Using Measurement and Verification to Manage Risk in Federal Energy- and Water-Saving Projects

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"Risk," in the context of measurement and verification (M&V), refers to the uncertainty that expected savings will be realized. Assumption of risk implies acceptance of the potential monetary consequences. Energy service companies (ESCOs) and agencies are reluctant to assume responsibility for factors they cannot control, and holding certain parameters fixed in the M&V plan can match up responsibilities.

For example, usage factors under the agency's control, such as lighting operating hours and thermostat set points, are typically held constant for the purposes of the contract. Using such "stipulations" means the ESCO and agency agree to use a set value for a parameter throughout the term of the contract, regardless of the actual behavior of that parameter.

If no values are fixed and savings are verified based entirely on measurements, all risk resides with the ESCO, who must show that the guaranteed savings are realized, regardless of contributing factors. Alternatively, the agency assumes the risk for the parameters that are held constant. In the event that the fixed values over- or understate the savings, the agency must still pay the ESCO according to the agreed-upon values. If the actual savings are greater than expected, the agency retains all the surplus savings. 

Usage Risk

"Risk," in the context of usage, stems from uncertainty in operational factors. For example, savings fluctuate depending on weather, how many hours equipment is used, user intervention, and maintenance practices. Because ESCOs often have no control over these factors, they are usually reluctant to assume usage risk. 

The agency generally assumes responsibility for usage risk by either allowing baseline adjustments based on measurements or by agreeing to fixed equipment operating hours and other usage-related factors.

Performance Risk 

"Performance risk" is the uncertainty associated with equipment performance. The ESCO is ultimately responsible for equipment selection, application, design, installation, and performance and typically assumes responsibility for achieving savings related to equipment performance. To validate performance, the ESCO must demonstrate that the equipment is operating as intended and has the potential to deliver the guaranteed savings. 

Fixing Parameters to Manage Risk

Fixing parameters in savings estimates can be a practical, cost-effective way to minimize M&V costs and allocate risks. These stipulations, when used appropriately, do not jeopardize the savings guarantee, the agency's ability to pay for the project, or the value of the project to the government. 

However, this strategy (holding variables constant through the term of an ESPC) shifts risk to the agency, so the agency should understand the potential consequences. Risk is minimized and optimally allocated through carefully crafted M&V requirements including diligent estimation of the fixed values, based on measurements.

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