NYSERDA Conference on On-Site Power Generation

I just spent two days at a NYSERDA conference about On-site power generation, which brought together solar PV, CHP and storage, in an attempt to inquire what could be done to achieve better integration and coordination among these market actors. The conference also at least acknowledged that there were many other technologies that could have been drawn in, but they just simply wanted to start somewhere. Still, we are in the Northeast, where 70% of building energy loads are thermal, and it remains amazing that solar thermal and heat pump solutions were not included in such a conference and trade show. We swam in between all the participants representing some dramatic efficiency measures, and the finance and economics to make projects better - we're making friends with all parties, because we shorten the paybacks of all On-Site Generation retrofit projects.

During the conference it hit me with even more force than usual how the entire energy retrofit business is a shambles that in large part is caused by the structure of incentives and regulation at both the federal, state, and local levels. At the same time, I am sincerely impressed with the REV process in NY State, which at least attempts to create a structure for energy solutions for the future, based on a clear awareness that the legacy regulatory structure is holding us back in the face of technology change.
Interestingly, this conference took place against the backdrop of all the uncertainty about the new administration and its energy policy, about which we know too little for now, as Bloomberg just reported in a major article that points towards a major shake-up. The good news was that I heard comments even from equipment vendors attempting overcome this confusion and take a longer view, such as one CHP vendor who pointed to the fact that they were at least discussing their solutions with clients in terms of long-term building values, which is of course the only valid perspective to have.

I got some welcome take-up for one of my own pet-peeves, that accountants should not be desinging energy systems. I advanced as an example of dysfunction how incentives and Energy Star ratings had promoted the use of tankless water heaters, but that in practice this was often a bad decision if a property owner found themselves a few years hence looking at either a heat pump solution or a solar thermal solution where DHW (Domestic Hot Water) storage provides the cheapest way to harvest energy. The premature decision to adopt tankless water heaters in that case amounts to throwing out the batteries with the bathwater. This is a typical example of how the 'energy efficiency' regulations themselves and the incentives cause capital destruction, in which property owners make decisions like so many chickens with their heads cut off. Sure, tankless water heaters may very well be very efficient by themselves, but that fails to take the overall building systems into account. The answer is that the only thing that will work in the long run is a carbon tax or similar solution, and not device-level incentives, so that the focus shifts to results, not how you get there. Politicians and accountants should not micromanage the design of systems, and make successful outcomes harder, not easier. Focusing on the results is the only way where engineers and economists can design the optimal solution that creates building value, and leave accountants and component-level tax-incentives out of it.  From that standpoint, it would be fine by me if the new administration just wiped out all incentives across the board, and let the markets sort it out - people would have to start thinking for themselves again.

Dysfunctions resulting from the incentive structure

The examples I have seen are many and varied, and anyone who has been around this industry for a while has seen the ridiculous results when tax- and other incentives and regulations dictate energy system design ahead of engineering and economics. My list includes:

• Tankless water heaters, even though they have valid application as backup in a renewable design.
• Condensing boilers in a back-up role where the heat-exchangers rot out if these don't run flat-out, yet the rules specify Energy Star boilers, which all come with heat-recovery. In short, in a backup role in a renewable design, 
• In general the incentives at the device level push over-use of certain devices, and this is often compounded by vendor greed, because they make more money over-specifying devices, instead of doing what's good for the customer. This can be seen in oversizing boilers or CHP or solar systems, all of which are commonly done. These equipment vendors sometimes take no interest in optimal outcomes for customers that can be realized through efficiency measures because they reduce the size of the systems they sell, even though they would sell more systems if they produced better economic outcomes for their customers. 
• Solar PV is the single most prominent example of a technology that thrives only because of incentives, but in practice it is a negative-NPV decision for most property owners in the Northeast, except for in specific design scenarios, particularly where it's combined with a heat-pump solution which by itself would increase electrical demand, but in combination could be very well an optimal solution in many cases. But the tariff structures and incentives are becoming an increasingly thorny issue here, particularly if grids are not designed for two-way traffic.

More Political Dysfunction ahead

The pendulum swings of politics are about to really upset the apple-cart of energy policy, as summarized in the Bloomberg article cited above, but there are limits even there, as summarized recently in a Forbes article by attorney Brian J. Potts: the new administration will have to pick favorites, for there are many clear examples of conflicting interests even among the fossil-fuel options. Another aspect that is a major unknown is what international response will be. Evidently, foreign investment in the US may suffer, and even US investors who are committed to a climate change vision may shift their investments outside the US as a result of regressive policies. Growing the US economy and dialing back energy policy may well prove to be incompatible. 

Needless to say the last word about our energy future has not been said, and for the real estate industry in particular, the fact remains that buildings will outlive the swings of politics, and smart decision making would focus on retrofits that make economic sense, and fortunately many renewable technologies are extremely valuable because they in fact eliminate major energy costs. Heat pumps with efficiency ranging from 200-250% for air source to 400-500% for ground source remain an attractive choice, and the applications for solar thermal, offering 4-5 times the energy output of Solar PV, are multiple. Solar PV without a subsidy regime to prop it up is not going to be very attractive in many cases, though it will be worthwhile in niche applications.

What will be interesting to see is how the states will respond, for increasing dysfunction at the federal level will shift the burden to the states. Will the Northwest reinforce its regional climate change efforts with Canada? Will California secede, or at least grow its climate leadership role?  Will New York and New England orient themselves to Canada more, where a serious climate change agenda is now a fact? We cannot ignore the fact that energy is the single largest industry in our industrialized society, and is key to our long-term welfare. 

The upshot is the major imponderables are the roles the states will play in energy policy, and the role the international community will play, the role that investors will play by voting with their dollars, and at the end of the day there is the fact that the Trump administration in no way has a mandate that would support the sweeping change it seems to be contemplating. So, the politico-economic outlook is definitely cloudy, and property owners must make their own long-term decisions, in which the only sane argument is to look 30-50 years out and ignore these short term swings. What remains is the fact that properties outlive political swings.

Creating Long-term Value

The simple must be, as always, that property owners must discipline themselves to look at energy retrofits as capital decisions, even though traditionally energy is treated as O&M (Operating and Maintenance) by most property owners. The reality is that the availability of many technology paths produce clear alternative scenarios for buildings, that must be evaluated as such as a long-term capital decision.

Site-Derived Renewable Energy (SDRE) is an alternative to the typical legacy energy plan that depends on buying energy from the grid (or oil, or propane deliveries, etc.), so the consideration of SDRE is a make-or-buy decision, but even within that, there are usually multiple scenarios which most often are mutually exclusive and have very different economic/financial outcomes. The unfortunate effect of the legacy incentive regime is that it is completely counterproductive to looking at long term capital decisions, for it tends to place the emphasis on short term payback at the equipment level, which can arguably be improved by incentives, but undermines the necessary discipline for long-term capital decisions. The prospect of dismantling various levels of incentives therefore shifts the focus from the short-sighted decision making that tends to create capital destruction, towards the long term decision making that helps property values and capital formation.

Hybrid systems are the future

At the convention I found myself happily technology agnostic, and plugging the idea that with some simple efficiency measures, we are able to take 20-30% of the energy demand out of buildings and shorten the payback of deep retrofits that include on-site generation by 20-50%. Needless to say we also have interesting financing partnerships developing, for shorter paybacks make financing easier. Most vendors welcome that conversation, but there are always a couple of regressive thinkers, who put the short term ahead of the long term, and their own commission check ahead of the customer's welfare, never realizing that happy customers will create referrals and more business. It drives home the point that property owners need to have the intelligence and advice on their side and look at the long term energy outlook for their buildings, at a holistic level, with at least a 30-year capital budget for energy provisioning.

Already, hybrid solar thermal cum fossil fuel heating systems are becoming the norm in places like Germany, and new solar thermal systems in this country are rapidly increasing the options, such as Zonbak, which is starting to ship in mid 2017. The future will be hybrid solutions in which the traditional silos will increasingly break down. You A/C does not have to be electric, it can be thermal, and your heating does not have to involve combustion, it can be largely or wholly thermal, with a little bit of electricity to keep it running.

In practice, some efficiency measures may be independent from structural retrofits, such as on-site generation, but in many cases it is not, and examples include both solar, and battery charging, and therefore BEV implementations. The fact is that harmonic noise is cumulative in a facility because of the shared neutral bus, and LEDs and solar inverters and battery chargers all inject harmonics into the electrical system, adding the load and therefore potentially increase the overall harmonic load, making harmonic filters every more critical. Are there other solutions? Yes, but they are more expensive, and on a facilities basis, the harmonic filters intercept the problem closest to the source, preventing deterioration of the whole circuit.

The benefits of harmonic filters:

10-30% reduced electrical bills,
20-50% shorter paybacks for retrofits.

Holistic Solutions Put Property Values Central

Selecting the right energy technology plan for your property with a life-cycle outlook and taking all the relevant efficiency measures into consideration at the same time, is the only valid way forward. The best advice amid the whole confused scenario is to keep your eyes on the ball, and that means to maximize long-term property values, and it's up to the political will to provide incentives to minimize environmental impacts. Both economizing water usages and minimizing GHG-emissions are part of the long term value picture, regardless if one administration or another changes the incentive regime. Don't let the vendor of solar panels, or CHP, or anything else be your only source of information, for at least some of them will sell you and oversized system. Don't put the incentives first. Good financing (including incentives) can make a good project better, but it can never make a bad project good. 

Financing Energy Retrofits and Capital Destruction

Creative finance solutions for energy retrofits abound, but most underwriters, including alternative financing programs such as PACE bonds, fall for the generally accepted delusion that energy efficiency should get top priority. This is a mistake - majoring in a minor - which increases underwriting risk, instead of decreasing it, for several reasons:

• If you start out with "energy efficiency" of an existing installation, that is not an energy retrofit at all, for you blithely accept that the design that was in place was the best one possible, and you are merely upgrading it, as in with more efficient versions of the same technology. The point of an energy retrofit is to use newer technology, which may necessitate a different design. An efficiency improvement in most cases is not a capital investment, but an operational expenditure.
• Since many of the newer technologies are about generating energy with solar, wind, geothermal, or even hydropower, they all imply a different model, and different designs. Specifically they enhance the capital asset, the building, with independent generating capacity. Financially they are also a permanent price hedge against energy price increases.
• Energy efficiency upgrades are also by nature short-term, they usually only achieve about a 30% improvement, which is easily wiped out by a few price hikes, therefore such upgrades should not be financed with long-term money, let alone be subsidized.

As demonstrated in earlier posts, financing energy efficiency with long-term money in most cases is a mistake, because the typical 30% or so improvement is all too easily wiped out by one or two price hikes, and because of the issue of diminishing returns, there is no follow-on strategy, and therefore it is financially unsound. Financially, energy efficiency is a horrible dead-end and should be avoided like the plague: again, it increases underwriting risk if it is pursued at the expense of an existing renewable option. As a strategy, investing in energy efficiency should be an absolute last resort, if you can't do anything better.

Renewables are an immediate and permanent asset of the building, regardless if you use solar, wind, or geothermal, or hydro-electric, plus any improvements to the building envelope now come back to you directly in terms of reducing the installed capacity you need. Renewables are an immediate energy price hedge. Because of diminishing returns, "investment" in energy efficiency is financially a shaky proposition, while renewables immediately raise building value.

Energy Retrofits Gone Wrong

Energy retrofits that prioritize energy efficiency amount to capital destruction, assuming there was an economically viable renewable option available. Thus underwriters of financing for buildings who focus on energy efficiency first are in most cases likely to be deteriorating their portfolio and needlessly increasing underwriting risk. This is long-term money for a short-term benefit, and that does not make for financial stability of the asset. Even PACE bonds have completely missed this issue, and all programs that I know of focus on energy efficiency first.

With proper financial planning, which is to say a 30 year capital budget for energy upgrades to a building, it will become very visible that renewable options are financially superior, for 30 years of zero energy bills will outweigh 30% energy savings. Or to put that differently, renewables may initially have a longer payback, but, properly evaluated, the renewable solution with a 7 year payback, may be superior over its life to a 4 year payback on an efficiency component, which "saves" 10%. The renewable energy equipment comes with zero energy bills, or in the worst case some 10-15% in back-up from a fossil fuel source.

How to underwrite energy retrofits

renewables improve value

The bottom line is that responsible financiers should demand a 30 year CAPM analysis of energy retrofits to the building, which could include an installation that could be spread over several years, and obviously realistic measures for maintenance and operating costs, noting that O&M are typically lower for renewable energy than for fossil fuel. Further, underwriters should rate projects based on the percentage of energy that is derived from renewables. The higher it is, the greater the financial stability of the building. My consulting firm DaBx Demand Side Solutions, publishes the DaBx Renewable Energy Retrofit Portfolio Standard (DaBx RERPS)

Conclusion: renewables reduce underwriting risk

Financing energy efficiency means financing short-term operational improvements with long-term money; energy retrofits with renewables reduce underwriting risk and improve the asset value of the property.

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.

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.

How to Stop Government Sponsored Capital Destruction

The indiscriminate push for energy efficiency over energy independence based on Renewable Energy results in a growing number of cases in missed opportunities for developing renewable infrastructure, which could have a wide range of beneficial effects in the long run, not least of which is the greater profitability of buildings, and their long term economic viability, and thus also building preservation.

We declared July 4th, 2011 Energy Independence day, by publishing our report DaBx PlaNYC2020 as a partial alternative to the PlaNYC2030 which the City has proposed, and we offered our report to the Mayor. Aside from that I felt that it was appropriate to also write to the Secretary of Energy, since ultimately many of the relevant policies originate at the federal level.

Whenever Energy Efficiency is pursued first, without examining the Energy Independence/Renewable Energy alternative first, some unfortunate outcomes result which are to the detriment of real estate values in the long run. In essence it is particularly the city's older apartment buildings which often offer the right economies of scale for the alternative, and there are very likely plenty of investors to be found who are interested in serious Green investments that produce long term steady income, so even if current owners are not interested, different investors could come into the market.

In order to get attention for the policy changes that are needed, we wrote to the Secretary of Energy:

quote

August 13, 2011

U.S. Dept. of Energy
Attn. Dr. Steven Chu,
Secretary of Energy
1000 Independence Avenue SW
Washington, DC 20585

Dear Mr. Chu

Re: DaBx PlaNYC2020 – A Paradigm Change

Attached we are sending you a copy of our alternative plan for energy independence in multi-family housing in NY, which was published on July 4^th, 2011 – Energy Independence Day, as I like to think of it.

We have provided the plan to NYC, and to Mayor Bloomberg specifically as a partial alternative to the PlanYC2030, which is now in its second generation. We are hopeful eventually to find both existing building owners and investors who see the opportunity. This is an area rife with opportunity for private/public partnership, and there are plenty of funds that would be interested in financing buildings that implement renewable energy, and reduce fossil fuel use in all forms by 60-80% as we think is possible.

In the meantime however, as a nation we are suffering a terrible case of group think, and it is driving us all, and this class of buildings in particular, straight off the cliff into the next energy crisis, not to mention that it's aggravating a long list of infrastructural risks and liabilities which could be solved by going the renewable energy route directly instead.

The point is this: there is a very large group of buildings in NY – the same no doubt applies for many other cities – which offer the right economies of scale for a holistic, integrated approach to renewable energy, where it can be economical today, not twenty years from now, and which will result in a massive improvement in the economics of those buildings, and the economic competitiveness of the cities. With that we will see asset values rise, and Freddie Mac and Fanny Mae, and FHA should all become supportive, once they understand the value adding capability of this radical investment strategy.

All the building blocks to the methodologies we propose are available today, and the only significant obstacles are government policies that prevent it from happening, some minor regulatory hurdles that could be improved, and the fact that all current official guidance, programs, incentives, seem to be based on the pat assumption that renewable energy is not (yet) economical, and thus it is never given serious thought, causing an indefinite postponement instead.

The whole situation is a classic example of a paradigm shift, the major problem is that by and large the unexamined assumptions that cause the present conundrum are based on evaluations of renewable energy in a fossil fuel driven context. Contrary to that, what is needed to make renewables pay is a strategy of complete re-engineering and rethinking the energy infrastructure of existing buildings, and since in NY there is already a program on the books for eliminating high viscosity fuels, there is a tremendous opportunity to do that extra step and do renewable energy now, not later.

Given that there is a group of buildings where renewable energy would be economical now, present practices, which are only becoming more and more entrenched, amount to nothing else but massive case of capital destruction with taxpayer money, or if you would, a government sponsored customer retention program for the oil and utility industry, at the expense of real estate values. Often it boils down to short term fixes financed with long term money, insuring that buildings will be under water again at the merest sign of the next energy crisis. Taken together, current policies also create an energy monoculture around natural gas, and a huge and growing threat to national security.

Our alternative plan, which we've published under a Creative Commons-Attribution-NonCommercial-ShareAlike 3.0 Unported License in furtherance of public discourse, proposes essentially that once the engineering integration is understood, renewable energy projects which individually might not be attractive investments, could generate compound returns, and thus taken together could be highly attractive, and result in rapidly increasing building values. Simply put, the same building that might be 30% more efficient with today's best practices in energy efficiency, could reduce fossil fuel use by 75%, and be off the grid for common areas, as well as supplying car charging station, or some of their tenants. Current energy efficiency programs are fighting the last war, when the winning insight was that a dollar spent on demand reduction was worth more than a dollar spent on increasing supply.

To make it even clearer, because there is no second act in energy efficiency investments, due to arithmetically diminishing returns to a limit that is well above 50% of usage, the currently dominant regime of energy efficiency to the detriment of energy independence also will lead to slum formation on a large scale, as it will massively erode the economic viability of buildings within the next 20 years. Following our design strategies, many old buildings could reduce fossil fuel usage by 60-80%, and be commercially viable for the next 50 years.

Because the two investment strategies – energy efficiency vs. energy independence - are mutually exclusive, the current practice of plunging into energy efficiency investments without thorough examination of the energy independence alternative, condemns buildings to what may be a sub-optimal strategy, if they would have been capable of significantly utilizing renewable energy.

Meanwhile, this country's infrastructure crisis is such that e.g. here in NY the Transportation and Delivery portion of energy bills is already 65%, and rising ahead of inflation indefinitely, and the renewable strategies we are advocating could speed the way towards the smart grid, not to mention accommodate electrical cars without causing congestion on the grid. Thus transportation and delivery cost are the real issue in the renewable energy strategies on the demand side which we are proposing.

Lastly, we emphasize that our multi-dimensional strategy recommendation (looking again at NYC, our home market) includes strong beneficial impacts in a wide range of related areas that are frequently overlooked:

• Clean Air: short route for NYC to meet Clean Air Act standards
• National Security: reduction of dependence on foreign oil, diversification of energy inputs: these buildings will stay lit in the next blackout
• Transition to the smart grid: these strategies provide an accelerated transition to a smart grid, by evolving micro-grids that will be semi-independent.
• Public Safety: Buildings staying lit in a blackout, survivable in case of failure of the gas grid, and can provide unlimited backup for cell towers.
• Public Health: Better indoor air quality in the Asthma capital of the world, a.k.a. the South Bronx.
• Defense: The emerging Natural Gas monoculture is a huge new liability, diversification should have high priority.
• Economic competitiveness: Thousands of old apartment buildings could be upgraded into some of the most Green and energy efficient modes of city living. The outer boroughs would benefit most. In the near term it means jobs.

Because of the importance of these issues at this critical junction in our nation's energy policy and future, I am sending you this letter as an open letter, which will be published on my blog at http://nycgreenapple.blogspot.com, as well as copies being sent to a number of relevant officials and business people.

Yours sincerely,

Rogier Fentener van Vlissingen

unquote

Of Hamster Cages, the Grand Canyon, and the Climbing of Mount Olympus

Energy Efficiency is a commendable thing, but I like to question its sometimes guileless application, which can product less than desirable results. As I point out repeatedly on this blog, energy efficiency, when applied in a fossil fuel framework, runs into the law of diminishing returns, and at some point it leads to capital destruction, because you spend yourself into a corner you cannot get out of, and in fact you are making the switch to renewables harder, not easier. Thus Energy Efficiency is not additive to Energy Independence. Everyone knows we can't save ourselves rich, but the same people blithely assume energy is the exception to the rule. It is not.

The following then is a thought experiment, for an imaginary old building of 100 apartments in an old city, like New York, with a steam heating plant burning oil, a coil in the boiler for hot water, etc. On day one, today its total fossil fuel consumption is 100, then some technology is implemented with a 10% efficiency improvement is implemented and it drops by 10 to 90. But the next improvement of 10% is now applied to the 90, and thus the improvement is only a further 9 points to 81, based on the original scale. The next improvement of 10% only moves the market 8.1 points to 72.9 on the original scale. And so on.

If we assume that we prioritized these investments based on their relative paybacks, selecting the first one first, etc. we will say that the paybacks are deteriorating for every next decision, and this function runs into a limit, because of diminishing returns. The end point of a fossil fuel based system, however efficient, is always a system burning fossil fuels. That limit might be an impressive improvement over past practice, but nevertheless the bills keep coming. Depending on what technologies are being implemented, there may also be an engineering interaction, because e.g. the function of certain controls might overlap, and you find that a 20% reduction, and a 10 % reduction result in about a 23% real reduction, or even less than expected based on the numerical analysis above. In short there are both arithemetic reasons and engineering reasons why 2+2=3 in this scenario, again we have diminishing returns for every subsequent investment, and we are painting ourselves into a corner.

The remaining fuel consumption (be it gas, oil, or electric), is subject to various price pressures, which in all likelihood will outrun inflation for the foreseeable future. In other words, let's say an overall 35% improvement in efficiency was achieved, this will inevitably eaten up by price creep for the irreducable remainder. For oil there are immediate price pressures, because of increased refining requirements in NYC. There might be some form of carbon taxation, and other pollution taxes. Gas is now the darling of fossil fuel, but even there, there are storm clouds on the horizon, and it has the same cost pressures on the delivery cost as does electricity. In the case of electricity, the cost of delivery is now 65% of the bill. Because of aging infrastructure, and the horrendous cost of upgrades, it is set to outrun inflation as far as the eye can see, and the other 35% of the bill is hostage to fossil fuel energy prices in general, as long as fossil fuels dominate. In short, every reasonable case would show a tendency for these prices to continuously outrun inflation. In short this scenario is the hamster cage of energy efficiency, if it is applied within a fossil fuel based framework.

Some of the improvements to the building envelope, to water consumption, are likely to be of equal value if we had developed the building with renewable energy, however in some respects technology selections and decisions might have been different in that case, for if it becomes a capital trade off against installed generating capacity, the evaluation for upgrades to the building envelope is far more straightforward than if it were against a forward string of "energy savings" which are discounted to the present. Depending on the energy systems in a design, different approaches to the building envelope might be selected than in the fossil fuel dominated case.

More importantly, the above defensive strategy ends up in capital destruction in the long run, exactly because of diminishing returns, and the fact that a fossil fuel based system somehow continues to burn fossil fuels, and be the victim of price increases. There is no way out of the trap of "efficient consumer" of energy, it merely cements the dependence upon subscription energy costs in all forms, as it stretches them as far as possible. This strategy does paint the investor into a corner, and the best you can expect is that your local utility sends you a certificate of honor for what an efficient customer you are. The point is, they get to keep you as a customer. But wait, it gets better.

The alternative to the above "energy efficiency" scenario is to choose a path towards energy independence. Energy efficiency plays a role here too, but it is more secondary, for the first order of business is selecting the generating technology or technologies. The generally accepted view is that renewable energy is not yet economical. Fortunately, there are some incentives, etc., and simply put, some buildings are more suited than others. So if you own the Empire State Building the focus is on energy efficiency, and renewable energy plays second fiddle. However, if you own an old line 5-8 story apartment building, like in the example we are discussing here, there might be a path towards a successful renewable strategy.

A renewable energy strategy takes a different mind set, and it takes more capital up front. Or, as an investment banker friend put it: You cannot cross the Grand Canyon in three easy steps -- I had to think about that image a while, but then I saw it: on the second step you fall to your death, so you must have a bridging strategy which takes the first three steps at once. The "Grand Canyon" of this situation is the shift - a paradigm shift - from consumption to production. It means starting to think about energy as a capital asset and therefore a profit center in building management, no longer as a business expense. The technologies are rapidly evolving to enable this type of thinking. Energy is becoming a technology business, and building-level generation is going to become the norm, be it that retrofitting old buildings, which were designed in the era of fossil fuels, is often a challenge, so the thing to do is to pick the right type of building to do these things. For most building portfolios, this will initially be a matter of pearl diving.

Also, along the lines of the things we said above about energy efficiency, if the building was recently overhauled based on the current common practice of emphasizing energy efficiency, then we've actually widened the Grand Canyon, because we've doubled down on our bet on the fossil fuels, which may not be the winning bet... There's no logic to this, other than, it seems to be what everybody does, and everybody assumes that renewable energy is not yet economical, and most folks are overlooking the possibility on that assumption, or if it is being attempted, renewable technologies are plugged in as a partial replacement within a design that is driven by the fossil fuel model, and most of the time that does not produce the desired results. However, by integrating technologies, in the right buildings hybrid solutions are possible which definitely allow a gradual development towards a renewable energy model, with energy as a profitable activity of the building.

The energy independence strategy will hinge on a comprehensive rethinking of energy use in a building, a very deliberate and extensive use of energy efficiency, as well as a long term plan which respects the interdependence of different generating technologies, so that and initial investment will lay the foundation for shifting into an energy production posture, and will be improved by subsequent enhancements. Conversely, if renewable energy is implemented without a long term energy plan, very likely the wrong sequence will be chosen, and the risk will be spending the same dollar two to three times over over the long run. In short, to get an initial bridgehead to the other side, it would behoove us to search out the narrowest point across, with more or less friendly features. By properly pre-planning for the interdependence of technologies in the context of a long term energy plan we will be making sure that we eventually do reach the top of Mount Olympus in the way of the classic Greek notion of making sure that our every step goes in that direction. The result will be a progressive accomplishment of energy independence. Independence from the grid, and 80-90% reduction in direct fossil fuel consumption is within reach in some cases in perfectly ordinary buildings, though the economic case is not yet easy, however once the foundational investment is made it gets easier, for different from the above "energy efficiency"scenario, the value of our investment now goes up with every price hike for fossil fuels, for here 2 + 2 =5, if you have got the engineering right. In five to ten years this approach should therefore yield improved property values by maybe 10 or 20% or more compared to the energy efficiency retrofit, who will be facing the same old problems in five to ten years, as energy pricing and "grid creep" catch up to them. The renewable energy choice will then be the only option, but the gulf is likely to be wider, because to some degree the same dollars will have to be spent twice.

To put it a different way, as is familiar to seasoned investors, all else being equal, investing for growth beats investing for efficiency and "savings," which is by definition a dead-ended strategy, something that becomes intuitively obvious by a reductio ad absurdum - anyone can see that 100% efficiency is impossible, just like you cannot save yourself rich. The strategy is clear enough and on a tactical level it boils down to finding the narrowest place to bridge the Grand Canyon, and to be like General George S. Patton who went back to square one, by selecting his route through Brittany and ultimately to Berlin based on Caesar's routes, where he could naturally ford rivers, so that the Germans could not stop him by demolishing bridges.

Strictly Kosher Renewable Energy Planning for Building Owners

The unfortunate reality is that most building owners large and small, if they buy into renewable energy at all, focus on the technology, not their building(s), and they are getting hosed financially, and even if it is a tax-deductible hosing, which is only a small consolation in the end. The single biggest failure of renewable energy is faulty analysis of the building level energy economics and engineering.

Vendors obviously and understandably focus on their technologies, which all of them in good faith or otherwise, believe to be a solution - no scratch that - THE solution. Equally obviously none of them are, for if there were any one solution, our energy problems would be over. Governments compound the problem by providing various incentives and programs to stimulate the development of renewable solutions but which generally suffer from various unspoken assumptions, and often inadvertently such programs produce unintended consequences which actually sabotage an economically viable renewable energy economy.

The way the market functions is this: the assumption is that we can never stop burning fossil fuels, so the de facto point of departure for most incentive programs, is that within the subscription model of energy (fossil fuels) the best we can hope for is reduce energy consumption, and become "energy efficient." Some programs even offer certificates you can hang on your wall or on your building, testifying to how efficient a customer you are for your local utility or oil company. These incentive programs in themselves work very well some of the time, but as part of the unintended consequences they in fact create a treadmill of capital destruction, in which cumulative energy efficiency investments run smack into the wall of deminishing returns, for contrary to the popular belief, energy efficiency is NOT additive, and does not lead to energy independence. We simply become more economically sustainable energy junkies, and the economies we achieved will soon be undermined by the relentlessly rising energy prices.

Nevertheless the majority of the market dances to the pied piper of energy efficiency, and never looks to energy independence let alone energy production and making money with energy. Yet this is what is vitally needed: a paradigm shift from energy consumption to energy production, and a concomitant change in investment outlook.

Vendors also make the problem worse, because they typically present their equipment as if they were free-standing investments, and try to compete on the shortest payback, helped by ever popular government incentives and other goodies, so that if you have only $50K to spend you'll pick the project with the fastest payback. In many cases you'll lock yourself out of the best energy strategies, and if you ever do find out, you'll end up investing the same dollar two or three times over. My favorite example these days is the "high-efficiency" Energy Star-rated tankless hot water heater. Of course it is very efficient in burning fossil fuels, but that's only relevant if burning fossil fuel is your only option, and not if harvesting (nearly) free energy is a viable alternative. It may be a great choice if your business is to sell hot water by the gallon on the street corner, but it's a lousy choice if you are the owner of a property, particularly a residential one, because Domestic Hot Water (DHW) is actually a natural storage of energy, and essentially "free" to the extent that it can be justified by Hot Water provisioning. Conversely depending on how we integrate energy in the building, and harvest peak load generating capacity (renewable energy), it may end up that analytically, the DHW is "free," because that storage capacity becomes materially important to the economics of building-level energy generation.

In short, the way to judge these investments is to view them as intra-marginal investments in your property, and evaluate their lifetime effects on the property's operating cash flow. Now that gas hot water heater may be cheaper to purchase, and more efficient than what it replaced, but it still has a nasty habit of burning gas, while the property next to you invested some more money, installed solar hot water, and almost completely eliminated their fuel bill for hot water. The storage of Domestic Hot Water meanwhile allows you to harvest the peak power from the sun, or the wind and store it as heat, eliminating even more energy bills. Over the 30 year lifetime of the solar system the neighbors would end up buying three gas hot water heaters, and pay the gas company every month. In short, as the owner of the building, you are not in the business of selling hot water on the corner, but improving the energy independence of the building, improving its operating cash flows, and eventually making money from energy, and that should be your vantage point, taken over the lifetime of the relevant technology, not judged by payback of an isolated piece of equipment. Proper analytical hygiene would also demand that also the price risks of oil, electric, and gas, including potential carbon taxation, are taken into account, compared to free energy which comes with a greater capital investment, but little or no subscription energy costs.

To put it differently, most available incentive programs really exist to extend the franchise of your local utility or the oil companies through "energy efficiency," but they do little for your business, or at the very least, they lead you eventually always to make the wrong investment decisions. Thus the Kosher financial recipe is to develop a long term strategic energy plan first. If you have a sound plan from an engineering and economic standpoint, it will give you increasing energy independence, and improving profitability, not merely energy efficiency and a pat on the sholder from the CEO of your utility company. Energy is becoming a technology business and a capital investment - a business opportunity - and it will gradually stop being an operating expense. Financially it is becoming a make or buy decision. Those who fail to notice this, will see the value of their real estate decline precipetously, for since it can be done, it will be done, and buildings without utility bills, and very low fossil fuel consumption will be worth more than the equivalent buildings, however "energy efficient," but still on the subscription model of energy. Our buildings are like babies about to be weaned off the breast of the subscription model of fossil fuels. As a society we are now at the stage of resenting it, but going back is no longer an option. We now need to learn how to walk.