The world is facing its most serious energy crisis since the oil shocks of the 1970s. Fossil fuel prices started to recover in 2021 as global demand returned following the pandemic, then spiked alarmingly in early 2022 following the invasion of Ukraine.
By the IMF’s reckoning, at the end of the first quarter of 2022, European crude oil prices had doubled, coal prices tripled and natural gas prices increased more than five-fold compared with early 2021. While prices have fallen back somewhat since then, elevated costs are expected to persist, with half of the increase in the price of coal and oil, and a quarter of the increase in the price of gas, predicted to continue through 2026. The US and Asia have also seen sharp increases, albeit on a lesser scale, with natural gas prices about 1.5 times higher.
Governments have introduced expensive support packages to prevent catastrophic damage to livelihoods, but soaring prices have nonetheless severely impacted the finances of many households and businesses. In the logistics sector, they have driven a sharp rise in operational expenses as the cost of transportation and of the energy required to light, heat, cool and power warehouses has increased.
Concerns have been raised that the situation could derail progress towards better environmental performance in the sector as occupiers look to pare back their expenses. “In times of economic downturn, corporate priorities do change. Based on that, we could anticipate that maybe sustainability will lose some of the focus it enjoyed in the past few years. And we saw that happen with the global financial crisis 15 years ago,” says Dragana Marina, sustainability research lead for continental Europe at CBRE.
“However, it is important to remember that sustainability is now playing a fundamentally different role in corporate strategy. Then it was a nice-to-have add-on. Now, it is so embedded into market practices that you can see it in all elements of the corporate strategy.”
That applies equally to major logistics businesses as those in other sectors, argues Nick Cook, president of GLP Europe: “Most big businesses these days, and the majority of our customers, are blue chip, global organizations which are taking sustainability more seriously from a moral perspective, as well as a financial one. I don’t think anyone is pausing their sustainability efforts. They can’t afford to.”
Opportunity in a crisis
Marina notes that the 1970s oil crisis was instrumental in driving the development of the wind power industry. “The question is, can we do the same right now? ESG and sustainability could turn out to be the winners from the current situation.”
For logistics businesses, energy is part of a complex overall operating cost equation that also includes labor, transportation, property and proximity to suppliers and customers. A small-scale study of the impact of higher energy costs on tenants across CBRE Investment Management’s European portfolio showed few of them considered it a big issue, says Laurie Lagarde, head of the manager’s EMEA logistics operator division.
“Most of them say it is a medium-sized issue and that they are covering it, unfortunately, in some cases, by passing on higher prices to the consumer,” she says. Lagarde notes that tenants occupying high-performing carbon-neutral buildings are in a more comfortable position because they see it as providing a competitive advantage. “There will be more demand, and more competition, for energy-efficient buildings, so where we have those buildings, rents may increase,” she predicts.
Energy is a more significant component of overall occupier costs than rent, which has sometimes attracted a disproportionate focus, says Cook. “Sustainability is not getting bumped down the agenda. In fact, it is quite the opposite.
“Customers are expecting us to deliver super-sustainable buildings with specifications that help them save money in their operational use, whether that is simple things like more roof lights, or rainwater harvesting, or more progressive stuff like the installation of roof-mounted photovoltaics linked up to battery storage for EV charging. These are discussions that we are having with all of our customers, in all of our markets, all of the time.”
Energy price volatility will encourage landlords and tenants to collaborate on making improvements, says Jack Cox, head of EMEA industrial and logistics capital markets at CBRE. He notes that while tenants are frequently reluctant to pay for better ESG credentials without evidence of a clear economic benefit, the current situation accelerates the timeframe within which capital expenditure necessary to install energy saving features such as LED lighting will pay back in terms of reduced bills. “Occupiers will pay more rent if they get a proportionate saving.”
The return on investment can also manifest in a less tangible, but no less important way, through increased liquidity, Cox adds. “Until recently, every warehouse that came to the market cleared. But with the volatility in financial markets there is more of a question over liquidity.
“It is impossible to set a prime yield without prime ESG credentials. That is just a fact of life today. But also, in a buyer’s market where buyers have the choice to allocate capital against various metrics, the number one item, particularly for those investors with the lowest cost of capital like insurance companies and core funds, is ESG.”
Elevated power costs encourage more logistics owners to install solar panels on building roofs by shortening the amortization period for investments in onsite renewables. “It draws into focus the importance and the scarcity of energy, how we should be using it carefully, and the environmental impact associated with it. In the logistics space, we have seen no end of calls to explore rooftop solar,” says Jonathan Hale, head of ESG consulting for the UK at global brokerage firm Knight Frank.
Energy remains a relatively small element of the overall cost of many logistics operations, points out Stuart Gibson, co-chief executive of Asian logistics platform ESR. “A 200,000 square meter warehouse in Tokyo, with a bit of automation, picking and packing, uses maybe two megawatts of energy. We can produce five megawatts from the solar on the roof,” he says.
High energy prices increase the profitability of selling on that excess electricity, however. “I can sell it to the grid operator or transfer it to our own data center business. Data center operators will be feeling the pinch because they suck up hundreds of megawatts. We can mitigate that because we produce so much energy from having the biggest rooftop area in Asia,” Gibson adds.
The US is the world’s largest natural gas producer, and with inventory levels far less depleted than in Europe, it has consequently been spared the worst effects of the energy crisis. “It is way less important here than it is in Europe,” observes Michael Neuman, head of industrial for the US and Latin America at investor Ivanhoé Cambridge.
He also notes that the sustainability agenda is less advanced in the US market, but he believes that the current situation could provide impetus for change. “There has still been a substantial increase in prices, and hopefully tenants will be more wary of their consumption and will try to make more savings.”
To date, ESG is a more mature and impactful issue in European industrial markets than it has been in the US, concedes Jason Tolliver, logistics and industrial co-lead for the Americas at brokerage and advisory firm Cushman & Wakefield. “However, it is top of mind for the largest corporate citizens, for institutional investors that are purchasing real estate, and for managers who are hoping to encourage investors from Europe.”
So far, energy price rises have not stifled demand for space, he says. “The impact from the occupier standpoint has been that costs are being passed on to the consumers further down the line.” The consequences for the wider economy may yet be felt within the industrial market, however.
“The key thing for an institutional investor to watch is what impact, if any, do gas and energy prices have on the discretionary spending of consumers, because industrial demand will ultimately rest upon that,” Tolliver says. “As consumers pull back, retail sales fall and logistics demand related to the movement and storage of those goods declines as well.”
Whatever the future trajectory of the logistics market, the requirement for greener buildings is now firmly entrenched, says Peter Ballon, global head of real estate at Canadian investor CPP Investments. “We lease to the largest, most sophisticated players, many of which have net-zero targets. Delivering the most energy-efficient and net zero-friendly buildings is definitely a competitive advantage, because this is their top priority. And that is not exclusive to Europe or the US. We see that across the world now.”
While headquarters have hitherto been the focal point of corporate sustainability plans, logistics offers a further frontier, and rising energy prices will not cause occupiers or investors in the sector to alter course, concludes Cox. “So much of the carbon footprint of organizations sits in their supply chain that the opportunity to mitigate that is a golden one,” he says.
“At a point in time when yields have rebased and total returns are increasingly focused on income, net operating income is one of the most important metrics, so there is a real financial benefit to doing the right thing.”