Wednesday, October 2, 2013

Energy: Clean, Renewable & Efficient

The insatiable demand for energy is testament to human progress and development and with the rise of emerging markets the trend will not abate. The IPCC (2011) estimates a global energy demand increase of 40 % by 2030 and we shall not forget that 1.3 billion people still lack access to electricity. Given the fact that energy causes 26 % of global GHG emissions (IPCC, 2007) there is an obvious need to decarbonize our energy mix. Renewables and energy efficiency measures hold great promise but capacity adding investments need to be smarter and bigger. How big? The World Economic Forum says around 750 billion USD/year through 2050 to deliver energy security for all in a sustainable fashion (Green Growth Investment Report, 2013).

Renewables and energy efficiency
Public acceptance for renewables is key to realizing any plan, especially when consumers start seeing new power lines, biomass facilities and wind farms close to home. Coupled with higher energy prices the appetite for new investments might falter as recent developments in Germany indicate. One possible way out of this dilemma is to turn consumers into prosumers, i.e. letting them produce energy, for example via solar power, and selling surplus production into the grid. Smart grids need another round of massive investments however. Catch-22 anyone?
Nonetheless, renewable energy like solar and wind is the fastest-growing source of energy generation, estimated to make up 25 % of the global power mix by 2018. Already in 2016, renewables will surpass natural gas, taking second place after coal as an energy source (IEA, 2013). Growing energy demand from fast growth nations where coal is still in heavy use means that the average unit of produced energy today has the same carbon intensity as 25 years ago (IEA, 2013). To turn the tables a global price on carbon is a must. It has to cost to pollute and harmful subsidies for the fossil industry should be phased out or at least be on par with those for renewables. All together, this will make renewables an even better business case.  

While the case for renewables remain contentious in some circles due to long financial payback time, effects on the landscape and remaining technological hurdles, the other side of emissions reductions represents a more straightforward case. Energy efficiency efforts seemingly provide rather predictable and often large financial returns while mitigating climate change. According to the IEA (2013) improving energy efficiency in building, transportation and industrial processes can reduce global energy needs by one third in 2050, saving money and reducing emissions. IEA also estimates that a global efficiency investment just under 12 trillion USD through 2035 would produce 18 trillion USD in higher economic output.

A word of caution regarding these and other widely circulated figures, they require much faster reduction of energy intensity than has ever been achieved in the past. Further obstacles include split incentives, i.e. not always the same people who pay for efficiency that receive the benefit and the so called rebound effect where lowered cost leads to increased demand, eroding expected savings and positive environmental impact. Hidden costs, for example rebates and use of consultants can also cut into the cost saving quite dramatically.

Nexus and Impact Investing

Smart energy investments need to consider effects on water and food, as they are closely interlinked and together impact the environment in a myriad ways. Using a Nexus approach, as we have stressed in previous blog posts, gives a deeper understanding of these linkages and how to best structure an investment to avoid negative effects in the adjoining sectors. It’s time to move away from the silo perspective.

To illustrate; the full food production and supply chain is responsible for around 30% of global energy demand. Energy is required for pumping, storing, distributing and treating water. Water for energy production currently amounts to about 8% of global water withdrawals (up to 45 % in industrialized countries). Biofuel demands could grow 100% by 2030 (IEA 2009); biofuels being highly water intensive, as is reclaimed wastewater and desalinated seawater. Renewables can cause other negative nexus externalities, for example high water demand per unit of energy for hydropower and large quantities of water for cooling solar installations. However, excluding large-scale hydro power plants, renewables consume much less water than fossil fuels and nuclear power. More than 40 % of freshwater used in the US can be attributed to the cooling of power plants, as a reminder. This complex picture teaches us to go deeper in our investment analysis – forego easy and superficial methods.

In particular, water and energy are deeply intertwined; energy and water producers will need to cooperate on an unprecedented scale, both in terms of on the ground projects and as co-investors. Consider the effects on the energy sectors in cases of water shortages; operations can shut down, causing blackouts and consequent economic damages to society. In water stressed regions the future financial viability of some energy plants can be questioned, not to mention its impact on water supplies, often competing with the agricultural sector for withdrawal rights.

Using a Nexus approach to identify possible negative externalities from an energy investment can be a crucial tool in the process of balancing and boosting financial and environmental returns. Healthy returns, either in the form of profits or cost savings are essential to future investments without having to resort to ruinous and lopsided subsidies. Structuring energy investments as impact investments offer the best of both worlds. Financial returns and positive environmental impact are not mutually exclusive as the old investment philosophy goes but in fact they are mutually reinforcing in a world where natural capital will have an increasing relevance on the balance sheet.

Including negative externalities in investment decisions can make the difference between going ahead with a non-renewable energy investment or using the same capital for a renewable energy project. Leave the coal in the ground or not? The intersection of the Nexus and Impact Investing can be just the right formula for business and governments making multi-billion investments in the above areas, especially in an ever more complex energy sector.