Energy Management
and Conservation
Handbook
ECONOMICS METHODS
Introduction
Economic-evaluation methods facilitate comparisons
among energy technology invest- ments. Generally, the
same methods can be used to compare investments in
energy sup- ply or energy efficiency. All sectors of the
energy community need guidelines for making
economically efficient energy-related decisions.
Making Economically Efficient Choices*
Economic-evaluation methods can be used in a number of ways to increase
the economic efficiency of energy-related decisions. There are methods that can
be used to obtain the largest possible savings in energy costs for a given
energy budget; there are methods that can be used to achieve a targeted
reduction in energy costs for the lowest possible effi- ciency/renewable
energy investment; and there are methods that can be used to determine
how much it pays to spend on energy efficiency and renewable energy to
lower total life- time costs, including both investment costs and energy costs.
Maximizing net benefits
Economic Evaluation Methods*
There are a number of closely related, commonly used methods for evaluating
economic performance. These include the life-cycle cost (LCC) method, levelized
cost of energy (LCOE) method, net present value (NPV) or NB (net present worth)
method, benefit/cost (or savings-to-investment) ratio (SIR) method, internal rate-
of-return (IRR) method, overall rate-of-return (ORR) method, and discounted
payback (DPB) method. All of these meth- ods are used when the important
effects can be measured in dollars. If incommensurable effects are critical to the
decision, it is important that they also be taken into account. But, because only
quantified effects are included in the calculations for these economic methods,
unquantified effects must be treated outside the models. Brief treatments of the
methods are provided; some additional methods are identified but not treated. For
more comprehensive treatments, see Ruegg and Marshall (1990).
1.Life-Cycle Cost (LCC) Method
The life-cycle costing method sums, for each investment
alternative, the costs of acquisi- tion, maintenance,
repair, replacement, energy, and any other monetary
costs (less than any income amounts, such as salvage
value) that are affected by the investment decision.
LCCA1 = IA1 + EA1 + MA1 + RA1 − SA1 (3.1)
where
LCCA1 = life-cycle cost of alternative A1
IA1 = present-value investment costs of alternative A1
EA1 = present-value energy costs associated with alternative
A1 MA1 = present-value nonfuel operating and maintenance cost of A1 RA1 = present-value repair and replacement
costs of A1
SA1 = present-value resale (or salvage) value less disposal cost associated with alternative A1
1. Risk Assessment
t
Many of the inputs to the evaluation methods mentioned earlier will be
highly uncertain at the time an investment decision must be made. To
make the most informed decision possible, an investor should employ
these methods within a framework that explicitly accounts for risk and
uncertainty.
• Expected value (EV) analysis
• Mean-variance criterion (MVC) and coefficient of variation
(CV)
• Risk-adjusted discount rate (RADR) technique
• Certainty equivalent (CE) technique
• Monte Carlo simulation
• Decision analysis
• Real options analysis (ROA)
• Sensitivity analysis
1.Building Blocks of Evaluation
Beyond the formula for the basic evaluation methods and risk
assessment techniques, the practitioner needs to know some of the
“nuts-and-bolts” of carrying out an economic analysis. He or she
needs to know how to structure the evaluation process; how to
choose a method of evaluation; how to estimate dollar costs and
benefits; how to perform dis- counting operations; how to select an
analysis period; how to choose a discount rate; how to adjust for
inflation; how to take into account taxes and financing; how to treat
residual values; and how to reflect assumptions and constraints,
among other things. This section provides brief guidelines for these
topics.
1. Economic Analysis Software for Renewable Energy Investments
Over the last three to four decades, a large number of models for the economic
analy- sis of renewable energy systems have been developed. In the early years,
the emphasis was on simpler models for the analysis of solar hot water and space
heating. In the last decade, the emphasis has shifted to models of renewable
electric technologies as those technologies have become more and more cost
competitive. At the same time due to the complexities of the electric system, the
models have become more and more sophisticated with respect to both system
performance and system economics and financing. The need for reliable power
and the variability of wind and solar are dealt with in many models by
performance projections down to the hourly level. Similarly, the complex
ownership and regulation of power plants and electric utilities has led to
increasingly sophisticated financing and ownership structures in today’s models.
We will examine these intricacies as we briefly review a handful of the more
prominent models used in the United States with an emphasis on the economic
measures used, the technologies treated, and the dif- ferent areas of emphasis of
the different models.
