STRATEGY SESSION ON ENERGY EFFICIENCY FINANCE
BACKGROUND CONCEPT NOTE
INTRODUCTION/EXECUTIVE SUMMARY The Institute for Industrial Productivity (IIP), together with international and local banks and private sector partners, is leading a public-‐private partnership (PPP) initiative promoting and securing energy efficiency (finance and implementation in industries in India, China and the US. The PPP initiative builds on a European Bank for Reconstruction and Development (EBRD) model of utilizing in-‐house energy efficiency engineers and international and local consultants to provide assessments of industries’ EE potentials when they seek a loan. This model will be duplicated, tailored and transferred to pilot regions and industry branches in India, China and the US – possibly with a pilot test in each of the countries. In principle, this PPP could be built and implemented in other regions of the world, in both private and public banks. Under the model, an industry – when seeking a loan -‐ is obliged to collaborate in an assessment of energy efficiency potential in their plant. The potential EE measures are assessed and presented as an EE project to the industry CFO by bank in-‐house experts and collaborating industry technical staff. A loan-‐increase is offered to finance implementation, although the project can be internally financed by the industry or even through a third-‐party “turn-‐key”/ energy service company (ESCO) like approach, should the industry so desire. This public-‐private partnership initiative will create an important new market for energy efficiency services at industries that utilize bank finance. In-‐house and local technicians will be involved and EE expertise will be built and utilized within individual industries and local markets. Simultaneously, the high-‐level executives of the industry will be made aware of the costs and benefits of the identified EE measures. In some cases, the banks may outsource the EE expertise/assessment and implementation to ESCOs and technology suppliers. The initiative will spur local investments, job creation and capacity building. 1. CONTEXT – OPPORTUNITIES AND CHALLENGES The potential of this approach is enormous, although not, as yet, quantified. The initiative could potentially finance EE projects whose value would be 10% or more of the lending to the industrial and commercial sectors of the participating banks. Given the process intensity of EE projects, there is a considerable growth potential 1
for the energy efficiency services market through the banking system, involving local engineering communities as well as vendors of EE equipment. Enhancing energy efficiency in industry can also have considerable local environmental benefits, as it diminishes the use of coal, the dominant fuel for industrial energy production, both electric and thermal, in both China and India. The negative environmental impacts of coal combustion on local air quality and health have been well-‐documented, as have the negative environmental impacts of coal mining, coal cleaning, and transport. Green growth potential While some of the borrowing industries may have already installed efficiency measures, others will not have exploited energy efficiency opportunities. Moreover, with the energy management training in companies that is integrated into the process, ongoing and growing energy efficiency savings can be expected. IIP will make an attempt to quantify these figures, extrapolating up from EBRD data and down from national banking statistics. Market and policy failures/barriers preventing opportunity to be seized Many financially viable EE opportunities are not taken up within the industrial sector. Key barriers such as lack of awareness and skills, both on the ground and in the board-‐rooms as well as communication between industry technical personnel and financial decision-‐makers have been identified. On the financing side, there are barriers related to perceived risks, market size, project size and related high transaction costs, as well as lack of standardized data and reporting. This PPP initiative addresses the “market failure” of EE awareness in industry, both at the board level, using engagement in obtaining a loan to create awareness of the financial opportunities of EE, and on the ground, by building EE capacity and skills among industry technicians. Further, the PPP addresses the market failure of securing EE financing by integrating EE financing into standard bank operations, building capacity within or linked to the local/national banking system – thus integrating EE into standard bank financing. Further key barriers relate to the lack of awareness on measures needed and financial returns – from industry investment decision-‐makers, the size and associated transaction costs if the EE measures are undertaken as stand-‐alone projects, and inconsistency in EE assessments. To overcome these barriers requires a combination of building awareness, enhancing technical capacity and providing financing supported jointly by the public and private sectors. It is worth noting that one of the most persistent barriers to EE finance by banks, the relatively small size of EE projects, becomes a positive factor in this program, inasmuch as lending for the EE measures can easily be added to the original loan amount. Global/regional/national readiness to act IIP is in consultation with the European Bank for Reconstruction and Development (EBRD) to seek their advice for developing a program that would provide technical support to interested banks to adopt the EBRD approach to mainstreaming EE financing, i.e. to integrating EE financing into standard bank operations. Initially, 2
requested by HSBC India, IIP is in the process of identifying an interested bank partner in China, and will explore the possibility of a US partner. In principle, such a program can be duplicated and transferred to any region and financial institutions around the world. In addition to the vast, yet un-‐quantified efficiency gains the EBRD experience shows a 50:1 leverage of audit expenses to EE investment. Why a PPP? Most energy efficiency measures should be taken up based on rational, economic decisions – but are not. The fundamental rationale of building a public-‐private partnership relies on the fact that it is not sufficient for public authorities to set EE goals and regulate on energy efficiency, and it is not sufficient for the private sector to develop and promote the technologies needed to reach speed and scale of EE improvements, particularly when environmental and social costs are not integrated into the price of the fossil fuel-‐based energy alternatives. These arguments themselves call for a public-‐private partnership to unlock the associated resource and green growth potential, especially since banks, and particularly private commercial banks, may deem program start up costs to be prohibitive and require government support to defray those costs. Costs include: dedication of an energy efficiency officer to start up and manage the program; the identification/contracting of engineering staff with appropriate experience in the industrial segments in which banks’ customers operate; raising of awareness of loan officers of the benefits of EE projects for their customers, their loan portfolios, and for their relationships with their customers; establishment of an screening system for rating the EE potential of loan applicants and integration of those ratings into existing loan processing databases. While income from the program currently supports EBRD in-‐house technical staff and their operations, set-‐up costs were financed by grants from European governments. Shortcomings of existing/other measures and initiatives to overcome barriers While there are sizeable and successful examples of bank financing of EE measures, they are almost exclusively carried out in specialized programs or departments, and are not integrated (or mainstreamed) in to standard bank activities. The 10 year EBRD experience with this approach has been uniquely successful in achieving mainstreaming. Moreover, since the due diligence on the borrower’s creditworthiness must be performed for the original loan application, a significant part of the transaction costs that would otherwise be charged to a stand-‐alone EE loan are, in fact, charged to the original loan. Finally, since the EE loan is paid by the savings that the EE measures produce, no additional security is required by the bank for the higher loan amount. 2. THE PPP – VISION, ORGANIZATION AND STRATEGY The PPP initiative will spur greener growth and local job creation and will address key barriers related to awareness, skills and financing of EE implementation in the industrial sector across India, China and the US. 3
Partners The Institute for Industrial Productivity (IIP) is leading the initiative. With a climate change perspective, IIP is focused on promoting EE in industries across India, China and the US. The PPP initiative will be piloted with banks in India and banks to be identified in China. The pilots, when successful, will be expanded to other Indian, Chinese, and US banks. In theory, all commercial and development banks could adopt the program, voluntarily, or by government mandate. The latter would be particularly justified where governments are willing to provide appropriate support for the EE assessments, as has been the case with bilateral support of the EBRD program. Given that each dollar of assessment costs produces 50 dollars of investment, one could imagine the eventual establishment of revolving funds at the banks to finance the operation. Besides national/local banks, the PPP initiative might require the engagement of industry technology experts, ESCOs and EE turn-‐key technology suppliers. The banks will need support to identify qualified technical personnel to perform facility audits, to recommend EE measures and to estimate their costs and financial returns. The specific technical capabilities required will depend on the make-‐up of local industry, and specifically, the make-‐up of the banks current and potential client base. Analysis of the bank partners’ current and prospective markets will determine the selection of supportive/coordinating partners. Organization and resources The Institute for Industrial Productivity is developing a case study on the EBRD program. GGGI has agreed to support the start-‐up of the PPP initiative. Overall strategy and approach The initial plan is to launch the EE-‐PPP-‐banking model with two pilot banks-‐ one in India, one in China shortly following 3GF in October 2012 and to explore an additional one in the US, thereafter. The IIP is developing a case study of the EBRD program discussing the organizational, institutional, financial, and technical issues that arose and how they were resolved, to use a roadmap for the pilots. Milestones and progress indicators 1. IIP Presents Case Study with illustrative transactions (ongoing) 2. The IIP will implement a pilot scheme and then scale 3. IIP works with one bank to develop a roadmap to replication of the EBRD program within the bank’s organization structure, corporate culture, and procedures (ongoing) 4. IIP works with bank to analyse the characteristics of the industrial and commercial market served by the bank (six months) 5. IIP will present their EE Finance initiative and assess the opportunity to broaden the scope and engage other financing institutions and private sector companies (at 3GF October meeting) 4
6. IIP identifies and helps to screen local EE technical experts for the identified industrial sectors in which the bank will be doing EE lending 7. IIP and local experts pre-‐screen ESCOs, equipment vendors, and other contractors with experience in the identified sectors as potential vendors for the bank’s clients’ EE projects (up to and after 3GF)
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