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A recent editorial from the Investors Chronicle posed this question about investment in green energy:

Thursday 2 September 2010 – Jonathan Eley, Editor, writes:

What are investors to make of green energy and other sustainable technologies? Instinctively, it should be a “big thing”. Carbon-based fuels are inevitably going to get more expensive, andgovernments around the world have pledged to spend mind-boggling amounts of money developing green technology and bribing us to adopt it. Yet despite this positive backdrop, picking winners at the company level has been frustratingly tricky – as anyone who’s invested in the sector will know to their cost.

[My emphasis]

Investors Chronicle

It is not surprising that investors should be both puzzled and worried, as a glance at some share performance charts for leading players in the wind power industry shows:

wind-power-share-prices.PNG

The extent to which public companies involved in what has become known as the green energy revolution can attract the support of investors is, perhaps, one of the more useful indicators of the state of play in the climate debate. However convincingly the IPCC may pontificate about the dangers of global warming and the need to reduce Co2 emissions immediately, and whatever pious aspirations worthy politicians may mouth, this tells us whether rhetoric is translating into action in the real world. Are investors willing to back what they are being told?

Without question, and for the foreseeable future, wind power is the only source of alternative energy that has progressed beyond the pipe dream stage, and can be reasonably described as an industry. It’s been around for about twenty years, and during that time the trading environment in which it operates has steadily improved. So why are there long faces among investors?

Nearly all the nations that are big players in the climate debate have free market economies. I say nearly all because China, which is certainly one of the most influential, still does not exactly fit this template. Surely, if the prophesies of planetary destruction that have become the common currency of environmentalism during the last decade are really taking hold worldwide, and becoming part of mainstream public policy, then this must be reflected in the financial markets. Companies that can really make a difference to the level of anthropogenic Co2 emissions should be booming, and those who are investing in this sector can reasonably expect to see a good return as the market grows. One does not have to look very far to find out why this is not happening.

In order for the value of a commodity to grow, be it gold, copper, oil, wheat, or pork bellies, there must be increasing demand; that is one of the most fundamental tenets of economics. Although there is an indisputable and continuous increase in the demand for electricity as the technological infrastructure that we have come to depend on steadily expands, that does not mean that consumers are willing to pay any price at all to purchase it. The usual rules of competition still apply. Although ethics may play some part in how consumers source their supplies, it is likely to be a very small part. If your company is being ethical, but your competitors are aggressively controlling costs, then unless you can persuade your customers that they should pay a premium in order to support your noble stance, they are likely to shop elsewhere. Green energy is expensive to produce and without subsidies it cannot compete with conventional sources.

Although it may be possible to persuade a proportion of the affluent middle classes in the leafy suburbs of the developed world to make sacrifices in order to feel that they are doing something worthwhile, that represents a very small part of the global energy market. In other words there may be a market for renewable energy as a boutique product, but that is not going to be the kind of operating environment that will attract global players and get stock markets excited. It isn’t going to have much effect on Co2 emissions either.

Governments in the developed world have launched a two-pronged offensive in an effort to overcome this problem. On the one hand they are providing subsidies to the producers in order to moderate prices, and at the same time requiring electricity suppliers to buy renewable energy regardless of the true cost.  On the other hand they are attempting to make renewables competitive by legislation. Carbon taxes and trading schemes are mooted as a means of making conventional power generation more expensive so that, perhaps, the price gap will close.

All these strategies should ring alarm bells for anyone who believes in free market economics. An artificially created market may provide the opportunity for profit in the short term, but it is inherently unstable and transient. At the same time there is the danger that if some countries obediently tax carbon  emmissions, and inflate their industries overheads by so doing, then countries that do not conform to the new ethics of carbon reduction will gain a  very real competitive advantage. When those countries that may prefer not to join the crusade have the kind of industrial clout packed by developing countries like China and India, then the developed world is obviously taking a very big risk.

Investment in electricity generation is a highly capital-intensive venture requiring sound strategic decisions covering decades rather than years in order to be profitable. Multinational companies that are not interested in trading opportunities in any one country, or even region, now dominate the power industry. In order to be profitable and grow they need to be able to take advantage of the opportunities offered by a global market, and global scale demand for un-subsidised green energy on a scale that ensures growth on a decadal scale does not exist. This market depends entirely on political measures for its existence. With commodities like copper, oil, wheat, or pork bellies, one can still be pretty certain that they will be in demand ten or twenty years time, although there may of course be price fluctuations. There is no such assurance where green energy is concerned; the market is only as robust as the political and economic policies that have created it.

If growth in the market you are investing in depends entirely on the gross subsidies provided by governments steadily increasing, and also governments continuing to legislate in order to boost demand, you need to be pretty damn certain that the political incentives that underpin those policies are here to stay. At the moment there is no reason to think that this is the case.

The cradle of climate alarmism has been the developed world  particularly the European Union  energetically supported by the United Nations in the form of its Intergovernmental Panel on Climate Change (IPCC) and its Framework Convention on Climate Change. In fact it would not be too much to say that the policies of all governments that aspire to reducing Co2 emissions are founded on their faith in the reports provided by the IPCC.

During the last year, the political and economic framework within which environmental policies are forged has changed dramatically. A combination of loss of confidence in the IPCC, growing public scepticism about a significant human contribution to climate change, and the need to cut expenditure in the face of continuing economic turmoil, has dulled enthusiasm for green energy. In the EU, France, Germany, Italy, and elsewhere subsidies are being cut. Emissions trading schemes intended to create demand for alternatives by loading the cost of conventional energy have become toxic political issues in the United States and Australia. The IPCC is now beset by criticisms of the integrity of its reports that have previously gone virtually unchallenged outside the blogosphere.

Looking to the future, the remaining months of this year are likely to provide a very rough ride for investors in green energy.

In mid-October, an IPCC meeting is scheduled at Busan, South Korea, to consider preparation of their Fifth Assessment Report due to be published in 2013/14. This is now likely to be overshadowed by controversies that could threaten the organisation’s future.  The InterAcademy Council has just published a report that is very critical of the IPCC procedures and past performance, particularly with regard to the way in which it has represented the manifest uncertainties that abound in climate research.

On top of this, the future of the current chairman, Dr Rajendra Pachauri, is in doubt. If the IPCC has problems, then this has happened on his watch. He is now into his second term in office and one of the more startling recommendations of the report is that one term is long enough. The resignation, or perhaps sacking, of the chairman will not enhance confidence in the IPCC. Worse, the issue of whether he should stay or go could split the member states.

If there is one thing that discourages investment it is uncertainty, and it would seem most unlikely that this meeting will pass without there being a good deal of blood on the carpet as the participants try to address the organisation’s problems. It is equally unlikely that a solution that will persuade the wider world that the IPCC has reformed itself and is back on track as a gilt edged authority on climate change can be found at just one meeting. The problems will rumble on.

If that was not enough, a climate summit will take place at Cancún, in Mexico, in early December. A year ago it was expected that this would be the crowning glory of the crusade against climate change, with a global treaty limiting Co2 emissions that had been hammered out at Copenhagen finally being ratified. Far from laying the foundations for this achievement, last year’s summit opened up rifts between the developed and developing world that, if anything, are likely to become even deeper at Cancún. The US has failed to introduce Co2 limitation legislation and is seen by its poorer neighbours as hypocritical when it calls upon other nations to do this in spite of the stifling effect that would have on their economic growth.

No one, not even the newly appointed head of the UNFCCC, is anticipating a breakthrough at Cancún. With the IPCC in disarray it now seems even less likely, and there is the very real danger that any attempt to get rid of Pachauri will be seen as an assault on a champion of the developing world.

Without a global treaty on carbon reduction that will guarantee that signatories everywhere will turn from their wicked fossil fuel ways, and wholeheartedly embrace alternatives, there will be no global market for green energy, and no reason to believe that one can be created any time soon. Until confidence is restored in the IPCC  which could be a very slow, or even impossible, process  cash strapped governments are most unlikely to promote renewables as a priority. Their electorates will not accept the swinging price hikes during difficult economic times that this would entail if the IPCC is no longer seen as a credible advocate of climate alarmism.

Investors in green energy will be well advised to accept their losses and get out before the end of the year.

Harmless Sky, 30 September 2010