Environmental Capital Group

The following article appeared in the December 2009 edition of Climate Change Business Journal (CCBJ). For the complete edition, please go to http://climatechangebusiness.com

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December, 2009

Environmental Capital Group Measures Benefits of Climate Change Investment

David Heppe, Managing Director of ECG, discusses quantification models, progress with pension funds, and the recession's impact on investors.

CCBJ: Can you give some examples of the due diligence, performance monitoring and reporting services that Environmental Capital Group (ECG) provides for investors?

DH: Our business started with the "Green Wave" of venture capital investments in clean technology, originated by the California Public Employees' Retirement System. Their visionary philosophy catalyzed the market with over $5 billion invested in clean energy and clean technology funds and companies. Environmental Capital Group is the environmental advisor to PCG Asset Management, which manages CalPERS' private equity investments in clean technologies through fund-of-funds structures.

ECG has developed innovative methods for measuring and quantifying the environmental benefits of cleantech investments. We diligence cleantech funds to determine their potential to yield material net environmental benefits, and we work with the fund managers to establish analytical frameworks for each portfolio company which relate business results to environmental impacts. For example, product units sold or material volume processed are converted to tons of emissions avoided or gallons of water saved.

ECG assesses improvement or net environmental benefits by comparing the positive and negative environmental impacts of the "new" technology to the baseline technology in common use. Embedded energy and water use are considered in comprehensive life cycle analyses. Business results are then collected annually and used to quantify actual environmental benefits in our CLEAN™ framework: Carbon, Land, Energy, Air and Natural Resources. The results are summarized in an annual report that aggregates environmental benefits at the program level.

CCBJ: What key expertise and skill sets are required for these services?

DH: Engineering backgrounds, pragmatic experience in operating companies and strong analytical skills are required. We work closely with PCG Asset Management to develop positive working relationships with both the cleantech VCs as well as the close to 200 portfolio companies. In addition, we seek deep technical advice when necessary from leading academic institutions such as Stanford, UC Berkeley, Princeton and Lawrence Berkeley National Labs.

CCBJ: What tough issues do you encounter? For example, if you're advising firms investing in biofuels, how do you choose a life cycle analysis method that will rigorously evaluate all impacts?

DH: It's funny that you ask about this one, because it is one of the more complex ones, so we actually sponsored some research at UC Berkeley to analyze this issue. Indirect land use is being better understood as an important factor with some biofuel production, and in complex issues like this we do sometimes turn to the research institutions. In most cases, however, we try to get within 80-90% accuracy on our calculations of environmental impact, and we are able to leverage a great deal of pre-existing work on embedded energy and its related impacts, for instance.

CCBJ: Many firms are in the development stage. How do you balance the potential environmental benefits of a company with the likelihood of its success as an investment?

DH: We really focus on the environmental impact issues, and our partner, PCG Asset Management, focuses on the financial side. PCG is rigorous in their approach to understanding the business and related financial aspects with companies and funds they invest in, and the 'green factor' is not considered in how successful an investment might be. The investments must first make money for the investors, and then we look at how good they will be for the planet. That said if a potential investment looks like it might have a negative environmental impact, the investment won't be made under this program.

CCBJ: The recession has been tough on the climate change industry and its investors. How has the recession changed institutional investors' expectations?

DH: One thing that has not changed is that investors do not expect to receive lower returns on their cleantech investments, just because they're doing something good for the environment. They expect market rate returns similar to other technology investments. Other than that, I think investors generally see the climate change industry as a good long-term area for investment, and therefore it has been hit less hard than some other sectors.

CCBJ: ECG is also working with pension and sovereign funds to put capital to work to develop cleantech industries in order to solve environmental problems, including climate change. With the vast erosion of wealth over the last 18 months, what's the situation now for pension funds, sovereign funds and their cleantech investments?

DH: We have helped establish a program called the P8, which brings the largest pension and sovereign funds together to work toward investing in climate change solutions. The economic crisis has delayed some investments, however, I think there is more recognition and resolve to work together now than 18 months ago, as the climate change situation becomes clearer. These large institutional investors are uniquely positioned with deep pockets and long-term horizons that are a natural fit for climate change solutions; particularly as the technologies are proven and scaling, capital and project finance are needed on a massive scale. And over the last 18 months, several technologies have come a long way toward being ready for scale up.

CCBJ: With Origo, another advisory firm, you're working with the State Department on an initiative to support cleantech investment in Asia, particularly around renewable energy and energy efficiency. What will ECG and Origo provide that cleantech investors and companies seeking investment could not achieve on their own?

DH: One of the big inhibitors to investment in the developing markets of Asia is risk: Risk in terms of country economics, government, currencies, etc. We have strong relationships with the multilateral development banks to bring de-risking capital to projects, which will enable the institutional investors to come into these markets. In addition, we have access to a great number of technology companies in the West, whose technologies are becoming commercial now. As those technologies become commercial, we can match them up with partners in developing markets to build businesses that would otherwise take longer or flounder due to poor match of technology and deployment partners.

CCBJ: A big slice of the cleantech industry is composed of companies developing products to market to the electric power sector or to the value chain of suppliers to that industry. What are your thoughts on how dynamic and responsive this industry is to new technology?

DH: Utilities and the power sector have been traditionally slower to move. However, they're needing to seriously look at upgrading their grids quickly to handle the increasing number of grid-connected renewable energy projects being implemented. In addition, a number of technologies pay for themselves quickly such as transformer monitoring and substation automation, which helps with earlier, more rapid adoption. As governments implement targets and policies for more renewables, we see the utilities becoming more responsive of necessity.

CCBJ: The climate change industry is highly sensitive to government policies. It now looks virtually certain that greenhouse gas emissions will be regulated in the United States. How do you think this will change the investment climate in renewable energy and energy efficiency?

DH: Over the long term, a price on carbon will be a tremendous boost to the industry. There will be uncertainty in the short term as the markets may experience teething pains and some instability, but as the market matures the returns for many technology companies will be enhanced enough to go from marginal to solidly viable and will help a number of industry sectors get down the learning curve more quickly so that the carbon incentives will not be necessary.

Reprinted from the "Executive Review" edition of Climate Change Business Journal, with permission from Environmental Business International Inc. © 2010 EBI Inc. www.climatechangebusiness.com

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