Energy Efficiency, Killing Us Softly

St. Patrick's day reminded me that it is high time we learn to tell the real green from the fake stuff, beginning with energy efficiency, which has been unjustly conflated with sustainability, when in fact it does the opposite: it increases carbon emissions over time, except at a slower rate. It's high time the FTC should start taking on green washing, beginning with such seriously misleading names as the ConEdison Greenteam. The fact is that, when energy efficiency is pursued without further qualification, and it is applied to systems that are 95% driven by fossil fuels, we are shooting ourselves in the foot with a bazooka. Making a bad system better will solve nothing, except making fossil fuels viable longer, instead of finding a real solution. The fact is, efficiency applies equally to fossil fuel-based systems or renewable energy systems, but only renewable energy systems can reduce GHG-emissions. So we are reminded once again, that it does not pay to major in a minor, or, in the words of the incomparable computer scientist Donald Knuth:

Premature optimization is the root of all evil.

Here is the quote from Donald Knuth, discussed in an article, the Fallacy of Premature Optimization. The energy equivalent to this proposition is that:

Premature Energy Efficiency is the best prophylactic against deep energy retrofits. Or, to but it more simply, if you pursue energy efficiency first, without regard to the long term energy plan for a facility, you will incur sunk costs, if nothing else because of diminishing returns.

Let me count the ways

In no particular order, but with some attempt at logical grouping, here come all the reasons, with some links to other posts on this site or other sites where appropriate. A completely logical and progressive ordering is not feasible due to the interdependence of many of the items listed here.

1. The obvious issue is that energy efficiency makes economic sense (to the extent that it is optimal) whether fossil fuel or renewable energy is used. Therefore, it is a secondary objective in an optimal design, not a primary one. The payback for efficiency comes from reduced energy bills in the future in the case of fossil fuels, or reduced capital expenditures in the present in the case of renewable energy (less installed capacity needed). Another way to state this is that energy efficiency does not generate energy: it is not an alternative method to generate energy.
2. Historically, the conflation of energy efficiency with "green" energy or sustainability, goes back to the energy crises of the 1970's. It was then thought, probably correctly, that the marginal dollar spent on reducing demand was more effective than investing it in increasing supply. The concept was enshrined by the thinking of Amory Lovins, who made the confusion complete by treating energy efficiency as the "fifth fuel." This type of thinking resulted in policy making that treats energy efficiency and renewable energy as interchangeable and complementary, or even additive, which most often is not the case, because different decisions would be made about energy efficiency in a fossil fuel infrastructure than in a renewable energy system. In truth, energy efficiency is not even an investment, it's a mere operational savings, and financially it should be treated accordingly. Renewable energy is truly an investment, a make versus buy decision, a permanent price hedge, and it improves building resilience, and adds value to the asset.
3. Then there is the famous Jevons paradox, which in effect states that increased efficiency increases demand, and therefore does no such thing as conserving energy. Jevons was speaking about coal, and by and large his predictions came true, and are equally relevant today about oil and gas.
4. It gets better (or worse, depending on your point of view). Steve Hallett, in The Efficiency Trap, takes his perspective from biological/systems thinking, and notes not only that greater efficiency lowers the cost of the energy input and stimulates demand, but there are often knock-on effects. For example not only did we fly more as flying became more efficient, but we also built more airports, etc. The end result is that energy efficiency "improvements" make the problem worse, not better, and we have plenty of historical examples to show this. At the other end, exploration costs are going up all the time, so that the massive carbon deposits we theoretically still have are becoming less and less economical to exploit (even aside from the GHG-emissions question). In short, energy efficiency keeps carbon energy more economical for a longer period of time, and therefore increases GHG-emissions over time, which is the opposite of what we want. Hallett's conclusion is simply that the road to hell is paved with efficiency. In his words: "Efficiency promises to conserve, but actually consumes. Efficiency is a trap."
5. The Jevons paradox and the efficiency trap are bad enough on a macro level, but on an individual project basis we see that if we do our economics right you cannot save yourself rich: energy efficiency yields diminishing returns whereas renewable energy generated on-site can bring compound returns. The truth quickly becomes evident if proper capital budgeting is done for the energy infrastructure of a building (home). Thus, within a given building retrofit, energy efficiency (of the fossil fuel-based infrastructure) competes against renewable energy. As long as payback of the equipment from marginal savings is used for decisions, energy efficiency will initially always seem to outperform renewable energy, but when 30-year cash flow analysis is used, renewable options often prove more attractive. Compound returns can be achieved from engineering synergies by integrating several technologies.
6. On the margin it is already clear that net-zero building is the healthiest construction sector, and has been so for several decades, regardless of economic cycles, and in downturns these buildings have kept their value better than other buildings. Since in the larger economic sense the rate of change at the margin drives valuation, it should be clear that fossil fuel buildings are going to continue to lose value at an accelerating rate.
7. Therefore, any older buildings worth preserving should switch to renewable energy and attempt to become net-zero or near-zero, and buildings that cannot make the switch to renewable energy will be the slums of the future, and ultimately headed for demolition. Along those lines the current fashion (think NYC Clean Heat) of switching fuels mostly from coal and heavy fuel to natural gas, amounts to capital destruction. The same applies for energy efficiency initiatives such as New York's Local Law 84/87/88: these measures constitute majoring in a minor, and therefore guarantee failure in the form of strongly suboptimal outcomes, including, at the extremes, the preservation of some buildings that should be demolished, and the failure to convert other buildings to renewable energy when they have the potential.
8. A systems approach is needed, and almost all policies and incentives have been targeted at the technology (widgets) level, not the system level. The smallest system, the economic atom of real estate is a single property (house, building), and above that are neighborhoods, towns, cities, regions, states, countries, and eventually the whole world. In some cases regional planning can be very effective, but we should engage everyone from the smallest economic unit of a single property on up. Incentivizing specific technologies leads to market distortions and bad engineering. Solar PPA's are a case in point. At 17% efficiency, Solar PV should be the last choice, as solar thermal is 98% efficient (or arguably more, because process heat is easy to store for intra-day usage, which gives you higher returns than selling your kWh's back to the grid or using expensive chemical batteries).
   Incentives for individual widgets reinforce a bad financial habit of evaluating options based on the payback of the equipment from energy savings, which flies in the face of optimal design on the level of the property as a whole. The Baucus energy tax proposal focuses on overall GHG-reductions, but so far addresses only the supply side of the grid. Clearly, the demand side should be included due to the huge potential for generating energy on-site with renewable energy.
9. Green finance, so-called, has been a mixed bag of various flavors of asset backed lending, justified by the fact that it is theoretically "low risk" because it offers what are deemed to be largely self-liquidating propositions, based on energy savings. This is a complete fallacy, and energy efficiency loans and solar PPAs may be the subprime loan scandal of future years. In many cases it is the ease of finance, ease of installation (solar PV!), and Wall Street greed, fueled by misplaced incentives, which are fleecing property owners of their equity, locking them into a suboptimal solution. They waste their roof space, and borrowing capacity when with the same space, using solar thermal (98% efficient), they could have easily provided complete HVAC, reduced GHG-emissions by over 50% while homes and buildings become much more valuable in the process.
10. Securitization of energy efficiency loan portfolios has already encountered some headwinds, and these issues will only become more evident as analysts learn to understand the absence of a sound economic foundation. The typical 15-25% "energy savings," is easily wiped out by both energy price hikes (the winter of 2014 gave us a taste of that!), and by comparable buildings going the renewable route and eliminating 50-90% of their energy bills, and GHG-emissions. (See #6 above).
11. The combination of technology-level incentives (such as tax incentives based on Energy Star ratings), and decision making based on marginal payback of equipment, and partial solutions, lead to either the wrong decisions from a whole building level, in some cases such that they lock buildings out of other, superior solutions, or else they risk "cherry picking" a whole building solution - which benefits the financiers who want to write "easy loans," but rob the building owners of the potential to add value.
12. Policies which limp on the dueling concepts of Energy Efficiency and Renewable Energy recall the roulette player who puts equal amounts of black and red. Treating Energy Efficiency as an alternative to Renewable Energy, or as a proxy for GHG-reductions ensures policy failure.

New York State Energy Plan

The review period for the 2014 Draft New York State Energy Plan is still open, and I have supplied my comments along the lines indicated here. On the whole, the plan has the laudable objective of 50% GHG-reductions by 2030 and 80% by 2050, but otherwise continues the errors that have ensured past policy failure by including energy efficiency and fuel switching in the options. Both of these options are environmentally counterproductive, and ensure minor GHG-reductions in the short term at best, and of course, if we want to achieve the objective of 50% GHG-reduction by 2030 and 80% by 2050, we should focus only on projects that can achieve over 50% GHG reduction. Therefore, neither fuel switching nor energy efficiency should be in the plan.

Letting the market take care of energy efficiency

There is huge potential for renewable energy retrofits that can produce 50% or better GHG-reductions right away, and more later, and in ways that make economic sense today, if property owners make use of the right decision-making models. The EPA provides the Energy Star Portfolio Manager to assess projects on a whole building basis, and the resulting models should be evaluated based on a 30-year CAPM cash flow analysis. This will quickly show that many renewable options that seemed expensive are actually economical based on the long tail of zero energy bills, while the 15-25% "energy savings"  from energy efficiency upgrades will quickly be found wanting, unless some of them can be integrated to directly increase the payoff from renewable energy options.

In short, competitive pressures will become more effective if policies and incentives support renewable energy first, and leave it to fossil fuel companies and their customers to work out arrangements for energy efficiency wherever it is economically justifiable.

Conclusion

We are now experiencing a paradigm shift from the fossil-fuel era to the renewable era, and there is huge potential for quantum improvements, even on a building retrofit basis. The major impediment to GHG-reductions is not technology but proper financial analysis along with incentives and programs that reinforce the wrong decisions. In short, as in any other paradigm change, it is our thinking that gets in the way, but that can be corrected. Once you get it, it's obvious. The 2014 New York State Energy Plan should focus on Renewable Energy, and leave Energy Efficiency to the market.

Energy Efficiency: The Cart Before the Horse

Energy Efficiency is almost universally being mistaken for a primary objective, but it is not. It is purely a secondary issue, a secondary objective. You first have to know what it is you are making more efficient, so the first question is: Do I make my energy or buy from the grid? Anyone who has operated complex systems knows that if you optimize for a secondary objective function first, you can get really disastrous financial outcomes. Yet, this is what we are doing as a society by focusing on energy efficiency first. We are not asking the first question first: Make or  buy? - do I want to make my energy, or do I want to buy from the grid? Energy efficiency does not beget sustainability.

If you started with a fossil fuel system, and you make it more efficient, you will simply get a more efficient fossil fuel system, and you will continue sinking in the endless energy bills that will remind you regularly of the joys of fossil fuels. Sooner or later the energy price hikes will wipe out the so-called "energy efficiency" which you paid a lot of money for. Once you have started down the path of energy efficiency, you have really invested yourself into a corner, and you'll be looking for a sequel, but diminishing returns will be facing you every way you turn. Energy efficiency does not beget Business Sustainability.

If you are making an investment today in fossil fuels, or even biodiesel, you are investing more money in a dead-end technology, for you are committing to paying energy bills forever. Moreover, with current developments, if you are investing in e.g. 15 year equipment, during its lifetime you are sure to have to deal with carbon taxation as well. Besides which, for both electricity and gas, the cost of the delivery and transportation is liable to rise faster than inflation, if you follow the track record of price hikes by your local utility. Make it as energy-efficient as you like, it does not add up to sustainability, even Energy Star is fool's gold.

Energy efficiency: how the trap is sprung

Here is how the energy efficiency trap works. Day one your energy bills were 100%, and we found some investments which enabled us for reasonable money to reduce our consumption by 28%, and therefore our base is now reduced to 72% of what it was. The projects we evaluated looked as follows:

1. For $25K we gained 20%, and that was reasonable, if our bills were $100,000/year to begin with, for this investment obviously had a one year payback.
2. Unfortunately, we then ran out of easy solutions, so the next phase was an $50,000 investment to get us the next 10%, but it works out to only 8% in reality, because our base has now come down. In short, this next project phase really has a 6.25 year payback ($8,000 in annual savings, vs. $50,000). Fortunately there was some incentive in the form of low-cost financing from our friendly gas company, that made it all a little better so we did it anyway.
3. However by year 5 the energy price hikes have wiped out the efficiency gains, and monetarily we're back in the same boat, we're consuming less, but the bills are back to the old level, so we start looking for another project.
4. Lo and behold we are lucky, and we find another $75,000 project, which saves us another 8%. 8% of $100,000 is $8,000, so our payback on this one is just shy of 10 years. We decide to forge ahead, for evidently energy prices will keep rising.
5. The next best project after that would cost us $100,000 and give another 8% improvement. Examples of this type of project are the notorious window replacements and the like, with 20 year paybacks.
6. The diminishing returns become more visible if you work on the basis of consumption, so you start with 100, and a 20% reduction leaves you 80%, the next 10% reduction is 8% off the original, and you're down to 72%. the next 8% reduction is 5.76% off the original, so you're down to 66.24% from the original, and the next 8% works out to 5.3%, leaving you at 60.94% of the original. So you are dealing with ever larger "investments" for ever decreasing returns.

In short, every next energy efficiency project gets worse in terms of financial results, and I continue to do just enough to keep the pain tolerable, and my friendly drug dealer... (oh sorry, utility company) is always there with financial incentives to make it just worth my while, and obviously retain my custom for another number of years. Customer retention is good for utilities, but not for property owners. This is not sustainability, but a dead-end. The point is this: in an older building you can always find one or two energy efficiency projects that will get you a reasonable financial result, or so you think. If you do not think ahead to the mounting cost of the follow-on steps, you will go along with it.

The renewable alternative, sustainability in practice

The renewable energy alternative starts with a MUCH larger initial investment, perhaps $150,000 or $200,000, and a long "payback," however, if I analyze it over a 30 year period, I begin to see that my remaining energy bills are immediately lower, let's say 65% versus of 100%, so I picked up 35% compared to 28% in the energy efficiency model.

However, if I do my 30 year plan properly, I will know in advance what my next options will be, and it might well be that there is a follow-on strategy, which because of renewable energy synergies that could pay off in spades. So in year 5, when energy prices wiped out the efficiency savings of the first model, with 39% cumulative price hikes, with our lower base of 65% of the original level, we are now at a $90K annual bill, compared to the efficiency alternative, which is back up to $100K already. But, now I can find an incremental $300K investment which wipes out my remaining energy bills to 20% of what they were, in short, I am picking up $72K in savings per year to pay for it. We are starting to have compounding returns, and again if we do a proper 30 year plan, we'll see that this next investment hugely adds to the NPV of our building. And I'm avoiding the risk of carbon taxation.

Renewable Adds Up

• Sustainability wins.
• Renewable energy does add up to sustainability, it's just a matter of finding the proverbial "low hanging fruit."
• By prioritizing energy efficiency, we face diminishing returns, and we never achieve sustainability.
• If we prioritize renewable energy and energy independence, every investment in efficiency (e.g. the building envelope etc.) pays of in reducing the capital expenditure for installed capacity. We enjoy compounding returns.
• Make a 30 year plan to establish the proper sequence of projects, for there will be engineering interdependencies.

ENERGY EFFICIENCY VERSUS RENEWABLE ENERGY: APPLES AND ORANGES

The identical building across the street which invested in energy efficiency is starting to experience exponentially longer "payback" periods due to diminishing returns, whereas our building with the renewable energy infrastructure is starting to realize synergies, and compounding of returns, all of which is going to come back in building value, for in year six the renewable building will have remaining energy bills of $18,000/year, whereas the efficiency building after its latest "upgrade" in year five, has bills of $92,000/year.

Again, if these buildings were identical, the "energy efficiency" building will now be worth at least $500,000 less than the renewable energy building. Now, the owner of the renewable building is starting to get excited, and he invests another $300,000 in Wind Energy, wiping out 75% of his common area bills, and supplying electricity at a profit to his tenants, which makes him net profitable on energy, and by year 8 of his renewable energy project, his building is now worth $1,000,000 more than the "efficiency" building. Again, compounding does work if you can integrate these various phases into a coherent plan.

Mutually exclusive alternatives

Because of engineering interdependencies, switching tracks once you have committed to the energy efficiency track, likely means you wasted at least 50% of your investment, in other words the hurdle that prevents you from switching tracks gets progressively bigger with every generation of upgrades to the renewable energy building, for the gap in operating results now grows explosively. This is again why you decide first if you want to make your own energy or buy from the grid. If your building is suitable, you should perhaps let the energy companies keep their financial incentives to themselves.

Conclusion:

Equipment vendors and energy companies will focus on energy efficiency and payback periods, which is good for their shareholders, but not a decision criteria for the value of your building. With renewable energy, greater energy efficiency of my building pays off by reducing installed generating capacity, and therefore reduced capital investment. Renewable energy produces compounding returns with successive projects over time.