The IPCC Working Group I released the first installment of their Sixth Assessment Report and their conclusions are clear:

• Global warming is primarily driven by human activities
• Weather patterns are changing dramatically – both geographically and temporally
• Coastlines, cities, and oceans are all bearing the brunt of the changes that have already begun

While the IPCC has been ringing the alarm bell for a long time, this latest update is the strongest warning to date.

With all that said, it is a Monday and a day that I typically reserve for optimism only. So where in all this is the silver lining? To be honest, there are many. We are seeing the beginning of a secular shift in investment demand. From individual investors to corporations to pension funds, everyone has awoken to the fact that there are myriad solutions to the fundamental problems the IPCC report is highlighting. Renewables, resource efficiency, water, waste, carbon capture, hydrogen, EVs – the list is long and growing. Not only are there ways to reduce carbon and greenhouse gas emissions across the economy, but we’re in the second inning of what is sure to be a multi-decade opportunity in sustainable investments.

IPCC Press Release

A common refrain is “Renewables are just virtue signaling. They’re not economic without subsidy.”

Actually, there’s a reason that the vast majority of 2020 new capacity build was expected to be renewables – ~78% to be more precise – according to the US EIA. And it’s not that utilities around the US (including MidAmerican Energy, Berkshire Hathaway’s energy business) are virtue signaling. They’re looking at the economics and realizing that they’re compelling.

And this reduction of the installed cost of solar year-over-year shows no signs of abating according to Woods Mackenzie – especially in the utility-scale solar segment – though the dramatic reduction in panel prices is likely mostly in the rear view mirror.

While “green” investments grew in 2020 by 9% despite the pandemic, the aggregate USD invested in renewable generation actually fell by 20% to $49.3B according to Bloomberg NEF in their annual review. China was at the top of the league tables for dollars installed with the US a distant second. In an ironic twist, the import tariffs on solar panels from China has led China to add new renewable capacity at almost twice the rate of the US. It’s perhaps noteworthy that the Chinese economy reportedly grew at 2.3% while the US contracted at -4.3%. Conversely, if the tariff were to be taken off, there’d be an immediate .20/W drop in delivered panel costs that would drop almost entirely to the bottom line of any project.

The dollar amounts invested are misleading in that the cost per MW installed of renewable power declines by a nominal amount every year so comparing year-over-year dollar amounts obscures the MWs installed. With that said, the US market clearly contracted during 2020 due primarily to a struggling onshore wind industry. In a sense, solar continues to eat the renewable world though off-shore wind is putting up a decent fight.

On the other side of the calculus from our perspective, EV vehicles & infrastructure have exploded in the last year. Nikola, Chargepoint, and Proterra, Rivian – just to name a few. While there’s a lot of opportunity in the electrification of transportation, it’s not immediately clear to us whether these valuations are well supported or merely aspirational. Hopefully, companies will grow into their valuations in short order.

Merging Environmental & Social Goals

Reading this opinion piece on CNN over the weekend – This town powered America for decades. What do we owe them?

Got me thinking about all the places that are in desperate need of economic revitalization. We have the tools to build back better the economic engine of places like Gilette, WY. Even as it takes a while for things like 3D printing to propagate through society to help ameliorate job losses like those suffered in coal country, good stewards of investment capital can help catalyze that change. While we driven by financial returns first and foremost, our conviction is that aligning investment capital with both ESG and SDG goals ultimately leads to higher risk adjusted returns.

So in the context of Gilette, we see a chance to bring investment expertise to bear in improving the lives of marginalized Americans who are looking for a better job and a better future for both themselves and their children rather than the status quo. We think these opportunities are abundant at this pivotal moment in America’s history and that they will prove to be the turbo-charger that propels the US into it’s next growth phase as we rebuild our aging infrastructure.

But let’s remember that the Longview Power “clean coal” plant that was lauded as the most advanced and cleanest coal-fired plant in the world is now seeking bankruptcy protection for the second time in a decade after costing $2.1 billion.  Coal provided only 17.1% of the US power mix for the month of March – a staggering retrenchment from ~46% only 10 years ago.  It is, quite literally, the canary in the coal mine for the fossil industry.

And while auto sales are collapsing, our research shows that EV sales are far less correlated to GDP growth than ICEs.  We see that consumers, based on a myriad of preferences, have been buying EVs and are continuing to do so.  EV growth in the US was expected to have a breakout year in 2020 before the virus started shuttering supply chains.  While we expect that the delay in 2021 model releases will only be modest, we expect that the automakers will divide into two groups – those that lead with their new EV lineups and those that retrench in an effort to conserve cash.  We posit that the future of the auto industry will belong to the former while the latter will ultimately lose market share and impair their brands.  

Many of you have been watching Sir David Attenborough, as I have, for years.  His voice has been the voice of nature for decades.  In this interview, he’s pleading with the world to make the changes necessary to preserve our home by ending the waste – the waste of energy, food, plastics, natural resources, etc. – that currently plagues our society.

It’s worth noting that habitat loss is one of the leading reasons that animals and humans are interacting more and more and why more zoonotic diseases are likely.  While many lament these kinds of ideas as a seeming death sentence for economic growth and frame them as permanent impoverishment for the bottom of the human pyramid, SOIL was founded on the principle that this is exactly the way to unlock both massive economic growth opportunities as well as an increase in the standards of living around the globe – from cleaner air and water to better educational opportunities and healthier foods and supply chains.

We are at a crossroads  – as a species.  In much the same way that we’ve come together across borders to curtail the spread of the coronavirus, so too can we do the same to begin a new era in our collective histories – one of unprecedented value creation and global wealth  – through the financing and deployment of sustainable opportunities and infrastructure around the world.

That alongside a rebound in demand and a potential production cut from OPEC+ (some day) will push WTI back to $50/bbl and they’ll be printing money.

A Little Bit of History

In early 2008, HH NG was north of $10/mmbtu and the long run average price was generally thought to be $7.5/mmbtu

GFC comes, the market collapses, shale comes online, etc. For a decade, the whole world has been thinking $2.5-3 is awfully cheap.  Know where it is today?  $1.7/mmbtu

Oil was at $99/bbl in ’08, dropped to $62, retested the highs, and then plummeted to $43 in ’16. Everyone was thinking it was a bargain but it barely got to $60 before it rolled over again and you see where it is now – $25

So that’s the brief history lesson of the last 12 years of fossil fuel prices in the United States.

Back to the Present

The estimates I’ve seen are that there’s been a 25Mbbl/day reduction in demand against a 100mbbl/day total use.  A 10mbbl/day cut from OPEC+ isn’t going to do anything. 

“Ultimately, the size of the demand shock is simply too large for a coordinated supply cut, setting the stage for a severe rebalancing,” the Wall Street bank said in a note dated on April 8.

Here’s where the train leaves the tracks – the OPEC+ nations are facing massive budget deficits in front of them.  Oil revenues are a primary source of income.  When the market goes from $55 to $28, the last thing they want to do is cut output because it amplifies the deficit.  So compliance is a fundamental problem with the arrangement.

And even when the world gets back to “normal”,  telecommuting, less air travel, less going out, etc. are all going to be here for a while – permanently impairing oil demand.

Here’s the Kicker

There’s a common misunderstanding of the way oil and gas prices relate to renewables.  The correlation between solar and oil returns is basically zero.  The correlation between solar and gas is about .14 – virtually meaningless.  You know what happened to renewable capacity while gas was kicking around the basement?

Installed wind capacity almost quadrupled from 25GW to 94GW
Installed solar?  .5GW to 51GW – 100-fold increase

Coal over that period?  Toast
Even Gas for generation is getting kicked around now.

The last bastion of gas demand has been plastics – but if you haven’t noticed, single-use plastics are disappearing faster than you can say “Houdini”.

Investors have made really good money in renewables while the oil and gas guys have been treading water for a couple of decades on a nominal basis.  Inflation adjusted, they just got smoked.

Fundamental Value & the Value Trap

With all that said, if shale collapses, it puts a floor under oil which pushes investment back to renewables (because of the misunderstanding I just outlined).  A lot of investors want to get long collapsed shale with DIP financing or buying credits at 20 cents on the dollar.  Either way, renewables is going to continue its assault on carbon assets.  You can’t put the horse back in the barn.

Last but not least, there’s the regulatory risk:
– that the world will get its act together and price carbon
– that some percentage of “proven reserves” are going to stay in the ground
– that wellhead methane is going to be regulated
– that states are going to want more jobs and will get on or continue to ride the massive job creation engine that is renewables

I’m calling it here – just like coal and gas before – oil is now a value trap;  getting long carbon assets is a mistake. 

The list is long and getting longer by the day – investment and asset managers around the world are waking up to the biggest opportunity in the next decade – sustainable investments.  We’re not surprised by this; in fact, it’s a welcome shift in the press coverage of the thesis.  While we’re cautiously optimistic, this isn’t to be viewed as a successful campaign in aligning assets with the goals of sustainability, but rather merely the end of the opening exchange as we move into the mid-game.

$750 Billion – that’s a big number even by today’s standards.  And it’s the headline number that Goldman Sachs used last year when it announced its formation of a sustainable finance unit.  When you peel the onion back, it’s $75B a year for the next 10 years and any and all activities which touch sustainability will count towards that number.  While the Wealth Management arm raised $2B for solar and wind investments, the vast majority of this touted activity will come in the forms of project finance and investment banking and are primarily reactive rather than proactive.

Larry Fink, CEO of Blackrock, has been a proponent of these proclamations since 2016.  And again in 2017.  But the actual allocations tell a different story, and that’s why we’re only cautiously optimistic.  On the one hand, Blackrock announced the closing of $1B towards a $2.5B project fund focused on solar, wind, and energy storage – which is great.  But let’s consider this in the broader context – Blackrock has $6.96 TRILLION under management so on a percentage basis, their commitment to renewables isn’t significant.  Even worse, they carry about $17.5B in exposure to coal companies and projects in their portfolios.

According to The Global Coal Exit List, “BlackRock is not only the largest investor in companies developing new coal plants, it is also the largest shareholder in oil, gas, and thermal coal reserves.”

This is at least partially a function of Blackrock being the largest asset manager in the world, but make no mistake, they are talking out of both sides of their mouths.  Even with their most recent announcement concerning a “25% of revenue” threshold for divestment in its discretionary portfolios, Blackrock will remain one of the largest shareholders of the world’s largest coal companies.

I won’t belabor the point.  These efforts are only scratching the surface.  Sustainable finance is by definition inclusive, distributed, and return-enhancing.  Investment firms like CircleUp are changing the investment process at its core and by extension, underpinning the real shift to sustainable finance.  Firms like ours are leveraging advances in machine learning and non-financial metrics to systematically originate, compare and execute investments in sustainability.  Other firms include Generate Capital and Generation Investment Management. And it’s these kinds of processes and firms that are going to get the world as a whole to where it needs to go in the next decade.

Happy 2020!

I built SOIL Funds Management to focus on sustainable private equity. But what does that mean?

On the front-end, we target businesses that we believe generate a sustainable competitive advantage by using a series of financial and non-financial screens. Like Farmers Insurance, we know a thing or two because we’ve seen a thing or two.

Typical financial metrics include things like Rev Growth, Gross margins, EBITDA growth, EBITDA margins, etc. Non-financial metrics include things like carbon, water, and jobs – metrics that are typically found in the IRIS database or embedded in the UN SDGs. These indicators are helpful for both prospectively for origination of opportunities and prescriptively to optimize investment outcomes.

What amazes me though is that there are still people that think there are holes in the thesis – that there’s no data to bear out the alpha. That’s simply not the case, nor has it been for some time. In much the same way that C&I solar and more recently, solar+ and microgrids, have remained a bright spot for project-level returns, so too has ESG-focused investing for public markets. Study after study has shown that there’s generally a correlation between good ESG performance and good financial returns including a lower cost of capital. And the list of investors that have proved this out in the public markets includes some of the biggest asset managers like Allianz.

Meanwhile, growth equity specifically has returned materially higher returns than other equity asset classes by anywhere from 200-500bps on average and as high as 900bps against larger buyout funds as determined by Cambridge Associates last year. They caution though that multiples for growth equity are stretched as well and that active managers will need to bring the entire tool kit to bear.

So when we put all of this in a mixing bowl, what do we get?

We focus on an area of investment that has historically outperformed (growth equity) with a thematic overlay that has been dismissed by many despite the data demonstrating alpha. We bring with us the experience, skill sets and infrastructure that are necessary to compete in this particular asset class.

One last thought on the Why – small businesses are the job growth engine of the United States. What we need as a country is dollars at scale flowing into growth companies that are going to make a real difference in sustainability and jobs. Getting excited because Blackrock introduced an S&P500 tracker ETF minus the coal companies is fine, but that’s not going to move the needle enough.

And that’s why we do what we do.