Featuring: Denise Knight, International Institute for Energy Conservation; Robert P. Taylor, World Bank; Pam Baldinger, Baldinger and Associates (discussant); Jennifer L. Turner, Environmental Change and Security Project (chair)
By Timothy Hildebrandt and Jennifer L. Turner
Since the 1997 financial crisis, many Asian countries have struggled with stalled economies, however China—perhaps proving itself as the most resilient dragon—has seen only a modest drop in its economic growth. China's economic dynamism is well known, but another little heralded aspect of China's growth has been the significant drop of energy consumption as the economy has expanded. The quadrupling of China's GDP from 1980 to 1995 resulted in only a doubling of energy demand. Despite this drop in energy intensity, China's economy still could benefit from energy efficiency improvements in the industrial and housing sectors. The past progress and the current commitment of the Chinese leadership to increase energy efficiency have motivated international organizations—governmental, bilateral, and nongovernmental alike—to offer their assistance to promote energy efficiency in China. This Wilson Center meeting highlighted the progress and challenges the World Bank and the International Institute for Energy Conservation have faced in implementing energy efficiency projects in China.
The World Bank and Energy Service Companies
In the 1990s, the World Bank began undertaking studies in China to explore opportunities for stimulating investment in energy efficient technologies. These studies emphasized the potential for cost effective retrofit projects—namely, small-scale projects adding a single piece of energy efficiency equipment to industries or improving management skills, rather than investing in projects to restructure a whole industry. Even though such small projects would generate fast and significant rates of return, such projects were not being undertaken in China. Through interviews Robert P. Taylor learned that Chinese factory managers either were unfamiliar with energy efficiency technologies or they did not believe that installing such technologies could generate a big rate of return. Investing in energy efficiency technology generates an estimated savings for factories (e.g., reduces operating costs by .1 percent), which is not as tangible an activity as taking out a loan to expand a factory or develop a new product line.
Not only do Chinese factory managers view installing such equipment as a low priority, but domestic banks also do not perceive these projects as attractive. Such small projects create high transaction costs, generate low returns, and utilize complex technology; so Chinese banks have difficulty in appraising the value of energy efficiency investment projects. At the more macro level, however, small investments into energy efficiency technologies could add up to large energy savings for Chinese industries and significant environmental benefits nationwide. Moreover, argued Taylor, a considerable amount of money could be made if these small investment projects could be packaged together.
In 1995, the World Bank spoke to officials in the Chinese State Economic Trade Committee (SETC), who were interested in moving China from a planned energy efficiency system to a free market structure. As an alternative to the usual World Bank energy efficiency loans to a large number of enterprises, Taylor suggested developing energy service companies (ESCO) to perform energy performance contracting. ESCOs specialize in performing detailed energy audits of the client's buildings or factories. These audits lead them to propose designs for new energy systems, as well as suggest improvements to operating practices that will improve energy efficiency. In addition to acting as a consultant, ESCOs also can provide investment for energy efficiency projects within their client's company. By developing and financing projects the ESCOs take on high levels of risk with the hope of earning high returns on their investment. While ESCOs are common in industrialized countries, few developing countries use such companies and until 1995 ESCOs were an unknown in China.
In order to help China develop stronger institutions to facilitate financing and encourage the adoption of energy efficient technologies in Chinese industries, SETC officials were willing to join the World Bank in an experiment to create ESCOs (dubbed energy management companies—EMCs—in China). Together with the Chinese government, the World Bank organized three joint stock companies (located in Liaoning and Shandong Provinces and Beijing). The first phase of the project consisted of the shareholders putting up equity of 30-50 million RMB and the provision of significant World Bank technical assistance to: (1) teach these companies how ESCOs worked in the United States and Europe; (2) help the Chinese ESCOs develop pilot projects; and (3) assist the ESCOs in creating contracts that suit the Chinese market and legal system.
After the technical assistance phase, these three ESCOs were given Global Environment Facility (GEF) support of $15 million and a World Bank loan of $60 million (with an additional $20 million line of credit) in 1998. These funds enabled each company to establish more pilot projects and increase their equity position. Through 1999-2000 the three ESCOs (1) acted as consultants and investors for approximately 50 projects; (2) developed more energy efficiency product lines to offer clients; and (3) hired more staff. By late 2000 each company began to earn some profits, which was significant since the World Bank loans had a high interest rate and carried a heavy foreign exchange risk. The companies are growing and next year plan to invest $26 million in another 80 projects.
Building on the ESCOs success, the World Bank is in the process of initiating the China Energy Conservation Phase II Project that will seek to build an ESCO/EMC energy efficiency industry. This second project aims to engage the Chinese financing community as the key financier for ESCOs/EMCs. This project is developing an EMC service group to train new companies and to provide policy advocacy services to the EMCs. The World Bank also is providing training programs to help Chinese managers set up ESCO/EMC businesses. In addition the project will create a guarantee fund, since the financial sector in China is half reformed and very risk adverse. The guarantee fund can provide partial credit for loans to the EMCs, which would lower banks' perception of risk.
International Institute for Energy Conservation's Efficient Motors Program
While the World Bank focused primarily on strengthening the financing opportunities for industries to install more energy efficient technologies, the International Institute for Energy Conservation (IIEC) a nongovernmental organization that aims to promote sustainable energy in industrializing and transition economies) sought to focus on one industry and to facilitate policy development and cooperation among stakeholders that would help to develop a market for an energy efficient product.. Led by Asia Director Denise Knight, IIEC developed a systematic plan of action to promote market transition in China:
(1) IIEC undertook a comprehensive market assessment of three high-energy using technologies in China—motors, transformers, and ballasts. The market assessment examined the existing institutions and legislation supporting energy efficiency development, current technological capabilities in China, and available financing for these three energy efficient technologies.
(2) After choosing a specific technology (motors), IIEC developed strategies to overcome current market and policy barriers;
(3) With this information, IIEC then sought to build collaboration with all interested parties in the government and business sectors; and,
(4) IIEC and its partners began implementing specific policies (standards and labeling), market training programs, and financial development measures to help promote the growth of the market for the chosen technology.
IIEC and its partners all agreed that motors were a cost effective technology, offering terrific savings potential and an untapped market for investments. This market was ideal for development in China, because prior to the IIEC program only 15 percent of Chinese motor manufacturers were producing products that actually met U.S. efficiency standards. These plants, however, focused on export products.
IIEC together with the government and business stakeholders confirmed that the key obstacle to energy efficient motor markets in China was that there was no way for motor manufacturers to differentiate their motors as efficient, for there existed no government policy or standards for energy efficient motors. Financing for such investment was also short. Therefore, IIEC needed the motors program to help prove that the savings in installing efficient motors would create real savings and that the motors would perform as expected. Chinese research institutes helped create the standards that were integral to the design of national energy efficient motors certification programs and efficiency standards. IIEC also initiated a demonstration of a very successful energy efficiency motors project with Shengli Oil-the second largest oil company in China.
One notable similarity in the World Bank and IIEC approaches to energy efficiency work in China was that both began their work by exploring why the energy efficiency markets remained untapped. Understanding the fundamental challenges to market development was integral to mapping out an effective strategy for their energy efficiency programs. Both Taylor and Knight discovered similar barriers to energy efficiency markets in China:
- Insufficient knowledge of energy efficiency and its benefits. Taylor noted that industry leaders often were unaware of projects already in existence that could result in significant savings and a possible rise of profits. Knight noted that the lack of clear standards for energy efficient products and widespread misunderstanding over what defines energy efficiency meant that many end users in China thought they already were purchasing energy efficient products.
- Perception of high risk. With so many opportunities for secure investments in China, there is great reluctance to invest in energy efficiency improvements, which do not produce immediate large cost savings to the producers and consumers. The lack of incentives to enter the energy efficiency markets and the perception of high risk are strong barriers to the development of an energy efficiency market in China. Taylor's conversation with one Chinese state-owned enterprise executive was quite telling: In investments in the company "I am not rewarded if I am successful, but, if I fail, I will face consequences."
- Lack of financing opportunities. Producers who opt to take the risk of investing in energy efficiency improvements or technology face one other stumbling block—limited financing.
Keys to Success
Although they employed different approaches to improve energy efficiency within China's manufacturing industries, the World Bank and IIEC both were relatively successful in developing energy efficiency markets. Pam Baldinger noted in her comments that while Taylor's project was more narrowly focused than IIEC's, both projects employed three basic strategies that help explain their successful work in China:
- Focused work. Knight emphasized in her talk that a narrow, clear project focus was paramount for successful work in China, for if a project can demonstrate concrete results in a single sector, this will create a model for others. Taylor also adopted a narrow focus in his work, for he believed success in creating a small number of demonstration projects would have a bigger impact than trying to implement a larger unmanageable financing project.
- Sustained dialogue with government and business stakeholders. Communicating with all levels is crucial for fruitful collaboration in China. For both Taylor and Knight, solely using Western-proven methods, or best practices in other Asian countries, would result in a model ill fit for the unique needs of Chinese stakeholders. For Knight, questions were posed at every stage. To assure clarification, IIEC asked collaborators very literal questions: "This is what we learned from you. Are we right? Here are some strategies. Are we on target?" It was also important to listen to the concerns expressed by users. In order to make investment rational, users wanted a proof of savings. IIEC responded by spelling the savings out. Constant discussions also revealed the danger of assumptions. Knight and her colleagues originally placed branding issues as priority number one; collaborators were quick to insist that government support, crucial for successful business ventures of all kinds in China, should be the top priority. (Knight also suggested that dialogue with international partners, and other organizations working in China can help avoid conflict. Talking with all other parties assures that there are no mixed signals in the market, no tripping over each other in an effort to do different work, no stepping on the toes of groups, or redoing work already done.)
- Strong relationship with the central government policymakers. Perhaps not unexpectedly, central government support is crucial for the success of international organizations, for high-level approval eases implementation and facilitates sufficient assistance from lower level governments and the business sector. Robert Taylor suggests that only with the help of the SETC was the World Bank able to create the three ESCOs. Having created a wholly new type of company, Chinese auditors and local governments were confused as how to categorize and tax service providers, equipment sellers or finance businesses. Through nine months of government dialogue led by SETC all of these stakeholders made decisions on how to treat ESCOs.
In their respective energy programs both Taylor and Knight aimed to create a successful model to prompt the development of energy efficiency markets that could be duplicated in industrial sectors throughout China. While the World Bank and IIEC projects were small in scale, they did demonstrate to key stakeholders in China that energy efficiency could produce great savings and give producers a tremendous competitive advantage. The success of the three ESCOs under the World Bank project could be measured by the return on their investments. Of 200 project loans, Taylor reported only three defaults and an average rate of return over 20 percent.
In the case of IIEC, the program succeeded not simply in demonstrating savings in production costs to the participating industries, but more importantly the program changed industry and energy policy. For example, prior to the motor market program there was a limited awareness of energy efficiency products in China among industry leaders and consumers. The program helped generate general knowledge on energy efficiency and motivate Chinese oil industry leaders to request a similar energy efficiency program in their sector. In the policy realm, the IIEC program led to the establishment of a high efficiency voluntary standard in July 2001, followed by high efficiency product certification guidelines, and in January 2002 a minimum efficiency standard.
The World Bank and IIEC are just two of many organizations involved in energy development. While insufficient funding has somewhat limited the extent of U.S. government energy efficiency cooperative projects, the foundation and multilateral communities have been key supporters of NGO and multilateral energy efficiency projects in China (For information on current U.S. government and NGO energy efficiency projects in China see China Environment Series 4).