Carbon Credits and Their Impact on Green Buildings

Carbon credits stimulate the use of renewable energy, construction of green buildings and energy retrofits for existing infrastructure properties. Carbon offsets enhance business case for green buildings and provide additional cash flow opportunities to building operators besides water and energy savings.

Green buildings are resource-efficient and positively impact the environment. Benefits of green buildings include better air and water quality, lower solid waste, conservation of natural resources and conservation of natural ecosystems. Furthermore, green buildings have economic benefits, including reduced operating costs, higher employee productivity and improved quality of life.

One of the leading standards for measuring the benefits of green buildings is the Leadership in Energy and Environmental Design (LEED) standard designed by the US Green Building Council. LEED — a third-party certification program and benchmarking system — concerns the design, construction and operation of green buildings. It recognizes performance in five areas: water savings, sustainable site development, material selection, energy efficiency and indoor environmental quality. It is based on a numerical rating system that allows for measurable benchmarks. The Green Building Initiative’s Green Globes for commercial buildings and National Association of Home Builders’ guidelines are other key green building rating systems.

US federal, state and local governments have introduced green building concepts into their programs and regulations. Since the late 1990s, the US federal government has been applying sustainable building principles to its own buildings through a series of executive branch policy statements. Furthermore, several federal agencies have embedded sustainable building requirements in their internal policies, including the LEED system, among other approaches.

While protocols on carbon credits are evolving globally, detailed rules exist under the Kyoto Protocol on ways carbon credits are generated. Notably, a CDM project under Kyoto Protocol must pursue an UN-approved ‘methodology’, which determines the process for setting a ‘baseline’ level of greenhouse gas (GHG) emissions (i.e., emissions that would occur without the project) and measures as well as monitors emission reductions achieved by the project compared to the baseline. Several CDM methodologies have been developed on green building principles. These include those that relate to energy efficiency in buildings, fuel switching in buildings and demand-side energy efficiency programs. Recently, methodologies have been developed that more directly relate to green buildings. These include projects to improve energy efficiency on the energy and demand side management for a hotel in India, improved energy efficiency measures regarding the Technopolis building in India and a housing energy upgrade project in Cape Town, South Africa.

Emission reduction from projects can be broadly grouped for the purposes of this paper into two categories — direct and indirect emission reductions. Projects that directly reduce emissions include those that directly emit GHGs into the atmosphere at sources. The bulk of GHG emissions from most commercial and residential buildings are ‘indirect ‘in that green building can reduce the emissions that occur at other sources. For instance, more efficient green buildings can reduce electrical consumption. If such buildings are connected to an electrical grid where electricity is provided by fossil-fuel power plants, this reduced electrical consumption can indirectly cut power plant emissions.

Myriad issues may surface while drafting transactional documentation concerning rights, such as carbon credits that are traded in rapidly evolving markets. One fundamental concern is who ‘owns’ the carbon credits and who can use their benefits. In theory, green building credits can be owned by parties including landlords or tenants or whoever undertakes a project to reduce GHG emissions associated with a building. Tradable rights arising from environmental benefits — referred to as ‘environmental attributes’ — may be allocated to parties to a contract including a lease or contract to retrofit or construct a building. Furthermore, some rights may be vested on a party by law, creating a potential subject of legal due diligence.

Another key issue concerns regulatory risk. Carbon markets are rapidly evolving, but it has been propelled by regulations driving the ‘compliance’ market — the Kyoto Protocol and the EU ETS, among others. Most commentators consider a compliance market driven by federal GHG legislation as, ultimately, the largest driver of a carbon market in the US. Where regulations drive markets, changes in regulations present a key risk, which should be considered and incorporated in applicable contractual arrangements. Problems may also arise while qualifying a project to obtain carbon credits. Several approaches have been adopted for allocating regulatory risks in the international Kyoto carbon credit market. For instance, the World Bank has developed publicly available form contracts that allocate regulatory risks in different ways. Similar issues should be considered when creating contracts in the US regarding projects that may generate tradable rights arising from green buildings.

Additionally, the roles and responsibilities regarding generating tradable benefits can be delineated and allocated, and the attendant costs split. For instance, contracts can establish responsibility for constructing green buildings in line with the plan and payment of certification costs. Risks and rewards — a function of the size of a project; potential value of environmental attributes; perceived risks; logistics required to develop these attributes; complexity of the underlying physical project and attribute allocation — may be included in (comparatively short, or detailed and complex) contractual provisions. Of course, a project may be exposed to various other risks. It may not turn out as intended. For example, a green building may not be built as designed, jeopardising its ‘green’ attributes.

There can be many ways to monetize environmental benefits from green buildings. Carbon credits present some complexity, but tradable rights arising out of ‘environmental attributes’ can be an important source of revenue for green buildings. Similar benefits may be available at the state and local levels, and international opportunities exist under the Kyoto Protocol, among others. Time will tell whether a wider market develops for carbon credits or green buildings give birth to other tradable rights. Addressing GHG emissions tied to buildings represents an important part of the climate change puzzle. And carbon credits or other tradable rights could incentivize the development of a green building market.

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