5: International cooperation in financing energy efficiency
investments in developing countries*
International financial cooperation: An overview
2. Financial assistance through the flexibility mechanism
under the UNFCCC convention
3. Official financial assistance in energy
4. Private financing
5. Role of host countries in promotion
of energy efficiency projects
In the Asia and the Pacific region, economic growth can be assumed
to resume and continue rigorously in the foreseeable future. Structural
economic changes can be expected to occur at regional and sub-regional
levels. While world energy consumption may rise by 60 per cent
between 1997 and 2020, the Energy Information Agency (EIA) projects
that consumption in developing nations will grow by 121 per cent
during this period . In the business-as-usual (BAU) projection,
the EIA also expects energy related emissions to grow by 40 per
cent from 1990 to 2010 and to grow by 72 per cent from 1990 to
In the industrialized countries energy supply infrastructures
are mostly in place, and energy consumption is only growing at
a moderate pace. In the developing countries, however, there is
a considerable amount of energy demand and energy sectors with
need to be expanded rapidly. The due expansion of the energy sectors
offers considerable scope for introducing energy efficiency elements.
In several studies, it is observed that economic growth can be
achieved at lower levels of energy intensity and that the rate
of carbon emission growth can be reduced by improvements in energy
efficiency . Several studies suggest that energy efficiency technologies
provide the most cost-effective opportunities of greenhouse gas
(GHG) mitigation in developing countries . Investments in energy
efficient technologies are expected to show good cash flow through
reduced operating costs .
Since industrialized countries have accepted their obligations
to reduce GHG emissions, some of them may be attracted to new
markets in developing countries. In this context, international
cooperation in financing energy efficiency investment in developing
countries can be promoted and it may be helpful for developing
countries to analyze the current trend of international capital
flows and to review the various activities of public and private
sectors in energy efficiency.
This chapter compiles available information on international cooperation
in financing energy efficiency investment provided by multilateral
financial organization, governments and private sectors. The subsequent
sections provide information on the international investment trends
and various programmes for international energy efficiency financing.
In section 1, recent trends in international financial cooperation
including both official and private sectors are introduced. Section
2 analyzes incentives to invest in energy efficiency projects
for the potential shareholders. Section 3 and 4 explain current
programmes of public and private sector cooperation in energy
efficiency investments. Section 5 concludes with a brief discussion
of the role of host countries to attract the international investments.
: International financial cooperation: An overview
1.1 International investment
and financial flows
The international financial flows can be categorized into official
development finance and private flows. The former includes grants
and loans to low and middle income countries with the objective
of promoting economic development and welfare. These types of
financial cooperation is provided under bilateral special agreements
among governments, and through multilateral development banks
and financing institution. Private flows are provided through
commercial banks and other financial institutions.
The "Global Development Finance 2000", Report of the World Bank
concludes that for the period of 1990-1997 developing countries
as a whole experienced an increase in net inflows. Aggregate net
long-term resource flows to developing countries reached US$290.7
billion in 1999 which is a 290 per cent increase over 1990 (see
Fig 4.1). During the fore mentioned period private capital became
the major source in international financial cooperation.
shown in Fig 4.1, official capital flows to developing countries
have tended to decrease during recent years. Official development
finance accounted for 56 per cent of the total amount of financial
flows in 1990, but it sharply dropped to 11 per cent in 1997. The
major financing source used to be the OECD's Development Assistance
Committee (DAC) , which is the principal coordinating body related
to financial cooperation with developing countries. While DAC countries
are recommended to set a target level of aid equal to 0.7 per cent
of GNP by the United Nations, the weighted average actual financial
support of DAC countries in 1998 was equal to 0.24 per cent of GNP.
It has fallen steadily from 0.33 per cent in 1990 to a record low
of 0.22 per cent in 1996. In 1998, there was a rebounding of official
assistance flows. However, it may be considered as emergency assistance
to counter the Asian crisis and may, therefore, only be transitory
Trends in official development finance
Multilateral organization such as development Banks, International
and Regional Funds and United Nations Agencies also played an important
role as a source of official development finance . Some agencies
have invested in rather new markets and tried to service the niche
between bilateral official finance and private capital. Therefore,
in spite of relatively small amounts of investment, their activities
have been relevant in the sense that the activities are likely to
be example to other investments and enhance the capacity building
of host countries.
Trends in private capital flows
In contrast with official flows, private capital flows have experienced
a substantial growth between 1990 and 1997. The rising of aggregate
net long-term resource flows during the 1990s essentially resulted
from the increase of private resource flows. As shown in figure
4.1, private flows were US$42.6 billion or only 43 per cent of aggregate
net long-term flows in 1990. After that, private investments have
gradually risen to US$238 billion, representing 82 per cent of total
flows in 1996.
In some developing countries private capital markets have matured.
Credit worthiness and macro-economic management has improved and
investor confidence has risen. These factors have contributed to
an increase in direct private investment. Borrowing from commercial
banks also increased due to greater use of guarantees from private
The recent financial crisis has led to a sharp temporary drop in
net long-term capital flows to developing countries. However, net
FDI flows stabilized in 1998 and even rose in 1999. The World Bank
explains that the resilience in FDI is partly due to the fact that
FDI is more responsive to long-term growth trends than to short
term changes in financial returns. FDI flows are also determined
in part by access to natural resources and human capital. Therefore
FDI can form an important and relatively stable economic link between
developing and developed countries. The World Bank estimates a continuous
increase in FDI and stresses its role in the economic growth of
developing countries. (see Fig 4.3)
According to World Bank data, FDI doubled in the past two decades
and reached 45 per cent of total private flows in 1996. It is also
observed that FDI tends to crowd in rather than displace other investment
. FDI provides additional gains to host countries through expansion
of international markets, human resource development and the spillover
of advanced technology, know-how, increased domestic competition
and management skill. A number of studies have analyzed the relationship
between FDI and the spillover of technology to host countries .
Although the growth of FDI in these days has slowed from its rapid
pace during the early 1990s, it is expected to increase moderately
over the next few years and to remain a major source of international
capital flows for developing countries.
Investment trends by region and sectors
In 1999, East Asia, the Middle East and North Africa, and Latin
America enjoyed rising investment inflows (in absolute terms), while
Eastern Europe and Central Asia, South Asia and SubSaharan Africa
faced decreasing private sector investment inflow (see Table 4.1).
It would appear that investment flows have been very sensitive to
policy changes. It has been revealed that countries with less attraction
to private capital suppliers relied primarily on official financing
to supplement domestic savings while countries that have built investment
climates friendly to foreign private investment have enjoyed growing
financial inflows. Countries with stable macro-economic conditions
and an environment that is appealing to business have been able
to attract private capital flows. Between 1990 and 1997-1998 there
has been a trend of reallocations in aid resulted from sharp cuts
in aid to countries with poor investment promotion policies compared
to modest cuts in aid to countries with good policies.
It is not easy to generalize the overall trends in the sectoral
allocation of foreign investment, mainly due to some difficulty
in obtaining sector specific data. In 1998, investment from DAC
countries in energy related fields was 5.9 per cent of total bilateral
financial cooperation. At the same time, energy sector projects
accounted for 5.1 per cent of World Bank lending and 10.9 per cent
of total lending of regional development banks. Table 4.2 shows
the total net disbursements from multilateral agencies to recipient
countries by sector including both loans and grants.
Total investment in energy projects with private participation in
developing countries has boomed during the past decade, rising from
less than US$2 billion in 1990 to US$ 46 billion in 1997. The high
growth rate in electricity demand in developing countries resulted
in the increased private sector participation and investments.
Latin America and South, Southeast and East Asia have led the growth
in private participation in energy sector projects. Latin America
accounted for 42 per cent of the investment in private sector energy
projects during the 1990s. Most of the countries in the region promoted
private participation in energy as part of broader sectoral reforms
aimed at creating more efficient and competitive energy markets
(see Fig 4.4).
Financial assistance through the flexibility mechanism under
the UNFCCC convention
2.1 Financial assistance
under the United Nations Framework Convention on Climate
Financial assistance to developing countries has been one of main
issues in the international debate during recent years. In 1992,
the United Nations Framework Convention on Climate Change (UNFCCC)
agreed on the principle that international cooperation is needed
to finance development needs.
The United Nations Framework Convention on Climate Change (UNFCCC)
defined Financial Mechanism in Article 11 as follows: "The developed
country Parties may also provide and developing country Parties
avail themselves of financial resources related to the implementation
of the Convention through bilateral, regional and other multilateral
There are two important dimensions linked to the issue of financial
cooperation: The first aspect is that financial mechanisms agreed
under the UNFCCC need to be based on market mechanism which means
that UNFCCC enhances active participation of private sector.
Financial mechanisms agreed upon under the UNFCCC also closely
relate to the matter of technology transfer. Article 11.3 of the
Convention includes the following provision: "The developed country
Parties and other developed Parties included in Annex II shall
also provide such financial resources, including for the transfer
of technology, needed by the developing country Parties to meet
the agreed full incremental costs of implementing measures".
Kyoto Mechanisms of the UNFCCC
The text of the Protocol to the UNFCCC was adopted at the third
session of the Conference of the Parties (COP 3) to the UNFCCC
in Kyoto, Japan, on 11 December 1997 . It manifests in Article
5, 12 and 17 of the so-called "Kyoto Mechanism" or "Flexibility
Mechanism", which is expected to assist Annex I parties fulfill
their commitments of quantitative emissions reduction. At the
same time, the Kyoto mechanism is also expected to help the non-Annex
I developing country parties to develop their economies in a sustainable
way. The following sections aim to explain the potential utilization
of the Kyoto Mechanism for developing countries.
Article 17: International emission trading (IET)
International emission trading (IET) is designed for Annex I parties
to the Convention to achieve the overall emission reduction targets
at the lowest cost. Annex I parties have quantitative mandate
to reduce GHG reduction by 2008 to 2012. Under IET, parties can
choose to purchase the credit of emission reductions or to sell
the credit if they have reserves. If any party control the emission
with low cost domestically, it may choose to sell the reduction
credit after reduction according to the market price. If any party
find the emission control is too costly, it can choose to buy
the credit. IET could, thus, be beneficial for all parties.
Table 4.3 presents results of macro economic models which estimate
the economic cost of Kyoto Commitments for OECD countries in case
of no emission trading, trading only within Annex I countries
and global trading. The results of macro economic models support
the basic notion that the more Parties participate in IET, the
lower the overall cost in emission reduction .
are some studies doubting the optimistic view on IET . However,
according to the domestic emission trading experience in United
States, the market incentive mechanism has been successful. The
acid rain provisions of the U.S Clean Air Act allow electric power
plants to trade sulfur dioxide allowances, resulting in an active
private market and less than 50 per cent cost of what was expected
in emission reduction . Alike domestic emission trading, the introduction
of IET would enable to achieve Kyoto targets with lower aggregate
Projects enhancing energy efficiency and reducing greenhouse gas
emissions may become viable by securing carbon contracts. IET
may encourage the participation of private sector, because the
emission reduction can become capitalized to the private benefit.
IET may be opened to the private sector of Annex I countries to
participate in emissions trading. Private sector participation
may also reduce the potential for large sellers or buyers to influence
market prices in their favor. However, entity trading would not
alter the fact that Parties, not firms, are ultimately responsible
for compliance with the Kyoto protocol.
Article 12 : Clean development mechanism (CDM)
While the environmental impact of reducing greenhouse gases would
be the same no matter where the reductions take place, the cost
of reducing greenhouse gas emissions can be many times greater
in some countries than in others. Therefore it may be more cost
effective to reduce emission in countries with the least cost.
That is the basic idea of Clean Development Mechanism (CDM). Annex
I parties to the convention may implement GHG mitigation project
activities in developing countries subject to approval of concerned
governments, and use a part of Certified Emissions Reductions
(CERs) generated from the projects to achieve compliance with
their commitment targets.
The potential size of CDM market seems to be attractive. Depending
on the economic model used by researcher and scenario such as
"EU ceiling scenario" and "no hot air scenario", the potential
scope for of CDM is estimated to range widely . One recent research
analysed the size of the CDM market as 132-358 MtC .
To attract potential investors from private sector, the economic
cost of emission reduction in CDM should be more cost effective
than domestic option within OECD countries. It is hard to quantify
the exact costs due to uncertainty of economic model and difference
with reality, but nearly all analysts agree CDM-based reductions
are likely to be less costly than domestic action.
CDM may become the main mechanism for resource transfer between
developed and developing countries and to promote the participation
of private sector accompanying technology transfer and advanced
management know-how .
The establishment of a "Clean development mechanism" is agreed
in principle but at the time of the preparation of this report,
all modalities were still under discussion. Following issues require
clarification and consensus: (a) How is assistance for mitigation
projects in host countries administered?; (b) What are the respective
roles of private and public financing?; (c) How can the baseline
be decided?; (d) Shall fixed discount rates be used in calculating
the financial viability? How will discount rates be decided?;
(e) What kind of capacity-building is required regarding these
entities on the part of hosts and investors? (development of a
guide to successful CDM projects, code-of conduct provisions).
In addition, in Art.12 paragraph 6 of Kyoto protocol, it says
that "the CDM shall assist in arranging funding of certified project
activities as necessary". That is, CDM investments are expected
to be addition to existing or planned projects rather than the
sole medium for basic project financing.
Article 6: Activities Implemented Jointly/Joint Implementation
JI is defined in Article 6 of the Kyoto Protocol and envisaged
to become operational by 2008. Entities of 'Annex I' countries
can fund emission reduction activities in non-Annex I countries
with a view to obtain the emission reduction units (ERUs) . Since
JI will be a new mechanism to get GHG reduction credits and trade
them, COP 1 had established Activities Implemented Jointly (AIJ)
under the pilot phase through decision 5/CP.1 to use its experience
and lessons to design the Kyoto mechanism properly.
The first Conference of Parties (COP1) agreed to establish AIJ
as a pilot trial phase of Joint Implementation. The only difference
between AIJ and JI is that collaboration under AIJ will not as
yet permit investor to get emission reduction credits, while investors
in the latter will be able to obtain some credits in the form
of ERU from 2008. The purpose of the AIJ programme is only to
gather lessons and experience on the opportunities and obstacles
for policies and measures of JI to avert confusion in implementing
(see Fig. 4.5).
The following criteria need to be met for projects to qualify
Project must contribute to achieving UNFCCC objectives;
Voluntary participation of non-Annex I country party ;
Acceptance, approval or endorsement by host country governments;
Compatible with and supportive of national environmental and
developmental priorities and strategies;
Contribution to cost-effectiveness in achieving global benefits;
Real, measurable, and long-term benefits related to the mitigation
of climate change that would not have occurred in the absence
of such activities;
Financing additional to financial obligations of Annex II
Parties and to official development assistance.
During the AIJ pilot project implementation phase, participants
can not as yet obtain credits for emission reduction activities.
Thus, one would expect only limited private sector's interest
and participation. Since its inception in 1995, however, AIJ has
attracted international attention. 103 activity reports were available
on 143 projects which were implemented in 27 host countries and
by 9 investor countries with a total of approximately 170 million
tons (Mt) of emissions reduced at a total cost of approximately
US$ 640 million .
In particular, looking at the share of private sector funding
in Fig 4.6, it would appear that there is a surprisingly large
participation of private investment (US$ 140 million), which compares
to US$46 million of public investment in AIJ projects. At the
time of the preparation of this report, seven parties (Japan,
Canada, Denmark, Iceland, Netherlands, Norway, Sweden, and U.S.A)
have actively supported the pilot phase of AIJ and most of the
private funding was from US investors. Schwarze (2000) considered
the active participation of US private sector as a result of the
US Initiative on Joint Implementation.
IPCC defines climate change mitigation activities as investments
including energy efficiency, renewable energy, fuel switching,
fugitive gas capture and land use change and forestry (LUCF) activities.
The largest number of projects implemented in AIJ were projects
in renewable energy and energy efficiency, together accounting
for 76 of the 95 projects (80 per cent). Only 17 per cent of the
projects have been related to LUCF activities. This sectoral distribution
of AIJ projects, however, is not equalized with the share of emission
reduction through projects. As seen in Fig.4.7, the amount of
emission reduction through LUCF activities accounts for 38 per
cent of total emission reductions.
The AIJ project described in detail in the Box 4.1 replaced approximately
200,000 ordinary, incandescent light bulbs with compact fluorescent
light bulbs (CFLs) in the Mexican cities of Monterrey and Guadalajara.
These CFLs require 25 per cent of the energy of incandescent bulbs,
resulting in less electricity generation and fewer fossil fuel
emissions. CFLs can last up to thirteen times longer than ordinary
bulbs. The emissions impact of the activity will continue until
early 2006, based on 33 month phase-in for the bulb sales and
an assumed average eight year life of each bulb.
AIJ projects have various scales, types and host countries. The
1998 report on AIJ presented by the UNFCCC Secretariat points
out that "the geographical distribution of activities showed a
marked imbalance". Of 139 projects, 95 projects were located in
economies in transition . Only 32 per cent the projects were located
elsewhere. Africa was particularly poorly represented, hosting
only one project. However, the greatest effect of GHG reduction
was achieved in Latin American countries with 44 per cent of all
GHG reduced or sequestered located there as compared to only 30
per cent in economies in transition.
It is not simple to measure the economics and benefits of AIJ
project since standardized formats for baselines of projects and
for reporting are not yet agreed. Schwarze (2000) compared the
average total cost per ton of CO2 equivalent reduced by activity
type which includes transaction cost for monitoring, verification
and general project administration. As a result, each of AIJ activities
is costing less than US$ 4 per ton of CO2 equivalent reduced.
Taking into account the amount of fuel saving through the project,
therefore, these activities are likely to be 'no regrets' options
with negative cost . The Kyoto mechanism could take the role to
fill the "commerciability" gap between amount of financing needed
to make a project commercially viable and the amount available.
To complement private investments, in order to address financial
risks associated with the projects, so-called 'financial additionality'
should be adopted appropriately to allow such complimentarity.
In addition, the Kyoto mechanism could enhance the international
cooperation and communication. Effective implementation of the
Kyoto mechanism requires appropriate support measures from both
donor and host countries.
1 of 2
* This part of the publication was prepared by ESCAP secretariat.
It is based on research work and drafts provided by Ga-hyeong
Hur, Seoul National University, Seoul, Republic of Korea.
1. International Energy Outlook, 16 March 2000.
2. Von Weitsaecker & Lovins & Lovins,1997, Factor Four : Doubling
wealth, Halving resource use, Earthscan
3. Tim Forsyth, 1999, International Investment and Climate Change
: Energy Technologies for Developing Countries, The Royal Institute
of International Affairs.
4. Alessandro Lanza, 1999, "The Clean Development Mechanism: Investment
Implications Trading and the Clean Development Mechanism : Resource
Transfers, Project Costs and Investment Incentives, IEA.
5. DAC data : The data cover aid loans and grants, other official
flows, private market transactions and assistance from non-governmental
organizations to each recipient country and recipient countries
combined. DAC countries - Australia, Austria, Belgium, Canada,
Denmark, Finland, France, Greece, Ireland, Italy, Japan, Luxembourg,
Netherlands, New Zealand, Norway, Portugal, Spain, Switzerland,
United Kingdom, United States.
6. Global Development Finance 2000
7. The World Bank Group comprises five organizations : the International
Bank for Reconstruction and Development (IBRD), the International
Development Association (IDA), the International Finance Corporation
(IFC), the Multilateral Investment Guarantee Agency (MIGA), and
the International Centre for the Settlement of Investment Disputes
8. Bosworth, Barry P., and Susan M.Collins. 1999. "Capital flows
to Developing Economics: Implications for Saving and investment",
Brookings Papers on Economic Activitiy.
9. E.Borenzstein, J. de Gregorio and J.Lee, 1995, "How does foreign
direct investment affect growth?", NBER working paper 557, National
Bureau of Economic Research, Cambridge, Mass., D.Coe, E. Helpman
and A.Hoffmaister, 1995, "North-South R&D spillovers", Discussion
paper 1133, Centre for Economic Policy Research, London.
10. The Convention entered into force on 21 March 1994 and received
181 instruments of ratification by 10 December 1999.
11. It shall enter into force on the ninetieth day after the date
on which not less than 55 Parties to the Convention, incorporating
Annex I Parties which accounted in total for at least 55 per cent
of the total carbon dioxide emissions for 1990 from that group,
have deposited their instruments of ratification, acceptance,
approval or accession. As at 13 January 2000, 84 Parties have
signed the Kyoto Protocol, but it didn't get ratification yet.
12. Differences in marginal cost of reductions between models
are based on (a) variations in business-as-usual projections of
CO2 emissions; (b) different assumptions on the availability and
cost of emission reduction; (c) more or less detailed treatment
of end-use energy and corresponding prices and taxes.
13. Some studies (Baron, 1999) indicate the result of macro-model
is too optimistic. However, it is generally agreed that the Kyoto
mechanism can reduce the overall cost of emission mitigation.
14. The United States Government (1999), The U.S. view : International
15. EU ceiling scenario considers EU as one entity with emission
reduction target, so surplus and deficit of emission reduction
of all EU member countries will be added in the end of target
year (2012). No hot air scenario suggest not to accept the emission
reduction of former soviet union which was produced by its economic
condition since 1990, not by effort to reduce the emission.
16. Zhang(2000), Estimating the potential size of the Kyoto flexibility
17. Art.12.9 allows private and/or public entities to participate
to the CDM, with further guidance to be given by the executive
18. ERU indicates the emission credits from JI, while CER comes
from CDM. Technical distinctions of two credits are under discussion.
19. Schwarze (2000), Activities Implemented Jointly : another
look at the facts, ecological economics32, pp.255-267.
20. they are mostly funded by European countries
21. Schwarze (2000), Activities Implemented Jointly : another
look at the facts, Ecological Economics 32, pp.255-267