Energy Efficiency and Climate Change: Conserving Power for a Sustainable Future

Energy Efficiency and Climate Change

ii ENERGY EFFICIENCY AND CLIMATE CHANGE

Energy Efficiency and Climate Change Conserving Power for a Sustainable Future

B. Sudhakara Reddy Gaudenz B. Assenza Dora Assenza Franziska Hasselmann

Copyright © B. Sudhakara Reddy, Gaudenz B. Assenza, Dora Assenza and Franziska Hasselmann, 2009 All rights reserved. No part of this book may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage or retrieval system, without permission in writing from the publisher. First published in 2009 by SAGE Publications India Pvt Ltd B1/I-1 Mohan Cooperative Industrial Area Mathura Road, New Delhi 110044, India www.sagepub.in SAGE Publications Inc 2455 Teller Road Thousand Oaks, California 91320, USA SAGE Publications Ltd 1 Oliver’s Yard 55 City Road London EC1Y 1SP, United Kingdom SAGE Publications Asia-Pacific Pte Ltd 33 Pekin Street #02-01 Far East Square Singapore 048763 Published by Vivek Mehra for SAGE Publications India Pvt Ltd, typeset in 10/12 pt Adobe Garamond by Star Compugraphics Private Limited, Delhi and printed at Chaman Enterprises, New Delhi. Library of Congress Cataloging-in-Publication Data Energy efficiency and climate change: conserving power for a sustainable future/ B. Sudhakara Reddy … [et al.]. p. cm. Includes bibliographical references and index. 1. Energy conservation. 2. Energy policy. 3. Climatic changes—Prevention. I. Sudhakara Reddy, B. TJ163. 3E4365

363. 738’746—dc22

2009

2009032025

ISBN: 978-81-321-0228-1 (HB) The SAGE Team: Elina Majumdar, Manali Das, Anju Saxena and Trinankur Banerjee

Contents

List of Tables List of Figures List of Boxes Preface 1

Energy, Economy and the Environment: An Introduction

2

Climate Debate

vi vii ix x 1 31

3 Win-Win Climate Policy

56

4

76

Fundamentals of Energy Efficiency

5 The Benefits and Drawbacks of Energy Efficiency

113

6 The Concept of Barriers and Drivers and its Application to Energy Efficiency

150

7

Energy Efficiency and International Environmental Law

183

8

Commercializing Clean Energy Technologies

214

9

Financing Energy Efficiency in Transition Economies

239

10 The Role of Institutions in Promoting Energy Efficiency

272

Epilogue: Road to a Sustainable Future: A Systematic Understanding of Energy Efficiency and Climate Change 305 Consolidated Bibliography About the Authors Index

319 341 343

List of Tables

2.1 2.2 4.1 4.2 4.3 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 6.1 7.1 8.1 9.1 10.1

Great weather disasters, 1950–2001 Projected climate change impacts compared to other environmental problems Functions of the actors in energy efficiency Overview of factors fostering the implementation of EE programmes Features of the energy sector relevant to policy Positive aspects of energy efficiency History of corporate environmentalism Potential savings due to increase in supply-side efficiency Potential savings due to increase in demand-side efficiency Potential savings due to other options Employment benefits in EU countries due to energy efficiency Energy-efficient homes vs. typical homes Energy efficiency projects Externalities of energy efficiency Variables in the causal model (examples) Emissions reduction obligation under Annex B to Kyoto Protocol Technology commercialization model Regional allocation of concessional flows, 1990–1999 Components of a sound performance analysis

45 48 97 101 103 115 124 125 126 128 132 135 138 145 172 198 222 246 281

List of Figures

1.1 1.2 1.3 1.4 2.1 2.2 2.3 2.4 3.1 3.2 4.1 4.2 4.3 4.4 4.5 4.6 4A.1 4A.2

5.1 5.2 6.1 6.2

Energy outlook in 2030 World energy investment, 2005–2030 Fuel share in energy investment requirements, 2005–2030 Share of energy investment of different countries and groups, 2005–2030 Trends in economic and insured losses, 1950–2004 Trend in annual frequency of great natural catastrophes, 1950–2004 Per capita CO2 emissions by Annex 1 and non-Annex 1 countries Recommendations to financial institutions and governments Fisher’s time-preference theory of interest Cost-benefit of a cleaner technology project Characterization of energy efficiency potential Technology choices for private sector investment in energy efficiency Inter-relationships among actors Actors’ perspectives Actor–factor influence state diagram Research environments Comparison of energy and entropy flows of (a) electric furnace and (b) heat pump World-wide averages of second-law efficiencies for the generation and transformation of electricity into energy services Methodology of selecting projects Benefits to various stakeholders—Local and global Schematic representation of profitability barriers Schematic representation of feasibility barriers

6 9 10 11 46 47 52 54 60 73 84 91 94 95 98 105 108

110 140 141 159 160

viii ENERGY EFFICIENCY AND CLIMATE CHANGE

6.3 6.4 6.5 7.1 8.1 8.2 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 10.1 10.2

Targeting micro, meso and macro barriers Structure of causal model Causal linkages The CDM project cycle The chain from basic research to commercialization Technology diffusion curve Net long-term flows to developing countries, 1995–2004 Sources of risk in energy efficiency investments Role of local financial institutions Role of ESCOs The functions of ESCO International ESCO and local partner Financing channels Pre-offer financial analysis Institutions involved in energy efficiency Roles of utilities

163 166 171 207 218 220 245 248 250 251 252 253 262 264 275 277

List of Boxes

1.1 4.1 4.2 5.1 5.2 5.3 6.1 7.1 8.1 8.2 9.1

10.1 10.2 10.3 10.4

Flow-on benefits to promote energy efficient practices Key reasons for advocating EE Ingredients of the techno-economic model of change Energy efficiency and the indoor environment Benefits of EE for business establishments Trade-off between a technology and service—An example The case of Hungary Standardized procedures for small-scale energy-efficiency projects proposed by the CDM Executive Board Luz International Limited—A failure story Case: The commercialization of the Internet ‘Securitizing’ the savings stream, developing financial structures and credit enhancements to support EE project loans Performance evaluation Performance description Performance prediction Performance prescription

24 81 89 116 122 136 181 209 226 235

249 284 285 285 285

Preface

Arising from the ashes of the Second World War, the industrialized countries embarked on an epoch of unprecedented growth and stability, but seem to have ignored emergencies, the predominant pattern being to live as if there was no tomorrow. Individuals, companies and nations borrowed with abandon, not realizing how overuse of energy, over-consumption of goods and resources and lack of ecological stewardship will destabilize the very fundamentals of prosperity in the future. In pursuit of development, industrialized nations exploited natural resources unhindered. And today, it’s the turn of the nature to react to its over-exploitation in the form of devastating changes in the climate. The developing countries that have very limited role in destroying the nature are caught in a great dilemma. With high vulnerability neither these countries can ignore climate change nor can they withstand its devastating changes. While struggling to meet the basic needs of their people, these countries are in a catch-22 situation (spurging is not an option). This book attempts to answer this dilemma of developing countries through sustainable marketbased energy-efficiency (EE) solutions. This book discusses the factor of energy, which drives all economies. Energy and development are correlated and the causation is both ways. More efficient energy use enhances production, promotes economic development and improves the standard of living. Energy is closely linked to economic opportunity, security and empowerment. Energy services are essential to both social and economic development and wider access to them is critical in achieving the Millennium Development Goals (MDGs) and thereby assist in sustainable human development. The future of energy seems uncertain. At the beginning of the 20th century, nuclear energy was unheard of. Today, the world abounds in nuclear reactors. Similarly, even to imagine the kind of life possible without petroleum products is extremely frightening. Although previous concerns about global energy scarcity have proved unfounded, there is a fierce debate

PREFACE

xi

whether the peak of oil utilization has already been reached, or whether oil extraction will still increase for years or perhaps even decades. Fossil fuels may never be fully exhausted, but their quality and accessibility are declining, and their end is most likely to be caused by demand constraints rather than resource limitations. After the reckless use of this scarce resource, modern society is now struggling to identify new energy resources. Global warming, acid rain, radioactive waste and other issues increasingly influence energy policies in the new world. The challenges of resource scarcity and environmental sustainability, have made the future of energy policy a hot topic among policy makers and academics. Understanding energy demand and how efficient use of energy is used is of interest to policy makers as both aspects influence economic development, environment and sustainability. Researchers and policy makers have turned their attention to the more efficient utilization of existing energy supplies to help meet society’s energy needs. Depending on the system and user investigated, it may be more economical to make efficient use of existing energy resources and reduce waste rather than develop new energy supplies to meet growing energy demand. EE investments can have broader societal benefits in addition to reduced energy costs. More efficient utilization of energy often leads to improved productivity and competitiveness in business and helps avoid or reduce environmental impacts associated with the extraction, delivery and combustion of fossil fuels. Yet, policies or programmes to increase EE often face daunting institutional, behavioural, financial and cultural barriers to their adoption. The global financial crisis and global warming arose from the same unsustainable economic policies, which aimed to maximize short-term growth at the expense of long-term development. This book shows that economic growth is not necessarily incompatible with sustainable development. The question is not whether growth or the environment is more important, but how the economy can become environmentally and socially sustainable. The volume shows that the real choice facing policy makers is between sustainable forms of economic development and unsustainable ones. It provides a systematic framework for students, policy makers, academics and others interested in the efficient utilization of energy. Chapter 1 of the volume introduces the key issues to be addressed in the subsequent discussions, that is, the interrelations among the environment, economy and energy (the three ‘Es’). The next two chapters deal with the ‘great climate debate’ and discuss clashing positions represented by sceptics and supporters of action on climate change. The discussion focuses on

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market-based measures as a means to increase the win-win opportunities and to attract investors to invest in climate change mitigation. Chapter 4 provides an overview of the fundamentals of EE. Chapters 5 and 6 develop a new systematic classification and explanation of benefits and drawbacks to EE. The topic of EE is approached with the aim of understanding the barriers to and the drivers for EE investments. The chapters try to identify (a) the drivers and barriers that affect the success or failure of EE investments and (b) the institutions that are responsible for the emergence of these barriers and drivers. This taxonomy aims to synthesize ideas from three broad perspectives, namely, micro (project/end user), meso (organization) and macro (state, market and civil society). Chapter 7 looks at the relationship between international environmental law and EE. A detailed treatment of the prerequisites for adopting a private sector-driven ‘business model’ approach for the successful diffusion of sustainable energy technologies (SETs) is presented in Chapter 8. Emphasis is laid on the mobilization of private capital and the commercialization of energy-efficient technologies (EETs). This private sector perspective is critical to reduce the burden on state budgets, which are creaking under the weight of numerous demands of urgent nature. This is expected to integrate the processes of market transformation and entrepreneurship development with innovative regulatory, marketing, financing, incentive and intermediary mechanisms. Chapter 9 discusses the linkages between EE and the financing mechanism. It shows how to tap the dynamism, innovation and power of markets for promoting EE and environmental concerns. It helps institutions that are involved in EE to identify and assess promising market opportunities, find local partners that are critical for success, package projects to make them attractive to lenders and investors and find sources of financing. Chapter 10 discusses the lessons of experience of institutions in supporting energy-efficient technologies. The emphasis is on analyzing the performance of organizations, particularly multilateral institutions (MIs) in promoting EETs. Many policies adopted in response to the global financial crisis are of a short-term nature, based on saving dirty industries with low or no profitability, while neglecting opportunities in EE, clean energy and intelligent resource management. The advantage of the EE approach is that it looks at real needs and at real human development. It provides value for money, for consumers, businesses and governments. For several decades, EE has been a growth industry creating new jobs at an ever-faster rate. Nevertheless, many governments, firms and consumers neglected the energy savings potential due to a complex web of barriers. These barriers are discussed here. The volume examines the approaches around the world that succeeded and failed, and draws lessons about the way to proceed.

PREFACE

xiii

In energy and environmental policy, the choice is between continuing the status quo, with most resources invested into fossil fuels, or promoting new forms of energy, especially renewable energy (megawatts) and EE (negawatts). To achieve win-win outcomes, which combine positive economic and environmental effects, policy makers can choose among a range of instruments, such as emissions trading, taxes, subsidies, command and control instruments, information mechanisms and voluntary mechanisms. This book explores public policy and technologies from the perspective of current political, economic and cultural realities as well as likely future trends. It argues that governments and firms can prosper and strengthen their security by investing in the growing green world market, securing patents for green technologies and adopting climate change measures that overall create more jobs than they destroy. We are indebted to the Indira Gandhi Institute of Development Research, Mumbai, India, and the collaborating universities, in particular Palacky University in Olomouc (Czech Republic) and the Catholic University of Ružomberok (Slovakia), including the faculty and staff of the respective organizations for their support of our efforts in writing this book and for providing all the necessary facilities that we all, too often, take for granted. There are some people who are mentors. The influence of the late Prof. Amulya K. N. Reddy (research supervisor of the first author) on the work described here is extremely significant. Prof. Reddy, a pioneer in the field, first introduced the first author to the issue of EE on which he had been engaged for some 20 years. For this, he is deeply indebted to him. There are others who provided important ideas. They include Dr. Eric Ferguson, The Netherlands; Dr. P. Balachandra, Department of Management Studies, Indian Institute of Science; Mr. K. Sreenivasa Rao, assistant editor, Journal of the Indian Institute of Science (JIISc), Bangalore, India and Mr. Hippu Salk Kristle Nathan (IGIDR, Mumbai) who have contributed to this book through technical and philosophical discussions of different parts of it. We offer them our sincere gratitude. The assistance of Tatyana Golubenko and the comments of Beatrice Maalouf in developing an early partial draft are gratefully acknowledged. We would like to thank Thomson Publishing Service, UK and Elsevier Science Publisher, UK, for permission to reproduce published material in Chapter 4 and Chapter 5. We thank Ms. Manali Das, Ms. Elina Majumdar and Ms. Meena Chakravorty and others at SAGE publications, New Delhi, for excellent handling of the publication of this volume. Last and most of all, BSR offers a special word of thanks to his wife, Lalitha, and sons, Sandeep and Siddarth, for the loving family environment

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that afforded him the tranquillity and peace of mind that made the writing possible. It is a pleasure to acknowledge their contribution and to thank them for it.

B. Sudhakara Reddy Gaudenz B. Assenza Dora Assenza Franziska Hasselmann

1 Energy, Economy and the Environment An Introduction

Energy development is a barometer of economic progress. The substitution of energy for human power in the performance of agriculture, industry and domestic services has contributed to the process of economic growth. The increased availability of energy services stimulates economic activity along different stages of the development process. Economic development accelerates when a society uses energy in new forms, adaptable to a range of needs based on its social and cultural characteristics. Understanding energy demand and how efficiently energy is used is of interest for policy makers as both aspects influence economic development, environment and sustainability. Throughout history and across the globe, energy utilization has followed a highly uneven process and has demonstrated dramatic variations in energy sources, use and growth rates. For example, in 2000, an average member of the American economy used hundred times more energy than his counterpart in Bangladesh. While in some countries, the per capita energy consumption is increasing rapidly, in others it has shown a decrease.1 In developing countries, fuel wood stoves can be found alongside nuclear reactors. Likewise, space vehicles coexist with bullock carts. 1

McNeill et al. 2001.

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ENERGY EFFICIENCY AND CLIMATE CHANGE

The world’s future energy path is uncertain. At the beginning of the 20th century, nuclear energy was unheard of, but, today, more than 400 nuclear power plants are in operation worldwide. Similarly, the present-day society cannot imagine life without petroleum products and electricity. However, the environmental implications of increased fossil fuel use and the risk of climate change in particular, will place limits on the use of fossil fuel resources. The progressive exhaustion of the easily accessible supplies will cause significant price increases by the turn of this century. The magnitude and speed of climate change is likely to be significant, but not completely certain. Increased greenhouse gas (GHG) concentrations are very likely to raise the Earth’s average temperature, influence precipitation and some storm patterns as well as raise sea levels.2 However, the amount and speed of future climate changes will ultimately depend on: whether GHGs and aerosol concentrations increase, stay the same or decrease; how strongly the features of the climate (for example, temperature, precipitation and sea level) respond to changes in GHG and aerosol concentrations; and how much the climate varies as a result of natural influences (for example, from volcanic activity and changes in the sun’s intensity) and its internal variability (referring to random changes in the circulation of the atmosphere and oceans).3 The fact is that the 10 warmest years in the instrumented temperature record (1861—the present day) have all occurred since 1990.4 However, the likelihood of deleterious impacts, as well as the cost and difficulty of adaptation, are expected to increase with magnitude and speed of the global climate change.5 The speed at which climate change is occurring and the uncertainty of the exact nature or timing of the impacts mean that a flexible and responsive approach to climate preparation will be needed.6 Faced with these challenges of climate change, economic development and sustainability, the future of energy and environmental policies have been a hot topic among policy makers and academics. Debates continue on the best energy source, with considerations of availability and cost of the resource, efficiency of production, public safety and health. Policy makers grapple with these decisions as well as with the consequences of use of different energy sources. Environmental concerns about global warming, acid rain, radioactive waste and other issues influence energy policies around the world. Understanding energy use in our society means understanding resources, their limitations and the environmental consequences of their use. 2

IPCC 2007d. EPA n.d. 4 Forestry Commission 2005. 5 Stern 2007. 6 CCIG 2008; IPCC 2007a. 3

ENERGY, ECONOMY AND THE ENVIRONMENT

3

Increasingly, researchers and policy makers have begun to focus on the more efficient utilization of existing energy supplies to help meet society’s energy needs. Depending on the system and user investigated it may be more economical to make efficient use of the existing energy resources and to reduce waste rather than to develop new energy supplies to meet growing energy demand. Energy efficiency (EE) has broader societal benefits in addition to reduced energy costs. More efficient utilization of energy often leads to improved productivity and competitiveness in business and helps avoid or reduce environmental impacts associated with development, combustion and delivery of fossil fuels. Yet, policies or programmes to increase EE often face daunting institutional, behavioural, financial and cultural barriers to their adoption. Consequently, researchers and policy makers are often confronted with an ‘energy efficiency gap’7 between the potential for energy savings and what is being realized in practice. The aim of this book is to provide a systematic framework for students, policy makers, academics and others interested in the efficient utilization of energy. The topic of EE is approached with the aim of understanding the barriers to and the drivers for EE investments. Particular emphasis is laid on the mobilization of private capital and the commercialization of energyefficient technologies (EETs). This private sector perspective is critical in order to reduce the burden on state budgets, which are creaking under the weight of enormous public expenses. Also, a business perspective on EE is necessary to tap the dynamism, innovation and power of markets for promoting environmental concerns. The environmental implications of EE investments as potential drivers for improved efficiency are a key focus of this book. The goal is to disseminate information on the development of policy instruments for promoting EE investments that can begin to bridge the gap between EE potential and practice. An attempt has been made in this volume to include the whole gamut of issues related to EE, development and environment. The introductory chapter ventures into the world of energy and EE by providing background, as well as context. Historically, supporters of energy efficiency defended the need for rational use of energy primarily on the basis of economic efficiency. However, the emergence of evidence of energy use contributing to climate change reinforces the case for EE. Chapter 2 on the great climate debate presents an independent assessment of the global level arguments both in favour and against climate change in terms of its causes, outcomes, policy initiatives, mitigation and adaptation methodologies. Chapter 3 examines a 7

Koopmans and te Velde 2001.

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ENERGY EFFICIENCY AND CLIMATE CHANGE

climate policy, which encourages win-win situations for both the environment and the economy. EE alternatives are considered as win-win opportunities for greenhouse gas mitigation. To familiarize the readers with the fundamentals of EE, Chapter 4 deals with the concept and unravels the complex linkages in terms of technology, policy, stakeholders and politics. A critical evaluation of energy efficiency is presented in Chapter 5 through an assessment of the benefits and drawbacks of adopting EETs and approaches. This assessment is made from the perspective of all stakeholders, namely, government, consumers, society, business, and so on. If the benefits of adopting EE are enormous, then, naturally, one is tempted to ask why this is not happening. In attempting to resolve this issue, Chapter 6 presents the theory behind the barriers that prevent and the drivers that promote the adoption of EE measures. In addition, a theoretical framework is provided to causally relate EE investments and existence of barriers. Chapter 7 pre-sents a discussion on the implications of international laws on climate change, environmental pollution, intellectual property rights, and so on, in the commercialization of EE. The benefits of EE cannot be realized until a large-scale diffusion of efficient technologies takes place. However, this can happen only if EE attains commercial status and spreads without any programmatic support. Chapter 8 discusses these aspects and presents a collaborative approach to achieve the goal of commercialization of EETs. A critical evaluation of financial mechanism is presented in Chapter 9 through an assessment of methods, channels and approaches in financing EE. Chapter 10 presents the role of multilateral institutions in promoting the adoption of EE measures.

1.1 Powering the World Economy In ancient times, human beings had a modest need for energy. They relied mainly on the energy from animal strength to do work. Humans first learned to control fire around one million BC and since then have used fire to cook food and to warm their shelters.8 There were water mills, wind mills and also solar energy for drying of foods. About 1000 BC, the Chinese discovered coal and started using it as a fuel, primarily for heating. Before the advent of coal, many regions experienced fuel crises due to the depletion of wood resources. The extraction and burning of coal made it possible to produce energy on a large scale and supply power to a growing economy. 8

Mitchem 1994.

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5

The invention of the steam engine in the 18th century, which has the capacity to convert heat from the combustion of coal and other fuels into mechanical energy, opened up new possibilities. The first steam engines were inefficient and wasted more than 99 per cent of energy, but by 1900, they had become 30 times more efficient than their predecessors. On top of this, steam engines, unlike watermills and windmills, could be set up anywhere, even on ships or railroad locomotives. The portability of the steam engine created a positive feedback loop, in that it enabled the transport of coal on a massive scale, providing fuel for more steam engines. Industrialization in the 19th century rested on this fact. World coal production, about 10 million tons in the year 1800, shot up 100-fold by the year 1900. Rough calculations suggest that the world in the 20th century used 10 times the energy used in the thousand years before A.D 1900.9 By the year 2030, it is predicted that energy consumption will increase by 52 per cent compared to energy demand in 2006 under a business as usual scenario.10 The Asian region will account for almost 40 per cent of that growth. Energy consumption in developing countries, particularly in China and India, has increased significantly in recent years. The share of the Organisation for Economic Co-operation and Development (OECD) nations in world energy demand is expected to fall from 56 per cent in 2006 to 47 per cent in 2030, while that of the Asian region, excluding Japan, will rise from 26 to 27 per cent (Figure 1.1). An increase is foreseen in the ratio for natural gas in the energy resources from 23 per cent in 2000 to 28 per cent in 2030, while the share of oil and coal will decrease proportionately. Notwithstanding these variations in the above ratios, consumption of fuels will increase due to a rise in the overall energy demand. The consumption of oil, coal and natural gas in the Asian region is expected to rise from 2000 through 2030 by 38, 79 and 19 per cent, respectively. It is estimated that by 2030 China’s dependency on oil will be about 30 per cent. However, if the world moves away from coal due to considerations for the environment and human health, there will be an increase in oil consumption in Asia and in the corresponding ratio too. Energy in central and eastern Europe during the socialist era was provided by coal, the most monolithic of the fuel mixes. For instance, Poland relied on coal for close to 70 per cent of its primary energy and 95 per cent of its electricity supply in 2005.11 Lithuania, Bulgaria, Slovakia and Hungary 9

McNeill et al. 2001. IEA 2008a. 11 Ibid. 10

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ENERGY EFFICIENCY AND CLIMATE CHANGE

Figure 1.1 Energy Outlook in 2030

Source: IEA 2006a.

ranked among the top 10 world-wide in terms of reliance on nuclear energy for electricity supply. For instance, Lithuania produced 85.6 per cent of electricity from nuclear energy in 1995.12 Another key characteristic of the energy supply of central European countries and the Soviet Republics was that they relied heavily on energy imports from Russia. Energy was one of the leashes through which Russia kept its republics and the satellite countries of CEE (Central and Eastern European) dependent, in accordance with the provisions of the Yalta Treaty since 1945. Large imports of natural gas, electricity, oil, nuclear fuel and other primary energy carriers built the basis of CEE energy supply. One of the positive legacies of the Soviet era for the CEE region is the high share of natural gas in the fuel mix, and the relatively well-developed infrastructure for natural gas. Since Russia is endowed with the lion’s share of the world’s natural gas reserves, it relies heavily on natural gas as a primary energy source. Furthermore, it has developed an extensive pipeline network 12

IEA 2008a.

ENERGY, ECONOMY AND THE ENVIRONMENT

7

to provide central European economies with natural gas. This has resulted in a high dependence on natural gas in these countries. The share of natural gas in Hungary’s energy supply presently exceeds 40 per cent, whilst more than 60 per cent of all Hungarian households are supplied with natural gas.13 Other countries in the region also rely largely on natural gas in their total primary energy supply, such as Ukraine (42.9 per cent), Romania (37.7 per cent) and Czechoslovakia (19.9 per cent).14 Since natural gas is the least polluting of the fossil fuels and emits only half as much carbon to the atmosphere per unit of energy as coal, this had a positive impact on the overall environmental performance of the energy sectors of these economies. While the reliance on natural gas was desirable from an environmental perspective in the short term, after the fall of the Soviet era, it raised concerns of national sovereignty in several CEE countries and in the former Soviet republics. Since diversifying the import sources of natural gas is burdensome due to the costly and time-consuming pipeline construction, fuel diversification emerged instead on the top of the energy policy agenda of several CEE countries as a tool to promote energy security. Natural gas, however, remains an important fuel in the CEE region. The energy industry was the largest polluter of the CEE region at the end of the socialist era. According to Kramer, the communists claimed that ‘(…) environmental pollution is the price that has to be paid for industrial development and the development of civilization’,15 Baker and Jehlicˇka illustrate further the attitude of the communists. They argued that environmental problems arising from industrial production were only temporary and would be solved in the near future through scientific and technological advances.16 In the so-called ‘Black Triangle’, which was an area of heavy industry and coal mining in Poland, Czechoslovakia and East Germany, acid rain has turned many square miles of forests into a moonscape. In the Orlické hory mountains, over two-thirds of the trees were dead by 1989, and even worse was the situation in the Krušné hory mountains and the Jizerské hory mountains.17 In this region, carbon emissions per unit of economic output were among the highest in the world; several times higher than those in OECD countries.

13

MOL 2001. IEA 2006a. 15 Kramer 1983, 204. 16 Baker and Jehlicˇka 1998, 7. 17 See Carter 1993, 72–73. 14

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ENERGY EFFICIENCY AND CLIMATE CHANGE

However, at the root of all environmental damages related to the energy sector was the wasteful production and use of energy in the CEE region. While quality of life was significantly lagging behind that in OECD countries, the levels of energy consumption per capita were comparable to those in the most developed economies. In 1989, a Russian citizen 18 consumed more energy than a citizen of any EC country, while he or she enjoyed only a fraction of the wealth of an EC citizen. As a result, environmental emissions per capita and per gross domestic product (GDP) were also high compared to the low standards of living. Thus, at the root of the energy-related environmental damages was the inefficiency of the energy chain, which is often characterized by energy intensity indicators such as total per capita energy supply (TPES)/GDP. The stage is set for intense competition for resources among countries seeking to secure their energy supply by diversifying sources and areas of origin. According to projections of the World Energy Council, the fuels most widely used today—coal, oil and natural gas—will still account for 19 two-thirds of primary energy even beyond six decades from now. Currently, coal is both cheap and abundant. Likewise, oil supplies are still high and new oil deposits are being discovered. Natural gas is the cleanest fossil fuel today but the transportation infrastructure is not very well developed in developing and transition countries. However, there is the option of reducing the use of fossil energy to counter their environmental implications. This can be done through EE measures and substitution of alternative energy sources, such as solar, wind, geothermal, modern biomass and traditional hydropower generation. According to the World Bank’s estimates, renewable energy could potentially provide up to 50 per cent of all energy by the middle of the 21st century, ‘(… ) given appropriate enabling policies and 20 new technology developments’. According to the International Energy Agency (IEA) estimates, the world’s increasing demand for energy will require a total investment of USD 20 trillion (value in 2005 dollars) by 2030 out of which about USD 11 trillion would be needed in the global electricity sector alone. Worldwide, the race is on to increase exploitation of existing oil fields and to find new ones. Capital expenditure in the oil industry amounts to just over

18

Certainly the citizens did not directly consume all this energy, but their per capita share of the national primary energy consumption was very high. 19 WEC 2006. 20 World Bank 2000, 23.

ENERGY, ECONOMY AND THE ENVIRONMENT

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one-fifth of the total energy investment. Projected oil development programmes in North America will require a total investment of USD 856 billion over 2005. In order to restore Iraqi oil production to the 1990 levels, some USD 5 billion will be needed over the next six years and, in a rapid growth scenario, production could reach 5.4 mb/d by 2030 at a cost of USD 54 billion. China will need a total of USD 7 trillion investments, which is 18 per cent of the total investment (Figure 1.2). Figure 1.2 World Energy Investment, 2005–2030

Source: IEA 2006a. Notes: E&D = Exploration and Development; T&D = Transmission and Distribution; LNG = Liquified Natural Gas.

The IEA states that a total investment of USD 20 trillion is required by the global oil and gas industry to keep pace with the anticipated demand over the next 30 years, of which about USD 700 billion is needed to support the Middle East oil sector. Oil from the Persian Gulf region will play an increasingly important role in the world economy. The uncertainty surrounding the developments in Iraq is a cause for concern. Investment in the global natural gas industry will average USD 157 billion a year over the next two decades to meet a near doubling in demand and to provide around 300 billion cubic metres of new gas production. Global investments in Russia’s energy sector are projected to exceed USD 195 billion by 2030. Peak investment would come in 2010 for prospecting

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new oil fields and gas reserves, maintaining old ones and improving the infrastructure for transporting oil. According to the IEA, the total level of investment in oil transportation will increase six-fold by 2030. Russia is poised to become one of the leading exporters of oil and gas by 2030, gaining an important niche in many markets, including Asia (Figure 1.3). Figure 1.3 Fuel Share in Energy Investment Requirements, 2005–2030

Source: IEA 2006a.

According to IEA, world-wide electricity demand will double in the next three decades, with an average annual increase of 3.2 per cent. To meet this growing demand, the world would further need around 5,100 GW electricity generating capacity by 2030, and about half of that needs to be built in Asia. Europe would need to invest about USD 1.7 trillion on power plants, transmission and distribution to meet an increasing demand for electricity and maintain the current capacity. Germany alone anticipates a new capacity of around 40,000 MW in electricity production in the coming decades, which corresponds roughly to 60 large-scale power plants (Figure 1.4).

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Figure 1.4 Share of Energy Investment of Different Countries and Groups, 2005–2030

Source: IEA 2006a.

Due to limited state budgets, financing for necessary energy sector investments in transition economies and developing countries will pose the greatest challenge in the decades ahead. Developing countries will account for over half of the total investments over the next 20 years, or USD 10.5 trillion, with transition economies accounting for USD 1.85 trillion. Brazil’s energy sector will need investments of USD 250 billion to meet the country’s electricity demand in the next 20 years. More than USD one trillion will need to be spent on China’s transmission and distribution networks—an amount equivalent to 2.1 per cent of China’s annual GDP. India will need an investment close to USD 100 billion in electric and oil sectors. Notwithstanding the projected rate of investment for new electricity supplies, an estimated 1.4 billion people, mostly in Africa and South Asia, will still remain without electricity connection. The underlying assumption of this overview, is in no way, that the firm predictions of various agencies such as the IEA can neither be influenced nor be avoided. It is our firm belief that policies do have the required leverage to influence the energy path. A significant reduction of energy consumption levels can be achieved if we promote such policies. Therefore, the issue is the need for a shift in paradigm—from policies which increase energy consumption to those that help to reduce it.

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1.2 The Geopolitics of Energy In the new millennium, new realities affecting the energy industry are constantly emerging not only because of events in the Middle East but also because of the environmental impacts of energy consumption and concerns about global sustainability. A strong interaction exists among energy, economics, technology, geopolitics and sustainability. The challenge for policy makers is to secure the long-term energy future without destroying the environmental systems that support the human race. It would be short-sighted of countries to focus only on their own energy security without due regard for the geopolitical and environmental risks and impacts. The invasion of Iraq in 2003 was seen by many as an expression of the mindset that oil equals security. According to these theorists, the geopolitical strategy of the United States (US) is based on the perceived need to maintain access to oil reserves not only in the Persian Gulf but also around the world. It is a common truism that all politics, including that of energy, is local. Yet the source of energy is global. That means that global energy supplies are potentially vulnerable to any disruptive event, anywhere, anytime. Vulnerability is ever present, regardless of the degree of dependence on imported oil. The national security of a country must be viewed as a question, not just of military hardware, but also of economic vulnerability, which is linked to the dependence on energy. This dependence has been amply demonstrated during the first oil crisis of 1973 when the price of crude oil increased four-fold. By 1973, according to some experts, oil had become the main source of energy of industrial economies around the world. Never before had industrial countries been so dependent on oil exporting countries. Seeing through this dependency, some Arab countries started considering the use of oil as a weapon to achieve their economic and political objectives. When Israel attacked the Golan Heights in 1973, the Arab countries agreed to an oil embargo. The economies of many developing countries were shattered due to supply restrictions and price increases. Unless the energy resources are diversified and used far more efficiently, many of the oil importing countries will remain vulnerable to the tempestuousness of the politics of oil. Access to Middle East oil and gas is likely to remain a major factor of international political relations. The challenges of energy security and sustainability are daunting and require a paradigm shift to reduce energy consumption levels. This calls

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for a much bolder approach, involving a combination of policy proposals and technologically feasible ideas, significant public investment in efficient systems, and stronger support for renewable energy resources as well as other alternative sources of energy.

1.3 The Energy–Environment Nexus—The Climate Change Energy is closely linked with key contemporary global challenges the world faces—social development and poverty alleviation, environmental degradation and climate change—and is therefore a defining issue of our time. Climate change is especially of concern to the energy sector, since the use of energy accounts for about 60 per cent of greenhouse gas emissions. But above all, it is a global concern because without new policy action, we run the risk of irreversibly altering the environmental basis for sustained economic prosperity. Climate change will impact our health, our security and our economies. The damage could be large and irreversible. The costs are also likely to be unevenly distributed, with poorer economies and households incurring greater losses. This is one of the many facets of the problem that complicates the international response to the challenge of climate change. In recent years, there has been a growing concern about global warming due to increased concentration of heat trapping gases in the atmosphere. As a result of burning coal, oil and other fossil fuels, large amounts of carbon dioxide (CO2) and sulphur dioxide (SO2) have been released into the atmosphere.21 Since the beginning of industrial revolution, the atmospheric concentration of carbon dioxide has increased by nearly 30 per cent, methane has more than doubled, and nitrous oxide has risen by about 15 per cent. These increases have enhanced the heat trapping capability of the earth’s atmosphere. Many scientists see links to global warming.22 Since the end of the 19th century, the global mean temperature of the earth surface has increased from 0.5°F to 1.0°F.23 21 SO2 is responsible for acid rain and the pollution of soil and water, forest and biological resources. CO2 is the main GHG responsible for climate change. 22 Common air pollutants such as sulphate aerosols cool the atmosphere by reflecting light back into space; however, sulphates are relatively short-lived in the atmosphere and vary regionally. 23 EPA , n.d.

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GHG emissions occur naturally but they can also be attributed to a number of human activities, namely, energy production and utilization, industrial processes, deforestation and agricultural practices. Of these, energy production and use account for nearly 50 per cent of the human caused increase in greenhouse gases in the atmosphere. Deforestation and agriculture together contribute about 25 per cent whereas industry is responsible for the remaining 25 per cent.24 While the great majority of GHGs such as water vapour occur naturally, scientists have linked the observed increase in greenhouse gases in the atmosphere to human activities. Developing countries, which were low-emitting countries until the 1970s, have become the fastest growing sources of GHG emissions, mainly due to economic growth. In 1950, North America and western Europe together accounted for 68 per cent of total emissions while in 2006 they represented only 40 per cent of the total. In contrast, the share of developing countries increased from 7 to 35 per cent of the world total.25 Since energy production and use is the single most important source of GHG emissions and coal demand is dominant in several key developing countries in Asia,26 the energy as well as environmental policies in these countries will strongly influence global environment in the future. As the exhaustion of fossil fuels and the environmental damage caused by pollutants of fossil fuel combustion became notable, energy experts began to seek alternative sources of energy. Some of the energy sources that are becoming popular are solar, wind, hydroelectric, biomass and geothermal energy. Many of them have been developed nearly a century ago. There are many reasons for the slow diffusion of these technologies. Whereas for solar radiation, the low energy density is a barrier for wind and hydro, it is their local availability and intermittent nature. Hydro is constrained by environmental concerns and low world availability while geothermal is mainly a local source with a low world maximum and technological problem like corrosion. Biomass competes with food and fodder crops, has low efficiency and high logistic costs. Nuclear energy is widely used today. Its efficiency in producing energy is attractive, but the risk of accidents and the disposal of radioactive waste are key concerns. A far more important issue 24

WRI 2003. WEC 2006. 26 Domestically produced coal is the predominant source of generating electricity. The quality of this coal is very poor (calorific value=2800 kcal/kg which is 40 per cent less than that is being produced in countries like USA). Hence, CO2 emissions from coal plants is higher in the Asia-Pacific region. 25

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is proliferation. Every nuclear plant produces plutonium, which can be reprocessed into fissile material for nuclear weapons relatively easily. Considering all these constraints, a very good alternative that is economically beneficial and environmentally sound is the efficient utilization of energy resources. By reducing the need to supply more energy inputs to the system, EE creates economic and environmental benefits. Until now, EE has not been sufficiently marketed this way. However, EE is not a magic bullet, but an essential part of any solution. It does not make the approaches to balancing the energy markets superfluous.

1.4 Energy Efficiency—The Other Paradigm Need for Energy Efficiency The thinking in developing countries and transition economies on energy production and utilization is mostly on the pattern prevailing in Europe and North America. Many countries adapted a nearly identical path of large scale, supply-side-oriented energy development. However, despite decades of adherence to this path, these countries have not met even the basic energy needs of the majority of their people. In such circumstances, a different paradigm of energy development needs to be developed. This approach goes beyond the traditional supply side one, using energy as a catalytic force to bring about both social and economic development. This type of development embraces the following principles: (a) development oriented, (b) service based, (c) endogenous, (d ) self-reliant, (e) environmentally 27 sound and ( f ) socially acceptable. To achieve these goals, an efficient utilization of resources is necessary. This is a holistic view of how to provide the energy need of all without destroying ecological balance. This approach is not merely looking for consumption growth, but for consumer value and human development. The paradigm with emphasis on EE could be turned into an engine of 28 growth that truly enhances livelihood levels of people at the lowest end of the economic ladder. The driving concern of this paradigm has been 27

Goldemberg et al. 1988. There is no intrinsic coupling between the EE approach and the livelihood levels of people or a catalytic force to social development. However, it fits well into such a development model. 28

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that the human dimensions of energy are as important as the technological. This approach is rooted in the conviction that energy needs cannot be met in isolation from other human problems. The emphasis must be on energy services—not merely on energy consumption or supply as an end in itself. The focus has to be on energy services that improve the Human Development Index directly, such as cooking, safe water, lighting, transportation, as well as 29 indirectly via employment and income generation. These needs have to be met through a combination of means using renewable resources, efficiency improvements and new technologies that can improve economic activities and at the same time reduce the risk of environmental degradation. Although the 1990s saw a re-emergence of EE as an important policy goal, the relentless growth of economic activity and population still dominated the public agenda, causing a multiple increase in aggregate demand for energy resources. An increasing share of energy consumption is attributable to developing countries, including such densely populated countries as India and China.30 If we project these trends into the future, the world could experience a shortage of finite and non-renewable fossil fuels by the first half of the 21st century. The energy sources that have sustained the civilized society for so long—fossil fuels—are becoming increasingly scarce. A much debated question is—what will happen when deposits run out? Judging by today’s level of energy consumption and technological possibilities, the world’s coal deposits may last a few centuries, natural gas for about 70 years and oil for more than 40 years.31 However, there is also an option of exploring other possibilities. There is a possibility of secondary and tertiary recovery, which can vastly increase oil recovery from oilfields. There are gigantic supplies of methane in geo-pressurized zones and clathrates. There are also tar sands, oil shales and deep-in-site gasification of fossil fuels. The mineral deposits may never be fully depleted if technological progress and changing energy structures make fossil fuels obsolete before the stocks run out. One should also take into account the self-regulation of the oil industry: if there are only 40 years of assured reserves, there will be a cut down on exploration, and so less new reserves will be found. Thus, the main question may not be about the time of depletion of coal, oil, and gas stocks, but about when these energy sources will be substituted by a combination of alternative energy

29

Reddy 2002. ESCAP 2008. 31 Torkunov 2001. 30

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sources, efficient technologies, lightweight materials and other advanced technologies. An energy revolution driven by concerns about economics, sustainable development, and energy security has been called for by many experts since 1970. However, only in recent times the installation of EETs has become an urgent task for industrial organizations and governments alike. In many countries this process has barely begun because of the absence of technological know-how and political will. The reasons for not promoting EE may become quite sensible, if one takes election within the next few years as the main government perspective and shareholder value as those of energy companies. There is neither political will nor industrial initiatives to develop technologies and know-how, that cannot be sold on a large scale. However, for those who want to take long-term responsibility, and to look for the future of humanity, these short-term optimizations are not sufficient. Even three decades after the first oil crisis the vast potential for EE and savings still remains to be harnessed. To achieve the goal of energy security and sustainability, the involvement of various stakeholders such as end users and many intermediate and down-stream institutions in setting up integrated energy systems is essential. This requires long-term planning, stable government and managerial skills. Usually an EE approach is not always the cheaper option. The advantages accrue over the much longer term: lesser dependency on foreign energy imports or local fossil resources; lower impact on the environment, and so on. But those advantages do not help the short-term development. On the contrary, the classical supply side approach is more flexible with standard equipment and widely-known technologies. Hence it is important that we should be much more careful in designing the EE system. To succeed in this approach, there is an urgent need for a paradigm shift in policies to support EE and renewable energy initiatives aided by appropriate incentives, standards and investments geared towards spurring private investment. This shift in energy policy should be rapid and sustained if it is not to run out of steam and give way to the previous status quo.32 In the following sections, each of these factors will be considered in more detail.

32 The evolution of human needs and the services that require energy, such as lighting, cooking, transport, or motive power have to be analyzed along with demographic and social trends. For a sustainable energy strategy, policy and planning should be thought of as part of a global policy involving land use, infrastructure, urbanization, lifestyles and region.

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The Economics of Energy Efficiency Generally the term EE is defined in a technical sense and relates a given level of service to a given level of input. To put it differently, an increase in EE occurs when either energy inputs are reduced for a given level of service or service is increased or enhanced for a given level of input. To be energy efficient per se is to provide services with an energy input that is small relative to a fixed standard or normal input. It is important to note that EE should not be regarded as an end in itself. It is a means to conserve natural resources, to reduce environmental degradation and to save money. It is true that EE helps to reduce GHG emissions. However, there is a debate about both its cost effectiveness and the policies that should be pursued to enhance EE.33 Improvements in EE will require active intervention in markets to overcome barriers and to stimulate drivers (see Chapter 6 on drivers and barriers). On the other hand, some argue that market barriers to the penetration of EETs do not represent real market failures that reduce economic efficiency. Under certain conditions, such as wrong choice of technology, expensive policy incentives, inefficient implementation, there can be trade-offs between economic efficiency and EE, even though these goals should go hand-in-hand logically. The balance of evidence supports the view that there is not always a ‘free lunch’ in EE. Nonetheless, a case can be made for the existence of certain inefficiencies in energy technology markets, thus raising the possibility of win-win EE enhancements. These issues are discussed in more detail in Chapters 3, 6 and 9. The cost effectiveness of an efficiency measure varies, depending on who evaluates the investment and which costs and benefits are considered. For example, from a business perspective, the only relevant costs and benefits are those borne by the energy user. These include expenditures on equipment, installation as well as operation and maintenance costs. The benefits include energy cost savings plus enhanced labour productivity, environmental compliance or product quality. These are the traditional accounting costs and benefits that affect the industry directly. From a societal viewpoint, there is a wider range of relevant costs and benefits. These include monetary, health and environmental costs and benefits that accrue to society. Certain societal benefits, such as reduced local air pollution or diminished threat for climate change are external to the market and are difficult to quantify. Moreover, they accrue to society at large, not directly to the particular party 33

See for example, Newell 2000.

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implementing efficiency measures. So it is important to analyze who bears the costs and who gets the benefits. Not until every actor has a positive cost-benefit perception will they participate and the EE system will take off. The EE approach can be termed as tightly coupled. The key economic question that will determine the pace of the widely anticipated energy revolution is the cost of improving EE relative to various forms of energy generation, such as for instance the cost of extracting fossil fuel and providing services through renewable energy sources. The fundamentals of EE are discussed in greater detail in Chapter 4. It is worth discussing three fundamental relationships here: z

z

z

With increasing costs of energy generation, the adoption of EETs will become a viable alternative. Since the contribution of renewable energy sources is marginal to the total energy mix the main economic driver for EE remains the utilization of fossil fuels. The more expensive the extraction of these fuels, the more attractive is the reduction in their use through efficiency measures. With increasing volatility of energy prices, many countries become vulnerable to such volatility. While the high and volatile oil prices may reduce economic growth in developed economies, they can trigger prolonged economic crisis in developing countries in the form of increasing budget deficits, trade imbalances, increased unemployment and impoverishment. Under these circumstances, the option of efficient utilization of energy becomes an attractive proposition. With increasing stability and soundness of economic policies and overall macroeconomic conditions, the probability of increasing EE will be higher. It is generally postulated that macroeconomic conditions matter less with regard to EE area because EE projects are more of a short-term proposition than fossil fuel or nuclear power projects. However, traditional energy investments tend to be large and long term, and hence the political and economic stability of the country is particularly important.

Energy Efficiency and Climate Change In recent years, the main focus of the global environment has been on global warming and the related policy responses. The exploitation of fossil fuels not only has contributed to human well-being, but has also led to increasing

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environmental pressure on the earth. Currently, climate change induced by humans is one of the most important environmental problems related to the use of fossil fuels. The emission of CO2, the most important of the greenhouse gases, is a direct result of the combustion of fossil fuels. One policy response of particular interest is EE. This can be used to reduce the level of CO2 in the atmosphere by reducing the amount of fossil fuels combusted and therefore the amount of CO2 released. Together with renewable energy, transportation and forestry projects, EE is widely viewed as one of the most accessible and cost-effective opportunities to mitigate climate change. The potential scale of efforts to improve efficiency levels depends on the outcome of a global negotiation process, in which governments meet regularly to discuss issues concerning climate change. Many proposals have been discussed but there is still uncertainty regarding the implementation of policy measures, particularly at the international level. This uncertainty has so far stemmed the flow of public and private capital into climate-friendly technologies. As a result, the boom in EE activities has not materialized so far, despite the recognized potential for cost-effective projects.

1.5 Energy for a Sustainable Future The term sustainable was popularized in 1987 by the World Commission on Environment and Development (WCED), a body that became known as the Brundtland Commission.34 The concept of sustainable development has come to embody a holistic vision of societal change, including political, economic and cultural.35 The strength of the concept is that it reflects widely shared concerns about the state of the world, and that it provides a common umbrella to numerous measures aimed at improving this state.36 Sustainable development integrates the concept of nature with society and

34

The body became known as the Brundtland Commission after its leader, Gro Harlem Brundtland, who was the prime minister of Norway at that time. 35 The state of the world and the instruments for promoting sustainable development are subject of numerous publications. Some of the best known are: (a) FAO 2000, (b) Lester R. Brown et al. 2000, (c) Renner and Sampat 2002, (d) UNEP 2001, (e) UNDP 2002 (f ) UNICEF 2003, (g) World Bank 2002a and (h) WRI 2003. 36 A limitation of the concept is its operationality. As it is all-embracing countless controversies about the state of the world and what measures should be taken to improve its state exist.

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its three fundamental constituent parts: politics, economics and culture. Nature provides the sources of energy, which in turn enable development. Oil, a non-renewable energy source, is the outcome of prehistoric fossil disintegration and compression. A significant amount of economic activity revolves around naturally extracted forms of renewable and non-renewable forms of natural resources such as forests and coal. These factors of production and consumption form the environmental constraints for economic progress, and define the environmental aspects of sustainable development.

Politics Can we possibly meet the energy requirements of nine billion people with a prosperous lifestyle? It is feasible to solve this problem. Yet, action on this front has been anaemic. Private investment in research has declined because sufficient incentives for invention are lacking. An increase in the price of fuels to reflect the environmental and security costs associated with each might be a solution. This solution conflicts with the policy demand to keep prices low. In many countries, a mixture of incentives and regulations for automobiles and appliances has been created in the past few decades, which help reduce emission levels. However, these are often offset by production as well as supply subsidies that keep prices artificially low. Since the full cost of energy consumption is not reflected in market prices, private incentives for innovation in EE and energy supplies are well below optimum. The case in point is the abandonment of research on coal gasification (or petroleum from coal) as it is more expensive than petroleum products.

Economics Economic activities not only include wealth and prosperity in a financial sense but also the provision or protection of qualitative features, such as environmental amenities and quality of life. Some of these qualitative features can be provided by economic activities. Equally important is the challenge to prevent the economy from creating excessive externalities and damaging the quality of life. The Human Development Index and similar alternatives to the indicator of GDP attempt to capture a broader dimension of development. As the Brundtland report definition mentions, sustainable development is future oriented in its outlook and hence imposes a responsibility on today’s generations. Environmental responsibility and social equity are key dimensions. One should also explore a concept that includes a negative term for environmental losses due to economic growth

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such as ‘Green Domestic Product (Green DP)’.37 Presently, the apparent gains in traditional GDP have been offset by significant losses in Green DP for a long time. If governments aim for growth, the direction of economic policies has to be changed totally. Around 2004, the Chinese government made an attempt to reflect whole cost accounting or environmental accounting in their country’s GDP. The effect lowered the country’s GDP so much that it was considered ‘politically unacceptable’. This is not to say that it should not be done but just that in the current global context it is political suicide for a country to implement it. So we have a case of environmental correctness in opposition to political expediency.

Culture An interesting aspect of the definition of the sustainable development is the attention given to local cultures and community-based decision making, a strategy that renders sustainable development less technocratic. Resource management approaches to sustainable development is a new class version of managerialism that functionally serves to globalize and perpetuate the techno-managerial elite’s control over everyday life. With increasing attention to issues of societal embedding and culture in the energy transition (for example, from use of biofuels to LPG) this situation may change, but it probably will remain problematic.

Energy for Sustainable Development Energy is the key driver of global economic development. However, a question may arise: Is the prevailing pattern of energy use and the economic development sustainable? A cursory glance at the global energy scene reveals a wide gap between actual and desired goals. To remember, the World Commission on Environment and Development defines sustainable development as something, which aims at promoting harmony among human beings and between humanity and nature.38 Further, the Commission defines sustainable energy development as meeting the needs of the present without compromising the ability of future generations to meet their own needs. Energy use is also related to social development in terms of improvement in quality of life, education, employment or poverty alleviation. 37 38

Hueting 1991. Brundtland 1987.

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Overall, to be sustainable the production and use of energy should conform to the following yardsticks—economic feasibility, social acceptability, environmental soundness and resource conservation. The World Energy Council (WEC)39 has set three principles for the sustainable development of energy—it must be accessible, available and acceptable. Accessibility to modern energy means that energy must be available at prices that are both affordable and sustainable. Then they are low enough for the poorest people, but still support the financial ability of utilities to maintain and develop their energy services by reflecting the real costs of energy production and distribution. Availability relates to long-term continuity of energy supply as well as to short-term quality of service because energy shortages are disruptive for economic development. This implies that the right energy mix relies on a well diversified portfolio of domestic or imported or regionally traded fuels and sources of energy. Acceptability is an issue for both traditional and modern energy. It covers many issues, such as deforestation, land degradation or soil acidification at the regional level, indoor or local pollution, GHG emissions and climate change, nuclear security, waste management and proliferation; and the possible negative impact of large dams or large scale modern biomass developments.

1.6 Understanding Trade-offs for a Successful Energy Policy Existing technologies and approaches can deliver significant gains in EE. However, to date, there has only been limited success in terms of adopting these technologies and approaches by industries and domestic markets. This is because, there is a general belief that inefficient practices are primarily caused by social, economic, informational and institutional actions working against a shift to more energy efficient practices. For example, there is a general acknowledgement of the fact that there are potential gains in areas other than those that directly benefit from improved energy management, but there is a limited understanding of the nature and extent of these ‘flowon’ benefits. In formulating energy policy, government agencies need to understand how to use these flow-on benefits to promote a wider adoption of energy efficient practices (Box 1.1). This requires identifying and quantifying the barriers and drivers in terms of factors such as economic growth, environment, employment and regional development. 39

WEC 2003.

24 ENERGY EFFICIENCY AND CLIMATE CHANGE Box 1.1 Flow-on Benefits to Promote Energy Efficient Practices How do you take a 29-year old office building from a 1-star to a 4-star rating under the Australian Building Greenhouse Rating (ABGR) scheme? It has been achieved by ‘looking for better ways of doing things’. The results have been startling, with the Council’s overall electricity bill slashed from USD 1 million in 1995 to around USD 550,000 per year. This equates to greenhouse gas savings of approximately 1,303 tons, equivalent to taking 289 cars permanently off the road. The Council’s administration building alone has reduced energy costs from USD 168,000 in 1995 to USD 65,000 in 2003. If the Council had not implemented energy savings, the 2003 energy bill would have been USD 1.2 million. Installing a USD 68 movement detector in the administration building toilets has achieved a 98 per cent saving in lighting energy use. Investing USD 72,000 in power factor correction in the administration centre, art gallery and city hall has achieved savings of USD 36,000 a year by improving the building’s power factor and reducing peak demand energy load. This eliminates the electricity supplier’s penalty for poor power factor. A USD 52,000 office lighting retrofit, which replaced the inefficient control gear in 1,200 twin 4018-watt fluorescent fittings with Gold Energy low loss ballasts and single triphosphor lamps, has achieved a 47 per cent reduction in office lighting energy use and a more uniform lighting output. An added benefit of installing triphosphor lamps has been the reduced loads on the air conditioning system due to reduced lighting heat. Plus, the lamps are now changed every five years instead of every two, reducing maintenance costs. The Council also controls the 2.4kW auto boiling units and chilled water drinking fountains so that they only operate when someone turns on the lights in a particular area. This reduces the operating time by 70 per cent and greenhouse pollution by 63 tons per annum. In the underground car park, the 29.5 kW exhaust fans operated for 18 hours a day, five days a week. By installing a Variable Speed Drive (VSD) and carbon monoxide sensors at a cost of USD 35,000, the energy usage and resultant greenhouse gas emissions dropped by 89 per cent. The project had a simple payback period of 3.2 years and cut emissions by 115 tons per annum. The windows in the administration building were replaced with double-glazed smart reflector glass, which reduced the internal surface temperature of the glass by 10 degrees Celsius in summer. Many of the changes have flow-on benefits such as reduced maintenance and a better working environment. The air conditioning system was modified to include an ecocycle, which now allows the building to automatically draw on 100 per cent outside air for almost half of the year, and has resulted in a more comfortable environment. The new Building Management System (Box 1.1 Continued )

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(Box 1.1 Continued ) determines when to introduce outside air. The consumption has been reduced from 2000 to 250 kWhr a day when 100 per cent fresh air is utilized. With the savings, it was possible to replace the air filtration system, which is now four times as efficient and a much better level of air quality is being enjoyed. The installation of VSDs on the main air handling fans has resulted in a significant reduction in noise levels, again adding to a better work environment. Source: Australian Building Green Rating Scheme 2001 (www.abgr.com.au)

A broader development-oriented approach is possible only if various stakeholders, namely, politicians, planners, equipment manufacturers, financial institutions and researchers begin, without delay, to channel the available human, technical and financial resources into the mass production and marketing of energy-efficient and environment-friendly technologies. This path bears the potential of providing employment opportunities, as these technologies are labour intensive. The implementation of such a system requires the reorientation of energy planning and the priorities of governments and utilities, a multiplying of research efforts for clean, renewable energy systems, and changing the mindset of consumers. Efficiency measures are, on an average, less capital-intensive per kilowatt than supply side options. Although many are aware of this truism, the knowledge about who can and should do what is lacking. Research is needed to underpin the development of national and regional strategies that will lead to greater adoption of both existing and new technologies and approaches for increasing EE. Such research will need to go further than simply identifying and describing the barriers. It will need to develop a fundamental understanding of the characteristics of these barriers so that government policy and planning agencies can design effective strategies for the implementation of solutions. It may involve the development and assessment of policies, which have the potential to promote new markets for energy-efficient practices, products or services. Further research should aim at identifying business models for commercialization of efficient technologies. The commercialization of EETs is of direct and immediate relevance to the development of government policies to promote EE government actions have the potential to facilitate a positive response by firms and businesses. Science and technology support will need to demonstrate how their proposed research will make a strategic contribution to the development of a policy that promotes uptake of energy-efficient practice by industry

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and the markets. Linkages and alignment to existing policy research, and even support from the private sector may need to be developed as part of formulating a proposal. Such linkages would need to be identified clearly. It should also become clear how the research project will build on previous or current research efforts, or how it will fill gaps in national and international research findings. Project proposals should provide evidence of strategic partnerships that ensure the implementation of energy efficiency projects. The key to a successful energy policy is to achieve: z

z

Greater efficiency in energy use by consumers, due to better management of existing equipment and buildings, switching to low carbon fuels such as natural gas; New investment in plants for low carbon generation in the future; public investment geared at stimulating private investments in new technologies and infrastructure which can transform the underlying demand for services, such as transport, power, shelter, and comfort, into less intensive demands for energy. The cost of reducing emission trends varies where there are many alternatives. Many demand policies have long lead times as consumers are needed to take a new investment. Also, habits as well as institutions have high inertia.

In the light of competing claims on scarce public funds, governments and multilateral institutions are unlikely to make up for the bulk part of this gap (between need and availability of funds) through massive investments. A significant proportion of capital must come from the private sector. Even if sufficient public capital is available, it could be argued that government investment is less effective as far as the stimulation of EE is concerned than measures that create the framework conditions, which favour private sector activities in EE. In other words, governments may be more effective if they shift their emphasis from direct financing of EE to: (a) overcoming the barriers that prevent the commercialization process and (b) stimulating the drivers that promote the commercialization process. These barriers and drivers vary with each actor in the system. If each actor, such as the public, the private, the local, national and multilateral is motivated, then the whole process starts. In recent years, a number of trends have accelerated the commercialization of EETs. These trends can be referred to as drivers and include factors such as high prices for fossil fuels, technological innovation, increasing economies of scale, rising environmental awareness, growing

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recognition of EE as a source of profit rather than cost, increasing investments of firms in this sector, and the prospect of stronger measures being introduced in the coming years at the national, regional and international levels in order to mitigate global warming. Any action to reinforce these drivers is likely to boost the commercialization trend.

1.7 The Role of Multilateral Institutions In order to understand the role of multilateral institutions (MIs) in financing efficiency improvements and the mitigation of environmental degradation, we need to take a glimpse at some of the international instruments put into place for tackling these issues, namely, the 1992 Rio Earth Summit and the Agenda 21, and the United Nations (UN) Millennium Declaration in September 2000. Of the many items in the Rio agenda, those relevant to this section are the financing of the development process and its derivative—the involvement of a wider number of stakeholders. In 1992, it became evident that Overseas Development Assistance (ODA) programmes were no longer sufficient to stimulate external financing in middle-and low-income countries particularly in debt-ridden sub-Saharan Africa, despite the commitment made by the developing world to devote 0.7 per cent of their gross national product (GNP) to ODA. Although the June 2001 UN Summit on Finance for Development reiterated much of the items already touched upon in Rio, it is clear that the world has become more conscious of the fact that the involvement of various stakeholders such as planners, consultants and academics from government, development agencies, private companies and non-governmental organizations (NGOs) is essential in achieving sustainable development. These actors tend to link up if they think they have something to offer and to gain. However, it is only when they clearly see a common interest that they will commit themselves substantially to a partnership by contributing material or intellectual resources. The objectives of the partners may be very different, but there can be a common interest and objectives shared by the partners. For example, a public–private partnerships (PPPs)40 is a promising option for meeting EE research needs because they tie research closely to users’ needs, provide opportunities to improve efficiency and can augment investments in research. This type of 40 The PPP is an agreement between the public and the private sector to assume coresponsibility and often co-ownership for service provision.

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partnership can at best develop in a network of institutions whose activities in the energy chain are integrated. This is not the same as a privatization agreement, wherein a corporation takes full responsibility for specific services. Rather, a partnership combines the advantages of the corporate sector’s dynamism, access to finances, knowledge of emerging technologies, managerial efficiency and entrepreneurial spirit—with the job generation and service delivery concerns of the public sector and local residents. Another mechanism is the UN Millennium Declaration of September 2000. The quote below taken from this historic Declaration codifies the multiple level role of international stakeholders in future development of the world. We resolve . . . to ensure greater policy coherence and to improve better cooperation between the UN, its agencies, the Bretton Woods institutions and the World Trade Organisation (WTO), as well as other multi-lateral bodies, with a view to achieving a fully co-ordinated approach to the problems of peace and development.41

Summarizing the diverse activities of MIs, one may identify five strands of activities: z

z

z z

z

Designing and implementing projects, which already have an economic and environmental rationale today, and which would receive an additional boost if emission reduction credits were available and tradable; Financing such projects and mobilizing cofinancing from public and private sources; Project brokering, facilitation and other intermediary mechanisms; Advising governments on the legal, policy regulatory changes required for greater EE and climate change mitigation and Providing technical assistance, research and training services.

Many multilateral institutions have a stake in the EE and climate arena. The UN administers the negotiations through its Climate Change Secretariat in Bonn, Germany. Various UN agencies develop projects related to climate change. The World Bank Group develops and cofinances projects and positions itself as a facilitator through initiatives like the Prototype Carbon Fund or Biocarbon Fund. The European Union (EU) funds climate projects and, unlike the other two multilateral groups, in addition has real leverage on the negotiation process as it represents a powerful group of countries. 41

Earth Summit 2001.

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The European Bank for Reconstruction and Development (EBRD) has a small but growing portfolio of climate change projects, in particular in the area of EE. Regardless of the performance of multilateral institutions, without increased pressure from the business community and civil society organizations, there is a low probability that flexible mechanisms (such as Clean Development Mechanism [CDM]) will be implemented on a global level in the near future. Factors such as lack of scientific consensus regarding the design of these mechanisms as well as worries about economic impacts suggest that the adoption and implementation of a climate regime may be further delayed. With these delays, it seems likely that many countries will miss the Kyoto Targets agreed upon in 1997. Despite the delays and setbacks, however, the policy debate shows no sign of abating, and there are still efforts to find consensus on the modalities of a global carbon trading system. On the national and international levels, there is a trend toward experimenting with flexible mechanisms. Corporate efforts to establish trading schemes and other responses to climate change are likely to continue regardless of the near-term negotiation outcomes. Likewise, an increasing number of governments support trial schemes in their home countries to test the feasibility of trading schemes and to gauge the support of participants and stakeholders for such instruments. Through trial and error, these corporate and government programmes provide the experience necessary to make carbon trading feasible on a larger scale. In many countries, including China, India and Japan, policy initiatives are gradually establishing a legal and regulatory basis for trading greenhouse gas reduction credits. At the same time, new technologies are entering the marketplace, and existing ones are becoming better and cheaper. Taken together, increasing prevalence of corporate initiatives, technological advances and regulatory changes add up to a dynamic environment, to which institutions involved in EE and climate change mitigation must constantly adjust.

1.8 Post Script Regarding the principles of sustainable development, creating an energy system and making it acceptable to all is of paramount importance. This creates a huge ethical problem. A rich person in a developed country can complain bitterly about the way poor countries are allowing their environment to be destroyed by economic development. On the contrary, a poor

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person in a developing country, ever doubtful about getting food, health care and education, would leap with joy at any improvement in the situation, and would not care for any environmental damage unless it affects his livelihood. How do we balance the short-term benefits to the population with the long-term interests of preserving the environment? And who do we think are the decision makers? Do the poor get a democratic vote? Do the rich and powerful decide? Another issue is the role of policies and political will. If EE policies are promoted, they will have a significant impact on energy growth and thereby on economic development. There can also be disastrous policies—a war can destroy the entire energy infrastructure thereby reducing energy use. The question therefore is: how much leverage can we give to constructive policies, say to avoid climate change? This is neither a technical issue nor an economic analysis, but one of analysis of the exercise of political power. How can governmental policies influence EE directions? These are the issues that need to be discussed and debated. The advantage of the EE approach is that it looks at real needs and at real human development. It aims for a useful value for the consumer. An EE approach can fit into the ‘livelihood’ approach. However, the reverse may not be true. For this we have to analyze dispassionately where the good niches exist and where the obstacles lie, both technically and institutionally. We need to study EE approaches around the world that have succeeded and failed, and to draw lessons from those about the way to proceed.

2 Climate Debate

For more than two decades, scientific and political communities have debated whether and how to act on climate change. This chapter synthesizes these long standing debates in two sections. The first section provides an overview of the development of international climate policy. The second section discusses clashing positions represented by sceptics and supporters of action on climate change.

2.1 Introduction At the beginning of the 21st century, the dispute on climate change continues to be hotly contested, but much of the disagreement has shifted from the scientific certainty of climate change to identifying appropriate policy responses. While most scientists agree that there is a significant human influence on the climate, a handful continues to insist that the observed warming is not a trend into the future, but merely a sign of natural climate variability. The debate centres on the causes and consequences of climate change, and what, if anything, should be done to mitigate the emissions of greenhouse gases (GHGs). At least three general policy responses can be distinguished: The first response is focused intervention to minimize the negative impacts on the environment. An important consideration is to ‘avoid cures that may be worse than the disease’. The second response is adaptation, which some economists prefer because the measures would be taken in the future and

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their discounted present cost is lower. This policy is controversial, however, because it does not prevent or mitigate climate change. The third type of policy response is prevention. This is promoted mainly by environmentalists, and requires immediate investments to prevent future damages.1 In the debate on climate change mitigation, we can distinguish two main groups, which may be referred to as sceptics and supporters. While the sceptics generally do not want to take action or want to postpone measures on climate change, the supporters claim that action is needed now. The categorization into two groups is simplified because there is quite significant variation within these broad camps.2 Before the clashing positions on climate change are introduced, the emerging political environment is outlined.

2.2 A Brief History of Climate Policy The question of how climate change might affect human activities appeared on the international agenda in 1979 at the World Climate Conference (WCC).3 The conference issued a declaration calling on the world’s governments ‘(…) to foresee and prevent potential man-made changes in 1

Schneider and Rickel 2002. It can be argued that it is problematic to use the categorization of sceptics and supporters because it is too difficult to capture the complexity of the issue and the diversity of viewpoints by categorizing the debate into two camps. This caveat is important, but it is equally valid to argue that even very differentiated views on climate change will ultimately have to decide upon basic dualistic questions that divide sceptics and supporters, such as whether climate change is influenced by human activities (yes/no), whether climate change will have serious impacts in the future (yes/no), whether governments shall spend money on avoiding climate change (yes/no), and so on. The answers to such questions determine which basic category the respondent belongs to, which still allows for the fact that there can be significant variation within each category. 3 The term ‘climate change’ is preferable to ‘global warming’. The latter refers to the observed heating of the earth’s atmosphere; whereas ‘climate change’ refers to a broader set of alterations in climate patterns, which include warming as well as cooling trends and other meteorological changes. Although some of the changes could be explained as natural climate variability, there is an increasing scientific consensus that climate change in recent history has been increasingly caused by human activities, including the burning of fossil fuels, deforestation and industrial activities such as cement production. These and other anthropogenic activities result in the emissions of GHGs, including carbon dioxide (CO2), chlorofluorocarbons (CFCs), methane (CH4) and nitrous oxide (N2O) and water vapour. Of these gases, carbon dioxide accounts for more than 90 per cent of GHG emissions. About three quarters of annual CO2 emissions result from burning fossil fuels including coal, oil and natural gas (IEA 1997a). 2

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climate that might be adverse to the well-being of humanity.’4 Following this conference, it took many years with further meetings and initiatives before the international community was able to agree on initial steps to deal with the problem.5 In 1988, the United Nations Environment Programme (UNEP) and the World Meteorological Organization (WMO) established the Intergovernmental Panel on Climate Change (IPCC) with the mandate ‘(…) to assess on a comprehensive, objective, open and transparent basis the scientific, technical and socio-economic information relevant to understanding the scientific basis of risk of human-induced climate change, its potential impacts and options for adaptation and mitigation’.6 The IPCC is a scientific body that includes 2,500 scientists, including eight Nobel laureates. Since its establishment, the Panel released four Assessment Reports in 1990, 1995, 2001 and 2007 (released recently), which summarized the state of scientific knowledge available at that time. These reports formulated a consensus opinion while pointing to areas that are uncertain or controversial and needed further research. In its First Assessment Report released in 1990, the Panel expressed concerns about the growing evidence of a human impact on climate change.7 The report was influential for the development of the United Nations Framework Convention on Climate Change (UNFCCC), which was adopted at the Earth Summit in 1992.8 In this non-binding document, 154 countries, plus the European Community, agreed on the ‘(…) stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system’.9 To achieve this goal, the countries were divided into two groups: the developed (Annex I) countries were encouraged to cut their emissions of GHGs back to the 1990 levels, while the remaining countries did not have to commit to such reductions, following a principle of ‘(…) common but differentiated 4

UNEP and UNFCCC 2002, Information Sheet 17. According to UNEP and UNFCCC (2002), the key events were the Villach Conference (October 1985), the Toronto Conference (June 1988), the Ottawa Conference (February 1989), the Tata Conference (February 1989), the Hague Conference (March 1989), the Noordwijk Ministerial Conference (November 1989), the Cairo Compact (December 1989), the Bergen Conference (May 1990) and the Second World Climate Conference (November 1990). 6 IPCC 2003, 2007c. 7 Houghton et al. 1990. 8 The Convention entered into force on 21 March 1994, 90 days after the receipt of the 50th instrument of ratification (see UNEP and UNFCCC 2002). An international convention must be ratified by national parliaments in order to be valid under national law. 9 UNFCCC, Article 2. 5

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responsibilities (…)’.10 In practice, differentiated responsibilities meant that developed countries were obliged to assume leadership in efforts to mitigate climate change.11 Another significant tenet in the UNFCCC is the precautionary principle.12 Article 3 of the Convention describes the notion as follows: ‘Where there are threats of serious or irreversible damage, lack of full scientific certainty should not be used as a reason for postponing such measures.’13 Science may never be able to predict exactly what will happen and where, but it can ‘(…) provide scenarios and assess the probabilities and consequences of various plausible alternatives.’14 According to the precautionary principle, policy decisions must be made under uncertainty when there is a risk of catastrophic damage. Also, the precautionary principle suggests that many segments of the private sector may be better off if serious costs are avoided by adopting precautionary measures. According to Franklin Nutter, the president of the Reinsurance Association of America, ‘The insurance business is first in line to be affected by climate change. It is clear that global warming could bankrupt the industry.’15 The development of the UNFCCC and other international environmental treaties was accompanied by the establishment of the Global Environment Facility (GEF) as a joint venture of the United Nations Development Programme (UNDP), (UNEP) and the World Bank. For the past 12 years, the GEF has been one of the main sources of international funding for clean energy and other measures to address climate change. The GEF does not implement environmental projects itself, but it provides grants and concessional funds for projects. Apart from climate change, the GEF also funds projects in areas, such as biological diversity, international waters and the depletion of the ozone layer. The purpose of the GEF is to fund reduction and adaptation measures both in countries in transition and in developing countries.16 According to Martinot and McDoom: GEF climate change projects represent an emerging body of experimental, caseoriented information on innovative approaches to promoting energy efficiency 10

UNFCCC, Article 3 This is the first of five guiding principles laid down in Article 3 of the UNFCCC. 12 The precautionary principle is also discussed in Section 12.2.2. 13 UNFCCC, Article 3 14 Schneider and Rickel 2002. 15 Innovest 2002a, 15. 16 Martinot and McDoom 2000, 16. 11

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and renewable energy technologies in developing countries and countries in transition. Although much project information exists in published and electronic form, no systematic review of these projects exists.17

Since its establishment in 1991, GEF has allocated more than USD 4 billion in grants and mobilized a further USD 12 billion in co-financing. So far, more than 1,000 projects have been supported by the GEF in transition economies and in developing countries. The GEF is supported by a large number of governments, which replenish the funds every three to four years. At the latest replenishment in August 2002, almost USD 3 billion were pledged to finance GEF activities until 2006.18 Although USD 3 billion is a significant sum, it translates to less than USD 1 billion a year, which is spread across many countries and multiple environmental problems. To assess the level of funding, compare USD 1 billion, for example, to USD 80 billion provided by the US Congress in March 2003 as a first instalment for the war in Iraq. In light of the scale and severity of global environmental problems, GEF funds by themselves cannot make a major difference. Since it is unlikely that governments will dramatically increase their allocations for the global environment in the foreseeable future, greater priority must be placed on devising ways to mobilize private capital to complement public funding. A strong regulatory framework can help increase private financing of sustainable development by providing clear signals and by reducing regulatory uncertainty. However, it appears that the current frameworks are woefully inadequate. Although 186 countries have so far ratified the UNFCCC19 since its adoption in 1992, the goal of limiting emissions in 2,000 to the 1990 levels was not achieved, mainly because the Convention was not binding. At the Rio meeting, a process was put in place to strengthen the regime over time. The participants agreed that the supreme decision making body of the UNFCCC and the Conference of the Parties (COP) would meet regularly to discuss further steps to mitigate climate change. At its first session, which took place in Berlin in 1995, the COP concluded that the 1992 UNFCC commitments were insufficient and that there was a need to establish compulsory targets. In December 1995, just in time for COP2, the IPCC released its ‘Second Assessment Report’, which was written and reviewed by about 2,000 scientists. The report reaffirmed that ‘(…) the

17

Martinot and McDoom 2000, 12. GEF n.d. 19 UNFCCC 2003. 18

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balance of evidence suggests that there is a discernible human influence on the global climate’. The report also noted ‘(…) the availability of the socalled no-regrets options and other cost-effective strategies for combating climate change’.20 The confirmation of the evidence on climate change galvanized policy 21 makers into action. The Kyoto Protocol was adopted on 11 December 1997 at the COP3. The Protocol for the first time set legally binding emission targets for a group of countries listed in Annex I. In Article 3 of the Protocol, Annex I countries committed to reduce their emissions of GHGs by at least 5 per cent below the 1990 level by the years 2008–2012.22 Individual commitments differ from this guideline in both directions. The 5 per cent group target would be achieved through the following cuts: z

z

z

Eight per cent by Switzerland, most Central and Eastern European states, and the European Union (EU). The EU will meet its group target by distributing different rates among its member states; Seven per cent by the US which in 2001 withdrew from the Kyoto Protocol; and Six per cent by Canada, Hungary, Japan and Poland.

In contrast, Russia, New Zealand and Ukraine are to stabilize their emissions, while Norway may increase emissions by up to 1 per cent, Australia by up to 8 per cent, and Iceland by up to 10 per cent.23 The Kyoto Protocol focuses on six GHGs: carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs) and sulphur hexafluoride (SF6). These gases are to be combined in a basket, with reductions in each gas translated into CO2 equivalents that are then added up to produce a single figure.24 According to Article 25 of the Kyoto Protocol, the agreement becomes valid:

20

UNEP and UNFCCC 2002, Information Sheet 17. The full name is The Kyoto Protocol to the United Nations Framework Convention on Climate Change. 22 Emission reductions need not be achieved by a fixed year, but the average of the committed five-year period will determine whether the Kyoto targets are achieved. 23 A list of reduction commitments of the parties can be found in Annex B to the Kyoto Protocol. 24 The concept Global Warming Potential (GWP) is used to calculate CO2 equivalents according to the IPCC methodology (see IPCC 1995). 21

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(…) on the ninetieth day after the date on which not less than 55 Parties to the Convention, incorporating Annex I Parties, which account for at least 55 per cent of the total carbon dioxide emissions for 1990 from that group, have deposited their instruments of ratification, acceptance, approval or accession.25

In March 2001, the United States, which represents about one quarter of global carbon dioxide emissions, withdrew from the Protocol. As of April 2003, 84 Parties had signed and 106 Parties had ratified or acceded to the Kyoto Protocol. This meant that the Protocol has 43.9 per cent in disposition. With the United States’ withdrawal, Russia’s ratification became pivotal for reaching the 55 per cent threshold for bringing the Protocol into force. The ‘Third Assessment Report’, which was published in 2001, reported the findings from three task forces: Working Group I dealt with the evidence on climate change, Working Group II focused on possible consequences and Working Group III examined mitigation options. The models of Working Group I found that in the course of the 20th century ‘globally averaged surface temperatures’ have risen 0.6°C, with a margin of error of ± 0.2°C. According to the IPCC Special Report on Emission Scenarios (SRES), the globally averaged surface air temperature is projected to increase between 1.4°C and 5.8°C by 2100 relative to the 1990 levels.26 The Working Group II identified different scenarios for the potential consequences that could follow from the range of projected increases in temperature. It also presented the consensus of the group as to their level of confidence with its predictions. The Working Group II confirmed that overall harmful impacts of climate change are likely to overshadow positive impacts. One prediction is that, as a result of the melting of the polar icecaps, the volume of the world’s oceans will increase, probably somewhere between 0.09 and 0.88 metres by 2100. The result could be coastal flooding that may dislocate up to several hundred million people world-wide. Other possible consequences of climate change include more frequent and extreme weather-related events, such as heat waves, droughts, fires, floods and storms, which could damage economies and result in negative impacts on human health. The scientists in Working Group II notes that a rise: (…) in the frequency or intensity of heat waves will increase the risk of mortality and morbidity, principally in older age groups and the urban poor 25 26

UNFCC 2003. IPCC 2001b, 2007c.

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ENERGY EFFICIENCY AND CLIMATE CHANGE (high confidence) (…). Any regional increases in climate extremes (storms, floods, cyclones, and so on) associated with climate change would cause physical damage, population displacement, and adverse effects on food production, freshwater availability and quality, and would increase the risks of infectious disease epidemics, particularly in developing countries (very high confidence/ well established).27

While shifting climate zones could exacerbate food shortages, climate change could also bring localized benefits to some regions, for example, the potential to grow wheat in Siberia. Alexander Bedritski and Yuri Israel, climate scientists in Russia, argue that a warming trend would be beneficial for their country. According to their model, Russia will enjoy high yields of potatoes and grains and thus the nation’s welfare will be increased.28 Working Group III, which assesses various climate change mitigation options, concluded that a wide range of policy instruments should be considered in order to stimulate participation of various stakeholders in climate change mitigation. Firms and financial institutions are among the main stakeholders to be targeted by policy measures. The IPCC experts believe that a broad selection of instruments enlarges the number of noregrets options and help to fit policies to short-, medium- and long-term goals.29 The Working Group estimated that about half of the total GHG emissions reductions attained by 2020 could be profitable, based on discount rates ranging from 5 to 12 per cent, which are in line with public sector discount rates.30 At the same time, they note that ‘Private internal rates of return vary greatly, and are often significantly higher, affecting the rate of adoption of these technologies by private entities.’31 The third volume of the fourth assessment report of the IPCC has been approved on 4 May 2007. According to the report, between 1970 and 2004, global emissions of CO2, CH4, N2O, HFCs, PFCs and SF6, weighted by their GWP, have increased by 70 per cent, from 28.7 to 49 Gigatons of carbon dioxide equivalents. The largest growth in global GHG emissions has come from the energy supply sector (an increase of 145 per cent); transport, 120 per cent; industry 65 per cent; and land use; land use change and forestry 40 per cent. A range of policies, including those on climate 27

IPCC 2001c. (chapter 2.2.2, page 2). Brown 2003. 29 IPCC 1995. 30 As we will note in the next chapter, public sector discount rates are controversial in the climate area. 31 IPCC 2001a, 2007b. 28

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change, energy security, and sustainable development, have been effective in reducing GHG emissions in different sectors and in many countries. The scale of such measures, however, has not yet been large enough to counteract the global growth in emissions. The report,32 which is a consensus document put together by 600 scientists and agreed by representatives of 113 countries, predicts continued warming of 0.2 °C per decade for the coming few decades. Over the 21st century it predicts a range of 1.1–2.9 °C warming in a scenario with low emissions of greenhouse gases, and 2.4–6.4 °C in a high-emissions scenario. The warming is expected to be the greatest over land, and the chance of heat wave increasing in frequency is greater than 90 per cent.33 The IPCC suggested enhancing the consideration of cross cutting issues, to involve more scientists from developing nations and economies in transition and to use more un-English literature. The IPCC also recommended developing better interactions with industrial and NGO sectors to help mobilize private capital for climate change mitigation in furtherance of the IGCC and Kyoto Protocol goals of achieving cost-effective emissions reductions.

2.3 Clashing Positions on Climate Change Sceptics The sceptics include, at one extreme, those who see climate change as a hoax inflated by media and who maintain that the only sensible solution is to do nothing. According to the supporters they misjudge the risks of climate change by making selective use of evidence. Backed by the fossil fuel lobby and its allies in the media, they endeavour to deflect attention from the emerging consensus in the scientific community. However, not all sceptics can be described as extreme and not everyone serves as a mouthpiece for the fossil fuel lobby. There are other groups of sceptics who do not discount the possibility of serious consequences of climate change, but who also believe that the cost of taking action now is higher than that of not taking action. One prominent sceptic, Wilfred Beckerman, expressed this position 32

The report provides an overall scientific view on climate change that integrates and synthesizes information from the three volumes around six topic areas that include: impacts, adaptation and vulnerability and mitigation of climate change. 33 IPCC 2007b.

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when he claimed that ‘Global warming is no cause for alarm or dramatic action. If dramatic action were taken, the effects on human welfare would be horrendous—even more horrendous perhaps than the effects of global 34 warming itself.’ In 1995, the Leipzig Declaration on Global Climate Change was signed by about one hundred scientists, stating that ‘Costly actions undertaken to reduce greenhouse emissions are not justified by the available scientific evidence.’35 Since climate modelling is not always precise, sceptics argue that it cannot serve as a basis for strong policy measures. John Christy, a professor of atmospheric science at the University of Alabama, notes that ‘Reports are filled with ifs, maybes and coulds’. What we do know is that 36 the climate varies naturally.’ Often the disbelief in climate science is rooted within a scepticism of the environmental movement—a reaction against inroads made by environmental ideas into mainstream policy. Mary Hager describes the lingering doubts about the conventional wisdom among those individuals who disagree with the general scientific consensus about the environment: What if global warming does not loom on the horizon, or if seasonal stratospheric ozone layer depletion is part of a natural cycle and not the creation of human created chemicals? What if pesticides really promote a more abundant and varied food supply for the world without causing cancer and ail in children? Or if hazards from abandoned wastes have been blown out of proportion?37

While a group of sceptics claim that global warming merely is a figment of imagination, more moderate groups recognize that there has been a warming trend and that this trend is likely to continue into the future. Some sceptics acknowledge that, based on the cumulative evidence, there could be serious consequences in the long run. Still, they argue that 34 Beckerman 1996. Wilfred Beckerman has been one of the favourite targets of environmentalists ever since he published the book Two Cheers for the Affluent Society: A Spirited Defence of Economic Growth (1974) in response to Donella Meadows et al., The Limits to Growth (1972) and other early environmental literature. 35 Smith 1997, 2. The Leipzig Declaration has been discounted by the fact that only a few signatories are considered respected scientists in the field (Jensen 1998). Given that hundreds of scientists work on every IPCC Assessment Report, and those contributions from sceptics are welcome, the results of these reports are generally more trusted than findings produced by individuals or relatively small groups, especially those whose objectivity is questioned because of conflicts of interest (EMS 2003). 36 GCC 2001. 37 Hager 1993, 10.

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predictions about future warming and the consequences associated with climate change are often exaggerated, and that the GHG theory is not the only plausible explanation of observed warming trends. For example, James Hansen, Makiko Sato and Reto Ruedy argue that too much emphasis has been placed on carbon dioxide, but they do not discount the possibility of CO2 being an important contributing cause to climate change.38 More the research conducted, the easier it becomes to support any position with evidence. Sceptics can point to an increasing number of studies on global warming that are inconclusive, while avoiding or disparaging conclusive studies. The moderates within the spectrum of sceptics are careful not to dismiss well-established facts, so as not to lose credibility. However, they emphasize evidence that undermines the impetus for policy action, and they point to real or perceived weaknesses in the research of their opponents. The European Science and Environment Forum for instance states that ‘Solar output and sunspot activity could well have played a major role in climate change as observed over the last century’,39 adding that there is a lack of ‘(…) firm geological evidence to support global warming’.40 Another sceptic, Patrick Michaels, explains the extremely hot summer of 1998 as ‘(…) the result of a strong El Nino superimposed on a decade in which temperature continues to reflect a warming that largely took place in the first half of this century’.41 In a congressional testimony, Michaels argued that future warming would be ‘(…) relatively modest (…)’42 and that forecasts of future impacts on ‘(…) ecosystems, health and the economy are based on old models which are in error’.43 Academic sceptics are supported by activists in anti-environmental groups. Jim Baca describes the movement ‘People for the West!’ whose members are engaged in grassroots mobilization by going door to door with petitions in rural and minority communities in the United States, by calling people, and by writing letters.44 According to Michael Bruner and Max Oelschlaeger, sceptics are successful due to ‘(…) their ability to articulate persuasive rationales through slogans, myths and narratives’.45 These narratives are disseminated through friendly media. Eileen Claussen, president of the Pew Center, a climate change research institute, argues that 38

Hansen et al. 2000. Landscheidt 2003. 40 Greenpeace n.d. 41 Michaels 1998, 1. 42 Michaels 1995. 43 Ibid. 44 Baca 1995, 54. 45 Bruner and Oelschlaeger 1994, 379. 39

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the Wall Street Journal is an influential source of such myths. To illustrate her point, Claussen cites following from the Wall Street Journal:46 Why require the nations of this planet to spend the hundreds of billions of dollars necessary to reduce carbon dioxide and other emissions when we don’t even know if the earth’s climate is getting permanently hotter or if that temperature change is caused by human activity or if that change is even dangerous?

In the United States, many sceptics, including the members of antienvironmental movements, are closely linked to the Republican Party, which increased their rhetoric and activism after the elections in 1994.47 Enraged by the signature of the Kyoto Protocol in December 1997, the conservative networks within the Republican Party engineered a withdrawal from the Protocol in 2001. President George W. Bush, who is ideologically close to these groups, preferred to face the wrath of the international community rather than to act against his own sources of support. In the words of one prominent sceptic, Charlie Coon, The President was right to let the international community know that the United States would be walking away from the Kyoto Protocol and to direct his Cabinet Secretaries to conduct a thorough review of climate change policies. Other countries should follow the President’s lead and refuse to ratify it. To do otherwise is short-sighted and, in the long run, will prove to be both environmentally and economically damaging.48

Sceptics and supporters base their arguments on different estimates of the cost of compliance with the Kyoto Protocol. Sceptics point to pessimistic scenarios, such as one developed by the Energy Information Administration (EIA), which showed that it would cost the United States 4.2 per cent of GDP to comply with Kyoto. Supporters cite more optimistic scenarios such as one conducted by the Council of Economic Advisers, which predicted that it would cost 1 per cent of GDP. 49 Sceptics suggest postponing action until there is greater certainty about the causes and consequences of climate change. They argue that it makes no sense to rush for ‘short-term’ Kyoto targets, and that it is better to wait until the market itself will force out carbon-intensive fossil fuels and will favour the use of more environmentally 46

Claussen 2002. Tokar 1995, 152. 48 Coon 2001b, 9–10. 49 For a comprehensive discussion on economic dimensions of climate change, see Tietenberg (1996). 47

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friendly fuels and energy-efficient technologies.50 Some scientists insist on letting the process of GHG emissions stabilization last for about 100 years. In their opinion such an approach will not harm the US and the global economy and will bring environmental benefits.51 Sceptics and lobbyists who strive to prevent action on climate change further are supported by groups in academia and by think tanks such as the Cato Institute, the Heritage Foundation and the American Enterprise Institute. Together with lobby organizations such as the Global Climate Coalition (GCC), this network develops the intellectual foundation for antienvironmentalism, and the justification for advising against ‘premature’ and ‘imprudent’ action.52 Resistance also comes from powerful industrial leaders and government officials, including cabinet level members in the Bush Administration with links to the fossil fuel industry such as Vice President Richard Cheney and Secretary of Defence Donald Rumsfeld. Much is at stake. A transition to renewable forms of energy and greater energy efficiency would make industries and markets react. The countries of OPEC (Organisation for Petroleum Exporting Countries) stand to lose most from the commercialization of clean energy technologies.53 Apart from a loss of revenue due to expanding alternative energy markets, the Kyoto sanctioning mechanisms for non-compliance could lead to a welfare decrease in the OPEC region.54 To prevent this, influential personalities such as Donald Pearlman, former official in the Reagan and Bush administration and Brian P. Flannery, Exxon, have been working to protect OPEC interests.55 Most scientists prefer to stay out of the politically charged ‘Greenhouse Wars’,56 which are less about science than about the quest for economic power. But it is difficult to avoid getting drawn into the battle. Many sceptics and supporters appear comfortable in the dual role of scientists and advocates. The main problem, however, is of economic nature. Scientists are dependent on research funds, and not all funding is free of political and economical interests.57 They realize that unless they become effective advocates, they can easily be ‘(…) over-ruled by the other stakeholders’.58 50

See Van Doren 1999. Walker et al. 1996. 52 The Global Climate Coalition (GCC) was one of the most outspoken and confrontational industry groups in the United States battling reductions in GHG emissions. 53 Yeh 1997. 54 Hagem et al. 2003. 55 EMS 2003. 56 Pearce 1997. 57 See for example Gelbspan 1995 and Collier 1997. 58 Greenpeace n.d. 51

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Supporters Many supporters of action on climate change agree with sceptics that the climate is influenced by multiple contributing factors, including natural causes. Without adopting a mono-causal point of view, many supporters nonetheless argue that the theory of human influence on the climate is well established. They also believe that many consequences of climate change, although not certain, are documented so well already that it would be irresponsible to wait for action. Hence the main issue for supporters is not whether to do something about climate change, but what to do about the problem. The debate centres on the effectiveness, cost and ethical appropriateness of various courses of action.59 While some supporters favour command and control mechanisms, such as regulated limits on GHG emissions, others would like to rely on economic instruments, such as for instance carbon taxes and market-based mechanisms such as emission trading. There is much debate on the role of the private sector in problem solving. Some believe that the private sector is crucial for any solution, while others question the motives of private actors. Many supporters agree that civil society should play a role in problem solving as well. And some argue that lasting solutions to environmental problems require more fundamental transformation, including changes in economic structures, the media and education.60 While some pessimists claim that it is already too late to take effective action on climate change, the majority argues that it is not too late to mitigate future damages. Supporters believe that if nothing is done, serious consequences are unavoidable, including rising sea levels, more extreme weather events, disruption of agriculture and impaired health. All of this could lead to major reductions in economic well-being and quality of life.61 To support their call for action, supporters refer to evidence of serious impacts. A report prepared by Innovest for the UNEP shows that banks, insurances and other businesses have already incurred significant losses due to climate change, and that these losses are likely to multiply if global warming is left unchecked. The report notes that global economic damages associated 59 For an interesting debate on ethics, see Michael Sandel’s editorial It’s Immoral to Buy the Right to Pollute, which was published in the New York Times on 15 December 1997 following the signature of the Kyoto Protocol, including the replies from Robert Stavins, Steven Shavell, Sanford Gains and Eric Maskin published on 17 December 1997. 60 For an analysis of the differing views on climate action and the Kyoto Protocol, see Jacoby et al. 1998. 61 See IPCC 2001c.

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with natural catastrophes have approximately doubled every 10 years, reaching almost USD 1 trillion in the course of the past 15 years. Annual weather-related disasters have quadrupled compared to 40 years ago; and insurance payouts have increased by a factor of 11, rising to an average of USD 10 billion annually during the 1990s. If we extrapolate these trends into the future, yearly losses will increase to almost USD 150 billion in the next decade.62 Table 2.1 lists the number of great weather-related disasters and the increase of economic and insured losses in the period from 1950 until 2001. Figure 2.1 illustrates the steeply increasing cost curve, which is believed to be at least partly related to climate change. The figure depicts the economic and insured losses and some of the projections and risks associated with climate change and their impacts on the ecosystem and human activity. However, care should be taken to correctly estimate the rate and scale of these losses since it may result in either too little attention and significant human costs or too much cost for unneeded preventative measures. Figure 2.2 shows the trend in annual frequency of great natural catastrophes between 1950 and 2004. It enables to understand the type of hazard and estimate the number of people that might suffer consequences. The results can be used to determine options for reducing or eliminating risks. Based on the numbers as shown in Table 2.2 pessimists among the supporters claim that the reduction of greenhouse gases will not always bring the intended results. For example, there may be little improvement with regard to the decline of forest areas or the number of malaria incidences, which are key areas of concern in relation to anthropogenic warming.63 However, the possibility of reducing GHC emissions not leading to rapid results cannot be used as an argument for doing nothing. The key issue Table 2.1 Great Weather Disasters, 1950–2001 Year 1950–59 1960–69 1970–79 1980–89 1990–99 Last 10 years: 1992–2001 Source: Innovest 2002a, 7. 62 63

Innovest 2002a, 6. Dorf 2001, 468.

Number

Economic losses

13 16 29 44 72 64

41.2 54.1 79.4 126.1 425.4 362.0

Insured losses – 7.2 11.5 23.0 98.9 79.3

Source: Munich Re 2004.

Figure 2.1 Trends in Economic and Insured Losses, 1950–2004 46 ENERGY EFFICIENCY AND CLIMATE CHANGE

Source: Munich Re 2004.

Figure 2.2 Trend in Annual Frequency of Great Natural Catastrophes, 1950–2004

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2060 for baseline. > 2100 for climate change

2050 2060 2100 2060 2100 2060 or 2100

Agricultural production

Global forest area Malaria incidence

Decrease 25–30 (+) %, relative to 1990 500 million 500 million Varies Varies Not applicable

Must increase 83%, relative to 1990

Baseline (includes impacts of environmental problems other than climate change)

64

Impacts of climate change, on top of the baseline Net global production would change –2.4% to +1.1%; but could substantially redistribute production from developing to developed countries Reduced loss of global forest area 25 to 40 million additional cases 50 to 80 million additional cases < 25 cm < 50 cm Unknown whether magnitudes or frequencies of occurrence will increase or decrease

Reprinted from Dorf 2001, 468 with permission from Elsevier Science and Cambridge University Press.

Sources: Dorf 2001, 468, referring to Goklany 1998, 2000 and IPCC 1996.64

Extreme weather events

Sea level rise

Year

Climate-sensitive sector/indicator

Impact/effect

Table 2.2 Projected Climate Change Impacts Compared to Other Environmental Problems

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is the uncertainty about the absorption capacity of ecological systems and the threshold at which such systems collapse. Richard Dorf argues that ‘(…) climate change on top of the other environmental problems may be the straw that breaks the camel’s back, particularly with respect to forests, ecosystems, and biodiversity, which suggests that immediate action ought to be taken to curtail GHG emissions’.65 If one compares the arguments of sceptics with those of supporters, one finds little common ground. In what follows, five issues will be analyzed to show how supporters differ from sceptics. Two further issues, the cost of climate change mitigation and the choice of discount rate, are discussed in the next chapter.

Scientific Knowledge In general, sceptics and supporters agree that there is a need for more knowledge on climate change, but they disagree on how much certainty has been achieved already, and how much is needed. Supporters believe that there is a sufficient basis of established facts to justify measures on climate change now. George Marshall argues that waiting for a complete scientific understanding will not be accepted as an excuse by future generations affected by global warming. Moreover, he states that ‘(…) there is far more certainty about climate change than there is about many other aspects of science on which policy decisions are routinely made’.66 Sceptics and supporters concur on the need to improve models designed to predict the course and consequences of climate change.

Alternative Explanations of Climate Change Supporters are not convinced about most alternative explanations of observed warming trends forwarded by sceptics. For example, supporters argue that there are not sufficient data to support the conclusion that the warming is due to sunspot activity, since satellite monitoring of the sun started not until the late 1970s.67 They also point out that the warming cannot be explained by the theory of long-run fluctuations, as going by this theory, the world would currently be in a cooling phase. They recall that in the 1970s, some scientists were concerned about the prospect of global cooling. 65

Ibid., 469–70. Marshall 2006. 67 Collier 1997. 66

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The Precautionary Principle Supporters advocate the application of the precautionary principle. This principle is considered necessary for environmental and health damage prevention in a forward-looking society. The precautionary principle was first applied in Germany in the 1970s. Later on, it was incorporated into international agreements, including the Bergen Declaration on Sustainable Development and the UNFCCC. In January 1998, the Wingspread Conference on the precautionary principle concluded that ‘(…) if a practice seems likely to harm the environment, even if proof of harm is not definitive, actions should be taken to eliminate or control the practice’.68 In the words of Raffensperger and Tickner, the precautionary principle is ‘(…) a tool with ethical power and scientific rigor’.69 One way to motivate ‘(…) the public and policy-makers to take preventative action in the face of possible climate change’ is to raise public awareness of health impacts’.70 According to Innovest, precaution is one of three fundamental principles, on which the evolving international policy framework should be based.71 A message for the industrial and the financial sector is that destructive impacts of climate change can have global implications and can affect any area of business activity. While four out of five business leaders from the top 500 companies are aware of financial risks caused by climate change, only two out of five are taking relevant steps to hedge possible threats and to make use of potential opportunities.72 The main areas of business involvement are emission trading mechanisms and greater investments in clean power technology. In this respect, a wide array of actions is developed specifically for policy makers, market regulators, commercial bank managers and other key decision makers.73 The main recommendations can be summed up as follows:

Trade-offs Many supporters are willing to countenance tradeoffs between a better environment and health on one side and wealth on the other side. Some 68

Maret 2000. Raffensperger and Tickner 1999. 70 Long and Iles 1997, 45. 71 Innovest 2002a. 72 Innovest 2003. 73 Innovest 2002b. 69

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supporters believe that developing countries need to make trade-offs between growth and a cleaner environment. Others believe that developing countries have an opportunity to leapfrog developed countries in terms of adopting cleaner technologies as a basis for development. The notion of leapfrogging over old technologies may be the best way to make action on climate change palatable to developing countries. These countries are and will remain concerned primarily about economic growth. As Thomas Schelling wrote, ‘The Chinese, Indonesians or Bangladeshis are not going to divert resources from their own development to reduce the greenhouse effect.’74

Benefits of Climate Change Supporters and sceptics agree about localized benefits and that some regions may become richer due to increased yield of crops. Nevertheless, they are not convinced that these benefits will outweigh the costs for any country, and much less for the world as a whole. Ute Collier writes that some agricultural plants, such as wheat, rice and soy beans, the so-called C3 plants, can be shown to thrive on greater concentrations of CO2 in laboratory experiments. She cautions, however, that: (…) levels of temperature and precipitation are also crucial and combined effects may be negative in some areas. Also, some important crop plants (C4 species, such as maize, sorghum and sugar cane) are less responsive to higher CO2 levels and are likely to suffer from water shortages and increased soil parching in a warmer climate.75

As regards the perspective of growing wheat in Siberia, a recent report by scientists from Moscow State University, the Russian Academy of Science and Kassel University in Germany highlights the weaknesses and omissions that produced such a promising forecast for Russia. The report indicates that warming in Russia is likely to bring droughts and bad harvests to 15 southern and western regions, which used to be the country’s granary. Some regions will suffer from flooding, while others will experience shortages of water. Some 77 million people may be negatively affected by 2020, and this number is forecast to increase to 141 million by 2070.76 74

Schelling 1997, 8. Collier 1997. 76 Brown 2003. 75

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Climate Realists Between climate change supporters and sceptics, there has been a tiny minority of analysts who are convinced of the urgency of the problem while remaining profoundly sceptical of the proposed solutions. Most of them are from developing countries and their voices have largely gone unheard. The data about emissions show (Figure 2.3) that developed countries (Annex 1) emit far more than that of developing countries (non-Annex 1). Global emissions, on per capita emissions, increased from 0.01 metric tons in 1800 to 1.2 tons in 2005. Average per capita emissions were 8.4 tons of carbon dioxide in the EU-15 and 19.7 tons in USA. Despite their faster growth in emissions, developing countries such as those from Asia still emit a lot fewer emissions (on a per capita basis) than countries from Europe and North America. Per capita emissions from China were 2.6 tons and for Figure 2.3 Per capita CO2 Emissions by Annex 1 and Non-Annex 1 Countries

Source: Dawson and Spannagle 2009.

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India the figure was 1.0 tons. By 2050, emissions will start stabilizing for both Annex 1 as well as for non-Annex 1 countries.77 For the developing countries, climate change issues are not the main concern when compared with problems, such as poverty, natural resource management, energy and livelihood needs. From their perspective, development should come first, that is, one should start from a sustainable development perspective, which prioritizes poverty reduction and equity. The challenge for such a type of development is the practical question of choosing sustainable pathways that provide food and energy security, employment opportunities and at the same time minimize environmental impacts.78 Hence, a less-polarized way of meeting the challenges of climate change is to build policies upon development priorities that are vitally important to developing countries. Such an approach views the risks of climate change not as a burden to be avoided, but as a side-benefit of sustainable development. And this could then lead to an alternative strategy for establishing cooperation between developing and developed nations. Such a strategy should involve efficient utilization of natural resources, increase in service levels, lower spending by the consumer on resource-related expenditure reduction and also reduction in air pollution levels (Figure 2.4).

2.4 Conclusion The term climate refers to the aggregate of all weather appearances over a period of time. It is widely agreed that the climate is changing but its future trajectory and impacts on the environment and society remain uncertain.79 There can be little doubt ‘(…) that man is capable of influencing the climate through human activities of many different kinds’.80 Although a matter of some debate with regard to data reliability, the curve of the global mean temperature has been rising since 1861 and although no single explanation for global warming can be given, the greenhouse effect is a plausible one. This effect is attributed to the greenhouse gases CO2, CH4, N2, O, O3 and FCCs.81 The clash between sceptics and supporters is likely to endure, and may even become more pitched as the stakes on climate change are raised. 77

IPCC 2007a. Bradley et al. 2005. 79 Heal and Kriström 2002, 3; Santamouris 2001, 22. 80 Santamouris 2001, 19. 81 Ibid. 78

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Figure 2.4 Recommendations to Financial Institutions and Governments

Source: Adapted from Innovest 2002b, 37–43.

The expansion of scientific knowledge is unlikely to end the debate, as each side will get more data to confirm their case. Sceptics will continue to assail supporters for blending science with environmental activism, and supporters

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will maintain their doubts about the scientific credibility of sceptics because of their links to economic interests. Regardless of who is right in this debate, each side is valuable to the other. A vocal group of contrarians is necessary to achieve scientific progress, since it forces supporters to improve their science and vice versa. It is necessary to point out the flaws in assumptions, logic, and method, and to propose counterarguments for every argument. The problem is not the scientific controversy, but the way in which science is used by economic and political interests, and the risk of scientists becoming pawns in a high stakes political game.

3 Win-Win Climate Policy

Climate change mitigation is related to costs. This chapter develops an outline of a win-win-oriented climate policy. As an introduction to the problem, the debate on abatement of costs is reviewed first. The discount rate partly influences how much money is spent on climate change mitigation. Therefore, this chapter discusses the question: ‘What discount rate should be applied for problems that are likely to peak in the medium to long-term future?’ The third section examines whether climate protection can yield benefits both for the environment and economy, thereby providing win-win opportunities. The last section discusses market-based measures as a means to increase the take up of win-win opportunities and to attract profit-minded investors for climate change mitigation.

3.1 Introduction A key issue in the debate on climate change is how much it will cost to reduce greenhouse gas (GHG) emission levels. In contrast to the ‘no-rush’ approach advocated by sceptics, supporters believe that the cost of delay is much higher than the cost of immediate action.1 When it comes to detailed calculations of the cost of climate change mitigation, sceptics sometimes use worst case assumptions, which partially 1

UNEP and UNFCCC 2002, Information Sheet 24.

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or completely exclude the use of market-based mechanisms and ‘no-regrets’ options. Supporters believe that there are significant opportunities in almost every country to achieve climate change mitigation at a zero or negative net economic cost. As Innovest argues in its report for the United Nations Environmental Programme (UNEP): (…) the right blend of policies, if skilfully introduced, can substantially reduce the direct and indirect costs of mitigation and perhaps even produce a net economic benefit. Cost benefit analyses of climate change mitigation often omit the fact that mitigation aims at preventing damages caused by climate change. If the cost of damages were taken into account, the estimates would look quite different.2

Indeed, the calculation of climate change mitigation costs depends largely on the assumptions underlying it. Many climate–economy models are based on the assumption that all profitable energy savings have already been bought, and therefore, greater energy savings will be worth purchasing only at higher energy prices. Using this as a starting point, computer models are developed to calculate the value of the energy tax needed based on historic elasticities, the subsequent negative effects on the economy and the cost of climate change mitigation. As Amory Lovins argues, climate models ‘(…) find carbon abatement to be costly because that is what they assume’.3 Climate models also tend to assume that the public sector will invest directly in greenhouse gas reduction, thus neglecting that the government may focus on mobilizing private capital instead. In doing the latter, major cost savings could be realized. However, it is difficult to say exactly how much money could be saved because there is little historical experience apart from Public–Private Partnership (PPP) programmes, which did not focus on climate change. Lovins further cites ‘(…) a heavily peer-reviewed five-Labs study (…)’,4 which demonstrated that it is possible to freeze US carbon emissions in 2010 at the 1990 levels at (…) net economic costs—under a range of assumptions and alternative methods of cost analysis—[that] will be near or below zero’. This can be achieved through a combination of energy efficiency, renewable energy and other low carbon options and would reduce the carbon intensity of the economy at an average rate of 2.5 per cent per year.5 Assuming this is 2

Innovest 2007a. Another difficulty consists in valuing natural assets. Lovins 2008. 4 Ibid. 5 McKinsey Global Institute 2007. 3

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correct, it suggests that accelerating sustainable energy development can be consistent with maintaining national and corporate competitiveness. Lovins points out that several Nobel prize winners in economics and 2,600 of their peers agreed that ‘(…) policy options exist that would slow climate change without harming American living standards, and these measures may in fact improve US productivity in the longer run’. These arguments have not significantly influenced the policies of President George W. Bush so far, who seems to believe that action on climate change is very costly. This contrasts with the position taken by the Clinton Administration, where Vice President Gore6 was a strong proponent of early action on climate change. The spectrum of scenarios presenting costs for global climate change abatement ranging from billions to net negative costs illustrate that costs are uncertain and difficult to calculate accurately. Based on figures from the Intergovernmental Panel on Climate Change (IPCC), an International Energy Agency (IEA) report claims that ‘(…) the potential for realizable noregret, cost-effective energy saving is very uncertain. Current estimates by IPCC suggest a range of 10–30 per cent gains on baseline trends over the next two to three decades’.7

3.2 The Choice of Discount Rate There are three types of capital investments: Those that have a net economic cost, those that are costless and those that yield a profit. Mobilizing private capital is not different: it can be costly, costless or profitable. How much money should be invested in climate change mitigation or in mobilizing private capital for climate change mitigation partly depends on the discount rate. Discounting converts the (full) values of the impacts that occur at different points of time into common units, for example, translating the costs of future climate change damages into ‘(…) equivalent values in today’s monetary units’.8 The application of discounting in environmental policy has long been controversial.9 In the climate area, the basic fault line runs between the

6

Gore was awarded Noble Prize (along with IPCC) in 2007. IEA 2006a. 8 Goulder and Stavins 2002, 674. 9 Weitzman 1994. 7

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sceptics who want to apply a similar discount rate as in any standard public investment decision, and the supporters who prefer to use a low or zero discount rate. Applying a discount rate means that damages, which are expected to occur in the long-term future have a very low present value, even if a reduced discount rate of 3 or 4 per cent is applied. Since the costs associated with climate change may peak in 50, 100, or more years, the discount rate methodology tells us to pay very little now to avert these damages.10 The higher the discount rate, the lower the investments we are willing to make today. William Cline argues that people ‘(…) who prefer discount rates of 10 per cent can (…) dismiss global warming 100 years from now, because however catastrophic it might be, it is worth only a few dollars today to try to avert it’.11 A lack of willingness to pay for climate change mitigation is particularly problematic if it turns out that climate change impacts are cataclysmic, matching or exceeding worst case scenarios. The report of the IPCC confirmed the possibility of ‘discontinuity scenarios’,12 in which GHG emissions shoot above an upper limit, leading to further disasters. According to Innovest, ‘The experience of the insurance industry shows that even small changes (<10 per cent) in event severity can generate multiple increases in damage.’13 The discount rate is controversial because it means to place a greater value on current relative to future lives.14 Nobel Prize winner economist James Tobin believes that in the long term discount rates should not be used, since their use ‘(…) reflects the impatience of those on the globe who would like their goodies now’.15

10 The question for economists is not only to estimate the cost of future damages, but also how much the gains from, for example, saved species are worth. The benefits could be vaccines, or just the enjoyment of the existence of the species (Goulder and Stavins 2002, 674). As David Pearce said, ‘A first step should be to improve the measurement of the value people put on the environment (…). Put a proper value on an environmental “good”, and the balance between costs and benefits will start to look greener’ (Heathfield and Russell 1992, 412, quoting an unpublished lecture by Pearce). 11 To ‘justify an aggressive and expensive effort to slow global warming’, Cline suggests a discount rate of 2 per cent (see Stokes 1992, 124–25). 12 IPCC 2001b. 13 Innovest 2002a, 7. 14 See Weiss 1990, for a proposal of how to protect the interests of future generations. 15 Stokes 1992, 124–25.

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The use of discount rates is based on Irving Fisher’s time-preference theory of interest shows the preference for today’s relative to tomorrow’s consumption (Figure 3.1). According to Fisher, the interest rate is determined by impatience and technological progress. The indifference curves U1, U2 and U3 represent the level of impatience about tomorrow’s consumption of society or an individual. The production possibility frontier (PPF) demonstrates the possibility to transfer today’s consumption into consumption of tomorrow. E is the equilibrium, in which satisfaction is maximized. The slopes of PPF and U2 in E are equal to minus (1 + r), with ‘r’ representing the real interest rate. The slopes express how much of the future goods are equivalent to today’s goods. The assumption is that economic subjects are not willing to sacrifice today’s consumption without getting any benefit for it. They favour today’s consumption over tomorrow’s consumption and want to be paid for waiting. Figure 3.1 Fisher’s Time-preference Theory of Interest

Source: Adapted from Samuelson and Nordhaus 1989, 387.

How much the choice of discount rate matters for the design of policy was illustrated by a study undertaken by William Nordhaus. Using the example of a tax on GHGs, he sought to determine an efficient policy response to climate change. In his ‘maximum damage’ scenario, a discount rate of 4 per cent suggests that an efficient level of the tax is USD 2.44 per ton of carbon, and the result would be a less than 5 per cent decrease in

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emissions compared to business as usual. A discount rate of zero, however, suggests an efficient tax of USD 65.94 per ton of carbon, which would lower emissions by one-third.16

3.3 ‘No-regrets’ and ‘Win-win’ Opportunities Already in 1992, the United Nations Framework Convention on Climate Change (UNFCCC) encouraged the use of cost-effective mechanisms for tackling climate change. This principle was reaffirmed later in the Kyoto Protocol. The principle of cost effectiveness influences (a) the type of project and (b) the type of policy instruments. This section focuses on types of projects, whereas the next one discusses policy instruments. No-regrets options have the potential to be welcomed by both, sceptics and supporters as they provide the dual benefit of climate change mitigation and economic improvement. The concept of no-regrets can be considered as synonym for the concept of win-win. There are two types of no-regrets, respectively win-win outcomes: z

z

16

The first type—economic win-win—is achieved when a problem is mitigated at a negative net economic cost, thus leading to a win for problem solving and a win for the economy. The second type— financial win-win—is achieved when a problem is mitigated at a profit (negative net financial cost), thus leading to a win for problem solving and a win for the particular investor, company or industry.17

Nordhaus 1991. Among financial win-win opportunities, we must distinguish between immediate and delayed financial win-win opportunities. Immediate win-win opportunities yield a direct profit on a project, whereas delayed financial win-win opportunities improve corporate profits/competitiveness over time. Michael Porter, a professor at the Harvard Business School, popularized the notion of delayed win-win opportunities (although he uses a different terminology). Porter argued that a well-designed environmental regulation improves corporate competitiveness over time by prodding firms to invest in more efficient technologies that not only improve environmental performance but also lower costs and improve the bottom line (Porter and van der Linde 1995). 17

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The distinction between economic and financial cost is important because the number of measures that are economically viable is probably higher than the number of measures that are financially profitable. This is because in a detailed economic analysis, externalities are taken into account, whereas in a financial analysis they are not. Few doubts that there are the proverbial USD 100 bills waiting to be picked up from the street, but the question is whether there are sufficient viable business propositions to make it worthwhile for businesses to alter their course and start systematically searching for win-win opportunities. The essence of the theory of private capital mobilization (PCM) is that win-win opportunities can be created.18 In other words, if there are too few USD 100 bills on the street, it is possible to print them. Where there are such bills, but barriers too to get hold of them, it is possible to reduce, remove, or overcome these barriers. The key is to focus on those win-win opportunities that require only a small subsidy or intervention and that create large external benefits. If we want to get businesses and financial institutions to be active participants in solving problems, it is not sufficient to demonstrate that their participation will be good for the economy or the society as a whole. But we also have to show that it will improve their balance sheets as well. If financial win-win situations can be created by mobilizing private capital, it is possible to strengthen the case against the argument that companies cannot afford to take environmental action. There is another way to conceptualize the win-win issue by using a stakeholder perspective. From a narrow view of this approach, win-win outcomes are achieved if the participant benefits from a particular project. From a broader view, win-win outcomes are related to the distribution of benefits to all stakeholders, also to those that are not directly involved within a project. In an ideal scenario, the government will achieve its policy goals, such as for instance reducing public expenditures, improving the environment or protecting disadvantaged social groups. Firms and financial institutions will achieve their business objectives, such as for instance making profits and improving their reputation. The civil society organizations will attain their aims, such as for instance improving the environment, ensuring democratic legitimacy and preventing corruption. A win-win solution means achieving those par-ticular goals the stakeholders define for themselves.

18

See Assenza 2005.

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There are GHG reduction measures at zero or negative net economic cost, which are good for the economy. However, it is a matter of disagreement how many opportunities are available, and what percentage of an environmental target can be achieved with no-regrets and win-win options. Supporters of action on climate change insist that there are plenty of noregrets opportunities, and that climate change can be mitigated in a costeffective way without undermining prosperity. Economic win-win situations contain activities that lead to positive environmental and developmental change. They do not involve significant trade-offs between the environment and the economy. Economic effects, thereby, can have many different meanings such as GDP, number of jobs created, consumer benefits, business competitiveness or average industry performance, and each researcher will have his or her own preference. Financial win-win opportunities combine profit and sustainability. In this way, win-win opportunities overcome asymmetrical interests that have often prevented effective problem solving. It is worth distinguishing between real win-win arrangements that involve a net positive pay-off for all stakeholders, and relative win-win arrangements, where some parties may have to pay something, but not as much as under alternative arrangements. The latter is the case when car manufacturers facing a costly carbon tax see a requirement to increase the sales of clean cars. Furthermore, it is useful to distinguish between win-win opportunities, which are exploited and those which are latent. The first type are win-win opportunities, which do not require any intervention from governments, multilateral institutions (MIs) or other parties because the private sector is aware of them and is already exploiting them. As they are privately financed without special incentives, there is no need to mobilize private capital. The second type of win-win opportunities are latent ones. Those may or may not be known to the private sector, and require a stimulus or some other form of intervention. The intervention may be regulatory, informational, financial or a combination of these. The intervention may be economywide—affecting all firms and financial institutions, sector-wide or targeted at particular companies and individuals. Any win–lose situation can be turned into a win-win situation by compensating the losers. An important question is how many latent win-win opportunities exist.19 There is much debate and uncertainty in estimating win-win options. 19

While there is no reliable data to quantify the amount of win-win opportunities in either category, it is analytically pertinent to draw the boundaries around the term ‘win-win’. A project can be considered win-win even if there are cheaper alternatives, that is, if opportunities

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For instance, a report by the IEA notes that the potential for realisable noregret, cost-effective energy savings is very uncertain. Current estimates by the IPCC suggest a range of 10–30 per cent gains on baseline trends over the next two to three decades.20 In the future, the driving force regarding the promotion of sustainable energy may shift increasingly from regulation to opportunity. While for a long time businesses adopted strategies of avoidance and outright resistance, in recent years an increasing number of businesses have begun to explore the profit potential of clean energy technologies. Oil giants redefined themselves as energy companies and, together with a host of engineering and technology companies, increased their exposure to clean energy technology. The more win-win opportunities exist, the cheaper it is to mitigate climate change. In fact, as long as win-win opportunities are exploited, mitigating climate change is economically and financially viable. However, although win-win opportunities are profitable, this does not necessarily mean that they are privately financed and that there is no need to mobilize private capital. Due to a variety of barriers, the private sector cannot take advantage of all profit opportunities. Since it is unlikely that all profit opportunities have been recognized and exploited, traditional policy options and marketbased measures can enable profit-minded investors to take advantage of environmental business opportunities. If win-win opportunities are sizeable, the question is how to realize them cost effectively and make them commercially self-sustaining over time. This question merits further attention by policy makers and the business community. In the absence of demonstrated linkages between different sectors, the technology options are given a superficial treatment by policy makers. To illustrate an example, access to electricity and subsidized kerosene is justified from the perspective of reduced forest loss. Reduced expenditure on health and retention of a healthy and productive community is seldom quantified. Policy makers would provide increased budgets for rural health care without considering a complementary budget for the diffusion of renewable energy technologies or electrification programmes. This does not demonstrate poor performance on the part of exist, which yield greater net economic/financial benefits relative to cost. For example, if a government provides a grant to a renewable energy power plant, the project may be considered ‘win-win’, as long as the project is financially profitable and the grant is lower than (a) the cost of subsidies given to generate an equivalent amount of electricity using conventional power technologies or (b) the avoided costs of environmental and health damage. If ‘win-win’ projects included only those that are least costly, there would be considerably fewer win-win opportunities, as only the best projects would qualify. 20 IPCC 2007f.

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policy makers but highlights the need for a pool of skills and resources for assisting policy makers in justifying decisions taken in the process of planning rural development.21

3.4 Market-based Climate Policy All environmental policy instruments, including traditional command and control mechanisms, such as performance standards and economic instruments, such as taxes and subsidies can have an impact on private investment decisions. However, market-based measures have the greatest potential to attract profit-minded investors for climate change mitigation. The main idea of market-based mechanisms is to solve environmental problems in an economically efficient way by sending appropriate price signals to private investors to internalize the societal costs of their business decisions and to provide an economic incentive for firms to reduce those costs. Marked-based measures are sometimes favoured due to ideological reasons; for example, the belief that the government is not capable of or efficient in providing solutions.22 However, markets require clear price signals and a legal framework. Therefore, market-based measures necessarily imply a role for the government. They would not thrive in an environment, entirely free of regulation, where the government does not provide clear rules and frameworking conditions.23 Warwick McKibbin and Peter Wilcoxen argue that mitigation policies, which do not minimize cost, are doomed to failure. For example, they propose coal market reform through reducing coal subsidies and trade barriers as a solution that will generate both economic and environmental benefits. According to their calculations, if western Europe and Japan would remove their coal production subsidies and import restrictions, OECD GHG emissions would decrease by 13 per cent and global emissions by 5 per cent by 2005.24 Whilst price reform of this kind may disadvantage fossil fuel industries, the renewable energy sector can anticipate inflows of capital that would otherwise go to carbon-intensive industries. Apart from subsidy reform, trading emissions may be an instrument with the greatest potential in terms of climate change mitigation. The first 21

IISD 2003. Anderson and Leal 2001. 23 Stavins 1989. 24 McKibbin and Wilcoxen 2002. 22

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emission trading schemes were developed in the United States.25 The most well-known programme is the sulphur dioxide trading scheme established at the beginning of the 1990s to tackle acid rain. This system enables firms to buy and sell rights to emit sulphur dioxide in a manner equivalent to buying and selling currencies in a foreign exchange market. The fact that it combines both environmental and economic benefits makes it attractive as a model for carbon trading systems. High penalties have prevented sources from violating the cap level—the maximum amount of allowable emissions. Indeed, since the acid rain programme commenced in 1995 sources included into the scheme comply with their caps at lower costs than predicted at the time the programme was implemented. (Emissions trading is an administrative approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants. It is sometimes called cap and trade.) The experience has shown that the programme can ensure emission reductions at the least cost to society. This outcome should make it attractive even in the eyes of those who tend not to trust in market solutions. The programme is successful as the trade is beneficial for both buyers and sellers. Sources that have a high cost of abatement can buy additional allowances at a lower price whilst sources that are able to reduce emissions below their cap are rewarded for better environmental performance by selling their extra allowances and making a profit. The total cost of reducing emissions through trading is smaller than that of other policy mechanisms. For instance, it was calculated that the Danish goal of 21 per cent and the European Union (EU) goal of 8 per cent of GHG abatement would be achieved at nine and 24 times the cost, respectively, by using taxation policy than with the use of emission trading.26 With regard to pollution permit trading, there is a clear incentive for decreasing emissions because there is a monetary value attached to allowances. Emission trading systems stimulate research and development, as the business sector can anticipate profitable emissions abatement. Furthermore, emission trading systems provide high flexibility in choosing which type of emission reduction—including investment into abatement technology, fuel switch, energy efficiency measures or utilization of renewable energy sources—is most suitable. In contrast, command and control approaches 25 See Hahn’s classic article ‘Economic Prescriptions for Environmental Problems: How the Patient Followed the Doctor’s Orders’ (1989) for a review of early efforts to achieve emission trading and emissions charges in the US and Europe. 26 Svendsen and Vesterdal 2003.

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that, for example, specify the types of pollution control devices to be installed do not provide the same degree of flexibility.27 In 2008, a new scheme came into operation, which promises to become the largest emission trading market in the world. The EU’s Emission Trading Scheme (ETS) would be applicable not only in the EU, but also in accession countries and the countries of the European Economic Area (EEA). The ETS is designed to contribute to the greenhouse gas reduction commitments under the Kyoto Protocol. The first emission trades have already been agreed to, indicating the interest of private sector actors. For example, Shell Trading will sell a considerable number of allowances to Nuon during the first compliance year.28 Several challenges in developing EU-wide emission trading remain to be addressed, including the harmonization of fragmented national markets, the possibility of interaction between parties covered by the EU scheme with other Kyoto parties on the base of bilateral agreements and building up links with project-based Kyoto mechanisms. There are voices advising against the use of credits from Joint Implementation (JI) and Clean Development Mechanism (CDM) in the ETS. In its letter to the European Commission dated 28 February 2003, the Climate Action Network (CAN) Europe expressed its reservations and demanded to ‘Keep the emission trading scheme as a domestic measure for cutting industry emissions!’29 The Network argued that some of these projects are non-additional and even environmentally destructive.30 Two EU countries, Denmark and the UK, have established national carbon emission schemes, already. Lessons learned from the Danish experience indicate that the level of CO2 emissions remains almost the same as in the baseline year. Therefore, Denmark is aware of the difficulty in meeting emission reduction goals with the help of measures, which are used only nationally. Denmark is ready to buy emission credits from other countries, which are below their Kyoto targets. The country is likely to become an active participant in the EU-wide emission trading scheme, as well as in other international schemes and projects aimed at GHG reduction. A study undertaken by Enviros Consulting, which evaluated the UK carbon trading programme, concluded that the scheme provided local companies with the necessary experience to enter the EU-wide emission trading 27

US EPA 2002. Shell International Limited 2003. 29 CAN 2003. 30 Ibid. 28

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system and other international carbon markets. At the same time, the study questions the effectiveness of the programme in decreasing UK carbon emissions. However, the authors of the study hope that as the scheme matures it will contribute to the UK Kyoto target more significantly. To improve the operation of the programme, Enviros Consulting recommends changing voluntary enforcement mechanisms into mandatory ones.31 Another major instrument for climate change mitigation is environmental taxation. Several industrialized countries introduced taxes on the carbon content of oil, coal, and gas. This measure is designed to cut the use of carbon-intensive fuels and increase the use of cleaner energy, thereby decreasing GHG emissions. In comparison to environmental taxes, emission trading may be more effective in terms of reaching an emission target, since it sets a strict emission goal. On the other hand, a tax may provide more up front certainty as to the cost of the programme, and it can be used in market segments where the establishment of an emission trading scheme is impractical or unwieldy. A mix of emission trading and environmental taxes may be the most effective approach in many countries. The former instrument is better applicable to large polluters, while the latter better suits small polluters.32 If an emission trading system is implemented at an international level, it could create strong demand for investment projects designed to reduce GHG emissions. Private capital could be mobilized through this mechanism because GHG reduction projects would yield credits that can be sold in the market. Firms that are able to reduce GHGs at a price below the trading price can make a profit out of mitigating climate change. In this way, climate change could become the basis for a growing sector of business activity, ultimately developing into a major economic driving force in the coming decades. Specialists from Natsource, DZ Bank and other organizations involved in climate change mitigation see a big advantage of a carbon market in that it will enable ‘(…) bringing future revenues from forward GHG contracts to the beginning of the project, rather than payments at the back end’. In their view it will help to get ‘(…) lots of projects off the ground because of the ability to accelerate cash flow in projects where cash is required in the early stages’.33 There are also critical voices concerning emission trading schemes.34 For example, Martin Tampier argues that the renewable energy sector will 31

Enviros Consultancy 2003. Svendsen and Vesterdal 2003. 33 Innovest 2002b, 28. 34 Victor 1991, for a critical perspective on market-based mechanisms. 32

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not be able to benefit from the ETS since renewables will not be covered. The only possibility for them to get involved is to offer renewable energy to those who might wish to substitute for fossil fuel generation. Moreover, for many firms, paying the non-compliance penalty might be cheaper than reducing their emissions. A low penalty would encourage many firms to prefer non-compliance rather than investing in more expensive clean technologies. Further, an emission trading scheme may not, in itself, be sufficient to achieve broader policy objectives, such as renewable energy development. It is not clear if emission trading will help renewables to cover the gap between production costs and electricity prices, and thereby, to become more competitive with conventional fuels. However, the future may bring a decrease of renewable energy prices and at the same time an increase in the prices for emission credits and energy from fossil fuels.35 Currently, energy efficiency projects may be better suited to take advantage of emission trading, while renewables could benefit from JI. However, this assumption should be subject to further research. The Transnational Institute states that JI and the CDM favour implementation of large scale renewable energy projects since small ones have more difficulties in measuring and identifying energy production. According to Bachram et al., ‘This undermines diversity and innovation in the renewable energy sector as a whole.’36 In terms of actual policy developments currently under implementation, the development of a GHG trading system would be an essential component of a reform of incentive structures. If the effectiveness of such a system is not whittled down in negotiation, and if compromise does not result in the lowest common denominator, GHG trading has the potential to mobilize large sums of private capital, especially if combined with carbon taxes and other policy instruments. The question is how to bring these ideas into practice. In order to make GHG markets operate efficiently, the main tasks include producing demand, enhancing buyer confidence in pricing, bringing greater liquidity to the GHG market, overcoming the short-term cash flow problems and creating larger economies of scale.37 The main task for private investors is to incorporate the effects of GHG regulations and carbon price sensitivities into the analysis of project economics.38 The interest among investors will increase if it can be shown that technologies become cheaper as a result of commercialization and that GHG emission markets offer opportunities to create profits from project 35

Tampier 2003. Bachram et al. 2003, 22. 37 Innovest 2002b. 38 Ibid. 36

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cash flows and advisory fees. The alternative to voluntary action on climate change is higher taxes and stricter environmental regulations, as well as higher indirect costs due to environmental and health damages, which ultimately are paid by households and firms. An important advantage of GHG trading is that it includes incentives based on self-interest, such as for instance, direct profit opportunities for firms, which can reduce pollution at less than the trading price. Thus, GHG trading is not favoured by arguments about enlightened self-interest, although these arguments may be important to long-term profits and business competitiveness. Market-based mechanisms should not be treated as a panacea for solving environmental problems, since there are cases, which require complementary mechanisms, including economic instruments and command-andcontrol approaches. However, market-based provisions should be further investigated and exploited when they offer advantages. The US sulphur trading programme has shown that market-based approaches can be costeffective in mobilizing private capital for clean technologies, which gives ground for optimism concerning carbon trading schemes. Using a mix of measures, climate change mitigation policy can provide a stimulus for speeding up the commercialization of clean energy technologies.39

3.5 Integrating Climate Policies with Development Priorities As climate change negotiations advance, it is becoming increasingly clear that there is a greater need to shift the focus on developing countries since the international negotiations have not adequately addressed their priorities for sustainable development, support for adaptation activities, aid assistance and technology transfer. This is because affordable and accessible modern energy services along with poverty reduction are essential to achieve sustainable development. Lack of access to these services adversely affects public health, constrains educational opportunities and impedes human development and well-being of nearly 1.6 billion people in developing countries. However, the proponents of climate change argue that affordable energy—in the form that is currently available—is also the cause of climate change. Hence, it is important to integrate development policies with

39

See Chapter 9 (this volume) for an analysis of commercialization.

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that of climate change, which means reconciling development and climate priorities. This means that countries must improve the prospects of integrating climate policy into development considerations, and vice versa. The key is to identify such sustainable development policies and measures (SDPAM) and promote them. The concept of SDPAM has been explored in the research community, including detailed case studies of policies in several developing countries.40 Winkler et al. put forward this approach mentioning that the policies and measures that are firmly within the national sustainable development priorities of the host country should be integrated into climate policies.41 However, a great deal of work remains to be done to explore the operational implications of this approach as part of an international policy framework. Bradley et al. have suggested that the use of SDPAM in developing countries gives an automatic recognition to climate policy, facilitates sharing of knowledge and expertise across borders, involves actual engagement in climate mitigation efforts rather than just providing lip service, and promotes both development and climate goals.42 The benefits that accrue to the society (economic, social, environmental, public health, and so on) independent of any direct benefits from mitigating climate change can be referred to as ‘co-benefits’. The IPCC Third Assessment Report on Mitigation differentiates ‘co-benefits’ as benefits intended as the primary objective of certain actions or policies from those that are secondary or incidental to it, which are named simply as ‘ancillary benefits’ for developing countries.43 The literature shows that several countries have already demonstrated the benefits (reduced poverty, increased employment opportunities, improvements in health, energy and food security and infrastructure) of an integrated approach.44 For example, the alcohol fuel programme in Brazil has provided significant economic and environmental benefits along with employment opportunities for hundreds of thousands of poor smallholder families (900,000 relatively well-paid jobs were created) in the Brazilian northern and north-eastern regions. The programme has helped to reduce its dependency on oil import; between 1975 and 2002, in terms of foreign

40 Bradley et al. 2005; Dubash and Bradley 2005; Moreira et al. 2005; Mwakasonda and Winkler 2005; Winkler et al. 2002 and Wei-Shiuen and Schipper 2005. 41 Winkler et al. 2002. 42 Bradley et al. 2005. 43 IPCC 2001a. 44 O’Brien et al. 2008; Ribeiro and Abreu, 2008.

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exchange savings, the programme has saved about USD 52 billion (January 2003 USD). It has also considerably reduced local air pollution in the cities.45 According to a study by Dubash and Bradley,46 the rural electrification programme in India can have significant local as well as global benefits. The study suggests that there are significant climate benefits to off-grid renewable energy that have not been explored in recent planning initiatives. The recent study by the Asian Development Bank (ADB) and Clear Air Initiative (CAI-Asia)47 identified a menu of short- to long-term transport policy interventions, which can bring about the most reduction in CO2 emissions in the transport sector. The proposed measures include interventions in vehicle fuel efficiency, transport demand management, transport and land use planning and biofuels. These measures reduce total fuel consumption significantly and land-use planning contributes to more reduction in CO2 emissions. China’s CDM is an example of similar success. World Bank-led study on the CDM market potential suggests that China will capture about 50 per cent of the world’s CDM market in 2010.48 China’s growing belief that CDM would play an important role in future global efforts to mitigate climate change has led China to gradually recognize the importance of capacity building at national, local and enterprise levels to ensure that China is well positioned to take advantage of CDM opportunities. This is in line with rules and modalities the UNFCCC have agreed upon to make the CDM fully operational. The CDM will channel private sector investment into emissions abatement projects in developing countries. In this way, it will promote sustainable development in these countries while offering industrialized governments credits against their Kyoto targets.49 A pledge-based approach by countries with bilateral and multilateral funding can bring in more success.50 A potentially important network is the CAN, which the UNEP is currently in the process of establishing in consultation with various stakeholders, including the governments of China, Indonesia and Pakistan. The objective of this network is to facilitate a more effective participation of Asian governments in climate-related negotiations. Although the planning for the network as far as known now is 45

Kok et al. 2008. Dubash and Bradley 2005. 47 ADB 2006. 48 World Bank 2004. 49 Zhang 2006. 50 Bradley et al. 2005. 46

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not specifically focused on co-benefits, it is clear that the establishment of the first formal climate network incorporating governments in Asia offers strong possibilities to integrate the co-benefits approach. However, there are certain trade-offs between certain aspects of development and addressing climate change, for example, food security versus energy security. Promoting large-scale bioenergy production is a prime example of a policy where trade-offs between food security, biodiversity and climate change have to be made. In terms of costs and benefits, one has to weigh higher costs of clean energy systems against social and economic benefits. This requires collaboration on multiple levels and from various perspectives. Greater effort needs to go into generating ideas from within developing countries and sharing them with the international community. The driving forces for the promotion of a sustainable energy path may shift increasingly from regulation to opportunity. While for a long time businesses adopted strategies of avoidance and outright resistance, in recent years an increasing number of them have begun to explore the profit potential of clean energy technologies (Figure 3.2). Figure 3.2 Cost-benefit of a Cleaner Technology Project

Source: Authors.

In short, economic prosperity, human development and environmental benefits should move hand-in-hand. Conversely, high-energy use places an enormous burden on long-term economic development and poses critical problems to improving living standards, particularly those from the developing countries. Inefficient technologies become a drain on factories,

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machinery and resources, affecting competitiveness. Hence, it is important to invest in the efficiency of the energy supply systems and reduce losses on the demand side. However, it is a matter of disagreement how many opportunities are available, and what percentage of an environmental target can be achieved with efficient technologies and win-win options. Nonetheless, it can be safely argued that there are plenty of these no-regrets opportunities, and that development can be achieved through these options and climate change can be mitigated in a cost-effective way without undermining prosperity.51

3.6 Conclusion Given the uncertainties about the costs of reducing GHGs, the best way to proceed may be the introduction of more flexibility into international trading programmes for carbon credits. While there are important implementation issues regarding the design and monitoring of such programmes that must be addressed, a well-planned emission trading system could succeed in getting governments to start moving towards climate protection, despite or because of worries about high climate change mitigation costs. If such systems are implemented, they are likely to create strong demand for investment projects designed to reduce GHG emissions. Private capital would be mobilized because GHG reduction projects would yield credits that can be sold in the market. The adoption of flexible mechanisms may well be the key to increased spending on environmental technologies, including energy efficiency and renewable energy. Whether the flexible mechanisms are effective or not depends on their design, implementation and the behaviour of participants within the regime. Nobody can predict how international action on climate change will evolve in the coming years and decades. After a boost through the adoption of the Kyoto Protocol in December 1997, international climate change negotiations have, at least temporarily, lost their momentum in two key areas. First, ratification has been slow and contentious, and second, there has been a lack of consensus on the modalities for implementing the so called flexible mechanisms—JI, the CDM and Emission Trading. If a climate regime is to be effective, it needs to give each actor incentives to participate in real emission reduction. Climate change negotiations so 51

Innovest 2002a; Pew Center 2001.

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far, have brought forward many good proposals to this effect. But there were counterproductive dynamics too driven by certain parties to the Kyoto Protocol, which have tried to use the climate negotiations as a means of attracting money from other participating countries. One example of this poker game has been exhibited by Russia in the question of ratifying the Kyoto Protocol. The climate negotiations will succeed only if sufficient numbers of players are driven by a problem solving attitude, and if there are countries or groups of countries willing to take a leadership role to push the process forward. In the absence of leadership, even well intentioned players remain uncoordinated, which increases the transaction costs and timeframe both of the negotiations, as well as of the pilot projects carried out for mitigating climate change. A Republican administration could, but does not want to, assume a leadership position in global environmental governance, and in the near future is unlikely to provide acceptable alternatives to the international community. The EU, another major player, is still too fragmented. Nevertheless, with the absence of America, the EU is the only powerful block able to retake the leadership.52 If new impetus is to be expected, it might come from the business community, as corporations and financial institutions, especially the insurance industry, have begun to adopt the view that climate change needs to be considered in terms of threats and opportunities.53 Still, actions from the private sector depend on the speed and efficiency of national governments. Due to their ability to change the incentive structures of the market, governments still hold the key to the feasibility and profitability of climate change mitigation measures. So far, the private sector has been waiting for policy signals, while governments have been waiting for greater private sector interest. It will be interesting to see which side will make the first move.

52 In October 1996, for example, the EU argued for quantified and binding reductions in a position paper presented to the FCCC executive secretary. One year later, this argument became the essence of the Kyoto Protocol. 53 MIs are also important actors, although they often reflect the consensus or conflict of their owners (the governments) and therefore cannot be quite as independent as global businesses and financial institutions. However, multilateral institutions are important sources of funding climate change mitigation projects, and they could play important roles as facilitators, catalysts and brokers in a climate regime.

4 Fundamentals of Energy Efficiency

Energy efficiency (EE) is widely viewed as an important element of economic and environmental policy. However, there is little agreement on specific EE goals and the strategies to attain them. The lack of consensus stems from the fact that there are differing views about the meaning of EE and the means of implementing it. How much one will actually benefit from EE depends on how one approaches the issue. Also, the success in EE improvements depends on how well various actors help each other, and how well their actions are integrated. The present chapter aims to explain the nature and purpose of EE as well as its relation to various actors of the society and the environment. The chapter also presents a short overview of the current debate on EE in which the EE gap and the rebound effects are the main constitutes.

4.1 Introduction It is hardly an exaggeration to say that with increasing affluence, energy has moved into the very centre of public concern. As populations expand and strive for better standards of living, per capita energy consumption rises, leading to an accelerated depletion of finite resources. It is not surprising that those who speak of conservation have been ridiculed for years as impractical and opponents of development. However, in recent years, there seems to be a widespread realization about the limits to energy consumption growth

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and the need for an efficient utilization of energy. Most importantly, there has been a shift away from thinking about EE and economic prosperity as mutually exclusive policy goals. This situation, we believe, begins with the understanding of the concept of EE. Energy is not an end in itself, but a means of providing services like illumination, space heating or conveyance. However, much of the information required to deal effectively with these issues is not readily available to end users and decision makers. So, it is true that even at this late date in the history of world energy, policy makers have no comprehensive plan of the design to describe, let alone correct, various dimensions of the energy system. The concept of energy efficiency varies depending on the person who is defining it. Economists, politicians and sociologists have very different views of EE. Often, the concept of EE is defined either in a technical sense or in a more broad and subjective sense. People with a social view of EE might consider energy savings to be a gain in welfare, while those with a more technical view of efficiency would classify the savings as resources saved. Many a times, the term ‘energy efficiency’ is used to describe what actually can be termed as energy conservation. In general, EE describes the relation of an activity or service and the energy used for this purpose.1 The precise definition of EE varies according to its field of application. The different meanings of efficiency in economy, ecology and technology contribute to this diversity. In their taxonomy of efficiency terms, Diekman et al. distinguish nine definitions and areas of application.2 An economic approach to EE, for instance, aims at the optimal resource allocation and minimal overall costs. EE in a more subjective sense may refer to the relative thrift or extravagance with which energy inputs are used to provide services such as powering a vehicle, firing a boiler, cooling an office or lighting a house. EE can be an economic concept—similar to that of productivity, a political concept—the result of EE policy, as well as a sociological concept—reflecting lifestyles of different groups. Hence, while trying to define EE, there is no single commonly accepted definition. It can be safely argued that an increase in EE is when either energy inputs are reduced for a given level of service or there is an increase or enhancement of services for a given level of input. To be energy efficient 1 The use of energy or an energy-related service is inter-related with a variety of influences: structure of the economy, state of technology, culture and lifestyle, geography, climate, consumer preferences and prices. 2 Diekman et al. 1999, 18. See further Brookes 2000.

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per se is to provide services with an energy input that is small relative to a fixed standard or normal input. However, in a narrow sense, EE indicators refer to technology and EE relates to the amount of energy needed to provide a service, which is defined as output of a technical facility or system.3 Investments in EE mean an improvement in the delivery of energy services, for example, in the sense that less energy brings the same end result. EE is a means to conserve natural resources, reduce environmental degradation, and—not least—to save money. It is true that EE helps to reduce Greenhouse Gas (GHG) emissions. However, there is an intense debate about both its cost effectiveness and the policies that should be pursued to enhance EE.4 Improvements in EE will require active intervention in markets to overcome barriers and to stimulate drivers (see Chapter 6 [this volume] on drivers and barriers). On the other hand some argue that market barriers to the penetration of EE technologies do not represent real market failures that reduce economic efficiency. There are trade-offs between economic efficiency and EE. It is possible to get more of the latter, but sometimes only at the cost of less of the former. Although energy and technology markets certainly are not perfect as all markets in practice, the balance of evidence supports the view that there is less of a ‘free lunch’ in EE than many have suggested. Nonetheless, a case can be made for the existence of certain inefficiencies in energy technology markets, thus raising the possibility of win-win energy efficiency enhancements.

4.2 Rationale for EE Intervention Nearly all devices and systems are less energy efficient in practice than their maximum efficiency in theory. There is always potential for improvement. Thus, few things are truly energy efficient. A device or system can only be more or less energy efficient than the alternatives at a given time, in a given situation. Thus, the technical potential can be defined as the achievable savings resulting from the maximum EE improvement available at a given time, regardless of cost considerations. Market potential is the saving that can be expected to be realized in practice. It reflects what is seen to be technically and financially viable by the consumers. Financial potential is the saving that can be achieved by optimizing the costs and achieving the 3 4

Diekman et al.1999, 25. See also Birol and Keppler 2000. Newell 2000.

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best resource utilization. It reflects the viewpoint of organizations. Economic potential is the saving that can be achieved at a net positive economic effect to society as a whole. Here, multiple economic actors are included and externalities are taken into consideration. An example would be the societal investment in EE to reduce growth in electricity demand. This might be less expensive than building a new power plant. These varying definitions point out the importance of various actors in determining potential energy savings. The size of the EE potential is not stable, but varies according to different sectors, energy prices and technological developments. The estimates of energy demand reduction through efficiency improvements are based on assumptions about technical factors, equipment costs, expected rates of market penetration, consumer behaviour and policy measures. When considering the potential for improvement, it is important to distinguish between the potential technological savings and actual ones. Often it is assumed that consumers behave in an economically rational way in view of a cost effective EE measure. However, the evaluation of the cost effectiveness of an EE measure depends largely on the discount rate used, though there is no agreement on what represents an appropriate discount rate. In some cases the discount rates applied to EE improvements are the same as those used by utilities for energy supply investments. In some cases, premiums are included to take into account resource depletion, energy security, environmental and other considerations in order to create ‘societal cost effectiveness’ measures. Most consumers make investment decisions without direct reference to discount rates and discounted capital flows. Even in business or industrial organizations, where investments are more likely to be evaluated in terms of rates of return or payback period, more stringent investment criteria are applied sometimes to EE investments than to production investments. Many EE measures that would be paid back in two years or less still do not appear financially attractive for many industrial organizations. For most firms, energy is not a major cost category. Hence, EE often is a minor consideration and it is expected that the costs have to be paid back at a rapid rate. Product characteristics are more important for individual consumers, as are productivity considerations for industrial consumers of which efficiency is only one component. In addition, investments in EE are subject to fluctuations with energy prices. Information on the performance of EE investments is often difficult to acquire. They are perceived as having a higher risk than many other business operations.

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These issues contribute to the problem of identifying a single, absolute cost effective potential. In practice, customers do not normally base their choices on formal economic calculations, but on considerations of comfort, quality and availability. Nevertheless a calculation of cost effectiveness gives valuable information about how well resources are used, and if their usage can be improved. The cost effectiveness of an efficiency measure depends on the costs and benefits considered. For example, from a business perspective, the costs and benefits which are relevant are those borne by the energy user. These include the expenditures for equipment, installation as well as operation and maintenance costs. The benefits include energy cost savings, enhanced labour productivity, environmental compliance or product quality. These are the traditional accounting costs and benefits that affect the industry directly. From a societal point of view there is a wider range of costs and benefits, which are relevant. These include monetary, health and environmental costs and benefits that accrue to society. Certain societal benefits, such as reduced local air pollution or diminished threat for climate change are external to the market and are difficult to quantify. Moreover, they accrue to society at large, not to the particular party implementing the efficiency measure. A sustainable energy policy will reduce these pressures by promoting EE. Also, the need to become more energy efficient will stimulate technological innovation by creating markets for more efficient, more advanced products and services. This will create more jobs dedicated to the research and development of energy efficient products, energy advice and saving services, for example, in energy distribution companies. EE, in short, is an untapped source of wealth creation. Investing in EE will prove to be a profoundly wise way to spend public and private money. While EE is an important objective in itself, promoting EE is also an essential part of an effective strategy to combat climate change. It is estimated that, by using the most advanced technologies, a CO2 reduction of about 50 per cent is possible until the year 2050.5 Energy efficiency, therefore, is a goldmine for CO2 reduction and should not be overlooked in aiming for the Kyoto targets and beyond. As Box 4.1 reveals, increasing EE fulfils multiple objectives.

5

Martinot and McDoom 2000.

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Box 4.1 Key Reasons for Advocating EE

Market Failures Payback gap—consumers face higher interest rate than producers. Differences of prices from marginal cost—with franchised monopolies or regulatory oversight, prices rarely reflect marginal cost. Risk sheltering of the utility—monopoly franchise or regulatory oversight shield utility from risk. Rate of return regulation—leads to an incentive to over invest. Externalities—externalities are not seen by market actors. Lack of information—consumers do not choose EE technologies because of lack of knowledge. High transaction costs—consumers miss opportunities because of high transaction costs. Disconnected decision makers or tenant/landlord relationships—consumers may not be able to influence EE decisions. This occurs, such as for instance, when one party, the landlord pays for the equipment while the other party, the tenant, pays the energy bill.

Other Reasons Ensuring adequate energy supply. Maintaining consumer price stability. Promoting greater equity with respect to energy cost burdens. Source: Adapted from Romeo Pacudan 2002.

4.3 The Energy Efficiency Debate There has been a long running debate between energy economists and energy analysts about various aspects of energy efficiency. One aspect is the rebound effect. Although definitions vary, this effect describes the following linkage: the efficient use of energy leads to an increase in the use of energy. This may offset the savings in energy use achieved by the EE improvement partly.6 The theory of the rebound effect is rooted in the neoclassical 6 Compare with Schipper 2000. This effect is also known as Khazzoom-Brookes postulate. Brookes advanced the argument (Laitner 2000, 471). For a recent history of the rebound effect see Schipper 2000.

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economic theory. The extent of the rebound effect depends on the price elasticity of demand. Therefore, the assumption of rational decision making is the precondition for an explanation of this effect.7 It is suggested that in practice the rebound effect is not high enough to subtract the potential contributions of EE to the reduction of carbon emissions or the justification of EE policies.8 Nonetheless, some implications for policy follow from this. Energy-efficient technologies (EETs) may need to be reinforced by market instruments. A continued measurement and explaining effort should be put on to the rebound effect as economies are complex and changing.9 Henry Saunders argues that ‘(…) energy efficiency gains can increase energy consumption by two means: by making energy appear effectively cheaper than other inputs; and by increasing economic growth, which pulls up energy use’.10 The debate grew more intense in the 21st century, spurred by concerns about global warming. The argument for EE, however, is independent of environmental concerns. The market failure that distorts energy use is the under-pricing of energy by regulators. Deregulation, therefore, is preferable with regard to EE as utilities are forced to reduce energy prices. Another aspect to which contributions to the EE debate can be associated is what one describes as a matter of governmental intervention. Gunn who investigated the paradigms of EE stated that it is important to recognize that the primary debate is over the optimal level of governmental intervention in energy markets rather than over the optimal level of EE.11 There are many forms of government intervention, such as subsidies and taxes, special purpose loans, and facilitation like information systems, wellstructured markets or approved suppliers. Further, there are guarantees for specific risks, or offering insurance, and the arrangement of objective non-partisan product information, like energy labelling. The justification and degree of governmental intervention is a matter of debate in the international literature. Barriers which are attributed to market failures make governmental intervention necessary and justifiable and a large body of

7

Berkhout et al. 2000. Berkhout et al. 2000; Greening et al. 2000; Laitner 2000; Schipper 2000. According to Schipper micro rebound effects for the energy end use might depending on initial costs, income and energy price range from 10–40 per cent (Schipper 2000). 9 Brännlund et al. 2004. 10 Saunders 1992. 11 Gunn 1997. 8

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international literature relates barriers to market failures.12 However, others claim that only few market failures can be defined as such.13 Haugland, Bergesen and Roland argue that most barriers merely reflect ‘(…) unaccounted (transaction) costs or simply result from the consumer’s liberty to choose freely his/her convenience and service levels and willingness to accept a higher energy bill for their personal taste or lifestyle’.14 Therefore, governmental intervention might be questionable.15 A large body of international literature puts effort into an empirical approach to this question with different objects of investigations and findings. Governmental stimulation of the implementation of new technology by promoting associated research and development was found to be counterproductive. Although it leads to technological progress, it may hinder corporate investments in new technology. Firms may favour to wait for the next generation of technological developments.16 In the case of restructuring electricity market, pro-interventionists ask whether the market alone is able to overcome EE barriers. It is argued that governmental support in promoting EE and load management can be advantageous.17 Further, an evaluation of US energy labelling programmes led Banerjee and Solomon to the conclusion that, ‘(…) government support is the most critical factor for the success of a labelling program’.18 Altogether, the challenge of reconciling government and free market contributions with regard to the energy market and EE remains. With regard to EE potential, a distinction has to be made between: (a) the economists’ potential: achievable by removing market failures, (b) the technologists’ potential: achievable by the additional removal of non-market/ market barriers and (c) the hypothetical potential: achievable through the

12

Helm 2002. In general, the definition of market failures depends partly on the societal goals which are seen as important within a society (for example, equity). The free market system may fail to achieve these goals. Economists have identified a number of market failures which partly explain this: externalities, lack of information, uncertainty, the existence of public goods or the time which is needed to response to a changing environment (Sloman and Sutcliffe 2000). 13 Gunn 1997. 14 Haugland et al. 1998, 47. 15 For a general discussion on benefits and drawbacks of free markets and government intervention see Sloman and Sutcliffe 2000. 16 Van Soest and Bulte 2001. 17 Vine et al. 2003. 18 Banerjee and Solomon 2003, 121.

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additional elimination of market failures in fuel and electricity markets.19 This framework is summarized in Figure 4.1. Figure 4.1 Characterization of Energy Efficiency Potential

Source: Jaffe Stavins 1994.

4.4 Understanding the ‘Energy Efficiency Gap’ The question being asked very often is why consumers and firms do not invest in cost-effective energy efficiency opportunities. Partly, the answer is that consumers and firms discount future savings of energy efficiency

19

Jaffe Stavins 1994.

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investments at rates well in excess of market rates for borrowings or savings. This pattern is referred to as the ‘energy efficiency gap’.20 To understand the EE gap, it is essential to study (a) the characteristics of markets for energyefficient technologies (EETs), (b) the nature of institutional energy-related decision making and (c) the nature of an individual consumer’s energyrelated decision making.

Markets Manufacturers, builders, designers and suppliers all face market-related barriers that inhibit the adoption of EETs. These barriers include organizational inertia, reluctance to change design and production cycles or the inability of a company to capture all the benefits of Research and Development (R&D) investments as competitors can copy products and services.

Institutions In large institutions, factors involved in decisions concerning EE investments include inconsistent application of budgeting procedures, predominance of payback period, split incentives, moderate transaction costs facing certain EE project proposals, effective communication for management of the results of EE programmes, and as far as firms with on site generation are concerned particular incentive problems.

Individual Consumers Factors influencing consumers in investing in EE include transaction costs on consumer decision making, the tendency of consumers to overemphasize initial appliance cost at the expense of future benefits, a lack of interest and the uncertainty about future benefits from efficiency investments. Even if all the energy saving potential could be tapped through EE, the payback gap would persist. Often, cost-effective energy saving options is not chosen. One reason is that many factors which are not directly quantifiable costs, such as the purchasing price, the maintenance cost, or energy costs, affect consumer decisions. Moreover, individuals and organizations do not

20

Reddy 2003.

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invest in EE because of a lack of information and awareness, a lack of technical personnel, a lack of investment funds, uncertainty about energy prices, uncertainty about equipment performance and social pressure. They also are discouraged by problems concerning the equipment supply infrastructure, and split incentives. In the energy sector there are areas where investment is low or misplaced from the EE point of view. For example, investment in new power plants may be avoided when a lower expenditure can be incurred in existing plants through the replacement of existing inefficient technologies with efficient ones. An energy system can meet new demand either by adding more supply capacity or by reducing the additional demand. Good economics suggests that the least cost option should be chosen. The dilemma is that different actors make the choice: it is the company on the supply side and the consumer on the demand side. They have different perspectives on their choices. In contrast to consumers, suppliers have more opportunities to obtain information and to spread their risks. In some cases, they even have a dominant position in the market or enjoy a monopoly position. Energy use is just one component of the desired service for a consumer. Investments may be made at lowest first cost without due consideration to life cycle costs. This problem is known as the ‘payback gap’.21 The investment behaviour of firms, which is unsatisfying with regard to EE, cannot be explained by barriers such as organizational failure or ignorance, solely.22 On the contrary, it may be an expression of rationality not to invest in a technology that seems to be economically beneficial according to a net present value approach. This is explained, inter alia, by the uncertainty of future technological progress and the irreversibility of investments in new technology.23 Many analysts claim that an ‘energy efficiency gap’ exists between the most EETs available at some point in time and those that are actually in use. However, the extent to which these technologies reduce energy use through improved EE remains open to debate. To estimate the actual potential one has to distinguish first between EE and economic efficiency.

21

Geller and Nadel 1994. Wells and Hoffman (2000) point out that organizational structure create a fundamental barrier to corporate investment in energy efficiency. In most American firms, energy functions are managed by cost centres which operate at a two-year payback rule. 23 Van Soest and Bulte 2001. 22

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Consider two air conditioners that are identical except that one has a higher EE and, as a result, is more costly to manufacture because high efficiency units require more cooling coils, larger evaporators, larger condensers as well as a greater research and development effort. On the other hand, using an engineering-economic model, the technologists define optimal EE by minimizing the total purchase and operating costs of an investment, where energy-operating costs are discounted at an appropriate discount rate. However, this approach does not describe all the issues that can influence EE investment decisions accurately. These issues relate to the fact that the weight given to different investment criteria by purchasers varies considerably. Investment criteria thereby are the purchaser’s discount rate, the investment lifetime, the price of energy, the purchase price and other costs. The magnitude of this ‘option-to-wait’ effect24 depends on projectspecific factors, such as the degree of energy price volatility, the degree of uncertainty with regard to investment costs and how fast energy and conservation technology prices change over time. Requiring consumers to purchase appliances with a higher level of efficiency based on a simplistic analysis could, in effect, impose extra costs on consumers.25 The result might be a higher level of EE, but a decrease in economic efficiency, as consumers could be forced to bear costs that they would have otherwise avoided. This gap suggests a role for policy measures focused on stimulating innovation and investments in EE improvement. Such policies would include the acceleration of technology development and demonstration, the stimulation of product demand through procurement activities, the application of efficiency standards, the influence of consumers’ energy-using behaviour, the organization of competitions between manufacturers for the most efficient products and the finding of ways to create markets for energy savings. Proponents of the EE gap suggest the consideration of alternative theories to gain new insights into the existence of this gap. Thompson, for

24 The techno-economic analysis does not account for changes over time in the savings that purchasers might enjoy from an extra investment in EE, which depends on trends and uncertainties in the prices of energy and conservation technologies. When making investments that can be delayed, such as the purchase of air-conditioning equipment, the presence of this uncertainty can lead to a higher investment-hurdle rate which is referred to as ‘option-to-wait’ effect. 25 Newell 2000.

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instance, points out that a single cost-benefit approach to EE investments which merely tests whether an investment in EE is financed by its associated fuel savings may lead to an undervaluing of EE improvements. The author argues that in many cases the consumer will benefit from an increase in utility and comfort, even if the efficiency measure is not suggested by a simple cost-benefit test.26 A major issue that deserves to be mentioned explicitly here is that of risk. Let us assume that a consumer would like to insulate his house, but is afraid that his house may react to the injection of insulating material into the cavity wall by creating points where moisture can penetrate the wall. That would cause enormous costs of repair. That risk is not covered by any guarantee of insurance. It can act as a major deterrent to having the insulation put in. Even worse are the risks one does not know. Such risk issues, especially small chances of large liabilities, need to be covered by some form of insurance or guarantee, or the investor will not be able to follow the financially most favourable option. Another major issue is that of transaction costs and other frictions. Eric Ferguson points out that, in Yemen, bakeries use extremely inefficient ‘tannur’ stoves to bake bread. Better stoves could be developed. However, even if these stoves would save 50 per cent of the energy, the cost of energy is less than 10 per cent of the sales price of the bread. So the baker is not likely to go through the trouble of installing an improved ‘tannur’ stove, by spending about 5 per cent of his total turnover, and taking a risk if the technology goes wrong. He has far more urgent things to take care of. Technologies that are embedded well ‘have low transaction costs’. EE is not yet embedded well within society, and hence the transaction costs, in terms of time and effort, are high. Another risk is the credibility of the supplier of the EE technology. If problems arise, the investor faces the problem, not the supplier, unless there is a warranty attached to the technology and the supplier has the necessary financial reserves to back up the warranty. One approach which belongs to the aspect of theory, modelling and system boundary is the modelling of consumer behaviour. Opponents to the existence of an EE gap criticize the assumed rational consumer behaviour: If a consumer is informed appropriately and if the energy saving measure is

26 Thompson 2002. Clinch and Healey (2001) present a template for a comprehensive costbenefit analysis of domestic energy conservation programmes by including components such as health benefits and comfort benefits. See further Goodacre et al. 2002.

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cost effective, then the consumer will adopt it, due to his rational decision making. Box 4.2 shows assumptions of the so-called techno-economic model of change. Box 4.2 Ingredients of the Techno-economic Model of Change Decisions are made by relatively autonomous individuals—that is, people are free to make energy efficient decisions if they choose so; People do not make energy efficient decisions for many reasons: because they do not know-how to, they are not aware of the benefits, there is a price distortion in the market or there is a misalignment of interests; Once individuals are personally convinced that they have the necessary information, and they receive the correct pricing or regulatory signals, they will adopt proven and cost effective energy saving technologies. Source: Based on Guy and Shove 2000: 59.27

4.5 Energy Efficiency: A Technological Perspective Technological innovation is a key factor in microeconomic explanations of consumer behaviour. Technological change may be interpreted as sociotechnical innovation. The need or demand for clean clothes, as for instance, was satisfied by hand washing years ago, but is satisfied by automatic washing machines today. Technology mediates psychological needs and demand for products.28 Technology also plays a role in market models. Technological progress and technological advance are crucial in Schumpeter’s model of dynamic competition. In his market model, competition over innovations in products and processes is central. Innovations by advances in technological knowledge as well as cost reductions by new technology and economies of scale are necessary for firms to stay in the market.29 From this perspective, economically beneficial EETs may be interpreted as a source of competitive advantage. Technology is even conceptualized as a component of models

27

With permission from Thomson Publishing Services, UK. Wheelock 2000. 29 Brown 2000. 28

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of capitalism. Improving the productivity of natural resources by changes in production process and technology is one of the four major shifts suggested by Lovins to achieve natural capitalism.30 The potential for EETs is quite large. In industry, electric motors offer the best opportunity to effect major saving potential. Replacing existing motor systems, which include inefficient motors, pumps, compressors or blowers with efficient ones can save electricity by 15–20 per cent. Also for an application, involving variable speed conditions, savings can be achieved by using electronic adjustable speed drives (ASDs), which control the speed of the motor depending on the process requirement. The ASDs can reduce electricity consumption by 15–20 per cent. After motors, lighting system represents another advance in providing significant conservation potential. Lighting innovations like the compact fluorescent tubes, electronic ballasts, advanced luminaries, reflectors or optical sensors can save electricity up to 60 per cent of the existing consumption levels. Other efficient technologies include waste heat recovery systems using absorption chillers, thermal cold storage for air conditioning, cogeneration of heat and electricity or efficient process technologies. The reason why the consumer can reduce energy consumption is very simple. Virtually, every technology, at present, uses far more energy than the minimum required by thermodynamic laws which specify the minimum amount of energy required to do the work. According to the European Commission, the ‘(…) average equipment used in the household sector in European Union (EU) countries is 50 per cent less efficient than the best equipment currently sold’.31 Some of the most common technology choices for private sector investment in EE are shown in Figure 4.2.32

4.6 Actors in the Field of Energy Efficiency There is a growing recognition that the usual investment decisions, such as payback period, rate of return on investment or net present value, do not account adequately for actual business behaviour. Technical solutions given in Figure 4.2 are not likely to succeed unless there is an interface between

30

Lovins et al. 2000. EC 2000, 142. 32 Technical experts at the World Bank Group and the Global Environment Facility 1997 (interviews). 31

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Figure 4.2 Technology Choices for Private Sector Investment in Energy Efficiency

Source: Authors. Note: ∗ District heating is a system for distributing heat generated in a centralized location for residential and commercial heating requirements such as water heating.

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various actors in the field of EE. Conventional energy programmes consist of only two main participants— suppliers and consumers. In contrast, the EE system consists of many actors, such as the equipment manufacturer, financial institutions, or non-governmental organizations (NGOs). If EE programmes are to be accepted widely, all of these parties should work together. Each actor relates to many other actors, experiences constraints and stimuli, has abilities and weaknesses, and holds rights, responsibilities and obligations. A series of decisions is the result. All the actors, and their decisions, describe the whole socio-technical structure and the processes that occur. Different categories of actors play various roles in the diffusion of EETs services to the consumers. These actors, such as, households, industries, commercial consumers, utilities, equipment manufacturers, planners, and so on, play a role in shaping the technology diffusion. The actors have interdependent influence. Each actor experiences constraints and stimuli; has abilities and weaknesses; and holds rights, responsibilities and obligations. All these lead to a series of decisions. A brief description of the role played by each of the major actors is given in the following sections:

Public Policy Institutions Public policy shaping institutions influence the EET market indirectly through taxes and subsidies. Taxes have a negative influence and subsidies a positive influence. Policy makers as actors of energy consumption work alongside those who frame policies pertaining to economics, technology and social welfare. The role of policy makers is to address the most pressing technology challenges facing the nation, including enhancing the efficiency of energy use. Sound energy policy requires more than a political balancing of popular interests. Because of the technological complexity of the national energy system, policy must also be consistent with technical and economic analyses.

Technology/Equipment Manufacturers In the chain of actors involved in the use of energy carriers, equipment manufacturers play an important role in optimizing fuel utilization. This is because they are the ones who supply energy-using devices. Their efficiency determines the benefits to various stakeholders. But households may not be

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interested in efficiency per se. What they are interested in, is the cost, that is, the ratio of investment to useful energy. This is not related to ‘efficiency’. There are many technologies that are highly efficient, but many households do not adopt them because they are prohibitively expensive. At the other end of the scale, if a manufacturer develops a technology (say solar water heater) with an efficiency of only 5 per cent, but is still cheap for the energy it supplies, it can be an excellent solution, as the ‘fuel’ is free, and the households do not care if there is fuel wastage. Hence, the equipment manufacturer indirectly plays an important role in the fuel choice.

NGOs and Others NGOs have their own influence on the technology choice which is varied and distinct from other actors. For example, there are several NGOs who are active in countries like India in the field of renewable energy. They help lowincome households to obtain renewable energy technologies like biogas plants.

Consumers Consumers play an important role in the choice of technology and are the main actors. From the perspective of the consumers, the technology choice depends mainly on the annual energy budgets coupled with the availability of a particular technology. The costs of energy utilizing devices like stoves or water heaters also have an impact. Thus, the consumer makes a choice based on the desires and priorities, especially the financial resources and related constraints. However, there are other external actors who influence the choice. For example, the subsidies provided by the government have a positive role in the selection and use of a particular technology. Consumers as final end uses influence his or her decisions, influenced by almost all other actors.

Inter-relationships among Various Actors Actors do not act independently since several actors have similar goal, that is, to supply energy to consumers in a cost-effective manner. The interrelationship among the actors may be analyzed by using a diagram. Figure 4.3 shows the government at the highest level connected to energy suppliers who in turn are inter-related to the consumer through intermediaries. If we

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Figure 4.3 Inter-relationships among Actors

Source: Authors.

want to change the existing system, we have to redesign the relationships among different actors and also introduce new actors. There is also a need for feedback mechanism from the consumers to the energy suppliers or the government.

Actor Analysis All the actors, and their decisions, describe the whole socio-technical structure and the processes that occur.33 Here we propose to classify actors into various levels, micro, meso, macro and meta. Micro level actors are those that influence at the lowest level, for example, at the consumer level. Meso level actors are those at the intermediate level, that is, in the supply stage. The macro level actors are at a higher level: state and central government, and the meta level actors are at the highest level, namely, international level. Here we develop a model which shows how various actors at the finance (meta), policy (macro), organizational (meso) and consumer (micro) levels influence EE. Modelling helps in identifying the causality as well as its intensity. Each actor in the field of EE has a specific function and responsibility. However, even without being an active performer, everyone can benefit 33

Reddy and Srinivas 2009.

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from the positive externalities of EE. The EE process needs cooperation and common achievement to be completed. Therefore, in order to promote EE-directed decisions, the government needs to establish structures which favour EE-directed decisions. Figure 4.4 illustrates actors in the field of EE from ‘macro’, ‘meso’, ‘meta’, and ‘micro’perspectives. Figure 4.4 Actors’ Perspectives

Source: Authors.

Level of Actors

Actors at the Micro Level The first ‘actor’ to look at is the consumer whose technology choices depend on the income, needs, prices, costs and availability of equipment and fuel, on the ‘status value’ of energy sources (‘for example, Liquefied petroleum gas [LPG] is more modern’) and on other factors. If we can find out the intensity of these choice factors it would help in predicting future behaviour. There are also NGOs who try to help the consumer in providing information about various energy technologies, availability, costs and benefits. To design better programmes, they are the persons/consumers to address (information, training, support by specialists, and so on).

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Actors at the Meso Level Organizations, such as utilities, energy development agencies, service companies, and so on are the actors at the meso level. These actors are the ‘intermediaries’, who trade in technologies/services. They play a major role in demonstrating energy savings through efficient systems. They gain from such campaigns and also contribute to creating awareness on EE.

Actors at the Macro Level These actors relate to the ‘higher-level’ institutions (state/market/civil society) that determine the setting under which the lower levels have to operate. These are the public utilities, which supply energy to consumers. There are also institutions (at national and state levels) that regulate tax and subsidies. Macro level actors are important because they have direct influence on the consumers.

Actors at the Meta Level These actors relate to the ‘highest-level’ institutions (World Bank/Asian Development Bank [ADB], Global Environment Facility [GEF], and so on) that help in obtaining finances to implement EE policies. These actors are very important since they have significant influence on the policy makers. Functions of actors in EE is shown in Table 4.1 along with their influencing variables.

Influence of Actors and Factors Technology choice analysis is facilitated by a state diagram depicting the influence of various factors and the corresponding actors. Figure 4.5 describes the Actor–Factor Influence Linkage state. Different types of actors, level of influence (low or high), and so on, are depicted. Household budget directly influences the fuel choice, whereas availability and price influence it indirectly. Policy makers have a great influence directly as well as indirectly. Actually the nature of influence can be graded, as low, medium or high. Here we take a descriptive approach.

Macro

Macro

Macro

Meso

Meso

Meso

Meta Meso

Micro

Micro

Governments

Energy supply agencies (Utilities)

Multilateral institutions

EE agencies

Business and industry enterprises

Equipment manufacturers

Financial institutions

Non-governmental organizations

Consumers

Source: Reddy and Srinivas 2009.

Level

Actors Establish legal and institutional frameworks; Integrate EE in decision making processes; Support administrative efforts to enhance EE; Provide transparent evaluations to learn and to guide. Improve energy services—supply, transmission and distribution; Propagate EE technologies; Change consumption patterns. Develop supporting instruments for monitoring and evaluation; Support mutual interest by adapting routines and instruments; Serve as a forum to disseminate results; Act as a clearing house to establish collaborative actions. Collect and propagate information about activities, experiences, programmes and projects; Develop and implement EE programmes. Disseminate the results achieved; Appeal to members to apply EE measures; Negotiate with partners involved in terms of achieving EE targets. Provide a whole range of devices—mechanical and electrical equipment—to the consumers; Cooperate on developing and later promoting EE technologies; Convince consumers to consider life cycle costs. Help to finance EE programmes; Cooperate with other agencies to implement common projects; Implement programmes and projects actively. Publicize best practice; Network to make use of the latest experiences in research, both in technology and applications. Collect appropriate information; Choice of technology.

Functions

Table 4.1 Functions of the Actors in Energy Efficiency

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Figure 4.5 Actor–Factor Influence State Diagram

Source: Authors.

On one side we have the actors, such as policy makers, supply agents, and so on, classified into macro, meso and micro actors. A list of factors influencing the technology choice through the actors is shown against them—namely, budget, price of energy, and so on. The connecting linkages between the actors and factors show the actors’ role on the influencing factor. For example, subsidy and taxes have an influence through the policy makers. Similarly price and availability are the influencing factors through subsidy agents. Multiple linkages are possible since an agent may influence through several factors. Likewise, a factor may be influenced by many agents. In order to indicate the level of influence a weightage may be assigned to each linkage. Here three levels of influence are used: high, moderate and weak influence, indicated by red, blue and green lines. Such a state diagram can be useful to analyze the technology choice and the role of actors. Now, the objective of the analysis being to find out the optimal way to enable technology choice by consumers, we can suggest modifications to the linkages and their weightages or levels of influence. These should be based on the observations of the data available as tabulated in the previous sections. As an example, the household budget deters the low-income household to use LPG for cooking. So the state transition diagram may be modified to enhance the role of financial institutions by providing loans

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at affordable rates to purchase LPG stoves. So this can be represented by a green to blue shift of weightage. Also new actors like entrepreneurs, NGOs, and so on, can be brought in to facilitate the transition. It is necessary to include extra slots for actors that may be influential in the future. Similarly, there may be factors that will become important in the future. Modification of state diagram is an effective way for effective fuel choice changes. The analytical approach presented above has the advantage of mathematical treatment. This can be implemented by introducing mathematical variable and functions representing the linkages. Also, the functional form may be chosen according to the corresponding weightages. The methodology of implementation consists of a list of all linkages that are modified. There are several possible state transitions as discussed further. Policy makers have a direct strong influence on the subsidy and a strong indirect influence on the price. Sometimes actors influence the factors whereas many times the factors are the main influence on actors. For example, external factors like the situation in oil importing countries influences public institutions/policy makers who in turn influence the availability. So Figure 4.5 also depicts the influence of external factors on the availability of resources. Most factors are inter-influential directly, which is shown by direct linkages. Thus, the representation can be used to analyze household fuel choice. The classification of actors into micro, meso, macro and meta greatly facilitates the analysis of role of actors. For example, household and supply intermediateries that are micro level actors influence directly, though aspects are different. They may be treated and analyzed similarly. In the next section, actor–factor linkages are analyzed using the state-diagram approach. For convenience, the inter-linkages discussed in this section are not considered explicitly.

Role of Actors: Needs and Priorities In order to achieve the goal of optimal stable state of actor influence leading to the highest level in the comfort ladder, their needs and priorities need to be analyzed accurately. First and the most important step is substituting inefficient technologies with efficient ones. As basic energy needs are met, consumer priorities shift to other, often higher quality services. Consumers can climb the technology ladder quickly due to shifts in technologies. This leads to an increasing stress on cleanliness, for environmental and health reasons on the one hand and the growing value placed on flexibility, saving time and avoiding disruptions on the other.

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While implementing EE programmes, one has to take human behaviour into consideration. Although there are technologically feasible and economically meaningful potentials for reducing energy consumption levels, the number of measures that is implemented is very small. This is due to the ‘implementation gap’ which means relating existing potentials to real world implementation. Barriers for the implementation of these measures are not only the political and economical setting, such as for instance the externalization of environmental costs, but also the behaviour of actors and decision makers. Actually, the implementation of energy efficiency measures can be considered as an ongoing social process involving the interaction of different actors inside and outside organizations. The process comprises different stages: an initial stage of motivation or willingness to act, several steps of problem solving and a final stage, where continuation is possible on the basis of the experiences made by the different actors. As shown in Table 4.2, the process of implementation can be described as a spiralling process of learning by individuals and organizations.34 The process of implementation is not straightforward, following a rational plan, but tends to be incomplete and full of unexpected side effects. Plateaus, stops and fall backs to earlier stages are possible. The complexity of the process reveals itself if one tries to relate the various factors exactly to energy efficiency measures. Thus, all the factors listed below and the associated activities lead to a best performing organization with regard to energy use.

4.7 Energy Efficiency Policies Energy efficiency policies usually consist of instruments of governmental intervention into the energy market. These instruments aim to overcome barriers to investment in EE improvements. Although there are some standard policy measures for governmental intervention in markets, such as taxes, subsidies, laws, regulations and provision of information or provision of services, their application varies according to each sector, taking into account their different characteristics. Table 4.3 gives an overview of further policy-relevant features of energy sectors. The choice of applied policy instrument is not only a matter of rational and techno-economic consideration, but is strongly dependent on 34

Friedemann and Andreas 1997.

Programme funding

Marketing

Preparation for action

Participation

Innovative actions

Motivation

Risk assumption

Learning from experience Cost reduction Programme expenditure

Networking Test

Sense of mastery Social pressure Models and experiences Analyses

Commitment

Experiences and models

Social influence

Motives

Factors

Processes

(Table 4.2 Continued)

Innovative actions by stakeholders are important with regard to improving the image of the programme. Material incentives are seen as most effective while non-material ones are effective as supplementary elements. Social norms are influential as negative incentives, such as public pressure, while positive social incentives, such as rewards seem to work. Previous experience of an organization, as well as successful models and reports provided by organizations are helpful. Committed actors in the organization foster decisions, which are economically and environmentally sound. The willingness to overcome obstacles is decisive. Withstanding the pressure fostered from outside the organization. Distribute successful models and experience reports within the organization. Analyze the techno-economic baseline, one’s own skills and competencies as well as those of target groups. Create an early and broadly based cooperation with local actors. Make a test run of the EE programme (not only for monitoring the programme technically but also for commercial purposes). Orientation to exemplary precursor programmes. Dispelling the factors that hinder in target group, such as environmental and social costs. Reduction of programme expenditure by following routine activities, standardization and free provision of third party services. Risk assumption by suitable persons or institutions in the case of necessary pre-financing.

Actions

Table 4.2 Overview of Factors Fostering the Implementation of EE Programmes

Personal relevance

Source: Authors.

Feedback

Positive relations Publicity

Interaction

Measurement Process evaluation and corrections Keeping attention Motivation

Evaluation mechanism Monitoring

Social comparison

Face-to-face communication Opinion leaders

Feedback of intermediate results keeps the programme in people’s minds. Besides keeping attention and signalling the progress, feedback can generate community spirit and a feeling of belonging. It engenders further motivation to participate. Look at feedback as a precondition for generating a process of dialogue and interactive exchange between actors and participants. Feedback provides positive effect on the programme organizers (image, customer ties). Good contact with the local press is important for the mediation of feedback to the public.

Pay attention to local networks, clarity and real world practicality of the information and message conveyed. Communicate a wide variety of advantages of participating in the programme, taking aspects of economic efficiency into account. Use the word of mouth and personal discussions to step up knowledge of the programme. Secure participation of multipliers and opinion leaders, particularly with regional networks, and institutions without vested interests. Prompting processes of social comparison (neighbourhood, municipal district, etc.) and competition. Ongoing programme monitoring and evaluation is a precondition for systematic further development and organic integration into existing structures. Developing suitable standards and measuring instruments and indicators at the planning stage. Enable corrections in the course of the programme by means of process evaluation.

High effort

Public relations and information strategy

Advantages

Actions Find sources in addition to public budgets, e.g., via contributions, donations, participation fees, etc. High intensity of promotion and appropriate provision of funds.

Factors Additional sources

Processes

(Table 4.2 Continued )

10–50 years

> 30 years

> 10–15 years

> 50 years

Residential and commercial For example, buildings, appliances or office equipment

Gas, oil and power production

Industry For example, industrial equipment

Transport For example, infrastructure

35

Government and private sector actors at the local, regional and national levels. High complexity as local decisions have implications for national policy.

Relatively small number of decision makers, strongly driven by bottom line.

Small number of large players, sometimes government owned or regulated.

Large number of decision makers, such as individual consumer, contractors or financial institutions.

Key decision maker

Regulatory and social instruments; building energy efficiency standards, technical assistance, audits, fiscal incentives for improving thermal efficiency and labelling. Electricity and gas market liberalization and deregulation, subsidy reform, falling prices, natural gas gaining market share in power sector or shift in policies for environment. Voluntary approaches, search for eco-efficient materials and energy intensity improvements, some regulatory mechanisms which are widely exempted from environmental tax instruments. Limited climate policy initiatives, some regulatory reforms, land use and community planning interacting with national policy.

Main policy developments related to climate change

Based on OECD 1999c, 2003. National Climate Policies and the Kyoto Protocol, p. 37, with permission from OECD.

Source: Based on OECD 2003.35

Capital stock turnover

Sector

Table 4.3 Features of the Energy Sector Relevant to Policy

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various actors.36 Most authors support the view that each policy instrument is linked to its own political economy and is distinct according to certain criteria of political choices, such as its degree of state intervention or the number of administrative and institutional resources needed.37 Labels and standards are examples of instruments which are widely used, especially to improve the EE of home appliances and office equipment—a sector of fast growing energy use.38 Labels inform about the energy use or EE of a certain product,39 while standards regulate minimum efficiency or maximum energy use levels for products in a mandatory way. The EU, for instance, applies labels on cloth dryers and washers, cloth washer-dryers, dishwashers and lamps as well as labels and standards on refrigerators and freezers. An outcome of the EU labelling programme was an improvement in EE of 6 per cent (from 2000 to 2004).40 Research and development (R&D) in EETs, such as low carbon fuels, advanced solar photo-voltaic technologies, is seen as long-term effort to reduce energy consumption levels. However, energy-related R&D carried out in an organized way by different actors and institutions, such as corporations, financial institutions or universities frequently does not achieve the expected short-term results. To help remedy this, the industry should play a key role in the development and implementation of new technologies. An efficient and productive approach to energy-related R&D requires the collaborative efforts of the government, industry and other organizations. There are two issues worth mentioning that highlight the complexity of the linkage between EE, R&D and policy. These are the concept of EE and the research environments which are interdependent. Different structures of interaction influence research priorities and the conceptualization of EE.41 Figure 4.6 gives an example of two possible research environments. These correlate with a certain degree of involvement of actors as far as the formulation of research schemes is concerned. Within the

36 OECD/IEA 2000; Varone and Aebischer 2001. In Varone and Aebischer (2001) a detailed empirical and comparative study of the applied policy instruments in the area of household appliances and office equipment in Canada, Denmark, United States, Sweden and Switzerland from 1973 to 1996 is given. OECD/IEA (2000) provides an overview over current labels and standards programmes in IEA countries. 37 Varone and Aebischer 2001, 617. 38 According to IEA 2006b, labels are used in 37 and standards in 34 countries. 39 Labels comprise different varieties, such as ‘comparison labels’ or ‘endorsement labels’ (OECD/IEA, 2000, 10). A famous example is the US Energy Star programme. 40 IEA 2006b. 41 Guy and Shove 2000.

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‘close communities’42 model, research schemes are negotiated informally among all actors. In contrast, within the ‘coordinated contractors’43 model, research schemes respond mainly to policy, whereas industry is not involved directly.44 This may have an impact on research objectives. Research management and funding further influences the range of disciplines considered and may hinder or enable opportunities for effective interdisciplinary inquiry.45 In the ‘close communities’ model, the disciplinary boundaries within which the energy problem is positioned were found to be relatively flexible, whereas in the ‘coordinated contractor’ model a more technical perspective dominates.46 Also the scientific institutions and research organizations should be seen as more or less impartial policy advisors and play an important role in reducing global environmental risks.47 Figure 4.6 Research Environments

Source: Guy and Shove 2000, 21ff.48

4.8 Conclusion The EE concept shifts the focus from energy generation to energy service. It provides a fertile ground for cost-effective technologies and managerial options in reducing energy consumption levels and thereby the environmental degradation. These EE programmes are appropriate where the efficiency of the device, especially the process is low and the energy 42

Ibid., 30. Ibid. 44 Guy and Shove 2000. 45 Lutzenhiser and Shove 1999. 46 Guy and Shove 2000. 47 Boehmer-Christiansen 2000. 48 Reprinted from Guy and Shove 2000, 21, 25 with permission from Thomson Publishing Services, UK. 43

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intensities are high. These programmes should be developed on a long-term perspective of providing the right incentives to customers regarding the real cost of energy resources rather than short-term, rationing-oriented programmes. EE policies and programmes should be integrated with overall energy planning. The task of an EE programme is to create incentives for each actor to move towards reducing energy consumption levels. That is where one needs the actor-oriented approach. No institution should have a special and dominant status. However, at the same time, it seems fair to argue that without strong, forward looking, gradually introduced, and long-term signals by the government, other actors are unlikely to move forward decisively, even though in many countries other actors are actually the primary driving force for policy change. With regard to climate change issues, EE will be just one of many approaches, and probably not the principal one. We can discover that the Kyoto regime proposal which can probably be considered deceased fails to address some of the major actors effectively, and creates major new barriers and frictions. However, despite this situation we should use energy more efficiently in future than we are using it today. Therefore, the concern is not about whether to implement EE programmes or not, but when, how, where and how fast?

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Appendix Concepts of Technological Efficiency49 A.1 Introduction While many people are familiar with the concept of first law efficiency, the notion of second law efficiency, suggested by Nakicenovic50 as an interesting, often more adequate definition of EE, is rather unknown. Here, we explain the concept of second law or entropy efficiency with a stylized example. The comparison of this concept to the notion of first law or energetic efficiency indicates that estimates about current efficiency improvement potentials depend heavily upon the efficiency concept employed. Moreover, we explain why prevailing energy efficiencies are grossly overestimated when measured in terms of first law efficiencies. High figures that are commonly reported for the first law efficiencies of current technologies lead to the impression that efficiency improvement potentials are almost exhausted. These high figures represent negative signals and, therefore, serious barriers on the route to a sustainable economic development via the accomplishment of high efficiency standards. In fact, the world-wide average of the second law efficiency of electricity consumption, for example, is estimated by Gilli et al. to be lower than 6 per cent.51 Thus, efficiency improvements appear to be promising52 and might be an important part of a broader strategy to restructure energy systems with respect to a sustainable economic development.

A.2 The Concepts of First and Second Law Efficiency The basic difference between both concepts is that while first law efficiency solely relates to the specific technology applied in order to satisfy certain tasks, for example, illumination and space heating, the concept of second law efficiency takes into account both the actual technology employed and the technology that would theoretically be the best for the same task. Our following example on whether to heat a house with either electric furnaces or heat pumps illustrates the difference between these two concepts. 49

This appendix is prepared by Manuel Frondel and Dirk Rubbelke. Nakicenovic 1996. 51 Gilli 1995. 52 See also Frondel et al. 2002. 50

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Consider a house that shall be heated up to the temperature of Tin = 21°C, while the outside temperature remains Tout = 1°C. Among a great variety of technologies available for this task, heating with furnaces is one of the methods mostly used, whereas heat pumps are rarely employed. When, for instance, an electric furnace is used, electric energy is transformed into heat. In practice, a part of the electric energy provided by a power plant cannot be transformed into the desired heat. That means, depending upon the furnace, more or less of the electric energy is wasted. The concept of first law efficiency measures the ratio of the minimum energy per time, such as for instance, the minimum power that is theoretically required to the power that is actually necessary to maintain a constant temperature with this electric furnace:

ε1 =

Pmin (electric furnace) Pactual (electric furnace)

(1)

The power that is actually necessary, Pactual (electric furnace), may be split into two parts: the minimum power Pmin (electric furnace) that is necessarily required and an amount of power that is wasted. Only if no power is wasted the first law efficiency will amount to 100 per cent. An ideally working furnace is an example. In practice, however, ε1 is smaller than 100 per cent. Typically, first law efficiencies of electric furnaces are in the range of 70 to 80 per cent, with best performing electric furnaces operating with efficiencies greater than 90 per cent. For the sake of simplicity, we assume that our electric furnace is perfect in terms of first law efficiencies: ε1 = 100 per cent. In this case, the minimum electric power is required to maintain the temperature level Tin (Figure A4.1), because the electric power Pel delivered is transformed completely into heat power, Pheat. Moreover, an . entropy flux S is produced by the furnace, providing the heat service ultimately desired. Due to imperfect insulation, the entropy flux produced is exported gradually, requiring a permanent heating. This heat or entropy production is similar to the Figure A4.1 Comparison of Energy and Entropy Flows of (a) Electric Furnace and (b) Heat Pump

Source: Reynolds and Lunnas 1978.

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entropy-producing rubbing of hands in order to warm them. A person who rubs his/her hands on a cold winter day experiences what entropy production is. Unlike an ideal electric furnace, a heat pump ideally does not produce entropy. Rather, the heat pump merely imports entropy from outside the house. Yet, without a heat pump, entropy, especially heat, would not flow from the lower temperature Tout to the higher temperature Tin by itself. By itself entropy, especially heat, flows from higher to lower temperatures. This is the reason why a heat pump is indispensable for delivering the heat power desired. As do electric furnaces, heat pumps run on electricity. Recall that, in our example, the heat pump is assumed to work ideally, that is, its first law efficiency equals 100 per cent. In other words, the electric power which is necessary for heating the house with a perfect heat pump equals precisely the minimum electric energy. Hence, both the ideal electric furnace and the ideal heat pump work equally well in terms of first law efficiency. Nevertheless, the furnace technology is inferior to that of the heat pump. For Tin = 21°C = 294 K and Tout = 1°C = 274 K, we obtain from the laws of physics.53 ⋅

Pel (heat pump) (Tin − Tout ) ⋅ S 20 K = = = 0.073 ⋅ Pel (furnace) 294 K T ⋅S

(2)

in

The minimum electric power required by the heat pump is lower than 8 per cent of the electric power required by the furnace for the same amount of heat power desired. Theoretically, a heat pump is the best technology. It needs only a minimum amount of electric power for the task of space heating because the heat pump imports almost all the heat from outdoors. On the other hand, an electric furnace is the worst technology. It requires the maximum amount of electric power for the same task, as no heat is imported at all (see Figure A4.1). Rather, the entire heat is produced inside. Inspired by equation (4.2) Nakicenovic54 as well as Frondel and Rubbelke55 define second law efficiency as the ratio of minimum power required by the theoretically best technology to the minimum power necessary for the technology actually employed in order to achieve the same task:56

ε2 =

Pmin (theoretically best technology ) . Pmin (actually applied tecchnology)

(3)

By definition, second law efficiency refers to both the technology actually employed and to the technology that would, at least theoretically, be the best. By contrast, first law efficiency relates only to the technology actually employed. 53

See Frondel and Rubbelke 2002, 290 and Figure 1. Nakicenovic 1996. 55 Frondel and Rubbelke 2002. 56 Nakicenovic (1996, 81) define second law efficiency as the ratio of theoretical minimum energy consumption for a particular task to the actual energy consumption for the same task. 54

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The miserable second law efficiency performance of electric furnaces reflects the poor match of the technology employed and the purpose for which energy is used: Heating with the help of electricity is a sin in terms of entropy because electricity has to be generated with some effort and is accompanied by a production of entropy in the form of waste heat. The high-quality energy in the form of electricity is misused for heating purposes, producing entropy in the form of heat once again, albeit desired now. With respect to entropy considerations, it would be better to use gas and to produce entropy in the form of desired heat only once. As far as first law efficiencies are concerned; such questions are not an issue. No alternatives, exclusively the technology actually employed, are taken into account. From this limited point of view and given the high first law efficiencies with which electric energy is transformed into the desired heat, heating with electricity seems to be a big deal. However, the fact that the second law efficiency is lower than 8 per cent in this example stresses the mismatch of the application of high-quality energy for low-quality energy services.

A.3 Real World Second Law Efficiencies Second law efficiencies as low as in our stylized example are far from being unrealistic. The second law efficiency of overall electricity consumption, for example, is estimated by Gilli et al. to be lower than 6 per cent on a world-wide average.57 In contrast to low second law efficiencies, however, commonly high first law efficiencies support the impression that further efficiency improvements are hardly possible. Moreover, while our example merely focuses on the efficiency with which space heating is accomplished by final energy in the form of electricity, we have to take into account that electricity must be produced out of primary energy. Figure A4.2 World-wide Averages of Second-law Efficiencies for the Generation and Transformation of Electricity into Energy Services

Source: Frondel and Rubbelke 2002.

57

Gilli et al. 1995.

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In Figure A4.2, efficiency considerations are extended to the complete generation and transformation chain, starting with primary energy and ending with the supply of the desired energy service. Figure A4.2 displays world-wide averages of second law efficiencies appraised by Gilli et al.58 for each conversion step. While primary energy carriers like coal, gas, and oil are transformed into final energy in the shape of electricity with rather high second law efficiencies –ε2 is about 72 per cent, including distribution losses, the least efficient part of the chain is the end use of electricity by consumers. Electricity is converted into useful energy, such as for instance for heating purposes, by consumption technologies, such as electric furnaces, with a second law efficiency whose world-wide average is estimated to be as low as 14 per cent.59 At a first glance, it looks like the final step. However, an energy service, such as heating a house, would require less useful energy if the house had better insulation. For such reasons, a final, artificial conversion step from useful energy to the ultimately desired energy service is introduced by Gilli et al.60 for which these authors appraise a second law efficiency of about 40 per cent. Hence, according to Gilli et al.61 the second law efficiency of electricity consumption is only about 5.6 per cent on an average, world-wide. This percentage suggests that there is a potential for efficiency improvements in the consumer’s sphere that is much higher than the potential in the producer’s sphere. Overall, the world-wide average of the entropy efficiency of all steps that are necessary to provide an energy service with the help of electricity is as low as 4 per cent. Low estimates of world-wide averages of second law efficiencies for the generation and transformation of electricity into energy services provided by Gilli et al.62 support our example, which indicates that much more efficient technologies than those currently applied might be available. Above all, ‘(…) end-use devices are on average the least efficient components of the energy system’.63 This result promises a higher potential for efficiency improvements in electricity consumption than in electricity generation. But how can we explain that the most efficient technologies are not implemented? Economic reasons, such as high time preference rates of consumers still prevent highly efficient consumption technologies, such as power-saving light bulbs, from being the current technical standard, although these technologies offer long run economic advantages for consumers.64 Prohibitively high information costs for consumers, partially caused by the common impression of high first law efficiencies, are but one example of those reasons and market failures. These problems could be solved by information programmes, energy contracting and demand-side management.

58

Gilli et al. 1995. Ibid. 60 Ibid. 61 Ibid. 62 Ibid. 63 Nakicenovic 1996, 18. 64 Ekins 1995. 59

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A.4 Conclusion In this contribution, we have illustrated the concept of second law efficiency with a stylized example. We have highlighted that technological efficiency potentials are, by far, not exhausted. This result contradicts common impressions of high technological efficiencies that are based on the concept of first law efficiency. The discrepancy is a consequence of the major distinction between both concepts. While first law efficiencies solely refer to the single technology actually applied for a special task, the concept of second law efficiency takes into account the purpose for which energy is required and relates two technologies to each other: the technology actually employed and the optimal technology for the same purpose. Space heating, for example, can be achieved more efficiently—in terms of second law efficiencies—and perhaps less expensively—in terms of marginal cost—on the basis of gas such as for instance, rather than by high-quality energy in the form of electricity. The concept of second law efficiency particularly emphasizes the mismatch of applying high-quality energy for low-quality energy services, such as space heating. In sum, with respect to both a sustainable economic development and an economically more efficient use of energy, it would be desirable in many situations if agents were better informed and took account of the purposes for which energy is required. However, although the potential for efficiency improvements seems to be substantial when technological efficiency is measured by the concept of second law efficiency, technological progress is only a necessary, yet not sufficient, condition for reducing pollutant emissions. The question is whether the rates of efficiency improvements will be higher than the world’s increasing rates of energy requirements. It is the level of real energy prices—which is partially affected by energy taxes— that will determine the answer to this question. Increasing energy prices may induce income and substitution effects that possibly dampen the future world-wide rise of energy demand. Moreover, a rise in energy prices may stimulate R&D, environmental innovation and demand-side management. Finally, higher prices might enhance the efficiency level of, specifically, consumption technologies.

5 The Benefits and Drawbacks of Energy Efficiency

The aim of this chapter is to discuss the methods of assessing the advantages and drawbacks of energy-efficient technologies (EET) as well as projects. It is a proven fact that in specific situations and well-chosen energy efficiency (EE) proposals, benefits significantly outweigh drawbacks. However, it is important to mention the perceived and actual disadvantages and complications. In the present chapter, both these aspects are discussed from the perspective of the governments, businesses establishments and households. As the scope of investigation is a global one and the resulting drawbacks as well as benefits emerge out of a specific situation, this chapter should be understood as giving directions of thought rather than empirical evidence. The purpose of this chapter is to help the reader decide which EE programmes would give positive effects, and which would not, based on which he can learn to discriminate between alternative EE proposals.

5.1 Introduction Energy efficiency improvements have multiple advantages, such as the efficient utilization of natural resources, reduction in air pollution levels and lower spending by the consumer on energy-related expenditure. Investments in EE result in long-term benefits, such as reduced energy consumption, local environmental enhancement and overall economic development. Energy use has environmental impacts, regardless of the source or mechanism.

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For example, hydroelectric projects affect their local ecological systems and displace long-standing social systems. Fossil fuel power creates pollution in the extraction, transportation and combustion of its raw materials. The long-term storage of the waste products of the nuclear power industry is an issue yet to be resolved. Cost-effective energy efficiency is the ultimate multi-pollutant reduction strategy. Many win-win opportunities for EET exist, which can provide benefits in terms of the following dimensions: domestic and global, environmental and economic, as well as benefits for multiple stakeholders in society. There are ways to ensure benefits for all parties, including the government, companies and consumers. Sectors for EE include industries, commercial establishments, households, municipal buildings, as well as transportation and agriculture. The industry category includes such heavy energy users like cement, aluminium, glass, chemicals, and pulp and paper. EE applies to various human activities like private, public or industrial. Each such activity has an actor who is carrying it out. One actor produces energy, another supplies technology while other actors market or use the technology or make policy decisions. If the central actor wants to introduce EE, he or she needs to contact the other actors to succeed. Many a time, the projects may fail even if the technology is valid and, conversely, may succeed even if the technology is not a sensible one.1 There are three consequences of these developments in EE. First, the EETs will make industries more efficient by improving the productivity of labour, leading to higher growth rates for many economies. Second, these new technologies require less electricity, petroleum products and gas as their fuel. The global demand for these carriers, then, will be less than it would have been without the technologies. Third, the efficient technologies afford business firms the opportunity to become global, moving their operations from one country to another on the basis of local economic and political considerations. As a result of these developments, policy makers should focus attention on the EE.

5.2 Benefits of Energy Efficiency The short- and long-term benefits of EE are given in Table 5.1. In households, improving the efficiency of energy use resulting in reduced energy requirement to provide a given amount of lighting, cooking, heating and other services is equivalent to an increase in income on account of 1

Dr Eric Ferguson 2003 (personal communication).

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Table 5.1 Positive Aspects of Energy Efficiency Short-term benefits

Long-term benefits

Reduces load, peak demand and energy use

Less oil wells, refineries, forests, land, water, etc. Less subject to security risks and interruptions Creates jobs and improves the economy Less subject to market and fuel price volatility Improve economic development Less transport (fuels to the energy generating places) Less health impacts Reduced environmental impacts (a) Local pollutants (b) Global pollutants (c) Water use Increases energy security

Reduces market prices for all consumers Often less costly and more cost effective Less subject to market and fuel price volatility No transportation and distribution costs Short gestation periods Fuel is saved Plantations are saved

Reduces local pollutants Improved quality of service Source: Authors.

reduced expenditure. In the long run, households enjoy the benefit of lower expenditures on energy, while increasing their comfort and well-being. For commercial and industrial sectors, using energy more efficiently reduces the cost of producing goods and services. This in turn can translate into lower production costs, higher output and more profits in the short term. The lower product price results in increased sales. This means that these sectors employ more workers to satisfy the increased demand for their products. The increased employment, of course, improves the performance of the local economy. The governments can also benefit from energy efficiency improvements as government-owned buildings can use less electricity, oil, gas and water. They can also use less electricity for street lighting. The local transport system that uses petrol and diesel fuel will save significant amounts of money if EETs are used. Similarly, reducing congestion and other measures can have a marked impact on local environmental conditions if a community currently relies on automobiles for local transportation. Global environmental conditions can improve to the extent that local energy efficiency improvements will reduce consumption of energy sources that produce greenhouse gases (GHGs). There is also an opportunity cost involved in the increase of EE. The increase in the efficiency results in reducing the resource utilization. The governments can use these resources to reduce taxes or increase spending on other goods and services. Local and

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global environmental conditions can improve if households, business enterprises and governments use energy more efficiently. EE programmes have widespread and diverse environmental impacts that go beyond GHG impacts. The environmental benefits associated with EE programmes can be just as important as the global warming benefits. Potential environmental impacts that need to be considered are presented in Box 5.1. Direct and indirect programme impacts need to be examined, as well as ‘avoided negative environmental impacts’ (for example, the deferral of the construction of a new power plant). Both gross and net impacts need to be evaluated. Box 5.1 Energy Efficiency and the Indoor Environment In developing countries, fuels are often burned in inefficient stoves, with inadequate or in many cases non-existent chimneys. The resulting indoor air pollution exposes families to particulates, carbon monoxide and other products of combustion. The costs of the failure to recognize the energy development linkage is evident in the nations’ health statistics. Studies indicate high risk, such as acute respiratory infections (ARI), chronic obstructive pulmonary disease (COPD), lung cancer and also tuberculosis (TB), asthma and blindness. In India, conservative estimates indicate that some 400–550 thousand premature deaths can be attributed annually to the use of biomass fuels in these population groups. Using a disability-adjusted lost life-year approach, the total is 4–6 per cent of the Indian national burden of disease, placing indoor air pollution as a major risk factor in the country. In a more recent study, respiratory diseases across all age groups cost the South African Department of Health USD 75 million in treatment costs alone. In addition to these costs, there are productivity and quality of life losses which are more difficult to quantify, but could conceivably add up to tens of millions of dollars equivalent per year. Substituting efficient fuel wood stoves in place of inefficient stoves or shifting from fuel wood to LPG can solve these problems. Source: Reddy and Srinivas 2009.

5.3 Energy Efficiency—Actors’ Perspectives EE programmes provide economic, environmental and social benefits for two reasons. First, the persistence of GHG reductions and the sustainability of EE programmes depend on individuals and local organizations that help support a programme during its lifetime. Both direct and indirect programme benefits will influence the motivation and commitment of programme participants. Hence, focusing only on environmental impacts

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would present a misleading picture of what is needed in making a programme successful or making its environmental benefits sustainable. Second, the diverse group of stakeholders (for example, government officials, project managers, non-profit organizations, community groups, project participants and international policy makers) are interested in, or involved in, EE programmes and are concerned about their multiple impacts. Looking at the perspectives of various actors should help to improve the credibility of the programme (by showing stakeholders that these impacts have, at least, been considered) as well as facilitate the review of EE programmes.

Governmental Perspective This perspective looks at the net costs of the EE project as a resource option based on the total costs to the government and the customer. Energy efficiency issues that also need to be looked at from the government perspective include national development goals, social equity, national priorities, selfreliance, energy security, policy making as well as institution forming. Energy inefficiency plagues almost all of the developing countries that face energy shortages. The process of reforms that are taking place in many developing countries emphasizes appropriate pricing and efficiency in the use of resources, including energy resources. Programmes to promote energy efficiency and incentives to adopt efficiency improving measures play an important role. A significant benefit from improved energy efficiency is the reduction in GHG emissions and a well practiced concept to facilitate parts of the Kyoto Protocol (1997) and further governmental agreements concerning environmental issues.2 Studies carried out at the Indira Gandhi Institute of Development Research (IGIDR), Bombay, India, reveal that the power sector is responsible for the highest direct CO2 emissions in India, followed by iron and steel, road and air transport and coal tar.3 There could be a significant reduction of these emissions through improving the efficiency of coal and electricity use. Hence, environmental benefits of energy efficient measures play an important role in reducing GHG emissions. If efficient measures are not implemented, power plants have to be constructed for which land, energy, steel, concrete as well as transportation 2

Under the United Nations Framework Convention on Climate Change (UNFCCC) in Kyoto, Japan (December 1997) countries agreed the first protocol which among others ‘strengthens the commitments of industrialised countries to reduce GHG emissions by establishing legally binding targets in the time frame 2008–2012 for a “basket” of six categories of direct greenhouse gases (CO2, CH4, N2O, PFCs, HFCs and SF6)’ (OECD 1999a, 16). 3 Parikh et al. 1994.

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facilities are required. During the operation, power plants use coal with significant ash content and emit CO2, SO2, NO2, and so on, which pollute air, water and land. Thus, environmental benefits also provide motivation for the implementation of energy efficient options. Also, alternative power generation through co-generation and biomass gasification reduces the electricity consumption. Since there are significant energy and carbon savings, Global Environmental Facility (GEF) funding will help these technologies to penetrate faster.4 Growing imports of oil are a major worry of many policy makers in developing countries. Thus, the government encourages programmes that substitute oil with other fuels or that increase the efficiency of oil use, particularly in the transportation sector. Thus, for example, it promotes the usage of compressed natural gas for vehicles, subsidizes electric vehicles and subsidizes urban mass transport. Energy security is an important issue that has to be tackled by the government. Over the last three decades, we have witnessed events that have transformed the outlook of the global oil market. The first oil crisis of 1973, the invasion of Kuwait by Iraq and the recent war on Iraq have resulted in sharp fluctuations in energy markets and reawakened concerns about energy security both for oil producers and consumers. Ensuring oil supply means being prepared to mitigate any short-term disruption of supply, and foster investment into a sustainable long-term supply. Mitigating short-term disruptions to oil supply involves use of oil stocks and emergency response measures, such as demand restraint, fuel switching and surge in production. Securing reliable, competitive and environmentally sustainable long-term oil supply in the world is the responsibility of the governments. In this respect, promotion of indigenous resource development; diversification of the energy mix and the supply sources for any individual fuel; and improved energy efficiency play an important role in reducing oil demand. Archaic economic, financial and institutional barriers might have kept out many efficiency measures. Due to controls and subsidies in this sector, many of the EETs do not even enter the demonstration level. To become attractive, these technologies need the removal of controls and the introduction of price reforms. This is happening gradually in all energy subsectors and many others besides steel, textiles and fertilizers. 4

Parikh et al. 1994.

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Moreover, due to the liberalization of import, developing economies are exposed to the rigours of competition and efficiency upgrades. Joint ventures in capital goods, such as cars, refrigerators and other consumer goods result in energy efficiency. Russia is an example worth mentioning here as it contrasts with the rest of Europe. For example, it takes five tons of coal in Russia to produce the amount of electricity that only one ton of coal would yield in the US. Similarly, it takes roughly eight Russian power plants to generate the amount of electricity that a single plant in western Europe produces and eight times 5 more electricity to light a house in Russia than in Germany. In short, economic prosperity and growth are enhanced by EE. Conversely, high-energy intensity places an enormous burden on long-term industrial competitiveness and poses critical problems to improving living standards. Energy inefficiency becomes a drain on factories, machinery and resources, affecting competitiveness. Hence, it is important that the government improves the efficiency of the energy supply systems and reduces losses at the demand side. In Thailand a valuable mechanism exists, which serves as the starting point of an integrated nation-wide energy efficiency programme. The National Energy Policy Office is an effective and pragmatic body in creating energy policies and establishing priorities for the economy. Thailand is a stellar regional example of introducing energy initiatives and priorities. The government and businesses understand the importance of 6 energy conservation and recognize the need to do more. An appropriate policy environment is necessary for the replicability and the sustainability of the EE options, if funded. Similarly, energy development agencies should be set up to pursue EE strategies. Along with that, power finance corporations, which take up small modernization projects to improve supply-side efficiencies, are needed. The established system for promoting efficiency improvements needs to be transformed to operate effectively in the new environment. The recent policy of economic liberalization seeks to promote an entry of the private sector—domestic and foreign—into all areas of the energy sector, be it coal, oil, gas or electricity. This means, that the administered prices have to go which means reduction in subsidy, if not complete removal. Moreover, due to the liberalization of import, the economies of various countries are exposed to the rigours of competition and efficiency upgrades. Joint ventures in the manufacture and distribution of capital goods, such as cars, refrigerators and other consumer goods have resulted in EE improvements. 5 6

Hill 2001. Ibid.

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Hence, strong government support and encouragement is needed to enforce minimal efficiency standards and other legislation. An institutional framework is required to ensure appropriate equipment certification, testing and energy auditing. The most effective approach is a collaborative effort between the government and businesses. To implement energy efficiency programmes and policies, the financial infrastructure is a must to support these investments. Some successful models have included financial support to help businesses to switch to more efficient systems. Energy service companies, leasing programmes, guarantee funds and insurance mechanisms are some of such models, which can play a critical role in the phase of transformation.

Business Perspectives It took a long time for the business community to come to terms with energy efficiency. John B. Robinson argues that the relative novelty of the energy efficiency field together with its technical nature and the invisibility of energy caused a lack of good information on EETs, their potentials and costs.7 There are also other issues pertaining to the attitudes. They include the lack of recognition of non-market needs of consumers, and the focus of the private sector on environmental remediation rather than pollution prevention. Leaving aside that business goals and the measurement of their successes are complex and a matter of debate, it can be safely assumed that business establishments are profit-seeking organizations. Therefore, unless industrial firms consider resource depletion and environmental degradation, in terms of economic and management concepts, such as customer demand for green products, they are not likely to integrate environmental aspects into their decision making process. However, EE is just one of the many names given to the concept of developing the economy while protecting the environment. Industrial ecology refers to the study of using resources efficiently as part of good business practices. Energy efficiency and pollution prevention involve the efficient use of resources, which is key to industrial development. Industries not only prevent pollution but can also enhance profits by reducing energy and material use. They save the direct costs of these resources, as well as reduce disposal costs, avoid fines, and minimize bad publicity. In addition, resource efficiency often enhances productivity, streamlines production and improves workplace conditions. Within many parts of the business community, there is traditionally resistance towards organized forms of protecting the environment.Without 7

Robinson 1991.

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being exhaustive, from an approach centred on society which views the state as ‘(…) tightly constrained by the structure of power within society (…)’ any kind of organization is a matter of power and lobbying.8 Therefore, an organized environmental protection group and movement, as well as governmental intervention might be interpreted as a loss of power and influence by the energy sector.9 S. Meyer provides another explanation for the renunciatory business behaviour with regard to environmental regulation: ‘Environmental costs are seen as a form of externally imposed social tax, an illegitimate tax placed on business.’10 However, in recent years, the industry has been increasingly active in finding ways to increase the quality and to decrease emissions at the same time. Relevant market players, including corporations, analysts, bankers, insurers and individual investors have started to take advantage of sustainability concerns. The financial industry is becoming aware of the cost of inaction. Environmental disasters have caused great losses in the insurance market and environmental factors influence company accounts, as for instance, in loss provisions and reserves made for contaminated land. According to Schmidheiny and Zorraquín, ‘They also see some of their colleagues making respectable returns in investment funds that trumpet their environmental ethics.’11 Many business establishments are introducing competition into their industries to make them more efficient. The advantages of competitive markets are well known: lower costs and prices, more product choices, better customer service and less intrusive regulation by government agencies. Efficient technological innovation allows competition in the industry. Using energy more efficiently reduces the cost of producing goods and services. Depending on the type of market, this resource-cost reduction can translate into lower production costs, higher output and more profits. If maximizing profit is assumed to be the main objective of companies, there is a compelling motive to save energy. Companies can produce and acquire new goods and services, which are less energy consuming and in these ways lower expenses. Investments into EE can greatly reduce, defer, simplify and cheapen investments while improving their technical performance. If the cost of EE investments exceeds the value of the energy savings, then the EE investments are not made. This means that energy efficiency is a good choice if and only if the company is using less than optimal energy technology.12 For example, Visteon Corporation improved its compressed 8

McGrew 2000, 183f. Humphrey et al. (2002) give an overview of the history and current trends of the environmental movement. 10 Meyer 1995, 11. 11 Schmidheiny and Zorraquín 1996, 78. 12 Ferguson 2003. 9

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air system at its automotive glass plant in Nashville (USA) in 2000 by replacing existing units by smaller and more energy efficient units. The total cost of project implementation was USD 724,000. The benefits were a total annual savings of USD 711,000, which lead to a simple payback of about one year, reduced annual energy consumption by 7.9 million kWh, reduced maintenance costs, improved system performance and avoided asbestos abatement costs to the tune of USD 800,00013 (Box 5.2). Box 5.2 Benefits of EE for Business Establishments Reduce, reuse, recycle, resell waste; Recover usable materials from wastes; Eliminate release of hazardous sludge; Reduce energy use; Reduce transportation; Increase production efficiency; Reduce operations downtime; Increase productivity; Reduce failure rates; Reduce operating expenses; Reduce water usage; Reduce disposal costs; Reduce chemical treatment liability; Reduce sewage expenses; Increase sales; Reduce capital costs; Improve product quality and longevity; Increase plant capacity; Reduce space requirements; Preserve and increase jobs; Reduce noise levels; ‘Reuse’ brownfield site; Free capacity at municipal treatment plants; Improve environmental reputation and image. Source: Based on Business Roundtable 2007 and Pye 1998.

Since the UN Intergovernmental Panel on Climate Change (IPCC) declared in its ‘Second Assessment Report’ from 1995 that ‘(…) significant no-regrets opportunities are available in most countries (…)’,14 there has been wide recognition within industry that climate change is not only a 13 14

OIT 2003. UNEP and UNFCC 1995

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problem but also an opportunity.15 In many cases, the business community is emerging as one of the major players in the quest to save the planet. The involvement of private industry, though driven by profit, is as crucial to the successful implementation of international agreements on global environmental issues as the role of governments and civic society. The Montreal Protocol has been a success story. Possibly the scope for private industry participation is even greater in the provisions of the Kyoto Protocol, which places legally binding limits for developed countries on the emission of six greenhouse gases. Although the mechanism for achieving the Kyoto targets is still developing, there is already considerable private sector interest in one of them, the Clean Development Mechanism (CDM). The CDM allows investments in projects in developing countries that reduce emissions, to generate certified emission reduction units, which in turn may contribute towards compliance by developed countries. The CDM has the potential to become a powerful instrument for foreign direct investment and technology transfer, provided certain conditions are met. The main goals of the CDM are to: Assist developing countries in achieving sustainable development; Assist developed countries in complying with part of their emission reduction commitments; and Achieve eco-efficient production with economic and environmental benefits. The most attractive feature of the CDM from the view of the private sector is that it will be project-based. Projects will most likely be of three types of which the mitigation of emissions through application of EETs is an important one. Thus, all CDM projects would have double dividends in the form of additional GHG reductions as well as energy efficiency and pollution prevention. Successful private sector involvement in the CDM will, however, require a number of conditions to be met for reducing inherent risks. These include assured credits, minimum overheads, flexibility, transparency and simplicity, an appeal mechanism and stability. Ultimately, it is the profit motive that will drive private participation in the CDM, and in other international initiatives supported by multilateral negotiated agreements. From an environmental perspective, therefore, the increasing EE is extremely important. A. Lovins, L.H. Lovins, and P. Hawken have proposed an approach which ‘(…) not only protects the biosphere but also improves profits and competitiveness’.16 According to their concept ‘Natural Capitalism’, business practices go through four major shifts: 15 16

Rogers 1997. Lovins et al. 2000, 251.

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‘Dramatically increase the productivity of natural resources.’17 This could be done by the application of systems thinking and the use of new and innovative technologies. ‘Whole-system thinking can help managers find small changes that lead to big savings that are cheap, free or even better than free (because they make the whole system cheaper to build)’.18 Produce according to biological models, as for instance via closed loop manufacturing. This will reduce waste drastically: For example, Du Pont recycles its polyester industrial film into new film, which leads to another design of the film with less material intake and less production costs and better performance of the film.19 Adopt a solutions-based business model. Reinvest in natural capital because ecosystem services are limiting factors.20 According to Richard Dorf, business corporations have made a transition in the past 50 years through several stages of corporate environmentalism. These stages are summarized in Table 5.2 Table 5.2 History of Corporate Environmentalism Stage

Decade Description

Industrial environmentalism

1960

Regulatory compliance

1970

Social responsibility

1980

Strategic environmentalism

1990

Sustainable environmentalism

2000

Internal problem solving: The impacts on environment were seen as outside the corporation. Regular departmental units were used to address these issues. Compliance with government regulations: Corporations became defensive as the number of regulations increased. Separate environmental departments were established by corporations. Impact reduction and protection of reputation: Corporations were dedicated actively. Recycling and waste reduction: Corporations were engaged proactively in programmes. The environmental departments became more influential. Integration of business goals and environmental goals: The environment is seen as a strategic issue and incorporated.

Source: Adapted from Dorf 2001, 41.21

17

Lovins et al. 2000. Ibid., 253. 19 Ibid. 20 Ibid. 21 Adapted from Dorf 2001, with permission from Elsevier Science. 18

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T. C. Russell, industrial programme manager for the Alliance to Save Energy, underlines the importance of communication and presentation to convince decision makers. There is a need to persuade them with hard facts and numbers that energy efficiency can save money, contribute to corporate goals and reduce energy use.22 In his article Justifying Energy Efficiency Projects to Management, Russell suggests how to interpret, as for instance, the benefits of fuel cost savings. ‘Implementing energy efficiency lets the corporation enjoy two benefits: decreased fuel expenditures per unit of production and fewer emission-related penalties.’23 The savings resulting from decreased expenditures for fuel are equivalent to a new source of capital. For publicly held corporations energy efficiency is a good way to add shareholder value.24 There are a large number of avenues to adopt energy efficiency measures, both from supply-side as well as demand-side. For example, a study conducted with reference to India reveals such avenues as shown in Tables 5.3, 5.4 and 5.5. Table 5.3 Potential Savings due to Increase in Supply-side Efficiency Economic cost Rs/kWh (2002 prices)

(a) Abated Carbon saving (kg/CO2/kWh compared to base)

Power (Coal-based power 2.50 plant as base technology) a. Combined cycle power 2.76 plants b. Integrated gassifier 3.15 combined cycle (IGCC) 2.91 c. Lsfig/Stig Inter-cooled steam injected gas turbine 3.32 d. PFBC Pressurized fluidized bed combustion e. Pulverized coal super2.92 critical boilers Auxiliary consumption 1520 GWh25 1.5 million tons 1.5 million distribution Rs 21.5 billion T&D and Transformers a. Amorphous core (Annual installed 150,000 transformers levelized) transformers added/year. Savings 4.13 Tg CO2 b. HVDC transmission 0.15 Tg CO2/year Rs 1.36 billion saving additional annualized cost

Base technology emission 1.3 kg/kWh 0.96 kg/kWh (a)

Option

Total potential

Source: Reddy and Balachandra 2003. 22

Russell 2001. Ibid., 24. 24 Ibid. 25 Per year for 210 MW for India. 23

0.28 kg/kWh (a) 0.79 kg/kWh (a)

0.32 ˝(a)

0.23 ˝(a) 1–55 Annual energy cost saving Rs 8.59 billion; energy saving 3.18 TWh. 120 million KWh/year saved—savings equal to Rs 45.12 million

Steel Cement

Aluminum

Industrial

Sector

Electric arc furnace Non-precalciner kiln

Non suspension preheater technology

Dry suspension preheater technology

Efficient technology Energy efficient motor Variable speed drive PUMPFAN Compact fluorescent lamp High power sodium vapour lamp Electronic ballast Vapour absorption refrigeration systems Efficient boiler ALCOA process

Base technology Standard motor No variable speed drive Standard PUMPFAN Incandescent lamp High power mercury vapour lamp Magnetic ballast No vapour absorption refrigeration systems Standard boiler Bayer Hall Heroult process No electric arc furnace Dry precalciner kiln

Option

Rs. 70 million for 850 tpd plant 0.87 Rs.1100/annum/ton of cement Rs.50 million

1.00 0.94

13.2 34.3

20–30% energy savings/year 44.3 1.72 GJ/ton of cement 1.53 GJ/ton

Economic cost (Rs/ kWh) (2002 prices) 1.20 1.55 1.27 0.61 0.64

Potential by 2015 (TWh) 57.9 291.0 55.8 2.9 1.2

Table 5.4 Potential Savings due to Increase in Demand-side Efficiency

194.13 kg/ton

31 218.42 kg/ton

9 24

CO2 emissions (million tons) 41 204 39 2 1

66

249 212

1.89

11.40

7.12 6.05

(Rs/ton) USD /ton 157 4.49 263 7.52 215 6.15 121 3.47 254 7.25

Cost (2002 prices)

126 ENERGY EFFICIENCY AND CLIMATE CHANGE

Source: Reddy and Balachandra 2003.

Compressed natural gas car Compressed natural gas bus Battery operated vehicle CFL ELB CFL ELB Efficient pump

Waste heat recovery system

No waste heat recovery systems

Petrol car Diesel bus Diesel Incandescent lamp Magnetic ballast Commercial Incandescent lamp Magnetic ballast Agriculture Standard pump

Transport Car Bus 3 wheeler Residential

No heat pump

Mercury cell Solvey process

Heat pump

Caustic soda Membrane process Soda ash Dual process

218.3 6.9 7.7 1.0 95

15–20% savings 15–20% savings

5% savings 80% electricity and coal savings 25–30% thermal energy 33% energy savings

Rs 1.5 million 0.65 1.02 0.63 10.00 27 million tons

Cost of recuperator = 0.9 tp 1.5 million

Rs 250 million Rs 130 million more than base technology Rs 10,000/kW

20–25% 20–25% 0.62 kg/VKM 153 5 5 10

0.96 ton of soda 101 kg/ton of soda ash 0.06 to 0.12 kg of steam generated 12 kg/ton of steel

130 265 128 243

3.71 7.57 3.66 6.94 13.60

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Rs 1900 per stove per year. Rs 187 per stove per year Rs 2,364 per unit Rs 1075 (1995–96 price)

c. LPG

d. Solar cooker e. Solar water heater f. PV. Lantern

Source: Reddy and Balachandra 2003.

Rs 485 per stove per year.

3,580 kg of CO2 per year compared to traditional wood stove. 3,350 kg of CO2 per year per stove compared to wood stove. 387 kg of CO2 860 kg of CO2 compared to wood stove. 1.3 kg of CO2/kWh for 100 kWh/year

1,230 kg of CO2 saved per year per stove

220 kg/CO2 per unit per year.

1.40 kWh/unit per year saved. No additional cost. Rs 120 per unit R.0.1/kg of CO2

Rural Cooking a. Improved cooking stoves with 10% efficiency improvement b. Kerosene stoves

160 kg/CO2 per unit saved. (1.6 kg/CO2 per kWh saved)

Rs 0.27/kWh saved. 100 KWh/unit per year saved

8.3 million units growing @ 21% per year

Domestic a. Increase energy efficiency ratio of domestic refrigerators b. Efficient air conditioners

Cost of carbon savings (1990 prices)

Cost of energy savings (1990 prices)

Saving potential

Sector

Table 5.5 Potential Savings due to Other Options

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Energy Efficiency and Clean Energy as New Hi-tech Markets Energy efficiency and clean energy may provide an opportunity to participate and create a new market. Patrick Mazza from Climate Solutions, an advocacy group, suggests that ‘Clean energy generation and end-use efficiency represent a USD 3.5 trillion market over the coming 20 years, even with no new public priority’.26 There will be plenty of business opportunities in resource efficiency and productivity in the energy, water, agriculture, transportation and forest product industries. Examples of these opportunities include fuel cells, enzyme-based water treatment systems, precision farming technologies and bio-based fuels and speciality chemicals. It is estimated that the combined value of the resource productivity and efficiency market of these industries exceeds USD 60 billion and is growing rapidly. As this market develops, it will increasingly attract the attention of, and investment by, major corporations world-wide. The industry leaders will seek to secure a strong position in EE technologies and products and business opportunities that will allow them to defend and enhance their competitive advantage. With the growth of the efficiency and productivity market, there will be an increasing demand from both large and small fast growing companies for financial services related to this niche sector. To help financial investors, large corporations, and young innovative companies capitalize on these business and investment opportunities, the government should focus its strategy and opportunity analysis on the fundamental drivers that fuel this market expansion. These drivers include:

Deregulation and Increased Competition The electric power industry is a case in point. The USD 500 billion US and European electric power industries are being deregulated to allow for increased competition in wholesale generation and retail energy services. This is driving the development and deployment of technologies that improve energy efficiency, reduce costs to customers and respond to customer demand for improved power quality. One example is distributed generation, which enables customers to manage and produce their electricity on site, recover waste heat for other purposes, and reduce their vulnerability to grid-related power disruptions. Sales of emerging distributed energy technologies, 26

Mazza 2002, 158.

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such as fuel cells microturbines and photovoltaics are expected to grow at 12 per cent annually, exceeding USD 10 billion in sales by the year 2010. In contrast, sales of traditional power equipment are growing at only 2 per cent annually.

New Information Technologies and E-commerce Information technology and the Internet are reshaping natural resourcebased industries, providing, in many ways, the most powerful systems and tools to increase efficiency and productivity. For example, remote metering technologies allow for real time measurement of energy use. This enables energy companies to price their products more effectively to encourage off peak usage and peak period conservation.

Environment as a Competitive Market Force Transportation industry is a good example for this. Environmental concerns, issues and regulations are impacting the business strategies and investment decisions of major corporations world-wide. For example, while global warming was not given much attention in the early and mid-1990s, companies in the energy and automotive industries are now integrating the issue into their core businesses and long-term strategies. Pressures to reduce local air pollution are also increasing. For example, the US requires the use of reformulated fuels in certain polluted regions, and the Environmental Protection Agency (EPA) has proposed a 97 per cent reduction in the average sulphur content in diesel fuel. These and other environmental issues and tighter standards are driving companies, such as Ford, BP Amoco, Toyota, Honda and Royal Dutch Shell to develop and invest in new low emission, low carbon fuels and technologies. In the automotive equipment market, new technologies include improved catalysts for pollution reduction, and new power systems such as hybrid electric vehicles and fuel cells. EE programmes reduce consumers’ risk in many ways. They are not subject to cost fluctuation once installed. In fact, they can help insulate the consumer from energy price risks. They are less susceptible to the risks of under- and over-bidding than supply options. They are not subject to major simultaneous interruptions. They contribute to overall system reliability by reducing demand in peak periods. Overall, efficiency can contribute to a more reliable supply of power as well as to stable capacities and energy prices.

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Society Perspective This perspective is similar to that of the government perspective but reflects the costs to society of energy efficiency projects. It includes externalities, that is, environmental factors, in the avoided costs. In this approach the issue is to see how EE can provide with a net positive economic benefit to the society as a whole. Here, various economic actors are included and externalities taken into consideration. From a national viewpoint, there is a wider range of relevant costs and benefits. These include monetary, health, and environmental costs and benefits that accrue to society. EE investment can create significant employment opportunities. Although providing employment was never a key aim of EE policy, the positive employment side effects of policies and programmes will prove to be useful in building support for EE investments across various governments. New jobs can be created especially in manufacturing and the construction sectors. This is particularly the case where EE projects can demonstrate positive impacts for social groups currently disadvantaged in the employment market; for example, those with low skills and few qualifications, living in economically deprived areas. Joanne Wade and Andrew Warren, have co-authored a paper in which the employment impacts of EE investment programmes in nine European Union (EU) Member States are discussed. Based on detailed case studies of 44 individual programmes and modelling of the wider effects, the study investigated short- and long-term impacts, both on total numbers of employed persons and on the skills mix utilized in the economy. The results confirm that there are net employment gains in virtually all cases. Table 5.6 illustrates these results in terms of net employment impacts. It can be noted that these are total impacts over an extended time period up to a maximum of 30 years in some cases. They suggest that employment gains for fiscal and regulatory policies are of a similar magnitude to the findings of the case study approach. However, they do suggest that the case study approach underestimates the positive effects of institutional programmes such as EE initiatives. The modelling results suggest a median employment gain of 29 person years per million whereas the case studies identified effects in the range of 8–14 person years per million. This difference demonstrates the fact that a case study approach cannot reflect fully the positive economic stimulus caused by private—rather than government—investment. Perhaps the most important, but least discussed and appreciated benefit of improving EE is the impact on local economies. Clearly households, enterprises and the government benefit directly by improving the efficiency of energy use. If they improve energy efficiency, they have more disposable

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Table 5.6 Employment Benefits in EU Countries due to Energy Efficiency

Schemes

Net employment (person/year)

Fiscal, residential France Germany UK Netherlands Germany UK Miscellaneous France Netherlands Spain UK

71,400 –4,200 3,815 1,000 3,800 17,400 81.7 3,800 3,344 12,260

Net employment per Net employment per million—government million invested invested 12.9 –9.5 9.3 12.6 Negligible 4.5 11.5 12.0 50.7 98.1

106.9 –31.7 9.3

11.5 372.5 265.4

Source: Wade and Warren 2001.

income. However, there is an important net benefit to local economies, too. If expenditures on energy are reduced, the savings will improve the performance of the local economy via the ‘multiplier effect’ to the extent the savings are spent in the local economy. The multiplier effect is an economic phenomenon characteristic of all economies, relating the spending and re-spending effects of money to the output of local economies. Also, the expenditures on energy efficiency improvements themselves will improve local economic performance because the materials and labour for those improvements are likely to come from the local economy. In today’s global market, economic growth is synonymous with efficient energy production, delivery and use. It enables increased output from power transmitters, electrical cables, motors and production units. On the supply side, it is no coincidence that energy production and delivery efficiency is higher in more developed economies.

Consumer Perspective Households experience two kinds of benefits: (a) direct benefits from reduced energy use and (b) indirect benefits stemming from improvements in previous stages through energy production, transmission and distribution, and so on. Direct benefits influence households due to savings resulting from lower energy bills and an increase in comfort. Indirect benefits of energy efficiency also influence households. For example, prices for consumers decline when

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energy efficiency improvements in industry lower production costs, and when advances in product designs reduce operation costs. In 1970s, when the first energy efficient houses were being built, the buildings looked like common, ordinary houses. Only the initial costs were higher. According to a report by the Iowa Association of Municipal Utilities and Iowa Energy Center, energy efficiency can add 2 to 3 per cent to the cost of a new house. ‘Builders tried long and hard to explain that their homes would be less expensive to own on a monthly basis than the traditionally constructed home, but many went out of business trying’.27 There is a failure of the normative principle of economic rationality, which claims that consumers act to maximise the net present value of their position by engaging in any economic transition that involves net benefits. Households like other economic subjects evaluate the current situation as more important than future well-being. An interesting approach in the Netherlands was the so-called insulation mortgage. The energy supplier gives the consumer an additional mortgage that covered the cost of thermally insulating the house, and the repayments on the mortgage were less than the savings on the energy bill. So, the user had no change in capital costs and lower recurrent costs. The problem arises with rented houses. The house owner does not worry about the energy bill. The person renting will never invest in a house that is not his own. In fact, in many countries, the law specifies that the owner could request that any changes, even improvements that the tenant had made to be ripped out at his expense when he leaves the house. As a result, it is nearly impossible to install EE technologies in such houses. The situation differs depending on whether the house is for leasing, renting or selling. In such situations, institutional innovations can be used to overcome this type of barrier. The concept of long-term profitability is especially difficult as far as individual economic subjects like households are concerned. Based on behavioural theories, Robinson writes ‘If investing in energy efficiency would provide energy services at a lower marginal cost per unit of service than buying fuel or electricity, then the rational consumer will undertake that investment’.28 Rational family units are assumed to invest their savings if this brings them higher profits than they would get from a commercial bank.29

27

Martin 1997, 5. Robinson 1991, 633. 29 If the household does not have enough cash or savings to invest directly in energy efficiency, possibilities of financing may be available. In practice, however, financing for EE upgrades are rarely used, unlike financing for cars, houses and consumer goods. 28

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In practice, most people would prefer cheap, energy wasting technologies, rather than opting for more expensive, but highly EETs. Another significant barrier to energy efficiency investments by household consumers is the transaction costs associated with gathering accurate information to make informed decisions. Suppose the consumer wants to insulate his house. Getting it all done is a huge hassle, and it is not at all easy to make the right choices about an issue that is likely unfamiliar and complex. Compounding the difficulties, a number of firms offer different insulating technologies. So with all these uncertainties, a safe and simple solution is not to insulate at all. Another issue is that of risk avoidance. For example, if the walls of a house are constructed by an inner and an outer brick wall with a gap in between, then filling this gap with insulating foam vastly improves the insulation. However, there is a small risk that this will cause moisture bridges between the walls and will cause moisture to appear on the inner walls. If that happens, it will cause huge expenses. It is not surprising that the consumer is hesitant. He could possibly buy an insurance against this risk, but to find out the right policy is a hassle again. The example mentioned above shows that not investing in EE can be a rational choice. If the government or any energy supplier or equipment supplier wants to promote EE, he will have to address these and similar issues. In such situations, the question of whether EE pays off is only one of the many points, and probably not the most important one. Table 5.7 compares an energy efficient house with a standard house. The houses are evaluated from the financial point of view. The first reaction would be to prefer the standard house, as it is cheaper even after including the mortgage amount. But when we compare the energy bills, the energy efficient house costs less. Moreover, the mortgage interest is tax deductible while energy costs are not. The income required for the EE house is about USD 90 less per month, or over USD 1,100 per year, than for the standard house. At the end, buying the energy efficient house means a positive net cash flow since the benefits from EE improvement—the energy cost savings—is higher than the increased investment stemming from payment for the improvement in a given period of time. One might well select the EE house since all the hassle of improving EE will reduce the monthly costs by 90 USD or 3 per cent. But often EE is not installed in most houses. If EE is installed in newly built houses the situation is far simpler. The owner has no choice and the builder or owner can be influenced by government policies. One major conclusion from this example is that in the housing sector, the main effort should go to new buildings and major replacements, like a new central heating

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Table 5.7 Energy-efficient Homes vs. Typical Homes Typical home

Component

Energy efficient home

$100,000 $10,000 $90,000 8% 30 $660 $167 $17 $844 $109 $953 $3,013 $36,159

Home Price Down Payment Mortgage Amount Interest Rate Term (Years) Monthly Mortgage Payment Taxes Insurance PITI∗ Monthly Energy Bills PITI+Energy∗∗ Monthly Income Required Annual Income Required

$105,000 $10,500 $94,500 8% 30 $693 $167 $17 $877 $72 $949 $2,922 $35,070

Source: Adapted from Martin 1997, 5. Notes: The interest part of the amount USD 693 is in the right column ‘Monthly Mortgage Payment’ is tax deductible. ∗ Principal, interest, taxes and insurance. ∗∗ A borrower qualification method that incorporates energy efficiency in the debtto-income ratios by adding the energy operating cost for the candidate house to other elements of the housing expenses.

boiler. Further, retrofitting EE is less important from a national point of view (Box 5.3). Households should see the whole package of energy efficiency. Many considerations play a role in the consumer’s decision making such as education, social status, convenience, feeling of competence and interest in new technologies as well as health and safety concerns. Swedes and Americans have different energy-using behaviours, and it is clear that a wide range of non-economic factors influence energy use. It is likely that people tend towards energy efficiency because of general attitudes to health, comfort 30 and convenience rather than because of saving energy. Based on analysis of efficiency programmes and consumer behaviour it is possible to design programmes, which make use of economic principles as well as other contributing factors that influence purchasing decisions. Successful EE programmes should include non-price factors, including awareness about environmental issues, energy consumption, and message on how to control and reduce energy waste. Identification of cost-effective energy efficiency projects and implementing them to reduce environmental impacts would provide a new opportunity 30

Robinson 1991, 633.

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Box 5.3 Trade-off between a Technology and Service—An Example The simplest and well-known example for the trade-off between energy service and energy-efficient technology is the compact fluorescent lamp (CFL) compared to the standard incandescent light bulb. A high quality CFL costs around USD 10, that is, 10 times as much as the incandescent light bulb (IB); but the CFL lasts 10 times as long and uses one-fourth or one-fifth of the energy used by IB. Hence, aggregated over the longer lifetime, the energy service from the CFL is much cheaper than from IB. There are examples for this trade-off for all services of energy. One point that has to be mentioned here is the replacement of IB with CFL. In the 1980s, the first CFL lamps were huge pots, the size of a pot of jam. They did not fit in any normal lampshades. Even today, CFL lamps are usually longer than incandescent lamps, and don’t fit in many lampshades. Again, CFLs do not light up instantly, and so they cannot be used if instant light is desired (lamps on a staircase or cellar). CFLs have a different colour. Mixing CFL and incandescent in one room looks ugly. If there are electronic dimmers on a few light fixtures, CFLs won’t work in them. To install the CFLs we must first replace the dimmers by normal switches. This shows that the choice for or against EE can often depend on quite subtle points, and that any ONE point can overrule all the advantages that EE would give. Source: Thomas et al. 2000.

to reduce imported fuels for those countries, which import petroleum products, and to foster growth. With cost-effective projects and their subsequent successful execution the apparent conflict between development and environment may be moderated. Such types of projects are also expected to be beneficial to the utilities, the consumers, the government, equipment manufacturers, institutions and the society in general. Through the reduction of GHGs the quality of life will be improved and the people, in general, will stand to benefit.

Energy Efficiency—Project Development There are various projects dealing with various aspects of energy and GHG reduction strategies on a country-specific basis. The international funding for most of these projects comes from the Global Environment Facility (GEF), United Nations Development Programme (UNDP), the World Bank, the Asian Development Bank (ADB), and so on. The ongoing assistance for a given option does not automatically rule out the option, as it needs to be ascertained whether involvement is still needed for furthering

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that option to its logical conclusion. For example, if only the feasibility analysis is done—which is the case with many of the projects—then based on that, a demonstration project may still be needed. In some cases further work may not be needed for the time being. In other cases, building upon ongoing efforts may make GEF involvement more successful and cost effective. A number of efficient options exist to reduce energy consumption. Hence, at the country level, it is important (a) to identify and evaluate various efficient options, (b) to develop specific investment projects and related institutional designs for selected policy options and (c) to strengthen the institutional and technical capabilities. These are critical steps. Careful preparation of project design is vital to its success. This requires technical skills that need to be developed. By the end of this project period, expertise in identifying and assessing various projects in the areas of power, coal, demand-side management and cogeneration could be achieved. These projects would promote more efficient use of power generation through renewable fuels, reducing demand for fuel through efficiency improvement in fuel use and power generation, reducing demand for power through demand-side management, better utilization of cogeneration and renewable fuels and reduction in use of petroleum products. Also the identification of donors and implementing agencies, the institutional and financial mechanisms could be done. Specifically the following achievements are expected at the end of the project. Several investment project options could be evaluated as part of the case studies undertaken in this project. On the basis of these evaluations, investment measures, including financial requirements would have been designed for the reduction of energy through various options. A plan, which includes measures that address the investment requirements, the institutional and economic incentives, and the associated environmental benefits. The mix of approaches appropriate to each technology will also be delineated. Models and methodologies for the technical and economic evaluation of EE options at the micro and macro level will be acquired or developed. Development of institutional mechanisms such as the Energy Service Company for implementing the selected options would have taken place. The projects that can be taken up for improving EE in various sectors are given in Table 5.8.

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Table 5.8 Energy Efficiency Projects Energy type 1. Electricity

2. Petroleum Products 3. Coal 4. Renewable Energy Sources

5. Transport 6. Buildings

Efficiency improvements Reduction of T&D losses Improving end use of electricity Agricultural pump-sets Domestic appliances Industrial motors Reduction of auxiliary consumption in power plants Industrial boilers Co-generation Coal beneficiation Coal bed methane Solar, thermal, including industrial process heat power generation Solar passive architecture Biomass energy Co-generation combustion gasification pyrolysis, etc. Solar photovoltaic power Fuel cells Compressed natural gas vehicles Electric vehicles Efficient buildings

Source: Authors.

The EE projects should be viewed in a programmatic context. The basic objective is to identify cost-effective options and assess specific investment and related institutional and policy options. This can be achieved through the evaluation of efficient options, identification of technology gaps, investment requirements, economic incentives and institutional mechanisms necessary to achieve technology penetration. The emphasis of this is on energy efficiency and fuel substitution and hence, the potential for reducing energy utilization in the long run. To be a successful energy efficiency project or programme, it should, Provide significant energy savings; Be cost-effective; Be comprehensive, striving to achieve all cost-effective savings available in each customer interaction;

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Be preferably large scale, creating EE capability as well as capturing present savings; Be monitored and evaluated, to documents saving and to support; Provide continuous improvement; and Pay particular attention to preventing lost opportunities. To select and give priorities to various EE projects, we need to weigh a variety of considerations. These criteria can be as follows: The magnitude of potential energy saving. How much resource can the energy efficient project eventually save? This depends on the extent of the use and its potential growth in future. The cost effectiveness of savings. How much would it cost to save one unit of energy? Replicability of the project. Can the project be taken off on its own after the initial momentum or not? Sustainability. Is the policy framework available such that the project benefits will last long? What are the perceived risks? Monitorability and measurability. Are the savings measurable and can the project be monitored or not? Implementability. How easy is it to implement the policy? Does it create incentives which are appropriate? Barriers. What are the barriers to the implementation of the project relating to technological, institutional, capacity, policy or transaction costs? This is a long list and there may not be an easy way to quantify all of these criteria. Qualitative assessment and a measure of judgement are inescapable. Figure 5.1 provides the methodology for selecting the projects. This is one method of selecting an EE project which is government-driven and supported by an international agency. Since the costs and benefits of energy efficiency projects vary according to the actor involved, it is important to consider these projects from the perspective of various stakeholders (Figure 5.2).

5.4 Drawbacks of Energy Efficiency While the benefits seem sufficient to justify investment in energy efficiency, individuals typically do not use societal criteria when making personal

140 ENERGY EFFICIENCY AND CLIMATE CHANGE Figure 5.1 Methodology of Selecting Projects

Source: Authors.

or business decisions. Consequently, if policy makers want individuals or corporations to invest in EE so that society can realize the benefits, they have to address the drawbacks that inhibit individuals or business houses from making these investments. It is of high importance to address them, since these negative factors can limit the extent of involvement of private capital, and the process of implementation of EE measures. Public money funds many governmental EE projects. The justification for this is to encourage people to invest in energy efficiency. These programmes

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Figure 5.2 Benefits to Various Stakeholders—Local and Global

Source: Authors.

allow the governments to invest in EETs and the markets to offer rebates and other incentives to increase the number of purchases of cost-effective measures. Subsidizing new energy efficiency measures will help them to gain market acceptance and will thus facilitate market transformation. The general perception is that, without subsidies, there is little customer investment in cost-effective energy efficiency. However, this type of incentive approach has drawbacks. Incentive programmes do not eliminate the underlying market barriers for most customers. Large segments of the potential market for such measures have not chosen efficient alternatives despite the availability of rebates or subsidies as part of the upfront costs. And among those who do participate, many do not repeat such purchasing patterns. Subsidizing one customer’s savings with other customers’ money can create resentment that undermines public support for and limits the sustainability of such programmes. However, the most significant drawback to incentive programmes is that they can have the unintended effect of limiting customer investment in energy efficiency. Customers learn to

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buy only those products that someone has determined merit a subsidy. Products without subsidies or with low subsidies, even if they are more cost-effective, become less desirable and less likely to be purchased. For example, when the state and federal tax credits for solar water heaters in the US ended in the early 1980s, the solar industry collapsed, even though the technology had improved and its cost effectiveness had increased as a result of rising energy prices. Thus, the key for success for long-term effects is the innovation in new technologies. There is a benefit in creating new technologies, improvements and innovations where the range of goods and services available for purchase are limited. Another drawback of energy efficiency investments is the small market for energy efficiency products and services. Typically in a free market, customers choose vendors that offer desired services at reasonable prices. In such a scenario, there is little or no government involvement. This ensures that customers will get the best price and can buy only the goods and services they want. It is based on the assumption that entrepreneurs will invent and market products if it is financially beneficial. However, the free market approach only works if the market for efficiency is structured in such a way that customers can actually express their desire for energy efficiency through purchases. This type of market structure does not exist in many parts of the world. Risks are another drawback of EE. EE investment involves borrowing capital; therefore the lenders and other investors must evaluate all risks which could affect their expected returns: project risks, credit risks and sovereign credit risks, as well as commercial and political risks. Consumers are risk-averse and most of them are not likely to pay an upfront cost for an efficiency measure, even if they are aware that there are life cycle savings and that the initial outlay is affordable. Additionally, electricity distribution companies and energy providers whose earnings decrease when electricity sales decrease may be reluctant to participate in energy efficient programmes and services that significantly lower their sales. The initial investment into the energy-efficient equipment is high, whereas benefits in terms of lower energy bills accrue slowly. The problem of initial high costs is strong in developing countries or countries in transition, where the domestic capital is not sufficient, the market not fully developed 31 and the energy prices subsidized. A comparison of direct purchasing prices 31

This argument applies not only to consumers but also to firms: There are still only few small- and medium-sized companies in transition economies interested in energy-efficient technologies due to their high initial costs. For large firms, many efficiency investments are too small to be attractive because of high transaction costs (Sudhakara Reddy 2004).

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of the cost of energy-efficient equipment, often, but not always, is higher than the costs of inefficient equipment while total lifetime cost of the former is always lower. These are the issues that the industrial management must study and take account of. If firms (due to lack of capital or difficulties in getting loans) require very short pay-back periods, while the country as a whole could sensibly invest with longer pay-back periods, then the level of EE investments by industry will be lower which would make it optimum for the nation. That situation would justify government measures, such as tax relief, subsidies, environmental regulations or advertisements to motivate firms to install more EE than they would do on their own. In countries, where the economic situation is not yet stabilized, investors seek short-term paybacks. When a company invests in energy efficiency, it reduces present earnings. This company will benefit in the future, but financial markets prefer and favour companies with high present earnings. Companies and governments tend to prefer short-term options despite the fact that energy efficient policies would save them money in the long run. The environmental sector has not attracted much investments and therefore there are few opportunities for investors, and most risk-averse portfolio managers understandably avoid many such programmes. Only low risk projects with the quickest payback and greatest return can get financing in the environmental sector. EE payback periods vary from a month to several years. The private sector is interested in payback up to two years. A study by Hagler Bailly Consulting notes that, ‘(…) in many emerging market countries, where interest rates and inflation remain high, only projects with a payback of one year may be considered attractive by the market until inflation and interest rates are reduced’.32 With such short paybacks, only the best EE projects will be attractive. According to OECD, ‘Local currency has generally only been available for very short-term loans in most EIT countries, for example up to one year. A one year term does not generally cover the payback period of many efficiency projects.’33 Even if the situation changes, the investment may never be earned back. This is a disincentive for choosing EETs. Beside initial high costs, uncertainty is a major drawback. Future economic, technological and political conditions are not foreseeable. EE is an outcome of human interaction and the concept is therefore inter-linked with political movements, which may change over time.

32 33

Hagler Bailly Consulting 1995. OECD 1997b, 81.

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The relationship between strict environmental regulation and competitiveness of firms is not a proven fact. On the one hand the Porter hypothesis suggests that ‘(…) well-designed environmental regulation should trigger innovations and enhance the competitiveness of firms’.34 Empirical evidence as well as theoretical approaches supports this hypothesis.35 On the other hand there are objections. In the eye of environmental economics empirical evidence in support of the hypothesis are exceptional case studies and they traditionally do not believe in ‘free lunches’.36 The recent findings of two authors may provide a good compromise. According to Armin Schmutzler ‘(…) environmental regulation may be beneficial for firm owners when conditions concerning the firm’s internal organization, the nature of the regulation, and the kind of potential innovation are satisfied’.37 Stephen Meyer concludes that there are both: Firms, such as 3M Corporation or Dupont, which transformed environmental regulations into an increase of productivity and cost savings as well as firms who lack the resources to adapt to the changing conditions.38

5.5 Externalities as Benefits and Drawbacks of Energy Efficiency This section illustrates the large number of externalities in energy efficiency, since EE provides external benefits or imposed external costs in addition to financial outcome and energy production. As suggested in Table 5.9, the positive externalities are substantial. The table shows that externalities exist on a local, national, regional and global level. Institutions, such as the GEF focus mainly on global externalities. This contrasts with the fact that national and local benefits and the participation of all stakeholders are increasingly important. The incremental cost principle, which requires GEF to pay only for the additional cost of global benefits, would not be suitable if the objective was to maximize overall net benefits regardless of whether they are local, national, regional or global. 34

Sinclair-Desgagne 1999, no page given in source. Ibid., 2, 11. 36 Schmutzler 2001, 87. 37 Ibid., 96. 38 Meyer 1995. 35

(vi) Faster and less costly decommissioning (reversible technologies)

Positive Externalities (i) Smaller impact of power disruption due to small size of power plants. (ii) Greater stability in energy supply through reactive power. This can lower the rate of brownouts and service interruptions, which can be costly for the economy. (iii) Improved access to electricity for rural populations through small, decentralized, modular technologies. (iv) Improved soils and greater wildlife diversity by growing energy crops on degraded land.Reclamation of degraded land and habitat (v) Greater flexibility in sitting due to small scale and variety of installation sizes.

Renewable energy

Table 5.9 Externalities of Energy Efficiency Externalities common to both RE and EE

(vii) Lower impact on indigenous people and local communities than fossil fuel-based projects and dams.

(v) Lower investments in transmission and distribution (T&D) through energy savings and power stations located closer to customer loads. (vi) Greater equality among nations due to greater global distribution of energy resources

(iii) Improved ability to hedge against currency and fuel price volatility through diversification of country’s energy profile. (iv) Increased export revenues from environment-friendly technologies (cf. wind power industry in Denmark).

(ii) Foreign exchange savings due to lower bills from imported energy.

(i) Lower environmental impacts on air, land, water, climate and biodiversity.

Energy efficiency

(Table 5.9 Continued )

Cost savings for households, firms, municipalities, hospitals and others. For example, lower transmission losses, cost for heating, lighting, less need for fuel supply infrastructure. Postponed investments in energy generation and distribution Faster payback frees capital for reinvestment. Lower impact of increases in tariffs due to lower consumption of electricity. Lower requirement for capital than generation and transmission Greater work productivity due to better visual, acoustic and thermal environment in efficient buildings

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(Table 5.9 Continued)

Renewable energy (viii) Better management of energy demand and reduced length of overall supply shortage due to shorter lead times (small scale, modular systems) (ix) Stimulation of entrepreneurship, and innovation and local private sector development due to smaller project scale and the need for local manpower and materials. (x) Regional development through projects, training and information dissemination (xi) Greater regional independence due to lower reliance on centralized power producers. (xii) Job and income creation due to intensive technologies and smaller project scale. This can (a) reduce rural–urban migration; (b) reduce income disparities. (xiii) Use of idle production capacity in economic recession. (xiv) Lower crime through better public lighting. (xv) Lower mortality and morbidity through lower pollution due to cleaner energy production, better heating systems, better isolated homes and improved water quality. This lowers healthcare costs.

Externalities common to both RE and EE

Energy efficiency

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Source: Authors.

Negative Externalities

(ii) Risk of monoculture due to bioenergy crops as well as the impact of biomass on water and soil. (iii) High land use for some renewables (e.g., solar farms)

(i) Visual intrusion and noise, especially wind power.

(iii) Negative environmental effects relating to production and disposal of toxic parts (e.g., batteries for solar energy storage)

(xvi) Possibility of repair work during operation (live maintenance) (xvii) Fewer national sovereignty issues and potential for conflict than oil and nuclear energy. (xviii) Enhanced security of energy supply. (xix) No need for coercive measures such as resettlement in large hydropower projects. (xx) Ability to reach remote rural populations to provide/save energy where customer demand is low. (xxi) Lower consumption of water and lower land use for some technologies (i) Pollution and waste produced by the production, distribution, and maintenance of renewable energy and energy efficiency equipment. (ii) Greater transaction costs, including management time, training and marketing.

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Energy efficiency can also have negative externalities.39 EE is often promoted based on the assumption that the positive externalities outweigh the negative ones. Sometimes positive externalities can outweigh the lack of financial viability (in addition to any negative externalities). Externalities not only are relevant with regard to the choice of technologies, but also with regard to the choice of financing arrangements. For example, mobilizing private sector funding will show effects in terms of social justice, access and control. It makes little sense to classify externalities into categories such as economic, political, cultural and social as these are highly interrelated. For example, energy efficient housing can lower morbidity and mortality, which at the same time saves costs and mitigates the strain on healthcare systems. Sustainable energy reduces environmental strains, which in turn lowers the need for pollution control and remediation investments. Most of the benefits and drawbacks of energy efficiency can be conceptualized as positive and negative externalities. However, there are some benefits and drawbacks that are relevant for the implementer himself. By way of illustration, if a firm or household invests in energy efficiency and saves money, the financial savings represent the benefit but not an externality.

5.6 Conclusion Certainly there are several reasons, a number of pros and cons to improve energy efficiency. Theoretically, with the magic formula ceteris paribus, the pros prevail and the experience from developed countries confirms this in practice as well. Transition economies have a chance to either improve or introduce energy efficiency, and despite the fact that the obstacles and negatives exist, EE has a great potential, which should be utilized. Whilst an increase in energy efficiency investment can generate economic and business opportunities, it cannot be done unless there is an effective institutional mechanism to provide financing as well as technological inputs. The chapter provides a broad picture of the benefits and drawbacks of energy efficiency investment programmes. This is an opportunity for energy efficiency policy makers to study and work together with those responsible for areas, such as economic regeneration and local sustainable development 39

Flaim 1995, 43–53; IEA 2007.

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to combine funding for projects that both improve energy efficiency and transform the economy. This may be a good way to increase the overall level of funding available for energy efficiency work whilst allowing it to make a useful contribution to social as well as environmental sustainability. However, assumptions should not be made about the suitability of programmes from one country for addressing specific issues in another, based solely on the evidence from this study. However, promising projects worthy of further study may be identified for each country depending on its specific conditions. Thus, approaches which demonstrate the potential to provide the right incentives at the right time can be identified and studied as appropriate.

6 The Concept of Barriers and Drivers and its Application to Energy Efficiency

The aim of the present chapter is to examine the nature of barriers and drivers to energy efficiency (EE), the circumstances in which they arise, their relative importance in different contexts and the manner in which different actors intervene to overcome these barriers. The chapter reviews current perspectives on barriers and drivers, classifies them according to their influencing patterns and provides supporting evidence for their prevalence. Finally, this chapter develops a new systematic classification and explanation of barriers and drivers to EE. Using an ‘actor-oriented approach’, the chapter tries to identify (a) the drivers and barriers that affect the success or failure of energy efficiency investments, and (b) the institutions that are responsible for the emergence of these barriers and drivers. This taxonomy aims to synthesize ideas from three broad perspectives, namely, micro (project), meso (organization) and macro (state, market and civil society). The chapter develops a systematic framework by looking at the issues from the perspective of different actors.1 This not only aids the understanding of 1 The actors include: the consumer/investors, utilities, government agencies (ministries, state agencies, parliamentary commissions and intergovernmental commissions), financial institutions, regulatory bodies, local authorities, research and development organizations, equipment manufacturers, market institutions, energy consultants, non-governmental organizations (NGOs), energy service companies, the international organizations (for example, Intergovernmental Panel on Climate Change [IPCC]), and so on.

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barriers and drivers, but also provides scope for appropriate policy interventions, too. This focus will help policy makers evaluate to what extent future interventions may be warranted and how one can judge the success of particular interventions.

6.1 Concepts Traditionally, economic development has been linked to energy adequacy. Countries pursuing economic growth are expected to resort to increasing levels of energy use. Achieving these levels of energy production and utilization through present technologies is not only difficult and expensive, but also environmentally unsustainable. Various studies indicate that increased EE can bridge the gap between growing demand and reduced energy supply without affecting adversely the quality of service.2 However, as past experience has shown, this may not happen, unless the issues that hinder the penetration of efficient technologies are addressed.3 There is a gap between the theoretical opportunities for cost-effective energy efficiency investments and the levels that can be achieved practically. The origins of the gap seem to lie in the set of barriers which may be divided into categories, such as financial, legal, organizational or informational. These barriers prevent investments in energy-efficient technologies (EETs). It is also certain that there are drivers that help increase investments. The barriers hinder the penetration of EET, even though these technologies have been shown to be economically cost effective. If policies to encourage investments in improved EE are to be successful, understanding the nature of these barriers and drivers is essential. These policies must succeed in the context of liberalizing energy markets, falling energy prices and an ongoing development of a broad-based energy service industry. If one wants to study barriers and drivers, the influence they have on the deployment of new energy technologies, and the way in which these barriers and drivers could be modified, one needs a taxonomy. This taxonomy can be linked to each barrier and driver, to the exact institutions that create it and the institutions on which it has an influence. Then the taxonomy becomes operational. For example, if someone wants to study the field, in a particular country, for a particular technology, the present taxonomy can 2 3

Golove and Eto 1996; Reddy 2003. Hollander and Schneider 1996; Reddy 1991; Sorrell et al. 2000.

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be used as a guide to determining what actors should be interviewed, what questions to be asked, and how to bring the replies together for analysis. This approach can best be described as an ‘actor-oriented approach’.4 In the present study, we have classified the barriers into barriers at the micro, meso and macro levels and have linked the barriers and drivers to institutions. Since the chapter deals with drivers and barriers to private investment in EETs, the first task is to understand the terminology: z

z

z

Drivers can be considered as the factors that promote private investment in energy efficiency; Barriers can be considered as the obstacles to private investment; and Risk can be defined as a special category of barrier with a probability distribution. To be more specific, it can be defined as an uncertainty connected to the future value of the variable, which could be political, legal or financial.

In other words, every factor that facilitates the implementation— feasibility—of a project, increases the returns or reduces the risk— profitability—of an investment can be considered as a driver. On the other hand, every factor that does the opposite is a barrier. In the following sections, the main characteristics of barriers are discussed.5 Thus, when we speak about barriers to private investment in EE, it is the investor who faces the barrier and the action that is hindered by the barrier is the investment of capital. Investment here is understood more broadly than just equity investment. It is understood as any type of funding provided with the objective of making a profit in an EE-related activity. The emphasis on making a profit reflects the fact that there can be no real commercialization if EE requires philanthropic or altruistic motives on the part of the investor. Moreover, one cannot speak of commercialization if a third party, usually the government, provides a subsidy that enables the project to yield a profit for the private investor. This may be called mobilizing private capital, but it is not a sign of commercialization; in fact, it may even have the opposite effect if private actors get used to subsidies and require support every time they invest in environmental activities. 4

Ferguson 2002. To make for easier reading, we are mainly using the term ‘barriers’ to make particular points, but the same points could be made by using the term ‘drivers’. 5

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6.2 The Terminology A barrier is a pull factor that inhibits investment in EETs. For empirical research on barriers to be fruitful we need to understand the nature of the barriers. This requires clarifying assumptions about the nature of individual behaviour and the relative importance of social structures and the role of markets. We also observe that the consumer’s response towards not exploiting the cost-effective technologies is sluggish. We provide explanation for such observations. The identification of the relevant actor is also crucial. For this we have to examine the role of individuals and organizations such as equipment manufacturers and government agencies. The outcome of this process will provide the reasons for the consumer not investing in cost-effective investments. Drivers can be considered as the factors that promote private investment in energy efficiency; Barriers can be considered as the obstacles to private investment; and Risk can be defined as a special category of barrier with a probability distribution. To be more specific, it can be defined as an uncertainty connected to the future value of the variable, which could be political, legal, financial, and so on. In other words, every factor that facilitates the implementation (feasibility) of a project and/or increases the returns/ reduces the risk (profitability) of an investment can be considered as a driver. On the other hand, every factor that does the opposite is a barrier. In the following sections, the main characteristics of barriers are discussed. The same arguments are valid with respect to drivers but in the opposite sense. First, barriers reduce the likelihood of a positive decision by a private investor,6 that is, they contribute to a no-go decision. There are factors that merely reduce the likelihood of a positive decision, while others singlehandedly cause a negative investment decision, which means that some barriers are more influential than others. There are two basic reasons for a

6 Here the term private investor is broadly defined as all private profit-oriented sources of capital, including individuals, companies operating in sustainable energy markets, greenhouse gas (GHG) producers, financial intermediaries and financial markets. Moreover, it should be noted that we are interested not in barriers and drivers to some vaguely defined concept like ‘private participation’ but in barriers and drivers to actual additional financial transactions. All forms of private participation that do not involve a financial transfer with the objective to make a profit are not counted. For example, it is not sufficient to succeed in ‘communicating’ with private actors, to get private investors ‘interested’ in particular ventures or to mobilize private sector actors to ‘become involved’ in public–private partnerships (PPPs), for example, by attending meetings, making joint declarations or engaging in consultations on policy.

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no-go decision: insufficient profitability or insufficient feasibility, or a combination of the two. In practice, there are usually several barriers and drivers contributing to either profitability or feasibility issues. The final outcome depends on whether the barriers are overall stronger than the drivers in the investor’s mind in terms of driving the decision. This brings us to the second characteristic. Second, barriers can become obstacles only if the investor perceives them as such. If the investor is not aware of a particular factor, or simply determined to proceed to invest, the particular barrier does not influence his decision. This means that the barrier may be real, but it has no influence on the investment decision. In short, reality is only important as far as the investor recognizes it and considers it relevant. There can be perceived barriers that are not real (for example, the fear of operating in a transition economy, when, in fact, that economy creates no untoward problems for the activity proposed) as well as perceived drivers that are not real (like the expectation of a subsidy that, in fact, will not be given). Third, some variables can, at the same time act as driving forces and also as barriers. Also, some barriers can be considered as driving forces in some countries and barriers in others. Therefore, a proper barrier analysis always needs to be a detailed one. This is especially the case if the investor has experience from other countries. And finally, it is also important to distinguish between the barrier and the result of a barrier. This distinction is important because the resulting impacts of a barrier can help identify/adopt appropriate response measures. Depending on the type of barriers they could result in inadequate financial support, lack of policy support, promote inefficient use of energy, and so on. In this chapter, we focus mainly on one result: the decision of private actors to provide money or withhold money for EE.

6.3 Existing Taxonomies According to neo-classical economic theory, one can classify the barriers in terms of market failure and can evaluate short-term policy options to address them. However, this theory neither explains the underlying causes for market failures nor provides directions to increased energy efficiency. The literature contains a great variety of taxonomies, which range from simple lists to useful and logical categorizations of barriers.

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Amulya K.N. Reddy in his pathbreaking study has classified the barriers into: z z z z z

Consumer-related; Equipment manufacturer-related; Utility-related; Financial institution-related and Government-related.7

Another useful scheme has been developed by Lukas Weber, which distinguishes between: z

z z

z

Institutional barriers: Barriers caused by political institutions, like state government or local authorities; Market barriers: Obstacles conditioned by the market; Organizational barriers: Barriers within organizations, especially within firms and Behavioural barriers: Barriers within individuals.8

Sorrell prepared a taxonomy based on a wide-ranging review of the literature by systematically classifying the barriers into three broad categories: neo-classical, behavioural and organizational. In addition, the taxonomy attempts to distinguish between barriers z z z

that justify policy intervention that justify organizational change and that do neither.9

According to Steven Nadel, the gap in energy efficiency and its use in the market can be explained through: z z z z

7

Payback gap; Lack of information; Limited access to capital; Lack of institutional estimates;

Reddy 1991. Weber 1997. 9 Sorrell et al. 2000. 8

156 ENERGY EFFICIENCY AND CLIMATE CHANGE z z z z

Market structure; Aversion to downtime and innovation; Standardized inventories and Purchase decision criterion.10

Edward Vine, Drury Crawley and Paul Centolella studied the market barriers in the residential sector and classified them into: z z

z

Lack of information about energy use; Lack of access to information about financing investments in general and EETs in particular and Low importance given to EE in decision making.11

According to the Energy and Environmental Economics Programme, San Francisco, California, barriers to EE can be classified as follows: z z z z z z z z

Imperfect information; Consumer attitudes; Limited access to capital, and cost disincentives; Misplaced incentives; Product life cycles; High consumer discount rates; Electricity rate distortions and regulatory uncertainty and Externalities.

In their paper on ‘Market Barriers to Energy Efficiency: A Critical Reappraisal of the Rationale for Public Policies to Promote Energy Efficiency’ from the year 1996, Golove and Eto studied the market barriers and concluded that there is a substantial ‘efficiency gap’ between a consumer’s actual investments in energy efficiency and those that appear to be in the consumer’s own interest. It was concluded that many of the market barriers can be understood as examples of market failures and do provide a prima facie basis for government intervention. Sudhakara Reddy in his work for the United Nations Environmental Programme, has categorized the barriers into z z

10 11

Financial-economic; Technical;

Nadel 1990. Vine et al. 1991.

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157

Awareness and information; Institutional-organizational; Regulatory and Personnel and behavioural barriers.12

In a recent study, ‘Barriers to and Driving Forces for Energy Efficiency in the Non-energy Intensive Manufacturing Industry inn Sweden’ P. Rohdin and P. Thollander investigated the importance of different barriers to the implementation of EE measures.13 The barriers include market and nonmarket, behavioural and organizational. The study also finds a number of drivers, such as the existence of people with real ambition and a long-term energy strategy at the site level. This review of the literature forms the basis for developing measures for each barrier to guide the empirical research. A taxonomy, which aims to synthesise barriers into three broad categories, namely, micro, meso and macro, has been developed.

6.4 Towards an Analytic Taxonomy The classification schemes mentioned above are useful only if they are complemented with an analytic approach. For this, the taxonomy can begin with the question, ‘What are the reasons for a negative decision by a private investor?’ The possible answers for this could be: z

z

z

z

12 13

The investor’s perception that the investment will be unprofitable, that is, the rate of returns on the investment will be smaller than the risk-adjusted opportunity cost of capital. The investor’s perception that the investment will not be feasible; for example, due to technical, legal, informational and other obstacles. Transaction costs: While standard energy solutions are available off the shelf, information about new technologies is not easily available. One has to do a lot of work to find them, assess them and obtain them. In every respect, this greatly increases the initial costs. Risk perception: Any investment involves uncertainties. If the risks associated with these uncertainties are too great, the investor will desist from making EE investments.

Reddy 2002. Rohdin and Thollander 2005.

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As it had been mentioned earlier, for every barrier, the determining factor is the value which is perceived. A barrier will only to be overcome if it is low enough to be acceptable and the investor is convinced of this fact. This is especially important for the barrier formed by some risks, as risks are notoriously difficult to judge. In addition, the investor will often, out of self-preservation, have to take account of the worst case risk, and that is a far bigger deterrent than the probable risk. Thus, we can distinguish the barriers to private financing as profitability-related, feasibility-related, information-related and risk-related. Profitability-related barriers are those that lessen the financial viability of energy efficiency projects, thereby reducing the willingness of profitoriented private investors to commit money to such projects. Specifically, these barriers influence the components of gross project revenue and project cost: The components making up gross project revenue can include: (a) project performance, like amount of energy saved; (b) sales volume, like number of energy efficient devices sold; (c) price, like price of energy efficient devices; (d) tariff, like electricity tariff and (e) collection rate, like rate of loan collection on energy efficient equipment sales, or rate of utility bill collection. The components of project cost include development and operating cost. Figure 6.1 shows a schematic representation of profitability barriers. Feasibility barriers reduce the likelihood of a project being implemented. Unlike profitability barriers, feasibility barriers have no impact on the economics of the project. Rather, they reduce the potential for successful project implementation and therefore increase the uncertainty about the project. In some cases, feasibility barriers may be so strong that no amount of profitability can outweigh their negative impact on the investor’s decision (Figure 6.2). There are some barriers, which affect both profitability and feasibility. For example, lack of information can raise the cost of a project, lower the profitability, and put the feasibility of a project in doubt at the same time. Investors may be reluctant to commit funds if they cannot verify the data or if they suspect hidden legal obstacles, such as restrictions on foreign ownership, capital repatriation, and so on. While discussing the drivers and barriers, it is important to consider the role of actors such as the national government, regional and local authorities; supranational bodies such as the European Union or the North American Free Trade Agreement; NGOs; international development agencies; the United Nations and its specialized bodies; the World Bank Group; international and national professional and trade bodies as well as others.

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Figure 6.1 Schematic Representation of Profitability Barriers

Source: Authors.

One could try to indicate which actor has the power to create, reduce or to remove certain barriers and on which actors the particular barrier has an influence. One could also try to indicate whether the barrier can be modified in the short term, by a subsidy for example; in the medium term, through new legislation for example; or only in the long term, through improving general education for example or probably never, like in the case of religious barriers. One could also look at the mechanisms as a means to overcome the usual constraints and pave the way for smooth functioning of projects. This, in turn, encourages the removal of barriers and affects investments positively. Such an actor-oriented approach would give clearer insights into barrier analysis.14

14

Reddy and Srinivas 2009.

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Figure 6.2 Schematic Representation of Feasibility Barriers

Source: Authors.

Through such an approach we can find the role of actors. For example, if any barrier is named, we can see who created it, and who, therefore, is able to remove it. Here, the actors can be divided into three sub-groups—micro, meso and macro. z

z

z

The micro barriers relate to the project designers. To make better projects, they are the persons to address by information, training or support by specialists. The meso barriers relate to the organizations, such as utilities, energy development agencies or service companies. Through new incentives, organizational reform, and other changes, barriers can be reduced or removed. The macro barriers relate to the top level institutions, such as the state, the market, or the civil society, that determine the setting under which the lower levels have to operate.

The actions needed to address barriers are different for each. Through this approach, we not only need to look at the barriers themselves, but

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also at the institutions and situations that create the barriers. Each actor would then have two roles: (a) in carrying out a project at his own level, the actor has to work within existing external constraints given by top level institutions and (b) the actor can establish conditions—either barriers or drivers—for other actors at a lower level. This approach can be used in surveys, by asking every actor to describe the types of barriers affecting profitability and feasibility as he perceives them. Micro barriers: These can be referred to as the obstacles that are unique to a particular project. Here the barriers could be in terms of project design. A poorly designed project can make insufficient use of synergies or drivers, or take too little account of barriers. The person to address is the project designer by information, training or support by specialists. Examples include: z

z

z

z

A district heating project, which only focuses on upgrading the heat generation unit, is likely to be less profitable than the one which, at the same time, upgrades leakage in distribution systems, creates incentives for energy savings, such as metering in households, and gradually raises heating prices to recover costs. A project to install natural gas-fired combined heat and power unit (CHP) is more expensive initially than upgrading a coal-fired heating unit. However, after a relatively short time, the extra expenses are amortized by additional heat and electricity output. A medium sized or large project, or a bundling of smaller projects, is usually more profitable than dispersed and one-off small projects due to lower transaction costs and economies of scale. A project that consults the representatives of affected target groups is more feasible usually than the one that is imposed from above.

By changing the features of a project—for example, by modifying incentives for energy savings, replacing the technology, increasing the project size or creating legitimacy through consultation—the financial viability and feasibility could be improved. Additionally, changes in project design can reduce the internal barriers to profitability and feasibility. Meso barriers: These relate to the organizations affiliated with the project. These barriers can be common to a wide variety of projects and can be tackled with efficient organizational design, human resource as well as time management. Examples include:

162 z

z

z

z

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The implementing agency may be understaffed, bureaucratic or lack proper incentives for promoting energy efficiency; The project target groups, such as municipalities, may be small, inexperienced and undercapitalized; The investors may lack experience in a particular technology or geographic area; The government authorities may put forward rules and procedures that can raise the cost of the project or reduce the feasibility of implementation.

Macro barriers: The macro barriers can be divided into three categories: state, market and civil society related. Since these barriers are not project or organization-specific, they cannot be altered by changing project or organizational design.15 For project sponsors and financiers, macro barriers are externally given and are difficult to influence unless they have the power of influencing politics, market or culture. In some cases, projects include policy components, which can affect macro variables, such as electricity tariffs, laws about who will keep financial savings from EE projects or subsidies. Usually it is easier for project sponsors and investors to change the project characteristics than to influence government policies such as electricity tariffs and subsidies. Therefore, many projects do not even attempt to change macro variables; instead they focus on overcoming or neutralizing the adverse effects of macro barriers through increased financial subsidies or, more rarely, through innovative project and organizational design. The benefits of tackling macro barriers as well as the sustainability of the results over time are usually much greater than focusing merely on micro and meso level barriers. Figure 6.3 illustrates three axes, namely, difficulty of implementation, benefits and sustainability of results. A dashed line has been drawn to illustrate the relationships among these three factors. According to Figure 6.3, if we target micro barriers (marked ‘a’ in the figure), we can expect relatively low benefits and sustainability of results, but these measures are also relatively easy to implement. But if we want to do something about macro barriers (marked ‘c’ in the figure), we can expect much greater difficulty, but also much higher benefits that are sustainable over time. Meso barriers lie somewhere in between on all dimensions (marked ‘b’ in the figure). 15 In some cases, projects can be immunized against the effects of policy and market barriers.

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Figure 6.3 Targeting Micro, Meso and Macro Barriers

Source: Authors.

Barriers relating to the state are those that can be traced to the behaviour, that is, action or inaction, of governments or state-run organizations. Barriers relating to the market are those that can be traced to the behaviour of individuals, private firms and financial institutions, which reflect the prevailing market structure. And finally, barriers relating to civil society can be traced to the behaviour of NGOs, academic institutions and other civil society organizations (CSOs). While the distinction among state, market and civil society barriers is useful as a means of classification, in practice, there are linkages among them. For example, markets react to policy changes and vice-versa. Policy is affected by the lobbying of firms and NGOs as well as other civil society organizations operating within a political and economic context. Efforts to remove or reduce macro barriers need to pay attention to these relationships in order to be effective.16

16

These inter-linkages exist. But the only people we can speak to are the actors. If they hold each other in a mutual network that makes change difficult, the issue may become one of trying to change that network.

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In summary, an analytic taxonomy starts with the basic reasons for the lack of private investment: the perception of lack of profitability and, respectively or, the lack of feasibility. This leads to a distinction between factors that cause the lack of profitability and others that cause the lack of feasibility. These factors may occur at three levels, micro (project), meso (organization) and macro (policy, market and civil society). At each of the three levels, there are measures that can address the profitability and feasibility issues. These measures will be introduced in the following section.

6.5 Causal Model of Private Investment Decision If the objective is to maximize private investment in EETs at a minimum cost to the consumer, we need to find out which factors (drivers and barriers) influence private investment decisions. But a list of factors is not sufficient. We need to know the relative contribution (causal weight) of these factors in terms of influencing investment decisions. Only then we would be able to design and prioritize measures to mobilize private capital for clean technologies. There are two types of measures: (a) those that stimulate the drivers of private investment and (b) those that reduce, remove or overcome the barriers to private investment. The best measures are those that have the greatest positive effect on mobilizing private capital relative to their cost for the taxpayers. In other words, we need to find the cheapest way to stimulate the key drivers and to remove the key barriers. For this, it is necessary to develop a causal model, which shows how the policy (macro), organizational (meso) and project (micro) level stimuli mechanisms interact with the determinants of private investment (barriers and drivers) to create an investment response. This leaves us with the task of investigating the relative importance of barrier and driver variables in stimulating or preventing private investment. Then we would be able to investigate the cost effectiveness of various measures in stimulating the drivers and removing the barriers (that is, the cost effectiveness to mobilize private capital). Cost effectiveness is defined in terms of ‘value’ for money. In our analysis, achieving cost effectiveness means maximizing the present value of private investment flows in relation to public capital spent to stimulate those flows. It may be worth reflecting upon why private investment is chosen as the dependent variable rather than a more traditional public policy target, such as social optimum, income distribution or environmental benefits. At first sight it might appear natural to choose environmental benefits as the

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dependent variable. For example, the Global Environment Facility (GEF) defines cost effectiveness in terms of maximizing the global environmental benefits relative to cost.17 In the area of climate change, the GEF measures how much greenhouse gases were abated relative to the capital spent. Costeffective projects are those that mitigate a specified amount of greenhouse gas emissions for a given cost. If the policy objective is to maximize environmental benefits, then the target should not be maximizing environmental benefits but rather private investment—specifically, maximizing private investment in clean technologies at a minimum cost to taxpayers. If one wants to maximize environmental benefits, why is it necessary to maximize private investment? This paradox is explained as follows: first, the sum of private investments in clean technologies is presumed to be positively correlated with environmental benefits (the higher the private investment, the greater the environmental benefits). Second, the more the private investment, the faster will be the process of commercialization of clean technologies. This in turn will maximize environmental benefits over time, because if environmental technologies become commercial, the amount of private financing will likely dwarf the current environmental investments that are mostly publicly funded. Shifting environmental investments to the private sector will reduce the dependence on taxpayer support and on scarce public budgets, and open environmental markets to the considerable sums of money looking for investment opportunities in national and global financial markets.18

Structure of the Causal Model The structure of the causal model is illustrated in Figure 6.4. The causal model links the stimulation mechanisms (the independent variables) with the private investment response (the dependent variable) through the determinants of private investment (linking variables in the causal pathway). The input variables (stimuli mechanism) are categorized into macro, meso and micro. The variables are ordered from those that stimulate the drivers 17 Cost effectiveness is one of 10 operational principles for development and implementation of the GEF’s work programme, ‘The GEF will ensure the cost effectiveness of its activities to maximize global environmental benefits’ (GEF 1996). 18 The assumption is not that investment in clean technologies is the only way to mitigate environmental problems. Rather the assumption is that without a significant shift of investment from polluting technologies to clean technologies, the world’s environmental problems cannot be solved.

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to those that overcome the barriers. The linking variables themselves are ordered from drivers to barriers. The effect of linking variables ranges from promotion of investment to prevention. The model is general and may include non-linear relationships. Figure 6.4 Structure of Causal Model

Source: Authors.

The factors that affect private investment are described as follows: z

z

Unpredictability: Private investors are not a homogeneous group. They have different goals, different perceptions, different decision making procedures and they apply different criteria for investment decisions. For example, if two investors face identical barriers and drivers, there is no guarantee that they will make the same decision. Multiple levels and linkages: Private Capital Mobilisation (PCM) mechanisms can be applied at three levels: the policy level, the organizational level and the project level. The interaction between multiple mechanisms at different levels can make it difficult to trace the linkages and identify the significance of each contributing cause.

THE CONCEPT OF BARRIERS AND DRIVERS z

z

z

z

167

Implementation: The level of PCM may depend not only on the properties of the instruments, such as type, characteristics, or scale, but also on the manner of implementation. Context: The level of PCM may also depend on the context/environment within which the variables, such as instruments, barriers, and drivers, are embedded. For example, a specific instrument may not be effective in mobilizing private capital unless there is a coherent overall policy design, organizational design or project design. Endogeneity: There is a possibility that there is a recursive effect between private investment and the stimuli that are applied (endogeneity). The causal model suggests that investment increases when stimuli increase, but it is equally plausible that stimuli increase when investment increases.19 For example, dialogue between policy makers and investors may create endogenous effects. Non-linearity: A multivariate regression is based on the assumption of linearity: when a variable X—propensity to invest for example— depends on variables y1 … yn, the assumption is that the relation is approximately linear in all of the variables. For investment decisions, this is not necessarily the case. Normally, there will be a large number of conditions, which all have to be satisfied before an investment decision can be made. Any one condition, when not fulfilled, can block the decision to invest, independently of the values of all other variables. No linear approximation can cover that.20

The causal model is made up of the dependent variable, the independent variable and the causal pathway that links both: z

The dependent variable is the investment response, that is, the decision of private investors, which can be either ‘yes’, ‘no’, ‘partially’, ‘maybe in the future’ or ‘yes, subject to condition x, y and z’. In other words, the decision is to finance, to refrain from financing, to finance it partially, to postpone a final decision or to make the investment decision contingent on the fulfilment of certain additional conditions,

19 This point was made by John Preston and Theodosios Palaskas in a report of 28 September 2000 evaluating Gaudenz Assenza’s doctoral dissertation. 20 One might say that it could be possible to design some other form of non-linear model, but then the number of degrees of freedom in choosing the model’s structure is infinite. No method exists to select the ‘right’ model structure. A linear model will not work, and there is no way to select a non-linear one.

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such as changes in the design of policies, organizations and projects. The level of private investment is ideally measured in terms of a cost effectiveness ratio such as the Private Capital Mobilization ratio (PCM ratio). The PCM ratio is an indicator that shows how costeffective measures—applied on different levels, such as policies, organizations and projects—have influenced the drivers and barriers to private investment, thus stimulating additional private investment. The ratio is calculated by the present value (PV) of private capital mobilized, divided by the PV of public expenditure on measures applied to mobilize private capital. n

PCM ratio =

∑ PV of private capital mobilized ∑ PV of public capital spent

=

I −D

∑ (1t + r )tt t =0 n

C −R

∑ (1t + r )tt t =0

Where It = amount of private capital in time t Dt = amount of private capital divested in period t Ct = amount of public expenditure in time t Rt = amount of public expenditure divested in time t r = project finance rate (that is, the rate of return appropriate for the overall level of risk) z

z

The independent variables are the stimuli (synonymous with terms like measures, actions, mechanisms and instruments) applied by the government or multilateral institutions to influence private investment decisions, or for other reasons that could affect the mobilization outcome. The stimuli mechanisms can either be carrots, such as grants, or sticks, such as threats to introduce efficiency regulation unless voluntary action is taken. The causal pathway is the transmission mechanism linking the stimuli, the independent variable, with the investment response, the dependent variable. This transmission mechanism consists of the variables that private investors consider before making an investment decision. These variables could be called ‘the determinants of private investment’ or ‘investment criteria’. They can have two manifestations either as drivers of private investment, or as barriers. Whether these variables actually act as drivers or barriers depends on the perception of the investor.

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169

In the present analysis, achieving cost effectiveness in terms of value for money means maximizing the present value of private investment flows in relation to the public capital spent to stimulate those flows. It may be worth reflecting upon why private investment is chosen as the dependent variable rather than the more traditional public policy targets, such as social optimum, income distribution or environmental benefits. At first sight it might appear natural to choose environmental benefits as the dependent variable. For example, the GEF defines cost effectiveness in terms of maximizing the global environmental benefits relative to cost.21 In the area of climate change, the GEF measures how much greenhouse gases were abated relative to capital spent. For GEF, cost-effective projects are those that mitigate a specified amount of greenhouse gas emissions for a given cost. These can be identified as projects with low unit abatement cost (UAC)—the cost per unit of GHG emissions abated or sequestered (expressed as USD per ton of carbon equivalent [USD/tC]).22 If the policy objective is to maximize environmental benefits, then the target should rather be a specific aim to maximize private investment in clean technologies at a minimum cost to taxpayers. If one wants to maximize environmental benefits, why is it necessary to maximize private investment? This paradox is explained as follows: first, the sum of private investments in clean technologies is presumed to be positively correlated with environmental benefits. Second, the more the private investment, the faster will be the process of commercialization of clean technologies. This in turn will maximize environmental benefits over time because if environmental technologies become commercial, the amount of private financing could dwarf the current environmental investments that are mostly publicly funded. Shifting environmental investments to the private sector will reduce the dependence on taxpayer support and on scarce public budgets, and open environmental markets to the considerable sums of money looking for investment opportunities in national and global financial markets.23

21 Cost effectiveness is one of 10 operational principles for development and implementation of the GEF’s work programme, ‘The GEF will ensure the cost effectiveness of its activities to maximize global environmental benefits.’ (GEF 1996). 22 GEF 1996, 38. Cost effectiveness is not always the decisive criterion for project selection. 23 The assumption is not that investment in clean technologies is the only way to mitigate environmental problems. Rather the assumption is that without a significant shift of investment from polluting technologies to clean technologies, the world’s environmental problems cannot be solved.

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A systematic analysis is still valuable and necessary, even if it is not possible to generalize cost-effectiveness rankings among different mechanisms, as well as rankings between the most important to the least important barriers and drivers. The value of this analysis lies particularly in making explicit how private capital mobilization works as a causal process—something that is not necessarily clear, neither to the outside observer, nor to the investor. The most important gap in the literature is not the knowledge of policy, institution and project designs, nor the knowledge of barriers and drivers, but the systematic understanding of the causal processes and the tracing of causal relationships in this subject area. As compared with Figure 6.4, the causal relations are illustrated in more detail. It depicts the causal pathway from stimulation to initiation or support of projects, to causal factors (barriers/drivers), and to investor response (project is financed or not). The causal model shows the structure and logic of the model—its transmission mechanism. It indicates that the challenge for any stimuli mechanism is to stimulate the drivers, to reduce, remove or to overcome the barriers to private investment. The figure also shows that the drivers and barriers can have an effect both on the profitability as well as on the feasibility of the project: the more barriers exist, and the stronger their cumulative effect, the less profitable the project will be, and the more likely that it cannot be implemented. Such links with feedback mechanism would help in the identification of corrective measures at every step. As illustrated in Figure 6.5, the barriers can further be classified into internal barriers—due to flaws in the project or the organization—and external barriers—policy, market and civil society. Internal barriers are easier to overcome because they require only changes in the project or the organizations involved in the project whereas external barriers require policy changes, measures to affect the workings of markets or measures to influence civil society or the culture of a country. In designing a complete model, there are numerous variables that could be relevant potentially, there are variables in the three categories of project, organization and policy design as well as in the causal pathway—the categories of drivers and barriers. To make this abstract model more accessible, Table 6.1 provides a list of examples of variables mentioned in the causal model classified as barriers or drivers based on their properties, like high or low. It can be noted that the variables relate to returns, risk or feasibility or a combination of these. However, this list is not comprehensive.

Source: Authors.

Figure 6.5 Causal Linkages

z

z

International environmental agreements Implementation of the Kyoto Protocol & Flexible Mechanisms

— Policies and programmes aimed at speeding up the process of investment — System-wide information dissemination

Subsidies and taxes on fossil fuels & EE (also indirect subsidies such as on transport of coal) Specifications in ownership construction and financing model to assure sufficient return over the life of the project Technology performance

z

z

z

z

Design and construction risk (e.g., time and cost-tocompletion) Market risk (e.g., sales risk and uncertain future demand of electricity)

— Efficiency (including T&D losses) — Simplicity & serviceability — Reliability

Trade policy (e.g., import duties and subsidies)

z

z

Electricity tariffs

— Transaction costs (e.g., initial start-up costs, due diligence) — Capital costs relative to market discount rates — Operating costs — Financing costs

Costs relative to project size; like:

z

z

Drivers and Barriers to private investment →

Policy Design affects drivers and barriers →

Legal, tax and regulatory changes z Electricity tariff reform z Reduction of subsidies to fossil fuels z Green tax reform z Legislation enabling independent power producers z Removing current R&D bias in favour of fossil fuels and nuclear energy

Causal pathway R

Independent variables X1 …Xn

Table 6.1 Variables in the Causal Model (Examples)

∑ PV of private capital mobilized = PCM ratio = ∑ PV of public capital spent

C −R

I −D

t =0

∑ (1t +r )tt

t =0 n

n

∑ (t1+r )tt

The level of private investment, ideally measured in terms of a cost-effectiveness ratio such as the Private Capital Mobilization ratio (PCM ratio)

— Direct PCM for particular projects — Indirect PCM through multiplier effects

There are two types of Private Capital Mobilization

Private Investment …thus increasing the PCM ratio

Dependent variable Y

z

z

Tradable permits and clean development mechanism Creation of a system of tradable GHG emission permits

z

z

z

z

z

z

z

z

z

z

z

z

z

z

z

z

z

z

z

Residual value risk Technology/obsolescence risk (e.g., uncertainties relating to forecasting technological innovations) Policy risk Fossil fuel price risk Contract enforcement risk International climate change negotiations and likelihood of forceful government action Foreign currency fluctuations (currency risk) and extent of local manufacturing State of infrastructure in a country: (a) general infrastructure such as roads, telecommunications and (b) technology-specific infrastructure such as availability of local manufacturers and service institutions Procurement policies (e.g., legal requirements to do competitive bidding based exclusively on lowest cost among all power sources vs. EE) Availability of data Management capacity Perception of EE technologies Knowledge by potential customers Marketing & sales infrastructure Local maintenance & support services Bill collection (including ability to speed up late payments and pursue payment default) Coordination of national & international efforts Integration of project with utility planning processes Energy planning methodologies (e.g., do they reflect the small-scale, modular nature of EE) (Table 6.1 Continued )

Organizational Design affects drivers and barriers → Institutional programmes z EE projects implemented by IFC z UN ECE energy efficiency projects & technical assistance procedures and incentives

Independent variables X1 …Xn

(Table 6.1 Continued )

Political support for the project at two levels: (a) the policy-making level and (b) energy planners, utility managers and other implementing agents Macroeconomic stability Income levels of target population Access to credit & leasing Investment policy regimes R&D policy Private power legislation

z

z

z

z

Whether investor has time and attention span Mood of the investor in moment of decision-making ‘Irrational’ factors (e.g., whether the investor likes the members of the project team) ‘Gut’ feelings

Other factors that may influence investment decisions are:

z

z

z

z

z

z

z

Causal pathway R

Dependent variable Y

Bonus for developing EE projects z Incentives for hiring experts on EE z Incentives for collaborating with other departments and institutions Project Design affects drivers and barriers → Financial incentives z Grants z Concessional loans z Guarantees z Equity investments

Source: Authors.

Design mechanisms z Clarity of project objectives z Contracts z Planning and risk appraisal z Quality project participants z Technology choice z Sound marketing and aftersales service

z

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6.6 Removing, Reducing and Avoiding the Barriers It is important to explore the relationship between the independent variables, which are the stimuli mechanisms, and the linking variables, the drivers and barriers, respectively. This relationship can be described as a process of stimulating the drivers and overcoming the barriers to private investment. Overcoming the barriers would reduce the overall financing need for energy efficiency and promote sustainable development. It is important to recognize that the process of overcoming barriers is not a single process, but, in fact, three separate processes. Type 1: Removing a barrier or risk means getting rid of a barrier altogether, so that all present and future projects no longer face that barrier. For example, if a government repeals a law that obstructs energy efficiency, the change of legislation will affect all present and future projects. Unless the law is reintroduced, the barrier is removed altogether. In terms of policy objectives, this is the most desirable form of overcoming barriers. Type 2: Reducing a barrier or risk means that the barrier remains in place, but that its deterrent effect is diminished. For example, if a government increases electricity tariffs but not sufficiently to cover long-run marginal costs, the barrier of distorted electricity pricing is reduced but not removed. Type 3: Avoiding a barrier or risk means that the barrier can be overcome or avoided during a particular project while remaining in place for others. While Type 1 and Type 2 are actions addressed primarily to the actor who has created the barrier, Type 3, is addressed primarily to the actor who has to deal with a barrier.

Of all the approaches to overcome barriers, removing obstacles may be the most expensive and difficult. Yet, it is probably the most cost effective, because in this way, barriers disappear for all projects in an economy. In practice, however, the most common approach seems to be the least effective, namely, the avoidance of barriers. It seems that many agencies promoting energy efficiency merely lift projects over the same hurdles time and again. From a public policy perspective, this is not a desirable approach, as it represents a waste of public funds. A case in point is the GEF. The operational strategy of GEF states that the removal of barriers to energy efficiency and renewable energy are central to the mission of the organization.24 The GEF supports projects 24

GEF 1996.

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and programmes that tackle institutional and structural shortcomings, and in this way modifies the barriers and drivers. Two of the 10 operational programmes at GEF are aimed at removing barriers to energy efficiency specifically (Operational Programme #5) and renewable energy (Operational Programme #6).25 However, the incremental cost principle, based on which GEF distributes its funds, contradicts this objective because it usually results merely in lifting the projects over barriers, rather than reducing or removing the barriers that create the incremental cost problem in the first place. As a result, the barriers remain in place to obstruct the next project. To illustrate this important point, consider an EE lighting project, which addresses two main barriers: high initial cost of efficient light bulbs and lack of consumer awareness. Given enough financial resources and successful project implementation, both barriers can be overcome. This, however, does not guarantee that those barriers will permanently disappear. It may happen that the consumers, who have got used to highly subsidized prices, make it difficult for the manufacturer to sell the bulbs at commercial prices once the project is over. This is because the consumers tend to forget the benefits of efficient light bulbs after a while, or because they are simply unwilling to accept increased prices. In order to prevent this, incentives must be given to the project developers to ensure the durability of the barrier removal measures so that the impact stretches beyond the individual project. The sustainability of barrier removal should be one of the main criteria by which development agencies allocate funding to projects. This should be made mandatory in all the business plans submitted as part of applications for energy efficiency funding. Many projects achieve barrier reduction. It can be hypothesized that all successful energy efficiency projects contribute to the reduction of costs or other barriers, thus accelerating the process of commercialization. Types 1 and 2 refer to possible actions by an authority, which is responsible for the barrier or driver, or has the power to modify it. The primary target for barrier removal and reduction should be the government, but other institutions may also be able to influence the process in direct and indirect ways. For example, rather than lobbying a reluctant government, it may in some cases be more effective to work with private sector or civil society organizations, if they have an influence on reducing or removing barriers. Type 3, as mentioned, refers to the ways in which the implementing agency and the project manager can get round the problem. Although this is usually the least cost option in the short term, avoiding a barrier is a short

25

GEF 1996.

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cut that should not be taken, as it does not improve the process of commercializing energy efficiency. In light of this analysis, one can arrive at two approaches to overcome the barriers to private investment. The first one has the primary objective of removing, or at least reducing barriers, which can be referred to as a targeted barrier removal effort. The second approach has the primary objective of maximizing the project’s profit. Examples for targeted barrier removal efforts include: z

z

z

Policy initiatives to remove direct and indirect subsidies for fossil fuels; Initiatives to provide energy efficiency information and to create awareness; Initiatives to train project developers, financiers and government officials, and to provide them with the means and incentives to change the structure of barriers and drivers.

In general, targeted barrier removal activities will not yield high financial returns. However, if successfully implemented, these activities are likely to yield high economic and environmental benefits per unit of taxpayer expenditure.

6.7 Analysis of Drivers Along with the barriers one should understand the motivation and forces that lead consumers to adopt energy efficient measures. Information directed towards understanding consumer’s decision-making behaviour and preferences as well as the behaviour of other stakeholders would give a better understanding of the drivers that push EE measures. A few examples of drivers are given as follows:

Awareness From above, it is clear that there are a wide variety of players who can contribute to barrier removal measures, stimulate the drivers and thereby help the penetration of energy-efficient technologies. A case in point is the strong competition between technology manufacturers that results in aggressive advertising campaigns. The advertising campaign in this example is the

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measure or stimulant, and the high level of awareness of energy-efficient technologies, thus created, is the driver.

Decrease in Technology Price Levels A high level of awareness is usually not sufficient to attract private investment and guarantee market success. The general understanding of market mechanisms dictates that the price of a technology is an important factor in its market penetration. Hence, one can assume that promotional activities are important, even though, there should be other considerations as well. Along with advertisement campaigns, competition should lead to a decrease in the cost of the technology. It is assumed that such reductions in prices lead to an increase in the sales of the technology.

Increase in Energy Prices Cost savings in energy bills through reduced use of energy is one of the reasons for the decision to buy energy efficient equipment. Increased energy prices place a higher burden on consumers. If there is a continuous and predictable increase in its price, consumers are more likely to adopt energy efficient equipment.

Technology Appeal While analyzing drivers, one factor that may be worth considering is the smartness of the technology. If the energy efficient equipment looks modern, appealing and fashionable, there is a higher probability of consumers purchasing the technology. These non-economic motivations, in general, dominate the decisions primarily of high-income groups, for whom, technological appeal is a major driving factor.

Non-energy Benefits Non-energy benefits are important drivers of EE. They accrue, for example, at the national level via improved competitiveness, energy security or job creation. From a consumer perspective, often it is the non-energy benefit that motivates decisions to adopt energy efficient measures. The benefits

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to the consumer through these measures include: (a) improved indoor environment, comfort, health, safety and productivity; (b) reduced noise; (c) labour and time savings; (d) improved process control; (e) increased reliability, amenity or convenience and (f ) direct and indirect economic benefits from downsizing or elimination of equipment.

Environmental Regulations Environmental regulations, if properly designed, can serve as a driver for investments in energy efficiency. In the absence of environmental regulations, the societal costs of electricity generation in the form of air emissions, water use and other environmental impacts are not borne by the energy producer or by the consumer. Consequently, these actors are not aware about the true societal costs of their production and consumption decisions. Environmental regulations can force producers and consumers to internalize these environmental costs into the price of their energy goods and services in the form of increased environmental compliance costs. These increased environmental costs can send a price signal for increased investments in EE by making efficiency investments comparatively more attractive financially. Not all environmental regulations are created equally. If environmental regulation simply mandates the installation of a particular pollution control device, then the industry’s response will be to seek ways to minimize its cost of compliance with the pollution control requirement and the price signal for efficiency investments will be muted. Once the pollution control device is installed, there will be little incentive to improve the efficiency of the overall production process. If, on the other hand, the environmental regulation uses market mechanisms to reward industry for reducing emissions through, for example, tradable permits, then the industry would have the incentive to improve the efficiency of and continuously improve its manufacturing process and potentially turn the environmental regulations into a source of profitability. A more efficient manufacturing process would naturally follow (Box 6.1).

6.8 Conclusion This chapter attempts to study the barriers and drivers that influence investments in EE by using an actor-oriented approach. It starts with the development of a new taxonomy of barriers and drivers by classifying them

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Box 6.1 The Case of Hungary Despite the fact that lighting usually represents only a fraction of national electricity consumption, the CFL is an ideal target for energy efficiency programmes for several reasons. When a general service incandescent lamp (GSL) is replaced by a compact fluorescent lamp (CFL), a very high energy saving potential (up to 80 per cent) can be realized while (arguably) maintaining same energy service (illumination). Hungary has experienced one of the most remarkable market successes in the penetration of EETs, particularly in lighting. Market shares of compact fluorescent CFLs in Hungary were negligible half a decade ago. But persistent efforts to overcome several market barriers have resulted in Hungary ranking among the eight countries in Europe with the highest penetration rates. A study by Diana Ürge-Vorsatz and Jochen Hauff of the Central European University, conducted in 1997 and 1999 covering 2,400 households revealed that the barriers and drivers to energy efficiency include: (a) electricity price hikes; (b) competition amongst suppliers of CFL; (c) awareness; (d) education level; (e) income; ( f ) age distribution; (g) size of household; (h) high first cost and (i) private funding. A higher electricity price in Hungary was the initial driving force to start the campaign for using CFL. The resulting awareness provided a fertile ground for an increase in CFL sales after drastic electricity price hikes pressed consumers to care about their utility bills. Another key reason of the success of CFL was the fierce market competition among CFL suppliers (meso driver), which resulted in decreased prices and, hence, greater demand. The competition amongst suppliers prompted them to execute strong marketing campaigns to raise awareness and education (macro drivers). The survey revealed that the average Hungarian did not know about CFLs at the beginning of the 1990s. But in 1997, the awareness about CFLs was found to be very high among almost all population groups (based on settlement type, geographic location, gender and income level). In terms of education levels, only 6 per cent of those with no complete primary school education had a CFL while 44 per cent of all households with a college or university degree opted for CFLs. However, there was no correlation between the level of wealth and the decision to use an efficient lighting technology. It was found that geographic location plays a significant role: a household in Budapest is almost twice as likely to use a CFL as one in rural areas. This is because the highly educated are more likely to live in Budapest; it can also be attributed to the fact that CFLs, or information on them, are less easily available in rural areas. Source: Ürege-Vorsatz and Hauff 2001.

in terms of profitability and feasibility of private investments in energy efficiency. The barriers are classified into three broad categories, namely, micro, meso and macro. In practice, these barriers are of the following types:

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perceptual-behavioural, financial-economic, institutional-structural and market oriented. Such classification is expected to help devise the response measures to remove, reduce or avoid the barriers. The chapter is also aimed at understanding which drivers contribute to the successful diffusion of EE measures. This would facilitate development of appropriate support mechanisms at financial, policy, institutional, regulation and information levels. Further, using this taxonomy, the chapter develops a theoretical framework which proposes a methodology to analyze the causal relationship between barriers/drivers and the appropriate response measures. This work brings out clearly the need for a different set of response measures, depending on which group a barrier belongs to. At the policy level, some barriers can hardly be influenced by an energy efficiency project team, and whoever encounters them has to accept them. But if the project is of a wider scope, let us say, a programme of institutional development financed by international donors, that programme may be able to modify some of the barriers. Hence, it is important to try to assess which barriers are unchangeable, and which may be worth of tackling by such programmes. This would help both, the multilateral and government agencies, in devising their strategies in terms of support to future barrier removal programmes. This analysis has profound implications for barrier taxonomy, which, in turn, helps design energy efficiency projects. The paper underlines the significance of the identification and classification of real barriers, which is a precondition for the successful diffusion of EETs.

7 Energy Efficiency and International Environmental Law

This chapter looks at the relationship between international environmental law and energy efficiency (EE). International environmental law has spoken repeatedly on the concept of EE but typically in the form of general statements in support of domestic efforts to improve efficiency and not in terms of specific goals or enforceable obligations. This is because historically international law has left EE policy to the domestic sphere. Certain provisions of international climate change treaties recently enacted, however, may signal an increased willingness of the international community to delve into EE matters. Notably, the Kyoto Protocol, as implemented by the Marrakech Accords, contains provisions for policies and measures, joint implementation (JI) and the clean development mechanism (CDM) that may indicate an increased willingness on the part of the international community to engage more directly in policy and implementation issues pertaining to EE.

7.1 Introduction The environmental impacts of energy development and use have been the subject of multiple international environmental treaties and agreements. Although these international treaties tend not to address EE directly, they act as important drivers for their improvements. Environmental targets

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exist in international law for both the reduction of climate change gases, and for airborne pollutants. Most notably, targets for greenhouse gases (GHGs) are found in the 1992 United Nations Framework Convention on Climate Change (UNFCCC) and its associated 1997 Kyoto Protocol. The UNFCCC establishes a voluntary goal for signatory countries to stabilize GHG emissions at the 1990 levels by the year 2000, a goal that has largely not been met. Following up on the Convention, the Kyoto Protocol imposes a mandatory obligation on signatory countries that, if ratified, calls for an aggregate reduction in GHG emissions of 5 per cent during the 2008 to 2012 timeframe. Because reducing energy use has the effect of reducing fossil fuel combustion, these pollution reduction targets can create a legal and regulatory incentive for energy efficiency improvements as one mechanism for meeting the targets. Similar targets exist for transboundary air pollutants. The 1979 Convention on Long Range Trans-boundary Air Pollution1 (LRTAP) and its associated protocols in 1985, 1988, 1991, 1994 and 1999, impose pollution reduction targets for conventional air pollutants. The 1985 Helsinki Protocol contains the basic provision for signatories to reduce their sulphur emissions ‘(…) by at least 30 per cent … by 1993’.2 The 1988 Sophia Protocol obliges parties to ‘(…) control and/or reduce their national annual emissions of nitrogen oxides (…)’3 to 1987 levels. The 1991 Volatile Organic Compounds Protocol mandated a 30 per cent cut by 1999.4 The 1994 Oslo Protocol, built upon the reductions in sulphur in the Helsinki Protocol, but deepened them even further.5 Finally, the 1999 Gothenburg Protocol eclipsed the earlier Protocols and set stronger differentiated reduction limits for sulphur, nitrogen oxides, volatile organic compounds (VOCs), and ammonia.6 After having been ratified by 16 countries, the protocol entered into force on 17 May 2005.7 While international environmental law has established multiple air pollution reduction targets under various treaties, it has not established

1 Convention on Long Range Transboundary Air Pollution. BH764.txt. Available online at http://www.unece.org/env/lrtap/ 2 UNECE-Helsinki Protocol. 1985. Article 2. 3 Ibid. 4 UNECE-VOC Protocol. 1991. Article 2.(2)(a). 5 UNECE-Oslo Protocol. 1994. Protocol on Further Sulphur Reductions. Article 2. 6 UNECE-Gothenburg Protocol. 1999. Annex II. Emission Ceilings. 7 Anon 2007.

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similar targets or standards for EE. If international law does address efficiency directly, it usually comes in the form of broad policy statements encouraging domestic action on efficiency with no binding effect or enforceable obligations at the international level. This is because EE policy has traditionally been regarded principally as a matter of domestic law, notwithstanding its global implications. Rather than addressing EE policy directly, international law tends to address the issue indirectly. Generally, international environmental laws establish emissions reduction targets for certain countries to meet over a defined time period. It then leaves it up to the individual countries to specify which policies and measures will be adopted to reach those emissions targets in accordance with that country’s own national strategy and priorities. Each individual country then decides whether and to what extent it will adopt policies and measures to promote energy efficiency in furtherance of that country’s commitments under the treaty. Recent international efforts on climate change, however, may signal an increasing willingness of the international community to delve into energy efficiency matters directly, at least under certain circumstances. The Kyoto Protocol, as implemented by the 2001 Marrakech Accords, sets forth three flexibility mechanisms—emissions trading, JI and CDM—that enable one country to meet part of its emissions reduction obligations through activities undertaken in other countries. These flexibility mechanisms represent special circumstances in which EE activities are taking place across borders with actors from more than one country in furtherance of international treaty obligations. Because activities by parties in one country help determine compliance with treaty obligations in another country, the international community has shown a greater willingness, at least in the case of CDM and JI, to depart from the general rule of leaving energy efficiency matters to the realm of domestic law and policy. The Kyoto Protocol also contains a rarely discussed and often overlooked provision for the coordination of policies and measures (PAMs) to achieve emissions reductions among signatory countries. Recent efforts to carry out the Kyoto directive concerning PAMs, as elaborated in the Marrakech Accords, could signal increased international involvement in the traditionally domestic sphere of energy efficiency policy. This chapter provides a chronology of international environmental law’s treatment of EE, including discussions of the various treaties addressing transboundary air pollution and climate change, and the Energy Charter Treaty (ECT). The chronology is followed by a more detailed discussion of the UNFCCC, Kyoto Protocol and Marrakech Accords. The overarching

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framework, guiding principles and organizational structure of the UNFCCC, which laid the foundation for the Kyoto Protocol, are first discussed. The Kyoto Protocol and Marrakech Accords are then addressed, including an assessment of the potential drivers and barriers they may create to increased energy efficiency investment.

7.2 International Efforts on Energy Efficiency The link between EE and pollution reduction has been discussed repeatedly in international treaties. The reasons for international support of EE are not limited to air pollution reduction. They also include a desire to reduce dependence on foreign oil supplies via using less imported fuels8 and sustainable economic development. The Council of Europe recognized in 1970 that ‘improvements of the thermal insulation of buildings, (…) results in a significant reduction of fuel consumption’.9 Organisation for Economic Co-operation and Development (OECD) Environmental Guidelines from 1974 added that ‘(…) establishment of regulations and higher standards for improved thermal insulation of new buildings’ was a useful method to increase efficiency.10 In addition, ‘(…) more efficient use of fuels was useful to reduce air pollution’.11 These views have subsequently been memorialized in the 1988 Sophia Protocol,12 the 1994 Sulphur Protocol13 and the 1999 Gothenburg Protocol14 under which the signatories all agree to undertake measures to increase energy efficiency as energy savings usually results in a reduction in sulphur emissions.15 Such early calls for improved energy efficiency coincided with the energy crisis of the 1970s and the political crisis

8

Anon 1980. Council of Europe Committee of Ministers. 1970. 10 OECD. 1974. 11 Ibid. Annex. 4.(d). 12 UNECE-Sophia Protocol. 1988. 13 UNECE-Oslo Protocol. 1994. Article 2 (4). 14 UNECE-Gothenburg Protocol. 1999. Article 6 (1)(c). Available online at http://www. unece.org/env/lrtap/ protocol/99multi_a4.htm 15 UNECE-Oslo Protocol. 1994. Annex IV. Control Technologies For Sulphur Emissions From Stationary Sources. Paragraph 9. 9

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at the end of that decade, where a number of countries tried to reduce their dependence on oil from the Middle East.16 The G7 endorsed this goal at the 1980 Venice Summit, stipulating that: Our objective is the introduction of increasingly fuel-efficient vehicles… We will accelerate this process, where appropriate, by arrangements or standards for improved automobile fuel efficiency, by gasoline pricing and taxation decisions, by research and development and by making public transport more attractive.17

Another protocol, the International Energy Efficiency Financing Protocol (IEEFP) provides guidelines for local financing institutions (LFIs) around the world to evaluate and finance energy efficiency and savingsbased renewable projects. The IEEFP is a long-term ‘grass roots’ solution to financing Energy Savings Projects. It is envisioned that the IEEFP will ultimately become the global ‘blue print’ for educating and training LFIs around the world on the special intricacies and benefits of financing energy savings projects. The IEEFP’s objective is to create a better understanding by LFIs and other global stakeholders on how Energy Savings generate savings from existing operating expenses of end-use consumers, and how this equates to new cash flow and increased credit capacity for end-use consumers to repay Energy Efficiency Financing Protocol (EEFP) loans.18 The other forum in which energy efficiency figures prominently in international law is the issue of climate change. The issue first appeared at the international level in 1989 when the G7 argued that in terms of reducing GHGs: ‘(…) energy efficiency could make a substantial contribution towards these goals’.19 The importance of investments in energy efficiency was noted later by them in 1994.20 In 1999, they announced their intention to

16 In 1972, before the Arab oil embargo, the total cost of US oil imports was only USD 5 billion. By 1980, this had risen to USD 80 billion and was coinciding with the political uncertainty associated with the Iranian revolution. The 1980 G7 Venice Communiqué clearly expressed this when they stipulated that: ‘We must rely on fuels other than oil to meet the energy needs of future economic growth’ (G7 Venice Summit 1980). 17 Ibid. 18 IPMVP. 2007. 19 G7 Paris Summit. 1989. 20 G7 Naples Summit 1994.

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reduce GHG emissions through: ‘(…) rational and efficient use of energy and through other cost-effective means’.21 The more forceful pronouncements on energy efficiency have come from Agenda 21 and the regime established under the UNFCCC. Agenda 21, adopted by more than 178 countries at the Earth Summit in Rio de Janeiro, Brazil in June 1992, establishes a comprehensive plan of action to be taken globally, nationally and locally in areas where humans impact the environment. With respect to energy efficiency, Agenda 2122 calls upon governments to ‘(…) encourage industry to increase and strengthen its capacity to develop technologies, products and processes that are safe, less polluting and make more efficient use of all resources and materials, including energy’.23 It also states that the signatories ‘(…) support the promotion of less polluting and more efficient technologies and processes in industries, taking into account area-specific accessible potentials for energy, particularly safe and renewable sources of energy, with a view to limiting industrial pollution and adverse impacts on the atmosphere’.24 The UNFCCC includes several policy pronouncements in support of energy efficiency. The preamble to the UNFCCC highlights the importance of assisting developing countries in ‘(…) achieving greater energy efficiency and for controlling GHG emissions in general, including through the application of new technologies on terms which make such an application economically and socially beneficial.’ 25 The Kyoto Protocol elaborates on the importance of energy efficiency, recommending that developed countries should pursue PAMs, such as, inter alia: ‘(…) enhancement of energy efficiency in relevant sectors of the national economy’.26 Subsequent decisions by the Council of Parties (COP)27 to the UNFCCC have emphasized the importance of energy efficiency, too, as a mechanism for combating climate change. In Bonn, Germany in July 2001,28 the COP reiterated at its sixth meeting that all market imperfections hindering the transfer of EETs to developing countries should be removed, especially for

21

G8 Koln Summit. 1999. Paragraph 33. UNDSD. 1993. Paragraphs 9.9; 9:12 (h)-(j). 23 Ibid., Chapter 9.18 (b). 24 Ibid., Chapter 9.18 (f ). 25 UNFCCC. Preamble. Paragraph 22. 26 UNFCCC. 1997. Article 2 (1)(a)(i). 27 The COP and overall institutional framework of the UNFCCC is discussed infra. 28 UNFCCC. 2001. 22

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the least developed countries (LDCs) and the most vulnerable countries.29 The Buenos Aires and Bonn meetings of the COP culminated in the agreement by the 7th COP of the Marrakech Accords in Marrakech, Morocco, in December 2001 (discussed in the following sections).30 The 10th COP focused on the post-2012 carbon reduction targets and on bringing developing countries into the process. It calls for both existing and new technologies to enable a more efficient and less carbon-intensive use of energy. The Twelfth COP (Nairobi, 6–17 November 2006) welcomed initiatives, such as the Nairobi Framework presented by the UN SecretaryGeneral and the Global Energy Efficiency and Renewable Energy Fund (GEEREF) established by the Commission. The 2002 World Summit on Sustainable Development (WSSD) also prominently featured energy efficiency. The parties to the World Summit reconfirmed the principles of Agenda 21 from a decade earlier. In addition to the general support for the development of energy efficiency, the participants agreed to: Integrate energy consideration, including energy efficiency (…) especially into policies of major energy-consuming sectors, and into the planning, operation and maintenance of long-lived energy consuming infrastructures, such as the public sector, transport, industry, agriculture, urban land use, tourism and construction sectors.31

The signatories also agreed to: Establish domestic programmes for energy efficiency, including, as appropriate, by accelerating the deployment of energy efficiency technologies, with the necessary support of the international community.32

Several United Nations agencies have also embraced the goals of energy efficiency and its promotion, including the World Bank33 and the Global

29

UNFCCC. 2001. UNFCCC. 2002a, 2002b. 31 WSSD. 2002. Paragraph 19 (b). (Note, the paragraph was agreed prior to the final document, and was not subject to change.) 32 Ibid., Paragraph 19(h). 33 YBIEL 4. 1993, 196. 30

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Environmental Facility (GEF).34 The G8 urged the GEF to continue to support projects with energy efficiency in 2001.35 The 2002 World Summit on Sustainable Development further reiterated the linkage of the GEF in this area.36 The Intergovernmental Panel on Climate Change (IPCC), an association of leading scientists advising the UNFCCC on climate change science, asserted that promoting the development and implementation of national and international energy efficiency standards was a low cost or cost-effective way to combat global warming.37 The 1996 ECT and its accompanying Energy Charter Protocol on Energy Efficiency and Related Environmental Aspects (PEEREA) are particularly noteworthy for their specific and detailed treatment of energy efficiency.38 The Energy Charter primarily is an international trade agreement, but it includes provisions, too, obligating signatories to implement domestic policy and measures to improve energy efficiency and calls for international cooperation on such matters (Energy Charter, Part IV, Art. 19). The ECT and Protocol can help promote information exchange and capacity building, particularly for economies in transition (EIT). Further, it explicitly recognizes the linkage between energy efficiency and sustainable economic

34

See YBIEL 6. 1995, 231. G8 Genoa Summit. 2001. Paragraph 27. 36 WSSD. 2002. Paragraph 19 (n). This was agreed prior to the summit, and not subject to change. 37 IPCC. 2006. 38 Available online at http://www.unescap.org/enrd/energy/compend/ceccpart5chapter1. htm. See also YBIEL 7. 1996, 173–174. Together with the Energy Charter Treaty, the Energy Charter Protocol on Energy Efficiency and Related Environmental Aspects was adopted on 17 December 1994, at Lisbon, Portugal, as Annex 3 to the Final Act of the European Energy Charter Conference. Members of the Energy Charter Conference include Albania, Armenia, Austria, Australia∗, Azerbaijan, Belarus∗, Belgium, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Cyprus, Denmark, Estonia, European Communities, Finland, France, Georgia, Germany, Greece, Hungary, Iceland∗, Ireland, Italy, Japan, Kazakhstan, Kyrgyzstan, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Moldova, Mongolia, Netherlands, Norway∗, Poland, Portugal, Romania, Russian Federation∗, Slovakia, Slovenia, Spain, Sweden, Switzerland, Tajikistan, The former Yugoslav Republic of Macedonia, Turkey, Turkmenistan, Ukraine, Uzbekistan, United Kingdom. (Ratification of the Energy Charter Treaty is still pending as of January 2003 for countries marked with an asterisk.) Observers to the Energy Charter Conference include Algeria, Bahrain, People’s Republic of China, Canada, Islamic Republic of Iran, Republic of Korea, Kuwait, Morocco, Oman, Qatar, Saudi Arabia, Tunisia, United Arab Emirates, United States of America, Venezuela and Federal Republic of Yugoslavia. See ‘What is the Energy Charter? An Introductory Guide,’ Energy Charter Secretariat, January 2003. Available online at http://www.encharter.org. 35

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development. Towards this end, it seeks to promote energy efficiency as a means of economic development independent of any GHG or air pollution reduction benefits. In addition, the Energy Charter adopts several other key principles of international environmental law, including the precautionary principle and the polluter pays principle.39 The accompanying PEEREA elaborates on some of the principles set forth in the ECT. The PEEREA contains a comprehensive list of policies, regulatory frameworks and activities that signatories may implement at the domestic level to improve energy efficiency.40 One particularly noteworthy principle embodied in PEEREA is the concept that energy efficiency ‘(…) can itself amount to an energy resource’.41 This explicit recognition of energy efficiency as a resource alternative could be interpreted as opening the door in the international law context to the introduction of planning concepts such as demand-side management and integrated resource planning.42 These planning principles have been used by many countries in the domestic regulatory context to provide an alternative, more comprehensive framework for making energy resource acquisition decisions than solely focusing on supply-side acquisition. The PEEREA is also noteworthy in that it adopts the concept of life cycle analysis in its definition of an ‘Energy Cycle’43 and encourages parties to minimize environmental impacts across that entire energy cycle. Furthermore, it explicitly recognizes the need for a 39

Bradbrook 1997b. Energy Charter Treaty, Art. 19(1). PEEREA 2008. Art. 3(2) and 8(2). These domestic policies may include, inter alia, (a) development of long-term energy demand and supply scenarios to guide decision making; assessment of the energy, environmental and economic impact of actions taken; definition of standards designed to improve the efficiency of energy using equipment, and efforts to harmonize these internationally to avoid trade distortions; development and encouragement of private initiative and industrial cooperation, including joint ventures; promotion of the use of the most energy-efficient technologies that are economically viable and environmentally sound; encouragement of innovative approaches for investments in energy efficiency improvements; development of appropriate energy balances and data bases; promotion of the creation of advisory and consultancy services which may be operated by public or private industry or utilities and which provide information about energy efficiency programmes and technologies, and assist consumers and enterprises; support and promotion of cogeneration and of measures to increase the efficiency of district heat production and distribution systems to buildings and industry. 41 PEEREA 2008. Art. 1(1). 42 Bradbrook 1997a. 43 ‘Energy Cycle’ is defined in the PEEREA as ‘the entire energy chain, including activities related to prospecting for, exploration, production, conversion, storage, transport, distribution and consumption of the various forms of energy, and the treatment and disposal of wastes, as well as the decommissioning, cessation or closure of these activities, minimizing harmful Environmental Impacts’ (PEEREA 2008. Art. 19(3)(a)). 40

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public policy response to promote energy efficiency, implicitly rejecting the argument that international trade and competition will, by themselves, lead to optimal levels of energy efficiency investment.44 However, the ECT and accompanying PEEREA are written using such amorphous and non-binding language as to preclude effective enforcement or compliance monitoring.45 Unlike the UNFCCC, Kyoto Protocol and LRTAP that include numerical goals, the ECT and PEEREA do not establish any concrete goals or outcomes for signatory countries to meet. Further, the tentative wording of the provisions leaves little opportunity for international enforcement or compliance monitoring, leading one commenter to characterize the Treaty as a ‘(…) hesitant first step in the environmental goal of promoting energy efficiency in the international law arena’.46 The European Union (EU) has also taken several steps to improve energy efficiency among its member countries, but with mixed success. In 1992, the European Commission (EC) announced that by 1994, manufactures and importers of a wide range of household appliances sold in the EC would have to supply prospective customers with information on the product’s energy consumption. As originally proposed, labels of energy consumption would have been required for refrigerators and freezers, washers and dryers, dishwashers, ovens, water heaters, lights and air conditioning units.47 However, these goals were not achieved and the commission was forced to replace the seven proposed directives with just one, stating the community should aim for improvements in all seven areas, but setting no standards, time limits, reporting requirements or minimal goals.48 By 1995, the only legal standards adopted were for refrigerators and boilers. At this point, the EU began finalizing its SAVE II programme, a Union-wide programme dedicated exclusively to promoting energy efficiency and encouraging energy saving behaviour in industry, commerce and the domestic sector as well as in transport through policy measures, information, studies and pilot actions, and the creation of local and regional energy management agencies. This shifted the EU’s focus from legal standards for energy efficiency to aid to regions with energy savings programmes.49 Many within the EU

44

Bradbrook 1997a. Ibid. 46 Ibid. 47 YBIEL 3. 1992, 273. 48 D. MacKenzie. 1992. YBIEL 4 1993, 144. 49 Anon 1995. YBIEL 6 1995, 201. 45

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have strongly advocated for improvements in the fuel efficiencies of motor vehicles, and in some key countries (such as the UK)50 in particular. Here, it was proposed, and supported by voluntary initiatives from the motorvehicle industry,51 that by 2008, fuel efficiency in the EU should be increased by 40 per cent.52 The EC has set detailed targets with the aim of developing action in the area of energy and environment policy introducing measures to ensure the long-term improvement of EE, through the use of market forces and new technologies. The Commission has proposed a new ‘Action Plan for energy efficiency’ in October 2006 aimed at achieving energy savings of 20 per cent by 2020.53 Virtually absent from international discussions of EE are coordinated efforts at consumer labelling schemes on EE, notwithstanding its strong linkage to international trade and commerce. Clearly labelled appliances, correctly specifying EE information help concerned consumers make informed choices on energy efficiency and use.54 Agenda 21 stipulates that it is necessary to ‘(…) establish or enhance, as appropriate, in cooperation with the private sector, labelling programmes for products to provide decision makers and consumers with information on opportunities for energy efficiency’.55 Despite the potential merits of this approach, there are no international law relating to the labelling of products or processes with regard to energy efficiency. Rather, this is dealt with in typically domestic and sometimes regional settings.56

7.3 The UN Framework Convention on Climate Change (UNFCCC) Adopted on 9 May 1992, the UNFCCC represents a landmark international agreement acknowledging the urgent need for the international community to address the growing risk of climate change. The UNFCCC establishes as 50 In the UK, the Royal Commission into Transport which recommended, inter alia, improving the fuel efficiency of UK cars by 40 per cent by 2005. Hamer 1994, 6. 51 The European Car Manufacturers promised to cut their CO2 emissions from new models by 25 per cent. This voluntary agreement negotiated with the European Commission means that by 2008, cars will have to emit an average of 140 grams of CO2 per kilometre, compared with 186 grams for cars at the end of the decade. Anon 1998, 5. 52 Henderson 1998, 18–19. 53 Directive 2006/32/EC of the European Parliament. 54 Bower 1991, 37. 55 UNDSD. 1993. Paragraphs 9.12(l). 56 Cordes 2000, 10–11.

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its ultimate objective the ‘(…) stabilization of GHG concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system’.57 Further, the Convention states that such stabilization should be achieved within a time frame sufficient to allow ecosystems to adapt naturally to the changing climate, to ensure that food production is not threatened and to allow economic development to proceed in a sustainable manner. The UNFCCC sets forth a series of principles for achieving the Convention’s objective. These principles have not only guided implementation of the UNFCCC but have also influenced subsequent negotiations and agreements on climate change. The principles are highlighted below: z

z

z

z

57

It recognizes the ‘(…) common but differentiated responsibilities and respective capabilities (…)’58 of countries to address climate change, and it called upon the developed countries to take the lead in combating climate change.59 It highlights the specific needs and special circumstances of developing countries, especially those that are particularly vulnerable to the adverse impacts of climate change and climate change mitigation.60 This includes those countries that could face the brunt of the adverse public health and environmental impacts of climate variability, including island countries and countries in low lying areas. The Convention also draws attention to those countries that could face adverse economic impacts from the implementation of GHG mitigation measures, as may be the case for developing countries heavily dependent on oil revenues. It expressly adopts the precautionary principle for public policy action in the face of uncertainty: ‘Where there are threats of serious and irreversible damage, lack of full scientific certainty should not be used as a reasons for taking precautionary measures to combat climate change.’61 It recognizes the right of a country to sustainable development.62 Thus, policies and measures to combat climate change should be integrated with national development programmes, while recognizing that economic development is essential for adapting to climate change.

UNFCCC. 2002b, Art. 2. Ibid., Art. 3(1). 59 Ibid. 60 Ibid., Art. 3(2). 61 Ibid., Art. 3(3). 62 Ibid., Art. 3(4). 58

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It directs the parties to cooperate to promote a supportive and open international economic system that would lead to sustainable economic development and growth for all parties. It further admonishes the parties that measures to combat climate change should not be used as a means for arbitrary or unjustifiable restraints on international trade.63

Consistent with the principle of differentiated responsibilities, the UN framework calls upon industrialized countries and EIT, referred to as Annex I Countries, to make non-binding voluntary commitments to stabilize GHGs emissions levels at 1990 levels by the year 2000.64 It then leaves it to the individual countries to select the policies and measures to reach that goal, subject to national priorities, individual country circumstances. By 2008, 192 countries were parties to the UNFCCC. The parties meet annually at the COP to monitor implementation of the UNFCCC and evaluate new strategies for addressing climate change. The COP has established two subsidiary bodies that meet at least bi-annually to carry out preparatory work for the COP meetings. They are the Subsidiary Body for Scientific and Technological Advise (SBSTA) and the Subsidiary Body for Implementation (SBI). The climate change secretariat supports the COP and the two subsidiary bodies by preparing background documents, providing technical advice, compiling data and helping with other matters as requested by the COP, SBSTA and SBI. Policies and measures to implement energy efficiency are not addressed directly in the UNFCCC, except in passing in the preamble.65 Nonetheless, indirectly the UNFCCC could serve as a driver for energy efficiency. While

63

UNFCCC. Art. 3(4). The countries making this commitment are listed in Annex I to the Convention and are therefore commonly referred to as ‘Annex I Countries’. EIT’s, which are listed among the Annex I countries, are granted additional flexibility in establishing a baseline. 65 The 22nd paragraph to the UNFCCC’s preamble states: 64

Recognizing that all countries, especially developing countries, need access to resources required to achieve sustainable social and economic development and that, in order for developing countries to progress towards that goal, their energy consumption will need to grow taking into account the possibilities for achieving greater energy efficiency and for controlling greenhouse gases in general, including through the application of new technologies on terms which make such application economically and socially beneficial. (UNFCCC 2003, 6)

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not obligated to do so, a country could decide to implement domestic policies and measures aimed at improving energy efficiency in furtherance of the treaty, if it decides such measures are consistent with its national priorities. The parties are obligated to report on the policies and measures that are implemented, but they are not required to demonstrate that the steps taken are sufficient to meet the UNFCCC’s goal of stabilizing GHG emissions. The UNFCCC also states that Annex I parties ‘(…) may implement such policies and measures jointly with other parties to the Convention’.66 This provision for activities implemented jointly (AIJ) is a precursor to the flexibility mechanisms under the Kyoto Protocol. An Annex I country may undertake a project in an EIT or developing country, including renewable energy, energy efficiency and forestry projects, in furtherance of the objectives of the Convention, but it may not count the emissions reduction offsets towards its goal of stabilizing GHG emission at 1990 levels. The Annex I parties then report on their AIJ activities to the UNFCCC secretariat, who synthesizes the information in an annual report. The objective and principles established by the UNFCCC continue to play an important role in shaping international environmental law on climate policy. Nonetheless, it became evident to many that the Convention’s voluntary commitments to stabilize emissions at the 1990 levels would be insufficient to reach its ultimate objective of stabilizing GHG emissions. During the summer of 1995, the COP issued the Berlin Mandate acknowledging that further action would be required on stabilizing GHG emissions. This led to new rounds of negotiations and the subsequent adoption by COP of the Kyoto Protocol in December 1997.

7.4 The Kyoto Protocol and the Marrakech Accords Supplementing and strengthening the UNFCCC, the Kyoto Protocol establishes legally binding emissions reduction targets for the Annex I industrialized countries. The parties agreed that the total level of emissions reductions among all Annex I countries would be reduced to a level at least 5 per cent below the 1990 levels by the 2008–2012 timeframe. Responsibility for achieving these emissions reductions are divided up

66

UNFCCC 2002a, Art. 4(2)(a).

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among the signatories at different levels depending on individual country circumstances, as set forth in Annex B to the Kyoto Protocol. Table 7.1 lists the emissions reduction obligations of the various countries. Some countries will be allowed to increase their emissions up to a certain amount above the 1990 levels, others have agreed to stabilize emissions at 1990 levels, while others have agreed to reduce emissions by a certain percentage below the 1990 baseline. The EU and the accession countries to the EU have indicated they intend to take advantage of a scheme under the Protocol that will allow them to pool their emissions reduction obligations together to meet a combined target of 8 per cent reduction below the 1990 levels. The emissions reduction target covers six major GHG emissions: carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydro fluorocarbons (HFC’s), perfluorocarbons (PFC’s) and sulphur hexafluoride (SF6) (Kyoto, Annex A). All six GHGs are considered together for accounting purposes as a basket of emissions. To provide a common matrix for quantifying emissions reductions, each of the six GHG emissions is measured for accounting purposes based on its global warming potential (GWP), a calculation based on its relative effect in warming the atmosphere over a 100-year period. The GWP of a metric ton of carbon dioxide is used as the common benchmark.67 For example, one ton of methane emissions has been determined to be equivalent to 23 tons of carbon dioxide emissions in terms of its GWP. For accounting purposes, a reduction in methane emissions of one ton, receives credit equal to a reduction in carbon dioxide emissions of 23 tons. The Protocol states that, for the first period of compliance, parties must demonstrate compliance over a five-year timeframe (2008–2012).68 A country’s average annual emissions over that five-year period must be below the country’s emissions reduction target. This multi-year timeframe for demonstrating compliance was chosen to account for possible annual fluctuations due to extreme weather conditions or upsurges in economic growth. Parties that exceed their targets may carry over the surplus to future compliance periods, subject to certain limitations. The emissions reduction levels and timeframes for future compliance periods will be the subject of subsequent negotiations. The Kyoto Protocol requires 55 parties to UNFCCC to ratify the Protocol, along with Annex I parties accounting for 55 per cent of the carbon dioxide emissions from Annex I countries based on emissions levels in 1990.69 As of November 2007, 174 parties have ratified the protocol. 67

UNFCC 1997, Kyoto Art. 5(3). Ibid., 3(1). 69 Ibid., 25. 68

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Table 7.1 Emissions Reduction Obligation under Annex B to Kyoto Protocol % Reduction/ Increase

Level of GHG emission changes

Countries

Parties that agreed to cap on increase in GHG emissions from 1990 level

Norway Australia Iceland

101% 108% 110%

Parties that agreed to stabilize GHG emissions at 1990 levels

New Zealand, Russian Federation∗ and Ukraine∗

100%

Parties that agreed to reduce GHG emissions

Croatia∗ Canada, Hungary∗, Japan and Poland∗ United States of America∗∗ Austria, Belgium, Bulgaria∗, Czech Republic∗, Denmark, Estonia∗, European Community, Finland, France, Germany, Greece, Ireland, Italy, Latvia∗, Liechtenstein, Lithuania∗, Luxembourg, Monaco, Netherlands, Portugal, Romania∗, Slovakia∗, Slovenia∗, Spain, Sweden, Switzerland and United Kingdom

95% 94% 93% 92%

Source: Kurokawa 2003. Notes: ∗Countries entitled to select the year 1995 as baseline emissions level instead of year 1990. ∗∗The United States of America has stated it does not intend to ratify the Kyoto Protocol.

Of these, 36 developed countries (plus the EU as a party in its own right) are required to reduce GHG emissions to the levels specified for each of them in the treaty (representing over 61.6 per cent of emissions from Annex I countries), with three more countries intending to participate. One hundred and thirty-seven developing countries have ratified the protocol, including Brazil, China and India, but have no obligation beyond monitoring and reporting emissions. As of 14 January 2009,186 countries have ratified the protocol.70 Under Kyoto, industrialized countries agreed to reduce their collective GHG emissions by 5.2 per cent compared to the year 1990. National limitations range from 8 per cent reductions for the EU and some others to 7 per cent for the

70

Anon 2009.

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United States and 6 per cent for Japan.71 Kyoto has its own share of critics who attribute it as nothing more than a global socialism initiative.

7.5 Policies and Measures Article 2 to the Protocol directs the parties to carry out PAMs domestically to achieve the emissions reductions targets. Unlike the UNFCCC, which is silent on the types of policies and measures available, the Kyoto Protocol lists eight representative PAMs that a country can take. Included in that list is the ‘(…) enhancement of energy efficiency in relevant sectors of the national economy’.72 But, as with the UNFCCC, the Kyoto Protocol leaves it up to the individual countries to decide which PAMs to implement ‘(…) in accordance with its national circumstances’.73 Yet, the Kyoto Protocol, if ratified, could differ dramatically from the UNFCCC as a driver for energy efficiency investment. In contrast to the voluntary emissions reduction goals under the UNFCCC, the legally enforceable cap on GHG emission under Kyoto would provide greater incentive for signatory countries to implement energy efficiency measures. Because energy efficiency is regarded as one of the more economical policy options available for reducing GHG emissions, it would appear likely that, if Kyoto is ratified, energy efficiency improvements will play an important role in helping signatory countries meet their Kyoto targets. The Protocol also creates the opportunity for the COP to play a proactive role in coordinating and promoting PAMs among signatory countries. It directs the signatories to enhance the individual and combined effectiveness of their domestic PAMs, and it directs the COP to facilitate such cooperation.74 In addition, Article 2 states that if the COP ‘(…) decides that it would be beneficial to coordinate any of the policies and measures […], taking into account different national circumstances and potential effects, it shall consider ways and means to elaborate the coordination of such policies and measures’.75 While the meaning of this provision is ambiguous, it does suggest that the COP may elect to take a more active role in coordinating PAMs.

71

UNEP 2009. UNFCC 1997, Kyoto Art. 2(1)(a)(i). 73 Ibid., 2(1)(a). 74 Ibid., 2(1)(b). 75 Ibid., 2(4). 72

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The Marrakech Accords provide more definitive guidance on PAMs, stating that COP should focus on improving transparency, effectiveness and compatibility of PAMs through, for example, specific criteria and quantitative measures.76 The Accords also direct the SBSTA, a subsidiary technical body to COP, to take the lead in conducting a series of forums on good practices for PAMs.

7.6 Flexibility Mechanisms The Kyoto Protocol establishes three flexibility mechanisms—emissions trading, JI and CDM—to provide economic incentives for parties to seek out cost-effective emissions reduction opportunities and to promote sustainable economic development. The cost of reducing GHG emission varies markedly across emissions source, geographic region and from country to country. The flexibility mechanisms seek to capitalize on this variability by allowing parties to meet their emissions reductions obligations outside their own country where more economical emissions reduction opportunities may be available. The Protocol, itself, does not impose any concrete limits on the extent to which a party may make use of the flexibility mechanisms, but it does state that domestic action must constitute a significant element of a party’s emissions reductions, and that the use of the flexibility mechanisms should be a ‘(…) supplement to domestic action’.77

Joint Implementation JI authorizes parties from Annex I countries to implement GHG emissions reduction projects in other Annex I countries in exchange for emissions reduction credits created by the projects.78 The project sponsor can then count the credits, in the form of emissions reduction units (ERUs), towards meeting its own emissions reduction targets under Kyoto.79 The emissions reductions must be in addition to any GHG emissions reductions that

76

UNFCC, Marrakech Decision 13/CP.7., Annex I. UNFCC, Marrakech, Decision 15/CP.7., Preamble paragraph 8. 78 UNFCC 1997, Kyoto Art. 6 79 Ibid., Kyoto Art. 6(1). 77

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would have occurred in the absence of the project—referred to as the additional requirement.80 To establish the quantity of ERUs created by a project, the project developer establishes a baseline for probable emissions levels in the absence of the project being implemented. The Marrakech Accords set out detailed requirements for establishing a baseline. A baseline is defined as the ‘(…) scenario that reasonably represents the anthropogenic emissions by sources or anthropogenic removals by sinks of greenhouse gases that would occur in the absence of the proposed project’.81 Baselines must be set on a project-specific basis and in a manner transparent and agreeable to all stakeholders. The baseline represents the business as usual scenario with ‘conservative assumptions’. More ambitious assumptions are considered under alternate scenarios. The baseline covers emissions from all six GHGs within the ‘project scope’ defined to encompass all anthropogenic emissions ‘(…) under the control of the project participants that are significant and reasonably attributable (…)’ to the project activity.82 The ERUs are then equal to the net reduction in GHG emissions from that baseline. The focus is on the net reductions in emissions because the project developer must also account for leakage, which is defined to encompass potential increases in GHG emissions outside the project boundary that can be ‘measured and attributed’ to the project activity.83 To avoid double counting of emissions reductions, the host country, which, in the case of JI, also has emissions reduction obligations under Kyoto, is prohibited from counting the GHG emissions reductions created by the project towards meeting its own Kyoto obligations. JI projects proceed along two tracks depending on the status of the host country. Track 1, applies to countries hosting JI projects where the host country meets the Protocol’s eligibility requirements for methodological and reporting obligations. In these instances, the host country is authorized to apply its own procedures for the project and for the issuance and transfer of ERUs to the project sponsor.84 Track 2, applies in cases where the host

80 Ibid., Kyoto Art. 6(1)(b), Additionality is discussed in more detail below in the discussion of CDM. 81 UNFCC 2002c. Addendum Volume II, Appendix B, Criteria for baseline setting and monitoring, Section 1, 21 January 2002 (hereinafter Marrakech). 82 Ibid., Appendix B, paragraph 4(c). 83 Ibid., paragraph 4(f ). 84 Ibid., paragraph 23.

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country does not meet the Protocol’s eligibility requirements.85 In such cases, responsibility for validating the project and authorizing the issuance and transfer of the ERUs rests with a 10-member international supervisory committee. The Marrakech Accords, Article 6, provide detailed requirements on the review and approval process for Track 2 JI projects.86 The project participants must prepare and submit a project design document (PDD) that includes, among other things, the methodology that will be used for calculating the emissions baseline, a demonstration that the project has been approved by the host country and other countries involved, proof of compliance with the additionally requirement, a monitoring plan to demonstrate that the emissions reduction have taken place and documentation of the environmental impacts of the project, including, if deemed necessary by the host country, an environmental impact assessment.87 Ultimately, it is up to the host country to determine the environmental compatibility of the project with national priorities. The project participants then submit the PDD to an independent entity that has been accredited by the international supervisory committee to validate JI projects.88 The independent entity publishes the PDD for 30 days for public comment, after which it makes a determination of compliance of the project with the Article 6 requirements. The independent entity’s determination is made public and becomes final 45 days later, unless one of the project participants or at least three members of the international supervisory committee request a formal review. After the project has commenced, the project participants submit a report to the independent entity on the project’s estimated emissions reductions, at which time the independent entity reviews the reports and determines the level of ERUs to be issued by the host country for the project.89 That decision becomes final unless objections are received from one of the project participants or at least three members of the supervisory committee. JI can act as a driver for energy efficiency by awarding emissions credits for the GHG emission reductions achieved by the projects. JI is an extension of the AIJ procedures set forth in the UNFCCC for joint projects among Annex I countries. Unlike the AIJ process in the UNFCCC, 85

Ibid., paragraph 24. The approval process for Track 1 projects will likely mirror the Track 2 process. However, it will be in accordance with the implementing laws and procedures of the host country. 87 UNFCCC 2002c, paragraph 31. 88 Ibid., paragraphs 32–35. 89 Ibid., paragraphs 36–39. 86

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however, the emissions reduction credits created by JI projects under Kyoto and Marrakech can be counted towards meeting the emissions reduction obligations of the project sponsor’s country. The Kyoto Protocol, if ratified, could create an important driver for energy efficiency investments in Annex I countries, particularly for EITs that have significant potential for energy efficiency improvement.

Clean Development Mechanism The CDM authorizes Annex I countries or their authorized public and private sector representatives to implement GHG emissions reduction projects in developing countries (non-Annex I countries) in exchange for GHG emissions reduction credits. CDM differs from JI in that the host country for CDM project activities is not one of the Annex I countries. However, the host country must be a signatory to Kyoto, and it must also establish a designated national authority (DNA) to authorize the project activity on behalf of the host country.90 The dual purposes of CDM are to assist non-Annex I parties in achieving sustainable development and to assist Annex I parties in achieving their GHG emissions targets.91 The project developer can use the certified emissions reductions (CERs) created by the project activity to meet the sponsoring country’s own Kyoto compliance obligations.92 Two per cent of the CERs generated by the project activity are contributed to an adaptation fund for least-developed countries.93 The approval process for CDM essentially mirrors the approval process for Track 2 JI projects, although there are some differences. The independent evaluator is called the Designated Operational Entity (DOE). A 10-member CDM Executive Board oversees the whole process. As with JI projects, CDM project participants submit a PDD that includes a detailed analysis of the emissions baseline, a demonstration of emissions additionality, detailed monitoring protocols and the host country’s determination of environmental acceptability.94 The requirements for developing the project boundary and accounting for leakage are similar to those for JI. In the PDD, the project developer selects a crediting period for the CERs, either (a) a fixed 10-year period with no option for renewal, or (b) a seven-year 90

Ibid., paragraph 29. UNFCC 1997, Kyoto, Art 12(2) 92 Ibid., Kyoto, Art. 12(3)(b). 93 UNFCC, Marrakech, Decision 17/CP.7., Preamble paragraph 15(a). 94 Ibid., Appendix B. 91

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period with the opportunity for two renewals, for a total of 21 years.95 The PDD also includes a description of the additional environmental benefits of the project activity and, if requested by the host country, an environmental impact assessment. The Marrakech Accords sets forth three standardized baseline methodologies from which a project developer may choose, or, alternatively, the project developer may propose its own baseline methodology subject to Executive Board approval. The three standardized baseline methodologies are as follows: z z

z

Existing actual or historical emissions. Emissions from a technology that represents an ‘economically attractive course of action’. In other words, the project developer looks at what would likely have been built, for example, a fossil fuel power plant, if the project activity is not undertaken. Average emissions of similar project activities undertaken in the previous five years, in similar social, economic, environmental and technological circumstances, and whose performance is among the top 20 per cent of their category. This category would apply to technologies that are raising the emissions performance bar for the chosen technological application.

As with JI, the baseline must be developed on a project-specific basis, and in a ‘(…) transparent and conservative manner.’96 The monitoring plan in the PDD must provide for the collection of all relevant data necessary for estimating or measuring anthropogenic emissions occurring within the project boundary during the crediting period.97 The monitoring plan must provide for monitoring for leakage outside the project boundary for sources that are ‘(…) significant and reasonably attributable to the project activity during the crediting period’.98 The plan must include quality assurance control procedures and for periodic calculation of GHG emissions reductions and leakage effects. The implementation of the monitoring plan then becomes a condition for the verification, certification and issuance of the CERs.

95

Ibid., paragraph 49. UNFCC, Marrakech, Decision 17/CP.7., paragraph 45(b). 97 Ibid., paragraphs 53–60. 98 Ibid., paragraph 53(c). 96

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The project participants submit the PDD to the DOE for its review in the validation phase.99 The DOE reviews the project activity, releases it for public comment and then decides whether to validate the project activity by registering it with the Executive Board. The DOE’s decision on validation becomes final after eight weeks, unless one of the project participants or at least three members of the Executive Board request review. Once the project activity has become operational, the project participants submit a monitoring report to a different DOE from the one that validated the project. In the verification phase, this new DOE verifies the emissions reductions and certifies the legitimacy of the CERs. Verification is the periodic independent review and ex-post determination by the DOE that the GHG emissions reductions have occurred as a result of the project activity during the verification period.100 The DOE compiles a verification report, which is made publicly available, that includes determinations that the project developer applied the monitoring methodologies correctly, that the project activity conforms to the PDD and that the project activity achieved the emissions reductions during the specified time period. Unless objection is received from one of the project participants or at least three members of the Executive Board within 15 days of certification, the Board issues the CERs to the project participants in the certification phase.101 Reviews of certification decisions are limited to issues of fraud, malfeasance or incompetence by the DOE. The Executive Board then instructs the CDM registry administrator to issue the specified quantity of CERs to the project participants, less administrative expenses and the 2 per cent levy for adaptation in least-developed countries. As per the International Energy Agency (IEA), the CDM is very much a creation of political necessity drawing on Brazilian proposals concerning the Clean Development Fund (CDF) and various proposals concerning JI. Under the CDF proposal, parties who fail to comply with their assigned emissions commitments in a given budget period are penalized through a requirement to contribute to the CDF. In turn, the proceeds accumulated in the CDF are used by developing countries to foster sustainable development. A fraction of the proceeds, no more than 10 per cent, would go to support adaptation measures in vulnerable countries. 99

Ibid., paragraphs 35–36, 40. Ibid., paragraphs 61–63. 101 UNFCC, Marrakech, Decision 17/CP.7., paragraphs 64–66. 100

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CDM holds promise for achieving significant energy efficiency improvements in developing countries in furtherance of Kyoto’s dual objectives of GHG emissions reductions for Annex I countries and sustainable economic development. The fundamental premise of CDM is that emissions reductions can be achieved at lower costs in developing countries than in industrialized countries. Many also see CDM as aiding in the transfer of financial resources and energy-efficient technology to developing economies. Certain aspects of the CDM framework, however, could create barriers to realizing the full potential of energy efficiency for reducing GHG emissions and promoting sustainable development. The detailed requirements of the PDD, along with the costs of DOE review, add to the transaction costs of the project. Further, the requirement for additionality and the difficulty in establishing a project-specific baseline may end up imposing barriers to certain types of projects. Additionality requires that a project activity results in GHG emissions that otherwise would not have occurred in the absence of the project. The logic behind this provision is that an Annex I country should not receive CERs for activities in developing countries that would likely have occurred in the normal course of economic development. However, this creates a counter intuitive situation in which a project activity with compelling economics may have a more difficult time qualifying for CERs than a project activity that is only marginally profitable. The theory is that, if the economics of the project are compelling, it should be implemented in due course and would therefore not be in addition to the normal course of economic development. As discussed in previous chapters, however, there are numerous examples of win-win energy-efficient technologies or more efficient practices that have not been adopted notwithstanding their potential cost savings. Such a project activity may still be able to receive certification, depending on the sometimes subjective judgements of the DOE and Executive Board, but the project activity’s favourable rate of return for investors may necessitate a stronger showing of some other barrier to commercialization or implementation of the technology or practice. Because CDM financing is only one component to the financing stream for a project activity, the additional requirement may end up shifting the focus of international project development work towards less commercially attractive projects, thus raising questions about the ability of the CDM to attract mainstream project developers. As on 25 September 2006, 316 CDM projects had been registered by the CDM Executive Board: 142 from India, 82 from Brazil, 49 from Mexico, 34 from China and the rest from other countries. Out of these, 140 fall in small scale category. There are 11 CDM project activities for which review

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has been requested and seven are currently under review by the CDM Executive Board. Four project activities have been rejected. In the pipeline, there are 1,150 projects out of which 412 are from India, 148 from China, 188 from Brazil, and 104 from Mexico. The number of CERs will be high in countries with high CO2 per generated kWh of power.102 The rigorous project-specific baseline and monitoring requirements applicable to CDM project activities could also end up screening out some types of meritorious projects (Figure 7.1). These types of project activities could potentially make significant contributions to sustainable economic development and GHG emissions reductions, but because of the rigour with which GHG emissions reductions must be demonstrated under Article 12, they may not be able to qualify for CDM validation and verification. For example, renewable energy and energy efficiency projects that are not connected to the electricity transmission grid, off-grid projects, may have a more difficult time in establishing an emissions baseline against which emissions reductions can be measured. In the case of on-grid renewable energy projects, the project developer can look to the existing emissions profile of the local or regional electricity transmission system and the types of electricity generation sources in the area to develop an estimate of what the Figure 7.1 The CDM Project Cycle

Source: cdm.unfccc.int/methodologies/

102

UNFCC 2006b.

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GHG emissions would be in the absence of the project activity. For off-grid project activities, however, it may be more difficult to quantify the GHG emissions that will be displaced. Because of the difficulties in establishing a baseline for off-grid projects, project developers may be inclined to bypass these types of projects and opt instead for more on-grid projects. Renewable energy and energy efficiency projects targeting household energy use or small businesses could present additional monitoring difficulties. First, the project developer would need to document the extent to which the technology is adopted, that is, its penetration rate. It would also need to develop a monitoring protocol capable of establishing the permanence of the measures installed. Establishing the penetration rate and permanence of measures, however, is difficult in the household and small business sectors because of the multiple parties involved and their geographic distribution, often across wide areas and in different communities. Consequently, projects targeting household energy use and small businesses, although meritorious, could end up under-represented in the CDM pipeline. Recognizing some of these limitations, the COP, at its eighth meeting in New Delhi, India, in October–November, 2002, authorized simplified procedures and modalities for small-scale project activities.103 The Protocol singles out small-scale projects because they are considered more vulnerable to high transaction costs associated with the regulatory approval process, as they often lack the economies of scale of larger projects over which to spread up-front fixed costs. Projects eligible for the simplified procedure must fall into one of the three categories: z

z

z

Renewable energy project activities with a maximum output capacity equivalent of up to 15 megawatts (MW); Energy efficiency projects that reduce energy consumption by up to 15 gigawatt-hours (GWh) per year; and Other project activities that reduce human-caused GHG emissions from sources that emit less than 15 kilotons of carbon dioxide equivalent annually.

The simplified procedures for small-scale projects include standardized baselines and simplified monitoring and verification protocols, which vary

103 Simplified modalities and procedures for small-scale clean development mechanism project activities, Decision 21, CP.8., Annex II, Appendix B (Directive 2003/87/EC).

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according to the type of project activity being proposed. The types of energy efficiency project activity for which standardized procedures have been developed are listed in Box 7.1.104 Project developers can bundle together similar small-scale projects to achieve greater economies of scale, provided the size thresholds are not exceeded. However, a larger project that exceeds the size threshold cannot be broken down into smaller projects to meet the size limit. The project developer is only required to assess the environmental impacts if requested to do so by the host country. To save on transaction costs, the same DOE can serve to validate the PDD as well to verify the emissions reductions and certify the CERs. The new simplified procedures for small-scale projects should help streamline the validation and verification process, providing greater certainty and predictability for project applicants. For example, in areas where diesel-fired generation or fuel-oil predominates for electricity generation, the project developer may use standard emissions factors for diesel generators set forth in the simplified procedures as their baseline. Box 7.1 Standardized Procedures for Small-scale Energy-Efficiency Projects Proposed by the CDM Executive Board z

z

z

z z

Electricity or district heating transmission and distribution system upgrades; Efficiency improvements at power stations and district heating sites and cogeneration; Energy efficient equipment (lamps, ballasts, motors, fans, air conditioners, appliances or refrigerators); Energy efficiency and fuel switching measures at industrial facilities; and Energy efficiency and fuel switching measures for buildings.

Source: Decision 21, Annex II, Appendix B, Section II.

Emissions Trading Article 17 of the Kyoto Protocol authorizes the establishment of GHG emissions trading among Annex I countries. Under an emissions trading system, Annex I parties can buy and sell GHG emissions reduction credits, or Assigned Amount Units (AAUs), among each other to count towards

104

Decision 21, Annex II, Appendix B, Section II.

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complying with their Kyoto obligations. The Protocol states that emissions trading shall be a supplement to domestic action. The objective is to create a commodity market in which the price for emissions allowances would be determined competitively based on supply and demand. If properly functioning, it would enable parties to seek out the lowest costs options for GHG emissions abatement and lower the overall economic costs of meeting the Kyoto targets. An emission trading system differs from JI and CDM in that the AAU’s are not project-based. Rather, the credits are treated as a fungible commodity regardless of source or how they were initially acquired. They may not even represent credits for actual emissions reductions. For example, they may have been allocated to a party based on historical GHG emissions. On 22 July 2003, the EU enacted legislation authorizing the establishment of a GHG emissions trading market in accordance with the Kyoto Protocol.105 The market is expected to begin trading carbon dioxide emissions credits in January 2005. Beginning in 2008, the EU may extend coverage of the market to cover the five remaining GHG emissions subject to regulation under the Kyoto Protocol. Closely watched will be the 23 October 2003 proposal from the Commission of the EU to accept for the trading ERUs and CERs from JI and CDM projects.106 To the extent that ERUs and CERs can be traded on the EU’s GHG emissions trading platform, it could increase the incentive for EU participants to make investments in JI and CDM projects abroad. By effectively creating an international market for GHG emissions reduction credits, the EU emissions trading scheme could potentially serve as a major driver for energy efficiency investments in EIC and in developing countries independent of whether the Kyoto Protocol is subsequently ratified.

Asia-Pacific Partnership on Clean Development and Climate The Asia-Pacific Partnership on Clean Development and Climate (APPCDC) brings together Australia, People’s Republic of China, India, Japan, Republic of Korea, the United States and Canada to address the challenges of climate

105

Directive 2003/87/EC. Commission of the European Union, Proposal for a Directive of the European Parliament and of the Council amending the Directive establishing a scheme for greenhouse gas emissions allowance trading within the Community, in respect of the Kyoto Protocol’s project mechanisms, 2003/0173 (COD), COM (2003) 403 final. 106

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change, energy security and air pollution in a way that encourages economic development and reduces poverty. The APPCDC represents countries that account for around half the world’s emissions, energy use, GDP and population, and is an important initiative that engages the key GHG emitting countries in the Asia-Pacific region. Through the APPCDC, business, government and researchers have agreed to work together to focus on the development, deployment and transfer of cleaner, more efficient technologies, which can achieve sustainable economic, social and environmental development. The APPCDC builds on the foundation of existing bilateral and multilateral initiatives complements. APPCDC has established eight public–private sector Task Forces covering: (a) cleaner fossil energy; (b) renewable energy and distributed generation; (c) power generation and transmission; (d) steel; (e) aluminium; ( f ) cement; (g) coal mining and (h) buildings and appliances. The partnership will help the partners build human and institutional capacity to strengthen cooperative efforts, and will seek opportunities to engage the private sector.107 The partnership had its official launch in January 2006 at a ceremony in Sydney, Australia. The alliance states that member nations have initiated nearly 100 projects aimed at clean energy capacity building and market formation since then. Building on these activities, long-term projects are scheduled to deploy clean energy and environment technologies and services. The pact allows those countries to set arbitrary goals for reducing GHG emissions individually, without any enforcement mechanism for these goals.

Post Kyoto Post-Kyoto negotiations refer to high level talks attempting to address global warming by limiting GHG emissions in the medium to long run. Generally part of the UNFCCC, these talks concern the period after the first ‘commitment period’ of the Kyoto Protocol, which is due to expire at the end of 2012. In the 2007 Vienna Climate Change Talks and Agreement under the auspices of the UNFCCC, countries have agreed on key elements for an effective international response to climate change.108 A key feature of the talks was a United Nations report that showed how energy efficiency 107 108

APP 2006. UNFCCC 2006a.

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could yield significant cuts in emissions at low cost. So, energy efficiency is slowly and steadily climbing the ladder of importance in mitigating the climate change.

7.7 Conclusion International environmental law has a lot of encouraging words for energy efficiency but little in the way of concrete goals or enforceable commitments, opting instead to leave the specifics of energy efficiency policy, implementation and enforcement to the domestic sphere. In those instances in which energy efficiency is addressed, it tends to lack definite commitments or enforceable obligations. International environmental law generally focuses on establishing goals or targets for certain desired environmental outcomes, for example, a reduction in GHG emissions, but then the policies and measures adopted to reach that goal are left to individual countries based on its own national priorities. It is then up to the signatory country to decide whether to enact energy efficiency policies and measures to reach those environmental outcomes. One noteworthy variation on this general policy is the ECT and its accompanying PEEREA, which establishes energy efficiency as a resource option and a policy instrument for sustainable development independent of its air pollution reduction benefits. The ECT, however, lacks concrete goals or enforceable obligations, once again leaving implementation principally to the domestic sphere. The Kyoto Protocol is generally seen as an important first step towards a truly global emission reduction regime that will stabilize GHG emissions, and provides the essential architecture for any future international agreement on climate change. Certain provisions of the Kyoto Protocol, as implemented by the Marrakech Accords, may signal an increased willingness of the international community to delve to energy efficiency matters. Article 2 to the Kyoto Protocol calls for the COP to play a proactive role in coordinating PAMs among signatory countries. Efforts in this area could potentially lead to the international efforts at establishing more concrete energy efficiency goals or targets. Because of the trans-boundary aspects of JI and CDM projects, the COP has also taken an active role in establishing the certification protocols for these types of GHG emissions reduction projects. While JI and CDM could potentially serve as a major driver for investments in energy efficiency—especially if the credits are accepted on the

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EU emissions trading scheme—the rigorous accreditation rules for these mechanisms may create barriers to the implementation of meritorious projects. Recognizing some of these barriers, the CDM Executive Board recently released simplified procedures for small-scale projects that may help counteract some of these barriers for eligible projects. These simplified rules may serve as a model for future efforts at standardization of the CDM project approval process. Nevertheless, by the end of the first commitment period of the Kyoto Protocol in 2012, a new international framework needs to have been negotiated and ratified that can deliver the stringent emission reductions the IPCC has clearly indicated are needed.

8 Commercializing Clean Energy Technologies

Commercialization is defined as the creation of self-sustaining markets that thrive in a level-playing field with other technologies without subsidies. Without commercial status, clean energy technologies are not only a constant drain on public finances, but they will also not benefit from the dynamism and innovation of the private economy. Private capital mobilization and commercialization are results of policy instruments such as eco-taxes and emissions markets as well as guiding principles that can affect the design of these policies.

8.1 Introduction Energy efficiency (EE) involves a transition to less energy- and resourceintensive modes of production and consumption. This transition will depend not only on the presence of alternative technology but also on its diffusion, dissemination and application in society at large. In other words, good technological options should not just lie on the shelf collecting dust.1 Energy-efficient technologies (EETs) can also be construed as creating new source of energy because they make an additional quantum of energy from the potential created through savings available. However, this potential 1

Dieperink et al. 2004.

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will remain on paper or remain just an estimated number unless there is large-scale diffusion of these technologies. An additional benefit of realizing this potential is the positive impact on the environment. Significant environmental benefits often are associated with the rapid diffusion of these technologies.2 The key question is how to achieve such a large-scale diffusion. Previous chapters have analyzed the large scope for EE in various spheres of the economic system. This was followed by a discussion on the existence of barriers, which prevent the large scale spread of EETs. In addition, there are drivers, which are likely to have a positive influence on the spread of EETs and practices. The rate of diffusion is affected both by factors that induce more rapid adoption of new technologies as well as by barriers that impede such a transition. The logical extension of this discussion is to present a possible pathway to achieve the large scale diffusion of EE measures. This chapter aims to do so by presenting a framework for a sustainable business approach to the spread of energy efficiency. Many efforts until now have promoted the spread of EE with objectives addressing concerns related to the consumer and the society, namely, the cost of technologies, consumer’s finances, the environment and scarce natural resources. If the cost of the technology is high, governments used to step in and provide subsidies. As long as subsidies are available, the technologies continue to penetrate. Once subsidies are ended, the diffusion usually stops as well. In such a scenario, EE promotion is state-centred, neglecting the business perspective which takes into consideration issues like profit maximization, cost reduction and new business opportunities in these efforts. That is the major reason why EE measures could not spread into the market effectively. Hence, there is an urgent need for a shift in the strategy for promoting energy efficiency. For this a framework is needed that equates individual concerns with those of the society, and environmentally sound technologies with commercial technologies. EETs need to attain the status of commercialized technologies in order to make any significant impact in the sphere of energy systems. It is very important to reach a stage of commercial acceptance of these technologies. In other words, commercialization should be the ultimate goal of any environmental technology. Commercialization means involvement of the private sector and requires the mobilization of large sums of private capital. While Private Capital Mobilization (PCM) is a key policy option for the commercialization of sustainable energy technologies, it is only a necessary 2

Reddy and Balachandra 2006b.

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but not a sufficient condition for commercialization. It is a necessary condition because when environmental technologies are publicly financed, by definition there can be no commercialization. Without commercial status, these technologies not only become a constant drain on public finances, but also do not benefit from the dynamism and innovation of the private economy. PCM is not sufficient for ensuring commercialization, however. Consider a scenario in which the public sector provides free money to firms and financial institutions in order to trigger private investment. The grants would likely have the intended effect as private capital would be mobilized, but in the medium to long term, such a strategy may have the opposite effect of commercialization: it could make environmental technologies more dependent on state subsidies because private actors get used to subsidies and become unable to survive without them. As soon as the free money is removed, subsidized activities would cease. What subsidies without a commercialization perspective can do to technological innovation is evident from the history of central planning: despite decades of state support, most technologies fell behind and could not compete after the Iron Curtain was removed. To illustrate the issues concerning commercialization, this chapter includes two case studies: The first case study deals with the company LUZ, which was enormously successful as long as it operated in a favourable policy environment. When the environment changed and the subsidies were eliminated, the company went bankrupt despite being the world leader in its field. To contrast this experience, the chapter presents another case study about the Internet industry, where the removal of subsidies did not have the same effect. The first case thus illustrates failed PCM/commercialization, whereas the second case exemplifies successful PCM/commercialization. If clean energy is to become a serious competition to fossil fuels, it is necessary to learn the lessons from such cases.

8.2 Technology Commercialization The Concept The commercialization concept describes the process of developing an idea into a marketable product. Commercialization is the total process of moving a technology from the concept stage, to the production of a product

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and from there, to market acceptance and use. Innovation is distinguished in the literature on the study of science and technology from invention even though these two terms are used interchangeably in ordinary language. The term innovation is used to describe the process of transforming an idea or concept into a product or service. It includes much more than the term invention, which is usually restricted to the process of going from an idea or concept to a contrivance or prototype or design. In addition to invention, innovation involves the crucial process of commercializing the product or service in the economic activity of the country. One way to represent the process of innovation is shown in Figure 8.1. The exact sequence of steps depends upon the sector, that is, industry, agriculture, transport, education, health or communication. One possible sequence of steps in the innovation chain may be as follows:3 The terms are defined as follows: z

z

z

z

Relevant Basic Research (RBR) refers to the synthesis or assembly of understanding relevant to the technological objectives; Applied Research (AR) is the activity of demonstrating the technical feasibility or the synthesis of understanding leading to a new technology; Development and Design (D&D) describes the activity of coming up with a version of the new product or service that can be commercialized in the economy, that is, a product or service that meets performance, reliability and economic requirements; and Engineering for Manufacturing (EfM) refers to the activity of demonstrating that the working technology can be manufactured at a price acceptable to the economy.

Research and Development (R&D) can be understood as a composite of the previous elements: Research = RBR + AR Development = D&D + Ef M Research and Development (R&D) = RBR + AR + D&D + EfM

It is important to note that every pattern of technology is socially conditioned. Technology is a product of its times and context, and bears the

3

Reddy 1986.

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Figure 8.1 The Chain from Basic Research to Commercialization

Source: Adapted from Reddy 1986.

stamp of its origins and nurture.4 It is in this sense that technology can be considered to resemble genetic material that carries the code of the society, which conceived and nurtured it and, given a favourable milieu, tries to 4

Reddy and Balachandra 2006b.

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replicate that society. Surely the reverse is equally true, namely, that technologies profoundly shape societies, sometimes in unanticipated ways, while creating both positive and negative effects in the process.

The Process Diffusion is the process by which a technology is adapted and gains acceptance by the consumers. The factors influencing the diffusion include: (a) technology appeal, (b) how information about the technology is communicated, (c) time and (d ) the nature of the social system into which the technology is being introduced. To increase the diffusion process, it is important to investigate how these factors interact to facilitate or impede the adoption of a specific technology among members of a particular adopter group. Technology diffusion occurs over time and can be seen as having five distinct stages, (a) knowledge, (b) persuasion, (c) decision, (d) implementation and (e) confirmation. The potential adopters of a technology must learn about the innovation, be persuaded as to the merits of the innovation, decide to adopt, implement the innovation, and confirm, reaffirm or reject the decision to adopt the innovation. Rate of diffusion theory states that technologies are diffused over time in a pattern that resembles an S-shaped curve. The rate of diffusion begins slowly, speeds up and eventually slows down (Figure 8.2). The fundamental assumption of technological diffusion is that there is an upper limit to the growth of a technology and the growth pattern follows a logistic path. According to this, each technology undergoes four different phases: learning, growth, saturation and decline. The technological diffusion path starts with a learning curve during the initial stages. The growth phase is usually a logistic substitution, but it usually ends up before being fully saturated. Then the growth rate slows down and declines logistically.5 Potential adopters of a technology judge an innovation based on their perceptions in regard to five attributes of the innovation.6 z z

5 6

Trialability: Can be tried on a limited basis before adoption; Observability: Offers observable results;

Marcetti 1972. Surry and Farquhar 1997.

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Figure 8.2 Technology Diffusion Curve

Source: Adapted from Rogers 1995.

z z z

Relative Advantage: Has an advantage relative to other innovations; Complexity: Is not overly complex and Compatibility: Is compatible with existing practices and values.

The study of diffusion process is valuable to the field of clean energy technology for various reasons: z

z

z

Most manufacturers are not aware of the underlying causes of technology’s diffusion. For a successful adoption, they should understand, predict and account for the factors that impede or facilitate the technology diffusion. Technology is inherently an innovation-based discipline. A manufacturer who understands the innovation process and theories of innovation diffusion will be more fully prepared to work effectively with potential adopters. The study of diffusion theory should lead to the development of a systematic, prescriptive model of adoption and diffusion. Manufacturers should understand the intrinsic resistance to change as the primary cause of technology’s diffusion problem.

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Technology manufacturers should also follow these steps: z z z z

z

Identify the potential adopter; Measure relevant potential adopter perceptions; Design and develop a user-friendly product; Inform the potential adopter about the product’s user-friendliness and Provide post adoption support.

According to Dieperink et al. the diffusion of technology is influenced by the following factors:7 z

z z

z z z

The decision making process of potentially adopting actors at the corporate or individual level; Corporate and individual characteristics; The influences impinging upon the company exerted by governments, the market and society at large; Government policy; Technical and economic characteristics of the innovation and Influences coming from the macro context such as the price of energy.

Dieperink et al. recommend a management strategy that is specific to the target group. That strategy may be summed up as follows: demonstrate the economic advantage of the technological innovation, make focused use of information channels, that is, information from suppliers and trade publications, and introduce simple incentives to reward innovative behaviour and to increase the expertise of the environmental inspectorates.

The Commercialization The commercialization process involves a process of developing technology from a concept to a commercially available device through the following steps: Concept → Feasible Device → Working Device → Manufacturable Device → Commercially Disseminated Device

7

Dieperink et al. 2004.

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Thus, technological diffusion is based on ideas, the conversion of ideas into inventions, the commercialization of inventions into innovations, and finally, the widespread adoption and dissemination of innovations by users. The terms commercialization and market formation denote a process, which makes technologies increasingly profitable over time and thus reduces the need for subsidies and other forms of support. Specifically, commercialization means letting private actors handle economic transactions such as developing and financing projects in accordance with basic rules established and enforced by the government (Table 8.1). Table 8.1 Technology Commercialization Model

Investigation phase Development phase Feasibility Planning Introduction Commercial Phase Full scale production Maturity

Technical

Market

Business

Technology concept assessment

Market needs assessment

Venture assessment

Technology feasibility Market study Engineering prototype Strategic marketing Pre-production Market validation prototype Production Production support

Economic feasibility Business plan Business Start-up

Sales and distribution Business growth Market diversification Business maturity

Source: Authors.

Commercialization is an important benchmark for environmental policy due to the various reasons. It is causally and positively related to the benefits associated with clean technologies such as environmental gains and health improvements. The faster the commercialization process, the greater are these benefits. When full commercialization is achieved, the benefits associated with clean technologies can come at zero or negative cost to taxpayers. Once a technology is commercial, benefits continue to accrue without incurring cost to taxpayers. The following indicators can be used to highlight different dimensions of commercialization:8 (a) the profitability of projects, (b) technology cost trends, (c) the share of private activity in the market (for example, share of energy production and savings generated by the private sector),9 (d) business and support service development, like clusters, (e) the availability of commercial financing, (f ) awareness and under8 Some of the items in the list are adapted from a list of seven core indicators for performance, developed by Nichols and Martinot (2000) for GEF. 9 Related but less precise indicators are: (a) installed capacity run by the private sector and (b) number of private businesses operating in a particular market.

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standing of technologies and benefits among consumers and businesses and (g) consumer and business demand. Taken together, these indicators can adequately represent the complex process of commercialization. Commercialization of EETs cannot be automatic because of the existence of barriers. The process can be smooth for those technologies, which are better off in terms of energy use efficiency or in terms of initial cost, quality, reliability, and so on. Market forces sometimes ensure the spread of such technologies despite the existence of barriers. However, technologies, which aim at commercialization solely with the advantage of EE, may not succeed. A special impetus is needed to make this happen. EETs in general, face problems, which are not faced by other technologies: z

z

z

EETs face competition from equally competent, cost-effective and mature existing technologies; The need for these technologies arises more because of environmental and social concerns rather than business concerns. There is resistance to change imposed by existing technological trajectories.10

Consider the example of compact fluorescent lamps (CFLs), which are far superior in terms of luminous efficiency and working life to the incandescent lamp. Even so, the diffusion of this technology met, and is still meeting, with considerable resistance from an established technology which has benefited from a long learning process, considerable economies of scale in production, a wide distribution network, technological interrelatedness, increasing informational returns, and so on.11 It is important to note that each technology occupies a different position in the process towards commercialization, and that this position can change over time. Some technologies commercialize faster than others. In general, one may say that the performance of environmentally sustainable technologies has not been stellar. At a time when the wheels of technological progress interlock more tightly with commerce and finance, many sustainable technologies lag behind other technologies in terms of commercialization, despite or perhaps because of long-standing efforts to promote them. Other technologies have experienced explosive market growth with less public support, while overcoming similar barriers that hold back environmental technologies, like sceptical consumers, lack of sales infrastructure and lack 10 11

Menanteau and Lefebvre 2000. Ibid.

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of a regulatory framework or unfavourable regulation. While technology sectors like the Internet, biotechnology, mobile telephony and others are growing in leaps and bounds, sustainable technologies live relatively quiet lives, ostensibly undisturbed by the hum and buzz in technology markets around them. EETs had modest beginnings with limited commercial opportunities, interest and funding. From the early 1970s onwards, especially after the first oil crisis in 1973, there have been steady streams of predictions that sometime in the not too distant future, the market for clean energy would boom. Decades have passed since these predictions, and despite many efforts of governments, multilateral institutions, non-governmental organizations (NGOs) and even a number of companies and investors, there has been no sustained take-off. The grip of conventional technologies on energy markets is still strong. Although some EETs have become profitable in certain applications, and others are on the verge of being profitable, there has been no overwhelming influx of human and financial capital into the clean energy sector.12 The revolution is still waiting to happen.13 It seems that without much greater private sector involvement and financing, governments and multilateral institutions cannot be effective at producing lasting technological innovation, technology diffusion and technology transfer.14 One may ask why governments, multilateral institutions and other organizations had such a limited success in enabling environmentally sound technologies to be financed in a commercial setting. Drawing upon a quite considerable treasure of experience, we can distinguish two basic explanatory avenues. One could be described as lack of trying, whereas the other could be termed as lack of ability. While so far the efforts in the diffusion of clean energy technologies have been largely government financed, the private sector has increased its investment exposure in recent

12 The International Energy Agency (IEA) has been tracking these trends in a number of publications, including 1997c, 1998a, 1999 and 2000a. 13 Some renewable energy technologies already achieve impressive growth rates: Hawken et al. (1999) cite figures that wind power is the fastest growing energy technology—even faster than EETs—with an annual growth rate of 26 per cent, while solar PV has recorded growth of between 23–42 per cent in the past few years. Based on Royal Dutch/Shell forecasts, renewables could supply up to half the world’s energy by 2050. 14 OECD 2000. The traditional model of technology transfer was a flow of equipment and know-how from industrial to developing countries. Reverse transfers as well as ‘South-South’ technological cooperation was neglected for a long time. In the sustainable energy sector, however, reverse transfers are becoming increasingly important, as many developing countries now have their own production of sustainable energy technologies.

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years. Fully-financed projects by the private sector are still limited to niche markets, but even traditionally hostile oil companies have begun to develop and finance clean energy projects. Critics have pointed out that the share of environmental investments is still very low and that they serve mainly as vehicles for public relations. Others argue that oil companies are genuinely transforming to become energy companies, and that they are preparing themselves for a future where emissions markets could accelerate the commercial development of clean energy technologies. Still, if sustainable energy is to take a significant share in the electricity market, and if the process of commercialization is to show results, substantially increased levels of private investment are required. Without such investment, there will be no significant cost reductions, which are essential to successful commercialization. With the kind of hurdles faced by EETs on the path of commercialization there cannot be a straightforward approach to reach the stated objective. There is a need to adopt a well designed integrated approach to facilitate large-scale diffusion of these technologies. Such a planned diffusion process should ultimately aim at a complete commercialization of these technologies without any support from any agency. In other words, such a process should lead to a completely market driven spread of environmental technologies. Private sector alone cannot drive this process without the active involvement of the government, the public sector and the public at large. All the stakeholders need to come together and work towards achieving the goal through public–private partnerships (PPPs). Large scale spread of Internet shows that the initiatives taken by strong and committed PPP can achieve the desired results (Box 8.1). The Internet is a prime example of the following recursive effect: private investment leads to commercialization, which in turn triggers further private capital flows. Like many other technologies, Internet applications were initially marginal and started to spread only when the private sector got interested and involved. However, unlike EETs, the Internet did not and does not face competition from any established conventional technology. Despite this fact the process of commercialization of Internet would provide an effective learning experience for achieving a similar status for EETs. For a successful commercialization process of EETs the involvement of various stakeholders of energy is absolutely necessary. The effective stakeholder linkage is necessary from initial technology development to the final stage of technology use. The committed involvement of a number of stakeholders is necessary to successfully complete the technology diffusion process. The perception of technology diffusion is likely to be different for

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Box 8.1 Luz International Limited—A Failure Story In response to the OPEC oil price hikes during the mid-1970s, the state of California took strong measures towards developing and commercializing clean energy technologies. Many projects were supported, but many of them failed. One of the beneficiaries of the subsidies was Luz International Limited (LUZ). Established in 1979, the company designed ever larger and more efficient power plants using solar thermal technologies. In the early 1990s, the company produced 355 MW, which constituted 95 per cent of world-wide solar electricity. About 140,000 households could be served with electricity. The technology of Luz consisted of solar thermal troughs that bundle the sunlight to heat oil and to generate steam, which in turn rotates the electric turbines. The state provided substantial direct subsidies—guaranteed fixed prices and tax benefits, which ensured the expansion of Luz. In 1984, Luz installed the first Solar Electric Generating System (SEGS I) at a cost of USD 62 million in Daggett, California. It had a capacity of 13.8 MW. SEGS I contained six hours of thermal storage, and used natural gas-based technology to supplement the solar energy. Based on the success of this first power plant, Luz constructed additional facilities. SEGS II through VII had 30 MW capacity each. In 1990, Luz completed the construction of the largest solar electricity facilities in the world (SEGS VIII and IX in Harper Lake). Each plant was able to generate 80 MW. When the government withdrew the incentives in the late 1980s, Luz could not offer the same conditions anymore. The changed state policy along with falling energy prices led to the bankruptcy of Luz on 25 November 1991. Michal Lotker, Luz vice president for Business Development summarized the problems as follows: [A] wide variety of factors has contributed to LUZ’s difficulties (…): falling fossil fuel prices, size limitations, inconsistent tax policy and lack of incentives for utility participation (…). [T]he LUZ experience shows that a company and a technology must have (…) a stable regulatory environment, a marketplace that values solar technologies’ mitigation of fuel price risk, and an overall tax structure that is both stable and equitable to all energy technologies. In his analysis of the Luz case, Eban Goodstein notes that despite the subsidies, the company may still have been disadvantaged relative to other power producers: For example, natural gas purchases are exempted from sales taxes under California law; utilities do not take the risk of swings in fuel prices into consideration when choosing new generating capacity; (…) (Box 8.1 Continued )

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(Box 8.1 Continued ) and they have only recently begun to incorporate environmental costs (adders) into capacity choices; and LUZ was constrained by law to build inefficiently small plants. Goodstein concludes that (…) without aggressive governmental action in the early 1980s, wind and solar electricity would not be commercial options for producing power (…) The optimistic moral of this story is that government policy can be effective in promoting clean technology. The pessimistic moral is that it can spend much more money than necessary to do so. Goodstein and Lotker emphasize the necessity of a long-term and predictable policy to support clean energy. Source: Goldstein 1999.

different stakeholders. For example, governments and end users need to understand the costs and benefits of a technology; innovators or the initial adopters need to adapt it to the requirements; manufacturers need to produce it, entrepreneurs need to market the technology while satisfying the end user needs and financiers need to appreciate the profitability nature of the projects. Engagement of all key stakeholders—governments, private sector, donors, financial institutions, technical institutions, community groups and other NGOs—are important for making a technology commercially viable.15

8.3 Commercialization of Energy-Efficient Technologies—The Mechanism EETs are among the most complex cluster of technologies for commercialization. First of all, most of these technologies are alternatives for wellestablished existing technologies and are still evolving, which makes it difficult to decide what exactly should be diffused or commercialized in terms of knowledge, techniques and hardware. Second, these technologies require an interconnecting series of difficult technological choices concerning resources, transformation processes and transportation systems. These choices are to a significant extent location-specific and cannot be 15

IPCC 2000.

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addressed easily on a generic level. Finally, there are a multitude of actors who potentially could become crucial players in local or global markets for these technologies. Because of these complexities, technology diffusion under current conditions has so far been dependent on government driven path-ways, such as active involvement in R&D activities, demonstration projects financed locally or internationally and government sponsored programmes to determine the resource availability. Commercialization processes with the active involvement of the private sector is yet to take place in a large scale. Despite many efforts to prepare environmental technologies for take-off, many remain on the runway, unable to lift off in same way as other technologies. Looking back at the history of environmental technologies, there is a pattern of state-sponsored gravity that keeps these technologies stuck to the ground. There is no reason to throw in the towel, however. Commercialization trajectories are notoriously unpredictable. Indeed, until the 1980s, there were few signs that microchips would once become the backbone of business; and until the 1990s, there were few signs that the Internet would become a major growth industry that would revolutionize the global economy. For many years, the conventional wisdom was one of limited commercial opportunity. Even large technology companies like Microsoft and IBM failed to anticipate the boom until the mid-1990s. Thus, nearly everyone was surprised when the revolution unfolded. Before anyone knew it, the Internet was changing the world. z

Lack of trying does not imply that there were no attempts to promote environmental technologies. It means that governments and multilateral institutions focused their attention on deploying technologies, rather than on commercialization as a policy objective. Clearly, not everybody has an interest in the commercialization of environmental technologies. While industries that focus on fossil fuels would be the primary losers, the commercialization of clean energy would also obviate the need for involvement of the state and multilateral institutions.16

16 The commercialization process is sometimes described as the ‘diffusion’ or ‘deployment’ of technology through the economy. Since this could be achieved through public provision, the terms ‘diffusion’ or ‘deployment’ do not highlight the need to make these technologies commercially viable. Therefore, these terms are not used here.

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Lack of ability is also a plausible explanation for the failure to create private sector capacity and motivation. There have been many public sector programmes to promote energy efficiency, but so far they have had limited impact in terms of bringing these technologies to market. Research and development, demonstrations, technical assistance, training programmes, institutional development and subsidies may all play a role in commercialization. However, the effectiveness of these instruments can be questioned, since despite many programmes, most clean energy technologies are still not commercial.

The sobering conclusion is that public sector programmes have not been successful in stimulating economies of scale, entrepreneurialism and technological innovation, which are key conditions for commercialization. In the energy efficiency field, the pace of commercialization process has been particularly slow, compared, for example, with consumer electronics technologies such as the Compact Disk (CD) and Digital Versatile Disk (DVD), which became commercial soon after introduction. Just like conventional power technologies, sustainable energy technologies require significant public investment over long periods of time. But there is no guarantee that energy technologies will be commercial even when they are produced with economies of scale. The experience with nuclear energy offers interesting lessons. After more than half a century of government aid and gigantic investments made into civilian and military uses of nuclear technologies—combined with intense efforts by the private sector to promote these technologies—nuclear energy is mature but still not commercial.17 In light of the prediction that nuclear power would be one day ‘(…) too cheap to meter’,18 it is noteworthy that many countries have decided against the civilian use of nuclear technology for commercial reasons. Since other countries retained their faith in nuclear technology, atomic energy remains one of the most heavily supported technologies and industries, subject to investment promotion and other means of mobilizing private capital. But commercialization is not guaranteed through generous subsidies. A recent example concerns the troubles at British Energy, a key provider of nuclear energy in the UK. Despite immense subsidies over decades, the company accumulated a debt of £600 million by 2002, and would have ended in bankruptcy without a further injection of government funding of £410 million. 17 18

IEA 1999. Goodstein 1999, 339.

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Could EETs endure the same fate as nuclear energy? It might well be that some technologies, for example, solar PV, will never be fully commercial for large-scale electricity generation. However, in selected applications and markets, clean energy technologies may have a good chance of becoming commercial. Comparing nuclear energy with sustainable energy is problematic. EETs are much more modular and flexible; they benefit to a greater extent from economies of scale (mass production); decommissioning and waste are not serious problems; and unlike nuclear power, sustainable energy technologies are insurable. While nuclear energy can be seen as a failure of taxpayer-supported technology, other technologies such as computers, telecommunications, biotechnology and the Internet were successes. Success or failure of technology promotion may not only depend on the quality of government policies and programmes, but also on the intrinsic characteristics of the technology and the target groups. For example, one reason why acceptance in consumer electronics market is often immediate could be the existence of a sufficient number of ‘pioneers’ who are ready to try out innovations. In some environmental technology sectors, there are also pioneers (for example, people installing solar roofs), but the general consumer response given to products like energy efficient lamps and solar roofs is lukewarm. While government policies and programmes have often failed in mobilizing private capital for sustainable energy, the intrinsic technological and environmental merits may warrant further efforts. After decades of government support, sustainable energy remains a policy favourite because it provides all the benefits of other energy technologies such as job creation and economic prosperity, while at the same time promoting environmental objectives.19 Amory Lovins was the first to outline a vision he termed the ‘soft energy path’, in which governments restructure economies to promote energy efficiency. He argued that such a path offers jobs, capital for business and other advantages. In the following decades he developed his ideas into a school of thought under the banner Natural Capitalism (1999). While so far EE has been largely government financed, the private sector has increased its investment exposure in recent years. Fully privately financed projects are still limited to niche markets, but even traditionally hostile oil companies have begun to develop and finance clean energy projects, and to

19

Lovins 1977, 23.

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prepare themselves for a future where emissions markets could accelerate the commercial development of clean energy technologies. Still, if sustainable energy is to take a significant share in the electricity market, and if the process of commercialization is to show results, substantially increased levels of private investment are required. Without such investment, there will be no significant cost reductions, which are essential for successful commercialization.

8.4 Success and Failure of PCM: Lessons Learnt One may speculate on the reasons why most clean energy technologies do not commercialize, or commercialize very slowly, and why in some cases the commercialization process is even hindered by efforts to promote these technologies. Clean energy technologies suffer from a mix of disadvantages, including: z

z

z

z

z

z

z

z

Perceptions of low return and high risk: This was initially the same for the Internet, but concerning environmental technologies these perceptions may be more deeply embedded; No expectations for future profits: In the case of the Internet, there was a lack of profitability, but anticipation of future profits triggered investments; Environmental technologies are not entertaining: Some of the most successful technologies rely on their entertainment value for sales; Drab promotion: Environmental technologies rarely get the bright and loud promotion that may propel other technologies; Lack of knowledge: Most people are not aware of the benefits of environmental technologies and how to use them; Conservatism: People tend to be conservative, avoid risks and follow others, unlike in the entertainment and consumer technology sector, where innovation is part of the entertainment; Lack of industrial lobby: Many successful technologies were promoted by large companies, such as the computer industry, telecommunications giants, oil companies, which ensured that their innovations get favourable regulations and incentives; Lack of political support: Partly due to the absence of a strong industrial lobby, there are few political parties, which focus their

232

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programmes on environmental issues, and those parties, which focus on the environment, are not necessarily familiar with, or in favour of, technological options and Lack of expertise: Clean energy technologies are still niche fields in most universities, businesses and governments.

One may believe that the Internet was invented at the beginning of the 1990s, but in fact the history of the Internet runs back several decades. In 1957, the Advanced Research Projects Agency (ARPA), the future sponsor of the Internet, was established. In 1967, Larry Roberts presented his paper on the design of ARPANET, a computer network, at a technology conference. Similar concepts were developed at three research centres simultaneously but independently: MIT (1961–1967), RAND (1962–1965), and NPL (1964–1967). In 1969, the invention of packet switches called Interface Message Processors (IMPs) enabled remote computer networks. The publicly funded network (ARPANET) consisted of four nodes, connecting computers at the University of California in Los Angeles, the Stanford Research Institute, the University of California in Santa Barbara and the University of Utah. The first demonstration of ARPANET to the public took place in 1972 at the International Computer Communication Conference. The current Internet communication protocols were adopted 10 years later, in 1982.20 The first applications of ARPANET served military and academic communities. On 6 August 1991, Tim Berners-Lee, a scientist at Geneva-based CERN posted a message to an electronic noticeboard to publicize his World Wide Web (WWW) project, including ‘(…) instructions on how to download the very first Web browser from the very first website http://info. cern.ch (...) Berners-Lee had no idea that he had fired the first shot in a revolution (…)’.21 During the 1990s, the WWW expanded and diversified into commercial uses and emerged as a new medium of economic and social exchange. The Internet sparked a new business model for offering products and services that rely on interactivity, direct exchange of information between sellers and buyers and virtual co-presence.22 Due to a proliferation of new businesses and applications, the Internet grew, first slowly, then in leaps and bounds.

20

Leiner et al. 2003; Thomas and Wyatt 1999. Berners-Lee et al. 2001. 22 Kothaa et al. 2001, 571. 21

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In 1990, only 11 countries were registered, and within four years, another 70 countries obtained national domains. The number of web servers grew from 623 in December 1993 to more than 35 million in December 2002.23 With the growing popularization of the Internet, a race for the most attractive domain names started. Many companies filed lawsuits when they found out that fast-moving entrepreneurs had snapped up their names. The Internet boom also triggered browser wars between the main antagonists Netscape and Microsoft.24 The growth of the Internet was not a result of a massive subsidy programme to mobilize private investment. Rather, it was a long-term collaborative effort between government agencies, private contractors, research institutes and universities. As shown in Box 8.2, the commercialization of the Internet was a result of planning and laissez-faire, including the planning of laissez-faire. After about two decades of public funding, ideas on commercialization and privatization started to be discussed and implemented. The government then withdrew its funding, letting the private sector to take over. A similar approach might be replicated in environmental technology sectors. The success of a technology ultimately depends on consumer interest and willingness to pay. In the case of the Internet, consumer interest was stimulated when the WWW became available through a graphical user interface in 1993 and when web surfing became widely available and affordable. Graham Thomas and Sally Wyatt explain how ‘(…) previously separate services such as information access, file transfer and electronic mail (…)’25 became available through one user-friendly interface. According to Graham and Wyatt, this made it possible to ‘(…) demonstrate the potential of the Internet to prospective users. In particular, firms saw the advantages of having an “online brochure” which could advertise their goods and services around the world at low cost’.26 In the 1990s, a new class of entrepreneurs emerged, seeking to make money on the web by offering information, entertainment and e-commerce. Most early ventures ended in bankruptcy, but initial lessons were learned and in some cases losses began to diminish. The outlook that Internet firms could yield vast profits in the future triggered massive flows of private investment. 23

Zakon 2003. Microsoft has been subject to protracted high-profile litigation for abuse of monopoly power, in part because of the tight integration of its Internet Explorer browser with the Windows operating system, which makes it difficult for inexperienced consumers to choose nonMicrosoft programmes. 25 Graham and Wyatt 1999, 686. 26 Ibid. 24

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In the second half of the 1990s, it seemed as if the Internet would become an unmitigated story of success. From 1995 to 1998, the share of commercial hosts grew from 47 per cent to 71 per cent.27 Mainstream companies increased their investments when they realized that they had underestimated the commercial potential of the Internet. Initial scepticism gave way to euphoria. With little more than an idea and a name, start-ups received multimillion dollar funding from venture capitalists and other financial actors. At the turn of the century, investors poured billions of dollars into almost any company that included a dot-com in its name.28 The value of Internet companies skyrocketed. Firms with annual revenues of tens of millions were valued at billions of dollars. A typical example, Inter-net Company Xoom.com was valued at about USD 1.5 billion in 1999 though it generated revenues of roughly USD 70 million in the same year.29 The turn of the century was a time of gold rush, with 20-something entrepreneurs making more money than the senior management of large industrial enterprises. When large enterprises placed their faith in the New Economy and made up for lost time, they also boomed. The speculative bubble associated with the Internet and the Nasdaq in particular had created such an out-of-this-world situation that the digital giant America Online (AOL) was able to purchase Time Warner, in a 183 billion-dollar deal that constituted the biggest— still pending—merger in all of history. And AOL was able to do so despite the fact that it had only 20 per cent the annual revenue and 15 per cent of the workforce of Time Warner. Many Internet investments cannot be explained by traditional risk and return criteria and cautious investment behaviour. Investors required little, if any, collateral. The lack of experience of many entrepreneurs did not cause alarm; and new money came in despite mounting losses. Some investors and firms saw the Internet as a strategic option. They were willing to lose money for a few years in order to be in pole position when the anticipated profits start to flow. But most investors and entrepreneurs believed that a dot-com company based on a good idea should bring profits in six–eight months. In most cases, this turned out to be unrealistic.

27

Ibid. Domain names, which sell for less than USD 30, became very valuable commodities. The domain business.com was purchased in 1997 for USD 150,000, and sold two years later for USD 7.5 million. The AltaVista domain name was bought for USD 3.3 million in 1998 (Pelline 1999). 29 Raynovich 1999. 28

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Box 8.2 Case: The Commercialization of the Internet The Internet represents one of the most successful examples of the benefits of public–private partnership, sustained investment and commitment to research and development. Beginning with the early research in packet switching, the government, industry and academia have been partners in evolving and deploying this new technology. The usefulness of computer networking—especially electronic mail— demonstrated by DARPA and US Department of Defence contractors on the ARPANET was not lost on other communities and disciplines, so that by the mid-1970s computer networks had begun to spring up wherever funding could be found for the purpose. A milestone in the commercialization of the Internet was the decision of the NSF to make the TCP/IP protocol mandatory for the NSFNET programme, thus unifying the language of the Internet. When Steve Wolff took over the NSFNET programme in 1986, he recognized the need for a wide area network to support the general academic and research community, along with the need to develop a strategy for establishing such infrastructure on a basis ultimately independent of direct federal funding. Several policies and strategies were adopted to achieve that end. NSF encouraged its regional (initially academic) networks of the NSFNET to seek commercial, non-academic customers, expand their facilities to serve them and exploit the resulting economies of scale to lower subscription costs for all. On the NSFNET Backbone— the national-scale segment of the NSFNET— NSF enforced an ‘Acceptable Use Policy’ (AUP), which prohibited backbone usage for purposes ‘not in support of Research and Education’. The predictable and intended result of encouraging commercial network traffic at the local and regional level, while denying its access to national-scale transport, was to stimulate the emergence and/or growth of ‘private’, competitive, long-haul networks such as PSI, UUNET, ANS CO+RE, and later others. This process of privately financed expansion for commercial uses was thrashed out starting in 1988 in a series of NSF-initiated conferences at Harvard’s Kennedy School of Government on ‘The Commercialization and Privatization of the Internet’, and on the ‘com-priv’ list on the net itself. NSF’s privatization policy culminated in April, 1995, with the defunding of the NSFNET Backbone. The funds thereby recovered were competitively redistributed to regional networks to buy national-scale Internet connectivity from the now numerous, private, long-distance networks. Source: Based on Leiner et al. 2000.

The gold rush lasted only so long as investors believed in it. After highprofile ventures came crashing down and others failed to deliver expected profits, investors collectively headed for the exit. The technology bubble

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burst. The US technology stock index, the NASDAQ, tumbled from a high of 5,123 on 10 March 2000 to below 2,900 in November 2000, a decrease of almost 50 per cent in eight months.30 This was followed by a further drop to 1,792 in August 2001. Since then the NASDAQ further declined, in the past two years languishing at levels mostly below 1,500—a loss of more than 70 per cent since the all-time high. The decline not only represented a gigantic elimination of paper wealth, but it also destroyed the myth of invincibility surrounding the Internet. Many people lost a significant amount of their savings. The young entrepreneurs that ran the ‘New Economy’ were suddenly unemployed or forced to end the profligate ways exhibited in the halcyon days. But the industry as a whole survived the shakeout. The bursting of the bubble may have actually strengthened the solid commercial players in the market. It was a classical process of ‘creative destruction’ that squeezed the excess out of the system. The lessons from this process helped companies develop strategies to survive competition, to offer more distinctive value to clients and to create a reliable customer base. The bankruptcy of many dot-com enterprises suggested that only those firms could succeed, which can benefit from wide distribution and economies of scale produced by data processing and communication technologies. The example of the Internet indicates that commercialization is not a linear process of ever increasing profitability, but a process of growth and decline, bust and boom, stop and go, trial and error. Today, the Internet is not only the largest information universe, but also the backbone of business and finance in many countries. E-commerce has become a permanent feature of the net. Technological progress has merged with innovative business ideas to devise new ways of increasing profits in business-to-business (B2B) and business-to-consumer (B2C) transactions. What started as a minor government-funded operation has become one of the main growth industries in the networked economy. Some technologies may never commercialize, but for those that do the basic process is often similar: initially state-funded, subsidy-dependent technologies begin to attract private funds and private sector interest, which stimulates innovation, cost-reduction and consumer interest in a mutually-reinforcing causal chain. Many technologies start out modestly and subsidy-dependent, facing scepticism and even ridicule. This phase can be short or long depending on the inflow of intellectual and financial capital and the degree of entrepreneurial attention.

30

The Observer 2000.

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8.5 Conclusion EETs are now somewhere between the stage of pure government as well as private provision. In this intermediary stage, mobilizing private capital can be cost-effective because projects are almost profitable and require only relatively small supportive interventions. Governments may use financial subsidies, but they may also focus on setting the framework conditions and incentive structures for the private sector. Politically, it is sometimes easier to provide financial incentives such as grants, concessional loans or guarantees rather than to change the basic framework conditions under which businesses operate, as the latter can bring disadvantages to industries with significant political clout. Clean energy technologies have so far not been able to enjoy a common recursive effect in technology lifecycles, namely, that greater private investment will lead to commercialization, which in turn will trigger further investment. Technologies that were initially marginal started to grow dramatically when the private sector got involved. For example, the Internet started out as a publicly funded project, until private actors realized the potential and started to invest. After a string of initial failures caused by lack of experience, a small but growing number of consumers and businesses began to catch on. When niche markets metamorphosed into mainstream markets, further private investment was triggered. This in turn led to an explosion of start-ups and further funding—this time on a massive scale. A bubble resulted and ultimately burst in March 2000. Technologies which grew in such a process include computers, mobile phones, microwave ovens, satellite navigation systems, and so on. If the Internet and other technologies can grow thanks to private investment and private sector interest, it appears logical to assume that a similar process should be possible for environmental technologies. The reality is different, however. Most environmental technologies have not yet entered a commercialization trajectory, and the private sector still bears a minor share of environmental financing. There are a few exceptions. For example, catalytic converters became standard in cars, not because of an organic commercialization process but because of relatively abrupt legislation making the devices obligatory. There are various factors that can explain why clean energy technologies tend to lag behind the commercialization trajectories of other technologies such as Internet-related technologies and consumer electronics. Since clean technologies are less attractive for many consumers and businesses, even

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more support may be needed from the public sector. In order to avoid subsidy dependence, clear signals need to be given that the support will be phased out and that technology improvements will be mandated, with preset deadlines that allow sufficient time for industries to adjust their strategies and investments. Despite the importance of commercialization of clean technologies in supporting sustainable development, it is also necessary to see their limits. Stewart Udall, an US Congressman and Secretary of the Interior, argued that: All the evidence suggests that we have consistently exaggerated the contributions of technological genius and underestimated the contributions of natural resources (…). We need (…) something we lost in our haste to remake the world: a sense of limits, an awareness of the importance of earth’s resources.31

31

Quoted in Meadows et al. 1992, 161.

9 Financing Energy Efficiency in Transition Economies

This chapter discusses the linkages between energy efficiency (EE) and the financing mechanism. Now that more financial and institutional resources are available to support EE in transition economies, it is important to channel these resources into profitable investments and indicate to financial institutions that their money is safer and profitable in EE projects. Getting finances in emerging markets means overcoming significant challenges. It requires careful planning, serious investment of time and resources, and simultaneously, aggressiveness and openness to other ways of doing business. For some companies, the costs may be too great. But EE markets also offer growth potential that is unimaginable in the technology-saturated developed economies. Institutions that approach these markets in a realistic, savvy and persistent manner often find that their efforts are more than well rewarded. This chapter is designed to help institutions that are involved in EE to identify and assess promising market opportunities, find the local partners that are critical for success, package projects to make them attractive to lenders and investors and find sources of financing for EE projects.

9.1 Introduction Access to adequate finance and investment is the first and basic prerequisite for the diffusion of EE measures. At the same time, the investment risks like geo-political, economic or regulatory are usually high in transition

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economies, and the lack of established financial markets and institutions make the task of attracting investment to EE projects even more challenging. There are also other factors like (a) unfamiliarity with many aspects of EE investments, especially the notion of basing financing on the realization of savings or negative cost stream; (b) weak credit strength of prospective borrowers relative to the amount of investment capital that is required and (c) requirement of a variety of resources that ought to be appraised and monitored and, thus, are judged as too costly and time consuming relative to the amount of profit and savings to be achieved. One of the keys to obtaining financing for projects is the ability of the potential investor to make the project economically viable. In short, projects must be bankable. This is especially true of capital-intensive projects that are financed by commercial sources of capital. Project success not only requires the requisite economic conditions, but also technical, business and financial skills that help the sponsor to sell the project to a bank or other source of capital. Under these circumstances, a new business-oriented approach needs to be developed for the EE projects to progress in transition economies. The key success factor to developing the market potential of EE is increased private sector participation. Ultimately, only the private sector can finance and deliver energy services on the required scale. It is beyond any doubt that developing countries would attract more domestic and foreign investment to EE projects if the necessary financial frameworks are in place, and appropriate financial incentives were provided to the private sector to ensure adequate financial returns and offset high-risk perceptions. Financing for EE must be managed effectively if it is to make any difference to local resource use as well as achieving global environmental goals. Efficient financial mechanisms, which are means or procedures in dispersing or utilizing funds, are of crucial importance. A good and proper financing mechanism can influence the adaptation of EE measures in several ways. For example, by contacting local utilities and promoting EE mortgages; cooperating with local builders, real-estate agents, contractors and others; establishing internal policies favouring EE, setting energy financing programme procedures and training staff who introduce the EE programmes.1 From the standpoint of many individual firms, the scale of financing that is available for EE projects may be too modest. So, involving private sector can be a good idea since there may be untapped sources of project funding.

1

Martin 1997, 4.

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The most useful role that financial institutions play is to demonstrate models for financing EE projects, particularly in transition economies. Here, the central challenge for these institutions is not the attitude of investors or the existence of stiff competition from conventional investments. Rather, it is to create a sustainable development strategy that takes into account existing inter-linkages between energy use, global environmental issues, and available financial mechanism and explore more effective coordination of the respective policy remedies. Furthermore, this strategy has to be implemented with the following three key goals in mind: engagement with the private sector, improving the social and environmental outcomes and identifying new financial resources. There is a clear need to establish the viability and importance of financing as a resource-conserving approach. It also helps in mainstreaming the concept of EE financing within the larger development economic thought. This is important to create a level-playing field for EE finance. Emphasis also needs to be placed on second-tier organizations such as local banks in order to support and promote EE finance initiatives. Thus, financial institutions and the governmental agencies that support EE have to face two key challenges if EE financing is to become a viable tool for resource conservation and achieve environmental goals: First, there is a need for repackaging EE financing. It needs to ‘graduate’ from the dependence on grants and its charity orientation, to one of self-sufficiency and financial sustainability. Second, there is a need for mainstreaming EE finance, focusing on governance of financial institutions (FIs). These call for a facilitative and supportive legislative environment to be put in place by national and local government agencies and financial institutions. This chapter discusses important issues related to financing EE, such as its reasoning and risks, roles of institutions, mechanisms and methods of financing.

9.2 Financing Energy Efficiency: Reasoning and Risks Micro Perspective Individuals invest in EE measures as it helps them to reduce energy bills and to afford quality energy services, for firms it improves the capacity and generates additional revenue and for the society it reduces the environmental impacts of electricity production and use. For the government, investments in energy efficiency can have a significant, positive impact on the key

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objectives of its energy policy: cutting carbon dioxide emissions, maintaining the reliability of energy supplies, competitive markets helping to raise the rate of sustainable economic growth and if properly targeted combating fuel poverty. Households and firms have yet to alter their behaviour in relation to investment in EE. This is because, for most users, energy costs typically have represented a very small percentage of the total expenditure and therefore is not a high priority item. By employing EE in a structured context, the realization can inform energy user about how energy is being used, the actual costs of energy and of methods and equipment that can be used to help control and reduce energy waste. EE does not mean rationing or having to do without energy. Rather, EE means identifying wasteful energy use, and taking action to reduce or eliminate that waste. By doing this, production levels of a firm should not be affected, but only the amount of energy and the expenses incurred in generating that production. The objective is to reduce energy costs, and consequently, increase profitability. Because EE improvements may require additional investment, it is essential that the individual or a company should have a firm grasp not only on their energy costs, but also on the potential for an adequate return on investment for any capital that they allocate. Investors in EE can be categorized into four groups. The first category of investors consists of individuals who invest their capital with little or no involvement of financial intermediaries. The second category belongs to companies operating in EE, including power producers, engineering companies, construction firms and manufacturers of EE equipment, private electric utilities, plant and system operators and energy service companies. The third type of investors includes GHG producers in industrialized countries, with an interest in offsetting their emissions by investing in clean technologies. This group is rather small, but could grow explosively depending on developments in post-Kyoto international climate negotiations. The fourth category consists of philanthropic individuals, foundations, non-governmental organizations (NGOs), and alternative investment organizations—for example, socially-oriented banks. To increase investments in EE, creating awareness, financial inducements and targeted support are essential. Effective support includes cases where an energy service provider offers to deal with all of the hassle and risk, in return for a share in the energy cost-saving benefits. Hence, to achieve high volume savings, at reasonable costs, over a sustained period of time, it is important to have a reliable financing mechanism. EE projects are not yet common to many utilities in transition economies because they result in electricity savings rather than electricity sales. In order

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to mobilize private capital, it is necessary to convince the utilities that (a) EE measures will lower operating costs due to saved energy; (b) utilities can sell saved energy and (c) the efficiency of electricity generation, transmission and distribution can be improved. Involving the energy supply industry could bring considerable synergies for promoting energy efficiency, such as incentives, standards, labels, cooperative procurement and other market transformation programmes. This may increase costs but also accelerate profits, which will attract private capital. For equipment manufacturers, there is a market for energy efficient products such as compact fluorescent lights, metering equipment, home isolation materials, and so on. Energy efficiency is considered to be a public goal. Due to this, EE project developers ask public financing sources for help as private investors determine whether the project is profitable or not. According to United Nations Economic Commission for Europe’s (UNECE) guide about the construction of business plans for EE projects, Time is often wasted applying to public institutions for (…) projects, where a combination of know-how, equipment and some funding are needed, but where it is difficult to set a fixed budget and a firm profit plan, or a list of equipment needed. (...) Public lenders prefer a large, well defined project.2

Macro Perspective Given the historical background of transition economies as well as current political and economic uncertainties, financial institutions in these countries are often unwilling to take the risks of loans for innovative or new activities, especially in countries with high interest rates. Because of the shortage of domestic capital for investment, these countries must complement their resources with foreign sponsors and lenders. The transaction costs of international project financing are high. However, multilateral institutions like the World Bank established loan facilities or credit lines with domestic financial intermediaries. These institutions prefer large projects. Multilateral institutions have different approaches in each country, recognizing that it would not be effective to treat all the countries in the same way with the same international lending terms. Multilateral institutions evaluate countries before providing them with financial assistance. Several indicators are used to detect whether the country is attractive or not: (a) macroeconomic stability and growth; (b) enforceability of contracts, 2

UNECE 2005.

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effectiveness and integrity of institutions; (c) environment for private investments; (d) energy prices; (e) demand for EE; (f ) well-functioning civil society and (g) urgency of local environmental problems. The World Bank, for example, sets sovereign risk guarantees as a precondition for lending. However, recipient countries often hesitate to provide governmental guarantees. One reason could be to avoid increasing foreign debt, argues Peter Laurson: Some CEE countries having access to direct foreign investment cut their new exposure to multilateral institutions to a minimum. Others have tried to shift the guarantee from the sovereign to a lower level such as a particular ministry but did not succeed with the lending institution.3

In the 1990s, private capital grew relative to official flows (Figure 9.1). A United Nations (UN) report noted that ‘Private capital became the major source in international financial cooperation.’4 However, most of these flows went to traditional sectors, for example, manufacturing, fossil fuel energy infrastructure and telecommunications. The same UN source provides an overview of flows to developing countries by region, from which the position of transition economies can be seen and compared. The role of the governments in promoting effective EE financing is especially important in developing economies where the energy sector is still in a flux. The state can secure property rights, remove barriers and introduce realistic and enforceable standards that encourage investments.5 The government has a significant responsibility in the process of designing a financial mechanism that helps in improving EE. For all EE projects, governments can mandate or prohibit particular behaviours as a part of regulatory interventions. The state can stimulate, support and accelerate it by institutional and legal framework, regulations, incentives, policy and specific programmes such as low-cost financing, grants, tax incentives and encouraging the establishments of Energy Service Companies (ESCOs).6 The major barriers to be overcome are: (a) macroeconomic climate; (b) lack of information and experience; (c) lack of credit history, credit 3

Laurson et al. 1995, 25–26. UN 2005. 5 Panayotou 1995a, 17. 6 An ESCO is a special-purpose company which gets a share from the company energy savings. ESCOs provide auditing, project management, implementation and finance expertise, so that the main company does not bear the risks and does not have to arrange the financing. ESCOs serve industrial companies, owners of commercial or multi-family buildings, public institutions and utilities. 4

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Figure 9.1 Net Long-term Flows to Developing Countries, 1995–2004

Source: Adapted from UN 2005.

worthiness; (d) institutions and ownership; (e) small scale of efficiency projects and (f ) energy prices. These can be overcome through modifying the tax system by introducing green taxes or implementing ecological tax reform; introducing market-based instruments for environmental management like flexible mechanisms. It can selectively use command and control instruments such as performance standards which include prescriptive and performance standards. A specific challenge for countries whose energy intensity is high is to bring an awareness of EE to individuals and firms, and to adopt the western know-how to the local needs and priorities. Although the private sector in transition economies can adopt accounting and financial practices that are employed in developed countries, the most important factor is the attractiveness of the project. In terms of cooperating with foreign partners over a longer period of time, there will be no room for bribes or gifts to officials.7 The private sector must find the best financial and fiscal strategies with local partners. It is worth mentioning that significant portion of the population in transition economies is highly educated, and this promises 7

UNECE 2005.

17.0 10.2 19.9 12.2 37.2 3.5 100

East Asia Latin America and the Caribbean Middle East and North Africa South Asia Sub-Saharan Africa Eastern Europe and Central Asia All developing countries

Source: UN 2001.

1990

Region 15.2 9.4 13.5 8.1 37.5 17.3 100

1997 18.4 9.4 11.1 12.6 33.0 15.5 100

1998 20.5 9.8 12.3 12.1 31.2 15.1 100

1999

Percentage of total concessional flows

Table 9.1 Regional Allocation of Concessional Flows, 1990–1999

0.8 0.4 1.3 1.3 5.8 0.1 1.5

1990

0.2 0.2 0.5 0.5 3.8 0.5 0.5

1997

0.4 0.2 0.8 0.8 3.9 0.6 0.6

1998

Percentage of regional GNP 0.3 0.2 0.8 0.8 5.2 0.6 0.6

1999

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flexibility and a quick adoption of new technologies, but a lack of experience with financial techniques is still a significant obstacle. Several conditions like the maturity of the market, the nature of the public policies and contextual conditions play a role in implementing EE.8 In developing countries, the situation is even more complex with few and lax environmental regulations where the resources are under-priced or often free.9 To achieve EE and the relevant investments, the structure of the energy sector is crucial. Many companies, brought to the market as a part of governmental privatization programmes, are forced to be more efficient and costconscious. Around the world, deregulation has caused the energy services market to grow faster, and has resulted in the entry of new companies.

Risks in Financing Financing EE project faces a wide range of risks, some are common, and some are specific either to the project or to a country. ‘The level of risk associated with energy efficiency investments is different from other types of investments,’10 claims a report of Hagler Bailly Consulting. Typical common risks can be divided into (a) commercial and (b) policy.11 Commercial risks are connected with developing and constructing the project. To this category belong risks relating to interest rate changes, inflation, currency risk and international price movements of raw materials and energy inputs. The policy risks include changes in the regulatory framework, war, civil disturbance and strikes. To mitigate the risks, the financial institutions should check the government’s macroeconomic record as well as the technical and managerial competence of the sponsors. Equity investors, long-term lenders, contractors and suppliers each face different risks. The methods in preventing exchange rate risks include fixing forward rates; adjusting electricity prices in accordance with the exchange rate and guaranteeing currency availability. There are institutions that guarantee against political risks, such as the Multilateral Investment Guarantee Agency (MIGA). The existence of such guarantees enables businesses take advantage of new investment opportunities.12

8

UNECE 2006. Schmidheiny and Zorraquín 1996, 41. 10 Hagler Bailly Consulting, Inc. 1996a. 11 IFC 2005. 12 World Bank 2005b, World Bank Group 2005. 9

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In circumstances of high risks, investors require a high rate of return. Sources of risk in EE investments include: Guarantees at the state or regional level as sovereign state guarantees or regional administration guarantees (Figure. 9.2).13 Figure 9.2 Sources of Risk in Energy Efficiency Investments

Source: Authors.

Financial viability of EE Projects There exists communication gaps that presently exist within the financial institutions on EE projects. Hence, it is important for the institutions to provide specialized EE-related training so that they would better understand how to assess the risks associated with such projects. There is also the need for a special, comprehensive assessment system for EE projects as they tend to be multi-faceted—both technical as well as financial in nature. Standardized appraisal methodologies may also reduce transaction costs. There can be a certification programme for ESCOs so that financial institutions and prospective customers can readily identify whether an ESCO possesses certain pre-established qualifications that overcome the

13

Hagler Bailly Consulting, Inc. 1996a.

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technology assessment barrier. There should also be an outreach programme to financial institutions, law firms, ESCOs and customers on performance contracting and Measurement and Verification (M&V) protocols. Box 9.1: ‘Securitizing’ the Savings Stream, Developing Financial Structures and Credit Enhancements to Support EE Project Loans Indian Renewable Energy Development Agency (IREDA) provided financing on a structured limited recourse basis for a heat recovery/cogeneration project involving a steel mill. It created a Special Purpose Vehicle (SPV) which serves as the borrower of the loan and the owner of the financed assets. The SPV is capitalized both with IREDA’s loan as well as equity contributed by the project sponsors. Although there is no corporate balance sheet or financial guarantee backing the loan, IREDA takes comfort in the fact that the steel company must have power to operate, which it cannot do without the equipment owned and operated by the SPV. An escrow account was created to shield IREDA from the payment risk of the SPV. This structure is common in limited recourse financings elsewhere and provides an early example of what banks will hopefully finance in the coming years. Another novel structure financed by IREDA involved the sale of capacitor banks to improve load factor at industrial facilities, a very common problem in India. The IREDA loan was for 75% of the USD 2 million project cost and is repaid over five years (including one year grace) at 13.5% p.a. Of particular note is that the lease payment from the utility is only due if the project achieves a minimum 95% load factor. Although Indian utilities are notoriously weak financially speaking, this structure allowed the equipment supplier to finance and install this equipment which otherwise would have been beyond the ability of the equipment supplier’s balance sheet to finance. Furthermore, IREDA took the performance risk of the equipment supplier without being exposed to its credit risk. Another case study, proposed by DSCL energy Services, involved a project that has not been able to attract financing. In this case, a paper mill with a weak balance sheet and a USD 3.4 million annual utility bill wants to undertake an EE project with an installed cost of USD 1 million. The projected savings on the utility bill is USD 1.2 million. These savings are the difference between the mill operating at a loss or a profit. Even though the project has an obviously high return on investment, the weak credit of the mill is the main impediment to completing the financing. It was suggested to DSCL that they work with the mill’s existing lead bank to finance the project since they (the bank) stood to lose much more than USD 1 million if the mill ceases operation— lessor and lessee. These structures illustrate how the financial institutions are able to structure the transaction to substantially mitigate the repayment risk of the ultimate end user of the EE equipment. Source: Anon 2002.

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9.3 Role of Financial Institutions Local Institutions Local financial institutions (Figure 9.3) and commercial credit providers offer finance through leasing and term loans. This is partly due to a lack of information about the potential of EE and partly due to a lack of resources. Financial institutions and other sources of private sector funding follow a well-defined due diligence process while evaluating loan and investment proposals. Environmental risks are often undervalued. It is here that the main challenge of mainstreaming EE lies. Financial institutions have a valuable contribution to make in protecting the environment while maintaining the health and profitability of their businesses. Most financial institutions pay by far the greatest level of attention to past costs, including regulatory ones. The weight of regulation is getting heavier, not just in developed countries. This does mean that a true assessment of risk must factor in the future costs of operation as well as the past performance. There is a long way to go but the process has undoubtedly begun. Figure 9.3 Role of Local Financial Institutions

Source: Authors.

International Institutions Often banks and private investors wait for a signal from the international financial community, the World Bank and others, before getting involved in large projects. There is a wide recognition, in international institutions, of the climate change and energy security issues. There is a clear rational appreciation of the value of carbon-free energy. But within these organizations

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there is still a subjective restraint to admit that energy efficiency is part of the solution. Thus, if the expectations of developing countries have to be met, new markets have to be opened. It is important to involve the international financial institutions and prepare a lending policy consistent with their energy policy goals. Financing energy efficiency should be an important component of their lending policy. Innovative and creative financial solutions are the need of the hour. There is a vicious circle of high-risk perception, leading to a high premium on financing cost, leading to an even higher risk perception, and so on. The challenge is to convert the vicious circle into a virtuous one.

Energy Service Companies/ESCO The ESCO or energy service company acts as a third party between the customer and the financial institution. This partnership enables the companies to invest in an efficiency upgrade and reduction of energy costs by using projected cash flows from future energy savings for investments today. The ESCOs are most active in the institutional, commercial, building and industry sectors (Figure 9.4). Figure 9.4 Role of ESCOs

Source: Authors.

‘When the energy service contracts expire, clients can continue to benefit from reduced energy costs. ESCOs thus present a “win–win” situation in terms of energy, economy and the environment,’14 notes European Bank for 14

Anon 2003b.

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Reconstruction and Development (EBRD). Figure 9.5 illustrates the main functions of ESCO. Figure 9.5 The Functions of ESCO

Source: Garforth and McClellan 1996.

International joint ventures can be useful for both partners; the international ESCO and the local partner. The ESCO brings its experience, its knowledge and its abilities to arrange and to help guarantee financing. The local partner knows the local environment and has contacts in local institutions. Figure 9.6 shows the interaction between an international ESCO and a local partner:15 ESCOs encourage not only energy efficiency upgrades and financial savings but also fulfil larger roles such as reducing CO2 emissions and overcoming obstacles of the capital markets. ESCOs overcome information asymmetries. According to the World Bank, Energy customers in developing countries are usually unaware of potential cost savings provided by energy efficiency investments. If they are aware, they are unlikely to implement actions since they are not likely to know what to do or how to do it, are reluctant to finance action and generally believe these actions are not worth the trouble. If energy efficiency investments are to occur, someone whose business is providing services must be involved, i.e., an ESCO.16

15 16

World Bank 2005a. Ibid.

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Figure 9.6 International ESCO and Local Partner

Source: World Bank 2005c.

According to Global Environment Facility (GEF), ‘For energy efficiency improvements in industry, energy service companies (ESCOs) are being piloted in several countries to demonstrate their commercial viability to financiers, in order to facilitate future energy efficiency investments.’17 There are several possibilities to promote ESCOs. The governments play an important role, since they can improve energy efficiency of government buildings, make contracts with ESCOs and increase awareness and acceptance of ESCOs. Another idea is to create state-owned ESCOs. In countries where it is difficult to establish private-sector ESCOs, it may be possible to develop a publicly owned ESCO that could be privatized at some point in future. The adoption of monitoring and verification protocols would decrease the transaction costs of negotiating individual performance contracts as well as removing some risk. Domestic commercial financiers may show a stronger interest in financing ESCOs if they can obtain partial credit guarantees so that the credit risk, debt or lease-financing to ESCOs is likely to be decreased. The amount of partial guarantees could be reduced when the commercial financiers are able to operate without it. This principle is built into an ESCO in Hungary. Thanks to support from the GEF, ‘Financing is medium to long term so that investments can be self-financing from the energy savings realized.’18 17 18

Martinot and McDoom 2000, 20. Ibid., 74.

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9.4 Financing Mechanisms The sources, availability and terms of financing are important considerations in investing. This information provides a good indication of the perceived risk of each project. Specific factors to consider include: (a) the presence of special funds or dedicated lines of credit for EE efficiency; (b) the existence of venture capital funds for the target country (c) incountry financing terms and rates and (d) the ability of national banks to provide project finance loans. The form of financing energy efficiency depends on evaluating a variety of factors, such as available cash, risk, time to arrange and organize the project, long-term profitability, leasing instead of buying and government guarantees. There are about six major forms of making energy efficiency investments: (a) direct investment; (b) local bank loans; (c) obligations and revenue bonds; (d) performance contracting—equipment and service contracts; (e) through third party financing—ESCOs and (f ) in-country funds based on loans or grants from multilateral or bilateral agencies.19

Direct Investment A private company purchases in cash the equipment or services. An example is the lowering of monthly energy bills by installing roof insulation or replacing windows or furnaces with more efficient ones. The company can make the direct investment on its own or with a contractor, but pays directly. The company carries all possible risks/benefits.

Recourse Financing If the company does not have enough money for the energy efficiency investment, or does not want to spend scarce liquidity on it, a recourse financing can be made. This means that the company can borrow the needed amount from commercial banks or lending agencies. The banks want a guarantee for the repayment, but only on rare occasions they may be willing to secure the loan in terms of the savings that are achieved by the energy efficiency project. There are some advantages in borrowing the money. The project savings can cover the loan payments, tax credits on the equipment can be taken and the interest may be tax-deductible. Contract disadvantages 19

Harris et al. 1994, 10.

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may be suggested and considered and payment be made to contractors or banks even if the savings are not realized. The transaction costs and the interest must be paid.

Issuing of Bonds In case large amount of money is required for a project, it is possible to obtain money through the public issue of bonds. Municipalities, governments, utilities and corporations may use this form of financing. Bonds can be used for 100 per cent financing of a project, but because they are costly, they are used for large multi-million dollar projects. Bonds are classified into two forms, as obligations similar to recourse financing, and revenue bonds, similar to non-recourse loans.

Performance Contracting Once investments in EE are proven profitable, another form of financing, called performance contracting, often carried out by ESCOs, is possible. This is a large and growing source of financing EE in many developed countries. In this financing, the savings are shared between the company and the performance contractor. The advantage for companies is that energy efficiency can be increased without making any initial capital investment. Performance contracting has a growing trend because of its win-win situation. Everyone comes out as a winner: businesses, government and the taxpayer. According to the EBRD’s ‘Mechanisms to Finance Climate Friendly Technologies,’ ‘Returns from performance contracts range from 20–40 per cent’.20

Leasing In this case, a third party provided the entire service which included the financing, installation, and maintenance of energy saving capital improvements. The contractor also dealt with EE equipment. Equipment contracts involve leasing instead of buying equipment, and transfer the risk to the supplier. The lease payments are lower than the expected savings, so these are shared by the equipment supplier and the owner of the building or company. Leasing is a very convenient solution for a company because 20

McClellan 2000.

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the supplier takes the risk. This is the main advantage of lease financing. Another advantage is that the leased equipment, as a property of a leasing company, is not taxed. Some obstacles may appear in using leasing for energy efficiency. One of the constraints is the collateral value of the equipment. The equipment leased or purchased offers a low collateral value. It is typical that once the equipment is installed, its resale value is uncertain and the equipment is almost impossible to remove. It is therefore recommended not to rely only on the asset value of the equipment but also on the creditworthiness of the lessee as well.21 Leasing companies are established for four reasons:22 z z z z

To identify local clients; To provide access to local currency; To provide on-going financing and For local political reasons.

According to an OECD report, ‘It is unlikely that local companies would be large enough or have a long enough credit history to provide finance by mortgaging their equity.’23 The barriers to EE can be overcome by the ESCO solution.

Multilateral and Bilateral Development Aid The last form of financing energy efficiency projects is through multilateral and bilateral development aid.

9.5 Financing Methods There are several methods of financing energy efficiency projects. These have been discussed in the following sections.

Standardization of the Fragmented Market In this method, finance agreement, protocols and certifications would provide and guarantee a certain level of uniformity and reduce transaction costs. 21

Hagler Bailly Consulting, Inc. 1996a, 3–9. OECD 1997a, 58. 23 Ibid., 90. 22

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However, there are certain contract structures typical for EE field that are applicable mainly in the USA and Europe. Other countries cannot easily adapt such structures without having similar environments as developed countries. ‘Legal and contractual issues become more important because this structure rests on an extensive network of contracts detailing the relationship of the parties.’24 In countries with flawed institutional and legal frameworks this may be problematic.

Aggregating Individual Projects into Large Programmes If the objectives are similar, aggregating individual projects into large programmes can be beneficial. Such programmes would allow the mass production of energy efficiency equipment. As small projects have high fixed transaction costs relative to total costs, there is an advantage in making large projects and programmes. Small projects can be bundled together, or can be linked to supply-side projects. Large programmes should reflect demands of specific users and locations. As different users have different motivations, such programmes should be integrated into sector strategies.25 Many individual → Large programmes → Mass production of EE equipment projects

Attracting Local Financial Institutions Through leasing and term loans, local financial institutions and commercial credit providers can be attracted. EE is widely financed in this way in the USA, but in CEE only few such institutions are involved. This is partly due to a lack of information about the potential of EE and partly due to a lack of resources.

Soft Financing In a pure market situation, there are several options and possibilities to make investing in EE more attractive, such as for instance softening the market 26 financing: 24

Hagler Bailly Consulting, Inc. 1996a. Schipper et al. 1992, 159–73. 26 Laurson et al. 1995, 33. 25

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z z z z z z

To provide a non-reimbursable grant as a kind of subsidy; To provide a reduced interest rate for a loan; To provide a guarantee from the public sector; To provide extra time for payment, repayment for a loan; To provide financing with equity features and To help in a case of very high discount rates.

All forms of soft financing bring, according to Panayotou, multiple effects, such as (…) soft financing (a) fills a gap when capital markets are yet underdeveloped; (b) it serves as an instrument of internalisation of positive externalities; (c) it helps address the worst environmental problems affecting health during a period of weak environmental awareness and low willingness (and ability) to pay; (d) it has demonstration effects and (e) it is necessary for clean ups of past contamination.27

This kind of help does not bring the structural change or any reform, but it helps to overcome the gap.

ESCOs Another method of financing EE projects is through ESCOs. Like local financial institutions, ESCOs play several roles:28 It takes responsibility to source finances for major upgrades of energy consuming facilities. Customers of ESCOs are companies with interest in energy efficiency but they are not financially ready for such investments or do not have the time to work on the improvements. ESCOs project financing is based on performance contracting. ESCO guarantees performance, which is convenient for the customers, and in case the performance is not delivered, ECSO assumes financing responsibilities. The customer can have several financial benefits from such cooperation. Examples of benefits are: z z z z z

27 28

Cost-free investment; Payment only if the cost reduction is delivered; Possible tax incentives; Future joint-implementation credits and Ability to invest scarce capital in core business.

Panayotou 1995a, 16. Hagler Bailly Consulting, Inc. 1996a.

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ESCOs can use a variety of finance schemes. The easiest is shared savings, that is, ESCOs get a part of the savings generated. If ESCOs do not have capital, then they can secure bank loans. In EE investments there is usually no collateral, the security for the bank is based on a contract which secures loans. According to OECD, ‘This means the ESCOs are effectively able to turn the cost savings from efficiency measures into a revenue stream that can be used to repay debt and provide a profit.’29 z

z

z

Important channels of financing are also retailers and wholesalers of equipment as well as service providers. As Hagler Bailly Consulting Inc. point out the financing mechanism can be enhanced by allowing ‘(…) recourse to the vendor through reserve funds, holdbacks, firstloss provisions or partial financing’.30 To establish special-purpose EE funds. This is a way to establish cooperation between the private and public sector, to lower the overall costs and to integrate government subsidies. To involve utilities in energy efficiency financing. The report Building a Sustainable Energy Path by Lee Schipper et al. argues that utilities should position themselves as comprehensive energy service companies rather than simply as energy supply companies.31 The utilities should play the key role in financing EE projects. Based on the US experience, ‘Utilities and other energy companies can play a major role in implementing energy efficiency measures, in creating public awareness and in financing through performance contracting.’32 In countries where there is no mature EE market, a considerable amount of education and convincing is needed in which the utilities can play an important role.33

The Guarantee Fund Financing to EE projects can also be made available to the ESCO on a projectby-project basis. In this case, it can be assumed that financing for 100 per cent of the project cost is available; however, it may be prudent to have the ESCO and customer to have a financial stake in the project as well. As a 29

OECD 1997a, 94. Hagler Bailly Consulting, Inc. 1996a. 31 Schipper et al. 1992, 159–73. 32 Harris et al. 1994, 13. 33 Hagler Bailly Consulting, Inc. 1996a. 30

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prerequisite to the financing, the ESCO can enter into a performance contract with the customer requiring the customer to make payments to the ESCO assuming the savings from the project materialize. The project and the technical capabilities of the ESCO that implement the project to mitigate the risk that the savings won’t materialize will be evaluated by an independent technical consultant assuming the project is implemented properly. This is intended to reduce the risk to the guarantee fund that the project will fail technically thus excusing the customer from making payments to the ESCO and exposing the guarantee fund to the credit risk of the ESCO. The guarantee fund would maintain an escrow account from which the financial institution could make draws in the event the ESCO fails to make timely payments. The guarantee fund is intended to be self-sustaining—the guarantee fees paid in by ESCOs would cover any loss experience. The merit of this scheme is that there is a financial benefit to all the stakeholders in the structure. It serves to leverage very scarce long-term risk capital and can be a way for banks to familiarize themselves with EE projects. It is also anticipated that the capital in the guarantee fund can be leveraged some 10 times. The obvious drawback is that it is a complicated structure which will entail both time and expense. Furthermore, it is not obvious at all as to who will provide the initial capitalization of the fund. What amount of leveraging of the fund the financial institutions will allow; how the fund would be replenished in the event of it running dry and what happens should the financial institutions view the fund as having insufficient capitalization to cover their loss exposure. There is also a possibility that the guarantee fund does nothing to reduce the domestic interest rates which are high already and, in fact, adds additional complexity and cost to any given transaction. Furthermore, there are at least three key uncertainties. It seems that there is an enormous untapped market among small- and medium-sized enterprises. There is a deep gap between the financial institutions that have money but face a shortage in bankable projects, and the markets that have lots of projects but no money. The goal, then, is to demonstrate innovative structured financing approaches using domestic institutions on smaller, pilot projects through the formation of specialized windows for EE loans. The activities include designing (a) credit appraisal standards for small and medium enterprises (SME) borrowers; (b) project appraisal methods; (c) EE loan contracting procedures to securitize repayments against energy savings and (d) standardized energy audit calculation methodologies. The financial institutions should also concentrate on (a) Participation in EE finance window; (b) Identification of potential project target

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borrowers; (c) Support for EE project group; (d) Support for development of project proposals and contracting arrangements for selected projects in representative sectors; (e) Information Dissemination; (f ) Dissemination of information on tools and financial products developed to non-participating institutions and (g) Dissemination of results of initial investments made by commercial windows for EE.

Energy Savings Insurance There are uncertainties about the projected energy savings and apprehension about potential disputes over these savings which involve financial risk. Energy Savings Insurance (ESI)—formal insurance of predicted energy savings—transfers financial risks away from the facility owner or energy services contractor. ESI providers manage risk via pre-construction design review as well as post-construction commissioning with measurement and verification of savings. ESI potentially can reduce the net cost of energy savings projects by reducing the interest rates charged by lenders, and by increasing the level of savings through quality control. Debt service can also be ensured by matching loan payments to projected energy savings while designing the insurance mechanism so that payments are made by the insurer in the event of a savings shortfall. ESI transfers performance risk from the balance sheet of the entity implementing the energy savings project, thereby freeing up capital otherwise needed to self-insure the savings. It reduces barriers to market entry of smaller energy services firms who do not have sufficiently strong balance sheets to self-insure the savings. It encourages those implementing energy saving projects to go beyond standard, tried-and-true measures and thereby achieve more significant levels of energy savings. ESI providers stand to be proponents of improved savings measurement and verification techniques, as well as maintenance, thereby contributing to national energy savings objectives and perhaps elevating the quality of information available for programme evaluation.

9.6 Financing Channels Identifying Sources of Financing Sources of financing for EE projects in emerging markets range from commercial banks, to specialized EE funds, to socially responsible investors.

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Financing through commercial banks remains difficult, in many cases, because EE investments often do not meet the standard investment criteria, such as collateral requirements. However, a growing number of specialized financing sources for EE efficiency are presently available. Each source has its own set of priorities and criteria used to select projects for investment. However, all of the sources have a commonality—they want to invest in projects that will generate enough EE savings cash flow to repay their investment. To obtain financing, the investors should be convinced that the project will be able to repay its financing. This section describes some of the key sources currently available to finance EE projects in emerging markets. While other sources exist, the institutions have departments that are active. For financing EE projects, each country should rely on its domestic resources more than on the external sources. Foreign aid is not a sustainable source of funding, although it plays a significant stimulating role in domestic resource mobilization. Only domestic funds can assure long-term financial sustainability. The state should set realistic conditions, and not be too ambitious. Environmental authorities need time to earn the credit worthiness to access funds such as municipal bonds. Through performance standards, the state should provide incentives to use the best available environmental technology. Figure 9.7 shows financing channels for EE projects. Figure 9.7 Financing Channels

Source: Authors.

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External financial resources are needed for at least five purposes:34 z To bridge the gap between the domestic demand and supply; z To resolve cash flow problems. The outputs of a project accrue only after months or years whereas the inputs (costs) must be paid immediately; z To cushion the short-term impacts of policy reforms, or to pay compensations; z To cover the foreign exchange components of investments and z To fix and clean up contaminated sites. Banks are interested in EE only in case they can accept the risks, returns and transaction costs. The risks must be adequately balanced by the returns: the greater the risk, the greater must be the return.

Private Financing For many years sustainable energy projects were funded almost exclusively by the public sector, and many projects were designed and implemented by multilateral institutions without significant private participation. The second stage, in which we are now, increasingly involves cooperative arrangements among governments, multilateral institutions and private investors. And the third, the future stage, may involve full commercialization in which the role of governments and multilateral institutions is reduced to a minimum. Stage 1 Public sector

Stage 2 Stage 3 Private → → Public Private sector sector ↔ sector

Multilateral or bilateral development institutions do not count as private investors, even if their capital is raised on private financial markets and their style of operation is similar to the private sector as in the case of International Finance Corporation (IFC) and EBRD. IFC and EBRD are private sector oriented and use private sector criteria and methods in investment decision making. However, there is a significant difference between private sector oriented and fully private-sector-based investment. Private sector orientation is the intermediate step between public sector driven activities and fully commercial operation. When sustainable energy activities are referred to as private sector, it does not necessarily mean that they are fully private sector-based. On the 34

Panayotou 1995a, 4.

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Figure 9.8 Pre-offer Financial Analysis

Source: Adapted from Laurson et al. 1995, 32–36.

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contrary, many such activities (a) are created and managed by multilateral institutions; (b) include public sector support from the GEF, bilateral donors and other taxpayer-funded institutions; (c) incorporate objectives that go beyond profit-maximization; (d) do not necessarily focus on the most profitable opportunities, but try to include near-commercial sectors to achieve deeper market penetration and catalytic market development effects and finally (e) they often mobilize capital from investors who are interested in profits but have strategic or altruistic commitments to the environment at the same time. Given these public sector features, is it justified to call these investment vehicles private sector oriented? Probably yes, because they: z z

z

Make investment decisions primarily on a commercial basis; Invest in companies and projects with majority private ownership and management; and Contain capital mobilized from profit-driven private investors.

These factors have not been common in sustainable energy activities so far. IFC is one of the pioneers in structuring large scale private sectororiented investment vehicles.

Relationship between Banks and ESCOs ESCOs are dependent on local financing. Several models can be used:35 z z z z

Direct financing of ESCOs; Partial loan guarantee to interest local banks; Revolving loan fund and Customers repay the developers of successful EE projects.

Whichever financing model is used, ESCOs have to find a bank that understands efficiency financing. Some banks have proved that it is possible to save money by being efficient. For instance, the investment bank Salomon Brothers has complex programmes on recycling, waste reduction, energy efficiency, environmental education and environmental financial risk management.36 Such banks could be willing to support energy efficiency projects of 35 36

Taylor et al. 2005 Schmidheiny and Zorraquín 1996, 14.

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their clients, which would have fewer environmental liabilities and therefore in a better position to repay loans. This is the main interest of the bank.37 On the whole, though, there are still very few financial institutions that can see the investment potential in environment-related sectors. There is a lack of environmental risk management expertise and knowledge about eco-efficiency technology.38 Scandinavian countries are most developed in this area, with researchers, consultants, environmental auditors and groups pressuring to better protection of the environment. If banks encourage customers towards energy efficiency, their behaviour would be similar to those financial institutions increasingly focusing on the protection of the environment such as the World Bank and EBRD who seek to find business opportunities in sustainable development. These multilateral development banks play key roles in exercising economic and environmental influence.39 If there is a financial motivation, even commercial banks will have an interest in promoting the environmental issues. ESCOs can make credit agreements with a bank that allows financing for upgrading plants and equipment for the customer. But before the bank agrees with the cooperation, several conditions must be clarified. The bank is concerned with the certainty of the future energy savings and with the assets that are used to secure the credit. The bank will evaluate such investment by asking questions such as: 40 z z z z

Is the customer creditworthy and trustworthy? Can I trust an ESCO performance guarantee? Is the deal big enough to be interesting? Do I have the investment officers with the right skills?

The bank should check whether the contracts define clearly cash flows and roles, whether credible performance guarantees debt coverage ratios of about 120 per cent. The ESCO ought to have resources to carry project preparation costs and to be resilient enough to fund failed guarantees. The bank should make sure that there are unlimited construction guarantees and to cooperate with ESCOs on reducing transaction costs. The banks can support ESCOs by lower interest rates because high interest rates (say, more than 10 or 20 per cent) are possible only for short-term 37

Schmidheiny and Zorraquín 1996, 100. Ibid., 40. 39 Ibid.,101. 40 Garforth and McClellan 1996. 38

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loans and therefore short-term projects. The amount of EE projects would be dramatically reduced since many projects are based on medium or longterm payback.41

Cost of Financing According to Laurson et al. financing ‘(…) in reality is not a major constraint for environmental investments in Central and Eastern Europe. It is not even the most important investment constraint’.42 It is thus not a question of resource constraints, but of learning and practicing new financial methods, which is a challenge for the private sector as well. Investments into energy efficiency require a complex process of planning, budgeting, evaluation of other investment opportunities and the relevant rate of return, and above all, the financing decision. Investors have several possibilities to compare EE projects with others:43 z

z

z

41

Net present value (NPV) calculations assess discounted cash flows based on revenues and savings as well as outflows like investment outlays, operation and maintenance costs. The NPV method covers important elements like depreciation, tax implications, variable cash flows and the time value of money. The calculations of the returns show whether the project is attractive or not. Benoit explains ‘Under World Bank policies a project must meet these conditions to be acceptable on economic grounds: the expected present value of the project’s net benefits must be higher than or equal to the expected net present value of mutually exclusive project alternatives.’44 Internal rate of return (IRR) is the discount rate at which a project would have a zero NPV. It means that the cumulative NPV of all project costs would equal the cumulative NPV of all project benefits. The IRR provides supplementary information about the financial viability of the project. Its percentage results allow projects of different sizes to be compared. Annualized life cycle costs method assesses economic lives and the cash flows over those lives. This analysis is especially useful for utilities that compare electricity supply and energy efficiency options to invest.

World Bank 2005a. Laurson et al. 1995, 5. 43 Hagler Bailly Consulting, Inc. 1996a. 44 Benoit 1996, 24. 42

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9.7 Successful Financing Environment A Favourable Business Climate The business climate of a country determines whether projects within that country can attract financing at reasonable interest rates. To assess the overall business climate of potential markets, the following market characteristics should be examined: z z z z z z z z

The economic growth rate, in terms of gross domestic product (GDP); Overall market size for specific EE technologies and services; Political stability; Government policies toward foreign investment; Inflation, interest and exchange rates; Trade volumes; Inward investment and Taxes, tariffs, red-tape and other disincentives.

A country with low inflation and low interest rates offers the best environment for initiating an EE project. However, the business climate in many transition economies may not be ideal. It may still be possible to develop and finance economically viable projects if other conditions are right.

Favourable Policy and Regulatory Environment Government and utility programmes can spur local markets for EE technologies and services. Many governments are adopting policies that encourage or require increased EE because it can reduce environmental damage, alleviate power shortages and increase global competitiveness and productivity. To increase the rate of diffusion of EE technologies, political will and commitment to EE is often critical to removal of market barriers such as high tariffs on imported EE technologies or subsidy structures that make investment in EE efficiency less attractive.

Energy Market Conditions Energy market conditions have a significant impact on the viability of EE projects. Fuel availability and prices and projected energy supply and

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demand are critical factors affecting the profitability of EE projects. Other factors that have to be taken into consideration include: (a) energy policies, legislation and regulations, such as EE efficiency standards, labelling practices and building codes; (b) the existence of utility restructuring activities and demand-side management programmes; (c) specific EE initiatives, such as tax incentives and (d) environmental regulations, such as limits on emissions of energy-related air pollutants, including nitrous oxides, methane, sulphur dioxide and carbon dioxide.

Good Project or Venture Economics The cost effectiveness of a product or service to the customer is a key determinant of the likelihood of success. Simple payback is calculated by dividing capital costs by annual savings or revenues to the customer. In general, shorter paybacks have a greater likelihood of success. Private project financing in transition economies is generally available for projects having a simple payback period of less than two years, and one year in countries with high interest rates and high inflation.

9.8 Conclusion Indeed, EE financing of climate change projects in the next decade or so through various funding mechanisms is an issue dominating regional and international debates. There are many issues that are to be discussed, that need more inputs and clarity, if this proposal has to be implemented in future. When considering the inclusion of an innovative financing mechanism in a project, the primary concerns of the financial institution include currency risk, the quality and suitability of the local financial partners and the profitability of the project. Given the complexity of setting up innovative financing mechanisms in developing countries, these institutions generally offer selected innovative financing modalities that have been designed already and are well tested. Projects should strive to work with institutions or groups that already have experience with innovative financing mechanisms thereby using existing capacity and allowing for training and capacity building under the project to help ensure future success. Since all countries do not have the existing capacity to deal with innovative financing mechanisms, it is not appropriate

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to require an innovative financing element in every project. Further, by making use of available knowledge, contacts, and close monitoring and evaluation capabilities, the financial institutions can continue to make use of innovative financing to provide outstanding support for projects that protect the environment and promote sustainable development. Energy efficiency technologies differ from other capital equipment. Because the money saved by installing energy efficiency equipment can be used to pay for its financing, this technology can be installed without having to increase operating costs or use precious capital budget. In fact, as long as the finance payments are lower than the monthly energy bills saved, a positive cash flow is created that can be used for other projects. Extending the repayment terms will reduce the monthly payment, improving the cash flow even more. In today’s economy of tight budgets and rising energy prices, a good energy efficiency policy is a necessary condition. As stewards of significant assets, public sector facilities and finance managers must aggressively manage all costs and maintain effective cash management programmes. Accelerating the diffusion of energy efficient technologies will improve both the services as well as the environment. It is not possible for countries, particularly from the developing world. to tackle and solve energy problems unless adequate funding is provided for environment and development. This means that the material basis for providing funding must first be safeguarded on a long-term basis, an aim that cannot be achieved with voluntary ad-hoc payments alone. It is important, therefore, that binding contributions should be specified by applying the normal UN rates, since the amount paid by each state should be in proportion to its economic strength. In addition, innovative steering and financing mechanisms should be implemented at the international level. If steering mechanisms are to induce the desired effects, it is imperative to internalize external costs, for example, by levying charges or issuing certificates. It is also necessary to provide additional funds to finance projects aimed at reducing the damage inflicted upon poor countries by global environmental change and help them to adapt accordingly. Besides the innovative financing mechanisms discussed here, a welcome move would be for the industrialized countries to honour their commitment, made at the Earth Summit in 1992, to increase substantially the level of financial support they provide to developing countries. It is precisely the poorest countries of the world that are worst affected by global change and its impacts. In this light, there is a need for a substantial increase in development of cooperation funding.

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The success of the EE programmes is critically dependent on how the funding is used for strategic initiatives. Given the burgeoning of interrelationships and mutual inter-dependencies in the world, it is in the interest of developed countries that the risks inherent in global change be warded off by preventive and curative strategies and programmes implemented by the international community. The developed world cannot achieve a high level of security, sustained prosperity and social stability unless it is prepared to cooperate closely on policy making at the international level. Of course, strategies for surmounting the problems that exist have a price. The politicians, business community and population must accept the fact that international efforts will require higher levels of funding than has hitherto been the case. The industrialized countries must accept the justified demands of developing countries for structural reforms at the global level and for greater transfer of resources. This seems to be a crucial prerequisite for success of EE projects. This is a rare opportunity to achieve key milestones in international environment and development policy. That opportunity must be exploited.

10 The Role of Institutions in Promoting Energy Efficiency

Using the example of support for clean energy in countries in transition, this chapter discusses the lessons of experience of institutions in supporting energyefficient technologies (EETs). The emphasis is on analyzing the performance of organizations, particularly the multilateral institutions (MIs) in promoting EETs. A key conclusion from the analysis is that although there may be some technical blueprints that MIs can apply to all countries, there are no blueprints for the design of projects. What works in one country does not necessarily work in another. Therefore, each project needs to be developed anew with reference to the implementing institutions and the framework conditions in a particular country.

10.1 Introduction Energy and environmental policies cannot be implemented at an abstract level. They require the involvement of people and organizations. The performance of organizations—public and private sectors, civil society as well as MIs—is at stake. Taking multilateral institutions as an example, this chapter deals with the role of organizations in catalyzing private sector funding to

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contribute to energy efficiency (EE), and how the performance could be improved. The basis for improvement is that the concept of performance needs to be measured effectively. Therefore, a significant part of the analysis is dedicated towards developing a methodology of performance analysis and outlining its key components and steps. MIs are chosen only as illustrative cases. In fact, any other type of organization can be used to highlight the organizational performance. Nevertheless, MIs are important actors in global environmental governance. They often are the only institutions enabling truly international solutions, which go beyond bilateral efforts at problem-solving. At the same time, their performance is hampered by two factors: first, limited resources; second, scope of action. Reflecting the consensus or conflict of their owners, the governments, these institutions cannot act quite as independently as global businesses and financial institutions. MIs are less important in terms of funding. They can provide for EE and emission reduction projects, but they can play an important role as facilitators, catalysts and brokers in a future global climate regime. MIs have a long record of promoting clean energy. So far, most of their efforts were geared towards state authorities, as the state was considered to be the key driver of development and a natural partner for MIs. Only recently civil society and the private sector came into focus. Privatization, private sector development and private finance have become the pillars of a new development paradigm. Also the role of the third sector, civil society, has been rediscovered after a long period of state-driven development. If we analyze the lessons gained in the promotion of clean energy, there is no better case than the developing economies, as these countries have a great potential to develop renewable energy and to improve EE. At the same time, they demonstrate the importance of external variables in explaining the performance of organizations. The success or failure of projects can be attributed to internal and external variables, and several plausible theoretical frameworks exist that can account for the performance of these institutions. This part discusses these variables and outlines three theoretical perspectives that explain the mixed record of organizations in supporting environmental technologies. The analysis has two limiting characteristics. First, it is bound to remain broad and somewhat rough as long as we refer to economies in transition and MIs in general terms, rather than to specific countries and organizations.

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Since we are dealing with a heterogeneous group of countries and organizations, there is a risk that general lessons of experience overlook the level of differentiation from country to country, and from organization to organization. Second, the analysis is limited to recent history, concentrating roughly on the period after the ‘end of history’1—a period that began with successive waves of revolution sweeping from central Europe to central Asia between 1989 and 1991. Although more than a decade has passed since the revolution, the period of study is still too short to gain a real understanding of the historical roots of the present problems in the energy sector of transition economies. Therefore, it should be emphasized at the outset that the history of the 20th century is critical to the understanding of current challenges. The following points serve to illustrate the historical legacy, which impacts the present situation.2 z

z

z

z z

z

z

z

For many decades, political considerations dominated economic ones, and environmental problems were neglected; There was an emphasis on the development of energy-intensive branches of industry; Under systems of central planning, subsidies amounted to as much as nine-tenths of the cost of energy; The pricing system induced inefficiency in firms and households; Civilian sectors experienced a slower technological development relative to the military–industrial complex; Energy systems were not well maintained and little money was spent on upgrading technologies; There was a lack of public awareness about renewable energy, energy savings and efficient energy use and Civil society was not vocal, leaving little or no room for the growth of an environmentally oriented opposition.

10.2 Role of Institutions in Promoting EE It is widely accepted that the participation of various institutions is essential for the effective management and financing of EE programmes. 1

Fukuyama 1989. Even today, several of these factors still play a role—in particular subsidies and information barriers. 2

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These institutions, including the government, industry, state utilities, financial institutions, non-governmental organizations (NGOs) and consumers have knowledge and network, but often lack funds, institutional capacity as well as extensive membership to contribute significantly to EE (Figure 10.1). Figure 10.1 Institutions Involved in Energy Efficiency

Source: Authors.

Government The MIs play a significant role in the development of countries. There are institutions at the local, national and international levels and have stakes in organizations. National and international committees suggest guidelines to preserve the environment. Governments are often both consumers and suppliers of goods and services, and there is a conflict of interest in both these roles. Hence, governmental institutions are taken for study in the stakeholder analysis. State policy has a major influence on the successful implementation of EE projects. Countries such as Denmark, the UK, Belgium and Italy show how policy can create a supportive framework that will allow energy companies to assist their customers with the more efficient use of electricity and gas.3 The state’s role in promoting effective environmental financing is especially important in developing economies where the energy sector is still in flux. The state can secure property rights, remove barriers and introduce realistic and enforceable standards that encourage foreign investments.4 The MIs play a significant role in the process of designing a financial mechanism that helps in improving EE. It can stimulate, support and accelerate it by institutional and legal frameworks, regulations, incentives, policy and specific programmes such as low-cost financing, grants, tax incentives and encouraging the establishments of Energy Service Companies (ESCOs). 3 4

Thomas et al. 2000. Panayotou 1995b, 17.

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These can be achieved by modifying the tax system to introduce green taxes or implement ecological tax reform, and by introducing market-based instruments for environmental management like flexible mechanisms. The government can selectively use command and control instruments, such as performance standards to effectively push EE programmes. A relatively inexpensive step is developing an easily accessible information network on technologies and programmes. The MIs can also assist in the analysis and implementation of the programmes to enable energy users to evaluate efficiency options. Well-calibrated interventions by the MIs are needed in the field of EE, even in the case of fully functioning markets in developed countries to avoid market failures such as: (a) lack of information; (b) high transaction cost; (c) split incentives; (d) externalities and (e) differences in product attributes.5 The MIs can support the business environment by removing some regulatory barriers to technological changes and could provide greater financial incentives for technological investments that reduce consumption and emissions.

Utilities The fundamental problem about energy utilization is one of economic scarcity, and the institutions that are most important in dealing with this issue are the utilities. Market competition alone does not provide incentives for electricity utility companies to invest in energy efficiency and hence appropriate market mechanisms are necessary. Utilities need to be involved to make EE programmes sustainable. However, whether a company would voluntarily try to reduce the demand for a product which it sells is difficult to find out. Utilities make profits by selling more energy and there is no incentive to reduce sales. Hence, it is important to break the link between profits and electricity sold. For greater efficiency, financial interests of the utility system should be aligned with the interests of their customers. The key to engaging the utilities is to remove their natural disinclination to invest in end-use efficiency. This can be done by using approaches such as true-ups that regulate the tariff structure in a flexible way ensuring that cost recovery for utilities over time is no longer dependent on sales volume in kWhs. There should also be a need for performance-based positive incentives for utilities (Figure 10.2). Another approach is to design EE programmes which would offer customers financing options at significantly lower costs. Utilities can 5

Hagler Bailly Consulting, Inc. 1996b.

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Figure 10.2 Roles of Utilities

Source: Authors.

experiment with new approaches to provide EE services to customers to study if financing can work in the new environment.

Research and Development Organizations It is important to mention the importance of research. In the context of EE technologies, this is the core business of international and advanced Research and Development (R&D). Over the years, these organizations have accumulated enormous technological, human and physical capacity, using international public resources, to undertake basic and strategic research and acquire enormous new technologies and knowledge. In terms of infrastructure, the developed countries have the most advanced and highly equipped laboratories with the state-of-the-art instruments unaffordable by any developing country. Hardly any national system in developing countries has such capacity. The international community employs the most qualified and experienced scientists, even those trained by developing countries, because they can pay them attractive remuneration. It is therefore imperative that these organizations maintain these technologies and knowledge and play the role of developing superior ‘technologies and acquiring new knowledge for application now and in future by all’. However, several promising end-use technologies still require R&D support. In particular, a number of issues like an increased share of renewable energy, the efficiency of fossil-fuel-based power production, more efficient electricity networks, or vehicle efficiency, can only be alleviated through efficient research and demonstration activities in connection with other regulatory and economy-based measures.

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Researchers have found that industrial energy demand can be potentially reduced by about 60 per cent theoretically and in practice by about 30 per cent if EETs are used. The governments in developed countries have recognized the efficiency gap and have realized their role in promoting EE programmes, encouraging awareness and implementing no-regrets measures.

Manufacturing Industry Industry can promote EE as well and complement state policies and programmes. It has expertise as well as knowledge of the plant and processes. They can position their projects to respond to customers’ needs and can influence policy making. The manufacturers have a relationship with the customers, who rely upon their products, services and expertise. This is likely to result in increased interest by energy users in EE, which will in turn give confidence to manufacturers to develop new methods and improve existing practices.6 In some sectors, multinational companies are establishing EET portfolios, showing likely buoyancy in sales and profits. However, most manufacturers are small with limited research capacity. Many may regard the time for payoff as too long or a change of their technologies as too risky. In such a scenario, the governments should provide a technology base for industry to prepare conditions to build new technologies and products. The cooperation between the government and large purchasers ought to be established in order to organize a market for advanced products. Such a market has been established, for example, for refrigerators in Sweden.7 Cooperation between the government and large equipment manufacturers can lead to common programmes to commercialize advanced EETs. Equipment vendors also play a significant role in the diffusion of EE technologies. Since the vendor is on-site and is involved with details of the facility, it is in a unique position to see opportunities for improving EE. Because of the existing relationship of the vendor with the customer, the industry can bring these technologies and products to the attention of the vendor as an alternative path to going through internal channels for implementing these projects. However, if the industry thinks in terms of strategic alliances with energy service companies; these new ventures would afford opportunities never realized before. What once may have been perceived as a conflict of interest might now be viewed as strategic alliance. 6 7

Schipper et al. 1990, 159–73. Ibid.

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Domestic Financial Institutions Financial institutions have to make a valuable contribution in protecting the environment while maintaining the health and profitability of their businesses. They have crucial links with commercial activity that generally degrades the environment. Their commitment and support for the precautionary approach to environmental management, which attempts to anticipate and prevent environmental degradation, is essential for achieving sustainable development. Financial institutions taking an eco-efficient approach have sometimes their first real exposure to environmental issues. This improved environmental performance generally brings with it an improved financial performance and a willingness to consider this area more proactively. Some years ago the phrase environment makes business sense was first used. Now it has become a key theme. Domestic financial institutions provide finance through leasing and term loans. EE is widely financed in this way in the USA, but not in many other countries. This is partly due to the lack of information about the potential of EE and of resources. Financial analysis is normally required to make a decision on any type of investment. Financial institutions and other sources of private sector funding follow a well-defined due diligence process when evaluating loan and investment proposals. Environmental risks are still often undervalued. It is here that the main challenge of mainstreaming EE lies. The financial institutions should support activities that have a slightly marginal increase in costs if environmental protection is in built into the project.

10.3 Performance Analysis of Multilateral Institutions Institutional Design8 According to Keohane et al.9 institutions can be understood as: …persistent and connected sets of rules and practices that prescribe behavioural roles, constrain activity and shape expectations. They may take the form of 8 9

Stine Madland Kaasa 2005 Keohane et al. 1993

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bureaucratic organizations, regimes [...], or conventions (informal practices). Based on the success or failure of problem-solving efforts, one can evaluate these institutions in implementation (‘implementation’ refers to the measures governments take to translate international accords into domestic law and policy).

It is important to distinguish between the different types of institutional consequences, namely, output, outcome and impact. Output is conceived of as the norms, principles and rules generated by the institution itself. Outcome refers to the implementation, that is, the changes in the behaviour of relevant actors (target groups), while impact connotes the tangible consequences affecting the physical problem at hand.10 The outcome and the impact of an institution can be determined only in retrospect—meaning several years after its entry into force. According to Underdal, Arild ‘if we want to evaluate regime effectiveness at an earlier stage—as we often do—the regime itself will be all that is known to us’.11 ‘It is not interests (preferences over outcome) that are adjusted when states cooperate, but policies (preferences over actions).’ Following this, institution facilitates cooperation not by changing actors’ interests or values, but by altering their ‘incentives’ for action. Regarding the political aspect of the problem, the degree of asymmetry in actors’ interests and preferences will be affected by whether the states’ preferences over action are identical, complementary or incompatible. According to this theory, ‘Climate Change’ is related to a long-standing interest conflict between Northern and Southern countries on the issues of environment and development. While the North has most often stressed the importance of environmental protection and conservation; the South has mostly been concerned over the development agenda. This conflict has influenced the decision-making process of the Commission on Sustainable Development (CSD) concerning issues, such as financial resources, technology transfer, and consumption and production. However, what is important here is that international institutions do matter; some make more impact and contribute to greater effectiveness than others because of their specific institutional features. It is therefore important to analyze how an institution is designed in order to understand why it is effective or ineffective, and moreover, to understand how it would be possible to enhance its effectiveness and evaluate its performance. In order to strengthen the performance of MIs, we need to know how to define and measure performance. It is necessary to develop a methodology 10 11

Easton 1965. Underdal 2002.

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that goes beyond traditional means of evaluation. This section argues that evaluation constitutes only the first step in a comprehensive performance analysis. The subsequent steps like explanation, prediction and prescription are equally important, and without addressing each of them in the proper order, there is a risk that the evaluation merely is a statement of opinion rather than a result of research. Table 10.1 lists the four key components of a sound performance analysis along with the matching research question for each component. Table 10.1 Components of a Sound Performance Analysis Component Performance evaluation Performance explanation Performance prediction Performance prescription

Research question What have multilateral institutions achieved in terms of mobilizing private capital for the global environment? What explains the performance of these institutions? Based on previous experience, can we predict performance? Based on previous experience, can we prescribe improvements?

Source: Authors.

As a starting point, it is useful to assume that there are no limitations to availability of data, as this will enable to construct a blueprint for a performance analysis. The term blueprint refers to a model that can be applied in different sectors and for different institutions. This blueprint cannot always be applied in its ideal form due to imperfect information. Limitations in data are ubiquitous, and sometimes make it impossible to carry out an ideal analysis. When it is impossible to follow the model procedure, compromises are inevitable. However, it is important that the model procedure is clear, so that informed choices and compromises can be made once data constraints present themselves.

The Selection of Performance Benchmarks Once the research questions are set, the next step is to define the criteria based on which the performance of MIs is analyzed. In other words, a decision is needed on which benchmarks are used to assess whether particular projects or programmes have been successes or failures. The selection of variables is not to be taken lightly, since it has implications on the feasibility of the research as well as the validity of the outcomes. The performance of MIs can be measured in terms of multiple criteria. Unless there is plenty of data and time, the objective, however, should not

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be to work with long lists of criteria for determining success or failure. It is important to reduce the number of criteria to those that are essential—the core criteria in a particular field of study. In the sustainable energy area, for example, it is possible to reduce a large number of criteria to one critical benchmark, namely, the extent to which MIs have contributed to the commercialization of clean energy technologies. As argued in Chapter 8 (this volume), commercialization is probably the single most important determinant of whether the activities of MIs in clean energy have been worthwhile or not.

From Evaluation to Performance Analysis MIs have been active in the clean energy field for several decades, but the wealth of experience has not yet been collected in a systematic way. There is no comprehensive study evaluating the performance of MIs in this field. Resources spent by MIs on drawing lessons from completed projects are low compared to resources allocated for project development. Many MIs keep paper trails of documents relating to projects and activities, but these documents are rarely analyzed in depth after projects are concluded. After project completion, team members are required to focus their time and attention on new projects and are given little time and incentive to analyze completed ones. Even when evaluations are undertaken, the lessons hardly are incorporated in future projects and programmes, and are usually not disseminated widely. As a result, there is little learning across institutions. Traditionally, performance analysis comes in the form of monitoring and evaluation (M&E) reports,12 which focus on individual projects or organizations and do not have a comparative component. Such evaluations have been consulted in the research for this thesis. While both internal and external analysts complete M&E reports, it is generally considered that external analysts are more independent. This may not always be the case, because external analysts can be friends of members of the project team. Also, they are often economically dependent on MIs, since they make a good living from contracts issued by MIs. In the field of development cooperation, there is increasing emphasis on independent evaluations as a means of ensuring accountability. Because of confidentiality issues, however, external analysts generally do not have access to

12

In the technical and financial fields, they are sometimes referred to as audits.

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project files, and their assignments tend to be short-term and limited in scope. Often evaluators are hired for a few days, rather than for weeks or months, and they are given narrow assignments that do not give room for in-depth investigation. This has to do with limited budgets as much as with an aversion to outsiders gaining insight into classified information. Time pressure, confidentiality and protection of commercial interests are obstacles to comprehensive evaluations. As a result, such evaluations are often not thorough and systematic enough for drawing well-grounded lessons. M&E reports may include some or all of the following components: financial performance, legal compliance, economic efficiency, cost effectiveness, relevance and achievement of programme results relative to a given set of objectives. The primary focus is often on examining individual activities relative to the given objectives. In the future, more emphasis needs to be placed on measuring effects broadly, including intended and unintended effects, direct and indirect effects, and short- and long-term effects. A more comprehensive performance measurement is more difficult, but also more valuable. Most M&E reports tend to follow a descriptive methodology, stating the outputs of a particular project or programme and providing an opinion as to whether it was a success or a failure in terms of given objectives. What is needed instead is a systematic performance measurement of outcomes and impacts, including performance explanations, such as detailed accounting why certain outcomes and impacts were achieved. After identifying what has worked and what has not, it is necessary to explain why, and to examine what can be done to improve performance. If sufficient data is available, this can be conducted in a quantitative way. If there are data limitations, qualitative in-depth case studies can also yield interesting results. Performance explanation is critical for performance prescription because it identifies the factors responsible for project success or failure. These factors can then be used for replicating successes and avoiding failures.

Building a Sound Performance Analysis Assuming that there are no data constraints, an idealized performance analysis would involve four steps: evaluation, explanation, prediction and prescription. The fourth step includes general recommendations in terms of objectives and targets (what needs to be achieved) as well as guidelines to the ways in which these targets can be achieved in particular circumstances (how it can be achieved). These steps are then followed by a fifth step,

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without which the performance analysis hardly is a worthwhile exercise— the implementation of the prescriptions. Accordingly, the objectives of a performance analysis are four-fold: first, to determine the performance of the multilateral institutions (evaluation); second, to examine the reasons for success or failure (explanation); third, to forecast future performance based on past experience (prediction); fourth, to provide prescriptions for performance improvement and guidance as to how these may be implemented in practice (prescription). All steps need to be conceptually and logically linked, and the practitioner should be able to use the recommendations for implementation. A general and vague formulation of recommendations can be a way to avoid accountability for subsequent lack of, or inadequate, implementation. Some steps of the performance analysis can be controversial: the more detailed the analysis, the more likely the discussions, which may cause offence to some parties. For multilateral institutions, which are working in the realm of diplomacy, evaluations are therefore a delicate matter. The following sections apply the four steps of a performance analysis using the example of the mobilization of private capital for clean energy. A mere description of the performance of multilateral institutions in mobilizing private capital for clean energy is not an interesting research outcome. An explanation is needed. The second step, therefore, is to determine why there was success or failure (or a mixed result) (Boxes 10.1, 10.2). Box 10.1 Performance Evaluation The first objective is to measure the performance of MIs. Recognizing the complex nature of mobilizing private capital, it is necessary to take into account any sign that private investors have provided additional capital, or are more likely to provide capital in the future. Performance analysis should be based on criteria clearly specified for evaluation, and guided by an appreciation of the difficulty of measuring and judging performance. The purpose of the performance evaluation is to review what has been done, how it was done, by which organizations and what results were achieved. The term results can include a range of indicators: agenda setting, output, outcome and impact. In practice, output variables are most straightforward. Source: Authors.

The third step in a performance analysis migrates from explanation to prediction and prescription (see Boxes 10.3, 10.4). Explanation is therefore the basis for arriving at plausible predictions and prescriptions. If we

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Box 10.2 Performance Description The second objective is to explain the findings on performance. The explanation can be at the micro, meso and macro levels. At the micro level, there is a need to explain why particular projects or activities were successful while others failed. At the meso level, the task is to explain why certain organizations have excelled or failed in particular fields. At the macro level, a general explanation may be sought as to why the multilateral system as a whole has performed the way it has. The macro level is the most difficult as the multilateral system is more a category of thought than an empirical and tangible phenomenon. Source: Authors. Box 10. 3 Performance Prediction The third step is to predict likely performance outcomes based on the presence or absence of certain variables, which are causally related to performance. Source: Authors. Box 10.4 Performance Prescription The fourth objective is to prescribe steps for performance improvement. The method to arrive at performance prescription can be analytical, determining the causal influence of independent variables and intermediary variables. Or, if data are lacking, a best practice analysis could be conducted, which synthesizes in qualitative terms the experience of MIs in mobilizing private capital. Best practice examples cannot be copied and applied in all situations alike, but they can serve as blueprints to be adopted, tailor-made, replicated and scaled up by organizations in different locations and circumstances. Through a replication of best practice, a multiplier effect may be achieved. Source: Authors.

understand which factors have influenced performance in the past and why, we can proceed to establish performance predictions and prescriptions: z

z

Prediction: If certain factors have been identified over time as contributors to success or failure, success or failure are likely to result whenever such factors are present in any project; Prescription: When factors that caused success or failure in the past are known, we can strengthen the problem-solving capacity of individual organizations and perhaps even the multilateral system as a whole.

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In this way, a sound performance analysis can contribute to mobilizing MIs more effectively in addressing global environmental problems. Applied to the topic of promoting clean energy, the primary goal is to accelerate the commercialization process. Therefore, the analysis starts with an assessment of the extent of evidence of commercialization, and whether the activities of MIs are causally related to this process (performance evaluation). After this, the focus is on commercialization as it is necessary to ascertain the conditions for success as well as the pathways to failure (performance explanation). The third step is to make predictions in future projects or projects that are still under implementation (performance prediction). And finally, having studied the process of success or failure, it is possible to uncover the levers for increasing the effectiveness of MIs (performance prescription).13 Prescription does not end with formulations, but also includes practical advice on how to implement the prescriptions for performance improvement. Each organization requires varied advice based on internal and external circumstances. Timing, political support and human resources play important roles to make performance improvement a reality. To summarize the methodology outlined here, a sound performance analysis proceeds from performance evaluation to causal analysis, and then moves to prediction and prescription. However, it does not end with the formulation of prescriptions. There is still a gap between prescription and implementation. Prescription has two parts: the first is about what should be done (objectives and content of action); and the second how it should be done (methods of implementation). Having the right knowledge on what to aim for and what should be done to reach these aims does not guarantee successful implementation. Even with good input, it is difficult to avoid past mistakes or replicate past successes. It is safe to assume that whatever had worked in the past will necessarily not work in the future in the same way. After presenting the general prescription on what needs to be done, the analyst should examine the issues and obstacles organizations face while implementing the prescriptions. The analyst should be cautious while visualizing solutions that are feasible to implement in practice. Ideally, there should be a close collaboration between the analyst and the implementing agent. The analyst benefits from information gained in practice, whereas the implementing agent needs to have a clear picture of what factors impact on the implementation process. 13

Assenza 2000.

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10.4 Internal and External Performance Variables The performance of MIs is affected by internal and external drivers, and constraints. Internal drivers and constraints are characteristics of organizational capacity, which include individual capabilities as well as factors such as availability of funds, priority given to sustainable energy, openness of organizational culture, like the ability and willingness to collaborate with other institutions, and other variables. External drivers and constraints are variables pertaining to other institutions and the country of operation. The success or failure of MIs depends as much on external variables as on internal ones, and for this reason, MIs cannot always be blamed for mishaps in their operations. It has long been fashionable to criticize MIs for a multitude of failures and to make them responsible for a host of ills. While some of the criticism may be justified, there is a tendency to forget that the performance of MIs depends on an appropriate operating environment. Since framework of conditions in the countries of operation influences the performance of multilateral institutions, attention needs to be paid to the conditions and context in which the MIs work. It is not reasonable to criticize MIs without examining to what extent perceived failures were caused by external variables, over which MIs have limited or no control. A European Bank for Reconstruction and Development (EBRD) paper noted that ‘(…) institutional and political features of the country can largely predict success or failure (…)’14 of MI operations.15 At the basic level, the state represents the trunk of the tree from which the branches grow. If the trunk is not healthy, it is unlikely that the rest of the tree is in good shape, and no forester will be able to save it. To cite an example, one widespread problem is the lack of good governance. In many countries corruption affects all levels of power; the rule of law is compromised through widespread bribery and political influence in the judiciary; and every year, human rights organizations highlight a host of violations, including excessive punishments and political trials. The lack of good governance primarily affects ordinary people, but it also influences organizations, such as MIs, firms and NGOs. The political environment is the most difficult for MIs to deal with, as any attempt to

14 15

Available online at http://www.adb.org/MDGs/multilateral.asp. Buiter and Fries 2002, 6.

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influence policies and governmental practices would raise allegations of interference with national sovereignty. MIs face many obstacles. One persistent obstacle is the widespread perception of a trade-off between the economy and the environment. Ecology is often perceived as a cost that needs to be avoided. Government officials and people at all levels of society perceive investing on the environment as waste, as an impediment to growth and a misallocation of funds away from productive uses. Since there is little awareness of win-win opportunities, very few attempts are made to integrate economic and environmental policies. The level of environmental action varies from country to country, but most policies are quite ambiguous and ineffectual. One NGO in Kazhakhistan made an apt point that is applicable to many other countries. It said that ‘(…) despite the government’s many attempts to develop systematic policies to promote rational resources use and environmental protection, these policies remain inconsistent, uncoordinated and at times contradictory’.16

10.5 Reasons for Failure There are three major sets of reasons for weak and inconsistent environmental policies, including policies for promoting sustainable energy.

Political Reasons Many governments stress the right of citizens to a healthy environment but in light of the record, sceptical citizens consider this type of rhetoric as empty words. The lack of right of citizens for a clean environment as well as a worsening environmental situation in some regions testifies to a general lack of political will to take decisive measures. Although transition economies have subscribed to numerous environmental treaties and have membership in international organizations, there is limited compliance with international agreements. The main local partners of MIs in the environmental field, the environment ministries, suffer from restricted powers and a lack of prestige within the governmental structure. Due to frequent reorganizations, people who 16

Kuratov et al. 2002, 10.

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serve as counterparts of MIs are often replaced, and principles such as keeping promises and taking responsibility for decisions are not always honoured. For these reasons, the environment for MI operations in transition countries is complex and precarious. Regardless of how well project concepts are developed on paper and how professionally they are implemented on the ground, such external conditions can lower the probability of success.

Economic Reasons Lack of resources for environmental issues constitutes a significant barrier to implementation of effective environmental policies. There is little reliable information about expenditure on the environment and funds allocated for the environment are generally diverted for other purposes. Firms and financial institutions in transition economies have yet to be sensitized to environmental issues, and there is little awareness of the economic cost of environmental neglect. Foreign companies have significant influence on the governments, especially in the natural resources sectors, but their influence has not been used to strengthen environmental standards. On the contrary, environmental laws have sometimes been altered in order to minimize ‘unnecessary’ expenditures for businesses.

Cultural Reasons At the core, many problems can be traced back to a lack of political will and a culture that does not value the environment as highly as economic progress. Nature and the economy are perceived in terms of a trade-off that is irreconcilable. One economics professor in the Czech Republic highlighted this trade-off by stating that ‘(…) a hungry child does not care about a blue sky’.17 There is a widespread perception of being left behind economically, fuelling a sense of urgency to catch up with the West in terms of living standards. It is believed that sustainable development is brought in as a counter to traditional economic development. There is great diversity among countries in transition and it is therefore difficult to generalize the overall progress achieved in terms of sustainable 17 Statement by a professor at the Technical University of Ostrava, Czech Republic (personal communication).

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development. Countries preparing for EU accession have taken significant initial steps to bring their regulatory frameworks in line with the acquis communautaire, and to narrow the gap relative to EU emissions standards. The reason for doing something about the environment is not the environment, but the prospect of joining the EU. This makes it easier to adopt environmental measures that would otherwise not muster sufficient political support. Compared to the accession countries, other transition economies lag behind in strengthening environmental protection laws. Lack of financial resources can be a reason for not taking action on the environment, but the real issue is environmental measures. The ministries responsible for environmental protection are weak relative to other ministries, lacking means to enforce their policies. Some institutions working in the environmental sphere have been dissolved a few years after establishment and others suffer from an unclear legal status and symbolic, if any, financial support from the government. This can be traced back to a culture that values industrialization higher than environmental sustainability—an enduring legacy of the Soviet system.

10.6 Explaining Performance In the following part, we will discuss the performance of MIs from three perspectives: the unitary rational actor model, the organizational capacity model and the stakeholder interaction model.18

The Unitary Rational Actor Model The unitary rational actor model19 explains performance in terms of power dynamics among states and among institutions. Sustainable energy activities are generally too small and uncontroversial to affect, or to be affected by, the relations between states. States are indirect actors in the multilateral system in the sense that governments leave most decisions to the management of MIs, which in turn leave most decisions to the project staff. The shareholders of MIs rarely exercise their powers in organizational decision making. 18 This three-fold structure has been inspired by the approach chosen by Graham Allison in his classic study Essence of Decision (see second edition of 1999 with Philip Zelikow). 19 Bendor 1985.

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In spite of this, it would be incorrect to characterize the governing bodies as rubberstamp parliaments, as they do occasionally exercise their control function, especially in larger projects and when a scandal occurs.20 Still, the governing bodies are overwhelmed by the amount of documentation they are requested to assess, and they have little choice but to rely on inputs and recommendations from the MI management for making decisions. Given the low degree of intervention, the governing bodies have little leeway in decision making. In this sense, MIs act as their own masters. Concerning the recipient side, the success or failure of projects is occasionally affected by power dynamics on the national, regional and local levels. Given the small size of most sustainable energy projects, agencies of the central government are rarely the main actors, but they have the power to affect the behaviour of all other actors through directives and regulatory framework. In the past, MI funds were disbursed to the Ministry of Finance, but in recent years there has been a decentralization and diversification of target groups, including direct disbursement to firms and to NGOs. The difficult operational environment MIs face in transition economies has been a cause of delay in many projects. Government interventions have often altered project schedules and required adjustments of project designs. For example, in Kazhakhistan, the World Bank reported that ‘(…) out of nine completed investment projects only two finished according to the implementation schedule, the remaining were either extended, restructured, or cancelled by the Government’s decision’.21 Delicate issues arise if MIs exert pressure on the government. Although investments of some external MIs are quite substantial, most governments are not economically dependent on them.22 The influence of these organizations is therefore limited, confined mostly to large projects that are considered crucial for a country. Since MIs are aware of their limited powers and their circumscribed room for manoeuvre, they are careful to conform to diplomatic etiquette and are unlikely to ‘rock the boat’.23 Some MIs have 20

A classical case is the World Bank’s Narmada Dam project in India. World Bank 2002, 1. 22 An exception may be dependence on the International Monetary Fund (IMF) in a financial crisis. 23 MIs tend to use diplomatic language in describing problems they encounter in projects. There is a preference to solve matters amicably and confidentially. Information on problems is generally not released to the public, and what has surfaced is through leakage. Information barriers may be necessary for keeping good relations between MIs and the government, but they prevent a spread of lessons across the multilateral system and other institutions, for which these lessons could be useful. If real progress is to occur, there needs to be a balance between diplomacy/confidentiality on the one hand, and transparency on the other. 21

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used aid to pressurize governments to meet their objectives and to take action on environmental issues, but this happens behind closed doors and is not reported in the public domain not to embarrass officials. A project failure is not always a failure. It can be a source of valuable lessons and as such it is not an event to hide from the public. An important issue is how to deal with situations if there are repeated failures owing to wrong decisions taken by the same individual or institution. A recent EBRD report recommends that if the recipient fails to honour its commitments, concrete, decisive and pre-defined measures need to be taken, including, if necessary, the cancellation of the project.24 In every case, the MIs must weigh the costs and benefits of available choices: for example, should they accept delays and impediments to projects, or should they exert pressure on state authorities, which if not handled diplomatically, risks termination or exclusion from the country?

The Organizational Capacity Model The organizational capacity model explains performance in terms of the ability and efficiency of institutions. In this model, it is useful to distinguish between MIs that are oriented towards operational activities and others that focus to a greater extent on normative activities. In practice, most organizations have both normative and operative functions, but some organizations like the World Bank concentrate more on the operative side of the spectrum, whereas the UN agencies generally tend to emphasize the normative side. This issue is at the core of a book by Helge Ole Bergesen and Leiv Lunde (1999) entitled Dynamos or Dynosaurs: Multilateral Institutions at the Turn of the Century. They start by distinguishing between two models of organization, the action organization and the political organization. Then they classify the functions of MIs in a continuum from normative to operative, arguing that in principle MIs can be established ‘(…) either to influence the perceptions and norms of relevant actors within a given set of issues, leaving actual implementation to them, or to carry action itself into the field following decisions by participating governments (or other actors)’.25 Organizations on either side of the normative–operative continuum do something, although the projects are very different in nature.

24 25

See Buiter and Fries 2002, 19–20, 23. Bergesen and Lunde 1999, 3.

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In both cases, one can distinguish between: z

z

z

z

Design capabilities: Developing the project concept, choosing among numerous design alternatives, analyzing the feasibility and risks or writing the project documentation; Investment capabilities: Identifying profitable projects, choosing financial instruments and structures or mitigating risks; Production capabilities: Implementing the project or overcoming problems; Linkage capabilities: Personnel selection, networking, establishing collaborations with other institutions or coordination.

Organizational capacity is relevant not only for the headquarters, but also for country offices and any other organization with a significant role in the project. Country offices are essential for effective project implementation, as projects cannot be managed remotely from places like London, New York and Washington, DC. The number of personnel in country offices varies from a few individuals to more than one hundred. The offices are often headed by foreigners, but increasingly rely on local managers and experts. In project documentation, the involvement of local professionals is regularly emphasized as a key factor for success. The knowledge of local conditions is a critical factor in the success of projects. In the past, there was a tendency to involve mostly foreign experts and to underrate the education and abilities of locals. To reduce the dependence on foreign expertise, significant resources have been dedicated in recent years for training. The countries need local professionals with experience on the international stage. Training such experts requires more than a few workshops to develop the necessary skills. However, sending locals for prolonged stays and studies abroad can add to brain drain, as some may choose to stay abroad after their studies or training. Geographic, linguistic and economic constraints can limit the efficient use of technologies and human resources. For example, long distances and inadequate infrastructure create a difficult working environment. Modern technologies, such as the Internet, email and online collaboration help to overcome these barriers. Some MIs use the Internet to introduce and promote information on their operations in the countries by maintaining special websites, but their content is generally limited and largely remains inaccessible for the public. Reflecting increasing concerns about corruption and organizational effectiveness, MIs have tried to tighten financial and implementation control over projects. Progress reports, project reviews and financial audits are prepared at regular intervals. In some cases, these are paper exercises without

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effect, but it can happen that an independent auditor will undertake a thorough audit. The review documents and audits are usually not accessible to the public. A frequent criticism of MIs has been that significant amounts of money are spent on reports, which include recommendations that are not implemented. There is a widespread perception that there is an imbalance between payments for reports, usually to foreign consultants, and funding of sustainable energy, including engineering work and equipment. Bulk of the advice given often gets ignored. This perception has been echoed by an NGO in these words: A significant portion of the funds allocated by donor nations and international financial institutions has been spent on scientific research, analytical reports, the organization of numerous meetings, payments to foreign consultants and local support staff, and so on. The result of this kind of assistance, more often than not, has consisted more of the development of general recommendations, programs, and concepts than in concrete help to solve environmental problems.26

Research is necessary to create a strategy and to choose appropriate methods of implementation. Likewise, workshops are useful for capacity building; and reports can be essential for monitoring as well as for exchange of information and experience. The challenge is to balance research and capacity building with spending on the installation of equipment and other direct ways of promoting sustainable energy. It is of little use to make feasibility studies, carry out a comprehensive preparatory phase, leaving behind truckloads of folders, if these efforts are not followed up by projects where concrete results and improvements are visible. MIs recognize that there is room for improvement of organizational capacity. For example, in one country evaluation, the World Bank admitted that it ‘(…) lacked a comprehensive, long-term approach to capacity building (…)’27 and that ‘(…) its early operations neglected environmental sustainability’.28 In order to improve the capacity-building activities supported by MIs, it should not rely on occasional weekend seminars with shifting groups of participants. Rather, it should be oriented towards selected groups of people that are trained, tested and certified in particular EE fields. Subsequently, these professionals need to be given an opportunity to use their newly gained knowledge. Funding should be available for 26

Kuratov et al. 2002, 17. World Bank 2002a, 32. 28 Ibid. 27

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projects they develop, for instance, through the Global Environmental Facility (GEF) Small Grants Programme. Alternatively, there should be a plan to involve these experts in projects that accompany or follow the training programmes. The objective is to prevent trained experts ending up working in fields unrelated to their training because of a lack of finance or project opportunities. The organizational capacity of MIs is often affected by the legacy of the work ethic prevailing under the socialist system, where everyone, except the members of the nomenclature, received the same wage, regardless of performance. Organizations today are still suffering from the fact that for several generations, everyone was used to merging into an anonymous working class, where individuals were best served not to stand out and not to show too much initiative. It will take time to reverse this culture, but MIs can start to change the work ethic in their organizations. Incentive structures are needed to motivate staff and to encourage an open and cooperative approach to other stakeholders, in particular NGOs and other civil society organizations (see the following section ‘the stakeholder interaction model’). To improve the accountability and transparency of MI operations, important documents, including independent evaluations, should be available to public, preferably on the Internet. This would increase public acceptance and credibility of MIs, and reduce the scope for doubt and suspicion caused by insufficient information and by over-reliance on materials that have the purpose of public relations and promoting the image of the organization.

The Stakeholder Interaction Model The stakeholder interaction model29 analyses the relations between MIs and various levels of stakeholders, including state agencies, NGOs, businesses, commercial banks and the general public. Not least, this model concerns itself with the interactions among MIs, which are characterized by competition versus cooperation as well as by complementarity versus overlap. Traditionally, the interaction among stakeholders has been inadequate, not only in the field of sustainable energy, but in all sectors. For example, in the above-mentioned country evaluation the World Bank acknowledged that in the past, ‘(…) strategy has not been developed through extensive collaboration with stakeholders’.30 Also governments have contributed to the fragmentation of efforts and the low level of coordination. 29 30

Mostashari and Sussman 2003. World Bank 2002a, 8.

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The stakeholder interaction model requires inclusion both of NGOs as well as the private sector. The relative neglect of the private sector goes against rhetoric to increase private participation in infrastructure, to mobilize the private sector for the environment and development and to build partnerships with private actors. The reliance on state institutions also highlights the fact that the energy sector in transition economies is only partially privatized and that the most powerful actor in the sector is still the state. There are at least three reasons why cooperation and coordination among stakeholders is often limited in practice: z

z

z

The first is a difficult operational environment such as long distances and lack of communication infrastructure. The second concerns efficiency. Many enterprises with the highest wastage of energy are in state ownership, and hence it makes sense to target them first. Moreover, focusing on the government rather than a broader selection of partners can ensure easier implementation of projects. Collaboration and coordination involve transaction costs. The inclusion of additional players can cause delays and disagreements, and in some cases disagreements can be a source of project failure. The third concerns psychology. Improved cooperation among MIs and stakeholders depends on attitudes and perceptions of individuals in charge of projects. When MI management considers civil society actors immature or otherwise unprepared for projects, it prefers not to involve them. However, the success of the GEF Small Grants Programme shows that collaboration with NGOs and similar organizations can be fruitful and worthwhile.

Most efforts of MIs are relatively fragmented and un-coordinated, and there is little medium- to long-term planning which enables projects to build on each other. Organizations and individuals tend to pursue their idiosyncratic objectives and agendas, and there is little systematic collaboration with other organizations. Although there are cases of coordination and collaboration, these efforts appear to be improvized rather than strategic, and they tend to depend on the initiative of individuals working within international organizations. To make MIs work as a system requires political will and funding. A sufficient number of governments would have to agree to establish and authorize organs of coordination and collaboration.

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As the case of the CSD shows, efforts to establish such institutions can fail to lead to synergies and multiplier effects. The CSD was designed to assume a coordinating function, bringing together fragmented UN efforts to promote sustainable development.31 In reality, sustainable development is promoted by numerous agencies within the UN system. Every organization establishes its own strategy and procedures, and there is limited central control and coordination. In the future, organs of collaboration could be established in specific areas where there is a clear need for collaboration; for example, in the area of climate change, where an international emissions market may be established that would require new mechanisms of monitoring and verification. All share the view that increased collaboration is a desirable target in light of the increasing complexity and cost of global problems. On the other hand, collaboration and coordination is not a guarantee for project success, and stakeholder interaction per se is not a panacea for improving the performance of MIs. The operational environment, efficiency imperatives and human psychology create barriers, which are hard to remove. This has given rise to calls for a more fundamental restructuring of international collaboration—for example, the idea to establish issue networks consisting of people within governments, the private sector, civil society and MIs who work long term on problems such as climate change, thus avoiding the problem of frequent personnel changes and political cycles that diminish the problem-solving effectiveness.

10.7 Barriers for the Successful Implementation of MI-funded Projects The major barriers for the successful implementation of MI-funded projects seem to be lack of adequate human resources at local level and the importance of involving stakeholders from across society, including those outside the energy sector, as these are ultimately the people who determine consumption. Cultural dimension of EE, with players who are quite different from those on the supply side, should not be underestimated. There should also be a distinction between sectors which have been liberalized and those which remain protected, such as tertiary public services and social housing, which need to be considered apart. 31

See Bergesen and Botnen 1996.

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Integration of EE in community sectoral policies: MIs should monitor measures such as R&D, taxation, state aid, public purchasing and cohesion policy so that they do not simply remain good intentions. While integrating, special attention should be paid to those citizens subject to fuel-poverty, especially from low-income countries. Technical and heating improvements to social housing should be made eligible for Structural Fund financing. R&D into EE matters should be developed, while bearing in mind that considerable progress can be made using the techniques and materials already available. Specific community energy policy measures like buildings, domestic appliances, fuel consumption of vehicles, informing consumers and professionals: These are essentially extensions of initiatives already in place. It is essential for MIs to monitor and evaluate initiatives that have been already launched, with emphasis on their implementation and without relying exclusively on government reports. Energy labelling is important and special attention should be given to it. This should increasingly become: z

z

An obligatory item of information on all products (including food) and constructions. Enabling the consumer to make purchasing choices based on energy.

Performance: Performance should be based on simple, familiar and nonbureaucratic system. Information and training should not be restricted by MIs to energy sector professionals alone, but should be extended to others, in particular to those working outside the energy field, such as architects, construction companies, property developers; planners and infrastructure managers but have a significant impact on EE. This is where a change of paradigm is needed as regards EE players. Information and training need to be provided as close as possible to the local level, as well as loud, clear signals at national and international levels to make citizens and stakeholders more receptive to the issue. Importance of local authorities: Local authorities are not yet given enough importance despite their role in developing EE propagation. They should be considered as places where local areas are made subject to proactive planning through urban development, land use, and traffic and transport plans. They are the only ones who deal with the traditional energy domains—buildings, transport and industry which are to be found under one roof. The way these are combined determines the energy performance of the local area.

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For example: z

z

z

How can solar panels be installed on roofs if the building permit does not allow such installation? How can low consumption areas be defined without the active involvement of local decision making bodies? What of plans for cycle and pedestrian routes and public transport?

Local authorities need to take initiatives to spread the concept of EE; time needs to be spent on informing and educating the general public to expand the current horizons, rather than rely on model towns and cities. They do not generally have adequate human resources to meet their everincreasing obligations. It is essential to appoint local teams to staff agencies, information centres and energy teams at local community administration level, particularly in countries with a tradition of centralization and planned economies, where their absence has a particularly damaging impact. These authorities are not sufficiently aware of others’ experiences and performance. It is essential to promote networking among them and their active participation in existing specialized networks as well as supporting the activities of such networks, on a national, regional and international level. Consumers: Close contact should be established with the citizens concerning everyday issues such as fuel-poverty through information, advice and support for initiatives, the creation of sustainable energy communities or energy forums: Investments should be made and public procurement of appliances, buildings, transport systems, services and infrastructure should be arranged, with the potential to strengthen the market in EE. Support from the consumers is essential if new kinds of initiatives are to be taken, new technical, logistical, communications and educational possibilities explored and good practices exchanged, and so on. However, the crux of the matter lies not only in the innovative or pioneering nature of initiatives but also in the widespread dissemination of tried and tested measures. Preparation of action plans: z

z

A regional and local section, including the measures to be taken at these levels to support initiatives. The drafting of local action plans to promote sustainable energy and combat climate change.

300 z

z

z

z

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Incentives to organize local energy forums to encourage the development of sustainable energy communities. Measures to encourage networking between local authorities at the national level. Support the formation and empowerment of local teams for the promotion of intelligent energy. Financial support mechanisms customized for different categories of consumer and which are as unbureaucratic as possible. Specific initiatives for households affected by fuel poverty. Legal urban planning provisions to promote intelligent energy.

Cooperation among countries: If the institutional mechanism in implementing the EE programmes has to be successful, there should be much closer and vigorous cooperation among majority of countries. The principal reasons for strengthening EE cooperation with third world countries are closely linked to the geopolitical and strategic interests of the developed countries and the business opportunities arising from them. A further reason is the contribution EE can make to economic and social development. Given the scarcity of energy resources and the limited spare production capacity, especially for hydrocarbons, it is obvious that energy importing countries increasingly become competitors for the same energy resources, for example, in Russia, the Middle East and the Caspian region. Therefore, EE is an issue in the interest of all energy importing countries and should be integrated into their global strategy for security of energy supply. Cooperation among developed and developing countries could be a useful tool for engaging them in climate action, while providing local benefits for insurance in terms of air quality and energy security, which are key concerns for a large number of developing countries. As the energy sector has to provide the lion’s share of the reduction targets, global climate change mitigation depends greatly on increased use of EE, renewable energy and other cleaner energy technologies in all countries. The first part of increased international cooperation on this issue can be among the industrial partners; particularly the Organisation for Economic Co-operation and Development (OECD) countries within the International Energy Agency (IEA) and can establish EE plans. At a later stage, developing countries could be encouraged to participate in these fora. The international financing institutions should pay greater attention to EE measures in their future financial and technical assistance operations to third world countries. Ways and means need to be explored on how international financial institutions can integrate EE considerations in all

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major investment projects. The fact that promotion of EE often passes through support for micro projects should not be an argument for these institutions not to engage themselves fully. Global lending facilities should be developed, and there is a need for more lending through intermediaries, for example, national agencies. The role of MIs is to make individuals and their political representatives aware of the urgency of improving EE. It is imperative for the environment, for the economy and for our health. Research is particularly vital to further improvements of the EE potential which will continue to grow as economies develop further.

10.8 Discussion and Conclusion In any analysis, we have to distinguish between the surface reality, captured for instance by statistics, and the deeper layers underneath these statistics. It feels safe to stick to empirical facts, uncovered through original research or by citing other sources. Still, there can be an impulse to peek beneath the data now and then. This is doable at a conceptual level, but when it comes to assessing an empirical phenomenon using imperfect data, there is a risk of skating on thin ice, in the worst case operating in the netherworld of conjecture. Consider the following example: Indicators of energy intensity measure how energy efficient a particular country is. Underneath the indicators are further layers of analysis, suggesting that inefficient energy use may be anchored in political and economic structures, in culture and psychology and in long-term practice. Exactly how these structures look, and what plays out in psychology and culture, is hard to judge. It is much more difficult to unearth these dimensions than to deal with tangible surface data on energy intensity. This discussion has direct implications for the work of MIs. These institutions not only have to overcome practical barriers in implementing their projects, but they also need to see below the surface reality in order to surmount more intangible political, institutional and psychological obstacles, which burden efforts to reform the energy sector and to promote sustainable development. If international civil servants define their task narrowly, they deal only with practical concerns, leaving broader, deeper or less tangible matters by the wayside. However, if MIs are to achieve lasting results in terms of promoting of sustainable energy, a deeper inquiry and

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broader involvement in tasks, such as developing civil society, transforming entrenched structures, and changing attitudes and behaviour cannot be avoided. Such tasks are inevitably much more ambiguous, controversial and complex than dealing with technical problems. Since it is difficult to assess the record of MIs in terms of the broader tasks and dimensions mentioned, it is tempting to focus the lens on the objects closest to the eye. The drawback is that we only see the tip of the iceberg, while the rest remains covered. To some, this may constitute a failure of the inquiry. To others it may be the only practicable way to conduct fact-based research. The trouble is that in many cases, the surface facts drawn from official statistics or reports of multilateral institutions are less trustworthy than a systematic inquiry into the rest of the iceberg. The limited ability to see the iceberg is not something unique to researchers. Many professionals working for MIs appear to operate with a similar vision in their daily work. The cause of this can be many things: a hurried tempo and overload of work, a limited vision provided by the particular academic training, lack of interest in what lays below the surface or simply because the tip of the iceberg presents itself first. To be fair, many professionals are aware of the larger context of their work, and their motivation is partly derived from this context, but at the end of the day, everyone is forced to direct attention towards practical, doable tasks, getting caught up with meetings, reports and other administrative details. Compromises are necessary to relieve the tension between space for inquiry and work output. At first sight, promoting sustainable energy may appear as a set of relatively straightforward technical tasks, but there are at least two complicating factors: The first has to do with the mission of MIs, which is not framed in terms of narrow technical objectives, but in very broad terms. There is much writing and rhetoric of how MIs are contributing to assist the transition and transformation process, how they are relieving poverty, increasing education, contributing to sustainable development and the like. On the one hand, this rhetoric creates expectations, which MIs are bound to disappoint. On the other hand, the broader rationale can be a motivating force, showing how each individual contributes to larger societal objectives. The second complicating factor is that seemingly technical tasks can become complex and multifaceted in light of the context in which MIs work. High performance in terms of promoting sustainable energy not only means to promote the right technical solutions and to follow professional standards in terms of project management and financial administration; high performance also means to navigate an ever-changing political, economic

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and cultural environment. An international civil servant performs multiple roles, including that of manager, expert and diplomat. To be successful, it is not sufficient to be capable in one’s field and position, as there are many add-on requirements in professional life: for example, one needs to be sensitive to cultural differences, capable of establishing and keeping trust, and skilled in developing relationships that last beyond the timeframe of a project. In conclusion, we may say that performance evaluations can focus on output, outcome, or impact measures, depending on how the project objectives have been formulated. If an evaluation takes place immediately at the completion of a project, it can hardly do more than measure outputs. Outcomes may become observable only some time after completion, and impacts may take years to materialize. Impacts can be understood narrowly as attainment of the organization’s strategic goals;32 alternatively, impacts can be defined more broadly as any positive or negative contribution to problem-solving, or any effect on the ‘balance of externalities’. Private capital mobilization (PCM) is not a standard criterion in project evaluation, but if it were, it could be an output or an outcome: As soon as financial closure is achieved (that is, well before the end of the project), it is possible to measure how much private money has been invested in a particular project (output); it is more difficult to measure how much private capital was mobilized over time (outcome). PCM should not be understood as an impact because it has no intrinsic merit. However, further research is needed on what impacts PCM has in terms of emissions reductions, commercialization or other impacts. In order to strengthen multilateral cooperation, it is necessary to take into account factors at different levels, such as the country environment, institutional differences and project characteristics. The conditions in transition economies vary significantly, and it is not easy to make general conclusions that apply to all countries. The same can be said about MIs. The UN is a very different institution than the World Bank, and both differ again strongly to the institutions affiliated with the European Union. Yet all of these institutions have been involved in promoting sustainable energy and it is worth learning from their experience. In light of these differences, the best approach is to focus on the common difficulties that institutions promoting sustainable energy have faced. The most common constraints appear to be external, outweighing positive factors. Many projects are hampered by deficiencies in governance, including 32

Nichols and Martinot 2000.

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arbitrary interventions, red tape, corruption, neglect of environmental problems, bureaucratic fragmentation and lack of awareness—to mention just a few of the most common barriers. A key conclusion from the analysis is that although there may be technical blueprints that MIs can apply to all countries, there are no blueprints for the design of projects. What works in one country does not necessarily work in another. Therefore, each project needs to be developed anew with reference to the implementing institutions and the framework conditions in a particular country. All participants need to have a stake in project development and agree on steps to be taken. One of the core themes is the problem of simplicity versus complexity. Promoting sustainable energy involves relatively straightforward tasks. Both the problems and solutions can be understood and addressed. This simplicity, however, belies the fundamental complexity of promoting any type of change in modern societies, even change that involves win-win outcomes. This problem applies to countries in transition as much as to industrial and developing countries. Thus, the main challenge may not consist in developing sustainable energy projects. The main challenge is to promote change in complex political, economic and cultural systems. The practical tasks at hand, like developing a clean power plan, would be relatively easy if they could be undertaken in a laboratory environment, but in the real world, there are additional layers of complexity. In a narrow sense, international civil servants are problem-solvers focusing on sustainable energy or other objectives. In a broader sense, they are also diplomats working in a risky and changing environment, where small decisions can have large consequences. If projects and programmes of multilateral institutions fail, it is usually because the people involved in a particular effort are overwhelmed by the of the environment in which they are working, not because there is a lack of expertise or ability in the particular field of operation. The performance of organizations therefore is strongly linked to the capabilities of its members in terms of navigating this complex environment, not only in terms of their technical skills.

Epilogue

Road to a Sustainable Future: A Systematic Understanding of Energy Efficiency and Climate Change

Human beings influence the climate through many activities. Though technological solutions exist, inefficient practices adapted by social, economic, informational and institutional actions hinder their penetration. We also believe that policies do have the required leverage to influence the energy path and a significant reduction of energy consumption levels can be achieved if such policies are promoted. Active intervention in markets and private capital mobilization are critical complements to policies. For students, policy makers, researchers, practitioners and all those who have interest in a sustainable future, a roadmap, based on energy efficiency, has been outlined here to attain sustainable development. A broad, in-depth and systematic understanding is attempted keeping the approaches simple, fundamental and promising. Although the reader is challenged to create a new knowledge by critically adapting his/her own experiences to the relatively complex contents of previous chapters, the central messages are provided here.

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E.1 Accelerating Technology Solutions It is important to accelerate technological diffusion and to get consumers to pay attention to climate change issues. A sustainable energy future cannot be understood in terms of technology alone. A strong interaction exists among energy, economy, environment, technology, geopolitics and sustainability. However, for a sustainable energy future, technological solutions are at the heart of an energy efficiency approach. Technology is the primary means to increase efficiency by increasing useful output or decreasing waste per unit input, that is, maximizing energy utilization. Other managerial measures of efficiency improvements are secondary and cannot achieve much without higher technological efficiency underneath. Energy is embedded in many aspects of human life and its efficient utilization is important from a variety of viewpoints, for example, energy–environment linkage. Energy production and use account for nearly 50 per cent of the human-caused increase in greenhouse gases (GHGs) in the atmosphere. Acid rain and air pollution are further side effects. It is estimated that, by using the most advanced technologies, a CO2 reduction of about 50 per cent is possible until the year 20501 and that the‘(…) average equipment used in the household sector in European Union (EU) countries is 50 per cent less efficient than the best equipment currently sold’.2 For all humans valuing future lives this is a key argument. Looking at current energy use trends and resource reserves, the main question is not about the period of depletion of coal, oil and gas stocks, but about the substitution by a combination of alternative energy sources, efficient technologies, lightweight materials and other advanced technologies. This approach requires action across all sectors of the economy, from electricity and transportation to agriculture. The successful development of these technologies requires substantial new investments in research, incentives for producers and consumers and emission reduction requirements to drive innovation. Governments at all levels need to encourage short-term action to reduce emissions while laying the groundwork for a longer-term technology revolution. In recent years, a number of trends have accelerated the utilization of energy-efficient technologies. ‘Technology push’ programmes, supported by subsidies, have created niche markets for otherwise expensive renewable 1 2

Martinot 2000. EC 2000, 142.

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energy technologies in many developing countries. While the quantitative impact of these systems may appear quite small, analysts argue that the most significant achievement of the renewable energy programme is the creation of domestic capacity that could sustain renewable energy markets in the future.

E.2 Geopolitics and Global Energy Security Understanding of energy security relies on geographical diversification of energy supplies, sources and stability of prices. Since the extraction and burning of coal started, energy is powering the world economy. Depletion of stocks and global energy supplies make countries vulnerable to disruptive events, no matter where they take place. The first oil crisis of 1973 or the invasion of Iraq in 2003 exemplified the consequences for nations when energy supply became uncertain. Therefore, national security must be interpreted in terms of economic vulnerability, which is linked to dependence on energy. Although energy security focuses on energy vulnerability rather than on energy imports, there may be economic and political incentives to reduce energy imports. As fears about the stability of the world’s energy resources grow, policy makers may integrate these security concerns into the climate change policies. If policy makers promise incentives for domestic energy sources and discourage energy imports, they have to choose different climate policies. In addition to the inefficiencies in carbon abatement policies, there may also be a global inefficiency associated with a country’s energy imports and exports. If governments seek to minimize their own costs rather than the world’s costs, they may choose substantially different abatement policies than are assumed in most climate change studies. Whether a country agrees to a target for a given amount of carbon abatement (focusing on quantity) or to reach a given marginal benefit associated with carbon abatement (focusing on the carbon price), it has an incentive to choose policies that deviate from those which would minimize world cost. Rather than simply abating on the basis of carbon intensity, the country may cut emissions more with those imported fuels and less with exported ones. This shows that climate change can be a geopolitical problem and the potential ramifications of its impacts on security are significant. Under these circumstances, a stage can be set for intense competition for resources among countries seeking to secure their energy supply by diversifying

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sources and areas of origin. The spatial politics of reducing GHG emissions should be looked into through an overview of the positions of the main actors in negotiations on the United Nations Framework Convention on Climate Change (UNFCC). These positions cannot be understood merely as the product of rational choices made by disembodied states. For this, a subaltern and class-based view of climate geopolitics is necessary that stresses on a local and social problem as much as it is a global environmental problem is necessary.

E.3 Improving Theories and Models There is a need for strategies to refine the models on which policies and programmes are based. That results from analyses and an understanding of past and current assumptions underlying energy efficiency and climate change approaches. Models of the world at the end guide actions upon the world. Careful and continuous refining of models should be an obvious task to any responsible thinker. Refining models hold potentials for new actions. This holds true for climate change models as well. Analyzing and understanding models—their logic and method—and to propose counterarguments for every argument is a fundamental precondition for refining existing ones and therefore policy programmes and actions. Several models on different levels of detail exist in the climate change field. We discuss some. Actions on climate change. Whether, how and when to act on climate change is an ongoing debate. Clashing positions represented by sceptics and supporters of action on climate change are built around different assumptions about the need for more scientific knowledge, alternative explanations of climate change, the precautionary principle, trade-offs of costs and benefits of climate change. Climate change mitigation. At the heart of climate change mitigation lie assumptions about costs. These assumptions are inputs into environment– economic models as well as economic decision support systems in view of energy efficiency investments. Estimations of net economic costs vary from a high value to zero depending partly on assumptions about discount rates. Irving Fisher’s time-preference theory of interest shows that discounting is related to how much value one places on current relative to future lives. The scenario envisaged by Nordhaus (1991) serves as an example: a discount rate of 4 per cent suggests that at an efficient level of tax is USD 2.44 per ton of carbon; the result would be a less than 5 per cent decrease in emissions compared to business as usual. A discount rate of zero, however, suggests an

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efficient tax of USD 65.94 per ton of carbon which would lower emissions by one third.3 Consumers as well as business and industrial organizations evaluate the cost effectiveness of energy efficiency (EE) measures. Most consumers make investment decisions without direct reference to discount rates and discounted capital flows. Business and industrial organizations often use rates of return or payback period for evaluations. However, often more stringent investment criteria are applied to EE investments than to production investments. Governmental intervention. The justification of governmental intervention is partly based on the existence of market barriers to the introduction of EE measures and technologies. The extent to which the non-application of efficient technologies can be dedicated to market failures is under dispute. Some argue that the freedom of the consumer to choose products depending on the lifestyle convenience is also responsible as people stick to conventional technologies regardless of EE indicators of alternatives. Techno-economic models of technology diffusion assume rational and comprehensively informed consumer decisions. The challenge of reconciling government and free market contributions with regard to the energy market and EE remains. More empirical certainty could increase the effectiveness of both—policy and market-based mechanisms.

E.4 Survival Strategy For a successful diffusion of EE measures it is important to understand attitudes, behaviour, consumer preference and ways to change them. Underlying every policy, legislative proposal, programme and economic model is a set of assumptions about how organizations and individuals behave and change. Hence, it is important to review the current assumptions and ‘common knowledge’ underlying energy and climate change approaches and discuss emerging strategies to refine the models on which policies and programmes are based. Studies of consumer preferences reveal that often non-energy benefits motivate decisions to adopt energy efficient measures. Those include: (a) improved indoor environment, comfort, health, safety and productivity; (b) reduced noise; (c) labour and time savings; (d) improved process control; (e) increased reliability, amenity or convenience and (f ) direct and indirect economic benefits from downsizing or elimination of equipment. Further, technology appeal was found to be important. 3

Nordhaus 1991.

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These non-economic motivations dominate the decisions primarily of high-income groups. Modern and fashionable technology designs appeal to consumers and there is a higher probability of consumers purchasing the technology. Behavioural theory suggests real world programming to speed diffusion of innovation. For greater diffusion of EE measures, it is important to combine the understanding of social norms with network analysis and map social chains of communication and power which can help policy makers catalyze voluntary behaviour changes more quickly. Education and information can accelerate citizen awareness and empower people to act. However, the truism that ‘knowledge is power’, while encouraging the sharing of information, tends to overlook the complexities of effective communication that can successfully move people to action. Even if there is a broad agreement that behaviour, choice and human action are key to affecting climate change, it’s another thing altogether to actually incorporate behavioural change into EE policy and programmes. There are real questions about whether we know enough about behaviour to see it as a reliable resource. Can behaviour changes result in persistent savings? How do ‘behavioural’ interventions such as social marketing (that rely on voluntary action) compare to traditional ‘technology’ programmes (that often involve subsidies)? Can the behaviour and technology approaches exist side-by-side, or should they be integrated? Should they be evaluated by the same standards? Does better understanding of behaviour force us to rethink well-tooled energy planning concepts, such as ‘free ridership’, ‘non-energy benefits’, ‘market transformation effects’ and ‘spill-overs’? What are the barriers to improved behavioural interventions as well the traps and perverse disincentives found in current (and emerging) markets? How does concern about global warming change this picture? To find answers to these questions, one has to probe the opinions, attitudes and preferences of individuals. It should look at public opinions and attitudes about energy efficiency and global warming, how they are changing and the conditions under which changes in attitude are likely to translate into climate-positive actions. We should also explore segmentation analysis— especially what it reveals about the different ways people respond to policy and programme communications—and suggest new approaches needed to move beyond ‘preaching to the choir’.

E.5 Individual Interests Versus Societal Interests Diffusion of EE measures depends mainly on human interaction for acceptance and behaviour.

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Energy efficiency investment has effects of society-wide interest that can be used by policy makers to catalyze voluntary behaviour. In a free market, customers will get the best price and can buy only the goods and services they wish to buy. However, the free market approach only works if the market for efficiency is structured in such a way that customers can actually express their desire for EE through purchases. This type of market structure does not exist in many parts of the world. EE measures can help to restructure and revamp the existing relatively small market for energy efficiency products into a free market. EE measures can create significant employment opportunities too. New jobs can be created especially in manufacturing and construction sectors. This is particularly the case where EE projects can demonstrate positive impacts for social groups currently disadvantaged in the employment market, for example, those with low skills and fewer qualifications, living in economically deprived areas with energy starved conditioning. In case of societal interests, EE measures cannot help reduce pollution levels, but can provide significant benefits for local economies. If expenditure on energy is reduced, the savings will improve the performance of the local economy via the ‘multiplier effect’ to the extent the savings are spent in the local economy. The multiplier effect is an economic phenomenon characteristic of all economies, relating the spending and re-spending effects of money on the output of local economies. Also, the expenditure on energy efficiency improvements itself will improve the local economic performance because the materials and labour for those improvements are likely to come from the local economy. In today’s global markets, economic growth is synonymous with efficient energy production, delivery and use. It enables increased output from power transmitters, electrical cables, motors and production units. On the supply side, it is no coincidence that energy production and delivery efficiency is higher in more developed economies.

E.6 Leveraging Past Lessons for Future Action To be successful in an EE approach to a sustainable energy future we need to learn from past experiences. The success and effective period of energy efficiency programmes depend on the circumstances of each programme. However, there are lessons from past energy efficiency programmes which can serve as general guidelines. Focus on people. One of the main lessons to learn is the need to focus on people. Individuals and local organizations that help support a programme

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during its lifetime and their motivation and commitment to programme affected by direct and indirect benefits need to be addressed. As a diverse group of stakeholders (government officials, project managers, non-profit organizations, community groups, project participants and international policy makers) are involved in EE programmes, looking at the perspectives of various actors should help improve the credibility of the programme as well as facilitate the review of EE programmes. Collaborate. From a governmental perspective, programmes addressing the business sector are found to be most effective if taking place in form of collaborations, thereby, supporting investments in financial infrastructure. Some successful models have included financial support to help businesses to switch to more efficient systems. Energy service companies, leasing programmes, guarantee funds and insurance mechanisms are some such models which can play a critical role in the phase of transformation. Focus on areas and mechanisms of high effectiveness. Governmental programmes need to analyze sectors carefully to find out where the sources of high effectiveness for EE measures lie. The Clean Development Mechanism (CDM) has attracted considerable private sector interest. The mechanism has the potential to become a powerful instrument for foreign direct investment and technology transfer. Private sector involvement in the CDM is successful as it is project based and inherent risks are reduced by assured credits, minimum overheads, flexibility, transparency and simplicity, an appeal mechanism and stability. Evaluate options and develop institutional and technical capabilities. At the country level, critical steps for successful government-driven programmes are (a) to identify and evaluate various efficient options; (b) to develop specific investment projects and related institutional designs for selected policy options; and (c) to strengthen the institutional and technical capabilities. For the EE programme to become successful the following conditions have to be met: (a) significant energy savings; (b) be cost effective; (c) be comprehensive; (d ) achieve all cost-effective savings available in each customer interaction; (e) be preferably large scale; ( f ) create EE capability as well as capture present savings; (g) be monitored and evaluated; (h) provide continuous improvement and (i) pay particular attention to prevent lost opportunities. Include non-price factors. Often consumers do not base their investment decisions solely on price. Many considerations play a role in the consumer’s decision making, such as education, social status, convenience, feeling of competence and interest in new technologies as well as health and safety concerns. To be successful, EE programmes need to include other non-price

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factors such as awareness about environmental issues, energy consumption and on how to control and reduce energy waste.

E.7 Integrating Climate Policies with Development Priorities Development vs. Environment In the interest of global sustainability and moving on to environmentally more desirable paths, the concept of economic and social development should be the top priority for developing countries. This means that the issue of climate change must be viewed through the lens of human development. The challenge for such a type of development is the practical question of choosing sustainable pathways that provide food and energy security, employment opportunities and at the same time minimize environmental impacts. Instead of focusing attention on policies to reduce climate change risks, the starting point should be development issues that are vital the economic development and how this can be achieved in an environmentfriendly manner. This means that environmental policies should be derived from development priorities. This needs a conceptual framework that places sustainable human development before climate change by reversing the existing framework. For that one has to find out alternative and cleaner pathways to achieve sustainable development goals that can also contribute to climate change goals. To achieve this objective, one has to reframe the global climate change debate as deriving from and complementing development priorities which can be approached at multiple levels and from various perspectives and should take into consideration the rapid economic growth to be achieved by developing countries. There is also the need to build scientific and technical capacity, advance scientific knowledge, and linking economic, social, technological perspectives with policy making. This ‘reversal thinking’ should map development, equity and vulnerability on to GHG emission problem. The determinants of this include financial resources, technology and importantly the availability of trained persons to use them effectively. Access to information and institutional mechanism (legal, social, and so on) is also important. For developing countries, climate change remains marginal to the pressing issues of poverty, natural resource management, food security, energy needs and access to modern transport or land use that takes into consideration development, equity and vulnerability and capture the

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attention of leading stakeholders. Presently, the cooperation efforts and analyses of climate change policies have been driven uniquely by concerns of the developed countries. From this perspective, related ancillary benefits in energy efficiency, and health impacts of local air pollution may be significant and promote actions, but they are only of secondary importance in that they may reduce the total costs of compliance with climate change commitments. Such an approach will have limited success in developing countries. The challenge then is to have integrated development and environmental policies so that the developing countries can stay on the path that minimizes the local and global environmental costs of relieving poverty, providing adequate food, supplying electricity to households and industry, and providing employment and transportation facilities consistent with the needs of the people of developing countries. It may not be easy to reframe global environmental policies as deriving from development priorities and solve the climate change problem. However, this new framework suggests that global collaboration on climate change should be approached at multiple levels through local and national development projects as well as through multilateral efforts to establish cooperation mechanisms within an equitable and efficient global climate change regime. According to this approach, a less-polarized way of meeting the challenges of sustainable development and climate change is necessary to build environmental and climate policy upon development priorities that are crucial to the billions of people from the developing world. For example, international financiers should prioritize projects that have a low financial cost per unit of GHG emission reduction, while national stakeholders are keen on national benefits of the activity in the form of employment generation, social development and local environmental improvements. Following that, it will be relevant to measure multiple financial, economic, social and environmental benefits of mitigation policies and then negotiation can take place between national stakeholders and international financiers to develop a portfolio of policy options that balance sustainable development and climate change policy priorities. Another issue is that of generalized methodologies. The parameters that are included in the models vary significantly by nation and region, and with time. Hence, it is important to develop localized models of environmental impacts, population exposure, preferences and valuation. This type of methodology is useful in understanding synergies and trade-offs between global and local environmental policies. Research is required on inter-linkages between sustainable development and climate change policies.

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However, a number of barriers—technical, financial and capacity—exist for implementing these initiatives.4 Barrier removal is an essential part of technology transfer and efficiency improvement. In this regard, governmental sector participation in technology diffusion should be seen as a way of obtaining economic, environmental and social benefits of clean technologies since private sector cannot be expected to bear the full transaction cost for barrier removal. To achieve this, policy makers need to design appropriate policy measures to promote cleaner technologies. There are also chicken and egg problems facing energy efficiency and renewable energy technology (RET) markets. On the one hand, the capital markets will not finance RET projects in the absence of a sufficient volume. On the other, the market for RET projects will not develop to be of a sufficient volume in the absence of adequate financing. Such issues have to be addressed. An innovative financial, institutional and implementational mechanism is needed that can support such integrated objectives. If such an approach were successful in altering development paths, the climate benefits will be substantial. In fact, the scenarios of the Intergovernmental Panel on Climate Change (IPCC) suggest that the type of development path taken by a country is more significant in terms of longterm emissions than explicit mitigation measures.5

E.8 Policy: Reflections and Future Directions There is a need for using sustainable development as a framework for climate change policies. Regarding the principle of sustainable development, creating a system and making it acceptable to all is of paramount importance. This creates a huge ethical problem. A rich person in a developed country can complain bitterly about the way poor countries allow their environment to be destroyed by economic development. On the contrary, a poor person in a developing country, ever uncertain of his next meal, health care, education, will rejoice at any improvement in the situation, and is unlikely to be concerned about damage to the environmental damage unless it affects his livelihood. How do we balance the short-term benefits of the population with the long-term interests of preserving the environment? In such a situation, the framework that is developed should reflect the needs 4 5

Reddy 2003. IPCC 2007.

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of developing countries and provide a constructive basis for combining the policies of local development and global climate change. For the implementation of such a framework the international climate change policies should be linked to sustainable development. There is also a need for a more systematic assessment of various institutions, market instruments and regulatory frameworks that can be used to support the implementation of these policies. A goal to ‘stabilize world climate’ is misplaced, not to mention its unattainable nature. Climate is a dynamic system within which extreme events and dramatic changes will always occur, irrespective of human actions or preferences. It is widely agreed that the climate is changing but its future trajectory and impacts on the environment and society remain uncertain.6 There can be little doubt ‘(…) that man is capable of influencing the climate through human activities of many different kinds’.7 Although a matter of some debate with regard to the data reliability, the curve of the global mean temperature has been rising since 1861 and although no single explanation for global warming can be given the greenhouse effect is a plausible one. This effect is attributed to the GHGs CO2, CH4, N2, O, O3 and FCCs.8 The clash between sceptics and supporters is likely to endure, and may even become more pitched as the stakes on climate change are raised. The expansion of scientific knowledge is unlikely to end the debate, as each side will get more data to confirm their case. Sceptics will continue to assail supporters for blending science with environmental activism, and supporters will maintain their doubts about the scientific credibility of sceptics because of their likely links to vested economic interests. Regardless of who is right in this debate, each side is valuable to the other. Like any democratic set-up, a vocal group of contrarians is necessary to achieve scientific progress, since it forces supporters to improve their science and vice versa. It is necessary to point out the flaws in assumptions, logic and method, and to propose counter-arguments for every argument. The problem is not the scientific controversy, but the way in which science is used by economic and political interests, and the risk that scientists could become pawns in a high-stakes political game. Development may well be a better strategy for reducing the impacts of climate change than focusing on CHG emission reduction. Developing countries, with less ability to prosper, afford and use new technologies, 6

Heal and Kriström 2002, 3; Santamouris 2001, 22. Santamouris 2001, 19. 8 Ibid., 25. 7

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have higher rates of hunger; poorer public health services; greater incidence of infectious and parasitic diseases; less access to education, safe water or sanitation; and, therefore, greater mortality rates and lower life expectancies. It is a proven fact that there are a large number of ‘no-regret options’ waiting to be exploited. These options have the potential to be welcomed by sceptics, supporters as well as neutral observers as they provide the dual benefit of economic improvement of the masses and climate change mitigation, a concept of win-win situation. Hence, the resources that are spent on emission reduction for the sake of avoiding impacts are better spent on vulnerability reduction in developing countries. This approach would enhance societies’ abilities to cope not only with climate change but also adversity in general, regardless of its cause, or whether it’s man-made or not. Such a multifaceted and holistic approach would help to improve the lives of people living in poverty, without compromising the ability to address future challenges, whether caused by climate change or something else. To compare the two strategies to reduce the impact of climate change, one has to address the trade-off between environmental protection and development in general, or even between emission reduction and development aid. In a narrow sense, cutting emissions helps alleviating malaria and water shortage. In a broader sense, the same money can be spent differently and directly to alleviate malaria and water shortage even more effectively. Only by considering the broader question we can decide how much effort should be expended on development vis-a-vis GHG emission abatement. The main problem lies not with the principles advocated by such approaches per se, but rather the structural barriers that have inhibited local actions towards achieving higher energy efficiency levels. The main barrier is the difference in approaches—growth-based and development-oriented. Another key barrier is the political and institutional context within which the energy development agencies operate. As communities do not function in isolation from the wider spheres of power and decision-making, much of what can be achieved through local actions can only be sustained, institutionalized and scaled up by removing the obstacles at the local, regional, national or international levels. One should also recognize and act upon the need for strategic alliances and partnerships among various actors, namely, central and local governments, NGOs and civil society organizations, local communities and households and the private sector. It means addressing energy development, environment, poverty, social justice, equity and gender issues as parts of the same political process of development. It involves bridging the gap between carefree selfishness in degrading the environment and changing

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attitudes—reduce–recycle–reuse (R–R–R). This strategy will have positive impacts not only on the quality of life but also on the resources and the environment. The climate negotiations will succeed only if developing countries are driven by development priorities, and if there are countries or groups of countries among them willing to take a leadership role to push the process forward. In the absence of leadership, even well-intentioned players remain uncoordinated, which increases the transaction costs. Hence, the issue of climate change should be approached at multiple levels through local, national and international development projects as well as through multilateral efforts to establish cooperation mechanisms within an equitable and efficient sustainable development regime.

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About the Authors

B. Sudhakara Reddy is a professor at the Indira Gandhi Institute of Development Research, Mumbai, India. He is a Member of the Editorial Committee on Energy Efficiency, Switzerland. He has also served as Expert, Evaluation of projects on Renewable Energy–FP7 Programme, European Commission, 2007; Member, Expert Appraisal Committee for Thermal Power and Coal Mine projects; Ministry of Environment and Forests, Government of India; Member, Board of Management, Indira Gandhi Institute of Development Research, Mumbai; Member, Research Advisory Committee, Institute for Global Environmental Strategies, Hayama, Japan; Member, Working Group on Energy Efficiency and DSM for formulation of 11th Five Year Plan (2007–2012), Planning Commission, Government of India; Member, Network of Advisors, Linx Research, New York, NY 10022; and Executive Committee Member (2004–2006), Indian Society for Ecological Economics (INSEE). Gaudenz B. Assenza is the lead author and project director of the research programme on ‘Energy and Climate Change’, 2001–2006 at Palacky University, Czech Republic. He is also the lead author and project director of the research project ‘Best Practices of Multilateral Institutions in Promoting Energy Efficiency’, 2001–2002, ext. 2002–2005, UN Foundation, USA and Fridtjof Nansen Institute, Norway. His publications include 5 Country Studies published by the United Nations: New York and Geneva, 2004–2020. He is the Member of UN Experts Group, ‘Energy Efficiency Investment Project for Climate Change Mitigation’ (ECE-CIS-99-043), 2000–2003, UNECE, Geneva. He is also a lecturer, Central European Studies Program (CESP), at Palacky University, since 2003, teaching ‘The Politics of the Environment in Central and Eastern Europe’.

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Dora Assenza is a senior lecturer of economics, Palacky University, Olomouc, Czech Republic. She is also a faculty member, teaching Environmental Economics at Valdesta State University, Georgia, USA. Franziska Hasselmann is a post-doc scientist at the Geography Unit, University of Fribourg, Switzerland and a visiting scientist at the Swiss Federal Institute for Forest, Snow and Landscape Research, Switzerland.

Index

actors in energy efficiency, 90, 92–93 functions of, 97 influence of actors and factors, 96, 98–99 actor–factor influence linkage state, 98 inter-relationships among actors, 93–94 level of, 94–95 macro level, 96 meso level, 96 meta level, 96 micro level, 95 perspectives of, 117 business perspectives, 120–128 consumer perspective, 132–136 governmental perspective, 117–120 society perspective, 131–132 role of actors, 99–100 factors fostering implementation of EE programmes, 101–102 Agenda 21, 188, 193 alcohol fuel programme, in Brazil, 71–72 alternative sources of energy, development of, 14 Annex I Countries, 33, 36, 195–198, 200, 203, 206, 209 ARPANET, computer network, 232 Asian Development Bank (ADB), 72, 96, 136 Asia-Pacific Partnership on Clean Development and Climate (APPCDC), 210–211 barriers, 3, 18, 23, 25, 26, 64, 78, 83. See also energy efficiency, private investment in defined, 152, 153 Black Triangle, 7

Brundtland Commission. See World Commission on Environment and Development (WCED) cap and trade. See emissions trading Central and Eastern European (CEE) region energy supply in, 6–7 environmental damages in, 7 life quality in, 8 certified emissions reductions (CERs), 203–207, 210 China’s CDM, study on, 72 Clean Development Fund (CDF), 205 Clean Development Mechanism (CDM), 28–29, 67, 72, 123, 203–210, 212–213, 312 clean technology project, cost benefit of, 73 Clear Air Initiative (CAI-Asia), 72 Climate Action Network (CAN), 67, 72–73 climate change. See also win-win climate policy alternative sources of energy, need of, 14–15 annual frequency of natural catastrophes, trend in, 45, 47 climate realists, views of, 52–53 per capita emissions by Annex 1 and non-Annex 1 countries, 52 recommendations to financial institutions and governments, 53–54 and concept of energy efficiency, 15 economic and insured losses, trend in, 45–46 and energy sector, 13–14 issues of difference, between sceptics and supporters, 49 alternative explanations of climate change, 49

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benefits of climate change, 51 precautionary principle, 50 scientific knowledge, 49 trade-offs, 50–51 projected climate change impacts, 45, 48–49 sceptics views on, 39–43 supporters of action on, 44–45, 56 great weather-related disasters, 45 climate change mitigation calculation of cost of, 56–58 discount rate, application of, 58–61 integrating climate policy into development policy, 70–74 market-based climate policy, 65–70 win-win opportunities for, 61–65 coal, 4, 307 consumption in Asian region, 5 discovery of, 4 global warming and use of, 13, 68, 117, 118 co-benefits, 71 Commercialization, 215–216 clean energy technologies and, 231 concept of, 216–219 diffusion process, 219–221 and clean energy technology, 220 technology diffusion curve, 220 of Internet, 233–236 Luz International Limited (LUZ), case study on, 216, 226–227 process of, 221–227 compact fluorescent lamps (CFLs), example of, 223 EETs and, 223–225, 227–231 and environmental policy, 222–223 technology commercialization model, 222 public sector money and, 216 Conference of the Parties (COP), 35–36, 188–189, 195–196, 199, 200, 208, 212 corporate environmentalism, stages of, 124 Cost effectiveness, 164–165 Designated Operational Entity (DOE), 203, 205–206 domestic financial institutions, 279

drivers, 26, 178. See also energy efficiency, private investment in definition of, 152, 153 examples of awareness of EETs, 178–179 compact fluorescent lamp (CFL) case in Hungary, 181 decrease in technology price levels, 179 environmental regulations, 180 increase in energy prices, 179 non-energy benefits, 179–180 technology appeal, 179 Dynamos or Dynosaurs: Multilateral Institutions at the Turn of the Century, 292 Economic development, and energy use, 1 emission of CO2, 13, 20, 38, 52, 53, 72, 117, 118, 126, 197 emissions trading, 65–66, 209–210 Emission Trading Scheme (ETS), 67 employment benefits in EU countries, 131–132 Energy Charter Treaty (ECT), 190–191 energy efficiency (EE), 3, 15, 29–30, 113–114, 151, 214. See also actors in energy efficiency actor-oriented approach (see energy efficiency, private investment in) actors in field of, 90, 92 consumers, 93 equipment manufacturers, 92–93 non-governmental organizations (NGOs), 93 public policy institutions, 92 benefits of, 114–116 for business establishments, 122 business opportunities and market growth, 129–130 environmental impacts and, 116 potential savings due to increase in demand-side efficiency, 126–127 potential savings due to increase in supply-side efficiency, 125 potential savings due to other options, 128 and climate change, 19–20 concept and definition of, 77–78

INDEX 345 cost effectiveness of, 18–19 drawbacks to, 139–144 EE potential, characterization of, 83–84 externalities in, 144–148 negative externalities, 147–148 positive externalities, 144–147 and financing of climate change projects (see finance and investment, for EE projects) governmental intervention in, 82–83 international efforts on, 186–193 inter-relationships among actors in, 93–94 need for, 15–17 policies, 100, 103–105 features of energy sector relevant to policy, 103 research and development (R&D) in EETs, 104 and research environments, 104–105 reasons for promoting of, 78–81 rebound effect and, 81–82 role of organizations in (see multilateral institutions (MIs), role in EETs) spread of, 215 technology, role of, 89–90 technology choices for private sector investment in EE, 91 energy efficiency gap, 3, 84–89 EE and economic efficiency, 86–87 individual consumer’s energy-related decision making, 85–86 institutional energy-related decision making and, 85 investment behaviour of firms, 86 market-related barriers and, 85 and modelling of consumer behaviour, 88–89 payback gap problem, 86 risk issues, 88 role for policy measures, 87 transaction costs, 88 energy efficiency, private investment in barriers in, 153 and analytic taxonomy, 157–164 characteristics of, 153–154 classification of, 154–157

and result of barrier, distinction between, 154 role of actors, 158–159 causal model of private investment decision, 164–165 causal linkages, 170–171 causal pathway in, 168 dependent variable in, 167–168 factors affecting private investment, 166–167 independent variable in, 168 structure of causal model, 165–166 variables in causal model, 172–175 drivers in, 153 overcoming barriers, process of, 176–178 risk in, 153 energy efficiency projects, 138 and benefits to various stakeholder, 141 development of, 136–137 international funding for, 136 methodology for selecting of, 140 requirements for, 138–139 selection criteria, 139 energy-efficient technologies (EETs), 3, 17, 25, 82, 85, 86, 90, 151, 214–215 commercialization of (see commercialization) energy policies, to promote EE, 23–27 commercialization of EE technologies, 25–27 flow-on benefits, use of, 23–25 Energy Savings Insurance (ESI), 261 energy security, 7, 12, 17, 115, 118, 300, 307 Energy Service Companies (ESCOs), 244, 251, 253, 258–260, 265–267 functions of, 252 international ESCO and local partner, 252–253 role of, 251 energy services, 16 Energy use in ancient times, 4 and climate change, 2, 13–15 and demand in world regions, 5–7 discovery of coal and, 4 and economic development, 1 energy efficiency (EE) investments, 3 in steam engine, 5

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understanding of, 2 by year 2030, 5–6 equipment vendors, 278 The European Bank for Reconstruction and Development (EBRD), 28 European Science and Environment Forum, on global warming, 41 European Union (EU), 28, 36, 66, 67, 75, 90, 104, 131, 197, 210, 290, 306 and climate projects, 28 employment benefits due to EE, 132 on energy efficiency, 192–193 feasibility barriers, 158 finance and investment, for EE projects, 239–241 financial viability of EE projects, 248–249 financing channels, 262 banks and ESCOs, relationship between, 265–267 cost of financing, 267 private financing, 263–265 sources of financing, 261–263 financing environment business climate, 268 energy market conditions, 268–269 policy and regulatory environment, 268 venture economics, 269 financing methods, 256 aggregating individual projects into large programmes, 257 attracting local financial institutions, 257 ESCOs, 258–259 ESI, 261 guarantee fund, 259–261 soft financing, 257–258 standardization of fragmented market, 256–257 forms of making EE investments, 254 direct investment, 254 issuing of bonds, 255 leasing, 255–256 multilateral and bilateral development aid, 256 performance contracting, 255

recourse financing, 254–255 macro perspective, 243–247 micro perspective, 241–243 risks in financing, 247–248 role of financial institutions ESCO, 251–253 international institutions, 250–251 local financial institutions, 250 Fisher’s time-preference theory of interest, 60, 308 fossil fuel, 2 depletion of, 16 and emission of greenhouse gases, 19–20 geopolitical strategy of United States (US), 12 geopolitics of, energy industry, 12–13 Global Climate Coalition (GCC), 43 Global Energy Efficiency and Renewable Energy Fund (GEEREF), 189 Global Environment Facility (GEF), 34–35, 118, 137, 176–177, 189–190, 253, 265, 295, 296 cost effectiveness, definition of, 165, 169 on ESCOs, 253 global externalities and, 144 global warming, 2, 13, 34, 44, 49, 82, 116, 130, 211, 310, 316 sceptics on, 40 global warming potential (GWP), 197 Gothenburg Protocol, 184 Green Domestic Product (Green DP), 22 greenhouse gas (GHG) emissions, 306 and climate change, 2, 13 developing countries and, 14 fourth assessment report of IPCC on, 37–38 human activities responsible for, 14 and Kyoto Protocol, 36, 197 Greenhouse Wars’, 43 Helsinki Protocol, 184 Human Development Index, 16 Indian Renewable Energy Development Agency (IREDA), 249

INDEX 347 Indira Gandhi Institute of Development Research (IGIDR), 117 industrial ecology, 120 innovation, 217–218 institutional barriers, 155 insulation mortgage, Netherlands, 133 Intergovernmental Panel on Climate Change (IPCC), 33, 38, 58, 190, 213, 315 First Assessment Report, 33 fourth assessment report, 38–39 Second Assessment Report, 35–36 Special Report on Emission Scenarios (SRES), 37 Third Assessment Report, 37 Working Group I, 37 Working Group II, 37–38 Working Group III, 38 International Energy Agency (IEA), 8, 58, 64, 205 estimations on fuel share in energy investment requirements, 10 share of energy investment by region, 10–11 on world energy investment, 8–10 on world-wide electricity demand, 10 International Energy Efficiency Financing Protocol (IEEFP), 187 international environmental law and EE policy, 184–185 APPCDC, efforts of, 210–211 international support of EE, 186–193 Kyoto Protocol and (see Kyoto Protocol) post-Kyoto negotiations, 211–213 role of UNFCCC, 193–196 investment in EE, 152 Justifying Energy Efficiency Projects to Management, 125 Kyoto Protocol, 36–37, 196–199 and emissions trading system, 209–210 flexibility mechanisms by, 185, 200 Clean Development Mechanism (CDM), 203–209 emissions trading, 209–210 Joint Implementation (JI), 200–203

policies and measures (PAMs) for emissions reductions, 185, 188, 199–200 on reduction in GHG emissions, 184 United States and, 42–43 Leasing, 255–256 Leipzig Declaration on Global Climate Change, 40 local economies, EE impact on, 131–132 Long Range Trans-boundary Air Pollution (LRTAP), 1979 Convention on, 184 macro barriers, 160, 162 market barriers, 18, 141, 155, 156, 268, 309 market-based measures, for climate change mitigation, 65, 68, 70 environmental taxation, 68 subsidy reform, 65 trading emissions, 65–68 Marrakech Accords, 185, 189, 200–202, 204. See also Kyoto Protocol baseline methodologies, 204 meso barriers, 160–162 micro barriers, 160, 161 mobilizing private capital, 152 multilateral institutions (MIs), role in EETs, 27–29, 243, 272–275, 301–304 barriers for, implementation of MIfunded projects, 297–301 institutions involved in EE, 275 domestic financial institutions, 279 government, 275–276 manufacturing industry, 278 Research and Development (R&D) organizations, 277–278 state utilities, 276–277 internal and external performance variables, 287–288 performance analysis of MIs evaluating performance of MIs, 282–283 idealized performance analysis, 283–286 institutional design, 279–281 selection of performance benchmarks, 281–282 performance of MIs

348

ENERGY EFFICIENCY AND CLIMATE CHANGE

organizational capacity model, 292–295 stakeholder interaction model, 295–297 unitary rational actor model, 290–292 reasons for weak environmental policies, 288 cultural reasons, 289–290 economic reasons, 289 political reasons, 288–289 Multilateral Investment Guarantee Agency (MIGA), 247 multiplier effect, 132 National Energy Policy Office, Thailand, 119 Natural Capitalism, concept of, 123–124 natural gas, 5, 8, 103, 118 as fuel in CEE region, 6–7 in Russia, 6–7 no-go decision, 153–154 no-regrets, concept of. See win-win climate policy nuclear energy commercialization of, 229 risk of use of, 14–15 use in Lithuania, 6 Oil crisis of 1973, 12 oil supply, and government responsibility, 118 Organisation for Economic Co-operation and Development (OECD) Environmental Guidelines, 186, 300 Organisation for Petroleum Exporting Countries (OPEC), 43 organizational capacity model, 292–295 Oslo Protocol, 184 Overseas Development Assistance (ODA) programmes, 27 payback gap, 86 People for the West! movement, 41 polar icecaps, melting of, 37 power sector, and energy efficient measures, 117–118 precautionary principle, 34, 50

private capital mobilization (PCM), 62, 166, 231, 303 for commercialization, 215–216 Private Capital Mobilization ratio (PCM ratio), 168 production possibility frontier (PPF), 60 profitability barriers, 158 project design document (PDD), 202–206 Protocol on Energy Efficiency and Related Environmental Aspects (PEEREA), 190–192 public–private partnerships (PPPs), 27–28, 225 research environments and EE, 104 ‘close communities’ model, 105 coordinated contractor model, 105 Rio Earth Summit 1992, 27–28 risk, defined, 152, 153 risks, in financing commercial risks, 247 policy risks, 247 sources of, 248 rural electrification programme, in India, 72 Russia, natural gas reserves in, 6–7 SAVE II programme, 192 second law efficiency, 107 and first law efficiency, difference between, 107 heating house with electric furnaces or heat pumps, example of, 108–110 real world second law efficiencies, 110–111 Siberia, growing wheat in, 38, 51 small-scale energy-efficiency, standardized procedures for, 209 soft energy path, 230 Sophia Protocol, 184 stakeholder interaction model, 295–297 steam engine, 5 Subsidiary Body for Implementation (SBI), 195 Subsidiary Body for Scientific and Technological Advise (SBSTA), 195, 200 sulphur dioxide trading scheme, 66 sustainable development, 20–21

INDEX 349 culture and, 22 and economics, 21–22 energy for, 22–23 politics and, 21 sustainable development, approaches based on EE for, 305 accelerating technology solutions, 306– 307 climate geopolitics and energy security, understanding of, 307–308 framework for climate change policies, development of, 315–318 improving theories and models, 308–309 individual interests vs. societal interests, 310–311 integrating climate policies with development priorities, 313–315 lessons from past experiences, 311–313 survival strategy, 309–310 sustainable development policies and measures (SDPAM), 71 sustainable energy development, 22 techno-economic model of change, 86 technology commercialization. See commercialization technology diffusion, 219–221 ‘Technology push’ programmes, 306–307 Thailand, EE programme in, 119 transboundary air pollutants, 184 UK carbon trading programme, Enviros Consulting study on, 67–68 unitary rational actor model, 290–292 United Nations Economic Commission for Europe’s (UNECE), 243 United Nations Environmental Programme, 156

United Nations Environment Programme (UNEP), 33 United Nations Framework Convention on Climate Change (UNFCCC), 33–35, 188, 193–196 COP meetings, 195 objective of, 194 principle of cost effectiveness, use of, 61 principles set by, 194–195 targets for GHG emissions, 184 UN Millennium Declaration of September 2000, 28 Volatile Organic Compounds Protocol, 184 volatile organic compounds (VOCs), 184 Wall Street Journal, 42 win-win climate policy, 61–65 economic win-win, 61–63 exploited win-win opportunities, 63 financial win-win, 61–63 latent win-win opportunities, 63–64 World Bank approach on EE financing, 243–244 World Bank’s estimates, on renewable energy, 8 World Climate Conference (WCC), 32–33 World Commission on Environment and Development (WCED), 20, 22 World Energy Council (WEC) on fuels widely used, 8 principles for sustainable development of energy, 23 World Meteorological Organization (WMO), 33 World Summit on Sustainable Development (WSSD), 189