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 and cost reduction.

For smaller energy uses, fixed costs such as a sustainability manager, 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.

A key question often asked is, what is the minimum energy expenditure where it makes sense to build a team, hire consultants and invest in data management?

How to practically build an internal energy management program

To build something that works, there are multiple inputs to manage and consider. So what is needed to achieve an effective energy management program? 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 modifications, motor, pump, lighting or other renewable energy options.

The Project Approach Trap

Many organisations don’t consider the enabling infrastructure 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.

There are several critiques of this approach:

• The “project” is often added to an existing staff members role, without consideration of the genuine time it takes to implement such efforts
• That staff time and organisational overhead required to project manage and deliver solution is not costed (“payback” based on the technology in isolation)
• Contingency 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 i.e. independent Measurement and Verification (M&V) to build confidence
• 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 and thinking holistically 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).

So, at what annual energy use should this holistic approach be considered?

(please note these metrics are general, based on organisations that have older equipment and therefore efficiency opportunities, and have not conducted such a program prior)

A worked example

To examine how energy cost savings can fund the enabling infrastructure (build a team, hire consultants, cover software and smart metering costs), we start with the following assumptions:

Fixed Costs:

• Staff costs of $120,000 per year 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)

Variable costs

• 5% of savings over five years used to fund expert consulting inputs and energy management software subscriptions

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 (conservative model)

Finance Assumptions

• Upgrades have a five year simple payback period (20% ROI) (please note that this ROI can be ambitious, and depends on underlying upgrades and scale of opportunity present)
• CapEx provided where 20% ROI on the physical infrastructure is available (simple payback on equipment vs. annual avoided costs / energy savings)
• Tax and depreciation treatment not included
• Saving inclusive of GST in the calculation method
• 7% discount factor used in Net Present Value (NPV) calculations

Financial analysis

Based on the fixed and variable costs above, the following scenarios are given for energy users with $1M to $25M in annual energy costs.

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) from building an energy management team with supporting infrastructure. If your annual energy spend is $2M/year then there is (using these assumptions) an 11% IRR and a positive NPV $525,000. Arguably this has marginal cost benefit, perhaps progress with this if you have additional sustainability interests.

We would suggest that energy management can be 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 may be time to review if a more sophisticated investment framework is possible so that energy wastage is reduced (given it funds itself with a positive NPV in the millions). Careful attention to assumptions is required given a detailed discounted cashflow model can be quite sensitive to inputs (tip: be quite conservative in forecasts).

While these numbers are general and each business varies, the key message is to model benefits using enabling infrastructure and physical infrastructure costs.

If you have an attractive investment return after preparing a conservative model, all factors considered, it would be a logical business decision to proceed.