the safety of capital improvements.
Shared Savings Program: moderate constraint. Since A&F is not involved in financing projects under shared savings, they will be less aware of expected savings. Further, this program makes efforts to allow host facilities to retain the state's portion of savings for the length of the contract. Nothing prevents A&F from reversing revenues, however.
Clean State Revolving Fund: potentially a moderate constraint. The Commonwealth should implement CSRF with a provision that provides for financial incentives.
DSM: moderate constraint. DSM projects under $100,000 do not require DCPO oversight and therefore an agency could implement DSM measures without the Administration's knowledge. Nevertheless, no provisions of DSM guarantee that host facilities will be allowed to keep savings.
Shared Savings Program: strong political viability and high political attractiveness. The Legislature established Shared Savings as a pilot program in 1984. DCPO has relied heavily on the program since its creation. The fact that ESCos pay all capital costs strikes a positive cord in political arenas. The public/private enterprise concept enhances Shared Savings' appeal, and furthers the Weld Administration's privatization goals. Shared Savings has strong political support, but the Legislature still has not made it into a permanent program.
Clean State Revolving Fund: good political viability and high political attractiveness. The state's revolving fund for water pollution abatement projects (MWPAT) has enjoyed strong success, and therefore, CSRF might attract similar political support. The Federal matching funds provide an incentive for the state to implement CSRF. Leveraged loans make CSRF even more attractive.
DSM: high political viability, but low political attractiveness. Implementation of DSM is not a problem, since it is in effect throughout the Commonwealth. But DSM has neither a high political profile and nor a strong political appeal, because it is outside of the public eye and the political arena.
Shared Savings Program: low startup costs. The Shared Savings Program is still officially in the pilot phase. The Legislature either has to renew the pilot program each year, or could enact Shared Savings as a permanent program. No new institutional capacity would be required to make Shared Savings permanent.
Clean State Revolving Fund: high startup costs. To establish this fund would require entirely new legislation. Institutional capacity to administrate the fund would have to be created. CSRF would need seed money to finance projects.
DSM: no startup costs. No legislative action needed; no institutional hurdles exist.
Shared Savings Program: low ongoing costs. ESCos cover all capital investments under the Shared Savings Program. Depending on the contract, either the ESCo or the Commonwealth may retain ownership of the equipment at the contract's termination. ESCos also maintain and repair equipment for the term of the contract. ESCos bear the risk of equipment failure. The only costs that the Commonwealth incurs are oversight and transaction costs.
Clean State Revolving Fund: moderate ongoing costs. The Clean State Revolving Fund would require initial seed money. But once it received capital, the CSRF could revolve funds over many years to fund several projects. The Commonwealth would not have to recapitalize CSRF for each conservation project. Just as with bond financing, however, the Commonwealth would bear the full cost of maintenance, and the full risk of equipment inefficacy.
DSM: low ongoing costs. Under DSM, utility companies pay for capital investments. Host facilities still bear the cost of maintaining the new equipment, and bear the risk of equipment failure. However, the utility has a strong incentive to install equipment that will reduce consumption for many years. Maintenance cost and equipment failure risk should be low under DSM.
Shared Savings Program: moderate control. Shared Savings circumvents much of the public procurement process, and therefore does not guard against corruption as much as bond funding does. However, the process still includes appropriate safety measures. DCPO shares control over equipment choice with ESCos. Since ESCos pay for and maintain the installed equipment, they have the incentive to choose equipment with high cost savings and low maintenance costs. Since Shared Savings contracts bind ESCos for 7-10 years, ESCos do not have a profit incentive to choose equipment with operating lives longer than the contracts. However, that timespan is often adequate to ensure long term quality.
Clean State Revolving Fund: moderate control. CSRF's enabling legislation could subject CSRF to the same procurement process as the Shared Savings Program. Doing so would give up some control against corruption. CSRF would retain full control over equipment choice, given that it pays for all capital improvements.
DSM: low control. Waste, fraud, and abuse is not relevant to DSM. Utility companies provide free capital equipment to the Commonwealth. The state does not need control over choosing which firm installs the equipment because public funds are not used to compensate that firm. The state does retain its oversight role to ensure safety. The state shares control over equipment choice with the utility.
Shared Savings Program: little capacity to expand. The Shared Savings Program exempts municipalities from Proposition 2-1/2. Shared Savings addresses water conservation projects in addition to energy conservation projects, but it does not address other CSI goals.
Clean State Revolving Fund: strong capacity to expand. The Clean State revolving fund could easily expand to assist municipalities in financing energy conservation. If the CSRF receives federal funds, it would be partially restricted in the type of projects that it addresses. The revolving fund concept could, however, be used to finance many types of environmental projects in Massachusetts.
DSM: mixed capacity to expand. DSM applies to both state and municipal buildings. However, DSM only applies to electricity conservation projects and as a potential model for water conservation projects.
Shared Savings Program: some diversity. Generally, ESCos seek projects with high utility expenses and large saving opportunities. Many smaller projects, or projects in remotely located facilities do not receive the attention of ESCos.
Clean State Revolving Fund: potential for high diversity. CSRF's goal would be to implement many projects and to balance environmental concerns with financial concerns. It would not have a strict profit mission. Therefore, it could potentially finance a wide array of projects.
DSM: moderately restrictive. some diversity. Utility companies will implement the projects that return the largest energy savings per dollar invested, but only in electricity conservation projects.
Shared Savings Program: good sustainability. The Legislature has consistently renewed the Shared Savings program since its creation as a pilot program in 1984. As a pilot program it could be dissolved relatively easily, but Shared Savings has enjoyed strong political support and its dissolution is unlikely.
Clean State Revolving Fund: high sustainability. If the Legislature were to create CSRF, and if CSRF were to receive federal matching funds, it would achieve a high level of sustainability.
DSM: highly sustainable. Utility companies have a strong profit incentive to continue DSM programs over time. A utility would abandon its DSM program only if excess capacity became very large. Given Massachusetts' growing energy needs, this is unlikely to happen. „EEF-Smy„ goes here, figure 5-1 Framework moons summary diagram „EEF-Dtl„ goes here, figure 5-2
This chapter presents specific action-oriented recommendations that the Commonwealth should implement to achieve its energy conservation goals. These recommendations address the barriers that prevent state agencies from pursuing energy efficiency projects.
The Shared Savings Program's enabling legislation exempts Shared Savings projects from the traditional public procurement process. Since Shared Savings' enactment, energy conservation service procurement has proceeded smoothly. The requirements on energy conservation projects under other programs should also be relaxed.
If CSRF administrators determine that substantial demand for energy conservation financing exists among municipalities, the Commonwealth should increase CSRF's level of capitalization. CSRF could then also offer leveraged pool loans for municipal projects throughout the state.
By establishing CSRF, the Commonwealth could receive $1 million in federal money.[40] In addition, the state would capture all resulting savings from the projects financed by the CSRF. Part of CSRF's savings would revert back to the CSRF to recapitalize the fund, and the remainder of savings would flow to the General Fund.
CSRF conservation efforts initially should complement, not replace the Shared Savings Program. However, if CSRF consistently outperforms the Shared Savings Program and demonstrates the capacity to replace ESCo financing, the Commonwealth should dissolve Shared Savings and focus resources on CSRF. Conversely, if CSRF fails to perform well, the Commonwealth should dissolve the revolving fund, and expand Shared Savings to permanent status. The analytical framework presented in Chapter Four could be used to evaluate and compare the performance of these projects once sufficient data exists.
The Commonwealth has taken advantage of the revolving loan fund concept since 1989, when it established the Massachusetts Water Pollution Abatement Trust Fund, (known as the MWPAT, the State Revolving Fund, or the SRF). The MWPAT provides funding exclusively for wastewater treatment projects within the Commonwealth. The enabling legislation authorizes the State Revolving Fund to loan money to any "town, city, district, commission, agency, authority, board or other instrumentality of the Commonwealth or of any of its political subdivisions, which is responsible for the ownership or operation of a water pollution abatement project."[43] Simply put, the MWPAT may loan money to many kinds of entities within both state and local government. In recent years, over seventy government entities have benefited from MWPAT loans. Similarly, the Clean State Revolving Fund could provide loans to municipal borrowers. Although the Clean State Executive Order does not specifically mention environmental projects outside of state government, assisting municipalities throughout the state to realize their energy conservation goals is well within the spirit of the Clean State Order.
Until the CSRF can evaluate the Commonwealth's total borrowing needs, and unless the CSRF receives a substantial amount seed-money, it should focus on issuing direct loans to state agencies. As the fund's equity grows (or if the Commonwealth were to infuse more capital into CSRF's equity funds), the CSRF could begin to expand its client base to municipal borrowers. Additional equity allows the CSRF to finance more projects. Substantial equity (around $20 million) begins to make leveraged loans economically viable. Below we discuss both direct and leveraged loans.
Direct Loans - Direct loans occur when a revolving fund loans money from out of its capital accounts, directly to a program participant. When one borrower repays its obligation, the fund can issue a subsequent loan to an additional borrower. A revolving fund's level of capitalization limits the number of projects that it can undertake when it chooses to issue direct loans. In other words, because loans come directly from its seed-money, CSRF could only loan as much money as it had to lend. Depending on the projected capital requirements of a program's participants, the fund administrators could choose to subsidize loans, to break even on its loans, or to generate operating profits. This decision will determine the number of future projects that CSRF will be able to undertake.
Below, Table G-1 graphically displays the flow of funds under direct loans. The CSRF would receive its initial seed-money from a combination of state and federal matching grants. Once capitalized, the fund could issue loans to state agencies for energy conservation projects. The state agency would hire a contractor (through DCPO) and would pay the contractor to install cost-saving equipment. As surplus revenues accumulated in the agency's budget, A&F could capture savings through reversion and cutting the agency's budget. (See Recommendation 1, for ways that the Commonwealth should share savings with agencies.) A portion of A&F's share of the savings would revert to the General Fund, while the remainder would go back to the CSRF as debt service repayment.
Leveraged Loans - Leveraged loans allow revolving funds to double their money. To issue leveraged loans, the CSRF must establish a 50% debt reserve fund. If, for example, CSRF were to receive $20 million in initial seed money, it could deposit this money in its reserve fund, and subsequently borrow $40 million on the municipal bond market. The reserve fund would provide a measure of financial security to bond holders. Meanwhile, the CSRF can invest the debt service fund and earn investment income on that account. If the CSRF were to borrow $40 million at 6% interest, and were to invest its original $20 million at a similar rate, then it could earn half of its interest obligation from the investment income on its debt service fund.[44,45] In turn, revolving funds pass this benefit on to program participants in the form of subsidized loans. Often revolving funds loan money to program participants at one-half of the interest rate that each participant would have paid if it were to issue bonds on its own.[46] By subsidizing loans, the CSRF would provide greater incentives for public facilities to pursue energy conservation opportunities.
Leveraged loans may take two forms: Stand alone loans and pooled loans. Stand alone loans are bond financed loans made on behalf of one, and only one borrower. In December 1993, for example, the MWPAT issued $86 million in bonds exclusively to finance MWRA capital investments. Stand alone loans are useful when a particular borrower has large capital needs (as is the case with the MWRA), or when the borrower's credit rating differs significantly from the credit rating of other program participants. Pooled loans occur when a revolving fund wants to raise money for many small projects at one time. It would not make sense for a revolving fund to issue $1 million in bonds on behalf of a single borrower. Ceteris paribus, large debt issues can attract lower interest rates and lower investment banking fees per bond than small issues. Therefore, the more projects a revolving fund finances in any one bond issue, the more debt it requires, and the lower is its average cost of borrowing. A revolving loan program can bundle many projects, and issue bonds to finance a pooled loan. From this pool of bond revenue, the revolving fund can appropriate funds according to each borrower's needs.
The MWPAT issues revenue bonds, and the CSRF could be established to do the same. Energy conservation projects in the Commonwealth could be financed through revenue bonds if these bonds could be linked to an identifiable revenue source. For municipal participants in the MWPAT revolving loan program, revenue bonds are secured by a pledge from each municipality to repay debt service on their loans. The revenues behind that pledge are be secured by three sources: (1) municipal water bills; (2) municipal taxing power; and (3) the MWPAT'S local aid intercept powers.[47] The CSRF could also issue revenue bonds for leveraged pool loans, as long as municipal borrowers pledged to repay their debt obligations. Payment could originate from general taxes, or a specific revenue stream, and granting the CSRF local aid intercept power would increase the security of its bonds.
Issuing leveraged loans to state agencies presents a slightly more complicated picture. State agencies do not have the legal authority borrow debt, nor to promise the repayment of debt service. They could not guarantee that their budget would include a line item for debt service in order to pay back a revolving fund loan. While the MWPAT has not lent money to a state agency for a wastewater treatment project in the past, it does receive financial aid (referred to as "contract assistance") from the Commonwealth. The MWPAT's enabling legislation authorizes the Secretary of the Executive Office of Administration and Finance to sign a contractual obligation, compelling the Commonwealth to make specified payments to MWPAT, for the purpose of subsidizing loans made to certain municipal borrowers. "Pursuant to the Commonwealth Assistance Contract and the Enabling Act, the Commonwealth has agreed to provide Contract Assistance Payments to the Trust to reduce the Scheduled Loan Repayments otherwise payable by certain Borrowers.... If the Commonwealth should fail to provide the Contract Assistance Payments... the Trust will diligently enforce the provisions of the Commonwealth Assistance Contract...and will pursue all remedies available under such contract."[48]
Similarly, the CSRF's enabling legislation could authorize the Secretary of A&F to enter into "appropriation backed contracts." An appropriation backed contract would serve as a legal obligation on the part of the Commonwealth to appropriate the repayment of debt service on behalf of state agencies participating in pool loans. The appropriation would appear on an agency's budget as a "fixed expense," not subject to budget cuts or revenue reversion. Further, the Commonwealth would have an added incentive to make sure that it repays its obligations to the CSRF. If the CSRF were established with some amount of federal money, the CSRF would be compelled to use its funds for their intended purpose. If the Commonwealth were to disregard its obligation to repay loans to the revolving fund, it may become difficult for the Commonwealth to receive federal grants for other purposes in the future. The federal requirement on use of funds adds a measure of security to the revolving fund, and helps to ensure that the program cannot be dissolved due to shifting spending priorities of the Administration, or following the election of a new governor.
Although the contract backed appropriation would constitute a legal obligation of the Commonwealth, it should not adversely affect the Commonwealth's general obligation credit. First of all, contract backed obligations are not a pledge of the full faith and credit of the Commonwealth. Therefore, contract backed obligations are less secure than a GO pledge, but do not significantly impact the GO credit. Secondly, compared to the Commonwealth's current outstanding debt of $7.3 billion, several million dollars in contract backed appropriations is insignificant. Finally, when implementing energy conservation projects, the Commonwealth's expected utility expenses decline, which should more than offset the increase in debt obligation. Appropriation backed contracts would not be legally binding without a two-thirds vote of the Legislature. Alternatively, the Commonwealth could offer its full faith and credit to secure repayment. This would impact the Commonwealth's GO credit rating, however, and would also require two-thirds vote of the Legislature.
The viability of revenue bond financing depends upon whether A&F can be authorized to enter into appropriation backed contracts, whether contracted engineering firms can cost-effectively guarantee savings, and whether potential bond investors will buy into the idea.
Our framework and terminology for this section will be that of "Reinventing Government."[50] Governor Weld is cited as saying that this book "will be required reading in the Weld Administration," and that he will deliver "entrepreneurial government" which focuses on "results, not rules."[51] One of the main themes of "reinvention" is that decision-making about budget expenditures should be decentralized, and that budgets should avoid line-item expenditures which limit rational decisions by agencies. This concluding section will apply that theme to Clean State goals.
(1) Capital expenditures are a separate line-item from operating expenses, which means that installing energy conservation equipment may not be done with funds allocated for electricity bills, even if the new equipment would reduce the electricity bills. An agency wishing to install energy-saving equipment must request capital funds as a separate budget item. Commonly, the new equipment has a payback period within the period of the current budget,[52,53,54] (e.g., installing new lighting which costs $2,000 but saves $3,000 in electricity costs in its first year). But even if that is so, agencies are not permitted to transfer funds from their line item for utility expenses for use on capital equipment. The result is that cost-effective conservation practices are often not implemented if they require purchasing capital equipment.[55]
If capital equipment were allowed to be purchased under the budget item of utility expenses, agencies could implement cost-saving (via energy-saving) capital improvements without prior budgetary approval. Conservation projects which would repay the cost of capital equipment in the same year would be undertaken by agencies within a general budget item of "heating and lighting expenses, repair, and capital equipment," for example. If repairs or new equipment would save money (and energy), then the agencies would do so, and could then use the saved money on other expenses. Making new "general budget items" would require legislative action to redefine the budget line items.
(2) Capital expenditures are permitted by a time-consuming process. DCPO performs an audit (in conjunction with a private ESCo), and the Legislature and A&F approve and allocate the necessary funds. The process typically takes two years from initiation of the paperwork until installation of the equipment actually begins. The long delay is wasteful in itself, (since the energy savings would have begun two years sooner without the delay), but more importantly, a long lag time discourages agencies from undertaking the process at all. DCPO does a good job with installing energy-efficient and water-efficient equipment, but with their limited resources, they cannot perform more than a few projects at any one time: the waiting list is long and the time in process is longer.[56,57,58]
One solution is to expand the staff and funding for DCPO's audit programs.[59] That would likely address the problem of the long waiting list and long lag time, but it does not address the underlying problem of a lack of incentive for agencies to initiate projects on their own and to seek energy-saving projects themselves. For the expansion of the DCPO audit program to be successful, there must be an accompanying political motivation applied to each agency, to make up for the lack of economic motivation. That is, DCPO must continue to have strong political support in order to continue with subsequent projects. Right now, the political support comes from the Clean State Initiative, but when Clean State becomes less current (or when the Weld Administration becomes history), that political support will fade.
The alternative solution is to address the underlying disincentives, so that economic motivation replaces political motivation as the driving force for implementing conservation projects. The budgetary considerations involved are discussed in section (4) below -- agencies would keep the savings generated by conservation programs. The more general consideration is that agencies would become responsible for making their own decisions on conservation projects. Given an economic incentive, agencies would implement cost-saving conservation projects as soon as the present value of such projects became positive (i.e., as soon as the long-term benefits outweighed the short-term costs). DCPO cannot be expected to audit every agency every year, regardless of its expansion, since many projects are too small for a centralized agency to handle.[60] A decentralized decision-making process would allow agencies to act on their own initiative, so that lag times and delays would be minimized, since the agencies would stand to gain by acting quickly.
(3) Section (1) discussed conservation projects with payback periods in the same fiscal period. Projects with one-year paybacks can be addressed by allowing transfers from operating expenses to capital expenditures, but projects with multi-year paybacks need more. To account for multi-year payback periods, multi-year financing methods are needed. These include: A) Amortization of costs (capital depreciation over the expected lifetime of the capital equipment), as is commonly done in business practice; B) Receiving funds from the "Clean State Revolving Fund" proposed above, or some other independent source of funding; or C) Instituting on-budget financing of individual projects.
The "reinventing" solution is to make any of those multi-year financing solutions available to agencies at their discretion. That is, instead of requiring A&F approval to receive and pay back CSRF loans, or instead of legislating a line-item increase for a project, the agency itself would decide when a project was worthwhile, and would adjust its internal allocation of resources accordingly. A source of capital funding would still be necessary, since for a multi-year project, an agency presumably could not shift sufficient resources to finance the project. If agencies were allowed to arrange their own financing, through any method in the above list, they would then have to concern themselves only with shifting sufficient resources to cover one year's worth of repayments, and would be in the same situation as in section (2). That is, economic motivation would be the driving force for multi-year payback projects as well.
(4) If the payback period for a conservation project is more than a year, agencies are further discouraged from undertaking the improvements, because they must lobby for the additional funding, and then, if the capital expenditures are successful at reducing their operating expenditures, their budget is reduced in subsequent budget cycles. That is, the agency which must expend the effort and initiative to undertake conservation measures does not reap the benefits of their efforts.
The "reinventing" solution is an "Expenditure Control Budget." The Legislature would decide on an overall budget for building operation, and would then let the agencies do with the funds as they see fit. If they save money, they keep it to spend on other projects -- i.e., unspent money is not returned at the end of the year. Some programs split the savings: if an agency reduces their budget, the agency retains 50% and returns 50% of their unspent allocations.
Keeping unspent allocations would apply to subsequent years as well. Agencies assume that any savings achieved, even if the agency could keep the savings in the current year, would be cut from their budget the next year, or at best at the next "budget crunch."[61] Institutional practices would have to change in order to address this barrier. Specifically, the Legislature could not vote on individual line items, so that the savings on one line item would be at the agency's discretion to transfer elsewhere. The Legislature would control only the overall budget of each agency, not the particular spending within the agency. In tight budget years, the Legislature could still cut agency budgets, but would not explicitly cut the savings which the agency had previously generated.
In order to expect rational economic behavior from agencies, they must be subject to the real costs of their energy and water use. That is, each agency would have to be charged for its resource usage, a system referred to as "utility charge-backs." The same logic applies to "rent charge-backs," so that agencies could rationally decide how much space to occupy based on the real costs of the space. Agencies which are located in communal buildings with communal utility payments might need some physical changes, such as separate utility meters -- those changes will not be discussed in this memo.
The current means of promoting energy conservation, DCPO-sponsored audits, could be expanded without "reinventing" anything. A&F has recommended that and has begun implementing it.[62] Increasing DCPO's capacity (Recommendation 3.3 above) would still entail externally-applied political motivation (as discussed in Section (2)). That is, political leadership is required for both the bureaucratic solution and the "reinventing" solution. The distinction is that the bureaucratic solution requires political leadership on an ongoing basis, and the "reinventing" solution requires political leadership to change the institutional practices. Changing the institutional practice, once successful, is more likely to survive future political battles because it would have to be actively changed back, rather than just passively cut.
Changing institutional practices has high political costs. The countering benefits are that decentralized decision-making results in more efficient outcomes. For the Clean State Initiative, that means more energy conservation and more water conservation with reduced costs to the taxpayer.
Most goals of the Clean State Initiative cost money -- conservation saves money. Energy conservation is a money-saving practice, and the economic incentive to save money should result in practices which keep up with efficient technology. That the energy efficiency of state facilities do not compare well with the efficiency of private buildings indicates that there are barriers to economically rational practices. That is, if the barriers are removed, state facilities will become as efficient as private facilities, without any further political incentives, without any further legislative or executive action, and without any further funding of any kind.
The primary barriers to energy efficiency are financial and bureaucratic. State agencies do not practice conservation because they do not have access to capital and other resources necessary to achieve efficiency -- that's the financial barrier. State agencies also do not practice conservation because they are subject to rules which disallow them from following economic incentives -- that's the bureaucratic barrier. This report discusses means of addressing the financial barriers. If financing were available for conservation projects, state agencies would implement them, given an internal environmental motivation or an external political motivation. "Reinventing" is necessary to remove the bureaucratic barriers: the budget would have to allow agencies to spend their funds as they see fit, and to keep any savings that they generate. If the bureaucratic barriers are removed, economic motivation would combine with both environmental motivation and political motivation in achieving Clean State goals.
The New Jersey system focuses on Demand Side Management (DSM); utility companies contract with ESCos to reduce energy consumption so that the utilities can avoid building new plants. New Hampshire instituted in 1993 a Shared Savings Program for retrofitting existing buildings; NH had previously focused on energy measures in new state facility construction. New York state has a well-developed energy conservation program, including an "Environmental Facilities Corporation" to finance projects. Connecticut has a DSM program which mandates that utilities service state facilities. The White House announced in March 1994 a new plan for energy efficiency and water conservation at federal facilities, including innovative financing via DSM and performance contracting. There are two multi-state programs promoting energy conservation. We will discuss the incentives and implications of DSM programs, which operates extensively in Massachusetts. The Institutional Conservation Program (ICP) is a federal grant program which finances energy conservation measures at schools and hospitals, both public and private.
New Jersey utilities actively pursue limiting the growth in demand. Under the state's Energy Conservation Standard Offer Program,[63] utilities may pay customers who reduce their energy usage. The regulations apply to both private and public facilities, and have been done at both. The state sets up the regulations which govern the utilities (since they are state-regulated), and approves the measurement methods in accordance with state standards. The utilities design projects at the customer facilities (via ESCos or energy engineering firms), and choose the projects themselves. After the project is completed, utilities send checks directly to the facility. Hence, energy savings is split between the host facility which reduces its energy usage (by reducing their energy bills, and by receiving utility payments) and the utility rate payers (by avoiding the cost of building new plants).
The state oversight is limited to ensuring accurate measurement. There is no direct state involvement after approval of the project, i.e., the utility and the host facility review energy usage and schedule payments without state oversight. The state defines "Approved Measurement Protocols," which differ by type of project. Common projects, such as lighting replacement, may use pre-approved protocols from previous projects. If no existing protocols are applicable, the utility and the state collaborate to define a new protocol, which is negotiated between the utility, the host facility, and the ESCo performing the work. The protocols include recovering for damages for missing target deadlines.
ESCos often recruit a host facility themselves, and then apply to the utility for approval and a contract. This system of ESCo initiation, common for the private sector, does not apply to state facilities, where competitive bidding is required. Typical ESCo criteria for selecting which facilities to recruit are that the host facility have a minimum of 200 KWh usage during the prime period, in order to generate enough savings to make the project worthwhile. ESCos are not certified (i.e., there is no Office of Contractor Certification as in Massachusetts). The state recommends screening, as with any business contract, but offers no approval of particular companies. Host facilities may perform the work themselves (i.e., act as their own ESCo), although most hire ESCos, with whom they then split their utility payments. The ESCo deals typically last 10 years.
With regard to state facilities,[64] the State Office of Energy (SOE, part of the Board of Regulatory Commissioners, which is the public utilities commission) acts as the intermediary for all state buildings. The host facility itself hires an ESCo to perform an audit, and based on the audit results, applies for funds from SOE. Host facilities may also contract for audits through the state's Central Contracting Unit. That process involves the Division of Building and Construction (DBC, part of the Treasury Department). The DBC sends out projects to bid, rates the engineers, and awards the project, subject to SOE review and approval. The process takes about four years when done through the DBC, about the same time as the Massachusetts public procurement process.
The New Jersey regulations allow the feasibility study (audit) and design to be done in one step, since the audit process must essentially design a project also. The audit/design phase and engineering phase may be done by the same contractor. The Massachusetts public procurement process requires that the audit phase and the design phase be done by separate contractors. Conditions which favor a consolidated audit plus design phase are that the host facility is a large or very inefficient energy user, and hence has little question as to eligibility.
The New Jersey equivalent of the Massachusetts Shared Savings Program is set up for separate design and engineering phases. ESCos provide services to the state, as a performance contract. ESCos focus on DSM more than they do on shared savings directly. Because of the utility involvement, shared savings are divided three ways, between the host facility, the ESCo, and the utility.
With regards to financing, New Jersey issued a $50 million Bond in the early 1980s to fund physical improvements for cost-effective energy conservation. The bond was intended to be allocated as $3 million for energy audits of state facilities, and $47 million for funding capital improvement projects. The bond fund is still active today, since fewer projects than expected were implemented, due to decreasing energy costs. The State Office of Energy has moved three times since the bond issuance, which has hindered the program as well.
The state's position on the Energy Conservation Program is that New Jersey should take advantage of DSM programs, since they work well in the private sector. The major problem with the state's using DSM is that "there are too many hands in the pie," according to SOE Reviewer Frank Parrotti. The SOE, the DBC, and the host facility must all collaborate, subject to review by the Attorney General's office. Developing an RFP is not a strong barrier to the program's success, but the standard RFP does not reflect utility's specific needs under DSM. Also, there aren't enough people knowledgeable enough about the program to make it work well. The primary benefit to the state is reduction of risk. The state has approved projects where the ESCo keeps all of the energy savings, in exchange for guaranteed reduction of risk.
In the early 1980s, there was little data collection, poor metering, and the data collected answered the wrong questions, according to SOE reviewer Frank Parrotti. He says that the program is hard to justify to the Legislature, based on its results.
The inactivity until last year was a result of the bankruptcy of PSNH, which has recently been resolved. NH has a DSM program (also run under DPW), which has also been inactive for state buildings, for the same reason. PSNH did operate some DSM projects while in receivership, but none with the state. The state has operated an ICP program (see ICP section below) for schools and hospitals.[66] Now that the bankruptcy is resolved, PSNH has scheduled a 5.5% per year increase in electricity prices, which has inspired the new state programs (oil, gas, and propane prices are expected to rise at 3%-4% per year, also). Manchester Technical College was recently retrofitted with energy-efficient lighting, in the first joint government-utility project in many years. NH DPW did the work itself, as part of a larger renovation project.
The new pilot Shared Savings Program advertised its first RFP in July 1993, for two buildings of the initial project's twelve. The twelve buildings constitute 65% of the office space used by the state government. The buildings were chosen because they are all managed under one agency, but the project is intended as a model for future agency-driven projects. The twelve buildings were bid as one project to avoid "cream skimming." The buildings include the State House and other historic buildings, in which historical amenities must remain undisturbed, raising the costs of installation. However, because many of the buildings are old and have not been upgraded for a long time, the savings generated is expected to be high. For the twelve buildings, the capital cost is estimated at $5.5 to $5.8 million (the first two cost $1.5 million), and the conservation measures will generate $6.3 million in savings (guaranteed by the ESCo) over the contract period of seven years.
Six ESCos responded to the RFP with bids, and Johnson Controls was selected (they and Honeywell are NH's largest ESCos). The selection process was under the advice and consent of a legislatively appointed committee. The contract pays Johnson back its capital costs plus $1, plus an appropriate return on capital. Under NH law, only energy savings can be used to pay back conservation improvements (even though these improvements include components other than energy conservation). Johnson is paid 100% of the energy savings generated, for seven years, beginning two months after project completion (the 7-year payback is also determined by law). Johnson guarantees a fixed amount of savings per year, and hence assumes all of the risk.
Executive Order 132 establishes the Energy Conservation Program with a goal of 20% energy reduction in state facilities by the year 2000. State agencies will submit annual plans of their progress towards that goal. Preliminary audits established baselines for energy consumption, based on age of the facilities and so on. The Office of General Services (procurement department) has set energy efficiency requirements for equipment purchases. The Executive Order also calls for streamlining the process of implementing energy conservation projects, and for expanding financing options.
The NY State Energy Office provides technical advice to assist state agencies in compliance with the Energy Conservation Program.[68] The Office of General Services provides standard contracts with specifications for energy efficiency for both design of new construction as well as for retrofits. The Division of the Budget assists with the Annual Plans and with identifying potential projects. State agencies themselves are charged with meeting the 20% goal.
The criteria for selecting projects is that they have a positive net present value and a simple payback period of five years or less. "The intent of reducing energy consumption is to conserve fuel and save money."[69] The program has so far accumulated $28.5 million in avoided costs since the base year of 1988-89, a 3.6% reduction.
Turning our attention, the Environmental Facilities Corporation was established in 1989 to address water pollution control via a State Revolving Fund (SRF).[71] The Fund provides low-interest loans to municipalities, based on bond issuances. The SRF allows the state to make $12 in loans for every $1 in State funds that New York contributes to the program, by leveraged loans and a federal subsidization "seed." We recommend that the New York Environmental Facilities Corporation's State Revolving Fund be the model for administering the Massachusetts Clean State Revolving Fund, as discussed in Appendix A.
The program has been in full operation for three years, since enabling legislation in 1990. In its first year, utilities spent $4.4 million on capital improvements, $4.0 million in the second year, and $4.4 million in the third year. The criteria for selecting projects is that they have a ten-year maximum payback. Of the projects completed, the average payback period is three years. Other than the payback criterion, facility selection is negotiated mutually between the utility and the state.
Connecticut is currently supplementing that program with a new four-year program in which the state pays for half the cost of the capital improvements and the utility pays for the other half. The state will use all bond funds for their half, and utilities may finance their half by increasing their rate base as before.
In terms of responsibility for the energy conservation measures, the utilities act as "general contractors" for the entire process. The utility selects engineering firms for audit, design, and installation of equipment. They are "biased" toward in-state firms, but there are no rules requiring so. There is no "low-bid" requirement, nor any other bidding requirements, for the engineering firms, since the utilities choose as they see fit.
The state's involvement is via the Department of Public Works (DPW) as technical advisor, and the Department of Energy as reviewer. The State Energy Office, under the Policy Development and Planning Division, maintains regular contact with host facilities, and performs field inspections of installed measures.
Connecticut's biggest problems with their program has been that the utilities are reluctant to cooperate with the program. The two major utilities in Connecticut are United Illuminating (in the south and east of the state), and Northeast Utilities, a division of Connecticut Light and Power (in the rest of the state). The incentive for the utilities to participate is the same as that for DSM programs -- utilities can reduce their peak demand. Northeast, however, is currently operating with "tremendous over-capacity," and hence would prefer to increase demand for the foreseeable future. As a result, Northeast has offered host facilities energy conservation measures with "no co-generation riders" -- i.e., facilities get free energy improvements if they agree to use power only from Northeast. Northeast wants the same arrangement with state facilities, and the state wants the opportunity for co-generation.[73] Northeast went "on strike" against the whole program, because they felt that it was inappropriate to pay state sales tax on their purchases for installation at state facilities. Connecticut and Northeast have spent "a year of wrangling" on these issues.
United Illuminating does not have an over-capacity problem, so they have participated more readily in the program. United concurred that the sales tax was inappropriate, but just didn't pay it, rather than attempt to negotiate its removal. Connecticut is considering using United as the general contractor within Northeast's territories, if the problems with Northeast cannot be resolved.
Financing for the installation of the conservation measures will use a variety of "innovative" mechanisms, including utility DSM programs, shared savings contracts, and performance contracts (¤401). The Office of Management and Budget (OMB) will host a workshop for agencies regarding financing, and will act to eliminate "unnecessary regulatory and procedural barriers" that slow implementation (¤402-3). The Department of Energy (DOE) will provide ongoing technical assistance regarding available technologies, lists of qualified water and energy service companies, sample contracts, and guidance manuals (¤501).
The federal Executive Order addresses many of the barriers discussed in this report. It explores incentives to builders, in the form of "award fees," for exceeding new construction efficiency guidelines, and for incentives to employees, both monetary and honorary, for exceptional performance (¤501(h) and ¤504). The federal plan addresses budgetary retention to create agency incentives. Starting in fiscal year 1995, agencies may retain utility rebates and incentives from conservation efforts (¤502). The retention is subject to OMB guidelines and legal limitations, but has been provided for by earlier legislation.[75] The federal plan also addresses bureaucratic hurdles by seeking regular input on overcoming "impediments." Finally, the federal plan addresses information constraints by providing for assistance on financing issues (by OMB) and technical issues (by DOE). Furthermore, DOE will identify efficient technologies which are "feasible but not yet available on the open market," for purposes of creating a market for advanced technologies (¤507(b)).
However, the federal Executive Order has some shortcomings. By mandating a fixed percentage for every facility, Clinton's plan mandates high costs. Older facilities can more readily reduce their energy consumption, since they have more room for improvement, especially if the facility had not been upgraded before 1985. That is, facility managers are rewarded for having energy-inefficient buildings, or for having been lax in the early 1980s.
The "showcase" concept is interesting, but why isn't the technology used in the showcases used in the other buildings? If the showcase technology is superior, it should be the technology of choice. Presumably the federal plan intends the showcases to fulfill a "leadership" role, or to achieve "technology forcing" by creating a market for innovative technologies.
DSM is based on a reluctance to increase short term capacity. Besides the financial cost of building a new plant, there is also a high political cost and other hidden costs (such as lawsuits, regulatory delays, and so on). In the long term, utilities want to increase capacity, since they can then sell more electricity. The costs of building a new plant is ultimately charged to the ratepayers, since regulators allow amortizing construction costs once new plants come on line.
Specifically, utilities have an incentive to implement DSM projects because they want to reduce peak demand. Utilities do not want to reduce the overall quantity of electricity used -- selling electricity to meet demand is their business and their obligation -- but utilities do want to reduce peak d