Towards an Analytic Taxonomy

The classification schemes mentioned above are useful only if they are complemented with an analytic approach. For this, the taxonomy can begin with the question, 'What are the reasons for a negative decision by a private investor?' The possible answers for this could be:

• The investor's perception that the investment will be unprofitable, that is, the rate of returns on the investment will be smaller than the risk-adjusted opportunity cost of capital.

• The investor's perception that the investment will not be feasible; for example, due to technical, legal, informational and other obstacles.

• Transaction costs: While standard energy solutions are available off the shelf, information about new technologies is not easily available. One has to do a lot of work to find them, assess them and obtain them. In every respect, this greatly increases the initial costs.

• Risk perception: Any investment involves uncertainties. If the risks associated with these uncertainties are too great, the investor will desist from making EE investments.

12 Reddy 2002.

13 Rohdin and Thollander 2005.

As it had been mentioned earlier, for every barrier, the determining factor is the value which is perceived. A barrier will only to be overcome if it is low enough to be acceptable and the investor is convinced of this fact. This is especially important for the barrier formed by some risks, as risks are notoriously difficult to judge. In addition, the investor will often, out of self-preservation, have to take account of the worst case risk, and that is a far bigger deterrent than the probable risk. Thus, we can distinguish the barriers to private financing as profitability-related, feasibility-related, information-related and risk-related.

Profitability-related barriers are those that lessen the financial viability of energy efficiency projects, thereby reducing the willingness of profit-oriented private investors to commit money to such projects. Specifically, these barriers influence the components of gross project revenue and project cost: The components making up gross project revenue can include: (a) project performance, like amount of energy saved; (b) sales volume, like number of energy efficient devices sold; (c) price, like price of energy efficient devices; (d) tariff, like electricity tariff and (e) collection rate, like rate of loan collection on energy efficient equipment sales, or rate of utility bill collection. The components of project cost include development and operating cost. Figure 6.1 shows a schematic representation of profitability barriers.

Feasibility barriers reduce the likelihood of a project being implemented. Unlike profitability barriers, feasibility barriers have no impact on the economics of the project. Rather, they reduce the potential for successful project implementation and therefore increase the uncertainty about the project. In some cases, feasibility barriers may be so strong that no amount of profitability can outweigh their negative impact on the investor's decision (Figure 6.2).

There are some barriers, which affect both profitability and feasibility. For example, lack of information can raise the cost of a project, lower the profitability, and put the feasibility of a project in doubt at the same time. Investors may be reluctant to commit funds if they cannot verify the data or if they suspect hidden legal obstacles, such as restrictions on foreign ownership, capital repatriation, and so on.

While discussing the drivers and barriers, it is important to consider the role of actors such as the national government, regional and local authorities; supranational bodies such as the European Union or the North American Free Trade Agreement; NGOs; international development agencies; the United Nations and its specialized bodies; the World Bank Group; international and national professional and trade bodies as well as others.

Figure 6.1 Schematic Representation of Profitability Barriers

Figure 6.1 Schematic Representation of Profitability Barriers

Source: Authors.

One could try to indicate which actor has the power to create, reduce or to remove certain barriers and on which actors the particular barrier has an influence. One could also try to indicate whether the barrier can be modified in the short term, by a subsidy for example; in the medium term, through new legislation for example; or only in the long term, through improving general education for example or probably never, like in the case of religious barriers. One could also look at the mechanisms as a means to overcome the usual constraints and pave the way for smooth functioning of projects. This, in turn, encourages the removal of barriers and affects investments positively. Such an actor-oriented approach would give clearer insights into barrier analysis.14

14 Reddy and Srinivas 2009.

Figure 6.2 Schematic Representation of Feasibility Barriers

Figure 6.2 Schematic Representation of Feasibility Barriers

Source: Authors.

Through such an approach we can find the role of actors. For example, if any barrier is named, we can see who created it, and who, therefore, is able to remove it. Here, the actors can be divided into three sub-groups—micro, meso and macro.

• The micro barriers relate to the project designers. To make better projects, they are the persons to address by information, training or support by specialists.

• The meso barriers relate to the organizations, such as utilities, energy development agencies or service companies. Through new incentives, organizational reform, and other changes, barriers can be reduced or removed.

• The macro barriers relate to the top level institutions, such as the state, the market, or the civil society, that determine the setting under which the lower levels have to operate.

The actions needed to address barriers are different for each. Through this approach, we not only need to look at the barriers themselves, but also at the institutions and situations that create the barriers. Each actor would then have two roles: (a) in carrying out a project at his own level, the actor has to work within existing external constraints given by top level institutions and (b) the actor can establish conditions—either barriers or drivers—for other actors at a lower level.

This approach can be used in surveys, by asking every actor to describe the types of barriers affecting profitability and feasibility as he perceives them.

Micro barriers: These can be referred to as the obstacles that are unique to a particular project. Here the barriers could be in terms of project design. A poorly designed project can make insufficient use of synergies or drivers, or take too little account of barriers. The person to address is the project designer by information, training or support by specialists. Examples include:

• A district heating project, which only focuses on upgrading the heat generation unit, is likely to be less profitable than the one which, at the same time, upgrades leakage in distribution systems, creates incentives for energy savings, such as metering in households, and gradually raises heating prices to recover costs.

• A project to install natural gas-fired combined heat and power unit (CHP) is more expensive initially than upgrading a coal-fired heating unit. However, after a relatively short time, the extra expenses are amortized by additional heat and electricity output.

• A medium sized or large project, or a bundling of smaller projects, is usually more profitable than dispersed and one-off small projects due to lower transaction costs and economies of scale.

• A project that consults the representatives of affected target groups is more feasible usually than the one that is imposed from above.

By changing the features of a project—for example, by modifying incentives for energy savings, replacing the technology, increasing the project size or creating legitimacy through consultation—the financial viability and feasibility could be improved. Additionally, changes in project design can reduce the internal barriers to profitability and feasibility.

Meso barriers: These relate to the organizations affiliated with the project. These barriers can be common to a wide variety of projects and can be tackled with efficient organizational design, human resource as well as time management. Examples include:

• The implementing agency may be understaffed, bureaucratic or lack proper incentives for promoting energy efficiency;

• The project target groups, such as municipalities, may be small, inexperienced and undercapitalized;

• The investors may lack experience in a particular technology or geographic area;

• The government authorities may put forward rules and procedures that can raise the cost of the project or reduce the feasibility of implementation.

Macro barriers: The macro barriers can be divided into three categories: state, market and civil society related. Since these barriers are not project or organization-specific, they cannot be altered by changing project or organizational design.15 For project sponsors and financiers, macro barriers are externally given and are difficult to influence unless they have the power of influencing politics, market or culture. In some cases, projects include policy components, which can affect macro variables, such as electricity tariffs, laws about who will keep financial savings from EE projects or subsidies. Usually it is easier for project sponsors and investors to change the project characteristics than to influence government policies such as electricity tariffs and subsidies. Therefore, many projects do not even attempt to change macro variables; instead they focus on overcoming or neutralizing the adverse effects of macro barriers through increased financial subsidies or, more rarely, through innovative project and organizational design.

The benefits of tackling macro barriers as well as the sustainability of the results over time are usually much greater than focusing merely on micro and meso level barriers.

Figure 6.3 illustrates three axes, namely, difficulty of implementation, benefits and sustainability of results. A dashed line has been drawn to illustrate the relationships among these three factors. According to Figure 6.3, if we target micro barriers (marked 'a' in the figure), we can expect relatively low benefits and sustainability of results, but these measures are also relatively easy to implement. But if we want to do something about macro barriers (marked 'c' in the figure), we can expect much greater difficulty, but also much higher benefits that are sustainable over time. Meso barriers lie somewhere in between on all dimensions (marked 'b' in the figure).

15 In some cases, projects can be immunized against the effects of policy and market barriers.

Figure 6.3 Targeting Micro, Meso and Macro Barriers

Figure 6.3 Targeting Micro, Meso and Macro Barriers

a = Measures targeting micro barriers b = Measures targeting meso barriers c = Measures targeting macro barriers

Source: Authors.

Barriers relating to the state are those that can be traced to the behaviour, that is, action or inaction, of governments or state-run organizations. Barriers relating to the market are those that can be traced to the behaviour of individuals, private firms and financial institutions, which reflect the prevailing market structure. And finally, barriers relating to civil society can be traced to the behaviour of NGOs, academic institutions and other civil society organizations (CSOs).

While the distinction among state, market and civil society barriers is useful as a means of classification, in practice, there are linkages among them. For example, markets react to policy changes and vice-versa. Policy is affected by the lobbying of firms and NGOs as well as other civil society organizations operating within a political and economic context. Efforts to remove or reduce macro barriers need to pay attention to these relationships in order to be effective.16

16 These inter-linkages exist. But the only people we can speak to are the actors. If they hold each other in a mutual network that makes change difficult, the issue may become one of trying to change that network.

In summary, an analytic taxonomy starts with the basic reasons for the lack of private investment: the perception of lack of profitability and, respectively or, the lack of feasibility. This leads to a distinction between factors that cause the lack of profitability and others that cause the lack of feasibility. These factors may occur at three levels, micro (project), meso (organization) and macro (policy, market and civil society). At each of the three levels, there are measures that can address the profitability and feasibility issues. These measures will be introduced in the following section.

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