Capital investments have long-term energy impact

Energy Expert Peter Garforth asks why do we decide against our best interests.

By Peter Garforth

Organizations from families to factories make investment decisions that affect energy productivity for decades to come. The choices made at these once-in-decades occasions rarely take energy sufficiently into account. These omissions result in lost financial returns, unforeseen risks and unexpected collateral disadvantages. The reasons we continue to do this are worth examining.

Manufacturers, especially in high-energy-consuming industries, are obliged to rebuild their processes every few years, often following a relatively predictable timetable. As each of these occasions approach, many questions are asked. Do we take an open look at the available technical options? Do we fully understand what new technology or management methods have become available? Within the company’s own operations, are other plants using different approaches that deliver substantially higher energy efficiencies or lower greenhouse gas emissions? Are competitors gaining efficiency through other technologies or management approaches? It’s even more important to ask these questions before new factories or production lines are built.

Even if these alternatives are investigated, all too often inertia kicks in and biases the perception of the various investment effects. Simply replacing the status quo with comparable technology has predictable costs and apparently few implementation uncertainties. It also has known operational outcomes, including energy efficiency gains. Adopting new, significantly more energy efficient solutions inevitably involves a greater degree of uncertainty in terms of overall investment and implementation risks.

At this point, comfort with familiarity has a habit of taking over. Investment risks for simple replacements are underestimated, whereas those for new solutions are frequently overstated. The energy efficiency gains are similarly seen as predictable and pretty much guaranteed for the replacement path, and somewhat less believable for new approaches. This latter point is even more true if the alternatives give breakthrough efficiency gains in the 30% range or higher.

Organizations from families to factories make investment decisions that affect energy productivity for decades to come.

– Peter Garforth

This built-in security bias is reinforced by the way future energy costs often are estimated, making the conventional outcome look increasingly like a forgone conclusion. History tells us one thing about energy costs — they’re highly unpredictable. As often covered in this column, future energy price volatility is likely to be even greater. Financial returns for an energy-efficiency investment always will be defined by avoided future energy costs, obviously making the assumptions on future energy prices key to making a final investment decision.

Energy suppliers and governments have a habit of presenting a long-term, stable outlook for energy prices, with low underlying increases. These scenarios owe as much to politics and marketing messages as they do to an objective assessment of the market. Other sources will have vastly different predictions, depending on both the nature of their organizations and the assumptions used. They always will represent a range from the doomsday merchants to the naive optimists. The only accurate prediction is that they’re all wrong.

If, as is usually the case, the energy suppliers’ and governmental outlooks are used to assess alternative investment solutions, alternative investments might fail the financial attractiveness test. If the more extreme high-price scenarios are used, alternatives will be seen as attractive in theory, but all too often, be rejected as unrealistic.

Last but not least, the most used investment decision method is still based on the lowest first cost. The combination of overestimating the cost and risks of change, along with understating the technical and financial value of efficiency invariably makes the status quo the most attractive option and the dominant decision. The less obvious factor is the pressure from the operating teams to stay with familiar approaches, which has a tendency to produce analyses that foster self-fulfilling prophecies.

We all know management should demand realistic benchmarking of risks and efficiency opportunities, require risk-adjusted investment analyses and make decisions that take into account the costs of decades of operation. In almost all cases, this approach results in significantly different decisions than an updated version of business-as-usual. The reality is invariably the reverse, resulting in long-term costs and loss of overall competitiveness.

It’s not easy to understand exactly what drives this behavior. The perfectly natural human fear of change and effects of inertia are obviously factors, and seem to be hardwired into our DNA. Future costs and risks inevitably feel less real than the actual cash being used for today’s investments. We only have to think how we often fail to buy higher efficiency homes, insist on energy efficient home remodeling, or even opt for the somewhat cheaper, somewhat less-efficient dishwasher to be sympathetic to the decisions made by industrial managers.

Collectively, we need to put in place approaches to decision-making that capture energy efficiency in a realistic way and overcome our natural instinct to stay with the familiar. If we don’t, we’ll be no better than most small investors who buy high and sell low for the same reasons — fear and inertia.

Peter Garforth is principal of Garforth International, Toledo, Ohio. He can be reached at peter@garforthint.com.

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