The daunting challenges of financing decarbonization at
the level required by the more aggressive decarbonization scenarios being
pushed by deep decarbonization and fast decarbonization advocates are quite
sobering. Trillions of dollars per year from the private sector would be
required to achieve those targets. That makes deep and fast decarbonization
less likely in reality. It is really a longshot but in some ways that depends
on how you look at it. Private capital deployment has constraints, and the
number one constraint is financial risk, which must be mitigated to the
satisfaction of the investors. As a business externality decarbonization is
inherently unprofitable, especially at first. It requires government
subsidization and/or the regulatory nudging of a carbon market. As long as public
and support is maintained, and private capital is available there can be
success. However, operating in crisis mode will probably not be helpful.
Cost Estimates
A presenter at
the recent Energy Futures Energy Finance Forum (EF3) live stream revealed that
current private equity per annum for decarbonization is at about $600 billion
and that would have to rise to $3-5 trillion annually to meet decarbonization
targets. The IEA estimates we need $4.4 trillion annually from about $1.4
trillion from all sources now, which means total annual investment must more
than triple to meet targets. Is that reasonable or sustainable? The number in
the billions is already high for inherently unprofitable investments and
increasing it by multiple times times is not going to be helpful to the world
economy, which is already struggling due to inflation and high interest rates. Investors
face many risks and to compel them towards more investments that are low return
at best but more likely little to no return certainly doesn’t seem like a sound
financial strategy. Of course, each project is different and must be evaluated individually.
The government needs to be mindful of vetting projects so that subsidies are
given to projects that can be viable and profitable at some point. Advanced
nuclear and CCS both support lowering the emissions intensity of reliable
non-intermittent energy sources and should perhaps be prioritized. Solar and
wind are best supported by current levels of tax credits and by investments in infrastructure
upgrades. Advanced nuclear is reliant on government subsidization. CCS, hydrogen,
and biofuels are favored by the fossil fuel industry which is a major source of
private capital for these projects as well as government incentives like 45Q.
Emphases
In the EF3
forum Senator Chris Coons emphasized the importance of investment for scaling
up new tech that looks promising, like small modular nuclear reactors, carbon
capture and sequestration, and hydrogen. He also noted the need for permitting
reform in both clean and fossil energy projects and the need for developing
countries to develop their fossil resources as well as clean energy. He also
emphasized the effectiveness of switching from coal to gas. These are all
pretty clear things to prioritize and expedite including stopping the nonsense
of not lending to developing countries for the fossil fuel projects they need
to help their economies, despite the emissions. In developing countries energy
and modern electricity access should trump decarbonization concerns.
Investment Risk Management
Investors face
several types of risk. There is technology risk, revenue risk, regulatory risk,
infrastructure risk, financial reg risk, reputational risk. The government can
alleviate some of those risks with subsidization, regulatory and permit reform
and streamlining, and longer-term financial backing. The IMF notes that subsidies
must be credible and irreversible. Corporate and institutional investors require
investments that are stable and steady in the longer term, even if returns are
low. All these risks need to be priced. Investors understand the “why” of what
they are doing in decarbonization investment but the “how” is the challenge.
There is a need to be pragmatic and to avoid being overly aspirational with
emissions reduction. We know that early-stage projects often have much higher
costs before scaling can happen, but we still need to concurrently assess costs
as projects are being developed. Former Energy Secretary Ernest Moniz
emphasized the government nudges that are now in place in the U.S. with the infrastructure
bill, the IRA, and the Chips Act. He suggested some goals for 2030 including
bringing projects to “manufacturability” so that scaling and filled “order
books” can bring down prices and increase speed and quality. He said that
demonstrable tech that can be deployed at scale should be a major goal for
2030. That does seem to be the case for both advanced nuclear and CCS. He also
noted that the hard to abate heavy industry sector needs to get moving as well
with government support. He also noted that the investment, tech, and policy communities
all need to be provided with enough information to be able to determine feasibility
of projects. Since there is blended public and private finance, there needs to
be a retuning of information sharing to all parties so that risks can be shared
and understood as best as possible by all parties.
These
different risks need to be evaluated for each technology and at each point
along the value chain of each technology. In order to attract institutional
investors these risks must be thoroughly analyzed, understood, and hedged. Decarbonization
investments are long-term and can be aligned with institutional investment but
only if properly risked. Below is a graph of the perspectives of each class of
investors. One can see that each class is more or less aligned with a different
phase of these energy decarbonization projects.
Energy Futures gives the innovation process itself four
phases: invention, translation, adoption, and diffusion. Between each of these
phases is a “valley of death,” a phrase which shows that there are several
perilous journeys that must be undertaken for each project where risk may kill
the project. This is why announcements of new scientific breakthroughs do not
often end up being new technological breakthroughs.
The third figure below simply shows that each of the
aforementioned risks need to be evaluated and mitigated as potential roadblocks
for each technology I order to get it across those valleys of death.
Climate Investment Exposure to Silicon Valley Bank
Failure
While there
has been quite a lot of blame going around about the Silicon Valley Bank (SVB) failure
and now the Signature Bank failure, its hard to pinpoint any specific blame
except to those managing the assets. I’m no finance expert by any means but I
can understand what I read. Progressives are blaming Trump (weakening of
Dodd-Frank in 2018). Conservatives are blaming Biden. Some are blaming the Fed.
Some are blaming woke investment. Some are blaming wealthy investors. However,
it seems that most agree that the banks exhibited poor risk management in light
of prevailing market conditions. Certainly, inflation and the reactionary climbing
interests rates were a factor, but one the bank managers should have been
hedged more against. SVB was involved in clean energy investment as well as
other investments with unpredictable returns involving startups and volatile markets
like cryptocurrencies. Fervo Energy, the company involved in a major DOE funded
geothermal energy research project in Utah, was an SVB customer. No doubt, many
other decarbonization investments were involved as well. SVB lent to a majority
of the community and residential solar projects in the country. Some have
called it a ‘climate bank.’ While solar projects are not considered risky, they
are generally low return and a portfolio full of low return projects is as not well-hedged
as one with high return projects to balance them. Some solar CEOs think that the
bank’s failure will indeed have an impact on the industry going forward but
will sort out eventually as other banks concur that these solar projects are
sound in the long term. Others think they will find other lenders quickly with
little disruption. While demand for solar projects is high, they dropped by 16%
in 2022 for a few reasons: Uyghur Forced Labor Prevention Act, higher interest
rates, and supply chain issues.
Unfortunately,
risky investments can become catastrophic as we have seen with some
cryptocurrency investments and the current bank runs. Decarbonization investments
need not be overly risky but by nature they are low return and often involve
venture capital. Thus, their risk profile is higher than most investments. The
current high inflation/high interest rate environment does not favor a majority
of investments and high risk is amplified in such an environment. This is yet
another among many reasons to tap the brakes on the energy transition. Aggressive
decarbonization pledges and mandates are due for re-tunings for a number of
reasons.
Even though I
have heard deep decarbonization advocates say we can’t afford to slow down
decarbonization, perhaps a better question is can we afford to speed it up? I
would say no, we can’t. Once again, as I have concluded in other articles the near-term
to 2030 decarbonization goals will likely have to be scaled back and they can
be since they are front-end loaded, meaning we can still approach later goals
without adhering to deep emissions cuts in the near term. One might also fault
the 1.5 deg scare with the ICCPs 2018 report as the reason 2030 goals got so
front-end loaded. I read that Greta Thunberg ‘quietly’ deleted a tweet from
2018 where she claimed the world would end in 2023 if we did not aggressively address
climate now. Oops.
Implications of U.S.-China Competition
As noted by Jennifer Lee in the Atlantic
Council’s Energy Source Newsletter, while the Chips Act and other maneuvers to beef
up U.S. domestic production of semiconductor chips, solar panels, lithium, and
other critical minerals, and associated supply chains are no doubt useful in
order to increase energy and tech security, in themselves they do not increase
the rate of decarbonization and will use up a significant portion of funding from
the infrastructure bill and the IRA. These useful spends won’t help us meet
decarbonization targets any faster. China strongly dominates rare earths and
rare earth processing as well as the solar the PV solar supply chain. They also
dominate wind energy supply chains. The expected U.S. restrictions on exports
to China of semiconductor chips is expected to be countered by China with a restriction
on solar panel equipment in a typical tit-for-tat. The reality is that our current
geopolitical tensions with China will hurt both countries, particularly in the
short-term, again leading to a slowing of decarbonization efforts as costs go
up. Another recent row involves the Ford-CATL EV battery deal which involves
Chinese-made lithium iron phosphate battery technology. Elements in both the
U.S. and China are claiming that they are wary about sharing technology. This
kind of suspicion and distrust is not conducive to successful cooperation. Of course,
some competition is healthy, but we need to be careful to avoid creating unnecessary
obstacles between the world’s two biggest carbon emitters.
Big Oil as Integrated Energy Companies Likely to Be
a Big Part of Private Decarbonization Investment
Big oil majors
have long been major investors in alternative energy, being instrumental in the
very development of tech like solar energy and lithium batteries. Now, as some
of the Euro-majors in particular are pivoting to become so-called integrated
energy companies, investment in clean energy is expected to increase in the
coming years. However, there will be bumps in the road. One bump was recently
revealed as BP pulled back their previously ambitious green energy investments.
It could simply be that their enthusiasm was too high and their goals overly
ambitious in the short-term. After the highly profitable 2022 for oil and gas they
perhaps wish they would have waited a bit longer to divert funds away from oil
and gas toward renewables and other green tech. Despite record profits, BP’s
underperformance relative to their peers led their management to scale back
their goals to decrease oil production by 40% by 2030 to a 25% reduction. Thus,
their decarbonization has been decelerated a bit, although they claim their
overall goals and plans for net-zero by 2050 have not changed. BP had increased
their investments in their so-called “transition growth engines” which include
renewables, bioenergy, CCS, hydrogen, and EV charging, from 3% to 30% since
2019. Susannah Streeter, head of money and markets at Hargreaves Lansdown,
noted that BP has two sets of investors to please: those seeking the highest profits
and those seeking responsible investing in clean energy tech. Half of BP’s
largest investors are in the Climate Action 100+ group of activist investors. They
have nudging sway and were not pleased by BP’s pullback. Shareholders approved
BP’s initial planned 40% production increase by 2030 so BP will have to be
careful going forward. In any case, the extreme profitability of 2022 allowed
them to actually increase their investments in those transition growth engines
as well as in more oil and gas production so the shear profitability of oil and
gas is funding both ventures. Indeed, many oil and gas companies are still flush
with cash so that will help with decarbonization capex in the near-term. This
is true of oil and gas companies across the board: majors, independents, and
private equity companies. Fiscal discipline has paid off and geopolitical
forces have added to the bounty. However, weather has not been cooperative for
the natural gas sector at least for the short term. Even so, the outlook is
decent as natural gas and LNG demand is expected to remain high for some time
to come.
Abated vs. Unabated Fossil Fuels
Ministers form
the 27 EU countries agreed on March 9 to focus on phase-out of unabated fossil
fuels at this year’s COP28. They also want the fossil fuel peak to come sooner
and to phase out all unabated fossil fuels well ahead of 2050. I see this as
more rhetoric since it is unlikely China and India are going to heavily pursue
CCS and methane emissions abatement in the near or medium term. Poor developing
countries would be burdened even more to be subjected to abatement. A question
would be what constitutes abated vs unabated. I see it as just another aspirational
statement but also as a nudge. While it may be fine to nudge those that can
financially handle abatement costs like Big Oil companies, the idea of nudging
those less able to fund abatement does not seem fair to me. African countries
have complained about restrictions on acquiring financing for fossil fuel projects.
I see this focus on abatement as an extension of that. I would suggest that they
be excluded from such requirements, with the caveat that they could add
abatements later or be subsidized for those abatements by other countries.
Conclusions
New decarbonized technologies like advanced
nuclear, CCS/CCUS, and hydrogen can be economic or relatively economic under
the right circumstances and with adequate support to get each technology going
towards full commercialization. However, support will need to be maintained and
economics will need to be constantly evaluated in order to fund the best
options optimally. Energy sources providing reliable power should be
prioritized over intermittent sources. Options like blue hydrogen should be
favored over green hydrogen where applicable, such as where natural gas is
abundant and cheap. The EF3 report acknowledges that profitability will take
time as first-of-a-kind projects will cost more, next-of-a-kind projects
somewhat less, and nth-of-a-kind projects will begin to gain financial
advantages. But Moniz’s admonition still stands – we need to demonstrate by
2030 that these projects can be deployed at scale.
References:
Increasing
the Quality of Investments for Deep Decarbonization. Energy Futures Finance
Forum. February 2023. EF3-Framing-the-Energy-Futures-Finance-Forum-1.pdf
Energy
Futures Finance Forum: Increasing Clean Energy Investment Quality: Live Stream
February 28, 2023.
Solar companies
offer reassurance after renewables financier Silicon Valley Bank collapses.
Diana DiGangi. Utility Dive. March 14, 2023. Solar
companies offer reassurance after renewables financier Silicon Valley Bank
collapses | Utility Dive
BP’s
green energy dilemma: investor confidence goes both ways. William Farrington. Proactive.
March 6, 2023. BP’s
green energy dilemma: investor confidence goes both ways
(proactiveinvestors.com)
Beauty
and the beast: Implications of the US-China tech war on climate and energy.
Jennifer Lee. Atlantic Council. EnergySource. March 6, 2023. Beauty
and the beast: Implications of the US-China tech war on climate and energy -
Atlantic Council
EU
agrees to push for global fossil fuel phase-out ahead of COP28.
EURACTIV/Reuters. March 10, 2023. EU
agrees to push for global fossil fuel phase-out ahead of COP28 – EURACTIV.com
No comments:
Post a Comment