Friday, 25 September 2009

Energy Efficiency in the home: a mortgage valuation problem

Our homes may well become energy and water efficient much faster if mortgage valuers start taking into account the energy & water performance of a house in their valuations. I find it difficult to believe that both here and in the US, this is not already being done.

With the rising cost of energy, the average UK gas and electric bill is around £1300 according to Uswitch. According to the Energy Saving Trust, this can be easily reduced by 30% saving £390. By plugging back the savings into other energy saving measures, over a few years' time, the home's energy consumption could be cut by 50-60%.

A 50% saving on energy consumption and water consumption would result in an annual saving of £806 which should be enough to make one monthly mortgage payment a year. Surely that's worth something to a bank. Over the 25 years of a mortgage, the saving would amount to £20,150. Taking into account inflation of energy prices at an average of 5% a year*, the saving would be around £38,500. It is difficult to say how this embedded saving should be factored in to the value of a property. The easiest way to measure it is to look at similar trends in the US. A study in California reveals that buyers are willing to pay an extra $20 for every $1 saved on permanent home energy efficiency investments ** (1). This is a far cry from what buyers are willing to pay in the UK. The Energy Saving Trust (EST) have assessed from market studies that buyers are willing to pay on average an extra £3,350, whilst some are willing to pay up to £15,000 for energy efficient homes. They found that 68% of people don't want a highly energy inefficient F or G rated home. Unfortunately, they don't have any info yet on what home improvements buyers value most. This makes it very difficult to determine whether or not home improvements are worth more than what people pay for them as they seem to be in the US.

The fact that some are willing to pay up to £15,000 seems like a reasonable premium but, mathematically, it's odd that they are a minority.

Their valuations certainly makes more sense than the current valuation of properties. At 28 times their annual average rental potential, the prices are far out of touch with reality (3). If a similar valuation were to be used for energy savings (money that stays in your pocket is as good as or better than money that comes into your pocket), taking into account 5% inflation over 25 years, the increment to the property's valuation should be £43,000!!

But we will not advocate such a high valuation. Current property valuations in relation to equities are unsustainable. They indicate that a property crash or a dramatic slow down in the increase of property prices over a number of years must occur to bring them back to reasonable levels in relation to their earnings potential. Of course, markets can stay irrational for extended periods of time so when prices will fall or stop growing could happen in a year or in 20. Nobody has a crystal ball to determine that.

Going back to our valuation problem, I think that a reasonable valuation for the moment would be 7-10 times the amount saved on permanent energy efficiency improvements. This in equity valuations is considered to be a bargain and 10-15 times the earnings (savings in this case) potential is considered to be fair value. Our valuation indicates that energy saving are incredibly undervalued in comparison to the valuations given by people surveyed by the Energy Saving Trust. But then again, average Joe hasn't a clue as to how to value stuff scientifically. The value of something is not just what people are willing to pay for it. This is one area where modern finance has come up with a better alternative: the value of something is equal to the present value of its discounted cash flows plus its value on disposal.

Our yardstick valuation of 7-10 times the energy savings would leave enough margin for the madness that usually takes place when it comes to valuing assets and allow for prices to get out of hand and valuations to climb up to 20 or 25 times the amount saved***. Energy saving investments will one day become fashionable. Everything in the press and on telly points to this. The latest round of EST adverts coupled with the government's adverts are going to have an impact and property buyers are going to become savvy to the presence of energy saving installations on properties. Once energy saving investments become fashionable, it is possible that their valuation will get out of hand, just as property valuations got out of hand as a result of greater availability of credit.

Looking back at the Californian valuations, we are not surprised at all that permanent energy efficiency improvements are valued at 20 times each $1 saved and that they effectively beat stock market returns and other investments. Indeed they should. It isn't rocket science: valuing energy savings is easy and straight forward. Once your cavity walls are filled, the work will last for the life of the property. Same for loft insulation and a host of other measures. Compare that to trying to value the future earnings stream of Intel, Dell, Dow Chemical, Shell or British Airways. Even pension fund manager who are supposed to be experts aren't very good at their jobs due to its complexity (90% of fund managers can't beat the performance of indexes). Take into account the recent stock market crash and you'll get it: stock market investments are insecure because they assume linear valuations and are vulnerable to 'Black Swanns' which makes valuations approximate and vulnerable to fear and greed. Property prices too are difficult to value. They are vulnerable to bank's willingness to lend, lending terms and the health of the economy. Now look at energy saving investments: what are they vulnerable to? Nothing. Their only caveat is that they decay. I have a boiler in my home that is 25 years old. It is woefully inefficient and the landlord won't replace it until it completely stops working. A new condensing boiler would save us £170 a year according to the Energy Saving Trust and around £200 according to my calculations. If it lasted as long as the old clunker we have, it would save us £4250-5000 over its lifetime, paying for itself twice over. Where else can you get such a straight forward easy to value return on investment? Permanent energy saving investments should be worth a lot just because of the security of the cash flow stream they provides in the form of savings.

The main reason why people invest in energy saving measures at the moment is because they can save money by implementing the measures. But not everyone believes the energy savings are possible and some people seem to be paralyzed or in no hurry when it comes to spending money on this. They're happy spending money on trivialities, things 'they like' but not on dull old energy saving stuff. And there maybe a good reason for that: take 2 fridges that look exactly the same, one is priced at £300 and the other at £500. The only difference is that one is more energy efficient. Which one is the buyer most likely to go for? The £300 one of course, because they see the extra £200 as an indulgence, even if it saves them money. People think short-term not long-term. The fact the £500 fridge is worth £300-600 as a fitting because it saves £30 a year isn't understood and the fact that it will pay for the extra cost in less than 7 years is not taken into account enough. With this kind of psychological blockage, it's no surprise that enthusiasm for energy efficiency isn't picking up speed faster. We prefer cheap, not running cheaply.

We've noticed from experience that the people who invest in energy saving measures tend to be quite savvy. The rest are perfectly happy to pay the utility bill when it comes in the post and look at forking out £250 for cavity wall insulation as something that means spending money now with no real assurance they'll get it back in the form of savings. That's probably why you hear politicians saying: "people won't invest in energy investments" whilst in the same breath mentioning the necessity to build incinerators. There's a very simple way to deal with the problem:

1) Get mortgage valuers to value the property's energy performance into the cost of the properties. The government should be ruthlessly lobbied about this by FOE, Greenpeace, EST and any other organization who understands that the reduction of our carbon emissions is intimately linked to the attractiveness of energy saving investments. If energy saving investments improve a property's value and save money: that makes them far more appealing than if they just save money.

2) Securitize energy saving investments (we've already posted on this topic) and enable people to pay for their energy efficiency investments through their bills. Utility companies could estimate the savings on each bill and bill the difference to people who've had improvements made. That will deal once and for all with the problem of a large proportion of the population who won't invest in energy savings.

There is one thing that flies in the face of government with regards the whole energy efficiency issue: people don't do it because it's boring and they don't believe in it. Our values are against conservation. It may have been easier to sell energy savings in the 30s or the 50s but not now because of the comfort and convenience culture. We don't have time and we don't really care about saving a few hundred. There's only one way to get the message through: by appealing to our greed. The day that people understand that they can take equity out of their homes through energy efficiency investments is the day that demand for that type of improvement will soar and that property speculation on that type of improvement will also kick in. Waiting for fuel prices to go up to motivate people to make improvements in energy efficiency will take too long.

Sources and notes:
* Energy prices have increased dramatically in the last few years however prior to that they were relatively stable. With world population growing and getting richer it is quite reasonable to assume energy prices will grow at a faster pace than inflation which historically has grow at 2.5-3%. Oil reserves are decreasing and so we should see an increase in demand for replacement technology. It is expected electricity demand will increase dramatically as a result. Gas prices which are correlated with the oil price should also increase as a result of increased oil scarcity.
The growth in energy prices could be countered by improvements in renewable energy technology but new technology may also increase demand for energy. An example in point is electric cars.
** We believe this "aberration" is due to Californian culture. California has been the cradle place of renewable energy technology for the past 40 years. The Governor is pro anything that has to do with green measures and Silicon Valley is becoming a major intellectual pole for the development of clean tech. Why Californians have historically been so interested in everything green, we don't know but one thing's for sure: with the threat of uncontrolable global warming looming the rest of the world is catching up quickly. If anything, what happens in California right now is the best crystal ball we can use to determine what to expect in the future.
*** It should be noted here that the best energy efficiency investments are invisible. For example, you cannot see cavity wall insulation but it is far cheaper and more cost-effective than solar panels. Yet people will attach more value to poor performing, 20 year old solar panels than to the existence of cavity wall insulation. This is just amazing! People have a tendency to overvalue what they can see and undervalue what they can't see. That's how property developers get away with making huge profits from implementing quite simple measures.
When looking at energy savings, people will attach disproportionate importance to what they can see such as the condition of the double glazing or the state of the boiler. They'll bearily notice that the toilet has been converted to a highly water efficient version or that the running cost of the house is half the national average. We are dealing here with a public transfixed by aesthitics. Selling a house has become an artful exercise in the manipulation of people's perception.

Wednesday, 23 September 2009

How much would it cost to end deforestation?


The rate of loss of primary forest as last measured between 2000-2005 was 6 million hectares. That's equivalent to 60,000 km2, an area the size of Ireland. And this is only for primary forest, that is ancient rainforest.

Stating that the rainforest is permanently lost in this case however is incorrect. The forest is not necessarily being clearcut or converted to other land use, it is reclassified from primary to modified natural rainforest due to the fact the forest have been subject to logging or another disturbance. (This is according to the Forest Assessment and Reporting Service)
The actual global deforestation rate is estimated at 13 million ha. per year.

The total forest cover is 4 billion ha. It is estimated that 1% of that, an area equal to 40 million ha is burnt down each year. This area is equal to 6.5 times the area of deforested primary forest and 3 times the area of total deforested area each year.

It has been estimated by the IPCC that deforestation accounts for 17-20% of global carbon dioxide emissions.


It seems to me that whilst all the publicity is on deforestation, very little publicity goes into forest fires mitigation. When I was a boy, the mountain next to where I lived was set alight. Hundreds of thousands of trees burned. The fire was spectacular. 20 years later and the forest is managed appropriately: it has been reforested, the land is grazed by feedstock and large strips of grassland divide the forest so that if it is set alight again, the fire's progress will be put in check when it reaches the grassland border. Forest fires really are a vitally important area of forest management we need to focus on because when a forest burns, we don't just lose a carbon sink, the carbon stored in the forest over decades of growth is released into the atmosphere all at once.

We are lucky in that respect that most of the forest fires occur in developed countries where we have enough money to protect our forests. The main forest fires I have heard of over the past few years were in California, Australia, Portugal, France and Spain. Most of the fires occurred in countries that are particularly dry in summer and occasionally windy. If the forest located in these areas were managed properly, a vitally important carbon sink would be preserved.


Primary forest
is located mainly in the tropics. Deforestation for logging is one of the causes of deforestation but another more important reason is natural resource extraction which is also very polluting.

One way to stop deforestation is to ensure the forest is worth more standing up than logged. By giving money to locals to protect the rainforest instead of selling their land, it is possible to avoid a substantial amount of logging. For larger scale projects, the idea has the potential to be extended to paying governments from developing countries but there is a lot of potential for corruption in that respect and for the money to go astray.

One of the charities trying to encourage the protection of the rainforest by ensuring it is worth more standing up than logged is Cool Earth. Based on the costings provided by Cool Earth to protect an acre of rainforest, the annual cost of protecting the rainforest could be between £891 million and £1.5 billion. Of course, this is a purely theoretical figure, there's only so much mileage in the work they can do.

If we take into account the fact that to protect the rainforest, the main job involves protecting the border most vulnerable to deforestation rather than the whole area at risk of deforestation, the cost could be considerably less. It may well be that the true cost is £445 to £750 million, it depends on whether deforestation only occurs at the borders of the forest or if areas deforested cut deeper into the forest.

Saturday, 12 September 2009

Birth Control

The cheapest way to cut down carbon emissions would be for us all to have less children. It's an easy equation: the average person living in the UK has a carbon footprint of 12.5 tonnes. Over a lifetime, that equates to more than 981 tonnes of CO2 per person. The lifetime environmental impact of a single individual is thus huge.

I remember an illustration from the Ecology of Commerce comparing us to algae. When algae grows in a lake, it can continue growing to take over the whole lake. However, if it does that, it will asphyxiate itself. Algae sucks up the oxygen in the water in order to grow and if there's no oxygen left in the water it dies. Algae grows so quickly that it is capable of doubling in size each day. However something odd happens when it reaches a life threatening level of growth. When algae takes over a lake, it stops growing once it reaches half of the lake's size. Paul Hawken seemed to hint to the idea that even algae is cleverer than us! Have a look at a boring video on the topic on our website (be patient with it, it takes some time to get interesting):
Arithmetic, Population and Energy

Several centuries ago, Malthus determined that our population should stop growing once it reached 1 billion. He thought that if it continued growing above that number, the Planet's resources would be over-stretched. He was right, scientists have calculated that our exploitation of the Planet's resources right now is 20% above what the Planet can cope with meaning that every year that goes by, we are accumulating ecological debt whilst our population is still growing.

On September 10 2009, the Sun published an article with an odd title: "Carbon mating, use a condom to err... cut down emissions" on page 31 (it's rare that environmental issues make front page news in the Sun, football was more important that day). It reported that contraception would be five times cheaper than any other method of tackling the world's greenhouse gases. The report came from the optimum population trust, a charity we recommend donating to.

The Study was compiled by the London School of Economics who found that every £4 extra spent on family planning for the next 40 years would reduce global CO2 emissions by a tonne. It would cost £19 to achieve the same result with low carbon technologies. The Trust recommended giving free condoms to women worldwide who wanted them and the Sun noted that the United Nations estimated 40% of all pregnancies were unintended. The total saving from making condoms freely available could be 34 gigatonnes of CO2!

I was discussing this with my wife when she came up with a very interesting idea. She said that we could learn from China's single child policy, whilst not repeating its mistakes. I insisted we couldn't: you can't stop women from having children if they want them, what we need is a complete cultural overhaul.

Well you made me think about having a second child, my individual responsibility and the importance of the small decisions we make, she said. I was impressed, I never remotely entertain the idea that my rants can make a thread of a difference. And birth control is far easier than cultural overhaul. When you have a problem, the simplest solution is often the best. My wife had a far better solution than I.

She pointed out that it is not necessary to impose birth control on the general public. I always thought there was no other way. The Chinese apparently forced women to have abortions and there was no end to the list of human rights infringements perpetrated for the application of the policy. No wonder most people find the thought of single child policy chilling.

There's no need for controversy about birth control. It's a plain fact that we cause pollution however much we would like to avoid it just by being alive. James Lovelock put it in a nice way: he said that the 7 billion of us just by breathing, were putting out 4 times as much CO2 in the air as all the airlines of the world and 10 times as much if we take into account our livestock. He said that if we really wanted to improve our carbon footprint, we could just hold our breath!

Since even the staunchest environmentalists have an ounce of survival instinct, we must look for more convenient solutions...

There are millions of educated couples having children and not realizing what the impact on future generations will be. As I listened to my wife, I envisioned the government running advertising campaigns on how much it could help if couples decided to limit themselves to a single child.

I remembered the taxi driver who took me to hospital after my daughter was born. His theory was that you always needed to have an extra child to keep company to the latest one. He was certain I would have another. He had 8 children and had resolved to keep adding to his family to insure that the last one wasn't lonely. I dared not tell him about my views on the topic...

It is a plain fact that in the developing world, large families are seen as insurance policies to look after the parents in old age. The logic is that the more children you have, the more likely it is that one of them will hit the big time and be able to look after the family when they can no longer look after themselves. So when we think about population growth, we turn our sights to the developing world. Here in the UK however, given that people are richer and more able to consume, consumption has overshot the Planet's ability to regenerate. Our lifestyle has become unsustainable due to population growth. If there weren't so many people on the Planet, there would be nothing wrong with it. The reality is that there's 7 billion of us and we only have one Planet to share. The Planet can tolerate 3 tonnes of CO2 per person at the most. This indicates that in terms of CO2 emissions, every child born in the UK requires 4 times the Planet's resources to meet their needs. Thus, when a child is born in the UK, it is equivalent to 4 children being born in the developing world. This is controversial but it is a fact. And that's why it's so important that we do something fast about our carbon emissions otherwise epidemics, famine and war; the consequences described by Malthus await us.

It would be worthwhile conducting further research on the psychology of people who decide to have small to medium size families so that appropriate advertising could be implemented to raise the level of awareness about the consequences of these choices.

One of the best ways you can support the fight against global warming is by supporting the main charity dealing with the Optimum Population Trust. They don't need much. Click here to donate.