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Ways to Fund Sustainability Solutions
Do not discard sustainability projects due to lack of funding without at least considering alternate ways to raise additional capital or to create non-capital structures for financing them.
The first thing to do when seeking funding for sustainability measures is to pursue available grants, rebates, and donations.
Sustainability strategies are particularly attractive to potential donors. Donors can be sourced through individuals, organizations, or businesses in your local community or through statewide and national foundations.
Most utilities have rebate programs that will help fund projects, particularly energy projects.
The Database of State Incentives for Renewables and Efficiency (DSIRE) website lists various available rebate and other government-derived funding programs. One challenge in using these kinds of sources is that the funding available is generally not enough to pay for an entire project, and the agency funding cycles and your organization’s capital approval process may not be aligned. The organization may have to accelerate its capital allocation process to allow capture of available funds, or it may have to coordinate the timing of rebates with the facility capital allocation process.
Utility companies may be able to offer facilities other ways to fund projects. They might be willing to build a power plant for the facility that would be paid for in the form of energy purchased from the plant. This arrangement would allow the facility to get a better plant than the organization itself could afford.
Many states have decoupled their utility company rates, meaning utilities will be rewarded financially for reducing energy demand, instead of simply getting a little bit of money for every unit sold. Thus, utilities are more likely to be willing to work with individual organizations to help them find ways to reduce their facilities’ energy demands.
States with Decoupled Utility Rates: Arkansas, California, Colorado, Connecticut, Idaho, Illinois, Indiana, Maryland, Massachusetts, New Jersey, New York, North Carolina, Minnesota, Oregon, Utah, Vermont, Virginia, Washington, Wisconsin.
Finally, rate structures can provide ways to implement sustainability strategies, primarily through changing the payback of the investment (keeping in mind the limited connection between payback and capital). Understanding the rate structures, including changes in rates, can provide ways to justify potential savings programs in new ways. The bottom line is that an organization interested in pursuing energy or water reduction strategies should approach its utility company about alternate ways to finance projects.
Government tax incentives are different from rebates. Tax incentives serve to speed up the payback for various types of initiatives, and thus are subject to the limitations suggested initially for expense savings related to capital investment.
Shared Savings Agreement Example
Lakeside Memorial Hospital
Using Energy Smart Decision Toolsï¿½ to evaluate alternatives, a program was developed using annual operating cost savings to fund both building upgrades and energy efficiency measures. The project included a new chiller plant, an improved and efficient heating and cooling distribution system, new efficient lighting, a modern building controls system, and a face-lift for the aging facade to welcome visitors to the hospital.The job resulted in a 30 percent reduction in annual operating costs with net savings exceeding $1 million over the term. The New York State Energy Research and Development Authority (NYSERDA) provided more than $500,000, and Lakeside Hospital was able to offset more than 3.2 million pounds in annual greenhouse gas emissions.
In addition, many hospitals are nonprofit and thus unable to access tax advantages directly. These hospitals can still access tax benefits indirectly through arrangements such as power purchase agreements, leases, or other structures that involve a for-profit third-party as described below.
Many hospitals have pursued energy demand reduction projects using shared savings contracts. According to the terms of these contracts, a third party will agree to finance, design, and install energy retrofit projects, with the costs to be paid from the energy savings that result. This contracting method is one way a nonprofit hospital can access the benefits of tax provisions. Also, because the method does not require capital, it can often be approved more easily than other kinds of projects within an institution. Some hospitals have had complaints about this method of contracting, at least partly because it can be difficult to estimate the actual savings. Some states have licensing laws for energy services companies (ESCOs) that provide these services.
Pioneer Valley Hospital
Pioneer Hospital illustrates how third-party ownership can be the right financing structure for some renewable energy projects.
Under a contract with Johnson Controls, Pioneer is installing solar photovoltaic panels that will generate 100 kilowatts of electricity. Given the plentiful sunshine in Southern California, hospital administrators felt it was the right thing to do for the local community, and they hope it will encourage other businesses to install renewable energy facilities. Funding for installation of the solar panels is coming from three primary sources:
The investors will actually own the solar equipment and sell the electricity it generates to the hospital at rates lower than the local utility is charging. This shields the hospital from volatility in electric rates. Third-party ownership of the solar equipment has other distinct advantages for Pioneer Hospital. It enables the hospital to avoid spending out of pocket dollars on the project, and it enables the hospital to keep the installation costs off its balance sheet as debt, an important consideration in this case.
This contracting arrangement is very similar to the shared savings agreements, in that it involves a third party that owns, finances, designs, installs, operates, and maintains a power-producing asset (usually a renewable energy source). In turn, the hospital agrees to purchase the power generated from the plant. Like the shared savings agreements, PPAs allow indirect access to tax provisions and avoid the need to go through the capital-planning process. These systems tend to experience fewer discontented users because the energy generated can be precisely measured.
Interestingly, PPAs can be applied to both smaller on-site facilities and to larger, utility-scale plants, allowing a health care facility to purchase larger quantities of renewable energy over a longer period of time.
This contracting arrangement, because it locks in an energy price for a long period, operates as an energy hedge. That is, it allows the facility owner to lock in the price of energy for several years, thus shielding the owner from the risk of significant price increases.
A lease provides a structure similar to the power purchase and shared savings agreements. For example, for a hospital considering a renewable energy system, under a power purchase agreement the owner would be obligated to buy all of the energy produced by the generation asset. However, the initial investment from the third party would remain constant, meaning the third party would earn a windfall over time. If, instead, the owner elected to lease the renewable energy system, the owner would pay a fixed amount and would benefit from any over-production. Of course, under-production would create the opposite result, meaning the lease structure largely shifts the performance risk/reward onto the owner and away from the vendor.
Unless a lease is structured properly, it may be seen as a capital purchase through loans (usually very expensive ones). If an organization agrees to a lease with the understanding that it will be an off-balance-sheet recurring expense, it will seriously impact the financials of the organization if it later must be reclassified as a capital expense.
This structure is very new, having mostly been used for residential properties in California. However, other states have enabling legislation, and the various energy bills at the federal level include provisions to allow this structure on a national basis. (Even if the federal bills do not advance, they are likely to be disassembled and resubmitted in pieces.)
Under the terms of this arrangement, the government agency covers the upfront costs for energy efficiency improvements and installation of renewable energy generation systems, generally through the sale of bonds. In exchange, the building owner agrees to pay a property tax assessment over some period of years to repay the initial investment. This structure is completely off the balance sheet (i.e., non-capital). It can be used for both for-profit and not-for-profit entities. For more information, visit the PaceNOW website.
States that Have Passed PACE Legislation: California, Colorado, Illinois, Louisana, Maryland, Nevada, New York, Ohio, Oklahoma, Oregon, Texas, Vermont, Virginia, and Wisconsin.
Revolving Loan Fund Example
Another funding strategy for sustainability projects is for an organization to use a shared savings agreement and act as its own energy services company. In this arrangement, when an organization invests in a sustainability project that is anticipated to save some expense money, it sets aside a portion of that saved money to fund new projects in the future. In this way, a single infusion of capital can be used to generate both immediate energy savings and a steady stream of capital for future projects. Strictly speaking, this method does not provide capital-free investment opportunities (depending on how accounting structures are set up), but it does better connect energy savings with capital allocation.
Many hospitals have some amount of investment funds, in the form of endowment, cash reserves, or retained earnings. The organization regularly develops investment strategies for this money, seeking the best combination of liquidity, risk, and return.
Many hospitals with this kind of funding have discovered that acting as their own energy services company and investing available funds in energy demand reduction projects or energy generation assets will yield a much higher return than investing that same money in the stock market or other available investment. This would be a balance sheet transaction and side-steps the capital allocation constraint, even though, strictly speaking, it does represent an investment of capital.
At present, there is no mandated federal market for emissions or offsets. However, there is one regional market (Regional Greenhouse Gas Initiative, or RGGI), and several others are being developed. In addition, the state of California is on schedule to begin its market-based system in 2012. But, even without mandatory markets, a number of voluntary markets are available as well as other channels through which to sell environmental attributes associated with energy demand reduction and renewable energy production.
Further, the United Nations Framework Convention on Climate Change is considering a number of changes to its clean development mechanism (CDM) framework that would set up protocols to allow building energy reductions to be counted as offsets in one way or another. Of course, since the United States is not a party to the Kyoto protocol, we can’t take advantage of these kinds of provisions, but if the United Nations passes these protocols, it may still be possible to apply them in the United States.
Carbon offsets and renewable energy credits (RECs) can be sold on a year-by-year basis, allowing an owner to choose to sell them one year and retain them the next. This is important because the owner may have a reason to want the ownership of the RECS/offsets. Managing them will take resources, however. Also, selling them can be difficult in the small quantities likely to be produced by one owner, meaning they would need to be sold through an aggregator, who would bundle the offsets/RECs from a number of sources and package them for sale in the markets. In general, it is much easier to simply sell the offsets/RECs to the contractor installing the panels or assets, as they are more likely to have the infrastructure to manage them and doing so might lower a project’s first costs if properly understood and applied.
One reason to be careful about selling offsets, though, is that a facility might be regulated in the future. There is currently no cap and trade system, and most systems being considered would focus on large emitters like cement plants and utility plants. However, some private organizations do have their own power plants and could come under the threshold requirements for inclusion in the cap and trade system. Alternatively, the markets may be set up to cover an enterprise rather than single buildings. In all legislation relating to the setup of such markets, the rules require regulators to give proper credit for early action. Early action means that, if an organization establishes a baseline before regulations are passed and then implements demand reductions or increases renewable energy production sources, it could be banking these credits to offset the immediate impacts of any future emission regulations. Again, careful accounting of these credits will be required, but could result in a big windfall.
Strictly speaking, this is not a method for financing the first cost of energy or sustainability projects. However, if an owner puts the project team, including designer, vendor, and builder, at risk on some portion of their fee to ensure performance, it will greatly inspire the team to deliver promised results. Too often, modeled performance does not materialize, but finger-pointing does. Putting the team’s compensation at risk will help you get your money’s worth from the capital dollars you do invest, thus ensuring the financial business case you anticipate.
One variant of this strategy would be to incent internal staff with performance rewards for achieving environmental performance improvements. Studies have shown conclusively that one of the largest hurdles in achieving real changes is not in the technologies we use, but in the behaviors we exhibit. Creating incentives for staff to do better is likely to lead to better outcomes through simple, low-cost behavior changes.
The greatest power from these various methods for reducing and offsetting first costs will come from imaginative combinations of these and other strategies. For instance, one health care chain is considering taking investment money, matching it with external grant money, and setting up an ESCO to invest in energy demand reduction projects in its hospitals. The hospitals will then repay the initial investments from energy savings, continually regenerating the initial investment for use in more projects.