The Voodoo Economics of Energy Efficiency

Recent reports continue to draw attention to the notion that energy efficiency predicts lower mortgage default rates. Indeed, it seems obvious that energy-efficient homes are worth more, and that mortgage default risk on such properties should be lower. This is the same kind of analysis that was previously used to promote PACE bonds. It may be superficially right, in the sense that the relationship is observable and provable, but it misses the point, simply because a more categorical understanding is possible. Or, while these relationships may exist and seem statistically significant, correlation does not imply causation. There is no consistent approach to underwriting risk for energy efficiency, nor is there an analytically sound approach to explaining why or to what extent the risk of defaulting on home loans is reduced under energy efficiency. The following attempts to fill that gap by means of a simple example.

Energy Efficiency is Secondary

First, energy efficiency is not a primary objective, but a secondary one. The first order of business is a make-or-buy decision about on site generation with renewables (Site Derived Renewable Energy) versus a carbon energy subscription. The easiest way to see this, is to realize that you cannot save yourself rich, something everybody knows and understands. Let's look at four people, property owners all, and their different approaches, Mr. Tinkerer, Ms. Efficiency, and Mr. Analyst, and Ms. Intuition.

Mr. Tinkerer - Energy Efficiency Flying by the Seat of your Pants

• Mr. Tinkerer begins by "saving" energy without thinking, and thereby accepts the status quo. In his single family home he has an $300 electrical bill and an $700 oil bill, for $1,000/month combined.
• He then buys some gadgetry that reduces energy consumption and some insulation, and his bills goes down to $900.
• A year or two later, after some energy price increases, and more wear and tear, he is back to paying $1,000 a month.
• He keeps tinkering and spending money on Energy Star appliances and other energy-efficient products, but never realizes why he's not achieving serious energy efficiency.

This is a case of casually pursuing energy efficiency, and it is probably the most common. Mr. Tinkerer operates from the unexamined belief that he can save himself rich, but all he does is overpay for "energy saving" devices, without ever realizing that energy savings are not additive. Most of us dabble in energy efficiency in similar ways, it's a way to shop without guilt. It probably is a wash in the beginning, we spend as much as we save, but in the long-run we spend way more than we "save." Sometimes it's a lot more, for the savings do not add up, EVER.

Ms. Efficiency - Energy Efficiency by the Book

• Ms. Efficiency really goes hog-wild, and does everything she can to reduce energy consumption, year after year. The first year she spends $3,000 and creates a 20% reduction, i.e. she enjoys a 15 month payback on her investment.
• The second year (she still have 3 months to go to earn back that first investment), she spends $6,000 for a further 10% reduction. Simplistically, 10% of the remaining $800/month energy bill is $80, and therefore she now enjoys a 75 month payback, or 6.25 years.
• The third year she can't find anything else to do, she wants to do something major, and now she talks to SolarCity (or any other similar provider of solar pv on a PPA- or lease-basis), and they can provide her with a solar panel (nothing down!!!) and reduce her electrical bill by 10% (she's already very efficient), for a further 3% of her overall energy bills. It's a 20 year Solar PPA. So now her monthly energy bills are down to $698.40 in constant dollars, but there were a few price increases, so she's at $750/month for the year. However, now her roof is covered with a beautiful shiny solar panel! She sends a Christmas card to her mother, to show off the solar panel, and mom is duly impressed with how green her daughter has become.
• However, once she analyzes the figures correctly, that solar panel is a 20 year investment of $40,000 for a 3% reduction in her energy bills (10% on electricity alone), which means a payback of 154 years.
• She's still paying $750/month in energy bills (including the $200/month solar lease), and the prospects remain that prices will go up for the remaining $550 "energy" portion of her monthly payments. What has she won? To a financier it seemed things have improved, for $750 now is less than $1000 a few years ago, but that PPA commits $40,000 of her borrowing capacity, and the panel locks out most of her roof, for any alternative uses that might prove to offer better results.
• The residual energy portion of her monthly obligations continues to be above 50% of her starting figure.

In short, a categorical make or buy decision has to be made first before anyone starts on efficiency: do we continue to buy energy, or can we economically make our own. On site renewable energy generation is the alternative to buying energy in perpetuity. Energy efficiency only comes into consideration AFTER we make that make or buy decision, or else we falsify that decision, which is now commonly the case.

Energy Efficiency and Diminishing Returns

The example above shows the effects of diminishing returns, the successive investments show less and less savings, because the base is growing smaller. Ms Efficiency started out investing $3,000 with a return of $200/mo then $6,000 with a return of $80/mo, and finally $40,000 with a return of $21.60/mo (clearly she is paying more for every successive improvement, while here additional savings decrease). This is a losing battle, and it is the battle home owners are losing all around the country, as long as they believe in the "savings" paradigm.

Short-term, yes cash flows are improving, but a few energy price hikes can wipe that out, and the result is that eventually the improvements prove minimal or non-existent within a few years.

PACE Bonds and Mortgage Default Risk

The rationale for the creation of PACE bonds was to provide building owners with a means of financing major capital investments up front to do material retrofits in the energy infrastructure of properties. Unfortunately, the PACE bond camp has been hi-jacked by the energy savers also, and thus they have become yet another customer retention program for the energy companies, and the vendors of energy saving widgets, which was not the original idea. PACE bonds were designed to overcome the capital intensity of the switch to renewable energy, not to squander money on energy efficiency enhancements. Investment in renewable energy moves energy from liabilities to assets, and therefore would structurally reduce underwriting risk, if the economics are solid.

Enter Mr. Analyst - Investing in Site Derived Renewable Energy first

Here is how it should work: Mr. Analyst, with the same $1,000/month energy bill, invests significant money (maybe $140,000), and gets 20-year PACE financing that costs him $900/month, but he wipes out 85% of his energy bills. He gets a geothermal heat pump that provides his HVAC, and a solar panel that offsets most of the electrical load. The first year he gets a 30% tax credit on some of that investment, etc., which helps, but he ends up in a similar situation to his neighbor Ms. Efficiency. She went the energy savings route for the first 3-5 years, but then gradually Ms. Efficiency observes her bills nudging above $1,000 again. Mr. Analyst stays steady at $900/mo in payments, and his residual energy bill of $150 grows a little bit, but not a lot. And Mr. Analyst looks better with every passing year. Let's assume that equipment lasts 30 years. By that time the energy profiles of the two homes will be vastly different.

Ms. Intuition - Thinking Long-Term

Ms. Intuition in the meantime may be even smarter, she gets the same geothermal heat pump, and puts it on a time of use meter, running it mostly at night. She reads the papers, and she sees that solar panels today are 15-20% efficient, but there's some new invention every few months that promises a great breakthrough. She waits a few years, until solar panels have gone from 15-20% efficiency to 35% efficiency, and she now installs a solar panel that completely offsets her electrical use, and she ends up with zero energy bills. In short, she "ate" the electricity cost for a few years, but she gained a technology advantage compared to Mr. Analyst. Geothermal heat pumps are already 400% efficient -- returning 4 joules for every 1 joule you supply -- and are not likely to get any better. With solar PV there is another patent announced every week to increase the conversion efficiency, so it was a reasonable guess to expect that the efficiency of that technology would increase in coming years, and that waiting could be prudent. Notice also that the solar panel here enhances the investment in the geothermal heat pump and improves the value of that energy price hedge even further.

These are just examples. The numbers are rough, to show orders of magnitude, but the principles are clear. They show that the passive stance of "energy efficiency" and "energy savings" is often bested by a focus on generating your own energy wherever it is economical.

• We can't save ourselves rich, and energy efficiency might reduce underwriting risk somewhat, but there are better alternatives, such as investing in Site Derived Renewable Energy (SDRE) instead of energy efficiency.
• Energy efficiency is an operational expense, not an investment, it is short term in nature and mostly not part of permanent plant, but subject to wear and tear.
• Energy generation with renewable sources is an investment that adds to property values, by moving energy from liabilities to assets.
• Logically, in the short-term "energy efficiency" might be a self-liquidating proposition, which by definition would reduce the underwriting risk and the chance of mortgage default by the amount cash outflows are reduced, however these effects don't last, for easily provable reasons.
• Site Derived Renewable Energy (SDRE) is a clear and lasting energy price hedge, certainly if more than 50% of the energy requirement can be economically generated on site. In this case the performance of the property improves with every energy price hike, and thus there is a long-term reduction in underwriting risk, and we can expect a commensurate, but lasting reduction in mortgage defaults.
• SDRE also offers protection against a carbon tax, if it ever were to come. Again, energy efficiency cannot do that, even if it may temporarily reduce mortgage default risk. 

Current research into the issues of mortgage default rates fail to distinguish these structurally and financially very different alternative scenarios, while it is analytically clear that the one has a short-term effect, and the other adds lasting value to a property.

Conclusion - Investment in SDRE wins out over Energy Efficiency

Energy efficiency can be shown to produce improved cash flows in the short-run, and therefore should reduce underwriting risk and mortgage defaults. However, for good analytical reasons the longer term value of energy efficiency alone is uncertain, and a better option is renewable energy generated on site (SDRE), that is justified not only by the marginal savings of the equipment, but also by the lasting improvement of property values.

Compound Returns from Renewable Energy

There are many ways to look at our energy conundrum, and to understand why we're so dysfunctional, and not getting the job done with renewable energy. As argued here repeatedly, one of the primary obstacles is putting the cart before the horse with honorable sounding secondary objectives, which obfuscate sound financial decisions. Energy efficiency, energy savings and clean air standards are examples that cause such distortions, and lead to policy failure. They are secondary objectives, not primary ones. The worst policy failures are resulting from confusing energy efficiency with renewable energy, and treating them as if they were interchangeable, or worse yet, additive, when they are often mutually exclusive in practice.

The effect of majoring in a minor by putting these secondary objectives first, is to postpone the switch to renewable energy indefinitely, and to subsidize the fossil fuel industry at the expense of property appreciation. Therefore it produces the opposite of energy independence and undermines any attempts to ever meet Clean Air standards, such as New York City pretends to want to do. Energy Star, NYSERDA MPP, NYC Clean Heat, PlaNYC, various tax incentives, are all examples where false priorities foul up sound financial decision-making about renewable energy. Collectively they have more to do with why we are not making the progress that we claim to want than anything else. They are examples of policy failures. Their ally is the fallacious financial practice of property owners making energy decisions based on payback of equipment, instead of net present value add to property values.

In short, government incentives have assisted property owners in making more bad decisions about energy faster, by rewarding them to ensure they keep making the wrong decisions, and the beneficiaries are the fossil fuel industry primarily, and to a lesser degree the manufacturers of energy efficiency equipment. It all comes at the expense of property values, so owners of real estate are destroying their capital asset base, to the extent that there are renewable alternatives that make economic sense, and in many, if not most cases, there are. False priorities supported with government incentives amount to government sponsored capital destruction in our economy, and serve to prevent the switch to sustainability. In NY State there is even an Energize New York Finance Handbook, and an exam to make sure you learn how to destroy your property values even quicker, using other people's money (but you're still liable). There is even an entire not for profit industry to help you manage your property into the toilet, such as "Energize New York, comfort and savings for your home."

Sustainability is only sustainable if it is also profitable

Adam Smith's invisible hand arguably does not always work, but sometimes it does. And here we have a capitalist society, embracing soviet style 20-year plans to make sure we prevent the invisible hand from working... But the good news is, there is a way to sort it out on an individual level, though eventually the whole structure of false incentives will have to be revised.

Every property owner can, with a simple spreadsheet make a 30 year energy plan for their property. And if you are lazy, you can make it a thesis project for your kid. It does not matter if you're going to sell it sooner than that or not, for if you invest wisely, it will come back to you when you sell it. After all, real estate simply has a long economic life, but if your analysis shows that your property is a wreck, and incapable of being made somewhat energy independent, sell it quickly while the going is good. The energy companies and the government will keep you in the poor house by confusing your decision-making and keeping you a slave to the energy companies longer than you have to be. Proper financial modeling is the way out, he process is a simple 30-year NPV analysis of all energy decisions about your property. Do not ever give in to the energy efficiency argument, it will keep you in bonds to carbon energy forever. Salesmen of energy efficiency and Solar PPAs are stealing appreciation of your property from you.

If you do that 30-year CAPM model, you will not easily make wrong energy decisions again. Never allow yourself to be seduced by the sellers of energy efficiency, and any government incentives, or subsidized finance from your energy company (talk about the fox watching the chicken coop). Remember always: Good financing or incentives can NEVER make a bad project good, it can ONLY make a good project better.  Hang that on your kitchen wall before you start talking about anything to do with energy in your property. Now for the good news: Renewable energy pays, because of compound returns.

Compound Returns from Renewable Energy Make Sustainability So

Payback of a piece of equipment may be useful as a quick and dirty calculation to see if it could have promise, but you need to have a coherent, holistic energy plan first, or else you will be cheated out of your money, and squandering it. The obvious mistake is if you start using equipment payback for your actual energy plan, such as models from NYSERDA and similar organizations elsewhere tend to do. Incentives are then added to the mix to make other objectives more attractive to property owners, either from a societal standpoint (and most often indirectly benefiting the energy companies and/or the manufacturers), or for the energy companies directly, and then if you add up all these wrong decisions and you score enough points in their system, you are rewarded with subsidized finance to help you destroy the value of your property faster. The shareholders of the energy companies thank you.

But now you know. And armed with your 30-year energy plan for your property, here is what you do: You do your model first. You focus on selecting the technologies that make the most long-term sense for your property. And next you figure it out with the NYSERDA MPP model, or your Energize New York application, or whatever is appropriate in your case, and you now figure out backwards how to maximize your use of incentives, and how to exceed their standards so that you do qualify for the subsidized financing, including PACE bonds. But never follow the methodology of these institutions, for it will destroy your property value. Your own economic energy plan must be king, meeting their objectives is a secondary criterion that gets you the financing you want, but you must take ownership of the plan.

Here's the payoff: on your list of potential things to do you might have a geothermal heat pump and a wind turbine, with paybacks of 8 and 7 years respectively, and they are kind of at the bottom of your list. But then you find out, when you integrate it in your model, that the heat pump allows you to store output from your wind energy in the form of pre-heated hot water. By doing so, you no longer have to sell excess energy back to the grid at wholesale rates, so you are now improving the payback on your wind turbine. Put together, they might have a 6 year payback, but again, the 30-year projection tells all.

Or, you were evaluating a tankless hot water heater with a 3-year payback and a solar thermal system with an 8 year payback, but your thirty year model reveals that the solar thermal system works out better in the long run, in part because with solar thermal you can harvest process heat, and if you take that effect into consideration, it may turn out that it's a better investment than tankless hot water heaters. Thirty years of no energy bills beats 30% energy 'savings' hands down. And of course solar thermal beats out solar PV because it produces 5x more energy per square foot, and on top of that allows storing process heat. All of which you would never see in a payback analysis, but you will see it in your 30-year model.

Or, you were evaluating a geothermal hot water against solar thermal hot water, and it turns out that on a payback basis solar thermal won, but then you started to look at your integrated model, and you could put your geothermal heat pump on a time of use meter, and integrated it with self dimming LEDs (100% dimmable!) for premises/common area lighting, and suddenly the geothermal hot water system won, and now you could look if you could drive your HVAC from geothermal also.

Sustainability through compound returns

Examples abound where the thirty year model shows you synergies of two (or more) technologies that you would not otherwise figure out, but most importantly it is the time value of money that allows you to see that 30 years of no energy bills beats 30% reduction in energy consumption most of the time, and a bigger capital outlay is warranted, and feasible if you can access subsidized financing. Such compound returns through synergy are worth gold.

Conclusion:

Renewable Energy done right produces compound returns through integrating several Clean Energy technologies at once. Energy Efficiency of a fossil fuel system produces strongly diminishing returns after you hit about 30% 'savings,' which is literally fool's gold. Only energy-efficient renewable energy gives you financial sustainability.

When Energy Star is Counter Productive

Energy Star is a powerful label. It does a lot of good for simple decisions, such as a kitchen appliance (as long as manufacturers are not gaming the system). Yet it is frequently used in counterproductive ways when it comes to more complex decisions, and, the program itself is counterproductive if it focuses on energy efficiency alone, such as it does for buildings.

Energy star appliances

Provided you have good data on the actual consumption of appliances--which has not always been easy--the Energy Star idea makes decisions easy. You know you want a refrigerator, you expect it to live 15 years, and you live in NY, so you look at the price forecast, and you see that the reference case from the US Energy Information Administration forecasts flat electricity rates for the next 15 years, evidently the spike from a few years ago is behind us. If I look at my bills, my rate per kWh may average (all in) 35 cents per kilowatt-hour. And so, if one fridge burns 100 kWh more per year than the other, then I stand to save $35/year for 15 years. So far, so good. As long a the data is real, it is easy. The only real issue then is about the quality of the disclosures.

Energy star appliances as components in a building project

It gets more complex when Energy Star components are specified for building projects, as happens when lenders, or the IRS, have this in their specifications. All with the best intentions, of course. However, it leads to sub-optimal choices in many cases, because for a building what really matters is the performance of the whole project, not just of the component.

My favorite example is the tankless hot water heater, which is being heavily pushed on consumers, but frequently is the worst possible choice. Yes, if the only thing you could ever do was to heat hot water with gas, more efficient is better. But the truth is that you have options like solar thermal and geothermal and both can produce a substantial amount of free BTUs for your hot water (and maybe HVAC as well). If you do a proper 30 year net present value analysis, the systems with free energy (renewable), may outperform the system that merely offers energy efficiency, because you continue to have energy bills even if you reduce consumption by 20% compared to your previous heater. That still leaves 80%, plus you probably need to replace that heater at least one time in the 30 year period. In the renewable case, your energy bills might be reduced to 15-25% of what they were before, just for backup, or complementary heat. Now if there are incentives in place which favor one over the other, and get people to make worse decisions, that's not good.

If you need a water heater for backup in a solar or geothermal install, an Energy Star rated 98% efficient heater with heat recovery (from the flue gas) may be the worst option, because not only is it much more expensive, but it will need to be replaced probably twice during the 30 years, because the heat recovery system will tend to become corroded when that heater is not running flat-out most of the time. You will get condensation, and maintenance nightmares. But the construction finance, or the IRS (tax incentives) specify that the components must be Energy Star, so your accountant wants to force you to use Energy Star equipment, when you know it will be a headache, and less economical in the long run. In short, in this case the Energy Star system might have made sense if it was a primary system, but it definitely is counterproductive as a backup system.

Energy star - Battle of the Buildings

At the building level the problem with the energy star approach really comes to the fore. Now it is all about majoring in a minor. Much ado about nothing. Whatever you want to call it. The major is Energy Generation, the minor is energy efficiency. When you major in a minor, you miss your objective. In this case the most energy-efficient solutions is often the worst one in the long-term. Energy Independence was the goal, and you focused on saving a nickel. You may win a prize, but the long-term value of your asset, your building will be depressed, if you chose energy efficiency of a carbon based energy infrastructure over a (more expensive) renewable energy solution that brings you energy independence. The reason is simple the 30% more efficient building will still use 70% of what it used before, and be subject to energy price swings as before. One or two price hikes can wipe that out. And the next investment in energy efficiency will run into a wall of diminishing returns, the next 10% of savings will likely cost more than the first 30%. To begin with the 10% savings off the original will now only be 7%, and it is a project you had on your original list, but you did not choose it, because you could get 30% from other sources. But now you've painted yourself into a corner.

If you can do one renewable project in that same building, and you are doing a proper 30 year financial analysis, you have now permanently replaced xyz amount of BTUs from renewable sources, and you still have all your options open. This is the beginning of

Only free energy is really free

energy independence. Now if there is a price hike, you may decide to do more insulation, and the result will be that your original investment, which was covering 30% of the BTU load, now will cover 50% of the BTU load, so you are getting compounding returns on your subsequent investments. The building that started on energy efficiency without first doing the make or buy decision about energy sourcing (from the grid or from renewables) can only get 7% improvement from his next investment, but you can get 20%.

In short, the two investment paths are explosively divergent, and in the end the building that  went for energy efficiency and won a prize will pay for their foolishness with lower building values. The whole problem starts with looking at energy efficiency at one point in time, versus looking at a 30 year time horizon on a CAPM basis (NPV analysis). Counterintuitively, the EPA is sponsoring energy INefficiency and capital destruction by foolishly promoting energy efficiency at ONE point in time. What is needed first is a proper make or buy decision - renewables versus the grid. Building owners may get to be on TV with their buildings for being so efficient, but they'll pay for it in lower building values.

Energy independence vs energy efficiency

To summarize, buildings are assets that last a long time, and they are complex energy systems which must be completely understood from the supply and the demand side before you can see what your best options are. Energy Efficiency of an existing carbon-based energy system may be your only option, but you can only make that decision by doing the 30 year economic analysis first. If renewables are an option at all they provide a long-term investment path with superior returns, and a realistic hedge against energy prices. Therefore they will provide for dramatically superior building values.

The upshot is: Energy Efficiency by itself achieves the opposite of Energy Independence in a Carbon-based system, and the Energy Star program is seriously counterproductive in these cases.

Off the grid in four easy lessons #4

Off the grid is a direction not a destination, and the principal instruments to get there are financial analysis and economic modeling, not technology. So never mind the government has no energy policy, just a rag-tag group of programs and incentives that tend to confuse people more than help towards a solution. Never mind that utilities and oil companies do everything they can to seduce real estate owners to remain happy carbon customers till the cows come home with all kinds of energy efficiency solutions. It is up to the property owner to make sense of them, and the principal tool you have is the Capital Asset Pricing Model, aka CAPM and once you start studying it, and looking into the various technology options you may have regardless of what your starting point is, you will be amazed. Research CAPM, study Internet resources, including CAPM Free Questions.

Energy Efficiency and equipment payback - the trap to be avoided

To recap from earlier posts: energy companies (utilities, oil companies, etc.), and vendors of equipment will inevitably try to get the attention of real estate owners with investments in  energy efficiency, which are to the benefits of their shareholders, and NOT of the real estate owners. The nature of energy efficiency is that the first investment always looks very good, and typically offers outsize returns (on the basis of payback), and 99.99999% of owners do not stop to think that they are committing to an investment path that perpetuates their indentured servitude to carbon energy. The vendors capitalize on these insights by selling their "solutions" based on marginal analysis of energy savings, always showing a wonderful payback for their equipment, and waiving around Energy Star labels, tax incentives, or other subsidies. If they are successful, you've invested your money in remaining the customer of your energy company forever. This is voluntary vendor lock-in. Various tax incentives, but also NYSERDA, Energy Star, CPC, PACE, and most mortgage providers will steer you wrong because their programs are useful only if your own CAPM analysis says so. Don't run your financial future based on someone else's say so.

The morning after effect comes in when you want to do the next "investment," which is worse but you'll probably still do it. Some day you'll have to realize that diminishing returns mandate that you'll never ever find another investment as good as the first one. The cynic might say these are not investments at all, but operational savings. Even various form of PPAs offered by energy companies tend to suffer the same analytical defects and will benefit the shareholders of the energy companies more than the home owner. Caveat Emptor!

Off the Grid with CAPM

Getting Off the Grid starts with the one and only thing that every property owner should do first, last and in between: make a 30 year financial model of your property, and use it to model your own strategic energy plan, always comparing the base case as the investment in energy efficiency based on the existing infrastructure, with the alternative case using green energy. Again, energy efficiency will never get you off the grid, green energy will, if you figure out the right way of implementation. The first decision is a make or buy decision about energy: should you buy it on a subscription basis, or generate your own. Watch values of net zero properties for reference.

It is never ever what the salesmen will tell you, nor should you let yourself be confused by tax incentives, NYSERDA programs, PACE and/or other energy efficiency finance. They will all steer you wrong, to the detriment of the long-term value of your asset, your property. Study the energy economics of your property first, before you figure out what incentive programs are to your long-term advantage. You will repeatedly find that financing mandates, e.g. of Energy Star equipment, may benefit the energy industry more than it benefits you. Don't buy it unless it actually helps improve the long-term value of your property. Financial sanity starts with CAPM!

Your CAPM Badge

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OFF the Grid: The basic assumptions about the relevant cash flows

Here is a list of the major cash flows and assumptions you need to document:

1. For starting asset value use Zillow, or a similar service.
2. Identify ALL forms of energy you use - it may be two or three.
3. Make a 12 month model so you start to see seasonality, you will therefore have 360 cash flow periods.
4. Track both consumption and pricing.
5. Notice that in deregulated states it probably makes sense to split the cost of delivery and supply. In many cases, certainly in NYC, delivery is 65% of your utility cost per kWh or per Therm, and rising inexorably ABOVE the rate of inflation. For my gas it is 95%, because I use so little of it.
6. Identify specific inflation rates for all your energy component costs and rates.
7. Track reasonable assumptions for maintenance (i.e. annual costs, but also periodic replacements, such as a boiler or water heater that may last 10 or 15 years).
8. Make a base case (A) based on your existing energy mix, with incremental investments in energy efficiency. You will start to see how these investments will get wiped out by ongoing price hikes, let alone spikes such as have happened from time to time.
9. Make a case B based on renewable energy. Try to identify the rationale for a strategy to eliminate one fuel completely (oil or gas), or as near as you can get to it.

Experiment with such a model until you are comfortable. Until you are, you are not ready to begin shopping for energy solutions.

Off the Grid: Sane assumptions for getting there

As much as possible try to think of projects to coincide with maintenance things you'd have to do anyway. In other words, if in five years you would have to replace your boiler, that may be the timing for switching to geothermal, or solar thermal, or some other combination, and you may only need a very small boiler for backup. Or, if your roof needs to be replaced that may be a time to improve on insulation, and/or solar or wind installations. You do not want to install a set of solar collectors with a 20-30 year life expectancy on a roof that only has 5 years of life left in it.

Avoid tankless water heaters like the plague. Domestic Hot Water storage is a very efficient energy store, you may need it in your design later on.

CAPM: valuation issues

Study the energy independence profile of homes in your area. With net zero homes and buildings growing, energy costs will increasingly become important in valuation. If a few homes in an area are energy independent or close to net zero, that will start to diminish the values of all other properties.

Be prepared to learn a lot. Both good and bad. The renewable energy path is more capital-intensive, but it will increase your property value more. You will find opportunities with compound returns because of synergies. Keep studying what is going on in your market, and never ever listen to a sales rep coming with payback periods, and various incentives. He or she is stealing the value of your home.

Off The Grid In Four Easy Lessons #1

Getting Off the Grid may sound easy, but it's hard to do, and the major reason it is so hard is financial, not technological. One of the major problems is that energy efficiency and green energy are being confused in the priorities. The majority of government programs in fact are unintentional (and in some cases intentional) subsidies to the fossil fuel industry, and the vendors of energy equipment make use of the confusion to sell us all more of their energy efficiency equipment, on the pretense that it is 'green,' and the wrong use of energy efficiency causes the indefinite postponement of the green energy economy. We want green energy and not green paint.

Off the grid living may be a marginal phenomenon, but it If you check out the Wikipedia article in the link above, you'll see that already in 2006 there were reports that the number of homes that were off the grid had been growing at 33% a year for 10 years. This off the grid trend is now rooted in seriously green energy, though not in all cases, and we should separate the survivalists from the regular economic approach choosing green living simply because it makes more economic sense. Today as I'm writing this, the Wall Street Journal just had a major article about Stealthy Green Homes. Off-Grid Real Estate is the thing to watch. Off the grid homes are no longer a marginal phenomenon. Anything growing at 33% for 10 years or more bears watching, and by the time WSJ reports it is becoming main stream, you can rest assured it is main stream already. The important point here is that this is mostly about new construction, and that of course gives you a lot of options to design things right from scratch. But, since there are more old homes than new ones, retrofitting is more important, and it is also more difficult.

Green energy confusion: avoid retrofits that invest in fossil fuel slavery

There is a general confusion that somehow energy efficiency and green energy

Green Energy, not Green Paint

are synonymous, and they are not. Energy efficiency will never add up to green energy, and if you are now consuming fossil fuel-based energy, and you start investing in energy efficiency, you are merely ensuring that you are never coming off the grid. You are merely investing your own money in becoming a better customer to your existing energy suppliers. In short, this is an issue of mixing up the priorities. The first decision is how you get your energy, fossil fuel (from the grid in the widest sense), or green energy in whatever form. Then you need to look at how you get there, and this is where efficiency comes in. With subscription fuels (fossil fuels and derivatives), efficiency pays off in reduced bills down the road, in green energy generation, efficiency pays off in reduced capital costs, because you need a lower installed capacity, and improved project returns.

Stop going off the grid with an energy star tankless hot water heater

The tankless hot water heaters is the poster child of the Energy Star program, and it is one of the worst investments you can make. This issue is emblematic for why efficiency should be considered second, not first. Since hot water is such a large portion of your energy bills in residential living, this is an easy target, and the federal government makes it worse by providing tax incentives for this type of Energy Star equipment, but home owners are in many cases stealing from themselves in the long run with lower asset appreciation. Assuming the tankless hot water heater is more efficient, all you are getting is lower energy bills, but you will still have energy bills. Such incremental investment in energy efficiency make you a better customer of your utility, at the cost of reduced appreciation of your major asset, your house. The shareholders of your utility thank you.

To see why, all you have to do is a 30 year CAPM evaluation of the project, which should be your planning framework for ALL energy decisions in your house. A solar hot water heater is a bigger investment, but once you take the 30 year horizon into account, you will see that it results in near ZERO energy bills for hot water (and yes, you could use a tankless hot water heater for backup, but a regular gas or electric water heater will do). Solar also has NO maintenance costs, while your tankless hot water heater probably needs to be replaced in 10 or 15 years. And by the way that backup heater does not need to be energy star rated, that's a waste of money. You'll use that backup heater perhaps for 15-20% of your BTU requirements for hot water.

Your tankless hot water heater may reduce your energy bills somewhat, perhaps even 15 or 20%. In other words, if you do your 30 year CAPM evaluation, you will have one or two replacements of that tankless hot water heater,  and 15 or 20% lower energy consumption, but the price can still go up or down with energy prices, and the cost of the grid (the DELIVERY cost of your gas or electric) keeps rising faster than inflation. Even the best tankless hot water heater can only reduce your energy bills, not eliminate them.

Off the grid with CAPM, not equipment payback

Before you start doing anything about energy upgrades in your house, make yourself a 30 year financial model based on the Capital Asset Pricing Model (CAPM), taking energy costs into account, and then figure out exactly what your best options are. If people did their sums right and did not allow the IRS to make their investment decisions, they'd be a lot richer, and their homes worth more. Next time a visiting salesman comes to your home, if he's pitching his latest energy-saving thingmajig with a superior payback period, and worse yet, with tax incentives, katy bar the door and do your own analysis first. He is stealing property value, value appreciation of your property, with your signature, even if he is armed with tax incentives and the blessings of the energy star program. A tankless hot water heater does not green energy make, nor will it get you off the grid.

Report 90by50 from the Urban Green Council

The recent 90by50 report from the Urban Green Council was an exceptionally well targeted feasibility study of the potential for drastic energy infrastructure change in New York City building stock. I already wrote about it on my green energy promotion blog. There is a lot to like about it, but it will also most likely be abused and bastardized in the process and the potential never realized. We seem to be a long way away from the kind of concerted action that is really needed, although the feasibility can no longer be in doubt.

While the report identifies clearly that things like New York's PlaNYC2030 were too conservative, and doomed to produce failure because it merely tinkers at the margins, this plan is too high level to be actionable as such, and therefore it may end up being its own worst enemy if we're not careful. Such a high level view has merits, but becomes tricky when it is combined with other high level views such as macro-economists are wont to produce and administrative institutions are wont to consume, so together they can make the high level nonsense that goes for energy policy, and worse, incentives.

However, the helpful implications are the fact that since reducing carbon emissions is definitely of primary importance, the sorts of marginal improvements that PlaNYC2030 envisaged were insignificant, if not counter-productive. There is great need to be more drastic than that. This was one of the reasons why, with my consulting company DaBx Demand Side Solutions, we issued a report 2 years ago, DaBx PlaNYC2020, to make the point that there was at least one class of buildings in New York that was capable of much faster and more drastic change in energy infrastructure, and achieve an 80-90% reduction in CO2 emissions in short order, with today's technology.

PlaNYC2020 alternatives, in relation to 90by50

In one way, I would consider our DaBx PlaNYC2020, of which Mayor Bloomberg was given a complimentary copy on July 4th, 2011 (which we dubbed 'energy independence day' for the occasion) to be a special case under the 90by50 approach, and in a way perhaps the low hanging fruit, although the technology path implied there is quite a bit different from the 90by50 model.

What the 90by50 report identified correctly, and one of the reasons why it chose a 37 year implementation period, is that the economically optimal way of achieving this transition would be to tie in as much as possible with the normal infrastructural overhauls that buildings need periodically. In our report we had argued that same point. For example, the program to phase out #6 oil and use natural gas or either #2 or #4 oil instead forces the issue and even provides subsidies to encourage such conversions, and thereby it preserves the carbon economy without any attempt to asses if renewable energy alternatives might be within reach. Clearly, if we could achieve substantial reductions in CO2 emissions, and at the same time improve long term building values by decoupling buildings from energy price hikes, not to mention any potential future CO2 assessments that would be desirable.

In short, there are certain building types that could make the transition to a low carbon lifestyle quicker than others, but that's being stopped by Soviet-style top-down twenty year plans and incentives to switch to Natural Gas. What we really need is grandfather provisions for buildings that commit to a renewable energy transition, but would be forced not to do so by the present deadlines for the conversion. Here is yet another example of how 'one size fits all' does not work for this problem, since there is such a wide range of structural potential and problems in different groups of buildings.

Methodology for Achieving the Green Energy future sooner

Bottom-up, not top-down

The risk of both the City's PlaNYC2030 and the 90by50 report is that they tend to steer towards a top-down approach. Much of this is predicated on how planners get their data. Planners are fed macro-economic pablum, which in the area of energy typically means an argument that by far energy efficiency gives us the best bang for the buck, and renewable energy is still mostly uncompetitive on the margin. And based on all that wonderful stuff, the administration then establishes policies accordingly.

Nobody seems to notice that in the process, the existing energy infrastructure is being taken for granted and treated as an unstated assumption, for the existing programs are typically geared towards energy efficiency, with the occasional cameo role for renewable technology. In other words, we start right away by optimizing for a secondary objective, efficiency, while skipping the initial make/or buy decision which should come first. It tends to be done correctly for new developments, but for existing buildings, this step is being overlooked. The further mistake that is implicitly made, is that renewables are evaluated in roles that are traditionally defined by the carbon energy model, and rarely do we see a systematic attempt to figure out what you can do differently with renewable technology, because of its unique properties, so that possibly you can pick up design advantages as compared to plugging renewable technology into a carbon based energy distribution model.

The first part of the insight into the potential of renewable technology is the extent to which it can be installed locally, so that a building in whole or in part supplies its own energy. A good example is sometimes provided by solar thermal. It is an often overlooked technology, yet it is 95-98% efficient compared to Solar PV at 15-20% efficiency. The question is, is there a practical way to integrate it into an existing building infrastructure. The cost of integration may kill the idea. However, it should evidently be tried, and be part of an evaluation.

CAPM, CAPM and more CAPM - the Capital Asset Pricing Model

In short, buildings should really begin to be looked at as potential energy producers, that can become partially independent from the grid. Net-zero is not a feasible objective in most cases for an existing structure, but enormous advances are feasible with today's technology. And such transitions can be incorporated in long term capital plans that take into account a 20-30 year equipment life cycle. Besides good engineering, the most critical piece is really  financial: a rigorous application of the Capital Asset Pricing Model should be the standard. If this is done, a far greater use of renewable energy technology is possible compared to what is being done today, and many existing incentives are counter productive at least some of the time, because the favor vendors of equipment and or the energy companies themselves, at the expense of the long term economic interests of the building owners.

There are also some regulatory hurdles that will need to be addressed. The famous split-incentive problem between landlords and tenants will have to be addressed. In low income housing there are rules that are promulgated by HPD and CPC, which prevent the highly necessary redesigning of energy infrastructure in building rehabilitations. And again, many incentive programs and tax abatements tend to steer property owners in the wrong direction. All of this is misguided policy, driven by the same macro-economic assessment that is erroneously applied to micro-economic planning at the building level, and it produces government sponsored capital destruction.

So again, we need to start working as if we were a capitalist society, from the viewpoint of the buildings as an asset, not with top-down soviet-style 20 year plans, that shove the macro-economic square peg, in the micro-economic round hole. Too many decisions are made driven by the latest incentive, instead of on a sound long-term economic basis, which would accrue to improved building values. An accelerated conversion to renewable energy would be more constructive to building preservation than the current regime of moving the deckchairs on the Titanic, and switching to natural gas as the "less dirty" carbon fuel. The vaunted role of natural gas as a "bridge fuel" is really a very destructive postponement, if it forestalls renewable energy in applications where it is economical today. Present HPD/CPC policies are merely creating the slums of the future, with real estate values held for ransom by energy prices, and landlords that are beholden to these rules are like lemmings waiting for the next energy crisis.