ESG Investing and Underwriting Principles

ESG investing is a growing field, but green underwriting has been slow to develop and cannot seem to get out of its own way. I am involved in the development of a new instrument, EB-Certs that can help and provide new flexibility in investing in deep retrofits. Watch for more news in this space.

In recent decades we have made huge strides in perfecting renewable energy technologies, developing new ones, and in many cases reviving old ones with modern day technology. Windmills have been around forever, but the new ones are just a little bit better. Refrigeration has been around forever, but heat pump technology has advanced rapidly in recent decades. In many cases government has helped in sponsoring research and advancing technology, in spite of the occasional failure. Fiascos like Solyndra and SolarCity might have been avoidable, it seems to me that certainly SolarCity and Tesla merely exploited the foolishness of too much funny money chasing too few projects, and as I am writing this, it seems the chickens are coming home to roost.

The bigger lesson ought to be that it is more important for people to be able to invest in energy retrofits on a rational basis.The technology is there, and too many subsidy schemes end up having unintended consequences like the inappropriate placement of solar panels that has resulted from the rooftop solar craze. Consumers ended up with solar panels on a lease or PPA basis, with up to 2.9% escalation while the market for electrical power has been essentially flat. The only people who benefited were the tax-shelter investors who who were SolarCity’s real customers, while the consumer paid through the nose. If you will, the consumer rented out their roof space too cheap and in many cases they lose money on the deal. Often, besides overpaying for electricity in absolute terms due to the escalation, other retrofits might have been more beneficial.

The bottom line is, we are now at a stage where energy retrofitting, done right, is a sound investment and many of the ways of stimulating it can become counter productive if it seduces people to prioritize the wrong technologies. Interfering with the market always introduces distortions that can become a problem in their own right when they misdirect investment to sub-optimal solutions. Anyone who has studied optimization should know that it is disastrous to optimize any system for a secondary parameter first.

Raw Economics First, Please

From an investment standpoint this means that we should first assess energy retrofits on the basis of raw economics, without any subsidies or incentives, to fairly compare the economic power of available alternatives, the motherhood and apple-pie principle here is that that financial incentives can make a good project better, but they can never make a bad project good. Ergo in order to make good decisions you first make a lifetime assessment (for most technologies, like solar panel,batteries and heat pump technologies, a 30-year lifecycle is a responsible minimum, but in some cases it may have to be as much as 50 years. With solar, you’ll have to replace inverters maybe every 10 years, and with heat pumps it’s usually the compressors. You take all that into account. Then you select whatever solution produces the highest positive NPV and only then do you evaluate the effects of subsidized financing and other incentives. The fact here is that the system you put in will substantially outlive the financing, and you definitely want to be long-term right not just short term right. The fact that the government wants to subsidize one technology or another, does not automatically mean that it is the optimal choice for your business or building. You want to make that a proper intra-marginal investment decision guided by consideration of capital allocation.

The Pitfalls

There are sometimes serious problems with existing underwriting policies, including things like the CBI, Climate Bond Initiative. Once specific parameters are used as proxies for the whole  system, we run into the typical problem of reductionist reasoning, that the whole is greater than the sum of its parts. Here are some examples of how things can go awry:

  1. Many supposedly “green” bonds, with CBI rating, are in fact regressive because they focus on energy efficiency only and therefore all they do is lower the cost of energy, which merely expands demand. There is always a great temptation for building/business owners to invest in efficiency and call it ‘green’ but what happens implicitly is that many efficiency measures have short paybacks, this acts as a prophylactic against doing deep retrofits – which tend to have longer paybacks and therefore become very hard or impossible to finance as a result of stripping out the effiency retrofits with short paybacks first. The problem here is a reductionist approach that focuses on a single measure and effectively torpedos sustainability, but because of the way the measurements are done is falsely given the appearance of “green.” I have written on this issue on my blogs for the past few years.
  2. A result of the above problems is that these meritorious “green”investments are not only mere window dressing that puts lipstick on a pig, but in reality strip the underlying asset of potential for serious value-added deep retrofits. The simple example is that a bunch of energy efficiencies with paybacks below five years, are actually an inferior investment to a deep energy retrofit with a payback of 7 – 12 years.  The smart investment strategy is to put two and two together, and average down the long paybacks with the short-payback efficiencies, resulting in potentially a far greater value add to the primary asset and to enterprise value.
  3. Another example is Tesla of course. There is no way that lugging an extra 1000 lbs of hardware around to haul the same payload reduces entropy – I don’t care what the accountants say. Even if you powered the whole thing with solar power, you are then creating a false argument for you are then diverting solar energy from other, more socially beneficial/valuable uses. So this is a complete Rube Goldberg, and a rich man’s hobby, but has nothing to do with sustainability.
  4. Yet another example are “net-zero” buildings, if they are not functionally part of an eco system that is in effect sustainable. I have begun to write about that here: In other words, the building may not be the correct entity for evaluation, or optimization by itself, unless the effect it has on the lives of the occupants are taken into consideration. If analyzed properly, a better building adds value to the life of the tenants and should command higher rents over its lifetime. Too narrow a focus on costs, means that we are merely building the slums of tomorrow today.

The question is, is there an easy alternative, without imposing a heavy penalty in terms of transaction costs. For that, it seems to make sense to me to rely as much as practical on operational measurements that should be needed for any good project. In other words, we should focus on practical, operational transparency, based on assessments that we should include in any project.

Here is a first draft, for discussion. Its initial intended use is for our exchange for EB-Certs, Energy-Based Certificates, a new investment vehicle for ESG investors to leverage the actual improvements offered by Deep Energy Retrofits, which are high quality intra-marginal investments with typically low beta and high alpha, and they should be cash flow positive and have a significant positive NPV for the host organization or building.

Sustainable, Low Entropy Draft Underwriting Criteria

Class 1: Energy Retrofits 70+

  1. 70% or more reduction in Green House Gas Consumption, based on 2-year history.
  2. The project incorporates at least one renewable energy generating technology.
  3. The project is certified cash-flow positive by a stated percentage on generally accepted energy price assumptions by independent auditors for the issuer at issue time.
  4. 30-year life-cycle Model with positive NPV, before subsidies and incentives, with annual scoring by independent auditor for the issuer.
  5. A cash flow analysis that takes any applicable subsidies and incentives into account.
  6. Independent 3rd party M&V Study according to US DOE M&V, with quarterly updates for the first year and annual updates under a Creative Commons Attributtion-NonCommerdcial-NoDerivatives 4.0 International License and made available to investors.
  7. A maximum 500 word narrative of the project and sustainability goals, verified by auditor, with annual updates.
  8. Issuer credit rating is A- or higher (Standard & Poor’s, Fitch), A3 or higher (Moody’s), which could naturally be arrived at synthetically with the aid of bank guarantees.
  9. All public audits/updates to cease upon redemption.
  10. This work is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License, and made available to investors. 2018, by Rogier Fentener van Vlissingen

We hope that EB-Certs may become the financial breakthrough to provide greater transparency and highly efficient and effective green underwriting by leveraging organic project analytics, thus helping ESG investors identify valuable projects.


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