Performance-based energy savings contracts may cost government

Energy savings performance contracts, which enable the government to use contractors to finance energy-saving capital improvements, were dealt a setback Tuesday when the Government Accountability Office said they can cost significantly more money than traditional financing through the appropriations process.

In six case studies examined in the report (GAO-05-55), the increase in cost from using energy savings performance contracts compared to upfront appropriations ranged from 8 percent to 56 percent.

Energy savings performance contracts are similar to share-in-savings contracts, which enable agencies to obtain capital more quickly than if they had to go through traditional appropriations. Agencies pay for only part of the cost of capital upfront, because contractors finance the bulk of the investment.

That financing comes with additional costs, because agencies compensate contractors for the cost of borrowing money as well as the risk involved. Contractors collect part of the savings generated from the investment, creating incentives to maximize savings.

Share-in-savings contracts have been gaining momentum lately, despite the controversy that surrounds them. The American Federation of Government Employees and Angela Styles, the former chief of the Office of Federal Procurement Policy, have argued that share-in-savings contracts allow agencies to sidestep congressional approval on spending projects, and in the long run, cost the government more money.

This latest GAO report lends some credibility to that view. Largely since the government can borrow money at a lower rate than private companies because the perceived risk is lower, the report found that private sector financing is more expensive. Allowing contractors to finance investments prevents agencies from taking advantage of government's low interest rates.

"The cheapest way to do this is to buy it upfront with appropriated funds, because the government can borrow money more cheaply than anyone else," said Susan Irving, director of federal budget analysis at GAO and co-author of the report.

The question to ask, she said, is whether the savings generated from the capital improvements offset the increase in cost from private sector financing.

Chip Mather, co-founder of Acquisition Solutions, Inc., which consults with federal agencies on acquisition issues, said that in many cases, because the federal budget is so tight, "there is no money to borrow, so many of these programs wouldn't get funded."

When he worked with the Air Force on energy savings contracts in 1978, he said, "We knew we were spending too much money [on energy costs], but we couldn't get the funding" to address the issue. The ability to use private financing, he said, saved the Air Force money.

Mather said he was surprised that the GAO found that private financing could cost up to 56 percent more than government financing. Part of that increase may be caused by paying the contractors' profits in order to compensate them for the risks they are assuming in investing in capital that may or may not generate significant savings, he said.

Rep. Tom Davis, R-Va., chairman of the House Government Reform Committee, has been a strong supporter of share-in-savings contracts.

"Share-in-savings contracts represent an innovative, performance-based approach to procurement that encourages industry to share technology and solutions with the government--without large upfront costs to the taxpayer," said Drew Crockett, spokesman for Davis, last month.

Agencies tend to support share-in-savings contracts because they provide more flexibility. In the Defense Department's written response to the report, Philip Grone, principal assistant deputy undersecretary of defense, wrote, "The department is concerned that the draft report reflects an incomplete analysis and an incorrect understanding of the energy savings performance contract program."

Defense officials disagreed with the GAO's recommendation that agencies perform business case analyses to compare financing options. Such analyses "would only translate to an increased administrative cost," they wrote.