Where to Look for Sustainable-Environment Investments

Focus on existing technologies entering the marketplace.....not brand new breakthrough technologies that could be years away from commercial deployment.

That's a crucial point that Joseph Romm made again this morning in his Climate Progress blog.  Personal Investors who are holding out to invest in totally new technologies will miss the highest-return investment opportunities available to them -- existing in recently-commercialized technologies, as we've seen (for example) in the past couple of years with wind and solar power.  Focus on existing technologies -- the ones that are being deployed commercially now or are about to be commercially deployed.

Romm writes:

• A critical historical fact was explained by Royal Dutch/Shell, in their 2001 scenarios for how energy use is likely to evolve over the next five decades (even with a carbon constraint): "Typically it has taken 25 years after commercial introduction for a primary energy form to obtain a 1% share of the global market."

• Note that this tiny toe-hold comes 25 yeas after commercial introduction. The first transition from scientific breakthrough to commercial introduction may itself take decades. We still haven't seen commercial introduction of a hydrogen fuel cell car and have barely seen any commercial fuel cells -- over 160 years after they were first invented.

• This tells you two important things. First, new breakthrough energy technologies simply don't enter the market fast enough to have a big impact in the time frame we care about. We are trying to get 5% to 10% market shares -- or more -- of the global market for energy, which means massive deployment by 2050 (if not sooner).

• Second, if you are in the kind of hurry we are in, then you are going to have to take unusual measures to deploy technologies far more aggressively than has ever occurred historically. That is, speeding up the deployment side is much more important than generating new technologies. Why? Virtually every supply technology in history has a steadily declining cost curve, whereby greater volume leads to lower cost in a predictable fashion because of economies of scale and the manufacturing learning curve. 

We believe it has become much easier than Romm says to develop a totally new technology and bring it to market, but we strongly agree with his overall point.  Leave the investing in totally new technologies to institutional investors such as venture capital firms to seed arrays of technologies in order to achieve one big hit that pays for all the misses.  Individual investors don't have access to arrays of seed-capital opportunities, or the ability to fund the investments -- unless they're entrepreneurs founding one of those businesses.

Asset Allocation and Dumb American "Energy Policy"

The bankruptcy of American "energy policy" supports  two major facets of our asset allocation strategy: (1) underweight U.S. equities relative to global equities because of bad U.S. policy and other unprecedented problems for the nation, and (2) invest aggressively in companies working to solve the energy crisis, which will exist for even longer thanks to America's bankrupt "energy policy" (see our Environment link).

Today's column by Thomas Friedman in the New York Times explains perfectly the vacuity of "energy policy" debate in the U.S.   It's appropriately titled "Dumb as We Wanna Be":

• It is great to see that we finally have some national unity on energy policy. Unfortunately, the unifying idea is so ridiculous, so unworthy of the people aspiring to lead our nation, it takes your breath away. Hillary Clinton has decided to line up with John McCain in pushing to suspend the federal excise tax on gasoline, 18.4 cents a gallon, for this summer's travel season. This is not an energy policy. This is money laundering: we borrow money from China and ship it to Saudi Arabia and take a little cut for ourselves as it goes through our gas tanks. What a way to build our country

• When the summer is over, we will have increased our debt to China, increased our transfer of wealth to Saudi Arabia and increased our contribution to global warming for our kids to inherit.

• No, no no, we'll just get the money by taxing Big Oil, says Mrs. Clinton. Even if you could do that, what a terrible way to spend precious tax dollars -- burning it up on the way to the beach rather than on innovation?

• The McCain-Clinton gas holiday proposal is a perfect example of what energy expert Peter Schwartz of Global Business Network describes as the true American energy policy today: "Maximize demand, minimize supply and buy the rest from the people who hate us the most." Good for Barack Obama for resisting this shameful pandering.

• But here's what's scary: our problem is so much worse than you think. We have no energy strategy. If you are going to use tax policy to shape energy strategy then you want to raise taxes on the things you want to discourage -- gasoline consumption and gas-guzzling cars -- and you want to lower taxes on the things you want to encourage -- new, renewable energy technologies. We are doing just the opposite.

• Are you sitting down?

• Few Americans know it, but for almost a year now, Congress has been bickering over whether and how to renew the investment tax credit to stimulate investment in solar energy and the production tax credit to encourage investment in wind energy. The bickering has been so poisonous hat when Congress passed the 2007 energy bill last December, it failed to extend any stimulus for wind and solar energy production. Oil and as kept all their credits, but those for wind and solar have been left to expire this December. I am not making this up. At a time when we should be throwing everything into clean power innovation, we are squabbling over pennies.

• These credits are critical because they ensure that if oil prices slip back down again -- which often happens -- investments in wind and solar would still be profitable. That's how you launch a new energy technology and help it achieve scale, so it can compete without subsidies.

• The Democrats wanted the wind and solar credits to be paid for by taking away tax credits from the oil industry.  President Bush said he would veto that. Neither side would back down, and Mr. Bush -- showing not one iota of leadership -- refused to get all the adults together in a room and work out a compromise. Stalemate. Meanwhile, Germany has a 20-year solar incentive program; Japan 12 years.  Ours, at best, run two years.

• "It's a disaster," says Michael Polsky, founder of Invenergy, one of the biggest wind-power developers in America. "Wind is a very capital-intensive industry, and financial institutions are not ready to take 'Congressional risk.' They say if you don't get the [production tax credit] we will not lend you the money to buy more turbines and build projects."

• It is also alarming, says Rhone Resch, the president of the Solar Energy Industries Association, that the U.S. has reached a point "where the priorities of Congress could become so distorted by politics" that it would turn its back on the next great global industry -- clean power-- "but that's exactly what's happening." If the wind and solar credits expire, says Resch, the impact in 2009 would be more than 100,000 jobs either lost or not created in these industries, and $20 billion worth of investments that won't be made [and another generation of debt-dependent energy import-dependence---this time dependent on imports of wind and solar instead of oil]

• While all the presidential candidates were railing about lost manufacturing jobs in Ohio, no one noticed that America's premier solar company, First Solar, from Toledo, Ohio, was opening its newest factory in the former East German -- 540 high-paying engineering jobs -- because Germany had created a booming solar market and America has not.

• In 1997, said Resch, America was the leader in solar energy technology, with 40% of global solar production. "Last year, we were less than 8%, and even most of that was manufacturing for overseas markets."

• The McCain-Clinton proposal is a reminder to me that the biggest energy crisis we have in our country today is the energy to be serious -- the energy to do big things in a sustained, focused and intelligent way. We are in the midst of a national political brownout.

Now, "The End of the Middle" of the Financial Crisis

We've gradually crept back into equities in the past month as we've blogged that the financial crisis has moved from "the beginning" to "the beginning of the middle." We now think a new milestone has been reached: we've progressed to "the end of the middle." (We're just one-step closer to the ultimate buy-signal, "the beginning of the end.")

So, what's changed? There are now many more reasons for the Fed to diminish the pace of its rate cutting, the most important of which is that the financial crisis appears to be easing by many indicators. Furthermore, the main global disaster scenario is premised on a U.S. dollar that weakens to oblivion -- If the Fed is able to diminish its rate-cutting pace, the dollar will find a fresh source of support to reduce the chances of a dollar melt-down. All of this could well combine to moderate commodity prices for a while, and that would be a crucial element in a more stable macro-economic outlook -- a necessary condition for restoring more of a balance that most securities markets will find bullish.

In other words, we continue to "muddle through" the financial crisis, which is the bullish scenario for equities. We still face a potentially uncomfortable global economic slowdown that will raise additional risks, such as that of a Developing Market crisis in some areas. That, in our view, would signal the real "beginning of the end" of the crisis, and a very good buying opportunity in equities.

The following Bloomberg article summarizes why we believe the financial crisis has taken a step toward ultimate resolution:

• Commodities Tumble Most in Five Weeks After Dollar Rebounds, by Ron Day

  April 29 (Bloomberg) -- Commodities fell the most in five weeks as a rally by the dollar eroded demand for energy, metals, crops and livestock as alternative investments.

  The weighted UBS Bloomberg Constant Maturity Commodity Index fell 1.9 percent to 1,508.21 at 4:11 p.m. New York time, the biggest drop since March 19. Wheat prices tumbled to a five- month low, crude oil slid more than $3 a barrel and silver dropped almost 3 percent.

  The dollar was poised for the first monthly advance against the euro this year on speculation the Federal Reserve will signal that it has finished lowering U.S. interest rates after six reductions since September. A week ago, the dollar plunged to a record against the euro, boosting demand for raw materials as a hedge against inflation.

  ``This may be a major change in perception about the dollar,'' said Dale Durchholz, a market analyst for AgriVisor Services Inc. in Bloomington, Illinois. ``The run-up in commodities prices has been tied to a weakening, and now it appears it may be reaching a bottom.''

  The UBS Bloomberg index has dropped 4.2 percent from a record 1,573.84 on Feb. 29. Before today, the gauge climbed 20 percent this year, while the Standard & Poor's 500 Index declined 4.9 percent and the dollar slid 5.5 percent against a weighted basket of the euro, yen, pound and three other major currencies.

  Futures on the Chicago Board of Trade show an 82 percent chance the Fed will cut the target rate for overnight lending by a quarter-percentage point to 2 percent tomorrow and odds of 71 percent that the rate will be held at that level in June.

  `Take Money Out'

  Fed Chairman Ben S. Bernanke is persuading investors that the financial markets are working again, some analysts said.

  The S&P 500 Index has rallied since the central bank backed the purchase of Bear Stearns Cos. on March 16. Companies sold $45.3 billion of debt last week, the most ever. High-yield bonds are poised for their best month in five years, and mortgage securities are outperforming Treasuries for the first time in 2008.

  ``Commodities have been the darlings of the investment space recently,'' said Eric Wittenauer, an energy and metals analyst at Wachovia Securities in St. Louis. ``Some investors may be looking at these developments as a sign to take money out of commodity markets.''

  Oil, gold, copper and tin have climbed to records this year as demand outpaced supplies. Rice, corn, soybean and wheat prices have also jumped to records, partly because of adverse weather and soaring consumption in Asia. Suring food costs have sparked protests and riots in countries including Haiti, Indonesia, Mexico and Egypt.

  `Fundamental Imbalance'

  ``The rising dollar won't change the fundamental imbalances driving commodity prices, but it may slow the climb as commodities traded in dollars become more expensive internationally,'' Matt Sena, co-manager of New York-based Castlestone Management LLC's Aliquot Commodity Fund, which oversees $900 billion in assets, said in an e-mail.

  Crude-oil futures for June delivery dropped $3.14, or 2.6 percent, to $115.61 a barrel the New York Mercantile Exchange. Yesterday, the price surged to a record $119.93. Natural gas tumbled 3.9 percent, and gasoline declined 3 percent.

  Wheat futures for July delivery fell 32.5 cents, or 3.9 percent, to $8.085 a bushel on the Chicago Board of Trade. Earlier, the price touched $8.0175, the lowest for a most-active contract since Nov. 21. Corn and soybeans also dropped.

  Silver futures for July delivery declined 48.3 cents, or 2.8 percent, to $16.64 an ounce on the Comex division of the Nymex. Gold, which often moves in the opposite direction of the dollar, fell 2 percent to $876.80.

Climate Change Adaptation - A Growing Key to Personal Asset Allocation

Some of our equity allocation is composed of companies whose technologies mitigate the effects of climate change -- clean energy companies, high-tech waste management, efficiency tools, etc. Our approach encompasses the widely held view that if capitalists do their job and if governments regulate more aggressively, the worst climate effects can be avoided.

However, we think investors would be foolish to ignore a uncommon, but growing, view that we must invest not only in mitigating the effects of climate change, but also adapting to the increasingly-likely scenario of unstoppable climate-induced devastation.

We broached the topic in our 3/26/08 post:

• [More people are] taking very me scientists' predictions that large areas of land will be rendered uninhabitable by temperature change and flood, that large fertile areas could become infertile, that population migration and changing disease vectors could pose enormous new challenges, and that some nations may act militarily in their own interests rather than work within the international community. It's one thing to invest in Brazil because it has a lot of water and fertile land (I'd call this part of a "mitigation" investment strategy), but it's another thing to try to model a range of devastating potential outcomes from climate change in order to drive a portion of one's investment.
  
  This latter type of speculation hopefully never occurs or is well beyond the time horizon of most investors, but some fairly dramatic changes are potentially within the time horizon of young home buyers choosing a location, insurance companies, and pension funds.

We're seeing an increase in "past the tipping point" arguments, including a few more today after the latest atmospheric C02 report. This one on Celcias.com:

• Worldwide, carbon dioxide (CO2) levels have risen again, according to the National Oceanic and Atmospheric Administration (NOAA).
  
  The rise, a disturbing 2.6 parts per million over 2006 levels, is attributed primarily to the burning of fossil fuels. However, another factor, which may present its own tipping point, is global warming’s effect on forests.
  
  When the earth warms, several things happen to forests. Boreal forests are displaced farther north, and the timberline (the altitude beyond which trees can’t grow) rises. Where warming is precipitous, forests fail to adapt and die, or are ravaged by pests which thrive in the absence of annual freezing. U.S. government reports indicate that temperate forests (maple-beech-birch) will shift north into Canada by the late 21st Century
  
  Forests act as carbon sinks, or storage depots. When trees grow, they store CO2 in a complex process that uses sunlight (photosynthesis) to convert CO2 and water into carbohydrates (food) and oxygen. When trees die, the process is reversed. All plants do this, but trees – with their longer life spans and greater mass – do it on a more significant, and more observable, level.
  
  Forest destruction is now happening all over Canada, as pine beetles destroy more than 50,000 square miles of forest, releasing an estimated 270 megatons of CO2 over the next 14 years. This represents the same amount that would potentially be reduced under the Kyoto Protocol, leaving a net gain to the environment of zero, at least on Canada’s part.
  
  The same infestations are being seen in the U.S. Northeast and Upper Midwest, with equally disastrous effects. In the West, entire stands of trees, weakened by drought (a regional side effect of global warming), have succumbed to pests, leaving the “stick-forests” of nightmares. From Washington to central Oregon, forests are dying from the top as trees turn an appalling shade of rust. In Japan, as recently as 2006, foresters were being encouraged to cull dead trees resulting from global warming (this in a country not known for its vast forests).
  
  In addition to rising CO2, the NOAA reports a substantial rise in methane over the last decade. Methane escapes when Arctic permafrost melts. Although the NOAA admitted it was too soon to tell if the current methane increase signals rapid Arctic thawing, the evidence – flooded Alaskan villages suing energy companies, and images of polar bears stranded on ice floes – speaks for itself. Scientists know that, if the Arctic permafrost thaws, catastrophic amounts of methane will be released, as they were in Western Siberia in 2006.
  
  When methane gets into the atmosphere, it increases the rate of global warming in a vicious cycle known as a “positive feedback loop”. According to Chris Field, the director of global ecology at the Carnegie Institution of Washington, this is an ominous development, because these warming mechanisms tend to be self-perpetuating.
  
  Sergei Kirpotin of Tomsk State University in Western Siberia notes that melting permafrost is an “ecological landslide” which is likely irreversible, and Larry Smith from UCLA estimates that the westernmost portion of the Siberian bog alone contains about 77 billion tons of methane, or one quarter of all the methane stored in landmasses worldwide.
  
  As forests die, releasing CO2, and permafrost melts, delivering methane, the earth – caught in this self-perpetuating loop – reaches a tipping point; a day and time beyond which it is no longer possible to restore the balance. This writer suspects we have already passed that point of no return. The results will be catastrophic climate change, increasing extinction of animal and beneficial insect species, crop failures, mass starvation and death from disease, all because we had to have SUVs and cities so bright they are visible from space.
  
  

Allocation and Africa -- II

We continue to think "Frontier Markets" -- and African markets particularly -- will rise toward the status of an asset class for many investors. This stems from (1) low portfolio-correlation of many African stock markets owing to highly country-specific developments, and (2) the world's race for resources that is increasingly investing in African nations. We highlighted these trends here and primarily here.

A Bloomberg article today highlights the additional drive toward #2, investment in Africa. (It's also suggested in the article that China's model of investment, which does not concern itself with human rights, may still do more good than harm. It this standard continues to be adopted, it could clear-away a major hurdle to African economic that was not possible when America's liberal values predominated in previous decades.)

From Bloomberg: (China Fund May Pledge $1 Billion in African Investment in '08)

• A Chinese fund set up to encourage investment in Africa may commit to spend $1 billion by the end of the year, Liliang Teng, president of the China-Africa Development Fund said today.

  The fund is in discussions with Chinese companies on projects to improve energy infrastructure in South Africa, Mozambique, Zimbabwe and eastern Africa, Teng said in interview at a business forum in Tanzania's northern city of Arusha.

  ``Besides energy and power plants we will also focus on infrastructure, like rail, roads and airports as well as other areas, including agriculture and manufacturing,'' he said.

  The China-Africa Development Fund, announced by Chinese President Hu Jintao in November 2006, will grow to $5 billion and may become bigger depending on its initial results, said Teng. Financed by the China Development Bank, it approved the first investments with four Chinese companies totaling $90 million on Jan. 15, according to a press release on its Web site.

  Sino-Steel Group, the China Building Material Co., Shenzhen Energy Group Co., and the CGC Overseas Construction Ltd. will use the money to develop electricity, construction, and mining projects in Africa, the statement said, without elaborating.

  China's trade with African nations will rise to $100 billion by 2010 from $73 billion last year and $2 billion in 1999, Khalid Malik, the United Nations resident coordinator in China, said at the opening of the China Africa Business Forum in Arusha today. The two-day summit is bringing together 300 trade officials and businesspeople.

  Critics say China's push into Africa for oil and raw materials to feed its growing economy in some cases disregards environmental laws, labor standards and human rights.

  Economist Jeffrey Sachs, the UN's special envoy on the Millennium Development Goals, said the positive impact of Chinese investment and skills transfer to Africa far outweigh the negatives.

  ``What is being promoted is a great increase in business development,'' Sachs said in a taped address.

  To contact the reporter on this story: Sarah McGregor in Dar es Salaam via Johannesburg at 1933 or abolleurs@bloomberg.net