Overcoming Barriers to Energy Efficiency Financing

Key market interventions with building owners and lenders can help them overcome financial and other barriers to energy efficiency financing, while promoting greater investment in efficiency across all sectors.

The global studies in Energy Efficiency 2017 (IEA) reveal that most energy efficiency investments are self-financed. This is understandable if energy efficiency is accepted as being the quality of equipment and vehicles or construction that improves performance. The investment owner typical recovers the incremental cost added through efficiency in a short amount of time, usually through reduced operating costs.

However, there are situations where financing is necessary to encourage owners to make efficiency upgrades. One such scenario is when owners do not have the funds or are unwilling to pay the associated incremental cost for energy efficiency. This includes low-income populations and consumers who are not convinced of the cost savings associated with energy efficient products. This scenario also applies to decision-making during the design and construction phases of new buildings. Another scenario where financing is necessary for efficiency upgrades occurs when owners do not have the funds to replace equipment that is still functioning but is inefficient. This includes owners across residential, commercial, and industrial sectors.

Owners can usually be successfully motivated to make single purchases of efficient products, such as light bulbs and refrigerators, if rebates are offered that reduce first-cost. To decide the amount of the rebate, energy efficiency program administrators can calculate the benefit of associated energy savings. The rebate amount should also take into account the cost of competitive products and the estimated price reduction needed to attract customers. Rebate programs are important to pair with communication campaigns that educate consumers about the cost savings they will receive through lower energy bills because of their purchase of efficient products. A rebate or similar buy-down approach can also be effective for large equipment, such as commercial motors and air conditioning systems, and to target a specific commercial or industrial subsector.

To increase efficiency in the public and private sector, it is often necessary to promote adoption of multiple technologies. Depending on the project size, owners of homes, commercial buildings, and factories may need to secure external financing, just as they would with any other large upgrade investment. Energy efficiency programs often focus on communicating savings potential to customers, identifying opportunities through audits and trainings, and conducting demonstration projects to prove savings and performance. Once convinced of the benefits, owners then need to find their own financing. Although this is still an evolving study area, several strategies have been effective at supporting financing and are described below.

Bundling Smaller Investments

Energy efficiency investments tend to be smaller, offer better returns, and provide quicker repayment than typical infrastructure investments. However, the small project size may negatively affect an owner’s investment decision. Even though efficiency investments offer very competitive returns, they are often overlooked in favor of larger, revenue-generating production investments. A key challenge within organizations is motivating senior managers to view efficiency investments as a strategic priority that supports profitability, growth, and sustainability.

Similarly, at major investment institutions, energy efficiency investments are often overlooked due to their smaller value and volume (but relatively high transaction cost). One way to offset this issue, is to bundle investments together and present banks with a comprehensive overview of the total costs and payback opportunity. For example, a USAID project in Bangladesh focused on energy-efficiency improvements in four high-consuming industrial sectors. The project assessed the finance barriers cited by local banks and worked with factory managers to gather loan requests for the most attractive package of different energy efficiency measures.

A similar strategy to overcome the small size of some efficiency investments is bulk purchasing. When the same product is purchased through bulk orders, the buyer can negotiate a better price. Government agencies or other program administrators can buy energy efficient equipment through bulk purchasing and pass the cost savings to the public. Energy Efficiency Services Limited (EESL), an energy service company created by the government of India, took this approach to increase use of LED bulbs, efficient fans, and other products. Under its Street Lighting National Programme (SLNP), EESL reduced the cost of LED street lights and covered the initial investment for municipalities. EESL is paid back by municipalities over time through the savings they receive from lower energy bills.

Minimizing Transaction Costs & Partial Loan Guarantees

Due to the nature of typical energy efficiency investing (that is, high volume and smaller loans), minimizing the transaction costs and sharing risk can make this type of investment more attractive to financiers. Developing country-specific protocols to measure energy baselines can reduce transaction costs. According to the Efficiency Valuation Organization’s (EVO’s) International Performance Measurement and Verification Protocol (IPMVP), a standardized protocol can reduce the time needed to measure baseline energy, increase confidence in the projected outcome of efficiency investments, and lead to higher investor confidence in project performance. Additionally, creating a clear and easy to understand protocol for measuring energy use before and after project implementation also improves an owner’s technical understanding of the project’s impact and can further mitigate lenders’ perceived risks.

International donors who have experience investing in energy efficiency projects may be willing to act as loan guarantors to local financial institutions if local borrowers default on their loans. These same donors can also provide technical assistance to help minimize such risks. See below for an example of partial loan guarantees in Central and Eastern Europe.

Fostering Technical Expertise

Projects that build new power generation typically produce metered output in kWh or units of fuel, making their performance fully transparent. Efficiency projects can similarly benefit from dedicated facility- or system-level metering to provide comparable information on project performance. Measuring the energy use of specific systems or devices within industrial facilities is relatively uncommon in developing countries but it can be very useful in determining where targeted energy efficiency investments will produce the greatest benefits.

To help building owners tackle the difficult process of estimating energy savings, external experts are often hired to help. Most firms do not have technically-trained, in-house energy managers with expertise in identifying savings opportunities. More commonly, energy is only one of the many responsibilities facility managers are entrusted with. Facility managers are also responsible for all aspects of facility operations and tend to not have a specific background in areas, such as energy. Investment in growing a local service industry with the skills needed to identify and assess energy efficiency opportunities is an important prerequisite for achieving widespread energy efficiency improvements. See the example below to learn about how USAID supported energy management training in Kazakhstan.

Increasing expertise among lenders (banks and other investors) is also important. Lenders are often unfamiliar with how energy efficiency projects can generate cost savings and how savings can create new cash flow and increased credit capacity. Low awareness, lack of information and technical understanding, and high perceived technical and business risks all prevent lenders from recognizing energy efficiency investments as being profitable. Providing technical and related training to lenders can help potential investors acknowledge the business case for energy efficiency.

On-Bill Financing

On-bill financing is a method of debt repayment for energy efficiency project loans. The customer pays back their loan over time through monthly charges added to their utility bills. Ideally, the additional charge is less than or equal to the energy cost savings the customer receives from their efficiency project. This would allow the customer to experiences positive cash flow and repay their debt without additional loans. On-bill financing can be structured as a loan repayment, where the utility customer is responsible for the balance of the loan if he/she terminates the utility account. Some utilities have created special tariffs for such situations. These tariffs are structured so that the debt repayment acts as a fee and the obligation of repayment is tied to the physical address. Under this system, if an owner sells his/her property, the future property owners are responsible for remaining payments.

On-bill financing for residential energy efficiency improvements is a concept that has not been fully explored in developing countries. Although it is attractive as an opportunity to address the first-cost barrier and the loan security concerns of lenders, on-bill financing is complex. It can entail software changes to utility billing systems; legal and financial agreements among lenders, utilities, and governments; and agreements on contingencies involving partial payment or default. These are barriers that can be targeted through utility technical assistance programs and other forms of consumer energy efficiency support. More information about on-bill financing can be found in the Pricing and Incentives Technical Guide.

Learn about private sector financing opportunities.