ENERGY EFFICIENCY: A NEW RESOURCE FOR SUSTAINABLE GROWTH RESEARCHING ENERGY EFFICIENCY PRACTICES AMONG UKRAINIAN COMPANIES

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2 1 ENERGY EFFICIENCY: A NEW RESOURCE FOR SUSTAINABLE GROWTH RESEARCHING ENERGY EFFICIENCY PRACTICES AMONG UKRAINIAN COMPANIES

3 3 Table of Contents Foreword... 4 Executive Summary Introduction Economic background Ukraine s industrial sector The government s role in promoting energy efficiency Ukraine Industry Perspective On Energy Efficiency Importance of energy efficiency Energy efficiency awareness among industrial companies Underestimation of EE potential by Ukrainian companies Current Energy Efficiency Practices Energy costs of production and projects underway Replacing outdated equipment Implementing energy efficiency measures Industry trends in approach to energy efficiency Organizing Energy Efficiency Programs: From Strategy To Implementation Strategy Organizational involvement in energy efficiency planning and implementation Tracking energy use Auditing for energy savings potential Implementation - evaluating equipment upgrades Project Financing Macroeconomic preconditions Investment potential for modernization Payback periods Results And Recommendations Findings Specific recommendations Annex 1. Methodology Of The Survey Annex 2. Overview Of Energy Efficiency Projects By Industry Annex 3. Outdated Energy-Intensive Equipment Across Industries... 49

4 4 Foreword Energy efficiency is an important developmental priority for IFC due to rapidly increasing demand for energy, growing supply constraints, and related concerns over the environmental and health effects of pollution. A significant increase in investments to improve worldwide energy efficiency, estimated at $170 billion annually through 2020, has the potential to reduce global energy demand growth by at least half the equivalent of 64 million barrels of oil per day. 1 Increasing energy efficiency is also critical to reducing greenhouse gas emissions, which in turn is crucial to reversing the effects of climate change. IFC, as part of its mandate to promote sustainable development in the private sector of developing economies, promotes the efficient use of energy in industrial enterprises. The long-term competitiveness of businesses is crucial if the private sector is to continue to grow. Implementing energy efficiency measures that reduce the share of energy costs in the operations of a business can make all the difference in determining its long-term success and viability. This report contains the findings of a survey carried out among Ukrainian enterprises in mid The survey, conducted using a detailed questionnaire and face-to-face interviews with the management of 100 companies, set out to obtain a picture of how industrial enterprises in Ukraine manage and finance energy efficiency improvements. Overall, this report provides information for company managers on how companies value the potential for energy efficiency and on the development potential for energy efficiency in industry (Chapter 2). It also provides information about organizational and administrative approaches for implementing energy efficiency measures (Chapter 3) and existing practices for financing energy efficiency investments (Chapter 4). In addition, the report discusses the opportunities for and benefits of attracting external financing for efficiency projects (Chapter 5). 1 McKinsey Global Institute, February 2008

5 EXECUTIVE SUMMARY 5 Executive Summary The industrial sector is a major contributor to Ukraine s economy, representing nearly a fifth of gross domestic product (GDP) and accounting for 41 percent of the country s primary energy consumption 2. For a country whose exports account for 42 percent of annual GDP 3 competitiveness is critical, and energy efficiency plays an important role. Ukraine is one of the most energy inefficient economies in the world, but has recently set a target of improving energy efficiency by 50 percent by Given the importance of the industrial sector in contributing to Ukraine s energy intensity, we set out to survey 325 enterprises throughout the country, and across several different industrial sectors (including chemicals, building-materials production, food processing, metal-working, and machine-building), on the issue of energy efficiency and understand where the gaps in enabling improvement are. This study aims to evaluate how Ukrainian enterprises perceive energy efficiency, determine which types of energy efficiency projects are implemented, how they finance energy efficiency investments, and raise awareness among industrial enterprises on how to improve their energy efficiency through technical and organizational measures. Generally we found that medium-sized businesses often do not realize the energy efficiency opportunity they have and their capacity to capture it. The information in this report will be of particular interest to equipment suppliers, project developers and policy makers. Also relevant to financial institutions, the report aims to provide unique insight into how industrial enterprises evaluate, plan, finance, and implement energy efficiency measures, and how financial institutions can support clients in unlocking a new lending market. In addition, we look at the current regulatory environment supporting energy efficiency investments and provide some best practice examples for policy improvements Energy Balance for Ukraine, International Energy Agency. Retrieved from balancetable.asp?country_code=ua 3 Data and Statistics for Ukraine, Retrieved from

6 6 EXECUTIVE SUMMARY KEY FINDINGS OF THE SURVEY RESULTS 82 percent of surveyed Ukrainian companies acknowledge the importance of energy efficiency, which is one of the highest ratings in the region, but they underestimate energy efficiency potential by 45 percent Ukrainian businesses spend more on energy than their peers in five other surveyed countries in the region 19 percent of production costs on average 70 percent of the companies interviewed can improve their bottom line by 4 percent; half of these companies can improve by 8-9 percent by further investing in energy efficiency and boosting competitiveness There is an urgent need to develop effective government policy to encourage energy efficiency improvements in the industrial sector which will stimulate investment more than 60 percent Surveyed Ukrainian companies plan to invest $128 million in the short term in energy efficiency improvements; policy makers estimate $6-$7 billion of investments per year through 2015 are needed nationwide Ukraine is one of the most energy intensive countries in the region, consuming 1.3 times more energy per unit of GDP 4 than Russia and around 3.8 times more than European countries. Figure 1. ENERGY INTENSITY OF UKRAINE AND OTHER ECA COUNTRIES Source: World Development Indicators 2006, World Bank. During the last five years the natural gas price has increased fourfold and the electricity price increased times, affecting the competitiveness of Ukrainian enterprises. In order to adjust to these new market conditions, companies can either accept a decline in profitability, or compensate with an increase in prices for their goods and services. Both options will have a negative effect on their competitiveness and improving energy efficiency provides an effective option which reduces exposure to rising energy prices and bolsters competitiveness. 4 in constant 2005 U.S. dollar at purchasing power parity

7 EXECUTIVE SUMMARY 7 ENERGY EFFICIENCY OPPORTUNITIES IN UKRAINIAN INDUSTRIAL SECTOR Surveyed Ukrainian companies are already recognising the importance of energy efficiency. Surveyed enterprises gave one of the highest ratings for the importance of energy efficiency among all six countries surveyed (Armenia, Azerbaijan, Belarus, Georgia, Russia, and Ukraine). 82 percent of companies rated energy efficiency as a business development priority, demonstrating that they see this as key to their business, but these firms have yet to take substantive action to improve the situation. In addition to this high rating, almost 90 percent of companies have already implemented some energy efficiency measures. The majority of the surveyed companies have implemented more than one energy efficiency project simultaneously, but these measures are generally low cost measures with lower impact. The Ukrainian businesses surveyed on average spend more on energy than their peers in any other country that participated in this regional survey on average 19 percent of production costs compared to percent in other countries. But this is not simply a function of high gas and power prices in Georgia, which has even higher energy input costs, energy as a proportion of production costs is actually 6 percent lower. There is a significant blind spot in the potential for energy efficiency. Company managers in the surveyed enterprises underestimate the potential for energy savings by 45 percent, on average, and these are among the highest underestimations among the surveyed countries. By further increasing energy efficiency at their enterprises, industries can save between 4 and 9 percent of their total production costs. These real monetary gains remain untapped, and represent an opportunity for competitiveness that is significantly overlooked. Ukrainian businesses could achieve these savings by replacing outdated equipment which results in high energy consumption. 30 percent of surveyed Ukrainian companies operate outdated energy intensive equipment over 15 years old. BARRIERS TO ENERGY EFFICIENCY IN INDUSTRY Energy audits are underutilized as an investment analysis tool and can be helpful in securing financing sources. Only about 30 percent of the companies surveyed performed energy audits, but those that have conducted audits are more likely to invest in more energy efficiency projects. Companies lack proper energy management practices. Only 45 percent of surveyed companies have division-level metering, and only around 15 percent deploy automated energy metering systems. Less than half of respondents have a developed plan to increase the energy efficiency of their enterprises and less than 19 percent incentivize their staff to save energy through bonuses or fines Ukrainian companies surveyed are not effectively using external financing to gain a competitive advantage through improved energy efficiency. Half the companies interviewed cite a lack of funds as the main reason for not implementing energy efficiency measures, but only 15 percent of respondents applied for external financing, 80 percent of which were successful. There is a need to further improve government policy for stimulating energy efficiency improvements in the industrial sector. Although the Ukrainian government has taken steps to improve the legal framework for fostering energy efficiency and setting a target to reduce GDP energy intensity by 50 percent by 2030, 62 percent of companies surveyed stated that the existing policy framework fails to encourage implementation of energy efficiency

8 8 RECOMMENDATIONS RECOMMENDATIONS Industry Increase awareness: Companies need to be educated about energy efficiency to better estimate areas for improvement and take appropriate action. This applies not just to management but to the whole organization. Training and information campaigns can improve company level awareness of energy efficiency and how it contributes to increasing competitiveness. Conduct energy audits: Companies should more effectively use energy audits, helping them determine the energy cost centers and prepare energy efficiency projects using proper technical and financial analysis. Performing financial analysis with a calculation of monetized energy efficiency gains will help in promoting energy efficiency projects among the management of a company. Improve energy management: Companies should upgrade energy metering systems at their enterprises, and introduce more detailed metering systems for the most energy intensive processes. A systematic approach to energy efficiency is required eg. developing an energy management standard that is integrated with other company processes. An energy management standard requires the following 5 : Management commitment Development of an energy management plan Establishing an energy use baseline Identifying an implementation team and coordinator Development of performance indicators and energy saving targets Ensuring continuous improvement Training employees on procedural/operational changes Use external financing: Ukrainian companies should not miss out on attracting external financing for energy efficiency projects as they have done in the past. Companies that use their own funds to finance improvements limit the choice of energy efficiency measures by the amount available for that investment to the simple low-cost measures, and more complex energy efficiency measures that would yield more energy savings are not usually implemented. Government During the past few years the Ukrainian Government has made some good progress in adopting a number of policies and by taking administrative steps to improve the uptake of energy efficiency in Ukraine. This includes: Reducing subsidies for energy consumption and increasing domestic tariffs on energy; Creation of the National Agency of Ukraine for Efficient Use of Energy Resources (NAER) in 2005 in order to improve coordination of energy efficiency policy, and the creation of a network of energy efficiency departments in various ministries and regional administrations; Ukraine is most recently redoubling efforts to improve by setting the State Target Program on decreasing the GDP energy intensity by 20% by 2015 and 50% by 2030 and creating the Energy Efficiency Action Plan which will focus on: Normative and legal framework for development of energy efficiency and renewable energy Strengthening the efficiency of the energy sector Development of renewable energy resources Strengthening the efficiency of energy transportation, etc. 5 Policies for Promoting Industrial Energy Efficiency in Developing Countries and Transition Economies, UNIDO 2007

9 RECOMMENDATIONS 9 However energy efficiency policy aimed at the industrial sector still needs some improvement: over 60 percent of the surveyed companies stated that the existing policy framework does not encourage implementation of energy efficiency projects, regardless of the policies and measures put in place to date. Information dissemination: It is necessary to develop a state program for the broad dissemination of information on energy efficiency. As noted above, enterprises lack good energy management practices and rarely use external financing for energy efficiency. Such a program should include benchmarking data and a best practice evaluation - proven methods of energy efficiency policy development that help businesses realize existing opportunities. It is necessary to develop and maintain a proper energy consumption database for all sectors of the economy, thus enabling a more targeted approach in the design and implementation of energy efficiency policy measures as well as proper evaluation of progress achieved. Develop policies to promote energy efficiency: These can include: Fiscal incentives for energy efficiency equipment, including accelerated depreciation, tax rebates and tax exemptions Stimulate energy audits for large enterprises, perhaps by providing rebates, incentives or mandating audits for companies above certain levels of energy consumption Energy performance standards for industrial equipment Energy consumption inspections against benchmarked data Facilitate investment in energy efficiency: The Ukrainian government should play an active role in ensuring the availability of long-term financing for energy efficiency through local and international financial institutions. Coordinated effort: NAER should coordinate activities on the development of energy policy with all stakeholder agencies, including state ministries, NGOs, industrial associations and other important stakeholders. Only a well coordinated approach can help Ukraine meet the ambitious target of a 50 percent reduction in the energy intensity of its economy by Greater impact in energy efficiency policy can be achieved through market driven approaches: In many countries, including Ukraine, governments tend to use state subsidy of project cost as the main instrument in energy efficiency policy. A more effective approach is to develop market mechanisms for energy efficiency financing, however. The focus should be on raising awareness to facilitate investments in energy efficiency in those sectors of the economy where the potential for commercially viable improvements in energy efficiency is high, making the implementation of such projects justified. Subsidies are more appropriate in sectors with low financial potential, such as the social sector. Financial Institutions Financing of energy efficiency improvements is an attractive emerging market segment: The investment requirements in energy efficiency are tremendous: according to the state program developed by NAER, the interim target of achieving 20% energy intensity improvements by 2015 will require $6-$7 billion of investment per year. Evidence from other countries shows that establishing a dedicated product for energy efficiency financing brings new businesses to financial institutions and helps build stronger relationships with clients. Financial institutions have a clear opportunity here, and are recommended to: Develop targeted energy efficiency financing products: Priorities include organizing an active marketing campaign for such products, engaging existing and prospective clients, establishing relations with energy auditors and equipment vendors. There are a number of factors contributing to the attractiveness of such products:

10 10 RECOMMENDATIONS Almost 90 percent of surveyed companies are already implementing energy efficiency measures The significant share of outdated equipment indicates future potential: Over 45 percent of companies surveyed operate equipment over 10 years old, while around 15% of companies use equipment for over 25 years Companies plan to invest more and attract external financing (surveyed companies alone plan to invest over $128 million in energy efficiency in the next two years) Energy efficiency financing can be less risky, as the technical risk of equipment performance is lower than market risks. Increasing energy prices further improves the payback of energy efficiency projects Of the range of companies surveyed food industry respondents plan to invest five times more in energy efficiency than during the previous two to three years, while the chemical industry plans to invest double the amount of the last three years Capacity building: Financial institutions should organize training on energy efficiency financing for their staff. This should include: Training for credit officers and risk specialists on both the technical and financial aspects of energy efficiency Training for marketing specialists on developing promotional campaigns and material for new energy efficiency financing products Capacity building with clients: FIs should work with their existing clients on increasing their awareness and understanding of energy efficiency. This should include promotion of energy audits with industrial clients and analysis of possible projects on increasing energy efficiency. FIs should partner with energy auditing companies, who could work with existing and prospective clients and build a pipeline of energy efficiency projects. With this study we aim to: Understand where the gaps are in improving industrial energy efficiency in Ukraine Better inform Ukrainian industry and its managers on where their blind spot is related to energy efficiency and provide a practical guide on how to go about monetizing this opportunity Highlight to financial institutions which industries are most active in making improvements, where the investment opportunities are, and that these investments can have a high level of bankability - specifically what kind of equipment upgrades clients should be seeking and why Provide input to policy makers and government representatives on where the opportunities for investment in energy efficiency are. This will enable policy development to overcome barriers to industry supporting investment in particular industry sectors and equipment so that improved fiscal policies can support the long term goal of energy intensity reduction Implementation of these measures by national authorities, financial institutions, and companies will mobilize the significant resources necessary to increase Ukrainian industry s energy efficiency and improve long-term competitiveness.

11 11 IFC S ROLE IN PROMOTING ENERGY EFFICIENCY Through its targeted advisory services programs IFC works to facilitate further development of energy efficiency in markets throughout the Europe and Central Asia Region by working with private sector companies, industry organizations, financial institutions, sub-national clients and government agencies at various levels. These advisory programs take a programmatic approach by systematically tackling barriers through: Capacity building with various stakeholders within a market or sector area Supporting changes to the regulatory environment to improve the investment climate Improving access to financing IFC has experience in successful development and implementation of the following advisory services products related to energy efficiency: Sustainable Energy Finance works with financial institutions (FIs) to improve access to financing by Small and Medium Enterprises by providing training, tools, best practices and ongoing support to FI clients in building and maintaining a pipeline of potential investments in both energy efficiency and small renewable energy projects Industry Sector Benchmarking, usually as a subset of the Cleaner Production program, helps company managers across a given sector to compare their performance against each other based on a set of criteria (e.g. energy, water, and materials efficiency) and understand where the potential is to implement energy efficiency improvements through the application of best available technologies Residential Energy Efficiency facilitates investments into energy efficient renovations of residential multi-family buildings by creating an effective legal and institutional platform to support condominium associations and housing management companies in obtaining access to finance to improve the energy efficiency of the country s existing housing stock Cleaner Production works directly with industrial, sub-national and agricultural clients to facilitate improvements in operational processes and enable investments to make more efficient use of inputs such as raw materials, energy and water along a company s value chain Carbon Finance helps project developers (in areas including Energy Efficiency, Waste Management and Renewable Energy all of which would qualify under CDM or Joint Implementation) and FIs preparing projects targeted at reducing greenhouse gases (GHG), to monetize emission reduction units and help developers sell those reductions in the carbon trade market. IFC also has unique experience in aggregation of carbon projects, making them more marketable, and also in provision of different types of guarantee mechanisms, facilitating the development of such projects Policy development, including advisory to policy makers on best practices and benchmarking, as well as helping in the development of policy documents, leveraging existing experience gained in developing laws and regulations on energy efficiency in the region

12 12 INTRODUCTION 1. INTRODUCTION Industry is a key contributor to Ukraine s economy, representing nearly one fifth of the nation s overall Gross Domestic Product (GDP), and accounting for 41 percent of the country s primary energy consumption 6. Ukraine is one of the most energy inefficient economies globally, but has recently set a target of improving energy efficiency by 50% by Given the importance of industry in contributing to Ukraine s energy intensity, we set out to survey 325 enterprises throughout the country, and across several different industrial sectors, on the issue of energy efficiency to understand where the gaps in enabling improvements are. This study aims to evaluate how Ukrainian enterprises perceive energy efficiency, determine which kinds of energy efficiency projects are implemented, how they finance energy efficiency investments, and to raise awareness among industrial enterprises about how to improve their energy efficiency. The information in this report will be of particular interest to equipment suppliers, project developers and policy makers. Also relevant to financial institutions, this report aims to provide unique insight into how industrial enterprises evaluate, plan, finance, and implement energy efficiency measures, and how financial institutions can support clients in unlocking a new lending market. However, gains in energy efficiency are related not just to the perceptions of company management and their investment plans for improvements. They are also closely linked to macroeconomic factors such as overall economic conditions and trends, utilization of existing production capacity, energy pricing, and the regulatory environment Economic background Since 2000, Ukraine has benefited from steady economic growth. Its GDP grew at over seven percent per year on average between 2000 and Ukraine s nominal GDP per capita in 2007 was $3, A number of factors explain the sustained growth over this period. Increasing global demand for steel, chemical products, and agricultural commodities utilized production capacities of steel and chemical manufacturers and agricultural companies. As a result, proceeds from this increase in exports brought a corresponding rise in disposable income for the wider Ukrainian population, fuelling domestic consumption. Internal demand then became a factor in driving economic growth. Moreover, starting from 2000, the share of less energy-intensive industries such as food processing and the service sector expanded, contributing to further economic growth. Low energy prices, notably natural gas, also played an important role in contributing to economic growth. Until 2005, Ukraine was importing natural gas at $50 per 1,000 cubic meters compared to the $210 average hub price in Europe for Other energy resources such as electricity and coal were priced in relation to natural gas. Energy prices overall started to increase in 2005, when the import price for natural gas increased. Between 2005 and 2009, the price of natural gas for industrial consumers increased almost fourfold. Electricity prices followed a similar trend, and prices were times higher in 2009 than in Energy Balance for Ukraine, International Energy Agency. Retrieved from balancetable.asp?country_code=ua 7 As of January 1, State Committee for Statistics. 8 BP Statistical Review of World Energy 2009

13 INTRODUCTION 13 Figure 2. NATURAL GAS AND ELECTRICITY PRICES IN UKRAINE Natural gas represents 32% of industrial energy supply the largest fuel source for industry in Ukraine Source: World Bank, Government of Ukraine, BP Statistical Review of World Energy Source: National Electricity Regulatory Commission of Ukraine Although the natural gas tariff for industrial sectors is not generally subsidized, individual industrial sectors (including chemical industries that use natural gas as raw material, producers of nitrogen fertilizers, some mining and metallurgical firms, and enterprises that use gas for processing sugar beets) do receive natural gas price subsidies. Subsidized energy tariffs provide a disincentive for implementation of energy efficiency measures because of the long payback period from energy savings, however. Despite a 30 percent reduction in energy intensity, an increased use of production capacity between 1995 and 2006, and steep trends in increasing energy costs, Ukraine remains one of the most energy-intensive economies in the world.

14 14 INTRODUCTION Figure 3. ENERGY INTENSITY OF SELECTED COUNTRIES ( ) Source: US Energy Information Administration Today, Ukraine remains one of the most energy intensive countries in the region, consuming 1.3 times more energy per unit of GDP than in Russia 9. The competitiveness of many Ukrainian companies is at the mercy of energy costs, which can be significantly reduced by improving energy efficiency. Ukraine thus faces a considerable challenge: as energy prices continue to converge with those in European markets, the competitiveness of its economy will suffer if its energy intensity remains at current levels.. This is particularly important for an economy in which 42% of GDP annually relies on exports 10, and the strength of which largely relies on its success in competing with other international manufacturers. 9 per constant 2005 U.S. dollar at purchasing power parity 10 Data and Statistics for Ukraine, Retrieved from

15 INTRODUCTION 15 Box 1: Ukraine and the global financial crisis The global financial crisis began to affect Ukraine in October 2008, and has had a substantial impact on its financial sector. The faltering global economy has caused a dramatic slowdown in demand for Ukrainian exports of steel products, one of the main drivers of Ukraine s economic growth. This, and the instability in the financial sector, poses challenges for domestic demand, the other key pillar of Ukraine s recent economic growth. In the context of weak demand on both the domestic and international markets, the medium-term prospects of Ukraine s industrial companies will depend on the extent to which they are able to compete in an environment in which prices for their goods will be a critical element in purchasing decisions by potential customers. The crisis is currently subsiding in Ukraine and both industry and the financial sector are recovering. In this respect, greater attention to energy efficiency will benefit the whole economy by increasing the competitiveness of companies and helping financial institutions by creating a new market opportunity for their products. Nonetheless, energy efficiency is a critical factor in Ukraine s recovery from the crisis.

16 16 INTRODUCTION 1.2. Ukraine s industrial sector Ukrainian industry is the largest energy user in the country, consuming around 41 percent of total energy consumption 11. This is due to the large share of heavy industry in the sector (e.g. mining, metal-processing), which uses highly energy intensive equipment. The following chart represents the main types of fuel energy resources used in Ukrainian industry. Figure 4. ENERGY CONSUMPTION MIX IN UKRAINIAN INDUSTRY 12 Ukrainian industrial sector is the largest energy user in the country, consuming around 41 percent of the total energy consumption in the country Figure 4 shows that Ukrainian industry relies heavily on coal and natural gas. Again taking note of increasing fuel prices, 50 percent of Ukrainian industry is reliant on sources whose price has increased percent on average over the last five years. In addition, improvements in coal and natural gas consumption represent the greatest opportunity for energy efficiency, particularly taking into account the potential for decreasing emissions of greenhouse gases (GHG). Decreased GHG emissions can serve as an additional source of cash flow through carbon finance mechanisms for companies, contributing to a faster payback of energy efficiency projects. Taking into account the high energy intensity of Ukrainian industry, it is important to understand the current trends, gaps and barriers to implementation of energy efficiency projects among small and medium sized enterprises in Ukraine. The manufacturing industry, which grew by 10 percent per year on average between 1997 and 2007, accounts for 18 percent of Ukraine s gross domestic product. This sector therefore represents an important factor in Ukraine meeting its long term target of a 50 percent improvement in energy intensity by The survey was conducted across five sectors of Ukrainian industry: food, chemicals, building materials, metals processing and machine building. These are generally highly energy intensive industries with significant energy saving potential. The selection of respondents for the survey focused on the main industrial sectors in Ukraine specifically, 14 and 17 percent of total respondents were from the food and metals industries, respectively. Similarly, 49 percent of total respondents were from medium-sized companies, which represent a large proportion of Ukrainian industrial enterprises. Annex 1 outlines the main characteristics of the survey and respondents, including annual turnover, staff count, etc, which formed basis for this report Energy Balance for Ukraine, International Energy Agency. Retrieved from balancetable.asp?country_code=ua Energy Balance for Ukraine, International Energy Agency. Retrieved from balancetable.asp?country_code=ua 13 For the purposes of this report, we divided companies into four categories according to turnover: 1) small companies with an annual turnover of up to $1 million, 2) medium companies with an annual turnover of $1 million-$5 million, 3) medium-large companies with an annual turnover of $5 million-$25 million, and 4) large companies with an annual turnover in excess of $25 million. The exchange rate applied in this report is $1=5.1 HYR

17 INTRODUCTION 17 Figure 5. UKRAINIAN INDUSTRY COMPOSITION (2007) 14 by contribution to GDP 1.3. The government s role in promoting energy efficiency Government policies can be instrumental in improving national economies overall energy efficiency, as well as stimulating investments at the company level. Policymakers have a wide range of instruments they can employ as they seek to reduce industrial energy consumption. These instruments are usually a combination of administrative or financial measures, set out as laws and executive decisions made by national, regional and local government agencies. Taken as a whole, they provide the legal framework for promoting greater energy efficiency. The effectiveness of these instruments, i.e. the reduction in the amount of energy consumed per unit of output, relies upon whether the measures are properly designed, funded, and appropriately enforced. Although the Ukrainian Government passed the Law on Energy Conservation in 1994, no policy instruments were developed to facilitate the implementation of energy efficiency measures or stimulate investment. In 1995 the Agency on Efficient Energy Use was established, but no steps were taken towards increasing the energy efficiency of the economy. In 1996, the Ukrainian government developed an Energy Efficiency Program, outlining a strategy of decreasing energy consumption in the industrial, energy and housing sectors by increasing energy efficiency. In its 2006 Energy Strategy to 2030, the government set a target of improving Ukraine s energy intensity by 50% by However, neither the 1996 Energy Efficiency Program, nor the 2006 Energy Strategy was successful due to a lack of adequate policy instruments and an enforceable energy efficiency improvement action plan. In 2005 the Agency was closed and the National Agency of Ukraine for Efficient Use of Energy Resources (NAER) was established. Although the new Agency has initiated a number of legislative acts aimed at reduction of energy consumption and promotion of energy efficient technologies which were approved or amended recently by the Government, the new and improved legislation is still purely declarative. According to the state targeted program developed by NAER, the GDP energy intensity of Ukraine should be decreased by 20% by 2015, requiring $6-$7 billion of investment per year. The longer term target is to reduce the GDP energy intensity ratio by 50% by In recent years some measures aimed at liberalization of energy price formation and the application of a competition price mechanism, as well as the creation of a legal environment for energy market development, have already been implemented. Additionally, the Ukrainian government recently developed appliance standards, created 14 Volume of industrial products (operations and services) sold in

18 18 INTRODUCTION a network of energy efficiency departments within various ministries and regional administrations, and took steps to improve the efficiency of vehicles and passenger transportation, which were relatively successful. At the same time energy subsidies, which actually hinder energy efficiency, were implemented in addition to policies such as normative energy use in industry with fines for noncompliance which were too low to be effective. Of the companies we surveyed, 37 percent had paid fines for excessive energy consumption. The average amount of each fine was about $1700 and represents 0.2 percent of the average energy costs per company. This is an extremely low amount that does little to discourage companies from excessive energy consumption. The Energy Efficiency National Action Plan has been under development since 2009, and will focus on the following areas: A normative and legal framework for development of energy efficiency and renewable energy Capacity building among governmental agencies Strengthening the efficiency of the energy sector Development of renewable energy resources Utilization of coal mine methane of as an alternative fuel Strengthening the efficiency of energy transportation (natural gas, transmission lines, heat) Increasing the energy efficiency of economic sectors Mobilizing renewable and conventional energy resources About two thirds of the surveyed companies said that the government does not effectively stimulate energy efficiency investment. The draft Action Plan contains a list of 13 normative and legal documents that should be developed. As part of this survey, companies were asked about the extent to which the existing legal framework promotes greater energy efficiency. Only 38 percent of companies said it stimulates implementation of energy efficiency measures. We also asked managers what policies they thought would promote energy efficiency in their companies. Figure 6. POLICY MEASURES FOR PROMOTING ENERGY EFFICIENCY (percentage of respondents) Which policy measures would stimulate energy efficiency projects at your company?

19 INTRODUCTION 19 Given the current legal framework in Ukraine, the following measures will more effectively promote industrial energy efficiency 15 : Better dissemination of information on energy efficiency: The Ukrainian government can create a program broadly and effectively to disseminate information about energy efficiency. Such a program will help Ukrainian companies realize their energy savings potential. Dissemination campaigns make information about energy efficiency investments more readily accessible and useful to industrial companies. It is important to include the following information in such dissemination programs: Benchmarking data to allow for sector wide comparisons of specific energy consumption Best practice evaluation to allow companies to identify their energy savings potential Model action plans and industrial equipment energy efficiency labeling information (if available) to show companies how they can best invest in energy efficiency, and Pilot projects with proven financial opportunities for energy efficient investments to show companies that they can acquire external financing for EE projects Facilitation of financing for energy efficiency investments through financial infacilitation of financing for energy efficiency investments through financial institutions: The Ukrainian government can play a more active role in ensuring access to long-term capital through development institutions. Development banks can allocate long-term credit lines dedicated to energy efficiency investments to Ukrainian financial institutions. This model has been tested in a number of countries, including Russia, by the IFC and EBRD, and has proven to be successful. Development of energy performance standards and labels for industrial equipment: The development of energy performance standards and labels for industrial equipment will help companies identify how to invest most effectively and will promote the use of more efficient equipment. In other countries, one of the most cost-effective methods for increasing energy efficiency at industrial companies has been to establish energy efficiency standards for industrial motors, power pumps, compressors, fans and other generic machinery. Currently energy performance standards for motors have been adopted in over 30 countries. It is essential to make a clear distinction between energy efficiency standards for equipment and a standard or norm for specific energy consumption. Equipment standards have proved to be an effective instrument in promoting energy efficiency in many countries, and can be valuable in Ukraine. However, a mandatory standard for specific energy consumption is likely to be a complicated measure with limited effect. Due to objective factors, specific energy consumption can vary significantly even for generic products. Many enterprises produce multiple products using the same equipment, and will not be able to attribute the consumed energy across a variety of products. In addition, an energy consumption standard will not incentivize companies to improve beyond the established norm. Fiscal incentives: Fiscal incentives in the form of tax relief can be an effective long-term measure to increase the attractiveness of energy efficiency investments. There are the three main forms of providing tax relief for purchasing energy efficient equipment: Accelerated depreciation improves companies cash flows by allowing for a faster write off of the cost of equipment against their taxable profit Tax rebates allow investors to deduct part of the equipment costs from profits Tax exemptions typically reduce or eliminate customs taxes on energy efficient equipment. 15 Energy Efficiency in Russia: Untapped Reserves, WB/IFC 2009

20 20 INTRODUCTION The tax relief approach has frequently been criticized for three reasons. First, it fails to stimulate small investments, which can be the most cost-effective energy savings measures. Second, it does not encourage changes in energy consumption behavior that can lead to substantial energy savings. As a result, additional government intervention is required to stimulate these no cost-low cost measures. Third, a substantial number of investors might have implemented the project anyway without any subsidy. For example, evaluation of the Dutch Energy Investment Deduction program concluded that 45 percent of surveyed participants would have made a purchase without a subsidy. Therefore, it is recommended that the list of eligible technologies be carefully selected based upon stringent eligibility criteria so that incentives are only provided to the most efficient equipment. International experience shows that tax relief for specific energy efficient equipment creates incentives for all relevant market participants. These programs typically reach a large number of entities and are less likely to discriminate unfairly between potential participants. The box below shows examples of successful tax relief policies in other countries. Many countries, including Ukraine, tend to use state subsidies of project costs as the main instrument in energy efficiency policy. This measure has a number of negative effects: 1) It is not a sustainable measure, as international experience shows that there is a sharp drop in demand for energy efficient equipment and technologies immediately after the elimination of subsidies; 2) There is a problem of free-riders companies that would have implemented these measures even without the subsidy, as a result of which the subsidy does not play a genuine stimulating role; 3) Subsidies do not stimulate development of energy efficient thinking and culture. It is more effective to develop market mechanisms for energy efficiency financing. Increasing awareness will facilitate investments in energy efficiency in those sectors of economy where the ratio of financial potential in energy efficiency is high relative to technical potential, making implementation of such projects justified. Subsidies are more applicable in sectors with low financial potential, such as the social sector, where the government deals with public benefits. Box 2: International results from tax relief policies UK: The British government introduced the 100 percent first-year Enhanced Capital Allowances program in This measure has resulted in energy efficient and environmentally friendly investments in 7000 equipment units totaling over 3 billion. Japan: The Energy Conservation and Recycling Assistance Law established accelerated depreciation for energy efficient equipment and led to the installation of approximately 25,000 pieces of equipment each year from 1996 to The Netherlands: The Danish Government introduced the Energy Investment Deduction program in Firms investing in energy savings could apply for tax deductions for eligible technology. Over 10,000 applicants benefited from 430 million of investments during the first year of the program s implementation. Participation in the program peaked in 2001, when over 28,000 applications representing over 1 billion in claims were filed. Sources: Tax and Fiscal Policies for Promotion of Industrial Energy Efficiency: A Survey of International Experience Lynn Price, Christina Galitsky, Jonathan Sinton Ernest Orlando Lawrence Berkeley National Laboratory Berkeley, 2005 Payable enhanced capital allowances HM Treasury, 2007 Effectiveness of Subsidizing Energy Saving Technologies: Evidence from Dutch Panel Data, Aalbers, R.F.T., de Groot, H.L.F., Vollebergh, H.R.J., 2004 Ukraine s recent steps in setting long-term energy efficiency improvement targets and establishing the National Action Plan are important moves toward improving EE. However it is also important that the Government of Ukraine take an active role in enhancing support for private sector investment in energy efficiency in order to make tangible gains through initiatives such as performance standards, fiscal incentives and raising of awareness.

21 UKRAINE INDUSTRY PERSPECTIVE ON ENERGY EFFICIENCY UKRAINE INDUSTRY PERSPECTIVE ON ENERGY EFFICIENCY 2.1 Importance of energy efficiency In the last chapter we highlighted the importance of awareness raising related to energy efficiency, to encourage SMEs to make investments in improvement. Our study shows that the issue of energy consumption is indeed important to Ukrainian company managers; half of the managers interviewed for this survey confirmed that energy efficiency is one of the three main priorities for their enterprises. The majority of surveyed managers believe that they have a reasonable understanding of their companies energy expenses. Most of them also believe that they know which measures should be implemented to increase their companies energy efficiency. Nonetheless, the fact that 50 percent of the management teams of the companies surveyed do not clearly proclaim energy efficiency to be one of the company s top priorities implies that a significant share of industrial enterprises do not recognize the link between energy efficiency and improving or maintaining competitiveness. This highlights the need to raise awareness about the benefits of energy efficiency by disseminating information about industrial energy efficiency technologies, benchmarks, best available technologies, and payback related to investments in energy efficiency measures. We looked into why improving energy efficiency is relevant to Ukrainian companies, and energy costs were the most commonly cited reason (55 percent of respondents). Increasing competitiveness by decreasing the share of energy costs in total operating costs and improving the reliability of energy supplies (31 percent and 25 percent of respondents respectively) are the other two top reasons why enterprises consider improving energy efficiency to be important. Figure 7. RELEVANCE OF IMPROVING ENERGY EFFICIENCY (percentage of respondents)

22 22 UKRAINE INDUSTRY PERSPECTIVE ON ENERGY EFFICIENCY 2.2. Energy efficiency awareness among industrial companies In addition to benchmarking their company s performance, including energy efficiency, against similar companies within the industry, company managers should be equipped with information related to their company s specific energy usage and evaluate the potential benefits of greater energy efficiency. The majority of the surveyed company managers stated that they have exact information on their companies energy expenses, and most of them also believe that they know which measures should be implemented in order to increase energy efficiency at their companies. Company managers claim to be well informed about energy efficiency measures despite the fact that only 37 percent of surveyed companies implemented energy audits at their facilities in Figure 8. MANAGEMENT AWARENESS (percentage of respondents) 2.3. Underestimation of EE potential by Ukrainian companies In Ukraine, company managers lack a thorough understanding of the savings potential of energy efficiency measures. Company managers of surveyed enterprises underestimated savings potential by 45 percent on average; particularly in crisis conditions and increasing energy costs, energy efficiency represents a tangible resource for sustained growth and competitiveness for Ukrainian industry. In the UK, for example, savings can be benchmarked as high as 30 percent for compressed air and around 20 percent for heating.