May 17, 2019

What stands in the way of investments in energy efficiency

Expediency, pragmatism, refraining from overconsumption - these are the trends in modern society. The quest for energy efficiency is a natural step in this direction. An echo of global trends is reaching our country too. We often hear about funds saved by some school or tenants’ association on energy resources, and even more often - about how much more it would be possible to save if only ...

Unfortunately, not everything is good with energy efficiency projects in Ukraine. First of all, we lack investment for this trend to manifest in projects en masse. According to the State Agency on Energy Efficiency, budgetary institutions alone would require at least $4.2–8.5 billion to be made energy efficient. Investors, however, are in no hurry to give their money to Ukrainian projects due to the lack of clear, transparent and convenient mechanisms of investors’ cooperation with communities, the state and associations of citizens. Nevertheless, there have already been successful cases like this in the country, which became possible thanks to coordinated actions and cooperation of business and the government.

Why we don't have enough investors in energy efficiency

Energy service is a particularly successful investment tool right now. It allows the energy service company (ESCO) to independently decide on the most cost-effective measures and implement them at their own expense, guaranteeing a certain amount of savings on energy consumption and/or energy expenses. For this, until the contract expires (maximum duration is 15 years), the customer pays to the ESCO a remuneration in the amount of 80-100% of the achieved savings. Over the past 3 years, 300 energy service contracts were signed in Kiev and fifteen Ukrainian oblasts worth UAH 323 million in total.

However, 4 factors in this market are preventing these figures to spike across the country:

1. Insufficient funds. The energy service company does not have enough funds of its own to implement multiple and expensive projects, and bank loans remain expensive and hard to get.

2. No legal guarantees for investing in facilities owned by state and municipal enterprises: boiler houses, water utilities, subways, etc.

Such customers do not have the status of managers of budgetary funds and thus cannot accept long-term energy service commitments and guarantee remuneration to investors several years in advance.

Also, by its legal nature, energy service is just that - a service. The obligations of customers under energy service contracts are considered debt. This means that payments for energy service may not be guaranteed by local municipalities or be included in the investment program of an enterprise whose rates are subject to state regulation. Thus, public utilities have no way to guarantee a settlement with ESCOs.

3. Poor qualifications and lack of institutional capacity of municipalities to attract private investment. Over the past 5 years, over 700 energy service tenders were announced in Ukraine. Of these, almost 50% were canceled or were never held. The main reasons for this are delays of local councils in approving essential contract provisions, lack of interested ESCOs, and violations of legislative requirements by customers when preparing and conducting public procurement.

4. It is difficult for large-scale projects to win bids under the NPV criterion (energy service contract efficiency). ESCOs that offer long-term and expensive projects on thermal modernization of buildings also offer large investments and are willing to guarantee a significant increase in the energy efficiency of buildings. However, the payback period of their investments is long and NPV is lower than that of cheap and fast projects, such as, for instance, installation of building heating substations. That is why such ESCOs usually lose tenders, even when their project looks more attractive to the customer.

However, investors, banks and municipalities are not stopping here, testing new models of financing such projects (factoring, co-financing with budget funds, etc.).

What can improve the situation

Pending examination in the parliament are bills No. 93862 and No. 93873 developed by the State Agency on Energy Efficiency, international organizations, relevant associations and industry experts to improve the energy service mechanism.

The most significant of the proposed changes are:

1. The customer’s ability to set the minimum percent of energy savings that must be achieved as a result of energy service. This will allow municipalities to indirectly influence which energy efficient measures ESCOs will suggest to them.

2. Ability to revise the terms of energy service contracts if additional energy efficiency measures have been agreed on at the expense of the municipality, as well as to change the rates of energy resources and utilities. This can reduce the ESCO’s risks associated with currency fluctuations and inflation, and will open up new opportunities for attracting foreign investment. On the other hand, it will also encourage municipalities to continue financing energy efficiency of facilities for which energy service contracts have already been concluded.

3. Introducing the principle of tacit consent and authorizing executive bodies of local councils to approve the terms of energy service contracts - this could reduce the effect of politics on such transactions.

4. Allowing recipients of budget funds to accept long-term financial commitments under energy service, that is, extending Budget Code guarantees to energy service projects of state and municipal enterprises: boiler houses, water utilities, subway, etc.

However, these changes will take time - the bills have not yet been considered by the Parliament in the first reading. Still, if NGOs keep putting on local authorities and voicing their demands, as well as keep talking about the need to develop proper regulation for this sector - all this can positively affect the state of energy efficiency in the country.

What can be done right now

It makes sense for Investors and communities should take a look at alternative legal mechanisms for investing in energy efficiency: public-private partnerships and third-party-finance. These mechanisms involve long formal legal procedures and a complex decision-making process at the local level, but they make it possible to make contracts flexible, legally implement the project at public utilities, provide for various formats and terms of paying for the project, protect investments with local guarantees and reflect project expenses in the investment programs of public utilities.

Representatives of all levels of government should continue preparing municipalities for attracting large-scale investments and using unconventional mechanisms for implementing energy service projects at the local level. This work should result in the following:

-   minimal number of procedural errors made by customers during the preparation and conduct of public procurement of energy services;

-   ability to use “non-price” criteria for evaluating tender proposals, and to implement projects on co-financing of energy services at the expense of budget funds;

-   developing tailored forms of energy service contracts that would provide more detailed terms and algorithms of work with ESCOs than those provided by model contracts approved by the Cabinet of Ministers.

To do this, one can use the guidelines prepared within the framework of projects of international organizations, in particular UNDP, participate in thematic events and seminars, or turn to experts in this field.