From Pollution Control to Profitable Pollution Prevention

As companies incorporate pollution prevention approaches in their strategic planning, capital investment priorities, and process design decisions, it is vital that they understand both the quantitative and qualitative dimensions of assessing pollution prevention projects. These projects tend to reduce or eliminate costs that may not be captured in cursory financial analyses due to the way costs are categorized and allocated by conventional management accounting systems. Additionally, pollution prevention projects often have impacts on a broad range of issues, such as market share and public impact that are difficult to quantify but that can be of strategic importance. Identifying and analyzing all costs and less tangible items is an important step in an evaluation of the potential benefits of pollution prevention projects.

Pollution prevention can take many forms – from simple “housekeeping improvements,” which cost little to carry out, to installation of expensive capital equipment. Although many pollution prevention projects, such as material substitution or process redesign, do not require large outlays for purchase of equipment, they may require extensive qualitative assessments related to such issues as product quality or employee health and safety. The analytical tools described here are applicable to the assessment of most pollution prevention initiatives that fit under the umbrella of the capital budgeting process. Pollution prevention projects involving capital budgeting generally include

1. new manufacturing equipment
2. replacement equipment
3. plant expansion and construction

Capital budgeting is a process of evaluating capital investment options based on a company’s needs and analyzing the impact of an investment on a company’s CF over time. Pollution prevention and other capital projects are justified by showing how the project will increase the company’s earnings as well. Financial tools demonstrate the importance of the pollution investment on a life cycle or total cost basis in terms of revenue, expenses, and profits. Key concepts and factors used in capital budgeting are described next.

Life cycle costing (LCC): Also referred to as total cost accounting, this method analyzes the costs and benefits associated with a piece of equipment or a procedure over the entire time the equipment or procedure is to be used. LCC is also a tool to determine the most cost‐effective option among different competing alternatives to purchase, own, operate, maintain and, finally, dispose of an object or process, when each is equally appropriate to be implemented on technical grounds. For example, for a highway pavement, in addition to the initial construction cost, LCC takes into account all the user costs (e.g. reduced capacity at work zones), and agency costs related to future activities, including future periodic maintenance and rehabilitation. All the costs are usually discounted and total to a present‐day value known as NPV. This example can be generalized on any type of material, product, or system.

In order to perform a LCC scoping is critical, what aspects are to be included and what not? If the scope becomes too large, the tool may become impractical to use and of limited ability to help in decision‐making and consideration of alternatives; if the scope is too small, then the results may be skewed by the choice of factors considered such that the output becomes unreliable or partisan. LCC has a broader scope, including environmental costs. To help building and facility managers make sound decisions, the US Federal Energy Management Program provides guidance and resources on applying LCC that permits the cost‐effectiveness of energy and water efficiency investments to be evaluated. LCC can be conducted in two approaches: deterministic and probabilistic method.

Present value (PV): The importance of PV, or present worth, lies in the fact time is money. The preference between a dollar now and a dollar a year from now is driven by the fact that dollar in‐hand can earn interest. Mathematically, this relationship is shown earlier in Eq. (7.2), with an example on present and future values.

Comparative factors for financial analysis: The more common methods for comparing investment options all utilize the PV equation presented in Eq. (7.2). Generally, one of the following four factors is used:

1. Payback period (PP): This factor measures how long it takes to return the initial investment capital. Conceptually, the project with the quickest return is the best investment.
2. Internal ROR: This factor is also called return on investment or ROI. It is the interest rate that would produce a return on the invested capital equivalent to the project’s return. For example, a pollution prevention project with an internal ROR of 20% would indicate that pursing the project would be equivalent to investing the money in a bank and receiving 20% interest.
3. Benefits cost ratio: This factor is a ratio determined by taking the total PV of all financial benefits of a pollution prevention project and dividing by the total PV of all costs of the project. If the ratio is greater than 1.0, the benefits outweigh the costs and the project is economically worthwhile to undertake.
4. Present value of net benefits: This factor shows the worth of a pollution prevention project as a PV sum. It is determined by calculating the PVs of all benefits, doing the same for all costs and subtracting the two totals. The new result would be an amount of money that would represent the tangible value of undertaking the project.

Life Cycle Costing

While firms can use any of these factors, the importance of the LCC (for total cost analysis) makes the PV of net benefits the preferred method. Additional details of LCC and TCA follows.

LCC tool and the total cost assessment (TCA) tool are introduced as concept overviews. Both tools can be used to establish economic criteria to justify pollution prevention projects. TCA is often used to describe the internal costs and savings, including environmental criteria. LCC includes all internal costs plus external costs incurred throughout the entire life cycle of a process, product, or activity.

LCC has been used for many years by both public and private sector. It associates economic criteria and societal (external) costs with pollution prevention opportunities. The purpose of LCC is to quantify a series of time varying costs for a given opportunity over an extended time horizon, and to represent these costs as a single value. These time varying costs usually include the following:

1. Capital expenditures. Cost for large, infrequent investment with long economic lives (e.g. new structures, major renovation and equipment replacement).
2. Nonrecurring operations and maintenance (O&M). Costs reflecting items that occur on a less frequent than annual basis that are not capital expenditures (e.g. repair or replacement of parts in a solvent distillation unit).
3. Recurring O&M. Costs for items that occur on an annual or more frequent basis (e.g. oil and hydraulic fluid changes).
4. Energy. All energy or power generation related costs. Although energy costs can be included as a recurring O&M cost, they are usually itemized because of their economic magnitude and sensitivity to both market prices and building utilization.
5. Residual value. Costs reflecting the value of equipment at the end of the LCC analysis period. This considers the effects of depreciation and service improvements.

By considering all costs, a LCC analysis can quantify relationships that exist between cost categories. For example, certain types of capital improvements will reduce operations, maintenance, and energy costs while increasing the equipment’s residual value at the end of the analysis period.

Societal (external) costs include those resulting from health and ecological damages, such as those related to unregulated emissions, wetland loss, or deforestation, can also be reflected in a LCC analysis either in a qualitative or in a quantitative manner. LCC includes the following cost components:

1. Extraction of natural resources. The costs of extracting the materials for use and any direct or indirect environmental cost for the process.
2. Production of raw materials. All of the costs of processing the raw materials.
3. Making the basic components and products. The total cost of material fabrication and product manufacturing.
4. Internal storage. The cost of packaging and storage of the product before it is shipped to distributors and/or retail stores.
5. Distribution and retail storage. The cost of distributing the products to retail stores including transportation costs, and the cost of retail storage before purchase by the consumers.
6. Product use. The cost of consumer use of the product. This could include any fuels, oils, maintenance, and repairs which must be made to the equipment.
7. Product disposal or reuse and/or recycling. The costs of disposal or recycling of the product.

Total Cost Assessment

The TCA tool is especially interesting because it usually employs both economic and environmental criteria. As with the LCC analysis, the TCA study is usually focused on a particular process as it affects the bottom‐line costs to the user. Environmental criteria are not explicit, i.e. success is not measured by waste reduction or resource conservation, but by cost savings. However, since the purpose of TCA is to change accounting practices by including environmental costs, environmental goals are met through cost reductions.

Because of its focus on cost and cost effectiveness, TCA shares many of the features of LCC analysis by tracking DC, such as capital expenditures and O&M expenses/revenues. However, TCA also includes IC, liability costs, and less tangible benefits – subjects that are not customarily included in both economic and environmental goals, because of its private‐sector orientation, as well as other economic computation methods.

Economic Consideration Associated with Pollution Prevention

The greatest driving force behind any pollution prevention (P²) plan is the promise of economic opportunities and cost savings over long‐term. Pollution prevention has been recognized as one of the lowest‐cost options for waste/pollutant management. Hence, an understanding of the economics involved in P² programs/options is important in making decisions at both the engineering and management levels. Every engineer should be able to exercise an economic evaluation of a proposed project. If the project cannot be justified economically after all factors – include those discussed earlier have been taken into account – it should obviously not be pursued. The earlier such a project is identified, the fewer resources will be wasted.

Before the true cost or profit of a P² program can be evaluated, the factors contributing to the economics must be recognized. As discussed earlier, there are two traditional contributing factors (capital costs, and operating and maintenance costs), but there are also other important costs and benefits associated with P² that need to be quantified if a meaningful economic analysis is going to be performed. The TCA aims to quantify not only the economic aspect of P² but also the social costs associated with the process, product, or a service from cradle‐to‐grave (i.e. life cycle). The TCA attempts to quantify less tangible benefits such as the reduced risk derived from not using a hazardous substance. The future is certain to see more emphasis placed on the TCA approach in any P² program. For example, a utility considering the option of converting from a gas‐fired boiler to coal‐firing is usually not concerned with the environmental effects and implications associated with such activities as mining, transporting, and storing the coal prior to its usage as an energy feedstock. Pollution prevention approaches will become more aware of this kind of need.