To understand the future of climate markets, follow the dull money

In the short run, the market is a voting machine. In the long run, it is a weighing machine.?

Warren Buffett’s canonical statement (adapting his hero Benjamin Graham) is exactly the kind of wisdom that everyone repeats even as they ignore it. In the last few years in particular global stock markets have outdone themselves; operating less as a voting machine than an all-out fraternity election-night party. Investors and firms alike dipped their cups into the punch bowl of QE a few too many times before drunkenly bidding up everything in sight, setting prudence on fire and launching it off the roof with a golf club.?

Now we have woken up to the morning after; but I’m yet to be convinced that a hangover is much of an aid to clear thinking. If anything, the shock to prices has seen markets as self-absorbed (and short-termist) as ever. Where can we find a reliable weighing of the future?

The rise of ESG is certainly a good thing, but for now it remains a side-hustle for the biggest multi-nationals as they try to survive the downturn and grind out another quarter of business-as-usual. There is a lot of exciting innovation going on at the riskier end of the curve amongst climate tech start-ups – but the mortality rate is far too high to give us a clear picture of the future yet. For a sober, long-term vision of where we are heading, we need to turn to the more boring end of the investment world. The ones who were at the party, but brought a book.

To understand the shape of the future, we should look at infrastructure.?

We’re not Bitcoin

My guide to the world of green infrastructure investment and my guest for season 2, episode 9 of the Conversations on Climate Podcast also happens to be a Warren Buffett fan. ‘I don't think there's any secret sauce,’ James Samworth told me; ‘[it’s] what Warren Buffett said he learned from Charlie Munger – he used to try and buy fair companies at great prices, and he learned to buy great companies at fair prices.’

Here is someone who knows how to stop at one glass of punch – and he means it. James is Partner at Schroders Greencoat, a world-leading manager of clean energy infrastructure where he heads up the Bioenergy and Heat Division. Talking to James made it clear that no one survives in his world without taking a clear-eyed approach to value. As he put it: we’re not Bitcoin.

All of our funds are long-dated funds, so we try to be good partners for people for the long term… What power price are your assets going to secure in the 2030s and 2040s? You can't sign a PPA going out that far, so you have to form some views and know how to price that.?

Equally, operating performance: as these technologies and sectors have matured, they have become more predictable. So there's more of a fixed income-like component to that element, but equally, that gets priced pretty tightly. The margin for error is pretty small. We have 50 engineers in our team… We hope to do our diligence as accurately as possible, buy good assets at fair prices, and then manage them really well for the long term.

This is the boring end of the stock market, as I’m sure James won’t mind me saying (he himself was a fascinating guest, and lit up his subject with wit and insight). It is almost a deliberately cultivated reputation: infrastructure means stable, reliable, moderate returns year after year. Schroders Greencoat barely even uses leverage. This is not the place to be launching moonshots or chasing memes. Instead, we have businesses built on making the right calls across a forty-year horizon with the lowest delta possible, which makes it a brilliant place to go if you want to forecast the future.

Of course, the view of the future from James’ perspective is very green. That’s no surprise given his remit; but the way he framed his analysis makes me believe that infrastructure will be an excellent bellwether for the future climate economy for three reasons.

Infrastructure is our food and drink

Firstly, infrastructure focusses on meeting critical needs – and the evidence is that investors in these essential functions are already facing up to the decarbonisation challenge.

‘Energy is fundamental to modern human life… it's probably number three after food and water in terms of basic needs,’ James explained. ‘In terms of the greening of infrastructure, renewables have gone from being a smallish niche market to being really very mainstream: the renewables market in the UK has probably ￡110-￡120 billion worth of built assets now; that there's compared to, say, ￡90 billion of water companies.’?

Of course, renewables are a booming market. But what James also made clear is that the energy transition is going to pull in infrastructure investment in so many other related markets. It will require new EV charging networks; domestic heating systems; energy storage; grid-level connectors and demand management; and potentially an industrial hydrogen infrastructure too. And energy is just one essential function. What about critical materials like steel and cement? Shipping? Aviation? Agriculture and food systems? All of these rely on their own infrastructures, and all of these investors already have an eye on a green future that will be worth trillions by 2030.

‘We've got a little while for the harder to abate sectors, but not masses of time if we need to build the technologies, the supply chains, the whole industries to decarbonize those,’ James pointed out. ‘So those investment decisions are being made now.’

Mind your asset

Secondly, infrastructure investors act as a bellwether because their fixed investments and distant time horizons make them take the risk of stranded assets very seriously. Opening a coal mine in the wake of the Ukrainian energy crisis might be profitable today, but will it pass the test over thirty years? ‘If you are thinking of investing in anything in the fossil fuels, you need to think about where's your customer in the 2040s,’ as James put it. But that risk goes beyond the most obvious candidates into more everyday infrastructure. As PwC’s Global Infrastructure Trends put it, how do you value car parks and petrol stations that aren’t adapting for EVs???

The trouble with infrastructure is that it sticks around. Decisions made today will carry multi-decade legacies, and the gravitational pull of path-dependency is very real. Unfortunately, too many investors are still ploughing capital into projects incommensurate with a safe future – new airports being a great example. I believe this speaks to the continuing power of fossil interests to lobby governments and wield political power, so there is a real risk that these projects won’t fail as they should, but will become magnets for subsidies and state sunset programs. The fact that these projects are still being valued by rational, long-term investors is a warning sign that we need to get serious about removing fossil subsidies today.?

Nowhere to hide

Finally, infrastructure offers us a window into a future where climate risks are at last properly priced in. That is because infrastructure is, to put it simply, right there. It is undeniably physical, geographically fixed, and exposed to changes in its environment. Some businesses still behave as though climate change is only ever going to happen somewhere else. Perhaps they believe they can just relocate their manufacturing, dance around jurisdictions, or stick it all in the cloud anyway (looking at you, Meta). But a port, a railway, or a water plant has nowhere to hide. And because the investment model is to pay an awful lot of money today, assuming you will be able to operate your asset for decades to come, there is a strong incentive to properly account for the impacts of climate change.

‘We own hard physical assets, and a solar farm can flood as easily as any other asset,’ James pointed out. So his firm is using the Taskforce for Climate-related Financial Disclosures framework to audit, mitigate, and disclose climate impacts transparently for their investors, and they have no choice but to take that process seriously. I believe the sector will continue to lead the way in properly internalising climate risks into their pricing and valuation models, and that will fundamentally change investment decisions as a result. As discount rates normalise, the margins are too tight not to. Where they lead, others will eventually follow.

Weighing it up

Infrastructure is one of the sectors closest to offering us the weighing function that well-functioning markets promise. It may not be the most exciting or innovative part of the climate world, but it plays a valuable role in showing us what is coming: secular transformations in critical services; the importance of pricing in climate risk; and the real threat of stranded assets if we don’t. So if you want to see into the future, follow the dull money.??

Delve deeper into the insightful world of sustainable infrastructure and discover future-forward strategies with James Samworth. Watch our full, enlightening conversation on the United Renewables website and join us in shaping a greener, more resilient tomorrow.

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