Risk Management for Energy Efficiency Projects in Developing Countries

Abstract

The present paper addresses risk management fundamentals for energy efficiency (EE) projects in developing countries. The starting point for this paper is that there are many profitable EE projects in nearly every industrial enterprise that are simply not implemented. Four problems are often identified as the culprits for failing to harvest such projects: 1) lack of a rational and feasible approach to finance these projects; 2) lack of a rational internal management approach in the enterprise to package these projects in such a manner that they can be identified and implemented while the “plant is running”; 3) the high perceived risk of these projects; and 4) the fact that management is often simply unaware of the existence of EE projects of value. This paper is primarily focused on the third of these failure factors, risk, but touches also on the fourth factor since reducing project risk is predicated on understanding and measurement of EE benefits. The paper begins with a simple framework that emphasizes two dimensions of the organizational and contractual environment of EE projects. The first dimension is the energy intensity (measured, say, in terms of the ratio of energy costs to the total cost of goods sold) for the focal company initiating an EE project - the higher the energy intensity, the larger the potential payoff from EE, and the greater the ease of focusing management attention on EE. The second dimension is the level of organizational and contractual complexity of a project. Generally, the larger the number of external parties involved in a project (both financial and technical), the greater the complexity of assuring the ability to satisfy constraints necessary for successful project completion and the greater the transactions costs of contracting. After elaborating this framework and providing examples to illustrate required risk management, the paper discusses best practices for EE project risk management with illustrative case studies. Thereafter behavioral and other impediments to effective risk management are described, together with methods for overcoming these impediments. The paper then considers the role of carbon offsets as a possible source of co-financing of EE projects, and the risks associated with obtaining such carbon offsets under the CDM process. Finally, the paper considers the role of Energy Service Companies (ESCOs) in identifying profitable EE projects, in managing these projects and in reducing their risks. The paper concludes with recommendations for both companies executing EE projects as well as for international organizations like UNIDO attempting to promote EE in industry in emerging economies.