Today I’m going to revisit the clean development mechanism (CDM) as a financing tool for green buildings and energy efficiency in developing countries. As I mentioned in a previous post on carbon finance, the CDM hasn’t done anything to date to finance investments in building energy efficiency in developing countries. But it’s starting to look like this may change soon. It’s time for developers in China to start thinking about how carbon finance can play a role in their projects and portfolios.
Before I get into the post, I think it’s worth mentioning one more time why carbon finance should be funding building energy efficiency projects. As the graph below shows (source: World Bank report [PDF]), efficiency is the largest piece in the puzzle of reducing our carbon emissions.
As I mentioned before, a recent UNEP study did a good job of describing why the CDM hasn’t been effective in funneling money into investments in building energy efficiency. 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. Most public input provided pretty sharp criticism (see this PDF for an example) as well as 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. But since no one can predict how long it could possibly take a body like the Executive Board to make up their mind, I won’t speculate here. Instead, I’ll just describe what the future might look like once a working carbon finance system is in place.
Greening building portfolios
The key place CDM will 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 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 should be pretty easy to combine these activities at different buildings into one CDM program. Essentially, once the first building is approved and verified, it should be straightforward to get the rest approved. Fourth, and most importantly, the emissions across an entire building portfolio are large.
How big does the portfolio need to be?
In order to make going through the hassles of the CDM process worthwhile, the portfolio of buildings needs to produce a large number of CERs. Wind projects provide a good proxy of how many CERs might be needed: general wisdom seems to be that most wind projects need to be at least 50 mW in order to make CDM financing worthwhile. A 50 mW wind plant with a 25% capacity factor in China would produce about 110,000 CERs a year (calculations available here).
A 150,000 square meter office building (about the size of Prosper Center) in China would normally produce 30,000 tons of carbon dioxide per year. If the building owner could prove a 50% reduction in carbon emissions through a combination of energy efficiency improvements and on-site renewable generation, this would result in 15,000 CERs per year. So a building owner would probably need a portfolio of at least 1,000,000 square meters to make the CDM financing process worthwhile.
Several China developers fit this bill: SOHO Group, with a portfolio of a million and a half square meters of property in Beijing, and CapitaLand China, with a massive portfolio in 5 different regions of China, are two good examples. I’m sure Vanke and several others also have big portfolios of real estate ripe for investments in energy efficiency.
Carbon finance will provide a large opportunity for these companies to make good investments in energy efficiency, but will not be a panacea. At $0.10 per kWh of electricity and $20 per ton of carbon, carbon finance will provide a 20% kicker on energy efficiency investments over and above the savings on the electric bill. I was surprised by how little this kicker matters. If a developer faces a 5 year payback on energy efficiency, carbon finance would only reduce this to 4. It helps, but probably not enough to change behavior. This is part of the reason why David Victor and others are saying current carbon prices are just too low to make much of a difference.
It’s important to note that this carbon credit kicker will also rise (or fall) with carbon prices, as portfolio owners would be entitled to a stream of income, rather than a lump sum payment. In a world of properly priced carbon (maybe $100/ ton or more?), this kicker will really matter.
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.
One option is for developers to contract directly with interested companies in America or other non-carbon regulated countries, allowing the developer to sell off the carbon credits from a large portfolio in bulk. The company purchasing the carbon credit could then tout it's carbon neutrality or environmental friendliness. In fact, for companies like CB Richard Ellis, who has committed to being carbon neutral in 2010, this might be an interesting option. CBRE manages a lot of buildings in China, and could finance energy efficiency upgrades and then take the resulting carbon credits to reach their carbon neutral goal. And while doing this, they would get first hand experience in the emerging field of carbon finance for green buildings, a market that will undoubtedly be huge for CBRE in the future.
Developers could also sell their credits to the voluntary markets, using the Gold Standard or other voluntary standards. Voluntary standards, generally less stringent than the CDM, might be more receptive to the programmatic nature of building energy efficiency reductions.
Regardless of what happens with the Executive Board, the pCDM and even the post-2012 climate treaty, carbon finance is not going 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.