An energy upgrade can do more than just trim energy costs. It can help boost productivity, reduce maintenance costs and improve overall facility performance. But success is far from assured. When planning and carrying out an energy project, the facility executive must avoid common pitfalls that can doom a project before it even gets under way.
Before doing anything else, the facility executive should understand the financial aspects of the project. Most finance departments view the facility group as spenders of money rather than producers of money. An energy upgrade project can reverse that perception. Seize the opportunity to communicate the idea to the chief financial executive.
First, determine if the contemplated project is being done on a “capital” or “performance” basis. A capital project entails spending company money and needs to be budgeted accordingly. Myriad financial hurdles need to be analyzed, including costs, benefits and return on investment. Will the project involve spending company cash or will some or all portions of the project be financed? If the latter, will it be traditional financing, a capital lease or an operating lease?
The facility executive should work closely with the organization’s financial group as the project is planned. That way, the facility executive is part of a team as the financing rationale is being formulated by the accounting department.
The facility executive can expect such comments as, “Why do we have to fix or replace the lights, boiler, or HVAC systems, etc.? They work just fine.” The reason is that the project will improve the bottom line and create positive cash flow with solid return on investment. Before saying this, however, the facility executive should be well aware of the financial hurdles and return-on-investment marks that the financial officer will be using to analyze the project.
The second financing model, being used more and more in recent years, is the performance-based energy upgrade project. In that approach, the contractor or energy service company (ESCO) is compensated based on performance (with performance being measured as energy and savings), in some cases guaranteeing that energy savings will result from the upgrade initiative. These guaranteed savings are then used to pay all project costs. Generally, these projects require a long-term service agreement with the contractor to be put in place, with the guarantee validated from year to year.
Performance-based financing mechanisms can take several forms. The project capitalization value can be either on balance sheet or off balance sheet.
Of course, in a performance-based upgrade with guaranteed savings, the contractor or ESCO will charge for taking on the risk that savings will not be as high as anticipated and will have its own overhead and margins to cover. As a result, projects of this nature will generally cost more over the long term than traditional capital projects; that is, the contractor or ESCO will keep a portion of the energy savings to cover those costs, as well as the costs of planning the upgrade and installing the new equipment. A company that can fund an upgrade itself will maximize savings; if funds are available, that’s clearly the best choice. Nevertheless, a performance-based approach is often a very effective way to get energy upgrades accomplished.
There are four basic kinds of performance contractors or ESCOs: those tied to utilities, equipment vendors, mechanical and electrical contractors, or independent engineering firms (consulting/developer based). Performance contracting is a highly competitive arena with marketing sizzle and aggressive savings offerings as the norm. A performance contract can serve an organization very well if critical details in contract negotiation and financing are handled carefully.
Of course, financing is only one element that has to be considered in planning. A good project plan includes a clear statement of vision, goals, objectives and methodology, along with a simple cost-benefit schedule that describes how much money will be spent and what benefits will be achieved.
Inviting Help
Initially, the plan should be packaged as an executive-summary type report for presentation to the financial group. By labeling the first version of the plan a draft, the facility executive invites the finance department to help shape the project — a good way to build an alliance and gain buy-in before requesting formal project approval and financing.
A clear, concise plan, approximately three pages, will illustrate and highlight the financial return or savings associated to the project. In the first version, don’t include any cost-benefit analysis or return-on-investment schedules — the idea is to solicit help from the financial officer in this process and, in the best scenario, get his or her help with the project.
Because the goal is to present energy savings as revenue rather than expense, be sure to capture operational savings beyond energy costs. The project will have an operations budget that will likely be established from a previous year’s expenditure; from the perspective of a financial officer, that baseline operational budget is somewhat fixed or a given. If the facility executive can show that an upgrade will reduce this baseline operational budget, the financial reality is that the savings will go directly to the bottom line or will minimally go into an “other income” category on the balance sheet.
The secret is to not give away all of the potential savings: Some should be reserved or scheduled into an incentive or reserve fund to be used for other project initiatives that may not necessarily reduce energy costs, but may improve the business environment or facility portfolio.
There’s another reason not to build the maximum proposal savings into a proposal: Projects rarely achieve the greatest savings that seem possible on paper. If the facility executive promises that maximum level of savings — and the financial officer builds it into the budget — any shortfall could make the project a failure from a financial perspective, no matter how much money it actually saves. And the financial department will be skeptical of future proposals for energy upgrades; that will help build a bridge between the facility and finance departments, not a wall. Far better to be conservative in estimating savings, and look like a hero if the project actually does better than budgeted.
In discussions about the financial justification for an energy project, it’s important to keep life-cycle costs in a prominent place on the agenda. Many times, a good project is turned down because the financial study is based solely on first cost rather than long-term costs, including operations and maintenance expenses.
Often, a higher first cost will result in lower operating and maintenance expenses; the added expense is recouped over a very short period of time when the cost of operations and maintenance is factored in. This analysis is very easy to assemble; most equipment vendors and contractors are able to produce it.
When doing performance-based energy upgrades, the contractor will most likely promote a more efficient system that may have a higher first cost because of superior return on investment and cash flow impact. An energy project analysis that does not study the long-term operating and maintenance aspects of the improvement may very well leave money on the table. It makes good business sense to look at the project both ways, even if the final decision is to go with lower initial cost.
Because energy upgrade projects don’t happen often, it is worthwhile to consider getting an experienced outside firm involved.
A long-term perspective is also important in preparing an upgrade strategy to present to the finance department. A long-term outlook might help prevent this all-too-familiar refrain: “I did a large lighting retrofit project last year that produced great results — now if I could only get management to approve fixing my boilers, chillers, HVAC or control problems. I wish they had returns like the lighting project.”
Many energy upgrade projects focus strictly on lighting. While this approach certainly will result in a winning project, many times a great opportunity is lost because the lighting initiative isn’t integrated with other energy upgrade projects. The facility executive should consider bundling the lighting upgrade with other measures and build a larger project.
One reason this integrated approach isn’t taken, say many facility executives, is that management won’t approve more money for the other projects. But companies are sometimes willing to expand the budget if a good plan is presented with the budget ramifications for bundling, or if both a capital and performance-based budget are presented. Facility executives who do lighting work as a stand alone and then undertake other energy upgrades afterwards risk being seen by the financial side of the organization as a constant drain on capital reserves or budgets.
Control and Monitoring
When energy upgrades are not monitored and tracked, the initial savings often dwindle over time. In most cases, it’s a combination of small things: temperature set points that are overridden and never reset, or lights that are left on longer. But whatever the causes, the end results are too often the same: The absence of a verification mechanism and lack of interest in validating economies means that costs creep up.
The control and automation system in place is the most effective process for validating and monitoring performance. But that system has an even more important role: turning things off.
In simple terms, a control system comprises two types of points. Monitoring points — inputs — supply critical information regarding status and values associated with measurements; control points — outputs — signal the on-off mechanism of devices. The best way to save energy is to turn things off: shutting off lights when no one is in the room, for example, or turning air handling equipment off at proper times. While there will always be more inputs than outputs, it is important to make sure that there are enough outputs. As a rule of thumb, if less than 25 percent of the points are outputs, it’s worth taking a close look at the whole proposal to assure that it is really capable of producing significant savings.
Reshaping Perceptions
A successful energy upgrade project can bring benefits beyond energy savings. One of those benefits can be a change in the way the facility department is perceived by top management.
More and more, the facility department is expected to be a business unit as opposed to a service unit. That seems completely appropriate, given the range of contributions the facility can make to the bottom line. No matter what the title, the time has clearly come for the facility executive to be part of the top management team. But the facility executive has to take the initiative. An energy upgrade is a good place to start.
Julian Arhire is a Manager with http://DtiCorp.com – http://DtiCorp.com carries more than 35,000 HVAC products, including industrial, commercial and residential parts and equipment from Honeywell, Johnson Contols, Robertshaw, Jandy, Grundfos, Armstrong and more.
