Climate Bailout: A financial tool to save the climate

In the financial crisis ten years ago, we saved the banks to prevent a collapse of our economy. Why not use this proven method for climate change mitigation? Dr. Matthias Kroll, Chief Economist (Future Finance) of the World Future Council, suggests a tool that could revolutionise our economic system and save the climate.

Climate change does and will even further change our natural environment. As a species, we depend on a healthy planet: farmers all over the globe have less productive harvests due to droughts, flooding, and other unusual weather patterns as a result of global warming. Our oceans absorb more carbon from the atmosphere and thanks to acidification, marine life is deteriorating – and fishermen catch less. Higher food prices in the developed world are one thing, but hundreds and thousands of people in developing countries suffer from hunger and poverty. Where there is hunger, there is no or very little development: Whoever is struggling to survive will not have the capacity to educate their children, especially girls. There is also a connection between climate change and political instability: regions affected by climate change are prone to conflict and inequality.

Renewable energies (RE) can promote sustainable development. A recent paper of the World Future Council goes even further, saying that sustainable development can only be reached by transitioning to 100 percent Renewable Energy: It can serve as a means for socio-economic development and help create an equitable society for today’s and future generations. Hereby, it supports the implementation of each sustainable development goal (SDG): The wide-range of co-benefits linked to RE development.

IN THE PHOTO: Fossil fuels are still labelled as “safe” or “conservative” investments, and are therefore favoured over renewables. PHOTO CREDIT: drpepperscott230 / Pixabay

Our economic system, however, is currently not working towards 100 percent Renewable Energies. Fossil fuels are the home base for our economy and even if we were to put ideology and biases aside, it truly is a great challenge to move away from fossil fuels. But we have no other option: It is estimated that more than 80 percent of the known coal deposits, 50 percent of gas, and one-third of the oil reserves cannot be used for energy production if global warming is to be kept below 2°C. To comply with the 1.5°C limit agreed in Paris, these estimates become significantly higher.

Even though the market for renewable energy production is growing and do we see a shift in mentality, our economies are still mostly fossil fuel oriented. Structural changes are necessary to make changes at large scale or, in other words, if we do not make changes on a structural level, the unsustainable fossil fuel based world economy is not going to change. What we need is a tool that reverses the incentive system to favour renewable energies over fossil fuels – and a powerful entity to implement it.

Climate Change is a lose-lose scenario for our economies

If we were to prolongate the tackling of climate change, severe problems for the financial stability would occur. The consequences of a global warming of more than 2°C would not only ruin the insurance industry but also lead to incalculable loan defaults in the banking sector. Consequently, the Global Risks Report 2018, of the World Economic Forum (WEF) identified climate change as the biggest global hazard.

The refusal to swiftly exit our fossil fuel economy leads us unquestionably into a major climate catastrophe. If we operate the fossil fuel exit as quickly as necessary to meet the 1.5° C limit, we unavoidably devaluate massive fossil-based assets in a way that leads to a systemic risk situation for the economic system. The entire fossil infrastructure (like power plants and oil refineries) and a large part of the raw material reserves in the balance sheets of energy companies become worthless. The “fossil” part of the business model of energy companies would become obsolete and its shares would devalue accordingly. Many institutional investors who have invested “conservatively” in energy stocks, are threatened with significant value adjustments, resulting in considerable uncertainty and instability on the financial markets.

At the same time, energy companies must invest in the construction of renewable energy generation and storage systems in order to participate in an energy supply business model compatible with the 1.5°C target. This necessary transformation will be even harder when they are weakened by the accelerated depreciation of their fossil fuel assets.

The abrupt end of the diverse fossil business models of energy companies will have a similar systemic impact on the economic stability of the entire economy as the banking crisis of 2008 had on the economy.

This is the reason why incentive tools like carbon taxes and CO2 emission trading systems are problematic. The idea to make hidden prices of burning fossil fuels visible is undoubtedly reasonable, however, carbon taxes or emission prices covering the real cost and possibly decreasing fossil fuel usage would still lead to a massive increase of stranded fossil assets.

IN THE PHOTO: The way our economies are designed today is greatly threatening our climate. PHOTO CREDIT: Gian-Reto Tarnutzer / Unsplash

Stranded Assets, verb: stranding – this term is not defined precisely, but generally they are assets that suffered from unexpected or premature devaluation and cause economic loss.

The second problem occurs if the revenues from these incentive tools are being used to support new renewable energies: fast decrease of fossil fuel also leads to a fast decrease of revenue which is needed to finance the RE transition.

We stand before a crucial dilemma: On one hand, we face inevitably hurling ourselves into an ecological and economic crisis if we refuse to fight our dependence on fossil fuels in exchange for renewable energies. On the other, if we pull out quickly enough to meet the less than 1.5 C global limit, we could depreciate existing massive fossil fuel assets, thus risking the stability of our economic systems.

Learning from history: the necessity of a ‘climate bailout’

Looking into recent history, we have seen the world community successfully tackling a global challenge in a systemic way: during the last financial crisis the Central Banks intervened to prevent a collapse of the whole banking system. A similar model could be applied to our current situation: A ‘climate bailout’ which would enable fossil fuel related companies to convert their almost lost fossil assets into sustainable renewable energy assets.

Assets which are threatened could only be sold at a minimum residual value to private investors. Passing on the losses to taxpayers would be neither politically nor financially realistic. The only institutions that have the economic potential to implement a “climate bailout” are Central Banks, just as they have done in the banking crisis since 2008.

Back then, the bank bailout was covered by the Central Banks’ mandate because dealing with the systemic consequences was not an option. From an economic perspective, the risks we are taking today by climate change are unacceptable and unsustainable. Besides all of the well-known environmental and social dangers, climate change is a threat to financial stability and therefore, all measures which could rescue the climate, like a fast scaling up of renewables energies, would be in line with the mandate of the Central Banks.

IN THE PHOTO: A Climate Bailout could save our climate and our economies without burdening the taxpayers”PHOTO CREDIT: Allef Vinicius / Unsplash 

The Bank of England has recently stated that climate change is now in the area of their responsibility due to the systemic spillover effects on the financial markets. In regards to the ECB, the ‘protection and improvement of the environment’ is an explicit part of their mandate (Art.127 TFEU and Art.3 TEU).

The ‘Climate Bailout’: The conversion of stranded fossil assets into renewable energy investments by Central Banks

To solve this dilemma, a new financial instrument is required to enable energy companies to convert their de facto “stranded” fossil fuel reserves into renewable energy (RE) assets. In order to initiate the conversion, energy companies must disclose their threatened fossil assets. The G20 Financial Stability Board (FSB) recently introduced the ‘Task Force on Climate-Related Financial Disclosures’ (TCFD) which is assigned to support this disclosure process in cooperation with the financial sector and the affected companies.

If companies identify the fossil assets they have, they must move them into a separate asset class. Central Banks must then provide papers securitising these assets as a tool for refinancing at their current value, so that the energy companies can sell these new papers without major losses. Central Banks can decide to either buy these securities directly or through the banking system. Central Banks must not insist on a repurchase obligation in order to guarantee the energy companies a secure planning horizon.

Securitising – conversion of an asset into marketable securities, typically for the purpose of raising liquidity by selling them to other investors.

However, Central Bank purchases should be limited to the extent that the new liquidity generated is used to finance investments in new additional renewable energies. Already existing or planned renewable energy units financed by other investors would be excluded. A detailed and transparent documentation by companies investing in RE with this new liquidity is required.

Fossil fuel assets which are threatened to become stranded can then be gradually replaced by sustainable assets in renewable energy units. In some respects, Central Banks would then  become a Bad Bank for obsolete fossil fuel assets, but without burden the taxpayer.

Bad Bank – a corporate structure to isolate defaulted or non-performing assets of banks or financial institutions. This instrument was used in the banking crisis after 2008 and the goal is the recovery of the banking system.

Reversing the incentive system

In the conversion process, high-risk assets become sustainable assets because the threatened assets can be used to obtain refinancing by Central Banks if the received new liquidity is invested in new renewable energy. Due to the fact that the disposal should take place closely to the current market price, energy companies have an incentive to convert their threatened assets as soon as possible, to prevent their value falling further.

IN THE PHOTO: With power comes responsibility. PHOTO CREDIT: Chris Li / Unsplash

This leads to a fundamental change in the incentive system.

Energy companies today have a strong interest to run their existing fossil fuel power plants as long as possible, after the implementation of a ‘climate bailout’ they would have a strong incentive for large-scale investments into renewable energies.

This would also lead to a change in their lobbying, because now they would be pushing politicians to improve the institutional frameworks for supporting a fast increase of renewable energies.

Stranded fossil assets in the balance sheets of the Central Banks

If Central Banks allow this type of refinancing without a repurchase obligation, they would obtain ownership of great quantities of unused fossil raw materials which cannot be incinerated.  

However, the residual long-term market-based value of the fossil fuels in their balance sheet is not important for the functioning of the Central Banks. Through their exceptional position in the financial system and their role as creators of legal tender, Central Banks can integrate stranded assets permanently at the purchase value into their balance sheet without any problems.

Distortion of competition?

The aim of this “climate bailout” is to relieve energy companies of their stranded fossil assets, in order to be able to invest on a vast scale in the construction of new and additional renewable energy units. This bailout only needs to guarantee the financial stability of energy companies to the extent that they can borrow in the private financial markets at sustainable interest rates to finance the transformation to the renewable energy economy.

This bailout must be designed so that companies with stranded fossil fuel assets would not become financially better off than those investing in renewables, but have no fossil legacy in their balance sheets.

Competition-distorting results must be prevented. As a compensatory measure, Central Banks may, therefore, to a certain extent, declare securities (green bonds) of RE investors eligible for Central Banks financing those who do not have fossil assets on their balance sheets. Again, this would require renouncing repurchase commitments, or very long maturities (for example a hundred years) with a very low-interest rate, in order to maximise the number of RE investments.

IN THE PHOTO: To significantly increase the volume of renewable energies, we need to reverse the incentive system. PHOTO CREDIT: Gustavo Quepón / Unsplash

The purchases of assets which are threatened from stranding have to be limited to an amount which would not hinder the Central Banks to operate their usual monetary policies. As the bailout measures of the Central Banks during the last financial crises have demonstrated, there is a large scope for converting fossil stranded assets into renewable energies.

Conclusion: green is the new black

As long as our incentive system favours fossil fuels over renewables, fossil fuels will be labelled as “safe” or “conservative” investments. This mindset cements a world order that has until today led straight into global warming and unsustainable use of or fossil resources, fueling a vicious cycle within which the UN Sustainable Development Goals cannot be reached. We need a systemic change to our current economy and the only institutions capable of achieving that are the Central Banks: they have the financial power to implement a “climate bailout” –  since climate change is threatening financial stability, it would be covered by the Central Banks mandate. They can make “Green” the new “Black”, and set standards towards a world economy based on renewable energy rather than fossil fuels.

It takes courage and a vision to initiate a revolution. Like with all systemic changes, some elements might not benefit from a transition towards 100 percent renewable energies – but the vast majority of people will. The tool suggested to achieve this transition has already proved itself. There is no other option than holistically changing our economic system if we don’t want to risk environmental, social, and economic disaster by 2030.

Matthias Kroll’s study Implementing a “climate bailout”: How to convert fossil fuel stranded assets into renewable energy investments can be accessed online.

The World Future Council brings the interests of future generations to the centre of policymaking. Its up to 50 eminent members from around the globe have already successfully promoted change. The Council addresses challenges to our common future and provides decision-makers with effective policy solutions. In-depth research underpins advocacy work for international agreements, regional policy frameworks and national lawmaking and thus produces practical and tangible results. In close collaboration with civil society actors, parliamentarians, governments, business and international organisations we identify future just policies around the globe. The results of this research then feed into our advocacy work, supporting decision makers in implementing those policies. The World Future Council is registered as a charitable foundation in Hamburg, Germany. Our work is not possible without continuous financial support from private and institutional donors. 


About the Author /

Dr. Matthias Kroll is Chief Economist (Future Finance) at the World Future Council. He studied political economics, sociology and law at the Hamburg University for Economics and Politics and graduated as a certified political economist, with a PhD in monetary theory and politics. In doing so he dealt with the question on how public expenses can be financed through the money generation of the central bank without creating inflation. Matthias taught economic policy at the University of Hamburg. Since 2010 he supports the work of the Future Finance Commission of the World Future Council.

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