Can green investment pay for itself?

In a series of blog posts leading to the launch of the Green Investment report 2013 on 21 January by the World Economic Forum’s Green Growth Action Alliance, a number of leading voices will present their particular perspectives. In the following post, Simon Zadek, Senior Fellow of the Global Green Growth Institute, discusses the current trends on Green Investment. 

According to the Green Growth Action Alliance`s report, Green Investment, US$100 trillion is needed by 2030 to finance infrastructure needs worldwide. Ironically, succeeding as currently envisaged would be a disaster for investors and the global community. Locking in “brown”, carbon and natural resource intensive infrastructure would accelerate us towards an unsustainable, 4C increase in global temperatures in the coming decades.

Greening investment is the one luxury that we must afford. Investors are reluctant, citing reduced risk-adjusted returns of green investment. And it’s true – According to the Alliance`s report, there are increased costs of US$ 0.7 trillion a year. There are also greater policy risks in going green, with policy back-peddling in the United States and the United Kingdom slashing the prospective returns on renewables. Technology risks for carbon capture and storage, shale gas and nuclear, further reinforce investors’ reluctance.

All true, but, in fact, investors are wrong; green investment will pay for itself. The International Energy Agency is one of a growing number of authoritative voices highlighting the potential net financial gains from green investments, particularly in green energy and energy efficiency. Furthermore, innovative public-private financing mechanisms have proved successful in reducing and distributing risks.

Green Investment highlights successful experience in these mechanisms, from feed-in tariffs to green bonds and political and currency risk guarantees attracting private investment. Investors are often inadequately informed of these proven approaches and, as a result, lose profitable opportunities. There is little to gain in waiting for perfect policies that will either never come, or, if they do, will lead to such a rush of investments that the potential for earning higher returns will be lost.

Carbon and natural resource-intensive investments are at risk of being “stranded”; that is, losing considerable value in the future because the investment community is mispricing risk. Investors are not pricing in prospective policy changes, such as carbon taxes, reduced fossil fuel subsidies and trade-related measures, all of which will dramatically reduce the value of carbon-intensive assets. HSBC research concluded that under what it considers likely future scenarios the value of coal assets held by United Kingdom mining majors could fall by 44%.

Collectively, continued brown investment will, over time, undermine economic growth, thereby damaging investment prospects. The World Bank has concluded that the current emissions path will lead to a 4C increase in global temperatures in the next 50 years, and a 6C increase by the turn of the century. By not pricing in climate risk, Sir Nicholas Stern, Chair, Grantham Research Institute on Climate Change and the Environment, United Kingdom, points out that investors are, in effect, betting on and indeed encouraging an unsustainable increase in global temperatures.

Greening investment makes sense for investors with a well-informed, long-term view, and reasonable expectations of risk-adjusted returns. But it takes a brave, smart and well-supported fund manager to step out from the shadows of an investment community largely trading short-term bets against itself. Larger institutional investors, pension funds and insurance companies, despite the growing call for “sustainable investment”, are not putting their money on the table.

Developing countries have a chance to leapfrog more mature and entrenched capital markets in richer nations by taking a long view in shaping regulations, the investment culture, and directly investment decisions where they involve state-controlled institutions. There are profitable opportunities to be reaped by avoiding distorting short termism, and huge public benefits to ensuring that green investment establishes durable infrastructure to support their future carbon and natural resource-efficient economies. And practice confirms the reality of this potential. Non-OECD investment in renewables grew fifteenfold between 2004 and 2011 at a rate of 47% a year. Clean-energy asset financing originating from developing countries in 2012 is on track for the first time to exceed those originating from developed countries.

The financial markets can and must be directed to deliver on their two inter-related duties, delivering robust risk-adjusted returns and supporting investment in tomorrow’s sustainable economy.

Investors in brown assets will eventually lose money as they lose value in the face of rising carbon and natural resource costs. But this may be too late on current trends to change the course of history. What is needed is for private investors to be helped and incentivized to green their portfolios, but equally to be penalized for failing to do so.

Four steps would help:

1. Scale up Good Practice: There needs to be wider deployment of successful experiences in public financing mechanisms that leverage private investment, such as those set out in Green Investment.
2. Disclose Practices: Investors could be required to disclose how they price carbon and natural resources in asset valuation, opening them to public scrutiny.
3. Price-In Brown Risk: Investment would be greened more quickly if both corporate and sovereign credit ratings took account of such eco-risks.
4. Broaden the Reform Lens: finally, financial market reforms going forward must be designed with the resilience of the wider economy and ecology in mind, not just the viability of financial institutions and markets.

Author: Simon Zadek is currently Visiting Scholar at Tsinghua School of Economics and Management, and has contributed to the preparation of the Green Investment report. He is a Senior Fellow of the Global Green Growth Institute.

Image: Wind turbines are seen in a farm REUTERS/Larry Downing