Environmental Technologies Industries

Environmental Technologies Industries

Market Plans

Climate Change Report

Chapter 3 - Funding and Financing Options

This chapter identifies funding and financing sources for climate change-related investment in developing
countries and exports of relevant U.S. technologies and services. As discussed in chapter 1, the Clean
Development Mechanism (CDM) is the main new driver behind the climate change mitigation technologies
market. It is also likely to generate the largest amount of funding for climate change projects in the developing
world. However, the CDM funding is not yet available, as the rules for CDM transactions are still under
discussion. In the meantime, multilateral donor projects, particularly Global Environment Facility-funded ones,
present significant market opportunities. This chapter also considers U.S. bilateral aid and financing programs
that are particularly relevant to U.S. technology and services companies, as well as other funding and financing
sources. Appendix A contains information on multilateral and bilateral donor-funded climate change projects
in selected countries. Relevant contact information for the funding and financing sources discussed in this
chapter is found in appendix B.

Project Funding Under CDM

The CDM, the Kyoto Protocol's flexible mechanism for cooperation in GHG (greenhouse gas) emission
reductions between developed and developing countries, has the potential to generate substantial financial
resources to cover the incremental costs of projects specifically designed to reduce greenhouse gases. In the
form of cofinancing within a larger project finance context, the CDM financing is expected to come exclusively
from annex I (i.e., developed) countries. [Annex I countries (as designated in annex I of the UN Framework
Convention on Climate Change) include most members of the Organization for Economic Cooperation and
Development plus the countries of Central and Eastern Europe.] For developing countries, the CDM
would bring foreign investment and access to cleaner technology. For industrialized countries, it would
provide a cheaper and more flexible way to meet their emission reduction targets. And for technology exporters,
it would bring market opportunities, new partnerships, and a better public image.

According to the World Business Council for Sustainable Development (Stigson, 1998 — see Bibliography),
business sees the CDM as a significant market opportunity. Private companies have a major role to play in the
CDM, as they will be responsible for financing and implementing most emission reductions over the next 15 years.
Although the rules of the CDM are still extremely vague, as indicated earlier, many U.S. companies are already
examining its business implications.

Some experts predict that depending on the market price of GHG emission reduction credits, total CDM funds
in 2010 could be between $5.2 billion and $17.4 billion, with totals ranging between $25 billion and $85 billion
from 2008–2012, excluding any CDM activity that may occur prior to 2008. The Business Council for
Sustainable Development — Latin America estimates a global CDM market at between $1 billion and $3 billion
per year (Business Council for Sustainable Development — Latin America, 1998).

The magnitude of CDM funding will be influenced by various factors affecting demand and supply for CDM
projects. Project demand from developed country sponsors will be influenced by such factors as:
The level of country commitments under the Kyoto Protocol;
The strength of climate change policies and regulations in developed countries;
The rules for financial transactions under the CDM;
Relative availability and cost of CDM transactions, project cofinancing, and insurance against developing
country risks; and
Cost and availability of other options to acquire GHG emission reduction credits.

The supply of CDM projects in developing countries will depend on individual countries’ interest in
participating in this mechanism and availability of other funding and financing sources for infrastructure
investments. The CDM envisions two options for project financing:
1) pooled investments globally managed and allocated by an oversight committee (the multilateral option); or
2) direct sponsor–host transactions at the project level (the bilateral option). A mix of both options may well
be adopted as a result of future discussions of CDM rules.

The multilateral option financing would function like a mutual fund. Projects would have to be reviewed and
approved by an investment committee, and proceeds (reduction credits) would be distributed based on
contributions from investing Annex I countries and/or their private sectors. The World Bank's proposed
Prototype Carbon Fund would operate along these lines.

The bilateral option is likely to generate a larger and more efficient market, unimpeded by bureaucratic
procedures of a global investment fund. The bilateral option would allow project sponsors to select what
they believe to be the most profitable projects. It would permit sponsors to focus on strategic regional
markets where they have complementary economic interests.

Under both options, CDM financing is likely to create great market opportunities for suppliers of climate
change-related equipment and services.

As mentioned in chapter 1, the Kyoto Protocol allows annex I countries to apply emission reduction credits
earned between 2000 and 2008 toward their commitments for 2008–2012. Companies from developed countries
that choose to undertake CDM projects as early as 2000 will do so for a variety of reasons. Some may desire
to distinguish the company as an early player who is willing to gain knowledge about the CDM through
project participation. This type of early action ideally will allow the company to gain experience, receive credit
for emission reductions, develop a potential niche in a particular country or region or a technology market, and
understand what is required for successful future projects. On the other hand, certain companies may not
participate in the early stages until the rules for earning GHG reduction credits become clear and an offset
trading market evolves.

Multilateral Donor Projects

Global Environment Facility Projects

The Global Environment Facility (GEF) provides grants and concessional funding to recipient countries for
projects and programs that protect the global environment and promote sustainable economic growth. The
facility, originally set up as a pilot program in 1991, was restructured and replenished with over $2 billion in
1994 to cover the agreed incremental costs of activities that benefit the global environment in four focal areas:
climate change, biological diversity, international waters, and stratospheric ozone.

The United Nations Framework Convention on Climate Change (UNFCCC) has designated GEF as its primary
funding mechanism. Climate change is a key focal area for GEF, accounting for about 45 percent of its total
allocations. Since its establishment, GEF has spent about $100-125 million a year to address climate change
under World Bank projects. GEF is the leading multilateral entity promoting energy efficiency and sustainable
energy technologies in developing countries. Each dollar of GEF climate change financing has stimulated
about $1.25 in associated World Bank financing, as well as about $4.00 in bilateral cofinancing, government
funds, and private capital. GEF funding for climate change projects is provided primarily as grants.

GEF’s strategy contains three operational programs that address long-term UNFCCC priorities for climate
change mitigation. The Operational Program on Removal of Barriers to Energy Efficiency and Energy
Conservation focuses on the following areas:

Electricity production and distribution (load analysis, better maintenance and instrumentation, and boiler
and turbine improvements);
Industrial energy consumption (efficient drives, motors, and improved systems configurations);
Manufacturing processes in energy-intensive industries (basic materials processing);
Effective use of energy-intensive materials;
Combined heat and power technologies;
Coal production, transport, storage, and use (best practice applications);
Manufacture of more energy-efficient equipment (refrigerators, industrial motors, and lighting systems);
Energy for rural and agro-processing industries;
Passive heating and cooling (building regulations and designs);
Commercial buildings (more efficient lighting and space conditioning); and
District heating and cooling (insulation, boiler tuning, and building controls).

The second operational program seeks to reduce GHG emissions associated with energy consumption and
production through increased use of already commercially viable renewable energy technologies, including:

Wind pumps for mechanical water pumping for agriculture and domestic water supply;
Low-temperature solar thermal heat for household and agricultural sectors;
Biomass and geothermal heat, including combined heat and power, and use of urban and industrial wastes
for process heat and district heating;
Wind, biomass, photovoltaics, small-scale hydro, and other renewable energy for rural electricity supply;
Renewable energy for grid-connected electricity (e.g., wind farms);
Storage systems (e.g., batteries) for cost-effective but intermittent renewable energy supplies; and
Biogas digesters for lighting and water pumping.

Examples of GEF Projects

GEF provided $26 million and investors in India $61 million more to finance 41 megawatts of wind power.
After the project's completion, public utilities and private energy developers added several hundred megawatts of new wind energy nationwide.

GEF’s Ilumex project in Mexico aimed at reducing energy waste and GHG emissions by proving the commercial viability of energy-efficient lighting in Guadalajara and Monterrey. GEF’s $10 million leveraged over $13 million in cofinancing. Mexican consumers and businesses in the project cities have since installed almost 400,000 more efficient lights than GEF originally projected. The result: 20,000 additional metric tons of carbon dioxide emission reductions.

Source: Global Environment Facility, 1999

The third operational program deals with the reduction of the long-term costs of low (or no) greenhouse
gas-emitting energy technologies, including:
Photovoltaics for grid-connected bulk power and distributed power (grid reinforcement and loss reduction)
applications;
Advanced biomass power through biomass gasification and gas turbines;
Advanced biomass feedstock to liquid fuels conversion process;
Solar thermal-electric technologies in high-insulation regions;
Wind power for large-scale grid-connected applications;
Fuel cells for mass transportation and distributed combined heat and power applications; and
Advanced fossil fuel gasification and power generation technologies, initially to include integrated
coal gasification and combined cycle technologies.

Table 3 summarizes ongoing GEF project funding by region and operational program.

Table 3 - GEF Project Funding by Region (US$ million)

	Energy Efficiency Program (OP 5)	Renewable Energy Program (OP 6)	Prospective Technologies Program (OP 7)	Total
Global	30.2	45.0	0	75.2
Latin America	37.1	25.2	52.4	114.7
Middle East/Africa	31.0	33.2	0	64.2
Asia	94.5	167.3	49.0	310.8
Eastern Europe	18.7	6.9	0	25.6
World Total	211.5	277.6	101.4	590.5

OP — Operational Program

World Bank's Prototype Carbon Fund

The World Bank is currently developing a post-Kyoto financing mechanism that would complement the GEF
funding — the Prototype Carbon Fund (PCF). The PCF is intended to achieve carbon and other GHG emissions
reductions while simultaneously supporting long-term efforts to create a sustainable carbon trading market.
The fund is designed to support the CDM and participate in it like any other entity permitted to do so under
the Kyoto Protocol. The PCF will operate in accordance with CDM procedures for registering carbon-reducing
projects, once such procedures are established. The fund was approved by the World Bank Board of Executive
Directors in July 1999 and is expected to become operational in February 2000 (BNA, 1999c — see Bibliography).

The legal framework for the PCF would be similar to that of a World Bank trust fund. The size of the PCF will be
$150 million, based upon contributions from 12 to 16 prospective participants, both public (industrialized countries
such as Finland, the Netherlands, Norway, and Sweden) and private (large companies such as British Petroleum,
Chevron, Tokyo Electric Power, etc.). The World Bank will make its investments in projects on the basis of project
selection guidelines that will be developed in consultation with the participants and hosts.

Once a project is selected, the World Bank, as administrator of the PCF, would sign separate agreements with
the host country and the project sponsor, specifying the amount to be paid to the host and to the sponsor for
the carbon offset. The negotiated price of the carbon offset would implicitly cover the cost of additional CO 2
emission reductions over the baseline, as well as a margin representing equitable benefit sharing of the gains
from the carbon offset between the World Bank and the host country. After verification of the carbon emission
reductions (also supported by the fund), PCF will facilitate issuance of creditworthy carbon offset certificates to
its developed country participants on a pro-rata basis.

The fund management expects to have two to three projects from the World Bank pipeline identified and ready
for implementation upon signature of the trust fund agreements. In the longer term, the PCF is expected to draw
on a combination of projects of other multilateral, bilateral, and private sector agencies.

Other World Bank Programs

Activities Implemented Jointly (AIJ). AIJ (a joint pilot project implementation mechanism under the UNFCCC)
implies that governments or companies contract with parties in another country to implement an activity that
reduces GHG emissions in that country. The World Bank initiated a three-year program on AIJ in collaboration
with the Government of Norway in April 1996. Four pilot projects have been launched (in Mexico, India, Poland,
and Burkina Faso), all of them linked to regular World Bank projects. The World Bank's AIJ pilot projects have
tested the means for estimating GHG emission reductions as well as monitoring, verification, reporting, and
institutional requirements for AIJ measures. The lessons learned will be used in future World Bank participation
in CDM projects.

Energy Sector Management Assistance Programme (ESMAP). ESMAP is a global technical assistance World
Bank program sponsored jointly with the United Nations Development Programme (UNDP). ESMAP focuses on
the role of energy in economic development with the objective of contributing to poverty alleviation and economic
development, improving living conditions, and preserving the environment in developing countries and economies
in transition. ESMAP channels free policy advice and other technical assistance to governments and focuses on
three priority areas:
Market-oriented energy sector reform and restructuring;
Access to efficient and affordable energy, including renewable energy technologies; and
Environmentally sustainable energy production, transportation, distribution and use.

ESMAP activities have substantially expanded the range of renewable energy investment operations entering
the World Bank's project pipeline. For example, ESMAP has succeeded in introducing innovations in renewable
energy lending such as the solar PV concession system for Argentina.

Asia Alternative Energy Program (ASTAE). ASTAE was established in 1992 to promote renewable energy
and energy efficiency in the World Bank's power sector lending operations in Asia. Since its inception,
ASTAE has supported a broad portfolio of alternative energy projects and activities throughout Asia.
ASTAE’s strategy also includes technical assistance to improve local technical expertise, system performance,
and institutional capability to design and implement alternative energy investment programs.

Renewable Energy and Energy Efficiency Fund (REEF). REEF is run by the International Finance Corporation
(IFC) and is expected to be the first global fund dedicated to investing in private sector renewable energy and
energy efficiency in developing countries. Now raising funding, the REEF will provide $150–210 million of
private and IFC capital for financing on- and off-grid projects of less than 50 MW.

Photovoltaic Market Transformation Initiative (PVMTI). PVMTI is now in its final stages of preparation by
IFC. This $30 million GEF fund will be used to accelerate the growth of PV markets in India, Kenya, and
Morocco by providing leverage to private companies on a competitive basis.

Small and Medium-Sized Enterprise (SME) Program. The SME Program is a $21 million activity of IFC
supported by GEF. It finances biodiversity and/or climate change projects carried out by SMEs in GEF-eligible
countries. Contingent, concessional loans are provided to financial intermediaries, which then finance the SMEs.
So far, two PV projects and one efficiency project have been approved at the time of the writing.

Solar Development Corporation (SDC). SDC is an initiative of the World Bank, IFC, and several private
foundations. SDC’s primary objective is to accelerate the development of viable private-sector business
activity in the distribution, retail, and financing of off-grid PV applications in developing countries. Up to
$50 million in capital is allocated for SDC, which, in addition to financing, will also make business advisory,
training, and market development services available to solar entrepreneurs.

Other Multilateral Donor Projects

The two largest regional multinational development banks — the Asian Development Bank (ADB) and the
Inter-American Development Bank (IDB) — have large portfolios of energy projects which represent a
substantial market for climate change-related technologies and services. Some of the projects are explicitly
concerned with GHG-reducing measures such as energy efficiency improvements or renewable energy
technologies. Examples include IDB’s Energy Efficiency Programs in Colombia ($12 million) and Mexico
($46.8 million), and ADB’s Wind Power Development Project in China ($600,000 in technical assistance).

Other energy projects such as those related to general power sector development and restructuring, new
power plant construction, and power transmission and distribution improvements (e.g., several ADB projects
in India) also create demand for energy-efficient technologies, equipment, and related services.

Large multisectoral environmental projects may also be of interest to U.S. suppliers of energy-efficient
technologies. For example, ADB’s Metro Manila Air Quality Improvement Project in the Philippines offers
opportunities for investments in the rehabilitation of the public transport fleet and transportation management
services.

U.S. Bilateral Aid and Financing Programs

USAID Climate Change Programs

The Climate Change Initiative of the U.S. Agency for International Development (USAID) was designed to
address the links between climate change and development with three main objectives:
1. To reduce the rate of growth in net greenhouse gas emissions by reducing emissions from greenhouse gas
sources and maintaining or increasing gas sinks;
2. To increase developing and transition country participation in the UNFCCC; and
3. To decrease developing and transition country vulnerability to the threats posed by climate change.

USAID has dedicated at least $1 billion in assistance grants to the task of decreasing the rate of growth in net
emissions of greenhouse gases in developing and transition countries. Programs targeted at the energy and
industrial sectors engage the private sector, remove barriers to, and create incentives for clean investment and
leverage financial sector resources.

The USAID Climate Change Initiative has the following elements:

Partnerships. Building on existing electric utility partnerships and the work of U.S.–Asia Environmental
Partnership and other relevant programs, USAID stimulates partnerships with growing energy-intensive
industries (potentially chemicals, steel, pulp and paper, automobiles, and agriculture). It brings together
private U.S. firms with counterparts in host countries to develop strategies for increasing productivity and
environmental soundness through improvements in management, production processes, and technologies.

Financing. USAID will help finance climate change-related projects by leveraging multilateral resources and
channeling private investment. The agency intends to create a fund to facilitate preparation of projects
cost-shared by industry. This fund will be used to induce a more environmentally sound approach to private
investments in energy generation. The investment fund will be paired with an effort to foster multilateral
development bank loans that encourage more environmentally sound energy production and use.
Finally, the Development Credit Authority will permit USAID to leverage commercial capital for “climate-friendly”
investment projects.

Policy Development. USAID plans to create a program to promote creation of regulatory and nonregulatory
incentives for economic development that is less carbon-intensive. The program will focus on policy and
regulatory reform and engage private financial institutions in the creation of economies that favor clean
investment. USAID currently has climate change-related activities in 44 countries throughout the world. In
the future, however, the agency expects to concentrate its resources on the 12 countries and regions that
contribute most to GHG emissions and are receptive to U.S. assistance: Brazil, Central Africa, Central America,
Central Asia, India, Indonesia, Mexico, Philippines, Poland, Russia, South Africa, and Ukraine. At least
40 percent of grant assistance and two-thirds of USAID’s use of credit instruments to combat climate change
will be devoted to these priority countries and regions. (Although China is a very large emitter of greenhouse
gases, USAID currently does not operate in China.)

Relevant U.S. Investment and Export Credit Programs

USAID Development Credit Authority (DCA). DCA is a general authority that permits USAID to offer credit
assistance for any development purpose of the U.S. Foreign Assistance Act. DCA is intended to serve as an
alternative funding tool to assist USAID missions in meeting their specific strategic objectives. DCA is intended
for countries and regions where USAID has an active presence. Global climate change activities are the key
sector for which USAID intends to use DCA. DCA is expected to become fully operational in FY 2000.

The credit assistance is in the form of direct loans and loan guarantees. Loan terms will be related to the needs
of each project but will not exceed 20 years. Loan guarantees will only be used where lenders engage in true risk
sharing with USAID and will cover no more than 50 percent of the lender's risk of loss. For projects to be eligible,
they must have positive financial rates of return so that the loans can be repaid. Loan amounts are expected to
be in the range of $2–20 million, depending on the project. The maximum loan amount is $100 million.

Export–Import Bank of the United States (Ex–Im Bank). Ex–Im Bank provides export credit support either to
U.S. exporters on a short-term basis or to foreign purchasers on a longer term basis (2–10 years). Through loan
guarantees and insurance, the agency fosters exports by making working capital available to U.S. exporters.
Alternatively, through similar mechanisms plus the extension of direct loans (and, on occasion, grants), Ex–Im
Bank provides credit at attractive interest rates to foreign buyers to encourage their purchase of U.S. goods
and services. Ex–Im Bank insures a wide variety of U.S. environmental exports, giving priority to small-business
transactions and the expansion of the overseas presence of the U.S. environmental goods and services industry.
Ex–Im Bank does not compete with commercial lenders, but assumes the risks they cannot accept. For example,
Ex–Im Bank provided a $49.7 million direct loan to fund a private geothermal power project in the Philippines for
Ormat Leyte Co. of Nevada. The loan covered 75 percent of the project's costs.

Ex–Im Bank has designed the Environmental Exports Program to provide enhanced levels of support for a broad
range of environmental exports. The program demonstrates Ex–Im Bank's resolve to reach out to small and large
exporters of environmental products and services. In 1997, the Environmental Exports Program approved 47
transactions for a total export value of $1.9 billion. The major features of the program are:
The short-term Environmental Export Insurance Policy will provide enhanced short-term, multi-buyer and
single-buyer insurance coverage for small environmental exporters. The program features policies that deliver
95 percent commercial coverage and 100 percent political coverage with no deductible.
Enhanced medium- and long-term support for environmental projects, products, and services. These
enhancements, which are reflected in Ex–Im Bank's loan and guarantee programs, include local cost
coverage equal to 15 percent of the United States contract price, capitalization of interest during construction,
and maximum allowable repayment terms permissible under the guidelines of the Organization for Economic
Cooperation and Development.

Ex–Im Bank Financing of a Cogeneration Project in Mexico

The U.S. firm Hartford Cogeneration was able to provide five-year financing for a Mexican customer using a Medium-Term Export Credit Insurance Policy from the U.S. Export–Import Bank. The policy enabled Hartford Cogeneration to obtain the necessary financing at a time when most U.S. banks were unwilling to provide medium-term financing to Mexico and medium-term credits from Mexican banks were too expensive.

In applying for the insurance policy, Hartford provided the Ex–Im Bank's loan officer with audited financial statements, a credit report, and a bank reference of the Mexican customer. After determining the creditworthiness of the Mexican customer, Ex-Im Bank issued the insurance policy to Hartford Cogeneration which then assigned the policy to a U.S. commercial bank.

Source: U.S. Department of Commerce, 1999.

Private Export Funding Corporation (PEFCO). PEFCO is a consortium of private lenders which acts as a
supplemental lender to traditional export financing sources. It works with Ex–Im Bank by using private capital
to finance U.S. exports. PEFCO makes loans to public and private borrowers located outside of the United States
who require medium- and/or long-term financing on purchases of U.S. goods and services through traditional
lenders or suppliers. In all cases, the loans made by PEFCO must be covered by the comprehensive guarantee of
repayment of principal and interest by Ex–Im Bank.

Overseas Private Investment Corporation (OPIC). OPIC finances medium- to long-term investment projects
through loan guarantees and direct loans. Direct loans are geared for small businesses or cooperatives and
usually range between $2 million and $10 million. Loan guarantees range between $10 million and $200 million.
OPIC protects U.S. business activities in emerging markets through its Investment Insurance Programs against
currency inconvertibility, expropriation (loss of investment due to expropriation, nationalization, or confiscation
by a foreign government), and political instability. The insurance programs also can be used to cover expanding
investments. OPIC also offers the Small Contractor's Guarantee Program, which assists small business construction
and service contractors. However, OPIC does not provide export financing.

There are also two funds operating under the aegis of OPIC that support U.S. environmental exports and
investment overseas:
OPIC Allied Capital International Small Business Fund: This is a $20 million equity fund which invests
in OPIC-designated countries and is managed by the Allied Capital Corporation. Eligible companies are
small U.S. businesses seeking risk capital to expand overseas. The preferred investment size is $2–5
million. One of the sectors targeted by the fund is environmental services.
OPIC Global Environmental Fund: This fund focuses primarily on equity investments in natural
resource-related sectors associated with the developing, financing, operating, or supplying of infrastructure
in clean energy, clean water, and waste management. Investment size can reach $10 million.

U.S. Small Business Administration (SBA). SBA's Export Working Capital Program guarantees up to $750,000
of either short- or long-term loans to help small businesses increase their export sales of products or services.
This program is designed to assist small businesses requiring capital to expand sales or manufacturing for
international markets, as well as meet their working capital needs. Loan proceeds may not be used to establish
operations overseas.

E&Co. — Energy Investment Service. E&Co is a nonprofit energy investment service whose mission is to
promote developing country energy enterprises that create economically self-sustaining energy projects that
use renewable energy, energy efficiency, or clean energy technologies to provide energy services, and produce
a more equal distribution of energy. E&Co offers (i) small loans to energy enterprises to advance projects in
developing countries which offer substantial promise but require modest amounts of funds to reach the next
stage of development; (ii) direct investment in energy enterprises and specific projects where such risk capital is
deemed critical to bringing the project to the attention of next-stage funders or investors; and (iii) intermediary
services by assisting energy enterprises in identifying financial resources — grants, loans, or equity — necessary
to fully implement a project under consideration.

International Fund for Renewable Energy and Energy Efficiency (IFREE). IFREE supports financially and
environmentally sustainable energy projects in emerging markets and facilitates partnerships between U.S.
energy entrepreneurs and their counterparts in developing countries. IFREE projects focus on the commercial
application of biomass, geothermal, hydropower, natural gas, solar photovoltaic, solar thermal, wind energy,
and energy efficiency technologies. IFREE’s Pre-Investment Funding Program offers conditional loans of up
to $50,000 for a maximum of one-half of the cost of pre-investment work for commercial projects in the developing
world which use one or more of the subject technologies.

Other Funding and Financing Sources

Commercial Debt Financing

U.S. Commercial Banks. U.S. commercial banks provide the bulk of trade and investment finance. In addition,
there are various types of private and public infrastructure funds that can be used to support technology
exports. The U.S. Department of Commerce maintains a national clearinghouse of private and public financial
institutions that offer trade finance. Also, the Office of Finance within the Department of Commerce's
International Trade Administration is in the process of developing a web-based export finance matching service
that will use a wide variety of financing sources to match exporter needs. This service will be available in the
year 2000.

Local Commercial Banks. Local financial institutions have an important role to play in financing small (under
$1 million) climate change-related investments, particularly in energy efficiency in the industrial, commercial, and
residential sectors.

It is generally easier to obtain commercial financing for an energy efficiency investment when it is part of a new
investment and not a retrofit. Many energy efficiency investments are imbedded in the goods and services that
constitute investments in a new plant or equipment. In these instances, the energy efficiency component can
account for a relatively small portion of the total investment. Such is the case in new commercial and residential
building construction, where the latest energy management systems and building controls are installed, and where
efficient windows, lighting, and heat, ventilating, and air conditioning systems are incorporated into the building
design.

Credit is generally tight in developing countries, making current conditions in local capital markets a significant
factor in financing energy efficiency investments. Chile is a positive example of a fairly well developed local
capital market, including a long-term bond market. However, in most other developing countries capital markets
are immature, and U.S. firms often find it too difficult and expensive to borrow money locally, unless local
financial institutions act as intermediaries for external financing sources such as multilateral development banks.

Vendor Financing

Vendor financing works best in mass market applications to finance exports (and sales in general) of common
equipment with a large number of end-users (e.g., utility boilers, industrial motors, and commercial lighting).
Sometimes, vendors form their own finance companies to serve these purposes, such as General Motors
Acceptance Corporation or Caterpillar Credit Corporation. A vendor finance program is a programmatic
relationship between an equipment marketer (the “vendor”) and a financial services company to provide
financing at the point of sale. An equipment marketer may be the manufacturer, but may also be a distributor
or retailer.

A vendor finance program consists of an agreement between the financier and the vendor (defining the
financing terms), and an agreement between the customer and the vendor (defining the customer's payment
obligations).

The vendor assumes the responsibility for documentation and other administrative tasks, and shares in
transaction costs. The vendor may provide certain credit enhancements, and provided a sufficient number
of transactions, credit may be extended to more end-users. In financing exports, it makes sense for vendors
to use export credit agencies (e.g., the U.S. Ex–Im Bank) as financiers.

USAID’s Industrial Motors Pilot Project in Mexico (1993-1998) provides an example of vendor financing. GE
Motors offered $1 million at attractive market rates for a three-year term to finance industrial motors as part of
the project. Several other motor manufacturers and adjustable-speed drive manufacturer Rubicom offered
similar financing packages.

Local Electric Utility Financing

Electric utilities can play an important role in financing energy efficiency projects that would reduce greenhouse
gas emissions. In addition to investments in energy efficiency on the supply side (e.g., in reducing transmission
and distribution losses), utilities in many countries are willing to finance demand-side management (DSM) programs
that offer them clear economic benefits.

In developing countries like India, China, Thailand, and Brazil, there is a shortage of power capacity. This gives
utilities an economic motivation to promote energy efficiency to reduce or avoid capital costs for new generation
and/or transmission and distribution capacity. DSM through end-use energy efficiency can be an effective means
for delaying capital expenditures for several years.

Another condition common in developing countries is cross-subsidizing of utility tariffs, where certain
customer classes (typically, residential, agricultural, or municipal customers) pay rates that are below the
utility's cost of service. In this case, the utility has a financial incentive to invest in end-use energy efficiency
for these customers as a way to reduce losses and to free up power that can be sold elsewhere, sometimes at a
higher tariff, thereby increasing revenues.

Because of their customer relationship, market position, access to capital, and existing systems to collect
payments through billing, utilities have natural advantages as financial services providers. By acting as a
financier, the utility earns fees and/or recovers its investment with interest.

Utilities’ financial services may take several forms, including direct loans or leases to customers. Alternatively,
the utility may choose to work with equipment vendors, offering finance programs marketed by selected
equipment sellers. Some financing programs may be focused on particular technologies such as compact
fluorescent lighting, motors, or capacitors. Although the utility serves as a vehicle to access financing for its
customers, the customer must repay the financing.

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