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Energy Innovation Isn’t Just About Technology

by Michael Levi
February 2, 2011

For many people, innovation is pretty much synonymous with technology. But when it comes to dealing with our energy and climate problems, we’re going to need innovation on other fronts. In particular, we’re going to need new business models that fit with clean energy. One key part of that that I keep coming back to in my thinking is finance.

It’s not fashionable these days to call for financial innovation, which people associate with ill-advised inventions like CDO-squareds. But as Bob Litan showed in a paper about a year ago, there’s actually been a lot of economically beneficial financial innovation in the past few decades. Where might creative finance help with our energy problems in the coming decades? Here are a couple ideas that help me think through the limits.

On the conventional end, energy efficiency finance stands out. The typical consumer appears to demand a very short payback period for investments in energy efficient equipment. This should, in theory, be the perfect opportunity for financial innovation: a third party should be able to absorb the up-front cost of the efficienct equipment, take a cut of the fuel savings, and make a profit, all while leaving enough for the original consumer to make some money too. (The same sort of innovation will generally make sense for renewable energy, which shares the same high up front cost vs fuel savings later feature.) Why hasn’t there been a proliferation of innovation in this area? I don’t know, but the companies that figure out how to do it at scale should profit handsomely while helping fix our energy problems. (Bonus unexpected source of progress: Success here will also require legal innovation.)

On the more speculative extreme, I wonder if we could see new variations on (or even substitutes for) venture capital emerge. Venture capital has become pretty much synonymous with financial support for cutting-edge technology. But the established VC model – relatively small scale of capital, 3-5 year investments – is a pretty poor match for much of the energy field, in which early stage projects will take much longer to mature and will cost a lot more money than the VC norm. The sharper analysts who understand this tend to conclude that government will need to step in to make sure technological progress happens. Perhaps. But the history of government support for innovation aimed  at commercial application isn’t all that encouraging. We’d be a lot better off if someone invented a financial structure that allowed investors to collectively take longer-term, higher-capital, risks. Perhaps that’s a pipe dream, but it’s worth recalling that venture capital basically didn’t exist seventy years ago, and didn’t really take off until the 1980s. When it did, it was partly in response to changes in federal rules that had previously deterred pension fund investments in VC. (It also followed an ill-fated earlier attempt by the U.S. government to spark VC.) Might we see new models for high-risk technology finance emerge? I don’t know, but I wouldn’t count it out.

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  • Posted by DaveG

    I wonder about the potential for supply-side solutions such as financial innovation as a mechanism to overcome demand-side barriers – is it possible to create investment opportunities enticing enough to get individuals and building owners to overcome inertia (a product of risk aversion and uncertainty)? In other words, I can’t help but answer your question above re: the puzzling lack of financial innovation in the energy efficiency (and renewables) sector as the product of weak demand-side imperatives and more specifically, weak regulatory frameworks on energy efficiency (and renewables).

    Cities are increasingly moving towards energy efficiency standards for new buildings (albeit typically only for large buildings), but continue to lag on efficiency regulations for existing building stock. While London, New York City, and Toronto, for example, have adopted voluntary programs aimed at spurring building retrofits (based on utilitarian logic and cost-benefit analysis) this approach has yet to achieve scale and I wonder whether it can without stronger regulatory measures. What this suggests to me is a political problem (how to overcome local resistance in order to get necessary regulations in place) that is unlikely to be overcome by financial innovation.

    The alternative, in some ways supportive of your argument, seems to be initiatives such as the C40/Clinton Climate Initiative Energy Efficiency Building Retrofit Program (EEBRP). However, in this instance, the innovation that I see in action is not financial in nature (the same utilitarian cost-benefit logic is still in operation: partnership b/w financial institutions, energy services companies, and building owners results in positive-sum gains for all three) but rather socio-political.

    The forging of relationships and links between cities and non-state actors, the publication of actions by cities, the creation of bonds between cities, and the pressure of competing with one another for status and reputation, may drive the expansion of the EEBRP amongst C40/CCI cities. And in turn this may (big question mark!) spur regulatory actions by cities that can drive investments in efficiency (and renewables) to scale.

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