Risk Assessment in Efficiency Valuation: Concepts and Practices

Paolo Bertoldi, European Commission DG JRC
Steve Kromer, EVO

Keywords

Abstract

Energy efficiency projects can be modelled as investment decisions under uncertainty. Efficiency projects occur in the physical world, but are justified through financial determinants. In the simplest sense, an efficiency project is no different from any other investment. The primary difference is the difficulty in quantifying the value and risk resulting from the investment, and apportioning the rewards to the participants.

A range of financial metrics are applied, such as benefit/cost ratios and simple paybacks. The energy efficiency industry is just beginning to add risk and uncertainty metrics for financial returns. Uncertainty can and should be included in the valuation of projects in a manner that is efficient both in terms of quantification of energy savings (physical settlement) and financial appropriation of the resulting value (financial settlement). Tools for establishing a baseline and measuring the resulting energy savings, such as the International Performance Measurement and Verification Protocol (IPMVP), provide a framework for defining options, but stop short of providing a financial decision framework that includes the costs and benefits of M&V for a particular project. Hence, critical decisions regarding the amount of metering for a particular program or project are typically made using expert judgement, not quantitative analysis. Whereas efficiency investments are becoming an ever more important part of global efforts to optimize productivity and reduce sources of climate change, all participants in efficiency projects will require enhanced guidance on risk reduction through the appropriate use of M&V.

This paper discusses a framework for performing efficiency investment valuation and making decisions based on the combined physical and financial uncertainty, and the value of information resulting from the M&V plan. The authors hope that wider discussion on this topic will lead to a growing body of expertise on efficiency valuation techniques and thereby enhance investment in efficiency.