Electrifying Buildings

This is one of several posts on new areas we are exploring for USV’s Climate Fund.

Electrifying buildings will play a critical role in managing our carbon budget.  Nearly 18% of global greenhouse gas emissions are attributed to powering residential and commercial properties (Figure 1).  Worldwide residential emissions alone are roughly equivalent to Europe’s entire carbon footprint.  The challenge is both global (building stock will double in area by 2060) and hyper-local (building codes and economic incentives are often applied at a city or county level).

Building electrification and grid decarbonization go hand-in-hand.  While electrification does not instantly make the energy supply entirely clean, it gives it a chance to be.  The process involves replacing a structure’s primary energy draws such as heating, cooling, and hot water (Figure 2) with electric equivalents.    In new construction, it means installing electric HVAC, electric hot water, and electric appliances from the start.  The hardware already exists and is well understood. 

In fact, building electrification is most often a collective coordination problem.  Property owners are highly fragmented in local markets with low software penetration and limited access to capital.  Historically, few companies have developed network effects that support national or international scale.  There are a number of reasons for this, including:

• Infrequent, low-information transactions: Equipment is most often replaced at the point of failure (every 15 – 20 years).  There are no flagship consumer experiences in this category, few financing options, and scarce market education about what to buy.  
• Fragmented decision structures: Companies face a spider web of tenants, property owners, and investors who share different goals and decision-rights when it comes to building maintenance/ upgrades.
• High costs and limited financing solutions: Construction is expensive.  High upfront costs are exacerbated by labor shortages in skilled trades as well as equipment bottlenecks for systems that are not yet manufactured at a national scale.
• Long project timelines and expected payback: Retrofits and new construction can take years to complete.  Payback periods are similarly long and often outside the ‘zone of consideration’ for many cash-strapped landlords or homeowners.
• Lack of standardization: Buildings are heterogenous, as are auditors, contractors, and local regulations.  There are few reliable channels to reach landlords in a cost-efficient manner.  Taken in combination with relatively low software penetration, opportunities for network effects have often been constrained to a particular city or region.

Recent technical advances, increased availability of project capital, and new regulations have changed the constraints of building electrification in many markets.  Working in tandem, they provide momentum to alter the potential adoption curve for electrification technology.  These changes include:

• Technological:
  • Falling cost of energy storage: Lower-cost, longer storage means it will be cheaper to load-shift a larger share of building electricity use, drawing power from the grid at the least expensive times of day.  This improves project economics and translates into direct savings for property owners.  Storage may range from utility-scale installations to individual home batteries.
  • Standardized grid software stack:  National software networks are beginning to emerge which will lay the foundation for the next layer of grid innovation.  For example, companies like Leap are creating a standardized way for energy assets to sell energy and capacity into wholesale markets.  This unlocks a foundational piece of standardization for the next level of decentralized coordination, allowing vehicle-to-grid (V2G), smart appliances, and home operating systems to communicate without the need to establish utility partnerships themselves.
  • Improved HVAC systems: HVAC is often the largest single load in a commercial or residential property.  It is also one of the fastest-growing strains on the grid.   For example, cooling demand is expected to more than double in the next twenty years as many nations face a confluence of rising incomes, increased urbanization, and warmer temperatures.  Fast-expanding markets like India, China, and Indonesia are expected to drive ~half of this growth (Figure 3) in global air conditioner stock.  
    • Updated HVAC technology is playing a critical role in improved electrification economics.  Air-source heat pumps (ASHPs) have become more efficient and suitable for cold climates, where ASHPs had previously struggled to replace natural gas.  Ground-source heat pumps are finding their required heat differential at shallower depths too, opening up new geographies to geothermal development at lower cost.  The refrigerants used in these systems are also improving, as countries meet international deadlines designed to phase-out ozone-depleting substances.

• Financial: 
  • Streamlined financing:  Turnkey retrofit platforms are drastically reducing decision complexity for landlords by coordinating project scoping, lending, and even pricing with contractors.  In some cases, these options are zero-money-down.
  • New forms of insurance:  New financial intermediaries are stepping-in to de-risk commercial and residential project development and widen the set of property owners who may be eligible to switch from fossil fuels to renewable sources in the near-term.
  • Trading platforms:  Trading platforms for offsets and renewable energy credits are helping to create price transparency and in some cases fungibility of these certificates across geographies, increasing the liquidity (and even potential value) of these contracts from one location to another.
  • Automated audits: Software-based audits and standardized reporting are reducing the time and cost associated with project development.  These solutions also unlock a standardized funnel to acquire customers by highlighting properties who would most benefit from building upgrades and retrofits.
• Regulatory:  State and federal incentives aimed at catalyzing grid parity, deploying project finance, and ensuring environmental justice continue to play a critical role in building electrification.  Policies range from residential solar mandates for new construction to strict penalties for buildings that fail to retrofit.  Federal efforts are also expected to lead the way on decarbonizing public housing and military bases, providing scaled proof-points that will accelerate private investment.
• Human capital:  A shortage of skilled tradespeople to build new construction as well as retrofit legacy properties presents a challenge to maintaining the cost efficiency of electrification projects.  Peer-to-peer apprenticeship models are beginning to emerge that will help reduce the cost of training and support graduates as they enter reliable, high-wage professions in fast-growing industries like solar installation.  These education platforms will play an important role in managing both labor supply and cost in the years to come.

We also recognize that there are locations where an absence of strong climate policies have made it difficult for retail electricity prices to compete with low-cost fossil fuels like natural gas.  Research suggests that regulatory changes taken independently or in tandem with technological progress on products like ASHPs would favorably alter the unit economics of electrification in these regions.  This means a shift in project cost is within reach from both a technological and regulatory perspective. 

USV is evaluating opportunities across geographies that will accelerate the pace of building retrofits and green new construction.  Many of the hurdles to building electrification will not be hardware-based, but rather questions of go-to-market, access to capital, brand building, and customer education.  Thankfully, these are challenges where start-ups succeed and often outpace incumbents.  In particular, we are excited about:

• Power system integrations: Platforms and protocols that enable buildings and appliances to act as flexible resources within a bi-directional grid, managing electricity demand and the operation of energy storage devices (including EVs) through connected, distributed networks.
• Simplified financing:  Low-friction financing options that better connect and inform project financiers, property owners, and contractors, accelerating the pace of retrofits and new construction through improved underwriting as well as price/ project transparency.
• Efficiency upgrades: Quieter, cheaper, more comfortable solutions that facilitate fuel switching and the more efficient use of electricity.  In particular, we’re paying attention to products that impact key building loads like HVAC and appliance/ envelope innovations that reduce electricity demand.
• Low carbon, high throughput construction:  Material and process upgrades that reduce the carbon footprint of affordable, new construction, in particular in markets slated for the highest levels of new building and square footage expansion.
• Decentralized generation and storage:  Platforms and networks that help deploy distributed energy resources at a building or community-level, to better optimize resource selection, manage electricity demand, and bring down the total cost of a clean grid.

As outlined in our research deck, some of the most interesting investment opportunities will be network-driven, grow through bottom-up adoption, and offer superior products to the current system (even when not accounting for their sustainability benefits).  Going forward, we’ll be sharing more about specific themes and opportunities related to building electrification.  If you are researching, investing, or growing a company in this category, we’d love to meet you and learn more.