Module 5 - Evaluating energy efficiency opportunities

Evaluating Energy Efficiency OpportunitiesModule 5

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Disclaimer

This material has been developed as part of the UTS Business School and Ernst & Young ‘Leadership & Change for Energy Efficiency in Accounting & Management’ project. The project is supported by the NSW Office of Environment & Heritage as part of the Energy Efficiency Training Program. For more information on the project, please go to: http://www.business.uts.edu.au/energyefficiency/.

This presentation is for educational purposes only, and does not contain specific or general advice. Please seek appropriate advice before making any financial decisions.

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Agenda

► Introduction

► Feasibility Analysis

► Simple Payback

► Net Present Value

► Internal Rate of Return

► Accounting Rate of Return

► Other Considerations

► Marginal Abatement Cost Curve (MACC)

► Case Study

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Outline

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Energy Efficiency

1.0 Define energy baseline

2.0 Measure energy data

3.0 Analyse efficiency

opportunities

4.0 Implement Opportunities

5.0 Control and monitor

energy

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Learning Objectives

At the end of this module, you will:

► Be able to complete a financial analysis of an opportunity and calculate various metrics that can be used to evaluate a project

► Payback

► Net present value

► Internal rate of return

► Accounting rate of return

► Be able to identify and quantify where possible the wider business costs and benefits resulting from an implemented opportunity

► Have a system for prioritising all the evaluated opportunities to maximise the value of energy savings

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Introduction

► This module provides a framework for the financial evaluation of energy and emissions reduction initiatives. When evaluating any such project, the decision to proceed should occur within the broader decision making process of your business.

► To ensure the successful implementation of any new energy saving measure you should, as a minimum:

► Produce a detailed cash flow of each alternative► Ensure that all costs and benefits are included► Consider any investment allowances, grants and taxation issues

► Undertake the financial appraisal of each

► Implement and monitor the performance of the project

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Simple Payback Period

Payback Period (PP) = The Costs of the Project/ Investment Annual Cash Inflows/ Savings

E.g. A lighting retrofit project costs $200,000 and the expected returns are $40,000 annually.

PP = $200,000 / 40,000 = 5 years.

The payback period is the time required for the cash inflows to equal the original cash investment, i.e. how long it takes to get your money back

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Net Present Value

NPV is what the project is worth today.

Projects with identical simple payback periods can have very different net present values depending on the timing and duration of cash flows.

E.g. Two $100,000 projects, each has a simple payback period of two years.

The projects are equal when using payback period, but project B is clearly superior, so projects with identical simple payback period can be ranked by calculating the present value of future cash flows.

Payback NPVInvestment

todayYr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10

Project A 2 ($12k) ($100k) $50k $50k

Project B 2 $188k ($100k) $50k $50k $50k $50k $50k $50k $50k $50k $50k $50k

NPV Yr 1 Yr 2

Project A $87k $50k $50k

Project B $83k $100k

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Internal Rate of Return (IRR)

► Discount rate at which the benefits equal the costs (i.e. NPV = 0)► The higher the cash flows after the initial investment, the higher the

discount rate needed to achieve NPV of zero, so a higher return► Indicates whether funds to be spent on energy saving investments

could be better deployed in other projects, or in an interest bearing deposit

► Investments are compared against a required rate of return that a business sets for proposals► If a project’s internal rate of return is greater than required rate of return

then it can be accepted► If it falls below the required rate of return then it should be rejected

► Can be calculated easily in Excel using IRR and XIRR functions

IRRInvestment

todayYr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10

Project A 21% ($100k) $25k $25k $25k $25k $25k $25k $25k $25k $25k $25k

Project B 49% ($100k) $50k $50k $50k $50k $50k $50k $50k $50k $50k $50k

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Accounting Rate of Return (ARR)

► Investments are compared against a required rate of return that a business sets for proposals► If a project’s accounting rate of return is equal to or greater than

required rate of return then it can be accepted► If it falls below the required rate of return then it should be rejected

► The higher the ARR the more attractive the investment

Accounting Rate of Return (ARR) = Average Cost Saving Initial Investment

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Feasibility analysis

Method Benefits Disadvantages

Payback ► Easy to compute► Easy to understand

►Ignores the benefits that occur after the payback period

►Ignores the time value of money

Net present value

► Accounts for changing value over time, i.e. time value of money

►Need to select an appropriate discount rate

Internal Rate of Return

► Provides a benchmark for what should and should not be invested in

►Need to select an appropriate benchmark IRR

►Doesn’t give an indication of the absolute value of a project

Accounting Rate of Return

► Easy to compute ►Ignores the time value of money

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Consider the full benefits

Energy efficiency actions often have benefits other than the obvious reductions in direct costs, e.g. converting from standard fluorescent tubes to triphospher tubes will not only save on electricity costs, but will also:

► Increase lamp life, thereby reducing the cost of ordering, purchasing, storing and installing replacement lamps

► Improve lamp light output, quality and reliability, potentially allowing the use of fewer fittings and/ or improving productivity through better lighting levels

Benefits could include (but are not limited to):► Reduced energy savings (gas, electricity, fuels)► Reduced maintenance savings► Savings from not having to purchase carbon offsets► Value of Energy Savings Certificate or equivalent produced

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Consider the full costs

► Costs go beyond the initial purchase price when you make a capital investment.

► When comparing more than one opportunity, merely looking at the purchase and installation price can ignore operational costs such as maintenance costs and can result in the company paying more over future years.

► Consider both capex and opex budgets in the financial analysis

Costs could include (but are not limited to):► Cost of the capital asset► Cost of alterations to existing capital assets► Repair costs► Consultancy fees

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Consider other funding opportunities

► When a grant or tax incentive is provided, this should be deducted from the initial implementation cost of the project.

► This may include:► Clean Technology Innovation grants► Clean Technology Investment grants► Clean Technologies Food and Foundries grants► R&D tax incentives

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Prioritising the implementation of opportunities

► All opportunities need to be scanned and prioritised to ensure your company’s limited resources are directed to those projects most likely to deliver the desired benefits.

► Marginal abatement cost curve (MACC):► Marginal abatement cost curves are a decision making tool used

to analyse investments in presence of a carbon price► MACCs can be used at an enterprise level, or can be used by

governments to assess impacts at a state, regional, and national level

► When a MACC is determined for an entity, the curve represents the marginal cost of the last unit of emission abated by that entity

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Source: http://www.climateworksaustralia.org/Low Carbon Growth Plan.pdf

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How to Create a MACC

1. Short-list a selection of carbon abatement options

2. Collect the relevant inputs for each abatement option; including: operational inputs, technical and regulatory information, financial and economic inputs

3. Build a customised analytical model

Key outputs include: ► Identification of the cost effectiveness of various abatement

options► Visual representation of the scale and effectiveness of these

options► Identification of opportunities to profitably engage in carbon

trading► Identification of the measures required to meet a set carbon cap► Assessment of the point where it is most efficient to simply

purchase more carbon credits on the market, identification of efficiency improvements available at the current $/t price

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Summary

► Selecting which projects to undertake can be done by comparing the different investment appraisal metrics for each project providing they have all been prepared on a consistent basis

► Ideally all the investment appraisal metrics should be considered

► Using one metric in isolation could lead to misleading results and potentially incorrect decisions being made

► Once the cash flows have been prepared, all metrics should be easy to calculate

► NPV, IRR. Payback and ARR are all financial metrics. Additionally, you can prioritise using tools such as a marginal abatement cost curve.

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Case Study 1 – Company A

► Company A's head office is considering an upgrade of its lighting in one of its manufacturing plants.

► The project will involve changing the existing lamps to new LED lights, which are 20% more energy efficient and will reduce the number of lamps needed by 30 per cent. The project will also involve the installation of time-delay switches, occupancy sensors and devices that detect daylight control lighting levels. These measures localise the control of lights so they are not running unnecessarily.

► The LED lamps last 5 times longer than the existing lamps. Furthermore, testing has found that the improved lighting quality will reduce the product defect rate by 3%.

► For an investment of $27k to buy and install the new lighting system, the consultant has advised Company A that it will save 200,000 kWh per annum

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Case Study 1 – Company A

What are the costs and benefits for Company A?

Savings► Electricity savings► Reduced maintenance costs► Reduced replacement costs

Costs► New lighting and fixtures

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Case Study 2 – Company B

► Company B’s brick manufacturing business has identified that it could potentially use the landfill gas from the landfill it owns to replace the natural gas that is it purchasing from its gas retailer to fuel its kiln.

► The project would involve constructing a landfill gas capture facility – cost $1.5m

► The company has secured a grant of $25,000 of the cost of plant and equipment to implement this project.

► Upgrades to the equipment also mean that less energy is required to run the kiln

► The company commissioned a consultant who found that the annual savings in natural gas used in the kiln from the project would be 130,000 GJ

► The landfill capture equipment has the potential to capture 400,000GJ. Neighbouring manufacturers to Company B have also expressed interest in purchasing landfill gas.

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Case Study 2 – Company B

What are the costs and benefits for Company B?

Savings► Natural gas savings► Carbon abatement savings from landfill► Carbon abatement savings from natural gas► Grant received

Costs► New capital equipment - $1.2m

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Case Study 3 – Company ABC

► How would Company ABC go about prioritising the energy efficiency opportunities it has identified?

Thank youModule 5