This article examines the life cycle costs of running a disciplined energy management program over a five year period, using conservative estimates (with key assumptions stated)
Does energy management have an investment grade ROI?
Within any large organisation, there are fixed and variable costs associated with developing a disciplined approach to energy management.
For smaller energy uses, the fixed costs such as “sustainability” staff, smart metering and consulting can often outweigh the potential benefit, whereby only a low internal rate of return (IRR) is generated (when considering all costs). This is possibly why small to medium energy users don’t hire engineers, use expert consultants or pay for sophisticated energy management software.
What is the minimum energy expenditure whereby a positive IRR is generated above the company investment hurdle rate?
What does it cost to systematically reduce energy wastage?
The short answer is a combination of physical upgrades and investments in enabling infrastructure, to identify and deliver capital projects.
- Enabling infrastructure includes both internal staff and external experts, smart metering and upfront investments in data management so that raw data can feed into energy management software.
- Physical infrastructure is the hardware or capital upgrades to systems, processes or equipment. These are the physical upgrades e.g. refrigeration, insulation, building envelope, motor, pump, lighting or other renewable energy options.
The Project Approach Trap
Many organisations lose the correct focus and get trapped in a project-based approach. This is where an individual technology or physical infrastructure upgrade is put forward in a one off business case and then implemented using internal staff.
There are several critiques of this approach:
- The staff time and organisational overhead required to project manage and deliver solution is not costed (“payback” based on the technology in isolation)
- Contingent costs are not budgeted (commissioning, maintenance, repairs and the costs of ongoing oversight)
- Savings estimates are often obtained from the equipment supplier (conflict of interest) with no internal capacity for energy accounting built
- Budget for verification of project cash flows rarely included (independent review to hold suppliers accountable)
- Anecdotal evidence suggests that organisations using a project-based approach only fund projects with a lower payback (leaving potential savings on the table)
- It also does not address the root causes of energy wastage, creating organisational risk with unnecessarily high energy OPEX costs.
A focus on including the supporting infrastructure prevents these issues and is a more mature investment methodology.
In the example below, this can be funded via savings with an investment grade return (provided you annual energy usage and savings are high enough).
A worked example
To examine how energy cost savings can fund the enabling infrastructure (build a team, hire consultants, installed software and smart metering, we start with the following assumptions:
- Staff costs of $120,000 FTE for a “sustainability” staff member that can deliver, with support from the consultant and software (multiple staff are included in the high annual energy use cases)
- 5% increase in staff costs per year
- Smart metering costs of $8,000 per site
- Incidental costs of $800 per site visit (site travel, accommodation etc)
- 5% of savings over five years used to fund expert consulting inputs and energy management software subscriptions (5 x 5 guaranteed savings model)
Energy Savings Assumptions
- 10% reduction in energy costs attributed to equipment, system and process upgrades (conservative)
- 2% annual reduction in energy costs attributed to internal Energy Management System (EnMS) managed by internal staff
- No increase in annual energy costs
- Upgrades have a five year simple payback period (20% ROI)
- No limit on CAPEX provided 20% ROI is available
- Tax and depreciation treatment not included (making cash flows conservative)
- 7% discount factor used in Net Present Value (NPV) calculations
Based on the fixed and variable costs above, the following scenarios are given for energy users with $1M to $25M in annual energy costs.
|Annual energy spend||IRR||NPV|
The savings here are presented as annual cash flows in a discounted cash flow model. The upfront costs are shown in Year 0. From Year 1 onwards, the energy savings are then presented, minus staff and other OPEX costs (net reduction in energy spend = cash flow outlined).
Based on the table above, if your energy spend is $1M/year (or less) it is likely there is little to no return on investment (2% IRR). If your annual energy spend is $2M/year then there is an 11% IRR and a positive NPV $525,000 (marginal cost benefit, progress with this if you have additional sustainability interests).
If you have a annual energy spend of less than $2M, it may be worthwhile to consider your options and not assume there is a positive return on investment (given the all in CAPEX and OPEX)
Websters Group would suggest that with an energy spend of greater than $3M/year, this should be examined given an attractive IRR of 14% and NPV over $1M.
Based on conservative assumptions, energy management is financially attractive for large energy users with $3M – $5M or greater in annual energy expenditure.
If your annual energy costs are in this range and you are still using a project based approach, it is time to change to a more sophisticated investment framework so that energy wastage is reduced (given it funds itself with a positive NPV in the millions)