Friday, 19 October 2007

Investing in climate change

Deutsche Asset Management has released an interesting report on Investing in climate change. It's based on the belief that climate change, and all the economic and technological issues around it, is emerging as a 'mega-trend' that will shape the asset management industry in the near future. Ultimately, they reckon, most mainstream investment analysis will have to take into account the effects of climate change in terms of costs and opportunities for companies and markets.

The Deutsche team neatly summarises the scientific and economic issues, drawing on various well-known sources including the IPCC's Nobel-winning work, the report on the economics of climate change by the newly ennobled Nicholas Stern, and the McKinsey paper setting out a cost curve for greenhouse gas reduction. Some parts do smacks of boardroom bullshit, though - a prize to anyone who can convincingly describe exactly what the graph on p10 tells you.

So what does it mean for cleantech venture investment?

Deutsche reckon that the impact of climate change 'as a complex and enduring economic force' over the next 5-10 years should create market inefficiencies which offer significant gains for smart investors. For retail investors, that creates a limited role for small-cap cleantech stocks as part of a well diversified portfolio. For institutional investors, a less diversified strategy focused on pure cleantech companies 'might make more sense as it creates more diversification against other asset classes'. Good news for specialist VCs raising funds - and, of course, for the beneficiaries of those funds.

The report also focuses on the role of government policy on the carbon-cutting technologies at the top end of the cost curve - ie, things like industrial carbon-capture and large-scale biodiesel which are currently prohibitively expensive but which may still be needed to hit the necessary emissions targets. Government policy can dramatically alter the cost structure of these technologies, through R&D support and encouraging economies of scale. Experience with other alternative energy tech shows that a doubling of capacity can create cost cuts of up to 35%, bringing expensive techs into a wider market. As the report notes, while it may be tempting for an investor to focus purely on technologies that are currently low-cost, 'some seemingly prohibitively-expensive technologies are potentially very important investment themes and therefore represent another key area for analysis and return generation'. Again, that suggests real opportunities for serious risk capital.

The full report is available, as a 2.6Mb PDF, from here.

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