Energy efficiency can be proven to be a good investment

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Building the business case for energy efficient buildings

Building owners and tenants tend to treat the expense of energy improvements for a new building or a renovation as a cost rather than an investment. The term cost is associated with a onetime expense with no consideration of future recovery, while an investment would consider the future benefit and potential financial return.  By reframing the evaluation, energy efficiency can be proven to be a good investment.

In a recent study prepared by Natural Resources Canada (NRCan) and presented at Canada’s provincial Energy and Mines Ministers’ Conference in August 2016, several barriers to financing energy efficient building projects were identified.  Examples of barriers include a lack of understanding about the environmental and economic benefits of energy efficiency upgrades; different interests when landlords are responsible for the improvements and tenants pay the energy bills; the cost of low carbon energy sources; and limits on debt levels.

Notwithstanding variations between regions and risk tolerances, the NRCan study summarized that establishing a strong business case is one of the biggest challenges to increasing the uptake of energy efficient building projects.

A common way to evaluate the merits of energy efficient design elements has traditionally been the Payback Method: the fewer years it takes to payback the capital cost, the better.  While it may be suitable for short-term investments, there are drawbacks to using the Payback Method for longer term investments.  In the Payback Method, there is no consideration for inflation, or the return that is earned after the cost of borrowing the money is repaid.  As an example, adding extra insulation to the walls and roof of a building will reduce energy costs to heat and cool the building compared to a building designed to minimum code requirements.  Assume the payback is calculated to be 15 years.  The decision on whether to invest in additional insulation is made on the basis of the 15-year payback period.  But what about the positive cash flow created by the energy savings after 15 years?  The cash flows may be substantial and could be important in evaluating a project.  

An alternative method to evaluate the merits of investing in energy efficient design elements is to use the Net Present Value Method.  The Net Present Value Method incorporates inflation into future cash flows to today’s dollars so that we can compare different future scenarios to the initial investment. Again, using the example of adding additional insulation to the walls and roof of a building, in year 16 and for the rest of the life of the building, the energy bill savings will start to contribute a positive cash flow.  The building with additional insulation and lower energy consumption is found to have a lower Net Present Value, i.e. be more affordable, than the building designed to minimum code requirements. 

The true value of energy efficient buildings is measured not only on economics, but also social and environmental performance.  However, with Canadian electricity rates rising, and carbon taxes and levies becoming more widely implemented, the economic benefits of energy improvements are increasing.  Now is the time to become well versed in Net Present Value calculations in order to evaluate the affordability and profitability of energy efficient building design and renovation projects.