Tag: ESAs

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Proving the Financial Soundness of Investments in Energy Use Reduction

Reducing energy use in buildings often requires an investment of capital, making an obligation of some sort, or both. As with any investment, there needs to be an acceptable financial return.

Returns are usually quantified in dollars saved. When looked at strictly from a dollars point of view, the investment can be looked at like other investments. The investment might even be compared to alternatives such as repaving a parking lot, expanding a workout area, or hiring more staff. Except it should be easier to quantify the return on the investment in energy reduction. Energy consumption can be easily measured. Things like parking lot improvements and staff may be desirable, but the returns are largely guesswork.

Payback Period

One of the easiest ways to quantify energy reduction return expectations is by estimating a simple payback period. Divide the expected annual savings by the initial cost.  If an expected simple payback period is really long, like 15 or 20 years, that investment can be quickly eliminated from contention without spending any more time on it.  There are probably  alternatives out there that will get a much faster payback.

Limitations to payback period as an investment metric include not quantifying changes in maintenance costs, which are not part of the initial investment. Also not accounted, but very significant are the returns that accrue after the payback period ends.  The time value of money is not accounted for.

Discounted Cash Flow Analysis (DCF)

Discounted cash flow accounts for the time value of money, and is therefore a metric that can be used if the quick-and-easy payback period metric passes muster.  DCF provides a closer look at the attractiveness of the investment opportunity.

DCF requires using a discount rate.  Different discount rates  make large impacts on the results of the analysis.  Therefore, it’s important to use one that is realistic, and even more important, to be consistent in using the same discount rate for all DCF analyses. 

Net Present Value (NPV)

Net Present Value also accounts for the time value of money, as  DCF is used to determine NPV.    Calculating the NPV results in either a positive number or a negative number.  A positive result usually indicates that an investment is worth doing.

Where NPV is less clear is when two different investment alternatives end up with positive NPVs.  The larger NPV is usually the best.  However, if more initial capital is required to reach that higher NPV, and that capital requirement comes at the expense of other things, such as necessary maintenance, then the answer is not so clear cut.

Internal Rate of Return (IRR)

The internal rate of return is another useful metric.  It shows the discount rate where the NPV of cash flows = zero (assuming NPV is positive).   The IRR is useful for determining if an investment is worthwhile.   If the IRR is higher than the cost of capital, and there is confidence in the assumptions made to determine the IRR, then the investment is probably worthwhile.

Valuation Effects

Another consideration for energy cost reduction is how the reduction in costs effects valuation.  A change to energy assets that creates a lasting and meaningful energy cost reduction most definitely will increase the value of the property or business.  Of course, to be true, the scale of energy use reduction must have a material affect on the cost structure. 

More details about the subject of how energy costs cuts affect valuation is available in this blog post.

Other Financial Considerations

In the world of energy efficiency, there are often additional factors to consider.  Some of these factors include:

  • No money down loans
  • Low interest loans
  • Energy services agreements (ESAs)
  • Tax credits
  • Tax deductions
  • Accelerated depreciation
  • Grants
  • Discounted fuel
  • Discounted power
  • Tradeable credits, and more.

CIMI Energy Can Help

CIMI Energy can perform these financial analyses and write up reports that help you to prioritize where to focus.  

Beyond the financial aspects of these investments, there are  environmental and sustainability considerations. CIMI Energy can help with this also.  If so desired, these considerations can be considered within the reports. 

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Pros and Cons of Energy Services Agreements (ESAs)

Energy Services Agreements (ESAs) are an innovation in how energy is managed and paid for. ESAs provide funding for energy-related capital improvements. They also provide other benefits as described in the list that follows. As might be expected, there are limitations that organizations need to weigh when considering entering into an ESA.

Pros of ESAs

1. No capital costs for retrofit borne by building owners
2. Net cash flow positive for building owners (usually)
3. Planning and execution of capital upgrade costs handled by ESA contractor
4. Maintenance of capital equipment managed, and costs borne by contractor
5. Organization management can stay focused on organization’s mission
6. ESAs often enable needed improvements to take place more quickly
7. Larger financial benefits can accrue when an ESA enables capital upgrades to be made near-term rather than waiting for capital to become available
8.  ESA payments can be treated as an expense
9. Gas is cheaper in some locations when used in CHP

Cons of ESAs

1. Upgrades to existing energy and water assets can cause temporary disruptions that need to be planned for
2. Contracting organization must have trust in ability of contractor to plan, execute and manage properly

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Energy Services Agreements (ESAs)

ABOUT ENERGY SERVICES AGREEMENTS (ESAs)
Energy Services Agreements essentially outsource your energy in a way that saves you money. Outsourcing has proven to be effective in many areas where core experience and focus are an advantage. Think about payroll services, food services, custodian services, headhunting services, etc. These are areas where outsourcing has taken hold long ago.

The production and consumption of energy has been going through big changes in recent years, leading to a great opportunity for organizations to cut energy costs significantly. To seize the opportunity, however, it takes specialized knowledge, an experienced team of engineers, and new capital equipment.

Ordinarily something like this would take a management team’s time and focus away from their core mission. It would ordinarily require a significant amount of capital to get it off the ground. Capital that could perhaps be preserved, or put to better use on something core to the mission of the organization.

So if an ESA can 1. save you money, 2. doesn’t distract your management team, and 3. requires no upfront capital, then you have a winning formula. That’s why we partner with RENEW Energy Partners, a pioneer in specialized Energy Service Agreements (ESAs) that require no upfront capital.

Advantages of an ESA
Operating Expenditures Saved Through Lower Energy Costs
ESAs save money. Typical ESAs involve replacing old, inefficient energy-consuming assets with new, more efficient assets. Examples include boilers, cooling units, lighting, building controls, etc. Experience has shown that reductions in energy use of between 30% and 50% can be achieved.

Savings Start Sooner
By moving forward with your energy upgrade through an ESA today, you start to gain the benefits of lower energy costs right away. Contrast this with an alternative scenario where you move forward with an energy upgrade independently, but 2 or 3 years further in the future. This alternative means that you miss out on 2 or 3 years of energy savings.

Lower Environmental Impact
By achieving large reductions in energy consumption, the environmental impact of operations is proportionally reduced as well. Carbon emissions in particular are reduced, thereby lowering the carbon footprint of your operations.

Increased Valuation
With an ESA, energy costs are lower, which leads to operating expenditures being lower. Therefore the profitability of the organization is typically increased. Profitability is obviously one key metric that organizations look at, as is valuation, which is also typically higher as well. A building with new HVAC, lighting and controls is valued more highly.

No Added Debt, Preservation of Capital
If an ESA bundles in all the capital, then there’s no upfront capital that’s necessary. Therefore, there’s no debt added to the balance sheet. Capital gets preserved, or deployed in other ways.

Outsourced Maintenance, Repairs & Insurance
By entering into an ESA, an organization essentially outsources all the fixed costs (i.e. equipment capital costs, maintenance, and insurance) related to the energy production. Additionally, during the length of the ESA, the ESA provider covers any equipment repairs, if any.

Less Risk of Breakdown or Failure
An organization that operates old and inefficient capital equipment bears a substantially higher risk of failure. Not everything that can go wrong is evident through inspections, or avoided through routine maintenance. The higher risk of failure leads to a higher risk of incurring repair costs, as well as going without energy for a period of time while the repair is being made.

Full Scope of Improvements Outsourced
By having an experienced team plan and manage the improvements, and optimize those improvements to maximize savings, the heavy lifting needed to make these big improvements is not placed on management.

Leveraging Team of Experts
The ESA comes backed with an experienced team of experts who have completed these types of projects in the past. The team includes financial investors, industry experts, and channel partners such as product manufacturers, engineers, and general contractors.

ESA Payments Can Be Expensed
ESA payments can be treated as a capital expense or as an operating expense.

Disadvantages of an ESA
No Depreciation
The only potential downside to entering into an ESA is that the “buyer” organization doesn’t get to depreciate the cost of the equipment. Of course, in most cases the equipment that’s being replaced is already fully depreciated, so there’s no depreciation impact in the financial statements of the organization.

Of course, if the buyer of the ESA invests in capital or labor instead of spending on the energy assets, that disadvantage is greatly mitigated, or even eliminated.

How an ESA is Priced and Paid For
With a RENEW Energy Partners ESA, no upfront payments are required. Energy audits (including a review of historical energy consumption), planning, and construction costs are all bundled into the ESA. Payments under the ESA are only a portion of the savings, so the organization making those payments is net cash flow positive from the start. The organization continues to pay its utility bills directly to the utility, which become lower, of course, after the investment in high-efficiency equipment is completed.

At the end of the term, the building owner can buy the project at fair market value or renew the ESA.