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November 21, 2002

To green or not to green?

Conventional economics and other obstacles to sustainable design

By WILLIAM R. BROZ
McGowan Broz Engineers

Broz
Broz

There are many shades of green. But sometimes, choosing any one of them is difficult. Consider these real-life scenarios:

A building owner rejects a carefully designed rainwater storage system—one that will cut potable water usage by 90 percent and cut the burden on the local stormwater utility by half—due to a long payback period.

A commercial developer, against every instinct to be a good “corporate citizen,” purges “green” design elements from his buildings. He can’t recover the initial investment when the building is “flipped.”

Bids for a new building come in high. Green design elements have added 10 percent to the building’s first cost and, despite positive net present value, the project manager deletes them from the project.

Sustainable design is thwarted! Who’s the villain?

Nobody. The building owner is responding to apparently unambiguous economic signals. The developer takes his cues from the behavior of prospective buyers. The project manager is dealing with a capital budget ceiling that can’t be violated. So, if not whom to blame, then what?

The common thread is economics. For the rainwater system, it’s a matter of incomplete economic information. For the developer, customer education. And for the building owner, an irrational bias toward capital costs in decision-making. So, are we looking at our economic decision processes the right way? How do you decide when “to green or not to green” anyway?

Conventional wisdom

In making go/no-go decisions on capital projects, most sophisticated businesses use some form of the discounted cash flow method. These techniques account for known cash flow streams associated with the project, and discount future cash flows for the cost of capital corresponding to risk characteristics of the industry, firm and project.

Methods to establish cash flows—initial, financing, (eternal) tax, operating and terminal—are well-established. And determining the cost of capital at any given time is straightforward for public companies or governmental entities. For instance, there will be historical information on bond yields used to rent money for similar past projects. This information is brought up to date with current economic and industry conditions. From there, the discounted cash flow is a matter of arithmetic.

It’s interesting to note, however, that many larger entities use much simpler (and less accurate) decision-making techniques. In his book “Natural Capitalism,” Paul Hawken points out that some four out of five capital spending decisions in U. S. industry today are made based on simple payback, measured in time to recover the initial capital expense. Simple payback is fine as an initial rough order-of-magnitude assessment. We use it frequently for that purpose, but for final decision-making it has a number of problems:

Time value of money isn’t considered
Cash flows after the payback period aren’t considered
There are no objective criteria for acceptability, i.e., what is a “good” payback? The percentage impact on net earnings will vary with industry norms for profitability.

But even with more sophisticated analyses, not all relevant costs may be considered. Part of this is that planners seldom look outside the project “box” to make decisions. As a result, actual impacts of the project on the broader community can be misgauged, and the decision becomes distorted.

Obstacles

Let’s look at a typical rainwater storage system. Rain collected from the roof is stored for future use in a subgrade vault, with enough storage capacity to make it through the dry season most years. Pumps deliver the water to the building’s landscape irrigation system, and to a dedicated plumbing system for toilet and urinal flushing. If there’s a drought, just enough city water is automatically added to enable continued operation.

For the system our firm actually designed, the initial “thumb shot” used simple payback, accounting for current water and stormwater tariffs. The result, however, was so financially unpromising that there was no further analysis. For something with such clear environmental benefits, however, this just didn’t sound right. Were we taking all appropriate costs into account? And does the price of the resource reflect its true cost?

Outside the box

“Natural capital” is an increasingly utilized and well-understood notion today. As defined by Hawken, it represents the value of “services” provided by our natural environment, analogous to the “service” provided by financial capital. In considering natural capital there is generally a single limiting resource or bottleneck, the scarcity of which can put the brakes on a particular economic activity. Lack of fresh water in a drought-prone region is a good example.

Some observers have even attempted to place a dollar value on the aggregate natural capital resources of the earth. That may be a little highfalutin in dealing with local resources, but the notion is an interesting one. How could we come closer to the true value of our freshwater resources and ability to treat stormwater, and apply it to our rainwater storage system?

Every municipal utility maintains a comprehensive plan addressing, among other things, all aspects of the utility’s resources, operations and maintenance and future expansion. Given the current status of the resource and demographic projections, a comprehensive water plan, for instance, may conclude that a new source facility, transmission system and distribution system will be required at some estimated time in the future. For a major city, this would typically be a “mega-project”—in the hundreds of millions or billion dollar range. The comprehensive wastewater plan would contain analogous information for the stormwater utility.

Now, suppose that every building in town started to retain stormwater and use it as described above. Among the many advantages, the need date for that new water system or stormwater plant would be pushed back—maybe way back, say five or 10 years. And that is worth some hard money: namely, the discounting of the financial resources needed to construct and operate the new or expanded system. As discussed above, the raw information needed to figure this out is all available.

From there, one could determine a marginal return to storing rainwater, and incorporate it into the discounted cash flow analysis for any such system. Though it’s philosophically difficult to arrive at an agreed-upon value of any natural capital resource, this would at least represent a start, and certainly a more accurate way to assess the true value of a project to its community. The results could also be applied to basic utility rates and rebate programs.

What’s being done now

The notion of tying rebates to avoided cost is not new. Several of our local utilities have been doing yeoman work in this area for many years. Puget Sound Energy is the most recent example of a utility’s explicitly associating its rebates to avoided cost—new power generation in this case. And Seattle City Light has maintained an active rebate program through thick and thin for the last 18 years, including its Energy Smart Services Program which provides technical assistance as well as financial incentives to property owners.

A new twist on these programs would be to correlate incentives with specific avoided costs associated with future capital spending. It would take some work to pull together all of the information described above. But given the proper visibility—say, as an explicit part of the rebate structure, or in local utility bills—it would pay dividends for any community.

Why it’s important

Broader visions of sustainability have gained currency today, going far beyond conventional “do more with less” approaches. In “Cradle to Cradle,” by William McDonough and Michael Braungart, “eco-effectiveness” is defined by economic activities that actually enhance—rather than degrade—the natural environment. We’re a long way from widespread implementation of such ideas, but improved economic metrics are a good first step.

Giving added visibility to future costs—and incorporating them into capital decision-making—is one such step. Perhaps most importantly, this visibility can help change the way we think about our decisions and their effect on the broader community. And once our paradigms change, action becomes possible.

The design community can help, in part by fostering the new aspects of project analysis described here. But large-scale action will ultimately be galvanized by effective political leadership.

William R. Broz is vice president of McGowan Broz Engineers, a Bellevue-based mechanical and electrical engineering firm.

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