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This section gives some general guidance on financial project appraisal for energy efficiency projects and illustrates it with a simple example. Finally, a possible structure of an energy efficiency investment proposal is given.
In this section, we use the simple payback method. It is an excellent start for ranking possible projects though, as it does not account for the time value of money, some institutions require other methods such as discounted cash flow and Net Present Value, particularly for larger projects. The following sites are among many which provide introductions to these issues:
http://www.toolkit.cch.com/text/P06_6530.asp
http://www.finaid.org/loans/npv.phtml
General Guidance
Financial appraisal should also be carried out on a life-cycle cost basis. When comparing competing technologies, that with the lowest initial cost is not necessarily the preferred option if the accumulated running costs are greater. As an example, the initial cost of buying, installing and commissioning an electric motor is typically 10% of the total cost over its lifetime when the electricity and maintenance costs are included. Purchasing an energy efficient motor, even if the initial cost is higher than a conventional one, has typically a very short payback time. Investment in capital intensive supply options such as renewable energy sources typically has a very long payback.
Investment incurs capital costs, but also others such as installation (the price quoted may apply only for the equipment delivered to the factory gates or the building entrance), training, project management and performance monitoring.When carrying out a financial appraisal of an energy efficiency capital cost project it is important that all likely costs and savings are quantified.
In some cases the capital cost of the equipment and the revenue savings in lower energy consumption are the only significant factor; in many others, however, this is not the case and significant errors can be made through simplistic assumptions. For example:
- improvements in building comfort can increase it value;
- new energy efficient plant can increase the throughput eg reduction of breakage in firing kilns;
- reduction in maintenance costs;
- improved throughput in factories and offices if comfort and lighting conditions are improved;
- reduction in waste disposal costs.
All investment is subject to uncertainty. The installed cost of the plant may be different from what was initially estimated (usually more, rarely less!), the price of fuels may vary, the cost of raw materials may change. It is essential to carry out a simple assessment of the key parameters which may change and carry out a sensitivity. The computer spreadsheet, with its "What if" capabilities is ideal for this issue. An illustration is included in the example below.
Examples
This example is very loosely based on a Canadian CADDET project, Described in Result Brochure 427. More detail is given in the relevant InfoStore entry. A fish farm uses a fuel oil-based system to ensure that the water is constantly at the optimal temperature of 12 degrees centigrade. Conventional technology is a fuel oil-based system while the new technology uses heat recovery from the effluent with a conventional heat exchanger and active recovery via an electrically operated heat pump between incoming preheated water and the used water outlet.
This is a hypothetical example set in a country where the unit of currency is the Argent, divided into 100 Argent Cents. Fuel oil costs 7.6 Argent Cents per kWh, electricity costs 5.3 Argent Cents per kWh
The system is old and needs to be replaced. The Technical Manager has located information about the project in the CADDET InfoStore and has undertaken all the steps set out in the technical appraisal page.
Conventional Technology Capital Cost
The system is available in-country at 75,000 Argents, in addition it will cost 25,000 to install it.
Total capital cost is 100,000 Argents
Heat Recovery Option Capital Cost
The system must be imported at a cif price of 55,000 US Dollars ie 165,000 Argents to which must be added 25% import tax ie 41,250 Argents. The equipment is more complex than the conventional one and the price for installation is 35,000 Argents
Total capital cost is 241,250 Argents
Conventional Technology Running Cost
The system consumes 1,500 MWh per year, at a cost of 1,500,000 * 7.6/100 = 114,000 Argents per year
Operation and Maintenance costs are estimated to be 9% of the capital cost ie 6,750 Argents per year.
Total running costs = 114,000 +6,750 = 120,750 Argents per year.
Heat Recovery Option Running Cost
The system consumes 500 MWh per year, at a cost of 500,000 * 5.3/100 = 26,500 Argents per year
Operation and Maintenance costs are estimated to be 11% of the capital cost ie 18,150Argents per year
Total running costs = 26,500 + 18,150 = 44,650 Argents per year.
Simple Payback Time
The marginal capital cost of the Heat Recovery Technology is 241,250 -100,000 = 141,250 Argents
The running cost saving is 120,750 - 44,650 = 76,100 Argents per year
The payback time is 141,250/76,100 ie 1.85 years. This is usually sufficiently attractive to justify continuing with the appraisal to a sensitivity analysis and perhaps a proposal for investment.
A more comprehensive appraisal might take account of the fact that the conventional system may produce more fish, perhaps because the temperature are more constant as the system is easier to control and the payback time would thus be reduced.
Sensitivity
"What if" calculations show that, if the price of electricity increased by 20%, which might be quite possible during the plant lifetime the payback time would increase to 2.1 years - probably still worth pursuing.
If experience were used to reduce the Operating and Maintenance cost to 9% of the capital cost, the payback time would fall to 1.78 years.
The new technology is clearly attractive on a simple appraisal. However, there are several issues to be considered before a full case can be made and presented. For example in the country concerned, fuel oil may be expensive but it is always available. However, electricity is subject to occasional cut-off. How long are the average cut-offs? What would be the consequences on production, and on the health of the fish of an average cut-off? How long are the longest cut-offs? The conventional equipment is made in the country and replacement parts are easily available. The new technology has to be imported. Would it be advisable to establish a store of key spare parts? What would be the cost implications (capital and running costs of a store)?
Completing the exercise
Once all the appraisal steps have been carried out, a case must be made first to senior management and then perhaps to financing institutions. Senior management should always be supportive of energy efficiency improvements, indeed many of the most successful organisations at improving energy efficiency have a senior executive who is responsible, among other things, for energy efficiency. Support from a committed senior manager is vital in persuading the Board of a company or organisation of the soundness of an investment proposal.
The following is a suggested structure for an energy efficiency investment proposal:
- Objectives
- Options
- Capital and other costs
- Benefits
- Financial appraisal
- Uncertainties and sensitivities
- Non-financial factors
- Option(s) representing best value for money
- Comparison with alternatives
- Suitable sources of funding
- Recommended course of action
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