Waking the Sleeping Giant – Next Generation Policy Instruments for Renewable Heating and Cooling in Commercial Buildings (RES-H-NEXT), [Veilleux, N., Rickerson, W

Home , Biomass heating system, Renewable Heat Incentive

WAKING THE

SLEEPING GIANT

NEXT GENERATION POLICY INSTRUMENTS FOR RENEWABLE HEATING & COOLING IN COMMERCIAL BUILDINGS (RES-H-NEXT)

Prepared for the IEA Implementing Agreement for

Renewable Energy Technology Deployment (IEA-RETD)

February 2015

ABOUT IEA-RETD The International Energy Agency’s Implementing Agreement for Renewable Energy Technology Deployment (IEA-RETD) provides a platform for enhancing international cooperation on policies, measures and market instruments to accelerate the global deployment of renewable energy technologies.

IEA-RETD aims to empower policy makers and energy market actors to make informed decisions by: (1) providing innovative policy options; (2) disseminating best practices related to policy measures and market instruments to increase deployment of renewable energy, and (3) increasing awareness of the short-, medium- and long-term impacts of renewable energy action and inaction.

For further information please visit: http://iea-retd.org or contact [email protected]. Twitter: @IEA_RETD

IEA-RETD is part of the IEA Energy Technology Network.

DISCLAIMER The IEA-RETD, formally known as the Implementing Agreement for Renewable Energy Technology Deployment, functions within a Framework created by the International Energy Agency (IEA). Views, findings and publications of IEA-RETD do not necessarily represent the views or policies of the IEA Secretariat or of its individual Member Countries. COPYRIGHT This publication should be cited as:

IEA-RETD (2015), Waking the Sleeping Giant – Next Generation Policy Instruments for Renewable Heating and Cooling in Commercial Buildings (RES-H-NEXT), [Veilleux, N., Rickerson, W. et al.; Meister Consultants Group], IEA Implementing Agreement for Renewable Energy Technology Deployment (IEA-RETD), Utrecht, 2015.

(Stichting Foundation Renewable Energy Technology Deployment)

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ACKNOWLEDGEMENTS The authors would like to thank the following IEA-RETD RES-H-NEXT Project Steering Group (PSG) members for their guidance and support throughout the project:

Joe Sousek, UK Department of Energy and Climate Change, PSG Chair Kristy Revell, UK Department of Energy and Climate Change Oliver Sutton, UK Department of Energy and Climate Change Adam Brown, International Energy Agency Kristian Petrick, Operating Agent Team, IEA-RETD David de Jager, Operating Agent, IEA-RETD

LEAD AUTHORS Neil Veilleux, Meister Consultants Group Wilson Rickerson, Meister Consultants Group

CONTRIBUTING AUTHORS Andy Belden, Meister Consultants Group Gregor Hintler, Meister Consultants Group Chad Laurent, Meister Consultants Group Caroline Palmer, Meister Consultants Group Lisa Young, Meister Consultants Group

STRATEGIC ADVISORS Veit Bürger, Oeko-Institut e.V. (Institute for Applied Ecology) Christiane Egger, OÖ Energiesparverband (Energy Agency for Upper Austria) Les Nelson, International Association of Plumbing and Mechanical Officials (IAPMO)

This report shall be cited as follows:

IEA-RETD (2015), Waking the sleeping giant - Next generation policy instruments for renewable heating and cooling in the commercial sector (RES-H-NEXT), [Veilleux, N., Rickerson, W. et al.; Meister Consultants Group], IEA Implementing Agreement for Renewable Energy Technology Deployment (IEA-RETD), Utrecht, 2015.

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EXECUTIVE SUMMARY Is a renewable transformation of heating and cooling in the commercial sector possible? Yes, but it requires the implementation of new and innovative (next generation) policies.

Renewable heating and cooling (RES-H/C) is the sleeping giant of renewable energy. Across the globe, it is estimated that thermal energy comprises approximately 50% of total global final energy demand (across the residential, commercial and industrial sectors). The majority of heat demand in buildings – over three quarters – is served by fossil fuels or traditional biomass. Modern (high efficiency, low emission) renewables are estimated to serve only 10% of thermal energy demand.

This report focuses on the commercial building sector, a significant user of thermal energy, especially in OECD countries. A number of country-level analyses make clear that the commercial building sector is a significant source of carbon dioxide (CO2) emissions (e.g. 18% in the UK), due to the heating and cooling load of buildings. It is furthermore expected that commercial building sector and energy use will increase in the future, with the IEA estimating that the floor area of commercial buildings will almost triple by 2050 and the World Energy Outlook estimating that commercial building energy demand will be the fastest growing energy sector.

Addressing heating and cooling in the commercial sector will be necessary to achieve a renewable energy transformation, and many analyses estimate that it will not be possible to achieve long-term climate, security, and energy goals without increasing the use of RES-H/C.

Despite its importance, there has historically been a lack of innovation and commitment to RES-H/C policy. RES-H/C technologies, especially within the commercial sector, receive a disproportionally small share of policy support (i.e. relative to renewable electricity technologies). Only a few jurisdictions – primarily located in Europe – have taken proactive steps to encourage widespread RES-H/C market development. As a result, the RES-H/C market in the commercial building sector has been slow to develop. This has been true even while the broader renewable energy market has experienced significant growth.

What can awaken this sleeping giant? What can policy makers do to accelerate market growth?

There is a clear need to develop and implement “next generation” policies to rouse RES-H/C markets. The figure below (see next page) illustrates next generation policies that could be implemented in jurisdictions across the globe.

Next generation policies have the potential to drive market development along the deployment curve, from the early-stage (i.e. inception) to mature (i.e. consolidated) market phases. Some of these policies have been implemented to support RES-H/C (such as mandates) but have been limited in ambition or not sufficiently enforced. Other policies have seen widespread implementation in the energy efficiency (EE) or renewable electricity (RES-E) sectors, but have not been widely adapted for RES-H/C in the commercial sector (e.g. performance based incentives).

Many of the next generation policies described here could address market barriers across all building types (i.e. residential and commercial). Section 3 of the report though pays special attention to how RES-H/C market barriers play out in the commercial sector and how next generation policies could address them.

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This includes, for example, the role of direct incentives and financing programs to address corporate investment and decision-making barriers; the potential for building mandates to address the split incentives between commercial landlords and tenants; or how third-party ownership models could address the lack of RES-H/C training among commercial building managers.

In order to drive RES-H/C market development, it is recommended that policymakers:

 Develop long-term plans and policy commitments. Policymakers should develop long-term plans to guide market development efforts for RES-H/C. This may include the creation of credible and ambitious targets that provide investors a clear idea of market size and opportunity. Especially in early stage markets, clear plans are needed to generate confidence among industry players. As markets progress along the deployment curve, it will be important for policymakers to update plans in order to address new market, technology, emission reduction, and cost developments.  Establish RES-H/C mandates for existing buildings or utilities. Strong regulatory requirements such as building or utility mandates can drive widespread adoption of RES-H/C, especially for existing buildings. For building mandates, policymakers can establish a mandate trigger (e.g. sale, lease, or renovation of the building) to overcome market barriers ranging from landlord-tenant challenges to low building refurbishment rates. In early-stage markets, it may be important to mandate RES-H/C in public buildings or new construction in order to demonstrate the viability of RES-H/C technologies to commercial real estate building owners. In take-off and consolidation markets, such mandates could be extended to existing buildings. Both utility and building mandates can be implemented in conjunction with performance based (or other) incentive programs to support compliance.  Design and implement performance-based incentives for RES-H/C. Incentives are often necessary in inception and take-off market phases to improve the return on investment of RES-H/C and drive market development. Upfront financial incentives such as rebates have historically supported RES-H/C market growth, though in the future it will likely be necessary to transition to PBIs, especially as policymakers place a higher priority on ensuring that energy production is maximized. In inception markets, it will be important to develop heat metering guidelines, so that useful heat production can be properly measured and rewarded. As markets develop, incentive levels should be revised downward via degression mechanisms. For regions that are served by district heating systems, policymakers have a unique opportunity to create new tariff and regulatory frameworks that could enable policies similar to net metering or feed-in tariffs for heating and cooling.  Drive down soft costs for RES-H/C. Policymakers also need to focus on implementing programs to drive down the cost of RES-H/C systems. A significant portion of installation costs for RES-H/C systems are soft costs, which are non-hardware costs such as installation labor, permitting, or customer acquisition costs, among others. In a few jurisdictions, policymakers have already implemented information and awareness campaigns for RES-H/C, but there are opportunities for more focused soft cost programs. Administrative and permitting processes should be streamlined, especially in inception markets. Across all market deployment phases, it is essential to regularly assess the current costs of RES-H/C in order to identify how best to drive down soft costs and/or price incentives.  Develop innovative financing and business models. Policymakers should develop enabling policies that support innovative financing. Third-party ownership models, for example, could provide “heat as a service” to commercial and institutional building owners, thus reducing the hassle and risk associated with RES-H/C. To succeed, however, these models will require lender and contractor outreach and education programs, especially in the inception and takeoff phases.

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Similarly, incentive and other programs to reduce development costs will be important to enable third- party owners to be able to effectively deploy RES-H/C at necessary rates of return. As the market develops, policymakers should consider implementing programs that help industry standardize technical requirements and contracting language in order to encourage securitization and bring new capital sources (e.g. institutional investors) to the market. These are all meaningful ways for policymakers to intervene and reduce risk associated with the deployment of new financing and business models.

The graph below illustrates general best practices for each policy field that can be applied to any given jurisdictions in one of the three market development phases (i.e. inception, take-off, or consolidation):

RES-H/C can also be deployed to support a number of parallel building and energy policy priorities. Policymakers should examine how RES-H/C fits into other energy goals and strategies, from the deployment of district heating networks, to low energy building requirements, or the integration of RES-H/C and heat storage with electric grid management strategies. Section 5 provides an initial exploration of how RES-H/C policies interact with these broader energy priorities.

A handful of jurisdictions across the globe have already pioneered the use of some of these next generation RES-H/C policies in commercial buildings. Some of these policies have been widely adopted in the RES-E or EE sectors. Where possible, these experiences are described in case studies and text boxes throughout this report, giving the reader a sense of the opportunities, challenges and needs to implement next generation RES-H/C policies. By assessing the most promising next generation policies, this report shows policymakers how they can take action in the near term and drive greater deployment of RES-H/C in commercial buildings to meet their energy and policy priorities.

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Table of Contents

About IEA-RETD ...... ii Acknowledgements ...... iii Executive Summary ...... iv 1 Introduction ...... 1 1.1 Report Structure ...... 3 2 Methodology ...... 5 2.1 Overview of Next Generation Policies ...... 5 2.1.1 Definition of RES-H/C Technologies ...... 7 2.1.2 Definition of Commercial & Institutional Sector ...... 9 2.2 RES-H/C Deployment Status across IEA-RETD Countries ...... 9 2.3 Economic & Technical Country conditions ...... 12 2.3.1 Climatic Conditions...... 12 2.3.2 The Status of Commercial BUILDING STOCK ...... 13 2.3.3 Regional District Heating Infrastructure ...... 15 2.3.4 Conventional Heating & Cooling Sources & Costs ...... 15 2.3.5 Summary: Country Conditions & Key Considerations for Policymakers ...... 15 2.4 Cost Effectiveness Assessment ...... 16 3 RES-H/C Barriers & Opportunities in the Commercial Sector ...... 18 3.1 Barriers to RES-H/C in the Commerical Sector ...... 18 3.1.1 Lack of Awareness about RES-H/C Technology ...... 18 3.1.2 Inadequate Expected Investment Returns & Capital Constraints ...... 18 3.1.3 Ownership Priorities & Decision Making Barriers ...... 19 3.1.4 Split Incentives ...... 19 3.1.5 Low Refurbishment Rates ...... 20 3.1.6 Insufficient Local Contractor Base ...... 20 3.1.7 Lack of Confidence in System Performance & Fuel Availability ...... 20 3.1.8 Operations Staff Training Requirements ...... 21 3.2 Opportunities for Integrating RES-H/C into Comprehensive Energy Plans ...... 21 4 RES-H/C Next Generation Policies ...... 23 4.1 Overview of Next Generation Policies ...... 23 4.2 RES-H/C Plans, Targets & Mandates ...... 26

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4.2.1 Background for RES-H/C Plans, Targets & Mandates ...... 26 4.2.2 Background for RES-H/C Mandates...... 28 4.2.3 Benefits of RES-H/C Plans, Targets & Mandates ...... 29 4.2.4 Policy Options for Building Mandates ...... 30 4.2.5 Policy Options for Utility Mandates ...... 33 4.2.6 Cost Effectiveness ...... 36 4.2.7 Summary for Policymakers...... 38 4.3 RES-H/C Performance Based Incentives...... 41 4.3.1 Background...... 41 4.3.1 Benefits of RES-H/C Performance based Incentives ...... 42 4.3.2 Policy Options for RES-H/C Performance Based Incentives ...... 42 4.3.3 Cost Effectiveness ...... 49 4.3.4 Summary for Policymakers...... 52 4.4 Soft Cost Reductions for RES-H/C ...... 54 4.4.1 Background...... 54 4.4.2 Benefits of Soft Cost Reduction Policies for RES-H/C ...... 55 4.4.3 Policy Options for Soft Cost Reduction Initiatives ...... 56 4.4.4 Cost Effectiveness ...... 58 4.4.5 Summary for Policymakers...... 59 4.5 Innovative Financing and Business Models for RES-H/C ...... 61 4.5.1 Background...... 61 4.5.2 Risk and Economic Considerations for Third-Party Ownership ...... 63 4.5.3 Benefits of Innovative Financing for RES-H/C ...... 64 4.5.4 Policy Options to Support Third-party Financing ...... 65 4.5.5 Cost Effectiveness ...... 67 4.5.6 Summary for Policymakers...... 68 4.6 Next Generation Policy Approaches ...... 69 5 RES-H/C & integrated energy planning ...... 71 5.1 Importance of Integrated Energy Planning ...... 71 5.1.1 RES-H/C & Low Energy Buildings ...... 72 5.1.2 RES-H/C & District Energy ...... 73 5.1.3 RES-H/C & Thermal Storage for Electric Grid Management ...... 75 6 Conclusion ...... 77

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Appendix A ...... 78 Appendix B ...... 80 References ...... 82

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1 INTRODUCTION The heating sector is the largest consumer of energy across the globe. As illustrated in Figure 1 below, it is estimated that thermal energy use comprises approximately 50% of total global final energy demand (across the residential, commercial and industrial sectors). However, the majority of heat demand in buildings – over three quarters – is served by fossil fuels or traditional biomass.1 Modern (high efficiency, low emission) renewables are estimated to serve only 10% of thermal energy demand in buildings.

Global Final Energy Use (FEH) Hea ng Fuel Use in Buildings 200 100% other, 1% modern

) biomass, 10%

Other, 9 E

(

160 t 80% tradi onal

a Industry, 78.8 e biomass, 33%

)

e E 120 60%

(

l coal, 7%

x 80 f oil, 16% e 40%

Buildings , 83.7 %

e t natural gas, 40 a 20% m 33%

0 0% Electricity Transport Hea ng Buildings Hea ng (83.7 EJ)

Figure 1. Estimated Global Final Energy Use and Heating Fuel Use in Buildings (Adapted from IEA, 2014)

Despite the significant opportunity for renewable heating and cooling, the RES-H/C market is relatively small and slow-growing, due in large part to the fact that RES-H/C technologies receive a disproportionally small share of policy support, especially when compared to renewable electricity technologies (Bürger et al., 2008; IEA, 2014; Rickerson et al., 2009). Only a few countries – primarily located in Europe – have taken proactive steps to encourage widespread RES-H/C market development. In fact, among global policymakers and industry experts, there is limited awareness of the development potential for RES-H/C.

In 2013, the Renewable Energy Policy Network for the 21st Century (REN21) evaluated renewable energy projections from 50 recently published scenarios and interviewed 170 leading experts to assess the “credible possibilities” for renewable heat, electricity, and transport (see Table 1 below). There was strong expert agreement that high shares of renewable electricity (RES-E) could be attained with relative ease. In contrast, RES-H/C was considered much more difficult to attain in large shares. REN21 concluded that although RES-H/C technologies have a track record of providing reliable energy, there is not widespread understanding among policymakers and experts regarding the need for, or policies necessary to support, market growth (REN21, 2013).

1 Traditional biomass is associated with deforestation and high levels of pollution. It is generally considered that it should be reduced through the deployment of modern renewables, including high efficiency, low emission biomass thermal, solar thermal, advanced heat pumps, or other renewable heating technologies.

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Table 1. Sectoral Shares of Renewable Energy in Recent Global Scenarios (Source: REN21, 2013).

Scenario By Year Electricity Heat Transport By 2030 – 2040 ExxonMobil Outlook for Energy: A View to 2040 (2012) 2040 16% -- -- BP Energy Outlook 2030 (2012) 2030 25% -- 7% IEA World Energy Outlook (2012) “New Policies” 2035 31% 14% 6% IEA World Energy Outlook (2012) “450” 2035 48% 19% 14% Greenpeace (2012) Energy [R]evolution 2030 61% 51% 17% By 2050 IEA Energy Technology Perspectives (2012) “2DS” 2050 57% -- 39% GEA Global Energy Assessment (2012) 2050 62% -- 30% IEA Energy Technology Perspectives (2012) “2DS High Renewables” 2050 71% -- -- Greenpeace (2012) Energy [R]evolution 2050 94% 91% 72% WWF (2011) Ecofys Energy Scenario 2050 100% 85% 100% Notes: Transport shares for IEA WEO, IEA ETP, and BP are only for biofuels; transport share for Greenpeace includes electric vehicles; transport share for WWF is entirely biofuels. Heat share for WWF is only industry and buildings. Electricity share for BP is estimated from graphics. Electricity share for GEA is based on the central “Efficiency” case.

Despite the lack of RES-H/C market momentum, REN21 highlights that there are a number of experts who foresee a need for a “cascade of new policies” for RES-H/C in order to meet a wide variety of country goals (see Text Box 1 below). Similarly, a number of recent studies conclude that it will be challenging, if not impossible, to achieve country climate, energy, and economic development goals without building local RES- H/C markets (Beerepoot & Marmion, 2012; Brown & Müller, 2011; Bürger et al., 2008; Eisentraut & Brown, 2014).

To scale up RES-H/C markets across the globe, there are clear challenges that need to be addressed. There is consensus that it will be difficult for RES-H/C to reach shares higher than 25% to 30% without “major transformations” in the residential and commercial building and energy sector (REN21, 2013). As described in Section 3.1, the RES-H/C industry faces a number of persistent barriers to development in the commercial sector. These challenges will require an integrated approach to energy planning and the deployment of next generation policies for RES-H/C.

This report seeks to build on experience with RES-H/C policy to date and identify next generation policies, focusing in particular on the existing commercial building stock.2 The next generation policies described in this report (i) are new and innovative for the RES-H/C sector, (ii) address one or more market barrier, and (iii) could enable RES-H/C markets to achieve large-scale, cost-effective, mainstream deployment over the next several decade.

2 Although the focus of this report is on the commercial sector, many of the next generation policies and programs suggested could be adapted across sectors, including residential, industrial, or other sectors.

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Text Box 1. RES-H/C and Country Policy Goals

RES-H/C can help policymakers achieve a number of country goals. These may include the following:

 Greenhouse gas reductions. Policymakers across the globe are discussing the potential for, and impacts of. decarbonisation policies on their jurisdictions. Heat accounts for more than 50% of global final energy consumption, and one-third of global energy-related carbon dioxide (CO2) emissions (or around 10 gigatonnes of CO2) (Eisentraut & Brown, 2014). This has significant implications for RES-H/C, which is often characterized as the “missing piece” of carbon planning (Rickerson et al., 2009).

 Climate adaptation. RES-H/C technologies can provide both climate mitigation and adaptation solutions. Heat deaths are projected to increase significantly under climate change. It will be essential to develop RES-H/C policies that support building owners as they upgrade infrastructure to adapt to the changing environment, including a growing need for efficient cooling systems in commercial buildings.

 Energy security. Recent events in Ukraine and Russia have highlighted energy security issues related to natural gas. Maintaining reliable access to natural gas, oil, or other fossil fuel sources for heating remains a significant concern due to risks related to energy market price volatility, geopolitical security, and economic growth impacts. There is an opportunity to manage these risks by assessing and planning for RES-H/C technology deployment within a security paradigm rather than just an energy paradigm. Energy security concerns will continue to drive the need for domestic energy resources such as RES-H/C as an alternative to imported natural gas and oil.

 Economic development. Economic development is a consistent objective of renewable energy policy. Numerous studies have concluded that RES-H/C technologies are among the most cost- effective renewable energy options for reducing fossil fuel dependency and GHG emissions (Langniss et al., 2007). RES-H/C presents opportunities for expanding local industries around innovative technology research, development, and manufacturing, thereby creating jobs and wider economic benefits.

1.1 REPORT STRUCTURE This report is structured as follows:

 Section 2 describes the methodology used to conduct this assessment. This includes the approach to developing next generation RES-H/C policies in the commercial sector, an overview of the current status of RES-H/C market deployment in IEA-RETD countries, and a review of the economic and technical conditions that may influence RES-H/C market development. Section 2 also describes the approach used to conduct a preliminary assessment of the cost effectiveness of next generation policies.  Section 3 summarizes the market barriers that have limited wider adoption of RES-H/C technologies in the commercial sector. It also describes opportunities for policymakers to integrate RES-H/C into comprehensive energy planning processes.

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 Section 4 describes next generation policies that can enable deployment of RES-H/C technologies, focusing on policies and practices that can be applied to new and existing buildings in the commercial sector across a range of jurisdictions.  Section 5 describes key issues policymakers may want to consider with regard to long-term RES-H/C energy planning and how RES-H/C policies may fit into a country’s broader energy strategy. Section 5 also takes a closer look at the potential interaction of of RES-H/C market scale-up with other emerging energy trends.

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2 METHODOLOGY 2.1 OVERVIEW OF NEXT GENERATION POLICIES Next generation policies for RES-H/C are defined as policies or initiatives that:

 Are new and innovative in the RES-H/C sector,  Address one or more market barrier, and  Could enable RES-H/C markets to achieve large-scale, cost-effective, mainstream deployment over the next several decades.

To identify potential next generation policies, a wide cross section of RES-H/C market development policies and studies from across the globe were reviewed. This included reviews of existing policies in leading RES-H/C jurisdictions such as the State of Upper Austria, Denmark, and Cyprus; policy development programs to improve RES-H/C penetration in European Member States (i.e. the RES-H Policy project3); policies and programs implemented in Mediterranean countries such as Israel or Tunisia; and initiatives in new or emerging markets such as the Commonwealth of Massachusetts in the US or the United Kingdom.

It is worth noting that there is not a standard procedure to classify or categorize renewable energy policy instruments. A variety of approaches exist depending upon the goals of the analysis and criteria considered (Bürger et al., 2008). For the purposes of this analysis, global policy practices were categorized using the framework summarized in Table 2.

Table 2. Overview of RES-H/C policies

Policy Category Description and overview for RES-H/C

Incentive policies encompass both upfront incentives (e.g. grants, rebates) as well as performance based incentives (PBIs). Jurisdictions like Germany or Upper Austria, which have a New incentive long track record of incentive support for RES-H/C, have focused almost exclusively on capacity- mechanisms for RES- based incentives such as grants or rebates. PBIs are rare in the RES-H/C sector, with only a H/C handful of countries known to have implemented them (Beerepoot & Marmion, 2012). The development and implementation of PBIs for RES-H/C are discussed in Section 4.3.

Financing programs may include low-interest loan programs (e.g. soft loans) as well as turnkey financing (e.g. third-party ownership models). Government support for RES-H/C financing Innovative financing programs, especially in Europe, has historically focused on development of soft loan programs. programs Policy support to encourage turnkey financing are far less common in the commercial RES-H/C sector. These are discussed in Section 4.5.

3 The RES-H Policy project was a multimillion dollar policy development program designed to improve RES-H/C penetration in European Member States in support of implementation of the EU Renewables Directive 2009/28/EC.

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Policy Category Description and overview for RES-H/C

A number of different product, industry and workforce standards or certifications govern the quality of RES-H/C technologies and markets. The competitive strength of the RES-H/C industry, Integrated product especially in Europe, relies upon the high quality of its products and workmanship (Sanner et al., and workforce 2011). However, for many RES-H/C technologies, there is not currently a commonly accepted standards for RES- international framework applicable to govern the certification and accreditation of RES-H/C H/C installers. In addition, there is a diversity of standards that governs the quality of manufactured products across the globe. While potentially worthy of study in the future, an analysis of product and workforce standards were determined to be outside the scope of this project.

Though RES-H/C obligations are becoming more common for new buildings, few jurisdictions have strong RES-H/C regulatory requirements for existing buildings. Moreover, it is notable that there are almost no policies structured to specifically promote RES-H/C in the industry and RES-H/ regulations or service sectors (Beerepoot & Marmion, 2012). There are a number of next generation building mandates regulatory policies that could be developed to influence adoption of RES-H/C technologies in the commercial sector. These include RES-H/C mandates for utilities and existing buildings and are discussed in Section 4.2.

When unfamiliar technologies such as RES-H/C are incorporated into the building stock, it is RES-H/C system critical to ensure that system designs are based on proven strategies. This usually requires the design standards or development of RES-H/C design standards and/or training for industry. While it is recognized guidelines that this is important to the long-term success and widespread utilization of RES-H/C technologies, elaboration of international design standards is outside the scope of this project.

There is limited data available on the hard and soft costs of RES-H/C technologies. Hardware costs consist of the mechanical equipment used in the RES-H/C system, while soft (also referred to as business process) costs make up the remaining portion of system cost. With the right data, Soft cost initiatives policy-makers can implement targeted initiatives to drive down soft costs for RES-H/C and for RES-H/C increase RES-H/C competitiveness, reduce time and hassle associated with permitting, increase public awareness, and improve market transparency for RES-H/C. Issues and options related to soft cost policies are described in Section 4.4.

A variety of other policies have been successfully deployed to support RES-H/C markets, either Cap and trade, directly or indirectly, such as carbon taxes or cap and trade. Many of these policies have been carbon taxes, and responsible for increasing the cost of fossil fuels, and thus improving the cost-effectiveness of other regulatory RES-H/C technologies. It is uncertain whether these policies alone are likely to achieve the approaches desired impact on RES-H/C market development, however, and their impact on RES-H/C has been assessed as “difficult to quantify and may well be negligible” (Bürger et al., 2008).

After reviewing global policy practices, the next generation policies that could support continued RES-H/C deployment were identified and assessed (see Section 4), with a focus on policies relevant to the commercial sector across a range of jurisdictions.

The sections below clarify terms and methodology that were used to conduct this assessment, including RES- H/C technologies (Section 2.1.1) and the definition of the commercial sector (Section 2.1.2). Section 2.2 describes the current state of RES-H/C market deployment in IEA-RETD countries, and Section 2.3 describes country conditions that may influence RES-H/C policy development in IEA-RETD countries.

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Section 2.4 describes the approach to assess relevant cost-effectiveness considerations across countries for each of the next generation policies reviewed.

2.1.1 DEFINITION OF RES-H/C TECHNOLOGIES The RES-H/C sector includes technologies that provide a range of heating and cooling services, including domestic hot water, process heat, heat and power, cooking, and space heating and cooling. As defined by IEA- RETD, RES-H/C includes biomass (e.g. wood pellets, chips, etc.), biogas, combined heat and power (CHP), solar thermal, solar PV thermal, high efficiency heat pumps (air and ground-source), as well as a number of waste heat technologies. Figure 3 below provides a summary of the major RES-H/C technologies and applications.

RES-H/C technologies have a number of features that are unique relative to EE or RES-E, and which can influence policy design.

 Custom sizing and installation. Unlike RES-E, RES-H/C is not usually integrated into an energy grid (unless it is part of a district heating network). As a result, RES-H/C systems must be sized and installed to meet on-site heating and cooling demand of local buildings. Because RES-H/C sizing requirements vary by technology, application, and building conditions, commercial-scale RES-H/C installations are complex and may require customized engineering solutions to ensure optimal performance.  Variable production profiles and applications. RES-H/C systems have a variety of different production profiles, which may vary based on weather, time, season, and temperature. In addition, heat, unlike electricity, is not a homogenous commodity. It can vary by temperature (i.e. low, medium or high temperature) and application (i.e. domestic hot water, space heating, space cooling, or process heat) (IEA, 2014).  Performance characteristics similar to both RES-E and EE. In some cases, RES-H/C technologies (e.g. ground source heat pumps or biomass heating) produce enough energy to remove the need for fossil fuels for building heating and cooling systems and/or can feed into a district heating grid, making them behave like RES-E technologies. In other cases, RES-H/C technologies (e.g. solar water heating) act more like energy efficiency technologies by significantly reducing – though not eliminating – the need for fossil fuel heating in buildings. In the past, this has created confusion regarding whether RES-H/C technologies should be considered energy efficiency, renewable energy technologies, or a separate category from a policy perspective.

As discussed in Section 4, these unique features require policy decisions regarding metering, proper project sizing, building integration requirements, and administrative protocols that may not be necessary for RES-E or EE.

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INPUT RENEWABLE HEAT TECHNOLOGY/PROCESS OUTPUT

Solar Non-concentrating Direct heat

collector Solar Low-concentrating Direct heat collector

SOLAR Solar High-concentrating Direct heat collector Steam turbine Heat and power

Solid and liquid Direct heat; Combustion or gasification biomass Heat and power

Solid and liquid Thermal Direct heat; Combustion

biomass gasification Heat and power

Grid injection Natural gas grid

Animal manure, Anaerobic Direct heat; BIOMASS energy crops, Combustion digestion Heat and power sludge nn

Grid injection Natural gas grid

Food and fiber Landfill Direct heat; Combustion product residues disposal Heat and power

Grid injection Natural gas grid

Geothermal Direct use Direct heat

Geothermal and enhanced Heat exchanger Direct heat geothermal

Steam turbine Heat and power Ambient heat

HEAT PUMPS (from air, Direct heat ground, water), Heat pump waste heat) Cooling

Renewable heat Sorption cooling Cooling

HEAT or waste heat

EXCESS

cooling low temp med temp high temp

Figure 3. RES-H/C technologies and applications in the commercial sector (adapted from IEA, 2014)

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2.1.2 DEFINITION OF COMMERCIAL & INSTITUTIONAL SECTOR To support the policy assessment for the commercial sector, a working definition for the new and existing buildings in the commercial and institutional sector (hereafter referred to as commercial) was also developed. For the purposes of this project, the commercial building sector includes building types used for the principal purposes described in Text Box 2 below. It does not include residential, industrial, manufacturing or domestic facilities.

Text Box 2. Defining Commercial Buildings (Source: US EIA, 2003)

Commercial buildings encompass a diversity of building types and purposes. This may include:

 Education includes buildings for academic or technical classroom instruction, such as elementary, middle, or high schools, and classroom buildings on college or university campuses.  Food sales include buildings used for retail or wholesale food sales.  Food service includes buildings used for the preparation and sale of food and beverages for consumption.  Service includes buildings in which some type of service is provided other than the sale of food or retail goods, such as carwashes, gas stations, repair shops, post offices, kennels, or copy shops.  Health care includes buildings used as diagnostic and treatment facilities for inpatient care, as well as facilities used for outpatient care (e.g. hospitals and clinics). The latter includes medical offices that use diagnostic equipment.  Lodging includes buildings used as accommodation for short- and long-term residents, including hotels, motels, retirement homes, or other residential care.  Mercantile / Commercial includes buildings used for the sale and display of goods other than food (e.g. dealerships, galleries, etc.) as well as shopping malls comprised of multiple connected establishments.  Office includes buildings used for general, professional, or administrative, bank, government, contractor, or sales offices.  Public assembly includes buildings in which people gather for social or recreational activities, including social meeting halls, cinemas, or transportation terminals.  Public order and safety includes buildings used for the preservation of law and order or public safety, including police and fire stations, jailhouses, or courthouses.  Religious worship includes buildings in which people gather for religious activities including chapels, churches, mosques or synagogues.  Warehouse and storage includes buildings used to store goods, manufactured products, merchandise, raw materials, or personal belongings, including non-refrigerated warehouses as well as distribution or shipping centers.

2.2 RES-H/C DEPLOYMENT STATUS ACROSS IEA- RETD COUNTRIES As described in Section 3.1, a number of barriers impede deployment of RES-H/C in the commercial sector. RES-H/C deployment is also affected by the maturity of the market and other country-specific conditions. Accordingly, different policies are required at different phases of market development (Brown & Müller, 2011).

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IEA has described three distinct market deployment phases for renewable energy technologies (Beerepoot & Marmion, 2012; Brown & Müller, 2011).

 The inception phase describes when the first examples of technology are deployed under commercial terms. At this stage, the market is immature, technologies are not well established, and the local supply chain is not in place. Financial institutions often perceive investments in the technology as risky. The priority for policymakers is to put in place the legislative framework to catalyze initial investment rounds.  The take-off phase describes when the market starts to grow rapidly. By this stage, technology deployment is underway and the national supply chain is in place, even if not fully developed. Financing institutions have increased knowledge of the technology and associated risks. The priority for policy makers is to maintain or accelerate market growth while managing policy costs.  The market consolidation phase describes where deployment grows toward saturation. Technologies are well established, the market has grown significantly, supply chains are robust, and finance and public institutions have streamlined their procedures. For RES-H/C, this means that the technologies are close to or fully competitive with fossil fuel alternatives (Brown & Müller, 2011).

Using the IEA phase and deployment curve as a model, each IEA-RETD country4 was evaluated to estimate the approximate level of RES-H/C market penetration. These estimates were derived by reviewing the percentage of RES-H/C technologies providing heating and cooling across all sectors in 2011 as well as each EU country’s RES-H/C projections for 2020 as stated in the National Renewable Energy Action Plans (NREAPs). As illustrated in Figure 3, all of the IEA-RETD countries are in either the inception or take-off phase for RES-H/C. A detailed analysis of specific RES-H/C technologies within the commercial sector would reveal much greater variability in the market deployment phases across countries. However, detailed information on the state of RES-H/C in the commercial building sector – the particular focus of this study – is not readily available from government statistics, as noted by other studies (Eisentraut & Brown, 2014).

4 The IEA-RETD member countries include Canada, Denmark, Japan, France, Germany, Ireland, Norway and the United Kingdom.

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Figure 3. IEA-RETD countries and the RES-H/C deployment curve5

As can be seen in Figure 4, Canada, the UK, and Ireland are in the inception phase of deployment. These are countries that have relatively new RES-H/C markets – with RES-H/C making up five percent or less of total market share for heating .

Germany and France are in the take-off phase of deployment. Currently, Germany’s RES-H/C market share is 12% and France is at 17%. RES-H/C technology deployment is widespread and strong national supply chains exist. These countries have projected RES-H/C market shares of 16% and 33% by 2020, respectively under their NREAPs.

Denmark and Norway are late-stage take-off markets. These countries have relatively large RES-H/C markets, where RES-H/C technologies serve over 30% of the total heating market. They are projected to have a RES-H/C market that makes up 40% and 43%, respectively, of the heating market by 2020.

5 Unable to assess (1) Japan’s and (2) Canada’s placement at this time due to lack of RES-H/C data, though it appears in both cases that these countries are in the inception phase for RES-H/C.

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None of the countries assessed were in the consolidation phase (estimated at 50% of market share or above). As stated above, the goal of this project is to explore development of new and innovative policies that could drive large-scale deployment of RES-H/C – enabling countries to move along the deployment curve. Next generation policies will help countries in the take-off phase transition into the consolidation phase and countries in the inception phase transition into the take-off phase. 2.3 ECONOMIC & TECHNICAL COUNTRY CONDITIONS The climate, the status of commercial building stock, heat distribution infrastructure, and conventional heating and cooling sources and prices are important country conditions to consider when evaluating RES-H/C policy best practices at the national level. These conditions influence the economics, feasibility, and technical potential of renewable heating and cooling technologies. Each is described below.

2.3.1 CLIMATIC CONDITIONS Buildings perform differently in cold and hot climates. It is therefore not possible to compare the heating and cooling requirements of northern European countries with the requirements of Australia or Southern India (Laustsen, 2008). As a result, each of the IEA-RETD countries were classified in one of six basic climatic zones based on heating and cooling requirements: (i) cold climate, (ii) heating-based climate, (iii) combined climate, (iv) moderate climate, (v) cooling-based climate and (vi) hot climate.

The following figure illustrates at a high level the current status of these climatic conditions in each IEA- RETD country.6 France and Japan have the warmest climates, and have both heating needs in the winter and cooling needs in the summer. These countries have been classified as “combined climate” countries. By contrast, Norway and Canada are the countries with the coldest climates, with heating needs nearly all year round, and fall into the “cold climate” category. Ireland, the UK, Denmark, and Germany, have heating needs in the winter and some cooling needs in the summer. The climates in these countries have been designated as “heating-based.”

Figure 4. Climatic classifications for each IEA-RETD country7

6 A more detailed analysis would reveal that climatic conditions vary across regions within a given country; however, for the purposes of this report, such a detailed analysis was not deemed necessary. 7 Climate zone classifications presented in this paper (cold climate, heating based climate, and combined climate) were sourced from an IEA information paper on energy efficiency and building codes (Laustsen, 2008). This paper suggests a simplification of the predominant

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Climate conditions influence the need for specific RES-H/C technologies. For example, heat pumps to provide cooling will likely have increased importance in regions with warmer climates. In regions with colder climates, policymakers can select from a variety of RES-H/C technologies to meet the large heating needs of commercial buildings.

2.3.2 THE STATUS OF COMMERCIAL BUILDING STOCK RES-H/C deployment potential can be further influenced by the age, condition, and existing heating infrastructure of commercial buildings. For example, buildings that are poorly insulated will require greater energy input to regulate indoor temperatures. Similarly, the fact that many buildings are designed to use and distribute heat from high temperature heating systems often makes them unsuitable for heat pumps or other low-temperature RES-H/C systems without making significant changes to the building infrastructure.

While a comprehensive assessment of the interaction of all building conditions on RES-H/C technologies is beyond the scope of this report, policymakers should be cognizant of the following factors when developing RES-H/C policies.

 Thermal end uses. Possible end uses for RES-H/C may include space heating, space cooling, domestic hot water (DHW), cooking, and process heat. Thermal load profiles in the commercial sector vary across building types, depending upon user habits and sector requirements. As a result, commercial buildings have a wide range of heating and hot water loads compared to the residential sector. Some renewable thermal technologies, like ground source heat pumps, are best suited to serve stable heating, cooling and hot water requirements such those needed for space conditioning in office buildings or education facilities. Biomass pellet systems, on the other hand, are well suited to provide variable heating loads or for combined heat and power (CHP). Solar thermal systems have a variable fuel source (i.e. the sun) and generally require back-up heating systems. Solar thermal is particularly well suited for building with high domestic hot water loads such as hospitals, car washes, or jailhouses.  Building heat distribution system. Buildings may be equipped with forced air, steam, or hydronic heat distribution systems to serve thermal end uses. It is important to match RES-H/C technologies to the temperature and distribution systems in the commercial building stock. Forced air systems circulate air through a building through ducts and vents, allowing the same distribution system to either heat or cool a property. Buildings with these heating and cooling distribution systems may be appropriate for biomass furnaces and both air and ground-source heat pumps. Hydronic heating can be subdivided into low and high temperature systems. Low-temperature hydronic distribution systems, such as radiant floor heating, can effectively distribute heat at temperatures e.g. under 49 degrees Celsius (C)). Low-temperature hydronic distribution systems may be best pared with SHW and heat pump technologies. High temperature hydronic heat distribution (e.g. fin-tube baseboard heaters), on the other hand, must achieve much higher water temperatures – sometimes exceeding 93 degrees C – to effectively heat a building (Siegenthaler, 2013).

International Climate Zone classification system, as defined by the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE) in its own Standard 169: Climatic Data for Building Design Standards.

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Steam heating systems boil and condense water for distribution through building pipes and radiators. For buildings with steam or high temperature hydronic systems, biomass boiler technologies may be most appropriate (Maker, 2004).  Building space. Design and installation of thermal systems also depends upon available space at building sites. Some RES-H/C equipment requires considerable space for installation, making available space in basements, utility rooms, or outside storage areas a key consideration in the design and installation. If a building uses a renewable thermal system for primary heating – and relies on fossil fuel systems to provide back-up heating on the coldest days – then the user must ensure they have adequate space for multiple heating units. When using multiple heating sources, then users will typically require space for hot water accumulators (e.g. tanks) to store energy from the various heat sources. Pellet and chip heating systems require basement or nearby (outside) space for fuel storage and boiler equipment.  Ground conditions. The ground and drilling conditions at the building site are of particular importance for GSHPs. Site-specific conditions frequently dictate the most appropriate ground coupling technology choice, and will influence the efficiency and cost of GSHP systems (Veilleux et al., 2012). High bedrock geology typically increases the drilling costs for vertical well GSHP systems. Heat pumps that can instead use groundwater wells as the source of working transfer fluid for the heat pump can have significantly lower the installed costs.  Roof conditions. For solar water heating systems, open access to un-shaded roof space is essential. The output of a solar system is proportional to the intensity of sunlight falling on the system. Greater amounts and duration of sunlight increase system performance, though systems can generate energy even on cloudy days. Rooftops must be able to structurally withstand the natural forces imposed on them (e.g. snow, wind, etc.), combined with the weight of the solar thermal system and other rooftop mechanical systems  Building efficiency. The energy efficiency and thermal performance of a building can influence the sizing, upfront costs, and operation of RES-H/C systems. Renewable thermal policies should be carefully coordinated with energy efficiency programs in order to develop a whole-building approach. The integrated design of an efficient building shell with a building’s heating, ventilation and cooling (HVAC) system is a vital area of focus when developing policy for energy in buildings (Taylor, 2011).  Building ownership structure. Commercial property owners are a diverse group with a highly differentiated goals and priorities, and these differences should be taken into account during the policy making process. Owners can be public agencies, non-profits or commercial entities. Commercial entities can be private corporations or publicly traded. Some owners may occupy a property themselves or rent the property to tenants. Furthermore, owners of commercial rental properties may manage those properties themselves or hire third parties to run the day-to-day operations of their facilities. The financial conditions of different owner types can also vary, with some owners having substantial access to capital while others may be unable to make large-scale investments in their buildings due to financial constraints. Different owners may have different views on the desirability of investing in RES-H/C technologies. Some may be willing to take on added costs or risks in order to capture savings and/or promote sustainable energy. Others may not find the potential paybacks compelling or may not be interested in exploring investments that are not core to their day-to-day business. .

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2.3.3 REGIONAL DISTRICT HEATING INFRASTRUCTURE A key consideration for RES-H/C market development is whether central district energy infrastructure is in place to distribute thermal energy, or whether distributed, customized RES-H/C installations must instead be installed on individual sites. Except for Ireland, all of the IEA-RETD countries have some existing district energy infrastructure. Denmark stands out as a leader in district heating deployment among IEA-RETD nations. District heating serves 35% of non-residential building energy needs on average. In 2008, the share of non-residential buildings heated via district heating networks was as high as 65% (Klima OG Energiministeriet, 2010).

Germany leads in terms of gross sales from district heating infrastructure. In 2011, Germany fed over 77,760 GWh of heat into the district heating grid, more than the combined district heating sales in Denmark, France, Norway, and Japan that same year. Based on available data comparisons, Japan leads on district cooling, selling over 3 million MWh in 2011, whereas France sold less than 1 million MWh of district cooling in the same year (EHP, 2011).

District heating infrastructure will influence the type of RES-H/C technologies that can be deployed and determines whether distributed generators can feed excess energy into the grid. As discussed in Sections 3.2, 4.3 and 5.1.2, the presence and extent of district energy infrastructure can have significant ramifications on technology deployment and incentive design.

2.3.4 CONVENTIONAL HEATING & COOLING SOURCES & COSTS It is clear the cost and availability of conventional energy resources is a driver of RES-H/C diffusion. Germany and Denmark, for example, have high conventional energy costs and robust RES-H/C markets. However, commercial decision-making about RES-H/C adoption and technology diffusion patterns are less well understood. Norway and France, for example, have relatively low conventional energy costs, though a number of RES-H/C technologies are also diffusing in these countries.

One of the challenges with analyzing technology diffusion is the lack of data about thermal energy use. Tracking thermal energy use across sectors (e.g. residential, commercial, industrial, etc.) and end-uses (e.g. space heating, cooling, hot water, etc.) is difficult, and there is generally not good data available on heating and cooling uses in the commercial sector (Eisentraut & Brown, 2014). Given the lack of data, it is challenging to assess the impact of conventional fuels on RES-H/C markets without conducting in- depth national surveys. Nonetheless, it is clear from qualitative analyses that energy prices do have an impact on the cost effectiveness of RES-H/C deployment and is an important consideration for policymakers. While no clear correlations could be gleaned from the data for this report, this assumption is expected to be generally true across countries.

2.3.5 SUMMARY: COUNTRY CONDITIONS & KEY CONSIDERATIONS FOR POLICYMAKERS The conditions described above will be important factors influencing policymakers’ decisions to develop and implement RES-H/C policies. Given the diversity of commercial building types, RES-H/C technologies, thermal energy end uses, conventional energy costs, and heating infrastructure, it can be challenging to develop RES-H/C policies that create broad-based markets with multiple technology types.

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Policies that promote development of one technology in one building type may result in limited market growth in other commercial building types. Policymakers interested in developing a self-sustaining commercial RES-H/C market may wish to begin the policy development process by conducting a market segmentation analysis of commercial property. Such analysis can allow policymakers to calibrate incentives, regulations and goals based on specific market needs. 2.4 COST EFFECTIVENESS ASSESSMENT Cost effectiveness is an essential consideration for the implementation of any new policy or program. There are well-established methodologies to evaluate policy cost-effectiveness, which typically involve identifying a range of possible policy options, monetizing the impacts of proposed policies (where feasible), and assessing the costs and benefits for options. Table 3 below provides a brief overview of a typical cost effectiveness analysis methodology, adapted from the methodology used by policymakers in the United Kingdom.

Table 3. Key Stages in Assessing Policy Cost in the United Kingdom (HM Treasury, 2003)

Assessment Stage Description

Justifying the need to take action may include an analysis of the possible negative consequences 1) Justify action of intervention, as well as the adverse results from a lack of intervention, both of which must be weighed and addressed to justify action.

Clarify the desired outcomes and objectives of a policy intervention. This supports analysis and 2) Set objectives identification of the full range of options available to achieve goals. At this stage, specific targets may be set to help measure progress towards the achievement of specified goals and objectives.

The option appraisal is often the most significant part of the analysis. Initially, a wide range of options is created and reviewed from which a targeted shortlist may be crafted. Each option is 3) Conduct options then appraised against a base case, and the best estimates of its costs and benefits – relative to appraisal the base case – are developed. These estimates can then be adjusted by considering different scenarios. In addition, each option’s sensitivity to changes can be modeled by changing key variables.

Following option appraisal, decision criteria and judgment are used to select the best option, 4) Develop & which should be refined into a solution. Consultation with key stakeholders is important at this implement solution stage, as a variety of unforeseen issues may have a material impact on the successful implementation of proposals.

Evaluation is similar in technique to the options appraisal, although it uses historic (actual or estimated) rather than forecasted data and takes place after the policy has been implemented. Its 5) Evaluation main purpose is to ensure that lessons are widely learned, communicated and applied when assessing new proposals.

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As can be seen from Table 3 above, cost effectiveness analyses depend upon value judgments and estimates, which are based on the unique contextual assumptions and requirements of a specific jurisdiction. Because this project is global in nature – and does not focus on any one country or jurisdiction – it is not possible to complete a comprehensive cost effectiveness analysis for any of the next generation policies described here.

However, a qualitative assessment of the types of costs and benefits that may be considered for any given policy type – as well as the potential distribution of those costs and benefits across stakeholder groups – is provided in the Distribution of Costs and Benefits sub-sections for each major next generation policy throughout Section 4. Key findings from representative case studies of existing policy cost-effectiveness assessments are also discussed as appropriate.

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3 RES-H/C BARRIERS & OPPORTUNITIES IN THE COMMERCIAL SECTOR 3.1 BARRIERS TO RES-H/C IN THE COMMERICAL SECTOR RES-H/C technologies have a lengthy track record of providing reliable energy in commercial buildings, but there are a number of market barriers that have limited wider adoption of these technologies. This section describes major barriers to RES-H/C adoption within the commercial sector based on recent literature (Brown & Müller, 2011; IEA-RETD 2011; Langniss et al., 2007).

3.1.1 LACK OF AWARENESS ABOUT RES-H/C TECHNOLOGY Many policymakers, consumers, and commercial real estate actors (e.g. architects, real estate agents, builders, etc.) are unfamiliar with RES-H/C technologies and their benefits, particularly in inception stage markets. A lack of awareness may be due to a number of factors, including low level of exposure to the technologies, lack of effective marketing by industries, and absence of government-led consumer education programs.

Manufacturers, who may have both renewable and non-renewable product lines, may have limited resources to devote to building a base of potential customers. This difficulty may be amplified because sales staff face the dual challenge of selling their specific product while convincing customers about the renewable thermal opportunity more broadly. Independent RES-H/C installers may also have limited resources to devote to building awareness of RES-H/C technologies and educating customers. Given these challenges, government entities can intervene by creating educational, marketing, or other customer acquisition campaigns that tout the benefits of these technologies (see Section 4.4 on soft cost reduction programs) as well as cultivating innovative finance and business models (see Section 4.5).

3.1.2 INADEQUATE EXPECTED INVESTMENT RETURNS & CAPITAL CONSTRAINTS In some countries, especially those with low fossil fuel prices and no policy support for RES-H/C, RES-H/C systems will have relatively poor economics and long payback times. In other countries, especially where conventional heating fuel prices are high, RES-H/C systems may be able to deliver significant savings and relatively short paybacks. However, many commercial customers have very low payback requirements, making it challenging to justify investment in RES-H/C (e.g. some hotels report that investments must meet a six- month payback threshold).

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In almost all cases, RES-H/C technologies are capital intensive (relative to conventional heating and cooling systems) and will have to compete for scarce internal investment dollars with other corporate or institutional priorities. This challenge is compounded by the fact that some entities may have a bias against making large capital investments that are not related to core business activities. As a result, decision-makers will often determine that the opportunity costs associated with focusing time, energy or capital on evaluating potential for RES-H/C heating systems is too great compared to potential returns (TCT, 2009).

Policy makers may be able to overcome these barriers by improving project economics through direct incentives (like performance based incentives – see Section 4.3) or fostering the development of innovative financing and business models (e.g. third-party ownership models – see Section 4.5) that reduce the need for customers to invest their own capital in RES-H/C projects.

3.1.3 OWNERSHIP PRIORITIES & DECISION MAKING BARRIERS Property owners may have widely varying goals related to their real estate investments. Some commercial buildings owners may have long-term plans to own and occupy a property, making them more inclined to make long-term investments. Other property owners may invest in real estate with the intention of re-selling a property within a few years. These owners may have limited motivation to make large capital investments in building energy systems. Policymakers may need to tailor building regulations for existing buildings (Section 4.2) and incentive programs (Section 4.3) to different property ownership strategies for existing buildings in order to ensure commercial RES-H/C expands broadly within the commercial property sector.

Additionally, internal management structures and ownership priorities may significantly influence investment in RES-H/C technologies. Building operations staff may be able to identify cost effective renewable projects, but without high-level management support for those projects, they are unlikely lead to viable installations. Internal decision making and priority setting processes within the ownership group of a commercial property can lead to underinvestment in promising, costs savings projects (Hiller et al., 2012).

3.1.4 SPLIT INCENTIVES Split incentives occur when participants in an economic exchange have different goals or incentives. In the case of commercial rental properties, depending on lease structure, the building tenant may be responsible for paying energy costs; however, the landlord makes investment decisions related to building heating system upgrades. In such cases, the landlord is typically not incentivized to invest in technologies that potentially reduce energy cost unless system costs can be passed on to the tenants, who benefit from reduced utility bills. Additionally, tenants do not typically make large investments in energy cost saving technologies because they do not own or have control over those building assets. This split incentive has been identified as a major barrier to energy cost saving technologies in the commercial building sector and has been well documented in a number of studies (Beerepoot & Marmion, 2012; TCT, 2009).

Lease structures that better align incentives have been proposed as potential solutions to this issue and efforts to promote these structures have been launched in several jurisdictions (CRiBE, 2009; Green Lease Library, n.d.; PlaNYC, 2014). Mandates for existing buildings can also provide the regulatory requirement necessary to better align landlord and tenant incentives (Section 4.2).

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3.1.5 LOW REFURBISHMENT RATES Commercial and institutional HVAC and water heating systems have long replacement cycles and low annual refurbishment rates. Given the significant capital expense, commercial property owners may be more inclined to make incremental repairs to older, less efficient building energy systems than to invest in new technologies. This tendency can lead to building systems that are maintained well beyond their design life. Low refurbishment and replacement rates reduce the opportunity to scale deployment of RES-H/C markets quickly. Most buildings replace heating systems only once every 15 to 30 years, and so the decisions that building owners make today will influence the RES-H/C market for the next several decades.

Mandates requiring integration of RES-H/C technologies in buildings can help address this barrier (Section 4.2). Innovative financing and ownership mechanisms, such as the provision of heat as a service to building users, may also offer a solution to this challenge (Section 4.5).

3.1.6 INSUFFICIENT LOCAL CONTRACTOR BASE In many early-stage RES-H/C markets, a lack of skilled and knowledgeable professionals with the expertise to design and install reliable, high-quality RES-H/C systems can be a significant barrier to market growth. RES-H/C technologies are often more complex than traditional heating and cooling technologies and may also require specialized training and skills to properly design and install. Improperly installed systems can damage the industry’s reputation. This issue has been identified as one of the reasons for the collapse of the solar water heating market in the Unites States after several years of rapid growth in the late 1970s and early 1980s (Sinclair, 2007).

A number of jurisdictions have implemented workforce training programs to overcome these challenges. Such initiatives are challenging to sustain over the long term without clear signals that significant market development will occur. While workforce training programs are not addressed specifically in this report, clear long term plans, regulations and incentives designed to sustain orderly market development can send the proper signal (see Sections 4.2 and 4.3).

3.1.7 LACK OF CONFIDENCE IN SYSTEM PERFORMANCE & FUEL AVAILABILITY RES-H/C typically involves more perceived risk than more traditional heating and cooling technologies because the technologies are unfamiliar to investors. Commercial customers may perceive risks related to overall system performance, product quality and durability, manufacturer warranty viability, long-term fuel availability, future fuel price uncertainty, and availability of ongoing maintenance services. These and other perceived risks may hinder early stage RES-H/C market growth, but may be less of a concern as markets grow and commercial and institutional customers become more familiar with these technologies.

Policymakers can foster early-stage market growth by creating programs and policies that promote RES-H/C ownership models designed to mitigate these perceived risks for end use customers. Third-party system owners are likely better prepared to both understand and mitigate the various operational risks associated with RES-H/C technologies (Section 4.5).

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3.1.8 OPERATIONS STAFF TRAINING REQUIREMENTS Without adequate maintenance, RES-H/C systems will not operate effectively, resulting in poor customer experiences. Large RES-H/C systems may require specialized knowledge to ensure optimal performance. Commercial and institutional entities may not wish to either hire or train employees who have with these specialized skills, preferring to invest in technologies with which are more familiar to their existing building operations staff. Increasing the knowledge and confidence of building managers to manage, maintain, and operate RES-H/C systems will be essential to support widespread technology adoption. Third-party system owners who can provide heat as a service could also be deployed to mitigate the various operational risks associated with RES-H/C technologies (Section 4.5). 3.2 OPPORTUNITIES FOR INTEGRATING RES-H/C INTO COMPREHENSIVE ENERGY PLANS The deployment of RES-H/C will be most successful if policymakers develop integrated policy approaches that address commercial building needs across the energy sectors. Policymakers should carefully consider the potential for integrating RES-H/C policies with other energy policies to better manage the development of the electric, heating, and building sectors. Section 5 explores these issues in greater detail; however, key considerations that may influence decisions regarding implementation of next generation RES-H/C policies are briefly introduced here.

 RES-H/C and low energy buildings. Low energy buildings are those with zero or minimal energy requirements for energy, due to highly insulated building envelopes, limited thermal loss and efficient appliances. Low energy building design for new construction has been taking on increased importance in many regions of the world, and policymakers are also beginning to consider the challenge for converting existing buildings to low energy. The trend towards low energy buildings development has important ramifications for RES-H/C. With low energy buildings, relatively small amounts of heating and cooling supply are sufficient to provide normal comfort levels in all seasons. There will likely continue to be a need for indoor climate control, especially for large commercial buildings with heat loading from electronic equipment and high number of occupants. RES-H/C technologies are often desirable to provide heating and cooling needs for low or zero carbon buildings.  RES-H/C and district energy expansion. RES-H/C has been widely integrated into district heating networks in regions such as northern European (e.g. Denmark). A number of other countries such as the UK are considering district energy networks for both new and existing buildings as a means to supply wider areas with centralized renewable heat installations. District heating systems could either support or constrict the development of RES-H/C markets. Some experts consider the lack of district energy a “severe structural barrier” to widespread utilization of RES-H/C, as they consider it more straightforward to transition a few centralized heat generators to RES-H/C than to transition many distributed building system (Bürger et al., 2008; REN21, 2013). On the other hand, RES-H/C systems that are implemented as part of a low energy building strategy could significantly reduce building heating demand, thus causing revenue erosion for district heating operators. Such a scenario could create stakeholder conflict related to the expansion of distributed RES-H/C systems.

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 RES-H/C and thermal storage for electric grid management. As greater shares of variable RES-E, such as wind or solar, are integrated into the electric grid, grid operators are facing new challenges to ensure flexibility and reliability of the system. There are opportunities to integrate RES-H/C and thermal storage into electric power grid planning and management in order to accommodate larger penetrations of variable generation. In particular, recent studies have shown that using CHP, heat pumps, and heat storage can provide significant balancing capability and contribute to a more flexible and efficient energy system (Hedegaard, 2013; Meibom et al., 2007; Mueller et al., 2014).

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4 RES-H/C NEXT GENERATION POLICIES 4.1 OVERVIEW OF NEXT GENERATION POLICIES This section describes next generation policies that can enable deployment of RES-H/C technologies, focusing in particular on policies and practices that can be applied to new and existing buildings in the commercial sector across a range of jurisdictions. The next generation policies described in this report are new and innovative in the RES-H/C sector, address one or more market barriers, and could enable RES-H/C markets to achieve cost-effective, mainstream deployment over the next several decades.

It is generally expected that next generation policies will drive market development along the deployment curve, helping countries move RES-H/C markets from the inception to take-off phase, and then from the take- off to the consolidation phase. Over the long-term, it is expected that next generation policies will enable RES- H/C technologies to compete with conventional, low-cost heating fuels. They will therefore be a key tool for countries to achieve long-term energy and climate ambitions, such as climate change mitigation, climate adaptation, economic development, and energy security.

When describing next generation RES-H/C policies, this report also takes into account lessons learned from RES-E and EE sectors, the unique features for RES-H/C policy, special features of commercial buildings, and the need for integrated energy policies.

 Lessons learned from RES-E and EE. As noted by numerous experts, policies for RES-H/C lag several years behind the RES-E and EE sectors (Beerepoot & Marmion, 2012; Eisentraut & Brown, 2014). Some of the next generation policies described below have seen widespread implementation in the EE or RES-E sectors. Accordingly, this report draws on lessons learned from the RES-E and EE sectors and applies them to RES-H/C.

 The unique features of RES-H/C. While policymakers can and should apply lessons learned from other sectors to RES-H/C, it is important to remember that RES-H/C has a number of unique features. As discussed in Section 2, RES-H/C technologies have custom sizing and installation requirements, variable production profiles and applications, and, in some cases, performance characteristics similar to both RES-E and EE. The unique features of RES-H/C require policymakers to consider special metering, project sizing, building integration, and administrative requirements.

 Special features of commercial and institutional buildings. As noted in Section 2, the commercial and institutional building sector encompasses a wide range of building types. Commercial building types have much higher and more variable heating loads, and more complex installation requirements, than residential buildings. This may make it challenging for policymakers to develop uniform technical or regulatory requirements to govern RES-H/C technologies across all building types. On the other hand, RES-H/C policy could be more cost-effective and efficient to implement than in the residential sector because of the potential for larger systems and fewer owners.

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 The need for integrated energy policies. As described in Section 3.2, the deployment of RES-H/C will be most successful if policymakers develop integrated RES-H/C policies, which address needs across the electricity, heating, and building sectors. Section 5 explores energy infrastructure planning and investment questions that have important implications for RES-H/C policy in the future.

Table 4 below provides an overview of the next generation policies explored in this report.

Table 4. Next generation RES-H/C policies for new and existing buildings in the commercial sector

Next Generation What Makes it Next Generation? Policy/Initiative  Long-term plans serve to guide policy-making and investment decisions. They are often – particularly in the case of early stage markets – accompanied by formal renewable energy targets, which can send clear signals to the marketplace about future government investment and regulations. By developing clear RES-H/C plans, policymakers can encourage industry leaders and investors to make the necessary investments in infrastructure to overcome market barriers and achieve broader energy and climate goals.  While renewable energy planning and targets are common in the RES-E sector, far fewer countries have established formal planning initiatives for RES-H/C. Develop long-  RES-H/C regulatory policies or mandates place a legal obligation to develop RES-H/C on term plans, specific entities, such as utilities, building owners (or developers), or fuel wholesalers. targets, and Mandates are often supported by penalties for non-compliance. mandates  Compared to the RES-E or EE sectors, relatively few governments have implemented regulations mandating the use or development of RES-H/C. Even fewer have developed mandates focused on existing building in the commercial sector.  Mandates can be a powerful tool to provide commercial building owners with the awareness and impetus to develop RES-H/ systems. Building mandates can be developed to address split incentive barriers by requiring the installation of RES-H/C systems in new and existing buildings at the time of building sale or lease or at the time that existing heating systems are replaced.  Performance-based incentives (PBIs) compensate RES-H/C systems specifically for the amount of generation or savings they produce (e.g. $/kWhth) during a certain period of time (e.g. 10 years).  Few countries have developed performance-based incentives (PBIs) for RES-H/C. On the Develop contrary, the majority of RES-H/C incentive programs are structured as grants or rebates. performance-  PBIs have been widely used in the RES-E sector, and it is anticipated that they will be an based incentives important RES-H/C incentive policy in coming years, especially as RES-H/C markets move (PBIs) for RES-H/C along the deployment curve and policymakers’ priorities shift from catalyzing initial investment to incentivizing efficient performance. PBIs encourage generators to maximize the quality of system installation and maintain systems over time. They also help ensure that ratepayers and taxpayers receive the full economic, environmental, and social benefits from the RES-H/C systems that are provided with incentives.

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Next Generation What Makes it Next Generation? Policy/Initiative  There are two types of costs associated with the purchase and installation of RES-H/C technologies: hardware costs and soft costs. Hardware costs consist of the equipment used in the system, while soft costs (also referred to as business process costs) make up the remaining portion of system cost.  Soft costs have not been well tracked for commercial RES-H/C systems – or the RES-H/C Drive soft cost sector broadly – and policymakers have not developed targeted programs to address RES- reductions H/C soft costs. By contrast, soft cost reduction programs have led to significant price declines within the solar PV sector.  Soft cost reduction programs can help to expedite installations, reduce time and hassle associated with permitting, increase market awareness, and increase transparency and confidence in the RES-H/C market.  Innovative financing and business models are strategies that address financial or behavioral barriers to RES-H/C deployment by creating value or reducing financial risk. In particular, these include turnkey RES-H/C financing and development services such as third-party ownership or other “heat as a service” models.  Traditionally, support for RES-H/C financing has focused on low-interest (soft) loan programs Enable innovative through commercial banks or dedicated loan facilities. Little attention has been given to the financing and needs, requirements, or supporting policies necessary to develop third-party financing and business models ownership models for RES-H/C in the commercial sector.  Third-party financing models can create benefits such as simplifying the decision-making process, reducing operating risk for system hosts, reducing the need for host sites to pursue complicated incentives, facilitating financing, and driving development of professional marketing campaigns to reach new customers for RES-H/C.

The following sections describe next generation RES-H/C policies for the commercial sector in greater detail. Each section provides a brief background on the next generation policies and also describes:

 Key policy design features,  Relevant case studies, and  Policy cost-effectiveness.

Each section concludes with a summary of key findings and best practice recommendations.

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4.2 RES-H/C PLANS, TARGETS & MANDATES 4.2.1 BACKGROUND FOR RES-H/C PLANS, TARGETS & MANDATES Long-term plans serve to guide policy-making and investment decisions in a region. They are often – particularly in the case of early stage markets – accompanied by renewable energy targets. By establishing a RES-H/C target, governments make a commitment to develop a certain percentage of total heating load, capacity (kWth), or total amount of energy (kWhth) from renewable thermal technologies. The creation of a RES-H/C plan with supporting targets is important to consider with a view to establishing clear objectives, identify suitable policy options, and measure progress.

Targets developed during the planning process may be mandatory or non-mandatory. Mandatory targets are usually enshrined in official legislation or regulations. As illustrated in Figure 5 (next page), only 17 countries have developed mandatory targets for RES-H/C.8 Germany, for example, passed the Act on the Promotion of Renewable Energy in the Heating Sector (EEWärme Gesetz), which established a target to supply 14% of total heating demand from a wide range of renewable energy sources (including solar thermal, biomass, geothermal, waste heat and CHP) by 2020. Other countries (e.g. Jordan, China, Algeria, Morocco, and Sierra Leone) have developed targets that focus on only one RES-H/C technology, such as solar thermal. There are no targets that focus exclusively on the commercial sector.

While few countries have established mandatory RES-H/C targets, European Union and Energy Community member countries have developed non-mandatory targets as part of National Renewable Energy Action Plans (NREAPs).9 NREAPs set forth pathways and projections for achieving EU energy and climate targets. For example, the United Kingdom estimates that it will achieve its formal target of 15% of energy consumption from renewable resources by supplying around 30% of electricity demand, 12% of heating and cooling demand, and 10% of transportation demand from renewables by 2020. In this case, the 12% renewable heating and cooling projection does not represent a mandatory commitment and could in fact be reduced or eliminated if regulators decided to instead increase RES-E (or renewable transportation) development. The projection is nonetheless a useful part of the planning process which provides investors a sense of the overall size of the market opportunity and also enables policymakers to measure RES-H/C development progress.

Once formal plans have been created, policymakers employ a variety of incentive and regulatory policies to achieve them. Next generation incentive policies are discussed in Section 4.3. Regulatory policies or mandates – especially those for existing buildings – are described below.

8 By comparison, there are over 144 known policy targets for the increased deployment of renewable energy across the globe, the overwhelming majority of which are focused on RES-E (REN21, 2014) 9 All EU member countries are required by the EU Directive on Renewable Energy (2009/28/EC) to develop NREAPs.

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Solar water heating target Renewable thermal targets

Solar water heating targets Algeria 490,000 m² collector area by 2020 Bhutan 3MW equivalent solar thermal by 2025 China 400 million m² collector area by 2015 India 15 million m² collector area by 2017 Jordan SHW on 30% of households by 2020 Lebanon 1.05 million m² collector area by 2020 Libya 450 MW installed capacity by 2025 Morocco 1.7 million m² collector area by 2020 Mozambique 100,000 solar heaters installed by 2025 Sierra 5% SHW penetration in restaurants & hotels, Leone 1% in residential sector by 2030 Swaziland SHW on 20% public buildings by 2014 Syria 100,000 m² collector area per year Tunisia 1 million m² collector area by 2016 Uganda 30,000 m² collector area by 2017 Yemen 230 GWth generation per year Renewable Thermal Targets Germany 14% building heat met with solar, biomass (liquid, solid & gas), geothermal by 2020 Thailand (All ktoe) 100 solar H/C, 1,000 biogas, 8,200 biomass, 35 MSW by 2021

Figure 5. National Renewable Thermal Targets Across the Globe

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4.2.2 BACKGROUND FOR RES-H/C MANDATES RES-H/C regulatory policies or mandates place an obligation to develop RES-H/C on specific entities, like utilities, building owners (or developers), or fuel wholesalers. Compared to the RES-E or EE sectors, relatively few governments have implemented regulatory policies requiring use of RES-H/C. Utility mandates such as renewable portfolio standards (RPS) have historically focused on RES-E. Only recently have two US states – Massachusetts and New Hampshire – developed comprehensive RES-H/C mandates for utilities (Section 4.2.5).

RES-H/C building mandates are somewhat more common, having been used in recent years especially in EU and Middle Eastern countries to require integration of RES-H/C in new construction or building renovations.10 Next generation building mandates described here focus on existing buildings, which are far less common.

There are only a few existing examples of RES-H/C building mandates for existing commercial buildings. As illustrated in Figure 6 below, Kenya requires new and existing buildings using 100 or more liters of hot water a day to source 60% of their hot water load from solar thermal. In Germany, the state of Baden Württemberg passed a local law (Erneuerbare-Wärme-Gesetz Baden Württemberg), which requires buildings replacing central heating systems to supply at least 10% of their heat supply from renewable energy (including solar thermal, biomass, bio-oil and biogas). Though this law currently applies only to residential buildings, it is possible that the mandate will be extended to commercial buildings in the future.

Lastly, wholesale fuel blending mandates have been used extensively in the United States and Europe to drive development of renewable biofuels for the heating and transportation sectors. This regulatory policy is relatively well established and not considered next generation. It therefore is not treated in detail in this report; however, interested readers should consult Mosey & Kreycik, 2008 and Kampman et al., 2013 for more information.

10 In addition, it is worth noting that the EU Energy Performance of Buildings Directive (2002/91/EC, EPBD), which requires all new buildings to be nearly zero energy by 2020, strongly encourages integration of RES-H/C for new construction projects. Though it does not explicitly mandate the use of RES-H/C, by mandating low energy building development, the policy strongly encourages builders to use air source heat pumps, solar water heating, and other RES-H/C technologies in new construction

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Figure 6. Examples of National and Sub-National Utility and Building Mandates11

4.2.3 BENEFITS OF RES-H/C PLANS, TARGETS & MANDATES In principle, there are a number of reasons to establish formal RES-H/C plans and implement regulatory policies (i.e. mandates) to achieve them.

4.2.3.1 Benefits of Plans and Supporting Targets Targets and clear long-term plans can provide the following benefits:

 Transform country energy portfolios. A national plan with clear objectives is an important first step to drive transformation of the national generation portfolio, position domestic industry to compete internationally, and support economic development in regions with abundant resources or chronic unemployment (Fulton & Mellquist, 2011). Because heating and cooling makes up 50% of total energy use (Eisentraut & Brown, 2014), it will be important for country leaders to establish develop clear long term plans to transform the heating and cooling sector away from fossil fuels and towards renewables to meet climate and energy goals.

11 Please see Appendix B for descriptions of each mandate above and others around the world.

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 Increase investor confidence. The planning process, including the creation of clear targets or commitments, is important to increase investor confidence in the RES-H/C sector (Fulton & Mellquist, 2011; Rickerson, et al., 2012). By providing transparency regarding the goals for RES-H/C development, especially as it relates to specific technologies, policymakers can reduce policy risk for investors. This in turn could reduce the overall cost of capital for RES-H/C and improve the overall cost-effectiveness of RES-H/C incentive programs (Fulton & Mellquist, 2011).

4.2.3.2 Benefits of Mandates Building and utility mandates provide the following benefits:

 Drive energy planning decisions in commercial buildings. As described in Section 2, design and installation of RES-H/C systems is often complex, requiring customers and installers to address plumbing, structural, load, and other requirements. Complexity is even greater for retrofits in existing buildings than for new construction. As a result, by implementing and enforcing building mandates, policymakers provide commercial building owners with the awareness and regulatory requirement to engage the necessary RES-H/C professionals to upgrade or replace their heating and cooling systems.  Address landlord tenant issues. As described in Section 3.1, split incentives between commercial landlords and tenants inhibit the installation of RES-H/C technologies. Building mandates can help address this issue by requiring the installation of RES-H/C systems in new and existing buildings at the time of building sale or lease or during the replacement of the existing heating system. In such a manner, strong regulatory policy can lead to widespread implementation of RES-H/C technologies in existing buildings.  Integrate RES-H/C into existing building stock. The establishment of building or utility mandates can drive market actors to make individual decisions that benefit society as a whole, i.e. improving the renewable profile of the heating and cooling sector within a reasonable period of time. This has been the experience, for example, of policy-makers in Carugate, Italy, where a local solar thermal mandate in residential and commercial buildings resulted in a per capita solar energy use nearly 30 times the national average (ESTIF, 2007).

4.2.4 POLICY OPTIONS FOR BUILDING MANDATES RES-H/C buildings mandates require building owners to source a minimum amount of their heating and cooling load from RES-H/C technologies. Building mandates are usually expressed as a percentage of the total energy demand of the building and the majority focus on new construction. As described above, there are a variety of RES-H/C building mandates in the world, each with varying requirements, eligible technologies, and applicable to various building sectors.

4.2.4.1 Compliance in New & Existing Buildings A key question for policymakers designing building mandates is determining what triggers compliance. The majority of energy efficiency and RES-H/C building mandates are triggered by new construction. Alternately, changes in building ownership or tenancy, building renovation, replacement of the central heating systems, or regularly required building energy audits could also trigger compliance.

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 Sale or lease of building. Compliance standards could be required for existing buildings, triggered by the sale or lease of the building. For example, building inspections are a common part of the process for real estate transactions, and buildings with boilers over a certain age (e.g. 10 to 15 years) could be required to upgrade their heating systems with a high efficiency RES-H/C system. Currently, there are no known RES-H/C mandates that are triggered by real estate transactions; however, the sale of a building is a trigger for building labelling programs in Europe, and integration of energy efficiency and RES-H/C technologies could be a logical next step to improve the energy performance of existing buildings.  Building renovation. Because building owners are already committing to significant investment and replacement of building systems, the building renovation process represents an opportune time to mandate installation of RES-H/C systems. In the EU, the Energy Performance of Buildings Directive (EPBD) already requires buildings that undergo major renovation with a useful floor area over 1000 m2 to meet minimum energy performance standards. Requiring the use of renewable heating and cooling technologies would be a potential next step to support market scale up.  Replacement of central heating system. Jurisdictions like Germany require all heating systems over 30 years in age to be replaced by higher efficient units (dena, 2014). In the German state of Baden Württemberg, there is a mandate requiring use of RES-H/C when the building’s heating system is replaced. The mandate currently applies only to residential buildings, though it is expected to be extended to commercial buildings in the future. In this case, compliance is certified by an expert and authorized by the local building authority within three months after the system goes into operation (ProSTO, n.d.).  Regular building audits and performance requirements. In the EU, the EPBD already requires regular inspections of heating and air conditioning systems, and it additionally requires use of a methodology to calculate and rate the integrated energy performance of buildings. By also requiring regular building energy performance audits, policymakers could ensure that building systems operate efficiently in order to meet low carbon standards and encourage the use of RES-H/C. Moreover, depending on the age of the building, regularly required audits could help building owners identify and resolve problems that occurred during design or construction, or address problems that have developed throughout the building's life. Such policies are emerging in jurisdictions like California and the EU, and policymakers could require building owners to install RES-H/C systems in order to ensure they meet a certain building energy performance standard.

Once the mandate is implemented, local officials (e.g. building code officials and inspectors) will need to enforce them. Depending upon the structure of the building mandate, this may include a variety of penalties, including fines or building permit delays. Policymakers may also wish to provide financial incentives to help building owners overcome financial barriers to complying with the mandate (e.g. property tax reductions). Regardless of incentives it is important for local officials to have the authority to impose significant sanctions for non-compliance. If sanctions are too weak, construction companies or building owners will most likely ignore requirements or cut corners (ESTIF, 2007).

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4.2.4.2 Eligible Technologies Any number of RES-H/C technologies can be integrated in building obligations. As with utility obligations (see Section 4.2.5), policymakers may define eligible RES-H/C technologies as one or more specific technologies that meet certain operational, application, or emission characteristics. In the case of building mandates, it may be most suitable to provide building owners a wide variety of technologies to choose from, so that they can meet their requirements with the lowest cost technology or the technology best suited to their building requirements.

4.2.4.3 Eligible Buildings and Heating Loads Policymakers must specify if new and/or existing buildings are subject to the requirement. Similarly, policymakers may choose to implement a building size threshold for compliance (e.g. buildings over a certain size or with a certain heating load), making commercial buildings a good starting point for regulating existing buildings. Moreover, policymakers may consider the advantages and disadvantages of placing building mandates on various building sectors. In many cases, building mandates for RES-H/C – especially SHW – have focused on the residential sector. Arguably, this is due to the perception that integration of residential RES-H/C systems is less complex. On the other hand, by focusing building mandates on the commercial sector, policymakers can limit the number of entities that they must regulate, while still covering a large portion of the building stock (based on total floor space), thus making the regulatory process more efficient.

The building mandate should also specify what heating loads are eligible. This may include domestic hot water (DHW), space heating, space cooling, or process heating. The percentage of the RES-H/C requirement for the buildings heating and cooling load will also have an impact on what technologies are most suitable. For example, it would be unreasonable to expect SHW to cover 100% of space heating load whereas biomass could be utilized to do so. Heat pumps could cover both space heating and cooling requirements for commercial buildings, whereas cooling remains challenging for other technologies to supply.

4.2.4.4 Measurement & Verification Once the required share of RES-H/C is established, procedures for the measurement and verification of the obligation must be established. In general, this requires two pieces of data: the heating and cooling load for the building (e.g. space and hot water) and the useful energy produced by the RES-H/C system. It is necessary to define standard criteria for both calculations (ESTIF, 2007).

For the building, this may require the installation and use of meters to measure heating and cooling load or estimation of standard building load calculations. In many markets, this will be an important step. For example, in the US, space and especially water heating loads are not typically measured with any degree of reliability in buildings (Navigant & MCG, 2014; Veilleux & Rickerson, 2013).As noted before, it is important to establish a clear methodology to estimate or meter useful heat production from RES-H/C systems. More information on methodologies to ensure useful heat production is provided in Section 4.3.2.4.

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4.2.5 POLICY OPTIONS FOR UTILITY MANDATES Mandates for utilities, also known as a quota mechanism or renewable portfolio standard (RPS), require utilities (or other entities12) to procure a certain percentage of energy from eligible renewable sources. This approach is commonly used in the RES-E sector, but has not seen widespread implementation for RES-H/C.

Integration of RES-H/C technologies into existing utility obligations could serve as an expedient means to establish new mandates. The following provides a high-level discussion of some of the key decision points and tradeoffs and discusses specific considerations for RES-H/C. Where appropriate, this section also describes a series of fundamental design issues that need to be addressed to implement utility mandates, specifically for the commercial RES-H/C market.

4.2.5.1 Utility Compliance The first step in the design of a utility mandate is for regulatory or legislative authorities to establish the appropriate obligation level for each utility. Once the obligation level is established, a mechanism must be established for the obligated entity to demonstrate that they have complied with the requirements. One way to do this is to use renewable energy certificates (which may or may not be tradable). Each energy certificates typically represents one megawatt-hour thermal (MWhth) of useful thermal output. Converting non-electric thermal output from RES-H/C generators into a measure equivalent to MWh is done using a direct conversion factor of 3,412,000 British thermal units (BTUs) to 1 MWh.

Utilities then procure the required number of certificates from RES-H/C generators in order to meet their specific obligation. In cases where utilities fail to obtain the necessary certificates within a determined period, they pay a fine – or alternative compliance payment – to regulatory authorities. This is a common approach taken to enforce compliance for utility RPS programs in the US as well as the Renewables Obligation in the UK.

Based on experiences from the RES-E sector, RES-H/C utility obligations could utilize a wide range of procurement mechanisms and incentive programs to support compliance and the achievement of targets. Though a comprehensive survey of potential procurement options is beyond the scope of this paper, these may include tradable credit markets, standard offer contracts (e.g. feed-in tariffs), or competitive bidding.

Text Box 3. RES-H/C Obligations for Massachusetts Utilities

Overview of the Massachusetts Alternative Portfolio Standard. Fossil fuels for heating and cooling contribute significantly to Greenhouse Gas (GHG) emissions. In order to meet the state’s climate target to reduce GHGs 25% by 2020, the Massachusetts legislature passed a bill to integrate RES-H/C technologies into the utilities’ Alternative Portfolio Standard (APS). Previously, only CHP, flywheels and a handful of other alternative technologies were eligible.

12 In some cases, compliance with the mandates are managed by public or non-profit entities that are responsible to procure renewable energy on behalf of (or in lieu of) the established electric or natural gas utilities. The states of Illinois, New York, and Vermont in the US, for example, have authorities that are responsible for target compliance and commodity procurement under the state RPS laws. There is not a central “utility” for heating and cooling in most countries, so a separate entity responsible for compliance may be useful for RES-H/C supply mandates going forward.

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Eligible Technologies. Eligible technologies include CHP, solar thermal, biomass, biogas, liquid biofuels as well as ground-source and air-source heat pumps. Heat pumps must rely on naturally occurring temperature differences in ground, air or water and biomass facilities must be low emission, high efficiency, and use fuel produced by means of sustainable forestry practices.

Obligation Standard. The obligation lies with the electric utilities, which must obtain a certain percentage of their retail energy from RES-H/C sources. The APS requires that 5% of the state’s electric load must be met with “alternative energy” by 2020. Generation of alternative energy credits (AECs) for each unit of useful thermal energy is measured on an electric equivalency basis, with 3.1412 million BTUs of heat equal to one MWh. In 2015, the year that renewable technologies become eligible for compliance, 3.75% of electric load must be met with alternative technologies.

Compliance and Penalties. Utilities fulfill the obligation by purchasing alternative energy credits (AECs) from eligible generators. If utilities have not purchased enough RECs to meet their annual renewable or alternative energy percentage obligations, they must pay an Alternative Compliance Payment (ACPs). The state government will use ACP funds to support new renewable generation projects in the state.

Key Considerations for RES-H/C Integration. Two major issues were debated by legislators when considering the integration of RES-H/C into the APS.

Regulation of Heating Providers. There was some disagreement in Massachusetts regarding whether electric utilities, and therefore their customers, should bear the costs of the program, or if instead all heating and cooling provider companies should bear the obligation. Electricity serves only a very small portion of heating load in the state. Fuel oil, propane, natural gas, and electric fuel providers in Massachusetts supply the majority of heating fuel. Some of these are regulated utilities, but many are not. State regulators determined that assigning the obligation to purchase renewable thermal credits to such a numerous and diverse group of suppliers, and holding them accountable for compliance with that requirement, would have been administratively burdensome. It would have moreover imposed significant compliance costs on many small companies.

Biomass Standards. Due to concerns regarding the GHG emission reduction potential of wood burning appliances, the eligibility of biomass in the APS proved to be a great source of controversy. To secure support from environmental groups for the bill, several eligibility restrictions were put in place for biomass fuels. To qualify as eligible, biomass, biogas, and bio-liquids must demonstrate that any wood used to create them is “produced by sustainable forestry practices.” In addition, biomass technologies must meet emission performance standards achievable by “best-in-class, commercially feasible” technologies and achieve at least a “50% reduction in life-cycle GHG emissions” compared to the fuel that is being displaced.

Outlook. Regulators are currently finalizing regulations to implement the APS. As a result, there is currently no information on the impact of the legislation on the RES-H/C market. However, the policy is generally expected to be one of several important actions taken on the part of policymakers to jumpstart the Massachusetts RES-H/C market.

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4.2.5.2 Calculation of Useful Heat Production A key issue for RES-H/C obligations is to ensure that RES-H/C generators receive incentives, payments, and/or certificates only for the production of useful heat. Because renewable heat can in most cases not be fed into the grid, and must instead be used on-site, there is a risk that generators may oversize systems or generate excess heat in order to generate a greater volume of certificates. This may be especially problematic if the generator receives a production payment for each unit of heat generated (see Section 4.3 for more on incentives).

To address this, policymakers should be sure to implement a reasonable methodology to estimate or meter useful heat production from RES-H/C systems, which can be recorded in utility tracking systems. At the same time, policymakers should be careful to not make metering requirements too onerous, thus placing undue administrative and technical burdens on renewable heat generators. Additional information on metering methodologies to ensure useful heat production is provided in Section 4.3.2.5.

4.2.5.3 Eligible Technologies Any number of RES-H/C technologies can be incorporated into a utility obligation. Air-source and ground- source heat pumps are often easiest to integrate, as they are commonly installed with utility-grade, electric meters that monitor their production. Within the US for example, heat pumps are widely eligible under state electric utility RPS programs.13

Technologies using forced air heating systems (as opposed to hydronic distribution systems) may pose the greatest challenges since they are more challenging to measure. In such cases, it may be most appropriate to estimate heat production or use some other means (other than metering) to calculate heat production (see Section 4.3.2.5).

In determining technology eligibility, policymakers may also consider whether utility obligations will be subdivided, and if so, how. RES-H/C obligations may focus on one or more specific technologies, creating technology bands or carve-outs that meet certain operational, application, and emission characteristics. When creating such carve-outs or technology bands, policy-makers can define an optimal mix of technologies in order to achieve policy objectives or acknowledge local market constraints (Bürger et al., 2011; Fulton & Mellquist, 2011).

Making utility obligations technology-specific could allow the government to create demand for one or more technologies that leverage local resources or infrastructure. Alternately, allowing a wide range of technologies to meet mandate requirements permits greater flexibility in the response of the obligated parties and can often reduce compliance costs (Bürger et al., 2011). Policymakers may also establish operational parameters in order to address efficiency and GHG emission reduction goals.

13 The performance of RES-H/C technologies under RES-E standards has to date been mixed and should be carefully considered by policymakers. A number of US states allow RES-H/C technologies to be eligible, but have not had well defined pathways for them to participate in the market. As a result, RES-H/C technologies have not thrived under RES-E mandates (Rickerson, Halfpenny, & Cohan, 2009). On the other hand, a flood of SWH participation in Australia’s national RPS in 200X caused certificate market prices to crash and delayed the growth of RES-E technologies (Carbon Markets Economics, 2009). Regardless, the next generation policy here proposes that RES-H/C should have stand alone mandates, or at least clear carve-outs within broader renewable standards.

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4.2.5.4 Eligible Counterfactual Fuels It is also important to specify what counterfactual fuels – such as natural gas, oil, or electric heating – may be displaced by RES-H/C systems, and specifically whether the utility obligation is “fuel neutral.” A key question regarding fuel neutrality is whether the mandated utility can procure RES-H/C certificates if the RES-H/C installation displaces a counterfactual fuel that is not sold by the utility.

In some jurisdictions, only RES-H/C technologies that displace the utility’s fuel (e.g. electricity or natural gas) have been eligible to meet the utility mandate. This has historically been the case for New York’s solar water heating rebate program, which has been implemented to fulfill the electric utility’s RPS requirement. Because very few buildings in New York use electricity to heat hot water, the program has had a very small effect on the adoption of solar water heating across the state. The state is currently in the process of reviewing its rules to make the program fuel neutral (e.g. able to displace fuel oil or natural gas in addition to electric heated hot water tanks), which is expected to increase the impact on solar water heating adoption (K. Stainken, personal communication, November 30, 2014).

Fuel neutrality may raise concerns of cross-subsidization if the utility obligation benefits consumers of other fuels whose heating and cooling systems are replaced by RES-H/C, rather than their ratepayers. On the other hand, some policy-makers suggest that this practice can also provide benefits. For example, policymakers in New Hampshire noted that integration of RES-H/C into the electric utility obligation benefits electric ratepayers, because RES-H/C technologies can fulfill the utility mandate at lower cost than RES-E technologies.

4.2.6 COST EFFECTIVENESS

4.2.6.1 Costs & Benefits for RES-H/C Mandates for RES-H/C can generate a wide range of costs and benefits. Depending upon the costs and benefits to be considered, the calculations can become complex. RES-H/C technologies may generate a broad range of external benefits that markets may not typically monetize, ranging from job creation to improved building comfort or energy security benefits, among others. Text Box 4 below illustrates an example from Germany’s Renewable Energies Heat Act (EEWärmeG), which mandates that owners of new buildings cover parts of their heating and cooling demand from renewable sources.

Policy interactions (e.g. between mandates and incentives) can influence the outcomes of the cost-benefit analysis. It may be most cost-effective to provide market actors a wide variety of technologies to choose from, so that they can meet their requirements with the lowest cost technology. In the final analysis, policymakers will need to carefully consider the range of options that will influence the implementation of a mandate to assess costs and benefits.

Text Box 4. Cost Effectiveness of the Renewable Energies Heat Act (EEWärme) Building Mandate

Overview. The Renewable Energies Heat Act (EEWärmeG) is a German law that mandates owners of certain building categories to cover parts of their heating and cooling demand from renewable sources. The minimum requirements vary by technology and building type. Currently, the act only applies to new buildings, though the individual federal states in Germany may choose to extend the regulation to the existing building stock. It also provides incentives to owners of existing buildings to increase the share of energy produced from RES-H/C technology.

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The objective of the act is to increase the share or energy from RES-H/C technologies to 14% of final energy consumption for heating and cooling by 2020. In 2012, the Federal Ministry for the Environment, Nature Conservation, Building and Nuclear Safety estimated the cost and benefits of the act. The analysis included the costs and benefits of all components of the act, including a RES-H/C incentive program. The calculations below refer to the analysis of the mandate only.

Stakeholders. Stakeholders and key parameters considered in the cost benefit analysis include:

 Companies: Potential impacts of increased renewable heating generation on electricity bills; initial investment costs, administrative burdens, and impacts on rural businesses  Society: Air quality and other environmental costs and benefits, including carbon emissions reductions  Government: Enforcement and compliance costs

Costs and benefits evaluated. The Ministry determined the (1) differential costs and (2) differential benefits of the (EEWärmeG) mandate.

Differential costs are the sum of the differences in costs between theoretical reference systems (fossil- fuel based) and the installed RES-H/C systems for the entire new building stock (differentiated by reference building type).14

Differential benefits are the difference in in environmental benefits between the theoretical reference systems (fossil-fuel based) and the installed RES-H/C systems.

Avoided environmental costs from the mandate represent avoided costs that would have been caused by damage from emissions.15

Major costs and benefit categories included:

 Carbon benefits: Approximately 640,000 tons of avoided CO2 (quantified as 10 million euros, i.e.

about 15 euro/t CO2)  Differential System Cost: RES-H/C systems were estimated to cost an additional 80 million euros than would have otherwise been spent based on annuity, maintenance, and fuel costs.

Results. The costs of the mandate alone for new buildings outweigh the benefits by 70 million euros based on the methodology described above. This could be attributed to the low energy demand of new buildings, and thus the limited cost savings potential from RES-H/C. In other words, if the mandates were applied to existing buildings, they may be more cost-effective.

In a 2012 evaluation, Fraunhofer ISI et all (2011i) finds that when the mandate was combined with an ongoing rebate for existing buildings, the differential benefits from avoided pollution outweigh the differential costs significantly. Costs of the act totaled 1.2 billion euros for 2011, and 1.8 billion for 2010, compared to benefits of 2.1 and 2.6 billion respectively.

14 Differential Cost = Σg Σi [(Specific costs of the RES-H/C system(Euro/kWh))14 – Specific cost of the fossil fuel system replaced by RES- H/C(Euro/kWh)) x Energy demand of RES-H/C technology x Share of the RES-H/C technology x Number of buildings]. Where “I” is the RES-H/C technology and “g” is the reference building type 15 Avoided environmental costs = {Sum of (Average energy demand of building type x Damage caused by emissions from new buildings x Share of energy of reference building replaced by RES-H/C) – Energy demand/ m² of building type with RES-H/C system x Damage caused by emissions from RES-H/C technology} x Weighing factor of RES-H/C technology x Total new area of building type

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4.2.6.2 Distribution of Costs & Benefits Distribution of costs and benefits will depend upon the type of mandate implemented. With regard to utility mandates, policy cost recovery will generally fall onto ratepayers through the imposition of surcharges on each kWh or electricity sold. As discussed in Section 4.3.3.1, the term “ratepayer” may not be neatly applicable for heating and cooling since there is not always a heating or cooling utility to recover costs.

With regard to building mandates, the burden of compliance usually falls to building owners. It is reasonable to expect that RES-H/C building regulations may be easier to implement in the commercial sector (as opposed to the residential sector) because there are fewer entities that are subject to regulation and enforcement actions. This could improve the cost efficiency of the policy.

Fuel savings (or costs) will typically accrue to the user of the building, which could be either the owner or the tenant. To ensure compliance, policymakers will need to assume some level of costs for administration and inspections. Social costs or benefits accrue widely to the general public through impacts to air quality, carbon reductions, or energy security.

4.2.7 SUMMARY FOR POLICYMAKERS

Table 5. Summary Considerations for Policymakers Utility Mandates

RES-H/C Targets

 Policymakers should develop clear long term plans and consider the appropriateness of targets to guide policymaking and investment decisions in their jurisdiction. This can be an important first step to drive transformation of the national portfolio, position the domestic industry to compete internationally, and support economic development in regions with abundant resources or chronic unemployment. Develop long term plans and  The establishment of clear long-term plans is important across all stages of targets for RES- market development. For inception markets, they are needed to generate H/C confidence among industry leaders and investors by providing a clear vision of development market size and opportunity.  For take-off markets, policymakers may choose to revise or update plans in order to address new market, technology, and cost developments. As the market develops, policymakers should be prepared to implement new plans and policies, which may include both policy incentives or regulatory policies like building or utility mandates.

Building Mandates

 Policymakers should consider the potential for requiring building owners to source a minimum amount of their heating and cooling load from RES-H/C technologies. By implementing building mandates, policymakers provide commercial building owners with the awareness, encouragement, or regulatory Assess suitability requirement necessary to engage RES-H/C professionals to upgrade or replace of building their heating and cooling systems. mandates  Building mandates can also help address landlord-tenant challenges by requiring the installation of RES-H/C systems in new and existing buildings at the time of building sale or lease or during the replacement of the existing heating system.

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 Strong regulatory policies like building mandates can drive widespread implementation of RES-H/C technologies in existing buildings. This approach may be particularly suitable for maturing markets that are in the take-off or entering the consolidation phases.

 A key question for policymakers establishing a building mandate is to determine what triggers compliance. While the majority of building mandates today are triggered by new construction, RES-H/C mandates could also be triggered by: (i) the sale or lease of a building, (ii) building renovation, (iii) or the replacement of a central heating system. In addition, policymakers may consider requiring regular building audits and performance requirements for buildings.  It is reasonable to expect that RES-H/C building regulations may be easier to implement in the commercial sector (as opposed to the residential sector) Determine because there are fewer entities that are subject to regulation and compliance enforcement actions. This could improve the cost efficiency of the policy. triggers and RES-H/C  Any number of RES-H/C technologies can be integrated into building eligibility obligations. Policy-makers may define one or more specific technologies, or a basket of technologies that meet certain operational, application, or emission characteristics, as eligible. It may be most cost-effective to provide building owners a wide variety of technologies to choose from, so that they can meet their requirements with the lowest cost technology.  The building mandate should also specify what heating loads are eligible. This may include domestic hot water (DHW), space heating, space cooling, or process heating. This decision will also have an impact on what technologies are most suitable.

 Once the required share of RES-H/C is established, procedures for the measurement and verification of the obligation must be established. Determine  For the building, this may require the installation and use of meters to measure measurement heating and cooling load, or estimations of standard building load calculations. and verification requirements  Additionally, it is important to implement a clear methodology to estimate or meter useful heat production from RES-H/C systems, which can be recorded in utility tracking systems.

Utility Mandates

 Mandates for utilities, also known as a quota mechanism or renewable portfolio standard (RPS), require utilities to procure a certain percentage of energy from eligible renewable sources. This approach is commonly used in the RES-E sector, but has not seen widespread implementation for RES-H/C.  RES-H/C utility obligations can be integrated with a wide range of other policies Assess suitability – especially incentive programs – to support compliance and achievement of of utility targets. By establishing stand-alone mandates or carve-outs for RES-H/C mandates technologies – either through existing or new utility obligations – policymakers could expediently and efficiently drive RES-H/C growth.  RES-H/C utility mandates can be successfully deployed across all stages of market development, from inception, through take-off and into consolidation phases.

Determine utility  Regulatory or legislative authorities establish the appropriate obligation level for obligation and each utility. Once established, utilities must secure a certain amount of energy RES-H/C from eligible RES-H/C generators (e.g. system owners). eligibility

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 Utilities could secure certificates from eligible generators to prove compliance with the mandate, depending on how the mandate is designed. Each energy certificate typically represents one megawatt-hour thermal (MWhth) of useful thermal output.  Converting non-electric thermal output from RES-H/C generators into a measure equivalent to MWh is done using a direct conversion factor of 3,412,000 British thermal units (BTUs) to 1 MWh.

 When developing utility mandates, it is important to specify what counterfactual fuels – natural gas, oil, or electric heating – may be displaced by RES-H/C systems, and specifically whether the utility obligation is “fuel neutral.”  The key question regarding fuel neutrality is whether the mandated utility can Clarify eligible procure RES-H/C certificates if the RES-H/C installation displaces a counterfactual counterfactual fuel that is not sold by the utility. fuels  In some cases, fuel neutrality may raise concerns of cross-subsidization if the utility obligation benefits consumers of other fuels (e.g. fuel oil or propane) rather than their ratepayers.  Questions of fuel neutrality can also impact policy cost-effectiveness, depending upon the commodity price of fossil fuels in the market.

 A key issue for RES-H/C obligations is to ensure that RES-H/C generators receive certificates only for the production of useful heat. Clarify  To address this, policy-makers may implement a reasonable methodology to calculation define and track “useful heat” production from RES-H/C systems. In cases where requirements for the methodology requires metering of small or large commercial systems, “useful heat” policymakers should establish accuracy requirements for metering; ongoing maintenance and inspectional requirements; metering measurement and design procedures for various heating system configurations; as well as the thermal output calculation for heating installations.

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4.3 RES-H/C PERFORMANCE BASED INCENTIVES 4.3.1 BACKGROUND An important component of next generation policy making for RES-H/C is to ensure that generators are compensated (or incentivized) for the energy, commodities, and other values that they produce. Compensation and incentives should generally be structured in a way that appropriately balances policy objectives with system economics and investor requirements. Historically, the most active RES-H/C markets around the world have supported market growth through the use of incentives that are calculated based on expenditure, capacity, a flat rate, or other upfront payment mechanism.

 Expenditure-based incentives. Expenditure-based payments are calculated based on total system cost. Geothermal heat pumps in the US, for example, are eligible for a 10% federal Investment Tax Credit (ITC) based on system cost (DSIRE, 2014).  Capacity-based incentives. Capacity-based payments are calculated based on installed system size (e.g. $/m2 of solar collector area). For example, as part of Germany’s MAP Program, solar-combi systems receive of 90 EUR/m2 for the first 40 m2 and 45 EUR/m2 of gross collector area for each additional m2 (BAFA, n.d.).  Flat rate incentives. Flat rate payments are applied uniformly to certain classes of technologies. The Ministry of Energy and Water in Lebanon created a $1.5 million that offers $200 grants for residential solar water heating systems in parallel with a dedicated loan program.  Upfront incentives for expected performance. It is also possible to structure payments such that systems receive upfront payments or frontloaded payments based on the expected performance of systems. This has been the approach, for example, in the Australian small-scale technology certificates (STCs) system, where solar thermal and heat pumps (along with numerous RES-E technologies) are eligible.

These types of “upfront” or “frontloaded” incentives and payment systems have driven a significant share of RES-H/C market growth around the world. While incentive regimes of this kind can encourage robust market development,16 they do create the risk of non-performance over the long-term (Barbose et al., 2006). “Next generation” policies will likely transition to performance-based incentives and payments, especially as RES-H/C markets scale up and policymakers place higher priority on ensuring that ongoing energy generation is rewarded.

Performance-based incentives (PBIs) compensate RES-H/C systems specifically for the amount of generation or savings they produce (e.g. $/therm or $/kWhth) during a certain period of time (e.g. 10 years). Overall, PBIs have been rare in the heating and cooling sector (Beerepoot & Marmion, 2012; Steinbach et al., 2013). Some countries like the UK, Australia, the Netherlands, Italy, and several US states have introduced PBIs for RES-H/C– but PBIs in general remain a policy frontier that most countries have not yet crossed.

16 The State of Upper Austria, for example, has famously developed one of the strongest renewable thermal clusters in the world thanks in part to its long standing capacity-based rebate program as well as a variety of other market development mechanisms.

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As discussed below, the UK is one of the first jurisdictions that has made a large-scale commitment to PBIs for the development of residential and commercial RES-H/C sectors through its Renewable Heating Incentive (RHI). Best practices from this and other emerging examples of successful PBI policies are discussed in the following sections.

4.3.1 BENEFITS OF RES-H/C PERFORMANCE BASED INCENTIVES There are a number of reasons for policy-makers to introduce PBIs.

 Maximize quality of installation. PBIs encourage generators to maximize the quality of system installation and maintain systems over time. The history of SWH systems in the US, for example, was driven by expenditure-based tax credit incentives. Many of these systems were installed and maintained poorly and gave the industry a bad reputation, which it has taken several decades to overcome (Lane, 2011). Performance-based payments can help avoid systems that perform poorly, and can also help to avoid “gold plated” projects that are designed to maximize expenditure-based incentive (Hoff, 2006).  Maximize ratepayer value. Performance-based payments help ensure that ratepayers and taxpayers receive the full economic, environmental, and social benefits from the RES-H/C systems that are provided with incentives.  Support mature market development. Many countries used upfront payments to initially support renewable electricity projects, such as PV and wind during the inception stage of market development. However, most countries transitioned to performance-based payments for both large- and small-scale systems as their markets increased in size. As they move up the deployment curve, the priority shifts from catalyzing initial investment to incentivizing efficient performance and managing near-term governmental budgetary constraints. PBIs now dominate the renewable electricity policy landscape (e.g. feed-in tariffs, competitive tenders, tradable credits, and net metering) globally.

It is anticipated that in coming years RES-H/C policy will need to make a similar transition towards PBIs. As discussed in greater detail below, a growing number of jurisdictions are undertaking this transition, although there are metering, administrative, policy design, and implementation challenges with performance-based payments for heat that need to be carefully considered and addressed.

4.3.2 POLICY OPTIONS FOR RES-H/C PERFORMANCE BASED INCENTIVES There are a many different options for designing effective performance-based incentives. Over the past two decades, many of these options have been discussed in great depth in literature focused on renewable electricity policy. Despite the benefits of PBIs, the experience of PBIs in the electricity sector, and the initial experiences of some countries for RES-H/C PBIs, there is little literature on the fundamental design features for performance-based incentives for the commercial RES-H/C market. Policymakers are just beginning to explore the development of performance incentives for the RES-H/C sector (Bürger et al., 2008; Steinbach et al., 2013), and best practices are still emerging.

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The following provides a high-level discussion of the key decision points, tradeoffs, and specific considerations for RES-H/C. This section also describes a series of design issues that need to be addressed to implement PBIs for the commercial RES-H/C market. The assessment draws on international case studies, including the United Kingdom’s Renewable Heating Incentive (RHI) (see Text Box 5).

Text Box 5. Overview of the U.K.’s Renewable Heat Incentive (RHI)

Background and Goals of the RHI. In November 2011, the United Kingdom launched the renewable heat incentive scheme. The program is intended to facilitate the uptake of renewable heating among non-domestic consumers and contribute to the on-going shift within the United Kingdom to a low- carbon economy. It is also expected to contribute to the Government’s objective of increasing the share of renewable heat generated to 12% by 2020.

RHI Tariff Structure. Similar to the way that a feed-in tariff rewards solar or wind generators of renewable electricity generation, the renewable heat incentive (RHI) rewards generators of biomass technologies, heat pumps, solar thermal and biomethane for heat production. An administratively set tariff17 is paid to residential, commercial, public and industrial consumers for every unit of renewable heat generated on a pence per kWh basis. In consultation with industry and other stakeholders, regulators established tariff levels to provide system owners an average internal rate of return (IRR) of 12%.

The amount paid to each installation is based on a tariff rate that takes into account the size of the system and the type of technology. Tariff support is delivered in the form of payments made every three months over a contract period that generally lasts 20 years.

The scheme is funded by from general government spending through 2017 and administered by the Gas and Electric Market Authority (Ofgem).

4.3.2.1 Approach to Setting the Payment Rate A key issue is determining the appropriate payment level or rate for PBIs. There are multiple ways in which a performance-based payment level can be determined. The most common include:

 Administratively set. Regulators or program implementers set the rates through an administrative process. The rates can be set, for example, based on the generation cost of specific RES-H/C technologies, the “avoided cost” of dominant conventional heating fuels, or on some other value. This has been the approach, for example, that the UK took in developing its Renewable Heating Incentive (RHI) program.  Competitively bid. The payment rate for RES-H/C can also be set through competitive mechanism such as price-based auctions.

17 In order to calculate the tariff, policymakers considered the compensation for the capital costs, which was the difference between the conventional and renewable technology while applying a 12% discount rate on this differential over the technology lifetime to calculate the annualized upfront payment. They additionally considered compensation for the operating costs (including fuel costs), which was the difference between the conventional and renewable technology as well as other non-financial barriers, which were barriers associated with the renewable technology under the relevant counterfactual.

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 Tradable credits. Payments can also be determined through short-term or spot market trading, based on supply and demand. Tradable credit markets are typically associated with heating supplier and utility mandates. In this case, market stakeholders who actively buy and sell tradable credits in the market set the price of the PBI. This is the approach, for example, that the State of New Hampshire uses for its renewable thermal RPS carve-out.

There have been vigorous debates between the comparative merits of these approaches during the past two decades around the world. In Europe and the US, for example, the perceived tradeoff between investor security and market competition animated a debate between proponents of tradable credits and administratively set (e.g. feed-in tariff) rates for the RES-E sector in the mid-2000s. A similar debate between competitively bid and administratively set rates also occurred in both Europe and the US, contrasting the price competition supported by bidding with the inclusiveness and lower transaction costs of administratively set rates. These debates have become more nuanced over time as policymakers have utilized these approaches in parallel to achieve different objectives and have combined elements of each of these policies into innovative new hybrids.

As PBIs are adapted to RES-H/C markets, policymakers will have an opportunity to leverage lessons learned from the RES-E sector and avoid the polemical arguments that have often characterized the energy policy dialogue. For example, while there may be both advantages and disadvantages to tradable credit and administratively set incentives, experience shows that both approaches can be designed to provide the transparency, longevity, and certainty necessary to attract investors and ensure long-term stable market development. Early debates about rate setting characterized competitive and administrative rate setting approaches as mutually exclusive alternatives (Commission of the European Communities, 2005; Hvelplund, 2001). As policies have evolved and diffused internationally, however, innovative design approaches have been introduced, such as:

 Parallel mechanisms. In some countries, tradable credits have been utilized for larger-scale systems, whereas administratively set rates have been used for smaller scale systems or specific technologies. This has been the case in the UK RES-E market, where the feed-in tariff has been used to support smaller-scale development and tradable credits have been used to support larger systems, and Italy, where a FIT was used to support PV while tradable credits were used to support non-PV systems. In each case, both mechanisms were used to support the achievement of national targets.

 Hybrid policies. In some countries, policymakers are combining elements of different policies to create innovative structures. Many of the RPS markets in the US, for example, utilized tradable credits exclusively in the late 1990s. Most states have now introduced some form of long-term stability for tradable credits. This has included competitive bidding for long-term credit contracts in New York and Connecticut, a loan program that has effectively served as a price floor in New Jersey, and standard offer contracts for credits in Delaware (Bird et al., 2011; Heeter & Bird, 2011). These policies maintain the ability to trade credits and utilize them for compliance, but also introduce more bankable ways for credits to be procured.

Internationally, there are many more examples of policies that move beyond standard labels and combine traditional approaches in new ways. By assessing policy design options, RES-H/C policymakers can move past philosophical debates and towards balanced policy solutions that best serve national RES-H/C objectives.

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4.3.2.2 Payment Duration The issue of payment duration can be complex. For “above market” incentives designed to provide generators with a specific return, shorter-term performance payments (e.g. 3-5 years) can provide a perverse incentive that encourages generators to abandon projects before the end of system life. Longer-term performance- based incentives, on the other hand, may require higher ratepayer impacts over time to produce the same return. Payments based on actual performance also introduce greater monitoring expense (Section 4.3.2.5) and introduce greater administrative complexity because they require a longer-term relationship between RES-H/C systems and program administrators (rather than a one-time payment).

However, longer-term payments can also push the final cost of RES-H/C downward because they allow capital costs to be levelized over a longer period of time. In this way, longer-term incentives can reduce RES-H/C levelized costs of energy to the point where they can serve as a hedge against conventional fuels – or even create savings when compared to conventional fuel alternatives on a levelized basis.

4.3.2.3 Interconnection and Commodities transferred PBI payments may or may not require generators to transfer RES-H/C commodities (e.g. energy, renewable energy credits, etc.) as a condition of receiving the production payment. The most basic transaction would award payments in exchange for heat energy (e.g. a heat purchase agreement).

In the RES-E sector, energy transfer is a common feature of many feed-in tariff schemes. In such cases, a wind generator receives a fixed payment for every kWh of electricity delivered to the grid. For RES-H/C, heat energy transfer is generally impossible in regions where on-site heating infrastructure is most common. If district heating is common in the region, it can allow end-users to feed heat back into the grid (see Text Box 6).

Text Box 6. Interconnecting RES-H/C into District Heating Networks: New Tariff Models, Business Models and Regulatory Frameworks

In many regions across Europe, municipalities have historically developed gas and coal-based combined heat and power (CHP) plants, which generate electricity for the wholesale power market and heat for local district heating customers. Municipalities have traditionally financed these CHP plants based on the assumption that they could sell power into the European Electricity Exchange (EEX) in order to generate stable revenues. Revenues from electricity sales in turn enabled them to provide heat at very low cost to municipal district heating customers.

More recently, however, wholesale electricity prices on the EEX have dropped significantly, due in large part to the greater number of solar and wind power facilities that have come online. Wind and solar power projects, which have virtually no fuel costs, can sell power into the EEX at very low marginal cost. This has depressed electricity prices on the EEX – in some cases leading to negative prices on the wholesale market – making it increasingly uneconomical for municipalities to operate gas or coal powered CHP plants.

This new market dynamic has important implications for municipal district heating networks. Municipalities are in many cases required to provide heat to users on their district heating network. Due to the current economics of the electricity market though, heat – which was once considered waste energy and thus very low cost to produce – has become much more expensive. In some municipalities in Austria, like Graz and Vienna, heat suppliers have had to operate gas-fired CHP plants at a loss in order to meet their local heating obligations.

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As a result, municipal energy utilities (like the one in Graz) have recently announced that they will be shutting down gas and coal CHP plants. In Graz’s case, this means that within the next several years, the municipality will lose nearly 80% of its current heat supply. As a result, energy planners are now evaluating opportunities for integrating alternative energy sources into district heating networks, including RES-H/C technologies such as biomass, solar thermal and heat pumps (Epp, 2014).

To do so, however, it may in some cases require the redevelopment of new heat networks. District heating systems have traditionally been developed as high temperature, high pressure systems (e.g. operating at 140 degrees C and in 15-bar networks) that are supplied from a few central locations. But many RES-H/C technologies – like heat pumps and solar thermal – operate best at lower temperatures and in lower pressure systems. There is significant possibility to integrate distributed heating systems into the network, enabling buildings to feed heat into the grid at lower return temperatures.

Facilitating such a shift will require development of new tariff models, business models and regulatory frameworks. In Denmark, for example, district heating operators are experimenting with new rate structures, offering customers lower heat prices if they can provide district heating return temperatures at levels that improve the utilization of renewable heat sources and facilitate greater system efficiency (Epp, 2014). Such shifts open up new possibilities for the development of feed-in tariffs or other PBI mechanisms for RES-H/C on next generation district heating networks.

Depending on the policy mechanisms and compliance frameworks put in place, however, other commodities may be transferred through a performance payment. These could include, for example, tradable compliance credits in jurisdictions (e.g. Massachusetts or New Hampshire) that have set up heat supply mandates (Section 4.2.5). As RES-H/C scales up in the future, however, there may be additional environmental (e.g. carbon credits) or market-based commodities that could be transferred as part of a PBI system.

When designing next generation polices, the rights to current, anticipated, and/or potential commodities under PBI payments should be clarified to the extent possible. If PBIs are intended to provide generators with a target return, then allowing additional commodities to be retained and sold into other markets creates the opportunity to capture excess profit. If PBIs are expected to provide only a portion of the required return, then RES-H/C system owners face the risk of having to sell multiple commodities to multiple counterparties.

4.3.2.4 Useful Heat Requirements As mentioned in Section 2.1.1, except in cases where RES-H/C is integrated into district heating networks, excess energy produced by RES-H/C technologies (beyond what is used on-site or practically stored) cannot be fed back into the grid. As a result, there is a risk that PBIs could create a perverse incentive, wherein system owners generate more heat than they can practically use or store on-site. This requires policy-makers to put in place mechanisms that ensure that only the production of useful heat – or heat that can be used on-site to address the operational and design needs of buildings – is incentivized.

As a first step, policy-makers may define what is meant by “useful” heat. UK and other policy-makers have established a number of principles that describe useful heat production (see Text Box 7). While different jurisdictions may establish different requirements, these principles provide a helpful benchmark by which to define useful heat.

Text Box 7. Defining Useful Heat for Performance Based Incentives

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Useful heat may be defined in a variety of ways. Policymakers have developed a number of principles to guide “useful heat” determinations for PBI programs. The following principles have guided policymaker actions in the United Kingdom and in US states like Massachusetts and New Hampshire.

 The heat load should serve an actual purpose. The heat load should serve an actual purpose and not be artificially created in order to claim a performance incentive. For example, a biomass heating system may not combust biomass and vent heat into the outside air (for no useful purpose) in order to receive performance payments. Some policies specify eligible and non-eligible applications for heat, characterizing uses for domestic water heating, space heating, or process heat. In the UK, the RHI specifies that acceptable heat uses are space, water, and process heating where the heat is used in fully enclosed structures (UK DECC, 2011).  RES-H/C should supply economically justifiable heating needs. RES-H/C technologies must supply heat to a load that would otherwise be met by an alternative heating source (natural gas or electricity, for example). It should not be designed to serve heat loads that would not otherwise be used. In some cases, this could eliminate swimming pool heating or other heating loads where the end-use application had not previously used heat from any source. Most, if not all, end-use applications that would otherwise use fossil fuels or electricity as a heat source should be eligible for PBI incentives, regardless of whether they are deemed to be “essential,” or “non-essential.”  The heat load should be measurable and verifiable. Heating applications that cannot be measured and verified are ineligible for PBIs. For example, in New Hampshire, the statute requires monitoring and verification of energy production by an independent entity as a condition for eligibility in the renewable thermal carve out.

Policy-makers have a number of options to ensure compliance with useful heat principles:

 Minimum energy efficiency requirements. By ensuring that basic building energy efficiency requirements are met as a pre-condition, the size of the RES-H/C system can be reduced, thus achieving significant reductions in installed costs. RES-H/C systems should be sized to meet the (remaining) heating and cooling load of the building. By properly sizing the RES-H/C system to meet the building’s energy load, system owners can increase the overall efficiency of their heating equipment and reduce the likelihood of wasting primary energy or damaging the RES-H/C system (e.g. overheating in a solar thermal system). In such a manner, PBI systems for renewable heat can also indirectly encourage energy efficiency measures.  Estimating RES-H/C production. There are a number of software programs and methodologies that policymakers can require installers and developers to use to estimate the necessary energy production. These generally provide users a means to estimate the building heat load and the optimal sizing and placement of the RES-H/C systems to meet that load. Estimation of heat use has been used widely in the United States and Europe to support both capacity and performance based incentive policies. Estimating is typically the preferred approach for incentive programs for small applications where the cost of metering can be disproportionately high. Due to the complexities of building occupancy and usage in commercial buildings, however, it can be challenging to establish a suitable methodology for estimating heat demand across the many building types and end-use applications found in the commercial sector.

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 Metering heat production. Ongoing monitoring of larger RES-H/C systems is necessary to ensure that the system is performing satisfactorily, and to measure delivered energy in order to calculate payment amounts for true performance based systems. Heat metering has been used widely in the private sector in many jurisdictions, especially in commercial applications; however, policy governing heat metering products and techniques for performance-based incentive programs has not been as widely developed, particularly in North America. Nevertheless, policy-makers are beginning to consider the issues and options related to heat metering standards in support of performance based incentives.

4.3.2.5 Heat Metering Standards As noted above, heat metering is arguably the most accurate means of establishing confidence in the operation of RES-H/C technologies, as it enables policymakers and other market actors to clearly verify the heat production capabilities of RES-H/C technologies. Heat metering standards are a prerequisite to build political and institutional support for the implementation of robust PBI programs. While heat metering in the commercial sector is common, heat metering policies and government regulations that support RES-H/C PBIs are just emerging

Many policymakers assume that heat metering is comparable to metering electricity; however, heat metering can be much more complicated. Unlike electricity metering, heat metering is not nearly as standard across technologies, and there are significant differences in metering requirements depending upon heat distribution system (e.g. hydronic, steam, or air).

The accurate measurement of a heat stream is dependent on the location of the heat metering sensing devices in the system to be metered. For example, heat meters used in hydronic applications are significantly affected by the configuration of the piping in the vicinity of the measurement sensors. Also, as with any mechanical device, heat metering equipment will require on-going maintenance and calibration. As a result, clarifying RES- H/C metering requirements for incentive policies can be time-consuming and controversial, as has proven to be the case in New Hampshire.

While a comprehensive assessment of heat metering is beyond the scope of this report, it is worth noting that several jurisdictions, notably Canada and Europe, have already established heat metering standards (CSA C900.1 and EN 1434, respectively). Canada developed their standard by adopting the CEN (European Committee for Standardization) EN 1434 Standard, and formulating “deviation” documents for each of the six sections of the standard to suit the Canadian market. The United States has decided to take the same approach in the development of a US heat metering standard, an effort that is well under way. These standards govern heat metering for hydronic systems (see Appendix A for a description of EN Standard 1434).

Every jurisdiction considering the use of metering requirements to manage PBIs will need to adopt or develop a heat metering standard that is suitable for their RES-H/C needs. With such a standard in place, policymakers can then establish heat metering guidelines and regulations that govern the implementation of PBI programs for relevant RES-H/C technologies. Key policy considerations are described below.

 Accuracy requirements and tradeoffs. Policymakers need to determine what level of accuracy is required or permitted for heat meters. Generally, the greater the meter accuracy, the more expensive the metering system. It is important to evaluate and appropriately manage the trade-offs between metering accuracy and the cost of the project. It is important to note that it can be exceedingly expensive for policymakers to ensure the same level of accuracy for heat metering as is common in the electricity sector.

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 Training for metering installation and thermal production calculation. The basic thermal equation for net energy output is well established.18 However, it is essential for installers to install meters in a consistent manner in order to provide meaningful readings when reporting output. Policymakers may wish to provide training for installers when introducing heat metering requirements. Key issues may include best practices on the placement of metering sensors, pressure drop considerations that affect accuracy, as well as how and how often output must be reported. Metering placement and design options can vary considerably across heating system configurations. Policymakers may consider developing best practices guidance for heat metering installations. Interested readers should review the UK’s heat metering placement guidance documents for possible approaches to metering a variety of renewable heating system installations (OFGEM, 2014).  Reporting requirements. Policymakers will need to establish clear guidelines related to meter reporting. This may include requiring system owners to manually self-report meter readings on a regular basis, installing meters capable of remote reading, or requiring third-party verification, among other options.  Ongoing maintenance and inspections. Policymakers should determine how often meters will need to be inspected and/or calibrated. There are commonly manufacturer specifications that provide guidance, which policymakers could adopt. In addition, utility or program administrators will need to designate a certified third-party to conduct meter readings and inspections to ensure the meter is operating appropriately.

4.3.3 COST EFFECTIVENESS

4.3.3.1 Cost and Benefits for RES-H/C PBI programs for RES-H/C can generate a wide range of costs and benefits. RES-H/C technologies may also generate a broad range of external benefits that markets may not monetize. For example, RES-H/C PBIs may actually cross-subsidize conventional fuel consumers if the incentives RES-H/C generators receive do not match the environmental, social, and infrastructural values that they create. In the UK, policymakers assessed externalities such as the carbon benefits and the air quality impacts associated with biomass heating, alongside the costs of the incentive itself. (see Text Box 8).

RES-H/C technologies may also create additional costs for the incumbent heating sector by requiring infrastructure upgrades (e.g. improving district energy system to accommodate a greater number of distributed thermal energy systems) or by eroding the revenue of existing players (e.g. reducing the sales of electric or gas utilities). The balance of these costs and benefits should be assessed when calibrating PBIs over time. This calibration will be particularly important over time as markets move from take-off and into consolidation.

18 In particular, the basic equation for “useful thermal energy output” is (renewable thermal energy generated) – (thermal energy storage losses) – (operating energy inputs in thermal equivalent).

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It is also important to note that cost-effectiveness can vary over time as cost and price dynamics change. As RES-H/C technologies become more competitive, they may generate direct savings (instead of costs) when compared to conventional fuels, as seen in some solar PV RES-E markets. In addition, commercial customers that lock into long-term fixed price contracts for renewable heat may initially create policy costs – but may eventually generate savings if the cost of conventional fuels rises above the RES-H/C LCOE. Accordingly, performance-based payment frameworks may therefore serve as hedge against conventional fuel prices in the near-term and may generate net savings over the mid- to long-term, depending on how the incentives are structured.

Text Box 8. Cost Effectiveness of the U.K. Non-domestic Renewable Heat Incentive (Department of Energy and Climate Change, 2011)

Overview. The Non-domestic Renewable Heat Incentive is a tariff paid to commercial, public and industrial consumers for every unit of renewable heat generated on a pence per kWh basis. Policymakers utilized a cost-effectiveness approach to evaluate the program, taking into consideration the different technologies and their rates of adoption, costs to consumers, environmental impacts, and other factors.

Key objectives and success criteria for the RHI include:

 Actual deployment of renewable heat installations,  Actual percentage of heat demand met by renewable heat (against trajectory), and  Cost of the scheme in relation to deployment levels

Stakeholders. Stakeholders and key parameters considered in the cost-effectiveness assessment include:

Costs and Benefits Evaluated. The UK used a formula to calculate the net present value (NPV) of the RHI.19 The time period considered is the policy lifetime of 30 years discounted to 2010 prices, using a private discount rate of 12% and a social discount rate of 3.5%. A positive NPV means there is a net benefit to society. A negative NPV indicates there is a net cost to society.

Major costs and benefit categories included:

 Subsidy Cost: Estimated costs are NPV £22 billion. The total paid subsidy to each installation is based on the following calculation: (kWhth of heat generated) x (the relevant tariff for the specific technology)  Resource Cost: Gross costs are estimated at NPV £11.5 billion. It is defined as the cost to society as firms adopt renewable heating technology, which is more expensive than conventional heating systems. The resource cost represents the cost difference between renewable heating and fossil fuel powered heating. It includes the net capital and on-going costs.

19 The basic equation is: (Subsidy cost + resource cost) + (carbon benefits inside the European Trading System (ETS) + carbon benefits outside ETS) + air quality costs + metering costs + admin burdens = Total NPV

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 Carbon benefits: Provides an estimate of the net social cost per ton of GHG reduction resulting from the RHI.  Air quality costs: Costs associated with the use of biomass are estimated at £1.8 billion. The negative impacts of the RHI on air quality will be addressed as biomass replaces gas or electric heating, as the switch to biomass from these fuels is expected to result in increased levels of particulate matter (PM10) and nitrogen oxide (NOx) emissions. Alternately, if biomass replaces heating oil or coal, then the impacts are generally positive.  Metering costs: For an organization to receive the tariff, they must install a Class 2 heat meter to determine the amount of heat generated by the renewable heat installation. The estimated costs for such installations are £250-£500milion.  Administrative burdens: Estimated costs are £250 million. The United Kingdom uses the Standard Cost Model (SCM) to assess the administrative burdens faced by firms in order to comply with the initiative. The Dept. of Energy and Climate Change applies similar burdens from other existing policies to estimate the unit burden of the RHI.

Results. The calculation of best estimate of final net benefit for the RHI in 2011 was negative £4.2 billion. This calculation does not take into account additional non-monetized benefits such as greater fuel supply diversity, increased economic competitiveness in green technology, and innovation. Reduced technology costs due to economies of scale and wider deployment are expected to reduce subsidy and resource costs, and increase both the carbon benefits and non-monetized diversity of supply benefits at an accelerating rate as installation drives the market up the deployment curve (UK DECC, 2011).

4.3.3.2 Distribution of Costs and Benefits As with RES-E policies, the two most common sources for policy cost recovery are ratepayers or taxpayers. In addition, as described in Text Box 8, policy costs may also be distributed across firms and society. Historically, the majority of RES-E incentives have been recovered from ratepayers through the imposition of surcharges on each kWh of electricity sold. Some markets (e.g. the Netherlands) have used budget appropriations (i.e. from tax revenues) to fund RES-E policies. However, taxpayer-funded revenue streams are generally characterized as being more vulnerable to political change and therefore less bankable.

It is worth noting that the term “ratepayer” may not be neatly applicable for heating and cooling since there is not always a heating or cooling utility. Although electric and gas utilities could be required to include an additional surcharge for each unit of heat they sell, it can be more challenging to assess comparable surcharges on less centralized heating distribution infrastructure, such as independent heating oil or propane distributors. Different jurisdictions have taken different approaches to policy cost recovery within the heating sector, and there are not yet common practices for recovering costs – particularly when the heating market is served by multiple fuels and by both centralized utilities and by smaller, more “independent” operators.

As noted in the Text Box above, commercial businesses will also be impacted by PBI policies as they may need to address administrative and compliance costs, as well as managing the burden of financing the initial upfront costs of installation. .

Policymakers should also take into account the broad social costs and benefits that accompanies the development of commercial RES-H/C systems. Biomass heating, for example, can add significant social costs in the form of particulate air emissions and overall air quality. This can be mitigated, in part, by requiring use of high efficiency, low emission biomass heating appliances.

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RES-H/C systems can also offer significant benefits in the form of carbon emission reductions. However, the level of benefit additionally depends upon the efficiency requirements for RES-H/C appliances, and for biomass heating systems in particular, the sustainability of feedstock used.

4.3.4 SUMMARY FOR POLICYMAKERS

Table 6. Summary Considerations for Performance-based Incentives

 Policymakers should consider the potential for developing PBIs to support RES- H/C market development. By incentivizing commercial building owners for the RES-H/C energy they produce, policy-makers can maximize the quality of the installation, maximize ratepayer value, and support mature market development within the commercial sector.  Small commercial (or residential) systems may benefit from “up-front PBI” Assess suitability structures – which estimate future production – in order to reduce the of performance disproportionately high costs associated with monitoring production and simplify based incentive administration. Large commercial systems, however, where ongoing metering is for local common are generally well suited to absorb the administrative costs related to jurisdiction monitoring system performance for a PBI system.  PBIs can and have been deployed across the market development spectrum – from the inception through the consolidation phase of market development. The UK for example, developed the RHI in order to jumpstart its market in the inception market phase. In some early stage markets though, policymakers may opt to develop capacity or rebate-based incentive programs, especially for small commercial systems, in order to gather market data and assess the needed price support.

 Payment levels for PBIs can be set using a variety of mechanisms including administratively set, competitively bid, and tradable credit market approaches.  There has been robust debate in policy circles regarding the pros and cons of varying approaches to setting payment levels. While the best approach for any jurisdiction will likely depend on the unique political and economic conditions and objectives in which local policymakers operate, it is important to note that policymakers can utilize these approaches in parallel to achieve targeted Determine objectives and can also combine elements of each of these policies into duration and innovative new hybrids. amount of  Similarly, establishing the payment duration can also be complex. For “above payments market” incentives designed to provide generators with a specific return, shorter-term performance payments (e.g. 3-5 years) can provide a perverse incentive that encourages generators to abandon projects before the end of system life. Longer-term performance-based incentives, on the other hand, may require higher ratepayer impacts over time to produce the same return, though they can also push the final cost of RES-H/C down because they allow capital costs to be levelized over a longer period of time. Policymakers should consider the pros and cons of each approach and assess the suitability for their specific jurisdiction.  Because most commercial buildings generate and consume heat on-site, the Clarify transfer transfer of energy – as is common in the RES-E sector – is often not a requirement of commodities for RES-H/C PBI systems. The exception is if the RES-H/C PBI is part of a district heating network where distributed generators can feed heat into the district heating grid.

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 Aside from energy, other commodities can easily be transferred as part of a RES- H/C PBI. These include tradable compliance credits or additional environment (e.g. carbon credits) or market-based commodities.  When designing PBIs for RES-H/C, it is essential to clarify the ownership rights associated with PBI payments as well as the means for tracking them. This can help policymakers ensure that the incentive provides generators with an appropriate return on investment.  Policymakers should establish clear guidelines defining what heat is useful and eligibility requirements for participation in the PBI system. Useful heat guidelines may, for example, stipulate that the heat load serves an actual purpose, supply economically justifiable heating needs, or be measurable and verifiable. In addition, useful heat guidelines may also require that minimum building energy efficiency standards in order to increase the likelihood that renewable heating systems are properly sized and reduce the likelihood that primary energy is wasted. Establish “useful  Policymakers should ensure that a heat metering standard is in place within their heat” and jurisdiction. For example, EN1434 governs heat meters in Europe and CSA C900.1 metering provides guidance for Canadian policymakers. A similar standard is currently requirements being developed within the US. With such a standard in place, policymakers can then establish heat metering guidelines and regulations that govern the implementation of PBI programs for relevant RES-H/C technologies.  In accordance with the relevant heat metering standard, policymakers should establish for small and large commercial systems the accuracy requirements for metering; ongoing maintenance and inspectional requirements; metering measurement and design procedures for various heating system configurations; as well as the thermal output calculation for heating installations.

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4.4 SOFT COST REDUCTIONS FOR RES-H/C 4.4.1 BACKGROUND There are two types of costs associated with the purchase and installation of RES-H/C technologies: hardware costs and soft costs. Hardware costs consist of the actual pieces of mechanical equipment used in the system. Soft costs, also referred to as “business process” costs (Friedman et al., 2013), make up the remaining portion of the system cost. Table 7 below describes typical soft costs associated with RES-H/C systems.

Table 7. Types of soft cost associated with RES-H/C

Soft Cost Category Description

The costs associated with customer marketing, advertising, lead development, and other closing costs related to RES-H/C customer acquisition. Lead development and customer Customer acquisition decision time is particularly long when the customer has to become educated on the technology, find an installer, understand the investment, and navigate the permitting, incentive and other administrative procedures.

Installation labor This includes all labor costs to install the RES-H/C system.

These include local permitting and inspection fees associated with building and zoning Permitting, inspection and codes as well as interconnection costs (if applicable) to connect with utility interconnection infrastructure.

Transaction costs and indirect This includes legal, accounting and other financial costs, as well as overhead and corporate costs administrative costs of the developer.

This encompasses the installer / developer mark up or profit margin that is passed on to Installer /developer profit the customer.

Supply chain costs include the cost of inventory, inventory replenishment and lead Supply chain costs times, product availability costs, supply chain-related transportation costs, distributor costs and mark up, and any shipping or receiving costs.

RES-H/C systems may be subject to a variety of federal, state or local taxes, including Taxes sales, VAT, property, or other taxes.

As can be seen above, a number of soft costs categories encompass market and process related costs that may be imposed by subnational governments who control permitting, zoning, code enforcement, and licensing processes for RES-H/C installations. These soft costs present an immediate opportunity for policy-makers to implement cost reduction policies, which do not rely on action at the federal or EU level or on technology cost breakthrough scenarios.

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It is worth noting that soft costs have not been well tracked for commercial RES-H/C systems – or the RES-H/C sector broadly. It is thus challenging at this time to articulate the potential impact of soft cost reduction policies on the RES-H/C market. However, by way of comparison, soft costs for solar photovoltaic (PV) installations comprise approximately 57% of the small (<250 kW) commercial price and 52% of the large (>250 kW) commercial system price in the US (Friedman et al., 2013). As a result, even if the equipment was free, a solar PV system would cost thousands of dollars, meaning that there is significant cost-savings to be achieved by reducing costs associated with customer acquisition, permitting and inspection, taxes, transaction and corporate needs, and the supply chain. It is expected that there are similar gains to be made across the RES- H/C sector, which relies on similar labor and corporate services, and is subject to similar tax and permitting regimes.

Preliminary analyses and interviews with RES-H/C industry experts support this hypothesis. The following section explores opportunities to reduce soft costs for RES-H/C systems. It draws on lessons learned for solar PV soft cost reduction programs and assessments that have taken place in the US and across Europe20 – and considers how or if these lessons can be applied to the RES-H/C sector for commercial buildings.

4.4.2 BENEFITS OF SOFT COST REDUCTION POLICIES FOR RES-H/C Soft cost reduction policies can provide a number of benefits. These include:

 Significant reduction of installation costs for RES-H/C. Soft cost reduction programs can lead to significant reductions in the installed costs of systems. As noted above, for solar PV, soft costs typically account for over half of the installation cost in the commercial sector. Initial analysis and interviews with installers suggest that soft costs represent fifty percent or more of the total installed cost of commercial scale solar water heating systems, even in active markets such as Germany (Bundesverband Solarwirtschaft, 2012; Veilleux & Rickerson, 2013). By analyzing RES-H/C soft costs and developing targeted programs to reduce their impact, policy-makers will likely be able to achieve significant cost reductions.  Streamlined installation processes. As noted previously, commercial RES-H/C installations can be complex. In many jurisdictions, it is likely that officials have put in place equally complex permitting and inspection requirements, which increase the time and cost of installation. By streamlining permitting and inspection processes, policy-makers can help to expedite installation, reducing time and expense for installers, developers, and end-users. For example, research in the US indicates that solar PV can be 10% to 15% lower in cost in jurisdictions with more favorable regulatory procedures (Burkhardt et al., 2014). These impacts were highest for small-scale systems, suggesting that streamlined regulatory processes will have the greatest impact on small commercial (or residential) systems, though commercial SHW installers report that it is an important issue for all system sizes.

20 In the U.S. the Department of Energy SunShot Initiative is the national solar PV soft cost reduction program. More on the SunShot Initiative can be found at: http://energy.gov/eere/sunshot/soft-costs In Europe, PV Legal, funded by the European Commission’s Intelligent Energy for Europe Programme ran from July 2009 until February 2012. Its aim was to “contribute reducing bureaucratic barriers holding back the development of Photovoltaic (PV) energy installations throughout Europe.” See: http://www.pvlegal.eu/en/home.html

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Streamlined permitting can be accomplished in part by educating permitting and inspection staff on the specifics of RES-H/C technologies and helping them design appropriate permitting processes. Awareness can also help reduce the number of inspections and delays due to concern over unfamiliar permit requests.  Increase market awareness. Customers are commonly unaware that RES-H/C technologies are a viable option for their building. By developing programs to increase customer awareness – and thereby reducing customer acquisition costs – policymakers can support market growth for RES-H/C. Contract closure rates suffer when the customer has to be educated on the merits of the technology and when administrative processes are complex and protracted.  Increase transparency. There tends to be a lack of transparency in many RES-H/C markets, especially those in earlier stages of development. Related to the market awareness benefits described above, there is a need in many RES-H/C markets to increase transparency around pricing, performance, and permitting from RES-H/C. A key step in this process is the development of standardized metering and performance reporting data for RES-H/C systems. In doing so, policy-makers can help to drive down costs and increase growth or RES-H/C.

4.4.3 POLICY OPTIONS FOR SOFT COST REDUCTION INITIATIVES Policy-makers have the opportunity to implement policies that standardize, streamline, and improve the transparency of the RES-H/C installation process. Many of these processes are ignored by energy policymakers, who tend to focus on subsidizing installations or reducing installed costs via technology improvements. While there is clearly a need to develop policies to subsidize equipment and reduce technology costs, there is also a need to address onerous permitting and zoning processes or provide assistance to improve customer awareness and streamline customer acquisition processes.

4.4.3.1 Customer Acquisition Customer acquisition costs include advertising, marketing, lead time and closing costs, as well as the costs of “dead-end” deals. These costs are especially high when the installer has to work to “convince” the customer of the merits of the technology in small or emerging markets. Customer acquisition costs are particularly high when it is challenging for customers to evaluate the value of the investment and/or navigate policy and incentive options.

Again using solar PV as a benchmark, approximately 5% of leads convert to actual contracts, and installers report that lead times can be up to a year from the time a potential customer calls to the time the system is finally operational (Laurent, 2014). Customer acquisition costs often make up 10% of the cost of a solar PV system.

Within the RES-H/C sector, anecdotal reports from SHW and biomass heating installers suggest that the industry faces similar challenges. For example, within the commercial building sector, German and US solar thermal industry leaders report that customer acquisition costs make up an even higher share of total installation costs, estimated at 50% of more of the cost of installation.

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There are a number of opportunities for policymakers to work to reduce these customer acquisition costs:

 Creation of automated site analysis tools. Online tools that can determine the type, size, and cost of RES-H/C technologies can help explain the benefits to customers and also streamline the process for installers. By making such tools readily available, installers can focus more of their time and efforts on customers who have the most suitable sites for the various RES-H/C technologies. Online tools have been developed for solar PV and solar thermal (e.g. Solar Kataster, City of Osnabrück, and the New York City solar resource maps).21 Within the RES-H/C sector, some manufacturers and distributors have sought to develop comparable tools for biomass heating and heat pumps, though they tend not to be as sophisticated and comprehensive as the solar site analysis tools, nor do they carry the neutral imprimatur of a government.  Group discount programs. The group discount model22 uses community-based marketing and outreach in order to drive local demand. A similar approach could be deployed for RES-H/C technologies in the small commercial (or residential) market. The group model generally involves a tiered pricing incentive that lowers the cost per installation as more customers sign-up over a set amount of time. Group discount programs (e.g. solarize programs) have proven to reduce the installed cost of solar PV by as much as 20-40% during the course of the program. Preliminary research suggests that reductions of 20% or greater could be achieved for RES-H/C installations (Navigant & MCG, 2014). These types of group discount programs are likely to have the greatest benefit for small commercial customers, because customer acquisition costs for small commercial systems tend to be highest (Friedman et al., 2013).

4.4.3.2 Permitting, Interconnection & Inspection Permitting, interconnection and inspection processes can add thousands of dollars to the cost of an installation. These costs are particularly burdensome on small commercial systems, where the cost of permitting can make up a disproportionate amount of the total installation cost. Simply making these processes transparent and available online can help reduce confusion both from the perspective of the installer and for the authority that is required to review permit applications.

In markets with low penetration of RES-H/C technologies, it is likely that permitting and inspection staff have seen few if any installations before. Unfamiliarity with RES-H/C technologies can lead to overly cumbersome processes with multiple inspections and redundant paper work. For example, some installers report that solar thermal installations have required up to five inspections when only one or two is generally needed. Similarly it can be challenging and time consuming to obtain ground source heat pump permitting approval and related drilling permits if staff are unfamiliar with the requirements of GSHP installation requirements. As a result, simplifying or streamlining permitting best practices can reduce permitting costs for both the permitting authority as well as the installer or developer.

21 For more, see National Renewable Energy Laboratory tools such as PVWatts and the System Advisor Model (SAM): www.nrel.gov/analysis/models_tools.html 22 The group discount (i.e. solarize) model has been effectively deployed by a number of jurisdictions in the United States. The first campaign started as a grassroots effort in Portland, Oregon. For more information, see: NREL. (2012). The Solarize guidebook: a community guide to collective purchasing of residential PV systems. U.S. DOE Sunshot Initiative. National Renewable Energy Laboratory. DOE/GO- 102012-3578.

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Although commercial systems are variable in their design, expedited permitting processes can be applied to the commercial sector. For example, model design guidelines, engineering specification templates, approval of basic system components, and engineering loading requirements could be standardized or streamlined for commercial systems. Some developers have created model engineering specifications sheets for solar water heating in order to help educate inspection staff. Such model guidelines could be utilized to develop an expedited process for systems that meet key design specifications.

4.4.3.3 Installation & Performance Making buildings “RES-H/C ready” provides an opportunity to reduce labor costs, a significant category of soft costs for new construction, renovations, or buildings undergoing a change of ownership. On the solar PV side, a “solar ready” building can help reduce labor costs by up to 60% as compared to an installation on an existing building that is not “solar ready.” Policymakers should conduct analyses to assess the potential for RES-H/C readiness, among other policies, to reduce labor costs associated with RES-H/C installation.

Governments can provide guidance for RES-H/C readiness, and can also even require new and existing buildings to be RES-H/C ready as a type of mandate (Section 4.2). RES-H/C readiness can include design features such as:

 Allowing space for related equipment in basements or utility rooms,  Providing the proper amperage service,  Providing enough space in circuit breaker boxes,  Providing enough roof space and orientation suitable for the equipment,  Pre-installing conduit or connection runs between the equipment and the interconnection or storage locations, and  Orienting the building to make is most suitable for the technology (e.g. shading cooling equipment, providing sunlight for SHW panels), etc.

4.4.3.4 Tracking Performance of Systems Tracking performance and creating performance databases for RES-H/C technologies can help reduce soft costs in a number of ways. These databases can help make customers comfortable with the performance and lifespan of the technologies. In addition, this data can help unlock innovative financing tools that rely on securitization or standardization by making the risks and performance metrics available to financiers. For example, in the US the National Renewable Energy Laboratory has partnered with SunSpec to build the O- SPaRC database to draw on performance data in solar PV systems across the US, providing investors the necessary information to conduct their analyses of solar as an asset class (NREL, 2013). A similar database for RES-H/C technologies would allow asset class analysis to be conducted in order to help foster innovative financing options such as those described in Section 4.5.

4.4.4 COST EFFECTIVENESS

4.4.4.1 Costs & Benefits for RES-H/C Soft cost initiatives have the potential to dramatically decrease the cost of RES-H/C technologies. Soft cost initiatives can reduce the costs of permitting, inspection, and interconnection as well as customer acquisition, and labor costs.

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The impact of soft cost reduction policies can be especially hard to measure, making a cost effectiveness assessment particularly difficult. In many cases, for example, soft cost reduction programs are designed to “prepare” the market for scale-up and actual benefits may be several years in the future (e.g. streamlined permitting processes). In other cases, the direct impact of the policy can be difficult to ascertain (e.g. performance tracking programs).

4.4.4.2 Distribution of Costs & Benefits Soft cost reduction programs have historically been paid for by taxpayers through government programs. In some instances, electricity ratepayers may bear the costs. For example, soft cost reduction programs in New York State and Massachusetts are funded via the renewable energy or energy efficiency surcharge on utility bills. In still other cases, some programs (e.g. customer acquisition programs) can be funded through non- profits or via a fee paid by installers. Governments may also bear some of the cost if the permitting reform involves a reduction in the permitting fees that governments are allowed to charge.

The benefits of these programs flow to various stakeholders:

 Installers in the form of reduced customer acquisition, permitting, inspection and interconnection costs along with more sales volume  Customers in the form of costs savings passed along by installers  Governments in the form of reduced time spent on permits and other bureaucratic processes

4.4.5 SUMMARY FOR POLICYMAKERS

Table 8. Soft Cost Reductions: Summary Considerations for Policymakers

 Policymakers should analyze the potential for soft cost reductions across RES- H/C technologies and sectors. Preliminary analyses suggest that there is significant potential for installed cost reductions by addressing soft costs. It is likely that a detailed analysis would reveal opportunities for soft cost reductions across the range of RES-H/C technologies for commercial buildings.  It may be appropriate to conduct soft cost analyses at any of the market Conduct development stages – and especially in the inception and take-off phases. detailed RES-H/C  In the inception stage, a soft cost study could be integrated into a broader soft cost analysis installed cost study, helping policymakers identify the right level of incentive support and assess potential for cost reduction initiatives in the future.  For markets in the takeoff phase, policymakers may monitor hard and soft costs and adjust incentives downward as prices decline. Similarly, results of the cost study may encourage policymakers to focus on new market development support programs to address specific soft costs (e.g. permitting, customer acquisition, etc.)

 Policymakers can play a key role in helping reduce customer acquisition costs. Customer acquisition costs are likely to be significant throughout both the Address inception and take off phases of the market. Education and outreach is customer typically most needed during the inception phase of the market, whereas bulk acquisition costs purchasing programs will help move the market from inception to take off.

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 Especially for small commercial systems, policymakers can encourage bulk purchasing policies such as solarize-style campaigns to increase the number of installations and drive down customer acquisition costs.  Policymakers can also create online site analysis and financing informational tools for small and large commercial systems.  Implementation costs associated with these types of soft cost reductions programs can either be born by taxpayers or by the private sector.

 Relative to residential systems, permitting costs are not as high for commercial systems. Nevertheless, policymakers can reduce the cost and (especially) the hassle of installing RES-H/C systems in the commercial sector by streamlining the permitting process for RES-H/C.  For markets in the inception phases, decreasing permitting costs can help make a jurisdiction “RES-H/C ready” and can avoid bottlenecks that would develop as the market enters the takeoff phase. Permitting cost reduction Streamline RES- programs can also be implemented during market takeoff and should be H/C Permitting established by the consolidation phase.  Taxpayers or ratepayers would likely bear the cost of streamlining permitting processes, because government staff time is needed to make the necessary revisions and policy changes. However, it is also expected that governments will see their operational costs decline when permitting processes are improved, because fewer inspections are needed and less time is spent reviewing applications due to application errors or rejections.

 Performance tracking helps standardize performance metrics unlocking additional financing tools and making the financing of RES-H/C systems easier for customers to understand. Combining performance tracking with incentive payments can also help track policymaker goals.  It will be especially important to make the case for performance and effectiveness of RES-H/C technologies in the inception phase of the market, so that banks and investors are comfortable with the technology as the market starts to scale up. Track  Performance tracking will continue to be important in the take-off and performance of consolidation phases to reduce the costs of capital. As more systems that are RES-H/C systems installed, investors will need clear performance metrics in order to bundle projects into pools for financing and bring low cost capital to support investment.  In the inception and early take-off stages, public tracking and standardization costs are typically born by government agencies (taxpayers). As the market matures, benefits will flow to the private sector and ratepayers when additional financing tools are developed and the installed cost of RES-H/C technologies decrease. It is reasonable to expect that the private sector will ultimately take over the performance tracking function in order to better manage investment portfolios.

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4.5 INNOVATIVE FINANCING AND BUSINESS MODELS FOR RES-H/C 4.5.1 BACKGROUND Innovative financing and business models are strategies that address financial or behavioral barriers to RES- H/C deployment by creating value or reducing financial risk. A number of recent assessments have described various financing or business models that could be deployed to grow RES-H/C markets by increasing access to new sources of private capital (Cliburn, 2012; Kim et al., 2012; IEA-RETD RE-BIZZ, 2012) In particular, turnkey RES-H/C financing and development services – including third-party ownership models – are gaining traction in Europe and the United States. As illustrated in Figure 7 below, turnkey RES-H/C developers provide a range of solutions for customers, including building energy assessment, design and planning, financing, construction and installation, and operations and monitoring (IEA-RETD RE-BIZZ, 2012).

Building Design & Evaluation & Financing Construction Audit Planning Monitoring Initial buiding Financing options & Installation Ongoing evaluation The RES-H/C system assessment is are evaluated and and monitoring is is sized and completed, structured, including Construction and performed as well designed to match including direct and third- installation are as regular the building host's preliminary analysis party ownership contracted out to maintenance to specific needs and for energy efficiency options reputable firms ensure the system budget and RES-H/C operates properly

Figure 7. Turnkey developers can provide building owners with a range of RES-H/C services

In the strictest sense of the term, turnkey developers provide all of these services, offering building owners a complete heating service ready for immediate use. Depending upon their specific needs, however, building owners can also contract out these services separately. This decision to do so generally depends upon the building owners’ comfort with managing the performance risk of the RES-H/C system, as well as the available financing options. As described in Section 3.1, it is clear that many commercial building customers require assistance assessing and managing the risk associated with the development and operation of RES-H/C systems. Turnkey providers can reduce the hassle associated with the implementation of unfamiliar technologies, simplifying the design, development, operation, and maintenance of RES-H/C systems by providing renewable “heat as a service” for end-users.

Turnkey RES-H/C developers can also arrange third-party ownership models under which a separate entity (sometimes the developer themselves) owns the system and assumes (in most cases) the operational risk.23

23 It is also worth noting that some energy service companies (ESCO) have developed models wherein building owners finance and own the system, though they transfer all operational risk via a performance guarantee.

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Generally speaking, this model enables hosts to integrate RES-H/C into their building for little or no money down, further reducing the risk and complexity related to system operation and maintenance. Assuming the right supporting policies are in place, third-party ownership models can provide customers with immediate cost-savings (e.g. cash flow positive in Year 1) (Cliburn, 2012).

Fostering a market for third-party ownership generally requires supportive policies. In markets where these models for RES-H/C have been successfully implemented, enabling policies have provided incentive that create additional project revenue as well as programs that offset development costs. For example, within the US, California, Hawaii, Maryland, North Carolina, and Washington DC are all jurisdictions that provide a host of incentives to drive down costs and spur third-party ownership for residential and commercial solar water heating (U.S. EPA, 2012). As a result, companies like Nextility offer a guaranteed solar thermal savings contract to commercial customers, an offering that is structured as a variable price power purchase agreement (PPA), which provides savings below the cost of customers’ conventional water heating fuel (e.g. natural gas, oil, or propane). Similarly, in Upper Austria, the state energy agency has provided grants covering 13.5% of investment costs for a biomass heating contracting program, which helped support implementation of 140 single building (including commercial) and district heating biomass projects (see Text Box 9).

The following section describes key features of third-party ownership as well as supporting policies that can create the conditions for third-party ownership and increased private sector investment in RES-H/C.

Text Box 9. Wood Energy Contracting: The Upper Austrian Experience

The state of Upper Austria is one of the largest markets globally for biomass heating and aims to serve100% of space heating load with renewable heat by 2030. Supported by a range of policies, from direct incentives, to fuel quality standards and educational programs, this market has grown substantially over the past several decades. In 2009, it was estimated that more than 15% of total energy in the region came from biomass and that there are over 40,000 biomass heating installations in the state. The biomass heating market includes an estimated 310 biomass fired district heating plants as well as an emerging third-party ownership model. Many of these systems are owned by local farming cooperatives, creating a local market for their own wood products.

The region has supported the development of third-party owned biomass systems (both district scale and single-building scale) through its Energy Contracting Program. Recognizing that third-parties may be better equipped to own and operate biomass thermal systems, Upper Austria offers a 13.5 percent investment cost subsidy (on top of other existing incentive programs) for biomass systems installed through a third-party contracting model (Egger et al., 2010). These incentive programs, along with stringent requirements for wood chip fuel quality and installation parameters, have enabled Upper Austria to enable development of third-party owned systems. In total, the program has supported over 100 third-party owned biomass projects in Upper Austria.

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4.5.2 RISK AND ECONOMIC CONSIDERATIONS FOR THIRD-PARTY OWNERSHIP Depending upon their risk appetite, project economics and local market conditions, commercial building owners may wish to explore third-party ownership models for RES-H/C technologies. While third-party ownership models create benefits for site hosts, e.g. generating energy savings without the risks of project ownership, they also have drawbacks. The addition of a third-party owner into a transaction may be less financially advantageous for a commercial building owner when compared to direct system ownership. Third- party owners will need to recoup their investment costs by reducing the total savings accrued to the site host. In other words, building owners opting to host a third-party owned system will almost certainly pay more for energy than if they owned the system outright.24

The suitability of third-party ownership for building owners generally depends on two issues: building owners’ appetite for performance risk and their financing options:

 Performance risk. Building owners should evaluate how much operational risk they are willing to absorb when installing a RES-H/C system. If the building owner opts to own the system, they will are responsible for ensuring that the system operates as predicted. For commercial customers with experienced building and maintenance staff, ownership may be a viable option. A lack of knowledge, time, or experience, however, may inhibit building owners from installing RES-H/C systems. In these cases, third-party ownership models, or other arrangements that shift performance risk away from the building owner, can address building these concerns.  Financing options. Customers with strong balance sheets or access to low cost financing may choose to finance the installation themselves. Many commercial customers – especially small and medium enterprises – may have difficulty securing debt with attractive terms. Even when commercial customers can access low-cost capital, they may not want to take on additional debt to install RES-H/C, especially if it will affect their ability to finance projects more closely aligned with their core business. In such cases, third-party ownership may be a good solution. RES-H/C developers can access financing in order to develop third-party owned systems. In some regions, third-party ownership models can be treated as off-balance sheet, which has important accounting benefits and can potentially affect building owners’ cost of borrowing as well as their ability to take on debt.25

Table 9 below provides a description of these considerations regarding direct and third-party ownership models.

Table 9. Key features of direct ownership and third-party ownership models

Direct Ownership Model Third-party Ownership Model

24 This, however, would not be the case if site hosts are unable to effectively monetize all of the available benefits of system ownership. For instance, third-party ownership for solar PV has been a popular option for non-profits in the United States as they are unable to take advantage of federal tax incentives. Under this scenario, the third-party system owners can benefit from those incentives and pass along a portion of that value to the site host through reduced power purchase rates. 25 This has historically been the case in the US, for example, though the accounting treatment is changing as the US attempts to harmonize its own accounting standards with those of the International Accounting Standards Board.

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 The building owner owns and finances the  A third-party financier owns the system. The Ownership system. In most cases, the building owner will third-party owner may or may not also be as Structure contract a developer to design, engineer, and the developer. install the system.  The building owner is exposed to the majority of the system performance risk.  However, there are a number of options that can  The third-party owner absorbs performance help building owners mitigate risk – including risk of the system as the owner of the system. manufacturers’ warranties and performance  Like a building owner, the third-party owner warranties from the installer. The latter is likely System will seek to mitigate risk by ensuring that the to be an option if the installer manages the Performance product has appropriate manufacturer operation and maintenance for the system. Risk warranties.  Alternately, building owners could enter into a  In addition, the third-party owner will charge performance guarantee with an ESCO, in which the building owner a mark-up for energy case the ESCO contractually absorbs all risk produced to offset the performance risk. associated with the performance of the system, while also permitting the building owner to own and finance the system.  Commercial customers may not want to take on additional debt to install RES-H/C, especially if it will affect their ability to  Customers with strong balance sheets or access finance project more closely aligned with to low cost debt are usually in the best position their core business. Financing to finance the installation themselves.  Assuming the right market conditions are in place, RES-H/C developers can access financing in order to invest in third-party owned systems. This can drive large infusions of capital.

4.5.3 BENEFITS OF INNOVATIVE FINANCING FOR RES-H/C Turnkey financing models can create benefits for all parties involved in a transaction, while overcoming a range of market barriers:

 Simplify decision-making and reduce risk for system hosts. The third-party agreement typically relieves the host of the responsibility for structuring and managing project development, system construction, operations and maintenance (O&M), and de-commissioning of the system (U.S. EPA, 2012). This can directly address barriers associated with the complexity of the decision-making process for building owners. By establishing one central entity – the system developer – to manage the numerous participants involved in design, development, and installation of the RES-H/C system, third- party owned systems can eliminate development complexity for building owners.  Facilitating financing. By addressing performance risk and helping system hosts think through ownership options, full service developers help facilitate access to finance. In some cases, the system host may have the most advantageous financing options. In other cases, third-party owners can bring large amounts of upstream financing to the market.

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 Drive professional marketing. Developers offering third-party ownership models are highly motivated to market and install RES-H/C systems. In many cases, they will have obtained upstream financing and will need to install a certain number of systems within a specified period of time in order to provide their investors with their required rate of return. As a result, they may develop and implement professional marketing campaigns to reach new customers and drive development of RES-H/C markets.  Capture value of tax Incentives. In markets where tax incentives are used to encourage RES-H/C development, third-party ownership provides opportunities for commercial and institutional end-users to capture the value of incentives. This is especially valuable for entities that do not have a significant tax liability themselves.

4.5.4 POLICY OPTIONS TO SUPPORT THIRD-PARTY FINANCING There are a number of enabling policies that allow third-party ownership models to develop. These will likely be especially important as markets move out of inception phase and into late-stage or consolidation phases. Policy-makers may consider the following issues to encourage development of third-party models and other financing and business model innovations:

 Incentives. In order for third-party financing models to be effective, project returns must be attractive enough to motivate both the project owner (the third-party financier) and the building site owner to pursue the project. Depending on the cost of the technology relative to traditional energy sources, this may require significant and sustained incentives. Alternately, policymakers could impose fossil fuel, carbon, or other taxes that would improve RES-H/C project economics relative to counterfactual fuels. This has been the approach taken by policymakers in Denmark. Regardless of whether policymakers implement incentives, taxes, or some other pricing mechanism, it is important that a sustained and credible commitment to providing market support incentives is deployed in order to induce new entrants into the renewable thermal third-party financing market. This is especially important given the cost and complexity associated with building a third-party renewable thermal company.26  Standardized technical requirements and contracts. Negotiating individual contracts for projects can be a time consuming and expensive process for third-party project developers. Customized contracts can delay project implementation and can create barriers to investment by capital providers. Policymakers may be able to support the development of third-party financing for renewable thermal technologies by working with industry stakeholders (e.g. manufacturers, project developers and capital providers) to develop model contracting language for third-party owned renewable thermal systems. In the United States, the National Renewable Energy Laboratory (NREL) has launched a similar initiative related to solar PV market development in order to reduce transaction costs related to solar contracting. The U.S. Environmental Protection Agency has similarly taken preliminary steps to help standardize contracting for commercial scale solar thermal projects in the commercial sector (U.S. EPA, 2012).

26 These can include costs such as marketing, standard contract development and legal fees, developing relationships with EPC contractors, developing relationships with capital providers, etc.

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 Outreach to lenders and contractors. Capital providers may be unfamiliar with renewable thermal technologies, their costs and benefits, and available incentives. Capital providers may mis-price the risk associated with new or unfamiliar technologies, adding to system financing costs and reducing the overall pool of potentially profitable projects. Policymakers can support the development of third- party financing models for specific renewable thermal technologies by improving investor knowledge of and confidence in these technologies. This could include the development of informational materials targeted at the investment community, the creation of project performance data sets, and direct engagement with financiers.

Text Box 10. Opportunities for Securitization of RES-H/C Assets

The Opportunity for Securitization in RES-H/C. Securitization refers to the process of pooling loans or other receivables in a trust, which issues debt against the pool of assets. It provides developers access to new sources of low cost capital, and has been used successfully in the past within housing, auto and student loans, and credit card receivables. At the end of the third quarter 2012 there was $1.7 trillion dollars outstanding in the asset-backed securities (SIFMA 2012).

Within clean energy, securitization has been used in several countries to scale clean energy markets. For instance, third-party ownership providers such as Solar City and SunRun have used securitization to support widespread deployment of solar PV in the United States. In takeoff and consolidation phase markets, there may be an opportunity to also securitize loan products to support large-scale RES-H/C deployment.

Debt issued in support of renewable heating and cooling project could be securitized into bonds for issuance into secondary capital markets. By bundling projects and creating a large pool of assets, capital providers such as pension and insurance funds may take an interest in investing in renewable heating and cooling projects. These types of capital providers can typically provide lower cost and longer-term debt than banks are able to provide. Lowering financing costs and lengthening repayment periods will improve renewable heating and cooling project cash flows, increasing the number of potentially viable projects.

Requirements for Securitization. Securitization requires appropriate underwriting standards and transparent project performance information in order to ensure that investors can understand the risks and benefits associated with any asset-backed security. This is an area where policymakers could support market development.

Asset securitization requires each project within a pool to have uniform financing agreements, because large investors are unwilling to accept risks associated with diverse, customized contracts. Investor risk can be lowered by creating industry standards related to system warranties and performance guarantees. Tracking by the Climate Bond Initiative suggests that bond investors are eager to invest in renewable energy projects, with recent green bond issuances being significantly oversubscribed. A new class of green bonds, those backed by renewable heating and cooling assets, could be highly attractive to bond investors who have an interest in supporting proven clean energy technologies that can result in stable cash flows.

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Securitization of poorly underwritten debt instruments – largely in home mortgages – was a major factor in the recent financial crisis. Proper due diligence on the part of investors and loan originators is critical to ensuring that debt instruments perform as expected. Given this, policymaker efforts to set RES-H/C performance standards in local markets can greatly reduce potential risk to investors in clean energy asset backed securities.

The Outlook for RES-H/C. Government agencies have intervened in the past to help securitize products and services. For example, KfW in Germany has long been a leader in facilitating securitization of clean energy project-backed debt and US states are in the process of implementing Green Bank programs and policies with the goal of securitizing debt for secondary markets. Securitization for RES-H/C is a complex process, but there will likely be opportunities for RES-H/C to benefit from the work already being done on the topic related to other energy technologies.

4.5.5 COST EFFECTIVENESS

4.5.5.1 Costs & Benefits for RES-H/C There are a number of costs and benefits associated with third-party ownership models for RES-H/C technologies and the policies that support them. Some policy options, such as direct incentives, will have varying costs and benefits based on the magnitude of the incentive provided and the overall societal benefits of the installed system. As discussed in other sections, the distributional effects of incentives and other enabling policies will be highly dependent on their magnitude, how they are funded, the type of technology receiving the incentive, and the sectors and sub-sectors that can access the incentives.

Other policies and programs that could promote third-party ownership of RES-H/C systems may have limited costs but substantial benefits. Government efforts to convene stakeholders and adopt standard contracting language may require relatively limited expense, but could result in substantial RES-H/C market growth. Similarly, outreach and education to contractors and lending institutions could require modest public sector budget appropriations, but result in significantly increased market development. Given the relatively low costs of these initiatives and the large potential societal benefits, policy makers may wish to explore the potential effectiveness of these market interventions before designing increased incentives in order to promote third- party ownership of RES-H/C technologies.

4.5.5.2 Distribution of Costs & Benefits Incentives that lead to the development of third-party ownership models for RES-H/C technologies will create differential distributions of costs and benefits than markets without third-party ownership models. This is because the addition of a third-party owner will require a new stream of benefits to flow to the system owners than would otherwise be necessary. For this reason, developing a robust third-party ownership market may require incentives above and what could be necessary in a well-functioning market without third-party ownership. Despite this, promotion of third-party ownership models may be attractive for policymakers in that they overcome a range of non-financial barriers to market development that might otherwise lead to limited RES-H/C market growth.

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4.5.6 SUMMARY FOR POLICYMAKERS

Summary Considerations for Policymakers: Innovative Financing and Business Models for RES-H/C

 Third-party ownership for RES-H/C provides “heat as a service” to commercial and institutional building owners. The turnkey model provides the end-user with a range of technical and financial solutions, including the building energy assessment, design and planning, financing options, installation, and operations Assess suitability of a RES-H/C system. of turnkey business models  By providing a comprehensive service, third-party ownership reduces the hassle and operational risk associated with the implementation of complex and unfamiliar technologies. Third-party ownership can also allow customers to benefit from financing they could not otherwise access and help drive professional marketing campaigns.

 There are a number of enabling policies that can allow third-party ownership models to thrive. These are especially important as markets move out of the inception phase and into the take-off or consolidation phases.  In order for third-party ownership to be effective, project returns must be attractive enough to motivate both the third-party project owner and the building owner. Incentives are often important in helping drive these models in the early phases of market development.  Standardized technical requirements are also important to reduce the time and Determine need expense of project development. Policymakers may be able to support third- for enabling party ownership models by helping industry stakeholders develop common policies contracting language for third-party owned systems.  Outreach to lenders and contractors is also important. Especially in the inception and early take-off phases, capital providers will likely be unfamiliar with the challenges and benefits associated with RES-H/C technologies and will be likely to mis-price the risk of these systems. This can add significant cost to the system and reduce the overall pool of potentially profitable projects. Policymakers can work to support the development of third-party ownership models by improving investor knowledge of and confidence in RES-H/C technologies.

 Securitization is the process of pooling loans or other receivables in a trust, which issues debt against the pool of assets. It is an important tool to scale-up capital provision and lower the cost of capital for renewable energy technologies like RES-H/C.  For take-off and consolidation phase markets, there is potential to securitize loan products to support large-scale RES-H/C deployment. Securitization would enable institutional investors like pension and insurance funds to provide capital to the RES-H/C market, thus providing lower cost and longer-term debt than Assess potential commercial banks are able to provide. Lowering the financing costs and for securitization lengthening repayment periods will improve RES-H/C project cash flows and increase the number of potentially viable projects.  Securitization requires appropriate underwriting standards and transparent project performance information in order to ensure investors understand the risks associated with the new security. Proper due diligence is critical to ensure that debt instruments perform as expected. As a result, policymaker efforts to set RES- H/C performance standards can greatly reduce potential risk to investors in clean energy backed securities.

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4.6 NEXT GENERATION POLICY APPROACHES To bring RES-H/C markets to scale, policymakers will need to develop comprehensive policy packages suitable for their specific jurisdiction. Policy packages should be designed to address the unique mix of barriers and market conditions at work in any given jurisdiction. It is generally not possible to prescribe a suitable policy package without carefully analyzing the goals, barriers and opportunities in a given jurisdiction. Having noted this limitation, however, Figure 8 below illustrates general best practices that can be applied to any given jurisdictions in one of the three market development phases (i.e. inception, take-off, or consolidation).

Figure 8. Next generation policies can drive deployment of RES-H/C across all stages of market development

For markets in the inception phase, it is important to develop a clear roadmap for market development, which may include the creation of ambitious and credible RES-H/C technology targets. This is important to show commitment to – and generate confidence in – the RES-H/C market. In addition, a suitable mix of incentive support should be developed to stimulate the market. This may include performance based incentives that are calculated based upon an initial assessment of installed costs and required rates of return for investors. When piloting PBIs, it will also be important to develop comprehensive heat metering standards, so that useful heat production can be properly metered, measured, and rewarded.

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During the inception phase, policymakers should also ensure that the necessary regulatory framework is in place. For example, when implementing installed cost assessments, policymakers should pay special attention to assessing soft costs, providing policymakers the information needed to launch soft cost reduction programs such as streamlined permitting and inspectional processes for RES-H/C. Other regulatory policies may include the development of pilot building mandates. It would be most suitable to impose mandates on a limited segment of the commercial building sector during the inception phase, such as public buildings or new buildings, in order to demonstrate the viability of RES-H/C technologies and build confidence in the market.

Policymakers should also consider education and engagement programs to help customers and lenders assess the risks and benefits of RES-H/C.

For markets in the take-off phase, it is important to refine and update plans in order to address new market, technology, and cost developments. At this stage, policymakers may also wish to strengthen regulatory requirements, impose more robust utility mandates, and incorporate existing buildings into RES-H/C building mandates. For building mandates, policymakers should also calibrate the mandate trigger (e.g. sale, lease, or renovation of the building) and to progressively address barriers such as landlord-tenant challenges and low building refurbishment rates.

At this phase, it is also anticipated that soft cost reduction programs – such as customer aggregation or streamlined permitting initiatives – will also place downward pressure on RES-H/C installed costs. As a result, policymakers should ensure that degression mechanisms are in place in order to give market actors clear signals regarding future incentive levels. It is important to set incentives at levels sufficient to ensure continued growth in deployment. In some jurisdictions, this could enable third-party ownership and other innovative financing programs to take root.

For regions that are served by district heating systems, policymakers have a unique opportunity to create new tariff and regulatory frameworks that could enable net metering or feed-in tariff style policies for heating and cooling.

For markets in the consolidation phase, policymakers will need to ensure that the broader energy market design is commensurate with high RES-H/C penetration levels and that economic support can be progressively phased out. Key issues and options related to energy integration and planning are addressed in the next section (Section 5).

Policymakers should be sure that regulatory and incentive policies are adjusted so that public acceptance is maintained, especially as deployment levels grow and projects have higher visibility and impact. As the market develops, policymakers should consider implementing programs that help industry standardize technical requirements and contracting language in order to encourage securitization and bring new capital sources (e.g. institutional investors) to the market. These are all meaningful ways for policymakers to intervene and reduce risk associated with the deployment of new financing and business models.

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5 RES-H/C & INTEGRATED ENERGY PLANNING 5.1 IMPORTANCE OF INTEGRATED ENERGY PLANNING Assuming that RES-H/C does achieve significant scale across jurisdictions over the next several decades, it will be important for policymakers to start planning now for how RES-H/C policies fit into broader energy strategies. Section 3.2 introduced a variety of energy infrastructure planning and investment issues that have important implications for RES-H/C, focusing in particular on how or if RES-H/C can integrate with low energy buildings, district energy, and electric grid management strategies. The following section takes a closer look at the implications of the commercial RES-H/C market going to scale and how it may threaten or benefit existing and emerging energy paradigms.

There are a variety of energy infrastructure planning and investment questions that have important implications for RES-H/C in the future:

 How will RES-H/C technologies influence the development of future building stock trends, such as low carbon or zero energy building requirements?  Should district heating systems be expanded in the future to support greater growth of RES-H/C?  How will RES-H/C technologies interact with the electricity grid and/or impact the business models of incumbent energy providers (e.g. electric and natural gas utilities)?

Depending upon the needs and resources across jurisdictions – and the individual RES-H/C technologies that are deployed to address those needs – the answers to these questions may vary widely. For example, some jurisdictions may emphasize development of large-scale biomass-based CHP for district energy as part of a broader agriculture (forestry) economic development strategy. Others may create policies that encourage integration of on-site RES-H/C systems like air source heat pumps or solar thermal to support development of zero or low-energy commercial buildings. Still others may drive widespread deployment of heat pumps and thermal storage in order to electrify the heating sector in order to absorb abundant renewable electricity resources. .

While a comprehensive analysis of these issues is beyond the scope of this report, it does raise a number of important questions for policymakers to consider. Without a coordinated planning effort, country policymakers could find themselves developing energy policies or strategies at odds with one another. The following explores how RES-H/C complements, threatens, or otherwise influences future energy strategies, focusing in particular on the interaction of commercial RES-H/C with low energy building strategies, district heating development, and electric grid management strategies.

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5.1.1 RES-H/C & LOW ENERGY BUILDINGS Low energy buildings are those with zero or minimal energy requirements for heating and cooling, due to highly insulated building envelopes with thermal loss. Low energy building design and construction is taking on increasing importance in many regions of the world. The European Union, in particular, passed a 2010 directive requiring all new buildings to be designed to be nearly carbon-neutral by 2018-2020. RES-H/C will likely have an important role to play in the deployment of low energy buildings across jurisdictions.

Threats and Benefits of RES-H/C. By significantly reducing energy demand, low energy buildings also reduce the need for heating and cooling appliances, including RES-H/C. For example, an analysis of the German heat market estimates that new building heating demand will decrease by 44% between 2005 and 2020 due to improved thermal insulation and more efficient use of energy (Bürger et al., 2008). For individual buildings, low energy building standards like Passive House seek to largely eliminate the need for conventional heating systems by making efficient use of the sun, internal heat sources, and heat recovery (Passive House Institute, 2012). This could represent a threat to the viability of the RES-H/C industry in the future. However, it appears unlikely that buildings will entirely eliminate heating loads. Thus, RES-H/C technologies will almost certainly be the preferred (low-carbon) means to fulfill building heating needs.

As global temperatures increase, many commercial buildings – especially those in traditionally colder climates – are experiencing or will experience a significantly increased need for cooling (Lu et al., 2008). RES-H/C technologies such as air and ground source heat pumps, and perhaps solar thermal cooling, can offer a viable means to cool low energy commercial buildings using renewable resources.

Jurisdictions like Baden Württemberg are also exploring ways to encourage nearly zero energy building performance requirements in existing buildings – by requiring RES-H/C systems to be integrated into existing buildings during building renovations or when heating systems are replaced. Such buildings typically deploy high efficiency or RES-H/C heating equipment such as air source or ground source heat pumps. Biomass based CHP combined with local district energy grid can also serve clusters of buildings – such as office parks, industrial parks, or neighborhoods – in order to cost effectively meet the combined heating and electricity needs of existing low energy buildings.

Summary. The trend towards low energy buildings provides a number of opportunities for RES-H/C, and policymakers should carefully consider how RES-H/C policies support low energy building objectives. With low energy buildings, relatively small amounts of heating and cooling supply are sufficient to provide normal comfort levels in all seasons. While reduced, there will continue to be a need provide heating and cooling supply, especially for large existing commercial buildings, which must regulate heat loading from electronic equipment and high number of occupants. RES-H/C technologies –such as biomass pellet systems, air-source or ground-source heat pumps, and solar thermal systems – are desirable low or zero carbon options to provide renewable heating and cooling needs for buildings

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5.1.2 RES-H/C & DISTRICT ENERGY District heating networks have been integrated into RES-H/C strategies in a number of regions, especially in northern Europe where countries like Denmark are in the process of transitioning away from fossil fuels and towards renewable heating technologies. A number of other countries like the UK are considering expansions or new development of district heating networks as a means to supply building clusters or neighborhoods with renewable heat. Depending upon policymakers’ priorities, next generation RES-H/C policies can both benefit and threaten existing district energy business models.

Threats and Benefits of RES-H/C. Some experts consider the lack of district energy as a “severe structural barrier” to widespread utilization of RES-H/C and a significant contributor to the lack of specific renewable heating policy (REN21, 2013). District heating is considered important for RES-H/C technologies because of the economies of scale. While some large commercial facilities can provide the necessary heat demand, there are a number of benefits that aggregating buildings in a heating networks can provide for RES-H/C (Bürger et al., 2008):

 Extracting large amounts of geothermal heat from depths greater than 2,000 meters tends to be economically feasible for very large heating loads, which may require the aggregation of a large number of energy consumers (i.e. through a local heat network).  Storing solar heat in the larger heat stores of a local heat network is generally cheaper and can be done over a longer period of time than for individual buildings alone. Experts note that aggregating heat load across buildings is the most efficient and cost-effective way to store heat from the summer for use in the winter.  CHP generation is most efficient for very large biomass plants. Furthermore, inexpensive, problematic biomass sources like straw, which require more effort to clean the flue gas, can be used in larger furnaces.  There is considerably greater complexity to developing policy to deploy many, distributed RES-H/C systems (across a variety of building types) instead of focusing on policies that support development of comparatively few centralized heating plants for district heating systems.

On the other hand, other policy experts point out that RES-H/C technologies are best suited to be integrated directly into buildings, with the option to feed into district heating networks as appropriate (Epp, 2014). In such a scenario, policymakers would need to develop new interconnection policies and tariffs to support distributed RES-H/C generation. This will require the implementation of performance based incentives or new tariff frameworks described in Section 4.3.2 (e.g. comparable to a feed-in tariff for RES-H/C).

For distributed RES-H/C systems on buildings to succeed in district heating networks, new tariff and regulatory frameworks will be necessary, even if incentives are no longer required. If RES-H/C technologies become broadly competitive with conventional fuels, there will need to be established rules in place that govern the interconnection of RES-H/C to the heating grid, the “dispatch” order of RES-H/C technologies compared to conventional systems, and the performance-based compensation for RES-H/C energy sources. It will also need to be determined whether RES-H/C systems should receive payment at the “avoided cost” of conventional fuels, or whether they should be compensated at a lower rate that reflects their specific generation costs.

Moreover, integration of RES-H/C into district heating grids will in many cases require technical upgrades to the grid. The district heating and cooling industry has proposed the development of “smart grids” for heating and cooling, which is based on the deployment of fourth generation district heating and cooling networks.

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As described in Text Box 11 below, fourth generation heating and cooling networks operate at significantly lower temperatures (55 degrees C) than conventional district heating networks and can better integrate RES- H/C technologies like heat pumps and solar thermal. Low temperature district heating networks also operate more efficiently and are better suited to supply low energy buildings than higher temperature networks, which will be important to assist in the transition to low energy buildings.

Text Box 11. RES-H/C and future district heating and cooling (DHC) networks

According to Euroheat and Power (2012), district heating and cooling (DHC) will serve as “the backbone of smart cities by 2030,” increasing communities’ flexibility to deploy energy efficiency and renewable energy systems.

DHC demand today is mainly covered by fossil fuels (or electric chillers for cooling). As noted previously, the high share of fossil fuels in the DHC heating markets creates challenges in terms of high fuel import rates, lower security of supply, high carbon dioxide emissions, and increased heating costs. DHC infrastructure can help remedy these problems by enabling the collection of waste heat and renewable energy from distributed resources, thus reducing the need for fossil fuels for heating.

Future development of low energy buildings and RES-H/C systems served by DHC networks will require a transition toward or new development of next (fourth) generation district heating systems, as well as the development of district cooling networks.

 First generation district heating systems consist primarily of steam systems. These systems were historically developed to use steam from power plants, though they are as a whole typically more expensive to construct and maintain than hot water systems and have higher operating temperatures resulting in greater heat losses. It is not expected that these will be developed in the future (BINE, 2007; DHC Platform, 2012).

 Second generation systems consist of high temperature (~120 degree Celsius) pressurized water systems. These systems emerged primarily in the 1930s and dominated through the 1970s.

 Third generation district heating systems were introduced in the 1970s and are the current (conventional) district heating systems. They supply medium temperature water (~90 degrees C). These systems continued the trend in district heating toward lower distribution temperatures, material lean components, and prefabricated components that require less manpower at construction sites (DHC Platform, 2012).

 Fourth generation district heating systems are the next generation of district heating systems. They have been piloted in a number of regions, including Denmark, and can supply low temperature water at approximately 55 degrees C (Wiltshire, 2012). This enables increased integration of low temperature RES-H/C technologies such as heat pumps and solar thermal systems. It additionally is expected to support more flexible distribution and the use of assembly-oriented components and flexible materials. The final result will be a more environmentally friendly, customer-oriented solution (DHC Platform, 2012).

 District cooling is also an option for municipal energy networks. District cooling is an environmentally optimized cooling solution, which uses local, natural resources such as seawater or absorption chillers to produce cooling. As with district heating, the customer is connected to the cooling production via a pipe network. Chilled water is distributed to the buildings where it loses its cold content, thus cooling down the building temperature.

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Summary. Both distributed and centralized RES-H/C generators can be integrated into district heating networks. Commercial buildings in particular could host large RES-H/C systems on district energy networks, providing benefits to the building owner and potentially to the heating network operator. While policies enabling decentralized commercial buildings to feed energy into the heating grid will likely cause economic, technical, and grid management challenges for district energy providers, experts note that it is not impossible. In fact, such a transition parallels challenges that solar PV has faced (and continues to face) with regard to feeding into the electric grid (IEA-RETD RE-PROSUMERS, 2014). Such strategies could drive innovation and enable development of smart grid development for the heating sector, offering significant opportunities for RES-H/C and low energy building development (Epp, 2014).

Policymakers should carefully consider how or whether they plan scaling up district heating networks in the future. As policymakers increase energy efficiency and move toward a low energy building future, they should carefully evaluate future building heating demand among buildings on existing district heating networks, assess potential for making significant energy efficiency improvements in buildings, and consider how best to integrate RES-H/C technologies into new and existing buildings as well as district energy infrastructure.

5.1.3 RES-H/C & THERMAL STORAGE FOR ELECTRIC GRID MANAGEMENT As greater shares of variable RES-E, such as wind or solar, are integrated into the electric grid, grid operators are facing new challenges to ensure flexibility and reliability of the system. There are opportunities to integrate RES-H/C and thermal storage into electric power grid planning and management in order to accommodate larger penetrations of variable generation. In particular, recent studies have shown that using CHP, heat pumps, and heat storage can provide significant balancing capability and contribute to a more flexible and efficient energy system (Hedegaard, 2013; Meibom et al., 2007; Mueller et al., 2014). These are especially suited for commercial buildings or district energy systems with large heating loads.

A number of smart grid concepts envision – or have piloted – the use of heat pumps to satisfy thermal demand or to replenish storage during periods of high power output from wind and solar. This results in a number of benefits. From a technical standpoint, storing energy in the form of heat is much more cost efficient than electrochemical storage. In addition, such they can lower investments in dispatchable power plants and optimize operation of wind power (Hedegaard, 2013; Mueller et al., 2014).

Threats and Benefits of RES-H/C. There are two approaches to electric storage that offer opportunities for RES-H/C technologies: short-term (hourly) storage, balancing demand shifts within a day, and longer-term (intra-week) storage, to balance variability in demand within a week. Both of these strategies offer utilities, district energy companies, building owners, or third-party service providers opportunities to better manage grid variability and profit from new business services.

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Individual heat pumps can contribute to short-term energy storage (up to a few hours). The most common type of heat pump today is a compression heat pump that uses electricity to transfer heat – usually from the ground or the outside air to a home. The heat energy can be stored either in water tanks or in the building itself (e.g. in the floor or the walls) for several hours (Hedegaard, 2013). This allows heat pumps to be operated flexibly – ramping up production at times of high electricity supply, and scaling back or turning off when there is a supply shortage. Depending upon the size of the commercial building, building owners could participate in the regulating power market or work with agents that aggregate heat pump capacity for the market.

For longer-term storage, large heat pumps, electric boilers, and heat storage capacity in district heating systems have the potential to allow for the storage of substantial amounts of energy. Here, large-scale compression heat pumps usually utilize wastewater, exhaust from industrial operations, ground water, lakes, rivers, or the sea as a heat source. They transfer heat to district heating systems, or provide direct thermal energy where it is required. Large heat pumps and electric boilers can also be operated flexibly and thus help balance energy supply and demand. Storage capacities of district heating systems are usually much greater than in individual buildings and can therefore function as a power balancing tool over longer periods of time. However, typical thermal losses (usually around 5%) do not permit for economic storage of much more than a week (Hedegaard, 2013). This approach offers new business and revenue generation opportunities for district energy providers.

Summary. RES-H/C and thermal storage strategies offer a promising opportunity to support improved management and development of the electric grid. With regard to next generation policies, utility mandates and performance based incentives could be developed to provide additional incentives for RES-H/C systems like ground source heat pumps that are deployed in areas which would most benefit from short- or longer- term storage opportunities. In addition, policymakers may consider various planning measures – ranging from strategic energy planning to energy systems modeling – to evaluate how best to facilitate the integration of RES-H/C technologies into the power grid and to build reliable and flexible energy networks.

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6 CONCLUSION RES-H/C holds considerable promise to help policymakers achieve long-term energy and climate ambitions – such as climate change mitigation, climate adaptation, economic development, and energy security. In many cases, it is already clear that it will not be possible to meet existing climate and energy goals without increasing the use of RES-H/C (Bürger et al., 2008). To scale the market in the commercial building sector, policymakers will need to address a number of persistent barriers to RES-H/C development. This will require targeted policy interventions to address the unique RES-H/C technical and market conditions for jurisdictions across the globe.

RES-H/C is also an essential part of planning for the long-term energy future, and RES-H/C technologies can be deployed to also support a number of building and energy policy priorities. The deployment of RES-H/C will be most successful if policymakers develop integrated policy approaches, which address commercial building needs across the energy efficiency, heating and cooling, and electricity sectors. An integrated policy approach will enable policymakers to better manage strategies to drive development of renewable heating and cooling markets, low energy buildings, district energy networks, as well as thermal storage for electric grid management.

There is a clear need to develop new and innovative – next generation – policies to rouse the RES-H/C market, overcome persistent market barriers, and enable RES-H/C to achieve massive, cost-effective, mainstream deployment in the next several decades. This report lays the groundwork for developing next generation policies, helping to clarify issues, options, and potential impacts and thus enable policymakers to take steps to move RES-H/C markets in their countries along the deployment curve and address their energy goals.

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APPENDIX A

Text Box 12. EN Standard 1434 – Heat Meters

EN 1434 provides technical guidance for heat meters. The standard consists of six major parts.

Part 1. General requirements describes complete and combined heat metering instruments as well as general parameters and operating requirements of heat meters. It also provides technical characteristics, which outline the design criteria for a heat meter, specifying that a heat meter must be durable under normal operating conditions, resistant to vandalism, and specifies the operational characteristics of the heat meter’s results display. The metrological characteristics define the maximum permissible error that is allowed for heat meters, and their subsections, to qualify for each of the three accuracy classes: Class 1, Class 2, and Class 3, with Class 1 being the most accurate.

Part 2. Constructional requirements provide design dimensions, materials, and components for various heat meter parts as well as guidance on how the interfaces of sub assemblies should be connected. Constructional requirements for complete meters are also covered. The standard then classifies various types of pulse output devices based on functionality, pulse type, and amount of electrical current.

Part 3. Data exchange and interfaces addresses the data exchange between a meter and a readout device. A meter can have either zero or a number of different interfaces to communicate data. The standard identifies requirements for the signal processor’s physical layer, link layer, and application layer, each based on if it relies on a wireless, optical, current loop, or a local bus or M‐ Bus interface. Based on the hardware interface type, the appropriate European standard is identified to guide the design.

Part 4. Pattern approval tests defines the specifications for the heat measuring instruments and the test conditions in the heat exchange circuit. A range of reference conditions for ambient temperature, relative humidity, and ambient air pressure are given and may not vary during the course of the measurement. Actual reference values and operating conditions are given in this section as well as methods for how tests are conducted, allowable error ranges, and required document submissions to the testing laboratory.

Part 5. Initial verification tests are divided in metrological, technical and administrative phases, and must be performed separately for each of the heat meter’s subassemblies. This section provides instructions and documentation to be delivered to the testing lab, and the required data sheets containing the test results and test conditions.

Part 6. Installation, commissioning, operational monitoring and maintenance explains the procedures and requirements for the design, installation, commissioning, operational monitoring, and maintenance of heat meters. It explains how heat meters should be implemented into larger heating systems; specifies installation procedures; lists the installation verification tests needed to check flow sensor position, temperature sensor dimension, fit, and installation; defines adequate heat meter distance from interference sources; and provides a procedure for verifying that the heat meter is earthed and functioning as it should.

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The Annex of Part 6 gives recommendations for the installation of heat meters into the heating system, of which they are a component. Given the operating and environmental conditions of the heat meter’s installation, the quality of heat conveying liquid, the primary water quality, and the secondary water quality, the Annex provides guidance on selecting an appropriate heat meter. The standard outlines the operational monitoring and maintenance requirements for heat meters and provides a sample maintenance report.

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APPENDIX B

Table 10. Selected RES-H/C mandates

NEW OR EXISTING JURISDICTION BUILDING SECTOR RES-H/C TECHNOLOGY BUILDINGS Most Residential & Israel New Construction Solar Thermal Commercial Israel has the oldest solar thermal building obligation in the world (since 1980), which applies to most new residential and commercial buildings (industrial facilities excluded). The obligation has supported widespread deployment of solar thermal and the technology is now widely integrated into both new and existing buildings: Israel now has almost 600 kWth solar thermal capacity installed per 1000 inhabitants, with such broad consumer acceptance that most solar thermal installations today are voluntarily sited atop buildings that are exempt from the law. Residential & New Construction / Madrid, Spain Solar Thermal Commercial Renovation Since 2003, the City of Madrid has required all new buildings or those undergoing major renovation to cover a minimum percentage of their domestic hot water load (dependent upon the type of demand) with solar thermal. This includes both residential and commercial sectors. Residential & Non- Solar, Biomass (gas, liquid, solid), Germany New Construction Residential Geothermal In 2009, Germany established a mandate requiring use of RES-H/C in all new buildings. This was developed to achieve Germany’s legally binding renewable heating target of 14% by 2020. Baden Wurttemberg, New Construction & Existing Solar, Biomass (bio-oil & biogas), Residential Germany Buildings Heat Pumps (ground) The German state of Baden Württemberg has required all new residential buildings constructed after 2008 to cover 20% of their yearly heat demand with renewable heat sources, and all existing residential buildings undergoing a modernization of their central heating system after 2008 to cover 10% of heat demand. Buildings using 100+ New Construction & Existing Kenya Solar Thermal liters/day Buildings

In 2012, Kenyan policy-makers issued legislation mandating that all new buildings using over 100 liters of hot water a day must utilize solar heating systems to meet at least 60% of their demand. Additionally, within five years, all existing buildings using over 100 liters of hot water a day must also install solar water heating systems to cover 60% of demand. Beijing and Kunming, Residential and New Construction Solar Thermal China Commercial Several Chinese cities have issued municipal solar water heating mandates, particularly for residential buildings, although Beijing and Kunming's mandates also apply to commercial buildings. In 2010, Kunming mandated that all newly constructed, renovated, and expanded residential homes, hotels, hospitals, retirement homes, school dormitories, nurseries, etc., must install solar water heating heaters during the construction process, for buildings under twelve stories. In 2012, Beijing introduced requirements that hotels, schools, hospitals, and swimming pools install solar thermal if no waste heat is used to cover domestic hot water demand.

New Construction / US Virgin islands All Buildings Solar Thermal Renovation All new or substantially modified developments must use efficient solar water heaters for at least 70% of the hot water

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load. Dubai, UAE Residential New Construction Solar Thermal For all new villas and labor accommodations, a SWH system must be installed to provide 75% of domestic hot water requirements Solar Thermal, Biomass Thermal, & New Hampshire, USA Utility Mandate 2% of State's Electric Load Ground Source Heat Pumps Requirement that 2% of the state’s electric load must be met with thermal sources, incl. Solar Thermal, Biomass Thermal, & Ground Source Heat Pumps, by 2025. CHP, Solar Thermal, Biomass, Biogas, Massachusetts, USA Utility Mandate 5% of State's Electric Load and Heat Pumps Requirement that 5% of the state’s electric load must be met with “alternative energy”, incl. CHP, solar thermal, biomass, biogas, and heat pumps, by 2020.

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