"Energy Economics 101"

“Energy Economics 101”

Presented byMiles Kubo, EVP/COO

September 30, 2005

Hilton Waikoloa Village

Energy Economics 101

Speaker BackgroundEducation

MBA, Finance The Wharton School,University of Pennsylvania

ExperienceEnergy ServicesMechanical ContractingInvestment BankingReal Estate Development


Program

Overview of “Energy Economics”

Recognizing Value in “Energy Investments”

Understanding the Importance of Financial Leverage

Summary of Concepts


Purpose

To help decision-makers understand thetrue economic valueof energy-efficiency projects, and the effects of financial leverage on them.


Why Energy Economics?

Get over the speed bump in the approval process.

Use language of finance for CFOs and financial executives.

Distill complex financial issues into simple elements.

Deliver “visual” presentations.


r = 10% CF0 = -1000CF1 = 400CF2 = 400CF3 = 400CF4 = 400CF5 = 400

CFt CF1 CF2 CFt

(1 + r)t (1 + r)1 (1 + r)2 (1 + r)tNPV = Σ = CF0 + + ++ …

The Problem with Economics

t = 0

T

??

? ??


Industry Background

“Over the past year oil prices have blasted

through the $40 barrier to $50 a barrel, then $60 and now $65 ”

MSNBCAugust 12, 2005


Industry Background

Understandingthe Utility Bill:

Energy Cost Adjustment

Base Rate (and Demand Charge)

$-$0.02$0.04$0.06$0.08$0.10$0.12$0.14$0.16$0.18$0.20

Jan-04 Jan-05 Jun-05

Energy Bill Comparson

ECAFBASE


Energy Efficiency Projects

Retrofits / UpgradesLighting ComponentsHVAC EquipmentPumps and Motors -- VFDs

Re-engineering / Re-designRetro-CommissioningLoad Shifting

(heating / cooling / electrical demand)System Changes

Sensors and Controls


Energy Project Evaluation

Technical Financial

Cash Stream of Usable or Savable Funds

Capital Budgeting Investing

Physical & Operational Improvements to Plant +


Capital Budgeting / Investing – Measurement

PaybackMeasures Time

Internal Rate of Return (IRR) andReturn on Investment (ROI)

Measures Percentage Return

Net Present Value (NPV)Measures Time-Adjusted Dollars

Cash Flow Analysis (CF or Discounted CF)Evaluates Events over Time


Investing

Time Value of Money“A Dollar Today is Worth More than a Dollar Tomorrow.”

Discount Rate (for NPV Calculations)A rate used to adjust future cash flows into current dollars.

WACC (Weighted Average Cost of Capital)Company-Specific Discount Rate

Hurdle RateCompany’s Required Return on Assets


Program




What is Value?

Energy Projects are good values…

“How Good is Good?”


The “Good” Investment -- Value: $1,00010-year, 10% Treasury Bond at Par

Annual Cash Flows

Bond Investment [A]

($1,000)

$0

$1,000

$2,000

Now Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10

Bond Investment [A]

($1,000)

$0

$1,000

$2,000



The Good Investment10-year, 10% Treasury Bond at Par

Cumulative Cash Flows

Bond Investment [A]

($1,000)

$0

$1,000

$2,000


Bond Investment [A]

($1,000)

$0

$1,000

$2,000



The Better Investment -- Value: $1,000Retrofit 20 light fixtures from T-12 to T-8

Annual Cash Flows

Energy Project [B]

($1,000)

$0

$1,000

$2,000


Energy Project [B]

($1,000)

$0

$1,000

$2,000



The Better InvestmentRetrofit 20 light fixtures from T-12 to T-8


Energy Project [B]

($1,000)

$0

$1,000

$2,000


Energy Project [B]

($1,000)

$0

$1,000

$2,000



The “Better” Better Investment -- Value: $1,000Retrofit 20 light fixtures from T-12 to T-8, Leased

Annual Cash Flows

Energy Project with Lease Financing [C]

($1,000)

$0

$1,000

$2,000



($1,000)

$0

$1,000

$2,000



The “Better” Better InvestmentRetrofit 20 light fixtures from T-12 to T-8, Leased



($1,000)

$0

$1,000

$2,000



($1,000)

$0

$1,000

$2,000



The Good Investment10-year, 10% Treasury Bond at Par


Bond Investment [A]

($1,000)

$0

$1,000

$2,000


Bond Investment [A]

($1,000)

$0

$1,000

$2,000



The Better InvestmentRetrofit 20 light fixtures from T-12 to T-8


Energy Project [B]

($1,000)

$0

$1,000

$2,000


Energy Project [B]

($1,000)

$0

$1,000

$2,000



The “Better” Better InvestmentRetrofit 20 light fixtures from T-12 to T-8, Leased



($1,000)

$0

$1,000

$2,000



($1,000)

$0

$1,000

$2,000



Comparing Returns -- $1,000 Investment

Investment Options

Internal Rate of Return (IRR)

Cumulative Cash Flow

Net Present Value (NPV)

@ 8% discount rate

@ 10% discount rate

@ 12% discount rate

[A]10% Bond

10%

$1,000

$124

$0

-$101

[B]Energy Project

46%

$2,502

$1,320

$1,130

$968

[C]Leased Project

NA %

$2,291

$1,305

$1,149

$1,017


What is Value?

“How Good is Good?”

10% Bond = “Good”

Energy Project = “Exceptional”

Leased Project = “Incredible”


Program





Impact of Leverage on Energy Projects

Cumulative 10-year Cash Flow -- Base Case

$50,734

$127,880

$373,483

$460,312

$549,745

($24,164)($96,882)

($167,481)

$207,340

$289,184

($200,000)

($100,000)

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Cumulative 10-year Cash Flow -- Base Case

$50,734

$127,880

$373,483

$460,312

$549,745

($24,164)($96,882)

($167,481)

$207,340

$289,184

($200,000)

($100,000)

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000


Lighting Project – 4,000 Fixtures -- Cost $240,000

Performance Measures

Payback 3.36 yr

IRR 43%

Cumulative Cash $549,745

NPV @10% $257,265


Payback 3.36 yr

IRR 43%


NPV @10% $257,265


Impact of Leverage on Energy ProjectsLighting Project – 4,000 Fixtures with 5-Year Lease at 7.75%

Cumulative 10-year Cash Flow -- 5-year Capital Lease

$60,766$75,545

$321,149

$407,977

$497,410

$236,849

$155,006

$29,645 $37,881$48,233

$0

$100,000

$200,000

$300,000

$400,000

$500,000


Cumulative 10-year Cash Flow -- 5-year Capital Lease

$60,766$75,545

$321,149

$407,977

$497,410

$236,849

$155,006

$29,645 $37,881$48,233

$0

$100,000

$200,000

$300,000

$400,000

$500,000



Payback 0 yr

IRR NA %


NPV @ 10% $265,754


Payback 0 yr

IRR NA %


NPV @ 10% $265,754


Comparing Returns – 4,000 Fixture Project

Payback



Net Present Value (NPV) @ 10%

Base

3.36 yr

43%

$549,745

$257,265

5-YrLease

0 yr

NA %

$497,410

$265,754


Project Summary -- Lighting

Upgrade of 4,000 fluorescent light fixtures

Longer life of lamps/ballast = less maintenance

More uniform lighting

Reduction of 625,000 kWH/year

Annual utility bill saving of $75,000/year

Annual lease payments of $62,000/year (5 yrs)

HECO rebate of $30,000


Multiple ECM Projects (Energy Conservation Measures)

T = 0 T = 1 T = 2 T = 3 T = 4 T = 5 T = 6 T = 7 T = 8 T = 9 T = 10

ECM 1 Chillers w/ Variable Speed Drive $0 ($198,802) ($198,802) ($198,802) ($198,802) ($198,802) ($198,802) ($198,803) $0 $0 $0Est. Utility Rebate $0 $44,000 $0 $0 $0 $0 $0 $0 $0 $0 $0

Annual Energy Saving $0 $185,000 $185,000 $185,000 $185,000 $185,000 $185,000 $185,000 $185,000 $185,000 $185,000

ECM 2 Variable Primary Flow System $0 ($16,722) ($16,722) ($16,722) ($16,722) ($16,722) ($16,722) ($16,723) $0 $0 $0Est. Utility Rebate $0 $8,000 $0 $0 $0 $0 $0 $0 $0 $0 $0


ECM 3 Condenser Water Pumps $0 ($3,159) ($3,159) ($3,159) ($3,159) ($3,159) ($3,159) ($3,160) $0 $0 $0Est. Utility Rebate $0 $2,000 $0 $0 $0 $0 $0 $0 $0 $0 $0


ECM 4 Energy Management System $0 ($20,438) ($20,438) ($20,438) ($20,438) ($20,438) ($20,438) ($20,439) $0 $0 $0Est. Utility Rebate $0 $8,000 $0 $0 $0 $0 $0 $0 $0 $0 $0


ECM 5 Digital Thermostats $0 ($25,826) ($25,826) ($25,826) ($25,826) ($25,826) ($25,826) ($25,827) $0 $0 $0Est. Utility Rebate $0 $15,000 $0 $0 $0 $0 $0 $0 $0 $0 $0


ECM 6 Lighting Upgrade $0 ($24,897) ($24,897) ($24,897) ($24,897) ($24,897) ($24,897) ($24,898) $0 $0 $0Est. Utility Rebate $0 $20,000 $0 $0 $0 $0 $0 $0 $0 $0 $0

Annual Energy Saving $0 $85,000 $85,000 $85,000 $85,000 $85,000 $85,000 $85,000 $85,000 $85,000 $85,000ECM 7 Evaporator Fan Controls $0 ($7,432) ($7,432) ($7,432) ($7,432) ($7,432) ($7,432) ($7,433) $0 $0 $0

Est. Utility Rebate $0 $3,000 $0 $0 $0 $0 $0 $0 $0 $0 $0Annual Energy Saving $0 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000

Cash Flow $0 $161,726 $61,726 $61,726 $61,726 $61,726 $61,726 $61,719 $359,000 $359,000 $359,000

Cumulative Cash Flow $0 $161,726 $223,452 $285,177 $346,903 $408,629 $470,355 $532,073 $891,073 $1,250,073 $1,609,073


ECM ProjectsMultiple ECMs for Resort Hotel – Cost $1,600,000

Multiple ECM Project

($1,500,000)

($1,000,000)

($500,000)

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

Cash Flow ($400,000) ($1,115,000) ($730,000) ($345,000) $40,000 $425,000 $810,000 $1,195,000 $1,580,000 $1,965,000 $2,350,000



Payback 4.2 yr

IRR 28 %

Cumulative Cash $2,350,000

NPV $877,871


Payback 4.2 yr

IRR 28 %


NPV $877,871


ECM ProjectsMultiple ECMs for Resort Hotel –7-Year Lease at 8%

Multiple ECM Project

($500,000)

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

Cash Flow $0 $161,726 $223,452 $285,177 $346,903 $408,629 $470,355 $532,073 $891,073 $1,250,073 $1,609,073



Payback 0 yr

IRR NA %


NPV $772,318


Payback 0 yr

IRR NA %


NPV $772,318


Comparing Returns – Multiple ECM Project

Payback



Net Present Value (NPV) @ 10%

Base

4.2 yr

28%

$2,350,000

$877,871

7-YrLease

0 yr

NA %

$1,609,073

$772,318

No Go Go


Project SummaryNew chillers, pumps, motors, lighting

- Eliminate “imminent failure” possibilities

Add VFDs, EMS, controls/thermostats

- lower maintenance/operating costs

Reduction of 2,000,000 kWh/year

Annual utility bill saving of $400,000/year

Annual lease payments of $300,000/year (7 yrs)

Utility rebate of $100,000


Financial Analysis of ProjectCASH FLOW:

Net Cash Flow of $100,000 / year (7 years)

One-time Utility rebate of $100,000

PAYBACK: 0 Years

IRR or ROI: Not Calculable

NPV: $772,318


Value of Cash Flow

Net Cash Flow of $100,000 / year (7 years)

How much sales revenue is needed?

If Net Operating Income is…

20% $ 500,000

10% $1,000,000

5% $2,000,000

2% $5,000,000


Understanding (Equipment) LeasesLeasing Considerations

Matching Cash Inflow & OutflowsNo Large Front-End PaymentCredit Review Easier than LoansResidual Risk on Operating LeaseTax Impacts / Tax ExemptNo Pre-payment of Lease

Leases allow Customers to tap into an“unrealized” cash stream.


Understanding (Equipment) Leases

Capital LeasesLike Loan Financing, $1.00 Buy-OutFixed Asset on Balance SheetDepreciation / Tax Credits

Operating LeasesFMV Residual at End of TermOperating ExpenseLessor takes Depreciation/ Tax CreditsOff-Balance Sheet Financing

Tax-Exempt LeasesPrivate and Nonprofit Sectors


Program




Summary of Concepts


Concepts

All capital improvement projects are not created equal.

“Use of Cash”or

“Source of Cash”?


Concepts

Energy Investments can Outperform Financial Investments

Project IRRs can generallyrange from 20% to 70%


Concepts

If you think you can’t afford it,Think Again!

Understand the Impact of Financial Leverage.


Concepts

Just because it“sounds too good to be true”,

doesn’t mean it is…

To tap into the unrealized cash stream, understand how it all fits

together.


Who Wins…

CustomerUtility CompanyServices ProvidersFinance CompaniesGovernmentsEnvironment

A Win-Win-Win-Win-Win-Win Situation.


References

http://www.energystar.gov/ia/business/COO-CFO_Paper_final.pdf

http://www.energyusernews.com/CDA/ArticleInformation/features/BNP__Features__Item/0,2584,104291,00.html

http://www.energystar.gov/ia/business/COO-CFO_Paper_final.pdf


References

http://www.worksmart-enterprises.com/theWorks/markettrans.pdf

http://www.gecapitalenergy.com/benefits.html

http://www.worksmart-enterprises.com/theWorks/markettrans.pdf


Mahalo…

…Questions?

2660 Waiwai Loop Honolulu, Hawaii 96819 (808) [email protected]

www.energy-industries.com

mailto:[email protected]

http://www.energy-industries.com/

"Energy Economics 101"

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