Wednesday, September 12, 2007

Energy: What Do You WANT it to Cost?

Here's the point of this post: you can either buy energy, or pay to avoid buying it. You should know what the cost is in either case.

Today, I visited a corrugated container manufacturer with a boiler that's near the end of its useful life. Annual boiler fuel consumption works out to 390,780 therms of natural gas. In its current condition, the facility's boiler fuel is used as follows:

1. Sixty-eight percent will be fully converted to heat that serves the corrugation process. An additional nine percent will accrue to unavoidable thermodynamic losses that occur as fuel is converted to heat. This 77 percent in aggregate is what I call "committed energy."

2. The remaining 23 percent will be wasted in ways that can and should be avoided. These therms are what I call "energy at-risk."

Consumers WILL PAY for energy at-risk in one of two ways: (1) they will buy the fuel at the supplier's contract price and then waste it, or they will pay for an energy improvement that will end the waste. In this case, we are dealing with therms, so the cost of either choice can be expressed on a per-therm basis. As was stated above, the supplier provides therms at a price of $1.61 per unit.

We tried to tally up the cost of individual improvements, but quickly decided that a complete boiler and steam system replacement may be the best option. Total installed cost: $269,205. This is a 25-year asset, and with the cost of capital being 8%, this amortizes to an annual payment of $25,219. Hold that thought.

The improvements would reduce the annual (budgeted) therm consumption from 390,780 to 298,998. The difference is 91,782 therms "at-risk" each year. In the coming year, the facility WILL PAY for those therms at-risk in one way or the other: (1) buy and waste at $1.61 each, if the energy supplier's price remains the same; or (2) pay to avoid purchasing these therms. They would "avoid purchasing" by investing in improvements that cut the energy waste. In this case, the annual amortized cost of the improvements is $25,219, or $0.2748 per therm.

So let's recap: 91,782 therms are at-risk. What to do? One option: buy and waste each at a cost of $1.61 per therm-- a price which can change at any time. The alternative: avoid buying these therms at a cost of only $0.2748 per unit-- a price that is amortized and will therefore remain the same for the next 25 years.

What's the final decision? We'll have to see, because it takes time for the management team to consider this proposal. And while they ponder it, their boiler continues to gobble up fuel at $1.61 per therm.



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