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3 Climate Tech Risks for 2024
And why surviving them matters
Before I begin what will undoubtedly feel like a pessimistic post, I'll preface that I am long-term bullish on all things climate tech. After all, I’m in the business of what can go right.
I am, however, also a pragmatist who grew up in a middle-class household and understands the budgeting required to support a family of four.
I also want to be a great investor. That means always considering the risks lurking around the corner. To paraphrase Charlie Munger, I want to know where a company could die so that it never goes there. So, evaluating risk is an important part of my job.
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Commercial Real Estate, We Have a Problem
A two-headed monster is staring commercial real estate in the face: interest rates and occupancy rates.
Over the next 3 years, over $1.5 TRILLION in debt will be refinanced at rates that are 3 times greater than when the original terms were set. The cost of capital for property owners will skyrocket.
Typically, the best way to offset the cost-of-capital increase is to increase rent. But, since COVID created a more friendly, flexible WFH environment, the demand for space has declined. When supply outpaces demand, raising prices is not an option.
Why does this matter to climate? The more capital that pays off interest, the less capital goes to long-term investments in EV charging, solar, and building efficiency upgrades.
Consumer Savings Down, Consumer Debt Up
Americans are burning through their savings at an unprecedented rate and simultaneously racking up credit card bills in a high-interest rate environment.
Net, households are stretching their budgets in both directions.
Much like the commercial real estate problem, this trend restricts the ability to invest in longer-term items like solar panels and EVs. Climate enthusiasts often argue that these technologies are better investments than their fossil fuel counterparts. In the long term, that's absolutely correct. But, tight budgets prohibit most consumers from thinking long-term. Humans are not rational, and stress makes that trait more apparent.
As I recently wrote, the average sustainability consumer increasingly mirrors the average American consumer. That's a long-term positive trend that will appear negative in the short run.
Buying an electric vehicle highlights the short-term tradeoffs that pay off before long-term gains kick in.
The average used EV is ~$41K compared to ~$26K for an ICE. That's a monthly payment difference of almost $300, assuming a 60-month loan and a $5K down payment. There are a lot of families where $300 is a big difference each month.
Even if we calculate the difference in gas at $4.00/gal versus charging, the 1-year difference is still $2,100 ($3,600 saved in payments minus $1,500 charging savings) back to the consumer. We can add maintenance to get to maybe a $1,500 1 year advantage to the ICE.
Electric vehicles are just one area where this applies. It's true of solar, heat pumps, and all upgrades to sustainability. They require an upfront investment either in cash (which Americans have less of) or debt (which is more expensive than it's been in 10 years) and have long payback periods. Like a business, you can’t consider long payback periods if you’re going to run out of cash.
Inflation and Interest Rates
If there's one trend that underlies all risk these days, it's inflation and the interest rate required to tame it.
Inflation remains persistent despite slowing down over the summer months. The fed has stated an annualized target of 2%, and while rates have increased dramatically, we're still above that number.
Sustainability and climate require massive investments in infrastructure. The US government and venture capital are attempting to step in, but private financing will always be a driver.
It doesn't matter if that financing comes from debt or equity. What does matter is the risk-free rate for private capital is as high as it's been in decades. That number determines the return hurdle new investments must meet.
For those unfamiliar, the risk-free rate is the return an investor can make without taking risks. It is used in calculating the hurdle certain investments must clear. Think of it as a tradeoff number - I can invest X amount of dollars and lose none of it at a return. Or I can take some risk to *potentially* get a higher return. The higher the no-risk return, the higher the potential return must be with risk.
Typically, that number is associated with something like a 10-year US treasury. Today, that number is 4.25%; it was less than 1% in 2020. The tradeoff number has become 4x higher in less than three years.
The bar for all investments, not just sustainable ones, is higher than ever. Projects can no longer be hopeful. They must generate returns.
Nassim Nicholas Taleb coined the term “antifragility” in his 2012 book.
Antifragility is a property of systems in which they increase in capability to thrive as a result of stressors, shocks, volatility, noise, mistakes, faults, attacks, or failures.
The last time we had shocks to the system, the energy transition completely collapsed.
I believe these short-term potential risks will prove the energy transition is anti-fragile. It will get stronger with shocks to the system.
Higher interest rates will help force the deployment of these assets to become more efficient. Discerning customers will provide a mechanism to bring affordability to the forefront.
We already know the energy transition is here to stay, but that staying power will be further proved when disruptions to the system make it stronger.