Why CFOs fall to do the right thing in energy efficiency: lack of information in both financial and managerial decision-making is leading CFOs to make wrong decisions when it comes to investing in projects for industrial energy efficiency and sustainability.

Author:March, David
Position:Strategy - Chief financial officers
 
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The world is facing both an energy and climate crisis while the United States wastes 58 percent of the energy it produces. U.S. companies could save trillions of dollars each year through simple energy efficiency improvements, yet investments in this area remain anemic. Lack of information in both financial and managerial decision-making is leading chief financial officers to make wrong decisions when it comes to investing in projects for industrial energy efficiency and sustainability.

There are alternative approaches that can be explored that relate to the current financial and managerial decision-making process for energy efficiency projects and offer a prescription that will meet both the needs of shareholders and the planet.

Energy Efficiency By the Book

Effectively investing shareholder profits is one of the most critical of all executive functions. This activity drives core business, strategy, directly protecting and creating shareholder value. It is likely no surprise that there has been considerable academic research performed on optimizing corporate capital allocation to achieve maximum shareholder value.

A survey of CFOs published in the Journal of Applied Corporate Finance found that the majority of companies interviewed applied sophisticated financial analysis techniques, specifically internal rate of return (IRR) and net present value (NPV) calculations in their capital budgeting processes.

This finding may hold the key to why companies are hesitant to make energy efficiency improvements. The adoption of NPV and IRR should ensure that capital budgets are allocated to projects with the highest return. It's only logical to assume that if there is an apparent under-investment in energy efficiency projects, they must either fail to meet the required rate of return (negative NPV), or there are additional projects with positive NPV than available capital.

In either case, the CFO who decides to not invest in energy efficiency projects would appear to be operating in the best interests of the shareholder. However, a more in-depth analysis of the data reveals a different possibility.

Energy efficiency investments in the United States could generate at least $1.2 trillion in recovered energy costs, according to findings from a McKinsey & Co. study. What's more, the risk-return profile of energy efficiency investments shows that they have a rate of return similar to equity investments in small to medium sized firms, but with a risk profile mimicking U.S. Treasury bills, according to a 2012 study from The American Council for an Energy-Efficient Economy (ACEEE). These findings drive toward two conclusions:

* It is highly unlikely that energy efficiency investments did not have positive NPV or were projected to offer significantly less value than alternative investments. The ACEEE determined the return on energy efficiency investments to be equal to or greater than the...

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