Session 8: Climate Finance, Innovation, and Challenges for Policy

We develop a new measure of impact elasticity, defined as a firm’s change in environmental impact due to a change in its cost of capital. We show empirically that a reduction in financing costs for firms that are already green leads to small improvements in impact at best. In contrast, increasing financing costs for brown firms leads to large negative changes in firm impact. Thus, sustainable investing that directs capital away from brown firms and toward green firms may be counterproductive, in that it makes brown firms more brown without making green firms more green. We further show that brown firms face very weak incentives to become more green. Due to a mistaken focus on percentage reductions in emissions, the sustainable investing movement primarily rewards green firms for economically trivial reductions in their already low levels of emissions.

We build on the estimated sectoral effects of climate transition policies from the general equilibrium models of Jorgenson et al. (2018), Goulder and Hafstead (2018), and NGFS (2022a) to investigate U.S. banks’ exposures to transition risks. Our results show that while banks’ exposures are meaningful, they are manageable. Exposures vary by model and policy scenario with the largest estimates coming from the NGFS (2022a) disorderly transition scenario, where the average bank exposure reaches 9 percent as of 2022. Banks’ exposures increase with the stringency of a carbon tax policy but tend to benefit from a corporate or capital tax cut redistribution policy relative to a lump sum dividend. Also, banks’ exposures increase, although not dramatically in stress scenarios. For example, according to Jorgenson et al. (2018), banks’ exposures range from 0.5—3.5 percent as of 2022. Assuming that loans to industries in the top two deciles most affected by the transition policy lose their entire value, banks’ exposures would increase to 12—14 percent. Finally, there is a downward trend in banks’ exposures to the riskiest industries, which appears to be at least in part due to banks gradually reducing funding to these industries.

We model stakeholder-driven institutional divestiture that promotes stranding of harmful assets through both a political channel and financial prices. We introduce two novel mechanisms. First, institutional divestiture weakens stakeholders’ asset exposures, improving political conditions for stranding. Second, institutional divestiture credibly communicates information about citizen preferences, environmental harm, and economic benefits to financial markets and political participants. These channels drive harmful-asset divestiture, which reduces the asset price and raises its strand probability. Support for divestiture increases under supermajority strand requirements, and when institutions internalize rest-of-world welfare. We detail the equilibrium interactions between information, divestiture, prices, and stranding in a dynamic, rational-expectations game.

We collect ownership data of U.S. power plants accounting for 99% of U.S. electricity generation over the 2008-2020 period. Domestic publicly listed corporations have reduced their ownership from 69% to 54% of total generation, while private equity, institutional investors, and foreign publicly listed corporations have increased their ownership from 8% to 24%. As of 2020, private equity, institutional investors, and foreign listed corporations together owned 59% of wind, 44% of solar, and 28% of natural gas generating
capacity. These new entrants have increased their share largely through the creation of new plants, rather than acquisitions of existing plants. We find only limited support for the leakage hypothesis that incumbent domestic listed corporations, which are subject to more disclosure requirements and scrutiny, sell older fossil-fuel power plants to the new ownership types in order to keep them alive. Domestic listed corporations are significantly more likely to decommission older fossil fuel power plants rather than to sell these assets. Market deregulation is the main economic factor explaining the heterogeneity in ownership structure in the electricity sector. Deregulated wholesale markets and retail markets offering choice to buyers attract more capital from new entrants to create new plants as well as stimulate incumbent owners to retire existing assets more quickly. Market deregulation explains the heterogeneity in ownership of power plants, and this relation is robust to controlling for climate concerns and renewable energy policy measures. The changing ownership structure has implications for electricity markets as private equity operates power plants at lower capacity factors and sells electricity for a $1.97 higher average price per MWh. Within markets of a given regulatory structure, time, and technology, private equity owners sell electricity under contracts with shorter duration, shorter increment pricing, and more peak-term periods, especially when selling electricity generated from fossil fuels.

We study the transition to a carbon-neutral economy via innovation that reduces the abatement cost of carbon-based energy.  This innovation is made probable through research and development (R&D). We focus on the economic and geoscientific uncertainty related to this transition and its impact on the social benefit of  R&D and cost of global warming. We take a broad perspective on uncertainty including both ambiguity across alternative economic and climate models and the potential misspecification of each such model.  We use methods from decision and control theory along with tools from asset pricing to quantify the importance of four alternative sources of uncertainty: i) the global warming impact of CO2 emissions, ii) the economic consequences of global warming, iii) the rise in productivity from economic growth, and iv) the likelihood of discovering new technology that reduces substantially the demand for carbon-based energy.  We represent social costs and benefits under uncertainty as expected discounted values of social payoffs using a probability measure adjusted for concerns about model misspecification and prior ambiguity.

We thank Joe Aldy, Richard Carson, Julie Cullen, Meredith Fowlie, Stephie Fried, Josh Graff Zivin, Gordon Hanson, Joanne Hsu, Louis Preonas, Joe Shapiro, David Victor, and participants of the August 2021 and June 2022 NBER Distributional Consequences of New Energy Technologies Conferences for their insightful feedback. We also thank the participants of the 2021 Association of Environmental and Resource Economists Annual Summer Conference, the
2022 Southern Economic Association Annual Meeting, the Consumer Financial Protection Bureau, Federal Reserve Bank of Philadelphia, and Federal Reserve Board Consumer Finance Round Robin, and seminars at the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of San Francisco for their comments. We thank Sarah Siegel, Cindy Zhao, Kimberly Kreiss, Jack Mueller, and Marcus Sander, who have provided excellent research assistance. Views expressed in this paper are those of the authors and do not reflect the views of the Federal Reserve Board, Federal Reserve Bank of San Francisco, the Federal Reserve System, its staff or the National Bureau of Economic Research.

We explore the effects of physical and regulatory risks related to biodiversity loss on economic activity and asset values. We first develop a news-based measure of aggregate biodiversity risk and analyze how it varies over time. We also construct and publicly release several firm-level measures of exposure to biodiversity risk, based on textual analyses of firms’ 10-K statements, a large survey of financial professionals, regulators, and academics, and the holdings of biodiversity-related funds. Exposures to biodiversity risk vary substantially across industries in a way that is economically sensible and distinct from exposures to climate risk. We find evidence that biodiversity risks already affect equity prices: returns of portfolios that are sorted on our measures of biodiversity risk exposure covary positively with innovations in aggregate biodiversity risk. However, our survey indicates that market participants do not perceive the current pricing of biodiversity risks to be adequate.