University of Idaho Administration Building. (Photo by: Education Images/Universal Images Group via … [+]
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University of Idaho Announces New Energy Partnership — Modeled on Ohio State and University of Iowa — to Boost Endowment and Resilience
Colleges and universities are turning to public-private partnerships (P3s) to upgrade campus energy systems, bolstering schools’ financial and environmental resilience. Higher education institutions face pressures to stabilize budgets, boost endowments, and optimize facilities usage. Many public universities also face shrinking state financial support, aging infrastructure, and projected declines in enrollment due to changing demographics. The COVID-19 pandemic has exacerbated these challenges. In response, some universities are trying creative ways to unlock the value embedded in their existing utility systems and enlisting private partners to make their physical operations and energy use more sustainable and efficient.
The “Big Ten” Model
The latest public university to embrace this emerging P3 trend is the University of Idaho, which on November 2, 2020 announced a 50-year concession with a private company to take over the university’s centralized district energy system. The new concession shows how budget-strapped universities and colleges can optimize critical utility systems and access significant funds for endowments and other purposes without incurring new debt or losing control of capital improvement programs.
Idaho is adopting the P3 model successfully implemented by two other Big Ten schools: the University of Iowa, which transferred its utility plant to a private concessionaire on March 11, 2020, and The Ohio State University, which created the P3 template and launched its concession on July 6, 2017, having previously used a P3 for its parking operations. In each of these cases, the concession contract was awarded after a transparent competitive bid process, and the jobs of existing university employees working on the utility plant were protected.
New P3 Concession for the University of Idaho
The Idaho State Board of Education on November 2, 2020 approved the University of Idaho’s 50-year lease and concession agreement with Sacyr Plenary Utility Partners Idaho LLC, a joint venture between Spanish company Sacyr and Los Angeles-based Plenary Americas. Under the new agreement, the school will receive an up-front payment of $225 million, the net proceeds of which will be invested to generate $6 million annually for the university to fund strategic initiatives. The university plans to use some of the new funds for student scholarships and research. The concession is designed to improve the efficiency of the university’s existing steam plant and utilities through a long-term maintenance plan.
The University of Idaho utility system suffers from millions of dollars in deferred maintenance, which the state has been unable to fund. The Sacyr/Plenary concessionaire is responsible for funding and constructing future capital improvements to the utility system, to be agreed from time to time with the university, and for operating and maintaining the system over the term of the concession. The University of Idaho will pay an annual fixed fee (escalating over time), plus an operations and maintenance fee to cover operating costs and a variable fee to cover the concessionaire’s costs associated with the improvements (including a return of and return on capital). The university and the private concessionaire will share the benefit of anticipated cost savings from upgrades and investments in efficiencies and processes. Seattle-based McKinstry Essention will operate the facilities for the concession company.
The University of Idaho’s centralized district energy system produces and distributes electricity, chilled water, steam and condensate, domestic water, compressed air for heating and cooling, stormwater, sanitary sewer and reclaimed water to meet the needs of the campus. The 94-year old system was originally designed to burn coal and was subsequently modified to burn natural gas and then wood chips from local lumber mills (with gas as a backup) as a way to reduce costs, lower greenhouse gas emissions, and remove wood waste in an environmentally friendly manner to improve forest health and reduce wildfire danger. The university has recently experimented with backpressure microturbines and solar panels to reduce its carbon footprint.
Unlocking Economic Value, Investing in Sustainability
Even before the COVID-19 pandemic, rising costs and declining levels of state support have pinched the budgets of major public universities. Raising funds for top faculty, innovative research centers, student programs, and financial aid has become more critical than ever. It is harder to find donors wanting to carve their name on a new power plant or steam tunnel. This situation makes it challenging for colleges and universities to fund capital improvements to campus systems that are essential to academic operations, medical centers and laboratories.
The first driver for schools like Idaho, Iowa and Ohio State is economic. Through these P3 concessions, the universities have been able to monetize existing non-core assets, creating new funds for endowments and special programs, while shifting operating risks to private partners who bring expertise and access to long-term capital to fund needed improvements.
In effect, the universities have converted illiquid, depreciating physical assets into pools of investable capital that should appreciate in value, creating an income stream for decades. In exchange, the universities agree to make regular payments, consisting of a minimum fixed fee plus variable cost recovery, to the concessionaire providing the energy services and upgrading the facilities. The capital improvement plans are reviewed regularly by all parties to ensure alignment with evolving university needs, system capacity and efficiency, and affordability.
Ohio State – First out of the Gate
In the case of Ohio State’s Comprehensive Energy Management Project, the university leased to the concessionaire utility-related land and facilities on the university’s 485-building Columbus campus for a 50-year term and transferred related personal property and equipment. The concessionaire operates, maintains and improves the utility system, including electricity, steam and condensate, chilled water, natural gas and geothermal power.
At inception of its concession agreement, OSU received over $1 billion in upfront payments and other consideration from the new concession company, Ohio State Energy Partners (OSEP), a joint venture between French company ENGIE North America and Canadian infrastructure fund Axium Infrastructure. OSU used the upfront payment to fund a new endowment, held by a specially formed 501(c)(3) non-profit corporation administered by the university. The Ohio State project is also intended to establish a major center for energy research and technology commercialization.
OSEP, the Ohio State concessionaire, will propose, provide the capital funding for and implement energy conservation measures to improve OSU’s sustainability. OSEP is required to meet the university’s goal of a 25 percent improvement in energy efficiency during the first 10 years of the concession. The university will have the right to review and approve proposed capital projects to ensure that they provide appropriate environmental and financial benefits to the school. The new digital platform rolled out by OSEP for the comprehensive management of buildings and utility plants on the OSU campus, for example, is already enabling the university to increase its participation in Demand Response and Capacity Performance programs with the regional transmission operator, creating ancillary revenues in addition to cost savings from reduced energy usage.
Hawkeyes Follow Buckeyes
Similarly, the University of Iowa is one of the first universities in the country to turn to the P3 delivery model to upgrade its utility plant. Earlier this year, the school entered until a 50-year concession with ENGIE North America and French infrastructure fund Meridiam. The concession covers all essential utilities for the University of Iowa’s sprawling campus and medical center, including almost 400 buildings, the university hospital, and research and lab facilities. Continuity of service is critical.
The agreement provides for an upfront payment to the university from the concessionaire that resulted in about $1 billion for a new endowment, after paying off $153 million in existing utility system bonds and $13 million in other fees and expenses. The new endowment should allow the University of Iowa to use grants of about $15 million per fiscal year to support its core missions of teaching, research and scholarship, plus other strategic initiatives.
The university also has committed to transitioning to a more sustainable energy platform. The concession agreement is designed for the university to meet its goal of being coal-free by no later than January 1, 2025, by shifting to renewable energy and other sustainable, lower-cost fuel options. To that end, the concession company is expected to modernize or replace the utility systems, including the university’s nearly century old coal-fired steam power plant, along with the existing chilled water plant and the water supply and purification facility.
Like the P3 concessions in Ohio and Idaho, the Iowa contract creates opportunities for energy-related research, learning opportunities and internships for students, and technology sharing.
Risk Transfer & Performance Incentives
Risk transfer is another goal of these P3 arrangements. The universities retain ownership of the physical assets but, through a long-term lease, transfer rights and responsibilities for maintaining and operating the systems to the private concession company. The concession contracts create accountability by requiring the private concessionaire to meet stringent performance standards for reliability, efficiency and sustainability. The performance standards require the concessionaire to operate and maintain the utility system to at least the same standards as the university previously achieved. In addition, the concessionaire must meet key performance indicators (KPIs), which are negotiated as part of the concession, covering specific quantitative metrics, such as unplanned outages, emergency response times, energy use intensity, and smart meter deployment.
Prospects for Innovation
In long-term concessions, the parties have to balance predictability of cash flows with the need for flexibility. Experimental technology may be discouraged if the question is “does the system work?”. But innovative solutions should be encouraged under P3 concessions to address “how well does the system work?”
By incentivizing the concessionaire economically to innovate, to adapt and adopt new ideas learned from other projects, and to experiment with possibly better solutions, P3 concession agreements can spur improvements in efficiency, operational flexibility and cost reduction that can be shared between the schools and the private operators. Both partners gain from improvements that might not be tried under a more conservative contractual risk allocation framework like those implemented so far.
Technical innovation is less welcome to the extent that continuity of service is placed at risk. Universities, especially those with hospitals or sensitive laboratory experiments, demand reliable utility services so that their academic buildings and medical centers can operate without interruption. Indeed, increased resilience and reliability are key goals of public infrastructure projects, beyond efficiency, life-cycle cost optimization, and sustainability.
Likewise, private sector partners depend on their projects operating without unplanned interruptions in service or technical surprises. These P3 projects can obtain long-term debt financing at a low cost – boosting equity investors’ returns through leverage while keeping costs to the university host low – only because the risks of penalties, default or termination under the concession agreements are extremely low.
The Only Constant is Change
The future creates opportunities for innovation in contracting models, technology and energy management systems as schools adapt to changing circumstances. It remains to be seen how economic cycles, state and national politics, the COVID-19 pandemic and its aftermath, and demographic trends will affect university utility systems and patterns of energy usage.
P3 structures may be an important part of the solution. More schools will likely copy the utility-style, cost-recovery models used to date by the Big Ten schools. Other schools, including well-endowed private colleges and universities, may experiment with alternative contractual structures that transfer more flexibility to P3 concessionaires in lieu of upfront payments, incentivizing innovation and risk sharing to improve utility systems’ performance and to reduce energy usage more aggressively.
In the short term, restrictions limiting classes and other on-campus activities during the 2020 pandemic have enabled schools to reduce operating costs and cut energy usage. Enrollments and funding may be jeopardized, however, by a longer economic recovery. Over time, it is possible that schools will reconfigure space on campus to accommodate different activity patterns, whether in classrooms, laboratories, dining and residence halls, or athletic and arts facilities. Increased physical distance in classrooms and improved HVAC and air filtration systems may require greater capital expenditures, further stressing school budgets.
Demands for power, cooling and connectivity may increase with the additional digital infrastructure needed for online education, cloud computing, wireless networks and advanced telecommunications. Shifting climate patterns may increase demands for heating and cooling or tools to deal with extreme weather. Technological improvements (including adaptive building systems, thermal design, energy storage, microgrids, and smart energy management systems and software) may facilitate operational efficiencies and cost reductions and may make intermittent renewable energy sources like wind and solar power more available at times of peak demand and more affordable.
There are ample opportunities to reimagine how P3 collaboration between universities and private partners can make schools more robust and stimulate research and development, with schools serving as both research centers and test beds for innovation by engineers, designers, financial investors and commercial parties alike. They key is to align interests around shared goals with a clear and fair allocation of risks and rewards.
