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Using energy efficiency as an incentive for formalization of illegal buildings in Montenegro


In the past decade, Montenegro has witnessed rapid urbanization fuelled by foreign direct investment on the Adriatic coast and in mountain resorts. This growth, which has significantly increased the GDP of the country for several years has, in parallel, caused negative effects such as urban sprawl in previously natural landscapes along the coast and around the capital Podgorica, resulting in large numbers of informally built constructions (buildings without a construction permit), both commercial and residential, that have very low energy efficiency characteristics, resulting in an overall increase in CO2 emissions due to rising energy demand in buildings.


In addition, in recent months we are faced with serious budget problems in Montenegro, the solution of which, among other things is seen in reducing the number of employees in state administration. On the other hand, the costs of living are significantly above the disposable budget of households. Particular problem is the high cost of electricity, which recently resulted in the street protests of discontented citizens. On one hand we have a government that alerts the lack of electricity, and on the other hand we have citizens that may hardly cover these costs.


Having this in mind, we can say that Montenegro is dealing with a double-challenge of inefficient space use (country features over 100,000 illegal homes, if distributed evenly implying that every other family lives in an illegal home) and inefficient energy use (Montenegro needs on average 8.5 times more energy per unit produced than an average EU country). 


How to solve a problem and please both sides? Is that feasible at all?


UNDP office in Montenegro came up with the idea to link solving the big problems in Montenegro, such as the problem of illegal construction, with increasing the level of energy efficiency in households, businesses and other facilities. Namely, UNDP proposes an integrated policy solution to the double-challenge in providing energy efficiency measures to incentivize households both to legalize their homes, and make them energy efficient. The idea and research that was recently conducted show how the legalization of illegal buildings by the introduction of mandatory energy efficiency measures in them, may at the same time result in the increase of revenue to the central and local budgets, reduction of negative impact on the environment, increase of employment, engagement of the economy, reduction of electricity consumption and thereby to reduce the need to import electricity, and ultimately to contribute to the welfare of the population.


Research (energy audits) that UNDP conducted during 2011 on 30 illegal houses in three pilot municipalities showed that significant savings in energy consumption could be realized. After revision of all provided audits, a general conclusion regarding possibilities for EE retrofitting in informal settlements is that, on average, with €3,800 investment in retrofits the annual savings are up to 60% (payoff in less than 6 years), and this is in accordance with current energy prices (€ 0.7/kWh as opposed to € 0.17 kWh which is average within liberalized energy market in Europe).


The most cost effective and most often basic EE measures that have been suggested are:

• appropriate isolation of external walls
• replacement of windows/doors
• isolation of roofs


EE audits also suggested implementation of additional measures, such as installations of central heating, which will not significantly improve EE performance, but will in general raise a living comfort for the inhabitants. These measures are relatively expensive, and with longer return on investment, but they are also included in narrative part of audits, in order to be considered by the owners as possibility for additional improvement of living conditions.


More detailed average results are, as follows:



Average building (heated) area


Average electricity bill [€/year] 

(for 2009/2010/2011)



(kWh/m2 year)





After EE retrofit measures



After EE retrofit measures



Calculated savings



Lowering of CO2 emission



Assessment of the investment in EE retrofit measures



Net savings



Return on investment [year]


Savings in delivered energy / wooden logs (kWh/ year)


Savings in delivered energy / electrical energy

(kWh/ year)




Based on these results, we propose an approach to formalizing informal settlements in Montenegro through implementing an energy efficiency incentive system for the households. The scheme is broken down into 2 steps: (1) a household receives a loan to improve energy efficiency. On average for a 100m2 household, €3,800 loan (with 4.5% interest rate) results in 59% of energy savings or €630 per year at the current energy prices; (2) a household enters into a contractual agreement with the Government/municipality to use the savings from energy efficiency to pay off the low-interest loan it received for the retrofit and the formalization cost.


The idea is to use possibility of getting soft loan with no or very low interest rate, with 20 years period for repayment that will be used for retrofitting the object. The main condition for loan is IF household apply for formalization process.


Below is explained one of possible scenarios for formalization using energy efficiency measures as incentive, for average residential building of 100m2.



Size of the


Cost for
energy per


cost (50€ per

Retrofitting cost
(interest rate 4.5% on
investment 3800

100 m2



5000 €


Scenario after
retrofitting (costs)



cost, 20 yr

retrofit cost,
15 yr period



36.90 €

20.90 €

32.00 €

89.9 €




This calculation shows that each household that apply for formalization will have almost the same cost as it pays regularly for electricity today, but now this cost covers electricity bill, but also retrofitting and formalization. This means that with same amount of financial resources, they will have legal, energy efficient and safer home.




The benefit for the household is dual- a title to the house and improved energy efficiency/ resulting financial savings. The benefit for the private sector is the increase in demand for retrofits and upgrading of the infrastructure that services informal settlements. The benefit for the municipality/Government is the steady supply of funding for the property tax.


Revenue from formalization to Government





After 20 years








This idea demonstrates potentials for using energy efficiency as an incentive for formalization of illegal households. Building on the wealth of research on decision making and behavioral economics, the solution features a revenue-neutral option that addresses dual challenges from the consumers’ perspectives (households: inefficient use of energy and illegal house) and dual challenge from the providers’ perspective (Government: low real estate tax collection and low investment in infrastructure). 


This solution has never been tested before. It will require a multidimensional approach to systemic level change (new regulation and policy development), institutional level change (establishing novel links between the municipal and national level, designing novel processes for financial management) and individual level (capacity building, behavioral change). On the positive note, regardless of its success, this proposal is likely to yield important lessons on the potential for manipulating incentives for green economy.  


Implications for future research include consideration of incentives related to clean energy production (e.g. solar and wind power) and sustainable urban development (e.g. municipality’s capacity to manage incoming funding for a greener and sustainable urbanization). 


UNDP office in Montenegro came up with the idea to link solving the big problems in Montenegro, such as the problem of illegal construction, with increasing the level of energy efficiency in households, businesses and other facilities. Namely, UNDP proposes an integrated approach that includes increase of energy efficiency level in buildings and use of financial resources made from savings in energy consumption to finance legalization process.

The idea, research and a prototype which were recently performed show how the legalization of informal settlements by the introduction of energy efficiency measures in them, may at the same time result in the increase of revenue to the central and local budgets, reduction of negative impact on the environment, increase of employment, engagement of the economy, reduction of electricity consumption and thereby reduce the need to import electricity, and ultimately contribute to raising the living standard.

Research (energy audits) that UNDP conducted during 2011 on 30 illegal houses in three pilot municipalities and prototype performed on 4 selected houses in Municipality of Bijelo Polje showed that significant savings in energy consumption could be realized. After revision and demonstration through the prototype, and the repeated reviews after reconstructions, the following conclusion was reached regarding the possibility for EE retrofitting in informal settlements: on average, a € 5,000 investment is needed for retrofit of a 100 m2 house, which creates annual energy savings of 63% on average (investment payoff around 6 years).

The formalization of Montenegro’s informal settlements represents a unique opportunity to not only insert EE considerations into regulation of this building stock (for the first time ever), but also to integrate informal neighbourhoods and settlements into municipal governments’ spatial planning in order to address urban-system GHG mitigation opportunities inside town areas.

Category of the action

Building efficiency, Social Action

What actions do you propose?

In the beginning of 2011 Ministry of Sustainable Development and Tourism of Montenegro and UNDP agreed on joint implementation of three new pilot projects which deal with problem of transformation of informal settlements to formal. This is related to three municipalities: Zabljak, Bijelo Polje and Bar. Purpose of the energy audits was to determine a baseline for consumption and potential savings, giving the most basic renovation/retrofit measures. Every energy audit consisted of basic information about the existing object, its current use, dimensions, number of inhabitants, heating periods during the day and the whole year, local climate characteristics etc.

The following most cost effective and most frequent basic EE measures have been suggested: appropriate isolation of external walls; replacement of windows/doors; roofs isolation, floors isolation. After review of the conducted audits, the general conclusion reached was that on average reconstruction (retrofitting) of illegal households in Montenegro could reach 59% of electricity consumption savings, which leads to the return period shorter than 7 years.

In order to test the above estimations through demonstration, during 2012 UNDP team performed a prototype i.e. reconstruction of 4 illegal household facilities in Bijelo Polje, measuring energy consumption before and after reconstruction.

Post reconstruction (retrofitting) audits showed even better results in relation to preliminary controls. Measurements conducted showed that energy savings vary from 50% to 82% (65% on average), which means the period of return on investment from 5 to 6.3 years.

The results obtained from energy audits and tested later through prototype, confirmed that the approach to informal settlements formalization in Montenegro which implies implementation of EE measures on illegal buildings is justified and can bring considerable economics benefits both to the state and the economy, and to population and their way and quality of life. Environmental impact which is reflected in the greenhouse gases effects reduction is not negligible either.

The basic results can be found below.

Experiment results –100 m2house

Energy audits of 34 objects (municipalities Bar, Bijelo Polje and Žabljak) showed that average energy consumption (electric energy, wood, and coal) on average amount to 57.416 KWh annually, i.e. 63.619 KWh annually for a 100 m2 household.

Implementation of EE measures implies: replacement of windows and doors, roof isolation,  isolation of external walls, where replacement of floors is needed. The average investment needed for implementation of the stated measures is 4,698 Euro, i.e. 5,000 Euro for a 100 m2 building.  In addition, an investment of 5.000 Euro creates 850 Euro of VAT.

Savings in energy consumption that can be achieved through the above measures amount on average to 34.760 KWh annually or 767 Euro, i.e. for a 100 m2 household to 37.900 KWh annually or 830 Euro. Thus, expressed in percentages the average electrical energy saving is 63%.

According to the records kept daily through the measurement book and reports of the supervision body, 5 workers were engaged on reconstruction every day (construction company); one employee was engaged for supervision works, and in the initial phase one employee for development of project documents and one for management of the entire process. For all this, engagement of seven persons per object/building is needed.

Based on the obtained entry data, it is easy to calculate the time period of return on investment into retrofitting, and it is on average 6,12 years.

In addition, EE measures can lead to reduction of CO2 emissions of 1.000 kg annually per object.

The presented data represent inputs for further analysis into effects of EE measures implemented on illegally constructed objects in Montenegro based on macro-economic indicators, and for determining the possibility to use financial means made through savings in energy consumption on micro and macro level, for financing the legalization process.

If the obtained data are estimated for the entire economy, taking into account the assumption that the number of illegally constructed objects in Montenegro is 100.000 the following macroeconomic implications are obtained:

***Note: with regard to the size of the objects, the assumption is that it is not realistic to expect that all objects are reconstructed in one year. We start from the assumption that this is a longstanding process, and that 10.000 objects can be reconstructed annually. This assumption was taken into account when calculating the annual data.

  • Level of investments – retrofit of 100.000 buildings would create around 470 million Euro direct investments in the construction sector and provide work for the entire construction sector in Montenegrin economy. Also, in an indirect manner this level of investment would stimulate increase of activities in other sectors and economic branches. At the annual level 47 million Euro of direct investments is expected, which is around 14% in relation to the current level of construction work in Montenegro;


  • Amount of revenues from VAT – direct effect of retrofit would reflect in an increase of revenues from VAT in the total amount of around 80 million Euro, i.e. 8 million € at the annual level, which would increase budget revenues from VAT by 2.5% at the annual level in the following 10 years;


  • Employment – when calculating the level of employment we took into account two scenarios. One is based on the results of the prototype and its extrapolation on the total number of objects. The second scenario starts from the fact which is the result of numerous investigations that tried to calculate the number of new jobs created by investments into energy efficiency, according to which an investment of one million dollars creates 10 jobs. The total number of jobs created by reconstruction of 100.000 objects, according to the first scenario, is assessed at around 60.000, which is significantly more in relation to the total number of unemployed in Montenegro, and would even mean the need to import work force. However, precise estimation of the number of employees cannot be made without information related to the dynamics of reconstructions, number of objects at the annual level, number of companies performing reconstructions, project development, energy audits, supervision and the like. Due to lack of adequate information, we used data from the second scenario, and according to it the total number of new jobs that can be created by the above legalization process amounts to 6.200 which reduces the number of unemployed by 13%;


  • Reduction of energy consumption in Montenegro – retrofit of 100.000 objects would lead to reduction in the total energy consumption by around 3.476 GWH for the period of 10 years, i.e. 347 GWh annually. This would have enormous positive effects on the already highly loaded energy network in Montenegro, i.e. it would reduce by 27% import of energy annually, and after less than 4 years it would entirely eliminate the need to import electric energy and create space for export of energy in the following years.


GDP – increased activity in the construction sector would have direct effect on the increase of GDP of 1,5% annually, in the following 10 years;

  • Amount of revenues from legalization – the amount of fee for legalization varies depending on a number of factors, such as: town in which the object is located, construction zone, urban or rural environment and the like. In the settlement Resnik-Rasovo, where the experiment was conducted, the legalization fee is 20 Euro per square meter. However, in Podgorica and the seaside towns it is considerably higher, while in some of the northern municipalities it is even lower. That is why in our analysis we started from the assumption that legalization cost is 50 Euro per square meter, and in compliance with the provisions of the new Law on Regularization of Illegal Objects, it is envisaged that legalization cost can be paid in the long time period (min 20 years), in monthly instalments. Taking into account all the above, we come to the conclusion that local self-governments in Montenegro can collect a total of  500 million Euro of revenues from legalization in the period of 20 years, i.e. 25 million Euro annually or slightly over 2 million Euro at the monthly level, which is considerable inflow for small municipal budgets. This would ensure sustainability of local budgets in the long run.


  • Increase of revenues from property tax - due to lack of an inventory of illegal objects which would provide information important for defining property tax rate (location, number of floors, floor area, use and the like) it is not possible to determine the amount of property tax that would be collected; however it is evident that 100.000 objects that make one half of the total number of registered households in Montenegro can generate considerable revenues for Montenegrin budget.

For implementation of the presented model of legalization, first of all the answer to the following question must be given: In what manner can funds for reconstruction of objects be secured?


The following financial mechanism can be recognized:


  • Commercial bank loans – on Montenegrin market there are loan arrangements for households and companies for investment into energy efficiency. Loans are given for the period of 7 years at the annual interest rate of 7%. This is the most unfavourable form of financial mechanism, however, the expected level of savings would be sufficient to cover the amount of monthly instalment for the loan.


  • Loan of international financial institution (EIB; EBRD and the like) –  the given mechanism implies organization of a state programme, similar to programmes implemented by the Government of Montenegro so far (such as Program 1000+ for example), which foresees the state taking loan from an international financial institution according to favourable credit conditions (low interest rate, grace period, adequate repayment term), which would be  offered  to owners of illegal objects through a network of commercial banks. Savings in energy consumption would be sufficient for covering the loan instalment and costs for legalization.


  • Entry of the ESCO company – ESCO - Energy Service Companies do business in the world acting both as investors and contractors of works for energy efficiency improvement. These companies perform energy audits, invest financial resources in reconstructions-retrofits and do reconstruction itself, perform control energy audits, and monitoring of consumption in the following several years; and they charge their services for a number of years (most frequently 8 to 10) from object owners at the monthly level, in the amount of savings made in energy consumption (or up to 80% of savings made).


  • Loans taken from the republican Investment-Development Fund – this option is similar to the option of loan taking, where the municipality/state could act as an ESCO company, which performs works, and collects its claims from savings made. For this option the existing capacities can be used (eg. Agency for Construction of Podgorica, and the like) which would gradually be increased and strengthened.


Who will take these actions?

Ministry for SUstainable Development and Tourism, montenegrin Municipalities, UNDP

Where will these actions be taken?

Whole Montenegrin theritory

How much will emissions be reduced or sequestered vs. business as usual levels?

 EE measures can lead to reduction of CO2 emissions of 1.000 kg annually per object. Estimation: for 100,000 houses, approximatelly 100 mil tones of CO2.

What are other key benefits?

GDP increase, economic activity increase, employment, increase of revenues from privatizaton etc - all presented above

What are the proposal’s costs?

aorund 1 mil euros for technical assistance for establishing a process, later the revenues gained from project could financed the whole project management, monitoring and evaluation and whole implementation.

Time line

next 10 years starting from September 2013.

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