JOANNE FOLEY: Hello and welcome to our WTW Construction Blueprints podcast. I'm Joanne Foley. I'm the head of construction for Europe at WTW and your host for today's podcast, where I'm delighted to be joined by Maria Gamez and Will Scargill from our climate practice. Hello, Will.
WILL SCARGILL: Hi, Joanne. Thanks for having us today.
JOANNE FOLEY: And hi, Maria.
MARIA GAMEZ: Hi, Joanne. I'm so excited to be here.
JOANNE FOLEY: Great. Thank you both. So if you listen regularly, you'll know our series of podcasts that aims to provide a focus on some of the most relevant topics facing the construction industry, and climate is certainly one of the most pressing indeed for many industries, so I'm really delighted to have Maria and Will here to share some of their insights specifically around the financial risks and maybe opportunities that are presenting to the construction sector from the transition to that lower carbon economy.
So guys, the statistics that we see often tell us that the built environment and the construction industry are significant contributors to carbon emissions. So is climate transition also a significant focus for the industry? and what are you seeing in terms of how it might affect the sector?
MARIA GAMEZ: Absolutely so yeah. Joanne, thank you again so much for having us. To first give you maybe some context as to what our knowledge on climate risk and construction is actually based on, Will and I are part of a team in the climate practice that focuses on quantifying transition risk, which is the climate transition analytics team. Makes sense. We focus on the economic and on the financial modeling of climate risk. We kind of specialize in identifying, quantifying, and mitigating transition risks. We look at transition kind of on a sector firm and asset level across scenarios. So constrained by the carbon budget of a transition scenario, we kind quantify how sectors will need to change in order to hit global targets.
For example, with our sector-level research, we might look at how many electric vehicles need to be on the road in each year until 2050 to limit global warming to two degrees. And then we determine the financial impact on businesses kind of across the board. And we also use in-house commodity modeling to calculate the impact that decreased fuel demand would actually have on the price of oil and, as a result, on the profitability of all kinds of oil assets.
These are just examples. Of course, we do this for all sectors basically, and all commodities kind of in an interlinked way. From a construction perspective, we look at how the demand for different building types, construction services might change and how the cost of construction materials would actually change.
So after that preamble, to go back to the question you actually asked, which was on possible changes in demand in the construction industry, possible changes in building types, building quality, kind of the first thing that I would probably talk about there is how the types of spaces that are actually needed in a transition would shift and how energy efficient those spaces would need to be, starting off with maybe commercial space demand.
So demand, for example, for new and existing office and retail space that's all, in our view, likely to decrease in a transition. So for offices, as a measure to improve energy efficiency and to reduce commuting emissions, you might see work styles needing to shift more towards working from home, which would then decrease overall office space in a transition, which is similar and kind of a carrying forward of some of the trends that we've seen since COVID, and it's kind of an easy lever for companies to pull if they're faced with reducing their emissions by regulators.
And then if you think about retail spaces as a result, thinking about maybe circular economy principles to reuse and recycle items, the demand for traditional retail spaces where you go to a store and buy a new top might decline with the demand for clothing, appliances, and other goods kind of going down because, in a transition, we just need to be way more efficient with our resources, items need to last longer, and my sweater might be owned by more than just myself.
Obviously, this wouldn't happen across all economies. It's definitely something that is stronger in developed regions like Europe, for example, where you actually have the stuff to circulate around. For example, Europe is quite saturated already with things that can kind of be passed out. If you've seen maybe in your local community a tool lending library or you've been on a second-hand clothes app like Depop. Those kind of trends are already kind of taking hold, and in a transition, those are likely to strengthen.
Aside from that demand for spaces changing, I mentioned energy efficiency earlier. Yes, existing and new spaces do need to improve their energy efficiency. So new builds, first of all, need to be built to much higher standards, and retrofitting rates need to ramp up significantly in a transition. So if you're thinking about what are the retrofitting rates right now, they're very low. They're about 1% per year right now 1% percent of the building stock and most of those are shallow renovations. So the renovations that are happening right now are not to the level needed to get buildings to be as energy efficient as they need to be, and that rate would actually need to double to get us anywhere near a net zero.
And what that kind of translates to is that by 2050, 85% of currently existing buildings actually need to have been retrofitted to a net zero standard. So, if you have a window, looking around you, that means that almost every building standing today will need to either be torn down and rebuilt in a very energy efficient way, or it's going to need to be retrofitted to a very high standard.
And as a side effect of that so kind of tying this back to actual demand for new builds that retrofitting need is going to result in a lot of buildings that have been deeply retrofitted, lasting longer, and having secondary impact on actual new volumes. You've probably heard about embodied carbon. That's definitely going to be an increasingly considered factor when a developer is looking at demolition versus retrofitting.
Maybe to give listeners a bit of an idea of what the definition of embodied carbon actually is, that is, the emissions that are associated with materials and the construction process of a building. So if you think about an office building, all of the embodied emissions are going to be the concrete, the steel, the energy that was needed to produce that concrete and steel, and the energy that was needed to transport that concrete and steel to the working site.
So if you retrofit instead of rebuild if you maintain that concrete and steel structure if you reuse as much as possible you can save those emissions needed to produce and transport, and those savings are pretty significant. So of course, it's different for every building, and not every building is a candidate for renovation, but if you look at some of the academic studies case studies, obviously but you can see that embodied carbon associated with a completely new building can be, in some cases, double that of a deeply retrofitted one, so there's a lot of savings to be made there if you have pressure to reduce emissions per square meter.
As a result, like I said, demand for totally new construction of all building types is likely to fall in a transition because of that retrofitting lever, and already you can kind of see the sprouts of this happening. So if you are based in London, maybe you can rattle off a couple of buildings that or a couple of sites that have seen this happen. For example, Battersea Power Station, which is now a mall, or you've got the BT telecom tower, which is going to be a hotel, or the old BT office building, which in a renovation is keeping that existing concrete structure and it's renewing the rest.
Yeah, I mean, summing it up, construction companies would probably face an overall lower demand for completely new construction based on the space demand lever and that retrofitting lever but they are likely to see upsides in any renovation or retrofitting business. With that being said, a definite requirement to adjust construction practices because retrofitting a power station into a mall it's not something you do every day, and it's something that kind of requires a more bespoke approach to new projects.
JOANNE FOLEY: Great. Thanks, Maria. That's really interesting. Construction, as an industry, were responding to societal demands and needs, and one of the bigger is around infrastructure. So I wonder, from your perspective, how might you see some of these transitions specifically impact the infrastructure sector?
MARIA GAMEZ: Yeah, for sure. So as you might expect, the biggest shifts in a transition would happen in energy and transportation infrastructure due to changes in the demand and costs for these kinds of infrastructures. Looking at air travel first as an obvious big emitter, we kind of intuitively know that air travel needs to decarbonize, but just decarbonizing air travel won't be enough. In developed markets, we actually need to fly less to hit two degrees and below targets.
So one level there might, for example, be business travel with businesses kind of having pressure on regulators to decarbonize their practices. You would see companies kind of mitigating their carbon emissions by sending their employees out less. But you would also see for consumers so for you or I that long-haul leisure travel is significantly diminished because it just costs way more.
So the cost of sustainable aviation fuel isn't going to be born necessarily by the airlines. They're going to pass it on to consumers, just like the carbon offsetting requirement that airlines might face would be passed on to consumers. And we see that lever really driving down long-haul air travel and kind of making tourism a lot more regional.
As a result, as you might expect, lower volumes and higher costs of transportation would mean that the profitability of airports decrease and that high fixed cost of running an airport would be spread over fewer flights and would decrease the margins for airports. As a result, obviously, you're going to build less airports, you're going to expand less airports, you're going to open up less new destinations, especially, like I said, in developed markets. We see this effect being somewhat less in developing economies.
On the flip side, it's not all bad in transportation infrastructure. Obviously, rail travel would need to expand quite a lot to absorb some of that travel desire. Right now, rail represents about 10% of all passenger travel. In a transition, that percentage would increase quite significantly with more infrastructure investment and that relative increase in the cost of flying, kind of pushing people more towards rail travel, and that expanding capacity would mean building new destinations so making new destinations accessible, but also expanding existing routes, which is a really good opportunity for new construction and pretty much most regions.
So that's transportation. An obvious instinctive downside that you might think about is energy infrastructure in the fossil fuel industry specifically. No surprise there. As demand for oil declines, the CapEx for greenfield and for brownfield production would decrease in a transition. But at the same time, a lot of types of renewable assets that are still very capital intensive but are highly demanded in their construction would see construction companies having plenty of work depending on the region and depending on their specialization.
So the impact of infrastructure is pretty varied. It depends on the construction company's kind of expertise, and who wins and loses in a transition would depend on companies understanding of what sectors are at risk and which sectors and markets will actually experience growth depending on how those companies position themselves.
JOANNE FOLEY: Great. So it's going to change not only with what we do, but how we do it, and how much of a factor, I wonder, is the impact on the cost of how we do it.
MARIA GAMEZ: I'll pass that one along to Will.
WILL SCARGILL: Thanks, Maria. So as the world looks to decarbonize, really, construction materials and the industries producing those materials actually pose some of the biggest sectoral decarbonization challenges, and a lot of that relates to the production of steel and cement, which Maria's already mentioned. So for cement, the emissions don't only come from the energy use in manufacturing, but there's also the limestone calcination process inherent in producing the clinker that acts as the binder in cement, which emits CO2 and actually emits a pretty significant portion of the overall emissions from the cement sector.
So what that means is that in addition to decarbonizing the energy that cement manufacturing plants use through using renewable energy, electrifying kilns, or changing to alternative fuels, the cement sector also needs to invest heavily in carbon capture and storage in order to capture those emissions that come from the chemical process around producing cement. There's also potential to switch to alternative cements that are free from limestone-based clinkers, but those are at a pretty early stage at the moment and so unlikely to play a very significant role as by 2050.
So when we look at the industry as a whole, we see carbon capture and storage playing quite a significant impact in decarbonizing cement, and in a net zero by 2050 scenario, we think those investments could increase the price of cement in Europe by 20% by mid-century. So that's quite a significant increase coming from those investments that need to be made to decarbonize.
So like cement, the steel sector also faces some pretty major capital investments to decarbonize. It's a very energy intensive production process. And here blast furnaces may need to be replaced with electric arc furnaces, or like cement, carbon capture may be needed to be added to production facilities. This all puts pressure on costs that may be passed through to construction projects.
If the world is to meet its climate goals, however, demand-side measures are also going to be needed. Maria's already mentioned some of these. Reducing the embodied carbon of buildings through retrofitting rather than doing complete new builds. However, construction is really going to have to become more efficient in materials use across the board. Designing more efficient structures is going to be important, but also wasting less and recycling more.
JOANNE FOLEY: Great. And how might we see all of these changes starting to impact the financials of construction companies that we already run at low margins?
WILL SCARGILL: The thing is, these are costs that are going to impact the whole construction industry as it decarbonizes, and therefore, there's quite a lot of likely potential for costs to be passed through to consumers and for firms therefore to hopefully maintain their margins. However, that will depend on the price elasticity of those markets and the availability of alternatives. And so, particularly say if you're selling into a declining sector where their own margins are pretty tight, that may be difficult for you to pass through those increased costs.
So with tight margins already in the construction sector, if you don't plan for those changes in costs, that could mean that projects that would be profitable would actually become unprofitable. And in order to make margin competitiveness, some of that efficiency that I mentioned before is actually going to be important from a business perspective as well as an environmental one, with construction companies becoming more efficient in their use of materials from a cost perspective and helping that bottom line.
JOANNE FOLEY: Oh, so you've really emphasized the importance of planning. So as a construction company, how do I start planning?
WILL SCARGILL: We'd say the first thing to do would be really to understand the risks to your lines of business and to your customers. So as Maria explained, a low carbon transition will mean declines in some construction markets but also offers significant growth in others. So I think really the first port of call should be to understand how those market trends could impact your future revenues, which areas of your business could face those declines, and which are going to see potentially higher growth as the world transitions.
On the other side of the coin, from a cost perspective, as we've said, it's going to be really crucial to gain an understanding of how your input costs might change. You can understand that, and it helps you to identify potential margin pressures and price future work correctly, but also to focus in on any areas where efficiency gains could help protect your bottom line. So doing analysis in order to project what those changes and costs could be for your business is really important.
After assessing the pressures that your business faces, it's crucial as well to incorporate that understanding into your strategy so that your business is ready for the risks that transition may bring and could also benefit from its opportunities. That might mean shifting your focus to the most resilient markets or being more efficient with materials or making wider changes to your business.
We've already seen companies start to do this. For example, with some cement companies developing new business lines around construction service, there's all equipment for energy-efficient refits. And this is really a question we work with clients a lot on and is at the heart of our work, and it's one that all businesses need to take seriously to develop a climate resilient strategy that helps your business succeed rather than just seeing climate risk as a disclosure exercise. It's really at the heart of planning for the future.
JOANNE FOLEY: Great. Thank you very much, both of you, for your contributions and sharing your perspective. Maria, any key takeaways before we wrap up?
MARIA GAMEZ: Yeah, for sure. Let me give a couple of highlights from my monologue earlier. I think the first takeaway would be that demand for different types of spaces is going to change in a transition. You got to be aware of where your specialties as a construction company lie so that you know where demand is going to go. The second one would be that the demand for how energy efficient space is going to change. And third of all, demand for retrofits is going to need to increase significantly in a transition, which is going to have an impact on the overall volume of new construction.
That does not necessarily mean that all hope is lost for construction companies. It just means that kind of building practices might need to become a lot more site-specific as retrofits are still a lot of work, but they are different from site-to-site from space-to-space.
JOANNE FOLEY: And Will, any final words from your perspective?
WILL SCARGILL: Yeah, so I would say the watchword is resilience, and often resilience is thought of from a climate risk perspective as kind of making your infrastructure and assets more resilient from the actual physical impacts of climate change, like building a seawall or making assets in another way, but really as crucial as that is making your business strategy resilient. And so I would say plan for different scenarios, understand how those market changes and costs may impact you, and incorporate that into your strategy because if you don't, then you're going to be caught out by those changes as they come on and as their world transitions.
JOANNE FOLEY: Thank you again, both of you very much. And thank you to everybody who has listened today and joined us on the WTW Construction Blueprints podcast. Until next time,
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