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Lund University School of Economics & Management Master Thesis Supervisor: Dr.

Susanna Thede Spring 2009

The Energy Service Company Industry in China What are its Driving Forces?

Natcha Tulyasuwan 861018-4528

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ACKNOWLEDGEMENT
I would like to express my gratitude to all those who gave me the possibility to complete this thesis. I am particularly thankful for Tina Wang for granting me her time and providing invaluable data for the analysis of this thesis. I am deeply indebted to my supervisor Dr. Susanna Thede whose continuous support, guidance, and encouragement helped me in all the time of research for and writing of this thesis. I am truly appreciative of Liam Lord for his precious time and effort spent looking into the manuscript for its structure, content, and use of English, and for his constructive advices and recommendations for improvement. I am obliged for Shakil Alyas not only for sharing his thoughts and opinions, but also for his passion for the ESCO that has been exceptionally inspirational to me. My deepest gratitude goes to my beloved family whose heartening words of wisdom and endless love enabled me to complete this work.

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ABSTRACT
In spite of the astonishing proliferation of the Energy Service Company (ESCO) Industry in China, the ESCO concept is relatively new. Reviews of current knowledge and literature divulge that the driving forces of the ESCO industry in China remain to be thoroughly examined. This paper consequently attempts to explore all avenues to the significant factors in steering the whirlwind development and the impressive performance of the ESCO industry in China. In tandem with the driving forces analysis, the policy recommendations are proposed in order to encourage enabling forces and to repress disabling ones for greater the ESCO industry expansion in China. Due to the insufficiency of quantitative data, the paper is conducted in a qualitative manner. Within the roaring energy efficiency industry, a sector poised for towering growth is the ESCO. The ESCO refers to a firm that develops, installs, and finances the energy efficiency improvement project. The ESCO assumes technical and performance risk, and earns proceeds from cash savings generated by the energy conserved. Because the remuneration of the ESCO is directly tied to its performance, it is thus in the best interest of the ESCO to save energy and simultaneously to mitigate the climate change effect that would have been otherwise intensified by the electricity generation. The size of the ESCO market in China is monumental: Its worth is estimated at 11 billion United States Dollars (USD). With the prospect, the ESCO industry has already been riding a wave of imposing growth as it has experienced triple-digit-expansion. The total investment value of the ESCO industry in China reached nearly 1 billion USD by 2007; This translates to a brisk expansion of about 600 percent based on 2003 level. Based on the comprehensive synopsis of the ESCO industry related issues within the context of China namely the energy demand characteristics, the climate change conditions, and the related national and international institutions, the investigation reveals six enabling forces, and three disabling forces. Apropos the enabling forces, they are: the energy and the climate change insecurity, the vast business opportunity at present and in the future, the national support, the international support, the active role of national association of the ESCOs, and the potential linkage to carbon credit market. Vis--vis the disabling forces, they are: the weak enforcement of environmental regulatory, the shortfall of financing, and the lack of access to public sector. In line with the masterly propagation of the ESCO industry in China, there are ways to actualize the unrealized potential that is fettered by disabling factors. Recommendations proposed to set Chinas hand to the issues are: (1) the tightened enforcement of the ESCOrelated regulatory through financial incentive as a winning inducement for local authorities in combination with a transparent and time-efficient monitoring system, (2) the promulgation of financial incentives by government to encourage local and foreign financiers to bankroll the ESCOs, (3) governmental regulatory reform in the financial sector via the formulation of policies targeting the ESCO concerns over the interest cap adjustment, favoritism eradication, and foreign investment inflow stimulus, (4) the forceful contribution from the EMCA via the capacity building in order to augment financial capability of the ESCOs and lenders, and via the communication in order to bridge the gap between the existing funds and the ESCOs, and (5) the inclusion of the ESCO service to Government Procurement list or Standard Performance Contract as an easier and faster alternative to implement. Key Words: Energy Service Company (ESCO), Energy Efficiency, China, and Driving Forces
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TABLE OF CONTENTS

1. INTRODUCTION ............................................................................................................. 8 1.1 Definition of the ESCO................................................................................................ 9 2. STUDY SCOPE, OBJECTIVES AND METHODOLOGY...............................................10 3. LITERATURE REVIEW .................................................................................................12 4. DEVELOPMENT AND PERFORMANCE OF THE ESCO INDUSTRY ........................15 5. DRIVING FORCES OF THE ESCO INDUSTRY............................................................17 5.1 Enabling Forces ..........................................................................................................17 Energy and Climate Change Insecurity .........................................................................17 Vast Business Opportunity ............................................................................................21 National Support...........................................................................................................24 International Support....................................................................................................27 Active Role of National Association of the ESCOs.........................................................31 Potential Linkage to the Carbon Credit Market.............................................................34 5.2 Disabling Forces .........................................................................................................38 Weak Enforcement of Environmental Regulatory Instruments .......................................38 Shortfall of Financing ...................................................................................................40 Lack of Access to the Public Sector...............................................................................43 6. CONCLUSIONS AND THE WAY FORWARD ..............................................................45 6.1 Conclusions ................................................................................................................45 6.2 Policy Recommendations............................................................................................47 7. REFERENCES.................................................................................................................49 8. APPENDICES..................................................................................................................59

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LIST OF FIGURES

Figure 1: The ESCO Project Cycle ........................................................................................ 9 Figure 2: Number of ESCO in China 1998-2007 Figure 3: Value of the ESCO Investment in China 2003-2007 ..............................................15 Figure 4: The ESCO Performance in China 2003-2008.........................................................16 Figure 5: Total Coal Production, Consumption, and Emission from Coal and Fossil Fuel in China 1998-2006 ..................................................................................................................18 Figure 6: Energy Intensity 1980-2020...................................................................................22 Figure 7: Energy Productivity 1980-2020 .............................................................................22 Figure 8: Annual Improvement of Energy Efficiency 2003-2020 ..........................................23 Figure 9: Expected Average Annual Carbon Credits from Registered Projects by Host Party 2009 Figure 10: Number of Registered CDM Energy Efficiency Projects 2009..35 Figure 11: Project Distribution of VER (Over the Counter Market) 2007..............................36

LIST OF BOXES

BOX 1: Greenhouse Gases and Climate Change ...................................................................18 BOX 2: The ESCO as A Multi-Win Mechanism ...................................................................19 BOX 3: What is Energy Productivity? ..................................................................................21 BOX 4: International Cooperation of the ESCO Industry in China........................................27 BOX 5: IFC and Its Financial Assistance ..............................................................................29 BOX 6: EMCAs Area of Activities .....................................................................................31 BOX 7: VER As An Alternative Door For Carbon Credits....................................................36

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LIST OF ACRONYMS
ADB CASS CCTV CDM CER CH4 CHUEE CO2 COD CSR DERC EBRD EEP EIA EMCA EPC ESCO EUEEP EVO FAO GDP GEF GHG GW HFCs IFAD IFC IPCC IPMVP JAESCO NAESCO KAESCO kWh MEP M &V NAO NBS NDRC NGO NOx ODA PFCs PFM PMU PoA R& D SF6 SME Asian Development Bank Chinese Academy of Social Science Chinas Central Television Clean Development Mechanism Certified Emission Reduction Methane China Utility-Based Energy Efficiency Finance Carbon Dioxide Chemical Oxygen Demand Corporate Social Responsibility Department of Environment and Resources Conservation European Bank for Reconstruction and Development EU-China Energy and Environment Program Environmental Impact Assessment Energy Management Company Association Energy Performance Contract Energy Service Company China End Use Energy Efficiency Project Efficiency Valuation Organization Food and Agriculture Organization of the United Nations Gross Domestic Product Global Environment Facility Greenhouse Gas Gigawatt Hydrofluocarbons International Fund for Agricultural Development International Finance Corporation International Panel on Climate Change International Performance Measurement and Verification Protocol Japan Association of Energy Service Companies National Association of Energy Service Companies Korean Association of Energy Service Companies Kilowatt per Hour Ministry of Environmental Protection Measurement and Verification National Audit Office National Bureau of Statistics National Development and Reform Commission Non-Governmental Organization Nitrous Oxide Official Development Aid Perfluorocarbons Public Finance Mechanism Program Management Unit of EEP Program of Acitivity Research and Development Sulphur Hexafluoride Small and Medium Enterprise
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SO2 SOE TPF US USD UNDP UNEP UNIDO WB WEC WRI


WMO

VAT VER

Sulphur Dioxide State-Owned Enterprise Third-Pary Finacing United States of America United States Dollar United Nations Development Program United Nations Environment Program United Nations Industrial Development Organization World Bank World Energy Council World Resource Institute World Meteorological Organization Value Added Tax Verified Emission Reduction or Voluntary Emission Reduction

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--------------------------------------------------------------------------------------------------------------"Promoting the saving of energy and resources should be taken as a priority by the country and viewed as one of the basic principles the government should follow in the future." Hu Jintao, President of China APEC CEO Summit, South Korea, November 17, 2005 (China Daily 2007a) ---------------------------------------------------------------------------------------------------------------

1. INTRODUCTION
For the past three decades since the economic reform1, China has made vast strides to ameliorate its economy and to lift millions of people out of severe poverty. Paved with good intention, the whirlwind economic growth has nevertheless placed massive demands on Chinas energy resources as well as environment. With the prevailing energy-inefficient grounding, and the prospect of heaving economic development continuance over the next several decades, China is desperate for mechanisms to safeguard energy security, and to combat climate change effects. Energy efficiency improvement appears to be the most attractive method of response. Reducing energy waste is the cheapest, easiest, and fastest way to support energy security and combat climate change without undermining the economic intensification (UNEP 2006b). Vigorous political attention has been paid to enhance energy efficiency in China; The energy efficiency industry2 is emerging as a marked growth sector with the country projected to spend as much as 300 billion United States Dollars (USD) over the next five years (China Daily
2007b).

Within the boisterous energy efficiency industry, a sector that has poised for the towering expansion is the Energy Service Company (ESCO). The ESCO refers to a firm that develops, installs, and finances the energy efficiency improvement project. With an Energy Performance Contract (EPC), the ESCO assumes the technical and the performance risks of the project, and earns the proceeds via cash savings generated from the energy conservation
(WB 2007).

Backed by the active national association of ESCO and Chinas leading position in the global carbon market, the market size of the ESCOs in China is monumental- about 11 billion USD with an average payback time of 1.3 years (WRI 2008). With such prospects, the ESCO industry has already been riding a wave of impressive development as it has experienced triple-digit-expansion. The total investment value of the ESCO industry in China reached nearly 1 billion USD: This translates to a brisk expansion of almost 600 percent compared to 2003. Irrespective of the astonishing advance of the ESCO industry in China, stimulating mechanisms behind the fast-paced escalation have yet to be thoroughly examined by researchers. This paper therefore aims to go over the driving forces, both enabling and disabling, behind the ESCO industry in China with a fine-toothed comb.
1

Chinese economic reform was initiated in 1978 by Deng Xiaoping, the leader of the Communist Party of China. The program is ongoing as of the early 21st century. As a result of the reform, the poverty rate went down from 53 percent of total population to 12 percent in 1981 and became 6 percent by 2001 (WB 2006). 2 Energy efficiency industry or market refers to businesses that offer products and services that improve energy efficiency thus lowering energy consumption according to the World Resources Institute or WRI (2008a). 8 (63) The Energy Service Company Industry in China

Following the study scope, objective, and method of evaluation in Chapter 2 is the literature review. Chapter 4 explains the concept of the ESCO business model and sketches the ESCO industry development over time and its performance in terms of the energy savings and the emission reductions. Chapter 5 examines the driving forces behind the express proliferation of the ESCO industry in the context of China. The Conclusions, including the policy recommendations derived from this study are provided in Chapter 6. 1.1 Definition of the ESCO According to the World Bank (WB) (2007), an ESCO is a new market-based mechanism to finance an energy efficiency project that saves money on fuel of electricity and guarantees of savings3 through EPC. The ESCO generates money from cost-savings to the customers and takes about 80 percent of the savings until its investment is paid off. This generally takes about one to three years (IFC 2009). Figure 1 illustrates the full service of the ESCO.
EE Analysis Project Design Financing Equipment Procurement Installation Monitoring &Verification Project Design Operation &Management

Figure 1: The ESCO Project Cycle Source: Zhao (2007)

Generally there are two types of financing: ESCO financing, and Third-Party Funding (TPF). The ESCO financing refers to the use of internal funds to finance the project, while the TPF refers the use of financial institution or bank funds to finance the project4 (rge-Vorsatz et al 2007a: 2; WEC 2008; Morel 2008: 20). According to Blanchard (2005a) and Chandler & Gwin (2009), the mainstream capitals of the ESCO industry in China come from the third party enterprises because the majority of the ESCOs are start-ups, Small and Medium Enterprises (SMEs) without financial security.

The ESCO guarantees the provision of the same level of energy at lower cost by implementing an energy efficiency project. 4 Please see Annex I for illustration of the TPF model. 9 (63) The Energy Service Company Industry in China

2. STUDY SCOPE, OBJECTIVES AND METHODOLOGY


Even with the upswing of the ESCO industry development, an application of the ESCO business model remains relatively new. Driving factors of the ESCO industry in China have not been comprehensively investigated prior to this paper. This paper henceforth ventures to investigate the forces behind the furious propagation of the ESCO industry in China. The paper addresses the development up to the time of writing, and the performance from the perspective of energy savings and emission reductions. It also focuses on the analysis of future outlook and the policy recommendation for the ESCO industry in China. According to the review of previous research, the explanatory factors of the ESCO industry growth in China consist of six enabling forces, and three disabling forces. As regards the enabling forces, the first refers to the energy and the climate change insecurity. The peaking energy demand and the continuation of coal as the dominant energy source has led China to face major supply-demand contradictions and severe climate change impacts. Since the ESCO is proven to combat the concerning challenges simultaneously, the prevailing insecurities henceforth have substantially raised the demand for ESCO service in China (rgeVorsatz et al 2007b: 11; Longhai 2007: 2; Shealy &Dorian 2007: 3; SCIO 2007: 3; Price & Xuejun 2007: 3; Andrews-Speed 2008: 1335;WEC 2008: 4; The Climate Group 2009: 15; Elsayed 2009).

The second refers to the vast business opportunity. China achieved the inspiring triumph in decreasing energy intensity for the past decades, albeit its current level of energy productivity remains low. This in turn provides opportunity for the ESCO to implement the energy efficiency projects at the lower price and the higher return. Together with the redoubtable development path of energy efficiency improvement and the promising prospect of Chinese expansion, an enormous market for the ESCOs awaits to be exploited in the future (UNEP
2001; Wang 2006; McKinsey &Company 2007; McKinsey &Company 2008a; Thomas 2008; The Climate Group 2009).

The third refers to the national support. The national development plan and program with an official quantitative target of the energy efficiency improvement in place, the financial incentive and disincentive, and the proper regulatory framework with the energy efficiency laws have provided the ESCO chance for success as well as legitimacy. Owing to the aggressive national support, the ESCO industry has been firmly promoted in China (rgeVorsatz et al 2007b: 11; Cosbey et al 2008: 35; MacLean et al 2008; WEC 2008:5; Xinhua 2008; The Climate Group 2009: 16-17).

The fourth refers to the active role of the national association of the ESCOs. The Energy Management Association (EMCA) is mandated to promote the fast and healthy proliferation of the ESCO industry. The EMCA therefore positions itself as a national platform joining the government, the ESCOs, the end-users and the financial organizations. More importantly, the EMCA has conducted numerous measures to strengthen the credibility and the reliability of the ESCOs (rge-Vorsatz et al 2007b: 13; Zhao 2007: 39). The fifth refers to the international support. The International organizations have played the considerable role since the introduction of the ESCO concept into China. Persistent and abundant assistances via research, information sharing, capacity building and financing initiatives from foreign partners have paved the way for the ESCO industry to flourish in China (rge-Vorsatz et al 2007a: 13; rge-Vorsatz et al 2007b: 11; Cosbey et al 2008: 38).

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Lastly, the sixth refers to the potential linkage to the carbon credit market. Thanks to the EMCA initiative, image improvement demand, the eligibility for implementation as a Clean Development Mechanism (CDM)5, the methodological availability, and the competitive setting of CDM in China, the trend of implementing the ESCO projects in the form of the CDM has been increasingly observable. The CDM and its alternative market of Verified Emission Reduction (VER) became linked and have fostered the ESCO industry growth in China substantially (rge-Vorsatz et al 2007b: 12; Longhai 2007: 18; SCIO 2008: 49). For the disabling forces, the first refers to the weak enforcement of the environmental regulation. Streams of policies or initiatives implemented do not guarantee an actualization of aspired outcomes. Backed by local authorities, the mounting evidences reveal high level of non-compliance in both private enterprises and SOEs. Therefore the productive outcome of the ESCO-supported policies and initiatives that were formulated have been dampened significantly (China Daily 2009c; China Daily 2009d). The second refers to the shortfall of financing. Many ESCOs are small in size, and rely on the TPF for investments. The biased use of limited capital, the lacking interest rate autonomy, the inadequate financial capability of the lenders and of the ESCOs, the high transaction costs, and the inability to access existing funds have severely restricted financial flow into the ESCO industry. The financing shortfall hence has stood in the way of the ESCO industry advancement in China (Blandchard 2005a: 3; rge-Vorsatz et al 2007a: 8; rge-Vorsatz et al 2007b: 12;
WEC 2008: 3).

The third refers to the lack of access to the public sector. With a number of energy-inefficient public buildings and large purchasing power, government authorities are attractive customers for the ESCOs. This attractiveness notwithstanding, the lack of accommodating apparatus to provide necessary access has led the ESCO industry in China to falter at the exploitation of immense energy efficiency potentials in the public sector (Van Wie McGrory et al 2006; rgeVorsatz et al 2007b: 13; Taylor 2008: 147; The Climate Group 2009; Li &Colombia 2009).

This paper is conducted with a qualitative approach. Due to the insufficiency of data available, the examination is descriptive. Analysis and conclusions are drawn from the desk review of documents, the review of statistics and the research output, namely publications and up to date websites.

As a result of the Kyoto Protocol, the CDM was created as a market mechanism that allows industrialized countries to meet their greenhouse gas reduction targets by financing emission reduction projects in developing countries. From the investment, the industrialized country will receive Certified Emissions Reduction (CER) and able to use for meeting national Kyoto target or trade the credits in global carbon trading market (UNFCCC 2009a). 11 (63) The Energy Service Company Industry in China

3. LITERATURE REVIEW
As the International Panel on Climate Change (IPCC) report highlights the urge of China's energy and environmental crisis, and suggests energy-efficiency finances as one of the market mechanisms to battle to issue, Watson (2003) discusses an opportunity for the ESCO industry in China with strong emphasis of construction sector. Similarly, Chinese Academy of Social Science or CASS (2007) discusses a colossal potential for the ESCO in government buildings both existing ones and newly constructed ones. The paper also confers about the consistent international support and the insufficient finances in the Chinese ESCO industry. On the one hand Cosbey et al (2008), MacLean et al (2008), and the Climate Group (2009) pinpoint the vital preconditions for the ESCO industry development of the governments role in implementing accommodating laws and regulations. On the other hand Taylor et al (2008) deliberate about the role of foreign partners as major players in financial support. rgeVorsatz et al (2007a) assess the ESCO industry in various countries including China. The overview encompasses both the enabling and the disabling forces aspect. Key messages have been drawn out from the relevant publications and are listed below. The IPCC6 Fourth Assessment Report 2007 notes the substance of energy supply security, given the growing demand from developing countries with the emphasis on China. The consequential outcome of the soaring energy demand, the climate change effects and the level of vulnerability, are conversed about. The report raises the urge to support the transition to more efficient and low/zero carbon technology via market mechanism. The transition needs to be complemented by encouraging regulations and the tax incentives (Parry et al 2007). Watson (2003) presents an opportunity of the ESCO industry in building sector, given the startling speed and the titanic scale of new constructions in China. The environmental impacts in term of deforestation and land conversion, energy consumption, greenhouse gases (GHGs) emissions, and municipal solid waste were addressed. Moreover, Watson suggests that the support from both market and government is prerequisite for a successful energy efficiency service industry. Cosbey et al (2008) briefly touch upon ESCO industry in developing countries as one of the innovative financing mechanisms that rely on the end-users to make purchasing decisions in Clean Energy Investment: Project Synthesis Report. They propose the government to play a crucial role in facilitating the ESCO industry via research, in nurturing networking among stakeholders, and in encouraging the multilateral and the bilateral information sharing activities. The United Nations Environment Programme (UNEP) (2008) in Public Finance Mechanisms (PFM)7 to Mobilize Investment in Climate Change Mitigation provides an overview of the

The Intergovernmental Panel of Climate Change (IPCC) is body for climate change assessment. It was established by the United Nations Environment Programme (UNEP) and the World Meteorological Organization (WMO) to provide scientific view on the current state of climate change and its potential environmental and socio-economic impacts (IPCC 2009). 7 Public Finance Mechanism (PFM) refers to a vehicle for governments to transfer public funds. Common climate change mitigation PFM include: credit lines, guarantees, debt financing, private
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financial mechanisms up to date to facilitate the climate change mitigation effort. The ESCO in China stipulates the research and the development support, the marketing support, the transaction structuring support, the staff training and the business planning, the establishment of technical standards. In other words, the governmental support to establish firm ground and investment-friendly climate for ESCO industry is necessary (MacLean et al 2008). The Climate Group (2009) argues for Chinas strong commitment towards a low-carbon economy. The paper aims to support the importance of national laws and legislation in reshaping China into a low-carbon economy. The evidence includes the Chinese governments ambitious monitoring, benchmarking and control system for the 1000 largest energy consuming companies also known as Chinas Top-1000 Enterprises Programme, a 20 percent energy intensity reduction target by 2010 and 15 percent renewable energy target by 2020, and energy efficiency improvement of building target of 65 percent. Taylor et al (2008) discuss Financing Energy Efficiency programs in developing countries and economies in transition in the World Bank (WB) Publication 2008. Various energy efficiency programs funded by the United Nations Foundation in Brazil, China, and India, undertaken from 2002 to 2006 are analyzed. A recurring message from the review is that effective development of energy efficiency programs requires an institutional development. Careful, incountry diagnostic works, along with financial and technical support are necessary in facilitating the growth in energy efficiency investment in the country. The World Energy Council (WEC)8 Report (2008) on energy efficiency policies around the world confers about the ESCO industry issues in regard to its development, its current situation, along with its opportunities and barriers. In this paper, the stimulating forces behind the growth of the ESCO industry are discussed around the high energy intensity context of China. Concerning the barriers, the lack of financing source and the lack of awareness of the ESCO concept are debated. The CASS9 (2007) depicts Chinas energy policy with respect to the economic growth and energy use, fuel diversity, carbon intensity and international cooperation. The paper deems the ESCO industry the rising star. It also considers the lack of financial resources and inadequate financial knowledge as barriers to the ESCO industry expansion in China. On the other hand, it praises the international support from organizations such as the WB and the Global Environmental Fund (GEF) as the incubator for Chinese ESCO industry. rge-Vorsatz et al (2007a) provides a concise overview of the ESCO industry development, along with the opportunities and the barriers in China. In addition to the enabling forces previously discussed by other researchers, an issue of potential combination with the CDM is proposed. For the barriers, apart from the echoing financial barriers, the absence of public
equity funds, venture capital funds, carbon finance, grants, loan softening programs, inducement prizes, and technical assistance (UNEP 2008:5). 8 The World Energy Council (WEC) is the multi-energy organization, with Member Committees in over 100 countries. Established in 1923, the organization encompasses a variety of energy types: coal, oil, natural gas, nuclear, hydro, and renewable (WEC 2009).
9

The Chinese Academy of Social Sciences (CASS) is the leading research organization in the fields of philosophy and social sciences of China, established in 1977. CASS was built on the Department of Philosophy and Social Sciences, Chinese Academy of Sciences and affiliated to the State Council of China (CASS 2009).
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procurement procedure, the institutional limitation of enterprise leaders and the absence of standardized procedure for auditing and verification are suggested as the impediments for the ESCO industry growth.

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4. DEVELOPMENT AND PERFORMANCE OF THE ESCO INDUSTRY


As a rejoinder to the energy crisis of the late 1970s, the ESCO was conceptualized and arose for the purpose of energy conservation (Bullock & Caraghaiur 2001). The model has gained public popularity over the years; it was proven to effectively alleviate energy insecurity by making energy conservation commercially lucrative. Subsequent to the robust achievement throughout United States of America (US) and Europe for the past 20 years, the ESCO concept was introduced into China in 1997 (Gilleard & Wan Yeung Kam-shim 2001; The Climate
Group 2009).

To ubiquitously popularize the innovative concept, three pilot projects were initiated in 1998, as part of the China Energy Conservation Project sponsored by the Government of China, the WB, and the GEF (WB 2008). The pilot projects have engendered the potent demonstrative effect and actualization of the innovative and money-spinning concept in China; the projects generated average returns of better than 20 percent (Blandchard 2005a; Zhao 2007). Unquestionably this drew more attention from the public and entrepreneurs searching for emerging business opportunities. Owing to the pilot projects and their success, the ESCO industry in China has since gained its vigorous momentum. As depicted in Figure 2 and 3, the ESCO development has been imposingly on the increase, both in term of number of the ESCO and the ESCO investment value. With the original number of three ESCOs in 1998, the figure jumped to 185 ESCOs by 2007. This represents an over sixtyfold increase since its introduction. Similarly, with the ESCO investment value, the amount of investment increased steadily with a substantial leap in 2006. The value raised noticeably- more than six times over four years or 680 percentfrom 141 million USD in 2003 to 960 million USD in 2007.

Figure 2: Number of the ESCO in China 1998-2007 Source: EMCA (2009)

Figure 3: Value of the ESCO Investment in China 2003-2007 Source: EMCA (2009)

The performance of the ESCO industry can be measured against its direct outcome in the form of the amount of energy savings (standard coal equivalent), and its consequential outcome as measured by the amount of CO2 emissions reduction (carbon dioxide equivalent). More than 80 percent of the total electricity production in China is derived from coal-based power plants. The electricity saved can henceforth translate into the amount of standard coal saved. In the same manner, this accordingly implies the reductions in CO2, SOx and NOx emissions, thus mitigating the air pollution, and the climate change. The electricity savings thus further translate to the amount of emissions saved (IBRD/WB 2007).
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As illustrated in Figure 4, the ESCO industry performance in China has been remarkable. From 75,530 tonnes of coal equivalent in 2003, the energy saved surged more than 16 times to 1,235,120 coal equivalent in 2008, which translates to an increased capability to reduce emissions from 487,300 tonnes of carbon dioxide equivalent to 76,985,000 tonnes of carbon dioxide equivalent for the same period (EMCA 2009). According to the WB (2008), the ESCO industry in China saved about as much energy in 2006 and 2007 as France would have consumed in standard-grade coal in the last two years.

Figure 4: The ESCO Performance in China 2003-2008 Source: EMCA (2009)

With the robust achievement throughout the US and Europe for the past decades, the ESCO concept was introduced into China. Thanks to the pilot projects, the profitable concept was materialized and popularized in China; The ESCO industry has gained its outstanding momentum since. The industry has been imposingly expanded in term of number of the ESCO and the investment value; The number jumped more than 60 times by 2007, whereas the investment value surged more than 6 times during 2003 to 2007. Concerning the performance, its attainment is astonishing with respect to the amount of energy savings and the amount of CO2 emissions reduction. For 2006 alone, the ESCOs have saved double the amount of energy that France would consume over a year. During 2003 to 2008, amount of energy saving and CO2 emission reduction mounted up 16 times. Against the gloomy backdrop of global financial crisis, doubts have been cast on the ESCO industry growth in China. The effects of economic downturn on the ESCO industry development and performance were accordingly at the heart of the annual conference of the EMCA held in Beijing in January 2009. Statistics of the EMCA reveal that the brisk expansion of the industry was maintained in 2008; this has led to the prediction that the rapid growth of the industry will persist in 2009 without any major interruptions (Shenwu 2009).

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5. DRIVING FORCES OF THE ESCO INDUSTRY 5.1 Enabling Forces


Energy and Climate Change Insecurity The tenacious linkage between Gross Domestic Product (GDP) and energy use is noticeable in China (NBS 2008). The accelerating industrialization and the soaring urbanization10 have increased energy demand tremendously; this consequently has posed the challenge of energy security in China. With great reliance on highly GHG polluting coal-fired stations, the power generation consequently has brought about another challenge of climate change security. China must inevitably combat the urgent challenges. Total energy consumption is fast approaching the US- the largest energy consumer in the world11. Ensuing from the national target to quadruple the per-capita GDP from 2000 to 202012 combined with the goal for the expeditious urbanization of 400 million people by 203013, the energy demand is expected to escalate in a sustained manner. Contradictions in supply and demand for energy have henceforth become robustly prominent in spite of Chinas ample deposits of cheap coal14 (He et al 2006: 3706; Shealy &Dorian 2007: 3; Andrews-Speed 2009: 1335; The Climate Group 2009: 8; McKinsey &Company 2009: 38). Coupled with the insufficient domestic supply capacity, shortages of coal, power, and oil were reported widely and two severe energy shortages occurred during the past five years. The first one began in 2003, and extended into 2004; A total of 24 Provincial areas witnessed power brownouts. The power deficit amounted to 10 percent of the installed capacity (Xinhua 2004). In 2008 China suffered the second acute power shortage; A total of 19 provincial areas encountered brownouts (NDRC 2008). Aside from the shortages, by 2007 China- the world's largest coal producer and consumer (EIA 2009) - had begun to depend on coal imports. In a similar vein China relies on imports for over 50 percent of oil supply. To sate the proliferating energy demand, both import figures are expected to rise further, and so as the reliance on international market with greater exposure to the global market price volatility. With more frequent power shortages and more dependence on international supply, Chinas energy security is inevitably concerning (Shealy &Dorian 2007: 7; Hang &Tu 2007: 2986; Jiang 2008: 3; NDRC 2008).

10

Unprecedented rate of urbanization- greater disposable income and higher standards of living of the emerging affluent- could manifest in more residential electricity use, more oil demand from increased number of cars and more building construction as people migrate into the cities (He et al 2006: 3706; Shealy &Dorian 2007: 3; WEC 2008: 4; Adrews-Speed 2008: 1336; The Climate Group 2009: 8; McKinsey &Company 2009: 38). 11 Please see Annex 2 for top 10 nations with high total energy consumption. 12 Quadrupling the GDP by 2020 translates to annual GDP rise of 7.2 percent. With annual energy consumption rise by 3.31 percent, the electricity power generation demanded will increase 5.3 percent per year (He et al 2006: 3706). 13 For more detailed forecast on Chinese urbanization rate, please see McKinsey &Company (2008a). 14 According to the International Energy Outlook 2008, coals costs are comparatively low relative to the costs of liquids and natural gas, and abundant resources in large energy-consuming countries like China make coal an economical fuel choice. The United States and India also share the similar characteristic (EIA 2008).
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Vis--vis the heavy dominance of coal as energy supply source in China, its relatively backward production and consumption coal has put ghastly pressure on the climate change. Sulphur Dioxide (SO2)15, particulate matter, and CO2 emitted in the course of production and utilization of coal has been the key ground of smoke pollution and GHG emission in China, as seen in Figure 516. BOX 1: Greenhouse Gases and Climate Change Greenhouse gases (GHGs) refer to the atmospheric gases that are accountable for causing the global warming and the climate change. Primary GHGs are CO2, Methane (CH4) and Nitrous Oxide (NOx). Less dominant, yet highly potent ones are Hydrofluorocarbons (HFCs), Perfluorocarbons (PFCs) and Sulphur Hexafluoride (SF6). GHGs act as the glass roof of a greenhouse. They entrap the heat and render the planet some 30 degrees Celsius warmer than it would be otherwise. By reason of human activities, particularly the burning of coal, oil, and natural gas at an unprecedented rate, CO2 is greatly propagated, and it is notably contributing to greater than 60 percent of the "enhanced greenhouse effect." The enhanced greenhouse effect is a warming of the earth's surface and lower atmosphere. A rise in the temperature will be accompanied by the changes in climate; the changes in cloud cover, precipitation, and wind patterns, along with the duration of seasons are some of the examples. In its Fourth Assessment Report, the IPCC projects that the heat waves and the heavy precipitation events are very likely to increase in frequency in the 21st century (UNFCCC 2009d).

Figure 5: Total Coal Production, Consumption, and Emission from Coal and Fossil Fuel in China 1998-2006 Source: Energy Information Administration (2008)

The increased GHGs have intensified the disastrous effect of global climate change. With the unremitting increase of GHGs, China has been ranked the world's largest SO2 emitter since 2005 and the largest CO2 emitter since 2007 (The Guardian 2007). As a direct outcome, the
15

Sulphur Dioxide (SO2) is primarily produced through the combustion of coal, coke, and petroleum products. It is a respiratory irritant and precursor to acid rain (Williams &Kahrl 2008). 16 The electricity sector, with coal-fired power generation as predominant source, accounted for 57 percent of Chinas SO2 emissions, 44 percent of particulate matter emissions, 80 percent of NOx emissions, and 49 percent of energy-related CO2 emissions in 2004 (William &Kahrl 2008).
18 (63) The Energy Service Company Industry in China

climate change effect China has been progressively more pronounced abreast. Chinas temperature has been on the increase, aligning with the global warming17. Extreme climate events have accelerated in frequency and intensity (SCIO 2007: 3; EIA 2008; SCIO 2008: 6; Williams &Kahrl 2008). Droughts have worsened especially in the northern and the north western China18. Heavier precipitation has occurred in s the southern China19. Arrid area now covers one quarter of Chinas land area. Snow disaster has become more recurrent in western China20 and sea level has risen by 90 millimetres over the past 30 years. The resulting GHGs from the increase in fossil fuel utilization is expected to continue, thus heightening the threat to climate change security in China (Gao 2007; Su et al 2007; SCIO 2008: 5; Williams &Fahrl 2008; CAAS/DECC/DfID
2008a; CAAS/DECC/DfID 2008b: 4; Xu et al 2009; Wang et al 2009)

Apparently, the energy and the climate insecurity have increasingly become a daunting task that requires urgent and strong measures to attend to for China. Against the exigent backdrop, the ESCO can endow through energy conservation without changing consumption lifestyle, while avoiding the hefty costs in sourcing new supply that includes the resource development, the new trading agreements, and the infrastructure construction. Furthermore, by conserving energy the ESCO also mitigates the climate change effect that would have happened from the electricity generation for the amount that it conserved. A kilowatt-hour saved from energy efficiency does just as much work as a kilowatt-hour from a power plant. But a kilowatt-hour from energy efficiency does not produce any greenhouse gases, and does not require the construction of a power plant or transmission lines," - Steven Kline, Vice President of US Utility firm PG &E Corporation (China Daily 2009e). BOX 2: The ESCO as A Multi-Win Mechanism The ESCO model is a multi- win mechanism21 as it simultaneously generates benefits to the ESCO- the end-user-energy and the environment. From an ESCO to end-user aspect, the ESCO earns profit by assisting the end users in providing more efficient technology. Meanwhile the end user benefits from the ownership of efficient technology without any upfront payment and from the full benefits from the cost savings, once the investment costs have been repaid (IFC 2009a; Bertoldi &Rezessy 2005). Scaling up to the energy and the environment aspect, because the remuneration of the ESCO is directly tied to the savings performance demonstrated. It is therefore in the ESCO best interest to enhance the energy and the CO2 emissions savings among other benefits22 (WEC
17

The temperature has risen about 1.1 degree Celsius over the last 100 years (1908-2007). China has experienced 21 warm winters with 2007 being the warmest year. 18 Please see CAAS/DECC/DfID (2008a) for drastic drought in Ningxia, the North Western region in China. Please see Yihui et al (2007) for Yangtze River basin and North China's severe drought. 19 For more discussion about changes in climate extremes and impacts on natural system in the Yangtze River Basin (YRB) in southern China, please see Xu et al (2009) and Su et al (2007). 20 Please see Wang et al (2009) for more information on the rising depth and days of snow cover in Northern Xinjiang. 21 The term was first introduced in 2007 by Shen Longhai, the director of EMCA. 22 World Energy Council (2008) suggests that the ESCOs bring in multiple benefits, they are: (1) it limits the macro economic impact of oil price fluctuations for oil importing countries; (2) it can extend the availability of fossil resources; (3) it contributes to poverty eradication; (4) it reduces
19 (63) The Energy Service Company Industry in China

In other words, the ESCO model provides the financial return to lower the tensions in domestic energy supply and to reduce the local pollution and the CO2 emissions would have had occurred from the electricity generation otherwise.
2008).

The astonishing economic development in China has posed a dreadful peril to national energy and climate change insecurity. The soaring energy demand and its projected continuance has accrued and amplified the energy insecurity through more frequent energy shortage, and greater reliance on the international supply. With the power generation structure of inefficient coal production and consumption, the tempestuous climate change effect has been vitally intensified as a result. The burgeoning force of circumstance has raised the arduous tasks for China. The necessity of abating the energy, reducing the fuel imports and locking in the lower energy demand for the long term in order to lessen the vulnerability to future energy shocks and disastrous climate change effects in a complementary manner to economic development became increasingly manifest. As the ESCO is deemed as a cost-efficient and environmentally attractive method to tackle the simultaneous challenges in China; the increasing insecurity has opened room of lucrative opportunities for the ESCO industry in China.

deforestation; (5) it enhances economic development by reducing energy shortages; (6) it increases competitiveness by reducing the energy costs.
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Vast Business Opportunity In spite of the consummate energy efficiency improvement achieved, the Chinese economy remains driven principally by the energy-intensive and low productivity industrial sector. This translates to a gargantuan market opportunity for the ESCO industry. It is estimated to be as great as 11 billion USD with the swift average payback time of 1.3 years (WRI 2008). Together with a foreseeable expansion in infrastructure to support the fast urbanization, there exists a vast business opportunity for the ESCO industry in China. BOX 3: What is Energy Productivity? Energy productivity is the ratio of value added to energy inputs. Similar to the labour or the capital productivity, the energy productivity measures the output and the quality of goods and services generated with a given set of input. In other words, it is an inverse of the energy intensity of GDP, measured as a ratio of energy inputs to GDP. Japan has been the leader in enhancing energy productivity. Thanks to its consistently high energy prices and its stringent energy efficiency standards, the Japanese gas- and coal-fired power plants are 70 percent more energy-efficient than the Russian ones, and the Japans standards for room air conditioners are almost 50 percent stricter than the Chinese ones. The energy productivity can be advanced in two ways. First, the economy uses energy less intensively. This involves generating a given level of the energy benefits with the fewer inputs by shifting to less energy-intensive appliances, using more technically efficient appliances, or changing source of the fuel mix to more efficient ones. Second, the economy can increase the output more rapidly than the demand for energy by changing from more to less energyintensive sectors, for example from the steel sector to the service sector, and ultimately to the higher value-added activities within the service sector. Since 1980 the improvement in energy efficiency has been substantially growing; the changes in input intensity, the technology, the fuel mix, and the economic activity have contributed to worldwide energy productivity raise of about 1 percent each year and 25 percent in total. Nonetheless the gain of 1 percent per year in energy efficiency improvement over the past decade has been outnumbered by the global energy demand growth of 1.6 percent each year, and most likely to continue to outpace in the near future as the demand is expected to grow even faster at the level of 2.2 percent per year (McKinsey &Company 2007). As illustrated in Figure 6 and 7, three observations are worthwhile to mention. First, the pace of energy efficiency enrichment in China has been remarkably swift. According to the National Bureau of Statistics (NBS) of China, the energy intensity has dropped over 60 percent since 1980 (The Climate Group 2009: 17). Conversely, the energy productivity was increased more than threefold over the period of 1980-2003. McKinsey &Company (2007) suspects that because China started from very low energy productivity level, therefore the country was enabled to leapfrog into rapid energy efficiency improvement. Second, the energy efficiency in China remains comparatively low. Though the energy intensity has decreased appreciably, it is still several times higher than many industrialized countries- more than fourfold of the European Union in 2003. This is by reason of the predominance of the energy-inefficient industrial sector in Chinese economy. The industrial sector in China is responsible for 71 percent of the energy demand, compared to 31 percent in Europe (Froggatt 2008: 9), and majority of them are characterized by the small-scaled and
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inefficient modes of production. The linchpin of the energy-inefficient industrial sector stems from the political system of annual performance evaluation of regional governments. The evaluation is based solely on economic growth figure, whilst turning a blind eye on social welfare, energy efficiency and environmental aftermath. This has thereby resulted in a disproportionate expansion of energyintensive industries into a large number of small-scaled plants that are energy-inefficient and highly polluting (China Statistic Year Book 2008; SCIO 2007: 4; Andrews-Speed 2008:1336; EIA 2008;
McKinsey &Company 2009:16; Elsayed 2009).

Third, the steadfast leaning of energy efficiency improvement evolution is discernible. This represents the committed efforts to enhance the energy productivity and to trim down the energy intensity. As a result, the firm ground in the energy efficiency improvement in China has been developed, and the strong momentum of the ESCO industry has been accumulated over the past decades. As a consequence of the well-built and persistent developmental path, this trend is expected to continue and will further facilitate even more impressive energy efficiency improvement level by 2020.

Figure 6: Energy Intensity 1980-2020 Source: McKinsey &Company (2007)

Figure 7: Energy Productivity 1980-2020 Source: McKinsey &Company (2007)

Because of Chinas low energy productivity, coupled with its low labour costs, the investment opportunity is much more appealing- about 35 percent lower investment costs than advanced economies. The ESCOs can therefore earn a hefty internal rate of return from projects in China (Thomas 2008). Additionally, China is hastily building new infrastructure, which gives the ESCO industry even more profitable opportunities because it cost less to install the energy-efficient technologies at the beginning, compared to retrofitting (BPOVIA 2008).
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Due to the prospect of the startling infrastructure construction scale and speed, China is regarded as an alluring source for ESCO business opportunities. Within the 2008 to 2025 timeframe, Chinas cities could build 5 billion square meters of roads and 170 new masstransit systems, which are double the size of what all Europe has today. The cities will construct 40 billion square meters of floor space in 5 million buildings, of which up to 50,000 will be skyscrapers; this is equivalent to twice the size of Chicago every year (McKinsey
&Company 2008b).

Endorsed by a global comparison analysis, China contains the superior potential for energy efficiency improvement in assorted sectors: steel, commercial, and residential as revealed in Figure 8. With the construction of new urban housing to support the urban population that is expected to double by 2030, the buildings with energy-efficient design and technologies23 are the key to helping China enhance its residential energy productivity by 2 percent annually to 2020 (McKinsey &Company 2007: 26; The Climate Group 2009; BPOVIA 2008).

Figure 8: Annual Improvement of Energy Efficiency 2003-2020 Source: McKinsey &Company (2008a)

At present-day, the level of the energy productivity in China remains low, meanwhile the level of energy intensity is still elevated, despite of the incisive augmentation of energy efficiency productivity of more than 60 percent over the past decades. Thanks to the low energy productivity backdrop, and the low labour costs, China can proffer the gainful opportunity as an untapped market for the ESCO service, with the lower cost and the greater return. Apart from the current appeal, Chinas future represents a promising path for the ESCO industry. The unswerving and blistering energy efficiency improvements over the past decades have provided Chinas energy efficiency with a firm ground for further expansion. Furthermore, Chinas rapid growth in its oversized infrastructure projects will reveal a massive market potential for the ESCO industry, with even richer rewards and broader areas.
23

Energy-efficient technologies for example, space-heating, ventilation, air-conditioning equipment, windows, doors, elevators and escalators, building insulation, heat exchangers, and solar-control glass (McKinsey &Company 2007: 26).
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National Support Clear vision and strong political attention towards improving the energy efficiency are increasingly marked. China has set the substantive policy frameworks designed to advance the energy efficiency throughout the country; Chinese government has rolled out a national programme prioritizing energy efficiency, along with the comprehensive series of favourable financial instruments and accommodating regulatory framework in various sectors. In the 11th Five-year Plan for National Economic and Social Development (2006-2010), the Medium- and Long-term Special Plan for Energy Conservation set a quantified goal for energy conservation. It stipulates that the energy consumption per GDP capita in 2010 should be 20 percent lower than that in 2005, and the total emissions should be reduced at least 10 percent by 2010. Under the National Climate Change Program, China pledged to transform its economy, to promote clean technologies and to improve energy efficiency (SCIO 2008:14- 21; Xinhua 2009; Longhai 2007:4; SCIO 2007; 7; Sugiyama et al 2008). In accordance to the national development plan and program, the energy efficiency projects are among the major beneficiaries of governments RMB- 4- trillion (586 billion USD) stimulus package that was recently launched in 200824. According to the Ministry of Environmental Protection, approximately 210 billion RMB (31 billion USD) will be spent on supporting environmental initiatives, with 40 billion RMB (6 billion USD) of the amount directing towards energy efficiency improvement (China Daily 2009b). There are four distinguished financial mechanisms which aim to endorse energy efficiency improvement. First, the differentiated pricing for electricity was initiated in 2004 covering 8000 enterprises. Electricity prices in 8 energy-intensive industries are charged according to their energy efficiency level- resulting in prices 10 to 30 percent higher than normal. By 2007, local officials are allowed to retain revenue from the price difference, thus raising incentives to enforce its implementation (Moskovitz et al 2007; Moskovitz 2008). Second, the taxation is used for energy-intensive products. In 2006, the Ministry of Finance increased the export taxes: 10 percent tax on steel and 5 percent tax on petroleum, coal and coke. In 2007, the export rebates of 533 energy- intensive and high polluting products were eliminated (The Climate Group 2009: 16; China Daily 2008a; MOF 2006; MOF 2007; MOF 2008). On the other hand, the exemption for income tax for all energy-savings service enterprises is granted for first three years of operation. Furthermore in 2009, the government also provides a 50 percent income tax reduction during the forth to sixth year of operation as part of Value Added Tax (VAT) Reform25 (HKTCD 2009b). Third, the feed-in tariffs and the tradable quotas are introduced. The National Development and Reform Commission (NDRC) lowered the feed-in tariffs for smaller generating units26 and allowing the generators to create new capacity to replace retired capacity as part of the
24 25

Please see Appendix 3 for more information. Previous to the reform, the ESCOs are to pay the base rate of 17 percent of total revenue as Value Added Tax (VAT). This tax is neither deductible nor avoidable. Coal companies, on the other hand, pay a 13% VAT (Chandler &Gwin 2008: 13; Forbes 2008; China Energy Recovery 2009; China Daily 2007c). 26 The generation tariff principle in China has been evolved to benchmark provincial generation tariffs differentiated by unit size and technology. Generators/Producers are paid for energy injected to the grid based on generation benchmark prices and assumption of energy to be generated.
24 (63) The Energy Service Company Industry in China

Mandatory Retirement Program. In 2008, the generating quotas were granted to those producers that were targeted to shut down for three to five years beyond the closure date, and the producers are able to sell these generation quotas27 to the larger generating units at a profitable price28 (PEI 2007; Williams &Kahrl 2008)29. Fourth, the bonuses30 are offered to the successful companies and regions that reach own individual 2010 energy consumption target announced by the Top 1000 Enterprise Energy Efficiency Action Plan31. The companies are to regularly conduct the energy auditing and report directly to the NBS32, to formulate the energy-saving plans, and to improve the energy efficiency by 25 percent on average and to meet the domestic best practice standards for energy efficiency (Longhai 2007: 7; SCIO 2008: 23; Andrews-Speed 2008: 1339; Xinhua 2008; The Climate
Group 2009: 16).

As part of the program, energy-saving achievement has been incorporated into the provincial government evaluation system. Rewards and punishments will be provided according to the level of performance. This in part provides a forceful incentive to the local officials to assist the enterprises in achieving the targets (Price &Xuejun 2007). The expansion of this initiative to all local authorities and all enterprises is coming to pass in the near future, as the Plan is already in place. The amended Energy Conservation Law encourages imports of energy-saving technologies and equipment, and forbids the energy-intensive ones. Since 2007 China released 46 national compulsory standards on the energy consumption issues ranging from coal-fired power to household induction cookers. The standards cover restricted energy consumption of 22

27

The quotas represent permission for power generation hours, emissions, and water use for a period of two to three years. Quotas will continue to be allocated to the enterprises of retired units (Tian 2008: 15). 28 In Hunan province, 20 decommissioned power producers traded 1.36 billion kWh of quota for 80 million RMB (11.7 million USD) in 2006. In the same province, 23 decommissioned power producers traded 1.42 billion kWh for 90 million RMB (13.2 million USD) during the first half of 2007 (Tian 2008:15). 29 The ramification has been impressive. During 2007, 553 smaller inefficient plants with total generating capacity of 14.38 Gigawatts (GW) were shut down. In 2008, the government closed 16.69 GW of plants. From 2006 to 2008, more than 34 GW of the most inefficient plants were closed down. In 2009, the Chinese government plans to replace 31 GW worth of coal-fired power plants with more efficient model, with 13 GW of capacity set to close this year and 10 GW in 2010 and 8 GW in 2011 respectively (Clean Tech 2009; Williams &Kahrl 2008). 30 Awards are offered to leader of successful companies and regions at an attractive rate: 29 USD and 36 USD for every tonne of coal equivalent saved per year for enterprises in East and West China respectively or 12 USD to 15 USD per tonne of CO2 equivalent reduced. Further links to local government participation is pronounced in this program (MOF 2007; Price &Xuejun 2007). 31 The plan is a nation wide energy-conserving campaign that has aimed at 1000 energy-intensive enterprises accounted for 33 percent of China's energy use, and 47 percent of industrial energy usage in 2004. 32 The reporting is performed through an online service in order to avoid data manipulation, thus increasing data reliability and credibility. The information will be provided to local government and National Development and Reform Commission (NDRC) and also release to public. Nonetheless when the data reaches the public, only an average of total energy use or energy use by industry manner not enterprise-specific manner is available (Price &Xuejun 2007: 8).
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products from the energy intensive industries; provide efficiency labelling33 for 16 household appliances and forbid the sale of unlabelled products in China; and fuel consumption limits on five vehicle types. This will steer the tastes of the Chinese population to energy efficient products and lifestyles (The Climate Group 2009: 16; China Daily 2008a; EIATrack 2009). The new Building Code of the Design Standard for Energy Conservation in Residential Buildings went into effect in 2006. This requires all new buildings to trim down their energy consumption34 by 50 percent or 65 percent in Beijing and Shanghai. The Beijing Municipal government already identified over 40 million square metres of floor space of older building that will be retrofitted voluntarily via the ESCOs. The new Building Code is estimated to provide new market opportunity of 220 billion USD in value of energy efficiency investment up to 2020 in China (MGI 2008: 15; SCIO 2008: 23; Andrews-Speed 2008: 1337; The Climate Group 2009). Additionally to ensure the full cooperation from all sectors of society for all the energy efficiency policies formulated in long-term, the Chinese government energetically campaigned and popularized the importance of energy conservation by various media to constantly strengthen the public awareness of the significance of energy efficiency improvement (China Daily 2008b). In 2008, the NRDC aired a seven-part television series about energy efficiency through Chinas Central Television (CCTV) to inform the public about the need for energy efficiency improvement (China-U.S. Energy Efficiency Alliance 2008). The Chinese government has taken the lead in directing the country to an energy efficient path. The latest national five-year development plan quantified energy efficiency target for the first time in Chinas history. Accordingly the stimulus plan clearly designates a considerable amount to incite energy efficiency market. Financially, the incentives and disincentives are made available in the form of differentiated pricing, taxation, the feed-in-tariffs and the tradable quotas, and the monetary bonuses to incentivize the enterprises, the citizens, and the local authorities. While the regulatory framework of Energy Conservation law is effective in broad areas from industrial, commercial, to citizens, the Building Code and the replacement plan concentrates on the building and power sector. To assure the effective implementation of its policies, the government uses media and campaigns to raise awareness of the energy efficiency significance and necessity to a greater extent. In combination, the prominent national support for energy efficiency implies the promising course for energy efficiency investment based industry such as the ESCO industry to prosper in China.

33

The China Energy Label shall include the name of the producer, the product brand, the degree of energy efficiency, the energy consumption volume, and the China energy efficiency standards referenced to determine the products degree of energy efficiency (EIATrack 2009). 34 The Circular on Strictly Following the Temperature Control Standards for Air-conditioners in Public Buildings has been issued; thus all air-conditioned public rooms in the country are kept no lower than 26 degree Celsius in summer and no higher than 20 degree Celsius in winter (SCIO 2008: 25; China Daily 2008a).
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International Support Starting from the initial introduction of the ESCO concept to China by the WB, the GEF in cooperation with the Chinese government, international organizations has incessantly played a critical role in the Chinese ESCO industry development and propagation. This has been performed primarily through the provision of capacity building, market development, financial support, and technical assistance. The ESCO industry in China has engaged in regular communications with foreign ESCO associations namely the National Association of the ESCO (NAESCO) of America, Japanese Association of the ESCO (JAESCO) of Japan, and Korean Association of the ESCO (KAESCO) of Korea as well as other associations in European countries. By doing so, the ESCO industry has been able to realize the needs for industry expansion via the frequent exchange of information and experiences (UNESCAP 2000; Painuly et al 2003; Ohshita et al 2008). Furthermore, there has been a trend of international cooperation- multilaterally and bilaterally. The international organizations come to Chinas aid via capacity building and market development, financial support and technical assistance. Major activities are highlighted in BOX 4 below. BOX 4: International Cooperation of the ESCO Industry in China
Multilateral Bilateral Cooperation World Bank (WB)35/ Global Environment Facility (GEF)36 / China / Program/ Projects Timeframe Total Amount of Fund (USD) 90 million
(GEF 2009a)

Access to Assistance

Type of Assistance MD, FS, TA


(WB 2008)

Energy Conservation Project Phase I under China's GEF Climate Change Program

1998- 2004
(GEF 2009a)

The Ministry of Finance of China, UNDP, UNEP, WB, ADB, EBRD37, UNIDO 38, FAO39, IFAD40
(GEF 2009a)

35

The World Bank (WB) is an international financial institution whose mission is to provide financial and technical assistance to developing countries around the world. WB assist in a wide array of investment, covering investments in education, health, public administration, infrastructure, financial and private sector development, agriculture, and environmental and natural resource management (WB 2009b). 36 The Global Environment Facility (GEF) is a global partnership among 178 countries, international institutions, NGOs, and the private sector. To date, GEF is the largest funder of projects to improve global environment; it provides grants for projects related to six focal areas: biodiversity, climate change, international waters, land degradation, the ozone layer, and persistent organic pollutants (GEF 2009b).
37

The European Bank for Reconstruction and Development (EBRD) is an international financial institution that sponsors projects in 30 countries from central Europe to central Asia, primarily to private sector clients. The bank is owned by 61 countries and two intergovernmental institutions (EBRD 2009). 38 The United Nations Industrial Development Organization (UNIDO) was established in 1996 to help developing countries upgrading standards of living through industries. UNIDO mobilizes knowledge, skills, information, and technology to developing nations with the thematic priorities of poverty reduction, trade capacity-building, and energy and environment (UNIDO 2009). 39 The Food and Agriculture Organization of the United Nations (FAO) was founded in 1954 as a specialized agency to lead international efforts to defeat hunger. FAO facilitates developing countries to modernize and improve agriculture, forestry, and fisheries and ensure good nutrition for all. At
27 (63) The Energy Service Company Industry in China

Multilateral Bilateral Cooperation European Union

Program/ Projects

Timeframe

WB/ GEF/ United Kingdom Japan/ France/ Asia Development Bank (ADB)41 International Finance Corporation (IFC)42/ GEF/ Finland/ Norway UNDP43/ GEF/ China

Benchmarking Tools for Energy Conservation in Energy Intensive Industries in China Project under the EU-China Energy and Environment Program (EEP) Energy Conservation Project Phase II Asia Clean Services Fund Energy

2008-2009
(EEP 2005a)

Total Amount of Fund (USD) N.A.

Access to Assistance

Type of Assistance CB
(EEP 2007)

Programme Management Unit (PMU) of the EU-China EEP


(EEP 2007)

2003present
(MacLean 2008)

26 million
(WB 2009a)

EMCA and China National Investment and Guarantee Company


(WB 2008)

CB, MD, FS, TA


(MacLean 2008)

2003-2013
(ADB 2003)

50 million
(JFS 2003)

FE Global Asia Clean Energy Services Management Corporation


(JFS 2003)

FS, TA
(JFS 2003)

China Utility-Based Energy Efficiency Finance Program (CHUEE) China End Use Energy Efficiency Project (EUEEP)

2004-2010 (first phase)


(IFC 2009c)

1.5 billion
(IFC 2009c)

The CHUEE partner banks or the IFC CHUEE team


(IFC 2009b)

FS, TA
(IFC 2009a; IFC 2009b)

2005-2017
(China/ UNDP/GEF 2003)

80 million
(China/ UNDP/GE F 2003)

Department of Environment and Resources Conservation (DERC), National Development and Reform Commission (NDRC), UNDP
(China/ UNDP/GEF 2003)

CB, FS, TA
(China/ UNDP/GEF 2003)

WB/ GEF

Energy Conservation Project Phase III Guangdong Energy Efficiency and Environment Improvement Investment Project under Energy Efficiency and Environment Improvement Investment Program (EEP)

2008present
(MacLean 2008)

N. A.

N.A.

FS, TA
(MacLean 2008)

ADB/ China

2008-2010
(ADB 2008)

142 million
(ADB 2009a)

Government of Guangdong Province (Government Debt Management Division), ADB (Energy Division)
(ADB 2009a)

MD, FS, TA
(ADB 2008)

Note:

MD- Market Development: creation of financial incentives for technology investments

present, additional priorities of FAO include energy and climate change in relation to food (FAO 2009). 40 The International Fund for Agricultural Development (IFAD) is a specialized agency to finance agricultural development projects in developing world with concentration in rural areas. Established in 1977, IFAD channels its fund through low-interest loans and grants to enable rural poor people to overcome poverty themselves (IFAD 2009). 41 The Asian Development Bank (ADB) is a regional development bank, with 68 member countries. It was established in 1966 and mandate to help its developing member countries to reduce poverty and improve quality of life through loans and technical assistance (ADB 2009). 42 The International Financial Corporation (IFC) is a member of the WB group, and aims to promote sustainable private sector investment in order to alleviate poverty and enhance quality of lives in developing world. Created in 1956, IFC is now the largest multilateral source of loan and equity financing for private sector for developing nations (IFC 2009d). 43 United Nations Development Program (UNDP) is the United Nations global development network. With local presence in 166 countries, UNDP tackles global issues of democratic governance, poverty reduction, crisis prevention and recovery, environment and energy, and HIV/AIDs (UNDP 2009b).
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CB- Capacity Building: establishment of a new centre of information exchange and support for training. FS- Financial Support: assistance in financing via grants or loans with low interest rate. TA- Technical Assistance: support for project background studies, feasibility studies and project design.

For the market development, the initial effort was taken by the Energy Conservation Project Phase I with the introduction of the ESCO concept into China. Via the three pilot projects' powerful demonstrative effect, the market for the ESCO industry in China has been created for the first time. The exertion to create market for the ESCO industry continued in Phase II (Blanchard 2005b: 2; Zhao 2007; UNEP 2006b: 25; MacLean 2008). The ADB in collaboration with the Chinese government attempted to do similarly, yet in a targeted area of Guangdong as part of the EEP (ADB 2008). Notable attempts for capacity building are the followings: the first refers to an establishment of a national association of the ESCO (EMCA) as a result of the Energy Conservation Project Phase I; the EMCA acts as a national platform to provide trainings, and seminars to develop capacity for all stakeholders (Zhao 2007; UNEP 2006a: 25). The second involves an initiative to develop the suitable institutional and legal framework for the industry through the EUEEP (Gov. of China/ UNDP/ GEF 2003: 36). The third refers to a provision of one-year training to the ESCO via its study on "Promotion of Benchmarking Tools for Energy Conservation in Energy Intensive Industries" (EEP 2007). With respect to the financial assistance, grants and loans are the primary forms of cofinancing, whilst loan guarantee, and risk sharing (or loss sharing) are the types of financial facility firmly established. Since the ESCO in China is often small-sized and is not set up by the large companies with an immense sum of their own funds, the financial support is hence of the essence. While some initiatives provide assistance in the form of loans only e.g. Guangdong Energy Efficiency and Environment Improvement Investment Program, CHUEE, Asia Clean Energy Services Fund, the others e.g. Energy Conservation Project, EUEEP provide in combinations. The continuous flow of co-finance with the sizable amount is apparent (ADB 2008). While the loan guarantee facility assumes the credit risk for the ESCOs, the risk sharing facility assumes the credit risk for the local banks. On the one hand the WB/GEF China Energy Conservation Project Phase II program offers a guarantee up to 90 percent of the value of the bank loans invested through its loan guarantee facility. On the other hand, IFCs CHUEE assures the loss of local banks lending to the ESCOs of less than 25 percent. Please see BOX 5 for more information regarding the CHUEE. BOX 5: IFC and Its Financial Assistance The International Finance Corporation (IFC)s China Utility-Based Energy Efficiency Finance Program (CHUEE) is noteworthy to mention as it has effectively shaped the financial solutions to the ESCO investment in China. The IFC tackles the financial concerns through two aspects: the technical assistance in financial engineering and the loan guarantee to alleviate risk-averse financial institution. The CHUEE works as a risk-sharing facility guaranteeing the private Chinese bank loans for the ESCO projects- was initiated in 2006 and expanded. The IFC takes a first loss position in loans; it ensures the private banks that they will not lose more than 25 percent of their loans for the first few projects they undertake. Coupled with the trainings for developing financial expertise to the banks and the financial institutions in risk-based lending, this familiarizes the financiers with the new ESCO concept that otherwise would remains an unfamiliar and risky
29 (63) The Energy Service Company Industry in China

business to engage in. With this reform, the IFC aims to assist China to be ultimately able to self-finance its vast energy efficiency potential for long-term success (Chandler &Gwin 2008: 11;
IFCb 2009; MacLean 2008: 6).

Concerning the technical assistance, it is a patent component in all 3 phases of the Energy Conservation project: technical and financial expertise to pilot the ESCOs in phase I; assisting specific business plan and loan guarantee transaction for the ESCOs and the local banks in phase II; and preparing long-term lending preparation for the financial institutions and the banks in phase III (Blanchard 2005b:2; Zhao 2007; MacLean 2008). With the Guangdong Energy Efficiency and Environment Improvement Investment Project, EUEEP and Asia Clean Energy Services Fund, similar technical and financial expertises are also available to the ESCOs (ADB 2008; Gov. of China/ UNDP/ GEF 2003: 36; ADB 2003). In support of Chinas ESCO industry expansion, the international support has been palpable since the first introduction of the ESCO concept into China. Frequent interactions between the Chinese and the foreign ESCO associations are proven beneficial due to the constructive exchange of knowledge and technology. Multilateral and bilateral cooperation has been unremittingly contributive to the advancement of the ESCO industry in many aspects, notably in the market development, the capacity building, the financial assistance, and the technical assistance. With respect to the market development, the introduction, along with the manifestation via pilot projects has paved the way for ESCO market in China. The Capacity building has laid firm ground, and continuously diffused thanks to the EMCA creation, the legal framework setting, and the training provision. The financial assistances were created through cofinancing and facilities, and continual flows are noticeable. The technical assistance propped Chinese ESCOs up with technical and financial expertise. Altogether, the well-built international support has been a long-standing factor that has accommodated the steady growth of the ESCO industry in China.

30 (63) The Energy Service Company Industry in China

Active Role of National Association of the ESCOs The Establishment of China Energy Management Company Association (EMCA) has stimulated the ESCO industry development with fervour. The EMCA is mandated to foster the blistering, and healthy proliferation of the ESCO industry. The EMCA sponsors, holds and participates in a whole range of activities with corresponding departments that take charge of these activities. The EMCA is an industrial association of Chinas the ESCO industry. It was established and entitled as the chief implementation body for a joint project of the Chinese Government, the WB and the GEF in April 2004. The membership base expanded to a great extent from 47 to 185 members in 2007 (UNF/UNEP/WB 2005; Zhao 2007; The ESCO Global Summit 2009). As portrayed in BOX 6, main activities include dissemination, technical assistance, communication and capacity building. BOX 6: EMCAs Area of Activities
Area of Activities Dissemination Purposes Disseminating relevant government policies Circulating and promoting ESCO concept Arranging sector-specific and regional specific meetings Assisting the ESCOs with financial issues by constructing a platform for discussing financing issues Organizing trainings, seminars, technical assistance, and consulting services Providing online expert forum on the official website Standardizing operations and opening up fields for business Establishing and maintaining an association website as an online platform of communication Publishing a newsletter Communicating with foreign ESCO associations Encouraging communication between the ESCOs, and other stakeholders namely energy efficiency equipment suppliers, foreign ESCOs, and research institutes Striving to enhance EMCAs capacity as a duty to association members Undertaking sector-specific research and policy study to build up friendly environment for the ESCOs industry Developing representative case studies for distribution

Technical Assistance

Communication

Capacity Building

Source: UNF/UNEP/WB (2005) and Zhao (2007)

Beyond the principal areas of activities as described, initiatives to tackle the urgent financial and credibility concerns are noteworthy. First the EMCA provides financial assistance and training to the ESCOs regarding understanding and applying for bank loans and loan guarantees to overcome the financial barrier. The key component of financial support offered by the EMCA is the access to the Loan Guarantee Program. For example, through the
31 (63) The Energy Service Company Industry in China

WB/GEF China Energy Conservation Project Phase II program, the EMCA members can apply for the guarantee up to 90 percent of the value of bank loans invested. The fund is expected to operate until 2010 and to support over 250 million USD of the guarantees (Market
Wire 2005).

Second, the EMCA directs its efforts to combat the blockade of low reliability and creditability of new ESCO through the development of an accreditation system, and the standardization for auditing protocol. Mistrust is often a significant barrier, particularly in a country with a large number of the ESCO like China; the palpable contribution of the EMCA to develop the accreditation system and to regain the trustworthiness from potential clients is embedded with its strict membership admission scheme. The admission process requires the ESCO applicant to satisfy numerous criteria: the minimum capital requirement, the prior experience and the completion of a training program related to the structure and the use of EPC, and the sponsorship by an EMCA committee member. As a result the EMCA members are comparatively more reliable and competitive; they have completed more projects in energy efficiency upgrades. The number of registered ESCO as members to the EMCA grew outstandingly from 47 to 153 between 2005 and 2007
(Market Wire 2005; Longhai 2007:9, Zhang 2008).

There had been a lack of standardized procedure for Measurement and Verification (M&V) 44. The customers and the lenders therefore often have doubts with regard to the procedures to conduct an energy audit before and after the implementation, as well as the ultimate savings achieved through implementing the proposed solutions (rge-Vorsatz et al 2007b: 13; Zhao 2007: 39). Many ESCOs have encountered negative impact on their marketing effectiveness as a result. If the customers cannot see clearly what has been done before, and the successful result after, then the ESCOs credibility is put at risk. Consequently, the EMCA embraced the International Performance Measurement and Verification Protocol (IPMVP) in March 2009. Through the establishment of Chinas first International Energy Efficiency Organization or Efficiency Valuation Organization (EVO), SGS-CSTC will act as authoritative organization to provide standardized M&V service. Together with the EMCA, the EVO recently launched the Chinese version of the latest edition (2007) of IPMVP45 in June 2009 to assist in specifying reliable and truthful M&V, and to support the rollout of the ESCO industry across China (SGS-CSTC 2009; SGS 2009). From its establishment in 2004 to 2007, statistics portray the express expansion of the EMCA of nearly fourfold compared to its original member-size. The EMCA mandates to foster the healthy development and proliferation of the ESCO industry across China. To accomplish its missions, the EMCA has promoted and disseminated the ESCO concept in China; provided

44

Measurement and Verification (M&V) standard is an essential pillar to develop energy management contract. M&V standard can be a deciding factor in convincing a client of a projects quality, as it determines the exact savings of both parties- energy-savings and energy expense- in energy management contract (Liu et al 2006). 45 The IPMVP provides guidelines to manage the retrofitting of existing buildings or industrial process, and the enhancement of energy efficiency for new buildings. Current focus in China involves the energy efficiency improvement to cope with Chinas rapid rate of new infrastructure, particularly construction of buildings. The IPMVP service will be provided by a trained professional, called Certified Measurement and Verification Professional (CMVP).
32 (63) The Energy Service Company Industry in China

the technical assistance; acted as a national platform of communication; and encouraged the building of capacity to all stakeholders. Further to the principal areas of activities, the EMCA has devoted initiatives to overcome hindrances occurred in the ESCO industry of financial and credibility barriers. With the financial capacity building and the consulting assistance, and the funding access provision from various sources, the EMCA assists its ESCO members to conquer the financial barrier. With the development of accreditation system and the standardization of M&V protocols, the EMCA can assist the members to overcome the credibility barrier. Clearly, the EMCAs dynamic role in the ESCO industry has forced the pace of expansion and has shattered the major barricades substantially

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Potential Linkage to the Carbon Credit Market Since the core business of the ESCO involves the energy efficiency improvement project that is regarded as the climate change mitigation project, the ESCO service therefore inherits strong links to the carbon credit market. Vigorous development of the carbon market in China is therefore complementary and beneficial to the ESCO industry. Linkages to the carbon credit schemes of the Clean Development Mechanism (CDM) and its alternative of Verified Emission Reduction (VER) are discussed here. On the one hand, the CDM indirectly fosters the ESCO industry through Research and Development (R&D) funds. The CDM projects, though not exclusive to the energy efficient ones, also alternatively support the ESCO industry by funnelling part of the carbon revenue to the project from a pool of capital to promote the R&D in energy efficiency sector. China has set aside 1 billion USD (financed by the sale of carbon credits) for the energy-efficient products and for further innovation in the area (McKinsey &Company 2008a). On the other hand, the CDM directly accommodates the ESCO industry growth through an application of the ESCO project as a CDM project. Recently there has been an observable trend in China that the energy efficient technology and equipment manufacturers from overseas are starting to implement the ESCO projects in combination with the CDM. This is to harness the prodigious potential of the energy efficiency market, while reaping the rewards of carbon revenue from the CDM market at the same time (rge-Vorsatz et al 2007b: 12). This trend became feasible and expedient by reasons of: firstly, the robust furtherance by the EMCA. The EMCA fiercely supported the ESCO-CDM linkage and prioritized the issue as its principal area of activity in 2007 (Zhao 2007). Secondly, the increased demand to upgrade companies green image. The Chinese entrepreneurs and foreign technology providers particularly from North America, Europe and Japan are increasingly proactive in having their projects implemented under the CDM label, in order to enhance their business image (rgeVorsatz et al 2007b: 12; Environment Management Research Centre 2009). Thirdly, the ESCO eligibility: The Chinese ESCO projects fall into the eligibility criteria of CDM that investment should espouse technology transfer to developing countries, but should not involve Official Development Aid (ODA). Fourthly, the approved methodologies and technologies available: There are over 30 methodologies for energy efficiency available at present to support ESCO projects46. Lastly, Chinas grounding in CDM as a facilitator: China can offer a competitive environment for the ESCO to develop the energy efficiency CDM from two aspects: largest host of the total CDM projects and of the total energy efficiency CDM projects. As shown in Figure 9, China currently dominates the CDM market as the worlds largest supplier of carbon credits from CDM. China has the highest number of registered CDM projects that accounts for more than 70 percent of the global CDM transaction volume (Capoor &Ambrosi 2008; UNFCCC 2009b; UNFCCC 2009c). As illustrated in Figure 10, China dominates the energy efficiency CDM markets. The Asia Pacific region hosts the highest number of energy efficiency projects and majority of them are located in China; Over 40 percent of the registered energy efficiency projects are in China (UNEP Risoe 2009a; UNEP Risoe 2009b).

46

Please see Appendix 3 for Approved Energy Efficiency CDM Methodologies and Number of Projects. 34 (63) The Energy Service Company Industry in China

Figure 9: Expected Average Annual Carbon Credits of Registerd Projects by Host Party 2009 Source: UNFCCC (2009c)

Figure 10: Number of Registered CDM from Energy Efficiency Projects 2009 Source: UNEP Risoe (2009b)

Nonetheless, a large potential for the ESCO lies in the building sector that is characterized by small-scaled emission reduction projects. With the current CDM configuration of insufficient backing for small-scaled projects, the enormous opportunity in the sector hence may not be realized. The UNFCCC acknowledged the concern and provided the innovative solution in response: bundling47 and the programmatic approach48. These initiatives aim to lower the validation and registration costs for small-scaled projects (Olsen &Fenhann 2008; Novikova et al 2006). Though the tools are relatively new and further clarifications are needed, they stand as the propitious path for the ESCO to implement via the CDM in China. Alternatively, the ESCO energy efficiency projects that fail to pass the tightly scrutinized regulations under the CDM are still able to earn credits via the voluntary system of VER49, although with the discounted value of 30 to 80 percent of the CDM credits price (Thomas 2008:13). Energy efficiency is among the dominant project types that are transacted in the VER. It accounts for 18 percent of the total projects transacted, as displayed in Figure 12. Chinas holding of a dominating position globally both in the absolute and the relative terms in the VER market50 appears as a stimulating and facilitating factor for the ESCO to develop the
47

Bundling allows several small-scale CDM project activities to form a single CDM portfolio. The bundled project activities are registered with an overall monitoring plan, verification and certification of emission reductions achieved covering all the bundled projects. The advantage is the lower costs of validation and verification, and the streamlining of these processes for the project participants. 48 Programmatic CDM or Program of Activities (PoA) permits multiple project activities to be integrated as one at the time of registration and allows additional projects to become part of registered project at any point in the life of the PoA. The PoA can involve projects being run in different countries. Distinct benefits comparing to bundling is that it is possible with the PoA to add more projects without validation renewal and no registration fee is payable on additional projects. 49 Please see the difference between the CDM and the VER scheme in Appendix 5 50 Since the VERs origination path is somewhat similar to the CDMs route- three common sources of the voluntary projects are reregistered CDM, projects with unapproved CDM methodology, and small-scale projects that cannot overcome CDM transaction costs barrier- the
35 (63) The Energy Service Company Industry in China

energy efficiency project, in combination with the VER as an alternative to the CDM (Hamilton
et al 2008: 8).

Figure 11: Project Distribution of VER (Over the Counter Market) 2007 Source: Hamilton et al (2008)

BOX 7: VER As An Alternative Door For Carbon Credits Over the past two decades, the eco-conscious companies, the environmental NGOs and the climate-friendly individuals have long been sponsoring the clean energy projects to offset their emissions. Until the international climate governance of the Kyoto Protocol came into force, the transactions were entered into voluntarily, rather than complying with the regulated emission quota scheme. As the market grew outside of the compliance market on a voluntary basis, they are referred to as the VER. As a non-regulated market, the VER developed outside the government policies. The Kyoto protocol and the European Emission Trading Scheme consequently do not recognize the credits generated from the market. Three major drivers deriving demand for the VER are the companys Corporate Social Responsibility (CSR) strategy, the profit making enterprise for speculation purpose, and the forward-looking companies seeking carbon trading experience to gain a competitive advantage in the future. With the demand being led by the private sector51 not by the public policy, the TFS Green (2009), a distinguished emissions broker company, suspects a strong potential for the VER to outstrip the compliance regime provided the dramatic acceleration of the market at present.52 Moreover coupled with the cloud of uncertainty over the future climate change (Post Kyoto 2012) legislation and treaties in CDM market, it is likely that the voluntary market will play increasingly critical role in protecting the environment succeeding or even replacing the CDM market. Previously just a parallel market, the carbon market has now become linked to, complemented, and fuelled the growth of the ESCO industry. The CDM nurtures the growth
uneven concentration in the CDM is therefore transferred to the VER ones with China and India having the dominant position in global market as primary producer of the carbon credits. 51 For the OTC market, private businesses purchased 80 per cent of the credits available, nongovernmental organizations (NGOs) accounted for 13 per cent, and individuals bought approximately 5 per cent. Interestingly governments responsible for 0.4 per cent of the credits transacted. 52 The voluntary markets grew at the rate of 165 per cent by volume, whereas the regulated markets experienced 71 per cent rate of expansion.
36 (63) The Energy Service Company Industry in China

of the ESCO industry indirectly through its donations to energy efficiency R&D, and directly through an application of the ESCO project as the CDM one. Owing to the EMCA initiative and the firms need for image enhancement, the eligibility criteria of CDM, the availability of related methodologies, and the competitive CDM setting of China, there is an emerging trend of implementing an ESCO project as a CDM project. With recent the CDM reform and its provision of novel tools, the large potential for the ESCO in the small-scaled building sector, it is becoming feasible to capture such potential via the CDM. Otherwise, the ESCO project failing to pass the CDM authorization can enjoy carbon revenues through an application of the project as a VER project, although this can offer smaller rewards than the CDM. Facilitated by a competitive VER grounding in China, the VER can assist in the ESCO industry expansion alternative to the CDM.

37 (63) The Energy Service Company Industry in China

5.2 Disabling Forces


Weak Enforcement of Environmental Regulatory Instruments Although there is a stream of regulatory instruments being implemented, stringent enforcement remains highly problematic in China. The conflicting translation of the central governments environmental policies at local level has crippled the desired outcome significantly. Many SOEs and private enterprises are flouting the laws and ignoring the targets, whilst the local governments are turning a blind eye. The application of environmental policies from the central government by the local governments has been feeble. According to a survey53 conducted by the environmental authority in Shanxi, result shows that about 90 percent of the local government officials interviewed have their main interest in the economic growth, regardless of its costs to the environment. These officials clearly have their own interests at heart when making environmental decisions locally (Jun 2007). As a result, the manipulation of environmental data and the violation to environmental laws are prevalent at a local level. In 2007, a power plant in Sichuan province was found flouting pollution laws. The plant had been protected by the local authority for years via the manipulation of pollution figures. Similarly, Luzhou Power Plant broke the Chinese pollution laws and was shielded by the local authority by understating the pollution level of discharge to Yangtze River by 44 times. Also in Sichuan, the drastic abuse of environmental laws in an industrial park area is obvious; nearly half of the enterprises were set up before getting an official approval and their industrial waste was hundreds of times over-discharged (China Daily 2007b). Not limited only to the private and small enterprises, surprisingly the SOEs are proven to have significant compliance problems with national energy saving and pollution reduction initiatives as well. This has raised cause for concern, since the SOEs are the enterprises subject to the highest level of scrutiny and control by the national government. On top of that, most national initiatives on energy efficiency are directed toward the SOEs (China Daily 2009c). According to the National Audit Office (NAO) report released in 2009, an investigation of compliance efforts of 41 major SOEs reveals that the majority of them failed to reach the energy efficiency target. Many SOEs fail to fulfill energy-saving targets, some companies show reverse trend in energy conservation. For example, energy consumption for aluminum production at Baotou Aluminium Company increased by 1.83 percent, instead of decreasing (China Daily 2009c). Missing not only the targets, some SOEs also do not conform to standards for emissions and treatment of pollution discharge. One-fourth of the SOEs fails to reach standards for Sulfur Dioxide (SO2) and record higher levels of Chemical Oxygen Demand (COD) than standard level. One SOE (without its name provided) discharges more than 5 times the level of COD concentration set by local government. Improper treatment of industrial waste is also found with a total of 209.800
53

A survey by environmental authorities in Shanxi asked if a mayor who achieves economic success at the cost of severe pollution should keep his job, 71% of public respondents answered no, but 90% of local government officials said yes. (Jun 2007).
38 (63) The Energy Service Company Industry in China

tonnes of hazardous wastes had been handed to unlicensed recycling companies, and another 108,000 tonnes were buried without any treatment (China Daily 2009c). More solid proofs of the weak enforcement are evident through the low compliance rate revealed by the Ministry of Environmental Protection (MEP) report that was published in 2009. About 15.5 percent of the projects construction commenced without approval; this implies the absence of Environmental Impact Assessment (EIA) that is required by law. Almost 10 percent of the enterprises that were decommissioned by the government resumed their production without authorization, and nearly 25 percent of primary polluters do not have functional treatment facilities (China Daily 2009d). As an outcome of the eminently weak enforcement throughout the country, the number of complaints to the environmental authorities has increased by 30 percent every year since 2002 and reached 600,000 in 2004. The number of mass protests caused by environmental issues has grown by 29 percent every year (Jun 2007). A number of problems, for example the energyinefficient and highly polluting plants of the energy intensive industry have been known about for years, yet they persist today regardless of many efforts to address (UNEP 2001; Wang 2006). Further elaborate pieces of evidence are the prevailing pollution level and the effects on human health. Two-thirds of 338 cities for which the national data is available are regarded as polluted, with three cities ranked among the ten most polluted cities in the world (WB 2007). Respiratory illness and cancers related to the air pollution are the primary causes of death in China, with approximately 750,000 premature deaths from respiratory diseases each year. A large number of initiatives that were promulgated cannot ensure an effective outcome. Stemming from the local governments prioritizing of economic prosperity, the environment is underrepresented in the decision-making process. A growing amount of evidences reveal high level of non-compliance at local level to centrally formulated environmental law and initiatives, interestingly to both the private enterprises and the SOEs. The evidence reveals that many SOEs under the governmental energy efficiency initiative neglect to pursue the target, and moreover they pervasively violate the laws regarding emission standards and pollution treatment. As most of the national support for energy efficiency is directed to the private enterprises, primarily to the SOEs as pilot cases, such weak enforcement therefore has prohibited the ESCO industry from reaping the full benefits of supportive laws and initiatives as it would have otherwise received.

39 (63) The Energy Service Company Industry in China

Shortfall of Financing Shortfall of finance appears to be highly challenging in China, where the ESCO industry is still young and unknown, and the banking sector is rather conservative. Most of the Chinese ESCOs have to exert a significant effort in order to secure funding for the projects, rather than focusing on developing the technical expertise- unlike in developed nations, where the mature financing sector takes care of the investment. The constrained lending stems from many-sided reasons: the first refers to the biased use of sparse investment capital. Chinas capital market54 surprisingly ranks among the smallest financial markets in the world, both in equity and commercial paper. The Chinese equity markets impart only about 25 percent of the capital provided by comparable markets in other developing economies, and the commercial debt presents only about 2 percent. Additionally, China is far less efficient in utilizing its meagre capital, when compared to other countries with similar stages of development, such as South Korea or Japan (Chandler &Gwin 2008: 7). Favouritism remains, in spite of the relaxed controls on bank lending to private companies, the loosened restrictions for bond issuance55 and the lowered interest rates in 2008. The majority of the national credits is thus far directed to the state-owned enterprises (SOEs) at the expense of the private companies. The SOEs generate less than 25 percent of the nations Gross Domestic Product (GDP), compared to the private firms that contribute more than 50 percent of the GDP. Though many SOEs have been restructured and became highly profitable, their productivity as a group is yet half that of the private companies, both in aggregate term and by industry (Chandler &Gwin 2008: 7; Kundu 2006). Considered as the decline of capital utilization efficiency, the Chinese financial system transfers thereabouts 25 percent of loan balances to the private companies. In 2008, Chinas SMEs received less than 10 percent of the total lending at four of the largest state-owned banks, with the omission of China Merchants Bank- the only non-governmental owned bank on the list (Fuhrman 2009). Many SMEs hence resort instead to international investors and the informal lending market, which has an estimated 100 billion USD of assets but also higher interest rates (Chandler &Gwin 2008: 7; Kundu 2006). The second refers to the lack of interest rate autonomy. The Chinese banks cannot set their own interest rate; The sovereignty belongs to the Chinese government. Generally the interest rates are regulated to 10 percent at the highest and in many cases the interest rates are about 8 percent. Similar limitation also applies to foreign shareholder loans to a Chinese joint venture partner. Inability to demand the interest rate to cover the projects credit risks has depressed judgment for lending to the ESCO ruthlessly (rge-Vorsatz et al 2007a: 9; WEC 2008:3; The Climate Group 2009: 8; Chandler &Gwin 2008:9). The cap on interest rates at the level that is inadequate to justify the risks heightens the inclination of domestic banks and foreign investors to be risk-averse; this undeniably
54

Capital market refers to a market where debt (an amount owed for funds borrowed can be represented by loan note, bond mortgage or other forms stating the repayment terms) or equity securities (ownership interest in a corporation in the form of common stock or preferred stock) are traded (Investorworld 2009). 55 China streamlined the approval system, replacing a previously tedious quota and case-by-case approval system. The redesign is to promote the market-orientated development of enterprise bond market and to expand the enterprise bond issuance size (Reuters 2008).
40 (63) The Energy Service Company Industry in China

discourages the banks and the investors from bankrolling the ESCO projects56. Simultaneously, this restrains risk-loving Chinese banks and foreign investors from lending to the ESCO in order to capture the risk premium from the ESCO project- with an attractive return rate of over 50 percent per year and a short payback period of one to three years (Expert
Group on Energy Efficiency 2007: 66; Chandler &Gwin 2008: 9).

The third refers to the insufficiency of financial capability. On the one hand, the lenders lack competence and experience to perform creditworthiness evaluation on the ESCO. Since the ESCOs generally are the start-ups with neither financial security nor credit history, the banks therefore cannot judge the ESCO creditworthiness in a regular way. Together with the unfamiliarity of the ESCO model, the deficit of information about potential and profitability of the ESCO projects, and the paucity of experience in lending to an ESCO, the lenders are consequently indisposed to underwrite small and new ESCO. On the other hand, many ESCOs have an inadequate financial management capability. Many ESCOs fail to articulate a transparent financial and accounting system required in order to instil confidence in the minds of potential equity investors. Only a handful of the ESCOs are able to establish a business plan with a lucid vision and a graspable growth strategy. In many cases, the ESCOs cannot define technologies to provide, and cannot translate the service to the clients sustainable growth strategy. Therefore the lenders are not convinced to provide capital for the ESCOs (Blandchard 2005b:3; Expert Group on Energy Efficiency 2007:66). The fourth detrimental financial aspect refers to the relatively high transaction cost due to the small size of project. Typically the ESCO investment opportunities are small-scaled, when compared to other industries in China. Additionally most of them are likely to be projectbased; this translates to the incapability to exploit an economy of scales and the confrontation of the high transaction costs per project. The ESCO investment is thus less attractive to the investors due to the relatively higher cost (Blandchard 2005b: 4). The fifth refers to the inability to gain an access to existing funds. Theoretically, provided the proliferating financial assistance for the ESCO industry particularly from the international support, financing for the ESCO should not be a concern. Nonetheless, the impediment seems to be the access to the financing; The link between the possible funder and the ESCO or the end-consumer is barely visible. This henceforth prohibits the money available from flowing into the ESCO industry in China (rge-Vorsatz et al 2007a: 9). In China, financing to the ESCO industry is noticeably restricted; firstly, on account of favouritism, the majority of limited national credits flow into the hands of the SOEs, instead of the more productive private sector including the ESCO industry. Secondly, the inability to justify the risk for the ESCO investment deters the risk-averse lenders from financing, while refraining the risk-loving lenders from bankrolling the high-risk, high-return business of the ESCO.

56

Compared to the energy-intensive industrial sectors, where risk-based lending is considered absent, risk aversion is thus not a constraint on lending. With at least 50 billion USD per year of investment for the past several years- two coal-fired power plants being built per week- annual investment in coalfired electric power in China outpace energy efficiency and clean energy investment by a ratio of ten to one (Chandler &Gwin 2008: 7).
41 (63) The Energy Service Company Industry in China

Thirdly, the lenders have inadequate knowledge and experience to perform financial evaluation of the ESCO; meanwhile the ESCOs do not have sufficient skills to convince for lending. This hence holds back the lenders from funding the ESCO industry. Fourthly the relatively higher transaction costs due to the small project sizes lessen business attractiveness of the ESCOs to the lenders. Fifthly, the linkage to funding is feeble, thus crippling the money available from financing the ESCO industry. On the whole, the shortfall of financing has hindered the progress in finance flow into the industry, hereafter hamstringing the escalation of the ESCO industry in China markedly.

42 (63) The Energy Service Company Industry in China

Lack of Access to the Public Sector Reflecting its organization under a formerly centrally- planned system, Chinese public sector is sizeable and on the increase; the public sector is regarded as a mounting energy-consuming sector. In spite of the redoubtable national support, there is an absence of access to the public sector. The ESCOs thus have lagged in the Chinese public facilities and have left the potential for energy efficiency gains in both the existing and the new public facilities largely untapped. The Public sector is an eye-catching area for the ESCOs for two reasons; the first refers to its large potential for energy efficiency improvement. According to the Ministry of Construction, although the public building area is less than 4 percent of the total land area, this translates to an area of public buildings as great as 600 million square meters as of 2005. Moreover, it accounts for 22 percent of total electricity consumption in cities and towns in China (Longhai 2007:11; Fan 2006). This is because many public buildings use low-cost inefficient appliances and equipment due to the historical purchasing policies that prioritize the least initial cost, instead of the long life cycle costs. With the level of electricity consumption of between 70 and 300 Kilowatt per hour (kWh) per year per unit area, this translates to 1.5 to 2 times that of the developed countries. This implies an annual energy saving potentials of 68 million tonnes of standard coal equivalent come from public buildings by 2020 or 210 billion kWh per year (Longhai
2007:13).

The second refers to its monumental spending power. China's public authorities are decidedly tempting customers for the ESCOs, because of their comparatively large spending power. In 2005, the government had an annual budget equivalent to 1.6 percent of the country's GDP, around 42.8 billion USD. The government is thus more capable of purchasing more resourceefficient service in the market than those consumers, according to the Ministry of Finance
(China Daily 2009a).

Through immense spending power, public sector can trigger and stimulate the ESCO industry development via consumption, production, and in effect, research and development in the area. With great demand for the ESCO service, this may stimulate greater and faster technological breakthroughs for the industry, according to Wang Conghu, a government procurement expert of Renmin University of China (China Daily 2009a). In order to capture the potential in the Chinese public sector, the facilitating instrument, namely the government procurement list, can serve such a critical role. There has been the discernible progress in incorporating energy efficiency consideration into the Procurement list. In 2004, the Government Procurement Law formulated listed energyefficient products as the preferential purchase items (Van Wie McGrory et al 2006: 5; Xinhua 2007). In 2007, new Government Procurement Law upgraded the energy-efficient products to be on the compulsory list of purchase items57. In 2009, Mandatory directive or the Opinion of the General Office of the State Council demanded tougher enforcement of the compulsory list
(China Daily 2009a).

57

The list published in 2007 consists of nine types of products, including air conditioners, fluorescent lamps, televisions, electric water heaters, computers, printers, computer monitors, urinals and toilet pans and water nozzles (China Daily 2009a).
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By incorporating the energy efficient products into the government procurement list, the embedded problem of the conflicting government purchase regulations, namely the forbidden saving retention investment58 and the unclear winning criteria59 that previously stood as the chief barriers to energy-efficient products, including the ESCO service are gradually eliminated. Thereby this has laid firm and facilitating ground for the ESCO service to be on the procurement list. Nonetheless, the ESCO service is currently not included on the compulsory procurement items, thus leading the ESCO to face considerable difficulties in negotiations with governmental bodies (rge-Vorsatz et al 2007b: 13; Van Wie McGrory et al 2006: 6). The public sector in China is deemed a massive and growing energy-consumer. Undeniably, the sector is alluring for the ESCOs for two rationales: its large energy efficiency improvement potential, and its monumental spending power. First, public buildings are shown to cover a vast area. Due to past purchasing policies and agenda, the buildings were built and equipped with low energy efficient design, material, and appliances, thus attributing to shocking power expense, and simultaneously providing large potential for the ESCO projects. Second, when compared to other consumers, government authorities are represents more capable of purchasing the ESCO service. Via its spending, public sector can pose tremendous effect to the ESCO industry through consumption, production, and R&D. Though progresses are made in incorporating energy efficient products onto the list, and the previous hindrances of the ESCO service are being removed as an effect of the addition, the ESCO service is not yet on the procurement list. This therefore causes the ESCO industry impediments in tapping into public sector energy efficiency potential.

58

Public authorities are not permitted to engage in such long-term investment- a currency outflow for investment today and to bring cost-savings in the future (rge-Vorsatz et al 2007b: 13; Van Wie McGrory et al 2006: 6). 59 Life-cycle costs are not traditionally employed as a basis for purchasing decisions in China, yet it is necessary for energy-efficient product purchase. As public authorities are more familiar with least initial cost method, the winning criteria for energy-efficient product is often doubtful (Van Wie McGrory et al 2006: 6).
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6. CONCLUSIONS AND THE WAY FORWARD 6.1 Conclusions


After an introduction into China, the three pilot ESCOs and their manifest success captured public attention, and inspired many more Chinese entrepreneurs to follow the similar route. Subsequently the ESCO industry has gathered the impetuous momentum up to now. The industry has developed remarkably: increasing in number to over 60 times the initial number, and increasing sixfold in investment value over five years. The industrys performance has been astonishing, with energy saving and emission reduction swelling to 16 times over the rate of five years ago. Notably, the astounding progress is likely to persist, even against the global economy backdrop. Six enabling forces are found behind the exceptional growth of the ESCO industry in China. They are: Firstly, the energy and the climate change insecurity. Stunning economic prosperity for the past decades has led to the threats of energy and climate change security. The energy demand surge has aroused more repeated energy shortages, and greater dependence on international supply. Prominent use of coal as an energy source has kindled the drastic climate change effects. The prolonged pattern of demand and coal use is expected, with more ghastly consequences ahead. Seeing the soaring insecurity as an opportunity, the time is ripe for the ESCO industry to flourish as a gainful panacea to the energy and climate vulnerability in China. Secondly, the vast business opportunity: Despite the noble achievements of the energy efficiency improvement upswing over the past decades, the energy productivity remains comparatively low. This implies the higher returns for energy efficiency investment in China today. Owing to the prospect of rapid infrastructure growth, coupled with the firm development ground in the energy efficiency arena, China harbours an alluring opportunity for the ESCO in the future. The vast investment opportunity now and in the future undeniably instigates the furious and extensive expansion of the ESCO industry in China. Thirdly, national support: As part of the National Five-Year Plan, the Chinese government sets a quantified target for energy efficiency, and incites the industry with money from the 2008 stimulus package. A series of financial incentives for the enterprises, the residents, and the government authorities have been formulated. Ample regulatory frameworks aiming at specific sectors have been inaugurated. Sequences of campaigns to popularize the energy efficiency improvement have been launched. Collectively, the national support has been progressively conspicuous and formidably created demand and opportunity which never existed before for the ESCO industry in China. Fourthly, international support: With foreign efforts, the ESCO concept was introduced and materialized for the first time in China. Perpetual interactions with international ESCO associations are favourable for its exchange of information. Unabated initiatives of the multilateral and bilateral donors are effective in facilitating market development, capacity building, financial assistance, and technical assistance. Owing to the longstanding international support since the commencement, the ESCO industry has vigorously blossomed in China. Fifthly, the active role of national associations of the ESCO: The EMCA has magnified stupendously both in its size and its advocacy on behalf of the ESCO industry. With the
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passion to cultivate thriving proliferation of the ESCO industry, the EMCA has directed its effort towards activities for the dissemination of the ESCO concept, the provision of technical assistance, the promotion of national and international communication, and capacity building for healthy development in the long-term. The EMCA has also resolved the barriers which occurred- barriers of finance and credibility- with success. Obviously, the active role of the EMCA has markedly smoothed the way for the ESCO industry to prosper in China. Lastly, the potential linkage to the carbon credit market: Regarding the ESCO project as a mitigation project, the carbon credit market became linked and has proven beneficial to the ESCO. Indirectly, the CDM fosters the ESCO via R&D funds. Directly, the CDM rewards carbon benefits to the ESCO; backings for the emerging trend are the EMCA initiative, the business image enhancement demand, the CDM eligibility, the available methodologies, the Chinese competitive CDM setting, and the CDM reform. Alternatives to the CDM, the ESCO can also enjoy carbon benefits via the VER. Evidently growing linkage to the carbon credit market offers the rich investment support to the ESCO industry. Three disabling forces are found to be influential in China the ESCO industry. They are: first of all, the weak enforcement of environmental regulatory instruments: The majority of local governments still nurture the economic proliferation at the expense of environment. As a result, in spite of the streams of regulations implemented, a high rate of non-compliance to environmental regulations including energy efficiency ones are apparent in China both in the private enterprises and the SOEs. As a majority of ESCO-related laws and initiatives are directed to such enterprises, the weak enforcement thereby hampers the ESCO industry growth severely by subduing productive outcomes from the strong national support in China. Second of all, the shortfall of financing: Financing is restricted in China by reasons of the biased use of sparse investment capital at the expense of private companies like the ESCO, the lacking autonomy of interest rate determination that heighten the lenders credit risk, the insufficiency of financial capability of both the lenders and the ESCO, the relatively high transaction cost due to small project size, and the inability to gain access to existing funds that encumber the ESCOs attempts to fully utilise the benefits of international support. On the whole, the shortfall of financing has stifled finance flow, henceforth distinctly impeding the progress of the ESCO industry in China. Third of all, the lack of access to the public sector: The public sector in China is an appealing customer for the ESCO. Skyrocketing power bills reveal the low energy efficiency condition of public buildings, and thus the large potential for the ESCO service. With the large purchasing power, the government authorities are capable and influential customers; it can contribute multiple positive effects to the industry on a large scale. Yet the lack of facilitating tools to provide access has led the ESCO industry in China to stumble upon great difficulties in unlocking the large efficiency potential in the public sector. It is evident from this study that the development and the performance of the ESCO industry in China has been impressive today and is likely to persist in the foreseeable future. All of the enabling forces behind success today are set to increase and endure to nurture further expansion. The energy and the climate change insecurity tend to intensify; The vast business opportunities exist both at present and in the future; The national support is prone to proceed even more aggressively; The international support is likely to carry on its massive cooperation; The EMCA active roles are on the increase and the linkage to the carbon market is gathering its momentum.
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presence of disabling forces, namely the weak enforcement of environmental regulatory, the financial shortfall and the lack of access to the public sector. Without any stringent enforcement, the supportive national laws and initiatives are not realized. Without adequate financing, the growth of the ESCO industry is hindered. Without access to the public sector, the opportunities for profitable energy efficiency improvement in the public sector are not exploited.

6.2 Policy Recommendations


As hindrances stand, means to break the barriers lie abreast. The recommendations to take the initiative are the following: First, the tightened enforcement of the ESCO-related regulatory instruments is of significance. To induce the stern actions throughout China, local authorities are the underpinning targets. The government can tempt the local authorities to comply with the ESCO-related laws and initiatives by adding on to the existing regimes and embedding into the new ones compelling financial incentives as a winning inducement. This could be coupled with the direct and realtime monitoring system between the government and the enterprises to enhance transparency and time-efficiency, while cutting the local authorities opportunities to endorse noncompliance. Second, the promulgation of financial incentives by the government to local banks and foreign owners for financing the ESCO is necessary. On an account of financial apparatus, there exist incentives and disincentives for energy efficiency to financial institutions, yet none are embedded with specific support for the ESCO. It can be performed through differentiated pricing, taxation, quotas, and subsidized interest rates to name but a few. Furthermore an establishment of special funding for the ESCO can be an essential ingredient. The government can funnel the proportion of fuel tax and electricity surcharge. This additional funding from the government can be used to accelerate the ability to self-finance the ESCO, thus creating a viable long-term solution to financial problem of the ESCO industry in China. In a complementary manner to the WB/GEFs Loan Guarantee Facility or the IFCs Risk-sharing Facility, the fund can provide partial or full risk coverage to the local banks, as a guarantee for the ESCO investment. Third, regulatory reform in the financial sector by the government is vital. For the heavier flow of national investment capital to the ESCO, the long-lasting favouritism needs to be eradicated. Some of the relevant regulatory frameworks are already in place to incite the lending from the local banks to the private sector by 2008, namely the relaxed controls on bank lending, the loosened restrictions for bond issuance, and the lowered interest rates for the private sector (Reuter 2008; Chandler &Gwin 2008). Despite the strong enforcement of the existing policies, and formulation of policies targeting concerns over the interest cap, the favouritism, and the heartening foreign investment inflow are of the essence. Fourth, the forceful contribution from the EMCA via the capacity building and communication is necessary. To trigger more lending, the EMCA can develop the lenders capacity for lending to the ESCO: creditworthiness performance, education of potentials and profitability of the ESCO in China. Meanwhile the EMCA can develop the ESCOs capacity for loan application: accounting transparency, business plans and strategy creation. Also the EMCAs role as an information platform needs to be strengthened in order to bridge the gap
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between the existing funds and the ESCOs, thus providing the ESCO access to the abundant finances already in existence. Fifth, the inclusion of the ESCO service to the Government Procurement list is of importance. The suggestion to incorporate the ESCO to the compulsory list is already made (rge-Vorsatz et al 2007b). Facilitated by the progressive addition of energy-efficient products into the list, the inclusion is likely to be viable. In the meantime, the EMCA can introduce a Standard Performance Contract for government as a temporary tool, as it is easier and faster to implement, yet can play a vastly constructive role in facilitating the growth of the ESCO service to tap into large potential in the Chinese public sector before the government procurement becomes effective.

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<http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTRESEARCH/0,,contentMDK:2063 4060~pagePK:64165401~piPK:64165026~theSitePK:469382,00.html > The World Bank (WB), Air Pollution, 2007, retrieved 15 July 2009, <http://siteresources.worldbank.org/DATASTATISTICS/Resources/table3_13.pdf> The World Bank (WB), World Bank, GEF-Backed Energy Efficiency Program Expands in China, January 2008, retrieved on 3 May 2009, <http://web.worldbank.org/WBSITE/EXTERNAL/NEWS/0,,contentMDK:21610830~pagePK:642570 43~piPK:437376~theSitePK:4607,00.html> The World Bank (WB) a, Energy Conservation Project Phase II, 2009, retrieved 7 July 2009, <http://web.worldbank.org/external/projects/main?Projectid=P067337&Type=Financial&theSitePK=4 0941&pagePK=64330670&menuPK=64282135&piPK=64302772 > The World Bank (WB) b, About Us, 2009, retrieved 15 July 2009, <http://web.worldbank.org/WBSITE/EXTERNAL/EXTABOUTUS/0,,pagePK:50004410~piPK:3660 2~theSitePK:29708,00.html> Thomas, Christopher, Financing Energy Efficiency in China, December 2008, retrieved 3 July 2009, <http://www.scribd.com/doc/9418448/Financing-Energy-Efficiency-in-China> Tian, Jun, Implementing Energy Efficiency Programs in Chinas Power Generation Sector: Case Study of a Recent Policy Initiative, 30 May 2008 United Nations Development Programme, (UNDP), About UNDP, 2009, retrieved 15 July 2009, <http://www.undp.org/about/ > United Nations Environment Programme (UNEP), Cutting Carbon, Our Planet, 2001, retrieved 3 July 2009, < http://www.unep.org/ourplanet/imgversn/123/ye.html> United Nations Environment Programme (UNEP) a, Improving Energy Efficiency in Industry in Asia, A Review of Financial Mechanisms as part of the Energy Efficiency Guide for Industry in Asia, June 2006 United Nations Environment Programme (UNEP) b, Fighting Climate Change through Energy Efficiency, 2006, retrieved 25 May 2006, <http://www.unep.org/Documents.Multilingual/Default.asp?DocumentID=477&ArticleID=5276&l=e n> United Nations Environment Programme (UNEP), Public Finance Mechanisms to Mobilize Investment in Climate Change Mitigation, December 2008 United Nations Environment Programme (UNEP) Risoe a, CDM Projects Grouped in Types, 2009, retrieved 19 May 2009, <http://cdmpipeline.org/cdm-projects-type.htm#2> United Nations Environment Programme (UNEP) Risoe b, CDM Pipeline Overview, 2009 United Nations Economic and Social Commission for Asia and the Pacific (UN ESCAP), Energy Efficiency: Promotion of Energy Efficiency in Industry and Financing of Investments, Bangkok, 2000 United Nations Framework Convention on Climate Change (UNFCCC) a, Mechanisms: CDM, 2009, retrieved 12 May 2009, <http://unfccc.int/kyoto_protocol/mechanisms/clean_development_mechanism/items/2718.php >

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8. APPENDICES
Appendix 1: Third Party Funding Model Source: World Energy Council (2008)

Energy Performance Contract End-user


Payment Service

Financing Agreement

THE ESCO

Payment Financing

Bank

Appendix 2: The World's Top Ten Nations with Largest Total Energy Consumption Source: International Energy Agency (2006)

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Appendix 3: China's Stimulus Package Source: Hong Kong Trade and Development Council (2009a)
Stimulus Measure
1. Speeding up construction of low-rent housing 2. Speeding up infrastructure projects rural

Specifics
Construction of low-rent public housing Residence renewal To encourage nomadic citizens to have permanent residence Installation of potable water infrastructure in rural areas Improving rural electricity grid Improving irrigation and achieving water-savings Construction of road networks into rural areas Speeding up the "South Water to the North" project Building a number of dedicated passenger railways, coal railways and rail networks in Central & Western China. Building airports in Central & Western China Improving the mainland's road networks Improving electricity grid in urban areas Speeding up projects like "West Gas to the East" Strengthening basic healthcare service provision Speeding premises renewal of secondary schools in rural areas Speeding up construction of sewage treatment, solid waste treatment facilities Supporting major energy-saving and emission-reduction projects Supporting technology upgrade of existing industries and productivity enhancement Supporting development of high-tech industries and services industries Speeding up Sichuan's reconstruction projects Raising the minimum purchase price for food Increasing various kinds of subsidies for farmers Raising welfares for farmers, retirees and other low income groups Reforming value-added-tax (VAT) to transfer it from production-based to consumption-based Reducing enterprises' burden of taxes by a magnitude of RMB120 billion. Lift restrictions on lending growth by eliminating quota of commercial banks Reasonably increasing loans to major projects, SMEs, productivity enhancement and rural development

3. Speeding up transportation infrastructure

4. Speeding up medical, healthcare and cultural businesses development 5. Strengthening environmentrelated investment 6. Speeding up industry upgrade and encouraging innovation 7. Speeding up Sichuan's reconstruction 8. Increasing urban, rural income 9. Reducing tax burden

10. Strengthening financial support to economic growth

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Appendix 4: Approved Energy Efficiency CMD Methodologies and Number of Projects Source: UNEP Risoe (2009a)
Methodology Number Sectors Number Projects of

AM45 (ver2) AM58 (ver2) AM67 (ver2)

ACM7 (ver3) AM14 (ver4) AM48 (ver2) AM76 AM52 (ver2) AM61 (ver2) AM62 (ver1.1) ACM13 (ver2) AM66 (ver1.2) ACM4 ACM12 (ver3.1) AM24 (ver2.1) AM32 AM49 (ver2) AM55 (ver1.2)

Energy Distribution: Grid connection of isolated electricity systems Introduction of a new primary district heating system Installation of energy efficient transformers in a power distribution grid Energy Efficiency, Supply Side: Conversion from single cycle to combined cycle power generation Natural gas-based package cogeneration New Cogeneration facilities supplying electricity and/or steam to multiple customers and displacing grid/ off grid steam and electricity generation with more carbon-intensive fuels Implementation of fossil fuel tri-generation systems in existing industrial facilities Increased electricity generation from existing hydropower stations through Decision Support System optimization Rehabilitation and/ or energy efficiency improvement in existing power plants Energy efficiency improvement of a power plant through retrofitting turbines New grid connected fossil fuel fired power plants using a less GHG intensive technology GHG emission reduction through waste heat utilization for preheating of raw material in sponge iron manufacturing process Energy Efficiency, Own Generation of Electricity: Waste gas and/or heat for power generation GHG reduction for waste gas or waste heat or waste pressure based energy system Waste gas recovery and utilization for power generation at cement plant Waste gas or waste heat based cogeneration system Gas based energy generation in an industrial facility Recovery and utilization of waste gas in refinery facilities Energy Efficiency, Industry: Steam system efficiency improvement by replacing steam traps and returning condensate Baseline methodology for steam optimization systems Improved electrical energy efficiency of an existing submerged electric arc furnace used for the production of SiMn Energy efficiency improvement projects: boiler rehabilitation or replacement in industrial and district heating sectors Energy efficiency improvement of a boiler by introducing oil/water emulsion technology Efficiency improvement by boiler replacement or rehabilitation and optional fuel switch in fossil fuel-fired steam boiler systems Power saving through replacement by efficient chillers Improved energy efficiency by modifying ferroalloy production facility

55

419

187

AM17 (ver2) AM18 (ver2.2) AM38 (ver2) AM44 AM54 (ver 2) AM56 AM60 (ver 1.1) AM68

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Methodology Number

Sectors

Number Projects

of

AM46 (ver2) AM70 AM71

AM20 (ver2) 30

Energy Efficiency, Households: Distribution of efficient light bulbs to households Manufacturing of energy efficient domestic refrigerators Manufacturing and servicing of domestic refrigeration appliances using a low GWP refrigerant Energy Efficiency, Service: Water pumping efficiency improvement Total

14

12 693

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Appendix 5: Differences between CDM and VER Scheme


CERs Mechanism Objective Functionality Market of operation Timeframe Participant eligibility Sellers Buyers Project coverage Project-based carbon credits through emission trading Promote investment for mitigation to climate change To fulfill the legally-binding commitment target framed by the Kyoto Protocol and the EU ETS Compliance market 2008-2012 Private and public of the countries that have ratified the Kyoto Protocol Private and public entities in developing countries that are ratified in the Kyoto Protocol Kyoto compliance buyers Waste handling and disposal, solvent use, fugitive emissions from production and consumption of halocarbons and sulphur hexafluoride, fugitive emissions from fuels, metal production, mining production, transport, construction, agriculture, afforestation and reforestation (A/R), chemical, manufacturing, and energy industries, energy distribution, energy demand Required CDM Registry Not required Available standards e.g. Gold Standard VERs Project-based carbon credits through emission trading Promote investment for mitigation to climate change To voluntarily offset own carbon footprint Voluntary market No limitation No limitation No limitation Voluntary buyers60 Extremely diverse, the ranges of technologies used in the compliance regime are eligible in the voluntary market, as well as others not currently accepted, such as avoided deforestation, land use and other transport projects.61

Registry Quality standard

Validation/ Verification Process of registration

Required By the DOE accredited by the UNFCCC Standardized CDM project cycle

Not required Available registries e.g. CDM, CCX, VER and Blue registry62 Not required Available standards e.g. Voluntary Carbon Standard (VCS), CDM/JI, VER +, Gold Standard63 , CCX, Greenhouse Friendly, Voluntary Offset Standard (VOS), Social Carbon, Climate Change and Biodiversity Standards (CCBS) and ISO 1406464 Not required By any professional environmental consultancies, could be the entities accredited by the UNFCCC No common procedure Not go through all steps in CDM project cycle, instead it is a simplified one.

60

Consumers in these markets include both organizations and individuals who voluntarily commit to offset some portion of their emissions from their operations, events, travel, products, concerts, or other activities. 61 For this reason, the voluntary niche is sometimes considered as testing ground for new technologies and methodologies. 62 The Blue Registry was cited as the most commonly utilized registry. 63 For Gold Standard, validation by an accredited DOE is necessary. 64 The Voluntary Carbon Standard were cited as the most frequently used standards, followed by the CDM/JI, Gold standard and the VER+. 63 (63) The Energy Service Company Industry in China