Risk management for energy efficiency projects in developing countries

The present paper addresses risk management fundamentals for energy efficiency (EE) projects in developing countries. The starting point of this paper is that there are many profitable EE projects in nearly every industrial enterprise that are simply not being implemented. Four problems are often identified as the cause for the failure to implement 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 primarily focuses on the third of these failure factors, namely risk, but also touches upon the fourth factor, as reducing project risk is predicated on understanding and measuring EE benefits. The paper introduces a simple framework that emphasizes two dimensions of the organizational and contractual environment of EE projects. The first dimension is energy intensity (measured, say, in terms of the ratio of energy costs to the total cost of goods sold) for the focal firm initiating an EE project—the higher the energy intensity, the larger the potential payoff from EE and the greater the ease of directing management’s attention to EE. The second dimension is a project’s level of organizational and contractual complexity. Generally, the larger the number of external parties involved in a project (both in financial and technical terms), the greater the complexity of assuring the ability to satisfy constraints necessary for successful project completion and the greater the transaction costs of contracting. After elaborating this framework and providing examples to illustrate the risk management required, the paper discusses best practices for EE project risk management with illustrative case studies. Thereafter, behavioural and other obstacles to effective risk management are described, together with methods for overcoming these obstacles. The paper then considers the role of carbon offsets as a possible source for co-financing 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 and in reducing their risks. The paper concludes with recommendations for both companies executing EE projects, as well as for international organizations like UNIDO which promote EE in industry in emerging economies.