Thursday, February 15, 2007

Payback on Energy Projects, Part 3

There's yet another way that "payback" can be misused as a way to evaluate energy projects. This is the result of looking at facility components one at a time, as opposed to a complete system.

To illustrate this, consider a simple portfolio of facility improvement opportunities. In this case, it's a boiler replacement and an insulation upgrade. These are presented as completely independent proposals:
Click on image to enlarge.

Now consider three different scenarios for implementation. See the synopsis beneath each scenario, shown below:

Click on image to enlarge.
SCENARIO 1 SYNOPSIS: Management entertains two separte energy project proposals. One vendor focuses on insulation, and nothing else. Another vendor focuses on a boiler upgrade, and nothing else. Management reviews the two vendor recommendations, side-by-side. Management has a five-year payback hurdle (the project must pay for itself in five years or less, or they won't accept it). Management accepts the insulation upgrade because it is the more attractive of the two options. The boiler upgrade is rejected. The facility lowers its annual energy expense to $910,000.

Click on image to enlarge.
SCENARIO 2 SYNOPSIS: Management pursues the insulation improvement first, for the same reason as above. Then a year later, they pull the old boiler replacement proposal off the shelf. They use the boiler vendor's original specs-- which predated the insulation upgrade-- to calculate the payback on boiler replacement. No one thought to downsize the boiler specs, which is now possible because proper insulation ensures less thermal loss, so less steam production is needed. After insulation improvements, annual energy expenses are $910,000. By using unadjusted boiler specs, management calculates that the boiler project would now pay for itself in 5.5 years. This does not meet the 5.0 year hurdle, so the boiler proposal is rejected. Management also rejects the opportunity to further reduce its energy expense.

Click on image to enlarge.
SCENARIO 3 SYNOPSIS: Management pursues the insulation improvement first, for the same reasons as above. However, this time, energy use is re-evaluated after the insulation improvement. The new audit finds that the existing steam demand can be met with a smaller boiler capacity. This is because insulation ensures that less steam output is lost to waste. Accordingly, the investment in boiler capacity can be scaled down. This time, because the smaller boiler requires less capital investment, the project yields a 4.8-year payback, beating the 5.0-year investment hurdle. Management accepts the project and effectively reduces its annual energy expenditure to $750,000.

Take-away lessons: Energy performance is a function of interaction among components. Payback results for system-wide improvements is not the same as the "sum" of payback on components. Acquire complete system energy evaluations, if at all possible.



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