Institutions targeting China should look to benefit from the latest renewable energy innovations, say Peter Heber Percy and Brione Bruce
China's rapid economic growth and escalating demand for energy has come at a considerable cost to its environment. The country is faced with the challenge of balancing robust economic growth with environmental protection and sustainable development.
The government's 12th five-year plan, defining the nation's strategic direction, has prioritised environmental and energy security issues. It includes targets for energy efficiency and carbon reduction, as well as increased use of renewables. To achieve these goals, China is expected to invest as much as $770bn (€593bn) in low-carbon energy by 2020, according to ASIRA and Impax Asset Management.
This confluence of factors presents two significant opportunities for investors. The first is in China's real estate sector. The foundation of a greener China lies in its buildings and the country's ability to construct energy-efficient structures. If the Chinese government follows the path of successful carbon legislators like Australia, carbon taxes and restrictions requiring state-owned enterprises to occupy green buildings will change the landscape entirely, making a broad segment of the existing built environment obsolete and driving tenants towards projects that incorporate sustainable principles. Very small preference changes will determine the fortunes of a broad scope of investors.
The second opportunity lies with the companies supplying clean energy to these buildings. Many clean energy generating technologies, including solar, photovoltaics (PV) and ground energy, are best suited to the localised delivery of energy to buildings, rather than national distribution networks. In response to this, a micro-utility business model has become increasingly prevalent, where companies supply clean energy to individual buildings but adopt a business model similar to a traditional utility. Green micro-utilities is a nascent sector likely to become an increasingly important component of energy generation and delivery in China.
Renewable energy technologies can provide clean heating and cooling to buildings with very significant cost savings and sustainability benefits. For example, ground energy (also known as ground source heat pump or Geoexchange), an established technology that is widely used across Europe and North America, is now gaining popularity in China. In parallel with the expanding renewables industry, alternative utility businesses such as micro-utilities and energy service companies offer opportunities for investors to participate in the growing renewable energy sector in China.
The use of environmental, social and governance (ESG) data in investment decisions is growing, with global funds under management invested based on ESG strategies now amounting to over $6.3trn, according to RepuTex. At the same time, industry organisations such as the Global Real Estate Sustainability Benchmark (GRESB) are working to improve disclosure and evaluate the sustainability performance of real estate portfolios around the globe. With a membership that includes 11 of the world's largest pension funds, representing $1.4trn in assets under management, the GRESB provides information to institutional investors and evaluates the sustainability of fund managers in the real estate industry.
This growing interest among investors, combined with steadily improving information and stronger ESG strategies among companies, presents an exciting opportunity to real estate investors. China, with its rapid growth and favourable policy environment, presents an attractive opportunity.
Sustainable real estate in China
In July 2011, the Chinese construction sector was valued at $1.41trn, according to Freedonia. Analysts believe the sector could grow to $2.4trn by 2020, with China overtaking the US as the word's largest construction market in 2018.
The energy required to drive and sustain this transition is enormous. Energy consumption by the building sector has risen by more than 10% annually over the past 20 years and now accounts for 27-42% of China's total energy consumption, making it one of the most energy-dependent sectors in the country. Of this, heating, cooling and hot water account for up to 52% of China's building energy consumption, according to Energenz Consulting. For China's energy efficiency strategy to succeed, the building sector must play a central role.
Although EU and US pension funds have taken the lead in promoting and auditing sustainability in real estate portfolios, the conditions remain challenging to incorporate material sustainability features in greenfield developments, particularly in Asia. The combination of demanding development programmes, lack of knowledge of sustainability technologies and, perhaps most importantly, the absence of a buy-in proposition for building developers, contractors and local design institutes, all pose material obstacles.
Although more fund managers are requesting that development partners ‘green-up' buildings, it takes a great deal of perseverance on the part of the general partner to gain the proactive support of all the development stakeholders, even in a very favourable policy environment. Nevertheless, as demand for buildings with green accreditations continues to increase exponentially, developers are likely to become more accommodating of this increasingly important real estate dynamic.
One barrier to the adoption of high-capital clean energy technologies is the significant up-front investment relative to conventional systems. As a result, alternative business models have evolved in China.
A number of clean energy companies in China use the energy management contract (EMC) model, where energy service companies (ESCOs) fund the initial cost of the system infrastructure and enter into a partnership with the building owner to share in the value of efficiencies created. The monetary value of energy savings to be shared between the building owner and ESCO is determined through regular energy audits. Nevertheless, in some cases, due to the complexity of the technologies applied and other factors that affect system efficiency and performance, the audit process can be challenging and create dispute risk issues.
An alternative to the EMC/ESCO business model is the micro-utility model, where the energy provider finances and operates the generation system, delivering energy to the building on a metered basis under long-term contract. There is no annual energy audit or profit sharing, thus mitigating dispute risks. The micro-utility company takes on all of the technology risk, and the client is guaranteed a utility rate at the beginning of the project that is generally 5-10% below the baseline ‘conventional system' utility costs.
Micro-utility businesses offer advantages to property developers and investors by providing low-cost structural finance. The initial development costs of the project are transferred to a team of experts familiar with the technology and the operating environment, and the cost savings and sustainability benefits are transferred immediately to the client. As the real estate landscape shifts in China, alternative utility models provide economical and attractive opportunities to investors.
Using renewable energy for building utilities offers significant sustainability benefits and long-term cost savings. Ground energy is a proven technology that taps into the free renewable energy stored in the earth and significantly lowers the amount of energy required for a building's heating, air conditioning and hot water needs.
During the summer, when ground temperature is lower than air temperature, the ground is used as a heat sink; in winter, when the reverse is true, heat energy is extracted. The effect is energy savings of up to 40%, equivalent levels of carbon reduction and, an increasingly important factor across Asia, significant water savings. This can translate into a 20% reduction in overall building energy consumption - a level that no other single technology is able to achieve.
According to the US Environmental Protection Agency, ground energy systems are "the most energy efficient, cost-effective and environmentally-friendly space conditioning systems available."
More than 32 countries worldwide use ground energy, including in the EU, Japan, the US, Canada and China. There are more than three million systems in operation in the world, with major growth potential coming from China, where the government is actively promoting the technology. Ground energy is best applied in new buildings during construction (although retrofits are possible) and can be tailored to a wide range of commercial, residential and industrial buildings.
Grocery retailer Tesco incorporated the technology in its recently opened logistics centre in Jiashan, Zhejiang province. The centre's ground-energy system provides energy-efficient heating, air conditioning and hot water to the facility year-round.
The ground-energy system, along with other sustainability features in the building, will produce substantial savings; the Jiashan centre expects to consume 45% less energy, 40% less water and reduce carbon emissions by 35% relative to conventional logistics developments.
Peter Heber Percy is a director and Brione Bruce is a consultant at Asia Clean Capital