Energy Cost Control: Show Me the Money! A Financial Calculator

1
Energy Cost ControlShow Me the Money!A
Financial Calculator

• Christopher Russell
• Energy PathFINDER
• www.energypathfinder.com
• [phone]
• crussell_at_energypathfinder.com

2
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
2
3
Use the Top Managers Language!
3
4
OUTLINE FOR TODAY

• PART 1 Economic Justification
• PART 2 Economic Metrics
• PART 3 Making the Case to Upper Management

4
5
U.S. INDUSTRY AVERAGE ENERGY DOLLAR BREAKDOWN OF
PRIMARY ENERGY SUPPLY
SOURCE http//www1.eere.energy.gov/industry/energ
y_systems/
5
6
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!

6
7
ABOUT ENERGY IMPROVEMENTSWhat do business
leaders want to know?

• Whats the benefit?
• How many dollars?
• How quickly do the dollars accrue?
• Whats the risk of investing?
• Whats the risk of NOT investing?
• Whats the most that I should pay for it?per
  current investment criteria
• How does this compare to other ways to use money?

7
8
OUTLINE FOR TODAY

• PART 1 Economic Justification
• PART 2 Economic Metrics
• PART 3 Making the Case to Upper Management

8
9

• 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

9
10
EXAMPLEPump OptimizationCity of Milford, CT

• CONSTRUCTION BUDGETProject Cost
  16,000Economic life 25 yearsCost of Capital
  7TARGET 1-YEAR PAYBACK
• ANNUAL CONSUMPTIONBefore 246,667
  kWhAfter 209,667 kWhElec _at_ 0.08/kWh
• MAINTENANCE COSTSBefore Annual overhaul costs
  _at_ 10,000After Annual overhaul costs _at_ 3,340

SOURCE http//www1.eere.energy.gov/industry/best
practices/pdfs/milford.pdf
10
11
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
11
12
12
13
YELLOW TAB DEMO
13
14
14
15
Simple Payback

• PROS
• Easy to understand
• Widely used

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

15
16
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 theres no wait to get the money back!

If getting the money back is a concern, then
theres no reason to make the investment.
16
17
Nominal Average Annual Return
Return onInvestment
ROI

Total Nominal Investment
9,620

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

60.13

16,000

• 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

17
18
Life-Cycle Cost
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.

• 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

18
19
GREEN TAB DEMO
19
20
20
21
Net Present Value(NPV)

• PROS
• Captures full measure of value added by the
  projects 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

21
22
Internal Rate of Return

• 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

22
23
RED TAB DEMO
23
24
24
25
Energy At-Risk
A
B
ANNUAL ENERGY CONSUMPTION
Annual energy use, current application in-place
Annual energy use, efficient alternative
25
26
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

26
27
EXAMPLEPump OptimizationCity of Milford, CT

• CONSTRUCTION BUDGETProject Cost
  16,000Economic life 25 yearsCost of Capital
  7TARGET 1-YEAR PAYBACK
• ANNUAL CONSUMPTIONBefore 842
  MMBtuAfter 715 MMBtuElec _at_ 23.45/MMBtu
• MAINTENANCE COSTSBefore Annual overhaul costs
  _at_ 10,000After Annual overhaul costs _at_ 3,340

SOURCE http//www1.eere.energy.gov/industry/best
practices/pdfs/milford.pdf
27
28
vs
CAPITAL RECOVERY FACTOR
UP-FRONT PROJECT COST
A B x C
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.

WHY ANNUALIZE?
28
29
PUMP OPTIMIZATION EXAMPLEAnnualized Project
Cost Per kWhSaved
ANNUALIZED PROJECT COST

29
30
PUMP OPTIMIZATION EXAMPLE
REJECT THE IMPROVEMENT
ACCEPT THE IMPROVEMENT
23.45 per MMBtu wasted
10.75 per MMBtu avoided
Energy At-Risk You will pay for it either way
ANNUAL ENERGY CONSUMPTION
23.45 per MMBtu consumed
23.45 per MMBtu consumed
Committed EnergyEnergy put to work as intended
Annual energy use, current application in-place
Annual energy use, efficient alternative
30
31
COST-BENEFIT RATIO
COST TO CONSERVE PER MMBtu
10.75
0.46


23.45
PRICE TO BUY PER MMBtu
This project allows the investor to pay 0.46 to
avoid buying 1.00s worth of energy
31
32
INTERPRETING ANNUALIZED COST ANALYSIS
ANNUAL GROSS ENERGY SAVINGS
?
ANNUALIZED PROJECT COST
COMMITTED EXPENDITURE
ANNUAL EXPENDITURE
32
33
COST OF DOING NOTHING
Volume of avoidable energy purchases
Net annual improvement in OM expenses
Annualized Penalty for Doing Nothing
x



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

33
34
BREAK-EVEN POINT
ANNUAL VALUE OF AVOIDED ENERGY PURCHASES
MAXIMUMANNUALIZEDPROJECT COST
SHOULD BE NO MORE THAN
Whats the MAXIMUM ACCEPTABLE project cost,
given certain investment criteria?
34
35
BREAK-EVEN CALCULATIONPump Optimization Example
UNITS OFAVOIDEDENERGY CONSUMPTION
DELIVERED PRICE PER UNIT OF ENERGY
MAXIMUMACCEPTABLEUP-FRONTPROJECT COST
x

BREAK-EVEN PROJECT COST

CRF
x
MAXIMUMACCEPTABLEUP-FRONTPROJECT COST
23.45
126


34,900
0.0848
NOTE CRF 0.0848 when n25 and i7
Actual cost is only 16,000 definitely worth it.
35
36
ONE PROJECT, TWO PRICE TAGSPump Optimization
Project
ACCEPT PROJECT REJECT PROJECT
GROSS ANNUAL SAVINGS GROSS ANNUAL SAVINGS GROSS ANNUAL SAVINGS 9,620 0
ANNUAL PAYOUT FOR ENERGY AT-RISK ANNUAL PAYOUT FOR ENERGY AT-RISK 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 PRICE TAG CAPITALIZED ANNUAL PAYOUT PRICE TAG CAPITALIZED ANNUAL PAYOUT 16,000 (1,357/CRF) 34,900 (2,960/CRF)
ANNUAL FREE CASH FLOW ANNUAL FREE CASH FLOW ANNUAL FREE CASH FLOW 8,263 -8,263
CRF i(1i)n/((1i)n)-1 NOTE CRF
0.0848 when n25 and i7
36
37
BLUE TAB DEMO
37
38
OUTLINE FOR TODAY

• PART 1 Economic Justification
• PART 2 Economic Metrics
• PART 3 Making the Case to Upper Management

38
39
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

39
40
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

40
41
THANK YOU!The discussion never ends.BLOG
http//energypathfinder.blogspot.comBOOK
Managing Energy from the Top DownWEB
www.energypathfinder.comFrom Shop Floor to Top
FloorBest Practices in Corporate Energy
ManagementChicago, April 6-7http//www.pewclimat
e.org/energy-efficiency/conference Energy
PathFINDER Christopher Russellcrussell_at_energypat
hfinder.com(443) 636-7746
41