ESCO market and Business at Turkey

Views on Turkey’s impending ESCO market
"Esin Okay a, , Nesrin Okay b, Alp Er S- . Konukman c, Ug˘ur Akman d"
The Energy Efficiency Law (EEL) of Turkey was developed as a
result of Turkey’s tasks of complying with the EU directives. The
law, expected to achieve 25–30% savings in total energy
consumption, came into force on May 2, 2007 through the law
number 5627. The English translation can be found at EIE (General
Directorate of Electrical Power Resources Survey and Development
Administration) web site (www.eie.gov.tr). The law exploits
the efficient use of energy and covers administrative structuring,
energy auditing, financial instruments and incentives, awareness
raising and the establishment of an Energy Service Company
(ESCO) market for energy efficiency (EE) services.
As stated in International Energy Agency’s (IEA) 2005 review of
Turkey, Turkey’s energy policy had been highly supply-oriented,
with emphasis placed on ensuring additional supply to meet the
growing demand, while EE had been a lower priority. Legislative
framework has been upgraded to be compatible with that of the
EU countries since 2001. Lately, new legal frameworks, such as the
Electricity Market Law, Natural Gas Market Law, Petroleum
Market Law, and EEL have been put into effect to end the state
monopoly and allow private-sector participation in energy
industries, aiming at cost-effective pricing through competition
under independent regulation and supervision of the Energy
Market Regulatory Authority (www.epdk.org.tr/english). These
developments are mostly due to the ongoing harmonization
process of the Turkish legislation with the EU. More information
on Turkey’s energy profile can be found at IEA’s web site
(www.iea.org).
The organization of this paper is as follows: Section 2 briefly
reviews the ESCO-related literature and financing mechanisms,
emphasizing the experiences in the developed and developing
countries. In Section 3, we reveal the place of ESCOs in the
organizational structure of the EEL of Turkey. Finally, Section 4
presents our views on possible issues on funding-related risks of
the forthcoming Turkish ESCO market.

Views on the forthcoming Turkish ESCO market financing
and risks
ESCOs must have strong assets to take on huge liabilities of
clients that have long-term projects and the financers should have
a strong balance sheet. This is extremely a big risk that points to a
considerably significant size-based balance sheet to finance
projects. Therefore, ESCOs should be committed to risk management,
as well. ESCO activities should be managed with riskreducing
methods like hedging instruments and venture capital.
We know that companies in Turkey do not use risk management
tools. They have problems of coping with the generally accepted
accounting and financial standards that especially lead to poor
management of assets and liabilities. At the same time, ESCOs
should anticipate macroeconomic factors of the country, foreseeing
the risks. Economic stability is another critical factor for the
future of an impending ESCO market where Turkey’s uncertain
economic performance beyond sustainability affects the expectations.
After the enactment of the EEL, Turkey’s hot issue is to
establish an ESCO Market. The next is to expect a considerable
interest of international investment entering the market. Without
that foreign capital, merely the support of international financial
institutions, the market will not be able to prosper because this is
primarily a risk-based capital system that Turkey does not still
have. The EEL aims to end the state monopoly, allow privatesector
participation in large industries, create competition under
independent regulation. However, one of the most important
difficulties that local companies—small- and medium-sized
ones—face in Turkey is the capital inadequacy; therefore, they
are insufficient to act as market-makers. Moreover, international
partners do need to see some potential of a stable economy and
good indicators free from country risk to invest. After privatization,
foreign companies exhibited a keen interest in Turkey.
Foreign direct investment will need a projection of the new era of
Turkey’s future economic condition and fundamentals. According
to the expectations, there are unfortunately some economic and
political problems that lead to uncertainty increasing the country
risk. That itself is enough to put both local companies and foreign
investors in a dilemma as a bad luck for the future of the market.
Turkey’s impending ESCO market will be sponsored by
government and WB funds during its incubation stage under the
SS financing mechanism. Creating a competitive, mature ESCO
market (Hungary, as a developing country model, has more than
200 ESCOs) through the GS mechanism is not possible under
today’s Turkish economic environment. Large current account
deficit financed by foreign capital flows, uncompleted structural
reforms, unfinished privatizations make the creation of a mature,
perfectly competitive ESCO market suspicious. This is supported
by the lessons learned from the unsuccessful implementations of
the BASEL-II for the small- and medium-sized firms in Turkey.
BASEL-II is the second of the Basel Accords, which are recommendations
on banking laws and regulations issued by the Basel
Committee on Banking Supervision. The purpose of BASEL-II is to
create an international standard that banking regulators can use
when creating regulations about how much capital banks need to
put aside to guard against the types of financial and operational
risks banks face. Just like the case of BASEL-II, Turkey’s poor
assessment of risk culture and investment appetite do not allow
such a risky and big system to progress. The BASEL-II implementations
are postponed to 2009 after a struggle of 4 years. In such a
market, candidate ESCOs in Turkey will not be ready for GS
financing mechanism just like small- and medium-sized companies
in Turkey not ready for the BASEL-II implementations.
Under a stable economy, Turkish energy policy should
establish appropriate incentives for EE and development of ESCO
market. Incentives like reduction on import duties, enabling
foreign partnerships probably by joint venturing, risk-sharing
with another forfeiting institution, proposing a third-party
financing network, providing a healthy relation within private
sector and finance sector, encouraging the emergence of smalland
medium-sized firms. Beyond the difficulties of bureaucracy,
there is lack of information and knowledge. Government should
increase information about EE projects, financing opportunities,
and services offered by ESCOs and complete the awaiting
regulations. Successful model of Hungary and problematic model
of India should be influential for enacting policy in Turkey. Not
adopted to BASEL-II, Turkish banks may resist financing
such ESCO projects because of the risky nature of this business
and economical uncertainties. Between 2002 and 2007, privatesector
external-debt stock increased to $150 billion, where
the share of banks and financial institutions has increased
to $51 billion, which is about 13% of the Turkish GNP. This points
to a sound indecision or hesitation for the private sector to
become involved in the ESCO market. Therefore an immediate
reform of both financial and institutional restructuring should be
implemented.
The bottom line is that in order to create a promising
competitive ESCO market, Turkish policy must be able to sustain
5% average growth rate for the coming decade and finish the
structural reforms which will invite necessary capital inflows to
ensure an economic stability and financing. EU and other
countries’ experiences are vital to guide Turkey to speed-up the
completion process for the awaiting regulations and foster the
establishment of the Turkish ESCO market.