Escalation Rates in Energy Savings Performance Contracts

Energy savings performance contracts (ESPCs) are very sensitive to the escalation rates applied to their flow of energy savings. For ESPC deals where annual savings must exceed annual payments (as in the federal sector), these escalation rates dictate the upper limit of the project scope that can be accommodated. The risk of overestimating escalation rates within an ESPC is obvious—actual savings could fall well short of payments made on the project. However, a less understood risk lies in the underestimation of escalation rates; not only can this limit the project’s scope, it can also serve to substantially raise interest costs on the project (since actual dollar savings are underapplied toward annual payments, drawing out the project’s term). Assuming the downsides to over- and under-escalating are equal, the goal in these projects should not be to lowball the expected actual escalation rate, as often occurs, but to make it accurate. The National Institute for Standards and Technology (NIST) developed and manages an energy escalation rates calculator, EERC, that employs the energy price paths forecasted by DOE’s Energy Information Administration (EIA). Because EIA has somewhat underestimated future energy prices in the recent past (since 2000), EERC can be seen as not only a reliable third-party estimate of escalation rates, but also a likely “safe” one (from the risk of overescalation). Its use is recommended, even beyond the federal audience for which it was developed.