Politics Of Coronavirus, Climate, & Commercial Real Estate – Part 1/2

Co-authored with Adam Crozier, B.Eng. Management

As COVID-19 burns through the world, and the United States is now the country with the largest number of cases, it’s worth looking into the future. This specific crystal ball is focused on commercial real estate, an important sector for clean technology. This is a longer term perspective, not a one year perspective. The projections we make are implications for the next 20 years, not just 2021. 

We foresee a softening of new commercial construction, a reduction in cosmetic renovations of existing stock, an increase in renovations focused on improving the net operating income including a strong focus on heat pumps displacing gas furnaces and existing air conditioning and an increased shift to distribution-center business models.

Image courtesy US Department of Energy

There are 6 million commercial buildings in Canada and the US alone and buildings are a major sector for climate action.

“Buildings and their construction together account for 36 percent of global energy use and 39 percent of energy-related carbon dioxide emissions annually, according to the United Nations Environment Program.”

There’s been an increased focus on embodied carbon as a wedge that must be addressed in new buildings, but those 6 million commercial buildings that already exist are built with a mix of high- and low-carbon material. The only addressable wedge for that set of buildings is on the energy use side, and a major portion of that is heating and air conditioning. Building construction and renovation will also be impacted by the aftershocks of the coronavirus, so we’ll cover those aspects as well.

This first part deals with the pertinent political changes pending due to the coronavirus, politics and global action on climate change. The second part deals with the implications for commercial real estate.

Political Winds Are Changing

An obvious aspect of the pandemic is political. At present, the US is a major outlier in not being signatory to the Paris Accord. Further, it’s not one of the 65 signatories to the Kigali Amendment to the Montreal Protocol, an amendment focused on reducing the global use of high global warming potential HFCs in refrigerants and air conditioners in favor of lower global warming potential (GWP) refrigerants, including better HFCs, HFOs, and carbon dioxide. 

While recently President Trump’s approval ratings for his handling of the pandemic have risen somewhat, public health experts have been appalled at his administration’s actions. Trump’s Administration disbanded the Pandemic Response Team, an Obama-era national office set up specifically to monitor global epidemics and to marshal US national resources to address them. Trump’s Administration allowed the CDC to have thousands of unfilled positions, something common across the federal bureaucracy. Trump’s Administration cut $15 billion in disease fighting budgets over the CDC, NSC, DHS, and HHS. Trump’s Administration shut down the National Security Council’s entire Global Health Security Unit. And, of course, there is Trump’s personal contribution of deeply challenged communications related to the severity, spread and solutions to the disease, including his failure to adhere to the traditional understanding that the buck stops with him.

“No, I don’t take responsibility at all”
President Donald Trump, March 13, 2020

Trump has been running on the economy, especially the Dow Jones Industrial Average and jobs, which had continued improving for the first years of his Presidency in line with the Obama-era recovery and improvements. The common wisdom — one weakly supported by evidence — is that incumbent Presidents win when the economy is strong. The economy is not strong and won’t be by November 2020, regardless of how Trump’s campaign might choose to spin it.

Even prior to the pandemic, Trump’s route to a second term was less rather than more likely. No candidate has been so relentlessly subjected to long term political slander as Hillary Clinton was. Joe Biden has a lock on the number of delegates required to make him the next Democratic nominee for the position of President. He will be the candidate chosen at whatever Convention the DNC pieces together in July in the age of social distancing when gatherings of 50,000 people who love to shake hands and clap shoulders isn’t recommended.

While the Republican campaign is working hard to make Joe Biden look as bad as Clinton, Biden has been much less subject to relentless investigations, doesn’t have the Bill Clinton shadows over his candidacy and doesn’t face the downsides of trying to president while female. He doesn’t have an FBI investigation into his email that would bombshell days before the election. He’s entering the race after Clinton won 2.7 million more of the popular vote than Trump in 2016, and after the Democratic mid-term nominees received almost 10 million more votes than the Republicans.

And as one of the authors has said in print and podcast, even before the pandemic, the Republicans were very likely to lose Florida and hence the Presidency over climate change. 

The odds that Biden will be the President in 2021 are high. The odds that Democratic control will be seen in both Houses of Congress is also high. But it would only take one House and the Presidency to see major action on climate, including signing the Paris Accord and the Kigali Amendment, both features of Biden’s climate action campaign plan.

Biden supports a carbon price, something that emerged in later debates as opposed to being in his formal plan, and that has direct implications if it could be implemented. The Canadian carbon price is already seeing cost implications of US$1 per gigajoule of natural gas for heating and will rise to close to $2 per gigajoule, something that would significantly increase commercial building heating costs.

Biden is being pressured to ban fracking, and has stated that he would prevent new fracking. That has major implications for natural gas prices in the US, and is in line with fracking bans emerging in other jurisdictions. Fracking for natural gas as a technology has a limited duration of operation per well, and building new capacity by rolling onto new wells in new areas is a major part of the business model of the industry. The industry is challenged by debt and bankruptcies in any event. A partial ban or a federal lands ban would seriously reduce fracking gas production.

Image courtesy eia.gov

And fracking gas production is one of the major things which keeps the price of natural gas very low. In Canada, where fracking is performed in Alberta and eastern BC, fracking is one of the key things that makes natural gas itself a volume revenue, no margin service offering for Fortis and Altagas, with distillates as the profitable portion of the business. 

The combination of political risks, bans in some places and debt further pressures the fracking industry. This will most likely lead to more volatility in gas prices in the upcoming decade. And commercial building operators want low volatility in their cost predictions. The high potential for a return to spiking winter gas prices and increased costs due to carbon pricing, plus social pressure, will push a lot more commercial buildings off of natural gas heating. But what will they move to?

This is where the Kigali Amendment kicks in as well. Its shift from high-GWP refrigerants means in many cases a change of mechanical cooling infrastructure, not just a replacement of refrigerants. And that opens the door to heat pumps with low-GWP refrigerants displacing both gas furnaces and air conditioners in commercial buildings, something we see as almost inevitable regardless. Moving from two HVAC components to a single component has cost advantages, including both reduced overall capital cost and reduced maintenance costs.

Right now in British Columbia natural gas is about 1/3 the cost per unit of energy vs electricity. Heat pumps generate a coefficient of performance (COP) of around 3-4, sometimes higher, but for the sake of this discussion we’ll be conservative and average at a COP of 2 throughout the year. With any significant increase in price for natural gas the economics for a heat pump operating on electricity become much more attractive and this is regardless of any added the air conditioning aspect brings.

For commercial real estate, the outlook means that operational cost projections of natural gas systems must include much greater potential for upwards price volatility of the fuel and a reversal of general lowered fuel cost due to fracking.

Read the second article in the series, which deals with the shifts in commercial real estate which will be occurring in office, retail and distribution centers, along with the climate implications of the combination of politics, climate and the coronavirus.

Adam Crozier and Michael Barnard are working with a team to develop a future-proofed business model for a low-carbon HVAC transformation company focusing on commercial real estate.