As China urbanizes, buildings in the country’s cities are a growing source of emissions and air pollution. Energy use from public sector buildings rose 15 percent between 2006 and 2010, and heat and electricity from emissions-intensive coal now account for half the energy consumption of public buildings in northern China. Installing efficient technologies and energy codes for new buildings can help, but what about inefficient existing buildings?

Today at the U.S.-China Symposium on Energy Performance Contracting in Beijing, the Chinese and U.S. governments announced a new pilot program that could offer a solution. The program seeks to build momentum for energy performance contracting (EPC), a renovation model where a building owner can work with a private company to install efficient technologies, and then use the cost savings from reduced energy consumption to pay for the efficiency upgrades. While EPCs are already used regularly in the United States, the pilot project will help expand the model in China as a way to curb emissions and save money.

China renews focus on efficient public buildings

In the United States, the federal government has a list of approved energy savings companies (ESCOs) that can bid on renovating government buildings. These ESCOs all use a standard contract approach, common measurement and verification rules to track energy savings, and they have relationships with financial institutions that fund the retrofits. Once energy efficiency renovations are in place, a building’s energy demand drops, and the savings are used to pay back the cost of the new technologies. The ESCO guarantees the energy-savings performance for 10-20 years, and once the investment is paid back, the government gets all savings generated through the efficiency measures. This is called a “guaranteed energy savings” model.

In China, however, EPC arrangements are far less common in buildings. The current “shared savings” model used in China requires the ESCO to provide the majority of the funding for the project, and the energy cost savings are split between the project host and the ESCO. This limits the size of the projects. Unlike guaranteed savings, the ESCO takes on all the risk, limiting the attractiveness of EPCs to external investors.

However, the opportunity to use EPCs to reduce energy demand should not be missed: China’s public buildings represent less than one percent of the country’s current EPCs, yet these buildings are responsible for 6.2 percent of the country’s total energy use at 192 million tons of coal equivalent. That’s slightly more than Spain’s total energy consumption in 2010. Chinese public buildings represent a significant market opportunity.

At this week’s conference, Chinese and U.S. participants from industry, finance and government discussed a new market opportunity analysis, a resource toolkit, and policy recommendations for the Chinese government, prepared by Lawrence Berkeley and the Pacific Northwest National Labs and the ESCO Committee of the China Energy Management Company Association. Here are four recommendations they make for policymakers to move beyond the shared savings model to expand building efficiency in Chinese cities:

• Expand tax and financial benefits beyond “shared savings” approaches: China’s federal tax and financial incentives are currently limited only to ESCOs that finance 70 percent of the project’s cost themselves. This requirement, combined with the fact that the ESCO and the building owner split the savings, favors smaller, single technology investments rather than bigger, bundled retrofits with deeper energy savings.

• Encourage third-party financing: External investors and banks are more likely to participate in the efficiency market if there are standard contracts, common measurement and verification protocols, and credit enhancement from government or multi-lateral development banks to reduce the risk and create confidence in EPCs in the building sector.

• Modify public sector procurement rules to favor energy efficiency: Two barriers exist today in China’s public buildings. For one, there are no rules and best practices identified to support the use of EPCs, making the process feel risky to city procurement officials. And second, energy budgets might be decreased if energy efficiency is achieved. While this appears logical, if the building manager is not given a budget that includes both energy cost and the funds to cover cost of the contract, he/she may feel that energy efficiency is too risky. Keeping a constant budget year-over-year as long as a performance contract is in place would help eliminate this concern.

• Provide special incentives for projects that deliver better energy savings: Today in China and the United States, most energy efficiency incentives like tax or utility rebates are provided for individual technologies. This is important, but incentives could also be provided if whole buildings or performance contracts deliver “deep” energy savings – say a 20 percent reduction from overall energy consumption.

Two building efficiency examples worth replicating

We’re already seeing some local governments and private companies overcome barriers to EPCs. For example, Shenzhen, located near Hong Kong, requires energy performance contracting in public buildings and creates its energy budget based on the energy intensity of the building rather than just looking at the cost of energy. When EPC projects reduce the building’s energy demand, the city does not reduce the building’s energy budget. Instead, the budget covers both utility bills and payments for the energy savings contract.

Private ESCO companies like Johnson Controls are trying a hybrid approach between China’s current shared savings model and the U.S. guaranteed energy savings model. One example is the Beijing Chemsunny World Trade Center project. For that building, Johnson Controls bundled many energy-savings technologies under one contract, guaranteeing that the project would reduce overall energy demand by 616 tons of coal. The owner paid 85 percent of the renovation cost up front and paid the remaining 15 percent after a year, when a third party verified that the intended energy savings were achieved.

In both Shenzhen and the Chemsunny World Trade Center, the contracting model was attractive to the owner of the building, as well as to the private contractor. The risks of the projects were managed in a way that both the building owner and the contractor were satisfied. These hybrid structures also encouraged deeper energy savings, which would make them attractive to external financiers.

Moving forward with greater efficiency

China’s cities are already grappling with the negative effects of buildings’ energy use. The country continues to rely heavily on coal, fueling dangerous climate change. And just this month, Beijing’s air pollution soared to a level 20 times higher than that which the World Health Organization says is healthy. Energy performance contracting is a cost-effective solution that yields benefits for citizens, for companies and for the planet. With the new approaches and pilot program launched today, industry and the government can together chart a new course.