Energy Cost Control: Show Me the Money! A Financial Calculator Christopher Russell Energy PathFINDER www.energypathfinder.com (443) 636-7746 crussell@energypathfinder. com
Mar 26, 2015
Energy Cost Control:Show Me the Money!
A Financial Calculator
Christopher RussellEnergy PathFINDER
www.energypathfinder.com(443) 636-7746
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
[email protected](443) 636-7746 41