WASHINGTON, DC—With states adopting programs to encourage buildings to install combined heating and power (CHP) systems, owners and asset managers are asking the bottom line question: how can CHP increase my operating income and asset value?

Every property owner or operator understands that each building varies in energy use, energy efficiency and fuel supply arrangement. Large users such as hospitals, universities, hotels, offices and residential buildings each have unique considerations. CHP presents an integrated alternative to using on-site oil or gas boilers for heating while purchasing electricity from the local utility.

Economics

By installing a CHP system, the building will generate its own electricity while using the waste heat to meet its thermal demands (heating, hot water and potential absorptive cooling). The corollary is that the cost difference between electric utility purchases and on-site generation increases, reducing utility costs and increasing income.

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You will see that CHP presents a cost effective way for a building to generate its own electricity, heating and cooling by running a single fuel input through a combined power and heating system. And CHP makes most economic sense when a building's thermal requirements are high, its boilers are aging, and electricity prices are greater than $0.10/kilowatt hour. According to the US Energy Information Administration, average revenue per kWh figures were higher than that in 31 states and the District of Columbia as of June 2015. Many end-of-use sector prices are currently above $0.10/kWh.

Example

To understand the economics, let's assume we have a commercial building with 500,000 square feet charging rent at $50/sq. ft., inclusive of energy. Now assume we have delivered natural gas at $11.00 mmBtu ($5.50 commodity), and electricity from the local utility at $0.20/kwh.

Such a building will spend roughly $3 million annually in energy expenses, and have net operating income of approximately $16 million. If the building's revenue increases by 6% per year, the asset would be valued at approximately $271 million.

Based on our usage assumptions, installing CHP will increase a building's net cash flow by approximately $830,000 annually and increase the asset value by approximately $14 million. The CHP system payback would be seven years, based solely on energy savings without even considering state incentives, depreciation or tax credits.

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Given the financial attractiveness of using CHP in our building, there remains the question of whether it makes sense to incur the higher costs to install CHP rather than replacing or retrofitting the system boilers. But even incurring the incremental capital costs of CHP can be avoided by entering into an Energy Services Agreement (ESA) with a third party developer who will agree to design, build, finance, own or lease, and operate the system for a specified term. The building owner will then acquire the asset at the end of the term at an agreed-upon price. Under this arrangement the CHP unit is off balance sheet. The developer finances the project and takes on the risks and liability for construction cost overruns, delays, forced outages and system performance, operating and maintenance expenses, and receives guaranteed energy savings towards heating, cooling, fuel and electricity.

Finally, CHP installation provides the building owner with decreased property, casualty and disaster recovery insurance costs, LEED points for up to 50% energy cost reduction over baseline, more competitive rental space due to reduced tenant costs, increased building sustainability and a reduced carbon footprint.

Far-Reaching Benefits

CHP is so important an option now because we have seen external events, such as storms or failed substation transformers, shut down the electric grid for extended periods of time and disrupt operations. Emergency backup generators are insufficient when outages fully utilize the fuel stored 'on-site' in a matter of hours. Facilities dependent on a stable electric supply may incur costs due to loss of production, compensation to customers, and equipment damage. Medical centers and nursing homes may be unable to continue to provide essential patient care.

But CHP systems at hospitals, universities, and other facilities operated continuously during major storms like Hurricanes Katrina and Sandy while nearby buildings lost power for days and even weeks. This was possible because CHP systems are primarily run on natural gas. The natural gas pipeline supply is not dependent on local electricity to maintain gas pressures to continue delivery in the pipeline. CHP systems are designed to operate independently of the grid and automatically “island” themselves from the utility grid during grid emergencies.

Merrill L. Kramer is an energy and project finance attorney in the Washington, DC office of Sullivan & Worcester LLP. He may be contacted at mkramer@sandw.com. The views expressed here are the author's own.

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Benefits of Combined Heating and Power Systems

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