The lifetime value of energy efficiency

PG&E
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Convincing financial decision makers to invest in energy efficiency can be difficult because of the substantial upfront costs involved. Payback analysis often doesn't help, since it ignores the benefits after the payback period—typically less than half the life of the project. To get to yes, it's important to look beyond first cost and evaluate the total cost of ownership of a project—the costs and benefits over its entire useful life. Life-cycle cost analysis (LCC) does just that, helping you estimate the lifetime financial impact of each project.


The total cost of ownership 

Life-cycle cost is the total cost of owning, operating, maintaining and disposing of equipment or building systems over the proposed lifetime of the project. For example, if a boiler retrofit has a projected lifetime of 20 years that would be the analysis period. Value categories incorporated in a life-cycle cost analysis, include:

 

  • Financing—loan payments and other financing charges
  • Energy costs
  • Non-fuel operating, maintenance and repair costs
  • Disposal cost or residual value
  • Equipment replacement costs

While the initial purchase price and financing costs are fixed, other costs can be more difficult to estimate. Calculate maximum annual energy costs by multiplying the equipment nameplate (kW or Btu) energy rating, efficiency rating, estimated operating hours and the average electric or gas rate. Estimating operating, maintenance, and repair costs over the life of equipment can be challenging. A good resource is the Facility Maintenance and Repair Cost Reference from Whitestone Research. It's difficult to project how much it will cost to replace equipment in the future; use current costs as starting point.

 

The changing value of money

Money changes value over time. An LCC analysis converts future cash flows to their present value by discounting them with an interest rate. An appropriate discount rate is often considered to be the weighted average cost of capital (WACC), which is the average return required by current providers of finance to the company. The WACC reflects both the current business risk of a company and the company's financial risk (how it is currently financed). An alternative surrogate for discount rate would be the marginal cost of capital, which is the cost of the last dollar of capital raised for the company. If financing is part of the project, use the loan interest rate as the discount factor.

 

Life-cycle cost calculation

After identifying all costs by year and discounting them to their present day value, add them to determine total life-cycle costs:

LCC = I + F + E + OMR + D + R

Where:

LCC = Life-cycle costs

I = Initial costs

F = Financing costs

E = Energy costs

OMR = Operating, maintenance and repair costs

D = Disposal cost or value

R = Replacement costs

 

The following table provides a simple example of the concept of LCC analysis. Two retrofit options are considered. Option A is a standard efficiency model, while Option B is a higher efficiency alternative. The initial cost and financing costs of Option B are higher. Both options assume a loan financing rate of 7 percent and subsequent partial system equipment replacement in five years. The initial costs are given in base value (the time of the initial investment) while future costs are discounted to present value using a discount rate of 8 percent. Since the total present value life-cycle cost of Option B ($95,641) is less than that of Option A ($107,417), the energy-efficient model is the more economical choice. Energy efficiency projects typically involve a great deal of uncertainty about their costs and potential savings. An LCC analysis provides demonstrated evidence that investing in energy efficiency saves more money in the long run. 

Option A Base ValueOption A Present ValueOption B Base ValueOption B Present Value
Initial Cost

$5,000

$5,000

$7,500

$7,500

Financing Costs

$27,871

$18,701

$33,440

$22,438

Energy Costs

$104,000

$69,785

$78,000

$52,339

OMR Costs

$15,000

$10,065

$13,000

$8,723

Replacement Cost

$5,000

$3,403

$7,500

$5,105

Disposal

$1,000

$463

$-1,000

$-463

Life-Cycle Cost

$157,687

$107,417

$135,940

$95,641