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Investing to avoid triple-threat climate risk explained

‘Most people think of the climate crisis as physical risk’: Bill Green, founder of Climate Adaptive Infrastructure, tells New Private Markets about the other pitfalls of high-carbon investments.

It’s hard to perform an old function in a new way, which is what many investors are attempting in trying to retrofit old infrastructure for the present and future challenge of climate.

At Climate Adaptive Infrastructure, a US firm founded by Bill Green, a veteran of the asset class, the firm’s business model is finding assets that support a low-carbon and long-lived future economy. New Private Markets recently spoke with Green to understand the opportunity that hedging in favour of climate change presents, and the risks of not doing so.

What does it mean for infrastructure to be “climate adaptive”?

CAI founder Bill Green

With many companies, you can decide on a new business model overnight. But if you build a toll road along the coast and below sea level, you can’t move that road. You can’t repurpose its business model. When you think about infrastructure – airports, toll roads, ports – it takes years to engineer it, finance it, and then it lasts for 30, 50 years. Maybe longer. But its sole purpose is that.

At CAI, we came to a realisation and understanding that while infrastructure is squarely in the line of fire of the climate crisis, the immediacy of these impacts has been largely overlooked. We found that to be both terrifying and also a significant opportunity to build a business model for this firm.

Is climate change risk simply how changing weather patterns impact assets?

Most people think of the climate crisis as physical risk: Superstorm Sandy in New York, fire season in northern California. I think most people will accept this is happening. But in certain ways, climate risk is more insidious because of what people are not talking about. The other two legs of that stool are policy and political risk.

We think this part of the conversation about the climate crisis has been largely missed, the triple-threat risk it presents to infrastructure more squarely than any other asset class.

Describe the other two legs of the climate risk stool.

Let’s take PG&E for example. PG&E is in bankruptcy. When asked, most people will say, “well that’s because of the fires”. But that’s not exactly true, the fires were a causal event. The bankruptcy was brought about by a law in California that says, “if you burn it, you buy it”. If you knew that would be enacted into law, would you still string high-voltage cables across tinder-dry forests? You might say, “well wait, this could potentially be a business model problem”.

Another example, Heathrow Airport Terminal 5. Heathrow Terminal 5 was built on the premise that a third runway would be built at the airport. But when the High Court in the UK said a third runway can’t be built because it would violate the Paris Climate Accord commitment, what happens to that investment? Obviously, it’s impaired.

That’s why we call it the triple-threat risk. Physical risk, but also policy and political risk is just as detrimental to investments.

Does climate adaptive infrastructure already exist, or is this mostly new-build opportunities?

There’s both. The key is to shift the lens a little bit and think about how the asset must be part of locking in a low-carbon trajectory. Typically, these assets are purpose-built to address just that.

An obvious example is investing in solar or wind generation instead of buying a coal plant and trying to turn it into something else. Both things are happening today, but people that have interconnections in existing coal-fired plants are trying to figure out how to change their entire business model.

Like I said, infrastructure assets are long-lived, they’re permanent. You build a port to ship coal or LNG, you’re going to fight like hell to continue to ship coal and LNG because that’s what your business is setup to do.

We have to think about what service the asset delivers over time and whether it’s locking in a higher or lower carbon emissions profile.

Does an asset manager need majority ownership to lock in a low-carbon trajectory?

Not exactly. These assets come with a profile, sort of like how we’re all born with a personality. Looking at an energy asset, whether it’s transmission or generation, you can very rapidly determine, judge and evaluate the carbon impact of what that asset will do today and in the future. An easy example: if I’m looking at a coal plant, I basically know I would be buying a coal plant. I may have a vision of what I might turn it into, but today, it’s a coal plant. I have a sense of the climate profile.

This brings us to a really important question which is: how do we go about our evaluation?

So how do you?

We’ve developed proprietary climate screenings that we utilise in conjunction with every single investment we make at the firm. The climate screenings we use are the lens through which every investment is viewed once it clears primary economic hurdles.

We’re asking upfront the same questions every manager’s asking: what are the returns, risks, where is it located? But we immediately segue into a series of factors which make up the climate screening that we conduct from there. And the screening is done by members of the investment committee, not a consultant or engineer that writes up a report. Every member of the investment committee has to participate and sign off on the final score.

Why is investing in fighting climate change a business model to build a firm around?

According to some studies, the world will spend around $2 trillion per year on new and upgraded infrastructure. If we spent all of that money the right way, we would see a significant curb in global carbon emissions.

On the other hand, if we spend it the wrong way, and I’m oversimplifying here, but we would basically be guaranteeing that young people won’t have the same future that I had living my life over the past 40 or 50 years.

How we think about infrastructure becomes all-important as we seek to lock in results. That’s why we have to come at this from different ways. You can’t just change a business model. You can’t unfry an egg. Once we do it, we do it.