As we continue to debate and discuss the future of international climate policy, how might a post-2012 policy affect clean energy and clean technology investment? During today's OnPoint, Michael Liebreich, CEO and founder of New Energy Finance, a London-based company that specializes in research of clean energy and carbon markets, discusses how game theory can be applied to climate negotiations. Liebreich comments on the importance of incentivizing clean energy investment throughout the world. He also explains what a recent 30 percent drop in ethanol prices will mean for investors and the biofuels industry.
Monica Trauzzi: Welcome to OnPoint. I'm Monica Trauzzi. Joining me today is Michael Liebreich, CEO and founder of New Energy Finance, a London-based company that specializes in research into clean energy and carbon markets. Michael, thanks for coming on the show.
Michael Liebreich: It's a great pleasure.
Monica Trauzzi: You recently wrote a paper leading off by saying, "The Kyoto Protocol is due to expire in 2012. Conventional wisdom, especially among its fans is that without agreement on a successor treaty the world will spiral into ever increasing emissions, and Climate catastrophe will follow." New Energy Finance disagrees. We just came off of a week of international meetings focusing just on this, the post-2012 treaty that most countries would like to sign onto. What do you mean by your statement? And do you disagree with these international meetings that are happening?
Michael Liebreich: The international meetings are very important, there's no question. That's not what we're saying. What we are saying though is that instead of hoping for a single big bang treaty that's going to save the world, we should be thinking about this as an ongoing process where over a period and a number of rounds, over a long period, a framework and emerges and countries take action to address climate change. And moreover, not only that that's the right way to think about it, but also we're actually optimistic that that is actually what's happening, that we are seeing progressive stages of negotiations and also significant action unilaterally by countries to address the problems.
Monica Trauzzi: What about the role of the U.N.? You talk about the U.N. as well and you say that the U.N. should stop focusing on corralling all members of the international community into one room and trying to get them to make simultaneous, binding commitments on emissions reductions. So what's the UN doing wrong? What could they be doing better? Last week's meeting at the UN is being hailed as highly successful.
Michael Liebreich: Yes and it was successful, but as a stage in a process. I think, again, it's this question of whether you see the U.N. as being somehow in charge of the process and driving the process and then policing the process or whether you see the U.N. as holding the ring while countries, over a long period, take successive bites out of the problem. So that's what we're saying. Now, where I come at this from, where we come at this from is looking at this not as a kind of a one-off game where countries will all sit in a room at once and come up with the outcome, winners and losers, and action plans, and then simply spend the next 50 years executing on that. Where we're coming at it from is saying, no, the game, it gets played repeatedly. Every year politicians, businessmen, financers have to think about what it is that they're going to do. And taking that point of view, the role of the U.N. is not to focus on that one big treaty, but to make sure that countries understand how best to play that game over a long period.
Monica Trauzzi: So what would a post-2012 agreement mean for investment in clean energy? Would it make it more secure? Would businesses invest more if they had this international treaty to look at?
Michael Liebreich: Yeah, clearly a post-2012 agreement, so if you like, the ink on the paper, would make it safer for investment. But what we're seeing is that investment is happening anyway. That's what we do as a company, is we track investments across all stages, every asset class, all stages of the industry, from early stage venture through private equity through the public markets through the asset finance. And it is increasing at an extraordinary rapid and sustained rate. And it's doing that because countries are taking action domestically and pretty much unilaterally. And if you look at what's happened with for instance the European carbon markets. That's almost a unilateral move by Europe without the participation of the U.S., without the participation of Australia, and without the participation of the developing world. And yet Europe is taking action and companies are investing accordingly. Now, the more certainty the policymakers can give about the long-term structures and the long-term price signals about carbon, then the safer the environment becomes to invest. But our thesis is that that is going to happen anyway because of the nature of the game and the negotiation. That countries are appropriately addressing the problem unilaterally.
Monica Trauzzi: I want to talk more about this game.
Michael Liebreich: Yeah.
Monica Trauzzi: Because you use game theory to discuss this point precisely. And you say that the U.S. needs to start being nice.
Michael Liebreich: Yup.
Monica Trauzzi: Europe needs to learn to retaliate and the developing world needs to forgive. Explain what the U.S. is doing wrong here, why the U.S. needs to be nicer.
Michael Liebreich: Well, let me go back to just -- let me explain what I mean by the game. A lot of people see climate change as being the tragedy of the commons and they characterize it as a prisoner's dilemma. In other words, if everybody else is going to fix the problem I don't have to do anything. But conversely, if nobody's going to fix the problem there's no point in my doing anything. So either way I don't do anything. And that's a classic prisoner's dilemma. And what we're saying is that if you play that game repeatedly however, than the strategies become very different, instead of just being to defect to do nothing. Then the appropriate strategy has four pieces. There's academic work. There's lots of work on repeated prisoner's dilemmas. And what it says is you should be nice. So you start off by making a unilateral commitment. Retaliatory if other people don't make their own commitments. Then you retaliate. You've got to find ways of retaliating, making it painful for them not to be part of the process. Forgiving, so the moment they do come back into the fold and they start to participate then you welcome them in. And in this case it might be technology transfer, it might be funding. There's all sorts of ways that you can signal forgiveness. And then clear, because if everybody knows that that's how the big nations, the powerful nations are going to play that game, then there's no point in trying to game it. There's no point in trying to defect and not take action. So the four pieces, nice, retaliatory, forgiving, and clear, that forms the framework of an appropriate sort of national or regional strategy. And then you can start to evaluate how are the different players doing? So you can look at Europe for instance and say, well, Europe unilaterally took a big commitment by signing up for Kyoto, ratifying it, and then building things like the European Carbon Trading Scheme. So no problem with nice, but Europe has a problem being retaliatory for historical, political reasons, or whatever, but doesn't have sanctions against countries or regions that don't participate. If you look at the U.S., the U.S. hasn't yet made its first big steps. So the U.S. is pursuing what in game theory we call the agnostic strategy and that is a problem because that is not then sending the right signals to, in this case particularly, the developing world, which has also not made its first commitment. When we talk about the developing world needs to be forgiving, I was recently at the U.N. General Assembly and I was talking to them, addressing them about investment activity. And delegate after delegate stands up and says this is a problem caused by essentially, they may not say it in these terms, but this is a problem caused by the colonial powers or former colonial powers. It is your problem. You fix it. And that rhetoric belies the activity that's actually going on in China, in India, in Brazil, in many, many countries on energy efficiency and addressing the carbon problem. But instead of using rhetoric that says we're part of this process and we'll do what we can, in fact, we're already doing what we can, you get a lot of signaling coming out, a lot of unforgiving language, which I think is clouding the picture and it reduces the effectiveness of their strategies.
Monica Trauzzi: OK, so let's talk a little bit domestically, the U.S. specifically. We're hearing a lot in Congress about an energy bill. We're also hearing about a potential climate bill that could be either a cap and trade or a carbon tax. How would something like a renewable portfolio standard or a cap and trade bill play into this?
Michael Liebreich: I think those are meaningful signals to the other players in the game. Those would be very, very meaningful steps. In fact, the energy bill, at the moment it seems to be sort of deadlocked because everybody wants one, but the different players want to make substantial commitments, but in different directions. Well, why don't you just put them all together and make all the commitments is what we would suggest. Renewable portfolio standards I think also would be a very strong signal, as would either a cap and trade or a carbon tax. And the reason those are all good signals is because they can't be faked. Like rhetoric can just be faked. Somebody can stand up and say, oh yes, we're taking climate change very seriously. But, in fact, the only signals that will be taken seriously by other players are flows of resources, and more than just political capital, flows of real financial economic resources. And when the other players start to see the U.S. doing things that really have economic impact, then I think you'll see different responses from, in this case, particularly the developing world.
Monica Trauzzi: I want to switch gears for a moment. The national price of ethanol has dropped by 30 percent since May. How dangerous is the climate right now for people who have made investments or are making investments in the ethanol industry?
Michael Liebreich: Well, ethanol was a very specific thing. We track investments across not just biofuels, but also wind and solar and marine and energy efficiency and carbon capture and storage and so on. Ethanol was a very specific situation where if you like there was an arbitrage opportunity. There was just a big gap that opened up between the cost of corn and the price of gasoline. And a lot of people looked at that and said, gee, we could build an ethanol plant and that crosses that gap. And look how good those margins are. And of course a lot of the people who were saying that actually didn't come from a commodities hedging background. They came from more of a venture capital, private equity background. And I think they just got wrong footed by the way these spreads can open up and then a bunch of things happen and those spreads can close back down again. So the short answer is, yes, that one is a dangerous place to put your money.
Monica Trauzzi: Are small businesses going to get hurt here? What do you see for the future of the ethanol industry?
Michael Liebreich: I think the ethanol industry will be safe-ish, and the reason is that it has a very substantial political following. So I think that ways will always be found to make sure there is a U.S. domestic ethanol industry. Will there be sufficient money available from either federal or state levels to make sure that these really substantial goals of 35 billion gallons and so on can -- will there be that much money available for the U.S. domestic ethanol industry? I suspect not.
Monica Trauzzi: What should the federal government be doing?
Michael Liebreich: I think the federal government has to do the following. We need a U.S. domestic ethanol industry, not just for climate reasons, which is more marginal, but also for energy security reasons. The question is how big should it be? Should it be providing three percent, five percent, seven percent, 15 percent, 20 percent of your transportation fuel? The answer I would come up with would be, let's call it 5, 6, 7 percent. The only way that it should be supported above that would be if it can be economically competitive. See, at that level it gives you a little bit of energy security. It doesn't cost too much. It's good thing to do. When you start going above that then you start to impose some very real costs on the U.S. economy, which would be unjustifiable unless you can either have a big breakthrough in cellulosic. Or more likely what you should be thinking of is using your ethanol strategy as a country to build links with Central and Latin America. And binding some of the countries that need some access to the U.S. markets into a North American economic system in a way that -- you know, it's a good tool to build some friendships in Central and Latin America.
Monica Trauzzi: More broadly, the U.S. has focused on creating and improving technologies in recent years. And we're leading in that area, really.
Michael Liebreich: Correct.
Monica Trauzzi: What are the main areas in which the U.S. lags in terms of clean energy investment?
Michael Liebreich: First of all, on technology investment, just to put some figures on that. If you look at early-stage venture investing in clean energy technologies the U.S. is out-investing Europe by three or four to one, just every single quarter. We look at the figures, three or four to one. You know California has really -- it's in the harness and it's just pulling away from everybody. So if there's going to be a clean energy Google or a clean energy eBay, it's probably going to be funded out of California or out of the U.S. venture-capital community. And that's great. What I would say is that the U.S., not surprisingly, is a bit of a patchwork. So for instance, you've got the Southeast, those southern and southeastern states where there's really very little progress. And there's more signs now coming out of South Carolina and science coming out of Florida. I think FPL just announced a $3 billion commitment to solar thermal power stations. So not photovoltaic panels, but thermal use of solar, which is very exciting. But it's a patchwork. And I think that in a sense what we see as the direction is good pretty much in every sector and in every region. But it's really a question of filling in the gaps, number one. And then looking at federal frameworks, because I think the way you see progress in the U.S., in legislation, tends to be there's a few kind of wacky states that go and do things unilaterally. And then some other states come along and they'll have a renewable portfolio standard or air quality they'll work. And then there comes a point where about half the states have adopted a model and then there starts to be a stronger and stronger push for federal frameworks. And I think we're at that point. Renewable portfolio standard is an absolutely clear case in point.
Monica Trauzzi: Twenty some odd states have --
Michael Liebreich: Twenty-six states I think it is. And it's time just to say, you know what, this is the way we do things and let's have a federal scheme, because there's a cost to business to having a different renewable portfolio standard in each state with a different legislative process, different decisionmaking process, different timeframes, different time horizons, different goals. So there comes a point where you say, you know what, this is imposing a cost on business now which can be reduced by simply taking a federal approach. So I think we're there on renewable portfolio standards. The consensus isn't possibly quite there yet on carbon, on having a national cap and trade, but it will get there. The trend is absolutely clear. So those are a couple of things that would definitely help.
Monica Trauzzi: OK, the perfect note to end on. Thanks for coming on the show.
Michael Liebreich: Thank you.
Monica Trauzzi: This is OnPoint. I'm Monica Trauzzi. Thanks for watching.
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