This article was originally published in the Organizations and Social Change blog. In April 2018, David authored a report ‘Financing Climate Resilience: Mobilizing Resources and Incentives to Protect Boston from Climate Risks’.

It’s approaching three years since hurricane Sandy killed over 230 people in 8 countries, and wreaked havoc on the New York-New Jersey region – and put climate adaptation firmly on the national agenda. Sandy, which disrupted at least 450,000 businesses in New York and New Jersey, illustrated how cascading impacts not only damage property but also disrupt businesses for extended periods of time, due to the interaction of power and communication outages, infrastructure damage, and supply chain disruptions. These complex interactions were not adequately understood or anticipated. The reinsurance company Munich Re has estimated insured losses at $25 billion and total losses of at least $50 billion in the US from Sandy. Looking to the future, the 2011 Mass Climate Adaptation report notes that: “Sea level rise of 0.65 meters (26 inches) in Boston by 2050 could damage assets worth an estimated $463 billion”. Cities and states have begun to devotesignificant resources to planning for sea level rise, more frequent and intense storms, and more intense heat and drought. In one design-for-climate-change scenario, Boston would be transformed into an American Venice.

There are some similarities between climate mitigation and adaptation, but also some important differences that need to be considered if we are to tackle the adaptation challenge effectively.  Some environmental groups have tried to avoid discussion of climate adaptation, for fear that it was conceding the mitigation battle to solve the climate problem at its source by reducing greenhouse gas (GHG) emissions. Adapting to the physical effects of climate change, however, is now an unavoidable reality, because our emissions trajectory has already locked in substantial climate impacts. Indeed, the immediacy and tangible costs of climate impacts may well provide a new impetus to reduce GHG emissions, as policymakers realize the huge costs of preparing coastal urban areas, which will rise steeply without more aggressive action to reduce emissions. Adaptation and mitigation should therefore be seen as complementary.

As business, academics, and policymakers begin to grapple with climate adaptation, some key differences from climate mitigation are becoming clear. First, while mitigation has primarily been understood as an issue affecting the global commons, adaptation is a very local concern, where vulnerabilities are highly dependent on local geography and the urban landscape. Addressing mitigation therefore requires countries to negotiate and collaborate on emissions reductions, as seen in December at COP-21 in Paris, because our fate depends on everybody else reducing their emissions as well. Adaptation, however, does not have these positive spillover effects; New York does not directly benefit if London invests to protect itself from rising seas – though opportunities for learning do exist. At the local level, some adaptation measures, especially sea walls, can even exacerbate problems down the coast. Cities therefore have a strong incentive to invest to protect themselves, but much less reason to collaborate.

Second, the key business players are different: For climate mitigation, the fossil fuel industry (and related sectors such as automobiles) saw high economic risks from climate regulation, and has historically been a strong political force against regulation, especially in the United States. For adaptation, the property sector is most vulnerable to direct physical losses, including commercial and retail businesses that occupy buildings at risk. As a result, the sector has been active in local discussions about adaptation, and generally supports publicly funded city or region wide approaches. The sector has, however, been wary of expensive private mandates to enhance building resilience, and is unclear how it might monetize the benefits of reduced risks.

The insurance sector also bears considerable economic risks from exposure to physical climate-related damages, and so has an interest in enhancing resilience. Insurance rates could play an important role in shaping incentives: insurance represents the price of risk, and this price could be used to steer new construction away from vulnerable areas and to encourage investments to reinforce buildings against storm damage. The price of risk for climate adaptation is analogous to the price of carbon for climate mitigation. Yet it is a tool that offers less leverage, because insurance is a relatively small cost of doing business, compared with the role carbon prices can play in switching to cleaner energy sources. The financial sector more broadly will be taking note of these physical risks. Just as investors are growing increasingly wary of carbon intense investments, they are increasingly likely to avoid assets, from commercial property to agricultural land, that are vulnerable to climate impacts.

Third, the broader business opportunities are also less clear with climate adaptation – while there will be a growing market for large construction and engineering projects, and specialized consulting services, it is hard to imagine the equivalent of the clean energy sector, which has blossomed into a $250 billion global market for solar, wind, and biofuels in 2013, and has been growing rapidly as an economic and political force. For climate mitigation, there are also substantial short-term economic benefits for organizations that invest in their own emissions reductions through energy efficiency measures such as insulation and high-efficiency lighting. For adaptation, there might be some opportunities for profitable investments in improving the resilience of facilities to flooding and wind damage, but there will also be a need for major public investment in expensive neighborhood and city level protection schemes. This raises difficult finance and governance problems, especially in the US context of fragmented authority.

The clustering of clean tech activity in the Boston area creates regional competitiveness impacts and signals the strength of the regional innovation economy, which helped to motivate GE to announce the relocation of its headquarters to Boston in January. Although there is unlikely to be a parallel climate adaptation business cluster, there may well be real value in addressing climate adaptation at the regional level. In the wake of hurricane Sandy,rents fell precipitously in the New York city area, as people feared the long-term economic impact from businesses avoiding a region perceived as vulnerable to major climate-related disruption. Since then, rents have more than recovered, partly due to the ongoing economic recovery, but also, according to some observers, as a result of the comprehensive adaptation planning for the region. Adaptation planning is likely to become an important ingredient of regional economic competitiveness, at least for vulnerable areas. Less clear is how this value can be leveraged in a way that can finance the huge expenditures involved in protecting a large metropolitan region.

Fourth, climate change raises important equity issues for both mitigation and adaptation. International negotiations over emissions reductions have long been bedeviled by the North-South divide, as low income countries of the global South do not want their future growth constrained by stringent GHG targets, when industrialized countries are responsible for the vast majority of historical emissions. Closer to home, workers in coal, oil, or the auto sectors do not want to bear the burden of a shift to a low-carbon economy. Climate adaptation also raises equity issues regarding the distribution of risks and costs, that are shaped by the local character of climate impacts and adaptation efforts. Some of the most vulnerable regions are in developing countries with few resources and which have contributed little to historical emissions. For example, regions in sub-Saharan Africa and the Middle East are facing the prospect of severe drought, while countries such as Bangladesh face catastrophic flooding as sea levels rise.

Even in industrialized countries, communities with high proportions of low-income and minority people (and the businesses they own and frequent) are generally much more vulnerable to climate impacts – buildings might be older and less resilient to storms and floods, they are less likely to have air conditioning to protect against extreme heat, and less likely to carry adequate insurance coverage to rebuild homes and businesses after a disaster. As insurance rates rise in vulnerable areas, or coverage is cancelled altogether, poorer communities will be disproportionately affected. One of the first papers on social justice in urban climate adaptation was published in early 2016, and points to some key issues: (1) broadening participation in adaptation planning to include com­munity or social justice advocacy groups; (2) expanding adaptation efforts to rapidly growing cities and those with low financial or technical capacity – climate impacts are estimated to cost cities in the Global South more than $109 billion annually in infrastructure invest­ments alone; and (3) integrating justice into infrastructure and urban design processes – this is key, because “cities often undertake climate-change-oriented projects as strategic decisions to protect existing centers of global investment, economic growth and infrastructure expansion, and not towards broader environ­mental or social justice goals”.

As the scientific evidence regarding climate change grows more dire, the political community is waking up to the urgency of the challenge. The targets set at the recent Paris COP21 climate conference require substantial decarbonization of our economy, reducing GHG emissions by around 80% by 2050, which some groups estimate might cost upwards of $1 trillion per year globally to restructure our energy, housing, and transportation infrastructure systems. The costs of climate adaptation are largely unknown for a 6 foot rise in sea level, but are likely to be at least on the same order of magnitude. Clearly, climate change is going to be a huge economic, financial, and political issue for decades to come. But it also offers a unique opportunity to recreate local economies in ways that address many of the social and economic challenges and inequalities that beset our society.  If trillions of dollars need to be invested to decarbonize our economies and make our cities resilient, this investment should be guided by a transformational vision of creating sustainable, resilient, prosperous and equitable communities.

This article was originally published on The Conversation. Read the original article.

In the run-up to the much-anticipated COP21 international climate summit in Paris, business leaders worldwide have shown substantial support for action on greenhouse gases (GHG).

The White House launched the American Business Act on Climate Pledge, with 81 companies representing US$5 trillion in market value committing to take more aggressive action. Ten large oil and gas companies, mostly from Europe and representing 20% of global production, announced an Oil and Gas Climate Initiative that “will collectively strengthen our actions and investments to contribute to reducing the GHG intensity of the global energy mix.” Nonprofit The Climate Group launched the RE100 Initiative, under which 45 large companies declared their intention to move toward 100% renewable energy over the next several decades.

This beehive of corporate activity represents a transformation in corporate attitudes and practices over the last couple of decades. At a recent talk at the University of Massachusetts, Boston, Rachel Kyte, World Bank group vice president and special envoy for climate change, said:

The private sector is at an inflection point; it’s very different than (the 2009 UN climate summit in) Copenhagen. There is an embrace of the science that there was not six years ago. There has also been an extraordinary evolution in the economics; we recognize that the cost of inaction will be brutal.

Can this “corporate pivot,” in Kyte’s words, save the planet from climate change?

What business brings

Business certainly brings vast financial, technological, organizational and human resources to bear, and it constitutes a powerful political force that can exercise considerable sway over public opinion and policymakers.

Business increasingly recognizes that, left unchecked, climate change presents a series of long-term risks, from flooding and drought to political instability and more drastic regulation. There are also significant business opportunities, particularly in clean energy and energy efficiency. The business of carbon measurement, reporting and management is itself booming.

While the shift in the stance of business is certainly welcome, unfortunately it is not moving us nearly far or fast enough toward decarbonizing our economy, which requires cutting GHG emissions at least 80% by 2050 to stabilize the planet’s climate system.

A key reason is that corporate climate-related initiatives are largely treated as part of their voluntary Corporate Social Responsibility (CSR) activities – all the new business initiatives mentioned above are voluntary. Although most large companies have now embraced CSR and more than 11,000 report their activities, these CSR-style measures usually don’t have much impact on the technologies, products and growth plans that constitute the heart of most businesses’ operations.

This disconnect helps explain the apparent paradox of intense corporate activity but slow movement toward actually reducing global emissions, which have continued to rise globally at 2%-3% a year until stalling in 2014. It is still unclear if this slowdown represents a turning point or is just a short-term effect of China’s slowing growth combined with cheap natural gas displacing coal in power generation.

Sustainability comes to coffee

My colleagues and I explored this paradox in a recent paper that examined the interaction of business, states and nongovernmental organizations (NGOs) as they developed CSR frameworks around sustainable coffee labels, such as Fair Trade. We described how the concept of sustainability had successfully moved from the margins to the mainstream, and had been embraced by leading coffee roasters and retailers. This success, however, came at a price. We argued:

Activists’ early visions of a more sustainable, equitable and accountable global coffee order have been diluted and absorbed by mainstream business. The idea of sustainability has been reduced to a set of standards and certifications for managing reputation, quality and supply chain risk.

We found that businesses and NGOs developed frameworks for CSR by negotiating codes of conduct, reporting standards, label certifications and auditing requirements. The push for sustainability led to a shift in how coffee is valued – economically, in the marketplace, and culturally, in the minds of the public. It introduced what we call a new “value regime” for coffee that captured growing consumer concerns for environmental and social conditions. Retailers like Starbucks successfully translated sustainable coffee into profitable new market segments with premium prices for branded high-end products. Roasters, and some growers, also profited from this economic model.

With certifications such as Fair Trade, many people now know more about the source of their coffee, but sustainable coffee hasn’t fundamentally changed the basic dynamics of the industry.
riot/flickr, CC BY-NC-ND
Though business initially resisted activists’ demands for sustainability, they have gradually become more collaborative in their approaches, negotiating pricing mechanisms and environmental standards, and sometimes launching their own sustainability labels. NGOs have also been willing to compromise to secure the mainstream uptake of sustainability by, for example, offering not only social and environmental certifications but also quality and supply chain management services.

Simultaneously, business has been willing to integrate CSR as a tool for measurement, management and disclosure that helps companies manage risks and differentiate their products and enhance their brands with consumers.

As a result, CSR has achieved some real, positive changes in business practices of the coffee industry. But CSR has not changed the fundamental inequalities in the sector. Affluent western consumers now purchase larger quantities of higher priced coffee, which is still served by low-wage retail employees and mostly grown by impoverished workers in developing countries.

There are some important parallels here for current efforts to address climate change in business. As in the coffee industry, sustainability has evolved to become a corporate tool for measuring carbon footprints and reporting various initiatives, from carpooling and recycling to renewable energy commitments.

These CSR measures do have a real impact, because measurement and reporting brings managerial attention to the potential for investing in the low-hanging fruit of emissions reductions, such as energy efficiency, with strong returns on investment. Many larger companies are hiring chief sustainability officers with broader mandates and bigger budgets than more traditional, compliance-focused environmental, health and safety managers.

Limits to CSR

These voluntary CSR-style measures, however, only take us so far. CSR is inherently limited by the difficulty in transitioning to a low-carbon value regime, an economic model that would need to generate value for businesses and also align with consumers’ values.

Consumers might be willing to pay a substantial premium for fair trade coffee lattes but are more resistant to paying significantly more for greener electricity or high-efficiency hybrid vehicles, let alone reducing their consumption or giving up their personal comforts. As a result, business finds it difficult to justify investing beyond the low-hanging fruit.

Walmart has installed solar panels at many of its stores, including this one in California. But even with a large initiative around sustainability, the company projects that its emissions will be flat, not go down, as revenue grows.
walmartcorporate/flickr, CC BY
Walmart is a good case study of the opportunities and limits of a CSR approach to climate change. With great fanfare, it is cutting emissions by millions of tons and saving many millions of dollars by reducing packaging and improving the efficiency of its distribution system and buildings. But it has made a commitment only to hold its absolute emissions flat this decade, due to anticipated growth in revenues, which entails more economic activity and associated emissions.

Unilever has made a much more ambitious “pledge to cut the company’s environmental impact in half by 2020.” Though it has made substantial strides, it acknowledges that the target will be impossible to meet. Consumers account for 70% of the company’s impact, and “their habits aren’t changing.”

So businesses might be very busy with myriad initiatives, but if actual results fall short, are they really sustainable? As John Ehrenfeld and Andrew Hoffman point out in their book Flourishing, sustainability has real meaning only if it achieves stability of the planet’s climate and ecosystems.

The corporatization of sustainability has led to more sophisticated ways to measure and report sustainability in business, which includes ESG (environment, social and governance) metrics on publicly traded companies. But this, too, has limitations. As Matt Moscardi, who leads ESG research in the finance industry at investor research firm MSCI, put it at forum at the University of Massachusetts, Boston in December 2014, “ESG factors and their integration in investing is largely driven by (economic) materiality, and not just by the virtue of moral obligation.”

In other words, aggressive, expensive measures to dramatically reduce GHG emissions will not be integrated into these investor-oriented metrics if they do not correlate with financial performance.

In energy, fast but not enough

Beyond CSR, the rapid growth of the clean energy sector, particularly solar and wind, is encouraging when it comes to reducing emissions and is attracting the attention of major investors. Goldman Sachs recently announced that it will triple its capital allocation to clean energy finance to $150 billion over the next 10 years.

Yet overall, new investment in clean energy has stagnated since 2011 at around $300 billion a year globally, after rising rapidly during the prior decade. And it’s far below the $1 trillion per year that some groups estimate is needed to avoid raising global average temperatures two degrees Celsius above preindustrial levels and the worst effects of climate change.

There are several troubling factors that are impeding the growth of clean energy. Subsidies for renewable energy have been reduced by governments concerned about budget deficits, and cheap natural gas has made it harder for renewables to compete. Political pressures are likely to keep carbon prices far below the level needed to have a real impact.

The delegates in Paris for COP21 are confronting a planetary emergency. Recent evidence regarding melting polar ice caps, methane emissions from permafrost and deforestation and forest fires suggests that we might be approaching a point of no return.

If we are to stay within the two degrees Celsius warming target, we need massive structural changes in our energy and transportation systems, as well as in our urban structures and agricultural and land use practices. Mobilizing the financial and technological resources of business is crucial, but voluntary CSR-style measures don’t go far enough. We can transform our economy and infrastructure, but it requires large-scale, coordinated economic, financial and policy measures at global, national and local levels. This is the challenge for Paris, and for decades to come.

David L Levy, Professor of Management, Director of the Center for Sustainable Enterprise and Regional Competitiveness, University of Massachusetts Boston

As regular readers will have noticed, ClimateInc is now dormant. I’ve learned that sustaining a blog individually is a lot of work, and a group effort is more feasible. I have now joined the editorial team of a new blog launched by our Organizations and Social Change group at UMass-Boston.This article is re-posted from there.

A milestone on the road to catastrophic climate change was reached last Thursday, May 9^th, when the Mauna Loa research center in Hawaii recorded atmospheric CO2 levels above 400 parts per million (ppm) for the first time. The level during pre-industrial times was around 280 ppm, and has been rising at an accelerating pace due to burning fossil fuels and clearing forests. For the last 400,000 years or so, CO2 levels have fluctuated between about 180 ppm, at the depths of ice ages, and 280 ppm during relatively short warm periods, or interglacials (see graphic). The last time CO2 levels reached 400 ppm was at least 3 million years ago, a much warmer world where sea levels were 60-80 feet higher.

Despite more than 20 years of accumulating evidence concerning the serious consequences of rising levels of CO2 and other greenhouse gases on the global climate, including rising sea levels, extreme temperatures, and more frequent floods and droughts, the organizational response has been dismally inadequate. Carbon markets have been widely embraced by many policymakers, academics, businesses, and even environmentalists as a way to put a price on carbon emissions, but these markets have clearly failed to address the issue. Carbon markets are complex political and legal constructions crafted to serve the interests of many actors, but they were deliberately designed not to disrupt our carbon intense economy and lifestyles.

Many have attributed the failure to address climate change to the vested interests and political power of the fossil fuel industry as well as the inertia of our complex fossil-fuel based society, with interlocking technologies, infrastructure, lifestyles, and corporate assets and competencies (See my earlier work on this here and here, and a recent introduction to an Organization Studies special issue on Climate Change and the Emergence of New Organizational Landscapes). Bill McKibben has written alarmingly about the 2795 Gigatons “of carbon already contained in the proven coal and oil and gas reserves of the fossil-fuel companies, and the countries (think Venezuela or Kuwait) that act like fossil-fuel companies. In short, it’s the fossil fuel we’re currently planning to burn.” This amount is five times more than we can realistically burn and hope to stay within the 2 degrees Celsius warming target, but McKibben points out that it is “economically above ground”, because it’s already figured into corporate share prices, credit ratings, and national budgets.

The 400 ppm threshold was reached just a few weeks after the European Union failed to agree on a plan to prop up the European Trading System (ETS), the world’s largest cap-and-trade market, prompting the price to collapse to under $4/ton. The recession and ensuing austerity has cut the EU’s appetite for subsidies for clean energy and shifted priorities. In the US, plans for a national cap-and-trade system failed in the Senate in 2010. Theda Skocpol, a political scientist at Harvard (fondly known here as UMass on the Charles) has recently attributed this failure to the collapse of political will after the recession, the resurgence of fossil fuel industry and Tea Party opposition to climate opposition, and strategic miscalculation by environmental groups who ignored the grassroots to focus their efforts on Washington DC elites.

In a similar vein, my own academic work has built on the work of Niccolò Machiavelli and Antonio Gramsci and developed the concept of ‘strategic power’, the ability to study a political arena and deploy resources in a way that integrates economic, cultural, and political forces to create real change. Unfortunately, groups funded by the fossil fuel industry, the Koch brothers, and other conservative billionaires have successfully exerted strategic power, exploiting the recession to lobby politicians, and organize and train anti-climate activists. Perhaps their biggest success has been to weave climate change into broader cultural-political themes dominant in the US, such as individualism and consumerism, fears of unemployment, suspicion of government and foreigners, hostility to taxes, and antagonism toward scientific, political, and financial elites (see my related 2009 blog piece).

Many of those concerned about climate change supported the development of carbon markets for strategic reasons, because they saw that carbon taxes and direct regulations were considered politically impossible. Drs. Peter Newell and Matthew Paterson, for example, in their 2010 book Climate Capitalism (see my review here), grudgingly embraced carbon markets, despite acknowledging their many flaws. They bring a political economy perspective to climate change; if we are to address climate change in a meaningful way within the necessary timescale, carbon capitalism is the only game in town that can galvanize a powerful network of actors with the potential to take serious action. They stress that carbon capitalism offers the opportunity to successfully mobilize the resources, energy, and political support of key sectors of business and finance, as well as policymakers. Carbon markets offer strategic flexibility for manufacturers, new market opportunities for traders and financial firms, and a source of capital for developing countries. A few key players, such as Cantor Fitzgerald and Deutsche Bank, were central figures in forging the carbon markets, and not surprisingly, they shaped the rules and processes to suit their capabilities and interests. Carbon markets are therefore political and institutional constructs, relying on a vast legal and accounting infrastructure to commoditize carbon: to establish property rights, count and certify tradable units, and to enable exchange across different jurisdictions and gases.

Dr. Janelle Knox-Hayes at Georgia Tech has spent the last couple of years studying the nascent carbon markets. The picture that emerges from her work is that these financial institutions are involved precisely because they see the opportunity to apply their financial expertise and institutional capacity to a new market. So these actors created carbon markets that look a lot like the markets for other financial instruments and commodities, complete with futures, options, and other derivatives. This is unsurprising, given what we know about how organizations build new institutions by adapting existing templates. These are the very same players who brought us sub-prime mortgages, collateralized debt obligations, credit default swaps, and value-at-risk models. These were attractive because plain-vanilla mortgages had become simple commodities with very low profit margins, while the complexity of new derivatives enabled these companies to charge high fees for specialized products and the associated proprietary expertise and valuation techniques. The financial firms thus have a vested interest in market instruments that are complex, opaque, volatile, and hard to value. So there are legitimate grounds for concern that carbon markets were not designed to provide the clear and simple price signals needed to stimulate a broad transition to a low-carbon economy.

“Carbon markets have lost us more than 15 years in the battle against climate change”, according to Dr. Steffen Böhm in a recent piece in the Guardian. He points to three systemic failures that have plagued carbon markets. First, the Clean Development Mechanism that generates a high proportion of globally traded credits is so flawed that many, if not most, CDM projects do not pass the “additionality” test of reducing emissions relative to a hypothetical business-as-usual baseline, and certainly don’t reduce emissions in any absolute sense. Second, carbon markets are beset by corruption and lack of independent oversight. Third, they can promote environmentally questionable practices, such as burning rice husks to generate ‘renewable’ power and carbon credits, instead of their traditional use as fertilizer – therefore increasing the use of energy intense chemical fertilizers.

Carbon markets were not primarily designed to solve the climate crisis, but rather to gain political support from business, policymakers and civil society actors in a grand ‘carbon compromise’. Competitiveness concerns led policymakers to design carbon markets to be sufficiently flexible and with sufficient credits that carbon prices would not impinge too much on corporate product strategies. Policymakers could claim to be addressing the issue without affecting core business strategies. The (failed) proposals for federal cap-and-trade in the US, as well as the RGGI system that (barely) functions in 10 northeastern states, were designed to keep carbon prices well below the $30/ton level, a price that roughly translates into an increase of 30c/gallon of gasoline, and about 2.1c/kWh of electricity. Prices in the RGGI market have recently been under $3/ton of CO2. While some point to the low price as an optimistic sign that carbon emissions are in fact lower than expected, the emission reductions are only a temporary result of the recession. If business is to commit large scale resources to long-term investments in carbon reduction, then the carbon price signal has to be strong, consistent, and predictable. Markets are not magic mechanisms that solve all problems, but political and institutional constructions that serve particular interests. As atmospheric carbon surges past 400 ppm, it’s clear that carbon markets have failed us, and a new strategy is needed.

I recently released a study of innovation in energy efficiency project finance, the culmination of five years’ effort in over twenty global capitals on more than a hundred projects. The report describes successful pilots, lessons learned, and implications for a broad acceleration in energy efficiency investment worldwide. Significantly, the report confirms the recent emergence of a new Asian center of innovation in energy efficiency project finance. The paper, entitled Making Energy Efficiency Bankable: Lessons Learned from a Global Market Transformation Effort, is co-authored with Christopher Seeley of the William J. Clinton Foundation, and will be presented at the 2012 ACEEE Summer Conference on Energy Efficiency in Buildings

We know that the cleanest, safest, and least costly energy is the energy we don’t use. Analysts have concluded repeatedly that investment in conservation is perhaps the most cost-effective alternative source of energy. Yet, despite decades of progress in building technology, surveys of energy efficiency investment have shown it repeatedly falling short of rational expectations.

Not long ago, a DOE report noted that U.S. investment in energy efficiency was no more than the total of budgeted efficiency programs funded by consumer electricity surcharges. Another report estimated the impact of utility-sponsored efficiency programs to be less than one-half of 1% of total building energy use in the past 20 years. Significantly expanded authorizations now coming online might raise that amount to a little over three-quarters of 1% in the next decade. Apparently, there’s more to creating a market for energy efficiency than some new technology and economic pump priming. Based on recent experience, the answer may lie in everyday commercial practices – that is, contracting, underwriting, funding, and debt servicing associated with energy efficiency projects.

Question: What is the significance of innovation in energy efficiency project finance? Answer:

I=K_r +T_e +D_e

Innovation in building energy efficiency results from the interplay of Knowledge from research, Technology from engineering, and Delivery to market from enlightened entrepreneurship. A common problem arises when a promising idea reaches a stage known as the “Valley of Death” — that is, when the idea is not yet perceived as workable in practice or at scale and is therefore considered too risky by traditional investors (read building owners and real estate lenders in the case of energy efficiency). Crossing the valley requires some kind of convincing demonstration of economic feasibility which in turn requires financial resources, hence the dilemma.

With a sound knowledge base and considerable proven technology, energy efficiency nevertheless suffers from a delivery gap attributable to widespread perceptions of financial risk and uncertain performance. While a number of seemingly practical project finance prototypes exist, to date there has not been sufficient commercial-scale demonstration of those models to confirm their economic viability – that is, profitability at acceptable risk.

Under these circumstances, loan investors are deterred from providing capital, bank regulators are not supportive of the risk, and investment portfolio managers have little access to energy efficiency returns. If nothing changes, energy efficiency will remain stuck in the Valley of Death for a long time to come. What is required is a way to cross the valley and expand large-scale delivery of energy efficiency to the global marketplace.

In May 2007, former U.S. President Bill Clinton launched an ambitious energy efficiency best practices effort. The Energy Efficiency Building Retrofit Program explored ways to make efficiency retrofit projects more bankable with unsubsidized, commercial lending models applicable in a variety of countries and considerably more scalable globally than current regulated and legislated models tied to local jurisdictions. The author was one of the guiding lights of that program, and his report, in cooperation with Clinton Foundation colleague Christopher Seeley, describes the innovative pilots undertaken, lessons learned, and implications for a broad acceleration of energy efficiency investment worldwide. It also confirms the emergence of a new Asian center of innovation in energy efficiency project finance.

Between them, the authors delivered pro bono advisory services to building owners for five years in over twenty large cities worldwide, negotiating technical and financial performance terms on more than a hundred building retrofit projects. Their experience suggests that, when contracting and lending are properly coordinated and deployed, their model has the potential to transform the market for energy efficiency. Here are the model’s distinct aspects.

Energy performance lending

For mortgaged properties with limited refinancing options, a new form of collateral and underwriting process for energy efficiency projects. Common real estate lending practice complicates energy efficiency projects because it can be difficult to add debt without refinancing a property completely. As proponents of PACE finance (both residential and commercial) have learned, the rights of first mortgage holders cannot be easily ignored.

Energy performance lending uses underwriting criteria which lean on energy efficiency project cash flows to secure loans. An analogy is the way that a drilling project is secured using the expected cash flows from oil. When used in conjunction with an enhanced contracting model, projects underwritten in this way can coexist with senior debt without affecting prior security interests.

Managed utilities service agreements

For multi-tenanted buildings, a special entity structure that removes a significant decision hurdle by eliminating split incentives between owners and leaseholders. In many tenant occupied buildings, because of the way leases are written, owners lack proper incentives to make energy efficiency investments in common areas of their building. Managed utilities treats energy use as an outsourced service, transferring project debt to a special purpose entity and converting repayment obligations to operating expense passed through to tenants under the terms of their lease. Tenants are protected against rent increases by savings guarantees in the contract, and rents decline at the end of the performance period with ongoing savings to tenants.

Energy performance contracting

An enhanced design-build approach to contracting energy efficiency retrofit projects which is the sine qua non of energy performance lending, effectively turning energy savings guarantees into a true credit enhancement. Owing to the generally strong credit of governments and bank willingness to offer favorable terms for government debt, performance contracting thrives in the U.S. public sector, but not in commercial real estate or other parts of the world. The energy services industry concluded uniform contract terms with the Clinton Foundation, delivering more credible savings guarantees and making third-party financing more attractive.

Municipal leasing

For local governments, capital budget competition and concerns over limits on agency bonding capacity can constrain energy efficiency investment. Yet with its high transaction costs and inflexible terms, bonding is in some ways ill suited for naturally smaller energy efficiency retrofit projects unless implemented as part of a much larger capital project.

Fortunately, virtually any essential-use energy efficiency project can be financed using a municipal lease, usually at a cost comparable to bonding. Depending on the project, the total cost of lease financing is often not greater than bonding because slight cost-of-funds premiums are offset by lower transaction costs and by flexible takedown and payment terms. Legal opinion holds that leases are not normally subject to the same borrowing caps as bonding, and the absence of high transactions costs make smaller projects more attractive.

Tax-exempt equipment leasing

Nonprofit institutions in the U.S. are partnering with public finance agencies, outside accountants, and credit rating agencies to create a new class of energy efficiency projects not subject to normal borrowing limits or rating concerns. Institutions rely on state financing agencies for tax-exempt borrowing as states alone have the authority to issue tax-exempt bonds, and all states have at least one agency that can bond on behalf of tax-exempt institutions. However, institutional borrowing can be limited by an institution’s balance sheet and possibly their credit rating.

Institutions have begun using a tax-exempt project finance structure linked to a performance-based contract that qualifies for off-balance-sheet treatment. The bonding agency agrees to hold title to the project during the performance period. With constraints eliminated, institutions are freed to undertake energy efficiency projects based on their inherent economics rather than competing for limited capital funds.

Conclusion

Evidenced by successful prototypes and pilots in Asia, it appears energy efficiency can be financed independent of local regulatory regimes and special-purpose incentives. The twenty-first century requires more such models to meet the challenge of low-carbon economic development. It’s conceivable that innovation in project finance can do for building efficiency in the coming century what 30-year mortgages did for home ownership in the last.

The refereed research, entitled Making energy efficiency bankable: Lessons learned from a global market transformation effort, will be formally presented at the biennial conference of the American Council for an Energy Efficient Economy (ACEEE) in August. Interested parties can download the paper for review beforehand or contact Milton Bevington (milton@mbpartners.org) for more information.

The speakers discussed the potential for green chemistry to make  production processes and final products safer in a variety of sectors, and to reduce waste and the use of toxic substances. At the same time, green chemistry can save companies money by reducing the need for costly chemicals, reagents and solvents, lowering insurance and legal costs, reducing waste disposal costs (which can exceed $5 per kg for some toxics), and saving energy. In the pharmaceutical industry, Buzz Cue noted that the ratio of waste to final product, called the E-factor could often reach 50 or 100. Applying green chemistry principles has the potential to cut this by a factor of 5 or 10. Pfizer has reduced the E-factor for Viagra from 108 to 8. Given that more than 1 billion kgs of pharmaceutical drugs are produced each year worldwide, the savings can quickly mount into the millions of dollars.

John Warner has developed a set of 12 principles that have become the cornerstone of green chemistry, and there are at least three common elements with the potential for substantial environmental benefits and cost savings: (1) simplifying the overall process, reducing the number of steps, and hence the need for solvents and reagents, and the attendant risks and energy use for heating and drying at each step (2) switching to safer processes and chemicals, frequently based on aqueous (water) solutions instead of organic chemicals (3) continuous process production with real time monitoring and control and (4) recycling chemicals used in the process.

The presentations and discussion got me thinking about the relationship between green chemistry and clean energy. There are some important similarities in the approaches:

1. It’s the economy, stupid! However important the health of the planet and our bodies are to us, the key to corporate adoption is making an effective business case. Advocates of clean energy and green chemistry have to demonstrate that investments meet the usual RoI hurdles (though they are frequently much less risky than investments in the core business, but that’s another story). For clean energy and green chemistry, there is plenty of low-hanging fruit, but cost is also a barrier for more systemic change.

2. Business model innovation is as important as technological innovation: The environmental benefits, and other co-benefits, need to be monetized, sometimes requiring creative business models. A lot can be done with existing technologies, but various market and non-market barriers exist, which business model innovation can help overcome.

3. The lean production principle: it’s usually cheaper, more reliable, and environmentally better to improve the core production process rather than add on “end of the pipe” solutions.

4.  Simplicity can require complexity: Einstein invested a lot of brains and sweat to arrive at E=MC². Simple, elegant solutions that save money and reduce environmental impacts are not always easy to find, and often require substantial investments of time and money in chemical science and process engineering.

5. Systemic perspectives: analyzing an entire production system from raw materials to disposal of final product, using life cycle analysis, can help identify ways to cut costs and reduce use (and waste) of energy, water and chemicals.

6. Don’t go it alone! The industry needs to collaborate to address some larger institutional and regulatory issues. FDA regulations, for example, can hinder process changes in the pharmaceutical industry, so the sector has formed a group to work with regulators. In a similar way, the clean energy sector has to work with regulators to facilitate distributed power (e.g. for net metering) and to establish standards and protocols, for example, for carbon measurement and for smart grid software.

Only one of the twelve principles of green chemistry is explicitly about energy efficiency, and it suggests that reactions be designed for ambient temperatures. The call for renewable feedstocks and to maximize atom efficiency also relate to energy use, but overall, the principles are mostly focused on questions of toxicity, hazards, and waste reduction. Given the energy intensity of the chemical sector, from the feedstocks to production, distribution, and waste disposal, waste reduction inherently saves substantial amounts of energy.

There is a lot of room, however, to explore the relationship between green chemistry and energy efficiency more closely. Energy use generates its own waste, of course, from particulates to carbon dioxide and SOx and NOx, but while these create environmental and public health issues, they are not considered particularly toxic, and are not the focus of green chemistry. Moreover, the chemical and pharmaceutical industries buy their energy-intense feedstock materials from other firms upstream on the value chain, over which they have little direct control. The larger companies could perhaps learn something from Walmart’s experiences in pressing suppliers and customers along the value chain for action.

Green chemistry could also learn a lesson from the energy arena about the potential for end use conservation and efficiency. The green chemistry principles seem to take final demand for products as given, rather than look for ways to reduce production. There has been increasing attention recently to the over-prescription of some types of drugs, and large quantities many drugs are discarded for various reasons. Chemicals used for agriculture could be reduced with organic and other alternative practices. The problem here is that while utilities are frequently given incentives for end-use energy reduction, most industries don’t see a good business model in reduced sales and production. One exception is Monsanto, which finds it profitable to sell GM seeds that are matched with lower volume but proprietary chemical pesticides and herbicides.

Green chemistry can also be used directly for clean energy purposes. My son’s first internship was in one of Professor John Warner’s labs at UMass-Boston, testing various kinds of non-silicon PV cells for their efficiency and longevity. Chemistry is also key to biofuels production, from algae to cellulosic ethanol, and to identifying catalysts for fuel cells. There is active investigation of direct air capture (DAC) of CO2 using chemical processes, though costs are currently prohibitive. For market reasons, the large pharmaceutical and chemical companies with substantial research budgets have not focused their attention and resources on applying green chemistry for clean energy and climate mitigation purposes, though this is huge potential in this area.

by David L. Levy

Despite the mounting evidence of severe climate change, there is a funding crisis for potential solutions. The Department of Energy released data at the beginning of November showing that global emissions of CO² rose 6% in 2010, despite the ongoing economic recession. This trajectory is higher than the worst case projections from the Intergovernmental Panel on Climate Change (IPCC) in it’s 2007 Fourth Assessement Report. The impacts are already being felt. A new IPCC report concludes that climate change is causing more extreme weather, especially heat waves, heavy precipitation, and coastal flooding (though the super-cautious IPCC hedged on hurricanes).

Yet November also witnessed setbacks for two key clean energy technologies. Beacon Power, a Boston-area developer of flywheel energy storage and power management systems for the grid, filed for bankruptcy the same week that the DoE released the grim emissions data. Just a few days later, the FutureGen 2.0 project, the leading US effort to develop commercial scale Carbon Capture and Storage (CCS) technology, suffered a major setback when the Midwestern power company Ameren announced that it could not provide an old power plant for the project due to financial difficulties. (Update: While Ameren will no longer be financially involved in the project, they are currently negotiating how the power plant may still be utilized for the project).

One important lesson is that public policy must be based on a clear understanding of the challenges facing the clean energy sector and the impact of regulation and programs on investment decisions and corporate business models. In the absence of a global framework for regulating emissions, the future of the planet largely rests on choices by private firms and investors regarding which technologies to pursue and commercialize. The clean energy sector, however, faces a host of risks that make investors wary. The risk is not that climate change is going away as a long-term driver; the problem is that there are large market uncertainties regarding the future of regulation and subsidies, which technologies will emerge as large-scale, low-cost, low-carbon alternatives, how consumers will respond, and how competitors will react.

Despite the woeful underfunding of clean energy research in the US, there is still a plethora of exciting technologies being developed in the laboratories of universities, government centers, and the private sector. For more mature technologies, large subsidies are flowing to commercial installations of solar and wind, perhaps too large, according to a critical New York Times article last week. While these subsidies are reducing costs by accelerating the technologies down the learning and scale curves, they tend to reinforce the dominance of early, low-cost “winners” in the marketplace, and provide little help for less mature but promising emerging technologies, such as Solyndra’s CIGS thin film glass tubes. As a result, these subsidies also tend to suck in a lot of low-cost Chinese imports rather than stimulate US production or research.

A structural problem, as Daniel Goldman wrote in an earlier Climate Inc. post, is the proverbial “valley of death” between lab research and commercial production, where “neither government, venture capital firms nor capital markets have tended to bear the risks associated with providing equity capital, which can amount to hundreds of millions of dollars, for initial deployment of capital intensive new clean energy technologies at commercial scale – described here as “first project commercialization.”  The US venture capital model evolved primarily to support the emergence of the software industry, which has relatively low capital intensity, but there is not currently an adequate private (or public) sector solution for clean energy. It’s far too early to know whether, for example, flywheel technology is better than batteries or compressed gas for power storage – and maybe there is a role for each of them, to meet different needs in different locations. But a market-based system that relies on private sector funding is failing us if it cuts off development of promising technologies before they even reach commercial scale testing.

Beacon Power has not yet closed its doors, and is trying to continue operating under bankruptcy. Since the summer, it has been testing a 20-megawatt flywheel plant in Stephentown, N.Y., which can absorb and supply power from the grid very rapidly, and is therefore valuable in frequency regulation. Another installation is planned for Pennsylvania. The more intermittent wind and solar that is connected to the grid, the greater the need for short-term storage solutions. Flywheels are able to deal with rapid fluctuations and match supply and demand more effectively and reliably than batteries, such as those from A123, or gas-fired plants (while reducing emissions from rapid cycling of gas plants). A few of the the 200 flywheels in Stephentown have experienced problems, but the system has performed well overall.

Until recently, Beacon Power has not been able to monetize the full advantages of flywheel storage. It was only on October 20^th that the Federal Regulatory Energy Commission (FERC) approved a change in regulations that makes grid operators pay, not just for the amount of power in reserve, but also for its effectiveness in grid stabilization. According to Bloomberg, this could double Beacon Power’s revenue and make it easier to find financing. But the ruling, which has been in the works since February, was too late to keep Beacon solvent. If we are to rely on price and market mechanisms, we need to build them to serve the planet.

The lack of a clear regulatory framework has also hurt offshore wind power in the US. Even now that the 450 MW Cape Wind project is most likely moving ahead, the damage from more than a decade of delays and uncertainty, resulting in millions of dollars in costs and legal fees, have probably dampened investors’ enthusiasm. The latest delay stems from a court ruling that the FAA needs to take another look at aviation hazards. With further financing still required for the $2.6 billion project and the company still negotiating to sell half the power output, the future is not yet secure. Meanwhile, the European Wind Energy Association expects annual investments in the European offshore wind industry to triple to reach 10 billion Euros by 2020.

Given the urgency of the situation, public policy needs to shape the market context in order to steer private investment decisions. We are not heading in the right direction, however. In the short term, the ongoing recession appears to be diverting attention from the climate issue and draining government, business, and consumers of resources. A new Ernst and Young report estimates that the recession could lead governments to cut spending on climate change by tens of billions of dollars. It’s more important than ever to focus government resources, and commercialization of carbon-reducing technologies is a critical area. But in addition to financial support, the problems facing Beacon Power, FutureGen and Cape Wind highlight the importance of reducing regulatory uncertainty.

By David L. Levy

The Massachusetts Clean Energy Center released the 2011 Massachusetts Clean Energy Industry Report this month, just a few weeks after the failures of solar firms Solyndra and Evergreen triggered a fierce debate about the prospects for green jobs in the US and the wisdom of government investment in clean energy. The answer to this $64,000 question is 64,000 clean energy jobs in Massachusetts in 4,909 clean energy companies. While the precise jobs number depends on assumptions about definitions and the methodology used, this figure represents a 6.7% increase from July 2010 to July 2011, a period of stagnancy in the national employment situation (and employment growth in Massachusetts was a meager 1%). Moreover, respondents to the survey used for this study were optimistic about future growth, expecting employment to grow by 15.2% by July 2012. About 40% of employers expect to take on more clean energy workers in the coming year, while only 2% expect fewer.

One way to put these numbers in perspective is to compare them to the first effort to measure the clean energy sector in Massachusetts, in which I was a participant. Back in 2004, we arrived at the figure of 11,000 people in approximately 400 firms, and predicted that the sector could reach 20,000 employees by 2010 “if Massachusetts remains at the forefront in terms of both policy and technology in clean energy development”. Despite the deep recession, the clean energy sector has far exceeded these expectations. One thing that has not changed, however, is the political sensitivity of these numbers. Just last week, former Massachusetts governor and presidential candidate Mitt Romney called the promise of green jobs “illusory”. Back in 2004, our report was not published for several years, apparently because of pressure from local business associations who were worried that the numbers might lead to carbon regulation.

In 2004, we identified an incipient clean energy cluster in the state, comprising not just clean energy firms, but geographically concentrated networks of related businesses, such as specialized suppliers, consulting and professional services, and venture capital firms, and other organizations, including industry associations, universities, research centers and supportive government agencies. Clusters are characterized by a concentration of sector-specific skills and a rich network of connections among people and organizations. In the case of Massachusetts, these skills draw from the advanced electronics, IT, and specialized manufacturing sectors in the region. We observed, for example, that a significant number of ex-employees of Polaroid had brought their thin-film engineering expertise to bear in solar and fuel cell technologies. We also noted that the state has substantial expertise in power electronics, which comprises at least 25% of the renewable energy value chains. A hidden asset in the state is a strong network of clean energy enthusiasts spanning business, government and academia that lends coherence and a sense of mission to the cluster.

Aside from the headline numbers, the report highlights the diversity of sectors, activities, and skill levels associated with clean energy. This makes an accurate count difficult, but highlights the many ways that clean energy is affecting the economy and the  broad range of job market opportunities being created. Relatively few of these jobs are in manufacturing, while the vast majority are in sales, distribution, and installation, positions which are location-specific and immune to outsourcing. A substantial number are in highly skilled research and development, which are also likely to be geographically “sticky”.

The 2011 study defined a clean energy firm “as an employer engaged in whole, or in part, in providing goods and services related to renewable energy, energy efficiency, alternative transportation, and carbon management.” Similarly, clean energy workers are defined as “employees which spend at least a portion of their time supporting the clean energy aspects of their businesses”. The study burrowed deep into organizations to reveal clean energy-related activities that earlier reports have missed. While more than half the firms in the study derive at least 50% of their revenues from clean energy products and services, more than one-third of the organizations got less than 25% of their revenues from clean energy. About half the organizations contacted had 5 or fewer clean energy employees. This reflects a large number of small companies in the region, but also a lot of businesses and organizations that would not usually identify themselves with the clean energy sector, but have a few employees working on, for example, energy efficiency or clean energy research.

While solar is by far the largest technology focus of the renewable energy companies, there is a broad range of other technologies in the cluster. Since 2004, biofuels, geothermal, and hydropower have become more prominent, while fuel cell activity has declined, in relative terms. Among energy efficiency firms, the largest number are in HVAC and building controls, but smart grid and demand response have been growing recently.

Back in 2004, we noted that Massachusetts had great potential in power electronics, the hardware and software needed for energy measurement, management, storage, connection, control, and conversion. Aside from a few pure plays, like Beacon Power, it’s still unclear from this report how many companies are active in this part of the clean energy value chain. Some are probably captured in the energy storage, smart grid, and demand response categories under energy efficiency, but there could be more activity here as well as unrecognized potential. The report does mention some of the university community – it reports 326 researchers in the University of Massachusetts system (not including Dartmouth), and even 37 on my own campus, UMass-Boston.

The regional cluster contains a growing number of professional service firms, such as law, accountancy, finance, and consulting companies with staff devoted to clean energy related issues. The region is also home to a large environmental NGO community as well as numerous government agency employees working in the field. The report does not explicitly discuss these workers or organizations. Yet, combined with the administrative, professional, and managerial employees at the firms included in the report, this is an important group of jobs that many surveys have neglected.

The study notes that the clean energy sector demands advanced expertise and education, and that about 60% of firms report great or some difficulty in recruiting workers with adequate experience and technical skills. But employers are not necessarily looking for clean energy experts. Echoing what I’ve been hearing elsewhere, they want people who are highly skilled in their primary field, whether that’s sales, installation, engineering, or accounting, and with some knowledge of (and passion for!) clean energy. Which brings me to a shameless plug – our clean energy education programs at UMass-Boston, including certificates in Clean Energy and Sustainability and an MBA track in Environmental Management, are designed specifically to serve professionals who are strong in their primary field, and want to deepen their clean energy expertise.

Economic development and workforce development must be done together.  That was the primary recommendation of two research reports released last month.  It’s a common sense conclusion that has important implications for the clean energy industry and the education and training community in Massachusetts.

The first report, from the Aspen Institute’s Workforce Strategies Initiative, examined efforts to align economic and workforce development programs in Louisville, Kentucky; Cleveland, Ohio; and Southwestern Pennsylvania.   The resulting report (Where Labor Supply Meets Labor Demand: Connecting Workforce Development to Economic Development in Local Labor Markets) identifies four critical capacities that development programs need to align themselves with the changing requirements of local employers, including:

1. Industry expertise and credibility
2. Deep knowledge about the local labor pool
3. Ability to conduct local labor market research that is informed by both data and industry intelligence
4. Relationship building and maintenance

Although it might seem obvious that employers, economic development professionals and the workforce community would travel in close alignment with one another, the Aspen Institute report suggests that this is often not the case.  In fact, it’s quite common for the three groups to work parallel to, or even at odds with, the goals of those they are trying to support.   By developing and sharing the four capacities Aspen identified, workforce and economic development groups can better serve job-seekers, career changers, students, employers, tax payers and training institutions.

The need for close collaboration between economic and workforce development has been evident to leaders in the Massachusetts clean energy industry for a long time.  To assure continued alignment, a coalition of organizations sponsored a series of leadership “summit” meetings in 2010 and early 2011.  The summits were held at UMass Lowell, in New Bedford, and at UMass Amherst.

The Summit organizers included Massachusetts Clean Energy Center, New England Clean Energy Council, Skillworks, Garfield Foundation, and the UMass campuses in Lowell, Dartmouth, Amherst and Boston.   In addition to dozens of clean energy company executives, the events attracted representatives from local and state government agencies, colleges and universities, vocational training schools, apprenticeship programs, social justice advocacy groups, workforce investment boards, and labor unions.  Over 300 leaders registered for the summit meetings.

A summary of conclusions from the three Massachusetts summits was released last month under the title Supporting and Growing the Clean Energy Sector in Massachusetts: Clean Energy Industry Economic and Workforce Development Leadership Summits.

The comments and suggestions from the Bay State summit meetings clustered around seven common themes, including:

1. Growing the Demand
2. Policy and Vision
3. Education
4. Training and Workforce Development
5. Research and Development Support
6. Innovation and Finance: Building Businesses
7. Social Justice

Within each of these themes, the detailed recommendations mirrored the central conclusions of the Aspen Institute report.  The Summit participants zeroed in on the need for shared, accurate, and detailed labor market information focused on clearly defined clean energy industry sectors so that workforce programs closely match employer needs at the local level.

The Aspen Institute study and the Massachusetts clean energy summit report were also closely aligned in calling for strong, sustained, personal relationships between employers and the economic and workforce professionals charged with growing the economy and training people to land jobs in a difficult employment market.

The 4^th Clean Energy Connections Conference in Springfield, Mass. on Nov. 2 will give the state’s clean energy economic and workforce development community a chance to review the comments and suggestions made at the original summit meetings, assess progress and pitfalls over the last few months, and discuss plans for staying aligned in 2012 and beyond.

As the Aspen Institute report notes, the recent recession has resulted in austerity policies that will strike hard at public and private budgets.  This harsher environment is reducing the margin of error for economic and workforce development programs. Taxpayers, employers and government officials are shining a bright spotlight on expenditures aimed at job creation and job placement.  They are demanding clear and measurable results.

To produce these results, employers, economic development professionals, and the workforce development community will need to support each other, produce and share high quality information, and work together toward closely aligned goals and objectives.  Working on separate, uncoordinated tracks, is simply not an option.

The American Energy Innovation Council (AEIC) released a new report last week, Catalyzing American Ingenuity: The Role of Government in Energy Innovation, which makes the case that the US government should dramatically increase its investment in energy innovation in order to enhance US competitiveness, energy independence, and create affordable clean-energy alternatives. The AEIC doesn’t represent the clean energy industry; rather, it’s a small but highly influential group of CEOs (and a couple of former CEOs) from Lockheed Martin, Xerox, Kleiner Perkins, Microsoft, Dupont, GE, and Cummins. The AEIC report makes the historical observation that “From gas turbines to smart phones, medical imaging technologies to space flight, GPS to the internet, government funded innovation research has improved lives, created jobs, and supported more than a century of U.S. preeminence.”

The report documents the various market failures that impede private sector investments, such as the risky, long term nature of R&D, a lack of competition, and the difficulty in monetizing all the benefits of clean energy. The report highlights the inadequacy of US investment in relation to global competitors, such as China and Germany, and recommends support for “innovation hubs” that encourage “concentrated talent, the exchange of ideas, and the creation of new technologies and ventures” in regional business clusters.

The report was released the same week that California-based solar firm Solyndra filed for bankruptcy after receiving hundreds of millions of dollars in government assistance and loan guarantees, fueling a fierce debate about the wisdom of government investment in clean energy. This is not the place to discuss the details of the Solyndra case (see here, here and here), but it’s clear that much of the criticism stems from a larger, ideologically-motivated campaign against government support for clean energy, with strong links to the political forces against carbon regulation. While it’s true that Solyndra and Massachusetts-based Evergreen have filed for bankruptcy and many manufacturers have seen their profit margins eroded by intense competition, the industry as a whole is booming. The solar industry is the fastest growing sector in the country, with sales rising 67% in 2010, and the cost of panels has fallen by 80% since 2008.     

Despite efforts by Fox News and the Competitive Enterprise Institute to disparage renewables and even claim that solar “doesn’t work”, the recent bankruptcies are actually a sign of the industry’s success, bringing the typical transition to maturity, commoditization, and a shakeout of higher-cost producers. Commoditization and cost pressures are severe in the power sector where price is the primary driver, while branding and differentiation are relatively unimportant. Unsurprisingly, manufacturing is therefore shifting rapidly to lower cost locations, notably China. Yet employment in the US solar sector has still grown by 6.8% since August 2010 (net, after taking into account the recent failures) and the US enjoyed a $1.9 billion trade surplus in solar products in 2010.

The AEIC report is only the most recent attempt to raise the alarm regarding US prospects in clean energy. Countries are frequently framed as being in a “race” for a dominant position. The Breakthrough Institute, for example, attracted substantial publicity for a 2009 report titled: Rising Tigers, Sleeping Giant: Asian nations set to dominate the clean energy race by out-investing the United States. The Pew Trust followed in 2010 with a report titled Who’s winning the clean energy race?, and the headline conclusion that the US has fallen to “a distant third in the race for clean energy investment” was picked up by a multitude of news sites.

The notion of a clean energy “race” does have valid conceptual grounding in the idea of regional business clusters. Clusters are geographically concentrated networks of businesses and related institutions such as industry associations, universities, training institutes, and research centers. Clusters usually comprise a range of connected value chain activities, including specialized suppliers and engineering firms, venture capital, professional services, as well as sophisticated customers demanding the latest and best features. As a result, clusters are characterized by a concentration of sector-specific skills and a rich network of connections among people and organizations.

Clusters are attractive as foundations for a dynamic regional economy because they tend to generate high levels of innovation, investment, and incomes. All the firms in the cluster benefit from lower costs, better access to specialized inputs, and the latest information on market trends, production techniques, and technological developments. Importantly, clusters are resilient and enduring, as once they reach a critical mass, their competitive advantages encourage self-sustaining growth. Moreover, business activities are geographically “sticky” and so can resist pressures to outsource to lower cost locations. Clusters therefore enjoy first-mover advantages, as early successes, such as Denmark’s wind industry, become established and enjoy enduring advantages.

A cluster promotion strategy is gaining attention in policy circles. The recent Brookings Institute report on the US clean energy sector found a strong assocation between concentration of business activity in metropolitan areas and rates of growth. The report noted that “Not only are other nations bidding to secure global production and the jobs that come with it but the United States currently risks failing to exploit growing world demand.”. A key recommendation is that the “federal government should increase its investment in new regional innovation and industry cluster programs.”

It’s important to note, however, that the success of the solar industry and its transition to maturity is a result of global investment in R&D and manufacturing, including substantial government support in China and Europe. Rapidly falling solar energy costs create widespread benefits for buyers of solar panels, for energy consumers, and for those employed in the fast-growing industry (not to mention the environmental benefits!). Moreover, national and regional clean energy clusters are not separate racing teams, but are elements of a larger complex global industry with intertwined value chains. Recent academic work has demonstrated how successful business innovators are connected through “global pipelines” to international business networks. In clean energy, many firms operate right from the outset with global customers, suppliers, capital, and technology.

In this dynamic and high-risk environment, the failure of a Solyndra or the shift of some commodity manufacturing to China does not necessarily signal the loss of US competitiveness. As the global clean energy industry grows and matures, firms will reconfigure their global value chains, shifting activities across countries. The US is likely to specialize more in services, finance, and design than manufacturing. It’s still important to invest in creating vibrant clean energy clusters, but the benefits should not be measured in short-term events or narrow national terms. Indeed, it’s critical to understand the competitive basis of high value-added regional clusters in the context of global industries, and to develop collaborative strategies among business, universities, and governments to support their growth.

While public policy and the media tend to focus on technological innovation as the key to addressing climate change and boosting clean energy, business model innovation (BMI) offers a path to rapid deployment of existing technologies. The concept was popularized and given its current acronym by Mark Johnson, Clayton Christensen, and Henning Kagermann in their Dec. 2008 Harvard Business Review article “Reinventing Your Business Model.” They point out that “Low-cost U.S. airlines grew from a blip on the radar screen to 55% of the market value of all carriers. Fully 11 of the 27 companies born in the last quarter century that grew their way into the Fortune 500 in the past 10 years did so through business model innovation.”

The potential for BMI in the development of the cleantech sector is only just beginning to be appreciated. Rob Day, a partner with Black Coral Capital in Boston, recently wrote about a new wave of startups that run lean and require less capital to scale up, so are less likely to founder in the infamous Valley of Death: “Some of this next wave of startups will be hardware, but many will be software and/or services…  Business model innovation will often be stressed over technological innovation.  They will sometimes marry energy-related market opportunities with Web2.0 and social media business models and platforms.”

A closer look reveals that BMI holds particular promise for unlocking the potential of clean energy and promoting economic competitiveness, investment and employment in high-cost regions. In addition to helping keep startups lean and capital efficient, BMI can develop systemic solutions that overcome some of the many market failures and institutional barriers to energy efficiency and clean energy. McKinsey’s famous Marginal Abatement Curve heralds the good news that about one-third of needed emissions reductions appear to have positive ROI with current technologies. The bad news is that about one-third of needed emissions reductions appear to have positive ROI – yet the necessary investments are not happening, due to these many hurdles. As with Zipcar, BMI provides ways to monetize the ancillary benefits of cutting emissions, and create business models that focus on features that people are willing to pay for.

BMI-based cleantech businesses are also more likely to keep jobs in high wage regions such as the US Northeast and California. Clean energy manufacturing jobs have been moving astonishingly quickly to China, even while there is still rapid technological evolution. Evergreen Solar and A123 Batteries, both based here in Massachusetts, are cases in point. Business model innovation often focuses on software and services, developing strong relationships with customers and building on existing capabilities in the region, so jobs are more likely to stay local. These factors also help to create barriers to entry, protecting the business model. Zipcar’s network of parking spots, for example, negotiated over several years with hundreds of companies and local authorities, would not be easy to replicate.   

Better Place is a powerful example of how BMI can overcome systemic barriers to technology deployment. The company is developing a national replaceable battery infrastructure for pure electric vehicles in Israel, Denmark, and elsewhere that transforms the business model for car ownership and fuel supply. Consumers buy a car without the expensive batteries, then contract with Better Place for battery replacement as a service, which is done in just a few minutes at a network of service stations. This model overcomes the physical limitations of batteries, in terms of range and charging time, and dramatically reduces the cost of new cars for consumers. As with Zipcar, governments are willing to subsidize the operation because it contributes toward reducing congestion and greenhouse gas emissions – again, monetizing ancillary benefits.

Energy efficiency and smart grid provide many opportunities for BMI. EnerNOC’s core business model, for example, is demand response and energy management, using sophisticated software and remote monitoring and control. Enernoc links the utilities, who are willing to pay for energy efficiency and for peak-period demand reduction, to a network of customers. Energy service companies like Ameresco are increasingly offering turnkey projects and performance contracts that reduce risks, capital requirements, and uncertainty for customers. Similarly, companies like Nexamp, Tioga Energy and Borrego offer renewable power purchase agreements based on DBOOM services – a complete package where the company designs, builds, owns, operates and manages the renewable energy installation, while the customer only pays for power.

Not surprisingly, then, these BMI-based companies are among the fastest growing businesses in the cleantech sector. Kevin Doyle, a Principal of Green Economy and Co-Chair of the New England Clean Energy Council‘s Workforce Development Group, has pointed to the large number employment opportunities at a range of cleantech companies, a number of which are in energy services and software. As a result, they are not just looking for engineers, but also for a range of business and professional skills and expertise – which highlights the purpose of our new clean energy programs at the University of Massachusetts, Boston!