Liebreich: Is It Right to Feel Optimistic, Pessimistic, or Even Both?

By Michael Liebreich
Chairman & CEO
New Energy Finance

We were delighted to welcome so many of you to the second New Energy Finance Summit in London earlier this month. If there was one single over-riding question, it was whether or not it was justifiable to feel optimistic about the state of the world, and about clean energy and the carbon markets in particular.

The confusing fact is, there is no single answer. It depends if you are looking short, medium or long term. In the short term, the clean energy sector is clearly going through a traumatic slow patch; in the medium term the drivers for growth remain as strong as ever, augmented now by ever greater promises of stimulus spending; but then in the long-term all of this may be pointless, as our current efforts are not on track to save the planet from catastrophic climate change.

For the past 18 months we have been building a sophisticated, systems-dynamic model of the world’s future energy choices. Named Global Futures, it looks at the leading 26 economies in detail, modelling their energy demand, their likely renewable energy growth trajectories – based on available resources, economics, policy and finance – and the extent to which carbon prices will drive changes in the mix of fossil fuels. It includes the impact of a resurgence in nuclear power and of the possible advent of carbon capture and storage. It crunches all of this and spits out the implications – in terms of emissions, investment and jobs.

The good news is, despite the current woes of the financial markets, which are having a worse-than-expected impact on investment activity this year, we are optimistic about growth in clean energy.

Investment in clean energy grew from $34bn in 2004 to $148bn in 2007, rising slightly to $155bn last year. In the base scenario of Global Futures we see this figure growing to $350bn by 2020, an increase of 125%. However, Global Futures also shows us that the world needs to be investing $500bn per annum in order to see CO2 emissions from energy peak before the year 2020. This confirms work we undertook in 2007 and is consistent with figures from Lord Stern and others.

The International Panel on Climate Change has said that the increase in average global temperatures needs to be kept to approximately two degrees Centigrade or less, to prevent very serious damage to human societies and to the ecosystem. To achieve this, we need to see CO2 emissions peak by 2015, or 2020 at the latest, but then we have to wean ourselves from fossil power even more aggressively thereafter.

So the medium-term picture for our industry is optimistic, but not enough for us to be optimistic about containing the risk of catastrophic climate change. Indeed the central scenario from Global Futures is that CO2 emissions will continue to rise all the way through to 2030. And if you were hoping that the recession will give us all a break, don’t. It takes a 3-4% bite out of emissions, but doesn’t change the slope of the curve once it is over: it may be reducing economic activity, but it is also pushing back growth and delaying cost reductions in clean energy.

The challenge facing all of us – governments, investors, and industry executives, is how to turn 125% growth in investment over 12 years into 225% growth. It shouldn’t be impossible – it’s only a question of turning 7% compound annual growth in investment into 10.3%. That’s it: 3% incremental growth in investment to save the world!

Of course first of all, there’s the little matter of the worst recession in living memory that we have to get through. The crisis has hit investment in clean energy hard – harder than anticipated. We are about to release our figures for investment activity for the first quarter of 2009, and I can tell you they are horrible. There has been an unprecedented crash in volume in every asset class. After defying gravity for the first half of 2008, they started to weaken, dropped significantly in Q4 and went off a cliff in Q1 this year.

The government response is unfolding in the shape of economic stimulus packages that earmark fresh money for clean energy projects and research. We have identified “green stimuli” worth around $150bn worldwide so far, with the US accounting for the largest chunk, at $66bn and China coming in second with $59bn. But there is clearly going to be a hiatus between the announcement of these programmes and the point at which money starts flowing.

This week saw US cylindrical thin film PV player Solyndra make history as the first clean energy recipient of a loan guarantee from the Department of Energy – under a programme which emerged from the 2005 Energy Bill. The Obama Administration is working feverishly to ensure that its stimulus doesn’t take a similar length of time to work its way to the front line, but it is still staffing up, and we cannot expect the flood-gates of money to open in 2009.

However, as Professor Cheng Siwei said in his Summit keynote speech, quoting Shelley: “O Wind, If Winter comes, can Spring be far behind?” I am writing this on the day after Timothy Geithner confounded his critics (at least temporarily) by announcing the detail of his plan to remove the impact of toxic assets from bank balance sheets, causing the S&P500; to leap by more than 7%. The oil price has gone back through the $50 mark, and last week IntercontinentalExchange became the first company to clear trades in the $27 trillion CDS market. The NEX, our index of clean energy stocks, has hauled itself back from its low of 132 to a less embarrassing 160.

Capital will start to flow again. As one panellist at the Summit put it: “Capital availability in March 2009 is simply that – capital availability in March 2009. We should assume that it will be different in December 2009, and totally altered in three years’ time.” The financial system is currently being lubricated by the biggest central bank monetary policy effort in history, not to mention the lowest interest rates ever in every country (save Japan). Banks are being recapitalised with hundreds of billions of dollars of government and institutional cash.

More needs to be done to ensure that the stimulus funds flow to the clean energy industry. Our Summit participants had a lot to say on the topic, and we will soon be publishing a communiqué on the subject, which we hope will be heeded in the corridors of power. Bankers and financiers may not be top of the politicians’ Christmas card lists right now, but we ignore their input into how to fix this crisis at our peril. Only they understand the detail of how investment decisions get made, at the pointy end of things, on the Street.

But banks are not the only game in town. The financial system is going to be re-wired over the next few years. Banks will face tighter regulation individually, and there will be a new level of scrutiny of their collective balance sheet to reduce systematic risk. Hedge funds will have to emerge from the shadow banking system into the cold hard light of capital adequacy rules. With banks and hedge funds handcuffed, it will be a case of back-to-basics for the capital markets, matching real investors, with clear risk appetites and return requirements, against opportunities with well-understood risks and returns. The clean energy industry can position itself to do very well in this environment – particularly with a little help from policy-makers.

Green mutual funds, ETFs and investment trusts with waivers on capital gains taxes, and green bonds with tax waivers on profits from interest could unleash a volume of investment into the sector that would dwarf any stimulus spending. The ever resourceful financial markets need to create new vehicles to provide savers with yield at risk levels that are transparent and well understood.

There may be early, tentative signs of this new fund spring. The European Fund and Asset Management Association says that inflows into German retail funds in January 2009 were EUR 8bn, the best monthly figure for years, while the US Investment Company Institute reports that mutual funds saw a net inflow of $25.4bn in January, after six successive months of heavy net outflows. Where are the clean energy funds positioning themselves to benefit from this inflow? Where are the governments encouraging and accelerating this re-routing of finance to the industries of the future?

A second important challenge for the financial sector is to work with the utilities to lease products to customers that enable them to gain immediate financial benefit in terms of lower utility bills from the installation of more efficient boilers, solar water heating and other micro-generation devices. In the current environment, utilities are the new banks, solid, dependable, able to tap into the bond markets even in these dark days. What have they been doing – at least some of them? Eyeing each other up as potential acquisition targets, and pushing back their clean energy investments!

A majority of utilities in the developed world now have some target for the percentage of renewable energy in their portfolios. Their strategy to date has been to reach the target by adding mainly clean energy. But now, a fall in forecast demand for energy as a result of the recession calls this into question. To reach their renewable percentage goals they will have to actually retire productive fossil-fueled capacity. Some are gambling that their political masters will not force them to do this, instead relaxing the renewable requirements. We believe they are significantly misreading the Zeitgeist. Europe has recently passed the 20-20-20 directive, making 20% renewable energy an explicit target in achieving a 20% reduction in carbon emissions by 2020. In the US, the majority of states have Renewable Portfolio Standards, and none are talking of relaxing them – indeed the next target of the new Administration is a combined Energy and Climate Bill which may well enshrine a Federal Renewable Portfolio Standard.

And the money is coming. To coincide with our Summit and in association with Deutsche Bank, New Energy Finance published a survey of attitudes towards climate change investing by asset owners and managers. The response from 106 institutions controlling over $1 trillion of assets was that institutions are remarkably positive on the idea of investing in clean energy. No fewer than 75% of respondents expected to have more invested in clean energy in 2012 than they do now, and 49% were either “more likely” or “much more likely” to increase their exposure to the sector than they were just a year ago.

These asset owners are right to be attracted to the sector. In the long term, the unstoppable drivers for the transition to low-carbon energy make it a key investment theme for the next decade. In the medium-term, the sector is expected to be one of the engines to power us out of recession, and generous government incentives are being added to the attractions of robust project cash flows and plummeting technology costs. In the short term, prices for clean energy assets – projects, private equity and public equity – have taken a hammering, and look set to pop.

And hence, despite the carnage of the current quarter, we are sticking with our Global Futures prediction for 2020 – that investment volume in clean energy will soar to $350bn and the clean energy industry has a very bright future indeed.

Just not quite bright enough, on current trends, to save the world. For that, more work will be needed – either a coordinated global push for clean energy on a scale we have not yet seen outside a few European countries, or a show-stopping agreement between the US and China in time for Copenhagen.

This may, just may, be on the cards. Chinese Premier Wen Jiabao’s recent statements on his worries about the dollar make this a whole lot more likely. Wen was making the point that he expects the US to raise taxes after the recession, rather than using inflation to get its public debt down to manageable proportions. A reasonable point when you own over $1 trillion of dollar-denominated assets. But perhaps something of a negotiating blunder in the run-up to Copenhagen. If the US does not introduce cap-and-trade with auctioned credits, there is a hole in Obama’s budget, which would cause the dollar to plummet. So US negotiators are presumably now pointing out that if China wants strong public finances in the US, it had better do what it can to help get a Federal cap-and-trade programme through Congress. And that means making some pretty big concessions, without which cap-and-trade in the US is politically radioactive.

So the form of a grand China-US bargain on carbon might be emerging: US goes for cap-and-trade – as much for budgetary hygiene as for environmental reasons – with China making some surprisingly big commitments on carbon, most likely through sectoral energy efficiency and intensity targets.

The industry certainly needs a big slug of good news. Next month we’ll be picking over the bones of the historic crash in clean energy investment activity of Q1 2009. It might be hard to avoid a touch of pessimism along with the medium-term and long-term optimism.

We will also be publishing the Summit Book, a faithful and, we hope, entertaining record of the insights that emerged from the event and the annual Awards Dinner on Thursday 5 March; and a communiqué for international policy-makers and investors ahead of the G20 meeting in London on 2 April.

Download the PDF here.

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