"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

Energy Economics 101

Program

Overview of “Energy Economics”

Recognizing Value in “Energy Investments”

Understanding the Importance of Financial Leverage

Summary of Concepts

Energy Economics 101

Purpose

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

Energy Economics 101

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.

Energy Economics 101

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

??

? ??

Energy Economics 101

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

Energy Economics 101

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 Economics 101

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 Economics 101

Energy Project Evaluation

Technical Financial

Cash Stream of Usable or Savable Funds

Capital Budgeting Investing

Physical & Operational Improvements to Plant +

Energy Economics 101

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

Energy Economics 101

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

Energy Economics 101

Program

Overview of “Energy Economics”

Recognizing Value in “Energy Investments”

Energy Economics 101

What is Value?

Energy Projects are good values…

“How Good is Good?”

Energy Economics 101

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

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

Energy Economics 101

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

Cumulative 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

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

Energy Economics 101

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

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

Energy Project [B]

($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

Energy Economics 101

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

Cumulative Cash Flows

Energy Project [B]

($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

Energy Project [B]

($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

Energy Economics 101

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

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

Energy Project with Lease Financing [C]

($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

Energy Economics 101

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

Cumulative Cash Flows

Energy Project with Lease Financing [C]

($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

Energy Project with Lease Financing [C]

($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

Energy Economics 101

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

Cumulative 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

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

Energy Economics 101

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

Cumulative Cash Flows

Energy Project [B]

($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

Energy Project [B]

($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

Energy Economics 101

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

Cumulative Cash Flows

Energy Project with Lease Financing [C]

($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

Energy Project with Lease Financing [C]

($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

Energy Economics 101

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

Energy Economics 101

What is Value?

“How Good is Good?”

10% Bond = “Good”

Energy Project = “Exceptional”

Leased Project = “Incredible”

Energy Economics 101

Program

Overview of “Energy Economics”

Recognizing Value in “Energy Investments”

Understanding the Importance of Financial Leverage

Energy Economics 101

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

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

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

Performance Measures

Payback 3.36 yr

IRR 43%

Cumulative Cash $549,745

NPV @10% $257,265

Performance Measures

Payback 3.36 yr

IRR 43%

Cumulative Cash $549,745

NPV @10% $257,265

Energy Economics 101

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

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 -- 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

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

Performance Measures

Payback 0 yr

IRR NA %

Cumulative Cash $497,410

NPV @ 10% $265,754

Performance Measures

Payback 0 yr

IRR NA %

Cumulative Cash $497,410

NPV @ 10% $265,754

Energy Economics 101

Comparing Returns – 4,000 Fixture Project

Payback

Internal Rate of Return (IRR)

Cumulative Cash Flow

Net Present Value (NPV) @ 10%

Base

3.36 yr

43%

$549,745

$257,265

5-YrLease

0 yr

NA %

$497,410

$265,754

Energy Economics 101

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

Energy Economics 101

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

Annual Energy Saving $0 $22,000 $22,000 $22,000 $22,000 $22,000 $22,000 $22,000 $22,000 $22,000 $22,000

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

Annual Energy Saving $0 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000

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

Annual Energy Saving $0 $19,000 $19,000 $19,000 $19,000 $19,000 $19,000 $19,000 $19,000 $19,000 $19,000

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

Annual Energy Saving $0 $39,000 $39,000 $39,000 $39,000 $39,000 $39,000 $39,000 $39,000 $39,000 $39,000

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

Energy Economics 101

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

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

Performance Measures

Payback 4.2 yr

IRR 28 %

Cumulative Cash $2,350,000

NPV $877,871

Performance Measures

Payback 4.2 yr

IRR 28 %

Cumulative Cash $2,350,000

NPV $877,871

Energy Economics 101

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

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

Performance Measures

Payback 0 yr

IRR NA %

Cumulative Cash $1,609,073

NPV $772,318

Performance Measures

Payback 0 yr

IRR NA %

Cumulative Cash $1,609,073

NPV $772,318

Energy Economics 101

Comparing Returns – Multiple ECM Project

Payback

Internal Rate of Return (IRR)

Cumulative Cash Flow

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

Energy Economics 101

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

Energy Economics 101

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

Energy Economics 101

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

Energy Economics 101

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.

Energy Economics 101

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

Energy Economics 101

Program

Overview of “Energy Economics”

Recognizing Value in “Energy Investments”

Understanding the Importance of Financial Leverage

Summary of Concepts

Energy Economics 101

Concepts

All capital improvement projects are not created equal.

“Use of Cash”or

“Source of Cash”?

Energy Economics 101

Concepts

Energy Investments can Outperform Financial Investments

Project IRRs can generallyrange from 20% to 70%

Energy Economics 101

Concepts

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

Understand the Impact of Financial Leverage.

Energy Economics 101

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.

Energy Economics 101

Who Wins…

CustomerUtility CompanyServices ProvidersFinance CompaniesGovernmentsEnvironment

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

Energy Economics 101

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

Energy Economics 101

References

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

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

Energy Economics 101

Mahalo…

…Questions?

2660 Waiwai Loop Honolulu, Hawaii 96819 (808) 839-7300miles.kubo@energy-industries.com

www.energy-industries.com