This inaugural insight connects Green Hedgehog to policy changes and carbon prices and taxes. We think we can generate both superior financial returns and environmental benefits.
Buildings are easy, low hanging fruit
Green Hedgehog’s focus on buildings is primarily a function of 2 factors: one, existing skillsets and experience in the real estate asset management space; and, two, a view that buildings are an opportunity where we see potential for faster reductions in emissions from both innovation and policy moves. Singapore, for example, has been raising energy efficiency standards, particularly for industrial and commercial buildings. Buildings, via the use of power, account for almost 14% of CO2e emissions.[1] Improvements in facility equipment and technologies, whether chillers or lighting, meanwhile, can reduce emissions in some cases by over 50%, and can be implemented quickly. A chiller retrofit can take less than 6 months and translate into tangible savings, both financial and environmental, immediately on completion. For policy makers, this is a relatively easy way to lower emissions and one that also creates jobs in the broader effort to transition economies. Regionally, given that the IEA estimates that ASEAN buildings account for 24% of energy-related emissions, we would not be surprised if other regional governments follow suit.
Buildings as stranded assets too?
The UK has gone even further, making it unlawful to extend or renew tenancy of certain buildings with very poor Energy Performance Certificates (EPCs), and raising the bar so that only the most efficient buildings can be tenanted by 2030. The government estimates that the proportion of buildings covered by these “minimum energy efficiency standards” will increase from 10% to 85%.[2] Unless building owners make efforts to materially improve the energy performance of their buildings, they will not be able to rent them out, resulting in significant stranded asset risk. In short, what is now signs of relatively small “green premiums” in buildings,[3] the potential is that these premiums may be much larger in the future. While we all know that policies can change, it is also the case that in order to achieve 2050 targets to keep warming to under 2degrees, all new and existing buildings need to be net zero.[4] We cannot rule out other countries also raising EPC standards.
The “full” energy cost perspective
These forces make us think in terms of full costs for energy. Currently, with elevated energy prices, simple payback periods for implementing energy efficiency projects are shorter and therefore more attractive. But oil prices may not always be high, especially if there is a global cyclical downturn. In order to drive the transition, we need the total costs of fossil fuels, including the cost of the externalities, to be high enough so that there is demand destruction for fossil fuels and continued shifting to renewable and other zero carbon sources of energy. Some companies are already trying to integrate an internal carbon price in their decision making. In a recent note, NUS researchers reported that between 2015 and 2020, the number of companies that use or plan to adopt an internal carbon price increased from 1,018 to 2,012 with growth across all regions and industrial sectors.[5] While there is no consensus on the “right” price nor clarity on how this internal price is used on a consistent basis, this is encouraging. From a country perspective, the more countries are incorporating an observable carbon price (or tax), effectively driving the “internalization of the externality”, the clearer the investment opportunities are.
What about water and waste management?
One of the challenges in our interactions with building owners is that many are happy to engage on energy efficiency but less so on either water or waste management or even indoor air quality. The prices of these are less observable or set too low currently to result in clear financial benefit today. But this may also change. The Potsdam Institute for Climate Impact Research this year assessed that the planetary boundary for freshwater has been crossed.[6] Given climate change, we have seen droughts as well as floods in multiple areas around the globe this year, suggesting water will increasingly not be available everywhere and always.[7] This is significant given the importance of water and could mean much higher water prices in the future, particularly for industry. Our base case is that the “under-pricing” of water (as well as waste) will translate to greater risks and higher costs in coming years.
Internalizing externalities
Even so, much of sustainable investing, is focused around measurable and verifiable carbon emissions. The cost of greenhouse gases has not been priced in by decision makers in the past. Typically, to internalize this externality, governments would use taxes or fines around greater regulations. Unfortunately, while we need a global tax or price of carbon, this is highly improbable in an increasingly politically fragmented world.[8]
However, there are developing trends which could mean that externalities today will have observable prices in the future. One is the deepening of both voluntary and compliance carbon markets.[9] Furthermore, there are offsets that are tied to UN Sustainable Development Goals which ultimately could reveal differentiated prices for social development targets. Another is more regulatory pressure, from carbon taxes to disclosure requirements by Central Banks and the adoption of accounting standards.[10] To be sure, much still needs to be done, but there are indications that prices for some of the more measurable externalities will, in coming years, be transparent and material enough to drive different decision making.[11]
Pragmatic Sustainable Investing
Our approach to sustainable investing takes these trends into account: we like investments which meet the cost of financial capital, and which give us optionality on, or exposure to, the repricing of an externality. The emergence of the “price” of this externality can be via government policy or capital flows from the private sector. From a practical standpoint, the more measurable this externality, the easier it is to calculate the impact we can have. In short, having a clear objective on what we want to achieve and getting ahead of policy offers investment returns that achieve social and financial goals.
In many ways, Green Hedgehog offers this to our building owner partners. The owners will put zero capital down, saving resources for other ventures. After the installations, they receive a much more efficient building, one that is “smarter” and offers significant savings if the cost of energy stays high or rises further. If the carbon price or tax rises further in coming years, or regulatory standards continue to tighten, their savings will be even greater. And with this also comes the potential for a rising “green premium” in the value of buildings. For Green Hedgehog, by financing their retrofits, we are able to generate a return and lower emissions. Together, we are able to achieve environmental targets without compromising financial returns.
[1] https://www.nccs.gov.sg/singapores-climate-action/singapore-emissions-profile/ . Industry accounts for the bulk of emissions at over 45% and an escalating carbon tax for high emitters is now in place (https://www.nccs.gov.sg/singapores-climate-action/carbon-tax/).
[2] https://www.simmons-simmons.com/en/publications/ckmxbrsri18pm0a34fznd79y4/mees-implementing-the-epc-b-target-by-2030
[3] https://www.jll.com.sg/en/newsroom/from-value-creation-to-value-preservation-real-estate-investors-rethink-the-value-of-green
[4] https://unfccc.int/news/every-building-on-the-planet-must-be-net-zero-carbon-by-2050
[5] https://esi.nus.edu.sg/docs/default-source/esi-policy-briefs/corporate-internal-carbon-pricing_global-trends-and-challenges.pdf
[6] https://www.pik-potsdam.de/en/news/latest-news/planetary-boundaries-update-freshwater-boundary-exceeds-safe-limits
[7] https://www.c2es.org/content/drought-and-climate-change/#:~:text=Some%20climate%20models%20find%20that,during%20periods%20of%20extreme%20precipitation.
[8] There are several articles also challenging the EU Carbon Border Adjustment Mechanism. https://taxation-customs.ec.europa.eu/green-taxation-0/carbon-border-adjustment-mechanism_en
[9] Singapore has set up the CIX while Malaysia too has announced setting up and exchange. There are already voluntary exchanges. We shall have more to say on this in future blogs.
[10] The establishment of the ISSB is potentially a major step forward given the industry standards that have continued to develop at SSAB. https://www.valuereportingfoundation.org/
[11] There are also investment flows into biodiversity where its harder to measure but where there have been important contributions. (https://www.gov.uk/government/publications/final-report-the-economics-of-biodiversity-the-dasgupta-review)