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Climate Volatility: A Predictable Increase in Forward Economic Volatility that can be Hedged.

Climate Volatility: A Predictable Increase in Forward Economic Volatility that can be Hedged.

Climate Volatility represents a predictable increase in forward economic volatility that can be hedged. We have a short window to act by pivoting social systems towards sustainability and implementing the Climate Volatility Hedge.

Climate Volatility is driven primarily by scarcity and high waste streams, in particular of greenhouse gas emissions of carbon dioxide and methane. (CV Factors). The impact of CV Factors is evident today and a dramatic increase in negative impacts is locked in’. Concentrated and decisive action taken today can avoid the most catastrophic impacts in the future.

A collision of CV Factors with social systems risk factors due to rising inequality in developed markets and a rising middle class in developing markets sets the stage for the increase in forward economic volatility.

It is important to understand that our problems are founded in mathematics and not ideology. So, too, are the solutions.

The Climate Volatility Hedge must be approached three ways:

  1. Infrastructure: Localized indoor agriculture, domestic industry built on renewable (and biodegradable) fibers and renewable energy provides community security, jobs and affordable access at a profit. Sustainable asset ownership acts as a hedge, with predictable bond-like cash flows plus upside optionality. Demand is rising for the production of these assets, and, is inelastic in the case of food and energy.
  2. Liquid Markets: Business models built on extraction of non-renewable natural capital, with long supply chains and high environmental externalities are at risk. Derivatives markets are under pricing this, with many companies in conventional food and energy businesses trading at implied volatility less than the S&P 500. A relative value hedge is the starting point with selective shorting of at-risk industries locked into subprime carbon/scarcity strategies.
  3. Stable Society: Clean food and energy assets, that are in part community owned, is an imperative to social restoration. Our current model incentives the erosion of the labor base without asking the question, “What then?”. We are at a critical point where automation, microchips and private capital investment strategies are eliminating labor capacity faster than society can adapt, re-train and re-tool. Sustainable Infrastructure and localization strategies are a key hedge against societal breakdown.

The concept of volatility is important in that it is a concept well understood by risk managers and investors. Volatility is the standard deviation or amount of predicted change over a given time period vs. some qualified expectation. In sustainability, climate volatility is dictated both by scarcity and high waste streams, and carbon waste in particular.

By predictable, the thesis also points to a mispricing. Although the impact of scarcity and high waste streams are inevitable, with impacts occurring earlier than expected, they are not being priced in by capital markets and investment flows. The predictable effects of climate volatility are not being communicated effectively by governments, businesses or educational institutions. This aberration will create the largest ‘unseen’ bump in forward economic volatility. It also tells us that an arbitrage exists.

Arbitrage conditions allow us to hedge Climate Volatility for a lower cost than we will pay in the future.

New Equilibrium: Understanding the Critical Need

In order to execute the hedge at the scale required, we must raise awareness and come to consensus on the root causes, impediments and solutions to our climate challenges.

One way to raise awareness is to continue to promote data driven arguments supporting the climate volatility thesis.

Data from NASA shows us that we have exited the old equilibrium with climate and are searching for a new one. Graphs from NASA inserted below depict; 1.) Carbon emissions as a % of atmosphere have risen beyond their long-term range,

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2.) In the short-term, CO2 emissions has steadily increased,

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and 3.) Average Temperatures are rising.

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Higher temperatures have predictable results including the melting of polar ice, rising sea levels, storm and drought intensification, extended periods of excessive heat, ocean acidification and more.

The downstream effects of these first order effects are clear and include; crop failures, mass die-off of livestock and ocean life, population displacement through forced migration, social conflict due to food and water scarcity and more.

In the simplest sense, we point to the science of Climate Volatility as the relative displacement of water and heat between soil, air and ocean and the impact of this displacement on forms of life. To understand the interaction of heat-trapping gases, like Carbon, and cooling gases like Oxygen, click HERE.

Many of the economic and social challenges of Climate Volatility are evident today but will increase dramatically in the future.

Impacts of Climate Volatility

We list below a few of the 14+ Climate Volatility impact areas raised by reports from the Intergovernmental Panel on Climate Change (IPCC) along with examples of impacts occurring today:

  • Food Production and Security: Just this year, a major South American Agriculture company, Adecoagro, reported a 30% loss in yield of corn and soy due to excessive heat. Across the globe conventional crops are pushing there temperature maximums with potentially disastrous results.
  • Vulnerable Societies: It is now widely understood that the Syrian conflict was sparked and intensified by a record drought that forced millions of refugees into urban areas after livestock die off and crop failures. Syria may be the extreme but these events are playing out across the world in Africa, China and parts of South America. Most models expect drought conditions in California to persevere for the foreseeable future and to be joined by record drought conditions in the dust bowl region. The northeast US too, has been in drought for much of 2016.
  • Extreme Weather: No storm is normal anymore. We are seeing epic rainfalls that often fall at rates of 1-3 inches per hour. Recent examples include;
    •  Dec 2015: A 1-in-a-1000 year rain floods parts of South Carolina dropping up to 2 feet of rain on places like Charleston in a single day.
    • Mar 2016: Record rainfalls in Louisiana trigger massive flooding with up to 26 inches of rain falling in a four day period.
    • May 2016: almost 9 inches of rain fall in two hours in Austin Texas.
    • July 2016: up to 10 inches of rain pummels parts of the Midwest bringing tornadoes and destruction from flooding.
    • Aug 2016: In Ellicott City, MD, a 1-in-a-1000 year storm drops 6.5 inches of rain in about 3 hours.

A small sample shows 5 1-in-a-1000 year events in an 8-month period. There are many more such events to pull from in that same period. The Volatility estimate is wrong.


  • Human Health: In 2016, an unprecedented heat wave met with intense drought in India to decimate livestock and crops, melt roads and cause human casualties.

Citibank estimates climate change inaction would cost $44 trillion globally by 2040. We think this is conservative – Climate change inaction could make money obsolete


The costs of Climate Volatility will be considerable and even more so if the dialogue remains muted and held back in places. What may be most alarming is collectively we a pursuing a broken food and energy strategy that exacerbates the risk.

A RISKY FOOD AND ENERGY STRATEGY

We currently have a risky food and energy strategy in that these systems are:

  • Concentrated: Our food and energy comes from large, centralized facilities that focus on intensification (doing one thing at scale). Long supply chains add to social costs and increase risks of systematic breakdown.
    • Energy: Another sniper attack against a major electrical sub-station, similar to the Metcalf Incident, was reported in 2016. The Metcalf incident could have knocked out power to parts of Silicon Valley for a period of months.
    • Food: Drought in places like California, responsible in 2014 for 32% of domestic fresh fruit and vegetable product, causes price spikes and shortages.
  • Productivity Challenged: In the conventional system, costs are rising with less and less output. It’s a classic industrial death spiral that has been distorted by structural impediments in the form of laws, investment structures and culture that favors the conventional model.
  • Carbon Intensive: Conventional Agriculture, Transportation and Electricity are the three main sources of Greenhouse Gas emissions, including CO2 and Methane

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  • Embedded with Systematic Risk: One needs to look no farther than the implosion of coal equity and near total closure of capital markets to new development to understand the risks embedded in trillions of dollars of Fossil Fuel market cap. UK bank head Mark Carney and former US Treasury Secretary Hank Paulson have been vocal in their warnings about subprime carbon. In short, there could be up to $28 Trillion of subprime carbon assets, unburnable and held on the books of oil and gas companies today.

Citibank goes one step farther, reporting that the total size of the carbon bubble could be upwards of $100 Trillion.

Our only hope is avoiding catastrophe is making peace with the facts, upping the dialogue and taking immediate and decisive action. Financial Engineering can help.

Financial Engineering A Climate Solution

Trillions of dollars in the investment community are tracking and following indicators known as factors to make trading decision. More than 1/2 of these decisions are fully automated. Factors dictate everything from short-term decision making on through to managing portfolio risk over long horizons. What if the factors understood Climate Volatility?

One way to educate the factors is by using well-understood concepts, like volatility and arbitrage to show the optimal portfolio includes the Climate Volatility hedge.

Put-Call Parity is a well known relationship that has guided the growth and evolution of the derivatives industry. Put-Call Parity describes a relationship between the cash market (today) and the forward market (the future). It’s derivation also includes valuation of individual options (to account for opportunities or risks that exist based on future conditions).

Below we insert a simple idea that Put-Call Parity, arbitrage concepts and other derivatives math can be used, in part, to begin to financially engineer a solution to Climate Volatility. We note the simplification of what’s presented here provides a basis for a discussion in this vein. Future Bright has also designed frameworks for valuation using Real Options and CAPM Extension methods.

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The left side of the equation represents the ability to invest in the CV Hedge today and the option that this investment becomes more valuable in the future. The right side represents current valuations for conventional industry, which we are told takes into account all available information. We argue that all available information and, in particular, information on climate risk is not being accounted for. The longer it takes to account for this risk, the more exponential the impact will be. This is known as gap risk.

If you were building a society today to compete globally, would you add more of the left side of the equation or the right? This thought analysis lies squarely in the pathway to paradigm shift. Would you build with clean, resilient assets that provide security and jobs to support society or would you build centralized production dependent on scarce resources and subject to price volatility, that contributes to economic instability and higher health costs? With no embedded interests, you would likely choose the former. It’s less risky.

The Coal industry is a good example where the transfer of assets has become prohibitive, effectively reducing equity value to zero. Other factors, outside of the market for company assets, can affect the valuation in today’s market. A key variable to watch is market demand failure for conventional goods. For example, food produced using pesticides is under increasing global scrutiny from consumers of all types. Whole countries are banning the use of certain pesticides and extending these bans to genetically modified crops (GMO’s). Consumer segments than can, are choosing away in increasing numbers. In fact, access and affordability are key impediments that keep more consumers from pivoting away faster from products they deem harmful to themselves and the planet.

The Climate Volatility Hedge delivers profits today and solves the problem of access and affordability.

The Climate Volatility Hedge

Controlled Environmental Agriculture: With crops failing and livestock dying due to excessive heat, an essential part of the CV hedge consists of a massive effort to build localized controlled environment agriculture. Future Bright estimates this opportunity, which includes Aquaculture, Greenhouse Hydroponics and Vertical Farming, exceeds $1 trillion in infrastructure alone, and is capable of both environmental and social restoration. Controlled Environment Agriculture can produce millions of jobs, provide food security, meet increasing demand for clean, healthy, local and organic product and, maybe most importantly, reduce the water demand of agriculture. Controlled Environment Agriculture uses up to 99% less water than conventional and is profitable at market prices around the world. Controlled Environment Agriculture provides stable cash flows and profitability today with embedded upside due to climate volatility, potential supply chain disruption and food and water shortages. We depict this potential in the graph below.

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Renewable Energy: Renewable Energy provides predictable cash flow with upside optionality. When the centralized grid model is disrupted due to storms or attack, renewable energy assets increase in value. When we realize the impact of water intensive energy strategies, long supply lines and high waste streams, renewable energy assets increase in value. The Renewable Energy revolution is already underway, with prices falling below conventional sources across the world and over $1 trillion in investment in the past 3 years, but a greater acceleration is needed. We need a ten-fold investment for both developing and developed markets. The technology is viable, we only need the political and corporate will to build an energy infrastructure that creates a viable path for survival.

Renewable Fibers: Everything made with fossil fuel based polymers and long replacement cycle resources like trees, can be made with hemp, bamboo and other renewable fibers. With afforestation of paramount importance to hedging climate volatility, breaking down structural impediments to renewable fiber farming and domestic manufacturing should be viewed as a tremendous opportunity. Both bamboo and hemp have yearly harvests (vs. decades for trees), sequester more carbon and emit more oxygen than trees.

Waste Reduction: The Consumer Leverage Point is of utmost importance here but so is the response of corporations in delivering viable consumer solutions. There are easy choices like using reusable bags and Klean Kanteens, supporting CSA’s and patronizing businesses committed to waste reduction. Harder it seems, is to get automobile companies to deliver electric vehicles that consumers want, banks to fund community microgrids and sustainable agriculture, investors to do the same, governments to support transition and re-training of fossil fuel workers, education systems to reach consensus and teach preparedness, markets to mobilize and penalize high waste activity in favor of clean and sustainable.

Liquid Markets & Financial Structures: We continue to see innovation in circumventional finance to give consumers the ability to support sustainability with their savings. Major impediments remains with large institutions making slow progress in the creation of investment vehicles and pathways for deployment. Crowd Equity is making progress but a $1M limit is too low to affect real change. Consumers and Investors should demand transparency and move their money to institutions capable of meeting the critical need. It is far easier to raise investment for abstract consumer technology than it is for food security. That’s backwards and must change for our survival.

Moonshot towards Deployment: We need a WWII scale mobilization from society and business to deploy renewable energy, storage and controlled environment solutions. Elon Musk tells us in Leonardo DiCaprio’s excellent documentary, ‘Before the Flood’, it would take 100 Tesla Gigafactory’s to power the world. Tesla can’t do it alone, but the Fortune 500, at the demand of employees, shareholders and a global public call to action, could.

The defining question of of our time is: Will we make the sustainability pivot and hedge climate volatility?

A Time of Action

We live in a time of action. One could view it as the last true time of action. If we continue on the same path and do nothing or even worsen the problem, we lock in the baton pass from human impact to climate chaos. This dark horizon awaits our grand children with many, many challenges in between.

There are many structural impediments to action. World leaders who question science, intuition and global pleas from citizens everywhere. Corporations vying to protect short-term profits and manage legacy books of coal, oil and gas assets. A broken system of healthcare and consumption that can be viewed from a high-level as nothing short of self-cannibalization. Make no mistake, making the sustainability pivot and hedging Climate Volatility will be the most challenging task ever undertaking by humanity, except for one…

The only challenge greater than hedging climate volatility today is living through the consequences if we don’t.

Pivoting towards sustainability and making the hedge involves re-engineering our food and energy systems, re-thinking our systems of education and equity, and creating a global economy around local opportunity with access for consumers and businesses to make good choices. It is the only way to restore environmental and social systems to lasting prosperity. The window is short – action is required today.

But it’s possible. Possible and profitable.

The solutions and technology to build a resilient, inclusive and secure society rest at our finger tips. Across the world, millions are rising up, educating themselves and demanding swift change. They are entrepreneurs, artists, scientists, business people, politicians, activists, mothers, fathers and children.

Yes, in today’s world of ubiquitous information, the children are becoming aware of the problem, the solutions and of our collective inaction. They are asking the question, “Why?” “Why won’t we act?”. Our decisions right now craft our legacy in their knowing eyes. We have the unique ability to answer firmly, ‘We can and we will’, from a perspective of both economics and morality.

Now, more than ever, we need market-based solutions that address climate volatility and strain in social systems.

Future Bright’s Climate Volatility Hedge represents a profitable today and a prosperous tomorrow.

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About the Author:

After 13 years in High Frequency Options Trading, I noticed something troubling. The technology we were developing was making labor obsolete. Coupled with a growing awareness of environmental issues and a focus lent from the realities of the financial crisis, I pivoted towards sustainability and formed Future Bright, a think tank, consultant and portfolio of start-ups designed to represent a hedge for Climate Volatility.

In my learning, I’ve tried to apply my understanding of closed loop systems and systematic trading (HFT), which blend behavioral finance with rules based systems and derivatives, which inform us about exponential risks within an oft-thought-of linear system to understand climate challenges.

The more I learned, the more I became convinced of the need for a lifelong commitment to sustainability. You can learn more about Future Bright’s efforts HERE.

This article presents the Future Bright thesis and hedge for Climate Volatility based on 5 years of research, observation and work with practitioners in clean food and energy, investment funds and banks.

5 Numbers on Water

5 Numbers on Water

5 numbers about a given topic in hopes of stimulating a math based discussion of sustainability and sustainable investing.

This post will attempt to follow a form that does one or all of the following:

  • Illuminates a problem in the context of environmental or social systems
  • Illustrates where industry may have to shift behavior due to the problem
  • Ties the problem to the economic system
  • Highlights potential investment solutions

Today’s 5 focuses on water scarcity and degradation touching on both freshwater and saltwater systems and making the link to economic and social systems through food.

5Water

Disclosure: Future Bright is a think tank and advisory in sustainability and investing. Future Bright has worked with renewable energy developers, energy efficiency funds, assets managers and vertical farm engineers on progressing solutions towards sustainability. This note is not an offer of services or investment of any kind. This is a blog post for informational purposes only. Those interested in consulting services, design work or industry analysis should contact Future Bright directly. (www.futurebrightblog.com)

Five Thankful Eyes “I’s”

Five Thankful Eyes “I’s”

Here are 5 “I’s” to be thankful for in our global pivot towards sustainability. Let’s keep in mind the goals here; that is, the efficient and restorative use of resources for a healthy, prosperous and profitable future. When we invest in sustainability today, we improve our communities and our environment so that future generations can live together and enjoy the planet as we have. If we invest locally, in food and energy independence, we improve our own security and that of our families.

There’s been tremendous momentum for the clean energy revolution in 2015. The clean food movement is gathering steam and knowledge of the economic benefits of localization are growing.  Here’s 5 “I’s” we can be thankful for:

Innovation: Even with research budgets flagging in many areas of the world, the private and public sector continue to innovate with new technology to solve the resource problem. As global recognition grows that the resource problem is one of math and not ideology, we can hope that momentum should increase. Here are a few notable 2015 innovation trends you can discuss around your community:

  • Microturbines: In February 2015, two private companies LucidPipe, the manufacturer, and Harbourton Alternative, the investor, teamed up with the City of Portland, OR to install a 200kw microturbine system in the city’s water pipes.While not disrupting the functioning of the pipes, the microturbines use the energy of the flow to create electricity. For the gearheads: the 200kw system expects to generate 1,100 MWh’s of electricity per year, enough for 150 homes, which implies a ~63% capacity factor for the technology (equivalent to some natural gas plants). The $2M in energy sales over the 20 year PPA life implies a kWh price of around $0.10. Microturbines and other technologies that capture wasted energy are going to be big business. Here’s another such innovation just waiting to be unlocked.
  • HumanPower: Here’s your future business. With proven technology, you retrofit the flywheel in rowing machines, treadmills and elliptical bikes to capture the wasted energy created when someone works out. The energy charges a battery, which the gym uses in conjunction with a smart meter when electricity rates are high. Bring in a specialty finance company, also you, to finance the savings and share your portion with investors. On to your global roll out but you won’t be the only one promoting financial and technological innovation to save resources – the big fish are getting involved too…
  • Bill Gates is expected to announce a multi-billion dollar clean technology innovation fund at the start of this year’s climate summit (COP21)  in Paris. Announced in the NYT this week, the fund will fuel needed innovation in new clean technologies that streamline and improve efficiency in energy systems. Kudos to Bill and other well resourced folks for doing what needs doing and while innovation is necessary, what we need more than ever is the all-in implementation of proven technology…

Implementation: There’s a whole slew of investor ready technologies just waiting for implementation in our energy systems. Three in particular, whose prices have fallen between 60-90% in a few short years are Solar PV, Wind and LED lighting. These technologies enable clean power generation and the implementation of energy efficiency retrofits at a profit for investors.

While investment growth has been brisk, with over a trillion dollars financing clean energy projects in the last few years globally, we’re still missing the mark for wide scale adoption for a few main reasons.

First, politicians have yet to get on board, come to consensus and steer the ship towards a clean energy solutions. The evidence they need, jobs, a reduction in pollution and a boost to the domestic economy is readily apparent and documented. Hopefully, COP21, continued activism from voters and transparency on funding sources can help us re-establish the right course and construct of our political systems. We need guidance at the local level, in zoning laws, at the national level, in right sizing a 5-to-1 subsidy advantage in favor of incumbent industries, and at the global level in the form of cooperation.

Second, Financial institutions are dragging their feet. While there have been a number of newsworthy commitments by banks to invest in clean energy and many of them have funded portfolios of projects, we’ve yet to see the wide scale pivot to build pathways to dedicated investment. 401K and other employ plans should all have a placeholder to participate in investments in clean energy across the capital stack that rival credit alternatives. Progress is being made at the corporate level but product groups are moving more slowly. You’re hear a lot of talk about investment opportunities in emerging markets, clean energy and water conservation but finding places to put your money is another story all together.

Part of the problem is the financial regulations prohibiting banks from investing balance sheet capital. While prudent in many cases, I view this as a large impediment to galvanizing investment into sustainable infrastructure. The net effect is that product innovation is low and lead times are exorbitantly long. It’s much easier for the banks to process innovate and ignore content all together.

An associated problem is the challenge of capital formation. Beyond the retail, private wealth and institutional landscape, the bulk of capital is tied up in the opaque world of private equity and venture capital. While there are offerings for clean energy and other sustainable investments they are difficult to track much less access for everyday investors and savers.

While the Impact investment arena is growing at a healthy clip, still more investment and financial innovation is needed to unlock a smooth pathway for capital formation and make these efforts more than just symbolic.

Recent regulatory changes on crowd equity funding and notable investment efforts from the likes of Howard Buffett’s i(x) are bright spots from opposing poles. While crowd equity funding is sure to evolve, the $1M annual limit is likely to limit any truly transformational results from this avenue alone.

Against a backdrop of structural headwinds but with economic tailwinds, the clean energy transformation has performed admirably. In the US, clean power made up 60% of new generation in 2015 and many areas of the globe are crafting plans or have significant investment already underway.

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Incubation: Young minds are reading. Today’s generation is coming up well-versed on high waste streams, climate risk and scarcity. Thanks to the internet and some progressive journalism from the majors (9 people own 1600 major news outlets) young people cannot only learn but use there voices to ask their teachers, parents and friends why we aren’t acting more decisively. Circumventional finance platforms like Mosaic, AgFunder and others are a direct result of these shifting winds but there net effect is still small next to the juggernauts of capital controls. Will the old guard shift beyond symbolism and listen to the voice of the new generation? Will politics recognize the majority call to action? One thing remains sure – the good ideas are incubation in the minds of the young and evidenced across the entrepreneurial landscape of the internet economy.

While the young give us hope; old ideas are rooted in the pivot to clean energy and sustainability as well. The insulation comes in the form of savings and security…

Insulation: Energy Efficiency is a creeping up as possibly the best risk-adjusted return option available today. When we lower operating costs, we insulate our business or our family from shocks to the economic system, like lost jobs or customers and general financial cycles. That’s exactly what early investors in energy efficiency are realizing, stability of returns reaching into the double digits for all stakeholders in many cases.

Doubly, both Efficiency and Renewable Energy offer security benefits at the national, state and local level. A distributed renewable grid system is a more difficult target for a terrorist attack, responds better in an environmental disaster and has none of the associated costs of fuel volatility of non-renewables. Energy Independence and thus security through renewables and efficiency should be hailed as the most American thing we can do. The companies that made fortunes on the last regime and fossil fuels should help us pivot (they have the capital), retrain their workers (it’s the right thing to do, again American) and continue to make fortunes. I can live with that and I’m pretty sure our children can but the move must be more than symbolic. It must be unconditional and tectonic not incremental, just like the banks. Then we can thank them for it instead of scratching our heads and wondering why we are liquidating the planet for a few more good decades. This brings us to inspiration – for our problems are many and without hope – it’s hard to be thankful for anything.

Inspiration: We can draw our inspiration from many places. Together, we’ve accomplished many great things and it hasn’t been easy. To all people fighting for a future that is profitable today and prosperous tomorrow, together we gather strength from each success. From the young around us, still rightfully enchanted by our beautiful world, to the artists, poets, journalists, pioneers, politicians, investors and ordinary citizens using their voices and positions to promote sustainability, our ability to sustain ourselves, we can say thanks.

I say thank you.

More people join everyday and slowly the impediments recede, the logic of pushing against becomes harder to defend. Mostly, we might draw our inspiration a beautiful day or a rising sun, which powers all life and can deliver 20,000 times the electricity we are using today.

Sunrise

Return to FUTURE BRIGHT

Future Bright

Future Bright

Future Bright’s focus has been on evolving pathways for institutional investment into sustainable infrastructure, equity and credit strategies.

By focusing the farthest upstream on the supply of food and energy these solution areas unlock shared savings for higher value added economic growth downstream.

For investors, the concept can be described as localizing our food and energy dividend using proven technology that reduces supply chain risk.

The three pillars of food and energy localization are energy efficiency, renewable energy and controlled environment agriculture a.k.a. Vertical Farming. For Infrastructure, the investments must satisfy three conditions.

Infrastructure Focus

  • Growth Markets with compelling economics
  • Markets where structure and financial innovation can unlock value
  • Investment that offer co-benefits / risk mitigation of social and environmental issues

Energy Efficiency assets are created when third party finance funds invest in energy efficiency retrofits for commercial, residential or industrial hosts. The retrofits can include LED lighting, insulation, HVAC and smart grid technologies The fund vets energy services companies and approves projects within the pipeline that meet criterion for credit quality, project scope and investment viability. The market size for C&I retrofits in the US alone is estimated to be around $300B, capable of unlocking shared savings of over $1T. Energy Efficiency Assets solve a market inefficiency and deliver returns in the form of highly predictable shared savings with upside optionality to investors. Returns attributable to investors can range from high single digits to the 30%+ on individual projects. As the market evolves, securitization, strategic buyers, improving technology and policy mandates will drive growth and sustain returns.

Additional co-benefits include keeping retrofits off-balance sheet, improved Quality of Life improvement for building occupants, cost predictability in capital budgeting, a reduction in carbon footprint and unlocked downstream savings to spend on higher value economic growth.

See Future Bright, ‘The Sleeping Giant’ for more on Energy Efficiency as an asset class.

Renewable Energy projects represent one of the fastest areas of growth for infrastructure worldwide. The deployment of proven technology in wind and solar PV is creating an investable asset class in the form of project equity, tax equity and project finance debt that can deliver attractive returns to investors. Additionally, the elimination of an operational supply chain and close to zero marginal cost of productivity are core de-risking features for renewable energy investors. Revenue is predictable and visible often for decades into the future. Renewable Energy project returns vary by class, location, size and other factors but generally can range from high single digits to mid-20’s unlevered with aggregate portfolios targeting returns in the low teens. Annual investment is averaging around $300B.

Additional benefits include a reduction in the carbon footprint, predictability in energy costs, job growth, energy security and access.

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Solar and Wind made up >60% of US installed capacity in the first 9 months of 2015. Oil, Hydro and other sources were zero or sub-1%.

Controlled Environment Agriculture (CEA) or Vertical Farming is a growth area targeting rising demand for clean, local and secure food supply. 15 commercial scale farms are in operation in the US with dozens more expected to come online in the near future. Falling technology costs, improved growing methodology and the need for resource efficient solutions in agriculture is driving growth and economics for CEA. An economic baseline has been reached for about a dozen varietals of leafy greens with value added potential in nutriceutical and consumer packaged goods (CPG’s) markets. The market for local fruits and vegetable was $7B in 2014. To reduce the carbon footprint of grid tied CEA, both renewables and efficiency can be applied.

Benefits include food security, health benefits, consistency, urban renewal, reduces water and transportation costs.

CEA1

Join the Future Bright distribution list or reach out for more on the CEA space.

Turning now to equity and credit themes, the focus becomes a factorized approach to both positive and negative drivers with respect to sustainable business models. Increasingly, investors are recognizing sustainability or ESG factors as being important to current bottom lines and future viability. Future Bright expects a long-term tailwind to shape both equity and credit market valuations guided by these and other factors:

Sustainability Factors

  • Energy / Revenue: Businesses can achieve a strategic advantage when they lower their cost per unit of energy required for one dollar of revenue. With renewable energy integration, many corporates are recognizing this benefit (see, Solar Power Growth Story).
  • Water / Revenue: Water supplies are increasingly at risk and strained throughout the globe presenting a particular risk to social and environmental system. High water user and businesses predicated on high water use are at risk. Efficiency technologies and business that create revenue with lower water intensity are set to benefit.
  • Useful Life / Replacement Cycle: With resources running out, businesses need to pay close attention to the replacement cycle for natural capital stocks their operations depend on. Sustainable fibers can right-size the useful life mismatch for industries in paper, plastics and other durable goods.
  • GHG Footprint / Revenue: It is recognized that increasing the intensity of carbon, a heat trapping gas, in the atmosphere increases the volatility of weather including rainfall and raises the probability of drought conditions and powerful storms. These factors affect economic activity directly. The global community is moving to address this risk to economic, social and environmental systems. Businesses that get ahead of the carbon curve will experience less disruption. Solution providers will benefit.
  • Future Waste Liability: Companies with high waste stream and large extraction footprints should be moving to address scarcity and detrimental waste impacts. Awareness is growing as to the health impacts and costs of toxins in food and energy systems.
  • Physical Supply Chain: Globalization only works when environmental and social systems are unaccounted for. However, these systems are required for healthy economic systems. Localization feeds vibrant economies while reducing transportation, health care and storage costs. Long supply chain credit is at risk.
  • Subsidy Risk: Subsidies exist in nearly every major industry. In mature industries they are embedded downstream with consumers, in developing industries they are embedded upstream with project developers.Carbon
  • Political Transparency: Sustainability is becoming a political issue as facts about health costs, climate change and public governance become more transparent. There is no reason to expect this trend to reverse given increasing access to information. Political systems can take decades to reshape but the early stages of recognizing the private sectors impact on social and environmental capital is taking shape. Businesses that recognize scarcity and waste streams, as a mathematical driver and risk factor should benefit. Politicians that do the same will be increasingly supported. It’s time to remove ideology from progress towards prosperity, by focusing on the math; we can.

 

Future Bright is looking for its next assignment. Does your organization want to explore these mega-trends in detail, build models, meet practitioners, make investments, design product and forge private-public partnerships? Let’s collaborate. ken@futurebrightllc.com

Disclosure: Future Bright is a think tank and advisory in sustainability and investing. Future Bright has worked with renewable energy developers, energy efficiency funds, assets managers and vertical farms on progressing solutions towards sustainability. This note is not an offer of services or investment of any kind. This is a blog post for informational purposes only. Those interested in consulting services, design work or industry analysis should contact Future Bright directly. (www.futurebrightblog.com)

 

The Sleeping Giant: Energy Efficiency Asset Class

The Sleeping Giant: Energy Efficiency Asset Class

The Takeaway: We’ve been sleeping on a pile of cash. The opportunity in Energy Efficiency is being driven by improving technology, supportive policy and adapting financial innovation. Innovations in the renewables industry will speed the creation of an energy efficiency asset class. Energy Efficiency as an asset class represents an attractive uncorrelated alternative to hybrid fixed income instruments. The opportunity represents another trillion-dollar sustainability option. It’s time to wake the Sleeping Giant.

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The giant is snoring loudly—he’s waking his neighbors—there’s dollars to be made. In July 2014, HSBC estimated the investment opportunity in energy efficiency could be worth up to $365B globally. The opportunity in the US alone could be around $200B (HSBC, Deutsche Bank). The bulk of that opportunity lies in retrofits to existing commercial, industrial and residential buildings.

Risk-Reward: From an investment lens, capturing waste and turning it into dollars through energy efficiency shared savings should be quite attractive. After all, no one is competing for these wasted dollars; they simply evaporate from the bottom line. Investment vehicles to access these captive returns are gaining recognition because they pool a portfolio of shared savings retrofits and give investors access to potentially uncorrelated returns. Depending on investment structure, energy efficiency can be seen as a hedge against a slowing economy for both businesses and investors and as a potential credit enhancement for the business and or tenet (through lower operational costs).

Still, complexities in the marketplace have made waking the giant more difficult. Stakeholder misalignment and opacity in commercial credit standards have hindered strategic origination and investor comfort. Some of these impediments seem to be lifting as adaptive policy, awareness and the search for diversified yield drive interest.

The value of retrofits is determined by the payback period for retrofitting with new technology and financial structure. The payback period is determined by the cost of new technology and energy prices. As the cost of technology falls or energy prices rise the value of retrofits increases. Further, retrofits often hold more value for businesses where facilities are operating for 8-16 hours per day.

At the technological core are light-emitting diodes or LED’s. Lighting efficiency is measured in lumens per watt or the amount of energy required to produce light. The more lumens, the brighter the light. The graphs from the US Energy Information Agency show us that LED’s are ~6X more powerful than incandescent bulbs and can last 30X as long.EE3EE2

The cost of LED lighting has fallen more than 80% since 2010 making payback periods often less than a year. Let’s illustrate with a simple example.

Building A has 100 60W incandescent lights (IC) and is exploring the value of an energy efficiency upgrade to LED’s. Lights currently run 16 hours per day and energy costs are $0.15/kwh.

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For our example, we assume that LED equivalents are four times more expensive than IC comparable. Channel checks show competition and gains in efficiency that are above and beyond the analysis above.

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Further gains in technological efficiency are expected while cost declines are predicted as well. The EIA forecasts lumens per watt to reach 150 by 2020 with a concurrent cost differential to be around 2. Regardless, the current environment appears to afford enough excess return (do we call it uncorrelated alpha?) to satisfy all required stakeholders at the tea party.

This trend bodes well for businesses geared to LED’s like vertical farming. Contact Future Bright to learn about transforming trends in sustainable agriculture.

LED are one facet of the energy efficiency equation. Gain and intelligence in smart grid technology can optimize and building energy usage further. Green boilers, grey water systems and improved insulation add to the bottom line and one cannot overlook the omnipresent chatter on the benefits of batteries and battery price parity (See Future Bright’s upcoming article, ‘Closing the Loop’ on batteries).

It is clear from the above example for LED’s that a compelling opportunity exists in energy efficiency retrofits but how do we unlock these saving. There are many challenges to scaling the market including matching the capital expenditure cycle for businesses, stakeholder misalignment and origination and scaling issues. We now address a few of the policy and financial engineering innovations addressing these impediments.

Financial Innovation / Supportive Policy:

PACE or Property Assessed Clean Energy is a means of financing retrofits through an increase in property tax liens. PACE is an innovation born of California that is now spreading nationally and from the residential market into the commercial market. PACE is attractive to financiers due to the lien status and value of residuals available in securitization. PACE programs continue to work through hurdles of aligning interests with the mortgage industry and bridge loan requirements but interest and investor appetite appears to be scaling.

Energy Services Agreements (ESA) fund off-balance sheet retrofits in exchange for shared savings. The shared savings are split between investors, investment managers and energy service companies in an innovation to overcome capital expenditure hurdles and bring new investors to the segment. ESA’s may prove attractive as they allows hosts to realize operational cost savings immediately with no capital expenditure. ESA’s are also less sensitive to regulatory or incentive structure although certain models could benefit from tailwinds in these areas. Challenges that exist in benchmarking and portfolio construction can be addressed with strategic origination channels, technology and insurance. ESA typical resemble the power purchase agreement (PPA) an innovation used to unlock financial interest in the solar market. In the case of ESA, contracts are for savings units as opposed to produced energy.

EE Loan: Traditional secured loans may provide more comfort for investors targeting and stable bond like return. Energy Efficiency loans can take many forms with some allocating a mix of shared savings in addition to a fixed rate of return. Collateral can be extended beyond the retrofit equipment in some cases.

Policy Support is driven by the will to invest in a low carbon economy. Efficiency fits into the equation of economic value add through localization. The dual mandates of mitigation of climate risk and more economic resilience through reduced operational cost volatility should keep policy support accommodating.

There are numerous other iterations in the marketplace vying for access to captive returns from energy efficiency retrofits. As the market scales and securitizations increase, more investors are sure to be attracted to the risk-reward characteristics and expectations for continued improvements in technology.

Investments: In terms of investing in energy efficiency—there are many potential articulations from securitized bonds, to equity, to PE-style investment vehicles. One company worth mentioning is Hannon Armstong (HASI). HASI is organized as a sustainable REIT and invests in renewable energy and energy efficiency projects typically in the form of loans. The stock is up 39% year to date and sports a 5.46% dividend yield so investors may want to consider relative performance.

From a platform perspective, large investors and institutions should take a close look at building capacity in the energy efficiency asset class. Some are taking note, as evidenced by GE’s announcement this week of the formation of Current, a wholly owned subsidiary to capture momentum in new energy trends including energy efficiency. GE is reported to have committed $1B in balance sheet to the problem. Now let’s see if they can solve the strategic origination problem.

One thing is for sure. The Giant is no longer sleeping deep. He’s yawning and beginning to stretch. Soon he will carry those who took notice of the opportunity.

Disclosure: Future Bright is a think tank and advisory in sustainability and investing. Future Bright has worked with renewable energy developers, energy efficiency funds, assets managers and vertical farms on progressing solutions towards sustainability. This note is not an offer of services or investment of any kind. This is a blog post for informational purposes only. Those interested in consulting services, design work or industry analysis should contact Future Bright directly. (www.futurebrightblog.com)

The Solar Power Growth Story

The Solar Power Growth Story

The tailwinds supporting the secular shift from non-renewable to renewable energy are strong and growing. Solar PV is experiencing tremendous growth from a low installed base while gains in technological efficiency, favorable policy and financial innovation are all increasing prospects and visibility for investors. Global recognition of the economics for a solution with zero marginal cost of production and low potential future waste liabilities are cementing solar at the core of the massive replacement cycle for energy systems.

The energy created by the sun that reaches the earth per year is equal to approximately 20,000 times the total demand by society. Photovoltaic (PV) cells are comprised of abundant materials and are designed with no moving parts’ they capture the sun’s energy and convert it into electricity. This electricity is exchanged for hard currency. There is minimal security, transport, environmental or storage hurdles. This is the solar power growth story.

Growth: The Solar PV industry has experienced a 23.2% compound annual growth in the past decade to 2014.

Total installed solar PV capacity increased 32% in 2014 to a cumulative 180 Gigawatts or between 1-2% of global electricity demand. 1 Gigawatt (GW) of solar PV is enough to power roughly 200,000 homes.

By comparison, global wind capacity stood at around 369 GW at the end of 2014.

Growth typically follows productivity gains. The pair of graphs below contrast the productivity gains (CAPEX efficiency) in solar vs. declining productivity in the Oil & Gas industry. In a confirmation of Future Bright’s thesis, investors have been rewarded for investing in industries with rising CAPEX productivity. In the case of solar, industry is building more capacity, with less dollars, using less land.

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The productivity of CAPEX is driven by a familiar story: Moore’s Law for the scaling of semiconductor technology.

Technology: The cost to install Solar PV has fallen dramatically over the last five years. The Photovoltaic cell, the core component of a solar power plant based on semiconductor technology, has fallen in cost by roughly 80% (right graph) while total installed cost have fallen by roughly half. With power prices stable or rising, these efficiency gains have led to improving economics for investors and implementers of renewable energy like solar PV.

A sample of projects from 2014 by the National Renewable Energy Laboratory (NREL) shows for utility scale projects, renewables like solar PV and wind have largely satisfied the cheapest to deliver condition for utility adoption.

LCOE

As Solar PV costs fall, global grid parity is on the horizon. Grid Parity occurs when a capacity source reaches or falls below the cost to generate electricity on the grid. In 2014, Solar PV had achieved grid parity in over a dozen US states and in over 100 countries. Deutsche Bank recently predicted 80% of the global market will reach grid parity by 2017 (Bloomberg, Cleantechica).

What happens when an energy technology with zero marginal cost of production reaches grid parity with fuel-based substitutes? We now stand at that intersection.

PV costs have continued to fall in 2015. Reported prices in both developed and developing markets have dropped an additional 10-20% in the past six months (Cowen). Germany, one of the worlds more mature markets for Solar PV and not a low-labor cost market, installs rooftop systems at around $1.2/W, which is around ½ the cost in the US market indicating further potential for CAPEX efficiency in growth markets like the US.

Policy: Policy support for renewables has been generally favorable around the globe. Job growth and the will to mitigate climate change risks are two main reasons for this support. Policy support can take many forms some of which include: Renewable Portfolio Standards (RPS), Feed-in Tariffs (FiT), Renewable Energy Credits (REC/SREC) or Tax Credits (including Carbon Taxes).

Renewable Portfolio Standards are state or federal level guidance for the percentage of the capacity mix that utilities must provide from renewables. For example, California just raised its renewable RPS to 50% and other states such as Massachusetts, Vermont, New Jersey and New York have progressive goals for RPS. To see your markets RPS, click here: RPS by State.

RPS are often paired with Feed-in Tariff or Renewable Energy Credits to create the proper market based mechanisms and incentives for growth. In SREC markets, renewable energy developers receive their negotiated offtake price (often a long-term contract discussed below) plus the value of the SREC at the time energy is produced. Forward markets exist for SREC’s with institutional participation allowing developers to hedge and increase bankability of projects. Feed-In Tariffs are mandated prices between developers and utilities for approved projects. Tariff rates typically ‘step-down’ overtime as capacity is added to meet goals.

FiT’s and RPS are also used at the country level across the globe. Some examples include:

  • Japan’s FiT system for solar implemented after the Fukashima disaster has resulted in 69GW of approved projects in less than 2 years
  • India has a seven-year goal of over 100GW of solar PV. Instrumental private capital partners like SunEdison are arriving to make the grid of the future a reality in India.
  • China’s recent accord with the US on carbon emissions anchors the countries’ position as a leader in investment into renewables and manufacturing. China could invest up to $2T over then next 15 years in renewables under the parameters of the Nov 14’ accord (WEO, Bloomberg).

Tax Credits have been instrumental in kick starting growth for market like the United States. The 30% Investment Tax Credit (ITC) will step-down, unless extended, to 10% at the end of 2016 and is expected to drive growth in the 2015-2016 development cycle.

THINK TANK: Future Bright predicts the 30% ITC for solar could be extended.

While there remains regressive policy in particular states and/or countries, it should be no doubt that governments’ the world over see their job security more than ever tied to their ability to steer the economic ship towards a low carbon future. Future Bright expects low-carbon strategy and climate change to be an inseparable part of elections and the democratic processes globally going forward.

Case in point – the Obama administrations final draft of the Clean Power Plan (CPP) directly addresses limits on carbon emission by imposing state-level standards and implementation guidelines. The CPP plan calls for emission reductions of 32% by 2030 vs. 2005 guidelines on a national basis and will be responsible for driving large investments in renewables and efficiency.

With or without policy support, overall growth prospects for renewables remain attractive, especially for developing markets:

  • According to the International Energy Agency, non-OECD countries will require $10 Trillion in investments into power generation and transmission. For non-OECD countries, sustainable development like renewables offer a cost advantage over substitutes

Improving economics and growth eventually attract expertise and innovation in financial engineering. We are seeing the early stages of a tremendous growth in financial innovation for renewable right now.

Financial Innovation: Solar Power has been made bankable by a financial innovation known as the Power Purchase Agreement (PPA). The PPA is a long-term offtake contract for all or a portion of the power produced by a solar plant which typical ranges from 10-25 years. PPA’s are signed with utilities, commercial or residential buyers and often carry escalators of between 1% and 5%. The escalators, the low and falling cost of solar and the ability to generate onsite energy with no transmission costs often generates contracted PPA’s below market prices for electricity. This shared savings approach used in solar represents the key driver of growth in renewables and other areas of sustainable investment.

Other financial innovations have arrived to scale the development of new solar capacity. Recognizing the value in stable cash flows for assets with inelastic demand, financial innovators have delivered the Yield Company. The Yield Company is a dividend oriented growth company spun out from a sponsor that bundled and acquires renewable energy assets to distribute cash flows to shareholders. Both public and private yield companies exist as a source of long-term value creation for owners given the growth prospects for renewables. Yield companies are analogous to the MLP boom fueled by the US shale gas expansion. In 2014, Yield Companies had a combined market capitalization of around $30B vs. $500B for MLP’s. The Yield Company is expected to lower the cost of development capital over time and fuel long-term growth in renewable capacity.

Impact: In addition to the economic value, renewables offer investors and communities other significant social and environmental dividends. These include:

  • Jobs: There are now over 7 million clean energy jobs worldwide. In the United States, Solar energy jobs grew at a 21.8% rate in 2014 vs. overall job growth of 1.3% (Energy.gov, The Energy Collective)
  • Reduced Water Use: To see the future of scarcity challenges, look west. Solar and Wind offer conservation benefits over substitute like hydraulic fracturing or nuclear in that they use little to no water in operation. Look for more about water on this blog. Its maybe the biggest blindside risk out there.
  • Security: whether it is from natural disaster or terrorist attack, renewables offer more resilience over the conventional grid. During hurricane Sandy, the 32MW Long Island’s Solar Farm endured minimal damage and was available for operation almost immediately. There were no reports of significant damage to solar and wind farms after the storm. If you doubt the threat of attacks to our energy infrastructure, google ‘The Metcalf Incident’ where you will read about the nearly successful assault in 2013 on a major PG&E sub-station responsible for providing power to Silicon Valley.
  • GHG Reductions: Renewable energy assets generate electricity with no global greenhouse gas by-product. The lack of pollution and the will to mitigate climate change through potential carbon taxes provides further upside potential to renewable energy asset owners.

 

Bottom Line: The economics make sense. Accelerating gains in technological efficiency, policy tailwinds and financial innovation are combining with positive impact qualities to make the Solar Power Growth Story unstoppable.

DEMAND: Corporate and Country Level Adoption is Strong

Many blue chip companies already have made significant investments in solar

Solar Makes Sense

Long-term asset owner will continue to be drawn by the zero operational supply chain and low potential future waste liabilities; qualities which should enhance value in times of economic stress. Individual investors and institutions have multiple ways to invest from liquid equities to fixed income securities to direct long-term investments and alternative fund structures. Renewable Energy asset ownership is ideal for institutions such as pension funds seeking to address potential asset liability mismatches.

 

Additional Sources

  • Database of State Incentives for Renewables and Efficiency, www.Dsire.org
  • National Renewable Energy Laboratory, NREL, www.nrel.gov
  • United Nations Environement Programme, http://www.unep.org/climatechange/mitigation/
  • S. Energy Information Administration, EIA, www.eia.gov
  • International Energy Agency, IEA, iea.org
  • Cleanedge
  • Cowen & Co
  • Bloomberg

Disclosure: Future Bright is a think tank and advisory in sustainability and investing. Future Bright has worked with renewable energy developers, energy efficiency funds, assets managers and vertical farms on progressing solutions towards sustainability. This note is not an offer of services or investment of any kind. This is a blog post for informational purposes only. Those interested in consulting services, design work or industry analysis should contact Future Bright directly. (www.futurebrightblog.com)