The financial implications of an energy strategy
04 January 2013
Short termism damages sustainability, says Mike Malina, founder and director of Energy Solutions Associates, and award winning building engineering services consultant. Here, we present an edited version of a presentation he made at the Motor Driven Systems conference last year, in which he makes the case for taking the long term view when investing in energy efficiency technologies.
The current financial system is geared to short-termism. To demonstrate this, we only need to look at the volatility of the stock markets. It seems to be human nature to measure only up to the horizon. In business, we seem to concentrate on looking at annual budgets rather than over the long term. There needs to be a total culture change, as sustainability is for the long term. But the whole economic system, from stocks and shares to commodities, continues to be driven by speculation and sentiment.
What will hopefully focus minds, however, is the significant pressure on energy and commodities prices, as the incentives will be greater than ever to make sure that savings are made. But to achieve this, investment will have to be made; as the old saying goes, you have to speculate to accumulate.
To meet environmental and business objectives for the future, energy efficient technologies will be a mainstay for economic survival for all businesses. This will be coupled with wider efficiency programmes. The key will be the communication of our solutions and technology developments to a much wider audience than we have considered before.
Developing a way to integrate wider sustainable engineering and finance will be the big challenge. How can we define sustainable building services and buildings in such a way that enables investors; developers; and finance professionals, including valuers and occupiers, to measure and attribute a financial value to sustainability?
The answer must be to change the way we conventionally measure finance. How we construct longer term measures will be the big question. A good example of how measurement is being changed would be the introduction of carbon accounting and the CRC energy efficiency scheme (formally known as the Carbon Reduction Commitment).
This involves measuring the price of carbon, which is obviously adding a completely different dimension to the conventional way of measuring finance in relation to energy consumed. So as well as paying for the energy, business is also paying a carbon tax on the use of energy. In the future this may be extended in some form to cover the domestic energy market, but has so far been held off due to the likely unpopular reaction to this at a time of significant energy price rises and recessional times.
When the CRC was first introduced, the idea was geared to a performance table where the top performers would get a rebate and gain financially in order to incentivise the process. However, many companies were shocked when the scheme changed in 2010, when the coalition government decided to keep all the payments, so that the CRC in effect became a carbon tax.
Industry and building owners were up in arms. It seems they didn't realise that the situation created an even bigger incentive to save, offset and reduce their energy consumption. The effect of the CRC seems to have been very much about concentrating people's minds on the price of carbon per ton. In this process, they seem to have forgotten about the initial cost of energy.
By reducing their payment of the carbon tax, they would at the same time be reducing their energy bills by saving their energy resources, so creating a double benefit on energy use. People become obsessed with the politics and the tax, but they need to see the CRC as an example of integrating a financial mechanism to incentivise sustainability.
Funding for sustainable building projects
Finding the finance in difficult economic times can be a challenge, not to mention attitudes to payback. Many companies seem not to want to borrow money to fund what others would consider a good return on investment (ROI). Especially if the debt charges would cover the on-going cost of the loan repayments, gained from the energy savings. This is very much a convention in finance where the funds may be available but the company doesn't want to accept any risks.
There are a number of established ways companies appraise investment potential, but the majority will be concerned at how long it will take to break even. With current investment rates and financial uncertainties it surprises me that so many good energy efficiency projects are held back, because even with return on investments within five years (which can cover a whole range of energy saving technologies) these projects do not get approval for funding.
All sorts of accounting techniques are used to measure traditional financial models. All rely on a capital sum to finance the project, which means many projects will need the total cost as up front capital. This can be illustrated as a graph showing traditional ROI.
An alternative model develops a system of financing a project that delivers a much shorter payback - ROI funded in stages by a finance provider. This commercial model is potentially similar to how the Green Deal may be financed over the term of many projects, small and larger scale.
To achieve an integration of finance and sustainability, and break down the barriers that currently exist, I believe that there has to be a significant and serious discussion between finance institutes and their equivalents in the engineering and sustainability fields to create a mutual understanding of the issues on both sides. Experience shows that, currently, finance people don't really have a grasp of sustainability issues and vice versa. Once we achieve this, integration can easily become the norm.
The cheapest kWh is the one you never use!
The reduction in energy use should be the priority issue, although many people and companies are looking at the installation of low carbon and renewable technologies as well. The big dilemma people are facing is when exactly to make the decision to install renewables, as there is so much conflicting information regarding their performance and the financial returns on different technologies. What is clear is that energy prices will inevitably continue to rise over the longer term.
An analogy might be deciding when to buy a new computer or upgrade an existing one. Ideally, it is best to buy a machine that is upgradable - the same goes for renewable and low carbon technologies.
However, this could be very difficult with photovoltaics for instance. The panels are manufactured, sealed and installed for a 25 year life, so it would be very hard to make them upgradable. During the 25 years of a photovoltaic panel's life, technology will undoubtedly develop and future panels will become more efficient. At present, the conversion rate from sunlight to electricity is just 12-18%, but there is the possibility that this will have increased to about 25% in a few years. This will improve still further as time goes on.
Faced with this fact, the incentive for early adopters was the feed-in tariff (FiT), which was really the only incentive to invest in current technology. Without this, it would be totally uneconomic to buy now. Those that took up the FiT in 2010-12 were guaranteed 43 pence per unit generated. At the time, the early adopters had to use the level of technology that was available. If they waited however, in the same way that one might wait to upgrade a computer, then they received a diminishing FiT, so it was clearly designed as a reward for early adopters, which of course would stimulate and create a market. On the other hand, as the technology develops and becomes more efficient, the photovoltaic panels will generate more electricity as the conversion ratio from sunlight to electricity will have improved.
The choice: renewables or efficiency
This argument, for both efficiency from technological development and costs, has also been made to me on the issue of fitting technology such as variable speed drives or EC fans. I counter this with the fact that the efficiencies and paybacks for motor driven systems far exceed any renewable technologies and don't require any subsidies or special financial treatment, such as FiTs or renewable heat incentive payments.
People tend to like new technologies and want to be part of their development in society. Nevertheless, this can distract our attention from the fact that the cheapest kilowatt of power is not solar: it's the kilowatt we never use in the first place. I would maintain that the key is still to focus on the energy hierarchy since the financial and environmental impact is far better served by reducing energy in the first place. Perhaps another way of looking at this is to combine the hierarchy with finance.
Whilst reducing energy usage is key, that is not to suggest that I'm not keen to see further investment in renewable energy. Once we've achieved the first steps on the energy hierarchy we must ultimately invest in renewables, perhaps by ring-fencing the savings from energy use reduction. That way, we could fund our photovoltaic panels from the energy hierarchy savings made earlier by reducing the energy demand.
We have to look at energy and all the other resource issues and impacts, from cradle to grave, for all activities we employ inside and outside our buildings and all the associated activities. Most importantly, there needs to be a simple process for the end user and/or consumer to evaluate and understand the true impact, both financially and from a sustainability point of view.
I propose we adopt the tried and tested 'A to G' rating method, which gives everyone a good understanding of what is efficient and what isn't. Complex arrangements for making sure that a universal and robust system is put in place can take place behind the scenes; for the decision maker, the simpler the system, the better. A-G can be used universally to label all products on a common measurable scale of energy with the cost and lifecycle data.
Ultimately, any energy efficiency measure to improve building performance, which can be financed from the savings on energy bills, should be considered.
The key to a universal and a much wider adoption of a motor driven system technology efficiency programme will be the education, training and awareness of not only the end users, but even more crucially of the industry itself.
Mike Malina is author of Delivering Sustainable Buildings: An Industry Insider's View published by Wiley-Blackwell this month. For details click here. DPA readers can obtain a 20 percent discount on the price of this title by using the discount code VBB09 at the Wiley.com checkout.