STRATEGIES FOR FINANCING ENERGY-RELATED IMPROVEMENTS By Ronald J. Ianoale, Esq., McManimon & Scotland, L.L.C.

Recent changes in energy-related laws provide New Jersey school districts with more alternatives to finance these improvements. The new legislation, coupled with regulations from the New Jersey Board of Public Utilities (BPU) and the New Jersey Department of Community Affairs, sometimes make it difficult to determine the best financial strategy. There are three ways school districts can finance energy-related improvements: (i) school bonds, (ii) Power Purchase Agreements (PPAs), and (iii) Energy Savings Improvement Programs (ESIPs). This article classifies energy-related improvements into two categories: energy conservation measures —improvements that consist primarily of making existing facilities more energy efficient and, one type of renewable energy technology1—solar energy. School Bonds New Jersey school districts can issue bonds2 to finance energy-related improvements. Energy conservation measures qualify for both debt service aid and regular operating district (ROD) grants administered by the New Jersey Schools Development Authority. Solar energy does not qualify for ROD grants but can receive state debt service aid.3 Solar energy projects also allow school districts to sell Solar Renewable Energy Certificates (SRECs).4 SRECs are a type of clean energy credit that can be bought or sold. An SREC is issued once a solar facility has generated 1 MWh through either estimated or actual metered production.

1 There are a variety of renewable energy technologies that can be used to generate electricity—wind, bio-power, and geothermal—to name a few. So far only power generated through photovoltaic panels appears to be the most cost effective for school districts.

2 Type I, vocational, and state-operated school districts only need the approval of their board of school estimate or capital projects control board to issue school bonds. Type II school districts need the approval of its voters to issue school bonds. It is anticipated that these bonds would be issued on a tax-exempt basis.

3 Based on a memo from Lucille E. Davy, Commissioner of Education, dated August 22, 2008, solar energy projects are not likely to qualify for grant funds as a result of the New Jersey Legislature authorizing an additional $3.9 billion of school construction funds on July 9, 2009. Nonetheless, solar energy projects so far are eligible costs under the Educational Facilities Construction and Financing Act and qualify for debt service aid.

4 For a full discussion about the financing of solar energy projects, see Ronald J. Ianoale, Financing Solar Energy Project by New Jersey School Districts, Key Post Magazine, Vol. XXV, No. 2, Jan., 2009, p. 10. SRECs can be sold separately from the electricity that the solar system saves, thus affording school districts another source of revenue to offset the cost and the payback period for such an installation. School districts can sell SRECs to an entity (primarily electricity suppliers) that must purchase them in order for that entity to fulfill its renewable portfolio standards5 as required by the BPU. Currently, the BPU allows SRECs to be sold for a 15-year period for each solar installation. The price of SRECs is determined primarily by supply and demand with the upward value of an SREC being influenced by the cost of a Solar Alternative Compliance Payment (SACP).6 The price of a SACP is established by the BPU above the target levels for an SREC, giving electric suppliers an incentive to purchase SRECs instead of SACPs. Power Purchase Agreements

The passage of the Public Laws of 2008, Chapter 83, effective September 10, 2008, authorizes school districts and other public entities to enter into Power Purchase Agreements (PPAs) for a maximum term of 15 years. The law requires the BPU to adopt guidelines for establishing the methodology for computing energy savings. The BPU adopted such guidelines in an Order approved on February 27, 2009, entitled Public Entity Energy Efficiency & Renewable Energy Cost Savings Guidelines. These guidelines can be obtained from the BPU’s website. PPAs shift the entire responsibility and risk of installing a solar energy installation to another party, or solar investor. The solar investor will finance, install, maintain, and own the solar project—providing a true “turnkey” operation for a school district.7 In exchange, a school district agrees to provide roof space or land for the solar installation and to purchase the electricity generated from the solar installation for a maximum period of 15 years. In general,

5 Renewable portfolio standards require electricity suppliers to obtain a certain percentage of the electricity that they sell from solar energy systems located in New Jersey.

6 SACP is sometimes referred to as a “penalty” because its value is always higher than the market value of an SREC. The BPU establishes an eight-year rolling schedule for SACP values and has set a value of $675/SACP through May 31, 2011, which is the upper limit for the sale of an SREC through that date. 7 See Local Finance Notice 2009-10, entitled Contracting for Renewable Energy Services: Update on Power Purchase Agreements, published by the New Jersey Dept. of Community Affairs and dated June 1, 2009. This Notice supplements an earlier Notice on this topic—Local Finance Notice 2008-20—requiring school districts and other local governmental units to select the solar investor through a competitive contracting process. See, e.g., N.J.S.A. 18A:18A-4.1 through 4.5.

-2- these agreements usually reduce a school district’s electricity costs by approximately 15% to 20% over the 15-year term. Ownership of the solar panels will usually vest with the school district at the end of the agreement. The solar investor benefits from the PPA by owning the SRECs, accelerating the depreciation of the solar panels, and use of 30% federal tax credits or grants.8 Energy Savings Improvement Programs

Energy Savings Improvement Programs (ESIPs) were approved into law on January 21, 2009.9 ESIPs are also known as performance contracts—i.e., the energy savings derived from the energy conservation measures to be financed exceeds the costs to design, install, and finance such improvements. The law permits all school districts to issue Energy Savings Obligations (ESOs) or energy lease purchase agreements for a maximum 15-year term. The ESIP legislation permits Type II school districts to finance energy conservation measures10 without the need for a bond referendum. The issuance of ESOs is considered a hybrid form of bond because the energy savings generated from the installation of energy conservation measures pay the principal of and interest on the bonds; for that reason, the debt service created by the ESOs is not paid from the debt service fund, but is paid from the general fund. Similarly, the payment of the principal portion and the interest portion on any rent due under an energy lease is also paid from the general fund’s energy savings. A school district issuing ESOs is required to introduce a refunding bond ordinance and submit the ordinance along with an application to the New Jersey Department of Community Affairs’ Local Finance Board for its approval before the school district can finally adopt the ordinance.

8 The 30% federal tax credit or grant is only available to a tax-paying entity and is authorized by the American Recovery and Reinvestment Act of 2009, effective February 17, 2009. 9 For a full discussion of ESIPs see Andrea L. Kahn, Developing, Financing and Implementing an Energy Savings Improvement Program, Key Post Magazine, Vol. XXVI, No. 3, April, 2010, p. 10.

10 While a school district is permitted to include solar energy project in an ESIP financing, these types of projects are generally not included for two reasons: the energy savings company, or ESCO, is unwilling to stipulate to an amount of SREC revenue that a solar installation will yield over 15 years, and the initial cost of a solar installation substantially reduces the energy savings of the other energy conservation measures being financed.

-3- ESIP financed improvements do not qualify for state aid either in the form of debt service aid or ROD grants. ESOs are secured by the “New Jersey Bond Reserve Act,” because a school district pledges its full faith and credit toward the payment of the principal of and interest on these securities. And because ESOs are enhanced by the “New Jersey Bond Reserve Act,” these securities will likely obtain a “AA” rating and ensure a competitive interest rate. Finally, the issuance of ESOs does not increase the debt limit of the school district.11 A school district also has the option of entering into a 15-year energy lease purchase agreement instead of issuing energy savings obligations. Use of an energy lease would most likely occur with a Type I school district, vocational school district, or state-operated school district. These school districts can circumvent the need for their municipal and county governing bodies to issue bonds on their behalf by entering into an energy lease to finance their improvements. Unlike typical equipment leases, an energy lease is not required to have an annual cancellation or subject to annual appropriation clause, which permits a school district to not appropriate a rent payment if it has insufficient funds to conduct a thorough and efficient education. And the payment of rent under the energy lease is not restricted to the energy savings in the event of a shortfall in the anticipated energy savings in any one year (which is a restriction in other state energy laws), but can be made from any line item in the general fund.12 Nor is the energy lease required to be approved by the Local Finance Board like the issuance of energy savings obligations. These several provisions in the ESIP legislation allow an energy lease to obtain interest rates that are only slightly higher than its companion security - energy savings obligations.

What Energy-Related Financing is Best for Your District?

11 See Local Finance Notice 2009-11, June 12, 2009, which interprets the ESIP legislation. The Notice provides several benefits to school districts that are not obvious from the legislation. 12 Since ESIP rent payments are generated from energy savings and if the energy savings match the rent payment, they should not count against a school district’s 2% tax levy cap imposed on its budget beginning in the 2011/2012 fiscal year, pursuant to the requirements of Ch. 44, P.L. 2010, and made effective July 13, 2010. Bond-financed projects (not ESOs) are not restricted by the 2% tax levy cap, because bonded debt service is paid from the school district’s debt service fund making these payments exempt from the cap.

-4- One often asked question is “Which of the three financing mechanisms—bonds, power purchase agreements, or ESIPs—is best for my school district?” The most appropriate response is “What does your school district want to achieve?” If a school district believes that its voters in the case of a Type II school district, or its county or municipal governing body in the case of a Type I school district or similarly organized school district, will authorize bonds, then the financing of energy-related improvements with bonds will enable a school district to receive the most amount of state aid and finance the largest number of projects. Bond-financed projects can receive ROD grants or debt service aid for their energy conservation measures and debt service aid for solar energy projects. State aid when combined with SREC revenue and the reduction in energy costs will enable a school district to accomplish the largest amount of energy improvements when compared to Power Purchase Agreements and ESIP financed projects. School districts that want to undertake only a solar energy project and do not believe that its voters, or county and municipal governing bodies, will authorize bonds should consider entering into a Power Purchase Agreement. Similarly, school districts that want to avoid a bond referendum, or asking their county and municipal governing bodies to issues bonds on their behalf, can benefit from an ESIP to finance their energy conservation measures. The number of energy conservation measures that can be financed under an ESIP, however, will be limited by the amount of energy savings that the energy conservation measures can generate.

Ronald J. Ianoale, Esq., is a member of the law firm McManimon & Scotland, L.L.C. He can be reached at rji@mandslaw,com or 973-622-5056.

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