Energy Cost Control:
Show Me the Money!
A Financial Calculator
Christopher Russell
Energy PathFINDER
www.energypathfinder.com
(443) 636-7746
crussell@energypathfinder.com
About Christopher Russell, C.E.M., C.R.M.

Energy Manager, Howard County
Maryland

Independent consulting since 2006
Principal, Energy Pathfinder

Director of Industrial Programs,
Alliance to Save Energy, 1999-2006

MBA, M.A., University of MD;
B.A., McGill University
Published
November 2009
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Use the Top Manager’s Language!
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OUTLINE FOR TODAY
• PART 1:
Economic Justification
• PART 2:
Economic Metrics
• PART 3:
“Making the Case” to Upper Management
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U.S. INDUSTRY AVERAGE ENERGY DOLLAR
BREAKDOWN OF PRIMARY ENERGY SUPPLY
PLANT BOUNDARY
$0.49
$0.12
$0.05
$0.05
$0.28
NET APPLIED TO WORK
CONVERSION LOSS
ONSITE DISTRIBUTION LOSS
CENTRAL PLANT LOSS
(c)2009 Energy Pathfinder Mangement
Consulting, LLC
SOURCE: http://www1.eere.energy.gov/industry/energy_systems/
www.energypathfinder.com
GENERATION,
TRANSMISSION,
DISTRIBUTION
LOSSES
PRIOR TO
DELIVERY
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CHALLENGE FOR FACILITY MANAGERS

Facilities at the end of the budget “food chain”

Limited staff, resources, analytical capability

Evaluating 21st century energy improvements
with 1920s investment analysis techniques!
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ABOUT ENERGY IMPROVEMENTS:
What do business leaders want to know?
• What’s the benefit?
– How many dollars?
– How quickly do the dollars accrue?
– What’s the risk of investing?
– What’s the risk of NOT investing?
• What’s the most that I should pay for it?
…per current investment criteria
• How does this compare to other ways to use
money?
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OUTLINE FOR TODAY
• PART 1:
Economic Justification
• PART 2:
Economic Metrics
• PART 3:
“Making the Case” to Upper Management
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ENERGY AT-RISK MODEL:
• Excel Spreadsheet provided by Xcel Energy
• You plug in project budget
• Model produces economic metrics
• Choose the best metric(s) for your audience
• Print results with your label/logo
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• CONSTRUCTION BUDGET:
Project Cost: $16,000
Economic life: 25 years
Cost of Capital: 7%
TARGET: 1-YEAR PAYBACK
• ANNUAL CONSUMPTION:
Before:
246,667 kWh
After:
209,667 kWh
Elec @ $0.08/kWh
EXAMPLE:
Pump Optimization
City of Milford, CT
• MAINTENANCE COSTS:
Before:
Annual overhaul costs @ $10,000
After:
Annual overhaul costs @ $ 3,340
SOURCE: http://www1.eere.energy.gov/industry/bestpractices/pdfs/milford.pdf
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Economic Metrics
•
•
•
•
•
•
•
Simple Payback
Return on Investment
Life Cycle Cost
Net Present Value
Internal Rate of Return
Ratio: Conserve or Buy?
Cost of Doing Nothing
SIMPLE
SOPHISTICATED
INTEGRATIVE
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YELLOW TABS
Data Entry
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YELLOW TAB DEMO
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GREEN TABS
Simple Metrics
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Simple Payback
PROS
• Easy to understand
• Widely used
Total cost to
install
Simple
=
Payback
Annual operating
savings
$16,000
1.7 Years =
$9,620
FAILS TO MEET TARGET
CONS
• Measures TIME, does NOT measure profitability or full value created
• Fails to account for benefits accruing after payback period is achieved
• Analysis does not clearly isolate the impact of individual variables
• Poor indication of risk (variability of results)
• Difficult to accommodate future investments (like overhauls)
• Fails to measure the cost of NOT doing the project
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PROBLEMS WITH “PAYBACK”
•
•
•
•
If a 12-month payback is better than 24 months…
Then a 6-month payback is better than 12 months…
So a zero-month payback must be best!
Because there’s no wait to get the money back!
If getting the money back is a concern,
then there’s no reason to make the investment.
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Return on
Investment
ROI
=
Nominal Average
Annual Return
Total Nominal
Investment
$9,620
PROS
60.13% =
$16,000
• Easy to understand
• Good for comparing the attractiveness of two or more projects
CONS
• Indicates average rate of return only; note that ROI varies over individual
years
• Does not discriminate the value of returns from different years
• ROI is confined to the project only; contribution to overall profitability or
wealth is not measured
• Analysis does not clearly isolate the impact of individual variables
• Fails to measure the cost of NOT doing the project
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Life-Cycle Cost
PROS
• Good for comparing the total
ownership for two or more similar
purpose projects.
Total cost of ownership, including
capital, operating costs and energy
consumption.
Maintenance
Capital
(1%)
(2%)
Energy
CONS
(97%)
• Difficult to implement as a practical management metric; no single person
of department clearly “owns” responsibility for life-cycle costs
• No indication of wealth created by the project or variability in profitability
• Not useful for comparing dissimilar projects
• Fails to measure the cost of NOT doing the project
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GREEN TAB DEMO
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RED TABS
Sophisticated Metrics
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T
Net Present Value
(NPV)
∑
t-1
Annual Cash Flowt
(1+r)t
-
Cash Flow
In Year0
-
$16,000
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∑
t-1
$9,620
(1+.07)t
PROS
• Captures full measure of value added by the project’s returns
• Reflects risk by incorporating the time-value of money
• Excellent tool for ranking two or more options by the value they generate
CONS
• Entire calculation relies on a series of guesses about future returns
• Analysis fails isolate variables that can be linked to specific responsibilities
• Fails to measure the cost of NOT doing the project
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Internal Rate
of Return
IRR = r so that:
T
Cash Flow
In Year0
+∑
t-1
Cash Flowt
(1+r)t
=0
Where “T” = economic life of the project in years
“t” represents each individual year in the project’s economic life
∑ indicates summation across all “t” years
PROS
• Measures rate of return for this project relative to any benchmark
• Reflects risk by incorporating the time-value of money
• Excellent tool for ranking two or more options by the value they generate
CONS
• Fails to measure the absolute value of wealth created
• Entire calculation relies on a series of guesses about future returns
• Analysis fails isolate variables that can be linked to specific responsibilities
• Fails to measure the cost of NOT doing the project
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RED TAB DEMO
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BLUE TABS
Integrative Metrics
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Energy At-Risk
A
B
ANNUAL ENERGY
CONSUMPTION
Energy consumption
avoided by investing in
an energy-efficient
alternative
VOLUME AT-RISK:
Buy & waste or
Pay to avoid buying.
PAY FOR IT
EITHER WAY.
COMMITTED
ENERGY VOLUME:
Buy & use
as intended.
Annual energy use,
current application
in-place
Annual energy use,
efficient alternative
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CONSERVE or BUY?
• Continue to BUY energy at-risk from the market?
– Remain exposed to constant price volatility
• CONSERVE energy by reducing the volume at-risk?
– Do projects when cost to conserve a unit of energy is less
than the price to buy it
– Annualized cost stays fixed over the economic life of the
project
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• CONSTRUCTION BUDGET:
Project Cost: $16,000
Economic life: 25 years
Cost of Capital: 7%
TARGET: 1-YEAR PAYBACK
• ANNUAL CONSUMPTION:
Before:
842 MMBtu
After:
715 MMBtu
Elec @ $23.45/MMBtu
EXAMPLE:
Pump Optimization
City of Milford, CT
• MAINTENANCE COSTS:
Before:
Annual overhaul costs @ $10,000
After:
Annual overhaul costs @ $ 3,340
SOURCE: http://www1.eere.energy.gov/industry/bestpractices/pdfs/milford.pdf
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ANNUALIZED COST
ANNUALIZED
PROJECT
COST
=
UP-FRONT
PROJECT
COST
CAPITALIZED COST
x
CAPITAL
RECOVERY
FACTOR
vs
A=BxC
CAPITAL RECOVERY FACTOR (CRF) =
ANNUALIZED
PROJECT COST
=
CRF
A=B
C
(i/12)*(1+i/12)n*12
[(1+i/12) ]-1
Where:
i = cost of capital or discount rate on future cash flows
n = economic life (years) of remedy (energy improvement project)
•
WHY
•
ANNUALIZE?
•
•
UP-FRONT
PROJECT
COST
n*12
X 12
Operating budgets are ANNUAL
Energy savings are accounted ANNUALLY
Compare ANNUAL cost to ANNUAL benefit
Compare 3-yr project to 10-year or 5-year
projects….
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PUMP OPTIMIZATION EXAMPLE:
Annualized Project Cost Per kWhSaved
ANNUALIZED
=
PROJECT COST
UP-FRONT
PROJECT x
COST
CAPITAL
RECOVERY
FACTOR
=
$16,000
x
.0848
ANNUALIZED
PROJECT COST
=
PER ANNUAL
MMBtu SAVINGS
$1,357
126
=
$10.75
$1,357
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PUMP OPTIMIZATION EXAMPLE
ANNUAL ENERGY
CONSUMPTION
REJECT THE
ACCEPT THE
IMPROVEMENT IMPROVEMENT
$23.45
$10.75
per MMBtu
wasted
per MMBtu
avoided
$23.45
$23.45
per MMBtu
consumed
per MMBtu
consumed
Annual energy use,
current application
in-place
Annual energy use,
efficient alternative
Energy At-Risk:
You will pay for it
either way
Committed Energy
Energy put to
work as intended
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COST-BENEFIT RATIO
COST TO CONSERVE
PER MMBtu
PRICE TO BUY
PER MMBtu
=
$10.75
$23.45
= 0.46
This project allows the investor to pay
$0.46 to avoid buying $1.00’s worth of energy
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INTERPRETING
ANNUALIZED COST ANALYSIS
Annualized net savings
ANNUAL
GROSS
ENERGY
SAVINGS
?
ANNUALIZED
PROJECT COST
COMMITTED
EXPENDITURE
ANNUAL
EXPENDITURE
Annualized penalty for
DOING NOTHING
Free cash flow to:
• Working capital
(finance your operations)
Or
• Investment capital
(finance your asset base)
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COST OF DOING NOTHING
Price per
unit to
buy
energy
-
Annualized
cost to avoid
purchasing a
unit of energy
x
Volume of
avoidable
energy
purchases
+
Net annual
improvement
in O&M
expenses
=
+
$6,660
=
Annualized
Penalty for
Doing Nothing
USING THE PUMP OPTIMIZATION EXAMPLE:
$23.45
per MMBtu
-
$10.75
per MMBtu
x
126
MMBtu
$8,263
$8,263 = annual premium paid over the
25-year economic life of the proposed improvement
• Assumes energy prices and cost of money stay constant
• Penalty for doing nothing goes up:
as energy prices rise and as interest rates fall
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BREAK-EVEN POINT
MAXIMUM
ANNUALIZED
PROJECT COST
SHOULD BE
NO MORE THAN
ANNUAL VALUE
OF AVOIDED ENERGY
PURCHASES
What’s the MAXIMUM ACCEPTABLE project cost,
given certain investment criteria?
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BREAK-EVEN CALCULATION:
Pump Optimization Example
MAXIMUM
ACCEPTABLE
UP-FRONT
PROJECT COST
DELIVERED
PRICE PER
UNIT OF
ENERGY
=
x
UNITS OF
AVOIDED
ENERGY
CONSUMPTION
=
BREAK-EVEN
PROJECT COST
CRF
MAXIMUM
ACCEPTABLE
UP-FRONT
PROJECT COST
=
$23.45
x
126
0.0848
=
$34,900
NOTE: CRF = 0.0848 when n=25 and i=7%
Actual cost is only $16,000… definitely worth it.
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ONE PROJECT, TWO PRICE TAGS
Pump Optimization Project
ACCEPT PROJECT
REJECT PROJECT
GROSS ANNUAL
SAVINGS
$9,620
$0
ANNUAL PAYOUT
FOR ENERGY
AT-RISK
Annualized project cost
(capital + interest)
Annual expenditure for
energy waste
$1,357
$2,960
$16,000
$34,900
($1,357/CRF*)
($2,960/CRF*)
$8,263
-$8,263
“PRICE TAG”:
CAPITALIZED
ANNUAL PAYOUT
ANNUAL FREE
CASH FLOW
*CRF: = [i(1+i)^n]/[((1+i)^n)-1] NOTE: CRF = 0.0848 when n=25 and i=7%
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BLUE TAB DEMO
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OUTLINE FOR TODAY
• PART 1:
Economic Justification
• PART 2:
Economic Metrics
• PART 3:
“Making the Case” to Upper Management
38
Still Need to Use Simple Payback?
• Pass up a good energy saving project?
• Add the capitalized value of energy waste to
the new core-business project
• A “good” core-business project is one that
pays for itself plus the energy waste
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IMPROVE YOUR CAPITAL BUDGET
REQUESTS
• “Package” your energy project with a core-business initiative
• Facilities provides a free cash flow subsidy to the core-business project
• At capital budget time, the core-business project manager becomes your
ally, not your competitor
• Same energy project, different title. You choose:
– “Pump Optimization Project”
– “$8,000 Free Cash Flow for 25 Years”
• Show TWO PRICE TAGS:
– Cost to accept, cost to reject
• Show the cash flow lost to rejecting or delaying your proposal
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THANK YOU!
The discussion never ends.
BLOG: http://energypathfinder.blogspot.com
BOOK: “Managing Energy from the Top Down”
WEB: www.energypathfinder.com
From Shop Floor to Top Floor
Best Practices in Corporate Energy Management
Chicago, April 6-7
http://www.pewclimate.org/energy-efficiency/conference
Energy PathFINDER
Christopher Russell
crussell@energypathfinder.com
(443) 636-7746
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