University energy P3s under scrutiny after Iowa breakdown

News Analysis 11 March

University energy P3s under scrutiny after Iowa breakdown

One of the biggest university energy P3s on record has devolved into litigation, potentially deterring some schools from pursuing this framework. Others are unphased.

By Andrew Vitelli and Eugene Gilligan

The University of Iowa’s public-private partnership for its energy system has devolved into litigation, with the private concessionaire suing the university in January.

The malfunction of one of the largest deals in this space so far – the upfront payment alone was USD 1.165bn – will not be helpful for the industry, the more than a dozen industry professionals spoken to for this article agreed.

Beyond that, there is little consensus about what the lawsuit portends for the university energy P3 space. Some expect Iowa’s experience to spook other schools and deter them from going the P3 route, while others active in these kinds of deals do not expect much of an impact. And while most spoken to see the issues raised in the lawsuit as specific to the University of Iowa’s deal, a handful fault the deal structure and foresee similar problems at other universities.

“In Cordia’s experience of executing deals with universities, our due diligence projected something like this could happen,” says Sameer Qureshi, director of acquisitions and development for the sustainable energy infrastructure firm Cordia. “We just didn’t foresee something happening this quickly.”

UI reached its deal with Engie and Meridiam in late 2019, with the Iowa Board of Regents approving the agreement 10 December. The deal structure emulated the 2017 P3 at The Ohio State University, right down to the identical USD 1.165bn upfront payment given to the university. Several subsequent deals followed similar structures. But among university officials spoken to for this article, none reported a similar experience to Iowa’s.

“I have no regrets,” says Scott Potter, senior director of comprehensive energy management at OSU.  “The [consortium of Engie and Axium] has invested hundreds of millions in projects for us, projects we wouldn’t have been able to do.”

A landmark deal, then trouble  

For its investment, the Engie and Meridiam team – called University of Iowa Energy Collaborative (UIEC) – received several sources of payment. These included an escalating annual fee, an operating and maintenance fee, and a variable fee for capital projects that the university and concessionaire each agreed upon. The UIEC bid’s upfront payment was USD 215m higher than the next highest bidder.

The capital projects piece of the equation featured in the concessionaire’s lawsuit against UI. The lawsuit says that the university in two instances approved a capital improvement project only to later revoke its approval. First, in September 2020, the university agreed to spend USD 2.5m to overhaul a turbine, but reversed course after the turbine suffered an “overspeed event” two months later, according to the filing. Then in mid-December 2020 UI said it would not pay for roof repairs agreed to months earlier after the roofs were further damaged in a storm, the lawsuit states, adding that the university has declined to make insurance claims.

These capital projects were just one source of tension cited in the lawsuit. UIEC says that the school has refused to pay a USD 1.5m operator fee as well as executive compensation for the consortium’s CEO and CFO. And the university disputed UIEC’s right to include any operator margin, according to the lawsuit.

Finally, according to UIEC’s filing, the university claimed that a March 2021 chilled water outage and an outage that October were unplanned, with the university threatening litigation. UIEC maintains both outages were planned with the knowledge of the university.

The university’s response to the filing was initially due 1 March but was given a 30-day extension, according to court documents.

In a statement sent in January, a spokesperson for UI said that the university and its P3 partners “have a disagreement regarding some of the terms and conditions of the 50-year P3 utilities partnership agreement.” Both the university and UIEC said they remain committed to the partnership.

Better luck elsewhere

Iowa was one of a handful of colleges and universities to sign energy partnerships since the OSU deal. The University of Idaho reached a deal with a team of Sacyr and Plenary in January 2021, with the university receiving a USD 225m upfront payment.

Both the university and the consortium still consider the partnership a success, according to Lee Espey, division operations officer for finance and administration at the University of Idaho, and Victor Borque Castillo, CEO of the private consortium.

“Where there are touchpoints, shared responsibilities, or decisions that have financial and operational implications for the other parties in the agreement, conflict could potentially arise, like in any business arrangement,” says Espey. “However, Sacyr/Plenary and the University of Idaho have taken a proactive approach to clarifying our understanding of the agreement, aligning processes to follow the agreement, and engaging in dialogue in good faith to move our partnership forward and achieve our goals.”

OSU’s Potter says that there have been a few amendments to the contract to address minor issues but that overall, the partnership has been beneficial.

“It’s a difficult contract, as anybody would expect it to be, but we are still progressing,” Potters says. “It still seems like it was the right deal to make for Ohio State.”

Other P3 deals deployed different structures. Duquesne University closed its deal with Cordia in May 2019 (Cordia was called Clearway Energy Group at the time). In March 2022, Louisiana State University (LSU) closed a deal with Centrio and Tiger Energy Partners, a joint venture of Bernhard Energy Solutions and Johnson Controls. These deals were focused less on maximizing the upfront payment to the university, though the Duquesne deal did include an upfront payment.

“From my perspective, the partnership has been nothing but positive,” says Russell Grunebach, associate vice president for finance and business at Duquesne.

Messages to a spokesperson for LSU were not returned, but a person familiar with the partnership said the teams have not run into any serious issues so far. An official at Fresno State, which closed a deal with Meridiam and Noresco in February 2021 for a P3 to modernize its central heating and cooling plant, says the university has weekly meetings with representatives from the two firms.

A troubled deal, or a faulty model

One of the disputes cited in the lawsuit centers on the approval of proposed capital projects for the university. There has long been some disagreement within the sector over the structure used in deals like the OSU and UI partnership, in particular over the universities’ cost of capital under the deals. The cost-of-capital formula for the OSU deal, for example, came out to somewhere between 6% and 7%; at the time of the deal, a university with a high-grade investment rating would typically pay 2-3% cost of capital. The UI deal employed a similar formula.

“With several decades deploying capital against this asset class, district energy, the analysis suggested that the formula being utilized might be rich. The schools should see some risk transfer for the capex premiums,” says Qureshi of Cordia. “In the future, we believe universities might be hesitant to execute capital projects through that formula, which is why our approach in the marketplace has been about allocation of risk, not risk transfer.”

The private sector partner, meanwhile, is dependent on a robust number of capital projects receiving the university’s approval to recoup their upfront investment, Qureshi says.

“If you're the concessionaire and the private industry, you underwrote a massive investment on the thesis that the universities are going to be able to do a lot of projects on campus and deploy significant capital to achieve their returns,” he says. “Our recommendation moving forward is for the universities to understand their objectives upfront and to get creative with how the financial treatment of the deal is designed.”

Cordia’s deal with Duquesne allows deals to be done at the university’s cost of capital, according to Qureshi.

OSU’s Potter acknowledges that the university’s cost of capital may be higher in some cases under the deal, but has pointed to the benefit of the deal allowing the university to focus on its core mission rather than running a utility system.

“You have to address the upfront payment somehow,” Potter says. “And that upfront payment is sitting in an endowment earning a lot of money.”

OSU has approved most but not all of the projects that have been proposed by the private consortium, according to Potter, and has not withdrawn any projects after approval.

At the University of Idaho, 14 capital improvements have been approved over the last two years, Espey says. 

“The success of the concessionaire in this particular template or structure is largely dependent on our ability to propose, obtain approval and execute these capital improvements,” adds Borque Castillo. “We found this process extremely collaborative from the very beginning.”

Will the lawsuit scare the market?

Even before the lawsuit, university interest in exploring energy P3s had slowed. Seeing one of the largest deals in the space – and one of only a handful to reach financial close to date – reach litigation so soon into a multi-decade deal could make universities even more hesitant to transact, several people spoken to for this article say.

But most in the industry believe the wider impact will be limited.

“I think it’s a one-off situation,” says an executive at one district energy firm. “There have been several deals done in the market, and most of them are going well.”

One advisor that has worked on these partnerships, meanwhile, said he has not seen universities considering P3s express concern about the lawsuit.

“Just based on the conversations I am having now, it isn't even in the top ten questions people are talking about,” he says. “It hasn't really come up.”

A spokesperson for the University of Maryland, which is in the process of selecting a preferred proponent for its NextGen utility P3, told Infralogic the lawsuit would not have any effect on its process.

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