UNIT – I

ENERGY AND ENVIRONMENT

Energy Engg. And Management
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 UNIT II

ENERGY CONSERVATION
.ENERGY SURVEYING & AUDITING

Energy Audit is the key to a systematic approach for decision-making in the area
of energy management. It attempts to balance the total energy inputs with its use, and serves to
identify all the energy streams in a facility. It quantifies energy usage according to its discrete
functions. Industrial energy audit is an effective tool in defining and pursuing comprehensive
energy management programme.

Need for Energy Audit

In any industry, the three top operating expenses are often found to be energy (both
electrical and thermal), labour and materials. If one were to relate to the manageability of the
cost or potential cost savings in each of the above components, energy would invariably emerge
as a top ranker, and thus energy management function constitutes a strategic area for cost
reduction.

Energy Audit will help to understand more about the ways energy and fuel are used in
any industry, and help in identifying the areas where waste can occur and where scope for
improvement exists. The Energy Audit would give a positive orientation to the energy cost
reduction, preventive maintenance and quality control programmes which are vital for
production and utility activities. Such an audit programme will help to keep focus on variations
which occur in the energy costs, availability and reliability of supply of energy, decide on
appropriate energy mix, identify energy conservation technologies, retrofit for energy
conservation equipment etc.In general, Energy Audit is the translation of conservation ideas into
realities, by lending technically feasible solutions with economic and other organizational
considerations within a specified time frame. The primary objective of Energy Audit is to
determine ways to reduce energy consumption per unit of product output or to lower operating
costs. Energy Audit provides a " bench-mark" (Reference point) for managing energy in the
organization and also provides the basis for planning a more effective use of energy throughout
the organization.
Type of Energy Audit

The type of Energy Audit to be performed depends on:

- Function and type of industry
- Depth to which final audit is needed, and
- Potential and magnitude of cost reduction desired
Thus Energy Audit can be classified into the following two types.
i) Preliminary Audit
ii) Detailed Audit

Preliminary Energy Audit Methodology

Preliminary energy audit is a relatively quick exercise to:

• Establish energy consumption in the organization
• Estimate the scope for saving
• Identify the most likely (and the easiest areas for attention
• Identify immediate (especially no-/low-cost) improvements/ savings
• Set a 'reference point'
• Identify areas for more detailed study/measurement
• Preliminary energy audit uses existing, or easily obtained data
Detailed Energy Audit Methodology

A comprehensive audit provides a detailed energy project implementation plan for a

facility, since it evaluates all major energy using systems.
This type of audit offers the most accurate estimate of energy savings and cost. It
considers the interactive effects of all projects, accounts for the energy use of all major
equipment, and includes detailed energy cost saving calculations and project cost.
In a comprehensive audit, one of the key elements is the energy balance. This is based on
an inventory of energy using systems, assumptions of current operating conditions and
calculations of energy use. This estimated use is then compared to utility bill charges.
Detailed energy auditing is carried out in three phases: Phase I, II and
III. Phase I - Pre Audit Phase
Phase II - Audit Phase
Phase III - Post Audit Phase
The information to be collected during the detailed audit includes: -

1. Energy consumption by type of energy, by department, by major items of process equip ment,
by end-use
2. Material balance data (raw materials, intermediate and final products, recycled materials, use
of scrap or waste products, production of by-products for re-use in other industries, etc.)
3. Energy cost and tariff data
4. Process and material flow diagrams
5. Generation and distribution of site services (eg.compressed air, steam).
6. Sources of energy supply (e.g. electricity from the grid or self-generation)
7. Potential for fuel substitution, process modifications, and the use of co-generation systems
(combined heat and power generation).
8. Energy Management procedures and energy awareness training programs within the
establishment. Existing baseline information and reports are useful to get consumption pattern,
production cost and productivity levels in terms of product per raw material inputs. The audit
team should collect the following baseline data:
- Technology, processes used and equipment details
- Capacity utilisation
- Amount & type of input materials used
- Water consumption
- Fuel Consumption
- Electrical energy consumption
- Steam consumption
- Other inputs such as compressed air, cooling water etc
- Quantity & type of wastes generated
- Percentage rejection / reprocessing
- Efficiencies / yield
Energy Audit Reporting Format

After successfully carried out energy audit energy manager/energy auditor should report
to the top management for effective communication and implementation. A typical energy audit
reporting contents and format are given below. The following format is applicable for most of
the industries. However the format can be suitably modified for specific requirement applicable
for a particular type of industry.
Understanding Energy Costs

Understanding energy cost is vital factor for awareness creation and saving calculation. In many
industries sufficient meters may not be available to measure all the energy used. In such cases,
invoices for fuels and electricity will be useful. The annual company balance sheet is the other
sources where fuel cost and power are given with production related information.

Energy invoices can be used for the following purposes:

• They provide a record of energy purchased in a given year, which gives a base-line for future
reference
• Energy invoices may indicate the potential for savings when related to production requirements
or to air conditioning requirements/space heating etc.
• When electricity is purchased on the basis of maximum demand tariff
• They can suggest where savings are most likely to be made.
• In later years invoices can be used to quantify the energy and cost savings made through energy
conservation measures
ENERGY CONSERVATION IN THERMAL SYSTEMS, BUILDINGS, ENGINEERING & PROCESS
INDUSTRIES
NON CONVENTIONAL ENERGY SOURCE SCHEMES

The contemporary non-conventional sources of energy like wind, tidal, solar etc. were the
conventional sources until James Watt invented the steam engine in the eighteenth century. In
fact, the New World was explored by man using wind-powered ships only. The nonconventional
sources are available free of cost, are pollution-free and inexhaustible. Man has used these
sources for many centuries in propelling ships, driving windmills for grinding corn and pumping
water, etc. Because of the poor technologies then existing, the cost of harnessing energy from
these sources was quite high. Also because of uncertainty of period of availability and the
difficulty of transporting this form of energy, to the place of its use are some of the factors which
came in the way of its adoption or development. The use of fossil fuels and nuclear energy
replaced totally the non-conventional methods because of inherent advantages of transportation
and certainty of availability; however these have polluted the atmosphere to a great extent. In
fact, it is feared that nuclear energy may prove to be quite hazardous in case it is not properly
controlled.
1. Wind Energy
The evolution of windmills into wind turbines did not happen overnight and
attempts to produce electricity with windmills date back to the beginning of the century.
It was Denmark which erected the first batch of steel windmills specially built for
generation of electricity. After World War II, the development of wind turbines was
totally hampered due to the installation of massive conventional power stations using
fossil fuels available at low cost. But the oil crisis of 1973 heralded a definite break
through in harnessing wind energy. Many European countries started pursuing the
development of wind turbine technology seriously and their development efforts are
continuing even today. The technology involves generation of electricity using turbines,
which converts mechanical energy created by the rotation of blades into electrical energy,
some times the mechanical energy from the mills is directly used for pumping water from
well also. The wind power programme in India was started during 1983-84 with the
efforts of the Ministry of Non-Conventional Energy Sources. In India the total installed
capacity from wind mills is 1612 MW, of which, Tamilnadu has an installed capacity of
858 MW as on 31.03.2002.
 Tamil Nadu is endowed with lengthy mountain ranges on its Western side with
three prominent passes in its length. These are with wind-potentials: (1) Palghat Pass in
Coimbatore District-1200 MW, (2) Shengottah Pass in Tirunelveli District-500MW and
(3) Aralvoymozhi Pass in Kanniyakumari District- 300 MW (Total potential-2000 MW).
The mountainous areas close to Cumbum Valley are observed to be having high potential
and, though coastal areas, central plains and hilly areas have been observed unsuitable for
wind power projects, Rameshwaram is found suitable.

2. Bio Energy Biomass is yet another important source of energy with potential to generate
power to the extent of more than 50% of the country’s requirements. India is
predominantly an agricultural economy, with huge quantity of biomass available in the
form of husk, straw, shells of coconuts wild bushes etc. With an estimated production of
350 million tons of agricultural waste every year, biomass is capable of supplementing
coal to the tune of about 200 million tonnes producing 17,000 MW of power and
resulting in a saving of about Rs.20,000 crores every year. Biomass available in India
comprises of rice husk, rice straw, bagasse, coconut shell, jute, cotton, husk etc. Biomass
can be obtained by raising energy farms or may be obtained from organic waste. The
biomass resources including large quantities of cattle dung can be used in bio-energy
technologies viz., biogas, gasifier, biomass combustion, cogeneration etc., to produce
energy-thermal or electricity. Biomass can be used in three ways – one in the form of gas
through gasifiers for thermal applications, second in the form of methane gas to run gas
engines and produce power and the third through combustion to produce steam and
thereby power.

3. Solar Energy Solar Power was once considered, like nuclear power, ‘too cheap to meter’
but this proved illusory because of the high cost of photovoltaic cells and due to limited
demand. Experts however believe that with mass production and improvement in
technology, the unit price would drop and this would make it attractive for the consumers
in relation to thermal or hydel power. The Solar Photo Voltaic (SPV) technology which
enables the direct conversion of sun light into electricity can be used to run pumps, lights,
refrigerators, TV sets, etc., and it has several distinct advantages, since it does not have
 moving parts, produces no noise or pollution, requires very little maintenance and can be
installed anywhere. These advantages make them an ideal power source for use
especially in remote and isolated areas which are not served by conventional electricity
making use of ample sunshine available in India, for nearly 300 days in a year. A Solar
Thermal Device, on the other hand captures and transfers the heat energy available in
solar radiation. The energy generated can be used for thermal applications in different
temperature ranges. The heat can be used directly or further converted into mechanical or
electrical energy. 4. Other Sources The other sources of renewable energy are
geothermal, ocean, hydrogen and fuel cells. These have immense energy potential,
though tapping this potential for power generation and other applications calls for
development of suitable technologies.

Recommendations/ Suggestions
a) A consistent and long term policy may be formulated and adopted to promote harnessing of
renewable energy sources in the State.
b) A Single Window Agency may be established under TEDA to act as a forum for speedy clearance
of projects.
c) Tariff may be restructured and power purchase policy revised suitably to make investment in
renewable energy attractive for investors taking into account not just the economic cost but also the
social/ environmental costs associated with conventional power sources.
d) The grant of suitable fiscal and financial incentives may be considered for investment in renewable
sources of energy taking into account the clean and green nature of the energy source such as
exemption from sales tax or sales tax deferral for investment in renewable energy projects
e) Merger of NBDP and IREP schemes along with staff may be undertaken so as to create field outfits
to promote renewable energy projects/ schemes
 UNIT III

ENERGY TECHNOLOGIES
ENERGY PERFORMANCE ASSESSMENT OF FURNACES

Industrial Heating Furnaces

Purpose of the Performance Test
WASTE HEAT RECOVERY
HEAT EXCHANGERS
HEAT PUMPS
 UNIT-IV
ENERGY MANAGEMENT

Principles of energy management

If energy productivity is an important opportunity for the nation as a whole, it is a
necessity for the individual company. It represents a real chance for creative management to
reduce that component of product cost.
Four main principles underlie in the basis of a well-organized program for energy
management: The first of these is to control the costs of the energy function or service
provided, but not the MWh of energy.
In addition to energy costs, it is useful to measure the depreciation, maintenance, labor,
and other operating costs involved in providing the conversion equipment necessary to deliver
required services. These costs add as much as 50% to the fuel cost.
For example - if we can lower the temperature level of a thermal process, along with reducing
heat loss will eventually be possible using other sources of heat, and from there to other parts
energy conversion elements. In turn, they may require less maintenance and repair. Thus, by
managing the quality of the heat achieves a multiplier effect.
The second principle of energy management is to control energy functions as a product
cost, not as a part of manufacturing or general overheadIt is surprising how many companies
still lump all energy costs into one general or manufacturing overhead account without
identifying those products with the highest energy function cost. In most cases, energy
functions must become part of the standard cost system so that each function can be assessed
as to its specific impact on the product cost. The minimum theoretical energy expenditure to
produce a given product can usually be determined en route to establishing a standard energy
cost for that product. As in all production cost functions, the minimum standard is often
difficult to meet, but it can serve as an indicator of the size of the opportunity.
In comparing actual values with minimum values, four possible approaches can be taken to
reduce the variance, usually in this order:
1. An hourly or daily control system can be installed to keep the function cost at the desired
level.
2. Fuel requirements can be switched to a cheaper and more available form.
3. A change can be made to the process methodology to reduce the need for the function.
4. New equipment can be installed to reduce the cost of the function.
 The starting point for reducing costs should be in achieving the minimum cost possible
with the present equipment and processes. Installing management control systems can indicate
what the lowest possible energy use is in a well-controlled situation. It is only at that point
when a change in process or equipment configuration should be considered. An equipment
change prior to actually minimizing the expenditure under the present system may lead to
oversizing new equipment or replacing equipment for unnecessary functions.
The third principle is to control and meter only the main energy functions - the roughly
20% that make up 80% of the costs (so called Pareto's Principle). It is important to focus
controls on those that represent the meaningful costs and aggregate the remaining items in a
general category. Many manufacturing plants in the United States have only one meter, that
leading from the gas main or electric main into the plant from the outside source. Regardless
of the reasonableness of the standard cost established, the inability to measure actual
consumption against that standard will render such a system useless. Sub metering the main
functions can provide the information not only to measure but to control costs in a short time
interval. The cost of metering and sub metering is usually incidental to the potential for
realizing significant cost improvements in the main energy functions of a production system.
The fourth principle is to put the major effort of an energy management program into
installing controls and achieving resultsIt is common to find general knowledge about how
large amounts of energy could be saved in a plant. The missing ingredient is the discipline
necessary to achieve these potential savings. Each step in saving energy needs to be monitored
frequently enough by the manager or first-line supervisor to see noticeable changes. Logging
of important fuel usage or behavioral observations are almost always necessary before any
particular savings results can be realized. Therefore, it is critical that an energy director or
committee have the authority from the chief executive to install controls, not just advise line
management. Those energy managers who have achieved the largest cost reductions actually
install systems and controls; they do not just provide good advice.
Energy Audit Instruments
The requirement for an energy audit such as identification and quantification of energy
necessitates measurements; these measurements require the use of instruments. These
instruments must be portable, durable, easy to operate and relatively inexpensive. The
parameters generally monitored during energy audit may include the following: Basic
Electrical Parameters in AC &DC systems - Voltage (V), Current (I), Power factor, Active
power (kW), apparent power (demand) (kVA), Reactive power (kVAr), Energy consumption
(kWh), Frequency (Hz), Harmonics, etc. Parameters of importance other than electrical such
as temperature & heat flow, radiation, air and gas flow, liquid flow, revolutions per minute
(RPM), air velocity, noise and vibration, dust concentration, Total Dissolved Solids (TDS),
pH, moisture content, relative humidity, flue gas analysis - CO2, O2, CO, SOx, NOx,
combustion efficiency etc. Key instruments for energy audit are listed below.
The operating instructions for all instruments must be understood and staff should
familiarize themselves with the instruments and their operation prior to actual audit use.
 subject of automatic controls is enormous, covering the control of variables such
As temperature, pressure, flow, level, and speed.The automatic controls can be divided into two
parts: The control of Heating, Ventilating and Air Conditioning systems (commonly known as
HVAC); and - Process control.
Both are immense subjects, the latter ranging from the control of a simple domestic
cooker to a complete production system or process, as may be found in a large petrochemical
complex. The Controls Engineer needs to have various skills at his command - knowledge of
mechanical engineering, electrical engineering, electronics and pneumatic systems, a working
understanding of HVAC design and process applications and, increasingly today, an
understanding of computers and digital communications. The intention of this chapter is to
provide a basic insight into the practical and theoretical facets of automatic control. It is
confined to the control of processes that utilise the following fluids: steam, water, compressed
air and hot oils.
Control is generally achieved by varying fluid flow using actuated valves. For the

Fluids mentioned above, the usual requirement is to measure and respond to changes in
temperature, pressure, level, humidity and flowrate. Almost always, the response to changes in
these physical properties must be within a given time. The combined manipulation of the valve
and its actuator with time, and the close control of the measured variable, will be explained later
in this Block. The control of fluids is not confined to valves. Some process streams are
manipulated by the action of variable speed pumps or fans.
Along with energy conservation, energy management systems (EMS) also have kept
this industry active in redesigning and improving their products; energy management systems
are computerized control systems implemented mostly by the utility industry, but also by large
manufacturers with their own power stations. Automatic controls have been altered and
redesigned for energy efficiency to work within these systems and for the HVAC units in the
buildings in which they are stored.
Computerized energy management systems,

on a smaller scale, also are being installed in commercial buildings. These systems
combine monitoring and controlling of HVAC units with security, lighting, and fire safety
systems.
Hotels, department stores, and grocery stores, all large users of energy, began
implementing energy management systems in the 1980s. In hotels, for instance, automatic
controls on heating and air-conditioning units are regulated by sensors in individual rooms that
detect whether the rooms are occupied; the controls also are linked to the hotel's front desk in
order to respond to check-ins and check-outs. Similarly, energy management systems have
saved energy and money for department and grocery stores. In these cases, computerized
systems are monitored for a chain of stores by a centralized network.
The industry entered the 1990s experiencing small growth following the decline in
construction of residential and commercial buildings. This modest growth, along with small
sales margins, limited research and development in new technologies and investment in new
facilities. In addition, as a result of the weak economy at the time, many companies chose to
upgrade their existing HVAC systems. Upgrading increased commercial repair and
maintenance, but sales of new HVAC systems rebounding by the end of the decade.
In the 2000s, the industry was dominated by large companies that continued to compete in a
saturated market by increasing efficiency in their products, such as improving circulation
control, compressor design, and network automation. Products became increasingly
standardized, causing companies to differentiate themselves by other means, such as expansion
into the global market. Deregulation of electricity was expected to be a significant factor in the
HVAC industry's future.

The need for automatic controls

There are three major reasons why process plant or buildings require automatic controls:
Safety
- The plant or process must be safe to operate. The more complex or dangerous the plant or
process, the greater is the need for automatic controls and safeguard protocol.
Stability The plant or processes should work steadily, predictably and repeatably, without
fluctuations or unplanned shutdowns.
- This is a primary requirement infactories and buildings to prevent spoilage, increase quality
and production rates, and maintain comfort. These are the fundamentals of economic
efficiency.
Other desirable benefits such as economy, speed, and reliability are also important, but
It is against the three major parameters of safety, stability and accuracy that each control
application will be measured.
Elements of automatic control
A controlled condition might be temperature, pressure, humidity, level, or flow. This
means that the measuring element could be a temperature sensor, a pressure transducer or
transmitter, a level detector, a humidity sensor or a flow sensor. The manipulated variable
could be steam, water, air, electricity, oil or gas, whilst the controlled device could be a valve,
damper, pump or fan. illustrates the component parts of a basic control system.
The sensor signals to the controller. The controller, which may take signals from more
than one sensor, determines whether a change is required in the manipulated variable, based
pressures as high as 60 PSI. Advantages of pneumatics: actuators for valve and damper
controls are inexpensive, easily maintained, and cost effective. The technology is mature,
controls are reliable, and different manufacturer components can be used interchangeably.
Disadvantages are: they require clean dry air, calibration of the controls on a regular basis, and
customized complex control panels for advanced temperature control systems.

Electric Control Systems

Electric control systems use electricity as the power source of a control device. This
system can have two position action in which the controller switches an electric motor,
resistance heating element, or solenoid coil directly or through microprocessor based electro-
mechanical means. Alternatively, the system can be proportional so that the controlled device
is modulated by an electric motor. Advantages are the two-position controls are simple and
reliable and use simple low voltage electrical technology. Disadvantages are the controls
cannot modulate and actuators can be expensive.
Electronic Control Systems
Electronic control systems use solid state components in electronic circuits to create
control signals in response to sensor information. Advantages are that modulated controls are
reliable and require less calibration and use electricity. Disadvantages are actuators and
controllers are expensive.
Digital Control System
Digital systems controllers utilize electronic technology to detect, amplify, and
evaluate sensor information. The evaluation can include sophisticated logical operations and
results in a output command signal. It is often necessary to convert this output command signal
to an electrical or pneumatic signal capable of operating a controlled device. Advantages are
that controls are highly reliable and require minimal maintenance. Disadvantages are initial
costs which may be high.
Equipment for automatic controls Sensors
Certain basic field hardware is necessary for a control system to function properly.
Sensors provide appropriate information concerningthe HVAC control system.
Communications
paths must be available to transmit sensor and control information. Often referred to as inputs,
sensed signals convey either analog or binary information. Analog Inputs convey variable
signals such as outdoor air temperature. Binary Inputs convey status signals such as fan or
pump status, ON or OFF. This network of field hardware must function properly if the
building control system is to be effective. It is a distinction of professional building
management for the entire network of sensors, controllers and communications to remain
functioning and accurate. This necessitates an investment in effective preventive maintenance
and continuous fault monitoring and correction, but pays rich dividends in the ability to
provide a well controlled, cost effective environment.
Sensors types include:
Temperature
Humidity
Pressure
Air Quality
Controllers
Controller types include:
Two Position
Proportional Action
Proportional plus Integral (PI)
Proportional Integral Derivative (PID)
Controllers are devices which create changes, known as system response according to sensor
information. Controllers play the critical role of maintaining the desired building conditions.
Controllers produce five distinct types of control action to control a buildings environment at
desired settings. These types of control action will be presented, beginning with the simplest
and progressing through the most sophisticated. Other types of control action are available.

CONTROLLED DEVICES
Controlled Devices include:
Valves
Dampers
Actuators for Valves and Dampers
Just about all HVAC control systems will require some type of controlled device. Water and
steam flow controlled devices are called valves while air flow controlled devices are called
dampers. The actuator performs the function of receiving the controllers command output
signal and produces a force or movement used to move the manipulated device usually the
valve or damper.
Advansed technology for effective facility control
Advances in technology brought direct digital control, lighting control, fire
management,security monitoring, distributed networks, personal computers, and sophisticated
graphics. Electronic chips replaced pneumatic controllers. Personal computers (PC’s) replaced
minicomputers. Software programs replaced hardwired logic.
Each new advancement in the electronics and communications industries was eagerly
snapped up by Facilities Management System (FMS) designers. (Note FMS is also sometime
referred to as EMS, but EMS are Energy management systems and FMS tend to be focused on
other uses of the data beyond energy conservations such as computerized maintenance
management.) Systems are now faster and more capable than ever before. Software programs,
electronic components, sensors, actuators, hardware packaging, and communications networks
are integrated, share information, and work together.
The overall purpose of a Facilities Management system is to make the job of facilities
people easier, to make a facility more efficient, and to keep a facility’s occupants comfortable
and safe.
The FMS can save money for building owners in several ways:
By increasing the productivity from
staff by doing mundane tasks for them.
By reducing energy consumption (energy management programs).
By identifying equipment needing maintenance, and even rotating the use of some
equipment.
By managing information.
When considering the use of any FMS, you must define the desired functions, make a
realistic financial analysis, and determine the amount of time available for building personnel
to use and learn to use the system. The following discussion investigates many of the options
available throughout the industry, although there may not be any single FMS which includes
them all.

ENERGY MANAGEMENT OPPORTUNITIES

Regular calibrationand maintenance programsare necessary if instruments are to produce
reliable data. With the use of electronics today, many instruments are now self-calibrating,
saving time and effort and offering continuous accuracy. However, the supporting system must
also be taken care of (e.g. ensuring that the compressed air is free of moisture and dirt and that
the line filters are maintained regularly).
The management of instrumentation, measuring and testing equipment – which
includes applicable test software – is well covered under the broadly used international
standards for quality and environmental management systems. Even facilities that have not yet
implemented these standards would be well advised to adopt the principles for sound
management of their instrumentation, metering and monitoring equipment.
Records
. Measuring, metering and monitoring equipment is not of much use without good record
keeping. Record keeping is particularly important to the process of identifying deviations from
normal operation and changes in energy efficiency. Important information should be logged at
regular intervals, either manually or automatically. Inexpensive electronic data-loggers with
many desirable features and capabilities are now available, and collecting and recording data
reliably has never been easier.
Analysis and follow-up
For the measuring or monitoring activity to make sense, there must be an analysis of
the monitored equipment’s performance records (conveniently facilitated by many software
packages available on the market) and a follow-up on deviations from optimal state.
Sometimes, of course, a suitable period must first pass in order to confirm that the deviation is
systemic in order to establish a trend and to confirm the need for a corrective or preventive
action. At other times, as in a case of simple process inattention, the follow-up must be
prompt.
Acquisition of new measuringand monitoring equipment and instrumentationwith an
optimum accuracy. For example, boiler plants and other facilities using combustion processes
consume significant quantities of fuel. For these, purchase of an oxygen and combustibles
analyser is justifiable because a regularly adjusted boiler combustion system can quickly pay
back the equipment cost. Similarly, equipment that detects compressed air leaks is a
worthwhile investment. Chances are that it will pay for itself in a short time.
Correct installation
One should not assume that an existing installation is functioning correctly just because
it has been in use for years. Often,measuring inaccuracies result from improper installation that
must be corrected. Nonintrusive measurement techniques are now available, with
correspondingly easier installation requirements.
Develop a proper designof instrument-measuring systems.
Detectors of abnormal conditions(e.g. doors to refrigerated warehouse left ajar; tank overflow
level situation).
HVAC monitoring sensors.
Replacementof pneumatic controls with direct digital controls;
A specific process equipment or application(e.g. boiler, peak demand regulation);

ENERGY MANAGEMENT INFORMATION SYSTEM (EMIS)

An Energy Management Information System (EMIS) provides relevant information
that makes energy performance visible to various levels of an organization, enabling
individuals and departments to plan, make decisions and take effective action to manage
energy. It can lead to productivity improvements through the continuous monitoring of energy
performance, and savings opportunities that, once implemented, are sustained over the long
term. The performance information generated by an EMIS enables organizations to take
actions that create financial value through the management and control of energy.

What is an EMIS?
An EMIS provides relevant information that makes energy performance visible so that key
individuals and departments within a business can take effective action to create financial
value for the organization. In practice, this means that an EMIS should:
ƒ Gather information on energy consumption;
ƒ Gather information on the useful outputs derived from the consumption of energy (e.g.,
production, heating, lighting);
ƒ Gather information on any other factors that may influence energy consumption (e.g.,
environmental factors such as ambient temperature and relative humidity, or operational
factors
such as building occupancy, packaging sizes);
Phases of EMIS development and Implementation
ƒ Contain analysis routines to allow for a comparison between energy consumption and utility
drivers;
ƒ Build and display energy performance reports.
With effective management systems in place, these performance reports can:
ƒ Act as a stimulus for investigation and identification of the root causes of both good and
poor
performance;
ƒ Promote operational best practices by eliminating the root causes of poor performance and
promoting activities that lead to good performance;ƒ Provide the justification for energy
saving projects by making visible the costs of current energy performance and providing a
baseline against which savings projects can be compared; and ƒ Demonstrate the success or
benefits of projects that have been implemented.an EMIS generally includes the following key
components:
ƒ Energy Account centres (EAcs) to manage the energy performance systems (e.g., may be
process lines, unit operations such as furnaces or driers, or components such as air
compressors or boilers).
ƒ Energy meters and sensors for the key environmental factors that influence energy
performance but over which operators have no control (e.g., temperature, relative humidity);ƒ
Production meters and sensors for the operational factors;ƒ data capture systems and data
historians to store this data; andƒ data analysis and reporting systems.
An EMIS does not exist in isolation but is part of an organization’s energy
management system (EnMS). Any EMIS should be adequate to the purpose of the
organization it serves, i.e., meet the requirements assigned to the EMIS by the organization
and be appropriate to the current status and anticipated development of the organization’s
energy management system. this means that assessors cannot simply restrict themselves to the
technical components of the EMIS during the audit, but must also address the interaction
between the EMIS and the EnMS.

Technical components of EMIS

What is the Scope of an EMIS?
Although an EMIS usually operates at a site level, in practice it can be implemented at many
levels:ƒ Restricted to an area of energy use – this may be a good starting point for those
organizations unfamiliar with the technique; ƒ Equipment or process – as an example, EMIS
can be used to control air compressors by comparing the compressed air generated with the
electricity used in generation with the compressed air generated during
production;ƒ Department level;ƒ Cost centre;ƒ Energy Account Centre;ƒ Site-wide;ƒ
Corporate – integrating the performance reporting from multiple sites into a corporate energy
or environmental report.

Outcomes and Benefits of an EMIS

The savings potential attributable to the implementation of an EMIS depends on a number of
different factors:
ƒ The type of process the site is operating;
ƒ The maturity of the organization in terms of its energy management systems and procedures;
The abilities and motivation of the operational staff. There are many types of self-assessment
tools available online to help evaluate this capacity. Of the three, the people element is the
most important. As a result, it can be difficult to define in advance the savings associated with
implementing an EMIS.
It is useful at this stage to clarify how implementing an EMIS may lead to savings. There are a
number of recognized outcomes of an EMIS: ƒ Reduced operational variability and embedding
of operational best practices. This is determined by an operator’s ability to recognize when the
process is operating well or poorly. Savings are made by eliminating the root causes of poor
performance and promoting activities that lead to good performance.
ƒ An investigation into the causes of poor performance and the identification of energy
conservation measures. Ideas for energy conservation measures may be developed as part of
the process of understanding the root causes of poor performance.
ƒ Benchmarking of similar processes across organizations. Why do the same production
processes have different energy performance characteristics at different sites?At a strategic
level, implementation of EMIS and energy management may also help to reduce the business
risk facing an organization as a result of volatility in energy prices.
 By reducing both the amount of operational variability and encouraging investment in
energy conservation measures, energy performance becomes more predictable. With
predictable energy consumption, the organization is better able to negotiate energy supply
agreements and more accurately forecast energy costs.
Energy Management, EMIS and Savings
There is extensive literature on establishing a systematic approach to the management
of energy. There is no “one size fits all” approach to the issue. As the purpose of installing an
EMIS is to provide information to people that enables energy improvement actions, the
organizational context that drives those actions is paramount to EMIS success. In other words,
an EMIS alone will not save money. An EMIS must be developed with careful consideration
of the broader context of the structured management of energy. The material and tools are
aimed at supporting this holistic concept of EMIS.
By placing an EMIS within a context of an energy management program with
continuous improvement as one of its objectives, it can also lead to productivity improvements
through the progressive elimination of wasted consumption. Using information gained about
the behaviors that lead to reduced energy consumption, best practices are quickly identified
and less efficient historic ways of working are challenged. Continuous monitoring of
performance also means that when savings opportunities are implemented they are sustained in
the long term and deviations from best performance can be quickly recognized and corrected

Savings from EMIS

 UNIT V
ECONOMICS AND FINANCE

Introduction

In the process of energy management, at some stage, investment would be required for reduc-
ing the energy consumption of a process or utility. Investment would be required for modifica-
tions/retrofitting and for incorporating new technology. It would be prudent to adopt a system-
atic approach for merit rating of the different investment options vis-à-vis the anticipated sav-
ings. It is essential to identify the benefits of the proposed measure with reference to not only
energy savings but also other associated benefits such as increased productivity, improved
prod-uct quality etc.
The cost involved in the proposed measure should be captured in totality viz.
• Direct project cost
• Additional operations and maintenance cost
• Training of personnel on new technology etc.
Based on the above, the investment analysis can be carried out by the techniques explained
in the later section of the chapter.

Investment Need, Appraisal and Criteria

To persuade your organization to commit itself to a program of investment in energy efficien-
cy, you need to demonstrate:
• The size of the energy problem it currently faces
• The technical and good housekeeping measure available to reduce waste
• The predicted return on any investment
• The real returns achieved on particular measures over time.
The need for investments in energy conservation can arise under following circumstances
• For new equipment, process improvements etc.
• To provide staff training
• To implement or upgrade the energy information system
Criteria

Any investment has to be seen as an addition and not as a substitute for having effective
man-agement practices for controlling energy consumption throughout your organization.
Spending money on technical improvements for energy management cannot compensate
for inadequate attention to gaining control over energy consumption. Therefore, before
you make any investments, it is important to ensure that

• You are getting the best performance from existing plant and equipment
• Your energy charges are set at the lowest possible tariffs
• You are consuming the best energy forms - fuels or electricity as efficiently as possible
• Good housekeeping practices are being regularly practiced.
When listing investment opportunities, the following criteria need to be considered:
• The energy consumption per unit of production of a plant or process
• The current state of repair and energy efficiency of the building design, plant and ser-
vices, including controls
• The quality of the indoor environment not just room temperatures but indoor air quality
and air change rates, drafts, under and overheating including glare, etc.
• The effect of any proposed measure on staff attitudes and behaviour.

Energy Proposals Vs Other Competitive Proposals

One of the most difficult problems which many energy managers face is justifying why
their organization should invest money in increasing its energy efficiency, especially when
there are other, seemingly more important priorities for the use of its capital.

• Organization typically give priority to investing in what they see as their core or profit-
making activities in preference to energy efficiency
• Even when they do invest in saving energy, they tend to demand faster rates of return
than they require from other kinds of investment.
Investment Appraisal
Energy manager has to identify how cost savings arising from energy management could
be redeployed within his organization to the maximum effect. To do this, he has to work out
how benefits of increased energy efficiency can be best sold to top management as,

• Reducing operating /production costs

• Increasing employee comfort and well-being
• Improving cost-effectiveness and/or profits
• Protecting under-funded core activities
• Enhancing the quality of service or customer care delivered
• Protecting the environment

Financial Analysis
In most respects, investment in energy efficiency is no different from any other area of
finan-cial management. So when your organization first decides to invest in increasing its
energy effi-ciency it should apply exactly the same criteria to reducing its energy consumption
as it applies to all its other investments. It should not require a faster or slower rate of return on
investment in energy efficiency than it demands elsewhere. The basic criteria for financial
investment appraisal include:
• Simple Payback - a measure of how long it will be before the investment makes
money, and how long the financing term needs to be
• Return on Investment (ROI) and Internal Rate of Return (IRR) - measure that
allow comparison with other investment options

• Net Present Value (NPV) and Cash Flow - measures that allow financial planning of
the project and provide the company with all the information needed to incorporate
energy efficiency projects into the corporate financial system.
Initially, when you can identify no or low cost investment opportunities, this principle
should not be difficult to maintain. However, if your organization decides to fund a rolling
pro-gram of such investments, then over time it will become increasingly difficult for you to
iden-tify opportunities, which conform to the principle. Before you'll reach this position, you
need to renegotiate the basis on which investment decisions are made.
It may require particular thoroughness to ensure that all the costs and benefits arising are
taken into account. As an approximate appraisal, simple payback (the total cost of the measure
divided by the annual savings arising from it expressed as years required for the original
invest-ment to be returned) is a useful tool.
 As the process becomes more sophisticated, financial criteria such as Discounted Cash
Flow, Internal Rate of Return and Net Present Value may be used. If you do not possess suffi-
cient financial expertise to calculate this yourself, you will need to ensure that you have
access, either within your own staff or elsewhere within the organization, to people who can
employ them on your behalf.
There are two quite separate grounds for arguing that, at least long after their payback peri-
ods. Such measure does not need to be written off using fast discounting rates but can be
regard-ed as adding to the long term value of the assets. For this reason, short term payback
can be an inadequate yardstick for assessin long after their payback periods. Such measure
does not need to be written off using fast discounting rates but can be regarded as adding to the
long term value of the assets. For this reason, short term payback can be an inadequate
yardstick for assessing longer term benefits. To assess the real gains from investing in saving
energy, you should use investment appraisal techniques, which accurately reflect the longevity
of the returns on particular types of technical measures.

Protecting Energy Investment

It is essential to keep a careful watch on your organization's maintenance policy and
practices in order to protect any investment already made in reducing your organization's
energy con-sumption. There is a clear dependence relationship between energy efficiency and
maintenance. This operates at two levels:
• Initially, improving energy efficiency is most cost-effectively done in existing facilities
through normal maintenance procedures
• Subsequently, unless maintenance is regularly undertaken, savings from installed tech-
nical measure, whether in new-build or existing facilities, may not be realized.

Financial Analysis Techniques

In this chapter, investment analysis tools relevant to energy management
projects will be discussed.

Simple Pay Back Period:

Simple Payback Period (SPP) represents, as a first approximation; the time (number
of years) required to recover the initial investment (First Cost), considering only the Net
Annual Saving:
The simple payback period is usually calculated as follows:

Examples

First cost
Simple payback period=
Yearly benefits − Yearly costs

Simple payback period for a continuous Deodorizer that costs Rs.60 lakhs to purchase and
install, Rs.1.5 lakhs per year on an average to operate and maintain and is expected to save Rs.
20 lakhs by reducing steam consumption (as compared to batch deodorizers), may be calculat-
ed as follows:According to the payback criterion, the shorter the payback period, the more
desirable the project.

Advantages

A widely used investment criterion, the payback period seems to offer the following
advantages:
• It is simple, both in concept and application. Obviously a shorter payback generally
indicates a more attractive investment. It does not use tedious calculations.
• It favours projects, which generate substantial cash inflows in earlier years, and dis-
criminates against projects, which bring substantial cash inflows in later years but not
in earlier years.

Limitations

• It fails to consider the time value of money. Cash inflows, in the payback calculation,
are simply added without suitable discounting. This violates the most basic principle of
financial analysis, which stipulates that cash flows occurring at different points of time
can be added or subtracted only after suitable compounding/discounting.
 • It ignores cash flows beyond the payback period. This leads to discrimination against
projects that generate substantial cash inflows in later years.

To illustrate, consider the cash flows of two projects, A and B:

The payback criterion prefers A, which has a payback period of 3 years, in comparison to B,

which has a payback period of 4 years, even though B has very substantial cash inflows in
years 5 and 6.
• It is a measure of a project's capital recovery, not profitability.
• Despite its limitations, the simple payback period has advantages in that it may be use-
ful for evaluating an investment.

Time Value of Money

A project usually entails an investment for the initial cost of installation, called the capital cost,
and a series of annual costs and/or cost savings (i.e. operating, energy, maintenance, etc.)
throughout the life of the project. To assess project feasibility, all these present and future cash
flows must be equated to a common basis. The problem with equating cash flows which occur
at different times is that the value of money changes with time. The method by which these
var-ious cash flows are related is called discounting, or the present value concept.
For example, if money can be deposited in the bank at 10% interest, then a Rs.100 deposit
will be worth Rs.110 in one year's time. Thus the Rs.110 in one year is a future value equiva-
lent to the Rs.100 present value.
In the same manner, Rs.100 received one year from now is only worth Rs.90.91 in today's
money (i.e. Rs.90.91 plus 10% interest equals Rs.100). Thus Rs.90.91 represents the present
value of Rs.100 cash flow occurring one year in the future. If the interest rate were something
different than 10%, then the equivalent present value would also change. The relationship
between present and future value is determined as follows:

n n
Future Value (FV) = NPV (1 + i) or NPV = FV / (1+i)
Where

FV = Future value of the cash flow

NPV= Net Present Value of the cash flow
i = Interest or discount rate
n = Number of years in the future

Return on Investment (ROI)

ROI expresses the "annual return" from the project as a percentage of capital cost. The annual
return takes into account the cash flows over the project life and the discount rate by convert-
ing the total present value of ongoing cash flows to an equivalent annual amount over the life
of the project, which can then be compared to the capital cost. ROI does not require similar
pro-ject life or capital cost for comparison.

This is a broad indicator of the annual return expected from initial capital investment,
expressed as a percentage:
Annual Net Cash Flow
ROI = --------------------------------- x 100
Capital Cost

ROI must always be higher than cost of money (interest rate); the greater the return on invest-
ment better is the investment.
Limitations

• It does not take into account the time value of money.

• It does not account for the variable nature of annual net cash inflows.
Net Present Value
The net present value (NPV) of a project is equal to the sum of the present values of
all the cash flows associated with it. Symbolically,

Where NPV = Net Present Value

CFt = Cash flow occurring at the end of year 't' (t=0,1,….n)

n = life of the project
k = Discount rate
The discount rate (k) employed for evaluating the present value of the expected future cash
flows should reflect the risk of the project.

Example
To illustrate the calculation of net present value, consider a project, which has the
following cash flow stream:

The cost of capital, κ, for the firm is 10 per cent. The net present value of the proposal is:
 The net present value represents the net benefit over and above the compensation for
time and risk.Hence the decision rule associated with the net present value criterion is:
"Accept the project if the net present value is positive and rejects the project if the net present
value is negative".

Advantages
The net present value criterion has considerable merits.
• It takes into account the time value of money.
• It considers the cash flow stream in its project life.
Internal Rate of Return
This method calculates the rate of return that the investment is expected to yield. The
internal rate of return (IRR) method expresses each investment alternative in terms of a rate of
return (a compound interest rate). The expected rate of return is the interest rate for which total
dis-counted benefits become just equal to total discounted costs (i.e net present benefits or net
annu-al benefits are equal to zero, or for which the benefit / cost ratio equals one). The
criterion for selection among alternatives is to choose the investment with the highest rate of
return.
The rate of return is usually calculated by a process of trial and error, whereby the net cash
flow is computed for various discount rates until its value is reduced to zero.
The internal rate of return (IRR) of a project is the discount rate, which makes its net pre-
sent value (NPV) equal to zero. It is the discount rate in the equation:

where CFt = cash flow at the end of year "t"

k = discount rate
n = life of the project.
CFt value will be negative if it is expenditure and positive if it is savings.
In the net present value calculation we assume that the discount rate (cost of capital) is
known and determine the net present value of the project. In the internal rate of return
calculation, we set the net present value equal to zero and determine the discount rate (internal
rate of return), which satisfies this condition.
To illustrate the calculation of internal rate of return, consider the cash flows of a
project:

The internal rate of return is the value of " κ " which satisfies the following equation:

The calculation of "k" involves a process of trial and error. We try different values of "k" till
we find that the right-hand side of the above equation is equal to 100,000. Let us, to begin
with, try k = 15 per cent. This makes the right-hand side equal to:
30,000 40,000 45,000
+------------- + --------------- + --------------- = 100, 802
2 3 4
(1.15) (1.15) (1.15)
(1. 1 5 )

This value is slightly higher than our target value, 100,000. So we increase the value of k from
15 per cent to 16 per cent. (In general, a higher k lowers and a smaller k increases the right-

hand side value). The right-hand side becomes:

30,000 30,000 40,000 45,000
------------ + ------------- +--------------- + --------------- = 98, 641
2 3 4
(1.16) (1.16) (1.16) (1.16)

Since this value is now less than 100,000, we conclude that the value of k lies between
15 per cent and 16 per cent. For most of the purposes this indication suffices.

Advantages
A popular discounted cash flow method, the internal rate of return criterion has several
advan-tages:
 • It takes into account the time value of money.
• It considers the cash flow stream in its entirety.
• It makes sense to businessmen who prefer to think in terms of rate of return and find an
absolute quantity, like net present value, somewhat difficult to work with.

Limitations

• The internal rate of return figure cannot distinguish between lending and borrowing and
hence a high internal rate of return need not necessarily be a desirable feature.
Example
Calculate the internal rate of return for an economizer that will cost Rs.500,000, will
last 10 years, and will result in fuel savings of Rs.150,000 each year.
Find the i that will equate the following:

Rs.500,000 = 150,000 x PV (A = 10 years, i = ?)

= Rs.150,000 x 3.571 - Rs.500,000 =

Rs.35,650

= Rs.150,000 x 3.092 - Rs. 500,000 =

-Rs. 36,200 NPV
25%
NPV 30%

For i = 25 per cent, net present value is positive; i = 30 per cent, net present value is negative.
Thus, for some discount rate between 25 and 30 per cent, present value benefits are equated to
present value costs. To find the rate more exactly, one can interpolate between the two rates as
follows:

i = 0.25 + (0.30-0.25) x 35650 / (35650 + 36200)

= 0.275, or 27.5 percent
Cash Flows
Generally there are two kinds of cash flow; the initial investment as one or more
installments, and the savings arising from the investment. This over simplifies the reality of
energy manage-ment investment.
There are usually other cash flows related to a project. These include the following:
• Capital costs are the costs associated with the design, planning, installation and com-
missioning of the project; these are usually one-time costs unaffected by inflation or
dis-count rate factors, although, as in the example, installments paid over a period of
time will have time costs associated with them.
• Annual cash flows, such as annual savings accruing from a project, occur each year
over the life of the project; these include taxes, insurance, equipment leases, energy
costs, ser-vicing, maintenance, operating labour, and so on. Increases in any of these
costs repre-sent negative cash flows, whereas decreases in the cost represent positive
cash flows.
Factors that need to be considered in calculating annual cash flows are:-
• Taxes, using the marginal tax rate applied to positive (i.e. increasing taxes) or negative
(i.e. decreasing taxes) cash flows.
• Asset depreciation, the depreciation of plant assets over their life; depreciation is a
"paper expense allocation" rather than a real cash flow, and therefore is not included
directly in the life cycle cost. However, depreciation is "real expense" in terms of tax
calculations, and therefore does have an impact on the tax calculation noted above. For
example, if a Rs.10,00,000 asset is depreciated at 20% and the marginal tax rate is 40%,
the depreciation would be Rs.200,000 and the tax cash flow would be Rs.80,000 and it
is this later amount that would show up in the costing calculation.
• Intermittent cash flows occur sporadically rather than annually during the life of the
pro-ject, relining a boiler once every five years would be an example.
Sensitivity and Risk Analysis

Many of the cash flows in the project are based on assumptions that have an element of uncer-
tainty. The present day cash flows, such as capital cost, energy cost savings, maintenance
costs, etc can usually be estimated fairly accurately. Even though these costs can be predicted
with some certainty, it should always be remembered that they are only estimates. Cash flows
in future years normally contain inflation components which are often "guess-timates" at best.
The project life itself is an estimate that can vary significantly.
Sensitivity analysis is an assessment of risk. Because of the uncertainty in assigning values
to the analysis, it is recommended that a sensitivity analysis be carried out - particularly on
projects where the feasibility is marginal. How sensitive is the project's feasibility to changes
in the input parameters? What if one or more of the factors in the analysis is not as favourable
as predicted? How much would it have to vary before the project becomes unviable? What is
the probability of this happening?
Suppose, for example, that a feasible project is based on an energy cost saving that
escalates at 10% per year, but a sensitivity analysis shows the break-even is at 9% (i.e. the
project becomes unviable if the inflation of energy cost falls below 9%). There is a high degree
of risk associated with this project - much greater than if the break-even value was at 2%.

Many of the computer spreadsheet programs have built-in "what if" functions that make
sensitivity analysis easy. If carried out manually, the sensitivity analysis can become laborious
reworking the analysis many times with various changes in the parameters.

Sensitivity analysis is undertaken to identify those parameters that are both uncertain and
for which the project decision, taken through the NPV or IRR, is sensitive. Switching values
showing the change in a variable required for the project decision to change from acceptance
to rejection are presented for key variables and can be compared with post evaluation results
for similar projects. For large projects and those close to the cut-off rate, a quantitative risk
analysis incorporating different ranges for key variables and the likelihood of their occurring
simultaneously is recommended. Sensitivity and risk analysis should lead to improved project
design, with actions militating against major sources of uncertainty being outlined

The various micro and macro factors that are considered for the sensitivity analysis are
listed below.

Micro factors
• Operating expenses (various expenses items)
• Capital structure
• Costs of debt, equity
 • Changing of the forms of finance e.g. leasing
• Changing the project duration

Macro factors
Macro economic variables are the variable that affects the operation of the industry
of which the firm operates. They cannot be changed by the firm's management. Macro
economic variables, which affect projects, include among others:
• Changes in interest rates
• Changes in the tax rates
• Changes in the accounting standards e.g. methods of calculating depreciation
• Changes in depreciation rates
• Extension of various government subsidized projects e.g. rural electrification
• General employment trends e.g. if the government changes the salary scales
• Imposition of regulations on environmental and safety issues in the industry
• Energy Price change
• Technology changes

The sensitivity analysis will bring changes in various items in the analysis of financial state-
ments or the projects, which in turn might lead to different conclusions regarding the imple-
mentation of projects.

Financing Options
There are various options for financing in-house energy management
1. From a central budget
2. From a specific departmental or section budget such as engineering
3. By obtaining a bank loan
4. By raising money from stock market
5. By awarding the project to Energy Service Company (ESCO)
6. By retaining a proportion of the savings achieved.

Self-Financing Energy Management

One way to make energy management self-financing is to split savings to provide
identifiable returns to each interested party. This has the following benefits:
 • Assigning a proportion of energy savings to your energy management budget means
you have a direct financial incentive to identify and quantify savings arising from your
own activities.
• Separately identified returns will help the constituent parts of your organization under-
standing whether they are each getting good value for money through their support for
energy management.
• If operated successfully, splitting the savings will improve motivation and commitment
to energy management throughout the organization since staff at all levels will see a
financial return for their effort or support.
• But the main benefit is on the independence and longevity of the energy management
function.

Ensuring Continuity

After implementation of energy savings, your organization ought to be able to make

consider-able savings at little cost (except for the funding needed for energy management
staff). The important question is what should happen to these savings?
If part of these easily achieved savings is not returned to your budget as energy manager,
then your access to self-generated investments funds to support future activities will be lost.
And later in the program, it is likely to be much harder for you to make savings.
However, if, an energy manager, has access to a proportion of the revenue savings arising
from staff's activities, then these can be reinvested in:
• Further energy efficiency measures
• Activities necessary to create the right climate for successful energy management
which do not, of themselves, directly generate savings
• Maintaining or up-grading the management information system.

Energy Performance Contracting and Role of ESCOS

If the project is to be financed externally, one of the attractive options for many
organizations is the use of energy performance contracts delivered by energy service
companies, or ESCOs.
ESCOs are usually companies that provide a complete energy project service, from
assessment to design to construction or installation, along with engineering and project
management services, and financing. In one way or another, the contract involves the
capitalization of all of the services and goods purchased, and repayment out of the energy
savings that result from the project.

In performance contracting, an end user (such as an industry, institution, or utility), seeking

to improve its energy efficiency, contracts with ESCO for energy efficiency services and
financing.

In some contracts, the ESCOs provide a guarantee for the savings that will be realized, and
absorbs the cost if real savings fall short of this level. Typically, there will be a risk
management cost involved in the contract in these situations. Insurance is sometimes attached,
at a cost, to protect the ESCO in the event of a savings shortfall.
Energy efficiency projects generate incremental cost savings as opposed to incremental
rev-enues from the sale of outputs. The energycost savings can be turned into incremental cash
flows to the lender or ESCO based onthe commitment of the energy user (and in some cases, a
utility) to pay for the savings.

What are performance contracts?

Performance contracting represents one of
the ways to address several of the most fre-
quently mentioned barriers to investment.
Performance contracting through an ESCO
transfers the technology and management
risks away from the end-user to the ESCO.
For energy users reluctant to invest in
energy efficiency, a performance contract
can be a powerful incentive to implement a
project. Performance contracting also mini-
mizes or eliminates the up-front cash outlay
required by the end-user. Payments are
made over time as the energy savings are
realized.
 Profitability Index (PI) is a capital budgeting technique to evaluate the investment
projects for their viability or profitability. Discounted cash flow technique is used in arriving
at the profitability index. It is also known as a benefit-cost ratio. Calculation of profitability
index is possible with a simple formula with inputs as – discount rate, cash inflows and
outflows. PI greater than or equal to 1 is interpreted as a good and acceptable criterion.

Profitability Index Definition:

Profitability Index is a ratio of discounted cash inflow to the discounted cash outflow.
Discounted cash inflow is our benefit in the project and the initial investment is our cost,
which is why we also call it benefit to cost ratio.

Profitability Index Method

The method used for arriving at profitability index of a proposed project is explained stepwise
below:
a) Find the expected cash inflows of the project
b) Find the cash outflows of the project (Initial Investment + any other cash outflow)
c) Decide an appropriate discount rate
d) Discount the expected cash inflows using the discount rate
e) Discount the future cash outflows and add to initial investment
f) Divide step (d) by step (e)

How to calculate the Profitability Index?

The calculation of PI is easily possible once we have the cash inflows and outflows
with appropriate discount rate are in place.

Profitability Index Formula:

The formula indicates the benefits in the numerator and costs in the denominator.
Formula for calculating Profitability Index is as follows:
Example of Profitability Index (PI):
Let’s assume the cash flows of a project as mentioned year wise in the second column of
the below table. The negative cash flows are the costs and positive ones are the benefits. In the
third column, they are discounted at 10% rate. All the discounted benefits are added to make $
16,832 and discounted costs to make $15,450.

Cash
Flows Discounted
Year (CF) CF @ 10% Benefits Costs

0 -10000 -10,000 10,000

1 5000 4,545 4,545

2 5000 4,132 4,132

3 -5000 -3,757 3,757

4 4000 2,732 2,732

5 4000 2,484 2,484

6 -3000 -1,693 1,693

7 3000 1,539 1,539

8 3000 1,400 1,400

Total 1,382 16,832 15,450

16832/15450 = 1.09

NPV Profitability Index

 The benefit to cost ratio or the PI can be found out by dividing benefits by costs
(16832/15450 = 1.382)

Acceptance Criteria or Interpretation:

A profitability index of anything equal to or greater than 1 is considered good. It means
that the project is worth executing. PI greater than 1 indicates that the project is paying
something more than the required rate of return of the investor. In our example, the project
should be accepted as it is greater than 1 i.e. 1.09.

Profitability Index (PI) and Net Present Value (NPV)

Profitability Index is closely linked with net present value. Both will present same results
as far as acceptance and rejections are concerned. It is because the almost same calculation is
followed in both. In PI, we divide our benefits by our costs whereas, in NPV, we deduct our
costs from the benefits. PI will give a relative value and contrarily

Profitability Index – Advantages and Disadvantages

The advantage of profitability method is that it considers the time value of money and
presents a relative profitability of the project. Relative profitability allows comparison of two
investments irrespective of their amount of investment. A higher PI would indicate a better IRR
and a lower PI would have lower IRR.
The main disadvantage of PI method is also its relative indications. Two projects having
the vast difference in investment and dollar return can have the same PI. In such situation,
therefore, the NPV method remains the best method.