Public Disclosure Authorized Final Report Scaling Up Thermal Retrofit of Residential and Public Public Disclosure Authorized Buildings in Eastern Europe March 2018 Public Disclosure Authorized Public Disclosure Authorized Energy and Extractives Global Practice Europe and Central Asia Region Copyright © 2018 The International Bank for Reconstruction and Development/ THE WORLD BANK GROUP 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing …. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, or its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. 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Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 2 Contents Abbreviations and Acronyms ....................................................................................................... 5 Acknowledgements ........................................................................................................................ 6 Executive Summary ....................................................................................................................... 7 Chapter 1: Introduction .............................................................................................................. 15 1.1 Background .......................................................................................................................... 15 1.2 Objectives ............................................................................................................................. 16 1.3 Methodology ........................................................................................................................ 16 1.4 Report Structure ................................................................................................................... 17 Chapter 2: The Energy Efficiency, Economy and Climate Nexus .......................................... 18 2.1 Background .......................................................................................................................... 18 2.2 What drives changes in energy intensity in European economies? ...................................... 19 2.3 Energy efficiency and the economy ..................................................................................... 21 2.4 Energy efficiency as a climate policy measure .................................................................... 23 Chapter 3. Enabling Environment for Energy Efficiency Investments .................................. 27 3.1 An assessment framework to evaluate policies, institutions, and financing ........................ 27 3.2 Findings from application of the assessment framework ..................................................... 29 3.3 Gap analysis ......................................................................................................................... 32 Chapter 4: Policy Interventions to Scale Up Thermal Retrofit of Buildings: An In-depth Analysis of Bulgaria and Croatia ............................................................................................... 38 4.1 Background of the model ..................................................................................................... 39 4.1 Croatia scenario analysis ...................................................................................................... 40 4.3 Bulgaria scenario analysis .................................................................................................... 45 Chapter 5. International Experience with Delivery Mechanisms for Thermal Retrofit of Buildings ....................................................................................................................................... 51 5.1 Delivering EE Retrofits in Public Buildings ........................................................................ 52 5.2 Delivering EE Retrofits in Residential Buildings ................................................................ 56 Chapter 6. Roadmap for Scaling up Thermal Retrofit of Buildings in Croatia .................... 62 6.1 Overview of building stock, retrofit needs, and stakeholders .............................................. 62 6.2 Scaling up residential building retrofits ............................................................................... 65 6.3 Scaling up public building retrofits ...................................................................................... 74 Chapter 7. Roadmap for Scaling up Thermal Retrofit of Buildings in Bulgaria ................... 82 7.1 Overview of building stock and retrofit needs ..................................................................... 82 7.2 Scaling up residential building retrofits ............................................................................... 84 7.3 Scaling up public building retrofits ...................................................................................... 88 Annex A: Detailed Analysis Behind the Energy Efficiency, Economy and Climate Nexus (Chapter 2) .................................................................................................................................... 95 Background ................................................................................................................................ 95 What drives changes in energy intensity in European economies? ............................................ 95 Energy efficiency and growth .................................................................................................... 97 Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 3 Economic efficiency of energy efficiency ................................................................................. 99 Energy efficiency and jobs ....................................................................................................... 101 The fiscal impact of energy efficiency ..................................................................................... 101 Energy efficiency as a climate policy measure ........................................................................ 102 What does past evidence tell us? .............................................................................................. 103 Going forward: how to continue the climate benefits of energy efficiency ............................. 106 Annex B. Effectiveness of EE Policies in Buildings: a Modeling Approach ......................... 113 Tools and methodology for prioritizing policies ...................................................................... 113 Methodology for Croatia .......................................................................................................... 116 Methodology for Bulgaria ........................................................................................................ 119 Annex C: Case Studies of Financing Mechanisms .................................................................. 121 Public Buildings Case Study: Armenia Dedicated Energy Efficiency Fund ........................... 121 Public Buildings Case Study: Belgium’s Fedesco ................................................................... 125 Residential Buildings Case Study: Lithuania Jessica Funds and the EnerVizija Model .......... 128 Residential Buildings Case Study: Poland Thermo-Modernization Program .......................... 134 References ................................................................................................................................... 138 Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 4 Abbreviations and Acronyms capex capital expenditure MoCPP Ministry of Construction and CG credit guarantee Physical Planning (Croatia) CP carbon prices mt metric ton DH district heating MWh megawatt-hour DSM demand-side management M&V measurement and verification ECA Europe and Central Asia mtoe million tonnes of oil equivalent ECO Energy Company Obligation (UK NEEAP National Energy Efficiency scheme) Action Plan ECS Energy Community Secretariat NPV net present value EC European Commission (EC) OFGEM Office of Gas and Electricity EE energy efficiency Markets (UK) EED Energy Efficiency Directive PIU project implementation unit EEO energy efficiency obligation PPP public-private partnership EMS energy management system R&D research and development EPBD Energy Performance of Buildings SEDA Sustainable Energy Development Directive Agency (Bulgaria) EPC energy performance contract SME small and medium-size enterprise EPEEF Environmental Protection and RE renewable energy Energy Efficiency Fund TA technical assistance ESA energy service agreement TRV thermostatic radiator valve ESCO energy service company TWh terawatt-hours ESMAP Energy Sector Management Assistance Program ESP energy service provider ESPC energy service performance contract ETS Emissions trading system EU European Union GEF Global Environment Facility GFA guarantee facility agreement GJ gigajoule GWh gigawatt-hour(s) HMO houses in multiple occupations HOA homeowner association HVAC heating, ventilation, and air conditioning IFC International Finance Corporation IFI international finance institution IPCC Intergovernmental Panel on Climate Change kgoe kilograms of oil equivalent kWh kilowatt-hour MAC marginal abatement cost MESC marginal energy saving cost (curve) MoF Ministry of Finance Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 5 Acknowledgements This report was written by a team including Claudia Ines Vasquez Suarez (Senior Energy Economist and Task Team Leader), Feng Liu (Senior Energy Specialist and co-Task Team Leader), and Grzegorz Peszko (Lead Economist). Jonathan Sinton (Senior Energy Specialist), Jas Singh (Senior Energy Specialist), Fan Zang (Senior Economist), Hua Du (Consultant) and Karuna Phillips (Consultant) also provided inputs to this report. The team would like to acknowledge valuable comments provided by Ranjit Lamech (Practice Manager), Peter Johansen (Senior Energy Specialist, peer reviewer), Luiz Maurer (Principal Industry Specialist, IFC, peer reviewer), and Andrey Milyutin (Senior Housing Specialist, IFC, peer reviewer). The final report was edited by Chris Marquardt. The report benefitted from inputs from the North-west Croatia Regional Energy Agency, the Buildings Performance Institute Europe, and Infraproject Consult in Bulgaria, as well as comments and inputs from government officials and stakeholders in Croatia and Bulgaria. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 6 Executive Summary The promise of EE building retrofits: Introduction lower bills, improved health and There is consensus among EU policy makers and its citizens on the internal comfort levels, renewed need to scale-up efforts to improve the energy efficiency of the building stock, lower energy imports, EU’s building stock, given that: enhance competitiveness, climate • Buildings are responsible for 40 percent of the EU’s primary change mitigation energy consumption, most of which is imported, and about 36 percent of its CO2 emissions, a key element in its climate commitments; • Renovating the dilapidated building stock is a priority for many Eastern Europe countries, as occupants often suffer from underheating with potential adverse health impacts, and heating costs can be substantially reduced. For these reasons, the EU reached a provisional political agreement in December 2017 to further accelerate the rate of building renovation towards more energy efficient systems, thereby tapping into the huge energy savings potential in the building sector. Croatia, Bulgaria, Poland and Romania have improved their energy efficiency considerably over the past 20 years. Yet each still lags the EU-15 countries in terms of energy productivity, or GDP per unit of energy used, and thus have not reached their optimal energy efficiency levels. So, while renovation experience in these countries demonstrate that heat demand can be reduced by 30– 50 percent in buildings with attractive economic returns, only a small portion of the pre-1990 residential and public buildings have undergone thermal retrofits—due to prevailing market failures, barriers and lack of adequate delivery mechanisms. How to ensure that the low-hanging While there is consensus about the goal of energy efficiency, how fruit is picked remains to realize this potential remains the subject of debate and a challenge discussion. On the one hand, the impacts of energy efficiency policies and programs depend in part on how they are designed, implemented, and financed. Because investments in thermal retrofits are financially attractive, in principle, they should happen on ‘their own’—provided there is an attractive investment climate and thus no need for government funding and intervention. However, experience with buildings thermal retrofit programs in these and other countries has shown such programs are among the most difficult to implement. As a result, the pace of renovation of the buildings stock has fallen significantly behind expectations and needs in these four countries. The annual renovation rate is low - between 0.12-0.45 percent. This report intends to contribute to the formulation of effective policies, financing, and delivery mechanisms for scaling-up thermal retrofits. Based on analytical framework in Figure ES-1, the report Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 7 Figure ES-1. The Energy Efficiency recommends strengthening the four columns of the building (laws, Promise policies and governance; markets; capacity and awareness; and financial incentives) to create an enabling environment for investments, and enhancing the base through the design and implementation of effective financing and delivery schemes. The widespread adoption of energy efficiency will require a mix of EE Promise: policies, measures and programs to overcome the financial, lower bills, improved institutional, technical and behavioral barriers common in most Laws, Markets Capacity Financial markets—along with some additional initiatives tailored policies, and and incentives specifically to the building sectors in these countries. awareness governance Gaps in Enabling Activities Supporting financing and delivery mechanism The analysis in this report focuses on public and residential buildings in Bulgaria, Croatia, Poland, and Romania. Compared to other sectors, single family and multifamily houses as well as public buildings remain inefficient with uneven service quality. A rapid assessment was conducted to assess gaps and prioritize action in the enabling environment (the four columns). Based on these Despite progres in enacting EU- findings, more specific recommendations on the financing compatible laws and regulations, schemes (including financial incentives), delivery mechanisms, and long-standing barriers hamper EE institutional set-ups are recommended for Croatia and Bulgaria. scale-up The rapid assessment concluded that these four countries have Legislati relatively strong legislative and regulatory frameworks in place in on & Market Governa Conditio line with the EU’s Energy Efficiency and Energy Performance of nce, 87% ns, 79% Buildings Directives. Implementation and enforcement of rules and regulations, however, remain a challenge in the countries Capacity (Figure ES-2). Specifically: • Building & Improvements in regulations to promote energy performance Bulgaria Awarene contracting (such as clarifying public procurement rules for ss, 45% Germany energy efficiency services in Croatia and Poland) and Denmark Building improvements to Homeowner Association Laws to facilitate France thermal retrofits in muiltifamily apartment buildings (in Figure ES-2. Progress and gaps on Bulgaria, Croatia and Romania) are needed; energy efficiency enabling efforts • The development and implementation of energy management systems are needed in Bulgaria, Romania and Poland, as well as further improved capacities for energy managers; • Cost-reflective energy pricing (particularly for space heating) remains to be introduced in the residential sectors in Bulgaria and Romania; • Further efforts are required to improve regulatory enforcement (e.g., building codes) and facilitate financing for the deployment of large-scale programs in all four countries; and • Capacity building and informational programs for a range of stakeholders—from service providers to auditors to information centers—are a gap in all four countries. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 8 Policy reforms, nor financial Optimal Package of Policies and Measures incentives, alone would unlock the While policy reforms are needed, they alone will not provide large savings potential. sufficient incentive to buildings owners, particularly in the residential sector, to invest in comprehensive thermal retrofits. A modelling exercise was undertaken to assess and optimize packages of policy reforms, government programs and financial incentives in order to mobilize the highest levels of investment in Bulgaria and Croatia. The model considered various government interventions (e.g., energy pricing reforms, information and training, energy efficiency obligations or EEOs, grants), four different packages of renovations—from shallow roof insulation to comprehensive deep retrofits, and building type (for both public and residential buildings). The results for each country analysis show that if current market and policies remain unchanged for the next 15 years (the baseline scenario), deep retrofits would likely take place in only a limited number of mostly non-residential buildings. Without policy reforms, only very The results for Bulgaria are presented in Figure ES-3. As show, high levels of subsidies would trigger policy reforms alone (scenario S4) would trigger low levels of investments in residential buildings investments in nonresidential buildings (offices and hospitals, and schools). Multifamily houses, which often have higher risks and transaction costs, show low uptake even when introducing energy price reforms and a 25 percent grant (scenario S5). The modelling also showed that, absent energy price reforms, very high levels of financial support would be needed to persuade homeowners to invest in energy efficiency measures. In multifamily residential housing, the deepest thermal renovation could be triggered only with high levels of grants (50-75 percent) without actions to address the barriers in the policy and institutional environment (Scenario S3). Of course, such levels of support are also not fiscally sustainable and if implemented, risk falling below the total investment requirements. To mobilize the higest levels of The most cost-effective package of interventions that would investments, interventions to reduce maximize energy savings are comprehensive market and risks and transaction costs coupled institutional reforms with additional revenue enhancement with revenue enhancement through EEOs or carbon pricing. The analysis also showed for instruments are needed single-family houses, the Bulgarian government will need to implement a comprehensive package of market reforms, such as (a) energy price reforms and measures reducing transaction costs and risks to the typical EU levels; and (b) additional market-based revenue enhancement through EEOs (as envisaged under the EU Energy Efficiency Directive) and/or carbon pricing (scenario S7). However, because market-compatible reforms need time to overcome peoples’ entrenched behaviors, the transition period may require an additional ‘market push’ such as small, temporary investment grants (25 percent of investment costs). Grants are generally most effective if they are structured to reward first Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 9 adopters and decline over time to avoid subsidy dependencies and other market distortionary effects. Figure ES-3. Impact of policy packages on annual energy savings in Bulgaria (GWh/year) Scenario legend: Renovation packag Scenarios (thermal insulation thickness No insulation S1 Baseline; no grants B Double glazing (baseline) 5 cm roof S2 Baseline + 25% grants R1 Double glazing 15 cm roof & walls, 10 cm floor S3 Baseline + 50% grants R2 Double glazing 15 cm roof, walls & floor S4 Soft policy measures only R3 Double glazing S5 Energy price reform + 25% grants R3 30 cm roof, 20 cm walls & 15 cm floor tripl Combined market reforms (soft policies and energy Substitution of the heating system S6 Th price reform, carbon price/EEO); no grants Installation of a heat recovery unit S7 Combined market reforms + 25% grant To support investment delivery, Financing and Implementation Options for Croatia and Bulgaria countries need to put in place All four countries need to develop strategies and long-term national long-term programs programs for the renovation of their building stocks, complete with financing and implementation mechanisms. While commercial financing should be the long-term goal, these programs may have to rely on significant public financing first to test the efficacy of various schemes and demonstrate their viability and risks, while building the capacity of the various private sector participants. In residential buildings, households’ decisions to undertake larger, complex renovations often hinge on the availability of credible information, realism of payback periods and access to long-term and low-cost capital. For multifamily buildings, additional approaches may be needed when complex measures require collective decision-making and action, for example, through Homeowner Associations. As mentioned above, public financing in the form of grants are likely to be needed as well to jump-start these programs. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 10 Some public financing is likely Experience from the EU and elsewhere shows that in the public needed to develop the financing and sector, public financing mechanisms are often necessary in the delivery mechanisms for public near-to-medium term to help public entities and municipalities buildings, including budget capture move into more-commercial schemes (Figure ES-3). This “ladder” schemes, energy efficiency revolving is illustrative only; not all mechanisms shown are mutually funds, public ESCOs, and credit lines exclusive, and governments need not move up every step of the with development banks ladder. One important characteristic of successful mechanisms implemented in the public buildings in Europe is that these were: (a) administered by a dedicated agency with competent and motivated staff; and, (b) offered not only dedicated financing, but also technical expertise in areas such as project evaluation, contracting of service providers, and supervision of works. Figure ES-4. Financing Ladder: Energy Efficiency Financing Options in the Public Sector Market Commercial Maturity Financing Advanced commercial or project financing (ESCOs) Public EE financing ladder Vendor credit, leasing Commercial financing, bonds Partial risk guarantees Credit line with commercial bank(s) Credit line with municipal (development) bank Public ESCOs EE revolving funds Utility (on-bill) financing MOF financing w/ budget capture Budget financing, grants w/ co-financing Public Grants Financing For the residential sector, most In the residential sector, international experience shows that in financing programs were coupled single-family buildings, households could be motivated to with extensive outreach and undertake small energy efficiency measures (e.g., replacement of information campaigns along with windows) by rising energy prices, information made available technical assistance to facilitate through public programs, and limited incentives—such as VAT access to financing and simplify reductions or other tax credits. Larger, more complex projects, implementation. however, may require correspondingly more substantial incentives, including grants or credit lines. Public information about the latter is key to their uptake, as is marketing to and on the part of the local banks that carry out the lending. For multiple- family buildings, additional approaches may be needed when complex measures require collective action, for example through HOAs. The capabilities of HOAs, including creditworthiness and access to financing, have become key to the success of deep retrofit measures. Financing options are show in table ES-1. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 11 Table ES-1. Major types of financing arrangements for residential buildings Option Countries Pros Cons Commercial Austria, Belgium, • Sustainable • May only serve very wealthy Bulgaria, Czech Rep., • Builds off existing credit creditworthy customers Bank Germany, Lithuania, systems • May involve high interest rates Lending Netherlands, Poland, • Allows for competition of • Banks may lack incentive to Romania, Spain, U.K. financing market aggressively Partial Hungary, Lithuania, • Encourages commercial • Requires mature banking Czech Republic, Slovak banks to finance EE sector interested in EE Credit Republic projects financing Guarantees • Helps overcome risk • May need substantial capacity perception of banks building of banks • Can lead to sustainable • May serve only creditworthy commercial financing customers EE Bulgaria, Greece, • Can be sustainable • May distort market Romania, Slovenia • Mandated to promote EE • Could create monopoly Revolving • Can develop specialized • May not operate efficiently Funds products • Can be captured by political • Centralized experience interests and lessons Utility EE Belgium, Denmark, • Can be done in • Utilities lack incentives to France, Ireland, Italy, sustainable manner reduce energy sales Obligations Netherlands, U.K. • Builds off of utility • Regulations may limit new utility relationships and services services, billing • Allows for simple • Can create monopoly collections (on-bill repayment) For Croatia the following delivery Croatia needs to move from pilot programs to large-scale national mechanisms are recommended: programs supported by dedicated, long-term financing and Residential buildings delivery mechanisms for retrofitting residential and public • Commercial bank lending buildings. These programs could facilitate the absorption of EU with capital grants structural funds—resources that can provide grant support to • Renovation loan fund accelerate adoption of energy efficiency measures and act as a catalyst to leverage commercial financing. For residential Public buildings buildings, two delivery mechanisms are recommended: (a) • Energy Efficiency Revolving commercial bank lending supported by a national grant facility for Fund capital subsidies and (b) a renovation loan fund supplemented by • Public ESCO (or Super ESCO) earmarked grants for capital subsidies. The renovation loan fund is considered a financial instrument and its approval process for using EU-funded grants can be expedited. For public buildings, two options are recommended: an Energy Efficiency Revolving Fund (EERF) and a public or super ESCO. The EERF (Figure ES-5) may be of particular interest since it could be established as a platform that deploys financial instruments supported by EU funds. To support the implementation of such large-scale programs, important policy measures need to be adopted, including: (i) implementation of cost-recovery prices for district heating and natural gas; (ii) enforcement of apartment-level, consumption- based billing for heating; and (iii) ensuring consistent application of ESCO regulations. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 12 Figure ES-5. Typical structure of an Energy Efficiency Revolving Fund For Bulgaria the following delivery Bulgaria needs to put in place large-scale national programs to mechanisms are recommended: retrofit buildings. The programs should be supported by dedicated, Residential buildings long-term (longer than two or three years) financing and delivery • Revolving Fund with mechanisms. The focus should be on the residential sector, despite municipal-led progress over the past couple of years; the challenge in the public implementation buildings sector is to move from high levels of grant financing (100 • Commercial bank lending percent) to more-sustainable financing mechanisms. For with capital subsidies residential buildings, two delivery mechanisms have direct Public buildings relevance to the current market conditions: (a) a revolving fund • Utility-based energy savings with decentralized implementation by municipalities (for program -based on Energy multifamily buildings) and (b) commercial bank lending supported Efficiency Obligations of by a renovation Fund for capital grants (expected to serve primarily instance single-family homes). For public buildings, a utility-based energy savings program can help move the market into a more sustainable financing scheme. Such program could build on the EEO Scheme that was introduced in the 2003 Energy Law and has the potential to help develop the ESCO market. To support the implementation of such large-scale national programs, important policy measures need to be adopted: (i) implementation of cost-recovery prices; and (ii) the development of secondary legislation to implement the EEO Scheme. Figure ES-5. Example of municipal-led implementation of EE investment in multifamily buildings Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 13 Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 14 Chapter 1: Introduction 1.1 Background As with other European Union (EU) countries, Croatia, Bulgaria, Poland and Romania depend on energy imports and heavily rely on fossil fuels. Energy Security is all the more relevant as they continue to try to surmount the effects of the recent global economic downturn while helping to mitigate climate change. Energy efficiency (EE) has long been recognized as an important means of addressing these challenges. It improves energy security by reducing energy demand and decreasing energy imports; helps reduce greenhouse gas emissions cost-effectively and immediately; and raises economic productivity, improving industrial competitiveness and boosting economic growth. In addition, given the countries’ respective national targets under the EU’s directives on climate and energy,1 pursuing EE is not an option but a need. While all four countries have advanced considerably in EE over the past 20 years, each still has a significant gap to close to reach the level of energy productivity2 of the EU-15 countries.3 The energy intensity of the four countries—that is, their consumption of primary energy4 per unit of GDP—fell by nearly half from the late 1980s to 2011 as they moved from centrally planned to market economies. The decline was most dramatic from 1988 to 2000 due to structural economic changes; in Poland, for instance, energy intensity fell 5% per year in the 1990s. The residential, commercial and public services sectors account for 36–49% of final energy consumption in all four countries. In these sectors, energy is used mainly for buildings, though in the public sector, for instance, significant energy goes for street lighting, water pumping and other public services. The efficiency potential in space heating—the largest energy end-use in buildings, at around 70%—is significant; pre-1990 buildings lacked insulation and heat metering of individual apartments, and the technical losses of district heating systems remain high. Heat tariffs are still set below cost recovery and consumption-based billing is generally absent (except in Poland and to a lesser extent in Bulgaria), meaning consumers lack a primary incentive to save heat. Renovation experience in these countries demonstrates that heat demand can be reduced by 30–50% in buildings, with attractive economic returns. Yet only a small portion of the pre-1990 residential and public buildings have undergone thermal retrofits5—even in Poland, which has the largest and most successful retrofit program among the four countries—due to prevailing barriers and lack of adequate delivery mechanisms. 1 The EU set a series of climate and energy targets to be met by 2020, known as the "20-20-20" targets. These are (a) a reduction in EU greenhouse gas emissions of at least 20% below 1990 levels; (b) an increase to 20% of the share of EU energy consumption derived from renewable resources; and (c) a 20% reduction in primary energy use compared with projected levels, to be achieved by improving energy efficiency. 2 Energy productivity is defined as “GDP per unit of energy used,” and is a measure of the economic value associated with energy use. Energy productivity if the inverse of energy intensity. 3 The term EU-15 refers to the 15 member states comprising the European Union from January 1995 to April 2004: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom. 4 Primary energy is a natural energy form that was either extracted or captured directly from natural resources such as crude oil, hard coal, natural gas, or are produced from primary commodities. It can be either non-renewable or renewable. 5 In this report, thermal retrofits are applications of technical measures that reduce heating or cooling loads (such as thermal insulation of the building envelope, replacement of boilers/internal piping systems, and installation of thermostatic radiator valves, among others) or improve the energy efficiency of building heating or cooling systems. These constitute comprehensive, whole- building retrofits, and are distinct from interventions involving the replacement of single appliances (such as room air conditioners) with more-efficient models. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 15 There is also significant room for EE improvements in industry in Bulgaria, Poland, Romania and, to a lesser extent, Croatia. In Bulgaria, manufacturing energy intensity is about twice as high as the EU average. In Romania, the energy intensity of the chemicals sector, the largest manufacturing energy user, is over four times the EU average. 1.2 Objectives The objective of this report is to identify policies, financing and delivery mechanisms with the view of scaling-up thermal retrofit of existing residential and public buildings in Bulgaria, Croatia, Poland, and Romania. These two segments of the building sector are critical to national goals for EE improvement, environmental protection and social development. Also, compared to other sectors, they remain underserved by existing programs and traditional financing mechanisms. With this in mind, the report focuses on Croatia and Bulgaria and identifies a menu of actionable and implementable interventions around program models, financing schemes, and institutional set-ups that take into account current policy and market conditions in the target countries, as well as examples of international good practice. 1.3 Methodology The analytical framework used in this report is summarized in the Figure 1 below. From a top-down approach, and in order to inform advice on EE policy, the report discusses what some observers call “the EE promise”: more-resilient and faster growth through improved productivity, positive fiscal impact, and necessary short- and medium-term efforts to fight against climate change. Based on analytical methods and empirical evidence, the report assesses the often-cited linkages between EE activities and broad economic outcomes—such as growth, productivity, jobs, and fiscal space—as well as the particular role of EE in mitigating greenhouse gas emissions. Second, in order to identify country-specific gaps and prioritize actions, a rapid national-level rapid assessment of the enabling foundations was carried out for EE in Bulgaria, Croatia, Poland and Romania. For reference purposes, a similar assessment was done for Demark, Germany and France as well. This rapid-assessment focused on five areas, or “building blocks” for EE: legislation and governance, building sector policy and regulation, market conditions, financing and implementation, and capacity building and awareness. Finally, the report dives into specific recommendations to scale-up thermal retrofit of existing residential and public buildings in Bulgaria and Croatia. The analysis identifies a menu of actionable and implementable interventions around program models, financing schemes, and institutional set-ups that take into account current policy and market conditions in the target countries, as well as examples of international good practice. Figure 1: The EE promise Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 16 1.4 Report Structure Following this introductory chapter, the report is divided into six chapters as follows: • Chapter 2 discusses the so called “EE promise”. It summarizes the concepts underlying, and evidence for, the role that EE may play in promoting growth, employment, fiscal health and environmental sustainability. • Chapter 3, building on the results of a rapid assessment framework, identifies the gaps in the prevailing policy, institutions, market conditions, financing and delivery capacities for EE investments in Bulgaria, Croatia, Poland and Romania. The four countries are compared with Denmark, France and Germany, which have been more successful at putting in place an enabling environment for large-scale deployment of EE programs. • Chapter 4 discusses the findings of an in-depth modeling exercise that attempts to quantify the potential impact of policy interventions on mobilizing investment in deep thermal renovation of existing buildings in Bulgaria and Croatia. Specifically, the analysis delves into the effectiveness of EE policies in prioritizing policy interventions. • Chapter 5 presents a conceptual tool for classifying financing and delivery mechanisms for EE investments according to levels of market maturity and degree of public vs. commercial financing. Based on the mechanism identified, the chapter describes how these have been implemented in other European countries. • Chapters 6 and 7 recommend specific financing and delivery mechanisms applicable to Croatia (Chapter 6) and Bulgaria (Chapter 7) that policy makers may consider in designing their EE programs in the residential and public buildings sectors. The selection and design of appropriate mechanisms was based on country-specific conditions identified in the rapid assessment and policy prioritization analyses, as well as on successful models implemented elsewhere in Europe. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 17 Chapter 2: The Energy Efficiency, Economy and Climate Nexus6 Main Messages • Since the early 2000s, energy intensity in Bulgaria, Croatia, Poland and Romania has fallen considerably, although it is still higher than the EU-15 average. The declines have been driven mainly by gains in technological efficiency. • Recent empirical evidence shows that improving EE improves productivity, thus contributing to more-resilient and faster economic growth. Increasing energy savings to economic optimum levels in these four countries will require dedicated policy interventions aimed at correcting market failures and removing barriers. • Because evidence on the impact of EE on economy-wide net job creation is inconclusive, employment gains by themselves are a poor objective for designing EE policies. • Although the fiscal impact of EE measures is usually positive, it depends on how measures are designed, implemented and financed. Subsidies for EE can reduce fiscal deficits if they judiciously unlock key barriers and help catalyze private financing. • EE is an important climate policy measure without which climate stabilization will not be achievable – especially in the short-to-medium term, when switching to low carbon fuels will be difficult because of slow capital-turnover cycles. This is particularly relevant for the four countries analyzed, due to their carbon-intensive energy mix. • EE has been the single largest contributor in reducing CO2 emissions in Bulgaria, Croatia, Romania and Poland over the past two decades. However, because economic growth generally results in increased emissions, a boost is required to achieve further energy savings. 2.1 Background Since 2002, energy intensity in the four countries studied has fallen considerably. Energy intensity fell fastest in Romania (3.2% per year from 2002 to 2012) and Bulgaria (3.0% per year), somewhat more slowly in Poland (2.6% per year), and still at a good pace in Croatia (1.4% per year). This is consistent with both ongoing economic restructuring and progress in EE implementation. The initial impact of the global financial crisis is visible, with a significant decline in energy intensity in 2008 as the most energy intensive activities (manufacturing especially) were affected. Despite improvements in reducing their energy intensity, the countries of Central and Eastern Europe are still struggling with a legacy of the energy-intensive industry and wasteful behavior entrenched by decades of central planning and lack of market price signals. The energy intensity of central European countries is inversely related to energy prices. Bulgaria is one of the most energy-intensive economies in the EU, with 0.21 tonnes of oil equivalent (toe) per $1000 (in constant 2005 U.S. dollars). Romania’s energy intensity (0.15 toe per $1000 2005) is also well above the average for the current 28-country EU (0.12 toe per $1000 2005), while Poland and Croatia are converging toward the EU average (Figure 2-1). By 2012, on a per capita basis, the use of primary energy and electricity in Romania and Croatia was somewhat over one-half of the EU average, and in Bulgaria and Poland it was about four-fifths of the 6 Annex A provides more details on the analytical work underpinning the findings and conclusions in the chapter. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 18 EU average. Per capita electricity use had similarly risen and, although it was still below half the EU average in Romania, in Poland and Croatia it was two-thirds, and in Bulgaria it was four-fifths of the EU average. Per capita consumption in the four countries is likely to rise as incomes continue to grow. There will be additional pressure to improve EE to improve productivity and economic competitiveness overall—as well as to reduce energy costs and reliance on energy imports; to mitigate the effects of rising energy prices, particularly on vulnerable populations; and to contribute to national, regional and global sustainability goals. In terms of sectors, according to 2012 data the shares of final energy consumption in the four countries are not far below the benchmarked countries of Denmark, France and Germany (Figure 2-2). Industrial energy use for all is within a few percentage points of the benchmarked countries, and for Bulgaria and Romania it is very similar to Germany’s 25%. The situation is similar for transport. All the countries studied have relatively high residential shares of consumption, while the share of commercial building energy use is much lower than the benchmarked countries. As a result, like in Europe as a whole, where buildings account for over two-fifths of final energy use, buildings, particularly in the residential sector, offer the largest target for EE. Figure 2-1. Energy Intensity Trends, Figure 2-2. Sectoral Shares of Final Energy 2002–12 Consumption, 2012 Source: World Energy Statistics and Balances database, International Energy Agency. 2.2 What drives changes in energy intensity in European economies? Changes in the energy intensity of an economy are driven by two independent factors: • Gains in technological efficiency—that is, changes in the EE per unit of production and consumption; and • Gains in structural efficiency—that is, structural changes in production and consumption patterns. An example of this is an increase in the share of less energy-intensive sectors, such as services. Both can accelerate economic growth. EE improvements reduce production costs, which boosts factory productivity, whereas structural changes reallocate resources to more productive uses. Although each may require different policy interventions, maintaining consistency between these policies is important. For example, subsidizing EE improvements in energy-intensive industries improves their energy productivity but may slow down their natural, market-driven decline, thus preventing capital Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 19 and workforce from being released to sectors of the economy that are more productive and less energy- intensive. The decomposition method7 is a useful way to determine which of these two factors—structural changes versus pure efficiency improvement—has been a decisive contributor to changes in the energy intensity of an economy. This method attributes changes in energy intensity to each factor separately, holding the other constant. The graphs in Figure 2-3 show the results of applying one of the decomposition methods—the Fisher Ideal Index—to determine the relative importance of technological and structural efficiency gains in selected countries over time.8 The general conclusion from this analysis is that in all regions the annual changes in energy intensity of the economies have been driven mainly by variations in pure technical EE. Figure 2-3. Historical Drivers of Energy Intensity Changes in the EU Source: Authors. Note: The thick red line indicates the changes in energy intensity of the economy—that is, trends in energy use relative to the gross domestic product (GDP). Thin blue and yellow lines show the contribution of structural shifts and technological EE improvements, respectively, to the changes in energy intensity. Broken down by time periods and groups of countries, however, the story is more nuanced. For example, after the financial crisis, the sectoral shift accounted for most of the decline in energy intensity in the EU-15 and in Croatia, offsetting negative trends in technological EE. In fact, energy intensity would have increased by 2011 without the structural transition toward less–energy-intensive sectors. In contrast, in Poland and other “new” EU member states, both structural shifts and changes in technological efficiency worked in the same direction. 7 A methodology of decomposition of the variation of the final energy consumption by sector into different explanatory factors. 8 Bulgaria and Romania are not analysed individually because of the lack of consistent time series of data in these periods. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 20 In Poland and other new EU member states, technological EE worsened between 2001 and 2004, then stabilized—whereas it continued deteriorating in “old” EU-15 countries until the financial crisis of 2008. In Croatia, after improving in 2000–07, technological EE started deteriorating around the time of the financial crisis. 2.3 Energy efficiency and the economy Economic growth: EE can contribute to higher economic output through improved energy productivity It is broadly recognized in the economic literature that improving EE contributes to more-resilient and faster economic growth through improved productivity. Improving energy productivity is one of the main pillars of growth, along with improving productivity of physical, natural capital (through nature conservation), man-made capital (e.g., through investments), human capital (e.g., through education), and intangible capital (e.g., through improved institutions). According to economic growth theory, a policy framework that supports market openness, competition, flexibility and innovation can magnify these spillover benefits and vastly accelerate technological progress. Some policies promoting EE—such as research and development (R&D) expenditures, removal of institutional barriers, and information dissemination—fall into this category and can stimulate economic growth both directly, by improving energy productivity, and indirectly, by strengthening spillover effect. The empirical literature that has focused ex post on the relationship between energy consumption and economic growth has generally confirmed that energy consumption and growth are linked, but conclusions on causality are mixed. Studies using multiple statistical models and testing methods, and covering a range of different countries, have presented diverging views as to whether energy consumption drives economic output or vice versa. These diverging points of view have had a major impact on the perception of the economic consequences of EE: most advanced empirical studies conclude that economic growth is compatible with EE. The major weakness of the empirical economic literature so far is that it has focused rather narrowly on the relationship between energy consumption and growth. It has rarely been designed to assess the relationship between trends in energy intensity (or its reverse—energy productivity9) and economic output. A recent report by Vivid Economics (2013) fills this research gap, at least for the high-income OECD countries, by examining the causal relationship between energy productivity and economic growth (after correcting for the impact of structural reforms). It found that an improvement in EE can contribute to higher economic output. In the OECD countries the economic growth was higher than changes in energy consumption, meaning that energy productivity increased. The authors warn that the same relationship may not be present in each individual country and can change over time. This conclusion is also not necessarily extendable to developing countries, although the authors point to the two effects that can influence the results as well as its applicability in the future: • Low-income countries usually have more potential for EE improvement as well as a naturally higher economic growth rate. • As countries become more energy efficient over time, they move closer to their maximum possible level of EE, at which point marginal gains are harder to make. 9 Energy productivity is defined as “GDP per unit of energy used,” and is a measure of the economic value associated with energy use. Energy intensity is defined as “the amount of energy used to produce a unit of GDP.” Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 21 Economic efficiency of energy efficiency: Increasing EE to its optimum level in each of the four countries analyzed justifies dedicated policy interventions From the microeconomic perspective, EE improves welfare as long as the marginal social benefits derived from energy savings are higher than the marginal social costs. The cost of energy savings reflects the upfront technical costs of implementing EE projects, including transaction costs and all “hidden” costs. The (present value of) benefits include financial savings from lower energy bills and the difference in the cost of maintenance and repairs of the new, more-efficient equipment and buildings. Another important component of economic benefits is the improvement in convenience and comfort often associated with new, modern equipment or renovated buildings. Abundant project-level experience suggests that (a) EU countries such as Bulgaria, Croatia, Poland, and Romania have not yet exploited all the low-cost energy-efficiency opportunities; and (b) the achieved level of energy savings is well below economic optimum levels. This is likely to be the case with projects that are in the lower part of the cost curve—that is, low-cost improvements of very inefficient facilities. This situation is due to the fact that investors are willing to deliver lower-level energy savings since they face distorted market incentives (such as fuel or energy subsidies) and various hidden costs, barriers and split incentives (these are discussed later). Therefore the increase of energy savings to economic optimum levels has a strong rationale in micro-economic efficiency, and justifies dedicated policy interventions aimed at correcting policy and markets failures and removing barriers. Energy efficiency and jobs: employment gains by themselves are a poor criterion for evaluating EE policies The results from existing studies on the net impact of EE on employment have so far been inconclusive. Project-level calculations and bottom-up models usually show the strongly positive employment effect of EE measures (World Bank and Climate Works Foundation 2014). The common limitation of the project-level approaches is that they cannot distinguish between net job creation and shifting jobs around the economy. In reality, EE policies (such as energy performance standards, energy price increase, or subsidies) cause jobs dislocation: in other words, jobs in energy-efficient activities are created while jobs in other sectors are displaced (Hughes 2011). Even if EE creates sustainable jobs, it may not do so cost-effectively. Policies that stimulate innovation and labor market flexibility are the best way to create new jobs and enhance the impact of targeted EE policies; yet investing the same amount of money in the small and medium-size enterprise (SME) sector without the condition that they be used for EE would likely create more jobs than targeted EE investments. Therefore employment gains by themselves are a poor criterion for evaluating EE projects or policies (Deichman and Zhang 2013). EE projects and policies demonstrate their benefits better through the lenses of cost/benefit considerations10 and productivity improvements, as well as external/indirect benefits from environmental improvements, learning and innovation. Although usually positive, the fiscal impact of EE measures depends on how they are designed, implemented, and financed Subsidies for EE projects would still reduce fiscal deficits as long as they are lower than the present value of public agencies’ financial savings. Energy savings reduce the operational costs of equipment and buildings. If project hosts are public entities, it means lower fiscal expenditures for public budgets. Ex ante estimates of monetary saving potential vary between 20% and 10 A common mistake in economic analysis done on a project or policy level is the treatment of wages as economic monetary benefits of a project or policy, whereas they should always be treated as a cost in the cost/benefit framework. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 22 60% depending on the sector and project type. Actual savings depend substantially on the behavior of the project host. Ministries of finance often look carefully at the tax revenue impact of EE improvements. On the one hand, new investments increase revenue from VAT and sales taxes. If such projects are profitable, they will also increase revenues from income taxes. On the other hand, sometimes ministries of finance are concerned that energy savings will decrease revenues from excise duties on energy commodities (as in Poland, for example). Also, policies that support EE with tax waivers and tax credits may raise concerns about impact on integrity of fiscal system, as they not only decrease fiscal benefits, but also create precedence, which may be used by other interest groups in a society to create loopholes in the tax system. Subsidies can also unlock key institutional barriers to EE projects, such as coordination costs of residents in multifamily buildings. This in turn would increase investments and revenues from VAT and sales taxes. For example, the net fiscal benefits of EE subsidies are stronger if they are designed to reward early movers for any extra risk they take and for the learning-curve benefits they provide to other market participants. Subsidies could then be predictably phased out to reduce fiscal burden and prevent permanent subsidy dependence and strategic delays of investments amid expectations that subsidies will increase in future. Subsidies to EE projects can also deliver a fiscal dividend if they are designed to leverage and not crowd out private finance, which is much more abundant and commercially motivated. In fact, a well- designed subsidy can play an important catalytic role in facilitating access to commercial finance for those project owners who want to invest in commercially viable projects but lack the fiscal space, credit capacity or track record necessary to raise debt or equity finance. 2.4 Energy efficiency as a climate policy measure The Intergovernmental Panel on Climate Change (IPCC) has collected considerable evidence that EE has contributed substantially to climate change mitigation by reducing emissions (IPCC 2014). Looking forward, the large economy-climate models will not be able to reach the climate stabilization target without a major breakthrough in EE—especially in the short-to-medium term, when a massive switch to low-carbon fuels in the energy, industrial and transport sectors is impossible because of slow capital-turnover cycles. In this section we first look into the past, to see how important EE has been in bringing down greenhouse gas emissions. We then look into the future to assess the potential of EE to be a continued driver of emission reduction. What does the empirical evidence tell us? For this report, a decomposition analysis 11 was used to determine how significant EE has been so far as a driver of the changes in carbon dioxide (CO2) emissions. The study first analyzed changes in CO2 emissions from energy use in Bulgaria, Croatia, Poland and Romania as well as a host of comparator countries from 1995 to 2010. As Table 2-1 shows, of the four countries (Bulgaria, Croatia, Poland and Romania), only Croatia increased total CO2 emissions from 1995 to 2010. The other three decreased emissions rapidly in the first sub-period (1995–2000), after the re-introduction of the market system, and then stabilized or even slightly increased later. This contrasts with the OECD countries, where emissions increased until the 2008 financial crisis, then plummeted. The BRIC countries, in turn, steadily increased emissions over 11 This study followed a methodology similar to that applied in Bacon and Kojima (2009), but with more recent data and differently aggregated countries. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 23 the entire period—except for Russia, which followed a path similar to its three Central European counterparts. Table 2-1. CO2 Emissions Changes in 1995–2010 Country 1995–2000 2000–05 2005–10 Total Bulgaria -10 3 -1 -8 Croatia 3 2 -1 4 Poland -41 2 1 -38 Romania -30 8 -17 -39 EU-12 -96 21 -36 -111 EU-15 77 108 -356 -171 EU-27 -20 130 -393 -282 Source: IEA (2013). The changes in emissions are then attributed to the sum of changes in the following drivers 12 (shown together with abbreviations used in the graphs below): a. Carbon intensity of fossil fuels consumed (Ceff) b. Share of fossil fuels in final energy consumption (Seff) c. Energy required to produce a unit of GDP, or energy intensity (Ieff) d. GDP per capita (Geff) e. Population (Peff) Energy efficiency was the single largest contributor to the reduction in CO2 emissions throughout the 1995–2010 period in all countries studied. The results are shown in Figure 2-4. As the bar charts show, per capita growth of economic output (Geff) was the main driver of emissions growth (upward- pointing bars), while energy intensity (Ieff) improvement was the main emission inhibitor (downward- pointing bars). During the entire 15-year period, improvement in energy intensity has led to a reduction of CO2 emissions by 31 million metric tons (mt), 4 mt, 201 mt and 58 mt for Bulgaria, Croatia, Poland, and Romania, respectively. 12 Data—including data on population, GDP (PPP in 2005 constant U.S. dollars), total primary energy supply (TPES), and CO2 emissions—are from IEA (2013). The data on fossil fuel supply is from the IEA World Energy Statistics and Balances database. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 24 Figure 2-4. Contributions of Five Factors to Changes in CO2 Emissions in Bulgaria, Croatia, Poland and Romania in 1995–2000, 2000–05, and 2005–10 (millions of metric tons) Source: Authors. Note: Ceff = carbon intensity of fossil fuels consumed; Seff = share of fossil fuels in final energy consumption; Ieff = energy required to produce a unit of GDP, or energy intensity; Geff = GDP per capita; Peff = population . In Bulgaria, EE improvements from 2000 to 2005 were not sufficient to offset the emission impact of economic growth. In the most recent of the three periods shown in the graphs, EE’s contribution to reducing CO2 emissions slightly weakened, but total emissions decreased because Bulgaria experienced a significant drop in GDP growth at the end of the decade. In the same period GDP decline was also a key driver of emission reduction in Croatia and Romania, as the energy intensity deteriorated in Croatia and only marginally improved in Romania. In contrast, the Polish economy was still growing by 2010, contributing to increased emissions that more than offset the impact of improvements in energy intensity. The four countries have been making mixed progress in decarbonizing their national primary energy mix. This is reflected by changes in the share of fossil fuel in total primary energy supply (Seff) and changes in the carbon intensity of fossil fuels used in energy generation (Ceff). Over the entire period, Seff was the second largest contributor to CO2 emissions reduction (next to the impact of energy intensity), leading to a CO2 reduction of 3 mt for Bulgaria, 0.6 mt for Croatia, 20 mt for Poland and 18 mt for Romania. Bulgaria recently (2005–10) re-carbonized its energy generation by using more fossil fuels in its energy mix and more carbon-intensive sources in its fuel mix. All other countries decarbonized their energy mixes, although progress was generally slow. Romania and Croatia progressed the most rapidly, although Romania slightly increased its carbon intensity of fuels over the period. Croatia made steady progress toward both less fossil fuels and a cleaner fuel mix. In Poland, because non-carbon energy sources have been steadily crowding out fossil fuels, the fuel mix became cleaner over the period— albeit at a slow pace that did not contribute significantly to reducing CO2 emissions. Decreasing population (Peff) in Bulgaria, Croatia and Romania contributed to small decreases of CO2 emissions, while in Poland the population effect only marginally increased emissions. This ex post decomposition analysis suggests the following conclusions: Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 25 • Economy-wide EE improvements have been so far the main driver of CO2 emissions reduction in all countries studied, dwarfing the impact of switching to cleaner fuels. • More recently, EE improvements have decelerated in several new EU member states. In future, this may not be enough to counterbalance the impact on emissions of increases in income and population unless policy incentives are corrected. • A boost to policy reform is particularly needed in Bulgaria. Countries like Poland and Romania, which improved their energy intensity from the second to the last sub-periods, will also need to bolster their efforts to counterbalance the increased emissions driven by economic growth. • In Bulgaria, Poland and Romania, the potential to reduce emission by decarbonizing energy generation (by switching to low- and no-carbon fuels) remains largely unexploited, suggesting weak policy efforts in this area thus far. • In the EU-15 countries, the main driver of emissions reduction from 2000 to 2010 was the economic crisis. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 26 Chapter 3. Enabling Environment for Energy Efficiency Investments Main Messages • An EE assessment framework was applied to identify gaps and prioritize actions to support EE. The countries analyzed demonstrated strengths in different topic areas. Croatia earned the highest marks in three out of the five topics (market conditions, capacity building and awareness, and industry). Bulgaria had the two highest scores for the two remaining topics (legislation and governance and building EE), reflecting its recent adoption of a number of policies and measures. • Croatia has a number of gaps in legislation and governance, including putting in place an adequate regulatory environment (such as clarifying public budgeting and procurement rules for ESCOs and legislation on HoAs) and clarifying the roles and responsibilities of agencies for EE implementation. • Cost-reflective energy pricing as one of the key barriers for the take-up of EE in the residential sector in Bulgaria. The country may also concentrate its efforts on, and mobilize resources to, strengthen energy service providers and managers. Deeper analysis is needed to prioritize specific interventions, which may be related mostly to improving enforcement and implementation of existing policies and regulations. • In Poland, sector-specific measures to be prioritized are especially numerous in the buildings sector. Regulations that would support utility-based measures, energy service performance contracting, and public procurement are absent, and there are gaps in energy codes, incentives for EE audits, and in building EE market characterization. • Romania has gaps to address in broad capacity building, including programs to expand awareness of EE. Greater political support is likely needed to develop EE legislation as well to define the basis for new programs. Measures such as incentives and financing for EE investments, and utility programs are also needed. Perhaps simpler to implement in the short term would be the institution of energy audit subsidies and HOA legislation. • Regional action is called for to develop energy management systems and developing capacity for energy managers. All four countries require further efforts to improve regulatory/policy enforcement and facilitate financing for the deployment of large- scale programs. 3.1 An assessment framework to evaluate policies, institutions, and financing As discussed in Chapter 2, continuing to improve EE and converge to EU-15 levels is a key priority for the governments of all four countries in this study. Each has taken significant steps to create the policy framework and market conditions needed to spur EE. All countries, except Croatia, exceeded their respective 2010 targets as set forth in their National Energy Efficiency Action Plans (NEEAP) (Table 3-1). Table 3-1. NEEAP Final Energy Savings Targets and Progress Achieved Interim Target Estimated Actual Final Target Country (2010) Savings (2010) (2016) Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 27 % of 2016 GWh GWh Target GWh Bulgaria 2,430 3,549 49% 7,291 Croatia 1,831 1,786 33% 5,492 Poland 11,878 35,320 66% 53,452 Romania 10,932 25,853 79% 32,564 Source: Country second NEEAPs. Experience in many regions of the world demonstrates that widespread adoption of EE requires a mix of policies, measures and programs to overcome the financial, institutional, technical and behavioral barriers common to most markets (ESMAP 2008). The World Bank recently developed an Assessment Framework for its EE projects based on the elements commonly deemed necessary to enable improvements in the efficiency of both residential and non-residential buildings. It was applied, for example, in a 2014 study of the Western Balkans (World Bank 2014), where it (a) proved useful in identifying country-specific and regional gaps for future interventions and (b) provided a basis for better coordinating donor and investment programs. For the present study, all four countries were assessed against specific criteria in the following topic areas: legislation and governance, market conditions, capacity building, industrial EE, building EE, and transport EE. The Assessment Framework was adapted and expanded to meet the specific aims of the project. It now includes six major topic areas or categories that reflect the framework elements that are needed across sectors and also those required to be tailored to specific sectors as shown in Figure 3-1. In addition to the four countries, Demark, France and Germany were included in the analysis to provide a point of comparison with selected high-income EU countries. Figure 3-1. Elements of the EE Assessment Framework Capacity Building Building Energy Efficiency Legislation & Governance • Energy entity/agency • Sector policies & regulations • EE law & secondary • Energy service providers • strategy • building codes legislation • Energy users • building certificates • EC Directive compliance • Monitoring & verification • public procurement • National EE strategy & plan institutions • equipment standards • National EE agency • Energy auditors • appliance labelling • Political support for EE • Energy managers & EMSs • legislation: HOAs, public • EE programming • Awareness & information agencies, utilities • Participation of civil society & • Performance recognition • Metering & billing private sector • Energy information centers • heat metering, • EE publications consumption-based billing • bill collections • Data & information • public, residential & commercial markets Market Conditions Industry Energy Efficiency • EE Investment financing • Energy pricing, metering & • Sector policies & regulations • financial incentives • strategy • energy audit subsidies billing • reporting, targets, standards • public, residential & • Incentives for EE investment commercial financing & labels • Energy auditing • ESCOs • Data & information • Energy managers • EE Investment financing • Energy service providers • financial incentives • Utility DSM • energy audit subsidies • EE financing • SME & large facility Transport Energy Efficiency • public financing • Sector policies & regulations • residential • obligatory audits of large • General characteristics & • commercial facilities structure • industrial • ESCOs • Promotional efforts Source: Adapted by authors from World Bank (2014) The Assessment Framework uses multiple indicators to assess country-specific progress in each of the topic areas. These indicators are assigned values based on documented survey results. Most are binary “yes/no” indicators, reflecting whether specified actions—such as the adoption of a NEEAP or the Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 28 launch of a financial incentive program—have been taken. Some are numeric indicators, such as the share of buildings with building-level metering of energy use, or the number of donor credit lines in place; values are assigned to ranges to reflect degree of implementation. A simple and transparent scoring mechanism, summing the number of checkmarks and assigned values, is applied to the results to arrive at an overall assessment. The resulting scores, presented in the next section, are preliminary representations of the countries’ respective progress in adopting good practices, as well as gaps that could potentially be targets of future activity. The Assessment Framework provides a current snapshot of progress on the basis of available (and sometimes incomplete) data, and is intended as a rapid assessment tool only. The results are not intended as a means of ranking countries or for any normative purpose. Rather, the purpose is to provide input into decision-making by specific countries regarding priorities for actions to support EE. Another important issue worth noting is that the framework focuses more on policy and regulatory frameworks than on actual implementation, since the latter is very difficult to measure. While Bulgaria may have shown relatively strong results, the fact that its energy intensity is 70% higher than Germany’s indicates that policy implementation and enforcement still lag. 3.2 Findings from application of the assessment framework Although no countries achieved full scores in any of the topic areas, as expected, the comparison countries (Demark, France and Germany) received close to full marks, in essence checking most—but not quite all—of the “boxes” on the screening checklist embodied in the Assessment Framework. Although the four countries studied here checked fewer boxes, each demonstrated strengths in at least several areas. For instance, Croatia earned the highest marks in three out of the five topic areas reported on here: market conditions, capacity building and awareness, and industry EE.13 Bulgaria had the highest scores for the remaining two topics, legislation and governance and building EE, reflecting the recent adoption of a number of policies and measures that are to be implemented in the coming months and years. Substantial opportunities exist for all the countries studied to improve in each of these areas.14 In the remainder of this section, results are summarized by topic area. The following section reports on the results country by country, providing a gap analysis intended to inform debate on national programs. The findings on legislation and governance (Figure 3-2) showed Bulgaria with relatively strong scores in each of the seven sub-topics. Good implementation will have to match adoption of policies and measures in order to translate into results, as noted previously. Poland, also a strong performer, would benefit from improving the design of its EE programs and boosting civil and private-sector participation. Romania could also improve political support and the legal and institutional bases for EE in addition to strengthening EE programs. While Croatia has achieved much in the legal and planning arenas, substantial work remains in other areas, including EE institutional development. 13 Because results from the transport sector of the Assessment Framework were incomplete for most of the countries, they are not analyzed here. 14 The assessments were carried out between 2014-2015. Since then, some of the score might have changed as a result of recent measures undertaken by each country. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 29 Figure 3-2. Summary Comparison: Legislation and Governance Source: Authors. The findings on market conditions (Figure 3-3) revealed utility demand-side management (DSM) to be the most challenging area, making it a regional gap. Romania has full scores for energy audits and managers, but significant opportunities exist in EE financing and incentives for EE investment; these are potentially “easy wins” for Romania. Croatia and Poland have made good progress in introducing EE financing mechanisms, but there is room for improvement in other areas, like energy management. Bulgaria’s achievements in introducing incentives for EE investment are counterbalanced by a need for energy price reform to reflect the full costs of energy supply. Figure 3-3. Summary Comparison: Market Conditions Source: Authors. Energy Management Systems emerged as a region-wide gap in the capacity building and awareness segment of the survey (Figure 3-4). Croatia scored highest in this category, with a few areas needing attention, like capacity of energy users and managers. Bulgaria can accomplish significantly more by ramping up efforts in capacity building for energy service providers (ESPs), energy managers and Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 30 energy management systems (EMSs). Poland has progressed well in energy institutions, users, information centers and ESPs, though significant opportunities remain in the other arenas covered. While Romania has done well on energy auditors, managers and information centers, other areas need work. Figure 3-4. Summary Comparison: Capacity Building and Awareness Source: Authors. Note: M&V = measurement and verification. The countries showed a range of performance in building EE (Figure 3-5), with Bulgaria making headway in filling gaps in its policy and regulatory apparatus, though with remaining opportunities in developing surveys and information systems to aid with project identification and market development. Although Croatia scored well in most categories, improvements are still needed in homeowner association (HOA) legislation and public procurement. Romania received a full mark for sectoral strategy, but it has yet to act on building energy codes and energy audit subsidies. Poland has taken steps to varying degrees in all areas except building energy codes, which should be a priority; building markets, public procurement and energy audits need work, too. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 31 Figure 3-5. Summary Comparison: Building Energy Efficiency Source: Authors. Finally, in the arena of industrial EE (Figure 3-6), Bulgaria and Croatia both made strong showings. Meanwhile, although Poland has made efforts in sector strategy and reporting, targeting, standards and labels, it has work to do on data and information availability and financial incentive programs for SMEs. Romania has made some moves in reporting, targeting, standards and labels—and, to a lesser degree, in data and information availability—but substantial effort is needed in sector strategy and financial incentive programs for SMEs. Figure 3-6. Summary Comparison: Industrial Energy Efficiency Source: Authors. 3.3 Gap analysis There are a number of ways to prioritize areas for improvement, and highlighting areas in which scores are relatively low is one straightforward method. The sensitivity of the method can be adjusted by selecting different thresholds for defining what constit utes a “gap”, and for this exercise it was set Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 32 simply at 50% for each sub-topic. Below that level, a country is assigned one point, indicating that the sub-topic is a pressing issue for the country to tackle. No mark is given for a score equal to or above 50%. The various topic areas have different numbers of subtopics, and so should not be directly compared to one another, nor are the results by country necessarily comparable. The intent of the screening is simply to flag areas for more in-depth consideration. By the same token, a small number of gaps identified is not necessarily a guarantor of good EE performance. In fact, if a country had a relatively high score but minimal progress in improvements in EE, it may indicate deficiencies in the design or implementation of policies and measures, for example, or a continued need for action on enabling factors (such as cost-reflectiveness of energy prices, institutional governance, M&E) that could help further unlock EE potential. The gap analysis reveals a number of areas of strength in the region. In recent years Bulgaria, Croatia, Poland and Romania have all made substantial progress in detailing their National Energy Efficiency Action Plans (NEEAPs) and in complying with EE directives from the European Commission (EC). In market development, all have made strides in energy auditing, and a good deal of progress has been made in building awareness and capacity in energy users. All four countries have taken steps in certain areas of building EE, including setting a strategy for building sector EE, building certification, appliance labeling, equipment standards, and establishing financial incentives and/or funds. In the industrial sector, they have all established industrial energy reporting systems, targets, standards and labels. Regional gaps The four countries were found to have significant gaps in capacity building and awareness as well as building EE. Within the former category, regional action seems to be called for to develop EMSs. For Poland and Romania in particular, capacity building for monitoring and verification institutions is urgently needed, as is promoting awareness. Developing capacity for energy managers is a pressing issue for Poland and Bulgaria. Within the building EE category, Poland and Romania especially are in need of progress on developing building energy codes; developing regulations for EE in public agencies, utility EE programs, and energy service performance contracts (ESPCs); and establishing energy audit subsidies. Croatia and Romania lack HOA regulations, a key ingredient to scaling up EE investment in residential buildings (see Box 3-1). Finally, it should be noted that all countries need to bolster their efforts to improve the enforcement of policies and regulations and to facilitate financing for the deployment of large-scale programs. Box 3-1: Importance of HOAs in acquiring commercial lending for long-term EE financing Homeowners associations (HOAs) are created with the intent of serving the collective needs of a group of property owners. The most common form of HOA is the condominium, though timeshares and cooperatives exist as well. A communal fund is levied from the property owners in the form of annual or monthly fees to pay for services and maintenance of common areas, including EE investments. Condominium associations can also take advantage of commercial lending options from banks. Lending to condominium associations has proven to be a profitable market for financial institutions in many countries. That said, there are several funding issues unique to this market that should be taken into consideration when lending to HOAs. In addition to the requirement for a strong culture of timely funding contributions, extraordinary disruptions of income (such as reduced cash flow following a natural disaster) and extraordinary expenses (such as large capital maintenance projects) should not be overlooked. A steady flow of assets is essential to the proper maintenance, effective management and ultimate success of such an ownership scheme as well as for obtaining commercial lending. When lending to condominium associations, as with lending to municipalities, it is important to develop long-term financing and regulatory frameworks for EE and capital repairs. There is, however, a need to improve HOAs’ ability Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 33 to enforce member payments in order to work with the lenders for long-term finance. This has a direct relevance for non-collateralized lending options (including by the Central Bank) for home repairs and thus affordability. Strong frameworks for decision making (including permanent, mandatory condominium membership) and payment enforcement are important in this regard. In Poland, lending to HOAs started in 1998 and continues to this today. The annual volume of these loans is approximately $400 million and there has not been a single default. This scale was achieved specifically over the span of the last seven years. In the early years of the scheme, total lending volume was modest, about $1–3 million per year. Polish banks found that lending to HOA was a marginally profitable, but very stable and virtually risk-free business. Accordingly, they have had to streamline procedures to reduce the cost of processing. They review only two financial criteria when deciding whether to issue each loan: the HOA’s average collection ratio (collected fees/budgeted fees) and the increase in the monthly fee as a result of the loan. It should be noted that the banks do not take in account the expected savings from EE investments. There are two reasons for this: performing the required review would increase processing costs, and the savings are not guaranteed. It is important for commercial banks to reduce operational risk in their lending. In the context of lending to HOAs, this requires ensuring the decision to lend to an HOA is carefully considered, that there is no fraud or open litigation, and that all registration documents are in order. Accordingly, banks tend to give HOA loan applicants standardized forms for decisions, protocols, and so on, thereby ensuring that they all meet bank requirements. Source: compiled by authors. Country gaps The Assessment Framework’s screening suggests that Croatia has a number of gaps in legislation and governance that, if they are to be addressed, will require greater political support. There are also significant opportunities for participation by civil society and the private sector (Figure 3-7). Strengthening is needed simultaneously for the national EE agency and for programming activities. Priorities for improving the enabling environment include building up a cadre of energy managers and enterprise management systems. The challenge of utility DSM remains to be undertaken as well. Unlocking EE in buildings would be aided by addressing public procurement rules and legislation on HOAs. In Croatia, major needs remain in building institutions of governance and putting legislation in place. Figure 3-7. Gap Analysis: Croatia Areas for improvement: Croatia Legislation & • Legislation and Governance: Governance, Germany National EE Agency, political support Transport EE, 51% for EE, EE programming, civil & Denmark 85% Market private participation Conditions, 64% France • Market Conditions: Energy managers, utility demand-side management and financing • Capacity Building and Awareness: Energy management systems Capacity • Building EE: Public procurement, Building & HOA legislation Industry EE, 94% Building Awareness, 77% (Residential, Public, Commercial) EE, 78% Source: Authors. For Bulgaria, the constraints on implementing EE are related less to legislation and governance, where a great deal has already been accomplished, than to setting the rules and providing resources needed for the financing and delivery of EE projects and programs. The main program is the National Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 34 Program for Energy Efficiency of Multifamily Buildings, which was launched on 1 February 2015 and has a budget of BGN 1 billion (about €500 million) financed by the State Budget. The program builds on past efforts that saw increasing levels of grants with very low participation rates. Given the strong demand for the program, it is expected that additional financing will be made available by the government through new State Guarantee in subsequent years to continue the program. The Assessment Framework suggests Bulgaria concentrate its efforts on, and mobilize resources to strengthen the capacity of, energy service providers and energy managers. This is for two reasons: to promote adoption of EMSs and to support energy information centers (Figure 3-8). Since there are very few items flagged in this particular screening exercise, other approaches are needed to prioritize next steps in the country’s program which are related mostly to improving enforcement and implementation of existing policies and regulations. Figure 3-8. Gap Analysis: Bulgaria Areas for improvement: Legislation & Bulgaria Governance, • Financing and delivery 87% Germany mechanisms for large-scale Denmark programs • Capacity Building and Awareness: France Energy Service Providers, energy Transport EE, managers, Energy Management 54% Market Systems, energy information centers Conditions, 79% • Building EE: Commercial and residential buildings market, buildings database • Cost-reflective pricing and enforcement of EE policies and Capacity regulations Building & • Sector Policies and regulations Awareness, 45% (modal shift from rail to road transport) Industry EE, 88% Building (Residential, Public, Commercial) EE, 83% Source: Authors. Another area where significant efforts are needed is providing incentives through cost-reflective prices. For instance, although market-based pricing of electricity was introduced for industrial and commercial consumers in 2014, it has yet to be widely adopted, and monitoring of implementation progress here is warranted. Regulated tariffs for domestic consumers are also set at below-cost levels. The screening exercise suggests Poland needs action across a broad front, including development of the institutions and personnel required for monitoring energy use and acting on the information gathered (Figure 3-9). Sector-specific measures to be prioritized are especially numerous in the buildings sector. Regulations that would support utility-based measures, energy service performance contracting, and public procurement are absent, and there are gaps in energy codes, incentives for EE audits, and in building EE market characterization. While EE in industry is somewhat more developed, work remains to be done in basic data information as well as incentives for SMEs. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 35 Figure 3-9. Gap Analysis: Poland Legislation & Areas for improvement: Poland Governance, • Market Conditions: Energy 75% Germany managers Denmark • Capacity Building and Awareness: M&V institutions, energy auditors, France energy managers, energy management systems, awareness and Transport EE, Market information 31% Conditions, • Building EE: Building energy 62% codes, public procurement, regulations, public & residential buildings market, buildings database, Industry EE, financial incentives & funding, 32% energy audit subsidies • Industry EE: Data information and Capacity availability, financial incentive Building & programs for SMEs Building (Residential, Awareness, • Transport EE: Sector policies and Public, Commercial) EE, regulations 48% 37% Source: Authors. Note: M&V = measurement and verification. The Assessment Framework indicates Romania has gaps to address in broad capacity building similar to those in Poland, including programs to expand awareness of EE (Figure 3-10). Greater political support is likely needed prior to addressing these needs, and EE legislation as well to define the basis for new programs. A program of market strengthening is also needed—from energy price reforms to incentives and financing for EE investments, and eventually to utility programs. Experience from other countries in the region would be useful to address the several areas in the buildings and industrial sectors that were identified. As in other countries in the region, building energy codes need bolstering. Perhaps simpler to implement in the short term would be the institution of energy audit subsidies and HOA legislation, and regulatory measures like those missing in Poland. Industry needs a strategic approach to EE and basic data, as well as incentives for SMEs, again as for Poland. Figure 3-10. Gap Analysis: Romania Areas of improvement Legislation & • Legislation & Governance: National EE Governance, Romania Law/legislation, political support for EE 59% Germany • Market Conditions: Energy pricing, metering and billing, incentives for EE Denmark investment, utility demand-side Transport EE, management & financing, EE financing 46% France • Capacity Building & Awareness: M&V institutions, energy management systems, Market awareness & information, performance Conditions, 41% recognition, publications • Building EE: Building energy codes, Industry EE, HOA legislation, regulations, buildings 24% database, energy audit subsidies • Industry EE: Sector strategy, data information & availability, financial incentive programs for SMEs Capacity Building & Building (Residential, • Transport EE: Sector policies & Awareness, 44% regulations Public, Commercial) EE, 57% Source: Authors. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 36 In all the countries, some sector-specific work remains to be done. However, even accounting for the greater amount of detail in the Assessment Framework in the buildings sector, action seems to be needed especially in the buildings sector in order to spur EE renovation of residential and public buildings. The broader enabling environment is, of course, crucial for the uptake of EE in existing buildings. The price level of delivered heat and the manner of billing are important factors that condition the willingness of consumers to undertake EE retrofits. Nevertheless, resolving pricing issues alone will not harvest a great deal of the existing efficiency potential due to the persistence of non-price barriers. As discussed in the next chapter, progress in the various arenas mentioned above remains necessary before, during and after price reforms. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 37 Chapter 4: Policy Interventions to Scale Up Thermal Retrofit of Buildings: An In-depth Analysis of Bulgaria and Croatia Main Messages • The largest technical energy saving potential in Bulgarian and Croatian buildings lies in the deep retrofit of residential buildings—mainly single-family homes, followed by deep thermal renovation of multifamily buildings and retrofitting of HVAC equipment in single-family houses. • Yet, if the present market and policy incentives remain unchanged for the next 15 years (the baseline scenario), only deep retrofit of some non-residential buildings, primarily offices and hospitals, would likely take place. • Multifamily buildings are particularly challenging because of higher risks and transaction costs. For this category, the deepest thermal renovation could be implemented only with high levels of grants (about 75%) without reforming the current distorted policy and institutional environment. • Neither energy price reform alone, nor grants without market reforms, will be sufficient to stimulate EE investments, especially in the residential sector. Introducing energy price reforms without reducing transaction costs and project risks will not lead to significant uptake of deep renovation and will only frustrate energy consumers with higher bills. But increasing subsidy in the absence of enabling market conditions is a waste of scarce public funds. • The most cost-effective policy packages that would mobilize the highest level of energy savings are comprehensive market and institutional reforms with additional revenue enhancement through EE obligations or carbon prices. • During the transition period before market reforms take full effect, temporary investment grants (covering 25% of investment costs, for example) designed to reward early movers are often needed as an additional “market push” to reward early movers and change entrenched behaviors. This chapter attempts to determine which policies and institutional reforms could be most effective in addressing some of the key barriers identified in Chapter 3. It focuses on EE financing and the incentives that would be required to harness the technical potential of deep thermal renovation of residential and public buildings in Bulgaria and Croatia.15 An in-depth modeling exercise was carried out to simulate expected investment decisions that would be made by individual building owners under various market and policy conditions.16 15 Deep thermal renovation refers to applying a comprehensive set of measures to substantially reduce heat losses of buildings, usually cutting specific heat consumption by 40% or more compared to pre-renovation consumption. These measures generally include (a) improved EE-upgraded windows and exterior doors and thermal insulation of roofs and exterior walls, in addition to (b) EE improvements to buildings’ internal heating systems (such as thermostatic radiator valves and EE-upgraded radiators). 16 A more detailed report of the analysis is found in Annex C. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 38 4.1 Background of the model Challenges in mobilizing investment for thermal renovation of buildings Understanding the economic drivers of investors’ behavior is key to designing successful policies that can effectively change investment decisions. Building owners must be willing to invest more than business-as-usual in order to meet higher energy performance requirements. They also need to have access to adequate finance for these investments. International experience shows that in advanced market economies, 60–80% of EE investments are self-financed (IEA 2014); in other words, building owners (public and private) are the main investors. EU funds are a catalyst for mobilizing the required funding, but they will always fall far short of meeting total investment requirements. Core financing derives from retained earnings of building owners as well as by public and private third party financiers. The core investors will not provide funding unless building owners are willing to invest and to pay a premium for deeper energy renovation. Willingness to invest in EE improvements is hampered both by various hidden costs and barriers and by market failures that are well recognized in the “energy efficiency gap” literature. A gap analysis was conducted in Chapter 3 with the aim of identifying and prioritizing policy interventions. Such policy and institutional actions can close this gap and enhance willingness to invest in deep energy renovation of buildings by making it more attractive to building owners and financiers alike. The challenge is that the EE gap is well recognized qualitatively but rarely quantified ex ante for policy design purposes. Policy makers usually do not know which barriers are critical and what package of reforms would most effectively change investors’ behavior. The analysis developed in this chapter attempts to quantify the impact of such interventions. The impact of policy interventions on the financial viability of energy renovations The “energy efficiency gap” literature identifies the hidden costs and links them to market failures (such as environmental externalities) or other barriers that prevent firms and households from undertaking potentially profitable (that is, economically efficient) energy-saving investments. The literature identifies behavioral barriers arising from principal-agent problems, other information asymmetries, the landlord-tenant divide, and “bounded rationality”.17 In addition, there are barriers mounted by distortionary, wasteful policies, such as energy price subsidies or fiscal rules that “confiscate” monetary savings from lower energy bills. A broader set of barriers were identified in Chapter 3; based on these, several policy scenarios (i.e., combinations of policies and measures) were developed. The various barriers affect the financial viability of energy renovation of buildings in different ways. For example: • Subsidized energy prices: o Reduce projects’ revenues from energy savings and o Introduce political risk, which is notoriously more difficult to evaluate and mitigate by economic agents than market risks, especially when a long-term investment horizon is needed. • Regulatory and institutional barriers: o Increase project costs, mainly by adding the transaction costs of preparing and implementing projects; and 17 Bounded rationality is the idea that when individuals make decisions, they are limited by the information they have, the cognitive limitations of their minds, and the time available to make the decisions. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 39 o Increase project risks, inflating the cost of capital whether (a) as an implicit discount rate applied by building owners to own funds or (b) as an explicit cost of borrowing from third-party financiers. See Annex B for details on the tool developed for this study, methodology, and definition of policy scenarios. 4.1 Croatia scenario analysis In Croatia, the analysis suggests that current market and policy incentives, if unchanged for the next 15 years (the baseline scenario), would encourage deep retrofits in only some non-residential building categories. Residential building owners would not have strong enough an incentive to invest in energy retrofitting of their buildings at scale. Deep energy renovation across all building categories could be triggered either by offering building owners 75% grants without changing the current distorted policy and institutional environment, or by implementing combined market reforms (that is, energy price reforms and measures reducing transaction costs and risks) without any investment grants. However, EE support that relies on very high grant intensity and few market and institutional reforms would be more costly to society and risky to investors, potentially undermining its effectiveness and sustainability. The most cost-effective policy packages that would mobilize the highest value of energy savings are comprehensive market and institutional reforms with additional revenue enhancement through EE obligations (EEOs) envisaged under the EU Energy Efficiency Directive,18 and/or carbon prices. Market-compatible reforms, however, require time to implement and time before they begin affecting entrenched behaviors. Therefore the transition period may require an additional “market push” achieved by means of a combination of small, temporary investment grants (covering 25% of investment costs, for example); to avoid subsidy dependency and other unwanted effects, these would be designed to reward early movers and then decline over time. Energy savings results Figure 4-1 (see following page) shows how various policy packages would perform in terms of achieving energy savings. The largest technical energy saving potential lies in the deep retrofit of single-family homes (R3-SFH—turquoise bars) followed by deep thermal renovation of multifamily buildings (R3-MFH—light green bars) and retrofitting of heating, ventilation and air-conditioning equipment in single-family houses (Th-SFHsdh—orange bars). Six policy packages—scenario S4 and scenarios S7 through S11—would be equally effective and would all deliver the deepest thermal renovation that is technically feasible across all building categories. Scenario S4 assumes building owners are offered 75% grants but the current distorted policy and institutional environment remains unchanged. Scenario S7 would achieve the same by implementing combined market reforms (that is, energy price reforms and soft measures reducing transaction costs and risks) without any investment grants. Once the enabling market conditions for EE are in place, adding more grants (scenarios S9 and S11) or introducing EE obligations or carbon prices (S8 and S10) would not deliver additional energy savings—although they may address missing barriers, as we discuss later. Policies that would fail to deliver expected results are 25% grants without any reforms (S2) and energy price reforms without any additional measures (S6). The former illustrates the challenge that investments in EE may not happen without enabling conditions, notwithstanding available investment 18 Under the Energy Efficiency Directive, EU countries should set up an EE obligation scheme. This scheme requires energy companies to achieve yearly energy savings of 1.5% of annual sales to final consumers. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 40 grants. The latter result confirms the practitioners’ intuition that increasing energy prices alone is not sufficient to trigger investments in EE of buildings. Additional policies are needed to increase building owners’ responsiveness to energy price signals. Figure 4-1. Impact of policy scenarios on annual energy savings (GWh/year) in Croatia Source: Authors Scenario legend: Renovation packages Scenarios (thermal insulation thickness and windows) Building Categories No insulation Single Family Houses, S1 Baseline; no grants B Double glazing (baseline) detached (SFHdh) 5 cm roof Single Family Houses, semi- S2 Baseline + 25% grants R1 Double glazing detached (SFHsdh) 15 cm roof & walls, 10 cm floor S3 Baseline + 50% grants R2 Multi Family Houses (MFH) Double glazing 15 cm roof, walls & floor S4 Baseline + 75% grants R3 Offices (Public & Private) Double glazing 30 cm roof, 20 cm walls & 15 cm floor S5 Soft policy measures only R3 Education Triple glazing Substitution of the heating system S6 Energy price reform only Th Health Installation of a heat recovery unit Combined market reforms (soft S7 policies and energy price reform); no Hotels & Restaurants grants Combined market reforms; no grants; S8 energy efficiency obligation (EEO)/carbon prices (CPO) Combined market reforms + EEO/CPO S9 + 25% grant Combined market reforms; no grants; S10 2xEEO/CPO Combined market reforms; EEO/CPO; S11 50% grant Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 41 Financial results Figure 4-2 suggests that the most cost-effective policy packages are scenarios S7 (combined market and institutional reforms without grants) and S8 (the same as S7 but with EE obligations or carbon prices). They achieve the same energy savings as S4, S9, S10 and S11 but with lower investment expenditures and with no cost to the government (no subsidies would be needed from government coffers). Figure 4-2. Financial impacts of EE policy packages in Croatia 19000 18000 Annual surplus (€M) 17000 Total monetary revenues (NPV) (€M) 16000 Total investment (€M) 15000 Total grant/subsidy budget (€M) 14000 13000 12000 11000 10000 €M 9000 8000 7000 6000 5000 4000 3000 2000 1000 0 S1 S2 S3 S4 S5 S6 S7 S8 S9 S10 S11 Source: Authors Note: The scenario numbers are the same as in Figure 4-1. NPV = net present value. Once market conditions are similar to those in the rest of EU, additional grants (as in scenario S9) increase building owner surplus at the expense of taxpayers without delivering additional energy savings, as discussed previously. Scenario S10 would need no direct subsidies but would also generate some windfall profits for building owners due to higher prices for white certificates19 or carbon prices. This surplus would need to be recovered from somewhere—for example, from all energy consumers in the form of higher retail prices. It should be stressed, however, that reasonable windfall profits may be needed for an interim period as the entrenched behavior of building owners and financial institutions gradually changes.20 These additional incentives may be important factors influencing behavior, because some residual hidden costs are not well represented in this model —the landlord-tenant divide, for example, or the risk of primary movers (the corollary of the costs of changing entrenched behavior). For this practical reason, for a limited period of time (or in particularly difficult niches of the housing market), small grants (S9) 19 The white certificates scheme is a market-based instruments where typically gas and electricity distributors are obliged to achieve a predefined energy efficiency targets and can achieve them either by saving energy themselves or purchasing energy efficiency certificates. 20 Windfall profits are not necessarily a bad thing. They can increase efficiency by acting as a catalyst of market transformation and innovation that rewards primary movers for taking risks that followers are initially reluctant to accept. When the power of demonstration attracts the followers to the market, however, the windfall profits should be phased out. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 42 or higher prices for white certificates/carbon prices (S10) may prove necessary to trigger investments until the critical mass of a sustainable EE market is achieved. Scenario S9 would require a modest subsidy budget (perhaps €1 billion) that could be funded from EU structural funds. Investment requirements: Figure 4-3 shows the volume and the structure of capital investment by scenario and building category. The highest volume of upfront financing would be needed in scenario S4, which features high grants under disabling market conditions. As in other effective scenarios, the most funding would be demanded for deep retrofit of single-family homes. This scenario assumes that three quarters (€3 billion all together) would be funded by grants, which will need to be mobilized from EU structural funds or domestic budget revenues. The remaining 25% would need to come from other sources (private or public), building owners, or third parties. If this remaining quarter comes in the form of grants as well, the total volume of financing may well rise above €4 billion. Figure 4-3. Investment volumes by scenario and building category (€M) in Croatia 4500 4000 3500 3000 2500 Capex in health service buildings (€M) Capex in educa on buildings (€M) 2000 Capex in office buildings (€M) Capex in hotels and restaurants (€M) 1500 Capex in single family homes (€M) Capex in mul -family homes (€M) 1000 500 0 1 2 3 4 5 6 7 8 9 10 11 Source: Authors Note: The scenario numbers are the same as in Figure 4-1. Other unwanted effects are also likely. Many investors may delay their projects while queuing for grants. If grants are paid after project completion (as EU grants typically are), the lack of availability of bridging finance may be a bottleneck. Paying grants upfront would increase the risk of project quality and delivery of results. Crowding out private finance would slow down the development of a sustainable market for EE services. Eventually—in the absence of price signals encouraging final consumers to use energy efficiently—the rebound effect would be strong enough (although it is not quantified in this analysis) that it would threaten to undermine a large portion of energy savings in absolute terms. Scenarios in which there is little or no grant financing (S7 through to S10) would require significant mobilization of private finance. Experience in other new EU member states shows that structuring private financial products for the large number of relatively small energy saving projects in residential buildings is challenging. Transaction costs for financial institutions are high. They are also usually unwilling to lend against expected project financial savings and expect traditional fixed-assets–based collateral, which many households may find difficult to provide. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 43 Conclusions The largest technical energy saving potential in Croatian buildings lies in the deep retrofit of residential buildings—mainly single-family homes, followed by deep thermal renovation of multifamily buildings and retrofitting of HVAC (heating, ventilation, and air conditioning) equipment in single-family houses. This analysis suggests that current market and policy incentives—if unchanged for the next 15 years (the baseline scenario)—would encourage deep retrofit of only some non-residential buildings. Of the various building categories, offices and hospitals represent the most profitable opportunities for thermal renovation. The owners of educational buildings (such as municipalities that own schools) would focus on retrofitting their heating and air conditioning systems rather than insulating building envelopes, which would lead to oversized heating sources and inefficient use of energy. Hotels and restaurants would likely choose upgrades to less-ambitious energy performance standards. The incentives for residential building owners would be too weak to prompt them to invest in thermal retrofitting of their buildings at scale. Without policy and institutional reforms, moreover, enforcement of energy performance requirements for residential buildings would be an uphill battle. Multifamily houses are particularly challenging because of higher risks and transaction costs. The major finding of this analysis is that creating enabling market conditions for thermal renovation of buildings can be an effective and efficient substitute for investment grants, whether funded from EU structural instruments or other public resources. Both policy packages could be equally effective. The deepest thermal renovation that is technically feasible across all building categories could be delivered either (a) by offering building owners 75% grants without changing the current distorted policy and institutional environment or (b) by implementing combined market reforms (that is, energy price reforms plus soft measures to reduce transaction costs and risks) without any investment grants. Neither energy price reform alone, nor grants without market reforms, will be sufficient to stimulate EE investments, especially in the residential sector. Introducing energy price reforms without reducing transaction costs and project risks will not drive significant energy savings and will only frustrate energy consumers with higher bills. Increasing the subsidy programs in the absence of enabling market conditions is a waste of scarce public funds. An EE support system that would rely on very high grant intensity (75% of investment costs) and few market and institutional reforms would be costly and risky. It would be costly because continued adverse market conditions would require higher capital spending to achieve similar energy savings compared to market-based policy reforms (€4 billion versus €3.4 billion, respectively). Such a scenario would also be costly to Croatian citizens as taxpayers, as it would crowd out €3 billion (assuming 75% grant intensity) of government spending on other important social needs. Without reforms, these large public funds would just be required to compensate for the perverse market incentives that would continue to encourage wasteful use of energy and keep the costs and risks high. High grants with weak market incentives would also be risky because the financial surplus of building owners would be significantly lower than under scenarios with comprehensive market reforms. Facing low surpluses, many building owners may hesitate to invest even if taxpayers (often the same people) cover 75% of upfront costs. Other likely unwanted effects of this scenario include delayed investment decisions, lower-quality energy services, higher installation and equipment costs, and the crowding out of private finance. In the absence of price signals encouraging final users to use energy efficiently, the rebound effect would be strong, threatening to undermine a large portion of energy savings in absolute terms. The most cost-effective policy packages that would mobilize the highest level of energy savings are comprehensive market and institutional reforms with additional revenue enhancement through EE obligations or carbon prices. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 44 4.3 Bulgaria scenario analysis In Bulgaria, the analysis suggests that current market and policy incentives—if unchanged for the next 15 years (the baseline scenario)—will encourage the deep retrofit of some, but not all, non-residential building categories. Existing incentives for residential building owners are too weak to prompt them to invest in energy retrofitting of their buildings at scale. To encourage the deep energy renovation of single-family houses, governments will need to implement a comprehensive package of market reforms, such as (a) energy price reforms and measures reducing transaction costs and risks to the typical EU level and (b) additional market-based revenue enhancement through EE obligations (as envisaged under the EU Energy Efficiency Directive) and/or carbon prices. In addition, an initial “market push” may be required. Because market-compatible reforms need time before they begin affecting peoples’ entrenched behavior, the transition period may require additional measures involving a combination of small, temporary investment grants (25% of investment costs) or the setting of higher prices for white certificates and/or carbon pricing. Grants will be most effective if they are structured to reward first movers and decline over time to avoid subsidy dependency and other unwanted effects. Mobilizing deep energy retrofit of multifamily houses would require even more aggressive policy support than the policy packages simulated in this study. Offering high grants (50% of investment costs) alone will likely not be effective in triggering deep energy modernization of any type of residential buildings without concomitant market and institutional reforms that improve the investment climate to the average EU level. Also, EE support that relies on very high grant intensity and little market and institutional reforms would be costly to the budget and risky to investors, potentially undermining its effectiveness. The cost-effective policy packages that would mobilize the highest value of energy savings compared to initial costs need to include market and institutional reforms. Energy savings results Figure 4-4 shows how different policy packages would perform in terms of achieving energy savings. Figure 4-4. Impact of policy packages on annual energy savings (GWh/year) in Bulgaria Source: Authors Scenario legend: Renovation packages (thermal insulation thickness and Scenarios windows) Building Categories Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 45 No insulation Single Family Houses, S1 Baseline; no grants B Double glazing (baseline) detached (SFHdh) 5 cm roof Single Family Houses, S2 Baseline + 25% grants R1 Double glazing semi-detached (SFHsdh) 15 cm roof & walls, 10 cm floor Multi Family Houses S3 Baseline + 50% grants R2 Double glazing (MFH) 15 cm roof, walls & floor S4 Soft policy measures only R3 Offices (Public & Private) Double glazing 30 cm roof, 20 cm walls & 15 cm S5 Energy price reform + 25% grants R3 Education floor triple glazing Combined market reforms (soft Substitution of the heating system S6 policies and energy price reform, Th Health Installation of a heat recovery unit carbon price/EEO); no grants Combined market reforms + 25% S7 Hotels & Restaurants grant Combined market reforms, carbon prices, and small 25% grants applied together (scenario S7) can deliver the highest energy savings—over 10.2 TWh per year, of which 7.8 TWh would be saved in the residential sector. This is the only policy mix that can trigger the financial viability of deep energy renovation of single-family homes (R3-SFH). But even this most ambitious policy mix seems to be insufficient to stimulate deep retrofit of multifamily buildings (R3-MFH). With these incentives in place, most of them would be locked in the second-stage energy renovation of multifamily houses (R2-MFH). Higher carbon prices, higher prices for white certificates, or higher grants would be needed if multifamily houses were to be renovated up to the highest achievable energy performance standards. It should be noted that in this scenario complete market and institutional reforms are blended with an additional 25% capital expenditure (capex) grant. As the simulations for Croatia show, similar effectiveness can also be achieved by substituting grants for increasing the rate of carbon price or level of ambition of the EE obligations. But such simulations were not conducted for Bulgaria in the timeframe of this project. The next-most effective scenario is S3, which assumes large grants (50% of capex) but business- as-usual investment climate, transaction costs and risks. It has a potential to achieve 7.6 TWH of energy savings per year—which is 2.6 TWh (or 25%) less than the combined market reforms scenario with smaller grants (S7). Most of these savings (5.2 TWh per year) would be achieved in the residential sector (single-family houses); however, large grants alone would not be enough to enable households to make investments in deep energy renovation of their single-family houses (R3-SFH) because only the second-best standard (R2-SFH) would be financially viable at scale. This means that most owners of single-family homes would lock their building into sub-optimal energy performance at the R2 level for the next 15–20 years. Multifamily homes would see only business-as-usual renovation, without noticeable energy performance improvements, except for investments in HVAC systems. A closer look at the model results, however, indicates that basic energy renovation of multifamily houses (R1-MFH) is only marginally unviable (the marginal energy saving cost is only 0.45$c/kWh), so several multifamily buildings may actually be renovated up to the basic energy performance standards in this scenario. Again, this would risk locking multifamily buildings into sub-standard energy performance for the next 20 years or so. Improving market conditions to a level comparable with the rest of the EU, but without grants (scenario S6), would make a difference—but less than the previous two policy mixes. It would deliver energy savings of 6.3 TWh per year, of which 4.2 TWh derive from the residential single- family houses. Only basic energy renovation (R1-SFH) would be triggered. This would be 3.9 TWh, or 38%, less than in scenario S7, notwithstanding the fact that the only difference between these two scenarios is a relatively small grant (25% of capex). It seems that with improved investment environment in Bulgaria, small grants can make big difference, while the previous scenario (S6) shows Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 46 that if the present weak investment climate continues, even relatively large grants will not mobilize residential EE investments at scale. Financial results The most cost-effective policy packages are S4 through S7, all of which involve market and institutional reforms. As shown in Figure 4-5, the ratio of lifetime monetary savings to initial capital investments is twice as high in scenarios with market reforms than in scenarios S2 and S3, which assume only grants and no reforms. Figure 4-5. Ratio of NPV of monetary savings accumulated over the projects’ lifetime to initial capital investments in Bulgaria Source: Authors Note: The scenario numbers are the same as in Figure 4-1. Market reforms in policy packages S6 and S7 generate the largest monetary revenues from energy savings—revenues that are significantly higher than the 50% capex grants in scenario S3 (Figure 4-6). In scenario S6, which assumes market reforms but no grants, the higher monetary savings are partly offset by the cost of capital, which—in the absence of grants—is higher than in scenarios S3 and S7, which feature subsidized investment costs. Figure 4-6. Total accumulated monetary savings over the projects’ lifetime (NPV, € millions) in Bulgaria Source: Authors Note: The scenario numbers are the same as in Figure 4-1. Investors’ annual surplus (the blue bars in Figure 4-7) is the highest in the combined market reforms and 25% grant scenario (S7). The surplus is only slightly larger with high upfront grants (S3) than without any grants (S6). The surplus in the high-grant scenario (S3) is financed mainly by taxpayers, Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 47 while in S6 and S7 the bulk of the surplus would be recovered from energy consumers in the form of higher retail energy prices. One way or another, the burden falls on the households. Fig. 4-7. Financial impacts of EE policy packages in Bulgaria Source: Authors Note: The scenario numbers are the same as in Figure 4-1. Renovation measures implemented under market-friendly conditions would have higher annual revenues, because these policies enhance operational cash flows rather than decreasing building owners’ upfront capital expenditures. Unsurprisingly, the scenario with very high grants (50% of capex) is the most costly to the public budget. Around €1.3 billion in additional funding would be needed during the simulation period, whether or not it is reimbursed from EU structural funds. When market reforms are implemented in scenario S7 the grant budget can fall to €898 million, meaning that market and institutional reform would release €441 million that can be used to meet other important social needs in the country. As expected, the scenario that combines market reform with a 25% grant (S7) is also the most capital intensive, because it triggers more-expensive deep energy modernization of single-family houses. Scenario S6 requires lower capital investments than S3 and (€2.2 billion versus €2.7 billion, respectively—the red bars in Figure 4-7), since it triggers less-ambitious energy renovation of single- family houses (R1-SFH) as opposed to R2-SFH in scenario S3. Investment requirements in the public sector (approximated by the capex in education and health sector—see Figure 4-8) are roughly the same in all policy scenarios (except baseline) and would amount to €475 million over the lifetime of the program. This is because energy renovation of education and health service buildings is more cost-effective (including transaction costs) and less risky than it is for residential buildings. All policy scenarios are broadly sufficient to encourage a similarly deep (R3) level of retrofit of these buildings. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 48 Figure 4-8. Public investment volumes by scenario and building category (€ millions) in Bulgaria Source: Authors Note: The scenario numbers are the same as in Figure 4-1. Conclusions This analysis indicates that market and institutional reforms in Bulgaria (especially energy price reform) are necessary for energy renovation of buildings to be both effective and cost-effective. But market and institutional reforms alone will not be enough to effectively trigger high standards of energy renovation in residential buildings. Additional incentives will also be needed as part of the complete “policy package”. In principle, offering high investment grants (50% of capex) without market reforms can be more effective (in terms of total energy savings) than market reforms without grants. However, both would trigger only suboptimal energy renovation of residential buildings. Such incomplete policy packages would carry a risk of widespread implementation of sub-standard investments—locking most residential buildings into relatively low energy-performance levels until the next investment cycle, which may come only in 20–25 years. Complete market reforms (which include energy price reform, soft policy measures to reduce risks and transaction costs, and carbon prices or EE obligations) also generate significantly higher financial surplus to the building owners than grants alone. This surplus will be significantly augmented if small grants are added to the market policies mix. Increasing carbon price levels, or the ambition of the EE obligations, can serve as an alternative to grants. Finally, additional incentives will be needed during an interim period while the entrenched behavior of building owners and financial institutions changes. These additional incentives may be required because some residual hidden costs are still not very well represented in this model —for example, the landlord-tenant divide or the risk of primary movers (the corollary of the costs of changing entrenched behavior). For this practical reason, for a limited period of time—or in particularly difficult niches of the housing market (especially multifamily houses)—small grants (S7) or higher prices for white certificates and carbon (not modelled here) may prove necessary to trigger investments in the near term until a critical mass is achieved in the sustainable EE market. Scenario S7 would require a modest subsidy budget (about €900 million) that could be funded from EU structural funds. The policy packages with market reforms would improve Bulgaria’s EE investment climate to a level similar to the rest of the EU. They would thus have a significantly higher benefit-to-cost ratio for building owners than packages with grants but business-as-usual market conditions. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 49 As the Croatia scenario analysis showed, EE support systems that would rely on very high grant intensity (75% of investment costs) and few market and institutional reforms (scenario S3) would be not only ineffective, but also costly and risky. It would be costly to the budget because high subsidies would have to make up for adverse market conditions. Taxpayers would foot a €1.3 billion bill through budget transfers, without even achieving the desired standard of energy performance. Although ultimately the EU taxpayers could pay a large portion of this bill through structural funds, this amount would nonetheless represent the alternative unfunded budget mandates foregone by Bulgarian citizens (in educational and health service buildings alone, market reforms would save over €400 million in public investments). Scenario S3 (high grants but weak market incentives) would also be risky, because building owners’ financial surplus would be lower than under scenarios where market reforms are implemented (S6 and S7). Facing low surplus, many building owners may hesitate to invest even when half of their upfront costs would be funded by grants. The fiscal cost of large grants is disproportionate to the profits generated by the energy renovation projects. Scenarios in which there is little or no grant financing (S4 through to S7) would require significant mobilization of private finance. Experience in other new EU member states shows that structuring private financial products for the large number of relatively small energy saving projects in residential buildings is challenging. Transaction costs for financial institutions are high. They are also usually unwilling to lend against expected project financial savings and expect traditional fixed-assets–based collateral, which many households may find difficult to provide. However, several ways to leverage private finance for small-scale residential EE projects exist, such as specialized credit lines and risk-sharing instruments provided by international financial institutions (such as the EBRD and World Bank), or energy performance contracts offered by specialized energy service companies (ESCOs). EE obligations can be instrumental in facilitating a vibrant ESCO market—as could be seen in the EU countries with the longest experience with EE obligations, such as France, Denmark and Italy. Structuring public and private financing for public buildings, hotels, restaurants and offices has proved much easier than for residential buildings. This calls for a differentiated approach to the various building categories. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 50 Chapter 5. International Experience with Delivery Mechanisms for Thermal Retrofit of Buildings Main messages: • New EU member countries share similar challenges in developing sustainable finance and effective implementation schemes for EE renovation in public and residential buildings. The experiences of early movers can provide useful lessons of tried and proven ideas.. • In the public sector, international experience shows that while commercial financing may be the long-term goal, public financing mechanisms are often necessary in the near- to-medium term to help public entities and municipalities transition to more commercial schemes. These public financing schemes often have dual objectives in demonstrating financial viability of project financing and private sector participation in project delivery. • In single-family buildings, households could be motivated to undertake EE measures by raising energy prices combined with cost-benefit information made available to them through public or utility programs. Household decisions to undertake larger, more complex and costly projects often hinge on credible and understandable information, as well as availability of long-term and low-cost capital. • For multiple-family buildings, additional approaches may be needed when complex measures require collective action, for example through HOAs. The capabilities of HOAs, including creditworthiness and access to financing, have become key to the success of EE retrofit measures. • Selection and design of appropriate mechanisms will be based on factors including (a) current legislative and regulatory conditions; (b) the maturity of financial and public credit markets; (c) the current state of local EE service markets, including ESCOs and energy auditors; and (d) the technical and financial capabilities of building owners to undertake EE projects. The implementation of previous EE projects financed by the World Bank and other international financial institutions (IFIs) confirms the findings in Chapter 4 that a combination of financing mechanisms—coupled with interventions in areas such as policies, regulation, information and awareness raising, and capacity building—is critical if EE programs are to be successfully assisted in overcoming some of these barriers. When designing EE programs, it is critical to choose both the most appropriate implementation mechanism (referred to as delivery mechanism in this report) as well as the best financing mechanism to help address some of the barriers identified earlier in the report and put in place adequate financing incentives (grants) to leverage private financing. This chapter presents a menu of options in terms of delivery and financing mechanisms that policy makers may consider when designing their EE programs for public and residential buildings. It also describes successful previous and ongoing programs that correspond to some of the options, and highlights the major lessons learned. Finally, it offers broad recommendations on how can the various options can be adapted to fit the existing environment in new EU member states. Annex C presents these and other case studies in greater detail. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 51 5.1 Delivering EE Retrofits in Public Buildings Financing mechanisms Financing mechanisms can be broken out a bit more finely by placing them on a “financing ladder” arranged according to level of market maturity and degree of public vs. commercial financing (Figure 5-1). This conceptual tool can help guide policy makers to select one or more options that can then be designed to provide financing products appropriate to conditions in their country. While commercial financing may be the long-term goal, public financing mechanisms are often necessary in the near-to- medium term to help public entities and municipalities transition to more-commercial schemes. Figure 5-1. Financing Ladder: Energy Efficiency Financing Options in the Public Sector Market Commercial Maturity Financing Advanced commercial or project financing (ESCOs) Public EE financing ladder Vendor credit, leasing Commercial financing, bonds Partial risk guarantees Credit line with commercial bank(s) Credit line with municipal (development) bank Public ESCOs EE revolving funds Utility (on-bill) financing MOF financing w/ budget capture Budget financing, grants w/ co-financing Public Grants Financing Source: Financing Municipal Energy Efficiency Projects: Energy Efficient Cities. World Bank (2014). This “ladder” is illustrative only; not all mechanisms shown are mutually exclusive, and governments need not move up every step of the ladder. The selection and design of appropriate mechanisms will be based on factors including (a) current legislative and regulatory conditions; (b) the maturity of financial and public credit markets; (c) the current state of local EE service markets, including ESCOs and energy auditors; and (d) the technical and financial capabilities of public entities to undertake EE projects. Targeted actions in other areas As discussed in Chapters 3 and 4, to be fully effective in facilitating EE in public buildings, these good practices in financing need to be complemented by good practices in other arenas. Policies and regulations, information and awareness, and capacity building activities are needed to overcome key barriers and constraints, including (a) a limited number of creditworthy public agencies and municipalities; (b) low or limited borrowing capacity; (c) small project sizes, leading to high transaction costs; (d) limited budget and technical capacity for preparing high-quality EE project proposals; and (e) high perceived risks, leading to behavioral inertia. Unlike the private sector, which responds to price signals and incentives, motivating the public sector typically requires a greater focus on policy, with supporting programs to reduce risk for the public Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 52 officials carrying out EE improvements. As Table 5-1 shows, changes in public procurement to focus on life-cycle costs rather than the lowest upfront cost are often important, as are modifications to budgeting rules that prevent public agencies from being penalized by reduced budgetary allocations when they save money through EE and conservation efforts (Limaye and Derbyshire 2014). Table 5-1. International Good Practices: Public Sector AREA ACTIVITIES Requiring EE targets and action plans Modifying public procurement and budgeting rules Policies and Regulations Public procurement of efficient products Equipment standards and labeling Grants, incentives and budget financing EE revolving funds Financing Utility financing Public ESCO Benchmarking and performance awards Information and EE technology databases Awareness Workshops on ESPC options Guidebooks, handbooks, case studies and tools Training of energy auditors and energy managers Training and Capacity Capacity building of facility engineers and managers Building Training of ESPs and banks/financial institutions Source: Limaye and Derbyshire (2014). Examples of Successful Options for Public Buildings Financing is an important, but not the only, barrier to carrying out EE retrofits in public buildings, so the model represented by Armenia’s Renewable Resources and Energy Efficiency (R2E2) Fund has strong advantages. A dedicated agency staffed by competent and motivated staff, the Fund is not only able to contract for various types of services, from simple to complex, for clients; it is also able to arrange financing to meet the needs of different types of clients—including those with their own revenue streams, like city governments, and those without, like schools. The R2E2 Fund benefitted early on from grant funds that allowed it to demonstrate the viability of projects. It also has resources to support its training and capacity-building efforts, which have helped stimulate demand for efficiency services on the part of the client base—thus addressing the problem that has afflicted many EE financing programs: failing to generate a significant project pipeline. Public Buildings Case Study 1: Armenia Renewable Resources & Energy Efficiency (R2E2) Fund Established in 2005, the national R2E2 Fund is an investment facility for financially viable public sector EE retrofits. Operating on commercial terms, the Fund is governed by a Board of Trustees that is chaired by the Minister of Energy and Natural Resources and supported by technical and financial staff. The initial US$22 million program (including US$15 million in IDA credit) was supplemented by US$10.7 million in 2012. It focuses on public facilities like street lighting, schools, hospitals, and city administration buildings, with an average project size of about US$100,000. R2E2 also provides technical assistance for project preparation and capacity building. For clients with revenue streams independent of the state budget, the Fund provides loans and fee-based services, including energy audits, procurement, project supervision, and contractor payment. For clients like schools that are not legally or budget independent, the Fund and its clients enter into energy service agreements (ESAs) in which the Fund pays up-front Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 53 and the client makes baseline payments into an escrow account until the retrofit is paid off through energy savings. The Fund subcontracts retrofit projects to ESCOs, which win bids based on the net present value (NPV) of their proposals, and which take on some performance risk. Implementation Arrangements under the R2E2 ESA model The results of the R2E2 Fund’s loans have exceeded expectations, with projects producing significant energy savings, leveraging of the loans by a ratio greater than 2:1, and a default rate under 1% —all the while introducing new safety norms; raising awareness of safety and EE; and building the capacity of HOAs, construction firms and ESCOs. Projects in schools often have energy savings of 40 to 50%, creating fertile ground for a revolving structure. The first five projects using the newer ESA mechanism promise similar levels of energy savings and simple payback periods of six to nine years. Other projects are in the pipeline. Factors essential to success of the program included grant-funding of initial projects at schools to demonstrate feasibility, training of contractors to ensure a sufficient stream of qualified bids, billing based on actual consumption to generate cash savings (universal in Armenia since there is no district heating), full payment discipline, and cost-reflective energy prices, as well as EE specialists staffed at the R2E2 Fund and on its Board. Belgium’s Fedesco illustrates a slightly different model wherein a public ESCO acts in a more limited fashion as a deal broker and as a technical supervisor. While it does not undertake EE projects itself, the entity has technical expertise in-house to evaluate projects, and is able to give financers independent confirmation of the technical merits of proposed projects. It arranges commercial financing for energy projects, and oversees contracting for other service providers to carry out the actual work. Fedesco benefits from being designated the sole provider of energy services to federal buildings in Belgium, but it bids out the service contracts competitively. On the other hand, as the subsidiary of a public investment corporation with a circumscribed client base, it has perhaps less scope for developing a wider range of approaches and services. Fedesco thus may not be the most effective model in the circumstances prevailing in the four countries with which this study is concerned; however, as a model proven to be effective in some situations, it provides a key point for the evolution of delivery schemes in the long-term. Public Buildings Case Study 2: Belgium’s Fedesco Fedesco is a public ESCO that facilitates and finances EE projects in federal government buildings in Belgium. It was founded in 2005 as a public limited company with capital of €6.5 million and €10 million in state guarantees. Its business model is the energy performance contract (EPC) developed by the Berlin Energy Agency and other partners in the EURCONTRACT project, with repayment based on actual savings and spread over several years. Projects receive either commercial bank financing with a state guarantee, or Fedesco’s internal funds. Because Fedesco has only 12 members of staff, while it prepares bidding documents and conducts procurement in-house, it subcontracts Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 54 retrofit work to private ESCOs or ESPs on a competitive basis. To cover project and financing costs plus a profit margin, Fedesco receives a defined percentage of project energy savings. It bears the obligation to repay bank loans, and assumes project performance risk. Stakeholder and funding source of Fedesco Because of this last point, capacity to manage technical risk has been key to Fedesco’s success. Its staff can identify and benchmark potential projects as well as oversee all work carried out by subcontractors, from audits to preparation of studies and technical specifications, to procurement. Its projects have resulted in energy savings worth over €1 million annually, with payback times of slightly over two years. Implementation under Fedesco model As a national-level entity with federal support (through its exclusive role in providing efficiency services to government buildings), Fedesco was able to take a lead at a time when few local governments had created their own ESCOs. It took a long-term view at its founding, and maintained its role through changes in government —partly by linking its activities to other national priorities, including sustainable development, climate change and public procurement. Fedesco enabled Belgium to meet the EU’s Energy Efficiency Directive to retrofit 3% of central government buildings annually, and put the country in a good position to meet emerging EU obligations on sustainability more broadly. Fedesco’s model of working across stakeholder groups to share knowledge and experience has allowed it to evolve from simply a third-party financier of public-sector projects to a company that provides a range of services and facilitates private sector participation. Fedesco was also instrumental in creating the Belgian ESCO association, which has a Knowledge Centre dedicated to building capacity in the industry. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 55 Looking ahead, there is considerable scope for Fedesco to support deeper retrofits, with longer payback periods, and to once again take the lead. 5.2 Delivering EE Retrofits in Residential Buildings Because the residential market is very diverse, finding effective delivery mechanisms for EE programs is challenging. International experience points to four main financing options to support EE improvements in residential buildings: (a) EE revolving funds; (b) credit lines with commercial bank financing; (c) partial credit or risk guarantees; and (d) utility EE obligations (Table 5-2). As in other sectors, the selection, design features, and products offered under each of the four options need to be tailored to the specific country conditions. Table 5-2. Major types of financing arrangements for residential buildings Option Countries Pros Cons Commercial Austria, Belgium, • Sustainable • May only serve very wealthy Bulgaria, Czech Rep., • Builds off existing credit creditworthy customers Bank Germany, Lithuania, systems • May involve high interest rates Lending Netherlands, Poland, • Allows for competition of • Banks may lack incentive to Romania, Spain, U.K. financing market aggressively Partial Hungary, Lithuania, • Encourages commercial • Requires mature banking Czech Republic, Slovak banks to finance EE sector interested in EE Credit Republic projects financing Guarantees • Helps overcome risk • May need substantial capacity perception of banks building of banks • Can lead to sustainable • May serve only creditworthy commercial financing customers EE Bulgaria, Greece, • Can be sustainable • May distort market Romania, Slovenia • Mandated to promote EE • Could create monopoly Revolving • Can develop specialized • May not operate efficiently Funds products • Can be captured by political • Centralized experience interests and lessons Utility EE Belgium, Denmark, • Can be done in • Utilities lack incentives to France, Ireland, Italy, sustainable manner reduce energy sales Obligations Netherlands, U.K. • Builds off of utility • Regulations may limit new utility relationships and services services, billing • Allows for simple • Can create monopoly collections (on-bill repayment) Source: Limaye and Derbyshire (2014). As discussed in Chapters 3 and 4, the financing of EE investments in the residential sector faces a number of barriers, most commonly (a) small project size and relatively high transaction costs, (b) subsidized energy tariffs and lack of consumption-based billing, (c) perception of high risk on the part of commercial banks, (d) issues with collective decision-making by homeowners associations, e) lack of homeowner’s creditworthiness in multifamily buildings, (f) relatively high commercial bank interest rates, and (g) high discount rates (or hurdle rates) on the part of residential consumers. Table 5-2 illustrates how the main financing options identified above can help address the prevailing barriers in the residential buildings sector. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 56 Table 5-2. International Good Practices: Residential Sector AREA ACTIVITIES Appliance standards and labeling Policies and Regulations Building codes and certificates Utility EE obligations Grants and incentives EE revolving funds Financing Credit lines with low interest loans Utility on-bill financing Public awareness campaigns Information and EE information centers Awareness Free or subsidized energy audits Guidebooks, handbooks, and tools Training and Capacity Training of residential energy auditors Building Benchmarking of energy consumption in housing Source: Limaye and Derbyshire (2014). Financing approaches for multifamily and single-family dwellings vary according to the combination of incentives, capabilities, and stakeholders (World Bank 2014). In single-family dwellings, as illustrated in Figure 5-2, households could be motivated to undertake EE measures due to rising prices combined with information made available to them through public programs and information or endorsement labels. For relatively small measures, like replacement of an appliance or windows, limited incentives—such as VAT reductions or other tax credits—may suffice to raise the rate of adoption. Larger, more complex projects, however, may require correspondingly more substantial incentives, including grants or credit lines. Public information about these latter programs is key to their uptake, as is marketing to and on the part of the local banks that carry out the lending. Figure 5-2. Financing Approaches for Single-Family Residences Source: World Bank (2014b). Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 57 For multiple-family buildings, additional approaches may be needed when measures are more complex than replacement of appliances or windows (Figure 5-3). Exterior insulation, HVAC system refurbishment, and other such projects involve common areas of multi-family buildings and therefore collective action, for example through HOAs. The capabilities of HOAs, including creditworthiness and access to financing, have become key to the success of EE retrofit measures (WB 2014). Figure 5-3: Financing Approach for Multiple-Family Residences Source: World Bank (2014b). Examples of Successful Financing Options for Residential Buildings Lithuania is one of several new EU member states that has achieved significant success in scaling up thermal retrofit of multi-family buildings using financial instruments. It has also demonstrated the need for targeted grant support when mobilizing the participation of low-income households, as well as the importance of pro-active implementation support from national and local governments, especially when the capacity of HOAs is lacking. Residential Buildings Case Study 1: Lithuania Jessica Funds + EnerVizija Model About two-thirds of Lithuanians live in apartment buildings, and nearly two-thirds of those buildings are in need of efficiency upgrades. A pilot project targeted such buildings from 1996 to 2003, as did a program funded by state subsidies and commercial loans from 2005 to 2010. Since 2010 Lithuania has used EU Joint European Support for Sustainable Investment in City Areas (JESSICA) funds to establish a Holding Fund —with assistance from the EC, the EIB (acting as fund manager) and the Council of Europe Development Bank (CEB) —to provide low-interest loans. The JESSICA fund received €127 million from the European Regional Development Fund (ERDF) and €100 million in national matching funds. The Ministry of Environment’s Housing & Urban Development Agency (HUDA) oversaw application of rules for soft loans (3% interest, 10 to 20 years maturity) to eligible applicants, including HOAs, apartment owners and municipal building administrators, for approved EE measures such as efficient windows, building envelope insulation, heating and distribution systems and glazing of balconies. EIB selected Urban Development Funds (UDFs) as intermediaries. Funding sources for the JESSICA Holding Fund Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 58 Alongside the loans are incentives and technical assistance funds, which have been key to widening participation. State subsidies are available, upon certification of savings, for up to 15% of upgrading costs. Until the end of 2014, projects certified to reduce energy use by at least 40% were eligible for additional 15% and 10% subsidies from the Climate Change Program. There are also funds available to cover costs for technical documentation and project management. However, even with subsidized loans, uptake of JESSICA funding was slow until the ESCO-type “EnerVizija” investment model was adopted, in which municipalities initiate renovation programs and authorize building administrators to manage them. The building administrators borrow renovation loans on behalf of apartment owners and repay them from their contracted share of energy savings. The burden of project design, management and borrowing is thus shifted away from apartment owners to specialized, technically competent entities. To further spur uptake, subsidy rules for low-income households were amended to require them to implement EE renovation projects or lose 50% to 100% of their state heating subsidies for three years. Implementation arrangement for JESSICA + EnerVizija Model With these changes, the pace of EE renovations in Lithuania rose from about 70 apartment buildings per year to 490. Even so, the total of about 2,400 buildings reached by the current and previous two programs is less than 7% of the 35,000 residential buildings erected before 1993, which are the most important renovation targets. Scaling up the program will require building on improvements introduced over the course of implementation, such as streamlining procurement through online catalogues of approved retrofits measures, centralized procurement through framework agreements with contractors and consultants, standardization of forms, training of city-level administrators, and specialized software to simplify their work. As the scale of renovations rises, there will necessarily be an impact on heat supply systems, and coordination with city-wide renovation programs will be needed as well. Poland’s thermo-modernization program shows the viability of using limited grants to leverage commercial bank financing for large-scale thermal retrofit of residential buildings. It also demonstrated the benefit of broad-based market development in supporting sustainable housing retrofit financing in Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 59 the long term, as well as the importance of maintaining consistency in government support efforts (for example, steady grant funding through a dedicated mechanism). Residential Buildings Case Study 2: Poland Thermo-Modernization Program Poland introduced a Thermo-Modernization (TM) program in 1998 to finance EE investments in existing non- commercial buildings. The TM program leverages domestic commercial financing by providing a significant subsidy upon completion of eligible projects. Five years after rollout, uptake remained low, so the government streamlined the application process and made grants available earlier, and response to the program improved. The state-owned Bank Gospodarstwa Krajowego (BGK) administers the program and disburses the TM subsidy. Sixteen banks participate by providing loans on commercial terms. The program supports EE investments in residential, non-commercial and public buildings, and district energy networks and providers. Eligible entities are HOAs, cooperatives, individuals, companies, and city and local authorities. Typical measures include insulation, window replacement, installation of thermostatic valves and weather- driven controllers, and water heater upgrades. Once investors identify an EE retrofit project, an energy auditor examines designs appropriate measures. Project proponents then submit the audit report with a combined application for a commercial loan (of up to 80% of project costs; see figure) and TM subsidy (up to 20% of the loan value) to one of the 16 participating banks, which appraises the loan application, verifies creditworthiness, and confirms eligibility for the subsidy. BGK then reviews the application package and commissions an independent verification of the energy audit. On approval, the borrower executes the EE project, usually through a contractor. Upon project completion, BGK disburses the TM funds to the bank, which applies it to the outstanding loan principal. Banks may also pay contractors directly, although this shifts the burden of procurement oversight to banks, and requires upfront expenditures by contractors, demanding that they have strong financial positions. Funding flows and contractual arrangements in Poland’s TM program The TM subsidy is 95% funded from the state budget. After BGK approves applications, participating banks provide commercial loans with a maximum maturity of 10 years. Grants are cannot exceed 16% of total project costs or 200% of verified annual energy savings. Subsidy application grew from just 144 in 1999, peaked at over 4,200 in 2012, then declined to about 1,500 per year. Of the 32,417 applications received as of March 2014, 30,153 were approved, with total subsidy value around US$533 million, representing 88% disbursement and leveraged US$2.56 billion in commercial project financing. Energy cost savings grew by 29% annually, from US$33 million in 2005 to US$252 million in 2013. Most subsidy applications came from HOAs (54%) and housing co-operatives (35%). The remainder were from municipalities (5%), individuals (4%) and social housing associations (2%). Most applications (93%) were for projects in apartment buildings, and a small number for public utility buildings (4%), detached houses (2%) and other buildings (1%). Although the Program does not track energy savings and emission reductions, between 1999 and 2012, based on a sample of 150 audits, energy savings were estimated to be 3,636 GWh/year and emission reductions to be 1.4 mt of Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 60 CO2, with average investment costs estimated to be about US$783/MWh and US$2,036/mt of CO2. On conservative assumptions, projects had an average payback period of 18 years. Allocation of state budget to the TM program has been volatile, leading in 2010 to “on-hold” applications totaling over US$50 million, providing a reminder that fiscal stability is critical to the success of such subsidy programs. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 61 Chapter 6. Roadmap for Scaling up Thermal Retrofit of Buildings in Croatia Main messages: • Croatia needs to move from pilot programs to large-scale national programs supported by dedicated, long-term financing and delivery mechanisms for retrofitting residential and public buildings. • Implementing these national programs will also facilitate the absorption of EU structural funds—resources that can provide grant support to accelerate adoption of EE measures and act as a catalyst to leverage private financing. • For residential buildings, two delivery mechanisms are recommended based on their relevance to the current conditions in Croatia: (a) commercial bank lending supported by a national grant facility for capital subsidies and (b) a renovation loan fund supplemented by earmarked grants for capital subsidies. The renovation loan fund is considered a financial instrument and its approval process for using EU-funded grants can be expedited. • For public buildings, two options are recommended: an EE Revolving Fund (EERF) and a public ESCO (or super-ESCO). The EERF may be of special interest since it could be established as a platform that deploy financial instruments supported by EU funds. • To support the implementation of such large-scale national programs, important policy measures need to be adopted. Among these should be (a) implementation of cost- recovery prices for district heat and natural gas; (b) enforcement of apartment-level, consumption-based billing for heat; and (c) ensuring consistent application of ESCO regulation. This chapter attempts to combine existing knowledge of, and experience with, the delivery mechanisms presented in Chapter 5 with the findings of the assessment framework discussed in Chapters 3 and 4 — with the objective of presenting options that Croatia (Chapter 6) and Bulgaria (Chapter 7) may consider in their efforts to scale up investments in thermal renovation of residential and public buildings. 6.1 Overview of building stock, retrofit needs, and stakeholders Croatia had 186 million square meters of estimated total floor area of residential, public and commercial buildings in 2011, of which 53% were family houses, 27% were multi-family buildings, 7% were public buildings and 13% were commercial buildings.21 The increment in the building stock in the past few years is likely to be small due to the recession, which caused a large contraction of the construction sector. Of the existing stock, buildings constructed in or after 2010 have significantly better thermal insulation than those constructed in or before 2005 (Figure 6-1) due to the implementation of more-stringent building EE codes, which were initially introduced in 1987. In 2013 21 Source: Ministry of Construction and Physical Planning (MoCPP) reports. Family houses include single-family houses and attached homes built on separate parcels (townhouses). Multi-family buildings are multi-unit apartment buildings. Public buildings include government buildings and buildings that serve public and social interest, such as hospitals and schools. Commercial buildings include properties owned or leased/rented by entities with a commercial business interest. Industrial buildings are not included in commercial buildings. Reported floor area covers building interior space only. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 62 Croatia transposed into national law the EU’s Energy Performance of Buildings Directive (2010 recast).22 The total floor area of pre-1988 buildings, which are generally deemed as needing comprehensive thermal retrofits, amounts to an estimated 142 million square meters, about 70% of the entire existing building stock. As of 2014, only a tiny fraction (probably less than one million square meters based on the scale of past and ongoing projects/programs) has undergone comprehensive building envelope thermal retrofit. The floor area of buildings with partial improvements (such as installation of double- glazed windows by apartment owners) is believed to be significant. Figure 6-1 Indicative specific heat consumption of buildings in Croatia Source: REGEA consultancy report to the World Bank. Note: Data are estimates based on design parameters. If Croatia is to carry out a comprehensive renovation of its entire stock of pre-1988 buildings in the next 20 years, the floor area of buildings needing renovation work would amount to about 7 million square meters per year, compared to the average new construction of less than 4 million square meters per year during 2006–09. The economic and employment impact of a sustained large-scale building retrofit effort would be significant. Based on the modeling/scenario work presented in Chapter 4, a scenario of combining market reforms, revenue enhancement from EE obligation and a 25% grant incentive (S9) would generate annual energy savings of 6,100 GWh, with €14.6 billion of net present value and at a total cost of €4.6 billion. Different retrofit strategies are needed for continental and coastal climate zones as there is significant difference in climate-induced space-conditioning needs. Financing and delivery mechanisms for sustained, large-scale EE investment programs also need to cater to the characteristics of the particular market segments, as broadly represented by the four categories of buildings identified above. Croatia has recently introduced three national initiatives for comprehensive building retrofit, including a program for retrofitting public buildings begun in 2012, a program for retrofitting family houses launched in March 2014, and a pilot program for retrofitting multi-family buildings started in May 2014. These national programs involve a host of stakeholders which are a fair representation of the full spectrum of market participants in Croatia’s building retrofit activities. Their current roles are summarized in Table 6-2. 22 On 19 May 2010, a “recast” of the Energy Performance of Buildings Directive was adopted by the European Parliament and the Council of the European Union in order to strengthen the energy performance requirements and to clarify and streamline some of the provisions from the 2002 Directive it replaces. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 63 Table 6-2. Croatia: stakeholder dynamics of the building retrofit market, 2014 Key Function Residential buildings Public buildings Government MoCPP Formulating national building National program for retrofitting National program for retrofitting (Ministry of Construction retrofit strategy and family houses (2014-20) public buildings (2012-15) and Physical Planning) implementation plans National program for retrofitting multi-family buildings (2014-20) APN Implementation agency for the No involvement Identification and tendering of (Agency for Transactions national retrofit program for retrofit projects and Mediation in Real public buildings Estate) Energy performance verification, and dispute mediation City government City initiated programs, co- Some city governments have co- Some cities have own-managed financing, implementation financed installation of heat cost retrofit program (e.g., Zagreb) support allocators in district heating served multi-family buildings Finance providers EPEEF National grant support for Grant support for heat cost Grant support for the national (Environmental Protection building retrofit, and EE in allocator installation, retrofit of retrofit program and Energy Efficiency Fund) general family houses and multi-family buildings HBOR Apex institution supporting Supported residential retrofits Part of the financing scheme for (Croatia Bank for commercial banks’ lending to the national retrofit program Development and building retrofit projects Reconstruction) Commercial banks Direct lending to building Lending to individual households, Lending to energy service retrofit projects home owner associations and providers housing management companies HAMAG Invest Provide loan guarantees to No involvement Providing loan guarantees to (Croatian agency for SMEs SMEs energy service providers and Investment) IFIs Credit and grant support to European Investment Bank funds No involvement (International finance participating commercial have been used in several retrofit institutions) banks projects Service providers Housing management Maintenance of commonly The housing management No involvement companies share parts of multi-family companies have acted as an buildings (e.g., exterior and intermediary between commercial roof) and public areas of banks, homeowners and property. Management of the contractors in several pilot retrofit reserve fund for maintenance. projects Construction companies and Engineering and construction Engineering and construction Performance-based contracting contractors and co-financing and co-financing (through third party) under the national retrofit program Energy service Energy audits, engineering and Energy audits, engineering and Same as above companies/providers construction, and co-financing construction Equipment and component Supply and installation, and Heat cost allocator installation and No involvement suppliers associated service if necessary billing service for district heating served buildings Energy utilities Network energy services A few district heating companies No involvement have played a facilitating role in heat cost allocator installation Beneficiaries Households Investment decision and co- For multi-family buildings, No involvement financing building-level organizational unit need to make collective decisions on retrofit investment and repayment arrangements if loan financing is involved Public entities Investment decision and co- Central ministries and municipal financing governments may be subjected to different budget constraints Source: Authors. The following two sections address scaling up retrofits in (a) residential buildings and (b) public buildings. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 64 6.2 Scaling up residential building retrofits The Starting Point Thermal retrofit of residential buildings in Croatia has so far occurred mostly through private initiative at limited scale.23 National programs for family houses and apartment buildings, respectively, only started in 2014 and the initial implementation results are still emerging (Box 6-1). Launching separate programs for family houses and multi-family buildings is considered appropriate from an implementation point of view because the two market segments, while having many common barriers, are distinctive in terms of investment decision process and the way the retrofit projects can be delivered. The sources of investment financing for individual households participating in both programs are similar: a sizable capital subsidy (at least 40% of eligible costs) and a household contribution, which may include borrowing from commercial banks. Box 6-1. Croatia’s national residential thermal retrofit programs, 2014–20 Croatia’s National thermal retrofit program for family houses was formally launched by the Ministry of Construction and Physical Planning (MoCPP) in March 2014. It targets EE upgrades of family houses built before 1987, when Croatia adopted its first building EE code. The program seeks to improve heating systems and replace electricity and fuel oil with more-economical energy sources, including renewables. The financing of the investments made under the program includes a 40% grant currently provided by the Environmental Protection and Energy Efficiency Fund (EPEEF), with the rest coming from households’ own capital or borrowing from banks. As a condition of the EPEEF grant financing, local and regional governments are expected to provide some grant funding (up to 10% of the eligible cost). The national thermal retrofit program for multi-family buildings is still in its pilot phase. The pilot scheme relies on the housing management companies acting as an intermediary for preparing and implementing the project. EPEEF finances the cost of project preparation (including energy audit, certification of building EE class and documentation) and 40% of eligible investment cost, while the homeowners of a building need to collectively borrow from a bank for the rest of capital needs. The responsible housing management company would then collect the monthly repayments to the bank using the existing building maintenance reserve fund mechanism. Source: Ministry of Construction and Physical Planning (MoCPP), Croatia The MoCPP and EPEEF have organized information campaigns, and there is broad awareness of the national programs. Interest from households in multi-family buildings is said to be further boosted by the looming deadlines for implementing apartment-level, consumption-based heat billing by the end of 2015 for small buildings and by the end of 2016 for high-rises. According to EPEEF, the demand for subsidy significantly exceeded its initial allocations for either program, indicating pent-up demand from households with resources. As of September 2014 the total investment (inclusive of subsidy) in residential thermal retrofit facilitated with EPEEF subsidy amounted to about €15 million, a small but significant start. There is a long way to go for the programs to reach the majority of households, especially those at the bottom 40% of the income ladder. The remainder of this section: • Reviews the main barriers to scaling up thermal retrofit investments in residential buildings in Croatia; • Suggests financing and delivery options; • Outlines the roles of various stakeholders; and • Recommends potential solutions. 23 Surveys indicate that in 2013 about 8% of households had capital expenditure on building maintenance work that either improved thermal comfort or reduced heat energy needs. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 65 Barriers common to all residential buildings in Croatia With few exceptions, financing and implementation of thermal retrofit in family houses and multi- apartment buildings face the same set of barriers or constraints as in many new EU member states. The most important, in terms of hampering sustained and large-scale thermal retrofit programs in Croatia, are as follows: • Insufficient energy price signals in gas and district heating and lack of consumption- based billing, especially those of natural gas and district heat. The price signals in district heating are further blunted by the lack of apartment-level, consumption-based billing. Croatia is moving toward cost-recovery tariffs for network energies (such as electricity, district heat and natural gas) and is implementing a program for apartment-level, consumption-based billing. • The financial limitations of low-income households. The ability of low-income households to finance any upfront costs of more-efficient equipment or thermal renovation costs is close to zero. Many multi-family buildings are inhabited by households from across all income levels. Poor households in such buildings may be reluctant to participate in collective decision- making processes or vote against renovation projects and as such may prevent decisions from being made. • The information and capacity gaps of key market participants, including households, homeowners associations, housing management companies, energy service providers, and banks. In part due to limited implementation, empirical data and analyses of real-world costs and benefits of thermal retrofits are still lacking, hindering the investment decision-making of both households and financers. • The lack of adequate and secure long-term grant funding necessary for mobilizing private and commercial financing. Due to (a) the inherent risk and return perceptions of both households and banks and (b) competition for private/commercial capital from other investment needs and opportunities, government grant support for reducing the cost to households (while also reducing risk for banks) appears indispensable in any large-scale residential thermal retrofit programs. • Cumbersome and inefficient implementation arrangements that hinder the delivery of thermal retrofit projects at scale. Residential retrofits are inherently processing-intensive because of the disaggregated nature of many smaller projects and the involvement of multiple construction trades. The current implementation process is driven primarily by public procurements conducted by EPEEF. In practice, each subproject (that is, each individual building) is evaluated on the basis of pre-determined criteria for eligibility for the EPEEF grant. Such arrangements incur high transaction costs and are unsuitable for large-scale programs. Barriers particular to thermal retrofit of multi-family buildings The implementation of the thermal retrofit program for multi-family buildings faces some unique challenges, including the following: • Collective decision making. Croatian law on ownership and other proprietary rights stipulates that each co-owner of a building is entitled to participate in decision making related to the building. For extraordinary activities such as major repairs, construction upgrades and similar joint investment decisions, all co-owners must consent.24 While some pragmatic approaches 24 In Croatia co-owners of multi-family residential buildings form owner assemblies or tenants’ councils. The coun cil selects a housing management company to provide technical maintenance and other building-related services in line with a contract signed by a building co-owners’ representative and the company. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 66 have enabled thermal retrofits to proceed without requiring unanimous co-owners’ consent,25 the unanimity provision is considered the most severe legal barrier to a large-scale thermal retrofit program for multi-family buildings. • Apartment-level consumption-based billing for households served by centralized heating, including buildings served by district heating systems or heat-only boilers. The government has set an end-of-2016 deadline for installing heat cost allocators in all centrally heated multi-family buildings. As of September 2014, more than 80% of such households had yet to comply, most of them in Zagreb. Recommended financing and delivery options Of the four main types of financing and delivery mechanisms for residential thermal retrofit discussed in Chapter 5 (Figure 5-2), the following two are considered to have direct relevance to the current conditions in Croatia: Option 1: Commercial bank lending supported by (a) a national grant fund facility for capital subsidies and (b) technical assistance for project preparation. This platform in principle would resemble the operational arrangements of the Thermo Modernization Fund in Poland (see “Residential Buildings Case Study 2” in Chapter 5) and would be in essence a natural evolution of the current schemes for family houses and multi-family buildings supported by grants –which could be provided by the Environmental Protection and Energy Efficiency Fund. The proposed scheme would help reconcile the EC’s intention to encourage the use of financial instruments with the need to quickly mobilize a critical mass of households to participate in the national programs so as to continuously strengthen the market. The government needs to reach an agreement with the EC about how much EU funding may be allocated to support the interim scheme and the exit strategy. Figure 6-2 illustrates a potential setup of the proposed scheme. After the aforementioned efforts are well under way, the government may consider carrying out a comprehensive mid-term assessment of implementation progress and problems so as to make timely adjustments and resolutions. A clear plan for phasing out the interim financing scheme and phasing in the financial instrument scheme (Option 2 below) could be prepared and communicated to market participants early to minimize interruptions during implementation. Since both schemes would adopt similar delivery modalities for family houses and multi-family buildings, respectively, the main challenge is maintaining a broad consistency of the financing terms and conditions in both schemes. In other words, households would not experience any significant changes in the net financial burden of their investments, while banks would see no significant changes in their risks and returns. 25 For example, one Croatian bank has financed several building envelope retrofit projects by requiring a minimum of 60% of the homeowners to agree to use an increased monthly contribution to the reserve fund managed by the housing management company to repay the loan co-signed by the housing management company. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 67 Figure 6-2. Potential setup of a grant fund facility for thermal retrofit of multi-family buildings26 Source: Authors. Option 2: A renovation loan fund supported by (a) earmarked grants for capital subsidies and (b) technical assistance for project preparation. The EC considers the renovation loan fund an “off-the-shelf” financial instrument for residential retrofit, meaning that there is an expedited approval process for using EU grants to capitalize the fund. The platform could resemble the operational arrangements of the JESSICA holding fund scheme in Lithuania but will need to be carefully designed to suit Croatia’s ma rket conditions. The initiative to pilot and scale up a financial-instrument–based platform needs to start as part of the overall plan for using EU funds to support residential thermal retrofit. The government has initiated an ex-ante assessment to determine the feasibility of potential type(s) of financial instrument. It is advisable to test the identified financial instrument in a limited number of cities or one large city before moving to a national platform. Whether and when the participating cities would need to stop accessing the interim financing scheme would need to be determined during the design phase of the pilot scheme, since the phasing out of the interim scheme would also be a testing item of the pilot. The renovation loan fund concept has been successfully applied in several countries, including Lithuania and Estonia; it is also identified by this study as a feasible option for Croatia. A stylized illustration of a potential pilot scheme is provided in Figure 6-3. 26 In the case of single family homes, the participating banks would lend directly to individual households. But the technical oversight of such renovation would rely on relevant local government agency, for example, agency responsible for construction quality inspection/oversight. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 68 Figure 6-3. Potential pilot scheme for a renovation loan fund involving one or multiple cities Source: Authors. Note: In the case of single family homes, the participating banks would lend directly to individual households. But the technical oversight of such renovation would rely on the relevant local government agency—for example, the agency responsible for construction quality inspection/oversight. As discussed in Chapter 4, either option could work in Croatia, but both may need substantial grant funding to be effective (25% is recommended based on the modeling work) provided that policy reforms are implemented to facilitate EE investments. The choice would hinge on the delivery model and capacity of market participants, as well as constraints on the use of EU funds (the link to financial instruments, for example). Given the current situation in Croatia, the operationalization of Option 1 is expected to be faster than Option 2—and could be considered as an interim arrangement for using EU grant resources, should the EC eventually require the use of financial instruments, thus the deployment of Option 2. Starting with Option 1 would allow Croatia to continue to expand its national retrofit programs for both family houses and multi-family buildings while transitioning to a financial- instrument–based platform. More details about how this transition may be managed are provided in the following Roadmap section. It would be advisable to pilot Option 2 in a large housing market such as Zagreb before scaling it up to national coverage. This would allow for the testing and fine-tuning of critical elements such as commercial bank participation, project implementation arrangements, and procurement facilitation, especially with regard to thermal retrofit of multi-apartment buildings. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 69 The intermediation/aggregation role An aggregation/bundling mechanism for retrofitting family houses would help to reduce transaction costs, increase the participation rates of eligible homeowners, and provide the necessary technical assistance. Using NGOs, community organizations, or a special program administrator could be potential solutions. For multi-family buildings, this intermediation can be provided by housing management companies— as practiced in a few completed thermal-retrofit projects. This represents a viable solution for the multiple implementation issues associated with weak homeowners’ organizations, risk mitigation in the eyes of banks, and project preparation and delivery. The housing management companies can also become a natural market aggregator for bundling multiple buildings for thermal retrofit. The current pilot scheme for retrofitting multi-family buildings supported by EPEEF is promising and could be scaled up by improving methods of supervising grant use. For both family houses and multi-family buildings, involving a third party to manage the retrofit process may be preferable for several reasons: • They bring project management skills; • By bundling projects, they can (a) reduce the transaction costs of financing and access to grants/subsidies and (b) reduce project costs by buying in bulk; • They may be creditworthy and able to access loans more cheaply (or from different sources, such as IFIs) than individuals or fairly new entities like houses in multiple occupation (HMOs); and • They may already be involved with the building/owners and have established a level of trust and procedure that enables them to reduce risks, including non-payment risk. Where such third parties do not exist, the local government could establish them; an example is the administrators described in the Lithuania case study in the “Examples of Successful Financing Options for Residential Buildings” section in Chapter 5 (see also Annex C). A roadmap for residential building retrofits Based on estimated capital spending, the current pace of residential thermal retrofit in Croatia is likely far below 0.5 million square meters per year. To renovate the entire stock of residential buildings constructed before 1988 (about 114 million square meters) in the next 20 years, the pace will need to be increased to about 5.7 million square meters per year, or 5% of the vintage residential building stock per year. Achieving such large-scale renovation is imperative—and should also be manageable if the implementation support is shared by local governments. But it will take some time to mobilize the requisite financial resources and build needed implementation capacity. The roadmap for the residential sector presented in Table 6-3 summarizes specific actions national and local governments can take in the next six years (2015–20) to establish a robust financing and delivery system for retrofitting family houses and multi-family buildings; it also outlines the role of the EC, IFIs and other donors. The roadmap recommends a pathway for moving from (a) a financing mechanism that relies on direct grant funding to leverage private and commercial financing to (b) one that enables the revolving (via financial instruments) of at least a part of the grant funding. The delivery mechanisms for either family houses or multi-family buildings would also evolve over time as all market participants become more knowledgeable and experienced and deliberate efforts are made to simplify and streamline procedures. Since many actions need to be undertaken more or less during the same period of time, the sequencing focuses on three broad phases during the six-year period. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 70 Table 6-3. Roadmap for Scaling Up Thermal Retrofit in Residential Buildings, 2015 –20 National Municipal IFIs and other Government Government EC donors 1. Getting started (2015–16) Complete the Commit staff and Facilitate local Support the use of Provide upfront rollout of resources for mobilization of EU funds for financing if needed apartment-level planning, support heating companies incentivizing rapid consumption- and supervision of and homeowners deployment of based heat billing the rollout heat cost allocators Implement tariff Build broad political Facilitate local Provide general Help design and reform of support and ensure implementation, guidance and EU- implement the network energies funding for social especially in wide requirements tariff reform and associated safety net outreach to low- program social safety net income households Review law and Initiate Facilitate regulation amendments information governing HOAs necessary for gathering and preventing deadlock homeowners in collective decision feedback Operationalize an Commit staff and Facilitate local Support the use of Help design and interim scheme resources for implementation, EU funds under the implement the for using EU designing and especially in interim scheme interim scheme funds for thermal implementing the mobilizing retrofit scheme homeowners Pilot a financial- Provide guidance For participating Support the use of Help design and instrument– and support to the cities, fully engage EU funds for the implement the based financing design and in the design and pilot pilot and delivery implementation of implementation of platform the pilot the pilot 2. Reaching scale (2017–18) Review progress Update national of national strategies on retrofit programs residential retrofit and adjust strategies Scale up the Phase out the Facilitate local Support the use of Assist in financial- interim scheme and implementation EU funds for the implementation instrument– expand the scale-up effort based financing application of financial instrument 3. Achieving sustainability (2019–20 and beyond) Complete Provide necessary Facilitate local Review potential transition to oversight of the implementation need of EU funds financial- financing platform for recapitalization instrument– based financing Roles of the government, the EC, IFIs and other donors Because scaling up residential thermal retrofit is a complex and capital-intensive endeavor, it will require a multi-pronged approach to address the previously identified barriers. Croatia’s national government needs to demonstrate strong leadership and commit the resources necessary to enable sustained efforts and broad participation. This will entail: Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 71 • Strengthening the national EE institution—especially its ability to support (a) the design and implementation of critical reform programs (for example, network energy tariffs and apartment-level consumption-based heat billing) and (b) the planning and implementation of large-scale investment programs supported by EU funds; and • Acting on all five barrier-removal recommendations elaborated in the section below. Municipalities/local governments will have to play a significant role in organizing and facilitating implementation. This could include: • Prioritizing buildings for renovation on the basis of energy performance, type and age of building, type of heating, and/or income level of the homeowners; • Identifying means of financial support for low-income households that will allow them to participate in thermal modernization programs (together with the national government agencies); and • Cooperating with other agencies in the provision of technical assistance to homeowners and implementation providers. The role of the EC is critical since Croatia needs to comply with EU-wide directives and regulations concerning the energy sector and EE in particular. Moreover, EU funds will be essential in shoring up the financial resources necessary for mobilizing private and commercial investments in residential thermal retrofit until the national government’s fiscal base is strong enough to shoulder the bulk of public finance needed. Although the use of financial instruments is preferred, the current circumstances in Croatia would justify the use of leveraged grant funding in the next 2 –3 years while piloting an appropriate financial instrument and scaling up its application in 3 –5 years’ time. Such evolutionary support by the EC would ensure a continuous building-up of the financing and delivery capacity in Croatia. Support from IFIs and donor agencies should be coordinated and aligned to provide critical technical assistance for program design and implementation, as well as to address potential upfront financing gaps. A strengthened national EE institution would help optimize the use of IFI and donor resources. Recommendations The following recommendations lay out the key actions needed to (a) facilitate the implementation of the proposed delivery mechanisms and (b) reduce and eventually remove the barriers. Recommendation 1: Accelerate the implementation of cost-recovery prices for all network energies and enforce apartment-level consumption-based billing. Since energy cost-savings represent the only cash flow of—and are the main justification for—thermal retrofit investment, the removal of any significant factors undermining the strength of that cash flow is a top priority. Current district heat tariffs in Croatia generally do not reflect supply costs and will need to be raised to cover the operating costs and prudent investment in maintaining and modernizing the capital assets. The government could realistically aim to achieve full cost-recovery for district heating in the next 3–5 years. In the meantime, the same cost-recovery principle would need to be applied to natural gas and electricity so as not to create imbalances that encourage uneconomic use of other network energies for space heating. In this connection, the critical supply-side issue needs to be addressed in parallel, the goal being to enable economically viable district heating companies to become financially self-sustaining and capable of withstanding and responding to the potentially significant decline in heat demand in the long term. This will require a combination of tariff reforms and investments in modernization of the district heating systems. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 72 All multi-apartment buildings comply with the mandatory apartment-level consumption-based heat billing as planned. This is likely to require an intensive campaign in the next two years, especially in the markets served by HEP-Toplinarstvo. Since the adoption of apartment-level consumption-based billing removes a critical market barrier to renovation of multi-family buildings, it is an investment for which a grant subsidy using EU funds would be well justified. Recommendation 2: Introduce a capital subsidy scheme that would enable low-income homeowners to participate in the national thermal retrofit programs. Low-income homeowners will need substantial financial support to invest in EE improvements of their homes, and the lowest-income households may need a more generous subsidy. The general subsidy scheme currently implemented by EPEEF should be analyzed to gauge its coverage of low-income homeowners. Future scheme(s) may be based on a simple schedule of targeted subsidy levels using a proven benchmarking system based on household income so as to stretch available financing and cover the largest possible number of buildings to be modernized. Households receiving substantial subsidies could be narrowly targeted, and subsidies well-funded, rather than being left as an unfunded mandate for local governments. Recommendation 3: Establish a dedicated long-term financing and delivery mechanism for residential thermal retrofit. Promoting the economically viable thermal retrofit of residential buildings will be a long-term effort. New EU member countries that have achieved large-scale investments—such as Czech Republic, Lithuania and Poland—have mobilized substantial grant resources through dedicated financing and delivery schemes, such as Poland’s Thermal Modernization Fund and Lithuania’s JESSICA Renovation Loan Fund. Such schemes provide (a) a stable platform from which dedicated staff can efficiently manage national retrofit programs and (b) a transparent structure for effective leverage of private and commercial financing. Thermal retrofits of family houses and multi-family buildings entail, respectively, projects of very different investment sizes, different required measures to be undertaken, and implementation arrangements. For this reason it is likely that separate windows under one scheme, or separate schemes, may be necessary to streamline project financing and delivery under either program. Once the basic scheme (or schemes) is selected, it must be carefully designed to suit the local market characteristics. The government plans to use the EU funds allocated under the 2014–2020 Operational Program as the main source of grant funding, supplemented by EPEEF funds. To capitalize on the momentum in residential retrofit, the government may need to consider interim arrangements for using EU funds to scale up ongoing programs, such as the EPEEF grant-support program (see recommended options in the section below). This would allow to lay down the foundations for the use of financial instruments, given the long lead-time for operationalizing these. Recommendation 4: Increase information outreach. Multiple information outreach channels could be used to maximize accessibility, especially by low- income homeowners. The relevant information—such as examples of other homes that have undertaken thermal retrofits, EE measures based on building type, EE and cost/financing calculators, lists of certified service providers and equipment suppliers, and contact details for financing and grant programs—could be made available through dedicated websites, utility bills, housing management companies, and local government offices that provide social services and where low-income households apply for social benefits. For multi-family buildings, the campaign to install heat cost allocators could be packaged with some basic information on the costs and benefits of thermal retrofit. Periodic surveys could be carried out to assess the effectiveness of these activities, and a feedback mechanism developed to improve them. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 73 Recommendation 5: Strengthen the capacity and effectiveness of homeowner organizations. For multi-family buildings, making building-wide improvements requires the cooperation of co- owners and/or a single legal entity responsible for the whole building. Homeowners associations (HOAs) provide a legitimate cooperation mechanism, but they do not always exist—or, if they exist, they may not be very effective. Joint investment decisions require that a majority of owners agree. If this quorum is set too high, it may be difficult or impossible to come to any decision. The current requirement in Croatia of unanimous decision by building co-owners for thermal retrofits (or other whole-building renovations) will need to be amended to provide a fair solution to potential deadlocks in collective decisions. Whole building thermal retrofits are capital intensive and require large contributions from each homeowner, affordable by collective borrowing from commercial banks. Such borrowing in general needs effective HOAs that the banks trust. HOAs also need to ensure that any EE benefits are fairly distributed across all homeowners and that good behavior (for lower heat consumption) is rewarded. Proper monitoring of energy savings can help avoid potential disputes while demonstrating the benefits to all HOA members. These issues can be addressed by providing technical assistance to HOAs in management and financial issues. 6.3 Scaling up public building retrofits The Starting Point Croatia’s national-level Public Building Retrofit Program was launched in 2012 by the MoCPP. Its implementation arrangements were revamped in the 2014–15 programming period, and the program is currently managed by the Agency for Transactions and Mediation in Immovable Properties ( Agencija za pravni promet I posredovanje nekretninama, or APN). The program’s main objective is to scale up EE in public buildings using extra-budgetary funds and commercial financing through energy performance contracting involving ESCOs. EPEEF offers grant financing to cover up to 40% of eligible costs of retrofit projects;27 the remainder is financed through commercial bank loans (to ESCOs) and ESCOs’ own capital. As an EU member state, Croatia is obliged to retrofit at least 3% of the total floor area of heated and/or cooled buildings owned or occupied by its central government per year starting January 1, 2014. The retrofitted buildings must meet the requirements set forth in the Energy Performance of Buildings Directive (2010/31/EU). This obligation formed the basis for Croatia’s ambitious 2014–15 targets for public building retrofit: • Completing the comprehensive energy renovation of 200 public sector buildings (representing an area of approximately 420,000 square meters); and • Reducing annual energy consumption in renovated buildings by 30-60%. However, as of May 2014, only a handful of projects (under the current scheme, each building represents one project) had reached financial closure and several others were still engaged in the public procurement process. If this pace continues, the planned 200-building retrofit target is unlikely to be met. The remainder of this section: • Reviews the main barriers to scaling up thermal retrofit investments in public buildings in Croatia; 27 EPEEF also provides funding for energy audit and energy certificate costs before the renovation. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 74 • Suggests financing and delivery options; and • Recommends potential solutions. Barriers to scaling up The national Public Building Retrofit Program is facing significant challenges. As with any new initiative, some relate to teething problems, such as issues associated with preparing and tendering projects. But some are systemic, such as difficulties in reaching financial closure for ESCO contracts. The following specific barriers have been identified as constraining the scale-up efforts for public building retrofit in Croatia: • Inconsistent implementation of energy performance contracts (EPC) for buildings owned by local governments. Although the Regulation on Contracting and Implementation of Energy Services in the Public Sector (O.G. 69/12) was adopted in 2012, paving the way for using ESCOs to deliver public building retrofit projects, in practice the implementation of the regulation is significantly affected by the lack of coordination between different governmental ministries. Every ESCO project still needs Ministry of Finance (MoF) approval, and the approval procedure (and required documentation) is the same as if the project investment were being counted as public debt. This has delayed EPC project implementation for municipalities, cities and counties, and several projects have been denied as a result. • Inefficient implementation arrangements under the current (2014–15) program scheme. This is especially the case with respect to the public procurement process, which tenders out each building as an individual project, slowing down the process and increasing transaction costs. • An underdeveloped ESCO market constraining the effective application of EPC under the current (2014–15) program scheme. While there are several energy service providers active in Croatia—including the HEP ESCO, which has carried out many projects in the public sector— few have the track record necessary, or are otherwise able, to undertake the full-fledged EPCs suggested by the current program. • Limitations and disincentives of public sector budget rules. According to the Law on Financing of Local and Regional Authorities, the central government must each year adopt a special regulation defining the method of calculating the financial support for local governments related to the operating expenses of budget-supported entities (such as schools and hospitals) using established factor benchmarks (such as the number of pupils, classes and schools). Any unspent funds must be returned to the state budget account. This provides little incentive to save budget- covered costs. Recommended financing and delivery options The following two options appear to be most relevant to addressing the main barriers and constraints to public building retrofit in Croatia: the public ESCO (or super-ESCO) and the energy efficiency revolving fund (EERF). Although both options are discussed here, the EERF may be of special interest since it could be established as a platform that deploy financial instruments supported by EU Funds, as well as carry out a super-ESCO function undertaking the Energy Service Agreement (ESA) approach. Option 1: Public ESCO A public ESCO is a government-owned corporation established primarily to undertake EE projects in the public sector. As a public enterprise, it can often sign contracts with other public agencies without going through a competitive process. This helps to overcome some of the more difficult procurement and other administrative challenges public agencies face when engaging private ESCOs. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 75 A public ESCO is also better able to access public, donor, and other funds and, thus, can offer 100% project financing to its clients. Clients generally repay the public ESCO based on the estimated energy cost savings, although sometimes a verification procedure is performed. The public ESCO will then subcontract all actual implementation to local contractors, thereby fostering a local ESCO industry. Public ESCOs can thus serve as an incubator for local ESCOs, while allowing the concept of energy performance contracts (EPCs) to become accepted and providing the local ESCOs with experience and a track record for their future marketing (Figure 6-5). Figure 6-5. Typical structure of a public ESCO model (Super-ESCO) Source: Limaye (2013). A number of variations of the public ESCO model have been used, depending on the local conditions and capabilities of existing entities. Some of the more common include “super ESCOs,”28 utility-based ESCOs, utility demand-side–management (DSM) ESCOs, and internal ESCOs. Typically, public ESCOs are formed when the local ESCO market is still nascent and public efforts are deemed necessary to catalyze ESCO business models. It can also be a way of accelerating investments in the public sector that private ESCOs may be unable to serve in the near term, and of providing economies-of-scale. However, the monopolistic behavior of public ESCOs is reason for caution; appropriate exit strategies and indicators should be developed to allow them to phase out when their goals have been achieved. An example of a Fund acting as a super-ESCO is the Renewable Resources and Energy Efficiency Fund (R2E2) Fund in Armenia (see Annex C). Option 2: Energy Efficiency Revolving Fund Under a typical EERF targeting the public sector, loans are provided to public agencies to cover the initial investment costs of EE projects; some of the resulting savings are then used to repay the EERF until the original investment is recovered, plus interest and service charges. The repayments can then be used to finance additional projects, thereby allowing the capital to revolve creating a sustainable financing mechanism. Since both the borrower and lender are publicly owned, such funds may often offer lower-cost financing with longer tenors (repayment periods) and less-stringent security requirements than typical commercial loans. Because EE projects have positive financial rates of return, capturing these cost savings and reusing them for new investments creates a more efficient use of public funds than typical 28A super-ESCO is a type of public ESCO that directly contracts with public entities and then subcontracts with smaller ESCOs/contractors on a competitive basis. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 76 budget- or grant-funded approaches. This can help demonstrate the commercial viability of EE investments and provide credit histories for public agencies, paving the way for future commercial financing. An EERF is generally an independent entity established by the government and managed by either an existing entity (such as a development bank) or a fund management company (referred to as the Fund Manager) selected by the government through a competitive process. Under either option, the Fund operator is supervised by a government-appointed board of directors that can include both government and nongovernment stakeholders. When a Fund Manager is engaged, a performance contract that takes into account several factors—such as cost recovery, deal flow, defaults, or customer satisfaction —is imperative. The typical structure of an EERF is illustrated in Figure 6-4. Figure 6-4. Typical structure of an EERF Source: Authors An EERF is generally capitalized from a range of sources including concessional loans or grant funds from donor agencies, government budget allocations, special tariffs or levies on electricity sales, petroleum taxes, or revenue bonds. The fund then provides financing to public agencies so that they can in turn finance EE investments in public sector buildings and other facilities, such as street lighting. The agencies can then use the accrued energy cost savings to repay the principal and interest on the debt. The installation and other services for project implementation are generally provided by independent energy service providers. Depending on the local market conditions and needs, the Fund may provide a full range of financial services (such as energy auditing, procurement, supervision, and monitoring) as well as financial products such as the following: • Loans to creditworthy municipalities with sufficient collateral and equity; • Energy service agreements to other entities (for an example, see Annex C’s discussion of the Armenia Renewable Resources and Energy Efficiency Fund) without their own budgets or capacity to implement projects; • Guarantees for commercial bank loans; and • ESCO financing and re-financing for public sector EE projects. Regardless of the financing products, repayments are based on the estimated or verified energy cost savings, thereby allowing funds to revolve while the public borrower maintains a positive cash flow. The repayment risk generally rests with the Fund, so some arrangements to secure payments are often made. This could include bundling energy utility payments with the Fund repayment; if the municipality does not pay, then the utility connection can be cut-off. Alternatively, the Fund can Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 77 request that the Ministry of Finance redirect a portion of future budgetary transfers from the public agency to the Fund until the Fund has recovered its payments. It is also recommended that the pricing of any technical assistance provided by the Fund allow for cost recovery, although the level of pricing may depend on the sources of the Fund and the nature of the public sector client being served. A road map for public building retrofits using an EERF The road forward for public building retrofits faces a critical juncture. Croatia can either continue with the current scheme or, instead, establish a more versatile platform, such as an EERF, that could address varied needs at local government levels. The latter is recommended because it can address the main challenges facing public building retrofit in Croatia. An EERF can be designed to serve the needs of all public agencies. Therefore, in addition to debt financing (i.e., loans) for EE projects, the EERF may have other financing options, or “windows,” that may include energy service agreements, risk guarantees, grants, and budget capture.29 Ideally, the EERF would also provide technical assistance to public agencies and energy service providers (ESPs), and may provide procurement and implementation services that will transfer some of the implementation risk to ESPs and facilitate the development of an energy services market. The major steps involved in establishing an EERF are summarized in Figure 6-6. Figure 6-6. A roadmap for establishing an energy efficiency revolving fund (EERF) Source: World Bank (2014) 29 Budget capture involves the borrower “repaying” the loan in the form of lowered budget outlays in future years. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 78 An EERF could take up to two years to establish. In the meantime, the current scheme could continue without interruption since it is already under implementation. The EERF would initially focus on local government buildings, especially those that could benefit from the ESA arrangements, thus addressing a critical market segment, which is difficult for the current scheme to serve. Recommendations Although the Ministry of Finance’s concerns about local government obligations in the EPC arrangement need to be clarified and addressed by improved communications and coordination between government agencies, these concerns are also associated with the complexity of the EPC. The procurement process could be improved by bundling projects or by using a different implementation approach under a super-ESCO arrangement. In order to accelerate public building retrofit in Croatia, the following recommendations may be considered: Recommendation 1. Address the divergent conditions between central government buildings and local government buildings with an appropriate financing and delivery mechanism. The current program scheme appears to be more suitable for central government buildings and for local governments with good financial standing. Under the current fiscal situation, the majority of local governments may not be well served by the current program. There also is the need to consider a scheme in which EU funds can be effectively de ployed. Two alternative schemes, a “super-ESCO” and an EERF, may be considered. The EERF is preferred for its versatility. Recommendation 2. Adjust public procurement regulations, including ESCO procurement and budget retention Public sector agencies typically have rigid procurement and budgeting rules that they see as necessary to ensure proper use of public funds and value for money. Unfortunately, sometimes these rules can encourage the opposite—by favoring lower-cost equipment that has much higher operating costs over its life span. Public agencies that try to amortize these higher upfront costs may be prevented from entering into multiyear contracts or retaining energy cost savings that may be needed to pay contracts in later years. Two key areas in the public sector regulations may need to be adjusted: • Retention of energy costs savings. Without the ability to retain cost savings, public agencies lack the incentive to implement EE measures. Such rules also constrain the agenci es’ ability to repay loans or enter into multi-year EPCs if the payments would be derived from energy cost savings in future years. Municipalities and some autonomous entities (such as hospitals and schools) receive budgetary allocations based on a formula and thus may not experience budgetary reductions if energy costs go down. Resolving this often requires amending existing budgeting rules and procedures to allow public agencies to retain their energy savings at least for the length of the EPC or EE loan period. • Facilitating procurement of ESCOs. There is consensus that EPCs can greatly facilitate EE implementation and help mobilize commercial financing for the public sector. Unfortunately, EPC procurement can be complex, since this type of contract (a) is a blend of goods, works, services, and sometimes financing; (b) uses an output-based rather than input-based approach to defining the project scope; (c) relies on a variety of cost factors for evaluation, which therefore necessitates a highest net present value (NPV) rather than a lowest-cost assessment; and (d) requires payments based on performance, which requires credible data on baseline and post-project energy use. While each of these issues can be complex, it is recommended to identify and build off of existing procurement precedents in other sectors that can serve as reference points. Recent procurement laws dealing with public-private partnerships (PPPs), management services contracts, output-based and performance-based infrastructure contracts, Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 79 cost plus contracts, and so on offer models that deal with similar issues. Building on these precedents, efforts would then be undertaken to develop tailored bidding documents for simplified ESCO contracts that seek to (a) use simplified design and construction contracts; (b) specify a minimum level of energy savings that must be achieved, rather than prescribing the specific EE measures to be installed; (c) base selection on the highest NPV; and (d) link at least partial payments (20–30%) to a commissioning test (comparing post-project with promised NPV) and one deferred payment (for example, 6–12 months after commissioning). Lessons from international experience reveal a continuum of approaches to allow and promote public procurement of ESCOs.30 Recommendation 3. Develop and pilot simplified ESCO contracts Currently, the ESCO market is underdeveloped in Croatia, with only a handful of active companies. Part of the challenge rests with the lack of a properly developed legal framework for ESCOs that lays out the rules and requirements for ESCOs operating in a given market. Equally important is the need to develop appropriate business models, simplified for the given market conditions, to help create a platform from which the industry can build and evolve over time. A variety of ESCO business models are currently being implemented around the world, ranging from full-service/high-risk contracts to low-service/low-risk contracts. Figure 6-7 ranks examples of such models in terms of service and risk levels, placing a circle over those deemed most relevant for Croatia in the near term. Figure 6-7. Examples of Various ESCO Business Models Source: ESMAP (2012). International ESCOs, and some local ones, can generally mobilize quickly in a given market if the market signals are correct. Most assess three conditions that need to be met: 1. Predictable and stable demand for ESCO services, which the public sector is often best placed to provide; 2. Reliable sources of local financing with creditworthy clients, which strong, sustainable financing schemes can address; and 3. Clearly defined rules for how ESCOs are expected to operate in a given market, which the public sector can provide within its public tenders—such as guidelines for defining baselines, requirements for audits, sources of financing, rules for payments and verification, and so on. 30For more information on ESCO procurement, see Singh et al. (2010) and ESMAP (2012), both available at http://www.esmap.org/node/270. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 80 Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 81 Chapter 7. Roadmap for Scaling up Thermal Retrofit of Buildings in Bulgaria Main messages: • Bulgaria needs to put in place large-scale national programs to retrofit buildings. The programs should be supported by a dedicated, long-term (longer than two or three years) financing and delivery mechanism. • The focus should be on the residential sector, where there has been very little progress over the last decade; the challenge in the public buildings sector is to move from high levels of grant financing to more-sustainable financing mechanisms. • For residential buildings, two delivery mechanisms have direct relevance to the current conditions in Bulgaria: (a) a revolving fund with decentralized implementation by municipalities (for multi-family buildings) and (b) commercial bank lending supported by a renovation Fund for capital grants (expected to serve primarily single family homes). • For public buildings, a utility-based energy savings program can help move the market into a more sustainable financing scheme. Such program could build on the Energy Efficiency Obligations (EEO) Scheme that was introduced in the 2003 Energy Law and has the potential to help develop the ESCO market. • To support the implementation of such large-scale national programs, important policy measures need to be adopted. For example, implementation of cost-recovery prices is of critical importance: EE investments can help offset price increases needed to put the sector on a financially sustainable footing. Also necessary is the development of secondary legislation to implement the Energy Service Obligations Scheme, along with softer measures such as increased information awareness of energy performance contracting. This chapter presents options that Bulgaria may consider in its efforts to scale up EE investments in residential and public buildings. 7.1 Overview of building stock and retrofit needs Bulgaria has 306 million square meters of building floor area, of which 63.80% is located in urban areas.31 The residential building stock accounts for the largest share, with about 80% of the total. Traditionally, the vast majority (97%) of Bulgaria’s housing building stock has been privately owned. There are an estimated 1.8 million detached single-family houses, 66% of them located in rural areas. In urban areas, 96% (close to 70,000 buildings) are multi-family apartment buildings. The non-residential segment is distributed across different building types as follows: offices 48%, wholesale and retail trade 20%, educational buildings 17%, hospitals 7%, sport facilities 4%, hotels and restaurants 2%, and other types of energy-consuming buildings 2%. Recent growth in the building stock has been very modest. Since the significant contraction in the construction market that followed the 2008 economic downturn, the rate of new construction in the residential sector has reached only 0.9%. 31 Data for this section are from the Buildings Performance Institute Europe (BPIE). Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 82 Building energy-efficiency codes, initially introduced in 2005, were amended in 2009 and 2013 to include more-stringent regulations. Bulgaria adopted the EU’s Energy Performance of Buildings Directive (2010 recast) in 2013. The total floor area of Bulgaria’s pre-1990 residential buildings in need of significant thermal renovation (due to inadequate maintenance) is an estimated 138 million square meters, which constitutes the overwhelming majority of the total residential building stock. As can be seen in Figure 7-1, specific energy consumption per heated area is significantly higher for both residential and public buildings built before 1990, mostly due to the very low quality of insulation. Energy consumption in residential buildings built between 1960 and 1980 is at least twice as high as in those built according to current standards. Figure 7-1. Indicative specific heat consumption of buildings in Bulgaria 450 400 350 300 All end uses (KWh/m2) 250 200 150 100 50 0 <1945 1946 - 1960 1960 - 1980 1981 - 1990 1991 - 2000 2001 - 2004 >2005 Single family houses Multi family houses Offices Educational buildings Hospitals Hotels & Restaurants Wholesale and retail trade Building Type In 2014 it was estimated that only a small fraction of Bulgaria’s buildings had gone through a deep thermal envelope retrofit. (Partial retrofit of building areas, specifically thermal insulation of individual apartments within multi-family blocks, has also taken place.) An estimated 95% of the country’s public buildings require renovation because most were built before 1986 at a time of low energy-performance standards. The renovation of public buildings has progressed more rapidly, funded mostly by grants from IFIs and EU structural funds (see below for more details on government programs). Based on the modeling/scenario work presented in Chapter 4, a scenario that combines market reforms, revenue enhancement from EE obligations, and a 25% grant incentive (S7) would generate annual energy savings of 10 TWh, with €29 billion of net present value and a total cost of €4.4 billion . Such a program would also contribute significantly to meeting the energy savings target set in the country’s National Energy Efficiency Action Plan (NEEAP) (see Table 7-1). Table 7-1. Phased Energy Efficiency Targets, 2015–26 Phase 1 Phase 2 Phase 3 RESULTS 2015-19 2019–22 2022–26 Total HOUSING Buildings renovated (number) 350 4,000 12,700 17,104 Building stock renovated (as % of total stock) 1.8% 21.1% 66.8% 90% Number of beneficiary households 13,024 148,842 472,574 636,449 Beneficiaries (as % of population) 0.4% 4.2% 13.3% 17.9% Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 83 ENERGY SECTOR Energy savings (GWh) 756 8,640 27,432 36,945 Value of energy savings ($ million) 42 481 1,528 2,058 Energy savings (as % of EE targets in NEEAP) 1% 8% 25% 34% ECONOMY Net economic benefits ($ million) 15 167 529 713 Energy Savings (as % of GDP) 0.0% 0.1% 0.3% 0.4% To realize this energy savings potential, Bulgaria would need to significantly scale up its efforts in both the residential and public buildings sectors—by implementing national programs, based on adequate delivery mechanisms, that address the key obstacles to EE investments in the current built environment. The remainder of this chapter identifies barriers and makes recommendations for (a) residential and (b) public buildings in Bulgaria. 7.2 Scaling up residential building retrofits A number of government and donor-funded programs and grants specifically target residential buildings in Bulgaria (Box 7-1). Overall, however, thermal retrofit programs have not been implemented on a large scale and have faced difficulties tapping into private funding. It is also evident that the design and implementation of programs for individual houses and multi-family apartment buildings would be distinct given the different decision-making processes and the way the investments are delivered. In Bulgaria, programs that initially targeted both market segments have quickly focused on just one. Overall, a significant amount of capital grant support has been needed to kick-start programs in multi- family houses (the grant support ranged from 85% to 100%). For single-family houses, credit lines channeled through local commercial banks have built the capacity of financial intermediaries with regard to EE lending and demonstrated that it is possible to leverage private sector financing for EE measures. The scale of these initiatives remains limited, though, because (a) few multi-family buildings have been renovated (even with high levels of capital grant) and (b) the individual loans are typically small (an average of €1,550) and fund individual EE measures, such as window replacement, rather than comprehensive thermal retrofits. Box 7-1. Bulgaria’s residential retrofit programs The Demonstration Project for the Renovation of Multi-family Buildings was implemented by the Ministry of Regional Development and Public Works (MRDPW) with support from UNDP. Under this program, which started in 2007, 27 multi-family buildings have been renovated and another 27 are under renovation. The project has demonstrated that energy savings of over 40%, along with substantial CO2 emission reductions, are possible and that building renovations are effective at job creation. The Energy Renovation of Bulgarian Homes project was launched in July 2012 with the financial support of “Regional Development 2007–2013,” a €50 million program co-financed by the EU through the European Regional Development Fund. The project extends to 36 urban centers and will be implemented through 2015. Eligible residential buildings (that is, six or more detached individual units and three or more floors) that are registered homeowner associations (HOAs) receive up to 75% of renovation costs as a grant. From 2007 to 2011, 50 multi- family buildings (representing 1,093 households and just under 81,000 square meters) were retrofitted. A similar BGN 10 million (currently about €5.1 million) scheme supports retrofits in social housing for vulnerable minority and disadvantaged groups through 100% grant financing. The Energy Efficiency Credit Line for Households was set up in 2005 as a collaborative initiative between the Bulgarian government, the EBRD and KIDSF (the Kozloduy International Decommissioning Support Fund, described in Box 7-2) to provide households and HOAs with credit lines for EE and renewable energy sources (RES) projects. Working with four local banks, the fund consisted of an EBRD loan of €90 million and €24.6 million in grant money from KIDSF. The grant funding provided up to 35% of the total loan. The credit line, which expired at the end of July 2014, disbursed approximately €62 million in loans and €11.3 million in grants while supporting over 40 thousand Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 84 projects. Most of these loans were for individual dwelling measures, with an average sub-loan size of €1,550; only 100 loans for whole-building refurbishments were made available under the credit line. Bulgaria’s National Energy Efficiency Program for Multi-family Buildings was launched in early February 2015 with an estimated €500 million in government funding. It provides 100% capital grants to HOAs of multi-family apartment buildings. The program is administered by municipalities, which are responsible for EE audits, design, works, supervision of works, and EE certification services. So far, the program’s results are encouraging in terms of its ability to foster the creation of HOAs. As of February 1, 2016, 2,584 HOAs were registered in 28 districts and 1,820 haven obtained financing. Through the Energy Efficiency Act, to help meet their target obligations, energy traders can implement (a) consumer information programs and (b) training aimed at increasing EE at the level of the final consumer. In the spring of 2013, the utility CEZ launched an information campaign titled “Energy Renovation in Bulgarian Homes” to raise public awareness of the program. In a more general sense, the Ministry of Economy and Energy (MoEE) promotes enhancing public awareness with regard to EE; it plans to begin a wide-spread information campaign a few months before the electricity market is liberalized in January 2016. The campaign will be a good opportunity for the government to raise awareness about the benefits of EE renovations, the availability of EU funds and the prospects of financial payback. Barriers to scaling up With a few exceptions, financing and implementation of thermal retrofit in family houses and multi- apartment buildings face the same set of barriers or constraints as in the case of Croatia. These barriers include the financial limitations of low-income households, information and capacity gaps among market participants, and cumbersome and inefficient implementation arrangements. The following are barriers that are particular to Bulgaria and that are the most important in terms of hampering sustained and large-scale thermal retrofit programs: a. Inefficient pricing signals, especially for power and district heating. The regulated prices of these commodities are set at levels below the full cost of service provision, thus giving households no incentive to save energy. Due to low power prices, the (inefficient) use of electricity for heating purposes is also encouraged. Bulgaria has made significant progress in recent years in installing building-level metering and apartment heat cost allocators; however, while consumption has fallen (in some cases up to 30%), households have no financial incentives to further reduce their consumption by investing in comprehensive thermal retrofits. b. Lack of adequate and secure long-term grant funding. The grant financing provided in a number of the programs implemented so far has been a crucial reason for their success. This is consistent with examples of thermal retrofit programs in Western Europe, even when prices have provided the right signals to incentivize EE investments. However, both the level and the overall amount of the grant subsidies have varied considerably, sometimes even within a single program. There is also not enough clarity on the availability of such funding in the medium term (beyond one year). This situation hinders market development because homeowners may be reluctant to invest if they expect that generous grants will be provided in the future. c. In multi-family apartment buildings, one of the key barriers is the current requirement for collective decisions to undertake thermal retrofits. Condominium associations remain rare in Bulgaria, with only a few established since the Condominium Law was amended in 2009. Even where condominiums are established, they lack the means to take collective decisions on buildings refurbishment and to establish binding arrangements with residents to collect payments—and, therefore, to borrow to pay for the refurbishments. The Condominium Law requires a 100% agreement by homeowners to undertake any of these actions. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 85 Recommended financing and delivery options The following two financing and delivery mechanisms appear to be the most relevant to Bulgaria’s efforts to scale up EE investments in the residential sector. Option 1. For multi-family buildings: a revolving fund with decentralized implementation by municipalities Financing: This option would resemble an energy efficiency revolving fund (EERF). In this setup, the initial upfront investments would be fully financed by the Revolving Fund, which could pool funding from the budget (grants), EU structural funds (grant), IFIs (loans) or commercial banks (loans). As mentioned in Chapter 4, grant funding will likely be necessary—at least in the first few years of implementation—to overcome persistent barriers in the multi-family buildings market segment. Specifically, it would help (a) address the affordability concerns of low-income homeowners and (b) provide the incentives necessary to overcome significant obstacles in the collective decision making to initiate EE investments. It is, however, recommended that homeowners co-finance the investments. They could be obliged to partially repay the initial upfront investments with funds from energy savings. This would avoid requiring them to pay up front for the EE investments in the form of co-financing, which in the past has proven to be one of the main constraints on EE investments. The repayment mechanisms could take the form either of direct payments by the HOAs to the Energy Efficiency Fund or of a contribution to be collected through monthly utility bills. Utilities would in turn make payments to the Energy Efficiency Fund. These partial repayments would allow the Fund to revolve the resources and repay loans and/or use them to increase the amount of EE investments, thus increasing the sustainability of the program. Implementation: One of the main features of this scheme is an entity responsible for taking on an intermediation role with HOAs to increase their participation and facilitate the bundling or aggregation of projects to reduce transaction costs. Centralized approaches (such as central project implementation units) have not yielded positive results to date. Instead, it is recommended that this role be delegated to municipalities, given their close relation with citizens and their experience with the implementation of EE projects—not to mention the limited number of entities that could play this intermediation role in Bulgaria (there are no housing management companies, for example, as in other countries in East and West Europe). Municipalities also often are in favor of EE renovations because of their positive impact in improving the living conditions and urban renewal of cities. The proposed model would ease the transition to a more commercially driven and decentralized mechanism similar to the Thermo Modernization Fund in Poland. It would (a) help build the HOA’s payment discipline, preparing them to access direct commercial financing from banks; (b) build the HOA’s capacity, so that they can enter into contracts with energy service providers; and (c) help build the capacity of construction companies, designers, and auditors so that they can provide bundled projects directly to the HOAs. Figure 7-2 illustrates this financial and implementation model. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 86 Figure 7-2. Municipal-led implementation of EE investment in multi-family buildings Grants State Budget Energy Efficiency Grants Revolving Fund EU Funds Partial repayment with monthly Loans energy savings IFIs / Commercial Financing Project Funding Documentatio n Project Home Owner Application Municipalities Associations Contract Payments EE audit Detailed Supervision Energy design/work Service Certificate s Energy Auditor Detailed design/ Construction Energy Efficiency Construction Supervision Certification Source: Authors. Option 2. For single-family houses: commercial bank lending supported by a renovation Fund for capital grants This model would build on the ongoing credit lines currently available in local banks to provide (a) commercial financing on soft terms and (b) capital grants for EE investments for the residential sector. The resources required to make the grants and soft financing available can be provided by the above- mentioned Revolving EE Fund or another housing retrofit capital grant fund. The Fund would pool resources from the budget, EU structural fund programs, or loans from IFIs. The proposed financing mechanism would provide targeted capital grant support and/or financing in soft terms for projects which could be adjusted (between 30% and 50%) to reach two market segments: (a) homeowners who wish to implement a comprehensive thermal retrofit (as opposed to the individual EE measures currently dominating the market) and (b) low and lower-middle income households who wish to implement EE measures. Grant support would help reduce the payback period of the deep thermal retrofit projects (currently 10–15 years) to acceptable levels for households (closer to 5 years) and make financing accessible to market segments that would otherwise would not be able or willing to borrow for EE investments. The EE investments could be implemented by ESCOs that would provide ready-made packages to homeowners including energy audits, design, and construction. Final payments could be tied to obtaining an energy certificate. It will be necessary to strengthen the existing firms involved in EE investments (such as auditors and construction companies) so that they can become energy service providers capable of offering a wider menu of EE services to homeowners (including turnkey products). Large-scale development of this implementation mechanism would help leverage private and commercial financing while also helping develop the capacity of commercial intermediaries to provide EE financing in market segments that are more difficult to reach, including comprehensive-retrofit and lower-income clients. As the market develops, it could be envisioned that HOAs also reach out to Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 87 private banks to co-finance thermal retrofits.32 Therefore, this mechanism could serve as a starting point for scaling up a financial-instrument–based platform for EE investments in residential buildings. Figure 7-3. Commercial bank lending supported by a Renovation EE Fund 7.3 Scaling up public building retrofits Renovation of public buildings has been achieved at a slightly faster pace than in the residential sector, but implementation still lags behind the EU Energy Efficiency Directive obligation of renovating at least 3% of residential (and commercial) buildings nationwide each year until 2050. A total of 183 state-owned buildings representing 1.4 million square feet were audited during 2011-13. Public buildings are required to implement EE measures within three years of being audited. The National Energy Efficiency Action Plan 2008–2016 set a national EE target of 9% over the nine-year period (a 3% increase during each three-year period) with fixed energy savings obligations (expressed in gigawatt-hours) divided into three groups. Central and local government buildings fall under the category of owners of public service buildings and have been responsible for saving an average of 914.6 GWh per year between 2008 and 2013. Individual energy savings targets for municipal and state administrators have been further encouraged by the development of annual reporting on EE plans and programs as well as the development of public-sector–specific ESCO contracting legislation—although ESCO companies not very well developed in Bulgaria. Owners of public buildings are obligated to undertake EE management that 32 Although this delivery mechanism can serve both single- and multi-family residential buildings, it is expected that in the early phase of implementation, it would target primarily individual family houses. One of the reasons for this is that financial intermediaries are less likely to help address the critical issues of fostering the organization of HOAs and reaching consensus for collective decision making. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 88 includes implementing the measures envisaged in the plans and programs and designating at least one employee to ensure compliance. They are also required to keep a record of monthly consumption by type of energy (including dates, prices and supplied amounts) as well as identification numbers of the documents certifying the quality of the fuels supplied. This information is then submitted to the Sustainable Energy Development Agency (SEDA). A penalty is enforced for not complying with the annual reporting requirement. Several financing sources are available to help public buildings fund EE measures; these are described in Box 7-2. In addition to the coordination efforts of SEDA, a Municipal Energy Efficiency Network EcoEnergy program and a Center for Energy Efficiency (EnEffect) are available to identify ways to reduce costs and enhance public awareness. Box 7-2. Bulgaria’s public retrofit programs The government established the Energy Efficiency and Renewable Sources Fund (EERSF) in February 2004 upon the adaptation of the Energy Efficiency Act. In addition to receiving €1.5 million from the government, the Fund was capitalized by grants from the World Bank (US$10 million) and the government of Austria (€1.5 million). Since launching in 2006, the Fund has offered financial products—such as credit at below-market interest rates, partial credit guarantees, and portfolio guarantees—to municipalities, the residential sector (see Box 7-1 earlier in this chapter), and SMEs to finance EE-related projects. Municipalities represent 53% of EERSF’s credit volume. From 2006 to 2014, 99 projects were financed, with a total value of BGN 36.9 million and BGN 24.1 million in credits. The Energy Efficiency and Renewable Energy Program was launched in in April 2012 as a collaboration between the governments of Bulgaria, Iceland, Liechtenstein and Norway. It was capitalized with a €13.26 million grant (85% of the total) from the Financial Mechanism of the European Economic Area (EEA FM) and €2.3 million (15% of the total) in public financing. The program, which will run until 2017, is designed to finance projects in public sector enterprises and buildings, including municipalities. Proposed projects cover small hydropower but also measures to increase EE (such as fuel switching and boiler replacement), renewables for heating, and administrative capacity strengthening. National co-financing is budgeted for each tranche, with maximum project grants at 100%, except for biomass production for small and medium-sized enterprises (SMEs). The Small-scale Local (Municipal) Investment Program was launched in July 2012 with the financial support of “Regional Development 2007–2013,” a €50 million program co-financed by the EU through the European Regional Development Fund. The program provides resources for the implementation of EE measures (such as energy audits, renovation, central heating installation, and RES heating and ventilation systems) to central government institutions and municipalities. For the small-scale local investment program, also known as “Basic Services for the…Rural Population,” €83.3 million was allocated between 2007 and 2013 to 178 exclusively smaller (that is, rural) municipalities, though not all of it for measures related to EE (flood protection was also covered). The Kozloduy International Decommissioning Support Fund (KIDSF ) was established in 2001 with grants from the EU to support the early decommissioning of several units of the Kozloduy nuclear power plant. Following the initial disbursement period, approximately 40% of the additional grant funding of €300 million (or €120 million) allocated for 2010–13 was dedicated to implementing EE in municipal buildings, public street lighting and district heating services. Barriers to scaling up Bulgaria has made progress in implementing nationwide EE programs for public buildings. The programs have been financed mainly with grants, however, and one of the challenges now is to make such programs more sustainable. Specific barriers in the Bulgarian EE market for public buildings include: • Low comfort levels (under-heating and under-illumination). Comfort levels and living conditions are often below average. Under these conditions, the financial savings accruing from increasing EE could be significantly reduced, thereby increasing the payback period of investments beyond five to seven years—making them unattractive to ESCOs and banks, for instance. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 89 • High transaction costs due to the lack of information. Building-level information is of poor quality (including obsolete meters) and statistics (such as historical energy expenditures) are not widely available, so it is difficult to establish a baseline. As a result, transaction costs are high and each building needs to be addressed individually. • An underdeveloped ESCO market and a lack of awareness of EPC contracts. Despite a relatively advanced legislative framework, the ESCO market has not picked up. A small ESCO market (7 to 12 EPC companies) has existed since the early 2000s, supported mainly by IFIs and donors. Because of the lack of a critical mass of successful examples and demonstration projects in the Bulgarian market, knowledge of EPC contracts and “trust” of ESCOs is low. Recommended financing and delivery option: A utility-based energy savings program Financing and delivery mechanisms are available and have proved successful at launching the large- scale renovation of the public building sector in Bulgaria (education and health institutions in particular). However, they are overly dependent on grant funding. For the country to meet its EE renovation target in public buildings, third-party financing will need to be mobilized. An important development was the introduction of an Energy Service Obligations Scheme, in line with the EU Energy Efficiency Directive, whereby individual targets were set for energy traders (suppliers) 33 equivalent to 1.5% of the annual amount of their energy sales to final customers. The intermediate savings target for this instrument by 2016 is 6TWh per year, or around two-thirds of the energy savings targets in Bulgaria’s NEEAP. As mentioned in Chapter 4, international experience suggests that most energy providers find ways to make a business virtue out of the necessity of regulatory compliance. In Denmark, France, Italy, and the UK, energy providers have met their energy savings goals with programs that have established new business lines or contributed to retention of customers (see Box 7-3). In the United States and Canada, energy providers have improved utilization of existing assets and avoided addition of new capacity through their energy saving activities. 33 Targets were set for electricity suppliers selling more than 75 GWh per year and including electricity traders, heat transmission companies, natural gas traders, traders selling liquid fuels (excluding transport fuels), and solid fuel traders. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 90 Box 7-3. Case study: the United Kingdom’s Energy Companies Obligation (ECO) scheme The Energy Companies Obligation (ECO) scheme is the United Kingdom’s principal instrument for alleviating fuel poverty and increasing energy efficiency in properties where improvements are most needed. It is an example of energy efficiency obligations (EEOs) – also known as energy savings obligations or energy efficiency resource standards – that impose legal obligations on energy suppliers to save energy. The ECO scheme supports economic but financially unattractive measures that are unsuitable for the UK’s “Green Deal” commercial scheme because the expected energy cost savings are not large enough to repay the investment costs. The ECO applies to energy companies that serve at least 250,000 domestic customers and provide at least 400 GWh of electricity or 2,000 GWh of gas. The first ECO program, referred to as ECO1, ran from January 2013 until March 2015; the second, ECO2 began in April 2015 and will run through March 2017. There are three obligations under the ECO scheme, each with its own objectives, targets and eligibility criteria. The Home Heating Cost Reduction Obligation (HHCRO) is designed to increase the affordability of home heating for low-income households, mainly through improvements in roof and wall thermal insulation as well as connections to district heating systems. The Carbon Emissions Reduction Obligation (CERO) is aimed at hard-to- treat properties with either solid or cavity walls, and it primarily covers roof and wall thermal insulation and connections to district heating systems. The Carbon Saving Community Obligation (CSCO) focuses on thermal insulation measures and connections to district heating systems in the communities which are most in need of energy efficiency improvements, with quotas for rural and deprived communities. The ECO delivery process consists of six steps which transform regulatory obligations into actual investments in energy savings: OFGEM Supplier Supplier OFGEM Secretary of calculates OFGEM allocates installs notifies State sets saving & processing obligations measures or secretary of obligation notifiies and points among purchase state of points OFGEM approval suppliers points savings • The Secretary of State for Energy and Climate Change sets countrywide number of ECO points for each obligation and monitors the delivery of the measures as well as the cost to the energy companies, through reports of scheme administrator reporting and brokerage market. • Office of Gas and Electricity Markets (OFGEM) administers ECO on behalf of the Department of Energy and Climate Change (DCEE). OFGEM distributes the points among the obligated energy suppliers based on each supplier's share of the gas and electricity supply market. • ECO suppliers deliver energy efficiency measures to households. They decide how to meet their obligation. They can purchase ECO points through a brokerage platform, or they can subcontract or use their own ECO installers to carry out energy efficiency measures. British Gas, for instance, delivered measures through subsidiary firms that were set up specifically to carry out insulations and other ECO measures. Suppliers also choose what homes to treat, which qualifying measures to carry out, and how much subsidy they provide to each heating or insulation measure. • Suppliers calculate and notify OGFEM of the achieved ECO savings. Suppliers are required to conduct technical and score monitoring inspections on ECO measures to ensure the required standards of installation are met and measures are scored accurately. Carbon and cost saving are calculated using appropriate approved methodologies. • OFGEM processes the reported savings and approves “ECO points” that suppliers earned towards their obligation. Together with OFGEM, the brokerage platform provides the government with transparent information on the progress and costs of delivering measures in the wider marketplace. • The regulatory compliance cycle is completed when OFGEM notifies the Secretary of State that a supplier has met its obligation. The ECO scheme is fully funded by energy suppliers up front. However, the energy companies are expected to recover the costs of measures by passing them onto all domestic consumers through levies on household energy bills. The government closely monitors costs to suppliers, and in December 2014 it amended the legislation in order to reduce the costs of delivering the scheme. The changes included lowering the targets and changing the eligibility requirements under CERO and CSCO. The ECO scheme was estimated to cost energy companies around £1.3 Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 91 billion per year on average to deliver. The actual total cost of delivering ECO1 up to March 2014, as reported by suppliers, was about £1.546 billion. Results: between January 2013 and March 2014 the ECO scheme benefited around 648,000 households, surpassing by far other programs for energy-saving home improvements in the UK such as the Cash Back and Green Deal measures. In 2014, the government credited its policies for reducing the average household gas and electricity bill by 6 percent. Nearly half that reduction may be attributed to the ECO scheme. However, only those who benefit from ECO measures will see a reduction in gas and electricity bills. As the costs are passed through and spread across all bill payers, others will face higher costs of household energy. Lessons learned: policymakers expected the suppliers to deliver ECO in tandem with the Green Deal, as the ECO scheme was intended to cover the financially unattractive energy efficiency investments. However, very low uptake of the Green Deal finance showed that avoiding p enalties was a much greater incentive for energy companies’ compliance. ECO is a popular program in part because it did not significantly increase energy bills. Customers felt only modest bill increases as they were already accustomed to paying the costs of earlier schemes that were also passed through electricity and gas bills. Still, the lower consumption dampens the effects of increases attributed to ECO financing, and the average bills are expected fall over time. One key lesson learned from the UK’s ECO experience is that it was important to incorporate changes over time, allowing the program to morph gradually to meet needs, as opposed to making precipitous changes. Issues such as rising energy prices and fuel poverty ultimately become the driving forces behind EEOs instead of its original purpose of incentivizing efficient consumption. Source: Compiled by authors. For further information, see http://www.energy-uk.org.uk/policy/energy- efficiency/energy-companies-obligation.html. It is recommended that energy service providers in Bulgaria play an increasingly important role in making energy services available to public building owners. The following are three options for services energy suppliers could offer: • Advice and assistance to building owners—such as energy audits and information on ways to save energy—communicated through advertising, web sites, and social media. • Incentives—through cost sharing or subsidies that make investments more affordable. Such incentives could also be targeted at certain groups, such as low-income family homeowners. Energy suppliers usually know their customer base well, so they are able to identify those who have previously received some kind of social assistance benefit to help them cover their energy expenditures (heating allowance). • Offer bundled EE packages—including identifying, financing, and installing multiple energy savings measures within a household or facility (such as a government building). The objective would be to maximize the uptake of EE measures that are economical for a given customer. Ideal candidates for the implementation of such programs are power distributors or district heating companies. However, in view of their financial constraints due to below-cost pricing in Bulgaria, financing support may be needed so that utilities can scale up their implementation of such programs and fulfill their ambitious energy savings targets. Financing support could allow them to distribute grants for cost-sharing initiatives and bear the upfront financing to offer bundled projects. One alternative is to allow utilities to recover their (financing) cost through a fee imposed on all consumers; another is to make available resources from a capital grant Fund (see below). The two alternatives are not mutually exclusive and can be combined to provide the resources necessary to launch such programs. Figure 7-4 illustrates what such a utility-based energy savings program might look like. Co-financing by building owners will also be expected, either in the form of upfront capital contributions or in monthly payments through on-bill financing. The latter provides an attractive way to minimize building owners’ down payments, which has proved one of the main obstacles to kick- start the market. It could also be more easily implemented by energy service providers because it could be implemented using the providers’ existing billing systems. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 92 In terms of implementation mechanisms, energy providers could choose to either implement the energy measures by themselves or procure the service from specialized energy service firms. There have been information campaigns implemented by a power distribution company, as explained earlier. District heating companies could also implement EE measures related to the improvement of the buildings’ heating systems. For more comprehensive undertakings, such as bundled offers, it is expected that such services would be procured from EE service providers, such as ESCOs. Such arrangements could help significantly develop the market for service companies and eventually the market for EPCs. Figure 7-4. Utility-based energy savings program Source: Authors Developing the secondary legislation necessary to implement the Energy Efficiency Obligation Scheme can help overcome barriers through the inclusion of personalized advice, technical knowledge, access to finance on favorable terms or through subsidies, lowered transaction costs, and the provision of quality assurance and confidence through a well-known brand. In particular, they can be a good way to foster the development of ESCOs. The provision of information on EE opportunities can include energy performance labels for buildings or equipment (to help building owners or operators make informed choices); training of energy auditors; establishment of clearinghouses for energy efficient technologies; establishment of regional EE agencies; and targeted information and promotion campaigns. For public buildings, it is critical to continue to enforce the requirement of audits and certification of all public services buildings so as to create adequate information and baseline information related to energy consumption to reduce transactions costs. Recommendations The following actions are recommended to overcome the aforementioned barriers in the Bulgarian buildings sector: Recommendation 1: Accelerate the implementation of cost-recovery prices for power and district heating. Increasing progressively-regulated prices to cover the cost of service could be phased in over the next 3–5 years—and the planned tariff increases communicated to the population—to provide the incentives and medium-term visibility needed to encourage investment in energy conservation measures. As mentioned earlier, price increases are inevitable if the power sector is to be put on a financially sustainable footing. EE investments can help households mitigate the adverse impact of such increases by allowing them to reduce their consumption and therefore their energy bill. Tariff increases will also Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 93 help strengthen the cash-flow of EE investments, reduce their payback time and perhaps make them more attractive for financial intermediaries. Recommendation 2: Develop a long-term housing renovation strategy. In view of the large investment needs and the limited fiscal space, it will be necessary to leverage private funding (such as HOA contributions and commercial financing) if Bulgaria is to effectively renovate its pre-1990 building stock. The government could consider developing and adopting a long- term, well-publicized program to renovate the remaining housing stock; this would reassure market stakeholders (such as auditors, construction firms, banks, and construction material providers) as to the government’s plans, thus enabling appropriate business planning. The government can also indicate the path of reduction of capital grant support over time and the corresponding need for increased private and commercial financing. Finally, it can help coordinate (and possibly streamline) existing/future programs and ensure that they do not compete with each other. Recommendation 3: Maintain and ensure the medium- and long-term sustainability of ongoing delivery mechanisms. Existing delivery mechanisms, such as the National Energy Efficiency Program for Multi-family Buildings, provide a good basis for scaling up EE investments in this market segment. It will be important to ensure the stability of this initiative as well as its financial sustainability in the face of decreasing levels of grant support. For individual family houses, existing delivery mechanisms through financial intermediaries can be strengthened in order to reach a broader market coverage. Options to establish alternative delivery mechanisms based on market principles for this market segment would also need to be explored; this includes energy service providers, discussed later in this chapter. Recommendation 4: Strengthen the capacity of homeowners associations and municipalities. HOAs are poised to play a more important role in EE program decision making, financing (in the medium-to-long term), and implementation (supervision of works, for example). Such roles will require recently created HOAs to build capacity rapidly as many of them are just being formed. Municipal governments need to play a bigger role in the implementation of the residential renovation programs, especially by increasing their role as facilitators of grassroots organizational efforts. The ongoing National Efficiency Program is moving in that direction and it will be critical to increase the capacity of municipalities (specially the small ones) so that they can live up to program expectations in terms of their role and responsibilities. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 94 Annex A: Detailed Analysis Behind the Energy Efficiency, Economy and Climate Nexus (Chapter 2) Background The countries of Central and Eastern Europe are still struggling with a legacy of the energy-intensive industry and wasteful behavior entrenched during communist times by decades of central planning and lack of market price signals. Of the four countries covered by this study, Poland has made the quickest progress with regard to market reforms in the energy sector. Energy prices in Croatia are relatively high, although significantly below the levels typical in the rest of EU. Bulgaria and Romania are lagging behind, although Romania has begun reducing gas price subsidies and liberalizing wholesale electricity prices and has set a schedule for liberalizing retail prices. Bulgaria’s government continues to keep retail power prices at the lowest level in the EU, not only depressing the power sector’s ability to recover costs and invest in reliable supply, but also lowering consumers’ interest in using energy efficiently. District heat prices are heavily distorted in both Romania and Bulgaria, where the heat infrastructure is unstainable and crumbling. In Poland, by contrast, prices cover all costs and the now-thriving district heating sector offers high-quality and energy-efficient heating services at competitive prices. The energy intensity of central European countries is inversely related to energy prices. Bulgaria is the second most energy-intensive economy in the EU after Estonia (which is a special case due to climatic conditions and unique fuel mix). Romania’s energy intensity is also well above the EU average, while Poland and Croatia are converging toward the EU average (see Figure A-1). Figure A-1: Energy Intensity, 2002–11 and Final Energy Consumption by Sector, 2012 Source: International Energy Agency. What drives changes in energy intensity in European economies? Changes in the energy intensity of an economy are driven by two independent factors: • Gains in technological efficiency—that is, changes in the EE per unit of production and consumption; and • Gains in structural efficiency—that is, structural changes in production and consumption patterns. An example of this is an increase in the share of less energy-intensive sectors, such as services. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 95 Both can accelerate economic growth. EE improvements reduce production costs, which boosts factory productivity, whereas structural changes reallocate resources to more productive uses. Although each may require different policy interventions, maintaining consistency between these policies is important. For example, subsidizing EE improvements in energy-intensive industries improves their energy productivity but may slow down their natural, market-driven decline, thus preventing capital and workforce from being released to sectors of the economy that are more productive and less energy- intensive. The decomposition method34 is a useful way to determine which of these two factors —structural changes versus pure efficiency improvement—has been a decisive contributor to changes in the energy intensity of an economy. This method attributes changes in energy intensity to each factor separately, holding the other constant. The graphs in Figure A-2 show the results of applying one of the decomposition methods—the Fisher Ideal Index—to determine the relative importance of technological and structural efficiency gains in selected countries over time.35 The general conclusion from this analysis is that in all regions the annual changes in energy intensity of the economies have been driven mainly by variations in pure technical EE. Figure A-2. Historical Drivers of Energy Intensity Changes in the EU Source: Authors. Note: The thick red line indicates the changes in energy intensity of the economy—that is, trends in energy use relative to the gross domestic product (GDP). The thin blue and yellow lines show the contribution of structural shifts and technological EE improvements, respectively, to the changes in energy intensity. 34 The decomposition method is a generic term for solutions in which a problem is “decomposed” into subproblems. 35 Bulgaria and Romania are not analysed individually because of the lack of consistent time series of data in these periods. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 96 Broken down by time periods and groups of countries, however, the story is more nuanced. For example, after the financial crisis, the sectoral shift accounted for most of the decline in energy intensity in the EU-15 and in Croatia, offsetting negative trends in technological EE. In fact, energy intensity would have increased by 2011 without the structural transition toward less –energy-intensive sectors. In contrast, in Poland and other “new” EU member states, both structural shifts and changes in technological efficiency worked in the same direction. In Poland and other new EU member states, technological EE worsened between 2001 and 2004, then stabilized—whereas it continued deteriorating in “old” EU-15 countries until the financial crisis of 2008. In Croatia, after improving in 2000–07, technological EE started deteriorating around the time of the financial crisis. The rest of this chapter summarizes (a) the concepts underlying, and evidence for, the roles EE may play in promoting growth, employment, fiscal health and environmental sustainability; and (b) the potential applicability of EE measures in Bulgaria, Croatia, Poland and Romania. Energy efficiency and growth It is broadly recognized in the economic literature that improving EE contributes to more-resilient and faster economic growth through improved productivity. Improving energy productivity is one of the main pillars of growth, along with improving productivity of physical, natural capital (through nature conservation), man-made capital (e.g., through investments), human capital (e.g., through education), and intangible capital (e.g., through improved institutions). Productivity improvement is driven by technological progress, which according to economic theory is subject to increasing returns; that is, it multiplies its own benefits. This is because discoverers can monopolize knowledge only for a limited time—often long enough to earn an adequate return—after which knowledge quickly becomes available as a free good to others, generating positive externalities and spillover benefits throughout the economy. According to growth theory,36 a policy framework that supports market openness, competition, flexibility and innovation can magnify these spillover benefits and vastly accelerate technological progress. Some policies promoting EE (such as R&D expenditures, removal of institutional barriers, and information dissemination) fall into this category and can stimulate economic growth both directly, by improving energy productivity, and indirectly, by strengthening the spillover effect. Although the empirical literature that focused ex post on the relationship between energy consumption and economic growth has generally confirmed that energy consumption and growth are linked, but conclusions on causality are mixed. Studies using multiple statistical models and testing methods, and covering a range of different countries have presented diverging views as to whether energy consumption drives economic output or vice versa. These diverging points of view have had a major impact on the perception of the economic consequences of EE. Although most advanced empirical studies conclude that economic growth is compatible with EE, several studies have also suggested that reducing energy consumption may have hindered growth. • Most recent empirical studies supported the proposition that EE increases economic growth by reducing production costs, which boosts overall factor productivity and therefore economic output.37 Vivid Economics (2013) notes also that causality can also work in the opposite 36 Endogenous growth theory holds that economic growth is primarily the result not of external forces, but of endogenous factors such as investment in human capital, innovation, and knowledge. 37 In such studies the causality between energy use and growth is found to be bidirectional, non-existent or working in a direction wherein GDP growth drives energy consumption (Kraft and Kraft 1978, Abosedra and Baghestani 1991). Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 97 direction: economic growth may lower energy intensity by increasing the share of less–energy- intensive sectors in an economy, such as high-tech manufacturing and services.38 • EE is sometimes found to be neutral to growth. For example, Australia, Canada, and the United States have been growing robustly so far, notwithstanding the relatively higher energy intensity of their economies compared to the EU or Japan (Gill et al., 2014). • The concerns that reduction of energy consumption may reduce economic output usually come from the studies that concluded that it is the energy consumption that drives economic growth (Narayan et al. 2010, Lee 2005). This was the prevailing perception until the oil crisis of the 1970s and early 1980s, although more recently Campo and Sarmiento (2013) concluded that for some energy-dependent Latin American countries (such as Argentina, Brazil and Chile) that are energy-dependent, “the policies that seek to conserve energy in the long run would have disastrous results on their economic growth” (pp. 252). The last group of stakeholders often refer to the economic impact of sudden and significant energy price shocks to conclude that lower energy consumption driven by high energy prices is detrimental to economic growth. Indeed, sharp, unexpected spikes of energy prices have usually triggered recessions in the past. Energy price shocks have been found to be one of the major causes of economic crises in the United States and elsewhere (Nordhaus 1980, Killian 2008, Hamilton 2009). The empirical literature on the growth impact of the expected steady increase in real prices of energy over a long time period is less developed, and its conclusions are more balanced. The long-term economic performance of Europe and Japan does not look inferior compared to that of Australia, Canada and the United States, Canada and Australia, despite historically much higher energy taxation (and hence consumer prices) in the former group of countries. The high share of taxes in the final energy price gives countries more room to cushion the impact of import price shocks by reducing the tax rate when the price spikes and increasing it when it drops. Because energy remains a significant factor of production, and its costs have been rising, energy- efficient industries and countries have developed a competitive cost advantage (McKinsey 2011). In this way, the efficient use of energy can contribute to more-resilient and faster economic growth because it is by reducing the amount of energy used per unit of output —and hence total energy cost and total energy demand. Reduced energy demand in turn mitigates the increase of domestic energy prices. The major weakness of the empirical economic literature so far is that it has focused rather narrowly on the relationship between energy consumption and growth. Studies are rarely designed to address the empirical question on assess the relationship between trends in energy intensity (or its opposite, energy productivity39) and economic output. The recent report by Vivid Economics (2013) fills this research gap, at least for the high-income OECD countries, by examining the causal relationship between energy productivity and economic growth (after correcting for the impact of structural reforms). It found that an improvement in EE can contribute to higher economic output. In the OECD countries the economic growth was higher than changes in energy consumption, meaning that energy productivity increased. The authors warn that the same relationship may not be present in each individual country and can change over time. This conclusion is also not necessarily extendable to developing countries, although the authors point to the two effects which that can influence the results as well as its applicability in the future (Vivid, 2013): 38 Campo and Sarmiento (2013) for most Latin America countries; Erol and Yu (1987) for Canada, France, Italy, Japan, the United Kingdom; Sims (1972) and Hwang and Gum (1992) for Taiwan; and Fatai et al. (2002), Yu and Hwang (1984) and Yu and Choi (1985) for a number of countries). 39 Energy productivity is, defined as “GDP per unit of energy used,” and is a measure of the economic value associated with energy use. Energy intensity is defined as “the amount of energy used to produce a unit of GDP.” Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 98 • Low-income countries usually have more potential for EE improvement as well as a naturally higher economic growth rate; • As countries became more energy efficient over time, they moved closer to their maximum possible level of EE, at which point when marginal gains are harder to make. One could expect, therefore, that the positive growth effect of increasing energy productivity should be stronger in relatively lower-income countries with particularly energy-intensive assets and habits. On the other hand, the empirical evidence indicates that many inefficient low-income countries are not decoupling their energy use from GDP. Energy intensity has been increasing in several middle-income countries (Haiyan Zhang and, Michael L. Lahr, 2013), while decreasing elsewhere in others, such as — for example, in China, Central and Eastern Europe, and Central Asia. Many researchers have found an inverted U-shape relationship between the energy-intensity indexes and measures of per capita income, suggesting that energy intensity first increases with income, but eventually decreases as countries become wealthier than average (Hu & Wang, 2006). This hypothesis of the energy intensity an inverted Kuznets curve for energy intensity suggests that, in the early stage of economic development, countries tends to rely on extensive industrialization and urbanization with through massive infrastructure and housing development, which will consume much energy and material (Lin et al. 2008). As they the countries get become richer the development becomes more dependent on high-end manufacturing and services and energy intensity falls. Arguably the “new” EU member states are at the latter stage. Some economic benefits manifest through improvements in welfare, but are not captured by the GDP metric. The GDP impact of changes in energy use should not be confused with the welfare impact of changes in consumption of energy services, such as warm houses, reliable appliances and light spaces (Deichman and Zhang 2013). For example, behavioral changes and small retrofits that people may undertake of their own accord in their homes can significantly improve thermal comfort and thus welfare, but the effect on GDP would be negligible (because, as few market transactions are involved), or even negative (because, as more-efficient buildings purchase less energy). Thus reductions of in energy use can marginally decreases GDP while simultaneously enhancing welfare, which demonstrates the limitations of the GDP indicator. Economic efficiency of energy efficiency From a microeconomic perspective, EE improves welfare as long as the marginal social benefits derived from energy savings are higher than the marginal social cost. The cost of energy savings reflects the upfront technical costs of implementing EE projects, including transaction costs and all “hidden” costs. The (present value of) benefits include financial savings from lower energy bills and the difference in the cost of maintenance and repairs of the new, more-efficient equipment and buildings. Another important component of economic benefits is the improvement in convenience and comfort often associated with new, modern equipment or renovated buildings. The benefits listed above are “private” in a sense that they a re enjoyed by the owners of EE projects. Beyond private benefits, however, there are also those that are normally not captured by investors but that improve the welfare of other individuals—as well as the profits of other firms. In this sense these “social” benefits are external to the project owners. They can be local/national (such as reduced dust or noise pollution) or truly global and trans-generational, such as reduction of emissions of greenhouse gasses. A concept of society here includes global community and future generations. This is illustrated in Figure A-3. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 99 Figure A-3: Welfare Microeconomics of Energy Efficiency Improvements Cost ($/kWh) Marginal cost of EE with hidden costs Social marginal benefit of EE Ps Private marginal benefit of EE Pp Qd Qp Qs Energy savings (kWh/y) In figure A-3, the energy savings up to Qp would be undertaken by firms and households (investors) in their own private interest—provided that the discount rate used to derive the curves is equal to their risk-adjusted expected rates of return, energy prices are not subsidized, and other barriers and hidden costs are not present. Projects saving energy beyond Qp would not be attractive to investors, but would yield positive return for the society up to the level Qs. Projects that reduce energy consumption beyond Qs would reduce social welfare and should not be undertaken from an economic standpoint of view because the social cost of saving additional kWh energy would become higher than surpass the social benefit; these would be inefficient EE projects. The level of energy savings that delivers net social benefits from the point of view of individual country countries (e.g. for example, local pollution) lies somewhere between Qp and Qs. In reality, however, the energy savings actually realized are often closer to Qd, which is the maximum that investors would be are willing to deliver under distorted market incentives (e.g. such as fuel or energy subsidies) and in the presence of various hidden costs, barriers and split incentives (these are discussed later). Therefore the increase of energy savings from constrained level Qd to Qs has a strong rationale in micro-economic efficiency, and justifies dedicated policy interventions aimed at correcting policy and markets failures and removing barriers. Abundant project-level experience suggests that (a) the EU-15 countries have not yet exploited all the low-cost energy-efficiency opportunities and (b) the achieved level of energy savings is well below Qp. This is likely to be the case with projects that in are in the low part of the cost curve—that is, low- cost improvements of very inefficient facilities. Achieving a certain level of ambitious energy performance standards in relatively efficient buildings or appliances may cause marginal cost to exceed marginal social benefits (beyond Qs). The EU European Court of Auditors, for example (ECA 2012), found that EE projects supported by the EU cohesion funds were not economically viable, with average pay back periods exceeding 50 years (in extreme cases, 150 years). The concerns regarding the projects’ cost -effectiveness of EE projects remain valid notwithstanding the weaknesses of this analysis: the Court narrowly defined returns as limited to financial revenues from energy savings, ignoring not only the value of comfort and convenience, but also of local and global external benefits. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 100 Energy efficiency and jobs The results from existing studies on the net impact of EE on employment have so far been inconclusive. Project-level calculations and bottom-up models usually show the strongly positive employment effect of EE measures (World Bank and Climate Works Foundation 2014). The common limitation of the project-level approaches is that they cannot distinguish between net job creation and shifting jobs around the economy. In reality, EE policies (such as energy performance standards, energy price increase, or subsidies) cause jobs dislocation; in other words, jobs in in energy-efficient activities are created while jobs in other sectors are destroyed (Hughes 2011). The only legitimate way to derive a conclusion from research on the net employment effect is to consider the entire economy, including inter-sectoral feedbacks through value chains and markets. Only general equilibrium models offer such a comprehensive perspective. However, the results of such economy-wide analyses do not give a strongly support for the hypothesis that green policies in general, and EE in particular, create net sustainable jobs (Bowen 2012). Even if EE creates sustainable jobs, it often does not do so cost-effectively. Policies that stimulate innovation and labor market flexibility are the best way to create new jobs and enhance the impact of targeted EE policies; yet investing the same amount of money in the small and medium-size enterprise (SME) sector without the condition that they be used for EE would likely create more jobs than targeted EE investments. Therefore employment gains by themselves are a poor criterion for evaluating EE projects or policies (Deichman and Zhang 2013). EE projects and policies demonstrate their benefits better through the lenses of cost/benefit considerations40 and productivity improvements, as well as external/indirect benefits from environmental improvements, learning and innovation. The fiscal impact of energy efficiency Although the fiscal impact of EE measures is usually positive, it depends how the measures are designed, implemented and financed. Energy savings reduce the operational costs of equipment and buildings. If project hosts are public entities, it means lower fiscal expenditures for public budgets. Ex ante estimates of monetary saving potential vary between 20% and 60% depending on the sector and project type. Actual savings depend substantially on the behavior of the project host. Before savings on energy bills can be enjoyed, however, EE measures require significant upfront capital investments. The net fiscal impact depends on both how large the investment costs are and how they are financed; a higher share of public funds in project financing erodes net fiscal savings. The traditional way means of financing public projects from public funds is gradually being gradually complemented by innovative off-budget financing structures and business models. Private energy service companies (ESCOs) have emerged worldwide as an alternative solution; they not only improve project design and management, but also increasingly arrange off-balance sheet financing against expected savings. To relieve public sector entities of the burden of financing energy-saving projects, ESCOs need a stable and enabling regulatory environment, as well as strong public institutions to partner with. Ministries of finance often look carefully at the tax revenue impact of EE improvements. On the one hand, new investments increase revenue from VAT and sales taxes. If such projects are profitable, they will also increase revenues from income taxes. On the other hand, sometimes ministries of finance are concerned that energy savings will decrease revenues from excise duties on energy commodities (as in 40 A common mistake in economic analysis done on a project or policy level is the treatment of wages as economic monetary benefits of a project or policy, whereas they should always be treated as a cost in the cost/benefit framework. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 101 Poland, for example). Also, policies that support EE with tax waivers and tax credits may raise concerns about impact on integrity of fiscal system, as they not only decrease fiscal benefits, but also create precedence, which may be used by other interest groups in a society to create loopholes in the tax system. Subsidies for EE projects would still reduce fiscal deficit as long as they are lower than the present value of public agencies’ financial savings. Subsidies can also unlock key institutional barriers to EE projects, such as coordination costs of residents in multifamily buildings. The net fiscal benefits of EE subsidies are stronger if they are designed to reward early movers for any extra risk they take and for the learning-curve benefits they provide to other market participants. Subsidies should then be predictably phased out to reduce fiscal burden and prevent permanent subsidy dependence and strategic delays of investments amid expectations that subsidies will increase in future. Ministries of finance are concerned if that energy subsidy programs lack credible sunset clauses, they may impose unlimited liabilities on public budgets. Subsidies to EE projects can also be wasted if other counterproductive policies, such as fuel or energy subsidies, have an opposite impact. It is smart to use public funds only when other market-compatible policies, especially those affecting price signals, provide consistent incentives. As demonstrated in Chapter 4 in the case study on EE in buildings in Bulgaria and Croatia, subsidies that complement rather than substitute for other enabling policies can be much smaller to while achieving the same effect. This saves public funds that can then be deployed to other productive uses in the economy. The effect is also more sustainable and replicable. Unsubsidized projects are proofs of energy-efficiency concept: they demonstrate that EE makes business sense and thus encourage commercial replication. Subsidies to EE projects can deliver a fiscal dividend if they are designed to leverage and crowd-in and work in concert with private finance, which is much more abundant and commercially motivated private finance. In fact a well-designed subsidy can play and important catalytic role in facilitating access to commercial finance for those project owners who want to invest in commercially viable projects but lack the fiscal space, credit capacity or track record necessary to raise debt or equity finance. The 2013 DFI Guidelines for the Use of Concessional Finance in Private Sector Operations41 offer pragmatic recommendations, endorsed by major multilateral development banks (MDBs) and bilateral financial institutions, on how to use subsidy programs in a smart and incentive-compatible manner. Ministries of finance can themselves contribute to a fiscal dividend by supporting multi-year investment planning and budget perspectives that allow public entities to enjoy monetary savings resulting from lower energy bills. Unfortunately, budget rules in several countries still automatically reduce operational budget allocation in the years following energy-saving investments that reduce energy bills. This discourages both investments and efficient behavior and makes it impossible to leverage off-budget private finance against energy savings. Public procurement rules also play an important role if they are designed to choose bidders who offer the lowest lifetime costs rather than the lowest upfront capital cost. Energy efficiency as a climate policy measure The Intergovernmental Panel on Climate Change (IPCC) has collected considerable evidence that EE has contributed substantially to climate change mitigation by reducing emissions (IPCC 2014). Looking forward, the large economy-climate models cannot find a solution to the climate stabilization target without major a breakthrough in EE—especially in the short-to-medium term, when a massive switch to low-carbon fuels in the energy, industrial and transport sectors is not possible because of 41 http://www.ebrd.com/downloads/news/roundtable.pdf. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 102 slow capital-turnover cycles. In this section we first look into the past to see how important EE has been in bringing down greenhouse gas emissions. Then we will look into the future to assess the potential of EE to be a continued driver of emission reduction. What does past evidence tell us? For this report, we employed a decomposition analysis 42 to determine how significant EE has been so far as a driver of the changes in carbon dioxide (CO2) emissions. For this purpose we first analyzed changes in CO2 emissions from energy use in Bulgaria, Croatia, Poland and Romania as well as a host of comparator countries from 1995 to 2010. As Table A-1 shows, of the four countries (Bulgaria, Croatia, Poland and Romania), only Croatia increased total CO2 emissions from 1995 to 2010. The other three decreased emissions rapidly in the first sub-period (1995–2000), after the re-introduction of the market system, and then stabilized or even slightly increased later. This contrasts with the OECD countries, which increased their emissions until the 2008 financial crisis, after which emissions plummeted. The BRIC countries, in turn, steadily increased emissions over the entire period—except for Russia, which followed a path similar to its three Central European counterparts. Table A-1. CO2 Emissions Changes in 1995–2010 Country 1995–2000 2000–05 2005–10 Total Bulgaria -10 3 -1 -8 Croatia 3 2 -1 4 Poland -41 2 1 -38 Romania -30 8 -17 -39 EU-12 -96 21 -36 -111 EU-15 77 108 -356 -171 EU-27 -20 130 -393 -282 Brazil 65 23 55 142 Russia -82 46 40 4 India 194 215 519 928 China 286 2136 1949 4371 Turkey 33 34 48 116 Japan 24 39 -68 -4 United States 450 113 -440 124 Source: IEA (2013). We then attributed the changes in emissions to the sum of changes in the following drivers 43 (shown together with abbreviations used in the graphs below): f. Carbon intensity of fossil fuels consumed (Ceff) g. Share of fossil fuels in final energy consumption (Seff) h. Energy required to produce a unit of GDP, or energy intensity (Ieff) i. GDP per capita (Geff) j. Population (Peff) 42 We followed a methodology similar to that applied in Bacon and Kojima (2009), but with more recent data and differently aggregated countries. 43 Data—including data on population, GDP (PPP in 2005 constant U.S. dollars), total primary energy supply (TPES), and CO2 emissions—are obtained from IEA (2013). The data on fossil fuel supply is from IEA World Energy Statistics and Balances database. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 103 The results are shown on Figures A-4a and A-4b. EE was the single largest contributor to the reduction in CO2 emissions throughout the 1995–2010 period in all countries studied. As the bar charts show, per capita growth of economic output (Geff) was the main driver of emissions growth (upward-pointing bars), while energy intensity (Ieff) improvement was the main emission inhibitor (downward-pointing bars). During the entire 15-year period, improvement in energy intensity has led to a reduction of CO2 emissions by 31 million metric tons (mt), 4 mt, 201 mt and 58 mt for Bulgaria, Croatia, Poland, and Romania, respectively. Figure A-4a. Contributions of Five Factors (Population, GDP, Energy Intensity, Primary Energy Mix, and Fossil Fuel Mix) to Changes in CO2 Emissions in Bulgaria, Croatia, Poland and Romania (millions of metric tons) Source: Authors, IEA (2013). In Bulgaria, EE improvements from 2000 to 2005 were not sufficient to offset the emission impact of economic growth. In the most recent period, EE’s contribution to reducing CO2 emissions slightly weakened, but total emissions decreased because Bulgaria experienced a significant drop in GDP growth rate in the end of the decade. In the same period GDP decline was also a key driver of emission reduction in Croatia and Romania, as the energy intensity deteriorated in Croatia and only marginally improved in Romania. In contrast, the Polish economy was still growing by 2010, contributing to increased emissions that more than offset the impact of improvements in energy intensity. The four countries have been making mixed progress in decarbonizing their national primary energy mix. This is reflected by changes in the share of fossil fuel in total primary energy supply (Seff) and changes in the carbon intensity of fossil fuels used in energy generation (Ceff) . Over the entire period, Seff was the second largest contributor to CO2 emissions reduction (next to the impact of energy intensity), leading to a CO2 reduction of 3 metric tons (mt) for Bulgaria, 0.6 mt for Croatia, 20 mt for Poland and 18 mt for Romania. Bulgaria recently (2005–10) re-carbonized its energy generation by using more fossil fuels in its energy mix and more carbon-intensive sources in its fuel mix. All other countries decarbonized their energy mixes, although progress was generally slow. Romania and Croatia progressed the most rapidly, although Romania slightly increased its carbon intensity of fuels over the period. Croatia made steady progress toward both less fossil fuels and a cleaner fuel mix. In Poland, because non-carbon energy Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 104 sources have been steadily crowding out fossil fuels, the fuel mix became cleaner over the period — albeit at a slow pace that did not contribute significantly to reducing CO2 emissions. Decreasing population (Peff) in Bulgaria, Croatia and Romania contributed to small decreases of CO2 emissions, while in Poland the population effect only marginally increased emissions. Similar decomposition analysis applied to the peer countries yields some interesting insights (see Figure A-4b). Figure A-4b. Breakdown of contributions of five factors (pop., GDP, energy intensity, primary energy mix, and fossil fuel mix) to changes in CO2 emissions in China, the EU, Japan, Russia and the United States (millions of tonnes) Source: Authors; IEA (2013). All the OECD countries studied and as well as in Russia, have decelerated the contribution of their per capita GDP decelerated as a factor to in CO2 emissions in 2005–10, in the most recent sub-period, due to the economic slow-down after the 2008 global financial crisis. For the United States and Japan, the output changes even reduced emissions as GDP per capita decreased between 2005 and 2010, although the growing U.S. population has pushed emissions upwards. In China, accelerating economic output per capita has boosted CO2 emissions much stronger far more than population growth did. This joint Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 105 effect was not fully counterbalanced by the improvements in energy intensity and carbon intensity of fossil fuels. Regarding EE in both old and new EU countries, a significant improvement in energy intensity of economy in the 1995–2000 period slowed down in the following period, only to improve again in the most recent final period. Coupled with the economic slow-down, this has led to significant reductions in total emissions, in particular especially in the EU-15. In the decade from 2000 to 2010 Japan has made impressive and accelerating progress in reducing the energy intensity of its economy. Combined with negative growth in the last final sub-period, it has triggered a rapid reduction in CO2 emissions— notwithstanding the fact that the share of fossil fuels in its energy mix increased considerably. The United States has experienced a consistent decline in the contribution of EE to CO2 emissions reduction during the three sub-periods. Although this suggests a weakened improvement in EE, although in the most recent period EE improvements were still strong and, combined with negative growth, contributed to a major decline in CO2 emissions.44 Both old (EU-15) and new (EU-12) European countries and as well as the United States have made consistent progress in the de-carbonization of their primary energy mixes in all three sub-periods, although in the years 2005–10 the new EU countries increased the share of fossil fuels in the energy mix. Note that de-carbonization through switching away from fossil fuels was stronger than through switching from coal to gas. Japan was on an opposite trend, as a decrease of the share of fossil fuels and their carbon intensity in the initial sub-period was reversed in the second sub-period and continued to grow until 2010 well before the Fukushima accident. China has been improving reducing the carbon intensity of its fossil fuel mix by switching away from more-polluting coal toward cleaner natural gas (as reflected by an increase in CO2 reduction from Ceff), although the share of fossil fuels in China’s energy mix has been steadily growing, notwithstanding investments in renewable sources and nuclear power. This ex post decomposition analysis suggests the following conclusions: • Economy-wide EE improvements have so far been the main driver of CO2 emissions reduction in all countries studied, dwarfing the impact of switching to cleaner fuels. • More recently, EE improvements have decelerated in several new EU member states. In future, this may not be enough to counterbalance the impact on emissions of increases in income and population unless policy incentives are corrected. • A boost to policy reform is particularly needed in Bulgaria. Countries like Poland and Romania, which improved their energy intensity from the second to the last sub-periods, will also need to bolster their efforts to counteract the increased emissions driven by economic growth. • In Bulgaria, Poland and Romania, the potential to reduce emission by decarbonizing energy generation (by switching to low- and no-carbon fuels) remains largely unexploited, suggesting weak policy efforts in this area thus far. • In the EU-15 countries, the main driver of emissions reduction from 2000 to 2010 was the economic crisis. • In the BRIC countries, EE improvements were by no means sufficient to counterbalance the emissions growth caused by increasing income and population. Going forward: how to continue the climate benefits of energy efficiency All economic models agree that end-use EE will have to deliver about half the emission reductions needed to stabilize global temperatures at a level that is less than the internationally agreed-upon limit of 2 degrees Celsius (3.6 degrees Fahrenheit) above pre-industrial levels. A recent review of seven 44 This data series does not fully capture the effect of the shale gas revolution in United States. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 106 integrated assessment models under the LIMITS project (Tavoni et al. 2015) found that until 2050 energy savings (through EE, conservation and structural changes) will be at least as important for decarbonization as renewable energy deployment. In its 2015 World Energy Outlook, the IEA expects that EE will have to account for almost over 50% of required emissions reductions (see Figure A-5). The rest of this forward-looking section discusses what would make people and firms use energy more efficiently and productively. Figure A-5. Portfolio of actions to reduce energy sector emissions, according to the IEA Source: IEA (2015). What makes firms and individuals use energy efficiently? EE policies rest heavily on the microeconomic concept that any individual or firm will save energy if the initial cost of achieving savings is lower than the present value of the expected benefits of reduced energy bills. The word expected is important here, because it implies that economic actors will discount future benefits by the individually perceived risks. Given risk aversion, consumers may desire a higher return on uncertain investments as compensation. The idea that EE makes economic sense implies an assumption about pre-existing inefficiencies in the behavior of economic agents. Until recently, economists were skeptical about the existence of the unutilized opportunities for energy savings with potentially high rates of returns. If rational economic agents do not harness these opportunities, they argued, they must face some hidden costs that the advocates of EE do not see. By and large the economists were right—and then they themselves proposed a solution. The “energy efficiency gap” literature emerged, starting with Jaffe and Stavins (1994) and DeCanio (1993, 1994, and 1998). It stresses that many of these hidden costs are rooted in market failures (such as environmental externalities) or other barriers that inhibit firms from undertaking potentially profitable energy-saving investments. This literature identifies behavioral barriers arising from principal-agent problems, other information asymmetries, the landlord-tenant divide, and bounded rationality (Paton 2001). The IPCC’s recent review of efficiency-gap studies conducted by the IPCC is summarized in Box A-1. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 107 Box A-1. Economic explanations for the apparent failure to pursue profitable mitigation/ energy- saving opportunities Price uncertainty and the irreversibility of investment may pose economic barriers to the timing of adoption of EE measures—it may pay to wait before making the investment (Hassett and Metcalf 1993, Metcalf 1994). Mitigation (EE) investments take time to pay off, and consumers act as if they are employing high discount rates when evaluating such investments (Hausman 1979). These consumer discount rates might be much higher than those of commercial businesses, reflecting liquidity and credit constraints. The durability of the existing capital stock can be a barrier to rapid deployment of otherwise profitable new technologies. Also, incentives can be split when the party that pays for an EE investment does not capture all the benefits, or vice versa. For example, a tenant installs an efficient refrigerator, but the landlord retains ownership when the tenant leaves. Or the landlord buys a refrigerator but doesn’t care about its EE. Such problems can also arise in organizations where different actors are responsible, say, for energy bills and investment accounts. Finally, energy users, especially residential users, may be uninformed, or poorly informed, about the energy savings they are forgoing. In some cases, the seller of the product has better information than the potential buyer (asymmetric information) and may fail to convey that information credibly (Bardhan et al. 2013). Recently, some economists have suggested that systematic behavioral biases in decision making can cause a failure to make an otherwise profitable investment. These have been classified as non-standard beliefs (e.g., incorrect assessments of fuel savings (Allcott 2013), non-standard preferences (e.g., loss aversion—Greene et al., 2009), and non-standard decision making (e.g., tax salience —Chetty et al. 2009). Such phenomena can give rise to what might be considered “mis-optimization” by decision makers, which in turn could create a role for efficiency improving policy not motivated by conventional market failures (Allcott et al., forthcoming). Both economic and non-economic reasons can explain why opportunities for profitable EE opportunities might exist untapped, as noted in recent reviews (Huntington 2011; Murphy and Jaccard 2011; Allcott and Greenstone 2012; Gillingham and Palmer 2014). Source: IPCC (2014). See bibliography for citations in this box. Market failures and institutional barriers are not the only hurdles for otherwise economically viable EE projects. Often governments create additional barriers themselves through incentive-incompatible policies, such as energy price subsidies or fiscal rules that “confiscate” savings made by public entities (as discussed in the preceding section on the fiscal impact of EE). Correcting market and policy failures delivers a double dividend: it improves economic and energy productivity at the same time. Policy reforms have proved critical to accelerating improvements in energy productivity improvements. In the former Soviet bloc, for example, a turning point in energy productivity coincided with the recovery from the collapse of the centrally planned system at around 1990. Market institutions, liberalized price signals and opening to international trade began correcting the inefficient legacies of the former regime—harnessing the most obvious, lowest-cost measures first, such as fixing leaking pipes and abandoning the least efficient, loss-making assets. Those countries in the region that reformed the least (most of the Central Asian countries, for example, or Bulgaria in the EU) have also been slow in decoupling energy consumption from economic growth and remain among the world’s most energy-intensive economies (EBRO 2013). China faced a turning point in its energy intensity trend around 1980, when Deng Xiaoping adopted a new strategy of gradual market reforms. Improving productivity of labor, capital and energy became the hallmark indicators of success of the new system (Levine, Step 1: Fix energy prices Subsidized energy prices discourage EE improvements because they make energy-wasteful behavior energy “cheap” to firms and consumers. There are many avenues through which governments subsidize wasteful energy use. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 108 One avenue is through fuel subsidies. They decrease the true economic cost of fuel inputs to final energy production. Electricity or heat produced from such subsidized fuels looks cheaper from the perspective of consumers, as in the case of coal in Poland and gas in Romania. But the social cost of fuel subsidies must be “recovered” from somebody. The burden generally falls on taxpayers (often the same people as consumers, but in a different role) through implicit or explicit state aid (such as aid given to coal mining in Poland). Sometimes taxpayers pay not through explicit cash transfers from the budget, but less visibly—through foregone revenues of fuel producers and the budget (as in the case of gas in Romania). In transport, subsidized oil extraction and processing lowers the gasoline price to vehicle drivers and encourages them to drive longer distances and buy cars that are more fuel-intensive. Another common type of subsidy inconsistent with energy efficiency incentives is an energy subsidy to final consumers. This may take a form of regulatory cap on retail electricity, heat, or gasoline pump prices. The taxpayers sometimes compensate producers, distributors and traders for their lost revenues through explicit budget transfers. If not (as in the case of electricity and heat producers in Bulgaria), the subsidy is “financed” through the suppressed margins along the energy value chain and e ventually through neglected maintenance and investments, which sooner or later leads to a deterioration in the quality of energy services to the subsidized consumers. The IEA estimates that only phasing out consumption-related subsidies will cut global energy-related CO2 emissions by about 7% by 2020 (IEA et al. 2010). The third form of subsidizing energy is a subtler one: tolerating the fact that some costs associated with energy generation are not born by the generators and users, but rather are transferred to third parties (hence they are called external costs). The best examples are the costs of local and global pollution associated with coal use, which are often equal to (or 2-3 times larger than) the market price of coal, though this varies considerably across countries (Parry et. al 2014). Many policy makers keep consumer energy prices low amid fears of poverty impact, recession, inflation or just political tensions. It has been widely recognized, however, that energy price subsidies are effective neither in fostering growth and economic stability, nor in protecting poorer consumers. They benefit mainly the rich consumers who use the bulk of the energy and capture most of the subsidy. Direct compensatory fiscal transfers to poor and vulnerable groups of consumers are a more-effective and -efficient means of mitigating the regressive impact of energy price increases. They encourage energy-efficient behavior by all households. Notwithstanding higher prices, people and firms can reduce their total energy bills with energy-saving projects. Such projects for can also be financed from the higher prices paid by rich households and from monetary savings made by public entities. Policy makers are often reluctant to charge households the full cost of energy even if they would be willing to pay more for a better quality of service. The long-term economic consequences of underpricing energy are excessive demand, unreliable energy services (outages, system losses), and over-reliance on energy intensive sectors and infrastructure. Any competitive advantage earned to energy intensive sectors is unsustainable, comes at a high cost to taxpayers, and suppresses the development of technologically advanced high-end manufacturing and services. Political gains are also short-lived (although sometimes long enough to win the next election), as energy price subsidies push the burden of accumulated neglected investments and costs of deteriorated infrastructure onto the voters. Step 2: Removing the barriers to enable prices do their job A suitably enabling policy environment for EE consists of two components: cost-reflective energy prices and a comprehensive package of complementary policies. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 109 Cost-reflective energy prices Cost-reflective energy prices—that is, prices that reflect the full costs of delivered energy, including social and environmental costs—are a prerequisite for creating a policy environment that supports energy efficiency. End-user energy prices include energy and carbon taxes as well as carbon prices, and can be backed by a social safety net (to prevent energy poverty) and by provisions to manage the impacts of structural change. Several jurisdictions have conveyed additional price signals through market-based instruments, such as energy efficiency obligations (sometimes with tradable “white” certificates) or energy-saving crediting schemes (such as India’s “Perform, Achieve and Trade” scheme). These measures are efficient (though sometimes not quite effective) ways to augment the revenues of energy efficiency projects. Energy prices alone, however, are not likely to stimulate the behavioral changes and investments needed to reduce energy consumption. The price elasticity of energy demand is usually low, especially in the short run, and depends on the barriers discussed earlier. A comprehensive package of complementary policies A comprehensive package of complementary policies should specifically target the identified institutional, behavioral and market barriers preventing economic agents from implementing economically viable energy-efficiency measures—thereby closing the energy efficiency gap. These policies should include the following: • Energy performance standards for buildings, vehicles and appliances (for example, Ecodesign) can influence investment or purchasing decisions that are otherwise very unresponsive to price signals. • Institutional and regulatory reforms can remove barriers and decrease the transaction costs and risks associated with energy efficiency projects. This includes addressing the landlord- tenant divide and coordinating costs among residents of multifamily buildings —costs that can be reduced by empowering housing management agencies or homeowner associations to make effective decisions on thermal retrofits to buildings and to raise necessary debt financing. Project construction and performance risks may also be transferred to the energy service companies (ESCOs), which are better equipped to manage them. • Demand-side participation includes energy market models that integrate demand-side resources, such as the ancillary services market, into electricity markets. • Provision of information on energy efficiency opportunities can include energy performance labels for buildings or equipment to help buyers make informed choices; training of energy auditors; establishing clearinghouses for energy efficient technologies; energy efficiency agencies; and targeted information and promotion campaigns. • Public procurement and fiscal rules should allow public entities to choose contractors offering the lowest lifetime project costs, monetize the benefits of future energy savings, to raise long term financing against expected savings, and implement energy saving projects through public- private partnerships. • Demonstration projects have the potential to change entrenched behavior resulting from a natural bias toward the status quo. • Access to finance enhancement for certain target groups (such as poor households, multifamily buildings, SMEs and public institutions) can take many forms of public interventions and concessional finance including grants, performance payments, concessional lending, or risk sharing and transfers. Financial products facilitate access to finance if they are structured to leverage access to private funding, decline in value over time, and do not provide perverse incentives to delay investments (see DFI Guidance for Using Investment Concessional Finance in Private Sector Operations, 2013.) Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 110 Without this comprehensively enabling policy environment, energy efficiency gains may be short- lived and unsustainable. The energy savings resulting from energy efficiency interventions can rebound after the projects are implemented, when increases in the absolute consumption of energy can offset efficiency gains. Therefore, the third step toward an enabling policy environment is needed. Step 3: Manage the rebound effect The climate benefits of EE improvements may be eroded by the so called “rebound effect”. This is the term used to describe observed reaction of consumers who increase their demand for energy when its cost is reduced by EE improvements (see Box A-2). At first glance the rebound effect appears to be a paradox, as first noticed by Jevons (1866) in the context of coal use. Indeed, how can improved EE cause consumption of energy to increase? Box A-2. The rebound effect unpacked The rebound effect can be ‘direct’, ‘indirect’ and or ‘economy wide’ (IPPC 2014, p. 54). • Direct rebounds appear when, for example, an energy-efficient car’s lower operating costs encourage its owner to drive further (Sorrell 2007), or when more-efficient lighting or buildings reduce behavioral incentives to save energy. In addition, this could apply to a company where new, energy- efficient technology reduces costs and leads to an increase in production. • Indirect rebounds (Lovins 1988, Sorrell 2007) appear when increased real income resulting from energy cost savings is used to invest or purchase other goods and services that emit greenhouse gases (Berkhout et al. 2000; Thomas and Azevedo 2013). For example, fuel savings from a fuel‐efficient car provides additional disposable income that could be spent on an additional holiday. These could include substitution or income effect or changes in consumption patterns (Thomas and Azevedo 2013). • Economy-wide rebounds include market price effects, economic growth effects, and adjustments in capital stocks that result in further increases in the long-run demand for energy (Howarth 1997). Upon closer examination, the rebound effect is shown to be a rational and expected behavior of consumers. As the cost of consuming a unit of energy service (such as light, heat or kilometers driven) decreases due to efficiency improvements, people and firms consume more of the service. For example, they set their home thermostats to higher temperatures, they turn on more lights than before, and they drive longer distances, albeit in more-efficient cars. Using more energy services when their costs fall improves welfare, especially in low-income countries, where low access to energy services is a constraint to development and contributes to the poverty trap. However, this rational and welfare-improving change in behavior may offset gains in the absolute reduction of energy consumption. What is good news from a welfare perspective may cause concerns if the policy objective is to displace some expensive sources from the generation mix or reduce the absolute levels of emissions associated with energy use. The empirical literature provides cautious and conditional support to the rebound effect hypothesis (Deichmann and Zhang 2013). Some analyses find little empirical evidence of the rebound effect, especially at the level of the economy (Turner 2011, Sorrell and Dimitropoulos 2008). The IPCC’s 5th Assessment Report (IPPC 2014) concludes, however, that there is general agreement that rebound effects exist, though there is little agreement in the literature as to its magnitude. A review of 500 rebound studies found that direct rebounds are likely to be over 10% and could be considerably higher. Other reviews quoted by IPCC have shown larger ranges of between 0% and 60% (Thomas and Azevedo 2013). For household efficiency measures, most studies show rebounds in developed countries in the region of 20−45% (the sum of direct and indirect rebound effects) (Greening et al. 2000; Bentzen 2004; Sorrell 2007; Sorrell et al. 2009; Haas and Biermayr 2000; Berkhout et al. 2000; Schipper and Grubb 2000; Freire González 2010). For private transport, there are some studies that support higher rebounds; for example, Frondel et al. (2012) posit rebounds of 57 −62%. There is Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 111 evidence to support the claim that rebound effects can be higher in developing countries; see Wang et al. (2012b), Fouquet (2012) and Chakravarty et al. 2013. One study reviewing the rebound effect in U.S. industry found a range of 20−70% (Saunders 2013). More recently, studies have linked the rebound effect to distortions arising from underlying policies, mainly subsidized energy prices (Sorell 2009), and have found that changes in consumption of the more-efficient energy services are highly dependent on the policy context. In the absence of price incentives to continuously improve energy efficiency, the rebound effect is likely to increase total energy consumption, notwithstanding unit efficiency improvements. If associated projects are supported by upfront capex (capital expenditure) subsidies without removing other price and non-price barriers, public funds are likely to be ineffective in tackling climate change, although they arguably will improve the welfare of the recipients. If the rebound effect is strong in future, the realized energy savings and related emissions reductions will be lower than the amounts that might otherwise be expected on the basis of engineering principles. In other words, depending on the size of rebound effect, higher energy savings will need to be achieved to deliver the same expected emissions reduction. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 112 Annex B. Effectiveness of EE Policies in Buildings: a Modeling Approach Tools and methodology for prioritizing policies Policy makers need modeling tools to prioritize policy interventions. Many technology-driven, bottom- up models suggest that EE measures almost always generate profits while reducing energy use and GHG emissions. This is the case, for example, with the traditional marginal abatement cost (MAC) curves used to simulate the cost and potential of emission reduction measures associated with EE. Such models usually show that the upfront costs of EE measures are more than offset by the present value of the lifetime energy savings. Economists are often skeptical about the existence of the unutilized opportunities for energy savings with potentially high rates of return. They argue that if rational economic agents do not harness these opportunities they must face some hidden costs that the advocates of EE do not see. Practitioners on the ground share the economists’ skepticism. Experience demonstrates that EE projects can be notoriously difficult to implement and finance at scale. Most engineering models, such as the traditional MAC curves, typically ignore these hidden costs. This is why projects that seem viable from an economic perspective may be unprofitable for investors from a risk-adjusted financial perspective. Many existing models omit not only financial costs but even some economic costs and benefits, such as the transaction costs of developing projects, closing financing, obtaining permits, and applying for grants. Other welfare-economic elements that are typically ignored include local environmental benefits and other co-benefits of EE projects or the benefits of increased comfort and convenience. For these reasons, the applicability of traditional MAC curves for policy analysis is limited and may lead to misleading conclusions.45 The model applied in this study incorporates explicit financial perspective and policy variables. It is capable of simulating the behavior of investors and financial institutions consistently from a financial perspective while incorporating the economic or social perspective on costs and benefits. Therefore it can be used to simulate the expected effectiveness of planned policy interventions to support EE projects. The model and the scope of analysis This study uses the modeling tool developed on the basis of the TUV Invert/EE-Lab model. It was redesigned, calibrated and populated with country-specific data.46 The analysis covers energy retrofit of existing buildings built before 2000; recently built and new buildings are excluded. 45 Traditional economic MAC curves are also criticized for being insensitive to the interdependency between measures and sequencing of the measures that may appear cheaper but create a long-term lock-in for carbon-intensive structures (Vogt-Schilb and Hallegate 2011). 46 Invert/EE-Lab is a dynamic, bottom-up model of the building stock. It calculates heating, cooling and hot water energy demand with endogenous simulation of technology choice for renovation and equipment. The model is able to evaluate the effects of different policy schemes on the energy carrier mix, CO2 reductions, and the costs of investments in (a) energy efficiency as well as (b) heating and cooling using renewable energy sources (RES-H/C). Through consultations with the World Bank and the project partners, the Energy Economics Group of the Vienna University of Technology’s Invert/EE-Lab model has been adapted to include more-refined policy variables. The outputs have Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 113 The building stock was split into five categories: • Health service • Education • Offices (public and private) • Residential single-family homes • Residential multi-family homes For each category the database includes, among other things: • Building stock and its energy performance • Energy consumption • Heating, ventilation, and air conditioning (HVAC) systems (stock and sales) • Ownership and tenure Energy renovation measures The alternative energy renovation measures for different building types were determined in two steps. First, local experts defined a baseline energy performance of building retrofit on the basis of observations of actual investments undertaken by Croatian building owners and administrators in the absence of any support measures. Next, local and international experts determined a menu of alternative energy renovation measures with increasing levels of energy performance. For each measure the incremental energy saving potential and incremental lifetime cost were estimated. The technical characteristics of these alternative energy renovation measures are summarized below. Plotting marginal energy saving cost curves As illustrated in Figure A-6, the tool for deriving marginal energy saving cost (MESC) curves makes use of the results derived from the model Invert/EE-Lab. Making use of the standardized format of delivered Invert/EE-Lab’s model outputs, the plotting tool aggregates results by building category, estimates the weighted average of incremental costs of renovations for every renovation package, aggregates the marginal energy savings, the annual monetary savings, total capex requirements and the total value of grants. The aggregated values are plotted according to the MESC curve format. been used by the Buildings Performance Institute Europe to produce financial marginal energy saving (MESC) cost curves. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 114 Figure A-6. Modeling steps Invert/EE-Lab results Building categories Aggregation Incremental costs by building category Plot Incremental energy savings by renovation package Incremental monetary savings Energy savings CAPEX requirements Associated costs Selection of the most cost Value of grants effective renovation option per building category Plot in Marginal Energy Saving Cost curve format Value of comfort and convenience This analysis includes an explicit quantification and incorporation of the value of changes in comfort and convenience associated with the energy renovation of a building. EE practitioners stress that investments in building retrofit are often driven not only—or even not primarily—by the expected energy savings, but rather by expected improvement in the building’s general comfort level and aesthetic appeal. Renovated HVAC units, control systems and building envelopes are also more convenient to operate and maintain. After consulting with experts and practitioners, we estimate the aggregate value of these comfort and convenience improvements to be about 40% of the monetary value of energy savings. Policy scenarios This study quantifies how the various combinations of policies and measures can influence the investment decisions of building owners and third party investors. The effectiveness of the following policies is simulated: • Soft policy measures: Soft policy measures are specific regulatory and institutional reforms that alleviate the key barriers and “hidden” costs that form the “EE gap”—that is, the distance between economic and financial or market costs of EE projects. For the purpose of this analysis we have estimated their value separately and grouped them into two categories: transaction costs and risks. They are two distinct categories in the financial model of investment decisions, although to a certain degree they are correlated. Therefore for this analysis an effort was taken to avoid overlap and keep the estimates conservative. • Measures to reduce transaction costs: We distinguish between two different types of transaction costs: project transaction costs and policy transaction costs. The former are associated with the implementation of the EE projects themselves. The latter are associated with application of the EE support policies. • Risk reduction/transfer measures: Analysts often note that EE projects are not as risky as investors and financiers perceive them to be. For example, investing in EE projects in industry can materially reduce borrowers’ credit risk by reducing their exposure to volatile energy costs and making profit margins more stable (Oxford Energy Associates 2013). But the willingness to invest in reality is determined by perceived risks, not “real” risks. • Technology learning curves: Learning curves result in accelerated cost reduction of energy saving technologies. Steeper learning curves (accelerated cost reduction) can be achieved by a Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 115 combination of economy of scale in market penetration of these technologies as well as by horizontal and technology-specific support for R&D and innovation. • Market-based, revenue-enhancing instruments: Obligations imposed on energy suppliers to deliver a certain quota of energy savings can increase the revenue stream of energy saving projects as well as reduce project risks. Energy suppliers (usually experienced energy companies) have to achieve energy savings either by investing in the assets of their customers (that is, the buildings they serve) or obtaining savings from third parties in the form of energy saving certificates. If such certificates are tradable they are called “white certificates” and can be an additional direct revenue flow for EE projects. The EU’s 2012 Energy Efficiency Directive47 requires member states to use EE obligations schemes or other targeted policy measures to drive EE improvements in households, industry and transport sectors. EE obligations as well as carbon prices also support the financial viability of energy saving projects indirectly. In proportion to how they are passed through to the energy prices of final consumers, they increase the value of savings, at no extra transaction costs to the building owners. In the same way, energy taxes benefit the financial viability of energy saving projects. • Investment grants: Investment grants simply reduce the upfront investment cost of energy saving projects. They can be structured as a percentage of eligible costs or as performance- based payments—that is, they can be scaled to the rate of energy savings expected from the project. • Energy prices: The energy pricing reforms usually assume (a) removal of market price distortions by accelerated full liberalization of electricity and gas prices all the way down to retail level and (b) full cost recovery of regulated prices, such as heat. Methodology for Croatia Assumptions about energy prices Although energy prices for Croatian households are not explicitly subsidized, they remain well below the prices faced by EU consumers on average. Coupled with assumptions about removal of barriers to intra-EU trade in gas and electricity, the energy subsidy reduction scenarios begin with energy prices at the current, distorted level. The base-year level of consumer household prices is as follows: • Electricity price 0.10 €/kWh • Gas price 10.32 €/GJ • District heat price 22.31 €/MWh The baseline energy price scenario assumes the gap between current retail energy prices in Croatia and average EU energy prices will remain constant. Local prices are assumed to grow from the current basis at the same rate as the EU prices as forecasted by Eurostat. By contrast, the energy price reform scenarios assume that Croatian energy prices will reach EU average levels within five years and then will follow the EU prices’ growth path. The district heating price is assumed to converge with the natural gas price per unit of heating value by 2020. Energy performance The energy performance of the measures included in this study can only be approximately related to the classes of energy performance requirements established under Croatian regulations and reported to EU under the EU Energy Performance of Buildings Directive (EPBD). This is because the latter ones depend on the initial conditions of specific buildings and the climatic zone. Nonetheless the 47 https://ec.europa.eu/energy/en/topics/energy-efficiency/energy-efficiency-directive. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 116 approximate concordance between the renovations measures used in this study and energy performance required under Croatian regulations is shown in Table A-2. Table A-2. Approximate concordance between renovations measures used in this study and energy performance required under Croatian regulations Heat Equivalent Energy Roof Wall Floor Windows Recovery Label/ Rating Thermal Insulation Thickness (cm) Baseline - - - Double glazing: GLASS Ug= 1.7 no E W/m²K; FRAME Uf=1.4 W/m²K R1 5 - - Double glazing: GLASS Ug= 1.7 no D W/m²K; FRAME Uf=1.4 W/m²K R2 15 15 10 Double glazing: GLASS Ug= 1.7 no B W/m²K; FRAME Uf=1.4 W/m²K R3 30 20 15 Triple glazing: GLASS Ug= 1.0 yes A W/m²K; FRAME Uf=1.0 W/m²K Non-residential Baseline - - - Double glazing: GLASS Ug= 1.7 no F W/m²K; FRAME Uf=1.4 W/m²K R1 5 - - Double glazing: GLASS Ug= 1.7 no E W/m²K; FRAME Uf=1.4 W/m²K R2 15 10 10 Double glazing: GLASS Ug= 1.7 no C W/m²K; FRAME Uf=1.4 W/m²K R3 30 25 15 Triple glazing: GLASS Ug= 1.0 yes B W/m²K; FRAME Uf=1.0 W/m²K Note: Data are for Continental Croatia. W/m²K = watts per meters squared kelvin. R1, R2, and R3 refer to renovation stages. Scenario structure The numerical assumptions for all policy measures are summarized in Table A-3. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 117 Table A-3. Summary of assumptions for policy scenarios Project Transaction Costs subsidies Single- Discount Electricity price Fossil fuel price (% of family Multifamily Non- rate (risk Learning Policy scenarios evolution evolution District heat price evolution capex) houses houses residential premium) curve % price Scenario reduction by # % % of installed cost 2030 S1 Baseline w/o grants 0% 10% 15% 15% 11% 10% S2 Baseline + 25% grants 25% 13.3% 22.5% 22.5% 11.0% 10% S3 Baseline + 50% grants EU average growth rate of energy prices (2.8% p.a.) 50% 14.7% 24.8% 24.8% 11.0% 10% S4 Baseline + 75% grants 75% 16.0% 27.0% 27.0% 11.0% 10% S5 Soft policy measures 0% 5.0% 7.5% 7.5% 5.5% 25% Converge with EU price in 5 converge with cost recovery tariff in S6 Energy price reform years; then along EU path 5 years; then increase with inflation 0% 10.0% 15.0% 15.0% 11.0% 10% Energy price reform + soft Converge with EU price in 5 converge as above; then increase S7 years; then along EU path with inflation 0% 5.0% 7.5% 7.5% 5.5% 25% measures (no grants) Combined market reforms + S8 Converge as above + 3 €c/kWh Converge as above + 2 €c/kWh 0% 6.0% 9.0% 9.0% 5.5% 25% EEO/CP (no grants) Combined market reforms; S9 Converge as above + 3 €c/kWh converge as above + 2 €c/kWh 25% 14.7% 24.8% 24.8% 5.5% 25% EEO/CP; 25% grant Combined market reforms; no S10 Converge as above + 6 €c/kWh converge as above + 4 €c/kWh 0% 14.7% 24.8% 24.8% 5.5% 25% grants; 2xEEO/CP Combined market reforms; S11 Converge as above + 3 €c/kWh converge as above + 2 €c/kWh 50% 14.7% 24.8% 24.8% 5.5% 25% EEO/CP; 50% grant Note: All scenarios include the value of improved comfort, convenience, and increased property value, estimated at 40% of the energy price (or value of savings). EEO = energy efficiency obligations. CP = carbon price. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 118 Methodology for Bulgaria Assumptions about energy prices The baseline policy scenario assumes that (a) the gap between current energy prices and average EU energy prices will maintain constant and (b) current energy prices will grow from the current basis at the same rate as the EU prices as forecasted by the Eurostat. By contrast, the energy price reform scenarios assume that Bulgarian energy prices will close the gap with EU average prices within five years and then will follow the EU prices’ growth path. The base-year level of consumer household prices is as follows: • Electricity price 0.09 €/kWh • Gas price 13.75 €/GJ • District heat price 38 €/MWh Energy renovation measures Tables A-4 and A-5 show the alternative energy renovation measures that were considered for different building types. Table A-4. Alternative energy renovation measures designed for this study Table A-5. Approximate concordance between renovations measures used in this study and energy performance required under Bulgarian regulations Alternative energy renovation Energy performance requirement building class under measures designed for this study Bulgarian regulations* Baseline n.a. R1 D R2 C R3 A-B * Approximate estimate. Scenario structure The numerical assumptions for all policy measures are summarized in Table A-6. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 119 Scaling Up Energy Efficiency in Bulgaria and Croatia Table A-6: Summary of assumptions for policy scenarios Transaction Costs Electricity Project Single- Discount price Fossil-fuel price subsidies (% family Multifamily Non- Rate (risk Learning Policy scenarios evolution evolution District heat price evolution of capex) houses houses residential premium) curve % price Scenario % % of installed cost reduction by # 2030 S1 Baseline w/o grants 0% 15% 20% 20% 18% 10% S2 Baseline + 25% grants 25% 20% 30% 30% 18% 10% EU average growth rate of energy prices (2.8% p.a.) S3 Baseline + 50% grants 50% 22% 33% 33% 18% 10% S4 Soft policy measures 0% 10% 15% 15% 9% 25% Energy price reform + 25% Converge with EU price in 5 converge with cost recovery tariff in 5 S5 years; then along EU path years; then increase with inflation 25% 20% 30% 30% 18% 10% grants Energy price reform + soft Converge with EU price in 5 converge as above; then increase S6 0% 8% 10% 10% 9% 25% measures + EEO/CP (no grants) years; then along EU path with inflation Combined market reforms + Converge as above + 3 S7 €c/kWh Converge as above + 2 €c/kWh 25% 25% 35% 9.0% 25% 25% EEO/CP + 25% grant Note: All scenarios include the value of improved comfort, convenience, and increased property value, estimated at 40% of the value of savings. EEO = energy efficiency obligations. CP = carbon price. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 120 Scaling Up Energy Efficiency in Bulgaria and Croatia Annex C: Case Studies of Financing Mechanisms Public Buildings Case Study: Armenia Dedicated Energy Efficiency Fund For many municipalities in developing countries, the greatest challenge facing their attempts to scale up investments in EE retrofit for public buildings is their inability to access to long-term and low-cost financing. National regulations may limit cities’ ability to borrow or raise funds in financial markets, and commercial banks do not lend to cities without (or with low) credit ratings. As a result, many financially viable public-building retrofit projects cannot find financing. The best way to address this issue is to develop a credible mechanism for capturing the energy-savings cash flow to repay borrowed money. A good example of this is an innovative approach used in Armenia. Establish ed in 2005, Armenia’s Renewable Resources and Energy Efficiency Fund (R2E2 Fund) is a national investment facility dedicated to investing in financially viable public sector EE retrofits. The Fund is governed by a Board of Trustees (BOT). The BOT is chaired by the Minister of Energy and Natural Resources with representatives from government, the private sector and academia. Its executive director, supported by technical and financial staffs, manages day-to-day activities on a commercial basis The Fund began its initial operations by managing a US$22 million program, of which US$15 million came in the form of an International Development Association (IDA) credit. Later on, in 2012, it developed a follow-on US$10.7 million program to support sustainable financing schemes for public sector buildings. The R2E2 Fund is focused on financing EE retrofit in public sector facilities—such as municipal street lighting, schools, hospitals, and administration buildings (average size about US$100,000). It is expected to finance projects worth $8.7 million between 2012 and 2015 and to provide technical assistance (TA) for project preparation and capacity building. The fund primarily finances insulation of walls, basements and attics, repair/replacement of external doors and windows, window optimization, and reflective surfacing of walls behind radiators—as well as improvements to (or replacement of) boilers and heating systems, replacement of mercury vapor lamps with high-pressure sodium vapor lamps (or light emitting diodes, LEDs), and replacement of incandescent bulbs with compact fluorescent lamps (CFLs). Delivery Mechanism The R2E2 Fund offers two types of products for clients with different borrowing capabilities: • For Type 1 clients, such as municipalities and public entities with revenue streams independent of the state budget, the Fund generally provides loans and additional fee-based services including energy audit, procurement of design and works, project supervision, and contractor payment. • For Type 2 clients, such as schools and other public entities that are not legally or budgetarily independent, the Fund and clients will enter into energy service agreements (ESAs) (see Figure C-1), in which the fund will pay for upfront retrofit costs and thus no debt is incurred by the client. Under the ESA arrangement, the Fund must conduct energy audits to determine baseline energy usage. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 121 Scaling Up Energy Efficiency in Bulgaria and Croatia Figure C-1. Implementation Arrangement for ESA model Screening criteria include: (a) confirmation of public ownership of facility; (b) structural soundness of the facility (absence of major structural damages that may jeopardize integral stability of the building); (c) absence of plans for closure, downsizing or privatization of the facility; and (d) comfort level of more than 50%. A secondary set of eligibility criteria, which will be based on due diligence by the R2E2 Fund, include (a) a minimum of 20% energy savings; (b) less than 10-year simple payback period for EE investments; (c) sub-projects should be at least US$50,000 and not more than US$500,000; and (d) the borrowers should be in good financial standing and demonstrate payment discipline. The R2E2 Fund generally subcontracts the actual implementation and delivery of the retrofit projects to energy service providers (ESCOs). Depending on the complexity of the projects and financing options, cities may follow several commonly used contracting models to procure EE services for the retrofit program. The sub-contracts include project design, supply, installation, and commissioning. In addition, the contract includes provisions to allocate some project performance risks to the contractors based on the actual energy savings generated from the project. Bidding screening is based on the Fund’s preliminary EE assessment of the building and minimum energy savings level (usually about 30%), but allows bidders to propose their own savings and plans to achieve them. Bids awarding is based on the highest net present value (NPV) based on a formula specified in the bidding documents for technically viable proposals. The R2E2 Fund has the capacity to identify project scope, develop bidding documents, and conduct the procurement itself. For type 1 clients, the loans are treated as municipal debt, with fixed repayment obligations to be made within their budget provisions in future years. The amount of the repayments will be designed to allow fund clients to repay the investment costs and service fees from the estimated energy cost savings. For type 2 clients, the ESA arrangement requires the R2E2 Fund to pay upfront retrofit costs to complete renovation. Public facilities are obligated to set aside an escrow account and make the payment of baseline energy costs (adjustments for energy prices, usage and so on) to this escrow account over the life of the agreement. With these payments, the Fund will pay the energy bills on behalf of the facility and retain the balance to cover its investment costs and service fee of up to 10 years. The agreement can also be designed in such a way that the duration could be adjusted if the fund Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 122 Scaling Up Energy Efficiency in Bulgaria and Croatia recovers its full investment earlier or later. If a payment is not made, the remedy would be a potential service disconnection. Typical payments from the R2E2 Fund to ESCO are set up as follows: • 20% upon contract signing • 10% upon approval of final design • 20% upon confirmed delivery of project per design • 30% upon commission testing • 10% after two weeks’ monitoring of operations • 10% after a one-year “defect and liability” period Results Overall the R2E2 Fund has exceeded expectations. The initial program led to the increase in the percentage of households with safe and efficient heating gas heating from 11% to about 71%. The program supported 8,265 poor households with capital grants, left 120 schools with improved heating and buildings, leveraged financing by more than 2:1 for the loan component, and had a default rate of less than 1%—while introducing new safety norms and standards, increasing awareness about safety and EE, and building capacity among HOAs, construction firms and ESCOs. The demonstration of its schools component, which often resulting in energy savings of 40-50%, created a fertile ground for the revolving structure. For the new program using ESAs, the first five investments for the Fund for facility renovations, totaling about US$475,000, have been identified and contracted. This batch included three schools, one hospital and one street lighting project, with savings estimated at 41-50%. Investments were US$40,000-$222,000 with simple payback periods between 6 and 9 years. All of the ESAs are 10 years, with the possibility of reducing the term if the savings are higher and Fund recovers its investment and fee earlier. Commissioning is expected by June 2013. In addition, the Fund has identified and is negotiating an additional $1.7 million in new ESAs which it expects to sign in the coming months. Lessons Development of the ESA mechanism would not have been possible without the earlier grant-funded schools component, which demonstrated the typical EE measures, payback periods, energy savings and investment costs. As the Fund and contractors implemented the initial program, they were able to better predict performance of subsequent projects. Still, the initial batch of tenders failed due to too few qualified bids, so ongoing training of contractors is necessary. The Fund now provides contractor training, usually linked to the issuance of new batches of tenders to ensure that new firms are able to enter the market, understand the tender requirements, and so on. Another critical element was the presence of cash savings by the municipalities/schools to be able to repay the loans. This requires that billing be done based on actual consumption (universal in Armenia since there is no district heating), there is full payment discipline, and energy prices reflect supply costs. Customers that do not pay their energy bills are cut off, so the use of the baseline energy payments, which the Fund uses to pay the subsequent energy bills and recover its investments. In the event the customer does not make this payment, the Fund cannot pay the energy bill and service is disrupted, providing a strong incentive for payments to be kept current. Of course no scheme can work without dedicated people. The Fund Director is dynamic and committed to ensuring the scheme is successful. The staff members have strong experience in the technical areas, Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 123 Scaling Up Energy Efficiency in Bulgaria and Croatia as well as procurement and financial management, to ensure quality is maintained. Finally, the Board is supportive of the Fund and works to address any issues that arise. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 124 Scaling Up Energy Efficiency in Bulgaria and Croatia Public Buildings Case Study: Belgium’s Fedesco Belgium’s public buildings represent huge potential for energy conservation. There are more than 1,400 federal buildings, representing about 7.5 million square meters of floor area. The total annual energy and water bills amount to more than €75 million. Annual energy consumption has reached 1.7 terawatt-hours, causing 500,000 tons of CO2 emissions. As a 100% subsidiary of the Federal Participation and Investment Corporation, Fedesco is a public energy services company (ESCO) that facilitates and finances EE projects in federal government buildings. In September 2005, the company was founded on the initiative of the federal government as a public limited company. It has a capital of €6.5 million with additional €10 million of state guarantee (Figure C-2). Figure C-2. Stakeholder and funding source of Fedesco Fedesco uses an energy performance contracting (EPC) contract based on the plan developed by the Berlin Energy Agency and other partners in the EURCONTRACT project. Tendering procedures and contracts have been specifically adapted to the Belgian public tendering law. Fedesco cooperates with the Federal Buildings Agency. In the short and medium terms, Fedesco works exclusively for the Federal Public Service (FPS), the Belgian Federal Public Service (PPS) and other federal government agencies. Fedesco works on projects that contribute to energy savings in federal government buildings and this assures the funding, with repayment based on the annual realized savings, spread over several years. Delivery Mechanism To implement projects: • Project initiation: (1) Fedesco cooperates exclusively with Federal Building Agency. (2) Fedesco enters into EPCs with public facilities without competition. • Loan Application: (3) Fedesco either uses internal funds or obtains financing from commercial banks (with a state guarantee). • Renovations: (4) Fedesco subcontracts EE retrofit work to private ESCOs or service providers on a competitive basis. (5) Private ESCOs or service providers implement EE retrofit measures. In these implementation arrangements Fedesco bears a direct contractual obligation to repay loans from the banks and assumes performance risks for thermal retrofits. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 125 Scaling Up Energy Efficiency in Bulgaria and Croatia Implementation arrangements for the Fedesco model Contractual Arrangement: • Fedesco & Public Facilities: Fedesco enters into an EPC contract with public facilities without competition to undertake building retrofit. • Fedesco & Private ESCOs: Fedesco subcontracts EE retrofit work to private ESCOs at a competitive basis. • Fedesco & Banks: Fedesco has obligation to repay the loan offered by the Bank. Fedesco has the in-house capacity to develop bidding documents and conduct procurement of works and services. Fedesco takes loans from commercial banks to finance the retrofit project. As prescribed in EPC contracts, a certain percentage of cost-saving is paid to Fedesco. The payment is large enough to (a) cover retrofit costs as well as any financing costs incurred and (b) result in a profit for Fedesco. Fedesco is contractually responsible for making repayments to the bank. It must also make payments for subcontracting services provided by private ESCOs. Managing Technical risks Fedesco has a strong technical capacity for ensuring the quality of renovation. Its expertise ranges from analyzing needs, identify potential buildings and benchmarking them to the full monitoring of the technical phases of a project: the execution of audits, conducting the necessary studies, writing of technical specifications and the procedures of public procurement. Results In 2012 Fedesco reported that total energy savings to date came to 19,883 MWh, which it valued at €1,937,159. The forecast was for annual savings of €1,109,681.61. The average payback for the measures was estimated to be 2.25 years. Total GHG savings to date totaled 9,400 tonnes of CO 2. Lessons It is essential for government to set an example to the rest of the country. In this case, the creation of Fedesco was innovative because few cities or regions had created their own specialized ESCO. It is important to take a long-term perspective, and Fedesco has maintained its role and status even with Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 126 Scaling Up Energy Efficiency in Bulgaria and Croatia changes in government. It is also important to link with other priorities, from sustainable development to climate change strategies to public procurement. An important lesson was in learning to work with other stakeholders in order to spread knowledge and experience. Exclusiveness is not a positive attribute. There is a need to replicate through learning lessons. The creation of Fedesco was also good preparation for future efforts because the EU strategies for climate change and EE are only going to become more ambitious over time. Fedesco was instrumental in creating BELESCO, the Belgian ESCO association, designed to foster the use of ESCOs in Belgium. The former director-general of Fedesco was the chairman of the association, and remains so today in his new role within a consulting company and a senior consultant to the Knowledge Centre. Its Knowledge Centre is an expression of the perceived need of capacity building within the country and from all indications it is successful. Fedesco has evolved from a normal third-party financer offering all services to a company that provides a range of services but that acts as a facilitator to bring in the private sector as much as possible. Implementation lessons ESCOs have a mixed record in Europe as a whole. Having the federal government supporting Fedesco has provided considerable confidence. Also, Fedesco was given exclusive opportunities in the federal government, and this helped ensure that Fedesco could set an important example to all stakeholders. It also put a lot of responsibility on Fedesco, and it has come through this well. Fedesco does not work in isolation, in fact almost the opposite. It works with a range of stakeholders in ministries and other government agencies to set a comprehensive approach. Fedesco has leveraged funds and this is important. Because Fedesco is relatively small (staff of 12), services provided (such as ongoing maintenance) must be contracted through private ESCOs or technical companies. Issues and challenges With payback periods of around two years, the level of ambition is not great. There is more pressure to have deep retrofits that could be up to a factor four renovation. Fedesco does not do those and most ESCOs do not do them. While ESCOs play an important role, they are not the whole answer. This is a big challenge. It is a challenge to play a bridging role between the public and private sectors, but with the right team and capacity, this can be developed. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 127 Scaling Up Energy Efficiency in Bulgaria and Croatia Residential Buildings Case Study: Lithuania Jessica Funds and the EnerVizija Model Multi-unit apartment buildings in Lithuania represent a huge opportunity for energy conservation. Around 66% of Lithuania’s population lives in apartment buildings. There are more than 37,267 apartment buildings in the state, with 24,000 requiring renovation. Lithuania’s residential EE program was implemented in three phases from 1996 to 2003. In the first phase (1996–2003), a World Bank- and donor-funded EE housing pilot project was implemented, with a total investment of US$28.6 million. In the second phase (2005-10), the 2004 Lithuanian Housing Strategy for Multi-apartment Buildings Renovation Program was adopted, which initially attracted commercial loans and state subsidies but later dried up, mainly due to limited state resources. JESSICA holding funds In the third phase (2010–13), Lithuania established a lending mechanism for residential EE using JESSICA (Joint European Support for Sustainable Investment in City Areas) funds from the European Union (EU). Developed by the European Commission (EC) and the European Investment Bank (EIB), in collaboration with the Council of Europe Development Bank (CEB), the JESSICA Holding Fund (HF) provides low-interest loans without the budgetary burden to the state. The JESSICA HF is managed by EIB. The amount initially approved for the JESSICA HF was €227 million, of which €127 million was allocated from the ERDF and was €100 million from national match funding (Figure C-3). The rules and conditions for participation in the JESSICA-based mechanism were approved by the government. The Housing and Urban Development Agency (HUDA) of the Ministry of Environment was appointed as administrator of these rules and conditions (including administration of the accompanying state subsidy provided to the participating owners of apartments). Figure C-3. Funding source of the JESSICA HF Eligible applicants for renovation loans from the JESSICA Fund include homeowner association (HOA) and apartment owners, buildings administrators appointed by municipalities or municipal entities. 17% of buildings in Lithuania are managed by HOA, 3% by Joint Activity Agreement (JAA) between owners of apartments, and the remaining 80% by administrators. The administrators may be (a) association of multi-apartment buildings, (b) administrators appointed by municipalities, or (c) person authorized under joint-venture agreement concluded by apartment owners. Eligible projects include EE measures in multi-apartment buildings include EE windows, insulations of building envelope, heating distribution systems and glazing of balconies. EIB selected Urban Development Funds (UDFs) as financial intermediaries to manage the disbursement and administration of credits to renovation project owners. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 128 Scaling Up Energy Efficiency in Bulgaria and Croatia Subsidies are available from State budget resources to a level of 15% of upgrading costs. The subsidy is payable on completion of the EE measures and receipt of a Class C or above Energy Performance Certificate. The State grant subsidy is administered by the Housing Energy Saving Agency alongside the JESSICA-based loan. An additional 15%+10% subsidy is currently available (until end-2014) for EE upgrading projects from Climate Change Program which achieve energy savings of not less than 40%. At no cost to the end user, TA is also available to cover (a) 100% of costs for technical documentation and (b) 100% of project management costs. EnerVizija model The application for JESSICA funding was slow until the introduction of municipal renovation programs based on the EnerVizija model—an ESCO type investment model (see delivery mechanism for details). Under this implementation model, municipalities are the entity who initiate city or district wide renovation programs which are then managed by authorized building administrators. The building administrators become the borrowers of the renovation loans instead of apartment owners. In such arrangement, the building administrators bear direct contractual obligation to repay the loan offered by the Bank. The financial saving on energy consumption is the main contributor to the repayment of the upgrading costs. Such a model shifts the burden of renovation and loan borrowing away from apartment owners. EnerVizija makes use of elements of the existing national program: availability of JESSICA soft loans, 15% State subsidy, and additional 25% subsidy provided by the Climate Change Program, and administrative oversight by the HESA of the Ministry of Environment and CPMA (Central Project Management Agency). Subsidy procedures for low-income persons were also amended to require eligible households to implement a renovation project or risk the possibility to decrease the level of state subsidy from 50% to 0% for heating costs for a period of 3 years. Such provision facilitates renovation decision-making process among low-income apartment owners. These changes accelerate the modernization process in Lithuania from about 70 apartment buildings a year to 490 buildings a year. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 129 Scaling Up Energy Efficiency in Bulgaria and Croatia Delivery Mechanism Implementation arrangement for JESSICA + EnerVizija Model Implementation Arrangement • Project initiation & accountability: Municipalities selected their least efficient buildings based on heating consumption records, initiate EE retrofit in multi-apartment buildings with consent of the homeowners, and appoint building administrators to implement the renovation. The municipalities are made accountable for project implementation. • Designing EE retrofit measures: Professional engineering services provide technical assistance to municipalities in energy audits and design of EE retrofit measures based on cost/benefit analysis. • Loan application: Building administrators are authorized by legislation to take loans on behalf of homeowners from selected financial intermediaries for implementing proposed EE renovation measures. • Renovation undertaking: Building administrators enter into contract with sub-contractors who undertake retrofit work according to the EE retrofit plan. The upgrading of buildings is based on standardized packages of EE measures selected on a cost/benefit basis. Contractual Arrangement • Municipal entity & Apartment Owners: Authorization Agreement is signed between apartment owners and municipal entity to initiate EE retrofit • Municipal entity & Subcontractors: Municipal entity enters into a sub-contract with contractors and engineers to implement EE retrofit measures Procurement Arrangement • Appointed building administrators handle procurement of all works and services according to the Public Procurement Law; • Where possible, procurement is conducted electronically with the electronic catalogue of the Central Procurement Organization (CPO) which have concluded framework agreements with contractors for purchase of standard package of typical multi-apartment buildings renovation works; Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 130 Scaling Up Energy Efficiency in Bulgaria and Croatia • Electronic catalogue streamlines procurement procedures for the renovation works. It also holds true for consulting services including building certification, preparation of renovation design or performance of construction supervision services; • Building Administrators can be assisted by the Commercial Partner in preparation of technical specifications and procurement documents, if necessary; • Procurement of upgrading works will be limited to those EE measures foreseen in the investment projects and eligible for State subsidy. Unless otherwise required by the Municipal Architect, all measures will be selected based on the least-cost principle. Funds Flow • Preparation phase: The preparatory works may include but not limited to energy audit, design of EE measures, and project administration. It can be financed either through a renovation loan or by furnishing invoices to BETA in order to be paid from state funds. • Renovation phase: Building administrator opens a credit line with the UDF; this is aggregated for all investments foreseen within the all buildings concerned. The Building administrator uses the credit line to pay invoices submitted by the relevant contractor(s) during execution of the upgrading works; the Consultant assists the Project Administrator to ensure that all works are correctly implemented and all invoices are accurate. The State grant subsidy is then disbursed to the UDF though the HESA according to factual works performed thereby (also for the Climate Change Programme). The CPMA pays out of its co-financing contribution in respect of the notified completed investment projects in case of INPP region municipality. • The payment declaration must be supported by (a) invoices from the contractor(s) and documents indicating the all works has been completed for the building(s) concerned and (b) Energy Performance Certificates indicating the requisite level of EE after the upgrading has been achieved (not less than Class C). Key financing terms: The typical loan amount per building is €200,000, repayable over 20 years at a fixed interest rate of 3% per annum. Borrowers are also entitled to claim a 15% support —from JESSICA HF, as a loan rebate in a form of an interest subsidy or the state—once the project achieves EE class D (20% reduction in energy costs). An additional 15% grant is provided under the Climate Change Programme, and an additional 10% is provided from state budget for buildings where energy consumption is reduced by 40%. These incentives—combined with average energy savings of 50% or more—have made the renovation program a very viable and attractive proposition for householders in apartment buildings. Managing technical risks (quality control): To control renovation quality, in addition to supervision performed by BETA and State Territorial Planning and Construction Inspectorate, officers appointed by municipalities will also monitor renovation process. The Ministry of Environment has started a separate session of training for the State Territorial Planning and Construction Inspectorate. During these training, newly amended legal framework and particular problems detected in renovation works have been explained to the inspectors. In addition, it is planned to include provisions in construction agreement under which 10%-15% of the construction cost will be withheld for the period of one year and later used to remedy any construction deficiencies. Managing credit risks (loan repayment): Since building administrator is the entity authorized to take loans on behalf of homeowners, it is legally obligated to repay the loan. Building administrator will collect monthly fee (percentage of energy savings from EE retrofit) from homeowners and use that to repay the loan. A portion of apartment owners failed to repay on time, which usually arises during the past repayment periods. It should be foreseen and agreed mechanism how and when the loan repayment can be deferred or extended. Debt service accounts could be used to compensate the payments. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 131 Scaling Up Energy Efficiency in Bulgaria and Croatia Managing procurement risks: Recognizing that there is a lack capacity in the municipal institutions to manage major construction projects, TA by a consultant is provided—in particular for the preparation of technical documentation to be used for procurement of works, contracting, management of upgrading processes and supervision of works. Results • The project pipeline by the end of 2013 reach 1,332 approved projects in 2013. This represented a substantial increase in demand from earlier programs, where only 1,075 multi- apartment buildings were implemented from 1996–2012. Still, these figures together represent only 4% of the 35,000 residential buildings constructed before 1993. • Total investment amounted to €114 million. • Total energy savings reached 82.25 GWh/year (8.22% of the program’s objective of 1,000 GWh year). • Total CO2 reduction equals 20.88 thousand tons/year (9.08% of the program’s objective of 230 thousand tons/year). • The majority of the investments involves external wall insulations (60.4%) and window replacement (10.6%). • The average investment for one apartment is ~€5,800. • The average expenses for 1 square meter heated area is ~€107. • The average investment for refurbishment of 1 multi-family building is ~€290,000. Lessons Direct borrowing by apartment owners, in the case of JESSICA financing, created an administrative burden for FIs. Current legislation provides that administrators or municipal entities can be authorized to take out renovation loans on behalf of apartment owners but for the benefit of apartment owners. Low-income households were not motivated to invest in EE and reduce energy bills. To deal with this issue, on May 16, 2013, the Law on Social Assistance was amended to state that low-income households refusing to participate in renovation could lose 50–100% of subsidies for their energy costs for a period of three years. Some of the borrowers (apartment owners) failed to repay on time, usually during the final repayment periods. To mitigate this issue, this should be foreseen and a mechanism developed to determine how and when the loan repayment should be deferred or extended. Debt service accounts could be used to compensate the payments. Preparing and executing the public procurement process takes time and requires a high degree of competence. The process can be simplified and accelerated via a CPO e-catalogue of centralized procurements under concluded Framework Agreements with potential contractors and consultants. The costs of project preparation, technical supervision and project administration have delayed the implementation of renovation works. Such costs can be covered by renovation loans or presented TA invoices can be paid by HESA from state funds. State institutions and FIs require a lot of documents because the renovation process is complicated. To mitigate this, standard forms have been prepared. Limited capacity of municipal entities or administrators to implement and administer city-wide renovation projects. To mitigate, specific training programs are delivered to municipal entities regarding renovation program implementation. A special software Enervizija IS will be made available to facilitate administration of payments received from apartment owners. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 132 Scaling Up Energy Efficiency in Bulgaria and Croatia One of the major concerns of apartment owners is the quality of renovation work. To mitigate this, along with the supervision functions performed by HESA, State Territorial Planning and Construction Inspectorate officers appointed by municipalities will also monitor renovations. The growing scope of renovations in cities may affect the central heating production and supply system due to the rapid decrease in heat energy consumption. To mitigate this, city-wide renovation programs should be coordinated with heat supply companies in order to allow them to plan required investments in infrastructure. Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 133 Scaling Up Energy Efficiency in Bulgaria and Croatia Residential Buildings Case Study: Poland Thermo-Modernization Program In 1988 Poland introduced a Thermo-Modernization (TM) program to address the financing needs for energy efficiency (EE) investments in existing non-commercial buildings. The TM program provides subsidies for eligible EE projects in order to leverage domestic commercial financing. The subsidy covers up to 20% of the loan amount and is paid once retrofit projects are completed. The first five years into program implementation were unsuccessful. In response, the government streamlined the application process and made the grant resources available earlier, resulting in a rapid uptake. The TM program is administered by the state-owned Bank Gospodarstwa Krajowego (BGK), which is responsible for disbursements of the TM subsidy. A network of 16 banks are participating in this program by providing loans for EE investments on commercial terms. The TM Program supports EE investments in residential, non-commercial and public buildings, as well as local heating networks and heating sources. Accordingly, eligible entities include: homeowner associations (HOA), cooperatives, individuals, commercial companies (but only for non-commercial buildings), municipalities and local authorities. The Program does not support projects that are financed by other state rehabilitation programs, such as the Renovations Bonus and the Compensation Bonus or projects supported by EU funds. Typical EE measures include thermal insulation of walls, roofs, ceiling over unheated basements, replacement of windows, installation of thermostatic valves, insulation of ducts, modernization of domestic hot water installations, and installation of weather-driven controllers. Delivery Mechanism Implementation arrangement for Poland’s Thermo-Modernization Program Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 134 Scaling Up Energy Efficiency in Bulgaria and Croatia Implementation arrangement • Project initiation: EE investors identify energy inefficient residential buildings and initiate EE retrofit. • Designing EE retrofit measures: An energy auditor is hired to conduct energy audit of targeted buildings and design corresponding EE measures. • Loan application: Together with the energy audit report, the EE investors submit a combined loan and TM bonus applications to one of the 16 participating Banks. Then the bank begins to appraise it by conducting standard due diligence, verifying creditworthiness of the applicant and confirming project eligibility for the TM subsidy. Once the appraisal is completed, the participating bank then furnish the whole package to BGK for final review. Subsequently, BGK reviews whole application package and commissions an independent verification of the energy audit submitted. • Renovation undertaking: Once project is approval by BGK, EE loan is disbursed by the participating bank to the borrower (EE investor) to execute the proposed EE retrofit plan measures. Usually EE investor sub-contract the EE retrofit work to a contractor. Upon project completion, BGK disburses the TM bonus to the participating bank to reduce the outstanding principal of the EE loan. The participating bank could also make direct payments to contractors after receiving their invoice. Contractual Arrangement • EE Investor & Energy Auditor: The energy auditor is hired to conduct energy auditing of proposed buildings, design EE retrofit measures and supervise renovation activities; • EE Investor & Contractor: The contractor is hired to implement the EE retrofit plan • BGK & Verifying Institution: A third-party institution is hired to verify the energy audit submitted by the EE investor. It should be noted that no post-renovation energy audit is in place to verify energy savings. Procurement Arrangement 1. Supplies purchase on contractor: Contractor is responsible for securing goods and materials necessary to complete EE retrofit plan 2. Retroactive financing: Contractor will purchase all supplies with internal funds and send invoices directly to the participating banks for reimbursement There are two drawbacks in such a procurement arrangement. First, a direct payment from a participating bank to a contractor means that the burden of procurement oversight rests solely on the bank, which would require a great deal of the bank’s resources if the job is to be done right. Second, retroactive financing requires upfront cost payment by contractors, demanding strong financial position from contractors. Fund flows The total funding needed to implement EE retrofit is sourced from three parts: (a) internal funds from EE investors; (b) commercial loans from participating banks; and (c) TM subsidies. (See Figure C-4). Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 135 Scaling Up Energy Efficiency in Bulgaria and Croatia Figure C-4. Funding sources for project implementation The TM subsidy is 95% funded from the state budget and channeled through the TM program managed by BGK. After approval of the application by BGK, participating banks provide loans on commercial terms with a maximum maturity of 10 years. The grant amount is limited to 20% of the commercial bank loan, but cannot exceed 16% of the total project costs or 200% of the expected annual energy costs savings (based on the verified energy audit). Upon project completion, the TM subsidy is provided directly to the participating bank and passed onto the EE investor as loan forgiveness. Experience on the ground indicates that actual allocation of state budget into TM program is somewhat volatile, due to fiscal constraints as a result of 2008 global financial recession. As a result, it led to a large volume of “on-hold” applications valued totally at over US$50 million in 2010. This implies that stable fiscal conditions are critical to the success of such subsidy program. Results The number of application for the TM subsidy totaled 32,417 as of March 31, 2014. It has grown steadily, starting at only 144 in 1999 and peaking at 4,215 in 2012, but with a significant drop to around 1,500 in 2013 and 2014. Of the total applications, 30,153 applications were approved, for a total value of around US$533 million. (So far, 88% of the subsidies have been disbursed.) The TM program has thus far leveraged US$2.56 billion (4.8 times the value of the subsidy) worth of commercial financing for EE investments, for a total value of over US$3 billion. Most (89%) TM subsidy applications have been submitted by homeowners associations (about 54%) and housing co-operatives (about 35%). The remaining 11% is split between municipalities (5%), individuals (4%) and social housing associations (2%). 93% of TM applications were for EE investments in apartment buildings. This was followed by public utility buildings (4%), detached house (2%) and others (1%). The energy cost savings due to the TM program have been growing at a compound annual growth rate of 29%, from US$33 million in 2005 to US$252 million in 2013. The following are the main results from the period between 1999 and 2012: Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 136 Scaling Up Energy Efficiency in Bulgaria and Croatia • The number of EE projects supported under the program was estimated at 24,130. Based on the share of applications received for multi-family buildings, the program is estimated to have supported EE investments in about 22,199 residential buildings projects. • The total EE investment value catalyzed by the Program is estimated at US$3 billion, of which US$2.3 billion was financed by loans from commercial banks. There are no data available on loan defaults. • The total amount of subsidies granted from the state budget amounted to PLN 1.42 billion (about US$450 million at current US$). • Although the Program does not officially track energy savings and emission reductions achieved, energy savings are estimated at 3,636 GWh/year and emission reduction at 1.399 million tCO2 based on a sample of 150 audits. • Annual average investment costs per MWh are estimate at US$ 783/MWh (at current US$) and average investment cost per MgCO2 at US$ 2,036/MgCO2. • Projects supported under the TM Investments Component of the GEF Project had an average payback period of 18.2 years (based on conservative assumptions) and the economic internal rate of return of the investments was only 0.2%. Lessons Learned • Partial grants are important drivers to kick-start EE in buildings • The Program design has to be flexible and simple • Implementation arrangements through BGK and a broad network of commercial helped to build capacity and strengthen outreach • Challenges related to strong market conditioning on the availability of subsidies Scaling Up Thermal Retrofit of Residential and Public Buildings in Eastern Europe 137 Scaling Up Energy Efficiency in Bulgaria and Croatia References Abosedra, S. and H. Baghestani (1991), “New evidence on the causal relationship between U.S. energy consumption and gross national product,” Journal of Energy and Development 14: 285–92. Bacon R. and M. Kojima (2009), Changes in CO2 Emissions from Energy Use (Washington, DC: World Bank). Bertoldi, Paolo, Paolo, Boza-Kiss Benigna, Panev Strahil, and Labanca Nicola (2013). 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