According to some, the power of greed shapes and drives our capital markets, and it is this greed that has led to the industrialization of the global society and ultimately to the buildup of excessive levels of Green House Gases (GHGs). Can the same capital markets save us from catastrophic climate change?
Our answer to this question is “yes, they can.” The transition to a sustainable economy requires a different interpretation of what drives our capital markets. In spite of how the profit motive may influence our capital markets, they exist as a creative source to address fundamental human concerns and needs and to organize the talents and resources necessary to manifest innovative solutions. From this perspective, rather than avarice, our capital markets translate the profit motive into unprecedented human creativity, and throughout history they have championed effective responses to many of the world’s greatest threats. In order for climate change to be successfully and permanently mitigated, clear signals need to be sent to suppliers and investors so that they can set off a process of innovation.
New Challenges
The challenges emerging from global climate change have historically been framed as a physics problem – the build up of too much CO2 concentration in the atmosphere is causing a greenhouse effect thereby warming the planet to higher and higher temperatures. Drilling down, it is the consequence of human activity that has led to this build-up of atmospheric CO2 beyond our earth’s capacity to absorb it into its soil and oceans. This change in the earth’s carbon cycle has occurred because of increased combustion of fossil fuels, releasing emissions into our atmosphere, that had been previously stored under the earth’s surface. Specifically, in spite of earlier visions of reduced energy consumption from greater efficiency and a more robust service-oriented economy versus a carbon based manufacturing one, there has been an increase in the sources of CO2 to run our industry and provide a global transportation network for our growing population. Even the newfound interest in the production and consumption of electronic data is tapping new energy requirements to unforeseen levels.
In fact, looking ahead to the future, the build-up of atmospheric CO2 is growing in spite of increasing natural resource scarcity and rising use of new technologies such as wind and solar energy. Population growth and higher energy use per person in the developing world offsets nearly any amount of reduced consumption or energy efficiency gains in the developed world. Rising global temperatures will undoubtedly create a greater risk to our fragile environment, our shared national economies and global security.
In the early 1980’s, the US was faced with a similar problem, one that was ultimately solved by allowing the capital markets to act. An acid rain epidemic was plaguing the eastern United States from Iowa to the Mid-Atlantic region, and the proper means to regulate sulfur oxide (Sox) was being hotly debated. In the end, the fist large and practical application of a “cap-and-trade” approach to reducing pollution was implemented.[1] Today we face a similar problem, and the capital markets can once again be called upon to send a clear signal to help solve it.
Looking Ahead
Recent studies show that policy initiatives since the 1990’s to bring nations together to fight climate change have not stopped or reversed the growth of global CO2 emissions.[2] Emissions are still on a trajectory to reach more than 800 ppm by the end of the century when nearly every scientist would agree that reaching 450 ppm or 500 ppm by mid century might be a “point of no return” in any effort to reverse the trajectory of rising global CO2 levels.[3]
The International Energy Agency (IEA) has issued frequent studies outlining the scale of deployment of new technologies such as wind, solar and nuclear power required to keep global emissions under 450 ppm. Their studies support switching from our current dependency on coal and oil and promoting a dramatic shift to new sources of renewable energy.[4] The National Renewable Energy Lab based in Golden, CO has run their own calculations on what it would take to convert to a reliable US electric system built on 80% renewables by 2050 promoting biomass, wind, concentrated solar energy, and new investments in hydrological reserves to build out a robust storage and distribution network.[5]
These calls to action have not gone unheard. Recently, the White House and the Environmental Protection Agency (EPA) proposed a plan that aims at a 30% reduction in CO2 emissions from 2005 levels for new and existing power plants by 2030. This proposal is an attempt at a compromise as it sets specific targets for each state, but provides those states with a broad degree of flexibility for meeting those limits. However, while these are steps in the right direction, they fail to empower the capital markets and champion the changes necessary to mitigate climate change.
Project Butterfly, a collaboration of business and science leaders, has attempted to reframe the problem by looking at the issue of climate change from a financial/policy perspective rather than from a physical or economic one. This organization has attempted to ascertain whether it is possible to create alignment of interests between key stakeholders connected to the production of CO2 and those stakeholders integral to a robust energy industry interested in preserving the environment so that these opposing sides can come together in agreement over the need for a price on carbon? Project Butterfly, with the assistance of a group affiliated with MIT and an international resource consultancy, worked to develop a climate and financial wealth model with two innovations, and the results of this modeling effort further point towards the need for a price on carbon.[6] The first innovation that separates this work from similar forecasting models is in the recognition and acknowledgement of importance of the four key stakeholder classes: (i) The environmental steward concerned about rising greenhouse gases, (ii) The energy supplier concerned about resource supply, (iii) The energy user concerned about price and (iv) The energy investor concerned about returns on capital. Implicitly, many current proposals require one or another of these classes to be losers. However, the Project Butterfly findings show that it is possible to reduce CO2 emissions while making each and every stakeholder class better off.
The second innovation was to transform an underlying economic model into a financial model, adding key variables used in business decisions. Using combined economic and financial modeling techniques, and requiring a positive outcome for all classes, the results showed that it is possible to increase the value of total energy assets, to reduce energy consumption without compromising economic growth, and to keep CO2 concentrations below 550 ppm for the 21st century. Specifically, by transforming the output of an economic model into the balance sheet variables—internal rate of return, return on investment, etc., required to support business decisions, and to then use those as the criteria in the model analysis. The best solution emerged not by promoting government expenditures in some kind of war against climate change, but rather by providing a clear signal to the market, largely in the form of a price on carbon, to promote innovation and investment. The solution was made possible by i) redirecting existing subsidies from oil and gas producers to to renewable generation producers and ii) internalizing externalities through the application of a $40/ton price on carbon emissions; iii) and promoting the necessity of energy efficiency measures.
The outputs from these combined actions allowed us to forecast and compare the profitability of all energy suppliers under a business-as-usual (BAU) scenario and the new business case (NBC). Changes in profitability are expressed as a function of net-present values (NPV), internal rates of return on invested capital (IRR), and debt coverage ratios (DCRs). According to the calculations, by the end of the century, each stakeholder under the NBC is better off, including the end user, while satisfying the environmental steward by limiting greenhouse gas concentrations (See Figure 1). In fact, the most telling output is the enormous spread in total supplier value, as indicated by the NPV of the Energy Investor, between BAU and NBC by the end of the century – $16 billion vs. $120 billion. This spread reveals the enormous opportunity for suppliers, investors, and energy users to hedge their risk by selling short BAU enterprises and going long with NBC technologies.
Figure 1 – Results: Business as Usual vs. New Business Case
Source 1 Project Butterfly Model (Oct. 2013)
The results suggest that Project Butterfly’s possible solution, which allowed civilization to avoid catastrophic climate change, only slightly differed from suggestions that are currently being debated by individuals in the world’s top think tanks. The difference was that the Project Butterfly model (i) searched for a financial solution to climate change, and (ii) searched for alignment among the stakeholder classes.
Figure 2 shows that under the status quo, there is growth in all forms of energy except for a peaking in electricity from oil. Alternatively, a new business case yields a much more substantive transition to renewable energy resources while simultaneously improving the conditions of all stakeholder classes, including the energy consumer.
Conclusion
So, how can society build alignment between the solar energy engineer and the coal miner, for example? The Project Butterfly model does deliver a crushing blow to the return profile of coal suppliers while dramatically opening up new market opportunities for suppliers of renewable energy and energy efficiency services creating a natural schism in the energy landscape. Some may argue “no foul” as it is often the unfortunate casualty that comes from the deconstruction of a market that in turn allows innovation and greater efficiency to emerge. However, does the solution to climate change still require further reshaping of the problem in order to find an agreeable political solution for all stakeholders?
The Project Butterfly analysis reveals that possible solutions inextricably depend upon the framing of the problem. The standard climate debate casts the perceived conflict between economic production and nature as an almost mythological trade off between mankind’s best and worst impulses. This lens and framing of the problem polarizes the conversation and leaves us with the status quo. Instead, by testing for a situation in which each stakeholder group has its interests met, or exceeded, allows the discussion to be reshaped as one between accepting the status quo or building a new business case.
The Project Butterfly simulations show the necessity for a price on carbon and the need for the capital markets to be presented clear guidelines which will ultimately define a new path forward, reshape the financing of energy, and enlist rather than demonize the private sector and the profit motive (a new business case). But the analysis must now be repeated within sectors to identify win-win strategies as well as between industry and societal sectors.
Nevertheless, the new business case provides a clear path for reducing individual, community, and corporate carbon footprints without compromising the interests of our key stakeholders classes. This leads to the building of a more hopeful scenario, where de-carbonization leads to new global wealth benefitting our collective future, and where suppliers can fairly compete for the energy services.
References and Notes
[1] Strock, Kristen E., Sarah J. Nelson, Jeffrey S. Kahl, Jasmine E. Saros, and William H. McDowell. “Decadal Trends Reveal Recent Acceleration in the Rate of Recovery from Acidification in the Northeastern U.S.” Environmental Science & Technology 48.9 (2014): 4681-5689. Web. <http://pubs.acs.org/doi/abs/10.1021/es404772n>.
[2] “Kyoto Protocol Had ‘limited Effect'” Japan Times RSS., 11 Apr. 2014. Web. 27 June 2014. <http://www.japantimes.co.jp/news/2014/04/11/national/kyoto-protocol-had-limited-effect/#.U62sGI1dU5k>.
[3] “Carbon Dioxide: Projected Emissions and Concentrations.” Carbon Dioxide. Intergovernmental Panel on Climate Change, 4 Apr. 2014. Web. 27 June 2014. <http://www.ipcc-data.org/observ/ddc_co2.html>.
[4] World Energy Outlook 2013. Paris: OECD/IEA, 2013. Print.
[5] National Renewable Energy Laboratory. (2012). Renewable Electricity Futures Study. Hand, M.M.; Baldwin, S.; DeMeo, E.; Reilly, J.M.; Mai, T.; Arent, D.; Porro, G.; Meshek, M.; Sandor, D. eds. 4 vols.
NREL/TP-6A20-52409. Golden, CO: National Renewable Energy Laboratory.
http://www.nrel.gov/analysis/re_futures/.
[6] “En-ROADS.” Climate Interactive: Tools for a Thriving Future. Web. 27 June 2014. <http%3A%2F%2Fwww.climateinteractive.org%2Ftools%2Fen-roads%2F>.
Mr. Stoner has spent 30 years as an energy executive having led two companies through venture funding to successful exits selling one to a publicly traded utility holding company and the second through a successful IPO on the London AIM Exchange. He is currently the Senior Managing Member of New Alchemy Energy Partners, LLC, which provides capital to US projects that displace conventional and traditional power sources and whose mission it is to decarbonize the US energy markets.
Dr. Schimel is currently leading research at NASA focused on carbon-cycle climate interactions, combining models and observations. He has published over 150 papers in the ecological, biogeochemical and climate literatures, written two books and edited three books. In 2007, he was one of the co-recipients of the Nobel Prize for his participation on the Intergovernmental Panel on Climate Change.
