Performance Based Contracting is the Future of the Residential Geothermal Business. Prove Me Wrong

If you’re serious about geothermal, you need to be monitoring your projects in real time. Click here to buy a Ground Energy Support monitoring package. Note, I advise Ground Energy Support.

This guest post was written by Matt Davis. Matt is on the ASTM thermal standards committee and is an expert at geothermal monitoring. His company, Ground Energy Support has logged more than 150,000 hours in real time data.

Real time geothermal heat pump monitoring is about to the change the geothermal industry and in 5 years it will become standard practice in competitive markets like New England and the mid-Atlantic. The best 50% of firms will double their businesses and the bottom 50% of firms will stop installing geothermal because they won’t be able to compete. This is great news for the industry and I’m on a personal mission to make this happen as fast as possible. If your business is in the top 50% of geothermal firms and you design and install high quality geothermal systems, you should quickly get familiar with real time monitoring because it will allow you to increase your profit on jobs and increase your sales. Two months ago, I went to an LI Geo meeting, pitched one of the contractors on using real time monitoring with a performance based contract, and he responded, “that’s exactly what I need, I’m not going to lose a $45,000 geothermal job to a competitor for an $800 piece of equipment.” If you’re not in the top 50%, watch out 😉

It will make your business more profitable in a few ways: 1) Increased customer satisfaction. 2) Work into a service agreement so that each sale brings in recurring revenue. 3) Increase sales by a) using other projects to show a potential clients during the sales process and b) offering a performance based contract to win any and all bids from competing geothermal companies that do not feel confident enough the in quality of their design and installation to GUARANTEE its performance.

To get familiar with real time geothermal technology, how it works, the difference between monitoring, measuring and metering, download “The Current State of Geothermal Monitoring”, published by Ground Energy Support and HeatSpring. I’m an advisor to Ground Energy Support.

Here’s what the Geothermal Monitoring Whitepaper will address

1. The difference between geothermal monitoring, measuring, and metering
2. Data collection
3. Calculation of the geoexchange with the ground loop
4. Modeling with system specifications
5. Deciding on the best measurement method based on goals, budget and accuracy requirements
6. Data analysis. How to interpret the data
7. Most common system performance issues with the geothermal heat pump operation, design and source side issues

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There are several trends that will make real time monitoring standard practice within 5 years.

1. Historical precedence with the solar PV industry.
2. Public policy is pushing towards performance based incentives.
3. Monitoring addresses and solves HUGE problems that our industry faces
4. Monitoring also addresses the top issues that homeowners have when looking to purchase geothermal and AFTER they have purchased a product. Addressing these issues will allow you to 1) increase sales by addressing client concerns and 2) increase referral business by increasing customer satisfaction.
5. Monitoring can be added to your existing O+M contracts
6. Use monitoring to structure a performance based contract.

Now, I’ll discuss each of these items in more depth.

1. Historical precedence in the solar PV industry

2. Public policy is pushing towards performance based incentives

Even if you don’t want to install real time monitoring, you may not have a choice, as more and more states are looking at production based incentives for renewable thermal technologies.

New Hampshire is leading the country in this effort and is currently working on establishing the rules and guidelines for implementing a law in 2013 that was passed in early 2012. You can read more about the New Hampshire program here.

1. State by State Comparison of Geothermal Heat Pump Legislation
2. US States Heating up to Renewable Thermal Heating and Cooling

Maryland has passed some legislation, and Massachusetts is looking to address renewable thermal technologies as well as Vermont. For Massachusetts and Vermont, it’s currently unclear how they will incent renewable thermal technologies, however they incentivize solar pv and wind on a production level, so my guess is that they’re pushing this way with renewable thermal technologies as well.

3. Monitoring addresses and solves huge problems that our industry faces.

Here are the largest problems our industry faces and why monitoring solves those problems.

• It’s not a visible technology — Real time monitoring makes the projects that you have completed VISIBLE because you can show a potential client other projects that have been completed around you.
• “Does the technology work?” — Again, real time monitoring will prove that the systems work because it is monitoring them work!
• How efficient are the systems? — This is one of the most important factors with monitoring, and that is that it can used to VERIFY the expected performance of a system compared to its expected performance developed with a software model during the design of the system.
• What is a quality installation and a poor installation. — This point goes hand in hand with the last point. By monitoring each system, and then comparing the system to the expected performance of a software model, we can start to determine the differences between an AMAZING system, a good system and a horrible system. More importantly, we’ll be able to find the contractors that are doing poor work.

4. Monitoring address top client concerns. Here’s the list of the top concerns and how they’re address.

• How much money am I saving? —Without monitoring, it’s very difficult/impossible to determine exactly how much money a client is spending on heating and cooling and how much money they are saving. Especially, in 3, 5 or 10 years. If the system is monitored, you can determine this.
• I’ve heard some bad stories about geothermal. What if the system doesn’t perform as promised? — As we all know, most poor geothermal installations are done by a small number of firms and this is largely because they are not designing the loop fields to ISO 13256 or not performing proper Manual J calculations. However, if a client has a problem with this, and you have 30 systems that are being monitored in real time, you can simply say that you do HIGH QUALITY work and here is the proof.
• How do I know if something goes wrong? — One of the amazing benefits of monitoring is being able to remotely see what is happening with a geothermal system so you can address issues before they become huge issues. Most homeowners will only get angry if a problem becomes so severe that their house gets cold and they are forced to call you. If you find problems before they become HUGE problems, you’ll be able to fix it more easily. If the service is part of an existing O+M contract, even better.

5. How monitoring can be added to your existing O+M contracts

6. How you can use monitoring to structure a performance based contract. 

Performance Based Contracts (PBC) are the most exciting part of the application of real time monitoring and it’s something the best firms will start doing.

In states like NH, where monitoring will be required, the best firms will start to do it, because they’re already spending money on the projects!

In the section on performance based contractors, here’s what I’m going to talk about.

• Purpose of a PBC is to increase sales, that’s it. What scenarios will it be able to improve sales?
• What does a PBC look like for geothermal?
• What would it look like in an existing contract with a homeowner?
• How do you reduce your risk? How are uncontrollable variables controlled? “I can’t control behavior argument”
• What is the homeowners recourse? What if the system underperforms?
• How could you structure it? How many clauses do you need to add to your contract, what do they say, what do they do, and how do you make sure your risk is covered.
• Does it increase your liability? How do you eliminate this?

Purpose of PBC is to increase sales, that’s it. What scenarios will it be able to improve sales?

The only purpose of a PBC is to increases sales. Why will it increase sales? Because it reduces risk for the property owner and sets you apart from other competition. Here are a few scenarios when offering a PBC should be worth it.

• You’re constantly bidding on jobs where the homeowner is getting 2 or more bids and you are not getting work. By offering a PBC, you’ll set yourself apart from the competition and will projects.
• The property owner wants to save money, but they’re not convinced that geothermal works.

What is a PBC for geothermal?

A PBC is a guarantee that a geothermal heat pump system will operate, on average, over a specific amount of time, above a certain COP or will deliver a specific amount of BTUs per kWh used.

What would it look like in an existing contract with a homeowner?

For an existing homeowner, the contract is you (the contractor) guaranteeing that a certain MMBTUs are delivered for a specific amount of kWh per year, or less.

Here is how the clause could read and an example of a diagram that could go along with it.

“XX company will guarantee that the geothermal system will deliver

up to ___ MMBTUs delivered for ____ kWh or less

to _____ MMBTU delivered for kWh or less

to ____ MMBTU delivered for kWh or less”

With this framework, you would then fill in the information based on the analysis for the specific site, and the electric rate.

Here is an example of a 2,000 square foot home that requires 50 MMBTU every heating season. Note that in the example, I’m only guaranteeing a COP of at 3.25, I’ll discuss why I do this below.

How do you reduce your, the contractors risk? How are uncontrollable variables controlled? “I can’t control behavior argument”

There are many contractors who have argued that you cannot “guarantee” something because you cannot control homeowners actions. This is untrue, and this is why a PBC would be structured in stages of delivered energy over a long period of time. The long period of time will averages over an extremely harsh winter. Also, for the above example, let’s assume that the heat loss on the house for the year is expected to be 50 MMBTUs for the entire heating system. The contractor then designs and installed a system that will deliver 50 MMBTU at an expected COP of 3.80. First, notice that on the PBC you DON’T NEED TO PUT THE DESIGN COP, you decrease your risk, any risk for that matter, by substantially reducing the COP that you guarantee.

Additionally, the two items that you cannot control are 1) weather and 2) the clients actions. Both issues are solves because the PBC is stated in terms of heat delivery and thus diminishing performance for the higher load is already incorporated.

What is the homeowners recourse? What if the system underperforms?

The recourse clause will be extremely simple: the purpose will be to make the homeowner “whole” for any additional fuel costs that they spent due to the system performing in a less efficient manner. The reason for this is simple, the client is paying XX dollars in electricity used to power for the heat pump for a specific amount of output, thus if the output is less, they are spending MORE in electricity for less output.

Here’s a simple example, bring the information from the example. If you are guaranteeing that the system will deliver 50MMBTU at a COP of at least 3.25, what are saying is that the homeowner will use 4507 kWh to get 50MMBTU at a COP of 3.25 (50MMBTU at a COP of 3.25 means 15.38MM BTUs are coming from electrical use, 15.38MMBTU is 4507 kWh).

4507kWh at $.17 per kWh equals $766. This means that they are spending $235 per “COP”, $766 / 3.25 per year. This also means they’re paying $23.5 per “.10 COP” and $2.35 per “.01 COP”. This is the amount that the performance contract would rebate to the homeowner for underperformance.

This is how the recourse will be structured

Given the cost of electricity is $ ____ per kWh, the cost of operating the system will not exceed:

__$XX_ for _____ MMBTU,

__$XX_ for _____ MMBTU,

__$XX_ for _____ MMBTU.

The recourse will be $___ per “.01” underperformance per COP per year, with the heating season starting on July 1 of every year.

In our example, this is how the example would look

Given the cost of electricity is $ .17 per kWh, the cost of operating the system will not exceed:

__$767_ for 50  MMBTU at a COP of 3.25,

__$1,099_ for 70  MMBTU at a COP of 3.00,

__$1,321_ for 80  MMBTU at a COP of 2.25.

The recourse will be $ 2.35 per “.01” underperformance per COP per year, with the heating season starting on July 1 of every year.

How could you structure it? How many clauses do you need to add to your contract, what do they say, what do they do, and how do you make sure you’re risk is covered.

In order to create a basic but effective PGC, a contractor would need to add a few clauses to their existing contracts.

1. Performance Clause
2. Monitoring technology and accuracy to be used
3. Homeowner resource
4. Length of the contract, 3 years, 5 years, etc.

Does it increase your liability? How do you eliminate this?

Many contractors feel uncomfortable offering this because they feel it increases their liability. There are things to note here that can be used to address liability.

1.  Only the best contractors should do this. We suspect only the best 25%  of geothermal contractors that are very confident in their designs will create this sort of contract, this will allow them to increase their business by selling more projects and taking them away from contractors that do poor work, this is good for the industry.
2. Also discount your COP by 20% from your model. If the software model expects that the system will operate at an average COP of 4.00 and deliver 50 MMBTUs, guarantee that the system will deliver up to 50 MMBTUs at a COP between 3.20 and 3.25.
3. As time passes, your risk for each project will decrease, not increase as you’ll start to gather data about actual performance and be able to fine-tune your performance guarantee.
4. Calculate what your highest amount of risk is in dollar amount. Let’s continue the number in our example above, if we assume that the PGC is good for 5 years, and each year the system performs at a COP of 3.0 delivering 50MMBTUs, and the guarantee is 3.25, the contractor will need to pay $58.75 per year, times 5 years = $293.75 over the entire period of the PBC.
5. Remember how rare an underperforming system is. Again, let’s remember how rare this would be. The system is designed to operate a COP of 4.00, you guarantee it for 3.25, and then it performs at a COP of 3.00, and even in this case, you’re out less than $300. If the project was a 4 ton job that you sold for $9,000 per ton with a 10% net margin, it means your net profit was $3,600. $293 is 8% of $3,600, which means that under worst case scenario, the net profit on the job will be 8% lower, $3,300 instead of $3,600.

If you have any thoughts, comments or questions about performance based contracts, feel free to leave a comment below

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