EUROPEAN COMMISSION DIRECTORATE GENERAL JRC JOINT RESEARCH CENTRE Institute for Energy Renewable Energy Unit FINANCING ENERGY EFFICIENCY: FORGING THE LINK BETWEEN FINANCING AND PROJECT IMPLEMENTATION Report prepared by the Joint Research Centre of the European Commission Authors: Silvia Rezessy and Paolo Bertoldi May 2010, Ispra TABLE OF CONTENT 1. INTRODUCTION ...........................................................................................................1 2. BARRIERS TO THE USE OF FINANCIAL INSTRUMENTS FOR ENERGY SAVINGS ..............................................................................................................................2 2.1. Market barriers and failures............................................................................................... 2 2.2. Legal barriers .................................................................................................................... 3 3. FINANCIAL INSTRUMENTS FOR ENERGY EFFICIENCY ...................................5 3.1. Debt financing .................................................................................................................. 5 3.2. Equity financing.............................................................................................................. 13 3.3. Subordinated Debt financing (mezzanine finance) .......................................................... 15 3.4. Project financing ............................................................................................................. 16 3.5. Other financing mechanisms: developing EE financial products and creating demand for EE finance ............................................................................................................................ 18 3.6. Supplementary mechanisms: public finance mechanisms, policies and programs............. 22 3.7. The Structural funds and EIB financing instruments....................................................... 25 4. FINANCING INSTRUMENTS FOR ENERGY EFFICIENCY IN THE EUROPEAN UNION: SUMMARY..................................................................................35 4.1. Examples of successful and innovative EE financing schemes........................................ 37 5. RECOMMENDATIONS............................................................................................... 41 5.1. Financial products........................................................................................................... 41 5.2. Bankable energy efficiency project pipelines.................................................................... 43 ANNEX I FINANCING ENERGY EFFICIENCY: COUNTRY SHEETS .....................1 ANNEX II OTHER FINANCING...................................................................................40 REFERENCE LIST...........................................................................................................44 2 LIST OF FIGURES, TABLES AND BOXES Figure 1. Financing model 1: end-user as borrower................................................................................7 Figure 2. Financing model 2: ESCO as borrower ...................................................................................7 Figure 3. Project financing: special purpose vehicle .............................................................................18 Figure 4. Energy efficiency, co-generation, energy management (total amount of SFCO funding, Community amount)..................................................................................................................................26 Figure 5. Indicative allocation by MS, 2007-2013 (current prices, million Euro).............................42 Table 1. JESSICA Funds...........................................................................................................................30 Box 1 The EIB-KfW Carbon Programme……………………………………………………...21 Box 2. Good practices on Structural Funds leveraging private and public sector co-financing ……………………………………………..………………………………………………….27 Box 3. Structural Funds and energy efficiency: Bulgaria and Lithuania………………………....28 Box 4. Good practice in project preparation: CPMA in Lithuania………………………............29 3 1. INTRODUCTION Energy efficiency is not a single market: it covers measures in a diverse range of end-user sectors, end-use equipment and technologies and consists of very large numbers of small, dispersed projects with a dispersed range of decision makers. Overall, many EE technologies are proven and economic: if properly financed, the investment costs are paid back over short periods from energy cost savings. Yet, projects with compelling economic returns remain unimplemented. Major causes for this gap are the lack of EE finance and delivery mechanisms that suit the specifics of EE projects [1] and the lack – in some markets – of pipelines of bankable energy efficiency projects. This report focuses on project financing for energy efficiency via financial intermediaries and is structured as follows: • Section 2 presents the barriers to financing energy efficiency projects; • Section 3 describes the variety of financial mechanisms common in EE financing, including supplementary public policies and programs and funding from the Structural and Cohesion Funds (SCF). Examples on how financing tools have been applied and outlines limitations and success factors for specific financing mechanisms. The review of financial instruments is not intended as all-inclusive list of all possible financing options, but covers the large majority of those most commonly used for and supportive of EE projects and by EE businesses; • Section 4 analyses the results of the survey of financing mechanisms for energy efficiency in the Member States and points to some successful and innovative financing schemes. Annex I contains detailed country files of financing for energy efficiency available in all Member States. Annex II reviews financing tools from International Financing Institutions; • Section 5 presents recommendations. 1 2. BARRIERS TO THE USE OF FINANCIAL INSTRUMENTS FOR ENERGY SAVINGS Causes of the capital market gap for EE financing have been well-documented and include [1-4]: 2.1. Market barriers and failures • High pre-investment development and transaction costs partially due to small size of projects, esp. in the residential sector; • Information failure on the side of customers: lack of customer awareness and a very high perceived risk of new more efficient technologies by both users and financiers, mistrust in energy audits, benefits initially invisible; • Information failure on the side of commercial financial institutions (CFIs): general lack of EE finance experience within commercial financial institutions, lack of dedicated time and resources to develop EE capacity and activities in-house; • Lack of visibility and scale of EE finance: EE projects often represent a relatively small niche business for major banks; • High perceived end-user credit risks; • Long marketing cycles associated with selling EE and scarcity of investment ready projects; • Low collateral asset value of EE equipment and difficulties creating creditworthy financing structures. Collateral value is low because for most EE projects equipment represents a sizeable share of total project cost with high portions of engineering, development and installation costs1; • Reluctance or impossibility for property owners to finance projects on-balance sheet; • Energy savings as revenue is foregone by financiers: cash flows from saving energy are not (yet) conventional revenues in what is still an asset-based culture in financing. This discourages CFIs' entry into this market. Energy cost savings should be incorporated into lenders' analysis of free cash flow and ability of borrowers and end-users to meet debt service payments [1]; • Even where payback periods are short and economic benefits clear, EE projects are often not implemented because of high upfront costs; 1 EE equipment is highly specific to a certain site or application. High asset specificity implies illiquidity of certain investments, which leads to higher interest rates being required by investors in those investments. Transaction cost economics uses the term “high assets specificity,”, which entails poorer collateral and creates higher risk in that specialized assets cannot be redeployed without sacrifice of productive value (see [5] ). Such assets adversely affect the firm’s ability to borrow because firm-specific assets often cannot be redeployed as collateral for borrowing. 2 • In the private sector (industry and service): budget priorities and thus differentiated treatment of core activity investment and 'auxiliary' investment – such as energy efficiency – in terms of expected PBT. Managers may accept PBT beyond 3 years only for investments in the production area. • In industry: business interruption due to EE implementation; • In residential and tertiary: Spilt incentives between building owners and tenants; • In residential: long payback periods, lack of contractors, small project size and lack of support for holistic retrofits; 2.2. Legal barriers • Public sector: the rules of public budgeting – including the annual budget cycle and multi- annual savings cash flow – make it difficult for public entities to finance energy efficiency investments from savings in energy costs (similar rules exist in large companies); • Public sector: local authorities may have to finance energy efficiency investments from their investment budget whereas the resulting