Energy Efficiency Guidelines for Office Buildings in Tropical Climate Design Tools for a Low Energy Demand: Cost aspects 2 Outline A. Life Cycle Cost analysis – What is LCC? – Comparison of LCC and other methods – Limitations of LCC B. Excel based tool for LCC analysis • Energy Payback Period (EPP). For example, a measure with an ini>al investment of $4,000 and an expected annual savings of $1,000 has an EPP of 4 years. • It does not account for the time value of money: the fact that the value of money does not remain constant all the time (i.e. $1,000 in the present are worth more than the same amount in the future); • It is not a measure of long-term economic performance because it only focuses on how quickly the initial investment can be recovered, ignoring all the costs and savings incurred after the point in time in which payback is reached; • It does not account for the opportunity cost; this is, that this money could had been invested in something else in exchange of a potentially higher return; • Life Cycle Cost – 3 indicators of economic performance: • Net Present Value (NPV) • Intenral Return Rate (IRR) • Savings to Investement ratio (SIR) • Net Present Value (NPV) For example, imagine that the country is experiencing an annual increase in its level of prices of 3%. This rate of inflaon is diminishing the future value of money as compared to their present value. At this 3% rate the present value (discounted value) of these $1,000 a year for the next four years is: $1,000/(1 + 3%) +$1,000/(1+3%)2 + $1,000/(1+3%)3 +$1,000/(1+3%)4 This is: $971 + $943 + $915 + $888 = $3,717 As it can be observed, the more far away in the future, the lower the present value of those $1,000. And when brought all of them to the present >me, they do not add $4,000 anymore but $3,717 instead. Why? Because when we want to buy something in the future with those same $1,000 their purchasing power would have diminished due to a general increase in the level of prices of 3%. 6 7 • NPV • discount rate operates in such a way so that the higher it is, the lower the present value of future amounts 8 – NPV: A measure of long-term economic performance For example, in the previous example perhaps the savings of the energy efficiency measure are expected only for the first 6 years, in which case their NPV is $1,000/(1 + 3%) +$1,000/(1+3%)2 + … +$1,000/(1+3%)6 = $5,417 or perhaps these savings are expected to con>nue all over the life-cycle of the building, with the building expected to last 30 years. In such case the NPV would be: $1,000/(1 + 3%) +$1,000/(1+3%)2 + … +$1,000/(1+3%)30 = $19,600 The difference in the NPV of this two streams of savings is considerable and this is why it is very important to also consider the long-term economic performance of the measure, something that the tradi>onal EPP did not do. 9 • IRR: – IRR is the rate of return that makes the net present value (NPV) of all savings (positive cash flows) and costs of maintenance (negative cash flows) from a particular energy efficiency measure equal to the original investment 10 For example, let’s imagine that the previous energy efficiency measure is expected to bring savings for the first 6 years only, in which case their NPV is $5,417. Considering that its ini>al investment is $4,000, what would be the rate of return (i) that equals the NPV of that stream of $1,000 a year in savings to $4,000 $1,000/(1 + i) +$1,000/(1+i)2 + … +$1,000/(1+i)6 = $4,000 This rate is 13% This is: $1,000/(1 + 13%) +$1,000/(1+13%)2 + … +$1,000/(1+13%)6 = $4,000 This 13% can then be compared to: • Cost of the loan required to finance such measure • Weighted Average Cost of Capital (WACC) of the organiza<ons • Alterna<ve investments With what it is to be compared would depend on how this energy efficiency measure is to be financed: • With a new loan from a financial ins>tu>on (+liability) → Cost of the loan • With a share capital increase (+equity) → WACC • With the organizaon’s own reserves (equity) → Alternave investments 11 • IRR: • the higher the IRR obtained the better the measure • compared to the rate of return offered by alternative investments • Is directly related to the cash-flows 12 • Savings to Investment ratio (SIR) SIR=Total savings / initial cost of the measure Following the above examples, for a measure with a capital cost of $4,000 and expected savings of $1,000 a year for a period of 6 years and a discount rate of 3% the SIR is: $5,417/$4,000 = 1.35 The discount rate applied would had to be higher than 13% for the SIR to fall below 1, in which case it could be said that the project does not pay for itself. 13 NPV > 0 • Limiting values of investments NPV = 0 Disc. rate SIR > 1 < IRR Disc. rate SIR = 1 NPV < 0 = IRR Disc. rate SIR < 1 > IRR 14 • Life Cycle Cost with – NPV – IRR – SIR …limitations? 15 • Limitations of LCC – Externalities – Based on assumptions and hypotheses – Increased resilience 16 • Limitations of LCC 1. Externalities: LCC is purely financial • Does not account for other costs: e.g. pollution • Comfort of users 17 • Limitations of LCC 2. Based on assumptions and hypotheses • Long-term analysis • difficult is to translate those future consumptions into future costs. – Need to use Scenarios – LCC as an ongoing decision-making tool For example, an organizaon has to choose between two possible op>ons: 1. A business as usual approach, 2. An energy efficient approach, which involves an addi>onal investment of $10,000 and savings of 5,000 kWh a year for the next 15 years. What would be the more viable op>on considering that the current electricity price is 20 cents of dollar per kWh? The answer would depend on the percentages applied for the increase in electricity prices and the discount rate. For example: For an expected increase in electricity prices of 3% a year and a discount rate of 12% a year, the business as usual approach is financially preferable, because the NPV of the future savings is $8,187, which is lower than the $10,000 in extra investment (SIR = 0.82) But for an expected increase in electricity prices of 8% a year and the same discount rate, the energy efficiency approach is financially more viable, with a NPV of the future savings of $11,352 (SIR=1.13). 18 • Limitations of LCC – Increased resilience For example, the extra $10,000 of the above example are for a design that avoids the need of air-condi>oning. The organizaon applies a 3% increase in electricity prices at a 12% discount rate, obtaining a SIR of 0.82. As a result decides to go for the conven>onal (baseline) op>on. Later on, due to frequent blackouts, it quickly realizes that it needs to invest in a power generator. If the energy efficiency approach had been chosen, the building would not need air condi>oning and would have a good source of natural light, without need for extra power. But as a result of choosing the conven>onal building, an extra investment of $1,000 is required for a power generator. The power generator produces electricity at a cost of $1 per kWh and it has to run for 10% of the >me. Under such circumstances, the difference in investment is not $10,000 anymore, but $9,000 Savings of energy efficiency op>on: $11,462 instead of the $8,187. SIR of the energy efficient op>on increases from 0.82 to 1.27 the moment that the power generator is added into the equaon. This is how an op>on that financially looked less arac>ve, ends up being the more viable one thanks to the beier resilience it offers to power shortages and future increases in the cost of 19 energy. • Conclusion on LCC analysis a. To evaluate the financial viability of inves>ng in an energy efficiency measure and b. To compare design alternaves that can perform the same func>on, in order to determine which one is the most cost effec>ve for a certain purpose. Has limitaons: – Op>ons should not be disregarded because SIR < 1 or IRR lower than alternave – Op>ons should not be disregarded because high ini>al investment 20 Excel based tool for LCC analysis 21 • Desired outputs; needed inputs 1. Cost components of Design - Buildings Energy Impact NPV LCC tool IRR SIR Country 2. General prices - inflation 3. Electricity prices 4. Future electricity prices Financial 5. Discount rate hypotheses 22 • Excel Tool – LCC analysis 1. Cost components of Buildings Financial parameters: 2. Projected future increase in general prices 3. Current electricity prices 4. Projected future increase in electricity prices 5. Discount rate 23 1. Costs components in LCC Analysis – Initial project costs: They include all the costs required for constructing the building. They are usually divided between ‘soft’ costs such as: design fees, permits, and ‘hard’ costs such as: materials, labor, equipment, furnishing, etc. – Utility Costs: They are usually divided between Energy Utility Costs such as: electricity, gas, steam water, and Non-Energy Utility Costs such as: reticulated water, sewer services.