Honing in on investment to deflate the Carbon Bubble

Honing in on investment to deflate the Carbon Bubble

With energy expected to feature prominently at Davos this month, what are the opportunities for investment in low carbon innovation in 2013?

By Nick Hay, Director, Cleantech, Edelman UK

For some energy investors, the second dash for gas represents a good enough reason to kick clean technologies into the long grass and to return to a short term approach to energy generation.  However, although the lower price of natural gas makes it harder for renewables to compete on cost, the long term expense of pushing the problem of climate change into the next decade is far higher.   Research by investment consultants Mercer, for example, found that continued delay in climate change action could cost institutional investors thousands of billions of dollars.

A second dash for gas, (unless supported by carbon capture technology), is not in the UK’s long term interest as it will lock in fossil fuel power stations, therefore raising the cost of meeting the nation’s legally binding carbon target to reduce emissions by 80 per cent by 2050.  Similarly, the US, which has been making headway in reducing emissions (if it had ratified the 1997 Kyoto protocol it would have now met its obligations), now stands to become the world’s largest gas producer by 2015.  In this case, the US’ single minded focus on energy self sufficiency will be met, but at the risk of placing undue bets on fossil fuel, just as we enter a carbon constrained world.

Carbon bubble

There is increasing awareness amongst investors that the huge reserves of coal, oil and gas held by companies are sub-prime assets.  According to the Carbon Tracker Initiative, 80 per cent of fossil fuel investments are effectively unburnable, since doing so would blow legally binding greenhouse gas emissions budgets.  To some extent, the carbon bubble is not the concern of fund managers, which are incentivised by short term returns.  However, further up the investment chain, asset owners (who invest over periods of upwards of 20 years), now face the realisation that continued large scale fossil fuel investment is leading us towards the same financial conditions that led to the 2007 crash.

Not all investors are content to sleepwalk into what Lord Stern called “the greatest market failure the world has seen” (Stern Review 2007).  There is a rising realisation that it is more economically prudent to invest in clean technologies, such as renewables, smart grid and greater energy efficiency, which will put the global energy supply on a secure, low carbon energy trajectory.  Indeed, many asset owners are looking to manage climate risk by hedging their portfolios – by investing in low-carbon assets so that when an adequate carbon floor price is reached, the loss of value in high carbon investments is offset by an increase in value in their low carbon investments.

But there’s a long way to go.  According to the AOD Project, less than two per cent of a typical asset owner’s portfolio is currently invested in low carbon assets; this is compared to an average of over 55 per cent of a portfolio being invested in high carbon assets.

According to Bloomberg New Energy Finance (BNEF), $268.7bn was invested in clean energy technologies last year, making 2012 the second most successful year on record for the global cleantech sector.  According to BNEF chief executive Michael Liebreich, “…the most striking aspect of these figures is that the decline was not bigger – given the fierce headwinds the clean energy sector faced in 2012 as a result of policy uncertainty, the ongoing European fiscal crisis, and continuing sharp falls in technology costs.”

Great advances have been made in the last decade, with technologies such as solar becoming mainstream, as indicated by a subsidiary of Berkshire Hathaway recently spending $2.5 billion on a major solar project.  But there’s a long way to go.  According to the IEA, $500bn a year must be invested in clean energy between 2010 and 2035, in order to transition to the low carbon economy.  According to the London School of Economics (LSE), only 30-40 per cent of the investment can be covered by balance sheets and project finance of UK utilities, leaving the majority investment share to come from other investors.  So what is attracting pension funds, banks and insurance companies to the market?

Stay tuned for the answer in part two of this series, available tomorrow…

Nick is head of Cleantech at Edelman UK

Follow him on Twitter at @naughtster and LinkedIN