If the EU “Renovation Wave” for buildings fails, the massive ramp up of clean electrification required to compensate will come into direct conflict with EU ETS pricing formulas, say Sebastian Osorio and Michael Pahle at the Potsdam Institute for Climate Impact Research and Oliver Ruhnau at the Hertie School in Berlin. If the cap in the original ETS is too tight relative to the Effort Sharing Regulation (ESR) targets, its carbon prices may rise considerably due to the additional electricity demand for heating and difficulties with decarbonising district heating. Carbon prices in the original ETS might become higher than those in the BRT ETS (for buildings and road transport), contrary to what is currently expected. This could hamper the electrification of heat, and result in technology lock-ins (e.g., replacing oil boilers for gas boilers). The authors urge the EC to limit price differences between the two systems so that adequate price signals ensure the phase-out of decentralised fossil boilers. The solution could be to adjust the cap with an eye on renovation progress, or to implement a gradual linking between the ETS and the BRT ETS. Thus, high price differentials could be automatically balanced out, paving the way for full integration from 2030 onwards.
What if the “Renovation Wave” fails?
Residential and commercial buildings in the EU consume 40% of total final energy, and account directly or indirectly for 36% of energy-related greenhouse gas emissions. A main pillar to decarbonise buildings is the ‘Renovation wave’ strategy. But what would happen if the related deep renovation failed?
In that case, electrification of decentralised heating and decarbonisation (and potential expansion) of district heating would need to scale up significantly. This in turn would create substantial additional demand for electricity, and potentially additional demand for district heating, leading to a gradual shift of the building sector from coverage under the Effort Sharing Regulation (ESR) to the Emission Trading System (ETS).
Depending on scope and pace of this inclusion, the currently proposed tightening of the cap could turn out to be too tight. This necessitates to better coordinate the interaction between the EST and the ESR, in particular with the upcoming ETS for buildings and road transport (BRT ETS).
Uncertainty around the Renovation Wave
To reduce emissions, the European Commission is aiming to enhance energy-efficient renovations through its ‘renovation wave’ strategy. With the EU Green Deal (EGD), the European Commission emphasises the need for urgent action through its ‘Fit for 55’ package in order to meet the long-term goal of climate neutrality by 2050.
In line with the Energy Efficiency First principle, the EGD intends to rigorously enforce the revised Energy Performance of Buildings Directive (EPBD) and trigger a ‘renovation wave’ with the aim of renovating Europe’s entire building stock by 2050 so that it becomes ‘nearly zero emissions’. Indeed, renovation has a large potential, considering that the lion’s share of buildings in Europe is old (two thirds of the EU building stock was built before 1980) and very inefficient (75% of buildings has poor energy performance).
There is nonetheless a substantial risk that efficiency gains do not to deliver the required emission reductions. Despite the large potential for energetic renovation, of the 12% of EU residential buildings undergoing some level of renovation each year, only 0.2% meet the deep renovation standards needed for nearly-zero emissions. Although the share of area renovated was as high as 24% in single states (Romania), deep renovations did not account for more than 0.3% (see upper panel in Figure 1).
As a result, heat-related consumption in buildings has rather stalled (space heating decreased only by 1% per year during 2012-2016). In the non-residential sector (see lower panel in Figure 1), the picture is even worse. Although deep renovation amounted to 0.3%, this was not enough to reduce space heating consumption, which indeed increased by 4%.
To illustrate the magnitude of the required ratcheting up, according to BPIE, deep renovation rates should increase to at least 2%, and rapidly get closer to 3%, delivering energy savings of 2.5% per year, in order to reach emission reductions (60% by 2030) aligned with the EGD.
However, an analysis of the long-term renovation strategies from 8 countries finds that such an objective is unlikely to be achieved and that none of the strategies is aligned with the climate-neutrality objective.
In addition to these historic trends, it remains questionable whether the new EU regulation can solve the fundamental problems behind this slow progress in heat decarbonisation. Apart from the lack of incentives to renovate resulting from the landlord-tenant dilemma, one of the biggest barriers is that consumers do not have adequate information to make decisions on renovation, especially for deep renovation which need a more comprehensive package of measures.
Other barriers include lack of a skilled workforce for installation and maintenance, lack of public and private financing instruments, long payback times, regulatory and administrative barriers, and lack of internalisation of carbon costs in heating fuels. Although these barriers are well-known, the regulation in place might not be enough to overcome them and reach required deep renovation rates.
If renovation fails, we’ll need more electrification and carbon-free district heating
If deep renovation indeed fails, electrification and carbon-free district heating would be needed all the more. Figure 2 provides an overview of the different decarbonisation options for heating. In general, the heat is generated either by decentralised heating systems, which serve single houses, or district heating, which supplies heat to a larger number of buildings.
The continued use of district heating, and possibly its extension in densely populated areas, would imply the challenging phase out of fossil-based plants connected to those networks (68% in 2020 at EU level, according to Eurostat figures). In fact, both decentralised heating and district heating are dominated by fossil fuels today.
The first decarbonisation option is the direct integration of renewables, including solar thermal and biomass, and waste heat from industries. However, this option is limited because of the adverse seasonal correlation of heating and solar radiation and because biomass may be primarily used for hard-to-decarbonise sectors, such as industry and long-haul transport. This means that most of the decarbonisation will depend on electrification using heat pumps and, to a lesser degree, electric boilers. Indeed, a previous Energy Post article questions spending on expensive renovation when buildings could be supplied by carbon-free electricity in the near future.
Both heat electrification and the decarbonisation of combined heat and power (CHP) connected to district heating would have considerable implications for the power sector. It is widely thought that the decarbonisation of the power sector will go smoothly. Coal phase-out (and eventually gas phase-out) resulting from higher prices in the EU ETS together with RES expansion plus the entry of large-scale energy storage could lead to a very rapid transition.
However, to what extent failing to deeply renovate could put this development upside down? According to a JRC report, if all current decentralised fossil-fuelled heat generation technologies were replaced by heat pumps overnight, heat pumps demand would be 26% of the total electricity demand adding 526 TWh to the final electricity consumption (2,910 TWh). This demand is not only very large in energy terms but also highly concentrated in winter, increasing the winter peak demand by 20% to 70%.
Although there is some correlation between heat demand and wind energy, it will still be a challenge to integrate this seasonal heat demand into the electricity system. If fossil-based CHP for district heating also needs to be decommissioned, this would not only imply a further increase in electricity demand in the case of centralised heat electrification, but also reduced electricity generation capacity, resulting in tighter capacity margins and higher electricity prices.
Further implications for the entire EU ETS
As a result, heat electrification and a potential expansion of district heating constitute a de facto inclusion of the building sector into the current EU ETS.
The lion share of heat demand is currently covered by decentralised boilers (90% in 2015), most of which use fossil fuels, producing on-site emissions. These emissions are currently covered by the European Effort Sharing Regulation (ESR), and decarbonisation is driven by national policies, including command and control measures, such indirect or direct ban to install new fossil-based boilers in several Member States (e.g., Belgium and the Netherlands), and national carbon pricing, potentially through a national ETS such as the proposed national German ETS for buildings and transport.
A second EU ETS for buildings and transport (BRT ETS) is currently under discussion, which would complement these national measures with a European price on carbon in the current non-ETS sectors. Independent of whether a BRT ETS is implemented, the building sector will be integrated in the current EU ETS: electric heaters and heat pumps are causing indirect emissions through electricity generation, which are accounted for within the current EU ETS. Likewise, emissions produced by district heating are included within the EU ETS.
The implications for the current EU ETS are substantial as it has already to deal with very ambitious targets. The ETS faces a very stringent landscape: under the ‘Fit for 55’ package (still to be negotiated), the LRF (linear reduction factor) will almost double (from current 2.2% to 4.2%), leading to a desired reduction of 61% by 2030 (from current 43%) with respect to 2005 levels.
While under current conditions the power sector is expected to provide most emission reductions in the EU ETS, it is not clear how easily it could keep up the pace in a scenario in which renovation fails and the power sector needs to cope with significantly more demand. This could even have an impact on how fast and costly the decarbonisation of energy-intensive industry takes place.
How to harmonise the intertwined EU policies?
The crucial issue here is how the cap in the current ETS should be set and how to better coordinate the interaction with the ESR/BRT ETS. If the cap in the original ETS is too tight relative to the ESR targets (or potentially the cap in the BRT ETS), carbon prices in the original ETS may rise considerably due to the additional electricity demand for heating and difficulties to decarbonise district heating. In the end, carbon prices in the original ETS might become higher than those in the BRT ETS, contrary to what is currently expected. This in turn can hamper an electrification of heat, which would actually be economically efficient. To account for this substantial risk originating from the uncertainty in building renovation, the European Commission should limit price differences between the two systems in order to ensure adequate price signals to phase-out decentralised fossil boilers.
If proper incentives are not implemented in time, the sector would likely face technology lock-ins (e.g., replacing oil boilers for gas boilers). A way out would be to adjust the cap contingent on renovation progress, or better to implement gradual linking between ETS and BRT ETS. In that way, high price differentials could be automatically balanced out, and the way would be paved for full integration from 2030 onwards.
Sebastian Osorio is a Postdoctoral Researcher at the Potsdam Institute for Climate Impact Research
Michael Pahle is a Working Group Leader at the Potsdam Institute for Climate Impact Research
Oliver Ruhnau is a Research Associate at the Hertie School in Berlin