Surrogate Metrics
to Evaluate the
Creditworthiness of SMEs for
Industrial Energy Efficiency
Finance
Sharing best practices
for the low carbon future
iipnetwork.org
Surrogate Metrics to Evaluate the
Creditworthiness of SMEs for Industrial
Energy Efficiency Finance
MAY 02, 2012
Authored by:
David Lee Hendrix, Dao Partners
Ray Cheung, Dao Partners
Disclaimer: This paper has been submitted for the eceee Summer Workshop on Industrial Energy Efficiency, 2012.
© Institue for Industrial Productivity, 2012. No reproduction, translation or other use of this publication, or any portion thereof, may be made without prior written permission.
Institute for Industrial Productivity
Promoting Energy Savings and GHG Mitigation Through Industrial Supply Chain Initiatives
The Institute for Industrial Productivity (IIP) provides companies
and governments with the best energy efficiency practices to
reduce energy costs and prepare for a low carbon future. Our global
team and independent experts offer an integrated service package
comprising technology, policy and financing components.
We are the partner of choice for companies and governments—whether the need
is best practice information or a tailored approach to implementing an initiative.
The Institute for Industrial Productivity works across the globe with a near-term focus on China, India, and
the USA to ensure industrial stakeholders have access to the most effective energy efficiency technology,
policy and financing approaches. We do this by:
sharing best practices and providing access to a network of international experts;
ll developing original research, analysis and databases; and
ll bridging the gap between government policy and industry implementation.
ll Companies, industry associations and governments can leverage our expertise to
achieve their goals.
Many companies, industry associations, and governments are aware that increasing energy efficiency cuts
costs and helps achieve sustainable economic growth, and they establish goals to boost energy productivity.
The Institute for Industrial Productivity helps these organizations understand which technologies, policies and
financing options will help them achieve their vision. Our integrated technology, policy and financing model
and our broad network of experts makes us the partner of choice for governments, and companies that share
our goal of competitive industries through a low carbon future. The Institute for Industrial Productivity is a
nonprofit organization independently funded by the ClimateWorks Foundation, serving as its Best Practice
Network partner for the industrial sector.
3
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Abstract
This study introduces innovative credit risk analysis techniques for the assessment of the financial strength
and viability of industrial small and medium enterprises (SME) seeking finance for green technologies. By
applying the techniques to an actual SME this study will demonstrate the viability of prudent actionable
measures to increasethe availability of energy efficiency finance for industrial SMEs in China.
Objective:
Propose a qualitative and quantitative framework for credit risk analysis, fundingstructure, and credit risk
management for the financing of Chinese industrial energy efficiency (EE) projects for small and medium
enterprises (SMEs), to allow underwriters to obviate or attenuate their reliance on audited financial
statements and lessen dependence on the financial sophistication of entrepreneurs and owners when
making credit decisions.
Audience:
Credit and finance officers, within banks and solution suppliers, who are seeking to finance China’s
industrial EE sector.
Intended Outcome:
Stimulate finance to credit-worthy EE projects in the Chinese industrial SME sector that will lead to
significant reductions in greenhouse gas emissions.
4
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Table of Contents
Abstract
4
7
7
7
China’s Industrial Energy Efficiency and SMEs
Opportunity: Policy Support of EE for Chinese SMEs and Energy Performance Contracts
The Challenge – SMEs Lack of Access to Credit and Limited Access to EE Financing
Credit and Performance Risks for SME Energy Finance
Credit Analysis for Energy Efficiency Finance
Credit Analysis for SMEs
Quantitative Metrics for SME EE Finance Credit and Performance Risks
Qualitative Metrics for SME EE Finance Credit and Performance Risks
Credit Risk Management for SME EE Finances
9
9
12
13
15
16
Case Study – EPC Contract with SME Petrochemical Refinery
18
Appendix
Appendix A: Chinese Government Objectives and Policies
Appendix B: Potential Energy Efficiency Gains in SMEs
Appendix C: Chinese Government Strategies to Achieve Energy Efficiency
Appendix D: Financing Resources for Energy Efficiency and SMEs
24
24
24
26
26
References
27
5
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
List of Figures & Tables
Exhibit 1: Chinese SME Access to Borrowing
7
Exhibit 2: Principles of Credit Analysis: The Three “C’s” – Character, Capacity, and Collateral
10
Exhibit 3: Key Indicators for the Three C’s of Energy Efficiency Finance
11
Exhibit 4: Credit Analysis Challenges Facing Lenders and SMEs
12
Exhibit 5: Key Quantitative Financial Performance Metrics
14
Exhibit 6: Examples of Key Quantitative Financial Performance Ratios
15
Exhibit 7: EPC Credit Risk Management Measures
16
Exhibit 8: Key Case Study Financials
18
Exhibit 9: Case Study Energy Savings / Capacity/ Cash Flow
18
Exhibit 10: Case Study Financial Proxy Information
19
Exhibit 11: Case Study Financial Details
20
Exhibit 12: Case Study Qualitative Credit and Performance Risks Analysis System
20
Exhibit 13: Case Study Credit and Performance Risk Metric Scores
21
Exhibit 14: Case Study EMC Credit Policy Example
22
Exhibit 15: Case Study Qualitative Credit and Performance Risks Analysis
22
Exhibit 16: Case Study Qualitative Credit and Performance Risks Analysis
22
Exhibit 17: Case Study Forecasted Cash Flow and Revenue from EPC Contract based on Credit Policy
23
Exhibit 18: Potential Energy Efficiency Gains
24
Exhibit 19: Energy Consumption Levels of Small Energy Intensive Industries in China
25
Exhibit 20: Market Value for Energy Savings in SMEs
25
6
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
China’s Industrial Energy Efficiency and SMEs
Opportunity: Policy Support of EE for Chinese SMEs and
Energy Performance Contracts
at both the central and local government levels. Thus, the use
of EPCs has a major part to play in financing industrial SME EE
improvements.
Improvement in the energy efficiency of China’s industrial sector
is one of the Chinese government’s top economic development
priorities. As part of its 12th Five-Year-plan (FYP), 2011-2015,
the State Council – China’s highest government entity – has
set as a national goal the reduction of energy intensity (energy
consumption per unit of GDP) by 16%.
The Challenge – SMEs Lack of Access to Credit and
Limited Access to EE Financing
In China as in many other emerging markets, SMEs chronically
lack access to traditional forms of finance because of their real
and perceived credit, operational and marketing risks. In addition,
SMEs often lack strong and transparent corporate governance
systems and financial reporting mechanisms. Many are young
companies without a credit history. The entrepreneur/owners
often intermingle personal and company finances. Chinese
SMEs have higher rates of bankruptcy than larger firms, often
attributable to the lack of access to the bank credit necessary
for the firm to achieve business and financial stability. Chinese
government statistics report that the average life cycle of a
Chinese SME is only 3 years.
In terms of industry size, the Chinese government has made
improving the energy efficiency of small and medium-sized
enterprises (SMEs) a top priority1. The Ministry of Industry and
Information Technology (MIIT) is requiring that Chinese SMEs
reduce their energy consumption by 25% by 2015. The rules
target SMEs in China’s key industries, including steel, nonferrous, metals, construction materials, petrochemical, paper and
printing. Firms that continue to operate in a polluting manner will
face economic sanctions, including the possibility of closure. The
action is significant given that there over 450,000 SMEs in the
industrial sector with a gross domestic product of over RMB46
trillion/US$7.3 trillion – accounting for close to 70% of China’s
industrial production.2
As a result, SMEs are perceived by banks to represent high
repayment risks, and notwithstanding their role in the economy,
less than 25% of Chinese SMEs have access to bank finance.
Without support from banks or other participants in the formal
financial system, SMEs must rely on informal, extremely
expensive, channels to finance their operations.
A key facet of China’s industrial energy efficiency strategy is to
encourage the use of energy performance contracts (EPCs) –
also known as energy management contracts (EMCs). EPCs
encompass performance-based engineering, procurement,
construction (EPC) and financing. Under the terms of an EPC,
a vendor of energy efficiency services and technologies accepts
the cash savings generated by energy-efficient upgrades
of the host’s facility as payment for the energy efficiency
improvements. Firms that provide EPCs are known as energy
service companies (ESCOs). In the “12th FYP Energy Saving
and Emission Reduction Work Plan”, the Chinese government
specifically states that it will strengthen its support of EPCs and
ESCOS by implementing new fiscal, tax, and financial incentives,
Exhibit 1: Chinese SME Access to Borrowing
100%
Bank & Informal
80%
Bank Finance
60%
Non-SME
SME
Informal Finance
No Credit
40%
20%
0%
1 The Chinese government defines Industrial SMEs as enterprises with less
than 1,000 employees and/or total annual sales of less than RMB400 million/
US$63 million.
2 Department Ministry of Industry and Information Technology of the People’s
Republic of China, “Directive on Strengthening the Energy Efficiency of Small and
Medium Enterprises, 2010.
This lack of credit severely limits the financing of industrial SME
energy efficiency (EE) projects by both the host and vendors.
7
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
of capital and support the scaling up of energy efficiency
improvements in the SME industrial sector in a manner that
generates attractive and acceptable risk-adjusted commercial
returns.
Since the typical industrial SME user lacks access to credit, it
will be unable to finance energy efficiency improvements to its
facilities. Moreover, most ESCOs are themselves SMEs. Given
its limited equity, the SME ESCO lacks the necessary capital
and administrative support infrastructure to provide financing of
EPC contracts with SME industry segments.
An additional challenge for banks is that many EE technologies
are new to the market and are often supplied by new cleantechnology companies. Banks are unsure whether these new
firms can deliver the energy savings required to provide the cash
flows to make the EPC payments. In addition, the monitoring
and verification of the actual EE benefits to the user continues
to be major challenge for EPC contracts. Such risks add
additional uncertainty for banks during the assessment of the
credit-worthiness of the Industrial SME EE projects.
In addition, the capacity of Chinese banks to provide EE finance
is often constrained by the lack a dedicated department to
review EE credit proposals. Thus, only a limited number of
banks have the ability to accurately assess and analyze the
creditworthiness of EE industrial SME projects. Often the
relatively high cost-to-serve dynamic (high transaction costs)
of SME lending can be more of a deterrent than collection and
loss concerns. By adopting new tools and techniques, banks
and ESCOs will accelerate the more efficient deployment
8
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Credit and Performance Risks for SME Energy Finance
In the face of such substantial opportunities and challenges,
banks and ESCOs need to develop new methods, as well as
adopt techniques successfully employed in other emerging
markets to assess and manage credit risks for Industrial SME
EE projects. While there is no substitute for rigorous financial
analysis, credit providers for EE projects − whether banks,
equipment vendors, or ESCOs − need to develop sound, prudent
and complementary alternative approaches to accurately assess
the credit and performance risks in a cost efficient manner.1
EPC contracts are, in function, similar to a capital lease or
finance lease – a type of asset-based finance, in which the
lessee seeks to acquire the right to use a cash-generating asset,
paying the asset’s owner for that use. The lessee has the right
to use and, depending on the type of lease, to purchase the
asset, during the lease period for as long as the lessee makes
the required payments (also known as rentals). During the lease
period, the lessor will recover a large part or all of the cost of the
asset, plus interest from the rentals paid by the lessee.
Under the terms of the EPC contract, the capital used to finance
the EE equipment is advanced as a loan, based on the ability of
the EE-host to generate or free up cash from the energy savings
to service the loan. The future energy savings are pledged to
securitize the EPC contract. Thus, credit analysis for energy
efficiency projects require the same analytical processes and
procedures as do capital leases.
Credit Analysis for Energy Efficiency Finance
The salient features of credit analysis for energy efficiency
finance are similar to those associated with asset-based or
project finance, in which the funds are provided to the borrower
based on his ability to use the assets or technologies purchased
to generate additional revenue or realize genuine cost savings,
which can then be deployed to repay the loan. In a very real
sense, the “asset” provides both the “first” and “second” way for
the financier (see “Principals of Credit Analysis” box, below). The
future-cash flows – also known as the receivables – from the
asset’s deployment are pledged to securitize the loan.
The following tables provide an overview of the basic criteria that
can be used to assess the credit-worthiness of an SME seeking
financial support, as well as an overview of how those criteria
can provide important context for financial decision-making by
lenders.
1 The mechanisms and processes proposed here focus only on the analysis and
management of the credit and performance risks posed by the Industrial EE SME
user. The case study assumes that there is no technology risk, i.e., the EE service
and technology, once deployed, will reliably deliver the projected energy savings.
In addition, the case study assumes that the ESCO and the user have agreed
upon the monitoring and verification of the energy savings from the EE project.
9
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Exhibit 2: Principles of Credit Analysis: The Three “C’s” – Character, Capacity, and Collateral
to generate cash, in both positive and negative scenarios,
such as cyclical economic downturns (stress tests).
The fundamentals of credit analysis strive to assess
the borrower’s character, capacity, and, collateral – also
known as the three C’s. Each of these “C’s” represents a
key determinant in the evaluation, and forecasting of the
borrower’s future credit and operational performance, as well
as of structure and pricing (risk weighted) of outstanding
balances.
Cash Flow: The borrower’s revenue or expense stream
that converts into cash over a given period and may be
used to service debt and loan obligations.
ll Cash and Asset conversion cycles: The time period it
takes for the borrower to convert its resource inputs into
cash for the company.
ll Character
Character is a borrower’s willingness to pay debts according
to agreed and committed terms. This is determined by an
assessment of the borrower’s current and past business
performance, repayment history and its reputation within the
industry, as well as the nature and viability of the industry or
sector itself within the macro economy.
Collateral
The borrower’s collateral is the insurance to the lender that
the debt will be paid back in the event that the cash flows
are insufficient. This is known as the “second way out”,
in which the lender has legal recourse to collect its funds
from the borrower’s assets, which can include property,
equipment and cash. In the case of project finance, in which
the “first way out” is the success of the project, a fixed and
floating charge – assets that are used to securitized the
debt - may be taken over all assets, shares of the company
pledged and cash flows assigned.
Credit history of the company and principals: The record of
an individual or company's past borrowing and repayment
patterns, including information about arrears, collection
problems, legal action and bankruptcy, if any.
ll Business performance: Quality of the borrower’s business
operations in the industry and sector compared to its
competitors. This includes its financial performance,
market position, customers and quality of its products and
services.
ll Valuation: Value of the assets pledged by the borrower.
ll Ability to perfect and crystallize lien: Since the value of
the assets pledged can change over time, their worth
must be “frozen” into a fixed value only at the time
of default – allowing a creditor to draw against the
“crystalized” value.
ll Ability to honor commitments: Present and past history
of the borrowers’ business transactions with key partners.
This includes their suppliers, customers, and employees
as well as banks and other sources of finance.
ll Ability to repossess: The legal right and physical ability
to easily (ideally without court action) to possession for
resale of the pledged assets in the event of a default.
ll Capacity
The borrower’s capacity is its ability to pay its debts. The
assessment focuses on the borrower’s potential to pay its
lenders immediately in cash – also known as the “first way
out”, in which the lender can immediately anticipate debt
service from the funds generated in the normal operation of a
borrower’s business. The analysis should focus on the ability
Identification of other options: Fixed and floating charges
over tangible chattels or elements of a cash conversion
cycle that can be pledged in support the loan. This
includes future earnings and cash flows as well as key
shareholder, cross group / company guarantees and legal
undertakings.
ll 10
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Exhibit 3: Key Indicators for the Three C’s of Energy Efficiency Finance
Character
Will the SME host
honor obligations to use
guaranteed energy saving
for debt service?
Trade Checking: check with the borrower’s customers/suppliers
–– Does the borrower pay bills on time, is it heavily indebted? Has it reneged on any
obligations?
ll Bank Checking: understand the borrower’s relationship with banks and other financiers
such as Credit Guarantee Companies, Credit Unions and Leasing firms.
–– What are current bank credit line limits and utilization patterns, including collection
activities, legal actions, and bankruptcy?
ll Income Statement Analysis: cash flow from normal trading activities
–– How do the borrower’s cash conversion cycle, operating margins, cost structure,
profitability and cash position compare to industry norms?
ll Balance Sheet Analysis: financial health of the borrower
–– Is the borrower heavily leveraged? Are its working capital, inventory and receivableto-sales ratios, and inventory mixes in line with others in the same industry or sector?
What is the debt service coverage ratio for business as usual?
ll Credit History Analysis: review and verification of key elements of owners’ personal
financial statements
–– What is the level and nature of the owners’ outstanding loan or debt obligations? What
are the reputations and positions of the borrowers and owners in the industry?
ll –– Is the borrower well regarded as to its technologies, competence, and integrity? Does
the firm treat its employees well and is it deemed capable of meeting its normal
business engagements?
Management knowledge and experience: quality of the borrowers’ management team
How long have the owners been in the industry, are they considered innovators or
followers?
ll Capacity
Does the borrower have the
financial and operational
capacity to pay the energy
saving payments?
Historical cash flow performance analysis: thorough assessment of last three year’s
financial operations provide insight in their future performance
–– What are the borrower’s financial and performance trends? Can the borrower explain
major shifts or negative trends? Does review and “stress testing” of cash flow
projections over the tenor of the EPC contract support the borrower’s positive financial
performance in the event of an economic downturn?
ll –– Will the firm generate sufficient savings through deployment and proper operations of
the EE equipment to make EPC payments?
11
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Exhibit 3 (CONTINUED): Key Indicators for the Three C’s of Energy Efficiency Finance
Collateral
Value of the EE technology: determined by users’ ability to generate cash flow from the
energy savings within the tenor period using “worst case” assumptions
–– Will the EE technology pay for itself, if used properly?
ll Does the borrower have
sufficient collateral to
securitize the EPC contract
in the event of nonpayment?
Ability of the credit provider to repossess the EE technology
–– Can the EE technology be physically removed from the user in the event of a default
without recourse to the courts?
ll –– What is the potential for the repossessed EE technology to be redeployed and generate
income the form of energy savings by another user?
Credit Analysis for SMEs
Effective credit analysis for SMEs requires that credit officers and underwriters focus on the fundamentals of financial performance
and apply proven creative methods in acquiring the relevant information to opine on credit-worthiness, to structure / document
facilities, and to employ appropriate risk-weighted pricing methodologies, as well as to put in place performance tracking and
reporting metrics. The table below lays out some of the challenges to adequate credit analysis for SMEs and proposed solutions.
Exhibit 4: Credit Analysis Challenges Facing Lenders and SMEs
Challenges
Solution
Lack of financial reporting capacity: The financial information
provided by the SMEs is often limited in scope and depth
because many firms lack experienced staff and strong financial
reporting systems.
Analysis should assess only key business indicators
based on easily accessible data, which is straightforward,
verifiable and germane. These should include:
ll
ll
Purpose: The reason for the loan or finance. Is the
quantum requested logical and commensurate with the
size of company; does it align with the SME’s industry
sector and business model.
ll
Lack of transparency: SMEs often understate asset values
and income while over reporting expenses for tax purposes. In
addition, the owners (principals) of SMEs often commingle
personal and company accounts for resource management and
tax planning purposes. As a result, the financial statements
of the firm often do not accurately reflect a firm’s business
performance.
ll
Period: The analysis is focused on assessing the SME’s
repayment capabilities within a certain tenor period.
ll
Proxy financial measures and industry norms, as needed.
Surrogate financial measures can be developed through:
ll
Listed companies in the same industry and geography
ll
Accounting firms which regularly audit firms within the
same industry or sector
ll
Industry associations
ll
Credit history of the SME firm and its principals
ll
12
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
To prudently assess the credit risk of SMEs in a cost-efficient
manner, the analysis should focus on performance or risk
indicators that have proven to be useful, in other markets and
over time, within specific industries as reliable discriminators for
predicting satisfactory credit behaviour and risk ranking. They
must aid in facility structuring and risk-based pricing. They
should include:
The following efforts are also necessary for thorough
assessment and prudent lending practices:
ll Analyze the credit history of the SME firm and its principals:
Since SMEs often lack credit history and the firm’s financials
are often intertwined with the principals’ personal financial
resources, the credit analysis may include both the firm
and its principals. The analysis of the principals should be
dependent on how much of the firm’s income and expenses
are reported in the principal’s personal accounts. Often a
“word picture” of a principal’s possible net worth or income
needs to be developed through frank discussions and
observations of life style rather than signed and audited
personal financial statements.
ll Use of proxy financial measures and industries norms:
The paucity of reliable financial statements and lack of
transparency characteristic of SMEs necessitates the use
of proxy / surrogate financial measures and industry norms.
While not a substitute for analysis of the borrower’s financial
performance, the use of such proxy measures have proven
to be a practical and reasonably reliable way of predicting
SMEs’ financial performance, in many emerging markets in
the absence of complete or transparent information – such
as professionally audited financial reports. Proxy financial
measures typically can be developed from the following
sources:
ll Fully understand the purpose of the financing required and
the appropriateness of the quantum requested as well as the
tenor.
ll Quantitative Metrics for SME EE Finance Credit and
Performance Risks
Listed companies: The publicly available financial data (Key
Balance Sheet and Income Ratios, Profitability dynamics and
Returns) of listed firms can be used as industry benchmarks
to be compared with SMEs and to help affirm the quality and
viability of a particular firm. The business operations of the
listed companies used as proxies should be in the same sector
and geography as those of the SME borrower.
ll Based on the above principles and proposed framework, credit
officers should assess the quantitative financial metrics that
capture:
Profit and Profitability
ll Firm Efficiency
ll Working Capital
Accounting firms: Credit officers can work with reputable
accounting firms which have a history of auditing companies
within a particular industry or sector to build, validate and
annually review key surrogate financial indicators and
assumptions.
ll ll Debt Service - Liquidity and Leverage
ll Borrowing Needs
ll Market Position
ll Industry associations: Industry associations have in-depth
knowledge of the financial conditions of their industry. In
many cases, such information is publicly available.
ll 13
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Exhibit 5: Key Quantitative Financial Performance Metrics
Profit and Profitability
Profit Margin
Net Income/Annual Sales
ll Return on Assets: ROA
Net income/Average Total Assets
ll Return on Equity: ROE
Net Income/Average Total Equity
ll Income recognition principles
Credit payments assessed as income
ll Firm Efficiency
Asset Turnover
Total Sales/Average Total Assets
ll Inventory Turnover
Cost of Goods Sold (COGS)/ Average Inventory
Number of Days in Period/Inventory Turnover
ll Receivable Turnover
Net Credit Sales/Average Receivable
Number of Days in Period/Receivable Turnover
ll Working Capital
Current
Current Assets/Current Liabilities
ll Quick Asset
Quick Assets/Current Liabilities
ll Working Capital
Net Working Capital/Total Assets
ll Debt Service – Liquidity and Leverage
Interest Coverage
Net Income Before Interest and Taxes/Interest Expenses
ll Debt Coverage
Net Income Before Debt Service and Taxes/Total Debt Repayment
ll Account Receivable Turnover
Net Credit Sales/Average Receivables
ll Assets Turnover
Sales/Average Total Assets
ll Debt Equity
Total Debt/Total Equity
ll Borrowing Needs
ll Market Position
ll Cash Conversion Cycle:
Days Inventory Outstanding (DIO) plus Days Sales (Receivable) Outstanding
(DRO) minus Days Payable Outstanding (DPO)DIO+DRO-DPO=CCC
Firm Position (quartiles)
Financial Performance and Size
14
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
accessible information. In order to provide an accurate picture
of the borrowers’ credit and performance risks, the qualitative
metrics should be used as a comprehensive framework and
be explicitly linked to the borrowers’ financial conditions and
the quantitative analysis. The key qualitative metrics must
be customized for the SME’s industry and should include the
following key metrics:
Qualitative Metrics for SME EE Finance Credit and
Performance Risks
In addition to quantitative analysis, credit officers should
conduct qualitative analysis of the SME borrower to rate its
credit, performance and market risks. Qualitative analysis is
fundamentally important because it identifies the key risks in
the industry where the borrower operates and provides a tangible
method to rate and rank borrower performance within the industry.
Cash Flows
ll Similar to quantitative analysis, effective qualitative analysis
requires the development of key metrics that represent the
credit, performance and market risks of the specific industry and
region of the borrower. Qualitative risk metrics should focus on
the key indicators that logically align with the SMEs’ industry
sector and business model and be based on practical and
Payment Risks
ll Operational Costs
ll Market Position and Risks
ll Exhibit 6: Examples of Key Quantitative Financial Performance Ratios
Cash Flows
Operational capacity - plant online operational rate
Access to suppliers and input
Quality of upstream suppliers
Payment source for Suppliers
Payment by cash/credit
Accounts payable turnover
Employee salaries
Profile of customers - Government, SOES, private firms (listed or SMEs)
Payment method from customers
Payment Risks
Financing situation of the borrower - self financed/credit
Contract enforcement factors - appointment terms of the contract signatory
Shareholders of the borrower - Government, SOEs or private enterprises, SMEs, individuals
Operational Costs
Management quality of the plant facility - quality and age of the current installed equipment
Market Risks and Position
Factors that determine first, second, and third tier firms - product quality, market and
customer segment
Past performance during previous economic/industry slowdown response from suppliers/
customers
Borrower’s management of key industry bottlenecks
Feedstock shortages
15
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Credit Risk Management for SME EE Finance
–– The credit score should differentiate the levels of risks
identified for users by specific industry and geography.
The outcome of the qualitative and quantitative analyses of the
borrower’s credit and performance risks is a credit rating based
on the financial position of the firm compared to its peers in the
industry. This credit rating indicates to the EE capital provider
whether his extension of credit under an EPC contract with the
EE technology user would constitute an acceptable level of risk,
i.e., would it be within the limits of the capital provider’s credit
policy. The credit policy should establish:
–– The scoring should be broken down into tiers that
categorize the low, medium and high risk EE users.
Payment structures and contract terms:
ll
–– These can be used to manage the user’s credit and
performance risks: payment structures, securitization
mechanisms, and third-party partnerships, and should be
applied according to the user’s risk.
Benchmarks for the energy efficiency technology users that
qualify for EPC finance:
ll Exhibit 7: EPC Credit Risk Management Measures
EPC Contract
Payment Structures
Tenor
Loans to lower risk EE users can have longer tenors that allow the EE credit provider to earn
more revenue from interest payments, while loans higher risks users should have shorter
tenors for their EPC contracts to reduce payment risks.
Sliding Scale Payments
To encourage higher risk users to pay more of the upfront costs of the EPC contract, EE
vendors can offer as an incentive a sliding scale of the share-savings (the user gains more of
the shared energy savings as the EPC contract progresses).
Balloon payments
Low risk users who are not convinced of the energy cost savings generated from the EE
technology can be provided as an incentive the option of small initial payments with a large
final payment at the end of tenor.
Fixed payment schedules
If the user poses a high payment risk, particularly on paying to the agreed-shared savings of
the EPC contract, EE vendors could set a fixed-payment plan based on a minimum energy
savings – to remove the incentive for cheating on the reporting of energy savings.
16
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Exhibit 7 (CONTINUED): EPC Credit Risk Management Measures
EPC Contract
Securitization
Mechanisms
Down payment
Low risk users should have lower down payment requirements in order to earn more
revenue from longer EPC tenors while higher risks users should have high down payment
requirements to cover the upfront costs of the EE vendor.
Lump-sum pre-payments
High risk users should be required to make lump-sum prepayments for a given time period
as a mechanism to minimize payment risks.
Guarantees/Escrow Accounts
High risk users could be required to pledge cash into a third party escrow bank savings
account, from which the payments for the EE loan are automatically debited.
Market Risks and
Position
Factors that determine first, second, and third tier firms - product quality, market and
customer segment)
ll Past performance during previous economic/industry slowdown response from suppliers/
customers
ll Borrower’s management of key industry bottlenecks
ll Feedstock shortages
ll EPC Contract
Partnerships
Banks
EE capital providers could enter into an arrangement in which the banks collect the EPC
payments from the EE users in return for a percentage of the payments.
Third-Party guarantees
EE capital providers could enter into an arrangement with entities that can provide
guarantees of the EE user’s compliance with the EPC contract. This could include credit
guarantee companies and the EE users’ customers, in which the payments from the EE
user’s customers are pledged to securitize the EE contract payments.
Government agencies
EE capital providers could enter into an arrangement with government agencies, in which
the government entities provide an enforcement mechanism to ensure the EE users’
contract payment. For example, government EE subsidies will only be disbursed to the EE
user after the payment is made to the ESCO.
17
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Case Study – EPC Contract with SME Petrochemical Refinery
ESCO ABC manufactures and installs patented energy efficient
boilers for the petrochemical industry. The technologies reduce
the amount of energy and water that is consumed during the
petrochemical refining process. ABC would like to enter into
an EPC contract with Refinery XXX – an SME petrochemical
refinery based in Shandong province. ABC has secured a credit
line from a local bank to self-finance the EPC contract and
would like structure the EPC contract based the credit and
performance risks of Refinery XXX.
Key Information of Refinery XXX:
Production Capacity of 2 million tons of oil per year
ll Staffing of 750 employees
ll Its largest shareholder and customer is a national state-owned
ll petrochemical company
Provided Unaudited Financials
ll Exhibit 8: Key Case Study Financials
Year
Financials
2008
2009
2010
2011
Gross Revenue (RMB100 million)
45.00
47.50
46.20
48.00
EBITDA (RMB100 million)
0.81
0.71
0.05
0.05
Net Profit Margin
0.12%
0.11%
0.9%
0.08%
ABC has forecast the cash flows from the potential energy and water savings from its energy efficient boilers.
Exhibit 9: Case Study Energy Savings / Capacity/ Cash Flow
Energy Savings Per Ton of Oil Processed (RMB/ton)
15
Water Savings Per Ton of Oil Processed (RMB/ton)
5
Net Profit Margin
0.12%
18
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Quantitative Credit and Performance Risks Analysis of Company XXX: Use a listed Shandong Petrochemical company for proxy financials
Exhibit 10: Case Study Financial Proxy Information
Sinopec Shandong Taishan Petroleum Co (Public, SHE:000554)
financials from Q12011 http://www.google.com/finance?q=SHE:000554&fstype=ii
Profit and Profitability
Profit Margin
Net Income/Annual Sales
Net Income
Annual Sales
1.6
893.2
Profit Margin
0.0
Working Capital
Current Ra o
Current Assets/Current Liabilities
Current Assets
322.80
Current Liabilities
54.40
Current Ra o
Debt Service - Liquidity and Leverage
Net Income Before
Total Profit
2.1
Financial Expenses
(0.1)
EBIT
2.1
5.93
Cash Conversion Cycle CCC
(Days)
Interest Coverage
Net Income Before Interest and Taxes/
Return on Assets (ROA)
Quick Asset Ra o
Net Income/Average Total Assets
Quick Assets/Current Liabilities
Net Income Before Interest
and Taxes
Net Income
Average Total Assets
Return On Assets
Current Assets
Inventory
Quick Assets
Interest Expenses
Interest Coverage
1.6
943.5
0.0
Current Liabilities
Quick Asset Ra o
Return on Equity (ROE)
322.80
48.57
274.23
54.40
5.04
Net Income/Average Total Equity
Net Income
Average Total Equity
1.6
879.6
Return on Equity
0.0
Working Capital/Total Assets Ra o
(0.1)
(25.8)
1.COGS/N umbe r of Days
Inventory
Net Income Before Debt
Svc and Taxes
Short-Term Debt
Long-term Debt
2.1
Number of Days
-
2. Average Inventory
3. Days Inventory
Outstanding: (DIO)
Efficiency
Asset Turnover
Total Sales/Average Total Assets
Total Assets
Total Sales
893.2
Working Capital/Total
Assets
Average Total Assets
Asset Turnover
943.5
0.9
0.54
17.46
9.92
Net Credit Sales/Average Receivables
Account Receivables
72.18
Total Sales
Cash Sales
Number of days
2.Average Account
Receivables
90.00
0.80
3.Days Sales Outstanding:
(DRO)
12.38
893.2
1,071.1
(177.9)
Cost of Goods Sold (COGS)/Average
Inventory
Account Receivable
Turnover
(2.5)
COGS
Average Inventory
Inventory Turnover
Asset Turnove r
Sales/Average Total Assets
Receivable Turnover
Annual Sales
Average Total Assets
Net Credit Sales/Average Receivable
Asset Turnover
Calculating Days Payable Outstanding
(DPO)
Cost of Goods Sold
Numbe r of Days
1. Cost of Goods
Sold/Number of Days
893.2
943.5
0.9
893.2
Number of Days in Period/Receivable
Number of Days In Period
90.0
Receivable Turnover Days
N/A
Receivable Turnover Rate
N/A
Data not listed on financials
90
1.Net Sales/Number of days
72.2
1,071.1
(177.9)
72.2
(2.5)
9.42
48.57
Account Receivable Turnover
Ave rage Receivable
Cash Sales
Net Credit Sales
Average Receivables
Receivable Turnover
848.22
90
893.23
90
Net Credit Sales
Total Sales
90
Calculating Days Receivable
Net Sales
Number of days
Inventory Turnover
848.2
48.6
17.5
Calculating Days Inventory
Cost of Goods Sold
Number of Days
Debt Coverage Ra o
Net Income Before Debt Svc &Taxes/
Total Debt Repay
Total Debt
Debt Coverage
N/A
Firm has no short-term or long-term
0.28
Days of Report
(49.66)
2.1
Net Working Capital/Total Assets
Current Assets
322.80
Current Liabilities
54.40
Net Working Capital
268.40
943.50
Cash Conversion Cycle CCC*
Days Inventory Outstanding + Days
Receivable Outstanding - Days
Payable Outstanding
DIO + DRO – DPO = CCC
Accounts Payable
Number of Days
2. Average Account Payable
3. Days Payable
Outstanding:(DPO)
Leverage
Debt Equity Ra o
Total Debt/ Total Equity
Short-Term Debt
Long-term Debt
Total Debt
Total Equity
879.6
Debt Equity Ra o
N/A
Firm has no short-term or long-term
debt
19
848.22
90
9.42
10.67
90
0.12
79.50
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Exhibit 11: Case Study Financial Details
Production Capacity
(10,000 tons per year)
Staffing
(staff per factory)
Gross Revenues
(RMB100 millions)
Costs
(RMB100 million)
Ist Tier
2nd Ti e r
3rd Ti e r
Large Medium
800
500
650
400
500
300
Small
300
200
100
Gross Rev/ Capacity
(RMB/ton)
Ist Tier
2nd Tier
3rd Tier
Large Medium
2,000
1,000
1,500
750
1,000
500
Small
400
300
200
EBITDA/Gross Revenue
( %)
Ist Tier
2nd Ti e r
3rd Ti e r
Large　Medium
100
75
80
60
50
30
Small
50
30
10
Cost Margin
Costs/Gross Revenue (%)
Ist Tier
2nd Tier
3rd Tier
Large　Medium
50
54
50
44
40
24
Small
38
24
8
Ist Tier
2nd Tier
3rd Tier
Large Medium
100%
122%
80%
98%
50%
49%
Small
163%
98%
33%
Ist Tier
2nd Tier
3rd Tier
Large Medium
100%
80%
80%
53%
46%
46%
Small
48%
40%
46%
Large Medium
100%
144%
125%
147%
219%
219%
Small
152%
160%
219%
Ist Tier
2nd Tier
3rd Tier
Highlighted figure is benchmark
Analysis: Refinery XXX is rated as a 2nd tier medium-sized petrochemical refinery. 2nd tier is defined as a firm whose market
position in terms of business performance (ie. gross rev/capacity; EBITDA/gross revenue, cost/gross revenue, etc) is in the second
quartile.
Exhibit 12: Case Study Qualitative Credit and Performance Risks Analysis System
Credit and Performance Risk Score System
Excellent
5
Above Average
4
Average
3
20
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Exhibit 13: Case Study Qualitative Credit and Performance Risks Analysis System
Credit and Performance Risk
Cash Flows
Payment Risks
Operational Costs
Market Risks and Position
Metric
Score
Operational capacity - plant online operational rate
operates at 50% capacity - above industry average
4
Access to suppliers and input
suppliers are mostly local state-owned enterprises
4
Quality of upstream suppliers
suppliers are mostly local state‐owned enterprises
4
Payment source for suppliers
90% is cash
4
Accounts payable turnover
turnover is 10 days ‐ above industry average
4
Profile of customers ‐ gov, SOES, private firms (listed or SMEs)
90% are SOEs
5
Payment method from customers
75% is cash
4
Financing situation of the borrower ‐ self financed/credit
self‐financed
4
Contract enforcement ‐appointment term of the contract signatory
refinery manager is expected to retire soon
3
Employee salaries
payment disputes with employees
3
Shareholders of the borrower
national SOE owns 75%, local government owns 25%
5
Management quality of the plant facility ‐ quality and age of the
current installed equipment
equipment is 20 years‐old, domestic made
5
Product quality, market and customer segment
customers are national SOEs
4
Past performance during previous economic/industry slowdown
response from suppliers/customers
customers continue to purchase because of gov subsidies
4
Borrower’s management of key industry bottlenecks
has assess to suppliers who share same SOE shareholder
3
Credit and Performance Score
21
3.9
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Exhibit 14: Case Study EMC Credit Policy Example
EMC Credit Policy
Down
Max EMC
Tenor
payment
(Months)
5.0 - 4.5
20%
4.4 - 4.0
Shared Savings
EMC Enforcement Measures
to be Adopted
48
Initial at 40/60 – final
payment of 70/30
Balloon payments
30%
36
Fixed at 50/50
Fixed payment schedules
3.9 - 3.5
40%
30
60/40
Quarterly lump-sum pre-payments;
Escrow Account
3.4 - 3.0
50%
24
55/45
Escrow Accounts; Government
guarantee
Credit Score
Exhibit 15: Case Study Qualitative Credit and Performance Risks Analysis
ESCO ABC ECP CONTRACT TERMS WITH REFINERY XXX
BASED ON CREDIT AND PERFORMANCE SCORE OF 3.9
40% down payment of the EPC contract
ll EPC contract tenor of 30 months
ll Share-shavings rate of 60%/40% throughout the EPC tenor
ll User should pay 3-months of prepayment of the guaranteed energy savings from the vendor upfront
ll User should establish a cash escrow account in a bank to make the EPC payments, which will be automatically
deducted on a quarterly basis.
ll Exhibit 16: Case Study Qualitative Credit and Performance Risks Analysis
Total Cash Savings (RMB/ton)
14.05
EPC Contract @60/40 shared savings (RMB/ton)
8.4
Forecasted Annual Production (tons)
1,000,000
Annual Cash Flow from EPC contract
8,400,000
Total Cash Flow from 3-year EPC contract
25,200,000
22
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Exhibit 17: Case Study Forecasted Cash Flow and Revenue from EPC Contract based on Credit Policy
Year 0
Year 1
Year 2
Year 3
Revenue (RMB)
10,080.000
5,040,000
5,040,000
5,040,000
Cost (RMB)
(10,000,000)
(1,500,000)
(1,500,000)
(1,500,000)
Net Cash Flow (RMB)
80,000
3,540,000
3,540,000
3,540,000
Total Net Revenue (RMB)
10,7000,00
23
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Appendix
consumption. Within the industrial sector, nine high consuming
industries - electric power, coal, steel, cement, non-ferrous
metal, coke, papermaking, leather making, and printing & dyeing
– have been targeted for large-scale improvements in energy
efficiency. In terms of industry size, the Chinese government has
focused on improving the energy efficiency of both large stateowned-enterprises (SOEs) and SMEs. The Ministry of Industry
and Information Technology (MIIT) is requiring that Chinese
SMEs reduce their energy consumption by 25% by 2015. The
rules target SMEs in China’s key industries, including steel, nonferrous, metals, construction materials, petrochemical, paper and
printing. Firms that continue to operate in polluting manner will
face economic sanctions, including the threat of closure.
Appendix A: Chinese Government Objectives and Policies
Improvement in the energy efficiency of China’s industrial sector
is one of the Chinese government’s top economic development
priorities. As part of its 12th Five-Year-plan (FYP), 2011-2015,
the State Council – China’s highest government entity – has
set as a national goal the reduction of energy intensity (energy
consumption per unit of GDP) by 16%.
To achieve the current energy intensity targets, the State
Council released the “12th FYP Energy Saving and Emission
Reduction Work Plan”, which outlines the country’s objectives
and strategies, with a specific focus on the country’s industrial
sector – which accounts for two-thirds of China’s total energy
Appendix B: Potential Energy Efficiency Gains in SMEs
Exhibit 18: Potential Energy Efficiency Gains
Iron &
Steel
Building
Material
Refinery
& Coking
Chemical &
Ammonia
Paper &
Pump
Textile
Production value (billion)
512.2
477
104.5
560
137.5
340.7
Number of enterprises
1777
5616
560
2275
882
1609
Energy Consumption (Mtce)
29.35
83.69
10.7
36.46
11.99
18.55
Summary: 15-20% EE improvement assumed in SME will lead to 45-50 Mtce energy saving. 5% EE improvement may come from production facility
renovation,5-8% EE improvement from phasing out backward equipment, industrial boiler renovation, heat and pressure recovery, and EE improvement for generic
equipment; 3-5% from energy management and production management improvement.
SME as defined by National Bureau Statistic (2003) are firms with less 2,000 employees, annual sales revenue below RMB300 million, and gross value of
assets less than RMB400 million). SMEs industry sector refer to enterprises whose energy consumption is about 5000-50000 tce per year.
Source: A study for Energy Efficiency Incentive Mechanism for Industrial Mid-Small Energy Use Enterprises, ERI, NDRC, Nov 2009.
24
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Achieving the energy efficiency improvement targets mandated for Chinese SMEs would have a significant impact on China’s
national economy and environment. Not only do Chinese SMEs account for 60% of China’s GDP, but they also are responsible for
78% of industrial employment. Chinese SMEs are, however, more energy inefficient and polluting than larger Chinese firms. Products
made by Chinese SMEs consume 30-60% more energy than the same product made by larger Chinese firms, according to the State
Council. In addition, the Chinese Academy of Science reports that Chinese exports, 90% of which are produced by SMEs, account
for 65% of China’s total greenhouse gas (GHG) emissions.1
Exhibit 19: Energy Consumption Levels of Small Energy Intensive Industries in China
Energy Consumption Levels of Small Energy Intensive Industries in China
Sector
Average Size
Consumption Levels
Thermal Power
Generation
100MW
Consume 30 to 60% more coal per output than
international thermal plants of 300MW
Blast Furnace
300 m3 (production capacity)
Consume 80kg more coal per ton of output than
blast furnaces of 1,000 m3 annual capacity
Coking Plant
300,000 tons annual output
Consume twice as much as coal per ton as
international coking plants
Cement
200,000 tons (production capacity)
Consume 30% more energy than advanced large
scale systems per ton of output
Paper Manufacturers
1260 tons (annual production capacity)
Consume 2.3 times more coal per unit of output
than large scale systems
Source: Development Research Council, State Council
Given the large number of industrial SMEs and their inefficient energy use, the potential size of the energy savings market for SMEs
is significant. The mandatory 25% reductions in energy consumption for industrial SMEs could create a market for energy efficiency
services and technologies valued at RMB250 billion/US$367 billion per year.
Exhibit 20: Market Value for Energy Saving in SMEs
Market Value for Energy Savings in SMEs
Amount of Electricity Consumed by Chinese Industry in 2008
2,112 Billion KWH
SMEs account for 70% of Total Electricity Consumption of Industry
1,478 Billion KWH
Reduction of Industry SME consumption by 25%
370 Billion KWH
Market Value for Energy Savings from SMEs (Industry electricity price is on average is 0.7 RMB per KWH)
258.7 Billion RMB
Estimates based on NDRC data
1 The 21st Century Business Herald, “Hidden Pollution Contained in Exports Can Reduce Emissions by 20%, March 8, 2011.
25
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
Appendix C: Chinese Government Strategies to Achieve
Energy Efficiency
Appendix D: Financing Resources for Energy Efficiency and
SMEs
A key element of China’s industry energy efficiency strategy is
to encourage the use of energy performance contracts (EPCs)
– also known as energy management contracts (EMCs).
EPCs are a performance-based engineering, procurement, and
construction (EPC) and financial mechanism, in which vendors
of energy efficiency services and technologies accept the cash
savings generated by their customers’ energy-efficient upgrades
to finance the customer’s energy efficiency improvements.
Firms that provide EPCs are known as energy saving companies
(ESCOS). In the “12th FYP Energy Saving and Emission
Reduction Work Plan”, the Chinese government specifically
states that it will strengthen its support of ECPs and ESCOS by
implementing new fiscal, tax, and financial incentives at both the
central and local government levels. Initiatives that have already
been launched include:
Given the strong government drive for industrial EE and its large
market size, Chinese and international financial institutions
have been actively increasing financing for EE and EPC projects.
The best known of these initiatives is the China Utility-Based
Energy Efficiency Finance Program (CHUEE) of the International
Finance Corporation (IFC). Founded in 2006, at the request
of the Chinese Ministry of Finance, CHUEE was designed to
achieve the following specific goals:
20 million tons of CO2 and other greenhouse gas emissions
(GHG) emission reduction per year, by 2010;
ll mobilization of RMB5-10 billion of energy efficiency project
financing to facilitate the implementation of energy
efficiency projects;
ll
further development of Green Financing in China; and
ll Government financial awards for completion of qualified EPC
projects, similar to those previously offered for large energy
conservation projects undertaken by enterprises themselves;
ll improved private enterprise access to finance in the energy
efficiency sector.
ll To stimulate energy efficiency investments, CHUEE established
partnerships with local Chinese banks through two main
instruments: bank guarantees for energy efficiency loans and
technical assistance to market players, including utilities,
equipment vendors, and energy service companies, to help
implement energy efficiency projects.
Turnover tax, value added tax, and partial corporate income
tax exemptions for qualified EPC projects, and clarification of
other aspects of tax incentives
ll Accounting provisions, including provision for government
entities to list EPC payments under energy costs; and
ll Encouragement for banks and other financial institutions to
create new credit products, to open up and expand the scope
of guarantee products, and simplify application and approval
procedures to meet the special needs of ESCO financing.
ll In its 2010 evaluation of the CHUEE program, the Independent
Evaluation Group (IEG) of the World Bank and IFC reported that
as of June 2009, the program’s banks provided loans totalling to
RMB3.5 billion/US$512 million. These loans financed 98 energy
efficiency projects, such as heat and gas recovery power generation
and the introduction of efficient production systems. The steel,
chemical, and cement industries were the largest beneficiaries.
Based on engineering calculations, these investments reduce GHG
emissions by 14 million tons of CO2 annually.
These efforts have led to a burgeoning EPC and ESCO industry
that has delivered substantial energy savings in China. According
to the Chinese Energy Management Company Association
(EMCA), energy performance contracting investment in 2010
totalled more than RMB28.74 billion/US$4.24 billion – an
increase of 48% since 2009, while the more than 900 ESCOS
were registered in China by the end of 2010. The energy savings
capacity of the new assets created in 2010 through EPCs rose
to about 10.6 million tons of coal equivalent per year.
In addition, EE projects have proven to be profitable with low risks.
According the EMCA, the financial payback of EPC contracts in
China is usually high − allowing the ESCO to receive full payment
and profits within three years or less. In addition, the CHUEE
program reported that there were no defaults in its EPC portfolio,
even during the 2009 financial crisis. As such, the default risks for
EPC contracts from economic downturns can be managed
26
Institute for Industrial Productivity
Surrogate Metrics to Evaluate the Creditworthiness of SMEs for Industrial Energy Efficiency Finance
EE projects involved large industrial users, simply because a
majority of the proposed SME EE projects were unable to find
local bank funding and thus not implemented. In its evaluation
of CHUEE, IEG found that more than 90% of their bank
clients would have invested in energy efficiency even without
the loans guaranteed by the program – meaning the projects
supported by CHUEE were mostly with those low risk users who
in fact had the capacity and the ability to finance the project
simply because they could secure bank finance without credit
enhancements or participation guarantees. The relatively low
additionality (marginal propensity to invest in GHG emissionreducing activities) at the end-user level reflects the fact that
most of the program’s guaranteed loans were used by large
companies that already had greater access to financial sources
than smaller companies; this was in contrast to the original plan
of emphasizing SMEs.
Despite the strong financial performance of EE projects, many
ESCOS cannot finance their EE projects because many of
them are SMEs. According to the EMCA, 46% of their member
ESCOs in 2009 had a registered capital of less than RMB5
million/US$737 thousand with the average for the members at
RMB27.8million/US$4.1 million. ESCO SMEs are particularly
disadvantaged in accessing finance from banks because the
banks are unfamiliar with their product and service offerings
and the nature of the Chinese environmental markets. Those
banks that do finance the EE industrial SME project do so based
on fully collateralized lending, in which the ESCO is required
to provide a 100% cash guarantee to the bank to secure the
credit line. As a result, many ESCOs are unable to implement or
replicate their EE projects.
In addition, almost all of the CHUEE support for industrial
References
China’s Energy Management Company Association (EMCA) and
Energy Pathways, “China’s ESCO Industry -2010,” 2011.
State Council of the People’s Republic of China, “12th FYP
Energy Saving and Emission Reduction Work Plan,” 2011.
Development Research Center, State Council of the People’s
Republic of China, “Long-term and Strategic Objectives and
Measures In Implementing Energy Efficiency,” 2008.
The World Bank, “Assessing the Impact of IFC’s China UtilityBased Energy Efficiency Finance Program,” 2010.
The 21st Century Business Herald, “Hidden Pollution Contained
in Exports Can Reduce Emissions by 20%,” March 8, 2011.
Ministry of Industry and Information Technology of the People’s
Republic of China, “Directive on Strengthening the Energy
Efficiency of Small and Medium Enterprises, 2010.
27
Sharing best practices for the low carbon future | iipnetwork.org
2200 Pennsylvania Avenue, N.W., 4th Floor, East Tower, Washington, D.C. 20037 U.S.A.
[email protected] | Twitter.com/iipnetwork