Module V-Energy Economics
• In the process of energy management, at
some stage, investment would be required for
reducing the energy consumption of a process
or utility
• Investment would be required for
modifications/retrofitting and for
incorporating new technology
• It would be prudent to adopt a systematic
approach for merit rating of the different
investment options
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• 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 product quality etc
• The cost involved in the proposed measure
should include
➢Direct project cost
➢Additional operations and maintenance cost
➢Training of personnel on new technology etc
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• Based on the above, the energy economics
can be carried out by the energy management
team
• 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
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➢Improving cost-effectiveness and/or profits
➢ Protecting under-funded core activities
➢ Enhancing the quality of service or customer
care delivered
➢ Protecting the environment
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Vidya Engineering College,Thrissur
Economic analysis methods
1)Cash Flow Model
2)Time Value of Money
3)Evaluation of Proposals
4) The payback period method
5)The average rate of return method
6) The internal rate of return method
7)The net present value method
8) Life Cycle Costing (LCC) approach
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Vidya Engineering College,Thrissur
1)Cash Flow Model
• Cash Flow (CF) is the increase or decrease in
the amount of money a business, institution,
or individual has
• In finance, the term is used to describe the
amount of cash (currency) that is generated or
consumed in a given time period
• Cash flow calculations provide information on
profitability, quality of earnings, liquidity, risks,
capital requirements, future growth,
dividends, etc.
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• They are some of the most important tools for
value investment analysis of investment
opportunities
• Cash flows are classified as operating,
investing, or financing activities on the
statement of cash flows, depending on the
nature of the transaction
• Each of these three classifications is defined as
follows
➢Operating activities include cash activities
related to net income
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• For example, cash generated from the sale of
goods (revenue) and cash paid for
merchandise (expense) are operating activities
because revenues and expenses are included
in net income
➢Investing activities include cash activities
related to noncurrent assets
• Noncurrent assets include (1) long-term
investments; (2) property, plant, and
equipment; and (3) the principal amount of
loans made to other entities
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• For example, cash generated from the sale of
land and cash paid for an investment in another
company are included in this category
• Note that interest received from loans is included
in operating activities
➢ Financing activities include cash activities related
to noncurrent liabilities and owners’ equity
• Noncurrent liabilities and owners’ equity items
include (1) the principal amount of long-term
debt, (2) stock sales and repurchases, and (3)
dividend payments
• Note that interest paid on long-term debt is
included in operating activities
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Vidya Engineering College,Thrissur
2)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
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Vidya Engineering College,Thrissur
• 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 various 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
equivalent to the Rs.100 present value
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• 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
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• The relationship between present and future
value is determined as follows:
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Vidya Engineering College,Thrissur
3)Evaluation of Proposals
• Following four methods are usually used for the
evaluation of capital investment proposals
i) The payback period method (also known as cash
payback period method)
ii)The average rate of return method
iii) The internal rate of return method
iV) The net present value method
Method i) and ii) are the methods that do not use
the present values. Method iii) and iV) use the
present values
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Vidya Engineering College,Thrissur
• So the methods for the evaluation of capital
investment can be grouped into two
categories:
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Vidya Engineering College,Thrissur
1)The payback period method
• The payback period is the length of time it
takes to recover the cost of an investment
• Shorter paybacks mean more attractive
investments, while longer payback periods are
less desirable
• The payback period is calculated by dividing
the amount of the investment by the annual
cash flow
• Payback period= Initial investment
Cash flow per year
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Vidya Engineering College,Thrissur
• Account and fund managers use the payback
period to determine whether to go through with
an investment
• One of the demerits of the payback period is that
it disregards the time value of money
• For example you have invested 1,00,000 with an
annual payback of Rs20,000 then
Payback period=100000/20000=5 years
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Vidya Engineering College,Thrissur
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Vidya Engineering College,Thrissur
2)The average rate of return method(ARR)
• This method is also known as Accounting rate
of return method
• It is based on accounting information rather
than cash flows
• It establishes relation between average annual
profits to total investments
• ARR= Average annual profit after tax *100
Average investment over the life of
the project
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➢Advantages of ARR
a) It is simple and easy to calculate
b) It takes into account all the savings over the
entire period of investment
c) It is based on accounting profit rather than
cash in flow. Accounting profit can be easily
obtained from financial statements
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d)It measures the benefit in percentage which
makes it easier to compare with other projects
e)This method helps to distinguish between
project where the timing of savings is
approximately the same
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Vidya Engineering College,Thrissur
3)The internal rate of return
method(IRR)
• The IRR is a discounting cash flow technique
gives a rate of return that is earned by a
project
• This technique is used for evaluation of big
projects and investment proposals
• It makes decision making fast and simple
• This is the most important alternative to NPV
• It is often used in practice and is intuitively
appealing
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Vidya Engineering College,Thrissur
• It is based entirely on the estimated cash flow
and is independent of interest rates found else
where
➢Advantages
• It is simply tells what the project under
concern will return in terms of percentage. We
do not need to decide a hurdle rate in
advance
➢Disadvantages
• It does not consider the dollar value
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Vidya Engineering College,Thrissur
4)The Net present value method(NPV)
• Net present value(NPV) is a method used to
determine the current value of all future cash
flows generated by a project including the
initial capital investment
• It is widely used in capital budgeting to
establish while projects are likely to turn the
greatest profit
• NPV is the arithmetic sum of the present value
of the future cash flows
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• Based on financial factors alone, only projects
with a zero or positive NPV are acceptable.
• IT will use three steps for the NPV method
NPV=Present value of cash in flows-Initial investment
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Vidya Engineering College,Thrissur
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Vidya Engineering College,Thrissur
Life Cycle Costing (LCC) approach
[Link] of LCC
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Vidya Engineering College,Thrissur
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• Life cycle costing, or whole-life costing, is the
process of estimating how much money you
will spend on an asset over the course of its
useful life
• Whole-life costing covers an asset’s costs from
the time you purchase it to the time you get
rid of it including the costs of acquisition,
maintenance, repair, replacement, energy, and
any other monetary costs (less any income
amounts, such as salvage value) that are
affected by the investment decision
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Vidya Engineering College,Thrissur
• The time value of money must be taken into
account for all amounts, and the amounts must
be considered over the relevant period
• To calculate an asset’s life cycle cost, estimate the
following expenses:
1)Purchase
2)Installation
3)Operating
4)Maintenance
5)Financing (example interest etc)
6) Depreciation
7)Disposal
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Vidya Engineering College,Thrissur
Computer aided energy management
• Computerized energy management system
(EMS) is a system of computer-aided tools
used by operators of electric utility grids to
monitor, control, and optimize the
performance of the generation and/or
transmission system
• The monitor and control functions are known
as Supervisory Control and Data Acquisition
(SCADA), followed by several on-line
application functions
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Vidya Engineering College,Thrissur
• Energy Management Software is a general
term referring to a variety of energy-related
software applications which may provide
utility bill tracking, real-time metering and
lighting control systems, building simulation
and modeling, carbon and sustainability
reporting , demand response, and/or energy
audits
• Managing energy can require a system of
systems approach
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Vidya Engineering College,Thrissur
Objectives of EMS
1)Maintaining the power system in a secure and
stable operating state by continuously
monitoring the power flowing in the lines and
voltage magnitudes at the buses
2)Maintaining the frequency within allowable
limits
3)Maintaining the tie-line power close to the
scheduled values
4)Economic Operation of the power systems
through real time dispatch and Control
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5)Optimal control of the power system using both
preventive and corrective control actions
6)Real time Economic Dispatch through real power
and reactive power control
7)Optimization of the power system for normal and
abnormal operating scenarios
8)Optimal control of the power system by
appropriate using both preventive and corrective
control actions
9)Maintenance scheduling of generation and
transmission systems
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Vidya Engineering College,Thrissur
EMS Architecture
Power and Information flow between Power systems, SCADA and EMS
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Vidya Engineering College,Thrissur
• Figure shows the components in EMS-SCADA
• Power Systems contain generators,
transformers, transmission lines, different
loads to industry and consumers
• SCADA consists mostly of hardware
components, which measure the quantities
(Voltage, current, power, etc.) from various
meters
• SCADA consists of collection of information
from meters distributed throughout the area
through Remote Terminal Units (RTUS).
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Vidya Engineering College,Thrissur
• EMS consists of a network of computers or work
stations which perform computational tasks for
decision making in real time operation and
control
• Both On-line and Off-Line functions can be
performed in an EMS
• The operators in an EMS send signals to the
power system through SCADA
• On line functions include mainly closed loop
control functions like automatic generation
control (AGC), load frequency control (LFC),
voltage reactive power control (volt-VAR control)
etc.
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Vidya Engineering College,Thrissur
• Open loop functions like Economic Dispatch
and Operator load flow, state estimation,
security assessment, etc are also performed in
real time as on line functions
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Vidya Engineering College,Thrissur
Problems
1)Calculate the 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)
2)A new small cogeneration plant installation is expected to reduce a
company’s annual energy bill by Rs.4,86,000/-.If the capital cost of the
new boiler installation is Rs.2,220,000/- and the annual maintenance
and operating costs are Rs.42000/-.Calculate the expected payback
period of the project?
• Problems
❖Cost of an heat exchanger is Rs.1.00 lakhs .Calculate simple pay back period
considering annual saving potential of Rs.60,000/- and annual operating cost
of Rs.15,000/- .
❖Calculate simple pay back period for a boiler that cost Rs.75.00 lakhs to
purchase and Rs.5 lakhs per year on an average to operate and maintain and
is expected to annually save Rs.30 lakhs.
NPV problem
Q)