EFFICIENCY:

Energy savers try to rebuild their 'brands' with government contracts

This story is the first in a two-part series. Tomorrow: cracking the private building market.

"No money down."

That's the pitch Donald Gilligan used to make as a salesman for an energy service company. And once upon a time, it was the overture to an energy-saving spiel that was very appealing.

He would look over a building's energy waste points from rooftop to basement. He would figure out how to plug those leaks, and how long it would take for each fix to pay itself off. Then he would write up a contract with the building owner.

No money down: The owner wouldn't have to pay a cent. All he or she had to do was sit back and let Gilligan's team tighten up the building. They could plan to change light bulbs, stuff insulation into the walls, perhaps downscale the old inefficient heater for a modern, smaller one.

Then Gilligan would create his payday by skimming off the utility bill savings for the length of the contract. When this contract was up, the building's owner would continue to have smaller utility bills. The savings from then on were pure gravy.

But another company came along with a better-sounding pitch. It was called Enron Energy Services, and it promised more than just savings. It went beyond "no money down" with an offer of a cash advance on the energy savings that were sure to come. In effect, it would pay a client to make his or her building more energy efficient.

It was one scheme in a house built with many of them that eventually crashed. Enron collapsed under the weight of promises founded largely on creative accounting.

But by that time, the damage was done. A few years after the debacle, Gilligan approached a consumer products company with his usual "no money down" pitch. But the company had a bad taste in its mouth from a recent experience. It had been working out a "no money down" contract with an energy efficiency company which, scandalized by the Enron events, shut down overnight.

Overcoming a bad taste

The company had spent immense resources on the contract "just to have the whole thing blow up," Gilligan recalled. "It was like I was trying to sell cyanide."

These days, Gilligan has given up his salesman's hat. Instead, he is a head advocate for an industry rebuilding its reputation.

Gilligan is the president of NAESCO, the National Association of Energy Service Companies. Its members, known as ESCOs, are firms that assess how a building can save energy, then write a contract guaranteeing the savings and retrofit the building.

In 2007, he and Lawrence Berkeley National Laboratory issued a report on the state of the industry. In the 1990s, they found, the ESCO business grew by 20 percent every year. But growth tumbled to 3 percent from 2001 to 2004, responding in large part to Enron's fall.

Since then, ESCOs have rebounded. Gilligan estimates that the industry raked in $5.5 billion in revenues last year, almost double what it was at mid-decade.

The efforts are considered among the most successful energy efficiency programs ever attempted in the United States. In the federal government alone, ESCO work saves $1.4 billion every year, after accounting for project costs. The energy saved each year is roughly that of 200,000 households.

Part of the reason the ESCOs' efforts have been celebrated is that they have addressed the central issue of energy efficiency in buildings: how to pay for it.

A trillion-dollar market in the making

Energy use in buildings accounts for 40 percent of the country's greenhouse gas emissions, and many have pointed out the enormous money-saving potential that would come with shaving off buildings' energy waste. According to a report released by McKinsey & Co. last month, aggressively making buildings and their equipment more efficient could cut energy demand by almost a quarter by 2020, to the tune of more than $1 trillion in savings.

But when it comes to this "no-brainer," the building sector suffers many a brain cramp. Among them: A renter may want to make her building more efficient, but will forgo it if she won't live there long enough to reap the payback. A building owner might want to install energy-efficient windows but balk at the higher up-front cost, especially if he doesn't have the cash to spare.

For ESCOs, the answer comes in three little words: "no money down."

That's the teaser for the Energy Savings Performance Contract, the main document ESCOs use in their business. These contracts, called ESPCs for short, aren't designed for every kind of building. Since they're based on long-term stability, the most eligible clients are those who plan to be around for a long time and can wait for their investments to pay themselves off.

That's why ESCOs' main clientele is governments, as well as other institutions like hospitals, schools and universities. According to the LBL report, they make up 80 percent of ESCO business. In each case, there is no up-front price tag for the project, even though costs can run into the hundreds of millions.

ESCO clients find the ESPC model attractive for various reasons. For one, it's a "turnkey" arrangement: The ESCO is responsible for raising the money from banks, retrofitting the building and verifying that it works, demanding minimal effort from building owners.

It also affords a great deal of choice. When an ESCO and a client hammer out an ESPC, they consider a long list of efficiency measures that a building could use. Each one is evaluated for its payback: Efficient light bulbs, for example, pay back within a few years, whereas the client could take much longer to recoup the investment on a large new water boiler. In the final ESPC, the client customizes the exact combination of fixes that meets her financial needs, in a time frame that she can stomach.

What happens to all the cash savings from the improved building? During the length of the contract, the ESCO gets to take a bite out of the utility savings, to cover costs and commission. But once the contract is over, the building owner has exclusive rights to energy savings for as long as he has it.

No energy cuts, no financial gain

Perhaps most importantly, an ESPC puts an ESCO on the hook for energy savings. Retrofitting a building takes technology, and technology isn't flawless. The "performance" in "performance contracting" obliges the ESCO to make sure the energy savings promised actually occur -- a crucial point, since that's the basis of paying for the project. If an ESCO's work doesn't function as promised, ESPCs actually require it to pay its client what the client was supposed to have saved.

It's a model that started catching on in the mid-1990s, with the first wave of deregulation in the electric industry. According to Gilligan, utility companies, expecting increased competition for customers, started buying up small energy service companies or starting their own, to try to gain a market advantage.

These early ESCOs experienced some stutters, since the utilities were new to the business of energy efficiency. But no one turned the model upside-down like Enron Energy Services, or EES, an ESCO formed by Enron.

"The Enron story sort of set the whole business back a couple years," Gilligan said. "What Enron would do is show up on day one and say, 'We've taken a look at your business, and we've present-valued a 10-year contract for energy supply and efficiency services. And here's a check.'"

As Congress and investigators would discover, EES was measuring the future efficiency savings that a building could offer, like any ESCO. It was combining these estimates with the deals it predicted it could get on electricity. But even before doing its projects, EES was already counting these savings in its books as current revenues. Meanwhile, its salesmen were closing similar contracts with other clients, adding to the company's portfolio.

Enron gets carried away, literally

The goal, investigators said, was to inflate the company's stock price. In Enron Corp. CEO Kenneth Lay's trial, prosecutors accused him of claiming that EES alone could boost Enron's stock by $23.

"EES just keeps banging away. Just keeps growing at a tremendous rate. Most importantly, net profits are growing," Lay said to employees in 2001, according to "Accounting/Finance Lessons of Enron," a textbook published in 2008.

In reality, EES was hemorrhaging millions of dollars, and the company had made promises it couldn't keep. Not only had it been overly optimistic about getting discount electricity rates -- lower rates would mean greater profits for EES -- but it had overestimated how easy it would be to deliver on its efficiency projects.

"It was this enormous amount of work which was much more complicated to deliver than they reckoned on," Gilligan said.

Years after Enron's downfall, ESCOs are climbing back into the market, largely with government business. The federal government, which operates 525,000 buildings nationwide and uses 1.6 percent of the country's energy, has been a main customer. That's because they are perfect candidates for ESPCs. Most of those buildings were built between the 1940s and 1960s, so they are far from cutting-edge. And as the sites of government agencies, they can plan to be around for a long time.

Some also credit the government with sowing the seeds for a lasting market. The 2007 energy bill, the Energy Independence and Security Act, permanently extended authority for agencies to use ESCOs. It also made an executive order by President George W. Bush into law, stating that federal agencies must reduce energy intensity 30 percent below 2003 levels by 2015.

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