How to make your business case for an energy efficiency makeover

One of the biggest challenges – and opportunities – for anyone interested in saving carbon and energy in their company, is to drag management’s head out of the sand on energy costs.

For many organisations, energy can feel like a relatively minor concern when it’s competing against their day-to-day work.

As a result, energy efficiency is often not seen as a strategic priority, despite all the benefits to be had, like improved comfort, saving money and tackling climate change.

So how’re you going to wake them up? How about putting together a watertight business case to whoever holds the purse strings?

Even though many of the ways to save energy involve little or no capital outlay they do involve staff time, so you have to present them with an offer they can’t turn down based on a solid financial argument.

Here’s how to go about this.

Projects are usually sold to management on the basis of return on investment. This can be expressed in two ways:

1. as an effective interest rate, based on the net present value; and
2. as a payback period, which is the length of time it takes for the initial investment to be recouped by the savings earned or income generated.

The most basic of these is simple payback. However, it doesn’t always illustrate the true benefits of an investment.

Suppose the boss demands a two-year payback period from any investment. Then, as the following example shows, they would miss out on the benefits of a project with a six-year payback period that actually had a better return on investment.

• A project costing $60,000 which receives $30,000 in benefit per year following completion but which only lasts for three years would yield a total of $90,000.

• A project which costs the same amount, but only yields $22,000 per year, yet lasts for six years would give a total of $132,000.

However, if it were only evaluated on a two-year basis, it would lose out to the three-year project. That would be bad news. Three years is really not very long.

Let’s face it, a project which repays its cost every three years is absolutely better than one which promises to return the investment in three years.

But your boss may not yet be convinced. To help hammer home the point, step forward the concept of discounted cash flow, which takes inflation into account.

Discounted cash flow offers a more realistic way of establishing payback. There are three stages for estimating DCF:

1. Estimate the resulting cash flow;
2. apply the discount rate;
3. calculate the end value (net present value).

The cash flow is taken from the estimated savings in energy cost resulting from the measure taken. This will depend upon projections of future energy cost. (For example, energy prices over the last three years can be projected on a median basis into the future. But these figures will then need to be discounted at a discount rate to be chosen.)

Discount rates are a function of the rate of inflation and represent what one unit of currency will be worth in a year’s or 10 years’ time. An average price is calculated this way for each year of the projected lifetime of the project. Each of these figures is then multiplied by the amount of energy expected to be saved every year.

The lifetime period chosen for the project will depend upon the expected lifetime of the technology. If it were a boiler, for example, it could be 15 years. Should it be an insulation measure, it could be 30 years.

The total cost savings from not using energy compared to not doing the project over the lifetime of the project will then be the sum of the cost of the saved energy used each year.

Applying this to the two projects above, with a 10 per cent discount rate, we can see that over three years it yields $81,300, not $90,000, but over six years it will give you back $103,083 not $132,000.

Remember, both projects cost the same –$60,000.

Subtracting this from the cost savings reveals that the net present value of the first is just $21,300, while that of the second is $43,082.98 – more than double.

Wow, only a pretty dumb boss would not now choose Project 2.

But there’s more.

The net present value can also let you compare projects to what would happen to the same amount of money if you invested it in a bank account with the same interest rate as the discount rate chosen. This might be something your boss can really understand.

You do this by calculating the internal rate of return (IRR), or the interest rate on the investment. It’s a little trick easily accomplished in Microsoft Excel as follows (and the figure below):

1. Type the initial expenditure into a cell on a spreadsheet. This must be a negative number.  Using the original example above, you would type –60,000 into the A1 cell;
2. enter the subsequent discounted cash return figures above for each year into the cells directly under the first one. Following the example in Project 1, this would mean typing 30,000 into cell A2, 27,000 into cell A3, etc.;
3. the IRR is then revealed by typing into the next cell beneath all the values the function command “=IRR(A1:A4)” (or whatever range of cells you’ve put all of those figures in) and pressing the enter key. In this case, the IRR value, 18 per cent, is then displayed in that cell.

Eighteen per cent would be a pretty persuasive rate of interest. But the IRR of the second project, calculated by the same method, is 20 per cent, and so – hey – provides an even better rate of return.

Presenting projects in such a way to senior management will allow them to compare the project with other projects they may be considering, as well as allowing you to prioritise projects.

Stubborn-as-an-ox management might still be reluctant to shell out the capital outlay, despite the long term benefits. In this case, there are some other tricks you can pull from your sleeve.

Firstly, check out asset finance such as leasing and renting. These techniques offset the monthly cost of the new equipment against the energy savings it delivers across the financing term, effectively making it a zero net cost or even cash positive investment.

Secondly, investigate whether you could bring on board the services of an Energy Services Company (ESCo), which would bear all the risk. This company then sells the service to your company under a long-term contract. The service could be heat, lighting, power, or a whole package which includes efficiency and energy management.

Sometimes these companies offer energy savings performance contracts, under which they develop, install and arrange financing for improvements to boost energy efficiency and lower costs. Of course it might cost more but that’s because you’re paying the company to take the risk rather than doing it yourself.

Thirdly, you could look to lease land or roof space to a local utility or energy firm. These guys would install equipment, for example solar panels or a CHP plant, and sell the electricity, reaping the benefit of any tax credits or subsidies. They’d pay rent to your company, and possibly sell a proportion of the energy generated at a discount. Sometimes these are called power purchase agreements.

Finally, you never know, but there might be some grants, tax credits and subsidies available at a local, national or federal level that you can build into your spreadsheet.

Happy selling!