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Decarbonizing the Building Sector

ESG

By Tom Abrams, CFA  |  June 8, 2022

According to the International Energy Agency (IEA), approximately 38% of global energy-related carbon dioxide (CO2) emissions arise from the building sector. Yet the building sector is one of the harder to decarbonize due to several challenges, including: retrofitting the massive existing global stock of residential and commercial buildings, moving many areas of the world away from in-building particulate and CO2-generating biomass and coal, and motivating efficiency and potentially more expensive building approaches.

The IEA currently sees the sector as “off-track” to reach carbon neutrality by 2050 and calls for “all new buildings and 20% of existing buildings to be zero-carbon” by 2030. The United Nations’ (UN’s) Intergovernmental Panel on Climate Change (IPCC) sees building sector carbon emissions continuing to grow, albeit at a slowing rate, through 2050.

Key Emissions Terms for the Building Sector

Of the 38% of global energy-related emissions from the building sector, about 9% arise directly from fossil fuel use in buildings (3% non-residential, 6% residential), 19% indirectly from heat and electricity generation used in buildings (8% non-residential, 11% residential), and an additional 10% is related to materials and the construction industry.

CO2 emissions during the construction of the building are considered “embodied.” CO2 emissions can equal 20-30% of the total emissions of a building during its lifetime. Embodied emissions are carbon emissions emitted from non-renewable electricity consumed during construction, carbon associated with all the construction materials (from extraction to processing and delivery), and carbon from fuels used by machinery and equipment.

iea-global-emissions-by-source

“Operating” emissions are the emissions associated with running the building, including fossil-fuel electricity, heat generation, or cooking, and can come from a variety of fuels. A near-zero energy building gets most of its operating energy needs from renewables. A net-zero energy building gets all its operating energy needs from renewables. A net-zero carbon building (ZCB) has a negative ongoing carbon footprint such that the carbon emitted during construction is offset during the life of the building.

Recent Energy and Emissions Trends for the Building Sector

A key driver for buildings’ energy and emissions growth has been the growth in floor space. Fortunately, advances in energy efficiency have helped to partially offset floor space growth. According to the IEA, between 2010 and 2019, final energy use in buildings increased at an average annual rate of 1%, slower than the 2% average annual expansion in floor area.

The IEA indicates that the fastest energy growth in the building sector is in space cooling, appliances, and miscellaneous electric plug-loads. Space cooling growth is a trend widely expected to continue based on global living standards and, ironically, from global warming itself. For example, the share of global households with air conditioning grew from 27% in 2010 to 35% in 2020, according to the IEA.

Globally, electricity is about one-third of building energy use, but fossil fuels—and their emissions—are a large part of remaining energy consumption and have experienced average annual growth of 0.7%. There are potential benefits from replacing traditional biomass use in some regions with cleaner biomass, biogas, lower-carbon electricity, and even liquefied petroleum gas (LPG).

The overall decline in global building energy intensity (energy use per square foot) is also attributed to building efficiency codes in many countries. These codes include additional and more stringent minimum energy performance standards (MEPS) for appliances and shifts to higher-efficiency heating technologies such as heat pumps. One hundred countries have MEPS in place for at least one of these end uses and another 20 are developing policies. Final energy use covered by MEPS globally is now above 80% for residential refrigerators and air conditioners, up from two-thirds in 2010, and just over 75% for lamps, an improvement of more than 30 percentage points in the same period.

eia-residential-commercial-energy-intensity-outlook

To meet the UN’s Net Zero Emissions by 2050 target, the IEA believes that all new buildings and 20% of existing buildings would need to be zero-carbon by 2030. In addition, average building sector energy intensity must decline nearly five times faster over the next 10 years compared to the past five. This means the energy consumed per square foot in 2030 must be 45% less than in 2020.

Data centers (frequently cloud storage hubs) are often a point of conversation when talking about decarbonizing new buildings. Data centers are large consumers of energy for both their data operations and for the cooling requirements of their equipment. With its high demand for electricity for processing power and cooling, cryptocurrency mining shares some of the same issues as data centers.

The IEA estimates that data centers consumed 1-1.5% of the world’s energy in 2020, an amount generally expected to grow. Drivers for this growth and likely adding to ongoing grid considerations are a potential doubling of internet traffic in coming years plus continued moves to cloud storage, crypto growth, and expansion in both residential and commercial uses of technology.

Efficiencies on the margin could help data center operators focus on controlling their carbon footprint. The next focus is probably hunting for more renewable energy sources, including solar panels and batteries on-site.

Options for Decarbonizing the Building Sector

The number one decarbonization option for the building sector is greater efficiency. The second is electrification with renewable power, as we see in other sectors.

Efficiency measures:

  • Passive design
  • Efficient heating, ventilation, and air conditioning (HVAC) equipment
  • On-site renewables where the building type and mechanicals allow
  • Off-site renewables, including hydrogen
  • Carbon offsets via investments elsewhere, including carbon capture at the utility level

Passive design elements:

  • Design and orientation
  • Insulation
  • Roof color
  • Window sizes
  • Glass choices
  • Shading

Operating steps:

  • Light emitting diode (LED) lighting
  • Digital monitoring and control
  • More efficient power, heating, and HVAC equipment
  • Solar water heating
  • Electricity storage

10 Key Measures from the UN’s Global Alliance for Buildings and Construction

  1. Establish and implement an ambitious energy code for buildings (new)
  2. Support the use of integrated design (new)
  3. Promote deep energy renovation (existing)
  4. Lead by example by decarbonizing public buildings (existing)
  5. Use energy information and behavior change to drive efficiency
  6. Promote financing for energy efficiency
  7. Enable easy access to information on the carbon footprint of materials
  8. Develop public procurement policies that incentivize materials with low carbon footprints
  9. Integrate nature-based solutions into urban planning, buildings, and construction
  10. Develop integrated resilience strategies and plans for the built environment

Source: U.S. Energy Information Administration, Annual Energy Outlook 2022, www.eia.gov.aeo

The publicly-traded real estate investment trust (REIT) industry is said to represent approximately 510,000 buildings. Because of REITs’ public ownership, they talk more about their climate mitigation strategies and are likely leading the overall building sector in the U.S. About two-thirds of the largest REITs—in line with the market—are reporting their carbon emissions, with many giving future targets as well.

Key Considerations for New Buildings

To reduce embodied carbon, contractors and the building products industries are working on lower-carbon materials. While announcements are gaining pace and are all incrementally positive, the tons and linear feet of lower-carbon materials over the next several years remain a very small part of overall materials used and can also be less economical for returns-focused builders.

Cement and steel are two industries in the industrial sector whose efforts to create lower-carbon products are sometimes in the news. Lower-carbon cement will use renewable energy, preheating with waste gas, using CCS (carbon capture and storage), recycling some concrete as an aggregates supplement, or to some degree, adding carbon into various types of cement for different performance characteristics, including added strength.

For global steel, there’s a slow shift to more electric arc furnace (EAF) steel, which has fewer emissions than traditional integrated steel, and as recycling networks improve, the use of scrap steel inputs. The U.S. is much further along in the percentage of EAF steel and developed scrap networks. That said, many EAFs globally have an interest in adding renewable electricity sources. In traditional blast furnace steel, some mills are adding CCS capabilities to coke ovens and furnaces to reduce net carbon footprints. For both cement and steel, introducing some level of hydrogen fuel to the “cooking” process has also begun to gain wider interest.

Other efforts in new buildings include the use of a broad array of digital technologies to monitor, meter, and control building operations with an eye toward efficiency. Engineers can increasingly use software to calculate a building project’s embodied carbon before construction and during operation to optimize the functional parts of their designs. While efforts to consider carbon-negative materials are interesting, they remain small in the context of the broader sector. These materials include flooring and ceiling tiles with captured mineral fibers, more wood products that act as carbon sinks, materials with recycled content, and a variety of lower carbon roofing materials.

Key Considerations for Existing Buildings

There is no magic bullet or universally adaptable solution for all types of structures. Each building has its own unique characteristics, such as geographic location, use, size, age, lease, utility, footprint, roof size, heating/cooling needs, space, etc. To these physical variables, we can add the financial ones, including capital requirements, ownership, lease structures, and local installation and energy costs. Each variable contributes to a need for a complex, building-by-building approach.

Key metrics that some companies are starting to consider or report include carbon intensity (e.g., net CO2 per ton of cement used), clean energy in the electricity mix, and average power utilization efficiency (PUE) improvements. There are many ways to attack these goals. Many buildings pursue efficiency standards (with LEED and Energy Star being two leading certifications) which are useful to establish some comparability and appeal to stakeholders. Some of the more common modifications to existing buildings can include:

  • Rooftop solar (applicable in some building types more than others)
  • Painting roofs a reflective color
  • Adding vegetation where possible
  • Coating or replacing windows
  • Adding passive cooling

In the residential space, newer energy-efficient appliances, heat pumps, solar panels, and other passive heating /cooling technologies (e.g., geothermal) are potential modifications, but these are often economically challenging. There are many small steps that can be taken in the commercial or residential building markets—the hope is that they provide meaningful benefits on a cumulative basis. The chart below from the EIA indicates that onsite generation will remain a small part of overall building energy consumption.

eia-residential-commercial-onsite-generation-versus-purchased-electricity

As with new buildings, adding an enhanced suite of digital sensors, meters, and control equipment can essentially add room-by-room zones of control, akin to lights that turn on when they sense when someone is in the room. More monitoring and control electronics can manage heating and cooling and detect anomalies even if management is located elsewhere.

eia-residential-commercial-electricity-intensity-by-end-use

eia-indexed-commercial-service-provided-per-square-foot-of-floorspace

In some cases, the timing, space requirements, or economics of an existing building modification are not tenable, in which case owners can take “offsite” steps to reduce carbon footprints. Some firms are buying renewable energy credits and carbon offsets, while others may make direct investments in reforestation or global renewable projects, even if they aren’t physically connected to these activities.

Additionally, some firms have also taken credit for reduced square footage (and associated emissions) and the reduction in employee commuting emissions. However, these claims are often criticized as just pushing the heating and cooling issue elsewhere rather than having a system-wide net impact. The charts below indicate where the EIA anticipates efficiency gains by 2050.

Challenges and Opportunities to Modifying Existing Buildings

The graphics below show areas of electricity consumption in U.S. buildings where efficiencies might be considered.

eia-residential-electricity-use-miscellaneous-electrical-loads

eia-commercial-electricity-use-miscellaneous-electrical-loads

Fully electrifying a home can improve carbon emissions; however, this can also be significantly more costly to install or operate. For example, New Jersey recently proposed that buildings with fossil-fuel-fired boilers should have to install electric ones while also indicating that there would be capital costs involved as well as operational costs running 4.2-4.9X higher. In addition, while some national agencies believe solar panels on a home improve its value, this is not true in all locations and can partly depend on the remaining financing structure of the solar panels when a house changes hands.

There is also the issue of “split incentives.” Many tenants with net leases pay their own utility bills. If a building owner wishes to spend money to green a building, the tenant benefits with lower electric bills or carbon credits rather than the owner through higher rent receipts, at least not immediately. Similarly, modifying a building’s controls, ductwork, piping, windows, or insulation while a tenant occupies the building can be very disruptive and landlords may not be able to make the desired changes. Many changes are then left until tenant turnover and equipment replacement cycles; however, the changes may still prove to be impossible (e.g., space constraints, existing HVAC systems, utility connections) or uneconomical (e.g., costs are at a significant premium while rents may have no pricing power).

Potential Opportunity for Policy to Help Drive Transition

Specific policy initiatives could include subsidies, rebates, financing structures, education on available technologies, construction company training, collectivized procurement schemes, and research and development (R&D) support. In what could be a precedent-setting move, the U.S. federal government recently established new efficiency standards for its many buildings.

Meanwhile, aligning building trade practices, supply lines, local considerations, economics, and politics has made the development of new codes and standards slower than many climate hawks would like. Tradeoffs between cost and rent potential—and chosen policy solutions—will vary across locations. For example, policymakers may choose to focus on new building codes or on motivating retrofits. Alternatively, a policymaker may emphasize regional low-carbon electricity and utility-scale batteries to help all building carbon footprints rather than focus on a specific market.

Some cities are moving to end the use of natural gas in new homes and buildings, including Berkeley, California, San Francisco, Seattle, Denver, and New York City. The hope is that the electricity replacing natural gas is increasingly low-carbon and, incidentally, reduces the growing demands for a constrained supply of natural gas otherwise needed for gas-fired generation. Rules and policies are slowly evolving around the world and are forcing change, even if modestly. The hope is for continued improvement in the pace of efficiency gains as new buildings enter the national stock of about 110 million residential homes and over 10 million commercial buildings and existing buildings are modified.

Environmental Considerations Beyond Emissions

While carbon emissions are the focus here, many buildings are also working to reduce their water footprint, provide safe operations, and build resilience to climate change. As noted above, some companies are investing in offsite domestic and international reforestation and biodiversity support. Investments in resilience—to winds, rain, rising water levels, seasonal electricity demand, and regional water shortages and surpluses (floods)—have all been announced in recent quarters by the building sector. As with overall energy efficiency, building health standards, ratings, and certifications can help building owners demonstrate quality health and comfort.

Some Potential Risks Facing the Building Sector

Under various climate change scenarios, individual buildings, company portfolios, and entire areas can be exposed to environmental change. While some may benefit from changes due to climate, others could experience significant drops in value. Exposures could include:

  • Decarbonization capital requirements, both voluntary and mandated
  • Loss of value due to flooding or fire
  • Risks to commuting “lanes” even if the building is unaffected
  • Regional volatility in water-stressed or energy-intensive industries
  • Knock-on impacts on the ability to service financing.

This article was originally published on the BTU Analytics website.

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.

BTU oil and gas data

Tom Abrams, CFA

Principal Content Manager, Deep Sector Content, Oil & Gas

Mr. Tom Abrams is the Principal Content Manager for oil and gas content at FactSet. In this role, he is responsible for integrating additional energy data onto the FactSet workstation, including drilling, production, cost, regulatory, and price information. Prior, he spent over 30 years working at sell- and buy-side firms, most recently as the sell-side midstream analyst at Morgan Stanley. He also held positions at Columbia Management, Dreyfus, Credit Suisse First Boston, Oppenheimer, and Lord Abbett. Mr. Abrams earned an MBA from the Cornell Graduate School of Business and holds a BA in economics from Hamilton College. He is a CFA charterholder.

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The information contained in this article is not investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.