The Promise of the New Energy ROI (Resilience, Optionality, Intelligence)

We live in a transitional time. The latest evidence was the news last Thursday that Earth's CO2 level passed 400 ppm for the first time in human history. While we’re not sure exactly where we're heading, one thing is quite clear – we need better frameworks to be able to adapt to these changes.

The latest attempt to offer one was at the Bloomberg New Energy Finance (BNEF) summit in New York last month where BNEF introduced the concept of New Energy ROI: Resilience, Optionality and Intelligence. The idea is not to replace the traditional ROI (return on investment), explains BNEF’s CEO Michael Liebreich, but to create a checklist to see whether your strategy stands up to the realities of the world. “If your strategies are not new ROI, they probably won’t deliver old ROI,” he added.

This framework tries to provide an answer to what Liebreich describes as the reality of the world’s energy transition, “It is dynamic, complex, unpredictable and fraught with risk.” If you think about it, this description, as well as BNEF’s new framework, can be a good fit for many other fields. After all, is there any industry where taking into consideration the interconnectedness and interdependence of systems, enhancing resilience, looking for smarter diversification and collecting, analyzing and harnessing data better doesn’t make sense?

As smart and to the point as it might sound, the new energy ROI is not completely flawless. One issue that Liebreich mentioned was that this framework is reactive, and in order to change the world, there’s a need for a fourth piece of the puzzle that will help investors become more proactive.

Another issue with the new ROI is that this rationale framework doesn’t fully take into consideration multiple irrational forces that shape our lives, like politics, status quo bias or, in general, what Dan Ariely describes as our difficulty to behave in a way that truly maximizes our interests. There’s no better example than the upcoming approval of the Keystone XL pipeline to demonstrate all three.

Let’s look into the new ROI to understand its value a little bit better. First, this new framework reflects the need to adopt a systems approach rather than just addressing and analyzing each component separately. “The value of a solar rooftop in a world of electric vehicles is very different from the value of the same solar rooftop in a world without,” Liebreich explains.

Another example he gave showing the logic of using a system-thinking approach, is the energy-water nexus in the case of global shale gas production, where many of the world shale gas resources are located in water-stressed areas. “Water will creep up on you if you’re not aware of its impact on your business,” he said. I guess no one would argue with the need for this kind of approach (even oil companies are starting to adopt it), so we can move on to the first part of the new ROI - resilience.

This concept, which has became a buzz word after Hurricane Sandy, reflects here the need to ask, “What’s the worst that can happen?” rather than “What is the expected outcome?” In this case, it relates to the fact that the energy world has become more volatile, addressing new sources of shocks, from cyber-security to climate change, in addition to traditional sources like accidents and geopolitical issues.

This part of the new ROI provides a good example of the limits of rational thinking – New York state, as we heard in one of the panels in the summit, and know from other initiatives, takes resilience very seriously, especially after Sandy. Texas, on the other hand, seems to believe in less regulation and government intervention even after an accident like the fertilizer plant explosion that provides evidence against this approach. Now, how many energy investors and companies do you think would stop doing business in Texas because it does seem to avoid the question, “What’s the worst that can happen?”

The second part is optionality, meaning, “in times of vulnerability options have extraordinary value,” Liebreich explains. The options to protect yourself against vulnerability can be divided into technological (like energy efficiency or fuel flexibility), operational (natural hedges, value chain diversification) and financial options (capital light, low leverage). It makes a lot of sense as the struggles of companies like Better Place, who bet only on one option demonstrate, but it might undervalue the risks of betting on too many options, as in the case of President Obama’s “all of the above” energy policy. In addition, this is a very complex task as we can see from the unsuccessful investment bets of Kleiner Perkins on various green technologies.

The last part is information. We have a tsunami of information, Liebreich told his audience at the summit, and the question is if you’re surfing on it or drowning in it. The information you need to pay attention to is machine intelligence, like smart grids, pervasive sensors or big data, and human intelligence, like consumer behavior or market intelligence. “In a volatile world, information is the only way you can protect your assets’ value,” Liebreich summarized.

Time will tell what role the new ROI will have for decision makers in the energy sector, but even with all its flaws there’s a good chance that those who will take the new ROI into consideration will be one step closer to delivering the old ROI.

[Image credit: Bloomberg New Energy Finance]

Raz Godelnik is the co-founder of Eco-Libris and an adjunct faculty at the University of Delaware’s Business School, CUNY SPS and the New School, teaching courses in green business, sustainable design and new product development. You can follow Raz on Twitter.