Wednesday, January 21, 2009

Incentivizing Green Construction

My friend Brandon had some interesting information. Turns out the ROI for green construction can be quite high:

"It's a week or so old, but I was quickly reading your blog (when I should be working) and was reminded of it by the NASA post:

It's based off of Harvard's Green Campus Loan Fund, which, I don't know if I've told you about it before, but it has been getting an annual return on investment of 30+% a year:
We're talking major retrofits of buildings- for example, installing a green roof can significantly lower both heating and cooling costs. Replacing old boilers for newer, higher efficiency ones can reduce energy consumption. Replacing showerheads for an entire house saves water and heating costs. "


The stimulus plan will fund some of that (via the first link), but certainly not all. So given that, it becomes an interesting question of market design. How do you get people to actually go out and do that on a mass scale in for-profit, as well as non-profit, environments?

There are three major challenges: Firstly, you need to overcome the cost of business interruptions, which will be major for many companies. It will stop others from proceeding for executive compensation or other reasons, even if a profit maximizing firm should proceed.

Secondly, the return can be great but if you don't have the seed capital, it's not going to happen. Oil's in contango right now (meaning a contract for oil in 6 months is more valuable than oil today), and until today, if you'd given me $8 million I could have earned you ~40% on your money in 6 months via arbitrage, plus or minus oil tanker rental fees. I could have bought oil at the $36 it was trading at yesterday and locked in a sale for $51 in six months, if I were willing to rent an oil tanker to store the oil (which requires roughly $8million worth of current oil). But because I don't have $8 million, I can't do it myself. This is a vast oversimplification of how to profit from contango via storage, but I think you get the point.

Finally, while an electricity tax increases incentives to do "green" renovations in a simple manner, the low cost of electricity in this country is a major reason for its progress, so you don't wanna tax it too much, especially given the recession.

Solution: Reclassify building codes to require green construction. If companies don't want to do it themselves, then have public utilities fund the construction in exchange for a bond worth half of the electricity savings. Companies receive low-cost relocation loans so they can work in another building til renovations are complete.

The business interruptions and inertia problem is overcome by a mandate. Business interruptions are expensive for companies, and even more so for the executives who run them. Building codes are the best way around that. You start by reclassifying building codes (All buildings need to have boilers meeting X specifications and roofs meeting Y specifications).

You then still have three problems. One, we're in the middle of a recession and you don't want to interrupt businesses' operations or you'll make it worse. Two, capital's still an issue - we're in the middle of a recession and capital is hard to come by. Three, redeployment of that capital and interruption of your business means you probably have to lay off some workers, even if just temporarily, which is bad for a recession. These things won't be easy outside of a recession, but are brutally difficult in one.

Solution to business interruptions comes in the form of low- or no- cost (inflation adjusted, of course) loans to businesses to rent real estate for the duration of construction. In many cases, that's a few days while a new boiler is put in, with no loan needed. If you need a new roof, it's probably longer, so you loan them money to rent commercial real estate and keep working with a much smaller interruption. That's money that will get paid back into the treasury, so it's pretty low-cost to the public. It also rejuvenates a struggling market for commercial real estate.

A cool way around the capital issue would be to require electric utilities to fund all that construction in return for a ~10 (5, 8, 12, 14, whatever, depending on the actual ROI) year commitment for companies to pay 50% of their energy savings to the utility. If the ROI is really 30-40%, utilities should be perfectly willing to do it, especially if they had access to more low-cost loans (a bank if one will do it, Federal if one won't in this environment) to fund it initially.

Some companies will want to fund green construction themselves and benefit from 100% of the savings immediately, and they can. However, for those who don't want to do it themselves, you're hurting those companies far less with this plan than by just requiring them to find the capital to do it themselves, because you're basically giving them a major energy cost reduction and a low-cost relocation loan just to vacate their facilities for a short period, with no capital required. As with all of my proposals, the actual numbers aren't the important part, and can get worked out - it's the structure.

Make all of those federal loans senior secured and the default rate on them should be quite low, representative of US business prospects in general post-recession (arguably a much better default rate than TARP-related loans, which are mostly tied to subprime mortgage payments and exclude the reliable prime payers). Ideally, a large bank would do the initial funding of the construction, if not the relocation, but because we're in a capital crunch, the Fed may have to do.

1 comment:

  1. Just to make a case and point, I was doing some studying, and came across this case study in my LEED handbook:

    "Carefully designed energy efficiency upgrades in buildings can frequently pay for themselves because of the resulting energy and maintenance savings. For instance, Adobe Systems, Inc. reduced its per employee electricity use at its headquarters by 35% and its natural gas use by 41%. Overall, Adobe implemented more than 60 upgrade projects, saving $1.2 million annually and achieving an 84% return on investment."