Talking clean energy investment with James Cameron

3 November 2014

A UN report issued earlier this year identified nearly US$200 trillion of assets in the global financial system, some of which could be reoriented towards sustainable development outcomes. Meanwhile, climate governance debates are increasingly seeing engagement from non-state actors, with financial options such as green bonds gaining popularity among investors. But how to ensure sustainable development in the context of divestment? What role can trade play as investors move towards greener finance trajectories? And how to include non-state actors in international climate change regulation efforts? These questions, and more, were put to a leading expert in this field in a BioRes interview conducted in mid-October.

A number of non-state actors engaged in the UN Climate Summit in September. Can you give us an overview of some of the green private sector financial commitments announced on the occasion?
[James Cameron]
Briefly, these included announcements from a collation of financial institutions, pension funds, insurance companies, development banks, and commercial banks. A total of 181 representatives from the business and investment communities were present.

Three major pension funds from Europe and North America said they would accelerate investments in low-carbon investments to the tune of more than US$31 billion by 2020. Commercial banks promised to provide US$30 billion in new climate finance by the end of 2015 through green bonds and other financing initiatives.

I think one of the more significant aspects of the summit was that institutional investors of various types, including the insurance industry, made significant commitments to deploy capital in climate-smart investments and to decarbonise their portfolios. This, by the way, will require a lot of work in order to figure out what that means and how you implement it. You have examples like AP4, the Swedish state pension fund that has a value of US$38 billion, declaring that they will decarbonise their entire equity portfolio.

Overall the insurance industry said it would double its green commitments to US$84 billion by the end of 2015 and increase by a factor of ten by 2020 the current amount placed in climate-friendly development. This marks a substantial shift; for the first time you see the insurance industry using investment to reduce climate risk rather than just using their risk brokerage and underwriting business to deal with the cost of the risk.

What potential impact might these commitments have on world energy markets?
Some bits are obvious, for example, the divestment movement is clearly going to have an effect on global energy markets, even if it is only modest at this stage and one should not over-exaggerate its impact. So far the divestment pledges represent small amounts of money when compared with total global energy investments. But the effect is nevertheless there.

Then there is the conversation on stranded assets and all of the work on the valuation of fossil fuel assets. There is also a sense that perhaps the mainstream market has not yet really understood the effect of climate change and also the possibility that the valuation methods for fossil fuel companies are not fit for purpose today. They don’t take into account the substitutability of one fuel for another – say coal for gas. They don’t take account of the highly likely regulation of the fossil fuel industry either through a price on carbon or some other factor that will increase the cost. They don’t take account of the fact that huge amounts of capital have to now be deployed in order to extract these reserves when there are other options for the use of that capital that institutional investors are interested in.

Combine all these factors, some of which are related to climate, some of which are cyclical, and you have a situation where world energy markets are going to be under real scrutiny in the foreseeable future to see whether investments already made are valuable and what alternatives exist.

Green bonds are one key tool in this area and have also gained popularity in recent years. Can you give us some of the history behind these and how they might contribute to climate mitigation or adaptation? And how to ensure genuine greenness?
I’ve been a proselytiser for green bonds for a long time so it’s been nice to see this concept take off from the first issuance by the World Bank in 2008. One of the reasons why I think these are important is they have the potential to carve out a new space in a very big market for the provision of credit and they tend to be attached to physical assets that provide yields for a long time.

Renewable energy is a classic example but it’s not the only one. Some of these bond issuances are associated with energy efficiency programmes in cities, while others are to do with how corporations are deploying their own capital to develop business strategies, such as ways to finance electric vehicles. The shape of the bond will of course depend on who is issuing it, what country or region is concerned, and so on. At one level they are income products like any other with some standards attached. The latter have fortunately now have been developed and applied.

Regarding the standardisation of green bonds, both in terms of integrity and transparency, there are a number of options out there. The Climate Bonds Initiative has a good collection. A group of banks have also got together to create the Green Bond Principles. These are voluntary and I think they will stay that way. It is possible that at some stage standardisation becomes mandatory in the sense that if you want to be in the market you have to apply one. But that would be no different from listing securities on exchange markets.

There are financial risks and rewards associated with the transition to a low carbon economy. Could you provide a brief outline of these?
There are always costs in big transitions and so it’s really a question of who bears these. Should it be the public, the incumbent, or does the newcomer in the market carry these in order to displace the incumbent? One of the things that we have probably underestimated in the last few years is the sheer power of the incumbency. They are really dominant in most of the critical markets, such as energy and power, but also in the infrastructure around these. It costs a lot of money to put different infrastructure down and pay for new distribution technology.

In the context of the need to transition to low-carbon economies, how would a global carbon divestment work, within the parameters of equitable, sustainable development?
This question is all about having real alternatives ready. If you are losing the dividend yield from your fossil fuel investment in equities at the top end of an index, what are you replacing it with? That’s why divestment and investment have to be together. Unfortunately we don’t yet have a portfolio of clean energy alternatives, although these are growing, that you can just switch to. If you are an equity analyst and you suddenly re-price the risk of the fossil fuel investments and re-price the alternatives so that they look more attractive, you can’t just switch out, because you just don’t have enough options. So one of the things we have to do is build those companies.

One thing that might occur as decarbonisation gains traction is convergence across sectors. It’s very interesting to see how engaged Google is in the energy sector. Many people are coming out of the internet world with great expertise in hardware-software combinations. They look at the energy sector now and think why do you have to be an expert at digging stuff out of the ground? Why couldn’t you be an expert in installing solar panels and making renewable energy work more efficiently because it could be attached to the internet of things? They start looking at how to make these machines perform better because they write the code for the software.

You can really see people coming across into power that have no background in geology, mining, digging or even burning stuff, but do have all the skills for a different type of energy deployment. Many technology companies also have enormous balance sheets to bring to the table whereas the incumbents in utilities are very stretched. And then you have fossil fuel companies allocating staggering amounts of money with no real certainty of returns.

What are some potential governance issues that could be addressed to help scale up green energy investment?
The truth is that we still need effective institutions. We discount this at our peril and we have done over many years thinking that the market will react appropriately when it just doesn’t. This is why I’m interested in the rise of green investment banks – there are a few of them around now – these talk to each other and will likely have a prominent role in the future.

We also have to combine relatively small amounts of public money with a lot of private finance. This requires good public policymaking and expertise within government that is actually often hard to find. There are a lot of governments trying to invest for the public good but they are often doing so without the right skills in the relevant departments. Clearly we also have to do more to apply incentives like a price or value for carbon in a way that is trusted and dependable.

How to ensure that developing countries also benefit from foreign direct investment (FDI)?
This is where the old leapfrog cliché comes to mind. In many instances the new stuff really is better than the old stuff and it is lower cost. If you’re using kerosene or wood and now you have solar PV, you displace something more expensive with the less expensive, and it works better. My feeling is that many of these clean energy or sustainable energy alternatives will eventually win on cost in the developing world.

In relation to trade policy, however, there are some ludicrous inefficiencies in the system that partly stem from strange coalitions of interest. Much of the need in developing countries is subject to many old-style rent seeking strategies of those who are in power. The tariff systems are also frequently mad. There’s no justification for them whatsoever other than someone is already there providing an energy service and doesn’t want any competition.

So what positive role for trade-related policies in levelling the playing field between renewable energy and fossil fuels?
The standard topics hold true. Perverse subsidies to support fossil fuels continue, some of these are really mad and have been sustained for years, delivering no good to anybody. And while they are usually unaffordable for many developing countries, it can often be difficult for governments to take them away, because certain groups of society get used to them. In the grand scheme of things they have to go though.

Renewable energy subsidies are necessary but they have to be carefully structured so that they don’t last forever. You need to make clear that these play a role in a transition period but are not in place to prop up profits for investors. Generating the right balance in these policies again requires effective institutions and the know-how to evaluate where the support boundaries lie.

We do of course also have barriers to trade in various environmental technologies and indeed services. This is crucial and a parallel can be found in telecoms trade. And increasingly these two sectors are related. Mobile phone penetration in East Africa carries with it renewable energy penetration through payment systems for PV.

Following on from this what is the relationship between innovation and investment in the clean energy sector?
I am quite confident that much of the innovation in this sector will take place in developing economies. What you want to do is break up the idea that all of the clean energy trade is North-South and start thinking about South-South flows. One of the interesting things in this area is that countries like China have deployed a huge amount of capital at low cost into the renewables sector. This places them at a comparative advantage to their equivalents elsewhere because it is the cost of capital that really drives innovation.

It is also the case that many of the pension funds of sub-Saharan Africa are prepared to take more risk with their investments than pension funds in Europe. You can’t get innovation and big technology transformation unless you take risk. The conditions might be better for innovation in terms of access to capital in many parts of the South, provided the level of expertise is good enough to take advantage of it, which is a big proviso. This is why China is scaling up PhD programmes in environmental technology and India likewise.

What do you expect from the upcoming UN Framework Convention on Climate Change (UNFCCC) talks? How can the climate regime assert that it is the future from an economic perspective?
I’m actually very optimistic about the UN climate talks. There will be an agreement and it will be described as a success. Of course whether it really is a success is something different.

My view is that the 2015 deal will be a relatively modest, symbolic, universal agreement and it will only be a real success if it is surrounded by a series of more specific agreements. Some of these may in fact only involve non-state actors. That is to say, there is work ongoing to try and construct the theory, justification, and process for building a non-state actor, sub-federal, and cities framework that would essentially be a networked agreement of commitments on tackling climate change.

These commitments often take the shape of statements of intent with a wide range of enforceability. If you could wrap up the multilateral agreement with this network of parallel, transparent, and accountable commitments, then you’d be starting to get towards real success and not just success on paper. Of course we may not succeed with this work but there is a lot of momentum around it at the moment, namely, two projects now intersecting with origins at Oxford and Yale respectively.

We’ll likely see the French presidency of the 2015 climate talk conference create a space for non-state engagement, much like at the recent UN Climate Summit, and I’d like to see this go one step further.

The vision would be to collate, aggregate, structure, and reveal these crucial stakeholder statements in a form that could give people confidence that they are going to implemented, which would in turn help to spur further investment. In many instances commitments are already logged, for example through the Carbon Disclosure Project, but we also need to collate these to show that we are closing the gap between climate ambition and action. [Editor’s note, see related article in this BioRes edition]

James Cameron is the non-executive chairman of Climate Change Capital. In addition, Cameron is the chairman of the Overseas Development Institute (ODI), a member of HM Treasury's Infrastructure UK advisory council, and a member of GE's ecomagination board. Cameron is also a member of the E15 Expert Group on Measures to Address Climate Change and the Trade System, and a founding Programme Advisory Board member of ICTSD, the publisher of BioRes. 

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