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.

January 5, 2017November 5, 2018

Distributed Energy

A powerful business case can be made for harnessing distributed energy, making it a fast growing category within the energy field. The fast pace of growth results from a combination of the maturation of a variety of alternative energy technologies, and the unwinding of utility regulation. The alternative energy technologies that typically comprise distributed energy provide building owners with the ability to cut energy costs, increase energy efficiency, reduce carbon emissions, increase reliability, and eliminate peak utility charges.

The Energy Market Transforms

Distributed energy equipment suppliers have invested heavily in hardware and software in order to achieve the goal of safe and dependable integration with the grid. Having achieved this goal, the available options for building owners to utilize alternative energy have broadened out.

A “mature” distributed energy sector means that all aspects of a distributed energy network operate safely, predictably, reliably, and cost effectively. Tying in new energy sources becomes a straightforward matter, and doing so does not adversely affect production and distribution from other parts of the grid. A mature sector also means that the power produced meets acceptable standards.

As noted above, deregulation of energy markets has been a driver of growth in distributed energy as well. With the elimination of utility monopolies, competition from new sources of power give organizations a choice in where they get their power. Among the available choices for building owners is to produce their own power, in whole or in part. In such cases, consumers become producers as well, leading to the label “prosumer”*.

With distributed energy, power sources can be placed on-site (such as on-site CHP), or off-site, such as from renewable energy sources like solar, wind, and biomass (usually as CHP). The power sources need not be local, as innovative energy contracts allow buyers to purchase the output from remote energy sources.

The Impetus for Distributed Energy

For building owners, making an investment in distributed energy must of course make sense from a timing perspective, as something that’s working is not ordinarily high on the priority list for change. The initial impetus that shifts an organization’s “energy inertia” can come from failing energy assets (such as a heating or cooling system that breaks down), or simply an energy audit that reveals costs above achievable benchmarks.

In most cases, there are several benefits that can be identified in advance. Opportunities in cost savings, as well as in enhanced efficiency and increased security and reliability are usually all present when the decision is made.

Benefits of Distributed Energy

Cost Savings

The most salient reason organizations give for choosing a distributed energy solution is to save money. The IRR (internal rate of return) for investing in distributed energy must be greater than the anticipated return offered by alternatives, including not doing anything (i.e. maintaining status quo) if that is a possibility.

With the fast pace of advancements in energy systems in recent decades, there are often good cost savings available just from reduced maintenance and repairs. By incorporating the right solutions at the outset, an on-site CHP project such as producing electricity while making process heat, space heat or hot water can bring predictable cost savings to the user.

Efficiency

Decentralization can also lead to higher efficiency where energy assets allow more energy to be captured from the fuel. A great example of this is when an organization produces it own power, and at the same time captures the “waste” heat for some internal process. Combined Heat and Power (CHP) is inherently more efficient than a case where standard power generators are used.

Higher system efficiency is to be had where companies with large electricity demand such as server farms (e.g. IT Services, ISPs, Amazon, Google, and other cloud services) are locating in out-of-the-way places that are newly served by the expansion of distributed energy. Server farms create a lot of heat, so their locations are often being located where electricity is cheap, and either where the climate is cool (making cooling the equipment much more efficient), or where the waste heat from the server farm can be used for some other purpose.

Security and Reliability

The electric grid is old and suffering from technological senescence. It is vulnerable to damaging natural and man-made events. Flooding events that cause power outages are more threatening than they used to be, particularly alongside rivers and sea coasts where much of the traditional power producing infrastructure is located. Wind storms, ice storms, fires, and human threats are thankfully uncommon, but real enough to be taken seriously.

Businesses rely on power. Distributed energy makes the power supply more reliable for those businesses with the foresight to take advantage.

Reduced Carbon Emissions

Alternative energy sources reduce carbon emissions. This result is caused either through the higher utilization of the energy content of fuel (i.e. efficiency), displacing a high-carbon fuel with a lower carbon fuel, or through the utilization of some form of renewable energy, such as wind or solar.

Hedging Against a Possible Carbon Tax

The idea of imposing a carbon tax is routinely discussed in Washington these days. Supporters include market-oriented conservatives, and progressives concerned about climate change. If a carbon tax were to be passed into law, it will be advantageous for organizations to be positioned with low-carbon utilizing assets in place.

For energy investments in durable goods expected to last 5 years or more, the possibility of a carbon tax is definitely something to weigh.

Eliminating Peak Power Charges

By providing an alternative source of energy to traditional utility-provided grid energy, additional cost savings can be secured by avoiding peak energy charges. More on this topic will be available in a separate blog post on this topic.

How to Proceed with Distributed Energy

What is required to reach cost savings, efficiency, and reliability goals with distributed energy is good planning, modelling, and execution. These are essential to achieve long-term success. Working with a team that has experience with all these working parts, and which is willing to learn about your businesses’ energy needs is probably the best way to achieve success.

CIMI Energy will serve as a conducer*, working with you and your internal team to ensure a successful result.

*An equivalent producer/consumer word blend to “prosumer” is “conducer”. But what I thought might have a lower chance of getting baked into the language, “conducer” is, as it turns out, an actual word in the dictionary. It means “a person or thing contributing to a specific result” 🙂