State and Local Government Energy Financing Primer
Energy consumption in state and local government buildings totals 980 trillion Btus annually – more than half of the total energy use of all government-owned buildings in the United States. With a 20% improvement in energy performance, these buildings could save $6 billion annually in avoided energy costs. Energy efficiency in the public sector reduces operational costs, frees up much-needed funding for public priorities, and demonstrates good stewardship of taxpayer dollars.
This primer serves as an introduction to critical issues in energy finance for public sector organizations. It provides case studies, market data, and other resources to help leaders in the sector take advantage of innovative financing strategies. The primer is part of the Better Buildings Financing Navigator, an online tool that helps public and private-sector organizations find financing solutions for energy efficiency and renewable energy projects.
For more specific information on energy financing in public universities or K-12 schools, visit the Higher Education Energy Financing Primer or Lawrence Berkeley National Lab’s Financing Energy Upgrades for K-12 School Districts.
Common Barriers to Financing
Competing spending and staff priorities can make it difficult to allocate available internal budget and access debt-based financing. Governments may also face the risk of decreases in future operational funding based on lower utility costs. Budget design and potential misalignment of energy cost savings (the office or department that implements projects does not keep the cost savings) may create additional complexities.
Governments may have debt restrictions in place, be hesitant to take on debt for energy projects, or require voter approval for certain debt instruments. Some governments (especially those smaller in size) may require a short payback period for all debt-financed projects (including energy projects).
Investments in improved energy performance of public buildings provide cost, environmental, and health benefits for communities, but these benefits are not fully realized due in part to a lack of trusted, accessible information for public-sector decision-makers on the benefits, features, and considerations of different financing options.
Common Financing Solutions
Governments with large projects or smaller projects that can be aggregated under one agreement may use ESPCs (sometimes referred to as energy performance contracts, EPCs) in which an energy service company (ESCO) coordinates installation and maintenance of efficiency improvements in a customer’s facilities and is paid from the associated guaranteed energy savings. Read more.
There are a few unique characteristics of the public sector that affect how an organization may choose to approach financing for energy projects:
- Lead by example: Because state and local governments have the opportunity to spur innovative energy efficiency and renewable energy solutions through actions focused on their own public buildings, many governments have implemented or are considering goals specifically for reducing the energy consumption of their building portfolio. Internal budgets may be able to pay for a portion of proposed projects, but many governments are leveraging external financing solutions to cover additional projects and realize savings more quickly than waiting for capital budget funds to become available.
- Financing programs: Financing programs can help governments structure and fund investments in energy efficiency and renewable energy. These programs can vary in size and scope, and there are often multiple target markets. Governments may leverage certain program resources to support the implementation of energy upgrades in their own facilities. Many programs also aim to support private-sector adoption through various mechanisms such as state revolving loan funds, Property Assessed Clean Energy (PACE) programs, and utility incentives and rebates. For more information on financing programs, visit DOE’s State & Local Energy Efficiency Action Network, the State and Local Solution Center, and EPA’s Clean Energy Financing Programs Decision Guide.
- Portfolio size: The size and demographics of a governmental jurisdiction can affect its ability to finance energy projects. Larger jurisdictions typically have more facilities and thus a greater savings potential. External financing solutions can help governments tackle a larger project pipeline.
- Project bundling: It is possible to group multiple sites with varying payback periods into a larger more comprehensive project under a single financing solution. Bundled projects enable greater overall savings across a wide range of facilities that might not be feasible as standalone projects.
- Building ownership: Government buildings rarely change ownership, allowing officials to consider taking a long-term investment approach with longer allowable paybacks. State policies typically allow ESPC contracts of up to 20 years.
- Utility incentives and rebates: Utility incentives and rebates exist for many energy projects that can help reduce total project costs. For more information on what is available in your jurisdiction, consider contacting your local utility.
Discussion of Common Financing Solutions:
Many governments are using internal funding options, i.e. capital budgets, to pay for energy upgrades without accessing external capital. This is often the most simple and direct method for funding projects, and it avoids some of the bureaucratic complexity that may come with seeking financing for projects. Internal funding allows the government to capture the full financial benefits of energy projects rather than paying a portion to a financing provider. While some governments simply implement projects on an as-needed basis, many have established dedicated financing programs or centrally managed internal funds to help structure their own investments in energy projects. Examples include revolving loan funds, and other types of dedicated capital pools set aside for a specific purpose. These programs or funds can have benefits including building a clear business case for sustainability, streamlining the budgeting process, and demonstrating a long-term commitment to sustainability. While many governments may prefer to pay for projects using internal funds, competing budget priorities, limited budgets, lack of information about available options, and other barriers may create impediments that external financing options can help solve.
Bonds are long-term debt instruments that can be issued by state and local governments to fund a variety of projects including energy efficiency and renewable energy projects. While energy projects are typically not the driver of most bond issuances, a share of bond proceeds can be put towards funding projects or entering into an ESPC. Bond financing is not limited to large projects as smaller projects can be pooled into a larger bond issuance. Bonds are typically considered low-risk and capital can be raised at low interest rates. Voter approval is typically required for governments to issue bonds, and the process for issuing bonds can be complex and time consuming.
Energy Savings Performance Contracting
State and local governments can use Energy Savings Performance Contracting to implement energy upgrades across government facilities. Under an ESPC, an ESCO coordinates installation and maintenance of efficiency improvements in a facility (or bundle of facilities for portfolio-wide initiatives) and guarantees the energy savings. Governments may elect to pay for the project costs using existing internal budgets or seek financing from a third-party lender. ESPCs are typically better suited for larger projects $1 million+, but smaller projects can and have worked. The scalability, measurement & verification of savings, energy performance guarantee, and longer contract terms of ESPCs are appealing for many governments. Conversely, ESPC assessments and negotiations do generally require significant staff time to coordinate, and a substantial portion of the cash flow from the project must be paid to the ESCO and the lender (if financed) during the contract. For additional information on ESPCs, visit DOE’s Energy Savings Performance Contracting Toolkit.
Leases are generally simple, quick, and accessible with minimal contract complexity. Leases also allow governments to capture a greater percentage of total cash flow from energy savings with no ESCO involved, but these savings are not guaranteed and operation and maintenance of equipment must be arranged by the government.
A tax-exempt lease-purchase agreement (also known as a municipal lease) is a common type of lease financing structure for public organizations to pay for equipment using their annual revenues. This option is an effective alternative to traditional debt financing but is only available to municipalities and other political subdivisions that qualify. Tax exempt leases have two unique attributes: (1) the lessor may claim a federal income tax exemption on the interest received from the customer under the lease, allowing them to offer a lower rate, and (2) the lease contract usually stipulates that if the customer fails to appropriate funds to make payments on the lease in any given year, its obligations to the lessor ends and the customer must return the equipment to the lessor. In most states, this non-appropriation clause means that (a) a tax-exempt lease is not considered debt and therefore voter approval is not required, and (b) lease payments may be made from operating rather than capital expense budgets.
Power Purchase Agreements (PPAs)
A PPA allows the customer to receive stable and often low-cost electricity with no upfront cost while also enabling the owner of the system to take advantage of tax credits. Once the third-party energy generation system is in place, governments then purchase the system's electric output for a predetermined period. Offsite or virtual PPAs, where the customer does not take physical delivery of the renewable power generated, are an alternative to onsite PPAs and are common among governments looking to procure renewable energy.
State of the Market
The public sector has been a leading sector in the implementation of ESPCs and the use of internal funding mechanisms such as revolving loan funds and other types of dedicated capital pools. Lawrence Berkeley National Labs reported that state, local, and K-12 sectors spent $2.5 billion on ESPCs in 2014 out of $5.2B in total ESPC activity across all sectors that year. Since 2012 the average size of an ESPC project in the MUSH (municipalities, universities, schools, hospitals) market has been about $3M.
The 25 partners of the Better Buildings ESPC Accelerator invested $2.1B in ESPC projects from January 2014 to December 2016. Additionally, Better Buildings Financial Allies have financed more than $2.2B in the public sector from 2015 to 2018.
Better Buildings Implementation Models
King County created the Fund to Reduce Energy Demand (FRED), a financing tool where the county budget office issues bonds and provides loans to county divisions for equipment upgrades to reduce energy use, and resulting utility bill savings are then used to pay back the bonds, resulting in a neutral or positive cash flow.
Minnesota delivers technical, financial, and contractual assistance to state agencies to support the implementation of Energy Savings Performance Contracting. GESP is available as a resource to all state agencies, local governments, and school districts in Minnesota.
D.C. Department of General Services Develops Extensive Solar Project Using a Power Purchase Agreement
The District of Columbia's Department of General Services engaged Sol Systems to develop one of the largest onsite solar energy projects in the U.S. on a 12-month timeline using a unique power purchase agreement. The project spans 35 facilities, including schools, hospitals, police facilities, and more.
If your government office is ready to take the next steps on financing for energy projects, consider doing the following:
- Engage the appropriate staff to assess the opportunities in your building portfolio that are feasible to implement. This may include a facility specific energy or sustainability manager or a facilities team for the building portfolio. Understanding the size and scope of the potential projects will help determine the appropriate financing mechanisms (e.g., whether an ESPC would be appropriate or how an internal fund should be sized). The facilities team often plays a lead role in getting projects done, including project design and implementation.
- Understand what internal capital (if any) can be accessed to fund potential projects and consider whether it could be structured into an internal fund or capital expenditure program.
- Assess if an ESPC is an option, particularly if you prefer to have a third party support the installation and operations of a project or want a performance guarantee.
- Consider using the Better Buildings Financing Navigator to explore the range of third-party financing options available, and connect directly with Financial Allies who may be able to finance your projects.
- Energy Savings Performance Contracting (ESPC) Toolkit
- Department of Energy State and Local Solution Center
- EPA’s Clean Energy Financing Programs Decision Guide
- Easy Access to Energy Improvement Funds in the Public Sector
- Financing Energy Upgrades For K-12 School Districts
- Performance-Based Contracting: A Primer for K-12 Schools
- Energy Efficiency in Water and Wastewater Facilities
- Energy Savings Performance Contracting for Water Resource Recovery Facilities
- Guide to Promoting an Energy Efficient Public Sector (PePS)