STUART THEOBALD: Investors not seeing green returns

Let’s talk for a moment about a different sort of green and gold: the future of a global green economy and the riches that might flow from it.

The problem is that while the hype is big, investors are just not seeing the returns.

Financial markets are the greatest prediction machines yet built, but if we examine them now, you’d be tempted to conclude that climate change isn’t happening and the global greening of the economy is a nonevent.

Oil companies trade at record levels while producers of critical inputs for the green transition, including many SA miners, are being neglected. Black is winning on this field at least.

What is going on?

The first point is that markets price according to a discount rate. This means that gains (or losses) now matter much more than gains (or losses) in future. Interest rates are key in this discounting, and of course these have been moving upward.

When that happens, the future becomes less material. With interest rates at 7%, as they were during Covid-19, a cash flow in five years of R1m would be worth R713,000 now.

But with interest rates at 11.75%, that same cash flow is worth only R574,000, a fall of 20%. Look out 10 years and the decrease in value is 35%.

The future has just become less material, even if it will be one of extreme weather events leading to economic chaos.

As a result of shifting discount rates, an oil company that has 10 years of strong profits ahead of it will have been made more valuable than an electric vehicle company that will make seven years of losses before hitting the scale and technology to be profitable.

So, we’ve seen investors swing towards near-term cash producers such as oil companies, even if they contribute to making the future bleaker.


The second point is that it is hard to estimate the cash flows arising from a future green economy. For example, the electric vehicle market depends on government subsidies, with many large markets offering incentives to car owners to switch to electric.

Eventually, as bans on internal combustion engines kick in, government finances are going to be forced into withdrawing subsidies and even introducing taxes, to make up for the loss of fuel levies. Would the prospect of profitability evaporate then?

The third point is that climate change is largely an externality. Investors gain exposure to a single issuer — a company’s shares or its debt. That company can act to reduce emissions, leading to a better overall economic outlook, but the costs sit with the company while the benefits sit with everyone.

An oil company might deliver overall positive economic value by transitioning to a sustainable business model, but it will be at the expense of shareholders. It is no surprise, therefore, that shareholders resist.

That is a stark reality for those who want financial markets to be the solution to the masses of investment required to transition the world’s economy. It is hard to do without clear cash flows that accrue to the investor, and cheap capital that allows investment with long-term payoffs.

Carbon taxes

This is why I think the future of green investment must be driven by far more robust regulation. This is happening — and investors should be pricing for it. There will be far higher carbon taxes, carbon budgets and carbon tariffs. These will shift the economics, making the cash flows to green firms much clearer.

Carbon markets are another important area for investors to consider. These are, frankly, a mess right now, but much intellectual effort is going into how to get them to work in the right way.

Carbon markets allow trade of carbon emissions through an instrument representing carbon removed from the atmosphere or at least prevented from being put into it. You will not be surprised to learn that there are problems about how these “carbon credits” are created. Does planting a forest that absorbs 100 tonnes of carbon count? As much as not cutting one down? Does putting a scrubber system at the top of a smokestack to desulferise flue gases from a power station count? Does simply switching off the power station count? The incentives created by credits can be perverse. We need a regulated system that ensures the creation of credits is robust and logical, driving real emissions reduction.

Last week the Climate Change Bill was introduced in parliament which will set budgets for greenhouse gas emissions for the country and for specific sectors. This is going to become an important driver of the economics of climate change — budgets will need to be managed carefully and carbon credits may be an important tool to do so.

The bill is a good piece of legislation that has the potential to drive real change. Combined with carbon taxes and offshore pressures via carbon tariffs, domestic investors really do need to be thinking about how their exposures will be affected.

Through these mechanisms, carbon emissions are going to become expensive. The present value will increase for companies that actively reduce emissions and those that do not produce them. I don’t think markets are pricing optimally for these. Therein lies the gold in

  • Stuart Theobald is chair of research-led consultancy Krutham (formerly Intellidex).