Financing the Future
Funding mechanisms are already in place for a wide range of green initiatives, but the building sector is being overlooked. Geoffrey Lewis investigates what role carbon finance will have in the green revolution.
The benefits of going green are by now obvious, but many developers still worry about the additional costs. To date, carbon finance has not been widely used to fund investments in building energy efficiency, but this is starting to change. Developers should keep their eyes on developments in the carbon finance arena, as carbon credits soon will be a viable source of financing for investments in green buildings. Carbon finance is an emerging source of funds for investments in carbon reduction technologies worldwide. The fundamental idea behind carbon finance is an offset: companies, individuals or organisations interested in offsetting their own emissions buy carbon reductions from elsewhere. Thus far, this process has been largely been driven by the clean development mechanism (CDM). The CDM has become the 800 pound gorilla in the carbon finance world, with the World Bank estimating that CDMbased credits make up 90 percent of the global carbon market. The CDM was established in the Kyoto Protocol and has been in effect since 2006.
The goal of the CDM is to create a financial incentive for developing countries to reduce their carbon emissions. The carbon savings result in a certified emission reduction (CER), equal to one ton of carbon dioxide, which can then be sold off to carbon exchanges in Europe and Japan. To date, the CDM has primarily facilitated financing emission reduction projects in China, where 73 percent of credits originate, according to the World Bank.
The CDM has had some notable successes to date. The market has certainly caught on: carbon transactions in 2007 totaled US$7.4 bil. And many credit CDM financing for helping drive the successful expansion of China’s wind industry: 90 percent of wind projects in China have applied for CDM financing The CDM has also had its failures. Ideally, the money from the CDM should be focused on getting the most cost-effective carbon reductions in order to lower the total overall economic burden of dealing with global warming. But unfortunately, this has not been the case. The CDM has completely ignored the easiest and largest source of carbon reductions globally: building energy efficiency.
Building opportunity
Buildings offer the largest low-cost potential for carbon reduction. The UN Intergovernmental Panel on Climate Change (IPCC) estimates that the building sector globally could save six gigatons of carbon dioxide per year in 2030, and most of it with no- to low-carbon price and the bulk of it in developing countries. This is far more reduction in carbon than any other sector analysed. To put this six gigatons into perspective, the World Bank expects China’s entire annual emissions to be about seven gigatons in 2030 assuming current growth patterns. So buildings can and must play a huge role in reducing CO2 emissions worldwide.
The CDM still has not been used to finance investments in green building or building energy efficiency programs. According to a recent UN Environment Programme (UNEP) report, of over 3000 CDM projects in the pipeline as of May 2008, only six dealt with energy efficiency. So why isn’t the CDM working to finance carbon reduction projects in the built environment? There are several key barriers to using carbon finance for green buildings. ‘CDM and other related offset programs have stacked the deck against buildings in some important ways. Most importantly, they have a system that emphasizes annual emissions reductions as the currency while imposing substantial transaction costs to enter the marketplace.’ says Chris Pyke, Director of Climate Change Services at CTG Energetics, a green building consultancy.
Scale matters
Unlike wind farms, which are large-scale and produce lots of credits, it’s hard for buildings to produce enough credits to cover transaction costs. An average 50,000 sqm office building in downtown Shanghai, even it was 50 percent more efficient than the average building, would still only produce a tenth of the CERs that a small wind farm would produce, according to an analysis by China Green Buildings Blog. At this level of CERs transaction costs are just too high for buildings to seek CDM financing. The programmatic CDM (pCDM) was established in 2005 to fix this problem, but hasn’t made much of an impact to date. Luckily, things may soon change. The Executive Board of the CDM, who oversees and decides on all policy changes, called for public input on how to fix the pCDM and will review the program at their next meeting in mid- February. Public input provided pretty sharp criticism. For example, Dr. Pan Jiahua, the leader of a study of pCDM funded the by Danish government, wrote what everyone was thinking: ‘it seems obvious that the new instrument has not been embraced by the market.’ The public comments also provided many recommendations that should hopefully be incorporated into updated guidelines for the pCDM, ideally allowing many more projects and groups of projects to get CDM financing.
Carbon finance potential
The key place where CDM has the potential to play a role is the greening of existing building portfolios. Existing building portfolios are well-suited to the CDM methodologies for several reasons. First, the emissions reductions baseline is solid, unlike for new buildings where the baseline is hypothetical and model-based, existing buildings already have a baseline in the form of their operating history and historical energy usage. Second, the emissions reductions from portfolios are verifiable. How much energy did the building use before, and how much less does it use now? Third, the energy-efficiency measures undertaken across a portfolio of buildings will all be pretty similar. Once some of the current pCDM roadblocks are removed, it ought to be pretty easy to combine these activities at different buildings into one CDM program. Fourth, and most importantly, the emissions across an entire building portfolio are large. Using small wind farms as a proxy, The China Green Buildings Blog estimates that a building portfolio would need to be at least 1 mil sqm to make the CDM financing process worthwhile. Several China developers fit this bill: SOHO group, with a portfolio of 1.5 mil sqm of property in Beijing and CapitaLand China, with a massive portfolio in 5 different regions of China, are two good examples. Vanke and several others also have big portfolios of real estate ripe for investments in energy efficiency.
A co-operative future
For developers and building owners with smaller portfolios, there are still options to access carbon finance markets through joint ventures with other small building owners. Developers could jointly offer up a large portfolio of energy efficiency improvements. The important thing is to ensure that there is some commonality between the buildings; for example, building owners could jointly pool energy efficiency investments in office buildings in Beijing, or on-site renewable generation at logistics facilities in the Pearl River Delta.
While the Executive Board tries to fix the pCDM, the voluntary carbon market is an option for developers who want to get ahead of the curve and learn how to use carbon finance to fund investments in energy efficiency. Developers could also sell their credits to the voluntary markets, using the Gold Standard or other voluntary standards. Voluntary standards might be more receptive to the programmatic nature of building energy efficiency reductions and give developers a head start on learning how to integrate carbon finance into energy efficiency investments. Regardless of what happens with the Executive Board, the pCDM and even the post-2012 climate treaty, carbon finance will not go away. Developers and building owners who stay up to date on the developments in the carbon markets will have a significant leg up on their competition.
Geoffrey Lewis, LEED AP, is a Fulbright Fellow researching green building practices in China at Tsinghua University.