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China's quest for energy efficiency

One of the most exciting approaches I've come across to tackle China's low levels of energy efficiency is a financing model called energy performance contracting. In the US it has played a major factor in reducing the amount of energy needed to produce one unit of GDP. Under an energy performance contract, Energy Service Companies (ESCOs) install energy saving technologies and methodologies and then share the resulting savings with the customer, so paying off the capital investment. Simple as it may seem at first glance, there are many hurdles to overcome in carrying out an ESCO project in China.

I have recently been working alongside Dr. Stephane Grand. He is managing partner at SJ Grand, a financial advisory firm, and has been working in China for over 15 years. He wrote his PhD dissertation on Chinese contract law and is a fan of the ESCO model. “China’s growing ESCO sector is a fascinating industry, not just because of the commercial opportunities, but because of the many economic, legal, technology and policy issues that impact on the industry’s development. Every ESCO project is a real test of whether China’s legal structures can stand up to such complex contracting.  Whereas the market seems extremely promising, the structural issues can be daunting for a foreign player.”

China has one of the worst ratios of energy use to GDP in the world, 2.5 times the world average, but despite the huge potential of China’s ESCO industry, it has yet to approach the size of the ESCO industry in the US.

The World Bank created China’s first ESCO companies back in 1997 and since then together with its commercial arm, the International Finance Corporation, has lent hundreds of millions of dollars to the energy efficiency industry. According to China’s Energy Management Association, set up by the World Bank to promote the interests of the industry, there are now over 250 ESCO companies in China. The Asian Development Bank, agencies of the UN, and development agencies from various nations contribute expertise and capital to China’s ESCO industry. Chinese government subsidies also aid companies implementing energy performance contracts.

However, cultural and institutional barriers exist that inhibit the kind of growth the Chinese ESCO industry is capable of. The concept of utilising energy efficiency in order to create a ‘savings stream’ runs contrary to China’s prevailing business culture of quick returns based on expansion and finding new markets. Chinese Banks are often unwilling to lend for energy efficiency projects because the benefits appear non-tangible and therefore risky.  The size of typical ESCO loans is often too small for Chinese banks to be worthwhile appraising, loan amounts usually range from $1m to $6m, much smaller than the large infrastructure projects and production expansion loans that loan officers typically appraise. A lack of standardized measures for energy use makes the measurement of energy savings difficult in China, and this, added to the nascent character of China’s legal apparatus, means that ESCO contracts are much riskier than in other countries.

Development institutions have sought to ameliorate these problems through loan guarantees, financial and technical assistance to banks and ESCO companies, as well as help to bundle up ESCO projects to reduce loan transaction costs. Their efforts have resulted in a growing ESCO industry in China, but one that is not yet fully independent of this development aid.

Chinese ESCO development is also dependent on domestic ESCO capability. If the appropriate energy efficiency technologies, methodologies and management expertise are not available in China then the huge energy savings potential will not be realised. Chinese ESCOs are currently typically small operations and are often dependent on one technology, such as energy efficient lighting, rather than a full service of energy saving methodologies.

Through my discussions with Stephane Grand a theme began to emerge – whether China’s ESCO market can really take off will depend on two things – firstly the extent to which China can develop more sophisticated market institutions and capabilities development, and secondly whether Chinese companies can capture the full-service capabilities of their American and European counterparts.

The market research and academic writing on China’s ESCO market, considering its importance for energy security, emissions reduction and as a barometer of China’s economic development, is severely lacking.

Mint Research and SJ Grand are partnering to write an academic study into China's ESCO industry, due to be published later this year.

US-based Honeywell International (NYSE:HON) has an active ESCO arm which implemented energy saving solutions at Tsingdao-Asahi’s brewery in Shenzhen, ultimately resulting in 17 percent annual energy savings.

 

China Energy Recovery, Inc. (OTC:CGYV)  designs, manufactures and installs waste heat energy recovery systems which provide facilities with greater energy efficiency. In July the company won a US$1.42 million contract to design and manufacture two waste heat recovery systems for Chinese fertiliser company Hubei Yangfeng Group.

Global Innovative Systems Inc. (OTC BB: GBSY) has a wholly owned subsidiary, Tech Team Development (Zhuhai) Limited ("TTZ"), that has admitted as a member of EMCA, China's energy management company association.

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