Carbon pricing

Carbon pricing mechanisms are market-based tools designed to reduce greenhouse gas (GHG) emissions by assigning a monetary cost to carbon emissions. By taking into account the environmental and social costs of carbon, these mechanisms incentivize businesses and individuals to reduce their carbon footprint and transition to cleaner technologies.

Carbon pricing mechanisms operate by either directly setting a price on carbon emissions or by creating a market for emission allowances. The two primary instruments are:

• Carbon taxes: whereby governments impose a fixed price on each ton of GHG emissions or the carbon content of fossil fuels. Carbon tax sets the costs of emissions, however the emission reduction outcome is not pre-defined and is left for the markets to respond.
• Emissions Trading Systems (ETS) (Cap-and-Trade): a cap is set on total emissions, and companies are issued allowances that they can trade. The market determines the price of carbon based on supply and demand. The EU Emissions Trading System, covering power generation, industry, and aviation, is the largest ETS globally.

Carbon pricing encourages the most economical emission reductions by allowing market forces to drive change. It also generates funds that can be reinvested in RE or environmental programs, and works well in combination with other climate policies. However, it may increase costs for consumers and carbon-intensive sectors, cause industry relocations to lower/avoid carbon pricing (leakage risks), require complex monitoring, reporting and verification systems.

As of 2024, carbon taxes and ETSs were implemented in 39 and 36 jurisdictions globally[1]. In 2023, carbon pricing revenues reached a record 104 billion USD. Carbon taxes and ETS covered 24% of the world’s emissions in 2024[2].

Despite the record revenue and the increased coverage, average carbon prices are still insufficient to incentivise renewables or energy efficiency on their own. At a global level, the effective price on carbon emissions from the energy sector was only around 3 USD/tonne of CO2 in 2023. Therefore, carbon pricing has to be supplemented by other policy measures.

[1] Carbon Pricing Dashboard, World Bank, https://carbonpricingdashboard.worldbank.org

[2] IRENA, COP28, COP29, GRA, MoEA and Government of Brazil (2024), Delivering on the UAE Consensus: Tracking progress toward tripling renewable energy capacity and doubling energy efficiency by 2030

Fiscal and financial incentives

Financial and fiscal incentives are used to improve access to capital, lower financing costs, reduce the burden of high upfront investments or production costs of RE projects, and address misalignment of incentives associated with energy-efficient technologies. They can be introduced in a variety of forms, such as tax incentives, capital subsidies, grants, performance-based incentives, concessional loans, guarantees and risk mitigation measures.

Fiscal (tax) incentives are typically offered in the form of reductions in sales, energy, value-added or other taxes or in the form of investment tax credits, production tax credits or accelerated depreciation.

Reduction in taxes reduce the cost of RE systems for the installer/generator and increase their affordability and profitability. These are the most widespread policy instruments globally as they can be applied to projects and installations of all sizes, and in areas that are not connected to the grid.

Production and investment tax credits can support large-scale deployment, mainly in the form of production tax credits based on actual energy produced and investment tax credits that address high upfront investment of a project. Therefore, production tax credits can be more effective in incentivising the maximisation of energy production.

Accelerated depreciation is an incentive that allows the owner of new assets to reduce taxable income by claiming a much larger than usual depreciation allowance in the early years of the RE assets’ operation.

Performance-based incentives are provided based on actual performance of an installed technology (e.g. cents per kWh payment). They are often provided by utilities and funded through utility customer payments.

Capital subsidies can be used to help create a level playing field with conventional energy technologies and reduce initial capital costs. They can be used to target very specific RE technologies as well as particular user segments or geographies. Capital subsidies are typically used in markets in the very early stages of deployment, after which they tend to be replaced by performance-based subsidies.

Grants are normally provided by local governments, development finance institutions or non-profit organisations to fund feasibility studies; research and development; system demonstration, installation and operation; pilot projects and business development. Through hybrid approaches, grants may also be combined with concessional loans to support RE and energy efficiency deployment.

Concessional loans are provided on favourable terms (below market price) with lower interest rates, longer maturities and longer grace periods compared to standard commercial market loans. These loans help to overcome such barriers as limited access to or shortage of financing, high cost of capital, unproven technology or business model, low creditworthiness of the customers, lack of awareness and technical implementation skills.

Risk mitigation measures aim to improve risk-return characteristics of a RE investments. Such measures may include guarantees (covering political, technology, credit risks), loss-sharing arrangements, local currency lending and hedging instruments, bankable project development and technical assistance. These de-risking instruments enhance financial returns and help attract private sector investors into RE projects.

Globally, financial and tax incentives are being implemented in over 130 countries. They are often applied in parallel with other regulatory and pricing policies.

Net metering

Net metering is widely regarded as having an important role in scaling of distributed generation (DG), especially solar PV. DG represents electricity generation capacity located on customer property (commercial, industrial or residential). Net metering policies determine how electricity customers with their own distributed generation capacity are compensated for electricity they deliver to the grid.

Under the net metering scheme every kWh of energy produced by consumer’s DG system goes toward reducing their electricity bill by the same amount. Customers offset the energy volume exported to the grid against their own energy consumption on 1-for-1 basis. Therefore, the energy sent to the grid is compensated for at the same rate as retail electricity tariff and is called the retail-parity compensation.

Together with DG system, new bi-directional meter, which can record energy export to the grid and energy import from the grid, is installed. At the end of each billing period, the utility totals up the energy that was injected to the grid and energy used from the grid. If the consumer used more electricity than sent, the utility bills for the difference. If the consumer sent more power than used, the utility records a credit balance that will be applied to the next period’s bill. Usually, the surplus (kWh credits) can be banked for a predefined period of time (credit rollover period), thus facilitating the offset. Unused credits at the end of that period are either compensated by the utility (at preset rate) or are lost.

Net metering programs may differ by their credit rollover period and redemption value of unused credits. Some net metering programs allow to carry over the credit indefinitely, but most often the accumulated credits are reconciled and settled on annual basis. The excess credits left at the end of rollover period are usually redeemed by utility company at a greatly reduced rate close to the wholesale price of electricity. This limits DG owners’ incentives to install systems considerably exceeding their self-usage.

Net metering is a very popular policy instrument used to encourage households, commercial entities and industrial facilities to invest in their own RE systems by enabling them to sell surplus electricity to the grid. The application of net metering proliferated strongly worldwide after year 2010, when around 70 countries have adopted this payment arrangement. By year 2023 end, a total of 92 countries had net metering policies in place[1].

Net metering is generally considered more favourable for distributed energy producers (compared to net billing or gross metering) because of typically higher compensation rate received for electricity sent to the grid. Net metering has helped to drive RE market by markedly lowering its customers’ electricity bills and shortening payback periods for investments into DG systems. However, the application of net metering remuneration schemes leads to the following challenges:

• Compensation at retail-parity rates encourages high-tariff-paying consumers to deploy DG, and in many cases, this is achieved at the expense of other customer groups
• Net meters distort revenue recovery and creates financial pressures for utility companies.

The alternative mechanisms to net metering, which measure and price the energy consumed from the grid separately from that of the energy fed to the grid, are gaining increasing popularity, including:

• Net billing, under which electricity delivered to the grid is compensated at a pre-determined rate, which is typically lower than the retail price or may vary based on the time of day
• Gross metering (buy-all, sell-all arrangement), under which a utility buys all electricity generated by the customer at one (usually, lower) rate and sells all the electricity consumed by the customer at a different rate (usually the same retail rate charged to any other customer).

In recent years, many countries were gradually moving away from net-metering-only programs by:

• materially amending, scaling down or even eliminating net metering
• shifting to (or adding) net billing and gross metering schemes
• introducing support policy features that incentivise the installation of energy storage systems.

[1] REN21 Policy Database, 2024

Auctions and tendering

Auctions and tenders have become a preferred alternative to feed-in tariffs (FITs) and feed-in premiums (FIPs) in many countries, particularly for scaling up large, utility-scale RE projects.

An auction is a competitive process for procuring electricity generated by renewable energy. It is designed to allocate a supply contract or incentive based solely on the bids submitted by participating bidders according to transparent award rules.

In auctions, there is no negotiation after the bidding concludes and the price is the only criterion to be evaluated. While the negotiated tenders may include additional criteria and have a post-bidding negotiation stage between buyer and seller, in which changes in project size and price are possible.

RE auctions and tenders are organised by public authorities who have the responsibility for the preparation of the auction documents, the publication of the auction, the evaluation of the bids and the selection of the winning bids. Depending on the auction design, the bids can refer to RE installed capacity or electricity production. The government sets the auction volume demanded, bidders then offer a price at which they are willing to build the project, and the government ranks the bids. Ranked bids are awarded until the auction volume is met. Auctions, therefore, organise the access to off-take contracts and determine the level of the price paid per unit of RE electricity or capacity.

Auction and negotiated tender procedures foresee competitive bidding and, ideally, limit participation to serious bidders via the use of qualification criteria. The auction is competitive if the total cumulated capacity or electricity production that is being offered in the bids exceeds the capacity or electricity production that is being auctioned.

The success of RE auctions is highly dependent on the auction design and process, which typically include:

• Reverse auction format, denoting the fact that bidders are bidding down to the lowest price, rather than upwards
• Auctioned item and volume (amount of electricity generation, installed capacity or financial budget)
• Site-specific (project site is pre-selected or pre-developed by the government) or site-agnostic (project sites are chosen by the bidders) auctions
• Technology type and technology size
• Static/sealed-bid auction (participants submit their bids simultaneously, and are unaware of competing bids) or dynamic auction (bidders observe the development of the competing bids, and adapt their bids during the auction)
• Technical and commercial requirements of the projects (grid connection agreements, environmental permits, approved zoning plans)
• Qualification criteria for participants (e.g. turnover volume, references, financial position)
• Financial guarantees from bidders, used to back up the penalties incurred in the event of a delay or failure to realise a project
• Deadlines and penalties, defining time commitments and the consequences for bidders for the non-realisation or delay of awarded projects
• Ceiling price, set in order to eliminate the risk of excessive bids that would result in high costs for the RE support scheme.

Auction and tender schemes bring the following main advantages:

• Stimulate competition between different operators, locations and technologies and provide cost-efficient way to promote RE technologies
• Contribute to discovery of the true costs of RE technologies and prevent overcompensation of electricity producers
• Effective for scaling large capacities in a relatively short time
• Allow planned and coordinated RE development and capacity additions
• Adapt to technology developments, changes in costs, market prices and conditions.

The use of RE auctions and other competitive price mechanisms has surged globally over the recent 10-15 years. This shift was driven by declining technology costs, the need for cost-competitive procurement and integration of RE into electricity generation mix. Auctions and tenders helped to attract significant private sector investments for large-scale RE projects. Auctions have also strongly facilitated the achievement of record-low costs for such renewables as solar PV and onshore wind (see Figure 3). Since 2010 levelized cost of electricity (LCOE) has declined by 10.4 and 3.4 times for large scale solar and onshore wind respectively.

Figure 1: Global weighted average LCOE of onshore wind and utility-scale solar PV projects, 2010-2023

Source: IRENA (2024), Renewable power generation costs in 2023

Auctions and tendering are being successfully used for large wind and solar PV and CSP power projects, as well as for biomass and geothermal power worldwide. Today, most utility-scale renewable electricity is procured through auctions and tenders. They are also increasingly being used for renewable-based hydrogen (including in Albania, Algeria, Greece, India and Romania)[1].

[1] IRENA, COP28, COP29, GRA, MoEA and Government of Brazil (2024), Delivering on the UAE Consensus: Tracking progress toward tripling renewable energy capacity and doubling energy efficiency by 2030

Integration with EED Goals and Key Elements

Energy services are integral to the overarching goals of the Energy Efficiency Directive (EED) and support several key elements:

• Energy Efficiency First Principle: Energy services embody the Energy Efficiency First principle by prioritizing and facilitating the implementation of energy-saving measures before considering additional energy supply options.
• Energy Efficiency Targets: The delivery of energy services directly contributes to achieving energy efficiency targets by identifying and implementing measures that reduce overall energy consumption.
• Alignment with Higher Climate Neutrality Goals: Energy services support the EU’s climate neutrality goals by reducing greenhouse gas emissions through enhanced energy efficiency and the adoption of sustainable practices.
• Multiple Benefits of Energy Efficiency: Energy services highlight the multiple benefits of energy efficiency, including cost savings, improved operational performance, and environmental benefits, encouraging broader acceptance and implementation.
• Heating and Cooling Planning: Energy services provide the expertise needed for effective heating and cooling planning, ensuring that systems are designed and implemented to maximize energy efficiency.
• Heat and Cooling Supply: Energy services support the optimization of heat and cooling supply systems, reducing energy consumption and improving system efficiency.
• Transformation, Transmission, and Distribution: By offering solutions to improve the efficiency of energy transformation, transmission, and distribution processes, energy services contribute to overall energy system optimization.
• Exemplary Role of the Public Sector: The public sector can leverage energy services to lead by example, implementing best practices in energy efficiency and demonstrating their benefits to other sectors.
• Exemplary Role of Public Buildings: Public buildings can benefit from energy services to implement state-of-the-art energy efficiency measures, serving as models for best practices.
• Energy-Efficient Public Procurement: Energy services guide public procurement processes to ensure that products and services meet high energy efficiency standards, driving market demand for efficient solutions.
• Energy Saving Obligations and Obligation Schemes: Energy services help design and implement measures to meet energy saving obligations, ensuring compliance with regulatory requirements and achieving mandated energy savings.
• Energy Audits and Energy Management: Providing high-quality energy audits and implementing effective energy management practices are core responsibilities of energy services, driving continuous improvement in energy performance.
• Efficiency in Data Centers: Energy services offer solutions to enhance the efficiency of data centers, optimizing their operations and reducing energy consumption.
• Billing Information: Accurate and detailed billing information provided through energy services helps consumers understand their energy use and identify opportunities for savings.
• Awareness Raising: Energy services play a key role in awareness-raising efforts, educating stakeholders about the benefits of energy efficiency and promoting best practices.
• Empowering and Protecting Vulnerable Consumers: Energy services ensure that energy efficiency measures are inclusive, benefiting vulnerable consumers and helping to reduce energy poverty.
• Energy Professionals: Energy services rely on skilled energy professionals to deliver high-quality and effective solutions, ensuring that energy efficiency projects are implemented successfully.
• Energy Services: This element itself highlights the importance of developing a robust energy services market to drive energy efficiency initiatives and achieve the goals of the EED.
• National Energy Efficiency Fund and Financing: Energy services facilitate access to national energy efficiency funds and financing options, making energy efficiency projects more feasible and cost-effective.
• National Technical Support: Providing technical support at the national level helps ensure that energy services are aligned with best practices and regulatory requirements, enhancing their effectiveness.

By integrating energy services across these key elements, the EED ensures a comprehensive approach to improving energy efficiency, driving cost-effective energy savings, and supporting the EU’s broader climate and energy goals.

Types of EPC contracts

Energy Performance Contracting (EPC) offers a flexible and effective framework for implementing energy efficiency projects, particularly in markets that are still developing, like Uzbekistan. Different EPC models cater to varying client needs and levels of market maturity, allowing for tailored approaches to energy savings. In the context of Uzbekistan’s emerging ESCO market, understanding these models is crucial for both public and private sector stakeholders.

This subchapter explores three primary EPC models: the Shared Savings Model (SSM), the Guaranteed Savings Model (GSM), and the Chauffage or Utility Purchase Agreement. Each model presents unique benefits and risks, making them suitable for different stages of market development. For an underdeveloped ESCO market such as Uzbekistan’s, starting with the GSM is recommended. This model reduces client risk by guaranteeing savings, making it an ideal entry point for building trust in EPCs. As the market matures, the SSM, where the ESCO and client share the savings, can be introduced, shifting more responsibility for financing and risk onto the ESCO. Finally, the Chauffage model, which involves the ESCO owning and operating the energy systems, offers another avenue for more advanced market engagements.

Shared savings model (SSM): In this model, the ESCO and the client share the cost savings achieved through energy efficiency measures. This approach is suitable for clients who prefer to reduce their upfront financial commitment, as the ESCO typically shoulders the initial project costs and recovers its investment through a share of the savings. In shared savings EPCs, cost savings (energy and O&M) from the project are shared between the ESCO Client and the ESCO.

• Arrangements vary, but payments to the ESCO may be a) a fixed percentage of savings, b) a minimum fee plus a share of the savings, or c) a scaled fee that decreases over time as the ESCO recoups its investment
• The ESCO typically provides the capital investment and assumes most of the risks
• Both the ESCO and the ESCO Client may see an additional monetary benefit if savings estimates are exceeded

Guaranteed savings model (GSM): In this structure, the ESCO guarantees a certain level of energy savings, and the client pays the ESCO based on the achieved savings. This model is more attractive to clients who want to mitigate financial risks, as the ESCO assumes the risk of not meeting the projected savings. Guaranteed savings contracts are the most common form of EPCs and are used by governments. These contracts are characterized by:

• A fixed term with a fixed payment schedule in which the ESCO ensures the savings (energy and O&M) will meet or exceed a minimum savings level (guaranteeing a minimum performance after implementation)
• Financing which is typically provided by the ESCO may also include capital investment from the ESCO Client

Chauffage or utility purchase agreements: Chauffage is a French word meaning ‘heating’ and is used to describe an arrangement popular with ESCOs in Europe and the USA. In this arrangement, the ESCO owns, operates, and maintains the energy-using equipment. The ESCO Client buys the end-use (e.g. heating, air-conditioning, lighting) for an agreed-upon rate and time. The ESCO may also negotiate with fuel and power suppliers to arrange purchase agreements and maintain those relationships and payments.

For an insufficiently developed ESCO market like Uzbekistan, it is recommended to first start using EPCs under the Guaranteed savings model until the private ESCOs turn to strong, trustful, and experienced companies, with good financial creditworthiness, ready and able to carry the project risks and to provide the performance guarantee for energy savings. Until then, they will not have access to financing in favorable conditions. Once the private ESCO market develops, the EPCs should be implemented under the Shared savings model, whereby the ESCO is responsible for the financing of the EE project.