Professional Documents
Culture Documents
Submitted by
Amit Jain
I.R.S.
ii
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 Personnels 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.
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iv
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
List of Abbreviations
REEPS
DSM
SDA
EBRD
SFCs
EE
Energy Efficiency
IIPEC
SIDBI
APCTT
EESL
IIUS
SIDCs
ABESCO
IED
ADB
IFC
ANEEL
SIDO
EMC
BEE
SME
IREDA
EMCA
BLY
SPV
MTEE
EPACT
BT
Business Tax
SRRM
MUSH
EPC
CCA
SSI
NAESCO
ESCO
TBSE
CDM
EUETS
NAPCC
TCOs
CED
NMEEE
FEED
UNEP
CONPET
FEMP
OECD
CPSUs
PACE
CSEP
PAT
UNFCC
GHG
HVAC
VAT
CSIO
Central Small Industries Organization
PROESCO Apoio a projetos de eficincia energtica
DCS
Designated Consumers
ICPEEB
PURPA
WEC
DIPP
RBI
IDIQ
Indefinite-Delivery, Indefinite-Quantity
DSIRE
WRI
vii
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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.
ix
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 Indias 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.
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.
xi
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.
xii
Summary of Recommendations_________
On Promotion of ESCOs and Cluster Approach
1. Conduct National SME Cluster Mapping Program to build SME Cluster Data Base for EE.
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. 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. Involve Multinational ESCOs in large federal energy efficiency projects including those
in MUSH1 sector who would engage Indian ESCOs as subcontractors in these projects
so as to help them in their capacity building.
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.
6. Establish Authority for Energy Performance Contracting Dispute Resolution for early
resolution of disputes between ESCOs and their customers.
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.
1
xiii
xiv
Table of Contents
S. No. Chapter No. Topic....................................................................................................Page No.
1
List of Abbreviations.......................................................................................................vii
Summary of Recommendations...................................................................................xiii
List of Tables..................................................................................................................xvii
List of Figures................................................................................................................xvii
List of Annexures..........................................................................................................xvii
Introduction......................................................................................................5-8
10
11
12
Part I
Role of ESCOs & Cluster Approach
14
15
16
17
xv
18
19
Chapter 10 ESCOs in China, Brazil and United States Lessons Learned..................... 37-38
20
21
(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
23
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
(A) Taxes and Fees: Increasing Costs Associated with Energy Use
(B) Fiscal Policies: Reducing Costs Associated with Increasing Energy Efficiency
(F) Status of direct tax Incentives for Improving energy efficiency in India
26
27
References.................................................................................................. 119-125
xvi
Sl. No.
List of Tables
Page Nos.
Tax and fiscal policies for encouraging investments in EE processes and equipments............... 74
Sl. No.
List of Figures
Page Nos.
Indian ESCO industries by revenues and year over year growth (%)............................................ 40
Sl. No.
List of Annexures
Page No.
1.
2.
3.
4.
5.
Annexure E: Database of U.S. State Incentives for Renewables and Efficiency (DSIRE).. 105-110
6.
7.
xvii
xviii
Part I
Chapter 1: Making ESCOs Popular in India
The 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 engineers 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 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.
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.
3
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 Indias 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
A
pproximately 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.
R
eferred to as: Mission Document in this paper.
D
emand 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 customers control, while the second is more utility controlled. (India Infrastructure Report -2010)
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 Indias 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 ESCOs 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
E
nergy 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.
N
MEEE-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/-
I nvestment 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 buildings 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/
E
SCOs 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.
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 companys
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-EnergyEfficiency-in-India
Chapter 1
Making ESCOs popular in India
ESCOs 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 engineers 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.
D
efinition 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.
C
luster 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 interfirm 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
12
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.
10
Chapter 2
Energy Conservation Potential in India
Conservative 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
11
Industrial, 49,
26.7%
Lighting, 70,
38.1%
Commerical, 0.8,
0.4%
Municipal, 3.7,
2.0%
Agriculture, 60,
32.7%
Source: Bhaskar Natarajan, EE Finance in IndiaSome Progress and What Next? report presented at the Asia
Clean Energy Forum, 2008, Asian Development Bank Headquarters, mainla, Philippines, June 35, 2008. Available
at http://www.adb.org/Documents/events/2008/ACEF/Session17-Natarajan.pdf (Accessed on September 20, 2008)
However, the NMEEEs 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 Kilowatthours 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
19
20
21
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.
Conversion factor as per BEE: 1MW 5.19 million units.
World Resources Institute(WRI) 2008 estimates.
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
12
Chapter 3
Significance of Indian SME Sector
The 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. Indias 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 Indias 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 countrys 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
26
World Bank study Energy intensive sectors of the Indian Economy: Options for low carbon development
27
13
Chapter 4
Market Transformation for energy efficient economic
development
Market 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 demandside 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 programs stated goals.
29
30
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.
M
arket 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).
Th
e 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 LDCs. 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).
15
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.
16
Part I
ROLE OF ESCOs &
CLUSTER APPROACH
17
18
Chapter 5
ESCOs in China, Brazil, United States and India
ESCOs 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 UNEPs 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, Brazils energy
consumption is only around 40 percent of Indias energy consumption, at about 224 million tons of
oil equivalent, and its per capita energy consumption is 2.4 times larger than that of Indias, yet the
aggregate revenue of Brazils ESCO industry is sixteen times greater than its Indian counterpart. Chinas
energy consumption is 3.3 times greater than Indias, 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 Indias 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
19
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.
20
Chapter 6
ESCOs in China
Recent 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 Chinas 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.
34
Zhao Ming, 2006. EMCA and Chinas 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 rge-Vorsatz, Sonja Kppel,
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 78, 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
21
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.
In order to further accelerate the Implementation of Energy Management Contracting to Promote the
Development of Energy Saving Service Industry, the General office of Chinas 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:
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
22
India. The existence and efforts of the national EMC Association of China (EMCA) is a second
factor that has enabled the industrys 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). EMCAs 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
rge-Vorsatz et al. 2007, WEC).
(v) Perception of ESCOs
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 Chinas 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
E
SCO Synthesis: An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja
Kppel, 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
23
Chapter 7
ESCOs in Brazil
High 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 Brazils 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 rge-Vorsatz, Sonja Kppel,
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: Brazils 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: Agncia Nactional de Energia Eltrica, Brazils electricity regulatory agency (known by the acronym ANEEL)
25
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 costplus 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
Brazils national electricity conservation program (PROCEL)50 was established in 1985. It funds or cofunds 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.
Brazils ESCO industrys 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/425290pub0ISBN11OFFICIA
L0USE0ONLY10.pdf accessed on 10/07/2011.
48
49
50
51
26
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 Brazils 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
(iv) Industry Support
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.
(v) Perception of ESCOs
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 80s
(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 rge-Vorsatz, Sonja
Kppel, 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
27
Chapter 8
ESCOs 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/425290PUB0ISBN11OFFICI
AL0USE0ONLY10.pdf accessed on 10/07/2011.
29
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 utilitys own avoided cost rate to the consumer; the avoided
56
57
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
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
30
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 riders61 and keep costs to the Federal treasury down62.
58
59
60
61
62
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
REEPs: Rate Payer Funded Energy Efficiency Programs
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.
Free Riders- are tax credit participants who would have purchased eligible products even if tax credits were not available.
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%20
white%20paper.pdf
31
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
64
65
66
67
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.
PACE : Property Assessed Clean Energy financing
Retrieved from Website: http://www.dsireusa.org/incentives/index.cfm?state=us&re=1&EE=1
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%20
white%20paper.pdf
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.
32
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 manufacturers 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 Support
The 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 ESCOs
Since 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
Programs 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.
68
69
70
ESCO Synthesis: An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja
Kppel, 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
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.
ESCO Synthesis An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja Kppel,
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
33
Chapter 9
Super ESCOs- The Concept
The 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
72
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/
For example: Berliner Energieagentur. See Geissler 2008.
35
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 terms74. 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. Philippiness
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 Scientific
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
36
Chapter 10
ESCOs in China, Brazil and United States
Lessons Learned
Lessons 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 Foundations 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.
ESCO Synthesis: An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja
Kppel, 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
37
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.
38
Chapter 11
ESCOs 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 12 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 industrys 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
82
World Resources Institute, New Ventures India 2009. / India Infrastructure Report 2010
Powering Up: The Investment Potential of Energy Service Companies in India by Ella Aglipay Delio, Saurabh Lall and
Chandan Singh; WRI
39
Figure: 3 Indian ESCO Industry Revenues (INR lakhs) & Year Over Year Growth (%)
10,000
8,000
6,000
4,000
2,000
0
2003
2004
2005
2006
2007
Source: POWERING UP: The Investment Potential of Energy Service Companies in India; Ella Aglipay Delio,
Saurabh Lall and Chandan Singh. WRI
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.
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 WRIs
survey, the average energy savings per implemented ESCO project was between 21 and 25 percent.
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
40
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.
41
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.
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86
87
88
89
90
Mission Document National Mission on Enhanced Energy Efficiency, June 2010, Pg. 143
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
S tate 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
P
erform 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
countrys 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
S tandards 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.
EESL website http://www.eesl.co.in/Website/Portals/0/Tender/Recruitment%20Final.pdf
42
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 Presidents
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 Presidents 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
44
Chapter 12
Energy 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 countrys 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 countrys woollen knitwear, 85% of the countrys
sewing machines and 60% of the nations 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 agro92
93
45
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 Indias
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
95
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.
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.
46
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.
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 SBIs 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
97
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/
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
47
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 Indias 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 energyefficiency 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
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
48
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_ESCLs final report, besides achieving successfully the energy
savings of around 10-20%, the key lessons learned were:
On EE Project implementation:
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.
On Financing:
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.
On Financial Intermediation:
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
49
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.
50
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.
51
Chapter 13
Barriers for ESCO Development in India
Although 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.
Identification of barriers is based on numerous studies conducted / papers and the NMEEE Mission Document
ESCO Synthesis: An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja
Kppel, 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
53
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 institutions 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.
The asset based lending stipulation of Reserve Bank of India prevents banks from lending nonrecourse 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
NMEEs 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
104
ESCO Synthesis An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja
Kppel, 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
105
54
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 banks 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 Barriers
Regulatory barriers107
Lack of legal and financial infrastructure to support performance contracts. Mistrust between
counterparts in the context of weak contract enforcement. Indias 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 Negawatts108 (or efficiency savings) in the context of project cash flows.
Lack of government enabling policies.
107
108
109
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.
ESCO Synthesis An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja
Kppel, 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
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
ESCO Synthesis An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja
Kppel, 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
55
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.
111
112
113
114
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
ESCO Synthesis An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja
Kppel, 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
India Infrastructure Report 2010
ESCO Synthesis An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja
Kppel, 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
ESCO Synthesis: An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja
Kppel, 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
56
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 customers 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 companys 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 sectors share in the ESCOs
activities is currently often much lower than its envisaged potential.
115
ESCOs synthesis.
57
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-IN
118
119
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-Efficiencyin-India
58
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, 14).120
120
Leslie A. Solmes; Energy Efficiency-Real Time Energy Infrastructure Investment and Risk Management, Performance
based Investment Financing, Chapter 11.
59
Chapter 14
CONCLUSIONS AND RECOMMENDATIONS
1. 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.
61
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 Indias 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
Commissions 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;
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
62
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.
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.
63
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 Indias 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.
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
64
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 lending124 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.
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 RBIs 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.
65
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.
66
Part II
ROLE OF TAX & FISCAL
INCENTIVES IN ENERGY AND
ENVIRONMENTAL POLICY
67
68
Chapter 15
Role of Tax and Fiscal Policies in removing barriers for
promotion of Industrial Energy Efficiency
Overview
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 Indias 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.
69
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 200001 to 55.7% in 2008-09. The growing importance of the direct taxes towards countrys 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 governments 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.
h
ttp://www.google.co.in/#sclient=psy-ab&hl=en&source=hp&q=percentage%20share%20of%20Direct%20taxes%20
in%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.
70
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 industrys 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 Commissions Taxation Paper on The
role of fiscal instruments in environmental policy by Katri Kosonen and Gatan Nicodme.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
The role of fiscal instruments in environmental policy by Katri Kosone (European Commission) and Gatan Nicodme
(European Commission, ECARES-ULB, CEB-Solvay Brussels School of Economics and Management, and CESifo) June
2009; Taxation Working Paper 19 of 2009.
133
71
Chapter 16
Role of Tax Policy
Government 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).
73
Table 3
Tax and Fiscal Policies for encouraging investment in EE processes and equipments
A. T
ax and fiscal policies that increase cost
associated with energy use
B. T
ax and fiscal policies that reduce the cost
associated with Energy use
1 Tax Incentives
a) Accelerated Depreciation
b) Tax deductions
c) Tax credits
d) Tax exemptions
e) Tax reductions
2 Grants / Non Tax Subsidies
3 Subsidized Energy Audits
4 Loans
a) Soft / Public Loans
b) Innovative Funds
I. Equity Participation through ESCOs
II. Guarantee Funds
III. Revolving Funds
IV. 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.
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
74
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 facilitys 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.
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.)
75
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 businesss 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,
76
as domestic sources of energy efficiency technology may be limited, and standard duties on imported
equipment may be a substantial barrier to their use.
Background Paper- Assessment of Energy Efficiency Financing Mechanism, Oct. 2010; IPEEC & BEE.
77
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.
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.
78
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 Netherlands 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 (Krmer and Stjernstrm, 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 Funds
Innovative 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.
79
INTEGRATED POLICIES
Complementing 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.
138
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
80
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).
140
141
142
143
144
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.
The role of fiscal instruments in environmental policy by Katri Kosonen (European Commission) and Gatan Nicodme
(European Commission, ECARES-ULB, CEB-Solvay Brussels School of Economics and Management, and CESifo)
Junem2009, Taxation Papers- European Commission.
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)
Bjrner, T.B. and Jensen, H.H., 2000. Industrial Energy Demand and the Effect of Taxes, Agreements and Subsidies.
Copenhagen: AKF Forlaget.
Finansministeriet, 1999. Evaluering af grnne 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
Bjrner, T.B. and Jensen, H.H., 2000. Industrial Energy Demand and the Effect of Taxes, Agreements and Subsidies.
Copenhagen: AKF Forlaget.
81
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 countrys 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 employers 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 (20012002) 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-andcredit 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 energyefficient equipment. The most well designed Energy or CO2 tax programs recycle the tax revenues
145
146
epartment of Environment, Food, and Rural Affairs (DEFRA), 2005a. UK Emissions Trading Scheme.
D
http://www.defra.gov.uk/environment/climatechange/trading/uk/index.htm
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
82
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 dont 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.
148
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
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.
83
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.
84
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
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.
85
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)
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
86
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
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 energyefficiency 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.
87
Chapter 17
Conclusions and Recommendations
Introducing Integrated Policies on Tax and Fiscal Incentives under Voluntary / Negotiated Agreement
Scheme
Indias 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
89
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
90
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.
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.
92
Annexure A
What 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 ESCOs payment is directly linked to the amount of energy saved (in physical or monetary terms).
* 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
155
World Future Council. (2011, May). Retrieved May 30, 2011, from Future Policy .org: http://www.futurepolicy.org/2723.
html
An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja Kppel, Chunyu Liang,
Benigna Kiss, Gireesh Goopalan Nair, Gamze Celikyilmaz; Central European University, 2007, World Energy Council.
93
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
projects 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 projectbeginning 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 characteristicsspecialization in energy management,
ability to aggregate projects, and expertise in delivering complete turnkey projects of technical advisory
plus financing.
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 customers balance sheet and is subject to
same evaluation as for any other loan including companys 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
157
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.
An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja Kppel, Chunyu Liang,
Benigna Kiss, Gireesh Goopalan Nair, Gamze Celikyilmaz; Central European University, 2007, World Energy Council.
94
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 offbalance 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
159
Assessment of Energy efficiency financing Mechanism Background Paper- Oct 2010 under International Partnership for
Energy Efficiency Cooperation (IPEEC) and Bureau of Energy Efficiency.
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
95
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
96
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) ESCOs 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) ESCOs 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.
Annexure C
CHINA ESCO INDUSTRY160
ENABLING FACTORS
The recent rapid development of the ESCO industry in China can be attributed to the following factors:
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 Chinas ESCO industry.
Financial factors
3. 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 sharedsavings 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
160
ESCO Synthesis: An Assessment of on Energy Service Companies (ESCOs) Worldwide, Diana rge-Vorsatz, Sonja Kppel,
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
99
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 Chinas 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 Chinas 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. UrgeVorsatz 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).
100
Annexure D
U.S. Federal and State Enabling Policies
A) 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 performancebased 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 mid1990s 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 .
161
Pay Back Time: An energy investments 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.
101
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)
162
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
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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 Councils 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.)
105
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 demandside 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 owners 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 systems actual performance
are generally more effective than payments based on a systems 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.
106
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
107
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 contractors license,
or of a specialty classification under a general electrical or plumbing license.
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 utilitys 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.
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
108
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.)
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 customers
generation exceeds the customers 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 utilitys full retail rate. Net metering is required by law in most U.S. states, but these policies vary
widely.
homeowners associations, neighborhood covenants and local ordinances from restricting a homeowners
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.
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Annexure F
Main Energy Efficiency Policies in India
Energy 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 Ministers
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 Indias annual energy consumption,
and nearly 100 million tons of carbon dioxide every year.
Enhanced Energy Efficiency Mission targets and measures:
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;
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 countrys 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 supercritical, ultra super-critical and IGCC power plants.
111
Annexure G
BEE Recommendations on Direct Taxes
Following 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 energysaving devices provided in Appendix I to the Income Tax Rules be extended to include all energyefficiency 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
113
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.
114
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 energyefficiency 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.
115
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
116
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 energyefficiency 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 Governments 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.
117
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