1. Energy Cost Control: Show Me the Money! A Financial Calculator Christopher Russell Energy PathFINDER 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 2006 Principal, 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. (c)2009 Energy Pathfinder Mangement Consulting, LLC www.energypathfinder.com 5 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 LOSS CENTRAL PLANT LOSS $0.05 $0.28 GENERATION, TRANSMISSION, DISTRIBUTION LOSSES PRIOR TO DELIVERY 5

6. CHALLENGE FOR FACILITY MANAGERS Facilities at the end of the budget food chain Limited staff, resources, analytical capability Evaluating 21 st century energy improvements with 1920s investment analysis techniques! 6

7. ABOUT ENERGY IMPROVEMENTS: What 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. CONSTRUCTION BUDGET: Project Cost: $16,000 Economic life: 25 years Cost of Capital: 7% TARGET: 1-YEAR PAYBACK ANNUAL CONSUMPTION: Before: 246,667 kWh After:209,667 kWh Elec @ $0.08/kWh MAINTENANCE COSTS: Before:Annual overhaul costs @ $10,000 After:Annual overhaul costs @ $ 3,340 EXAMPLE: Pump Optimization City of Milford, CT 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. Data Entry YELLOW TABS 12

13. YELLOW TAB DEMO 13

14. Simple Metrics GREEN TABS 14

15. 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 Simple Payback = PROS Easy to understand Widely used $16,000 $9,620 1.7 Years = FAILS TO MEET TARGET 15

16. 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. PROBLEMS WITH PAYBACK 16

17. Return on Investment 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 $16,000 60.13% = 17

18. 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%) 18

19. GREEN TAB DEMO 19

20. Sophisticated Metrics RED TABS 20

21. 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 projects 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 Flow t (1+r) t T t-1 - Cash Flow In Year 0 $9,620 (1+.07) t 25 t-1 - $16,000 21

22. 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 Flow t (1+r) t T t-1 + Cash Flow In Year 0 = 0 IRR = r so that: Where T = economic life of the project in years t represents each individual year in the projects economic life indicates summation across all t years 22

23. RED TAB DEMO 23

24. Integrative Metrics BLUE TABS 24

25. Annual energy use, current application in-place Annual energy use, efficient alternative Energy consumption avoided by investing in an energy-efficient alternative COMMITTED ENERGY VOLUME: Buy & use as intended. ANNUAL ENERGY CONSUMPTION A B Energy At-Risk VOLUME AT-RISK: Buy & waste or Pay to avoid buying. PAY FOR IT EITHER WAY. 25

26. 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? 26

27. CONSTRUCTION BUDGET: Project Cost: $16,000 Economic life: 25 years Cost of Capital: 7% TARGET: 1-YEAR PAYBACK ANNUAL CONSUMPTION: Before: 842 MMBtu After:715 MMBtu Elec @ $23.45/MMBtu MAINTENANCE COSTS: Before:Annual overhaul costs @ $10,000 After:Annual overhaul costs @ $ 3,340 EXAMPLE: Pump Optimization City of Milford, CT SOURCE: http://www1.eere.energy.gov/industry/bestpractices/pdfs/milford.pdf 27

28. Where: i = cost of capital or discount rate on future cash flows n = 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…. WHY ANNUALIZE? vs ANNUALIZED PROJECT COST UP-FRONT PROJECT COST CAPITAL RECOVERY FACTOR = x ANNUALIZED COST ANNUALIZED PROJECT COST CRF = UP-FRONT PROJECT COST CAPITALIZED COST A = B x C ACAC = B UP-FRONT PROJECT COST CAPITAL RECOVERY FACTOR X 12 28

29. PUMP OPTIMIZATION EXAMPLE: Annualized Project Cost Per kWhSaved ANNUALIZED PROJECT COST = UP-FRONT PROJECT COST x CAPITAL RECOVERY FACTOR $1,357 = $16,000x.0848 ANNUALIZED PROJECT COST PER ANNUAL MMBtu SAVINGS = $1,357 126 = $10.75 29

30. Annual energy use, current application in-place Annual energy use, efficient alternative ANNUAL ENERGY CONSUMPTION REJECT THE IMPROVEMENT $23.45 per MMBtu consumed $23.45 per MMBtu wasted $10.75 per MMBtu avoided Committed Energy Energy put to work as intended Energy At-Risk: You will pay for it either way $23.45 per MMBtu consumed ACCEPT THE IMPROVEMENT PUMP OPTIMIZATION EXAMPLE 30

31. 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 $1.00s worth of energy 31

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

33. COST OF DOING NOTHING = Annualized Penalty for Doing Nothing Price per unit to buy energy Annualized cost to avoid purchasing a unit of energy - x Volume of avoidable energy purchases USING THE PUMP OPTIMIZATION EXAMPLE: = $23.45 per MMBtu $10.75 per MMBtu -x 126 MMBtu $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 33

34. BREAK-EVEN POINT Whats the MAXIMUM ACCEPTABLE project cost, given certain investment criteria? SHOULD BE NO MORE THAN MAXIMUM ANNUALIZED PROJECT COST ANNUAL VALUE OF AVOIDED ENERGY PURCHASES 34

35. BREAK-EVEN CALCULATION: Pump Optimization Example MAXIMUM ACCEPTABLE UP-FRONT PROJECT COST DELIVERED PRICE PER UNIT OF ENERGY UNITS OF AVOIDED ENERGY CONSUMPTION = x= BREAK-EVEN PROJECT COST CRF MAXIMUM ACCEPTABLE UP-FRONT PROJECT COST $23.45126 = x = $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 TAGS Pump Optimization Project ACCEPT PROJECTREJECT 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% 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.com BOOK: Managing Energy from the Top Down WEB: www.energypathfinder.com From Shop Floor to Top Floor Best Practices in Corporate Energy Management Chicago, April 6-7 http://www.pewclimate.org/energy-efficiency/conference Energy PathFINDER Christopher Russell crussell@energypathfinder.com (443) 636-7746http://energypathfinder.blogspot.comwww.energypathfinder.com crussell@energypathfinder.com 41