Final Thesis

i

PPD 569Applied International Policy and Management ProjectInternational Public Policy and Management Program

Fall 2011

Unlocking Energy Efficiency Market in India’s SME Sector

Cluster Approach and Role of ESCOs & Fiscal Incentives

Submitted by

Amit Jain I.R.S.

Commissioner of Income Tax

Masters Project submitted in partial fulfillment of the requirement for award of Master’s Degree in Public Policy and Management.

USC Sol Price School of Public Policy University of Southern California

Los Angeles, U.S.A.

ii

iii

ACKNOWLEDGEMENT______________________

In the first place I would like to thank the Department of Revenue, Government of India, for sponsoring me under the Govt. of India, Ministry of Personnel’s DOP&T partial funding scheme for foreign study in 2009 to pursue the International Public Policy and Management Program at the University of Southern California, Los Angeles, U.S.A.

I am especially thankful to my supervisor Professor Melissa Lopez for painstakingly guiding me in writing this project report, her supervision, advice, and guidance from the very early stage of this Project as well as giving me extraordinary experiences throughout the research. Discussions with her were of immense help in understanding the technique as to how to narrow down and identify a policy problem and ways to approach a public policy issue. Her crucial contribution made her a backbone of this research and so to this Masters Project.

I express my special gratitude to Dr. Joyce Mann, Director International Education Program, for her continued help that I needed from time to time and above all and the most needed she provided me unflinching encouragement and support in various ways throughout without which it would have been impossible for me to successfully complete the course. I am indebted to her more than she knows.

I am also thankful to the faculty and staff specially Dr. Joanna Yu and Ann Abrahamyan of the IPPAM Program for the guidance and support provided during the course.

I am grateful to all my classmates at the IPPAM, who were always ready to share their varied experiences with me.

I also acknowledge with thanks the support of Dr. Ramesh Jalan, Resource Person & Moderator, Climate Change Community, Solution Exchange, and United Nations Development Programme New Delhi, India for help in providing books and articles and useful links that I could not have possibly located on my own which has triggered my interest and nourished me with the knowledge and intellectual maturity on as vast a topic as climate change and energy efficiency that I will benefit from, for a long time to come. I am grateful in every possible way to Dr. Jalan and hope to keep up our collaboration in the future.

I am grateful to my late father for his eternal benevolence. He was the one who put the fundaments of my learning character and showed me the joy of intellectual pursuit ever since I was a child. I am grateful to my mother for her inseparable support and prayers.

iv

Words fail me to express my appreciation to my wife Neeru whose dedication, love and persistent confidence in me, has taken the load off my shoulder and enabled me to pursue the course. I am equally thankful to my daughters Nikita, Ankita and son Abhinav for their boundless support and best wishes throughout my stay in the U.S. while they stayed with their mother and continued their studies in India.

Finally, I would like to thank everybody who was important to the successful realization of thesis, as well as expressing my apology that I could not mention personally one by one.

v

DISCLAIMER_______________________________

The views expressed in this Project reflect my personal opinion and in no way reflect the official policy of the Government of India.

vi

vii

ABESCO Association of Brazilian Energy Service Companies

IED Institute of Entrepreneurship Development

ADB Asian Development bank

IFC International Finance Cooperation

ANEEL Agência Nactional de Energia Elétrica, Brazil’s Electricity Regulatory Agency

IIPEC India Industry Program for Energy Conservation

APCTT Asia Pacific Council for Technology Transfer

IIUS Industrial Infrastructure Upgradation Scheme

ASSOCHAM Association of Chamber of Commerce in India IPMVP International Performance Measurement and Verification Protocol

BEE Bureau of Energy Efficiency

IREDA Indian Renewable Energy Development Agency

BLY Bachat Lamp Yojna

MTEE Market Transformation for Energy Efficiency

BT Business Tax

MUSH Municipal, University, School and Hospitals

CCA Climate Change Agreement

NAESCO National Association for Energy Service Companies

CDM Clean Development Mechanism

NAPCC National Action Plan for Climate Change

CED Centre for Entrepreneurship Development

NMEEE National Mission for Enhanced Energy Efficiency

CONPET Brazil’s National Program for the Rational Use of Natural Gas and Oil Products

OECD Organization for Economic Co-operation and Development

CPSUs Central Public Sector Undertakings

PACE Property Assessed Clean Energy

CSEP China Sustainable Energy Program

PAT Perform Achieve and Trade

CSIO Central Small Industries Organization PROESCO Apoio a projetos de eficiência energética

DCS Designated Consumers

PURPA Public Utility Regulatory Policies Act

DIPP Department of Industrial policy and Promotion RBI Reserve Bank of India

DSIRE Database of U.S. State Incentives for Renewables and Efficiency

REEPS Ratepayer-Funded Energy-Efficiency Programs

DSM Demand Side Measures

SDA State Designated Agencies

EBRD European Bank for Reconstruction and Development

SFCs State Finance Corporations

EE Energy Efficiency

SIDBI Small Industries Development Bank of India

EESL Energy Efficiency Services Limited

SIDCs Small Industries Development Corporation

EIT China Enterprise Income Tax China

SIDO Small Industries Development Organization

EMC Energy Management Companies

SME Small and Medium Enterprises

EMCA Energy Management Companies Association

SPV Special Purpose Vehicle

EPACT Energy Policy Act

SRRM Steel Rerolling mills

EPC Energy Performance Contracting

SSI Small Scale Industries

ESCO Energy Service Companies

TBSE Technology Bureau for Small Enterprises

EUETS European Union Emission Trading scheme

TCOs Technical Consultancy Organizations

FEED Framework for Energy Efficient Economic Development

UNEP United Nations Environment Program

FEMP Federal Energy Management Program

UNESCAP United Nation Economic and Social Council for Asia and Pacific

GEF Global Environment Facility

UNFCC United Nations Framework for Climate Change

GHG Green House Gas UNIDO United Nations Industrial Development Organization

HVAC Heating, Ventilation, and Air Conditioning

VAT Value Added Tax

ICPEEB Indian Council for Promotion of Energy Efficiency Business

WEC World Energy Council

IDIQ Indefinite-Delivery, Indefinite-Quantity

WRI World Resource Institute

LIST Of AbbREvIATIONS

viii

ix

ExECuTIvE SuMMARy______________________

The GDP growth rate in India hovering at around 8% since 2000 has catapulted the Indian economy into generating 3-4 times the energy that it is producing at present in the near future i.e. within the next 25 years. This is essential if the above growth rates are expected to continue during the next phase of development in India in the coming decades. Approximately 80-82% of the electricity production in India comes from fossil fuels out of which 53% electricity generation is coal based. Increasing supply would mean higher GHG emissions that may lead to adverse environmental impacts. Further, setting up of generating plants to produce energy is an expensive proposition, especially for a developing country like India, where providing food for its exponentially increasing population is of prime concern as 21% of the people were undernourished in 2007 and 42% of the children remained malnourished in 2011. The challenge before India is therefore to curtail this demand without compromising on its economic growth.

Conservative estimates of the potential of energy efficiency in India based on sectoral consumption on all India basis for the year 2007-08 is about 15% of the electricity consumed. Therefore, it is imperative for an emerging economy like India to adopt enhanced energy efficiency (EE) measures to curtail the increasing demand of energy, which is expected to increase beyond sustainable levels both from the point of view of economic sustainability and also environmental sustainability.

Recognizing the importance of energy efficiency in tackling the challenge of climate change and curtailing the demand for energy from fossil fuels, the Government of India launched the National Mission for Enhanced Energy Efficiency (NMEEE) under the National Action Plan on Climate Change (NAPCC) to achieve about 20,000 MW of avoided generation capacity in the country by 2022. The NMEEE includes ambitious plans and initiative like Market Transformation for Energy Efficiency (MTEE) to accelerate the shift to energy efficient appliances through tax incentives with large scale Demand Side Management (DSM) program in different industrial sectors; development of robust Energy Service Companies (ESCOs) and ultimately addressing market uncertainties through a comprehensive strategy for removal of the major barriers prevalent and foreseen in enhancing energy efficiency in India.

It is estimated that about 48% of the total energy consumed in the industrial sector is from Small and Medium Enterprises (SMEs) and by adopting energy conservation measures, at least 25% of it could be potentially saved, without any substantial investments. Therefore, promoting energy efficiency in the SME sector needs to be one of the top priorities of the Government of India. Further, a majority of the SMEs are located in around 390 clusters across India. Consequently, it is possible to achieve substantial energy efficiency by adopting a “Cluster Approach” while implementing energy conservation projects for SMEs. However, a comprehensive national data base of SME clusters is the need of the hour and it is imperative to involve ESCOs and other related stakeholders in implementing energy efficiency projects in India.

x

It is pertinent to point out that ESCOs worldwide have been successful in enhancing energy efficiency of SMEs. For example, the energy consumption in Brazil is about 40 % of India’s but the aggregate revenue generation from the ESCO industry is sixteen times greater than that of India. Further, China consumes 3.3 times more energy than India but the aggregate revenue of its ESCO industry is 6.8 times greater.

Innovative mechanism like guaranteed savings ESCO projects financed through tax exemption leasing arrangements have contributed to the establishment of a robust ESCO Industry in the United States. The concept of Super-ESCOs and the Super Energy Service Performance Contracts (ESPCs) which are Indefinite-Delivery, Indefinite-Quantity (IDIQ) contracts needs to be replicated in India in order to create a vibrant ESCO industry. There is a need to accelerate the growth of Indian ESCO industry by learning from the experiences of other countries as till now less than 5% of the existing market potential has been realized.

The barriers to energy efficiency in Indian Small and Medium Enterprises (SMEs) include the reluctance of organizations to enter into long-term contracts; non-involvement of top management in energy efficiency projects; inadequate awareness on the potential of energy efficiency and its benefits to the organization and often with very limited investment ; lack of in-house engineering and technical manpower to implement energy-efficiency projects; access to external funds from financial institutions as they are reluctant to finance ‘new’ energy-efficient technologies, particularly those proposed by SMEs. In addition scarce capital base of Indian ESCOs, inadequate access to bank finance, limited knowledge within ESCOs, reliability of services provided , inadequate information, lack of experience and most importantly, high transaction costs have led to limited growth of the ESCO industry in India so far.

In order to overcome the barriers to implement energy efficiency projects, there is an urgent need to initiate market transformation towards preferential adoption of energy efficient products and technologies. A National Technical Assistance and Knowledge Management Program on Energy Efficiency for capacity building and increasing awareness for Energy Efficiency amongst the SMEs and Banks are of paramount importance.

Further, the Clean Development Mechanism (CDM) could play a critical role in addressing the challenges related to financing of energy efficiency projects. Therefore, measures to reduce transaction cost of CDM projects are essential. The Government of India could provide fiscal and tax incentives under direct and indirect taxes to companies involved in promoting or adopting energy efficient technologies.

The funds allocated for providing energy subsidies by the Government of India could be much more efficiently utilized for implementing enhanced energy efficiency projects. It is appropriate to declare Energy Efficiency lending to SMEs as Priority Sector Lending by the Reserve Bank of India and simultaneously allow cash flow based financing for EE projects by issuing clear guidelines to Commercialized Banks in this regard.

xi

Several measures are already being implemented by the Government of India including the Energy Conservation Act in 2001 (EC Act), Energy Conservation Building Code (ECBC) etc. The establishment of the Bureau of Energy Efficiency (BEE), which has been specifically mandated to promote and implement energy efficiency projects in the country, has provided the required momentum and impetus required in this endeavor.

The EC Act aims to strengthen the delivery mechanism of energy efficiency services, which targets capacity building of ESCOs. Energy Efficiency Services Ltd (EESL) is a public sector enterprise established by Government of India for implementing energy efficiency projects and is similar to the Super ESCO Model of the US and could result in substantial growth of the ESCO industry in India with hand holding support and encouragement from EESL.

The role of tax and fiscal policies in removing barriers for promotion of industrial energy efficiency projects needs special focus as tax benefits are an effective tool in promoting energy efficiency in the country. Tax concessions such as accelerated depreciation, tax reduction, and tax exemptions could help to accelerate adoption of energy efficient technologies and its implementation in SMEs. It is also essential to publish an industry wise list of eligible technologies and equipment that would qualify for tax exemptions.

There is an urgent need to introduce Integrated Tax Policy on Tax and Fiscal incentives for Energy efficiency projects. For example, the climate change levies on industry, in line with the national commitments made by UK in the international arena have enabled the country to meet its international obligations.

Based on study of successful ESCO models in other countries and analysis of the opportunities and barriers in India following recommendations can be made:

A National SME Cluster Mapping Program to build SME Cluster Data Base for •EE needs to be conducted.It is important to integrate energy efficiency improvement schemes of BEE with the •Industrial Infrastructure Upgradation Scheme (IIUS) of Department of Industrial Policy and Promotion (DIPP) and involve ESCOs as the SPVs for implementing the EE through EPC.There is a need to initiate a National Technical Assistance and Knowledge Management •Program on Energy Efficiency for capacity building and increasing awareness for Energy Efficiency amongst the SMEs and Banks.Involving Multinational ESCOs in large federal energy efficiency projects including •those in Municipalities, Universities, Schools and Hospitals (MUSH) sector is important. There is a need to declare EE lending to SMEs as Priority Sector Lending by the •Reserve Bank of India and simultaneously allow cash flow based financing for EE projects by issuing clear guidelines to Banks in this regard.Establishing Authority for Energy Performance Contracting Dispute Resolution for •early resolution of disputes between ESCOs and their customers is crucial.

xii

Revival of the Indian Council for Promotion of Energy Efficiency Business (ICPEEB) •and SME Cluster Associations is required.

Specific recommendations for fiscal measures that were found relevant are:

BEE needs to establish a Joint Committee with Ministry of Finance on tax and fiscal •incentives for promotion of energy efficiency.

There is a need to devise “Integrated Programs” for Industry specific clusters combining •tax and fiscal policies.

BEE can establish a list of eligible technologies and equipments that will qualify for •tax exemptions.

In conclusion it is pertinent to highlight that a comprehensive approach towards the removal of key barriers in financing, government initiatives, enabling policies, fiscal/tax incentives and strong industry support will be crucial in enhancing the role of ESCOs in promoting energy efficiency in the SME sector in India.

xiii

SuMMARy Of RECOMMENDATIONS_________On Promotion of ESCOs and Cluster Approach

Conduct National SME Cluster Mapping Program to build SME Cluster Data Base for EE.1. Establish “Integrated programs on Energy Efficiency for SME Clusters” and combine 2. energy efficiency improvement schemes of BEE with the IIUS of DIPP and involve ESCOs as the SPVs for implementing the EE through EPC.Initiate a National Technical Assistance and Knowledge Management Program on 3. Energy Efficiency for capacity building and increasing awareness for Energy Efficiency amongst the SMEs and Banks.Involve Multinational ESCOs in large federal energy efficiency projects including those 4. in MUSH1 sector who would engage Indian ESCOs as subcontractors in these projects so as to help them in their capacity building. Declare Energy Efficiency lending to SMEs as Priority Sector Lending by the Reserve 5. Bank of India and simultaneously allow cash flow based financing for EE projects by issuing clear guidelines to Banks in this regard.Establish Authority for Energy Performance Contracting Dispute Resolution for early 6. resolution of disputes between ESCOs and their customers. Revive the ICPEEB and SME Cluster Associations. Ensure that the new or revived SME 7. industry associations are linked with ICPEEB so that they have an equal representation among all companies in the industry.

On Tax and Fiscal Policies for promoting Energy EfficiencyThe Government must Introduce Integrated Tax Policy on Tax and Fiscal incentives 8. for Energy efficiency as a policy initiative. Formulate Integrated Tax Policy for Energy Efficiency to suggest Tax incentives to the 9. SMEs in Industry specific clusters under Voluntary or Negotiated Agreements and link it with the suggested “Integrated programs on Energy Efficiency for SME Clusters”. BEE should establish a Core Committee on tax and fiscal incentives for promotion of 10. energy efficiency Jointly with Ministry of Finance.The core committee will propose integrated policies on taxation and fiscal incentives 11. for industry specific clusters for promotion of energy efficiency for at least a minimum period of 10 years to bring in market certainty and kick start the process of market transformation.

The recommendations of the core committee to be finally made part of the •Finance Bill in the Union Budget. The Joint Core committee will also suggest tax incentives for ESCOs.•Concurrently, BEE must establish industry wise list of eligible technologies •and equipments that the ESCOs would be required to bring in to qualify for tax exemptions.

1 MUSH sector or MUSH market refers to an abbreviation of the public sector segment or niche market of municipalities (M), universities (U), schools (S) and hospitals (H). http://en.wikipedia.org/wiki/Mush

xiv

xv

TAbLE Of CONTENTS

S. No. Chapter No. Topic ...................................................................................................Page No.

1 List of Abbreviations ......................................................................................................vii

2 Executive Summary .................................................................................................. ix-xii

3 Summary of Recommendations ..................................................................................xiii

4 List of Tables .................................................................................................................xvii

5 List of Figures ...............................................................................................................xvii

6 List of Annexures .........................................................................................................xvii

7 Chapter Wise Highlights ............................................................................................. 1-4

8 Introduction .....................................................................................................5-8

9 Chapter 1 Making ESCOs popular in India ....................................................................9-10

10 Chapter 2 Energy Conservation Potential in India ......................................................11-12

11 Chapter 3 Significance of Indian SME sector ...............................................................13-14

12 Chapter 4 Market Transformation for energy efficient economic development .........15-16

(i) Market Transformation in Indian Context

Part I Role of ESCOs & Cluster Approach

14 Chapter 5 ESCOs in China, Brazil, United States and India ........................................19-20

15 Chapter 6 ESCOs in China ............................................................................................21-24

(i) Financing ESCOs in China

(ii) Government initiatives in China

(iii) Tax incentives in China

(iv) Industry Support

(v) Perception of ESCOs

16 Chapter 7 ESCOs in Brazil ............................................................................................25-28

(i) Financing ESCOs in Brazil

(ii) Government initiatives in Brazil

(iii) Tax/Fiscal incentives in Brazil



17 Chapter 8 ESCOs in United States ................................................................................29-34

(i) Evolution and Development of ESCO-EPC delivery Model

(ii) Financing ESCOs in United States

(iii) Government initiatives in United States

(iv) Tax/Fiscal incentives in United States

(v) Industry Support

(vi) Perception of ESCOs

xvi

18 Chapter 9 Super ESCOs- The Concept ..........................................................................35-36

(i) Some international examples of Super ESCOs

19 Chapter 10 ESCOs in China, Brazil and United States – Lessons Learned ....................37-38

20 Chapter 11 ESCOs in India 39-44

(i) Growth of Indian ESCOs

(ii) Types and Activities of ESCOs

(iii) Number, size and location of Indian ESCOs

(iv) Financing of ESCOs in India

(v) Government Initiatives and Policies

(vi) The Energy Efficiency Services Limited

(vii) Tax Incentives

(viii) Industry Support

(ix) Perception of ESCOs

21 Chapter 12 Energy Efficiency and SME Cluster Approach.............................................45-52

(i) SME Clusters in Indian Context

(ii) Lessons learned from the UNDP GEF project “EE in steel re-rolling mills”

(iii) Lessons learned from EE Projects in the SME paper cluster in states of Punjab,Haryana and Uttarakhand

(iv) Energy efficiency Projects in Indian SMEs and key lessons learnt

22 Chapter 13 Barriers For ESCO Development in India ...................................................53-60

(i) General Barriers

(ii) Specific Barriers

23 Chapter 14 Conclusions and Recommendations ............................................................61-66

Part II Role of Tax & Fiscal Incentives in Energy and Environmental Policy

24 Chapter 15 Role of Tax and Fiscal Policies in removing barriers for promotion of Industrial Energy Efficiency : Overview ......................................................69-72

25 Chapter 16 Role of Tax Policy .........................................................................................73-88

(A) Taxes and Fees: Increasing Costs Associated with Energy Use

(B) Fiscal Policies: Reducing Costs Associated with Increasing Energy Efficiency

(C) Integrated Policies

(D) Industrial Energy Efficiency International Best Practices

(E) Direct Fiscal Incentives to Promote Energy efficiency

(F) Status of direct tax Incentives for Improving energy efficiency in India

26 Chapter 17 Conclusions and Recommendations ............................................................89-92

27 References ................................................................................................. 119-125

xvii

Sl. No. List of Tables Page Nos.

1 Energy Savings Investment Potential in India ................................................................................. 13

2 ESCO country statistics ....................................................................................................................... 19

3 Tax and fiscal policies for encouraging investments in EE processes and equipments .............. 74

Sl. No. List of Figures Page Nos.

1 Potential energy savings in India by sector (Billion KWh) ............................................................ 14

2 Illustration of a Super ESCO- The EC2 Corporation of Philippines ............................................. 35

3 Indian ESCO industries by revenues and year over year growth (%) ........................................... 40

4 Energy Performance Contracting ...................................................................................................... 93

Sl. No. List of Annexures Page No.

1. Annexure A: What is an ESCO .................................................................................................... 93-96

2. Annexure B: Fiscal and Tax Incentives in China ..................................................................... 97-98

3. Annexure C: China ESCO Industry ......................................................................................... 99-100

4. Annexure D: U.S. Federal and State Enabling Policies .......................................................... 101-104

5. Annexure E: Database of U.S. State Incentives for Renewables and Efficiency (DSIRE) . 105-110

6. Annexure F: Main Energy Efficiency Policies in India ...................................................... 111-112

7. Annexure G: BEE Recommendations on Direct Taxes ......................................................... 113-118

xviii


1

Chapter Wise Highlights

Part I

Chapter 1: Making ESCOs Popular in IndiaThe chapter briefly introduces the barriers to energy efficiency improvement in Indian Small and Medium Enterprises (SMEs). For example many customers specially find the model too good to be true, are reluctant to sign a long-term contract, involvement of top management is limited as energy efficiency is considered engineer’s domain etc. The chapter also includes the cluster approach example that could accelerate the deployment of energy efficiency. The need for analysis of the potential for energy conservation in the SME sector and its impact on the SMEs is being highlighted.

Chapter 2: Energy Conservation Potential in India The chapter highlights the potential of energy saving, GHG emission reduction and energy efficiency investment that exists in India. For example the estimated energy conservation potential on all India basis for the year 2007-08 is about 15% of the electricity consumed. The savings potential of around 75.4 billion Kilowatt hour (KWh) by implementing energy efficiency measures in India exists. An aggregate investment potential of USD 9.8 billion, with a total savings of 183.5 billion kWh and 148.6 million tons of CO2 equivalent emissions is projected. It is highlighted that only 5% of the ESCO market has been tapped mainly for lighting and some industrial appliances.

Chapter 3: Significance of Indian SME Sector The significance of Indian SMEs for implementation of energy efficiency measures has been highlighted. SMEs account for 48% of the total energy consumed in industrial sector and 25% of it can be potentially saved. India’s 3 million SMEs constitute 80% of the total number of industrial enterprises in the country contributing 45% of industrial production, 17% to GDP and represents 40% of India’s exports. The chapter provides estimates that there are around 390 SME clusters in India that face high energy costs for electricity and fossil fuels. It is emphasized that energy efficiency in SMEs needs to be the priority for the ESCOs in India.

Chapter 4: Market Transformation for Energy Efficient Economic Development

The need for market transformation policies to address a set of barriers through a mix of incentives, information, targets, and standards has been emphasized. The concept of market transformation evolved from the demand-side management (DSM) experiences in North America and Sweden of power utilities in the 1980s and early 1990s. The utility- driven DSM programs and their salient features have been highlighted.


2

Market Transformation in Indian Context

The chapter focuses on crucial issues related to market transformation in the Indian context. The measures that could help overcome the “first cost bias” to initiate market transformation towards the preferential adoption of energy efficient products and technologies have been emphasized. The importance of Clean Development Mechanism (CDM) and the barrier of high transaction costs in the process have been mentioned. Possible government interventions in facilitating ESCO based investments have been highlighted. The negligible development in the area relating to providing fiscal and tax incentives under direct and indirect taxes to the SMEs sector have been highlighted.

Chapter 5: ESCOs in China, Brazil, United States and India The chapter provides a brief introduction of the status of ESCOs in China, Brazil, United States and India. The World Bank and UNEP supported 3 Country Energy Efficiency Program in Brazil, China and India has been highlighted. The per capita, aggregate energy consumption and the difference in scale of ESCOs operation has been highlighted. For example China’s energy consumption is 3.3 times greater than India’s, and its per capita energy consumption is 2.8 times larger, yet the aggregate revenue of its ESCO industry is 6.8 times greater than that of India.

Chapter 6: ESCOs in ChinaThe chapter focuses on status of ESCOs in China particularly financing, government initiatives, tax incentives, industry support and perception of ESCOs. ESCOs in China are also referred to as EMC, or Energy Management Companies are being benefited by the national loan guarantee program. The Chinese ESCO industry has grown from US $260 million in 2006 to over US $1 billion in 2007. The two phased goals for promoting ESCOs by the government of China have been highlighted. The strong presence of a national ESCO association and their activities has been mentioned.

Chapter 7: ESCOs in BrazilThe chapter mentions that ESCOs in Brazil are mainly small and medium size companies, typically engineering firms or consultancy firms and lighting projects are the most common type of their projects. The role of Brazilian government through initiatives including utility wire-charge program and its national electricity conservation program are mentioned. ESCOs in Brazil either finance their own projects via own capital or involve a third party for financing EE projects. The Brazilian ESCO Association (ABESCO) and its activities have been highlighted. The barriers including scarcity of capital, lack of information and experience related to ESCOs have been mentioned.

Chapter 8: ESCOs in United States The evolution and development of ESCO- EPC delivery Model in US has been highlighted. The mechanisms like guaranteed savings ESCO projects financed through tax exempt leasing arrangements have been elaborated. The US Energy Policy Initiatives that comprise of various government enabling policies to stimulate US ESCO industry development are mentioned. The role of Super-ESCOs in the US ESCO market and the Super Energy Service Performance Contracts (ESPCs) that are indefinite-delivery, indefinite-quantity (IDIQ) contracts has been highlighted.

Chapter 9: Super ESCOs- The ConceptThe concept of super ESCOs that has evolved from the United States has been elaborated. The Super ESCO may also provide credit or risk guarantees for ESCO projects, or act as a leasing or financing company to provide ESCOs and/or customers EE equipment on lease or on benefit-sharing terms. Some international examples of Super ESCOs including the FEDESCO, super ESCO established by the Belgian federal government in 2005, the Fakai Scientific Electricity Services Limited Corporation in China and Energy Efficiency Services Ltd (EESL) as implementing entity for energy efficiency improvements in India have been mentioned.


3

Chapter 10: ESCOs in China, Brazil and United States – Lessons Learned The chapter emphasizes on the lessons that could be learnt from ESCOs in China, Brazil and United States. Programmes that enabled China to decouple energy use from economic growth have been highlighted. The government programmes in Brazil that enabled accelerated financing of ESCOs have been mentioned. Need for appropriate policy support, financial policy mechanisms, government leadership and encouragement of investment in all sectors has been highlighted.

Chapter 11: ESCOs in IndiaThe chapter focuses on the evolution, status and barriers to ESCOs in India. It is mentioned that in India, despite implementing a number of demonstration projects in the public, commercial and industrial sectors, ESCOs have not achieved a critical mass in terms of numbers. Information about ESCOs accredited with the BEE. The Energy Conservation Act in 2001 (EC Act), its provisions enabling successful implementation of ESCOs, fiscal incentives for energy efficiency projects and developments in the sector have been elaborated.

Chapter 12: Energy Efficiency and SME Cluster Approach Emphasizing on the use of SME Cluster Approach for accelerated energy efficiency deployment the chapter provides details of SME clusters in India, the organizations supporting energy efficiency in SMEs and successful approaches. Highlighting the example of the UNDP GEF project on energy efficiency in steel re-rolling mills the chapter has shared lessons that could help in implementation of similar projects. The need for additional government support and removal of other barriers has been emphasized.

Chapter 13: Barriers for ESCO Development in India The chapter elaborates on the barriers for Indian ESCOs including general barriers and specific barriers. Scarce capital base of Indian ESCOs, inadequate access to bank finance, limited knowledge of ESCOs, reliability concerns, inadequate information and awareness, lack of experience and limited knowledge of EE Projects and the EPC, high administrative, transaction costs etc. have been elaborated. Suggestions regarding measures that could help accelerate the growth of ESCOs in India have been provided.

Chapter 14: Conclusions and Recommendations The chapter provides recommendations for successful adoption of cluster approach and other measures for energy efficiency in India. Conducting National SME Cluster Mapping Program to build SME Cluster Data Base; establishing “Integrated programs on Energy Efficiency for SME Clusters”; initiation of a National Technical Assistance and Knowledge Management Program on Energy Efficiency; involvement of Multinational ESCOs in large federal energy efficiency projects; priority sector lending provisions for energy efficiency are some of the measures suggested.

Part II

Chapter 15: Role of Tax and Fiscal Policies in removing barriers for promotion of Industrial Energy Efficiency: Overview

The role of tax and fiscal policies in removing barriers for promotion of industrial energy efficiency has been highlighted. The Emerging taxation Regime in India post 1991 tax reforms has been discussed. Various studies related to taxation and fiscal policies promoting energy efficiency have also been described.


4

Chapter 16: Role of Tax Policy The chapter particularly focuses on role of tax polices and briefly describes other fiscal incentive approaches. Cases where taxes are effective in promoting energy efficiency have been mentioned. Example of integrating climate change levies with Climate Change Agreements (CCA) from UK has been elaborated along with the Emission Trading scheme in Europe. Tax relief programs such as accelerated depreciation, tax reductions, and tax exemptions have been discussed. The present direct tax incentives in India for energy efficiency have been mentioned.

Chapter 17: Conclusions and RecommendationsRecommendations related to introduction of Integrated Tax Policy on Tax and Fiscal incentives for Energy efficiency as a policy initiative; establishment of a Core Committee on tax and fiscal incentives for promotion of energy efficiency Jointly with Ministry of Finance by Bureau of Energy Efficiency (BEE) and establishment of industry wise list of eligible technologies and equipments that the ESCOs would be required to bring in to qualify for tax exemptions have been elaborated.

_ _ _


5

Introduction

In order to support the growing economy of India at 8% to 10% annually over the next 25 years, an increase of at least 3 to 4 times of primary energy supply from the present level is imperative, which would be generated primarily from coal2. To curtail this demand, India has adopted energy efficiency (EE) measures as a policy tool to balance its needs and reduce the overall GHG emissions.India ratified United Nations Framework Convention on Climate Change (UNFCCC) on 1st November 1993 and the Kyoto Protocol on 26th August 2002. The Government released The Indian “National Action Plan on Climate Change” (NAPCC), in June 2008 and announced its intention to voluntarily reduce India’s carbon intensity by 20-25% by 2020, compared to 2005 levels. NAPCC charts the likely future direction of energy efficiency policies with a “National Mission on Enhanced Energy Efficiency” (NMEEE)3 as one of eight national missions to address the impact of climate change in India. It proposes initiatives like Market Transformation for Energy Efficiency (MTEE) to accelerate the shift to energy efficient appliances through tax incentives, to help finance demand side management (DSM)4 programs in industrial sectors. Innovative financial instruments are proposed to enhance energy efficiency along with a National Energy Efficiency Clean Development Mechanism (CDM) Road map. The NMEEE stresses the need to supplement the efforts of the government to create the market for energy efficiency with appropriate fiscal instruments. These need to be designed to address the objective of offering concessions on taxes to attract investments in energy efficiency under the Framework for Energy Efficient Economic Development (FEED). Bureau of Energy Efficiency (BEE) is the nodal central statutory body established under the Energy Conservation Act of 2001 under the Ministry of Power to facilitate and coordinate the EE initiatives at the Central and State level. It has been entrusted with the task of implementation of the NMEEE. The primary goal of BEE is to reduce the energy intensity in Indian economy and its mission is to institutionalize EE Services, enable delivery mechanisms in the country and provide leadership to the key players involved in energy conservation activities.Keeping in view the huge potential for energy efficiency & conservation and the total immediate market potential for energy savings estimated to be around 53 billion KWh and corresponding peak saving of 8935 MW (Datta Roy, 2004), BEE has taken up the promotion of ESCOs (Energy Service Companies). It will be one of the key delivery options for providing the necessary energy efficiency

2 Approximately 80-82% of the electricity production in India comes from fossil fuels out of which 53% electricity generation is coal based and as per the estimates coal will continue to dominate the electricity production for the next 50 years or even more. This means power generation will remain a major source of CO2 emission. Meeting the primary energy demand only by increasing supply would mean higher GHG emissions which have been estimated at 133 million metric tons of additional CO2 emissions per year that may lead to adverse environmental impacts.

3 Referred to as: “Mission Document” in this paper.4 Demand Side Management (DSM) is a cooperative effort between utility and consumers to conserve energy and / or to

optimize electricity demand to manage around utilities peak loads. Active load management practices allow the utilities to shift precisely quantified loads for relatively specific periods of time to accommodate explicit needs. The first is generally in the customer’s control, while the second is more utility controlled. (India Infrastructure Report -2010)


6

solutions in different sectors as an important aspect for its future climate change mitigation and energy security5 strategies. The government considers that a robust ESCO industry can unlock India’s huge energy efficiency market [estimated to be Rs 74000 Crore (US 15 Billion)]6 and provide a platform for market transformation towards energy efficient economic development. Based on survey of international experience worldwide, the NMEEE7 -Mission document identifies specialized Energy Service Companies (ESCOs) as one of the key elements for the success of the energy efficiency market which combined with fiscal incentives can help in unlocking the energy efficiency market potential and deliver both energy savings and financial returns.

Typically under the Energy Performance Contracting (EPC) an ESCO conducts investment grade energy audit8 and thereafter develop recommendations and design based on the audit. It then secures financing for the energy efficiency projects which are ultimately implemented. During the implementation phase the ESCO9 would be responsible for procurement of energy efficient equipments, maintaining and verification of energy consumption and assume the risk involved in the expected amount of energy savings. The ESCO’s remuneration depends upon savings being actually achieved and measured. Further the ESCO service fee is paid from the savings achieved, so there is no burden on existing cash flow of the customer. Simultaneously the customer benefits from the latest energy efficiency expertise, technology and increased income. EPC is a sort of “creative financing” for capital improvement which allows funding energy efficiency upgrades from cost reductions. (Bertoldi and Rezessy, 2005)10 There are two models which are most commonly used for financing the energy performance contract undertaken by the ESCOs. One is the guaranteed savings model in which the ESCO makes arrangements for financing but the funds are borrowed by the customer who takes the obligation to repay the loan. The ESCO guarantees a certain level of energy savings to the customer. This model is based on end-user or third party financing. The second is the shared savings model. Under this scheme the ESCO finances the project itself, either from its own capital or by borrowing

5 Energy Security: Definition: “We are energy secure when we can supply lifeline energy to all our citizens irrespective of their ability to pay for it as well as meet their effective demand for safe and convenient energy to satisfy their various needs at competitive prices, at all times and with a prescribed confidence level considering shocks and disruptions that can be reasonably expected”. Integrated Energy Policy-Report of the Expert Committee- Planning Commission; Govt. of India, August 2006. India currently suffers a significant demand and supply mismatch in the power sector – the overall energy deficit was estimated at 10% and peak exceeded 17% in 2007.

6 NMEEE-Mission Document, June 2010; Energy Efficiency Financing Platform - page33. * One lakh = 100 000 (0.1 million) ** One crore = 10 million = one hundred lakhs Conversion rate: 1 US$=Rs. 50/-

7 NMEEE-Mission Document, June 2010; page 33.8 Investment Grade Energy Audit: Energy Efficiency is an investment and not an expense. The traditional energy audit does

not sufficiently consider how implemented measures will behave over time. Because auditors must consider the conditions under which measures will function during the life of the project, an IGA builds on the conventional energy audit. Unlike the traditional energy audit, which assumes that all conditions (related to system, payback, and people) remain the same over time, an IGA attempts to predict a building’s energy use more accurately by adding the dimension of a risk assessment component, which evaluates conditions in a specific building or process. Aspects of the IGA include risk management, the “people” factor, M&V, financing issues, report presentation guidelines, and master planning strategies. (See Hansen, S. and Brown, J. 2003; Investment Grade Audit-Making smart energy choices. Fairmont Press: Lilbourn). http://what-when-how.com/energy-engineering/energy-service-companies-europe/

9 ESCOs offer a wide range of activities to energy users, primarily in industrial and commercial sectors and to public institutions. The four major categories of services are (1) the operation and maintenance of installations such as cogeneration, district heating units, and small-scale residential boilers; (2) the supply of energy, often in the form of power and heat from cogeneration but also gas sourcing; (3) facility management in various areas ranging from technical management and cleaning to safety and security; and (4) energy management, including energy audits, consulting, and demand monitoring and management.

10 Energy Service Companies in Europe, Status report 2005, Paolo Bertoldi and Silvia Rezessy, European Commission, DG JRC, Institute for Environment and Sustainability, Renewable Energies Unit.


7

from the bank. For a detailed description on nature of EPC, financing and types of ESCO- EPC models please refer to Annexure ‘A’.

ESCOs can help the Indian industry to significantly reduce its energy costs through economically attractive measures while reducing the risk of projects. ESCOs can assure that the return on investments in energy efficiency which is not exposed to market and financial risks can be sustained over long periods. ESCOs complement existing company resources that can then focus on the core areas of the company’s activity, thus bringing in even greater returns to the company. In the current economic scenario, ESCOs have a major role to play in helping Indian companies become more competitive in the global market11. (Athale and Chavan 2008)

11 ESCOs: The need of the hour for Energy Efficiency in India by Shishir Athale; and Mohan Chavan; 2008, Sudnya Industrial Services Pvt. Ltd, Pune. Available on http://www.docstoc.com/docs/26030648/ESCOs_-The-need-of-the-hour-for-Energy-Efficiency-in-India


9

Chapter 1Making ESCOs popular in IndiaESCOs in India face a number of critical barriers that need to be addressed. Most of the barriers will be eliminated with the lapse of time as the market becomes more familiar with the business. The greatest barrier to energy efficiency improvement in Indian Small and Medium Enterprises (SMEs)12 is that this is still considered to be the engineer’s domain. Getting CEOs and CFOs interested in energy efficiency improvement will certainly give a fillip to ESCOs. (Athale and Chavan) The concept of ESCOs and the Energy performance contracting (EPC) is new and not widely known. Many customers specially the SMEs find the model too good to be true, and are reluctant to sign a long-term contract. Besides this there are too few ESCOs in India. This is largely because there are very few persons who have the technical, financial and contracting knowledge to be able to deliver a good service and high transaction/administrative costs associated with the EPC. The barriers to ESCO development will be dealt in more detail in the later part of the paper.

India has nearly three million small and medium enterprises (SMEs) which constitute more than 80% of the total number of industrial enterprises in the country contributing 45% of industrial production (World Bank)13 . The Indian SME sector is facing high and rising energy costs whereas the export oriented SMEs are facing increased global competition. Many Indian SMEs are energy intensive employing inefficient and outmoded technologies resulting in lower energy efficiency (EE) and energy intensity figures that endanger their competitiveness and future growth. Large numbers of SMEs are located in clusters14 in various states of the countries and have large potential for energy savings. Despite huge unrealized potential for improvements in energy efficiency, this sector has fallen behind the larger Indian industries benchmarks in terms of productivity, technology upgradation and energy efficiency.

12 Definition of Small and Medium Enterprises (SMEs): According to the “Micro, Small and Medium Enterprises Development Act” of 2006 , small enterprises (SEs) engaged in manufacturing and production are defined as units, where the investment in plant and machinery is more than twenty five lakh rupees (INR 2.5 million/ 0.5 million USD) but does not exceed five crore rupees (INR 50 Million/ I.0 million USD) and medium-sized enterprises (MEs) are defined as units whose investment in plant and machinery (original cost) exceeds rupees five crore ( 1.0 million USD) but does not exceed ten crore rupees (Rs. 100 million/ 2 million USD). The corresponding limit for micro enterprises is INR 2.5 million (0.5 million USD).

13 World Bank Document/ World Bank study “Energy intensive sectors of the Indian Economy: Options for low carbon development”

14 A CLUSTER is defined as a local agglomeration of enterprises, which are producing and selling a range of related and complementary products and services. They also share similar inputs, in particular similar energy use characteristics, which is important in the context of replicability of EE initiatives. A cluster can include both a specific sector and technology focus and a geographic focus for grouping units, and may include several industrial categories which share similar potentials for specific technical interventions. The growth and formation of these clusters are mainly due to market based and local regulatory and policy-driven reasons.

Cluster in the Indian Context is the sectoral and geographical concentration of enterprises, in particular Small and Medium Enterprises (SME), faced with common opportunities and threats which can: (i) Give rise to external economies (e.g. specialized suppliers of raw materials, components and machinery; sector specific skills etc.); (ii) Favor the emergence of specialized technical, administrative and financial services; (iii) Create a conducive ground for the development of inter-firm cooperation and specialization as well as of cooperation among public and private local institutions to promote local production, innovation and collective learning. http://laghuudyog.gov.in/clusters/clus/ovrclus.htm


10

It is envisaged that interventions at cluster level focusing on energy/resource efficiency, energy conservation and technology up gradation would be helpful in addressing the cluster specific problems and enhancing energy efficiency in SMEs. Given the existing market barriers15 observed in India, there is a need for a programmatic approach to systematically support the aggregate demand for EE investment in SME industrial clusters and to create a sustainable mechanism for identifying, and financing various industry specific EE investments that is replicable at the local cluster level. Energy conservation addresses competitiveness, energy security, environment and supply and market transformation related issues in an integrated manner. Therefore it becomes crucial to analyze the potential for energy conservation in the SME sector by examining the overall energy conservation potential in India and its impact on the SMEs.

15 The Reserve Bank of India (RBI) statistics show that the year on year growth rate of bank credit to SMEs fell from 35.6% in 2007 to 7.4% in 2008, even while the overall year on year growth rate of bank credit to industry (including large corporations) increased from 29.4% to 30.2% over the same period.


11

Chapter 2Energy Conservation Potential in IndiaConservative estimates of energy efficiency and conservation potential in Indian economy based on sectoral consumption (agriculture, commercial, municipalities, SMEs, domestic and industries) on all India basis for the year 2007-08 is about 15% of the electricity consumed. Study conducted by National Productivity Council highlights a savings potential of 75.4 billion Kilowatt hour (KWh) by implementing energy efficiency in various sectors which is more than the overall energy deficit in the country of 73.1 billion KWh reported during 2007-08.

According to the Asian Development Bank (ADB) and BEE , the aggregate investment potential in these sectors for energy savings amounts to USD 9.8 billion, with a total savings of 183.5 billion kWh and 148.6 million tons of CO2 equivalent emissions. (Ella Aglipay Delio, 2009).

Table 1: Energy savings investment potential in India

Source: Investment Potential of Energy Service Companies in India, (Ella Aglipay Delio, 2009); WRI

16 State wise electricity consumption & conservation potential in India- Report , prepared by National Productivity Council (NPC) for Bureau of Energy Efficiency (BEE)

17 Emission factor 0.81 tons CO2/MWh. Available at http://www.cea.nic.in/planning/c%20and%20e/user_guide_ver2.pdf (Ella Aglipay Delio, 2009).


12

However, the NMEEE’s overall assessment estimates that savings from energy efficiency and energy conservation can result in avoided capacity addition of 19,598 MW.18 (101.7 Billion Units)19. The potential for energy conservation exists in every sector as can be seen from the table 1 above. It is most prominent in Lighting, industrial and agriculture sectors. Whereas lighting sector offers most cost effective opportunities to reduce energy consumption and quickest paybacks, the agriculture sector has little demand for energy efficiency because of the subsidized electricity rates although there is conservation potential of 60 billion KWh just by replacement of inefficient water pumps This would involve investment of 3.75 billion USD20 . Energy audits in some of the government buildings have shown potential energy savings between 20 to 46 % and can be another prospective area21 .

The scope for implementing energy efficiency projects through ESCOs performance contracting is vast and is estimated to be around Rs. 14000 crore (USD 2.8 Billion) as per the study conducted by the Asian Development Bank and BEE. So far only 5% of this market has been tapped mainly for lighting and some industrial appliances.

Bureau of Energy Efficiency estimates the total energy efficiency market in India at Rs. 74000 Crore (Rs.740 billion/14.8 billion USD). The market transformation through DSM would attract investments of around Rs. 44000 Crore (8.8 billion USD) that can save energy of 74.4 billion units, avoid capacity additions of 14335 MW, and reduce emissions of GHGs by 72.74 Million tons. The investment potential in the industrial sector comprising of SMEs is around Rs.12100 Crore (USD 2.42 Billion) with energy savings of 49 Billion Kilowatt-hours and can avoid capacity addition of about 7000 MW. The balance investment potential of around Rs 30,000 Crore (6 billion USD) relates to the investments required to achieve savings in the 714 designated consumers (DCs) which are large industries identified in the 9 sectors viz. the railways, aluminum, cement, chlor-alkali, fertilizers, integrated steel plants, pulp and paper, textiles and thermal power stations.

18 Other estimates point out that since these savings will be on the demand side which would include transmission and distribution as well, the avoided capacity addition would further get translated to avoided investment of Rs. 1,95,980 Crore. The resultant reduction in CO2 emissions would be 98.55 million tons.

19 Conversion factor as per BEE: 1MW≡ 5.19 million units.20 World Resources Institute(WRI) 2008 estimates.21 Ella Aglipay Delio, S. L. (2009, April). POWERING UP-The Investment Potential of Energy Service Companies in India.

Retrieved May 29th , 2011, from World Resources Institute: http://www.wri.org/publication/powering-up#data-sources

Source: Bhaskar Natarajan, “EE Finance in India—Some Progress and What Next? report presented at the Asia Clean Energy Forum, 2008, Asian Development Bank Headquarters, mainla, Philippines, June 3—5, 2008. Available at http://www.adb.org/Documents/events/2008/ACEF/Session17-Natarajan.pdf (Accessed on September 20, 2008)

figure 1. potential energy savings in india by sector (billion kwh)

Lighting, 70, 38.1%

Industrial, 49,26.7%

Commerical, 0.8,0.4%

Agriculture, 60,32.7%

Municipal, 3.7,2.0%


13

Chapter 3Significance of Indian SME SectorThe major segment for potential Energy efficiency is the industrial sector which accounts for 48% of the total energy consumed, 25% of which can be potentially saved. India’s 3 million SMEs22 constitute 80% of the total number of industrial enterprises in the country contributing 45% of industrial production, 17% to GDP23 and represents 40% of India’s exports. SME sector as per the Ministry of Small and Medium Enterprises is the largest single employment sector after agriculture, constituting about 45% of industrial sector employment. SME sector also plays a significant role in terms of balanced and sustainable growth, deployment of entrepreneurial skills, and represents the greatest potential to create new wage employment opportunities (World Bank)24 .

In order to be financially competitive, a large number of SMEs have been created in clusters in different parts of the country. It is estimated that there are around 390 SME clusters25 in India. Price and cost pressures are areas of high and increasing importance to SME units in the current environment of increased global competition. Unlike agriculture and some other sectors, energy prices are not explicitly subsidized for SMEs and these units face high energy costs for electricity and fossil fuels. The extreme price volatility witnessed in India in 2008 has significantly increased SME awareness of the importance of managing energy expenditures, especially for those industries where energy is a significant portion of production costs. Improvements in SME energy efficiency can have a significant total impact on total industrial sector energy consumption for the country as a whole26.

In the past, wide-ranging governmental programs of fiscal incentives and other interventions have been offered to SME units (primarily SSI units27 only) to address technology up graduation and productivity improvements but they have not resulted in large scale replication. SMEs especially those for whom energy costs represent a large portion of total production costs, can reap high direct economic benefits from improving efficiency of energy conversion and reduction of energy use, yet numerous barriers and market failures have prevented widespread adoption.

22 World Bank Project Appraisal Document, Report No. 54343-IN; April 2010 / World Bank study “Energy intensive sectors of the Indian Economy: Options for low carbon development.

23 Associated Chambers of Commerce India (ASSOCHAM) had calculated in 2008 that the direct contribution of SMEs to India GDP would rise from 17% to 22% by 2012. Other estimates attribute approximately 60 percent of the country’s GDP to the SME sector when including indirect contributions.

24 World Bank Project Appraisal Document, The Financing Energy Efficiency at MSMEs Project; Report No. 54343-IN; April 30, 2010 / World Bank study “Energy intensive sectors of the Indian Economy: Options for low carbon development”

25 List of Indian SME clusters is available at http://www.msmefoundation.org/indian_msmecluster.aspx 26 World Bank study “Energy intensive sectors of the Indian Economy: Options for low carbon development “27 SSI Units are Small Scale Industrial Units


15

Chapter 4Market Transformation for energy efficient economic developmentMarket transformation policies attempt to address a set of barriers through a mix of incentives, information, targets, and standards28. The concept of market transformation29 evolved from the demand-side management (DSM) experiences in North America and Sweden of power utilities in the 1980s and early 1990s. The utility- driven DSM programs used various methods including audits, information, rebates etc. to achieve a target penetration of a number of energy-efficient products. These programs typically sought to meet short-term energy efficiency objectives, such as energy savings per year without explicitly addressing the underlying market barriers that exist and hinder the long-term adoption of energy-efficient products and practices (Nadel and Latham, 1998). However, it has been observed that DSM programs have been producing sustained changes in the marketplace; i.e. changes brought about by a program persisted beyond the program’s stated goals.

Market Transformation in Indian ContextGreater use of energy efficient products and technologies is often constrained because of their high initial costs than that of less efficient products. The “first cost bias” needs to be overcome to initiate market transformation towards the preferential adoption of energy efficient products and technologies.

Although clean development mechanism (CDM)30 is an appropriate instrument which not only promotes energy efficient equipments but also helps pay for it, yet due to high transaction costs it is beyond the means of the typical small or medium projects related to energy efficiency. Therefore CDM has not been able to make an impact on the market for energy efficiency even though India accounts for about 30% of projects registered with UNFCC under CDM (mostly in renewable sector), its share in revenue from CDM is only 24% of global revenue, much lower than that of China which is about 40%. However international experience shows that when there is larger aggregation / bundling of the projects especially

28 Renewable Energy and Energy Efficiency Policy Analysis Report Prepared for: The Sustainable Energy Policy Initiative Department of Sustainable Development Organization of American States. Prepared by: Energy and Security Group; February, 2007.

29 Market transformation is a process whereby energy efficiency innovations are introduced in the market place and overtime penetrate a large portion of the eligible market. Once a new product or other type of innovation is introduced, its penetration begins to rise through early adopters. Penetration then “takes off “as awareness of technology and its advantages grows. The adoption process continues until market penetration levels off at “full market potential”. Market transformation involves ongoing and lasting change, such that market does not regress to lower levels of efficiency at some later time” (Geller and Nadel 1994).

30 The Clean Development Mechanism (CDM) is a facility for trading ‘certified emission reductions (CERs) between developing and developed countries, thus saving non-renewable carbon emissions by promoting renewable energy, energy efficiency and/or carbon sequestration projects in LDC’s. The purpose of the CDM is to help these latter countries meet their obligations under the Kyoto Protocol while at the same time promoting “sustainable” development in the former countries, thereby reducing the build-up of greenhouse gases (GHG). The critical element for the success of the CDM is the participation of a broad cross-section of buyers (ultimately from developed countries) and sellers (from developing countries) of CERs. Trading is the final step, which starts with project formulation, through successful implementation and then certification.- (Matthew Mendis and Keith Openshaw 2003).


16

with the involvement of public sector (as for example in China) CDM can make an impact on the market for energy efficiency the potential of which could be unlocked through ESCOs.

ESCO based investments in energy efficiency through government interventions has been identified31 as one of the key delivery options for market transformation in India. ESCOs can provide access to innovative financing that clients might not be able to acquire on their own, as well as reducing burdens to public budgets (Metz, 2007). ESCOs can meet the needs of both the client and the financial institution (ESMAP, 2006). In addition, for many energy efficiency projects that are small scale, and due to high transaction costs would not be undertaken by industrial, commercial or public sector clients on their own, ESCOs can perform a key role as bundlers of these projects, allowing them to proceed. They can also bundle the procurement of technology over several projects (Roy, 2006)32.

Thus Market Transformation for Energy Efficiency (MTEE) in Indian context would include:

1. Large scale Demand Side Management (DSM) in different sectors including Municipalities, agriculture, commercial building , distribution transformers, small and medium enterprises and aggregation of small DSM Projects and to manage the many and dispersed flows of small credits through ESCOs.

2. Development of robust ESCO Industry and

3. Addressing market failures33 through a comprehensive approach towards the removal of key barriers in the following areas:

a. Financing

b. Government initiatives and enabling policies

c. Fiscal/Tax incentives

d. Strong industry support

While some initial progress has been made in the area of removal of financing barriers for ESCO development in India there is almost negligible development in the area relating to providing fiscal and tax incentives under direct and indirect taxes to the SMEs sector and to the consumers for promotion of energy efficiency investments. A detailed discussion on barriers of ESCO development and implementation of energy efficiency in the SME sector in India and on the role of tax and fiscal incentives is provided in the later part of the paper. However, ESCOs in China, Brazil and the U.S. have made considerable progress in this regard.

31 National Roadmap for CDM – National Mission for Enhanced Energy Efficiency-Mission Document, June 2010.32 Energy service companies in developing countries: Potential and practice; International Institute for Sustainable

Development (IISD) , Jennifer Ellis, March 2009. http://www.iisd.org 33 Market failures include misplaced incentives, unpriced costs, unpriced benefits, distortionary fiscal and regulatory policies,

and costly, insufficient, or inaccurate information. Market barriers are other non-market failure obstacles that include low priority of energy issues, capital market barriers, and incomplete markets for energy efficiency.


17

Part I

ROLE OF ESCOs &

CLUSTER APPROACH


18


19

Chapter 5ESCOs in China, Brazil, United States and IndiaESCOs have been instrumental in bringing successfully the energy efficiency improvements and energy conservation in developed countries specially the U.S.A., OECD countries and Japan. ESCOs have evolved to a mature industry from simple energy auditing over the period of time in these countries. However ESCO is relatively a new concept for the developing and transition economies.

Brazil, China and India participated in the World Bank and UNEP’s supported 3 Country Energy Efficiency Program formally titled as “Developing Financial Intermediation Mechanisms for Energy Efficiency Projects in Brazil, China, and India” in order to substantially increase investments in the energy efficiency sector and also to share operational experiences in implementation of energy efficiency investment projects in the three countries. Although in all these three countries the ESCO industries started almost at the same time and are economies in transition yet the state of development of ESCO industry in the three countries differ considerably as is evident from the analysis given in the table below.

Table: 2 ESCO Country Statistics

Source: Investment Potential of Energy Service Companies in India, Ella Aglipay Delio, Saurabh Lall & Chandan Singh; World Resource Institute (WRI)

The World Resources Institute (WRI) analysis in the above table shows that for instance, Brazil’s energy consumption is only around 40 percent of India’s energy consumption, at about 224 million tons of oil equivalent, and its per capita energy consumption is 2.4 times larger than that of India’s, yet the aggregate revenue of Brazil’s ESCO industry is sixteen times greater than its Indian counterpart. China’s energy consumption is 3.3 times greater than India’s, and its per capita energy consumption is 2.8 times larger, yet the aggregate revenue of its ESCO industry is 6.8 times greater than that of India. The study concludes that although the Indian industry is growing at a fast rate, their cross-country comparative analysis underscores that it remains far from realizing its full potential.

Comparing India’s ESCO industry with Brazil and China will enable us to know what facilitated or hindered the growth of ESCOs in India. At the same time, comparing with the U.S. which has the most developed ESCO industry in the world will help in determining how the Indian industry is performing and what challenges it could expect in the future. It can also help to analyze factors that could either


20

contribute to or hinder the growth of the Indian ESCO industry and how effective ESCOs role can be in bringing large scale energy efficiency investments in Indian SMEs leading to unlocking of the EE market in this sector. Additionally, it can give insights as to how large ESCOs can be brought in to help remove market barriers for the EE investments in SME sector taking the advantage of existence of clusters in India. Keeping in view the similar characteristics like geographical location, markets, products manufactured, technology, development issues and common pool of resources, cluster based approach has often been undertaken while working with SMEs in china, Brazil and India.


21

Chapter 6ESCOs in ChinaRecent times have witnessed a very rapid increase in the number of ESCOs in China( also referred to as EMC, or Energy Management Company) and now playing an important role in achieving the objective of energy conservation in the country. One distinctive feature of China’s ESCOs is that the shared savings and guaranteed savings contracts are most sought-after. The largest number of ESCO projects implemented in China is found in the building sector (Zhao Ming, 2006).34

Chinese ESCOs are now targeting the huge potential in the large scale energy-intensive industries, like iron and steel and cement, where large quantities of heat is being wasted as there are no measures primarily due to lack of investment (Chen 2006) by the concerned industries. An important trend of recent origin indicates that several foreign ESCOs, primarily from USA and Europe, are involved in setting up subsidiaries in China (Zhao Ming, 2006), keeping in view the enormous potential in the country. One of the salient features of the ESCOs from Europe / USA is that they are keen to provide their own energy efficient technologies and are willing to operate the project as a partner in order to ensure adequate returns on their investment (Chen 2006)35.

(i) Financing ESCOs in China

The existence of a national loan guarantee program has been instrumental in giving a momentum to the development of ESCO industry in China. Starting in 1998, the World Bank and the Global Environment Facility36 (GEF) promoted the nascent Chinese ESCO industry by funding China’s first three officially recognized ESCOs established in Beijing, Liaoning and Shandong by the China Energy Conservation Project37. The ECSO industry adopted the shared savings business model. This model was able to work effectively because of donors’ funding38. In order to build on the success of the first three ESCOs in China, the Commercial Loan Guarantee Program received financing grant (26 million USD) from the World Bank and GEF. This introduced local financing institutions to the shared savings model by providing partial loan guarantees for

34 Zhao Ming, 2006. EMCA and China’s ESCO Industry. Presentation at the 2006 Conference on Energy Conservation in Buildings, Energy Performance Contracting and Financial Guarantee for Energy Efficiency Projects, Beijing, China, July 25-26, 2006.

35 ESCO Synthesis: An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana Ürge-Vorsatz, Sonja Köppel, Chunyu Liang, Benigna Kiss, Gireesh Goopalan Nair, Gamze Celikyilmaz; WEC ADEME project on energy efficiency policies; Central European University, 2007, World Energy Council. Retrieved from: http://www.worldenergy.org/documents/esco_synthesis.pdf

36 Programs financed by the Global Environmental Facility, the World Bank, UNDP, IFC, EBRD, IADB, and other overseas development agencies have supported the establishment and financing of ESCOs in many developing economies. The Global Environment Facility (GEF) is the primary energy efficiency investor, for instance, with $850 million in direct investment in 90 countries and nearly $6 billion in co-financing (GEF 2009).

37 Secretary General Zhao Ming, “EMCA and ESCO Industry Development in China,” report presented at CTI Industry Joint Seminar: Successful Cases of Technology Transfer in Asian Countries, China ESCO Association, March 7–8, 2007. Available at: http://www.resourcesaver.com/file/toolmanager/customo105c399f92027.pdf (accessed on June 3, 2011).

38 Ella Aglipay Delio, S. L. (2009, April). POWERING UP: The Investment Potential of Energy Service Companies in India. Retrieved May 29th , 2011, from World Resources Institute: http://www.wri.org/publication/powering-up#data-sources


22

energy performance contracting. Over time, the guarantee program has allowed ESCOs to secure their own financing. By 2009, the number of such shared savings model ESCOs had grown from the initial three to 502. The number of contracted projects has grown to 4,000, and the value of these projects had grown to Rmb 28 billion. (Neal Stender and Forrest L. Ye, 2010)39. The majority of the projects developed by ESCOs has been funded by the project operators as majority of the ESCOs are too small and consequently do not have the capacity to take the entire financial risk of the project. Further, there is a lack of awareness amongst the banks in China regarding financing energy efficiency projects through third party financing, as banks are conservative and require collaterals as a guarantees for any loan disbursed by them.

(ii) Government initiatives in China In 2006, the Chinese government launched an aggressive Five Year Plan (2006 – 2010) to reduce both energy consumption and emissions. Part of the plan involves decreasing the country’s energy intensity by 20 percent (Taylor, 2009). Many programs have commenced and very specific targets have been set for each of China’s provinces with regard to how much energy has to be saved. This has created a very receptive market for ESCO services in the last two years and is a key part of the reason for the massive growth in the Chinese ESCO industry from US $260 million in 2006 to over US $1 billion in 2007 (Taylor, 2009)40.

In order to further accelerate the Implementation of Energy Management Contracting to Promote the Development of Energy Saving Service Industry, the General office of China’s State Council, in April 2010, announced the following two phased general goals and policies for energy-saving retrofitting of existing facilities in China:

a) The first phase goals are to support both specialized and large scale ESCOs in order to establish a more active energy service market by 2012.

b) The second phase goals are to improve related mechanisms, to further expand the size and number of ESCOs, and to make EMC one of the major models for China energy-consumption retrofitting by 2015.

However during this process following major obstacles in the expansion of ESCO activities were identified:

unclear accounting treatment; •tax disincentives; and •Incompatibility with existing financing models.•

(iii) Tax/Fiscal Incentives in ChinaTo overcome the barriers relating to tax disincentives, unclear accounting treatment and incompatibility with the existing financing models the Chinese government expanded official incentives and support to Energy Service Companies (ESCOs) and their customers by specifying a number of tax clarifications and preferences that includes exemption from Enterprise Income Tax (EIT) for a period of three years, exemption from Value added Tax (VAT) and Business Tax (BT), government-encouraged financing, and direct government subsidies. (Neal Stender and Forrest L. Ye, 2010). For details on tax benefits please see Annexure-B.


The strong presence of a national ESCO association focused on market development has given the momentum to the Chinese ESCO industry in the past decade making the industry grow faster than

39 Neal Stender and Forrest L. Ye, O. H. (2010, June). Incentives for energy service companies- Rewarding Green Efforts. Retrieved May 30, 2011, from www.chinalawandpractice.com: http://www.orrick.com/fileupload/2741.pdf

40 WEC Energy service companies in developing countries: Potential and practice, Jennifer Ellis , March 2009. IISD


23

India. The existence and efforts of the national EMC Association of China (EMCA) is a second factor that has enabled the industry’s continuing high level of growth. The EMCA provides technical assistance to new market entrants and represents the industry to the government and potential customers in order to facilitate market development. (Ella Aglipay Delio, 2009). EMCA’s main activities include: assisting the Government in disseminating energy conservation policies and regulations; disseminating EPC nationwide; developing capacity building and establishing platforms for information exchange for member EMCos; conducting ESCO policy researches, etc. (Diana Ürge-Vorsatz et al. 2007, WEC).


The recent rapid development of the ESCO industry in China can be attributed to the factors such as large market potential in energy efficiency, international (WB/GEF Project) and governmental support which helped in strong financial support and the establishment of EMCA , good practices in managing credit risks, rising awareness of cost savings potentials through energy conservation in industries, transfer of advanced knowhow from foreign ESCOs and finally the foreign ESCOs used combination of EPC with the clean development mechanism (CDM) strengthening their ability to penetrate China’s huge energy efficiency market by bringing additional revenues which Chinese project operators can expect from the sales of carbon emissions reduction credits (Chen 2006). For details on enabling factors41 for Chinese ESCO industry please refer to Annexure C.

41 ESCO Synthesis: An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana Ürge-Vorsatz, Sonja Köppel, Chunyu Liang, Benigna Kiss, Gireesh Goopalan Nair, Gamze Celikyilmaz; WEC, ADEME project on energy efficiency policies; Central European University, 2007, World Energy Council. Retrieved from: http://www.worldenergy.org/documents/esco_synthesis.pdf


25

Chapter 7ESCOs in BrazilHigh inflation and dependency on imports of fossil fuels led to fuel shifting policies and the promotion of renewable energy sources in Brazil in the early 1980s. This made Brazil’s energy system one of the least carbon-intensive in the world (IEA, 2002). However, the high dependence on hydropower makes the Brazilian energy system vulnerable to natural conditions. For example, long draughts caused the electricity scarcity for the country in 2001 and 2002. This led, the Brazilian Government to cut electricity and implement rationing policies all over the country. The energy performance contracting came into existence much early and thus is not a new concept in Brazil, compared to other developing countries.(ESCO Synthesis). ESCOs in Brazil are mainly small and medium size companies, typically engineering firms or consultancy firms (El- Salmawy, 2006). Lighting projects are the most common type of their projects. However, there are also process control, motor drives and cogeneration projects (Monteiro, 2006)42.

(i) Financing ESCOs in Brazil

The Brazilian government has played a very active role in the financial support of ESCOs and energy efficiency projects in the form of two main initiatives: its utility wire-charge43 program and its national electricity conservation program. CONPET44 is an energy efficiency program for a sustainable use of resources managed by Petrobras for the Brazilian Government and is focused on the reduction of oil and natural gas consumption in Brazilian industry 45(Jennifer Ellis, March 2009. IISD).

Soon after the power sector reforms in 1995, Brazil introduced public benefit wire charge mechanism in 1998 which generated substantial funds to be used for energy efficiency and renewable energy investments. ANEEL46, the regulating agency of the power sector started with a mandatory “wire charge” of 1% of annual utility net revenues which were to be used by the utilities themselves for specified public benefit investment. The allocation of wire charge revenue has under gone significant

42 ESCO Synthesis An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana Ürge-Vorsatz, Sonja Köppel, Chunyu Liang, Benigna Kiss, Gireesh Goopalan Nair, Gamze Celikyilmaz; WEC ADEME project on energy efficiency policies; Central European University, 2007, World Energy Council. Retrieved from: http://www.worldenergy.org/documents/esco_synthesis.pdf

43 Wire Charges: Brazil’s Public Benefit Wire-Charge is a mechanism to collect revenues in an equitable manner to support energy efficiency and other public interest programs by way of levying a charge or fees on the utilities. A specified percentage of annual utility net revenues are mandated to be used, primarily by the utilities themselves, for the public benefit investment. Thus the wire-charge generates substantial funds to be used for energy efficiency and renewable energy investments and is an important source of investment in energy efficiency.

44 CONPET: http://www.conpet.gov.br/w3/ National Program for the Rational Use of Natural Gas and Oil Products (CONPET) is umbrella legislation for a variety of

projects aimed at reducing losses and eliminating waste in energy production and use, encouraging the adoption of more energy efficient technologies and delays the need for new investment in electrical stations and oil refineries. The Program targets the transport, industrial and commercial/residential sectors, setting energy efficiency indexes, reviewing technical standards, demonstrating incentives to reduce fuel consumption, and increasing public awareness about energy efficiency. http://projects.wri.org/sd-pams-database/brazil/national-program-rational-use-natural-gas-and-oil-products-conpet

45 WEC Energy service companies in developing countries: Potential and practice, Jennifer Ellis, March 2009. IISD 46 ANEEL: Agência Nactional de Energia Elétrica, Brazil’s electricity regulatory agency (known by the acronym ANEEL)


26

changes over the years and shows the gradually diminishing share allocated to energy efficiency from 0.90% in 1998-99 to 0.50% from 200747. All projects though initially were implemented on a grant basis, but later, the utilities were allowed to recuperate their energy efficiency expenditures under part of the wire-charge program. The returned funds could be used partly for new energy efficiency projects, and partly to reduce electricity rates for consumers. From 1998 to 2004, energy efficiency investments through the wire charge have increased from approximately US $35 million annually to US $76 million annually (Taylor et al., 2008). The regulated energy efficiency programs acted as Brazilian ESCOs main source of funding48. Some of the largest utilities in Brazil are increasingly outsourcing energy efficiency projects to ESCOs. For example, during 2002, 117 contracts were signed with ESCOs, representing about 20 percent of the investments in the energy efficiency utilities’ regulated programs. The type of projects is decided by the utilities and ESCOs compete for designing and implementing the projects. However, these contracts are not performance contracts but conventional engineering services contracts with remuneration on a cost–plus basis49. ESCOs in Brazil either finance their own projects via own capital or involve a third party for financing EE projects. The most common types of performance contracts are “guaranteed savings” and “first out” types (Monteiro, 2006). The biggest financial resource of ESCOs is the 1 % wire charge tax from utility companies: utility companies in Brazil have to allocate 1% of their revenues for either energy efficiency or R&D projects on energy efficiency (ESCO Synthesis).

(ii) Government Initiatives in Brazil

Brazil’s national electricity conservation program (PROCEL)50 was established in 1985. It funds or co-funds energy efficiency projects including research and development, education, labeling and standards and demonstration projects (Taylor et al., 2008). It has provided support for ESCOs which has been channeled through ABESCO, the Brazil association of energy service companies (Taylor et al., 2008)51. Brazil’s ESCO industry’s growth is basically because of the two major government initiatives taken by ANEEL (the Brazilian Electricity Regulatory Agency) and active role of the Brazilian Energy Service Company Association (ABESCO) which has led to larger capitalization of ESCO industries.

The two government initiatives were:

a) ANEEL made it mandatory for the utilities to invest 0.9% of their revenues in Energy efficiency projects including demand side projects and R&D efforts. Thereafter in 2007, the mandate was modified making it mandatory for the utilities to invest 0.5% of their revenues strictly in the demand side energy efficiency projects. This resulted in increase in investment of about 350 million Reais a year (150.5 million USD). The projects were approved by ANEEL and implemented by the ESCOs.

47 Financing Energy Efficiency. – Lessons from Brazil, China, India and beyond. Robert P. Taylor, Dhandrashekar Govindarajalu, Jeremy Levin, Anke S. Meyer and William A. Ward. 2008, The World Bank; The Energy Sector Management Assistance Program (ESMAP) available on www at: http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2008/02/18/000333037_20080218015226/Rendered/PDF/425290pub0ISBN11OFFICIAL0USE0ONLY10.pdf accessed on 10/07/2011.

48 ABESCO (2005a, 2005b).49 Financing Energy Efficiency. – Lessons from Brazil, China, India and beyond. Robert P. Taylor, Dhandrashekar Govindarajalu,

Jeremy Levin, Anke S. Meyer and William A. Ward. 2008, The World Bank; The Energy Sector Management Assistance Program (ESMAP) retrieved on 10/07/2011 from http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2008/02/18/000333037_20080218015226/Rendered/PDF/425290PUB0ISBN11OFFICIAL0USE0ONLY10.pdf

50 PROCEL is a federal agency funded by the government with more than 15 years’ experience in funding and developing energy conservation programs. PROCEL also receives assistance from and cooperates with European, Canadian, US and international agencies and experts.

51 WEC Energy service companies in developing countries: Potential and practice, Jennifer Ellis , March 2009. IISD


27

b) The second initiative was the creation of credit line of 100 million Reais in 2006, a loan guarantee fund for energy efficiency projects called “PROESCO” by the Brazil’s Bank for Social and Economic Development under the Ministry of Development, industry and Foreign Trade. By 2009 with the help of three major private banks and a second government bank acting a intermediaries were able to approve about 60-80 million Reais (USD 25.8 to 34.4 million USDs). The Brazilian National Development Bank (BNDES) shares upto 80 percent of the credit risk, while the remaining 20 percent is taken up by the intermediary bank. The guarantee fee is paid by the borrower (CRISIL, 2004)52 .

However recently, the Brazilian Government decided to totally cut the financial resources of ESCOs from the wire charge tax, which has so far been the Brazilian ESCOs’ main financial resource, because of some “macroeconomic and budgetary reasons”.

(iii) Tax / Fiscal Incentives in Brazil

The Brazilian government has often given priority to incentivize export-led production expansion over efficiency and productivity improvements. This created a business climate in Brazil to be a great barrier to energy efficiency. There are no tax incentives, such as import duty reduction, for energy efficient appliances and equipment, making it difficult for distributors of foreign equipment to find a “ready” market for energy efficient technology and equipment in the private sector. Brazil has made significant progress in reforming its legal system in recent years.53


The Brazilian ESCO Association (ABESCO) has been a strong lobbyist and promoter of ESCO industry which no organization in India could do. For example ABESCO was instrumental in persuading the three major private banks to become intermediaries to PRESCO line of credit.


Institutional framework in Brazil is suitable for the development of the ESCO Industry. There is a substantial potential for EE projects, and awareness for the need of such projects. Moreover, the financial programs that have been initiated by the Government have already led to the development of many ESCOs (Brazil Country Team. 2006). However, ESCOs in Brazil still suffer from scarcity of available capital, lack of information and experience by financial institutions about EE projects, and perceive the financial institutions for EE projects as “risky business” (Monteiro, 2006; Amaral, 2006)54 which complicate the sustainable ESCO sector development; but the ESCO industry can be considered as successful in Brazil. Today, many ESCOs believe that Energy performance contracting is a good or at least developing business in Brazil. One of the reasons of success of ESCOs in Brazil is the Financial support from the government. Unlike many other developing countries, Brazil has experienced active involvement of utilities in end-use efficiency programs starting from the 80’s (Global Energy Efficiency Initiative, 1991).

52 WEC Energy service companies in developing countries: Potential and practice, Jennifer Ellis , March 2009. IISD 53 Moving Markets for Energy Efficiency in Brazil – CORE International Inc. Website, retrieved on 22-07-2011 from http://

www.coreintl.com/projects/Signature_Projects/Moving_Markets_for_Energy_Efficiency_in_Brazil.html 54 ESCO Synthesis: An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana Ürge-Vorsatz, Sonja

Köppel, Chunyu Liang, Benigna Kiss, Gireesh Goopalan Nair, Gamze Celikyilmaz; WEC, ADEME project on energy efficiency policies; Central European University, 2007, World Energy Council. Retrieved from: http://www.worldenergy.org/documents/esco_synthesis.pdf


29

Chapter 8ESCOs in United States of America(i) Evolution and Development of ESCO- EPC delivery Model:

The American ESCO experience provides valuable lessons from the similarities and contrasts for energy efficiency financing in the emerging economies. Comparing with the mature ESCO industry in the U.S. can thus help to determine and devise strategies on removal of barriers for the Indian ESCO industry. The United States is described as the oldest and most mature ESCO market in the world (Goldman et al. 2005). However, activities are mainly concentrated in the public sector and in a limited number of states. Ever since the development of the ESCOs in Northern America in the late 1970s when in response to the growing energy prices due to oil shocks both in United States and Canada the Federal, state /provincial and local governments utilized ESCOs as a way to overcome barriers preventing implementation of energy efficiency projects in Public sector buildings. Energy performance contracting was slowly established as a viable, self-sustaining business activity. The ESCO Concept is now often presented as a model delivery mechanism for energy efficiency retrofits in developing countries and emerging market economies. The energy efficiency programs were first introduced in the public sector buildings known as ‘The Public Building Energy Efficiency Programs’ aimed to reduce energy expenditures and meet public policy goals of reducing energy use. The Federal, state/provincial and local governments needed firms with energy efficiency expertise and project implementation experience to develop projects that would have neutral cash flow i.e. no increase in capital or operating budgets while delivering cost effective investments. Energy performance contracting (EPC) was developed as a concept to deliver these objectives and the governments utilized ESCOs as a way to overcome barriers preventing the implementing the Energy efficiency projects. The success of the ESCOs and the EPC in the public buildings established the credibility of the delivery mechanism in the government as well as the financial Institutions and in due course of time the ESCO-EPC became the dominant model of Energy efficiency delivery mechanism within the Federal, state/provincial, and local governments and agencies to reduce energy use and to save the operating costs. Thus the development of ESCO industry owes significantly to the initial push by the active intervention, participation and facilitation of the governments at all levels55 .However the ESCO industry in United States has undergone change over years. The initial model of energy efficiency service delivery was shared savings model which was abandoned in 1980s due to excessive litigation over claimed savings and was eventually changed to guaranteed savings model where the government client take out the loan for financing the energy efficiency investment backed by ESCOs guarantee of the related energy savings. This guaranteed savings model continued to evolve and develop an increasing number of financing options. This model is now being used in almost 90% of the performance contracts. Thus the U.S. ESCO industry has undergone a major change in customer acceptability and composition.

55 Financing Energy Efficiency. – Lessons from Brazil, China, India and beyond. Robert P. Taylor, Dhandrashekar Govindarajalu, Jeremy Levin, Anke S. Meyer and William A. Ward. 2008 , The World Bank; The Energy Sector Management Assistance Program (ESMAP) available on internet at http://wwwwds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2008/02/18/000333037_20080218015226/Rendered/PDF/425290PUB0ISBN11OFFICIAL0USE0ONLY10.pdf accessed on 10/07/2011.


30

By 2000, U.S. ESCO industry project investment reached to whopping 2.1 billion US $. During the 1990s, in the first half of the decade, the industry grew at a 24% annualized rate. With saturation and maturity of performance contracting in the institutional market and the upheaval and uncertainties created by electricity restructuring and retail competition in certain states between 1996 and 2000 the industry underwent a concentration process resulting in the slowing down of revenue growth to 9% per year.56

(ii) Financing ESCOs in the United States

The initial push to the U.S. ESCO industry was given by the Federal Grants provided under the Federal Institutional Conservation Program in late 1970s for energy efficiency improvements in the State Public schools and hospitals administered by the state energy offices. Federal grants were provided for both technical assistance and capital investment and an equal share of capital were also required by the nonfederal sources. Since Federal rules allowed nonfederal share to include payments from performance contracting with private partners, this led to the state and local officials to seek out private partners as a means of providing nonfederal funding as well as their expertise in developing and implementing EE Projects. The program was implemented by almost 50 state energy offices and was driven by the “use or lose” policy which resulted in extensive replication by ESCOs over the large potential market armed with the innovations and the lessons learned from the early implementation of the Program. With the passage of time the success and growth in ESCO industry built up confidence amongst the financial institutions which became more aware on the economics of the EPC. At the same time the energy offices became the main advocates of the EPC by ESCOs in public buildings (Robert P. Taylor, 2008).

Subsequently, guaranteed savings ESCO projects financed through tax exempt leasing arrangements became an important financing mechanism for energy efficiency investments in the institutional sector in the United States. (Robert P. Taylor, 2008) This financing mechanism has the following advantages:

a) The projects can be included in the operating budget rather than in the capital budget.

b) They require no voter or legislative approval;

c) The projects can be established as Master Lease, allowing continuous drawdown of funds as needed;

d) The projects are long term (10-15 years) ; and

e) They can be more easily approved within government procurement systems than a capital budget item.

In the US, banks now finance almost all energy performance contract projects. The clients are able to get their projects financed directly with a financial institution rather than the ESCO. The reason is that there is greater awareness amongst the Banks regarding the savings potential that can be achieved through an experienced ESCO and therefore easy availability of capital and better interest rates that they can obtain.57 (Ella Aglipay Delio, 2009)

(iii) Government initiatives in United States

The Public Utility Regulatory Policies Act (PURPA), passed in 1978 by the United States Congress as part of the National Energy Act was meant to promote greater use of domestic renewable energy. The law forced regulated, natural monopoly electric utilities to buy power from other more efficient producers, if that cost was less than the utility’s own “avoided cost” rate to the consumer; the avoided

56 Review of U.S. ESCO Industry Market Trends: An Empirical Analysis of Project Data, Charles Goldman, Nicole Hopper, Julie Osborn, LBNL Environmental Energy Technologies Division, January 2005. Available on www at http://eetd.lbl.gov/EA/EMP/reports/52320.pdf

57 ICF International, Introduction to Energy Performance Contracting (Washington, DC: National Association of Energy Services Companies, October 2007). Available at http://www.energystar.gov/ia/partners/spp_res/Introduction_to_Performance_Contracting.pdf


31

cost rate was the additional costs that the electric utility would incur if it generated the required power itself, or if available, could purchase its demand requirements from another source58 (Goldman et al., LBNL 2005).

US Energy Policy Initiatives comprised of various government enabling policies to stimulate US ESCO industry development. They included:

Utility Demand Side Management through Public Benefit Programs such as REEPs •State and Federal Enabling Legislation promoting performance contracting by legislation•Other support for procurement processes that encourage performance contracting.•

For details on policies that were intended to stimulate U.S. ESCO industry development and their potential impacts please see Annexure-V.

With these developments the ESCO industry became a formidable force in Energy efficiency financing and implementation in the U.S. According to the Lawrence and Berkley National Laboratory the US ESCO industry accounted for energy efficiency projects (institutional and private sector) of at least US$16 -20 billion between 1990 and 2000. The institutional sector accounted for 75% of project investment and the remainder by the private sector. (Robert P. Taylor, 2008).

Besides the above initiatives, the U.S. government in an attempt to combat the growing energy problems passed The Energy Policy Act of 2005 (EPACT) changing the U.S. energy policy by providing tax incentives and loan guarantees for energy conservation of various types. The following section deals in detail the various energy efficiency tax incentives provided between 2005 and 2011 and the lessons learned from the Federal energy tax incentives.

(iv) Tax/Fiscal Incentives in United States

Initially the Energy Policy Act (EPAct) of 1992 set goals, created mandates, and amended utility laws to increase clean energy use and improve overall energy efficiency in the United States. The Act provided incentives for clean and renewable energy, provided incentives for energy conservation in buildings and directed the federal government to increase energy conservation in federal buildings, integrate the use of alternative fuel vehicles in federal and state fleets, authorized tax incentives and marketing strategies for renewable energy technologies in an effort to encourage commercial sales and production.

Thereafter, The EP Act 2005 established a comprehensive scheme for energy efficiency tax incentives in the three sectors: Residential, Commercial and Transportation and was the first in the series of energy legislation that has advanced market transformation for a number of key products. These were the first major federal energy efficiency tax incentives in two decades. The main purpose of these incentives60 was to increase the market share of advanced energy efficiency products and encourage home and business owners to undertake energy efficiency improvements. Tax incentives were designed to cover the highest levels of efficiency ( e.g. equipment and practices with less than 5% market share) sold in 2005 in order to minimize the “free riders”61 and keep costs to the Federal treasury down62.

58 Review of U.S. ESCO Industry Market Trends: An Empirical Analysis of Project Data, Charles Goldman, Nicole Hopper, Julie Osborn, LBNL Environmental Energy Technologies Division, January 2005.Available on www at http://eetd.lbl.gov/EA/EMP/reports/52320.pdf

59 REEPs: Rate Payer Funded Energy Efficiency Programs60 Tax credits have been preferred over tax deductions as tax incentives. The rationale behind introducing the tax credits

instead of tax deduction was that a tax credit is generally more valuable than an equivalent tax deduction because a tax credit reduces tax dollar-for-dollar, while a deduction only removes a percentage of the tax that is owed. Consumers can itemize purchases on their federal income tax form, which will lower the total amount of tax they owe the government.

61 Free Riders- are tax credit participants who would have purchased eligible products even if tax credits were not available.62 Assessing the Harvest: Implementation of the Energy Efficiency Provisions in the Energy Policy Act of 2005; Rachel Gold

and Steve Nadel Energy Efficiency Tax Incentives, 2005-2011: How Have They Performed? Rachel Gold and Steven Nadel, June 2011. (An ACEEE White Paper). Available at : http://www.aceee.org/files/pdf/white-paper/Tax%20incentive%20white%20paper.pdf


32

The energy efficiency incentives and policies established by the federal government, state governments, U.S. territories, larger local governments and larger utilities can be categorized into two groups63 (DSIRE):

Financial Incentives• for energy efficiency include a variety of tax incentives such as: corporate tax incentives-tax credits, deductions and exemptions, personal tax incentives- income tax credits and deductions, Property tax incentives- exemptions, exclusions, abatements and credits and sales tax incentives. Financing incentives include: rebates, grants, leasing and loan programs, PACE64 financing, Performance based incentives (PBIs), utility rebate discounts, green building incentives and other incentives like industry recruitment support etc..Rules, Regulations & Policies• include appliance/equipment efficiency standards, public benefits funds, and construction & design standards (including building energy codes and energy standards for public buildings).

For details of tax and financial incentives and rules and regulation, please see Annexure E65

It can be seen that the Energy Policy Acts enacted from time to time focused on giving tax incentives to the consumers and the customers that is the end users. However as regards to the ESCOs it seems that instead of providing tax incentives directly to the ESCOs the government promoted enabling laws facilitating the entry of ESCOs in Public Utilities and Federal buildings and supporting them with financing. Similarly in case of corporate tax incentives which include tax credits, deductions and exemptions are available only if corporation has invested a minimum amount in eligible projects mostly related to renewable energy technologies. These incentives are usually designed as temporary measures to support industries in their early years. They commonly include a sunset provision to encourage the industries to become self-sufficient. Analyzing the status of energy efficiency tax incentives based on the review of performance of the existing Federal energy efficiency tax incentives between 2005 and 2011 in their latest report “Assessing the Harvest: Implementation of Energy Efficiency provisions in Energy Policy Act of 2005”, Gold and Nadel (2011) have concluded that the incentives have been largely successful in moving the products and processes along the market transformation curve. “The main lessons were the importance of education and the stake holder engagement, of “getting the details right” and of carefully considering the market conditions and barriers to product acceptance in order to choose the best policy or actions to address them (Rachel Gold and Steve Nadel, 2011)66 .” The major lessons learned include the importance of Market Certainty and tying Market Actor Education to Legislation that is education of consumers and key actors in the supply chain is essential for tax incentives.Energy efficiency policies like tax incentives are aimed at market transformation efforts67 which work best when they are systematically reevaluated and updated throughout the lifetime of the effort. For example the energy savings standards were gradually made more and more stringent for claiming Tax incentives for energy efficient The tax incentives pushed the market for energy efficient appliances forward ensuring that the next standard would achieve higher levels of energy savings cost efficiently. The three main

63 The Database of State Incentives for Renewable Energy (DSIRE) maintains comprehensive information on state, local, utility and federal incentives and policies that promote renewable energy and energy efficiency. Established in 1995 and funded by the U.S. Department of Energy, DSIRE tracks energy efficiency incentives and policies established by the federal government, state governments, U.S. territories, larger local governments and larger utilities.

64 PACE : Property Assessed Clean Energy financing65 Retrieved from Website: http://www.dsireusa.org/incentives/index.cfm?state=us&re=1&EE=166 Assessing the Harvest: Implementation of the Energy Efficiency Provisions in the Energy Policy Act of 2005; Rachel Gold

and Steve Nadel Energy Efficiency Tax Incentives, 2005-2011: How Have They Performed? Rachel Gold and Steven Nadel, June 2011. (An ACEEE White Paper). Available at : http://www.aceee.org/files/pdf/white-paper/Tax%20incentive%20white%20paper.pdf

67 Market Transformation efforts are strategic intervention in a market to create lasting change in market behavior by removing identified barriers or exploiting opportunities to accelerate the adoption of cost effective energy efficiency. These energy efficiency tax incentives were aimed at removing barriers toward sthe beginning of the market transformation curve, to encourage greater adoption of technologies with low market share.


33

reasons for the success were that the incentives were uninterrupted, robust stakeholder involvement and education and that the incentives were well timed. In contrast there were interruptions for the residential HVAC and building envelop tax incentives and lower involvement of stakeholders during negotiations about commercial building tax deductions and so there was unevenness in the treatment of HVAC and whole building improvements versus lighting in the bill. In conclusion, the tax credits have been quite successful in cases of energy e residential efficiency improvements in residential sector through the appliance manufacturers and new home builder incentives. Moderate success was achieved in residential insulation and HVAC tax credits. The hybrid vehicles tax credit helped expand domestic car manufacturer’s participation in hybrid market. The commercial building tax deduction helped improve the efficiency of commercial buildings which were much more successful for lighting improvements than for building envelope and HVAC measures. The window incentives lead to massive sale of windows but suffer from high levels of “free riders”.(v) Industry SupportThe most important ESCO association in the United States, named National Association of Energy Service Companies (NAESCO), comprises about 100 members at the moment (NAESCO 2006). For more than 20 years, it has been the major representative organization of the US ESCO industry, providing technical and informational support to its members as well as an accreditation program (NAESCO 200668). (vi) Perception of ESCOsSince early 1990s, ESCOs investment in energy efficiency retrofits at public and institutional facilities in the United States reached $15-19 billion (NAESCO 2005). Most of these ESCO projects were at no cost or a negative cost to the government. Since 1998, $1.9 billion in private-sector funds has been invested in energy efficiency projects at federal facilities. The reasons for success were a combination of enabling federal legislation and governmental programs including public benefit charges, electricity restructuring, utility DSM programs, customer education and information as well as DSM bidding that had facilitated the development of the ESCO-market in the USA. The public sector has played a very important role and is still by far the major ESCO target area in the US. Due to supportive legislation, public institutions can enter into multi-year financial commitments and make their procurement decisions more flexible favoring ‘‘best value’’ proposals rather than lowest cost bids (Goldman et al. 2005). Other enabling factor in enhancing energy efficiency in the United States was the important role played by the Super ESCOs. The so-called Super-ESCOs in the US ESCO market69 acted at the same time both as energy providers and as energy service companies. Super Energy Service Performance Contracts (ESPCs) are indefinite-delivery, indefinite-quantity (IDIQ) contracts established by the Department of Energy (DOE) and aimed at increasing the practicality and cost-effectiveness of ESPCs and thereby their use by federal agencies (FEMP 2007). These general contracts were competitively awarded to ESCOs who demonstrated that they were able to provide energy projects to federal customers. As the general terms and conditions are defined in the IDIQ contracts and agencies implement projects by awarding delivery orders to the Super ESPC ESCOs, this concept can be implemented much faster than a normal ESPC project. The Federal Energy Management Program’s Regional Super ESPCs are confined to specific U.S. regions whereas Technology-Specific Super ESPCs grant access financing for several advanced energy technologies to any facility (FEMP 2007)70.


69 The evolution of the U.S. ESCO Industry: From ESCO to Super ESCO, Edward Vine, Nakagami H., Chiharu Murakosh, October 1998; Environmental Energy Technologies Division, Ernest Orlando Lawrence Berkley National Laboratory.



35

Chapter 9Super ESCOs- The ConceptThe concept of super ESCOs has evolved from the United States where Super ESCOs are referred to as the energy service companies that provide traditional energy services and supply gas and/or electricity (and/or other fuels) to customers (examples: Duke Solutions, Edison Source, Enron Energy Services, PG&E Energy Services, and X energy). Thus in U.S. the Super ESCO is a large ESCO that provides both energy efficiency as well as energy procurement services. Super ESCOs are becoming key players in providing energy and energy-efficiency services to utility customers and utility companies are expected to be either competing or partnering with Super ESCOs.

However, recently, to overcome some of the financing and implementation barriers to the large scale implementation of energy efficiency projects in the developing countries, the concept of Super ESCO has got modified. For developing countries the Super ESCO model can be “defined as an entity that is established by the Government and functions as an ESCO for the public sector market (hospitals, schools, municipalities, government buildings and other public facilities); and also support capacity development and project development activities of existing private sector ESCOs including helping create new ESCOs (Limaye and Limaye 2011).71

The Super ESCOs are capitalized with sufficient funds by the government to undertake public sector ESPC projects and to leverage commercial financing. A Super ESCO can also be established by a private sector organization, an NGO, or as public private partnership72; although there are very few known examples of such Super ESCOs.

Figure: 2 Illustration of a Super ESCO - The EC2 Corporation in the Philippines.

Source: Hasnie, Sohail, “ESCOs in the Philippines”, presentation at the Workshop on ESCOs and Energy Efficiency Projects, Asian Development Bank, January 200973.

71 Scaling up Energy Efficiency: the Case for a Super ESCO; Dilip R. Limaye, Emily S. Limaye. Review Paper, Energy Efficiency (2011) 4:133-144 Avilable on internet at http://www.springerlink.com/content/764u30527m73j354/

72 For example: Berliner Energieagentur. See Geissler 2008.


36

A primary function of the Super ESCO is financing that is to facilitate access to project financing by developing relationships with local or international financial institutions. The Super ESCO may also provide credit or risk guarantees for ESCO projects, or act as a leasing or financing company to provide ESCOs and/or customers EE equipment on lease or on benefit-sharing terms”74. Super ESCOs have been identified as potentially viable model for the developing countries by the World Bank study based on international experience in public procurement of energy efficiency services. (Singh et al 2009)75 With the advantage of size and credibility as a public institution on their side, a Super ESCO is uniquely placed to overcome a number of barriers faced by the smaller ESCO companies. For example in the private sector, the Super ESCO can play a major role in providing technical assistance, training, capacity development and implementation of the EE projects using private sector ESCOs as implementing agents, thereby increasing their level of competence and experience. In public sector Super ESCOs can target huge untapped energy efficiency market by providing project financing to address the budgeting issues of public agencies because Zero budgeting policy of many governments provides little incentive for saving energy costs. Super ESCO can develop incentive mechanisms for public agencies. (Limaye and Limaye 2011). Consequently, the Super ESCOs can act as vehicle for facilitating large-scale implementation of energy efficiency projects.

(i) Some International examples of Super ESCOs

Besides United States there are several countries where Super ESCOs have been set up such as FEDESCO established by the Belgian federal government in 2005. It provides professional energy services and innovative financing and energy savings performance contracting to the private ESCOs. Hravatska Electro-privreda (HEP) ESCO of Croatia offers EE services to public and private clients. Philippines’s EC2 Corporation was established with the help of Asian Development Bank in 2009 to develop and implement the energy efficiency projects in the public sector facilities and to help support the development of private sector ESCO operations for private facilities in Philippines. In China the Fakai Scien¬tific Electricity Services Limited Corporation, was formed as a Super ESCO, to encourage, promote, and implement energy efficiency and DSM projects in the Hebei Province of China. Indian government has recently set up a public sector corporate entity M/s Energy Efficiency Services Ltd (EESL)76 for implementing entity for energy efficiency improvements in India. Although it is not established as a Super ESCO as it will not be an energy supplier yet it would be performing most of the functions that are normally conducted by a super ESCO.

73 Scaling up Energy Efficiency: the Case for a Super ESCO; Dilip R. Limaye, Emily S. Limaye. Review Paper, Energy Efficiency (2011) 4:133-144 Avilable on internet at http://www.springerlink.com/content/764u30527m73j354/ and India Infrastructure Report 2010, Infrastructure Development in Low Carbon Economy- Chapter 8, Drivers for energy efficiency Industries by Lenora Suki

74 Scaling up Energy Efficiency: the Case for a Super ESCO; Dilip R. Limaye, Emily S. Limaye. Review Paper, Energy Efficiency (2011) 4:133-144

75 Singh, J., Limaye, D., Henderson, B., & Shi, X. (2009). Public procurement of energy efficiency services: Lessons from International experience. The World Bank, November 2009.

76 EESL website http://www.eesl.co.in/Website/Portals/0/Tender/Recruitment%20Final.pdf


37

Chapter 10ESCOs in China, Brazil and United States – Lessons LearnedLessons Learned from ESCOs in China77

China launched an aggressive expansion plan of ESCO industry to meet the large market demand. For further development of ESCOs- EPC, China undertook steps to enhance the capacities of ESCOs both internally and externally. Internally, by enhancing their capacity in market development, securing project financing, and risk management as well as project implementation and externally, by the government lead EE promotion policies especially establishing financial and public procurement policies. China introduced the energy strategy of “insisting on both resource development and resource conservation with the conservation as the first priority”. Numerous energy-efficiency polices were adopted that successfully reduced energy use while the economy grew at a rapid pace. Through these programs China was able to decouple energy use from economic growth, allowing the nation to industrialize without draining the national budget to pay exorbitant energy costs that would have occurred without such a concerted effort (Sinton et al., 1998).Simultaneously, the Energy Foundation’s China Sustainable Energy Program (CSEP) has undertaken a major project investigating fiscal and tax policy options for stimulating energy efficiency and renewable energy development in China. China has recently introduced two phase energy efficiency development policy and undertaken major steps to boost energy efficiency investments in Industry by providing comprehensive scheme of tax and fiscal incentives.Standardization of the energy audit, monitoring and verification, making enforceable the existing measurement and verification protocols that are internationally acknowledged, such as the International Performance Measurement and Verification Protocol (IPMVP) are some of the important enabling factors for ESCOs development in China.

Lessons learned from ESCOs in Brazil

The Brazilian government has played a very active role in the financial support of ESCOs and energy efficiency projects in the form of two main initiatives: its utility wire-charge program and its national electricity conservation program and the active role of the Brazilian Energy Service Company Association (ABESCO) which has led to larger capitalization of ESCO industries.

Lessons learned from ESCOs in U.S.

ESCOs in the United States work mainly with the public sector. The reasons for success were a combination of enabling federal legislation and governmental programs including public benefit charges, electricity restructuring, utility DSM programs, customer education and information as well as DSM bidding complimented with well-established US contract law, reasonable interest rates and good relationships



38

with customers facilitated the development of the ESCO-market in the USA. ESCOs have demonstrated that performance contracting, in combination with other supporting policies, can be used to address and overcome many market barriers that inhibit energy-efficiency investments among large institutional, public sector customers78. The US experience has shown that the government should not exclusively provide financial support to ESCOs, but design ESCO-friendly legal systems with modified government procurement practices (“best value” instead of lowest bid approach), as well as provide incentives or even requirements for public buildings to be improved under EPC. (Goldman et al.; 2005)79

The important lessons from collaborative study80 conducted by the NAESCO and Earnest Orlando Lawrence Berkley National Laboratory (LBNL) on 1500 completed ESCO projects in U.S. are:

First, appropriate policy support can stimulate viable private sector ESCO industries that deliver •significant economic and environmental benefits. Performance contracting works best in a business environment where there is a well-established contract law.

Second, policy mechanisms need not be strictly financial. Analysis shows that enabling legislation, •regulations, and information/training can be just as effective as project subsidies. Financial support for an “infant industry” and incentives to customers will most likely be necessary to jump-start an ESCO industry. However, based on U.S. experience, over time an increasing share of projects can be developed by ESCOs without direct financial incentives. Thus, there is the potential for a viable self-sustaining private sector energy efficiency industry to develop that offers services to large customers.

Third, government leadership in the form of policies that promote energy efficiency in federal, •state and local government buildings can be effective at promoting energy efficiency by signaling that it is an important priority, while encouraging development of a private sector energy efficiency services industry.

Fourth, ESCOs and the performance contracting business model will not overcome barriers •to energy efficiency in all market segments. To achieve optimal levels of energy efficiency in society as a whole, it is important to encourage investment in all sectors, some of which may be best served by small, localized contractors, other types of service providers, or other policy strategies such as building and appliance codes and efficiency standards. Thus, there is still a strong argument for targeted policy support.

Finally, significant change has occurred in the number and composition of ESCOs, their business •strategies, and mix of products and services. In the U.S., over the last 15 years, the ESCO market has shifted away from “shared savings” to “guaranteed savings” type contracts and has survived a declining market share for “performance based” contracts and entry by major new competitors such as retail energy service providers.

78 Based on conclusions drawn by a collaborative study conducted by the NAESCO and Earnest Orlando Lawrence Berkley National Laboratory (LBNL) on 1500 completed ESCO projects in U.S.

79 Review of U.S. ESCO Industry Market Trends: An Empirical Analysis of Project Data, Charles Goldman, Nicole Hopper, Julie Osborn, LBNL Environmental Energy Technologies Division, January 2005. Available on www at http://eetd.lbl.gov/EA/EMP/reports/52320.pdf

80 Based on conclusions drawn by a collaborative study conducted by the NAESCO and Earnest Orlando Lawrence Berkley National Laboratory (LBNL) on 1500 completed ESCO projects in U.S.


39

Chapter 11ESCOs in India(i) Growth of Indian ESCOs

The ESCOs in India, in contrast to its fairly matured energy audits market, are a fairly new concept, which appeared for the first time in 1994-95. The beginning of the Indian ESCO industry can be attributed to the USAID supported EMCAT Program in the mid-1990s when some energy auditors / consultants from India went on a study tour to USA and some of the US based energy specialists came to India for training on the ESCO project development. This led to the establishment of three ESCOs in India viz. Thermax-EPS, Bohruka-Intesco and Saha-Sprague, each with some collaboration or tie up with a U.S. based ESCO. The Indian ESCO industry has continued to grow since then and a wide range of projects have been executed in different sectors ranging between USD $ 3000 to U.D. $ 2 million (World Bank et al, 2006) with attractive average payback period between 1 and 3 years for most of the energy efficiency projects undertaken by ESCOs.

Also there has been international support for capacity building of ESCOs in the country during the last 5-6 years for example the Energy Conservation and Commercialization (ECO) Project by USAID, the Three country Energy Efficiency Project (3 CEE project) of China, Brazil and India by the World Bank and UNEP.

ESCOs’ have focused primarily on buildings and lighting so far, 36 per cent of their business in India and well-managed ESCO-led projects have had short payoff times (as short as 1–2 years), solid IRRs and low risk profiles.81

In India, despite implementing a number of demonstration projects in the public, commercial and industrial sectors (Cherail, 2005), ESCOs have not achieved a critical mass in terms of numbers. Indian ESCOs are generally small in size and weak in asset base (Sridharen, 2005). The typical size project in India is small (US $0.1 to 1.1 million) and payback is usually within two years (Sridharen, 2005). Most projects have been financed by the client and are undertaken in accordance with the guaranteed savings scheme; however there are many shared savings projects also. (Roy, 2003).

Although no comprehensive data is available on ESCOs in India however a recent WRI conducted survey82 on 24 ESCOs in India determined that “in 2007, the revenues for these twenty-four companies’ ESCO services were more than INR 8,640 lakhs (USD 17.7 million) 13. The six largest companies earned INR 7, 258 lakhs (USD 14.8 million), which accounted for 84 percent of the industry’s revenues. From 2003 to 2007, revenues grew at a compounded annual growth rate of 95.6 percent, from a low base of less than 500 lakhs (USD 1.02 million)”.

Nonetheless, as the energy efficiency and conservation potential is huge in India, the ESCO industry is expected to continue growing in the coming years.

81 World Resources Institute, New Ventures India 2009. / India Infrastructure Report 201082 Powering Up: The Investment Potential of Energy Service Companies in India by Ella Aglipay Delio, Saurabh Lall and

Chandan Singh; WRI


40

Figure: 3 Indian ESCO Industry Revenues (INR lakhs) & Year Over Year Growth (%)

Source: POWERING UP: The Investment Potential of Energy Service Companies in India; Ella Aglipay Delio, Saurabh Lall and Chandan Singh. WRI

The present ESCO industry comprises:

Consultant ESCOs: These ESCOs are run by the energy auditors (EAs) or technical or engineering •consultants with small operations some of them engaged in performance contracts with their clients.

Vendor Driven ESCOs: Some of the equipment manufacturers also offer ESCO type services. •They may have some intellectual assets, in the form of some EE equipments which they have marketed successfully.

General ESCOs: An ESCO not owned or operated by an equipment manufacturer or an energy •supplier. (WRI 2011)

(ii) Types and activities of ESCOs:

The ESCOs in India can be broadly classified into two types, i.e.

Equipment related and •

Service-related ESCOs. •

The equipment linked ESCOs generally manufacture/provide one set of products, like lighting, whereas service providers cater to different sectors. A few of the ESCOs, especially equipment manufacturers, have taken up the ESCO projects as joint ventures with foreign companies. ESCOs in the country undertake a broad range of projects in different customer categories like in private industries, commercial and government buildings, power utilities and municipal corporations (Sridharan, 2005). According to WRI’s survey, the average energy savings per implemented ESCO project was between 21 and 25 percent.

(iii) Number, size and location of Indian ESCOs:

Number:

Although twenty six ESCOs are reported to be operating in the country (WRI, 2007) according to the industry practitioners, currently only around twelve may be seriously doing ESCO business (ESCO Synthesis). At present there are 89 ESCOs accredited with the BEE as of October 2010. Out of these only 9 of them have been classified as grade 1 and 21 ESCOs are grade 2. The balance 56 ESCOs are in the grade 3 or 4 category on the scale of 1-5(with grade 1 the best). While the Grade five companies are 3. Grading is done to highlight the ability of an energy service company (ESCO) to undertake energy efficiency projects. The grading is expected to aid ESCOs in successfully bidding for Energy services projects and to arrange financing for the execution of such projects83.

83 BEE web site www.bee-india.nic.in retrieved on 22-07-2011 from U.P. State Designated Agency web site http://www.upsda.in/files/List%20of%20ESCOs%20as%20on%2021-10-1010.pdf

Indu

stry

Rev

enue

(IN

R la

khs)

2003 2004 2005 2006 2007

Source: WRI Indian ESCOs Survey, 2008.

10,000

8,000

6,000

4,000

2,000

0


41

Size:Except a few, the ESCOs in the country are small or medium scale private players with consultant strength of five or less. Most of the ESCOs in the country operate from a single state with no branch offices. Many of them are formed by former energy auditors or engineering consultants that started with a small asset base.Location:The ESCO companies are located in only a few states and the majority of the ESCO industry has grown mainly in three regions, clustered around the cities of Delhi in Northern India, Hyderabad, Bangalore and Chennai in southern India and Mumbai, Pune, in Western India. The reasons for high concentration of ESCOs in these regions are the high concentration of industries.

(iv) Financing of ESCOs in IndiaThe ESCO projects in India are generally carried out under the guaranteed savings scheme but in a few cases the shared savings scheme is also used. The Indian Renewable Energy Development Agency Ltd (IREDA), is a prominent organization in India in Energy Efficiency financing. The World Bank has extended a Line of Credit to IREDA for developing and financing energy efficiency and conservation projects that includes project implemented in ESCO model (including performance contracting and revenue sharing).India’s participation in the World Bank supported “Three Country Energy Efficiency Project (3 CEE) , led India’s five largest banks to establish small energy efficiency lending programs, which are expanding and attracting some attention . These five prominent banks Viz. State Bank of India (SBI), Canara Bank, Union Bank of India, Bank of India and Bank of Baroda launched EE schemes for SMEs clusters. The 3CEE project completed in 2006, aiming to increase energy efficiency investment in the country, was a major initiative towards capacity building of ESCOs. The Indian commercial banks mentioned earlier have introduced energy efficiency schemes in their portfolio targeting SMEs. Some of these banks have some incentive schemes in place as well, like partially covering the cost of energy audit and detailed project preparation The newly launched ECO III project by USAID has deliverables to build capacities of ESCOs like, developing specific Monitoring & Verification protocol across sectors suitable to Indian conditions, to improve the marketing and concept selling skills of ESCOs etc.(v) Government Initiatives and PoliciesIndia has offered support to the ESCO industry primarily through policy development. The Indian government enacted the Energy Conservation Act in 2001 (EC Act) and established a Bureau of Energy Efficiency (BEE). Mandatory energy auditing in designated consumers has been a key driver of the ESCO industry in India (CRISIL, 2004). The EC Act also aims to strengthen the delivery mechanism of energy efficiency services, which targets capacity building of ESCOs. Furthermore, the National electricity policy (2005) suggests that energy conservation will be adopted in all government buildings for which the energy saving potential is estimated to be30%. Building codes, requirements for appliance standards and labeling and accreditation for energy managers and auditors have also been established (Sridharen, 2005). The India Industry Program for Energy Conservation (IIPEC) was also launched (Roy, 2003). These initiatives all gave ESCO business somewhat of a boost (Cherail, 2005). BEE has enlisted ESCOs for government building EE projects (Sridharen, 2005). However it is argued that the EC Act is not being enforced strongly (Dhingra and Julena, 2005), and there is weak or no legal framework to safeguard ESCO contracts (Sridharen, 2005). The main Energy Efficiency Policies of Government of India are given in Annexure F.

(vi) The Energy Efficiency Services Limited (EESL).

Government of India has recently set up a national level organization called M/s Energy Efficiency Services Ltd (EESL)84 as a public sector corporate implementing entity for energy efficiency improvements in



42

India. The government considers that if the energy efficiency market is to take off, a separate implementing agency is essential, which can address all the issues, overcome barriers to investing in energy efficiency projects, and lead the market by implementing energy efficiency projects. The EESL would fit into this role well and would push the energy efficiency market further.85 Although EESL is not formally designated as a Super ESCO but the nature of role envisaged for this organization makes it similar to what Super ESCOs are known to carry out in U.S. or other countries except that unlike in U.S. the EESL will not be an energy supplier.

EESL is supposed to play a multidimensional role and compete in the open market to tap business in the area of energy efficiency. Thus it would act as an ESCO and work for implementing programs like “Bachat Lamp Yojana86”, energy efficiency in buildings, Agriculture DSM, agricultural pumping and municipalities DSM, as a consultancy organization for CDM projects in Industrial sector, DSM, energy efficiency, and combined heat and power and finally act as a Resource Centre for capacity building of State designated agencies (SDAs)87, training and capacity building of utilities, training and capacity building of other stake holders and bankers and training under lifelong learning(3L) program and an implementing agency for Govt. schemes like Perform Achieve and Trade (PAT)88, Standards & Labeling etc.89

Energy Efficiency Services Limited (EESL) is a Joint Venture Company of 4 Central Public Sector Undertakings (CPSUs) of Ministry of Power, Government of India - NTPC Limited, Powergrid Corporation of India Limited, Power Finance Corporation and Rural Electrification Corporation. It has been formed to lead the market development and implementation functions of the National Mission for Enhanced Energy Efficiency (NMEEE). Incorporated in 2009 it has commenced business from 11th February 2010 with the authorized share capital of Rs. 190 Crore and the paid-up capital is Rs. 100 Crore ($20Million)with equal contribution from the above mentioned 4 CPSUs. It is claimed to be the first such company in South Asia exclusively for implementation of energy efficiency as on date with very few such instances in the world90.

85 “Mission Document” National Mission on Enhanced Energy Efficiency, June 2010, Pg. 14386 “Bachat Lamp Yojna” (BLY): It is a CFL based CDM Scheme designed as a public-private partnership between the

Government of India, private sector CFL suppliers and State level Electricity Distribution Companies (DISCOMs). It aims at the large scale replacement of incandescent bulbs in households by CFLs. It seeks to provide CFLs to households at the price similar to that of incandescent bulbs and plans to utilize the Clean Development Mechanism (CDM) of the Kyoto Protocol to recover the cost differential between the market price of the CFLs and the price at which they are sold to households. http://emt-india.com/BEE-BLY/BhachatLampYojna.pdf

87 State Designated Agencies (SDAs): SDAs are statutory bodies set up under section 15 of the Energy Conservation Act, 2001; at the state level to implement the Act. They are the nodal agencies at state level and need to coordinate and cooperate with BEE at the central level to ensure a smooth and speedy implementation of the Act in the country. SDAs have an important role to play particularly in creating public awareness and enforcement of the EC Act, 2001 at the grass root level. List of SDAs available at www.emt-india.net/SDA/SDA.htm and Background note on SDAs available at http://220.156.189.23/miscellaneous/documents/useful_downloads/Background%20Note.pdf

88 Perform Achieve and Trade (PAT): The Perform Achieve and Trade scheme is a market-based mechanism to enhance energy efficiency in the ‘Designated Consumers’ (large energy-intensive industries and facilities).In this PAT mechanism of Energy Efficient industries would be able to trade off their efficiency certificates (ESCerts)to less energy efficient industries. PAT program will have the flexibility for the industries to gain benefit under United Nations’ CDM as well. This would be country’s first trading mechanism to fight Climate Change by reducing emissions. PAT mechanism is expected to save 10 million tonnes equivalent of oil in next three years starting April 2011. The Ministry of Power (MoP) has notified industrial units and other establishments consuming energy more than the threshold in 9 industrial sectors namely Thermal Power Plants, Fertilizer, Cement, Pulp and Paper, Textiles, Chlor-Alkali, Iron & Steel, Aluminum and Railways in March, 2007 as DCs under PAT Scheme. www.india.gov.in/allimpfrms/alldocs/15659.pdf

89 Standards and Labeling (S&L): BEE launched S&L Scheme as voluntary basis under National Energy Labeling Program on 18th May 2006 covering 11 products phase wise. It is the direct outcome of section 14 cl. (a)-(d) of E C Act 2001. The standard and labelling scheme for energy efficiency of appliances, is intended to provide information on energy performance so that consumers are able to make informed decisions while purchasing appliances. It was also started in order to create the appropriate legal and regulatory environment for energy efficient end use products.



43

(vii) Tax Incentives

Currently only accelerated depreciation is provided to the customers / users of the Energy Saving or renewable energy devises under the direct tax laws. The Direct taxes Code Bill 2010 has been introduced in the Parliament to replace the existing Income tax Act of 1961 and will come into force with effect from the 1st day of April, 2012. However even this new Direct Taxes Code does not contain any corresponding provisions relating the tax exemptions / incentives that can be said to be a specifically related to the energy efficiency which can provide incentives to Indian industries for adopting energy efficient technologies as has been mentioned in the recommendations made by BEE in the mission document of the NMEEE. Under indirect taxes, specific concessional rates of duty are only available to CFLs and not all energy efficient products. Further waiver of import tariffs and taxes for EE technology imports, are dealt with on case by case basis in India, meaning higher costs for those imported technologies that are not available in the domestic markets at present.

Under NMEE’s proposed framework for Energy Efficient Economic Development (FEED), emphasis has been placed on supplementing the government’s efforts to create a market for energy efficiency with appropriate fiscal instruments offering concessions on taxes and duties to attract investments within the existing tax regime. However there seems to be no serious review exercise having taken place to consider an integrated tax policy for energy efficiency consisting of tax incentives, rebates, credits subsidies etc. and their alignment with the prevailing tax framework in India in line with the emerging taxation regime under the proposed Direct Taxes Code 2010 and Goods and Services Tax.

(viii) Industry Support

The Indian Council for Promotion of Energy Efficiency Business (ICPEEB) is the association for the ESCOs in the country. The Association is new and was formed in 2005, mainly under the 3 CEE project initiatives, wherein the World Bank had entrusted one of the private ESCOs to develop a business plan for ICPEEB. ICPEEB, which is still in its fledgling stage, currently has a brief profile of eight ESCOs.

(ix) Perception of ESCOs

Since the enactment of the Energy Conservation Act in 2001 and the establishment of BEE, ESCOs have undertaken several projects in public as well as private sector in India. In almost all the cases the projects have been successful in terms of decreasing the energy consumption of the organization or the industry where energy efficiency improvements were carried out. Following are the examples of Demonstration projects where ESCOs in India have successfully implemented EE projects in India:

a) Energy-efficient lighting retrofit for New Delhi Municipal Corporation’s Palika Kendra, implemented by DSCL ESCO Ltd, has resulted in 48 per cent load reduction from 264 to 138 kilo Watts. Investment Rs. 30 Lakhs (USD 75,000), annual savings INR 20 Lakhs (USD 50,000) with the payback period of 18 months.

b) A 135-room five-star hotel in Hyderabad saved Rs 33 lakh (Rs 3.3 million) in a year on electricity and oil costs -- 25 per cent of the hotel’s annual energy bill.

c) Lilavati Hospital in Mumbai, India. The hospital simply upgraded the old air-conditioning system that used to comprise 60 percent of the hospital’s energy usage. Investment involved: INR 6 lakhs (USD 12,000) and Annual Savings achieved: INR 8.5 lakhs (USD 17,000), Payback period: Nine months.

d) A Rs 307 lakh (Rs 30.7 million)-project designed by an ESCO for Airports Authority of India for IGI Airport is expected to result in annual savings of Rs 386 lakh (Rs 38.6 million) -- a return of investment of Rs 125 per cent.

e) In orbit Mall –the largest Mall in Mumbai, India under took Energy Efficiency Building Retrofit Program resulting in Improvement in Energy Infrastructure, Reduction in Energy Cost by 36%, Reduction in Operational Expenses and Environmental Impact - 408,315 Kg of CO2.


44

Recently there has also been support by the government and international funding agencies for capacity building of ESCOs. The most significant in this direction was the initiative by the BEE, wherein energy audits were conducted in nine government buildings in New Delhi which included the President’s House. This was followed by the implementation of the suggestions made in the energy audit through performance contract mode by an ESCO in 2006 at the President’s House.

Despite several demonstration projects that exist evidencing the success of ESCOs in the area of energy conservation yet the effectiveness of ESCOs in India is not significant in terms of increasing energy efficiency (Karrir, 2005). They are still at nascent stage and are unlikely to develop without sustained government support (CRISIL, 2004; Dhingra and Julena 2005; Govindarajalu, 2006). India faces enormous challenges associated with limited energy supply, energy technical and commercial losses and the State Energy Board distribution structure, and therefore there are not as many opportunities for, or interest in, energy efficiency projects as in other countries91. The situation is further compounded by general and widespread misconceptions about ESCOs and ESCO led Energy Performance Contracting (EPC) in India especially in the SME sector due to which ESCOs have not been able to penetrate the SME sector in big way. To promote large scale energy efficiency investments by Indian SMEs, acceptance of ESCOs by the SME sector is crucial. The majority of the SMEs in India are located in clusters. A cluster approach for making ESCOs popular in the SME sector can be a viable option.

91 WEC- ESCOs in Developing Countries


45

Chapter 12Energy Efficiency and SME Cluster Approach(i) SME Clusters in Indian Context

According to the UNIDO, there exist about 388 SME clusters92 in India. These clusters are overwhelmingly predominant with small industries and the share of medium and large industries in the sales turnover, production and employment is nominal. The size in terms of the number of units and the quantum of output of clusters may vary significantly. Some of them are so big that they produce upto 70 to 80% of the total volume of that particular product produced in India. For example, the township of Panipat produces 75% of the total blankets produced in the country. Similarly Tirupur, a small township in the Coimbatore district of Tamil Nadu contributes 80% of the country’s cotton hosiery exports. Yet another example would be of the city of Agra, virtually a Footwear City with 800 registered and 6,000 unregistered small and cottage footwear production units, making 1.5 lakh pairs of shoes per day with a production value of 1.3 million dollars per day and exporting shoes worth US $ 57.14 million per year93. Similarly Ludhiana in the state of Punjab produces 95% of the country’s woollen knitwear, 85% of the country’s sewing machines and 60% of the nation’s bicycle and bicycle parts.In order to help the small scale industries sector integrate with the industry at large within liberalized economic framework, the government of India has announced various policy measures from time to time. For example, to ensure a better flow of credit to the SSI through measures such as expansion of ‘single window’ loan scheme. Banks are encouraged to open specialized SSI branches and to give greater priority to the sector in their annual credit budgets etc. At national level, several institutions have been set up. There is ‘Central Small Industries Organization’ (CSIO) which has been renamed as ‘Small Industries Development Organization’ (SIDO). There are a number of other technical institutions that are working closely with SIDO, which are more specialized in the fields of Tool designing, Electronics and Measuring instruments, Prototype development and Hand tools etc. These institutions provide technical and management consultancy, organize training programs, conduct techno-economic surveys, prepare project profiles and help prepare unit specific project reports. At state level also the government has setup institutions such as Small Industry Development Corporations (SIDCs) to develop infrastructure in the form of industrial plots and industrial sheds, State Financial Corporations (SFCs) to provide long term credit facilities, State Exports Promotion Corporations to provide marketing assistance for exports from the small scale sector, Technical Consultancy Organizations (TCOs) that provide technical, financial and marketing consultancy to the sector, Centre for Entrepreneurship Development (CEDs) and Institute of Entrepreneurship Development (IEDs) have been set up to promote entrepreneurship through training.However, there is no special policy either of the central government or state governments for the promotion of the SME clusters in general. The industrial policy related to small scale sector is a small component of the industrial policy in general which relates to the entire small scale sector rather than based on national or regional priorities by focusing on certain industrial group or cluster of industries. The state governments have however provided special policy incentives for the electronics and agro-

92 UNIDO List of SME Clusters in India, available at http://dcmsme.gov.in/clusters/clus/smelist.htm#clus 93 ‘Special feature on Leather and leather goods’, The Economic Times, New Delhi, October 21, 1996.


46

processing industry but these are also directed towards the sectors as a whole instead of clusters. There have however been attempts to strengthen the clusters by providing support through the general schemes related to technology upgradation, infrastructure provision and training through various institutions at the national and state levels.Nevertheless, support from the government institutions has helped in making the small industries sector credit worthy for receiving financing and to undertake the Energy performance contracting as a viable and sustainable option. Taking advantage of the existence of product specific industrial clusters, which have common opportunities and threats and offer ease of implementation of program to a large number of SMEs at one geographic location, several initiatives have been undertaken by the government and institutions in the past to strengthen the SMEs existing in these clusters. Since the program design and implementation were specific to a cluster these were termed as cluster approach. Major cluster initiatives undertaken in the past was with respect to bank lending schemes for technology upgradation taken up by the State Bank of India (Project Uptech) and Small Industries Development Bank of India (SIDBI); GEF and World Bank supported energy efficiency financing projects in different clusters such as steel rerolling mills, paper and pulp, glass and automobiles. Secondly, the Govt. of India’s Department of Industrial Policy and Planning (DIPP) promoted upgradation of Industrial Infrastructure of the SMEs for enhancing their global competitiveness and has undertaken many cluster based infrastructure upgradation programs under its Industrial Infrastructure Upgradation Scheme (IIUS). Energy efficiency investment has two major components. One is the technology upgradation, selection and adoption of energy efficient and clean technology in which ESCOs specialize and the second is the financing which is an essential component of ESCO-energy performance contracting. For any large scale energy efficiency investment as envisaged under the NMEEE both these need to be addressed in an integrated manner. Fortunately programs in both these areas have been promoted by the government ministries or institutions though in piecemeal and as per their own objectives. Therefore a look at the experiences gained from these programs which have been attempted in the past based on cluster approach in both the above stated areas can provide lessons to enable large scale energy efficiency investments in the SME sector in an integrated manner under cluster approach. Previous Experiences with Cluster Lending and Technology Upgradation / Energy Efficiency activities in Indian SME Clusters94 Cluster lending95 represents an innovative approach that can bring specialized technical support and outreach to smaller enterprises along with follow-up loan provision based on a standardized, replicable model, can result in substantial reductions in transaction costs per loan and can be utilized by domestic financial institutions to increase lending for energy efficiency projects in the SME sector (Robert P. Taylor, et al. 2008). Lending to SMEs is a priority set by the government of India for the nationalized banks in India, keeping in view the importance of SMEs for economic growth, employment, and exports. The cluster lending strategy for reaching SMEs has been under implementation since the late 1980s, and was initially undertaken for reasons other than energy efficiency. To service financing needs for energy efficiency projects, the State Bank of India (SBI) adopted a unique cluster lending strategy under Project Uptech, which several other banks followed with some variations.

94 FINANCING ENERGY EFFICIENCY- Lessons from Brazil, China, India, and Beyond by Robert P. Taylor, Chandrasekar Govindarajalu, Jeremy Levin, Anke S. Meyer and William A. Ward; World Bank / ESMAP.

95 “Cluster lending” refers to lending operations targeted at certain clusters of industries that are co-located for some economic (or policy) reason. The objectives of cluster lending programs include lending for investments to increase SME competitiveness through technology upgradation, cost reduction (through reduced wastage and increased operational efficiencies), increased productivity, and (in some cases) improved product mix.


47

SME cluster lending in India has focused upon (i) a specific sector or technology group, or (ii) upon a geographically grouped cluster that includes several industrial categories but is concentrated on a few technical interventions as a mechanism for minimizing assessment and appraisal costs and time. Essentially two types of cluster lending programs have been tried so far:

a) Upgradation of technology and improving overall performance in a holistic manner with energy efficiency improvements as an integral component without being the sole objective.

b) Where energy efficiency improvement is the prime lending objective.

In keeping with its mandate, SIDBI has emerged as the principal financial institution to promote, finance, and develop the SME sector in India. The approaches taken by SBI and SIDBI are similar as these institutions clearly recognized the following:

High transaction costs in relation to loan transaction size made it necessary to find solutions that •reduce the cost per enterprise and/or per transaction.Improvement in energy efficiency usually is a consequence of technology upgradation and need •not be the sole objective of lending.Technology solutions for SMEs are seldom readily available off the shelf, even if a large number •of SMEs need the same or similar solutions.

As a result, SBI and SIDBI took various measures to support some of their technology development work, for example, SBI contracted external industry experts and (where necessary) research- development organizations and SIDBI created a specialized agency, the Technology Bureau for Small Enterprises (TBSE)96. The experience from SBI’s Project Uptech and SIDBI helped provide a good base for the Indian banking community to launch energy efficiency- focused cluster lending programs. Several other initiatives have been supported by Government of India from internal resources or with donor/bilateral support targeting improvements in Energy Efficiency, in the SME sector. These have produced numerous pilot successes, but widespread replication is somehow missing. Emphasis on credible energy audits and Technical assistance initiatives need to be addressed on priority. The trend was reinforced with the joint policy directive of the government and the Reserve Bank of India of August 2005, which urged banks to increase credit to SMEs97 substantially. Thus the energy efficiency improvements were only made a part of the technology upgradation effort and remained limited to energy audits and engagement of external industry consultants. There was neither a focus on enhancing energy efficiency in the SMEs nor engagement of ESCOs for energy performance contracting. The effort remained primarily as a lending scheme by the banks. However success from previous cluster lending programs provided comfort for extending it to energy efficiency schemes.

Prompted and encouraged by the World Bank – UNEP Three Country Energy Efficiency Project, five banks viz. the State Bank of India, Canara Bank, Union Bank of India, Bank of India and Bank of Baroda

96 Technology Bureau for Small Enterprises is an endeavor to bridge the technology gap. It is a collaboration between the United Nations’ Asian and Pacific Centre for Transfer of Technology APCTT) and Small Industries Development Bank of India (SIDBI) and represents, under one roof, synergy of technology and finance. It offers a professionally managed system for partner search, provides a gateway to global technology market, renders customised service and wide ranging affiliations and takes up project appraisal and preparation of business plan. http://www.angelfire.com/ny/tbse/

97 Ministry of Micro Small & Medium Enterprises, through office of Development Commissioner (MSME) launched “integrated technology up gradation and management program” (UPTECH) in 1998, which has now been renamed as “Small industry Cluster Development Program”. Scheme applies to any Cluster of industries where there is commonality in method of production, quality control and testing, energy conservations, pollution control etc. among units of Cluster. While taking care of the modernization and technological needs of the Cluster, it covers comprehensive range of issues related to technology up gradation, improvement of productivity energy conservation, environmentally friendliness, product diversification skill up gradation and market development. http://www.msmediraipur.gov.in/integerated.htm


48

formulated and launched energy efficiency schemes targeted at SMEs. The rationale for attempting to reduce transaction costs and for adopting the cluster lending approach for energy efficiency is supported by all five banks. For the most part, each specific cluster project has been considered a success by the entire banking and development community. Though several SME clusters have been targeted by these projects, however, lessons learned from steel re-rolling, pulp and paper SME clusters which are relatively more energy intensive are discussed below.

(ii) Lessons learned from the UNDP GEF project “EE in steel re-rolling mills”

Steel production is an energy intensive process and generates large amounts of waste. In India production of one tonne of crude steel from iron ore generates about 1.2 tonnes of solid waste and approximately 2.5 tonnes of carbon dioxide and other pollutants. Within India’s small and medium enterprises (SMEs), there are more than 1200 steel rerolling mills (SRRM). 75% of these are small scale units. The SMEs engaged in steel rerolling constitutes an important link in the overall supply chain of steel by contributing to more than 57% of steel produced in the country. But the mills have grown haphazardly utilizing technologies that are outdated and have low investment and high production costs. The direct energy use in this sector includes fossil fuels (furnace oil, natural gas and coal) and electrical energy. The specific energy use ranges from 56-66 litres of furnace oil (or 226-229 Kg of coal) and 165-192 KWh of electricity to produce one tonne of steel. The direct energy cost in the SME mills is estimated at 25-30% of the overall production costs98.

Direct energy use in the SRRM sector includes heating fuels and electric energy. Indirect energy use is accounted by the use of energy-intensive raw materials. The SRRM units are characterised by the use of outdated and low-investment technologies and practices. In general, there is low awareness about energy efficiency and many companies lack the in-house engineering and technical manpower to absorb energy-efficiency measures in their process and to operate high-end technologies. There is lack of experience in accessing external funds, while financial institutions are reluctant to lend for ‘new’ energy-efficient technology. These barriers hamper the widespread application of energy-efficient technologies and practices.

To remove barriers to energy efficiency in steel re-rolling mills (SRM) in India, eco-technologies were introduced in 32 model units. The interventions in 15 units helped reduce electricity consumption by 1.4million units and furnace oil by 104 tonnes in 2009. This is equivalent to a 20 percent reduction in energy consumption and an equal quantum of carbon dioxide reduction (UNDP MTR)99 .

The UNDP GEF project “EE in steel re-rolling mills” project was designed to promote widespread adoption of EE technologies and practices in a SME dominated energy-intensive subsector. As highlighted in the 2007 UNDP mid-term review100, this project was characterized by a slow take-up of investments for EE technologies due to the ‘wait-and-see’ approach that many SMEs adopted for the following reasons:

With the steel market in India booming and production rising, many units are quite profitable •and feel less urgency to invest in energy-efficient and clean technology (despite their favorable rates of return).While some units may fear that changing their production line implies idle time and thus revenue •foregone due to reduced sales. Most units are family-run businesses, in which consensus on the need for new technology requiring high investment in sometimes hard to reach.

98 Figures based on 2004 estimates.99 UNDP India Mid Term Review of the Country Programme Action Plan 2008-2012; FINAL REPORT, September 2010,

Kalyani Menon-Sen and AK Shiva Kumar. Retrieved from internet on 20-11-2011 www.undp.org.in/sites/default/files/reports.../UNDP-MTR-Report.pdf

100 MID-TERM REVIEW, Energy Efficiency in Steel Re-Rolling Mills, Government of India; United Nations Development Programme, Global Environment Facility, FINAL VERSION, 8 August 2007; Jan van den Akker-International consultant and Rajesh Kumar Singh-National consultant. Retrieved from internet on 20-11-2011 www.erc.undp.org/evaluationadmin/downloaddocument.html?docid=1344


49

Smaller units as especially in the MSME sector are not interested in expensive state-of-the-art •technology even if investment cost can be recovered quickly. Many units seem to be reluctant to invest in excess of Rs. 10 million.In general, failure to trigger wide-spread market response and active participation was attributed •to lack of foresight about current attitudes regarding solutions to EE. Often, developing trust among the key actors (e.g. energy auditor, vendor, and enterprise) was not given adequate attention at the program design stage. Confidence-building measures involving the users and service providers are of considerable importance for the ultimate success of the project, i.e. actual implementation of EE investments and realization of energy savings and emission reductions.

(iii) Lessons learned from EE Projects in the SME paper clusters in states of Punjab, Haryana, and Uttarakhand.

The project was implemented by DSCL Energy Service Company (DSCLES) under the World Bank/UNEP/3C EE Project101. As per the DSCL_ESCL’s final report, besides achieving successfully the energy savings of around 10-20%, the key lessons learned were:

• OnEEProjectsandinvestments:

a) Although there is awareness about energy efficiency potential, management attention still continues to be for increasing production.

b) Major focus for reducing energy cost is in cogeneration.c) Cluster approach has its advantage of replication but some challenges have been faced in for

sharing of technical information by different companies.

• OnEEProjectimplementation:

a) Most of the mills are continuously upgrading capacity and product mix and as such are cautious about investments in equipment retrofit. This also affects the Performance Measurement and Verification (PMV)

b) PMV for projects face hurdle and therefore a non-intrusive PMV system needs to be developed for such kind of industries.

• OnFinancing:

a) Reluctance of units to disclose financial information required for the loan application.b) Whereas the good creditworthy units generally have cash for investment for EE projects but

tend to avoid going through the procedure hassle of loan sanction for such small projects, the less creditworthy would not be able to get loan sanctioned as per the present security norms of the banks and F.Is.

c) High charges of bank guarantee (4%) required for security negates benefits of supposed concessional EE financing.

d) Financing schemes launched by commercial banks need to be back up by marketing and process innovation efforts.

• OnFinancialIntermediation:

a) For smaller loan present system of intermediation is unlikely to work.b) Present system of transaction and security requirement also pose challenge for ESCO system

of financing to develop.

101 Development of Financial Intermediation Mechanism for Energy efficiency investments in Developing countries , Under World Bank / UN Foundation – UNEP Technical Assistance Project; Development of Energy Efficiency Projects in SME Paper cluster in the States of Punjab/ Haryana/ Uttaranchal- Final Report 2005, by DSCL Energy Service Company Ltd. Accessed on 11-08-2011, available at: http://3countryee.org/public/FinancingEEprojectsPaperIndia.pdf


50

Most important learning is that the creditworthy industries would avail benefit of separate EE financing scheme only with better and more flexible incentive scheme. For rest, the efforts made by various institutions and consultants to innovate financing scheme within present guidelines of lending have not produced desired results and similar efforts in future should first look into possible solution for changing such guidelines.

(iv) Energy efficiency Projects in Indian SMEs and key lessons learnt:

Review of the experience with global EE financing projects, such as the World Bank – UNEP Three Country EE project (2008), the World Bank GEF EE Portfolio Review (2004) and EE projects implemented in India, particularly the World Bank Renewable Energy II project with IREDA and UNDP/GEF projects in SME clusters including EE in steel re-rolling mills (SRRMs) and SME Paper clusters emphasize the following lessons learnt:

The experience showed that the replication potential is high in all cases, the savings potential •(percentage of energy use) is also high in all cases with attractive payback periods and IRR. (3CEE Project-India Country Report, 2006). However, the entire concept has not taken off in the manner that was initially envisaged (Robert P. Taylor, 2008).The borrower demand for the new lending schemes was lower than projected; it has been •determined that insufficient attention was paid to demand generation activities in the clusters themselves, where numerous market barriers beyond access to bank finance still prevail. EE financing projects should be based on commercial principles, investment-driven and avoid •undue distortion of the market (e.g. lending to one sector, supporting only certain transaction/ESCO models, providing subsidized credit, providing only a directed line of credit). Program structures should carefully consider cost-recovery, leveraging commercial financing and maximizing private sector participation and local competition. Appropriate fees for products and risks should be adopted to ensure market incentives guide end-user decision making. The use of technical assistance is most effective when focused on transactions and targeted to creditworthy end-users.Marketing of EE of SMEs is not easy, as EE investments are not typically high on SMEs’ priority •lists of capital uses. Achievements of a high penetration rate of EE investments in SME clusters therefore requires a large, holistic TA effort delivered over a longer term to truly build a sufficient level of knowledge, acceptance, trust and ultimate demand for EE goods and services.Technical assistance to commercial financial institutions is an important element of building •institutional capacity to mainstream knowledge regarding clean energy market development: In order to adequately scale up EE lending, the local banking sector must be an active participant. TA support can increase knowledge of the technical, policy and regulatory aspects of this market to allow improved understanding of sector risks when providing debt financing for such projects. Therefore, awareness and capacity building of commercial financial institutions for clean energy market development projects should be incorporated into initial project designs.A comprehensive and holistic market assessment is a key pre-condition required for the early •identification of a robust pipeline of projects to be financed. For this a comprehensive survey of the SME sector in India with selection of the most appropriate technologies and geographical areas needs to be taken up.EE loans are typically small, particularly when potential clients are from the SME sector. This •poses major challenges to keep transaction costs reasonable. Mechanisms for reducing those costs include the use of ESCOs combined with geographical and industry-specific clustering approaches in the SME sector which can reduce transaction costs through standardization and enhanced familiarity by key stakeholders of identified EE investments among units with similar characteristics.


51

Robust monitoring and evaluation plans should be created upfront, incorporating periodic •project review. Allowing for flexibility in program design is important so that project components that do not work in practice are detected early and can be adjusted during implementation if necessary to ensure achievement of development objectives.

Smaller EE projects identified for the SME sector face additional market barriers and may be •best financed by local banks. Larger industrial companies with enhanced access to information, technical consultants and finance typically find it less difficult to implement EE projects from a variety of funding sources when compared to the SME project. Many SMEs have strong existing lending relationships with their local banks, including hypothecation of existing assets to secure previous term loans, and therefore obtaining loans from outside (new) centralized sources can sometimes prove difficult. It is observed that future efforts designed to finance EE at SMEs should work through local financing institutions with strong local presence as they may be better placed to expand EE lending to this sector.

From the above discussion it becomes pertinent to identify clearly the general and specific barriers that hinder ESCO development and their penetration in the SME sector on one hand and on the other make it difficult to implement energy efficiency programs to enable large scale energy efficiency investments by the Indian SMEs.


53

Chapter 13Barriers for ESCO Development in IndiaAlthough potential exists in promoting energy efficiency in the country , significant barriers prevent the ESCO concept from really taking off and make the ESCO Energy performance contracting (EPC) mechanism difficult to implement, particularly by Indian SMEs. The barriers that are identified102 in the Indian context can be grouped into two categories:

General barriers for Indian ESCOs and Energy Performance contracting (EPC).•Specific barriers in Implementation of Energy Efficiency investments by Indian SME Sector. •

BARRIERS FOR INDIAN ESCOs(i) GENERAL BARRIERS

A. FINANCING BARRIERS103 1. Scarce capital base of Indian ESCOs:

i. The numbers of ESCOs in India are very few and they are primarily small service companies that have limited financial resources. Only a few ESCO projects can be financed with their own resources and it is difficult for them to raise money.

ii. Some banks are interested in the performance contracting model offered by ESCOs, but in most cases ESCOs lack adequate collaterals to the banks.

iii. End users are reluctant to offer credit enhancements demanded by commercial banks (e.g. personal guarantees, real property collateral etc.).

2. Inadequate Access to bank finance:ESCOs lack adequate access to project finance for meeting upfront costs of energy efficiency retrofit projects:

i. Most banks require collateral of at least 100% of the loan value, which, in light of the above is difficult for ESCOs to provide.

ii. Non-recourse finances are also not easily available because such projects are perceived to be high risk projects.

iii. Most banks are yet to initiate comprehensive or long-term lending programs for energy efficiency projects in the country as a whole.

3. Limited knowledge of ESCOs and reliability concerns:

Inadequate information and awareness:a) Local banks require adequate information for taking decisions regarding energy-saving

investments. The Experience of other agencies in implementing such projects and the urgent need to promote energy efficiency for overall public good needs to be highlighted.

102 Identification of barriers is based on numerous studies conducted / papers and the NMEEE Mission Document 103 ESCO Synthesis: An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana Ürge-Vorsatz, Sonja

Köppel, Chunyu Liang, Benigna Kiss, Gireesh Goopalan Nair, Gamze Celikyilmaz; WEC ADEME project on energy efficiency policies; Central European University, 2007, World Energy Council. Retrieved from: http://www.worldenergy.org/documents/esco_synthesis.pdf


54

b) Both consumers and banks are not fully aware of financial options and benefits from energy savings. Consequently it is believed that committing funds for energy efficiency projects carries very high risks.

Lack of experience and limited knowledge of EE Projects and the EPC:The Financial institution’s and banks’ interest in funding ESCO projects remains low as financial conditions of ESCOs/end-users are not as per the banking norms, lack of technical expertise to evaluate EE projects by banks etc. The challenge of measuring savings requires a clear definition of project elements, savings expectations, financing terms and measurement and monitoring arrangements, all of which are difficult for non-technical staff at the bank to monitor.

Further, the banks lack confidence that ESCO performance estimates will turn out to be accurate. FIs, incorrectly, perceive energy efficiency projects as inherently more risky than other investments, and generally require a large proportion of equity funding from the ESCO for a project leading to high project development cost.

ESCOs and their clients are unknown or not considered creditworthy:In India, many ESCOs find it extremely difficult to know whether the clients they are dealing with are creditworthy and sometimes find out that no one is willing to lend money to the potential client. However, by that time they have completed all the preparatory work for the award of the EPC contract to them. This type of risk can be particularly problematic for new and small ESCOs.104

4. High administrative/ transaction costs:

Energy efficiency projects are relatively small and carry high transaction costs for lenders and end-users especially, with unfamiliar procedures such as energy performance contracting. The owners focus on minimizing first-costs and hence confine themselves only to rudimentary levels of energy efficiency. High transaction costs result from legal, technical and transactional complexities, like non standardized deal structures and substantial technical content in project appraisal, development, and monitoring.

Institutional Barriers in financing:

Conventional financing rules are inconsistent with Energy performance contracting (EPC).

In general financial institutions have not been able to realize the importance of energy efficiency. Some reasons for the failure are listed below:

The asset based lending stipulation of Reserve Bank of India prevents banks from lending non-•recourse lending without security. Accordingly, F.Is. prefer asset based financing over cash flow project based financing and require short payback periods and prefer commercial risk over technical risk. Large, experienced, and well-recognized equipment and controls companies may extend full recourse vendor finance to their most creditworthy clients, limiting the penetration of EE improvements and potentially covering a very narrow set of EE investments.105 NMEE’s ‘Mission Document’ highlights that Energy-efficiency projects lack the fiscal incentives •to banks under direct taxes currently enjoyed by the infrastructure sector. This aspect will be dealt under role of fiscal incentives in the part II of the paper.Absence of an institutional guarantee mechanism. •Most FIs prefer lending for working capital and there is preference for large projects or large •enterprises. One of the major problems related to financing EE measures that are retrofitted to the


105 India Infrastructure Report 2010


55

existing equipment is that if the equipment to which retrofitting is done is already hypothecated to the bank, which provides working capital to the unit, then this can cause a security concern. This is because as a usual security norm all the present and future assets generated by the project are kept as security for the bank’s loan. This prevents the ESCO from hypothecating the assets to the bank as a security (Cherail K, 2004). Standardized documentation and structuring templates need to be developed. Fund providers •must exercise creativity in structuring obligations, project risk and claims on assets and cash flows.106 Though some of the banks have EE schemes for SMEs, the financing available from such schemes •needs to be made attractive to the end users.

Apart from this, in order to avoid taxes, cash transactions are prevalent in SMEs in the country. This could be a major barrier against undertaking energy efficiency projects with SMEs requiring verification until taxation is simplified and better governed (DSCL ESCO, 2005).

B. GOvERNMENT POLICIES, STRUCTURAL AND POLITICAL BARRIERSRegulatory barriers107

Lack of legal and financial infrastructure to support performance contracts. Mistrust between •counterparts in the context of weak contract enforcement. India’s weak legal system with respect to contract enforcement and dispute resolution in respect of the ESCOs and its customers limits the market penetration of ESCOs, complicating the structured transactions used in energy performance contracts.Lack of Government Mandate to invest in energy efficiency projects or lack of accountability of •implementing agency leading to lack of enforcement of standards, codes, and labeling.Difficulty of measuring ‘Negawatts’• 108 (or efficiency savings) in the context of project cash flows.Lack of government enabling policies.•

Subsidized Energy Prices109 The money spent on energy subsidies at present could be much more efficiently spent on energy efficiency improvements.

106 More senior claims on assets, such as with buildings, make structuring diffi cult. Cities are now promoting energy efficiency in the residential sector by establishing a first lien through property taxes or sequestering utility payments. Source: India Infrastructure Report 2010.


108 Negawatts:”Negawatts”, refer to units of electric capacity, Watthours, and hence “Negawatthours”, refer to electric energy. In keeping with the standard lingo, however, we use the more common term “Negawatt” to refer to both capacity and energy.

Negawatt power is a theoretical unit of power representing an amount of energy (measured in Watts) saved. The term was coined by the Chief Scientist of the Rocky Mountain Institute and environmentalist, Amory Lovins in 1989. Energy is saved by either increased efficiency or reduced energy consumption; the conserved energy is a “negawatt”. The concept of a negawatt is simply a measure of power that is not used. Negawatts are a form of encouragement to motivate consumers to conserve energy. Amory Lovins considers the concept of conservation “a change in behavior based on the attitude ‘Do Less to Use Less’”. He makes a distinction between conservation and efficiency by defining efficiency as “the application of technologies and best practices to eliminate waste based on the attitude, ‘Do the same or more with less.” Negawatts have the potential to be measured in the future with grid systems, smart meters, and other energy tracking devices; however, they currently cannot be accurately measured. Negawatts can only be theoretically determined based on the history of consumption. http://en.wikipedia.org/wiki/Negawatt_power#Definition



56

Wastage in residential and agricultural sectors could be avoided by removing cross subsidized electricity prices. Cross subsidy in agriculture results in wastage of power and water while delivering poor service110.

Funding for EPC competes with explicit or implicit energy price subsidies and other energy efficiency support mechanisms such as subsidies and soft loans provided by the governments.111 Uniform attractiveness of specific EE measures across the country could be achieved if the difference in electricity tariffs in different states is reduced. Determining electricity tariffs are still mainly the prerogative of the States, there exists variation in electricity tariffs for different consumer segments across the country due to reasons like different energy mix in power generation, cross subsidies etc. Hence the payback for energy efficient products suited to that market varies accordingly and can affect subsequent ESCOs’ interest. The federal structure of India makes country-wide support-programs or favorable legislation for ESCOs challenging because policy tools, energy prices may vary widely within the country.Structural / Political Barriers

1. Partial risk guarantees would be able to incentivize sufficient due diligence and monitoring only if adequate level of guarantees are set and the technical expertise is within the implementing authority. Guarantee facilities can take on too much leverage and amplify default probabilities.112

2. A plethora of financial support mechanisms such as grants, concessional loans, credit facilities etc. are offered to countries in transition and developing countries by the European Bank for Reconstruction and Development (EBRD), the World Bank, the Global Environmental Facility (GEF), International Finance Cooperation (IFC) etc. However the missing link between possible funders and ESCOs/ their clients’ needs to be established.113

3. Limited human resourcesi. India’s technical expertise is impressive, but special efforts are required to meet the scale of

human resources needed, given that, semiskilled and low skilled workers often execute and manage such investments in the longer term.

ii. EPC business requires deep know-how of energy, financing, buildings, and industry processes to implement a win-win project. Several experts in EPC are needed in India. The appropriate energy efficiency technology and equipment is sometimes not manufactured domestically or is very costly, for example due to high import taxes. If the ESCOs are not engineering companies themselves, they need to purchase these equipments somehow (Vine 2005). Linking the Clean-Development and EPC is therefore a promising new concept if the EPC project is implemented in a developing country.

(ii) SPECIFIC BARRIERS

Barriers for ESCOs in Indian industrial Sector114 In the industrial sector, EPC is much less frequent than in the public sector due to several reasons. Some of them are as follows:

110 India Infrastructure Report 2010, Infrastructure in low carbon economy-Drivers of Energy Efficiency Industries- Indian and International Experience in Infrastructure, Lenora Suki; Pg 123-143


112 India Infrastructure Report 2010113 ESCO Synthesis An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana Ürge-Vorsatz, Sonja

Köppel, Chunyu Liang, Benigna Kiss, Gireesh Goopalan Nair, Gamze Celikyilmaz; WEC ADEME project on energy efficiency policies; Central European University, 2007, World Energy Council. Retrieved from: http://www.worldenergy.org/documents/esco_synthesis.pdf



57

1. In India, large and professionally managed industries prefer only suggestions and new ideas from energy audit firms based on a fixed fee because they have the capability to implement recommendations on their own. However smaller firms have little technical know-how and no capability to implement recommendations to reduce energy cost, stand greatly benefitted from an ESCO even at a higher cost (Raghuraman V, 2006). ESCOs need to ascertain the credit worthiness of these smaller firms. Hence the most desirable clients are not interested in ESCOs, and those firms that may associate with an ESCO will not easily find an ESCO willing to take the risks.115

2. Identification of customers for ESCO projects is challenging. It is extremely difficult for ESCOs to determine without the customer’s cooperation whether they are dealing with a creditworthy customer or not (Athale S., 2006,). It is likely that the ESCO might spend substantial time and effort only to discover that although the customer is willing to implement the project, no one is willing to finance the customer. This leads to heavy financial burden on small ESCOs.

3. Reluctance towards external financing: The interest especially of non-energy intensive industrial firms in EPC is generally limited as compared to their core activities. Even Indian Small and Medium Enterprises (SMEs) are reluctant to ask for external financing from banks or ESCOs for energy efficiency and would rather use their own funds if the projects are quite attractive (India country report).

4. EPC can limit the company’s investment ability since the loans and payments for EPC can negatively affect the balance sheet.

5. For safeguarding trade secrets and preventing interruptions of the production many companies do not allow ESCOs to check the core industrial processes. For these reasons, ESCOs concentrate on standard applications such as boilers, pumps etc., in the industrial sector rather than on processes.

6. In the industrial sector the time spans considered by many companies are shorter than the payback-periods for many ESCO-projects: Managers accept payback-periods longer than 3 years only when investments in the production area are concerned, but not for “inputs” such as energy. Life-cycle costs are rarely taken into account. Further in performance evaluation managers are evaluated only according to the improvements achieved during their tenure, but since energy efficiency improvements can have payback periods of several years, they are often attributed to their successors.

7. Many companies prefer to modernize their outdated manufacturing processes rather than invest their revenues in energy efficiency (Painuly et al. 2003).

8. The SMEs typically have unexploited opportunities for substantial energy efficiency gains but usually do not have the in-house capacity to prepare and implement the projects needed to achieve energy savings. Barriers in accessing commercial financing of cost-effective energy efficiency projects also exist besides the challenges faced by the SMEs, barriers are also faced by Indian banks in lending to SMEs, including high (per loan dollar) transaction costs and the increased risk associated with lending to smaller clients.

To summarize, barriers in the industrial sector are not mostly of a financial nature, but are rather due to low interest and fears of potential clients therefore the industrial sector’s share in the ESCO’s activities is currently often much lower than its envisaged potential.

115 ESCOs synthesis.


58

SPECIFIC BARRIERS IN INDIAN SME SECTORMAIN BARRIERS TO IMPLEMENTATION OF EE INVESTMENTS BY INDIAN SMEs

Indian SMEs could enhance productivity in general and in EE in particular substantially compared to industrial companies. Recent attempts of several Indian banks to introduce financial products aimed at increased lending for SMEs EE projects had limited success. Based on previous experiences116 of the World Bank /UNEP 3CEE Project, and that of Indian banks with the SME cluster lending; appraisal study117 was undertaken by the World Bank for financing EE investments in Indian MSMEs118. The study has pointed out that the main barriers to uptake of EE investment in energy-intensive SMEs include the following:

a) A central barrier is the current gap in understanding between the energy auditors and EE practitioners developing technical proposals for SME clients and the local banks evaluating the loan proposals, not technical studies. EE investments usually do not generate additional revenues, but rather contribute to bottom line earnings through a reduction in energy expenditures. This can make it difficult for banks to identify and capture cash flows or treat energy savings as assets of sufficient market value to justify a loan, despite the overall benefits which will accrue to the borrower if implemented. This often results in either rejection of EE loan applications or offering of unattractive financial proposal due to high risk perceptions.

b) As the EE components of SME loans are often small, they could lead to higher transaction costs as a percentage of investment as compared to large loans, reducing the attractiveness to the banks as a specific lending product. Appraisal processes need to be simplified, both on the credit worthiness and technical assessment side.

c) There is also limited information among banking sector stakeholders about the potential market for lending and the portfolio benefits in terms of improved asset quality that can be achieved by increasing EE of existing clients.

d) Despite several pilot efforts by the GoI and donors, imperfect information about EE among SMEs still persists. Even though investment projects incorporating the adoption of efficient technologies would have high rates of return. SMEs are concerned about additional costs such as disruption of their production process, need for training of employees and so on. Many of the previous GoI and donor programs were focused on outreach and preparation of energy audits, with limited translation of these initial audits into actual investments and replication by non-participants.

e) Widespread misconceptions about ESCOs:119

i. An ESCO always finances its projects: This is the most common misconception about ESCOs though this is only one way of financing energy efficiency projects.

ii. An ESCO bring in technologies that we do not know: While ESCOs are usually aware of new energy efficient technologies they may consider deploying them only if they believe that the risk of failure is low. Since an ESCO implements proven technologies for energy cost reduction because it has to guarantee performance it is very likely that the measures recommended by an ESCO are well known to engineers working in the facility where an ESCO is engaged. However, it is the ability to actually implement the solution that is vitally important for success in energy efficiency projects – and this is what the ESCOs bring to the project.

116 See, for example, the 50 case studies of actually implemented EE projects in Indian industries, assembled under the Three Country EE project, http://www.3countryee.org/public/EECaseStudiesIndustriesIndia.pdf

117 World Bank : Financing Energy Efficiency at MSMEs Project, Project Appraisal Document, Report No. 54343-IN118 MSMEs are Micro, Small and Medium Enterprises119 ESCOs: The need of the hour for Energy Efficiency in India by Shishir Athale; and Mohan Chavan; 2008, Sudnya Industrial

Services Pvt. Ltd, Pune http://www.docstoc.com/docs/26030648/ESCOs_-The-need-of-the-hour-for-Energy-Efficiency-in-India


59

iii. An ESCO is a consultant/energy auditor: This is another common equivalence in the minds of customers. While consultants and auditors provide essential services they do not assume project risks. Consultants unlike ESCOs provide fee based advisory services without bearing any risk of non-performance or poor performance of the projects. (Athale and Chavan 2008)

f) SME units remain generally unfamiliar with the performance of readily available efficient equipment in Indian conditions. This is partially due to a divided market where first-tier manufactures and vendors of EE equipment focus on larger industrial companies and SMEs are mainly served by second tier suppliers.

g) Lack of conducive policies for EE at the national level, inadequate information and awareness about EE, especially among state designated agencies, are causing the proliferation of unfocused initiatives and ineffective implementation of program and projects not just in the SME sector but more generally.

h) Support for ESCOs.Internationally, many projects that promote EE investments have used ESCOs as a delivery mechanism. In the Indian context, this mechanism has achieved limited success, especially in the SME sector. ESCOs in India face a number of constraints which are exacerbated in the SME market due to high risk perceptions in dealing with these smaller clients. Many SMEs are tax-oriented in their reporting, and are extremely reluctant to having outsiders (i.e. the ESCO) collect detailed operational and performance information as part of their energy analysis work.

i) Line of credit and Credit Guarantee Scheme

Providing dedicated lines of credit is a widely used mechanism to support EE financing in situations where credit is not available from commercial lenders or non-banking financial institutions. However, this is not the case in India where numerous local banks have large and expanding portfolios of standard SME loans which can accommodate EE investments. There are several current financial offerings that are available in the Indian market. For example five banks (State Bank of India, Canara Bank, Union Bank, Bank of Baroda and the Bank of India) have supported new dedicated term lending schemes for EE in recent years. Furthermore, there are number of credit lines now made available with SIDBI which focus on EE or explicitly include it as eligible, including the $400 million as IBRD additional finance. SIDBI and competing Indian commercial banks with their extensive local branch networks and existing relationships to SMEs will be well placed to expand commercial financing for EE. Establishing a new credit guarantee scheme would not by itself significantly contribute to increasing EE investment in India considering the barriers and current bank lending behaviors to SMEs. Furthermore, a risk sharing facility already exists to mitigate certain risks of bank lending for smaller sized loans to the Indian SME sector. The credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) is currently operating as an associate institution of SIDBI and it is judged that expanded support for this existing instrument will be more beneficial in mainstreaming EE lending at participating banks than developing and capitalizing a new dedicated energy efficient guarantee product. It can be seen from the above discussion that there are not many barriers of financial nature for the SME sector rather it is its uptake due to low interest and concerns of potential clients. However what is required is the demand generation support in the form of Technical Assistance (TA) activities which can be used to expand the use of the current existing CGTMSE to EE investments for smaller SMEs.

“Lack of domestic sources of capital is rarely the true problem. Instead inadequate systems for accessing funds are usually the main problem.” (The World Bank – ESMAP Report May 2006, 1–4).120

120 Leslie A. Solmes; Energy Efficiency-Real Time Energy Infrastructure Investment and Risk Management, Performance based Investment Financing, Chapter 11.


61

Chapter 14CONCLUSIONS AND RECOMMENDATIONS1. Cluster Approach

Cluster Approach has numerous advantages. It allows the sector specific focus to devise energy efficiency programs which help in framing targeted policies. Further, it allows easy sharing of technical information by different companies, common marketing efforts with respect to financing schemes of commercial banks in a particular cluster thereby creating adequate demand generation for energy efficiency financing. The cluster approach can reduce transaction costs with the help of ESCOs, make it easier to involve local financial institutions and banks which have a strong local presence and can facilitate aggressive expansion plan for ESCO industry by enhancing capacity of ESCOs both internally and externally. However successful programs based on cluster approach cannot be started unless a comprehensive national data base on SME clusters is developed. This can be done by undertaking a national level cluster mapping program by the BEE in coordination with Ministry of Micro Small and Medium Enterprises and Central Electricity Authority of India. This database would be built to contain all relevant data required for the energy efficiency investments and measures such as listing of major energy consuming industries clusters, their current energy consumption and technology in use, available EE technologies etc. This would help analyse specific intervention in terms of energy efficient technologies and innovative financing for the EPC through ESCOs that can be widely replicated in the SMEs in a particular cluster. Because a cluster is situated in one particular State, the issue of variation in electricity tariff rates can be adequately addressed while devising EE financing scheme and the payback periods.

Recommendation 1

Conduct National SME Cluster Mapping Program to build SME Cluster Data Base for EE.

2. Linking Energy Efficiency improvements in SMEs with flagship program of Govt. of India under “Integrated programs on Energy Efficiency for SME Clusters”

Department of Industrial Policy and Promotion (DIPP) initiated Industrial Infrastructure Upgradation Scheme (IIUS) in 2003 as a Central Sector Scheme. The objective was to enhance competitiveness of industry by providing quality infrastructure121 through public-private partnership in selected functional clusters. The Scheme targeted existing industrial clusters with high growth potential requiring assistance for upgradation of infrastructure to world class standards. It was implemented through a Special Purpose Vehicle (SPV), a non-profit making company registered under section 25 of the Companies Act having complete operational autonomy to develop, operate and maintain the infrastructure. It had representatives from cluster associations, local industries, financial institutions, State & Central Government and R&D organisation. This arrangement ensured the creation of useful assets and sustainability of assets created through an appropriate revenue generation mechanism. The SPV was funded to a maximum of 75% by

121 A DIPP conducted study determined that one of the most important factor inhibiting growth and competitiveness of Indian industries specially the small and medium industries is the inadequate industrial infrastructure.


62

Central grant-in-aid and the balance 25% by other stakeholders of the respective cluster/location with a minimum industry contribution of 15% of total project cost in the form of cash.

IIUS has played an important role in terms of providing insights into experiences of cluster approach, developing better methodologies and relevant information. Besides, it also has enriched experience in assisting such clusters by identifying and arranging services pertinent for the clusters.

Currently, UNIDO is implementing a project in India with the aim of developing capabilities at both the local and the national levels to promote Small Scale Industries (SSI) networking and cluster development. Known as the UNIDO Country Programme 2008-2012122, it is aimed at raising the competitiveness of industrial enterprises through industrial policy advice, investment and technology promotion, through technology-oriented initiatives to increase productivity, quality, energy efficiency, occupational health and safety and the environmental sustainability of industrial production.

What is important about this initiative is that this program also draws strength through collaborative support from national developmental institutions like Small Industries Development Bank of India (SIDBI) and more recently office of the Development Commissioner Small Scale Industry (DCSSI). It is aligned to the objectives of the Government of India’s 11th Five-Year Plan 2008-2012 and the National Manufacturing Competitiveness Strategy. The overarching objective is the diffusion of best practices in sustainable industrial development. The strategy will distinguish best practices touching upon technology aspects of production (with emphasis on environmentally sustainable technologies, productivity improvements and quality management) on the one hand and, on the other hand, social capital issues encompassing human resource management and industrial organization in clusters of small and medium enterprises. Likewise, diffusion can be within India in line with the Planning Commission’s call for more inclusive growth. The implementation of the program is monitored by a Steering Committee (chaired by Development Commissioner, Small Scale Industries the Ministry of Small Scale Industries), whose task is also to strengthen the synergy between this program and other Government initiatives aimed at the development of small-scale enterprises. The Country Programme 2008-2012 has the following key areas with respect to energy efficiency improvements and sustainability under its overall strategy (UNIDO 2008-2012):

The induction of clean technologies under a broad framework of “Industry and climate change” •and aims at developing a clean-green industry;

Measures to introduce energy efficiency and conservation; •

Acquisition, assimilation and development of new manufacturing technologies; •

Investment promotion; •

Therefore if the energy efficiency improvement schemes of BEE are integrated with the programs promoted by the DIPP under IIUS in future similar to the UNIDO Country Program it will be the most cost-effective intervention at the level of industrial clusters in the country. The role of the Special Purpose vehicle (SPV) can be effectively played by the ESCOs under the overall supervision of EESL with BEE as the apex regulatory body. The cluster approach will not only provide ease of replication of EE measures but will also reduce the transaction costs. For this, the first activity to be conducted would be a cluster mapping which would inter alia identify the major SME clusters in the country and analyse the specific interventions that need to be made in those clusters in order to enhance their competitiveness including energy efficiency. In the light of the importance of SME clusters in India, a conscious effort to promote energy efficiency in industrial development through cluster approach needs to be taken up. The success

122 Country Programme of Cooperation between the Republic of India and UNIDO 2008-2012: Towards inclusive growth: Strengthening the competitiveness and productivity of industrial enterprises. Retrieved from internet on 14th Nov. 2011. dipp.nic.in/English/.../CountryProgramme_UNIDO_2008-2012.pdf


63

of the program should be built around the private sector initiative ably supported by the government and other support institutions.

Recommendation 2

Establish “Integrated programs on Energy Efficiency for SME Clusters” and combine energy efficiency improvement schemes of BEE with the IIUS of DIPP and involve ESCOs as the SPvs for implementing the EE through EPC.

3. National Technical Assistance and Knowledge Management Program

Inadequate information and awareness on EE is one of the major barriers inhibiting SMEs to take up the energy efficiency improvements. To address this barrier a National Technical Assistance program could be undertaken by the EESL. Building capacity and increasing awareness of EE and benefits of EPC at the cluster and plant level on large sale through the implementation of outreach efforts, dissemination of information on successful projects, packaging potential investment proposals in EE for financing by local banks or other sources and training Industry Cluster Associations to enable them to carry out outreach activities in their respective clusters could form the core components of the Technical Assistance and Knowledge Management Program. The program can be implemented through EESL in coordination with SIDBI and can pool resources from UN agencies such as Asia Pacific Council for Technology Transfer (APCTT) under UNESCAP, UNIDO etc. This program should have two components, one, technical assistance to the SMEs for adequate demand generation and second, technical assistance to commercial financial institutions and banks to increase their knowledge of energy efficiency and energy performance contracting.

Recommendation 3

Initiate a National Technical Assistance and Knowledge Management Program on Energy Efficiency for capacity building and increasing awareness for Energy Efficiency amongst the SMEs and Banks.

4. Capacity building of Indian ESCOs by Involving Multinational ESCOs

Multi-national ESCOs have been a component of ESCO development in some developing countries, in some cases through partnerships with local ESCOs, but more often operating on their own. ESCO companies in United States have considered expanding their markets overseas but are very selective due to the range of financial, administrative and cultural impediments, as well as the large initial investments, lagging profit and long-term commitment required (Lee et al., 2003; Cowan,2009; Lockhart, 2009).

In order to be successful in developing countries, given the multiple challenges, U.S. ESCOs generally have to send their most experienced personnel, which they often do not wish to lose from their U.S. operations (Cowan, 2009). Moreover, in developing countries, ESCOs are often expected by the private and public sector to finance the project themselves (Lockhart, 2009). Undertaking the project financing presents too much risk including risks associated with the clients to many U.S. ESCOS when there are still significant market opportunities in the United States.

Nevertheless, the large market opportunities in some developing countries are being recognized by some of the larger U.S. and European ESCOs (Hansen, 2009a). In particular, Honeywell, Siemens and Johnson Controls are larger global ESCOs that are active in developing country ESCO industries (Zhao, 2007; Hansen, 2009a; Lockhart, 2009). For example, Siemens is engaged in strategic geographic expansion into Asia-Pacific, including China, Korea, Singapore and Taiwan, as well as India (Sugay, 2009). Honeywell has an ESCO presence in countries such as Poland, India, Hungary and China. In India, Honeywell started as a joint venture company with an Indian company, but Honeywell recently became the major


64

stakeholder in that company and till 2005 had delivered 35 energy efficiency projects in India (Sharma, 2005). A key element of success for Siemens and Honeywell is that their ESCO operations are part of their overall operations, and they already have offices in many developing countries (Lockhart, 2009; Sugay, 2009). For example, Honeywell is a multinational company and a global leader in energy control systems for buildings and industrial processes. Their ESCO business is just a component of their overall energy efficiency operations. Their size provides them with many financing options and as a result, these companies often provide the financing for their ESCO projects in developing countries themselves, through their own financial arms (Sugay, 2009). This resolves the financing challenges that are often a large barrier to ESCO projects in developing countries. The presence of offices with pre-existing employees in these countries eases the challenges associated with finding appropriate staff and/or moving North American or European staff to these countries. In the case of Siemens, the local offices are contacted by strategic expansion staff and provided with training and toolboxes of processes and procedures with regard to how expanding into the ESCO business could be profitable (Sugay, 2009). Additional people are then hired locally if that office decides to proceed. (Jennifer Ellis 2009)Nevertheless, even with established ESCO offices, some multi-national ESCOs face challenges achieving similar profits from some developing country projects compared to those in North America, due to smaller project size, and more limited types of project offerings due to more limited local expertise (Sugay, 2009).However with cluster approach, if greater efforts are made to remove the barriers to ESCOs, the problem of smaller project size can be overcome and it is likely that there will be more U.S. and European ESCOs interested in conducting business in India. Involving multinational ESCOs will boost ESCO development and energy efficiency performance contracting.Although financing is not a constraint in EE investment in SMEs, yet India’s newly created EESL can provide for the lack of much needed missing link between the International institutions that provide financial support such as EBRD, World Bank, GEF, IFC etc. and the ESCOs. Similarly multinational ESCOs by their sheer size and experience can play an important role in removing certain critical barriers by providing necessary technical manpower, formulating sector specific Performance Measurement and Verification (PMV) Protocols and clean technology inputs etc. and most important trust amongst the key actors.

Recommendation 4

Involve Multinational ESCOs in large federal energy efficiency projects including those in MUSH123 sector who would engage Indian ESCOs as subcontractors in these projects so as to help them in their capacity building.

5. Enabling Government Policies

5.1 Bringing Energy Efficiency Lending to SMEs under Priority Sector Lending

Under Conventional financial rules, RBI does not allow banks to give non-recourse lending without security which require long pay back periods. This lending is based on cash flow project based financing and therefore acts as a barrier for banks and institutions entering into energy performance contracting. Further, since majority of the SMEs have taken loans for their projects or for working capital, their present and future assets are already hypothecated to the local banks. This hampers a separate retrofitting energy efficiency financing by any other financial institution. One of the important lessons learned from previous lending experiences is that any future efforts designed to finance EE at SMEs should work

123 MUSH sector or MUSH market refers to an abbreviation of the public sector segment or niche market of municipalities (M), universities (U), schools (S) and hospitals (H). http://en.wikipedia.org/wiki/Mush


65

through local financing institutions with strong local presence as they may be better placed to expand EE lending to this sector. Therefore, in order to implement an aggressive expansion plan of ESCOs and EE investments, Reserve Bank of India needs to declare lending under energy efficiency projects to SMEs as “priority sector lending”124 so that the banks which are already financing these SMEs can also take up EE financing. Further the RBI should also should allow cash flow based financing for EE projects and spell out clear guidelines to banks. It is envisaged that when the proposed National Technical Assistance and Knowledge Management Program is implemented it would simultaneously help in demand creation for energy efficiency financing amongst the SMEs.

Recommendation 5

Declare Energy Efficiency lending to SMEs as Priority Sector Lending by the Reserve Bank of India and simultaneously allow cash flow based financing for EE projects by issuing clear guidelines to Banks in this regard.

5.2 Establishing EPC Dispute Resolution Mechanism

Energy performance contracting is a new concept. The Indian Contract Act is well established. Contracting under the energy efficiency involves complex performance measurement, verification of energy savings and non-recourse financing where repayments are based on cash flow. This gives rise to a unique set of circumstances during the implementation of EPC between the ESCOs and the customers which can give rise to disputes mostly with respect to measurement, verifications of energy savings, payment of fees of ESCOs and repayments of financing received by the customer. It is therefore necessary to support and protect ESCOs from the high risk perceptions they have in dealing with the smaller clients like the SMEs. This is all the more important when multinational ESCOs are necessary to be brought in for helping Indian ESCOs in implementation and capacity building.

The government should establish a mechanism to fast track the dispute resolutions between ESCOs and customers to ensure support to ESCOs and motivate them to take up EPC in SMEs in a big way. This can be done by establishing a separate Authority for EPC dispute Resolution which has the powers to adjudicate on the EPC disputes.

Recommendation 6

Establish Authority for Energy Performance Contracting Dispute Resolution for early resolution of disputes between ESCOs and their customers.

6. Creating a strong Industry Association

One of the common enabling factors for development of ESCOs and adoption of large scale energy efficiency measures by the industries in China, Brazil, and the United States was the existence of a strong national association dedicated to the growth of the ESCO industry. In India also, almost each

124 Under priority lending, the Government of India through the Reserve Bank of India (RBI) mandates certain type of lending on the Banks operating in India irrespective of their origin. RBI sets targets in terms of percentage (of total money lent by the Banks) to be lent to certain sectors, which in RBI’s perception would not have had access to organised lending market or could not afford to pay the interest at the commercial rate. This type of lending is called Priority Sector Lending. Financing of Small Scale Industry, small business, agricultural activities and export activities fall under this category. This is also called directed credit in Indian Banking system. Financing Priority Sector in the economy is not strictly on commercial basis as the banks are directed by the RBI that loans must be given on reduced interest rates with discounts to promote these fields. Part of the cost of this concession is borne by RBI by means of refinancing such loans at concessional rate. Indian Banks, therefore, contribute towards economic development of the country by subsidizing the business activities undertaken by entrepreneurs in the areas which are considered “priority sector” by RBI.


66

SME Industry cluster has an industry association. These associations are either not active or they lack adequate awareness towards EE. These associations should be revived and made more active in order to increase awareness, build the credibility of the local industry, facilitate financing for ESCO projects, act as mediators between the government and industry and help advocate policies. Such organization would also coordinate the efforts of various government and nongovernment agencies to help the ESCO industry. ICPEEB (Indian Council for Promotion of Energy Efficiency Business) established in 2005 has not resulted in the promotion of the ESCO industry in India. This organisation should be revived and the cluster associations should be linked with the ICPEEB and made their subsidiary organizations so as to form a national level forum that has adequate representation.

Recommendation 7

Revive the ICPEEB and SME Cluster Associations. Ensure that the new or revived SME industry associations are linked with ICPEEB so that they have an equal representation among all companies in the industry.


67

Part II

ROLE OF TAX & FISCAL

INCENTIvES IN ENERGY AND

ENvIRONMENTAL POLICY


68


69

Chapter 15Role of Tax and Fiscal Policies in removing barriers for promotion of Industrial Energy EfficiencyOverview

Bureau of Energy Efficiency (BEE) in its National Mission for Enhanced Energy Efficiency (NMEEE) Mission Document has made several recommendations on fiscal proposals under Direct and Indirect Taxes. Under Direct Taxes it has suggested for providing tax incentives for energy efficient products and equipments and to promote energy efficiency through tax policy under the emerging taxation regime and prevailing tax framework. A complete list of incentives recommended under the Direct taxes is given in Annexure G. The present paper analyses the recommendations on fiscal proposals related to direct taxes only, examines the pros and cons and the feasibility of incorporating the proposals in the direct taxes statutes for promoting and incentivising energy efficiency in Industries particularly the SMEs. Since these incentives are supposed to be in tune with India’s prevailing tax framework and emerging taxation regime, it is important to have a look at the nature and current framework of taxation regime in India and the role of tax policy in generating demand for energy efficiency improvements. Emerging taxation Regime in India post 1991 tax reformsPost 1991 liberalisation of the Indian Economy was marked by several structural adjustment programs125

(SAP) in line with the advice and reforms advocated by the World Bank and the International Monetary Fund (IMF). The structural adjustments consisted formulation and implementation of new policies based on the ‘Washington consensus’126 as allowed by domestic conditions. Balanced budget, with deficit of a

125 In 1991, India faced an unprecedented balance of payments crisis. For almost a decade the government had borrowed heavily to support an economic strategy that relied on expansionary public spending to finance growth. From 1980 to 1991 India’s domestic public debt increased steadily, from 36 percent to 56 percent of the GDP, while its external debt more than tripled to $70 billion. India’s creditworthiness was downgraded, effectively cutting its access to sources of commercial credit. By early 1991, India was on the brink of default. Then, in 1991, India’s first comprehensive economic policy reform program was launched which the World Bank supported with a $500 million structural adjustment operation (SAL), approved in December 1991 and closed in December 1993. The SAL’s objectives were twofold: (1) to help India address its immediate balance of payments crisis and (2) to support a broad set of policy reforms aimed at liberalizing the Indian economy and opening it up to more competition both from within and abroad. http://lnweb90.worldbank.org/oed/oeddoclib.nsf/b57456d58aba40e585256ad400736404/0586cc45a28a2749852567f5005d8c89?OpenDocument

Structural Adjustments: Structural Adjustment Policies are economic policies which countries must follow in order to qualify for new World Bank and International Monetary Fund (IMF) loans and help them make debt repayments on the older debts owed to commercial banks, governments and the World Bank. Although SAPs are designed for individual countries but have common guiding principles and features which include export-led growth; privatisation and liberalisation; and the efficiency of the free market. SAPs generally require countries to devalue their currencies against the dollar; lift import and export restrictions; balance their budgets and not overspend; and remove price controls and state subsidies. http://www.whirledbank.org/development/sap.html

126 The term “Washington Consensus” was coined by economist John Williamson, 1989 to describe a set of ten specific economic policy prescriptions that he considered constituted the “standard” reform package promoted for crisis-wracked developing countries. These policies were advocated by Washington, D.C.-based institutions such as the International Monetary Fund (IMF), World Bank, and the US Treasury Department. These are (1)Fiscal discipline (2) A reordering of public expenditure priorities toward fields offering both high economic returns and the potential to improve income distribution, such as primary health care, primary education, and infrastructure (3) Tax reform (to lower marginal rates and broaden the tax base) (4) Interest rate liberalization (5) A competitive exchange rate (6)Trade liberalization (7)


70

few percent of GDP, expenditure controls, and broad based taxation with low marginal rates were some of the important policy measures undertaken as per the reform package advocated by the International Monetary Fund and the World Bank. India brought about major changes in its Income Tax law and procedure in order to attract foreign capital investments and to raise additional revenue by widening the tax base and lowering the tax rates which is trend towards ‘base broadening and rate flattening” to meet the growing developmental needs of the country.

As a consequence, Peak Personal Income Tax (PIT) was brought down from 50% in 1991-92 to 30% in 1997-98 and Corporate Tax (CT) from 45% in 1991-92 to 30% in 2006-07. Presently, both CT and PIT peak rate is 30% a trend followed by the other emerging economies like in Chile and Uruguay (Harberger, 1989), Colombia (McLure, 1989), Indonesia (Gillis, 1989) and Jamaica (Bahl, 1989). Consequently the direct taxes collection rose from Rs. 38895 Crore (7.8 Billion USD) in 1996-97 to Rs. 377982 Crore (75.58 Billion USD). The number of effective tax payers increased from 11.64 million to 34.08 million and the Direct Taxes to GDP ratio increased from 2.68 in 1996-97 to 6.13 in 2009-10. The percentage share of revenue realization from direct taxes127 to the total revenue realization increased from 36.3% in 2000-01 to 55.7% in 2008-09. The growing importance of the direct taxes towards country’s overall revenue generation is evidenced by the fact that the percentage share of revenue realization from indirect taxes declined from 63.7% in 2000-01 to 44.3% in 2008-09128. With the reduction in tax rates the existing tax rates in India have become competitive and comparable with other nations and in fact are one of the lowest if effective rate of taxation is taken into account.

Currently the Indian government’s efforts are directed towards raising the revenue collections from direct taxes year after year. Therefore to augment revenue collections, before affecting any further rate cut, it would become necessary to reduce and eliminate deductions or exemptions besides widening the tax base. Tax breaks are inefficient and costly instruments of public policy as they are loss to revenue which remains unqualified. In many countries, like Indonesia, while tax rates were reduced during the course of tax reforms there was a complete elimination of incentives and deductions. The IMF missions generally recommend ‘elimination of most deductions’.129

The basic tenet of the NMEEE is to ensure sustainable growth through an appropriate mix of “4 Es”: Energy, Efficiency, Equity and Environment. As regards the equity, a well administered income tax system ideally should be horizontally and vertically equitable130 (though practically difficult to achieve). In practice,

Liberalization of inflows of foreign direct investment (8) Privatization (9) Deregulation (to abolish barriers to entry and exit) and (10) Secure property rights. www.iie.com/publications/papers/williamson0904-2.pdf

127 Direct Tax: A Direct tax is a kind of charge, which is imposed directly on the taxpayer and paid directly to the central government by the persons (juristic or natural) on whom it is imposed. A direct tax is one that cannot be shifted by the taxpayer to someone else. The some important direct taxes imposed in India are as under: Personal Income Tax, Corporation Tax, Wealth Tax and Gift tax.

Indirect Tax: An indirect tax is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the customer). An indirect tax is one that can be shifted by the taxpayer to someone else. An indirect tax may increase the price of a good so that consumers are actually paying the tax by paying more for the products. The some important indirect taxes imposed in India are as under: Customs Duty, Central Excise duty, Service tax, Value added Tax.

128 Revenue collection from indirect taxes increased from ` 1198.14 billion in 2000-01 to ` 2446.67 billion in 2009-10. The increase is because the percentage share of revenue realization from service tax to the total revenue realization from indirect taxes increased substantially from 2.2% in 2000-01 to 23.5% in 2009-10.

http://www.google.co.in/#sclient=psy-ab&hl=en&source=hp&q=percentage%20share%20of%20Direct%20taxes%20in%20total%20revenue%20collection%20in%20india%20ax%20r&pbx=1&oq=&aq=&aqi=&aql=&gs_sm=&gs_upl=&bav=on.2,or.r_gc.r_pw.,cf.osb&fp=12050a415eec4921&biw=1536&bih=773&pf=p&pdl=3000

129 Vito Tanzi, The IMF and the Tax Reform, Eds. Bagchi and Stern: Tax Policy and Planning in Developing Countries, Oxford University Press, Delhi,1994.

130 Horizontal equity implies that those placed in similar economic circumstances should be treated the same that is taxed at the same rate. Vertical equity concept relates to use of progressively higher rates of tax (tax the rich more heavily than the poor) to attain goal of reduction of income inequality. However, companies are taxed at uniform rate, as equity is concerned with people and not with organisations.


71

number of concessions/ exemptions that are provided adversely affects equity. Further, weakness in tax administration, and resultant evasion (which is common in India), also affects equity. Under a weak tax administration the proportion of unreported income is high and formal sector is taxed more heavily than informal sector. Similarly, exemptions generally work for the benefit of the rich.

It is under the above scenario of emerging taxation regime and the prevailing tax framework in India, tax and fiscal policies to promote energy efficiency in Industries, particularly, the SME sector needs to be examined.

While considering the tax related energy efficiency policies for incentivizing industry’s shift towards adoption of more EE technologies or EE products it is important to keep in mind that any cost related decision concerning energy efficiency, at the individual level, is based on a trade-off between an immediate cost and a future decrease in energy expenses expected from increased efficiency. The higher the energy price, observed or expected, the more attractive are the energy efficient solutions. Making a “good” investment decision, for domestic appliances or industrial devices, from the energy efficiency viewpoint relies on a sound economic rationale. Price signals are necessary. In market economies, where most energy prices to final consumers are deregulated, prices should normally reflect fairly accurately the supply costs. However, for several reasons, they often reflect only a part of the overall costs of fuels and electricity. They include none, or just a few, environmental externalities and long-run marginal development costs. As a result, decisions made by final consumers when purchasing equipment or making an energy efficient investment (e.g. retrofitting) often do not reflect the drive towards the most cost effective solutions from the public interest viewpoint, creating a gap between the actual achievements in energy efficiency and what could be achieved through an accurate price system accounting for all costs involved. (Lynn Price et al., LBNA; 2005)131

Taxation is used by governments to reduce or suppress price distortions at the consumer level. In that sense, taxation is always complementary to energy efficiency policies and measures. Taxation determines the effectiveness of EE policies and measures though it constitutes one of the components in the overall scheme. Clear price signals alone are not enough to achieve a rationalization of energy use, as there are multiple market failures that prevent consumers from choosing the most cost effective solution and therefore there still exists a large potential for energy efficiency improvements. To reinforce the role of energy prices, additional policy measures are necessary in market economies, firstly to create the appropriate market conditions for efficient equipment and secondly to drive consumer choice towards the most cost effective solutions132(WEC, 2010).

Before discussing the suitability of various tax and fiscal incentives in promoting ESCOs in India and investments in energy efficiency by Indian SMEs it will be necessary to understand the role of tax and fiscal policies in promoting energy efficiency and how they help in encouraging investments in EE processes and equipments. The discussion on the role of tax policies in the following sections of the paper is primarily based on the Ernest Orlando Lawrence Berkeley National Laboratory Berkeley, CA USA paper on Tax and Fiscal Policies for Promotion of Industrial Energy Efficiency: A Survey of International Experience by Lynn Price, Christina Galitsky and Jonathan Sinton and European Commission’s Taxation Paper on The role of fiscal instruments in environmental policy by Katri Kosonen and Gaëtan Nicodème.133

131 Tax and Fiscal Policies for Promotion of Industrial Energy Efficiency: A Survey of International Experience- Lynn Price, Christina Galitsky, Jonathan Sinton; Environmental Energy Technologies Division Ernest Orlando Lawrence Berkeley National Laboratory Berkeley, CA 94720 USA Ernst Worrell, Wina Graus Ecofys Utrecht, The Netherlands; September 2005. Retrieved from internet http://ies.lbl.gov/iespubs/58128.pdf

132 Energy Efficiency: Recipe for success, World Energy Council -for sustainable development, 2010. Retrieved from the internet available at: http://www.worldenergy.org/documents/fdeneff_v2.pdf

133 The role of fiscal instruments in environmental policy by Katri Kosone (European Commission) and Gaëtan Nicodème (European Commission, ECARES-ULB, CEB-Solvay Brussels School of Economics and Management, and CESifo) June 2009; Taxation Working Paper 19 of 2009.


73

Chapter 16Role of Tax PolicyGovernment tax policy, namely taxes and tax incentives, can help generate demand for energy efficiency improvements. Energy taxes can be used to raise revenue to fund government programs more directly aimed at promoting energy efficiency that serves the dual purpose of encouraging reduced energy consumption and promoting energy efficiency investments. Taxes are effective in promoting energy efficiency in cases where:

The level of taxation is sufficiently high to induce the desired change. If the level of tax is set too •low, then energy users will simply pay the tax without changing their consumption patterns.Where demand, either for the energy source being taxed or the products made using that energy •source, is sufficiently elastic that increased prices will affect purchasing behavior. If energy costs cannot be passed on to buyers of a product, industry will have a strong incentive to reduce energy costs to stay competitive.

Tax incentives (or tax relief) use the reward of reduced taxes to encourage desired behavior. Tax incentives tied to energy efficiency investments essentially reduce the cost of the energy efficiency improvement, which will serve to encourage more businesses to make that investment (thereby increasing demand for energy efficiency projects). Tax incentives are, therefore, a type of subsidy representing a transfer of wealth from one group (society at large) to another group (investors in energy efficiency).Direct and indirect subsidies for distinct groups of energy users (e.g. households, large energy users) are often incorporated into national or regional energy prices. Reducing such subsidies or using energy and CO2 taxes to balance the effect of subsidies provides the energy consumer with a more realistic indication of the actual costs associated with certain forms of energy. In addition, taxes can also be used to more accurately reflect the environmental costs, or “externalities”, associated with energy consumption. Economic incentives that directly reduce the costs associated with increasing energy efficiency include subsidies and loans. Subsidies can either be public funds given directly to the entity investing in energy efficiency or they can be in the form of subsidized services, such as audits. There are also various types of loans with low interest rates for purchase of energy-efficient equipment and loan guarantee schemes. In addition to these individual measures, integrated policies that combine a variety of financial policies in a national-level energy or GHG emissions mitigation program are also found in a number of countries. Such integrated policies are often national-level energy or GHG programs that combine a number of tax and fiscal instruments along with other energy efficiency mechanisms such as voluntary agreements. Another example of an integrated policy is emissions trading which involves establishing a desired emissions level (or cap) and allocating permits to industries that can then trade the permits in order to most cost-effectively reach the set emissions cap.Tax and fiscal policies for encouraging investment in energy-efficient industrial equipment and processes operate either through increasing the costs associated with energy use to stimulate energy efficiency or by reducing the costs associated with energy efficiency investments. Various forms of these instruments have been tried in numerous countries over the past two to three decades134 (Lynn Price et al. 2005).


74

Table 3

Tax and Fiscal Policies for encouraging investment in EE processes and equipments

A. Tax and fiscal policies that increase cost associated with energy use

B. Tax and fiscal policies that reduce the cost associated with Energy use

1. Energy or Energy Related CO2 Taxes2. Pollution Levies / Taxes3. Public Benefit Charges

1 Tax Incentives a) Accelerated Depreciation b) Tax deductions c) Tax credits d) Tax exemptions e) Tax reductions2 Grants / Non Tax Subsidies3 Subsidized Energy Audits4 Loans a) Soft / Public Loans b) Innovative FundsI. Equity Participation through ESCOsII. Guarantee FundsIII. Revolving FundsIV. Venture Capital

Adapted from Tax and Fiscal Policies for Promotion of Industrial Energy Efficiency: A Survey of International Experience- Lynn Price et al., 2005.

A. Taxes and Fees for Increasing Costs Associated with Energy Use

Taxes and fees associated with energy use or with emissions that result from consumption of energy are imposed on users with the goal of creating incentives to reduce wasteful energy consumption practices or for creating public programs and funds to encourage energy efficiency. Such policies include energy or energy-related CO2 taxes, pollution levies, and public benefit charges.

1. Energy or Energy-Related CO2 Taxes

Environmental or “green” taxes such as those imposed on energy use or energy-related CO2 emissions, are considered by economists as theoretically superior to other policy instruments because they internalize the environmental costs associated with energy consumption. The advantages of such taxes are that they aim to reduce demand for the product taxed, they raise revenues, and they reduce pollution and related detrimental health and labor productivity impacts (Royal Society, 2002). Environmental taxes can also bring a “double dividend” through tax shifting where income or labour-related taxes are reduced, creating additional jobs while protecting the environment. The disadvantages are that taxes can have undesirable effects such as disproportional impact on certain sectors of society (e.g. poor households) or on the competitiveness of industrial sectors (Scrimgeour et al., 2005). Controlling and sanctioning related to taxes can be expensive for governments (Johannsen, 2002). Taxes can also result in strong opposition (Royal Society, 2002) and their enactment can become mired in political debate (Johannsen, 2002). While higher prices of energy, either through energy taxes or through carbon taxes, are believed to encourage greater energy efficiency over the long term, a study of small and



75

medium industrial firms in the United States has found that, in the short term, policies to reduce the up-front costs of efficiency investments, e.g., subsidies and tax relief, are more effective at inducing efficiency than higher energy prices (Anderson and Newell, 2004). Evaluations of the effectiveness of carbon taxes, though, highlight that they generally achieve their objective of reducing emissions (Scrimgeour et al., 2005).Energy or energy-related carbon dioxide (CO2) taxes have been used in a number of countries to provide an incentive to industry to improve the energy management at their facilities through both behavioural changes and investments in energy-efficient equipment. Often these taxes are combined with tax rebates for companies that sign voluntary agreements and reach specified energy efficiency improvements levels.A recent evaluation of energy and CO2 emissions taxes provides the following guidance (OECD/IEA, 2003):

“When setting individual tax rates, governments need to ensure that rates are high enough to be effective and provide sufficient incentive for action while ensuring that they are not so high that industries close down or relocate, which could just result in carbon ‘leakage’ rather than reduction. Governments have approached this issue in various ways. For example, some governments have decided, for competitiveness reasons, to allow industry complete or partial exemptions from carbon or carbon/energy taxes applied elsewhere in the economy.”

2. Pollution Levies Pollution levies on energy-intensive industries are also a type of tax aimed at reducing emissions and wastes. The pollution levies works towards internalization of the external costs.135 A tax that directly tackles the source of externality, i.e. emissions, is also called root taxation. Pollution levies are imposed on violators of pollution emissions standards in a number of countries. While these levies are not directly tied to a facility’s energy consumption, they are typically imposed on large energy-consuming facilities and the regulated emissions are often associated with energy use. In general, levels of penalties for environmental offences have been rising across countries, regardless of the type of regulatory system. Minimum penalties are typically small and maxima can be quite large, giving administrative and judicial authorities wide discretionary powers.

Thus, although the idea of such Pigouvian taxes is appealing, it has also some caveats in both theoretical and practical sense.

3. Public Benefits ChargesPublic benefit programs (also called public goods charges, system benefits charges or line charge programs) impose a small energy tax on all users of specific fuels (e.g. electricity) in order to establish public programs and funds that encourage energy efficiency improvement.B. Fiscal Policies for Reducing Costs Associated with Increasing Energy Efficiency

Fiscal policies include grants or subsidies for investments in energy efficiency, subsidized audits, loans [such as public loans (soft Loan) and a number of innovative loan funds, guarantee funds, equity participation through ESCOs and venture capital], tax incentives for purchase of energy-efficient equipment, and tax relief as an element of a larger energy or GHG emission tax or negotiated agreement scheme.

135 When a tax on emissions is set equal to the value marginal social damage caused by those emissions, it is said to fully internalize external costs. External costs arise, because environmental quality has the property of a public good, the provision of which is not ensured by the market mechanism. Taxes can be used to correct for this market failure. Such taxes – called Pigouvian taxes - ensure that pollution is reduced to the level at which the marginal private benefit to the polluter is precisely equal to the marginal social costs (i.e. external costs) caused by the pollution. It corresponds to the “Polluter Pays Principle”, as the polluter pays in the form of the tax the cost of pollution to the society. Note also that in the presence of certainty, a cap-and-trade scheme on emissions is equivalent to an emission tax with respect to static and dynamic efficiency. (Tax and Fiscal Policies for Promotion of Industrial Energy Efficiency: A Survey of International Experience- Lynn Price et al.)


76

Fiscal incentives indirectly reduce the cost of investments in energy efficiency by reducing taxes paid by consumers. Such incentives can be tax reductions or rebates provided as part of a larger energy or CO2 emissions tax scheme or can be in the form of accelerated depreciation, tax credits, tax deductions and tax exemptions tied to specific energy-efficient technology investments.

1. Tax Incentives

Tax incentives (or tax relief) use the reward of reduced taxes to encourage desired behavior. Tax incentives tied to energy efficiency investments essentially reduce the cost of the energy efficiency improvement, which will serve to encourage more businesses to make that investment (thereby increasing demand for energy efficiency projects). Tax incentives are, therefore, a type of subsidy representing a transfer of wealth from one group (society at large) to another group (investors in energy efficiency). To facilitate implementation, tax incentives for energy efficiency investments are typically tied to specific equipment purchases – e.g., a list of equipments such as equipments with long payback periods but with large energy efficiency potential identified in advance by the government providing the subsidy or specific technologies, usually innovative technologies that may represent riskier investment decision. Like tax incentives, non-tax subsidies also reduce the cost of equipment, thereby encouraging a business to make energy efficient improvements or purchase a piece of equipment that is more expensive, but more energy efficient, than an alternative.

There are a number of ways in which tax incentives can promote investment in energy efficiency:

a) Accelerated depreciation:

These types of incentives allow businesses to depreciate the costs of their investments in energy efficiency technologies at a higher rate. The effect of more rapid depreciation is to reduce a business’s taxable income as compared with use of normal depreciation during the depreciable life of the equipment purchased. The reduced tax burden effectively reduces the cost of the equipment, making it a more attractive investment option.

b) Tax deductions:

Under this type of incentive, businesses are allowed to deduct some or all of the cost of investment in energy efficiency technologies from their annual profits. The savings accrued to the business is equivalent to the amount of tax the company would have paid on the amount of the deduction. If a company pays 30 percent corporate income taxes, for example, then the savings generated by allowing a deduction of the full cost of energy efficient equipment would be 30 percent of the cost of the equipment.

c) Tax credits:

Tax credit systems allow a business to reduce its total tax liability by some or all of the cost of an investment in energy efficiency. Tax credits typically generate more savings to business than tax deductions or accelerated depreciation, since they represent an absolute reduction in the amount of taxes paid, while tax deductions and accelerated depreciation only reduce the amount of taxable profit and therefore reduce taxes only by a percentage of the cost of the investment. In addition, the savings associated with a tax credit are more directly tied to the energy efficiency investment.

d) Tax Exemptions: These relate to specific cases when purchasers are exempt from paying customs taxes on certain imported energy-efficient equipment.

e) Tax reductions: Under a tax reduction incentive, taxes paid on the purchase of energy efficiency equipment, such as VAT or import duties, are reduced. In developing countries, reduction of import duties can be significant,


77

as domestic sources of energy efficiency technology may be limited, and standard duties on imported equipment may be a substantial barrier to their use.

Advantages of Tax Incentives vis-à-vis TaxationThere are advantages to the use of tax incentives, particularly relative to taxation, for promoting investments in energy efficiency. These include:

I. Tax incentives are more likely to be effective than taxes on fuel or power use, if the goal is to promote investments in energy efficiency equipment and technologies. The benefits of the tax incentive are directly linked to the investment.

II. Compared with other types of subsidies, tax incentives may also be preferable because they are typically easier to implement. While useful tools, tax incentives have certain disadvantages including the following:

a) Tax incentives may not be the most effective way to actually reduce energy use or promote energy efficiency. Typical tax incentive programs are tied to the cost of the equipment purchased rather than to the efficiency performance of that equipment. Tax incentives could be made more effective in this regard if there was a performance incentive built in as well. Such a program, however, would be more complicated to implement.

b) Tax incentives are subject to the problem of the “free rider.” Some companies may get the benefit of a tax reduction for energy efficiency investments that they would have made in any case; even without the tax incentive. Tax incentives can require a large expenditure of public funds in the form of revenue foregone. Substantial effort may be required to establish a list of eligible technologies and equipment that are new and currently lack profitability, particularly if this is being done to reduce “free riders.” Also, any tax savings to business represents reduced tax revenue to the government.

c) Some may attempt to “game” the system. For example, contractors may raise technology costs in order to increase tax credits for their customers.

Decisions regarding the purchase of energy-efficient technologies are typically based more on the cost of the equipment than on the expected cost of energy used to power the equipment. This implies that tax relief for energy-efficient technologies may be more effective than taxing energy. However, there are some disadvantages to the tax relief approach, including the fact that they do not provide incentives to conserve energy, can result in large expenditures of public funds, and are subject to a large number of “free-riders”, or investors who take advantage of the program even though they would have made the investment without the tax relief (Newell, 2004). Overall evaluations show that tax relief for energy-efficient technologies “may involve a considerable amount of free riders” but that the amount of free riders differs by technology. Programs should be designed such that they avoid providing tax relief for technologies that are already profitable (de Beer et al., 2000).

The effectiveness of tax incentives is tied directly to the effectiveness of a tax system itself. Tax incentives work because they reduce taxes, and businesses are keen to have their taxes reduced. However, in cases where tax evasion is easy and tax collection rates are low, tax incentives lose their effectiveness.136 Because the tax incentives may require large expenditure of public funds, the tax incentives are less effective where economies are in recession or in transition and the governments are not able to forego tax revenue required for development purposes.

136 Background Paper- Assessment of Energy Efficiency Financing Mechanism, Oct. 2010; IPEEC & BEE.


78

2. Grant or Subsidies

Non-Tax Subsidies/ Grants

An energy efficiency subsidy can be broadly defined as “public funds given directly to the party implementing an energy efficiency project.”137 Those providing the grants or subsidies, generally the public sector, do not seek a direct financial benefit in the form of return on investment. However, the subsidies are generally provided by the public sector which do not seek direct return on investments under the assumption that although the subsidy may be uneconomic for the individual consumer, it will financially benefit the sector and/or country as a whole.Developing countries with higher risk market environments for investments may find that direct public funding in the form of grants or subsidies are a viable option for encouraging investment in energy efficiency. Public funds may also be needed where competition with more traditional investments such as infrastructure expansion receives most of the available financing. Some subsidy programs target equipment producers to encourage further energy efficiency research and development. Other subsidy programs will target a specific industry group, such as small and medium sized enterprises (SMEs) that may have relatively greater difficulty in making investments than other industry groups. Tax incentives are a particular type of subsidy, since reductions in taxes represent a transfer of public funds (in the form of lost government revenue) to the person or entity receiving the tax benefit. Non-tax subsidies (also referred to as “grants”) are a more direct means of making that transfer of funds and can be provided to businesses that invest in energy efficiency improvements in a variety of ways:

I. As a fixed payment for an eligible investment.II. As a percentage of the total value of the investment (usually capped at some level). (WEC

2004).III. As an amount linked to the amount saved in energy or energy costs (a performance-based

approach).

There are a number of situations in which subsidies can be an effective means to encourage investment in energy efficient technologies. Direct funding can be more effective in generating investments in these environments than more indirect tax incentives.

Advantages of Non Tax Subsidies

Non Tax Subsidies have Advantages in following conditions:

I. Where energy efficiency projects are too small to get attention from commercial banks II. Where non-asset based energy-efficiency projects are considered by commercial banks to be

more risky, and therefore has greater loan risks, than asset-based projects III. In countries where energy prices are subsidized and therefore do not reflect the real costs of

energy or are too low to make energy efficiency projects profitable.IV. Where there are target audiences – e.g., SMEs or specific industry sectors – that face particular

difficulty in obtaining financing for projects.

Disadvantages of Non Tax Subsidies

Potentially effective, subsidy programs also have disadvantages that should be considered before they are implemented:

137 Grants and subsidies are also given for energy efficiency research and development projects, demonstration projects, and market development and procurement programs in many countries. In this report only grants and subsidies for implementing energy efficiency measures in an industrial plant as fiscal policy measures are considered, though these other programs do exist.


79

I. Similar to tax incentive programs, non-tax subsidies are subject to the problem of free riders. The free rider problem can be minimized in the same manner – by carefully defining the types of investments that qualify for the subsidy.

II. Lack of knowledge on the part of the target audience may prevent use of the subsidy. Outreach programs may therefore be necessary to maximize the effectiveness of these programs.

III. High transactions costs, in the form of significant paperwork or other application processes, can also discourage subsidy use. Streamlined application processes, if possible, should be employed.

IV. Subsidy programs can be costly to operate. Governments must set up and operate the program, and subsidy payments high enough to induce investment may constitute a substantial transfer of public funds to the private sector

To combat these problems, grants and subsidies are now limited to better target the proper audience (WEC, 2001a). They can be restricted to certain types of investment, such as a selected list of equipment with a long payback time but high efficiency gains, or can be evaluated on the basis of cost-effectiveness. They can also be targeted toward firms that are more energy-intensive, are of a certain target size, or are participating in a voluntary agreement program. (Price et al. 2005)Subsidy schemes focus more on small or medium sized enterprises, which may not otherwise be able to afford to undertake large energy efficiency projects. For example the Netherland’s BSET Program focused on small or medium sized enterprises, covering up to 25% of the costs for specific technologies such as heat recovery, heat pumps and absorption cooling (Kræmer and Stjernström, 1997). The Scottish Clean Energy Demonstration Scheme (SCEDS) also focuses on small to medium sized businesses (SEEO, 2005). Denmark prioritized the distribution of grants and subsidies to energy-intensive industries and companies involved in a voluntary agreement (Danish Energy Agency, 2000).

3. Subsidized Audits Energy audits, funded by the government or public utilities, can be partially subsidized or provided entirely free of charge to industry, reducing the transaction costs associated with implementation of new energy-efficient technologies A successful energy audit can be done by the auditors who fully understand the production and operational processes at the audited plant. Thus, some countries provide a directory or network of accredited auditors or consultants to perform the audits. Targeting specific customers can overcome certain obstacles encountered in audit programs around the world, such as simply a lack of knowledge of the program or free-ridership. One such targeting method is to provide audits as a benefit for participants in voluntary agreements, such as in Denmark, the Netherlands and Sweden.

4. Loans(a) Public Loans (Soft Loans)Public or soft loans are loans subsidized by public funding that are offered at interest rates below market interest rates for investments in energy efficiency.(b) Innovative FundsInnovative funds are aimed at increasing the involvement of banks and private capital in energy efficiency investments are also being used in some countries. In an effort to reduce public debt, trends show a movement toward these types of private sector, rather than the public sector, funds (WEC, 2004). By involving the private sector who seeks profits from their loans, these countries hope to develop a self-sustaining market in the long term, while obtaining a good return on investment in the short term. Generally, both private, “innovative” and public, “soft” loans are used in a given scheme; many innovative funds themselves employ partial public funding. The main goal of an innovative funding scheme is to get the banks involved and introduce them to making profits by employing energy efficiency. Innovative funds include equity participation through ESCOs, guarantee funds, revolving funds, and venture capital funds.


80

INTEGRATED POLICIESComplementing taxes with other fiscal instruments138

There are two basic reasons why tax instruments alone may be insufficient to tackle environmental problems and need to be complemented with other policy instruments.First, due to information costs and asymmetries emission, taxes, which ensure the optimal outcome in the first-best world, may be difficult to implement in practice. Emissions are not observed at the market place, and their measurement and monitoring may be prohibitively costly or technically unfeasible. It may also be administratively cheaper to use the existing tax system to address environmental problems, for instance by the differentiation of the tax rates in indirect taxation, than to introduce entirely new taxes. Therefore, taxes are often based on the sales of goods that are related to the externality rather than on the externality itself. As the tax bases of such instruments are imperfect proxies for the externality, they correct for the externality in an inefficient way compared to first-best instruments. The inefficiency arises from the fact that the behavioural response to such a tax is inadequate; it induces consumers to reduce the consumption of the good in question, but not to cut emissions. For example, an output tax on electricity provides an incentive to reduce electricity consumption but not to reduce the carbon emissions in electricity generation. On these grounds some authors suggest the use of multi-part instruments, i.e. the combinations of indirect taxes with other fiscal instruments (subsidies), which could better target emissions or other externalities than a single tax instrument.The second, justification for using the combination of instruments in environmental policies is the presence of market imperfections or market failures other than the environmental externality. Under such condition, a single tax instrument might be inefficient or its use may involve much higher costs than the combination of two or more instruments, even if an efficient first-best instrument were available. Complementary instruments can be of diverse nature, ranging from information campaign, labelling and direct subsidies to differentiated indirect tax rates in favour of clean products. It has to be kept in mind, however, that the use of complementary instruments, in particular, the fiscal instruments, are not without caveats, and should be in each case carefully designed and evaluated. First, all subsidies - given either directly or through the tax system - cost money to governments. They have to be financed either by increasing other taxes or reducing public expenditure, which will entail welfare costs. Moreover, administrative costs of subsidy/incentive schemes may also be high compared with increasing existing taxes. Therefore the benefits achieved through the use of tax incentives (in the form of energy saving or lower emissions) should always be compared to the costs before implementing such measures. Secondly, fiscal incentives may not be effective, even disregarding the costs. There are number of reasons for this. First, all fiscal incentives are not necessarily passed through to consumer prices, at least in the short-term, in which case they would not have the desired effect on consumer behaviour. Second, the effectiveness of incentive schemes may be reduced by the rebound effect and free-rider problem. (Goulder and Parry, 2008) The rebound effect implies that lower prices of appliance would induce the consumers to purchase more of them, or use them more intensively, which would eventually lead to higher energy consumption. The free-rider problem means that subsidies are given to consumers who would have bought the energy-efficient appliance in any case.( Lynn Price et al. 2005)To sum up, root taxation or regulation measures alone are successful only if the benefits of using complementary instruments do not exceed the budgetary costs or if there are no market imperfections that may justify the use of complementary instruments. However, in case of contrary situation, complementary instruments are more successful.



81

For example if there is a problem of inadequate information on energy savings then Information campaign can be used as complementary instrument. On the other hand, if there are problems of affordability, and /or principal agent problem, and/or myopic consumers, and /or high search costs then Fiscal incentives as complementary instrument could be adopted provided that the risks of free riders and the risks of rebound effects139 are limited. It needs to be ensured that the fiscal incentives would help diverting the production from informal to formal sector and are likely to be passed on to consumers. However, if these conditions are not fulfilled, then the root taxation or regulations are better options.140 (Katri and Gaetan).

Industrial Energy Efficiency International Best Practices

i. Integrating CO2 taxes with subsidies and tax rebates under voluntary agreementsDenmark used integrated policy combining CO2 Taxes and Voluntary Agreements to reach its climate political goals under the Kyoto Protocol to reduce greenhouse gas emissions by 21% below 1990 levels by 2008-2012, corresponding to a total emission level of 54.9 million ton CO2. Denmark has undertaken a succession of integrated greenhouse gas emissions reduction strategies over the years. A central element in these strategies has been the use of household and business energy and CO2 taxation, as a way to provide economic incentives for energy conservation and fuel switching. The business CO2 tax has been combined with subsidies for clean energy technology investments and tax rebates for energy-intensive industries that enter into voluntary agreements141. Under the agreements, the companies are required to implement all “profitable” energy savings projects, which are defined as projects with payback periods of up to four years, as identified in an energy audit or through internal investigations. In addition, companies must introduce energy management and motivate staff to ensure that investments in new equipment are energy efficient. Subsidies are provided for up to 30-50% of the cost of energy efficient investments (Bjørner and Jensen 2000; Johannsen, 2002)142. The business energy and CO2 taxes created a substantial environmental effect in an economically efficient way, while taking international competitiveness into proper consideration. (Finansministeriet 1999)143. Study points to an overall reduction in energy consumption levels of 10% and taken alone, the energy efficiency agreements led to a reduction in energy consumption of 9% (Bjørner and Jensen 2000)144.

139 The rebound effect implies that lower prices of appliance would induce the consumers to purchase more of them, or use them more intensively, which would eventually lead to higher energy consumption. The free-rider problem means that subsidies are given even to those consumers who would have bought the energy-efficient appliance in any case.

140 The role of fiscal instruments in environmental policy by Katri Kosonen (European Commission) and Gaëtan Nicodème (European Commission, ECARES-ULB, CEB-Solvay Brussels School of Economics and Management, and CESifo) Junem2009, Taxation Papers- European Commission.

141 Voluntary Agreements: Voluntary agreements are “essentially a contract between the government and industry, or negotiated targets with commitments and time schedules on the part of all participating parties” (IEA, 1997a). These agreements typically have a long-term outlook, covering a period of five to ten years, so that strategic energy-efficiency investments can be planned and implemented. A key element of voluntary agreements is that they focus the attention of all actors on energy efficiency or emission reduction goals. Voluntary agreement programs can be roughly divided into three broad categories: 1) programs that are completely voluntary, 2) programs that use the threat of future regulations or energy/greenhouse gas emissions taxes as a motivation for participation, and 3) programs that are implemented in conjunction with an existing energy/GHG emissions tax policy or with strict regulations.1 A variety of government provided incentives as well as penalties are associated with these programs. (Voluntary Agreements for Energy Efficiency or GHG Emissions Reduction in Industry: An Assessment of Programs Around the World-Lynn Price, Lawrence Berkeley National Laboratory; 2005)

142 Bjørner, T.B. and Jensen, H.H., 2000. Industrial Energy Demand and the Effect of Taxes, Agreements and Subsidies. Copenhagen: AKF Forlaget.

143 Finansministeriet, 1999. Evaluering af grønne afgifter og erhvervene. Schultz Forlag. Referred in Tax and Fiscal Policies for Promotion of Industrial Energy Efficiency: A Survey of International Experience-Lynn Price et al. http://ies.lbl.gov/iespubs/58128.pdf

144 Bjørner, T.B. and Jensen, H.H., 2000. Industrial Energy Demand and the Effect of Taxes, Agreements and Subsidies. Copenhagen: AKF Forlaget.


82

ii. Integrating Climate Change Levies with Climate Change Agreements (CCA)

UK combined Climate Change Levy and Climate Change Agreements. The UK Climate Change Program was established in 2000 to meet both the country’s Kyoto Protocol commitment of a 12.5% reduction in greenhouse gas emissions by 2008-2012 relative to 1990 and the domestic goal of a 20% CO2 emissions reduction relative to 1990 by 2010 (DEFRA, 2000)145. A key element of the Climate Change Program is the Climate Change Levy which is an energy tax applied to industry, commerce, agriculture, and the public sector. The levy does not apply to domestic customers or charities. The revenues from the levy are returned to the taxed sectors through a 0.3% reduction in the rate of employer’s National Insurance Contributions. In addition, programs that provide financial incentives for adoption of energy efficiency and renewable energy, as well as the Enhanced Capital Allowance Scheme that provides 100% first year capital allowances for specified energy efficiency investments are also offered to industry, commerce, and the public sector (DEFRA, 2004). Along with the Climate Change Levy and the financial incentive programs, certain companies can also participate in Climate Change Agreements (CCAs). Through the CCAs, energy-intensive industrial sectors established energy efficiency improvement targets. Companies that meet their agreed-upon target are given an 80% discount from the Climate Change Levy. During the first target period (2001-2002) total reductions of 4.3 MtC were realized, which was three times higher than the target for that period (Pender, 2004)146.

iii. Emission Trading

Emissions trading schemes are based on the allocation of an authorization to emit a ton of a pollutant also known as “assigned amount units (AAUs)”. A limited number of ‘emission permits’ that represent an aggregate emission level below current practice are allocated, creating a market also known as “Carbon Market” in which the permits have a positive value (Gehring and Streck, 2005). The use of tradable permits (emission trading), as a useful regulatory tool is based on the notion that all parties will benefit from free and voluntary trades.

There are two types of emissions trading systems: cap-and-trade and baseline-and-credit systems. Most implemented trading systems are cap and trade systems which are based on an absolute emissions limit granted outright or auctioned to participating entities for a specified time period. Under a baseline-and-credit system, emissions reduction credits are granted against a projected baseline of emissions and these credits can be used to meet an absolute target (Gehring and Streck, 2005).In January 2005, the European Union Greenhouse Gas Emission Trading Scheme (EUETS) commenced operation as the largest multi-country, multi-sector GHG emission trading scheme worldwide (European Commission, 2005). The EU ETS is the first international trading system for CO2 emissions in the world to help EU Member States achieve compliance with their commitments under the Kyoto Protocol. A number of exchanges have been set up to facilitate the trade in emission allowances.To identify the country or program that represents international best practice for each specific policy is often difficult, however it is clear that the most effective policies combine a number of tax and fiscal programs in an effort to provide a clear economic signal to industry that investments in energy efficiency are a high priority. Many countries use energy taxes or levy CO2 taxes to provide an incentive to industry to improve the energy management at their facilities through both behavioural changes and investments in energy-efficient equipment. The most well designed Energy or CO2 tax programs recycle the tax revenues

145 Department of Environment, Food, and Rural Affairs (DEFRA), 2005a. UK Emissions Trading Scheme. http://www.defra.gov.uk/environment/climatechange/trading/uk/index.htm 146 Pender, M., 2004. UK Climate Change Agreements. Presentation to China Iron and Steel Association Delegation referred

in Tax and Fiscal Policies for Promotion of Industrial Energy Efficiency: A Survey of International Experience- Lynn Price, et al. Retrieved from internet http://ies.lbl.gov/iespubs/58128.pdf


83

collected back into the economy. This extra revenue balances with the revenue that is foregone in order to provide tax incentives for energy-efficiency investments or to provide information and auditing programs, and provide tax reductions for industries that meet energy efficiency targets under voluntary or negotiated agreements as the case may be for a particular Program. Fiscal policies such as grants or subsidies for investments in energy efficiency, subsidized audits, loans, and tax relief, are used in many countries to promote industrial energy efficiency investments. Simple, transparent processes with limited transaction costs are essential for all fiscal policies or the costs of participation in the program will outweigh the benefits for the enterprise. Targeting audiences will limit free-ridership and inform intended customers of the energy efficiency program or policy. Linking programs to cost-effectiveness criterion or voluntary agreements have also proven successful in many countries. Subsidized audit programs for industry are the most popular policy employed around the world to induce efficiency investments. Although public loans are less popular than outright energy efficiency subsidies, innovative funding mechanisms such as ESCOs, guarantee funds, revolving funds, and venture capital funds are growing in popularity. For loans sponsoring energy efficiency projects, successful uptake requires interest rates and perceived risk to private institutions to be minimized. Because of the risks involved with the innovative funding programs, fund managers for these programs need expertise in energy/environmental issues and financial issues, as well as international experience where projects span multiple countries. Projects selected should have a high threshold for qualification, i.e., be high quality and bankable. Tax relief programs such as accelerated depreciation, tax reductions, and tax exemptions are used to guide investors toward purchases of more energy efficient equipment, but it is important to design such programs so that they don’t provide tax relief for technologies that are already profitable. Overall, the best practices internationally are those that combine tax and fiscal policies into an integrated program that provides clear economic signals and incentives that raise management awareness so that industries are motivated to reduce the costs associated with consumption of polluting energy sources and to improve the energy efficiency of their facilities.

Advantages of fiscal instruments as policy instruments147 Compared with regulatory instruments (standards, quotas, product bans) the main advantage of taxes and other market-based instruments is efficiency. Pollution taxes induce each polluter to reduce the pollution up to the point where the marginal cost of pollution abatement is equal to the tax. In this way the costs of reaching a given environmental target are minimized (static efficiency). Moreover, polluters have more flexibility to choose the level and the method of abatement. Imposing taxes and charges generally requires less detailed information than regulation and thus entail lower administrative costs. Market-based instruments set a price on each unit of pollution / emissions and thus induce firms to constantly seek new pollution abatements possibilities and to invest in less-polluting technologies. This is a powerful incentive for innovation (dynamic efficiency).

Pros and Cons of Environmental taxesTaxes and charges are effective instruments to change consumers’ behaviour to a more sustainable direction. However in presence of these already existing distorting taxes the introduction of environmental taxes has a negative welfare effect known as “tax interaction effect”.148 Revenue recycling


148 In the presence of distorting taxes the introduction of an environmental tax entails a welfare cost as far as it reduce labour supply by increasing consumer prices and thus reducing real wages. According to Parry and Oates (1998) this negative welfare effect, labelled “tax interaction effect”.


84

also cannot remove the negative welfare effect of environmental taxes because the tax interaction effect is always bigger than the revenue recycling effect and therefore environmental taxes do not represent a win-win option and always entail some economic costs which increases the excess burden of taxation. This implies that the “double dividend” associated with environmental tax reforms also does not hold good.

The revenues raised through environmental taxation however could be used in other ways for the benefit of the environment, the economy or both. First, the governments could earmark part of tax revenues for specific environmental purposes, such as financing eco-efficiency or eco-innovation investments. Secondly, tax revenues could also be used to compensate the households and businesses, who suffer disproportionately from higher taxation.

Compensation could take the form of income tax reductions or tax credits targeted to those specific groups. Financing the tax credits for energy efficiency, which are discussed in more details below, would be a way to reduce the regressivity of energy taxation and enhance energy-efficiency at the same time.

In spite of these advantages, root taxes149 are not always the best instrument to address environmental problems. In some cases direct regulation would bring forth the desired environmental outcome more effectively. This is the case, in particular, when environmental damages are location-specific and vary with the source of pollution, and therefore more targeted instruments than general emissions taxes are required. On the other hand, quantity based instruments, such as emission quotas, are often favoured on the ground they bring forth more certainty in reaching given environmental targets than price-based instruments, such as taxes. Combinations of taxes and other policy instruments may also turn out to be more effective than using taxes alone. (Lynn Price et al. 2005)

The adverse effects of environmental taxes on the income distribution between the households and on the international competitiveness of firms are usually considered to be main obstacles to setting taxes at the environmentally effective level. (Lynn Price et al. 2005)

Environmentally-related taxes are levied on goods deemed of basic necessity (e.g. energy or transport), which put a disproportionate burden on low-income households who spend more on these goods in relative terms (i.e. as a share of household income) than high-income households. Taxes on electricity and heating may have a regressive impact, as low-income households generally spend a larger share of their total spending on these items than high-income households. The recycling of tax revenues through the reductions of income taxes or social security contributions considerably mitigate the regressive impact of energy taxation, and completely reverse it, if the tax cuts boost employment sufficiently to increase the disposable income of the households at the low end of the income scale150. Using targeted tax credits or subsidies in combination with taxes are also an effective approach to compensate the low-income households for the impact of higher energy taxes.

International competitiveness may be adversely affected, when a country unilaterally sets taxes on industrial inputs, in particular on energy. This increase of production costs could put local firms in a competitive disadvantage, with, as possible consequences, firms relocating to other regions or losing market shares to foreign competitors.

149 Root Taxes: Tax that directly tackles the source of externality, i.e. emissions, is also called root taxation.150 This was the case in the study carried out by Cambridge Econometrics (2008) for the Impact Assessment of the Revision of

Energy Tax Directive. In the study the revenue recycling is assumed to go through the reductions of the employers’ social security contributions, which have a strong effect on employment and household disposable income, since the model used in the study (E3ME) allows involuntary unemployment in labour markets even in the long-run.


85

DIRECT FISCAL INCENTIVES TO PROMOTE ENERGY-EFFICIENCY151 Direct fiscal incentives refer to subsidies paid directly in cash or given through the tax system in the form of tax credits, allowances or exemptions to the consumers and producers of environmental-friendly products.

The costs and benefits of direct fiscal incentives

Three types of fiscal incentives viz. subsidy for consumers, tax credit for manufacturers and tax credit for consumers were examined in a study152 for four different EU Member States (France, Denmark, Italy, and Poland) in which these policies were compared in each case to an alternative policy measure. The costs and benefits of policies were assessed with a help of an economic model of consumer behaviour, which assumes that the consumer always selects the appliance category with best net present value. The benefit consists of the monetary value the reductions of GHG emissions achieved through energy savings resulting from the shifts to more energy-efficient categories of products. The costs are the sum of welfare and administrative costs.

The results indicate that subsidy policies can indeed usefully complement tax instruments in promoting energy efficiency and may entail much bigger benefits in this regard than tax increases in specific cases. However, as the results above indicate, this depends on the product and markets conditions and, in each case, these should be carefully investigated. The design of the instrument also matters: direct subsidies (paid in cash) and tax credits to consumers have by far lower overall costs relative to the benefit achieved than tax credits to manufacturers. Although subsidy policies tend to have higher welfare costs than tax policies, they certainly offer a feasible alternative to tax increases, in particular, when distributional and political concerns constrain the use of tax instruments.

Direct fiscal incentives in comparison with reduced vat rates

Direct fiscal incentives address the same policy objective as reduced VAT rates and represent in this sense an alternative instrument. They have a number of advantages compared to reduced VAT rates such as:

1. Subsidy schemes can be better targeted to specific consumer groups, e.g. low income households. This helps to address distributional concerns of energy taxation. Targeting may also alleviate the free-rider problem, namely the fact that the benefit of a reduced VAT rate also goes to the consumers, who would purchase an energy-efficient appliance in any case. Hence the same target can be achieved more cost-effectively. In addition, direct fiscal incentives are likely to be more visible to consumers and thus may have a stronger signalling effect than reduced VAT rates.

2. Contrary to direct tax incentives VAT reduced rates are not effective in the case of taxable economic agents which can deduct VAT paid on inputs.

3. Direct fiscal incentives would not probably create the risk of distorting cross-border trade in the same way as reduced VAT rates, if they are targeted only to the residents of a country.

4. Subsidies delivered at the check-out or as income tax credits to consumers are more certain to reach the consumer than reduced VAT, which may not be entirely passed through to retail prices. The same does not apply, however, to corporate tax credits given to the manufacturers.


152 Study carried out for DG TAXUD in 2008- Bio Intelligence Service (2008)- A study on the costs and benefits associated with the use of tax incentives to promote the manufacturing of more and better energy-efficient appliances and equipment and the consumer purchasing of these products. Final report, December 2008.


86

5. Direct subsidies can be more calibrated to the product characteristics: (a) some products need higher subsidies than others to motivate consumers.

Reduced VAT may not sufficiently bridge the upfront price gap (which is the most relevant market failure for VAT to tackle) in case of large price difference between energy efficient and less efficient products and of (downward) price effects on the old stocks of less efficient products, (b) some products to be promoted also often have other better standards (of luxury) than the ones the specific policy wants to promote; and (c) the VAT instrument lacks flexibility in terms of tackling a possible rebound effect (e.g. it cannot be required that a purchase subject to a reduced rate concerns a replacement of an old appliance).

To sum up direct tax subsidies are superior to reduced vAT rates where (i) there is a need to target some consumers, or (ii) where buyers can deduct vAT, or (iii) where there is a risk of cross border shopping on the single market, or (iv) where there is a risk that reduced vAT rates will not be passed on to the consumers, or (v) where there is a need to calibrate the instrument to the product features.153

On the other hand, compared to reduced VAT rates, the creation of a subsidy scheme can be administratively more complex than the differentiation of rates in an existing tax regime (VAT) and thus may entail higher administrative costs. Finally, it must be taken into consideration that direct fiscal incentives, unlike reduced VAT rates, belong to the sole competence of the Member States and that therefore their use remains inevitably dispersed if the Member States do not coordinate their action in this regard. (Lynn Price et al. 2005)

STATUS OF DIRECT TAX INCENTIVES FOR IMPROVING ENERGY EFFICIENCY IN INDIA

India has to develop an integrated policy that can provide clear economic signals and incentives so that the industries particularly the SMEs are motivated to improve the energy efficiency of their facilities. Although provisions like accelerated depreciation are available to industry on installation of specified energy saving devices in the Income tax Act / the new Direct Taxes code, however, a basic fiscal framework for facilitating the objective of enhancing energy efficiency in the country is still lacking. An integrated policy in Indian context would mean a combination of the central and state levied direct and indirect taxes, complemented with central and state provided tax and non-tax fiscal incentives in the form of grants or subsidies etc.

The National Mission on Enhanced Energy Efficiency (NMEEE) –Mission Document emphasizes the following:

I. That the Government needs to take up measures for providing appropriate tax incentives for energy efficient products to promote energy efficiency through the taxation policy which should not only be consistent with the prevailing tax framework in India but also with the basic tenets of the proposed taxation regime under the new Direct Tax Code and Goods and Services Tax.

II. It also suggests exploring the possibility of including carbon finances, particularly for international protocols, in the same manner as is available for the Montreal Protocol under the direct tax laws.

III. The incentives should be in line with the philosophy of the Direct Taxes Code to establish an economically efficient, effective and equitable direct tax system’.

Large-scale roll-out of products and services related to energy efficiency requires that they overcome the cost disadvantage they face when competing with comparable energy-consuming products and services.

153 Cross Border Shopping: Cross border shopping is the name given to the activity wherein private individuals buy goods abroad because of lower taxes and import them for their own consumption, without declaring them in full in order to avoid paying import duties. (OECD) http://stats.oecd.org/glossary/detail.asp?ID=488


87

To create and increase a market for such products and services, it is necessary to develop, manufacture, and supply them efficiently, fiscal incentives will have to be provided under the two broad categories viz. direct and Indirect taxes taking into consideration the following stakeholders who are expected to participate in the energy efficiency projects:

End-users or customers•

Manufacturers and traders•

Energy service companies (ESCOs)•

Financial institutions and ESCOs granting loans•

Keeping the above perspective in mind, the NMEEE –Mission Document has suggested the following:

a) From the perspective of income tax (Direct Taxes), benefits such as accelerated tax depreciation and absence of withholding tax on overseas borrowings will confer immediate tax advantages on energy-efficiency projects.

b) Multiple transaction costs – customs duty, excise duty, VAT, R&D cess, service tax, (Indirect Taxes) etc. - are incurred before a product or a service reaches the customer. These costs often have a cascading effect and form a significant proportion of the total cost of the product or service. Often, with electricity being an output, the cost of taxes on the input also forms a part of the price of the product or service. The Mission Document suggests that customs duty, VAT, R&D cess and service tax should be eliminated on specified energy-efficiency products.

c) Research and development is the key to develop new technologies and to make the existing processes more efficient. Therefore, it proposes that the cost of undertaking R&D activities in this sector be made tax-deductible under direct taxes.

d) Finances are often a major cost of capital-intensive project. To reduce these costs, tax exemptions to lenders are proposed, which, in turn, will lower the interest rates for loans. To access seed capital, it is essential to encourage venture capitalists to invest in energy-efficiency projects.

e) It proposes to set up ESCOs for providing such turnkey services to energy-efficiency projects as feasibility analysis, design engineering and construction management. The proposed role of ESCOs is similar to that of an infrastructure-related service company. Accordingly, benefits similar to those available to infrastructure projects such as income tax holidays should also be extended to ESCOs.

The details of various tax incentives under the direct taxes suggested by the BEE in the NMEEE Mission document are detailed in Annexure G. The proposed incentives cover almost all the stakeholders and the list is exhaustive suggesting all possible incentives across the board. However this list drawn by the BEE remains at best an academic exercise because feasibility aspects of extending all of these exemptions have not been examined by the government more so by the Ministry of Finance. The following discussion attempts to draw conclusions on how tax and fiscal incentives for promotion of EE are required to be crafted based on international experiences and permitting local conditions that exist in India and thereafter suggests the next steps in the form of recommendations.


89

Chapter 17Conclusions and RecommendationsIntroducing Integrated Policies on Tax and Fiscal Incentives under Voluntary / Negotiated Agreement Scheme

India’s emerging taxation regime and the prevailing tax framework is characterised by the lowering of tax rates and widening of tax base with focus on increasing revenue collections and minimising tax deductions and exemptions.

Achieving the targets with respect to energy savings and reductions of greenhouse gas emissions and to bring in energy efficient market transformation requires coordinated efforts in a number of policy areas. Fiscal instruments can play an important role in reaching these goals, alone or in complement to other market based instruments and regulatory measures. The advantage of fiscal instruments compared to regulatory instruments is often their efficiency and the fact that they can raise revenues that can be used to reduce the negative effects of the distorting taxes elsewhere in the economy. Root taxation often proves to be superior to regulation when environmental damages are not location-specific and do not vary with the source of pollution which is rarely so. Tax instruments alone are generally insufficient and need to be complemented by other fiscal instruments. Such complementarities are especially called for when there are information costs or market failures.

Industrial energy efficiency best international practices use “Integrated Programs” that combine tax and fiscal policies. Revenues from taxes and fees such as energy related CO2 taxes, pollution levies or public benefit charges are returned to the taxed sector (Revenue Recycling) in the form of incentives, grants, or subsidies etc.

Most effective policies combine a number of tax and fiscal programs to provide clear economic signals to the industry towards energy efficiency. For example, high polluting SMEs such as iron and steel, paper and pulp, chemical and leather industries etc. are location specific as they exist in clusters. Thus these clusters can be targeted for imposing taxes like pollution levies on the “polluters pay principle” or imposing a wire/public benefit charge provided this is complemented with directed subsidy or grants by the state governments through SDAs.

The underlying philosophy is that the cost of adoption of clean technology or energy efficiency retrofitting by the industry should not be passed on to the consumers and that the industries have a strong incentive to reduce energy costs to stay competitive.

Recommendation 8

The Government must Introduce Integrated Tax Policy on Tax and Fiscal incentives for Energy efficiency as a policy initiative.

Market Transformation through tax incentives under Cluster Based Approach

In order to achieve a sustainable growth and to bring in Market Transformation it is important that incentives for promoting investments in EE are provided to the industries not only for adopting energy


90

efficient technologies in their production processes but also to shift towards production of more EE products and appliances as well by these industries. However since tax incentives are associated with the problem of “free riders” therefore a carefully crafted program would be required to be worked out where tax incentives should be provided only for technologies that lack current profitability, but that which government wants to promote – e.g. technology that is relatively new and innovative, but that offers significant efficiencies over more established technologies. Substantial efforts will be required from BEE to establish a list of eligible technologies and equipments that can be linked with the incentives to avoid the free rider problem. Because taxes have to be imposed on the industries to raise revenues and complimented with incentives therefore industries have to be involved in this process. Best way to introduce these is either through Voluntary Agreements or under a Negotiated Agreement Scheme. To ensure compliance the Central Electricity Authority (CEA) and State Electricity Boards can create mandates through the Energy Conservation Act of 2001 so that they can be enforced by the BEE or the State Designated Agencies (SDAs).

SME Cluster approach provides ease of devising such carefully crafted programs that are specific for a particular industry group in a cluster where specific taxes/charges can be levied and at the same time sector specific incentives can be provided under voluntary or negotiated agreements between the government and the members of the SME cluster.

The NMEEE Mission Document suggests as much as ten types of exemptions/deductions (please see annexure G). Although China has announced quite a large number of tax exemptions to local industries in general and ESCOs in particular to provide incentives for energy efficiency, however, unlike China, India is a market economy where rates of taxation are already low as compared internationally. Therefore, any generalised tax exemptions/deductions to industry can result into problem of free riders which might result in a drastic decline in revenues as unintended consequences. Such incentives cannot be provided on standalone basis unless they are made part of an integrated program. Besides this, in United States which has the most well developed ESCO industry, the tax deductions/exemptions are given directly to the actual consumers of EE appliances by way of tax credits and not to the industry- an important way to help in market transformation. Consumer tax incentives have been largely successful in moving the products and processes along the market transformation curve.

Providing Consumer a tax credit against the purchase of EE products and appliances in India is not only difficult to implement but also can be subjected to intense problem of “free riders” and therefore will not be feasible at present given the difficulties in tracking of the claims filed by the consumers across the country.

In India, Cluster approach can provide solution to majority of the problems discussed above to a large extent. For example, cluster specific “Integrated Programs” can be easy to implement and monitor. Further, mandating for EE and framing “Negotiated Agreements” between industry and the government for carrying out necessary EE improvements are easier to implement and monitor given the similar type of manufacturing undertaken by the SMEs in a cluster. Integrated programs can carefully combine taxes and fiscal incentives and integrated with technology upgradation including EE retrofitting in the existing SMEs knowledge management initiatives, financing, engaging ESCOs through revenue recycling where aspect of equity in taxation can be more easily addressed. It is therefore argued that cluster specific incentives provided to SMEs under Negotiated Agreements can deliver the desired and avoid the problem of free ridership.

Recommendation 9

Formulate Integrated Tax Policy for Energy Efficiency to suggest Tax incentives to the SMEs in Industry specific clusters under voluntary or Negotiated Agreements and link it with the suggested “Integrated programs on Energy Efficiency for SME Clusters”


91

Establishing Joint Committee on Integrated Tax Policy for Energy Efficiency with the Ministry of Finance by BEE and Tax incentives to ESCOs

From the NMEEE Mission Document it appears that while recommending various tax incentives for promoting energy efficiency or exemptions to ESCOs the BEE has not consulted Ministry of Finance at any stage. This has led to a policy gap in as much as the recommendations are not consistent with the mandate given to BEE under the National Action Plan for Climate Change (NAPCC) that the tax incentives should be aligned with the current tax framework and proposed taxation regime. Further, the tax/ fiscal incentives have to be provided in the finance bill and incorporated in the direct taxes code (Act) and Goods and Services tax Act so as to make them legally enforceable. This is possible only when the proposals are considered by the government during the Central Budget exercise undertaken by the Ministry of Finance.

Therefore, before the government can allow any large scale tax rebates/deductions or incentives as suggested in the NMEEE Mission Document of BEE, it would be required to ascertain the effect these tax incentives would have on the overall revenue collections. Tax rebates or incentives can be allowed for a short period of say 5 to 10 years to start with in order to see the performance with respect to their effectiveness, efficiency, adaptability and implementability. It is advocated that large scale EE improvements is expected to unlock the EE market to the tune of Rs. 12.8 Billion and Rs. in SME sector alone. Therefore, it would also be required to analyse the projections of revenue realisations after the period of tax rebates/ deductions ends in order to work out the quantum of incentives to be provided during this period to balance the revenue foregone with the higher returns of revenues expected from market transformation later. Investments saved due to capacity additions avoided in the form of establishing more power generation facilities will also be accounted for in the overall working.

There is therefore a need to establish urgently a joint committee on tax and fiscal incentives for promoting energy efficiency by the BEE to go into the entire gamut of fiscal incentives with the Ministry of finance, Govt. of India before any industry specific incentives can be worked out that can be applied to a specific cluster under an integrated program for industry specific clusters.

Tax incentives to ESCOs

As regards extending tax incentives to ESCOs, contrasting examples exist like in China where ESCOs can obtain a six-year tax holiday; in which no corporate income tax is payable for the first three years, and subsequently a 50% reduction in tax rates applies for the remaining three years. In contrast to China, the U.S. government promoted enabling laws facilitating entry of ESCOs in Public Utilities and supporting them with financing instead of providing tax incentives directly to the ESCOs. Likewise for the corporates, tax incentives were provided to them only if they made a minimum amount of investments in the eligible EE project. These incentives were designed as temporary measure to support industries in their early years and commonly included a sunset provision to encourage the industries to become self-sufficient.

ESCOs are necessary for initiating large scale EE improvements in industry and to kick-start the process of market transformation for energy efficient economic development. Therefore, in order to create a favourable climate for the ESCOs in India and more particularly to attract the Multinational ESCOs to come and operate, tax exemptions and deductions in the form of tax holidays/ tax breaks can be provided to them subject to conditions. These can be for example bringing in specified EE technologies in India, undertaking capacity building of smaller local ESCOs and investing minimum specified amounts in energy efficiency projects / schemes. To give a kick-start to the process of market transformation and to provide market certainty the tax holiday should be provided for a period of at least 10 years. Initially a tax holiday can be provided for a period of 5 years and thereafter can be extended further depending upon the performance with progressive taxation. The emphasis should not only be towards improving energy efficiency in existing manufacturing processes but also in shifting towards manufacturing of more energy efficient appliances.


92

Recommendation 10

BEE should establish a Core Committee on tax and fiscal incentives for promotion of energy efficiency Jointly with Ministry of Finance.

The core committee will propose integrated policies on taxation and fiscal incentives for •industry specific clusters for promotion of energy efficiency for at least a minimum period of 10 years to bring in market certainty and kick start the process of market transformation.

The recommendations of the core committee to be finally made part of the Finance Bill in •the Union Budget.

Recommendation 11

The Joint Core committee will also suggest tax incentives for ESCOs.•

Concurrently, BEE must establish industry wise list of eligible technologies and equipments •that the ESCOs would be required to bring in to qualify for tax exemptions.


93

Annexure AWhat is an ESCO?

An ESCO is a company that provides comprehensive energy efficiency related and other value added services (like load reduction) to its clients and for which the performance contracting is a core part of its energy efficiency services business154. (Goldman et al. 2002; Hopper et al. 2005). Energy services include for example energy audits, energy management, and energy or equipment supply, provision of services such as space heating (Bertoldi and Rezessy 2005)155.Energy Service Companies are also known as Energy Management Companies (in China). It is the performance based contracting that differentiates ESCOs from other firms that offer energy efficiency improvement or energy services , such as consulting firms and equipment contractors, This means that the ESCO’s payment is directly linked to the amount of energy saved (in physical or monetary terms).

What are Energy Services Company Performance Contracts?

Energy Service Company (ESCO) performance contracts or Energy performance contracting are innovative financial arrangements that combine the design and implementation of energy efficiency projects with financing and guarantee of performance. It is a market-oriented mechanism for overcoming the major barriers (i.e. investment costs) to delivering energy efficiency improvements in any facility in which energy is used, including all types of buildings and industrial processes.Performance contracting involves an ESCOs contracting to reduce a customer’s energy consumption in return for payments/fees designed to be made based on the amount of savings that an ESCO improvements are able to generate for their customers, thereby avoiding (at all times, but most significantly in the early stages of the project) any net increase in the customer’s expenses or capital investments4. It is the linkage of performance and payment that defines performance contracting.

Figure: Energy Performance Contracting

* Note: Note that on this graph real cost refers to the initial cost, while the contracting rate depicts the cost savings which in this case are shared between the customer and the ESCO. Source: Berlin Energy Agency Source: (World Future Council, 2011)

154 World Future Council. (2011, May). Retrieved May 30, 2011, from Future Policy .org: http://www.futurepolicy.org/2723.html

155 An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana Ürge-Vorsatz, Sonja Köppel, Chunyu Liang, Benigna Kiss, Gireesh Goopalan Nair, Gamze Celikyilmaz; Central European University, 2007, World Energy Council.


94

ESCOs offer similar services as Energy Service Providing Companies (ESPCs). However, ESCOs guarantee the savings and their remuneration is linked to the projects’ performance. ESCOs conduct energy audits, develop recommendations and design based on audit, secure financing for the energy efficiency projects (upon agreement with the customer concerning recommendations), and finally implement the project that is -install and maintain the energy efficient equipment involved; measure, monitor, and verify the project’s energy savings; and assume the risk involved in the expected amount of energy savings. Thus ESCOs take financial, technical and other risks (Bertoldi et al 2006)156. If at the end the changes do not result in savings the customers do not pay the ESCOs. Typically, all costs associated with the project–beginning with audit and design is bundled together so the customer does not incur any cost until the stream of savings begins. The uniqueness of performance contracting is that the customer does not incur any upfront costs for its energy efficiency investments and all payments to ESCOs come out from the savings.ESCOs competitive advantages rests on three characteristics––specialization in energy management, ability to aggregate projects, and expertise in delivering complete turnkey projects of technical advisory plus financing.

Financing and Types of ESCO Energy Performance Contracting – (ESCO EPC)

Financing for the investment can either be provided by the ESCO from its internal funds (ESCO financing) or by the customer backed by a savings guarantee from the ESCO (end-user/ customer financing). Another way is third party funding (TPF) in which a financial institution or bank allows a credit either to the ESCO or directly to its client backed by a guarantee for the projected energy or cost savings given by the ESCO (Bertoldi and Rezessy 2005). Under off-balance sheet financing, also called non-appropriation financing, the financiers hold the title to equipment during the project. This can be very beneficial for public and private customers because the debt service is treated as an operational expense and not a capital obligation, so the debt rating is not affected. This is important as borrowing capital is freed up157.There are two types / Models of ESCOs that are most common (Bertoldi and Rezessy 2005):

a) Guaranteed Savings: In this model the ESCO completes an audit, develops recommendations and designs, makes arrangements for project financing and implements the project. The ESCO guarantees a certain level of energy savings to the customer.

Key Features include :-

The funds are borrowed by the customer who takes the obligation to repay the loan. The ESCO •helps in identifying and facilitates the loan application process.The ESCO guarantees that the stream of savings will be sufficient to cover the cost of loan •repayments. The ESCO would pay the difference if the targets are not met, Likewise if savings minimum are exceeded, then the customer pays the ESCO a percentage of savings. Thus the ESCO assumes the performance risk while the bank takes the credit risk.The loan is similar to any other loan, it appears in the customer’s balance sheet and is subject to •same evaluation as for any other loan including company’s own internal evaluation process for any capital investment and therefore compete against other investment options.

This model is therefore based on end-user or third party financing. It has the advantage that interest rates are usually much lower and therefore more energy efficiency investment is possible. Also in such a situation since financing is not done by ESCO therefore it can take up more projects.

156 Bertoldi, P. and Rezessy, S. 2005. Energy Service Companies in Europe, Status Report 2005. Ispra, Italy: European Commission DG Joint Research Center referred in the article at sl. no. 4 above.

157 An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana Ürge-Vorsatz, Sonja Köppel, Chunyu Liang, Benigna Kiss, Gireesh Goopalan Nair, Gamze Celikyilmaz; Central European University, 2007, World Energy Council.


95

Another variant of guaranteed savings model is ‘Pay from Savings’ arrangement. Under this the payment schedule depends on the level of savings. If savings are greater than anticipated, repayment will be faster. If savings are lower than expected, the contract can be extended to allow the ESCO to recover its agreed payment. A related arrangement is the “first out” model, in which the ESCO receives all energy cost savings until it has received its agreed payment. Generally, this arrangement is lower risk for the ESCO, since it receives its full payment more quickly than under the traditional guaranteed savings approach158.

b) Shared Savings: Under this scheme, the ESCO finances the project itself, either from its own capital or by borrowing from the bank.

Key features are:

The ESCO assumes both performance risk and the credit risk associated with the project.•

The customer does not have to borrow so the project does not appear on its balance sheet.•

The customer generally pays a higher percentage of the projects savings to the ESCO than for a •guaranteed savings project.

For the customer, the project is treated as a new equity and not subjected to its internal investment •criteria.

If bank financing is used, the bank retains the right to receive from the stream of payments as a •security for the loan or takes a security interest in any equipment that is installed as a part of the project.

The shared savings project is good alternative for customers that cannot or will not use its own borrowing capacity for the project however the capacity of ESCOs to undertake many projects is limited by the financial strength of the ESCO.

c) Other Models:

World Bank159 in the review of its own energy efficiency portfolio notes that typical western models may not offer the best alternative in the developing world, although an arrangement that allows off-balance sheet financing (shared savings) would be ideal for industry with limited investment capacity. `The World Bank specifically lists the following additional models (generally running in order of higher service/higher risk to lower service/lower risk options) and recommends that a variety of approaches should be considered in promoting ESCOs:

I. End-Use Outsourcing: The ESCO takes over operation and maintenance of the equipment and sells the output (e.g., steam, heating/cooling, lighting) to the customer at an agreed price. Costs for all equipment upgrades, repairs, etc. are borne by the ESCO, but ownership typically remains with the customer. This model is also sometimes referred to as Chauffage or Contract Energy Management.

II. Equipment Supplier Credit: The equipment supplier designs and commissions the project, verifying that the performance/energy savings matches expectations. Payment can either be made on a lump-sum basis after commissioning or over time (typically from the estimated energy savings). Ownership of the equipment is transferred to the customer immediately.

158 Assessment of Energy efficiency financing Mechanism – Background Paper- Oct 2010 under International Partnership for Energy Efficiency Cooperation (IPEEC) and Bureau of Energy Efficiency.

159 World Bank GEF Energy Efficiency Portfolio Review and Practitioners, Handbook, 2004 retrieved from World Bank website : http://siteresources.worldbank.org/INTCC/812001-1110807496989/20480590/WBGEFEnergyEfficiencyHandbook2004.pdf


96

III. Equipment Leasing: Similar to supplier credit, the supplier receives fixed payments from the estimated energy savings. However, in this case the supplier owns the equipment until all the lease payments, and any transfer payments, are completed.

IV. Technical Consultant (w/Performance-based Payments): The ESCO conducts an audit and assists with project implementation. The ESCO and customer agree on a performance-based fee, which can include penalties for lower energy savings and bonuses for higher savings.

V. Technical Consultant (w/Fixed Payments): The ESCO conducts an audit, designs the project and either assists the customer to implement the project or simply advises the customer for a fixed, lump-sum fee.

Source: World Bank GEF Energy Efficiency Portfolio Review and Practitioners, Handbook, 2004


97

Annexure B

CHINA

FISCAL / TAX INCENTIVES

Tax Benefits for ESCOs announced by the Chinese government in 2010 are:

a) Gross revenues of ESCOs derived from an EMC project will be exempted from both Business Tax (BT) (which is applicable to most services) and VAT (which is applicable to most goods) for a specified period of time. ESCOs provide combination of goods and services that result in confusion about which payments under its contracts are subject to BT and which are subject to VAT because of differential rate of taxation; 3% rate of BT is applicable to construction, installation or transportation service revenues, and the 5% rate of BT is applicable to design or consulting service revenues. This resulted not only in confusion but also in over-taxation because the tax authorities are entitled to apply the highest rate to revenues that the taxpayer cannot prove are allocable to a lower-rate category of services. The exemption from BT is expected to be very valuable for ESCOs as it will incentivize customers for purchasing services to meet any need that can be satisfied through a purchase of goods. Exemption from VAT will clear tax disincentives.

b) ESCO’s net income derived from an EMC project will be exempt from Enterprise Income Tax (EIT) for a period of three years, and will be reduced by 50% during the subsequent three years.

c) ESCO’s transfer to a customer of equipment or other asset ownership at the end of an EMC project, “free of charge”, will not result in the ESCO being forced to recognize directly any revenues or income. Previously, tax authorities had the power to insist on recognition of deemed income.

d) Key criteria specified for an ESCO to become eligible for the above incentives include minimum registered capital of Rmb 1 million, and demonstration of certain technical capabilities required by provincial governments.

Tax Benefits to Customers

a) Customers of ESCOs will also enjoy corresponding benefits. The above asset transfers will not impose any mandatory accounting or tax detriments on customers, who will be permitted to treat the transferred assets as fully amortized or depreciated.

b) The most immediate tax benefit to customers will be the right to treat, as currently deductible expenses, the full amount of payments to an ESCO under an EMC, rather than requiring the allocation of any portion of such payments to (depreciable or amortizable) capital investment.

c) Government agencies and public institutions, which would be prospective suitable customers of EMC projects will benefit from clarified and preferential accounting changes. These customers will be permitted to treat payments under an EMC as “energy expenses” and to treat their receipt of assets under such an EMC as receipt of “donations” (Neal Stender and Forrest L. Ye, 2010).


99

Annexure C

CHINA ESCO INDUSTRY160

ENABLING FACTORS The recent rapid development of the ESCO industry in China can be attributed to the following factors:

General energy market context

1. Large market potential in energy efficiency. China’s economy is among the most energy-intensive ones in the world. China’s CO2 emissions have risen from 1.4% of the global total since the foundation of the country to 20% at the beginning of the 21st century. Despite the rapidly growing economy, China’s energy intensity remains very high. During the past five years, the growth rate of China’s energy demand has greatly surpassed that of the economic growth rate (Dai 2006). In June 2004, the Chinese government released its Special Plan on Energy Conservation in the Mid- to Long-term, with its focus on reducing China’s GDP energy intensity by 20%, as well as a reduction in the total emissions of pollutants by 20% below the current level. The plan intends to achieve its goals by 2020. Given the size of the energy and economic system of China, a 20% reduction in energy intensity implies a large market potential for ESCOs to realize.

International programs

1. International and governmental support-the WB/GEF project.

International and governmental support is vital to initiatives that bring in new concepts like EPC into China (World Bank et al, 2006). Governmental involvement in China often gives new business models credibility as well as legitimacy. The first phase of the WB/GEF project helped establish the three pilot ESCOs that received strong financial support to start up their business. Their success has a very strong demonstration effect on the market. The project also helped with the establishment of EMCA, which is playing an important role in China’s ESCO industry.

FINANCIAL FACTORS3. Good practice in managing credit risk.

Risk management on clients’ creditworthiness is deemed as the top challenge for Chinese ESCOs. Successful ESCOs so far in the market have set up a good practice in managing the credit risk associated with their clients. Good practice in managing clients’ credibility becomes crucial for the success of ESCOs. It was found out that the prevailing practice of EPC in the market goes in the form of shared-savings in which the majority of cost savings in the first 1-3 years goes to the ESCO involved and all the savings belong to the customer afterwards (Wang Shumao, 2006). In the extreme case, this is a first-out arrangement whereby the ESCO party received 100% of the energy savings until the project costs and



100

ESCO profits are fully paid. The exact duration of the contract will then depend on the level of energy savings achieved: the greater the savings, the shorter the contract. In such arrangement it becomes easier for the ESCO to manage the risks associated with customers’ willingness to comply with the contracts.

Other factors

4. Rising awareness of cost saving potentials through energy conservation in industries.

Another enabling factor for China’s ESCOs can be the rising awareness of energy conservation in the industries, including privately- and publicly-owned industries where energy cost accounts for a growing portion of their production costs. Starting from 2006, the government will take into account indicators on energy savings when evaluating officials’ performance. This measure puts pressure on the government at different levels to prioritize energy savings. It is expected that government-driven actions will lead to a signification impact on energy conservation in China.

5. Transfer of advanced know-how.

Many of the Chinese industries are willing to conserve energy but their motivation declined by lack of technology and know-how due to the high cost of technology imports and lack of qualified personnel to implement their energy saving plans (Chen, 2006). The entry of foreign ESCOs that provide advanced technology and management has made the ESCO business very attractive to industries in China.

6. Combination with the Clean Development Mechanism (CDM).

Another trend has been observed that energy efficient technology providers and equipment manufacturers from overseas (mainly North America, Europe and Japan) are starting to implement ESCO projects in the form of EPC combined with CDM. This aims at strengthening their ability to penetrate China’s huge energy efficiency market by bringing additional revenues which Chinese project operators can expect from the sales of carbon emissions reduction credits (Chen 2006).

CDM requires that eligible projects must be additional in terms of technology advancement and that investment should not involve Official Development Aid (ODA). Due to the fact that in many cases transferred technologies and equipment represent a high standard and investment into ESCO projects does not relate to ODA, such type of ESCO projects have very high potential in implementing the CDM. Chinese entrepreneurs are very proactive in having their projects labeled as CDM for business image purposes. The widespread concept of CDM has accelerated the dissemination of ESCOs, but it has been noticed that presently the only successful type of energy efficiency project falls under the category of waste heat utilization and not all of them are implemented through EPC. Potential exists in other energy efficient technologies but due to the availability of CDM methodologies their implementation under CDM is rather slow. However, although the buildings sector has one of the biggest ESCO market potential, CDM has been found inefficient in small emissions reduction projects (Novikova A., D. Urge-Vorsatz and C. Liang 2006),. It can be foreseen that without any major changes in the international rules, CDM will not harvest the low-hanging fruits in the buildings sector through ESCOs. As a matter of fact, technology-transfer-based ESCOs have been seeking projects mainly from the large energy consuming industries to combine with the CDM (Chen 2006).


101

Annexure D

U.S. Federal and State Enabling PoliciesA) Ratepayer-Funded Energy-Efficiency Programs (REEPs)

Under REEPs, ESCOs used rebates that were offered by utilities for installation of high efficiency equipment to buy down the initial cost of projects. ESCOs also participated heavily in “performance-based” programs in which utilities provided incentives for verified electricity and peak demand savings from customer facilities. Initially, these programs were administered by utilities, and their funding peaked at US$1.7 billion in 1993-94 (Nadel 2000). However the prospect of electricity restructuring in the mid-1990s contributed to significant erosion in utility support for energy efficiency programs in many states and funding dropped by 40-50% nationally (Nadel 2000). As part of restructuring legislation, many states included provisions for a system benefit or public purpose charge to fund energy efficiency and/or renewable energy programs. Administration of public purpose programs varies by state. This role may be filled by utilities with prior experience administering DSM programs, existing or new state agencies, or non-profit corporations.

ESCOs are supposed to leverage the value of REEP incentives by passing some or all of the payments through to the customer, effectively reducing the cost of the project although it is difficult to know whether these incentives were actually passed. Thus, while utility DSM and public benefit financial incentives have certainly aided ESCO project development, it is not clear that they are responsible for enabling the development of projects that would otherwise not have been cost-effective. Utility and public purpose energy efficiency programs have also provided important indirect benefits – such as raising customer awareness about high-efficiency products, providing information on savings potential, and decreasing customer perceptions of technical and market risks from new technologies or firms – that facilitate development of ESCO projects but are not possible to quantify .

B) State policies to promote performance contractingEnabling legislation for Institutional Markets- Most States promote performance contracting by legislation. States with statutes that allow performance contracting in the institutional market typically designate one or more state agencies as administrative lead to develop consistent policies and program guidelines and provide technical assistance and training to state or local facility energy managers on performance contracting with ESCOs.

State performance-contracting enabling legislation is a mechanism for encouraging ESCO business practices that focuses on removing institutional barriers to performance contracting for state entities – schools, universities and state and local governments. The enabling legislation allow them to enter into multiyear financial commitment, flexible procurement rules, decision favoring “best value” rather than “lowest costs bids” and setting maximum payback161 periods allowed for the projects.

161 Pay Back Time: An energy investment’s simple payback period is the amount of time it will take to recover the initial investment in energy savings, dividing initial installed cost by the annual energy cost savings. It is not taking into account the time value of money, inflation, project lifetime or operation and maintenance costs.


102

C) Federal facility energy-efficiency programs

The federal Energy Policy Act of 1992 mandated that federal agencies take prescribed steps to manage their energy use and pursue cost-effective energy-efficiency investments and established aggressive energy reduction targets. Included among the many provisions was enabling legislation for Energy Savings Performance Contracts (ESPC) of up to 25 years for ESCO projects, as well as continued support for Utility Energy Savings Contracts (UESC), in which utilities manage and oversee energy efficiency improvements at federal customer sites. These contracting mechanisms allow Federal agencies to leverage private sector funding for energy improvements. Without this option, federal agencies would have to rely on congressional appropriations for capital improvements, which, in recent years, have been far lower than agency capital requests. Between 1988 and 2002, federal agencies have signed ESPC contracts and delivery orders for about US$1.2 billion in energy efficiency investments (FEMP 2002).

Currently the Federal Energy Management Program (FEMP) developed the Super Energy Savings Performance Contracts (Super ESPCs) for use by the Federal agencies to implement comprehensive energy savings projects. This concept allows federal agencies to bypass procurement procedures and deal directly with a prequalified ESCO on energy projects. The Super ESPCs conducts tasks such as comprehensive energy audits, identifies “bankable” measures to solve energy efficiency problems, arranges financing, guarantees an annual level of cost savings to the agency and takes on responsibility of implementing the agreed measures. The agency pays from a portion of guaranteed savings. Super ESPC concept resulted in energy efficiency investments of US$1.9 billion by 19 agencies in 46 states by mid-2007. The Energy Policy Act of 2005 has extended the authority for Super ESPCs until 2016.

In U.S., ESCO activity is concentrated in states with high economic activity and strong policy support. In 2006 revenue earned from ESCO Industry was US$ 3.6 Billion with just 46 companies and the major client segment was the government sector. State enabling policies have boosted the industry in medium-sized states. ESCOs in U.S. have proven resilient in the face of restructuring. The performance of ESCO industry in U.S. shows that a private sector energy-efficiency services industry that targets large commercial and industrial customers is viable and self-sustaining with appropriate policy support – both financial and non-financial. US ESCOs are concentrated in 4 states (New York, New Jersey, California and Texas) account for 44% of all investment costs. The median project time in the US is 10 years and the simple payback time is 7 years. The size of projects varied widely with project costs ranging from US$ 200,000 to greater than US$20 million.

Public benefit Charges (PBCs)

These programs provide important benefits; schemes whereby a fee imposed on all distributed electricity would fund these programs were developed and implemented in a number of states in U.S.A. (Eto et al., 1998). These fees have been variously termed public benefits charges (PBCs), public goods charges; system benefits charges, line charges, and wires charges. Programs supported by PBCs include energy-efficiency programs, assistance to low-income households, promotion of renewable energy sources, and research, development, and demonstration (RD&D) for improved energy supply and end-use technologies. In most of the states in U.S. with system benefits programs, industrial firms participate in programs run with PBC proceeds. In a very few cases, industrial customers have opted out of participation due to perceived disadvantages. New York’s Energy and Research Development Authority (NYSERDA) provides a number of energy-efficiency related services to the industrial sector using funding from the state’s PBC. These services include a 50% cost-shared Flex/Tech Technical Assistance Study in which the industrial facility provided a detailed on-site engineering study that results in a priority list of conservation measures, a commercial/industrial performance program in which energy service companies (ESCOs) provide energy savings in the areas of lighting, motors, and space cooling,


103

and a loan fund that provides interest rate reductions on energy efficiency and renewable energy projects that have payback periods of 10 years or less (Perry, 2004). California has instituted a variety of programs, financed by a Public Goods Charge and administered by utilities, to serve non-residential customers (FEMP, 2005). Programs that apply to industrial customers include subsidized energy audits, Savings by Design, Standard Performance Contract, the Express Efficiency Program, and the 500 Plus Peak Program162. ( Lynn Price et al. 2005)



105

Annexure E

Database of U.S. State Incentives for Renewables and Efficiency- (DSIRE) Information on federal, state, local, and utility incentives.

Retrieved from: http://www.dsireusa.org/glossary/ on 25-07-2011

DSIRE organizes incentives and policies that promote renewable energy and energy efficiency into two general categories -- (1) Financial Incentives and (2) Rules, Regulations & Policies -- and roughly 30 specific types of incentives and policies. This glossary provides a description of each specific incentive and policy type.

FINANCIAL INCENTIVES

Corporate Tax Incentives

Corporate tax incentives include tax credits, deductions and exemptions. These incentives are available in some states to corporations that purchase and install eligible renewable energy or energy efficiency equipment, or to construct green buildings. In a few cases, the incentive is based on the amount of energy produced by an eligible facility. Some states allow the tax credit only if a corporation has invested a minimum amount in an eligible project. Typically, there is a maximum limit on the dollar amount of the credit or deduction. In recent years, the federal government has offered corporate tax incentives for renewables and energy efficiency. (Note that corporate tax incentives designed to support manufacturing and the development of renewable energy systems or equipment, or energy efficiency equipment, are categorized as “Industry Recruitment/Support” in DSIRE.)

Grant Programs

States offer a variety of grant programs to encourage the use and development of renewables and energy efficiency. Most programs offer support for a broad range of technologies, while a few programs focus on promoting a single technology, such as photovoltaic (PV) systems. Grants are available primarily to the commercial, industrial, utility, education and/or government sectors. Most grant programs are designed to pay down the cost of eligible systems or equipment. Others focus on research and development, or support project commercialization. In recent years, the federal government has offered grants for renewables and energy efficiency projects for end-users. Grants are usually competitive.

Green Building Incentives

Green buildings are designed and constructed using practices and materials that minimize the impacts of the building on the environment and human health. Many cities and counties offer financial incentives to promote green building. The most common form of incentive is a reduction or waiver of a building permit fee. The U.S. Green Building Council’s Leadership in Energy and Environmental Design (LEED) is a popular point-based certification program for green buildings. The LEED system awards points for site selection and development; material, energy and water efficiency; indoor air quality; innovation; and the application of renewable technologies. (Note that this category includes green building incentives that do not fall under other DSIRE incentive categories, such as tax incentives and grant programs.)


106

Industry Recruitment/Support

To promote economic development and the creation of jobs, some states offer financial incentives to recruit or cultivate the manufacturing and development of renewable energy systems and equipment. These incentives commonly take the form of tax credits, tax exemptions and grants. In some cases, the amount of the incentive depends on the quantity of eligible equipment that a company manufactures. Most of these incentives apply to several renewable energy technologies, but a few states target specific technologies, such as wind or solar. These incentives are usually designed as temporary measures to support industries in their early years. They commonly include a sunset provision to encourage the industries to become self-sufficient.

Leasing Programs

A handful of programs have been established by government agencies and utilities that allow homeowners, businesses, and other entities to lease energy-efficient equipment or renewable energy systems. In some cases, the customer may choose to purchase the system after a specified period of time. (Note that it is increasingly common for companies to lease energy equipment to customers. However, with the exception of incentives offered by utilities, DSIRE generally does not include incentives offered by businesses.)

Loan Programs

Loan programs provide financing for the purchase of renewable energy or energy efficiency systems or equipment. Low-interest or zero-interest loans for energy efficiency projects are a common demand-side management (DSM) practice for electric utilities. State governments also offer low-interest loans for a broad range of renewable energy and energy efficiency measures. These programs are commonly available to the residential, commercial, industrial, transportation, public and/or non-profit sectors. Loan rates and terms vary by program; in some cases, they are determined on an individual project basis. Loan terms are generally 10 years or less. In recent years, the federal government has offered loans and/or loan guarantees for renewables and energy efficiency projects.

PACE Financing

Property-Assessed Clean Energy (PACE) financing effectively allows property owners to borrow money to pay for renewable energy and/or energy-efficiency improvements. The amount borrowed is typically repaid over a period of years via a special assessment on the owner’s property. In general, local governments (such as cities and counties) that choose to offer PACE financing must be authorized to do so by state law.

Performance-Based Incentives

Performance-based incentives (PBIs), also known as production incentives, provide cash payments based on the number of kilowatt-hours (kWh) or BTUs generated by a renewable energy system. A “feed-in tariff ” is an example of a PBI. To ensure project quality, payments based on a system’s actual performance are generally more effective than payments based on a system’s rated capacity. (Note that tax incentives based on the amount of energy produced by an eligible commercial facility are categorized as “Corporate Tax Incentives” in DSIRE.)

Personal Tax Incentives

Personal tax incentives include income tax credits and deductions. Many states offer these incentives to reduce the expense of purchasing and installing renewable energy or energy efficiency systems and equipment. The percentage of the credit or deduction varies by state, and in most cases, there is a maximum limit on the dollar amount of the credit or deduction. An allowable credit may include carryover provisions, or it may be structured so that the credit is spread out over a certain number of years. Eligible technologies vary widely by state. In recent years, the federal government has offered personal tax credits for renewables and energy efficiency.


107

Property Tax Incentives

Property tax incentives include exemptions, exclusions, abatements and credits. Most property tax incentives provide that the added value of a renewable energy system is excluded from the valuation of the property for taxation purposes. For example, if a new heating system that uses renewable energy costs more than a conventional heating system, the additional cost of the renewable energy system is not included in the property assessment. In a few cases, property tax incentives apply to the additional cost of a green building. Because property taxes are collected locally, some states have granted local taxing authorities the option of allowing a property tax incentive for renewables.

Rebate Programs

States, utilities and a few local governments offer rebates to promote the installation of renewables and energy efficiency projects. The majority of rebate programs that support renewables are administered by states, municipal utilities and electric cooperatives; these programs commonly provide funding for solar water heating and/or photovoltaic (PV) systems. Most rebate programs that support energy efficiency are administered by utilities. Rebate amounts vary widely by technology and program administrator.

Sales Tax Incentives

Sales tax incentives typically provide an exemption from, or refund of, the state sales tax (or sales and use tax) for the purchase of a renewable energy system, an energy-efficient appliance, or other energy efficiency measures. Several states have established an annual “sales tax holiday” for energy efficiency measures by annually allowing a temporary exemption – usually for one or two days – from the state sales tax.

Utility Rate Discounts

A few utilities offer rate discounts to encourage residential energy efficiency. For homes that meet certain energy efficiency criteria, such as those established by the federal Energy Star program, the owner or tenant is awarded a discount on his or her electric bills.

RULES, REGULATIONS & POLICIES

Appliance/Equipment Efficiency Standards

Many states have established minimum efficiency standards for certain appliances and equipment. In these states, the retail sale of appliances and equipment that do not meet the established standards is prohibited. The federal government has also established efficiency standards for certain appliances and equipment. When both the federal government and a state have adopted efficiency standards for the same type of appliance or equipment, the federal standard overrides the state standard (even if the state standard is stricter).

Building Energy Codes

Building energy codes adopted by states (and some local governments) require commercial and/or residential construction to adhere to certain energy standards. While some government entities have developed their own building energy codes, many use existing codes (sometimes with state-specific amendments), such as the International Energy Conservation Code (IECC), developed and published by the International Code Council (ICC); or ASHRAE 90.1, developed by the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE). A few local building energy codes require certain commercial facilities to meet green building standards.

Contractor Licensing

Some states have adopted a licensing process for renewable energy contractors. Several states have adopted contractor licensing requirements for solar water heating, active and passive solar space heating, solar industrial process heat, solar-thermal electricity, and photovoltaics (PV). These requirements are


108

designed to ensure that contractors have the necessary knowledge and experience to install systems properly. Solar licenses typically take the form of either a separate, specialized solar contractor’s license, or of a specialty classification under a general electrical or plumbing license.

Energy Efficiency Resource Standards

Energy efficiency resource standards (EERS) are state policies that require utilities to meet specific targets for energy savings according to a set schedule. EERS policies establish separate reduction targets for electricity sales, peak electric demand and/or natural gas consumption. In most cases, utilities must achieve energy savings by developing demand-side management (DSM) programs, which typically provide financial incentives to customers to install energy-efficient equipment. An EERS policy is sometimes coupled with a state’s renewables portfolio standard (RPS). In these cases, energy efficiency is typically included as a lower-tier resource.

Energy Standards for Public Buildings

Many states and local governments, as well as the federal government, have chosen to lead by example by requiring new government buildings to meet strict energy standards. DSIRE includes policies that have established green building standards, energy-reduction goals, equipment-procurement requirements, and/or the use of on-site renewable energy. Many of these policies require that new government buildings (and renovated buildings, in some cases) attain a certain level of certification under the U.S. Green Building Council’s Leadership in Energy and Environmental Design (LEED) program. Equipment-procurement policies often mandate the use of the most efficient equipment, including equipment that meets federal Energy Star criteria. Policies designed to encourage the use of on-site renewables generally establish conditional requirements tied to life-cycle cost analysis.

Equipment Certification Requirements

Policies requiring renewable energy equipment to meet certain standards serve to protect consumers from buying inferior equipment. These requirements not only benefit consumers; they also protect the renewable energy industry by keeping substandard systems out of the market.

Generation Disclosure

Some states require electric utilities to provide their customers with specific information about the electricity that the utility supplies. This information, which generally must be shared with customers periodically, usually includes the utility’s fuel mix percentages and emissions statistics. In states with restructured electricity markets, generation disclosure policies are designed to help consumers make informed decisions about the electricity and suppliers they choose. A few states that have not fully restructured their electricity markets require generation disclosure by utilities.

Green Power Purchasing Policies

Government entities, businesses, residents, schools, non-profits and others can play a significant role in supporting renewable energy by buying electricity from renewable resources, or by buying renewable energy credits (RECs). Many state and local governments, as well as the federal government, have committed to buying green power to account for a certain percentage of their electricity consumption. Green power purchases are typically executed through contracts with green power marketers or project developers, through utility green power programs, or through community aggregation.

Interconnection Standards

Interconnection standards specify the technical and procedural process by which a customer connects an electricity-generating to the grid. Such standards include the technical and contractual terms that system owners and utilities must abide by. State public utilities commissions typically establish standards for


109

interconnection to the distribution grid, while the Federal Energy Regulatory Commission (FERC) has adopted standards for interconnection to the transmission level. Many states have adopted interconnection standards, but some states’ standards apply only to investor-owned utilities -- not to municipal utilities or electric cooperatives. (Several states have adopted interconnection guidelines, which are weaker than standards and generally apply only to net-metered systems.)

Line Extension Analysis

When a prospective customer requests electric service for a home or facility that is not currently served by the electric grid, the customer usually must pay a distance-based fee for the cost of extending power lines to the home or facility. In some cases, it is cheaper to use an on-site renewable energy system to meet a prospective customer’s electricity needs. A few states require utilities to provide information regarding renewable energy options when a line extension is requested.

Mandatory Utility Green Power Option

Several states require electric utilities to offer customers the option to buy electricity generated from renewable resources, commonly known as “green power.” Typically, utilities offer green power generated using renewable resources that the utilities own (or for which they contract), or they buy renewable energy credits (RECs) from a provider certified by a state public utilities commission.

Net Metering

For electric customers who generate their own electricity, net metering allows for the flow of electricity both to and from the customer – typically through a single, bi-directional meter. When a customer’s generation exceeds the customer’s use, electricity from the customer flows back to the grid, offsetting electricity consumed by the customer at a different time during the same billing cycle. In effect, the customer uses excess generation to offset electricity that the customer otherwise would have to purchase at the utility’s full retail rate. Net metering is required by law in most U.S. states, but these policies vary widely.

Public Benefit Funds

Most public benefit funds (PBFs) were developed by states during the electric utility restructuring era, in the late 1990s, to ensure continued support for renewable energy, energy efficiency and low-income energy programs. These funds are commonly supported through a very small surcharge on electricity consumption (e.g., $0.002/kWh). This charge is sometimes referred to as a “system benefits charge” (SBC). PBFs commonly support rebate programs, loan programs, research and development, and energy education programs.

Renewables Portfolio Standards

Renewable portfolio standards (RPSs) require utilities to use renewable energy or renewable energy credits (RECs) to account for a certain percentage of their retail electricity sales -- or a certain amount of generating capacity -- according to a specified schedule. (Renewable portfolio goals are similar to RPS policies, but renewable portfolio goals are not legally binding.) Most U.S. states have established an RPS. The term “set-aside” or “carve-out” refers to a provision within an RPS that requires utilities to use a specific renewable resource (usually solar energy) to account for a certain percentage of their retail electricity sales (or a certain amount of generating capacity) according to a set schedule.

Solar and Wind Access Policies

Solar and wind access policies are designed to establish a right to install and operate a solar or wind energy system at a home or other facility. Some solar access laws also ensure a system owner’s access to sunlight. These laws may be implemented at both the state and local levels. In some states, access rights prohibit


110

homeowners associations, neighborhood covenants and local ordinances from restricting a homeowner’s right to use solar energy. Easements, the most common form of solar access policy, allow for the rights to existing access to a renewable resource on the part of one property owner to be secured from an owner whose property could be developed in such a way as to restrict that resource. An easement is usually transferred with the property title. At the local level, communities use several policies to protect solar access, including solar access ordinances, development guidelines requiring proper street orientation, zoning ordinances that contain building height restrictions, and solar permits.

Solar and Wind Permitting Standards

Permitting standards can facilitate the installation of wind and solar energy systems by specifying the conditions and fees involved in project development. Some local governments have adopted simplified or expedited permitting standards for wind and/or solar. “Top-of-the-stack” permitting (or fast-track permitting) saves system owners and project developers time and money. Some states have capped fees that local governments may charge for a permit for a solar or wind energy system. In addition, some states have developed (or have supported the development of) model wind ordinances for use by local governments


111

Annexure F

Main Energy Efficiency Policies in IndiaEnergy Conservation Act (2001)

This act establishes the Bureau of Energy Efficiency (BEE). Measures implemented under the Act include a requirement for large energy consuming industries to undertake energy audits.

Integrated Energy Policy (2006)

This sets out energy policies and targets for long-term energy security, to sustain social and economic development by 2031/32.

Energy Conservation Building Code (2006)

The code applies to all large new buildings and sets minimum requirements for building envelope components, lighting, HVAC, electrical system, water heating and pumping systems. The code is voluntary but is expected to become mandatory.

Energy Labeling Program for Appliances (2006)

This BEE program covers electrical appliances including refrigerators, fluorescent tube lamps, air conditioners and distribution transformers. It follows a five point rating scale, with one star implying low energy efficiency while a five star rating represents highest energy efficiency.

National Action Plan on Climate Change (2008)

The NAPCC Enhanced Energy Efficiency Mission was recently approved by the Prime Minister’s Council on Climate Change. The Mission will enable about Rs. 740 billion worth of transactions in energy efficiency. In doing so, it will, by 2015, help save about 5% of India’s annual energy consumption, and nearly 100 million tons of carbon dioxide every year.

Enhanced Energy Efficiency Mission targets and measures:

Mandating specific energy consumption decreases in large energy-consuming industries, •including Perform, Achieve & Trade (PAT) energy efficiency trading scheme;

Implementing energy incentives, including reduced taxes on energy efficient appliances and the •creation of new standards;

Financing for public-private partnerships to reduce energy consumption through demand side •management programs in the municipal, buildings and agricultural sectors;

Extending the existing Energy Conservation Building Code;•

Emphasizing urban waste management and recycling, including power production from waste. •

To further increase energy efficiency, the Indian government plans to retire 7% of the country’s inefficient coal plants by 2012, and an additional 10,000 MW by 2017. The government has also said that about 90% of the new capacity that will be added between 2007 and 2031/32 would come from more efficient super-critical, ultra super-critical and IGCC power plants.


113

Annexure G

BEE Recommendations on Direct TaxesFollowing is the list of incentives recommended by BEE in the NMEE Mission Document which are suggested to be incorporated in the Direct taxes code. The existing Income Tax Act of 1961 is proposed to be replaced by a new code to be called as Direct Tax Code 2009.The Finance Minister of India unveiled the Direct Taxes Code Bill, 2009 (DTC) on 12 August 2009, which shall replace the current Indian Income Tax Act of 1961. This Code in expected to come into force from 1 April 2012.

1. Accelerated depreciation.The Income tax Act, 1961, provides the following income tax benefit for energy-efficient projects.Accelerated depreciation under Section 32 of the Income Tax Act, 1961, on specified energy saving devices; accelerated depreciation of 80%. An additional depreciation at the rate of 20% is available on plant and machinery used for manufacturing and production in the year in which these assets are first put to use, subject to certain conditions.The current legislation therefore has limited incentives or a framework to encourage penetration of energy efficient projects in India. In order to achieve the objectives outlined in the NMEEE and to meet the expectations of various stakeholders in this sector.

Present provisions:Specified energy-savings devices are eligible for an accelerated depreciation of 80% on written down value (WDV) basis. This concession has provided a boost to investment mage in this sector.

Recommendation:It is recommended that the rate of depreciation be enhanced to 100% and the list of specified energy-saving devices provided in Appendix I to the Income Tax Rules be extended to include all energy-efficiency devices certified or notified by the BEE.Under the new DTC the rate of depreciation on such devices should be enhanced to 100% in the Fifteenth Schedule of the DTC.

2. Exemption in respect of subsidy/grant/ concession received from the Central Government/ BEE/ any of her institution for promoting or undertaking any energy-efficiency project under section 10 of the Act.

Present provisions:Revenue subsidies received are taxable in the hands of the recipient. The subsidy/ grant received towards depreciable asset in computing depreciation.The tax treatment of subsidy received is a matter of prolonged tax litigation. The tax treatment depends on the nature of the subsidy, namely whether it is in the nature of capital or revenue, which is further dependent on the purpose for which the subsidy is granted by the specified institutions.

Recommendation:

Under the existing I.T. Act, it is recommended that a new subsection be inserted under Section 10 to provide that any subsidy, grant or concession received for promoting or undertaking any energy-efficiency


114

project should be exempt from income tax in the hands of the recipient. Such provisions would be available for energy-efficiency projects registered and accredited by the BEE. If the subsidy, grant of concession is granted towards purchase of capital assets, such subsidy should not be reduced from the actual cost of capital assets in computing the depreciation such assets under Section 32 of the Act. Accordingly, appropriate exclusions should be made in the definition of actual cost under Section 43 of the Act.

Under the new Direct Taxes code Tax exemption should be provided to the recipient of any subsidy/ grant/ concession received for promoting or undertaking any energy-efficiency project under section 9 of the DTC (inclusion in the Sixth Schedule). In the case of capital subsidy, the recipient should be permitted to claim depreciation on the amount of subsidy received towards the capital asset. Exclusion to this effect should be made in Section 43 of the DTC.

Rationale: The grant of subsidy would reduce the amount of investment required to be made by a project owner and this would encourage setting up of energy-efficiency projects in India. A specific exemption would provide clarity on the treatment of such sums and thus mitigate litigation.

3. Weighted deduction for in-house R&D expenditure

Present provisions:Under existing I.T. Act, section 35(2AB) allows a weighted deduction of 150% on expenditure incurred on scientific research (except expenditure on land and building) in an approved in-house R&D facility to businesses engaged in manufacturing or producing specified articles or things as well as articles to things notified by the Central Board of Direct Taxes.

Recommendation:The Mission Document suggests that the weighted deduction should be extended to expenditure incurred on scientific research to businesses engaged in the manufacture of articles on the energy-efficiency sector specified by the BEE and notified by the Board of Direct Taxes under Section 35(2AB) of the Act.Under the new DTC the weighted deduction should be extended to expenditure incurred on scientific research to businesses engaged in the manufacture of articles in the energy-efficiency sector under Section 39 of the DTC.

Rationale:Such financial incentives for research would encourage companies to build R&D facilities, which are central to the development of energy-efficiency projects.

4. Removal of surcharge.

Present provisions:At present, surcharge is levied on companies with a total income of Rs 1 crore (at the rate of 10% for domestic companies and 2.5% for foreign companies) on the amount total tax computed as per the provisions of the Act.

Recommendation:It is recommended that the assesses being companies engaged in the manufacture or production of energy-efficiency equipment or devices specifically certified or notified by the BEE for such purpose should be exempted from the surcharge. It is also recommended that the First Schedule to the Act should be suitably amended to provide for exemption from surcharge on the total income tax payable by a taxpayer subject to certain conditions, such as the following:

a) The assessee is engaged in manufacturing or producing energy-efficiency equipment or devices certified or notified by the BEE.

b) The exemption would be available once the number of units manufactured or produced exceeds a prescribed threshold.


115

c) The product should be sold to consumers in India at a concessional price and may be approved by the BEE.

Under the new DTC also, companies engaged in the manufacture of energy-efficiency devices should not be subject to a surcharge on the total tax.

Rationale:The exemption from surcharge based on the number of energy-efficiency units manufactured would provide an incentive for setting up of manufacturing facilities in India. This would result in savings to the project owners, which would translate into manufacturing facilities being set up in India. This in turn would reduce the cost at which such goods are available consumers and enhance market penetration of energy-efficiency equipment in the country.

5. Tax holiday to specified energy-efficiency projects and ESCOs.

Present provisions:At present no such provision exists in the Act. However, similar exemptions are available for the infrastructure sector (section 80IA) and renewable energy (section 80JJA). Provisions exist for a tax holiday for power, infrastructure and other sectors. Deduction under Chapter VIA of the Act to profits and gains derived by energy service companies from performance contraction and / or special-purpose vehicles undertaking energy-efficiency project that are registered and accredited by the BEE (ESCOs and specified energy-efficiency projects)

Recommendation:It is recommended that a new sub section be inserted under Section 80 to provide for 100% deduction to profits and gains derived by ESCOs from the business of performance contracting in implementing energy-efficiency projects or specified energy-efficiency projects. Profits and gains for this purpose should also include interest income received by ESCOs for financing the specified energy-efficiency projects. The deduction would be available to ESCOs or energy-efficiency projects registered and accredited by the BEE and the claim would need to be accompanied by a certificate of implementation from the BEE on a yearly basis for implementing energy-efficiency projects.Whereas, under the new DTC, transitional provisions to be inserted under Section 282 of the DTC. These provisions should provide for grand – fathering of 100% tax holiday for ESCOs and specified energy-efficiency projects for the unexpired period. Since DTC does not prescribe profit-linked incentives, recommendations for a profit –linked tax holiday under the DTC regime has not been made.

Rationale:ESCOs or energy-efficiency projects in India are at a pilot stage and there is a need to enhance their presence to promote energy efficiency. This alone is expected to provide a favorable environment for investments in energy-efficiency.

6. Exemption to venture capital funds for investments in ESCOs and companies engaged in specified energy-efficiency projects.

Present provisions:

Under the Act, exemption is available for, income of a venture capital fund from investment made in the specified sectors. Section 10(23FB) of the Act provides for an exemption with respect to the entire income venture capital funds from investments made in the specified sectors such as nanotechnology, biofuels, IT and hotels.

Recommendation:

It is recommended that the list of existing sectors under sections 10(23FB) should be expanded including investment is ESCOs and companies engaged in specified energy-efficiency projects.DTC prescribes a blanket exemption irrespective of the sector in which such investment is made.


116

Rationale:

Venture capital funds have shown only limited interest in energy-efficiency so far. The finance incentive suggested above would encourage venture capital funds to invest in entities providing services related to energy efficiency, which would be in the large interest in the nations.

Under the Act, exemption is available for, income of a venture capital fund from investment made in the specified sectors. DTC prescribes a blanket exemption irrespective of the sector in which such investment is made.

The recommendation under this is that the list of existing sectors should be expanded to include investment in ESCOs and companies engaged in specified energy-efficiency projects.

The DTC proposes to grant a pass-through status to venture capital funds irrespective of the sector in which the investment is made. Therefore, no specific provision is required in this regard.

7. Minimum Alternate tax (MAT).

Present provisions:

MAT is applicable to a company even if it is claiming a tax holding under any of the provisions for the Act. MAT is payable by such companies at the rate of 16.995% on ‘book profits’ during the tax holding period if total tax falls below 15% of the book profits of the company. Under the current Direct Taxes Act, MAT is payable at the rate of 2% on the gross assets’ of the company. MAT/GAT (Gross Asset Tax) is applicable to a company even if it is eligible for tax holiday/ investment linked incentives under the Act/DTC.

Recommendation:

It is recommended that the explanation to Section 115JB should be amended to provide that no MAT shall be payable in respect of profits and gains derived by ESCOs and specified energy-efficiency projects from specified businesses eligible for dedication under Section 80.

The definition of ‘gross assets’ under Section 97 of the DTC for the purposes of GAT should exclude energy-efficiency devices and equipment certified or notified by BEE.

Rationale:

The benefit of a tax holiday is normally offset by applicability of MAT during the tax holiday period. The exemption from MAT during the tax holiday period would enable ESCOs and owners of specified energy-efficiency projects to reap full benefits of the tax holiday.

8. Exemption from interest income of specified institutions located outside India on foreign currency loans provided to ESCOs and specified energy-efficiency projects in India.

Act and DTC provides for exemption on certain interest income subject to prescribed conditions. Exemptions under Section 10(15) of the Act are on interest received by specified institutions. Outside India on foreign currency loans granted to ESCOs and specified energy-efficiency projects.

Present provisions:

Section 10(15) provides exemption on certain interest income subject to prescribed conditions. The sub clause (f) provides exemption on interest payable by an industrial undertaking on amounts borrowed by it in foreign currency from sources outside India under a loan agreement approved by Central Government before June 2001 in order to address the need for industry development in India.

Recommendation:

Mission Document recommends that tax exemption should be available on the interest income received by specified institutions located outside India on foreign currency loans provided to ESCOs and specified


117

energy-efficiency projects in India under Section 10(15) of the Act. It recommends that the clause (f) should be reinstated to grant income tax exemption on the interest income received by specified institutions located outside India on foreign currency loan granted to ESCOs and specified energy-efficiency projects with a view to promote clear industrial development in India.

Rationale:

This exemption would encourage specified institutions located outside India to finance ESCOs and specified energy-efficiency projects that are capital-starved. Also, eliminating the tax burden on interest income would translate beneficial lending rates to ESCOs and specified energy-efficiency projects.

Tax exemption should be available on the interest income received by specified institutions located outside India on foreign currency loans provided to ESCOs and specified energy-efficiency projects in India under Section 9 of the DTC (inclusion in the Sixth schedule).

9. Exemption in respect of income received from sale of CERs and E S Certs.

Present provisions:

Taking cognizance of issues related to the environment, the Government has exempted income tax on the sums received under the Montreal Protocol in connection with phasing out of Ozone Depleting Substances (ODS). Exemption under Section 10 of the Act in respect of income received from sale of Certified Emission Reductions (CERs) and Energy Efficiency Certificates (ESCerts).

Recommendation:

It is recommended that a new subsection be inserted under Section 10 to provide that any sums received from sale of CERs issued under the Kyoto Protocol for projects registered with the Nation Framework Convention on Climate Change (UNFCCC) and ESCerts issued for projects registered with the BEE are exempt from income tax.

Under the proposed DTC, sums received from sale of CERs issued under the Kyoto protocol for projects registered with the UNFCCC and ESCerts issued by the BEE for projects registered with BEE should be exempt from income tax under Section 9 of the DTC (inclusion in the Sixth Schedule).

Rationale:

The measure suggested above would encourage taxpayers to generate CERs and ESCerts by setting up projects under the Clean Development Mechanism (CDM) including energy-efficiency projects in India, which would ultimately support the Government’s continuing commitment to promote clean energy and combat global warning.

10. Introduction of the industrial park scheme for energy-efficient projects

A specific scheme exists for businesses in special Economic Zones, etc.

Under the existing provisions of Income Tax, 100% tax holiday should be available for 10 years to undertaking located in the notified areas and engaged in manufacturer and trade of energy-efficient products notified by the BEE. This benefit will be similar to that available for SEZs. However, unlike SEZs, which is export-oriented, this benefit would be granted for clearances in the domestic tariff area. A new section 10D in the Act could be inserted.

Under Indirect tax the Mission Document suggests that the overall input and output side exemptions from customers, excise, service tax and VAT/ CST should be granted to manufacturing and trading units located in such areas.

Recommendation under the proposed DTC and GST regime stipulate that the transition provision should provide for tax holiday benefit for the unexpired period. Input and output side exemptions from customs, excise and service tax should be granted to the eligible units under the GST regime.


119

References1. National Action Plan on Climate Change (NAPCC), Prime Ministers council on Climate Change,

Govt. of India.

2. 3i Network. (2010). India Infrastructure Report -2010. New Delhi, India

3. Planning Commission, Govt. of India. (August 2006). Integrated Energy Policy-Report of the Expert Committee. New Delhi, India

4. Bureau of Energy Efficiency, Ministry of Power, Government of India. (2010). Mission Document National Mission on Enhanced Energy Efficiency (NMEEE). New Delhi, India.

5. Climate Conundrum, Article by Anil Ananthaswamy, New Scientist, Pg 39-41; 26 June 2010 issue.

6. Physical Climate Science since IPCC AR4 Summary

7. Can we make our energy future more sustainable? Article by Robert L. Evans P Eng PhD in Innovation Magazine Nov / December 2007 Pages 26-30.

8. ‘India: Greenhouse Gas Emission 2007’ Report, Ministry of Environment and Forests, Government of India.

9. GHG Emissions in India 2007 main report.

10. IPCC Synthesis Report.

11. IPCC Executive summary for Policy Makers.

12. National Energy Map for India: Technology Vision 2030; Tata Energy Research Institute (TERI) Report.

13. Energy in India for the Coming Decades, article by by Anil Kakodkar Chairman, Atomic Energy Commission, India retrieved from internet from www.dae.gov.in/iaea/ak-paris0305.doc

14. Are sea levels trends along the North Indian coasts consistent with global estimates? By Unnikrishnan and D. Shanker, Global Planetary Change, 57, 301 (2007).

15. India Infrastructure report 2010, Chapter 9, International Trading of Emission Rights Its Implications for Low-Carbon Growth in India by Vijay P. Ojha.

16. India Infrastructure Report 2010, Chapter 8, Drivers of Energy Efficiency Industries Indian and International Experience in Infrastructure by Lenora Suki.

17. Promotion of energy efficiency in industries and financing of investments –U.N. Economic and social commission for Asia and Pacific accessed from http://www.unescap.org/esd/energy/publications/finance/index.html (retrieved on 17th Oct 2010)

18. Carbon Disclosure Project Report -Corporate Clean Energy Investment Trends in Brazil, China, India and South Africa- retrieved from Google on 17-11-2010 https://www.cdproject.net/CDPResults/Clean%20energy%20trends%20in%20emerging%20markets%20ENGLISH.pdf

19. Renewable Energy and Energy Efficiency Status in India – Report compiled by ICLEI South Asia, May 2007.

20. Future Energy Trends and GHG Emissions for India by P.R Shukla , Amit Garg, and Debyani Ghosh retrieved available at http://www.e2analytics.com

21. Robert Mendelsohn, - Climate Change and Economic Growth – Working Paper No. 60; Commission on Growth and Development, June 2009. International Bank for Reconstruction and Development / World Bank. www.growthcommision.org


120

22. Mendelsohn, R., A. Dinar, and L. Williams 2006. “The distributional impact of climate change on rich and poor countries.” Environment and Development Economics 11:1-20

23. Improving Energy efficiency in Asia’s Industries- Sophie Punte; Peter Repinski; Sara Gabrielsson, Greener Management International; Summer 2005; 50; ABI/INFORM Global retrieved from internet.

24. Improving Energy Efficiency in Industry in Asia - A Policy Review as part of the Energy Efficiency Guide for Industry in Asia. Available at www.energyefficiencyasia.org

25. Hansen, S. and Brown, J. (2003). Investment Grade Audit-Making smart energy choices. Fairmont Press: Lilbourn. Retrieved from: http://what-when-how.com/energy-engineering/energy-service-companies-europe/

26. Institute for Environment and Sustainability, Renewable Energies Unit, European Commission (2005). Energy Service Companies in Europe, Status report 2005, Bertoldi, P. & Rezessy, S.

27. Sudnya Industrial Services Pvt. Ltd., (2008). ESCOs: The need of the hour for Energy Efficiency in India. Pune, Maharashtra, India. Athale, S. & Chavan, M. Retrieved from: http://www.docstoc.com/docs/26030648/ESCOs_-The-need-of-the-hour-for-Energy-Efficiency-in-India

28. South Asia Sustainable Development Department, World Bank (December 2009). Energy intensive sectors of the Indian Economy: Options for low carbon development. New Delhi, India. Retrieved from: http://siteresources.worldbank.org/INTINDIA/Resources/LCD-Synopsis-Dec2009.pdf

29. Energy Management Group, National Productivity Council (NPC), (December, 2009). State wise electricity consumption & conservation potential in India- Report. New Delhi, India. Retrieved from: http://www.emt-india.net/eca2009/14Dec2009/CombinedSummaryReport.pdf

30. Central Electricity Authority, Ministry of Power, Government of India. (2008). Emission factor 0.81 tons CO2/MWh. Retrieved from: http://www.cea.nic.in/reports/planning/cdm_co2/user_guide_ver4.pdf

31. Delio, E. A., Lall, S. & Singh, C. (April, 2009). POWERING UP-The Investment Potential of Energy Service Companies in India. World Resources Institute. Retrieved from: http://www.wri.org/publication/powering-up#data-sources (Accessed on 29th, May, 2011)

32. The World Bank. (2010). Project Appraisal Document, Report No. 54343-IN; April 2010 / World Bank study “Energy intensive sectors of the Indian Economy: Options for low carbon development. Retrieved from: http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2010/05/14/000020953_20100514150657/Rendered/PDF/543430PAD0P100101Official0Use0Only1.pdf

33. Foundation for MSME Clusters. List of Indian SME clusters. New Delhi, India. Retrieved from: http://www.msmefoundation.org/indian_msmecluster.aspx

34. Energy and Security Group, (February, 2007). Renewable Energy and Energy Efficiency Policy Analysis Report Prepared for: The Sustainable Energy Policy Initiative Department of Sustainable Development Organization of American States.

Retrieved from: http://toolkits.reeep.org/file_upload/10401021_2.pdf35. Geller, H. and Nadel, S. (1994) “Market transformation strategies to promote end-use efficiency”

Annual Review of Energy and the Environment 19 301-346 Retrieved from: http://martinot.info/Birner_Martinot_EP.pdf

36. Mendis, M. & Openshaw, K., (2003). THE Clean Development Mechanism: Making it Operational. Environment, Development And Sustainability, Volume 6, Numbers 1-2, 183-211, doi: 10.1023/B:ENVI.0000003637.28190.ca

Retrieved from: http://www.springerlink.com/content/n74414120v2216x5/


121

37. Ellis, J. (March 2009).Energy service companies in developing countries: Potential and practice. International Institute for Sustainable Development (IISD).

Retrieved from: http://www.iisd.org/pdf/2009/bali_2_copenhagen_escos.pdf 38. Ming, Z. (2006). EMCA and China’s ESCO Industry. Presentation at the 2006 Conference on

Energy Conservation in Buildings, Energy Performance Contracting and Financial Guarantee for Energy Efficiency Projects, Beijing, China, July 25-26, 2006.

Retrieved from: http://www.resourcesaver.com/file/toolmanager/CustomO105C399F92027.pdf (Accessed on June 3, 2011).

39. WEC ADEME project on energy efficiency policies; Central European University, World Energy Council (2007).

40. ESCO Synthesis: An Assessment of on Energy Service Companies (ESCOs) Worldwide. Budapest, Hungary: Ürge-Vorsatz, D., Köppel, S., Liang ,C., Kiss, B., Nair, G. G. & Celikyilmaz, G. Retrieved from: http://www.worldenergy.org/documents/esco_synthesis.pdf

41. World Resources Institute. (April, 2009). Powering Up: The Investment Potential of Energy Service Companies in India. Washington D C, USA: Delio, E., Lall, S., Singh, C.

Retrieved from: http://www.wri.org/publication/powering-up#data-sources (Accessed on 29th May, 2011)

42. Orrick Herrington & Sutcliffe (June, 2010). Incentives for energy service companies- Rewarding Green Efforts. China: Stender, N. & L, Y. F.

Retrieved from: http://www.orrick.com/fileupload/2741.pdf43. The Renewable Energy & Energy Efficiency Partnership (REEEP). Brazil’s Public Benefit Wire-

Charge Mechanism: Fueling Energy Conservation. Retrieved from: http://www.reeep.org/file_upload/2785_tmpphpC9wvEx.pdf 44. World Resource Institute. Brazil: National Program for the Rational Use of Natural Gas and Oil

Products (CONPET) (http://www.conpet.gov.br/w3/). Retrieved from: http://projects.wri.org/sd-pams-database/brazil/national-program-rational-use-natural-gas-and-oil-products-conpet

45. The Energy Sector Management Assistance Program (ESMAP), The World Bank. (2008). Financing Energy Efficiency. – Lessons from Brazil, China, India and beyond. Washington DC, USA: Taylor, R. P., Govindarajalu, D., Levin, J., Meyer, A. S. & Ward, W. A.

Retrieved from: http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2008/02/18/000333037_20080218015226/Rendered/PDF/425290PUB0ISBN11OFFICIAL0USE0ONLY10.pdf (Accessed on 10/07/2011)

46. Update on Brazil’s National Electricity Conservation Program (PROCEL). Geller, H., de Almeida, M., Lima, M., Pimental, G. & Pinhel, A. (1999). Retrieved from: www.aceee.org/pubs/i992.htm

47. CORE International Inc. Website, Moving Markets for Energy Efficiency in Brazil. Retrieved from: http://www.coreintl.com/projects/Signature_Projects/Moving_Markets_for_

Energy_Efficiency_in_Brazil.html (Accessed on 22/07/2011)48. LBNL Environmental Energy Technologies Division. (January, 2005). Review of U.S. ESCO

Industry Market Trends: An Empirical Analysis of Project Data. USA: Goldman C., Hopper N., Osborn J. Retrieved from: http://eetd.lbl.gov/EA/EMP/reports/52320.pdf

49. ICF International. (October, 2007). Introduction to Energy Performance Contracting, Washington, DC: National Association of Energy Services Companies.

Retrieved from: http://www.energystar.gov/ia/partners/spp_res/Introduction_to_Performance_Contracting.pdf


122

50. REEPs: Rate Payer Funded Energy Efficiency Programs American Council for an Energy-Efficient Economy (ACEEE). (May, 1998). REEPs: Ratepayer-Funded Energy Efficient Programs in a Restructured Electricity Industry: Issues and Options for Regulators and Legislators. Washington D.C., USA: Eto, J., Goldman, C. & Nadel, S. Retrieved from: http://www.aceee.org/research-report/u982

51. American Council for an Energy-Efficient Economy (ACEEE). (March, 2011). Assessing the Harvest: Implementation of the Energy Efficiency Provisions in the Energy Policy Act of 2005. Washington D.C., USA: Gold, R. & Nadel, S. Retrieved from: http://www.aceee.org/research-report/e113

52. American Council for an Energy-Efficient Economy. (ACEEE). (June 2011). Energy Efficiency Tax Incentives, 2005-2011: How Have They Performed?. Washington D.C., USA: Gold, R. & Nadel, S.

Retrieved from: http://www.aceee.org/files/pdf/white-paper/Tax%20incentive%20white%20paper.pdf

53. The Database of State Incentives for Renewable Energy (DSIRE), U.S. Department of Energy. Retrieved from: http://www.dsireusa.org/incentives/index.cfm?state=us&re=1&EE=1

54. PACE : Property Assessed Clean Energy financing Retrieved from: http://pacenow.org/blog/55. Mendis, M. & Openshaw, K. (2003). The Clean Development Mechanism: Making it Operational.

Environment, Development And Sustainability, Volume 6, Numbers 1-2, 183-211, doi: 10.1023/B:ENVI.0000003637.28190.ca

Retrieved from: http://www.springerlink.com/content/n74414120v2216x5/56. Vine, E., Nakagami, H. & Murakosh, C. (June 1999). The evolution of the U.S. ESCO Industry:

From ESCO to Super ESCO. Energy, Volume 24, Issue 6, Pages 479-492, doi: 10.1016/S0360-5442(99)00009-2

Retrieved from: http://www.sciencedirect.com/science/article/pii/S036054429900009257. Limaye, D. R. & Limaye, E. S. (2011). Scaling up Energy Efficiency: the Case for a Super ESCO;

Review Paper, Energy Efficiency, 4:133-144, doi: 10.1007/s12053-011-9119-5 Retrieved from: http://www.springerlink.com/content/764u30527m73j354/ 58. The Berliner Energieagentur is a modern energy service company located in Berlin, Germany.

Retrieved from: http://www.berliner-e-agentur.de/ 59. Singh, J., Limaye, D., Henderson, B. & Shi, X. (2009). Public procurement of energy efficiency

services: Lessons from International experience. The World Bank. Retrieved from: http://www.esmap.org/esmap/node/27060. Energy Efficiency Services Limited. A Joint Venture of PSUs of Ministry of Power, Government

of India. Retrieved from: http://www.eesl.co.in/Website/Portals/0/Tender/Recruitment%20Final.pdf

61. Osborn, J., Goldman, C., Hopper, N. & Singer, T. (August, 2002). Assessing U.S. ESCO Industry: Results from the NAESCO Database Project. Ernest Orlando Lawrence Berkeley National Laboratory, University of California Berkeley, Berkeley, California

Retrieved from: http://eetd.lbl.gov/ea/emp/reports/50304.pdf 62. World Resources Institute, New Ventures India 2009. Retrieved from: http://www.new-ventures.

org/63. Bureau of Energy Efficiency, Government of India. Retrieved from: www.bee-india.nic.in

(Accessed on 22-07-2011)


123

64. Uttar Pradesh State Designated Agency. Retrieved from: http://www.upsda.in/files/List%20of%20ESCOs%20as%20on%2021-10-1010.pdf

65. Bachat Lamp Yojna (BLY) Documents at United Nations Framework Convention on Climate Change Platform. Retrieved from: http://cdm.unfccc.int/ProgrammeOfActivities/Validation/DB/WOW1YYO9VEFAM3D6H2GJ4BZ4AW9YJL/view.html

66. List of State Designated Agencies (SDAs) for states in India. Retrieved from: http://www.sdabeebreda.com/State%20designated%20agencies.htm

67. Perform Achieve and Trade (PAT) details provided in National Mission on Enhanced Energy Efficiency section of Bureau of Energy Efficiency (BEE), Ministry of Power, Government of India. Retrieved from: http://www.beeindia.in/

68. Standards and Labeling programme of Bureau of Energy Efficiency (BEE), Ministry of Power, Government of India. Retrieved from: http://www.beeindia.in/

69. UNIDO List of SME Clusters in India. Retrieved from: http://dcmsme.gov.in/clusters/clus/smelist.htm#clus

70. ‘Special feature on Leather and leather goods’, The Economic Times, New Delhi, October 21, 1996.

71. Technology Bureau for Small Enterprises, United Nations’ Asian and Pacific Centre for Transfer of Technology APCTT) and Small Industries Development Bank of India (SIDBI). Retrieved from: http://www.angelfire.com/ny/tbse/

72. Integrated Technology Up gradation and Management Program (UPTECH), Ministry of Micro Small & Medium Enterprises, Government of India. Retrieved from: http://www.msmediraipur.gov.in/integerated.htm

73. Menon, Sen, K. & Kumar, AK. S. (September, 2010). UNDP India Mid Term Review of the Country Programme Action Plan 2008-2012. New Delhi, India Retrieved from: www.undp.org.in/sites/default/files/reports.../UNDP-MTR-Report.pdf (Accessed on 20-11-2011)

74. Akker, J. & Singh, R. K. (August, 2007). Mid Term Review of Energy Efficiency in Steel Re-Rolling Mills project of United Nations Development Programme, Government of India, Global Environment Facility. New Delhi, India

Retrieved from: www.erc.undp.org/evaluationadmin/downloaddocument.html?docid=1344 (Accessed on 20-11-2011) 75. DSCL Energy Service Company Ltd. (September, 2005). Development of Financial Intermediation

Mechanism for Energy efficiency investments in Developing countries , Under World Bank / UN Foundation – UNEP Technical Assistance Project. New Delhi, India

Retrieved from: http://3countryee.org/public/FinancingEEprojectsPaperIndia.pdf (Accessed on 11-08-2011)76. Negawatt from Wiki: http://en.wikipedia.org/wiki/Negawatt_power#Definition 77. UNEP Risoe Centre. (September, 2007). Developing Financial Intermediation Mechanisms for

Energy efficiency Projects in Brazil, China and India. Denmark Retrieved from: http://www.3countryee.org/public/EECaseStudiesIndustriesIndia.pdf 78. The World Bank. (2010). Financing Energy Efficiency at MSMEs Project, Project Appraisal

Document, Report No. 54343-IN. India Retrieved from: http://www-wds.worldbank.org/external/default/main?pagePK=64193027&piP

K=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=51351213&theSitePK=40941&entityID=000020953_20100514150657&searchMenuPK=51351213&theSitePK=40941


124

79. Solmes, L. A. (2010). Energy Efficiency-Real Time Energy Infrastructure Investment and Risk Management, Performance based Investment Financing, Chapter 11. Springer

80. UNIDO. (2008). Country Programme of Cooperation between the Republic of India and UNIDO 2008-2012: Towards inclusive growth: Strengthening the competitiveness and productivity of industrial enterprises. India

Retrieved from: http://www.dipp.nic.in/whatsnew/CountryProgramme_UNIDO_2008-2012.pdf (Accessed on 14 November 2011)

81. Public Sector from Wiki: http://en.wikipedia.org/wiki/Public_sector

82. Niche market from Wiki: http://en.wikipedia.org/wiki/Niche_market

83. MUSH refers to municipalities (M), universities (U), schools (S) and hospitals (H) from Wiki: http://en.wikipedia.org/wiki/Mush

84. Price, L., Galitsky, C., Sinton, J., Worrell, E., Graus, W. (September, 2005). Tax and Fiscal Policies for Promotion of Industrial Energy Efficiency: A Survey of International Experience.

Retrieved from: http://ies.lbl.gov/iespubs/58128.pdf

85. World Energy Council -for sustainable development. (2010). Energy Efficiency: Recipe for success.

Retrieved from: http://www.worldenergy.org/documents/fdeneff_v2.pdf

86. International Partnership for Energy Efficiency Cooperation (IPEEC). (October, 2010). Background Paper- Assessment of Energy Efficiency Financing Mechanism.

Retrieved from: http://www.ipeec.org/task_aeefm.html

87. AKF Forlaget. (2000). Industrial Energy Demand and the Effect of Taxes, Agreements and Subsidies. Copenhagen, Denmark: Bjørner, T.B. & Jensen, H.H.

Retrieved from: www.akf.dk/udgivelser/2000/pdf/industrial_energy_demand.pdf

88. Department of Environment, Food, and Rural Affairs (DEFRA) (2005). UK Emissions Trading Scheme. United Kingdom

Retrieved from: http://www.decc.gov.uk/en/content/cms/emissions/ccas/uk_ets/uk_ets.aspx

89. Resources for the Future. (1998). Policy Analysis in a Second-Best World. Washington, DC, USA: Parry, I. W. H. and Oates, W. E.

Retrieved from: http://www.rff.org/documents/rff-dp-98-48.pdf

90. Cambridge Econometrics. (2008). Review of the Energy Taxation Directive: Final modelling results. A report for DG TAXUD, European Commission.

91. Bio Intelligence Service. (2008). A study on the costs and benefits associated with the use of tax incentives to promote the manufacturing of more and better energy-efficient appliances and equipment and the consumer purchasing of these products. Paris, France

Retrieved from: http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/economic_studies/study_costs_benefits_bio_en.pdf

92. World Future Council. (2011). Policy: Energy performance contracting.

Retrieved from: http://www.futurepolicy.org/2723.html (Accessed on 30th May, 2011)

93. Bertoldi, P. & Rezessy, S. (2005). Energy Service Companies in Europe, Status Report 2005. Ispra, Italy: European Commission, DG Joint Research Center

Retrieved from: http://www.managenergy.net/resources/941


125

94. Climate Change Team, World Bank Environment Department, World Bank. (2004). GEF Energy Efficiency Portfolio Review and Practitioners, Handbook.

Retrieved from: http://siteresources.worldbank.org/INTCC/812001-1110807496989/20480590/WBGEFEnergyEfficiencyHandbook2004.pdf

95. Policies for Promoting Industrial Energy Efficiency in Developing Countries and Transition Economies, Executive Summary, United Nations Industrial Development Organization, 2008; http://industrial-energy.lbl.gov/files/industrial-energy/active/0/ind_energy_efficiencyEbookv2-1.pdf

_ _ _ _ _