Green Alpha's Next Economy

The Economic Case for Divesting from Fossil Fuels: 10 Keys

Securities of fossil fuels firms, as an economic sector, may soon be on the decline. Predictions as to when oil, gas and coal will become a smaller part of the investment society makes into its total energy mix in favor of renewables (such as solar, wind and ocean energies) vary, ranging from 2060 on the long side (this prediction from oil industry powerhouse Shell) to 2030 or even sooner on the shorter side (as reported by Bloomberg). But so far, markets appear to be mispricing the risk this presents to fossil fuels companies, and their share prices for now remain stable. In our opinion, it’s not too soon to consider divesting from fossil fuels while one might still recover significant value.

Coal, oil, and natural gas, though, are the main sources of energy that have gotten civilization this far (at least since the late 1700s, or the entire industrial revolution), so why are many expecting them to so quickly diminish in importance? 

Mostly because of recent innovation and renewable energies’ efficiency and cost gains. Our ‘next economy’ thesis asserts that the energy and material resources we need to host an indefinitely thriving economy exist in more than sufficient quantities (particularly energy), if we would only collect and use them in smart and efficient ways. The innovations required to put world economies on a long term sustainable path largely exist today. For example, the various forms of solar energy collection have become so efficient over the last 20 years that all of civilization’s energy requirements could presently be met by covering 0.3% of the earth’s land surface with solar panels and concentrated solar thermal systems. Our models insist that through promoting true sustainability solutions in materials and energy, we can indeed maintain a healthy, thriving biosphere, all while growing our economies and improving standards of living potentially everywhere, for everyone.

This in mind, we put together 10 primary reasons why fossil fuels investments, in next economy terms and indeed in general economic terms, no longer appear to be the attractive source of risk-adjusted returns they have historically been.

Fossil fuels are economically becoming subprime because:

1. Fossil fuels have the capacity to threaten basic systems.

Warming and its sequelae such as severe weather, droughts, floods, more frequent and intense storms and attendant uncertainties all undermine our basic economic foundations. A recent World Bank report conceded that “There is … no certainty that adaptation to a 4° C world is possible,” referring to a global average temperature increase of 7.2 degrees Fahrenheit from pre-industrial times that is considered likely by scientists over the next few decades if fossil fuels’ use is not soon severely limited. To rephrase what this means, the traditionally conservative World Bank believes that human economies may not be able to adapt to a world that has on average warmed four degrees Celsius or more. Note that the global temperature has risen nearly one degree Fahrenheit since 1975.

Millions of pages have been written on the underlying reason for the unsustainability of fossil fuels. Their power to disrupt basic climate and therefore world societies is vast, complicated and is a topic best left to our best specialists. I suggest to the interested reader the works of more qualified practitioners including Dr. James Hansen, Lester Brown and Bill McKibben.

2. Fossil fuel assets present abandonment risk.

Fossil fuels companies are now confronted by the risk that many of the still-in-the-ground assets they count on their balance sheets and/or in their future revenue projections may never be recovered or realized. As this becomes the apparent, their asset valuations and revenue guidance may be revealed as currently far too high, and the values of their companies and stocks overvalued. Citing abandonment risk, Bloomberg recently reported that “Investors in carbon-intensive business could see $6 trillion wasted as policies limiting global warming stop them from exploiting their coal, oil and gas reserves.”  Carbon Tracker reports that “Between 60-80% of coal, oil and gas reserves of publicly listed companies are ‘unburnable’ if the world is to have a chance of not exceeding global warming of 2°C.”

The press down under is reporting that “Australian based analysts at Citigroup say fossil fuel reserves in Australia face significant value destruction in a carbon constrained world, with the value of thermal coal reserves likely to be slashed dramatically if governments get serious about climate action…Fossil fuel asset owners could be best advised to dig the resource up as quickly as they can.”

Over at HSBC they recently pushed up a similar report, encompassing a global scale, essentially saying we can’t count all the fossil fuel reserves on firms’ balance sheets because we cannot burn them all and therefore “Oil and gas majors, including, BP, Shell and Statoil, could face a loss in market value of up to 60 percent should the international community stick to its agreed emission reduction targets.” (As reported by GreenBiz.com.) (I don’t believe most policymakers in governments around the world currently have the wherewithal to honor their various carbon reduction treaties, but I also don’t believe that matters. Peak oil demand is upon us because the alternatives are simply becoming far more competitive and because awareness of fossil fuels’ dangers is rapidly advancing.)

What Bloomberg, Citi and HSBC are saying, in sum, is that infinite growth of a known harmful asset – in this case an asset with the ability to disrupt climate and civilization – must come to an end, and soon.  And shares of the firms exploiting this asset are at risk.

3. Renewables are becoming too competitive for fossil fuels.

Forbes has quoted Rick Needham, director of energy and sustainability at Google saying, “While fossil-based prices are on a cost curve that goes up, renewable prices are on this march downward.” That pretty much sums it up. In just the last five years, solar photovoltaic module prices have fallen 80 percent and wind turbines have become 29 percent less expensive. Moreover, after the initial investment, renewables such as wind and solar, having no cost of fuel, will prove far too competitive for fossil fuels no matter how cheap those may appear to be. Cheap fuel is still more than free fuel.

One of the first major investors to recognize this was Warren Buffett. Via his MidAmerican Energy subsidiary, he has quietly made Berkshire-Hathaway America’s single largest owner of both solar and wind electrical power generation capacity. Patrick Goodman, Buffett’s CFO of MidAmerican said simply “we believe renewables is the better investment right now.” Warren Buffet, who believes that once a good investment has been identified it’s time to “back up the truck,” is showing no signs of giving up his leader status on solar, having just begun construction on the “largest solar plant in the world.”

All this is happening now, today, with today’s technologies and today’s economics. That the smart money already sees renewable energies as more competitive long term than fossil fuels is obvious. The ‘smart money,’ by the way means individuals as well as institutions. Solar crowdfunding pioneer Mosaic in April of this year sold out the first tranche of $100 million in solar project investments to Californians in just hours.

Further technological advances aren’t required to make renewables competitive, but advances are occurring. Fossil fuels will represent only a small percentage of all energy investments in just a few years for a simple reason: few will want to invest in the less profitable technologies of the past.

4. Fossil fuels firms are beginning to have to pay for their externalities.

Fossil fuels companies have never had to pay for their economic externalities such as pollution, warming, health effects and contaminated water and farmland. There are signs that this is beginning to change, and firms will increasingly be liable for damages in the tens if not hundreds of billions. The highest profile example is BP’s Deepwater Horizon spill, the worst oil spill in U.S. history. BP has already been required to set up a US$20 billion fund to cover cleanup and damage costs, and perhaps far more significantly, is facing potentially “tens of billions” in additional damage payments pending the outcome of what the Financial Times is (in a dedicated section) calling the “trial of the century,” now underway in Louisiana. The FT is also reporting that BP is facing an additional 2,200 lawsuits related to the spill. Even if BP should prevail in most or even all of these suits, the massive costs of these litigations will start to become a drag on the firms’ traditionally easy profitability. Newsweek has a longform piece covering many details including additional BP liabilities such as: “that BP lied about the amount of oil it discharged into the gulf is already established. Lying to Congress about that was one of 14 felonies to which BP pleaded guilty last year in a legal settlement with the Justice Department that included a $4.5 billion fine, the largest fine ever levied against a corporation in the U.S.” BP’s continuing potential liabilities from this one incident, including “uncapped class-action settlements with private plaintiffs” and “civil charges brought by the Justice Department” and “a gross negligence finding [that] could nearly quadruple the civil damages owed by BP under the Clean Water Act to $21 billion,” show the danger to shareholders. Any representative of an asset class carrying this kind of risk can justifiably be labeled a subprime investment.

Other firms facing liability issues surrounding the dangerous nature of their products include Chevron, which has had to abandon Ecuador altogether to avoid paying a $US19 billion settlement there in a “nightmare case” that threatens to drag on around the world as Ecuador seeks payment via Chevron’s assets in other nations.

5. Fossil fuels are likely to have to face carbon taxes.

There will be carbon taxes in many if not most countries that will directly impact the profit margins of fossil fuels firms. The New York Times Op-Ed framed the argument like this:

“Substituting a carbon tax for some of our current taxes — on payroll, on investment, on businesses and on workers — is a no-brainer. Why tax good things when you can tax bad things, like emissions? The idea has support from economists across the political spectrum, from Arthur B. Laffer and N. Gregory Mankiw on the right to Peter Orszag and Joseph E. Stiglitz on the left. That’s because economists know that a carbon tax swap can reduce the economic drag created by our current tax system and increase long-run growth by nudging the economy away from consumption and borrowing and toward saving and investment.”

A carbon tax is good for everyone but fossil fuels companies, who will see their profits reduced (or attempt to pass the costs on to consumers, reducing demand for their products further). So far, several nations, provinces and individual municipalities have implemented a carbon tax, and many others have carbon trading schemes (the Carbon Tax Center is a good resource for keeping up with these). Carbon taxes can raise revenues, shrink deficits, and move tax burden away from citizens, all while slowing the worst effects of warming. Look for their implementations to continue to spread.

6. Fossil fuels will soon face diminishing governmental subsidies and benefits.

Fossil fuels have received as much as half a trillion dollars per year in subsidies from the U.S. alone. To the extent that austerity or desires to balance budgets, combined with legislation to limit greenhouse gas emissions, reduce the scale of this windfall, the seemingly easy profitability of these companies will be undermined. This point, as well as point five above, is more fully developed in point seven.

7. There is growing global institutional belief that transition to renewables solves climate AND economy.

We’ve already seen the dire warnings about warming coming from the World Bank, and discussed the positions of Bloomberg, Citi and HSBC. These institutions are far from alone. The International Monetary Fund, in calling for “Energy Subsidy Reform,” recently calculated that between directly lowered prices, tax breaks, and the failure to properly price carbon, the world subsidized fossil fuel use by over $1.9 trillion in 2011 — or eight percent of global government revenues, representing a huge drag on economies. The United States taxpayer is fossil fuels’ largest benefactor at $502 billion in 2011. China came in second at $279 billion, and Russia was third at $116 billion. For perspective, that $502 billion is just over 3% of the US economy, currently being given away to big fossil fuels companies.

The IMF concluded that the “link between subsidies, consumption of energy, and climate change has added a new dimension to the debate on energy subsidies.”  The IMF’s solution to both economic and climate risk (as reported by The Hill) is in two simple parts: “end fossil fuel subsidies and tax carbon.”  The solution to both climate and economy is worldwide conversion from fossil fuels to renewables.

8. Fossil fuels are the ultimate non-circular: they’re completely consumed upon first use, so more primary source extraction is required.

As I mentioned above, to get global economies on an indefinitely sustainable foundation, we need to make far more efficient use not only of energies but also of raw materials. Fossil fuels represent both raw resources and energy sources, and they represent the worst of both. Smart, efficient use of materials means reusing nearly everything at the end of its lifecycle to repurpose into something else we need. For a thriving, sustainable long-term economy, we need to get close to perfect recycling of resources of all kinds so we can minimize our depletist impacts on earth and avoid the basic environmental degradations that go along with those.

This approach of course excludes fossil fuels and other resources that are consumed entirely on their first use. Raw materials can keep economies growing for a long time if we preferentially mine our huge stockpiles of already extracted resources and minimize extraction from primary, geological sources. But fossil fuels, unlike materials used to make solar panels and wind turbines, don’t work like that. Since they are consumed entirely on their first use, reuse is impossible and we have to literally go back to the well for more. This means ever more greenhouse gasses in the atmosphere, ever more degrading of the local environments where extraction takes place, ever more risk of accidents, and the possibility of eventually exhausting the resource completely (although on this last point I personally believe we will – for the reasons presented here – reach peak demand far before we fully exhaust fossil fuel reserves).

9. Distributed renewable energy grid is more secure than traditional hub and spoke systems, even those powered by domestic fossil fuels.

FERC Chairman Jon Wellinghoff has recently said, “It wouldn’t take that much to take the bulk of the power system down. If you took down the transformers and the substations so they’re out permanently, we could be out for a long, long time,” and “A more distributed system is much more resilient…Millions of distributed generators can’t be taken down at once.”

This is common sense. And short of equipping every home and business with its own diesel or natural gas generator – which of course would be disastrous for local areas’ air quality – fossil fuels can never offer anything like the kind of security and resilience that distributed renewables like rooftop solar can.

10. Renewables will counter fossil fuels’ endless ‘boom and bust’ economic cycles.

As I’ve posted before, the price of oil and other fossil fuels has, at least since World War II, been the main control knob permitting expansion and causing contraction of world economies. It’s widely known that 10 of the last 11 major recessions were preceded by peaks in oil prices. Rising oil prices are inflationary, adding to the costs of almost everything from transportation to fertilizers to plastics, and they therefore cause demand for all these affected items to become depressed, slowing economic production.  Renewables, relying as they do on free fuels like sunlight, present no such economic pressures, and as they become an ever larger percentage of our energy mix, fossil fuels’ huge GDP drag will begin to disappear.

Conclusion                                                              

What then is the future for fossil fuels versus renewables? Fossil fuels have already begun to rapidly lose market share. In 2012, most new electricity generating capacity brought online in the United States was from renewables, and in January and now March 2013, all new U.S. electrical generating capacity was provided by renewables. So where is this headed?

Image courtesy BNEF

Bloomberg New energy Finance (BNEF) has calculated that “70% of new power generation capacity added between 2012 and 2030 will be from renewable technologies (including large hydro). Only 25% will be in the form of coal, gas or oil.” BNEF CEO Michael Liebreich has said "I believe we're in a phase of change where renewables are going to take the sting out of growth in energy demand," which goes to our thesis that we can both lighten our ecological footprint and increase our standards of living.

So add Bloomberg to the growing group of financial analysts warning that fossil fuel investments are poised to become a bad bet. 

Citi bank, in its note about the Australian coal industry, went as far as to warn investors that it will be difficult to extract value from their still-in-the-ground resources as action on climate change advances, stating, "If the unburnable carbon scenario does occur, it is difficult to see how the value of fossil fuel reserves can be maintained, so we see few options for risk mitigation." (Italics added; Source.)

Well, with all due respect to Citi, I can think of one option: we, like Buffett and Google, can instead invest in civilization’s non-carbon sources of power. As the IMF pointed out, the solution to both climate and economy is worldwide conversion from fossil fuels to renewables. This massive conversion program will lead to powerful economic growth, less economic drag from energy costs, higher revenue for treasuries, and strong employment drivers.

If we fear for the future, it is paradoxical to attempt to mitigate risks by remaining invested in fossil fuels. What we do now will bring about the future for better or worse. If we’re to emerge from our 19^th century energy system, it must be us, now, today, who set that emergence in motion. Leave fossil fuels for those who prefer to look backwards.

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, LLC. He is co-manager of the Shelton Green Alpha Fund (NEXTX), of the Green Alpha ® Next Economy Index, and of the Sierra Club Green Alpha Portfolio. He also authors the Sierra Club’s green economics blog, "Green Alpha's Next Economy."

Your Portfolio Is Hooked on Fossil Fuels

You are drilling for oil and natural gas, and you probably don’t even know it.  What, you say you’ve never near a drilling rig, and aren’t even sure what one looks like?  You’re still drilling, because companies you own are drilling.

Many financial advisors and asset managers routinely assume that broadly diversified stock portfolios will have holdings in fossil fuels companies.  Even most stock mutual funds that identify themselves as ‘green’ funds contain natural gas and even oil holdings.

This is not only morally questionable, it’s also likely to lead to disappointing returns.  If the goal of investing is to grow assets, accrue wealth, and prepare for our futures, then it’s key to invest in companies, industries and sectors that will still be there and growing in that future. Similarly, our collective macroeconomic goals shouldn’t be to keep the economy ticking along for the next quarter or current political term, but to keep it healthy so we may thrive for decades if not centuries. Fossil fuels companies fail on both these fronts: they face an uphill battle trying to grow into the medium and long term, and, for many reasons, they also hinder our chances of achieving economy-wide long-term economic growth, which limits your and my chances of positive portfolio returns.

We at Green Alpha believe that fossil fuels have no place in portfolios designed to capitalize on the emerging, sustainable, green, thriving next economy. We picture and model, rather, a next economy comprised of enterprises whose technologies, material inputs, and/or practices have not proven deleterious to the environmental underpinnings of the global economy; and, equally important, those whose businesses have a better than average probability of keeping economic production running close to capacity (meaning close to full employment and therefore causing sufficient economic demand to keep economies healthy). Healthy, innovative economies made up of healthy companies have always proven better for portfolio performance. Next economy companies are innovation leaders in all areas, not just in the energy industries; they exist now and will continue to emerge in all economic sectors, providing all products, goods and services required to have a fully functioning, even thriving global economy. And we believe that next economy companies will continue to win market share from legacy firms, and that they therefore provide superior odds of delivering long term competitive returns.

There are several key reasons this should be the case. As a global economy, we can no longer afford to wait for our basic economic underpinnings to break before we fix them. Too many issues, economy wide, from agriculture to water to warming, all damaged by fossil fuels, have been ignored and left to degrade. By now it’s clear that fossil fuels, including natural gas, do not result in us growing a thriving next economy. Between greenhouse gas emissions, toxic emissions (such as mercury), accidents, spills and contamination of soil, groundwater and oceans, to say they have proven deleterious to our environmental-macroeconomic underpinnings is an understatement. We need to make sure the earth’s basic systems - which global economies rely upon - keep on functioning. And the time to do that is now, while they’re still working.

Fortunately, as a global economy we are now (for the first time since the beginning of the industrial revolution) in a position to begin transitioning to methods that will allow us to run sustainably using advancements like far cheaper and more beneficial sources of energy. As inexpensive, unlimited renewables gain more market share, fossil fuels by definition will be losing market share, meaning stocks of companies providing the most economically competitive renewables will be in a better position to deliver superior stock performance than will oil, coal or even natural gas. Indeed, Shell Oil has recently projected that renewables will eclipse oil as society’s primary source of energy, making up as much as 40% of all energy used within the next 47 years. Considering the booming growth of renewables in recent years (particularly solar), I wouldn’t be surprised if this occurs much sooner; but in any case the writing is now officially on the wall. Fossil fuels have already begun to lose market share to renewables. In 2012, most new electricity generating capacity brought online in the United States was from renewables, and in January 2013, all new U.S. electrical generating capacity was provided by renewables. If these trends are even close to future outcomes, Shell’s prediction will have proven far too optimistic for the future of oil.

Further, from a stock valuation point of view it has also become clear that shares of fossil fuels companies have become far more risky as an asset class than they were even a few years ago. Most policy observers believe that within a few years there will be a worldwide price on carbon via some combination of carbon taxes, cap-and-trade schemes and/or requirements to sequester carbon via ‘capture and storage’ technologies. When these emerge in large ways, they will represent new systemic costs of business for fossil fuels companies that will potentially badly damage their margins. In addition, in a potentially more financially perilous risk, there is the ongoing specter incredibly expensive damage from accidents associated with fossil fuels. For example, look at BP’s management’s and shareholders’ objections to settlements and potential further judicially mandated costs and penalties relating to the 2010 Deepwater Horizon spill (above and beyond the $20 billion trust already established by BP). BP's tortured arguments and huge efforts to avoid further financial liability for an accident for which they clearly are partially responsible reveals the devastating risks the oil industry will be facing as it reaches ever further for product. BP’s continuing potential liabilities from this one incident, including “uncapped class-action settlements with private plaintiffs” and “civil charges brought by the Justice Department” and “a gross negligence finding [that] could nearly quadruple the civil damages owed by BP under the Clean Water Act to $21 billion” among others, show, more than anything, that oil as an asset class is becoming a subprime investment.

All this being the case, why are fossil fuels companies’ stocks considered mandatory holdings by many professional money managers and investment banks? The primary answer is ‘modern portfolio theory;’ that body of knowledge regarding how to build diversified portfolios of stocks taught at MBA and finance departments all over the world and considered sacrosanct by most practitioners. There are good reasons modern portfolio theory (MPT) is so widely practiced, mainly that its underlying goal, to maximize return for a given level of financial risk, is any portfolio manager’s ultimate duty. MPT asserts that the way to achieve this is to have appropriate portfolio exposure to various asset classes like cash, bonds, stocks, commodities, and from there to follow the proscribed allocation to specific sectors and industries within these groups in order to achieve the most “efficient frontier” mix of securities. The sectors proscribed by modern portfolio theory, as it is typically practiced, include fossil fuels such as oil and gas. But let’s recall that this theory was pioneered in the 1930s, and was considered more or less perfected by Harry Markowitz in the 1950s, culminating in his 1959 book “PORTFOLIO SELECTION EFFICIENT DIVERSIFICATION OF INVESTMENTS.” For Markowitz and his predecessors, fossil fuels were the only visible source of energy sufficient to power society, and by requiring portfolio allocations to these industries, they were effectively making sure investors got in on the profitable business of what was really the only energy available. Modern portfolio theory’s asset allocation models were made for and reflect a world where fossil fuels were the only imaginable primary power source. Moreover, in the 1950s, there were fewer material resource constraints, a far lower global population, the word ‘scarcity’ did not apply to the natural world, and no one had heard of climate change or global warming, so there really were no reasons to think twice about fossil fuels or to imagine reasons their returns could be at risk. But we don’t live in that world anymore.

Building a Fossil Fuels Free Portfolio

Next economy portfolio theory differs from MPT by recognizing that we live in an economy that no longer resembles the world of the 1950s. Where modern portfolio theory defines risk as financial risk only, next economy theory is also concerned with the risks of earth’s support systems failing. Where modern portfolio theory says to invest in oil and coal, then, next economy theory says to look for primary energy replacements that have not proven damaging to the environment to a degree where they disrupt economics and even society.

And in realizing that energy now means far more than it did in Markowitz’s day, and by observing that many if not all economic sectors from transportation to agriculture could be run in a sustainable fashion, largely using current technologies and approaches, we build portfolios comprised of next economy companies. This in turn helps the green economy to continue to accelerate, and provides clients with opportunity for competitive returns.  Investing in the growing technologies of the future just makes better common sense than investing in the riskier, slowly shrinking technologies of the past.

Where modern portfolio theory says, ‘buy all these 1950s economic sectors,’ next economy theory says ‘look for all the ways there are to keep the economy going such that we, as a global economy, can thrive indefinitely.’ In that sense, we argue that current portfolio theory is upside down. So-called “Modern” Portfolio Theory is backward looking, but wise investors look forward.  We must think very carefully about asset allocation in the modern economy, and start to make changes. Traditional asset classes must evolve (“critical power sources” rather than “oil and gas”, for example), and our portfolios must reflect that and begin to invest in fully functional enterprises that are both environmentally and economically sustainable far farther into our future than current MPT could foresee. But if MPT is all we know, how do we accomplish that? The only answer to that can be that we have to develop new processes. Green Alpha’s attempt at that, in some ways representing a reversal of traditional models of asset management, works like this:

1. Begin at the highest macroeconomic and ecological levels and make an objective assessment regarding the most pressing issues confronting world economies

2. Having identified key issues, the next step is to rigorously research scientific consensus and new approaches to the technologies, ideas and business practices best positioned to and most likely to successfully drive growth while aiding in mitigation of and/or adaptation of issues (such as climate change and resource scarcity)

3. Of these approaches, then, we ask in the third step which can practically be deployed or practiced – that is, used in the real world

4. Then, of these working, functional, practical approaches, we fourth ask which can also be aligned with economic interests such that they can attract market capital and inspire both entrepreneurs and established companies to engage. In other words, which can be deployed as profitable businesses

5. Only now, at this point, do we in our fifth step identify specific companies that come as close as possible to meeting these criteria

6. Looking at granular company-level financial data comes last for us, and is only applied to qualified next economy companies, as identified via the five-stage methodology above. In the final step then, we apply quantitative, rigorous, bottom-up financial analysis to identify stocks of next economy companies that offer the best financial positions with minimized risk, with particular focus on growth potential and market liquidity and bankruptcy risks.

The tools applied in the final step are universally known and practiced and do not bear describing here. And in any case this is not the piece of portfolio management we're redefining. Suffice it to say that from a bottom up fundamental quant perspective, we don't believe one can improve much Graham-Dodd valuation methodology.

Practicing this methodology, we arrive at innovative, fully diversified portfolios comprised of firms that are working now and are positioned to keep working far into the future as the next economy emerges to displace the fossil fuels economy.

As businesses advance the better, cheaper, more efficient technologies that do not result in further warming, increased resource scarcity, deadly pollution, and soil and groundwater contamination, we can only imagine the productivity, lifestyle and well-being surges that will be unleashed. So enough with traditional, oil based economic models. 

We live in a new world, and it’s time we acted like it.

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, LLC. He is co-manager of the Shelton Green Alpha Fund (NEXTX), of the Green Alpha ® Next Economy Index, and of the Sierra Club Green Alpha Portfolio. He also authors the Sierra Club’s green economics blog, "Green Alpha's Next Economy."

Note:  This post originally appeared here on ALT ENERGY STOCKS. Thanks to Editor Tom Konrad for his insights during drafting. 

Investing in the Unspeakable

Today’s post is by fellow green economist Tom Konrad. Tom is a financial analyst, portfolio manager, and freelance writer specializing in renewable energy and energy efficiency investing.  He writes articles about investing in clean energy for AltEnergyStocks.com, and at the Green Stocks blog on Forbes.com.  He is featured in the 2011 anthology Fleeing Vesuvius: Overcoming the Risks of Economic and Environmental Collapse.

The thesis of Tom’s post below is one close to us at Green Alpha: that one can’t continue to invest in fossil fuels – even where using ‘best of breed’ methods to pick the best of unsustainable industries - and expect there ultimately to be a better economic or environmental outcome. When existing technologies have proven incontrovertibly deleterious, arguments to keep them in one’s asset allocation models - even if at somewhat lower portfolio weights - reflect inappropriate attachment to short term benefits that may still obtain even though the input function involved (e.g. fossil fuels) is shown to ultimately result in economic disruption or even potential collapse.

We know many “Green Alpha’s Next Economy” readers share these views, and we therefore thought cross-posting Tom’s arguments here may be appreciated. -- G.J.

By Tom Konrad CFA

Since 350.org began its campaign to get endowments and pensions to divest from fossil fuels, I’ve heard two basic criticisms of the movement from my colleagues in the investment management profession.

• Endowments selling their fossil fuel investments won’t stop us from using fossil fuels.
• Morality has no place in investment decision making.

Both these arguments fail to pass the sniff test, and the point of my title and subtitle were show their failings in a stark light to those who don’t necessarily agree with the need to transition away from fossil fuels.

The Effectiveness of Divestment

Starting with the first argument, that divestment will not be effective at combating climate change. While there may be some question about the effectiveness of divestment, its effectiveness or ineffectiveness is beside the point. If you doubt me, try to imagine trying to persuade His Holiness the Pope that the Church investing in abortion clinics would be all right, since abortions would continue to be performed with or without the Church's money. You may not agree with the Pope's stance on abortion, but I'm sure you'll agree that you'd be unlikely to get out of that conversation without having to say more than a few Hail Marys.

Since the Church’s stance on abortion is a moral one, the effectiveness of abortion divestment is irrelevant compared to the hypocrisy of any such investments.  As is the hypocrisy of institutions whose mission is to ensure our future well-being when they invest in companies which undermine that well being.

Morality and Investing

The second argument, that morality has no place in investment decisions, is equally specious. Just ask His Holiness (assuming you still have a voice left, after all the Hail Marys.)  If you think this only applies to religious institutions, consider the following investment:

You are traveling in a country where murder is perfectly legal on Fridays. A trustworthy man of your acquaintance has been hired to feed a dozen children to starving lions for the amusement of his wealthy patron, for which he will be paid $100,000. Unfortunately (for him, if not for the children), your acquaintance lacks the funds to acquire the necessary starving lions, and he turns to you.  If you invest the $10,000 he needs to purchase the lions today, and he will repay you with half of his fee ($50,000) after he is paid next week. In order to emphasize the moral aspects of the investment, we are assuming that all this is perfectly legal, and, because of both your acquaintance's reputation and the legal documents which have been drawn up, you have no doubt you will be paid. As an investment, feeding children to hungry lions would be rock solid,  and would result in a five-fold return on your investment in less than a week.

Low risk, high reward: Sounds like a great investment. Except for the feeding children to lions part. You wouldn't have to be religious to want to avoid this lion-feeding investment.

Conclusion

There are still valid arguments that Endowments and other such institutional investors should continue to invest in fossil fuels.  If it it is their considered belief that the profits from such investments can be used to more than offset the harm done by those investments, then they might consider it moral to invest anyway.  Yet even this decision would be morally questionable.  Is it right to feed a dozen children to starving lions, even if the funds will be used to save two dozen children from similar fates?

In any case, this is not an argument that morality has no place in investing.  Rather, it is about what is the best way to serve the institution's mission. In short, it is about taking a moral stance with investments, both the institutions’ and our own.

Is there a cost to investing with out morals? Perhaps. There is also the possibility of financial gain.  If governments ever decide to get serious about climate change, they will take actions which make it less profitable to extract and burn fossil fuels.  Less profitable operations would hurt the stock prices of such companies. That's why oil and coal companies are so adamant about opposing any sort of climate legislation. Companies which provide alternatives to fossil fuels, or enable us to use less of it will benefit from the same legislation.

When regulators enforce regulations which reflect a moral principal, moral investors will benefit, and amoral investors will be hurt. This brings us to another reason to apply our morality to our investment decisions: it aligns our financial interests with what we know to be right.  In a democratic society, this frees us to push our lawmakers to act in a moral fashion, without having to worry that the reforms we are pushing for will harm our financial interests.

There may or may not be a cost to investing in fossil fuels, and divesting from fossil fuels will not stop the economy running on them. But if you believe that burning fossil fuels is harming our current and unborn children, why are you investing in them? And why is your college or pension fund?

Update: Although this article was published at shortly after Pope Benedict XVI announced his resignation, it was written before the news came out, and has nothing to do with the resignation, which was apparently due to poor health.

This article was first published on the author's Forbes.com blog, Green Stocks on February 11th.  Forbes' editors felt the headline would be offensive to some, and a reworked version is now posted here.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, and is co-manager of the Green Alpha ® Next Economy Index, or GANEX and the Sierra Club Green Alpha Portfolio. He also authors the blog "Green Alpha's Next Economy."

Inevitable Shifts and Indispensable Technologies: Next Economy Inflection, Pt. III

Back at the New Year, I thought it’d be fun to write up a short recap of some of the evidence that, finally, the world is waking up to the real need to get our economies on a footing that can allow it to persist indefinitely. In that post I wrote of those observations that “these are just the first few recent ‘tipping point’-like stories to come to mind. I've read dozens more examples recently, and I feel the fact that I can no longer be aware of all the evidence of inflection much less keep track of it all is surely a sign in itself.”

2013 has already revealed key moves forward from institutions not traditionally aligned with post fossil fuels economy thinking.

First is the U.S. Government, which released its somewhat regular (approximately every four years), multi-agency National Climate Assessment (caution: link is to the full report PDF of 147MB) on January 11th. Its message is unequivocal, “…observed climatic changes are having wide-ranging impacts in every region of our country and most sectors of our economy. Some of these changes can be beneficial, such as longer growing seasons in many regions and a longer shipping season on the Great Lakes. But many more have already proven to be detrimental, largely because society and its infrastructure were designed for the climate of the past, not for the rapidly changing climate of the present or the future.” (Italics mine.) Federal scientists and career professionals clearly get the need for transition, as does at least one governor.

In his 2013 State of the State Address, New York Governor Andrew M. Cuomo went far beyond recognition of these facts and expressed his desire to make his state an economic leader in and therefore a beneficiary of the next economy transition: “The economy of tomorrow is the clean tech economy.  We all know it, it’s a foot race – whatever state, whatever region gets there first wins the prize, and we want it to be New York.” On the topic of government inflection, I suppose it’s obligatory to mention that during his second inaugural address, President Obama did appear to be talking the talk on climate. But we’ve heard encouraging words from him before, most notably during his 2011 State of the Union Address, which I discussed at the time as being generally positive. Time will tell. As many have pointed out, the watershed decision for Obama will be final approval or disapproval of the Keystone XL pipeline. Approval would demonstrate beyond any doubt that he prioritizes short term political/monetary benefits over the long term health of the American economy or environment.

Next, in the realm of leading think tanks, the World Economic Forum (WEF), leading up to its annual meeting at Davos, Switzerland, issued its “Global Risks Report 2013,” citing climate change, water scarcity and greenhouse gas emissions among society’s chief risk factors. There’s a slightly longer discussion of WEF’s important acknowledgements towards the end of our 2012 annual shareholder letter.

Finally, Bloomberg last week reported about Goldman-Sachs that, “[t]he investment bank is backing renewable energy that it expects will gain favor in a global shift it says is inevitable. That’s why short-term volatility will be trumped by long-term gains as emerging technologies first become commonplace and then become indispensable, according to Stuart Bernstein, the Goldman partner overseeing its renewables unit.” (Italics again mine.) ‘Inevitable shifts and indispensable technologies’ might as well have been Green Alpha’s motto these past five years, and it’s great to see the world’s leading bank, which for better and worse also influences the highest monetary and fiscal policymakers worldwide, thus publicly recognize reality.

As one colleague remarked to me via email, “nobody can accuse the Goldman boys and girls of being dumb...”

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, and is co-manager of the Green Alpha ® Next Economy Index, or GANEX and the Sierra Club Green Alpha Portfolio. He also authors the blog "Green Alpha's Next Economy."

Progress Towards Inflection: Green Alpha Advisors' Annual Client Letter and Portfolio Commentary 2012

2012 saw a return to positive performance for the next economy and for markets overall. Generally, global economic conditions, as indicated by some jobs growth, slowly improving industrial output and a housing rebound, improved marginally, but debt crises in Europe and America, exacerbated by eternal dithering, gamesmanship and posturing by politicians and other policy makers on both continents, kept optimism in check and moderated expectations for growth. With respect to the next economy, though, growth and expectations for growth began showing real signs of building momentum as mainstream awareness of the need ensure the longevity of the world economy by changing some of its foundations continued to advance. Thus our ‘next economy’ macroeconomic thesis became still more relevant and closer to fruition.

The basic macroeconomics of the next economy thesis are fundamental, and their essentials don’t change over time.  As we wrote in last year's letter: “Earth’s economies may stagnate or grow; either way, we believe things like renewable energy, clean transportation, sustainable infrastructure and water resources must grow in value. Over time, the value of stocks in our models will not be dependent on Wall Street gamesmanship, but on simple necessity. As awareness of the magnitude of our growing resource-climate-security problems advances, so will the valuations of our portfolio companies.” Even as chronic fiscal imbalances distract world leaders’ attention from climate and resource challenges, business, individual and institutional investors, academia, think tanks and research all are addressing the latter at an ever accelerating pace.

Thus we continue to be very optimistic about our potential to provide competitive long term returns performance to our portfolio shareholders. Essentially, Green Alpha Advisors is an asset manager offering portfolios of stocks in companies with proven business plans responding to the challenges presented by a warming, increasingly populous, resource-constrained world. Portfolios of these companies deliver growth in all sectors including transportation, communications, commerce, infrastructure, materials, energy, agriculture and water. Considering:

I. The world’s population is growing fast, but its resources aren’t,

II. Energy security and national security depend upon the U.S. minimizing use of foreign oil,

III. The fossil-fuels based economy, with its digging, burning, scarring of the landscape, disruption of ecology, and disease causing pollution, is ultimately too expensive to maintain, and

IV. Climate change,

it’s clear the time is past due for serious investment in mitigation and adaptation, and indeed the signs that people and institutions are getting that are becoming omnipresent.

Each of the three Green Alpha portfolios saw a positive return for 2012. Our flagship green economy benchmark, the Green Alpha Next Economy Index (or GANEX) returned 4.21%; our Sierra Club Green Alpha portfolio (SCGA), actively managed and more concentrated than the GANEX, returned 6.79%; and our newest portfolio, the Green Alpha Growth and Income Portfolio (GAGIP), was up 6.96% for the partial year from its inception on October 8^th, 2012.  While we are happy to return to positive performance after a tough year for next economy stocks in 2011, we did nevertheless underperform the legacy fossil-fuels based indices; the S&P 500 was up 16% and the Dow Jones Industrial Average returned 7.26% in 2012. All three of our portfolios did however outperform prominent green economy ETF portfolios (see discussion below).

All Green Alpha portfolios are based on our universe of next economy companies, with individual securities and weights selected to best fit the mandate of each portfolio. We’re especially pleased that December 30^th 2012 saw the fourth anniversary of the inception of the GANEX, reflecting a four year track record milestone measuring the growth and progress of the overall next economy. (On the topic of portfolios, look for an exciting announcement from us later in Q1 regarding our fourth and newest portfolio offering that will greatly enhance our ability to serve current and future clients.)

On the securities level, we saw once again in 2012 the importance of diversification across all sectors of the next economy. We find it hard to overemphasize this point: the post fossil fuels economy is emerging in all sectors, so to invest as though renewable energy (as critical as it is) is the only aspect of a green economy is shortsighted and results in high volatility. Attempting to represent the entirety of the next economy, our Green Alpha Next Economy Index (GANEX) is invested in 27 sectors and 52 sub-sectors, spanning, we believe, nearly everything required for a broad-based economic system to function. Reviewing GANEX’s top five 2012 total return performers gives some indication of its diversification:

1. Badger Meter, Inc. (BMI), 63.98%. Badger makes water meters, “flow measurement and control solutions” for farming, commercial, utility and residential applications. The U.S. drought of 2012 (and continuing) has brought the need for smarter, more productive water management into sharp focus. You can’t manage what you don’t measure.
2. Trex Company, Inc. (TREX), 62.51%.  Trex is the world's largest manufacturer of high performance wood-alternative decking. We consider Trex a prime example of waste-to-value economics that not only keeps huge quantities of waste out of landfills and oceans (Trex used 3.1 billion plastic bags in 2010, participates in a system responsible for 70% of all U.S. plastic bag recycling, and has never harvested a single tree to make its product), but also delivers a superior product with better long term value. In a world of constrained resources, making great stuff from leftovers is the best of all worlds.
3. Cree, Inc. (CREE), 54.17%. Cree is a leading developer of high efficiency LED lighting and systems and semiconductors for radio frequency applications. Cree LEDs can provide illumination as efficiently as 200 lumens per Watt, compared to 14½ lumens per Watt of a 60W incandescent bulb. This translates to big savings in energy and money, and is a straightforward example of one of our primary themes, focusing on innovation in economic efficiencies – getting more output out of less input.
4. Valmont Industries, Inc. (VMI), 51.03%. Valmont Industries provides critical infrastructure such as efficient mechanized poles and towers for wind turbines, lighting, communications and more. In 2012, VMI gave our portfolios exposure to the infrastructure aspects multiple trends such as the booming mobile and mobile web markets as well as the growing wind energy sector without the risk associated with an individual turbine manufacturer. Full disclosure, for valuation reasons, we removed Valmont from our portfolios as of year-end 2012.
5. The Hain Celestial Group, Inc. (HAIN), 47.9%. Hain Celestial is a leader in natural and organic food that vertically integrates manufacturing, marketing sales and distribution. We think of Hain as a macroeconomic bet on efforts of people to improve their individual health, and also on efforts at a policy and advocacy level to manage mushrooming and economically destructive escalation in healthcare costs. In addition, from a long-term agricultural management point of view, we think that that industry’s ever more potent pesticides, herbicides and petroleum based fertilizers will prove so deleterious to human health, land productivity and biosphere health that organic methods will continue to increase in popularity, and may one day even be required.

From the standpoint of our next economy sector classification scheme (NESC), the top performing Industry and Sector in the GANEX Portfolio was the Products (Industry), Capital Goods & Equipment (Sector), with Portfolio exposure of 16.11%. 

The chart below shows the performance of the GANEX, from its inception on December 30, 2008 to the end of 2012, versus two prominent green exchange traded funds, the Guggenheim Solar portfolio (TAN, in gold here), and the PowerShares WilderHill Clean Energy ETF (PBW, the black line). Over this period, the GANEX returned 28.15%, while the TAN was -79.22% and PBW performance was -46.68%. To be clear, GANEX differs significantly from these other two. TAN is a basket of exclusively solar and solar-related stocks, and PBW, though not as sector focused as TAN, is limited primarily (but not exclusively) to renewable energy. GANEX by contrast attempts to capture the entirety of the next economy, including renewable energy and solar, but also everything else we’ll need to have a thriving economic system, including, again, transportation, communications, commerce, infrastructure, materials, energy, agriculture, water and more. So while the comparison with these two may not be exact, we believe it does show the importance of careful diversification into all areas of the emerging green economy.  

Inception to 12/31/12 GANEX chart w/PBW and TAN

While we are generally growth oriented managers, we also in 2012 had good reason to believe that many of our holdings represent excellent values. As of December 31^st 2012, 66 of our 80 holdings were trading below the average (1979 to present) price to book ratio of the S&P 500 index.  Our average price to book was 1.45, compared to 2.27 for the S&P 500.

Finally, a compelling argument, if we needed one, for hastening the transition to an economy that can persist and even thrive in a warming world was recently articulated by the World Economic Forum at Davos. "On the economic front, global resilience is being tested by bold monetary and austere fiscal policies. On the environmental front, the Earth's resilience is being tested by rising global temperatures and extreme weather events that are likely to become more frequent and severe. A sudden and massive collapse on one front is certain to doom the other's chances of developing an effective, long-term solution." In other words, we need to get the economy on a sustainable footing before it comes unraveled. Given the imperative of this reality, we have difficulty imagining a near-future scenario where the best next economy companies don’t become the most important to society and subsequently, potentially the best performing.

The decisions we make as an interconnected global civilization now will be the difference between catastrophe and a thriving society with a healthy economy. Given the stakes, we have no doubts about how to place our bets.

Thanks for your continued support of Green Alpha Advisors and investing in the next economy.

 

Sincerely,

 

Garvin Jabusch, Co-Founder & Chief Investment Officer

Jeremy Deems, Co-Founder, Chief Financial Officer & Chief Operating Officer

 

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, and is co-manager of the Green Alpha ® Next Economy Index, or GANEX and the Sierra Club Green Alpha Portfolio. He also authors the blog "Green Alpha's Next Economy."

2013: Green Economy Inflection Point

There are a few truths that make the fundamental case that investing in the emerging next economy is the clearest path to long term competitive portfolio performance. First, innovation – meaning improving economic output without increasing material or capital inputs - always wins. This is simply how capitalism works, money chasing the best ideas, and has been the basis of the industrial revolution. Second, successfully mitigating the worst effects of economically and societally disastrous climate change (that we're not already irreversibly committed to) will save enormous costs, provide generational investment opportunities and also be inestimably economically stimulative.

For over a decade now, Green Alpha cofounders Jeremy Deems and I have been wondering when popular awareness of these truths would emerge. And while I can't represent that we're there yet, I can say that we definitely are noticing a major shift in both frequency and tone of recent journalism and punditry on the subject of sustainability economics. Fellow green economist Tom Konrad got me thinking about all this when he asked me and a few other money managers for thoughts about 2013 for his Forbes piece on the subject. The more I thought about framing an answer, the more I realized how much momentum I’ve been noticing just over the last quarter or so. To give an idea of what I mean, here's a representative but far from complete list of some smart people and organizations articulating a vision of and working towards a next economy wherein society can thrive without exceeding earth's tolerances or threatening the underpinnings of the global economy. Each of these is worth delving into in its own right.

- PricewaterhouseCoopers’ November 2012 report titled “Too late for two degrees?” (N.B., 3.6 degrees Fahrenheit) states flatly that “[i]t’s time to plan for a warmer world.” Since, as they conclude, to limit warming to two degrees Celsius, the world needs to begin slowing its carbon dioxide emissions “by 5.1 percent every year from now to 2050, essentially slamming the breaks on [CO2 emissions] growth starting right now," is not going to happen, we need to take all realistic mitigation steps we can and also plan for adaptation. Coming as it does from a mainstream accounting and auditing firm with no tree hugger ax to grind, this serves as a particularly stark warning, but also signals the truly massive scale of the investment opportunity.

- The National Research Council’s report (via the National Academy) on climate change and national security, “Climate and Social Stress: Implications for Security Analysis,” released in November 2012, was “prepared at the request of the U.S. intelligence community.” It provides a clear-eyed look at economic and politico-social consequences of climate change.  It states, in part, “[a]s a practical matter, [climate change] means that significant burdens of adaptation will be imposed on all societies and that unusually severe climate perturbations will [be] encountered in some parts of the world over the next decade with an increasing frequency and severity thereafter. There is compelling reason to presume that specific failures of adaptation will occur with consequences more severe than any yet experienced, severe enough to compel more extensive international engagement than has yet been anticipated or organized.” When realized, this “more extensive international engagement” means more opportunities for companies providing solutions, and crucially, in this case, the momentum for economic transition is coming from the security and intelligence community. The more disparate the voices urging transition, the closer to popular inflection we become.

- Not to be outdone by the National Academy, the World Bank (also in November 2012) warned that in its opinion, the globe is on track for warming of four degrees Celsius (7.2 degrees Fahrenheit) if mitigation does not commence immediately. The Bank, in asserting that that kind of warming could devastate the global economy, cited in particular “Ocean Acidification,” “Heat Extremes,” “Lower agricultural yields,” and “Risks to Human Support Systems.” The Bank concludes by indicating a pressing need for “increased support for adaptation, mitigation, inclusive green growth and climate-smart development.”

- Warren Buffett’s MidAmerican Renewables has been pouring money into renewable energy projects. In addition to US$11 billion invested in renewable energies over the last year or so, MidAmerican just announced that it’s investing $2.5 billion more for a 579 Megawatt plant in Los Angeles County. As MidAmerican’s Chief Financial Officer Patrick Goodman recently said, “we believe renewables is the better investment right now.” Buffett, certainly not one to invest this kind of money for the sake of being “green,” sums up the opportunity this way: “[m]any more wind and solar projects will almost certainly follow.”

- The U.S. Department of Defense, which cares first about national security, second about costs and traditionally not much about ecology, has nevertheless put together America’s single most impressive list of renewable energy and low and zero emissions transportation initiatives. Why? As then Joint Chiefs Chairman Admiral Dennis McGinn said, “Ultimately, as we gain proficiency in generating sustainable, renewable energy sources as a nation we build national strengths and stability.” How far is the military going with these projects? “The DOD is positioned to become the single most important driver of the cleantech revolution in the United States,” according to Clint Wheelock, president of Pike Research, one of America’s leading pure research firms on the subject of renewable energy.

- The insurance industry, which ultimately has to pay every time there’s a new climate disaster, has had enough. Munich RE, a leading global reinsurer whose climate practice releases key reports on the economic risks of climate change, in October wrote (registration required), "[i]n the long term, anthropogenic climate change is believed to be a significant loss driver…It particularly affects formation of heatwaves, droughts, thunderstorms and -- in the long run -- tropical cyclone intensity."

- Reuters recently published a piece explaining “Why you need a climate change portfolio,” using the cogent argument “[w]hether you believe in man-made global warming or not, it's undeniable that trillions of dollars will be spent on technologies to address the collateral damage of climate change.” We do believe in climate change, so we think there may be reason for all those dollars to flow to the appropriate mitigation and adaptation technologies with even more velocity than Reuters may be assuming.

- 350.org’s “Fossil Free” institutional divestment campaign is, amazingly, already starting to see some traction. Really. From 350’s website: “Seattle Mayor Mike McGinn sent a letter to the city’s two chief pension funds on friday [sic], formally requesting that they ‘refrain from future investments in fossil fuel companies and begin the process of divesting our pension portfolio from those companies.’”

- Even the slow-to-change traditional investment banking industry is showing signs of tuning into reality. In a blog post on its website, the New York Times cites evidence for “A Change in the Weather on Wall Street,” largely as a result of superstorm Sandy, which impacted Wall Street directly. But in addition, “[t]he other new argument is economic. Until this year, the political calculus about climate change had only one side. The oil and coal companies made sure everyone knew about the costs of action. But few people mentioned the costs of inaction. Now they cannot be ignored.”

Public opinion has already begun to change. According to Yale University’s Public Support for Climate and Energy Policies (Nov 13, 2012) report, “A large majority of Americans (77%) say global warming should be a “very high” (18%), “high” (25%), or “medium” priority (34%) for the president and Congress. One in four (23%) say it should be a low priority.”

These are just the first few recent ‘tipping point’-like stories to come to mind. I've read dozens more examples recently, and I feel the fact that I can no longer be aware of all the evidence of inflection much less keep track of it all is surely a sign in itself.

There are several additional trends underway now that may have significant impacts on renewable energy companies and their stocks in 2013: the new, emerging ways to invest in and to monetize electric utility revenues from scale solar and wind plants, and infrastructure upgrades to accommodate a renewables-friendly distributed smart grid (especially where networks have been damaged (such as in the wake of superstorm Sandy). Each of these presents opportunities and interesting ways to invest.

For us, though, the most interesting macroeconomic trend is simply that the green economy is finally showing signs of approaching a meaningful inflection point into mainstream consciousness.   

Adding it all up, it sure seems like the time is now.

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, and is co-manager of the Green Alpha ® Next Economy Index, or GANEX and the Sierra Club Green Alpha Portfolio. He also authors the blog "Green Alpha's Next Economy."

We're Staring Down the Wrong Barrel

Idiocy. Apologies, but that’s the word that captures the moment. Fiscal cliff and the debt ceiling, our twin emergencies and news pundit obsessions, are distracting most Americans from the other, far more financially destructive crisis: global climate change. Nonstop media coverage of what is really little more than political posturing and jockeying for power is cloaking a basic reality: that the US$700 billion tax hike and budget cut consequences of failing to reach partisan agreement by December 31st are trivial compared to the dollar costs of climate inaction. Leaving aside the basic existential threat posed by warming, it is suspected that climate change will cost up to or even exceed five percent (5%!) of global GDP per year starting, well, pretty much right now. Recovery from superstorm Sandy alone is expected to cost $50 billion. Adding up the costs of the now thousands of annual extreme, record-breaking weather events, one can easily see how such a significant portion of our collective productivity will be used up (see top reinsurer Munich Re's recent assessment of these risks here). Five percent of global GDP is about $3,500 billion, per year. The World Bank, while not attempting to calculate the costs, warned last month that, as the Guardian put it, "climate change could devastate the global economy." As warming-related culprits, the Bank cites mainly fresh water scarcity, agricultural destruction, sea level rise and worsening global health problems.

So not addressing climate is crushingly expensive. But so too would be mitigation, right? No. On the contrary, investment in a low carbon economy can not only help us minimize the still avoidable costs of warming, but also can be extremely economically stimulative. Why? Because innovation -- increasing economic productivity and output -- always wins. And right now, many of the most economically efficient and productive innovations could also -- almost incidentally -- be labeled as green tech. Warming is only one of many reasons world economies are now moving towards newer, better technologies. Making energy, for example, without ever paying a penny for fuel is clearly superior to the two-centuries old technology of burning fossils, even if one disregards climate aspects. In agriculture, in-ground irrigation is measurably far more cost efficient than wasteful, high-evaporation, above-ground irrigation. Innovation always wins, and usually creates jobs and incomes. As Bill Clinton recently said, "Once people know the facts, nobody's against this, but there are still too few...Americans who understand what a huge impact this could have on their future, who understand that there are already more people working in clean energy than in traditional energy. There are still too few people who intensely believe that the consequences of climate change can be calamitous, and that there are wildly profitable ways to avoid climate change. This is a great time to be alive. We just have to make sure that more people understand it and that more people participate in it." [Italics added] Reuters recently echoed Clinton's remarks in the article "Why You Need a Climate Change Portfolio" saying, "entire industries are adapting to the impact global warming is having on energy and food production, infrastructure and transportation." PricewaterhouseCoopers’ contribution to the discussion is to assert that with respect to warming, "the only way to avoid pessimistic scenarios will be radical transformations in ways the global economy functions," meaning radical opportunities for investment return and job creation.

In Washington, though, there is widespread belief that we must choose between a healthy economy and embracing the efficient next economy. President Obama laid down the essence of this false choice in his first post-election presser: "I think the American people right now have been so focused, and will continue to be focused on our economy and jobs and growth, that if the message is somehow we're going to ignore jobs and growth simply to address climate change, I don't think anybody is going to go for that. I won't go for that." I can't imagine the president isn't aware that, according to a recent Yale University survey, "a large majority of Americans (77%) say global warming should be a 'very high' (18%), 'high' (25%), or 'medium' priority (34%) for the president and Congress."  I can only speculate that Obama believes discussing climate, even though it has broad support, will damage his effort at bipartisanship and so he chooses to ignore it. But that's a dangerous and cynical political calculation given the stakes. My favorite refutation of Washington's fake dichotomy has been, "it's not jobs vs. climate. It's about a disaster economy vs. an adaptive one."

Obama and Boehner talk and talk about whether or not closing loopholes constitutes tax increases and about which, if any, Americans will get small increases to their nominal tax rate. Not discussed: the climate cliff. (Image: policymic.com)

Of the two emergencies that politicians will currently "go for," the fiscal cliff is more relevant to society than the debt ceiling, involving as it does legitimate budgetary discussions including, presumably, energy, climate and other related expenditures and/or cuts (as David Roberts (@drgrist) recently tweeted, "What percentage of Americans realize that deficit talk is almost entirely about panicking them into accepting cuts in social spending?"). At the least, a small carbon tax should be up for discussion as a potential source of new revenue, but as it is, that’s not even on the table.

As for the other topic, please keep in mind that debate about whether or not to raise the debt ceiling is nothing more than deciding whether or not to pay for the budgets congress and the executive branch have already agreed to and passed in previous sessions. Failing to raise the debt ceiling to meet our established obligations is like someone running up a credit card then deciding not to pay the bill because it's not "fiscally responsible." We could default on the credit card, but then our creditworthiness is downgraded, the interest we have to pay goes up, and we’re in a worse financial death spiral. The debt ceiling debate amounts to little more than base, petty politics at their worst, and as such  (apart from political benefits accrued by a few) it's a waste of time. And it is occurring at the same time we're being warned that "CO2 emissions rises mean dangerous climate change is now almost certain," meaning the world economy is headed towards a genuine cliff.  

Yet meanwhile, Boehner, Reid, Obama, Geithner et al., remain consumed by sniping at one another over a mostly false debate. And they’re probably going to do it all over again -- or rather keep it going -- in February, when the debt ceiling comes back up for another increase. Idiocy.

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, and is co-manager of the Green Alpha ® Next Economy Index, or GANEX and the Sierra Club Green Alpha Portfolio. He also authors the blog "Green Alpha's Next Economy."

350.org's Smart New Campaign

Many parallels exist between the college campus divestiture campaigns of the 1980s and today. Both were/are seeking to apply intense student and community pressure to persuade boards of trustees to get endowment monies out of investments in businesses or locations perceived as undesirable. In the '80s it was South Africa and Apartheid that students objected to. Back then, one could almost conceive of college students versus a beleaguered South African government as something of a fair fistfight between entities with comparable chances of winning popular opinion and thus investment dollars to their side. And indeed the students did ultimately prevail, redirecting investment capital away from South Africa, thus driving government capitulation on Apartheid, a historical bright spot that is now giving inspiration and belief in the power of action to a new generation.

Sierra Club Executive director Michael Brune speaks at Bill Mckibben's "Do the Math" 350.org tour in Durham, N.C., November 19, 2012 (Image source: Appalachian Voices, photo by Kevin Sewell).

But this time is different. This time the enemy, the target of proposed divestiture, is not a group of entrenched old men clinging to their racist past, but instead the wealthiest and most profitable industry in human history, fossil fuels. The fossil fuels industry and its several parts and cronies, big oil, big coal, natural gas, and some large financial institutions, will not retire as quietly into the night. Indeed, they began firing the first shots in this war decades ago when they first perceived that renewables could one day disrupt their extremely efficient and profitable businesses. Media disinformation about climate and renewables, influencing elections, lobbying, buying fossil fuels favorable policy; these are just some of the ways they've been pre-fighting the war of divestiture for decades.

Further, the fossil fuels industry along with its allies on Wall Street has actually been waging a divestment campaign on renewables stocks, particularly over the last two years. Using major media outlets to decry renewable energies and label them "pipe dreams," and "untenable" "job killers"(they’re actually the reverse), and using tactics such as misrepresenting renewable energy companies' earnings on-air, they have been mounting an economy-wide renewables divestiture campaign under the guise of normal financial coverage and popular opinion. This push to dictate conventional wisdom and thus discourage anyone from wanting to invest in renewables is also given legitimacy via biased bank research reports. Finally, renewable stocks are beaten down to their penny-stock graves by concentrated short selling attacks where multiple banks and other institutions join in selling as many shares of the target company as they can -- whether or not they actually have the shares to sell -- to drive the price down to where no reasonable lay investor can still imagine there is any value.

They have been working hard and long, and largely successfully, to maintain their status quo. This time, it’ll take more than a few campus shanty towns and disrupted trustee board meetings to earn change.

So to me it seems like 350.org's divestiture campaign to get money out of fossil fuels stocks is brilliant in that it is the first time we're fighting fire directly with fire. We need to understand that this time around we're bringing the fistfight to an armored division, and that we're bringing it maybe two decades late. But, finally, rather than just protesting, we're sending - or trying to send- the only message oil bosses understand: that there now may be a threat to their equity share prices, public opinion, and, soon, even short term revenues. We’re finally getting onto their turf.

So, just maybe, speaking their language will get them to understand that we must and will transform our energy society into one that can thrive on a finite earth, and also that the builders and inventors of the tech and systems that will get us there stand to earn enormous profits. Joining in this new wave of innovation, in other words, is the way forward for these behemoths of the past if they want to maintain their relevance in the final scheme of things. Impacting their share price is a good way to start attracting their attention.

Finally, let's recall that in the U.S., support of ending Apartheid became a non-partisan issue -- college students now have the opportunity show big oil that this isn't a republican or democrat issue; renewables aren't just supported by liberals, but by all people who are hopeful for our future and feel a responsibility to right the course of the planet's economies.

So please, charge on with the divestment campaign, we'll even be here to help, but remember that unlike last time, our adversary is resourceful and unfathomably rich, so there will certainly be some blowback along the way. If we can advance by baby steps -- divestiture of a college or two here and there -- I would hail that as a tremendous start and a victory, then, rebel like, we can leverage those early gains, combined with stories about times when we were set back, into tales that inspire faith that the world's largest industry really can be challenged. 

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, and is co-manager of the Green Alpha ® Next Economy Index, or GANEX and the Sierra Club Green Alpha Portfolio. He also authors the blog "Green Alpha's Next Economy."

Four American Stocks for the Next Economy

Note: this post first appeared online in Financial Advisor magazine's "Portfolio Manager Insights" section.

The Green Alpha Advisors' approach to portfolio management utilizes a top-down macroeconomic model reflecting how global economies will evolve to meet demands presented by modern challenges such as resource scarcity, growing populations, land and food management, atmospheric carbon and extreme weather, to name a few.

These emerging challenges are daunting, but fortunately, society is answering and acting to preserve our economies and way of life with a new wave of innovation, the like of which has not been seen since the information technology revolution of the 1990s and the industrial revolution before that. 

The companies providing these innovations will see rapidly increasing demand over the next few years as economies rise to meet big challenges, and capital, as it always does, will flow to the best solutions. This is what defines the next economy: it is comprised of companies providing products and services that can thrive in the future economy as well as they do now (perhaps even better), and/or companies whose business is directly in the path of solving one or more of our main challenges.

It is among these innovators that one may now find the next Googles, Apples and Amazons. And, as with the first to see the promise of information technology, the first investors into the next wave of innovation will be the ones who have the best chance of outsized returns. With that in mind, here are four companies, based here in the U.S., that are timely in their deployment of innovative technologies, ideas and services. The global economy's next leap forward is beginning with firms like these.

Ocean Power Technologies, Inc. (OPTT) designs, makes and deploys ocean buoys that generate electricity from the kinetic energy of ocean waves. Their technology is proven effective, and in places where waves are always present (like the West coast of the U.S.), it doesn't suffer from intermittency as do wind and solar. Among Ocean Power’s best customers and advocates is the U.S. Navy, which has identified wave electricity as a way to power bases and missions, and yet have no reliance on external sources.  Ocean Power has also recently teamed up with Lockheed Martin to deliver two utility-scale projects, one off the coast of Oregon and the other for the Commonwealth of Australia. This is a small company with great growth prospects.

UQM Technologies, Inc. (UQM) makes propulsion systems for electric vehicles (EVs). UQM is not an electric car maker, but provides power systems and drive trains to companies making or converting fleets to electric. FedEx, UPS, London Taxi cabs, Audi and many others have converted portions of their fleets to electric using UQM. UQM's systems are remarkably efficient. FedEx CEO Fred Smith has said his electric delivery vans operate at 75% less cost than diesel vans. As Smith said, "Not 7.5%, 75%. These are big numbers." Recently, UQM has also entered into a memo of understanding to provide its electric propulsion systems to China's "New Energy Vehicles" state program. With its record of quality implementations, strong client list and ability to deliver big cost savings, UQM is a great way to get exposure to the EV sector without betting on any individual car company.

GT Advanced Technologies Inc. (GTAT) is an original equipment manufacturer (OEM) providing the machines that help make light emitting diodes (LEDs) and solar panels. LEDs are bright, adaptable to uses from TVs to phones to streetlights, make light with far less electricity than incandescent or fluorescent, and last as long as 20 years between replacing. As a result, the LED sector is booming. Solar, for its part, is clearly going to be one of the main pieces of our electricity mix going forward, and the guys who make the machines that make the panels should have steady business as this growth accelerates and will be less sensitive to fluctuations in the prices of the panels themselves (as opposed to panel and module manufacturers).

Remarkably, GT was competing just fine toe-to-toe with the Chinese solar industry, long before U.S. tariffs on Chinese solar came along, a fact that inspires confidence in management effectiveness. In both LED and solar, GT Advanced Technologies is a great way to invest in an overall industry without having to select individual product manufacturers. 

Trex Company Inc. (TREX) manufactures and distributes wood-composite lumber substitutes for residential and commercial decking, railing, fencing and similar applications. Trex makes its products from reclaimed wood and plastic waste, and their boards are attractive and very durable. (Trex claims a positive return on investment of its products versus wood is less than 6 years). We consider Trex a prime example of waste-to-value economics that not only keeps huge quantities of waste out of landfills and oceans (Trex used 3.1 billion plastic bags in 2010, and is responsible for 70% of all U.S. plastic bag recycling), but also delivers a superior product with better long term value. In a world of constrained resources, making great stuff from leftovers is the best of all worlds.

Each of these four firms has a great operational story, and they fit well within Green Alpha’s macroeconomic thesis. In addition though, three of the four have to differing degrees suffered share price setbacks recently, providing attractive entry points. Ocean Power and UQM Technologies in particular have suffered long retrenchments but due to recent business improvements have begun to see share prices stabilize. OPTT is trading below both cash and book value and, with several projects upcoming, should be able to reach profitability and expand from there. UQM is expecting to reach profitability in its next full calendar year, and could be poised for rapid growth.

Already profitable and with a much larger market cap, GT Advanced Technologies is less speculative that the OPTT or UQM, yet has seen its share price decline rapidly as well. GTAT’s solar business probably explains that, as solar manufacturing stocks as a group have done poorly since mid-2011, but the market may be mispricing GTAT on this basis for two reasons. First, GTAT is not a panel maker, but a business to business panel equipment provider, where orders have remained more consistent. Further, GTAT’s other business, LED lighting, should be insulating it from the full vagaries of solar valuations. Second, GTAT has a very strong balance sheet which should allow it to withstand solar’s downturn, and the company remains profitable, expecting steady or modestly growing EPS for the next couple of years. Still, the company today trades at only 63% of sales and only 1.6 times book, so there’s plenty of upside potential as the company comes back to objectively reasonable valuation.

Trex is the one firm discussed here to have had outstanding share price performance so far this year, and with good reason. After losing $0.75 per share in 2011, the company is poised to earn $1.58 in 2012 and is forecasting $2.33 EPS for next year. Booming growth by any reckoning, resulting in a forward year PE of 14. Given their earnings growth, TREX need only return to their historical PE average just above 19 to deliver a nice return to forward looking next economy investors.

Disclosure: Green Alpha Advisors is long GOOG, OPTT, GTAT, UQM and TREX, but has no positions in AAPL, AMZN, NSU, FDX, UPS or LMT.

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, and is co-manager of the Green Alpha ® Next Economy Index, or GANEX and the Sierra Club Green Alpha Portfolio. He also authors the blog "Green Alpha's Next Economy."

Hurricane Sandy: "It's Global Warming, Stupid"

On today's broadcast of the news show Democracy Now hosted by Amy Goodman, Cynthia Rosenzweig, co-chair of the New York City Panel on Climate Change, went out of her way to begin her comments on Hurricane Sandy and the effects of global warming to issue a disclaimer: "but first Amy, I need to make something very clear: any one storm cannot be associated directly with climate change…we have to be very careful not to say Hurricane Sandy was caused by climate change." Unfortunately, this could easily be taken to imply that warming and Sandy may have had nothing at all to do with one another. The word "associated" is particularly misleading (as opposed to "caused") because to say a given storm and global warming aren’t associated is flat untrue. Rosenzweig said this right at the beginning of her segment, before she went on to explain about the dangers of climate change (which as a distinguished climate scientist she is qualified to do). This is the kind of overly couched, ass-covering commentary that drives me crazy. Because the fact is that global warming did, unquestionably, influence Sandy. 

Bloomberg Businessweek Cover, November 5, 2012.

Basic chemistry proves carbon dioxide traps heat, primarily infrared wavelengths. This has been known since 1859, and is clearly demonstrated in this great BBC video experiment. (If you have any doubts at all regarding the fundamental science, watch it, and even if you don’t, it’s pretty cool). Since the beginning of the fossil fuels era, the amount of carbon dioxide in the atmosphere has increased close to 43 percent, from 280 parts per million (PPM) to 400 PPM. That is a lot more carbon dioxide holding a lot more heat energy. So much energy that simple calculations reveal that between 1951 and 2011, extra carbon dioxide in the atmosphere has added energy in the amount of 210 sextillion additional joules that would not be here at the old 280 PPM levels.  (Energy or heat wise, a joule is a little less than a quarter of a calorie.) So we've added 210,000,000,000,000,000,000,000 extra joules of heat and counting (we're adding about 34 billion tons more per year), and that energy is in every molecule of the atmosphere. That's how it works. More energy in any system means that system is powered to be more active. If you throw a ball 43 percent harder it will fly with more force. If a gallon of gas gets you and your car 20 miles, 1.43 gallons will get you 28.6 miles. That's what warming is, extra energy rendered as heat.

Small wonder insurers have concluded that the rate of weather-related disasters has quintupled over the last three decades. Yes, there were storms back before warming, when the atmosphere was still at 280 PPM, but they had a lot less energy to work with. There can be no question that the additional energy in the molecules of the atmosphere comprising Sandy influenced her strength. On the contrary, physics indicates that it's impossible for all that energy not to have influence, as if somehow Sandy existed in a 280 PMM atmosphere, as if she grew in a bubble shielded from reality. She didn’t, we don’t. It is worth observing that with energy in the atmosphere at its highest in the era of human recordkeeping, Sandy came ashore with record rainfall and record storm surges.  (Spoiler: as additional carbon dioxide traps still more additional energy in the atmosphere, more extreme weather event records will be set. Soon.) Sandy may well have existed in a 280 PPM world, but there is no way she would have been the same storm with the same energy; implying that all things might have been equal in a pre-warming world and present day is misleading and just wrong.

However well intentioned, comments like Dr. Rosenzweig’s provide the kind of exclamation that gets repeated without context ad nauseum by proponents of climate disinformation. Don’t be surprised if disinformer-in-chief Senator James Inhofe even quotes her on the floor of the Senate to make his case for "drill baby drill." (Don't laugh, Inhofe has applied this tactic using the words of 350.org’s Bill McKibben, Grist’s David Roberts and others; see this year’s Senate Hearing on Climate Change, starting at 1:40 in this video.)

Fortunately, not all media communication on warming is so timid. Enter Mike Bloomberg. His approach to business and government has been empirically rational and evidence based. If data tell him something unequivocally, that's what he seems to believe. His endorsement of President Obama in next week's election was made on the same basis, "I want our president to place scientific evidence and risk management above electoral politics." So for him and his organization it made sense for the post-Sandy cover of their flagship magazine Bloomberg Business Week to read "It's Global Warming, Stupid," above an image of a Sandy-flooded New York City. This is evidence based, real, non-misleading climate communication, from a man not afraid of backlash. Kudos, Mayor Bloomberg. Your unwillingness to temper science in the face of monetarily or ideologically motivated pressure shows us a real way forward.

But still there remains the other end of the communications spectrum. In her effort to be fair and balanced, and qualified as she is, Dr. Rosenzweig seems not to realize that her language plays into the hands of climate change deniers funded by and existing for the benefit of the fossil fuels industry. Many news viewers and listeners don’t get past the first 30 seconds of a segment, so unfortunately all some people heard was an expert say, “we have to be very careful not to say Hurricane Sandy was caused by climate change.” As a result, more people, not less, arguably think climate science must be debatable. It’s not.

We’ve been so conditioned by climate deniers’ chimera of false fairness and by fear of being labeled ‘extremist’ that now even climate scientists are making arguments that seem to encourage doubt. Dr. Rosenzweig, plainly speaking the truth is not extremism. Fear to do so is.

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, and is co-manager of the Green Alpha ® Next Economy Index, or GANEX and the Sierra Club Green Alpha Portfolio. He also authors the blog "Green Alpha's Next Economy."