Two Business Cycles to Prepare for A Low-Carbon World
December 7, 2018
Climate investment was $70 BN in 2016. 990 institutions with $7.2 TN of AUM declared some form of fossil fuel divestment. Going forward, 2,400 asset managers representing $82 TN have agreed to UN PRI commitment on ESG issues. Total AUM committed to PRI has grown 19% in the past 12 months.
This week, as delegates from nearly 200 nations congregate in Katowice for COP24, the 24th annual UNFCCC conference on climate change, ‘tis the season to take stock of the state of climate politics around the world. Spoiler alert, it’s not a particularly jolly read.
Paris, at least on the surface, serves as a great metaphor for global climate politics. Three years ago, those same COP delegates gathered with their political masters in the City of Lights to sign an historic agreement committing the world to limit global warming to below 2°C. Today, Paris is again in the news – but this time for riots triggered by increases in fuel tax designed to help deliver France’s climate goals. Lofty ideals, soaring rhetoric, ambitious targets – meet popular push-back!
But is Paris really shorthand for what the state of the climate world, or is the reality more complicated?
Reasons to be fearful
Events around the globe certainly make it easy to paint a picture of climate policy in disarray. Exhibit A is, of course, President Donald Trump’s decision in June 2017 to pull out of the Paris agreement. But this year has delivered a number of other high-profile examples.
Ontario Conservative Premier Doug Ford campaigned and won on a promise to pull the province out of its cap-and-trade scheme. Tony Abbott and his merry fossil-funded clique in the Australian Liberal Party used concern over the cost of climate action to wrest control from more moderate colleagues for the second time. A year ago, Scott Morrison was brandishing a lump of coal on the floor of the Australian parliament and telling his fellow MPs not to be scared of it; today he’s Prime Minister.
In Brazil, during his successful presidential campaign, Jair Bolsonaro used a threat to quit the Paris Agreement to signal his business-friendliness. He has since relented, but one of his first acts as President was to rescind the country’s offer to host the next COP meeting after Katowice. China is once again using coal-fired power station construction as a means of delivering economic stimulus at home and securing influence overseas.
Even Germany’s commitment to climate action looks wobbly. The ruling coalition’s governing document abandoned the country’s 2020 goal of a 40% emission reduction over 1990 levels, replacing it with a longer-term goal, and abrogated the selection of a year by which the country’s coal-fired power plants would be closed – delegating the decision to a special “Coal Commission” that looks set to miss its year-end reporting deadline.
Global emissions, almost flat between 2013 and 2016, returned to growth in 2017, and will be up again in 2018. Once again, the European Union has proven long on rhetoric but short on action: with emissions growth of 1.5% in 2017, it has no moral high ground in Katowice from which to lecture the U.S. – where coal plants continue to close and emissions to drop.
But before you conclude that the world is failing to address the climate challenge, and that wait-and-see or business-as-usual are viable business strategies, read on.
Reasons to be cheerful, part 1: it’s not all about climate politics
First of all, you should never assign excessive weight to global climate diplomacy.
After all, what are the delegates gathering in Katowice to discuss? The Paris Rule-Book. I’m sure climate aficionados will in time treat the eventual product with the reverence of a Medieval palimpsest, but I can only get so excited about a set of binding rules designed to track voluntary commitments.
The struggle to produce the Rule Book is in reality another skirmish in two ancient (in climate negotiation terms) conflicts between the developing and developed worlds. The first revolves around whether both should follow the same procedures to track commitments, with the developing world arguing for leniency and the developed world pushing back; the second is the old chestnut of climate finance, with the developing world trying to shake down the developed world for $100 billion annually by 2020, as promised in 2009 in Copenhagen, and even bigger sums beyond.
It’s not quite two bald men arguing over a comb, but not far from it. The UN Framework Convention on Climate Change recently reported that north-south climate investment reached $70 billion in 2016; so just a 9% annual increase over the remaining four years would see the developed world live up to its Copenhagen commitment – not that this will mollify many developing countries, which wanted the money to be handed to them to spend as they saw fit, rather than invested in directly relevant projects.
Meanwhile, the topic that should urgently be on the agenda in Katowice – trade – is missing. In 2016, the world’s major emitters failed at the last moment to sign an Environmental Goods Agreement that would have significantly lowered the cost of clean energy and transport; today, they are turning those same sectors, so vital for climate action, into battlegrounds in the trade war that is the biggest current threat to the global economy. This needs to stop.
Perhaps the most interesting thing about the talks in Katowice is that U.S. negotiators – many of them the same people as have been negotiating for years – seem as interested as ever in winning negotiating points, despite the fact that officially the U.S. is pulling out and will not be bound by the results. It does rather look like they are hedging their bets, in case either the current unpredictable President or the next one recommits the country to the Paris Agreement.
Reasons to be cheerful, part 2: clean energy and transport fundamentals
Just as the Paris Agreement in 2015 did not drive the precipitous drop in wind and solar power prices that began in 2010, any agreement in Katowice is not needed to drive the mainstreaming of electric vehicles that began a few years ago. Climate economics precede climate diplomacy, not the other way around, and the economics keep looking better and better.
In the second half of 2018 alone, the BNEF global benchmark levelized cost for solar fell by 14% and the wind benchmark by 6% (client links: web | terminal). Despite cutting support for solar power mid-year, China looks set to install another 40GW by year-end, down around 25% on last year, but with the entire shortfall set to be taken up by growth in other markets. 2018 might end up seeing the slowest rate of growth for PV installations globally since at least 2012, but the big Chinese solar manufacturers are all planning two- to three-fold increases in capacity in the next two to three years. The solar industry will return to strong growth in the near future, powered by its unbeatable value proposition, as well as strong national and sub-national policy signals – such as California’s pledge to reach zero net emissions by 2045, Spain’s target of 100% renewable power by 2050, and Queensland, Australia’s promise to reach net zero emissions by 2050.
The wind industry is set to have its second-best year ever, with around 55GW added. The next few years will see installations get into record territory, with 30GW of new projects in the U.S. alone by 2020, and the arrival of giant offshore turbines which will power over 100GW of offshore projects by 2030.
In transportation, 2018 saw demand for electric cars reach 5% of sales in China; China’s internal combustion car market is flat, with all growth now being absorbed by EVs. Progress has been a bit slower in Europe and the U.S., with sales only reaching around 2% of new cars but, with the launch of the Tesla Model 3 and hundreds of new models from big manufacturers reaching the showrooms, things are going to be moving fast.
On the streets, the Charge of the Chargers has begun – and it’s going to be a battle royal between big oil and big utility. Shell has bought New Motion, BP has bought Chargemaster, Total has bought G2mobility. Equinor-backed Chargepoint has just closed a $240 million Series H funding round – with Chevron, among others, as an investor. (Disclaimer: I am a minor shareholder in Chargepoint.)
Lithium-ion battery production reached an important milestone in 2018, with more than 50% of output devoted to EVs, rather than consumer goods. The battery supply chain may look a bit constrained between now and 2021, but at that point lithium-ion manufacturing capacity will soar to 630GWh, three times current output. Tesla’s 100MW, 130MWh Hornsdale Power Reserve battery has proven unbeatable at providing short-term grid services, earning its owners very healthy returns in the process.
These pioneering sectors of wind, solar, EVs and batteries are being joined by others. The digitization of energy and transport infrastructure is starting to create value in the billions of dollars. Utility-of-the-future business models, designed around time-of-day pricing, are starting to get real traction. The next generation of clean technologies in heat, industrial processes, recycling, shipping, heavy road transportation and power-to-gas are readying themselves in the wings. Over 150 million people in the developing world have received their first ever modern energy services courtesy of distributed systems.
It is clearly riskier to bet against this march of clean energy and transportation than to bet on it.
Reasons to be cheerful, part 3: finance is waking up to climate risk and disclosure
The third reason that investors and executives need to beware of misreading the Zeitgeist is that shareholders and lenders are becoming increasingly uncomfortable with high-carbon business models.
While only 990 institutions – with $7.2 trillion under management, just 3% of total global savings – have actually declared some form of fossil fuel divestment, these are only the lead steers. More importantly, the main herd of investors is spooked and starting to eye its escape route.
The UN Principles of Responsible Investment (PRI) commit asset owners and managers to incorporate environmental, social and governance issues, to seek disclosure from the entities in which they invest, and to disclose their own ESG activities. Climate and emissions are, of course, core areas of ESG focus. Nearly 2,400 major asset owners and asset managers with $82 trillion under management have already signed up to PRI, with total assets subject to PRI growing by 19% in the past 12 months. PRI is on its way to becoming a global industry standard.
Another important initiative is the Task Force on Climate-Related Financial Disclosures (TCFD), set up in 2017 at the request of Mark Carney, Governor of the Bank of England and chair of the Financial Stability Board, and with Michael Bloomberg, founder and majority owner of Bloomberg LP as chairman. By September, institutions with over $100 trillion of assets under management had indicated support for its recommendations.
It’s not just about disclosure and scrutiny. Activists are becoming more confident, more organized and more confrontational toward those delaying climate action. New climate warriors on the block, Extinction Rebellion, underlined their radical credentials last month by occupying the offices of Greenpeace, accusing them of being complicit with the corporate world’s dash through the planet’s remaining carbon budget. The Sunrise Movement – supported by new Democrat superstar Alexandria Ocasio-Cortez – occupied the office of U.S. Democrat party grandee Nancy Pelosi. Some 15,000 Australian school children took part in a one-day school strike to protest their government’s lack of climate action.
Investors and executives should be concerned not just about direct action by activists, but about the threat of legal jeopardy into which excessive emissions or poor climate governance may place them. So far only Mexico and the U.K. among the major economies have enacted binding climate legislation, the London School of Economics has identified 25 climate-related lawsuits brought against governments or their representatives.
The courts have already ruled against the Dutch government, forcing it to accelerate cuts in carbon emissions. In the U.S., a number of cities and counties in California, New York, Colorado, Washington and Maine have filed civil lawsuits against oil and gas companies. The landmark Juliana versus United States case pits 21 plaintiffs aged between 11 and 22 against the U.S. Federal government. Even if it is thrown out, the NGO coordinating it, Our Children’s Trust, has initiated similar suits in state courts from Alaska to Florida.
The era of corporates and investors turning a blind eye to climate change, pretending it presents no risk or treating it like someone else’s problem, is surely drawing to a close.
Reasons to be cheerful, part 4: When in the pits, look out for the pendulum
The fourth reason why investors and executives should not take their cue from the words of anti-climate populists is that those populists may shortly find themselves on the losing side of history.
In the 2018 midterm elections, President Trump hung onto enough seats to maintain Republican control of the Senate; Democrats gained control of the House and picked up seven governorships. Three of them – Nevada, Maine and New Mexico – were in states where renewable energy mandates had recently been vetoed by Republican governors. Wisconsin’s governor-elect, Tony Evers, campaigned on a pledge to join 17 other governors committed to the goals of the Paris agreement. Clearly the public likes renewable energy a lot more than many corporate leaders or lawmakers think.
Climate action at the sub-national level is in robust good health. In the run-up to Katowice, the Climate Group, Carbon Disclosure Project and PwC reported that 120 states and regions from 32 countries, representing 21% of the global economy and 672 million people, have signed up to their own climate targets. Most pledges were from members of the Under2 Coalition, committing to reductions of 6.2% per year, the rate required to keep the planet below 2°C of global warming.
In Australia, Morrison’s time as Prime Minister looks set to be limited. In October, he lost his parliamentary majority when outsider Kerryn Phelps, campaigning on a platform including support for climate action and opposition to the controversial Adani Carmichael coal super-mine, won the by-election in Malcolm Turnbull’s old seat. The country must hold a general election before May next year, and electoral meltdown for the Liberals is a distinct possibility.
Canada is an important market to watch in 2019. Ottawa has decreed that all provinces must impose a carbon price of at least C$20. Those states that do not already do so will be subject to a Federal levy, but it will be returned directly to residents. The experiences of Australia and Ontario have showed how easy it is for populist conservatives to attack carbon taxes or credit auctions that are not fiscally neutral. If Canada’s scheme secures good public support, that will surely encourage fans of Carbon Fee and Dividend, the fiscally neutral approach promoted in the U.S. by the bipartisan Citizen’s Climate Lobby.
Even when it comes to the riots in Paris, the lesson is not that the public reject any and all action on climate. It is that the public expects climate action to be efficient as well as effective; policy to focus as much on the carrot of affordable clean solutions as on the stick of raising the cost of dirty ones; costs to be equitably shared; and for the benefits to be clearly communicated.
Make no mistake, the political pendulum is on the move back toward rapid climate action almost everywhere in the world.
Some thoughts on business cycles and speed of change
If the past 15 years have demonstrated anything, it is that the transition to clean energy and transportation will not be smooth. It will continue to be characterized by cycles, every six or seven years.
The first cycle of the modern clean energy transition ran from 2004 to 2010. We saw an explosion of interest in clean energy; investment grew from around $100 billion per year to $350 billion; cleantech went through its big bubble; many were foolishly optimistic and ended the cycle bitterly disappointed. The second cycle has run from 2011 until now, producing dramatic falls in wind and solar costs, and the beginnings of real scale. While investment stalled at an average of $350 billion per year – around one dollar in every six invested in the energy sector – by the end of 2018 wind and solar were generating around 7.5% of all electricity in the world.
The idea of the six- or seven-year business cycle is useful in thinking about how the energy and transport transition might play out. Bill Gates’s favorite economist, Vaclav Smil, points out that it took the better part of a century for coal to displace wood, or for oil and gas to start displacing coal; however, Peter Tertzakian, executive director of ARC Financial Corporation, urges us to focus on transformations market by market. What we see is that in one business cycle, sectors can be utterly transformed. In the past six years, LED lighting has gone from less than 5% of the global lighting market to more than 40%; coal in the U.K. has gone from over 40% to under 5%; plug-in vehicles in Norway have gone from around 5% of sales to nearly 50%.
The recent Intergovernmental Panel on Climate Change Special Report (SR15), published this October, makes clear that by 2030, one of two things will have happened: either we will have reduced emissions by 45%, or we will have burned through the remaining 580 GtCO2 carbon budget for a 50% chance of holding average temperature increases below 1.5°C. For a 50% chance of keeping below 2°C, the required emission reduction by 2030 still has to be at least 20%.
That is just 12 years away. Think about it: not only does each 6-year business cycle bear the risk of destroying businesses or business models that currently look impregnable; in just two business cycles – well within the range of our remaining careers – we will find ourselves in a world where either carbon emissions are dramatically lower, or there will be no remaining carbon budget, and presumably no societal license to operate carbon-intensive businesses.
Once you accept that the world is going to look very different at the end of the next two business cycles, whether we listen to the warnings of scientists or not, priorities become refreshingly clear.
Ignore the noise, focus on the signal. Trump is noise. Katowice is noise. Weather is noise. News is noise. The signal is, where do you want to be at the end of those two cycles? What portfolio do you want to own? What business do you want to be in? What business do you not want to be in? And – crucially – what do you need to do right now in order to get an edge on your competitors?
I warned you I was not offering jolly seasonal thoughts. But hopefully they are thoughts you can turn into action. Perhaps more New Year’s Resolution than Christmas Cheer.
Two business cycles. Don’t waste them.
Trends in Sustainable Investment: Energy Security, Environmental Sustainability and Affordability and Access.
By 2050, up to 90% of OECD generation will be from renewables.
IEA predicts renewables will be 40% global power generation by 2040.
400 global companies, cities, states and regions set 100% renewable energy targets
Energy is at the root of modern economies and is vital to the Fourth Industrial Revolution and the internet of things. The challenge for policymakers is to craft policy frameworks that enable the three critical goals of energy security, environmental sustainability and affordability and access while the energy sector undergoes a fundamental transition.
Maintaining a balance between these three goals creates a "trilemma," which is getting more complex for countries and energy companies — especially given the uncertain pace of the transition to decentralized, decarbonized and digital systems. Put differently, we are trying to build a bridge while crossing it.
The comparative rankings and profiles of the 125 economies covered in the World Energy Trilemma Index 2018 highlight how the exponential acceleration of interconnected megatrends shaping the global energy sector are rapidly evolving the means to achieve and balance energy trilemma goals.
Evolving energy sources are shifting the definition of and means by which to achieve energy security. In a fossil fuel-driven world, energy security was ensured by the security of energy supply. But technology has led to an increased supply of natural gas and has driven improved performance and reduced costs of renewables. Today’s energy security increasingly implies flexibility of a diversified grid, which is hard to measure and even harder to ensure.
For example, coal-fired electricity generation in OECD countries is in terminal decline. Initially displaced by cleaner natural gas, it has been increasingly losing ground to renewable sources that continue to grow faster than predicted: The share of renewable generation has doubled every 5.5 years. Under these trends, coal-fired power and nuclear no longer will be viable sources of power in OECD countries by 2050. For example, in the United States, the share of electricity generated from coal dropped from 52.8 percent in 1997 to 45 percent in 2009, and then to 30.1 percent in 2017. Meanwhile, the share of natural gas in 2017 stood at 31.7 percent, and the share of renewables was at 17.1 percent.
Today’s energy security increasingly implies flexibility of a diversified grid, which is hard to measure and even harder to ensure.
On this trajectory, by 2050, up to 90 percent of OECD generation will be from renewables. The IEA predicts that the share of all renewables in total global power generation will be 40 percent by 2040 [PDF].
Looking outside the OECD, coal as a percentage of total electricity generation is expected to remain high in the near term. For example, coal is on track to grow to 75 percent in India by 2027 and to 56 percent in Indonesia in the near term.
However, China may be indicative of future trends in other countries that hope to balance energy security, increased energy access and environmental sustainability. Coal is on track to drop to 56 percent of total energy generation in China — from 80 percent in 2007, as China continues its focus on increasing renewables.
Fossil fuels are also affected by the movement to divest from fossil fuel [PDF], which has grown 11,900 percent from $52 billion assets under management four years ago to over $6 trillion today, with nearly 1,000 institutional investors pledging to divest from coal, oil and gas. This trend is likely to have increasing impacts beyond OECD countries in upcoming years.
Along with this, investment in clean energy has grown at 14 percent CAGR over the past 10 years.
Access and affordability
Decentralization and democratization of the energy system will shift the definition of energy access and affordability.
The adoption of renewable generation, distributed energy resources (DER), deployment of smart grids, energy storage solutions and electrification of transport are just some trends transforming the generation, transmission and distribution of electricity. Supplies of ever-cheaper mainstream wind and solar power are driving down wholesale electricity prices. The expansion of renewables is expected to further drive growth in battery storage capacity and subsequently decrease installation costs, further disrupting the traditional model of centralized power generation and distribution. Many incumbent utilities companies in Western countries are struggling to adapt, as their business models are perceived as in decline. They soon may be replaced by potentially new business models from challenger companies.
Decentralization and democratization of the energy system will shift the definition of energy access and affordability.
Under these forces, Europe will see a mostly decentralized and highly democratized energy system by 2040. Elsewhere, DER is creating new opportunities for low-income economies to provide secure, reliable and affordable energy through mini- or microgrids.
The number of residential and industrial "prosumers" — those who both consume and produce electricity — at a local level is already rising. They soon will play a far more active role in the energy system as a whole as they look to manage energy costs and the sources of their energy, enabled by evolving technologies such as blockchain.
For example, in September, Apple, Akamai, Etsy and Swiss Re leveraged their collective buying power jointly to purchase renewable energy in the U.S. PJM energy market with the largest aggregated corporate renewable energy transaction to date.
Shifts in electricity generation and transportation fuels will help meet energy sustainability goals, and the energy transition will change the economics of the oil and gas industry. For example, recently, nearly 400 global companies, cities, states and regions set 100 percent renewable energy targets and/or zero-emissions targets, including California, the world’s fifth-largest economy, and companies with collective annual revenues of more than $2.75 trillion.
Energy companies and regulators will have to adapt and develop innovative mechanisms to respond to these goals. The shift to electrification of mobility will affect liquid-fuels demand and create new competitors and collaborators. Consider the e-vehicle charging infrastructure initiative in California backed by the state’s three investor-owned utilities. The lines are blurring between utilities, O&G majors and investors as drivers of disruption challenge existing structures.
As with other areas of the energy transition, the pace of electrification is uncertain but can be expected to grow rapidly. Regulations, including pressure to phase out internal combustion engine vehicles, are pushing the switch toward EVs, with predictions of worldwide e-vehicle growth at 11 million in 2025 and with China accounting for almost 50 percent of the global EV market. Countries and companies are battling for competitive positions in the changing mobility sector. The United Kingdom, for example, recently set out a plan to become the world leader in electric and zero-emission vans, trucks and cars.
Leveraging evolving technology opportunities to simultaneously focus on the three aspects of the energy trilemma — security, equity and environmental sustainability — not only can grow economies, but also can transform societies. Yet the complexity of issues facing the globalized energy industry make them impossible for countries to tackle in isolation.
Navigating through evolving policy and regulatory frameworks across states, along with innovating in the field of power generation, is key to achieving progress and maintaining balance. In this changing context, policymakers at all levels and those in the energy sector, both legacy and new players, must engage to ensure policy and regulatory frameworks enable economies and societies to fully leverage the new opportunities to meet the energy trilemma.
How a Big Bank Fueled the Green Energy Boom
Source: Bank of America
Wind and solar energy projects were struggling to attract investors. Then Bank of America got creative.
By MATTHEW HEIMER
OKLAHOMA IS AN EPICENTER of fossil-fuel production, a state where oil-well pump jacks punctuate the pastures. But if you drive out to Grady County, an hour west of Oklahoma City, you’ll encounter a different mechanical landscape. There, atop the hills outside Minco, dozens of 80-meter-tall turbines churn, their blades generating a steady drone to accompany the occasional dairy-cow bleat and the buzz of distant cars.
This metallic display is part of Pioneer Plains, a sprawling wind-power project that generates electricity for some 42,000 homes. The turbines are part of a highstakes transformation in the energy economy—a bet that renewable power can scale up as a cost-effective replacement for fuels that contribute to climate change. But the wind farm is also a symbol of financial transformation: It might never have sprouted if it weren’t for “green bonds”—an investment vehicle that didn’t exist a decade ago.
Those bonds were the brainchild of dealmakers at Bank of America—the $87 billion, 209,000-employee giant that occupies the No. 3 spot on Fortune’s Change the World list this year. Their work is part of BofA’s $125 billion Environmental Business Initiative, a campaign that has established the Charlotte based bank as a powerhouse in “climate finance”—the unglamorous but essential business of steering investor capital into the low-carbon economy. Green bonds, which the bank all but invented, have raised $442 billion worldwide since 2013, helping borrowers both tiny (the Antioch, Calif., Unified School District) and enormous (trillion-dollar Apple) pay for renewable-energy innovations.
Courtesy of NextEraMost environmental advocates agree that a renewable revolution can’t happen without a big private-sector push. And a behemoth like Bank of America—with its web of relationships and deep pool of expertise—can make a decisive impact in connecting investors with cash-hungry green projects. “Doing the first-ever commercial green bonds, appealing to institutional investors—BofA gave this market credibility,” says Sean Kidney, cofounder and CEO of the Climate Bonds Initiative (CBI), a London nonprofit that tracks green-energy investing. “They’ve been invaluable.”
IN AN ERA WHEN AMERICANS can buy solar power through their local utilities and run errands in Teslas, it’s hard to imagine that wind farms or solar-panel arrays ever went begging for funds. But a decade ago, during the financial-crisis catastrophe, that’s exactly what was happening. “Risk appetite was really diminished,” explains Suzanne Buchta, managing director of ESG debt-capital markets at BofA Merrill Lynch. “And most environmental investing was seen as risky.”
At the time, Bank of America was paying a heavy price for misjudging risk. Bad bets on subprime mortgages had demolished its balance sheet. Fleeing investors wiped out more than 80% of its market value, and the bank wound up taking $45 billion in federal bailout money. Brian Moynihan, who was tapped as CEO in December 2009, found himself holding multiple rounds of soul-searching with his C-suite team. The bailout had been repaid by then, but the new theme, as Moynihan recalls it, was “Why are we here? Who would miss us if we were gone?”
Bank of America’s leaders rethought their mission, retrenching around more conservative investing and basic business and consumer lending. During that pivot, Anne Finucane, then the bank’s global chief strategy and marketing officer, became convinced that green investing could fit under that umbrella. The bank had made a $20 billion commitment to such projects in 2007, and modest successes with projects like energy-efficient buildings had encouraged her and her team. “We were convinced by the business that we were doing that this could work on a larger scale,” Finucane recalls, “but we had to prove it.”
In 2013 she got her chance: At her urging, Bank of America committed to deploying another $125 billion for “low-carbon and sustainable business.” That mobilized an army of employees to dream up and pitch new projects. Underwriters who could sell ideas to investors; energy-market traders who knew where clean power was in demand; engineers who knew the ins and outs of turbines and solar panels—BofA had plenty of employees in each category. Finucane, who’s now the bank’s vice chairwoman, acted as connector and advocate, bringing people from disparate teams together and helping them get buy-in from the top. “If you ask people to think outside their comfort zone, to work and think horizontally, a lot can happen,” she says.
“We were taking people off the things that they knew how to do, and putting them on things they didn’t know how to do,” agrees Alex Liftman, Bank of America’s global environmental executive. “And they came up with ideas twice as fast as we expected.
A decade ago, “Most environmental investing was seen as risky.” —SUZANNE BUCHTA, BOFA MERRILL LYNCH
Courtesy of Bank of AmericaONE SUCH BRAINSTORMER was Buchta, the debt specialist. An avid hiker and nature lover, she had been mulling how to draw investors into green projects, and she knew bonds had advantages over stocks. One was stability: Bond interest is predictable, and only during major meltdowns do most bonds become as volatile as stocks. That makes bonds hugely appealing to the risk-averse pension-fund managers, insurers, and other institutional investors that oversee the lion’s share of global capital. Another advantage was “ring fencing”: Unlike stocks, bonds could be structured to require issuers to use the proceeds only for specific purposes.
Beginning in 2013, Buchta collaborated with her counterparts at several big banks, hashing out some broad “Green Bond Principles.” A bond, they agreed, could be called “green” only if its proceeds paid for projects with a clearly positive environmental impact. Issuers would have to be transparent with investors about where the money went and how the projects progressed, and, ideally, an independent party would certify the bond’s greenness. “The brilliant thing about the concept is that it’s so simple and so easily accessible,” says Buchta: A green bond would offer investors a clear, verifiable connection between their financial commitment and a project that helps the climate.
To test the concept, Bank of America played guinea pig. In 2013 it issued the first-ever “benchmark-size” (that is, big) corporate green bond. BofA borrowed $500 million from investors, deploying the proceeds into a dozen different projects. The funds paid for turbines at Pioneer Plains; they also helped upgrade some 170,000 streetlights in Los Angeles and Oakland with energy-saving LED bulbs, and enabled Antioch to build solar arrays at 24 schools.
BEFORE AND AFTER: A view of Los Angeles from the slopes of Mount Wilson, before (bottom) and after (top) the city retrofitted tens of thousands of streetlights with LED bulbs, in a project financed in part by a Bank of America green bond. The orange glow is a sign of the energy “leaked” by traditional sodium bulbs.
Courtesy of Los Angeles Bureau of Street LightingOn their own, those small, potentially risky projects would have struggled to attract lenders and would have borrowed at high rates if they could borrow at all. By bundling them and backing them with its own credit rating, Bank of America brought the cost down. (The three-year bond paid 1.35%—attractive to investors in a low-rate climate, but a bargain for borrowers.) And although the payout wasn’t huge, the bond issue was oversubscribed: With institutional investors seeking more green opportunities, there was more demand than there were bonds to sell.
The market had its proof of concept—and other borrowers rushed in. The Commonwealth of Massachusetts issued the first municipal bond to be labeled “green,” in 2013. The giant utility Southern Co. raised more than $1 billion for solar and wind projects. Apple issued $2.5 billion in green bonds in 2016 and 2017, financing an effort to run more of its facilities on renewable power. BofA was the lead underwriter on each of those deals, playing matchmaker to attract investors. To date, it has underwritten $27 billion worth of green bonds, more than any U.S. bank. At the same time, a broader market has taken off. Since Jan. 1, 2017, there have been $254 billion in green-bond issuances, according to CBI—more than in the previous four years combined.
Bank staffers take pride in the creative ways they’ve deployed capital for green causes. At Pioneer Plains (which is owned by NextEra Energy, No. 21 on the Change the World list) and two dozen other energy projects, BofA has used bond proceeds to make “tax equity” investments, paying developers upfront in return for the right to claim their green-energy tax credits. The deals give the developers funding for construction and repairs; the bank uses the credits to cut its own tax bill. Another BofA project, the Catalytic Finance Initiative, specializes in crafty climate-finance puzzle solving. Last year the CFI team helped Vivint Solar package the cash flows from 30,000 of its residential solar accounts into a $203 million bond and sell the debt to investors.
A bond deal structured by Bank of America helped Vivint Solar raise more than $200 million.
Courtesy of Vivint Solar
BofA doesn’t break out how much revenue its environmental business has generated, but underwriting fees, loan interest, and advisory fees have made the enterprise profitable. To date, the bank has deployed more than $96 billion of the $145 billion it has committed to green business since 2007. Its own fortunes have improved lately too. Over the past three years, its stock has risen twice as fast as the S&P 500, and profits are up 20%.
A bond deal structured by Bank of America helped Vivint Solar raise more than $200 million.In April, four economists released a working paper that gave green-bond fans reason for optimism. They found that municipal bonds labeled “green” paid six basis points (0.06%) less in yield than nongreen bonds—and that the effect doubled or tripled for bonds that took the extra step of being certified green. Bond yields fall when buyers drive up prices, so the lower yields suggest that demand for green bonds is stronger than the norm. On a typical muni bond, that could result in millions of dollars in savings on interest. Compared with those benefits, “the cost of certifying a green bond is modest,” says coauthor Jeffrey Wurgler, a professor of finance at the NYU Stern School of Business, while borrower and investor alike “get a green glow.”
The urgent question is how much bigger and brighter that glow can get, and how quickly. Electric-vehicle production, energy storage, the building of “smart grids”—all are areas where great strides could be made, but only if the private sector can mobilize the money to fund them, at the rate of trillions per year rather than billions. “Public capital is not enough,” notes BofA’s Moynihan. “But private capital has to be accessed in a way that it’s used to being accessed.” If green bonds, with their relative stability and familiarity, lure more big money into the game, Bank of America will have done a lot to pave the way for it.
Private Equity Firm TPG Plans to Raise Second Social Impact Fund
Bill McGlashan, the chief executive of TPG’s Rise fund, which raised $2 billion two years ago, said it invested only in companies that fit with its social impact requirements.CreditCreditVictor J. Blue/BloombergBy Michael J. de la Merced
LONDON — When TPG raised a $2 billion fund for so-called social impact investing in 2016, some on Wall Street questioned whether the investment firm could succeed — especially at that scale.
Two years later, that social impact fund, called Rise, is now 75 percent invested, having taken stakes in companies ranging from online education start-ups to an Indian dairy company.
Now TPG is preparing to start raising a second Rise fund after receiving strong interest from investors, according to people with direct knowledge of the matter who were not authorized to speak publicly about the negotiations. The Rise team has also been in talks to take over the $1 billion health care fund run by Abraaj, the troubled Dubai-based private equity firm, these people added.
TPG executives said Rise’s biggest achievement was figuring out a way to measure an investment’s benefits for society, while generating returns similar to traditional investment funds. Bill McGlashan, the Rise fund’s chief executive, declined to comment on its actual performance or on the fund-raising efforts.
Mr. McGlashan said Rise looked at the same kinds of investments as TPG Growth — the fund known for its investments in prominent technology start-ups like Uber and Spotify — but took only companies that fit with its social impact requirements.
To evaluate potential Rise investments and measure their social impact, TPG created a complicated system with partners like the Bridgespan Group, a nonprofit consultancy, and KPMG to incorporate what the firm said were hundreds of academic studies.
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The model tracks a variety of factors, from improving employment to reducing disease. In the case of EverFi, which produces social education content for universities and which the Rise fund invested in last year, it measures the company’s ability to raise students’ financial literacy and reduce alcohol abuse.
Mr. McGlashan acknowledged that the danger with social impact investing was “greenwashing,” or labeling investments as socially friendly that aren’t. Rise, he said, tests its measurements with outside organizations.
The model has helped separate Rise from private equity funds looking to make similar investments. DreamBox Learning, an online math education company whose curriculums adapt to individual students, chose Rise as an investor not just because of its team — which includes John Rogers, an investor who specializes in education companies, and Arne Duncan, the former secretary of education — but because of its ability to measure the company’s effects on society.
“There are other impact funds out there, but I haven’t seen anything else that has the same measurement,” Jessie Woolley-Wilson, DreamBox’s chief executive, said in a telephone interview.
While some of TPG’s biggest competitors have already jumped into social impact investing, including Bain Capital and KKR, TPG is considering making its impact measure available to draw more private equity firms into the field and to persuade more companies to behave in socially conscious ways.
“It is our hope that this innovation will have the second-order effect of encouraging our peers and leading institutions to increase their focus on impact,” Jim Coulter, a TPG co-chief executive, said in a statement.
How the World’s Governments are Approaching Earth-Friendly Investing
By Nathaniel Bullard and Daniel Shurey.
Green bonds are a fast-growing financial instrument, with annual issuances of less than a billion dollars a decade ago having grown to more than $170 billion last year. They’re increasingly popular as a way to fund environmentally friendly infrastructure, energy efficiency and clean energy. As the market grows, an intriguing split is emerging between green bond markets: Asia gets carrots, and Europe gets sticks.
Green bonds are still only a drop in the bucket of the world’s fixed-income market: only about half a percent of all issues last year. The U.S. alone issued nearly $8 trillion of new debt securities in 2017.
If the finance community wants to see the green segment move from esoterica to a meaningful component of global capital markets, volumes will need to shift from the billions to the trillions.
Cue governments. A growing number of market regulators now believe that top-down measures are important for moving green capital flows into the trillions of dollars. So how do governments engage in a market that has so far developed organically? In the simplest terms, there are three options for intervention: Incentivize growth with a carrot, force growth with a stick, or walk ahead to lead by example. While many countries agree on the need for government involvement, authorities in each of the three major key regions for bond issuance — Asia-Pacific, Europe and the U.S. — are taking very different approaches to the challenge.
Asian governments are all about carrots. Five incentive programs are either in effect or in development throughout the region, with China, Hong Kong, Japan, Malaysia and Singapore all vying to incubate green markets locally. The most common form of incentive is a grant for green bond issuance costs — in particular, the cost of third-party verification of “greenness.” These costs are usually small compared to the amount of capital raised via a green bond, but issuers can find them hard to justify if they aren’t guaranteed to declare a bond green.
Hong Kong recently announced the most generous support system yet, with a trial plan to cover up to HK$2.5 million ($160,000) of eligible issuance expenses for qualifying green bonds. Far more significant in scale are the incentives announced by the People’s Bank of China. The PBOC recently announced that it is also mulling the creation of pilot zones for green financial incentives, but no details have so far been given. In the meantime, the country already offers a regulatory carrot: fast-tracking some approvals for eligible green bonds over regular bonds.
Green bonds were born in Europe, in an environment with few financial or regulatory incentives for green finance but with abundant proposals for ways to create scale. In March, the European Commission released an action plan to scale sustainable finance in the region. The plan focuses on enforcing behavioral changes on the demand, rather than on the supply, side of the green market equation. Proposals include a push to clarify the duties of asset managers so that environmental, social and governance issues are considered in investment decisions, as well as rules to make sure banks incorporate sustainability in their capital lending requirements. It’s a more muscular approach than in Asia, and it’s also structured more around penalty than around opportunity.
The third government tactic is to lead by example. In the past five years, a market in sovereign green bonds has emerged. These supersized green securities are issued by a country’s treasury to demonstrate political commitment to sustainability. While all the green sovereigns to date have been issued by European or Asian-Pacific authorities, they were a tiny market until this year, with issuances exceeding $14 billion through the end of June. That said, until this year, green sovereigns were actually a smaller market than U.S. municipal green bonds. That market exceeded $10 billion last year with zero leadership from the federal government, as scaling green finance does not seem particularly high up on the agenda of an administration that pulled out of the Paris climate accord.
Instead, green finance programs are being led by state and local entities engaged in climate change issues, as well as government-sponsored enterprises, such as mortgage giant Fannie Mae. Nearly $30 billion worth of green municipal bonds have been sold in the U.S. to date, far surpassing the $25 billion of global green sovereign notes.
The need for new, cleaner and greener infrastructure is clear in the U.S., but green municipal bonds also give states a chance to rebuke the current federal view on climate change. In fact, nine of the top 10 largest issuers of green municipal bonds are from states that are signatories to America’s Pledge — a coalition of organizations that want to maintain the U.S.’s prior commitment to the Paris Agreement.
Whether it is national carrots and sticks or local motivations, government-led green bond initiatives are mobilizing billions of dollars every year. In this regard, green bonds are following a path trod by clean energy a decade ago, when many governments around the world took similar approaches to intervention with the renewable energy market. Authorities offered both carrots (like subsidies) and sticks (like minimum renewable energy sales requirements of utilities) to help scale the market and bring costs down. Today, we see numerous examples of highly competitive renewable energy projects that are able to thrive in the market without any government support whatsoever. Carrots and sticks worked well enough for clean energy that they’re often unnecessary today. Perhaps they’ll work just as effectively for green bonds, and become unnecessary as well.
About Bloomberg NEFBloomberg NEF (BNEF), Bloomberg’s primary research service, covers clean energy, advanced transport, digital industry, innovative materials and commodities. We help corporate strategy, finance and policy professionals navigate change and generate opportunities.
4 Key Takeaways from a Recent Energy Investor Conference
By: Dr. Chris Wedding, Managing Partner
I recently spoke about investing in energy storage at the SuperReturn Energy investor conference in Boston. In this blog, I hope to pass along 4 of my top 100 takeaways.
(OK, slight exaggeration, but productive indeed.)
Unfortunately, I am unable to also magically transmit the decadent Legal Seafoods’ lobster tails and sushi rolls from the sponsored dinner (#WeLoveLawFirms) or the conference bling (#MyKidsLoveGiftsFromWorkTravel).
1. Natural gas is misunderstood.
First, low commodity prices will not always mean low power prices. The costs of distribution of gas to the power plant, plus the transmission and distribution of the electricity it produces take place on an ancient grid. (That’s a technical term. But Edison would recognize today’s grid if he magically reappeared in his Florida laboratory.)
Recent research suggests that the average age for power lines is 28 years, while the U.S. DOE quotes studies by the Brattle Group (for the Edison Electric Institute) estimating about $2T in investment needs for the grid from 2010 to 2030 just to maintain the service reliability.
Second, natural gas is not a perfect “bridge” to a low carbon future.
On one hand, its emissions factor (pounds of CO2 per BTU emitted when burned) is roughly 43% lower than burning coal (whose butt it is kicking).
On the other hand, the operational emissions factor for natural gas is infinitely higher than solar or wind (#DivideByZero). Also, methane leaks during exploration and distribution likely counteract its lower greenhouse gas emissions (compared to coal, that is) when combusted at power plants. As you know, methane’s greenhouse gas impact is at least 30x more potent than CO2.
Third, there are two giants in the natural gas ecosystem that see some writing on the wall, and I think they see lots of four-letter words there.
GE has laid off 12,000 workers in its power generation business, and now Siemens is considering selling offits natural gas turbine business, whose Q2 revenue was down to $114M from $438M in Q2 2017.
And with Bloomberg estimating 157 GW of renewables added vs. just 70 GW of conventional power in 2017, we can understand why they might be making those moves.
Having said all of that, I don’t pretend to live in a world of rainbows and unicorns. Conventional energy will likely be part of the global mix for many decades to come. Even in a world where solar and wind power dominate, this analysis shows that natural gas will have a large, though diminishing role over time.
2. $1T of clean energy investment presents challenges for entrepreneurs and investors.
Most climate change scientists, policymakers, and private sector leaders project a need for $1T of low-carbon investment needed per year in companies and projects in order to keep global temperature increases below 2o C.
However, last year Bloomberg suggests that global clean energy investment stood at just $333B. By my math, that’s 67% lower than the amount of capital we will need.
To get there, we need at least two things:
As for investor interest, it is growing.
When I first began speaking at the SuperReturn investor conference series three years ago in Boston, London, and Berlin, I was often part of the 1%. (No, not that 1%. I am a pauper compared to my colleagues in attendance who manage billions in capital.)
What I mean is that I was often the only guy talking about the future opportunities and threats presented by the mainstreaming of energy storage and electric vehicles, or the continuation of investment opportunities in solar, despite the challenges of (and false conflation with) the cleantech VC missteps of the late 2000’s.
Today, many more investment professionals -- with decades on Wall Street instead of roots in the jungles of the Central American rainforest -- are making big investment commitments to renewables, exploring new deals in energy storage, or analyzing the threats that EVs pose to mid- and long-term oil prices.
[You can read more here about the mainstreaming of renewable energy investing in my feature piece for Preqin, a global leading for market intelligence for private capital markets.]
In contrast to this growing interest, investors worry about yield compression.
With lots of capital chasing a disproportionately smaller number of good deals at scale, and with risks being hammered out of renewable energy infrastructure, IRRs have gone down.
[Note: Although IRRs are a helpful underwriting metric, many investors prefer to look at the “multiple of invested capital,” or total cash out vs. total cash invested.]
When I first began investing in solar power projects, we underwrote to private equity returns north of 20%. Today investors in operating projects might get 6-9%, while those investing in development plus operation and/or platform plays (investing in the development company, too) are targeting “mid-teens” returns.
To clarify, these are leveraged returns.
And when most oil and gas investors hear this, they laugh a little on the inside when comparing these numbers to their target returns from 20-30%. But this is apples-to-orange, due to risk. Renewable energy infrastructure returns are based on [15-25]-year contracted cash flows, while oil and gas investments often depend on far riskier exploration and development, plus volatile global commodity markets.
As for deal flow, scale and quality are the two constraints.
Regarding the scale of these markets, things are getting better. For example, annual U.S. solar project installations are up roughly 50% versus just two years ago, and by 2023 total installed U.S. solar capacity is expected to increase by more than 2x.
But we still need more entrepreneurs to build more projects and companies worthy of investors’ capital. (A tantalizing call to action, for sure.)
Regarding quality, over the years, we’ve vetted 100s of MWs of solar projects. But very few have passed review and made it to investment committees. Again, things are getting better. Developers and entrepreneurs are learning from past mistakes (e.g., using venture capital, the most expensive capital on earth, to built factories to make s*#t).
For more about what it takes to increase a company’s chances of raising capital, we’ve written a few primers, structured in numbered lists, with attempts at humor included.
3. We overestimate the impact of new tech in the short-term, and underestimate its impacts in long-term.
This quote from Bill Gates highlights a comment from an investor panelist: In the current energy transition, trillions of dollars will be created and destroyed.
Another investor put is this way: If you have no strategy on the growing role of clean energy, then you’re leaving value on the table.
For my panel on energy storage investments, the topic on most investors’ minds was this: “Is energy storage a real market today?”
Opinions varied. But here is the right one: Heck ya, it’s real today. But it’s not real everywhere...yet. Hence the confusion.
There are hundreds of millions of investment already committed to or invested in batteries each year at the utility, commercial and industrial, and residential level, including projects involving our clients.
Consider these stats from Greentech Media:
To be sure, the bulk of energy storage investments have yet to come. Bloomberg estimates $100B invested by 2030. For a great graph of billions of dollars projected to be invested, check out the black bar graph here.
But even today, giants like NextEra estimate that no new gas peaker plants will be built post-2020 due to the falling price and increasing performance of large-scale battery storage.
[For more about energy storage investing, you can read our research here -- Financing Energy Storage: A Cheat Sheet.]
Despite early indications of massive growth for new clean energy solutions like storage or EVs, most people see them as a long-term thing. Not a material consideration for today’s portfolio.
However, this graph from NYT / HBR shows that often new technologies are being adopted on increasingly quick timelines, following S-curves with step change growth, not incremental linear progress.
Of course, when comparing EV adoption to smartphone adoption, investors at the conference pointed out that there is a massive difference in the CapEx among these items; hence much slower adoption is possible.
But if any fraction of Tony Seba’s projections in his ReThinkX report on the future of transportation are correct (the question may be “when, not if”), then we could be talking about switching from a CapEx discussion to an OpEx discussion, thereby making the mass transition from ICE (internal combustion engine) vehicles to EVs much quicker.
According to one investor panelist, this research estimates that most Americans spend about $10,000 per year on their cars, while ReThinkX projects that autonomous shared EVs could reduce personal travel costs by 90% while also delivering convenience, too. (Ah...to relax and work while going to the airport in a Lyft, instead of navigating traffic and crowded parking garages in my own vehicle.)
Building on that theme, while at the event, I received an update from Bloomberg on their EV projections for 2040: 55% of new sales and 33% of global fleet. (#ThatAintNoNiche)
[Quick aside: Some panelists laughed at the idea that EVs meant clean energy. True, it depends on the grid mix of high vs. low carbon energy sources. But this calculator from U.S. DOE shows that EV CO2 emissions are roughly 50% less than gasoline-powered cars based on average in the U.S. The calculator lets you see differences by state location, too.]
Panelists also noted that major adoption of EVs in the U.S. could lead to 2x growth in utility power output, even describing this monumental revenue-generating opportunity as a “w*t dream” for utilities.
(And, yes, the room was mostly full of men. I apologize. Just the messenger...)
In a time when Moody’s just gave the utility sector a negative outlook for the first time in history, maybe Elon Musk is right: The electrification of transportation could be a much needed savior for the challenged power sector.
Considering that the average capacity factor for U.S power plants is roughly 40%, the utility sector has lots of excess capacity in sunk costs to harness with 100+ EV models coming online by 2020.
[Background: Most grids tend to overbuild capacity in order to manage peak loads, thereby underutilizing power plants and perhaps wasting CapEx for perhaps 90%+ of the hours in a year.]
On a related note, solar plus storage has until recently been an enticing topic for discussions at conferences, or fun projects for my graduate students. But this, too, is changing quickly.
Today almost all renewable energy RFPs from utilities in deregulated markets require the inclusion of energy storage capacity.
And suprisingly, the bids are coming in at very low prices. As an example, Xcel Energy’s recent process resulted in 10+GW of bids for solar plus storage at 3.6 c/kWh and wind plus storage at 1.8 c/kWh, which are both new record low prices.
Finally, investors often feel limited in their consideration of long-term trends and multi-decade infrastructure assets due to the [8-10]-year life of most private equity funds.
In response, panelists came out in two camps:
4. Definitions of ESG and sustainable energy vary widely.
Despite the concern that ESG (Environment, Social, Governance) or sustainable investing is for hippies who love to earn below market financial returns, many investment giants would disagree. Below are samples of their thinking:
Yet still there is confusion about what the terms mean.
Some panelists said their investments in oil and gas have been doing ESG for many years. Now they just needed to add social sustainability goals.
However, they were equating ESG with HSE -- Health Safety, and Environment. While there is overlap, and both are important, there is at least one key difference:
Furthermore, some conventional energy asset managers, intending to do better in ESG, described their greenhouse gas footprinting efforts, and believe that that their conventional energy holdings are low carbon.
Some said the CO2 impacts of oil and gas investments were very low impact because exploring, drilling, and transporting via pipelines constituted a very small amount of the sector’s air pollution.
This is true relative to the combustion of those resources. However, companies are increasingly being expected to consider and account for broader life cycle impacts of their investments, inside and outside of their direct corporate control.
In this new world order, a new analogy may apply: Making guns, but not accepting some accountability for gun deaths, could be a dead argument.
(Yep, pun and controversy intended.)
New Tools to Overcome Barriers to Financing Impact Projects
by Norton Rose Fulbright
When traditional forms of funding are unavailable because private investors are risk averse, enthused philanthropic organi- zations have devised ways to minimize risks and thereby lower the barriers to private investment.
The impact investment mechanisms they use include guaran- tees, first-loss reserves and other structures.
The Global Impact Investing Network, an industry associa- tion for social finance, defines “impact investments” as “invest- ments made into companies, organizations and funds with the intention to generate social and environmental impact along- side a financial return.” In May 2017, the association published the seventh edition of its annual impact investor survey. Collectively 208 respondents reported managing a total of $114 billion in impact assets. In total, 205 investors committed more than $22 billion to impact investments in 2016 and are expected to commit 17% more ($25.9 billion) in 2017. Figures for 2018 are not yet available.
Guarantees are used to enhance credit. Only creditworthy proj- ects can secure financings. Sometimes one or more narrow risks are scaring away private investors. Guarantors are usually third parties who contribute to impact investments by partnering with public institutions to offer a loan guarantee (often in the form of a grant) to reduce particular risks and potential losses. Hypothetically, this could be seen within a multi-layered capital structure like a social investment bond or SIB featuring senior investors, subordinate investors, recoverable grants, non-recov- erable grants and guarantors. SIBs are discussed in more detail later in this article.
Some of the first SIBs in the United States had guarantors like Bloomberg Philanthropies and The Rockefeller Foundation.
According to the Global Impact Investing Network, guarantees have covered 9% to 75% in impact investment capital.
Community-based solar projects, battery backup, distributed co-generation and micro-grids are all areas within the renewable energy sector that could benefit from guarantees. These projects involve new business models that could benefit from credit enhancement while in the testing and proving stages. Community solar projects often require financing on longer terms than banks are prepared to lend. Guarantees could be used in such cases to cover refinancing risk.
The challenges to using guarantees in impact investment include perception issues. Philanthropic organizations might be reluctant to be seen only as a last-resort option to “bail out” deals gone bad, which could be addressed in part by holding a diverse impact investing portfolio of investments and loans as a form of downside protection. Additionally, there are only a limited number of organizations that are willing and able to provide third-party guarantees with the structure and coverage levels needed.
Catalytic First-Loss Capital
Catalytic first-loss capital — called CFLC for short — refers to an investor, or grant-maker, agreeing to bear the first losses for an impact investment in order to catalyze participation by other investors.
The fact that someone else will take the first-loss position makes other investors more likely to invest, assuming the par- ticular risk is a reduction in revenue rather than total inability of the project to perform.
The first-loss position can be shed to an impact organization through a range of instruments, including grants, capital contri- bution commitments, subordinated debt and guarantees.
The fact that a philanthropic organization or public entity like a green bank is willing to take the first-loss position improves the risk-return profile for private-sector investors. At the same time, it helps to channel commercial capital toward the achievement of certain social or environmental outcomes.
CFLC can play a critical role in the impact investing industry. It helps to test new business models, increase investor familiarity with community investing, and make capital available on appro- priate terms for new types of deals. For philanthropic organiza- tions or public finance institutions, social aspects play a more important role than financial returns. Thus, they have room to play the role of a CFLC provider to help unlock capital from inves- tors with more interest in financial returns.
Many impact investors choose to invest through funds whose social, environmental and financial goals match their own. Major financial players like Blackrock and Goldman Sachs have report- edly ramped up their impact investing offerings in response to client demand.
Impact investment was responsible for more than $114 billion in assets in 2017, ranging from equity shares in real estate (par- ticularly renewable energy real estate) to loans for businesses in emerging markets and social enterprise investments within developed economies. The Wharton Social Impact Initiative reported that the pooled, internal rate of return on 170 impact investments, made solely by private equity funds through 2017, was 12.9%.
SIBs and DIBs
The United Nations Development Programme defines social impact bonds as a form of public-private partnership where one or more investors provide upfront capital for the realization of public projects that generate verifiable social or environmen- tal outcomes.
Under a typical model, the government contracts with an intermediary or project sponsor to implement a social or envi- ronmental project in exchange for the promise of a payment contingent on the social outcomes delivered by the project.
The intermediary, service providers and anchor investors will then conduct assessments to determine whether the project is viable. After developing a detailed project plan and metrics for measuring success, the intermediary raises the capital for the project from commercial and philanthropic investors. Once enough funds have been raised, the service providers begin to execute the program. At some time after implementation, an independent third party uses the agreed metrics to evaluate whether the project is a success. If the program meets or exceeds expectations, then the outcome funder will repay the full amount of upfront capital plus a return on the invested capital. If the project is not successful, then there is no payment.
Development impact bonds or DIBs are similar to the SIB model. Unlike SIBs, DIBs involve donor agencies, either as full or partial sponsors of outcomes, and the project is by definition in a developing country.
SIBs and DIBs are not bonds in the traditional sense. Investor returns are linked to results. SIBs and DIBs operate as equity investments with investors owning a stake in the project and later receiving dividends if the project is successful. The approach is also referred to as pay-for-success in the United States.
A notable recent example of a SIB is the DC water environ- mental impact bond that was issued in September 2016 by the District of Columbia Water and Sewer Authority in an effort to redirect approximately two billion gallons of sewage overflow away from the Chesapeake Bay to improve water quality in the US capital. The Authority used a pay-for-success model to share performance risk between itself and investors. Under this model, its cost of capital (the interest paid to investors) would be reduced in the event of flow reduction underperformance. Its cost of capital (the return to investors) would increase in the event of flow reduction overperformance.
Social Success Note
A social success note or SSN is a concept that was developed and piloted by The Rockefeller Foundation and Yunus Social Business. It is an innovative pay-for-success financing mechanism that addresses the investment gap for impact-oriented enterprises.
In the SSN structure, a private investor agrees to make capital available to an impact enterprise at a below-market rate. The impact enterprise is obligated to repay the capital. If the enter- prise achieves a predetermined social outcome, then a philanthropic outcome payer provides the inves- tor an additional “impact payment” that aims to get the investor to a market-rate return. The investor bears the risk of the impact not being achieved, which would lower the return to the investor.
The SSN serves two goals: to attract private capital while placing the risk of the impact not being achieved on the investor. Unlike other pay-for-success models, where the returns to the investor are linked only to the outcomes, the impact risk is limited to the return portion that is provided by the philanthropic orga- nization. The philanthropic organization stands to achieve the desired impact for a limited cost and bears no cost if the impact is not achieved.
Private foundations have been instrumental in advancing impact investments. An initiative called “Smart Power for Rural Development,” launched by The Rockefeller Foundation, is an example of an effort aimed at spreading use of renewable energy to areas that are lagging adoption of renewable energy in major markets. This $75 million initiative began in 2015 to promote decentralized renewable energy projects to India and some countries within sub-Saharan Africa.
Bill Gates has become a vocal advocate for impact investment in clean energy projects. In 2016, Gates founded the Breakthrough Energy Coalition as a gathering of business leaders, entrepre- neurs and institutional investors devoted to promoting original, zero-emissions energy technologies.
Gates later established Breakthrough Energy Ventures, a fund with a capitalization of $1 billion and a goal of bringing reliable and cost-effective clean energy to parts of the world that are not currently served by it. What is unique about the venture fund is that it provides a space for investors who are patient and tolerant of risks. Investors determine profitability through the lens of risk-adjusted returns over a longer trajectory of time as compared to other funds. Meanwhile, the coalition advocates for the private sector playing a larger role in the procurement, management and distribution of energy, as com- pared to relying solely on public resources.
In 2016, global wind and solar company Mainstream Renewable Power closed a $117.5 million equity financing package as part of its funding commitment to Lekela Power to build 1,300 megawatts of solar and wind power projects across Africa over three years through 2019. The Rockefeller Brothers Fund, a private grant-making foundation, was part of the investor consortium that also included entities such as the International Finance Corporation and Latin American & Caribbean Fund. The deal was evidence of the increased interest among private and public-sector investors to ensure that not only are there reason- able financial returns, but there is also a positive social and environmental component.
The Dutch Infrastructure Development Fund invested in 2013 in a special-purpose vehicle set up by Newcom, LLC, a Mongolian clean energy and company, to finance the construction of the Salkhit wind farm and related transmission lines in Mongolia to bring the power to the electricity grid. The total investment was €21.4 million of senior debt and €5.3 million of equity. The European Bank for Reconstruction and Development was a co- investor, alongside the Mongolian developer. The wind farm offsets 180,000 tons of carbon dioxide emissions per year, saving 1.6 million tons of fresh water and reducing coal usage by 122,000 tons annually.
New UN Model Lighting Regulation = $18 Billion in Savingswww.nrdc.org/experts/noah-horowitz/new-model-lighting-regulation-18-billion-savings
The United Nations today announced a groundbreaking model energy efficiency regulation for everyday light bulbs that can be easily adopted by interested developing and emerging economies. The potential savings from transitioning from old-fashioned incandescent bulbs to energy-efficient LEDs in nations that do not already have energy efficiency standards could be massive—$18 billion in electricity costs and more than 160 million tons of carbon dioxide emissions avoided every year. Once all the lighting sockets in these countries contain LED light bulbs, the amount of electricity saved would be equivalent to Mexico's annual electricity consumption.
The model regulation announced at the international Energy Efficiency Global Forum in Copenhagen results from an innovative collaboration between the world’s largest lighting company, Philips Lighting, now known as Signify, and the Natural Resources Defense Council under the auspices of United Nations (UN) Environment. The concept of setting a single model energy efficiency regulation for adoption by multiple developing countries around the world is a very powerful one. We are hopeful that similarly ambitious initiatives for other products will be developed as a means to drive down global electricity use and avoid the associated climate-warming pollution that comes from burning fossil fuels.
Why Does This Matter?
Lighting represents 15 percent of all worldwide electricity use and there are billions of inefficient incandescent and halogen light bulbs installed and still being sold around the world. While regulations that phase out future sales of these inefficient bulbs are due to go into effect throughout the European Union later this year and in the United States in 2020 (and are already in effect in California), similar policies do not exist in most developing and emerging economies. The model regulation provides everything an interested country needs to move forward to eliminate the most energy-wasting bulbs: scope, test methods, minimum efficiency levels for each type of bulb, and some basic performance requirements to ensure that consumers have a good experience with the LED bulbs they will be buying. The model regulation is ready to be “cut and pasted” into law by any country ready to take the next step and adopt them.
The model regulation will be distributed to interested countries in Asia, Africa, and Latin America. Countries implementing the regulation will also reduce trade barriers and provide opportunities for sharing resources, including testing facilities, joint procurement, and market monitoring. The model regulation provides countries with two options: the first and preferred option will require all new bulbs to be as efficient as an LED bulb, whereas the second would also allow CFLs, which are slightly less efficient and contain mercury, which requires special collection and recycling.
The potential enormous electricity bill and carbon savings are due to the fact that LEDs use up to 90 percent less energy than incandescent bulbs. In other words, one 10-watt LED light bulb will produce the same amount of light as the old 60-watt bulb it replaces. In addition, the consumer can easily save $50 to $100 on their energy bills over the lifetime for each LED bulb installed. (Note: LEDs last 10 to 25 years under normal operation—around 3 hours per day—depending on the model selected.)
How Fast Will This Change Occur?
Through the United for Efficiency (U4E) project, the UN will reach out to developing and emerging economies like Thailand, Turkey, and South Africa, and encourage them to adopt the model regulation and to phase out sales of inefficient light bulbs as soon as possible. Light bulbs represent a unique opportunity for rapid savings because incandescent and halogen bulbs are usually replaced within a year or two due to their short lifetimes. Therefore, the transition can occur much faster than with other products, such as refrigerators which are only replaced once every 10 to 15 years. The switch to LED lighting represents one of the fastest and cheapest ways to deliver mammoth carbon pollution savings in a hurry.
How Did All of This Come About?
The UN’s United for Efficiency project is a unique public-private partnership meant to ensure that the light bulbs and other key products sold in developing and emerging economies, such as air conditioners and motors, are just as efficient as those being sold elsewhere. In order to prevent a future patchwork of regulations whereby each country sets a slightly different set of efficiency regulations, Philips Lighting worked with NRDC to develop mutually agreeable minimum efficiency levels and performance standards, including some key criteria (e.g., avoid early bulb failure, ensure decent color quality, etc.). Lighting companies benefit greatly from a single set of test methods and requirements, and the cost of the LED bulbs can go down due to economies of scale from producing greater volumes of the same bulbs. Philips Lighting has officially endorsed the model regulation and other lighting manufacturers and organizations are expected to do the same.
By not being stuck with the old, inefficient technologies, developing countries can avoid being the dumping ground for energy-wasting bulbs banned in other nations. Countries that adopt the model regulation will also avoid the burdens of high energy bills, poor air quality, and remove some of the stress from their commonly overloaded electricity grids.
Kudos to UN Environment and Philips Lighting/Signify for helping to make this happen for light bulbs.
We look forward to similar future announcements from UN Environment for model efficiency regulations for big energy-consuming products like air conditioners and refrigerators, which will be purchased in rapidly increasing numbers in developing and emerging countries in the next several years.
Green Bonds' Growing Role in ESG Investing
Source: Lazard Asset Management
Green bonds are an important component of ESG investing. They align investors with environmentally friendly projects and provide crucial social benefits.
Demand for green bonds is surging. Green bond issuance has steadily increased since 2007 and is expected to surpass $250 billion in 2018.
As the global economy shifts to a low-carbon footprint, portfolios that have proactively reduced their carbon exposure may be better positioned to outperform the broad market.
We believe integrating ESG factors and green bonds into a portfolio may lead to better returns.
The focus on responsible investing has grown rapidly over the past decade, and it is now considered mainstream in many parts of the world to incorporate environmental, social, and governance (ESG) factors into investment analysis. Since the Principles for Responsible Investing (PRI) initiative was launched in 2006 with support from the United Nations, more than 1,800 signatories, nearly 400 of which manage roughly $70 trillion of assets, have joined this effort (Exhibit 1). There is also increased awareness of the UN Sustainable Development Goals (SDGs) which cover a broad range of economic and social development issues. Here, we describe green bonds and their underlying principles, and explain the market for these securities as well as their issuance.
The Principles for Responsible Investing (PRI) is the world’s leading proponent of responsible investment. Asset owners and investment manager signatories are required to report on their responsible investment activities annually through the PRI Reporting Framework.
Why Green Bonds?
A green bond is a standard fixed income instrument whose proceeds are used to finance "green” or environmentally friendly projects. This type of investment is compatible with an ESG framework (especially the environmental and social factors). In the past, investors have tended to focus more specifically on governance factors to better understand the risks and opportunities associated with lending to different entities. Today, however, instruments like green bonds are allowing investors to directly address the environmental and social aspects of their investments. Proceeds from green bonds issued to finance solar or wind projects, for instance, may also provide clean water, lessen pollution, and introduce a sustainable energy source to remote areas.
From an investment perspective, green bonds provide an ESG-friendly option for investors wanting to navigate the transition away from fossil fuel investments and reduce exposure to "stranded assets,” such as coal companies. Momentum for green bonds has strengthened as various global institutions and organizations increasingly divest their portfolios away from fossil fuel investments as they focus on mitigating or addressing climate change. This trend should help support strong valuations for green bonds. Issuance is also increasing as the "labeled” (bonds that are certified as green) and "unlabeled” (projects that are linked to environmental benefits but are not certified green) markets evolve. We believe that countries and companies that can reduce carbon emissions and adapt to, or mitigate climate change will be better positioned to prosper.
Green bonds are particularly important to the clean energy, infrastructure, and transportation industries as they allow countries and companies to obtain funding to achieve positive and sustainable environmental and social goals.
Climate change is a potential disruptive factor for asset valuations. In 2015, the United Nations Climate Change Conference (COP 21) convened with the goal of securing global commitments to reduce greenhouse gas emissions in order to limit the increase in global temperatures to 2 degrees Celsius. Today, 195 countries have signed on to this initiative and many cities and companies have adopted their own targets for reduced emissions.
We believe the energy revolution will not only provide positive environmental benefits, but will also have a significant effect on the investment landscape. In recent years, investment in wind, solar, and other renewable energy technologies has grown fast, and we expect this momentum to continue (Exhibit 2), particularly in Europe, China, and India. Even in the United States, renewable energy represents over 15% of power generation.
Green bonds are a vehicle for financing sustainable infrastructure projects, which are increasing in number. The cost of developing needed global infrastructure by 2025 is estimated to be at least $78 trillion. These projects range from building new transportation facilities and energy efficient buildings to enabling sustainable water management and sustainable agriculture. Green bonds lend themselves well to public-private partnerships where private sector efficiencies are combined with public sector governance. These investment collaborations tend to be relatively more stable as both parties have aligned interests. With global monetary policy largely exhausted in many countries, green bonds could help support infrastructure spending. This could provide much-needed fiscal stimulus for local and global growth, while also helping to achieve environmental and social goals.
Gasoline-powered vehicles, or internal combustion engine vehicles, account for a meaningful part of global oil consumption. Meanwhile, the growth of the global electric vehicle (EV) market is expected to reduce demand for fossil fuels and a growing number of countries are considering banning the sale of new gasoline-powered vehicles (Exhibit 3). Norway, a large petroleum-producing country, was an early proponent of this trend and currently boasts EV penetration close to 50%, which is in line with its goal to ban new sales of internal combustion engine vehicles by 2025.
Green bonds are a great way to participate in "disruptive technologies” within the transportation/EV sector. Proceeds from some of these bonds have been used to support development of car batteries and charging station infrastructure. Toyota and Geely (which manufactures taxis used in London) have both issued green bonds to help finance EV research and manufacturing.
Green Bond Issuance and Use of Proceeds
Green bond issuance has steadily increased since 2007, when the European Investment Bank issued the first "Climate Awareness Bond.” Total issuance surpassed expectations in 2017 and is expected to exceed $250 billion in 2018 (Exhibit 4). Citigroup estimates that green bonds could grow into a trillion dollar conduit for climate-related investments by 2020 and SEB, a Swedish bank, predicts that 20% of all bond issuance may be "green” within a few years.
Banks and corporations in the developed world are expected to issue more green bonds. There should also be active issuance by sovereigns and municipalities and we expect a greater number of green securitized bonds. In the emerging markets, Chinese companies had significant green bond issuance in 2016 and other countries, such as India, Kenya, and Fiji, have started to issue green bonds.
While green bond proceeds have been put to use in many ways, in the past they have primarily been channeled to renewable energy and energy efficiency projects (Exhibit 5). Efforts to develop low-carbon transportation and sustainable water and waste management are increasing and green bonds are becoming a more commonplace form of financing for urban metro and rail projects. Export Development Canada (EDC) and Kommuninvest are two organizations that are heavily committed to supporting "green” projects. Financial institutions, such as Barclays, have also issued green bonds. As added incentive, the European Commission is considering lower capital requirements for bank lending to select "environmentally friendly” projects.
Green Bond Principles and Governance
Rules continue to emerge to govern the nascent green bond sector. The Green Bond Principles (GBP) are currently the most well-established framework for evaluating these instruments. The GBP were developed by the International Capital Markets Association and have four components: use of proceeds, process for project evaluation, management of proceeds, and project reporting. These are voluntary guidelines and the determination of what constitutes a green bond is still left to the issuers and underwriters. Many issuers choose to secure an independent review and to this end a Climate Bond Certification is generally recommended. Examples of organizations who conduct this independent verification include Sustainalytics, Cicero, DNV GL, and accounting firms such as Ernst & Young and Deloitte.
Moody’s was one of the early entrants to the green bond "second opinions” market in 2016, and constructed a methodology to assess the environmental credentials of issuers. Its framework evaluates the issuer’s approach to managing, administering, allocating, and reporting on the projects financed by green bonds, and produces a composite grade ranging from "Excellent” (GB1) to "Poor” (GB5). The use of proceeds carries the largest weighting (40%) in their score.
S&P also launched a Green Evaluation Tool to score green projects according to the quality of governance, transparency of a transaction, and the environmental impact associated with the project. As investors continue to integrate sustainability into their investment process, we expect that green bond standards and classifications will continue to develop in scope and detail.
Green Bond Investment Opportunities
The Bloomberg Barclays MSCI Global Green Bond Index draws heavily from the GBP and has a stated aim to offer investors an objective, robust measure of the green bond market. The index’s characteristics have evolved over the past few years, but agency and supranational issuers still dominate, accounting for almost half of all green bond issuance. Sovereign issuers were very active in 2017, and France now has the biggest single green bond outstanding at €9.7 billion. US mortgage lending agency Fannie Mae topped the charts with over $27 billion of green mortgage-backed securities issuance aimed at funding a multifamily green initiative program. Corporations representing industries ranging from financials to utilities to industrials are also increasing their market share. Municipal issuers are participating, but some of these issue sizes are small, and as such they may not be accessible to institutional investors. The index’s currency breakdown is largely euro- and US dollar–denominated, along with roughly 10%–15% represented by Canadian dollars, British pounds and others. This index also excludes high yield securities as well as Chinese renminbi–denominated green bonds.
Ultimately, we believe that an active and tactical approach to investing in green bonds may allow investors to better manage risk factors, such as those relating to currencies and rates. In addition, the index only includes "labeled” green bonds, and there may be additional opportunities in bonds not labeled "green” whose proceeds are applied toward advancing positive environmental and social causes.
An example of an attractive relative value opportunity can be seen in Mexico’s first green bond issuance, initiated by Nacional Financiera (NAFIN), a development bank, whose proceeds are being used exclusively to fund and invest in wind projects (Exhibit 6). Not only is NAFIN supported by an explicit guarantee from the Mexican government, but the bond was also issued at an attractive spread over Mexican government bonds. The issuer obtained an independent review from Sustainalytics, is Climate Bond Certified, and received the "Green Bond of the Year” award for 2015.
Mention of these securities should not be considered a recommendation or solicitation to purchase or sell the securities. It should not be assumed that any investment in these securities was, or will prove to be, profitable, or that the investment decisions we make in the future will be profitable or equal to the investment performance of securities referenced herein. There is no assurance that any securities referenced herein are currently held in the portfolio or that securities sold have not been repurchased. The securities mentioned may not represent the entire portfolio.
Source: Lazard, Bloomberg
An Important Element of ESG Investing
The green bond market is rapidly growing and evolving, but it is still in the early stages of development. A key driver of its momentum is the increasing engagement with ESG factors and sustainable investing on the part of issuers and investors. Green bonds offer governments and companies a way to capitalize on this trend. As society focuses on reducing its carbon footprint, we believe portfolios that recognize this secular trend and proactively reduce their carbon exposure may be better positioned to outperform the broad market. We believe an investment approach that emphasizes sustainability is better placed to add value in the long run. Based on our observations as managers of global fixed income portfolios, the integration of ESG factors and green bonds into the investment process can help investors reap opportunistic gains as well as defend returns.
Global energy demand grew by 2.1% in 2017, and carbon emissions rose for the first time since 2014
Report: Global Energy and CO2 Status Report
- Oil demand grew by 1.6%, more than twice the average annual rate seen over the past decade, driven by the transport sector (in particular a growing share of SUVs and trucks in major economies) as well as rising petrochemical demand.
- Natural gas consumption grew 3%, the most of all fossil fuels, with China alone accounting for nearly a third of this growth, and the buildings and industry sectors contributing to 80% of the increase in global demand.
- Coal demand rose about 1%, reversing declines over the previous two years, driven by an increase in coal-fired electricity generation mostly in Asia.
- Renewables had the highest growth rate of any fuel, meeting a quarter of world energy demand growth, as renewables-based electricity generation rose 6.3%, driven by expansion of wind, solar and hydropower.
- Electricity generation increased by 3.1%, significantly faster than overall energy demand, and India and China together accounting for 70% of the global increase.
- Energy efficiency improvements slowed significantly, with global energy intensity improving by only 1.7% in 2017 compared with 2.3% on average over the last three years, caused by an apparent slowdown in efficiency policy coverage and stringency and lower energy prices.
- Fossil fuels accounted for 81% of total energy demand in 2017, a level that has remained stable for more than three decades.