News Article
November 5, 2011

Allocating Capital for Energy Efficiency in Corporate Budgets

Project Risk for Energy Efficiency

Allocating capital for energy efficiency

Decades of experience on energy efficiency projects shows that most common efficiency investments have well-documented performance. Lighting retrofits, for example, have been widely adopted. This is an easy first step, as lighting represents almost 18 percent of global electricity use1 and lighting retrofits provide a quick payback – between two and four years2 for LEDs and less than one year for compact fluorescent lighting3.



Equipment retrofits and replacements are also good investments for energy savings: for example, chillers use approximately 20 percent of total electrical power generated in North America, and the US Department of Energy estimates that chillers expend up to 30 percent of their energy through inefficiency. The payback for chiller retrofits varies by geography, with a range cited by E Source from 1.6 years in Miami to 9.3 years in Minneapolis4. Both lighting and equipment savings are easy to measure – assuming no change in use, the improved efficiency from new or modified lighting and equipment can create straightforward consumption reductions and cut monthly energy bills.



For companies without internal capital or expertise, energy performance contracting can deliver equipment and guarantee the technology’s performance and the energy savings. Energy services companies (ESCO) partner with the customer and get paid through realized energy savings – minimizing the customer’s risk. A review of some of the largest ESCOs in North America reveals that payouts for non-performance of an energy services contract are less than one percent of the total value of companies’ contracts5, further demonstrating that project risk is quite low for typical energy efficiency investments.



 

What About Return on Investment?

According to three third-party data points for energy efficiency metrics, the range for energy efficiency internal rate of return (IRR) is between 12.77 and 18.8 percent. This represents a wide range of project types – from lighting retrofits, to whole-building improvements, to employee engagement initiatives. Given that the average energy efficiency IRR is higher than the historic cost of capital for most companies, energy efficiency should be an attractive option for capital budget allocation.

 

Energy Efficiency Metric

Project Notes

Source

12.77% IRR

Build-up model of WACC for energy efficiency

Neil Peretz. “Growing the Energy Efficiency Market through Third-party Financing.” October 2009.

17% IRR

Cross-sectional study of existing energy efficiency technologies around the globe

McKinsey Global Institute. “How the world should invest in energy efficiency.” July 2008.

18.8% IRR

62 completed projects including energy efficiency, chiller upgrades, solar PV/thermal, cogeneration, and HVAC equipment

Johnson & Johnson 2009 Sustainability Report.





 

The Opportunity to Allocate

These days, many organizations are looking for a way to position themselves to take advantage of increased opportunities when the economy improves. Many companies, from those with a technology focus to big-box retailers, have held on to cash reserves generated during the economic downturn6. Many companies are planning to increase capital spending in the next year – by 6.6% on average, according to a third-quarter Duke/CFO Business Outlook Survey7. At the same time, companies with large real estate assets are facing an evolving set of energy management issues within their facilities, including 1) lowering energy costs, 2) anticipating legislative and policy risk, 3) meeting corporate sustainability goals. Allocating a portion of a capital budget for energy efficiency can help a company mitigate those issues.



How much should be allocated? As an example, Johnson & Johnson (J&J) has a program called the “Climate Friendly Energy Policy,” with goals to reduce facility and transportation emissions. J&J allocates $40 million per year in its capital budget to meet its reduction goals. By completing 62 energy reduction projects between 2005 and 2009, J&J has invested $187 million in capital with an 18.8 percent IRR. The projects have saved 247,000 megawatt-hours of energy per year – equivalent to turning off almost half a million 60-watt light bulbs or disconnecting 20,000 US homes for a year8. According to the company’s website, J&J has achieved a 16 percent absolute reduction in carbon dioxide emissions while experiencing sales growth of more than 450 percent.



 

The Multiple Benefits of Energy Efficiency

Beyond strict financial metrics, allocating for energy efficiency can boost a company in other ways. For example, the 2008 Energy Pulse study by the Shelton Group found that 82 percent of respondents thought it was important for a company to be environmentally responsible At the same time, a global study by Tandberg found that “almost 80 percent of workers believe that working for an environmentally ethical organization is important.9” Since energy reductions lead directly to greenhouse gas reductions, a company can do a better job of “greening” itself through building efficiency projects. Increasing quantifiable corporate social responsibility through improved impact on the environment is an additional benefit of energy efficiency.



 

A Call for Energy Efficiency Allocation

Now – while capital is available and energy uncertainty is high – is the time to take control of spending on energy resources. There are many time-tested and investment-approved technologies to improve energy performance in buildings. By allocating a portion of their capital budgets to energy efficiency, companies are opting for a low-risk, high-value investment with strong economic and environmental returns.



November 2011

 

1 Accessed September 15, 2010. [http://www.greenbiz.com/news/2010/05/20/leds-poised-outshine-all-others-44b-lighting-market/?src=int]

2 Accessed Oct. 26, 2010. [http://www.ledsavingsolutions.com/]

3 Accessed Oct. 26, 2010. [http://www.epa.gov/statelocalclimate/documents/pdf/table_rules_of_thumb.pdf]

4 Accessed Oct. 26, 2010. [http://www.touchstoneenergy.com/efficiency/bea/Documents/CoolingTechnologiesUpdate.pdf]

5 Ameresco (AMRC) 10Q submitted Sept. 7, 2010. Johnson Controls internal data.

6 Wall Street Journal. “Companies like Bed Bath Need Capital Ideas.” Sept. 22, 2010 by Kelly Evans

7 “Is Cash Peaking?” Sept. 30, 2010 by Vincent Ryan. Accessed Oct. 8, 2010. [www.cfo.com]

8 2009 Sustainability Report. Accessed Oct. 12, 2010. [www.investor.jnj.com]

9 “Corporate Environmental Behavior and the Impact on Brand Values.” Accessed Sept. 16, 2010. [http://www.ivci.com/pdf/corporate-environmental-behaviour-and-the-impact-on-brand-values.pdf]

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