The global financing market for energy-efficiency projects is facing many hurdles, according to Esteban Suárez, a representative of the Energy Savings Insurance Team at Inter-American Development Bank (IDB). These include asymmetric distribution of information, absence of standardized financing instruments, misinformation about potential obstacles, and a lack of risk insurance.
Presently, a small team of around 20 people at IDB is targeting bringing multiple actors in the same arena to solve these issues via standardized contracts, risk insurance, and third-party audits in Latin America, Suárez said.
If successful, Suárez said, the ESI scheme could attract between $10-100 billion in energy-efficiency project investments and provide an annual emission reduction of around 20-200 MtCO2 by 2030. This builds on IDB’s insights from its existing Energy Savings Insurance (ESI) program, which has been expanding in South America. Program developers are working to remove barriers that prevent enterprises from pursuing energy efficiency in developing nations.
Barriers to Easy Energy-Efficiency Measures
From a global perspective, energy-efficiency projects are the easiest hurdle on the road to achieving the 2◦C Paris Agreement target. However, often, the simple measures that can yield quick and effective results are most difficult to implement. That is what is happening with energy-efficiency projects even though they are the easiest-to-reach solutions for decarbonizing energy systems.
Many industries in developing countries still use outdated technology and equipment. Upgrade projects and retrofits employing the latest technologies can reduce the energy intensity of these nations. (Energy intensity is defined as units of energy per unit of GDP in a given country.)
Typically, these projects have a positive net present value (NPV) and a short payback period. In the long term, undertaking these projects is profitable. Still, Suárez said, this obvious conclusion finds poor reception in small and medium enterprises (SME) in developing countries.
For the already burdened management in the SME sector, Suárez said, hurdles like searches for project finance and expert consultants, lack of knowledge about technologies, and lack of trust of subcontractors can be big deterrents. The fact that many other firms have not undertaken such projects adds onto the spiral effect, making energy-efficiency investments seem riskier than they actually are.
Cooperation to Develop an Insurance Scheme
In 2015, Suárez said, IDB and the Danish government undertook a five-year technical cooperation to resolve these barriers in the energy-efficiency market. The Danish government provided funds to employ consultants, including specialists in law and finance, to develop the ESI scheme.
Suárez said that by 2020, IDB aims to develop the policy framework, support mechanisms, and standardized structures for the ESI scheme. Most of the energy-efficiency projects have good returns and low risks. They make economic sense for the banks that are considering providing financing.
In an ideal and efficient market, banks would be automatically attracted towards these projects.
IDB is facilitating the initial deployment in Latin America until the project gains sufficient traction and can be taken ahead independently by national development banks, Suárez said.
Reduction of the Transaction Costs and Insurance of the Biggest Risks
These energy-efficiency projects are a coordinated effort between multiple parties, Suárez said. SME firms contract Technology Service Providers (TSPs) to implement energy-saving measures such as installing new boiler or cogeneration units, retrofitting air conditioners, or upgrading refrigeration units. After the initial capital expenditure, the project generates a steady cash flow over future periods via savings on energy bills.
Typically, according to IDB, banks can finance up to 80 percent of the capital costs for projects with proven technology. The interest on the loans is usually based on the credit assessment of the SME and the payback period of the project. But the risk associated with probable underperformance of the projects deters the banks from these undertakings.
Creation of Energy Savings Insurance (ESI)
Suárez said IDB has developed standardized energy performance contracts for SMEs and TSPs that can reduce costs of transactions, address the need for legal expertise, and respond to the risk of low performance.
SME and TSPs sign the standardized energy performance contract. Suárez said this contract requires the TSP to implement a project that will provide the SME with the promised energy savings for a certain negotiated cost.
Further, Suárez said, TSPs are obligated to buy ESI from certified insurance providers to cover the service sold to the SME. In case of underperformance, the insurance provides compensation to the SME. SMEs can use then use this compensation to service their bank debt.
Trust between SMEs, TSPs and Banks
Suárez said it is vital to ensure trust for successful deployment in these efforts involving multiple parties.
IDB has formed partnerships with the national development banks to build steady credit lines, Suárez said. It has also kept an open market for Tier 1 banks to advance loans. The insurance providers are limited to one or two accredited national champions.
Suárez said the scheme is open for entry to both SMEs and TSPs. Any firm can engage in energy-efficiency projects using the ESI framework. As long as it follows standardized contracts, it can access both insurance and loans from the market.
To regulate the market, IDB has also included third-party auditors to do feasibility studies and plans, Suárez said. These auditors essentially act as referees of the scheme and help in de-risking the TSP market.
Implementation of ESI
Banks analyze each energy-efficiency project to calculate the payback period using the inputs like price of technology and future price of electricity, Suárez said. They structure the loan in accordance with this analysis. The average cost of the energy-efficiency projects in the ESI scheme is $250,000 with a range of $30,000 to $2 million.
Many international donors like the Danish government, Clean Technology Fund, and Green Carbon Fund have come forward to finance the project development. They have each earmarked around $20-25 million, Suárez said.
The scheme is already underway in Mexico and Colombia, Suárez said. It is under development in Brazil, Nicaragua and Peru, where IDB is building partnerships with development banks, insurance providers, and performance auditors.