Impacts of COVID-19 on ESG and Clean Technologies
by Michael Zimmer, Washington Counsel, Microgrid Institute
Recent surveys of various market responses indicate the current global focus on environment, social and governance (ESG) issues will continue and likely increase with additional market-based tools in response to the COVID-19 pandemic and economic collapse . Activist shareholder interest still exists in reducing coal, oil and gas usage while focusing on a decarbonization strategy in rebuilding global economies in a post-COVID 19 restructuring. Other pro-growth advocates will seek a COVID- 19 recovery that reverts to the status quo using heavy fossil fuels masked as cheaper, and more productive. This transformation to resilience and sustainability will increasingly be grounded in build -own-operate structures for smarter energy and infrastructure development using public-private partnerships and market incentive
The market collapse in first quarter 2020 proved that more sustainable, ESG companies were less volatile, better managed and less risky. The ESG company shares generally did not plunge at market levels and declines reaching 38%. Their costs of equity and debt capital are lower. They are often evaluated as better managed enterprises with higher market evaluations. A return to the status quo would be costly, risky and not durable.
We will also see an increased focus on FEWS issues centering on the new resource revolution including regenerative agriculture, sustainable meat and food processing, microgrids, food wastes to biogas, and efficient electricity utilization for water treatment, transportation and buildings energy use. The final transformation after the public health crisis passes will center on resilience rather than mere reliability for housing, public health, food, electricity, energy, and increasingly broadband access.
Several observations and insights arise from recent discussions in Europe and the US that the author has conducted:
1. CONSTRUCTION & SUPPLY CHAINS. Cleantech projects under construction have continued. COVID-19 impacts may occur for new projects and key resources in the supply chain appearing later in 2020. Layoffs in the clean tech industry reached 110,000 workers in the US, mostly in the residential solar, energy efficiency, and clean transportation sectors. This may impact construction schedules and delays into 2021 - 22 for renewables. These types of utility grade construction projects are deemed state critical or essential facilities in COVID- 19 protocols. But, that status is subject to the continuing availability of supplies and performance of the supply chain in the US, Europe and Asia for equipment and products. This issue also impacts infrastructure recovery strategies, and the need to stimulate sound 'shovel ready' projects, including clean technologies.
2. INVESTMENT INTEREST INCREASING. Investor monies are still flowing to clean technology opportunities. The appetite for such investments is increasing not on a green nor sustainability basis, but because of resiliency. The focus will increase on metrics, performance data, energy storage and construction. The pandemic has exposed the shortfalls of mere transactional short-term thinking and the necessity for more durable mid and long -term strategies. Some capital commitments for renewable projects are being reneged upon creating a slowdown in tax equity deals .This is occurring because the tax appetite of investors is not clear with COVID-19 related market gains and uncertain but projected losses on 2020 operations. There are new net operating loss reserve carryforwards that were included in recent COVID-19 economic relief legislation from Congress. These provisions plus new Federal lending programs , and the Federal tax credits for clean tech will support investor and tax planning ahead. This favors clean tech strategies going forward over continual reliance on fossil fuels after the COVID-19 market meltdown, the escalating domestic and global environmental challenges, and the global market volatility and uncertainty for oil created by Russia and Saudi Arabia in the first quarter, 2020.
3. RESIDENTIAL SLOWDOWN. There is a cleantech slowdown occurring more in the residential sector especially for energy efficiency, and solar installations. They are down 75% based upon data from Bloomberg and other sources because of state COVID-19 shutdown policies precluding marketing, sales installation calls. But by 2021 , an increasing demand is forecast which will over double the prior year demand levels because of the presence of expiring Federal tax credits. Availability of factories for solar panels production in the EU and China will become critical raising the importance of monitoring the supply chain for resource deliveries from 2021-23.
4. TAX EQUITY MARKET. The tax equity market for renewables investment is not transparent and is not clear over the depth of the recession and who exactly will be impacted . But after COVID-19 recovery, equity will be seeking reductions in leverage ratios. The nature of the technologies impacted will be uncertain for 6 - 12 months ahead. We are seeing downsizing of utility projects, with some permitting delays especially for solar and off shore wind projects in the US. But the equity will be here to stay as COVID-19 bailouts by the Congress will foster needs for higher corporate tax rates by 2021-22.
5. GREEN BONDS GROW. The green bond market appetite is increasing. Corporate debt has also shown an interest in green bonds with more demand . The long-term, sources of operating wealth, such as pension funds and insurance companies are a critical element of this evolving marketplace. Green bonds reached $ 255 billion of issuances by 2019, with a forecast continuing trajectory. This is a 51% growth rate over 2018 according to Climate Bonds Initiative. A critical question is whether the issuers will hold the bond product for their own account or will they be packaging the green bonds to ultimately sell them off. Green bonds also present a correlated risk in a portfolio . They are proven to offer more revenue stability and lower volatility than the public capital markets. The price-earnings ratio is more stable with green bonds and sustainable company equities performed quite well in first quarter 2020. A new interest may be growing with resilience bonds yet to be defined, while looking ahead separate from green bonds .
6. PUBLIC-PRIVATE PARTNERSHIPS. We should see considerable public dollars invested ahead with public-private partnerships. These types of investments are showing better returns from ESG investments, more stable revenues with less volatility in the markets served based upon Wall Street analysis. HBSC observed that stronger ESG commitments in companies has reduced their market volatility over 80%. Moody's recently reported that over 33% of private ratings issued highlighted climate change as a critical investment factor in the projects. Standards and metrics in this space need additional improvement with further data. Goldman Sachs is reporting lower interest rates affixed with projects that verify higher environmental performance.
7. LOWER ENERGY PRICES. It is still unclear what the political impact of low energy prices will be on clean tech after COVID-19. Lower fossil fuel prices may defer support and postpone investment for clean technology economically, except if the investment decision is driven by resilience. Tax credits create an additional short run stimulus and timing benefit for cleantech over the next three years. It is not yet clear how lower energy prices will impact public policy support for cleantech. This will vary by state in the US, and foreign countries and will be used by political parties for different purposes. But there is a 66% reduction in running rigs by 2020, and a 75% decline in wells fracked this year. Lower energy prices will exist for several years . These conditions and a lack of storage clearly will delay gasification, carbon capture & sequestration, hydrogen and nuclear projects because of first hurdle costs until after 2028. Also the O&G sector must repay $135 billion of shale debt and interest by 2020-25.
8. ELECTRIC RATE RELIEF. COVID-19 electricity rate relief will increase as an issue among the states for electric utilities. This will foster renewed interest in carbon free goals, transmission & distribution modernization, and increased recognition of the value of distributed resources and resilience in state electricity planning. Increased pressure will mount to switch more ratemaking to formulaic rates, add COVID-19 surcharges, with a shifting of more costs into variable rate cost recovery increasing total costs to all classes of customers. This will continue to foster increased interest in distributed energy, microgrids and behind the meter projects with energy storage in some jurisdictions provided by new market entrants, competitive vendors, and lower cost suppliers than the legacy utility.
9. CORPORATE PPAs. Corporate power purchase agreements (PPAs) for renewable energy are increasing with momentum over the last three months. They are increasingly important for investors but also stakeholders, and employees themselves. There is an intergenerational transfer of power/momentum by those under 40 years currently in our corporations. In 2020, 50% of the workforce is comprised of Millenial and Gen Z employees with different values, goals and market perspectives, reaching over 75% by 2030. Companies seek the PPA's as a prudent form of energy management and procurement. These PPA's are seen as leading to lower operating costs, with environmental , operating efficiency, hedging, social responsibility and resilience benefits in the choice over historical utility service laden with surcharges, pricing volatility and rent transfer payments.
10. ELEVATION OF 'SOCIAL' IN ESG PLANNING. Increasingly, the emphasis will be on 'social' strategies in ESG planning. More resilience and resource planning supports stakeholders rather than merely shareholders in this corporate market transformation. The pandemic has shed light on social inequalities at new levels. Companies will be asked to provide better market balance on hiring, salaries, sick leave, benefits, pensions and medical care as an investment in quality human capital. The power and velocity of social media after the COVID-19 recovery will only accelerate this prioritization to the level of awareness struck for the environment since 2000 in global planning. The better companies will be focusing on communities, collaboration with colleagues, and customers grounded in better objective data. They will also recognize the FEWS nexus coupled with public health as a powerful narrative.
11. STATES AND CITIES. States and cities have received less than 5% of Federal COVID-19 relief funding to date. There will be a need for new tools like the old US Treasury Section 1603 grants and the critical focus on predevelopment, and 'shovel ready' funding . This is needed to support good projects in the energy, transmission and distribution, water, remediation and broadband space. The pandemic escalates the value of distributed resource approaches vs. utility scale because of employment, automation, resilience, economic development and jobs issues . Renewables will also continue seeking the distributed model plus the utility scale model to achieve better resiliency, price hedging and operating outcomes for customers coupled with energy storage. Distributed energy also creates more new and blue collar jobs and enjoys more political support than larger scale utility projects. However, the utility market is increasingly shifting to larger scale utility owned and operated wind, offshore wind and solar projects over the upcoming decade
12. CDFIS. Community development financial institutions (CDFI's) need processing support for applications seeking federal funds to support smaller scale developers. They receive less assistance and support and less federal funding under COVID-19 relief programs. The smaller companies need help with the applications, and will require a longer road to rebuild their pipeline and project development capacity by securing funding access and better banking and law firm support.
13. CARBON CAPTURE & NUCLEAR. Will COVID-19 impact nuclear or carbon capture sequestration? Market wisdom is that the pandemic will not help these technologies in the short term. Carbon capture and sequestration is still in development with technical difficulties and severe economic challenges. The O&G fracking downfall will also hurt this technology and its wider deployment. Nuclear power faces the same conditions with higher costs per kilowatt hour confronting less expensive and less volatile supply opportunities for power ahead over the decade of 2020 - 2030. Better economics is needed, although interest is being shown in these technologies from the oil majors , including Royal Dutch Shell.
14. REDUCED VOLATILITY. The stronger level of ESG commitment in companies has reduced market volatility by 81% based upon recent analysis by HBSC. COVID-19 stock performances shows a 100 - 100 basis point positive difference with more resilience perceived in such companies to confront cycles. The ESG commitment tends to manage costs and protect margins for these companies' products and services.
15. MARKET TRANSFORMATION. Post -pandemic recovery will foster structural shifts in the economy as priorities will shift and new markets, with opportunities to serve under different business models will be emphasized. Social topics will see increased messaging , marketing and management because the wrong outcomes are detrimental to reputation and branding. Social issues will become embedded more deeply with investment decisions, but also will impact the access to human capital, and the desirability for partnering and venturing. Failures will be passed on to the marketplace on a continual basis. Environmental concerns will compete now more with human capital, cost controls and financial management issues. This will foster a new environment focusing on communities, colleagues and customers first-- representing a major market shift of the past 45 years.
16. MATERIALITY. Materiality assessments and changes are occurring on company operations focused on increasing transparency with climate, health, inequality, joint venturing, and energy. Similarly, corporate strategies help illustrate how human capital questions are managed. A quality workforce will increasingly be demanded because these are critical questions for the current younger workforce and offer competitive edge in industry sectors. Pandemic and supply chain issues, climate risks and new geopolitical risks will be part of the materiality review and updating .
17. DATA. Comparisons on ESG issues are difficult because discrete data sets are not sorted . Some data is subjective, anecdotal and sloppy. It often is not standardized. The Sustainability Accounting Standards Board (SASB) performance parameters are a good place to start in evaluating company ESG responsibilities and performance. This foundation is better in updating concepts of materiality for disclosure purposes in clean tech investing.
18. GREENWASHING. Increasingly forecasts are stating that greenwashing is over and is not going to be tolerated as credible corporate conduct, nor necessarily in conduct by NGOs . Social media creates branding and reputational risk enforcement. New materiality standards and ESG reporting are likely within a year creating regulatory and financial reporting enforcement.
19. SHORT TERM VS. LONG TERM. The COVID-19 experience highlights the fallacy of transactional, short-term financial planning in the US which has been the hallmark since 1980. There is a heavy overweighting in financial analysis on 1 to 3 year numbers which should likely shift to performance numbers 5 and 10 years out offering a longer-term view. This is a review that assesses durability, quality of management direction, and which is not merely transactional financial engineering. This will foster better scoring for durability, resiliency assessments and company performance. The market is continuing to reward ESG planning and company financial analysis in the cost of lending, better access to human capital, equity and debt pricing with lower volatility, and the critical nature of substantive progress for branding and product marketing purposes.
Conclusion
Institutional investors will derisk asset portfolios from resilience risks. They also will show an aversion to lending capital increasingly for 'dirty assets'. COVID-19 recovery will face cheap, lower cost energy as a strategy to return the US economy to greatness. Increasing reliance on investment risks, sustainability and ESG principles will ensure that reinvestment is wiser, grounded in durability and resilience. This is essential to ensure that US investment, infrastructure and recovery strategies don't become tomorrow's stranded assets in the face of new economic risks, climate change, pandemics and technological transformation. Otherwise, we will be stuck in managing 19th century fuels, in old 20th century infrastructure, with escalating degradation of our ecosystems, wondering why we can no longer compete as a nation to meet the needs of customers and markets in the 21st century.
About the Author
Mr. Zimmer is Washington Counsel to Microgrid Institute, and previously served as senior counsel with Thompson Hine LLP, practicing in the firm's Energy unit in the Corporate Transactions Group in Washington, D.C. He focused on natural gas, electricity, water and utility regulation, dispersed energy, cogeneration and micro grids, renewables and environment, and energy corporate acquisition and project finance transactions nationwide. He has been involved since 1985 in mergers, acquisitions, construction, development and project financing assignments in the non-utility generation, renewables, natural gas and electric, rural cooperatives, clean tech energy, emissions trading, and manufacturing sectors. Some of these transactions involve financings for some of the largest undertakings in the United States in these industries, with a composite value in his career exceeding $15 billion. He has over a decade's international experience on energy and renewables transactions in over 25 countries, and has served on the development of energy and infrastructure projects in over 35 states in almost 40 years of service.
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