INDUSTRY AND ENERGY DEPARTMENT WORKING PAPERENERGY SERIES PAPER No. 4

Improving Power System Efficiencyin the Developing Countries ThroughPerformance Contracting

May 1988

The V' Id ik lr and 9=r r i t

Oa~~ ~ ~~~~~ -a

~~, , . -. - j. . o -.. e ~ -

TheV Itrd ik Ir r y nrld rr r~ .rt l PPR

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

IMPROVING POWER SYSTEM EFFICIENCY

IN THE

DEVELOPING COUNTRIES

THROUGH PERFORMANCE CONTRACTING

April 1988

by

Philip YatesConsultant

Industry and Energy Department, PPR

Copyright (c) 1988The World Bank1818 H Street, NWWashington, DC 20433USA

This paper is one of a series issued by the Industry and EnergyDepartment for the information and guidance of Bank staff. Thepaper may not be published or quoted as representing the views ofthe Bank Group, nor does the Bank Group accept responsibility forits accuracy or completeness.

Abstract

This paper suggests using energy performancecontracting to improve the operational and institutionalefficiency of electric utilities in the developing countries. Inthe United States, considerable success has been achieved withenergy performance contracts whereby contractors undertake toeffect savings in energy consumption for industrial andcommercial facilities in exchange for a share of the savings. inthe developing countries, various forms of performance contractshave been considered whereby governments grant utilities moreflexibility in salaries, procurement, operations, etc. inexchange for their commitments to improve utility productivityand efficiency. The paper recommends merging the two concepts sothat a utility would engage a contractor to effect operationalimprovements under an energy performance contract for a share ofthe savings, thereby allowing the utility to meet its efficiencyimprovement targets agreed with government in exchange forgreater autonomy. The Appendix shows a sample energy performancecontract.

Table of Contents

I. Introduction and Summary . . . . . . . . .. . . . . 1

II. BackgroundA. The Potential for Private Sector

Involvement in Developing CountryUtilities . . . . .. . .* * * * a * * * * *. 3

B. Private Sector Performance Contracting . . . . . 5C. Government/Utility Performance Contracts . . . . 9D. Utility Twinning . . . . . . . . . . . . . . . . 11

III. Barriers to Performance Contracting . . . . . . . . 12A. Operational Control . . . . . . . . . . . . . . 13B. Foreign Exchange . . . . . . . . . . . . . . . 14

IV. A Model Energy Performance ContractUsing Concessional Lending . . . . . . . . . . . . 15Step One: The Lender Determines

to Test the Concept . . . . . . . . . 15Step Two: The Government/Utility

Performance Contract . . . . . . . . . 15Step Three: Request for Proposal . . . . . . . . . 16Step Four: Contractor Selection . . . . . . . . . 17Step Five: Preliminary Analysis Contract . . . . 18step Six: Negotiating the Details . . . . . . . 19Step Seven: Implementing the Contract . . . . . . . 22

V. Conclusion . . . . . . . . . . . . . . . . . . . . . 23

Appendix -- Sample Guaranteed Savings Contract

IMPROVING POWER SYSTEM EFFICIENCY

IN THE

DEVELOPING COUNTRIES

THROUGH PERFORMANCE CONTRACTING

by

Philip Yates1

I. Introduction and Summary.

It is ge.nerally recognized that electric utility-ystems in the developing co4ntries &re less efficient thanutility systems in developed countries.2 Many developingcountry utilities can improve their efficiency at relativelylow cost, through better planning, improved maintenanceprocedures, adequate stocks of critical spare parts, andincreased training of utility personnel.3 In short,improving the operation of existing facilities may be themost attractive energy investment available to a utility in adeveloping country.

While there are a number of reasons for theseoperational defi;ciencies, the core problem is institutional.Developing country utilities are usually government-owned,and over-control by government frequently leads to decisionsthat conflict with good operational practice. Because ofthese institutional barriers, developing countries cannotimprove utility efficiency simply by spending more money.Any money allocated to improve utility efficiency should bespent as part of a program that increases the chances that(1) funds are expended appropriately, (2) personnel are

1. Philip Yates, 3502 N.E. Flanders, Portland, Oregon,97232, is an attorney and energy consultant who has workedextensively on energy performance contracts in the United States.

2. C. Tabet and R. Skjoeldebrand, "UnavailabilityFactors of Thermal Generating Plant and AvailabilityStatistics, 13th Congress of the World Energy Conference,October 5-11, Cannes, France.

3. "Power system efficiency" is used in this paper inits broadest possible sense, to include availability factors,power plant fuel efficiency, line/distribution losses,billing procedures and administrative overhead.

2

trained, and (3) trained people stay at their jobs aftertraining.

The "performance contract" concept may be apotential solution to this institutional problem. There aretwo basic forms of this kind of contract that are relevant tothis paper.

1. Private sector "energy performance contracts"have been used by large industrial and commercial energyusers to lower their energy bills with little or no capitaloutlay. The energy performance contractor provides theengineering, capital, and ongoing maintenance needed toderive energy savings through the installation of energyefficiency devices or equipment, e.g. a heat exchanger on anindustrial boiler. In exchange for this investment, theenergy performance contractor receives a share of the energysavings that are generated over the length of the contract.

2. The term "performance contract" has also beenused to describe an arrangement between a government-ownedutility and its central government, under which the centralgovernment agrees to provide greater freedom to utilitymanagement, e.g. an exemption from civil service regulations,in exchange for the improved performance of the utility.This type of "performance contract" has been used in a numberof countries as a means of targeting and monitoring theperformance of government-owned organizations such asutilities.4

This paper discusses the concept of merging theprivate sector energy performance contract with thegovernment/utility performance contract to form the basis ofa program that can solve some of the institutional problemsthat inhibit the efficient operation of many utilities indeveloping countries.

Section II contains a discussion of the potentialfor improving tne efficiency of utilities in developingcountries, the various types of energy performance contractsthat have been used by the private sector, thegovernment/utility performance contract model, and utilitytwinning. Section III outlines the potential synergy betweenprivate sector performance contracts and government/utility

4. For the private sector energy performance contract,an energy performance contract usually creates a benefit forthe building or facility owner by reducing energyconsumption. In the utility context, the benefit is morelikely to be increased production rather than reducedconsumption.

3

performance contracts. Section IV addresses the design of apotential pilot project to test this potential synergy.Section V contains the conclusion of the paper. A samplecontract between a government agency and a private sectorenergy performance contractor is contained in the Appendix.

II. Background.

A. The Potential for Private Sector Involvement inDeveloping Country Utiities.

A precondition to private sector participation in aparticular market is the opportunity to make a profit.Fortunately, there are obvious money-making opportunities inimproving the efficiency of developing country utilities. Ifadequate foreign exchange is available, these opportunitiescould attract private energy performance contractors.

For example, based on a survey conducted by theWorld Energy Conference, the average "availability factor"(the percentage of time a generating plant is capable ofservice) for 100-199 MW generating units in the U.S. is 81%.In contrast, the average availability for the sarme class ofplant in the developing countries is 75%*.5 While the averagedifferences are not as great for larger units, the averagesobscure the extremes. In India, for example, availabilityaverages 66-70%, with some uits below 50%.6 Conversely,many European and North American utilities are able toachieve availability factors in excess of 85%.

The economic impact of low availability isstaggering. A 1% improvement in a 320 MW coal-fired unit'savailability factor can reduce costs by US$500,000 a year.7

For larger units, the losses are even more severe. Forexample, losing a 550 MW plant for a day can cost

5 Id., note 1.

6. S.A. Subramanian, "Management of Availability inOperation," World Energy Conference, Rome, Italy, 28-31October, 1985.

7. G. Galli, "Availability Management: The Experienceof ENEL," World Energy Conference, Rome, Italy, 28-31October, 1985.

4

US$240,000,8 while losing a 600-700 NW plant for a day cancost US$300*000.9

These losses result from replacing power from a"down" plant with power from a plant that is less efficientand/or uses a more expensive fuel, e.g. replacing a unitfired with domestic coal with a unit fired with imported oil.However, for many utilities, an even larger price is paidindirectlv through reduced economic activity caused by poorpower quality and blackouts. Blackouts reduce economicactivity in the short run (an industrial facility shuts down)and in the long run (the decision not to locate a newindustry in an area with poor power quality). Further,blackouts lower utility revenues because no power is soldduring a blackout, and poor electricity supply reduces thepower market.

Losses of a similar scale are found in many othersegments of the develop ng country utility operation, i.e.transmission, distribution, administration and billing. Inparticular, poor planning for the transmission/distributionsystem and poor billing procedures produce truly awesomelosses in utility revenues.

For example, in Nigeria the gross revenues of theNigerian Electric Power Authority (NEPA) are US$127 millionper year. These revenues are derived from only 60% of theelectricity that NEPA produces, because total system losses(technical and non-technical) are 40%. Thus, in Nigeria, areduction of one percent in system losses is worth over US$2million per year to the utility.10

The poor efficiency of developing country utilitiescreates potentially profitable market opportunities for firmsthat can help improve utility performance. The market is notonly large, it is growing -- about $50 billion is spent onnew developing country power systems each year and annualaverage developing country load growth is 7%1.2

S. J. Krasnodebski & M.S. Grover, "Life Cycle Costs inPlanning and Designing for Availability," World EnergyConference, Rome, Italy, 28-31 October, 1985.

9. P.C. Warner, H. Langner, "High Availability in SteamGenerator/Turbine Units," World Energy Conference, Rome,Italy, 28-31 October, 1985.

10. World Bank Report No. 6923-UNI, p.24 and annex 1-2.

11. Christopher Flavin, "Electricity for a DevelopingWorld: New Directions," Worldwatch Paper 70, January 1986.

5

Many architectural and engine-ring f irms and a fewutilities are pursuing this market. However, theinternational debt situation and limited foreign aid preventsmany developing country power authorities from acquiring theforeign exchange needed to improve utility efficiency levelsby hiring expatriate consultants under a traditional fee-for-services arrangement. Furthermore, as indicated above, evenif the capital is available from concessional lenders *rother sources, many efficiency problems are fundamentallyinstitutional -- valid recommendations are ignored, andexpatriate personnel either fail to train indigenouspersonnel or the personnel that are trained leave the utilityfor the private sector.

In short, two problems must be solved. First,developing country utilities must gain greater access toforeign exchange in a manner that allows them to attractprivate contractors interested in improving utilityefficiency. Second, institutional barriers to efficiencymust be removed or modified.

The thesis of this paper Is that performancecontracts can be used to solve the second problem.

B. Private Sector Performance Contracting.

Energy performance contracts executed by private Lsector firms are generally structured as follows:

(1) A contractor provides a client (usually a facilityowner) with an engineering report. If the client agreesto install the items recommended by the contractor,there is no immediate charge for the report. If forsome reason the client decides not to go through withthe program, the client pays the contractor for thereport.

(2) Based on the engineering that is provided, thecontractor and the client agree, through contractnegotiations, to the implementation of improvedoperating procedures (including training to be providedby the contractor) and the installation of energy savingdevices.

(3) The procedures are implemented and the devices areinstalled by the contractor, again at no immediate costto. the client.

(4) The contractor's compensation is in some manner tiedto the financial benefit that the contractor's effortshelped to generate.

6

This basic structure can take a nurnber of differentforms, with the greatest distinction being the manner inwhich compensation is tied to performance. The most commonenergy performance contracts are shared savings, pay fromsavings, guaranteed savings, and micro-utility arrangemer.ts.

Each of the most typical energy performancecontracts is described below:

1. Shared Savinas. Under a "shared savings"contract an energy performance contractor provides energyefficiency services and equipment (the equipment can besupplied by a lender or lease company affiliated with thecontractor), in exchange for a share of the energy costsavings or increased revenues that are generated. Under thisarrangemez:t, the risks of non-performance and the benefits ofover-performance shift almost totally from the facility ownerto the contractor.

For example, assume a facility has a need for$1,000,!000 in rehabilitation improvements that is expected todecrease the facility's energy and operating costs byPO00,000 per year. An energy service company could propose

design, install and maintain these improvements inexchange for one-half of the increased savings for a periodof seven years, or an estimated $1,750,000 over the period ofthe contract. The contractor can lose money if the savingsdo not increase as much as expected. On the other hand, ifsavings increase more than expected, the contractor wouldmake mcre than the estimated fee.

2. Pay-from-savings, A "pay-from-savings"arrangement is similar to a shared savings arrangement,except that the maximum payment is fixed, with the conditionthat the payments will never exceed the increased savingsthat are generated. Like a shared savings contract, a pay-from-savings arrangement limits the exposure of the facilityowner to the increased savings that are generated. However,pay-from-savings limits the contractor's downside risk (bygiving the contractor 100% of the increased savings until themaximum fee amount is reached) while also limiting thecontractor's upside potential.

Using same hypothetical example, the contractorcould agree to provide the $1,000,000 improvements inexchange for an annual maximum fee of $250,000 per year forfive years. If the facility owner's savings increase by only$100,000 per year, the contractor would be paid this amount.However, if the increase in !avings is $750,000 per year, thecontractor would receive no more than the maximum paymentunder the contract ($250,000).

7

3. Guaranteed Performance. Under a "guaranteedsavings" plan, an energy performance contractor provides aguarantee that a certain level of performance will beachieved. Under this type of arrangement the contractor canprovide the financing, take over the responsibility to paythe facility's energy expenses, and bill the facility ownerfor a percentage of the facility's prior energy costs. Thecontractor's gross revenues are the difference between theamount paid to it by the facility owner and the amount thecontractor pays to the utility/energy supplier.

For example, if the annual energy costs of thefacility had been $1 million per year, the contractor couldagree to pay the energy costs of the facility and install itsequipment in exchange for 90% of this amount from thefacility owner each year for a period of ten years. If thecontractor can lower the facility's energy bills to $700,000per year, the contractor pays out this amount and receives$900,000, for gross revenues of $200,000 per year.

Under another form of guaranteed savings, thefacility owner borrows the money from a bank or other lender.Although the money is borrowed by the facility owner, thecontractor guarantees that the increased savings will be morethan sufficient to pay the debt service on the loan. Byproviding the contractor with its payment at the beginning ofthe contract (at the completion of the installation), thefacility owner lowers the contractor' finance costs (theselower costs should be passed on the facility owner) whilealso affording the facility owner the ability to takeadvantage of potential financing advantages uniquelyavailable to it. e.g. concessional lending.12

For example, the facility owner could borrow the$1,000,000 for a five year period with annual payments of$225,000 per year. The contractor could agree to guaranteethe facility owner that its increase in savings will be atleast $225,000 per year. At the completion of theinstallation, the contractor receives the $1,000,000 for itswork. If the savings are $250,000 or more each year,everyone is satisfied. However, if the first year's savingsare only $150,000, then the contractor would pay $100,000 tothe facility owner (the difference between the increase insavings and the guaranteed amount).

12. In the U.S., guaranteed savings is popular withstate and local governments because interest paid by theseentities are not subject to federal income tax. Theguarantee savings approach allows government clients to enterinto performance contracts using low cost government debt.

8

4. Micro-Utility. A "micro-utility" approachworks for those energy investments that can be directlymetered. Under this approach, the contractor installsequipment (usually generating equipment) and contracts tosell the output to the facility owner for a stipulatedamount. The example set forth above cannot easily fit intothis model, because most energy savings devices cannot bedirectly metered.

These four basic approaches to energy performanczecontracting can be combined or altered to meet a variety ofneeds and circumstances. Further, each type of paymentscheme can be 3tructured into a number of different legalforms, including various combinations of leases, servicecontracts, installment contracts, insurance policies, bonds,etc. The appropriate payment scheme and legal structure mustbe determined by the facility owner and the contractor on acase-by-case basis.

An energy performance contract can providesignificant benefits for the owner of the facility. Mostimportantly for m a owners, there is no need for "up-front"capital expendit Also, there is limited risk, becausethere are no payments due unless there are measurableperformance improvements, and generally the payments arestructured to be less than the savings so that there isalways a positive cash flow for the facility owner. Further,the energy performance contractor may be able to act morequickly and do a better job than the facility owner could dofor itself.

However, there are significant costs as well. Theperformance contractor will require a profit commensuratewith its perceived risk. If risks are very high, the profitmargin must likewise be very high. To lower those risks (andthe required return to the contractor), performance contractsusually include a provision under which the facility owneragrees to operate the facility according to the contractor'sspecifications. While contractual operational parametersmay limit the contractor's risk and thus reduce the requiredprofit margin, the issue of losing exclusive operationalcontrcl is a significant problem for many facility owners.

Administrative costs are also significant.Performance contracts are complex. They require asubstantial amount of effort to negotiate, and once thecontract is underway it may be costly and difficult toaccurately measure performance. Further, even after asuccessful negotiation, enforcement of the obligationscreated by the agreement have caused problems for a

9

relatively large percentage of facility owners that haveengaged in these arrangements.

For many government facility owners, the benefitsof an energy performance contract are greater than the costs.Indeed, the popularity of performance contracting appears nowto be greater in the public than in the private sector in theUnited States. The reason is principally that the publicsector is more risk averse and less motivated by profitmaximization than the private sector. Since performancecontracts are characterized by lower risk for the facilityowner, performance contracting clearly appeals to governmentfacility owners on this basis.

Cogeneration and small power production facilitiesare frequently installed under contracts that both limit therisk of the facility owner and reward the contractor for goodperformance. Performance contracting has also been used inlarge industrial applications. However, performancecontracts have been used most often to install energy savingdevices in commercial buildings.

C. Government/Utility Performance Contracts.

Many observers complain that developing countryutility managers cannot improve the efficiency of utilityoperations because of controls placed upon the utility by thecentral government. They argue that if the controls arelifted, performance would improve.

For example, a major problem for many developingcountry utilities is unscheduled outages. These are morefrequent than "optimum" usually because the utility haspostponed scheduled preventive maintenance. Unfortunately,the decision to postpone a scheduled outage is sometimes apolitical rather than a technical or economic decision.Further, unscheduled outages are longer than necessary due toa lack of critical spare parts and poorly equipped repairshops. Again, the decision to short-change maintenance infavor of new, more visible (and more popular) projects is apolitical decision with adverse economic consequences.

Equally important, many developing countryutilities have problems in training and retaining qualifiedmaintenance personnel, due largely to civil serviceregulations13 and higher pay in the private sector.14 AS

13. David Jhirad, Pirooz Sharafi, Ed Hillsman,"Innovative Approaches to Electric Power Delivery inDeveloping Countries," Asia and Near East Workshop, Asian

10

long as the utility is run as just another part of thegovernment bureaucracy, these regulations and pay limitationswill inhibit significant improvement in managementperformance. Poor management is not surprising when uppermanagement are politically appointed (frequently with noregard for professional competence), and when managementdecisions are politically motivated.

Many believe that if these political influences areremoved (also called "privatizing" or "commercializing" theutility), improved utility performance can be achieved withlittle capital outlay. Unfortunately, privatizing developingcountry utility operations is extraordinarily difficult. Forunderstandable reasons, central governments are reluctant torelinquish control of what is frequently the most capital-intensive segment in the economy. However, for reasons thatare just as understandable, many international lendinginstitutions are beginning to insist on management reforms asa condition to providing loans for developing countryutilities.

These management reforms can be instituted througha government/utility performance contract. Since utilityperformance can be quantified in a relatively straightforwardfashion, a government/utility performance contract conditionsthe granting of management freedom with measurableimprovements in utility opera.__.ns.

A government/utility performance contract couldwork as follows:

(1) The central government agrees to exempt theelectric utility from one or more of the constraints underwhich the utility has previously operated, e.g. civil serviceregulations, procurement regulations, interference withmaintenance decisions from political appointees, timelypayment of utility bills Dy government agencies, etc.

(2) The electric utility agrees to improveperformance according to some measurable criteria, e.g.availability factor, employees per MW, losses due totechnical and non-technical factors, etc.

(3) If the electric utility meets its goals, thecentral government continues and expands the operationalfreedom of action of the utility. However, if the goals are

Institute of Technology, Bangkok, Thailand, September 29-October 3, 1986.

14. Id., Note 11.

11

not met, the freedoms that were previously granted can bewithdrawn.

The performance contract provides the utility ameasurable basis upon which it can extract freedom from thecentral government on a gradual basis. It also provides thecentral government with the power to reimpose controls unlesscertain goals are met. This freedom and the threat of losingit has the potential to provide important non-monetaryincentives to utility management to achieve the goals setforth in the performance contract.

Most of the problems associated with private sectorenergy performance contracts will also be present in agovernment/utility performance contracts. The centralgovernment and the utility will find it difficult to estimatereasonable savings goals and investment needs and to measureperformance improvements. In addition to these problems,utility and government officials will face the difficulty ofnegotiating issues of extreme sensitivity, e.g. changingworking conditions for unionized workers. Further, enforcinga performance contract against the central government may beimpossible, even if the negotiated performance targets aremet.-15

Despite these difficulties, commercialization ofdeveloping country utilities is regarded by many as anecessary precondition to improving their efficiency. Agovernment/utility performance contract is one way to meetthis precondition in a manner that may be more acceptable tothe central government. Further, as discussed below,operational flexibility for the utility will be a reauirementof any private sector firm that is interested in providingenergy services and equipment to a developing country utilityunder a performance contract.

D. Utility Twinnina.

"Utility twinning" is based on the concept that adeveloping country utility can gain useful training fromanother, "consulting," utility. This training can take placeat the facilities of the developing country utility or at thefacilities of the consulting utility. "Twinning" has beenused in a number of countries, with mixed results. Despitethese mixed results, the twinning concept could *be coupled

15. A central government that decides that autonomy forthe utility is not in the national interest is unlikely to bedissuaded by a contract from reasserting control,particularly if the contract was executed by a previous government.

12

with the performance contract concepts discussed above,particularly for the private sector electric utilities thatdominate the United States.

The author has discussed the performancecontract/utility twinning concept with a number of U.S.utilities.16 More than a few expressed an interest inestablishing a partnership with a developing country utilitythrough a long-term performance contract. There are threeprincipal reasons for this interest:

o many U.S. utilities have excess engineeringcapabilities and investment capital due to domestic cut-backsin power plant construction;

o many U.S. utilities have non-regulatedsubsidiaries that are already involved (domestically) inperformance contracting, others have non-regulatedsubsidiaries that are involved in international marketing ofconsulting services, and both kinds of subsidiaries areseeking new markets; and

a utilities -are experienced in making equityinvestments.

There are obvious advantages in establishing amutually advantageous long-term relationship between anefficiently run, capital rich utility and a poorly run,capital short utility. As described in the next section, itmay be possible to structure this relationship as an energyperformance contract in tandem with a centralgovernment/utility performance contract.

III. Barriers to Performance Contracting.

Private sector energy performance contracting hasnot yet been used to improve a developing country utility'slevel of efficiency. One reason for this is the relativelyshort history of private sector energy performancecontracting.17 However, there are two fundamental problemsthat must be overcome before private sector energy

16. Research by Philip Yates for USAID, October, 1986.

17. Private sector energy performance contracting hasbeen used for decades in France on a small scale forresidential apartment buildings. In 1978, the business tookoff in the U.S. as a result of favorable tax treatment.Thus, large scale energy performance contracts have only aten-year history.

13

performance contracts can be used to improve the energyefficiency of developing country utilities.

These problems are: (1) the energy performancecontractor needs to control the factors that influence theperformance of the utility; and (2) most developing countryutilities do not have the foreign exchange available to allowforeign contractors and investors to remove their profits inhard currency. The first of these problems can be dealt with(at least in part) through the mechanism of the centralgovernment/utility performance contract. The second mayrequire concessional lending from bilateral and multilateralagencies.

A. Operation>. Control.

A basic tenet of energy performance contracting isthat the contractor must have control over the factors thatgovern the quantifiable measure of performance. For example,assume a developing country utility contracts with an energyperformance contractor to provide training, pay bonuses forexemplary employees, spare parts, and management assistancein exchange for 10% of the increased revenues that areproduced for the utility through improved power plantavailability. Assume also that, as part of its managementassistance, the contractor develops a preventive maintenanceschedule for the plant. Because the contractor stands tolose its investment (in the training, pay bonuses, spareparts, and management studies) if the maintenance schedule isnot followed, the contractor is certain to insist, as acondition to making the investment, that the utility abide bythe contractor's maintenance schedule.

Likewise, the control of utility operations is thekey issue addressed by the central government/utilityperformance contract concept discussed above. However, ifthe utility is not currently staffed with competent managers,simply providing greater power to management is unlikely toproduce a significant short-term improvement in utilityoperations. Indeed, if the developing country utility'smanagement is tnr.ly incompetent, providing them with greateroperational freedom could degrade short-term performance.Accordingly, a developing country utility that lacksmanagement skills needs to be able to acquire managementexpertise in order to meet its performance obligations to thegovernment.

Clearly, the combination of a government/utilityperformance contract and a utility/contractor energyperformance contract has the potential for a synergisticeffect. The first contract provides the flexibility needed

14

for good management decisions, and the second provides theskills needed to make the freedoms pay off. Further, sincethe contracts are structured so that neither the utility northe energy performance contractor receives its "payoff"(freedom, higher pay and greater status for the utilitymanagers.; profits for the oLntractor) in the absence ofperformance, a program structured around a combination ofthese two perrormance contracts may be politically acceptableto the central government.

15

B. Foreign Exchanae.

Eve. if an energy performance contractor was ableto secure absolute control over the operations of adeveloping country utility plant, the contractor would not beinterested in investing in improving the plant's efficiencyunless the contractor's profits can be expatriated from thecountry. Unfortunately, the countries with the greatestutility efficiency problems usually have such limited foreignexchange that there is not enough to pay expatriatecontractors or investors, regardless of the profitability oftheir efforts.

This is true even if the savings produced by theenergy performance contractor are savings in foreignexchange. For example, many developing country utilitiesfuel utility boilers with imported oil, which is purchasedwith foreign exchange. An energy performance contract couldbe structured between the utility and an expatriate firm toimprove the efficiency of the utility's operation and thusreduce the country's imports of oil. However, if other, moresenior creditors are already "in line" for payments from thecountry's limited foreign exchange reserves, there will benone left for the energy performance contractor.

Accordingly, a private sector energy performancecontract can work for most developing country utilities onlyif the contract is in some manner connected with one of thecountry's senior creditors, i.e. one of the concessionallending institutions.

However, an energy performance contract requiresperiodic payments to the contractor based on the measure ofperformance for each period of the contract, e.g. 50% of thesavings each year for five years. Thus, for concessionallending to be used in conjunction with the energy performancecontract concept, the lender must be willing to leave the"account open" for the period of the contract, or tootherwise provide for foreign exchange payments to thecontractor for each year of a relatively long-term contract.Thus, energy performance contracting will not only requirereforms in the developing country utilities; it may alsorequir, reforms in international lending practices (which donot currently allow this kind of long-term paymentstructure).

16

IV. A Model Eneroy Performance Contract Usina ConcessionalLendingL..

No developing country utility has yet entered intoan energy performance contract in conjunction with agovernment/utility performance contract. Despite the appealof this concept on a theoretical basis, it will remain only atheory until it is attempted in some country. The followingdescribes how the concept could be pilot tested by aninternational lending institution.

Step One: The Lender Determines to Test the Concept.

An international concessional lender decides tocondition its next energy sector loan to a developing countryutility on the structural reform of the utility. The long-term goal of this restructuring is to improve the quality ofthe utility's management, so that the utility will operatemore efficiently. Specific needs identified by the lenderare better training, higher status and higher pay for alllevels of the utility's management, independence frompolitical control, and relief from stultifying procurementregulations. Also needed are higher tariffs and forgovernment agencies to pay their power bills.

The lender decides that the utility managementwants greater freedom from the central government, and willenthusiastically support the testing of the synergy betweenthe private sector energy performance contract and thegovernment/utility performance contract. Accordingly, thelender modifies its lending procedures to meet the needs ofan energy performance contract procurement.

In effect, the lender creates an escrow account toreceive the loan proceeds. The escrow funds will be drawndown for disbursement to the contractor at the end of eachyear (yearly outlays will necessary vary, because performancerill vary from year to year). The escrow must remain inplace for the duration of the contract, which is likely to befrom five to ten years.

SteD Two: The Government/Utility Performance Contract.

The utility and the central government (underpressure from the lender) negotiate a government/utilityperformance contract. The contract has a number of stages,with a performance target associated with each stage.

For example, the first stage could call for thelifting of central government control over personnel,

17

procurement and maintenance decisions. The utility'sperformance target (over some time period) could be toimprove system losses by, say, 5%, and to increasepreductivity by some specific measure, e.g. reduce the ratioof employees to MW produced by 5%. If these targets are met,the second stage would call for the utility to be providedwith the authority to increase tariffs according to someformula based on its cost of providing service. Since thislatter reform is financial rather than operational, theperformance goal should be in measurable financial terms,e.g. amount of government subsidy per MW produced.

Obviously, the reforms needed and the performanceimprovements that can be expected to result from thesereforms will vary from utility to utility.

Step Three: Reauest for Proposal.

Once the government/utility performance contract isnegotiated, the utility knows what freedoms it has, and whatperformance targets it must meet. The utility publishes a"Request for Proposals" (RFP) to select a contractor toimprove the efficiency of the utility under an energyperformance contract. The RFP states the performanceimprovement that is deemed achievable, and the time periodover which that goal should be achieved. The RFP isstructured in two steps: (1) a preliminary analysis; and (2)an energy performance contract.

The first step calls for the contractor to providea preliminary engineering analysis for the utility. Thecontractor will be asked to identify operational improvementsthat should be undertaken by the utility. Included in thesetasks will be the work elements the utility identified in theRFP, plus others that the contractor believes are important.Essentially, the contractor is asked in the first step tospecify its recommendation for the scope of work under thesecond step -- the energy performance contract. Thepreliminary analysis contract will be for a relatively shorttime period, e.g. three to six months.

The second step of the procurement is thenegotiation of the long-term energy performance contractbetween the utility and the contractor. Only if thenegotiations are successful will the contractor begin toimplement the recommendations it made in the preliminaryanalysis.

The RFP specifies the compensation mechani3m forthe contractor: the contractor's costs are guaranteed, butits profits are tied to performance improvements. This

18

assures the contractor that its participation with theutility will not lose money. This limitation on thecontractor's risk is suggested because some limitation onrisk will almost certainly be required until contractors gainthe confidence that they can make money improving developingcountry utility efficiency using the performance contractingconcept.

A basic rule of economics is at play: the higherthe risk on the contractor, the higher the return that willbe required to induce a contractor to take that risk. Theapplication of this rule means that the pzofits that will bedemanded under an energy performance contract (even with therisk limitation feature suggested here) are higher than theprofits that would be demanded under a straight fee-for-service contract. Later, if performance contracting fordeveloping country utilities proves successful, a developingcountry utility may be able to negotiate a "pure" energyperformance contract, such as a shared savings contract,which ties all of the contractor's compensation (return ofinvestment capital plus profits) to performance improvements.Of course, the contractor's profit expectations under this"pure" contract will have to be higher than under thecompensation scheme suggested here.

Under the RFP's compensation scheme, the contractorbills the utility for two items (all bills will be paid fromthe escrow account set up by the lender). First, thecontractor periodically sends "cost bills", to recover itsexpenses as those expenses are incurred. Cost bills arereviewed and paid just as normal fee-for-service bills.Second, the contractor sends "performance bills" at periodicintervals. Performance bills are reviewed to determinewhether or not the contractor's bills match the performancelevels actually achieved.

While the RFP states an upper limit for allpayments to the contractor under the contract, the RFP doesnot allocate those costs between "cost" payments and"pprformance" payments. The RFP will allow the contractorand the utility to negotiate a split between the availablefunds between contractor costs and performance-based profits.

Step Four: Contractor Selection.

Under traditional procedures, the governmentdictates the terms of the contract, and awards that contractto the firm that presents the "lowest responsible bid" toperform the contract. However, in the context of energyperformance contracting, there are two basic problems withtraditional bid procedures.

19

The first is that an energy performance contractcannot be executed until after the contractor has completed apreliminary analysis that provides to the contractor anunderstanding of what is needed to achieve a givenimprovement in performance. This understanding cannot begained by reading the RFP. In each case, the contractorneeds to make this evaluation on its own. Since the utilitycannot expect each prospective bidder to make this evaluationat its cost in anticipation of winning the bid, it makessense for the utility to select the winning bidder, allow thewinner t;- perform a preliminary analysis, and begin contractnegotiations upon the completion of the analysis.

The second problem with "lowest responsible bidder"procedures is the difficulty in producing cost numbers thatwill allow meaningful comparisons. More often than not whendealing with energy efficiency, the lowest "first cost" isnot the lowest "life-cycle cost." Choosing the lowest firstcost energy performance contractor may be a mistake, whilerelying on a contractor's savings projections for a life-cycle cost analysis may also be a mistake. Further, for manyenergy performance contracts there are no fixed cost. Ifcontractor X bids "50% of savings" and contractor Y bids "40%of savings," can it be said that contractor Y has the lowestbid? Contractor Y will not be the low bid if the savingsthat can be achieved by contractor X are 20% more than thesavings that can be achieved by contractor Y. And, ofcourse, there is no way to tell from the bid numbers whichcontractor is most likely to achieve the greatest savings.

Conversely, an examination of aualifications mayprovide a good indication of the firm that it is the mostlikely to achieve the best performance. Accordingly, theappropriate criteria is "most qualified bidder" rather than"lowest responsible bidder." Qualification criteria caninclude a host of specific qualifications, e.g. nativelanguage capabilities, financial strength, professionalexpertise, experience in improving the efficiency of similarfacilities, etc. Of course, "qualifications" are moresubjective than "lowest bid," which is why the procureiraentflexibility provided to the utility by the government/utilityperformance contract will be useful in selecting the energyperformance contractor.

SteD Five: Preliminary Analysis Contract.

Once the utility determines that a contractor isthe "best qualified," the utility and the contractor executea contract under which the contractor can cond-ict a"preliminary analysis."

20

The contractor sends its cost bill for preliminaryanalysis as soon as the analysis is complete. However, thereis no immediate opportunity for the contractor to make aprofit on the preliminary analysis. A profit on thepreliminary analysis will only be possible if the contractorand the utility execute an energy performance contract and ifthe contractor improves the utility's performance under thecontract.

Step Six: Ne_otiatina the Details.

Upon the completion of the preliminary analysis,the parties will be ready to negotiate an energy performancecontract.

The negotiations could immediately fail because thecontractor concludes that the utility's performance cannot beimproved for the amount specified in the RFP. (If thecontrator needs a particular profit to participate, andthe direct costs of the program will exhaust all or almostall of the funds available from the lender, then thecontractor will not be interested in proceeding.) If this isthe case, then the utility may determine that its facilitiesare not suitable for the energy pertormance contract concept,and terminate the program.

Alternatively, negotiations could fail because theutility and the contractor cannot agree upon the scope ofwork, the issues of operational control, the cost/profitsplit of the available funds, or upon the way thatperformance will be measured. If one of these issues causesnegotiations to break down, the utility may find it desirableto terminate its relationship with the winning bidder,contact the second best qualified bidder and execute acontract with that contractor to provide an independentreview of the preliminary analysis,15 and begin negotiationsanew.

A successful negotiation of an energy performancecontract is dependent upon the clear understanding of both

18. Although each energy performance contractor willinsist that only it can perform the engineering upon which itperformanc,e contracts will be based, the cost of thisengineering will be much lower if another firm has alreadyperformed the work. The second firm then needs to do nothingmore than verify that the results are accurate. Only if thefirst job is inadequate will the second attempt be expensive.

21

parties that risk allocation is the fundamental purpose ofthe contract. In particular, the utility must understandthat the potential profits that will flow to the contractorif the performance targets are met must be higher (perhapsmuch higher) than the profits the contractor would make on astraight fee-for-services contract. Otherwise, thecontractor will have no incentive to take the risk ofentering into a contract that potentially will provide noprofits. Conversely, the contractor must understand that itsopportunity for higher profits must in fact be offset byhigher r_sks; there is no reason for the utility to payhigher than normal profits unlesa the contractor assumesgreater than normal risks. The relationship between risksand rewards is fundamental to all aspect of an energyperformance contract.

For example, there is a clear connection betweenthe ,rofit formula (how improvements in performance relate tocontractor profits) and the operational assurances that thecontractor receives. If the contractor does not receive thecontrol it needs for the profit formula it proposes in thenegotiations (e.g. 10% of the improved revenues that accrueto the utility as a result of its services), it may live withless control with a more generous formula (e.g. 20% of therevenues). Conversely, if the utility believes that thec,ontractor's profit formula is excessive, the contractor mayinsist on greater operational control than originallyproposed in exchange for a lowering of the profit formula.

In addition to the fundamental issues of risk andreward, there are a number of other contractual issues thatwill be the subject of the negotions. However, only theissues related to the measurement of performance will beaddressed here.

An energy performance contract must include a"baseline formula" under which performance improvements canbe measured. In effect, the baseline formula ishypothetical; it estimates what the performance of thefacility would have been if the performance contractor hadnot provided its services. The facility owner does not wantto pay for performance that would have been achieved withoutthe intervention of the performance contractor. Likewise,the performance contractor does not want to lose revenuesthrough actions over which it has no control. A baselineformula should be fair and simple, and yet be flexible enoughto deal with tha myriad of factors that can affect energyperformance.

Utility facilities change over time, with orwithout a performance contractor in the picture. Equipmentis added or removed; refurbishing takes place; loads change;

22

fuel quality changes. The baseline formula should be able topredict how these changes would_ha_e affected the performanceof the facility if there had been no program implemented bythe performance contractor.

A baseline formula requires an adequate databaseand a methodology for manipulating the data. The requireddata falls into three general categories: historicalperformance, facility characteristic variables, and othervariables.

The starting point is the facility's pastperformance. The main consideration in negotiations iswhether there are anomalies or trends in the data. If thereare, the "raw" data must be adjusted to compensate for theanomaly or trend. For example, if the utility has installedperformance-enhancing equipment shortly before entering intoan energy performance contract, the baseline formula shouldnot be based on raw historical data. The new equipment willalready be influencing the facility's performance. Unlessthe baseline is adjusted for this, the contractor will bepaid for savings that would have occurred regardless of itsefforts. In this situation a baseline formula can still benegotiated, but it must be based upon theoretical (and lower)performance figures than the raw numbers. In somesituations, the raw numbers are so erratic (sometimes forreasons that are not readily apparent) that a good baselineis impossible to generate and performance contracting issimply inappropriate.

The second point of negotiation involves thecharacteristics of the facility. It is important toinventory all significant equipment in the facility and tolist them in the contract, because a change in ti.is equipmentwill have an impact on energy performance. Likewise, thefacility's general characteristics must be identified, sothat any refurbishing can be quantified and its energy impactcomputed.

Finally, the other known variables that affectperformance must be accounted for. For example, if a coalfired plant is the subject of the energy performancecontract, the quality of the coal must be addressed in theperformance formula. If coal quality goes up or down,performance and maintenance costs will be affected. If thisfactor is beyond the control of the energy performancecontractor, the baseline formula should be able to makeadjustments for changes in coal quality.

After agreement is reached on the appropriate datato consider, agreement must then be reached on how tomanipulate that data. It is beyond the scope of this paper

23

to delve into the intricacies of the different methodologies.However, it is extremely important to recognize that unknownfactors can cause variations in performance. For example,efficiency over time is rarely steady; even factoring in allknown variables, performance can vary for unknown reasons.Consequently, it can be expected that in some periodsperformance improvement may be measured without any effortfrom anyone. To eliminate the chance of paying for randomperformance improvements, the contract should require acertain minimum level of performance improvements before anypayment is due.

Absolute baseline accuracy is a laudable goal, butalmost impossible to achieve. What is achievable isfairness. There should be an equal probability that themeasured improvement is higher or lower than the "actual"improvement. Under a fair baseline formula it is likely thatone or the other party may come out a little ahead butneither party will know which is the winner. In a successfulproject, neither will care.

Step Seven: Implementing the Contract.

One of the attractive features of an energyperformance contract is that the success or failure of thecontract is readily apparent -- performance either improvesor it does not. Clearly, the success of an energyperformance contract between a developing country utility anda private sector contractor will depend on the quality of thecontractor and the willingness of the utility to follow thecontractor's suggested changes.

However, an energy performance contract is a long-term undertaking. It is extraordinarily difficult toconsider in a contract all the things that may turn out to beimportant in several years. Accordingly, success also willdepend on the reasonableness of each of the parties, andtheir willingness to flexibly respond to unforseen events.Further, because the contract is long-term, it may be severalyears before an energy performance contract can be consideredto be a success or a failure.

V. Conclusion.

The efficiency problems of developing countryutilities are enormous and not easily solved. Energyperformance contracting can help solve some of theinstitutional problems of the utilities of developingcountries by providing a mechanism through whichinstitutional reforms can be implemented.

24

During the current developing country debt crisis,international lenders and aid institutions may wish to focustheir aid to improve utility efficiency through performancecontracts. If performance contracting can be tested anddeveloped with the assistance of subsidies during the presentperiod, unsubsidized performance contracting will be morelikely to be used by private investor3 when developingcountries have.better access to foreign exchange.

I APPENDIX

Sampto

ENERGY PERFORMANCE AGREENENT

BETWEEN STATE AGENCY AND PRIVATE COITRACTOR

(Names and addresses of the parties have been removod].

CONTRACT CONTENT

Section 1- Definitions2 Covenants3 - Energy Audit4 - Basetine Energy Consumptiot.S - Baseline Nodification6 - Cateulation of Energy Savings7 - Payment Process8 - Independent Audit9 - Agreement Term10 - Equipment Access11 - Equipment Maintenance12 - Equipment Operation13 - Guarantee of Savings14 - Energy Cost Changes15 - Project Implementation16 - Assignment of Contract17 - Training and Other Services18 - Equipment Acquisition19 - Lfability Insurance20 - Bonding21 - Hold Harmless22 - funding Out Ctause23 - Events of Defautt24 - Arbitration

Exhibit A - Equipment DescriptionB - Baseline ConsumptionC - Savings CalculationsD- Contractor PaymentE - Guaranteed SavingsF - Training and Other ServicesG - Equipment Acquisition ValueH - Liabitity InsuranceI - Standards of Service and Comfort

II APPENIXfl

ENERGY NANAGENENT AGREENENT

THIS AGREEMENT, made and entered into this ___ day of 19____ shall bethe agreed basis of performing the follw-ins work by and between

…T_ hereinafter referred to as the Owner, and __hereinafter referred to as the Contractor.

The Owner has determined that a need exists to secure energy management equipment andservices for the purpose of reducing energy consumption at the following facility(s):

The Owner is authorized by the laws of the State of to enter into thisAgreement, and

The Contractor is authorized by the laws of the State of to provide suchenergy management equipment and services, and,

The Owner has requested the Contractor to provide for such energy management equipmentand services.

THEREFORE: It is agreed. in exchange for mutual consideration, as follows:

SECTION 1DEFINITIONS

Unless otherwise stated, the terms defined in this Section have the meaning specifiedfor alt purposes of this Agreement.

"Agreement" means this Agreement and any amendment or supplements including theExhibits attached hereto.

"Agreement Term" means the duration of this Agrement as provided in Section 9 of thisAgreement.

"Audit" means a detailed energy audit of a facility which Identifies the energyconservation measure and services to be recommended for inclusion in the energymanagement agreement.

"Saseline" means the monthly baseline energy consumption of the facility as calculat-dfrom historicat energy use for all fuels and normalized monthly for weather.

"Contractor" means an entity functioning as an energy service company (ESCo).

nEmergency" means any sudden or unforeseen situation that requires immediate actionincluding threats to life, safety and health.

"Energy Savings" means the reduction in energy consumption during the current periodwhich *a the difference between the baseline consumption and the current consumptionfor all fuels.

"Energy Cost Savings" means energy savings in kWh, therms, sallons, tons, etc.multiplied times the current (or monthly average) unit price for that type of energy.

"Energy Service Company" means the company which provides services that include, butare not limited to financing, design, installation, repair, maintenance, management,technical advice, and/or training for energy conservation project(s).

"Equipment" means the personal and/or real property described in Exhibit A, anyamendments thereto, and any other energy conservation measures the parties agree upon.

III APP4DLC"Full Contract Amount" means the total amount to be reimbursoed the Contractor for theEquipment and Services provided under the conditions of the Agreement.

"Owner" means the State of _._.. _...and/or its ltwful successors or assigns.

UServicesU means those personal services provided by the Conitractor to fulfill therequirements of this Agreement to Include maintenance, monitering, training and otherservices as described in Exhibit F.

SECTION 2COVENANTS OF AGREEMENT

The Owner covenants that it is a duly constituted agency of the State ofand is authorized by the laws of the State of to enter

into the transaction contemptated by this Agreement and to carry out its obtlgations.The Owner has been duty authorized to execute and deliver this Agreement and agreesthat it will do or cause to be done all things necessary to preserve and keep theAgreement In full force and effect.

The Owner further covenants that all procedures have been met and that the Owner hascomplied with all selection requirements where necessary and by due notificatfonpresented this Agreement for approval end adoption as a valid obligation on Its part.

SECTION 3ENERGY AUDIT

The Contractor shall undertake a detailed energy audit of the facility(s) at itsexpense. The Owner agrees to furnish the Contractor with any prior energy audits whichhave been performed on the Owner's facility, current and historical energy consumptionfor the facility, occupancy information, a description of ener y management practicespresently utilized and other information which may assist the Cintraector In conductinga detailed energy audit.

The owner further agrees to pay the Contractor a predetermined fee for the energy auditif the Owner fails to enter Into an energy management agreement with the Contractorthrough no fault of the Contractor. Peyment to the Contractor mill be based upon thereasonable value of the equipment and services recommended to the Owner. The Ownerwill consider such things as effect on facility operation and budget, maintenance,environmental constraints, technical feasibility and accuracy of computations indetermining the appropriateness of the Contractor's rec^mmendations. The Owner willhave no payment obligations under this Agreement in the event the audit shows an energyconsumption savings of lese than ten percent (10X) annually or the Contractor is unableto provide financing for ti.e project(s).

The energy audit will include an analysis and description of the facility's energyconsuming equipmert, a description of the current maintenance practices, recommendedenergy conservation measures, and services for inclusion in the energy managementagreement, baseline energy consumption, energy savings, energy cost savings, equipmentdescription, training requirements, construction schedule, payment procedures,guarantees, warranties and other ftems which the Contractor may identify in the audit.

SECTION 4BASELINE ENERGY CONSUMPTION

The baseline of energy consumption for the facility(s) which will be used to determinethe amount of energy consumption savings is shown In Exhibit B, attached hereto andincorporated by reference.

SECTION 5BASELINE MODIFICATION

Nodificatfon of the facitity baseline energy consumption may be required to reflect anyplanned or actual material changes in the facility(s), changes In facility use orchanges in energy supplied to the facility(s). Such changes shall include thefollowing:

iv APPEDl

a. A change in operating hours of the facility(s) or a change in the operating hours ofany energy consuming equipment.

b. A change In the occupancy rate or occupateiy pattern of the facititycs).

c. A material change in a structure to include building remodeling, additions ordemolitions.

d. A change in the types of equipment used In the facilttyCs).

e. Any other conditions which may affect or change annual energy use by five percent(5x) or more, thereby requ1ring baseline modifications.

Baseline modification will be accomplished through mutual apr- ment by the owner andContractor. The Owner shall detiver to the Contractor within ten days of receipt ofsuch information calculate a modified baseline and forward to the Owner a notice of theproposed modification. Such modification shall become effcctive within ten days ofreceipt by the owner unless disapproved by the Owner. Cost to modify the baselineshall be borne by the owner when such modification is requested by the Owner. Anydisagreement on any proposed baseline modification shall be negotiated in good faith byboth parties.

SECTION 6CALCULATION OF ENERGY SAVINGS

Total energy savings is the projected energy consumption (baseline consumption adjustedfor weather and occupancy) less the monitored energy consumption. The procedures forcalculating energy consumption, energy savings and energy cost savings is presented inExhibit C, attached hereto and incorporated by reference.

SECTION 7PAYMENT FOR EQUIPNENT AND SERVICES

Payment to the Contractor will be indexed to the energy cost savings resulting from theimplementation of energy conserving measures and services. The Owner agrees to pay tothe Contractor as compensation for its services an amount which shall not exceed theamount of energy cost savings. Such payments shall be made on a monthly basis and willbecome due within thirty days of receipt of the Contractor's invoice. The terms of thepayment process are shown in Exhibit D.

Contractor invoicing and Owner payment shall be accomplished in the following manner:

a. The Owner will send to the Contractor copies of all energy bills for the facilityand copies of all other data required by Exhibit C within ten days after the receipt bythe Owner.b. The Contractor slill caleulate the energy consumption savings achieved by comparingenergy consumption for the current month with consumption during the equivalentbaseline month prescribed in Exhibit C.

c. The Contractor shall multiply the amount of saved energy by the unit cost (monthlyaverage) then in effect for each type of energy which was consumed during the month.The sum of each type of energy cost savings wilt be the total amount of energy costsavings for that month.

d. The Contractor will prepare and send to the Owner a monthly invoice for the amountof compensation as defined in Exhibit 0. The invoice will set forth the amounts ofenergy consumption savings, energy consumption cost savings and theamount due the Contractor. The Contractor will attach its calculations with theinvoice.

e. Within sixty (60) days after each anniversary of the commencement date of theAgreement, the Contractor will calculate the annual cost savings or guaranteed minimumenergy cost savings whichever is greater.

v APEffND

SECTION 8INDEPENDENT AUDIT

The Owner may, at its own expense, have conducted an independent audit of theContractor4s energy savings calculations and billings. Such audit, to be done by anenergy auditor, certified public accountant or other qualified person agreed to by theparties. may be conducted at any time during the term of this Agreement.Irregularities in savings or payments that may arise from the audit mill be resolved bythe provisions set forth in Exhibit "Eu.

SECTION 9AGREEMENT TERM

The term of this Agreement shall begin on the date of the execution of this Agreementand shalt run cont{nuously from such date until ___ . The commencementdate shall be the first date of the month after the monthTin which the Contractor hassubstantially completed installation of the Equipment and such Equipment is operatingand producing an energy savings confirmed in writing by the Owner and the Contractor.The Contractor will deliver a written notice to the Owner that it has substantiallycompleted the Equipment installation.

SECTION 10EQUIPMENT ACCESS

The Owner shall provide mutually satisfactory reasonable rent free space to theContractor for the installation and operation of the Equipment and shall protect itsown property. The Owner shall further provide access to its facility for theContractor and its subcontractors during regular operating hours and such hours as maybe requested by the Contractor which are acceptable to the Owner. The purpose of suchaccess shall be to install, adjust, inspect and/or maintain the Equipment and to makeany necessary emergency repairs.

SECTION 11EQUIPMENT MAINTENANCE

The Contractor will provide for all necessary maintenance of the installed Equipmentunless maintenance responsibilities have been transferred to the Owner through mutualagreement. The Contractor's maintenance responsibilities includes normal maintenance,adjustments, repairs and service as necessary to keep the Equipment in normal runningorder and to assure the continued comfort and safety of the facility occupants. TheContractor will avoid interruptions of the facility operation, as well as any adverseeffect on the health or safety of the building occupants. The Owner shall incur noadditional costs for such maintenance or repairs, except when the need for such serviceis due to improper operation or negligence by the Owner.

SECTION 12EQUIPMENT OPERATION

The Contractor shall at all times attempt to attain the maximum energy consumptionsavings and associated cost savings from the Equipment installed under this Agreementand from pre-existing equipment, which may include recommendations to improve theexisting methods for operating and maintaining the Owner's facility. The Contractorwill, under no circumstances, operate and maintain such Equipment in a manner whichwill reduce the standards of comfort, health and safety as defined in Exhibit 1,attached hereto and incorporated by reference.

The Owner shall operate the Equipment in complience with the Contractor's instructionsand shall make modifications to operation only through written approval of theContractor, unless an emergency situation exists. The Owner will notify the Contractorwithin twenty-four hours of any emergency or malfunction in the operation of theEquipment or of any interruption of energy which may effect the operation of theEquipment.

vi APPENDIK

The Contractor may replace or upgrade Equipment for the purpose of maximizing energysavings. Such modification wtll requfre the written approval of the Owner, which shallnot be unreasonably withheld when the modification does not adversely effect thefacility operation. Such replacement, modification or addition shalt be performed bythe Contractor at no cost to the Owner.

SECTION 13GUARANTEE OF SAVINGS

The Contractor shall guarantee the Owner that the facility energy costs plus costsassociated with payments to the Contractor for that same period will be less then theenergy costs for that period before implementation of energy conserving measures by theContractor. The guarantee will provide for a mutually agreeable minimum level ofenergy seavngs to the Owner before payments to the Contractor become due. In the eventthe energy savings do not equal the guaranteed minimum level, the Contractor shaltreimburse the Owner for the shortfall within nWnety days of the annual anniversary dateof implementation of the energy conserving project. Such guarantee shall be writtenwith an insurance firm familiar with third party financing of energy projects and willachieve the guaranteed minimum level of savings. The mutually agreeable guaranteedminimum level of savings is presented in Exhibit E attached hereto and incorporated byreference.

SECTION 14ENERGY COST CHANGES

The Contractor assumes no responsibility or liability and shall not be required tocompensate the Owner for a shortfall in energy cost savings as a result of reducedenergy costs. The Contractor's liability to generate energy cost savings shall bebased on current energy costs. In the event the quantity saved times the currentenergy cost, due to reduced energy costs, does not equal or exceed the payment due theContractor, the Owner shall use its best efforts to obtain additional adequate funds tomeet fts obligations hereunder. Increases in energy costs which may result in energycost savings exceeding the amount required and guaranteed for the purposes of thisAgreement will benefit the Owner and the Owner is under no obligation to share thesewindfall energy cost savings with the Contractor.

SECTION ISPROJECT INPLENENTATION

The Contractor wfll begin installing energy conserving equipment and will beginproviding energy management services in the Owner's facility within sixty days ofsigning of this Agreement. Such equipment will be fully insetalled within …..... daysof signing of this Agreement, and will from that time forward provide the energysavings described in this Agreement. Failure of the Contractor to install equipmentand reduce energy consumption within -- days will be cause for default. Such delaysmay result In penalties, Agreement termination or other remedies as described inSection 23.

SECTION 16ASSIGUNENT OF CONTRACT

The Contractor may assfgn or transfer its rights and obligations stated herein onlywith the prier written consent of the Owner. Owner consent will be provided only whenthe assignees agree to honor the terms of this Agreement and other terms which mayarise from assignment of Contractor rights and obligations.

SECTION 17PERSONNEL TRAINING AND OTHER SERVICES

The Contractor will provide training to Owner personnel on the proper operation andmaintenance of any Equipment fnstalled or modified under this Agreement. Training mayaolso be provided on the proper operation and maintenance of existing equipment or onother areas of faciltity operation which may affect energy consumption. Such training

vi' APFEND

will be provided as defined in Exhibit F, attached hereto and incorporated byreference.

SECTION 18EQUIPNENT ACQUISITION

The Owner may at any time terminate this Agreement by paying for the Equipmentinstalled pursuant to this Agreement or by exercising the default remedies as definedin Section 23. Owner acquisition may not be sooner than one year after the effectivedate of this Agreement and wilL be accomplished by notifying the Contractor not lessthan ninety days prIor to the intended date of acquisition. Payment of the acqufsitionvalue of the Equipment shall be the lesser of the fair market value of the Equipment orthe amount calculated pursuant to Exhibit G, attached hereto and incorpe ated byreference. Acceptance of equipment fs contingent upon inspection and written approvalby the Owner and receipt of all related insurance documents and permits.

SECTION 19LIABILITY INSURANCE

The Contractor mill, at all times during the term of this Agreement, maintain in fullforce and effect, at its own expense, casualty and liability insurance on the Equipmentand liability insurance for its other undertakings. If any item of the Equipment isdamaged or destroyed by an event which is covered by insurance, the Contractor willutilize the insurance proceeds to repair or replace the Equipment. If the Insuranceprocee;, are insufficient or if the Equipment has been damaged or destroyed by enuninsured casualty, the Contractor will provide the necessary funds to repair orreplace the Equipment at no cost to the Owner. Liab{i'ty insurance will be maintainedas described in Exhibit H.

SECTION 20BONDING

The Contractor will, at all times during the term of this Agreement, maintain in fullforce and effect, at its own expense, a Payment and Performance Bond.

The Contractor shall make, execute and deliver to the Owner, prior to the commencementof any work under this agrement, a good and sufficient bond with a surety company,conditioned that the Contractor shall faithfully perform all provisions of thisAgreements and pay all laborers, mechanics, and subcontractors and materialmen, and allpersons who supply such person for the carrying on of work under this Agreement. TheBond shall be equal 4o the full contract amount agreed to be paid for such work, andshall be to the State of ___ . The Contractor shall indemnify the State of___ … against any loss or damage directly due to the failure of the Contractorto faithfully perform the conditions of the Agreement.

Sureties or Bonding Companies must be register with the State ofInsurance Commissioner's Office.

SECTION 21HOLD HARMLESS

The Contractor shalt protect, Indemnify, and save the Owner harmless from and againstany damage, cost or liability for injury or death to person or to damage or destructionof property, arising from the acts of the Contractor, his employees or hissubcontractors in the performance of this Agreement.

If the Injuries, death or damages as provided in the preceding paragraph Is caused byor results from the concurrent negligence of (a) the indemnitee or the indemniteelsagents or employees, the indemnity provisions provided in the preceding paragraph shallbe valid and enforceable only to the extent of the indemnitor's negligence.

The Contractor will further hold harmless the Owner from all fees, taxes, andassessments which may be levied upon or with respect to the Equipment installed underthis Agreement, and shall hold the Owner harmless from any other charges which may beimposed or incurred by any public or private authority with respect to the Equipment orIts operation.

viii APPENDIX

This Agriement shall be fnterpreted, construed and enforced in all respects inaccordance with the laws of the State of _ . In case of any lawsuit, venue wiltbe in __ County.

SECTION 22LEGISLATIVE APPROPRIATION AND FISCAL FUNDING OUT CLAUSE

The Owner's obligation to pay any amounts due under this Agreement or to perform anycovenants requiring or resulting in expenditure of money are contingent and expresslylimited to the extent of legislative appropriations made to fund this Agreement.Nothing contained In any uther Section of this Agreement shall be construed as creatingany monetary obligation on the part of the Owner beyond such current and specifielegislatilve appropriations.

In the event that the Legislature foils to appropriate the funds necessary to continuethis Agreement, the Agreement s%all be terminated as to any obligations of the Ownerrequiring the expenditure of money for which no such appropriation is available to theend of the last fiscal year for which such appropriation is available. In such event,atl obtigations of the Owner will cease so long as all payments previously approved orappropriated have been paid, and all interest of the Owner in the Equipment willterminate and this Agreement shatl be terminated.

Notwithstanding the foregoing, the Owner agrees not to te-minate this Agreement underthis provision for the fiscal year in question. if any future funds are appropriatedin order to continue this Agreement, the Owner will use its best efforts to obtaininclusion of such funds in its budget.

SECTION 23EVENTS OF DEFAULT

Events of default by the Owner. Each of the following events or conditions shallconstitute an OEvent by Defaultt by the Owner:

a. Any failure by the Owner to pay the Contractor compensation as required by Section 7and Exhibit D for a period of ninety days after the date of the iAvoiee;

b. Any material failure by the Owner to comply with the terms and conditions of thisAgreement, including breach of any covenant contained herein, providing that suchfailure continues for thirty days after notice to the Owner requesting that suchfailure to perform be remedied, or if a remedy cannot be effected in such thirty days,without commencement of a remedy and diligent subsequent completion therefor;

c. Any voluntery discontinuation of use of more than percent of the facility inwhich the Contractor has provided energy equipment and service for more than ___- daysduring the first years of this Agreement which would thereby reduce energysavings and the Owner's ability to make payments to the Contractor as described inExhibit 0.

Events of default by the Contractor. Each of the following events or conditions shallconstitute an "Event of Default" by the Contractor:

a. The Equipment fails to function properly or as described in Exhibit A;

b. The Contractor felts to produce the level of energy savings guaranteed and asdescribed in Section 13;

c. The standards of comfort and service required are not provided due to failure of theContractor to maintain repair, or adjust the Equipment, or failure to provide otherservices as described in Exhibit J and said failure continues for thirty days afterwritten notice to the Contractor;

d. Any material faiLure by the Contractor to perform or comply with the terms andconditions of this Agreement, provided that such failure continues for thirty daysafter written notice to the Contractor demanding that such failure be cured, or if acure cannot be effected in such thirty days, without commencement of a cure anddiligent subsequent completion.

ix APEND

Remedies. In the event of default by the Owner, the Contractor may exercise allremedies aveilable at law or at equity including bringing action for recovery ofamounts due and unpaid by the Owner. Also, the Contractor may, without recourse to thelegal process, terminate this Agreement by delivery of notice declaring termination,enter the facility and dismentle and/or remove the Equipment from the facility andreconnect and restore the Owner's equipment to the condition which existed prior to theInception of the Agreement, normal wear and tear excepted.

In the event of defeult by the Contractor. the Owner may exercise all remediesavailable at lam or at equity including bringing action for recovery of amounts due tothe Owner, and/or for damages. Also, the Owner may exercise its option to purchase theEquipment for the acquisition value as set forth in Exhibit H. Further, the Owner may,without recourse to the legal process, .erminate this Agreement by delivery of noticedeclaring termination, whereupon the Contractor shall remove the Equ!oment andreconnect and restore the Owner's original equipment to the condition which existedprior to the inception of this Agreement, normal wear and tear excepted.

Liquidated Damages. In the event of default by the Owner, the Owner shall be liable tothe Contractor, as liquidated damages in lieu of atl other claims for damages, theacquisition value of the Equipment as set forth in Exhibit G. In th,e event of defaultby the Contractor, the Contractor shall be liable to the Owner, for "Lost energysavings opportunities", as liquidated damages in lieu of all other claims for damages,the following amounts:

Default Date Lost Opportunity Amount

Month/Day/Year S

SECTION 24ARBITRATION

All disputes, claims or questions subject to arbitration under this Agrement and underthe law shall be submitted to arbitration in accordance with the provisions thenobtaining, of the Standard Form of Arbitration Procedure of the American Arbitrationassociation, and this Agreement shall be specifically enforceable under the prevailingarbitration law, and judgment upon the award rendered may be entered in the state orfederal court having jurisdiction. It is mutually agreed that with regard to alldisputes, claims or questions subject to arbitration, the decision of the arbitratorsshalt be a condition precedent to any right of legal action that either party may haveagainst the other.motice of the demand for arbitration of a dispute shall be filed in writing with theother party within thirty (30) days of last written impasse.

This Agreement, together with the Exhibits attached hereto, constitutes the entireAgreement between the parties and this Agreement shall not be modified, altered, orchanged except to the extent agreed to by the parties in writing. Any provision ofthis Agreement found to be prohibited by law shall be ineffective to the extent of suchprohibition without invalidating the remainder of this Agreement. Nothing containedherein shall be construed to require the Owner to pay for additional Equipmentinstalled by the contractor but such additional transactions shall be subject tonegotiations between the parties. Subject to the specific provisions of thisAgreement, this Agreement shall be binding upon the insure to the benefit of theparties and their respective successors and assigns.

IN WITNESS WHEREOF: Owner and Contractor have caused thisAgreement to be executed by their respective officers dulyauthorized.

OWNER: CONTRACTOR:

APPxNDC

EXHIBIT A

DESCRIPTION OF EQUIPMENT

_ will fnutall and provide maintenance and repair for the Equipment

Item ModelDeseriptlon Nanufacturer Number Quantity

EXHIBIT B

FACILITY BASELINE ENERGY CONSUMPTION

Tthe parties agree that the following Baseline data has been determined in a mannerwhich is acceptable to the Owner and to the Contractor, and that the data is acceptablefor the purposes deffned in this Agreement.

The baseline energy consumption shown in the three-year average energy consumption for

January February March April ect.

Number of Days in Month

Electricity Consumed (kWh)

kWh/Day

Demand for Electricity (kw)

ku/Day

[other energy consumed]

-- /Day

BTUs Consumed

BTUs/Day

Heating Degree Days Elapsed

Heating Degree Days/Day

Cooline Degree Days Elapsed

Cooling Degree Days/Day

xi APEDxDC

EXHIBIT C

METHOD OF CALCULATING ENERGY SAVINGS

All energy savings produced by energy conserving measures under this Agreement whichare affected by degree day changes shall be normalized for such weather changes and theenergy cost savings calculated as follows:

A. Calculate Energy Consumption.

1. For each energy account bill for the month calculated the average daily energyconsumption in units/day by dividing the total units of energy consumed by the numberof days in the billing period.

2. For each energy account bill multiply the units/day by the number of days in themonth.

3. For each energy account bill, sum the unfts calculated in A.2.

4. Electrical demand for the month will be the electricaf demand usage for thebilling month.

B. Calrulate Energy Savings.

1. Subtract the total amount of energy consumed calculated in A,3 from the baselineenergy consumption for that month.

2. Determine the energy savings as done in B,1 for each type of energy.

3. Determine the electric demand savings in units of kw by subtracting the demandcalculated in A,.4 from the baseline demand for the month.

C. Calculate Cost Savings.

Calendar month energy cost savings will be determined by applying the average cost/unitof energy to the energy savings in the following manner:

1. For each energy account bill calculate the average cost/unit of energy bydividing the total amount of the bill for energy by the total units of energy includedin the bill.

2. For all energy account bills calculate the total cost of the energy consumedduring the calendar month by multiplying the average cost/unit of energy by the energyconsumption for the energy.

3. For each type of energy used calculate the total cost savings by multiplying theaverage cost/unit of that energy savings in units of that energy.

4. For each rate schedule with a demand cost component, calculate the total costsavings by multiplying the current monthly demand unit cost, including adjustments tobase charge, by the corresponding demand savings for the same rateschedule asdetermined in B.3.

5. Calculate the total cost savings during the calender month in question as the sumof the total cost savings for each type of energy during the calendar month ascalculated under C,3 & C,4 above.

D. Adjustments to Calculated Savings.

An hourty energy simulation (thermal model) program will be used to estimate energy useat baseline operating hours and at actual operating hours. If there is a variation inthe actual hours of operation of more than tOX from the baseline for more than ___ ofthe yeer, an adjustment will be madefor actual hours. The ratio of the baseline energy use and the estimated actual usewill be used to adjust for actual hours.

xii APPENC

EXHIBIT D

CONTRACTOR PAYMENT

Compensation for - services described herein will be made(monthly/quarterly)T[n the following amounts.

Month/Year Amounts

... ........ .......................................................................

EXHIBIT E

GUARANTEED SAVINGS AMOUNT

*Est tatedYear Fuel Type Fuel Savings Cost Savings

* eased on current costs.

EXHIBIT F

TRAINING AND OTHER CONTRACTOR SERVICES

________ ________ agrees to provide the following training or other services:

........---....--...-. ..-----.......--........--....-..-. .....-..-...--. .-.. ... ....... ................. .......

EQUIPMENT ACQUISITION VALUE

Year Acquisition Value

2 S

3

4

6

8

9

10

5111 ~~APPIDD

COUTUAC?O0S*LAILT uUIC

The Contractor shatl obtain ell Insurance require bederunder, and such insurance mustbe approved by the Ownce, prieor to the cemencoment of any work under this Agreement.The Contractor mill not allow any subcontractor to commence work on a subcontract untilsuch subcontractor hba obtained insuranee siilaor to that r"uired hereunder for theContractor. Companies writing the insurance under this Exhibit shall be licensed to dobusiness in the State of or be permitted to do business under theSurplus Lien Law of the State _____ .

The Contractor shell cotply sith the State Industrial Insurance Act, theFederal Longshoremen's and Narber Workers' Act, and the Jones Act. The Contractorshall purchase and maintain during the life of this Agreement *stop-gap" insurance forall of its employees to be engaged in work on this project under this Agreement.

The Contractor shatl take out and maintain, during the life of this Agreement, BodilyInjury Liability and Property &amage Liability Insurance. The Amounts of suchinsurance shall not be less then:

(a) Comprehensive Seneret Sedily Injury LiabilitV Insurance

PER PERSON PER oecuUselee

8500.000 81,000,000

(b) Comprehensive Property Damaae Insurance

PER PERSON PEn OGCUEEUCE

5500.000 91,000,000

(c) Comprehensivo Autoeabilo Dodity Injury Insurensc

PER PERSOD Poe OCCURBEUeC

8500.000 6S,000,@00

(d) Comprehensive AtemEObile Property Damage Insurance

PER OCCURRENCE

$500,000

(e) Contractors, et their option, may purchase omprehonsivo general ltibiltty andproperty damage and eceprebenoive automebile bodily Injury and property damageInsurance In a combined singlo iiatt policy not loss than One Nillion and No/100Dollars ($10.000.00) per oecurrence. 1ith respect to projects and completedoperations, the limit of liability itil pplty In the sgeregateo

The insurance covereSe under this lxhibit shall protest the Contractor from claims fordamaoes which may arise from work performed under this Agreement, whether work be bycontractor or by any subcontractor.

The State of , shal be named on all cortifieates of insurance as anAdditional Insured fie ;ertiflate of Insurance shall cover the work specified Inthis Agreement and designated under the specific contract number.

No cancellation of the foregoing policies shall be effeetive without thirty (30) daysprior notice to the Owner.

xiv APPENDI

EXHIBIT I

STANDARDS OF SERVICE AND COMFORT

ogrees to maintain for the term of this Agreement environmentalcondlti*;rs;es aot ~rothahereunder.

Ninimum room temperature during occupied hours during heating season:

Naximum room temperature during occupied hours during cooling seeson:

Ninimu domestic hot water temperaure

Ninimum lighting levels: HallwaysCtassroomGymnasiumOther

Occupied hours heating season:

Month/Day Operating Hours

Occupied hours cooling season:

Month/Day Operating Hours

MEHEGY SERIES PAPERS

No. 1 Energy Issues in the Developing World, February 1988

No. 2 A Review of World Bank Lending for Electric Power,March 1988

No. 3 Some Considerations in Collecting Data on HouseholdEnergy Consumption, March 1988