“The idea of DCF assumes that you have alternate investments and that there is continuity between investor and recipient of proceeds, but with long-term environmental problems those conditions aren’t satisfied.” —Daniel Kammen, University of California, Berkeley
“The decisions made over next few years and decades will affect life on this planet for hundreds of thousands of years.” —Ken Caldeira, Stanford University
“There is a data problem that needs to be resolved through standard-setting.” —Chad Spitler, BlackRock
Kleeman began by questioning whether there is a correct way to analyze long-term, large-scale investments such as those that might have major sustainability impacts. He stated that some people believe that discounted cash-flow analysis (DCF), a common approach to analyzing capital investments, should be used. However, he pointed out that DCF does not capture the whole picture. He questioned how people could look at sustainability investments, use DCF and still say it’s a bad investment.
Kleeman referred to the Stern Review on the Economics of Climate Change, which estimates that for the next 20 years, we must invest 2 percent of global GDP, or US$1.5 trillion, each year to avoid the worst effects of climate change. However, climate mitigation only becomes a “good investment” when the discount rate reaches around 1 percent. At 2–3 percent, it is a “money loser.” He pointed out that most strategic decisions are not made based on the DCF valuation, citing wars, major corporate strategic investments, infrastructure, and health care. Kleeman asked how should we value mitigation and sustainable investment?
Caldeira responded first, saying that investments in mitigation and sustainable investment are long-term, whereas many traditional investments are relatively short-term. Decisions that we make over the next few years and decades will affect life on this planet for hundreds of thousands of years, so applying DCF does not necessarily capture the real effects of these decisions. If the Romans had had an industrial revolution, the ice caps would still be melting and ocean would still be rising. DCF would suggest that the investments made then would somehow benefit people in the future. Given this outcome, this seems like a suspect assumption.
Kammen described California’s greenhouse gas emissions management system—designed to reach a 1990 baseline by 2020 and 80 percent lower than that by 2050—as an example of controlling emissions. The effort is focused on minimizing risks, not eliminating them, and looks at near-term changes that will have long-term impacts. California’s decision was not based on DCF analysis but on political debates and private interests. This same philosophy can be applied to large investment decisions such as the Keystone Pipeline, where it is difficult to assess the opportunity cost using DCF.
Kleeman made the observation that there are often short-term decisions where DCF may apply. He asked the panelists whether there is another frame that companies can use to balance both short-term and long-term implications while providing for a broad set of sustainability and opportunity tradeoffs.
Caldeira said part of the problem is a dysfunctional political system. Kammen noted that if you focus on individual targets for sustainability, then you will get it wrong. With just four decades to create a new climate plan, California’s dense policy structure allows the state to be more resilient, since the measures of policy structure have linkages to other legislation. Single targets or objectives make you more vulnerable.
Spitler shifted the conversation to highlight the data quality issues around environmental, social, and governance data. Currently there is not much comparability, and metrics don’t match up, making it difficult to quantify. Much of the data problem revolves around the need to set standards for metrics. They have found that the data with most potential has been on the humanistic side, such as the Board of Directors structure. For this reason they have focused on integrating governance into their investment process.
Kleeman then asked the panelists what kinds of opportunities companies can take advantage of as a result of economic shifts. Kammen highlighted the boom in clean tech from subsidies in Germany and the resulting transformation their economy. Spitler said that most of the conversation has been about risk, but the flipside is how you identify opportunity, with the volatility in wind and solar investments as an example of a potentially risky short-term investment but strong long-term investment. He said a sound investment philosophy is to buy companies that you believe in with products that you like, and align your investments with personal beliefs.
During the Q&A, an audience member asked about bridging DCF and public policy. Caldeira responded that the concept is that there is some sort of endowment that we want to pass on. Conventional tools are not the problem, the constraint of assuming that to be sustainable you will have to leave the planet as good or better is the problem. Kammen highlighted Norway’s policy of using wealth from exporting carbon for positive impacts, underlining that clear policy leads to clear vision.
Another audience member asked about the evolution of using DCF to analyze investments. Kammen mentioned that some argue that we should adopt declining discount rates. Caldeira pointed out that the idea of DCF assumes that you have alternate investments and that there is continuity between investor and recipient of proceeds but with long-term environmental problems, those conditions aren’t satisfied.