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Economic Feasibility

Emerging Drivers|Siting & Permitting|Technical Feasibility|Economic Feasibility|Next Steps

 


Economic Benefits

CHP on campus, in the right situation, has many economic benefits, including:

  • Lower capital costs.  Buildings connected to district energy systems also have lower capital costs for their energy equipment because they don't need conventional boilers and chillers. They save valuable upfront dollars they can invest elsewhere. Plus, they save building space that can be used for other more valuable purposes.

  • Lower life-cycle costs. Since buildings using district energy service don't need boilers or chillers, building owners and managers reduce their upfront capital requirements and their ongoing, operating, maintenance and labor costs considerably. That means less financial risk and a far better return on investment - plus the elimination of principal and interest payments, property taxes associated with new boiler and chiller installations, costly insurance and annual maintenance contracts, and costs associated with operating boilers and chillers.

  • Fuel diversity to mitigate risk.The beauty of a district energy system is that since it serves so many customers from one location, it can accomplish things individual buildings usually cannot. For instance, district energy systems can use a variety of conventional fuels such as coal, oil and natural gas, whichever fuel is most competitive at the time. And because of a district energy system's size, the district energy plant can also transition to use renewable fuels such as biomass, geothermal, and combined heat and power. A campus could give additional consideration to CHP projects that do not rely solely on gas or oil, e.g., coal, biomass, landfill gas and waste energy, although these fuels have inherent limitations. In considering coal's suitability for CHP, it is important to note that coal projects are rarely effective in projects less than 50 MW, rendering it cost-ineffective for all but the largest Industrial and District Energy projects. Coal gasification is not cost effective at this time. If coal were available to fuel a CHP project, it would not always result in GHG reductions, for example in the Northwest. Biomass would need to be available in a large quantity, in close proximity to the end-use facility, year-round, and be available for it to be a viable CHP feedstock, which is a rare combination of factors.

  • Reliability. Building owners and managers can count on district energy systems since energy professionals operate around-the-clock and have backup systems readily available. Most district energy systems operate at a reliability of "five nines" (99.999 percent). To IDEA's knowledge, there have been no rolling "heat-outs" related to district energy systems.

  • Comfort and convenience to end-users. District energy service allows building operators manage and control their own indoor environments. Building occupants can be both comfortable and satisfied, no matter what the outdoor temperature. District energy is available whenever a building needs heating or cooling. So even if there are unusually warm days in January, a building can receive chilled water or steam for air conditioning, without starting up its own chillers. In addition, district energy reduces vibrations and noise problems that could annoy building occupants and frees up building space so more room is available to meet increasing tenant storage needs.

New CHP project growth across the country, has been progressing because of lower natural gas prices, making spark spread a useful CHP potential indicator.

Marketers feel it is important to target recession proof or prioritized markets that show need for additional electric/thermal energy capacity, the need for reliable power is due to critical research, NOx nonattainment status, etc.óand colleges and universities and downtowns seem to be ideal candidates in an unpredictable economy, with volatile and high natural gas prices.


Assess Interconnect and Utility Relations

Although interconnection fees, exit charges, standby charges, and departing load fees have traditionally been an economic deterrent for CHP projects, the recent IDEA survey ranks interconnect and its myriad fees and tariffs as a very low concern for large District Energy projects under consideration.

Several states have implemented CHP market incentives or have created regulatory environments conducive to CHP market penetration. In general, the following states have made noteworthy regulatory decisions that are already affecting the viability of CHP projects:

  • California has issued environmental regulations that may create a more favorable environment for CHP.

  • New York is developing environmental guidelines that may create a more favorable environment for CHP. NYSERDA has issued RFP's for $15,000,000 to support CHP demonstration projects in New York. The New York Public Service Commission on Feb. 19, 2003 ordered the state's major natural gas utilities to file special delivery rates for nonresidential customers who operate their own gas-fired distributed generation units.

  • New Jersey has also shown a strong commitment to CHP by waiving exit fees and fuel taxes on CHP systems. New Jersey also uses output-based permitting.

  • Texas is a model for CHP regulations with the Texas Public Utility Commission CHP interconnect rule and Texas Commission on Environmental Quality small generator permitting.

  • Florida state law only allows ownership of electricity generation by utilities.

  • A major Illinois utility has discouraging interconnect fees.

Assess Economic Feasibility  

Scope Financing Options

In the IDEA survey, 90% of respondents identified money as the obstacle to CHP implementation.  Ultimately, the decision to expand a central plant and build CHP hinges on economics.  Facility managers need to understand the features and benefits of various financing strategies to best guide projects to the approval stage and make sound fiscal recommendations at the board of trustees level. 

According to Oak Ridge National Laboratory, the U.S. EPA's Office of the Comptroller, and Neil Zobler of Catalyst, CHP project developers could use one or a combination of the following financing options:

Vendor Financing

In vendor financing, the vendor of an integrated CHP system or a major component provides financing. Vendors can provide financing at attractive low costs to stimulate markets, which is common for energy technologies. Vendor financing is generally suitable for small projects up to $400,000. Some large vendors do provide financing for larger projects.

Leasing

Leasing energy equipment has become the fastest growing equipment activity within the leasing industry. The lease payments may be bundled to include maintenance services, property taxes, and insurance.

An operating lease appears as an operating expense in the financial statement. Operating leases are often referred to as "off balance sheet" financing and usually treated as operating expenses. To qualify as an operating lease, the agreement must NOT (a) transfer ownership of the equipment at the end of the lease term; (b) contain a bargain purchase option; (c) have a term that exceeds 75% of the useful economic life of the equipment; or (d) have a present value at the beginning of the lease term of the minimum lease payments greater than 90% of the fair value at the inception of the lease, using the incremental borrowing rate of the lessee as the discount rate.

A municipal lease is tax-exempt and offers below-market rates.

In a leveraged lease, the lessor provides a minimum amount of its own equity, borrows the rest of the project capital from a third party, and is entitled to the tax benefits of asset depreciation.

Capital lease obligations are reflected on the balance sheet and may be subject to lender and or internal capital budget constraints. The general characteristics of a capital lease are as follows:

  • Appears on the balance sheet as debt for purchase
  • Requires transfer of owner at the end of the lease
  • Specifies the terms of future exchange of ownership
  • Lease term is at least 75% of the equipment life
  • Net present value of lease payments is about 90% of the equipment value

A "true lease" defines types of transactions that qualify as leases under the Internal Revenue code so the lessor can claim tax incentives of ownership and the lessee can claim rental payments as tax deductions. Because the final decision to purchase the leased equipment is deferred until the end of the lease contract (at its then "fair market value"), monthly rental payments are usually expensed for tax purposes.

Bonds

Bonds are interest-bearing certificates sold by corporations and government (city, municipality, county, state, school districts, and statutory authorities) to raise money for projects. A bond is basically a written promise to repay borrowed money on a definite schedule and usually at a fixed rate of interest for the life of the bond. Bonds can stretch out payments for new projects over a period of 15 to 30 years. State and local governments repay bond debts with taxes, fees, or other sources of governmental revenue.

There are two types of bonds:

  • General obligation bonds are issued by state or local governments and paid out of a general fund. These bonds are paid by secured assets or by the taxing power of the government. Since general obligation bonds could result in increased taxes, taxpayers generally resist issuance of this type of bond.

  • Revenue bonds are paid back by the revenues generated or savings achieved from project implementation. These bonds do not require increased tax burden, are generally issued by public utilities, and much are easier to issue than general revenue bonds.

Since most government bonds are tax-exempt, bondholders are generally willing to accept a correspondingly lower rate of return on their investment than they would expect on a comparable commercial bond. Bond financing, therefore, can often provide state and local governments with low-interest capital.

Some state and local governments are required by statute to seek voter approval for certain types of bond issues. For example, most state and local governments cannot issue general obligation bonds without voter approval. If achieving this type of approval is difficult or time-consuming, state and local governments may want to consider issuing bonds that do not require voter approval, or exploring other options for capital financing, even if interest costs may be higher.

The Tax Reform Act of 1986 altered the tax-exempt status of some government-issued bonds. The Act reclassified bonds into two categories:

  • Governmental purpose bonds are automatically tax-exempt, but private activity bonds must meet certain criteria in order to be classified as tax-exempt. To qualify as a governmental purpose bond, at least 90 percent of the bond proceeds must be used by a state or local government, and no more than 10 percent of the debt service on the bond may be derived from or secured by a trade or business. If a bond does not meet these criteria, it is classified as a private activity bond.

  • Private activity bonds are issued for specific public-purpose projectsósuch as water supply facilities, sewage treatment plants, solid waste disposal facilities, and some hazardous waste plantsócan be tax-exempt. However, each state is limited to issuing private activity bonds in the amount of $50 per capita or $150 million each year, whichever is greater.

U.S. EPA compares bond features in a chart found at http://www.epa.gov/efinpage/

Tax-exempt Municipal Lease-Purchase Agreements

State universities and colleges, community colleges, and municipalities are able to issue tax-exempt commitments, which can have substantially lower interest rates than commercial transactions. Financing paid out of operating expenses is preferable to making capital budget obligations, which usually require voter approval. Tax-exempt Municipal Lease-Purchase Agreements are well accepted financial instruments commonly used to finance everything from school buses to photocopiers. 

Payments may be tied to the annual operating budget of the tax-exempt organization. These lease-purchase agreements often contain "non-appropriation" language limiting the lessee's payment obligations to the current budget appropriation period. In most states, this allows the financing agreement to be treated not as a capital debt obligation, but part of the organization's operating budget and an expense item for accounting purposes. Hence, the approval process for a lease is generally much easier, faster, and ultimately less expensive than issuing a bond, especially when voter referendums can be avoided. With rare exception, tax-exempt lease financing payments are structured to allow the cost of the lease payments to be less than the energy savings. 

Energy Savings Performance Contract

In an Energy Savings Performance Contract (ESPC), an energy services company (ESCO) finances the entire project. In return, the ESCO gets a share of the energy cost savings and guarantees the performance of the CHP system. An ESPC mitigates the risks associated with new technologies for building owners, and allows operation and maintenance of the new system by ESCO specialists.

ESPCs are frequently used for public-sector projects. There are no upfront costs other than technical and contracting support.  Traditional ESPCs contain three components:

  • A project development agreement,

  • An energy services agreement, and

  • A financing agreement. 

As such, an ESPC is not a financing agreement by itself, but it may contain the financing component. Most lending institutions prefer to see the financing section as a stand-alone agreement that can be sold into the secondary market. This helps creates demand for this financial instrument, usually resulting in better pricing.

ESPCs come in all sizes and shapes. 

  • Guaranteed Savings Agreements account for about 85% of the ESPCs in the public sector. In these agreements, an energy service provider or insurance company guarantees that the equipment installed will generate the promised savings.

  • Stipulated Savings Agreements measure the savings one time. They are a cost-effective alternative to ongoing measurement and verification when the project variables are predictable and unlikely to fluctuate. 

Two types of allowable savings include:

  • Energy Cost Savings: These savings recur as a result of decreased usage or cost either from renewable energy sources, decreased peak demand, or correcting a power factor.

  • Energy-Related Cost Savings: These savings reflect a reduction in expenses related to energy consuming equipment. They are either one-time (avoided expenditures of O&M funds) or recurring (reduced O&M).

 The potential benefits of ESPC contracting include:

  • Experienced ESCO contractors

  • High degree of control over project

  • Integrated approach to project development

  • No appropriation delays, ceilings, or priorities

  • Performance guarantees

  • Annual audit report verifies results

Bank Loan

Commercial banks can provide loans to pay for some or all of the cost of installing a CHP system for both private and public developers. Availability of the loan depends on the credit history and financial statements of the borrower and the cash flow expected to be available to pay the principal and interest. The borrower also must be able to provide collateral in case the loan is not paid back. Typically, the loan is paid back by fixed payments (principal plus interest) every month over the period of the loan term, regardless of the actual project performance. For small businesses, the Small Business Administration (SBA) can guarantee bank loans up to $750,000 for energy efficiency projects. An SBA guarantee could favorably affect a borrower's ability to secure a loan.

Partnership

In partnership financing, the members of the partnership pool their money to invest in one or multiple projects. This approach lends itself to strategic alliances among major suppliers of fuel, equipment, and services. The rate of return on the investment depends on the economic performance of the project. Therefore, there is no guaranteed rate of return.

There are two options in forming a partnership for installing and operating CHP systems: general and limited. In a general partnership, all partners have unlimited liability. In a limited liability partnership, liabilities of the partners are limited to their investment in the partnership.

A joint venture is like a partnership that dissolves when the project is completed.

Utility Programs

Most utilities now have unregulated energy services businesses through which they can arrange project financing. To provide such a financing, utilities secure long-term contracts and ordering agreements from customers to sell electric power and other services.

Utilities might offer incentives for CHP systems as part of demand-side management (DSM). They might offer technical assistance, low-cost financing, or rebates to encourage integrated CHP systems in their service territories. They might also offer CHP services through tariffs approved by state utility commissions.

Utility Energy Service Contracts (UESC) are specific contracts that allow utilities to provide agencies with comprehensive energy and water efficiency improvements and demand reduction services. Utilities front the capital costs and are paid out of savings.

  • Potential benefits of UESCs include:

  • Flexibility in project scope and size; smaller projects feasible

  • Your utility may have unique expertise and knowledge of your facility

  • Non-competitive procurement (due to established source authority) reduces time and resources

  • One-stop shopping for a turnkey project

  • Relationship with known entity

  • Payment through the utility bill

  • Pay through energy savings

One successful example of a UESC is the General Services Administration project in Washington, DC:

  • $64 million cogeneration project financed by utility partner Washington Gas

  • Project replaces existing refrigeration equipment & increases plant's capacity to meet chilled water needs; also includes O&M services

  • Eliminates need to replace small, aging chiller plants

  • Cogeneration technology will improve regional air quality

For more information on financing federal projects using UESCs, visit the Federal Energy Management Program website.

End-Use Purchase (Chauffage)

In an end-use purchase program, a building owner purchases the benefits of a CHP system (electricity, cooling, or heating) rather than financing and purchasing the equipment. In this approach, the risk of project nonperformance falls on the owner/operator of the equipment.

Appropriations

Some organizations appropriate their own funds to purchase a system outright. A decision to appropriate funds is made on the basis of the organization's "minimum attractive rate of return" (MARR). Federal governments can appropriate funds. This approach represents the lowest cost of money because the government's MARR is that for a treasury bill of a comparable term. 

State Programs

Many states offer system benefits charges and/or renewable energy programs to support CHP. These states include:

  • Connecticut

  • Massachusetts

  • New York

  • Rhode Island

According to project developer Jerry Sullivan from Cinergy, 18-24 months is a typical development time, and millions of dollars are involved--so evaluating and managing risk is critical to a project's success. ESCO's, vendor financing, private ventures, and alternative financing paradigms from industry may play a role in mitigating risks to the end-user.

Sullivan points out that risk can include a requirement to meet air quality standards by adding selective catalytic reduction systems (SCR), which means costs over and above the usual capital and "soft" costs.

Assuming the risk of fuel is another major consideration, and some end-users work with their energy service provider to spread that risk.  For additional resources, please visit IDEA's On-Line Resource Guide.

Drafted by D&R International  |  Supported by ORNL  |  Feedback and questions

 





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