Energy Performance Contracting: Alternative Financing for Energy Efficiency Projects in the Hotel Industry

Submitted to the Mexico Hotel Association
by Joe Loper (Alliance to Save Energy)

Hotel guests won’t be denied the comforts and convenience they expect in their lodging. They want control over room temperatures, the ability to take hot showers 24 hours a day, and to leave their rooms without worrying whether their lights have been turned off. They want round-the-clock room service and access to restaurants, business offices, conference rooms, stores, and spas. The primary focus of hotel owners and managers is to deliver these amenities.

Reducing energy costs while continuing to meet the diverse requirements of hotel guests can be challenging. But it is a challenge worth taking. Hotels consume large amounts of energy. Energy costs in the lodging industry average about $16NP per square foot. Luxury hotels may spend as much as $4000NP annually per room for energy. While energy costs are not the greatest cost faced by hotel management, they represent a substantial savings opportunity.

The challenge that hotel managers face is to find the time, technical know-how and financial resources to identify and implement energy efficiency measures. Fortunately, there are companies in Mexico that can help.

Energy Services Companies (ESCOs) help overcome several key barriers to the implementation of energy-saving projects in hotels, including lack of technical expertise, and financing. An ESCO will identify and evaluate energy and cost-saving opportunities, arrange financing, and maintain equipment after it is installed. Many ESCOs also offer energy performance contracting services for which the ESCO compensation is based on the level of savings generated by the project. While relatively new in Mexico, energy performance contracting has been used widely throughout the United States and Europe for nearly a decade to finance energy efficiency projects.

Energy Services Companies will work with a hotel to identify and select energy performance improvements that are the most cost-effective. A good ESCO relies on the practical knowledge of hotel employees and management to determine the most cost-effective performance improvement measures. The ESCO provides the necessary technical assessments, develops engineering specifications, sources equipment, identifies financial resources, and implements the performance improvement measures.

Improvements typically include:

• Optimizing performance of existing equipment and operations
• Integrating systems and operations
• Improving operations and maintenance procedures
• Upgrading and commissioning new equipment
• Analysis and renegotiation of utility rates and services

The most likely opportunity areas for energy efficiency improvements in the hotel sector are cooling systems (42 percent of energy load) and lighting (36 percent) followed by refrigeration, motors, elevators, and laundry.

Arranging Financing

A range of options exists for hotels to finance energy performance improvements, including direct purchasing, conventional commercial financing, equipment leasing, or performance-based financing. Once a potential project is identified, the ESCO will structure and recommend a menu of financing options and explain the advantages and disadvantages of each option. Hotel management can then choose the plan that best fits the hotel’s needs.

Although a variety of contract structures can be negotiated with the hotel client, ESCO can invest their own capital in the project and assume the risk of that investment by guaranteeing performance and deferring compensation from the client until the energy savings are realized. The ESCO may also involve the participation of commercial lenders and other equity sources to manage the risk and ensure the lowest cost of capital.

Off- Balance Sheet Financing: Most ESEs offer "off-balance sheet" financing so that only the current portion (that paid during the accounting period) appears on the client’s balance sheet. The ESCO provides or arranges (with others) all equity and debt based on project performance and typically provides a performance guarantee and/or shares in the savings for some period after the project completion. If the project fails to perform as stated, the ESCO (or equity holders) is subject to the financial obligation. Off-balance sheet financing can be a very valuable option for a hotel whose existing debt burden is too high to allow it to take on additional financing.

On-Balance Sheet Financing: Alternatively, the ESCO can raise funds based on the strength of client’s credit. The ESCO still guarantees a certain level of performance benefits adequate to cover the client’s obligations to its lenders and investors, but the client bears the financial risk of performance if the ESCO doesn’t deliver on its guarantee. In this case, the financing is be "on the balance sheet" and the current portion of the obligation is listed on the client’s balance sheet as current liability and the current long-term portion is listed as long-term liability.

Measuring & Verifying Performance

The ESCO also works with hotel management to establish a method for measuring and verifying a project’s performance. Measurement & Verification (M&V) is used to determine the value and distribution of the performance benefits. An effective M&V protocol must be developed before a project is implemented to ensure the project’s success and that the performance improvements are sustained over time. Depending on the nature of the project and the needs of the client, M&V of a project’s performance can be comprehensive (e.g., covering an entire facility) or can encompass single systems or pieces of equipment:

Measured Capacity/ Stipulated Performance: M&V is based on measurement of an agreed-upon performance factor (e.g. hours of operation) and applied to equipment performance before and after the implementation of an energy saving measure. This approach works best where the performance improvements involve installation of individual units of equipment or discrete systems within a hotel. The ESCO and the owner agree on a payment stream that is not subject to fluctuation due to changes in operation, weather, or other factors. Payments may be revised based on periodic measurement of the performance of the installed equipment or processes.

Measured Capacity/ Measured Performance: Performance improvements are monitored continuously to measure and verify performance. They are then compared to a baseline to determine the level of shared performance benefits. This approach applies best when the owner wants long-term continuous measurement of performance (providing long-term "persistence data") so that performance improvements can be optimized on a real-time basis.

Entire Facility Performance (Main Meter Measurement): Performance benefits are determined by measuring the change in performance of the entire facility. This approach applies best in situations where the owner wants to measure interactions between systems and when individual performance improvements can’t be measured directly.

M&V is perhaps the most important ingredient of a performance contract. At the same time, M&V adds additional labor and monitoring equipment costs to a project. The M&V should be rigorous enough to ensure the performance of a project, while at the same time not undermining the project’s economics. This is a key point of negotiation between the ESCO and the client.

The success of Mexican hotels depends on their ability to provide a comfortable environment for their customers and to reduce energy and other costs. Performance-based financing offers an alternative to traditional corporate financing to achieve the needed energy efficiency improvements in hotels.

Performance contracts address several of the most frequently mentioned barriers to investment in hotel projects. They transfer part of the technology and management risks of a project from the hotel to the performance contractor. They also minimize the hotel’s up-front cash outlays. For companies reluctant or unable to invest in energy efficiency and productivity improvements, a performance contract can be a powerful tool.

On the other hand, performance contracts are not something all hotel managers should consider. They are not free. Like any business, the ESCO charges for its services. Therefore, the hotel must pay for any performance guarantees provided by the ESCO. They must also pay for financing arranged by the ESCO and for any engineering and analyses conducted by the ESCO. While all of these costs can be rolled into the project and paid for over the life of the project, they are nevertheless not free.

Some hotels have the financial, technical and management resources to enable them to identify, evaluate, finance, implement, and maintain an energy saving project. These hotels are likely better off using their own in-house resources. Other hotels, however, do not have the necessary capabilities. By working with an ESCO to implement their projects they are able to take advantage of energy saving opportunities that otherwise would not be implemented.

Author

Joe Loper is Vice President of Research and Analysis at the Alliance to Save Energy. The Alliance is a non-profit, non-government organization based in Washington D.C. that works in Mexico to help raise the awareness that saving energy saves businesses money, strengthens the Mexican economy and protects the environment. The Alliance provides Mexican hotel, hospital and industrial facility managers with access to information, technology, services, and financing by organizing educational-business seminars with energy efficiency product and service suppliers and government and non-government energy conservation agencies.