PROGRESS REPORT ON THE APEC ENERGY EFFICIENCY AND RENEWABLE ENERGY FINANCING TASK FORCE

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1 PROGRESS REPORT ON THE APEC ENERGY EFFICIENCY AND RENEWABLE ENERGY FINANCING TASK FORCE Seminar on Local Banks Training for Financing EERE A Seminar on Local Banks Training for Financing Energy Efficiency and Renewable Energy Projects was held in Mexico City on November The event was organized by the Comisión Nacional para el Ahorro de Energía (Mexico s National Commission for Energy Savings, CONAE) and the Secretaria de Energia (SENER) with support from the Association of Banks of Mexico (ABM) and APEC (through $50,000 provided by the Trade and Investment Liberalisation Fund). The seminar brought together high-level decision makers from government, financing institutions and senior officials from multilateral organizations. The purpose of the Seminar was to further build capacity in local banking institutions in order to reduce barriers that energy users, Energy Service Companies (ESCOs), and other project developers face in accessing financing for renewable energy (RE) and energy efficiency (EE) projects. The design, promotion, implementation, and the establishment of financial mechanisms and programs were also discussed during this two-day Seminar. Lessons learned on barriers to the use of various financing mechanisms were a major focus. There is growing public support for renewable and energy efficient technologies, as well as growing investment in such technologies. Current approaches used by local banking institutions to financing RE and EE are inadequate to realize the full potential of RE and EE technologies, despite significant business potential in these areas. To encourage the development and use of these technologies, particularly by small and medium sized companies (SMEs), viable and innovative financing mechanisms must be in place. Over the course of the two-day Seminar, several themes emerged, including: risks and barriers to RE and EE projects; the need for an enabling environment (incentives/regulations) for RE and EE projects; possible financing mechanisms (partial credit risk guarantee and performance risk guarantee programme); risk management instruments for RE and EE projects; and technical and legal requirements for RE and EE financing. To better understand these recurrent themes, presenters described the context of RE and EE - both at global level and specifically in Mexico. Several presenters discussed the global trends over the last few years in sustainable energy investments. Some of the key findings include: 1 Sustainable energy investment was $70.9 billion in 2006, an increase of 43% over 2005 (the energy technologies with the highest levels of investment are wind, 1 UNEP/SEFI, Global Trends in Sustainable Energy Investment 2007.

2 solar, and biofuels which reflects technology maturity, policy incentives and investor appetite). Investment in sustainable energy is still very much driven by policy, which today includes a broadening array of tariff and fiscal support regimes in many countries that together create a stable environment globally for continued sector growth (greening of industry and public awareness of climate change and other environmental issues are key drivers of renewable energy and energy efficiency). Venture capital, private equity, research and development, public market activity, new asset financing and mergers and acquisition in renewable technologies have all increased since Energy efficiency is a significant, but largely invisible market, which is now attracting an increasing share of the market as investors see its role in addressing growing global energy demand. Capital has shifted to developing countries, which saw higher private investment in 2006 (China, Brazil and India are increasingly major producers of and markets for sustainable energy). Some of the key RE and EE conclusions on Mexico include: There is significant potential energy saving in Mexico. Conservative estimates suggest that 20% of current energy consumption could be saved through improved energy efficiency measures (translating approximately to US $103 billion in savings). There is tremendous potential to reduce energy demand by improving and promoting EE initiatives, particularly with Petróleos Mexicanos (Pemex), the Comisión Federal de Electricidad (CFE) and Luz y Fuerza del Centro (the two Mexican state-owned electricity companies). For , the Government of Mexico has developed a series of sustainable energy policies, including mitigating greenhouse gas (GHG) emissions through its National Strategy on Climate Action (Estrategia Nacional de Acción Climática), promoting energy efficiency (by putting 16% of energy savings in Mexico s national energy consumption) and renewable energy (24% of the generated energy from electricity is to be derived from renewable energy). These policies will have significant benefits for the private sector: increased transactions in GHG emissions markets; increased competitiveness in energy efficiency markets and decreased longer-term costs in operation and maintenance; and secure and quality energy supply by taking advantage of renewable energy. 2

3 The housing market in Mexico is booming with approximately 750,000 units constructed annually. There are vast opportunities for RE and particularly EE initiatives to take place in this sector. La Comisión Nacional para el Ahorro de Energía (CONAE) can effectively collaborate with financial institutions given its technical expertise and tools designed to evaluate energy efficiencies for the private sector. The active and constant participation of financial institutions is fundamental to improve the potential energy savings and increase the national use of renewable energy. Persistent risks and barriers to energy efficiency and renewable energy financing were discussed throughout the Seminar, including: Policy and Regulatory Context Environmental, regulatory and/or permitting issues Political and social risks Lack of awareness Lack of incentives/supporting policies Financial Under-financed Bankers/Investors lack of knowledge and experience with EE and RE projects Elevated transaction costs Lack of actuarial data making assessments risk difficult Lack of appropriate/affordable risk management instruments Onerous underwriting standards Non-traditional RE risk Banks are generally not familiar with the performance of RE and EE projects Many EE projects are often too small for bank financing under normal lending practices Economies of scale in assessing RE and EE projects in order to reduce financial and transactions costs Technological/Capacity New technology to test Performance risk Design and technology failure Lack of local industry capacity/human resources Inexperienced developers Lack of funding 3

4 Enabling incentives for energy efficiency and renewable energy projects, including innovative financial mechanisms and policies, were discussed by several presenters Because RE is generally more expensive than EE, longer-term financing is necessary. The Grupo Santander identified the need for a clear regulatory framework, grid capacity and favourable treatment of renewable energy by host governments as financing conditions. In addition, Santander also looked more favourably at providing financing if several similar initiatives, such as wind projects, could be grouped together as opposed to one-offs projects. Indonesia, in collaboration with the Asian Development Bank (ADB), has developed EE priorities and is currently in the process of designing and establishing ADB s Clean Energy Financing Partnership Facility (CEFPF). The CEFPF is designed to finance: (i) smaller EE investments that require quick transactions; (ii) technology transfer costs of clean technologies for a small number of high-impact demonstration projects that will catalyze deployment of clean energy technologies; and (iii) grant assistance for activities such as the development of a knowledge-based and incentive mechanism; the advocacy, institutional capacity, and project preparation for the establishment, monitoring, and evaluation of financing mechanisms. While the CEFPF operates in different countries, in Indonesia, the Facility will be accessed through local financial institutions. Capacity building to scale up energy efficiency and renewable energy investments was another focus. There is a significant role for governments to play in creating an enabling environment for RE and EE projects. It was noted, as an example, that several governments in the region had included renewable energy in their national energy policy strategies, including Brazil, Argentina, Chile, Guatemala and the Dominican Republic. Governments are also able to develop fiscal incentives to promote RE and EE projects which can include subsidies, fiscal credits and exemptions. For instance, efforts by the Mexican Government have been made to promote incentives by reforming several of its laws, including the Income Tax Law. Given the recent impetus around energy efficiency, carbon credits and renewable energy, international institutions, such as the Asian Development Bank and the World Bank, are mobilizing to support programmes aimed at promoting clean energy technologies. The Global Environment Facility (GEF) GEF, as a financial organization, unites 178 member governments, in partnership with non-government organizations, international institutions and the private sector to provide grants to developing countries and countries with economies in transition for projects to address environmental issues such as climate change and biodiversity. Established in 1991, the GEF is today the largest funder of projects to improve the global environment. It has allocated $7.4 billion, supplemented by more than $28 billion in cofinancing, for more than 1,980 projects in over 160 countries. 4

5 Multilateral organizations, such as the World Bank, UN Agencies, the Organization of American States, and the Inter-American Development Bank, provide resources, technical assistance and raise awareness on EE and RE issues. Clean Development Mechanism (CDM) - The CDM is an arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment to invest in projects that reduce emissions in developing countries as an alternative to more expensive emission reductions in their own countries. The most important factor of a carbon project is that it establishes that it would not have occurred without the additional incentive provided by emission reductions credits. As of March 2007, 245 CDM projects were in place in Latin America of which Brazil and Mexico accounted for 172. There are also a number of international partnerships and associations, including Global Village Energy Partnership (GVEP), Renewable Energy Network for the 21 st Century (REN21), Latin American Energy Organization (OLADE) and the Renewable Energy and Energy Efficiency Partnership (REEEP), which are actively involved in raising the profile of EE and RE projects. Financing mechanisms tailored to energy efficiency and renewable energy projects, including partial credit risk guarantee and performance risk guarantee programmes, are slowly emerging. Seminar speakers made a distinction between financing EE and RE projects. EE projects, if they are making improvements to existing processes, are more likely to be corporate financed (i.e., on balance sheet). So if the incentives are right and inefficiency is not subsidized, most EE projects should finance themselves without the need for particularly complex structures. On the other hand, generally speaking, RE projects have a more complex project finance structures than EE projects. As such, sponsor support and other forms of credit support may be needed to mitigate risks to the cash flow. Speakers suggested that project finance structures that have been used in traditional energy can also be adapted to RE projects while taking into account the different risks associated with such projects. Increasingly, ESCOs are managing RE and EE projects. As a consequence, business models are being designed based on ESCOs participation in these markets. The purpose of ESCOs is to develop, finance and implement energy efficiency and savings-based renewable projects (ESPs) on a turn-key basis. They provide standard services such as investment grade energy audits, comprehensive engineering design, and long-term performance guarantees. Benefits to customers from an ESCO business model are: No capital cost for ownership of ESPs No payment except from actual savings No impact on credit capacity (shared savings) Almost no financial risk for development, implementation or performance of ESPs Measured reductions in operating costs and GHG emissions Improved efficiency ratios (return on assets, return on equity) 5

6 Based on the participation of ESCOs, two primary structures have been developed: Guaranteed Savings (where the customers assume investment repayment risk) and Shared Savings (where customers assume no risk, tending to limit long-term growth and competition within the ESCO industry). In Mexico, there are four to five meaningful ESCOs at present. They are relatively small businesses; the industry is severely limited by a lack of accessible and affordable debt financing for its paid-from-savings ESPs. While ESCOs are able to play a vital function in building services and industrial process services as examples, lack of viable project financing is a key impediment for ESCOs since they are a service company and not a bank. Unlike other types of companies, ESCOs cannot invest working capital. Therefore, local financial institutions, in their traditional risk assessments, are not in position to finance ESCO initiatives. Economic incentives provided by certification of emission reduction projects was also discussed during the Seminar as EE and RE directly affect climate change. Japan Carbon Finance and FC2E provide two clear examples on innovative financing mechanisms to reduce greenhouse gas emissions by purchasing certification credits. The Japan GHG Reduction Fund (JGRF) and the Instituto de Crédito Oficial (ICO) and Santander Investment in Spain are revolving funding mechanisms. The Fondo de Carbono para la Empresa Española (FC2E), sponsored by the Instituto de Crédito Oficial (ICO) and Santander Investment, is the first mixed-capital Carbon Fund managed in Spain. FC2E aims to diversify its portfolio by purchasing Certified Emission Reductions (CERs) from Asian project developers and uses the appraisal of Clean Development Mechanisms (CDM) and Joint Implementation (JI) projects. CDM and JI are emissions trading mechanisms under the Kyoto Protocol. They offer project developers in developing countries and in Central and Eastern Europe the opportunity to attract financing for sustainable development projects. Governments and companies in industrialised countries can use the carbon credits from these projects to offset their own emissions. Technical and legal requirements for energy efficiency and renewable financing were the focus of a series of technical sessions. Baker and McKenzie discussed at some length the various agreements and other legal documents that would be required to secure financing for RE and EE projects. Several types of financing sources were mentioned such as commercial banks, development banks, and instruments for public debt. The need for due diligence from both a legal and financial perspective was discussed to determine certain criteria, such as the financial and technical viability, and the optimum risk and costs associated with a possible project. The importance of engaging lawyers and local financial institutions at the onset of a project was also highlighted. 6

7 Lessons Learned: One of the most significant barriers to widespread implementation of EE and RE technologies is the lack of reliable and commercially-viable financing to end users, developers (including ESCOs), contractors, manufacturers and vendors. The issue is not a lack of available funds, as discussed throughout the Seminar; rather the problem is accessing existing funds at local and regional financial institutions (LFIs). This is primarily as a result of LFIs current asset-based lending practices. LFIs will need to reconsider how they examine EE and RE projects and how these fit into the LFI s lending infrastructure. Given current constraints, some presenters did not foresee an immediate solution for EE projects because many EE markets are not sufficiently developed to motivate LFIs to invest in a new lending infrastructure (RE projects were not discussed). However, proposed solutions were presented. An International Energy Efficiency Project Financing Protocol could become a blue print for LFIs to finance EE projects. Also, an EE project Incentives Fund could drive market growth of EE industry through financial incentives to end users and LFIs. Energy Performance Services, a consulting firm, recently undertook a training session with several Mexican financial institutions to discuss the financial barriers to clean energy technologies. One of the outcomes of this session was that all participating bankers agreed that their respective LFIs could finance energy and saving-based renewable projects. However, additional collateral would be required, and LFIs would have to be involved at the onset of a proposed initiative to help develop the legal and financing structures to make LFIs feel secure with a possible loan. The main obstacle raised was how difficult it would be to change the LFIs culture to financing EPS from savings. A role for government and development banks was highlighted as a possible mitigation strategy so that there could be a complementary role between institutions. Key factors to promote EE and RE projects include technological capabilities, an adequate regulatory framework and private/public financing opportunities to encourage market development of EE and RE technologies. Sound and viable technologies open a path for financing. Mexico is moving away from fossil fuels to increasingly include renewable energy and promote energy efficiency measures. Environmental factors at both local and global levels have prompted the previous and the current administrations to be more strategic and visionary with regard to energy production and consumption. 7