There’s no beating around the bush with climate bonds czar Sean Kidney. He may be based in the UK and spend a lot of time travelling the rarefied world of global institutional investment and policy making, but when it comes to making a point on a clean economy and how to finance it, it’s his Australian-grown directness that sticks.
China for instance.
“I think China will take off like a skyrocket in the next six months,” he says, during one of his recent lightning visits to Sydney.
He’s referring to the greening of China’s economy and even more powerfully, the greening of its finance.
His Climate Bonds Initiative, which promotes climate bonds (with low carbon emissions) and green bonds (focused on sustainable investments) on Tuesday released a new report with recommendations for how Chinese policy makers can grow the green bond market.
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He’s confident there is no stopping a green finance giant in that country.
“In China the government wants to green their economy,” he says.
The drivers – and methods – are solidly pragmatic.
Looming powerfully is the threat of social unrest from appalling pollution. See this recent shattering video on this topic now banned in China if you have any doubts. This recent story in China Dialogue said the popularity of the video, before it was removed from popular video and social media sites, was tantamount to a mandate for the government to act on its environmental problems, and was a turning point for China’s environmental policy.
Then there’s the methods. Kidney says there is widespread discontent with the previous economic model of sending funds to the provinces because in the past decade the failure rate has been about 25-40 per cent.
Instead, the Chinese are looking at market forces and that means green finance.
“That’s not market forces the way Milton Freedman understands it. It’s market forces in a highly engineered economy,” Kidney says.
But as the video shows, there are huge interest groups that don’t change because it will cost them economically. So is the Chinese government serious?
“They are so serious,” Kidney says. “I mean China is incredible at the centre.”
That’s the stratospheric levels of cabinet and the People’s Bank of China that he’s been dealing with to pursue his green bonds agenda.
“At that level, the government is so aware and they’ve said they will target 7.5 per cent growth rate and not a nine and 10 per cent rate specifically as a trade-off for greening the economy.”
And there have been lots of “aggressive statements” on cleaning up pollution.
Kidney says two policy papers will back his view. One will be from the People’s Bank of China and one will be from the National Development Research Centre.
“Both of these papers are revolutionary in Western terms.
‘They’ve basically accepted all the recommendations that have been thrown at them about greening the finance system; I think there is a bloody good chance they will implement the lot.
“I honestly think it will be a skyrocket of a place.
“Think about what they’ve got in front of them. They’ve already got a five-year plan of aggressive green targets. And a new five-year plan is likely to be even more aggressive in green targets.
“They’ve got a visceral threat to the Communist Party regime, which is air pollution in Shanghai and Beijing.
“And a huge proportion of the social disruption is to do with environment. They know that; they’re fully aware of it. They’re not stupid.
“They also know they have to transition the economy anyway, away from crude, dirty, to a different type of economy. It’s a resource efficiency issue.
“They’re not short of capital.”
Yes there will be pushback he says.
“China is not a monolith like people think. They are a bunch of competing fiefdoms and central provinces.”
So expect some disruption. But amid all of this is a central government hell bent on “trying to redesign the settings of the system to shift to green”.
The rest of the world isn’t doing so badly either
According to Kidney things aren’t looking too bad right now in his patch. Green bonds are at about US$50 billion in issuance, up from US$39 billion last year and they’re on track to get to US$100 billion this year. That’s about the size at which they’ll be a “game changer”.
Twenty minutes with Kidney and his breakneck speaking speed and you get what he’s talking about.
The great green wave
First, green bonds and the green economy are almost perfectly suited to each other, he says.
Essentially the bonds are a low-risk, low-interest-rate finance product that comes into a project and refinances it after the high-risk, high-interest rate development phase is completed.
“All green infrastructure is the same; it’s high risk to begin with then it sits on the ground and earns money. Whether it’s rail or clean water, it’s the same thing.”
Climate bonds are perfect for renewable energy because after the expensive risky development phase the “opex” (operational expenditure) is so low it looks like an annuity.
“So the easier it is to refinance your assets in a green bond market the easier it is to do equity investment and bank lending because you’re no longer looking at the possibility of a 20-year investment; you feel comfortable it’s only going to be three years.”
What it’s not is a development bond.
To lend on construction, he says, you need to be familiar with construction risk and you need the due diligence capability.
“That’s something for banks – equity investors – that’s their business.
“Our mission is to make it easier for equity funds to refinance a project as soon after it’s built.
“Think of it as a wave. The front end of the wave – the churn is equity; the long slow part of the wave is pension funds and insurance funds.”
Right now climate bonds don’t cost less, but they don’t cost more either. In the future Kidney says they may in fact come down in price as the market gets used to the idea they are lower risk.
Low interest rates are certainly a drawcard. It’s the way the European Central Bank is hoping to encourage Poland to get out of coal – simple: slash the cost of financing clean energy.
“Make them an offer they can’t refuse,” Kidney says.
What about nuclear power?
We flag the resurgent push for nuclear power in Australia, but Kidney has trouble believing this.
“I don’t see it building up,” he says – until we point to a mountain of column centimetres in the financial press and the South Australian royal commission into the industry.
“That’s very funny. Good luck to them,” he says.
Nowhere is anyone looking seriously at nuclear, he says.
The European Commission report on the UK’s nuclear program was “laughable”.
“But the economics of nuclear are a bit crazy. Because of the tail risk issues, so it only works with government subsidies. It’s not a commercial investment opportunity.”
And a nuclear plant takes 10 years to build.
“Hardly a fast-track solution to bringing down emissions”.
Besides, one more Fukishima type disaster and capital would quickly go to ground.
Climate bonds recognises nuclear power because it is a low emissions energy source.
“We do include nuclear power in our green bonds because they’re low carbon but we won’t certify them under a Climate Bond Standard because quite frankly we can’t see the benefits of nuclear in a rapid transition.”
Think of Egypt, which built a solar power plant in seven months.
“Why would you take any other path?”
The real action, he says, is with solar. It grew 42 per cent in 2013, he says, quoting International Energy Agency figures; geothermal grew at 8-9 per cent and wind at 19 per cent.
“So solar is away. We don’t have to worry about solar, he says.
“But now we have to worry about everything else.
“In order to avoid catastrophic climate change we need have every wedge growing at maximum rates so we need wind at 25 per cent compound growth and geothermal at 25 per cent and energy efficiency to grow at 25 per cent globally as an industry.”
Interest
Kidney says the biggest appetite for green bonds is coming from Europe – Scandinavia, the Netherlands and France. A lot of the activity is in purchasing, not issuance, he says. The US “munis” (municipal funds) are another emerging market.
“And we expect to see continual take up by national development banks this year, so sovereign style issuance.”
Australia has participated in two green bonds, one through Stockland and another through NAB. A third, managed by Ernst & Young, is in the wings. EY recently won the right to be an approved verifier or certifier of green bonds, partly on the back of this impending deal.
On the global outlook in the climate wars, Kidney says the conservatives in the UK still have some “lunatic deniers, but they’re in the minority, and it’s still light years ahead of Australia”.
“There are still some idiots around who deny the science but you only have to think that there’s more unanimity in the scientific literature on climate change than there is about gravity.
“So what are you going to believe? This is about infrastructure. Do you ask the citizens for their opinions on how to build a bridge?
“Feel free to take a balanced view but in the mean time the rest of the planet is getting on with the program.”