Why Don’t More Companies Implement Energy Efficiency Measures?
The recent furore over a proposal to introduce vehicle efficiency standards in Australia highlights a general and intransigent resistance to energy efficiency policies. Since the 1970s, researchers have investigated the energy efficiency paradox: despite making good economic sense, the majority of companies do not implement substantive energy efficiency programmes. This lack of action costs the economy and the environment dearly. The IEA has estimated that if businesses around the world adopted all the quick wins available, we would reduce energy demand by 3.6 exajoules per year. That’s equivalent to 60% of Australia’s annual energy consumption and to an annual cost saving of $200 billion AUD (based on 20 c/kWh).
Running the Numbers – Is It Worth Paying More for a More Efficient Air Conditioner?
What’s stopping businesses from taking action? The financial picture is pretty clear. Efficiency projects stack up well when using typical payback analyses, e.g. IRR/NPV calculations. As an example, take purchasing a new air conditioner for the office. The office needs a cooling capacity of 5kW. There are several options with the least efficient unit costing $1200 (power input 1.7 kW) and the most efficient costing $1500 (power input of 1.16 kW). The upfront cost is $300 more for the more efficient unit but the annual cost savings are $56.31 (based on electricity prices of 20c/kWh). Assuming the unit lasts for 10 years, this cost saving represents an internal rate of return (IRR) of 17.8% and a net present value (NPV) of $103.11 based on an 8% discount rate. The numbers are likely to be even better than that given that electricity prices are substantially outpacing inflation.
With all this information, the decision is crystal clear. Of course you’d go for the more efficient unit. How often can you achieve an IRR of 17.8%? This example deals with a very small unit with running costs that can be paid for with petty cash but when you scale up to bigger A/C units, the difference is profound.
Let’s do the same analysis with a 150 kW cooling capacity unit. This time the upfront cost is 30x more – $36,000 for the less efficient unit and $45,000 for the more efficient unit. Annual running costs for the less efficient unit are $5,318.57 vs $3,629.14. The more efficient unit will pay for itself in 5.33 years. NPV is $3,161 and IRR is 17.3%. Again an easy decision assuming you have sufficient capital available for a 5 year payback.
Why Would You Buy the Less Efficient Unit?
Traditional economic theory is based on Homo Economicus, a highly rational fellow who always makes the best decisions for himself. He’d always opt for the more efficient unit in the above examples. However, real humans don’t necessarily behave rationally. Indeed, research study after research study has found that businesses choose not to embark on efficiency projects even when it makes clear economic sense to do so.
According to the research, common barriers to adopting efficiency initiatives are:
1. Information Asymmetry and Data Gaps
Finding the data on actual consumption is not easy. If you shop on Harvey Norman online, you won’t find power input in the product specs. They’ll tell you the cooling capacity (confusingly also in kW equivalents) but they de-emphasise energy star ratings and flat out hide the power input figures. Even the manufacturer didn’t provide that information on their website. I had to dig into data.gov.au to find real numbers. Sathaye and Murtishaw (2004) found that this experience is common. The “information cost” of collecting data to support energy efficiency investments can add up to 6% of the total investment. It’s not just the time involved in making procurement decisions, companies also lack insight into their current consumption patterns. Unless they’ve installed submetering, all they’ll get is one big bill at the end of the month with no granularity into which pieces of equipment are chewing up the most kWh.
2. The Landlord-tenant Problem
Many businesses don’t own their premises. This means that they and their landlords have diametrically opposed mindsets when it comes to efficiency investments. The landlord normally has to pay for capital improvements (e.g. putting insulation in) but the tenant pays for operating expenses (e.g. electricity costs from heating). In this situation, neither party wins from efficiency projects. The landlord is reluctant to invest in structural improvements because the capital cost will be high and they don’t feel the monthly pain from utility bills.
3. Perceived Risk
Another factor is perceived risk. As with any change management process, there will be laggards and luddites. They are (sometimes rightly) concerned that swapping out equipment might have impacts on operations. For example, let’s suppose that the business pondering an A/C upgrade is a data centre. They’ve promised their clients 5 nines (99.999%) reliability. If the new air conditioner doesn’t work as well, servers might overheat and they’ll have angry customers beating down their doors.
4. Access to Capital
Even if key stakeholders buy in, funding capital upgrades can be tricky. For early stage/cashflow constrained businesses, a 5 year payback on a more efficient A/C unit might be too long to wait. If the business owner isn’t sure they’ll still have their doors open in 12 months, it would be pretty bold to invest in a longer term project that isn’t directly aligned to their business.
5. Lack of Interest
Until recently, utility bills have been a minor component of a business’s operating expenses. In 2007, the average Australian business spent 1.6% of total operating expenses on electricity (source – IEA). Ten years on, that figure has almost certainly increased but with the growth of the service economy, electricity bills still pale in comparison with larger expenses like payroll. Unless the business is in manufacturing or has a deep commitment to environmental sustainability, the care factor is likely to be low.
What’s Different About Businesses That Do Invest in Energy Efficiency Initiatives?
Rohdin and Thollander (2005) investigated the characteristics of Swedish manufacturing firms that invested in energy efficiency initiatives. Compared to their less efficient counterparts, these companies tended to have a longer term perspective, with long range energy forecasts and key stakeholders who were motivated to become more sustainable. DeCanio and Watkins (2006) performed a similar study with US firms. They found that firms with more employees were more likely to join government energy efficiency programmes possibly because economies of scale meant they could have a dedicated person working on efficiency initiatives. Financial performance (earnings per share and price to equity ratio) was also significantly correlated with participation in efficiency programs. This could be because more financially successful firms have more working capital available to invest in capital upgrades.
What Can Be Done to Support and Encourage Energy Efficiency Initiatives in SMEs?
According to the research, SMEs are less likely to embark on energy efficiency initiatives. They are less likely to have dedicated personnel available to collect data on energy consumption and make informed procurement decisions; are more likely to rent/lease premises and thus be constrained by the landlord/tenant problem; have less redundancy in operations so if an operational interruption occurs, it has a major impact; have less cash in the bank for major capital upgrades; and are more focused on keeping the doors open than on undertaking sustainability initiatives.
You might think that manufacturing, mining and transport would be the major electricity users in Australia but 2016 stats from the ABS indicate that service based businesses, accommodation providers, food services and retail operators use 51% of Australia’s electricity consumption. Many of these businesses fall into the SME bracket. For this reason, encouraging efficiency initiatives in smaller firms is vital. Some tactics that might help are:
1. Fill Data Gaps by Rolling Out Smart Meters
It’s difficult to identify wasteful consumption patterns without solid data. The Australian electricity market commission (AEMC) is launching the power of choice programme which will allow households and businesses to receive a smart meter that will provide far more granular energy usage data. The cost of these meters is negligible compared to the potential for savings particularly if smart software like EnergyLink is used to identify inefficient consumption patterns and benchmark the site with other sites in the same industry.
2. Address Information Asymmetry Through Better EnergyStar/NABERS Programmes
The EnergyRating stickers have been extraordinarily helpful (to the tune of $57 billion in savings) in driving more efficient purchases in Australia. However, currently the programme only applies to household appliances. Providing clear benchmarking data for commercial appliances would help SMEs make more efficient procurement decisions without incurring the data wrangling overhead of sourcing the figures themselves.
Similarly, the NABERS programme has put pressure on large buildings to up their game when it comes to energy efficiency. From July 1st 2017, the commercial building disclosure program will extend to all commercial buildings with more than 1000 sq. metres of floorspace (previously > 2000 sq. m). The enhanced transparency that comes from NABERS reporting will help SMEs make better decisions when leasing office space. Down the track, it may help to extend NABERS to other types of buildings, though assistance with reporting and compliance would be needed.
3. Shared Efficiency Dividends
Innovative business models are needed to overcome the landlord tenant problem. One example is Power Ledger’s peer to peer energy trading system where landlords can install solar panels on the roof of the premises and then charge tenants for electricity, allowing the landlord to recoup the cost of the solar array and the tenant to purchase cheap, green power.
4. Access to Green Loans
Green loans are a recent market entrant that can help SMEs invest in efficiency upgrades. It’s encouraging to see major banks like Westpac, NAB and ANZ joining smaller players like Bendigo Bank in offering green loans at reduced interest rates.
5. Share the Wins
To change the perception of energy efficiency as something that only big companies can do, we need to hear more success stories about small businesses that have made efficiency upgrades and reaped the rewards. The federal government’s Energy Exchange website features several case studies and we’ll hopefully see more over the coming years. At EnergyLink, we plan to start a customer stories podcast where we interview our SME clients to allow them to share their wins.
The Outlook for Energy Efficiency
With the arrival of smart meters and machine learning algorithms, the future is bright for energy efficiency. It’s becoming easier and easier to identify potential improvements and to see where you rank compared to similar businesses.
At EnergyLink, we are passionate about accelerating the efficiency transformation and helping unlock the 3.6 exajoules of potential annual energy savings around the world. If you’d like to explore how your business could become more efficient, contact our team.