Climate change remains a key issue to be addressed in the coming decade. We say decade because it may already be too late.
We will all have to pay a price for burning fossil fuels, but unfortunately most of that price will not be paid by those who burn fossil fuels. This is a classic negative externality problem: the benefits of an activity—in this case, burning fossil fuels to produce energy—are privatized, while the costs to human health and the environment , are socialized.
In theory, we know how to deal with these issues. We can either regulate the activity, as President Richard Nixon did with the creation of the Environmental Protection Agency (EPA) to reduce air and water pollution in the 1970s. Or we can internalize costs by putting a price on carbon credits or instituting cap and trade programs as is common in Europe and is now being introduced in China.
The problem with these approaches is that they are green sticks. They restrict entrepreneurial freedom and are therefore, shall we say, not very popular with companies that burn fossil fuels. But that doesn’t mean we care about popularity as much as incentives. Big oil resistance to environmental regulation and carbon pricing in the United States has been enormous, although recent events Exxon And Shell indicate that he may be losing the fight.
Nevertheless, the current price of carbon emissions is generally too low, and is at best 50% of what it should be, according to estimates. Carbon emitters spend big on lobbying keep this cost well below the required threshold to encourage the rapid and effective change that is needed to avoid the worst consequences of climate change.
But regulation will have to go even further than carbon pricing. Do we also need rules to help prevent and manage the risk of stranded assets? In a word, yes.
It got us thinking. . . . Instead of using green sticks to force change, why don’t we use green carrots to incite change? After all, these approaches are not mutually exclusive.
One way to introduce green carrots is to create a market for royalties from R&D in renewable and sustainable energy. The oil and gas and mining industries are already among the leading developers of green technology patents, but monetizing this research is difficult. A company can either use the know-how and deploy the technology in-house or stick with it.
Meanwhile, a mining company building a new mine can sell future production from that mine to royalty companies in exchange for a lump sum payment. For the royalty company, this is the equivalent of buying an annuity financed by the production of the mine. By the way, greening so-called dirty industries has perhaps the greatest potential to counter climate change.
In the field of biotechnologies, companies have already specialized in the financing of intellectual property (IP) in exchange for a share of the revenues generated by the finished product. Why is there no such system in place for the development of green technologies?
Currently, US taxpayers receive tax relief for investments in oil exploration projects. Why don’t we close this tax loophole and use the money raised to pay super royalties to energy and mining companies that develop green technologies?
Alternatively, we could support dedicated royalty companies in the field of green technologies to open up a new market. Investors could then invest in the shares of these green technology royalty companies and profit from changing the world instead of saving taxes on burning it.
We could even go further and learn from successful venture capital (VC) models in countries like Israel. Today, Israel is one of the world’s leading tech hubs, and much of the credit goes to the government-funded business incubator Yozma. In 1993, the government created Yozma by endowing it with a capital of 100 million dollars. Yozma has backed early-stage companies in exchange for up to 40% equity in the projects – on the condition that private investors fund the rest. After seven years, investors could repay Yozma’s government support at face value plus interest. It worked, and in 1998 the venture capital market in Israel grew big enough for Yozma to be privatized.
This effectiveness in providing a carrot for investments should not be underestimated. Today, Israel spends more on R&D as a share of GDP than any other country and ranks just behind the United States in terms of venture capital investment relative to GDP. Israel used carrots to turn its rusty 1990s economy into a modern, high-tech economy. Why can’t the United States use the same approach to accelerate its transition from a carbon-based to a green economy and ask big oil companies to lead the way?
If the carrots are tasty and the incentives are right, oil and mining companies will willingly invest in green technologies. The old adage that doing well while doing good is the way to go for all of us.
And even though we think of sticks first, we must never forget the appeal of carrots.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.
Image credit: ©Getty Images / Vitalina Rybakova
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