What's the Payback on Home Energy Efficiency?

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payback granite countertop home energy efficiency cost effectiveness

Here's Why That's the Wrong Question!

If you're investing in energy efficiency improvements for your existing home or buying a new high performance home, calculating the simple payback for your investment is at best incomplete and at worst, completely irrelevant. Before I get to the reasons why payback isn't the right way to look at home energy efficiency improvements, let's define simple payback.

Let's say you buy a new refrigerator to replace that old energy hog from the '80s you've kept way too long. I did this a few years ago, and the old fridge was using 150 kilowatt-hours (kWh) per month (as measured with my WattsUp Pro). The new fridge uses only 40 kWh per month. At $0.10 per kWh, this change led to savings of (110 kWh / month) x ($0.10 / kWh) = $11 per month, or $132 per year.

To calculate a simple payback time in years, you plug the numbers into this equation:

Simple Payback = Total Cost ÷ Annual Savings

When you run the numbers for this fridge, whose cost was $800, you find that the simple payback is just a bit more than 6 years.

Strike 1 Against Simple Payback

Right away, you may see one problem with using simple payback in this example. If you've got to replace your fridge anyway, using the total cost here would be the wrong number. If you made a choice between an efficient model and a less expensive inefficient refrigerator, then the difference in cost is what you should use. For example, if the more efficient model cost $132 extra and saved $132 per year, the payback on the extra efficiency is one year.

Strike 2 Against Simple Payback

What's the payback on the granite countertops in the kitchen? What's the payback on those hardwood floors? And, most important of all, how long will it take for that beer-launching refrigerator to pay for itself? (You'll have to watch the video to find Dave Letterman's answer to that last question.)

The point here is that payback measures only cost effectiveness, but if the investment has other benefits as well, payback is an incomplete picture of the value of your investment. When you invest in a high performance home, energy efficiency is only one of the benefits. You also get comfort, healthfulness, and durability.

Strike 3 Against Simple Payback

The final strike against payback is that it's completely irrelevant if the investment is financed over time. How can you pay yourself back for something you haven't completely paid for? You can't!

In this case, the relevant measure is cash flow. Here's an example:

 
Standard Home
Efficient Home
Home Price
$200,000
$203,200
Mortgage Payment
$908
$923
Energy Bills
$302
$256
True Cost
$1210
$1179
Net
 
-$31

As you can see, it makes complete sense to buy what looks like the more expensive house because that extra $3200 pays for itself in the first month.

If I'm trying to get you to buy the more energy efficient home, I'll offer you this deal: You can buy it for exactly the same monthly payment as the other house would cost ($908) except I'm going to come to you and ask for another $15 each month (extra mortgage payment) and then I'll give you $46 (energy savings). You end up with an extra $31 in your pocket each month!

So, let's get over this obsession with payback. If you're paying cashing for something whose only purpose is to generate savings and has no other benefits, then simple payback is relevant. In other situations, it's best just to forget all about payback.

 

Granite countertop photo by granite-charlotte, from Flickr.com

Comments

Mike

Thank you Allison for this post. I've long felt that the concept of simple payback has hindered the acceptance of energy retrofits in the market, see here: 
 
http://www.demandsidesolutions.com/2010/08/upselling-just-dont-call-it-e... 
 
I've been stewing over a response to this post by GreenTech where the simple payback metric is used against energy conservation measures: 
 
http://www.greentechmedia.com/articles/read/does-energy-conservation-wor... 
 
Your post comes at a good time. This is a worthwhile debate to have.

Allison Bailes

Thanks, Mike. Simple payback certainly has its place, but when you're talking about big expensive retrofits, even when you're paying cash, there are better ways to assess cost effectiveness (such as net present value). I'm glad to have an ally in this. Also, thanks for pointing out that GreenTech article. I responded to it this morning.

David Butler

Simple payback is indeed misleading. As you point out in the refrigerator example, payback works best when comparing two otherwise equivalent alternatives. 
 
To do it properly, I always nail down the non-negotiable requirements that have no financial benefit -- for example, durability, safety and comfort. Any product that doesn't meet those requirements is discarded. Only then can I evaluate the energy savings of more efficient products.  
 
I compare the marginal cost with the present value of the energy savings using an appropriate time horizon and a reasonable discount rate (or interest rate, if financing is involved). 
 
When comparing products with different life expectancies (e.g., a tankless water heater vs. a conventional model with glass-lined tank), I set the time horizon to the one with the shortest lifespan and set a residual value for the product with the longer life. Depending on the client's situation, I sometimes double the time horizon and include replacement costs for the shorter life product at the midway point. 
 
This all sounds complicated but I've done this so many times that it gets to be old hat. The question must always be: Is there a less expensive way to achieve the same or better energy savings without compromising on comfort, durability and safety? 
 
One more thing... I've seen people justify expensive energy retrofits using crazy inflation for energy costs. I don't have a crystal ball but when the primary heating fuel is electricity (e.g., heat pump), I only inflate electric rates to the point where PV may reasonably be expected to be at parity, regardless of whether PV is in the current plan.

Paul Reynolds

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jak42

Allison, 
 
Excellent article. I try to avoid talking about payback in my blog. My preferred metric is dollars per kg of carbon eliminated. That is an indication of how economically efficient the technology is. The assumption being that you want to buy technologies that eliminate the most carbon for the money you put into them. I don't discount subsidies. The whole point of subsidies is to get the market in renewables and, maybe someday, efficiency going. So they should legitimately be included in the calculation.