Fjord IT participated on this year Envirotech & Clean Energy Investor Summit in London, where former US vice-president Mr Al Gore, now Chairman of Generation Investment Management, held keynote “New Opportunities for Sustainable Capitalism”. This article represents some of my main take-a-ways from the speech:
Denial is still a serious problem! In spite of that, we are in a perfect storm with many effects – some of them good. This storm brings with it change; strategic investors are coming in and technologies that have had succeeded in the market are now mature.
So where is the trend going? Looking 6-7 years ahead from now, renewables price will be below average grid from fossils fuels. How? The cost-down curve for (solar) photovoltaics, wind and a whole suite of energy efficiency technologies will push down the price of renewable power below or equal to the grid average of price where 85% of the world’s people live, according to Gore.
This storm challenges us to think differently, one way of doing that is to learn from the mistakes done in the past; The standard model in economics has been challenged quite severely by behavioural finance, analytics and a whole range of other assumptions, but the repeat appearance of bubbles in the market actually presents the assumption of perfect information, as a lie.
For instance, let’s take the emergence of mobile phone in the 80′s. AT&T concluded after a great deal of study that by the year 2000, there would be 900,000 mobile phones in worlds markets. By the year of 2000, there were 109m! They were off by 108m in their forecast. Now there are 5 billion mobile phones. Gore asked:“Now, why were those projections not only wrong, but unbelievably wrong?”
There are several reasons: Firstly, many market analysts had difficulty shifting gears in the presence of a cost-down curve that is steep and relentless, and that continued. Secondly, the quality improved and size became more practical – both unanticipated. Thirdly, the purchase decision was in the hands of the individuals and not in the hands of the utilities or large companies. Fourth, they did not take into account the leapfrog opportunity poor countries had in going straight to the widely distributed model.
“Now think about distributed energy – both photovoltaic and wind. The same four, almost, are present.” Which in my opinion gives great cause for reflection.
The Next Bubble: Stranded Carbon Assets
Gore argued by reminding us of the sub-prime mortgage fiasco, “In the aftermath of the credit crisis and the great recession, it certainly did seem ridiculous to have ever believed that is was a good idea to invest in millions of mortgages given to people who had no possible way to pay the mortgages. Somehow, that risk was invisible to so many, to the majority. And why is that?”
Gore explained that there are a lot of reasons, behavioural finance offers some help in this, but basically the complexity of these instruments and the assumption of perfect information tempted investors to go along with the enthusiastic crowd and confused risk with uncertainty. “As the economist Frank Knight has established, there’s a really important – subtle but crucial – distinction between risk and uncertainty. Uncertainty is more dangerous in the view of most good investors, because you can’t price it. But there is a tendency to mislabel risk as uncertainty, and then to conclude that since it can’t be measured, it’s safe to ignore it“. This is dangerous.
And those sub-prime mortgage assets were massively re-priced.”...When they were re-priced, it really caused ostensibly a global run on the banks, the credit crisis and other factors contributed to the great recession and the larger housing bubble, but in retrospect it was obviously a mistake”.
Gore believes that the same mistake is being made now, with sub-prime carbon assets. A stranded asset is“an asset which loses significant economic value well ahead of its anticipated useful life, as a result of changes in legislation, regulation, market forces, disruptive innovation, societal norms, or environmental shocks”1. There are $7 trillion worth of sub-prime carbon assets on the books of multinational public companies today. There’s another $14 trillion owned by sovereigns. “Now, this group knows better than most that the climate crisis is unfortunately real, and Mother Nature is kind of underscoring the seriousness that is approaching”.
The Financial Risks in the Eye of the Storm
According to Gore there are three key risks driven by climate change:2
a. Direct Regulation: Regulations through national, regional, state or local carbon pricing or “cap and trade schemes”, that would mean a shift in the valuation of carbon-intensive assets.
b. Indirect Regulation: Increased pollution control, water-use restrictions, or policies targeting health related concerns; indirect regulation could negatively impact carbon-intensive business models.
c. Renewable Energy and Efficiency Mandates: Mandates on renewable energy adoption as well as the implementation of efficiency standards can lead to the accelerated development and adoption of alternatives to carbon-intensive assets.
d. Impending Regulation: A significant overhand of other impending regulatory actions creates uncertainty for long-lived carbon-intensive assets, and is likely to add to the pressures that will increasingly drive capital away from those assets.
2. Market Forces
Renewable technologies are becoming economically competitive with traditional energy sources in several countries – without the need for subsidies – because cost continues to decline. Cost competitiveness, combined with the ability to secure stable, long-term prices for power, and produce electricity through a distributed model, and are driving increased allocation of capital away from fossil fuels and towards renewables.
3. Socio-political Pressures
In the absence of regulation, socio-political pressures could create an environment where carbon-intensive businesses could lose their license to operate.
We see some of these risks being played out already, for example the US firm Consol recently announced it was considering divesting from coal despite having mined since the American civil war. China has just announced a ban on any new coal-burning facilities in three of the most heavily polluted regions, and they are ready to put in place a cap and trade programme in two regions and five cities, where they say it will be a pilot for a nationwide cap and trade programme by 2015. “Some sceptics say they’ll never follow through on that; I’m not so sure”.
The Evidence: Every storm is different
Statistics shows us that extreme weather events has increased around the world during the last 30 years: “There is 4% more water vapour in the Earth’s atmosphere today than 30 years ago. And by the way, that 4% may sound like a small number, but it’s actually not, because the moisture that falls to the ground as it did three days ago in southern England doesn’t just originate in the part of the sky directly above where it falls. It is funnelled toward the storm’s release point from often 2,000km away, and so the extra 4% must be multiplied by the vast volume of the sky contained in that 2,000km tail that’s funnelling the moisture towards the drain”…”These basins of water vapour in the sky are much more full than they were only three decades ago. And so every storm is different. Every storm.”…We have changed our world as we used to know it.
Gore continued: “We’re still putting 90m tonnes of global warming pollution into the atmosphere every day, as if it’s an open sewer. And it is trapping a lot of heat.” All that energy has a system dynamic effect on our climate, Increased sea levels leads to melting ice in Antarctica and Greenland which again leads to heat absorption in the Arctic Ocean, which again leads to high-pressure/low-pressure balance and changes the jet stream. This again affects something and so it continues.
“The current emission rates, about 90m tonnes a day and increasing, will mean we cross the 2C threshold – and that is insane. We really should not do that“.
The Solution: Sustainable Capitalism
Capitalism is the base of every successful economy in the world as it is more compatible with higher levels of freedom and allocation of sources. It also balances supply demand, and most importantly, it unlocks more of the human potential for development. But, it does not include global warming in its profit and loss statements, GDP or corporate books.
In fact the creator of GDP, Simon Kuznets, urged publicly many times to not use GDP as a guide for national economic policy. “Well, we do. It’s the Holy Grail“…”it excludes the depletion of natural resource; it excludes not only negative externalities but positive externalities like investments in education and mental healthcare. And it excludes the distribution of income“.
“So we need to examine how to make our systems more sustainable, but for the moment, the most urgent challenge for all is to accelerate the level and quality of investing in sustainability. There is a huge cost of these stranded carbon assets, and there are huge opportunities to be gained.”
“It’s not easy, it’s extremely challenging, but those of you who are a part of this effort, in my humble opinion have made the right decision. I hope that it will be extremely successful financially for you. I know that it is work worth doing, and I congratulate you for it.”
I had the opportunity to ask Mr Gore what it will cost if we don’t invest in innovation and sustainable solutions, and he answered: “A lot! It is difficult to say precise, but a lot!“. However, he continued to say that we are on a positive curve, that we will not end there, and down the line those that did not respond to this storm will go from denial to despair.
What do you think? And are you willing to pay the price of despair?
Full transcript Gore’s speech can be found here: http://blueandgreentomorrow.com/2013/11/01/al-gores-speech-on-the-new-opportunities-for-sustainable-capitalism-full-text/
1, 2 Generation Foundation. October 30, 2013. Stranded Caron Assets: Why and How Carbon Risks should Be Incorporated in Investment Analysis” http://genfound.org/media/pdf-generation-foundation-stranded-carbon-assets-v1.pdf