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Business Officer Magazine

Alternative Energy Economics

While the credit crunch has put the squeeze on many campus projects, a variety of financing approaches is available for funding renewable energy initiatives.

By Michael Philips and Lee White

Alternative Energy Economics CoverA new wood-chip and oil-fired cogeneration plant is the pride of Vermont’s Middlebury College community. The $11 million plant, scheduled to be fully operational by late January, is the culmination of a project initiated and guided in large part by Middlebury students.

Burning the wood chips allows Middlebury to cut its fuel oil use in half while reducing the college’s carbon emissions by 12,500 tons annually. The plant will provide the campus with 20 percent of its annual electricity demand and 50 percent of its annual heating demand.

Financing the plant is fairly straightforward. The college issued a 40-year, tax-exempt bond with a fixed interest rate of 5 percent. While other options were considered, Patrick Norton, Middlebury’s vice president for administration and chief financial officer, is pleased with the simple approach and the 8 percent internal rate of return, which is achieved through a significant reduction in oil usage at the plant. “The cost and financing were not the main concerns of the trustees,” says Norton. “The risk that was foremost on the minds of trustees and the administration was the supply risk—that is, whether we can ensure delivery of 20,000 tons of wood chips a year to keep the biomass plant fueled and therefore get our carbon reduction and financial payback.”

Grab a Seat at the Smart and Sustainable Campuses Conference

Environmental consciousness is at an all-time high, and colleges and universities are experiencing increased pressures from stakeholders to lower carbon outputs, green campus operations, and graduate students equipped to lead sustainability initiatives in all sectors. Join NACUBO—in partnership with several other higher education associations, the U.S. Environmental Protection Agency, and the University of Maryland, College Park—for a comprehensive symposium on sustainability that includes operational solutions, smart growth policies, and strategies for achieving climate neutrality.

The 4th Annual Smart and Sustainable Campuses Conference will be held April 5–7, at the Inn and Conference Center adjacent to the campus of the University of Maryland. Sessions will address obstacles to reaching sustainability on campus, including financing, curriculum integration, and fulfilling the obligations of the American College & University Presidents Climate Commitment. New this year are more solutions-focused presentations; networking opportunities; basic, intermediate, and advanced concurrent sessions; poster sessions; and issue-specific hands-on workshops.

The conference is designed for chief business and financial officers, sustainability professionals, facilities directors, environmental health and safety directors, and campus planners. Discounts are offered for campus teams of four or more. To register or for more information on this and other programs, go to or call 800.462.4916.

In fact, the wood-chip contract structure is perhaps the most interesting aspect of the project. Such arrangements can be risky, since it’s often difficult to obtain long-term contracts. The typically small-scale operators, for whom chip sales are a sideline, can go out of business whenever the timber market takes a downturn. Middlebury mitigates this possibility by using up to a dozen suppliers. Rather than deal with individual suppliers directly, the college has a three-year contract with a forest products company that serves as a broker, arranging for fuel purchases and deliveries, which average three truckloads per day. The contract is structured so that the broker has an incentive to get the best possible price per ton from suppliers: The lower the price per ton, the higher the fee Middlebury pays the broker. Eventually, the college plans to grow some portion of its own wood supply.

Across the United States, an increasing number of higher education institutions are pursuing large-scale renewable energy projects, in some cases as part of their commitment to achieving carbon neutrality under the American College & University Presidents Climate Commitment ( While many projects benefit from some grant or gift funding, very few are funded exclusively this way.

So, where does the rest of the capital come from? What financing structures are available to institutions that want to install solar, wind, geothermal, or biomass systems that can generate a sizeable share of their campus energy needs? And, how can costs be lowered by structuring deals with private investors? What follows is an overview of some of the more common and emerging financing sources and structures for campus renewable energy projects.

Clean Renewable Energy Bonds

While nearly every energy project involves some debt, a range of possibilities exists for managing that debt. Among the options are energy bonds. Public colleges and universities have access to the U.S. Department of Energy’s low-cost Clean Renewable Energy Bonds. Established by the Energy Policy Act of 2005, CREBs are tax-credit bonds for which interest is paid in the form of federal tax credits by the U.S. government in lieu of interest paid by the issuers. Investors typically require a small amount of supplemental interest paid by the issuer (usually 1 or 2 percent in addition to the tax credits), because the federal formula for setting the tax credit is slightly below normal capital market returns. This program allows public entities to finance renewable energy projects at significantly lower costs than those associated with traditional financing mechanisms.

Issuers apply for an allocation of CREBs from the U.S. Treasury, which historically has shown a preference for granting issuing authority to smaller projects first. Typical allocations range from $1 million to $5 million. The Energy Improvement and Extension Act of 2008 established an allocation of $800 million for new CREBs.

Higher education institutions that have secured CREBs include the University of Minnesota, Morris, and Oakland University in Rochester, Michigan. Oakland is applying its $1.5 million CREB toward a proposed $7.5 million wind power project, and it has asked for proposals from commercial banks for ways to structure the remaining $6 million. Steve Roberts, Oakland’s assistant vice president for finance and administration, thinks there may be an advantage for a single bank to take the CREB and finance the rest of the project. “If you have one source arranging all the financing, you may get a better deal,” says Roberts. He thinks the $6 million might be raised through a bank-qualified loan, which is a less-expensive form of tax-exempt financing than a bond and is most applicable to smaller projects.

Important to note is that independent colleges and universities cannot use CREBs, since federal legislation makes the bonds available only to governmental entities, American Indian tribes, and utility cooperatives. However, if an independent institution is located within the service territory of a municipal utility, the college or university could become the beneficiary of CREBs issued by the utility.

Governmental Purpose and Private Activity Bonds

In times of normally functioning capital markets, all public and independent institutions have access to the tax-exempt capital market to finance physical facilities. Public institutions can issue governmental purpose bonds to buy or build renewable facilities that an institution would directly own and operate, such as wind turbines, solar thermal systems, renewable cogeneration plants, and photovoltaic energy installations.

*An increasingly popular option for colleges and universities is to have a solar energy system installed on campus using a solar service agreement.

As 501(c)(3) not-for-profit organizations, independent colleges and universities can issue tax-exempt bonds for renewable projects that they own and operate. Technically, these private activity bonds are issued by a state or local government that serves as a governmental bond–issuing conduit to an independent institution.

Interestingly, tax-exempt private activity bond categories do not include most private company–owned renewable energy projects, such as wind, solar, or geothermal, or even projects that reduce pollution by offsetting greenhouse gas emissions from fossil fuel plants. Tax-exempt bonds can, however, be issued for waste recovery projects, including those that would include renewable energy attributes. And, legislation may soon be on the way to expand tax-exempt, bond-financing project options for privately owned and, in particular, community-scale projects. Sen. Ken Salazar (D-CO) has proposed legislation (S. 672) to add renewable energy projects to the list of eligible tax-exempt, bond-financed activities.

Private activity bonds can also be used to finance a few types of renewable projects that would not be owned by a campus but could benefit an institution. In one example, a California flagship public university is considering an idea allowing it to benefit from the private activity tax-exempt bond proceeds from the financing of a landfill gas collection facility. BioFuel Energy is applying for approximately $16.5 million in tax-exempt bonds from the California Pollution Control Financing Authority to finance a landfill gas collection and purification facility and other related project costs. The facility will capture greenhouse gases emitted from a waste facility and, through a purification process, convert those gases into a renewable fuel, which has characteristics similar to natural gas and can be used as a direct substitute for it in electricity generation. The gas will be packaged into special tube trailers transportable to consumers throughout the region, including the university.

Endowment Fund Loans

Carleton College, Northfield, Minnesota, is pioneering another vehicle for financing renewable energy debt. The institution used an 8 percent loan from its endowment fund to pay the majority of costs associated with building a 1.65-megawatt utility-grade wind turbine near its campus. As the project’s promoter, Carleton’s facilities department showed trustees how the turbine’s electricity sales to the local utility could be used to service the debt and provide the endowment with the same return it had averaged over the previous five years.

In essence, the way it works is that during periods when the wind blows more than expected, the project sells more electricity and makes larger principal payments on the loan. When the wind isn’t blowing as hard or as frequently, the project has to draw from the facilities department’s contingency fund to make the minimum payment. After four years of operation, the results have been good overall: The project is on course to repay the 20-year loan in only 12 years. “The project has worked out well enough that we’re looking seriously at a second wind turbine,” says Rob Lamppa, Carleton’s director of energy management.

One additional note of interest about the Carleton project is that the green electricity does not come directly to the campus but is sold to the utility. In Carleton’s case, the college did not have a choice on this matter; the utility insisted on establishing a power purchase agreement between the college and the utility specifying how much electricity, at what price, and over what time period the utility would purchase the electricity. An advantage of such an agreement is that it provides security for a project lender—in this case, Carleton’s endowment fund.

Private-Sector Tax Incentives

When it comes to ownership of renewable energy projects, the federal government’s tax incentives strongly favor the private sector. In fact, these incentives are available only to tax-paying companies, since they involve some form of tax relief—for example, tax credits and tax deductions. The tax benefit is substantial, often subsidizing more than half of a project’s capital costs. It therefore often makes more economic sense for colleges and universities to partner with the private sector for renewable energy projects. A common partnership is to form a power purchase agreement in which a private company agrees to build, own, and maintain a renewable energy project in an institution’s building or on its land. The energy from that facility is sold to the institution over the course of an agreed-upon term—for instance, a 15- or 20-year power agreement.

An increasingly popular option for colleges and universities is to have a solar energy system installed on campus using a solar service agreement. In this approach, a vendor installs the system, continues to own and maintain it, and takes advantage of all federal and state grants, rebates, and tax incentives. The institution makes no capital investment and is required only to purchase the electricity generated by the system at a price equal to, or slightly less than, what it would normally pay for its electricity.

Currently, the solar service agreement model is driven largely by state solar energy policy. In states with generous solar tax incentives, including California and New Jersey, a vendor can attract investors that have high tax-relief appetites for these advantages. Examples of higher education institutions that have relatively large tax-driven solar installations on their campuses include Stevens Institute of Technology, Hoboken, New Jersey, and several California State University campuses.

In other states, renewable energy deals are driven largely by requirements that electric utilities provide a certain percentage of electricity generated from solar energy. These are known as renewable portfolio standards. While utilities can satisfy this requirement by building their own solar projects, they often purchase renewable energy certificates from the owners of nonutility solar energy projects. RECs represent the environmental attributes of a renewable energy project—including reductions in carbon dioxide, sulfur dioxides, nitrogen oxides, and other greenhouse gases—and can be counted toward carbon-reduction measures. In states that have solar energy purchase requirements for their utilities, the solar RECs sell for $200 to $350 per megawatt hour compared to RECs from wind, landfill gas, and other renewable energy sources, which usually range in price from $20 to $50 per megawatt hour.

Although these projects are largely driven by REC sales, the solar project owners also receive revenue from selling the actual electric power. Since selling the electricity to the utility will get project owners a wholesale price only, they are attracted to entities that have large rooftop areas or available land and that are accustomed to paying the retail price for their electricity. Both criteria make colleges and universities prime targets for such ventures.

In one example, Arizona State University, Tempe, is using the solar service agreement model to add 7 megawatts of solar power to its campus facilities. Its request for proposal to vendors seeking creative financing approaches discusses the benefits of the solar service model: “It gives customers a way to switch to solar electricity at competitive rates while avoiding capital expenditures and maintenance costs for the [photovoltaic] system. It also provides the customer a very reliable energy source especially during the peak (and most expensive) hours of the day. The developer receives a low-risk return on the investment as well as the renewable rebates from the utility, federal and state solar tax credits, and can potentially sell carbon credits to companies needing to offset their carbon emissions.”

One downside of the solar service agreement approach is that a participating institution cannot count the solar electricity generation toward its efforts to reduce its own carbon footprint. Instead, the project sponsor retains ownership of the associated RECs and sells them to the utilities; in return, the utilities are allowed to claim the carbon reductions.

Performance Contracts

Renewable energy projects are increasingly included in performance contracts at colleges, universities, and other institutions. Performance contracting is commonly used to ensure that promised savings from energy efficiency investments truly materialize. A performance contractor, known as an “energy service company,” may install high-efficiency lighting systems, air handling systems, boilers, and so forth. The ESCO guarantees that a certain minimum level of savings will accrue to the client. If the savings do not materialize, the company pays the difference and makes improvements until the installations perform properly. If such contracts are structured appropriately, the savings from the efficiency improvements will be sufficient to service the debt used to pay for the efficiency measures. The debt can also cost less as the result of the lender understanding performance contracting and the energy savings that are virtually guaranteed by a creditworthy ESCO.

*Performance contracting is commonly used to ensure that promised savings from energy efficiency investments truly materialize.

Energy services companies regard renewable energy efforts, particularly solar photovoltaic projects, as another measure that can be implemented as part of a performance contract. Similar to its guarantees for energy efficiency improvements, an ESCO guarantees that a renewable energy project will reduce by a certain amount the electricity purchased from the grid. Mount Wachusett Community College, Gardner, Massachusetts, used a performance contract as the vehicle for financing a biomass project. Other schools that have pursued the performance contracting approach for renewable energy are Emory University, Atlanta, and the University of Wisconsin Oshkosh.

Because renewable energy projects tend to have longer paybacks than many energy efficiency measures, one challenge is to structure a performance contract so that a less-economical renewable energy project is offset by highly economical energy efficiency measures. For instance, while the price of a major energy efficiency upgrade may run in the tens or hundreds of thousands of dollars, a large renewable energy project of 1 megawatt or more may cost millions of dollars. In this case, the payback period for the renewable energy project far exceeds the payback period of the efficiency upgrade.

A good approach is to consider combining long-term and short-term payback items to yield a net payback that is reasonable enough to allow for adequate savings to service the debt. Keep in mind that such an approach might result in the ESCO reducing the number of medium-term payback items in the portfolio to keep the payback sufficiently low. Therefore, smaller renewable energy projects may be best suited for performance contracts. As a general rule, a renewable energy project should not cost more than one third or one fourth of the capital cost of the overall package if the institution wants to service the debt from utility savings.

Colleges and universities that have already made major investments in energy efficiency upgrades may find they no longer have sufficient payback opportunities with which to offset a long-payback renewable energy project. This bears implications for an institution’s sustainable energy investment strategy independent of any performance contracting vehicles. Though tempting, investing in lighting upgrades and other quick-payback measures by themselves may make the next set of investments in medium-term and longer-term payback measures much more difficult.

Renewable Energy Hedge Agreements

Some companies have started marketing a renewable energy hedge, a financial agreement entered into by a renewable energy generator and a power customer that is intended to protect both parties against price volatility and that includes the sale of RECs. The agreement allows the power purchasers to lock in the cost of electrical energy with a clean energy wind project over a long-term contract. Actual energy from the wind project is not delivered to the customer but is sold to the grid at wholesale energy pricing. A renewable energy hedge can be compared to a long-term, fixed-rate mortgage in that customer payments remain at the agreed-upon rate over a specified period of time.

With an energy hedge agreement, colleges and universities can take advantage of low energy-cost volatility even without taking delivery of actual renewable wind energy. Likewise, the purchase of RECs provides carbon-free-equivalent energy from the wind energy company to help a campus achieve its sustainability objectives.

In one example, Iberdrola Renewables, the world’s largest owner of wind assets, allows a college or university in proximity to one of the company’s wind projects to use the project to hedge against the volatility of energy pricing from the institution’s local utility. In 2007, Southern New Hampshire University, Manchester, entered into a hedge agreement with Iberdrola subsidiary PPM Energy, resulting in a cutting-edge financing plan for its energy consumption that won SNHU a U.S. Environmental Protection Agency 2007–08 College & University Green Power Challenge award.

In broad strokes, the hedge agreement enables SNHU to stabilize its energy prices, offset all its carbon emissions, and invest in other carbon-offsetting technology. In particular, the university’s contract guarantees a fixed price for 15 years for the 15 million kilowatt hours of electricity it will use annually, including an estimated power use of buildings that will be constructed during the next 2 years. Assuming the cost of power increases during the next 15 years, the agreement would translate into an average savings of $1.2 million per year for electricity and natural gas. If energy costs follow a high-price scenario in the future, savings are projected to average $2.6 million per year over the next 15 years.

While SNHU will continue to obtain its electricity and natural gas from its current traditional sources, the university will receive 17,500 RECs per year as part of the hedge agreement. This results in 13,125 tons of reduced carbon dioxide emissions per year, or the combined annual carbon output of more than 2,100 cars, according to EPA calculations. The certificates will be used to offset the 11,400 tons of carbon dioxide that SNHU is projected to emit each year. The university will allocate the remaining certificates to invest in other carbon-offsetting projects. The renewable energy hedge will be settled at one of PPM Energy’s sites, and the RECs will come from the company’s national portfolio of renewable energy projects, which could include wind, solar, or other renewable sources.

“From an environmental perspective, becoming a carbon-neutral campus is a substantial and dramatic illustration of the university’s commitment to sustainability,” says SNHU President Paul LeBlanc. “From a business perspective, we lock in our energy costs for the next 15 years. The projected savings may be substantial. From a community perspective, we are being innovative by adapting a sophisticated but well-established financial tool to the relationship of renewable energy providers and consumers. This is a triple win.”

While other universities have entered into REC-purchasing agreements to offset carbon outputs or price hedge agreements to stabilize prices, SNHU is doing both. “We have a lot more work to do with conservation and the retrofitting of older buildings, but climate change looms as the single most important challenge facing this next generation of students,” says LeBlanc. “We want to both educate and model innovative solutions.”

Power Prepayments

Some institutions are evaluating the possibility of prepaying for a longer-term renewable energy power supply, such as a utility-scale wind farm (see figure, “How Do Energy Prepayments Work?”). The source of funding for a significant power prepurchase could be the proceeds from institution-issued taxable bonds. The institution would negotiate a residual ownership interest in the project at the then–fair market value of the project. The project owner would use the prepayment to assist in financing the initial project, thus reducing its equity requirement for a capital-intensive project. Bonds have already funded electrical energy prepurchases by major utilities such as American Municipal Power–Ohio ($304 million in 2007) and the City of Fayetteville, North Carolina ($142 million in 2005). In one higher education example, a consortium of Colorado public and independent colleges and universities is currently investigating this approach.

Financing Energy Security

No doubt additional financing options may emerge in the coming years as gains are made in renewable energy generation. For the short term, pursuing the most advantageous financing approach based on an institution’s specific needs can significantly reduce long-term costs. Doing so may also ultimately help generate revenue for the campus while reducing its carbon footprint and exposure to volatile fossil fuel prices.

As Tom McGinn, project manager of the Middlebury wood-chip project points out, it’s reliance on conventional fuels, not renewable energy, that is becoming more risky. “If you look at the supply chain for oil,” he says, “it’s very long and stretches back to refineries, tankers, and places like Saudi Arabia. You go up the supply chain for wood, and you end up at a guy in a forest with a chain saw.”

MICHAEL PHILIPS is principal, Energy Ventures International, Takoma Park, Maryland.

LEE WHITE is executive vice president for George K. Baum & Co., Denver.