In most respects, investment in energy efficiency is no different from any other area of financial management. So when your organization first decides to invest in increasing its energy efficiency it should apply exactly the same criteria to reducing its energy consumption as it applies to all its other investments. It should not require a faster or slower rate of return on investment in energy efficiency than it demands elsewhere.
The basic criteria for financial investment appraisal include:
• Simple Payback – a measure of how long it will be before the investment makes money, and how long the financing term needs to be
• Return on Investment (ROI) and Internal Rate of Return (IRR) – measure that allow comparison with other investment options
• Net Present Value (NPV) and Cash Flow – measures that allow financial planning of the project and provide the company with all the information needed to incorporate energy efficiency projects into the corporate financial system.
Initially, when you can identify no or low cost investment opportunities, this principle should not be difficult to maintain. However, if your organization decides to fund a rolling program of such investments, then over time it will become increasingly difficult for you to identify opportunities, which conform to the principle. Before you’ll reach this position, you need to renegotiate the basis on which investment decisions are made.
It may require particular thoroughness to ensure that all the costs and benefits arising are taken into account. As an approximate appraisal, simple payback (the total cost of the measure divided by the annual savings arising from it expressed as years required for the original investment to be returned) is a useful tool.
As the process becomes more sophisticated, financial criteria such as Discounted Cash Flow, Internal Rate of Return and Net Present Value may be used. If you do not possess sufficient financial expertise to calculate these yourself, you will need to ensure that you have access, either within your own staff or elsewhere within the organization, to people who can employ them on your behalf.
There are two quite separate grounds for arguing that, at least towards the later part of your energy management program, your organization could begin to apply a slower rate of return to its investments in energy efficiency than it applies elsewhere.
The benefits arising from some energy saving measures may continue long after their payback periods. Such measure does not need to be written off using fast discounting rates but can be regarded as adding to the long term value of the assets. For this reason, short term payback can be an inadequate yardstick for assessing longer term benefits. To assess the real gains from investing in saving energy, you should use investment appraisal techniques, which accurately reflect the longevity of the returns on particular types of technical measures.