The fledgling climate-change sector faces its first economic recession. David Metcalfe from research firm Verdantix predicts that some firms will hit the wall, but others will emerge stronger that ever

The low-carbon sector is unlikely to escape the ripple effects of the financial crisis and the ensuing recession, but the analysis of Verdantix suggests that it is not very close to the epicentre of the meltdown and will rebound strongly in 2010.

The “climate change industry” refers to a relatively new batch of firms, such as CDM developers, energy efficiency equipment providers and sustainability consultants, who are providing products and services linked to climate change.

We looked at market data on GDP forecasts, trends in investor behaviour, industry data on the impact of the financial crisis and announcements by the UK’s leading firms to gain a better understanding of how recession will affect the sector, which up until now has been profiting from a “green boom”.

Nobody escapes a recession

To make the right business decisions we need to take on board the reality of what is happening in the global economy. In 2008 and 2009 developed economies will experience flat or negative growth. Forecasts for the UK are for a 1% fall in GDP in 2009 and a 1% increase in 2010.

The crisis in the banking sector will take two years to fix as banks deleverage and rebuild capital. Investors have had their fingers charred to the bone and will dodge high-risk ventures. Corporate profitability is declining and the number of bankruptices is on the increase. The worst affected sectors are property, financial services and consumer markets.

The bad news for the low-carbon sector is that nobody escapes a recession. Negatives for the sector will be driven by:

- CFOs who block discretionary spend on corporate social responsibility, the purchase of voluntary offsets for “climate neutrality” programmes and capital expenditure – for energy efficiency equipment such as new Heating Ventilation and Air Conditioning (HVAC) systems.

- CEOs who postpone climate-change strategy development. For many CEOs, climate change is not a short-term risk and is heavily outweighed by immediate concerns over topline growth and rolling over debt financing. Detailed climate-change strategy reviews will be postponed, according to the practice leaders of management consulting firms.

- Investors who flee high-risk propositions. Fear and risk aversion will deter large investments in niche, risky markets such as Clean Development Mechanism projects. Our analysis indicates that shrinking investor appetitite will hit marginal renewable energy opportunities, such as offshore wind.

- Policymakers, expected to water down legislation. Negotiations on the EU’s Climate and Energy package – which are essential for the carbon credit development sector – now take place against the backdrop of recession. Environment ministers from countries like Poland and Italy have already won concessions to reduce the costs of climate-change legislation for their industries.

Slower growth for 2009

The ripple effects from the financial crisis will hit the climate-change sector. Firms with unproven business models, slim profit margins or the need for additional equity or debt funding are likely to shut down or get acquired. Despite the turmoil, Verdantix’s analysis suggests that positive drivers for the climate change sector in 2009 include:

- Support by compliance requirements. During the boom years, politicians convinced voters of the need to combat climate change. The Kyoto Protocol, the EU’s Emissions Trading Scheme, California’s AB 32 legislation and Australia’s Garnaut Review proposals will drive demand for carbon credit development, consulting advice on compliance and government lobbying.

- Alignment with cost-saving opportunities. Corporate climate-change strategies dovetail with energy-efficiency programs. Look at Tesco’s project on data centre overhaul, part of the UK retailer’s £500 million climate-change initiative that has driven business for Deloitte’s technology services and Microsoft’s hardware and software.

- Equity funding, not debt funding. The majority of new ventures in carbon markets, like CDM developers and cleantech, rely on already-committed equity financing. The sector will not have the debt plug pulled on its growth. But funding will be harder to find. CDM developers may turn to local sources of finance, such as the Industrial and Commercial Bank of China.

Roaring back to life in 2010

Based on the most recent forecasts from government agencies, the earliest we expect GDP growth of developed economies to return to trend growth is in 2011. Verdantix analysis suggests that after slower growth in 2009, the climate-change sector will roar back to life in 2010 due to:

- Reduced policy uncertainty. By mid-2010 executives and investors will have answers to today’s unresolved questions, such as: What will be the climate change policy of the new US president? When will the new US president engage in cap-and-trade legislation? What will the EU’s Climate and Energy package look like? What agreements will the UNFCCC Copenhagen negotiations in December 2009 bring?

- Proven benefits of climate-change strategy. Verdantix surveys of climate change leaders show that 74% believe industry leadership on climate change already confers a competitive advantage. The competition today between Siemens and GE to sell “environmental products” such as hybrid locomotives and plug-in vehicles will deliver proven benefits for smaller peers to imitate by 2010 – five years after GE started its ecomagination programme.

- Financial bite from climate-change regulations. Many policies follow the example set by the EU Emissions Trading Scheme: start the regime with a low cost learning phase spanning two to three years then impose increasing costs that force organisations to begin their transition to a low-carbon model. The EU ETS is already starting to bite power generators in 2008. With every year that goes by, the short-term financial impact of climate-change policy targets increases. This spurs spending on a wide range of climate-change products and services, from clean-tech equipment to technology services and management consulting.

- Investors seeking a new investment theme. After struggling to raise new funds in 2008 and 2009, survivors in the clean-tech sector will be well positioned, with a few customers and strong financial management to seek initial public offerings, raise more equity capital or debt finance. Funds like Kleiner Perkins Caufield & Byers and Generation Investment Management LLP, with well-connected principals, will drive investment and kick start IPO exits. Surviving new ventures, especially carbon-credit developers, are likely to be acquired by large industrial groups such as Veolia Environnement and Tata Steel.

By the end of 2010 the climate change winners and losers will be clear. Firms that are unprofitable today, operate in a high-risk market and require additional funding to reach profitability will go out of business. We expect numerous voluntary offset providers, carbon-trading desks, advertising-funded “green consumer” propositions, and carbon-credit developers to hit the wall or get acquired.

By contrast, firms with robust business models, strong financial backing and a track record of profitability will survive the 2009-10 shake-out and be in a position to win big.

David Metcalfe is a director of Verdantix. The report “Financial Crisis Triggers Climate Change Shake-Out” is available at www.verdantix.com.

Source:

Write to the Editor at zara@climatechangecorp.com.