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

Energy Cost Control: Show Me the Money! A Financial Calculator. Christopher Russell Energy Path FINDER www.energypathfinder.com (443) 636-7746 crussell@energypathfinder.com. About Christopher Russell, C.E.M., C.R.M. Energy Manager, Howard County Maryland

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

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  1. Energy Cost Control:Show Me the Money!A Financial Calculator Christopher Russell EnergyPathFINDER www.energypathfinder.com (443) 636-7746 crussell@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 Manager’s 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 PLANT BOUNDARY $0.49 $0.12 $0.05 $0.05 $0.28 NET APPLIED TO WORK GENERATION, TRANSMISSION, DISTRIBUTION LOSSES PRIOR TO DELIVERY CONVERSION LOSS ONSITE DISTRIBUTION LOSS CENTRAL PLANT LOSS (c)2009 Energy Pathfinder Mangement Consulting, LLC www.energypathfinder.com SOURCE: http://www1.eere.energy.gov/industry/energy_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 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? 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. EXAMPLE:Pump OptimizationCity of Milford, CT • 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 SOURCE: http://www1.eere.energy.gov/industry/bestpractices/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. YELLOW TABS Data Entry 12

  13. YELLOW TAB DEMO 13

  14. GREEN TABS Simple Metrics 14

  15. Simple Payback Total cost to install $16,000 1.7 Years = Simple Payback $9,620 = Annual operating savings 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 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. 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. Maintenance (1%) Capital (2%) PROS • Good for comparing the total ownership for two or more similar purpose projects. Energy (97%) 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. RED TABS Sophisticated Metrics 20

  21. Net Present Value(NPV) 25 T ∑ ∑ - - Annual Cash Flowt $9,620 Cash Flow In Year0 $16,000 (1+.07)t (1+r)t t-1 t-1 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 21

  22. IRR = r so that: Internal Rate of Return T ∑ + = 0 Cash Flowt Cash Flow In Year0 (1+r)t t-1 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 22

  23. RED TAB DEMO 23

  24. BLUE TABS Integrative Metrics 24

  25. 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. 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. EXAMPLE:Pump OptimizationCity of Milford, CT • 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 SOURCE: http://www1.eere.energy.gov/industry/bestpractices/pdfs/milford.pdf 27

  28. (i/12)*(1+i/12)n*12 CAPITAL RECOVERY FACTOR (CRF) = [(1+i/12)n*12]-1 Where: i = cost of capital or discount rate on future cash flows n = economic life (years) of remedy (energy improvement project) ANNUALIZED COST CAPITALIZED COST vs CAPITAL RECOVERY FACTOR ANNUALIZED PROJECT COST UP-FRONT PROJECT COST UP-FRONT PROJECT COST ANNUALIZEDPROJECT COST CAPITAL RECOVERY FACTOR UP-FRONT PROJECT COST = x = CRF A C = B 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. CAPITAL RECOVERY FACTOR UP-FRONT PROJECT COST x .0848 $1,357 $16,000 x = ANNUALIZED PROJECT COST PER ANNUAL MMBtu SAVINGS $1,357 126 = = $10.75 PUMP OPTIMIZATION EXAMPLE:Annualized 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 $1.00’s worth of energy 31

  32. INTERPRETING ANNUALIZED COST ANALYSIS Annualized net savings ANNUAL GROSS ENERGY SAVINGS ? Annualized penalty for DOING NOTHING ANNUALIZED PROJECT COST • Free cash flow to: • Working capital • (finance your operations) • Or • Investment capital • (finance your asset base) COMMITTED EXPENDITURE ANNUAL EXPENDITURE 32

  33. USING THE PUMP OPTIMIZATION EXAMPLE: = - x 126 MMBtu $6,660 $23.45 per MMBtu $10.75 per MMBtu COST OF DOING NOTHING Price per unit to buy energy Annualized cost to avoid purchasing a unit of energy - Volume of avoidable energy purchases Net annual improvement in O&M 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 What’s the MAXIMUM ACCEPTABLE project cost, given certain investment criteria? 34

  35. BREAK-EVEN CALCULATION:Pump 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 n=25 and i=7% Actual cost is only $16,000… definitely worth it. 35

  36. ONE PROJECT, TWO PRICE TAGSPump Optimization Project *CRF: = [i(1+i)^n]/[((1+i)^n)-1] NOTE: CRF = 0.0848 when n=25 and i=7% 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 Down”WEB: www.energypathfinder.comFrom Shop Floor to Top FloorBest Practices in Corporate Energy ManagementChicago, April 6-7http://www.pewclimate.org/energy-efficiency/conference EnergyPathFINDERChristopher Russellcrussell@energypathfinder.com(443) 636-7746 41

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