Hey! Look! Climate policy that would actually work!

by | Nov 26, 2009


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?

Author

  • Alex Evans is founder of Larger Us, which explores how we can use psychology to reduce political tribalism and polarisation, a senior fellow at New York University, and author of The Myth Gap: What Happens When Evidence and Arguments Aren’t Enough? (Penguin, 2017). He is a former Campaign Director of the 50 million member global citizen’s movement Avaaz, special adviser to two UK Cabinet Ministers, climate expert in the UN Secretary-General’s office, and was Research Director for the Business Commission on Sustainable Development. Alex lives with his wife and two children in Yorkshire.


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