The Procurement of Energy Efficiency Performance

Contracts in Brazil’s Public Sector

Alan Douglas Poole – December 1, 2008

Public sector procurement of EE performance contracts in Brazil

There has been an active energy efficiency services sector in Brazil since the mid-1990s. The
Brazilian ESCO Association (ABESCO) was founded in 1997. Ever since that time, there has
been considerable interest in developing a viable approach for the public sector procurement of
energy efficiency services using performance contracts.
Public sector energy consumption is dominated by electricity.1 The 33 TWh consumed in 2006
accounted for about 8.5% of Brazil’s total electricity consumption of 390 TWh in 2006. The
public sector consumption is divided roughly equally between public lighting, water and sewage
and diverse government buildings.
The main conditions of the legal framework at the Federal level which effect public sector
procurement are found in the general law for procurement (Law 8666 of 1993) as well as in
legislation on the budgeting process – Law nº 4320 of 1964 and the Complementary Law 101
of 2000 (known as the Law of Fiscal Responsibility). There is equivalent State level legislation
which follows the basic lines of the Federal laws.
The requirements in this legislation which are most critical for RFPs involving energy efficiency
performance contracts are:
a) the project description in the tender document,
b) the assignment of budget line items for investment and savings,
c) restrictions on the length of the contract and
d) the criteria for evaluating the proposals.
These key points will each be reviewed below.
These requirements have represented a major barrier to the procurement of EE performance
contracts. As a consequence there have been only two attempts at procurement using this
contracting mode.
1. The first RFP was published in December, 1999 by INFRAERO, the Federal company
which owns and operates Brazil’s airports. It sought to contract energy and water saving
retrofits in the terminal of Tancredo Neves (Confins) International Airport, which serves
Belo Horizonte. The contract with the winning consortium began in November 2000 and
ended in October, 2005.
2. The second RFP was published in December, 2005 by SABESP, a company owned by
the State of São Paulo which provides water and sanitation services to most of the state.
It sought to contract services to improve the efficiency of electricity use in two sewage
treatment plants in metropolitan São Paulo. The contract with the winning firm began in
April 2006 and is scheduled to terminate in 2011.

1
In 2006 82.3% of energy consumption in the public sector (excluding public transport) was in the form of
electricity, followed by 11.8% in LPG. In terms of economic value, the share of electricity was over 90%.

1
Although in both cases the type of procurement was under the same broad category as defined
by Brazilian law – “Technical and Price” - there are some significant differences between these
RFPs. Some may be seen in the requirements for proposals responding to the two RFPs,
which are summarized in Table 1.

Table 1: Requirements for proposals responding to RFPs

INFRAERO
• Proof of payment of all taxes
• Affidavit of visit to the facility
Technical Proposal including:
• Qualifications of the team & firm with affidavits
• Proposed Workplan 1
Price Proposal including:
• Savings in each year, as % of baseline cost.
• Total investment in each year. Minimum total
investment of US$152,000 is required.2
• Share of savings allocated to host in each year.
Minimum of 10% is required.
SABESP
• Proof of payment of all taxes
• Minimum indices of financial health 3
• Affidavit of visit to the facility
Technical Proposal including:
• Proposed Workplan 4
• Qualifications of the team & firm with affidavits
• A chronogram of activities 5
Price Proposal with budget spreadsheet including:
• Savings proposed in R$. Minimum savings of
US$58,000 per month are required.6
• Share of savings allocated to host. Minimum of
10% is required.

Notes to the table:

1
The Workplan has 3 components: a) the steps and methodology that the bidder will follow
to prepare the diagnostic audit and to implement the proposed measures to save energy; b)
the quantification of the projected energy savings from each measure, linked to the
modernity [sic] of the technology employed; c) a detailed chronogram of the steps to be
taken in the activities of both the diagnostic phase and the implementation phase.
2
The total investment includes all diagnostic and implementation costs, including taxes. At
least 45% of the total proposed investment must be in systems and equipment. The
minimum total investment required was R$ 280,000 which was equivalent to US$ 152,170 in
December 1999 at the prevailing exchange rate of about R$ 1.84/US$ when the RFP was
published
3
Coefficient of liquidity exceeds 1.10. Debt less than 70% of total assets.
4
The Workplan has 4 components: a) the steps and methodology that the bidder will follow
to implement the proposed measures to save energy; b) knowledge about the problems
existing in the facility; c) the quantification of the projected energy savings from each
measure; d) a detailed representation of the steps to be taken in all phases of the project.
5
The Chronogram has 3 components: a) the chronogram itself, considering the physical and
financial landmarks described in the RFP as well as restrictions on interfering with the plants’
operation; b) a description of the equipment to be installed; c) a description of the services
to be provided.
6
The minimum monthly savings required were R$ 125,000 which was equivalent to US$
58,140 in early 2006 at the prevailing exchange rate of about R$ 2.15/ US$.

The transaction costs for preparing the proposals were quite high in both cases and the number
of ESCOs who effectively made bids was very small. In the case of the INFRAERO project, 26
firms paid a fee to receive the RFP and details of the airport facility, but only two bids were
actually presented. The response to SABESP’s RFP was also tiny. The very small number of
bids is a major problem. Ways must be sought to reduce the up-front transaction costs and
increase the objectivity of the bid evaluation process.

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Other important differences between the two RFPs are that the in the case of INFRAERO there
is nothing more than a very general description of the services to be performed and there is no
copy of the contract to be signed (absent only the values determined in the bid). The contract
was left open for final negotiation after the winning bid had been selected. These omissions
are in fact illegal and if there had been a court challenge the whole procurement process would
probably have been annulled.
The RFP prepared by SABESP has these two essential elements and thus represents a more
robust model in this respect. The issues surrounding the project description will be discussed in
more detail in the next section.
Though it is more robust as a model, the SABESP RFP still treads in legal grey areas and
presents risks. Uncertainties rather than outright prohibitions are the main challenge now and
several will be discussed in the sections which follow. There is a need for explicit guidelines
and clarifications by the legal authorities of the Executive. A Federal Task Force was formed a
couple of years ago to provide such guidance, but has not so far produced any public
document.
Despite these legal difficulties, the two projects appear to have been quite successful. The
INFRAERO project achieved a reduction of more than 40% in the electricity and water costs of
the airport, though only a part of these economic benefits were due to gains in efficiency. The
SABESP project is still underway but appears to be achieving projected savings.
The technical measures undertaken in the two projects are summarized in Boxes 1 and 2.

Box 1 – Measures Undertaken at Confins International Airport (INFRAERO)

• Assistance in meeting immediate goals for rationing 1
• Hardware and software to control peak-hour use of air conditioning and renegotiation of contract
with the electric utility.
• Renegotiation of contract with the water utility after measuring the volume of sewage produced
and performing a feasibility study for an artesian well.
• Systematic search made for leaks in the water supply system. Three leaks were detected and
eliminated.
• Equipment installed to reduce flow of water in the principal points of use – such as bathrooms.
• Retrofit of more than 1000 points of lighting (including fluorescent lamps, reactors and reflectors)
in the administrative building and departure lounges.
• Installation of a generator for peak-load and emergency use, which permitted a renegotiation of
the contract with the electric utility.
• Program of training and consciousness raising of employees in the airport.
1
During June 2001-February 2002, electricity rationing was imposed in Brazil. This activity
had not been foreseen in the original contract, however the ESCO provided assistance to the
airport to achieve immediate reductions of energy use of about 20%.

Box 2 – Measures at the Novo Mundo and ABC Sewage Treatment Plants (SABESP)
• Remove two of the four blowers of 2612 kW in the ABC plant, which has excess blower capacity.
Transfer two blowers of 1300 kW from the Novo Mundo plant to the ABC plant, reconfigured to
operate at 6.9 kV instead of 13.9 kV.
• Install new ducting dimensioned for these blowers and the control and auxiliary equipment
needed for their integration in the ABC plant.
• In order to improve the energy performance of the Novo Mundo plant, permitting it to operate with

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 lower blower capacity:
a. Clean the three aeration tanks and anoxic chambers, removing about 6000 m3 of sand & mud.
b. Recondition the bubble diffusers in the aeration tanks, using existing equipment and piping if
possible in one of the tanks.

As can be seen with these two projects, there are no restrictions on the type of energy efficiency
measures in projects (e.g., lighting, HVAC, motors/ pumps, control systems). In addition, more
than one kind of EE measure can be implemented in a single project. Savings in water use can
also be included in the project.

Definition of the project for the RFP and the performance of energy audits
Brazilian legislation requires that any RFP must include a “basic project” (projeto básico) which
defines the work to be contracted, as well as demonstrating its feasibility – both technical,
economic and environmental. Contracted services must be consistent with the values
established in the “basic project”. It should also demonstrate that the costs of implementation
are compatible with resources available to the public agency and show that the relevant
technical alternatives were evaluated and the most favorable one was selected. The “basic
project” must not be prepared by any entity which is bidding to execute the project.
All this presents a major challenge for the procurement of energy efficiency services with
performance contracts. In order to comply with the requirements of the procurement law,
interpreted in a strict manner, it would be necessary to carry out a quite detailed audit to prepare
the “basic project”. Besides being costly this would also probably overwhelm the technical
capability of the government agency interested in obtaining the services. In addition, part of the
point of contracting energy efficiency services is to have the ESCO perform the more detailed
diagnostic work, which requires specialized skills. This requirement would impose a certain
redundancy of diagnostic costs which would increase costs, since for an ESCO to make a
credible guarantee of a project it must perform an audit itself. It would also reduce the
possibility of innovation by the ESCO.
An approach that has been suggested (Nexant, 2004) is to develop a model for a simplified
project description which includes the following information:
a. Energy bills (water bills when relevant) for at least the previous 12 months and
preferably three years, in order to serve as a baseline of consumption.
b. A definition of the energy end-uses which must be addressed.
c. An inventory of the energy using equipment to be considered, including: the type of
equipment, manufacturer, model, power rating and age. .
d. Location of the facility, with drawings of the layout and photographs.
e. Operating conditions of the facility in question.
f. Restrictions and conditions for scheduling and executing the retrofit work, such as when
work can be performed and the deadline for completion.
g. Minimum savings which must be achieved.
h. The maximum permitted length of the contract.
i. A ceiling for payments which may be made, at least in the first year.

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 j. Probably a generic technical analysis of the possible energy savings concluding with an
estimate of the maximum possible percentage savings – which would underpin the
ceiling for payments in the previous item.
This approach mitigates but does not eliminate the legal risks associated with an RFP for
energy efficiency performance contracting, due to the underlying concept of the “basic project”
in Brazilian legislation which assumes quite a detailed and complete description. For this
reason, it was proposed in the Nexant study that a Presidential Decree be promulgated which
would provide clear guidelines for the “basic project” in these circumstances. A draft Decree
was prepared which, among other things, defined minimum needs for the “basic project” along
the lines described above.
Despite the proposed simplifications in the Decree in some cases it may be necessary to
engage a specialized entity in order to prepare an adequate RFP, since the complexity of the
task may exceed the government agency’s capabilities. At present there is no unit within the
government which provides support to agencies in the preparation of RFPs. It is worthwhile
observing that the two historic RFPs described above were prepared by agencies whose in-
house technical capability is far greater than usual.
Brazil’s procurement rules require that, before the contracted services be executed, an
“executive project” (projeto executivo) be prepared which details (and is consistent with) the
“basic project” in the RFP. This “executive project” may be elaborated by the contracted firm.
For energy efficiency performance contracts it corresponds to the more detailed audits prepared
by the ESCO. In both of the historic projects detailed audits were performed by the ESCO after
winning the bid and were paid for as part of the project costs. There was no explicit mechanism
for adjusting changes in the savings estimated in the bid, except that, in the SABESP project,
there was allowance for the ESCO to share the savings achieved up to 120% of the level
stipulated in the bid. Beyond that level, any additional gains would accrue entirely to SABESP.
Any shortfall of achieved savings relative to the level specified in the bid would be subject to
penalties. There is therefore some bias to be conservative in the estimation of savings for the
bid.

Preparing the budget to allow for payment of services

Within the government’s budgetary process there are several big problems facing the
procurement of energy efficiency performance contracts.
First, Brazilian legislation clearly prohibits using resources budgeted for one purpose (say
purchasing electricity) to another purpose (investments to save energy). This complicates life
because the idea of performance contracting is to use resources saved in energy purchases to
pay for the investment. It is necessary to create some link between the energy saved and the
resources to pay for the energy efficiency measures.
Another dimension of this problem is that purchases of energy and water are classified as
operating expenses. How best to classify the payment of a performance contract is a bit of a
conundrum. There is clearly an investment, but there are also services which occur over time.
The general tendency has been to treat the payments as coming under the investment budget.
However, this makes the linking of energy savings to performance contract payments even
more tenuous, since the government’s investment budget is treated quite separately from its
operating budget. The Nexant study cited earlier suggested that the issue be addressed in the
proposed Presidential Decree.

5
A second related problem, is that it is necessary in every RFP to stipulate a line item in the
agency’s annual budget which will cover the expenses and assign a value. While the RFPs
prepared by INFRAERO and SABESP did stipulate a line item they did not give a value for the
coming year. This is one more reason why the procurement process could have been annulled
if it had been challenged in court.
Of course, fixing a value for the annual disbursement (for both energy purchases and payments
for contracted EE services) before the bidding has occurred is problematic. It helps somewhat
that the value can be a ceiling and that this maximum need only apply to the first year of the
contract. Even so, this requirement adds difficulty to preparing an adequate RFP. Without at
least a preliminary audit any estimate is likely to be quite arbitrary. The most logical approach
would be to use the value of the energy actually consumed before the investments as a
reference – the underlying notion being that total disbursements for both energy and the
amortization of the energy efficiency investment should not exceed the disbursements just for
energy beforehand. Unfortunately, this approach would confront the restriction described at the
opening point in this section: resources can’t be shifted from one purpose to another (i.e. energy
expenses to efficiency investments).
Again, a Presidential Decree might help (though this particular point was not proposed in the
Nexant study) especially if it emphasized the concept of “energy services” rather than simply
energy. Perhaps energy efficiency expenditures could then be fitted into the same budgetary
category as energy expenditures.

The problem of multi-year energy efficiency performance contracts

Brazilian law determines that the length of contracts should not exceed the time limit of the
budget item which will pay for them (article 57 of Law nº 8.666/1993). Since budgets are
passed annually this generally means that contracts must also be annual, though they can be
renewed successively.
Almost all energy efficiency performance contracts must be multi-year in order to be
economically viable, especially if the principle that “the savings pay for the amortization of the
investment” is to be respected. In this context, the ESCO faces a serious risk of non-payment
which would make it impossible to obtain commercial loans.
In the two historic performance contracts reviewed here, multiyear terms were stipulated in the
RFP, without however, any legal justification being given. In the case of INFRAERO the term
was 60 months, including the implementation phase. In the case of SABESP a maximum of 58
months were allowed, with up to 10 months for implementation and 48 months for the sharing of
benefits after commissioning. In both the INFRAERO and SABESP projects the ESCO was
paid, but no loan was obtained by the ESCO to finance the investment.
There are two approaches to mitigating this legal risk within the existing legislation: (a) include
the project’s goals in the “Multiyear Budget Plan” (Plano Plurianual); (b) characterize the project
as being of “continuous services” for which longer contractual terms (up to 60 months are
permitted) can result in better conditions for the Administration.
Unfortunately, neither approach definitely resolves the problem. In the first, if the project’s term
extends beyond the horizon of the existing “Multiyear Budget Plan”, which is at most four years,
there is significant risk of non-renewal in the subsequent plan.
In the second approach, characterizing the project as being of “continuous services”, there is
the risk that a more conservatively strict reading of the law would lead to the rejection of the
“continuous” nature of the service being provided. How “continuous” is the service of installing

6
some new equipment in a retrofit? The argument would be considerably strengthened by the
inclusion of maintenance services by the ESCO, but this may not always be feasible.
In the draft Presidential Decree prepared by the Nexant report, a limit of four years for the
performance contract’s period of payment was proposed, linking it explicitly to the “Multiyear
Budget Plan”. It is hoped that this language reduces the legal uncertainty.
This is perhaps the most difficult issue to resolve within the current legislative framework being
applied to this kind of procurement. A definitive solution might possibly pass through the
application of the principles used for “Public-Private Partnerships” or PPPs, since these permit
long term contracts. Legislation introducing PPPs in Brazil was passed in 2004. The PPP
approach could also mitigate other difficulties in the procurement of energy efficiency services
with performance contracts. However, it is not clear to what extent PPPs could be used for
contracting this type of service and the whole approach has had some difficulty in being
implemented in practice. The possibilities and issues are briefly discussed in a section below.

Evaluation Criteria Used to Select the ESCO

Brazilian law permits two basic categories of selection criteria: (a) lowest price only and (b)
lowest price and best technical proposal. Both of the historic RFPs reviewed here were of the
latter type. In the RFP for INFRAERO, the quality of the technical proposal had a weight of
40%. In the SABESP RFP this weighting was increased to 70%. Table 2 compares the criteria
and their weightings in the two RFPs.
The price criterion used was not in fact the “lowest price” but was the “highest benefit” to the
contracting agency. There are precedents in Brazil for modifying the criterion in this way.
Nevertheless, the Nexant study deemed it prudent to clarify and reinforce this interpretation in
the proposed Presidential Decree.

Table 2: Criteria for selection and their weights used in the two tenders

INFRAERO (2000) Weight (%) SABESP (2006) Weight (%)

Index of Technical Proposal 1
40% Index of Technical 70%
Proposal 1
Number of technical affidavits of 40% PT1 - Workplan 3 30%
the firm
Number of professionals with 10% PT2 – Qualifications of 30%
higher degrees team & firm 4
Experience of the team, with 10% PT3 – Chronogram 5 40%
proofs
Basic Workplan 2 40%

Index of Price Proposal 1

60% Index of Price Proposal 30%
1

Savings proposed as % of 30% Savings proposed in R$ 50%

baseline value
Total investment made 40% Share of savings allocated 50%
to host
Share of savings allocated to 30%
host
Notes to the table:

7
1
Both of the RFPs use an “index” which compares the points given to the proposal to the
best score among all the proposals in each sub-category.
2
The Workplan has 3 components: a) the steps and methodology that the bidder will follow
to prepare the diagnostic audit and to implement the proposed measures to save energy; b)
the quantification of the projected energy savings from each measure, linked to the
modernity [sic] of the technology employed; c) a detailed chronogram of the steps to be
taken in the activities of both the diagnostic phase and the implementation phase.
3
The Workplan has 4 components, which are weighted equally: a) the steps and
methodology that the bidder will follow to implement the proposed measures to save
energy; b) knowledge about the problems existing in the facility; c) the quantification of the
projected energy savings from each measure; d) a detailed presentation of the steps to be
taken in all phases of the project.
4
The sum of the individual qualifications of the team are weighted 50% of this item’s total.
The organization of the team and attributions of its members are weighted 10%. The
experience of the firm(s) is weighted 40% - divided equally between experience in energy
efficiency analyses and audits of relevant energy processes and in the implementation of
projects.
5
The Chronogram has 3 components: a) the chronogram itself, weighted 20%; b) a
description of the equipment to be installed, weighted 40%; c) a description of the services
to be provided, weighted 40%.

In doing so, it would make sense to go a step further in rationalizing the concept of “greatest
benefit” than was proposed in the draft Decree of 2004 and the accompanying Exposition of
Motives (Nexant, 2004). Basically, this involves simplifying the multiple parameters used to
calculate the “greatest benefit” in the historic RFPs by substituting them with the Net Present
Value (NPV) to the public agency as the single criterion.
The argument for this change begins by observing that a challenge facing the procurement
process is how to achieve as much as possible of the savings which are economically feasible.
If care isn’t taken only the investments with highest returns will be made and many economically
interesting measures will be foregone – a result known as “cream skimming” or “cherry picking”
in the energy efficiency business.
In both of the historic RFPs one selection criterion was the total amount of savings achieved,
which points towards higher investments. The second criterion was the % share which goes to
the public agency. The higher the weight given to the second criterion, the greater the
emphasis on profitability versus total savings. In the case of SABESP equal weight was given
to each criterion. INFRAERO gave more emphasis to higher investment, indeed it created a
third criterion referring directly to investment. This particular investment criterion is
questionable, since it refers to inputs rather than the results – which are what really interest us.
What is the right balance? Different weightings can influence proposals significantly, since the
ESCO preparing a bid will “game” the process (looking over his shoulder at the competition).
Any answer seems arbitrary given the information available to the public agency when it is
preparing the RFP.
This problem can be avoided by using the NPV to the public sector agency, since it incorporates
both factors: total savings and the share to the agency. The principal parameter to discuss and
then establish in the RFP would be the appropriate discount rate to be used. This presumably
would be related to broader government guidelines.
Using the NPV would also facilitate another reform which would increase the realism of the
selection process and is consistent with the general objective of introducing life-cycle costing
methodologies into the government procurement of equipment. The historic RFPs only

8
considered as benefits the savings achieved during the term of the contract. This term is limited
by legal considerations to less than 5 years and bears no relation with the useful life of the
equipment. This restriction would represent a serious distortion when considering some more
capital intensive measures, such as air conditioning systems, which typically have a useful life
which is much longer than 5 years.
Fortunately an official reference exists to establish the useful lives of different kinds of energy
using equipment. The regulator of Brazil’s power sector publishes a manual with the rules for
preparing and implementing energy efficiency projects under the utility wire-charge program
(ANEEL, 2008). In this program the utilities must perform NPV calculations on their projects
and there are clear guidelines for selecting the useful life of different kinds of electrical
equipment. The discount rate to be used is also stipulated.
Regarding the “technical” component of the evaluation, the Nexant study was quite critical of the
approach taken in the RFP of INFRAERO (this study was published well before the SABESP
RFP). There was little in the way of material to support an objective comparison of the proposed
measures to be taken. Meanwhile one sees great weight given to the experience of the
company and the members of the team.
This emphasis on qualifications may have been justified in these historic RFPs given their
pioneering nature and the lack of experience with the ESCO market at the time. However, it
would be a mistake to continue this approach in the future.
The Nexant study proposed that, at least in the case of simpler projects, the whole “technical”
component be eliminated altogether for individual RFPs. Instead, ESCOs would pass through a
process of pre-qualification and be selected only by “price” (i.e. the highest NPV of benefits to
the public agency). This would help to reduce the high transaction costs of bidding. Even if
there were a technical component in the selection criteria, it should focus more on the actual
measures to be taken and much less on qualifications – again there should be some pre-
qualification of firms. Certainly the technical component should not be dominant in weight. In
SABESP’s RFP the technical component weighed 70% in the evaluation of proposals, which
seems extraordinarily high, especially when one considers the subjective nature of many of the
requisites.
One should not forget that the performance guarantee given by the ESCO to achieve the
proposed savings (including penalties in the contracts for under performance) should strongly
inhibit proposals by unqualified firms. Following this line of reasoning, what is need is more
attention to the follow-up verification procedures and, looking further ahead, the development of
a publicly available database that accompanies projects’ forecasted and achieved results.
It is appropriate here to remember the need, highlighted earlier, to attract more bidders to the
competitive procurement process. It will obviously help if the procurement is placed on a
sounder legal basis so that diverse legal (and eventually financial) risks are minimized. Various
steps in this direction are discussed in this chapter. Beyond that it is necessary to recognize
that the transaction costs for bidders are inherently high and therefore to try to eliminate or
minimize requirements that add costs without enhancing the ability to objectively compare
proposals.
Pre-qualification, as already observed, is a way of reducing the transaction costs for each bid –
though this approach will only function if there is a program to solicit energy efficiency services
through a number of different RFPs instead of an isolated project. It is also crucial that the
evaluation process be perceived as objective. If much weight is given to subjective criteria
which are easy to manipulate many potential bidders will desist.

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It is instructive to compare the selection process in the public sector with what occurs in the
private sector. In the latter it is normal to make an initial proposal with preliminary estimates of
the potential savings and their cost. If the client is interested, the parties then sign a contract
which, at a minimum, allows the ESCO to recover the cost of the detailed audit which will
determine the efficiency measures to be taken and the levels of the savings which will actually
be guaranteed in a follow-up agreement
The public bidding process “jumps a step” as it were. The first audit must be the basis for the
savings which will be guaranteed in the contract. Either the ESCO invests more in this first
audit – with a very high risk of losing all his investment – or he opts for more subjective
judgments. Most ESCOs will probably be quite conservative, which will often mean lost
opportunities for the client. Some may risk more optimistic estimates and hope the project
evolves favorably if they win. Many RSCOs, feeling uncomfortable, will simply desist.

Project financing
A key motive for interest in the use of performance contracts for implementing energy efficiency
services in the public sector is the possibility that the ESCO can finance the investments. The
public sector in Brazil has been very limited in its capability to finance investments, a fact which
has led to other innovations to attract private sector financing, such as the Public-Private
Partnerships (PPP) which will be discussed in a following section.
As such, discussion has focused on contractual models whereby the financing is provided via
the ESCO – basically along the lines of “shared savings” contracts. Both of the historic projects
using performance contracts were of this type, with the public agency receiving 20% of the
gains over a four year period and all the savings thereafter (in the case of INFRAERO there
were some savings which were shared in the first year of the five year contract). In this kind of
contract there is no explicit rate for the average cost of the capital invested, though an implicit
rate could be calculated.
In both of the historic projects (INFRAERO and SABESP) there was no third party financing of
the investment by the ESCO, such as loans from commercial banks. All resources were
provided by the ESCO itself. The legal risks concerning payment which were reviewed above –
especially the problem with multi-year contracts - precluded any access to debt financing, even
before considering issues of the perceived credit worthiness of the government agencies who
are contracting the services.
However, once the legal uncertainties surrounding the contracts are resolved the issue of
creditworthiness will need to be addressed if performance contracting is to become a significant
source of investment in public sector energy efficiency in the future.
The perceived creditworthiness of government entities varies enormously, especially at the
State and municipal level. Investors will often want special guarantees of payment. This has,
for example, been a major issue in establishing the Public-Private Partnerships referred to
elsewhere. In this case a specific fund was established to provide guarantees for partnerships
at the Federal level. Something similar might be tried for energy efficiency. A Guarantee
Facility for energy efficiency has long been proposed to overcome what is perhaps the greatest
barrier to energy efficiency projects in general (not just in the public sector). A study performed
for the World Bank (Lima et alii, 2006) found that such a Facility could have a major impact and
would not require much capital. This approach deserves more attention.
Another possible approach is exemplified by the PMAT credit line of the BNDES (the National
Development Bank) for municipal governments. This credit line is specifically for investments

10
which increase municipal income or reduce costs and is available for energy efficiency projects.
It is not subject to many of the restrictions on municipal borrowing and is thus exceptionally
attractive. In this case the basic financial model for contracting would change – the municipal
government would take out the loan instead of the ESCO, which would only provide
performance guarantees (the “guaranteed savings” model). This would be something like the
approach used in the United States. While this option is only open for municipal governments it
might conceivably be extended to State governments.

Types of performance guarantees

In both of the historic projects the winning ESCO was required to make a deposit in an escrow
account controlled by the public agency. In the case of INFRAERO this was equivalent to 5% of
the total savings forecast in the contract. In the case of SABESP, it was 3% of the value of the
payments to be made to the ESCO which are foreseen in the contract. These deposits served
as a kind of performance bond and would be returned (after deductions, if there were any) after
the conclusion of the contract. If there are any deductions during the term of the contract, they
must be immediately replaced by the ESCO in order to keep the deposit at the stipulated level.
In addition, the SABESP contract has clauses concerning changes in the payments by the
public agency to the ESCO in cases where the ESCO achieved either (a) smaller savings than
foreseen in the contract, or (b) larger savings. In the former case the reduction in the payments
is in the same proportion as the % shortfall of the achieved versus the contracted value for the
month. That is, if the ESCO achieved 75% of the value foreseen it receives 75% of the monthly
payment foreseen. If the ESCO’s results are better than expected, the same logic applies up to
120% of the contracted value. Above this level, all the additional savings would go to SABESP.
An initiative to strengthen the credibility of the technical guarantees given by ESCOs may be
established in the near future. The GEF, together with the IDB and UNDP, has been developing
a project together with the Brazilian government entitled “Market Transformation for Energy
Efficiency in Buildings”. A key component of this proposed project is funding to capitalize a
mechanism to insure the performance of energy efficiency projects in buildings in both the
public and private sectors. Candidate projects and the contractors would be evaluated by a
specialized insurance agent and the insurance would cover at least part of any shortfall in
performance. If this mechanism is in fact implemented it might simplify the procurement
process, as well as strengthening the guarantees.

Measurement and verification procedures

In both of the historic projects with performance contracts, all payments to the ESCO are based
on measurements taken of energy consumption (and water in the case of INFRAERO).
Measurements are taken by the ESCO on a monthly basis after the commissioning of the
efficiency measures. In the case of SABESP, the average of the savings calculated during the
first 6 months after commissioning is taken to be the value of monthly payments to be made in
the remaining 42 months of the contracts – though measurements continue to be made.
There is no specific reference in the contracts to the methodology or any protocol (such as the
IPMVP) for performing the measurements or establishing the baseline, though utility meters
appear to have been used. In the case of INFRAERO there was considerable difficulty in
reaching agreement on a baseline given the complexities of the factors which influence the
airport’s operation and consumption of energy and water.

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No arbitration mechanisms for disputes were established in the historic performance contracts,
though disagreements (principally about the baseline to be used for calculating the savings)
appear to have been settled amicably.
Non-judicial arbitration mechanisms do exist in Brazil and are quite commonly allowed for in
private sector contracts. The issue of using arbitration in the case of contracts with the public
sector is more complex and the basic jurisprudence does not appear to have been settled. The
use of arbitration is explicitly foreseen in the legislation which introduced PPPs (Public-Private
Partnerships) in Brazil, but the extent to which it can be applied has been strongly questioned.
The Presidential Decree which was proposed in 2004 did briefly address the issue of
measurement and verification. It insists that the methodology to be used for the verification of
results should be included in the RFP (or the contract template which must be annexed to the
RFP). It allows the ESCO to make the measurements, if the contracting agency agrees.
However, the measurements should be adequately documented to “allow their possible
contestation”. If a third party used, this person or firm may not have “participated in any bid to
provide energy efficiency services to the public sector in the previous 12 months”. The objective
was to avoid possible conflicts of interest by using a specialized M&V agent rather than some
ESCO which may be a competitor (or ally) of the ESCO providing the service.
Such a specialized agent does not exist in Brazil, nor is there any training or certification
program for professionals in M&V – which is a major problem in general for performance
contracting.
It might be helpful if a new version of this Presidential Decree were to address the issue of
arbitration. This might be legally sustainable if it clearly restricted the scope of the arbitration
procedure to establishment of the baseline and the verification of the results – both highly
technical areas which would be very difficult for normal courts to deal with in a timely manner.

Managing a program: project facilitators and incentives for public sector staff
There has so far been little attention given to providing incentives for public sector staff to
improve energy efficiency. More typical has been a “command and control” approach such as
that embodied in a Presidential Decree in 2000 which required a 20% reduction in energy use in
Federal buildings. The results of that decree were minimal, though during the temporary
emergency of rationing from June, 2001 through February 2002 reductions of that order were
achieved.
Since the procurement of energy efficiency projects has remained highly experimental with an
overhang of legal problems and questions, there has been relatively little attention to the
management dimension of the challenge, including such issues as: staff incentives, technical
support and training, development of models for RFPs and contracts, bundling of projects,
commissioning and monitoring.
A natural place to support the development of government energy efficiency programs is
PROCEL – the national electricity conservation program administered by Eletrobrás, which is
the Federal holding company in the power sector. PROCEL has several potentially relevant
sub-programs which have been in place since at least 2000.
• PROCEL EPP – Energy management in public buildings at the Federal, State and
municipal levels. Supports the creation of a database of government buildings, training
of building managers and seminars to raise awareness. More than 200 audits have
been performed since 1997, though no information is available on follow-up. There is a
specific line of activity focused hospitals.

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 • SANEAR – Energy management for water and sewage treatment systems as well as
more efficient water use by consumers. Supports investments in laboratories for EE,
technical manuals, training and seminars, manuals for financing via utilities. Participated
in funding 9 projects with water utilities, investing almost R$ 4 million (~US$1.6 million).
• PROCEL GEM - Energy management in municipalities: Provides training, manuals and
software to assist municipal governments in developing energy management capability
and preparing plans. Supports the program “Network of Efficient Cities” and promotes
the “Energy Efficient City” prize.
• RELUZ – Energy efficient public street lighting. Established in 2000, the goal was to
substitute 5 out of the 13 million street lamps existing in 2004. Approximately 2.5 million
have been substituted. The program uses low cost financing from Eletrobrás provided
through the utilities.
PROCEL acts primarily with and through utilities. It participates in the interagency Task Force
which was created to seek ways to allow performance contracting for public buildings.
However, outside of this attribution, PROCEL has so far had very little involvement with the
subject of performance contracting, other than a cursory guide on measurement and
verification. It had no role in the preparation of the two historic performance contracts.
The public benefit wire-charge levied on electricity distribution utilities and regulated by ANEEL
(the Federal Regulator of the power sector) is a potential source of support to prepare projects
for procurement. New regulations were published for this program in February, 2008 and
explicitly allow the program to carry out projects of “Municipal Energy Management” (ANEEL,
2008 and Jannuzzi et alii, 2008). It should be easy to extend this mandate to support State
level efforts as well. Currently all wire-charge projects are managed by the local utilities, but the
new regulations permit other institutional arrangements if this were deemed to be more
efficacious by the regulator. Elsewhere the wire-charge will be considered as an alternative
approach to implementing energy efficiency projects in the public sector.
The GEF/IDB project “Market Transformation for Energy Efficiency in Buildings” cited earlier
with respect to guarantees includes a major component to assist the public sector in defining
energy efficiency measurements and preparing for the procurement of energy efficiency projects
with performance contracts (Meyer & Johnson, 2008). If finally implemented it could provide
valuable support both in the design of a program and of incentives for agencies and staff, as
well as developing an institutional nucleus with capability to assist public sector agencies.

Public-Private Partnerships
Legislation enabling Public-Private Partnerships (PPPs) in Brazil was passed in December,
2004 (Federal Law #11,079). This approach was adopted in order to open the range of
possibilities for private sector investment, given the limits on public sector investment capability.
The legal framework for PPPs could in principle relieve many of the difficulties confronting the
conventional procurement of energy efficiency services with performance contracts. It
eliminates the problem for multiyear contracts and guarantees payments to the ESCO
(facilitating access to credit). It uses technical prequalification of firms. There is somewhat
more flexibility in defining the project for the RFP and for setting the values for budgetary
purposes.
However, there are doubts as to whether the PPP approach could be used. It is viewed as an
alternative either for classical concessions – such as for toll roads – or as a means for the

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private sector to operate “administrative concessions” such as operating prisons or hospitals. In
the former consumers make all or most of the payments while in the latter the government pays.
The PPP is expressly not intended to substitute for administrative procurement that would
normally be covered by Law 8666. The rules for PPPs do not allow projects of less than R$ 20
million (~US$ 10 million), with terms of less than 5 years or which only provide labor, installation
of equipment or execution of a public work. The complex contractual structure of PPPs also
involves high transaction costs. A Special Purpose Company (SPC) must be established, for
example.
An argument can certainly be made that energy efficiency performance contracts fit into the
concept of PPPs. After all, they involve financing, specialized design work, commitments to
measured performance and maintaining efficiency gains over time. The litany of difficulties with
the Procrustean bed of standard administrative procurement which has been discussed in this
chapter and the inability to build from the experience with pioneering contracts are themselves
an argument to consider the use of PPPs.
Of course, there is the issue of scale. The R$ 20 million lower limit means that it will be
necessary to bundle projects because most public sector buildings have relatively modest
energy consumption. Fortunately, most public buildings have relatively standardized
consumption patterns which should facilitate their classification for bundling. Initial analyses
along these lines have already been performed, for example, to group together say 100 schools
in a region. The high transaction costs of any foreseeable procurement process mean that it will
be necessary to bundle projects into a single RFP in order to have a viable program – whether it
is a PPP or not. Another advantage of bundling is that it should reduce the risk of the ESCO
when making performance guarantees at a given cost. This risk reduction effect has already
been observed in contracts in the private sector with, say, chains of supermarkets.
The possibility of using the PPP approach deserves discussion even if the near term
applications are probably rather limited. PPPs are complex and represent a big jump in scale,
very few ESCOs would be capable of undertaking such a project, or even credibly bidding for it.
But the challenge is interesting and if some of the elements of the PPP approach could be
incorporated into the procurement process for energy efficiency there would be big gains.

Conclusion
There are many difficulties facing the public sector procurement of energy efficiency retrofit
projects with performance contracts. These have so far prevented the development of any
program building from the experience of pioneer experimental projects. However, the benefits
of consolidating such a program would be large. The reduction in operating costs of the various
levels of government could well exceed a billion dollars a year.
We have also seen that there are diverse possible approaches to mitigate or eliminate these
difficulties. What seems lacking is the political will and priority to tackle the issue. The Federal
government established an interagency Task Force years ago, which so far has come up with
no public recommendations. Inaction at the Federal level has had an inhibiting effect on States
and municipalities interested in developing initiatives. Hopefully, a clearer appreciation of the
costs and benefits will eventually motivate action on a question for which there are indeed
answers.

References

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ANEEL: Manual para Elaboracão do Programa de Eficiência Energética - 2008; SPE –
Superintendência de Pesquisa e Desenvolvimento e Eficiência Energética; Agência Nacional de
Energia Elétrica; approved by the Normative Resolution nº 300 of February 12, 2008.
Jannuzzi, G.M., Saidel, M.A., Haddad, J., Poole, A.D. & Johnson, T.M.; Brazil’s Energy
Efficiency Program for Electricity Utilities: Evaluation of the Program and Recommendations for
Revising Current Regulations; Part I of “Brazil Energy Efficiency Studies”, World Bank/ESMAP,
May 2008.
Lima, L.E.A., Poole, A.D., Ayres, C. M., Hackerott, C.F., Campos, M.; Analysis of the Viability
and Design of a Guarantee Facility for Energy Efficiency Projects; prepared in English and
Portuguese for the project “Developing Financial Intermediation Mechanisms for Energy
Efficiency Projects in Brazil, China and India”, World Bank, August 2006.
Meyer, A.S. & Johnson, T.M.; Energy Efficiency in the Public Sector: A Summary of
International Experience with Public Buildings and Its Relevance for Brazil; Part II of “Brazil
Energy Efficiency Studies”, World Bank/ESMAP, May 2008.
Nexant Ltda: Contratos de Desempenho para Serviços de Eficiência Energética no Setor
Público do Brasil: Questões Jurídicas e Possíveis Soluções; report for the U.S. Agency for
International Development and Brazil’s Ministry of Mines and Energy, Brasília DF, 2004

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