The carbon tax is dead… long live carbon scarcity! What’s an entrepreneur to do?
In a week of horrifying weather images and carbon market evolutions, I suggest we should keep our eyes on where private investment is moving
It’s been a tough week for the planet, with floods and fires which stagger the imagination. In Germany and China floods swept away cars, parts of buildings, and caused incredible human suffering. In the Pacific Northwest and much of Canada, rampant fires burnt many thousands of acres, creating their own weather systems and sending smoke hurtling across the US which in turn reddened skies and burnt lungs on the east coast. The visuals were staggering, the panic was real & understandable, and all the while the world of carbon regulation & investment tumbled along with a few confounding ups & downs.
Amidst all the images of devastation, several carbon markets took major steps forward, the US carbon tax was declared dead, and several big private investors announced major funds to invest in climate. Wait what? This week I’ll try to make sense of it all, and lay out what I’d do if I were an entrepreneur these days facing all these complex inputs. The punchline? Go build a carbon teracorn.
Getting fit in the EU?
In the “good news” department, the EU unveiled it’s FitFor55 plan to cut emissions by 55% by 2030. There’s all kinds of goodness in here, ranging from increased sectors covered by the EU carbon market, and increased ambition, as well as lots of subsidies for things that will need to happen like refitting houses, green hydrogen, etc. The really key thing here, vs. other markets is that there is a hard cap on emissions, and it is being cranked down to meet the EU’s portion of the Paris goals - EU ministers are not waiting to see if other countries get there first. And they are actively working on a CBAM (or carbon border adjustment mechanism) or border adjustment tax / tariff, call it what you will. Many European industries are howling at the prospect of imports being advantaged if only domestic companies have to pay for the carbon they emit - so the G20 is actively discussing how to do deal with this, likely through an equalization of carbon payments on import, and early perspective seems to be that this might be able to pass muster with the WTO. This idea of a border adjustment has so much appeal that several US senators have proposed a carbon tariff in the US, despite the fact that the US doesn’t have a domestic carbon price — a difference which might easily make that proposal run afoul of WTO rules.
Did China launch a carbon market this week or not?
The Chinese carbon market launched this week, which is a great headline even if much delayed (China emits a meaningful portion of the world’s carbon, and continues to bring more coal plants online as living standards there increase and consumes demand more energy). The initial price is low ($7/ton vs. nearly $60/ton in Europe today), but for anyone who cares about actual carbon scarcity, it’s important to look at not the price (which is an outcome not an input in a cap-and-trade market) but the cap itself1. There is currently no binding cap that will bite into China’s emissions, but that’s hardly surprising given that China hasn’t made any meaningful international political commitments yet on overall emissions. But what they are signaling is that they are preparing the market so that they will be able to impose a cap. And while there are many shortcomings in their market mechanisms, the groundwork is being laid today. Very analogous criticisms could have been (and were) leveled at the EU carbon market when it launched. “It’s not binding!” “Prices are too low!” “There are too many carveouts!” My basic take is that China is about 10 years behind Europe, and there’s a lot of work to do, but for US pundits to throw stones at China for getting a market started with a non-zero price and a bunch of imperfections is hypocritical in the extreme; they should be focusing on getting a US market in place that’s at least as good if not a whole lot better.
But aren’t US carbon taxes dead?
Amidst all this, Robinson Meyer published a beautiful obituary for carbon taxes in the US. As he says eloquently, “it reshaped how the world thought about climate change. But its prized trait—bloodless economic efficiency—won it few friends on the right or left.” The history and the politics are a worthy refresher for anyone, like me, who believes that we need policies that are effective, efficient, and equitable - but most importantly at this point, we need policies that are effective at reducing emissions, and efficient because we are going to need every drop of economic firepower we have to keep the economy running as we make this transition. It looks like we are headed for another record year of emissions, and the images from the “front lines” (eg, forest fires, floods, drought, etc) are not looking good. It is true that carbon taxes seem to have truly found a way to be popular amongst a relatively few policy nerds and so politically unpopular that it’s kryptonite.
And so here in the US, headed into COP26 in Glasgow, we are left with a few potential hopes for US & global carbon scarcity.
If a carbon tariff on imports gets legs, but falls foul of WTO rules because you can’t tax things made by other countries that you don’t tax yourself domestically, perhaps that will provide fodder for a domestic cap-and-trade
The CES (clean electricity standard) remains a very potent lever - which unfortunately only addresses one sector, but a big one. It sure ain’t nothing. If we can achieve this, we get a meaningful way towards US carbon scarcity. Unfortunately it’s likely a fairly inefficient one (because government decides on the rewards and punishments for certain actions, and because it has unequal effects / costs across sectors), but it is likely to drive carbon scarcity.
Border tariffs / adjustments imposed by Europe may advance the game in the US, bringing some US producers who export into the column of being more indifferent to whether we tax emissions directly here or on import to Europe
Those pictures of devastation may have a direct effect on leaders (or at least on their kids and grandkids who may in turn make demands and change the narrative and make those reports of the death premature)
China may decide to seize the international high ground in the vacuum left by the US, and begin to catalyze international support for carbon scarcity and international investment in developing markets. It would fit nicely with the diplomacy they’ve been pursuing so effectively for the past few years. This would be great. Carbon scarcity is not a topic for narrow national interests, though private & national fortunes will be made off of it.
But what about those $6b?
At the same time, General Atlantic announced a $4 billion fund (including $1b of its own money) focused on climate technology through “Beyond Net Zero” strategy. Note importantly that that is specifically $4b of growth equity - not early stage. And they say that they’re focused on exactly the right stuff in decarbonization - reducing emissions through efficiency, optimizing supply chains, and carbon removals. Also Generate Capital closed a $2b fund to focus on clean infrastructure. So if all these (largely US-based) capital flows are happening in a place where there is no real carbon scarcity yet, what’s going on? Well, those investors are betting that there will be carbon scarcity - that the globe will not continue to push emissions into the air that result in us knowingly boiling ourselves alive. While generally investors do not bet on regulation, they seem to be betting on this kind of regulation. While they are likely investing in decent businesses today, they are calculating that when we actually begin to more aggressively cut emissions (as the EU has begun to do), the value of those businesses will skyrocket. I’m not on their investment committees, but I’m fairly confident that they’re doing either an implicit or explicit version of “how much will that company be worth when the carbon price (or shadow price) is $100 or $200”.
So what’s an entrepreneur to do? Follow the future $
Follow the money. Or where the money will be. Earlier this week I spoke to a highly accomplished young software product manager, headed off to business school with an interest in working on climate tech. The climate innovation space is rife with great ideas on how to create green this and green that; but I think that the value lens is still too abstract and speculative.
I’d suggest that as a way of cutting through the confusion, entrepreneurs focus on where the opportunity is when carbon becomes scarce. Build business plans and stress test them for potential profit generation / TAM / SAM at various shadow carbon prices (say $50, $100, $150/ton). And then, though this is hard, think about where you’ll be able to generate a moat and defend that profit pool through IP, scale or network economics when other potential competitors also see that same price.
Am I saying that Robinson Meyer is premature in his report of the death of carbon taxes and that there will be a US carbon tax? Nope. I do remain hopeful that reports of the tax’s demise are premature, but I’m a realist. I do think a clever politician who was willing to make a big bet (Joe? Joe?) could craft a form of UBI (universal basic income), float that in the wake of child tax credit’s forthcoming expiry, and fund it with a fee on pollution2. But that’s immaterial to my point. If we are to eventually reduce emissions, that’ll either be reflected in an explicit price (you emit X tons, you pay X*$Y) or an implicit one (you can’t do X, Y or Z or you pay exorbitant fees). And big, smart, investors are already making bets that we will do one or the other - that carbon emissions will become scarce / valuable. They are betting that there will be big $ to be made investing in companies that profit as that price (or shadow price) goes up. They are going “long carbon”— another way of saying they are investing in decarbonization through efficiency and removals.
Carbon teracorns? Oh yeah.
If I were a young entrepreneur, that’s where I’d be headed - go build what I call “long carbon”3. Take a look at the specifics of what General Atlantic is planning to fund, and build that. Because if carbon scarcity takes hold (and it better, or this week’s weather headlines will be ‘summer’), then the price or shadow price of emissions is going to increase, and valuations of companies that prosper under expensive4 carbon will skyrocket, precisely because they are doing good. There has never been a simpler way to frame being an impact entrepreneur. Build a company that will be incredibly valuable in a world of scarce emissions, and you will make the world a better place. Your profit is, by definition, the downfall of the dirty5. If you can make a huge business in a world of expensive carbon6, you have done a lot to fix the problem.
Unicorns ($1B valuations) have become so popular they are a dime a dozen. My prediction? There will be many Teracorns ($1T) created as carbon becomes scarce7.
Gernot Wagner and Nat Keohane said this perfectly in an FT piece in 2013(!) outlining why the EU carbon market had wandered around in the wilderness with low prices for so long - there was a recession so emissions lowered below the cap, but the cap on emissions was mechanically lowering over time - and so emissions were “on track”. The headline says it all - to judge a carbon market, look at the cap not the price. Please, please repeat this phrase over and over again in your head. The purchasers of emissions credits will howl, and concerned bystanders will scream if the price of emissions goes high (in the former case) or too low (in the latter) - but the price doesn’t matter, it’s an outcome. Just watch the cap.
For any politicians reading along, RFF’s recent working paper on Swedish opposition to the (very substantial) carbon tax there is very compelling. It basically says that people want these to be fair - which I read as “consistent, holistic, and soak the rich when it counts”. Are Swedes the same as folks in the US? Nope. But I believe it. No carve-outs. If billionaires want to go to space, charge ‘em for all they burn. Housing? Fossil fuel subsidies? Get rid of ‘em. Even playing field. Say what you mean to do - eliminate emissions, plain and simple. Explain why it puts $ in everyone’s checkbooks (not just because of rebates, but because of efficiency) and stand by it.
I know it’s confusing to some that I say “long carbon”. Isn’t it saying that you think something is valuable when you are long it? Well yes, it is saying precisely that. But don’t we want to avoid carbon emissions? Yes - that’s why I think they should (eventually) be excruciatingly expensive, and in the near term very expensive. But they are free nearly everywhere today. And so I’m betting on appreciation in the price of carbon emissions, or “going long carbon”.
Or as my British friends say, “dear”
I’m very interested in what will constitute a moat or defensible profit pool in a world of decarbonization. Competitive carbon advantage sounds good as a concept… but what will it actually mean? Where are carbon network effects to be found? Scale economies make sense… but there’s a lot to work out here.
Normally investors and entrepreneurs do not build into their business plans “I’m assuming that the world will change in this way, that consumers and governments are going to do something different than they do today”. This is generally categorized as insanity, not good marketing or strategic vision. Yes, I am suggesting that now is a good time to actually place substantial bets that governments will do something different and make carbon scarce.
If you want a simple primer on what’s likely going to happen (or need to happen), and a fine blueprint for one way to attack building companies that will capture these profit pools, read Saul Griffith’s amazing work and build the things that will get this done. For a great listen, try his interview with Ezra Klein on electrifying everything. For a more specific read / blueprint, here’s a great starter called “One Billion Machines”. And if you want to go deep, read the handbook for Rewiring America. Go start the companies that get this done.