Green investment: if the stick doesn’t work, better try the carrot

Photo Robert Bell / Professor of Management and Former Chairman, Department of Economics, Brooklyn College, City University of New York / February 8th, 2016

How to reverse climate change? The current discussion focuses on reducing carbon consumption. But the policy instruments and tools available today are neither efficient, nor realistic. Both cap and trade and carbon taxes are variations of coercive systems. They can work if they are coercive enough. But who wants to live in Green Stalinism? So if the stick doesn't work, better try the carrot. It is time to turn the creativeness of financial innovation into something useful.

ParisTech Review – In several pieces published before COP21, you have painted a bleak picture of the landscape, even in the case an agreement would be achieved. Why such a pessimistic view?

Robert Bell – I’m just considering the numbers. And what they say is that if we are in a war to save the climate, we are without question losing it. Although promoters of green energy have made significant progress, the promoters of fossil fuels have done much better, and are still doing better, even with the collapse in the oil price. In 2013, for every dollar invested in renewable energy, fossil fuel promoters had thrown four dollars into their activities. So, for every dollar bet on hope, there were, in 2013, four dollars bet on doom. This is what I call the Hope/Doom Ratio. It’s a simple way, based strictly on investment, which isn’t a bad forecaster of the future, to see if our grandchildren have much of a chance to survive global warming.

In fact, worldwide, renewable energy investment actually slid in 2013, for the second year in a row, falling to $254 Billion, according to the Financial Times of 25 June 2014. In contrast to the declining capital expenditure for renewable energy, since 2011 International Energy Agency data shows that, for fossil fuels, investment had increased, until quite recently, approaching $1Trillion by 2013. More recent data for fossil fuel, with the collapse of the oil price, has not been so readily available. I contacted a number of good sources, and either they don’t have it or say they are working on it, or want too much money from me for it. I can’t seem to get the information for the shuffling of paper ownership investment in the form of public market, venture capital and private equity investment. And there has been a lot of that with the bankruptcies, and near bankruptcies of some oil and gas drillers. Some of the surviving companies, as well as vulture capitalist companies, are picking up the existing assets of bankrupt companies on the cheap, but they are still paying in total a lot of money for it. My suspicion is that the total investment in fossil fuel is down from the $1 Trillion of 2013, but not by as much as the drop in oil and gas asset investment and exploration would suggest, because of the scooping up of asset ownership on the cheap. Capital investment in exploration and development of oil and gas dropped 24% to $694 Billion in 2015 compared to 2014, according to Rystad Energy in Oslo. This means the figure for oil and gas (but not coal and not shuffling paper ownership) in 2014 was $860 Billion.

In 2014 the International Energy Agency noted, in their World Energy Outlook, “Today’s share of fossil fuels in the global primary energy mix – 82%, according to IEA data– is exactly as it was 25 years ago.”

Renewable energy investment has gone up a bit lately, reaching about $329 Billion in 2015, according to Bloomberg New Energy Finance.  But this shouldn’t cause us to break out the champagne. My New York researcher and occasional co-author, Oleg Rusetsky, found a significant quote from page 41 of the International Energy Agency’s WEO2015 Special Report on Energy and Climate Change, prepared for COP21. In a scenario to describe the world by 2030, the IEA said: “Neither the scale nor the composition of energy sector investment in the INDC Scenario [i.e., the nationally announced carbon reduction targets released at COP21] is suited to move the world onto a 2 °C path [by 2030]. Cumulative investment in fossil-fuel supply accounts for close to 45% of the energy sector total, while low-carbon energy supply accounts for 15% [italics added].”

So the IEA figures projected from 2015 show that based on the carbon reductions announced at COP21, we still have a Hope/Doom ratio of 15%/45% = 1/3 in expected investment for the next 15 years. In other words, based on the IEA’s expected investment figures, our grandchildren are cooked.

If we wish to reverse the Hope/Doom Ratio investment in renewables has to be four times its size in 2013, reaching $1Trillion each year in renewables and energy efficiency by 2030.

Achieving this reversal is now an official global will. What do you think of the policy instruments and tools available today?

They are so bad that in uncharitable moments I think they were invented by the oil companies to fool greens into pushing policies that are guaranteed to keep oil in use until it is too late to save the world from its consequences. They are guaranteed to fail.

They focus on a negative, reducing carbon consumption, and suggest an almost impossible objective – taxing existing activities. Setting aside a couple of small but admirable countries, such as Sweden, carbon taxes, so far, have been politically impossible at the level necessary to be effective against global warming, and cap and trade is simply open to too many abuses—including issuing too many permits from the get-go (often giving them away), and stealing them. Cap and trade involves governments getting together and setting limits of carbon and then letting financial markets distribute the permits to burn that carbon. The governments are supposed to be honest and the financial markets efficient. Instead we get the efficiency of governments and the honesty of markets, giving us in the only large existing carbon trading system a derisory carbon price of €5 to €7 per ton on the European emissions trading scheme.

Given our general experience with both governments and markets, I cannot see how it would not always be so. Does anyone seriously believe that any future coalition of willing governments would be any better than the ones we’ve already seen?

The evidence for the failure of these approaches is clear and compelling; no materially significant carbon tax exists in a major country — nearly every political leader who proposes or institutes one either backs off or gets defeated in the following election — and the few cap and trade systems to deal with global warming which have been tried have been embarrassingly ineffective. On top of the so far insurmountable political obstacles, these types of systems, if they ever could be made to work, force people to change their existing behavior, which may be an excellent idea, but is very difficult to achieve in most areas of human activity.

Both cap and trade and carbon taxes are variations of coercive systems. With cap and trade, the total amount of carbon is limited by the state or an organization established by states, and you have to buy your right to burn it. With carbon taxes, the government agent, with his badge and gun, shows up to collect. Of course, coercive systems can work if they are coercive enough. But who wants to live in Green Stalinism?

So if the stick doesn’t work, better try the carrot?

Exactly. We need to reward investment in what we want, not punish investment in what we don’t want – and then let market forces do what they do.

Recent history can help us. These types of incentives, both official and not, are in fact what pushed e-commerce and the Internet in the 1990s and 2000s. In many jurisdictions, e-commerce was untaxed, as a way to encourage its growth, and to the detriment of brick and mortar retail operations. Some of the latter simply went into e-commerce too, just to compete, and thereby further accelerated the trend to e-commerce.

So here is my suggestion: instead of taxing carbon, we should de-tax renewables. Profit from long-term investment in renewable energy should simply not be taxed at any level, just as Internet sales in the US have not been taxed at federal, state or local levels. Dividends from pure plays in renewables should also be tax free, and from non-pure plays in proportion to their renewable components, as determined by the relevant tax authorities.

This is a radical move. Consumption of renewable energy should also not be taxed, at least for a while—until the renewables build-up is big enough that consumers have no choice but to stick with it. Fossil fuel investments should continue to be taxed as they are now, which already includes massive subsidies or tax shelters (in US shale gas, for instance). This would give a huge incentive to existing utilities and oil companies to jump into renewable energy, and to shift out of fossil fuel as fast as possible.

Aren’t you overoptimistic about utilities jumping into renewable energy?

Most of them are already exploring new ways of producing energy. Of course, the managers of incumbent utilities could be temperamentally against a change or see too many difficulties to make significant renewable energy investment, even though it has a huge tax advantage, and in some countries these managers could refuse to buy the energy (electricity or gas) produced by others from renewable sources. But from a higher point of view this would not be an obstacle, but an opportunity. There would be so much new money in play, lured by the tax story, that competitors to the incumbent utilities would spring up everywhere. Industries would use the tax advantage to produce their own energy, and then perhaps sell it to nearby customers. Already companies with server farms, which consume massive amounts of energy, are setting up their own renewable energy productions to avoid the charge of contributing to global warming. Yahoo, Google, Apple, the cell phone network providers, etc., could become new energy producers. The incumbent utilities might then feel compelled to enter the game and compete.

This process has actually begun in Germany, where over 25% of electricity is now sourced from, basically, wind and solar. The country’s biggest utility, Eon, split into two units on January 1 of this year, 2016, keeping the renewables business and energy services as its core activities and selling off as a separate business the fossil fuels units, now called Uniper. One could say that Eon had no choice in the German context. In fact, rival German utility RWE announced a few weeks before the official Eon split that it would do the same thing. Such splits may spread, if we believe, as I do, Johannes Teyssen, the Eon’s CEO: “Just the fact that companies like [Google and Apple] are looking and investing shows that you had better prepare yourself for a new kind of competition” (Financial Times, 2 December 2015).

So I don’t think I am overly optimistic. Actually many signs already suggest the arrival of new, powerful and smart players in the field of energy. The game is changing. A zero-rate taxation of CO2-free energy investment would just accelerate this change.

What about governments? What would be the incentive for them?

In a word, leverage. They give up a little bit of tax revenue in green investment to get a vastly bigger amount of tax revenue from the surrounding newly created businesses. This is precisely what happened in the shale oil and gas areas in the US. The US federal tax code allowed the drillers to depreciate 100% of any costs they could possibly associate with drilling and fracking the hole in the year that they drilled it. So if they drilled enough holes, this accelerated depreciation put off paying any federal taxes until Doomsday. The CEO of one major driller, Chesapeake Energy, proudly announced a couple of years ago that his company had drilled and fracked some 16,000 holes since he founded the company in 1989. Multiply that number by $3 Million to $5 million per hole, and you can see why the company hardly paid any federal taxes. But they, and all the others doing the same thing, produced what we have endlessly heard was a shale revolution. And the tax boom in the drilling areas was spectacular. Local governments had more money than they knew what to do with. The federal government raked in tax revenue from those boom businesses, their payroll taxes, and also from stock market share sales. The stocks, for a while, were on a one way ride to the moon, and each profitable transaction produced an unavoidable tax payment to the federal government.

However, keep in mind that I’m not proposing to apply a zero-rate tax, or some other tax advantage that has that effect, to any green investment—just to green energy production investment. Our goal is to massively and quickly build up a green energy industry, just as the accelerated depreciation produced, in the US, a massive new shale oil and gas industry. From a global warming standpoint, that industry is a catastrophe. But the same or a similar tax incentive could save the world if applied to renewable energy.

But the shale boom bubble is now bursting in the US.

All bubbles eventually burst. The dotcom-internet bubble burst, but the world got the New Economy, with its limitless data and limitless communication—smart phones with their unlimited calls, texts, new apps practically every day, internet searches at whim, etc. The Green Bubble will not only give us the possibility of surviving global warming, but will give us limitless pollution free energy. As with the earlier bubbles, some investors will lose.

Let’s discuss the outcomes. Isn’t the economic effect, though not marginal, limited?

It depends on the tax incentive system. KPMG, the accounting giant, has published a report of the tax incentives policies of some 30 countries, including China which has used tax incentives with spectacular success. There are lots of different ways to design the policies, and I make no claim to know which ones are the best. It depends on the country. The US shale story isn’t even in their report. That said, either the tax policy has a big effect – and it will most probably create bubbles, as described in my book The Green Bubble – or its effects are limited, and so it isn’t a good tax policy.  We need to get out of global warming fast, and whatever does that and creates prosperity, even if only for a while, is good. Recently, all prosperity is only for a while anyway.

It is a well-known fact that fund managers and investment bankers act as a herd. If for some reason they decided to act as a herd to invest in renewable energy, and they did it long enough – say 25 years – they could actually save the world. For a long time renewable energy was viewed as highly risky, and it was also very sensitive to external factors such as oil prices. When the herd of fund managers acted in their “risk off” manner, they sold their stakes in renewables. When they decided to go “risk on,” renewable investment increased. For markets to save the world from global warming, we would need either a very long period of “risk on” or a very long period of “risk off,” with renewables repositioned as a good risk-off investment. And that may have started to happen. Oil prices have been collapsing, investment in new oil exploration and development has been declining, but investment in renewable energy infrastructure has been increasing—the opposite of what used to happen.  It is happening largely because cheap oil, from Saudi Arabia, the lowest cost producer at $4 to $6 per barrel, kills investment in expensive oil. This is happening in the context of materially improved electric cars (some with over 300 km range on a single charge); utilities, like Eon, dumping their old-economy fossil fuel businesses in favor of renewable energy; a material improvement in energy efficiency; a general recognition that wind turbines and solar panels really work and are getting cheaper (and more efficient); and a world-wide recognition that global warming is real and requires an urgent response, thus making wind farms more acceptable in some places. Investors who have lost their shirts on expensive deep-water oil, shale oil, tar sands oil, are unlikely to be eager to rush back into those failed businesses—although some venture and vulture capitalists are scooping them up. Even Saudi Arabia is talking about an IPO of Saudi Aramco—in other words, they may be dumping their (fossil fuel) assets on gullible investors.

But this new way of looking at renewables may not last. Oil could still bounce back another time or two, for example if a major oil exporter suddenly dropped out of the picture for some political or geopolitical reason. So we should think of developing new investment vehicles, designed for very long term green or renewable investment—a duration of the same order as the climate crisis itself. One way to do this is with massive green energy funds with a very long lock-up, on the order of some 25 years. I proposed this mechanism, which I dubbed the “Green Redemption Fund,” at the G20 in Korea in 2010. Redemption was not intended in the religious sense, but rather the redemption of honor, facing the question posed by children and grandchildren who would demand what we had done to avert climate catastrophe. I proposed that civil society, including religious organizations, foundations, private corporations and family trusts, establish very long term Green Redemption Funds to finance the saving of the planet. The invested money would be exclusively in green technology, locked up for a very long time and all dividends would be reinvested. They would also be an answer to the bubble problem. When green assets dropped in price during a general market slide, they could have the cash or the borrowing power to buy them up cheaply. The challenge is huge. It requires an answer of the same magnitude as the crisis. It’s time to turn the creativeness of financial innovation into something useful for the human race instead of against it.


  • The Green Bubble: Waste into Wealth: The New Energy Revolution
    Robert Bell
    List Price: EUR 32,37

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