Overcoming Hurdles

Introduction

This page explains different financing alternatives to cover the capital cost of the GHP system, and provides guidance on ensuring proper conditioning of ventilation air and minimizing ground loop costs, which are two other common concerns with GHP systems.

Financing Alternatives

Their energy cost savings compared with conventional heating and cooling systems, enable GHP systems to "pay back" their higher capital cost premium within two to eight years. Having an energy-efficient HVAC system also recuces a school's exposure to future energy price increases. Even so, school divisions may be reluctant to risk more money now for predicted energy savings later, particularly with a technology that is new to them. This section looks at innovative ways of shifting this risk to third-party financers or performance contractors. First, however, it will be helpful to look at the traditional method school divisions use to finance their capital construction programs, namely the issue of general obligation bonds.

Bond Issue

The building and renovation of schools are not financed through a school division's operating funds, but through bond issues. The sale of general obligation bonds is a form of long-term borrowing that spreads the cost of major capital improvements over the years the facilities are used. Incorporated cities and towns may issue general obligation bonds without a referendum. The total debt outstanding, however, may not exceed 10% of the assessed value of real property in that city or town. Counties are not subject to any ceiling, but must submit the proposed bond issue to public referendum, for voter approval.

There are three methods by which localities can issue general obligation debt for public school construction:

1. Local Borrowing. School divisions arrange the sale of debt independently in either the public or private markets.
2. Literary Fund Loan. The Literary Fund is a permanent and perpetual school fund established by the Constitution of Virginia in 1810 and administered by the DOE and is used by local school divisions as a source of low-interest loans for the purpose of “erecting, altering, or enlarging school buildings.” The Board of Education has set the maximum loan amount available for a single project through the Literary Fund at $7.5 million. The interest rate charged to local school divisions is determined from the school division’s Composite Index of Local Ability-to-Pay and 2 ranges from 2% to 6%.
3. Virginia Public School Authority. The Virginia Public School Authority (VPSA), administered by the Authority’s Board of Commissioners, is a bond bank which provides low-cost financing of capital projects for public schools. It provides financing to school divisions through grants and investments and by buying and selling local school bonds. The authority also manages and administers money that the General Assembly transfers to it from Virginia's Literary Fund and other sources. The VPSA loan program provides market access to those communities which do not have ready access and provide low-cost financing to communities needing assistance.

Lease - Purchase

The tax-exempt lease purchase agreement is an alternative means of financing school capital equipment in a manner that meets the basic objective of debt (spreading the cost of financing over the life of an asset) while not violating constitutional or statutory limitations of the issuance of public debt. The tax-exempt lease purchase does not constitute debt, since the school board's payment obligation is appropriated on an annual basis. Thus, the contract might last for years, but each fiscal year's rental payments are made out of the school division's current operating budget.

Leases and lease-purchase agreements should be designed so that the energy savings are sufficient to pay for the financing charges. While the time period of a lease can vary significantly, leases in which the lessee assumes ownership of the equipment generally range from 5 to 10 years.

• Operating leases are usually for a short term - sometimes for less than one year. At the end of the lease period, the lessee may either renegotiate the lease, buy the equipment for its fair market value, or acquire other equipment. The lessor is considered the owner of the leased equipment and can claim tax benefits for its depreciation.
• Financing leases are agreements in which the lessee essentially pays for the equipment in monthly installments. Although payments are generally higher than for an operating lease, the lessee may purchase the equipment at the end of the lease for a nominal amount (commonly $1.00). The lessee is considered the owner of the equipment and may claim certain tax benefits for its depreciation.
• Municipal leases are available only to tax-exempt entities such as school districts or municipalities [Section 265(b)(3) of the Internal Revenue Code]. Under this type of lease, the lessor does not have to pay taxes on the interest portion of the lessee's payments, and can offer a lower interest rate than usual for financing leases. Because of restrictions against multi-year liabilities, the municipality specifies in the contract that the lease will be renewed each year. This places a higher risk on the lessor, who must be prepared for the possibility that funding for the lease may not be appropriated. Therefore, the lessor may charge an interest rate as much as 2% above the tax-exempt bond rate, but still lower than rates for regular financing leases. Even so, municipal leases are generally faster and more flexible financing tools than tax-exempt bonds.
• Guaranteed savings leases are the same as financing or operating leases, but with an additional guaranteed savings clause. Under this type of lease, the lessee is guaranteed that the annual payments for leasing the energy efficiency improvements will not exceed the energy savings generated by them. The school or community pays the contractor a fixed payment per month. However, if the actual energy savings are less than the fixed payment, the school or community pays only the amount saved and receives a credit for the difference.

  Performance Contracting

  Energy performance contracts are generally financing or operating leases provided by an Energy Service Company (ESCo) or equipment manufacturer. What distinguished these contracts is that they provide a guarantee on energy savings from the installed retrofit measures, and they usually also offer a range of associated design, installation, and maintenance services. The contract period can range from 5 to 10 years, and the customer is required to have a certain minimum level of capital investment (generally $200,000 or more) before a contract will be considered. Under an energy performance contract, the ESCo provides a service package that typically includes the design and engineering, financing, installation, and maintenance of retrofit measures to improve energy efficiency. The scope of the improvements can range from work that affects a single part of a building's energy- using infrastructure (such as lighting) to a complete package of improvements for multiple buildings and facilities.

  Generally, the service provider will guarantee savings as a result of improvements in both energy and maintenance efficiencies. Flat-fee payments tend to be structured to maintain a positive cash flow to the customer with whom the agreement is made. With the increasing deregulation of conventional energy utilities, several larger utilities have formed unregulated subsidiaries that offer a full range of energy efficiency services under performance agreements.

  An energy performance contract must define the method for establishing the baseline costs and cost savings and for the distribution of the savings to the parties. The contract also must specify how the savings will be determined and address contingencies such as utility rate changes and variations in the use and occupancy of a building. While several excellent guides exist for selecting and negotiating energy performance contracts, large or complicated contracts should be negotiated with the assistance of experienced legal counsel.

  One of the most important bills that passed during the 2002 Session of the Virginia General Assembly is the Public-Private Education Facilities and Infrastructure Act of 2002 (PPEFIA), which became effective July 1, 2002. The PPEFIA authorizes a public entity to enter into a comprehensive agreement for an educational facility or other infrastructure project, either through competitive sealed bidding or competitive negotiation. This authority extends to the Commonwealth and any agency, authority or political subdivision thereof, including any county, city or town; it is also applicable to any regional entity that serves a public purpose. This represents an important new opportunity for school districts to implement GHP projects by shifting the risk of project financing to a private entity already experienced in designing and installing successful GHP systems.

  Conditioning Ventilation Air

  Students in poorly ventilated schools suffer from drowsiness and poor concentration. To avoid these problems, ASHRAE Standard 62-1989 requires that school buildings have a ventilation rate of 15 cfm/person. This must be accounted for in a total building design that is carefully integrated with the GHP system design to avoid oversized systems and excessive energy costs associated with outside air treatment. Separate systems may be required for pre-heating intake air or exhaust air heat recovery, increasing total project cost; however, ignoring these requirements or making inadequate ventilation air treatment provisions can generate even more costly retrofits to correct indoor air quality deficiencies after the GHP system has been installed.

  Minimizing Ground Loop Costs

  The largest capital cost component of a GHP system is the installation of the well field and its associated ground-loop and distribution piping, which typically amounts to 40-50% of the total GHP capital cost. The following table presents tyical GHP capital cost ranges per square foot of conditioned floor space. Ground-loop costs can be controlled through stringent design and installation specifications and exacting requirements for drilling/installation contractor qualifications, as described at the bottom of the page on Developing Projects.

  ESTIMATED GCHP SYSTEM SQUARE FOOT COSTS
  Type of Construction	New ($ per SF)	Renovation ($ per SF)
  Assuming controlled well field costs	$12 - $15	$14 - $17
  Assuming uncontrolled well field costs	$14 - $18	$16 - $21