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.

When Energy Efficiency is a Trap

Massive new programs for energy efficiency are being deployed all around, and however wonderful they are, when they are applied in the right places, it remains equally true that under certain circumstances, they can be disastrously wrong.

As pointed out throughout this site, there is a huge class of buildings in New York, in the form of the City's old-line apartment buildings which because of their size and proportions make excellent targets for deploying renewable energy, yet they are caught up in the energy efficiency craze, and in the process destroying their renewable energy potential with tax payer subsidies.

The key insight is that the two investment strategies energy independence and energy efficiency of existing infrastructure are mutually exclusive, and progressively so. In other words if your building at the outset had a reasonable potential do switch to a largely renewable infrastructure, then every investment you make unthinkingly in energy efficiency of your fossil-fuel based infrastructure makes it harder financially to switch to the renewable energy strategy.

Successive investments in energy efficiency do not cumulatively add up to energy independence, on the contrary, they act to postpone energy independence indefinitely, and perpetuate your building, as a consumer of fossil fuels, albeit an ever more efficient one, and from that point of view they are customer acquisition programs for the fossil fuel based economy. In short, if there is an alternative, to unthinkingly commit more and more money to becoming simply more efficient in consuming fossil fuel based energy, is a bit like a junkie learning to 'manage' his habit.

The current spate of programs that are geared to achieving an 15% reduction in energy usage across the board, becomes a self fulfilling prophecy, as in the process there are thousands of buildings that would have been capable of 60-80% reduction of fossil fuel based energy usage, but they will never make that change, because of a whole system of incentives and programs that encourage them to make small incremental changes in usage, in lieu of radical re-engineering their energy systems and achieving deep energy change.

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

DaBx PlaNYC2020 Draft

Finally I have brought together the whole integrated vision for a renewable infrastructure, as an alternative, but also complimentary approach to the city's PlaNYC2030.

It is the city's old line apartment buildings, those grand old buildings of 5-6 stories that made the glory days of the Grand Concourse etc, which are the richest target of opportunity for what the city apparently calls Deep Energy Change - a radical shift to a renewable base of energy production. It is these grand old buildings which are there in their hundreds and thousands, that potentially are the proverbial low hanging fruit for an energy revolution that will accomplish deep energy change.

These buildings offer the right scale, large enough but not too large (as skyscrapers would be), to be able to make them substantially energy independent with today's technology. Simply put with the combination of a modicum of grounds around the building, usually plenty of available space in the basement, a flat roof, and few shading problems, usually all or most of the available conditions are in place to accomplish a substantially feasible program of conversion to renewable technologies today.

The prevailing framework of policies and incentives focuses on energy efficiency before energy independence perversely  provides the indefinite postponement of energy independence with government subsidies. It promotes shallow energy change and in the process effectively prevents deep energy change from ever happening. For a building owner, if they are not planning for energy independence now, and develop long term plans to get there, they will never get there. Failing to plan definitely is planning to fail. To the extent that owners are following the current framework of energy efficiency oriented upgrades, they are digging their own graves, in the form of a collective next energy cirisis, moreover, this is often financed with long term money, ensuring that buildings will be under water again in the next energy crisis when it comes. Thus the present model is building the slums of tomorrow, and practicing capital destruction.

Any owners who have done nothing, and are still operating with the old steam boiler and hot water from a coil in the boiler, are actually potentially in better shape than the ones who have followed the prevailing energy efficiency regime, because every dollar they invested in making a fossil fuel infrastructure more efficient, becomes an obstacle for the economic justification of a switch to the energy independence program.

Very evidently, the administration is talking about "deep energy change,"  without much clarity that the current policy framework is an effective deterrent for its accomplishments. We can only hope that the administration can find ways to encourage a shift. There are a number of ways in which law makers and regulators can effectively make these changes possible, and even speed up adoption.

We are publishing the report in two forms, for $99 as an open-ended subscription to the report and all major revisions, and $25 for one time copies.
The subscription version can be found here: http://www.dabxdemandsidesolutions.com/Services.html
and one time copies can be ordered here: http://www.scribd.com/doc/58761637/DaBx-PlaNYC2020-Draft

What Was The Question?

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

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

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

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

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

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

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

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

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

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.

Of PACE Bonds, Freddie Mac, Fannie Mae and Property Values

There are some fascinating developments around PACE bonds, and apparent obstructionism on the part of Freddie Mac and Fannie Mae, as reported in the New York Times on June 30th, 2010, "Loan Giants Threaten Energy-Efficiency Programs."

Based on some of the issues discussed in recent posts on this site, Freddie Mac and Fannie Mae arguably are actually right to threaten these energy efficiency programs, for to the extent that PACE bonds can be used to extend the fossil fuel franchise, they are suboptimal, and therefore destructive of real estate values.

The smart thing to do would be to have maybe the energy department provide simple criteria to ensure that the energy enhancements are viable renewable energy investments which would in fact enhance property values and therefore provide increased security for any mortgages, so that the technicality of the priority lien becomes irrelevant. After all an investment with a thirty year useful life, and a five year payback, in fact offers twenty-five years of free cash flows from energy "savings," which means a tremendous increase in value of the underlying asset.

This issue goes to the heart of the matter and is very suggestive of a constructive solution. The nation certainly needs some support for real estate values, and the unfortunate fact is that the current confusion of energy efficiency and energy independence based on renewable energy in the rules and incentives, by Energy Star as much as by the ARRA incentives, which in turn depend on the Energy Star programs, is to blame for this confusion. Energy Efficiency only makes sense within the context of a viable renewable energy program, when it comes in the context of a direct trade off against installed capacity, and an improvement of the economics of the project.

Energy Efficiency as applied to extending the franchise of fossil-fuel based energy solutions does not deserve tax credits, or other incentives, it is an operational savings. To emphasize again an issue that I've raised in other posts on this site: Energy Star rated High Efficiency Tankless Hot Water Heaters are perhaps the poster child of federal subsidies for increasing our dependence on fossil fuels, and preventing a switch to renewable energy at a time when numerous viable renewable DHW solutions exist in the market place. They should be outlawed, not subsidized. There are many other examples along these lines, but this one has perhaps more visibility than anything.

If you think of these issues over the typical thirty year life of a mortgage then you'll quickly see that a 30-40% gain in efficiency in water heating with fossil fuels will be eventually offset by energy prices, and perhaps forms of carbon taxation, while solar or geothermal hot water are available and reduce dependence on subscription energy by 80-99%. Energy Efficiency of fossil fuel based systems only possibly makes sense if there is no economically viable renewable alternative. Thus the issue here is "free energy" versus a temporary reduction in energy bills, and the permanently free energy will win the day in most cases if the value of that free energy over the next 30 years is taken into account, and that is a direct enhancement to property values.

The whole issue goes back to focus on payback periods of the investments as if they were independent of the buildings. They should instead be viewed as intra-marginal investments in the building, to ensure that they enhance property values. For society as a whole this will lead to the optimal result.

Freddie Mac did the right thing for the wrong reasons, and the solution lies in a test along the lines suggested here to ensure that such energy investments are constructive and supportive of property values, not a mere green washing that undermines long term real estate values for the appearance of being green.

The Lessons of Lamborghini Applied To Energy in Buildings

Lamborghini underwent an interesting paradigm shift with their latest new model, the limited edition Gallardo LP 570-4 Superleggera  and the lessons of their design considerations are relevant to what is going on around energy usage in buildings. The "Eureka" came when they finally understood that investment in more horse power was running smack into the wall of diminishing returns as it was becoming exponentially more expensive as it became less and less effective, while reducing weight was so much more effective that at that level of performance carbon fiber became a totally affordable option by comparison in seeking to raise performance.

In buildings the reverse paradigm shift needs to happen. We have been overemphasizing energy efficiency, without looking into energy production sufficiently. Often because energy efficiency investments tend to be smaller, and more easily justified, and no one seems to realize that in the process we cheat ourselves out of the investment decision to produce energy in the first place and become at least somewhat energy independent. Simply put, since money tends to have some resource constraints (costs and availability), by nickel and diming ourselves into a stupor with more and more energy efficiency, we will ensure that we will never invest in energy production and energy independence because the more efficient we become at burning fossil fuel, the lower are the returns on investing in renewable production. So energy efficiency is the lullaby which will make us once again the perfect little victims for the next energy price spike. Still the energy efficient buildings which do not invest in renewable production will eventually be worth less than the equivalent buildings which do because of the rising value of eliminating recurrent subscription costs of energy.

Seen in this light, energy efficiency is not a worthwhile goal unless it is truly the only option, and the basic make or buy decision of renewable energy production versus the alternatives should be considered first, lest we cheat ourselves out of ever making it. The way current policy and incentives reward energy savings on a par with renewable energy causes a metastatic cancer in our energy posture as a country, in which we continue to tinker with becoming simply more efficient addicts to fossil fuel consumption without ever making the switch to energy independence through renewable energy production. The way out of this delusion is to ask which building is worth more, this energy efficient building, which shaved 25% off their energy bills or the equivalent building next door which is e.g. 50, 60 or 70%% energy independent. Now it all comes down to a real estate decision, not an energy saving decision, and if you think you are in the real estate business, that is likely to be your better investment posture. And again, decision made, you can improve on it with energy efficiency.

Or, to put it differently, energy independence produces a higher property values than energy efficiency, and the order in which we consider these options matters a lot. As soon as some of the market adopts an energy production posture building values of those that don't will be depressed. Every investment in energy production is a direct price hedge, while energy efficiency for fossil fuels only attenuates the price risks. Politically the upshot is that the national interest in energy security coincides with a maximal use of renewable energy at the building level, and current incentives produce wildly suboptimal results. For real estate owners it is hard work to make the right energy decisions in spite of incentive systems which are very seductive, and make the wrong investment decisions seem plausible.

Renewable Energy is the Real Energy Independence

Energy independence is the goal of renewable energy, it is a make or buy decision, but in the transition we will simply have gradually decreasing dependence on fossil fuels, before we achieve complete self-sufficiency from renewable sources.

Energy efficiency however, is a subgoal, and it is counter-productive if it is elevated to the primary goal, for it tends to include the unstated assumption that all our buildings can do is to consume energy, based on the recent subscription model of fossil fuel based consumption, and thus it overlooks the productive capacity which is now a reality, with increasing numbers of renewable technologies becoming available at building scale. In short investments in, or subsidies for "energy efficiency," such as is now common practice, do not optimally augment values of building stock, but are instead supportive of extending the franchise of oil companies, utilities, and constitute a subsidy of technology manufacturers, and therefore come at the expense of real estate values on the margin. Or, to put it differently from the standpoint of extending the fossil fuel franchises, energy efficiency is additive, so that in a fair world the providers of those fuels should pay for it, not the building owner.

If we focus purely on Energy Efficiency, i.e. reducing consumptions through various forms of economizing, be it through technology or sacrifice of convenience, we are locking ourselves into the consumption model, the subscription model of fossil fuels, which is the unstated assumption behind "Energy Efficiency." If instead we see energy efficiency from a production standpoint, there is a direct capital trade-off against installed capacity. Your boiler doesn't live forever, but your investment in energy efficiency by means of improvements to the building envelope directly reduces the size of your next boiler, and depending on where you are in the life-cycle of your boiler, this may be more or less relevant. Depending on what other things you undertake in your building, the economic life of your boiler may become shorter than its mechanical life expectancy.

Energy Independence with Renewable Energy will never arrive if we focus on energy efficiency only, we will merely extend the fossil fuel economy a bit longer. In this area failing to plan is definitely planning to fail. There has to be deliberate planning to shift from the consumption model, which is the model of the utilities and oil companies, to the production model, which is the model of renewable energy and of increasingly energy independent buildings. The most important aspect of renewable energy technology is that it is coming down to building scale in a variety of ways, and thus the opportunity arises to produce the energy right where it is used, and avoid high transportation costs (including some transmission losses), as well as avoiding the subscription model of energy. This is a make or buy decision, and with current technology we are shifting to a situation where the economics favor local production. This is particularly evident in metropolitan markets where the transport costs of energy are some of the highest.

Do You Want The Problem or Would You Rather Have The Solution?

The other night I attended a presentation on the new 2010 NYC Energy Code for buildings, and of course it is all wonderful progress, and woven into the presentations were plenty of interesting examples of buildings making quantum breakthroughs, though the emphasis remains on new construction, such as the NY Times building, which seems to be wonderful, and whereas the electrical code requires a capacity of 3 Watts/SqFt, the new energy code will stipulate a design spec of 1 Watt/SqFt, but the Times building accomplishes .36 Watt SqFt. So some people do get it.

Of course, since we have more old buildings than new, as buildings have a nasty habit of lasting a century or so, what will be really interesting will be to see how many retrofits will really achieve these kinds of quantum breakthroughs, helped along no doubt by various incentives, in a time when building new is going to be less frequent. For the occasion of this presentation a couple of fresh cans of energy consultants were of course opened up and paraded around to add their wisdom to the mix, while owners reps were quietly figuring out the lowest cost route to meeting the new mandates, which will ensure further capital destruction by incrementalism. Meeting the standards at the lowest cost will doom building owners to failure. More than likely most owners will follow that route for the first twenty years or so, and some are going to see their portfolio values plummet. And there is an army of consultants ready to help them achieve this. The money is in creating the quantum breakthroughs.

Standards, and codes like this one, are minimum design specs, which raise the threshold, but thankfully leave us free to exceed them, and that will hopefully become the real competition. Particularly because the new rules force all the energy data into the open, a feature that may be more important than any of the specific requirements. The energy profile of buildings now becomes a significant feature, and will be quickly reflected in the value of buildings. Which would you rather have, the building with 200 apartments using $500/unit/year in fossil fuels for the owners account, or the building of 200 apartments using $2,000/unit/year that's next to it? Or a million SqFt at .36 Watts or at 3.0 Watts/SqFt? Come and see the new slums, they'll be determined by energy intensity more so than location.

The secret will lie in creating quantum breakthroughs, by focusing on the solution not the problem. And the solution means building level production of energy as the primary mindset, so that the grid, (electric, gas), or oil are relegated to a complimentary and/or backup role, not a primary role. The technology to do it is increasingly available. Energy is becoming a technology business, and a capital asset of buildings. Energy efficiency may make sense for standards like these, but the real focus will be energy as a capital asset, energy as a value proposition and even a profit center. Assuming that owning and operating a building is driven by a profit motive, the question is not the lowest cost to meet the standard, but how much value can I add to a building with an optimally value-enhancing energy infrastructure, which should easily exceed the mandated standards.

The real breakthroughs however will come in the outer boroughs, and the suburbs, not in Manhattan, because there are fewer limitations of all kinds, which typically plague built-up areas, from lack of space, to shade from a neigboring building, and other physical restrictions. Therefore watch the values of real estate start to shift towards the outer boroughs in the next 10-20 years. Very few new LEED Platinum buildings will be commissioned in this period, and retrofits will be where the action is.

In short, if energy efficiency is mistaken for a design goal, not a minimum standard, we are reinforcing the problem. Energy efficiency is a second order parameter. If we focus on energy independence and creating value from energy, the optimal level of energy efficiency that will follow from those design goals will inevitably exceed those design standards (please do check to make sure), because there is money in it. The focus on efficiency as a primary goal reinforces the problem, and maintains our co-dependent relationship with the subscription model of energy. Because of diminishing returns, energy efficiency becomes a capital sink, and creates a metastatic cancer which blocks energy independence. Shifting radically to energy as a value proposition and an important intra-marginal investment in my building is a quantum shift, truly a paradigm shift, and this is where the money is. Energy now becomes a positive value, and whatever we can achieve now means we are focusing on the glass being half full, instead of being half empty, never mind the consolation that we may be draining it more slowly. It is not about a beautiful certificate from your local utility attesting to the energy efficiency, actual building values will be the only real parameter that counts.

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.

Solution Selling and its Undoing

Technology vendors tend to focus on selling "solutions" in which their respective technologies play the starring role. At times this may be an obvious ploy, but often enough it is done in good faith, but can be disastrous nevertheless, because it focuses on the strengths of the technology in isolation, and not its relevance to a building energy infrastructure.

Owners who buy such would-be solutions without properly reviewing the technology in context as an integral part of a long term energy infrastructure, rather than in a stand alone fashion, will pay dearly for such carelessness. At times it may even turn out that certain technologies are complementary from an the standpoint of energy engineering economics, when in the competitive sales process, where vendors all operate in their own silos, they are presented as competitive solutions in a way which is very misleading, unless owners have competent engineering and planning staff at their disposal. Existing incentives often make sloppy analysis worse by distorting the picture even more. Once technology commitments are made in the wrong order, it can be very expensive to undo them.


A proper financial discipline in this regard will view all such investments in the context of a strategic shift towards long term energy independence, which will be driven by the economics of energy as an asset, not a liability, and from the standpoint of producing energy, rather than consuming energy - which can only be mitigated somewhat by "energy efficiency." Moreover the building needs to be appreciated as a whole, and individual functions which are subsystems of that whole should never be analyzed in isolation, at the risk of serious capital destruction, if perceived problems of subsystems are solved without addressing the whole system as and integral energy and economic system.

A good example is very easy to find in today's market place. An apparent tradeoff decision may seem to exist between a "High Efficiency" (preferably "Energy Star" rated) hot water heater (gas or electric, depending on local rates), and either a geothermal or solar thermal hot water system. Vendors present their "solution" based on the payback periods, and their jubilant claims are enhanced further by the various incentives that are available, and predictably owners come to the wrong decisions. If a good solar or geothermal system has a 30 year life expectancy (and a 20 year warranty), during that same period, the hotwater heater may need to be replaced two or three times, and it comes with a constant and still substantial series of energy bills, all driven predominantly by the cost of fossil fuel (and delivery costs), which are rising relentlessly.

Based on payback alone the High Efficiency fossil fuel based method is likely to win. In NY, the typical situation is an old system in an apartment building which is based on a coil in a steam boiler, which is only 50% efficient as a hot water heater, and the modern high efficiency gas-fired water heaters are 95% efficient. Easy solution. However, remember, this still assumes a constant series of gas bills, and two or three replacements over the 30 year lifespan of the alternative system based on renewable energy. A geothermal system may offer 200% in system efficiency by comparison, and a solar thermal sytems may offer near infinite efficiency because the only fossil fuel bills it brings along on a recurrent basis is a little backup heat for the periods when there is no solar energy to harvest. And in both systems the harvesting problem of peak-load energy may be offset with water storage.

In short, when properly analyzed as an intramarginal investment in the building the $150K Solar or Geothermal system may end up being a better investment than the $15K high efficiency gas heater, while the payback period of the gas heater would definitely be shorter, when seen in isolation, but it comes with still recurrent and comparatively substantial energy subscription costs as well as two or three replacements over time. And the return on the more expensive system may be greater than on the cheaper fossil-fuel based solution. There may be other knock-on integration effects which further increase the value of the geothermal or solar solutions, where recurrent energy costs may be less than half or even only 10% of the gas fired alternative. It all becomes easy to understand when you see two identical buildings side by side, each with 100 apartments, and one spends $1,000 per apartment per year for Domestic Hot Water (DHW), based on the old coil in steam boiler, and the other $100, or $200 based on a renewable solution, while the third chose the lower capital investment of a simple high efficiency gas fired heater, but still ends up with bills of $500 per apartment per year. Energy independence in economic terms is thus a make or buy decision, or, to put it differently it boils down to buying free cash flow. The real issue is the resulting real estate value of the building, which is not what's on the mind of the equipment vendors. They would rather bamboozle the owners with magical payback numbers. So I keep reminding owners that they're in the real estate business, not in the hot water business, for that is where the deception starts.