Yoshiki Ogawa Professor, the Department of Policy Studies, the Faculty of Economics, Toyo University, Japan The 34 th IAEE International Conference, Stockholm,

Analysis on the Role of Energy Service Companies (ESCO) Business

on Energy Saving Activities

Yoshiki Ogawa

Professor, the Department of Policy Studies,

the Faculty of Economics, Toyo University, Japan

The 34th IAEE International Conference, Stockholm, June 22, 2011

ESCO Activities in Japan

Market size:US$12 mil. (5.8%) in 1998 to US$478 mil. (64%) in 2007 ESCO activities in Japan has drastically increased since 2001

ESCO Activities in the United States

ESCO Activities in USA was started in 1970’s and increased in 1990’s Also increased recently due to ESPC (Energy performance service

contract) effectuated again from 2004 and reached to US$4,100 mil

(Source) Reports made by Lawrence Berkeley Lab.

ESCO Activities in People Republic of China

ESCO activities in China was started by 3 large EMCs in 1997 Market size:US$104 mil. (43%) in 2003 to US$1,619 mil. (32%) in 2008 ESCO in China increased drastically in 2006-2008 due to the loan guarantee

Specific Characteristics of ESCO Activities <Japan> ESP: Energy Service Provider (Large size SSC) Market share: SSC+ESP 90%, GSC 10%, number share GSC 61% Small investment=>GSC, large investment, long-term contract=>SSC ESCO in business sector increased recently due to oil price hike No of ESCO enterprises from 16 (beginning) to 121 (now)

<The United States> ESCO in Public sector (local gov., state univ., etc. ) reached to 87% ESCO in private facilities less than 15% (different from in Japan) Almost all ESCO was made by GSC after 1996 Before 25-30% SSC No of ESCO enterprises from 63 (2000) to 40 (now) 12 ESCO 88%

<China> No. of ESCO enterprises from first 3 via 59 (2003) to 454 (now) The numerous smaller ESCO has entered into the market recently ESCO was mainly made by SSC (70%) in buildings GSC in industry Smaller ESCO just sales of saving equipment short recovery yearsSSC: Shared Saving Contract, GSC: Guaranteed Saving Contract

Various Barriers Disturbing Ene-Saving Activities<Viewpoints from microeconomics>(1) Higher risk of investment recovery(2) Imperfect information on energy saving potential(3) Sunk cost difficult to estimate or easy to overlook(4) Individual peculiarity and variety(5) Difficulty in capital arrangement (6) Opposite selection due to asymmetric information(7) Inconsistency of incentives among different players<Viewpoints from behavior theory>(8) Partially ideal behavior due to limited perception and information(9) Force of habits and customs(10) Credibility to options(11) Individual sense of values<Viewpoints from organization theory>(12) Structure of power in the organization(13) Culture different from individual organization

Risk-Profit Simulation of ESCO Activities (1)

<Contract period> 3 years, 5 years, 10 years, and 15 years The longer contract period means the longer recovery time of

investment and the lower profitability

<Type of energy saving activities> Customer’s own manage (S-repair), GSC and SSC GSC: ESCO covers initial 5 years (maximum), guarantee the

performance and get 5% of energy saving money SSC: ESCO covers whole contract period, guarantee the accidents

and the performance and get 49% of total profit

Risk-Profit Simulation of ESCO Activities (2)<Different conditions on barriers > Case 1: Non-risk Assumed no accident and no performance down

Case 2: Existing risks Shutdown by accident: assumed probability 2%/Year Performance 20% down: assumed probability 5%/Year Performance 50% down: assumed probability 3%/Year

Case 3: Existing risks + Asymmetric information SSC: Probabilities are the same as Case 2. GSC: Probabilities changes only in the covering period (max. 5 years) shown bellow After then the same as customer’s own manage Shutdown by accident: assumed probability 3%/Year Performance 20% down: assumed probability 7.5%/Year Performance 50% down: assumed probability 4.5%/Year Customer’s own manage Shutdown by accident: assumed probability 4%/Year Performance 20% down: assumed probability 10%/Year Performance 50% down: assumed probability 6%/Year

Changes in Expected Profits between Non-risk and Existing risks cases

Contract period = 10 years

Changes in Expected Profits between Existing risks and + Anti-symmetric information cases

Contract period = 10 years

Summary of Simulation Results (1)

In the case of existing risks + asymmetric information (Case 3), the customer profit decreases rapidly in customer own manage case and GSC.

Thus, the results suggest that SSC can play a certain role in order to avoid several risks possible to happen and losses due to asymmetric information.

Profit Changes by Contract Period and Type between Non-risk and Existing risks cases

S-repair: Customer’s own manage

Profit Changes by Contract Period and Type between Existing risks and + Anti-symmetric information cases

S-repair: Customer’s own manage

Summary of Simulation Results (2) In the case of the shorter recovery intervals of investment

such as 3 years and 5 years, the profit difference among customer own manage, GSC and SSC is significantly large.

Therefore, SSC could not have advantage in shorter period.

In the case of longer recovery intervals of investment such as 10 years and 15 years, the profitability of energy savings becomes lower and the profit difference among customer own manage, GSC and SSC is not so large.

Therefore, SSC can play an important role on energy savings activities in longer period.

Concluding Remarks We compared saving activities by customer’s own manage, GSC or SSC.

The customer profit decreases more rapidly in customer own manage and GSC than SSC (Case 3) . SSC can play a certain role to avoid some risks and losses due to asymmetric information.

In recent years, GSC has become a main stream in USA. Though SSC has been mainly developed in Japan, GSC will be reconsidered in Japan, because the burden of SSC is too large for ESCO. On the other hand, in Asian countries, especially in China, SSC will play a important role to promote saving activities from now.

In Japan, new systems such as emission trading, domestic CDM etc. is developed to cope with CO2 reductions in smaller businesses, offices and homes. It is important to relate ESCO to these newly developed systems.

We conclude that ESCO will be important for achieving energy saving and reducing CO2 emissions in Japan and Asian Countries. We also need to consider how to remove various barriers for energy saving and how to promote ESCO in Japan and Asian Countries, especially in China.