Michael S. Capitalism for all From the CFA Institute Research Foundation.
Climate change remains an important issue for the next decade. We call it decade because it may be too late now.
We all have to pay a price for burning fossil fuels, but unfortunately the lion’s share of that price will not be paid by those who burn fossil fuels. This is a classic problem of a negative externality: the profit of an activity – in this case, the burning of fossil fuels for energy production – is personalized, while the cost of human health and the environment is socialized.
Theoretically, we know how to deal with these problems. We can either control activity, as President Richard Nixon created the Environmental Protection Agency (EPA) in the 1970s to reduce air and water pollution. Or we can internalize costs by setting the price of carbon credits or launching a cap-and-trade program that is common throughout Europe, and now it is being introduced in China.
The problem with this method is that these are green sticks. They limit freedom of enterprise and, so to speak, are not very popular with companies that burn fossil fuels. But that doesn’t mean we value popularity as much as we care about motivation. Big Oil’s resistance to environmental control and carbon pricing in the United States has been overwhelming, although recent events in Exxon and Shell indicate that it could lose the war.
Nonetheless, the current cost of carbon emissions is usually very low, and is estimated to be the best 50% of what should be. Carbon emitters are lobbying hard to keep the necessary spending limits below to encourage the rapid and effective change needed to avoid the worst consequences of climate change.
But regulations need to go further than carbon pricing. What rules do we need to prevent and manage the risk of stuck assets? In a word, yes.
It made us think. . . . Instead of using green sticks for change, why don’t we use green carrots to tempt change? After all, these methods are not mutually exclusive.
One way to introduce green carrots is to create a market for royalties from R&D to renewable and sustainable energy. Both the oil and gas and mining industries are already among the top developers of green technology patents, yet this research is difficult to monetize. A company may use knowledge and introduce internal technology, or may be stuck with it.
Meanwhile, if a mining company builds a new mine, the future production of that mine can be sold to the royalty companies for a single payment. For a royalty company, this is equivalent to an annual purchase financed for mine production. However, greening of so-called dirty industries is probably the biggest possibility of tackling climate change.
In the biotech space, companies have already specialized in financing intellectual property (IP) in exchange for a portion of the revenue generated from finished products. Why there is no such system for the development of green technology?
At the moment, U.S. taxpayers receive a tax break for investing in oil exploration projects. Why don’t we stop this tax evasion and use the money raised to pay super royalties to green technology developing energy and mining companies?
Alternatively, we can support dedicated royalty companies in place of green technology to open up a new market. Investors can then invest in shares of these green technology royalty companies and make a profit by changing the world instead of saving taxes on fuel.
We can even go one step further and learn from successful Venture Capital (VC) models in countries like Israel. Today, Israel is one of the world’s leading technology centers and the government-funded business incubator Yojma is credited with much. In 1993, the government established Yojma with a capital of 100 100 million. Yojma supported early-stage initiatives in exchange for a 0% share in the project যদি if private investors financed the rest. After seven years, investors can return government support from Yojma at face value and interest. It worked and in 1998, the VC market in Israel became large enough to privatize Yojma.
This effectiveness of providing carrots for investment should not be underestimated. Today, Israel spends more on R&D as part of GDP than any other nation, and second only to the United States in terms of venture capital investment. Israel has turned its rust into a modern high-tech economy of the 1990s by using carrots. Why can’t the United States use the same method to accelerate its transition from a carbon-based economy to a green one and ask Big Oil to show the way?
If the carrots are delicious and the incentives are right, oil and mining companies will gladly invest in green technology. The old adage of doing good while doing good is the way forward for all of us.
And when we first think of sticks, we should never forget the appeal of carrots.
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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.
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