Abstract
Value at Risk (VaR) is a measure of risk for potential losses within a portfolio of investments. Investments in energy efficiency in a manufacturing environment compete in terms of payback period, ease of investment, and transaction costs with other investments (production, safety, engineering, etc.). Because manufacturers have limited amounts of capital to allocate, investments in productivity tend to be prioritized over energy efficiency projects that offer similar paybacks. Value at Risk (VaR) can be used to quantify how risk-weighted expenditures change over time. Energy efficiency investments are often believed to offer relatively stable payoffs compared to changes in production and other assets, particularly when evaluated using methodologies such as simple payback. Incorporating methodologies such as VaR can provide a stronger business case for energy efficiency investments by quantifying value beyond what is captured in other Return on Investment calculations.
In this paper we outline a methodology for applying VaR in the context of the variety of investments made by manufacturing organizations. Additionally, we profile the stability of energy efficiency (EE) and renewable energy (RE) investments compared to other types of investments made in manufacturing. By applying VaR to these investments, energy managers can better translate the financial benefits of energy-related capital projects in a way that is more compelling to Corporate Finance and Treasury departments. This common language also allows Corporate Finance and Treasury departments to support large, strategic deployments of capital for such projects based on a targeted objective – the management of financial risk for the organization’s shareholders.
