Whither Climate Investors’ Opportunity Set?
Climate-Tech Investing In The Time of COVID-19 — Article 1
For the past four years, I worked as an ESG-investor, leading Inherent Group’s research and investments into companies enabling the transition to a lower-carbon economy, with a particular focus on the energy sector. That role was coming to an end in early January, even before COVID-19 shut down the rest of the world.
As I sit in my house under lock-down with my little family of four, north of New York City under siege, jobless, with a grandparent lost to the pandemic, a parent that fortunately recovered from a mild case, a best-case scenario that the world returns back to “normal” in perhaps 6–8 weeks, I thought I would go back to a project I did not have time to get to at Inherent Group because building a company from scratch is…a lot of work.
Since early December I have had nearly 150 meetings with public and private investors, allocators, industry executives, and advisors in the arena of ESG investing. I keep circling back to one central and recurring disagreement. One group believes there are a myriad of opportunities and a dearth of capital and a separate group believes there aren’t enough opportunities to put substantial money to work within sustainability. Who is right?
This will be the first question I attack in a series of articles. These will take a single complex climate investing topic (others might include: “are liquefied natural gas (LNG) assets good for long-term de-carbonization?”, “should we assume gas stations have a positive terminal value?” , “is 45Q the social cost of carbon we’ve all been waiting for?”) and attempt, through a combination of down in the trenches experience, consultation with actual scientists, and a little additional elbow grease to simplify the parameters and translate the jargon so that I can offer an actual conclusion, or at least outline the arguments for respectful disagreement.
I will resist spending much time writing about how the current pandemic is a warm-up for the climate crisis slowly boiling all of us like unwitting frogs because that has been aptly discussed, but I have to start with one point in case it was not already made plain by the past six weeks: we are only as safe as the weakest link in our planet and we need to work on our global resilience.
We are collectively facing climate change and each year that passes we will have greater climate volatility and more urgency to act. Therein lies one way in which the COVID-19 pandemic does not map well to climate change. Assuming SARS-CoV-2 acts as other viruses of its type, most of us will eventually catch it, or be vaccinated, and develop antibodies that provide significant if not life-long immunity. It’s a one-time event for each person and the herd. Climate change risk, by awful juxtaposition, is additive. The Earth’s atmosphere is like a bathtub filling with water and each year we add another inch to the tub with very little draining out. Overflow is a matter of time, measured in years, not centuries.
I am often asked what a person can do to reduce their impact on the environment. Individual consumer choices can occasionally virally pressure for change (see: plastic straw ban) but the necessary change for the really big climate resiliency must occur at the system-design level. As William McDonough put it, author of Cradle to Cradle, “You don’t filter smokestacks or water. Instead, you put the filter in your head and design the problem out of existence.” I will come back to this design theme often.
Now that environmental, social, and governance (ESG) investing has become important to capital gatekeepers, are there really enough ESG opportunities for capital allocators to invest in?
To have the conversation, it is necessary to level-set on some definitions. What exactly does investing mean when you add the adjective: impact, double-bottom-line, ESG, sustainable, clean-tech, climate-tech, enviro-tech, or circular economy to it?
Here are my rough justice definitions:
· Impact and double-bottom line investing mean “for-profit and for-good” and judging by the large, round, roguish eyes from companies struggling to raise capital imply a concessionary aspect…e.g. “we’ll accept some discount to a market return if it’s also pushing forward a key area of environmental or social concern.”
· ESG and sustainable investing means incorporating overlooked negative and positive externalities into your underwriting requirements.
· Clean-tech or climate-tech means investing in companies that theoretically should benefit from a key climate resilience tailwind.
· Enviro-tech and circular-economy mean investing in companies that are taking into account the full cycle of production. Historically, we have been an extract, use, and discard society, where often the discarded portion is unpaid for. These investments either focus on or incorporate the discarded portion and in a perfect world “leave no trace” as the entire remnant of the post-consumer product is reused.
The 2018 IPCC report, with combined authorship from hundreds of the leading international climate scientists, estimates we need to invest $2.4T USD annually in the energy system between now and 2035 to keep the planet from warming more than 1.5 degrees Celsius (1.5C) and $6.4T USD annually in the energy + transportation + other infrastructure systems between now and 2035 to keep the planet from warming more than 2 degrees Celsius (2C). To put these annual spending numbers into context, all 500 companies in the S&P500 spent ~$760B USD on capital expenditures in 2019. The US federal government budget in 2019 was $4.4T USD and total government spending worldwide was ~3–4x this amount, or approximately $16T. It’s reasonable to assume most of this money was not spent on climate resilience leaving a cavernous gap large enough to drive a global fleet of electric buses through. So why do some large capital allocators not see a significant opportunity to invest in climate-tech where others see a near-infinite opportunity?
I believe the answer comes down to creativity. If an investor is looking for a confidential investment memo (CIM) to say on the cover “climate-tech”, they are not applying second-order thinking to the topic. Climate investing comes in all shapes and sizes as every sector of the economy needs to reduce its carbon emissions and physical waste to net-zero. Any company re-thinking the design of a sub-sector of the economy to limit the waste qualifies as climate investing or whatever term from the list above you want to use.
Within energy, not only do we need the obvious investments in solar and wind generation, but we also need trillions invested in smart grid infrastructure, energy storage, energy efficiency, and the accompanying data-intensive software solutions. Within mobility, not only do we need millions of zero-carbon vehicles, we need trillions invested in re-shaping global refueling and charging infrastructure and supply chain optimization. Within the built environment, we need trillions invested to convert homes from oil and gas heating, ventilation, and air conditioning (HVAC) and other gas appliances to electrically-powered systems and to build with sustainably sourced materials with proper end-of-life disposal for construction waste. Within agriculture, we need trillions invested in harnessing methane produced by livestock and maximizing our land availability through precision agriculture and vertical farming. Within the industrial sector, we need trillions invested to retrofit carbon-intensive processes to make cement, steel, aluminum, and commodity chemicals to carbon-neutral processes.
But don’t take my word for it, take the 2018 IPCC Report’s word: “Pathways limiting global warming to 1.5°C with no or limited overshoot would require rapid and far-reaching transitions in energy, land, urban and infrastructure (including transport and buildings), and industrial systems (high confidence). These systems transitions are unprecedented in terms of scale, but not necessarily in terms of speed, and imply deep emissions reductions in all sectors, a wide portfolio of mitigation options and a significant upscaling of investments in those options.”
About the Author:
Benjamin M. Hogan, CFA
At Inherent Group, Ben led investments into companies enabling the transition to a lower-carbon economy, with a particular focus on the energy sector. In addition, Ben engaged with management teams to improve their ESG practices. Prior to Inherent Group, Ben led energy investing at Orange Capital, a $1.5B AUM special situations and activist hedge fund. Prior to Orange Capital, Ben worked in private equity at AMF, a subsidiary of Credit Suisse, which successfully invested $1B into 21 asset managers. Ben started as an M&A Analyst at Berkshire Global Advisors, a boutique M&A advisory firm focused on the asset management industry. Ben holds a B.Sc. in Economics from Duke University as well as the Chartered Financial Analyst (CFA) designation. In addition, Ben is pursuing a part-time M.Sc. in Sustainability Science at Columbia University with a focus on climate science.