As the cost of battery technology to power electrified vehicles (EVs) comes down to competitive levels, there will be an important opportunity to invest in commercial businesses in many mobility sectors. Already, the case for investment is very clear and pronounced. Lithium-ion battery pack costs for EVs have been declining, and in the next five years are projected to be cost-competitive with conventional internal combustion engine vehicles. These pricing signals are assisted by the policy stimulus, such as the $7,500 U.S. federal government tax credit, or the exemption of a registration fee in several Chinese cities as well as in countries like Norway.
For their part, investors may turn increasingly to “green bonds,” a term to connote debt securities issued by municipalities or companies to finance projects which enhance environmental outcomes, such as CO2 emissions reductions. Recently, a group of academic researchers published a paper entitled, “Financing the Response to Climate Change: The Pricing and Ownership of U.S. Green Bonds.” (Apologies, but you will have to pay $5 to access that link if you are not a subscriber.) In this paper, the co-authors do empirical analysis to conclude that yes, green bond issuance, especially by municipal governments, has increased since 2010. In 2016, they report that total green bond issuance was $6.5 billion in the U.S. By way of comparison, plain vanilla “ordinary” bond issuance in 2016 was $363 billion. You can see that the market for green bonds is rather small.
I read this paper with interest because of an idea I had in 2004 whereby companies like Ford, where I worked as chief global economist, could fund their work in alternative fuel vehicles by issuing “green bonds.” The idea centered on an experience I had when I was an economist at Mellon Bank. In the mid-1980s, well before my arrival there, Mellon Bank suffered substantial loan losses from a trifecta of bad exposures. It had lent money to sovereign governments in Latin America, it made loans to energy companies hit by a drop in oil prices from $30 to $10 per barrel, and it made a series of bad real estate loans. Mellon Bank was downgraded to one notch above investment grade. The book value of the bad loans totaled $1 billion.
Mellon Bank’s management put in place a survival plan. It launched a separate company called Grant Street Bank. This “bad bank” was a separate institution with no recourse back to Mellon. Grant Street’s financial structure included senior “junk” debt, preferred stock, and equity. Mellon sold $1 billion of bad assets to Grant Street. Mellon charged a management fee to Grant Street for asset management. Then Grant Street issued junk bonds to pay the management fee. As this plan was implemented, Mellon wrote down $350 million (this write-off is like a charge against earnings). Mellon got $650 million in cash from Grant Street (proceeds from junk bond issuance). And over a three year period, Grant Street Bank proceeded through the loan workout and ultimately closed its doors.
The plan was successful in a number of ways. It removed uncertainty around a pool of bad assets for Mellon. The company remained investment grade and survived. For Grant Street Bank, its preferred stock holders got paid fully for its holdings of equity (100 cents on the $1). And finally, Mellon’s losses — i.e., the $350 million write down — could have been much larger without this good bank – bad bank plan. The disadvantage, of course, was that $350 million is a high price tag for removing uncertainty among the investors who owned Mellon stock and bonds, or among the customers who banked at Mellon.
Now fast forward to today. Our U.S. policy makers have still not implemented any plan to pay for or compensate for the social cost of carbon, however much that may be. As the technology underpinning EVs becomes more economic, and as renewables and its storage become more economic, now is the time to consider a striking jump up in green bonds. Indeed, an automotive company could deploy the good bank – bad bank model quite readily. If you have looked at the financial market signals recently, isn’t that what it may be discovering? If the market valuation of Tesla, with one plant and around 7,000 workers, could be larger than GM, with dozens of plants and over 150,000 workers worldwide, then are we not seeing the potential of green bonds at the doorstep of automotive companies? Set up a company which issues green bonds, and green equity for that matter, in order to fund the transition to EVs. Keep a running tab of the emissions savings from this transition which the customer and the business can benefit from should a trading scheme for credits emerge in the future.
The co-authors of the green bond paper referenced above do find that the yield green bond issuers must pay is several basis points higher than what they would pay when issuing an ordinary bond. This means that green bond investors sacrifice some return for holding these type of bonds. From my perspective, some of this lower return on green bonds may be due to the low volume of these securities, the lack of a robust secondary market, which means that the price discovery process is crimped. But this is not unusual for an early stage marketplace. Green bond investors are putting other ‘points on the board’ for their constituents, such as enjoying the personal benefit of knowing you are helping the environment. Not all people have the resources to afford this personal “good feeling” that comes from social impact investing. It is judged that the harmful, adverse consequences of climate change are mounting and the costs are surely greater than the rate of return between ordinary and green bonds. Over time, with the help of prudent, evidence-based policymaking, green bonds could offer an attractive avenue to transform the emissions landscape of the mobility sector.
Editor’s Note: The political economy of climate change is complex and vexing. Another great paper published recently is “An Economist’s Guide to Climate Change Science.” (And yes, you can obtain a complimentary copy of this paper.)