What Was The Question?

A paradigm shift starts by flushing out the assumptions that are unconsciously taken for granted. The classic business school example was the great crash of the railroad company, which followed... you get it: the railroad rush and boom... if only, the theory goes, they thought of themselves as transportation companies instead of as railroads. But, naturally it is only typical that when we are successful at what we do, we do not have eyes and ears for the next thing, for almost everyone falls for the temptation of believing themselves and their business invincible - after all their accountants tell them they are making record profits, so they must be doing it right. There seems to be no need to question the "accepted" model and the long forgotten assumptions that underlie it.

Energy policy is such an area. Technology is shifting very fast, but the use of it for the most part is unimaginative, and plagued with those unconscious assumptions. So we end up plugging renewable energy into a business model that is based on the subscription model of energy, and the capital expense for renewables does not seem to be warranted. We are oblivious to the fact that we asked the wrong question.

The question seems to be I'm now spending, let's say $100,000 a year for energy in my building, what can I do to reduce my cost? The first round of answers came from the utility industry and was based on the insight that sometimes you get more bang for the buck by reducing demand than by increasing supply, so incentives were created to achieve that. But on the basis of an individual building manager, answer is not enough, for it does not address the true economics of building ownership - it simply perpetuates the franchise of the utilities, which defeats the purpose in the long run, which must be energy independence. This approach is akin to a heroin addict who goes on methadone for a while because he can't afford his daily fix any longer, but then after awhile goes back to heroin when he thinks he can manage it. Making the addiction "manageable" does not solve the problem. Or, to use another metaphor, our real estate industry is like a little baby who refuses to be weaned from the breast of the utilities and the oil companies and start eating solid food.

To put it in financial terms, if the question is how do I reduce my $100,000 energy expenditures, then I tend to get focused on energy conservation as an investment, which always produces the predictable diminishing returns. Simply put, when I started I had the choice of 5 technology options, and since I'm conservative and prudent (or so I think), I take the one with the shortest payback first. It saves me 10%, so now my base is 90% of what it was before. The next one also saves 10% but only 9% on the original scale, so the second 10% reduction brings my expenditure to $81,000 annually, and the third 10% to $72,900. Note, in actual life the results will likely be worse, because some of these options tend to partially cancel each other out, so in reality I may get to $75,000 in constant dollars.

Next I contemplate a much more expensive option, which promises a 30% savings, however since my base is now only $75,000 and my payback period now is 4 years, when it would have been only 3 years, if I had done this investment first. Not to worry, just wait until the energy prices go up again, and your payback will meet your criteria. Or did you think energy prices were going down? The bottom line is, that of the five options we had we should have contemplated the biggest one first, and the other second, for otherwise we talk ourselves out of the deal. The longest payback should have won out on that basis, if it was within the criteria at the outset.

However, we are still investing with diminishing returns, so incrementally every dollar yields less, and we run up against a hard limit beyond which we cannot go with this approach. The alternative is to learn to wean ourselves from the breast milk of the local utilities and the oil companies. When is the time? Perhaps we should first max out our investment in energy conservation, before we wake up? Or should we wake up now and start properly investing in the profitability of our business, instead of just incrementally spending ourselves into the corner of diminishing returns, and be totally stuck when the next energy crisis hits?

The point is very simple, that solar hot water heater, may have a 6 year payback, even after incentives, and it has a 30 year lifespan, but that high efficiency gas hot water heater with its 3 year payback only has a 10 year life expectancy, so over the 30 years you will still have gas bills, and 3 replacements, while the solar plant has negligeable O&M costs. In six years, which building will produce a higher asset value mine with an energy cost of $20,000 a year, or yours - an identical twin otherwise - with a proud certificate of achievement from ConEdison and NYSERDA on the wall that you are one of their most efficient consumers because you reduced your energy consumption by 30%? By the way, you're now only 4 years away from having to replace that high efficiency gas hot water heater, and I don't think that a new one that's 99.6% efficient in the lab is going to make much difference over the old one which was 99.5% efficient, and looked like such a bargain. And meanwhile my building may still be buying energy in one form, but quietly it is generating an offsetting amount of energy in another form, and monetizing it, so that it is effectively hedged against the cost of energy going up.

So, financial common sense would argue that you quit listening to the vendors who are pushing their devices based on payback - let the shortest payback win - and treat these investments as intra-marginal investments in your building, and focus on long term asset value of your portfolio. In short a discounted cash flow model, and NPV should be your criteria, as well as the long term engineering path towards energy independence. I know, the banks will gladly lend you 20 year money for a 5 year problem fix. Sure, you can save a lot of energy, and you can afford to service the loan, but after all, whose interests do you serve - the utilities, the oil dealers, the banks, or perhaps creating value in your own business should be considered?

In short the next question that should be questioned is: "How do I reduce my energy bills?" The proper question should be: "How do I create the highest asset values in my buildings?" and energy should be looked at as a profit center, not a cost center. Even an economically minimally viable path towards energy independence will create higher asset values, than current practices that are focused on energy conservation, energy efficiency. You may have to give up on those certificates of achievement from your local utility.