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Investing in Climate Change 2009NECESSITY AND OPPORTUNITY IN TURBULENT TIMES
OCTOBER 2008
http://dbadvisors.com/climatechang
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Climate Change Investment Research
We would like to thank the following Deutsche Bank contributors: Jed Brawley, Paul Buchwitz, Loretta Dennett,
Gem Dematas, Josh Feinman, Suleyman Gokcan, Theresa Gusman, Mark C. Lewis, Nektarios Kessidis, Michael
Marcus, Sabine Miltner, Adam Sieminski, Michele Shehata, John Willis, Joe Wong, and Muttasif Zaidi.
Mark Fulton
Managing Director
Global Head of Climate Change Investment Research: New Yorkmark.fulton@db.com
+1(212) 454-7881
Bruce M. Kahn, PhD
Director
Senior Investment Analyst: New York
bruce.kahn@db.com
+1(212) 454-3017
Mark Dominik
Vice President
Senior Research Analyst: London
mark.dominik@db.com
+44(20) 754-78943
Emily Soong
Research Analyst
New York
emily-a.soong@db.com+1(212) 454-9227
Jake BakerResearch Analyst
New York
jake.baker@db.com
+1(212) 454-2675
Lucy Cotter
Research Analyst
London
lucy.cotter@db.com
+44(20) 754-75822
*Bar chart in cover image sourced from New Energy Finance.
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The necessity: Tackling carbon.
One year ago, we published Investing in Climate Change: An Asset Management Perspective.
We argued that the growing investment opportunities in climate change were driven by long-term
mega-trends that would continue into the oreseeable uture.
One year on, the absolute necessity to act now to mitigate and adapt to climate change is even more
urgent, and the opportunities generated by the sector continue to increase. New evidence has
established that carbon in the atmosphere has reached an 800,000 year high (see graph below).
The leading scientic research shows that we are careening towards the tipping point where average
global temperatures are likely to rise by 2C or more. Beyond 450 ppm CO2e, it is increasingly likely thata series o macro-climatic shits will set up a sel-sustaining cycle o rapid global warming. Without
signicant and immediate action, or some unoreseen miracle, this tipping point stands no more than
15 to 20 years away.
The research in this report is driven by these two imperatives o necessity and opportunity. We have
a new challenge, however, added to the mix: how to nd the nancing to develop and deploy the
technologies we need to mitigate and adapt to climate change. Trillions o dollars have already been
wiped o the global balance sheet by alling asset values, and the worlds major economies are
heading into recession. Investors understandably lack condence at the moment and governments,
who are dealing with the contingencies o the banking challenge, will be reluctant to commit
urther capital to the climate change sector or the oreseeable uture.
Investing in Climate Change, One Year On
Kevin Parker
Member o the Group Executive Committee
Global Head o Asset Management
400
380
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800,000
AtmosphericC
O2concentration,ppm
Years before present
700,000 600,000 500,000 400,000 300,000 200,000 100,000 0
Concentration in 2008: 385 ppm
i Investing in Climate Change 2009
Todays atmospheric CO2concentrations are higher than they have been or at least 800,000 years
Source: D. Lthi,High-resolution carbon dioxide concentration record 650,000-800,000 years beore present, Nature, 15 May 2008. Continued on next page.
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Governments around the world can, however, take a big step in the right direction by agreeing to pricethe carbon externality. This would mean a global carbon tax in one orm or another, such as cap-and-
trade. The aim must be to create a clear long-term regulatory regime that determines a market-driven
cost o carbon while at the same time encouraging the development o alternatives. I governments
recognize the necessity o creating the right regulatory environment, investors will recognize the
opportunity and step in.
There are numerous examples o governments already heading in the right direction. The recent renewal
o the Production Tax Credit and Investment Tax Credit in the US assured solar and wind energy the
regulatory certainty and proper incentives or continued development o the sector. And one need only
look to Germanys Renewable Energy Sources Act or an example o true commitment to climate change
mitigation. Germany has created a riendly environment or renewable energies to power up and connect
to the grid through its system o eed-in taris and transparent and enorceable policies or renewable
development. Any successul regulatory rameworks must have these clear, comprehensiveprocedures to incentivize industry and create capital ormation over the longer term.
Achieving this kind o regulatory consistency on a global scale is a massive project, o course. But the
world cannot wait. The potential economic, social and political upheavals that could result rom a ailure
to tackle carbon emissions may be irrevocable. Severe though it is, the current nancial crisis can
eventually be xed, and should not be used as an excuse or inaction.
ii Investing in Climate Change 2009
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Editorial
The opportunity: Low carbon prosperity.
As Kevin Parker points out in his opening letter, this is no time or governments to back away rom cli-
mate change initiatives in the ace o tough economic conditions. The necessity to encourage mitigation
and adaptation remains urgent. For investors, this creates opportunity.
Constructing the right regulatory environment is a long-term goal or governments. Over the short-term,
however, there is an economic slowdown to contend with. I governments are going to stimulate their
economies, as many almost certainly will over the next year or two, they should support a climate-riend-
ly approach. There are numerous reasons or doing this. Organization or Economic Co-Operation andDevelopment politicians are talking a lot about energy security, which can be made climate-riendly when
ocused on renewables and clean coal technologies. Energy eciency technologies are obviously highly
desirable in economies acing recession. Inrastructure stimulus can be tied directly to climate-sensitive
sectors such as power grids, water, buildings and public transport. Climate change industries, in act,
present a vast new eld or the creation o new technologies and jobs. The current economic downturn
presents governments with a historic opportunity to climate proo their economies as they upgrade
inrastructure as a core response to the economic downturn.
This is just one o the reasons why we continue to expect a long-term secular growth trend in many
climate change opportunities. In the energy sector alone, the International Energy Agency estimates
that about $45 trillion will be needed to develop and deploy new, clean technologies between now and
2050. This represents nothing less than a low-carbon Industrial Revolution. Writers and policymakers
rom across the political and intellectual spectrum have recognized the potential this holds or long termjob growth and industry creation. The debate around climate change is shiting away rom cost and risk
towards the question o how to capitalize on exciting opportunities.
Here again, the nancial disruption o the last ew months is a potential distraction. One consistent
theme to emerge rom the market turmoil is that there are no sae havens just now. Climate change, like
almost all other asset classes, has not been spared rom the broader market downturn. So where is the
new investment capital going to come rom?
We believe that or investors, climate change has a built-in advantage over most other sectors. Its regu-
lated markets hold the promise o enormous secular growth. In the long-term, the earnings o companies
and projects that are supported by governments or policy reasons are more trustworthy. There is, in
short, a signicant saety net eect here.
In the rst part o our report, we determine that climate change is well-suited or public equity markets
and particularly private markets such as venture capital, private equity, inrastructure and timberland. In
the second part o our report, we examine some o the technical aspects o how regulation interacts with
the underlying dynamics o technology costs and energy prices. This compendium provides an analytical
ramework that investors can use to understand the climate change opportunity.
Mark Fulton
Global Head o Climate Change Investment Research
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Complete whitepaper and individual chapters available online.
http://dbadvisors.com/climatechange
List o exhibits and boxes v
Part I. Necessity and Opportunity in Turbulent Times
I. Investor summary 1
II. What is new in climate change investing? 6
III. Low carbon prosperity 18
IV. The credit crisis and climate change investing 26
V. Investment attributes o the climate change universe 36
VI. Market sizing: Scarce resources and the size o the markets 54
VII. Carbon and energy prices 68
Part II. An Analytical Perspective
I. Investor summary 92
II. Government policies & regulation: An analytical ramework 96
III. The investor perspective: Risk & Return around commercial breakeven 116
IV. Clean technologies: Deepening, broadening and developing 128
Appendix
I. Kevin Parker: Perspective on carbon prices 137
II. The science o climate change 138
III. Carbon Capture and Storage (CCS) & Forestry 143
IV. Recent regulatory developments 149
V. Critical actors or achieving commercial breakeven 152
iv Investing in Climate Change 2009
Table o Contents: Investing in Climate Change 2009
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List o Exhibits & Boxes: Investing in Climate Change 200
We draw rom multiple sources to illustrate our thesis.
Part I. Necessity and Opportunity in Turbulent Times
What is new in climate change investing?
Exhibit 2.1: The Four Pillars o Climate Change
Exhibit 2.2: Todays CO2
concentrations are higher than they have been or at least 800,000 years
Box 2.1: The EPICA Project
Exhibit 2.3: Oil price trends
Exhibit 2.4: Trading Volumes on the EU-ETS are growing
Exhibit 2.5: Phase-II EU Carbon Prices have been trading near or above 20
Box 2.2: Geo-planetary Engineering Looking or silver bullet solutions to climate change?
Box 2.3: Advances in solar storage technologies at MIT
Low carbon prosperity
Box 3.1: Energy security
Exhibit 3.1: A low carbon Industrial Revolution is urgently needed
The credit crisis and climate change investing
Exhibit 4.1: The climate change universe has historically outperormed the world index
Exhibit 4.2: The ratio o the climate change universe to the world index
Exhibit 4.3: The climate change universe shows variable correlation to nancial markets
Exhibit 4.4: The correlation o the climate change universe to nancial markets over dierent timerames
Exhibit 4.5: The correlation between energy and the solar sector
Exhibit 4.6: Historical P/E o the DWS Climate Change Alpha Pool vs. the MSCI World IndexExhibit 4.7: Distribution o historical P/E o the DWS Climate Change Alpha Pool
Exhibit 4.8: Leading wind companies P/E with one year orward earnings
Exhibit 4.9: Leading solar companies P/E with one year orward earnings
Exhibit 4.10: VC investment: Inormatiom Technology vs. cleantech ($ billion)
Exhibit 4.11: Sub-sector VC / PE investment by stage
Investment attributes o the climate change universe
Exhibit 5.1: Climate change: An integrated ramework o mitigation and adaptation
Exhibit 5.2: The climate change investment universe
Exhibit 5.3: The illustrative lietime o an identiable investment theme
Exhibit 5.4: Economic correlations o climate change sectors
Exhibit 5.5: Climate change sector correlations with real GDP growth
Exhibit 5.6: Specic investment strategies or climate change
Exhibit 5.7: The climate change universe asset class t
Exhibit 5.8: The perormance o carbon beta leaders vs. laggards
Exhibit 5.9: The spread o market cap weighted returns o the climate change universe
Exhibit 5.10: The volatility o the climate change universe
Exhibit 5 11: The investment spectrum or the private market climate change universe
Exhibit 5.12: U.S. Private Equity Index Compared to Other Market Indices or the One Year Ended December 31, 2007
Exhibit 5.13: What is inrastructure investing?
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Exhibit 5.14: The low volatility o inrastructure investing
Exhibit 5.15: Inrastructure investing: Relative placement along risk return spectrum
Exhibit 5.16: Timberland investing: Relative placement along risk return spectrum
Box 5.1: Ecient rontier: Balancing risk and returnExhibit 5.17: Inputs or ecient rontier analysis
Exhibit 5.18 Ecient rontier: Adding climate change can potentially add benets to portolios
Exhibit 5.19: Traditional portolio 5% allocation o each climate change sector
Exhibit 5.20: Comparison o traditional portolios with climate change strategies
Market sizing o the clean tech universe
Exhibit 6.1: Low carbon projected growth o renewable power generation
Exhibit 6.2: Water consumption and population growth
Exhibit 6.3: Demand and production o cereal ood balances by 2030
Exhibit 6.4: Wind, solar, biouels and uel cells expected to see $254.5bn o global revenue by 2017
Exhibit 6.5: Total solar PV installations by 2013, Global (MW)
Exhibit 6.6: Total solar PV installations by technology by 2013, Global (MW)
Exhibit 6.7: Crystalline silicon continues to lead by global market share through 2013 - $64.1bn
Exhibit 6.8: Wind power installations, Global (MW)
Exhibit 6.9: Wind penetration by 2030, % o total generating capacity (MW)
Exhibit 6.10: Oshore wind projects
Exhibit 6.11: Energy storage market size by sector, Global $bn
Exhibit 6.12: Transportation energy storage market size, Global 2004 2012
Exhibit 6.13: Global sales o products incorporating nanotechnology by sector ($M)
Exhibit 6.14: Biouels produced, Global (Gallons)
Exhibit 6.15: Ethanol production mostly rom grain eedstocks except or Brazil, Global
Exhibit 6.16: Biodiesel production, Global
Exhibit 6.17: Global new nuclear capacity planned (GW)
Exhibit 6.18: Planned carbon capture & storage (CCS) projectsExhibit 6.19: Annual worldwide cleantech investment is expected to reach $450bn by 2012 and $600bn by 2020
Exhibit 6.20: Global venture capital investments, 3Q 2008
Exhibit 6.21: Global venture capital investments by region, 3Q 2008
Exhibit 6.22: Total global new investment in clean energy 2007 & 1H 2008
Exhibit 6.23: Global new investment by technology 2007 & 1H 2008, $M
Exhibit 6.24: New investment by region (VC/PE, Public Markets, Asset Finance), 2004 vs. 2007
Exhibit 6.25: Global PE/VC transactions in clean energy companies, $M
Exhibit 6.26: VC/PE investment by technology, $M
Exhibit 6.27: Global asset nancing, $M
Exhibit 6.28. Asset nancing investment by technology, $M
Exhibit 6.29: Global transactions on public markets, $M
Exhibit 6.30: Public market investment by technology, $M
Exhibit 6.31: Growth o carbon markets: reported transaction volumes rom 2003-2008, Gt CO2e
Exhibit 6.32: Potential total size o carbon markets in 2020
Exhibit 6.33: Sustainable energy unds by type and asset class, March 2008, $M
Exhibit 6.34: Carbon unds, 2004 2007, $M
Exhibit 6.35: Estimated number o climate change-related mutual unds/ETFs, March 2008
Exhibit 6.36: Estimated number o green hedge und managers
Exhibit 6.37: Estimated number o private equity unds, September 2007
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Carbon and energy prices
Exhibit 7.1: More than hal o greenhouse gas emissions came rom ossil uel combustion in 2005
Exhibit 7.2: CO2
emissions rom ossil uel combustion have increased dramatically since the
beginning o the Industrial Revolution
Exhibit 7.3: Over time, the US has transitioned rom dirty, inecient ossil uels to cleaner,
more ecient ossil uels
Exhibit 7.4: Energy demand is expected to increase signicantly by 2030
Exhibit 7.5: The West Texas Intermediate crude oil price has been volatile
Exhibit 7.6: The majority o world oil reserves are concentrated in OPEC countries
Exhibit 7.7: The nding costs or oil are increasing
Exhibit 7.8: The nding costs o oil and oil price are related
Exhibit 7.9: Market views on long-term oil prices as o September 2008 (real $)
Exhibit 7.10: The Henry Hub natural gas price
Exhibit 7.11: The global supply/demand balance or LNG
Exhibit 7.12: The natural gas trade is increasingly global
Exhibit 7.13: Market views on long-term natural gas prices as o September 2008 (real $)
Exhibit 7.14: Newcastle coal price has recently spiked
Exhibit 7.15: The rapid expansion o coal use is likely to continue
Exhibit 7.16: Market views on long-term coal prices as o September 2008 (real $)
Exhibit 7.17: Oil and gas prices have been correlated with EUA prices
Exhibit 7.18: In the long-term, carbon and energy prices are likely to increase
Exhibit 7.19: Supply and demand equilibrium or substitutable uels
Exhibit 7.20: The eect o carbon prices on equilibrium or substitutable uels
Exhibit 7.21: Scaling capacity leads to greater uptake o clean energy
Exhibit 7.22: Supply shock: Constraints (peak oil scenario)
Exhibit 7.23: Supply shock: Surplus (coal glut scenario)
Exhibit 7.24: Demand expansion (emerging market growth scenario)
Part II. An Analytical Perspective
Government policy & regulation
Exhibit 2.1: The longer the world waits beore beginning signicant mitigation, the more radical the
cuts need to be
Box 2.1: Climate change: mitigation, abatement and cost
Exhibit 2.2: Dierent regulatory policies impact dierent parts o the greenhouse gas mitigation policy curve
Exhibit 2.3: There are three broad sets o policy options available
Exhibit 2.4: Examples o carbon pricing in practiceExhibit 2.5: Looking or a global carbon price
Exhibit 2.6: Examples o traditional regulation in practice
Box 2.2: Renewable Portolio Standards (RPS) in the US
Exhibit 2.7: 32 US states have Renewable Portolio Standards
Exhibit 2.8: Examples o innovation policy in practice
Box 2.3: Feed-in taris
Exhibit 2.9: Uptake o regulatory policy in 60 countries
Exhibit 2.10: As mitigation options reach commercial breakeven, carbon price can replace most other incentives
Exhibit 2.11: Dierent regulatory policy sets impact dierent parts o the greenhouse gas mitigation policy curve
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From the policy curve to the commercial breakeven opportunity
Exhibit 2a.1: Building the commercially viable investor opportunity curve
The investor perspective: Risk & Return around commercial breakeven
Exhibit 3.1: Dynamics o commercial breakeven
Box 3.1: Calculating LCOE
Exhibit 3.2: Key drivers o LCOE or a specic technology
Box 3.2: Understanding electricity markets
Exhibit 3.3: Developing the investors spreadsheet
Exhibit 3.4: Using the investors spreadsheet to illustrate the risk/return drivers o alpha
Exhibit 3.5: Energy price, carbon and regulatory risk/return are engaged in a dynamic interaction
Exhibit 3.6: The curve shits down i oil and energy prices increaseExhibit 3.7: Dierent mitigation opportunities have dierent sensitivities to changes in oil price
Clean technologies: deepening, broadening and development
Exhibit 4.1: Understanding mitigation through the stabilization triangle and Pacala and Socolows wedges
Exhibit 4.2: Combining wedges to achieve mitigation targets
Exhibit 4.3: The technology development pipeline
Exhibit 4.4: Examples o technological developments
Exhibit 4.5: Mapping the nanotechnology development pipeline
Exhibit 4.6: Mapping the solar technology development pipeline
Appendix: The science o climate change
Exhibit A2.1: The anthropogenic greenhouse eect results rom multiple sources.
Exhibit A2.2: Atmospheric greenhouse gas concentrations are on the rise
Exhibit A2.3: Range o warming scenarios
Exhibit A2.4: Examples o potential impacts o climate change
Appendix: Carbon Capture and Storage (CCS) & Forestry
Exhibit A3.1: Mitigation measures below40/ton in orestry could save 7.9 GT CO2e by 2030
Exhibit A3.2: Economics o early commercial CCS projects
Exhibit A3.3: BCG estimates that the costs o CCS will be signicantly lower than those developed by McKinsey
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In this paper, we examine the climate change investment universe. This paper reviews the arguments we made last year
in Investing in Climate Change: An Asset Management Perspective, and updates them, given the current market context.
The components we examine in detail in this paper are:
The investment opportunity in climate change has become broader, deeper, and more complex since
we published Investing in Climate Change: An Asset Management Perspective. In the last year:
Energy prices have experienced increased volatility; Some renewables have moved closer to commercial breakeven with conventional energy as their costs
have come down;
Some progress has been made negotiating the successor to the Kyoto Protocol;
Emissions trading regimes such as the EU-ETS have been strengthened;
Cap-and-trade is spreading to new geographies, such as New Zealand, Australia, and some US states (through
the adoption o the Regional Greenhouse Gas Initiative);
The climate change policy response in the US is gathering momentum;
The climate change technology universe has grown leading to more opportunities or investors.
As a result, we have expanded some o the denitions in our Four Pillars o Climate Change Investment, and
looked at developments in the past year in this context (See Ex. 2.1)
Government policy in climate change remains active. Government priorities, such as energy security and
providing a green collar economic stimulus are contributing to the climate change debate;
Carbon in Europe has been trading near or above 20s, new regions are establishing cap-and-trade regimes or
discussing them, and international negotiations are cautiously moving orward towards a global agreement
to succeed Kyoto. Commodity prices particularly energy prices have become more prominent in
discussions o climate change investing;
Corporations have increased activity in climate change over the past year and the investment universe has
expanded;
Climate change technologies have developed and broadened.
II. What is new in climate change investing?
Climatechangeisalargeandgrowinginvestmentopportunity.Therehavebeensignicant and meaningul developments since we published Investing in
Climate Change: An Asset Management Perspectivelast year.
Climatechangesectorshavebeencaughtupinthevolatilityofthecreditcrisis.We believe that given their regulatory support, they should eventually recover wellwith value established in many sectors.
Webelieveclimatechangewhencombinedwithenergysecuritywillplayarolein government eorts to stimulate economies in 2009. We do not expect governmentsto back o the science and its implication or action, which remains a necessity.
Theopportunitysuitsmostassetclasses.
Energypriceshavebeenveryvolatile.Inthelong-term,weexpecthighoilandgasprices, weaker coal prices and we see carbon prices, as they are adopted, beingthe key backstop to ensuring clean energy is deployed.
Part I. Necessity and Opportunity in Turbulent Times
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The scientic debate over climate change
One o the most important scientic announcements in our view was the updating o the ice core history, now
dating back 800,000 years, depicting the extraordinarily high and previously unseen levels o carbon that we are
now acing; (See Ex. 2.2)
We believe that the credible scientic debate is over. Indeed, as more dynamic models o climate change are
developed, we expect to see estimates o the danger o global warming increase.
Low-carbonprosperity:ananswertothecreditcrisisandenergysecurity?
Over the course o the past ew months, there has been more discussion o the potential or stimulus in climate
change-related sectors to contribute to liting the economy out o the current morass. We believe this is a
signicant opportunity;
Energy security has also been a linked issue or policy makers in terms o long-term availability o energy and the
economic implications o securing it.
Energy eciency is also a key way to deliver climate change mitigation with a long-term payback.
Politicalsupportforalow-carbonIndustrialRevolution
Policymakers across the political spectrum have also emphasized the potential or low-carbon prosperity;
In the US, both Presidential candidates have talked about renewable energy in particular as a source o growth
and job creation;
The UK Prime Minister has stated that a low-carbon economy can be a new engine o productivity and economic
growth;
The German chancellor has argued that climate change can be a win-win situation i Germany invests in
growing clean industries and creating new jobs;
Chinese ocials have underscored the importance o environmental protection in Chinas development;
The Indian Prime Minister has said that sustainable development can go hand-in-hand with Indias growth
objectives.
In the very long-term, the underlying climate change sectors have the potential to grow to very large scale in
the multi-trillion dollar energy, automotive and industrial markets.
The eect o the credit crisis on climate change investment sectors
Ater generally outperorming in 2006 September, 2007, listed equity climate change sectors lost ground
against the market when the more pronounced credit crisis correction took hold rom May 2008 onwards;
(See Ex. 4.1, 4.2)
In September 2008, many renewable stocks were aggressively sold o early in the month as liquidity
considerations aected markets. Weaker energy prices led them lower as the regulatory support in the US or the
Production Tax Credit (PTC) and the Investment Tax Credit (ITC) wavered in particular;
The Troubled Asset Relie Act o 2008 (TARP) package in the US did extend solar and wind regulatory support,
but or now markets are not ocusing on undamental support actors or company earnings;
At a valuation level, the DWS climate change alpha pool P/E has only been marginally above the MSCI World,
and is now looking more attractive ollowing the correction; (See Ex. 4.6)
At a sector level, there have been signs o infated valuations, with solar being the most noted example.
That is now disappearing and the credit crisis correction looks to be delivering attractive valuations given strong
regulatory support or earnings;
III. Low carbon prosperity
IV. The credit crisis and climate change investing
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From a credit supply perspective, which will aect public and private markets, certainly some companies and
projects will nd it dicult to raise debt capital, increasing reliance on equity and having to price or that.
We believe that the more dependable regulatory environment or climate change will continue to see money
move towards climate change sectors in private markets.
Based on the key drivers in the climate change space, we have dened our broad sectors or climate change
investment (See Ex. 5.2)
Clean Energy: (Power Generation, Inrastructure, Power Storage, Transport and Biouels);
Environmental Resource Management: (Water, Agriculture, Waste Management);
Energy and Material Eciency: (Advanced Materials, Building Eciency, Power Grid Eciency);
Environmental Services: (Environmental Protection, Business Services);Combined, these sectors represent a ast-growing multi-hundred billion dollar marketplace, which oers
numerous and compelling investment opportunities.
Investment Attributes
We also looked at the arguments around whether climate change would persist over time or ultimately, simply
become assimilated into markets. All Alpha actors will ade into the background eventually. (See Ex. 5.3)
Thereore, it becomes a question o how long the trend can last. Given the 40-50 year investment horizon and
the size o the problem $45 trillion o investment needed in energy markets alone we believe that climate
change will remain the source o identiable Alpha or many years ahead;
Key climate change sectors exhibit low-moderate correlation to the general economy;
Listed equity markets have shown high correlation to the MSCI World Index, industrial companies and
depending on the composition o the index, to small cap companies. While water and agriculture might be
expected to show low correlation over the long term, more recently they have been caught up with the general
market correction; (See Ex. 5.4, 5.5)
One correlation that has attracted investor attention is renewable energy with oil prices. There is reason to
expect renewables to track on the upside as rising oil prices make renewables more attractive on a breakeven
analysis. On the downside, so long as regulatory support is there, renewables should outperorm traditional
energy sources in the long-term.
The investment attributes o climate change suit most asset classes:
Venture capital, private equity, inrastructure and public equity;
Hedge unds can create strategies across this space;
The technology drivers o climate change are particularly suitable to venture capital (VC) and private equity (PE).
(See Ex. 5.5)
The eect o climate change sectors on asset classes and portolios
Looking at the investment attributes o climate change-related sectors, we can see that these are suited
to the broad array o investment strategies. This includes listed equities, VC/PE or new technologies, and
inrastructure or scaling up many areas o the climate change universe;
As an example o how climate change aects portolios, we have looked at the eect o an ecient rontier
o including renewables, water and agriculture at dierent levels o asset allocation over the 2006-to-date
timerame. Given historic risk/return tradeos, the rontier shits up by nearly 1% i 5% o unds are allocated
into each o these sectors. (See Ex. 5.18)
V. Investment attributes o climate change
Part I. Necessity and Opportunity in Turbulent Times
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A number o actors are acting together to create the climate change opportunity. Global population and
GDP are rising ast
The IEA calls or $45 trillion o investment in industry technologies by 2050;
The growing global population and increasing wealth o that population will lead to signicant increases in
demand or water, ood and energy;
YTD 2008 VC/PE investment gures depict a continuously growing and healthy climate change sector;
As a result, rom a ~$150 billion market in 2007, investment across capital markets is projected to reach $650
billion p.a. over the next 20 years;
All this has led to a deepening and broadening o the opportunities or investors.
Global coal, oil and gas use and their contributions to anthropogenic greenhouse gas emissions
Three ossil uels coal, oil and gas supply 88% o the worlds primary energy and are responsible or about
60% o global greenhouse gas emissions. Consumption is set to rise as the worlds population grows and
wealth increases;
Over the past 200 years, as the world has gone through a series o energy transitions, the most notable energy
quality improvements have been made in volumetric density: there is more energy in a given volume o oil than
there is in a given volume o coal or wood;
Some aspects o energy quality have been harmed by the transitions in energy over the past 200 years, most
notably spatial distribution, nancial risk, risk to human health and amenability to mass storage;
While improvements have been made in emissions intensity o energy (emissions per Joule) over the past
200 years, renewable energy is the nal phase o reducing emission intensity towards zero;
There are energy quality problems associated with renewables. Very large industries are expected to emerge to
deal with problems associated with intermittency, gravimetric density, volumetric density and ease o transport
o renewables. This will be a key area or investors as renewables grow to scale.
Developments in coal, oil and gas prices
Fossil uel prices have been trending up in the last ew years, recently spiking but then collapsing;
In the long-run (beyond 2015), oil prices are expected to return to above $90 a barrel (in real terms), gas prices
are expected to return to at least $9/MMBtu (in real terms), and coal prices are expected to all back to a $50-
$75/ton range (in real terms);
Coal prices in particular will have serious implications or greenhouse gas mitigation and carbon pricing.
The dynamic interrelationship o coal, oil gas and carbon
Carbon price, the supply/demand balance o each o the three most important ossil uels, and the scaling
capacity o renewables are intricately linked in a dynamic relationship; Currently, the market has tended to correlate carbon prices in Europe with oil and gas prices, because carbon is
used primarily to motivate uel switching in the EU ETS. In the long-run, we do not expect that to hold,
especially as coal becomes more plentiul;
In the long-run, we expect coal prices to drop, while prices or oil, gas, electricity, road transport uels and
carbon rise. This is due to a complex interrelationship between key drivers o energy demand and supply: the
growth o emerging markets, peak oil and a potential coal glut.
In eect, carbon prices will become the crucial backstop or clean energy.
VI. Market sizing: Scarce resources and the size o the markets
VII. Carbon and energy prices
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Governmentpolicyinclimatechangeremainsactive.Governmentpriorities,such as energy security and providing a green collar economic stimulus arecontributing to the climate change debate.
CarboninEuropehasbeentradingnearorabove20s, new regions are establishing cap-and-traderegimesordiscussingthem,andinternationalnegotiationsare
cautiously moving orward towards a global agreement to succeed Kyoto.Commodity prices particularly energy prices have become more prominentin discussions o climate change investing.
Corporationshaveincreasedactivityinclimatechangesectorsoverthepastyearand
the investing universe has expanded.
ClimateChangetechnologieshavedevelpedandbroadened.
What is New in Climate Change Investing?II
In that paper, we:
Recognised that there is overwhelming scientic evidence that climate change is happening;
Acknowledged that companies and investors are quickly realizing that climate change is not merely a social, political
or moral issue, but an economic and business issue that is translating into a wave o investment and innovation;
Reviewed some o the broader trends within which climate change is situated, including energy security;
Provided investors with an overview o the climate change investment universe;
Explained that climate change investing is primarily driven by economic returns, but has socially responsible
attributes.
Discussed the large-scale investing opportunity represented by climate change;
Examined the expanding range o climate change investment strategies available; Set out the our pillars o climate change investment, which were:
1. Government environmental policy and regulatory drivers;
2. Carbon prices;
3. The corporate response: competitive response and risk mitigation;
4. Low-carbon technologies and services.
For investors, we have separately looked at recent nancial market events in Chapter IV o Part I.
More undamentally, there have been developments in each o our our pillars o climate change since we published
Investing in Climate Change: An Asset Management Perspectivelast year. We examine these in this chapter.
There have also been important advances in:
The science o climate change, and regulation;
The growing awareness that climate change investment can exert a positive impact on economies;
More emphasis on energy security;
Carbon and commodity markets, especially energy prices;
And the scale o opportunities available to investors, in terms o expanded breadth and depth in company
opportunities and underlying technologies.
We have thereore adapted and expanded our views o the pillars o the climate change investment universe. See exhibit 2.1.
One year ago, we published Investing in Climate Change: An Asset Management Perspective.
What has changed since last year?
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EX 2.1: The Four Pillars o Climate Change
We review the scientic basis or climate change in Appendix II. But one advance in our understanding o climate change
that was made last year deserves special mention. Research published in Nature in May, 2008 revealed that todays
concentrations o CO2
are the highest in 800,000 years1 longer than the history o human lie on earth. The publication
adds 150,000 years to the previous record. See exhibit 2.2 and box 2.1.
In the ollowing sections, we review the most important developments in our pillars over the course o the past year.
1D. Lthi, High-resolution carbon dioxide concentration record 650,000-800,00 years beore present, Nature, 15 May 2008.
Government environmental policy and regulatory drivers
New Science: Carbon at 800,000 year highs
The Four Pillars of Climate Change Investment
Governmentenvironmentalpolicy and
regulatorydrivers
- Science- Voters- Low Carbonprosperity- Energysecurity
Carbon and
energy prices
The scientific evidence base
Corporate
response:
competitive
response and
risk mitigation
Low carbon
technologies
and services
Our updated view o the climate change investment universe
Source: DeAM analysis, 2008.
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EX 2.2: Todays CO2
concentrations are higher than they have been or at least 800,000 years
The current atmospheric concentration o CO2
is around 385ppm,2 which represents an increase o nearly 40% over pre-
industrial levels o 280 ppm. Under business as usual projections, atmospheric greenhouse gas concentrations, measured
on a CO2-equivalent basis which take into account both CO
2and other gases, such as methane and N
2O that contribute
to global warmingare set to rise beyond 600ppm by 2050. There is general consensus in the scientic community that
this cannot be allowed to take place, at the risk o catastrophic warming.
The scientic evidence appears to be overwhelming on any credible basis. New climate models, which incorporate non-
linear eedback loops, demonstrate that at each heightened concentration o greenhouse gases, the potential warming is
much higher than originally thought.
Source: D. Lthi,High-resolution carbon dioxide concentration record 650,000-800,000 years beore present, Nature, 15 May 2008.
2Hansen, J (2008) NASAs Goodard Institute or Space Studies, Target Atmospheric CO2: Where Should Humanity Aim?.
What is New in Climate Change Investing?II
400
380
360
340
320
300
280
260
240
220
200
180
160
800,000
AtmosphericCO
2concentration,ppm
Years before present
700,000 600,000 500,000 400,000 300,000 200,000 100,000 0
Concentration in 2008: 385 ppm
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Ater similar projects in Greenland and at the Kohnen Station in Dronning Maud Land, Antarctica, the European Project or Ice
Coring in Antarctica (EPICA) drilled an ice core to a depth o 3,270 meters at the Concordia Station, Dome C in Antarctica. This core
provides the longest climate record that we possess today.
Core segments were extracted using a cylindrical drill. A variety o tests were then conducted on the cores including analysis o thegas trapped in air bubbles, analysis o isotopes present in the ice or the air bubbles, optical analysis o the ice (polarity o thin slices,
transmission properties), size o the crystals, electrical properties o the ice (electrical resistance depending on dissolved salts),
temperature where it was extracted, thickness o each layer and time reconstruction.
In May, 2008, EPICA published an article in Naturethat documented that atmospheric CO2
concentrations are now at the highest
levels they have reached over the past 800,000 years, adding another 150,000 years to the previous climatic record.
Box 2.1: The EPICA Project
Photo: By Guillaume Darguad, EPICA Glaciology Project
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Government: environmental policies and regulations
We discuss the opportunity or governments to use climate change as an impetus or growth during the credit crisis
in Chapter III o Part I.
Update on the UN negotiating process
The United Nations Framework Convention on Climate Change (UNFCCC) is responsible or international climate change
negotiations. In December 2007, negotiators met or the 2007 United Nations Climate Change Conerence in Bali. The
conerence included meetings o the 13th Conerence o Parties (COP 13) to the UNFCCC and the 3rd Meeting o the
Parties (MOP 3) to the Kyoto Protocol.
The countries participating in the conerence agreed to adopt the Bali Road Map. The Road Map is meant to lead to a bind-
ing commitment to succeed the Kyoto Protocol, which expires in 2012. This commitment should be negotiated at COP
15, which will take place in Copenhagen in December, 2009.
The Bali Road Map, agreed by the parties to the UNFCCC at the conerence:
Gained acknowledgement rom the signatories to the UNFCCC, which includes the US, EU, China and India, that
evidence or global warming is unequivocal and that reduced emissions were required to avoid severe climate
change impacts;
Stipulated that nations would develop policy and incentives to protect orests;
Recognised that nations would enhance cooperation around adaptation;
Underscored the need or nations to acilitate transer o clean technologies.
The next 12 months including the US Presidential election will be crucial in determining how well these ideas can be
expressed at a global policy level, particularly in the ace o weaker economies.
New developments in national and regional regulation
Signicant regulatory and legislative activity also took place at the national and regional level over the course o the
past year.
United States:
The Americas Climate Security Act o 2007, also known as the Lieberman-Warner bill, made it through Senate
committee and was debated on the Senate foor. Although the bill did not pass, it represents an important
milestone in US regulation, as it included long-term emissions reductions targets that were reasonably ambitious
and it proposed a cap-and-trade scheme or the power, transportation and industry sectors;
Meanwhile, a long awaited discussion drat o the Dingell-Boucher Climate Change Bill was released early in
October 2008. The Bill seeks to cut US greenhouse gas emissions by around 80% over the next 40 years and callsor a cap-and-trade program to achieve these reductions, with two major provisions or carbon oset credits: a
domestic oset program and an international emission allowance program.
Both John McCain and Barack Obama have announced their support or emissions cap-and-trade.
Both have talked extensively about energy security, alternative energy policy and creating new green jobs.
Signicant regional leadership has emerged on climate change. Thirty-two states now have renewable
portolio standards, up rom 25 in 2007, a number o regional climate initiatives are moving rapidly towards
instituting cap-and-trade regimes with the Northeastern Regional Greenhouse Gas Initiative (RGGI) starting
to trade, and Assembly Bill 32 (AB 32) established a comprehensive program o regulatory and market
mechanisms or mitigation in Caliornia.
Congress extended incentives or wind and solar as part o the Emergency Economic Stabilization Act o 2008.
What is New in Climate Change Investing?II
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The Production Tax Credit (PTC) has been extended or one year or large-scale wind projects and the Investment
Tax Credit (ITC) has been extended or eight years or solar projects. The new legislation now also permits utilities
to take advantage o the energy tax credits. $2.5bn was granted or CCS demonstration.
European Union:
In the Climate Action and Renewable Energy Package released in January, 2008, the European
Commision committed to unilaterally reduce overall emissions to at least 20% below 1990 levels by 2020 (and
to 30% i other developed countries make comparable eorts), and targeted increasing the share o renewable
energy use to 20% by 2020;
In a revision o the EU ETS, the European Parliaments Environment Committee voted in October, 2008, to cut EU
greenhouse gas emissions rom most industrial sectors by 21% rom 2005 levels by 2020 and to phase out ree
allocation o emission permits, leading to ull auctioning, with an exception or energy-intensive sectors that ace
international competition;
On a more cautious note, Germanys government has backed an almost total exemption or industry rom the new
European rules that would orce companies to pay or the carbon dioxide they emit through auctioning emission
credits in the ETS rather than through the current system o ree distribution o permits. Italy is also pushing or
ree distribution o carbon permits or specied sectors, and a coalition o eastern European countries have pressed
to delay discussion o the EU climate plan beyond December 2008;
A ramework has been developed to allow additional state aid or carbon capture and storage demonstration plants;
The EU has proposed capping carbon dioxide emissions rom new vehicles to an average o 130g/km by 2012,
compared to the current 158g/km;
While most developments have indicated increased ambition and action in the climate change space, the EU goal
o increasing the share o biouels in transport to 10% has been rolled-back to 5%, in light o ood vs. uel debates.
China:
In December 2007, China issued its rst white paper on energy conditions and policies that advocated or energy
conservation, accelerated technological innovation, and improved coordination between energy and environmental
development;
The tax rate or big cars has been doubled to 40%, while the tax on cars with small engines has been reduced
rom 3% to 1%;
Government buildings are now required to conorm to energy eciency standards;
Ten provinces, municipalities and regions have begun piloting a new energy regulation to stop xed-asset projects
that do not meet national energy standards. This regulation is set to be rolled-out nationwide once piloting is complete;
In 2009, a package o laws will come into orce that aim to create a recycling economy, reduce pollution 10%
below 2005 levels by 2010, and increase monitoring o capital-intensive assets.
India:
The Indian National Action Plan on Climate Change was released in June, 2008. The plan established 8 national
missions running through 2017, which include major investments in solar capacity, energy eciency, water useeciency, and orestry;
The Indian government is also mandating the retirement o inecient coal-red power plants and requiring big
consumers o energy to conduct energy audits.
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Energy prices and their complex linkage to climate change
When we last published, oil prices had hit $80 a barrel. These were record prices, and energy was justiably high on
the agenda. With energy prices having risen so much urther through 2008 and then recently corrected back to 2006/07
levels, there has been an increased ocus by the market on their infuence.
In the past year, we have seen oil prices pass $140 a barrel, with extraordinary increases in price volatility. See exhibit 2.3.
Coal prices have risen signicantly rom about $50/ton in 2007 to a $195/ton record in July, 2008, beore alling back to
around $115/ton in October. Natural gas (Henry Hub benchmark) has gone rom about $5.50/MMBtu a year ago to over
$13/MMBtu this summer, and has come back under $7/MMBtu as o publication.
Energy prices are volatile and have gotten signicantly more volatile over the course o the past year. Relying on them
or the scaling o clean technologies is risky. And in the long run, coal is plentiul and prices are likely to all. For this
reason, we believe that regulation and carbon pricing in particular are vital backstops to energy prices, diversiying
the risks acing clean energy investment and bringing an increased level o predictability to the market. We look in much
more detail in Chapter VII o Part I at the long-term outlook or energy prices and how these might impact the prospects
o renewable energy and carbon pricing.
3Energy security and America, BP CEO Tony Hayward details commitment to U.S. energy security in the new era, The Houston Forum, November 8, 2007.
EX 2.3: Oil price trends
Crudeoilpricessawaten-foldincreasebetweentheirlowinthelate1990sandhighinJuly2008,buthaverecently allen back to 2006/07 levels.
Carbon and energy prices
Source: US EIA, 2008; The National Industrial Transportation League, 2008 and DeAm Team Analysis, 2008.
What is New in Climate Change Investing?II
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Carbon markets
Since last year, carbon markets have grown signicantly, the price o carbon has increased, and new regions and
countries are considering establishing carbon cap-and-trade markets. Developments o particular note are:
The European Union Emission Trading Scheme (EU-ETS) entered its second phase in January, 2008.In its second phase o operation, the regime is signicantly strengthened:
Trading volumes have been strong since Phase II has begun. See exhibit 2.4.
EU emission allowances (EUAs) have been trading near or above the 20/ton range putting
a much more meaningul price on carbon than was the case under the price collapse at the end
o Phase I. See exhibit 2.5.
Over-the-counter and exchange volumes or EUAs
OTC-Volume
Exchange -Volume
EX 2.4:TradingvolumesontheEU-ETSaregrowing
Source: DeAM Team Analysis; Press Search, 2008.
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EX 2.5:Phase-IIEUcarbonpriceshavebeentradingnearorabove 20
Price or Forward EUAs
Source: DeAM Analysis; Press search, 2008
What is New in Climate Change Investing?II
The National Allocation Plans or the second phase will result in average cuts o 7% below 2005 emission levels.
This cut is signicantly more stringent than the 1.9% rise over 2005 levels that was allowed under the Phase I;
Phase II credits are bankable into Phase III which should prevent a price collapse at the end o Phase II;
The scheme has expanded to include three new, non-EU, countries Norway, Iceland and Liechtenstein;
The aviation industry is set to join the scheme around 2010, expanding the sectors covered by the EU-ETS.
In Chapter VII o Part I we look at the relationship that carbon prices have with energy prices in general. The EU
ETS tends to encourage a airly noticeable correlation between oil prices and carbon prices due to the uel switch
ocus between gas and coal. See exhibit 17 in Chapter VII.
The Kyoto Protocol Mechanisms are healthy, with more than 3,000 Clean Development Mechanism projects in the
pipeline according to the UNFCCC. These projects are expected to result in 2.7 GT o Certied Emissions Reductions
(CERs) rom Clean Development Mechanism (CDM) projects through 2012. Over the last year, aside rom the growth
in CDM projects, two important trends have emerged:
The secondary CER market is growing quickly, registering 1,000% growth over 2007;
The Emissions Reduction Unit (ERU) market under the Joint Implementation mechanism has also emerged
as a rapid center o growth.
Prices or CERs and ERUs have been strong, with some orward CER contracts trading near 25/ton over the summer.
New Zealandand Australia are the rst countries outside the EU-ETS to establish mandatory nationalemissions trading schemes. Legislation establishing an emissions trading scheme in New Zealand was passed
on September 10, 2008, and legislation or an Australian trading scheme is being drated or release in
December, 2008.
The voluntary markets although small compared to the EU-ETS and markets or Kyoto Protocol credits are
also growing quickly. Volume on the Chicago Climate Exchange rom January to August, 2008, was up by over
300% compared to the same period in 2007.
USregional markets, such as the Regional Greenhouse Gas Initiative (RGGI) in the Northeast US,
are ramping up. In October, 2008, RGGI held its rst pre-compliance CO2
auction.
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growing investing opportunity in climate
change in Chapter V o Part I.
RiskManagement-Whatarethe risks and how are they
being managed?
The insurance industry has already
begun to eel the eects o climate
change and takes the issue serious-
ly. In the US insurers have started to
cancel homeowner policies in hur-
ricane and wildre risk areas;
In 2007, a group o global insurers,
re-insurers and brokers developed
a set o ClimateWise principlesin response to global warming, de-
signed to promote greener policies.
The principles will enable companies
throughout the world to build climate
change into their business opera-
tions;
Some insurance companies are
already adjusting their products and
services to suit emerging marketsthat have resulted rom climate
change such as weather risk, carbon
trading and the clean technology
industry;
The Carbon Disclosure Project
(CDP) operates to create lasting rela-
tionships between shareholders and
corporations regarding implications
or shareholder value and commer-
cial operations presented by climate
change. It represents 385 institution-
al investors with a combined $57.5trillion o assets under management;
A coalition in the US, led by Ceres,
has encouraged improved climate
change disclosure and governance
at dozens o companies and has
engaged with regulators such
as the Securities and Exchange
Commission by calling or publiclytraded companies to assess and ully
disclose their nancial risks rom
climate change. Deutsche Asset
Management was a signatory;
We are seeing more attempts to
measure the net carbon position o
companies and then assess carbon
risk or carbon beta.
Scientists have recently discussed planetary engineering as one climate change mitigation strategy. The Royal Society in the UK has
published a series o papers outlining some o the options and suggesting a ew experiments to test these. Proposals include:
Fertilizingtheoceanswithiron,asthisisthelimitingnutrientinsomeoceanareas,toencourageblooms
o planktonic algae that draw carbon dioxide out o the atmosphere;
Recyclingcarbondioxidefromtheatmosphereintofuel,byreactingitwithhydrogen;
EjectingcarbondioxidefromtheatmosphereattheEarthspoles,usingtheplanetsmagneticeld;
Reectingsunlightbacktoouterspacetocooltheplanet.Thisisproposedbyincreasingtheamount
o pollution in the atmosphere so that particles refect sunlight back in to space;
Sprayingcloudswithseawater,resultinginparticlesofsaltformingthroughevaporation.Theseactasnuclei
around which droplets o water can condense, creating more sunlight-refecting clouds
The Economistmagazine notes that history is littered with plans that went awry because too little was known about complex
natural systems. Altering the atmosphere or the oceans on the scale required to do this would be extremely risky, expensive and
complex. Modiying the climate will have physical and biological consequences, some o which will be unpredictable and could be
more detrimental than the problems they were designed to remedy. There is also a large moral hazard here, that people would see
geo-engineering as an excuse to continue polluting the atmosphere.
Although the jury is still out on geo-planetary engineering, we doubt it will be the silver bullet that solves climate change.
While no silver bullet technologies have been discovered since we published Investing in Climate Change: An Asset
Management Perspectivelast year, there has been talk o planet-level solutions to climate change although proving
these proposals seems unlikely at present. See box 2.2.
Low carbon technologies and services
Box 2.2:Geo-planetaryEngineeringLookingforsilverbulletsolutionstoclimatechange?
What is New in Climate Change Investing?II
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It is impossible or us to list all o the gradual advances in technology that have occurred over the past year. In terms o
a standout, a notable potential advance in technology involves storage o solar energy. Massachusetts Institute o
Technology (MIT) developed a process that allows the suns energy to be used to split water into hydrogen and oxygen
gases to store energy. Later, the oxygen and hydrogen may be recombined inside a uel cell, creating carbon-reeelectricity. While it will take about a decade or the technology to reach commercial development and deployment,
it represents an important step orward or alternative energy. See box 2.3.
Inspired by photosynthesis, Daniel Noceras team o researchers at MIT has discovered a low-cost process
to store solar energy. The process uses the suns energy and catalysts to split water into oxygen and
hydrogen gas. Later, the oxygen and hydrogen can be recombined in a uel cell, allowing use o solar
energy even at night. More work is needed to integrate the technology into solar systems, but the advance
is an important step orward -- it may be the critical technology needed to allow solar and other renewable
sources to be used as baseload power rather than as intermittent sources, enabling a signicant
decarbonization o the electricity generation market.
Box 2.3: Advances in solar storage technologies at MIT
Photo: Tom White, MIT: Major discovery rom MIT primed to unlease solar revolution, MIT News, July 31, 2008
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Low Carbon ProsperityIII
In Chapter IV o Part I, we look at the direct impact o the credit crisis on climate change investment markets in
detail. Here, we discuss the great potential climate change presents at this critical point in time. Unlike the initial
outbust o interest in climate change rom 1990 through 1992, which aded in the ace o a nancial crisis and
recession, we believe that climate change investing in the early 21st century, based upon solid science, is poised to
make a very dierent impact as governments look or ways to stabilize economies and promote energy security.
Over the past year, commentators and policymakers have become increasingly vocal about the potential to build
a prosperous, low-carbon world.
For instance, Yvo de Boer, the Executive Secretary o the UNFCCC, stated in October 2008 that the current global
market situation could provide an opportunity or the world nancial system to reconstruct itsel to promote low
carbon growth as governments now have an opportunity to create and enorce policy which stimulates competition
to und clean industry. And in October 2008, the Independent Climate Institute said that the current global market
turmoil reinorces the need and urgency or strong leadership on climate reorms.
It is our belie that ater the nancial system is stabilized, the urgent question will be how to stabilize the broader
economy. We believe that climate change, green and energy security will be key aspects o government
support o economies.
Over the past year, climate change and its relationship to other government priorities, such as energy security and
low-carbon prosperity, have moved up the global agenda. It is worth examining the recent emphasis on energy
security.
I. Low carbon prosperity: An answer to the credit crisis?
As the credit crisis continues, the ocus is shiting to the world economy slipping intoa recession.
Politicians recognize that the diculties conronting nancial markets today aresome o the worst they have seen. But as the nancial sector stabilizes, the realeconomy will become the key ocus.
Low carbon prosperity, linked to energy security, is emerging as a potential wayto lit the economy out o its current morass. Writers and politicians point to thepotentialforalowcarbonIndustrialRevolutiontocreatemillionsofnew,high-paying
jobs.
Thisisleadingintheshort-termtoafocusonmoreincentivesandtaxbreaks.However,inthelonger-term,acarbonpricewillstillberequired,andhowthecostsand benets o the carbon price are distributed will be a key issue.
It is also interesting to see energy eciency as a driver during an economicdownturn. Over time, money can actually be saved through eciency measures.
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The quest or security o energy supply in a world o scarce resources is not new. For most o the past 100 years,
sovereign states have sought to avoid political dependence on their energy suppliers by promoting diversity
o supply. In more recent times, oils exhaustibility or the limits to production within a given timerame and
the implications o ever-increasing-demand in a world o limited supply have come to the ore. In the wake o
the recent spike in energy prices and global uncertainty about the uture price trend, the issue has gained new
prominence on the political stage.
While energy security is oten seen as independence o supply, more importantly, it is easy access to a plentiul
supply o a scarce and dwindling resource. See box 3.1.
In many senses, politicians are citing
energy security more than climate
change just now in their push or
renewable energy policies. While the
result may be similar in the short-
term, in the long-run, we believe that
climate change is a more serious
challenge and a more encompassing
one or policymakers, and energy
security should not be an excuse to
divert rom renewables to dirtier ossil
uel sources such as tar sands and oil
shale.
Low Carbon Prosperity Economic
Growth Opportunities
In addition to increasing energy
security, politicians and business
people are realizing that alternative
energy can be a source o growth.
Over the past year, low-carbon
prosperity has entered the political
discourse policymakers now cite the
creation o high-paying green collar
jobs as a major reason or pursuing
ambitious innovation policy in the
cleantech space.
Much o the debate about climate
change has ocused on the cost to
the economy o implementing the
required clean-up. Indeed, Sterns
analysis (See chapter 10 o the Stern
Review Report) was expressed in this
way; however, as Stern points out
(See page 240 o the Stern Review
Report), there are many macro-
economic climate change models
showing a wide range o economic
outcomes. Some, which emphasize
the investment dollars needed to
upgrade the economys inrastructure,
show a net gain to the economy. It
is this investment need (See Market
Sizing, Chapter VI o Part I), that the
prosperity o the low carbon economy
is based on and that provides the
opportunity or investors.
Research by the Potsdam Institute
indicates that, in Germany, the
transition to a low-carbon economy
will spur a wave o innovation and
job growth. A new study published
by the Center or Energy, Resources
and Economic Sustainability at the
University o Caliornia, Berkeley,
indicates that Caliornias energy-
eciency policies created nearly
1.5 million jobs rom 1977 to 2007.
Global insight has recently published
a study citing the potential or green
job growth in the US.2 In light o these
ndings, US politicians have been
vocal about the job creation potential
o climate change: Barack Obama has
proposed spending $150 billion over
10 years in a push to create 5 million
green collar jobs. He plans to raise
this money by auctioning carbon
credits.
This raises the issue o the cost o a
cap-and-trade system. Certainly some
sectors will be aected by carbon
pricing, but the scale and shape o the
impact depends on how the transer
costs are dealt with, as well as how
markets are designed. We discuss
carbon market design in more detail in
Chapter II o Part II.
Box 3.1: Energy Security
In November 2007, BP CEO Tony Hayward dened energy security as access to reliable sources o energy,
at an aordable price, produced in environmentally responsible and sae manner.1
Haywards denitionadds a ourth pillar to the traditional denition o energy security: environmental responsibility. Politicians
and businessmen have recognized the importance o clean alternatives or energy security and are actively
promoting renewable energy.
1Energy security and America, BP CEO Tony Hayward details commitment to U.S. energy security in the new era, The Houston Forum, November 8,2007.2US Metro economies: Current and potential jobs in the US economy, Global Insight, 2008.
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EX 3.1: A low carbon Industrial Revolution is urgently needed
0 10 20 30 40 50 60 70 80 90 100 110 120 130
Carbon productivity needs to rise three times as fast as laborproductivity did during the Industrial Revolution
10
8
6
4
2
0
IndexYear 0=1
Years
Carbon productivity growth required
2008-2050
US labor productivity growth 1830-1955
Source: Contours o the World Economy 1-2003 A.D., Maddison, 2007; McKinsey analysis.
Nevertheless, we believe that
anything that resembles a tax or
increase in cost will need to be well
understood and phased-in to gain
acceptance. Right now, the ocus is
more on providing a stimulus to the
economy through incentives. This
becomes evident in reviewing the
comments o politicians around the
world, as collected in box 3.3.
We discuss the short-term magnitude
o the investment task in Chapter VI
o Part I. However, it is worth looking
at the challenge rom a long-term
perspective. In June, 2008, the
McKinsey Global Institute published
a report outlining the challenge
o raising carbon productivity,
comparing the potential to the rise
in labor productivity in the Industrial
Revolution. See exhibit 3.1
Achieving the increases in carbon
productivity required to meet long-
term stabilization targets will require
a revolution on the scale o the
Industrial Revolution. But while, in the
Industrial Revolution, it took over 120
years or labor productivity to rise 10-
old, we have only 40 years to achieve
a commensurate increase in carbon
productivity.
Some o the challenge in raising
carbon productivity will lie in a
massive decarbonization o the
worlds inrastructure. Over the
past 150 years, thousands o cities,
airports, highways, power plants and
actories have been built many o
which rely on ossil uels and carbon-
intensive processes. We are entering
a period o massive capital stock
turnover in the next ew decades.
Much o the aging inrastructure in
the West will need to be replaced,
and the global inrastructure base
will expand dramatically as China,
India and the rest o the developing
world continue to rapidly industrialize.
Where inrastructure investments
are climate-riendly such as many
investments in water, agriculture,
renewables, energy ecient buildings
and public transport they t the
broader climate change investing
theme.
Against the backdrop o the scale o
investment that needs to be made in
clean energy and inrastructure, some
commentators see the potential to
reinvigorate the broader economy.
In his 2008 book Bad Money, Kevin
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Phillips argues that the recent
economic turmoil is caused by an
over-reliance on debt and the nancial
sector in the US. The way to rebuild
the economy, according to Phillips,
is through activities that create real
value. The one he cites as holding the
most promise is alternative energy:
not only would it create high-paying,
domestic jobs, but it would also
decrease Americas dependence on
imported oil and on the willingness o
oil-exporting states to buy US debt to
nance Americas thirst or energy.
Thomas Friedmans thesis in his most
recent book, Hot, Flat and Crowded
also underscores the potential that
a low carbon Industrial Revolution
holds. Friedman quotes an interview
with energy expert David Rothkop as
he sets up his thesis:
The hallmark o those companies
and countries that continually thrive
is that they continually reinventthemselves, noted David Rothkop,
an energy expert and visiting scholar
at the Carnegie Endowment. We
reinvented ourselves as a continental
industrial power in the nineteenth
century, and we reinvented ourselves
as a global industrial power in the
twentieth century and then as a global
inormation society in the twenty-rst
century. Now we have to or our
own sake and the worlds reinvent
ourselves one more time. MakingAmerica the worlds greenest country
is not a selfess act o charity or
nave moral indulgence. It is now a
core national security and economic
interest.
Green is not simply a new orm o
generating electric power, added
Rothkop. It is a new orm o
generating national power period.3
The challenge is great, and so is the
opportunity. The Industrial Revolution
was a time o great innovation
the steam engine, the telegraph,
the locomotive, the telephone, the
airplane, the automobile and the
sewing machine all came into being
in that time o great change. The lie
expectancy and standard o living
o most Westerners improved as a
result o the Industrial Revolution.
Increasingly, intellectuals and writers
are recognizing that a low carbon
Industrial Revolution holds much o
the promise o the original Industrial
Revolution. And politicians are
beginning to develop policy proposals
that would begin to implement these
ideas.
3Thomas Friedman, Hot, Flat and Crowded, 2008, p. 23.
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Energyefciencythelow-cost,long-termpaybackoption
While we do not ocus on energy eciency in detail in this edition, it is worth noting that in the current turbulent
economic times, energy eciency using less energy to provide the same level o services has become even
more compelling. Short-term investments in energy-ecient products and inrastructure can stimulate economic
growth while reducing emissions. Because many energy eciency opportunities are net cost negative, over the
long-term, the investments made in energy eciency more than pay themselves back.
Amory Lovins, Chairman and Chie Scientist o the Rocky Mountain Institute and a member o the Deutsche Bank
Climate Change Advisory Board, has long advocated or the promise o energy eciency a promise which, The
Economistmagazine noted on September 4, 2008, others are beginning to understand. Lovins argues that the USs
electricity bill could be halved through energy-eciency measures, many o which could pay or themselves in about
a year.
Improvements in both supply-side and demand-side eciency can reduce the worlds dependence on ossil uels
and mitigate greenhouse gas emissions. On the supply-side, more ecient power plants, such as Integrated Gas
Combined Cycle plants, save energy by lowering the heat rate. On the demand-side, increased end-user eciency
can be achieved through use o more energy-ecient equipment and appliances such as low-energy light bulbs.
The McKinsey-Vattenall greenhouse gas mitigation policy curve shows that the abatement potential rom energy
eciency could be as much as 6 GT CO2e/year by 2030 and this is achievable at negative costs varying between
-160/tonCO2e and -10/tonCO
2e.3
Because the costs are negative, some eciency changes should happen naturally as they make economic sense.
However, some individual energy savings may not be made without intervention. This is due in part to bounded
rationality where consumers are locked into preconceived ideas and ail to make changes even when presentedwith inormation that justiy those changes. We look at how the regulatory environment would enable us to unlock
some o this opportunity in more detail in Chapter II o part II.
Lovins believes energy eciency and renewables can solve the whole energy problem, describing the hard energy
path as involving inecient liquid uel, automotive transport and centralized electricity generating acilities. The sot
energy path on the other hand involves the ecient use o energy, diversity o energy production methods and
reliance on sot technologies including wind and solar. His book, Winning the Oil Endgame, presented the US with
an independent, transdisciplinary analysis o ways to reduce petroleum dependence. The book argues that hal o
our oil needs, hal o our gas needs and three-ourths o our electricity requirements could be eliminated, i intelligent
investments were made, while maintaining a stable, growing economy. Lovins also introduced the concept o
negawatt power in the book, whereby investment is made to reduce electricity demand instead o increasing
generating capacity. Negawatts are the hypothetical tradable units o saved energy due to energy eciency.
The wisdom o Lovinss arguments was recognized by The Economistmagazine:
Mr Lovins should be pleased, but his satisaction at having been proved right is tempered by lingering unease that
there are echoes o the 1980s in todays debate. The main problem with the approach to energy in the 1970s, he
argues, was that the issue was dened as a supply shortage. The question they asked was how to get more energy,
at any price, instead o asking: How should we use energy, why are we using it so wasteully and what do people
really use energy or?4
4McKinsey-Vattenall greenhouse gas abatement cost curve, 2007.
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Although we acknowledge the potential that energy eciency has in stimulating economic recovery, reducing
energy costs to end-users and climate change mitigation, a more detailed analysis o the benets and actors
surrounding energy eciency are out o the scope o this paper.
Politicians around the world and across the political spectrum have been vocal in recognizing the opportunity low-
carbon prosperity represents. Many o them have proposed and are implementing tax credits, subsidies, incentives
and R&D programs or clean-technologies.
We provide an overview o what politicians are saying about low-carbon prosperity:
II. Political support or a low carbon Industrial Revolution
Politiciansandlow-carbonprosperity(innoparticularorder)
And it is absolutely critical that we understand this is not just a challenge, its an opportunity, because i we create
a new energy economy, we can create ve million new jobs, easily, here in the United States. It can be an engine
that drives us into the uture the same way the computer was the engine or economic growth over the last couple
o decades. And we can do it, but were going to have to make an investment. The same way the computer was
originally invented by a bunch o government scientists who were trying to gure out, or deense purposes, how to
communicate, weve got to understand that this is a national security issue, as well. US Senator Barack Obama,
Democratic Presidential Nominee, US Presidential Debate, Nashville, September 7th 2008.
Look, we are in tough economic times; we all know that. And lets keep never orget the struggle that Americans are
in today. But when we can when we have an issue that we may hand our children and our grandchildren a damaged
planet, I have disagreed strongly with the Bush administration on this issue. I traveled all over the world looking at the
eects o greenhouse gas emissions, Joe Lieberman and I.... We can move orward, and clean up our climate, and
develop green technologies, and alternate alternative energies or or hybrid, or hydrogen, or battery-powered cars,
so that we can clean up our environment and at the same time get our economy going by creating millions o jobs.
US Senator John McCain, Republican Presidential Nominee, US Presidential Debate, Nashville, September 7th 2008.
With American people pinched at the pump, and seriously concerned about the state o the economy, the House
has taken action today to cut taxes or millions o middle-class amilies, invest in renewable energy technologies to
create high-paying green jobs, make America more energy independent.... Nancy Pelosi, Speaker, US House oRepresentatives, Statement on Renewable Energy and Job Creation Tax Act o 2008.
The US has invested nearly $18 billion to research, develop and promote clean and ecient energy technologies.
Our investments in research and technology are bringing the world closer to a remarkable breakthrough an age o
clean energy where we can power our growing economies and improve the lives o our people...it will be a moment
when we choose to expand prosperity instead o accepting stagnation US President George Bush, Remarks at
the US Department o State, Washington DC, September 2007.
5The Economist, September 2008. The Frugal Cornucopian
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I think we can all agree that we need to view this not as a crisis but as an opportunity. The transition rom ossil
uels o old to the renewable uels o tomorrow can create jobs, protect our national security and cleanse our
environment. Harry Reid, US Senate Majority Leader, Bipartisan Senate Energy Summit, September 12th, 2008.
All our needs o the country, all our goals as an economy point in exactly the same direction to tackle climate
change, to improve energy security, to create jobs and to stimulate business to grow. Every economy in the world
now share a common interest in this transition to a low carbon global economy. For the threat o climate changeis
a threat to the prosperity and security o the whole world. I believe that the benets to amilies and to businesses o
reducing oil dependence and tackling climate change will be immense. It will mean the creation o hundreds, indeed
thousands o new jobs and business opportunities to meet the new demand or environmental goods and services.
And this is the biggest prize o all: the chance to seize the economic uture securing our prosperity as a nation by
reaping the benets o the global transition to a low carbon economy. The act is that, in the 21st century, the global
low-carbon economy will be a key driver o our economic prosperity. And now you should look at it this way, we
are about to embark on a ourth technological transormation to low-carbon energy and energy eciency. And in their
wake as beore will come a myriad o changes in the way we live, the way we move around, the way we will
run our businesses, the things we produce and consume which will make the low carbon economy a new engine
o productivity and economic growth. Gordon Brown, Prime Minister o the United Kingdom, Speaking at The
Governments Low Carbon Economy Summit, June 27th 2008.
Britain cant aord not to go greenor the sake o our uture prosperity and our current cost o living, we must
wean ourselves o ossil uels and go green. Rt. Hon David Cameron, MP, Leader o the Conservative Party in the
United Kingdom.
In tough economic times, some people ask whether we should retreat rom our climate change objectives. In our
view it would be quite wrong to row back and those who say we should, misunderstand the relationship between
the economic and environmental tasks we ace. Rt. Hon Ed Miliband, UK Secretary o State or Energy andClimate Change, Speech in Parliament, October 16, 2008.
France isnt late but France wants now to be in the lead. We havent got to choose between saving the planet
and growth, we need a growth that consumes less energy and ewer raw materials. Nicolas Sarkozy, President o
France, Speech at the UN General Assembly, September 2007.
The climate package is so important that we cannot simply drop it, under the pretext o a nancial crisis. - Nicolas
Sarkozy, President o France, EU Summit in Brussels, October 16, 2008.
We absolutely must get an agreement on the climate and energy package that aims to make Europe a low-
energy and low-carbon economy. The idea is to encourage European companies to reduce their energy needs and
emissions. Admittedly, this requires heavy investment, but it means European industry has the chance to get a headstart. Tomorrows competitiveness and jobs depend on it. Jean-Louis Borloo, French Minister o the Environment,
Interview in the weekly Le Journal du Dimanche, June 2008.
Climate change tests our ability to open a new chapter in economic development which will, in turn, pose entirely
new challenges. We can experience a win-win situation i we decide to invest in new ways in research and
technology, in new structures to secure our opportunities and thereby securing jobs in the long term. Angela
Merkel, Chancellor o Germany, Speech at the International Transport Forum, May, 2008.
The systematic expansion o renewable energy is not only good rom the environmental and climate policy point o
view but also or innovation, growth and employment in Germany. Sigmar Gabriel, German Environment Minister,
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Renewable Energy World, April, 2008.
Countermeasures to global warming will create new demand, new jobs and new income. A low-carbon society is
one that oers great opportunities or economic activity that is compatible with the environment. Yasuo Fukada,
Outgoing Prime Minister o Japan, Speech at the Japan Press Club, 9th June 2008
I believe that the pursuit o ecologically sustainable development need not be in contradiction to achieving our
growth objectives. Manmohan Singh, Prime Minister o India, Prime Ministers address at 63rd session o UN
General Assembly, September 27th
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