CDIE Impact Evaluation SAVING ENERGY IN THE CZECH REPUBLIC After 40 years of communist political repression and a straitjacket of economic controls, the Czech Republic has broken free. USAID has played a key role in two major problems facing the country: inefficient energy use and high levels of pollution. USAID projects demonstrated that energy conservation can þ Reduce wasteful and inefficient industrial energy use at relatively low cost þ Generate high rates of return for individual factories and the country þ Reduce pollution at relatively low cost þ Be effectively promoted by a nongovernmental organization The projects also pointed up some areas of difficulty: þ An uncertain investment or business climate deters investments in energy conservation þ Price distortions harm energy efficiency þ A technical solution of better equipment is rarely enough; improved business planning, marketing, and finance are needed þ There is a need for a more effective strategy for test-marketing and disseminating new approaches to energy conservation PN-ABS-546 1996, Number 2 SUMMARY The Czech "velvet revolution" of 1989 ended 40 years of communist rule and set the stage for major democratic reforms. Along with dramatic political change came economic reforms heading the coun- try away from central planning and toward a relatively open and free market. Under communism, central planners decided what would be produced and how. For a new factory, for example, planners would choose a site, pick a production process, select equipment, and deter- mine the type of workers needed. Planners and factory managers made technical decisions only--they did not worry about prices and markets. Market demand was not a concern; nor was the price of labor, machinery, energy, and raw materials. Planners believed society's problems were best solved by cheap energy, cheap capital, and subsidized prices for major industrial inputs and essential consumer goods. The environment was seen as a free input, with almost no attention to pollution and health-related effects. With the end of communism the economy shifted to international prices, and many Czech firms now faced international competition. The move to a market-based economy was traumatic, particularly for industries with old and inefficient equipment. Czech industry had some advantages--industrial quality was good and workers were highly skilled and relatively low-cost. However, industrial energy requirements were extremely high, and industrial pollution was poisoning the population. The Czech Republic is situated in the "black triangle," one of the world's environmental hot spots. Severe environmental degradation results from economic policies that promoted highly polluting heavy industry, discouraged energy conservation, encouraged the use of dirty fuels, and had few con- trols on industrial pollution. In fact, while the Czech people harbored a wide range of complaints against the communist government, a universal rallying cry was the environment. They may not have understood how economic theory relates energy efficiency to energy pricing and pollution, but they did understand how poor environmental conditions affect their health and living conditions. The overall USAID assistance program dealt with a number of problems in the transition from a centrally planned economy to a free market economy.* One of the biggest problems in the transition was cheap energy. USAID confronted that problem with two projects. The Emergency Energy project began in 1990 and was followed six months later by the Regional Energy Efficiency project. The rationale for Agency assistance was economic: if the Czech economy could use energy more effi- ciently, it could maintain economic momentum, advance economic restructuring, and deal with pollu- tion problems. The projects provided consultants, training, energy audits, and energy conservation equipment. They also provided support for a nongovernmental energy conservation organization known by the acronym "SEVEn." All together, the projects invested approximately $500,000 in sup- port of energy conservation at five industrial plants. The projects demonstrated that energy conservation works. Companies that made energy investments saw very high financial rates of return, averaging 122 percent. This represents financial costs and benefits directly related to the company and the energy it saves. It excludes benefits flowing to the economy as a whole (reduced pollution, increased taxes) and costs to the economy and USAID for project management. Including these costs and benefits yields an economic rate of return for the economy as a whole of 50 percent--still a very good rate. SEVEn has played a major role in energy conservation. Being separate from the government and special interests, it has been able to press the government for policy reforms while serving as a matchmaker, bringing together industry and energy service providers. In most other countries USAID has had only fair to poor results working with government energy organizations. Working with a nongovernmental organization might provide a model worth following elsewhere. Energy conservation is more than a technical or engineering issue of making energy-efficient equip- ment available. Business decision-making is influenced by prices, markets, and incentives. Under communism, Czech industry directed all attention at meeting production targets, not reducing costs. Prices and incentives did not encourage energy efficiency or controls on pollution. Even now, with communism gone and with nearly free markets, the old business culture survives in many firms. Moreover, it has taken the government several years to shift most energy prices to international lev- els. The government has stressed pollution control rather than energy conservation. Stiff regulations and fines have forced factories to switch to cleaner fuels and improved burner combustion. Pollution con- trol has done more than just cut down on pollution--it has discouraged wasteful and inefficient energy consumption. A factor impeding widespread success of the USAID project was limited dissemination. The project succeeded at the five demonstration factories and with SEVEn, but the energy conservation message has been slow to spread throughout the country. The technology clearly works, but more needs to be done to spread the word. CDIE STUDY In September 1995, a four-person team assessed two USAID energy conservation projects: the November 1990 Emergency Energy project and the May 1991 Regional Energy Efficiency pro- ject. The team consisted of Joseph M. Lieberson, team leader and economist with the Agency's Center for Development Information and Evalua- tion (CDIE); Matthew Addison, energy econo- mist with Development Alternatives, Inc.; Frank Hahn, energy engineer with Development Alter- natives, Inc.; and Alberto Sabadell, environmen- tal engineer with USAID's Global Bureau. This was one of six impact assessments on ener- gy conservation carried out by CDIE. The other countries in the series are Guatemala, Hungary, Jamaica, Pakistan, and the Philippines. All of the country evaluations examined the economic and environmental impact of USAID projects by ex- ploring the same four questions: 1. Policy reform. What has been the impact of government energy policy, energy pricing decisions, environmental policy, and privatization? 2. Technology transfer. Was the right tech- nology selected, was it adopted, and is it still being used? 3. Education and awareness. How success- ful was the project at spreading the energy conservation message? 4. Institution building. Were government and private sector institutions strengthened to the point where they could pro- mote energy conservation after USAID funding ended? BACKGROUND The Czech Republic is shifting to a free market system and opening its economy to trade with Western Europe. However the economy has a major problem: it is excessively dependent on energy. Compared with Western European coun- tries, the Czech Republic requires nearly six times more energy to produce a unit of gross do- mestic product (GDP) (see figure 1). This is due to inefficient energy production and transmis- sion, use of antiquated and energy-wasteful capi- tal equipment, and artificially low energy prices that discourage conservation. In addition, high energy use and dirty fuels generate air pollution four to eight time higher than in Western Europe (see figure 2). Project Rationale: Why Energy Conservation? After the fall of communism, Czechoslovakia launched major economic reforms. But in late 1990, just as reforms were starting, the economy faced a serious economic crisis because of dra- matic changes in international energy markets. Almost all oil and gas had been imported from the Soviet Union, and the Soviets were now cut- ting back on deliveries and shifting to hard-cur- rency payments. With Iraq's invasion of Kuwait and the cutoff of Iraqi and Kuwaiti oil, interna- tional prices soared. Experts assumed oil prices would remain at $31 a barrel (from a 1990 preinvasion low of $13) and possibly move higher. The new, democratically elected Czech govern- ment was starting to reform and modernize the economy, but higher oil prices and energy short- ages could derail those efforts. Faced with mounting financial and industrial problems, pres- sure might arise to return to the old system of state controls and allocations. USAID assistance could help cushion the shock and even use the energy crisis as a way to reform Czech industry and encourage a market-based approach toward development. The rationale for USAID assistance was eco- nomic: a Czech economy using energy more efficiently would save foreign exchange, maintain economic momentum, and then move forward on economic restructuring. Energy conservation was a means to help the economy--not an end in itself. USAID projects provided energy consul- tants, energy audits, funds for energy con- servation investments, and training for Czech energy auditors who then helped factories improve their energy efficiency. The project also provided start-up funding for an energy/environmental group known by the acronym "SEVEn." A nongovern- mental organization (NGO), SEVEn is now highly successful and operating inde- pendent of donor funding. SEVEn helped spawn two private energy service compa- nies that work as energy conservation con- sultants. USAID projects supported energy conservation demonstration investments in five factories. The investments generally went to low-cost, quick-payback measures such as steam traps, steam valves, thermostats, and energy-monitoring equipment. PROGRAM ELEMENTS Policy Reform The era of cheap energy is coming to an end, but the politics of ending it is difficult. Previ- ously, the government set energy prices low to encourage industrial production and to provide cheap energy to households. Major reforms started in 1989 with the end of communism, and from 1989 to 1991 energy prices were raised dramatically, moving close to world market lev- els. Since 1991, however, as the economy has slipped into recession and political resolve has softened, energy prices have lagged behind infla- tion. Energy price increases were outweighed by massive inflation. As a result, from 1989 through 1994 real energy prices (adjusted for inflation) declined for most industrial fuels (see figure 3). It was difficult to encourage energy conservation and energy efficiency in industry when energy prices were falling. More over, during 1989-93, energy intensity increased--that is, it now took more energy to produce a given level of output. Energy efficiency was slipping because of two factors: 1) The economy was in recession and factories were operating well be- low capacity. This meant it was hard to maintain energy efficiency. 2) With fuel prices becoming relatively cheaper, there was no incentive to con- serve energy use. Even with these problems, for industry most energy prices are now moving close to costs of production. Only the residential sector still receives highly subsidized energy. The government is hesitant to raise energy prices to households, fearing political backlash. Czech environmental policy has reduced pollu- tion through regulation. New laws require major reductions in pollution by 1998 with reductions being phased in over several years. When factories exceed emission limits they must pay fines, and if they fail to meet the 1998 standards they will be forced to shut down. Factory managers are taking the regulations seri- ously. The fines, and in particular the prospect of having to close down production in 1998, have provided them with a strong incentive to clean up their smokestacks. The pollution policy already is having an impact, with significant de- clines in sulfur dioxide and nitrogen oxides emis- sions (see figure 4). Factories and the national electricity-generating company are switching from coal to cleaner fuels, installing stack scrub- bers, changing production processes, and improving burners and boilers to reduce pollu- tion. In addition to reducing pollution, this ap- proach discourages wasteful energy consumption. Technology Probably as important as the equipment were the introduction of energy planning techniques and training in ways to develop business and finan- cial plans for energy conservation. The projects demonstrated how a good financial and business plan incorporates and ranks investments in a manner understandable to company managers. This approach enabled engineers and management to agree on investments that generated en- ergy savings. Long known for its industrial excellence, the Czech Republic is a country comfortable with technology and innovation, and manufacturing standards are high compared with those of other ex-Soviet bloc countries. Under communism, however, industry concentrated on production and output, with less concern for costs, including energy costs. There was little initiative to bring innovative technologies to management. It was in this environment that the USAID projects were begun in 1991. In many projects in other countries, USAID in- troduces new technologies. That was not the case in the Czech Republic. Most of the energy conservation hardware was known to Czech engineers. Changes initiated by the projects were mainly in the use of existing technologies to solve problems new to the Republic. The USAID projects took low-cost hardware and software technologies and applied them to Czech industries. Under communism, management had little incentive to apply its knowledge to solving energy efficiency or pollution problems. The USAID projects demonstrated low-cost, quick-fix, off-the-shelf solutions that could meet the needs of energy conservation. Principal hardware consisted of valves, thermostats, steam traps, insulation, and lighting. Principal software introduced was automatic controls, energy poli- cies, planning techniques, and business plans and know-how. Engineers were trained to prepare financial feasi- bility studies management could understand. Management was quick to realize that simple, low-cost investments could save energy and re- duce operating costs while having a positive en- vironmental impact. The projects demonstrated how a good financial and business plan incorpo- rates and ranks investments in a manner that can be understood by a company's managers. This knowledge caused both engineers and manage- ment to seek out and propose investments that generated energy savings. Industrial managers and lenders have been shown by demonstration the benefits of energy co