Hey! Look! Climate policy that would actually work! Alex Evans
November 26, 2009 | More on Climate and resource scarcity, Economics and development | 3 comments
So imagine if you will that you’re a small energy company. You’re thinking about building a wind farm, say, off the coast of Yorkshire. Problem is, you’re struggling to find investors to finance the project. Every time you talk to venture capital companies, private equity firms or other financiers, you get the same response. They’re worried about the risk – specifically, the risk of politicians lacking (how to put it?) lead in their pencil.
What, the investors ask you, happens if policy failure means that fossil prices stay low, so your wind farm can’t compete? Or, for that matter, if prices for emissions permits stay at rock bottom because government caves in to lobbying on permit allocation? What happens if the government simply misses all of its climate targets?
So maybe the investors agree to finance your project, but at punishing rates of interest. Or maybe they decide not to finance it at all. Either way, your energy firm and the government are stuck together in a vicious circle of self-fulfilling prophecy. The government can’t deliver its climatepolicy targets unless people like you build things like wind farms. But you can’t access capital at reasonable rates unless the investors are convinced that there’s a real future for what you want to build - and they figure that the government’s record of fudges kind of speaks for itself.
This is the kind of dilemma that David and talked about in our report on institutional architecture for climate change, where we argued that a key requirements for moving forward on climate policy was clearer signals from the future – whereby everyone believes that the low carbon economy is actually going to happen, and consequently acts in ways that deliver exactly that outcome.
Well, Michael Mainelli - a good friend of ours whom we worked with on the London Accord, which brought together a raft of investment banks in a collaborative research project on climate change – has come up with a delicious proposal that would in effect amount to just such a signal from the future. You’ll like this.
Michael’s solution: index-linked carbon bonds. Cast yourself back to the blowy Yorkshire coast and that offshore turbine array you’re itching to build. Then suppose that the way you raise the cash is to work with a finance house – a renewables specialist like Impax Capital, say - to issue a bond. But the trick you do is to say that the bonds are index-linked to the three risks mentioned above: government performance on climate targets, fossil fuel prices and emission targets. What the index link does is ensure that the cost of your capital gets reduced where the risk of government [in]action threatens the profitability of your project.
So that’s your arse covered. But, you ask, why would any investor buy such bonds – in effect, betting a lot of cash that the government is going to achieve 100% matching of words with action – when so much of the evidence suggests that it might just be easier to make a large withdrawal from the nearest ATM and then feed it into the nearest paper shredder? Who’s going to cover investors’ arses?
This is where it gets really smart. Mainelli’s suggestion: governments issue their own bonds, but with the opposite risk profile. Where your wind farm bonds reduce the cost of capital in line with government’s climate performance, government bonds go the other way around: the worse they perform on climate policy, the more expensive it becomes for them to service the government debt.
By issuing bonds with this kind of index-link, then – and let’s face it, one thing the UK government is going to be doing a lot of for the foreseeable future is issuing bonds – the government would be pulling off a double win.
First, it’s creating a mechanism that will create real incentives for policymakers to deliver what they promise on climate change. Instead of the usual story now – where the Treasury is constantly holding back climate progress because it thinks it’ll cost a lot – the Treasury will be leading the charge because reducing emissions will save it money.
And second, the government would be creating an awesome hedging mechanism for investors interested in putting cash into clean energy projects like our wind farm in Yorkshire – because government would actually be putting its money where its mouth is – not through some crappy subsidy worth a few tens of million quid, dreamt up because the PM wants an announceable for his next speech, but woven elegantly into the very core of the gilts market. Wouldn’t that be a thing to see?
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A rather different model is a Power Purchase Agreement as set up by Utilyx between Sainsbury and wind farm created by A7 Lochhead.
http://www.actionsustainability.com/news/62/Sainsburys-buys-power-from-generator/
Very interesting; but….
Surely you don’t eliminate the political risk – you actually multiply x2. In the real world, how could you ever index government performance, relative to and defined by what? You also assume that Western governments would have any problem in defaulting on such instruments – quite the reverse, probably a tidy vote winner when the time comes. Stop assuming that political risk (in the dire sense) is only the affliction of emerging markets – putting your money where you mouth is can cut two ways on this one…
One final point – something Whitehall should hopefully understand after the Array project, when Shell left you looking like turnips, to really attract seriosu investment in renewables, you have to really offer the best return on investment. Not just in your own back yard, but globally – that also means sorting out the practicalities of planning, capacity constraints and nimbyism – and it also means benchmarking against investing in the black stuff. Venture capitalists aren’t going to get you much, you need the energy giants properly onboard… as above, assuming the government would be credible to the end on this is horse manure.
As for ‘crappy subsidies’ this is true of the UK. But a not so crappy subsidy (dressed up as the feed in tarrif) in Germany, does actually work.
This would probably be the quickest recipe to never achieving any major renewables in the UK – not the way to go. Simple = good, complex (as the RO is) = costly disaster. This wouldn’t only be expensive, but poliically embarrasing… nice to see your faith in governments remains in fine spirit tho.
Yes, although, sadly, i am not a banker, i think it would; and i don’t think it would be that difficult to index government performance. Eg, one of the UK’s present targets is to provide 15.4% of all electricity supply from renewable sources by 2015. The achievement or non-achievement of such quantified targets could determine the value of the index-linked carbon bonds. After all, there are inflation-linked bonds or equity-linked notes and bonds.
As well as incentivising ‘renewable’ enterprise, such a mechanism might spur on the government to meet their emissions targets. As you imply, it would give them an incentive too.
Also, perhaps it could somehow bypass the animosity of fossil-fuel producing factions that Germany has had to contend with since introducing subsidies for renewable energy firms. But it would surely ensure that R & D projects continued to be pursued, another cited failing of the German subsidy scheme. Renewables could mean a lost job to a fossel fuel worker, which is most unfortunate, but doesn’t this need to be tempered with the fact that if we don’t reduce our carbon output, the survival of humanity probably hangs very much in the balance. On the other hand, once more radical policies are put in place, it may clearly signal to fossil fuel industries that the way forward is renewables, and thus young people may stop entering into this job area.
If we cannot rely on the government to push forward renewable energy then we certainly cannot rely on business. Shell exited from the Array project (wind turbines) because it ceased to be commercially viable for them. It looked to pastures new in terms of biofuels instead. However, as has been pointed out, growing these increases the likelihood of the global poor experiencing food deficits. This is how unincentivised capitalism works. Well, there is still Prince Charles.
Actually, i believe, it is Sweden that is at the top of the world green league table, with their pledge to achieve an oil-free economy by 2020 (though have seen other targets reported that are more modest). And, as i understand, this, if not initially government-led, is very much government supported, indeed, it could not have happened without full government backing. i think one of the ways this is being facilitated is by tax on polluting cars and incentives to buy green cars.
The Swedes thought that a Sweden free of fossil fuels would give them enormous advantages, not least by reducing the impact from fluctuations in oil prices. (http://peakoil.blogspot.com/2008/05/sweden-plans-to-be-world-first-oil-free.html)
Incidentally, another incentive for the hypothetical creation of this Yorkshire farm might be that wind power in the UK costs half that of German generated wind power, apparently. So, come any integration of the Euro power grid, to have such energy could be profitable for the UK. It seems that the installation of turbines has to be considered carefully because the hum can upset some. There is also the problem of birds being killed – but couldn’t this tendency be eliminated?
Lastly, and again, perhaps separate to the bond issue, when Shell pulled out of the Array project, Friends of the Earth advised that the government should encourage manufacturing of turbines in the UK. http://news.bbc.co.uk/1/hi/business/7377164.stm