Can the Free Market Fix Climate Change?

Within the world of business and investing, the words "climate change" often invoke extreme points of view. One on hand, a changing environment poses significant risks to industries, companies, and thus, stock prices. On the other, legitimate concerns exist over increased government regulation, diminishing economic growth, and the elimination of jobs, all of which could affect – you guessed it – stock prices.

In recent years, these different perspectives have appeared irreconcilable. But to Ramez Naam, author of a new book, The Infinite Resource: The Power of Ideas on a Finite Planet, a viable "win-win" solution is just around the corner. In fact, history has shown that humans can solve these types of problems by embracing the free market – without sacrificing economic prosperity.

Over the summer, The Motley Fool invited John Vechey, founder of PopCap Games, to visit our headquarters and chat with a wide variety of climate change experts. The focus was on how investors can avoid certain risks, 'green' their portfolio, and prompt market-driven solutions.

Vechey and I spoke with Mr. Naam, who won the 2005 HG Wells Award for his nonfiction book, More than Human, about his latest research and ideas for addressing climate change. What follows are excerpted highlights from this eye-opening and inspiring discussion.

For the full audio interview and transcript, click here.

On the current polarized debate...

[W]hether it's climate or energy and fossil fuels or feeding the planet, it's really very polarized.

You've got people who say, "Hey, look. There's no problem whatsoever" and ignore the real problems, and there's other people who say, "We're doomed," or "The only way that we can address these problems is to give up on wealth and affluence and economic growth."

I thought both of those were wrong and there was room for something in the middle.

On human ingenuity ...

Two hundred years ago, someone named Malthus -- we now talk about "Malthusian" catastrophes -- Malthus was a philosopher, or actually a reverend, who wrote that there was no way that food supplies could keep up with population and we were going to have massive famine.

In 1968 Paul Ehrlich, who wrote this book called The Population Bomb, a top New York Times best-seller, where he said humans are going to die, the hunger rate is going to go up because we can't possibly keep up with the population growth to feed the world.

The hunger rate and the starvation rate have gone down following both of those books. We faced the ozone hole, and that's not fixed yet but we've eliminated emissions of CFCs. The same thing with acid rain.

Whenever we get serious about these problems, we learn to innovate in a way that solves them without being overly expensive and without really impacting economic growth.

On the lack of a catalyst for change...

It's about self-interest in a certain sense. Wherever a solution is well aligned with somebody's self-interest...the market kind of figures it out by itself.

When it's an externality; when it's steam or sulfur dioxide coming out from your factory causing acid rain hundreds of miles away or thousands of miles, then we need to help fix the market.

You're right that climate change is kind of more spread out than any of the other problems, except maybe the ozone layer, and it does operate on a somewhat longer-term basis, but it's not all long-term. Some of it is here, right now.

This past year we saw a spike in people's belief in climate change as a problem in the U.S. Why? Because of Superstorm Sandy hitting New York, because of the drought that wiped out a quarter of the corn crops in the U.S. this summer.

People don't really get persuaded by science or by fancy graphs or something like that. It's those kind of visceral things they can touch and feel that sway opinion. That's what will ultimately sway opinion on climate.

On pricing carbon and profit sharing...

Americans, in surveys say, "Yeah, we should do something about climate change," but if you ask them, "Hey, what if we made fossil fuel energy a little bit more expensive?" they'd say, "Oh, no. Not that."

Imagine this. Imagine you get up in the morning, you go to your mailbox, you check your mailbox, and there's a check there. The check says, "Hey, Mr. and Mrs. Smith, here's your check for $600, which is your fraction, this quarter, of the fees that companies paid to emit carbon dioxide and other greenhouse gases into the atmosphere."

The idea is we'll levy a fee whenever carbon dioxide is emitted because we know that it does damage to all of us, indirectly. But then the government doesn't keep that fee. They just pass it back to consumers.

How does that help you? Well, your energy prices have gone up. Certainly if you use coal electricity, or to a lesser extent natural gas, your electricity prices at home may have gone up.

We don't want that to make things worse for a typical American family, so you get this check that is an even dividend for every man, woman, and child in America, of how much industry had to pay for emitting carbon dioxide.

Why does that help? Because now with this money in hand, you've got a couple of options. You could pay more for that electricity, or you could say, "Hey, maybe I should go ahead and install solar on my roof," or "Hey, maybe I should install better insulation."

Because the cost of coal and natural gas and oil has gone up, but the cost of insulation hasn't, the cost of solar and wind hasn't, it shifts people's purchasing behavior and industry purchasing behavior, toward those renewables.

That's a very big effect, actually.

On company's current sustainability efforts

It's really tough now. Some companies are trying it. Even Wal-Mart (WMT 1.32%) recently has announced a big sustainability initiative, and that's huge. They're the largest retailer in the world.

But the incentives still don't align right because if a company tries to pass these costs on to consumers, the price goes up so a consumer might go to their competitors. That's why you want it to be an even playing field.

On the inevitable rise of green energy...

We're going to deploy green energy. Solar energy, for a long time it was incredibly expensive but it's gotten cheap fast -- so cheap that you can now buy 20 times as many solar electricity per dollar as you could in 1980 -- and that trend's continuing...We're going to build better batteries, we're going to develop next generation biofuels, and we're going to find ways to reduce our carbon emissions.

The question is just how fast do we have to do these things? We already need to do it kind of fast, on a historical scale.

On potential 'stranded assets'... 

Duke Energy (DUK 0.77%), if it was a country, would be the ninth largest emitter of carbon dioxide on the planet. It's the largest utility in the U.S., but you see them investing heavily in wind and solar because they're not dumb. They see where this is happening.

That said, I would be very, very careful about fossil fuel-based stocks right now, especially stocks of companies that are linked to coal because coal is the dirtiest fuel. It's the one that releases the most CO2 per unit of energy that you get, about twice as much as natural gas, so it's the one that's going to get hit by regulations the hardest.

On China's huge renewables advantage...

Renewable energy, especially solar, is set to massively disrupt the traditional energy industries. It's going to be a multi-trillion dollar industry and we're basically handing it to China. If you look at investment just in the private sector last year, China invested almost twice as much -- $65 billion, versus our $35 billion -- in deploying solar and wind.

China has the biggest supplier and the biggest manufacturer of solar. They have two of the biggest manufacturers of wind. They know there's going to be a huge, huge industry and they want to own it, and we're basically handing it to them right now.

On advancements in battery technology...

We've made incredible advances. We're not there yet, clearly. The reason that Tesla's (TSLA 12.06%) Model S is so expensive almost entirely comes down to the battery pack, which costs I think $28,000 for just the battery expense.

The price of a lithium-ion battery is at 1/10 of what it was in the mid-1990s, per unit of energy storage. That technology is reaching its limits, though...so now people are working on a few different new battery technologies out there, and some of them look super promising.

I will say the solar industry, it still isn't mature but it's super crowded right now. It's going to be a huge boom, but there are literally hundreds of companies.

I think the boom in battery technology is going to be even larger from an investor standpoint, because there's so much investment that needs to be made in deploying batteries.

On the false promise of a single energy breakthrough... 

It's going to be a blend of technologies. You're not going to see that, "Hey, solar is 100% of energy around the world." That's just not going to be the case because where I live in Seattle it doesn't make sense to deploy solar on my rooftop, ever.

Wind is going to be big in some places. We'll probably keep using fossil fuels for decades; nuclear as well. That said, the biggest things in terms of growth rate really are solar and batteries. Then further I'd say possibly next-gen biofuels.

On how to invest in renewables...

I would say, for most investors, don't try to pick individual stocks because it's a very Darwinian market. What I mean by that is it's early stage. It's a huge market opportunity but there's a lot of companies and it's a very fungible commodity. It's whoever has the cheapest product so a lot of companies will fail.

The way that I advise people is really pick a fund or a set of funds that invest broadly in the area and track that. As I said, the S&P Global Clean Energy Index is doing extremely well. That's an easy way for investors to diversify while getting into this area.

There's a number of mutual funds in the area that have done well. Guinness Atkinson Alternative Energy has been doing very well. Firsthand Alternative Energy has been doing very well. New Alternatives is another one.

How to uncover the 'infinite resource'...

I'm a huge believer in bottom-up innovation. Innovation doesn't typically come when somebody from the top says, "Hey, let's do this." It really comes when you have a whole lot of ideas competing with one another, and the best one wins and ideas can cross-pollinate.

I think in green energy, renewable energy...we have that competition, that diversity of ideas. We just don't always have the incentives for victory. 

You can point to a lot of other ecological things around the world that have value. Getting off of climate change for a sec, say, the ocean's coral reefs actually bring the planet about a trillion dollars' worth of services each year, it's estimated, based on filtering water and nursing fish and so on.

Trillion dollar service; why isn't there a billion dollar start-up opportunity in helping coral reefs stay healthy, because they're at great risk? Well, it's because the incentives aren't there.

We have the competitive part down. We have the fast-moving part down, but the incentives need to get tweaked in various places to reflect the real value of our shared resources, our shared commons.

On whether we'll run out of time... 

I think we will fix the problem, one way or another. It's kind of a question of how much damage we take. If the Arctic ice cap really melts, that's going to release a huge amount -- about another trillion tons -- of buried carbon that could heat up the planet a lot, so taking more of a risk.

I think we'll take government action when two lines cross.

One is the trend line of how much people believe that climate change is a problem, and that's kind of a jagged line. It's kind of two steps forward, one step back, but it generally rises as weather gets weirder, as droughts happen, as forest fires happen, it's always going to go up as things get worse and worse.

The other line is the cost of solutions, and that line is dropping because of the innovations in solar and wind and batteries. When those cross, I think Americans will say, "OK, the problem is real, I'm convinced, and the cost isn't that bad. Let's do something about it."

Then we'll actually -- later than we needed to -- but then we'll actually take government action, I believe.

On how you can make a difference...

I'd say the biggest thing you can do, as an individual if you're convinced that these are issues is communicate with other people, especially those who don't agree, and you try to persuade them as to why these are real issues.

And act politically. That doesn't have to be a whole lot. Call your state legislator. Call your city councilmen. They don't get many constituent calls at all – maybe one a day. That one call can actually make a difference in terms of their voting pattern.

As investors, though, I think we have bigger leverage and really it's a win-win. We have the ability to help push the companies that are going to make the things happen that will help the planet, while helping us get richer, and we have a chance to get a good rate of return on those already.