Summary:
This paper reviews the relevant design elements of carbon and environmental markets and explores how they could influence the design of Building Performance Standards (BPS) programs. Carbon and environmental markets have existed for more than three decades, giving policymakers experience with scope and target setting and the design of flexibility provisions. The paper also sketches out how the sector-specific BPS programs overlap and interact with existing cross-sectoral programs—state-level clean energy and renewable portfolio standards (RPS), the Regional Greenhouse Gas Initiative (RGGI), electricity markets, and transport electrification.
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Discussion
BPS programs can use several design options pioneered in the carbon markets— multiyear compliance periods, absolute or benchmarked targets, and various flexibility mechanisms—to provide flexibility, help balance environmental goals and compliance costs, and even generate revenues to fund related building efficiency programs. Initially focusing on the largest buildings or largest emitters allows a program to capture the bulk of the relevant emissions or energy consumption while lowering the administrative burden. Because BPS programs have a small geographic scope, leakage is a risk: the highest emitters, notably data centers and industrial sites, would have an incentive to exit the city if compliance costs become significant. This risk can be mitigated with tailored baselines, special allocation provisions, or a broader geographic scope—all strategies that have been used in carbon markets.
Understanding how trading of compliance obligations affects building owners’ retrofit decisions, compliance costs, and savings opportunities requires knowledge of the building sector’s abatement options and costs. Including tradable markets in a BPS design increases compliance flexibility, both across entities and across time when allowance banking is permitted. However, for a market to work effectively, building owners must have a clear understanding of the cost and the energy or emissions savings of various retrofit packages for their properties. The benefits of trading within a corporate bubble versus across all covered entities is difficult to gauge without an indepth understanding of the ownership structure of the city’s covered building stock.
BPS policies target both electricity and energy consumption and thus interact with other environmental programs. These interactions can take different forms, which are not always intuitive:
• The environmental benefits can be additive. For example, the New York City BPS should create demand for local renewable energy that is supplemental to the state’s Clean Energy Standard since New York State RECs can be sold only to compliance entities.• Program-related emissions reductions could be offsetting. That might be the case with RGGI if emissions reductions tied to a BPS reduce the compliance burden for RGGI generators but not the RGGI cap.• Buildings might be subject to conflicting measures if, for example, the state RPS drives emissions reductions that are not fully factored into a city BPS program’s algorithms used to calculate emissions, or if electric car charging stations increase electricity consumption covered by the program.
Although that list reveals potential policy and market interactions with BPS policies, further quantitative analysis is required to understand the magnitude of these interactions and their effects on emissions. As they develop future policies and modify current designs, municipal officials should recognize these interactions and adapt policy designs as necessary to counter or limit adverse consequences.
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Scope
The first carbon market design question is, Which entities should be covered? The answer must balance two goals: capturing as much of the sector’s emissions as possible while keeping the number of compliance entities reasonable. Carbon markets therefore do not cover individual homes or vehicles but set the point of compliance at the power plant, refinery, or point of fuel distribution. BPS program designers must choose whether to regulate entities based on their size or based on their consumption or emissions level.
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Price Formation
Regulatory programs entail compliance costs that can be expressed as cost per unit of emissions or energy consumption reduced. These compliance costs are reasonably transparent in tradable programs, which have transactable prices, and they are implicit in nontrading programs. This section uses a very simple conceptual model to illustrate price formation and trading dynamics in BPS programs.
Our hypothetical program targets energy reductions, which can be translated into carbon reductions. It has five buildings and two owners. All buildings face a 10 percent reduction target in the first phase of compliance. Each building has three abatement options: a lighting retrofit, the addition of window films, and an HVAC retrofit; not all options are available to all buildings (Table 3).
With no trading, each building must meet the reduction target individually (Figure 2). This means buildings 1, 3, and 5 will invest in a lighting retrofit because that is the most cost-effective option. However, buildings 2 and 4 will have to upgrade their HVAC systems to meet the requirement because a window treatment, by itself, is insufficient to meet the reduction target. The average cost per square foot of the combined treatments is $3.90 per square foot, and the total reduction far exceeds the phase’s 10 percent target, since consumption is reduced by 17.2 percent. The program’s average cost-effectiveness is calculated as the cost per Btu reduced, and it stands at $0.29 per Btu. The DC program does not plan to include trading between covered entities. It does, however, have a baseline in ENERGY STAR units, which means that buildings that are already efficient may not have to go through upgrades in the initial compliance periods.
In a tradable market, building owners can use the market price to inform their efficiency investment decisions. Our MAC curve tells us that the building stock can achieve an average 10.2 percent consumption reduction across all buildings by applying the two most cost-effective measures: lighting and windows. The marginal cost, or cost of the last measure applied, is $0.13 per Btu, which is the cost of the window treatment. In a well-functioning market, that market price is available to building owners to inform their decisions: buildings 1, 3, and 5 would receive a lighting retrofit and buildings 1, 2, 4, and 5 would get window films. Two buildings apply both measures, one retrofits the lighting only, one applies the window treatment only, and one building does neither. The cost of these measures averaged over the building stock is $0.08 per square foot. This solution is about three times more cost-effective than the no-trading approach. To come into compliance, building owner B, who is undercomplying, would buy the compliance units she needs to meet her obligations from building owner A, who is overcomplying. That transaction would take place at the marginal cost of $0.13 per Btu. In a transparent market, all building owners who have abatement options below $0.13 per Btu have an incentive to apply them. More expensive mitigation options are delayed to later compliance phases. This flexibility gives building managers time to plan efficiency improvement projects that match the lifetime of existing equipment. If a building owner needs to replace an HVAC system, thereby achieving emissions reductions greater than the target, she can use the allowance market to help fund the upgrades by selling excess compliance units.
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by Véronique Bugnion and Karen Palmer
Resources For the Future (RFF) www.RFF.org
Report (20-13); October 29, 2020
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