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The views expressed in this IEA Insights paper do not necessarily reflect the views or policy of the International Energy Agency (IEA)

Secretariat or of its individual member countries. This paper is a work in progress and/or is produced in parallel with or

contributing to other IEA work or formal publication; comments are welcome, directed to email [email protected].

OECD/IEA,2012

OECD

IEA

2012

Mobilisinginvestment

inenergyefficiency

Economicinstruments

forlowenergybuildings

AnuschkaHilke

LisaRyan


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INTERNATIONAL ENERGY AGENCY

The International Energy Agency (IEA), an autonomous agency, was established in November 1974.Its primary mandate was and is two-fold: to promote energy security amongst its membercountries through collective response to physical disruptions in oil supply, and provide authoritative

research and analysis on ways to ensure reliable, affordable and clean energy for its 28 membercountries and beyond. The IEA carries out a comprehensive programme of energy co-operation amongits member countries, each o which is obliged to hold oil stocks equivalent to 90 days o its net imports.The Agencys aims include the following objectives:

n Secure member countries access to reliable and ample supplies o all orms o energy; in particular,through maintaining eective emergency response capabilities in case o oil supply disruptions.

n Promote sustainable energy policies that spur economic growth and environmental protectionin a global context particularly in terms o reducing greenhouse-gas emissions that contributeto climate change.

n Improve transparency of international markets through collection and analysis ofenergy data.

n Support global collaboration on energy technology to secure uture energy supplies

and mitigate their environmental impact, including through improved energyefciency and development and deployment o low-carbon technologies.

n Find solutions to global energy challenges through engagement anddialogue with non-member countries, industry, international

organisations and other stakeholders.IEA member countries:

Australia

Austria

Belgium

Canada

Czech Republic

Denmark

Finland

France

Germany

Greece

Hungary

Ireland

Italy

Japan

Korea (Republic of)

Luxembourg

NetherlandsNew Zealand

Norway

Poland

Portugal

Slovak Republic

Spain

Sweden

Switzerland

Turkey

United Kingdom

United States

The European Commission

also participates in

the work of the IEA.

OECD/IEA, 2012

International Energy Agency9 rue de la Fdration

75739 Paris Cedex 15, France

www.iea.org

Please note that this publicationis subject to specic restrictionsthat limit its use and distribution.

The terms and conditions are available online athttp://www.iea.org/termsandconditionsuseandcopyright/


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OECD/IEA2012 MobilisinginvestmentinenergyefficiencyEconomicinstrumentsforlowenergybuildings

Page|1

TableofContents

Acknowledgements..........................................................................................................................5

ExecutiveSummary..........................................................................................................................7

Economicinstrumentsinenergyefficiencypolicy....................................................................8

Economicinstrumentsforlowenergybuildings.......................................................................8

Fundingeconomicinstruments...............................................................................................11

Futureconsiderations..............................................................................................................11

Introduction....................................................................................................................................13

Reportscopeandstructure.....................................................................................................13

Methodologicalissues.............................................................................................................14

PARTI:Economicinstrumentsinenergyefficiencypolicy...........................................................15

Energytaxes

and

price

subsidies

.............................................................................................

17

Taxrelief..................................................................................................................................18

Grants......................................................................................................................................19

Loanprogrammes....................................................................................................................20

Guarantees..............................................................................................................................21

Otherstructuredfinance.........................................................................................................22

Whitecertificatesandobligationschemes.............................................................................23

Carbonmarkets.......................................................................................................................24

Publicprocurementandinfrastructureinvestment................................................................24

Energyefficiency

R&D

support

................................................................................................

25

PARTII:Economicinstrumentstomobiliseinvestmentinenergyefficiencyinbuildings..........26

II.1Introductiontothebuildingssectorandenergyefficiencypolicy....................................26

Energyefficiencyandbuildings.......................................................................................26

Theroleofgovernmentstoreduceenergyconsumptioninbuildings...........................28

II.2Economicinstrumentsandlowenergybuildings.............................................................32

Energytaxesandpricesubsidies.....................................................................................33

Taxrelief..........................................................................................................................35

Grants...............................................................................................................................37

Loanprogrammes

............................................................................................................

40

Guarantees.......................................................................................................................43

Otherstructuredfinance.................................................................................................45

Whitecertificatemarketsandobligationschemes.........................................................53

Carbonmarkets................................................................................................................56

Publicprocurementandinfrastructureinvestment........................................................59

R&Dsupportforenergyefficiency..................................................................................61

II.3Discussionofcurrentuseofeconomicinstrumentsforlowenergybuildings.................63

II.4Movingtowardsdeepretrofithowcaneconomicinstrumentshelp?...........................64

II.5Selection

and

design

of

economic

instruments

for

low

energy

buildings

........................

66


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Mobilisinginvestmentinenergyefficiency OECD/IEA2012Economicinstrumentsforlowenergybuildings

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II.6Returnonpublicinvestmentinlowenergybuildings.......................................................69

PARTIII:Fundingeconomicinstruments.......................................................................................73

III.1Sourcesoffunding............................................................................................................73

Generalbudgetallocationsandearmarkedtaxrevenuesandcharges..........................74

Emissionallowanceauctioning........................................................................................77

Institutionalinvestingandprivateinvestmentfunds......................................................80

III.2Intermediariesandgreenbonds......................................................................................82

Energyefficiencyagencies...............................................................................................82

Dedicatedfundsforenergyefficiency.............................................................................83

Publicbanks.....................................................................................................................85

Greenbonds.....................................................................................................................88

III.3Discussionoffundingforlowenergybuildings...............................................................90

Conclusions.....................................................................................................................................94

Annexselectedcasestudies........................................................................................................96

Canada:ecoENERGYRetrofit HomesProgram......................................................................97

France:EcoPTZgreenloanandtaxincentives.....................................................................103

Germany:KfWloansandgrantsforenergyefficiencyinresidentialbuildings....................114

Italy:taxincentivesandwhitecertificates............................................................................126

Ireland:HomeEnergySavingSchemegrants........................................................................136

Acronyms,abbreviationsandunitsofmeasure..........................................................................142

References....................................................................................................................................144

Listof

Figures

Figure1Overviewofeconomicinstruments...............................................................................16Figure2RD&DnationalpublicspendingforEEinbuildings,appliancesandequipment...........62Figure3Developmentofeconomicinstrumentsovertime........................................................67Figure4Designoptionsforgovernmentinvolvementinloansforlowenergybuildings...........68Figure5Multiplebenefitsoflowenergybuildings.....................................................................70Figure6Volumeofgrantsandloans20012009.......................................................................118Figure7Numberofgrantsandloans20052010......................................................................118Figure8Reductionsinfinalenergydemand20052010...........................................................120Figure9AvoidedCO2equivalentemissionscumulated20052010..........................................121Figure10Employmenteffects20052010.................................................................................123Figure11Percentageeffectivenessofenergyefficiencymeasures..........................................134

ListofTables

Table1IEAmembercountrieswithhighesttaxesonhouseholdenergyin2011.......................33Table2ObligationschemeswithtradingoptionsinEurope.......................................................54Table3Comparisonofeconomicinstrumentsforlowenergybuildings....................................71Table4Examplesofearmarkedenvironmentallyrelatedtaxes..................................................75Table5Comparingcharges,earmarkedtaxesandgeneralbudgetallocations..........................77

Table6Overview

of

existing

emission

trading

schemes

.............................................................

78

Table7ExamplesforGreenInvestmentSchemesinHungary,LatviaandCzechRepublic.........80


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Table8ThemarketpremiumofgreencommercialbuildingsintheUnitedStatesandAustralia....................................................................................................................81

Table9Existinggreenbondsforenergyefficiency......................................................................88Table10Summaryoffundingsourcesforeconomicinstrumentsforenergyefficiency............92Table11ResidentialEnergyUseandEnergySavingsperHousehold,Pre1945to

20002009.....................................................................................................................

99

Table12SummaryofecoENERGYretrofit HomesprogrammeApril20072012....................102

Table13CIDD:taxcreditsavailableforvarioustypesofequipment........................................105Table14CIDD:estimatedenergydemandandemissionreductions........................................106Table15CIDD:costs20052009................................................................................................107

Table16EcoPTZ:eligiblemeasuresandmaximumloansizesandterms................................109Table17EcoPTZ:uptakeandcharacteristicsofloans..............................................................111Table18CO2refurbishmentofbuildingsandEnergyefficientrefurbishment:

mainfeatures...............................................................................................................115Table19Measuresundertakeninbuildingsparticipatingintheprogrammes20052010.......119Table20Estimatedratioofpubliccoststoenergyandemissionsavings.................................122

Table21

Total

impact

in

millions

of

Euros

according

to

the

two

employment

scenarios

.........

124

Table22Annualenergysavingsachievedin2010comparedtotargetsfor2010and2016....126Table23CumulativeTargetsfortheItalianWhiteCertificateSystem(Mtoe/year).................129Table24EnergysavingsachievedthroughWhiteCertificatesby30September2010.............130Table25MeasuressupportedandleveloftaxcreditsinItaly..................................................132Table26ClaimsandinvestmentsupportedbytheItaliantaxcredits,2009.............................132Table27Performanceindicatorsofthe55%taxdeductionprogramme..................................133Table28Economicefficiencyofincentives...............................................................................134Table29MeasuresandgrantamountsundertheHomeEnergySaving(HES)Scheme...........137Table30Installedmeasuresperdwellingtype2009/2010.......................................................138

Table31Estimatedsavingsperyear..........................................................................................138

Table32

Value

of

awarded

tax

credits

=government

revenue

foregone

(Euros)

.....................

139

Table33OverviewofCostBenefitAnalysisresults(includingsensitivityanalysis)..................140

ListofBoxes

Box1Definitionoflowenergybuildingsanddeepretrofitofbuildings.....................................28Box2Investmentneededgloballytoreduceenergyconsumptionofbuildingsby2050...........31Box3ExperienceswiththeuseofhouseholdenergytaxesinDenmark....................................35Box4GrantsforlowincomehouseholdsinNewZealand..........................................................39

Box5Experiences

with

green

loans

from

Australia

.....................................................................

43

Box6ExperienceswithrisksharingfacilitiesinEasternandCentralEuropeforresidentialbuildings...........................................................................................................................44

Box7ExperienceswithonbillfinancingintheUnitedStates.....................................................46Box8NewonbillfinancinginitiativeintheUnitedKingdom:theGreenDeal...........................47Box9ExperienceswithPACEintheUnitedStates......................................................................49Box10ESCOmarketandperformancecontractingintheUnitedStates....................................52Box11Emissiontradingforbuildings:TheTokyourbancapandtradeprogramme.................57Box12CDMProgrammeofActivitiesforsustainablehousinginMexico...................................58Box13GermanexperienceinearmarkingrevenuesfromETSallowanceauctioning................79Box14Privateinvestmentfundsandenergyefficiency:TheClimateChangePropertyFund....81

Box15

Efficiency

Vermont

...........................................................................................................

83


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Box16EuropeanUnionfundsusedforenergyefficiencyfinance..............................................85Box17ExperiencewithpublicbanksfromGermanyandUnitedKingdom................................87Box18QualifiedEnergyConservationBondsintheUnitedStates.............................................90Box19TheroleandfunctioningoftheSGFGASinFrance........................................................110Box20TheGermanEnergySavingsOrdinance(EnEV)..............................................................114Box

21

Application

procedures

..................................................................................................

116

Box22ENEA:Italysagencyfornewtechnologies,energyandsustainableeconomicdevelopment..................................................................................................................127


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Acknowledgements

ThemainauthorsofthisreportareAnuschkaHilke(previouslyofthe IEA)andLisaRyanoftheEnergy Efficiency Unit in the Sustainable Technology Policy Directorate of the IEA. Charlotte

Forbesand

Ellina

Levina

made

substantial

contributions

in

the

early

conception

of

the

project.

In

addition, Charlotte Forbes provided background research and compilation of information oneconomicinstrumentsused inIEAcountriesto improvetheenergyefficiencyofbuildings.EllinaLevinaauthoredthecasestudyonItaly.

Theauthorsaregrateful fortheguidanceandsupportgivenbyRobertTromop,asheadoftheEnergyEfficiencyUnit,andPhilippeBenoit,headoftheEnergyandEnvironmentDivision,andfortheirconsidered reviewof thework. BoDiczfalusy,directorof theSustainableTechnologyandPolicyDirectorateprovidedleadershipandoverallencouragement.

We are also particularly grateful for the time taken to review this report by IEA colleagues:

Grayson Heffner, Christina Hood, Marc Lafrance, Yamina Saheb, Cecilia Tam; and by OECD

colleagues

also:

Nils

Axel

Braathen,

Christopher

Kaminker,

and

Virginie

Marchal.

The IEAwould like to thank participants in theworkshop hosted by the IEA onThe Future ofEnergyEfficiencyFinance inMarch2012,which includedpresentationsonthetopicsdiscussedhere.1

Many of these participants also provided review comments on the final report as part of anextensiveconsultationandreviewprocess indevelopingthispublication.Weparticularlythankthefollowingpeoplefortheirreviewsandcontributionstotheworkshopanddocument:

BogdanAtanasiu,BPIE

Mlanie Barcet and Colas Paris, Ministre de lEcologie, du Dveloppement Durable et delEnergie,France

CatherineJ.

Bell,

American

Council

for

an

Energy

Efficient

Economy

MurrayBirt,DeutscheBankGroupBenCaldecott,ClimateChangeCapitalDean Cooper, United Nations Environment Programme, Division of Technology, Industry andEconomicsSusanneDyrboel,RockwoolInternationalA/SAlessandroFederici,ENEAAgimeGerbeti,GestoredeiServiziEnergetici GSES.pp.a.,MartinGaudet,DebraHaltrecht,VictoriaIngram,PhilJago,AnnKowal,ReneLazarowich,ClaudeLefranois,LauraOleson,SiddiqMcDoom,KellySmith,NaturalResourcesCanadaIngridHolmes,E3G

BretKadison,

Rosebud

Capital

AlexandraLangenheldandPaoloBertoldi,JointResearchCentre,EuropeanCommissionDilipR.Limaye,SRCGlobalInc.

VivienLo,GudrunGumb,RudolfHennes,MartinMllerandMarkusSchnborn,KfWBankMariaMendiluceandPhilippeFonta,WorldBusinessCouncilforSustainableDevelopmentMurrayBirt,DeutscheBankGroupRobertNuijandRomanDoubrava,DGEnergy,EuropeanCommissionKarstenNeuhoff,DIWBerlinChristinePatterson,EnergyEfficiencyandConservationAuthority,NewZealandRobinReid,WorldEconomicForum

1http://www.iea.org/newsroomandevents/workshops/workshop/name,14184,en.html


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NickRobins,HSBCBankPlcStephanedelaRueduCan,LaurenceBerkeleyNationalLaboratoryJimScheerandJosephineMaguire,SustainableEnergyAuthorityofIrelandThomasSchubert,EuropeanCommission,DGResearchMikaelSkouAndersen,EuropeanEnvironmentAgency

PeterSweatman,

Climate

Strategy

and

Partners

Matthew Wittenstein, Molly Lunn, Johanna Zetterberg and John Cabaniss, United StatesDepartmentofEnergy.

TheresultingdocumentistheIEAinterpretationoftheseworkshops,withadditionalinformation

incorporatedtoprovideamorecompletepicture,anddoesnotnecessarilyrepresenttheviewsofalltheworkshopparticipantsandreviewers.

This publication has benefitted from the inputs of Angela Gosman, Marilyn Smith, Astrid

Dumond,MurielCustodio,CherylHaines,andRebeccaGaghen inthe IEACommunicationsandInformationOffice.JennyGellandAudreyGlynnformattedthereport.


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ExecutiveSummary

Taxes, loans and grants, trading schemes and white certificates, public procurement and

investment inR&Dor infrastructure:known collectivelyaseconomic instruments, these tools

canbepowerfulmeansofmobilisingthefinancesneededtoachievepolicygoalsbyimplementingenergyefficiencymeasures.Theroleofeconomicinstrumentsistokickstarttheprivatefinancialmarkets and to motivate private investors to fund EE measures. They should reinforce and

promoteenergyperformanceregulations.

This IEA analysis addresses the fact that, to date, relatively little effort has been directed

towardevaluatinghowwelleconomicinstrumentswork.Usingthebuildingssectortoillustratehowsuchmeasurescansupportenergyefficiency,thispapercanhelppolicymakersbetterselectanddesigneconomicinstrumentsappropriatetotheirpolicyobjectivesandnationalcontexts.

Thisreportsthreemainaimsareto:

Examinehoweconomicinstrumentsarecurrentlyusedinenergyefficiencypolicy;

Considerhow

economic

instruments

can

be

more

effective

and

efficient

in

supporting

lowenergybuildings;and

Assesshoweconomicinstrumentsshouldbefunded,wherepublicoutlayisneeded.

The purpose of economic instruments in energy efficiency policy is to provide financial

incentives to invest inenergy efficiencymeasures through price and investment signals. Thesignalsmaybeintheformofincentives(e.g.viasubsidiesintheformofagrant,aconcessionalloanorsomeformofdirectpublic investment)ordisincentives(e.g.throughprice increasesviataxes or the creation of a market for energy efficiency certificates). Economic instruments canalso be used to increase the amount of finance available or to improve financing terms (e.g.throughreducedinterestrates,theunlockingofthirdpartyfinanceordedicatedcreditlines).

Economic

instruments

can

be

clustered

into

four

categories,

each

of

which

has

specific

advantagesinsomecontexts:

Fiscalinstruments:

o taxeso taxreliefs

Financialmeasures:

o loans

o grants

Tradingschemes:

o emissionstradingschemes

o whitecertificates Directinvestment:

o publicprocuremento publicinvestmentinR&D

o investmentinpublicinfrastructure.

Thisreport isstructured inthreeparts:(i)ataxonomyofeconomic instrumentsused inenergy

efficiencypolicy; (ii) theuseofeconomic instruments toachieve lowenergybuildings;and (iii)how these economic instruments are funded when public funds are needed. As a broadintroduction,thefirstsectiondescribesandcomparesthemaindesignfeaturesofeacheconomic

instrument.The

second

section

investigates

how

economic

instruments

are

used

to

improve

the


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energyperformanceinthebuildingssector,providinginsightsastowhichislikelytobeeffectiveindifferentcircumstancesortoovercomespecificbarrierstoenergyefficiency.Thefinalsectionexplores how economic instruments in energy efficiency policy can be funded and/or raiserevenue. The first and third sections are crosssectoral, and relevant for improving energyefficiency in all sectors. The middle section provides lessons learned from implementing

economicinstruments

specifically

to

support

the

finance

of

low

energy

buildings.

Many

of

the

experiences in the buildings sector will surely be useful to policy makers seeking to improveenergyefficiencyinothersectors.

Economicinstrumentsinenergyefficiencypolicy

Economic instrumentsareusedbyall IEAcountrygovernments inenergyefficiencypolicy to

address barriers such as externalities, split incentives, perceived high investment risk, lackingaccesstofinance,hightransactioncostsandbehaviouralissues.

Some general lessons canbedrawn from experienceswitheconomic instruments inenergy

efficiencypolicy

to

date.

Whenpartofawelldesignedandcoherentpolicypackage,economic instrumentshavebetter potential to deliver maximum impact on the market and to be economically

efficient.Thepolicypackageshouldalsoincludeminimumenergyperformancestandardsorregulations,informationandawarenessraisingmeasures,andcapacitybuilding.

Barriersthatneedtobeovercometoencourageinvestmentshouldunderpinthechoiceand design of economic instruments for energy efficiency. Other determining factorsincludethesector(s)tobeaddressed,nationalcircumstancesandotherpoliciesinplace.

Asenergypricesaredriversfor investment inenergyefficiency,theuseofenergytaxesand removal of energy price subsidies are prerequisites to putting in place any public

financingprogramme

or

other

subsidies.

Tax relief and grants can act as sweeteners to encourage investment in energyefficiency that might otherwise not take place but are likely to leverage only smallerinvestments.

Public funds and guarantees provide access to finance as the energy efficiency marketdevelopsandlargerinvestmentsareencouragedormandated.Financemaybecombinedwithincentivestoencourageuptakeoftheprogramme.

Publicprivatefinancing instrumentsopenupnewwaysoffinancing,enablingpeopletoinvestinenergyefficiencymeasuresthatmightnotbeeligibleforregularbankloans.

Todate,

thorough

evaluations

of

economic

instruments

have

been

rare,

even

though

these

instruments are widely used in IEA member countries. Most reporting on governmentprogrammes focuses only on outcomes in terms of related costs and programme participants;reallifeimpactsarerarelyassessedandatbestmodelled.Divergingindicatorsandmetricsusedin the few available evaluations make it difficult to conduct a comparative analysis of impactsgenerated through government programmes. This paper aims to address gaps in knowledge,advanceunderstandingandidentifyareasforfutureinvestigation.

Economicinstrumentsforlowenergybuildings

Makingthebuildingssectormoreenergyefficient isaglobalchallengeof increasingurgency.

Thebuildingssectorrepresents32%ofglobalfinalenergyconsumptionandrecenttrendsshow


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annual demand growth at almost 2%. While many costeffective measures to deliver energysavingshavebeenidentifiedforbothnewandexistingbuildings,implementationishinderedbyanumber of sectorspecific barriers. Policy makers need to put in place a strong and enablingpolicy framework, comprising regulation, information and economic instruments, in order tomobilisetheestimatedUSD11.5trillionneededonagloballevelupto2050todrasticallyreduce

theenergy

consumption

in

buildings

compared

with

business

as

usual.

Policy goals should be set to deliver nearly zeroenergy new buildings and deep retrofit of

existing buildings. As the rate of construction of new buildings is low in IEA countries, deepretrofitsoftheexistingbuildingstockwillplaythecrucialpart inreducingenergyconsumptionfromthebuildingssector.

All IEA countrieshaveat leastoneeconomic instrument inplace to supportenergyefficient

buildings.2 Historically, energy taxes,grants and tax relief have been the schemes favoured bymostgovernments.

Current targets and eligibility requirements attached to the economic instruments used for

energy

efficiency

in

buildings

are,

with

few

exceptions,

not

very

ambitious.

This

analysis

shows

thatthere isastrong focuson lowcostandquickwinsthroughthereplacementofequipment(lightingandHVAC),ratherthanimprovementsinthebuildingenvelopeorwholebuildingenergyperformance.Subsidieshavebeenmainlyattachedtorequirementsforeligibleenergyefficiencytechnologies and do not take a wholebuilding approach. It is difficult to find examples ofeconomicinstrumentsorsubsidiesthatapplytoambitiouslevelsofoverallbuildingperformanceimprovements,althoughsomedoexist(e.g.theKfWloanschemeinGermany).

Sofarefficiencyimprovementsof10%to30%,ratherthantrulylowenergybuildings,havebeendeliveredthroughmostprogrammes.Onaverage,greaterimprovementsinenergyefficiencyarelikelytobeneededacrossthebuildingsstock(amountswillvaryforeachbuilding,dependingontype, location and other factors). Achieving only 20%, for example, can be expected to have a

lockin

effect

that

results

in

unrealised

energy

savings

potential

over

the

next

decades.

Economic

instrumentsareneededthatenableand incentivisedeeperenergyretrofits,whethervoluntaryormandated.

Moreambitiousandtargeteddeepcutsinenergyconsumptionforretrofitofbuildingsshould

be the core element of energy efficiency policy. Governments should design economicinstrumentsthat:

(i) Provide greater access to finance for deep retrofit of buildings: policy makers need toreplace or complement direct subsidies as incentives for individual energy efficiencymeasuresandequipmentwith financing instruments thatare tied tosignificantcuts inwholebuildingenergyperformance.

(ii) Supportprivate

investment

in

low

energy

buildings

by:

o Setting up loan programmes directly through public banks or financial

institutions,withpreferentialrateloanswhereneeded;

o Assistingfinancialinstitutionswithriskguaranteesorcreditlinesuntiltheyhavebuiltupexperience;

o Encouraging the private sector through changes to legal requirements thatfacilitatepublicprocurement,energyperformancecontracting,onbill financingorotherthirdpartyfinance.

2Available

at

http://www.iea.org/policiesandmeasures/energyefficiency/


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In all cases, government support should be tied to ambitious energy performanceimprovementsinlinewithadeepretrofittingstrategy.

(iii)Focusonwholebuildingenergyperformance:evenwhenastepbysteprefurbishmentapproachistaken,anintegratedassessmentofefficiencypotentialforthewholebuildingshouldbecarriedoutsothatearlyrefurbishmentstepsdonotimpedelaterones.

(iv)Addresssplitincentives:thelandlordtenantproblemislikelytoberesolvedonlythroughmandatory retrofitting obligations. The issue of the full costs being recouped over thelong term canbeaddressed through financingmechanisms thatattach the loan to the

property,ratherthantotheinitialinvestor.

(v) Encouragehigherrenovationrates:incentiveswillplayanimportantroleinencouraginginvestors to undertake renovation and deep retrofit. Unless future regulatoryrequirementsorsignificantenergypricehikesareexpected, it isunlikely,however,thatany financial incentive on its own would be large enough to encourage the depth ofretrofitneededinmanybuildings.

(vi)Timethe

economic

instruments

to

match

the

development

of

mandatory

standards

and

themarketforlowenergybuildings:atanearlystageofawarenessandimplementationof lowenergy buildings (i.e. before introducing ambitious energy codes for existingbuildings), energy taxes and grants and/or tax relief can encourage early movers toinvest.Anyannouncementoffuturestringentenergyperformancebuildingsregulationsshouldbecombinedwithstraightforwardaccesstofinancewithfavourableterms,whichmightincludesomeincentives.Onceambitiousenergyperformancerequirementsareinplaceforrenovation,subsidiesshouldnotberequired;however,financialarrangementsandguaranteesareneeded toencourageprivatesector investment in themarket.Anypublicfinanceshouldbereferencedtothebuildingenergycodesinforceorplanned,andshouldnotestablishalternativemetricsinparallel.

Monitoringand

evaluation

are

key

to

understanding

the

effectiveness

and

efficiency

of

economic instruments, and to making necessary adjustments to improve their impact.Monitoringandevaluation,includingthedefinitionofabaselinestartingpointandtargetstobeachieved,needtobepartofthedesignofeconomicinstruments.Closemonitoringofrealcostsanduptakeoftheprogrammecangiveearlyindicationsofdesignflaws.Regularevaluationshelptoensuretheprogrammeismeetingitstargetsand,eventually,toidentifynecessarychanges.

Training and capacity building are needed at many levels to complement effective policy

design. Financial institutions need greater capacity to assess risks and potentials attached toenergyefficiencyinvestments.Publicinstitutionsneedtrainingforthesmoothimplementationofprogrammes.Assessorsneed tobetrainedandcertified tocarryoutbuildingenergyefficiency

audits

to

a

high

standard

in

terms

of

accuracy

so

that

audits

are

credible

as

a

basis

for

programmesorloanapplications.

Experiencetodatewith innovativefinancialmechanismsshouldbeuseful indeterminingthe

instruments needed to develop longterm financing options for deep retrofits. Multipleinnovativeapproacheshavebeendevelopedinrecentyears,suchaspreferentialrateloans,onbill and financing through initiatives such as the Property Assessed Clean Energy (PACE)programmeintheUnitedStates.DetailedcasestudiesinthisreportassessexamplesofeconomicinstrumentsforenergyefficiencyinthebuildingssectorinCanada(grants),France(taxreliefandloans),Germany(loansandgrants),Ireland(grants)andItaly(whitecertificatesandtaxrelief).


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Fundingeconomicinstruments

Someeconomicinstrumentsrequireoutlayofpublicbudget.Grants,loansandtaxreliefrequirebudgets,whichcanbemadeupofamixofpublicandprivate funds.Thefundingmayevenberaisedfromothereconomicinstrumentssuchastaxesandemissionstradingauctionrevenues.

Arangeofpublicfundingsourcescanbeusedtofundeconomicinstruments,includingbudget

allocations,dedicated funds,publicbanks,earmarked taxesandcharges,and revenues from

emission allowance auctioning. Private sources of funds such as institutional investors and

private investment funds can beblendedwith public resources to fund economic instruments.Theseoptionsareequallyvalidforenergyefficiencyprojectsbeyondthebuildingssector.

Policymakers should consider several factorswhendecidingappropriate sourcesof funding

streamsforenergyefficiencyeconomicinstruments,eachofwhichisexaminedinmoredetailinthepaper:

stabilityandsustainabilityofthefundingstream;

leastoverall

cost

to

society

including

public

and

private

costs;

splitbetweencostspaidbypublicandprivatesectors;

administrativesimplicity;

abilitytoleverageprivatefunds;and

publicbudgetconstraints.

The longterm goal should be to engage the private sector such that the energy efficiency

market becomes selfsustaining. Financial institutions need to recognise energy efficiencyinvestmentsasasourceofvaluablenewclientsanddeals;yettoworkinthismarket,theymusthavethecapacitytoevaluatetheriskassociatedwithdifferentinvestments.Policymakersneedto develop partnerships with financial institutions to build familiarity and trust in the business

casefor

energy

efficiency

investments.

Futureconsiderations

Thisreportfindsthat investments inenergyefficiencymeasuresare lowriskandcanprovide

high returns to investorsand lenders. Financial instruments have the advantage of being lesscapitalintensiveforthepublicbudget,leveragingmoreprivateinvestmentsandprovidingmorestable longterm financingopportunities.Governmentscouldhelpmotivatethe financialsectortoinvestinlowenergybuildingsbybuildingupevidenceandgoodpracticesinthreemainareas:

Accumulate proof that default rates of loans for lowenergy buildings are low and

presentalow

risk

investment

opportunity;

Monetise the multiple benefits attached to energy efficiency investments andstandardisemethodologiestocompletecostbenefitassessmentsofinvestment;and

Develop rating criteria for energy efficiency investments to increase attractiveness tolargeinvestors.

The lessons learned from this evaluation and the relevant case studies can be transferred andadaptedtoothersectorandcountrycontexts.Whileregulationswillcontinuetoplayakeyrolein creating demand for ambitious energy efficiency, economic instruments and private financewill be crucial in meeting that demand. Without stringent energy performance requirements,economic instruments are unlikely to deliver enough of an incentive to mobilise the finance

neededfor

dramatic

reductions

in

energy

consumption.


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Betterevaluationanddata relatedtothetechnicaland financialrequirementsof lowenergy

buildingsareneeded to be able to assess properly the design of finance to meet longer termpolicygoalsforlowenergybuildings.Alsothewidersocietalbenefitsassociatedwithlowenergybuildingsshouldbeestimatedand internalised in interestrates for financeofenergyefficiencymeasuresinthebuildingssector.

Public investments inenergyefficiencyyieldmore thanenergy savingsalone. The return onpublic investment can include increased wellbeing, economic development, energy security,health, andothersocietal benefitswell into the future.Policy makersshould takeawideviewand consider these benefits in designing and funding more ambitious policy instruments toimproveenergyefficiency.


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Introduction

The IEAprojectoneconomic instrumentsforthepromotionofhigherenergyefficiencyaimstoidentifyeffectivewaysofmobilisingincreasedinvestmentinenergyefficiency,byevaluatingthe

useof

economic

instruments

across

different

sectors.

This

analysis

should

help

policy

makers

from relevant institutions (such as energy,economy, financeor environmentministries)betterunderstand,selectanddesignappropriateeconomicinstrumentstoimproveenergyefficiencyinindividual sectors. Future reports under this project will focus on the transport and industrialsectors.

Thisreportfocusesontheuseofeconomicinstrumentstosupportenergyefficiency,particularlyinthebuildingssector.Theobjectivesofthereportareto:

Examine how economic instruments are currently used to improve energy efficiency,with a particular focus on improving the energy performance of buildings in IEAcountries;

Considerthe

most

effective

and

efficient

use

of

economic

instruments

to

drive

forward

lowenergybuildings;and

Identify the sources of public funding of economic instruments, where subsidies areneeded.

It should draw out insights for policy makers trying to identify and design the most applicablepoliciesfortheirnationalcircumstancesto improveenergyefficiency,notonly inbuildings,butalsoinothersectorswheresimilarconditionsexist.

Reportscopeandstructure

Thisreport

examines

the

experience

with

economic

instruments

in

energy

efficiency

policy.

It

is

targetedatpolicymakersdevelopingenergyefficiencypolicyinthebuildingsandothersectors.

Thisfirstsectionpresentseconomicinstrumentsrelevanttoenergyefficiencypolicy.Itdescribesthe range of economic instruments used in energy efficiency policy generally and outlines themain featuresofeach. Itshould providesomebackground on economic instruments and theirstrengthsandweaknesses.

The second section investigates how economic instruments are used to improve the energyperformanceofonesectorinparticular,thebuildingssector.Inthisinstance,thebuildingssectorserves to examine more closely the use of economic instruments in practice. This sectionprovides a systematic overview of the effectiveness of existing economic policies in delivering

low

energy

buildings

in

IEA

member

countries.

The

focus

is

on

policies

for

the

energy

efficiency

(EE)refurbishmentofexistingbuildings,andinparticulardeepretrofit,whichisthepriorityinIEAcountries,eventhoughinsomecasesalsopoliciesfornewbuildingsarecovered.

Thethirdsectionofthereportprovidesanoverviewofpossiblefundingsourcesandtherelevantintermediariesforeconomicinstrumentswhereapplicabletoenergyefficiencypolicy.Economicinstruments are made up of revenue raisers, i.e. taxes, charges, and trading schemes; andsubsidies.Thepublicfundingpartofthereportfocusesonthesourceoffundsforthesubsidiespart of economic instruments. The discussion of the different approaches to funding energyefficiencyisenrichedbyawiderangeofexamplesfromexperiencesinIEAcountries.

Thefirstandthirdsectionsarecrosssectoralandrelevantfor improvingenergyefficiency inallsectors. The middle section provides lessons learned from implementation of economicinstruments to improve the energy efficiency specifically in the buildings sector. It examines


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whether the current crop of economic instruments is delivering the deep cuts in energyconsumptioninbuildingsneededandhoweconomicinstrumentsshouldbeadaptedtomobilisethefinancethatwillberequiredinthefuture.

Methodologicalissues

The initial information on existing economic instruments has been obtained mainly from thecurrentIEApoliciesandmeasures(PaMs)databaseonenergyefficiency.3Thisdatabaseprovidesanoverviewofeconomic instrumentscurrentlyinoperation inIEAcountriestosupportenergyefficiencymeasures;thesehavebeenverifiedbycorrespondingwithcountriesthroughthe IEAEnergy efficiency Working Party government delegates and crosschecked with the OECDeconomicinstrumentsdatabase.4Insomecountries,thesameinstrumentsareusedtopromoterenewableenergyandthedistinctionhasbeenmadewherepossible.

The information was completed by a literature review of evaluations of economic instrumentsand funding mechanisms in the buildings sector. For selected countries (France, Germany,

Ireland,and

Italy),

in

depth

case

studies

of

country

experiences

with

different

types

of

economic

instruments and funding mechanisms were developed with input from policy makers in therespectivecountries.Thecasestudiesevaluatetheeffectivenessandefficiencyofdifferentpolicyinstruments using an evaluation matrix developed by the authors. First results, as well asevaluation methods and case studies, were discussed during an expert workshop, which tookplaceon15March2012inParis,France.5

Veryfewthoroughevaluationsofeconomicinstrumentsinenergyefficiencypolicyareavailablethatwouldfacilitatebenefitcostratiocomparisons.Theavailablesourcesdonotallowgeneralrecommendations on which policies are most effective or efficient. In many cases, evaluations

include more outcomerelated indicators (e.g. public spending, number of programmeparticipants)thanimpactrelatedindicators(reductioninenergydemand,reboundeffects,freeridership6) and where these are available, they are in many cases based on surveys of a smallsampleofprogrammeparticipantsandreportthetechnicalpotentialsofpoliciesratherthanreallife savings achieved. Additionally, the indicators used in available evaluations in differentprogrammesaretoodifferenttoallowacomparativeanalysis.7Oftenbaselinesarenotdefinedat thestart ofprogramsand then it ishard toevaluatewhatchanges haveoccurred from thebaselineasaresultofthisprogramme.Duetothelackofcomparabledata,theanalysisremainsqualitativeanddescriptivebutshouldneverthelessprovideinsightsforpolicymakersdevelopingstrategiestodramaticallyimprovetheenergyperformanceinbuildingsandothersectors.

3Availableatwww.iea.org/policiesandmeasures/

4www.oecd.org/env/policies/database

5Fordocumentationoftheworkshopsee:www.iea.org/newsroomandevents/workshops/name,14184,en.html

6Reboundeffectortakebackeffectiswhenimprovementsinenergyefficiencydonotrealisetheexpectedenergysavings

due to either more intensive activity (the direct rebound effect) or reinvestment of the financial savings in other energyintensiveactivitiesorservices.Freeridershipisthephenomenonofinvestorstakingadvantageofasubsidyeventhoughtheywouldhaveinvestedintheenergyefficientmeasureintheabsenceoftheincentive.Thismeansthatthesubsidyisgrantedtoconsumers who did not need it and that the programme is not creating any incentives for increased energy efficiencymeasures.7Althoughsomecountriesaredevelopingstandardisedmethodstoevaluateenergysavingsdatafromenergyefficiencypolicy

(i.e. in the US see http://www1.eere.energy.gov/office_eere/de_umpp. html; in the EU see http://www.evaluateenergy

savings.eu/emeees/en/publications/reports/EMEEES_WP61_report_090430.pdf


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PARTI:Economicinstrumentsinenergyefficiency

policy

Economic

instruments

in

energy

efficiency

policy

include

all

policy

instruments

that

relate

to

fiscal, financial and other economic incentives and disincentives to deliver energy efficiencyimprovementsacrossallsectors.

The term economic instruments is not welldefined in the context of energy efficiency policy.Often inenergyefficiencypolicythetermfinancial instruments isusedtodescribepoliciesthat

provide incentives forenergyefficiency measures.However, the termeconomic instruments isbroader and is used in the economics and environmental policy literature to describe price,incentives, finance, or trading schemes in policy. The term economic instruments moreaccuratelyencompassestherangeoffiscalinstrumentsandfinancialmechanismsusedbypolicymakersinenergyefficiencypolicy.

Economic instrumentsareusedbyallgovernmentsofIEAmembercountriesto improveenergy

efficiencyindifferentsectors.Theycanaddressbarrierstoenergyefficiencysuchas:

Marketfailuresincludingexternalities,whereenergyendusersdonotpaythefullcosttosociety of their energy consumption, and split incentives, which is when the economicbenefits of an energy efficiency measure do not accrue to the financier of thosemeasures;

Uncertainty and risk associated with recoupment of the costs of energy efficiencyinvestmentinthefuture;

Lackofaccesstofinanceforenergyefficiencyprojectsthroughunfamiliarity infinancialinstitutions, lackofcollateral,anddifficulty inmeasuringenergysavingsassociatedwithinvestmentsinenergyefficiency;

Relativelyhightransactioncostsofsmallprojects;and

Behaviouralissuesintheformofinertiaandboundedrationality.8

Figure 1 provides a schematic diagram for economic instruments. We categorise economicinstruments under four headings fiscal instruments, financial mechanisms, trading schemes,anddirectinvestment.Theclassificationofpolicyinstrumentscanbeamatterforsomedebate.We define fiscal instruments as those policy instruments that relate to the public treasury orgovernmentrevenuesandtherefore includetaxes,taxrelief,andusercharges inthiscategory.Financialmechanismsrelatetoraisingmoneyandmarketsthroughthe issuanceofdebtand/orequity.Aswithalldefinitions,therearesomegreyareas.Grantscouldbeincludedineitherthefiscalorfinancialcategories.Herewehaveincludedtheminthefinancialmechanismscategory,

as

most

governments

provide

grants

with

the

goal

of

leveraging

further

private

finance

for

energy efficiency.Direct investmentsbygovernmentsareoftennot included indescriptionsofsubsidiesandincentivesforenergyefficiencybutplayanimportantroleininfluencingpricesandmarketsforenergyefficiencymeasures.Theindividualinstrumentsaredescribedinmoredetailinthenextsections.

8 Bounded rationality iswhen decisionmakers do not make choices rationally, as generallyassumed in classicaleconomic

theory.


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Figure1Overviewofeconomicinstruments

Economicinstrumentsforenergyefficiency

Fiscalinstruments

Taxrelief

Taxes

Charges

Financialmeasures

Loans

Grants

Tradingschemes

Emissionstradingschemes

Whitecertificateschemes

Directinvestment

Publicprocurement

rules

Publicinfrastructure

RD&Dinvestment

Source:IEA

Economic instruments can overcome the presence of externalities by adjusting the costs andbenefits of an energy efficiency measure or by internalising the costs to society of pollutingbehaviour in order to reflect the effects on the public good associated with energy efficiencyimprovements on the one hand and pollution on the other hand. Split incentives can beaddressedbyensuringthattherearebenefitstotheagentinvesting inenergyefficiencyorthat

theinvestment

costs

can

be

passed

on

to

the

tenant

or

beneficiary

of

the

reduced

energy

bills.

The second barrier of uncertainty or risk can also be addressed by sending a longterm pricesignaltothemarket thatenergyefficiency is importantandreducingthecostsassociatedwithenergy efficiency investments. Similarly, the proportionally high transaction costs triggered bythesmallsizeofenergyefficiencyprojectscanalsobepartiallyovercomethrougharealignmentofincentivestoinvestinenergyefficiencybyeconomicinstruments.

Finally, evidence that consumer decisions are not always perfectly rational is quite strong(Gillingham et al., 2009). Economic instruments can address this partly by, for example,overcoming inertia through giving a strong price signal, by bringing energy efficiency to theattentionofboardsofmanagementinbusinessesorbysimplygivingconsumersthefeelingthat

theycan

make

agood

deal.

Tailoring to national circumstances and good design are important in the successful use ofeconomic instruments in energy efficiency policy. Firstly, the appropriate choice of economicpolicyinstrumenttoaddressalackofinvestmentinenergyefficiencymaydifferineachcountrydepending on national circumstances, such as economic situation, demographics, and energyprices,thebarriers identifiedto improvementsinenergyefficiency,andthetargetedsector.Ananalysis of these factors should be carried out in advance of the choice of instrument. Forexample, taxes, tax relief and grants are likely to be suitable tools to address externalities byreadjusting the prices of energy and energyusing equipment to promote energyefficientbehaviourandinvestments.However,biggerenergyefficiencyprojectsinindustryorinbuildings

may require additional economic instruments in the form of financial mechanisms, if the

significantfinance

needed

to

fund

these

projects

is

not

available

from

traditional

sources

due

to


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theissuesgivenaboveinthebarrieronlackofaccesstocapital.Countriesmayprioritiseenergyefficiencyinonesectoroveranotherbecauseofhistoricalorprojectedenergyuseinthatsectororperceivedaccessibility. It is importanttoknowwhicheconomic instrumentsare likelytobemoresuitabletoaddressenergyefficiencyintheprioritysectors.

Secondly,good

design

of

economic

instruments

is

important

and

may

have

as

strong

an

influence

on the effectiveness and economic efficiency of the policy as the type of policy instrumentchosen in some cases. Monitoring and evaluation of the economic instrument are importantchecks to determine if progress is made towards energy efficiency goals, as defined at theintroductionoftheeconomic instruments.Stability inthedesignand longtermfunding(wherenecessary) of economic instruments is needed to give investors confidence in the viability ofenergy efficiency measures. Choosing the appropriate source of funds for such economicinstrumentsispartofthisprocess.

Thegoalofeconomicinstruments istoultimatelykickstarttheprivatefinancialmarketsandtomotivate investors to fund energy efficiency measures. An important indicator of theeffectiveness of economic instruments is the amount of private funds leveraged through the

public

funds

spent,

called

the

leverage

ratio.

The

definition

of

leverage

ratio

varies

between

financial institutions and countries. From a government authoritys perspective it can beapproximatelydefinedastheratiobetweenthetotalamountfinancedforanenergyefficiencymeasure and the total amount of public funding provided. However, there can be differentdefinitionsused(asreviewedbyBrownetal.2011,CDCClimate2012,Clappetal.2012,UNAGF2010) and therefore clear definitions are needed when discussing the leverage ratio. In thisreport,thetermleverageratioisusedtomeantheratioofthepublictoprivatecofinancingofanenergyefficiencymeasureorproject.9

Theleverageratiomaynotbethemostimportantmeasureofeffectivenessofpublicfunds.Forexample,itismaybepossibletofindprivatefinancemorereadilyforlowercostmeasuresthanhighercostmeasures,resultinginahigherleverageratio,althoughitmaybeinsocietysinteresttousepublicfundingforhighercostenergyefficiencymeasures.Moreimportantmaybewhichkindsofenergyefficiencyprojectsarebeingdeliveredasaresultoftheeconomicinstrument,i.e.whetherdeepercutsinenergyconsumptionareachieved.Nevertheless,ahighleverageratioisaveryimportantaspectasitmaximisestheimpactofeveryunitofpublicmoneyinvested.

In all cases, economic instruments should be part of a policy package made up of regulatory,informationandeconomicpolicies.Withoutacoherent,consistentpolicyframework,economicinstrumentsarelesseffectiveandeconomicallyefficient.Economicinstrumentsontheirownwilloftennotbeenoughtotransformthemarketforenergyefficiencyproductsandservices;longertermregulationsandframeworksareneededtoprovideforwardlookinginvestorswithdirectionand reassurance that energy efficiency is a longterm trend and requirement. Information and

awarenessraising

measures

are

needed

to

support

behavioural

change

and

achieve

real

world

reductionsinenergydemand.

The next subsections describe the main features of economic instruments as they are used inenergyefficiencypolicy.

EnergytaxesandpricesubsidiesEnergy taxes and price subsidies are economic instruments that directly affect the price ofenergy.Theyarethetwomainfiscaltoolsatgovernmentsdisposaltoinfluencethepricepaidfor

9ThisissimilartothedefinitionusedbyclimatefundssuchastheGlobalEnvironmentFundandtheCleanTechnologyFund

(Brownet

al.

2011).


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energybyconsumers.Highenergypricesprovidean incentive to invest inenergyefficiency astheyshortenpaybackperiodsandincreasethenetbenefitsofsuchinvestments.Conversely,lowenergypricesanddirectenergysubsidiesencouragemorewastefulconsumptionofenergyandmakeinvestmentsinenergyefficiencylessattractive.

Asafirst

step

to

encourage

improved

energy

efficiency,

it

is

important

to

remove

energy

price

subsidies as far as possible. This is a precondition for the effective use of other economicinstruments.Subsidisingenergyefficiencyinvestments,whileatthesametimesubsidisingenergyconsumption, is a less efficient and effective use of public funds. The uptake of financinginstruments that address the availability of financing for energy efficiency investments is alsolikelytobehigherifenergypricesareelevated.

Within OECD countries,directly subsidised energy prices remain the exception rather than therule, even though a number of various indirect subsidies exist (e.g. subsidies for R&D, publicinsurancefornuclearplants,military interventionstosecureenergysupply infrastructure,etc.).But indirect subsidies are very difficult to track. A preliminary OECD inventory of estimatedbudgetarysupportandtaxexpendituresforfossilfuelsacross24OECDcountries,remarksthat,

withinthe

OECD,

the

consumption

of

the

majority

of

fuels

is

taxed

to

some

degree.

And

even

though between USD 45 billion and USD 75 billion in support for production and use of fossilfuelshasbeenidentified,thesearemainlyexemptionsfromsomeformofenergytaxes.Notallofthemcanclearlybe labelledas inefficientsubsidies(OECD,2011b).Whereenergyconsumptionsubsidiesexistandaredeemednecessary, itshouldbeensuredthatthesearewelltargetedtoservetheiroriginalpurposesandtoavoidincentivisingwastefulenergyconsumption.

Energy taxes are often set with the main purpose of raising revenue rather than influencingenergy consumption. However, a large area of study is on the potential double dividend ofraisingenergyorotherenvironmentaltaxes.This literature focusesonestimatingthepotentialdoublebenefitofenergytaxesthroughbothareductionindemandforenergyconsumptionandincreased revenue, facilitating the lowering of other taxes, for example on labour (Bovenberg,1999).

The OECD/EEA database on instruments used for environmental policy and natural resourcemanagementdefinesenvironmentallyrelatedtaxesasanycompulsory,unrequitedpaymenttogeneral government levied on taxbases deemed to be of particular environmental relevance.Taxes are unrequited in the sense that benefits provided by government to taxpayers are notnormally in proportion to their payments.10 Environmentallyrelated taxes can be used toincludecosts inthepriceofenergy thatarenot includedbythemarketbutwhicharepaidbysociety,suchase.g.healthcostsduetoenvironmentalpollution.Therevenuesfromenergytaxesmay flow intocentralgovernment treasuriesbut inmanycountriesaportionalsomaybeearmarkedforenergyrelatedpurposessuchasenergyefficiencyandrenewableenergy.

TaxreliefTax relief isaneconomic instrument thateffectivelyreducestaxesonparticulargoodsorforacertain part of the population to correctmarket failuresand in this case overcome barriers toenergy efficiency investment. It is referred to by the OECD as taxexpenditures and defined asprovisions of tax law, regulation or practices that reduce or postpone revenue for acomparatively narrow population of taxpayers relative to a benchmark tax (OECD, 2010a). Inenergyefficiencypolicyseveraltypesoftaxreliefarecommonlyusedwhichreducetax liabilitywheninvestmentstoimproveenergyefficiencyaremade:

10The

database

and

definitions

are

available

at

www2.oecd.org/ecoinst/queries/

version

from

13.04.2012.


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Tax deduction: eligible investment costs relating to energy efficiency measures can bededucted (fully or in part) from income or revenues liable to taxation. Eligible investmentcostsmostlycoverpurchasecostsof materialsorequipmentimprovingenergyefficiency,butmay also include related services such as the installation costs of an energy efficiency

measure;

Taxcredits:aresimilartotaxdeductionsbutinvestmentcostsarededucted(fullyorinpart)from respective taxes due to be paid. Tax credits may also be refundable if tax credits arehigherthantaxesdue,whichisthecaseforexampleinBelgium.11

Tax reductions and rebates: purchase taxes or sales taxes are reduced for qualifyingequipmentorservices,e.g.reducedvalueaddedtaxesforinsulationmaterialandinstallationservices in the United Kingdom.12 This is either done directly at the point of sale (taxreductions)orapplicationsfortaxrefundmustbefiledafterthepurchase(taxrebates);

Accelerated depreciation allowances, which allow purchasers to writeoff the cost ofdepreciationofqualifyingequipmentmorerapidlythanstandardequipment,thuseffectivelyreducingtheaftertaxtotalcostoftheequipment;

Tax or customs duty exemptions

which

relieve

purchasers

from

paying

customs

duties

or

importtaxesonqualifying importedequipmentorexcisetaxonconsumptionorpurchaseofspecifiedproducts,e.g.highlyefficientappliances.

TheWorldEconomicForumnotesthatoneadvantageoftax incentivesovergrants, isthattheyaremore likelytoencouragegreaterscaleofprojectsastheyareusuallygrantedovera longertimeperiodanddonothavealimitedbudgetattached(WEF2011,pp.25).

GrantsThrough grant schemes, an amount of money that covers all or part of the energy efficiencyinvestment is provided to individuals or businesses. The award of a grant may be for specific

piecesof

energy

efficient

equipment

(on

atechnology

list

for

example)

or

may

be

tied

to

energy

performance,andmaybesetatafixedamountorasashareoftheinvestmentmade.Grantscanbefundedthroughenergyefficiencyagencies,dedicatedfundsorpublicbanks.

Grants can be effective in encouraging people to undertake investment in energy efficiencymeasures that they might not otherwise do. But in order to actually influence investmentdecisions,theyneedtocoverasignificantshareofthetotalinvestmentcosts.Thereforegrantsinenergy efficiency programmes have tended to favour less ambitious measures where theinvestmentcostsarelower.

Grant schemes are costly to public budgets compared to other forms of finance such as lowinterestloans.Fromanadministrativepointofview,programmerunningcostscanbelowerfor

grantsschemes,

compared

to

loan

schemes,

because

no

payback

needs

to

be

administered.

Comparedtotaxincentives,grantsmightbeequallycostlyinthattheamountssubsidisedmaybethe same. However, grants require outlay of the public budget, while tax incentives impactrevenues. Costs for grants may, however, be easier to track and control as they will have acertainbudget limit,whereastax incentivesaredifficultto limittoacertainamountofrevenueforgoneandtheamountsmayonlycometolightattheendofthefiscalyear.Taxincentivesmaybemoresuitable for larger investments,asthesubsidy is likelytorepresentasmallershareof

11Seeformoreinformation(inFrench):http://www.minfin.fgov.be/portail2/fr/themes/dwelling/energysaving/index.htm

12Seeformoreinformation:http://webarchive.nationalarchives.gov.uk/+/http://www.hm

treasury.gov.uk/budget/budget_2000/press_notices/bud_bud00_pressenergy.cfm


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theoverallinvestmentbecauseitislimitedtothetaxratenormallypaid.13

Freeriding,i.e.theshareofpeoplethatwouldalsohaveinvestedintheabsenceoftheincentive,is an important issue for both grants and tax incentives. Therefore eligibility criteria for botheconomicinstrumentsshouldbeambitioustoensurethatthesubsidytargetsadvancedproducts

andreal

energy

efficiency

improvements.

LoanprogrammesFinancemaybeneededtocovertheupfrontcostsofmeasurestoimproveenergyefficiency.Forambitious measures thatsignificantly improve the energy performance of a building, industrialfacility or other assets, the investment may be considerable and require debt financing. Debtfinancing,suchasloans,seemstobeparticularlyadaptedtothecharacteristicsofcomprehensiveenergy efficiency investments, which can have high upfront costs and lead to monthly savingsthatmaybeusedtoservicethedebt.

Anotheradvantageof loan financing isthat it isawellestablishedwayof financingupgradeor

constructionmeasures

and

that

expenditures

for

energy

efficiency

investments

may

piggy

back

on loan financing for othergeneral investments.However there areseveralbarriers to privatedebtfinanceforenergyefficiency improvements,whichmeansthatpublicpolicyandfundsareneededtointerveneinthemarket.

From the investors perspective, there may a number of reasons for reluctance to take onincreaseddebtto financeenergyefficiencymeasures.Thesemay includeageneralaversion todebt, a lack of interest in undertaking investment in energy efficiency measures or a lack ofconfidence that investments will lead to the estimated savings. Another barrier is that a largeinvestmentin,forexample,adeepretrofit,mayrequireasubstantialloanoveralongperiodoftime.Howeveriftheassetissoldintheshortormediumterm,i.e.beforematurityofthatloan,theinitialinvestorwillberesponsibleforfullrepaymentoftheloanwithoutanyguaranteethat

theresale

value

of

the

property

or

business

will

reflect

the

energy

efficiency

investment.

Fromthelendersperspective,despitetheslowlybutsurelyincreasingamountofinformationon

theeffectivenessofenergyefficiencyinvestments,privatelendersstilldonottranslatethelowerrisksandhigherreturnsofgreeninvestmentsinto lowerinterestrates(Katsetal.,2011pp.2021).Sincetherepaymentisbasedonprojectedenergysavingsratherthanassetstosecuritisetheloan, financial institutions may perceive energy efficiency loans as higher risk. Additionally,industrialfacilitiesorbuildingsoftenalreadyhaveaprimaryloanattachedforwhichthebuildingisusedascollateral.Acquiringasecond loan for thesamebuildingoranextensionto the firstloan can be complicated, but may be possible especially when much of the original loan hasalready been repaid or when the upgrade positively affects the business or property value.Evidenceonmarketpremiumsforenergyefficiency investmentsarediscussed inmoredetail inthesectiononinstitutionalinvestingandprivateinvestmentfundsinthethirdpartofthereport.

Variousformsofeconomic instrumentsareused inenergyefficiencypolicytosupportthedebtfinance or loans market for energy efficiency measures. Governments can support loans byinterveninginthemarket,eitherdirectlywithcreditlinestofinancialinstitutionsatconcessionalormarketratesorprovidingloansdirectlytoinvestors,orindirectlythroughpoliciesthatenablefinancing arrangements through third parties (described under Other structured finance). Inbothcases taking loans forenergyefficiencybecomesmoreattractive topotential investorsas

13 This depends on the rate of tax normally paid; for industry, corporate tax varies considerably between countries. In

countrieswherecorporatetaxisloworthereistaxreliefondepreciationofequipmentinanycase,thesubsidyforenergy

efficiencymeasures

is

likely

to

be

alow

share

of

the

investment.


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wellastolocalfinancialinstitutions.

Closecooperationwithprivatefinancialinstitutionswithregardtoprogrammeimplementationis very important for several reasons. Governments can use the existing, often highlydecentralised, structures of private financial institutions to engage directly with potential

investors.

Also

making

use

of

their

financial

expertise

and

methods

of

client

advice

andassessmentisveryimportant.Inordertofamiliarisefinancialinstitutionswiththespecifications

oftheloanprogrammes, includingtechnicalknowhowonenergyefficiencyaswellaseligibilitycriteria,specialisedtrainingandtechnicalassistanceisnecessary.Thisisalsoimportanttoenablethe private financial sector in the long term to serve this market segment without furthergovernmentengagement.

Concessionalloans

Concessional loansarewhensubsidiesareprovidedto reduce thecostof loans to investors inenergyefficiencymeasures.Thereareseveralwaysthiscanbedone.Publicfundsmaybeusedto

fundthe

whole

loan

amount

through

credit

lines

to

commercial

financial

institutions

that

are

thenonlentatpreferentialtopotentialinvestors.Financialinstitutionscanfindthismechanismattractive,astheydonotneedtousetheirownfunds,anditcanencouragethemtoengage innew(energyefficiency) lendingactivities.This isespeciallyattractive intimeswhere liquidity isconstrained,i.e.whenitisdifficultorexpensivetogetrefinancingonthefinancialmarkets.

Alternatively,public fundscansubsidiseonlythe interestratesand/orcanprovidepartialdebtrelief for energy efficiency loans. The remaining loan amount is provided by fully participatingfinancialinstitutionsorthirdparties.Theinterestratesubsidymaybepassedoninfulloronlyinparttotheborrowers.Subsidisedinterestratescanbeofgreatinteresttopotentialinvestors,asthey can significantly cut financing costs depending on how high is the subsidy. However, incontrast to credit lines, subsidised interest rates may not be enough to encourage financialinstitutionstoactivelyseekcustomersforloansforenergyefficiencymeasures,asthereisstillariskinvolvedwiththeloanthatmaybeperceivedashighcomparedtoloansinareasthebankismorefamiliar.

GuaranteesSomeofthebarrierstoenergyefficiencyfinancerelatenottoa lackofavailabilityoffundsbutrathertotheperceptionofrisk.Risksharingarrangements inthe formof loanguaranteesthatreducetheperceived risksassociatedwith the investmentcan increase the leverageofprivatedebtfinanceandinvolvenewactorsinfinancinginvestmentsinenergyefficiency.

Loanguarantees

are

when

public

funds

provide

default

guarantees

for

loans

to

energy

efficiency

projects.Therisksharingfacilitycomprisesapublicpartnerthatwillguaranteeallorsomepartof the risk, a local financial institution that provides loans and energy efficiency projectdevelopers in need of project finance (IEA, 2011a). Guarantees can be given for specific largescale projects with a risk sharing agreement adapted to the specific project design or to aportfolio of similar projects, i.e. all loans to a certain class of borrowers (portfolio guarantee).Alternatively,a loan lossreserve fundcanbesetuptopay (fullyorpartially) for loandefaults.Suchafundcanalsoserveasatemporalbuffer,whenthere isnottheriskofaclientsdefault,

but payments are simply delayed (Rezessy and Bertoldi, 2010). Risk guarantee funds typicallyhaveasizeof210%oftheoverallloanportfolio(Katsetal.,2011pp.37).

Losses

can

be

taken

over

fully

or

partially

by

the

public

institution.

The

risk

remaining

with

the

privatebankwilldeterminebyhowmuchtheriskpremiumontheloancanbedecreased.There


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existanumberofdifferentwaystosharetheriskbetweenthepublicinstitutionandtheprivatebank(IEA,2011a):

Equalrisksharing(paripassu):eachpartnertakesonanequalshareoftheloss.

Prorataguarantee:thelossissharedaccordingtoapredefinedpercentagebetweenthe

partners;atypical

share

of

the

public

party

can

lie

between

50%

and

80%.

Firstlossguarantee:all lossesuptoapredeterminedmaximumamountwillbecoveredbythepublicinstitution,whiletheprivatebankpaysforlossesabovethisamount.

Secondloss guarantee: all losses exceeding a predefined amount are paid for by thepublic institution.Potential lossesoftheprivate institutionarethuscappedandcannot

exceedthedeterminedamount.14

OtherstructuredfinanceOther financial instruments do not require public funds directly but enable financingarrangements to facilitate third party finance for projectbased loans (loan enhancements).

Governments

can

ensure

that

the

legislative

framework

is

in

place

to

enable

various

loan

repaymentmodesandnewbusinessmodelstofinanceenergyefficiencymeasures.

Thisencouragesprivate finance in themarket forenergyefficiency.Wegroupseveraloftheseinstrumentstogetheras:

Energyprovideronbillfinancing(tariffsandloans)

Propertyassessedcleanenergy(PACE)

Energyperformancecontracting

Onbillfinancearrangementsthroughenergyproviderstietherepaymentsofloanstopaymentofexistingutilitybills.Policyisfrequentlyrequiredtoenableenergyproviderstoprovidefinance

to

customers

and

to

develop

the

legal

arrangements

required

to

sort

out

seniority

of

payments,

andliabilityfornonpaymentissues.

The investor avoids putting up the full amount of finance initially for the upfront costs of theenergyefficiencymeasuresbutpaysthecostsaspartofregularutilitybillpaymentsovertime.The loan can, in some cases, be transferred with ownership of the business or property, thusenablinglongerpaybackperiodsofupto20years.

Onbillfinancecanassistinovercomingthemarketfailure,splitincentives,thatoftenoccursasabarrier to investment in more ambitious and/or costly energy efficiency measures over longperiods because the investor may not recoup the benefit of his investment. Firstly, tying theamountofrepaymentstotheenergysavedgivesasenseofsecurityandaperceivedavoidanceofupfront costs. Secondly, attaching repayment of the loan to the asset rather than the initialinvestor

means

that

there

can

be

an

incentive

to

undertake

longer

term

finance

and

therefore

moreambitionsmeasures,even ifhewishestosellthebusinessorpropertybeforethe loan ismatured. Energyproviders are wellpositioned to provide onbill finance since they have aregular payment method in place. They also have a large and broad commercial and privatecustomerbasethatcanbetargetedforenergyefficiencyimprovements.

Property assessed clean energy (PACE) schemes represent a special kind of onbill financingarrangement where the local government institutions that administer property taxes provideloansforenergyefficiencyinvestments.Thelocalpublicinstitutionprovidesaloantotheowner,which is repaidviaanassessment (orsurcharge)on thepropertytax.PACEcan inprinciplebe

14These

are

described

in

detail

in

another

IEA

report

PublicPrivatePartnershipsforEnergyefficiencyFinance

(IEA

2011).


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appliedtotheresidentialandthecommercialsector,butonlybuildingownerscanmakeuseofit(RezessyandBertoldi,2010ppp. 3839).Thesplitincentivebetweenownersandtenantscanbeovercome incaseswherepropertytaxpaymentsarepassedthroughtotenants,which isoftenpossibleforcommercialorindustrialtenants(DellaCroce,KaminkerandStewart,2011ppp. 4344).

Energy performance contracting (EPC) presents another way of organising energy efficiencyfinance. It involvesan EnergyService Company (ESCO)whichcanprovideavarietyofservices,includingfinanceinsomecases,butmostimportantlywillguaranteeenergysavingsofacertainamount.TheremunerationoftheESCOdependsontheachievementoftheguaranteedsavings.As the guarantor of the savings, the ESCO remains involved in measuring and verifying thesavingsduringthedebtrepaymentperiod.ESCOsmayalsoprovideother formsofcontracting,suchaschauffage,firstout,BuiltOwnOperateTransferorleasingcontracts(BertoldiandRezessy,2005).ESCOsandenergyperformancecontractingaremainlyfoundinthepublicsectorbutalsosomeexamplesexistintheindustrialandcommercialbuildingssectors.

ManygovernmentsareinterestedinonbillfinancingmechanismsandESCObusinessmodelsfor

theirability

to

address

some

of

the

key

barriers

to

energy

efficiency

finance.

However,

they

can

be complex and costly to set up and there have been varying levels of success in theirimplementationtodate.

WhitecertificatesandobligationschemesAwhitecertificateisadocumentissuedbyanauthorisedbodycertifyingthataspecifiedamountof energy savings has been achieved. Markets for white certificates can be set up as part ofenergysupplierobligationschemes.Thecertificatescanbeusedbythecompanywhohassavedtheenergyforcompliancewiththeirenergysavingtargetsorcanbetradedwithotherfirms in

thesameobligationscheme.

Obligation

schemes

that

require

energy

providers

to

engage

in

energysaving

activities

are

a

growing phenomenon worldwide. Obligation schemes as such can be considered a regulatoryinstrument, as energy providers are obliged by law to engage in energy saving activities withregardtotheirclients(UNEP,2007ppp. 3233).

Underobligationschemes,energyprovidersmayachievetherequiredenergysavingsviaarangeof instruments implemented by themselves or through subcontractors, these may include:information, communication, advice and assistance as well as offering customers financialincentives, offering the replacement of equipment which may be acquired through bulkprocurement or even the implementation of comprehensive measures (Heffner, DuPont andRybka,2012).Thescopeofenergyprovidersincludedintheschemediffersbycountryinsomecases only electricity suppliers are obligated whereas in others, the scope is much wider andincludesheatingfuelandtransportfuelproviders.

Some obligation schemes enable energy providers to provide some form of energy efficiencyfinance and to eventually recover the related costs via the energy bills (onbill finance asdescribedabove)orthroughspecificusercharges(publicbenefitcharges).Thismayincludethepossibilityforenergyproviderstotakeondebt.Throughtheobligationscheme,energysuppliersmaybemotivatedtoprovideanimportantsourceoffinanceforinvestmentsinenergyefficiencytocustomersorprovideincentivestoencourageprivateinvestmentinenergyefficiency.

Tradingofwhitecertificatesencouragessomeflexibilityinthemarketandeconomicefficiencysothat energyproviders with lower costoptions carry out moreenergy efficiencymeasures thanthosewithhighercosts.Whitecertificateschemescanalsoenableotheractorsthantheobliged

partiesto

engage

in

energy

efficiency

investments

as

the

white

certificates

provide

aform

of


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(additional) remuneration to these investors. This additional revenue can be an incentive toinvest in the firstplace (asthepaybackperiodcanbeshortened toanacceptable level)or tomakeagreaterinvestment(whilekeepingthepaybackperiodconstant).

CarbonmarketsCarbonmarketscanprovideasourceoffundsforenergyefficiencymeasures.Therevenuesfromemissions trading schemes can be used to fund energy efficiency measures. Alternatively,greenhouse gas (GHG) emission reduction projects, i.e. energy efficiency measures, in need offundscanbematchedwith investorsthatareobligedtofinanceabatementactivitiesundertheUNFCCCKyotoprotocol.15 In this latter case, there isno lending or granting of funds involved;instead, emission reductions are purchased. Carbon markets thus present a way of leveragingprivate and public funds for energy efficiency measures for the purpose of reducing GHGemissions(RezessyandBertoldi,2010).

Twogeneraltypesofmarketmechanismshavebeensetupp. ThefirstisGHGemissionstradingschemes, both at the national or regional level, to fulfil local climate objectives, and

internationallyunder

the

UNFCCC

Kyoto

Protocol.

Companies

covered

by

the

emissions

trading

schemesarerequiredtoholdsufficientallowancesfortheGHGemissionstheyproduce.Theseallowancescanbetradedwithothercompanies inthescheme.Energyefficiencymeasurescan

be an important lowcost way for companies to reduce their emissions. If allowances areauctioned,therevenuesareaccruedbythetreasuryandcanberingfencedforenergyefficiencymeasures.

The second type of mechanism is crediting schemes, such as the Kyoto Protocols CleanDevelopment Mechanism (CDM) and Joint Implementation (JI). These allow obliged parties tofinance GHG emission reduction activities outside their territories. Through a CDM project, an

obligedpartycanfinanceabatementactivitiesindevelopingcountries,whilethroughJIprojects,

an

obliged

party

can

finance

abatement

activities

in

another

country

equally

obliged

under

the

Protocol. In both types of schemes GHG emissions reductions in industrial sectors and energyprovidershavemainlybeentargeted.

PublicprocurementandinfrastructureinvestmentThepublicsectorholdssignificantpotentialtoimproveenergyefficiencybydeployingadvancedtechnologies and/or developing the market for improved energy efficiency. The small size ofenergy efficiency projects is a significant barrier facing energy efficiency measures. The publicsectorisanimportantmarket,representingbetween10and20%ofnationalGDP,thatcanassistindevelopingthemarketforenergyefficiencyproductsandservicesthroughitsnotinsignificantpurchasingpower(Singhetal.,2010).Inmanycountriesfacilitieswithacommonfunctionsuch

as

schools

and

hospitals

offer

opportunities

to

bundle

energy

efficiency

projects,

attracting

largerscale financeand new businesses to theenergyefficiencymarket. Thepublicsectorcanalsoplaya leadershiprole indemonstratingthepotentialofenergyefficiencytoreduceenergyconsumptionandshowcasingnewtechnologiesandenergymanagement.The largepurchasingpowerofthepublicsectorcanbeacatalystfordevelopingtheenergyefficiencymarket(Singhetal.,2010)

However, in many countries, barriers remain to public sector investment in energy efficiency.Rules governing the public procurement of energy savings performance contracts (ESPCs) and

15UnitedNationsFrameworkConventiononClimateChangeKyotoProtocolavailableat

http://unfccc.int/kyoto_protocol/mechanisms/items/1673.php


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energyefficient equipment can overcome many of these barriers. Governments have useddifferentapproachestoencouragetheprocurementofenergyefficiencyservicesandproducts,including the creation of dedicated agencies to the procurement of energy efficiencyrelatedservices, establishing model contracts, creation of public energy service providers to avoidprocurementrelatedissues(Singhetal.,2010;IEA,2011a).Anotherwayistorequirethatagiven

energyperformance

improvement

is

achieved

by

the

public

sector

and

ensure

that

there

are

no

institutionalormarketbarrierstoimplementingtherequirement.

EnergyefficiencyR&DsupportReducingenergyconsumptionrequiresnotonly incremental improvements intechnologiesbutalso breakthrough developments. There are three welldocumented steps in technologicalchange invention, innovation, and diffusion or adoption (Schumpeter, 1942). The economicinstrumentsforenergyefficiencydescribedabovefocusonimprovingthepricesignaltosupportthis third step by encouraging consumers and businesses to invest in energy efficiency.Governments also need to ensure sufficient longterm research and development (R&D) to

provideincentives

for

supply

driven

technological

change.

Thejustification for using public funds to invest in R&D is explained by two market failuresfirstly,therearepositiveexternalities,where thebenefitsof theR&Darenot recoupedby the

investor, in the form of a time lag between the moment of investment and the benefits fromR&D to the company and the public. There are also spillover effects where other companiesbenefitfromtheR&Dofthecompanywhoinitiallyinvestedinatechnology.Secondly,ifenergypricesarenothighthereislit

mobilising investment ee final

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