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Colleges, Universities, and Renewable Energy: A Perfect Match

University Business, June 2011

Colleges and universities essentially operate as self-contained small cities, providing huge amounts of energy to its campuses, in increasing amounts, all day, every day. The higher education sector owns and operates tens of thousands of buildings, owns millions of acres of land and spends nearly $10 billion each year on energy. Given the large energy needs of our college campuses, combined with the social conscience of today's faculties and students, it is not surprising that such institutions are beginning to take a leading role in the development and implementation of renewable energy projects across the country.

The benefits associated with the development of on-site, "green" energy systems--solar photovoltaic systems, wind power systems, and cogeneration facilities--include reduced energy costs, enhanced service reliability, and a smaller carbon footprint. Renewable energy also reduces global warming, our dependence on unreliable--and sometimes hostile--foreign sources of fossil fuels, and helps to develop new industries, innovation, and jobs in the United States.

In fact, for many of those reasons, the use of renewable energy is something on which conservatives and liberals can agree, albeit perhaps for different reasons. Universities and their facilities managers are learning that large energy projects are supported by numerous government incentives and subsidies. Since some of these cost incentives are available for a limited time or for a limited pool of projects, officials at colleges and universities who are interested in renewable energy should move forward quickly to evaluate these projects.

College campuses are large energy consumers and have a continuous need for electricity, heating, cooling ,and hot water.

As part of their sustainability programs, many driven by pressure from socially and environmentally-conscious students and faculty, colleges and universities have made efforts to limit or control energy consumption and reduce their carbon footprints. Many have conducted, or are planning to conduct, audits that identify energy-saving measures, which include energy-efficient lighting, HVAC systems upgrades, and improvements in performance of central chilled water and steam boiler systems. However, despite large-scale programs to reduce carbon footprints, many institutions have been doing so by purchasing certified green energy from third parties or by purchasing renewable energy certificates ("RECs") from green producers to offset the school's carbon footprint.

In fact, by making these purchases, some colleges now claim to be 100 percent carbon neutral. Even with these types of improvements, colleges and universities continue to be large users of electricity, natural gas, and other fuels. To claim to be carbon neutral while saving costs in energy purchases altogether--and truly lessen their carbon footprint and dependence on the local power grid--colleges and universities need to produce electricity on site through use of distributed generation. The use of solar photovoltaic systems, wind power, and cogeneration also have the potential to generate substantial cost savings.

Cogeneration, or combined heat and power ("CHP"), is a form of green energy that combines generation of heat and electricity, and has been used by large institutions, including hospitals and some universities, for decades. To generate electricity on site, natural gas fuels a turbine that in the process produces waste heat. Instead of dissipating the turbine's waste heat into the atmosphere or local waterways, CHP uses the extra heat to produce steam and hot water. A cogeneration unit can also produce chilled water by combining processes with absorption cooling equipment.

Cogeneration is considered a green technology because it has a high level of energy efficiency. One cogeneration unit can capture 70 to 80 percent more of the BTU, or energy content, of the incoming natural gas, compared with only 30 to 35 percent of the fuel's BTU value for a typical utility-scale power plant. The difference stems mainly from the fact that, with cogeneration, the waste heat is re-used rather than released into the environment. Through use of cogeneration, colleges and universities can eliminate up to 20,000 tons of air pollutants each year for every 7.5 megawatts of CHP facility installed.

For college campuses, cogeneration provides another advantage: a lessened dependence on the surrounding electric grid. In the event of blackouts or brownouts, a campus with an appropriately sized CHP unit is able to meet its own requirements for electric power.

Solar, wind and cogeneration units can provide energy efficiency and independence, but facility managers often wonder how to build such projects cost-effectively. The answer: Third party providers that are available to design, build, and operate these facilities allow schools to reap substantial cost savings and reduce production of greenhouse gases without committing considerable capital of their own.

In developing solar, wind, and cogeneration projects, colleges and universities are able to exploit numerous state and federal programs. Consequently, capital costs for green energy projects are paid partly by the federal government, by state agencies, and by ratepayers.

With respect to solar photovoltaic systems, the federal tax incentives available are substantial. Typically, either the college itself or a third party provider serving the campus is able to obtain a 30 percent investment tax credit covering the cost of equipment and its installation.

For the remainder of 2011, eligible construction projects have an objective safe harbor: if at least five percent of the costs have been incurred, the project owner may opt to receive a direct cash grant from the U.S. Treasury in lieu of the 30 percent investment tax credit.

Not only does the federal government offer a 30 percent cost share--either in the form of the investment tax credit or a cash grant--but the project owner also is able to take advantage of accelerated depreciation. For eligible projects completed in 2011, the investment may be eligible for "bonus depreciation," in which the entire investment is depreciated over a single year.

Wind projects often are eligible either for this tax credit or for a different tax incentive. A third party developer may build wind turbines on a college campus and obtain a tax subsidy for every kilowatt hour of electric power sold to the hospital over a 10-year period. The credit is determined by multiplying 2.2 cents per kilowatt hour with the kilowatt hours of electricity that are: (1) produced by the taxpayer from wind power facilities during a 10-year period; and (2) sold by the taxpayer to an unrelated person during the taxable year.

There are numerous grants and other incentives available from the federal government and the Department of Energy. Such incentives would help finance or fund a portion of the initial capital cost of the project, making the large expenditure more attractive to non-profit institutions like colleges and universities that cannot usually take advantage of incentives based on tax credits and enhanced depreciation.

In addition to federal tax cuts, many states offer direct grants and incentives for investments in renewable energy facilities, including sales tax exemptions and other tax breaks.

Many States also have adopted portfolio standards that require electric utilities and other retail power providers to utilize specified percentages of renewable energy. Under these programs, the owners of green energy facilities receive renewable energy certificates ("RECs") for each megawatt hour of power produced per year.

As noted earlier, colleges and universities have become purchasers of RECs to help offset their carbon footprints, but these RECs then may be sold on the open market, generating a large revenue stream for the project owner.

The two most common financial approaches in implementing a renewable energy structure are: (1) direct ownership by the school; or (2) third party ownership, in which an independent service provider owns the renewable energy facility and sells its output to the school.

Under the direct ownership financial model, the college or university arranges for a third party to design and build the renewable energy facility. With this approach, the school takes advantage of the tax incentives itself. Where applicable, the school also obtains and sells the renewable energy certificates (RECs). This approach typically works more effectively for a for-profit institution able to use the tax credits and other tax incentives.

The main advantage of the direct ownership financial model is that the school retains full control of the facility. Additionally, there is no third party that would typically demand a reasonable return on its investment. This is particularly beneficial if the school has low-cost capital available or the ability to fund the project through its endowment.

A disadvantage of this approach is that the school bears some construction and operating risks. Also, a tax-exempt facility cannot take advantage of the federal income tax credit, direct grant or depreciation. If the facility does not operate as planned, the school may bear additional costs or lose a portion of the expected cost savings.

Under the third-party ownership financial model, the school enters into either a power purchase agreement or an energy services agreement with a third party that designs, builds, owns, and operates the facility. The school leases space or land to this third party and essentially agrees to purchase the full output of the facility, which may be either electricity alone or electric power along with steam and chilled water at a substantial discount off the market cost, and obtains a long-term agreement for financial planning purposes.

Another advantage of this approach is that the third-party provider typically remains responsible for the operation and maintenance of the facility. The third party also may have engineering personnel with substantial operating expertise. Most of the construction and operating risks are imposed on the third-party owner; thus, if the facility produces less power or less steam than expected, the school simply buys less and increases its purchases from other suppliers. This approach is often attractive for colleges because a third-party owner is able to exploit the tax incentives far more easily than a non-profit organization.

The main disadvantage of this approach is that the third-party provider must be compensated appropriately for providing its own capital and for providing services on an ongoing basis. For cogeneration projects, the service provider may have to maintain a staff on site, and arrangements may be needed for joint use of certain facilities.

Now marks an opportune time for colleges and universities to evaluate the development of on-site renewable energy facilities. If properly structured, such projects can reduce operating costs, increase the reliability of electricity supply, and substantially shrink a school's carbon footprint.

Michael J. Mann and Todd B. Reinstein are partners at the firm Pepper Hamilton LLP.