Energy Economics and Policy Spring Term. Student project:

Energy Economics and Policy Spring Term 2011 Student project: Analysis of investment in energy efficient heating technologies for a single-family house and possibles incentives policies Malco Parola April 2011 Professor: Thomas Rutherford

Contents Abstract... 2 1. Introduction... 3 2. Model... 6 3 Results... 8 3.1 Scenario 1... 8 3.2 Scenario 2... 8 3.2 Scenario 3... 9 3.2 Scenario 4... 9 4 Possible policies... 10 4.1 Income tax deduction... 10 4.2 Increase taxes on energy sources (fuel, electricity) used for heating and warm water production... 10 4.3 Subsidies for green technologies... 10 4.4 Moral incentives... 11 4.5 Coercive incentives... 11 5 Conclusions... 12 5.1 Water heat pump... 12 5.2 Air heat pump... 12 5.3 Solar collectors... 13 5.4 Energy policies... 13 References... 14 Appendix... 15 1/15

Abstract The aim of this study is to check if the installation of water heat pump, air heat pump and solar collectors in single-family house in Switzerland are profitable for the house owners. Also some possible energy policies are discussed and analyzed with help of the results. The study analyses four scenarios. The scenarios consider different electricity price increase of 0%, 2.5%, 5% and 7.5%. For each scenario the payback period, discounted payback period (or IRR, internal rate of return) and the net present value are computed. The results show that only with a price increase of 5%, which is not realistic, the investment are profitable for the two types of heat pumps. The solar panel are neither profitable with a 7.5% price increase. Therefore, in order to spread these technologies, incentives have to be developed. Five types of incentives have been analyzed: coercive, increase taxes on energy sources (fuel, electricity) used for heating and warm water production, income tax deduction, subsidies and moral. The conclusions are that the actual incentives of income tax deduction works well and should be developed more. Moreover some direct subsidies to the installation costs have been suggested. The calculation of the subsidy amount is based on the 30 years net present value. 2/15

1. Introduction Energy efficiency it s always more a hot topic. Energy resources are scarce and non-renewable energy resource are expected to peak, optimistically, in the next decades [1]. Another problem of these resources is that they often belong to unstable and not always very friendly (with the developed countries) countries. Oil has been one of the main cause of the last United States and Europe wars. The independence from oil and other fossil fuels of the eastern country it s becoming more and more important. An alternative would have been nuclear power but after the recent accident in Japan the populations seems to have turned quite strongly against this technology. Many countries had to renounce to their nuclear power projects because of the governmental party fair of losing the elections. Other energy resource alternative are not suitable to produce such a big amount of energy at the current state of the technology. Therefore the pressure on decreasing energy consumption is getting higher. Switzerland, through a project of ETH Zürich, want to have a 2000 Watt society by 2050 [2]. This means that every Swiss citizen should consume on average 2000 Watt per year, everything included. Figure 1: time series of the energy consumption is Switzerland [2]. Unfortunately, the data shows another reality. The electricity consumption trend is continuously increasing. The average increase is around 2 %, as shown in Figure 1. In 2010 the consumption reached also a rate of 4% after the drop of 2009 caused by the financial crisis. The Swiss electricity mix is composed only by 5% fossil combustible. The electricity production is mainly provided by hydropower plant (55%) and nuclear power plant (40%). This allows Switzerland to have very low greenhouse gasses emission. However Swiss politician are evaluating some hypothesis for the future of nuclear power plants [3]. One of these is to completely abandon this technology. So the need of significant measures to decrease energy consumption is getting higher and higher. 3/15

Figure 2: Swiss electricity mix [2]. Figure 3: energy consumption in year 2009 divided into five categories: Households, Industry, Services, Transport and the Statistic Difference [2]. 4/15

One of the sector with most energy savings potential is the building sector. It accounts almost one third of total energy consumption (Figure 1) and around 50 percent of electricity consumption [2]. The most effective measure is the application of an insulation layer. Savings are very high and are not expensive if already foreseen in the concept of the building. In case of restructuration the cost could be significant. A particular efficient insulation is a transparent insulation that allows solar transmittance of more than 50%. This solution need some investments but the payback period is quite good (5-8 years) [5]. Another possibility is to produce energy with solar panels. The energy payback period of solar panels is nowadays from 2 to 5 years. However the economic payback period is longer, thus not always projectors are foreseeing to install solar panels. A major problem of analyzing investments is the price prediction. In the energy sector it s particularly difficult because it s a very volatile market. The price are changing very fast and considerably. Moreover the future of fossil fuel is also very uncertain. The prediction of peak oil is not very accurate and scientist are still discussing if it already occurred or not. Anyway most likely the energy prices will increase. Thus this report will describe four different scenarios with different hypothesis of price increase. The last possibility that the study takes in consideration is the installation of a water heat pump or an air heat pump. The investment costs are very high but also the energy saved is considerable. The aim of this study it s to analyze the economic payback period of solar panels and heat pumps and then to find some policy that could incentives private investors to install these technologies. 5/15

2. Model In this study two models are utilized: the Net Present Value and the discounted payback period. The Net Present Value it s defined as follow: = + With: (1 + ) o o o o C 0 : initial investment n: number of years taken in consideration C t : savings in year t i: discount rate The discounted payback period or IRR (Internal Rate of Return) is defined as the year in which the Net Present Value is zero. The simple payback period is computed as follow: = / The model concept is that an initial investment of x occurred at time t=0. The investment correspond to the installation cost of the air heat pump, water heat pump or solar collectors. The savings come from the less electricity consumption. An average electricity price of 0.17 CHF/kWh is assumed. Different scenarios are computed based on different price expectations: the price is not expected to change and prices increase of 2,5%, 5% and 7,5%. The discount rate is assumed to be 0.05. The installation costs are estimated on an empirical basis and come from the web site hausinfo.ch [7]. The costs are computed for an average single-family house. The consumption is estimated from an average rate per square meters of 70 kwh/(m 2 *a). This value represent an average for new buildings in Switzerland and it s given by the Swiss label Minenergie [8]. The average area of a family house it s assumed to be 150 m 2, so the total energy need for both heating and warming the water is 10 500 kwh/a. This is a very simple model that does not take in consideration many variables. The model is also very parameter sensitive. For example the choice of the discount rate is very important. The discount rate is a prediction and it s considered to be constant in time. Both characteristic trigger a lot of uncertainty in the value. It is very difficult if not impossible to predict how much the money of today is worth in 1 or 2 years. We assumed it for 50 years to be constant. This will not obviously be true. It is just an assumed average. The problem is that a small variation in this variable could cause a quite important difference in the results. Also the installation costs of the different technologies can vary quite a lot depending on the region, the location and many technical factors such as relief, ground geology and temperature, exposition, etc. 6/15

Another problem is the estimation of the electricity need of the household. An average value is computed from the average consumption per square meter and multiplying it with the average surface of an household. This estimation could be quite good. The main problem is that the house electricity consumption depends strongly on the behavior of the inhabitants. The difference in consumption in the same house could be in the order of 200% [9]. This simple model also doesn t take into account the rebound (or takeback) effect. In this case the consumption would not decrease as expected because the consumer would react to an cheaper services consuming more. Greening et al. (2000) estimated this effect in range from 10 to 30% and Haas and Biermayr (2000) found an interval of 20 to 30% for space heating. In this study other models like the Cost of Conserved Energy (CCE) are not taken in consideration because of time limits constraint. However the calculations done in this study allow to make some consideration and suggestion for energy policies and will be presented in section 4. Other models like multiple criteria analysis or also the two-factors method suggested by Martinaitis et al. (2005) are more accurate and could be suitable for further analysis. 7/15

3 Results In this section the results for the different technology installed are described for the four scenario analyzed. 3.1 Scenario 1 Scenario 1 analyzes the different technologies in the case the electricity price won t change. The results of the computation are summarized in Table 1. Table 1: results for Scenario 1 analysis. Payback period Disc. Payback period NPV for 30 years Water Heat Pump 26 - -15.000 Air Heat Pump 23 - -9.000 Solar collectors 50 - -18.000 The results show that if the price do not change it s not worth for a private investor to install a technology taken in consideration in this study. The payback period is very high and in the case of solar collectors is also higher than the life expectance of 30 years [13]. The net present value shows the amount of money that would have to be paid in order to use the technology and not a conventional one. An air heat pump, a water heat pump and solar connectors would need more 9 000, 15 000 and 18 0000 Swiss Francs, respectively. The discounted payback period do not exist because the savings are going towards zero because of the discount rate. 3.2 Scenario 2 Scenario 2 is given by a price increase of 2.5% per year. All the rest stay the same. This price increase will compensate the discount rate in the Net Present Value. Table 2: results for Scenario 2 analysis. Payback period Disc. Payback period NPV for 30 years Water Heat Pump 19 43-7.000 Air Heat Pump 18 36-3.000 Solar collectors 32 - -15.000 With a 2.5% price increase the payback period is close to the expected lifetime of the installation which is assumed to be 15 years for the water heat pump and the air heat pump and 30 years for the solar collectors. Without considering the discount factor, the investment could be justified. However the discounted payback period is still very high. For solar collectors is still above 50 years. Also the Net Present Value still shows negative values. The solar collectors are quite expensive. An air heat pump has now only a NPV of 3 000 Swiss Francs. May be somebody could already think to spend this money for ethical reasons while in Scenario 1 this possibility is not very likely to happen. 8/15

3.2 Scenario 3 This Scenario study the price increase of 5% per year. By this rate the discount rate is exactly compensated by the price increase. So the net present value shows the same results of the scenario with zero discount rate and no price increase. Table 3: results for Scenario 3 analysis. Payback period Disc. Payback period NPV for 30 years Water Heat Pump 16 26 5.000 Air Heat Pump 15 23 7.000 Solar collectors 25 50-10.000 The payback period is only slightly smaller than for Scenario 2 but the discounted payback period shows a strong decrease. However it s still far away from the lifetime of the technology installed. The Net Present Value is for the two types of heat pump for the first time positive. This means that installing the heat pump will make the investor save 5 000 and 7 000 Swiss Francs for a water and air heat pump reciprocally. The payback period of the solar collectors is for the first time lower than the expected lifetime but still the net present value shows negative value. It s still not profitable to invest in solar collectors. 3.2 Scenario 4 Scenario 4 analyses the price increase of 7.5% per year. The results are summarized in table 4. Table 4: for Scenario 4 analysis. Payback period Disc. Payback period NPV for 30 years Water Heat Pump 14 19 25.000 Air Heat Pump 13 18 23.000 Solar collectors 20 32-2.435 Also this scenario shows similar payback periods of the previous two, the period is just slightly lower. On the other hand the discounted payback period significant decrease getting close to the expected life time of the installation. The net present value increased by factor 5 and factor 3 for the water and the air heat pump, reciprocally. This means that now savings are considerable, almost 1 000 Swiss Francs per year. The solar panels still have a negative net present value but now it s much closer to zero. However also with this scenario it s not profitable to invest in solar energie. 9/15

4 Possible policies In this section possible policies for the Swiss Government are analyzed and some suggestion are presented. The goal is to internalized the positive externalities that the adoption of green technologies could trigger. The possible policies are: Income tax deduction Increase taxes on energy sources (fuel, electricity) used for heating and warm water production Subsidies for green technologies Moral incentives Coercive incentives There are positive externalities because the electricity production is strongly supported by the Swiss Government. For example nuclear power plants and dams are very expensive to build and they are build by the Swiss Government. The decrease of energy consumption by the Swiss population will also decrease the demand and so the need of electricity and, last but not least, the expenditure of the government itself. Thus it s convenient for every stakeholder to decrease energy consumption. From this point of view it s interesting to compare the economic payback period and the energy payback period. It s interest and of advantage for every stakeholder if this two criteria would have the same value. In this case the positive externality would be internalized and the market could find an efficient solution. 4.1 Income tax deduction Nowadays in Switzerland the expenses for energy conserving measures are income tax deductible [14]. But the amortization over several year is not possible. The deduction has to be made in the same year of the transaction. However, accordingly to a survey, house owners consider this incentive as important [16]. 4.2 Increase taxes on energy sources (fuel, electricity) used for heating and warm water production This incentives has the advantage to generate an income to the government. However the productivity of the whole country could be affected. For this reason this measures has to be analyzed from more point of views and the consequences on the whole Swiss economy have to be found. 4.3 Subsidies for green technologies This option does not imply influences on other economic sectors but it needs some investment from the government. In Switzerland subsidies in energy conservation measures in the building sector already exist but differ from cantons to cantons. Some of them use a modular policy that subside single components while most of them apply a threshold policy by subsiding the Minenergie standard. The modular subsidies are based on the contribution scheme of the Swiss Federal Government (Table 5). 10/15

Table 5: Subsidy scheme of Swiss Federal Government [15]. Component Required U-value [W/m 2 *K] Subsidy [CHF/m 2 ] Floor 0.3 30 Façade 0.3 30 Roof 0.3 20 Windows 1.5 75 However these subsidies are given only in case of good insulation and not to green technology installation. A possibility would be to give the house owner a subsidy equal to the net present value of 30 years for a price increase of 2.5% per year, which is the most likely to be close to reality. In this case also for the private investor would be profitable to install an energy efficient system. This solution could be quite expensive because the subventions, following the computations of this study, would be between 3 000 to 15 000 CHF depending on the chosen technology. 4.4 Moral incentives Moral incentives have to be taken in consideration. The environmental consciousness in the population is very important. Unfortunately, nowadays green technologies and energy efficiency are just welcome when they have also an economical pay back. Moreover the trend is not to have the same service with less environmental impact, but, with the same environmental impact, increase the service or the performance. In our society you are cool if you are performing well, not if you are environmental friendly or you behave in a moral way. This behavior could be changed but need some investment of the government. Information campaign have to be done. Everybody should know that, if somebody is not behaving environmental friendly, the whole society would be worse off. 4.5 Coercive incentives Coercive incentives should be applied only in extreme cases. This study do not provide any additional information about possible coercive incentives. In case of green technology investment this kind of incentives are not considered to be applicable. 11/15

5 Conclusions In this study three different types of energy efficient installations are analysed: the water heat pump, the air heat pump and the solar collectors. For each of them the payback time, the internal rate of return and the net present value for 30 years are computed. Then some possible government policies are presented and discussed. The conclusions of the results are described for the three technology and for the policy analysis separately in this section. 5.1 Water heat pump The water heat pump allowed to save quite a lot of energy. Thus the price increase effect is an important factor for this technology. The scenarios shows that for a discount rate of 5%, the price has to increase for the same amount in order to have a positive net present value after 30 years. It is assumed that in this 30 years no more operational costs are expected respect to a conventional heating system. The payback period is quite good, it goes from the 26 years of Scenario 1 to the 14 years of Scenario 4. The expected life time it s not easy to know. Some value find in the web are in the range from 15 to 30 years. The payback period is in the same range. Thus, if the discount rate is not considered the investment can be considerable profitable. The discounted payback period or IRR (internal rate of return) is quite high. Just in Scenario 3 (5% of price increase per year) is lower than 30 years. This price increase is really considerable and not very likely to happen. In order to spread this technology, that is also the most efficient, some incentives have to be given. 5.2 Air heat pump The air heat pump does not have the same energy saving potential of the water heat pump. On the other hand the installation costs are much lower. In this study the costs are supposed to be 10 000 CHF lower than for the water heat pump, at 25 000. The price increase in this case play a minor role. The payback time is slightly smaller than for the water heat pump but not significantly. The discounted payback period follow the same trend as the one of the water heat pump and it is also quite high for all the scenarios. The net present value is also better than for the water heat pump. Just in Scenario 4, with a not realistic increase of 7.5% in the price, the air heat pump shows a worse net present value after 30 years. Anyway at these conditions a profitable case is not very likely neither for this technology. Also in this case some incentives are needed. 12/15

5.3 Solar collectors The solar collectors have a different utilization of heat pumps. They can only be used for warm up water. This allows a much smaller energy saving potential. On the other hand they don t require any operational energy. The result is anyway a smaller energy saving rates, at least for the amount of energy consumption of a single-family house. The results are quite different from the one of the heat pumps, too. The payback period is much higher, about 50 years. Solar collectors are expected to last 30 years. So also with the simple payback period is not worth to invest in this technology. The discounted payback period show also worse results. For the first two scenarios is even above 50 years. The net present value is not better and even with a very high price increase in Scenario 4 is negative. Knowing that the energy payback time of a solar panel is between 2 and 5 years, is evident that the high energetic potential is not reproduced from an economic point of view. With these values it s also worth for the government to think about incentives also if they have to be significant. It is of society s interest that the energy payback and the financial payback were similar. 5.4 Energy policies Coercive policies should be applied only in extreme situations. This study show that other incentives could be enough in order to make the investment in efficient technologies profitable. Also an increase in taxes on energy sources (fuel, electricity) used for heating and warm water production has to be analyzed carefully. Probably such an incentive would have an impact on economic activities. This impact could be significant and has to be studied. The income tax deduction is a useful incentive and is also appreciate by the house owners. It should be spread and may be a system that permit to amortize over several year could be developed. Subsidies should also be developed in order to incentive house owners to install energy efficient technologies. A direct subsidy that could cover a part of the installation cost could be a possibility. The subvention should be based on the net present value calculations. May be an average between Scenario 1 and Scenario 2 could be a good estimation of the amount of the subvention. So the subventios should amount between 7 000-15 000, 3 000-9 000 and 15 000-18 000 Swiss Francs for water heating pump, air heating pump and solar collectors, respectively. This policy could be quite expensive for the Swiss Government. An estimation of these costs should be done in order to see if it is realistic. The moral incentives could contribute to increase the spread of energy efficient technologies or to decrease the amount of subventions. The social acceptance of such technologies should be incentivized and supported. 13/15

References [1] CJ Campbell, 2000. World Oil and Gas. [2] Bundesamt für Energie, Gesamtenergiestatistik 2009, http://www.bfe.admin.ch/themen/00526/00541/00542/00631/index.html?lang=en [3] http://www.eda.admin.ch/eda/en/home/recent/media/single.html?id=38570 [4] International Energy Agency, http://www.worldenergyoutlook.org [5] Wong I. L. et al, 2007. A review of transparent insulation systems an the evaluation of payback period for building applications. [6] Amstald R. W. et al., 2006. Economic potential of energy-efficient retrofitting in the Swiss residential building sector. The effects of policy instruments and energy price expectations. [7] http://www.hausinfo.ch/ [8] http://www.minergie.ch/ [9] Karlsson J.F. et al, 2006. A comprehensive investigation of a low-energy building in Sweden. [10] Greening L.A. et al., 2000. Energy efficiency and consumption the rebound effect a survey. [11] Haas et al., 2000. The rebound effect for space heating: empirical evidence from Austria. [12] Martinaitis et al., 2005. A two-factor method for appraising building renovation and energy efficiency improvement projects. [13] Knapp K. and Jester T., 2001. Empirical investigation of the energy payback time for photovoltaic modules. [14] SR730.111.3, 1998. http://www.admin.ch/ch/d/gg/cr/1998/19980084.html [15] SR642.116, 1992. http://www.admin.ch/ch/d/sr/c642_116.html [16] econcept/cepe, 2005. http://www.cepe.ch/research/projects/mobilisation_buildings/mobilisation_buildings.htm 14/15

Appendix Calculation for Water Heat Pump, Scenario 1. 15/15