Growth of Energy Service Companies (ESCOs) in India
Posted in Operations & IT Articles, Total Reads: 5108
, Published on 18 July 2013
The rapid economic growth in India has significantly increased the energy demand in the country. The growing energy deficit coupled with fluctuating global energy prices has led to greater focus on energy efficiency. This article tracks the growth of the Energy Service Companies (ESCOs) in India during the last couple of decades. It also identifies the growth potential of the ESCO industry and the associated growth drivers. The article further explains the major growth barriers and the way forward for the industry.
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The Indian economy has grown rapidly in the last couple of decades leading to increased energy needs. India is the 3rd largest consumer of energy accounting for 5 % of the global energy consumption  and it imports 70% of hydrocarbons used in the energy generation in the country .By 2016, it is expected that the energy consumption in India would increase by 60 % compared to the levels in 2003.
Even after appreciable power generation capacity addition in the country, the supply has not kept pace with the growth in demand and this has resulted in energy shortages. Compounding the energy deficit, India is ranked among the lowest energy efficient countries in the world. The growing energy concerns in the country have prompted the government to incentivize investment in the energy sector. This has created significant opportunities for energy efficiency projects in the country resulting in a proliferation of Energy Service Companies (ESCOs).
Energy Service Company (ESCO)
Energy Service Company (ESCO) is a typical service company in the energy sector which identifies opportunities for increasing the energy efficiency of industrial and commercial units, among others, through design of comprehensive energy solutions. The ESCO conducts energy audits and recommends areas for energy-savings. It provides comprehensive services right from the recommendation stage to the project implementation and verification. The earnings of the ESCO are contingent upon the amount of cost savings accrued by the customer during the project.
ESCOs Financial Model: Among many available models, The Guaranteed savings model4 (Figure 1) is the most popular model used for financing the energy savings project. The third party lender will finance the project with the facility owner providing recourse to their balance sheet. The owner shares the risk by having recourse to the ESCOs guarantee. This model ensures sharing of risk between the parties involved.
ESCO: Present Scenario
The ESCO industry in India is relatively small and young compared with those in other nations. In the early 1990’s, the U.S. Agency of International Development was instrumental in setting up of ESCOs in India. From a humble beginning of 3 ESCOs in the early 1990s, the country has witnessed the growth in the number of ESCOs to 114 today of which 25 new companies were accredited in 2010-11 .
The government of India during this period has strengthened the institutional and legal framework in the country by passing the Energy Conservation Act in 2001. The upshot of the act was the creation of Bureau of Energy Efficiency (BEE) which had the mandate to promote energy efficiency industry.
In 2002, the World Bank and United Nations Environment Programme (UNEP) launched the technical assistance project known as the Three-Country Energy Efficiency (3CEE) project in India, China and Brazil. The 3CEE project mainly aimed at providing financial support to the ESCO projects in the three countries. The project has also provided a mechanism for seamless transfer of technical expertise between the three countries, largely benefitting the ESCO sector.
The Indian ESCO industry can be broadly segmented into Industrial, Commercial, and Government customers (Figure 2).
The main growth drivers for the ESCO industry are rising energy costs coupled with the macro trends prompting the enterprises to improve their cost-effectiveness. A survey conducted by World Resources Institute (WRI) in 2008 estimated the investment potential in the country to be USD 9.8 billion. From 2003 to 2007, the ESCO industry revenues grew with an annual growth rate of 95.6 % . The growth is expected to continue due to immense untapped investment potential and several new entrants making their way into the industry.
Going forward, the ESCO industry can tap the cogeneration and captive power market. These projects improve the reliability of power supply, reducing the dependence of industries on the grid. Such projects presently account to only 5 % of the ESCOs revenues and offer huge scope for investment .
ESCO: Barriers for Growth
The concept of ESCO offers a great deal of promise for tackling the energy crush that our country faces today. However, this industry is facing several barriers to growth, such as:
Lack of Awareness: Most of the organizations have a hazy understanding of the whole concept of ESCO. It is generally perceived that the ESCOs make profits at the expense of the company.
Access to Finance: The projects undertaken by the ESCOs are mostly capital intensive. The ESCOs are dependent on either the prospective clients or the banks for funding. The banks often lack awareness on the savings potential of the projects resulting in higher interest rates and capital costs. About 42 % of the ESCOs surveyed by WRI faced capital financing issues; this particularly is the case with smaller companies in the industry .
Technology Bias: The industry is presently dominated by vendor driven ESCOs, which are affiliated to equipment manufacturing companies. The clients generally perceive the services offered by the ESCOs to be biased, rather than providing comprehensive energy management solutions.
Energy Savings Tracking: The energy savings is measured based on a baseline set during the start of the project. Due to costly metering systems the energy monitoring has become a hurdle for many clients. The mismatch due to faulty tracking systems has often become a point of dispute between the ESCO and the client. This has resulted in loss of earnings for the ESCO and also created mistrust between the parties.
Although the ESCO industry in India is nascent and offers great potential for growth, there are several barriers to be overcome. It takes a concerted effort on the part of Industry, Banks, Government Agencies and ESCOs to achieve the mission of an energy efficient India.
The Industries must realize the long term benefits of energy efficient processes and invest in ESCO projects. The government also needs to incentivize the industries to take up ESCO projects by providing income-tax rebates and other benefits. The banks and other financial institutions must support the ESCOs by providing them with access to capital. Last but not least, the ESCOs should work towards enhancing their technical expertise and gaining the trust of all the stakeholders involved.
This article has been authored by M S Pavan Kumar and Shalini Vaddy from IIM Ahmedabad
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