Energy Cost Control:Show Me the Money!

A Financial Calculator

Christopher RussellEnergy 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 2006Principal, 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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(c)2009 Energy Pathfinder Mangement Consulting, LLC

www.energypathfinder.com5

PLANT BOUNDARY

U.S. INDUSTRY AVERAGE ENERGY DOLLAR BREAKDOWN OF PRIMARY ENERGY SUPPLY

SOURCE: http://www1.eere.energy.gov/industry/energy_systems/

$0.49

NET APPLIED TO WORK

$0.12

CONVERSION LOSS

$0.05

ONSITE DISTRIBUTION LOSSCENTRAL PLANT LOSS

$0.05

$0.28GENERATION,

TRANSMISSION,DISTRIBUTION

LOSSESPRIOR 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 improvementswith 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: $16,000Economic life: 25 yearsCost of Capital: 7%TARGET: 1-YEAR PAYBACK

• ANNUAL CONSUMPTION:Before: 246,667 kWhAfter: 209,667 kWhElec @ $0.08/kWh

• MAINTENANCE COSTS:Before:Annual overhaul costs @ $10,000After: Annual overhaul costs @ $ 3,340

EXAMPLE:Pump OptimizationCity of Milford, CT

SOURCE: http://www1.eere.energy.gov/industry/bestpractices/pdfs/milford.pdf 10

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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Data EntryYELLOW TABS

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YELLOW TAB DEMO

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Simple MetricsGREEN TABS

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Simple Payback

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

Total cost to install

Annual operating savings

SimplePayback =

PROS• Easy to understand• Widely used

$16,000

$9,6201.7 Years=

FAILS TO MEET TARGET

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• 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.

PROBLEMS WITH “PAYBACK”

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Return onInvestment

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

Nominal Average Annual Return

Total Nominal Investment

ROI =

PROS• Easy to understand• Good for comparing the attractiveness of two or more projects

$9,620

$16,00060.13% =

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Life-Cycle Cost

CONS• 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

Total cost of ownership, including capital, operating costs and energy

consumption.

PROS• Good for comparing the total

ownership for two or more similar purpose projects.

Capital (2%)

Energy (97%)

Maintenance(1%)

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GREEN TAB DEMO

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Sophisticated MetricsRED TABS

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Net Present Value(NPV)

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

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

Annual Cash Flowt

(1+r)t∑T

t-1- Cash Flow

In Year0

$9,620

(1+.07)t∑25

t-1- $16,000

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Internal Rate of Return

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

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

Cash Flowt

(1+r)t∑T

t-1+Cash Flow

In Year0= 0

IRR = r so that:

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

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RED TAB DEMO

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Integrative MetricsBLUE TABS

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Annual energy use, current application

in-place

Annual energy use, efficient alternative

Energy consumptionavoided by investing in

an energy-efficient alternative

COMMITTEDENERGY VOLUME:Buy & useas intended.AN

NU

AL E

NER

GY

CON

SUM

PTIO

N

A B

Energy At-Risk

VOLUME AT-RISK:Buy & waste orPay to avoid buying.PAY FOR IT EITHER WAY.

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• 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

CONSERVE or BUY?

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• CONSTRUCTION BUDGET:Project Cost: $16,000Economic life: 25 yearsCost of Capital: 7%TARGET: 1-YEAR PAYBACK

• ANNUAL CONSUMPTION:Before: 842 MMBtuAfter: 715 MMBtuElec @ $23.45/MMBtu

• MAINTENANCE COSTS:Before:Annual overhaul costs @ $10,000After: Annual overhaul costs @ $ 3,340

EXAMPLE:Pump OptimizationCity of Milford, CT

SOURCE: http://www1.eere.energy.gov/industry/bestpractices/pdfs/milford.pdf27

Where:i = cost of capital or discount rate on future cash flowsn = economic life (years) of remedy (energy improvement project)

CAPITAL RECOVERY FACTOR (CRF) = (i/12)*(1+i/12)n*12

[(1+i/12)n*12]-1

• 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….

WHYANNUALIZE?

vs

A = B x C AC

= B

UP-FRONTPROJECT

COST

CAPITALRECOVERY

FACTOR

X 12

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PUMP OPTIMIZATION EXAMPLE:Annualized Project Cost Per kWhSaved

ANNUALIZEDPROJECT COST

=UP-FRONTPROJECT

COSTx

CAPITALRECOVERY

FACTOR

$1,357 = $16,000 x .0848

ANNUALIZEDPROJECT COST

PER ANNUALMMBtu SAVINGS

=$1,357

126 = $10.75

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Annual energy use, current application

in-place

Annual energy use, efficient alternative

ANN

UAL

EN

ERG

Y CO

NSU

MPT

ION

REJECT THEIMPROVEMENT

$23.45per MMBtuconsumed

$23.45per MMBtu

wasted

$10.75per MMBtu

avoided

Committed EnergyEnergy put to

work as intended

Energy At-Risk:You will pay for it either way

$23.45per MMBtuconsumed

ACCEPT THEIMPROVEMENT

PUMP OPTIMIZATION EXAMPLE

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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

ANNUALEXPENDITURE

COMMITTEDEXPENDITURE

ANNUALIZEDPROJECT COST

ANNUALGROSS

ENERGYSAVINGS

Annualized net savings

Annualized penalty forDOING 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

=AnnualizedPenalty forDoing Nothing

Price per unit to

buy energy

Annualized cost to avoid purchasing a unit of energy

- xVolume ofavoidable

energy purchases

USING THE PUMP OPTIMIZATION EXAMPLE:

=$23.45per MMBtu

$10.75per MMBtu

- x 126MMBtu

$6,660

$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

Net annual improvement

in O&M expenses

+

+ $8,263

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BREAK-EVEN POINT

What’s the MAXIMUM ACCEPTABLE project cost, given certain investment criteria?

SHOULD BE NO MORE THAN

MAXIMUMANNUALIZED

PROJECT COST

ANNUAL VALUEOF AVOIDED ENERGY

PURCHASES

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BREAK-EVEN CALCULATION:Pump Optimization Example

MAXIMUMACCEPTABLE

UP-FRONTPROJECT COST

DELIVERED PRICE PERUNIT OFENERGY

UNITS OFAVOIDEDENERGY

CONSUMPTION= x = BREAK-EVEN

PROJECT COST

CRF

MAXIMUMACCEPTABLE

UP-FRONTPROJECT COST

$23.45 126= x = $34,900

0.0848

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 TAGSPump Optimization Project

ACCEPT PROJECT REJECT PROJECT

GROSS ANNUAL SAVINGS $9,620 $0

ANNUAL PAYOUT

FOR ENERGY

AT-RISK

Annualized project cost

(capital + interest)

$1,357

Annual expenditure for energy waste

$2,960

“PRICE TAG”: CAPITALIZED

ANNUAL PAYOUT

$16,000($1,357/CRF*)

$34,900($2,960/CRF*)

ANNUAL FREE CASH FLOW $8,263 -$8,263

*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

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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.comBOOK: “Managing Energy from the Top Down”

WEB: www.energypathfinder.com

From Shop Floor to Top FloorBest Practices in Corporate Energy Management

Chicago, April 6-7http://www.pewclimate.org/energy-efficiency/conference

Energy PathFINDER Christopher Russell

crussell@energypathfinder.com(443) 636-7746 41