Capital “Secrets” of Energy Cost Control

Sooner or later, an organization that is serious about energy cost-control will pursue capital projects. By that, we mean investments in high-cost equipment that will be financed over a number of years. These investments include key energy-using hardware such as boilers, air compressors, chillers, metering systems, etc.

You will recall an earlier post that discussed the merits of “projects” versus “processes” as energy cost-control strategies. When seeking results strictly through capital projects, here’s the basic financial equation for project evaluation:



This is derived from the capitalized income concept, which divides net income by a discount (hurdle) rate to yield a capitalized value. You’ll see that formula in real estate, for example, for determining a property’s capitalized value. In this instance, however, we are capitalizing an increment of net income—expressed here as a percent reduction in energy expenses. We can use “income” interchangeably with “expense” because a dollar saved is a dollar earned.

When using this formula as written, one calculates the maximum capital to be expended, given (1) a current level of energy expenditure, (2) a hurdle rate, and (3) a desired percent reduction in energy expenses. An alternative approach for the same formula is to insert a fixed amount for capital expenditure and solve instead for the desired percent reduction in energy expense. In other words, this second approach describes the percent savings that should be achieved by a certain amount of capital expenditure. Notice also how the volume of allowable capital expenditure decreases as risk rises. The higher the risk, the higher the discount rate—the denominator of the equation shown above (rate of return on capital).

And now, the secrets of capital investment….

Remember that capital projects do not always guarantee results. To offset the risk of failure, finance people will arbitrarily raise the discount rate for evaluating energy projects. Just how much of an adjustment is needed is a matter of individual judgment. A higher discount rate yields less capital for an energy manager to work with. The energy manager can and should offset capital investment risk, effectively lowering the discount rate. How? New capital assets should be accompanied by behavioral and procedural changes that reduce energy waste. Staff need to be aware of wasteful practices. Energy-smart behavior needs to become a part of standard operating procedures. Energy cost-control performance needs to be wrapped into daily job accountabilities. This effort requires some communication, discipline, and cross-departmental coordination. Companies that develop these management skills can effectively reduce the risk on their future capital projects.

Budget Bonus for Energy Managers?

This time of year finds many energy managers busy assembling next year's budget. Manufacturing managers are focusing on two components for energy. They are (1) consumption, which reflects energy required per unit of output times some targeted production volume, and (2) a desired price for energy purchases that can be approximated through contracts (hedges) for energy purchases. Lesser informed budget analysts are simply taking the sum total of 2006 energy expenditures and budgeting the same amount (plus five percent, maybe) for next year.

Two Thousand Six has been a strange year for energy prices. After a dramatic price spike in the wake of last year's hurricane season, we've seen a relative dip in energy prices, especially natural gas. How long prices will stay at this level is anyone's guess. Weather and geopolitical events have notoriously unpredictable impacts on energy markets. It would be folly to assume that today's energy prices are destined to prevail throughout the coming year.

Many companies are seeing an energy budget surplus through 2006, thanks to the soft energy markets that prevailed through the latter part of this year. They now have an opportunity to invest that surplus in facility improvements that will reduce future energy costs. An energy assessment (audit) is an excellent investment that yields a blueprint for such improvements. Combustion tune-ups, steam and compressed air leak repair, insulation, and heat recovery from combustion gasses and steam condensate are a few of the simple but valuable examples. Free, unbiased technical guidance describing these opportunities can be found at the U.S. Department of Energy's BestPractices website.

The Industry-Energy Knowledge Gap: Getting Wider?

I’ve learned a few things from the National Association of Manufacturers’ ShopFloor.org. They share some rather sobering observations about government policy and its impact—or lack thereof—on manufacturing competitiveness. Here’s my reaction:

It’s worth mentioning that manufacturing, along with mining and agriculture, is the true foundation of an economy. All other activities—banking, real estate, wholesaling, retailing, broadcasting, the U.S. Marine Corps, places of worship, and so on—merely rearrange the value that the industrial foundation produces.

The diminishing number of U.S. engineering degree holders is an eye-opener. There is a growing disconnect between non-technical corporate leaders and the people who make things happen on the plant floor. Industrial decisions are increasingly made by people have no concept of how heat, force, and motive power are applied to raw materials to transform them into the products we use every day. Similarly, many policy leaders are not familiar with industrial decision-making, which challenges business leaders to strike a balance among risk, time, and money. Also, let’s remember that our manufacturing facilities have fewer production people trying to cover more responsibilities. As a consequence, competition arises within industrial corporations, especially at budget time, pitting plant against plant, department against department. Example? During a recent plant walk-through, a question about a persistent steam leak was met with the response “it’s not my leak.”

So to sum it up: a dim awareness of how manufacturing works—of how resources are budgeted and utilized in the creation of wealth—opens the door to waste and inefficiency. This insidious “competitor” resides inside our own facilities, inflating the cost of the goods we produce, effectively undermining our competitiveness. The good news is that this "competitor" can be acted upon immediately, without the time and effort needed to draft a bill and broker a policy consensus.

Wanted: Amnesty for Yesterday's Energy Waste

A lot of people in industry are afraid to admit that they waste energy. Top managers, especially, have no practical choice but to say we are already as efficient as we can be. Think about it: if a facility manager says “Sure, we have a number of inefficiencies, and they’ve accumulated under my watch,” how long can he expect to stay employed? Managers have to consider the scrutiny imposed by boards of directors and shareholders. Admitting to energy waste is an embarrassment with potentially dire consequences.

A similar sentiment manifests on the plant floor, where that’s the way we’ve always done it is a common refrain. Energy is not wasted on purpose or by design—instead, it is the natural consequence of having too few people monitoring too many dynamic business forces.

Manufacturing leaders need to “declare amnesty” for plant personnel who are on the front lines of energy use. Individuals should not be reprimanded for organizational gaps in energy decision-making. The causes of energy waste are deep-rooted. These causes took time to manifest, and are never limited to one individual’s actions. Energy solutions will depend on cross-departmental communications that may be unprecedented in many facilities. Top managers must recognize and untangle the organizational barriers that prevent collaboration.

For example, it is common for equipment operators to never see the invoices for the fuel and power consumed by their department. Accounting staff may not fully understand how energy consumption is related to the invoices they review. Organizational disconnects like this allow industrial energy waste to go unchecked. There are many other examples.

This explains the call for amnesty within industrial facilities. U.S. industry cannot afford energy waste, nor can it afford to waste time by trying to avoid or assign blame for yesterday’s decisions.

Energy Cost Control: Projects or Process?

Almost every discussion I have with people on the front lines of American industry focuses on the role of “projects” in controlling energy costs. By “projects,” I mean a new boiler, turbine, cooling tower, air compressor, or some other significant hardware installation, paid for through capital investment. The logic behind “projects” is straightforward: plug in this new black box, flick the switch, and get back to business-as-usual. The new hardware, we anticipate, will save energy for us.

What these projects fail to address, however, is the energy waste attributable to bad work habits, improper maintenance, and lack of best-practice training and discipline. In other words, the potential impact of expensive hardware is compromised if people don’t use it properly. There are a lot of black boxes out there on facility floors, by-passed and collecting dust because the people who could get the most from it have been reassigned, laid-off, or simply not held accountable for energy performance.

The project approach comes naturally to engineering-minded decision makers. This comment is not meant to detract from engineers—in fact, their skills remain central to the sustained reliability and efficiency of any production facility. We point here to a void in the discipline and accountability that characterize continuous energy improvement. Facility managers rightfully prioritize activities that make products and get them out the door. But this is too often at the expense of internal efficiencies (including energy consumption) that can potentially add to operating income. After all, a dollar saved is no less valuable than a dollar earned. People in operations, maintenance, procurement, and finance all play a role in the continuous process of energy cost control. It should not, and cannot, be a task addressed solely by the episodic engineering “project.”

Energy management involves benchmarking of energy use, goals for improvement, metrics for ongoing measurement, and accountability for getting things done. Why manage energy? Volatile fuel prices are only one reason. It’s also the fact that energy use is pervasive throughout a facility, at every stage of production. If you monitor energy use, you have a pulse on the tempo of activity throughout the facility. If you pursue energy management, you develop leadership that can be leveraged for managing raw materials, labor, production schedules and other activities. In sum, these are the pivotal elements of industrial competitiveness.

Embedded Energy Costs as a Competitive Handicap

How do energy costs impact U.S. industrial competitiveness? Consider something called "embedded energy costs." I’ll give you an example. The direct energy cost for assembling my car might have been $70. That’s about three-tenths of one percent of the retail cost… no big deal, right? But think again— there was energy consumed in mining the iron ore, copper, and bauxite; in metal treating; and in producing the plastics, paints and dyes, carpet fibers, rubber, and glass. The upstream energy costs are disguised in the cost of inputs, and it’s eating profit margins at every link in the value chain. So that’s one opportunity. Product fabricators can partner with their input suppliers to map their energy intensity and strategically squeeze out those costs. 3M is a good example. They reduced their energy per pound of product by 27 percent between 2000 and 2004. They beat their own goal, and make that fact public as they market their products to other industrial consumers. Companies like Wal*Mart and Toyota are always partnering to achieve economies in distribution and inventory, so why not in energy management? The information technology exists. It can be done.

Energy Assessment Opportunities

(The following is taken directly from a U.S. Department of Energy announcement)

Energy Savings Assessments are no-cost or cost-shared three day industrial manufacturing energy system assessments that identify opportunities for large energy and particularly natural gas using facilities to save substantial amounts of energy. Energy Savings Assessments (ESAs) identify immediate and long-term opportunities to save energy and money in your plant, focusing on steam, process heating, compressed air, fan, or pumping systems. If your company is selected for an assessment, an ESA Energy Expert will work with you on site to identify savings opportunities. Your plant's employees will also help gather data, learn about software tools, and perform a system analysis, so they can continue to find energy savings after the assessment.

In 2007, DOE is offering new opportunities for manufacturers to take part in ESAs. In addition to process heating and steam systems, your plant could be eligible for a no-cost assessment in compressed air, fan, and pumping systems. You can also expand your options with cost-shared assessments. We invite you to join us in saving energy-and money-today!

You can participate in any of these ways:

* You can apply online for an ESA that identifies key opportunities to reduce your plant's energy use and environmental emissions while improving productivity. If your plant is selected, the assessment will be scheduled in 2007.

* Partner with ITP by cosponsoring assessments, events, and training; linking to the Save Energy Now Web site; and increasing awareness about energy efficiency and cost savings within your plant or with your customers.

* At any time, you can take advantage of the many tools and resources that ITP provides to improve your plant's energy efficiency and bottom line.

For more information, visit the Save Energy Now Web site, www.eere.energy.gov/industry/saveenergynow, or contact the Energy Efficiency and Renewable Energy Information Center at 1-877-337-3463.

The Little Company that Could (...control energy costs)

I visited a manufacturing facility in Pennsylvania this week that wants to do something about high and volatile energy expenses. They are learning quickly about the "medicine" for energy cost control. Many companies rely exclusively on capital projects to solve energy challenges. That approach may or may not work. The odds of success are better if behavior and procedures evolve before new hardware is acquired. However, "change" is a tall order for the staff of many facilities. You can see why, especially when rosters are trimmed to the bone and people accumulate multiple responsibilities. This situation is all too common in U.S. manufacturing today. Over-stretched workers crave routine-- it is relief from the "fire drills" that sometimes characterize today's lean-and-mean production environments.

During my visit to this Pennsylvania plant, I got a pretty good feeling that the people there can adapt. A positive, can-do attitude was pervasive during my walk-through. Staff people greeted me with smiles. The facility was clean and well-lit. The common areas and rest rooms were obviously well cared-for. Glass cases in the lobby proudly displayed their products as well as trophies from the little league teams that the plant sponsors. In short, there is evidence of a quality covenant between management and the facility staff-- a relationship of mutual respect and concern for their facility and its current and future viability.

There is certainly plenty of work to do there to get an energy management discipline in place. But at least these early observations assure me that this facility has the intangibles needed to be successful.