Opportunities to increase financing for energy efficiency in developing countries focus on mechanisms that build credit for borrowers, share risk, and capitalize on energy savings and payback potential.

Developing economies sometimes lack robust and established financial markets to facilitate funding for energy efficiency improvements. Instead of creating or reforming a country’s entire financial sector, governments can focus on providing new credit lines, sharing investment risk, and supporting performance contracting to promote financing for energy efficiency.

Credit Development

Market actors looking for energy efficiency financing have varying degrees of creditworthiness. This creates a challenge for standardized underwriting to support the markets that are most in need of financing. Borrowers with good credit do not necessarily need dedicated financing. They may have access to revolving credit accounts, personal loans, business lines of credit, cash, and other financial means to cover a range of energy efficiency investments.

Governments and financial institutions can shift capital investment toward energy efficiency by establishing credit facilities and other mechanisms that provide customized financing. Over the last decade, the European Bank for Reconstruction and Development (EBRD) has created many Sustainable Energy Financing Facilities, which offer credit lines to partner banks in the former Soviet Union and to North African countries. These partner banks are local banks that already have credit relationships with industrial clients. They split the EBRD funding and on-lend to small and medium enterprises (SMEs), typically for small loans ranging between $500,000 to $5,000,000. This level of funding is usually sufficient to make efficiency improvements with quick payback periods, such as the purchase of economical motors with modern control systems. The EBRD pays for marketing, audits of the industrial premises, and training of partner bank officials to assess energy efficiency applications so that they can ensure that risks are managed and the funding is well-targeted. A systematic approach involves development of standard “approved equipment” and “approved supplier” lists. These lists facilitate negotiations with suppliers for discounts and reduce transaction costs and risks.

Ak-Kuu, the Kyrgyz Republic’s largest poultry company, benefited from EBRD’s approach by utilizing a €1.2 million loan in 2014 to achieve annual savings of 1,529 MWh of energy and 279 tons of CO₂ emissions. The loan from KyrSEFF was used to modernize outdated equipment with energy efficient options. KyrSEFF provided an analysis of energy saving potential within the company’s technical, financial, and environmental constraints and requirements. Ak-Kuu used the savings in energy costs to repay the loan in 3 years, increasing their own revenue in the following years. The company continued their success with a second loan from KyrSEFF for additional efficiency improvements.

Credit enhancement is often part of, or developed in parallel with, credit facility initiatives. This involves dedicating public funds to reduce perceived risks, interest rates, and other costs associated with designated financing. Governments (and sometimes financial institutions with government backing, such as regional development banks) can establish a variety of lending mechanisms. These mechanisms include loan guarantees (i.e., loans are guaranteed by a federal agency program), loan loss reserves (i.e., a pool of funds equal to a percentage of the total loan portfolio is set aside to cover defaults), and loan insurance (i.e., governments insure loans, recovering program costs through insurance premiums attached to loan payments).

Secondary Market Loan Pooling and Shared Risk

Loan pooling is a means of reducing transaction costs and increasing investor interest by combining similar types of loans, which can then be repackaged as securities and purchased by other investors. In developed countries, loan pooling is applied to car loans, mortgages, and credit card debt. This type of secondary market financing provides low-cost financing or “liquidity” for borrowers, while creating profitable investment vehicles for investors. Because financial institutions may lack technical experience and/or borrowers may lack credit, shared-risk schemes provide necessary guarantees that lenders will not lose their entire investment if the borrower defaults. Many multilateral development banks and international donors have developed programs that leverage shared-risk schemes to facilitate private sector energy efficiency investments in developing countries.

Although such experience is limited and anecdotal in the energy efficiency sector, some investors have been willing to purchase energy efficiency loan portfolios. Perhaps the most successful pooling experience has been associated with the U.S. Energy Savings Performance Contracting (ESPC) program. ESPC engages pre-qualified energy service companies (ESCOs) to develop energy efficiency projects at U.S. Government facilities according to technical and contract rules that provide technical rigor and financial transparency to ESPC projects. These firms create individualized trusts that pool select ESPC debt instruments. A key element of their success is that ESPC loans are viewed as equivalent to U.S. Government bonds in terms of risk. The individual projects also tend to be several million dollars each, which helps support the transaction costs needed for these firms to make their margins. Although this model involves complex transactions, it could be replicated in countries with sufficiently creditworthy governments.

Another example of loan pooling is USAID’s Development Credit Authority (DCA). Serving as the guarantor in case of loan default, the USAID DCA facilitated an investment guarantee of $100 million in funding to promote clean energy solutions for India through a partnership with U.S.-based institutional investor, Northern Lights Capital Group. This negotiation was implemented via a local partner, Nereus Capital’s India Alternative Energy Fund. This fund’s investment focus includes wind power, hydropower, solar power, and large-scale energy efficiency projects.

Performance Contracting

Energy performance contracts (EPCs) and energy service agreements (ESAs) are two types of contracts paid on the basis of actual energy saved. They are offered by energy service companies (ESCOs) to customers (e.g., individuals, building owners, and real estate companies) to finance energy efficiency projects. ESCOs typically act as the project developer and work with a customer to define a potential project. The ESCO then uses performance-based contracting to develop the project specifics within certain economic and financial parameters, usually over extended periods, such as 10 years or more. Expected energy savings for the customer can be used as the basis for project repayment rates. Alternatively, customers can receive a guarantee from the ESCO that their savings will exceed their average payments. Any savings during the contract term beyond what was guaranteed by the ESCO are additional benefits to the customer. Savings below the agreed levels can result in payments from the ESCO to the customer. In addition, since the customer owns the equipment, any savings after the contract ends go straight the customer.

ESCOs often assume the majority of the risk in these types of projects, which can be challenging if the ESCO is not well equipped to estimate savings, install equipment, manage facility performance, and/or secure financing on favorable terms. For example, customers would not be willing to pay over the negotiated extended period, for an energy efficiency project if it turns out that the project did not deliver the promised cost savings.

Financing made available through legislation, international agreements, and other policies is commonly used to develop and implement ESPCs. To advance the EPC market in China, a U.S.-China government partnership initiated a number of joint activities, including market analyses, pilot projects, tool development, and training. The government agencies worked with an industry-led working group that had members from both countries. Outputs of the project included three public policy recommendations to address key barriers in the market: (1) guidance on energy goal setting and enforcement, including accountability and reporting processes, (2) budgeting rules that allow institutions to retain savings resulting from EPCs, and (3) government-wide information and facilitation support. Project deliverables are publically available through the University of Maryland’s Joint Global Change Research Institute.

In 2008, the Government of India took steps to develop their ESCO energy efficiency market by sharing the associated technical, financial, construction, and performance risks. The Partial Risk Guarantee Program for Energy Efficiency (PRGFEE) lowered the risk to lenders through repayment guarantees made by the Bureau of Energy Efficiency for a maximum of 50% of the loan. The program was designed to demonstrate achievable savings in energy and greenhouse gas emissions and increase the exposure of local lenders.

Learn about the key players in the energy efficiency financing sector.