Post written by Rob Shear, CEO of PACE Sage Capital, LLC
For many PACE enabled states, there is a process that we call “Energy Engineering” to qualify the PACE Project measures and dollars. How it works depends upon what the state PACE statute says about qualification and what, if any, calculation has to be made by an Engineer to meet the qualifications.
All of this ties into the public policy of PACE to improve and encourage energy efficiency and conservation for buildings and new property developments.
For illustrative purposes, we will discuss Missouri and Nebraska.
SIR – before we begin, there is a key term called SIR, an acronym for “Savings to Investment Ratio”, that is a critical ratio for PACE qualification. SIR generally means the estimated energy (and water in Nebraska) cost savings over the useful life of each energy conservation measure (ECM) being financed by PACE, compared to the cost of the PACE Project. The definitions of “cost of the PACE Project” are slightly different for each of our illustrative states. For both states, the SIR has to be equal to or greater than 1.0.
The PACE statute in Missouri says the following:
67.2815. 1. A clean energy development board shall not enter into an assessment contract or levy or collect a special assessment for a project without making a finding that there are sufficient resources to complete the project and that the estimated economic benefit expected from the project during the financing period is equal to or greater than the cost of the project.
The bold/underlined part of the paragraph is the SIR for Missouri. What is included in “economic benefit”? For Missouri, Engineers calculate energy cost savings, deferred maintenance savings (eg, if a roof is replaced, whatever deferred maintenance there was for the old roof has been eliminated and that is an economic benefit) and capital cost avoidance (capital cost reduction that results from a spend that is lower than the spend that would otherwise been required if the project was not done).
What is the “cost of the project”? The PACE Clean Energy Boards in Missouri have interpreted “cost of the project” to mean hard and soft costs for each ECM being financed by PACE and fees and transaction costs of the PACE financing. Notably, not the interest cost of the PACE financing.
The PACE statute in Nebraska says the following:
…there are sufficient resources to complete the energy project and that the estimated economic benefit, including, but not limited to, energy cost savings, maintenance cost savings, and other property operating savings expected from the energy project during the financing period, is equal to or greater than the principal cost of the energy project.
The two differences in the Nebraska SIR from Missouri are:
- Nebraska will include water cost savings in the calculations;
- The estimated savings have to be equal to or greater than the “principal” cost of the energy project, and the fees and transaction costs of the PACE financing are not included in the principal cost of the energy project.
Weighted Average Useful Life of ECMs
Both Missouri and Nebraska PACE laws say that the term of the PACE financing cannot exceed the weighted average useful life (weighted by amount spent on each ECM) of the PACE ECMs. Missouri, however, has a maximum PACE term of 20 years even if the weighted average useful life of the PACE ECMs is longer. Nebraska does not have a maximum term.
Baseline Calculations and Reasonable Assumption for Increased Costs
The Engineer that provides the calculations to meet the SIR requirements first creates a baseline year 1 savings estimate for each PACE ECM for the first year after the PACE project completion. Then the Engineer adds a compounding factor assumption for annual estimated increases in utility and other related costs. The baseline savings are then increased each year by the compounding factor (eg 5%) for the useful life of each ECM and then a total savings amount (economic benefit) for the PACE Project is calculated.
To visualize and simplify these calculations, here are two real Engineer charts for a recently closed PACE Project financing:
The first chart describes each of the six PACE ECMs. The second chart shows the costs of each ECM and the ECM total cost ($1,304,796), the useful life of each ECM, the year 1 estimated baseline cost savings for energy ($27,653) and maintenance & operating items ($13,050), the total estimated savings for each over the PACE financing term using a 5% compounding increase factor and the total estimated savings for the whole PACE Project ($1,381,994).
The SIR is greater than 1.0 ($1,381,994/$1,304,796) = 1.06. All of the ECMs in the chart qualify for this PACE Project financing.